OSI Systems, Inc.
Q3 2021 Earnings Call Transcript

Published: 2 May 2021

[Operator:]

Good day, and thank you for standing by. Welcome to the OSI Systems Third Quarter Fiscal Year 2021 Earnings Conference Call. At this time all participants are in listen-only mode. After the speakers' presentation, there'll be a question-and-answer session. I would now like to turn the conference over to your speaker today, Alan Edrick, Chief Financial Officer. Please go ahead.

[Alan Edrick:]

Hello. 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, our President and CEO.

[Deepak Chopra:]

Thank you, Alan. And again, good morning and welcome to the OSI Systems earnings conference call for the third quarter of fiscal 2021.

[Alan Edrick:]

Well, thank you, Deepak. Let's review the Q3 financial results in greater detail. Our revenues in Q3 of fiscal 2021 were $284 million compared to $293 million in the prior year Q3. Similar to the first half of fiscal 2021, we reported strong third quarter fiscal sales growth in the Healthcare and Opto divisions, with the reduction in Security division revenues due to the continued effects of the pandemic.

[Operator:]

Thank you. Our first question comes from Jeff Martin with Roth Capital Partners. Your line is open.

[Jeff Martin:]

Thanks. Good morning, Alan and Deepak. How are you?

[Deepak Chopra:]

Fine. Thank you.

[Alan Edrick:]

Good, Jeff. Thank you.

[Jeff Martin:]

Great. I was just curious if you could give us some perspective, it sounds like your outlook for Security, at least on a sequential basis and year-over-year, expecting growth year-over-year. It sounds like it's strengthening sequentially. I was just curious if there is a lifting of certain COVID restrictions, if you just have visibility to recognition of things that may have been pushed out from Q3? What specifically do you see as improving relative to the last two quarters in Security?

[Deepak Chopra:]

Good question, Jeff. And obviously, the first thing we have to say is, the uncertainties are already there. Especially in our cargo business, we have to make sure and it's required that the site is ready, the equipment is signed off by the customers representatives, we can send people there to get them installed. All that stuff has been challenging. In some cases, as I mentioned in my call, that where we actually ship the equipment and it's at the customer site, but we could not get in time either our people there or the customers people to be able to be there to sign off. So those are the kinds of things that we think and getting a little better feeling that as this pandemic wanes down, it will open up more and the demand is still there. We have not seen any significant kind of any cancellations or terminations of any kind. These are just delays, most of the equipment is at a unique place that the customer wants. And we feel that the pipeline of requirement globally, including US and international continues to be very strong, both domestically and internationally.

[Alan Edrick:]

And Jeff, this is Alan, just to add on to that. Yes, the visibility for Q4, we believe to be very strong in our Security business, with a very strong backlog scheduled to be delivered or converted into revenue in the quarter. So we feel very strong about where we stand at this position as we wind down the fiscal year.

[Jeff Martin:]

Okay, great. And then on the Healthcare segment, it's experienced a double-digit growth for four straight quarters. How do you feel about Healthcare heading in the fiscal 2022? Some of it's obviously going to be a headwind to growth from COVID-related purchases of patient monitoring. Could you give us some relative perspective, what kind of headwind you're facing from the uplift of COVID this past 12 months with respect to patient monitors?

[Deepak Chopra:]

Well, number one is, we are still building up the budget for 2022. Q4 still looks very good for us. I remember this business is lot of book and ship. So you can't look three, four quarters ahead, but we are feeling good about it. The preliminary things look like, yes. And with some COVID waning down, there'll be some downwards, not significant. But other products like cardiology will pickup, which has been delayed due to COVID. So all in all, we are quite feeling good about it, also we are heavily investing in R&D, on cloud computing, at home care, connectivity stories which lot of people are now talking about it. At the same time, the cardiology product line, we have new products being introduced. We are building towards a complete revamp of the new platform. So, all that stuff is there, which makes us feel good about it. And safe and sound, which we did a very, what I call it, critical acquisition of a technology has been proven to be very good, which differentiate us, we have been able to differentiate us from our competitors with this new add on feature.

