Osi Systems Inc Q1 FY2025 Earnings Call

Thank you for standing by, and welcome to the OSI Systems First Quarter 2025 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. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Alan Edrick, Executive Vice President and Chief Financial Officer of OSI. Please go ahead, sir.

Well, thank you. Good morning, and thank you for joining us. As said, 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 '25 first 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 fiscal year 2024 third-quarter financial results. Before we discuss the 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 both to GAAP and non-GAAP financial measures when describing the company's results. For further 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 high-level summary of our financial performance for the third quarter of fiscal '25, and then turn the call over to Deepak for a discussion of our business and our operational performance. We will then finish with more detail regarding our financial results and a discussion of our updated outlook for fiscal year '25. Following our fiscal '24 financial results, featuring record revenues and non-GAAP EPS, we started fiscal '25 by posting record Q1 financial results, led by the Security division, resulting in robust year-over-year revenue growth and a significant increase in year-over-year operating income. We are encouraged by the momentum reflected in our Q1 financial performance. So, I'll start with a high-level summary of our fiscal '25 Q1 results. First, revenues increased 23% year-over-year to a Q1 record of $344 million, driven by the performance in our Security division, where Q1 revenues were up 36% year-over-year. Second, the significant revenue growth led to record Q1 non-GAAP adjusted earnings per share of $1.25. Third, bookings were again solid, and we ended the quarter with a backlog of approximately $1.8 billion. Our healthy backlog and robust pipeline of opportunities provide good visibility going forward. Fourth, we completed a convertible debt financing in July, raising gross proceeds of $350 million, which reduced our weighted average cost of borrowings and was immediately accretive. Concurrent with this transaction, we repurchased approximately 531,000 shares of our common stock. And finally, in September, we completed a strategic bolt-on acquisition in our Security division. While the acquired business did not significantly enhance our Q1 revenues, this deal is expected to be accretive to fiscal '25 non-GAAP earnings per share. Before diving more deeply into our financial results and discussing the updated fiscal '25 outlook, I will turn the call over to Deepak.

