Q2 2020 Earnings Call

Turning to listen only mode. After the speakers presentation, there will be a question and answer session to ask a question. During the session. You want me to press Star one on your telephone. Please be advised that today's conference is being recorded if you require any further assistance. Please press star zero I would now like to hand, the conference over to your speaker today Alan Edrick.

Chief Financial Officer. Thank you. Please go ahead Sir.

Thank you good afternoon, Thank you for joining us.

I am Alan Edrick, Executive Vice President and CFO , Although OSI systems.

And I'm here today, with Deepak Chopra, our president and CEO .

Welcome to deal with our systems fiscal 2022nd quarter Conference call, we would like to extend a warm welcome to anyone who is the first time participant on our conference calls we're glad that you can join us.

Earlier today, we issued a press release announcing our second quarter fiscal year 2020 financial results.

Before we discuss the results I would like to remind everyone that today's discussion will include forward looking statements.

In connection with this conference call the company wishes to take advantage of the Safe Harbor provisions of the private Securities Litigation Reform Act of 1995 with respect to statements that may be deemed to be forward looking under the securities laws.

These forward looking statements are based on management's current expectations and are subject to uncertainties risks assumptions and contingencies, many of which are outside the company's control.

Such statements include without limitation.

For information regarding the expected financial and operational performance the company in its operating divisions.

Including the company is expected revenues and earnings.

Undue reliance should not be placed on our forward looking statements as actual results could differ materially from our forward looking statements due to numerous factors, including but not limited to factors described in the company's periodic reports filed with the FCC from time design.

All forward looking statements made on this call are based on currently available information and speak only as of the date of this call and the company undertakes no obligation to update any forward looking statement that becomes untrue because of subsequent events or new information or otherwise.

During today's conference call, we may refer to both GAAP and non-GAAP financial measures.

For information regarding non-GAAP measures and comparable GAAP measures of the company's results in a quantitative reconciliation of those figures.

Please refer to today's earnings press release, which has been furnished to the FCC as an exhibit to a current report on form 8-K.

Before turning the call over to Deepak to discuss the company's general business and operations I will take a few minutes to provide a high level financial overview of the second quarter results.

First we reported record second quarter fiscal.

2020 revenues of 305 billion, a 1% year over year increase.

The key driver for the increased revenues was the strength of our security Division sales, which was partially offset by soft healthcare division sales.

Second we reported record Q2, GAAP diluted diluted earnings per share of $1.12 compared to one dollar three in the same prior year period.

non-GAAP , EPS, which exclude certain items specified in our earnings release and also reference later on this call came in at a record one dollar and 27 cents per diluted share for Q2 of fiscal 2000.

Compared to $1.19 per diluted share for Q2 of fiscal 19, as we leverage higher revenues and strong expense management to generate earnings growth.

Third our fiscal 2020 Q2 cash flow from operations was 35 million driven by record profits and improved inventory management.

And finally, our Q2 2020 book to Bill ratio was approximately 1.1, driven by strong security division bookings across multiple platforms.

Our backlog increased sequentially from 869 million at the end of Q1 to $886 million as of December 30, Onest 2019.

Before diving more deeply into our financial results and discussing our fiscal 2020 updated guidance.

Let me turn the call over to divide.

Thank you Alex.

Thanks to everyone for joining us on today's call.

For the second quarter fiscal 2020.

We again achieved a record sales and earnings and delivered robust cash flow.

Let's review the Q2 performance and highlights for each division beginning with the security.

Q2 revenues and the security Division, what 202 million.

A 7% increase from the prior year, achieving a record sales for any quarter in our history.

We saw strong sales of cargo and vehicle inspection systems, our board and border applications and checkpoints solutions and service for air cargo and airport security applications.

We continue to see sustainable future growth in these areas of the marketplace.

Security bookings in the quarter was strong at 234 million, representing an approximate 1.2 book to Bill ratio.

We continue to gain traction with the port and border customers.

We expect to begin our Don key programs, and Guatemala, and say Lanka and the near future.

We announced last week the extension of the M. stacked program in Mexico until May 2020.

We are actively engaged with mexicos government on a broader long term program.

As you know we've had a successful eight years ongoing program and we believe that we are very valid position.

As you can understand.

We cannot comment any further on this matter.

With respect to the us.

It is fairly well known and we have said it in the previous calls that the US government focus on the southern border with Mexico.

As heightened.

Leading to significant increased funding for non inclusive security equipment.

As you know we have a lot of cargo scanning equipment at the border on the U.S side.

Although there have been some order push outs the opportunity pipeline continues to look very very robust.

We have had several other wins during the quarter.

