Q1 2021 OSI Systems Inc Earnings Call

October 29, 2020

[music] my pencil, ladies and gentlemen, thank you for standing by and welcome to the oil Sands Systems, Inc. First quarter 2021.

The conference call.

At this time, all participants on a listen only mode. After the presentation. There will be a question and answer session to ask a question. During the session you will need to press Star then one on your telephone.

Please be advised that todays conference is being recorded if.

If you require any further assistance. Please press star then zero.

I'd now like to hand, the conference over to your speaker for today, Alan Edrick, Chief Chief Financial Officer, Sir you may begin.

Thank you.

Good morning, and thank you for joining us I'm, Alan Edrick Executive Vice President and CFO, Although aside systems.

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

Headquartered in Los Angeles, and home of the World Champion Dodgers and Lakers. We welcome you to the oversized systems fiscal 21 first quarter conference call.

We are pleased that you can join us as we review our financial and operational results and discuss our updated outlook for fiscal 21.

Before we discuss our Q1 results I would like to remind everyone that today's discussion will include forward looking statements and the company wishes to take advantage of the Safe Harbor provisions of the private Securities Litigation Reform Act of 995.

With respect to such forward looking statements all.

All forward looking statements made on this call are based on currently available information and the company undertakes no obligation to update any forward looking statement based on subsequent events or new information or otherwise.

During today's call, we refer to both GAAP and non-GAAP financial measures when describing the company's results for information regarding non-GAAP measures and GAAP measures of the company's results and a quantitative reconciliation of those figures. Please refer to today's earnings release.

I will begin with a summary of our financial performance for the first quarter of fiscal 21, and then turn the call over to Deepak for an overview of the business.

I will then finish with more detail regarding our financial results and a discussion of our updated outlook for fiscal 21.

We are working hard to mitigate the impact of the continuing COVID-19 pandemic.

Our priorities that I always say systems remains to deliver on commitments to our customers into our partners and position the company for long term success, while preserving the safety of our employees.

Now we will jump into some highlights.

First we achieved record non-GAAP Q1 earnings per share of one dollar six up 16% from Q1 of fiscal 20, despite the negative impact on revenues of the pandemic, most notably in our security Division.

Second we reported a significant year over year increase in the adjusted operating margin to 11.3% in Q1 fiscal 21.

Appeared to 9.1% in the same period last year.

Third.

Bookings were very strong in the first quarter. The Q1 book to Bill ratio was 1.6, leading to a 17% increase in backlog since the start of the fiscal year.

And finally, we had another quarter of strong cash flow conversion, resulting in record first quarter operating cash flow of $54 million.

Before diving more deeply into our financial results, let me turn the call over to Deepak.

Thank you Alan.

Good morning.

Overall, we are pleased with the fiscal 2021 first quarter performance fees.

Featuring strong earnings and cash flow as Alan has mentioned and robust bookings across all divisions.

Despite the continued impact of over 19.

Our book to Bill ratio of 1.6 for the whole company led to significant growth in the backlog.

We entered Q2 with a solid pipeline of near term opportunities.

Talking about each division's performance in the quarter, starting with the security Division.

Q1 bookings were $254 million.

At 1.9 book to Bill ratio.

These bookings position security for a strong fiscal 2021 second half continuing into fiscal 2002.

We are seeing demand improvement in many end markets.

Although as we have mentioned before the order.

Order cycle not surprisingly in the context of the pandemic have been somewhat stretched from historical patterns.

We have had several notable Q1 booking wins in aviation.

We were very pleased to announce at 59 million dollar contract to provide multiple RTD 110, CD checked baggage machines and explosive trace detection systems for the Hamada International Airport in Qatar.

This was a very important win involving an airport that had not previously been a wrapper scan customer.

Air cargo customers continue to improve their screening infrastructure and capacity and during the quarter, we announced an order for DHL.

For RTT, one dense and our new machine already on 927, do and energy machine.

Though the aviation market faces significant challenges due to the COVID-19 impact.

On passenger air travel.

We are seeing signs of improvement as certain international airports are taking this opportunity to upgrade their infrastructure. The newer screening technologies as mentioned earlier in the previous calls the air cargo market and logistics market growth.

Globally continues to show growth.

For both Sen borders we continue to expand our reach.

We had several important wins in Q1 in this area.

During the quarter, we announced a contract win for $31 million to provide our Eagle and 60 mobile high energy cargo and vehicle inspection systems.

In addition.

Earlier this week, we announced a significant $93 million award.

From an international customer in the middle East to provide multiple platforms, including our Eagle cargo.

Vical inspection portals, both mobile and stationary raptor scan baggage and parcel screening machines and trace detection systems.

We will also provide installation maintenance training and follow on support under this contract.

Based on this customers current project timeline, we believe that some caution that we could record revenues beginning in Q4 of fiscal 21, and continuing into fiscal 2002 and beyond.

We continue to work with prospective customers in the us and internationally on critical projects that are at various stages of vendor selection.

In addition to significant international demand evidenced by bookings in the last quarter, we have several line of sight opportunities in the us.

Typically as you know, we see significant purchases by the US government in that government, yet and and ending September tuck it but because of the circumstances. Some of these have been delayed but we remain very strong.

Positive with these opportunities and are well placed.

On turnkey services, our contracts in Albania, and critical continued to do well.

We also commenced operations in Guatemala at the Port of Santo Tomas Castilian, but.

The contract for the Mexico program Expo.

Expired in June 2020.

And reaching a box for what for US has not materialized, although we remain optimistic in our last conference call. So we are bound down this operation and looking forward to executing on other new turnkey programs globally.

We are raising our guidance.

Due to the overall strength in our business, including very strong security bookings and a robust pipeline of sales opportunities in the us and international in spite of the shutdown in Mexico, Alan will talk a little bit more about it.

Moving to the Optoelectronic and manufacturing Division.

So again delivered strong results with record fuel rod revenues generating 9% growth over the prior year and solid adjusted operating income.

The diversity of opt those geographic reach and customer base has helped us achieve positive results. During these uncertain times.

Furthermore.

The division and Theres fuel too good a record backlog, we expect opto to continue to move forward with a strong fiscal 2021 fiscal year.

And finally discussing the strong progress in the healthcare Division Spacelabs, where Q1 sales were up 28% and operating income increased over threefold in comparison with the first quarter of fiscal 20.

Higher demand for patient monitoring products on a global basis drove the growth as we continue to benefit in part by the pandemic by the pandemic.

This division.

Which typically book since shipped much office business in the same quarter.

A key into Q1 book to Bill ratio of over one.

The healthcare team has done a great job with operations and supply chain management to capitalize on increasing demand.

We continue to invest significant resources in R&D to enhance remote monitoring and patient management technologies and have several new products slated for launch this year and next across our product families. We are very pleased with the momentum in our healthcare business and the stock.

Mhm execution by management.

Overall, I'm happy with our Q1 performance Security Division is laying the groundwork for the future, but strong bookings as we walk through the Industrys current challenges October continues to execute for OEM customers in various industries and help get is performing at a high level, we look forward.

Through the remainder of the fiscal 2021 with that I will hand, the call back over to Alan to talk in more detail about our financial performance before opening the call for questions. Thank you.

Thank you the Buck.

