Osi Systems Inc (OSIS) Q2 2023 Earnings Call Transcript

Good day, and thank you for standing by. Welcome to OSI Systems, Inc. Second Quarter 2023 Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Alan Edrick, Executive Vice President and Chief Financial Officer. Please go ahead.

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. Welcome to the OSI Systems Fiscal '23 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 '23 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 1995 with respect to such forward-looking statements. All forward-looking statements made on this call are based on currently available information, and the company undertakes no obligation to update any forward-looking statement based on subsequent events or new information or otherwise. During today's call, we will refer to both GAAP and non-GAAP financial measures when describing the company's results. For information regarding non-GAAP measures and GAAP measures of the company's results and a quantitative reconciliation of those figures, please refer to today's earnings release. I will begin with a discussion of our Q2 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 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. But let's start with a high-level summary of our Q2 results. 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 Opto divisions, which were in part offset by soft Healthcare division sales and an approximate $4 million 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. And third, our Q2 bookings were over $500 million, representing a book-to-bill ratio of approximately 1.7, leading to a record quarter end backlog of nearly $1.5 billion. Before diving more deeply into our financial results and discussing the fiscal '23 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 of fiscal '23 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 '23, and this also positions the Security division, especially really well entering for fiscal '24. Let's discuss each division's performance, starting with Security. 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 2.3 for Q2 and 1.9x for the first half of fiscal '23 for this division. We continue to deliver on the large existing U.S. customers border protection programs we announced in fiscal '22. These programs focus on improving Security at the U.S. borders by utilizing our cargo and vehicle inspection platforms, Search Scan integration software and gatekeeper vehicle checkpoint lane control solutions. Search Scan is our 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. Search Scan is also comparable with third-party inspection systems, making it a versatile option in the marketplace. Based upon 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 an exceptional bookings highlighted by a $200-plus million 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 civil works, 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 '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 Orion 920 CX baggage and parcel inspection systems and Metor6X 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 our products in the Middle East for a long time to come. In turnkey 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 multiyear contract, which we received earlier in fiscal 2023. As part of this contract, we expect to manage screening services at a European airport for staff, airline crews and vehicles at perimeter entry points. Initially though, as we have said before, this is a small contract, but it's 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 Optoelectronics 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. Opto 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 sourcing and further derisk 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, the United Kingdom and the U.S. 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 a 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 2023 second quarter performance as we grew our top line, achieved significant bookings that have resulted in a record backlog. In addition, with the record backlog and a strong pipeline of opportunities, we believe we are well positioned for the second half of fiscal 2023 and '24. 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 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 strength in third-party sales to a diversified customer base as well as intercompany sales to support the 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 comparison given the prior year elevated demand during the COVID Omicron variant surge. The Q2 gross margin was 32.5%, which, while consistent with that of Q1, was about 3.6% 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; 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 was 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 1, which carried a lower rate than our current bank borrowings. We executed an interest rate swap during Q1, picks a portion of our floating rate bank debt. On the tax side, the reported effective tax rate at our 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 3 divisions, coupled with the reduction in the Opto operating margin due to a difficult prior year comparison. The adjusted operating margin in the Security division increased to 14.7% in Q2 from 14.2% in the prior year 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 Opto 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 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 the 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 buybacks. Besides a little over $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 Healthcare 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 '23. The non-GAAP diluted EPS range excludes potential impairment, restructuring and other charges; amortization of acquired intangible assets; and non-cash 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 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.

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

Yes. The first question is about the large international order worth over $200 million on the Security side. Could you discuss the timing a bit? What does the "plus" signify? Is the entire amount related to maintenance? How large can this contract potentially become? Will it all be produced and delivered in fiscal 2024?

Brian, this is Deepak here. All I can say is that the majority or a significant portion of the $200-plus million contract is equipment. There is some civil works and some maintenance. And regarding the manufacturing and delivery, we said it in our speech, there's insignificant revenue in the rest of '23. It's all focused on 2024. Second thing that you answered is, long term, yes, there could be more potential add-ons. Definitely, service and support. This kind of equipment has 7-, 10-year-plus life cycle, upgrades and stuff. So we're very excited about it, and this is a significant win. And also, this was an international competition, and we got the majority of the business.

Was it the first time I heard that the business was split between you and what I assume is 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 the significant majority of the business.

Okay. And then moving on to 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 as in the couple of hundred million or $100-plus million that you're working on? Can you discuss a little bit what's in your pipeline? Because this was so significant. Are there other ones like that out there?

Well, Brian, you know that we don't talk about any specifics, but I think you already got the answer yourself. This is not the only one. It's international. Our equipment is very much desired. It's a marketplace that looks at security all over the globe, including the U.S. So we have others in the pipeline. And this is in the cargo side, and there are also areas in the aviation side. So the pipeline continues to be quite strong.

Great. Just a couple of quick questions about the other divisions. Healthcare was weak. What do you anticipate from Healthcare in terms of new products and which areas?