With Ford and border customers, we announced three of these.

Just a $15 million award by an International Airport authority to provide multiple units of the company's rapid scan Eagle P 60 high energy excellent cargo and vehicle inspection systems.

Where we would also construct civil works to support the installation of systems as well as provide training and follow on maintenance and support.

Two and award by an international customer valued at approximately $14 million to provide multiple units of cargo and vehicle inspection systems and baggage and parcel inspection systems with a follow on maintenance service and support contract.

And the third at $12 million award to provide operation and maintain and services for rapid scan systems and ask any security screening systems.

In aviation passenger and air cargo security, we continue to make good progress without real time, demography, RTT 110 explosive detection systems.

As an example of one of these numerous wins in the quarter, we announced a $15 million award for the RTT 110 from a global logistics provider for air cargo.

This air cargo when builds upon the success we've achieved over the years since RTT one tends initial European certification in 2013.

This approval or put another pipeline of international airport customers seeking to comply with the European explosive detection standards add up the upcoming deadline.

Over the last few months, we have further enhanced our position in this marketplace by getting the RTT 110 certified to European unions. Later standard 3.28, 0.1, sorry, which has more stringent requirements for the false alarm and threat detection accuracy. The RTD one Dan.

Was also recently approved in the United States by the TSA for the Air cargo standard assay, DSL, which allows us now to offer this product to global air logistics companies.

And finally shortly after the quarter end China's aviation authority see a C notified us that the RTD one Dan has been approved for use that China's airwatch.

Overall, we're very pleased with our performance and momentum in the security marketplace. The pipeline as mentioned before activity remains strong and we look forward to the second half of fiscal 2024. This division.

Moving to our Optoelectronics Division.

Where revenues for the quarter were a record $73 million for Q2.

Opto Division expanded operating margins through a favorable sales mix and improved operational efficiencies, resulting in the highest Q2 adjusted operating income and the dividend history.

As we've mentioned before we are focused in this division on the type of growth that helps to expand profitability through leveraging the existing channels and manufacturing infrastructure auto strategic acquisitions that would add to the core competencies up this division.

Moving onto the healthcare division.

Richard reported revenue of $42 million.

19% lower than the division revenue in the same period a year ago.

We are disappointed by these results.

The sales drop resulted partially from push outs of certain projects due to hospital readiness for construction schedule delays.

The overall sales cycle, although has been lengthened as the result of group purchasing intermediaries.

We have seen that trend, resulting in a significantly higher backlog for the division.

The new healthcare Division, President, who joined us in fiscal Q1.

Is making strides and is focused on strengthening our market position and operations and cost rationalization.

We're also working to enhance our core products and develop new offerings for patient monitoring and cardiology.

Looking ahead, the healthcare divisions long term market prospects remain favorable and we will continue our efforts to improve the business.

Overall, we are pleased to complete the first staffed with a robust opportunity pipeline.

The security Division continues to see growth in opportunities from its end markets of transportation cargo and infrastructure, especially in the us.

International customers are also increasingly seeking integrated solution offerings.

Which includes service training civil works data analytics and management.

Which we are well positioned to provide.

The opto division's ability to deliver strong profitability allows us to invest for growth organically and through strategic acquisitions.

Finally, the healthcare divisions end markets of monitoring and cardiology.

Our position in stable and addressable markets and does operational execution and related improvements should translate to better financial performance in the future.

I look forward to the second half.

I will not done the call back over to Alan to further discuss our financial performance before opening the call for questions. Thank you all.

Thank you Dave Buck.

Now I will review the financial results for our 2020 fiscal second quarter greater detail.

As mentioned previously our revenues in Q2 fiscal 20 were 305 million.

Revenues in the security Division reached a record Q2 level of 202 million a year over year increase of 7% driven primarily by growth in cargo equipment and checkpoint inspection sales. In addition security service revenues also increased year over year.

Opto Division sales increased modestly as strong intercompany sales to support the security Division were countered by a reduction in external sales.

And as Deepak pointed out.

Our health care Division struggled with sales down markedly.

While the health care backlog remains strong up 26% as compared to the end of Q2 in the prior fiscal year, the timing of certain deliveries as requested by customers has pushed out.

Our Q2 gross margin of 36.3% was comparable with the same prior year quarter end up sequentially from 34.1% recorded in Q1 at fiscal 20.

As mentioned on previous calls our gross margin will fluctuate from period to period based on revenue mix among other factors.

Moving to operating expenses.

As DNA expenses were well managed and decreased 5% year over year.

As a percentage of sales as DNA expenses decreased to 20.9% in Q2 fiscal 20 compared to 22.1% in Q2 of the prior year.