Now I will review the financial results for our 2021 fiscal first quarter in greater detail.

Our revenues in Q1 of fiscal 2021 were 255 million as compared to $291 million in the prior year Q1.

We saw strong sales growth in the healthcare and opto divisions, but a sizable reduction in first quarter revenues and security Hell.

Health Care Division revenues as Deepak mentioned increased 28% year over year with strength across our patient monitoring portfolio in all major geographic channels and increased sales of supplies and accessories.

Opto sales rebounded significantly from pandemic related challenges last quarter with Q1 third party sales up 11% year over year, driven by strong organic growth in our contract manufacturing group as well as incremental revenues from small acquisition completed in the second half of fiscal 2020.

And as expected we saw a reduction in revenue in the security division with sales down 29% year over year, largely due to the impact of the pandemic on certain aviation and cargo customers.

Security bookings in Q1 were extremely strong however, with a book to Bill of 1.9 and significant growth in backlog.

Our Q1 gross margin of 37.6% was up 350 basis points from the Q1 fiscal 20 gross margin of 34.1% driven by margin expansion in each of our healthcare and security divisions.

The increase in the health care gross margin was due to economies of scale associated with the revenue increase featuring strong U.S sales, which generally carries stronger margins than international sales in.

In addition, our health care Division as gross margin is inherently greater than our other two divisions. So a higher proportion of our consolidated sales in health care results in an overall increase no sized gross margins.

The gross margin improvement in security was notable given the change in sales and was driven by a favorable revenue mix and excellent operational execution.

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

Moving to operating expenses.

The company adjusted its cost structure toward the end of fiscal 20 and early in fiscal 21 in response to the pandemic. The results of these initiatives were reflected in Q1, SG expenses, decreasing 6% year over year and 3% sequentially.

We were diligently across each of our divisions to improve efficiencies and prudently manage our cost structure with heightened focus during these uncertain times.

R&D expenses in Q1 were 12.1 million right.

Representing a year over year decrease of 15% and a 6% sequential decrease.

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 business.

In Q1 of fiscal 21, we recorded an $8.4 million impairment restructuring and other charge. This charge was primarily associated with the exit of the EMS that contract and other reductions in workforce to streamline our cost structure.

Moving to interest and taxes.

Net interest and other expense in Q1 of fiscal 21 decreased to $4.2 million from $4.7 million in the same prior year period because of reduced borrowings given the strong cash flow in a declining interest rate environment since last year.

On the tax side, excluding the impact of discrete tax items, our effective tax rate in Q1 fiscal 21 was 27.5% compared to 27.9% in Q1 of fiscal 20.

We recognize discrete tax benefits of zero point $3 million in Q1 of fiscal 21 compared to $6.2 million in the comparable prior year period.

As a result, we reported a tax provision under GAAP of 25.3% in Q1 of fiscal 21 compared to a tax benefit rate of negative 2.9% recorded in Q1 of fiscal 2000.

Let's now turn to a discussion of our non-GAAP adjusted operating margin as defined in our press release.

Overall, our adjusted operating margin increased from 9.1% in Q1 of fiscal 22, 11.3% in Q1 of fiscal 21.

We were pleased with the significant margin expansion, especially in the face of overall.

Topline headwinds.

The adjusted operating margin in our security Division improved to 14.8% in the latest quarter compared to 12.2% in the prior year first quarter driven.

Driven by a favorable mix of revenues sound operational execution and cost control actions.

Our health care Division reported significant operating margin expansion more than doubling from 7% in Q1 last year to 17.8% in Q1 of fiscal 21, driven in part by leveraging the fixed cost structure with improved sales strong cost controls and sound operational execution.

[music].

These improvements in security and healthcare were partially offset by a reduction in the adjusted operating margin in our Opto division from 13% in Q1 of the last fiscal year to 12.1% in Q1 of fiscal 21, primarily driven by a less favorable mix of customer revenues.

Moving over to cash flow.

As mentioned before this was a very strong quarter of cash flow generation in.

In Q1, we produced 54 million in operating cash flow compared with about $25 million in the same prior year period. This.

This was achieved despite increasing inventory as we prepare for sales growth and higher DSO due to timing of collections as certain customers stretch out payments.

Capex in the first fiscal quarter was $3.8 million, while depreciation and amortization in Q1 was $10 million.

Our cash flow conversion was again exceptionally strong.

We were active with our stock buyback program as part of our overall capital allocation strategy.

During Q1 of fiscal 21, we repurchased 320000 shares under our current Dod under our current buyback program, leaving approximately 2.7 million shares available to repurchase under the program.

Our balance sheet is strong.

With modest net leverage and no significant debt maturities until fiscal 2003.

Finally, let's turn to guidance.

Our initial fiscal 21 guidance range as announced in August included a modest amount of fiscal 21 revenues and earnings associated with the potential turnkey contract in Mexico, replacing the recently expired Mexico contract.

Though that contract did not materialize, we are pleased to nonetheless raise both our sales and our earnings guidance for fiscal 21, given our first quarter results and the strength of our business and outlook for the remainder of the year.

As a result, we are increasing revenue guidance to the range of 1.1 billion to 1.142 billion from $1.09 billion to $1.14 billion.

Similarly.

We are increasing our non-GAAP earnings per diluted share guidance to the range of $4.65 to $5.10 per share from $4.50 to $5.05 per share.

We expect to see revenue headwinds continue in the second quarter of fiscal 21 in our security division stemming from the pandemic, but then believe we will build positive momentum as the year proceeds supported by the strong backlog.

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

We currently believe this revenue and non-GAAP earnings guidance reflect reasonable estimates and we have included the anticipated impact of the COVID-19 pandemic in our guidance.

Given uncertainties as to the duration and scope of the pandemic as well as other variables. However, the extent to which COVID-19 may impact the company's financial results is difficult to predict and could vary materially from the anticipated impact currently reflected in our estimates and guidance.

Actual revenues and non-GAAP earnings per diluted share can also vary from the anticipated ranges due to other risks and uncertainties discussed in our SEC filings.

In the face of these challenging times.

We continue to remain steadfastly focused on the growth of our business through investment in product development and strategic acquisitions will also acutely managing our cost structure.

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

Finally, and importantly, we would like to take this opportunity to thank the global Lois I systems team for its dedication and supporting our customers in contributing to the creation of value for our stakeholders, while maintaining a commitment to safety in the face of uncertainty at.

At this time, we'd be happy to open the call to questions.

Thank you.

Ladies and gentlemen, as a reminder to ask the question do we need to press Star then one on your telephone.

So with Phil Your question press the pound key again.

Good question.

Well, we come back to Ken.

Our first question comes from the line of Jeff Martin.

Capital Your line is open.

Thanks, Good morning, Deepak and Alan how are you.

Good job. Thank you.

Great well first of all I want to commend you on a.

Strong performance and particularly in the billings in the quarter and the fact that you raised guidance despite.

Yet backing Mexico out of out of your assumptions within guidance.

Nice to see.

Wondering to start out.

Could go through the security segment discuss to what degree things continue to be pushed out the right to the right and what factors are really driving that if that's the same as what we saw in Q4 or are nearing changing factors.

Jeff This is the first half.

Thanks for the compliment.

