Q4 2022 OSI Systems Inc Earnings Call

August 18, 2022

The conference will begin shortly to raise your hand during Q&A you can dial star one one.

[music].

Yeah.

Hello, Thank you for standing by and welcome to the OSI Systems, Inc. Fourth quarter 2022 conference call. At this time all participants are in a listen only mode. After the speaker presentation. There will be a question and answer session to ask a question during the <unk>.

And you will need to press star one one on your telephone. Please be advised that today's conference may be recorded I would 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 am Alan Edric, Executive Vice President and CFO of OSI systems.

Deepak Chopra, our president and CEO could not joining the call today due to an unavoidable last minute complex.

Welcome to the OSI systems fiscal 'twenty, two fourth quarter conference call.

Let's review, our business performance financial and operational results.

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

Before we discuss our 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 statements based upon subsequent events or new information or otherwise.

During today's call references will be made to both GAAP and non-GAAP financial measures when describing the company's results for.

For information regarding non-GAAP measures.

GAAP measures of the company's results and a quantitative reconciliation of those figures.

Please refer to today's earnings release.

Let's begin with a discussion of our financial performance for the fourth quarter of fiscal 2020 to provide an overview of our business performance.

And then let's finish up with more detail regarding our financial results and a discussion of our outlook for fiscal 'twenty three.

We are pleased with our results last quarter, particularly given the macroeconomic challenges, we faced including supply chain delays and logistics cost disruptive geopolitical events. The COVID-19, pandemic inflation and rising interest rates as we manage the current environment, we continue to prioritize delivering on commitments.

To our customers and partners and positioning the company for long term success.

Now, let's go through a high level summary of our financial results.

First.

We reported record Q4 revenues of $337 million or 1% year over year increase driven by record security Division sales the <unk>.

Strengthened security sales was partially offset by a slight reduction in year over year. After sales, mainly due to certain supply chain constraints and a small reduction in health care Division sales.

Second.

We reported record Q4 adjusted earnings per share of $1 96 up 27% from Q4 of the prior year driven by productivity improvements and favorable sales mix tighter cost controls, a lower tax rate and reduced share count, which outweighed higher supply chain logistics and labor costs.

Third.

Bookings were solid with a book to Bill ratio of just above one for Q4 at 113 for the full fiscal year.

We concluded the fiscal year with a record Q4 backlog of over $1 2 billion, a 15% increase over the backlog at the end of fiscal 'twenty one.

And finally operating cash flow for the fourth quarter was strong as we generated approximately $22 million, while capital expenditures were approximately $5 million.

We spent approximately $15 million and our stock buyback program in the fourth fiscal quarter.

Before diving more deeply into our financial results and discussing the fiscal 'twenty three outlook.

Let's provide more detail of our business performance by division, starting with security, where Q4 and fiscal 'twenty, two revenues increased 4% and 5% respectively year over year.

Security is Q4 book to Bill ratio of one point.

Was solid given record sales in the quarter.

The security Division ended fiscal 'twenty, two with a backlog, 10% higher than the end of fiscal 'twenty one.

Q4 was highlighted by robust performance important and border security related products and services.

With some notable bookings for these products, particularly with international customers.

We previously announced its yield these wins, a $12 million international contract to provide <unk> drive through cargo and vehicle inspection systems and related products and follow on services.

Another $12 million International Award for Eagle 60, mobile high energy cargo and vehicle inspection systems, along with follow on service and support.

And a $29 million international order to provide several cargo and vehicle inspection systems and various mobile and fixed configurations.

As international travel restrictions are gradually dissipating, we're capitalizing on opportunities where face to face sales and customer support are crucial.

In the U S. We began to deliver on the significant awards received earlier in fiscal 'twenty two under the indefinite delivery indefinite quantity contracts or IDI cues from the U S customs and border protection in Q4.

