Good day and thank you for standing by. Welcome to the OSI Systems, Inc. First Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to turn the conference over to your speaker today, Alan Edrick, Chief Finance Officer. Please go ahead.

Well, thank you. Hello 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 first 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 first quarter of fiscal 2023 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 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. I will begin with a discussion of our Q1 financial performance 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 the year. Our first quarter revenues and earnings were generally consistent with our expectations. We anticipated a softer start to the fiscal year with momentum building beginning in Q2 as supported by the timing of planned deliveries from our significant backlog. As we navigate the current economic environment, including supply chain delays and increased cost, disruptive…

Thank you, Alan, and good morning to all of you. Our fiscal 2023 first quarter’s performance was generally to our expectations. As Alan mentioned, we expected the revenue growth in fiscal 2023 to be more skewed towards the second quarter, third quarter and fourth quarter. We had very good bookings quarter, achieving a book-to-bill ratio of 1.2. Despite our start to the fiscal year, with a significant backlog and near-term visibility on certain attractive opportunities, we expect the 2023 fiscal year to be in line with our initial revenue and adjusted earnings guidance, implying strong growth for the next nine months. Our operating cash flow in Q1 exceeded operating cash flow in the same quarter last year and we anticipate even greater operating cash flow over the balance of the year. I will now talk about each division’s performance in the quarter, starting with the Security division where Q1 revenues were 3% lower year-over-year and bookings were approximately $204 million for a book-to-bill ratio of 1.4 for the quarter. The lower operating margin in the Security division for the quarter was mainly due to the product mix and lower revenue of the division. We expect Security division operating margins to improve significantly as we progress through the rest of the year. Overall demand for checkpoint Security products and related services continued to improve as airport and related activities has ramped up. We saw higher demand for our supplies and accessories also, which include consumable items that are a recurring revenue source. Rapiscan’s inspection systems will be used, we are very proud of it at, the FIFA World Cup 2022 to be held in Qatar. We are finalizing our preparation for the event, which starts in late November. Our ORION 920CX baggage and parcel inspection systems, Large Tunnel 922CX models and…

Thank you, Deepak. Now let’s review the financial results for our first quarter in greater detail. Our first quarter revenues were down 4% compared with that of the prior year Q1 or approximately 2% on a constant currency basis given the strength of the dollar. Fiscal first quarter Security division revenues were down 3%, largely due to the unfavorable FX impact. The Security division book-to-bill as Deepak mentioned was approximately 1.4, positioning the division well going forward and we anticipate significant sales growth commencing this quarter. Opto sales increased 2% year-over-year on the growth of intercompany sales to support anticipated upcoming security sales, while Opto third-party sales were consistent with third-party sales in the prior year quarter. Opto bookings were again solid, leading to a record Opto backlog, but supply chain constraints have led to delays in production and shipments of certain orders. The Healthcare division reported a 14% reduction in year-over-year revenues in part due to a tougher year-over-year comp, given the prior year demand during the COVID Delta variant surge. The Q1 gross margin was 32.6%, about 2.9% below that of the prior year. This change was primarily driven by the lower sales in the Healthcare division, which carries the highest gross margin of our three divisions, higher Opto sales as a percentage of total sales, as this division tends to carry the lowest gross margin of the three divisions, and a less favorable mix in the Security division sales with increases in certain component and freight costs adversely impacting each division’s gross margin. Our gross margin, in general, will fluctuate from period-to-period based on revenue mix and volume, inflation, impacts to the supply chain, among other factors. Moving to operating expenses, we continue to work diligently across each of our divisions to improve efficiencies and prudently manage…

Thank you. [Operator Instructions] And our first question comes from Brian Ruttenbur from Imperial Capital. Your line is now open.

Great. Thank you very much. Great quarter and let me jump right into questions.

Thanks, Brian.

So can you give us an update on the status of the TSA certification where you are on the CT based inspection equipment?

Yes, Brian. Hi. This is Deepak here. As we have mentioned before on the checked baggage side, the present certification that we have is 5.8, which applies to cargo and we have been very successful in that side. There is no specific qualification for the ongoing replacement cycle, which according to TSA is still couple of years away and they are still finalizing with the European Union what the final procedure is going to be. So, at this stage, we have 5.8, same as other people and we are very successful in whatever is happening, especially in the cargo space.

