Hello, thank you for standing by and welcome to the OSI Systems, Inc. Fourth Quarter 2012 Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker today, Alan Edrick, Chief Financial Officer. Please go ahead.

Well, thank you. Good afternoon and thank you for joining us. I'm Alan Edrick, Executive Vice President and CFO of OSI Systems. Deepak Chopra, our President and CEO, could not join the call today due to an unavoidable last minute complex. Welcome to the OSI Systems fiscal ‘22 fourth quarter conference call. Let's review our business performance, financial and operational results. Earlier today we issued a press release announcing our fourth quarter and fiscal year ‘22 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 statements based upon subsequent events or new information, or otherwise. During today's call, references will be made to both GAAP and non-GAAP financial measures. When describing the company's results. For information regarding non-GAAP measures and GAAP measures of the company's results and a quantitative reconciliation of those figures, please refer to today's earnings release. Let's begin with the discussion of our financial performance for the fourth quarter of fiscal 2022, provide an overview of our business performance and then let's finish up with more detail regarding our financial results and a discussion of our outlook for fiscal ’23. We are pleased with our results last quarter, particularly given the macroeconomic challenges we faced, including supply chain delays and logistics cost, disruptive geopolitical events, the COVID-19 pandemic, inflation and rising interest rates. As we managed the current environment, we continue to prioritize delivering on commitments to our customers and partners and positioning the company…

Thank you. [Operator Instructions] Our first question comes from Brian Ruttenbur with Imperial Capital. You may proceed.

Yes, thank you very much. A couple of quick questions. First of all on the quarterly breakdown, you mentioned that it's going to be weighted to the second, third and fourth quarter is going to be your strongest, can you talk a little bit about first quarter, are we going to be looking flattish year-over-year first quarter 2023 versus, first quarter of 2022?

Yeah, great question, Brian. We had some strong sales in our Q1 of fiscal 2022. So as we currently look out, although we provide annual guidance. We're currently anticipating that Q1 will be down a little bit from what it was a year ago. The nice thing for our whole year was, while we were very back-loaded in fiscal ‘22 to Q4, we think it'll be a little bit more evenly distributed between Q2 and Q3 and Q4, while Q1 just becomes a little softer based upon our customer delivery preferences and some supply chain limitations.

And that's going to be primarily the security division is going to be weighted that way or is it all divisions in that first quarter?

I think we're seeing it throughout our business.

Okay. Very good. Next question is in terms of cash flow for fiscal 2023. The last year or so because a building receivables and a variety of other things cash flow hasn't been as strong as historically it's been. Can you talk a little bit about cash flow, what you anticipate in 2023 or give us a proxy?

Sure. Great question and you're right, Brian. When we look back from ‘19, ’20, ’21, our free cash flow or operating cash flow was outstanding. Generally, we had a conversion above 100% of net income. In fiscal 22, we made the intentional decision to increase our inventory levels in order to mitigate some of the risks in supply chain and the plan for some of the growth in the strength in the backlog. So our cash flow was a bit lower than we historically see. As we move to fiscal ’23, as we sit here today, we're anticipating a nice rebound and returning to some of the historical cash flow levels that we've typically seen. And now we can see that potentially even accelerating from there. So we're looking to a strong free cash flow year in fiscal ‘23 for us.

Okay. And then -- thank you. And then one other just follow-up and I'll give the line to somebody else. On the Opto side, you're probably more exposed to economic factors in that division maybe than others. Can you talk about what you're seeing in terms of backlog booking specifically in the Opto division?

Yeah. So we're really, really encouraged by what we see in the Opto division. We have had 10 consecutive quarters in Opto with a book to bill north of 1 and we entered fiscal ‘23 with an all-time record backlog in Opto. We do not have any exposure to any concentration in any particular industry. We deal with Aerospace and Defense and Medical, Technology, Automotive, Test and Measurement, Industrial, just to name a few. We're continuing to see strong order flow and with our strong backlog, we think we're going to be continuing to deliver quite nicely. The biggest challenge we have in Opto is, is just getting some of the components in order to finish off some of the products in order to deliver to our customer base. But the nice thing is, we are seeing still strong demand and are anticipating a very solid year yet again for Opto.

Thank you.

Thank you. One moment for questions. Our next question comes from Larry Solow with CJS Securities. You may proceed.

Great, thanks. Thank you for taking the questions. Just a couple of maybe on the -- quick follow-ups on the CBP orders and delivery timeline. So it sounds like you mentioned stretched out a little bit over a three-year period. Could you -- can you just give us an idea. Do you previously think they would be done more like in the next year or two years, how much -- just trying to get a better scope on how far out extend they're becoming? And does that maybe suggest that future orders might be sort of in the back half of that five year timeline if some of these deliveries, if they're not ready for certain deliveries yet today?

