Q3 2022 OSI Systems Inc Earnings Call

April 28, 2022

Good day, and thank you for standing by and welcome to the OSI Systems, Inc. Third quarter 2022 conference call. At this time, all participants are in a listen only mode.

After the speaker's presentation, there will be a question and answer session.

Ask a question during the session you will need to press Star and then one of your telephone.

Please be advised that today's conference is being recorded if you require any further assistance. Please press star and then zero.

I'd now like to hand, the conference over to your Speaker today, Alan <unk> Chief Financial Officer. Please go ahead.

Well thank you.

Good afternoon, and thank you for joining us I'm, Alan Edric, Executive Vice President and CFO of OSI systems, and I'm here today, with Deepak Chopra, our president and CEO .

Welcome to the OSI systems fiscal 'twenty, two third quarter conference call. We are pleased that you can join US as we review our financial and operational highlights.

Earlier today, we issued a press release announcing our third quarter of fiscal year 'twenty two financial results.

Before we discuss our Q3 results. However, I would like to remind everyone that today's discussion will include forward looking statements and the company wishes to take advantage of the Safe Harbor provisions of the private Securities Litigation Reform Act of 1095 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.

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 third quarter of fiscal 'twenty, two and then turn the call over to Deepak for an overview of our business performance.

I will then finish with more detail regarding our financial results and a discussion of our outlook for the full year of 'twenty fiscal 'twenty two.

We are pleased with our results this quarter, despite global marketplace challenges, including increasing supply chain delays and logistics cost and geopolitical events.

As we work through this environment, we continue to prioritize delivering on commitments to our customers and to our partners positioning the company for long term success and ensuring the safety of our employees.

Now we will go through a high level summary of our financial results.

Q3 revenues of $290 million, representing 2% year over year increase driven by growth in security and opto sales, which were partially offset by an expected small reduction in year over year Health care Division sales.

Q3, non-GAAP earnings per share were $1 43 up 4% from Q3 of fiscal 'twenty, one driven by a lower tax rate and smaller share count, which outweighed increased R&D higher supply chain costs, and a less favorable product mix.

Bookings were solid with a Q3 book to Bill ratio of one one.

We ended the quarter with a near record backlog of over $1 2 billion, representing a 14% increase.

Since the end of the last fiscal year.

Operating cash flow for the third quarter was strong as we generated approximately $38 million, while capex was approximately $3 million.

Finally, we were active with strategic transactions this past quarter as we acquired two small security companies and unlocked significant value in certain corporate owned real estate through a sale leaseback transaction.

We also spent approximately $51 million in our share repurchase program.

Before diving more deeply into our financial results I will turn the call over to Deepak.

Thank you Alan.

And again, good afternoon, and welcome to the OSI systems earnings call for the third quarter of fiscal 2022.

We are pleased with our third quarter results, where we achieved solid rocket stability and strong cash flow on slightly higher revenues from the prior year.

Overall bookings continued to be robust and strong as we ended Q3 with a backlog of $1 2 million approximated.

Going into our third quarter highlights in each division.

And then I'll turn it back over to Alan to provide further detail on our deep financial performance.

Starting with security, where revenues grew 5% from the prior year.

Facing the challenges that Alan mentioned from the global supply chain and logistics and travel constraints continue as we speak even today.

During the quarter.

Continued to strengthen our offerings to the marketplace as we made two small strategic acquisitions, which are consistent with our focus on increasing the service and software and a portion of it.

Cutting revenue base.

We acquired a longstanding international distributor and a key European region that we believe has many growth opportunities for our solutions, including establishing a direct local sales service and support footprint.

We took a similar approach in another region, a few years ago, and which we have seen a marked increase in sales since that acquisition.

We also acquired a U S based company called Gatekeeper rich.

Which provide intelligent.

Optical inspection and the recognition solution to identify threats and provide real time actionable intelligence.

These solutions are utilized for border crossings.

Checkpoints are critical infrastructure worldwide.

<unk> acquisition.

<unk>, our hardware offering wireless proprietary software used for the integration of third party solutions for example in vehicle identification facial recognition and container tracking.

<unk> the capabilities of our.

Third scan software platform on.

Integration software for cargo and vehicle inspection at checkpoints and border crossings.

As we have mentioned before we are excited about the traction we are gaining with our search scan software as a service or SaaS model with potential customers.

Over the last few years, we have made a concerted effort to grow our revenues from systems integration software and ongoing service and support.

These complementary offerings on included in many of our proposals and provide a more steady stream of revenues over the life of the program as compared to a traditional standalone inspection hardware sale. Moreover.

Recurring revenue contribution from software.

So its scan operator and maintain this training modules and automated image analysis <unk> has the potential to significantly enhance the overall margins in this division.

In addition to making acquisitions like gatekeeper, which brings new bipolar and passenger IV checkpoints software, we are making significant R&D investments to further enhance our overall software solution offering into the category.

During the quarter.

We made progress on our ongoing major programs, including the one with the U S customs and border protection CBP.

We are in various stages up supporting the enhancement of the U S border security infrastructure, utilizing our cargo and whitefield scanning platform than <unk> based technologies.

In addition to the hardware.

<unk> stent and the offerings from gatekeeper.

Included in the solution for some of these airports that CBP.

We believe that this will continue to grow as CVP continues to expand this approach <unk>.

S border crossings on the southern border with Mexico.

As you will have much that you might have heard that our ongoing discussion in Washington D C.

100% inspection at the southern border with Mexico.

As you might have as an example of the importance of our solutions in helping protect borders and preventing the movement of illegal drugs and contraband.

<unk> recently announced a significant drug seizure.

At a border crossing the El Dorado, Texas.

Multiple screening methods and technologies, what used to find the Max.

And inside of trucks trailer that was also getting food packages.

Truly proud of our contribution in helping secure U S borders.

Our current deep program in Albania Bureau, nickel and Guatemala had been running as expected and are invaluable and demonstrating our large program experience and capabilities to customers as they bid on major projects worldwide. Most of these programs also have already into.

Big stone scan into their software.

The aviation passenger traffic domestically is returning closer to pre COVID-19 levels, while international traffic is returning at a slower pace.

Since we have exposure to both U S and international airports.

Next our aviation business worldwide to grow as these customers will require the latest technology inspection systems service and support to handle the growth and efficient manner.

During March we.

We hosted our Napa <unk> systems Golf Classic FPGA to an event that was held in Biloxi, Mississippi.

We want to congratulate the winner Steve Elkhart, and thank all others that help make it a successful event many important employees industry partners and customers, both domestic and international and the opportunity to attend an interactive the classic.

Events also raised $1 6 million to support local Kennedy's in coastal Mississippi.

Over the last couple of years. The security Division has successfully managed to work through the Covid related challenges in the marketplace and meet customer demand.

Going forward, we anticipate higher demand exports borders in airports and a greater willingness from these customers to initiate major projects that were delayed during the pandemic.

We have a strong backlog and a pipeline of significant global opportunities across our broader portfolio.

The recent acquisitions during the quarter also bring new customer relationships that we can leverage to provide other products and services from our existing offerings.

With a strong backlog we are poised for a significant sequential increase in sales and profits in this division.