Thank you, Alan, and good morning to everybody, and afternoon. I'm pleased with the company's robust fiscal 2025 first quarter performance. As Alan mentioned, we achieved an impressive 23% revenue growth, leading to a higher year-over-year operating margin. We closed the quarter with a backlog near all-time high of $1.8 billion and are optimistic about the remainder of fiscal 2025 and beyond. So, let's dive into the performance and highlights of each of our three divisions for the first quarter, beginning with the Security division, where Q1 revenues were up 36% year-over-year resulting in increased operating profits. Also, Security bookings were solid. During the quarter, we continued to deliver on port and border security initiatives with Mexico's defense agency SEDENA on the $500 million-plus contract and with another international customer on a $200 million contract. In addition, shortly after the quarter end, we announced the commencement of operations of our turnkey screening services in Uruguay, utilizing our cargo and vehicle inspection systems along with our proprietary CertScan integration platform. We will also provide on this contract ongoing management training, equipment maintenance, and support as part of the Uruguay contract. The Uruguay program now joins a list of our longstanding successful multiyear turnkey projects in Puerto Rico, Albania, and Guatemala and serves as further evidence for potential customers of the breadth of our capabilities to manage large-scale security programs in various parts of the world. During Q1, we had several wins in security, which we announced during the quarter. First, a $17 million international order to provide Eagle P60 high-energy drive-through cargo and vehicle inspection systems and T60 trailer-mounted vehicle inspection systems, including maintenance, service, and support. Second, a $26 million services order from an international customer to maintain and service its existing installed base of cargo and vehicle inspection systems. Third, a $10 million order from yet another international customer to provide the Z Backscatter Van, ZBV, mobile cargo and vehicle inspection systems, including training, service, and support. And finally, domestically, we announced a contract an order of about $27 million for maintenance, services, and technology support for the installed base of Rapiscan cargo and vehicle inspection systems. The agreement contains potential options for orders totaling up to $117 million over a three-year period. In Aviation, we continue to make progress on our existing international airport project awards as airports expand and upgrade existing infrastructure, especially in Europe, the Middle East, and Latin America. Our overall activity at airports and air cargo facilities continues to be robust. We have a good pipeline. We are also focused on developing new offerings for airports and air cargo customers, such as providing employee screening solutions for these customers. In some instances, this could be opportunities for complete turnkey services or hardware sales with remote monitoring services possibilities. As Alan mentioned, during the first quarter of fiscal '25, we acquired a U.S.-based company that provides high-power radio frequency-based transmission and amplification solutions for critical military communication, space communications, navigation, and surveillance applications, both for U.S. and international customers. Like our company's legacy offerings, these products help provide security and safety for people and critical infrastructure. We work with numerous defense and security agencies that utilize this technology in communication and surveillance solutions. In summary, this acquisition adds proven radio frequency-based technology and products to our portfolio, allowing us to leverage further our global manufacturing, sales, and service support infrastructure. Overall, the Security division had a strong start in fiscal 2025, and we look forward to Security achieving a high level of performance for the balance of '25 and beyond. Moving to the Optoelectronics and Manufacturing division, after reporting revenues of $98 million, including intercompany sales to reach a new first quarter record, while delivering solid profitability, we saw notable strength and growth in our Flex circuits product line. Many of our customers for Flex circuits are from consumer tech and advanced medical device industries. We also have many customers who are leading OEMs in defense electronics. To that end, we announced a $5 million order for advanced optical sensors that the customer will integrate into its complex navigation and guidance systems. I should note here that an order of this size is relatively large for this division. Our operations in Mexico, which we began at the end of Q2 last year, are ramping up as we continue to introduce our existing and potential customer base to its capabilities and the net benefits of nearshoring. The uncertainty and risk for OEMs with China-centric supply chains have never been more significant, and our global manufacturing presence in the U.S., Mexico, U.K., India, Indonesia, and Malaysia provides a viable alternative to reducing these risks. Finally, on to the Healthcare division. Q1 sales were down slightly year-over-year due to challenging market conditions, as we have mentioned before. Still, the division delivered improved profitability in part due to a more streamlined infrastructure. To support our customers, this division continues to offer innovative solutions and market its differentiation offerings like The Rothman Index based predictive analytics software and safe and sound patient alarm management software. We are focused on developing the next generation of patient monitoring solutions and continue to progress accordingly with an improved cost structure and a growing opportunity pipeline. We expect Healthcare's performance to improve over the balance of fiscal '25. In summary, with a significant backlog and a clear path to near-term opportunities, we are increasingly confident about our prospects for fiscal 2025 and beyond. Our strategy of being a vertically integrated supplier with a flexible and responsive global footprint that meets its customers' needs while we continue to invest in and acquire strategic technologies and capabilities has created a robust business with long-term sustainable growth potential. Finally, as you know, I have announced my retirement from my position as Chief Executive Officer of the company at the end of calendar 2024. Though I will remain as Executive Chairman of the Board. In 1987, we laid the foundation for what would become OSI Systems, starting as an Opto sensors Inc. company and embarked on a new chapter by going public in 1997. From the beginning, our mission has been unwavering to deliver essential components and systems that enhance the safety and health of society. With the seasoned expertise of our current OSI management team, I'm confident in our ability to ascend to even more significant achievements. We expect to announce a successor before the end of the quarter. As such, this is expected to be my last earnings call as CEO, and it has been my privilege to lead the company over the past years, and I look forward to supporting OSI's journey ahead. With that, I turn the call over to Alan to talk in more detail about our financial performance and updated guidance before opening the call for questions. Thank you.

