OSI Systems, Inc. (NASDAQ:OSIS) Q2 2024 Earnings Call Transcript

OSI Systems, Inc. (NASDAQ:OSIS) Q2 2024 Earnings Call Transcript January 25, 2024

OSI Systems, Inc. beats earnings expectations. Reported EPS is $2.21, expectations were $1.74. OSIS isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and thank you for standing by. Welcome to the OSI Systems, Inc. Second Quarter 2024 Conference Call. [Operator Instructions] 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, CFO. Please go ahead.

Alan Edrick: Well, 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 ‘24 second 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 2024 fiscal year second quarter financial results. Before we discuss our results, however, I’d 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 second quarter of fiscal ’24 and then turn the call over to Deepak for a discussion of our business and operational performance.

We will then finish with more detail regarding our financial results and a discussion of our outlook for fiscal year of 2024. We mentioned on the last earnings call that we expected to see accelerated growth beginning in Q2, and that was indeed the case. Our second quarter financial results were very strong with the Security Division again generating double-digit revenue growth and significant year-over-year operating margin expansion. The Opto division performed solidly, while the Healthcare division experienced a challenging quarter. We anticipate significant overall revenue and earnings growth for the balance of fiscal ‘24, and we are encouraged by the momentum in the business. Let’s start with a summary of our fiscal 2024 Q2 results. First, revenues increased 26% year-over-year to a Q2 record of $373 million, driven by the performance in our Security division where revenues were up 49% year-over-year.

Second, the strong revenue growth coupled with gross margin expansion led to record Q2 non-GAAP adjusted earnings per share of $2.21, up 86% from Q2 of the prior fiscal year. Third, bookings were solid with a book-to-bill of approximately 1, and we ended the quarter with a backlog of nearly $1.8 billion. This strong backlog provides outstanding visibility for the full fiscal year. Before diving more deeply into our financial results and discussing the fiscal ‘24 outlook, I’ll turn the call over to Deepak.

Deepak Chopra : Thank you, Alan, and thank you to everyone joining us today. I’m happy to report a record breaking second quarter for fiscal 2024 with revenues reaching $373 million, representing 26% growth year-over-year, and operating income growing 105% over the same period from last year. This exceptional performance was driven by relentless execution in security, complemented by solid results in the Optoelectronics and Manufacturing division. Our backlog, as Alan mentioned, and opportunity pipeline remains extremely healthy, providing confidence for strong performance in the second half of ‘24 and beyond. Let’s discuss each division’s performance starting with Security. The Security division delivered Q2 revenues of $250 million, representing 49% growth year-over-year from last year.

Then double this profitability in the same period. The adjusted operating margin expanded significantly to 22.7%, reflecting a favorable mix of higher gross margin sales, efficient operations and robust market demand. Bookings were also solid, despite the sizable conversion of backlog to revenue in the quarter. The security division’s backlog at the end of Q2 was comparable to the start of the fiscal year, given a book-to-bill ratio of approximately 1.0 in the first half of fiscal 2024. Q2 marked the commencement of revenue recognition on our recent major cargo programs announced earlier with SEDENA, the Mexican Defense Agency, as well as continued momentum on the cargo program with a large international customer previously announced. We continued to expand our presence for potent border solutions and secured significant recent new contracts Shortly after the quarter end, we announced a $59 million contract that we received in Q2 from an EMEA region customer for various cargo and vehicle inspection platforms, including our Eagle Series and car view systems.

Furthermore, we are expected to integrate these inspection systems into a national command center through our proprietary CertScan integration platform, which has been gaining traction with port and border custom agencies worldwide, and allows us to differentiate our offering from our competitors. During the quarter, we also announced a $5 million award from a Latin American customer for port security solutions, including installation and integration support for the Eagle P60 High Energy Drive-through Cargo and Vehicle Inspection Z Portals High Throughput, and the VM500 Drive-through Radiation Monitoring Portal. Both of these awards include maintenance and service elements and highlight the compelling value and versatility of the multiple platforms available in our broad portfolio, creating ample opportunities for recurring revenue going forward.

Our aviation business also had a good quarter as well as airport related activity continue to return to pre-pandemic levels. As a testament to our expansion at airports, we converted on a couple of significant airport opportunities. During Q2, we announced an $18 million contract to enhance an international airport security infrastructure with advanced screening solutions, including the RTT110 Real Time Tomography, explosion detection systems for screening whole baggage, metal walkthrough metal detectors, and Itemiser 5X Explosive Trace Detection System for secondary screening of passengers. We will be providing comprehensive multi-year maintenance service and support as part of these awards. We also announced another international airport win of a $15 million order for various checkpoint screening systems, enhancing air passenger safety and threat detection capabilities.