These programs not only utilize our cargo and vehicle inspection platforms, but also our search scan software and vehicle checkpoint Lane control solutions from Gatekeeper a business we acquired in the second half of fiscal 'twenty two.

We anticipate recognizing most of the revenue from these delivery orders over the next three years, which is somewhat longer than originally expected mainly due to customer readiness timing.

These were the first orders under the five year Iqs and there is opportunity to receive additional orders. During this timeframe as CVP continues to work towards their goals at the U S Southern border.

We continued to see traction with large U S customers for search scan our proprietary software platform that a cyber secure can manage inspection image data integrates with other it systems at checkpoints and facilitates the automation of inspection activity.

We're also working on international opportunities that would rely on search scan is a key component where equipment installation image data management systems integration and training are required.

Our turnkey service programs continued to perform well in Puerto Rico, Albania in Guatemala, and we are actively pursuing additional turnkey services opportunities.

Our revenue growth in ports and border security was offset to some degree by the lower revenues in our aviation related business.

Within this sector there were bright spots during the year as we worked with global logistics carriers, such as DHL and Fedex to address their demands for air cargo screening as passenger aviation related sales were more modest.

We anticipate that we could see an overall improvement in the aviation sector in calendar 'twenty three and forward as demand at international airports is anticipated to increase for servicing and upgrading passenger and baggage and baggage inspection infrastructure.

I should note that while aviation is an important market for us long term and accounted for under 10% of the total company revenues in fiscal 'twenty two.

These percentages will fluctuate year to year based on upgrade and replacement cycles among other factors.

Looking ahead with a significant backlog and a strong pipeline of opportunities with.

The security Division enters fiscal 'twenty three in a good position to drive revenue growth.

Moving onto optoelectronics.

The optoelectronics and manufacturing division generated total revenues, including intercompany of $367 million for fiscal 'twenty two.

Representing representing a 5% increase over revenues in the prior fiscal year and a new record for the division.

The Opto Division had strong bookings, finishing the fiscal year with a book to bill ratio of one two and a record year end backlog.

<unk> continues to support a wide variety of Oems in aerospace defense healthcare test and measurement automotive and consumer technologies.

Supply chain constraints longer lead times, and rising input costs adversely impacted us in fiscal 'twenty, two and continue to adversely impact us today.

We have been proactive however, and increased our inventory of certain materials to help mitigate the impact of supply chain disruptions.

And continuing to serve our customer base, while adjusting our pricing to reflect the increased material costs in this division.

During fiscal 'twenty, two we broadened our global operational footprint and improved our ability to handle heightened demand with the addition of our new Indian manufacturing facility is now nearly fully operational and as necessary regulatory approvals and customer acceptance, particularly from health care customers.

We also further vertically integrated our flexible circuit manufacturing operations.

By adding a wet etch processing operation, reducing our reliance on outsourcing to an already constrained global electronics supply chain, which.

This is expected to increase operating margins as well.

After a started fiscal 'twenty three with a large backlog and a global customer base that continues to rely on suppliers like auto that can execute in a tough environment.

We believe that we are well positioned in the Opto division for a strong year, although supply chain constraints are expected to push certain planned Q1 revenues into a subsequent quarter.

Moving to healthcare.

The healthcare division's fiscal 'twenty, two revenues were 3% below fiscal 'twenty one as expected.

Lower revenue level in fiscal 'twenty, two resulted primarily from reductions in pandemic related health care spending.

We continue to invest significant resources in R&D in our healthcare division to enhance our core offerings and to develop new products and patient monitoring and diagnostic cardiac cardiology that align well with the trend in the marketplace for enhanced digital connectivity to enable hospital to home patient care.

Looking ahead in the healthcare Division, we will focus on the continued growth of our cardiology and remote monitoring business and also drive recurring services supplies and accessories revenues.

To counter the drawdown of the elevated purchases of patient monitoring products during the pandemic.

Now, let's go through the financial results for our fourth quarter in greater detail.

