Q1 2022 OSI Systems Inc Earnings Call
Yes.
Ladies and gentlemen, thank you for standing by and welcome to the OSI Systems, Inc. First quarter 2022 conference call.
At this time all participants are in a listen only mode. After the Speakers' presentation. There would be a question and answer session to ask a question. During this session you will need for starting one on your telephone.
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I would now like to turn the conference over to your speaker for today, Alan <unk>, Chief Financial Officer, Sir you may begin.
Well thank you.
Good morning, and thank you for joining us.
Ellen Edric executive Vice President and CFO of OSI systems.
I am here today, with Deepak Chopra, our president and CEO.
Welcome to the OSI systems fiscal 'twenty, two first quarter conference call.
We are pleased that you can join us as we review our financial and our operational results.
Earlier today, we issued a press release announcing our first quarter fiscal year 'twenty two financial results.
Before we discuss these 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 1995 with respect to such forward looking statements.
All forward looking statements made on this call are based on currently available information and the company undertakes no obligation to update any forward looking statement based on subsequent events or new information or otherwise.
During today's call, we will refer to both GAAP and non-GAAP financial measures when describing the company's results.
For information regarding non-GAAP measures and GAAP measures of the company's results and a quantitative reconciliation of those figures. Please refer to today's earnings release.
I will begin with a discussion of our financial performance for the first quarter of fiscal 'twenty two.
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 the outlook for fiscal 'twenty two.
Despite the continuing impacts from Covid as well as supply chain and logistics challenges the company performed well during our first quarter.
Our priority at OSI systems remains to deliver on commitments to our customers and our partners and position the company for long term success, while preserving the safety of our employees.
Now lets cover some highlights.
First <unk>.
Q1 revenues increased 10% year over year, all organically driven by strength in our security and Opto electronics manufacturing divisions.
Second we achieved record Q1 non-GAAP earnings per share of $1 16 up 9% from Q1 of fiscal 'twenty, one despite a volatile backdrop of travel restrictions short term plant closures and supply chain constraints.
And third bookings were strong in the first quarter. The Q1 book to Bill ratio was 1.6, leading to a 15% increase in backlog since the beginning of the quarter.
Our backlog exceeded $1 2 billion for the first time.
Before diving more deeply into our financial results, let me turn the call over to Deepak.
Thank you Alan.
And good morning to all of you.
We are pleased with our fiscal 2022 first quarter performance.
Which showed strong revenues bookings and earnings.
We delivered a strong first quarter, despite an environment that included overseas.
Partial shutdowns due to the pandemic and the ongoing supply chain disruption.
I am pleased with our disciplined execution.
Which enabled us to navigate these challenges and capitalize on the ongoing recovery in certain of our end markets.
As I look pattern mentioned with a record backlog of over $1 $2 billion.
We are well positioned for the future.
Talking about each division's performance in the quarter, starting with the security Division.
The first quarter revenues grew 11% year over year.
The division.
Significant bookings, resulting in a book to bill ratio of 1.9.
Shortly after the quarter end.
We announced key wins that we achieved during Q1.
It went up on major customers U S customer.
Border protection CBP.
To enhance border security infrastructure.
Under the contract for the LDP low energy scanners.
MEP medium energy scanners.
I'd Iqs with CBP, we received out of back the largest order to date, the opening approximately $200 million.
As you know that.
The September quarter is also the government in here and we are very very excited about this huge win.
We have the potential to receive another $65 million under these orders.
The CBP exercises its options.
We expect to fulfill these orders over the next couple of years commencing in late fiscal 2022.
We look forward to providing our car wheel and land scanner, the Z portal backscatter scanners, and our Eagle 60, <unk> inspection systems.
Support the <unk> target of achieving 100% screening at border crossings.
In addition.
A meaningful portion of our order values are our so called Hawk proprietary search scan integration platform software for image analysis data integration and inspection.
We believe.
That the third scan software as we've mentioned before as well.
Potential to become a standalone platform agnostic offering in the marketplace.
Site CBP.
Other customers around the globe are also looking at CBP I was looking at the <unk> software.
Our turnkey service Operation that Bureau, Rico, Albania, and Guatemala continued to do well as our customers rely on these programs do reinforced trade and tariff requirements.
During the quarter we saw.
Successfully won orders with a number of key aviation and critical infrastructure customers.
And grier revenues from the prior year for baggage and parcel inspection systems and explosive trace detection systems.
During the quarter, we announced an order for approximately $13 million to provide multiple units of our R&D team 110 real time tomography.
Explosive detection systems for an Asia Pacific International Airport.
The air passenger traffic levels are improving but have not returned to pre pandemic levels. As you know and does the demand for related products service and spares is recovering those slowly.
I should also note that the pandemic related travel restrictions continue to complicate the process for scheduling site acceptance testing for new product installations in certain parts of the globe.
We expect to continue dealing with the challenges in Q2 and going forward.
The environment to improve thereafter.
Although some unpredictability the mains.