Okay. Is there any update on the upgrade cycle that’s supposed to be happening, I guess, for the last five years, we have been talking about this, but in terms of the U.S. TSA with checked baggage?

Well, the only thing we know is that is pushed out, it’s 2024, 2025, but we hear it’s not in our hands. It’s in TSA’s hands and they basically have to make their decision, and COVID has pushed everything to the right. But in the European side, there’s much more activity and we are very well qualified to win those orders.

Great. Moving onto the Opto side real quick, it continues to perform extremely well. What is driving that, is there anything specific -- a specific sector, a specific product that is driving all this growth?

Well, maybe Alan can add on to it, but in my view, looking at it, all the sectors have done very well. Automotive sector has been very, very successful. Medical has been very good and it continues to show very strong growth. That’s one of the things that Alex -- Alan mentioned also. The flex circuit, which is a division in the OSI Electronics has done very well and we won some great kudos from our customers. But in aerospace, in defense, in high-tech consumer electronics, industrial, name the sector, good news is that’s one of the things we are very proud about it. It’s a very diversified product portfolio. And we personally think one of the things that I have said it before, one of the things that has also helped us very much, there’s a lot of desire by the OEM customers to move away from China and with our presence in Indonesia, our presence in Malaysia, our presence in India, it’s been a good blessing for us and that’s one of the reasons I said in my speech that, we have expanded our facilities there. That has been a big positive. Alan?

Yeah. I think what Deepak was describing is exactly right. Our diversified model, our diversified customer base in medical, defense, aerospace, technology, industrial, automotive, amongst others has really played us well. And I would really say hats off to a lot of our sales and business development teams who are going out there and getting new business from existing customers, as well as bringing in brand new customers. So we have really seen tremendous strength in the division and we are certainly hopeful we are going to see that continue for the foreseeable future.

Great. And then just my final question is on the Healthcare division. It was weak kind of year-over-year from first quarter last year. When do you expect to see that recovery and was there a specific reason, it was weak year-over-year in this first quarter, was there a specific shipment or a product line that didn’t go out?

Well, again, Brian, one thing is that first quarter is relatively weak to begin with historically, and secondly, that we expected that. Last year, COVID was still there, lot of demand of patient monitoring at quick turnaround that demand has slowed down. So that -- it’s down, obviously, we are not that happy. But we look at the second quarter, third quarter and fourth quarter will be stronger and there is lot more activity and one of the things is we are investing quite heavily in SafeNSound, our software platform, which has been very well received and can -- and basically makes us a little bit different than our competitors and we continue to look at that as a growth opportunity and it also has higher margin. Alan, do you want to add on?

Yeah. I think that Deepak summarized it well. But, Brian, we do expect to bounce back with a stronger sequential quarter for sure here in Q2 and pick up some further strength in the second half of the year. So we do believe the performance in the Healthcare division will look much better the rest of the year compared to Q1.

Great. Thank you very much.

And thank you and one moment for our next question. And our next question comes from Larry Solow from CJS Securities. Your line is now open.

Great. Good morning, guys. Just a couple of follow-ups, Deepak, you mentioned and I know you even talked about this for a couple of years, just the large couple of orders, I think, $200 million with Customs and Border Protection, has that actually -- have you started to deliver on that at all? And then, I guess, part two, I know I think last quarter you talked about a little bit of a stretch out in terms of deliveries. Is there any update on that and it’s been about a year since you I guess I think there’s still a pretty large piece of the IDIQ remaining. What’s your visibility on additional orders?

Larry, this is Alan. I will take the first part of the question and Deepak can follow on. So, yeah, we began delivering some of that CBP orders from the IDIQ in Q4 of last year, was continued into Q1 of this year. Pretty modest revenues, I think, as Deepak mentioned in his opening remarks this quarter. That being said, we expect to see a significant acceleration of the revenues beginning now. So we will see much bigger revenues in Q2 and Q3 and Q4 continuing on into 2024 and maybe part of 2025. So that’s kind of what our current outlook is and then we would anticipate there could be follow-on orders. Deepak, if you want to add?