So I've mentioned <unk> revenues were up 1% compared with that of the prior year Q4.

Fiscal fourth quarter Security Division revenues were up 4% on a very challenging comp given the divisional is exceptional performance in Q4 of fiscal 'twenty one.

This increase was primarily driven by our cargo and vehicle inspection offerings.

While both product and service revenues increased we saw a more notable increase in service revenues.

Aviation related sales were again down year over year. However, we are seeing increased activity levels in this area.

Up to a third party sales decreased 1% year over year for the quarter, while off to a total sales, including intercompany sales decreased 2% year over year.

Though we entered Q4 with a then record backlog and now enter fiscal 'twenty three with the new record order backlog.

Supply chain constraints have led to delays in production and shipments of certain orders.

The healthcare Division reported a 3% reduction in Q4 year over year revenues.

While patient monitoring and cardiology sales decreased in the quarter. There was an increase in services supplies and accessories sales, which tend to be recurring in nature.

The fiscal 'twenty to Q4 gross margin was 36, 4%.

Compared to 35, 5% reported in Q4 fiscal 'twenty one.

The increase was driven primarily by a 9% increase in service revenues, which tend to carry a better gross margin and product sales as.

As well as the mix of sales within our security and Opto divisions.

The small reduction in health care Division sales, which has the highest gross margin among the three divisions, partially offset the increases just noted.

We also experienced increases in certain component and freight costs in each division. These.

These increased costs are expected to impact overall gross margin in fiscal 'twenty three.

Our gross margin will fluctuate from period to period based upon our 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.

Our Q4 results again demonstrate the success of these efforts.

Q4, SG&A expenses were $66 million or 19, 5% of sales compared to $68 million or 25% of sales in the prior year Q4.

Research and development expenses in Q4 of fiscal 'twenty, 2% or $14 6 million, representing a year over year increase of 5%.

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

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

In Q4 of fiscal 'twenty, two we recorded $2 7 million of restructuring and other charges as compared to $2 2 million in Q4 of the prior fiscal year.

Over to interest and taxes.

Net interest and other expense in Q4 of fiscal 'twenty two decreased to $2 4 million from $4 1 million in the same prior year period, primarily due to the adoption of accounting standard.

<unk> 2020 that show six which eliminated the noncash interest expense associated with our convertible debt as we've previously discussed.

However, our cash interest expense increased approximately 17% in Q4 of fiscal 'twenty, two compared to Q4 the prior year.

I will further discuss interest expense in the context of our fiscal 'twenty three guidance later on this call.

On the tax side, our reported effective tax rate under GAAP was 9% in Q4 of fiscal 'twenty, two compared to 12, 9% in the prior year Q4.

In Q4 of fiscal 'twenty, two we recognized a discrete tax benefit of $4 9 million as compared to $4 8 million in Q4 last year.

Excluding the impact of discrete tax items, our effective tax rate in Q2 of fiscal 'twenty. Two was 22, 3% compared to an effective tax rate of 26, 3% in Q4 fiscal 'twenty one.

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

Overall.

Our adjusted operating margin in Q4 of fiscal 'twenty, two increased 150 basis points to 13, 7% compared to 12, 2% in the same prior year period.

This operating margin expansion was driven by an improved gross margin highlighted by increased service revenues and strong SG&A expense management.

We're particularly pleased with the increase in the non-GAAP adjusted operating margin in our security Division, which expanded to 19, 7% in the last quarter of fiscal 'twenty two from 18, 8% in the prior fiscal year fourth quarter, driven by increased service gross margin and lower operating expenses.

We were also delighted that the adjusted operating margin in our Opto Division increased to 12, 7% in Q4 of the 2022 fiscal year from 11% in the prior fiscal year fourth quarter, despite slightly lower revenues due in part to gross margin expansion on a favorable product mix.

And with lower revenues and a less favorable revenue mix.

The adjusted operating margin of our health care Division decreased to eight 9% from 11, 8% in the prior year.