The increasing security backlog demonstrates sustained and growing demand for our products and services setting up well as we continued to fiscal 'twenty, two and moving to fiscal 'twenty three and we look forward to serving a global customer base and aviation aircraft.
Coal logistics, both border and critical infrastructure.
One of the comments I've made in the previous calls I want to emphasize again that during this period one of the areas in security that has been very successfully growing for us is the logistics and air cargo.
Customers like DHL Express and these people are very much expanding as you know their ability to deliver product and we are very much integrated with our products.
Moving to the opto electronic and manufacturing division.
<unk> again delivered strong results with record Q1 revenues representing growth exceeding 15% over the prior year and maintain double digit adjusted operating margins, which is impressive given that we face supply chain shortages and cost increases in this pandemic environment.
The division achieved a record bookings and ended with a record backlog.
Op dose or digital equipment manufacturing customer base as exposure in multiple markets up health care defense space and automotive among others.
As we now have a proven ability to deliver in a pandemic challenging environment.
These customers serving critical markets have remained loyal and in many cases collaborated with us to manage lead time and delivery schedules.
Our team is working diligently to many of the other cost elements within our control and remain focused on execution.
Finally, moving to the health care Division.
We finished Q1 with sales down slightly about 2% lower than prior year. This was expected we had said that before as some of the COVID-19 related tailwind that we experienced a year ago have somewhat dissipated.
Although demand in America, our largest revenue region continues to be strong and growing.
But we did see some demand softening in the EMEA region.
During the quarter, we announced an order valued at approximately $3 million to provide patient monitoring solutions and related accessories to our Midwest and U S based hospitals.
We expect to provide exhibit rental stations expression patient monitors and killed patient monitors.
As information connectivity ease of access and portability becomes increasingly important in caring for patients.
<unk> continued to invest in advancing our key product platforms and patient monitoring and cardiology to take advantage of these trends.
Going forward, we have said before that cardiology is a focus for us to grow as it's the highest margin business.
Space Labs, and the health care group, we are encouraged by the performance of the health care team as it is delivered.
<unk> quarters of double digit adjusted operating margins.
Overall I'm pleased with our Q1 performance. Despite the continued challenges related to the pandemic. Our team remains focused on serving its global customer base.
We have a significant backlog and security a record backlog in opto and the health care Division has been critical in continuing to serve the hospital customer base that is at the forefront of fighting the global pandemic we.
We are hopeful that the industry wide supply chain disruptions and cost increases will normalize in the near future. However, we are prepared to continue operating in this environment and remain vigilant and finding opportunities to grow the top line and leveraging our operations and global.
Presence in the marketplace.
Look forward to the rest of fiscal 'twenty, two 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 Deepak.
Now I will review the financial results for our fiscal first quarter in some greater detail.
As we mentioned earlier Q1 revenues were up 10% over the prior year driven by solid growth in each of the security and opto divisions.
Security revenues were up 11% year over year, driven by our cargo and vehicle inspection products and our checkpoint systems the.
The Security Division Q1 book to Bill as Deepak mentioned was $1 nine leading to significant backlog growth in the security Division.
After sales, including intercompany sales increased 16% year over year, continuing the momentum that we saw throughout fiscal 'twenty one.
Third party opto sales in the first quarter were up 15%, while intercompany sales in the quarter were up 17% year over year.
The opt to a book to Bill was one four resulting in record backlog for the division.
The growth in security and Opto sales was partially offset by a 2% reduction in year over year revenues in the health care Division, which was anticipated as Deepak mentioned Walt.
While patient monitoring sales are expected to be a bit more challenged this fiscal year.
Several initiatives surrounding our cardiology product line, including new product releases and building out the U S sales team are beginning to pay off for.
For Q1, cardiology related sales increased significantly year over year.
The Q1 gross margin was 35, 6% compared to 37, 6% reported in Q1 of last year.
This was driven primarily by the mix of revenues among and within our divisions and increase in component costs.
<unk> revenue growth in our Opto division, which inherently carries a lower gross margin than our other two divisions placed.
Places downward pressure on the consolidated gross margin.
The mix of products and sales within the security and Opto divisions were also less favorable than the prior year's comparable quarter.
Partially offsetting these reductions was an increase in the gross margin in the health care Division driven by the growth in cardiology sales, which tends to carry a higher contribution margin.
Like many companies, we experienced increases in certain component and freight cost, which impacted gross margin on a division and consolidated basis as well as.
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.
We continue to work diligently across each of our divisions to improve efficiencies and prudently manage our SG&A cost structure.
This quarter's results demonstrate the success of these efforts.
Q1, SG&A expenses were $57 million or 20, 25% of sales.
Compared to $59 million or 23% of sales in the prior year Q1.
Research and development expenses in Q1 were $14 8 million representing.
Representing a year over year increase of 23%.
We continue to dedicate.
<unk> resources to R&D.
Particularly in security and health care.
We remain focused on innovative product development, which we view as vital to the long term success of our businesses.
In Q1 of fiscal 'twenty, two we recorded a $2 5 million.