We work diligently across each of our divisions to improve efficiencies and prudently manage our cost structure in this quarter's performance in this area whether it was another good example of these efforts.

R&D expenses in Q2 were 14.9 million up 16% from the same quarter over the prior year.

Each division incurred more R&D costs, but the increase was largely driven by investments in the security Division.

We remain focused on innovative product development, which we view as vital to the long term success of our business.

In Q2 fiscal 20, we recorded a 0.9 million benefit in restructuring and other charges due primarily to insurance recoveries compared to 1.3 million benefit in Q2 fiscal 19.

Let's move to interest and taxes.

Interest and other expense in Q2 of 20 decreased to 4.8 million from 5.6 million in the same prior year period as a result of lower average borrowings due to the strong trailing year cash flow and lower average interest rates under our credit facility.

On the tax side, excluding the impact of discrete tax items, our effective tax rate in Q2 fiscal 20 was 27.7% compared to 28.3% in Q2 fiscal 19.

We recognized a discrete tax benefit of 0.7 million primarily for equity based compensation in the most recently completed a quarter compared to a 0.4 million tax benefit also for equity based compensation in the same quarter last year.

As a result, we reported a tax revision under GAAP of 25.3% in Q2 fiscal 20 compared to 26.8% in Q2 fiscal 19.

Let's now turn to a discussion of our non-GAAP adjusted operating margin, which excludes restructuring and other charges in amortization expense of acquired intangible assets.

The company's non-GAAP adjusted operating margin in Q2 fiscal 20 increased to 11.6% from 11.4% in Q2 fiscal 19.

We saw a nice operating margin expansion in our security in our opto division's partially offset by reduced operating margins in the healthcare Division.

The security division's operating margin expanded to 15.7% in Q2 of this fiscal year from 15.3% in Q2 of last fiscal year.

The Opto Division continued its momentum reporting a record Q2 operating margin of 13.5% in fiscal 2000 compared to 12.9% in Q2 of fiscal 19.

Moving to cash flow.

In Q2 fiscal 20, we generated approximately 35 million and operating cash flow driven by strong profits in improved inventory management as days inventory on hand decreased to 118 days from 149 days in Q2 of the prior year.

This was partially offset by an increase in days sales outstanding to 77 days in Q2 fiscal 20 from 68 days in Q2 of fiscal 19 as international sales involving longer average collection times represented a higher percentage of overall sales.

Capex in the second fiscal quarter was 5.6 million, while depreciation and amortization expense in the quarter was 13.4 million.

We were active in our stock buyback program.

Acquiring 140823 shares during the quarter.

As of December 30, Onest 2019, 295833 shares were available for additional repurchase under the current program.

Our balance sheet remains strong we ended the second fiscal quarter with net leverage as calculated under our credit facility of under 1.4.

And finally turning to guidance.

For fiscal 20, we're reducing our sales guidance to a range of 1.25 billion to 1.24 billion.

The reduction reflects softness in the healthcare division coupled with some push outs of US security orders that we continue to believe we're well positioned to receive.

Despite the sales change.

Given stronger expected consolidated margins were slightly increasing our non-GAAP earnings per diluted share guidance to $4.63 to $4.85.

This non-GAAP diluted EPS range excludes potential impairment restructuring and other charges amortization of acquired intangible assets and noncash interest expense and their associated tax effects as well as discrete tax items.

We currently believe the sales and non-GAAP earnings guidance reflect reasonable estimates actual sales and non-GAAP earnings. However could vary from the anticipated ranges due to the risks and uncertainties, specifically affecting our business and generally affecting industries in which we operate.

These risks and uncertainties include items beyond our control such as site readiness for product installations evolving government trade policies customer acceptance of our products and the timing of orders in contract renewals and each division.

And other risks and uncertainties discussed in our SEC filings.

We have continued to focus on the growth of our business, while investing in product development, making selective strategic acquisitions and managing our cost structure.

We believe these efforts will enable oversight to continue our leadership role in providing innovative products and solutions.

Thank you for participating on this conference call.

And at this time, we would like to open the call to questions.

As a reminder to ask a question you want me to press Star one on your telephone to withdraw your question press the pound King Please standby, where we compile the Cabernet roster.

Our first question is from Jeff Martin from Roth Capital Partners. Your line is now.

Thanks, Good afternoon guys.

Good afternoon I just.

I was wondering if you could elaborate on the order push out those essentially tied to the customs and border related.

Work you're getting.

Yes. This is the book hair.

As you know we have centered in the previous calls all that budget for the non interest of equipment has significantly increased over the last year.

For customs and border patrol group.

And.

