Q2 2023 OSI Systems Inc Earnings Call

January 26, 2023

Speaker 1: The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 11.

Speaker 2: Welcome to OSI Assistance, Inc. 2nd Quarter 2023 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 star-1-1 on your telephone. You will then hear an automated message advising your hand is raised.

Speaker 3: To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Allen Edrick, Executive Vice President and Chief Financial Officer. Please go ahead.

Speaker 4: Thank you. Good morning and thank you for joining us. I'm Alan Edrick, Executive Vice President and CFO of OSI Systems and I'm here today with Deepak Chopra, OSI's President and CEO .

Speaker 5: Welcome to the OSI Systems Fiscal 23 second quarter conference call.

Speaker 6: results.

Speaker 7: Earlier today, we issued a press release announcing our second quarter fiscal 23 financial results.

Speaker 8: 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 1995 with respect to such forward-looking statements.

Speaker 9: to update any forward-looking statement based on subsequent events or new information or otherwise.

Speaker 10: During today's call, we will refer to both GAAP and non-GAAP financial measures when describing the company's results. For information regarding non-GAAP measures and GAAP measures of the company's results and a quantitative reconciliation of those figures, please refer to today's earnings release.

Speaker 11: I will begin with a discussion of our Q2 financial performance and then turn the call over to Deepak for an overview of our business performance.

Speaker 12: We will then finish with more detail regarding our financial results and a discussion of our outlook for the overall fiscal year.

Speaker 13: Our second quarter financial results were solid as we navigated the current economic environment, which continues to be impacted by supply chain delays and increased costs, disruptive geopolitical events, inflation and rising interest rates.

Speaker 14: Our bookings and book-to-bill ratio were very strong last quarter, and we were awarded some significant contracts, which we will discuss during this call.

Speaker 15: So let's start with a high-level summary of our Q2 results.

Speaker 16: First, we reported Q2 revenues of $296 million, representing a year-over-year increase of 7%, driven by solid revenue growth in our Security and Opt-Out divisions, which were in part offset by soft healthcare division sales.

Speaker 17: and an approximate $4 million unfavorable FX impact.

Speaker 18: Second, we reported Q2 adjusted earnings per share of $1.19 down from $1.28 in Q2 of the prior year as a result of a less favorable mix of sales, which was anticipated, and additional interest expense.

Speaker 19: And third, our Q2 bookings were over 500 million, representing a book-to-bill ratio of approximately 1.7, leading to a record quarter and backlog of nearly 1.5 billion.

Speaker 20: Before diving more deeply into our financial results and discussing the fiscal 23 outlook I will turn the call over to Deebok.

Speaker 21: Thank you Alan.

Speaker 22: And thanks to everyone joining us on today's call.

Speaker 23: Our performance in Q2 of fiscal 23 was solid as we grew the top line.

Speaker 24: while continuing to successfully operate in a macro environment challenged by the multiple factors that Alan mentioned.

Speaker 25: Our YouTube bookings were very strong, resulting in a record quarter-end backlog.

Speaker 26: were very strong, resulting in a record quarter-end backlog. We believe

Speaker 27: We are well positioned for the second half of fiscal 23, and this also positions the security division especially really well entering for fiscal 24.

Speaker 28: Let's discuss each division's performance starting with security.

Speaker 29: The security division delivered Q2 revenues of $167 million.

Speaker 30: about 15 percent higher than Q2 in the prior year.

Speaker 31: We were pleased with the divisions profitability.

Speaker 32: expanding our operating margin to 12.9%.

Our security bookings were very strong and resulted in a book to bill ratio of 2.3.

for Q2 and 1.9 times for the first half of fiscal 23 for this division.

We continue to deliver on the large existing U.S. Customs and Border Protection, CBP, programs we announced in fiscal 2022.

The CBP programs focus on improving security.

at the U.S. borders by utilizing our cargo and vehicle inspection platforms.

CertScan integration software and Gatekeeper vehicle checkpoint lane control solutions.

SertScan is a proprietary software solution that helps manage inspection image data, traffic, vehicle identification, and integrates with other systems at checkpoints to streamline and facilitate the inspection process.

SIRS scan is also compatible with third-party inspection systems, making it a versatile option in the marketplace.

Based upon CBP's current timing,

Some push out from Q3 to Q4 has happened from what was previously anticipated.

While Q2 year over year security division revenues were up double digits.

and operating margin expanded.

We believe the most notable item of the quarter.

Was I except those bookings?

highlighted by a 200 plus million dollar international order.

that we received in December and announced shortly afterward, quarter-end in January .

Our deliverables are expected to include a number of our cargo and vehicle inspection products.

and radiation portal monitors, along with managing the civil works and providing operator training and ongoing maintenance in the coming years.

We are not forecasting any significant revenues related to this award in fiscal 23, but this contract provides strong visibility into fiscal 2020 and the 24 security revenues.

We are currently working on the schedule with this customer and expect to have more to share on future calls.

though we will start some of the manufacturing production in fiscal 23.

during November and December

We were proud to support the security efforts at the FIFA World Cup in Qatar.

as the primary provider of security detection products.

This event was held at multiple stadiums around Doha, and our ODEON 920CX baggage and parcel inspection systems

and METOR 6X walk-through metal detectors were successfully utilized to provide screening for over 2.5 million ticket holders.

and their belongings.

In addition, these products were also used at the primary airport, hotels and other venues throughout the city.

This order was and will be a great showcase for rapid scan products in the Middle East for time to come.

In turn, key services are projects in Albania, Puerto Rico, and Guatemala continue to perform well.

The initial planning phase is underwear for the new turnkey Airport Services multi-year contract, which we received earlier in fiscal 2023.

As part of this contract, we expect to manage screening services at a European airport for the staff, airline crews, and vehicles at perimeter entry points.

Initially though, as you said before, this is a small contract but it is a first in the aviation space.

Looking ahead, we believe that security with a strong backlog and visibility into other key opportunities in the pipeline is well positioned for the second half of fiscal 2023 and beyond.

Shifting to the electronics division, that had another great quarter as third party Q2 revenues were 80 million, which represented a new quarterly record for the division.

This division achieved a solid operating margin in spite of continued supply chain cost pressures.

Apto serves a diversified OEM customer base in aerospace, defense, healthcare, and consumer technology among others.

In these markets

certain OEMs

are seeking to reduce their exposure to China's sourcing.

further de-risk their supply chains by transitioning to other viable manufacturing regions in the East.

We believe we could benefit significantly from this given our global manufacturing footprint covering Malaysia, Indonesia, India, United Kingdom and the US. Looking ahead with a strong Q2 ending backlog.

that is almost 20% higher than this time last year. Opto is well positioned.

Moving to the healthcare division.

This was a disappointing quarter.

But we believe and expect.

stronger second half of the fiscal year in this division.

We continue to significantly invest in developing new products.

to further strengthen our patient monitoring and cardiology portfolio.

Subsequent to the quarter end, we bolstered the sales leadership in the U.S. with talent that we believe will help drive stronger results and position the business to thrive.

Going forward, we plan to maintain our focus on innovation and operational execution.

while staying flexible to handle the opportunities as markets can change quickly.

Overall, we are pleased with the company's fiscal 2020 three second quarter performance as we grew our top line, achieved significant bookings that have resulted in a record backlog.