Impairment restructuring and other charges as compared to $8 4 million in Q1 of the prior fiscal year.
Moving to interest and taxes.
Net interest and other expense in Q1 of fiscal 'twenty two decreased to 2.81 million from $4 2 million in the same prior year period, primarily due to the adoption of the new accounting standard ASU 2020 that show six which eliminates the noncash interest expense associated.
With our convertible debt.
It also increases the debt on the balance sheet by eliminating the unamortized discount, which was approximately $10 million prior to adoption.
On the tax side, excluding the impact of discrete tax items, our effective tax rate in Q1 fiscal 'twenty. Two was 2025, 4% compared to 27, 5% in Q1 of fiscal 'twenty one.
We recognized discrete tax benefits of $2 1 million in Q1 of fiscal year 'twenty, two compared to zero point $3 million in the comparable prior year period.
As a result, the reported effective tax rate was 15, 9% in Q1 and fiscal 'twenty two compared to 25, 3% in Q1 of fiscal 'twenty one under GAAP.
I will now turn to a discussion of our non-GAAP adjusted operating margin.
Overall, our adjusted operating margin decreased to 10, 9% in Q1 of fiscal 'twenty. Two from 11, 3% in Q1 of last year driven by the previously discussed factors related to the gross margin increased investment in research and development and the previously discussed changes in health care.
We were pleased with the increase in the adjusted operating margin in our security Division.
Which expanded to a record 16, 2% in Q1 this year as compared to 14, 8% in the prior year first quarter.
This Q1 record margin in security was offset by reductions in the other two divisions.
Our health care Division adjusted operating margin was 12, 1% in Q1 of this year compared to 17, 8% in Q1 of last year.
The variance was driven by economies of scale associated with a higher level of sales in the prior year towards the beginning of the pandemic that boosted that fiscal 'twenty, one margin as well as increased R&D in the fiscal 'twenty, two first quarter to support new product development higher component costs in this challenging supply chain environment.
And increased investments in infrastructure to support future growth that put downward pressure on the fiscal 'twenty two margin for health care.
Aside from last year, the adjusted Health Care Division operating margin for Q1 of fiscal 'twenty two was the strongest on record for Q1.
Similarly, our opto division's adjusted operating margin decreased to 11, 4% in Q1 of fiscal 'twenty two.
12, 1% in Q1 of last fiscal year, primarily due to a less favorable mix of customer revenues and rising costs in the supply chain.
Moving to cash flow.
In Q1 cash used by operations was $11 million. This was driven in part by a decision to increase inventory levels to mitigate certain supply chain challenges and the timing of payments to vendors and collections from customers that some parties have been delaying payments in the current business environment.
Capex in the first fiscal quarter was $3 5 million, while depreciation and amortization expense in Q1 was $9 7 million.
We were active in our stock buyback program.
During Q1 of fiscal 'twenty, two we deployed approximately $16 million to repurchase 168506 shares at an average price of approximately $96, leaving approximately two 4 million shares available to repurchase under the current program.
Our balance sheet is solid with significant capacity for acquisitions and additional stock buybacks.
Our convertible notes mature in September of 2022, and thus are now reflected as a current liability.
Given the general strength of the balance sheet and liquidity through our credit facilities. We believe there are various favorable options available to us to satisfy our obligations under the convertible notes.
And finally turning to guidance.
As Deepak described although we are pursuing a number of opportunities that could potentially bolster our fiscal 'twenty two results.
We are simultaneously cognizant of the current environment, which we have seen among other things timing challenges associated with product installation and acceptance testing in our security Division and.
And headwinds in the supply chain as.
As such we are reiterating the fiscal 'twenty, two sales and non-GAAP EPS guidance previously provided.
While we manage through the pandemic and supply chain challenges.
Based upon our projected backlog delivery schedule.
We anticipate the second half of the fiscal year to be stronger than the first half.
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 and supply chain challenges in our guidance.
Given uncertainties as to the duration and scope of each as well as other variables. However, the extent to which COVID-19, and the supply chain may impact the Companys financial results.
Is difficult to predict and could vary significantly from the anticipated impact currently currently reflected in our estimates and guidance.
Actual revenues and non-GAAP earnings per diluted shares could also vary from the anticipated ranges due to other risks and uncertainties discussed in our SEC filings.
In the face of these challenging times, we continue to remain steadfastly focused on.
The growth of our businesses through investment in product development and potential strategic acquisitions and continued management of our cost structure.
We believe our efforts in these areas will enable OSI to continue our leadership in providing innovative products and solutions.
We delivered strong first quarter results and continued to navigate effectively through uncertainty.
While gaining traction in key strategic growth areas and positioning the company to capitalize on improving end markets.
Finally, we would like to take this opportunity to thank the global OSI systems team for its continued dedication in supporting our customers and contributing to the creation of value for our stakeholders, while maintaining a firm commitment to safety.
And at this time, we'd like to open the call to questions.
Thank you.
Ladies and gentlemen, as a reminder to ask a question you will need to press Star then one on your telephone.
Withdraw your question press the pound key.
