All right. Welcome back, everybody, to the CJS 25th Annual New Ideas for the New Year Conference. I'm Larry Solow, a partner and research analyst here at CJS. I'm happy to welcome our next company, OSI Systems. With us today are Alan Edrick, CFO, who's walking on air after the Rams win last night, as well as Ajay Vashist, VP of Business Development and Strategy. Alan, go ahead. Take it away.
Well, Larry, thank you. Good morning and good afternoon to all. And thank you for that shout-out to the Rams. Yes, we're quite excited. But we're even more excited to talk about the OSI Systems story. So I'm going to walk through just a handful of slides, maybe 10 to 12, to give a big picture overview of OSI. And then we'll turn it over for Q&A, which we're quite interested in taking. So kind of a big picture perspective on OSI, we are three businesses. We're a security business, a health care business, and what ties it all together is our Optoelectronics business. Most folks are primarily interested in our security division, which generates over two-thirds of our revenue and has been growing quite significantly. We're a June 30th fiscal year, so we just finished up our midway point, our half year here.
We'll be reporting our quarterly results later next week. Our security business, we tend to be the number one player in the world in security detection, focused on cargo and vehicle inspection at ports and borders, as well as at aviation and checkpoints and a variety of other settings. In health care, we sell in the hospitals. We sell patient monitoring products and cardiology products. And we have some great recurring revenue and service and supplies and accessories. And what ties everything together is our Optoelectronics business, which, unlike security and health care, which sells to the end customer, in Opto, we primarily manufacture for the Fortune 500 in a variety of different industries. But in addition to manufacturing for third parties, our Opto division supplies many of the key components that go into our security products and many of the key components that go into our health care products.
So through that vertical integration, we enhance the overall OSI-wide gross margin. We can be faster and more responsive to our customer needs and have greater control of the supply chain, which has been critically important over a number of years. As we look at the overall company, we do think we're a compelling investment opportunity. We have various business models that have some great tailwinds. What's often underappreciated about us is just the level of our recurring revenue. We have significant recurring revenue in security and health care. We think both of those will be increasing over time. And then while our Opto business doesn't usually meet the classic definition of recurring revenue, it has very sticky revenue, high, high, high repeat revenue. So we do have some very diverse growing markets.
We've got a great track record of financial performance over the years, good top-line growth coupled with nice EPS growth. We are focused on coming out with the next generation of products, so we invest a significant amount in R&D, and we've had a number of innovative solutions come out. We really serve a blue-chip customer base and have a great track record and a strong management team, including the addition of a new CEO who just started with us at the beginning of this year as CEO, though he's been a long-time senior leader within our company leading our Security division. As we take a look at our overall business, we give annual guidance for both our revenues and earnings. This year, we've given guidance that we're going to grow between 8.5% and 10.2% in revenue.
That's coming off of a very strong year, providing a tougher comp where we grew over 20% last year. We expect to leverage that strong revenue growth to accelerate growth in earnings. We ended fiscal 2024 as well as our September quarter with a very strong backlog, so we have excellent visibility into our revenues in fiscal 2025 and beyond through the very strong backlog and a very robust pipeline of opportunities, so we're quite excited about this. A couple of financial slides. We've shown good, strong revenue growth over the years. It took a little bit of a pause during COVID, as you imagine, we sell into airports and others, but as we've come out of COVID, we started to accelerate that growth in 2023. As I mentioned earlier, we had very strong growth in fiscal 2024.
We've given quite attractive guidance for fiscal 2025 on the revenue side. What you see on EPS is we've got a great track record of growing our EPS through a variety of economic cycles. Even in periods like fiscal 2020 to 2022, when our revenues were a bit more muted, given COVID, we were still getting more productive, more efficient. You could see very strong EPS growth even during these periods. I mentioned earlier a little bit about our recurring revenue. In security, we believe about 30% of our revenue is recurring. In health care, it's closer to 40%. In Optoelectronics, this repeat revenue we have is over 80%. So it really gives us some great visibility into some nice high-margin business. Our backlog has been growing over the years.
And as we converted a significant amount of our backlog into revenue over the last year or so, the very, very strong bookings and book-to-bill that we've had has helped maintain our backlog at these near-record levels. From a cash flow perspective, we've historically been a very strong generator of operating cash flow and free cash flow. Over the last couple of years, we've been investing heavily in working capital, namely inventory and receivables, to support the very strong revenue growth we have. As we move into calendar 2025 and 2026, we think there's a tremendous opportunity for very strong cash flow generation. And we fully expect that to occur. With that, in our capital allocation, we've been active in acquisitions over the past. We're a disciplined buyer. But we've done acquisitions that have been very strategic and have generally been kind of accretive right out of the gate.