In addition, with a record backlog and a strong pipeline of opportunities, we believe we are well positioned for the second half of fiscal 2023 and 2024.

I would like to thank our employees, customers and shareholders and look forward to the second half.

I will now turn the call back over to Alan Edrick to further discuss our financial performance.

before we open the call for questions. Thank you.

Well, thank you, Deepak.

Now I will review the financial results for our second quarter in some greater detail.

As said, our fiscal Q2 revenues were up 7% compared with that of the prior year Q2.

Q2's security division revenues were up 15%, largely due to the growth in our cargo and vehicle inspection products and related service revenue.

The security division's book-to-bill ratio was approximately 2.3.

positioning the division well for strong revenue growth in the second half of fiscal 23 and into fiscal 24.

Opto sales increased 8% year over year with strengthened third-party sales to a diversified customer base.

as well as intercompany sales to support anticipated upcoming Security Division revenue growth.

Opto bookings were again solid, leading to a record Q2 backlog for the Opto division.

As Deepak mentioned, the healthcare division, which is our smallest business unit representing about 15% of our overall first half sales, reported a 17% reduction in year-over-year revenues in a more challenging marketplace and in part due to a tougher year-over-year comp given the prior year elevated demand during the COVID Omicron variant surge.

which carries the highest gross margin of our three divisions.

Higher Opto sales as a percentage of total sales, which carries the lowest gross margin of the three divisions.

and a less favorable mix in security division sales.

Our gross margin is also impacted by increases in certain component costs.

In general, our gross margin will fluctuate from period to period based on revenue mix and volume, inflation, and impacts of supply chain among other factors.

Based upon our forecasted conversion of backlog to revenue and pipeline of opportunities,

We anticipate a stronger gross margin in the second half of fiscal 23 compared to the first half of this year.

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 Q2 results reflected these efforts.

Q2 SG&A expenses were $54 million or 18.3% of sales compared to $54.9 million or 19.8% of sales in the prior year Q2.

While foreign exchange created a headwind for Q2 revenues, it did have a beneficial impact on our operating expenses again this quarter.

Research and development expenses in Q2 of fiscal 23 were $14.5 million, consistent with that of the first quarter, and just below the prior year amount of $15 million.

We continue to dedicate considerable resources to R&D, particularly in security and healthcare, as we remain focused on innovative product development, which we view as vital to the long-term success of our businesses.

In Q2 of Fiscal 23, we recorded $2.3 million of restructuring and other charges compared to just under $1 million of such charges in Q2 of the prior fiscal year.

Moving to interest and taxes.

Net interest and other expense in Q2 of fiscal 23 increased to $5.2 million from $2.2 million in the same prior year period, primarily due to rising interest rates and the maturity of our 1.25% convertible notes on September 1st.

which carried a lower rate than our current bank borrowings.

We executed an interest rate swap during Q1 to fix a portion of our floating rate bank debt.

On the tax side, the reported effective tax rate under GAAP was 19.5% in Q2 of Fiscal 23 compared to 26.3% in Q2 of Fiscal 22.

In Q2 of this year, we recognized discrete tax benefits of $0.8 million as compared to a discrete tax expense of $0.3 million in Q2 last year.

excluding the impact of discrete tax items, our normalized effective tax rate in Q2 of fiscal 23 was 23% compared to a normalized effective tax rate of 25% in Q2 of fiscal 22.

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

Overall, our non-GAAP adjusted operating margin in Q2 of fiscal 23 decreased to 10.7% from 12.0% in the same prior year period.

This was primarily driven by the weakness in revenue in the healthcare division, which carries the highest contribution margin of our three divisions.

coupled with a reduction in the opto operating margin due to a difficult prior year comp.

The adjusted operating margin in the Security Division increased to 14.7% in Q2, from 14.2% in the prior year's second fiscal quarter, driven by higher revenue and disciplined opex management.

We expect to see sequential improvement in this division in Q3 and in Q4 on stronger revenues and a more favorable revenue mix.

We were pleased with the adjusted operating margin in our Opto Division of 13.1% in the second quarter of Fiscal 23, representing our second best result historically for this division.

We believe Optus also poised for second half year-over-year adjusted operating margin expansion.

With lower revenues and a less favorable revenue mix, the adjusted operating margin of our healthcare division decreased to 8.6% from 13.8% in the prior year.

We currently expect the healthcare division to show significant Q3 operating margin improvement over Q2 driven primarily by revenue growth.

Moving to cash flow.

Cash flow used in operations was $9 million in Q2 of fiscal 23 compared to cash provided by operations.

of $14 million in the same prior year quarter.

For the first half of fiscal 23, our operating cash flow is ahead of where we were for the first half of fiscal 22.

That being said, we typically deliver much stronger operating cash flow.

In the first half of this fiscal year, we have increased inventory to support anticipated sales growth, as well as to mitigate supply chain risks.

In addition, we have an elevated level of DSO due to slower customer payments and have other working capital uses including the timing of payments.

CAPEX in the second fiscal quarter was $3.6 million while depreciation and amortization expense in Q2 was $9.6 million.

We continue to be active in our stock buyback program, during which we spent approximately $4.5 million to repurchase about 53,000 shares this past quarter.

Our board increased the buyback authorization earlier this fiscal year, and as of quarter end 1.86 million shares were available to repurchase under the program.

Our balance sheet is solid, with net leverage of 1.8 and significant capacity for acquisitions and additional stock live-acts.

Aside from a little north of $7 million of annual required principal payments under our bank term loan, the bulk of our debt matures in fiscal 27.

Finally, turning to guidance.

We are tightening our fiscal 23 revenues range guidance by 10 million at the top end, primarily attributable to the softness we saw in the health care division this past quarter.

However, we are reiterating our previous non-GAAP earnings per share guidance.

This guidance implies revenue growth in the range of 8-12% and non-GAAP adjusted diluted EPS growth of 17-23% over the remaining 6 months of fiscal 23.

The non-gap diluted EPS range excludes potential impairment restructuring and other charges, amortization required intangible assets, and the effort means additional injury symptoms.

non-cash interest expense and their associated tax effects as well as discrete tax and other non-recurring items.

We currently believe this revenue and non-GAAP earnings guidance reflects reasonable estimates. The actual impact on the company's financial results of disruptions and increased costs in the supply chain and inflation in 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.

We continue to remain focused on the growth of our businesses and proactive management of our cost structure.

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

We expect to continue to navigate through the current dynamic and challenging environment, while gaining traction in key strategic growth areas and positioning the company to capitalize on certain 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 partners. And at this time, we would like to open the call to questions.

As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster.

And our first question comes from the line of Brian

Ruttenberg with Imperial Capital, your line is open.

Yes, thank you very much. So first question is on the security side, the large $200 million plus international order. Can you talk a little bit about, you talked a little bit about timing, but what does the plus mean? Is that all on the maintenance side? How big can it be?

All I can say that is that.

<unk> are significant portion of the 200, plus many of our contract is equipment.

There is some civil works.

<unk> maintains.

And regarding the manufacturing and delivery.

The Senate in Iowa speech, there is insignificant revenue.

And the rest of 'twenty three.

It's all focused on 2024.

Second thing that you will answer this.