Thank you, Deepak. Now, I will review in greater detail the financial results for the fiscal '25 first quarter. Again, Q1 revenues were up 23% compared with revenues in the first quarter of the prior fiscal year. This increase was primarily driven by our largest division, Security. The 36% year-over-year increase in Q1 Security division revenues was led by strong growth in our cargo and vehicle inspection product sales, as well as solid growth in our aviation and checkpoint product sales. Q1 revenues included continued shipments from the $200 million-plus cargo contract announced in January '23, and also from the $500 million-plus cargo contract announced in March '23. In addition, year-over-year Security division services revenues increased 11%. Third-party Opto sales were solid, delivering an 8% year-over-year increase driven by growth from our new Mexico operations. We continue to see certain Opto customers adjusting inventory levels and ordering patterns, which we anticipate seeing through the second quarter of fiscal '25 and perhaps a little beyond. Revenues in the Healthcare division in the first quarter '25, as Deepak mentioned, were roughly the same as Q1 revenues in the last fiscal year. The fiscal '25 Q1 gross margin of 35.3% was in line with the 35.4% gross margin in Q1 of last fiscal year and up sequentially from the 32.1% in Q4 of fiscal '24. Our gross margin will generally fluctuate from period to period based on revenue mix and volume, impacts of changes in supply chain costs, and inflation generally, among other factors. Moving to operating expenses. We continue to work diligently across each of our divisions to improve efficiency and manage our SG&A cost structure. Q1 SG&A expenses were $72 million or 21.0% of sales compared to $60 million or 21.4% of sales in Q1 of the prior year. The year-over-year dollar increase in costs resulted primarily from higher compensation costs in support of the company's growth and the weakening of the U.S. dollar, creating unfavorable foreign exchange rates. Research and development expenses in Q1 of fiscal '25 were $17.8 million or 5.2% of revenues compared to $15.9 million or 5.7% of revenues in the same prior year quarter. We continue to dedicate considerable resources to R&D, particularly in our Security and our Healthcare divisions as we remain focused on innovative product development, which we view as vital to the long-term success of our businesses. We recorded $1.2 million of restructuring and other charges in Q1 of fiscal '25 compared to $0.5 million in the same quarter of the prior year. Moving to interest and taxes. Net interest and other expenses in Q1 increased to $7.4 million in fiscal '25 and from $5.7 million in fiscal '24, primarily due to a higher amount of borrowings, partially offset by the favorable impact of the convertible notes issued during Q1, which were partially used to repay higher cost borrowings. Our reported effective tax rate under GAAP was 21.9% in Q1 of fiscal '25 compared to 23.4% in Q1 last year. Excluding the impact of discrete tax items, our normalized effective tax rate, which is the rate reflected in our calculation of non-GAAP adjusted EPS, was 24% in Q1 of fiscal '25 compared to 25.8% in Q1 of '24. I will now turn to a discussion of our non-GAAP adjusted operating margin. Overall, our adjusted operating margin in the first quarter of fiscal '25 increased to 10.3% from 9.6% in Q1 of fiscal '24. The Q1 fiscal '25 non-GAAP adjusted operating margin of 14.4% in the Security division was up slightly from the comparable prior year quarter and included the absorption of the notable adverse foreign exchange. The adjusted operating margin in our Opto division was 12.0% in the first quarter of fiscal '25 compared to 12.8% in last year's Q1. Excluding the adverse impact of foreign exchange in the Opto division, the margin was relatively in line year-over-year. The Healthcare division reported a nominal increase in its adjusted operating margin. Moving to cash flow. Cash used in operations in the first quarter was $37 million, primarily in relation to higher inventories and receivables in support of the Security division's revenue growth. CapEx in the first quarter was $7.7 million, while depreciation and amortization expense in Q1 was $11.5 million. With respect to cash flow, I wanted to take a moment to provide some additional accounting insight on our receivables and DSO, both of which have risen primarily due to our significant international security contracts. Under GAAP, we typically recognize revenue as we ship or deliver products depending upon the specific contractual obligations. In civil works, we typically recognize revenue over time as we complete the construction phase and ultimately install the products. On certain contracts, like our significant international security contracts we earlier referenced, billing is triggered by the achievement of certain project milestones, which are highly influenced by the customer's timeline and sign off. As such, an unbilled receivable is recorded as we recognize revenue under GAAP, but billing and the resulting cash collection occur subsequent to the achievement of the milestone. Therefore, the elevated accounts receivable and days sales outstanding is normal course for large government contracts, does not factor into the cash economics of the transactions and is just timing related. Our goal is to collect cash as early as we can, and the trends for typical billed receivables remain strong as days sales outstanding for billed receivables is approximately 87 days. We anticipate operating cash flow could be quite significant in the second half of fiscal '25 and potentially even stronger in fiscal '26. Our balance sheet is solid, with net leverage of about 2.3 as calculated under our credit facility. Aside from $7.5 million of annual required principal repayments under our bank term loan, the bulk of our debt matures in fiscal '27. As mentioned earlier, during Q1, we issued $350 million of convertible notes with a coupon of 2.25% due in fiscal '30 and an initial conversion price of approximately $192. The proceeds were used to partially pay down our bank revolver and to repurchase approximately 531,000 shares of our common stock as well as cover transaction costs. This transaction provides enhanced liquidity to capitalize on future strategic initiatives while simultaneously being immediately accretive given the significant reduction in interest costs and a reduction in our share count. As a result of the completion of the convertible notes deal and partial paydown of our bank debt and the interest rate swap we entered into approximately two years ago, over 70% of our debt was fixed versus floating at the end of Q1. Finally, turning to guidance. We are updating our fiscal '25 revenues and non-GAAP diluted EPS guidance. For fiscal year '25, we anticipate revenues in the range of $1.67 billion to $1.695 billion, increasing our guidance on year-over-year revenue growth from a range of 5.3% to 7.2% to a range of 8.5% to 10.2% growth. We are also increasing fiscal '25 non-GAAP adjusted earnings per diluted share guidance to a range of $9 to $9.30 per share or 10.7% to 14.4% growth. This fiscal '25 non-GAAP diluted EPS guidance excludes potential impairment, restructuring, and other charges, amortization of acquired intangible assets and their associated tax effects, as well as discrete tax and other nonrecurring items. We currently believe this guidance reflects reasonable estimates. The actual impact on the company's financial results of timing changes on the expected conversion of backlog to revenues, disruptions in the supply chain, and inflation is difficult to predict and could vary significantly from the anticipated impact currently reflected in our guidance. Actual revenues and non-GAAP EPS could also vary from the guidance indicated above due to other risks and uncertainties discussed in our SEC filings. We continue to remain focused on the growth of our businesses. We believe our efforts will enable OSI to continue providing innovative products and solutions. We would like to take this opportunity to thank the global OSI team for its continued dedication in supporting our customers and partners.