Yeah. Larry, this Deepak here. Alan put it well. The ramp-up will start faster now in Q2, Q3, Q4 of this year compared to what wasn’t just and most of that has nothing to do with us. It’s the delay and…

Okay.

… the civil work’s not ready in some other places. It’s the delay from that side. So that it will continue and like, Alan mentioned, it will continue into 2024 and beyond, and we still are very confident that with that, we are very well positioned that from the IDIQ, there might -- there could be some additional bookings also as more products are delivered. So that -- we look at this as a long-term play, we have always said that, and yes, some of the things are not in our hands but CBP is a very focused customer and they need certain things to be done at the border and we are very well placed with it including our CertScan software, which is very important.

And is the CBP, I guess, would that be the only agency involved, I guess, for the U.S. border, southern and northern border, would that be or are there other agencies and then other, I assume there are significant international opportunities around, because in terms of vehicle inspection across the globe, I think, is minimal today, right? And there are -- I don’t know if it’s aggressive estimates, but people want to eventually target searching a lot of -- a large majority at least of commercial vehicles, if I am not mistaken?

Well, you put it very well. CBP is the main customer in that. Yes, there is international traction and that’s why we are very excited about the CertScan software implementation also. But, in addition, one of the other comments we want to make is, there are other agencies, which is not to do with border security.

Right.

There are other agency like State Department, The Department of Defense and stuff, also very big customers for us and we continue to get a lot of success with the other divisions of the U.S. Government and international governments.

Got it. Okay. Great. Just I want a quick follow-up just on Brian’s question on the Opto segment and you said backlog was up 22% year-over-year. It’s a pretty significant number. Is that I assume some price is in there or is it mostly volume, was there any tuck-in acquisitions in that or what kind of drove that, it is a large number, is it -- are there some larger longer lead time orders in there that’s skewing that or is it just pretty much pure growth?

Larry, this is Alan. Good question. And it is all organic as we haven’t done any acquisitions during that period of time in the Opto division. What we are seeing from some of the customers with some of the challenges and supply chain and longer lead times is at times they are giving us a longer order. If somebody used to give us a three-month order, they might give us a six-month order. If somebody gave us a six-month order in the past, perhaps it might give us a nine-month order. So we are getting some larger orders as a result of that to give greater visibility going forward. Little bit of price with passing on certain purchase price variances and stuff with inflation, and certainly, growth in unit volume as well, so really a combination of all of those factors.

Larry, just to add on…

Got you. Yeah.

Just to add on to it. It’s Deepak here. The other thing I want to…

Sure.

… emphasize, there is a lot of focus on it to move away from China. And if you have done…

Right.

… well with your customer and you have the ability to support it and you have the supply chain under control and facilities like we have and we have said that we have expanded them in Batam, Indonesia, Malaysia, India, that has played a big part of capturing more business from our regular customers who basically are more focused on seeing growth and working with a smaller bunch of vendors and we have -- we are well positioned in various places and have been a very, very good supplier to our customers.

All right. Great. I appreciate that color. Awesome. Just last question just on the cash flow, Alan, I know Q1, obviously, was a little bit certainly into the backend loaded year, but the operating cash flow did exceed net income in the quarter even on adjusted basis. Do you expect that to continue on a full year basis, I don’t think you guys are, typically it’s a free cash flow, but do you expect operating cash flow and free cash flow to, obviously, improve over last year, but do you expect it to sort of come close to net income as it has in the past?

Yeah. Larry, while we did not provide cash flow guidance per se...

Right.

We really think there is opportunity for strong free cash flow in fiscal 2023.

Okay.

That being said, we do expect inventory to remain at an elevated level this year. But in terms of…

Right.

… the conversion, I do think we can have very strong conversion certainly north of where we were last year and approaching where we used to be in the past. And all three of our businesses are finally tune to the key levers that drive the strong operating cash flow and free cash flow. So, yeah, some great opportunity there.

Got it. Great. Thanks. Thanks again.

And thank you and one moment for our next question. And our next question comes from Christopher Glynn from Oppenheimer. Your line is now open.