Well, though we've mentioned that before, and Alan also talked to you, our focus is primarily our products are patient monitoring and 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 it's basically late to '24, '25 kind of timeframe. We are also very much focused on home care, connectivity, remote monitoring. So that we're doing a lot of investment in expanding our reach in the patient monitoring stuff and on what we call cardiology in like patches and wireless and wearable kind of a thing.

Okay. Very good. And then just last question on the Opto side. It doesn't appear that there's any slowdown in demand. Is the supply chain normalized enough for you guys moving forward? Or are there things that you can't produce that if you had 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 certain challenges. And you're right, there's a certain backlog that we have that we'd be able to convert to revenue on an accelerated basis if not for those final missing components that are still supply chain-challenged. 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, 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, there is a big focus on the OEM customers who are trying to get away from dependence on China. And our facilities in Batam, Indonesia; Malaysia; our new facilities, expansion in India, we have a lot of opportunity to work with our customer base. We're happy with us and feel confident that we can be there longer-term for them. That's been a big growth story, and we think that will continue.

And our next question comes from Larry Solow with CJS Securities.

I have a couple of follow-up questions. Regarding the large deal, it seems you don't have complete visibility on the timing, but it looks like the delivery will take a few quarters. I'm interested in understanding the maintenance aspect of the service. How should we think about that? Currently, service revenue is around 25% of total revenue. Would this maintenance component be more in the 10% to 20% range? Also, could you clarify whether this customer is a government or private entity?

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'll have a better feel, probably by the time of our next conference call, as to what that rollout may look like. But it will begin in fiscal '24 and expect it to be substantial. While Deepak mentioned that it's predominantly product sales and civil works, there is a service element of it, too. And you're right, as the initial service contract ends and warranty period ends, there's always a nice recurring revenue that comes with service and spare parts thereafter. So we are looking for that to be a nice recurring revenue base for us.

Okay. I understand it's not fully turnkey and there are some missing aspects that are somewhat quasi-turnkey. Can we assume that this will yield a better margin than your typical product sales?

Yes. So Larry, this is not turnkey. This would be a sort of a typical product sale, except on quite a large scale. As you know, we don't go into margins on specific programs, but 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. Speaking about service revenue, it experienced a nice increase this quarter, growing nearly 10%. I didn't check previous quarters, but this seems to be the trend for at least the last eight quarters, possibly more. Was there something specific that drove this increase? I know you may be ramping up more in Guatemala than before.

Really, as some of our products rolled off of warranty and came onto service contracts, they accelerated some of the service revenue for us, and we think that's maintainable. So as we look forward, we expect to have continued strong service revenues.

Okay. Fair enough. Regarding security, you mentioned you were pleased with the margins and considered performance to be good. It seems primarily to be a mix issue. Although margins have increased slightly both sequentially and year-over-year, they were notably stronger in the latter half of last year. I just want to clarify if you anticipate a similar pattern 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, a few pushouts. We're a little bit more weighted to Q4 than Q3, and we would expect strong operating margins in each of those quarters.

Okay. To follow up on Brian's question regarding Healthcare, specifically on the patient monitor side, will 2024 and 2025 involve a complete next-generation overhaul, or will it be more of a partial update? Can you provide any additional details on that?

Well, it's Deepak here. It's not an overall delay; instead, we are enhancing our products with more applications, better connectivity, improved results, increased reliability, and additional features. This will start coming in late '24 and '25. However, with these enhancements, we are investing significantly in research and development, as this marks a substantial upgrade for the next generation of the entire system for the coming decade.

Okay. Great. Last question, just on free cash flow. Alan, you mentioned it was up a little bit on the first half year-over-year, but basically pretty close to flat the last 2 years in the front half. And usually, I think the front half is a little bit better for you guys historically. So 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?

Yes, great question, Larry. We're really excited as we enter fiscal '24. In fiscal '23, besides this new large contract, we see a strong opportunity for operating and free cash flow in the second half. However, due to this large contract and our preparations for fiscal '24, we expect to make significant investments in inventory as we start to produce and manufacture these products. As a result, our cash flow may be somewhat lower than what we typically experience in fiscal '23, but we anticipate a very strong cash flow in fiscal '24 and '25.

And our next question comes from Christopher Glynn with Oppenheimer.

So I had a couple of questions also on this kind of convergence of 2 large projects, the CBP and the new international win, just addressed one on the free cash flow side. But I'm curious, as you have these 2 large programs set to both be materially active in fiscal '24, curious about your capacity. And are you walking away from any nice margin, kind of $0.50 pieces of business to execute on these $10 billion?

Well, this is Deepak here. Absolutely not. We have the capacity. We have facilities in England. We have facilities in the U.S. We have facilities 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 relationships. So that when we want to expand the cargo product line or the detection product line in Rapiscan, we have the ability to go to the vendor base that's friendly to us, plus expand our own intercompany manufacturing of the Optoelectronics division, which supplies key componentry to these areas. So no, we're not going to pass any business just for this. This was planned. And we are very much focused, and that's one of the things that Alan said that this is a significant win, but we've handled these things before. And we're going to start manufacturing. And yes, there's the inventory increase. Yes, there will be more production pressure in fiscal '23 towards 24%, but we are capable of it. Alan, do you want to add anything?