At this time, we will open the call to questions.

Yeah, thanks. And go Dodgers indeed. I guess, just looking at this, I wanted to get a little bit more color. I mean, this is actually usually a seasonally slower quarter, particularly in Europe in the later summer months, but the Security backlog is doing quite well. The overall backlog actually kind of increased $100 million sequentially. I know you announced $80-plus million or so in Security awards during the quarter, but you did have about $0.25 billion of security revenue. Could you provide just a little bit more granularity on what's been driving that backlog growth overall despite it being a little bit seasonally slower as we kind of touched on.

Sure, Josh. This is Alan. Great question. So yes, we've seen strength in our Security division. And you're right, with sometimes a typically slower seasonal quarter on the revenue side. We really saw strength across our businesses. We saw it across the geographies, the Americas, Asia-Pacific, and the EMEA region. We saw strength across our product lines in aviation and in cargo and solutions. So, it was really a nice bookings quarter for us, positioning us with an excellent backlog as we look out to the rest of fiscal '25 and beyond.

Thanks. And then just kind of curious, you're clearly the lead horse when you look at security, cargo vehicle inspection. You did note that you're seeing good revenue as well as opportunities on aviation and things like that as well. What's the opportunity do you think to potentially increase size and market share on that piece of the business where you're still probably like the number two or number three player into the lead player like you are on traditional cargo and vehicle inspection systems?