We believe that our ability to offer leading technology and innovative solutions positions us well into fiscal 'twenty three and beyond.

Moving to our Optoelectronics and manufacturing division in Q3 revenues were solid.

While bookings were exceptional leading to a record backlog for the division.

The Opto Division continues to work through global supply chain and logistics challenges.

Successful. So it's large OEM base that also includes our other divisions security and health care.

<unk> saw growth across certain product groups, especially optical components and assemblies for healthcare and technology Oems we.

We announced a couple of notable wins and multiyear order for approximately $35 million.

And provide electronic assemblies for use in patient get obligations and in order for approximately $5 million to provide electronic components to a leading excellent imaging OEM manufacturer.

During the quarter.

Dividend also continue just efforts to make its new Indian facility fully operational which expands our footprint in the region to handle the anticipated future growth, especially for healthcare products.

Moving to the healthcare Division space Labs, where we had a strong quarter.

Although revenues were down about 3% than the prior year's Q3, which was expected as last year's Q3 contained patient monitoring revenues from Covid related tailwind. The division achieved nice operating margin expansion driven by higher gross margins from a favorable product mix.

During the quarter, we saw strength in the U S channels.

Cardiology products continued to do well in the quarter with double digit revenue growth.

During the quarter. We also continued to make significant investments in research and development for new products as we did with a safe and sound technology acquisition, we will continue to explore opportunities to add technology to enhance our core product portfolio of patient monitoring and cardiology.

Overall, the healthcare Division has performed well as the market activity has shifted from COVID-19 centric demand to more normal historical demand patterns.

This year I've been impressed with the commitment of our employees to manage the unique challenges in the marketplace and relentlessly sell of our customer base. We look forward to finishing the year strong and further enhancing our value to our customers that are critical in promoting health and safety worldwide as always I would like to.

Thank our employees customers and stockholders for their continued support.

With that I'm going to turn the call over back to Alan to talk more in detail about our financial results and guidance before we open the call for questions. Thank you.

Well, thank you Deepak.

Now I will review the financial results for our fiscal third quarter and a little greater detail.

As mentioned earlier fiscal Q3 revenues were up 2% compared with that of the prior year.

Security Division revenues were up 5% with increases in both product and service sales, mainly driven by our cargo and vehicle inspection products.

Although aviation related sales were down year over year. We are currently seeing an uptick in activity in this arena.

Auto sales, including intercompany sales increased 2% year over year with continued momentum in this sector.

The growth in security and Opto sales were partially offset by a 3% reduction in year over year revenues in the healthcare division given the elevated demand for patient monitoring products as deep as Deepak described earlier, creating difficult comps for this division in fiscal 'twenty two.

While patient monitoring sales decreased cardiology related sales increased significantly for the third consecutive quarter.

The Q3 gross margin was 35, 4% compared to 36, 7% reported in Q3 of fiscal 'twenty one.

The mix of sales within the security division were less favorable than in the prior year's comparable quarter.

And revenues in our healthcare division, which carries a higher gross margin than our other two divisions were down slightly each of which has a downward impact on the consolidated margin.

Many companies, we experienced increases in certain component in freight and freight costs in each division.

Which impacted the gross margin overall.

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 to prudently manage our SG&A cost structure. This quarter's results again demonstrate the success of these efforts.

Q3, SG&A expenses were $58 million comparable to last year or 19, 9% of sales compared to 24% of sales in the prior year Q3.

R&D expenses in Q3 of fiscal 'twenty, two were $15 1 million.

Representing a year over year increase of 9%.

We continue to dedicate considerable resources to R&D, particularly in security and healthcare.

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

In Q3 of fiscal 'twenty, two we recorded a $1 $5 billion restructuring and other charge as compared to a benefit of <unk> $3 million in Q3 of the prior fiscal year.

As previously mentioned, we successfully executed the sale leaseback of our Hawthorne, California facilities.

At an attractive sale price of $32 million. This.

This resulted in a pretax gain of approximately $27 million, which has been recorded in other income and excluded from our non-GAAP earnings.

Moving to interest and taxes.

Net interest and other expense in Q3 of fiscal 'twenty, two decreased to $2 3 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 eliminated the noncash interest expense associated with our convertible debt.

We note that adoption of the accounting standard also resulted in increased debt on the balance sheet by eliminating the unamortized discount of approximately $10 million.

On the tax side, our reported effective tax rate GAAP was 21, 21% in Q3 fiscal 'twenty two compared to 33, 7% in Q3 of fiscal 'twenty one.

In Q3 of this year, we recognized a discrete tax benefit of <unk> 2 million as compared to a $2 $2 million discrete tax expense in Q3 of last year.

I will now turn to a discussion of our non-GAAP adjusted operating margin.

Overall, our non-GAAP adjusted operating margin was 11, 4% in Q3 of fiscal 'twenty two as.

As compared to 12, 6% in Q3 of last year.

The change was primarily driven by the previously discussed factors related to gross margin and increased investment in research and development.

We were pleased with the increase in the adjusted operating margin in our Opto Division.

Which expanded to 12, 9% in Q3 this year as compared to 12, 5% in the prior year third quarter.

We were also pleased that the adjusted operating margin in our healthcare Division expanded to 14, 7% in Q3 of fiscal 'twenty two.

Compared to 13, 9% in Q3 last year.

This increase was driven by a stronger gross margin due to a favorable product mix, including strong high margin cardiology sales.

The security division's adjusted operating margin decreased to 14, 9% in Q3 of this year from 17, 9% in Q3 of the last fiscal year.

Which more than offset the improvements in the other two divisions, primarily due to a less favorable mix of customer revenues rising.

Rising costs in the supply chain higher marketing expenses for promotional activities that were specific to Q3.

And increased R&D to support new product development.

Let's move to cash flow.

Cash provided by operations was $38 4 million in Q3 <unk>.

Capex in the third quarter was $2 9 million, while depreciation and amortization expense in Q3 was $9 8 million.

As previously mentioned, we paid cash of approximately $14 million for the two acquisitions, but received $32 million on the property sale and the sale leaseback transaction.

We were quite active in our stock buyback program.

During Q3 of fiscal 'twenty, two we spent approximately $51 5 million to repurchase over 600000 shares, leaving approximately one 4 million shares available to repurchase under the current program.

Our balance sheet is solid with net leverage under one five and significant capacity for acquisitions and additional stock buybacks we.

We have multiple alternatives to satisfy our obligations under the convertible notes, which mature in September .

And finally turning to guidance.

As Deepak described we are anticipating strong sequential growth in Q4 supported by the backlog and sales pipeline.

We are reiterating our previous fiscal 'twenty, two sales guidance of a range of $1 6 billion to $1 95 billion as well as the non-GAAP EPS guidance of a range of $5 75 to 602 per diluted share.

We currently believe this revenue and non-GAAP earnings guidance reflect reasonable estimates and we have taken into account the anticipated impacts of the COVID-19, pandemic and supply chain challenges in our guidance give.

Given uncertainties as to the duration and scope of the pandemic and supply chain disruptions as well as other variables. However, the extent of the impact on the company's financial results is difficult to predict and could vary significantly from the anticipated impacts currently reflected in our estimates and guidance.

Actual revenues and non-GAAP earnings per diluted share 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 focused on the growth of our businesses.