No, I think that's summarized quite nicely.

I agree. On my follow-up was on O&M segment. It's kind of in and around the electronics area. We're starting to see a lot of destocking. You've noted consistently you're expanding scope with existing and adding new because of your fulfillment capabilities and great global presence. Just from an end market point of view, I was curious. I think you're kind of insulated there, too, maybe two thirds of your business is defense. Health care and automotive certainly hasn't overshot from a cyclical perspective. So do you feel you're 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. We have such a broad customer base that no one industry or no one specific area affects us up and down. We are very broad. Our marketplace, as you mentioned, aerospace, defense, medical, automotive, it's a very broad portfolio. And that's been our success story, and that has been very well done. And at the same time, I've emphasized again and again that for the 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 are a good vendor, we have a long-term relationship to keep expanding, and we can have the ability to talk to our customers. Do you want us to manufacture in India for the Indian market? Do you want to manufacture in Malaysia, Indonesia? We can do all that, and that's been a very big plus story, and we look at that as a broad-based not dependent on any one specific thing or customer or industrial.

And your next question comes from Jeff Martin with ROTH Capital Partners.

Wanted to get a sense as the large international cargo vehicle inspection order was a competitive bid. Curious, what factors do you believe ultimately led to you limiting the award?

I don't understand the question.

The question was what were the competitive factors that led us to win the $200 million-plus deal.

Sorry for the confusion. Essentially, we've stated before that we view ourselves as one of the leading players in the cargo sector. Our customers depend on us, and we have an excellent reputation. Being a reliable vendor and supplier to CBP serves as a significant endorsement. This recognition is global, and we consistently mention that we are always invited to important events. We take pride in our ability to perform well, showcasing our strong capabilities without errors. Our technology, particularly the Search Scan software, is distinctive. Our product range is extensive, and we believe we offer the most comprehensive portfolio available, including transmissive backscatter combinations. In summary, our competitive advantage lies in our diverse product offerings, strong industry reputation, and commitment to delivering reliable products while maintaining long-term credibility. Alan?

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

Okay. Great. And then with respect to your anticipated improvement in the Healthcare division for the second half of the year, are there any specific factors that come into play there? And is the challenges you've had in the first half, how much of that do you think is internal factors versus external market factors?

Jeff, this is Alan. So good questions. Some of the reasons why we have a bit more confidence in this second half as we enter Q3 compared to the first half really is based on the pipeline of opportunities that we're looking at. We're seeing some more sizable opportunities that weren't available in the first half. You talked about why we were softer in the first half. Part of it was indeed the marketplace. The hospital market has been a bit more challenged, their own financials at hospitals. And then some of it was a little bit self-inflicted as well from a timing perspective on some of our products as well. It's a little bit of a combination of both, but we do feel better for this for the second half and with 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.

Yes. Okay. And then last question for me is with the FIFA equipment on display, it has been the event to card. You mentioned that opportunities in the Middle East with showcasing equipment. Curious if there's near-term opportunities or if that's a longer-term expectation.

Well, Deepak here. What I meant was it's a great showcase. It's been very well received. Lot of kudos, a lot of exposure to various people in the Middle East. I would say, and we don't comment on it, there are opportunities all over the world. The Middle East has always been a strong pipeline opportunity. And we continue to look at it, but I do want to comment on anything specific that's there. Alan? It's just a broader application. And it's out there, and we feel that it's very good for us to be a showcase as what happened. And it's a very successful event.

Our next question comes from Josh Nichols with B. Riley.

Just kind of to extrapolate a little bit further. Clearly, the company is positioned for a pretty strong second half given what we're seeing with the backlog and the order flow. On the gross margin front, I think last year, you were doing 35%, 36% in gross margin. Do you expect that that's kind of achievable in the second half of this year, given that you're targeting kind of 10-ish percent top line growth in the back half?

Josh, this is Alan. A 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 by any means.

Yes. And then just for cash flow, understandable, right? There's some upfront investment for these big orders, a lot of which it seems like you're 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 you've kind of historically achieved as some of the revenue materializes?

Yes, Josh, I think there's a fantastic opportunity for next year in fiscal '24 and '25 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 and '25 based upon what we see today for cash flow.

Perfect. I have one last question about the timing. Regarding the approximately $200 million in CBP orders, I know deliveries are ongoing. How much of that is still pending? How much will be delivered in the second half of this year versus next year? I assume most will come next year, but any clarity on that would be appreciated.

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, and we do expect substantial CBP revenues in fiscal '24 as well. We don't quantify by the dollar amount, but we do see a big uptick happening here in the second half and into fiscal '24 as well.

And at this time, I'm showing no further questions.

Thank you all again for participating in our conference call. I want to thank specifically our employees and our stockholders for supporting us. We continue 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 you very much. Have a good day. Bye.

This concludes today's conference call. Thank you for participating. You may now disconnect.