OSI Systems, Inc. (NASDAQ:OSIS) Q4 2023 Earnings Call Transcript

OSI Systems, Inc. (NASDAQ:OSIS) Q4 2023 Earnings Call Transcript August 24, 2023

OSI Systems, Inc. beats earnings expectations. Reported EPS is $2.66, expectations were $2.54.

Operator: Good day, everyone. Thank you for standing by and welcome to the OSI Systems, Inc. Fourth Quarter and Fiscal Year 2023 Conference Call. It is now my pleasure to turn the call over to the Chief Financial Officer, Alan Edrick.

Alan Edrick: Well, thank you. Good morning and thank you for joining us. I am Alan Edrick, Executive Vice President and CFO of OSI Systems and I am here today with Deepak Chopra, OSI’s President and CEO. Welcome to the OSI Systems fiscal 2023 fourth quarter and year end 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 2023 fiscal year fourth quarter and full year financial results. Before we discuss these 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 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 press release. I will begin with a discussion of our financial performance for the fourth quarter of fiscal 2023 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 fiscal year 2024.

Our fourth quarter financial results were excellent, with all three divisions producing double-digit revenue growth and significant growth in our overall operating income. We are pleased about the strong finish to the fiscal year and are even more excited about our prospects for the new fiscal year. I will start with a high level summary of our Q4 results. First, we reported record Q4 revenues of $412 million, representing a year-over-year increase of 22%, driven by revenue growth of 29% in our Security division, 11% in the Opto division and 18% in the Healthcare division. Second, we reported record Q4 non-GAAP adjusted earnings per share of $2.66 and up 36% from the $1.96 in Q4 of the prior fiscal year, as strong operating results significantly overcame the negative impact of approximately $0.15 per share of additional interest expense associated with higher interest rates in the fourth quarter of fiscal 2023 versus fiscal 2022.

Third, we ended the year with a record year-end backlog of just over $1.8 billion. The book-to-bill ratio in Q4 was 1.8%, led by the extremely strong performance of the Security division. This record backlog provides exceptional visibility as we enter fiscal 2024 and demonstrates the strong momentum across our businesses. Before diving more deeply into our financial results and discussing the fiscal 2024 outlook, I will turn the call over to Deepak.

Deepak Chopra: Good morning, everyone. And thank you very much for joining us today as we discuss the OSI Systems’ strong performance for the fourth quarter and fiscal year 2023. In fiscal 2023, all three of our divisions enhanced operations to efficiently capitalize on their respective opportunity pipelines. We saw our revenues grow year-over-year by 22% in the fiscal 2023 fourth quarter and 8% for the full year 2023, while delivering strong profitability. We ended the fiscal year with a record reported backlog of $1.8 billion, which is 46% higher than our backlog the previous fiscal year-end, providing the company with excellent visibility as we enter the new year. We dive into the highlights now. Our Security division delivered excellent results in the fiscal 2023 fourth quarter, with revenues increasing 29% year-over-year.

We experienced sales growth across our major Security product categories with particularly robust growth in our cargo and vehicle inspection products. Our book-to-bill ratio was 2.4 for the fourth quarter. Most notably in Security in April, we booked one of the largest awards in the history of our industry. This approximately $500 million net of VAT award was received from Mexico’s Secretaría de la Defensa Nacional referred as SEDENA. Under the Security program, we are slated to provide a range of inspection systems including the Eagle high energy and low energy cargo inspection portals, the Carview Vehicle Inspection System and our proprietary CertScan Multisite Integration Platform for inspecting trucks, buses and cars at Mexico’s Northern and Southern border checkpoints.

We also expect to provide civil works, training and follow-on service as part of this important Security initiative by the Mexican Government. We anticipate the contract ramp-up should begin in the second quarter of this fiscal year 2024. Near the end of the last quarter, we commenced delivery on the other large cargo win of over $200 million from an international customer that we announced in the third quarter. We anticipate further revenue in 2024 with ramp-up accelerating in our second fiscal quarter of the year. We expect to provide further updates on timing of the revenues for both of these large programs in future earnings call. Throughout the fourth quarter of 2023, we completed several domestic and international Security projects at ports, borders and airports driving substantial revenue growth.