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Please standby, while we compile the Q&A roster.
Our first question comes from the line of Brian Rottenberg.
For your capital your line is open.
Yes, thank you very much.
First question on the Big order with CBP can you you talk about the timing I think deep Hock you mentioned that most of this is going to start shipping kind of the end of fiscal 'twenty two.
Should we expect that the majority of that $200 million will get shipped in fiscal 'twenty three.
Does deep O'hare, yes, I said that.
We had.
That that by the fourth quarter of this year and start shipping.
<unk> reshaped next year is going to go into the next year following that too.
But again I want to emphasize that it could be a little earlier.
It might have been pushed to the right. It really depends upon the customer readiness and the ability to install and sign off.
Alan you want to say something.
Yes, Brian I would I would echo what Deepak said very exciting order for us large order for our sets us up well as we move into fiscal 'twenty, three and even 'twenty four we anticipate there could be a <unk>.
A modest amount of revenues towards the end of our fiscal 'twenty two.
Brian This is deepak here I just want to add onto that since you know a lot about that marketplace.
I'd say that but I want to emphasize that.
Out of all the various people who got orders on the NII system.
At that time, we got the largest order.
Our products are very well received it's a very broad base and not only gets the products, but it also has a <unk> scan.
Proprietary software integration with it so we're very excited about that and we want to look forward to it as you can imagine that as this goes.
For US forward it has much more potential to become bigger and bigger on not only just for CBP, but other places in the world will be watching how this progresses.
Great.
In the in your backlog numbers is that $200 million in that backlog.
Yes. It is Brian it's part of the September 30th backlog.
Okay great.
And then.
<unk> already talked about maybe a little bit of mix shift on gross margins in the period, just because of the revenue mix where was stronger on the opto.
<unk> Opto came in really strong for first quarter is that sustainable at those levels.
Brian It's a good question, although we don't provide guidance by division.
We believe the outlook for opto is extremely strong.
Record backlog, so even though we had record revenues with a very strong book to Bill ratio. It provides great visibility going forward now of course, we will have more difficult comps going forward and after as well because opto had such a fantastic fiscal.
Fiscal 'twenty, one in each and every quarter, but on an absolute dollar basis, we feel very very good about where opto will be through the rest of the year, we won't see that we don't anticipate seeing 15%, 16% type year over year growth, but on an absolute dollar basis very strong revenues going forward as well.
Great and then just a couple of other little things on SG&A and R&D SG.
SG&A.
It was down year over year is that a good number to look at or is there any aberration because travel it appears is coming back.
In the fourth quarter going into first quarter calendar.
Is it travel related that is down or is it head count reduction why is SG&A down.
Yeah. So we're really trying to this is Alan we're really trying to manage our cost structure nicely into and our team has done a great job in that regard there was nothing particularly unusual of a significant nature. In Q1, we did start to see travel begin to tick up in our first quarter in all three of our da.
Visions, and we expect will probably tick up even a little bit further as the year progresses as travel begins to open up even a little bit more so we will see that SG&A fluctuate from period to period.
But there wasn't anything.
Of a material nature that was super unusual in Q1.
And then R&D was up.
It appears pretty dramatically year over year, and even sequentially. If there are new projects going on is this.
Something that just seasonally happened.
Looking back at your historical just at $14 8 million looks historically pretty high for a first quarter.
Brian This is al again Youre right. It is high for a typical first quarter, but we felt those investments were quite prudent to make in both our security divisions and in our health care Division.
We invested significantly in R&D in the first quarter for a number of new exciting projects coming out.
To fill demand in the global marketplace, and we really think this can make a difference for us going forward in the future we.
We will continue to focus on R&D, we think it will be at a at a more elevated level than it was last year, because we think thats, so important to driving shareholder value.
Going forward, but we wouldn't look for it.
Accelerate to any significant degree.
On a sequential basis, yes.
<unk> led us to contemplate.
Brian.
An example is for example, with just $200 million of order from CBP and I mentioned some of the products <unk> systems to <unk>.
Some of them are new systems. So the focus has been that as you go into a new platform new products. It increases the R&D Similarly in health care and as Alan has mentioned.
We basically are investing quite a lot into the new platform in patient monitoring and cardiology, the big focus for us because it's the highest margin product and we want to go forward to grow that business.
Ting is that.
Understand when they compare it to the year before obviously with the pandemic and the disruptions in chunks that travel restriction. The people working remote last year was relatively there'll be looked at it unusually low and then when we come back into it would be on new products, new platforms and innovation.
They are a technology company and we're going to continue to focus on and the rewards will come in the years later.
No. That's good last question just real quick on working capital and.
And cash flows.
Obviously, you took inventory up you already highlighted that.
You would expect.
Our positive cash flows for second quarter third quarter, when do you see that that's going to turn.
Brian Zelle and good question and although we don't provide guidance for cash flow generally let me kind of give you a kind of directional we expect that we'll have good strong positive free cash flow for fiscal 'twenty two.
As we've shown in past years.
Kind of in the near term with some of the supply chain.
