OSI Systems Inc. Q3 2023 Earnings Call

April 27, 2023

Thank you Bruce.

Welcome to the OSI Systems, Inc. Third quarter 2023 conference call.

At this time all participants are in listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need to press star one on your telephone.

To remove yourself from the queue simply press star one again.

As a reminder, today's program is being recorded and now I'd like to introduce your host for today's program.

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

Oh. Thank you good morning, and thank you for joining us I'm, Alan Edric Executive Vice President and CFO of OSI systems, and I'm here today, with Deepak Chopra, OSI as president and CEO .

Welcome to the OSI systems fiscal 'twenty three third quarter conference call. We are pleased that you can join us as we review our financials.

Our operational results.

Earlier today, we issued a press release announcing our third 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 comparable 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 Q3 financial performance and then turn the call over to Deepak 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 remainder of the fiscal year.

Our third quarter financial results were solid as we navigated the current economic environment, which continues to be impacted by supply chain delays and increased cost disruptive geopolitical events inflation and rising interest rates. We are excited about finishing the fiscal year strong and entering fiscal 'twenty four with solid.

Visibility given excellent backlog.

I will start with a high level summary of our Q3 results.

First.

We reported Q3 revenues of $303 million, representing a year over year increase of 4% driven by solid revenue growth in our security and opto divisions, which was in part offset by soft health care Division sales and an approximate $4 million unfavorable FX impact compared to prior year.

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Second we reported Q3 adjusted adjusted earnings per share of $1 49 up from $1 43 in Q3 of the prior fiscal year. Despite the negative impact of approximately <unk> 16 per share of additional interest expense due to higher interest rates this year versus last year.

Third we generated strong third quarter operating cash flow of $65 million.

And fourth while our Q3 bookings were sound, perhaps the most notable item is that just after quarter end, we executed a contract for a security bookings of over $500 million net of that representing one of the largest contracts in the industry, providing an excellent start to Q4 bookings in.

Greatly enhancing the already strong visibility we have into fiscal 'twenty four.

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 Allen.

And welcome once again to the OSI systems earnings call for the third quarter of fiscal 2023.

As Jim mentioned.

We are pleased with our third quarter performance in which we grew revenues by 4% and adjusted operating income by 18% from the same period, a year ago, while generating 68% more operating cash flow in comparison to Q3 of 2022.

Our robust backlog not only instills confidence for Q4.

Provision positions us well for a very strong fiscal 2024.

I will briefly touch on some key highlights from our third quarter performance across each division before turning back the call to Alan for more in depth discussion of our financial results.

Beginning with the security Division, where revenues grew 13% in Q3.

Significant operating margin expansion from the buyer prior year's comparable quarter.

Just before the quarter end.

As Alan mentioned, we announced an award notification of a significant contract valued at approximately $600 million they can close.

Approximately 16% value added tax from Mexico.

Document of National Defense.

Dana for our cargo and vehicle inspection systems and related services.

Under this award we expect to provide multiple units of Eagle <unk> high energy dry cargo and vehicle inspection systems Z backscatter cargo inspection portals, <unk> inspection systems, and a proprietary search scan software multi site integration platform.

These solutions are.

Land to be utilized to inspect trucks buses and cars.

Customs border checkpoints, increasing the safety and integrity of Mexico's borders.

We are honored.

While our solutions to play a crucial role in facilitating the smooth flow of trade I note.

And I want to make it very focused clear that even Dolby analysis Sedona Award in Q3.

The related contract was executed early in Q4, and thus is not reflected in the Q3 bookings our quarter end backlog.

Also want to mention that this was a competitive bid and which we are succeeding before selected.

This Mexico Award followed another large $200 million International order that we received in Q2 and announced in early Q3.

These exciting sizeable deals and.

Enhanced our visibility and provides confidence as we enter Q4 and approach the next fiscal year 2024.

These wins also bolster our market presence as we expand in key regions.

Throughout Q3, we continued to deliver on our U S customs and border protection CBP contracts.

There we are supporting the enhancement of U S. U S border security infrastructure, using various cargo and Waco scanning platforms and the search scan integration platform.

These initial delivery orders valued at approximately $200 million.

<unk> under the elite MEP indefinite and definite quantity awards, which had a combined potential award value of approximately $870 million.

CBP has room under these IDI cues to issue additional.

Additional delivery orders to one or more of the vendors that are qualified on these contracts.

It is also important to highlight that the Mexico Sedona award as well as our ongoing efforts at CVP U S. All four border and customs agencies across the Americas, the opportunity to access a comprehensive and integrated solutions.

By incorporating search scan software.

Right right software solution that helps manage inspection image data traffic and vehicle identification of checkpoints, we are able to unified platform that cater to the unique needs of these clients. This would make the trade more smoother.

Between Mexico and U S.

Our turnkey projects in Albania, theoretical and Guatemala had been operating as anticipated and we continue to these projects to demonstrate our experience and capabilities of handling large scale programs.

As Alan mentioned.

This contract, especially to setup.

To our knowledge the biggest contract in the industry to antibody for equipment.

On the aviation side, we continue to sell by airport customers and other critical transportation and public infrastructure customers worldwide in Q3, we announced an order worth approximately $20 million.

From an airport on the Portugal, the order and was providing multiple units of our RTP real time tomography explosive detection systems.

Units are expected to be installed at various airports across Portugal.

Through enhanced security by screening passengers all checked baggage. Additionally, as part of this award we are engaged to deliver ongoing maintenance service and support for these installations to ensure the system is reliable operation.

During the quarter. We also received a $16 million service contract renewal from an OEM for checkpoint maintains at U S airports.

Looking ahead, we continue to see productivity, improving and anticipate that airport authorities will make prudent capital investments to continue upgrading security infrastructure for passenger safety.

Moving onto our optoelectronics and manufacturing division.

We reported revenue growth of 2% in the third quarter.

Accompanied by strong operating margin expansion.

Continued to experience some supply chain challenges for specific components, but we are actively implementing strategies to lessen the impact and maintain smooth operations.

Opto Division continues to work with a broad base of customers, primarily technology Oems to provide components and sub assemblies from our operations in the U S UK, Canada, Malaysia, Indonesia and India.

Our backlog continues to be strong with a diversified OEM customer base and we continue to position ourselves.

As an option for Oems that seek offshore manufacturing partners as an alternative to China based manufacturing.

And finally.

Onto the healthcare Division, where revenues were approximately 16% lower than in the prior year's Q3.

Disappointing.

Capex spending in the hospital industry continues to be challenged by several elements, including elevated spending during the pandemic years and the current economic environment of constrained capital markets.

During the quarter, we announced a $3 million order to provide patient monitoring solutions and support services to a Canadian based hospitals.

This is a strategic win in a critical region for us during Q3, we completed the acquisition of a small company called <unk> health.