Moving to cash flow.

Cash flow provided by operations was $22 million in Q4 fiscal 'twenty, two compared to $8 million in the same prior year quarter, driven by higher higher profits and certain working capital improvements cap.

Capex in the fourth quarter was $4 6 million, while depreciation and amortization expense in Q4 was $9 7 million.

We continue to be active in our stock buyback program in the quarter during which we spent approximately $14 8 million to repurchase 177336 shares, leaving approximately one 5 million shares available to repurchase under the current authorized share repurchase program.

Our balance sheet is solid with.

With net leverage under one five and significant capacity for acquisitions and additional stock buybacks.

Our convertible notes mature next month.

We increased our credit facility in December of 2021, and contemplation of retiring the convertible notes.

We expect to utilize $100 million from our delayed draw term loan and $142 million from our revolver to retire the approximately $242 million of convertible notes outstanding.

We anticipate having over $300 million available under our credit facility. Following the retirement of the convertible notes.

Including the outstanding letters of credit.

In this rising interest rate environment.

We anticipate our borrowing costs will approximately double in fiscal 'twenty three at the current level of doubt of debt outstanding.

Finally, turning to guidance.

For fiscal 'twenty three the company.

<unk> anticipates revenues in the range of $1 $240 million to $1 billion and $275 million in.

And adjusted earnings per diluted share in the range of $6 <unk> to $6 25.

The non-GAAP diluted EPS range excludes potential impairment restructuring and other charges amortization of acquired intangible assets and noncash interest expense.

And their associated tax effects as well as discrete tax and other nonrecurring items.

Given the current rising interest rate environment.

The adjusted EPS guidance reflects an impact of approximately <unk> 30 per diluted share of expected increases in interest expense, resulting from the utilization of our credit facility to retire our maturing low interest rate convertible notes as well as higher cost on the existing outstanding borrowings.

Our earnings guidance also contemplates increased costs associated with certain products already in backlog, which we do not expect to pass onto customers most notably in the security Division.

In fiscal 'twenty, two our performance was heavily weighted to the fourth fiscal quarter.

Based on what we're currently seeing from our backlog and pipeline of opportunities and factoring and customer timeline preferences for deliveries and supply chain limitations.

We currently anticipate revenues and adjusted operating income will be strongest in fiscal <unk> fiscal quarters, two through four in fiscal 'twenty three.

We currently believe this revenue and adjusted earnings guidance reflects reasonable estimates.

The actual impact on the company's financial results of the pandemic supply chain disruptions and increasing cost and rising inflation and interest rates is difficult to predict and could vary significantly from the anticipated impact 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 providing innovative products and solutions.

We delivered solid results throughout fiscal 'twenty, two in a dynamic and challenging environment.

We continue 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 OSI systems team for its continued dedication in supporting our customers and contributing to the creation of value for our stockholders and other 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 one on your telephone please standby, while we compile the Q&A roster.

Okay.

<unk>.

Our first question comes from Brian <unk> with Imperial Capital You May proceed.

Yes. Thank you very much a couple of quick questions.

First of all on.

On the quarterly breakdown, you mentioned that it's going to be weighted.

Third and fourth quarters can be your strongest.

Can you talk a little bit about first quarter are we going to be looking flattish year over year first quarter.

2023 versus first quarter of 2022.

Yes, Great question, Brian We had some strong sales in our Q1 of fiscal 2022. So as we currently look out although we provide annual guidance. We're currently anticipating that Q1 will be down a little bit from from what it was a year ago. The nice thing for our whole year was while we were very back loaded in FIS.

<unk> 22 to Q4, we think it'll be a little bit more evenly distributed between Q2 and three and four while Q1, just becomes a little softer based upon customer delivery preferences as the supply chain limitations.

And that is going to be primarily the security division is going to be weighted that way.

Or is it all divisions in that first quarter.

I think we're seeing it throughout our business.

Very good next question.