Long term, yes, there could be more potential add ons.

Definitely service and support our disc kind of equipment has 710 year plus lifecycle upgrades and stuff. So we're very excited about it and this is a significant win.

And also.

This was a international competition and we've got the majority of the business.

What's that.

That's the first time I heard that.

This was split between you and I assume your largest.

One of your largest competitors is that correct.

I can't talk about.

Other competitors budget was international competition.

We got a significant majority of the business.

Okay.

And then.

Moving onto pipeline on the security side.

This was a very large award.

That I wasn't aware of you were bidding on are there other such large awards and then a couple of hundred million dollars of 100 plus million that youre working on can you discuss a little bit whats in your pipeline.

Because this was so significant are there other ones like this out there.

But Brian you know that we don't talk about any specifics, but I think you've already got the answer yourself.

This is not the only one.

International on equipment is very much desired marketplace, which looks at <unk> all over the globe, including U S. So we have in the pipeline and this isn't the cargo side and there are also areas in the aviation side. So the pipeline continues to be.

Quite strong.

Great.

Just a couple quick questions on the other divisions healthcare.

Was weak.

What do you anticipate seasonally a little bit weak what do you anticipate out of health care.

Coming up.

New products and what areas.

Well.

<unk> mentioned that before in Netherlands also talk to you up for a focused is primarily our products our patient monitoring and cardiology.

Patient monitoring we have a lot of innovative new products being developed.

It takes time, we have.

<unk> a whole new.

<unk> line.

And we think its up basically in 2020.

'twenty 'twenty four 'twenty five cannot have timelines.

Also much very much focused on homecare connectivity.

The remote.

Shipment mountain monitoring so that we are doing a lot of investment.

And expanding on it.

Auditor.

<unk> in the patient monitoring staff and on what we call connected <unk>.

<unk>.

Like batches and coated wireless and Kelly kind of a thing.

Okay very good. Thank you very much for that answer and then just last question on the opto side.

It doesn't appear that there is any slowdown in demand.

On.

Yes.

The supply chain normalized enough for you guys moving forward are there things that you can't produce that if you add a proper supply chain or a normalized supply chain you'd be producing.

Brian This is Alan good question and while we see some signs of the supply chain improvement, there's still a certain challenges and youre right. There is certain backlog that we have that we'd be able to convert to revenue and an accelerated basis or if not four.

Those final missing components that are still supply chain challenge. So yes, we still see nice strong demand, we've got a heck of a backlog.

And as the supply chain issues begin to ease up that should help as well.

Brian This is deepak just to add on to what Alan said.

It's been a very good success kudos to the team, but I said in the last.

October call also.

That is a big focus on the OEM customers, who are trying to.

Get away from dependence on China.

And our facilities in <unk>, Indonesia, Malaysia, our new facilities expansion in India.

We have a lot of opportunity to work with our customer base, we are happy with us and feel confident that we can be there longer term for them. That's been a big growth story and Thats been and we think that will continue.

Alright, thank you.

Thank you one moment for our next question.

And our next question comes from Larry Solow with CJS Securities. Your line is open.

Great. Thanks, Good morning, good afternoon.

Just a couple of follow ups on the on the large deal.

Thank you have a great 100% visibility on timing at all but it does sound like it will be pretty much a few quarter type of <unk>.

Delivery.

I'm, just curious that the maintenance part or the service part.

How should we look at that is that like.

I know your service revenue today about 25% of your total revenue, but is this more like a recurring piece would be like a 10% to 20% type range anyway to just comment.

Think of that and then the second part of that question is this is a government customer.

Those are private.

Sure.

Hey, Larry this is Alan good questions.

This is a sovereign customer.

So we like that aspect of it.

We're working with the customer currently on the anticipated timing and we will have.

We will have a better feel probably by the time of our next conference call as to what that rollout look like but it will begin in fiscal 'twenty, four and expected to be substantial.

While Deepak mentioned that it's predominantly product sales in civil works. There is the service element of it too and you are right as the as the <unk>.

So service contract ends in warranty period, and there is always a.

A nice recurring revenue that comes with services spare parts. Thereafter. So we are looking at for that to be a nice recurring revenue base for us.

Okay and is this I mean, I know, it's not it's not full turnkey.

Missing aspects it sort of quasi turnkey.

But is it should we assume this is a better margin than sort of your normal product sales.

Alright.

Yes, Larry this is not this is not turnkey with us would be a sort of a typical product sale, except on a quite a large scale.

As you know we don't go into.

We don't go into margins on specific programs.

But we are.

We do like the economies of scale and benefits that we get when we produce products in volume, so thats, usually beneficial to our margins.

Okay, that's fair.

Steve just on the service revenue on that topic, you had a nice little bump this quarter I think service revenue grew like close to 10%.

Hi.

I didn't look back, but it sounds like less.

Eight quarters, maybe more than that so.

Was there something.

I know you're sort of ramping up maybe a little bit more in Guatemala that you have or what was there anything specific driven.

Really at some of our products rolled off of warranty and became under service contracts that accelerated some of the service revenue for us and we think.

Maintainable, so as we look forward, we expect to have continued strong service revenues.

Okay Fair enough and then just on security you mentioned margins were.

You guys said you were.

Please and you thought the performance was good there. So is it just seems like it.

Alright, dominantly a mix issue there I know, they're up a little bit sequentially and even year over year, but if you look back the last couple of.

Back half of last year, I know margins were quite strong.

I just want to clarify you kind of expect that same it feels like that same kind of cadence this year.

Yes, Larry this is Alan.

We do expect the operating margins for security to be much stronger in the second half than we saw in the first half.

As Deepak mentioned, you push outs were a little bit more weighted to Q4 than Q3, and we would we would.

<unk> strong operating margins in.

In each of those quarters.

Okay.

Just to follow up on Brian's question on the on the healthcare on the sort of the patient monitor side.

<unk> thousand 425 is that would that be like a whole next generation a hole.

Swapped out.

Would that just be partial.

Alright, any more color on that.

Well this is deepak here.

It's not like a overall push out kind of a day youre add on deal products. That's more applications more connectivity better is that it's more of a liability.

And more features are that.

It would be it would start coming in late 'twenty, four and 'twenty five.

But when you do that you basically are looking at what we call and Thats why they are significant R&D investment, it's a significant what I would be call. It upgrade to the next generation for the next 10 years. The next generation of the whole.

<unk> system.

Okay. Great last question just on free cash flow. Alan you mentioned was up a little bit on the first half year over year, but basically pretty close to flat last two years in the front half.

Usually I think in front of us a little bit better for you guys historically.

What's your thoughts sort of in the back half of this year for cash flow and then even going forward just from a high level over the next few years. Thanks.

Yes, great Great question, Larry and we're really excited about we move into fiscal 'twenty four in fiscal 'twenty three.

Outside of this new large contract, we would say the opportunity for strong operating and free cash flow in the second half would be extremely robust.

That being said with those large contracts and prepping for it for fiscal 'twenty four.

There is likely going to be a substantial investment in inventory as we begin to produce and manufacture these products. So.

We'll probably see a little bit muted more muted cash flow than we've historically seen in fiscal 'twenty three with the opportunity for very strong cash flow in fiscal 'twenty for us last 25.

Great. Thanks, Thanks for all the color I appreciate it.