Company that develops predictive enterprise software to alert clinicians and doctors to patient deterioration.

Thank you reduce in hospital mortality unplanned transfers to the ICU and drive more timely decisions, making optimized patient care.

Better health predictive solution, along with our existing statement found patient alarm management help us differentiate in the marketplace.

During the quarter.

<unk> added new talent to the sales and marketing leadership in the U S.

Q4 is typically a strong quarter for space labs based on seasonality and near term visibility on certain opportunities. We believe that space labs has the potential to perform much better in Q4 than its recent performance of Q3.

Overall, we are on track to finish Q2 thousand 23 strong and continue our momentum into the next fiscal year as always I would like to thank our employees customers and stockholders for their continued support with that.

Ill turn over the call back over to Alan to talk in more detail about our financial results and guidance before we open the call for questions. Thank you.

Thank you Deepak now ill review the financial results for our third quarter in a bit greater detail again, our fiscal Q3 revenues were up 4% compared with out of the prior year Q.

Q3 Security Division revenues were up 13% largely due to the growth in our cargo and vehicle inspection products and related service revenue.

Auto sales increased 2% year over year with modest growth in third party sales to a diversified customer base.

Lamented by strong intercompany sales to support anticipated upcoming security Division growth.

And as Deepak mentioned, the health care Division, which is our smallest business unit, representing approximately 15% of our nine month sales reported a 16% reduction in year over year revenues and a more challenging marketplace.

The Q3 gross margin of 34, 3% was approximately one 1% below that of the prior year Q3.

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 and a less favorable mix in our 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 inflation and impacts of the supply chain cost changes among other factors.

Moving to operating expenses.

We continue to work diligently across each of our divisions.

To improve efficiencies and prudently manage our SG&A cost structure.

Our Q3 results reflect these efforts.

Q3, SG&A expenses were $53 7 million or 17, 7% of sales compared to $57 8 million were 19, 9% of sales in the prior year Q3.

While foreign exchange created a headwind for Q3 revenues. It did have a beneficial impact on our operating expenses again this quarter.

Research and development expenses in Q3 of fiscal 'twenty, three were $14 9 million slightly down from $15 1 million in the same prior year quarter.

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 Q3 of fiscal 'twenty, three we recorded <unk> 9 million of restructuring and other charges compared to $1 $5 million of such charges in Q3 of the prior fiscal year.

Moving to interest and taxes.

Net interest and other expense in Q3 increased from $2 3 million in fiscal 'twenty, two to $5 7 million in fiscal 'twenty, three primarily due to rising interest rates and the maturity on September one 2022 of our 125% convertible notes, which carried a lower rate than our current bank borrowings we.

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 23, 8% in Q3 of this year compared to 21, 21% in Q3 of fiscal 'twenty two.

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

Excluding the impact of discrete tax items, our normalized effective tax rate in Q3 of fiscal 'twenty. Three was 23, 2% compared to a normalized effective tax rate of 25% in Q3 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 increased from 11, 4% in Q3 of fiscal 'twenty two to 12, 9% in the third quarter of fiscal 'twenty, three driven by strength in each of the security and opto divisions.

The adjusted operating margin in the security Division increased from $14 14, 9% in Q3 of last year.

To 18, 3% in Q3 of 'twenty three.

Due to higher revenue and lower operating expenses.

We were also pleased with the adjusted operating margin expansion in our Opto Division, which increased to 14, 1% in the third quarter of fiscal 2023 compared to 12, 9% in last year's Q3.

These increases were partially offset by challenges in the health care Division, where the adjusted operating margin decreased to five 4% from 14, 7% in the prior year due to lower sales and a less favorable revenue mix.

As Deepak mentioned, we currently expect the healthcare Division to show significant Q4 operating margin improvement, both sequentially and potentially year over year due primarily to revenue growth.

Moving to cash flow.

Cash provided by operations was extremely robust.

In a $65 million in Q3 of fiscal 2003 compared to $38 million in the same prior year quarter, driven by strong collections and customer advances.

We anticipate building inventory during upcoming quarters in preparation for a program deliveries under the two large security division contracts announced last quarter.

Capex in the 2023 third fiscal quarter was $5 7 million, while depreciation and amortization expense in Q3 was $9 7 million.

We were again active in our stock buyback program. This past quarter during which we spent approximately $13 million to repurchase approximately 138000 shares.

Our board increased the buyback authorization earlier this fiscal year and as of quarter end. The program allowed for a repurchase of up to 172 million shares.

Our balance sheet is solid.

With modest net leverage and significant capacity for acquisitions.

And additional stock buybacks.

<unk> from just over $7 million of annual required principal payments under our bank term loan the bulk of our debt matures in fiscal 2027.

And finally turning to guidance.

We are reiterating our fiscal 'twenty, three revenues and non-GAAP EPS guidance.

The fiscal 'twenty, three and non-GAAP diluted EPS guidance 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 on the company's financial results of disruptions and increased costs in the supply chain and inflation and interest rates is difficult to predict and it could vary significantly from the anticipated impact currently 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 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.

Certainly.

Once again, if you have a question at this time. Please press star one on your telephone one moment for our first question.

And our first question comes from the line of Josh Nichols from B Riley Your question. Please.

Yes, Thanks for taking my question and great to see.

Backlog here, so just to clarify here so.

The $500 million net of the VAT.

Award does not include the current backlog, so implying year end backlog should be to.

$2 billion, plus right all else equal and there is still opportunity for additional expansion with the CBP on top of the $200 million of awards you've already received is that a fair assessment.

Absolutely this is deepak here.

You've said it very well.

Want to add onto it that besides CBP add ons that are other.

Opportunities that we continue to look at.

Thanks, and then the other thing I wanted to hit on Allen, you talked a little bit about.

The EPS headwind from the higher interest expense I mean, you've maintained EPS guidance. This year, despite what's been a pretty significant.

Rising rate environment.

Look here EPS guidance for the year is up like 30, or so and that probably excludes around 50.

The headwind from those higher rates that we've talked about previously.

So just if we were to extrapolate that into next year, I know youre, not giving guidance for fiscal 'twenty four but just that alone would apply around $7 a share in EPS.

Next year, if you have a similar kind of growth trajectory and that really doesn't factor in all of these additional large orders that you've seen given that you'd probably expect growth to accelerate materially from the 6% that guidance implies for for this year and also without any margin expansion, which is also I would assume.

Maybe likely is that also fair assessment.

Well, Josh you've summarized things quite nicely, yes, we have tremendous visibility as we sit here two months before the start of our next fiscal year.

Into fiscal 'twenty, four which which we're extremely excited about.

Youre also right about the interest expense it was.

Significant headwind.

Year over year for fiscal 'twenty is re compared to fiscal 'twenty, two even a headwind given what we expected at the time, we came out with guidance in August as rates.