In terms of cash flow.

For fiscal 2023.

The last year or so.

Because of building receive bolt on a variety of other things cash.

Cash flow hasn't been as strong as historically.

Ben can you talk a little bit about cash flow what you anticipate.

In 2023 or give us a proxy.

Sure sure Great question, and you're right, Brian when we look back 2019 2021.

Our free cash flow, our operating cash flow was outstanding generally we had a conversion above 100% of net income in fiscal 'twenty. Two we made the intentional decision to increase our inventory levels in order to mitigate some of the risks and supply chain and to plan for some of the growth and the strength in the backlog. So our cash flow was a bit lower than historic.

We see as we move to fiscal 'twenty three.

As we sit here today, we are anticipating a nice rebound and returning to some of the historical cash flow levels that we've typically seen in and then we can see that potentially even accelerating from there. So we're looking to a strong free cash flow year in fiscal 'twenty three for us.

Okay and then thank you and then one other just follow up and I'll get in line with somebody else on the Opco side.

You are probably more exposed to economic factors in that division maybe than others can you talk about what youre seeing in terms of.

Backlog bookings specifically in the Opto Division.

Yeah, Yeah. So we're really really encouraged by what we see in the Opto Division, we've had 10 consecutive quarters in auto with a book to Bill North of one.

We enter fiscal 'twenty three with an all time record backlog and after we do not have any exposure to any.

Any concentration in any particular industry, we deal with aerospace and defense and medical technology automotive test and measurement.

Industrial just to name a few.

We're continuing to see strong order flow.

And with our strong backlog, we think we're going to be continuing to deliver quite nicely. The biggest challenge. We have in <unk> is just getting some of the components in order to finish off some of the products in order to deliver to our customer base.

But the nice thing is we are seeing still still strong demand and.

Are anticipating a very solid year, yet again dropdown.

Thank you.

Thank you one moment for questions.

Our next question comes from Larry <unk> with.

<unk> Securities you May proceed.

Great. Thanks, Thank you for taking the questions just a couple maybe on quick follow ups on the CBP orders.

And delivery timeline, so it sounds like.

You mentioned stretched out a little bit over a three year period.

Did you can you just give us an idea as you previously think there would be done more like in the next year or two years, how much just trying to get a better scope and how far out extend theyre, becoming and does that maybe.

Suggest that future orders might be sort of in the back half of that five year timeline of some of these deliveries if they're not ready for certain deliveries yet today.

Larry Thanks for the question good question.

And Youre right on point on the first point.

We were initially anticipating that the couple of hundred million dollars of orders that we received about a year ago would be primarily delivered in our fiscal 'twenty three and.

24, so there was a bit more front loading to it.

Based upon.

Customer request.

Asked us to elongate that process a bit. So now we're currently anticipating that most of it will be delivered over over a three year time period rather than two.

We're ready we're prepared to do it faster.

If they want it faster, but it looks like it will be out for that timeframe in terms of when the next orders would come.

On those iqs.

Always difficult to say, but I would imagine that there'll be wanting to see some some deliveries of the products have a more substantial nature and then we should see.

Some potential.

Some potential new orders and there is significant balances left on those iqs for them.

Make further purchases.

Okay.

All in your backlog obviously.

Book to Bill I guess trailing is one one.

I know you don't guide to the quarter I mean to the segment what do you do.

You think in security you have you grow year over year or is that tough to say on a topline basis.

We're absolutely expecting to grow year over year on the security business in fiscal 'twenty, three and that's what's implied in our guidance.

And what about just in terms of inflation and stuff.

I think you kind of suggest that you don't have.

Obviously once you sell your contracts are fixed at the time I guess that there.

Deliveries of Syn <unk>.

You raised prices over time, how do you sort of offset some of these inflationary pressures that you are not passing on to your customers at all.

Yes, good question and it really can vary by division Larry in the Opto business.

We're able to pass on.

A good portion of those material cost increase.