Thank you one moment for our next question.

And our next question comes from Christopher Glynn with Oppenheimer. Your line is open.

Thank you.

Morning, or afternoon, I guess, depending on where you are.

So I had a couple of questions also on.

Sure.

This kind of convergence of two large projects the seat CBP and the new international win just addressed one on the free cash flow side.

But I'm curious as you have these two large programs set to.

Both be materially active in fiscal 'twenty, four curious about your capacity and.

Are you walking away from any.

Nice margin kind of 50 pieces.

Business to execute on these $10 bills.

Well this is deepak here absolutely not.

We have the capacity we have facilities in England, we have facilities in U S. We have.

Entities.

To help and this is a thing that we've been saying all along that differentiates us from our competitors.

We also have what we call intercompany relationship so that when we want to expand the cargo product line or the <unk>.

<unk> product line and perhaps a scan.

The ability to go to the vendor base, that's friendly to us plus expand our own intercompany manufacturing of Optoelectronics division with supply componentry.

<unk> areas.

No we're not going to pass any business just for this.

Plan.

And we have made in Mexico, because that's what I'm, saying that as Alan said that this is a significant win but we've handled these things before and we're going to start manufacturing of yes, the inventory increase yes, there'll be more production pressure.

Fiscal 'twenty three 'twenty.

<unk> 24.

But we are capable of it.

Adam do you want to add anything no I think thats summarize sequent natural.

I agree.

Follow up.

Was on O&M segment.

It's kind of in and around the electronics area, which is starting to see a lot of.

Destocking, you've noted consistently you're expanding scope with existing and adding new because of your fulfillment.

Abilities and great Global presence just from an end market point of view I was curious I think you are kind of insulated there to maybe two thirds of your business is defense health care and.

Automotive certainly hasnt overshot from a cyclical perspective, do you feel youre kind of insulated from the.

So called electronic cycle, that's clearly rolling in some areas.

Well very good question.

The good news for US is we are so diversified which have such a broad customer base that no one industry or no one specific area.

As up and down they are very broad.

Our marketplace as you mentioned aerospace defense medical and automotive its a very broad portfolio.

And thats been a success story.

That has been very well done and at the same time I've emphasized again and again that took time to come this big focus on.

Our customer base looking to get less dependent on China makes the big plus long term investment with their vendors and if we had a good vendor we have a long term relationship to keep expanding and we can have the ability to talk to our customers don't want us to manufacture in India for the Indian market the auto manufacturer.

And in Malaysia.

Indonesia, we can do all that and Thats been a very big plus story and we look at that as a broad based not dependent on any one specific thing our.

Our customer our industry.

Great. Thanks for the color.

Thank you Glenn.

Our next question.

And our next question comes from Jeff Martin with Roth Capital Partners. Your line is open.

Thanks, Good morning, Deepak and Alan Hope you're doing well.

Wanted to get a sense.

And in international.

Cargo and vehicle inspection order was a competitive bid.

What factors do you believe.

And all of that.

Yes.

Sure.

I couldn't understand the question. The question was what were the competitive factors that led us to win.

The 200 million dollar plus deals.

Sorry.

Very clear.

Basically.

We have said that before you know we consider ourselves.

One of the top performers.

In the cargo space.

Customers rely on us we have a very good reputation.

And.

Being a vendor and a good supplier to CDP also is.

The Big plus is a good date excellence.

So thats all over the world.

We have considered and we always say that if there is going to be a dinner party. We definitely get invited does advance we get invited.

And then we.

Proud about that we are advancing steps are good we don't trip over each other.

And our technology is good search scan software is a unique thing our product base is very broad we have what we call the broadest product portfolio to offer to the customer Trust Missive Backscatter combination.

All I can say is that our.

Our competition advantage is that we have the product base.

We are well regarded and we have very good reputation to deliver the product and to maintain.

Our credibility lockdown.

Sure the product quality the service organization the reputation all of those really factored in in addition to all the areas that Doug mentioned.

Okay, Great and then with respect to your anticipated improvement in the health care to get into the second half of the year.

Okay.

Factors that come into play there.

Challenges, we've had in the first half.

Much of that do you think.

In turn all factors versus market.

External market factors.

Jeff This is Alan so good questions. Some of the reasons why we have a bit more confidence in this <unk>.

Second half as we as we enter Q3 compared to the first half really is as based on the pipeline of opportunities that we're looking at we're seeing some more more sizeable opportunities than were available in the first half.

You talk about why are we soft during the first half.

That was indeed, the marketplace. The hospital market has been a bit more challenged.

Their own financials at hospitals.

And then some of it.

It was a little bit self inflicted as well from a timing perspective.

Some of our products as well so the combination of both but we do feel better for this for the second half and with a very strong contribution margins.

Our revenues go up from what you saw in Q2, there is a big pull through to operating income and operating margin.

Yeah, Okay, and then last question for me.

The equipment.

Equipment.

The event to Cod.

You mentioned that also can enable the mentally.

What's your thinking of equipment.

If there is near term opportunities if thats a longer term expectation.

Well deeper here what I meant was it's a great showcase its been very well received.

A lot of kudos lot of exposure to awareness.

People in Middle East.

I won't say and Matt.

Ill comment on it there are opportunities all over the world.

Middle East has always been a strong.

Pipeline opportunity.

We continue to look at it but I don't want to comment on anything specific that's there Alan just a broader application and it's out there and we feel that is ready it's very good for us to be a shell cash.

<unk>.

What happened and if a very successful event.

Great.

Sure.

Thank you and as a reminder to ask a question. Please press star one one on your telephone and if you wish to withdraw all please press star one one again.

Okay.

And our next question comes from Josh Nichols with B Riley Your line is open.

Yes, thanks for taking my question.

Just to kind of to extrapolate a little bit further clearly the company's position for a pretty strong second half given what we're seeing with backlog and the order flow.

On the gross margin front I think last year, you were doing 35, 36% gross margin do you expect that.

Kind of achievable in the second half of this year, given that you're targeting kind of 10 ish percent.

Topline growth in the back half.

Josh This is Alan very good question and we do expect to see stronger gross margins in the second half than the first half and I think the numbers you alluded to.

Not unreasonable, but by any means.

And then just for cash flow.

Understandable right. There's some upfront investment for these big orders a lot of which it seems like youre going to be coming through.

Next fiscal year fair to assume that like the free cash flow cadence is going to be let's call. It maybe comparable to last year, but.

Next year likely to be in excess of the 100 or so million dollars, you've kind of historically ritchie achieved some of the revenue.

Materializes.

Yes, Josh I think there is.

Fantastic opportunity for next year in fiscal 'twenty, four and 'twenty five for extremely strong cash flow kind of getting back to.

Historical levels and then some.

That being said, perhaps there's other new large opportunities as well that could factor into that as well, but yes big opportunities for $24 25 based upon what we see today for cash flow.

Perfect and then last question for me.

Just trying to figure out the timing a little bit so of the $200 million or so of CBP orders I know you've been delivering on that but like how much is left like how much of that is going to be coming in in the back half versus like next year is it.

I assume the majority will come next year, but any clarity you can provide on that would be helpful.

Sure Josh This is Alan Yeah, we do expect significant CBP revenues in the second half of this fiscal year more than we saw in the first half.