Steadily increased throughout the year so.

We're really pleased with the overall performance on the bottom line in light of those headwinds and Youre right, while it's premature for us at this point to give guidance.

We typically do so following our Q4 call following our Q4, which will be our next call. We do anticipate there is tremendous opportunity to leverage the strong sales growth that will anticipate for next year into into higher earnings growth.

Thanks, and then last question for me.

One is like how much of this GBP $200 million of orders from the CBP.

Has been delivered or is going to be delivered this year versus rolling into next year. I know you also mentioned that the other $200 million award announced last quarter.

<unk> effectively going to be almost all totally recognized in fiscal.

24 is that still the case.

This is Allen Josh So a couple of questions there on CVP.

As you know, we got off to a little slower start in the first half of this fiscal year as the customer had delayed certain deliveries and acceptance tests, we're really seeing that pick up or revenues were much stronger than in Q3 for CVP and are anticipated to be in in Q4, as well and I think as we said on the on the last call or.

Two.

We expect CVP revenues to continue nicely into not only 24, but probably it's a fiscal 'twenty fives as well so it positions us quite nicely with respect to the large $200 million international order that.

We also announced at the beginning of last quarter.

Haven't yet said, what the timing of those revenues will be as we continue to work with the customer on that but.

But suffice it to say, we do expect very significant revenues from that contract in the next fiscal year.

Well great.

Alan Deepak really looking forward to.

To see how things shake out for next fiscal year, given the visibility and unprecedented backlog ill, let someone else take a turn.

Thank you.

Thank you one moment for our next question.

And our next question comes from the line of Brian Rotenberg from Imperial Capital. Your question. Please.

Great Great quarter first question I have is cash flow was very strong in the period and maybe given all the build out that you're doing with these big contracts can you talk about cash flows a little bit for the remainder of the year and then where you see kind of cash flows going in 2020 for I don't know.

How long was build out is going to last as you probably have to stockpile some inventory for these big contracts.

Brian This is Alan Great question, Yes, we were exceptionally pleased with the extremely strong free cash flow that we delivered in Q3.

And as you correctly point out with these two large contracts with the Dana contract and the other large international contracts, we're going to be building inventory over the next several quarters for this contract so.

Good good issue to have so as a result, we're not anticipating any any significant cash flow necessarily in Q4.

And maybe into early fiscal 'twenty four.

But as we then begin to begin to deliver the product.

We expect there'll be us.

A very rich amount of cash flow for us on an overall basis. So very excited about that so probably some near term cash flow headwinds in some medium and long term significant cash flow generation.

Okay.

Thank you very much.

Interest expense also that was brought up by the previous analyst.

Hi.

Could you talk a little bit about your plans maybe to lock in some long term rates are you guys continue to pay down debt I noticed that you paid down some debt in the period what are the plans there and what you what is your current cost of capital.

Yes, good questions, Brian Zelle. It again, so we did lock in.

The majority of our debt last in Q1 of last year. So in the August September timeframe through an interest rate swap that swap was at 326%.

So we feel good about that we do expect to pay down debt as we as we generate cash flow as we did this past quarter.

And.

Although we're always looking at other opportunities that would be the alternative uses of cash flow as well. So we feel good about that position overall.

Okay.

And then maybe the last one is for <unk>, but Alan.

And if it's for you instead.

The health care.

Where do you see the future of the healthcare Division I've spent several years since I've asked that question.

They had a little blip here and you expected to come back in the fourth quarter, but maybe you can talk a little bit about health care, and where you see it going.

Okay.

Wow.

Brian .

We are quite confident about the healthcare business as Alan has mentioned just keep in mind, we've said it before it is the highest margin business.

We are investing heavily to continue to do that for R&D for the new platform that we're developing which we have said it before.

It's going to change our whole platform, it's going to take couple of years to do it in the meantime be remain confident and the disappointing Q3, specifically, especially when you also compare it with the covenant related previous.

What I call it tailwind.

But at the same time and maybe Alan can comment on at this quarter Q3, we were expecting some.

Significant size contract.

<unk> got delayed.

We are told that.

It will happen.

So that we believe also normally seasonally Q4 is stronger than Q3 anyway that Q4 will be a stronger quarter for it.

And we are quite confident and keep in mind that we've bought better health.

Couple of couple of quarters that will be bought Samsung we believe in that platform. We are looking at it in the connectivity story. Besides patient monitoring we are looking at cardiology, we're trying to make it a services company in a way in some products. So all in all we are quite excited about it and as we have said it would be.

Yes, it's disappointing, it's a book and ship into it.

So that as these contracts get delayed it changes from one quarter to the other but with the margin. It is with the connectivity that we're looking at with the new change we have made in the sales management team a view of North America, we are very.

Confident of the future of space like Alan do you want to add something.

I think you said that well, yes, we were Q3 was a challenging quarter as Deepak mentioned had a contract or two that we are anticipating coming in it would have been a very different outlook and we arent anticipating that in Q4, and therefore, we feel cautiously confident that.

We will see a much different picture financial picture in Q4 than we saw in Q3 and with the strong R&D programs that are taking place with some of the new patient monitoring platforms and cardiology products. We think the future is going to be bright overall for the division.

Great. Thank you.

Thank you one moment for our next question.

And our next question comes from the line of Jeff Martin from Roth Capital.

<unk>.

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

Hi, Geoff Allan just an observation here SG&A over really the last four years, if you extrapolate it through the end of this fiscal year.

And has declined every year.

I know you're constantly evaluating efficiencies, but just was curious with respect to fiscal 'twenty four.

How are we going to start to see SG&A.

Expand again, because the business is likely to see significant acceleration in revenue growth tied to these larger contracts.

Jeff, Yes, really good question and we have we do monitor our costs quite quite judiciously as we move into fiscal 'twenty four.

We would expect SG&A as a percentage of revenues.

To decline, but on an absolute dollar basis to increase.

Consistent with.

We're seeing significant sales growth and.

And some of the variable costs that come with that so yes, we would anticipate on an absolute dollar increase in SG&A in our next fiscal year.

Okay great.

And then with respect to the U S CBP contract.

Order.

As we exit fiscal 'twenty, three where do you think you'll be in terms of percentage delivery against that contract.

And on top of that are you currently.

Seeing activity or interest in follow on orders or tack on orders.

Hi, Jeff.

I'm going to ask a portion of it and Adam can answer.

We really can't break it down into into specifics into what percentage and this year next year, what Alan has said it that it's been a little slow start, but Q3 was more shipments to <unk>. In Q2 Q4 also has seen anything going to be more.

The contract rather than contracts with.

Taken in 2000, 2000, 2025, and 26, but we also want to emphasize.

<unk> as I mentioned before for the total two programs, putting about $800 million range.

US and other vendors onto that only 200 million was let out to us.