Nearly immediately that's most of our customers as they as they will understand it and the security business, which tends to be <unk>.

Longer lead time backlog, if you have an order in the backlog, particularly to a government type customer that it's been there for a while.

It's difficult to pass on costs as they move up with that particular contract and we think that will impact us a little bit which is embedded in our guidance, but as we come out with new orders and New awards the pricing that we do factors in in that new cost structure for us at the same time, we're always trying to counter some of those increases.

And some of those input costs with more efficiencies and productivity improvements, which the team has been.

Very good at achieving.

Okay, great and if I can just switch gears and squeeze one more question just on the healthcare front, what's going on in terms of.

Next generation monitors is that still.

In the Q and is that more of a fiscal 'twenty four.

Okay.

Yes, so developing in the patient monitoring platform and some of the new products is very much in the Q, It's where we're investing a sizeable portion of our R&D in our healthcare division. So the team is making progress in those efforts.

We won't see any of that impact here in fiscal 2023 on the top line.

But we do look at that as a long term growth driver for the health care business. So a very important element for us.

Okay I appreciate it I'll call back to Tom.

Thank you.

Thank you one moment for questions.

Our next question comes from Jeff Martin with Roth You May proceed.

Thanks, Hi, Alan wanted.

I wanted to get a sense for.

Increased free cash flow in fiscal 'twenty, three at least relative to 2002.

How are you looking at use of that cash flow.

And share repurchases acquisitions or debt reduction.

Hi, Jeff.

Good question, you really hit on.

All three areas that we focus on for capital allocation in.

In fiscal 'twenty, two we did some some small acquisitions.

But we invested pretty heavily in stock buyback throughout the year as we look at fiscal 'twenty. Three we think all three of those options are available to us while we'd like to grow organically, we'd like to give a bit of a boost to that an acceleration factor through M&A, which has been part of our DNA and our history. So we'd like to continue to do good strategic.

<unk> that that adds some nice shareholder value supplementing that we'll always look at it.

Stock buyback in.

In residual cash that we have in and paying down some of our revolver balances. So all three are are at play for us.

Okay, and then in terms of gross margins for this year, how should we think of them relative to fiscal 'twenty. Two we've got in our materials cost increase in some of the areas of the business you will have to absorb.

Offsetting that I would think you've got higher software and services concentration that partially offset that but what how should we think about gross margins this year relative to fiscal 'twenty two.

Yes, Jeff.

You've hit the nail on the head again with some of the puts and takes.

Generally speaking as our as our sales rise we would look at some economies of scale and look to have.

Expanded gross margins I think with some of the higher costs given some of the supply chain challenges in some of the costs are already embedded in some of the backlog. We have I think we're currently anticipating.

Dissipating that our gross margin will be relatively comparable to what we saw in fiscal 'twenty two on a full year basis, it'll bounce around a little bit based on the mix of revenues and the level of revenues from quarter to quarter, but on an annual basis should be comparable.

Give or take a bit.

Okay, and then last question on <unk> I was curious on the aviation market and the CIS.

<unk> segment are you seeing increased engagement on the client side in terms of building sales pipeline what gives you.

Suggestion that that market may be turning around this year.

Yes, we are definitely seeing more activity on the agent aviation side.

The level of Rfps, the customer business that we're having we don't anticipate that will drive a material amount of increased revenues in the first half of the year, but as we move into the second half and into calendar 'twenty. Three we think there is a.

Nice opportunity for growth in aviation and we're hearing good things from from our sales and marketing teams in that regard.

And remain optimistic that that will be the case okay.

Okay, great well good luck with that.

Thank you.

Thank you one moment for questions.

Our next question comes from Josh Nichols with B Riley you May proceed.

Yes, thanks for taking my question.

I guess Mike.

I'm trying to get a little bit better handle on some of the.

Large security orders from the GBP rate those now going to be filled over three years, I think thats fine, but how much of the $1 2 billion backlog do you think is going to be flowing through to revenue in fiscal 'twenty three given like the extension of that CBP Award.