Basically what we said in the last quarter also last conference call.

The challenge that we have is.

Not the bookings the challenge is to actually be able to to travel to that international flash to sign off on the equipment to assemble the equipment to get the civil works done.

And then ultimately the customer has to provide their people to sign off on the on the installation.

Weather, except or whether some border crossing whether it's large infrastructure project at the airport and that's been the big challenge of the uncertainty and Thats. What happened also as we had projected.

In India in Q1.

And and we think thats going to continue the uncertainty so the pipeline of being able to take the revenue uncertainty becomes a little bit longer because we don't know when they're going to sign off on the other hand. The positive is that during this time some of the customers, especially international Dave.

We are using this time to build up the infrastructure because the traffic is down so they want to place orders they want to get the new technology up and running so that they are at the end that activity is quite strong deal activity off demonstrations and people are getting more used to doing it on a video.

Or self inspection self check.

And all that stuff is changing the way the groundwork bizarre and the other one that has been very positive for us as you know everybody is increase their ship a shipments through the house to their office that means that all the cargo air carriers and stuff they continue to increase and expand Dan Dan.

A bit debt facilities, which require security equipment.

Okay.

Okay, Great Thats very helpful. And then you mentioned Opco should continue to be strong. This year security is going to improve in mall in the back half Q2, we'll see from this.

Same challenges but.

Could you address the healthcare segment, how that should progress throughout the year.

I want to take a shot at it.

We've seen strength and if this trend to not get us it's a global.

Yes looks like a spend demick based more and more people want to stay home. They don't Delhi as they do Kelly they need more checkup, Don and out we are building up new platforms for that.

How long this pandemic is on a continual for the growth I don't know off except.

Except ultimately this has changed the whole way of doing business. So we continue to think that this thing is not going to slowdown.

So ultimately allergic depends upon when some people are talking about.

Second we have coming some people are talking about elective surgery that coming back. All we are seeing is they cautiously be a monitoring week by week month by month, we continue to look at what the opportunities are and they have some larger opportunities that some hospitals that bacon. The next shot again using this.

Time to upgrade that equipment and to put new platforms that can do this more remote monitoring.

Alan you want to add something.

And I think that that covers it nicely.

Okay and.

And then with the strong cash flow and cash flow conversion that you're having how should we think about capital allocation here you still have I think it's two point almost 2.7 million shares remaining on your repurchase authorization, how should we think of that versus acquisitions versus.

Repayment of debt.

And Jeff This is Alan.

Youre right, our free cash flow has been a bit extremely strong and when we look at capital allocation, we kind of look at it on a multifold basis, none of which is mutually exclusive. So we do look at stock buyback, we look at the reducing reducing our debt. We look at acquisitions are a big part of our strategy.

And then we also look to win some new Turnkeys, which requires some upfront capex the good part, giving our given our low net.

Net leverage and cash flow generation means we can actually do all four of these things.

Simultaneously of course, depending upon the size of an acquisition. So we expect to continue to be looking into in all four areas.

Great Thats helpful. Thanks for taking my questions.

Thank you.

Our next question comes from the line of Larry Solow CJS. Your line is open.

Good good.

Good afternoon, Thanks for taking my questions and congrats on a good quarter and bookings.

Bookings can you just just clarify Tom I know you don't breakout specific contracts, but.

Just from a high level with Mexico was partially in the this year's guidance in the back half or any any help there and obviously it sounds like you have a lot of other things to fill in that gap, but.

Could you maybe just give.

Give us a little bit of an art gun high level on what that was contributing on on a longer term basis, because I know, it's sort of was the bellwether of Europe used to be for several years.

Terms of turnkey so to.

Trying to get a little more color for folks out there.

Sure Larry This is Alan.

Good good question, So our Mexico revenues in fiscal 2020 were $60 million embedded in our guidance for fiscal 2021 was we thought we would have a little bit more than three quarters of the year worth of revenue is associated with Mexico.

But at a reduced rate we expected there to be some price concessions in that so given that we are no longer including that.

But are able to raise guidance based upon the strength of the overall business in all three divisions, we think is particularly noteworthy.

Right. Okay. So from a revenue basis essentially you raised your revenue by about extra that except contract 65, 70 million or something I guess.

If we take out that 45.

But was that an outsized contributor on it on the margin I know you don't want to give specifics.

We've had a normal turnkey kind of margin how should we look at that revenue that's coming out.

So the revenue is coming out achieved operating margins that were above our corporate average.

Right.

The nice part is you know the business is doing so well that.

We're delivering strong earnings and strong margins, even even taking that out.

Just for a little bit more clarity, we had embedded in the neighborhood of about $30 million of revenue into our fiscal 21 guidance initially from Mexico. So thats NESA portion that came out.

Okay. Okay.

Okay fair enough and anything just qualitatively it sounds like.

You've taken them out for this year is that something that.

Do you know.

And has that.

The parties moved onto the have other alternatives is there any way you could add ons is something that this could come back to the table at some point.

Good question that if a deeper hair.

Yes on the last conference call. We were still optimistic you said it very well they still have a very large equipment base offer after scan the journey doctors can handle and service and maintain so we still think that up it might happen, but we could not wait any long.

So we basically decided to move on we got other opportunities.

But discussions to that continues but given as you as you can see it's a tough environment economy wise in Mexico over the pandemic with the economy and stuff they got down maybe bigger priorities more towards the pandemic than to look at it but the traffic at at the border crossings is not reduced.

And are they still have to do business with with the northeast United States. So on equipment is lying unused we have done very good job of shutting it down to make sure that it commands intact, but ultimately of the bromine has Mexican demand has to decide equipment belongs to them. They have to decide what they were.

On a deal with it and we are there for them than ever they want anything.

Right right Okay.

Move on because obviously have a lot of good things to.

To talk about so just on the on the.

Two very strong bookings in Q.

Can you just discuss sort of the nature of the bookings in terms of the timeline is this sounds like a lot of these things are short term mid term like you.

I know you called out the deal post the quarter that may run into 23, but this.

Big number you put up to 50 something to that before I think is that over the next couple of weeks, we expect delivery.

Larry This is Alan so I'll take a shot at that so so you're right the big contract that we mentioned for.

Aggregated $93 million.

We expect we'll start to see some revenues for that and.

As early as our fourth fiscal quarter and continuing into 22 and beyond.

The 59 million dollar contract that Doug mentioned as well we've already started to be in good begin to recognize revenues through the remainder of the bookings. So we'll go through sort of a normal normal cadence cargo generally cargo vehicle inspection products generally have a little bit longer lead time and some of our basic.

Baggage inspection products.

Can go a little bit shorter so.

Good portion that will will be delivered before.

So those two items I mentioned in in fiscal 21 with some of that continuing into fiscal 22 in <unk> and beyond for for some service contracts and up this a depot here just to add on to what Alan said and I said it in my script.

Normally commit at this time of the year.

End of US government there is lot of activity.

Because of the election, and because of the pandemic and stuff that travelers addiction and stuff that has been pushed to the right.

We're still very confident feeling good about it and as that happens that was stock resulting into revenue in the latter part of the year on and go beyond into fiscal 2002, and there is a lot of demand.

Right right no great and just on the on the cost side, you spoke to especially on a consolidated basis.