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 solid results during the first nine months of fiscal 'twenty two in a dynamic changing environment 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.

We would like to take this opportunity to thank the global lower sized team for its continued dedication in supporting our customers and contributing to the creation of value for our stakeholders and at this time, we'd like to open the call to questions.

Thank you as a reminder to ask a question you will need to press Star and then one on your telephone.

Your question. Please press the pound team.

And our first question comes from Brian Wittenberg from Imperial Capital. Your line is open.

Yes. Thank you very much so first of all wanted to dig down on the two acquisitions you made.

Can you give us some kind of scale on size and how much you paid for those ballpark is it bigger than a breadbox anything that you can give us in terms of what these two acquisitions would add to revenue.

And how much you bet.

Sure Brian This is Alan good questions.

The acquisition prices were a total of about $14 million plus some contingent earn out.

In terms of the scale that they are not large what we would anticipate for our fourth quarter would be something about around $3 million revenue contribution.

Bought these later in February so for the Q3 contributed about $1 million in revenues.

But no particular profit in such a short time.

Great. Thank you. Yes go ahead, Brian Yes. This is deepak just to add on as I mentioned these acquisitions basically are made especially gatekeeper for a longer term view of adding on to our product portfolio in security and on the software enhancement and rethink that.

It will have good impact.

'twenty three and beyond.

Great.

We're down that road talking about gatekeeper in search and you can give us an update on.

Kind of traction where you are on certain scan if theres been any new wins, what the pipelines looking at looking like first part Sam.

Well, we are very excited about it to as we mentioned in the previous call for Q2 on the $200 million order that we got from CBP.

Ted.

Portion of it for the software such scan.

We are implementing it and I mentioned just now in my.

In my presentation, we believe that there is a lot of thought going on in Washington stopped getting onto a 100% inspection at the southern border not just of course, but at the border crossings and to get there.

CVP needs to be more efficient they need to have more.

Software integration to be able to have control control centers all back is right up the alley.

Ill.

So again, we are working with our customer at the same Donlin mentioned all our other donkey systems already absorbed Ken we had in answering it in any place that we are offering an international sector. We continue to offer <unk> as a model and at the same time.

The good thing about this model is that it's agnostic foreign equipment.

Some of our competitor units are also going to integrated into the software at black follow ups.

So get to keep it on the other hand, the test other products, which complement.

After scan products, we believe that the issue of recognition manifest to be able to see.

The reader.

<unk> made readers and stuff all of that software enhances our capability of offering a solution and most important thing in this thing that we have to continue to say that Brian .

We believe that this software model has now blocked traction.

Working and it's basically going to enhance the margin of the division and has the ability to have what is called licensing fees upgrade ability.

Multiple years of enhancement with a very good margin as we go forward.

Okay.

And then just last question. Thank you very much deepak for that color.

On the repurchasing front, you repurchased a lot of shares in the period and have a lot more outstanding.

Is the plan to continue repurchasing at this kind of aggressive rate our ways.

The quarter this last quarter, an aberration because you had all the cash come in from the sale leaseback.

Yes, Brian Good question. So we we.

We certainly utilize some of the cash that came in from the sale leaseback, but well beyond that in terms of what we repurchased.

We look at our overall capital allocation and believe that stock buyback is an attractive element for us with one 4 million shares available to repurchase it continues.

To represent a very.

Attractive option for us, but as you know we don't comment on specifically, what we may or may not buy.

Alright, Thank you very much.

Thank you. Our next question comes from Larry Solow from CJS Securities. Your line is open.

Great. Thanks, guys good afternoon.

A couple on the on the supply chain and logistics area.

Have you seen supply chain.

The costs and as well as just supply in general things gotten better worse can you kind of just give us a feel of what you guys are seeing specifically.

Well, we can predict.

In some areas its gotten better in some areas. It's just the same we don't think there is going to get worse.

<unk> created a big challenge it changes.

And our supply chain, especially in the electronic components.

Is definitely a big challenge not only for supply of the product, but also what is call end of life.

Some.

Vendors are basically stopping production.

So basically it's there it's not going away, but we as a company. We feel we are stronger than our competitors because we are vertically integrated and we have division and manufacturing in various parts of the world.

So we are capable of handling it better and we have looked at the supply chain in a very focused manner and we are very much addressing.

Okay.

Fair enough.

Give us a little more the book to Bill you saw I think you said it was one one I assume thats, mostly security and health care.

And very.

Security.

I mean security and health care.

Okay, mostly.

<unk> backlog business. So can you just give us a little more color there was it sounds like <unk> might have been.

Leading the way there is that correct.

Yes, Larry this is Alan good question, Yes, <unk> had terrific bookings security was solid as well and Youre right its security and after that really sort of lead the way to the $1 one.

I would say it was a little bit more tilted towards towards auto and this particular quarter.

With strong overall.

Okay and you guys just in terms of the supply chain just touching back on that.

Is it limited.

Actual areas, where you're not able to up sell things in your leasing revenue on the table because of the lack of supply.

Or other reasons.

Well.

Theyre not theyre not going any place, let me say, we are not going to supply and the customers understand it.

Alright, basically it just pushes to the right.

<unk>.

Customers are patient they understand the issues and in some cases, especially in the optical side.

Customer base and the Oems large manner.

Manufacturers' bake also come to help and assist after division to procure material.

Okay. Okay Gotcha. Okay. Just last question just in terms of the guidance.

Sometimes you guys would narrow it by the fourth quarter pretty wide range for the for the last quarter of the year or is that just because uncertain times.

Rather just leave it alone.

I think call it to that.

Yes, Larry this is Alan you're right typically would narrow it in the fourth quarter.

We do believe these times are sort of unprecedented over the last couple of years.

And both of them.

Lately, so with all that uncertainty out there we felt it most prudent to leave the range as it is.

Fair enough that makes sense, okay, great. Thanks, guys I appreciate it.

Thank you. Our next question comes from Josh Nichols from B Riley Your line is open.

Yes, thanks for taking my question.

I think you mentioned.

You're going to start delivering on those big IQ and CVP I think in the fiscal fourth quarter is that still the case or like what's.

Any clarity you can provide.

And how quickly those might ramp up and is that going to be like a 12 to 18 months delivery timeframe and what the expectation there is.

Josh This is Alan Yeah. Good question, we do expect to get some revenues from that in Q4, though somewhat modest we expect it to really be a big contributor to our revenues in each of fiscal 'twenty, three and 'twenty four and then some of the service component for for many years after that but fiscal 'twenty three 'twenty four it will be the the <unk>.

Revenue components from those contracts.

And then glad to hear the company.

Focusing more in targeting some of these.

Software opportunities specifically like search scan that you mentioned.

But think.

Think about the size of the opportunity as far as like the software piece of the business.

Were to expand beyond just doing the supports and things like that but but more towards like the southern border scanning Mike.

Any way you can help train type of opportunity when we think about like next fiscal year for search.

Scan if some of these do things differently.

What opportunities do come to fruition.

Well, obviously, we don't want to break it down but what we can say is as we move forward.

Content of software will continue in absolute dollars to keep going up.

Because as there are more sites installed as there are more customers who will accept it.