Items, we will continue to invest prudently in inventory and manage our our vendors appropriately too some of which require a little bit more timely payments than pre pandemic.
The nice thing is we have such a strong balance sheet and we have such a stronger credit facility that affords us the.
The luxury and the opportunity to to do what's best for the business on an overall basis, but we've always been a good strong free cash flow generating company and we expect will continue to be just a just a few things from a timing perspective that could vary from quarter to quarter basis.
Great. Thank you.
Thank you.
Our next question comes from the line of Jeff Martin with Roth Capital Partners. Your line is open.
Good morning, Deepak and Alan how are you.
Hi, Thank you good Jeff Thanks.
Was curious if you could elaborate on your comment that the opportunities are in front of you that could bolster our 2022 I assume youre, referring largely to the CBP contract.
Are you alluding to other things that maybe we haven't heard much about yet, but what specifically are those maybe by by segment or by you know by end market would be helpful.
Good question do you have does Deepak here.
Definitely and one is our products are very well entrenched in both health care and security globally, including U S and other places.
There's uncertainty going to one of the things that Adam has mentioned in the previous calls.
We have some products already built.
But just deliver them. So when we say that what is opportunities into fiscal 'twenty two.
As the things open up as travel opens up as our ability to install units and sign off and stuff but.
It can increase the revenue but.
But we just want to be cautious we want to be conservative.
Same way as a supply chain, how we all think is going to get better, but theres going to be a challenge and we have to manage it right and our backlog in optical our backlog and security customers are dying for product they want to get the product as a matter of fact I mentioned that in my call. Some of the customer that even helping is collaborating with us.
To get more material in and in some places we have been able to pass them on the cost.
So I look at this not just as the CBP opportunity, but as things open up as logistics open up air cargo opens up people want more product automotive using it every day, we are very much involved in the automotive industry and they are begging us to get the product.
It sounds encouraging.
I wanted to ask a question around search scan.
Im.
Alluding to you could sell it as a standalone product I assume that's to your fairly large installed base existing install base, but.
With this retrofit into.
John.
Rapiscan equipment, that's already out in the marketplace help us kind of shape, how youre going about this opportunity and how should passion.
As an outside group to think about it.
Good question I'll go down duration I did make the statement.
<unk> from we are developing such scan is agnostic to the equipment that is very important. Yes. Obviously, we are focused on to get the installed base of <unk> scan and new products, which has the integration of the software, but this software is agnostic it can be used and is being used and tested.
<unk> third party other peoples products.
So that can be integrated into a central program for image analysis or inspection data integration and stuff and we are focused on that and developing it as fast as possible and doing education to our customers to think about it.
Standalone software.
Great and then just wanted to ask a question around component and freight costs.
What what's your overlying thought process behind.
Conceding some margin versus raising pricing.
Setting higher pricing I would assume some of your existing contracts have the pricing already fixed in there where you can't necessarily go back in.
And as for adjusting.
Adjustments on components and freight, but how should we think about when those pressures my knees and what strategically.
You may do to to offset some of those pressures.
So let me let me take a broader answer and then Alan.
We can comment on it.
There is no fixed time that this problem is going to go away.
This is a challenge we've been saying it we are addressing it the team is working well.
We look at this compared to our competitors.
We are in a better position and what might mean by that is one we are multi nation manufacturing plants. We are all over the world, Malaysia, Indonesia, India U S. England everywhere. So we have a little bit better control of the freight and the ability to get components in those parts of the world depending on the customers.
<unk>.
But do we also as Alan has mentioned increasing the inventory buying product that we know we need and we can take some risk into it because if you look within the customer wants it the person who can deliver that's the owner and gets that.
Yes in some cases, we've been able to pass on the material cost of the customers can understand it in some cases, you said it right. It's a fixed price contract from before it's difficult to do that.
Great is a big challenge and it's not just the price, but the unpredictability of freight of receiving win is a big problem. There are lots of challenges in that again, we think we are better position than our competitors that we have of the broader vertically integrated company intercompany between opto and <unk>.
<unk> in health care, so we can handle it better at.
Adam, Yes, Deepak stated it well Jeff but.
Many of our customers, particularly our OEM customers certainly understand the component cost increases and in many of those cases, where we're able to pass on the increased cost to them in other cases, particularly end customers.
Where there is.
Been an order on the books for a long time in backlog those would be more difficult. So so it's a balancing act.
We think we do what's most prudent for the company and the customer but it is a balancing act.
Great.
Much appreciate that and their insights and good luck with the balance of the year.
Thank you.
Thank you.
Our next question comes from the line of Larry Solow with CJS Securities. Your line is open.
Great Good afternoon, or good morning to you guys about California.
A couple a couple of follow ups.
First one is just on the obviously the large order from customs and border patrol.
Okay.
I'm not mistaken. So this is for screening of vehicles right.
Not there isn't much screening today on the borders I believe it's below 5%.
Ultimate goal I don't know how many years that some of it is to sort of get this call it 75%.
So it seems like Theres a lot more opportunity just within.