Yes, you know being down.

Unethical to come up with a good amount of that was probably focused on the security piece where.

You're the law firms 50 million, an absolute basis in revenue, but only two 3 million operating profit plus.

I suppose would be.

Cuts in all as revenue starts to come back.

Without guiding specifically, but I would assume you're you're Mart your segment margins and security should hopefully on the longer term exceed sort of their previous highs in terms.

Yes, Larry lots at lots of opportunities for margin expansion always contributes to it will be the revenue mix, both the both the products and the geographic channels, but.

But but you are exactly right. Some of the changes we made in our cost structure or more permanent in nature and as some of the changes that we made will be more kind of variable in nature, but youre right. There is always opportunities for strong operating margin expansion, which the team is highly focused on achieving.

And then just lastly, Alan.

On the free cash flow in the and on the growth strong conversion.

What's driving that increase is there more room to run is it.

Just to remind us where you stand on some of your working capital metrics.

That's driven some of the improvement.

Sure, Yes, great great operating cash flow great free cash flow, we're very pleased with it.

Interestingly.

Not being driven by outstanding working capital metrics I mentioned in sort of the prepared remarks their dsos up so in this in these times some of our customers or are just taking a little bit longer to pay so when we can get dsos back to a little bit more normalized level, that's actually an opportunity to to drops to increase in free cash flow.

For us on the inventory side.

Similarly.

Weve actually been investing a little bit more in inventory as we're expecting our sales volumes due to be picking up here through the balance of the year. So I think what's really driven it has been a has been a strong profits.

Some working capital metric positivity.

And we expect that throughout the balance of the year, we're going to have a continued strong cash flow.

Great excellent. Thanks for the color I appreciate it.

Thank you.

As a reminder, ladies and gentlemen, Thats star one to ask the question.

Our next question comes from the line of Sheila.

Okay Hello.

Jefferies. Your line is open.

Hey, good morning, good afternoon.

I wanted to ask about the contract will be back I think you mentioned that in terms of the middle eastern customer and security and it sounded like some sort of turnkey involvement as well as as products. So can you just maybe talk about that program and and your scope as you expand your poor thing part of business.

Thank you Sheila.

It does not it on key project.

It's a lot of equipment, both cargo and the.

Mission Signup equipment.

Its installation and service it's maintained inch.

And it's going to continue it could have an off sale as you know that after a couple of years disc.

This continues for the next 510 years, so that it can longer Tom normal.

Equipment sales maintenance and service now that doesn't mean that so much equipment on the ground and this particular country already has a good customer of rapid scan plot infrastructure support continues to expand and yes. It can lead long term formal training.

Mark or audit semi turnkey integrated product line, but right now on this particular 90 came in in our order its equipment maintenance installation and service.

Okay. Thank you and then on.

Just the security Decrementals are very good in the quarter, Despite a pretty big decline in the top line what was the mix headwind Alan if you could elaborate on that at all as arguments telling.

Sure sure so.

I would say is really kind of a few things.

Once some of our some of our other turnkey projects.

Were extremely successful in the in the quarter and generated strong a strong contribution margins strong operating margins.

Some of the some of the product mix that we had throughout the various businesses were very strong as well and then the basic.

Cost control initiatives, where we're crates were quite solid across the group also so all of that led to as you mentioned you know very very strong operating margins in light of revenue reductions in that in that segment.

And then just from that.

Top line you guys mentioned, you Apple pretty weak, while the rest of world and implement putting a time to implement a lot of upgrade.

Why is the U.S. week I would just think actually the elections are probably a reason for them to spend given the government fiscal year and I couldn't quite square that away.

There is the potential that I won't use the word week I would say that pushed to the right.

The rest of the world.

Now that the deal some countries have different.

Political situation. Some people are more dependent upon transport business with each other some people more aviation relate gave some boats and do it us on the other hand definitely is going through some.

It has to do with the election, I wonder with a pandemic travel distinction out to get various things inspected even so we don't think so that that discussion. This will continue I think that some of the upgrade it have to be done.

The government of the year has ended.

Some of that acquired mentioned that they need to upgrade their border crossings and boards.

There is going to happen.

The upgrade is eminent though it's got pushed to the right AD board upgrade to new equipment is going to happen just pushed to the right.

Okay.

And then last question from me. Thanks, guys for answering I believe is health care. You did mentioned it is quite short cycle that you are seeing very good momentum in that business.

What what is the product driving that what you've seen.

While most of these patient monitoring.

It's it's our it's not infrastructure monitoring patient monitoring which sits right next to the bed side are in there in a in a larger installed base where all the.

Beds data gets consolidated into into one central station.

And it's being bought by as they expand what I call the patient bed in inquiries. So they need more beds they need more space. So our monitoring equipment is very well regarded.

And then we are also seeing some momentum, though not as much in our cardiology business.

Okay.

Thank you so much.

Thank you.

As a reminder, ladies and gentlemen, Thats star one to ask a question.

Our next question comes from the line of Chuck Josh Nichols with B. Riley.

Your line is open.

An exceptionally strong quarter, especially for medical.

Can you provide a little bit of additional color or detail on you.

You can pick the growth rate is expected to kind of continue from where it is hearing.

The company's sustain like these types of significant margin contributions going forward given the continued demand.

Hey, Josh This is Alan good question. Thank you.

We expect to see some some nice momentum in the health care business, continuing not necessarily at a 28% year over year growth rate that was a particularly strong quarter.

In terms of the margins in the contribution margins and operating margins.

This is a business that is so sensitive to the topline so to the extent that revenues.

Stacy say similar or grow then there is a nice opportunities to to enhance the margins overall the business.

You know to the extent revenues in a particular quarter were less you'd have the similar effect. The strong contribution margins make the operating margins are extremely sensitive to the topline in this business.

Thanks, Alan and then just because this year is a little bit different I guess.

I wanted to ask how do you expect the backlog to kind of flow this year as far as how much of the current backlog of $1 billion is expected to be recognized this fiscal year and how is that going to trend given that you are seeing an increase in order flow. Although some of the shipments are a little bit delayed.

Yes, yes. Good question from up from our best estimates and these can can change a lot based on what you are hearing from Deepak earlier, but but roughly half of the backlog. We think will convert to revenue through the course of the remaining nine months of the fiscal year.

With the remaining portion of the backlog converting in fiscal 22 in thereafter and that tends to be relatively similar at this point of the year to what we've seen in past years. It can fluctuate from time to time, but that seems to be a pretty good proxy.

Thanks, and then just to round things out it looks like you're expecting some some good operational performance out of up though as well could you just hit on any particular areas as far as end markets or specific products that you are seeing relative strength or weakness too in that area.

Again, good question does the Procare. Fortunately, we have always said that the opto business is a very broad customer base.

The OEM supplier to a very broad industries aerospace defense.

Health care.

And all those industries, Fortunately are showing a lot of growth, especially healthcare.

And it's also global all if the healthcare is not just for US it's for Asia rights for Europe.

Aerospace latest traction even in Europe, and us and in the defense industry. So that does have a broad base of product.

Product line and they are all OEM suppliers originally can manufacture we supply to other end users with the result that a backlog and the predictability is much better compared to way end product in like in healthcare and security, but on the other hand of this also as we saw what happened in the previous call.