Big portion of it so theres still a lot of room as we move forward for CVP to put new orders against us on those iqs, which will continue into 'twenty five 'twenty six and beyond and on top of that we've said it before one of the things that we are very much focused into it.

It's not just selling the equipment.

But the search scan software, which we continue to work and we are very excited about it and with the sedan on contract.

From Mexico, which we have said it at the northern borders between Mexico and U S that is a very big plus point for longer term cooperation between the two countries and to make the trade goal simpler faster and we continue to say that as this thing has looked at it and people are happy with.

The customers that are happy with it. This is a good selling point to the rest of the world wherever that is trade challenges there to duplicate the same thing and we are very well positioned for it. So we're very excited about it.

That's a great segue into my final question Deepak as.

Is the coordination and integration between the U S and Mexico already and plan or is that just in the initial stages of discussion and was that a big part of the decision process.

First of all Dana.

With rapid scan.

Well number one of our competitive bids.

And I think we've said it before.

Not based just on price it was based on performance.

And the experience.

But I can't say anything about the governments have to do whatever they have to do but they have shared information in a way well.

The CVP was very complementary and.

I don't know that could have helped.

But how they do it in the future and it all depends on politically.

But what I look at it is as as we have said it before and the other programs that we havent, Guatemala in Puerto Rico, and Albania, all of them had been very very successful and the customer is very happy it does help in the trade and we keep looking at it that the whole world has to look at this and with the way the efficient way of trade.

It will help but I can't say, what what they plan to do and what they are doing between the countries.

Got it. Thank you look forward to the fiscal 'twenty guidance next quarter.

Thank you.

Thank you once again, if you have a question at this time, Please press star one one.

One moment for our next question.

And our next question comes from the line of Larry Solow from CJS Securities. Your question. Please.

Great.

Good afternoon.

A quick question just maybe a couple of follow ups on <unk>.

<unk>.

Where do you guys have begun and do you think you mentioned the competitive bidding process in Mexico.

What do you think do you think certain scan as youre differentiated there what do you think sort of is driving at all.

Your fair share if not bleeding.

And most of this newer vehicle inspection and cargo inspection.

Good question I would say start getting one of them, but there is a lot of other we consider ourselves to be the preeminent technology provider and cargo in the world. We can say that confidently multi energy backscatter, our ability to interact with radiation portals to interact with the.

With the.

License leaders.

Integration size of each service provider iconic customer happiness and the global presence. So all those factors do come into play and one of the most important factors that come into play is the hit.

History of performance and execution. So I won't say just search scan for is a combination of all of this innovation upgrade of technology, new products, the ability to be able to to perform and be flexible both customer demand Alan do you want to add something to it.

I think that summarized it very well.

Got it and then could you just just for.

For clarification, so the three contracts or whatever they total I don't know 567 hundred $800 million undermined is there.

Can we expect like a real real.

Current portion of that.

I think these contracts close to $1 billion actually if you add all three of them.

Sure.

Would that would be would there be like a reoccurring portion kind of just like 25% of this number which is kind of what you are.

Reoccurring service portion is today.

Sort of color on that.

Number one.

When you add it up you're trying to add the CVP contract.

The international contract and a sedan.

Yes right.

Together enter but keep in mind to CBP CBP 200 minute our contract as part of an <unk> IQ, which is 800 money right.

Not all of that is going to address what they can do whatever they want but we are well positioned customers very happy.

And the other side of the question. What you said is these contracts do include some service and maintenance anyway, and most of these life span of these equipments and stopped by more than 10 12 15 years. So there's a follow on service and maintenance upgrading and stuff that continues but on top of that I want.

To say, yes, they are large contracts, but that doesn't mean that they're not other big potential contracts out in the rest of the world.

Keep in mind, a couple of years ago, We added 700 million September 50 million <unk> contract from Mexico services.

<unk> long term continuous and Thats a big contract. So there are other opportunities. We look at these as a very big stepping stone for us to be able to convince other parts of the world that these are great things to work together and we are well equipped to manage and support the customer.

Alan got Larry Larry one of the nice things about this is I think as you're alluding to is as we get this bigger and bigger install base out there you get those nice recurring revenue through service and the service revenue generally carries a nice healthy margin associated with it as well. So it provides a steady stream of recurring revenue for many many years.

To come.

Yeah, Yeah, exactly and your service revenue has kind of jumped up a little bit over the last few quarters.

Definitely helpful.

Just for clarification I know you kind of you said the international contract will begin in fiscal 'twenty four.

Sounds like you'll get a good portion of that whether or not thats the majority or not thank.

Thank you really clarifying there, but but in terms of Mexico do you also expect that to.

Driving contributions in this upcoming fiscal year.

Larry This is Alan so we're working with the customer on the timing of.

Deliveries for that in revenue, but yes. The answer is yes, we do expect revenues to commence for the Mexico. So Dana contract in fiscal 'twenty four we will have more clarity on timing at our next call, but yes, we do expect revenues in fiscal 'twenty.

Okay, Great and then just lastly, just on auto I think it was.

A little.

A little slower growth this quarter on the top line.

I think that was kind of expected, but just just the general backlog has been growing up I.

I think at least as of last quarter won't be updated it this quarter, but it was up I think 20% year over year.

Whats whats sort of the disconnect between a 20% rise in backlog and sort of flattish.

It isn't just that most of these orders are longer term or what is.

Is it timing related or any color there would be great.

Good question good observation, yes, keep in mind that business is a different business.

And during the last year, especially with Colgate and supply chain initiatives like that the customers placed orders.

Just two.

When I call their yes, taking had into that so that we have a longer term.

Backlog in the <unk>.

That area.

And some of the customers have now looked at it and see what their needs are and starting to push and shove into it.

But that backlog is what I call. It as large contracts and then it takes some time before the next ones come in it's a longer term play Alan maybe you can clarify a little bit more yes. That's the primary thing just the timing of deliveries to customers some of them who are adjusting their own.

Inventory on hand requirements.

Supply chain continues to play a role in that to where we might have 99% of the components, but we might be missing.

Some small components that have delayed certain shipments, but that's the general area. So yes. The backlog at opto is very strong revenue the conversion to revenue will be nice and the productivity gains that have been.

Really really noteworthy which has generated a lot of the operating margin expansion.

Just to add on just to add on to the.

Other maybe little bit of a broader thing, but I did say in my in my speech.

One of the big things about that optical business is.

Global presence manufacturing that are U S Resurrection, Canada, and England, It's in Malaysia, Indonesia, India that helps a lot because the OEM customers that we have to place.

Place orders and other focused is supply chain issue in the different parts of the world can supply different products and everybody is looking at alternate to China.

Been a very big plus point long term and continue to work towards that and use that effectively.

Great and you just mentioned so Paul if I could just slip one more question.

This significant ramp coming up and security.

Is there any concern about your ability or the supply chain ability to kind of.