Larry, thanks for the question. Good question. And you're right on point on the first point. The --we weren’t initially anticipating that the couple of hundred million dollars of orders that we received about a year ago would be primarily delivered in our fiscal ‘23 and ‘24. So there was a bit more front-loading to it. Based upon customer request they've asked us to elongate that process a bit. So now we're currently anticipating that most of it will be delivered over a three-year time period rather than two. We're are ready, we're prepared to do it faster if they want it faster, but it looks like it will be out at that timeframe. In terms of when the next orders would come on those IDIQs always difficult to say, but I would imagine that there'll be wanting to see some deliveries of the products of a more substantial nature and then we should see some potential new orders and there is significant balances left on those IDIQs for them to make further purchases.

Okay. And all in, your backlog, obviously, is -- your book-to-bill, I guess, trailing is 1.1. I know you don't sort of guide to the quarter. I mean to the segment, but do you think in Security you grow year-over-year or is that tough say on a topline basis?

We are absolutely expecting to grow year-over-year on the Security business in fiscal ‘23 and that's what's implied in our guidance.

And what about just in terms of inflation and stuff, I think you kind of suggested you don't pass, obviously, once you sell your contracts are fixed at the time, I guess, that there are -- deliveries are signed on. But you do you raise prices over time. How do you sort of offset some of these inflationary pressures if you're now passing onto your customers at all?

Yeah. Good question, and it really can vary by division, Larry. In the Opto business, we're able to pass on a good portion of those material cost increase nearly immediately to most of our customers as they well understand it. In the security business, which tends to be longer lead time backlog, if you have an order in the backlog, particularly to a government type customer that it's been there for a while, it's difficult to pass on cost as they move up with that particular contract and we think that will impact us a little bit, which is embedded in in our guidance, but as we come out with new orders and new awards, the pricing that we do factors in that new cost structure for us. At the same time, we're always trying to counter some of those increases and some of those input costs with more efficiencies and productivity improvements, which the team has been very good at achieving.

Okay, great. And then if I can maybe switch gears and squeeze one more question, just on the Healthcare front, what's going on in terms of next-generation monitors? Is that still in the queue? And is that more of a fiscal ‘24 event?

Yes. So, developing a new patient monitoring platform and some of the new products is very much in the queue. It's where we're investing a sizable portion of our R&D in our Healthcare division. So the team was making progress in those efforts, we won't see any of that impact here in fiscal 2023 on the topline. But we do look at that as a long-term growth driver for the Healthcare business. So a very important element for us.

Okay. I appreciate all the color. Thanks again.

Thank you.

Thank you. One moment for questions. Our next question comes from Jeff Martin with ROTH. You may proceed.

Thanks. Hi, Alan. I wanted to get a sense for with increased free cash flow in fiscal ‘23 at least relative to ‘22. How are you looking at use of that cash flow and share repurchases, acquisitions or debt reduction.

Hi, Jeff. Good question. You really hit on all three areas that we focus on for capital allocation. In fiscal ’22 we did some small acquisitions, but we invested pretty heavily in stock buyback throughout the year. As we look at fiscal ’23 we think all three of those options are available to us. While we'd like to grow organically, we'd like to give a bit of a boost to that acceleration factor through M&A, which has been part of our DNA in our history. So we'd like to continue to do good strategic acquisitions that add some nice shareholder value. Supplementing that, we'll always look at stock buyback and residual cash that we have in paying down some of our revolver balances. So all three are at play for us.

Yeah. Okay. And then in terms of gross margins for this year, how should we think of them relative to fiscal ’22. We have got the materials cost increase in some of the areas of the business still have to absorb. You are offsetting that, I would think you've got higher software and services concentration that partially offsets that, but what -- how should we think about gross margins this year relative to fiscal ’22?

Yeah, Jeff, you've hit the nail on the head again with some of the puts and takes. Generally speaking, as our sales rise, we would look at some economies of scale and look to have expanded gross margins. I think with some of the higher costs, given some of the supply chain challenges and some of the cost that’s already embedded in some of the backlog we have, I think we're currently anticipating that our gross margin will be relatively comparable to what we saw in fiscal ‘22 on a full-year basis, it will bounce around a little bit based on the mix of revenues and the level of revenues from quarter to quarter on an annual basis should be comparable, give or take a bit.

Okay. And then last question is, I was curious on the Aviation market in the Security segment, are you seeing increased engagement on the client side in terms of building some sales pipeline, what gives you a suggestion that that market may be turning around this year?