Order of the cause of the pandemic, if the factories off our customers auto impacted off slow down our people on as many people. So obviously that they would push push back to the right some of that coming OEM requirements. So we see that happening sometime they in some cases our international.

Please ourselves are impacted can bid on them at 100% can beat on them at 50% can bid on them at 25%. So there's a little bit of this challenge that's going on but overall of the automotive industry also is showing a lot of strength.

Yes.

Thanks, guys. That's all from me on back in the queue.

Thank you.

Im showing no further questions at this time I would now like to turn it back over to Deepak for closing remarks.

Thank you very much for attending this call I know the market is still open. So you took time to listen to us I want to thank everyone for joining the call, especially again as Alan mentioned I want to thank all the employees. This is a challenging time for us globally that 7000 employees globally. They are very sensitive to there.

The wellbeing of Theyve done a great job and tanks to our customers for their patients and to our stockholders to continue to have interest in us. Thank you very much.

Okay.

Ladies and gentlemen. This concludes today's conference call. Thank you for your participation you may now disconnect everyone have a wonderful day.

[music].

No.

[music].

Ladies and gentlemen, thank you for standing by welcome to the Osats systems <unk> first quarter 2021 conference call.

At this time all participants on in listen only mode.

After the speaker's presentation, there will be a question and answer session to ask a question. During the session you will need to press Star then one on your telephone.

Please be advised that todays conference is being recorded.

If you require any further assistance. Please press Star then zero I would now like to hand, the conference over to your speaker for today, Alan Edrick, Chief Financial Officer, Sir you may begin.

Thank you.

Good morning, and thank you for joining us.

One Edrick executive Vice President and CFO, although OSI systems and I'm here today with deep Chopra, our president and CEO.

According to Los Angeles, and hold the World Champion Dodgers the Lakers.

Welcome you to the Osats systems fiscal 21 first quarter conference call here.

We're pleased that you can join US as we review our financial and operational results and discuss our updated outlook for fiscal 21.

Before we discuss our Q1 results I.

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.

During today's call, we refer to both GAAP and non-GAAP financial measures when describing the company's results for.

Information regarding non-GAAP measures and GAAP measures of the company's results and a quantitative reconciliation of those figures. Please refer to today's earnings release.

I will begin with a summary of our financial performance for the first quarter of fiscal 21, and then turn the call over to D block for an overview of the business.

I will then finish with more detail regarding our financial results and a discussion of our updated outlook for fiscal 21.

We are working hard to mitigate the impact of the continuing COVID-19 pandemic.

Our priorities that I always say systems remains to deliver on commitments to our customers and to our partners and position the company for long term success, while preserving the safety of our employees.

Now we will jump into some highlights [laughter].

First we achieved record non-GAAP Q1 earnings per share of a dollar six up 16% from Q1 of fiscal 20.

Despite the negative impact on revenues are the pandemic, most notably in our security Division.

Second we reported a significant year over year increase in the adjusted operating margin to 11.3% in Q1 fiscal 21.

Compared to 9.1% in the same period last year.

Third bookings were very strong in the first quarter. The Q1 book to Bill ratio was 1.6, leading to a 17% increase in backlog since the start of the fiscal year.

And finally, we had another quarter of strong cash flow conversion, resulting in record first quarter operating cash flow of $54 million.

Before diving more deeply into our financial results, let me turn the call over to Deepak.

Thank you Alan.

Hi, good morning.

Overall.

But he used to bid up fiscal 2021 first quarter performance.

Featuring strong earnings and cash flow as Alan has mentioned.

Robust bookings across all divisions. Despite the continued impact of over 19.

Our book to Bill ratio of 1.6 for the whole company led to significant growth in the backlog.

I took your do but a solid pipeline of near term opportunities.

Talking about each division's performance in the quarter, starting with the security Division Q.

Q1 bookings were 254 million.

What a 1.9 book to Bill racial.

These bookings positions security for a strong fiscal 2021 second half continuing into fiscal 22.

We are seeing demand improvement in many end markets.

Although as we have mentioned before so order cycle not surprisingly in the context of the pandemic happing somewhat stretched from historical patterns.

We never had several notable Q1 booking wage in aviation.

We're very pleased to announce if 59 million dollar contract to provide multiple RTT, one Dan Seagate checked baggage machines and explosive trace detection systems for the Ahmad International Airport in Qatar.

This was a very important to win involving an airport that had not previously been rapid scan customer.

Air cargo customers continued to improve their screening infrastructure and capacity and during the war, we announced an order for DHL for RTT, one status and our new machine already on 927 doing energy machine.

No the aviation market faces significant challenges due to the colder Nike any impact on passenger air travel.

We are seeing signs of improvement as certain international airports are.

Taking this opportunity.

Great debt infrastructure, when Youre screening technologies as mentioned earlier.

Previous calls the air cargo market and logistics market globally continues to show growth.

For Boston borders.

Continued to expand our reach we had several important wins in Q1 in this area.

During the quarter, we announced a contract win for $31 million to provide our Eagle M. 60, mobile high energy cargo and vehicle inspection systems.

In addition.

Earlier this week, we announced significant $93 million award.

From an international customer in the middle East to provide most people platforms, including our Eagle cargo [noise].

Michael inspection portals, both mobile and stationary raptor scan baggage and parcel screening machines and trace detection systems.

We will also provide installation maintenance training and follow on support under this contract.

Based on this customers Qatar project timeline, we believe that some caution that we could record revenues beginning in Q4 of fiscal 21, and continuing into fiscal 2002 and beyond.

We continue to work with prospective customers in the us and internationally on critical projects that are at various stages of vendor selection.

In addition to significant international demand evidenced by bookings in the last quarter.

We have several other line of sight opportunities in the us.

Typically as you know, we see significant purchases by the U.S. government and the government, yet and and ending September tied to yet, but because of the circumstances. Some of these have been delayed but we remain very strong.

Positive with these opportunities and are well placed.

On don't these services are talk Directionally, benioff and geopolitical continued to do well.

We also commenced operations in Guatemala at the Port of SAP Demoss Castillo.

Contract for the Mexico program.

Expired in June 2020.

And reaching a bottom or what for US has not materialized. Although we remain optimistic in our last conference call. So we are bound donges operation and looking forward to executing on other new turnkey programs globally.

We are raising our guidance.

Due to the overall strength in our business, including very strong security bookings and a robust pipeline up sales opportunities in the U.S. and international in spite of the shutdown in Mexico, Adam will talk a little bit more about it.

Moving to the Opto electronic manufacturing division.

So again delivered strong results with record fuel.

Revenue was generating 9% growth over the prior year and solid adjusted operating income.

The diversity of our geographic reach and customer base has helped us achieve positive results. During these uncertain times farther.

Furthermore.

The division and it does feel too good.

We had a record backlog, we expect opto continued to move forward with a strong fiscal 2021 fiscal year.

And finally discussing the strong progress in the healthcare Division Spacelabs. We had Q1 sales were up 28% and operating income increased over three fold in comparison with the first quarter of fiscal 20.

Higher demand for patient monitoring products on a global basis drove the growth as we continue to benefit and blocked by the fact that by the pandemic.

This division.

Mitch typically books, then shipped much off this business in the same quarter a.