As we have said that software as a SaaS software. It is ultra agnostic to the equipment. So just think about it that all whether the equipment is rapiscan equipment. It made by the <unk> competitors.

If the customer is going to go back and standardize it can make one central station to do integration the software will be needed and that not only is it installation software, but also licensing fees and as the what we call number of shares increased as they get more people are trained to be on the software.

To increase so we can give you the exact size, but we believe that going forward as a percentage of revenue. So ex scan gatekeeper and some of the other integrator software will continue to go up.

Yep.

And it had high margin.

Thanks, and then just last question I guess, two part question kind of but it's related.

So one given the vertical integration into global presence, you probably have better visibility and a lot of the companies one.

Andy any indication of when the supply chain may.

Start to ease or is it too hard to say and then the second part is like.

<unk> is a tough environment to grow and given that these headwinds are there like.

With the supply chain at least in the near term what I kind of wanted to.

So against the opportunities on the horizon.

<unk> could accelerate the company's growth rate.

Mid single digit to low double digit level over the next year or so.

Supply chain constraints start to ease.

Well good question difficult to predict all we can say is without broad.

From our base with our broad what I call vertical integration.

There is not a customer out there who as they need product more approach us ought to be one approach to that so as the supply chain gets a little bit better as there is more travel as we are able to travel and see the customers.

Face to face that's all growth everywhere domestic growth is definitely their CBP has made it very clear and like I mentioned in my presentation.

Washington D. C. Congress has been talking about 100% inspection at the borders that is a major major increase and as that goes and the interaction with other.

Part of doing business in other countries.

We'll continue to grow and supply chain sooner or later, we'll get better.

Thanks, that's all for me.

Thank you our next.

Question comes from Sara.

Hi, Oh go from Jefferies. Your line is open.

Hey, good afternoon, Deepak Alan Thank you.

Maybe just on the topic of the Dod.

How much of your security business comes from the Department of Defense and when we think about the budget just released.

What line items, where should we be looking for OSI direct benefit.

Number one <unk> is also a good customer for us we do business with them, especially there is a lot of interest right now in the international sector.

To help resolve this conflict thats going on.

We can break it down specifically, but if you want to go look into it you just look into it non intrusive equipment for basis protection or borders.

Places, where there is a high risk of bad things coming across the border and those are the kind of places where Vod all over internationally.

They use that equipment.

For example, at one time, we had a lot of equipment in Afghanistan.

That was a great thing and at the same way there are other places in the world, where Vod is very much interested especially with what's happening in the world.

And then on.

And we.

I think about the end markets that you service within security.

And Julien <unk>.

Buying and I might have missed them, but I think you said aviation was down so.

So can you go around the different end markets and maybe give us what are the trends you're seeing.

Well, what we said was that at the borders and as the porch.

<unk> continues to be very robust.

Air cargo continues to be very robust as there is more.

Air freight going over definitely aviation passenger business airports have been down for last couple of years, but it's coming back you can just see it everywhere airlines are increasing their flights they are increasing their cost structure, they need more than one more people into it because somebody is coming and there's more travel and as that happens.

Globally.

The Air force need to ramp up so we think that that's a little bit behind the other businesses.

But it is coming back.

Okay. So we should think about as they receive funds they'll deploy them for security equipment.

That's the way to sort of think about that and then did you quantify the supply chain impact for profitability. How do we think about security margins not only in Q4 ramping backup but into fiscal 'twenty three.

Sheila this is Alan.

I would anticipate that we'll see.

A nice sequential improvement in the operating margins for security in the Q4.

So we feel quite confident about that at this point in time, we don't quantify the supply chain issues. We will expect the supply chain issues challenges will continue to be there for prop.

The balance of this calendar year.

But nonetheless, we expect some expansion of our operating margins.

Thank you.

Thank you and as a reminder to ask a question. Please press star and then one more.

Our next question comes from Jeff Martin from Roth Capital Partners. Your line is open.

Thanks, Good afternoon, Dave.

Dave I was intrigued by your comment with respect to.

Customers are increasingly willing to initiate projects delayed and the pandemic is that with respect to.

Orders that had been pushed to the right are you referring to taking on new projects.

Adam do you want to take that and you repeat that again I didn't understand very well, Jeff can you repeat it.

Oh, Yes, I was referring to your comment in your prepared remarks regarding customer willingness to initiate projects that were delayed in the pandemic I was curious if those were existing Warner John those are potential new orders.

And anything you could provide some color around that maybe an example would be helpful.

I would say, it's both ways some of the orders we already have.

And now that it's getting a little bit easier to travel and installation and stuff customers are encouraging to get that started but most of the stuff is new business, especially in aviation as Ed and I. Both mentioned aviation has been a little bit.

A little bit I would say significantly hurt the last couple of years, it's coming back and that happens. That's the area that we think that theres going to be much more demand. The other businesses. Most of them are longer lead items, you're going to be already have the products or they are already in our pipeline. Just a question of its supply chain and be able to get an install.

And sign up from the customers.

Okay, Great and then with respect to border protection.

We've talked a lot about the U S opportunity are you seeing increased opportunities in international markets as well.

The answer is yes.

One area.

That every every country.

Wants to do it the right way to think of it this way I'm sure you've heard about it yet.

All the ports at every place there is such a big waiting list.

One is able to expedite the freight.

By inspection from the source, where the ship left.

And to come to U S or Europe , it doesn't need duplicate inspections. So everybody is working that way.

And we have got a very successful model already working between one and the Black Sea port.

It's a wonderful system thats, working very well, which has increased the apprehension about almost 30% of the carnival coming from there to the U S.

Okay, Great and then last question for me you mentioned, the significant margin expansion opportunity within security relating to <unk>.

Software and SaaS model curious if you could maybe.

Looking at Crystal ball here and give us a sense of where you think security margins could go over the long term as.

Feasible to get north of 20% on the operating margin side for security.

Hey, Jeff This is Alan I would say in particular quarters, we could we could certainly get north of 20% in terms of being there on a long term sustainable basis. It is absolutely a goal.

It's a question of how fast <unk> and some of our other.

Proprietary software products.

Our adopted because those do approach typical SaaS like margins. So certainly a goal to have nice margin expansion in the security business.

Great. Thanks, Thanks for your time and good luck with the strong fourth quarter and closed the year out strong here.

Thank you.

Thank you and.

And our last question comes from Brian Rotenberg from Ontario Capital. Your line is open.

Yes, just as a follow up guys real quick.

You talked several times about the 100% inspection potentially.

For I assume cargo.

Port and border inspection coming into the United States, where are we now last numbers I've heard is we're at sub 10% and what im trying to get to is what does this mean in terms of potential equipment sale then.

And trying to.

Understand where we are now and where it could potentially go.

Well, Brian very good question, and we won't comment on it because the numbers are all over the place all I can say to you is that's why we obtain and a significant growth opportunity.

And you have one cannot go efficiently to that high number of inspection without getting one.

When I called software integration and to be able to be more efficient with collection of the data the images bussing. The trucks fast so that we think that that golden opportunity, there's a lot of potential.

And all we all I can say that is that on the southern border at certain places between us and the customer we have actually demonstrated at one or two crossings that we can do 100% inspection.