Keep up with that pace.

In order to make these deliveries over the next 234 years.

Definitely.

It's a big ramp up but we are well positioned again internal intercompany also is a big asset.

We have between the.

Supplying the product, which our competitors don't have it.

We are basically very much focused into it once it has shown a javelin.

At the same time, we feel that.

<unk>.

We are we are very much equipped and we continue to look at it we are working with the customer we're working with our vendors.

Alexandra that definitely bigger supply chain issues cost issues.

So we continue to look at it but that's what our strength as we continue to focus on it.

Great. Thanks, I appreciate all the color.

Thank you. This does conclude the question and answer session of today's program I'd like to hand, the program back to Deepak Chopra for any further remarks.

Thank you all once again for attending our conference call and I again want to thank our employees our stockholders for their confidence in us.

Worldwide employees all over.

It is a very exciting time, we are focused or focused onto it and we'll again talk to you and have a better feeling in August went into a conference call at <unk> for the year end.

The next year it looks like with a $2 billion backlog, we are very much focused and excited about it. Thank you very much.

Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program you may now disconnect good day.

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Thank you for standing by and.

Welcome to the OSI Systems, Inc. Third quarter 2023 conference call.

To remove yourself from the queue simply press Star one again as a reminder, today's program is being recorded.

Now I'd like to introduce your host for todays program Alan Edric.

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

Thank you.

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

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

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

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

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 comparable 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 Q3 financial performance and then turn the call over to Deepak for an overview of our business performance we.

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

We are excited about finishing the fiscal year strong and entering fiscal 'twenty four with solid visibility given excellent backlog.

I will start with a high level summary of our Q3 results.

First.

We reported Q3 revenues of $303 million, representing a year over year increase of 4%.

Driven by solid revenue growth in our security and Opto divisions, which was in part offset by soft healthcare business sales and an approximate $4 million unfavorable.

Unfavorable FX impact compared to prior year rates.

Second we reported Q3 adjusted adjusted earnings per share of $1 49.

From $1 43 in Q3 of the prior fiscal year. Despite the negative impact of approximately <unk> 16 per share of additional interest expense due to higher interest rates this year versus last year.

Third we generated strong third quarter operating cash flow of $65 million.

And fourth while our Q3 bookings were sound, perhaps the most notable item is that just after quarter end, we executed a contract for security bookings of over $500 million net of that representing one of the largest contracts in the industry, providing an excellent start to Q4 bookings in <unk>.

Lately enhancing the already strong visibility we have into fiscal 'twenty for us.

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

Thank you Alan.

And welcome once again to the OSI systems earnings call for the third quarter of fiscal 2023.

As Andrew mentioned.

We are pleased with our fiscal third quarter performance in which we grew revenues.

By 4% and adjusted operating income by 18% from the same period, a year ago, while generating 68% more operating cash flow in comparison to Q3 of 2022.

Our robust backlog not only instills confidence for Q4.

Provision positions us well for a very strong fiscal 2024.

I will briefly touch on some key highlights from our third quarter performance across each division before turning back the call to Alan for more in depth discussion of our financial results.

Beginning with the security Division, where revenues grew 13% in Q3.

Significant operating margin expansion from the buyer prior year's comparable quarter.

Just before the quarter end.

As Alan mentioned, we announced an award notification of a significant contract valued at approximately $600 million, which includes approximately 16% value added tax from Mexico Department of National Defence Savannah for our cargo.

And <unk> inspection systems and related services.

Under this award.

We expect to provide multiple units of Eagle <unk> high energy drive thru cargo and vehicle inspection systems Z Backscatter cargo inspection portals car view vehicle inspection systems, and a proprietary search scan software multi site integration platform.

These solutions are.

Planned to be utilized to inspect trucks buses and cars at <unk>.

Customs border checkpoints, increasing the safety and integrity of Mexico's borders.

We are honored.

Our solutions to play a crucial role in facilitating the smooth flow of trade.

I note.

And I want to make it very focused clear that even Dolby analysis Sedona Award in Q3.

The related contract was executed early in Q4 and that is not reflected in the Q3 bookings our quarter end backlog.

So I want to mention that this was a competitive bid and which we've our success.

We were selected.

This Mexico Award followed another large $200 million International order that we received in Q2 and announced in early Q3.

These exciting sizable deals enhanced our visibility and provide confidence.

As we enter Q4 and approach the next fiscal year 2020 for these.

These wins also bolster our market presence as we expand in key regions.

Throughout Q3, we continued to deliver on our U S customs and border protection CBP contracts.

Where we are supporting the enhancement of U S. U S border security infrastructure, using various cargo and vikar scanning platforms and the search scan integration platform.

These initial delivery orders valued at approximately $200 million.

<unk> under the LCP and MEP.

Phoenix indefinite quantity awards, which had a combined potential award value of approximately $870 million.

CBP has room under these <unk> has to issue additional delivery orders to one or more of the vendors that are qualified on these contracts.

It is also important to highlight that the Mexico sedan award as well as our ongoing efforts at CBP U S. All four border and customs agencies across the Americas, the opportunity to access comprehensive and integrated solutions.

By incorporating search scan software.

Brightly software solution that helps manage inspection image data traffic in Vical identification at checkpoints, we are able to unified platform that cater to the unique needs of these clients. This would make the trade more smoother.

Between Mexico and U S.

Our turnkey projects in Albania.

And Guatemala had been operating as anticipated and we continue to these projects to demonstrate our experience and capabilities of handling large scale programs.

As Alan mentioned this.

This contract, especially to setup two.

Our knowledge, but the biggest contract in the industry to antibody for equipment.

From an airport is the Portugal, the order and was providing multiple units of our RTD against time Kaumography explosive detection systems. These units are expected to be installed at various airports across Portugal.

<unk> security by screening passengers.

Baggage. Additionally, as part of this award we are engaged to deliver ongoing maintenance service and support for these installations to ensure their systems and reliable operation.

During the quarter. We also received a $16 million of service contract renewal.

From an OEM for checkpoint, Montana at U S airports.

Looking ahead, we can.

Continue to see productivity, improving and anticipate that airport authorities will make prudent capital investments to continue upgrading security infrastructure for passenger safety.

Moving onto our optoelectronics and manufacturing division.

We reported revenue growth of 2% in the third quarter.

Accompanied by strong operating margin expansion.

We continue to experience some supply chain challenges for specific components.

We are actively implementing strategies to lessen the impact and maintain smooth operations.

Backlog continues to be strong with a diversified OEM customer base and we continue to position ourselves as an option for Oems that seek offshore manufacturing partners as an alternative to China based manufacturing.

And finally.

Onto the healthcare Division, where revenues were approximately 16% lower than in the prior year's Q3 <unk>.

Disappointing.