A key Q1 book to Bill ratio over one.

The healthcare team has done a great job with operations and supply chain management to capitalize on increasing demand.

Execution by management.

Overall, I'm happy with our Q1 performance Security Division is laying the groundwork for the future, but strong bookings as we walk through the Industrys current challenges up dope continues to execute for OEM customers in various industries and help get is performing at a high level, we look forward.

Does the remainder of the fiscal 2021 with that.

I'll hand, the call back over to Alan to talk in more detail about our financial performance before opening the call for questions. Thank you.

Thank you the Buck.

Now I will review the financial results for our 2021 fiscal first quarter in greater detail.

Revenues in Q1 of fiscal 2021 were 255 million as compared to $291 million in the prior year Q1.

We saw strong sales growth in the healthcare and opto divisions, but a sizable reduction in first quarter revenues and security health.

Opto sales rebounded significantly from pandemic related challenges last quarter with Q1 third party sales up 11% year over year, driven by strong organic growth in our contract manufacturing group as well as incremental revenues from a small acquisition completed in the second half of fiscal 2020.

And as expected we saw a reduction in revenue in the security division with sales down 29% year over year, largely due to the impact of the pandemic uncertain aviation and cargo customers.

Security bookings in Q1 were extremely strong however, with a book to Bill of 1.9 and significant growth in backlog.

Our Q1 gross margin of 37.6% was up 350 basis points from the Q1 fiscal 20 gross margin of 34.1% driven by margin expansion in each of our healthcare and security divisions.

The increase in the health care gross margin was due to economies of scale associated with the revenue increase featuring strong U.S. sales, which generally carry stronger margins than international sales.

In addition, our health care Division is gross margin is inherently greater than our other two divisions. So a higher proportion of our consolidated sales in health care results in an overall increase no size gross margin.

The gross margin improvement in security was notable given the change in sales and was driven by a favorable revenue mix and excellent operational execution.

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

Moving to operating expenses.

The company adjusted its cost structure toward the end of fiscal 20 and early in fiscal 21 in response to the pandemic. The results of these initiatives were reflected in Q1, SGN, a expenses decreasing 6% year over year and 3% sequentially.

We worked diligently across each of our divisions to improve efficiencies and prudently manage our cost structure with heightened focus during these uncertain times.

R&D expenses in Q1 were 12.1 million right.

Representing a year over year decrease of 15% and a 6% sequential decrease.

In Q1 of fiscal 21, we recorded an 8.4 million impairment restructuring and other charge. This charge was primarily associated with the exit of the EPS that contract and other reductions in workforce to streamline our cost structure.

Moving to interest and taxes.

Net interest and other expense in Q1 of fiscal 21 decreased to 4.2 million from $4.7 million in the same prior year period because of reduced borrowings given the strong cash flow in a declining interest rate environment since last year.

On the tax side, excluding the impact of discrete tax items, our effective tax rate in Q1 fiscal 21 was 27.5% compared to 27.9% in Q1 of fiscal 20.

We recognize discrete tax benefits of zero point $3 million in Q1 of fiscal 21 compared to $6.2 million in the comparable prior year period.

As a result, we reported a tax provision under GAAP of 25.3% in Q1 at fiscal 21 compared to a tax benefit rate of negative 2.9% recorded in Q1 of fiscal 2000.

Let's now turn to a discussion of our non-GAAP adjusted operating margin.

As defined in our press release.

Overall, our adjusted operating margin increased from 9.1% in Q1 of fiscal 22, 11.3% in Q1 of fiscal 21.

We were pleased with the significant margin expansion, especially in the face of overall.

Applying headwinds.

The adjusted operating margin in our security Division improved to 14.8% in the latest quarter compared to 12.2% in the prior year first quarter.

Driven by a favorable mix of revenue is sound operational execution and cost control actions.

[music].

These improvements in security and healthcare were partially offset by a reduction in the adjusted operating margin in our Opto division from 13% in Q1 of the last fiscal year to 12.1% in Q1 at this school 21, primarily driven by a less favorable mix of customer revenues.

Moving over to cash flow.

As mentioned before this was a very strong quarter of cash flow generation in.

In Q1, we produced 54 million in operating cash flow compared with about $25 million in the same prior year period. This.

This was achieved despite increasing inventory as we prepare for sales growth and higher dsos due to timing of collections as certain customers stretch out payments.

Capex in the first fiscal quarter was $3.8 million, while depreciation and amortization in Q1 was $10 million our.

Our cash flow conversion was again exceptionally strong.

We were active with our stock buyback program as part of our overall capital allocation strategy.

During Q1 of fiscal 21, we repurchased 320000 shares under our current stock under our current buyback program, leaving approximately 2.7 million shares available to repurchase under the program.

Our balance sheet is strong with.

With modest net leverage and no significant debt maturities until fiscal 23.

Finally, let's turn to guidance.

No that contract did not materialize, we are pleased to nonetheless raise both our sales and our earnings guidance for fiscal 21, given our first quarter results and the strength of our business and outlook for the remainder of the year.

As a result, we are increasing revenue guidance to the range of 1.1 billion to 1.142 billion.

$1.09 billion to $1.14 billion.

Similarly, we are increasing our non-GAAP earnings per diluted share guidance to the range of $4.65 to $5.10 per share from $4.50 to $5.05 per share.

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

We currently believe this revenue and non-GAAP earnings guidance reflect reasonable estimates and we have included the anticipated impact of the COVID-19 pandemic in our guidance.

Actual revenues and non-GAAP earnings per diluted share could also vary from the anticipated ranges due to other risks and uncertainties discussed under SEC filings.

In the face of these challenging times.

We continue to remain steadfastly focused on the growth of our business through investment in product development and strategic acquisitions will also acutely managing our cost structure.

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

At this time, we'd be happy to open the call to questions.

Thank you ladies.

Ladies and gentlemen, as a reminder to ask the question you will need to press Star then one on your telephone.

So with Cowen Your question press the pound key.

Again that star one to ask a question.

Please.

Compared to Q.

Our first question comes from the line of Jeff Martin with Roth Capital. Your line is open.

Thanks, Good morning, the POC and I'll tell you.

Oh good job. Thank you.

Great well first of all I want to commend you on.

Strong performance and particularly in the billings in the quarter and the.

Fact that you raised guidance despite.

Yeah.

Backing Mexico out of out of your assumptions within guidance.

Nice to see.

I'm wondering.

Wondering that started out.

Could go through the security segment.

Skus to what degree things continue to be pushed out the right to the right and what factors are really driving that if that's the same as what we saw in Q4, there are our near and changing factors.

Jeff This is the book.

Thanks for the compliment up.

Basically what we said in the last quarter also last conference call.

The challenge that we have is not a bookings the challenge is to actually be able to to travel to that international place to sign off on the equipment to assemble the equipment to get the civil works done.

And then ultimately the customer has to provide their people to sign off on the on the installation.

Fedex or whether it's a border crossing weather et cetera, large infrastructure project at the airport and that's been the Big challenge of the uncertainty and that's what happened also as we had projected.

And in Q1.

And and we think thats going to continue the uncertainty so the pipeline of being able to take the revenue uncertainty becomes a little bit longer because we don't know when they're going to sign up on the other hand. The positive is that during this time some of the customers, especially international Dave.