Thanks. Good morning and good afternoon…

Hi.

… depending on where you are I guess. So question on Optoelectronics, curious if you could size the past due backlog. And also related to that, if and as you are able to unlock it, is there a real run rate step-up related to that in and around what you mentioned about migration from China? It just seems like this business is kind of restrained and as good as the numbers have been, the backdrop that you describe is -- almost sounds like it’s in another realm still?

Yeah. Chris, really good question. This is Alan. I wouldn’t necessarily categorize it as past due backlog, because we are working quite well with all the customers there. But that being said, there’s probably some opportunity, probably, something less than $10 million of what -- of extra revenues we could have had had there not been certain component shortages [Audio Gap] You might have 98% of the parts, but if you are missing those final 2%, you can’t ship a complete part. So it’s not a big back up there that will then unleash significantly higher revenues. But we just expect continued strength in the business each quarter over the balance of the fiscal year.

This is Deepak. I mean I think Alan has put it well. I will also emphasize to it that we are very much focused on what we call it, value added. So if you are working with the customer to supply $5 of parts, the focus now with a broad technology and our global presence, we are trying to work out can we add more value to that, which is a very, very good strategy for the Opto group, because that gets us higher on the food chain on the customer’s list, and as the customer looks at it, we basically continue to work with them to get more value-added that we can supply, which we think long term will continue to grow.

Great. And one on Security,. You have had backlog there and a big chunk from the CBP. And in some cases, backlog businesses have a little bit more challenged with price cost. It certainly sounds like you have flushed out the worst of price cost mismatch in backlog in the current quarter. But I just want to revisit first affirm from that point or clarify and then with the big IDIQ win, how do you preserve the economics of those wins from when you bid and is that even possible?

Good question. You are absolutely right, on longer term contracts, price is fixed, so you can’t change it. But we haven’t seen, though, there has been some push outs and scrap, because of component shortages and site not ready. But I would say on a bigger scale up till now we have not seen too much erosion of our margin on the -- on what I call on paper looking at the products. And the same way, think about it that all indications are that there is some easing in the supply chain, both in freight and in component cost and stuff. So as we push that product out with a longer time frame we have, we expect that things will stabilize.

Great. Thank you.

And thank you and one moment for our next question. And our next question comes from Jeff Martin from ROTH Capital. Your line is now open.

Thanks. Good morning, Alan and Deepak. Hope you are doing well. Deepak, I wanted to see if you could give us a little more detail around the traction that CertScan may be getting, is it still too early to be talking too much about that? Also curious about how long the sales cycle is there and when we might expect to see a little more accelerated ramp for it?

Again, good question.

And as you say, secondarily, how that ties into the Quadriga acquisition that you have mentioned this morning?

Thank you. Good question, Jeff. With the way it’s been slow progress with CBP in this quarter, we expect the second quarter, third quarter, fourth quarter to be stronger. Same thing as it goes in 2024. As more and more installed base happens, it also brings with it the CertScan software. And the other good news for us is that we have been -- we have got the certification on what is called ATO, which is a big plus for the software to be installed at various locations that the customer wants. So we continue to see progress, though, it’s a slow progress. At the same time, Quadriga bring to us a combination of training and CertScan, so we can mix the things together and give more applications and more capability of supporting additional functions that the customer wants us to do. So all that stuff continues to our focus that ultimately this software, not only just in the U.S., but in other parts of the world, will continue to become like a licensing software with a recurring revenue, which is happening. It’s not like its tomorrow. It’s education purposes that we have to work with the customer and their needs, but all indications are that in many places, especially with CBP, we are getting a lot of traction.

Okay. Great. And then you would mentioned that first new multiyear turnkey customer in airport aviation. I am curious in a little bit of background how that opportunity evolved and eventually came to light, and then, what you are thinking in terms of, is that a major strategic initiative for Rapiscan going forward?