Okay, and what is the timing potentially of that 100% inspection that theyre talking about.

Is it five years are they talking that it can be done quicker.

I guess youll gasoline has got his mind.

I come back to it is that positive thing it's working towards that.

Again, it has to be efficient to the efficiency and the ability for Congress to have money available.

And we think that that's golden opportunity and it will continue to grow and we are we are well positioned but I can't say when it will happen how fast it will happen all I can say is that as you look at that.

The forecast and the talk of.

<unk> growth opportunity over the next couple of years.

Great. Thank you very much.

Thank you.

Showing no further questions from our phone line.

Yes.

Well, thank you very much and again I want to thank all the employees and also the patience of our customers and the support of our stockholders.

We're not saying, it's not been a challenging time.

We're going to continue through this but we are well positioned we.

We are addressing all the issues supply chain logistics freight R&D new products.

Employee safety customer satisfaction, that's all in our blood and we will continue to do the best we can.

We are feeling very good about it that will have a strong year end and looking forward to that plus continued years of growth.

And the business. Thank you.

Yes.

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

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Okay.

And thank you for standing by and welcome to the OSI Systems, Inc. Third quarter 2022 conference call. At this time, all participants are in a listen only mode.

After the speaker's presentation, there will be a question and answer session.

To ask a question during the session you will need to press Simon wanting your telephone please.

Please be advised that today's conference is being recorded.

Barring any further assistance please press star and then zero.

I'd now like to hand, the conference over to your Speaker today, Alan <unk> Chief Financial Officer. Please go ahead.

Well thank you.

Good afternoon, and thank you for joining us I'm, Alan Edric, Executive Vice President and CFO of OSI systems, and I'm here today, with Deepak Chopra, our president and CEO .

Welcome to the OSI systems fiscal 'twenty, two third quarter conference call. We are pleased that you can join US as we review our financial and operational highlights.

Earlier today, we issued a press release announcing our third quarter of fiscal year 'twenty two financial results.

Before we discuss our Q3 results. However, I would like to remind everyone that today's discussion will include forward looking statements and the company wishes to take advantage of the Safe Harbor provisions of the private Securities Litigation Reform Act of 1995 with respect to such forward looking statements.

All forward looking statements made on this call are based on currently available information and the company undertakes no obligation to update any forward looking statements.

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.

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 third quarter of fiscal 'twenty, two and then turn the call over to Deepak for an overview of our business performance.

I will then finish with more detail regarding our financial results and a discussion of our outlook for the full year of 2000 fiscal 2000.

We are pleased with our results this quarter, despite global marketplace challenges, including increasing supply chain delays in logistics cost and geopolitical events.

Now we will go through a high level summary of our financial results.

Bookings were solid with a Q3 book to Bill ratio of one one.

We ended the quarter with a near record backlog of over $1 2 billion, representing a 14% increase.

Since the end of the last fiscal year.

Operating cash flow for the third quarter was strong as we generated approximately $38 million, while capex was approximately $3 million.

We also spent approximately $51 million in our share repurchase program.

Before diving more deeply into our financial results I will turn the call over to Deepak.

Thank you Alan.

And again, good afternoon, and welcome to the OSI systems earnings call for the third quarter of fiscal 2022.

We are pleased with our third quarter results, where we achieved solid rocket stability and strong cash flow on slightly higher revenues from the prior year.

Overall bookings continued to be robust and strong as we ended Q3 with a backlog of $1 2 million approximated.

Going into our third quarter highlights in each division.

And then I'll turn it back over to Alan to provide further detail on our deep financial performance.

Starting with security, where revenues grew 5% from the prior year. Despite facing the challenges that Alan mentioned from a global supply chain and logistics and travel constraints that continue as we speak even today.

During the quarter.

We continued to strengthen our offerings to the marketplace.

As we made two small strategic acquisitions, which are consistent with our focus on increasing the service and software portion.

Cutting revenue base.

We took a similar approach in another region, a few years ago, and which we have seen a marked increase in sales since that acquisition.

We also acquired a U S based company called Gatekeeper.

Which provide intelligent optical inspection and the recognition solutions to identify threats and provide real time actionable intelligence.

<unk> solutions are utilized.

Border crossings and checkpoint X critical infrastructure worldwide.

<unk> acquisition.

<unk> plans on hardware offering wireless proprietary software used for the integration of third party solutions for example in vehicle identification facial recognition and container tracking complements the capabilities of our <unk>.

Third scan software platform on integration software for cargo and vehicle inspection at checkpoints and border crossings.

As we have mentioned before we are excited about the traction we are gaining with our search scan software as a service or SaaS model with potential customers.

Over the last few years, we have made a concerted effort to grow our revenues from systems integration software and ongoing service and support.

These complementary offerings are included in many of our proposals and provide a more steady stream of revenues over the life of the program as compared to a traditional standalone inspection hardware sale. Moreover high.

Higher recurring revenue contribution from software such as search scan operator in Medina training modules and automated image analysis logarithms has the potential to significantly enhance the overall margins in this division.

In addition to making acquisitions like gatekeeper, which brings new vehicle and passenger checkpoint software, we are making significant R&D investments to further enhance our overall software solution offering and securities.

During the quarter.

We made progress on our ongoing major programs, including the one with the U S customs and border protection CBP.

We are in various stages up supporting the enhancement of the U S border security infrastructure, utilizing our cargo and whitefield scanning platforms with X Ray based technologies and.

In addition to the hardware.

The extent and the offerings from gatekeeper.

Included in the solution for some of these airports that CBP.

We believe that this will continue to grow as CVP continues to expand this approach <unk>.

S border crossings on the southern border with Mexico.

I might have heard that our ongoing discussion in Washington, DC to get to 100% inspection at the southern border with Mexico.

As you might have as an example of the importance of our solutions in helping protect borders and preventing the movement of illegal drugs and contraband CVP recently announced a significant drop seizure.

At a border crossing the El Dorado, Texas.

Multiple screening methods and technologies were used to find the mix hidden inside of trucks trailer that was also getting food packages. We are truly proud of our contribution in helping secure U S borders.

<unk> deep programs in Albania beyond our nickel and Guatemala had been running as expected and are invaluable and demonstrating our large program experience and capabilities to customers as we bid on major projects worldwide.

Most of these programs also have already integrated <unk> into their software.

The aviation passenger traffic domestically is returning closer to pre COVID-19 levels, while international traffic is returning at a slower pace.

Since we have exposure to both U S and international airports.

Next our aviation business worldwide to grow as these customers will require the latest technology inspection systems service and support to handle the growth and efficient manner.

During March we hosted our Napa <unk> systems called classic FPGA toward event that was held in Biloxi, Mississippi.

We want to congratulate the winner Steve Elkhart, and thank all others that help make it a successful event many of our employees industry partners and customers, both domestic and international had the opportunity to attend an interactive the classic.

Events also raised $1 6 million to support local Kennedy's in coastal Mississippi.

Over the last couple of years. The security Division has successfully managed to work through the Covid related challenges in the marketplace and meet customer demand.

Going forward, we anticipate higher demand exports borders in airports and a greater willingness from these customers to initiate major projects that were delayed during the pandemic.

We have a strong backlog and a pipeline of significant global opportunities across our broader portfolio.