Our using this time to build up the infrastructure because the traffic is down so they want to place orders they want to get the new technology up and running so that they are there and that activity is quite strong the activity of demonstrations and people are getting more to use still doing it on a video.

Or self inspection self check.

And all that stuff is changing the way the ground goes R and the other one that has been very positive for US as you know everybody has increased their ship shipped matched to their house to their office that means that all the article air carriers and stuff they continue to increase and expand Dan there.

A bit debt facilities, which have lashed security equipment.

Okay.

Okay, Great Thats very helpful. And then you mentioned are there should continue to be strong. This year security is going to improve them more in the back half Q2, we'll see some.

Same challenges that could.

Could you address the healthcare segment, how that should progress throughout the year.

I want to take a shot at it.

We've seen strength.

And if the strength does not get us its global.

Yes looks like a spend nemec based more and more people want to stay home. They don't Delhi as they do Kelly that need more checkup done and we are building up new platforms for that.

How long this pandemic is going to continue for the growth I don't know except.

Except.

Maybe this has changed the whole way of doing business. So we continue to think that this thing is not going to slowdown.

So ultimately ben's upon when some people are talking about.

Second we have coming some people are talking about elective surgery that coming back. All we are seeing is very cautiously be a monitoring week by week month by month, we continue to look at what the opportunities are and they have some larger opportunities that some hospitals I've taken the next shot again using the.

Time to upgrade that equipment and to put new platforms that can do this more remote monitoring.

Alan you want to add something.

No I think that that covers it nicely.

Okay and.

Repayment of debt.

Jeff This is Alan.

You're right our free cash flow has been a bit extremely strong and when we look at capital allocation, we kind of look at it on a multifold basis, none of which is mutually exclusive. So we do look at stock buyback, we look at reducing reducing our debt. We look at acquisitions are a big part of our strategy.

And then we also look to with some new turnkeys, which require some upfront capex the good part, giving our given our low net.

Net leverage and cash flow generation means we can actually do all four of these things.

Simultaneously of course, depending upon the size of an acquisition. So we expect to continue to be looking at in all four areas.

Great Thats helpful. Thanks for taking my questions.

Thank you.

Our next question comes from the line of Larry Solow CJS. Your line is open.

Good.

Good afternoon, Thanks for taking my questions and congrats on a good quarter bookings.

Bookings can you just just clarify I know you don't break out specific contracts, but.

Just from a high level with Mexico was partially in the this year's guidance in the back half or.

Any help there and obviously it sounds like you have a lot of other things to fill in that gap, but.

Could you maybe just give.

Give us a little bit of an art gun high level on what that was contributing on a long term basis, because I know, it's sort of was the bellwether of your used to be for several years.

Terms of turnkey so.

Just trying to get a little more color for folks out there.

Sure Larry This is Alan.

Revenues associated with Mexico.

But at a reduced rate we expected there to be some price concessions in that so given that we are no longer including that.

What are able to raise guidance based upon the strength of the overall business in all three divisions, we think is particularly noteworthy.

Right. Okay. So from a revenue basis essentially you raised your revenue by about X X that contract 65, 70 million or something I guess.

If we take out that 45.

But was that an outsized contributor on on the margin I know you don't want to give specifics, but we've had a normal turnkey type margin how should we look at that revenue that's coming out.

So the revenue is coming out achieved operating margins that were above our corporate average.

Right. The nice part is the business is doing so well that.

We're delivering strong earnings and strong margins, even even taking that out.

Just for a little bit more clarity, we had embedded in the neighborhood of about $30 million of revenue into our fiscal 21 guidance initially from Mexico. So thats the portion that came out.

Okay. Okay.

Okay fair enough and anything just qualitatively it sounds like.

You've taken enough that this year is that something that.

Yeah.

Has that have done.

The parties moved onto that have other alternatives.

Well you could now is this something that this could come back to the table at some point.

Good question that it is a deeper hair.

Yes on the last conference call, we were still optimistic yes.

You said it very well they still have a very large equipment.

Equipment base of rapid scan the journey that hes can handle and service and maintain.

So we still think that up it.

It might happen, but we could not wait any longer so we basically decided to move on we got other opportunities.

But discussion still continues but as you as you can see it's a tough environment economy wise in Mexico over the pandemic with the economy and stuff. They got maybe bigger priorities more towards the pandemic than to look at it but the traffic at at the border crossings is not renewed.

Saying are they still have to do business with with the northeast United States. So our equipment is lying unused and we have done very good job of shutting it down to make sure that it commands intact, but ultimately of the.

The government has Mexican demand has to decide equipment belongs to them. They have to decide what they want to do with it and we are there for them than ever they want anything.

Right right, Okay, let's move on because obviously have a lot of good things.

Talk about so just on the on the obviously very strong bookings in Q.

Can you just discuss sort of the nature of the bookings in terms of the timeline is this sounds like a lot of these things are short term mid term like you.

I know you called out the deal post the quarter that may run into 23, but.

Big number you put up to 50 something to that before I think is that over the next couple of weeks, we expect delivery.

Larry This is Alan so I'll take a shot at that so so you're right the big contract that we mentioned for.

Aggregated $93 million.

We expect we'll start to see some revenues for that and.

As early as our fourth fiscal quarter and continuing into 22 Mboe.

Beyond.

The 59 million dollar contract that we both mentioned as well we've already started to be begin to recognize revenue is sort of the remainder of the bookings will go through sort of a normal normal cadence cargo generally cargo and vehicle inspection products generally have a little bit longer lead time and some of our basic.

Baggage inspection products.

Can go a little bit shorter so.

Good portion of that will will be delivered.

So those two items I mentioned in in fiscal 21 with some of the continuing into fiscal 22 and beyond for for some service contracts and this a depot here just to add onto what Alan said and I said it in my script.

Yes, normally but at this time of the year.

At the end of U.S. government, there's a lot of activity.

Because of the election, and because of the pandemic and stuff like travel restriction and stuff that has been pushed to the right.

We're still very confident feeling good about it and as that happens that plus stock resulting into revenue in the latter part of the year on and go beyond into fiscal 2002.

There is a lot of demand.

Right right no great and just on the on the cost side.

Look to especially on a consolidated basis.

You know being down.

I think from a good amount of that was probably focused on the security piece, where you are going to law firms 50 million, an absolute basis in revenue, but the only two or 3 million operating profit.

I suppose.

What's it all as revenue starts to come back.

Without guiding specifically, but I would assume you're you're Mart your segment margins and security should hopefully in the longer term exceed sort of their previous highs in terms.

Yes, Larry lots and lots of opportunities for margin expansion always will contribute to it will be the revenue mix, both both the products and the geographic channels.

But but you're exactly right some of the changes we made in our cost structure or more permanent in nature and in some of the changes that we made will be more kind of variable in nature, but youre right. There is always opportunities for strong operating margin expansion, which the team is highly focused on achieving.

And then just lastly, Alan.

On the free cash flow in the end of the grow strong conversion.

What's driving that increase is there more room to run is it.

Just remind us where you stand on some of your working capital metrics.

Thats driven some of the improvement.

Sure, Yes, great great operating cash flow great free cash flow, we are very pleased with it.