Good question again. This is Deepak here. Definitely, we see good pipeline, strong expectations in the aviation and air cargo space, primarily into the international sector. As I mentioned, in Latin America, in Asia, and in Europe, everywhere there is much more traffic of passengers going, which is making the airports get to the next level of upgrading their systems. At the same time, we have said many times before on our calls, air cargo is a very focused space for us, and we continue to grow in that business. And our idea also is that we want to do something different, innovative, what wise mentioned, employee screening both at the airports and air cargo freight facilities. So, all that adds up to, in our opinion, that whole area will continue to see growth, and we are well-positioned into it. At the same time, I know that people ask us about the U.S., we are working with TSA. And whenever the next replacement cycle comes in, we'll be ready.

Thanks. Then just last question for me, just touching on the acquisition, good to see the company adding some RF to the product portfolio. I know you described it as a bolt-on acquisition. So, I assume it's not going to be a huge contributor to revenue or EPS for this year. But if you could provide any additional color on that? And then also expectations in terms of potential synergies or how you could layer this into your global footprint for sales and manufacturing and potentially ramp up sales or expand margins on that front?

Again, good question. As you know that our strategy is that we look at one plus one must make more than two. This is a strategic acquisition. It's a little different technology, but it fits very well in because the same customers that this company works with, we work with the same customers, both domestically and international. And with our footprint being larger, we expect that we'll be able to put this together and be able to go after a much broader customer base. At the same time, with our service support with our manufacturing, it definitely has synergy into it. But more important into it, it broadens our technology platform, which is what we've been doing for the last decade or so to broaden our product portfolio.

Thank you so much. And Deepak, congratulations on the professional journey and also on the partial retirement, I guess. So, my first question is about the pipeline. And I understand for competitive reasons, you cannot give like a lot of granularity into it. But like how should we think about the pipeline of opportunities in the next, call it, like six months or 12 months? And is there like particular big contracts there that we should be watchful for specific regions? Like how should we think about that?

Well, again, good question, but you also answered it too, that we can't be very specific. Basically, we have been saying for a long time, we consider ourselves in the cargo space as a leading company. We are very much focused on it domestically, with CBP and other State Department and other customers there. Internationally, with the broad base that we have, there's a lot of activity. And the other thing that it's tough to say it. But as the world becomes more unsafe, it requires more security awareness, and we have the products for that. And we have a very broad reach. So, we look at this as a very strong pipeline, very strong globally. And with our name and our reputation, and our turnkey services in various parts of the world, we definitely get invited to every dance there is.

If I assume that about 50% of your backlog will convert over the next 12 months, and considering that the aftermarket support is not fully accounted for, it seems that there is still a significant gap in revenue needed to secure contracts. How does the strength of the pipeline compare to this situation?

Very strong. And all the time, we've been saying it, these kind of contracts take longer years and time, the bigger the size it is. So, we've been working with these customers for a long time. And with our reputation and our success in the U.S. and Mexico and other places, we feel very good about it that these things will mature in a timely fashion.

What are the key risks that you're looking at in terms of like timing of those opportunities?

Key risks?

Any challenges, yeah.

The world economy always presents a potential risk. However, aside from that, situations can change from time to time, such as unrest in various places or changes in government funding. I don’t perceive any specific risk; history speaks for itself. We are currently facing unrest in both the Middle East and the Ukraine-Russia region. Our pipeline has not weakened, and we are continually assessing it. Furthermore, as companies shift away from China and seek to establish manufacturing in other regions, we are well-positioned with the necessary products and infrastructure for ports, borders, and airports. We do not view this as a risk at all.

Great. And then let me double tap into what you just mentioned, but not only from a Security point of view, but from the Optoelectronics type of opportunity. You mentioned this $5 million order that you received. Could you please give us some color around the demand, especially in the U.S. or the U.K. for this type of niche sensor sort of electronics?