The recent acquisitions during the quarter also bring new customer relationships that we can leverage to provide other products and services from our existing offerings.

With a strong backlog we are poised for a significant sequential increase in sales and profits in this division, we believe that our ability to offer leading technology and innovative solutions positions us well into fiscal 'twenty three and beyond.

Moving to our Optoelectronics and manufacturing division in Q3 revenues were solid while bookings were exceptional leading to a record backlog for the division.

The Opto Division continues to work through global supply chain and logistics challenges.

Successfully solved its large OEM base that also includes our other divisions security and healthcare.

<unk> saw growth across certain product groups, especially optical components and assemblies for healthcare and technology Oems via.

We announced a couple of notable wins and multiyear order for approximately $35 million.

To provide electronic assemblies for use in patient care applications and in order for approximately $5 million to provide electronic components to a leading excellent imaging OEM manufacturer.

During the quarter Opto Division also continued efforts to make us new Indian facility fully operational which expands our footprint in the region to handle the anticipated future growth, especially for health care products.

Moving to the healthcare Division space Labs, we had we had a strong quarter.

During the quarter, we saw strength in the U S channels.

Cardiology products continued to do well in the quarter with double digit revenue growth.

Overall, the healthcare Division has performed well as the market activity has shifted from COVID-19 centric demand to more normal historical demand patterns.

We want this year I've been impressed with the commitment of our employees to manage the unique challenges in the marketplace and relentlessly serve our customer base, we look forward to finishing the year strong and further enhancing our value to our customers that are critical in promoting health and safety worldwide as always I would like to.

Thank our employees customers and stockholders for their continued support.

With that I'm going to turn the call over back to Alan to talk more in detail about our financial results and guidance before we open the call for questions. Thank you.

Well, thank you Deepak.

Now I will review the financial results for our fiscal third quarter and a little greater detail.

As mentioned earlier fiscal Q3 revenues were up 2% compared with that of the prior year.

Security Division revenues were up 5% with increases in both product and service sales, mainly driven by our cargo and vehicle inspection products.

Although aviation related sales were down year over year. We are currently seeing an uptick in activity in this arena.

After a sales, including intercompany sales increased 2% year over year with continued momentum in this sector.

While patient monitoring sales decreased cardiology related sales increased significantly for the third consecutive quarter.

The Q3 gross margin was 35, 4% compared to 36, 7% reported in Q3 of fiscal 'twenty one.

The mix of sales within the security division were less favorable than in the prior year's comparable quarter.

And revenues in our healthcare division, which carries a higher gross margin than our other two divisions were down slightly each of which has a downward impact on the consolidated margin.

Many companies, we experienced increases in certain component and Frank and freight costs in each division.

Which impacted the gross margin overall.

Our gross margin will fluctuate from period to period based on revenue mix and volume among other factors.

Moving to operating expenses.

Q3, SG&A expenses were $58 million comparable to last year or 19, 9% of sales compared to 24% of sales in the prior year Q3.

R&D expenses in Q3 of fiscal 'twenty, two were $15 1 million.

Representing a year over year increase of 9%.

We continue to dedicate considerable resources to R&D, particularly in security and healthcare.

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

In Q3 of fiscal 'twenty, two we recorded a $1 $5 billion restructuring and other charge as compared to a benefit of <unk> 3 million in Q3 of the prior fiscal year.

As previously mentioned, we successfully executed the sale leaseback of our Hawthorne, California facilities.

At an attractive sale price of $32 million. This.

This resulted in a pretax gain of approximately $27 million, which has been recorded in other income and excluded from our non-GAAP earnings.

Moving to interest and taxes.

Net interest and other expense in Q3 of fiscal 'twenty, two decreased to $2 3 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 eliminated the noncash interest expense associated with our convertible debt.

We note that adoption of the accounting standard also resulted in increased debt on the balance sheet by eliminating the unamortized discount of approximately $10 million.

On the tax side, our reported effective tax rate and GAAP was 21, 21% in Q3 fiscal 'twenty two compared to 33, 7% in Q3 of fiscal 'twenty one.

In Q3 of this year, we recognized a discrete tax benefit of <unk> 2 million as compared to a $2 $2 million discrete tax expense in Q3 of last year.

I will now turn to a discussion of our non-GAAP adjusted operating margin.

Overall, our non-GAAP adjusted operating margin was 11, 4% in Q3 of fiscal 'twenty two.

As compared to 12, 6% in Q3 of last year.

The change was primarily driven by the previously discussed factors related to gross margin and increased investment in research and development.

We were pleased with the increase in the adjusted operating margin in our Opto Division.

Which expanded to 12, 9% in Q3 this year as compared to 12, 5% in the prior year third quarter.

We were also pleased that the adjusted operating margin in our healthcare Division expanded to 14, 7% in Q3 of fiscal 'twenty, two compared to 13, 9% in Q3 last year.

This increase was driven by a stronger gross margin due to a favorable product mix, including strong high margin cardiology sales.

The security division's adjusted operating margin decreased to 14, 9% in Q3 of this year from 17, 9% in Q3 of the last fiscal year.

Which more than offset the improvements in the other two divisions, primarily due to a less favorable mix of customer revenues.

Rising costs in the supply chain.

Higher marketing expenses for promotional activities that were specific to Q3 and.

And increased R&D to support new product development.

Let's move to cash flow.

Cash provided by operations was $38 4 million in Q3 <unk>.

Capex in the third quarter was $2 9 million, while depreciation and amortization expense in Q3 was $9 8 million.

As previously mentioned, we paid cash of approximately $14 million for the two acquisitions, but received $32 million on the property sale and the sale leaseback transaction.

We were quite active in our stock buyback program.

During Q3 of fiscal 'twenty, two we spent approximately $51 5 million to repurchase over 600000 shares, leaving approximately one 4 million shares available to repurchase under the current program.

Our balance sheet is solid with net leverage under one five and.

And significant capacity for acquisitions and additional stock buybacks.

We have multiple alternatives to satisfy our obligations under the convertible notes, which mature in September .

And finally turning to guidance.

As Deepak described we are anticipating strong sequential growth in Q4 supported by the backlog and sales pipeline.

We are reiterating our previous fiscal 'twenty, two sales guidance of a range of $1 6 billion to $1 195 billion as well as the non-GAAP EPS guidance of a range of $5 75 to 602 per diluted share.

Given uncertainties as to the duration and scope of the pandemic and supply chain disruptions as well as other variables. However, the extent of the impact on the company's financial results is difficult to predict it could vary significantly from the anticipated impacts currently reflected in our estimates and guidance.

Actual revenues and non-GAAP earnings per diluted share 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 focused on the growth of our businesses.

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 would like to take this opportunity to thank the global lower sized team for his continued dedication in supporting our customers and contributing to the creation of value for our stakeholders and at this time wed like to open the call to questions.

Thank you as a reminder to ask a question you will need to press Star and then one on your telephone to withdraw.

Your question. Please press the pound team.

And our first question comes from Brian Rotenberg from Imperial Capital. Your line is open.

Yes. Thank you very much so first of all wanted to dig down on the two acquisitions you made.

Can you give us some kind of scale on size and how much you paid for those ballpark.