Capex spending in the hospital industry continues to be challenged by several elements, including elevated spending during the pandemic es and the current economic environment of constrained capital markets.

During the quarter, we announced a $3 million order to provide patient monitoring solutions and support services to our Canadian based hospital.

This is a strategic win in a critical region for us during Q3, we completed the acquisition of a small company called <unk> Health a company that develops predictive enterprise software to alert clinicians and doctors to patient deterioration.

Helping to reduce in hospital mortality unplanned transfers to the ICU and drive more timely decisions, making optimized patient care.

The better health predictive solution, along with our existing statement town patient alarm management help us differentiate in the marketplace during the quarter.

Also added new talent to the sales and marketing leadership in the U S.

Q4 is typically a strong quarter for space labs based on seasonality and near term visibility on certain opportunities. We believe expanse labs has the potential to perform much better in Q4 <unk> recent performance of Q3.

Overall, we are on track to finish Q.

23, strong and continue our momentum into the next fiscal year as always I would like to thank our employees customers and stockholders for their continued support with that I am going to turn over the call back over to Alan to talk in more detail about our financial results and guidance before we open the call for questions. Thank you.

Thank you Deepak now ill review the financial results for our third quarter in a bit greater detail again, our fiscal Q3 revenues were up 4% compared with out of the prior year Q.

Q3 Security Division revenues were up 13% largely due to the growth in our cargo and vehicle inspection products and related service revenue.

Auto sales increased 2% year over year with modest growth in third party sales to a diversified customer base supplemented by strong intercompany sales to support anticipated upcoming security Division growth.

The Q3 gross margin of 34, 3% was approximately one 1% below that of the prior year Q3. 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 and a less favorable mix in our 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 inflation and impacts of supply chain cost changes among other factors.

Moving to operating expenses.

We continue to work diligently across each of our divisions.

To improve efficiencies and prudently manage our SG&A cost structure.

Our Q3 results reflect these efforts.

Q3, SG&A expenses were $53 7 million or 17, 7% of sales compared to $57 8 million or 19, 9% of sales in the prior year Q3.

While foreign exchange created a headwind for Q3 revenues. It did have a beneficial impact on our operating expenses again this quarter.

Research and development expenses in Q3 of fiscal 'twenty, three were $14 9 million slightly down from $15 1 million in the same prior year quarter.

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 Q3 of fiscal 'twenty, three we recorded <unk> 9 million of restructuring and other charges compared to $1 5 million of such charges in Q3 of the prior fiscal year.

Moving to interest and taxes.

Net interest and other expense in Q3 increased from $2 3 million in fiscal 'twenty, two to $5 7 million in fiscal 'twenty, three primarily due to rising interest rates and the maturity on September one 2022 of our one 2% to 5% convertible notes, 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 23, 8% in Q3 of this year compared to 21, 21% in Q3 of fiscal 'twenty two.

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

Excluding the impact of discrete tax items, our normalized effective tax rate in Q3 of fiscal 'twenty. Three was 23, 2% compared to a normalized effective tax rate of 25% in Q3 of fiscal 'twenty two.

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

The adjusted operating margin in the Security Division increased from 14 14, 9% in Q3 of last year.

To 18, 3% in Q3 of 'twenty three.

Due to higher revenue and lower operating expenses.

We were also pleased with the adjusted operating margin expansion in our Opto Division, which increased to 14, 1% in the third quarter of fiscal 2023 compared to 12, 9% in last year's Q3.

As Deepak mentioned, we currently expect the healthcare Division to show significant Q4 operating margin improvement, both sequentially and potentially year over year due primarily to revenue growth.

Moving to cash flow.

Cash provided by operations was extremely robust.

Being in a $65 million in Q3 of fiscal 'twenty, three compared to $38 million in the same prior year quarter, driven by strong collections and customer advances.

We anticipate building inventory during upcoming quarters in preparation for a program deliveries under the two large security division contracts announced last quarter.

Capex in the 2023 third fiscal quarter was $5 7 million, while depreciation and amortization expense in Q3 was $9 7 million.

We were again active in our stock buyback program. This past quarter during which we spent approximately $13 million to repurchase approximately 138000 shares.

Our board increased the buyback authorization earlier this fiscal year and as of quarter end. The program allowed for a repurchase of up to 172 million shares.

Our balance sheet is solid.

With modest net leverage and significant capacity for acquisitions and additional stock buybacks.

<unk> from just over $7 million of annual required principal payments under our bank term loan the bulk of our debt matures in fiscal 2027.

And finally turning to guidance.

We are reiterating our fiscal 'twenty, three revenues and non-GAAP EPS guidance.

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 and interest rates is difficult to predict and could vary significantly from the anticipated impact currently currently reflected in our estimates and guidance.

Actual revenues and non-GAAP earnings per diluted 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 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 his continued dedication in supporting our customers and partners and at this time, we would like to open the call to questions.

Certainly.

Once again, if you have any questions at this time. Please press star one on your telephone one moment for our first question.

And our first question comes from the line of Josh Nichols from B Riley Your question. Please.

Yes, Thanks for taking my question and great to see.

Backlog here, so just to clarify here so.

The $500 million net of the VAT.

Award does not included in our current backlog, so implying year end backlog should be to.

$2 billion, plus right all else equal and there is still opportunity for additional expansion with the CBP on top of the $200 million of awards you've already received is that a fair assessment.

Absolutely this deeper care.

You have said it very well.

Want to add onto it.

Besides CBP add ons that are other.

Opportunities that we continue to look at.

Thanks, and then the other thing I wanted to hit on Allen, you talked a little bit about.

The EPS headwind from the higher interest expense I mean, you've maintained EPS guidance. This year, despite what's been a pretty significant.

Rising rate environment.

Look here EPS guidance for the year is up like 30, or so and that probably excludes around 50.

The headwind from those higher rates that we've talked about previously.

So just if we were to extrapolate that into next year, I know youre, not giving guidance for fiscal 'twenty, four but just that alone would imply around $7 a share in EPS.

Next year, if you have a similar kind of growth trajectory and that really doesn't factor in all of these additional large orders that you've seen given that you would probably expect growth to accelerate materially from the 6% that guidance implies for for this year and also without any margin expansion, which is also I would have.

Jim maybe likely is that also a fair assessment.

Well, Josh you've summarized things quite nicely, yes, we have tremendous visibility as we sit here two months before the start of our next fiscal year.

Into fiscal 'twenty, four which which we're extremely excited about.

Youre also right about the interest expense it was a significant headwind.

Year over year for fiscal 'twenty is re compared to fiscal 'twenty, two even a headwind given what we expected at the time, we came out with guidance in August as rates have steadily increased throughout the year. So.

Yes, we're really pleased with the overall performance on the bottom line in light of those headwinds and Youre right, while it's premature for us at this point to give guidance.