Again, good question. So, the reason we mentioned that $5 million is a significant order. That's in the Optoelectronics side. Those are components and subassemblies that we make for other OEMs, and what we mentioned is that pipeline is a very reliable pipeline because we are designing to those customers in the medical industry, in the aerospace industry, defense industry, consumer industry so that we have a very good foresight into that pipeline. And our customer base is very strong and our manufacturing global in Malaysia, Indonesia, India, U.K., that helps us very much in the new facility in Mexico as people start looking at more alternatives to China, so that looks like, again, a good opportunity and a good strong visibility.

Thank you. And last one from me on the receivables. Thank you for the color on the unbilled receivables that when you think about like future contracts, considering these accounting issues, but also that you're actually transferring some of your assets? Like, is there any way you can like request earlier payment for a down payment from these international customers in contracts that are these large or how that works?

Yeah. Mariana, this is Alan. Great three questions. We have very often in the past requested considerable advances and down payments, which helped to fray some of the inventory buildup and some of the accounts receivable. When we can get that? We absolutely do. There are certain contracts that go out by RFP where we cannot really dictate terms. The terms are kind of dictated by the customers in those regards. And if they make good strong economic sense for us to take the contract, even though it might require some adverse cash flow on a short-term basis, we will go ahead and proceed with that. But whenever we can get customer advances or can negotiate payment terms that are more favorable to us, we absolutely do. We're keenly in tune with that.

Yeah. Hi, thanks for the question. I guess, following up on the working capital and thanks for the color. Alan, I guess, is there a target we should think about getting back to like days of receivables or sort of however you want to frame it? I'm just trying to think if there's an opportunity to get back to kind of the level of receivables we were at two or three years ago? Or has something in the business changed that maybe that's going to linger a little bit higher than it had been in the past?

Yes, good question, Matt. This is Alan. We believe we can return to the DSO levels we had in the past. A significant factor behind the higher DSO and unbilled receivables is the large contract we have in Mexico, the SEDENA contract. Although this is a strong contract in terms of sales and earnings and provides us with a solid entry point, it comes with milestones where cash flow isn’t as robust. We will certainly seek more contracts like this in the future, which may occasionally impact our DSO negatively. However, historically, our DSO has been relatively stable and lower than it is currently, and we expect to return to that norm in the future.

Thank you. Regarding the Healthcare business, it's good to see profits increase even with steady sales. Can you elaborate on how you achieved that? Should we expect a similar increase year-over-year? I understand there’s some seasonality, but will we see a comparable rise?

Yeah. Matt, this is Alan. You're right. So, seasonally speaking, the healthcare business is slowest in the Q1 in the September quarter. So, as Deepak mentioned in his earlier remarks, we do expect improved performance through the rest of the year. The way we got to stronger profits on similar or slightly down revenues was also the initiatives that Deepak referred to, where we enhanced the operational infrastructure and took out some costs. The healthcare business for us is the highest contribution margin business. So, as revenues go up, there's an awful big pull-through is operating income and EBITDA. So, as we do anticipate revenues being stronger in future quarters than they were in Q1, coupled with the leaner cost structure that we have, there's a really nice opportunity for some nice margin expansion.

Thank you. Good morning, Deepak and Alan. I wanted to dive in a little more on aviation. It was interesting that you talked about remote monitoring capability. Do you see that being a near-term driver? Is that more of an intermediate to longer term driver?

I believe this is more of an intermediate to longer-term opportunity. We already have some pilot projects in progress. Similar to our work on the cargo side and turnkey business, these types of products require time to develop. We have established a control room for remote monitoring of employee screening and are in discussions with several airports regarding their employee screening needs. Therefore, the timeline is longer, but we see good potential here, and we have the capability to pursue it with our technology and experience from the cargo side. It seems like a promising product line to target. I wanted to thank everybody for listening to us, and I want to thank all the employees and our customers for trusting in us. And I'm looking forward to continued growth, and I'm there to support the management of OSI. Thank you.

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