Among the systems provided for this award include the ORION 920CT Checkpoint Screening System, ORION 920DX Dual View Checkpoint Screening Systems, and Itemiser 5X Explosive Trace Detection Systems. Besides the equipment as well as recurring maintenance and service revenue in forward years. Our turnkey projects continue to do well in Albania, Puerto Rico and Guatemala. The aviation project for turnkey service that we announced last year at a European airport went live in December. For this airport, we manage screening services for the staff, airline crews and vehicles at perimeter entry points. In addition, the planning phase has started for the recently awarded Uruguay or turnkey contract, and we look forward to becoming operational later this calendar year.

With the numerous port and border opportunities in our pipeline, there are often meaningful discussions regarding a turnkey offering, even if the initial RFP or tender is for just traditional equipment and service only. We are excited to be the only company in the security screening marketplace that can point to a decade-long history of proven experience in managing successful turnkey programs of various sizes and scopes worldwide. Looking ahead, we believe that Security division has unprecedented visibility with a strong backlog and pipeline of opportunities for robust growth in balanced 2024 and beyond years. Let’s looking at the Optoelectronics Division, which had another solid quarter. The Opto division has been working with certain OEM customers to accommodate their demand forecast that have involved some short-term, near-term push outs of deliveries.

We see this as a transitional phase as OEMs in competitive markets increased levels to mitigate delays as a result of supply chain disruptions during the pandemic economy. Concurrently, we are also working with multiple OEMs to take over new programs as they trim their supplier base and gravitate towards more reliable and versatile suppliers like us. To that end, we had several notable bookings during the quarter and announced orders valued in aggregate of about $14 million. That included a $5 million order to provide electronic assemblies to a leading technology OEM customer, another $5 million for electronic assemblies to a motion control and fluid technology OEM. And finally, a $4 million order to supply military-grade components for missile systems to a leading defense electronics OEM.

These awards highlight our capability to cater to our customer’s base diverse and specialized needs. Building on a trend started last year, we are engaging with several customers that have a China centric supply chains and are looking to shift the focus to other regions like Southeast Asia, the U.S. or even near shore U.S., to help mitigate disruptions due to shutdowns in freight transportation. Consequently, we now have a wholly-owned facility open just now operational in Mexico that has about 60,000 square feet dedicated to manufacturing electronic components and higher-level assemblies. We are excited about this endeavor as many customers have indicated a clear desire to source from near shore, especially for finished products that are eventually destined for their customers in the U.S. Looking ahead, we believe that the Opto division is well positioned for long-term success.

And finally, let’s discuss the Healthcare division where revenues were down approximately 4% compared to the same period in the prior year. Definitely a disappointment. We had anticipated modest growth, but certain larger U.S. patient monitoring orders did not materialize in time. However, overall bookings were solid as the book-to-bill ratio was nearly 1.2, which is encouraging. The hospital market continues to be challenged, but we had several nice order wins during the quarter and continue to strength our hospital presence. We announced three orders totaling approximately $12 million, which included a $5 million order for patient monitoring solutions and related accessories for a U.S.-based hospital where we will also provide our advanced Rothman Index Safe and Sound Exhibit Central Station and Queue Bedside Patient monitors.

This order arrived unfortunately close to the end of the quarter and could not be delivered within the quarter, but revenue is expected to commence in Q3. As I mentioned on the last call, Spacelabs is working on new innovative offerings to the marketplace, such as leasing and subscription programs to help reduce the burden of capital spending by the hospitals. To that end, I am happy to announce that Spacelabs has commenced offering remote telemetry management services to hospitals utilizing the SafeNSound digital health platform and mobile app to provide real-time patient monitoring services. We are committed to enhancing patient care and expanding our footprint in the healthcare sector by offering differentiated innovative features like SafeNSound patient alarm management and Rothman Predictive Health Analytics.

We continue to significantly invest in developing new products to further strengthen our patient monitoring portfolio, including our next generation platform. Going forward, we will continue to focus on operational execution and aggressively pursue sales growth in this division that has the highest contribution margin in our company. Overall, we are very pleased with the company’s fiscal 2024 second quarter performance. We are in a good position for the second half of ‘24 and have attained good visibility into fiscal 2025 and thereafter. Alan now will talk more in detail about our updated fiscal 2024 financial guidance and then we’ll open up to questions.