As we typically do so following our Q4 call following our Q4, which will be our next call. We do anticipate there is tremendous opportunity to leverage the strong sales growth that will anticipate for next year into into higher earnings growth.

Thanks, and then last question for me.

One is like how much of the GBP $200 million of orders from the CBP has been delivered or is going to be delivered this year versus rolling into next year. I know you also mentioned that the.

The other $200 million award announced last quarter was effectively going to be almost all totally recognized in fiscal <unk>.

24 is that still the case.

This is Allen Josh.

Questions there on CVP.

As you know, we got off to a little slower start in the first half of this fiscal year as the customer had.

<unk> certain deliveries and acceptance tests, we're really seeing that pick up where revenues were much stronger than in Q3 for CVP and are anticipated to be in in Q4, as well and I think as we said on the on the last call or two.

We expect CDP revenues to continue nicely into not only 24, but probably to fiscal 'twenty five as.

As well so it positions us quite nicely with respect to the large $200 million International order that we.

We also announced at the beginning of last quarter.

We haven't yet said with the timing of those revenues will be as we continue to work with the customer on that.

But suffice it to say, we do expect very significant revenues from that contract in the next fiscal year.

Well great.

Alan Deepak really looking forward.

To see how things shake out for next fiscal year, given the visibility and unprecedented backlog ill, let someone else take it John .

Thank you. Thank you.

Thank you one moment for our next question.

And our next question comes from the line of Brian Rotenberg from Imperial Capital. Your question. Please.

Great Great quarter first question I have is cash flow.

Strong in the period.

And maybe given all the build out that you're doing with these big contracts can you talk about cash flows a little bit for the remainder of the year and then where you see kind of cash flows going in 2020 for I don't know how long. This build out is going to last as you probably have to stockpile some inventory for these big contracts.

Brian This is Alan Great question, Yes, we were exceptionally pleased with the extremely strong free cash flow that we delivered in Q3.

And as you correctly point out with these two large contracts with the Dana contract and the other large international contract, we're going to be building inventory over the next several quarters before this contract so.

Good good issue to have so as a result, we're not anticipating any any significant cash flow necessarily in Q4.

And maybe into early fiscal 'twenty four.

But as we then begin to begin to deliver the product.

We expect there'll be.

A very rich amount of cash flow for us on an overall basis. So very excited about that so probably some near term cash flow headwinds in some medium and long term significant cash flow generation.

Okay.

Thank you very much.

Interest expense also that was brought up by the previous analyst.

Hi.

Could you talk a little bit about your plans maybe to lock in some long term rates or are you guys continue to pay down debt I noticed that you paid down some debt in the period what are the plans there and what and what is your current cost of capital.

Yes, good questions, Brian Zachman again, so we did lock in.

The majority of our debt last in Q1 of last year. So in the August September timeframe through an interest rate swap that swap was at three 2% 6%.

So we feel good about that we do expect to pay down debt as we as we generate cash flow as we did this past quarter.

And.

Although we're always looking at other opportunities that would be alternative uses of cash flow as well. So we feel good about that position overall.

Okay.

And then maybe the last one is for <unk> to Alan Please chime in if it's for you instead.

The health care.

Where do you see the future.

<unk> care Division, it's been several years since I've asked that question.

And they had a little blip here and do you expect them to come back in the fourth quarter, but maybe you can talk a little bit about health care, and where you see it going.

Wow.

Brian We are we are quite confident about the health care business as Alan has mentioned just keep in mind, we've said it before it is the highest margin business.

We are investing heavily continue to do that for R&D for the new platform that we're developing which we have said it before.

It's going to change our whole platform, it's going to take couple of years to do it in the meantime, we remain confident and what a disappointing Q3, specifically, especially when you also compared with the cover related previous.

What I call it tailwind.

But at the same time and maybe Alan can comment on at this quarter Q3, we were expecting some.

Significant size contract.

<unk> got delayed.

We are told that they have.

<unk> will happen.

We believe also normally seasonally Q4 stronger than Q3 anyway that Q4 will be a stronger quarter for it.

And we are quite confident and keep in mind that we've bought better health.

A couple of couple of quarters that will be bought Samsung. We believe in that platform. We are looking at it in the connectivity story. Besides patient monitoring we are looking at cardiology, we're trying to make it a services company in a way in some products. So all in all we are quite excited about it and as we have said it.

Before yes, it's disappointing, it's a book and ship into it.

Confident of the future of space Labs, Alan do you want to add something.

I think you said that well, yes, we were Q3 was a challenging quarter as Deepak mentioned had a contract or two that we are anticipating come in it would have been a very different outlook and we arent anticipating that in Q4, and therefore, we feel.

Confident that we.

You will see a much different picture financial picture in Q4 than we saw in Q3 and with the strong R&D programs that are taking place for some of the new patient monitoring platforms and cardiology products. We think the future is going to be bright overall for the division.

Great. Thank you.

Thank you one moment for our next question.

And our next question comes from the line of Jeff Martin from Roth Capital.

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

Hi, Geoff Allan just an observation here SG&A over really the last four years, if you extrapolate that through the end of this fiscal year.

Declined every year.

Got it.

I know you're constantly evaluating efficiencies, but just was curious with respect to fiscal 'twenty four.

Are we going to are we going to start to see SG&A.

Expand again, because the business is likely to see significant acceleration in revenue growth tied to these larger contracts.

Jeff, Yes, really good question and we have we do monitor our costs quite quite judiciously as we move into fiscal 'twenty four.

We would expect SG&A as a percentage of revenues.

To decline, but on an absolute dollar basis to increase.

Consistent with.

We're seeing significant sales growth.

And some of the variable costs that come with that so yes, we would anticipate on an absolute dollar increase in SG&A.

Our next fiscal year.

Okay, Great and then with respect to the U S CBP contract.

Order.

As we exit fiscal 'twenty, three where do you think you'll be in terms of percentage delivery against that contract.

And on top of that are you currently.

Seeing activity or interest in follow on orders or tack on orders.

Hi, Jeff.

I'm going to ask a portion of it as an add on can answer we really can't break it down into into specifics into what percentage in this year next year, what Alan has said it that it's been a little slow start, but Q3 was more shipments to <unk>. In Q2 Q4 also has seen anything going to be more but the contract present.

Contracts, we've taken in 2000, 2024, 25, and 26, but we also want to emphasize.

<unk> as I mentioned before for the total two programs, putting about $800 million range.

US and other lenders are that only 200 million was laid out to us.

Big portion of it. So there is still a lot of room as we move forward for CVP to put new orders against us on those <unk>, which will continue into 'twenty five 'twenty six and beyond and on top of that we've said before one of the things that we are very much focused into it.

It is not just selling the equipment.

But the search scan software, which we continue to work and we are very excited about it and with the sedan on contract.

