OSI Systems, Inc. (NASDAQ:OSIS) Q3 2024 Earnings Call Transcript April 25, 2024
OSI Systems, Inc. beats earnings expectations. Reported EPS is $2.16, expectations were $2.11. OSI Systems, Inc. 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. Third Quarter 2024 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. [Operator Instructions] Please be advised today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Alan Edrick, Chief Financial Officer. Please go ahead.
Alan Edrick: 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 third 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 2024 fiscal year 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 ‘24, 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 ’24. Following record revenues and non-GAAP EPS in Q2, our third quarter financial results were very strong led by the Security division, which delivered extraordinary revenue growth and a significant increase in year over year operating income and adjusted EPS. We are encouraged by the momentum in our overall business as evidenced by another quarter of strong bookings. Let’s start with a high-level summary of our fiscal ‘24 Q3 results. First, revenues increased 34% year over year to a Q3 record of $405 million, driven by the performance in our Security division where revenues were up 60% year over year. Second, the significant revenue growth led to record Q3 non-GAAP adjusted earnings per share of $2.16 up 45% from Q3 of the prior fiscal year.
Third bookings were again strong with the book-to-bill of just over one, and we ended the quarter with a backlog of nearly 1.8 billion. The strong backlog provides good visibility for the balance of the fiscal year and into future years. 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 welcome to the OSI Systems earnings call for the third quarter of fiscal 2024. We are very pleased with our fiscal third quarter performance in which revenues grew 34% to a record $405 million. We had a book to bill of exceeding one and finished the quarter with a healthy backlog of about 1.8 billion. Our reserves were primarily driven by our Security division, which continues to perform well. I will now discuss some key highlights from our third quarter performance across each division before handing it back to Alan for a further discussion of our financial results. Beginning with the Security division where year over year revenues grew 60% in Q3, the division’s bookings were approximately 300 million plus achieving a book to build exceeding one.
During the quarter, we continued to deliver on the two major programs, the approximately $500 million contract with SEDENA, which is Mexico’s Department of National Defense for cargo and vehicle inspection systems and related services, and a 200 plus million cargo program with another international customer. Our cargo and solutions team has been relentless in its efforts and both programs are progressing well. In March, we announced a new a $100 contract for various cargo and vehicle inspection systems. As you may recall, we previously announced the receipt of a large award of $59 million at the end of Q2 for cargo and vehicle inspection systems from another international customer. These significant recent awards, in addition to the combined 7 million of contracts discussed earlier, provide great confidence and sustainable growth worldwide for cargo, as a market leadership breadth of product and solutions portfolio and our ability to deliver are being recognized and awarded going into Q4 and into fiscal 2025.
We are spending a fair amount of time here talking about the programs and market traction, but let me take a moment to provide an example here to illustrate how we affect everyday life and wellbeing with our cargo security products. We learned during the quarter that U.S. Customs and Border Protection CBP Officers at the Camino Real International Bridge on the Texas U.S. Mexico border performed a secondary inspection on a suspicious truck manifesting a shipment of chemicals, designated for agricultural use. The scans utilizing our company’s Z Portal cargo scanners revealed anomalies in the cargo and CBP officers subsequently discovered 6.5 tons of methamphetamine, which had a street value of $117 million. The largest ever met seizure in the U.S. Port of Entry.
We are proud to support the US CBP and their critical homeland security mission in stopping illegal drugs and other contraband and entering our nation. Moving on to the aviation and checkpoints, business continues to perform well with strong revenues and bookings. During Q3, we announced $21 million award from an international airport for checkpoint security infrastructure solutions, including our 920CT computerized tomography screening systems with automated tray return system, along with a multi-year service and support. We also announced a $27 million award from a leading European airport to provide the Itemiser 5x explosive trace detection ETD systems for secondary screening of passengers and carry-on baggage. As a side comment, the Itemiser 5x in addition to recurring service revenue like other products also has an ongoing revenue — recurring revenue of consumables, which has a very healthy margin.
And finally, we announced a $4 million award from a leading global air cargo logistics customer to provide various screening systems including the RTT 110 CT-based explosive detection system, the Orion 927DX and the 937DX for large package screening and the 920CX for smaller packages. As you can see from the different products mentioned, it helps to have a broad portfolio, which we are proud to say that we have the broadest portfolio compared to our competitors and utilizing this features and technology variations to provide optimized solutions for customers. We have seen over the last few quarters that airports and air cargo customers are making significant security infrastructure investments, and our business has benefit, and we believe that this trend will continue into fiscal ‘25 and beyond.
Our turnkey projects in Albania, Periodico, Guatemala, and the European airport have been performing as anticipated. In addition, we are also gearing up to begin our latest turnkey Uruguay — turnkey, which we expect to commence sometime in summer. In security, we look to finish the year strong, recent bookings activity and a significant opportunity pipeline suggests continued strong growth demand for 2025 and beyond. Moving to our Optoelectronics and Manufacturing division, where it was an uncharacteristic softer quarter, which we think is a one-off. We continue to work with several major customers to sync with their inventory demand forecast, which has impacted revenues in the short term as we had anticipated. The Opto Division achieved a book to bill exceeding one for the quarter, which bodes well for the business going forward.
We announced a couple of Optos key wins, including a $15 million order from a healthcare OEM to provide critical subassemblies that are used in its innovative and specialized solutions. We also announced a $3 million award from major defense electronics OEM to provide sensors for advanced missile systems. During Q3, we began introducing prospective customers to a new operation in Mexico, Tecate, which has given us a significant capacity to help customers aspiring to shift work from Asia to nearshore. Looking ahead, we expect Opto to return to form in Q4 and believe the division is well positioned for fiscal ‘25 as the inventory rightsizing winds down with many of our customers. Finally, moving on to the Healthcare division, where revenues were approximately 6% lower than in the prior year’s Q3.