Alan Edrick : Well, thank you, Deepak. So let’s review in greater detail the financial results for our fiscal ‘24 second quarter. Again, our fiscal Q2 revenues were up 26% with the second quarter of the prior fiscal year. Q2 Security division revenues were up 49%, largely the results of sales growth of our cargo and vehicle inspection products. We also had double-digit revenue growth in our aviation and checkpoint products and related services. Q2 revenues included continued shipments from the $200 million plus cargo contract announced in January ‘23, and initial revenues from the $500 million plus cargo contract announced in March ‘23. Opto sales were down approximately 1% year-over-year. Strong intercompany Opto sales to support anticipated Security division growth were partially offset by reduced third-party revenues as certain Opto customers decreased inventory levels or are experiencing program delays, which we anticipate will continue to impact us for another quarter or so.

The Healthcare division sales decreased 4% year-over-year with growth in recurring revenues of SaaS, service, supplies and accessories, along with growth in cardiology product revenues. These increases though were outweighed by a decrease in revenues reported for our largest product family, patient monitoring, in the challenging hospital CapEx environment. The fiscal ‘24 Q2 gross margin of 37.9% was up over 500 basis points from the 32.5% gross margin in Q2 last year. While the gross margin expanded in each division, the most notable improvement was seen in the security division, which experienced a favorable mix of sales along with strong operational execution. Our gross margin will generally fluctuate from period to period based on revenue mix and volume, inflation and impacts of changes in supply chain costs amongst other factors.

Moving to operating expenses. We continue to work diligently across each of our divisions to improve efficiency and to prudently manage our SG&A cost structure. Q2 SG&A expenses were $71.6 million or 19.2% of sales compared to 18.3% of sales in Q2 of the prior year. The year-over-year increase was driven by higher compensation costs, including incentive compensation linked to our significant sales growth, increased professional fees, and a higher level of bad debt expense than in the prior year Q2. We expect to leverage our SG&A for fiscal ‘24 where such expenses are expected to decline as a percentage of sales on a full-year basis, implying a lower SG&A run rate in the second half of the 2024 fiscal year then we reported in Q2. Research and development expenses in Q2 of fiscal ‘24 were $16.4 million or 4.4% of sales, compared to $14.5 million or 4.9% of sales from the 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. We recorded $1 million of restructuring and other charges in Q2 of fiscal 2024, compared to $2.3 million of such charges in Q2 of the prior fiscal year. Moving to interest and taxes. Net interest and other expenses in Q2 increased to $6.5 million in fiscal year ‘24 from $5.2 million in fiscal year ‘23, primarily due to increased interest rates on a higher level of borrowings. We executed an interest rate swap during Q1 of fiscal ‘23 to fix a portion of our floating rate bank debt. Our reported effective tax rate under GAAP was 20.2% in Q2 of fiscal ‘24 compared to 19.5% in Q2 of fiscal ‘23.

In Q2 of fiscal ‘24, we recognized a discrete tax benefit of $2.5 million compared to $0.7 million in Q2 of the last fiscal year. Excluding the impact of discrete tax items, our normalized effective tax rate in Q2 of fiscal ‘24 was 25.7% compared to a normalized effective tax rate of 23% in Q2 last year. I will now turn to a discussion of our non-GAAP adjusted operating margin. Overall, our non-GAAP adjusted operating margin in the second quarter of fiscal ‘24 increased to 15.5% from 10.7% in Q2 of fiscal ’23, driven by strength in the Security division. The non-GAAP adjusted operating margin in the Security division expanded to 22.1% in Q2 of this year from 14.7% in Q2 of last year, primarily due to a favorable sales mix and operational improvements.

The adjusted operating margin in our Opto division was again solid, increasing to 13.4% in the second quarter of fiscal 2024 from 13.1% in last year’s Q2. The Healthcare’s division’s adjusted operating margin was negligible with the reduction in the division sales. Moving to cashflow. As mentioned on past calls, we expected to invest significant amounts in working capital associated with the anticipated strong growth in security. In Q2, cash used in operations was $23.5 million, primarily due to increases in accounts receivable associated with the revenue growth and inventory increases in preparation for program deliveries under the two large security division contracts announced last year. CapEx in the second quarter was $3.5 million, while depreciation and amortization expense was $10.3 million.

Our balance sheet is solid with, modest net leverage of under 1.4x, and significant capacity for investments, acquisitions, and stock buybacks. Aside from $7.5 million of annual required principle payments under our bank term loan, the bulk of our debt matures in fiscal 2027. Finally, turning to guidance. We are increasing both our fiscal ‘24 revenues and non-GAAP diluted EPS guidance. We currently expect our fiscal 2024 revenues to increase more than 19% over revenues in fiscal ‘23, and we anticipate our fiscal 2024 non-GAAP diluted EPS to grow more than 29% over our non-GAAP diluted EPS in fiscal ‘23. This non-GAAP diluted EPS guidance excludes potential impairment restructuring and other charges, amortization of inquired intangible assets and their associated tax effects, as well as discrete tax and other non-recurring items.