[Jeff Martin:]

Very helpful. Thanks for your time guys.

[Operator:]

Thank you. Our next question comes from Josh Nichols with B. Riley. Your line is open.

[Josh Nichols:]

Good to see strong orders, right, over the last 90 or 180 days the company has press released out here. I wanted to ask like, not just seems like you have good visibility into 4Q, but looking at next fiscal year, do you think that there is going to be a little bit of more of a return to normalcy in the company, maybe able to achieve this like mid-to-high single-digit top line growth? And kind of what you're seeing for what's already been built in for next year, given the cadence of the order flow and how those are going to be coming in over the next several quarters?

[Alan Edrick:]

Josh, this is Alan. So, thank you for your comments. While we intend to provide guidance for fiscal 2022 on our next call, as we generally do in August. I guess, suffice it to say that we feel good about going into fiscal 2022 with a little bit more of a return to normalcy in the Security business, the strong backlog that we have, the pipeline of opportunities, the tremendous momentum that our Opto business has shown and the strength of healthcare overall. We feel very good heading into fiscal 2022. So, we're excited to wind down our fourth quarter and finish fiscal 2021 strong. But I think we're even more excited to move into fiscal 2022.

[Josh Nichols:]

Thanks, Alan. That's great to hear. And then just looking here one pretty large hunting license, right, with the IDIQ here, one of three. Any color that you can provide as far as potential timing of the orders, is that more like a first half or second half potential for next year? I realize, like I said, it's not an order, but just looking if you have any visibility on timing given the size of the opportunity there?

[Deepak Chopra:]

Good question. It's Deepak here. Yes, we are excited about it. Timing wise, it's difficult to predict, and the amount is difficult to predict. But we are told that when these kind of IDIQs get into place, the next step is a pretty fast-moving specific orders because that's how the government works. So we are quite excited about it. Our products are very well received. We have a very good relationship with the customer and we expect that before the government fiscal year which is September, there should be lot of more activity up actual orders on this particular specific thing. And just to add on to it, this is not the only thing that's in the pipeline. We have maintained it. There are other orders and other opportunities with the US government that we are quite actively pursuing.

[Josh Nichols:]

Thanks for clarifying that. And then last question for me, then I'll let someone else take a turn. Is that, the company is now at two consecutive quarters where you're doing north of 17% EBITDA margin, higher than the company has historically done despite some of the revenue headwinds that you had mentioned. Fair to assume that as you guys return to year-over-year growth that you're going to see at least be able to maintain and possibly expand the type of operating leverage? Or is there a little bit more investment that you're going to be looking to do on the sales and marketing R&D front over the next few quarters?

[Alan Edrick:]

Yes, Josh, a good question. So our goal is always to expand margins. We look to expand our operating margins and our EBITDA margins. And we balance that at times with specific initiatives, like you just mentioned in terms of R&D investments and sometimes on the commercial side as well. But the overall goal of the company is to show margin expansion, top line growth coupled with margin expansion.

[Josh Nichols:]

Thanks, guys.

[Operator:]

Thank you. Our next question comes from Greg Konrad with Jefferies. Your line is open.

[Greg Konrad:]

A couple of quick follow-ups to those. I mean, first, you started the year really strong in cash. Is there any way to think about conversion going forward? And as the business comes back, any working capital needs or anything that we should kind of be thinking about when we model cash out?

[Alan Edrick:]

Sure. Yes, good question, Greg. It's been a strong cash flow year for us. Of course, given what our implied growth rate is for Q4 and the belief of top line growth going forward, of course, there'll be some need for investment in working capital as potentially for receivables and inventory, which is a good issue to have. We also benefit a little bit this year by some higher customer advances, which helps our cash flow as well. But overall, given the increased levels of profits and the continued relentless focus on working capital management, we think we will continue to be a strong cash flow conversion player.