This division continues to work through a challenging hospital CapEx environment despite that healthcare had an active booking score just before quarter end, we won a $6 million order from a U.S.-based hospital for our patient monitoring systems, including exhibit central stations, expression patient monitors, and queue patient monitors, which we expect to begin delivering in Q4. Our patient monitoring solutions allow customers to enhance their services by integrating features like the SafeNSound digital health platform and mobile app. This addition enables real time patient monitoring services. Additionally, customers can leverage the Rothman Predictive Health Analytics software to access advanced health analytics further augmenting our comprehensive monitoring offerings.
We continue to invest heavily in developing new products, primarily in our next-generation platform for patient monitoring products and solutions. Overall, we are excited about a strong finish in fiscal ‘24 and continuing our momentum into the next fiscal year and beyond. As always, I would like to thank our employees, customers, and stockholders for their continued support. With that, I will turn the call back over to Alan to discuss her financial results and guidance in more detail before we open for questions.
Alan Edrick: Thank you, Deepak. Now, I will review in greater detail the financial results for our third quarter. Again, our fiscal ‘24 Q3 revenues were up 34% compared with revenues in the third quarter of the prior fiscal year. The 60% year-over-year increase in Q3 Security division revenues was largely the result of sales growth of our cargo and vehicle inspection products. We also had double digit percentage revenue growth in our aviation and checkpoint products in related services. Q3 revenues included continued shipments from the $200 million plus cargo contract announced in January of 2023, and significant revenues from the $500 million plus cargo contract announced in March of 23. Third-party Opto sales were down approximately 3% year-over-year.
As mentioned on last quarter’s call, we anticipated that with certain Opto customers adjusting inventory levels and/or ordering patterns, revenues in this division would continue to be impacted over the short term and that has indeed been the case. As Deepak mentioned, we see this improving going forward. The Healthcare division sales decreased 6% year-over-year in this challenging hospital CapEx environment. The fiscal ‘24 Q3 gross margin of 33.6% was down from the 34.3% gross margin in Q3 last year. This was largely due to the mix of revenues. As our Q3 growth, this year was driven by a significant increase in product revenues, which carry a less favorable margin than service revenues and a less favorable mix of service revenues in the quarter as well.
Thus, while the gross margin on product sales increased, the gross margin on service revenues decreased year-over-year. 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 among 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. Q3 SG&A expenses for $66.6 million or 16.4% of sales compared to 17.7% of sales in Q3 of the prior year. The year-over-year increase in absolute cost was driven by higher compensation, including incentive compensation linked to our significant sales growth, increased professional fees in unfavorable FX among other items.
Research and development expenses in Q3 of fiscal ‘24 were $17.1 million or 4.2% of sales compared to $14.9 million or 4.9% of sales in the same prior year quarter. We continue to dedicate considerable resources to R&D, particularly in our Security and Healthcare segments 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 Q3 of fiscal ‘24. Moving to interest in taxes. Net interest and other expenses in Q3 increased to $7.4 million in fiscal ‘24 from $5.7 million in fiscal ‘23, primarily due to increased interest rates on a higher level of borrowings. We executed an interest rate swap during Q1 at fiscal ‘23 to fix a portion of our floating rate bank debt.
Our reported effective tax rate under GAAP was 22.6% in Q3 of fiscal ’24 compared to 23.8% in Q3 of fiscal ‘23. In Q3 of each of fiscal ‘24 and ‘23, we recognized immaterial amounts of discrete tax items, excluding the impact of discrete tax items. Our normalized non-GAAP effective tax rate in Q3 fiscal ‘24 was 23.0% compared to a normalized effective tax rate of 23.2% in Q3 of fiscal ‘23. I’ll now turn to a discussion of our non-GAAP adjusted operating margin. Overall, our adjusted operating margin in the third quarter of fiscal ‘24 increased to 13.9% from 12.9% in Q3 of fiscal ‘23, driven by the strong performance of the Security division. The non-GAAP adjusted operating margin in the Security division expanded to 18.6% in Q3 of fiscal ‘24 from 18.3% in Q3 of ‘23, primarily driven by higher product revenues.
The adjusted operating margin in our Opto division decreased to 12.2% in the third quarter of fiscal ‘24 from 14.1% in last year’s comparable quarter due to lower sales and a less favorable product mix. We anticipate a sequential improvement in this division as we finish out fiscal ‘24. The Healthcare division’s adjusted operating margin was negligible given the reduction in the division of sales. Moving to cash flow, we invested significant amounts in working capital associated with the Company’s strong growth. In Q3, cash used in operations was $52 million, primarily due to increases in accounts receivable associated with the Security division revenue growth. CapEx in Q3 of fiscal ‘24 was $4.9 million, while depreciation and amortization expense was $10.6 million.
Our balance sheet is solid with modest net leverage of 1.5. Aside from $7.5 million of annual required principled payments under our bank term loan, the bulk of our debt matures in fiscal ‘27. And finally, let’s turn to guidance. We are increasing our non-GAAP diluted EPS guidance to growth of over 30% earnings per share over fiscal ‘23, while maintaining our revenue guidance of an increase of more than 19%. This fiscal ‘24 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 of timing changes on the expected conversion of backlog to 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 results and non-GAAP earnings per share could 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, again, thank the global OSI team for its continued dedication and supporting our customers and partners.
And at this time, we’d like to open the call to questions.
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