Additionally, increased activity at airports boosted service revenue from the aviation segment of our business. We strive to enhance service revenue growth across all product areas, including aviation. It is particularly gratifying to see this growth in our service activity at multiple airports after the slowdown during the pandemic. During the last quarter, we announced approximately $21 million in awards from international airport customers from our RTT 110 Real Time Tomography explosive detection systems for checked or baggage screening. We are pleased with the expansion of the footprint of our RTT system, a platform which has been widely adopted with several 100 systems already operating at international airports and global logistics hubs at air cargo carriers.

We are very happy to announce that we have reached approximately 500 units of our RTT systems installed worldwide, which is a great achievement. Recently, we were informed of our selection as the primary security detection provider for the 2024 Paris Olympic Games in France. While revenue for this project is likely to be recognized primarily in fiscal 2025, this is expected to be an excellent opportunity to demonstrate our broad range of Security solutions at a major venue and build upon our success as the leading Security provider at the FIFA World Cup games in Qatar held during fiscal 2023, as just if SYI [ph], we did the London Olympics also in the past. This is a good achievement and is a very good project for us. It was a competitive bid and we scored the best.

Earlier this month, we received notification that the Itemiser 5X Trace Detection system has been qualified for addition to the TSA Air Cargo Screening Technology List, ACSTL, authorizing its use for air cargo screening in the U.S. This development further strengthens our ACSTL approved offering portfolio that includes a diverse range of Xray inspection platforms suitable for both small and large parcels, advanced trace detection for explosives and a broad selection of related supplies and accessories. As we have mentioned before in our calls, air cargo has been a very good product customer base for us and continues to grow. As we look to the future in our Security division, our focus remains on product innovation, operational excellence and expanding our market presence.

With a record year backlog and a robust opportunity pipeline, we are extremely excited about the division’s growth. Our turnkey services projects in Puerto Rico, Albania and other parts of the world continue to perform very well. Over to the Optoelectronics group. The Optoelectronics and Manufacturing division achieved a significant milestone with record Q4 revenues of crossing $100 million, including intercompany sales 11% growth over Q4 2022. Furthermore, our Opto sales surged to $387 million for the full fiscal year, a 6% increase over sales in the last fiscal year. Opto continued to engage throughout the fiscal year with potential customers, keen on establishing supplier partnerships as an alternate to China. In addition, Opto has benefited from partnering with leading OEMs that are well positioned in their market segments.

Furthermore, Opto’s vertically integrated structure has become a strong advantage in the marketplace as it provides greater flexibility and optionality in supply chain management. Our expensive operating infrastructure spanning the U.S., U.K., India, Indonesia and Malaysia also offers flexibility in meeting these customer demands. As we transition into fiscal 2024, we anticipate Opto to uphold the consistency in performance we have come to expect. Following a challenging third quarter in fiscal 2023, the Healthcare division posted a strong fourth quarter performance with an 18% year-over-year revenue increase, despite continuing volatility in the CapEx spending by hospitals the Healthcare division team secured significant wins. During the quarter, we announced a noteworthy order of approximately $12 million from a major U.S. hospital for a wide range of patient monitoring, innovative clinical workflow and connectivity solutions.

The Healthcare team also worked diligently to integrate the acquisition of the Rothman Index-based predictive analytics software into our business operations. In fiscal 2024, we expect to integrate this clinical analytics solution into our SaaS platform, SafeNSound, aiming to enhance clinical insights and workflows for patients of various acuities and ages. In addition, the Healthcare division is focused on developing innovative new business models and solutions such as leasing and subscription programs centered around the needs of hospitals operating in today’s challenging environment. Looking ahead, we are confident about our company’s future. Thanks to our strong marketing position and compelling solutions and the dedication of our excellent team.

We are extremely excited about our fiscal 2024 and anticipate significant growth on both the topline and bottomline which Alan will discuss shortly. In closing, I would like to thank all our employees and customers and business partners. With that, I am going to turn the call over back to Alan to talk in more detail about our financial results and fiscal 2004 (sic) [2024] guidance before we open the call for questions. Thank you.