Interestingly.

Not being driven by outstanding working capital metrics I mentioned in the sort of the prepared remarks their dsos up so in this in these times some of our customers or are just taking a little bit longer to pay so when we can get dsos back to a little bit more normalized level, that's actually an opportunity to to drops to increase in free cash flow.

For us on the inventory side.

Similarly.

Weve actually been investing a little bit more in inventory as we are expecting our sales volumes due to be picking up here through the balance of the year. So I think what's really driven it has been a has been a strong profits.

Some working capital metric positivity.

And we expect that throughout the balance of the year, we're going to have a continued strong cash flow.

Great excellent. Thanks for the color I appreciate it.

Thank you.

As a reminder, ladies and gentlemen, Thats star one to ask the question.

Our next question comes from the line of Sheila.

Okay.

With Jefferies. Your line is open.

Hey, good morning, good afternoon.

I wanted to ask about the contracts at the back I think you mentioned that in terms of the middle eastern customer and security and it sounded like some sort of turnkey involvement as well as as products. So can you just maybe talk about that program and and your scope as you expand your ports in cargo business.

Thank you Sheila.

It does not it does keep project.

It's a lot of equipment, both cargo and aviation signup equipment. Its installation its share of ish, it's maintained inch and it's going to continue to have enough Dale as you know that opt a couple of years.

This continues for the next 510 years, so that it can longer Tom normal.

Equipment sales maintenance and service now that doesn't mean that so much equipment on the ground and this particular country already has a good customer of rapid scan sought infrastructure support continues to expand.

And yes. It can lead long term formal training more color audit Semite Donkey integrated product line, but right now on this particular 90 came in at our order its equipment maintenance installation and service.

Okay. Thank you and then on.

Just the security Decrementals are very good in the quarter, Despite a pretty big decline in the top line what was the mix headwind Alan if you could elaborate on that at all sorry go ahead.

Sure sure so I.

I would say is really kind of a few things once.

Once of our some of our other turnkey projects.

Were extremely successful in the in the quarter and generated strong a strong contribution margins strong operating margins.

Some of the some of the product mix that we had throughout the various businesses were very strong as well and then the basic.

Cost control initiatives were credits were quite solid across the group also so all of that led to as you mentioned you know very very strong operating margins in light of revenue reductions in that in that segment.

And then just on the.

Top line you guys mentioned, you Apple pretty required in the rest of world is implement taking the time to implement a lot of upgrade.

Why is the U.S. week I would just think actually the elections are probably a reason for them to spend given the government's fiscal year on it but I couldn't quite square that away.

There's the potential for that.

I wouldn't use the word week I would say that pushed to the right.

No thats to the world.

The D. Some countries have different.

Political situation. Some people are more dependent upon transport them business with each other or some people more aviation related games and boats and do it us on the other hand definitely is going through some things.

He has to do with the election I'm new to with a pandemic travel distinction out to get various things inspected even so we don't think so that that disk and this will continue I think that some of the upgrades have to be done.

The government up though the years ended some.

Some of that is why I mentioned that they need to upgrade their border crossings and boards.

There is going to happen.

The upgrade is eminent though it's got pushed to the right AD Board.

Great the new equipment is going to happen just pushed to the right.

Okay.

And then last question for me Thanks, guys for answering all these is health care. You did mentioned it is quite short cycle that youre seeing very good momentum in that business.

What what is the product driving that where are you seeing.

While most of these patient monitoring.

It's our site infrastructure monitoring patient monitoring, which sits right next to the bed side are and that in a in a larger installed base were already.

Bench data gets consolidated into into one central station.

And it's being bought by as they expand what I call the patient bed in inquiries. So they need more beds they need more space. So our monitoring equipment is very well regarded.

And then we're also seeing some momentum does not as much in our cardiology business.

Okay.

Thank you so much.

Thank you.

As a reminder, ladies and gentlemen, Thats star one to ask a question.

Our next question comes from the line of Chuck Josh Nichols with B. Riley.

Your line is open.

An exceptionally strong quarter, especially for medical.

Can you provide a little bit of additional color or detail on you.

You can pick the growth rate is expected to kind of continue from where it is here and.

The company's sustain like these types of significant margin contributions going forward given the continued demand.

Hi, Josh This is Alan good question. Thank you.

We expect to see some some nice momentum in the health care business, continuing not necessarily at a 28% year over year growth rate you know that was a particularly strong quarter.

In terms of the margins in the contribution margins and operating margins.

This is a business that is so sensitive to the top line so to the extent that revenues.

Stacy say similar or grow then there is a nice opportunities to enhance the margins overall the business.

Thanks, Alan and then just because this year is a little bit different I guess.

I wanted to ask how do you expect the.

Backlog to kind of flow this year as far as how much of that the current backlog of $1 billion is expected to be recognized this fiscal year and how is that going to trend given that you are seeing an increase in order flow. Although some of the shipments are a little bit delayed.

Yes, yes. Good question you know from our best estimates and these can can change a lot based on what you are hearing from Deepak earlier, but but roughly half of the backlog. We think will convert to revenue through the course of the remaining nine months of the fiscal year.

The remaining portion of the backlog converting in fiscal 22 and thereafter and.

That tends to be relatively similar at this point of the year to what we've seen in past years. It can fluctuate from time to time, but that seems to be a pretty good proxy.

Thanks, and then just to round things out it looks like you're expecting some good operational performance out of opto as well could you just hit on any particular areas as far as end markets or specific products that you are.

And relative strength or weakness too in that area.

Again, good question does the Procare. Fortunately, we have always said that the opto business is a very broad customer base.

OEM supplier to a very broad industrial aerospace defense.

Healthcare.

And all those industries, Fortunately are showing a lot of growth, especially healthcare.

And it's also global all if the healthcare is not just for US it's for Asia, It's for Europe.

Aerospace datas traction even in Europe and us.

End up in the defense industry. So that is a very broad base product.

Product line and they are all OEM suppliers, what do you think one manufacturer we supply to other end users with the result that a backlog and the predictability is much better compared to way end product in like in healthcare and security.

But on the other hand. This also as we saw what happened in the previous quarter of the cause of the pandemic at the factories off our customers auto impacted off slow down our people on as many people. So obviously that they would push push back to the right some of that coming OEM requirements. So.

We see that happening sometime they in some cases, our international factories ourselves are impacted can bid on them at 100% can bid on them at 50% ended on them at 25%. So there's a little bit of this challenge that's going on but overall all.

The automotive industry also is showing a lot of strength.

Yeah. Thanks, guys. That's all from me are back in the queue.

Thank you.

I'm showing no further questions at this time I would now like to turn it back over to Deepak for closing remarks.

Thank you very much for attending this call I know the market is still open. So you took time to listen to us I want to thank everyone for joining the call, especially again as Alan mentioned I want to thank all the employees. This is a challenging time for us globally at 7000 employees globally, we are very sensitive to their.

Our wellbeing, all they've done a great job and tax to our customers for their patients and to our stockholders to continue to have interest in us. Thank you very much.

Okay.

Ladies and gentlemen. This concludes today's conference call. Thank you for your participation you may now disconnect everyone have a wonderful day.

Q1 2021 OSI Systems Inc Earnings Call

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