Yeah. We are definitely seeing more activity on the aviation side, the level of RFPs the customer business that we're having, we don't anticipate that will drive a material amount of increased revenues in the first half of the year, but as we move into second half and into calendar ’23 we think there is a nice opportunity for growth in aviation and we're hearing good things from our sales and marketing teams in that regard and remain optimistic that will be the case.

Okay, great. Well, good luck with that.

Thank you.

Thank you. One moment for questions. Our next question comes from Josh Nichols with B. Riley. You may proceed.

Yeah. Thanks for taking my question. I guess like I'm trying to get a little bit better handle on it. So some of the large security orders from the CBP right, those now going to be filled over three years, I think that's fine, but how much of the $1.2 billion backlog do you think is going to be flowing through to revenue in fiscal ‘23 given like the extension of that CBP award?

Yeah. Our estimate, Josh, at this point would be something north of $700 million would likely flow through to fiscal ’23. That number could end up being little higher or a little bit lower, but our best guess is little bit north of $700 million at this point. So what that means is, we got some pretty good revenue visibility as we start out here in fiscal ’23.

Yeah, it sounds like it -- I'm thinking just looking at here, the service revenue levels that you did this quarter were higher than, I guess, anything I could recall, right. At least in the last few years, is that expressed to be sustainable or what's -- a little bit more detail on what's driving that? And are those gross margin impact is going to likely flow through into next year as well?

Yeah, we are really pleased with the work done by our service team in increasing some of the service orders and the revenues and the flow down to margin. Q4 was very strong on the service side. As we look forward, outside of Q1, which is historically a little bit softer on the service side as parts of the world seem to be more indication during the during the summer timeframe. We would anticipate that we'll continue to have strong service revenue levels, particularly in Q2, Q3 and Q4. And I would like to see that continue to flow down and expand our margins in that arena. So we look at that is a great opportunity. Embedded in that is also some of the recurring revenues that we're doing in Search Scan, some of our software and some acceleration and turnkey revenues that we're doing. So yeah, we believe there is a nice opportunity to continue to show strength within the service revenues as part of our consolidated revenues.

Thanks. Last question for me, I know you've mentioned Search Scan in the last couple of quarters, right? I think most people are aware of the existing turnkey contracts you have, but in terms of new opportunities on those two higher margin fronts, is the stuff that you mentioned that you're pursuing kind of incremental or some of these like larger eight, nine figure potential opportunities if you are to secure them.

Yeah, I think the -- I think some of the near-term opportunities are incremental that are nice level of revenues, at nice margins. And I think more on the kind of the medium-term and long-term, there are some very, very substantial opportunities that we're pursuing that will be in our pipeline. Always difficult to estimate when that actually might hit, but very exciting opportunity pipeline on the service side for us, including in Search Scan and including in Turkey.

Thanks, Alan.

Thank you.

Thank you. [Operator Instructions] Our next question comes from Ellen Page with Jefferies. You may proceed.

Hi guys. Thanks for the question. Just [indiscernible] healthcare margins, you mentioned some mix in that, but they were down almost 600 bps sequentially with the detrimental of over 100% by my math, can you discuss the drivers of an improvement in that margin. And when you expect to get back into the mid-teens?

Yeah. Hi, Ellen. Good question. So while our Q4 revenues were in line with our expectations in health care, the margins were lower, as you've noted. This really was due to a less favorable mix of revenues in the quarter and we also have some operating expenses that exceeded some of our expectations. The margin in our healthcare business is highly sensitive to the top line, so a little bounce around from time to time, because the incremental margins and the contribution margins are so strong when revenues go up. There is a big flow through to the operating margin. And similarly, if revenues are down, you can't change your cost structure enough to mitigate that. Our team is highly focused on delivering strong operating margins on an annual basis. So we're optimistic that as we move forward the team will continue to improve operating margins in the health care business. Again like much of the rest of our business focused beyond the first quarter great.

Great. And then on Security margins are well above where they've been. Should we think of high teens as sustainable level as you continue to execute on some of these larger contracts?

Yeah, we're always focused on operating margin expansion in security as well. It will also move from period to period, based upon the level of the revenues and the mix of the revenues with some of the recurring revenues and some of the new programs that we're moving into, we think there's opportunities on a longer-term basis to absolutely expand those margins. On a shorter term basis, we do have some headwinds with supply chain and some of the strong backlog that we have that has some locked in pricing, while some of the input costs have gone up. So we think the margin expansion opportunities will move forward probably more in the medium and the long-term.

Thanks for that color. I'll hop back in the queue.

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Alan for any further remarks.

Well, thank you very much. It's been an interesting year. Overall, I think our team proved that it can really deliver to customers and operationally execute in an incredibly challenging environment. I'd like to lastly thank all in attendance for joining this call and we look forward to speaking to you in a couple of months on our next quarterly call. Thank you.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.