Alan Edrick: Well, thank you, Deepak. Now let’s review the financial results for our fourth quarter in some greater detail. Again, our fiscal Q4 revenues were up 22% compared with that of the fourth quarter in the prior year. Q4 Security division revenues were up 29%, largely due to the growth in our cargo and vehicle inspection products and related service revenue. This included our first shipments from the $200 million plus cargo contract announced in January and continued strength in deliveries on the two significant U.S. Customs and Border Protection awards received in fiscal 2022. Aviation related revenues increased as well. Opto sales were up 11% year-over-year, with 8% growth in third-party sales to a diversified customer base, supplemented by strong intercompany sales to support the anticipated Security division growth.

And the Healthcare division finished the year on a high note, reporting 18% Q4 sales growth, highlighted by a significant competitive conversion win at a prominent U.S. hospital that Deepak just mentioned and that we announced in May. The Q4 gross margin of 34.7% was up sequentially over the 34.3% in Q3, though approximately 1.6% below that of prior year Q4. The year-over-year gross margin in the Opto division continued to expand and the Healthcare division reported a comparable gross margin to that of the prior year’s fourth quarter. However, a less favorable mix in Security division sales, coupled with certain supply chain cost increases resulted in an overall reduced year-over-year Q4 gross margin in Security and the company overall. Our gross margin will, in general, fluctuate from period-to-period based on revenue mix and volume, inflation and impacts of changes in supply chain costs, among other factors.

Moving to operating expenses. We continue to work diligently across each of our divisions to improve efficiency and prudently manage our SG&A cost structure. Our fiscal 2023 Q4 results again reflect these efforts. Q4 SG&A expenses were $67.2 million or 16.3% of sales, compared to $65.5 million or 19.6% of sales in the prior year Q4. As a result, SG&A expenses increased 2% on a 22% increase in sales. Research and development expenses in Q4 of fiscal 2023 were $15.5 million, up from $14.6 million in the same prior year quarter. We continue to dedicate considerable resources to R&D, particularly in Security and Healthcare as we remain focused on innovative product development, which we view as vital to the long-term success of our businesses. In Q4 of fiscal 2023, we recorded $3.2 million of impairment, restructuring and other charges, compared to $2.7 million of such charges in Q4 of the prior fiscal year.

Moving over to interest and taxes. Net interest and other expense in Q4 increased from $2.4 million in fiscal 2022 and to $5.7 million in fiscal 2023, primarily due to rising interest rates and the maturity on September 1, 2022 of our 1.25% convertible notes, which carried a lower rate than our current bank borrowings. We executed an interest rate swap during Q1 of fiscal 2023 to fix a portion of our floating rate bank debt. On the tax side, the reported effective tax rate under GAAP was 17.6% in Q4 of fiscal 2023, compared to 9% in Q4 of fiscal 2022. In Q4 of fiscal 2023, we recognized a discrete tax benefit of $2.2 million, compared to $4.9 million in Q4 of the last fiscal year. Excluding the impact of discrete tax items, our effective tax rate in fiscal 2023 was 21.9%, compared to an effective tax rate of 22.4% in Q4 of fiscal 2022.

I will now turn to a discussion of our non-GAAP adjusted operating margin. Overall, our adjusted operating margin increased from 13.7% in Q4 of fiscal 2022 to 15.6% in the fourth quarter of fiscal 2023, driven by strength across each of our three divisions. The adjusted operating margin in the Security division remained solid, though declining slightly to 19.3% in Q4 of 2023 from 19.7% in Q4 of 2022, primarily from the mix of sales and supply chain impact mentioned earlier. We were pleased with the adjusted operating margin expansion in our Opto division, which increased to 13.8% in Q4 of fiscal 2023, compared to 12.7% in last year’s Q4 due to strong sales and a favorable mix of revenues. And with the strong sales growth in the Healthcare division, this segment’s adjusted operating margin expanded to 12.1% from 8.9% in Q4 of the prior year.

Moving to cash flow. Cash provided by operations was $22 million in Q4 of fiscal 2023, which was comparable to the prior year’s fourth quarter. We anticipate building inventory during upcoming quarters in preparation for program deliveries under the two large Security division contracts announced in fiscal 2023. CapEx in the fourth quarter of 2023 was $3.1 million, while depreciation and amortization in Q4 was $9.7 million. Our balance sheet is solid with modest net leverage of under 1.5 and significant capacity for investments, acquisitions and stock buybacks. Aside from $7.5 million of annualized — of annual required principal payments under our bank term loan, the bulk of our debt matures in fiscal 2027. And finally, turning to guidance.