Some of the execution of leasing those orders and stuff had become little bit more challenging.

Because of the significant increase off their budgets.

We feel very confident about it we are actively involved.

While we have not of equipment at the out at the border both sites both on the website in the Mexico.

And we feel good about of the pipeline continues to be strong, but but the real lab sort of thing is when they get or when they get ordered and when they're ready to receive it.

Right, Okay, and then the health the healthcare related push out seeing more.

Out of your control onetime in nature any idea of when those might hit are they going to be in the second fiscal half of the year. What is exactly included in your guidance in terms of.

On that particular one.

Basically does that limit of change in the marketplace. As you know this launch consolidation going on in the hospital space.

And as the IDN groups of the purchasing groups get bigger they have lots of hospitals to work with construction delay.

Receiving of steel the equipment.

Changes from one side to the other and that has really become little bit more difficult to predict.

And one of things that as Alan mentioned, I mentioned that the backlog looks good.

But some of the.

Actual shipping and acceptance because a lot dependent upon the ready readiness of the customer to receiving and Jeff. This is Alan just to add on the a little bit more color.

Based on what we're hearing from some of the customers some of those push outs will move into.

Q4 and into our next fiscal year.

Great that's helpful and then.

I wanted to touch on your comment where the robust pipeline, especially in the us.

In previous calls it really focused more on international.

As being that the stronger of the two is that a shift and what you're seeing in the marketplace in terms of near term just.

Just to clarify both sides look very robust.

And Thats one of these are the also said our book to Bill Augurs very strong at 1.2 in the security growth.

The reason I wanted to just emphasize that Sean.

There's a lot of activity on the us side.

And at these us finite products the already have the equipment and some of that stuff. So there is no shortage or change in the robust pipeline, both international and domestic.

And we continue to pursue the opportunities all over the globe.

Great. Thanks for taking my question.

Thank you.

Thank you. Our next question comes from the liner Larry Solow from C.J.F. Securities. Your line is now open.

Great. Thanks.

Just a good good afternoon, guys just to clarify on the on the.

On the US security side in sort of what was contemplated your guide it sounds like.

Maybe you had a little bit of.

Little bit more expectations for maybe some some sooner skus soon or sales on the southern border, but it sounds like overall.

Maybe pushed out a little bit, but the opportunity seems like it's actually growing even more than you, maybe maybe not above expectation, but sounds like it's a short term issue in the growth sounds like it will be there is a good of.

Summarize that.

Absolutely I Couldnt upsetting better.

Yes, exactly what we feel the pipeline very strong and the budget is is significantly increased our we're well positioned we have lot of equipment, we have good relationship with the customer.

And again a game on emphasize on both sides of the border and we feel that the pipeline continues to be very robust.

And now we expect to be quite successful and on the Mexico side. I know you could you to do you can comment too much but it sounds like you mentioned broader potentially of road deal going forward. So I assume that would be I guess more on the border patrol saw but may be even more broader based on that or in other areas to is it fair to say.

Well the less we talked the better yoga and been appreciated but all I can say is all inclusive okay fair enough and do you expect from I know that that's sort of the four month extension.

Standard or you guys for negotiate just to add four months, but.

Do you expect maybe.

Hi, good contract before that aren't from development on apoquel towards yet.

Well the thing is that.

They do it airway on basically we had in active discussions on them and hopefully out by the by the end of May.

We should we should have a broader program, but there's no guarantee.

On target the Guatemalan then Sri Lanka.

We're set to start a quarter or maybe two quarters ago, and then that did that get delayed a little bit.

Youre incurring some costs added up.

Well.

The thing is always these kinds of programs. The stopping is that starting actual date as Len unpredictable. We have done everything we are ready.

The equipment is Dan and be test data and everything else that now just a question ups starting to start doing the scanning.

And we're quite excited about it then yes, we had announced and before we are expecting now and we want to say it carefully in near future.

Got it and then just on the book to Bill you guys, usually sort of referred to that the non turnkey, but but I guess the this numbers sort of.

Bill or bookings versus your total revenue right. So thats sort of encompassing I'll just turn key revenue on okay got it turnkey orders probably not right.

Larry This is Alan Yes. This was for the company overall in the division overall.

And there was some there was some turnkey orders in there okay. Okay.

All right and then Okay. Just just lastly, anything you can just a little more color on the new President Healthcare Division I think you said you just came in last quarter from them second.

While we have quite positive about end means of any detail oriented guy comes from the medical industry from Philip send some of the other in a big boys.

Based in based in Seattle very much focused we're looking at.

Cost rationalization looking at more focus on on product development as we've said in the last.