[Greg Konrad:]

And then, I mean, we talked a little bit about Security and some of the delays in actually booking revenues, but you've had pretty strong book to bills. Has there been any delays in terms of signing deals? You mentioned you had a strong pipeline in Security, as COVID maybe subsides a little bit, are you expecting maybe orders to even step up as there has been some delays or is that more just on the revenue side?

[Alan Edrick:]

Again, good question. I think you answered yourself. Yes, obviously, with this pandemic, the ability to closure is not that simple. Yes, there has been some delays. But I look at that as a positive sign, that as the pandemic wanes down, we already have a very strong backlog. And, but the demand of the products are already there. So as it opens up, the demand will continue to be strong. And then if you are in the right place and you have the right products and you can deliver in a timely fashion, I think you have a great success story, written on it. So we feel that yes, it's been tough in Q3, as Alan mentioned, Security revenue was down. But that was because of the delay and acceptance and stuff, not to do anything do with the orders. So backlog is so strong, so we believe that Q4 and going into fiscal 2022, Security will continue to see growth.

[Greg Konrad:]

And then maybe just one last one that's maybe a little bit longer term or kind of looking back. I mean, I think back to AS&E and ETD, over the past three or four years, and kind of expanding the portfolio. And you mentioned that $15 million international airport, and it seems pretty broad from an order perspective. I mean, over the past couple of years is there any way to think about the sell through of kind of the expanded portfolio, both organically and inorganically? And maybe customer take when you kind of go to RFPs or new business, kind of how that's trended as the portfolio maybe has broadened both organically and inorganically?

[Deepak Chopra:]

Well, very broad question. Definitely, the broader the portfolio better chance of capturing especially large customers who have a very broader requirement. And AS&E has been a great success, and the RTT has been great, the 920 CT, the trace everything put together, especially with the integration solution at the same time, and to be able to book software integration with it, that'll give us a lot of strength to differentiate from our competitors. At the same time, as you sort of led to it, we are very, very acquisitive minded. So if we can find the right products to broaden our portfolio, to make it more acceptable to the customer's needs, we'll go do it. We have a very strong balance sheet. We are not shy of doing it.

[Greg Konrad:]

Thank you.

[Operator:]

Thank you. Our next question comes from Christopher Glynn with Oppenheimer. Your line is open.

[Christopher Glynn:]

I think a lot of companies have talked about components and freight headwinds, in particular getting a little bit more treacherous in the June quarter. I didn't hear too much about that. Is that something that is not causing you particular heartburn?

[Alan Edrick:]

Well, I wouldn't say that that it's not causing, but we are very much focused on it. We have been working on it. It doesn't seem materialities for Q4, but we are looking at all aspects. And at the same time, that's another reason if the inventory shows little sign of growth, that means that we are trying to get more product under our belt to make sure that when there are shortages and things that we have the product. The other thing is, in our space, compared to our competitors, we are a very vertically integrated company. So we have a little bit more strength compared to our competitors to be able to cater to needs of our customers because we are vertically integrated, we're manufacturing in almost every place that there is. So we can manage it better, whether it's Asia, whether it's Europe, whether it's US, whether it's Latin America. So that gives us much more strength to be able to manage this. But definitely, I would say, I'm not going to say we don't have concerns about it, we do, but we are managing it very well.

[Christopher Glynn:]

Okay. And thank you for that. And on Optoelectronics, I'm curious, just big picture, what's going on there in terms of how much of the momentum and market penetration is positioned to drive as the macro cycle eventually levels off versus really being a demand pull story here from the V inflection?

[Deepak Chopra:]

Again, good question. The good news again is in the Opto business, we have a very broad customer base

[Christopher Glynn:]

Thanks. Just one more if I may. The Security margin, I'm curious how that's positioned for fiscal 2022, if you get say low double-digit top line via your bookings in your pipeline. This year you called out favorable mix and some temporary cost controls. Wondering how those might juxtapose if you're getting solid top line next year. And is there an obvious mix signal there that we need to consider in modeling?