And we do expect substantial CVP revenues in fiscal 'twenty four is well, we don't quantify by the by the dollar amount, but we do see a big uptick happening here in the second half and into fiscal 'twenty four as well.

Great. Thank you.

And at this time I am showing no further questions.

Thank you all again for participating in our conference call.

I want to thank.

Typically our employees.

And our stockholders.

Supporting us we continued to focus on the product line manufacturing challenges with supply chain and working with our customers' needs and we look forward to speaking with you at our next earnings call. Thank.

Thank you very much have a good day.

Hi.

And this concludes today's conference call. Thank you for participating you may now disconnect.

The conference will begin shortly to raise and lower Johan during Q&A, you can dial star one one.

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Thanks.

Good day and thank you for standing by welcome to OSI Systems, Inc. Second quarter 2023 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.

To ask a question. During this session you will need to press star one one on your telephone you will then hear an automated message advising your hand is raised to withdraw your question. Please press star one one again please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today Alan.

Edric Executive Vice President and Chief Financial Officer. Please go ahead.

Thank you.

And thank you for joining us.

Alan Edric Executive Vice President and CFO of OSI systems, and I'm here today, with Deepak Chopra, OSI President and CEO .

Welcome to the OSI systems fiscal 'twenty, three second quarter conference call.

We are pleased that you can join us as we review our financial and operational results.

Earlier today, we issued a press release announcing our second quarter fiscal 'twenty three 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 on subsequent events or new information or otherwise.

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

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

I will begin with a discussion of our Q2 financial performance and then turn the call over to <unk> for an overview of our business performance. We will then finish with more detail regarding our financial results and a discussion of our outlook for the overall fiscal year.

Our second quarter financial results were solid as we navigated the current economic environment, which continues to be impacted by supply chain delays and increased costs disruptive geopolitical events inflation and rising interest rates.

Our bookings and book to Bill ratio were very strong last quarter, and we were awarded some significant contracts, which we will discuss during this call.

Well, let's start with a high level summary of our Q2 results.

First we reported Q2 revenues of $296 million representing.

Representing a year over year increase of 7% driven by solid revenue growth in our security and opto divisions, which were in part offset by soft healthcare division sales and an approximate $4 million unfavorable.

Unfavorable FX impact.

Second we reported Q2 adjusted earnings per share of $1 19 down from $1 28 in Q2 of the prior year as a result of a less favorable mix of sales, which was anticipated and additional interest expense.

Third our Q2 bookings were over $500 million, representing a book to bill ratio of approximately $1 seven leading to a record quarter end backlog of nearly $1 5 billion.

Before diving more deeply into our financial results and discussing the fiscal 'twenty three outlook I will turn the call over to Deepak.

Thank you Alan.

And thanks to everyone joining us on today's call.

Our performance in Q2, our fiscal 'twenty three was solid as we grew the top line.

While continuing to successfully operate in a macro environment challenged by the multiple factors that Alan mentioned.

Our Q2 bookings were very strong, resulting in a record quarter end backlog.

We believe.

We are well positioned for the second half of fiscal 'twenty three and this also positions the security division, especially really well entering fiscal 'twenty four.

Let's discuss each division's performance starting the securities.

The security Division delivered Q2 revenues of $167 million.

About 15% higher than Q2 in the prior year.

We were pleased with the division's profitability expanding our operating margin to 12, 9%.

Our security bookings were.

Very strong and resulted in a book to bill ratio of two three.

For Q2, and one nine times for the first half of fiscal 'twenty three for this division.

We continue to deliver on the large existing U S customs and border protection CBP programs, we announced in fiscal 'twenty two.

CVP programs focus on improving security at.

At the U S borders by utilizing our cargo and vehicle inspection platforms, such scan integration software and gatekeeper vehicle checkpoint NAND controller solutions.

Such scan is a proprietary software solution.

To manage inspection image data traffic vehicle identification and integrate with other systems at checkpoints to streamline and facilitate the inspection process.

So I'd scanning is also compatible with packet inspection systems, making it a versatile option in the marketplace.

Based upon CBP current timing.

Some pushout from Q3 to Q4 has happened from what was previously anticipated.

While Q2 year over year Security Division revenues were up double digits and operating margin expanded.

We believe the most notable item of the quarter was our exceptional bookings.

Might get by a 200 plus million dollar International order that we received in December .

And are now shortly afterward quarter end in January .

Our deliverables are expected to include a number of our cargo and vehicle inspection products and radiation quarter monitors along with the managing the civil works and for widening operator training and ongoing maintenance and the coming years.

We are not forecasting any significant revenues related to this award in fiscal 'twenty three.

This contract provides strong visibility into fiscal 2000, 22000 and for security revenues.

We are currently working on the schedule, we discussed tomorrow and expect to have more to share on future calls.

We will start some of the manufacturing production.

Fiscal 'twenty three.

During November and December .

We're proud to support the security efforts at the FIFA World Cup in Qatar.

As the primary provider of security detection products.

This event was held at multiple stadiums around Doha, and are already at 920, CX baggage and parcel inspection systems.

And met our six X walks through metal detectors.

Successfully utilized to provide screening for over two 5 million ticket holders.

And their belongings.

In addition, these products what also used at the primary airport hotels and other venues throughout the city.

This order was and will be a great showcase for the Rapiscan products and middle East for time to gap.

And don't give services our projects in Albania, Puerto Rico, and Guatemala continued to perform well.

The initial planning phase is underway for the new turnkey airport services might be a contract, which we received early in fiscal 2023.

As part of this contract we expect to manage screening services at a European airport for the staff airline crews and vehicles at brand better entry points.

Initially, though as we have said before this is a small contract.

It's a first in the aviation space.

Looking ahead, we believe that security with a strong backlog and visibility into other key opportunity. The pipeline is well position for the second half of fiscal 2023 and beyond.

Shifting to auto Electronics Division that had another great quarter as third party Q2 revenues were $80 million, which represented a new quarterly record for the division.

This division achieved a solid operating margin in spite of continued supply chain cost pressures extra.

Those subs at diversified OEM customer base, and aerospace defense healthcare and consumer technology among others in these markets.

Certain Oems are seeking to reduce their exposure to China sourcing and.

And further de risk their supply chains by transitioning to other viable manufacturing regions in the east we believe we could benefit significantly from this given our global manufacturing footprint covering Malaysia.

In Asia, India, United Kingdom, and the U S. Looking ahead with a strong Q2, ending backlog that is almost 20% higher than this time last year.

<unk> is well positioned.

Moving to the healthcare Division.

This was a disappointing quarter.

But we believe and expect stronger second half of the fiscal year in this division.

We continue to significantly invest in developing new products.

Further strengthen our patient monitoring and cardiology portfolio.

Subsequent to the quarter end, we bolstered the sales leadership in U S with talent that we believe.

Will help drive stronger results and positioned the business to thrive.

Going forward we.

Plan to maintain our focus on innovation and operational execution wise.

While staying flexible to handle the opportunities as markets can change quickly.

Overall, we are pleased with the company's fiscal 2023 second quarter performance as we grew our top line achieved significant bookings that resulted in a record backlog.

In addition, with a record backlog and a strong pipeline of opportunities. We believe we are well positioned for the second half of fiscal 2023 and 'twenty four.