The U S in the CBP.
Fair statement I know you mentioned that hopefully other countries will adopt as well, but just within.
On the U S borders it seems like there's a.
Much larger opportunity.
Multi year opportunities that fare.
Very well said I think you answered it yes, there is a need for it there is a lot of.
When I call it wishful wishful expectations of 100% as rich.
I don't think Thats, 5% I think it's more than that but telecom definitely data is much more opportunity, but I want to emphasize even on that besides just the equipment just think about it that the integration of all these systems to a central station makes it more.
Efficient and that we think is important besides the new equipment. Besides is state of the arc products. If the integration, that's where it will come back to the search scan.
And all the nations all the border border Patrol's OLED countries ultimately for data.
Our reporting right for certain.
Purposes, they all need these kind of products and the more than one can centralize it make it more efficient.
Better and we think we are ready we are well positioned.
Yes.
Right, Okay, and then just switching gears on the health care side.
The sort of the product investment and rollout seems more focus on cardiology is it more is it I guess its a combination of new products within cardiology and it sounds like if I'm not mistaken most of the sales historically have been.
Overseas or I think a lot of them.
That business was in the U K and maybe some partially in Europe too. So is it a U is it.
On the cardiology side.
Number one just to emphasize it odd development for new products and that we said. It is also focused on patient monitoring which is the majority of our sales.
But ultimately cardiology, which is a smaller portion of it but we think that has better growth opportunity. So we are investing in both regarding the geographic thing obviously, we look at all of it.
Monitoring being significant and U S has 70 plus percent. We can continue to look at that and I did mentioned in my call. We're looking at connectivity and remote monitoring homecare all kinds of stuff.
That is what everybody is looking at especially during the pandemic.
Development and research we are doing is to make our products more suitable do it on the cardiology front definitely originally it was more into the European sector, but we are also focused in and growth in U S. And we have already started it and we believe that will continue both in in Europe, but primarily also.
So the bigger market and we continue to look at it. So it's in both how long do you want to comment on something yes, well said APAC, but youre right, Larry historically, our strength of our cardiology business has been Germany, and the UK and some other select international markets. We've been building out the U S sales and marketing team and infrastructure, we saw a tremendous growth year over year in the U.
In Q1, and expect that we will continue to be a nice part of our growth through the balance of this year and for many years going forward.
The increased R&D investment is in both cardiology and patient monitoring.
But principally in patient monitoring for some new platforms that we'll have coming out in the future.
And then just switching gears onto the opto side.
The book to Bill the order trends seem to have improved sequentially.
Last couple of quarters.
Yeah.
I know it seems to be coming from a lot of areas.
Has anything changed over the last year or so are you seeing strength in any particular, one or two areas more than others.
Automotive before recently that where you are.
Seeing a lot of the strength.
Yes, So hey, Larry this is Alan Youre right I mean, I think we've now had seven straight quarters of tremendous book to Bill ratios for the Opto Division.
And while we're seeing broad based strength in our opto business really what we think we have seen dominate a lot of those bookings has really been our Asian operations.
And within our Asian operations, we sell to a real diversified customer mix, yes, automotive is part of it which has been great.
But also to a number of other type of industrial customers medical customers.
Aerospace and defense.
And even technology, so it's been a broad based strong demand.
Led by our Asian operations, but our North American and UK operations have done extraordinarily well in.
And bookings simultaneously.
Just to add onto it Barry.
Yes, absolutely.
Ill health.
Besides automotive defense Aerospace health care.
We've always been in that.
Thanks, Laura if you could have supplied moura that demand.
Revenue would have been even higher so in anticipation of that growth, which we think is going to continue.
We are expanding our Asian operation by a new factory in India.
We believe that long term in the opto business.
In the OEM space, and health care, and automotive and aerospace defense and stuff. It will continue to grow but at the same time, we want to caution supply chain becomes and freight and logistics is a challenging point.
Alright, and then if I may just finish on that note.
<unk>, obviously, it sounds like accumulate worst refer certainly on a macro level and it does seem like it's gotten a little bit worse for you guys too.
With that said.
It sounds like you expect free cash flow to sort of two certainly.
Reaccelerate, perhaps this quarter.
Do you still think I know you don't guide full year basis, but fair to say that free cash flow may be down some year over year last year, you had an amazing year and benefit I think even from some working capital stuff. So it does seem like with the negative working capital.
At least in the beginning of the year and some excess inventory just to offset some of these supply chain issues.
We will be down this year year over year, but it doesn't sound like long term anything because it really.
Change in terms of your free cash flow generation capabilities.
Larry This is Alan Yes, I think you said that well long term cash flow generation continues to be quite strong for us on a.
Looking at fiscal 'twenty, two specifically some of the growth in the topline and the investments that we're making in inventory.
In this sort of unique situation that we're in today.
I think your overall assessment for cash flow. This year as is correct of course.
As the situation improves going forward there could be a real nice bolus of cash flow some of the working capital metrics inventory turns dsos.
And AP revert more back to regress to the mean, so some great opportunities there.