From Mexico, which we have said it at the northern borders between Mexico and U S that is a very big plus point for longer term cooperation between the two countries and to make the trade goal simpler and faster and we continue to say that as this thing has looked at it and people are happy with.

The customers are happy with it. This is a good selling point to the rest of the world wherever that is trade challenges there to duplicate the same thing and we are very well positioned for it. So we're very excited about it.

That's a great segue into my final question. Deepak is is the coordination and integration between U S and Mexico already in plan or is that just in the initial stages of discussion and was that a big part of the decision process first of all Dana.

To go with rapid scan.

Well number one the competitive bid and I think we've said it before that this was not based just on price. It was based on performance.

And the experience.

But I can't say anything about the governments have to do whatever they have to do but they have shared information in a way that the CVP was very complementary and I.

I don't know that could have helped.

But how they do it in the future and it all depends on politically.

What I look at it is as as we have said it before and the other programs that we havent, Guatemala in Puerto Rico, and Albania, all of them had been very very successful and the customer is very happy it does help in the trade and we keep looking at it that the whole world has to look at this and with the way the efficient way of trade.

It will help but I can't say, what what they plan to do and what they are doing between the countries.

Got it. Thank you look forward to the fiscal 'twenty guidance next quarter.

Thank you.

Thank you once again, if you have a question at this time, Please press star one one.

One moment for our next question.

And our next question comes from the line of Larry Solow from CJS Securities. Your question. Please.

Great. Good morning, good afternoon quick.

Quick question, just maybe a couple of follow ups on <unk>.

Large awards the kinds of beginning thank you mentioned the competitive bidding process in Mexico.

What do you think do you think search scan as Youre differentiated there what do you think sort of is driving at all.

Your fair share if not bleeding.

And most of this newer vehicle inspection and cargo inspection.

With the licensed.

Licensed readers.

Integration size of each service provider iconic customer happiness and the global presence. So all those factors do come into play and one of the most important factor that come into play is the hit.

History of performance and execution. So I won't say just search scan is a combination of all of this innovation upgrade of technology, new products, the ability to be able to to perform and be flexible both customer demand Helen do you want to add something to it.

I think you summarized it very well.

Got it and then could you just just for clarification.

So the three contracts or whatever they total I don't know 567 hundred $800 million is there.

Can we expect like a reoccurring portion of that comp I think these contracts. They are close to $1 billion actually if you add all three of them.

Would that would be would there be like a reoccurring portion that kind of is like 25% of this number which is kind of what you are.

Reoccurring service portion is today any sort of color on that.

Number one.

When you do that when you add it up here.

Add the CVP contract.

The international contract and a sedan.

Yes, Adam together.

Together enter but keep in mind, the CVP CBP 200 minute our contract as part of an <unk> IQ, which is 800 money right.

All of that is going to address what they can do whatever they want but we are well positioned customers very happy.

Seth Yes. These are large contracts, but that doesn't mean that they're not other big potential contracts out of the rest of the world.

Keep in mind, a couple of years ago, We added 700 million September 50 million <unk> contract from Mexico services.

Puerto Rico long term continues and that's a big contract. So that there are other opportunities. We look at these as a very big stepping stone for us to be able to convince other parts of the world that these are great things to work together and we are well equipped to manage and support the customer.

Alan got Larry Larry one of the nice things about this is I think as you're alluding to is as we get those bigger and bigger install base out there you get those nice recurring revenue through service and the service revenue generally carries a nice healthy margin associated with it as well. So it provides a steady stream of recurring revenue for many many years.

To come.

Yeah, Yeah, exactly and your service revenue has kind of jumped up a little bit over the last few quarters, which is definitely helpful.

And then just for clarification I know you kind of you said the international contract will begin in fiscal 'twenty four it south.

Like you'll get a good portion of that whether or not thats. The majority are not im not I don't think.

Thank you really clarifying there, but but in terms of Mexico do you also expect that to.

Driving contributions in this upcoming fiscal year.

Larry This is Alan so we're working with the customer on the timing of of deliveries for that revenue, but yes. The answer is yes, we do expect revenues to commence for the Mexico. So Dana contract in fiscal 'twenty four we will have more clarity on timing at our next call, but yes, we do expect revenues in fiscal 'twenty.

Okay, Great and then just lastly, just on auto.

I think it was.

This little slower growth this quarter on the top line I think that was kind of expected, but just just the general backlog has been growing up.

I think at least as of last quarter won't be updated it this quarter, but it was up I think 20% year over year.

Whats whats sort of the disconnect between a 20% rise in backlog and sort of flattish sales or is it just that most of these orders are longer term or what is.

Is it timing related or any color there would be great.

Good question good observation, yes, keep in mind that business is a different business.

And during the last year, especially with Covid and supply chain initiatives like that the customers placed orders.

Just two.

When I call their yes, taking had into that so that we have a longer term.

Backlog.

In that area.

<unk>.

Some of the customers have now looked at it and see what their needs are and starting to push and shove into it but.

Inventory on hand requirements.

Supply chain continues to play a role in that to where we might have 99% of the components, but we might be missing.

Really really noteworthy which has generated a lot of the operating margin expansion.

And I'll just to add on just to add on to the other.

And maybe a little bit of a broader thing what I did say in my in my speech.

One of the big things about that optical business is.

Global presence manufacturing that are U S Resurrection, Canada, and England, it's in Malaysia, and Indonesia, India that helps a lot because the OEM customers that we have to place.

Place orders and other focused is supply chain issue in the different parts of the world can supply different products and everybody is looking at alternate to China.

Been a very big plus point long term and continue to work towards that and use that effectively.

Great and you just mentioned so Paul if I could just slip one more question.

This significant ramp coming up and security.

Is there any concern about your ability or the supply chain ability to kind of.

Keep up with that pace.

To make these deliveries over the next 234 years.

Definitely.

A big ramp up but we are well positioned again internal intercompany also is a big asset that can be had between the <unk>.

Supplying the product, which our competitors don't have at <unk>.

And we are basically very much focused into it won't stay that started Jonathan.

But at the same time, we frame.

That.

We are we are very much equipped and we continue to look at it we are working with the customer we're working with our vendors.

As Alan mentioned that definitely bigger supply chain issues cost issues.

So we continue to look at it but that's what our strength as we continue to focus on it.

Great. Thanks, I appreciate all the color.

Thank you. This does conclude the question and answer session of today's program I'd like to hand, the program back to Deepak Chopra for any further remarks.

Thank you all once again for attending our conference call and I again want to thank our employees our stockholders for their confidence in us.

Worldwide employees are lower.

It is a very exciting time, we have focused our focused onto it and we'll again talk to you and have a better feeling in August went into a conference call at <unk> for the year end.

The next year it looks like with a $2 billion backlog, we are very much focused and excited about it. Thank you very much.

Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program you may now disconnect good day.

OSI Systems Inc. Q3 2023 Earnings Call

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