I would like to thank our employees customers and shareholders and look forward to the second half.

I'll now turn the call back over to Alan Edric to further discuss our financial performance before we open the call for questions. Thank you.

Well, thank you Deepak.

Now I will review the financial results for our second quarter in some greater detail.

As said our fiscal Q2 revenues were up 7% compared with that of the prior year Q to.

Q2 Security Division revenues were up 15% largely due to the growth in our cargo and vehicle inspection products and related service revenue with.

The security division's book to Bill ratio was approximately $2 three.

Positioning the division well for strong revenue growth in the second half of fiscal 'twenty, three and into fiscal 'twenty four.

After a sales increased 8% year over year with strength in third party sales to a diversified customer base as.

As well as intercompany sales to support anticipated upcoming security Division revenue growth.

After a bookings were again solid leading to a record Q2 backlog for the Opto Division.

As Deepak mentioned, the health care Division, which is our smallest business unit, representing about 15% of our overall first half sales.

Ported a 17% reduction in year over year revenues, and a more challenging marketplace and in part due to a tougher year over year comp given the prior year elevated demand during the Covid omicron variance search.

The Q2 gross margin was 32, 5%, which while consistent with that of Q1 was about three 6% below that of the prior year Q2.

This year over year change was primarily driven by lower sales in the healthcare division, which carries the highest gross margin of our three divisions.

Our after sales as a percentage of total sales, which carries the lowest gross margin of the three divisions.

In a less favorable mix in the security Division sales.

Our gross margin was also impacted by increases in certain component cost.

In general our gross margin will fluctuate from period to period based on revenue mix and volume installation and impacts of the supply chain among other factors.

Based upon our forecast of conversion of backlog to revenue and pipeline of opportunities.

We anticipate a stronger gross margin in the second half of fiscal 2003 compared to the first half of this year.

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 Q2 results reflect these efforts.

Q2, SG&A expenses were $54 million or 18, 3% of sales compared to $54 9 million or 19, 8% of sales in the prior year Q2.

While foreign exchange created a headwind for Q2 revenues. It did have a beneficial impact on our operating expenses again this quarter.

Research and development expenses in Q2 of fiscal 'twenty, 3% or $14 5 million consistent with that of the first quarter and just below the prior year amount of $50 million.

We continue to dedicate considerable resources to R&D, particularly in security and health care as we remain focused on innovative product development, which we view as vital to the long term success of our businesses.

In Q2 of fiscal 'twenty, three we recorded $2 3 million of restructuring and other charges compared to just under $1 million of such charges in Q2 of the prior fiscal year.

Moving to interest and taxes.

Net interest and other expense in Q2 of fiscal 'twenty three increased to $5 2 million from $2 2 million in the same prior year period, primarily due to rising interest rates and the maturity of our one 5% convertible notes on September one.

Which carried a lower rate than our current bank borrowings.

We executed an interest rate swap during Q1 to fix a portion of our floating rate bank debt.

On the tax side, the reported effective tax rate at or GAAP was 19, 5% in Q2 of fiscal 'twenty three compared to 26, 3% in Q2 of fiscal 'twenty two.

In Q2 of this year, we recognized discrete tax benefits of <unk> 8 million as compared to a discrete tax expense of <unk> 3 million in Q2 last year.

Excluding the impact of discrete tax items, our normalized effective tax rate in Q2 of fiscal 'twenty three was 23% compared to a normalized effective tax rate of 25% in Q2 of fiscal 'twenty two.

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

Overall, our non-GAAP adjusted operating margin in Q2 of fiscal 'twenty three decreased to 10, 7% from 12, 8% in the same prior year period.

This was primarily driven by the weakness in revenue in the healthcare division, which carries the highest contribution margin of our three divisions.

Coupled with the reduction in the opto operating margin due to a difficult prior year comp.

The adjusted operating margin in the security Division increased to 14, 7% in Q2 from.

From 14, 2% in the prior year's second fiscal quarter, driven by higher revenue and disciplined Opex management.

We expect to see sequential improvement in this division in Q3.

And in Q4 on stronger revenues in a more favorable revenue mix.

We were pleased with the adjusted operating margin and are off to a division of 13, 1% in the second quarter of fiscal 'twenty three representing our second best results historically for this division.

We believe <unk> is also poised for second half year over year adjusted operating margin expansion.

With lower revenues and a less favorable revenue mix. The adjusted operating margin of our health care Division decreased to eight 6% from 13, 8% in the prior year.

We currently expect the healthcare division to show significant Q3 operating margin improvement over Q2, driven primarily by revenue growth.

Moving to cash flow.

Cash flow used in operations was $9 million in Q2 of fiscal 2003 compared to cash provided by operations of.

A $14 million in the same prior year quarter.

For the first half of fiscal 'twenty three our operating cash flow is ahead of where we were for the first half of fiscal 'twenty two.

That being said, we typically deliver much stronger operating cash flow in.

In the first half of this fiscal year, we have increased inventory to support anticipated sales growth as well as to mitigate supply chain risks.

In addition, we have an elevated level of DSO due to slower customer payments and other working capital uses including the timing of payments.

Capex in the second fiscal quarter was $3 6 million, while depreciation and amortization expense in Q2 was $9 6 million.

We continue to be active in our stock buyback program during which we spent approximately $4 5 million to repurchase about 53000 shares this past quarter.

Our board increased the buyback authorization earlier this fiscal year and as of quarter end 186 million shares were available to repurchase under the program.

Our balance sheet is solid.

With net leverage of one eight and significant capacity for acquisitions and additional stock buybacks.

<unk> from a little north of $7 million of annual required principal payments under our bank term loan.

The bulk of our debt matures in fiscal 2007.

Finally, turning to guidance.

We are tightening our fiscal 'twenty three revenues range guidance by $10 million at the top in primarily attributable to the softness we saw in the health care Division this past quarter.

However, we are reiterating our previous non-GAAP earnings per share guidance.

This guidance implies revenue growth in the range of 8% to 12% and non-GAAP adjusted diluted EPS growth of 17% to 23% over the remaining six months of fiscal 'twenty three.

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.

We currently believe this revenue and non-GAAP earnings guidance reflects reasonable estimates the actual impact of the company's financial results of disruptions and increased costs in the supply chain and 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.

We continue to remain focused on the growth of our businesses and proactive management of our cost structure we.

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

We would like to take this opportunity to thank the global OSI systems team for his continued dedication in supporting our customers and partners and at this time, we would like to open the call to questions.

As a reminder to ask a question. Please press star one on your telephone and wait for your name to be announced to withdraw. Your question. Please press star one again, please standby, while we compile the Q&A roster.

And our first question comes from the line of Brian .

Ruttenberg with Imperial capital your line is open.

Yes, thank you very much.

So first question is on the large on the security side, the large $200 million plus.

International Order can you talk a little bit about you.

You talked a little bit about timing, but what is the plus Nate is that all on the maintenance side, how big can this contract yet.

The timing is it all going to get produced in fiscal <unk>.

And delivered in fiscal 2024.

Brian This is deepak here.

<unk>.

All I can say that is that.

Majority are significant portion of that 200, plus many of our contract is equipment.

There is some civil works.

And some maintains.

And regarding the manufacturing and delivery.