We currently believe this guidance reflects reasonable estimates. The actual impact on the company’s financial results of timing changes on expected revenues, 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 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 and proactive management of our cost structure. 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 Systems team for its continued dedication in supporting our customers and partners. And at this time, we’d like to open the call to questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Josh Nichols from B. Riley.

Josh Nichols: Great to see such strong results, particularly from the Security division. I think you highlighted on the call, but you’ve had pretty strong award wins this year as well too, year to date, including that $59 million award out of the EMEA region. One, fair to assume that’s not a backlog because it happened after quarter end. And then two, are you seeing other opportunities in this region or others with things like the conflict in Israel that are going on that could offer some large contract wins later this calendar year?

Deepak Chopra : As I mentioned in my call, the pipeline in security looks very strong to us and in basically all regions. The only place that there is a little bit of slow down and everybody on hold is in U.S. because of what’s going on in Washington. But all over the world, the pipeline is very strong and we believe that we are very well poised to win some other strong big contracts all over the globe. Not only just in cargo, but even in aviation.

Josh Nichols: And then just since you touched on the U.S. I know, we don’t have a budget yet. But if you’re looking here, there’s clearly a lot of focus on the southern border. You’ve had some very nice large award winds there. Could you talk about some of the opportunity that could come to fruition later this year on that front? Because there’s still some good amount of availability under the IDIQs, or even later potentially, if we look at like a TSA refresh next calendar year or something like that.

Deepak Chopra : Again, good question on the southern border, definitely there’s a lot of interest and even in the temporary budgets that are being talked about it, there’s lots of interest from both sides of the house for enhancing the border security. And we’ve said that before, we are very well poised for it. And the CVP itself has an IDIQ out there, which still has a lot of capacity and we are very much favored as a strong partner in that space. On your second half of the question, aviation, definitely the airport — air traffic is increasing all over the globe, and we believe that we are very well poised for it, both domestically and internationally. And we’ve announced some orders internationally that there is a lot of growth opportunity and definitely there is some uncertainty with the Middle East, what’s going on in the Ukraine.

But we also look at it, and we’ve said it in a couple of times before, sooner or later, as this thing settle down and I keep praying that it does, all the areas around that area where there’s conflict, all those countries will need security equipment. And we again, are very well poised for it.

Josh Nichols: Thanks. The last question for me. One, impressive that the company’s maintained this $1.8 billion backlog, despite what’s been a pretty high conversion for the security with record 2Q revenue. I presume the visibility into not just this year, but fiscal ‘25 has to be improving as well with these new awards. Like, how much of the backlog do you think you’re going to have for next year, and how much visibility do you have and confidence that you’re going to be able to grow the top line, not just this year, but next year as well too?

Deepak Chopra : Well, again, very good question. As we have said that, our backlog, even after the — what you just mentioned, after a strong Q2 in revenue, still is very strong. Pipeline seems strong, and we think that it’ll continue into the next years, not just ’25, into ‘26 and beyond. But as you know that, we already said that historically, it’s a lumpy business. Some customers push it out, some people want it even accelerated into it, so that can happen. We don’t want to give any specific numbers, but all we are saying is that we are sitting very pretty with a very strong backlog and a very strong pipeline, and the economy is looking good. The interest rates hopefully will come down, traffic is increasing, freight has to be moved around, and we think that all of that looks like good for the next coming years. Alan, you want to add something?

Alan Edrick : No, I think that sums it up quite nicely. Strong visibility for the remainder of this year and into coming years. So we think we’re quite well positioned.

Operator: Our next question comes from the line of Christopher Glynn from Oppenheimer.

Christopher Glynn : Question on healthcare. It sounds like a little better second half, most likely little seasonal help, right? And perhaps, it’ll still be a little below normalized and maybe, if you can just work with that construct a little bit, how do we think about natural market normalization or progression beyond this year, the pandemic growth is maybe more digested, perhaps that’s still an overhang or is the market just become a bit more of a street fight?

Deepak Chopra: Well, again, you sort of answered it to yourself. During the pandemic, we got a little, I would call it a great tailwinds, and that’s definitely slowing down. And if you read it everywhere, healthcare section is a challenging section. The hospitals are having a tough time. But at the same time, we believe that we have approached some new technology and products that we are looking at it. And one of the things that we are very much excited about it is, besides selling monitors, which is one of our primary businesses, that because of the shortness of capital and stuff, we believe the subscription model looks like a good catchall for medium to small hospitals. And we are very proud to announce that we actually have, what I said, a startup of what we call is a remote telemetry.