[Alan Edrick:]

Yes, Chris, this is Alan. Good question, also. So again, our goal is always to improve operating margins. Our operating margins have been very, very sound in the Security business in this year on some revenue headwinds. There'll certainly be some opportunities for economies of scale, as we move forward with planned growth. Simultaneously there'll be some of the kind of temporary reductions that we've seen in, let's call it lower travel and some other type of lower expenses that happened during the pandemic, that would come back. So, a little bit too early to call yet for fiscal 2022, but we feel very good about where our business will be in Security next year.

[Christopher Glynn:]

Great. Thank you, both.

[Operator:]

Thank you. Our next question comes from Brian Ruttenbur with Imperial Capital. Your line is open.

[Brian Ruttenbur:]

Great. Thank you, guys, very much. It's been a while, and I hope you're both doing well.

[Deepak Chopra:]

Thank you. It's great to hear your voice. My God, love it.

[Brian Ruttenbur:]

Been following you guys for 15 plus years to go into the dark side and banking and back. So a couple of quick questions. First of all on the IDIQ, $400 million cargo order on the IDIQ side with US government. Who else is on that IDIQ? Is that traditional competitors like Leidos and Smith? And then maybe you can talk a little bit about your traditional win rates on something of that size?

[Deepak Chopra:]

Well, I think you are very astute. You already named the other people, so I don't have to add to it. Welcome back. It's great to hear your voice. Regarding the win rate, yes, it's very difficult to, you know us. We are not going to say anything. All I'm going to say that is, that we are very well positioned. We have very good product and especially with what I call combination of high energy, low energy, transmissive, backscatter, all those things put together make us very unique. And we are very well positioned to capture a big portion of this business.

[Brian Ruttenbur:]

Great. And that's going to be roughly $400 million over five years that it's going to be led out, and it's primarily is it border patrol related? Is that what it is?

[Deepak Chopra:]

It's all at the borders.

[Brian Ruttenbur:]

Okay.

[Deepak Chopra:]

Mostly of the southern border, but maybe some at northern border too.

[Brian Ruttenbur:]

Okay. And then the next just a follow-up question in terms of kind of a technology update and Security, there has been a lot of talk on the personnel screening side. And historically, that's been a very small part of what you guys do. But given our recent SPAC from , and yes, that's talking a lot about growth in the personnel screening side. Can you talk a little bit about what you're seeing in terms of competitive pressures, new technologies on a personnel screening, is this just a one-off? Or is there a huge uptick happening in personnel screening? Maybe you can address that.

[Deepak Chopra:]

Well, again, you know the market better than us. Personnel screening has always been part of our portfolio. We've got great product in it. We've done a lot of advances in it. We believe that's a great opportunity long-term. Obviously, I won't comment on and their expectations and what they've write, what they've written. But as a company, it's part of our critical infrastructure program. And we do have some very good products and have had a very good success, both in what I call aviation area. But also in prisons and in nuclear facilities and even in some high opportunity kind of places where people are concerned with, of security. So, I look at this as a great opportunity. But if you ask me, is this opportunity bigger than all the other opportunities? No. We look at cargo and ports and borders as the biggest opportunity. And in that area, besides equipment, as you know, we are also into the software integration platforms. That has been very well received and we are very excited about that.

[Brian Ruttenbur:]

Great. Thank you very much.

[Operator:]

Thank you. And there are no other questions in the queue. I'd like to turn the call back to management for any closing remarks.

[Deepak Chopra:]

Thank you, everybody. Again, want to thank for all the support and confidence from us, and thanking the team. As Alan and I've said, I'm very humbled about the team's performance globally of OSI Systems companies during this pandemic challenging time. To emphasize it, we are manufacturing company, we've had a couple of cases, we've handled it very well. And we are very proud to say that, as a company, we continue to look after the health and security of our own people, at the same time deliver on our commitments to our customers. And that's the motto and we'll continue doing it. And thank you very much for all your support. Looking forward to ending the year in a strong way and talk to you after that, to talk about the next fiscal year. Thank you very much.

[Operator:]

Thank you. This concludes today's conference call.