Although we are focusing focusing very much on patient monitoring and cardiology.

We have exited the anesthesia business and this guy's very much focused on it and working with as Alan you want to add something.

Yeah, we're very pleased with the with the work that their new President is doing his is energized the team and they are moving in the right direction and.

We're very hopeful and confident that we're going to see some nice progress.

Excellent. Thank you appreciate it.

Thank you. Our next question comes from the line of Josh Nichols from B. Riley FBR. Your line is now fan.

Yeah. Thanks for taking my question I did want to ask there's been a nice uptick over last few years indirect sales to the U.S. government and sounds like despite a couple of push outs. That's likely to continue could you help frame how big of an opportunity you see within the U.S. regarding.

Companies RTT 10, now that's been certified and you have this approaching February 2021 deadline, where everything's going after.

Be processed.

There's a deeper care good question plus the I want to focus on it that.

The uptake in the us side of the business up to now has mostly been in cargo.

We have as you know that date is not procurement activity going on for checked baggage.

In the airports.

Our new endeavor of using the RTT into the air cargo space has been very well received.

We are working the large logistics carriers, both international and domestic in about a very good success rate in it and we feel that growth will continue so we feel that the 2021 222 of when the deadlines come on the new us so absent acquirements come we're well positioned and we.

We believe that the total pipeline boat in the aviation air cargo and cargo border. We continue to be growth for the next couple of years, especially in us but also international.

Mhm.

Thanks, Kevin I want to hit on the company's had some really strong operating cash flow for the first half this year 60 million.

With good expense.

And working capital management, what are the expectation that in that regard for the for the back half of the year Alan.

Sure as are good question Josh.

We expect to continue to generate nice nice operating cash flow.

Cash flow is not a metric that we provide guidance on overall, but we're going to continue to focus on the on strong working capital management and increase profits and the two of those.

Should combined to generate good cash flow for us in the back half of the year as well.

And could you provide a little bit of update that we've talked about before about the progress.

Regarding the integrated service contract and abilities and how thats been coming along.

Well.

We are making progress.

And we have we are hoping to go live.

In in the near future.

Obviously in some of those places.

Political.

Climates change.

And we continue to look at it but remain very positive lot of interest and the interesting thing is that data has been no lack of interest.

And as we get more and more progress and people get used to Andy said before.

That the integrated services is catching up.

We have that we have a very broad marketing marketing group working globally to look at that area and we continue to look at various opportunities not just in middle East, but in Asia, and Latin America, and frankly, even in U.S.

That's great and our pop back in the queue. Thank you.

Thank you as a reminder, ladies and gentlemen, if you have a question. Please press the star and the number one key well you touched on telephone.

And our next question comes from Greg Conrad from Jefferies. Your line is now open.

Good evening.

Hi, just kind of touched on the last question I mean, I know you provided some numbers in the past I mean is there any way to think about how far we are through the European upgrade cycle on kind of how that filters into potential U.S. requirement.

Good question again.

I think it couple of after closing on both somebody did ask and I'd be guessing but.

But I would say that maybe half done.

But 40, 550% and we've said it that we've been quite successfully and we continue to pursue more aggressively.

As they go forward.

For for the remainder of the year to the deadline.

Thank you and then Jeff and healthcare is hoping to get a little bit more color you talked about a lengthening sales cycle and larger buying group I mean, one has there been any change in the competitiveness of the market in two I think that business has always been at margins that are maybe.

Most sensitive to volume is there any reason to not think that that relationship would hold kind of when volumes come back in terms of incremental.

Good question and I think you answered yourself good there's no ASP erosion that we've seen margins remained very healthy and yes. The nature of the Beast is that it's very much tied to the revenue so as the revenue comes back up.

The margin contribution to the bottom line with the significant Alan you want to add something.

Well said that the healthcare businesses, our highest contribution margin business, which is very sensitive to the topline. So as revenues go up because the big pull through operating margins and of course in versus true as well.

Thanks, Glenn just last one for me I mean, it seemed like you mentioned five or six things that are kind of driving the growth insecurity, one of them where services for airport security I mean, any color or notable around kind of the regional perspective or is that fairly broad base.

I would say, it's pretty broad based gain I want to emphasize not just the airports and stuff on border crossings boats or sporting events cruise lines Numb border bullies.

A logistics air cargo, we'd feel is a very good growth opportunity and though we have very that placed in that.

Thank you.

Thank you at this time I'm showing no further questions I would like to turn the call back over to the speakers for closing remarks.

Ladies and gentlemen, thanks, once again for participating in our conference call. We look forward to the second half and speaking the due at the next earnings call for Q3 in April .

Good day, Thank you everyone.

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