Bigger than a bread box anything that you can give us in terms of what these two acquisitions would add to revenue and how much you pay.

Sure. Brian This is Alan good questions. The acquisition prices were a total of about $14 million plus some contingent earn out.

In terms of the scale or Theyre not large what we would anticipate for our fourth quarter would be something about around $3 million revenue contribution.

We bought these later in February so for the Q3 contributed about $1 million in revenues.

But no particular profit in such a short time.

Great. Thank you. Yes go ahead, Brian Yes. This is deepak just to add on as I mentioned these acquisitions basically are made especially gatekeeper for a longer term view of adding on to our <unk>.

Roddick portfolio in security.

And on the software enhancement and we think that it will have good impact in fiscal 'twenty three and beyond.

Great.

Maybe.

We're down that road talking about gatekeeper in search and you can give us an update on.

Kind of traction where you are on certain scan if theres been any new wins, what the pipelines looking at looking like first part Sam.

Well, we already are very excited about it to as we mentioned in the previous call for the Q2 on the $200 million order that we got from CBP.

Ted.

<unk> of it for the software such scan.

We are implementing it and I mentioned just now in my.

In my presentation, we believe that there is a lot of talk going on in Washington stopped getting onto a 100% inspection at the southern border not just at the ports, but at the border crossings and to get there.

CVP needs to be more efficient they need to have more software integration to be able to have a drug control centers. All back is right up the alley.

<unk>.

So again, we are working with our customer at the same time I mentioned, all our other donkey systems already absorbed scan we on an answering it in any place that we are offering an international sector. We continue to offer <unk> scan as a model and at the same time.

Good thing about this model is that is agnostic foreign equipment.

And some of our competitor units are also getting integrated into the software platform of <unk>.

So get keep it on the other hand, the test other products, which complement that.

The Rapiscan products, we believe that the issue of recognition manifest to be able to see the reader.

Led readers and stuff all of that software enhances our capability of offering a solution and most important thing in this thing that we have to continue to say that Brian .

We believe that this software model has now got traction.

Working and it's basically going to enhance the margin of the division and has the ability to have what is called licensing fees upgrade.

So that will have a multiple years of enhancement with a very good margin as we go forward.

Hello.

And then just last question. Thank you very much deepak for that color.

On the repurchasing front, you repurchased a lot of shares in the period and have a lot more outstanding.

Is the plan to continue repurchasing at this kind of aggressive rate our ways.

The quarter this last quarter, an aberration because you had all the cash come in from the sale leaseback.

Yes.

Yes, Brian Good question. So we we.

We certainly utilize some of the cash that came in from the sale leaseback, but well beyond that in terms of what we repurchased.

We look at our overall capital allocation and believe that stock buyback is an attractive element for us with one 4 million shares available to repurchase it continues to.

To represent a very.

Attractive option for us, but as you know we don't comment on specifically, what we may or may not buy.

Alright, Thank you very much.

Thank you. Our next question is from Larry Solow from CJS Securities. Your line is open.

Great. Thanks, guys good afternoon.

A couple on the on the supply chain and logistics area.

Have you seen supply chain.

The costs and as well as just supply in general things gotten better worse can you kind of just give us a feel of what you guys are seeing specifically.

Well, we can predict.

In some areas its gotten better in some areas. It's just the same we don't think thats going to get worse, but freight is a big challenge it changes.

And our supply chain, especially in the electronic components.

It is definitely a big challenge not only for supply of the product, but also what is call end of life.

Some.

Vendors are basically stopping production.

So we are capable of handling it better and we have looked at the supply chain in a very focused manner and we are very much addressing.

Okay.

Fair enough and now.

Give us a little more the book to Bill You said I think you said it was one one I assume thats, mostly security and healthcare.

Any.

And security.

I mean security in Opco that health care.

Mostly.

Backlog business. So can you just give us a little more color there was it sounds like <unk> been.

Leading the way there is that correct.

Yes, Larry This is Alan Good question. You also had terrific bookings security was solid as well and Youre right. Its security and after that really sort of lead the way to the $1. One I would say it was a little bit more tilted towards towards auto and this particular quarter.

But strong overall.

Okay and you guys just in terms of the supply chain just touching back on that.

Is it limited.

Actual areas, where you're not able to up sell things in your leasing revenue on the table because of the lack of supply.

Or other reasons.

Well, yes.

We're not we're not going any place let me say, we are not going to supply and the customer to understand it.

Alright, basically it just pushes to the right.

And <unk>.

Customers outpatient they understand the issues and in some cases, especially on the optical side.

The customer base of the Oems large manufacturers bake also come to help and assist after division to procure the materials.

Okay.

I Gotcha, Okay, just last question.

In terms of the guidance.

Sometimes you guys would narrow it by the fourth quarter pretty wide range for the for the last quarter of the year is that just because uncertain times are you just rather just leave it alone I think call it to that.

Yes, Larry this is Alan you're right typically would narrow it in the fourth quarter.

We do believe these times are sort of unprecedented over the last couple of years.

Absolutely lately, so with all that uncertainty out there we felt it most prudent to leave the range as it is.

Fair enough that makes sense, okay, great. Thanks, guys I appreciate it.

Thank you. Our next question comes from Josh Nichols from B Riley Your line is open.

Yes, thanks for taking my question.

I think you mentioned.

You're going to start delivering on those big IQ and with CBD I think in the fiscal fourth quarter is that still the case or like what's.

Any clarity you can provide.

How quickly those might ramp up and is that going to be like a 12 to 18 months delivery timeframe and what the expectation there.

The big revenue components from those contracts.

And then glad to hear the company.

Focusing more in targeting some of these.

Software opportunities specifically like search scan that you mentioned.

But.

Think about the size of the opportunity as far as like the software piece of the business.

Were to expand beyond just doing like supports and things like that but more towards like the southern border scanning Mike.

Any way you can help frame what type of opportunity when we think about like next fiscal year for search scan. If some of these do think youre seeing that opportunities do come to fruition.

Well, obviously, we don't want to break it down but what we can say is as we move forward.

Content of software will continue in absolute dollars to keep going up.

As there are more sites installed as there are more customers, who accepted as and as we have said that software as a SaaS software as ultra agnostic to the equipment. So just think about it that all whether the equipment is rapiscan equipment on it.

Made by an FX gains competitors, if the customer is going to go back and standardize it can make one central station to do integration the software will be needed and that not only is it flushed installation software, but also licensing fees and as the what we call number of shares increased as they get more people are trained.

On the software.

Continue to increase so we can give you the exact size, but we believe that going forward as a percentage of revenue. So ex scan gatekeeper and some of the other integrated software will continue to go.

Up.

And it had high margin.

Thanks, and then just last question I guess, two part question kind of it is related.

So one given the vertical integration and a global presence you probably have better visibility and a lot of the companies one.

Andy any indication of when the supply chain may start to ease or is it too hard to say and then the second part is like.

Acknowledging is a tough environment to grow and given that these headwinds are there like.

With the supply chain at least in the near term what are kind of the one or two.

First the opportunities on the horizon.

Do you think could accelerate the company's growth rate.

Mid single digit to low double digit level over the next year or so.

Supply chain constraints start to ease.

Good question difficult to predict all we can say is.