Got it great I appreciate the color guys. Thanks.
Yeah.
Thank you.
Our next question comes from the line of Christopher Glynn with Oppenheimer. Your line is open.
Sure.
Hey, good morning, guys things sound.
Sounds great nice job.
I wanted to spend a.
Little bit of time on health care and the margin opportunity couple of questions.
As diagnostic cardiology kind of.
<unk> continues to ramp.
We see a mixed tailwind as the year goes on and start to leverage higher investment.
Or is that more in the out years, how do you think about.
And a range of run rate expansion really for the health care segment.
Over the next couple of years as you are now live with <unk>.
Cardiology and.
Chin closer on.
Monitoring.
Chris This is Alan good question.
The diagnostic cardiology and remote cardiology products for us.
Do provide the highest contribution margin within the health care Division that being said patient monitoring has nice contribution margins as well, but as we experienced a greater growth rate in the near term and cardiology relative to patient monitoring. We do think that provides some wind at our tail for on the gross margin side.
And leveraging that down to the bottom line.
So we're excited about those growth opportunities in the near term in cardiology and in the in the medium term.
And longer term for patient monitoring.
Okay.
Some of your GPO wins like you highlighted premier last quarter with patient monitoring of those nice channel opportunities because of cardiology, two or is it really different.
No those represent real nice opportunity opportunities as well and the team that manages our GPO relationships is in contact with each of those GPO is we're on we're on.
Tract with some of them on cardiology and looking to expand further with.
With the rest as the new products come out.
This is deepak here I just wanted to again emphasize that say that the ratio between patient monitoring and cardiology.
It is very much focused.
Towards the patient monitoring side cardiology is relatively small so it might take some time for a significant impact to happen.
When you look at area growth wise.
At the same time, we have to focus on the <unk>.
<unk> and <unk>.
Enhancement of the features in our patient monitoring which will continue so I just wanted to make sure that one realizes that the ratio between the two product lines.
Quite a lack of 70% of our revenue is from monitoring.
Yes, I appreciate you highlighting those dynamics.
Curious on security, there's been some real high profile I'll stop there.
How would you characterize the sort of smaller project activity, there kind of a grab bag of venues things like that.
Well good question again, I think most of it most of the questions that have been on the lottery order, but.
We have more than 20000 installed base all over the world. So we sell many many products in the $15000 range and $5000 range.
Multimillion dollars ranges. So we haven't given up or there is not just focused on one big contract.
<unk> our park.
<unk> remains very robust and strong globally.
And as we have mentioned that I'm sure you read about it.
They had a slower traffic traffic traffic travel growth passenger counts are slowly increasing by beta still unpredictability all the airports around it they have to change their products. So they still have to go get the new ones that trying to this there's all kinds of courthouses prisons.
Carnival cruises all that stuff is there and we have a very broad product line, which caters to all of it.
Thanks, Ken good morning.
Thank you.
Thank you.
Our next question comes from the line of Sheila <unk>.
<unk> with Jefferies. Your line is open hi, good morning, guys. Thanks for taking my question.
Can we go back to the CBP order of 200 million.
Was that competitive and how it could we think about that does it.
$200 million over the next two years is there any are there any offsets to that.
Well good.
Good question, Sheila and different box I'll answer it number one all these things these large ones that all competitive.
It's not like uniqueness, we are very proud of it that we got and multiple companies got what is called <unk> indefinite delivery indefinite quantity orders.
And then came the real orders were very proud to say, we've got the largest share. We think our product is superior we think our product is good.
The answer to your second question is the $100 million.
This is a great win and it's going to be spread over the clean little bit start as we said in the fourth quarter, hopefully and this year. It goes into 2023 and 24, but there's nothing in.
There's more.
Our rail scanners, we are developing and we've had some input and that their products are all over and then the other thing is we are also very proud to say that we're also looking at software integration.
Is what we call it agnostic and we continue to go back and make that point. So that we think is a new endeavor new area for us to grow at a good margin product.
Okay cool.
And is there anything that that that was yes.
The loss in the quarter or this is all the new win.
Well, it's all add on nothing is lost.
Some of the other orders or internationally.
Pushed out we have not lost any and we continue to look at.
In the air passenger area and borders and patrol and I want to emphasize again and again I say that in many calls.
Air cargo logistics area. All of this what you are hearing about increased shipments and stuff that is benefit for us because our products are used by these logistics companies and air cargo companies.
That makes sense and then you guys topics that extensively about R&D being higher given your investment in cardiology.
Just had been around 12% for the last two quarters, how long is the R&D cycle, how should we think about that investment weighing on profitability.
Sure Sheila this is Alan.
And again the investment in health care in R&D is primarily on patient monitoring cardiology as well.
The majority of it is in patient monitoring.
As we come out with the new platform. So the heightened R&D spending.
For health care, we will certainly be with us through the balance of this fiscal year.
And into next as we.
As we look to roll out these exciting new products.
And then lastly I'll.
Sheila just to add onto it.