We are initiating our fiscal 2024 revenues and non-GAAP diluted EPS guidance. We currently expect our fiscal 2024 revenues to increase more than 18% over revenues in fiscal 2023 and our fiscal 2024 adjusted EPS to grow more than 25% over adjusted EPS in fiscal 2023. We typically provide a range for such guidance. However, as we continue to work with certain large customers on the timing of deliveries and our supply chain partners on the timing of component deliveries, we believe the guidance provided is more appropriate at this time. We expect first quarter revenue growth to be at a modest level with significant revenue growth for the remainder of the year. The expected adjusted EPS growth factors in increased interest expense given the change in the rate environment over the past year.

This guidance also contemplates a higher effective tax rate due to rate increases in the U.K. and a higher tax rate in Mexico than throughout much of the world. This fiscal 2024 non-GAAP diluted EPS guidance 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 non-recurring items. We currently believe this guidance reflects reasonable estimates. The actual impact on the company’s financial results and 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 anticipated 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 would like to open the call to questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Larry Solow with CJS. Please proceed.

Larry Solow: Great. Thanks. Good morning or good afternoon. I guess just a couple of clarifications. So it just feels like on the revenue growth side, Alan, maybe you could just help me with this. So the CBP contracts are obviously well in earnest and probably this will be their biggest year or maybe last year and this year is the biggest two, but international contract sounds like it’s just starting to ramp, Mexico is more like a Q2 start, but probably be bigger next couple of years. I am just trying to get a little better frame of sort of the revenue growth outlook over the next two years, three years as the kind of put all these large contracts together, maybe if you can help me with that?

Alan Edrick: Sure, Larry. Good question and you are right. The Mexico contracts, we expect to really start showing the significant revenue beginning in Q2 in earnest and going on from there. And the revenue from these large contracts that we announced in fiscal 2023, our multiyear revenue opportunity. So we are excited about that. The high watermark for our CBP revenues from the IDIQs, the two IDIQs that we got in fiscal 2022, were in fiscal 2023. So we had significant revenues in fiscal 2023. We will continue to have nice revenues in fiscal 2022 and fiscal 2024, but at a level probably about half of where we were in fiscal 2023. So a really nice position to be in and we are quite excited about the outlook for fiscal 2024 and beyond.

Larry Solow: And on the CBP contract, now that you have kind of gone through some of that because I know it was a little bit slower first and I believe there’s also some remaining IDIQ dollars out there. So what’s sort of the outlook for that contract or additional dollars from the CBP or other U.S. organizations or perhaps internationally, without get into specifics, do you feel like you will have other opportunities that go out over the next few years?

Deepak Chopra: A very broad question, Larry. Good question. On the CBP, as we have announced, the total IDIQs, on the two IDIQs in 2022, we announced the total number was more close to $800 million. Out of that, we got about a $200 million contract which we are delivering. As Alan mentioned, a big chunk of that revenue out in 2023, but it will continue in 2024 and 2025. We are well positioned, though, there’s no guarantee, we are well positioned for getting more contracts from CBP. We can’t say anything about the timing. But invariably, these IDIQs customers give you that, but there’s more potential, and if you do good with a customer, they give you more business. We are very well positioned into it and we are very, very close and working very well together with our customer.

Regarding the international contracts, we continue to have a very broad bad funnel. There are all kinds of orders floating around all over the world. We can’t talk about timing and one of the things we have always said to you in that regard, the bookings also come not in a very consistent way. It comes in ups and downs, but we are very much excited about it. And the second thing is obvious, as we get more successful in these large contracts, we continue to gain more momentum and we can very confidently say that we are eminently the largest supplier in the cargo side of the business, at the same time, have the broadest product portfolio and happy customers.

Larry Solow: Great. If I could just squeeze one more in, just margin, it feels like some inefficiencies some component shortages, and obviously, you are ramping up very fast, excuse me, rapidly. Do you feel like over time, you can get margin — I would think maybe significant margin improvement are this much fast revenue growth in contracts? Thanks.