With our broad brushed.

Customer base with our broad what I call vertical integration.

<unk> is not a customer out there who as they need product more approach us or be one approach to that so as a supply chain gets a little bit better as there is more travel as we are able to travel and see the customers more.

Face to face that's all growth everywhere.

<unk> growth is definitely their CBP has made it very clear and like I mentioned in my presentation, Washington D. C. Congress has been talking about 100% inspection at the borders that is a major major increase and as that goes and the interaction with other <unk>.

Off of doing business in other countries. This will continue to grow and supply chain sooner or later, we'll get back.

Yes.

Thanks, that's all for me.

Thank you. Our next question comes from Sara.

Ergo from Jefferies. Your line is open.

Hey, good afternoon, Deepak Alan Thank you.

Maybe just on the topic of the D O D. How much of your security business kind of span the department of defense and when we think about the budget just released.

What line items, where should we be looking for OSI direct benefit.

While a number one <unk> is also a good customer for us we do business with them, especially there is a lot of interest right now in the international sector.

To help with all of this conflict thats going on.

We can't break it out specifically, but if you want to go look into it just look into it.

Non intrusive equipment.

Four basis protection or borders.

Places, where there is a high risk of bad things coming across the border.

And those are the kind of places where Vod.

Internationally.

They use that equipment.

For example, at one time, we had a lot of the company in Afghanistan.

And that was a great thing and at the same way there are other places in the world, where Vod is very much interested especially with what's happening in the world.

And then on.

When we.

Think about the end markets that you service within security.

And Julien <unk>.

One of buying it I might have missed something but I think you said aviation was down so.

So can you go around the different end markets and maybe give us sort of the trends youre seeing.

Well, what we said was stacked up at the borders and it supports that.

<unk> continues to be very robust.

Air cargo continues to be very robust as there is more.

Air freight going over definitely aviation passenger business airports have been down for last couple of years, but it's coming back you can just see it everywhere airlines are increasing their flights they are increasing their cost structure, they need more data more and more people into it because somebody is coming and there's more travel and as that happens.

Globally.

The airports need to ramp up so we think that thats, a little bit behind the other businesses.

But it is coming back.

Okay. So we should think about as they receive funds they'll deploy them for security equipment.

That's the way.

Think about that and then did you quantify the supply chain impact for profitability. How do we think about security margins not only in Q4 ramping backup into fiscal 'twenty three.

Sheila this is Alan.

We would anticipate that we'll see.

A nice sequential improvement in.

The operating margins for security in the Q4.

So we feel quite confident about that at this point in time, we don't quantify the supply chain issues. We expect the supply chain issues challenges will continue to be there for <unk>.

The balance of this calendar year, but.

But nonetheless, we expect some expansion of our operating margins.

Okay. Thank you.

Thank you and as a reminder to ask a question. Please press star and then one more.

Our next question comes from Jeff Martin from Roth Capital Partners. Your line is open.

Thanks, Good afternoon debacle.

Deepak I was intrigued by your comment with respect to yes.

Customers are increasingly willing to initiate products related to pandemic is that with respect to.

Orders that had been pushed to the right are you referring to taking on new projects.

Adam do you want to take that can you repeat that again I didn't understand very well, Jeff can you repeat it.

Potential new orders.

And anything you could provide some color around that maybe an example would be helpful.

Well I would say, it's both ways some of the orders we already have.

And now that it's getting little bit easier to travel and installation and stuff customers are encouraging to get that started but most of the stuff is new business, especially in aviation as Ed and I. Both mentioned aviation has been a little bit.

A little bit hard I would say significantly hurt the last couple of years, it's coming back and that happens. That's the area that we think that theres going to be much more demand. The other businesses. Most of them are longer lead items that we already have the products or that's already in our pipeline just a question of its supply chain and be able to get and install.

And sign up from the customers.

Okay, Great and then with respect to border protection.

We've talked a lot about the U S opportunity are you seeing increased opportunities in international markets as well.

The answer is yes.

It's one area.

That every every country.

Wants to do it the right way to think of it this way I am sure you heard about it.

All the ports at every place there is such a big waiting list.

One is able to expedite the freight.

By inspection from the source, where the ship left.

And to come to U S or Europe , it doesn't need duplicate inspections. So everybody is working that way.

And we have got a very successful model already working between why don't O'hara and the Black Sea Port.

It's a wonderful system, that's working very well, which has increased the epigenetic by almost 30% of the carnival coming from there to the U S.

Okay, Great and then last question for me you mentioned, the significant margin expansion opportunity within security relating to <unk>.

Software and SaaS model curious if you could maybe.

Looking at our Crystal ball here and give us a sense of where you think security margins could go over the long term as.

Feasible to get north of 20% on the operating margin side for security.

Hey, Jeff This is Alan I would say a particular quarters, we could we could certainly get north of 20% in terms of being there on a long term sustainable basis. It is absolutely a goal.

It's a question of how fast <unk> scan and some of our other.

Proprietary software products.

Our adopted because those do approach typical SaaS like margins. So certainly a goal to have nice margin expansion in the security business.

Great. Thanks for your time and good luck with the strong fourth quarter and closed the year out strong here.

Thank you.

Thank you and.

And our last question comes from Brian Rotenberg from Ontario Capital. Your line is now open.

Yes, just as a follow up guys real quick.

You talked several times about the 100% inspection potentially.

For I assume cargo.

Port and border inspection coming into the United States, where are we now the last numbers I've heard is we're at sub 10% and what I'm trying to get to is what does this mean in terms of potential equipment sale then.

And trying to.

Understand where we are now and where it could potentially go.

Well, Brian very good question, and we won't comment on it because the numbers are all over the place all I can say to you is that's why we obtain it a significant growth opportunity.

And your one cannot goal efficiently to that high number of inspection without getting one.

When I called software integration and to be able to be more efficient with collection of the data the images bussing the trucks fast so that we think that that set.

Golden opportunity, there's a lot of potential.

And all we all I can say that is that on the southern border at certain places between us and the customer we have actually demonstrated at one or two crossings that we can do 100% inspection.

Okay, and what is the timing potentially of that 100% inspection that theyre talking about.

Is it five years are they talking that it can be done quicker.

I guess youll gasoline has got his mind.

I come back to it is that positive thing it's working towards that.

Again, it has to be efficient to the efficiency and the ability for Congress to have money available.

And we think that that's golden opportunity and it will continue to grow and we are we are well positioned.

<unk>, but I can't say when it will happen how fast it'll happen all I can say is that as you look at the forecast and the talk of.

There is growth opportunity over the next couple of years.

Yes.

Great. Thank you very much.

Thank you and I am showing no further questions from our phone line.

Yes.

Well, thank you very much and again I want to thank all the employees.

And also the patience of our customers and the support of our stockholders.

We're not saying, it's not been a challenging time.

We're going to continue through this but we are well positioned.

We are addressing all the issues supply chain logistics freight R&D new products.

Employee safety customer satisfaction, that's all in our blood and we will continue to do the best we can.

And we.

We are feeling very good about it that will have a strong year end and looking forward to that plus continued years of growth.

And the business. Thank you.

Yes.

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

Q3 2022 OSI Systems Inc Earnings Call

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