Yes, our estimate Josh at this point would be something north of $700 million would likely slow through to fiscal 'twenty three.

Pin number could end up being a little higher a little bit lower but our best guess is a little bit north of $700 million at this point. So what that means is we've got some pretty good revenue visibility as.

As we start out here in fiscal 'twenty three.

Yes, it sounds like it.

I'm thinking just looking at here the service revenue levels that you did this quarter were higher than I guess anything I could recall right at least in the last few years.

Is that expected to be sustainable.

A little bit more detail on what's driving that and are.

Are those gross margin impact is going to likely flow through into next year as well.

Yeah, we're real pleased with the.

The work done by our service team in increasing.

Some of the service orders in the revenues and the flow down to margin.

Q4 was very strong on the service side.

As we look forward outside of Q1, which is historically a little bit softer on the service side is.

Parts of the World.

Seem to be more on vacation during the during the summer timeframe.

We would anticipate that we'll continue to have strong service revenue levels, particularly in Q2, Q3, and Q4 and wed like to see that continue to flow down and expand our margins in that arena. So we look at that as a great opportunity.

Embedded in that is also some of the recurring revenues that we're doing in search scan some of our software.

And some acceleration and some turnkey revenues that were doing so yes. We believe there is a nice opportunity to continue to show strength within the service revenues as part of our consolidated revenues.

Thanks last question for me.

I know you've mentioned search scan the last couple of quarters right. I think most people are aware of the existing turnkey contracts you have.

But in terms of new opportunities on those two higher margin fronts.

You mentioned that youre pursuing kind of incremental or some of these like larger eight nine figure potential opportunities. If you are to secure them.

Yes, I think the.

I think some of the near term opportunities are incremental.

A nice level of revenues.

At nice margins and I think more in the kind of the meteor medium term and long term there is some.

Very very substantial opportunities that we're pursuing that will be in our pipeline always difficult too.

Estimate when that actually might hit, but very exciting opportunity pipeline on the service side for us.

Including <unk> and including in Turkey.

Thanks Al.

Thank you.

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

Our next question comes from Ellen Page with Jefferies. You May proceed.

Okay.

Hi, guys. Thanks for the question.

Just looking at healthcare margins, you mentioned some mix in that but they were down.

Almost 600.

Chile.

With the decremental over 100 per ton.

By my math.

Can you discuss the drivers of an improvement in that margin and when you expect to get back.

Mid teens.

Yes, Hi, Alan.

Question, So while our Q4 revenues were in line with our expectations and healthcare the margins were lower as you have noted.

This really was due to a less favorable mix of revenues in the quarter and we also had some operating expenses that exceeded some of our expectations.

The margin in our health care business is highly sensitive to the top line. So it will bounce around from time to time, because the incremental margins and the contribution margins are so strong when.

Revenues go up there is a big flow through to the operating margin.

And similarly, if revenues are down.

You can't change your cost structure enough to mitigate that.

Our team is highly focused on delivering strong operating margins on an annual basis. So we're optimistic that as we.

Move forward the team will continue to improve operating margins in the health care business again like much of the rest of our business.

Focused beyond the first quarter.

Great.

And then on <unk>.

<unk> margins are well above where they've been.

Should we think of high teens and sustainable level as you continue to execute on some of these larger contracts.

Yes, we're always focused on operating margin expansion and security as well. It will also move from period to period based upon the level of the revenues and the mix of the revenues.

With some of the recurring revenues and some of the new programs that we're moving into we think theres opportunities.

On a longer term basis.

Absolutely expand those those margins on a shorter term basis, we do have some some headwinds with with supply chain and some of the strong backlog that we have that has some locked in pricing.

While some of the input costs have gone up.

So we think the margin expansion opportunities.

We'll move forward.

Q4 2022 OSI Systems Inc Earnings Call

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