The Senate in Iowa speech.

There is insignificant revenue.

Within the rest of 'twenty three.

It's all focused on 2024.

Second thing that you answer this.

Long term, yes, there could be more potential add ons definitely service and support this kind of equipment has 710 year plus lifecycle upgrades and stuff. So we are very excited about it and this is a significant win.

And also this was a international competition and we've got the majority of the business.

What's that.

That's the first time I heard that.

Business was split between you and I assume your largest or.

One of your largest competitors is that correct.

I can't talk about.

What other competitors, but it was international competition, we got a significant majority of the business.

Okay.

And then moving onto pipeline on the security side.

This was a very large award.

But Brian you know that we don't talk about any specifics, but I think you've already got the answer yourself.

This is not the only one.

International on equipment is very much desired marketplace, which looks at just <unk> all over the globe, including U S. So we have in the pipeline and this isn't the cargo side and there are also areas in the aviation side. So the pipeline continues to be.

Quite strong.

Great.

Just a couple quick questions on the other divisions healthcare.

Was weak.

What do you anticipate seasonally a little bit weak what do you anticipate out of healthcare you have coming up.

New products and what areas.

Well, we've mentioned that before in Ireland also Dr queue up.

Our focus is primarily on products for patient monitoring.

In cardiology.

Patient monitoring we have a lot of innovative new products being developed.

It takes time, we are developing a whole new.

Product line.

And we think its up basically at <unk> 'twenty late 'twenty 'twenty four 'twenty five.

Timeline.

We are also much very much focused on homecare connectivity.

Remote.

Shipment mountain monitoring so that we are doing a lot of investment and expanding our.

The auditors.

Reach in the patient monitoring stuff.

And on what we call connect cardiology.

And like batches and code of BIOLASE, and Kelly kind of a thing.

Okay very good. Thank you very much for that answer and then just last question on the opto side.

It doesn't appear that there is any slowdown in demand.

As the supply chain normalized enough for you guys. Moving forward are there things that you can't produce that if you add a proper supply chain or a normalized supply chain you'd be producing.

Brian This is Alan good question and while we see some signs of the supply chain improvement there is still out there.

Challenges and Youre right. There is certain backlog that we have that we'd be able to convert to revenue and an accelerated basis if not four.

Those final missing components that are still supply chain challenge. So yes, we still see nice strong demand, we've got a heck of a backlog.

And as the supply chain issues begin to ease up that should help as well.

Brian This is deepak just to add onto what Alan said.

It's been a very good success kudos to the team, but I said in the last.

October call also.

That is a big focus on the OEM customers.

Trying to.

Get away from dependence on China.

And our facilities in Vietnam, Indonesia, Malaysia, our new facilities expansion in India.

We have a lot of opportunity to work with our customer base, we are happy with us.

And feel confident that we can be there longer term for them that's been a big growth story and Thats been and we think that will continue.

Alright, thank you.

Thank you.

Our next question.

And our next question comes from Larry Solow with CJS Securities. Your line is open.

Great. Thanks, good morning, or good afternoon.

Just a couple of follow ups on the on the large deal.

Thank you have a great 100% visibility on timing at all but it does sound like it will be pretty much a few quarter type of delay.

Delivery.

I'm, just curious that the maintenance part or the service part.

How should we look at that is that like.

I know your service revenue, 25% of your total revenue, but is this more of like a recurring piece would be like a 10% to 20% type range anyway to just comment.

Think of that and then the second part of that question is just a government customer.

Poser private.

Sure.

Hey, Larry this is Alan good questions.

This is a sovereign customer.

Yeah. So so we like that aspect of it.

We're working with the customer currently on the anticipated timing and we will have.

We will have a better feel probably by the time of our next conference call as to what that rollout look like but it will begin in fiscal 'twenty, four and expected to be substantial.

While Deepak mentioned that it's predominantly product sales in civil works. There is a service element of it too and you are right as the as the <unk>.

So the service contract ends in warranty period, and there is always a.

A nice recurring revenue that comes with services spare parts. Thereafter. So we are looking at for that to be a nice recurring revenue base for us.

Okay and is this I mean, I know, it's not it's not full turnkey.

Missing aspects it sort of quasi turnkey.

Is it should we assume this is a better margin and sort of your normal product sales.

Yes, Larry this is not this is not turnkey. This with this would be a sort of a typical product sale, except on a quite a large scale.

As you know we don't go into.

We don't go into margins on specific programs.

But we are we do like the economies of scale and benefits that we get when we produce products in volume. So that's usually beneficial to our margins.

Okay, that's fair.

Just on the service revenue on that topic, you had a nice little bump this quarter I think service revenue grew like close to 10%.

Hi.

I didn't look back, but it's certainly less.

Eight quarters, maybe more than that so.

Was there something.

I know you're sort of ramping up maybe a little bit more in Guatemala that you have or what was there anything specific driven that.

Really at some of our products rolled off of warranty and became onto service contracts that accelerated some of the service revenue for us and we think.

Maintainable, so as we look forward, we expect to have continued strong service revenues.

Okay Fair enough and then just on security you mentioned.

Margins were.

You guys said you were pleased when you thought the performance was good there. So it just seems like.

Alright, dominantly a mix issue there I know they are up a little bit sequentially and even year over year, but if you look back the last couple of the back half of last year had no margins work.

Quite strongly.

I just want to clarify you kind of expect that same it feels like that same kind of cadence this year.

Yes, Larry this is Alan.

We do expect the operating margins for security to be much stronger in the second half than we saw in the first half.

Deepak mentioned, you push outs were a little bit more weighted to Q4 than Q3, and we would we would.

Strong operating margins.

In each of those quarters.

Okay.

Just to follow up on Brian's question on the on the healthcare on the sort of the patient monitor side.

<unk> thousand 425 is that would that be like a whole next generation a hole.

Swap out.

Or would that just be partial or any more color on that.

Well this is deepak here.

It's not like an overall push out kind of a day youre add on deal products, that's more applications more connectivity better results motor liability.

And more features are that.

It would be it would start coming in late 'twenty, four and 'twenty five.

But when you do that you basically are looking at what we call and Thats why they are significant R&D investment, it's a significant what I'd call. It upgrade to the next generation for the next 10 years. The next generation of the whole.

Our system.

Okay. Great last question just on free cash flow. Alan you mentioned was up a little bit on the first half year over year, but basically pretty close to flat.

Last two years in the front half.

And usually I think the front end a little bit better for you guys historically.

What's your thoughts sort of in the back half of this year for cash flow and then even going forward just from a high level over the next few years. Thanks.

Yes, great Great question, Larry and we're really excited about we move into fiscal 'twenty four in fiscal 'twenty three.

Outside of this new large contract, we would say the opportunity for strong operating and free cash flow in the second half would be extremely robust.

That being said with those large contracts and prepping for it for fiscal 'twenty four.

There is likely going to be a substantial investment in inventory.

As we begin to produce and manufacture these products so.

We'll probably see a little bit muted more muted cash flow than we've historically seen in fiscal 'twenty three with the opportunity for very strong cash flow in fiscal 'twenty for us last 25.

Great. Thanks, Thanks for all the color I appreciate it.

Thank you one moment for our next question.

And our next question comes from Christopher Glynn with Oppenheimer. Your line is open.