Besides it because everybody talks about cardiology patient monitoring I did say also have RMB and security all of these new products that we're coming up with all the new innovations. We are doing that also has R&D in it and we continue to focus on that too.
Yes, Okay that makes sense and then maybe last one on opto you guys talked a lot about pricing and supply chain.
A lot of that supply chain.
After the most price sensitive segment.
Are you actually benefiting from price.
As inflation has hit and Theres shortages.
Wow.
I don't think so that that I can say it in a positive way.
Once it benefit it's a challenge.
And what I wanted to say that is that this whole thing everybody's addressing everybody is going to look at it everybody is going to have some some impact on it on the negative side and we're just monitoring it and we think that we are better positioned than some of our competitors across the across the product lines.
But not in the benefit from it.
We're all looking at.
How we can minimize the impact.
Okay. That's helpful. Thanks, so much.
Thank you.
As a reminder, ladies and gentlemen, Thats star one to ask the question.
Our next question comes from the line of Josh Nichols with B Riley Your line is open.
Yeah, I was going I, just wanted to get a little bit of clarification you.
You mentioned, a little bit of gross margin impact, but overall the company has been navigating that pretty well given it <unk> seasonally slower how should we be thinking about that for the remainder of the year you had some some opto expenses, but also I would assume like the higher revenue base as we work through the year should potentially.
Help offset some of that is our expectation that the company is kind of gross margin get back to like the 36 plus percent range or what's the thought there.
Josh This is Alan good.
Good question and that will certainly vary from quarter to quarter, depending upon the mix between the three divisions.
The products within those three divisions, but youre, absolutely right as we get economies of scale, particularly weighted a bit more to the second half where we indicated that we expect a higher second half revenues in the first half revenues there's opportunities to take the gross margins to those levels that youre talking about and then as we <unk>.
Again experienced health care growth again.
In future periods health care carries the highest gross margin among the three divisions. So when you weight that altogether. It can have a favorable impact on our consolidated gross margin.
Thanks.
And then just.
On the CB <unk> rewards right, so $200 million another $65 million follow on opportunity, but I mean, those two IDI cues, where like close to $900 million in aggregate is there opportunity that like later this fiscal year, we could you could secure like another $100 million or so out of those orders or what's the.
<unk> upside opportunity beyond the 265 that were at today.
Very good question and very good data that you've got that is true.
<unk> for the LDP that mep's, our close to $859 million.
They have not released all that.
We got the biggest share.
And there is more opportunity as the years go by the look at the products they look at it.
Keep talking about CBP this Dod.
The state Department there.
Our other areas in the government also who use the similar kind of equipment. So there is lot more opportunity into it and what I emphasized was that as these units get deployed as they look at and define Q&A I'm sure they're going to ask for some changes in fine tuning them ultimately this basically phase.
That the companies who got these orders they will continue to grow.
<unk> installed base as they progress to what CBP and Vod and other people want.
So there is more opportunity.
Got it and then last question for me.
You've talked about M&A and like the company's leverage has continued to decrease to deploying capital to buyback stock but.
Theres been a while since there has been a large acquisition I think you guys now have the balance sheet to be able to do it at least once you do a refi of the.
The convertible notes, but what's your thought process as far as key criteria that you are looking to do like the acquisition have to accelerate the company's growth recurring revenue profitability and I guess I'd also ask like what's your thoughts on like valuation framework considering that right.
A lot of assets are probably priced a little bit higher than they might have been like a year or two ago.
My God, you've said you've already answered yourself exactly.
We put in better words.
All of the above.
We are very focused.
We have done all of the acquisitions, we've said it many times by the same time, we just don't do an acquisition just for the sake of an acquisition it must make strategic sense.
Would either be strategic to our product portfolio audits innovation technology. That's out there we are looking at all the aspects there are but youre also right what you said.
We are not going to do anything stupid to buy something at an overpriced asset, which makes no sense just to do an acquisition Adam you want to add on yes, absolutely.
You're absolutely right, Josh we have a lot of dry powder available at our disposal with a strong balance sheet. We're always looking to do acquisitions that could fill our channel need or a technology need or take us in a new.
Our new technology direction, we look for stuff that will accelerate our growth and will be accretive to our earnings.
And as you rightly pointed out to valuations and multiples are at different levels than.
Historically worse, so we balance all of that.
And are hopeful of being able to deploy.
Some of our strong cash flow and balance sheet, not just to stock buyback, but to supplementing good organic growth with some acquisition growth.
Great. Thanks.
Thank you.
Im showing no further questions in the queue.
I would now like to turn the call back over to Dave portfolio closing remarks.
Thank you very much and again.
Thank all of you for your support and I want to again, thank and emphasize to the employees of OSI systems globally. During all of this challenging times they have worked exceptionally.
For the betterment of the company and at the same time satisfying our customers' needs I want to thank them thank them very much.
Looking forward to the rest of the year and we'll talk to you.
In late January on there on that.
You too.
Thank you very much.
Ladies and gentlemen, this concludes today's conference call. Thank you.
You for your participation you may now disconnect.
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