Well, I will answer it backwards. One, we think just look at our history. From where we were five years, 10 years ago, we basically have taken on a new line. Ports and borders have been very well received with our turnkey solution have been very successful. So we have been working very diligently to see what other places we can look at it. Aviation happens to be another area, which as you have read, I am sure, everybody is talking about it, you can do inspections fast enough, if you have to keep increasing the people, labor is not there. So this kind of automation is a natural play. We have demonstrated to the customers, have been working with them, what can be done in the ports and border security and other areas. So we found a successful win in a new area internationally. Though very small right now, it’s a -- what I would call, is a beginning of a new marketplace opening up for the aviation side. And we are working diligently. It’s not a needle changer right now. But it’s strategically very well. And as that expands and gets more successful and we can take more show and tell to other customers, we think it’s a new market.

Great. And last question with the hurricane going through Puerto Rico and causing significant disruption. I was just curious if you saw any disruption with your turnkey operations there.

Jeff, this is Alan. No significant disruption, obviously,. for a few days while it was occurring, but our general volumes in Puerto Rico tend to be about the same, some delays and some paperwork and the like down there, but overall, no significant change in Puerto Rico.

And just to add on to it, fortunately, no damage to our equipment and our employees are all safe. And during all this time, we work diligently and we continued, as Alan mentioned, we are continuing to work.

Excellent. Thanks for your time, guys.

Thank you.

And thank you. [Operator Instructions] Our next question comes from Josh Nichols from B. Riley. Your line is now open.

Yeah. Thanks for taking my question. One, I just want to ask a little bit about the small acquisition that you did. I know that that’s going to be integrated with CertScan. Could you elaborate a little bit on that and progress that the company has made growing it’s more SaaS revenue base and the opportunity on that front as we look out a little bit further?

Well, good question. It’s a very small acquisition. They do training. They are based in U.K. They do training for people in the inspection space at checkpoints. We had been using them as a vendor for some time and thought it was strategically good that now we know about it to combine it so that we can broaden our CertScan platform for opening more applications to our broader customer base. And, yes, it’s all heading towards a SaaS model between CertScan and Quadriga and we feel that we will continue. But, again, I want to emphasize, and again, before the other person ask the question, we definitely believe long-term this will continue to grow. It’s a slow part. It’s a new area we are entering into. We are working with our customers. And according to SaaS model, we look at it as a licensing plus good margin. And we are also very much focused on to it that it’s agnostic to which equipment it’s hooked on to whether it’s Rapiscan equipment or a competitor’s equipment, whether it’s X-ray machines, whether it’s television cameras or whatever. So we continue to broaden our application need for this software model.

Thanks. And then just curious, so the new turnkey that you announced, small in size, but a first in the airport aviation sector, is this like a land and expand opportunity, could this become more meaningful? I am just curious about the growth opportunities here or if there’s more opportunities in the aviation sector where previously you haven’t really done so much on the turnkey side?

Yes, yes and yes. We basically have a multiyear contract. It’s starting very small to see whether the viability of it. As it expands, even at the present customer, it can significantly expand as more and more applications are into it. And then, as this becomes a model, same model that we have said before from Puerto Rico to Mexico to Albania, to that end of borders and ports, we feel that it’s a good model to expand into the aviation sector and we will continue to see some success as we demonstrate the efficiency of that -- of this turnkey model.

Thanks. And then last question for me, just with shares kind of trading pretty depressed level 7 times to 8 times EBITDA, despite you have a record backlog and I think the outlook for this year is that growth is going to accelerate materially relative to last year. What’s your thoughts on the buyback? You have obviously been buying back pretty aggressively, but the cash over $50 million, are you comfortable allocating a very large percentage of your free cash flow to share buybacks if the stock does remain at these levels or what’s your thoughts on the capital allocation strategy there?

Well, we don’t talk about what these things are specifically in the future. But you said it very well, we are very much aggressive in it, we feel we are undervalued and we continue to look at when we are able to buy. And the Board has been very, very supportive of it with the increasing of the stock purchase plan, and we have been very active into it and we will continue to be active.

Great. Thank you.

And thank you. And I am showing no further questions at this time.

Well, I want to thank everybody. I know it’s in the morning time and the market is still open. Thank you very much for taking the time to attend it. I want to thank all of those in attendance toward it. And I again want to emphasize and thank our employees and their families and our customers to be full support in working together and we thank you and look forward to your next -- to our next conference call. Thank you very much.

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