Thank you good morning, or afternoon, I guess, depending on where you are.

So I had a couple of questions also on.

This kind of convergence of two large projects.

CBP and the new international win.

Lynn just addressed one on the free cash flow side.

But I'm curious as you have these two large programs set to.

Both be materially active in fiscal 'twenty, four curious about your capacity and.

Are you walking away from any.

Net nice margin kind of 50 pieces of business to execute on these $10 bills.

Well this is deepak here absolutely not.

We have the capacity we have facilities in England, we add facilities and U S.

Presented these.

To help and this is a thing that we've been saying all along that differentiates us from our competitors.

We also have what we call intercompany relationship so that when we want to expand the cargo product line or the.

Detection product line and Rapiscan.

We have the ability to go to the vendor base that stranded gas plus expand our own intercompany manufacturing of Optoelectronics division with supply componentry.

These areas.

No we're not going to pass any business just published.

Plan.

And we have made in Mexico, because that's one thing that Alan said that this is a significant win but we've handled these things before.

We are going to start manufacturing of yes, the inventory increase yes, there'll be more production pressure.

In fiscal 'twenty three are towards.

<unk> 24.

But we are capable of it.

Adam do you want to add anything no I think thats summarized sequential.

I agree.

I follow up.

Was on O&M segment.

It's kind of in and around the electronics area, which is starting to see a lot of.

Destocking, you've noted consistently you're expanding scope with existing and adding new because of your fulfillment.

Abilities and great Global presence just from an end market point of view I was curious.

I think you are kind of insulated there to maybe two thirds of your business is defense health care and.

Automotive certainly hasnt overshot from a cyclical perspective do you feel you are kind of insulated from the.

So called electronic cycle, that's clearly rolling in some areas.

Well very good question.

Good news for US is we are so diversified.

Such a broad customer base that no one industry or no one specific area affects us up and down they are very broad.

Our marketplace as you mentioned aerospace defense medical and automotive its a very broad portfolio and thats been a success story.

That has been very well done and at the same time I've emphasized again and again.

The cost of time to come this big focus on.

Customer base looking to get less dependent on China mix, the big plus long term investment.

Their vendors and if we had a good vendor we have a long term relationship to keep expanding and we can have the ability to talk to our customers don't want us to manufacture in India for the Indian market the auto manufacturer in Malaysia.

Indonesia, we can do all that and Thats been a very big plus story and we look at that as a broad based not dependent on any one specific thing.

Customer or industry.

Great. Thanks for the color.

Thank you.

Our next question.

And our next question comes from Jeff Martin with Roth Capital Partners. Your line is open.

Thanks, Good morning, Deepak and Alan what we are doing well.

Wanted to get a sense could see international car rental vehicle production order was a competitive bid.

What factors do you believe that.

Okay.

I don't understand the question. The question was what were the competitive factors that led us to win.

The 200 million dollar plus deals.

Sorry.

Not very clear.

Basically.

We have said that before you know we consider ourselves.

One of the top performers.

In the cargo space.

Customers rely on us we have a very good reputation.

And.

<unk>.

Vendor and a good supplier to CBP also is a big plus is a good bit affluence.

So thats all over the world.

<unk> considered and we always say that if there is going to be a dinner party, we definitely get invited.

Once we get invited in.

We feel proud about that we are advancing steps are good we don't trip over each other.

Our technology is good search scan software is a unique thing our product base is very broad we have what we call the broadest product portfolio to offer to the customer Trust Missive Backscatter combination. So all I can say is that.

Our competition advantage is that we have the product base.

We are well regarded and we have very good reputation to deliver the product and to maintain.

Our credibility lockdown.

Sure the product quality the service organization the reputation all of those really factored in in addition to all the areas that Doug mentioned.

Okay, Great and then with respect to your anticipated improvement in the health care Division.

Half of the year.

Factors that come into play there.

Challenges, we've had in the first half.

How much of that you think.

Internal factors for us was market.

External market factors.

Jeff This is Alan so good questions. Some of the reasons why we are a bit more confidence in this.

You talk about why would we soft during the first half.

Part of it was indeed, the marketplace the hospital market.

It's been a bit more challenged.

Their own financials at hospitals.

And then some of it.

It was a little bit self inflicted as well from a timing perspective.

On some of our products as well so a little combination of both but we do feel better for this for the second half and with a very strong contribution margins as our revenues go up from what you saw in Q2, there's a big pull through to operating income and operating margin.

Yeah, Okay, and then last question for me.

Yeah.

Equipment.

Play.

The event to Cod.

You mentioned that also can enable the mentally.

Sure, Thank you and equipment.

Okay.

Near term opportunities, if thats a longer term expectation.

Well leave it here.

What I meant was it's a great showcase its been very well received.

A lot of kudos lot of exposure.

Various people in middle East.

I won't say, we don't comment on it there are opportunities all over the world Middle East has always been a strong pipeline opportunity and we continue to look at it but I don't want to comment on anything specific that's there Alan just a broader application and it's out there in <unk>.

That is very it's very good for us to be a shell cash.

What happened and if a very successful event.

Great. Thanks for your time.

Yes.

Thank you and as a reminder to ask a question. Please press star one one on your telephone and if you wish to withdraw all please press star one one again.

Okay.

And our next question comes from Josh Nichols with B Riley Your line is open.

Yes, thanks for taking my question.

Just to kind of to extrapolate a little bit further clearly the company's position for a pretty strong second half given what we're seeing with backlog and the order flow.

On the gross margin front I think last year, you were doing 35, 36% gross margin do you expect that that's kind of achievable in the second half of this year given that you are targeting kind of 10 ish percent.

Topline growth.

The back half.

Josh This is Alan very good question and we do expect to see stronger gross margins in the second half than the first half and I think the numbers you alluded to.

Are not unreasonable, but by any means.

And then just for cash flow understandable.

Understandable right. There's some upfront investment for these big orders a lot of which it seems like youre going to be coming through.

Next fiscal year fair to assume that like the free cash flow cadence is going to be let's call. It maybe comparable to last year, but.

Next year likely to be in excess of the 100 or so million dollars, you've kind of historically ritchie achieved some of the revenue.

<unk>.

Yes, Josh I think there is.

Fantastic opportunity for next year in fiscal 'twenty, four and 'twenty five for extremely strong cash flow kind of getting back to.

Historical levels and then some.

That being said, perhaps there's other new large opportunities as well that that could factor into that as well, but yes big opportunities for 24 and 25 based upon what we see today for cash flow.

Perfect and then last question for me.

Assume the majority will come next year, but any clarity you can provide on that would be helpful.

Sure Josh This is Alan Yes, we do expect significant CBP revenues in the second half of this fiscal year more than we saw in the first half.

We do expect substantial CVP revenues in fiscal 'twenty four is well, we don't quantify by the by the dollar amount, but we do see a big uptick happening here in the second half and in <unk>.

Fiscal 'twenty four as well.

Great. Thank you.

And at this time I am showing no further questions.

Thank you all again for participating in our conference call.

I want to thank specifically our employees.

And our stockholders.

Thank you very much have a good day.

Hi.

And this concludes today's conference call. Thank you for participating you may now disconnect.

Q2 2023 OSI Systems Inc Earnings Call

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