We also invest in CapEx and some stock buyback. We have a strong balance sheet, overall very modest net leverage. Again, as mentioned a bit earlier, the markets that we participate in have some great tailwinds. Unfortunately, the world's not getting a lot safer, as we see throughout the global nature, but that plays well into what we do. In Optoelectronics, with such a diversified product portfolio and customer base, we think we're well positioned for nice growth going forward, and with an aging population in health care, it provides a nice market for us as well. At the heart of things, we're a technology company. We invest a significant amount in R&D, primarily in our security and in our health care arenas. This has allowed us to capture some significant new market opportunities and come out with a number of new products.
Really has allowed us to be what we believe today to be the number one player in the security detection market. We are a global company. We are headquartered in California. We do a lot of our manufacturing in low-cost jurisdictions, such as Indonesia, Malaysia, India, and Mexico. We don't have any China exposure from a manufacturing perspective, very minimal from a sales perspective. Then we have sales and R&D facilities throughout the world as well. I'm going to sort of stop it there and turn it over to you, Larry, to start the Q&A.
Awesome. Thank you, Alan. I appreciate that. I'm going to go ahead and start the Q&A. If anybody has a question, please don't hesitate to type that into the portal, and then I will try and weave that into our conversation. I guess first, to start with, Alan, just going to ask a couple of macro questions to all our presenters as we go around. First question for you, as you look at you're sort of in the middle of your fiscal year already, but as you look at over the next 12 to 18 months, what are some of the specific milestones or positive catalysts that we should look for? And on the flip side, what is or are some of the risks or concerns you might have?
Yeah. So as we look out in our crystal ball of the next 12 to 18 months, we're quite excited. On the security space, we see a growing global demand. Here in the United States, with the new administration, heavily focused on the border, a Congress that is very supportive of what they call NII, or Non-Intrusive Inspection Systems, at the border, which are the security scanning products that we provide. We think the outlook for demand in the United States could be significantly stronger. Globally, we see a great deal of demand and opportunity in the Middle East, in Latin America, in Asia, and other parts of the world as well. So we're quite excited about our security business. We also see an increasing install base that's going to lead to higher service revenues. And service revenues generally carry higher margins as well.
The security landscape for us and our outlook is very solid. We are quite excited about that, in addition to a number of other areas. In the health care space, kind of what excites us is some of the new product portfolio that we have coming out around 18 months from now is when kind of the first phase is scheduled to launch, which is exciting for us. And then the Opto space, playing in such a diversified arena with aerospace and defense companies, medical, technology, automotive, industrial, all quite exciting for us. We view the future quite positive. Of course, on the flip side, it is really just what we do not know in terms of what might take place in kind of the overall macro environment. But from the arenas that we play in, we are very, very bullish.
What about just in terms of on the potential negative for you, or maybe not, question we're getting a lot is just on the potential impact of tariffs and how you are preparing for any uncertainty around them?
Yeah. So again, a little bit early and premature on tariffs. But we are all preparing for it to see what may or may not occur. We don't believe we have as much exposure, probably, as many companies to the tariffs. As mentioned earlier, we don't do much in China. So that doesn't appear to impact us as much. We have a small manufacturing and a very small manufacturing operation in Mexico, as well as in Canada. So our teams are taking steps to figure out how we can best position ourselves there. But in the end, we don't think it's going to have a material impact on us.
Gotcha. OK. And delving into a little bit more of the company's specific things. Obviously, security has been your biggest segment. It's been your biggest growth driver the last few years. And it feels like that's going to be the growth driver going forward, not to discount the other segments. But just trying to, can you just help us? You've seen this acceleration in demand, especially coming out of the cargo and vehicle inspection area the last few years. You mentioned the non-intrusive inspections, the NII. So is it a technology lever that we've pulled down that's improved this spending? What's sort of driven that acceleration in these areas?
I really believe it's kind of the need for added security protection at ports and borders and critical infrastructure. As you know, airports is a regulated environment. And all airports have screening equipment. So it's mostly a replacement market. Sometimes there's new airports and new terminals. But that's mostly a replacement market. Whereas in the cargo area, which is generally an unregulated market, it's still in kind of the very early innings. And with the world not getting a whole lot safer, there's a whole host of countries who are looking to put in added securities at their ports and borders and critical infrastructure. And then, of course, right here in the U.S., with the U.S.-Mexico border, the U.S. is continually trying to stop the inflow of drugs and other contraband into the U.S.
And similarly, Mexico is looking to stop the flow of cash and guns coming back into the country. So there's just been a huge global demand for our security products. And we don't see that changing going forward. So we're excited about it.
And just specifically, so you mentioned security. I'm obviously post-9/11, especially in the U.S. But even now, I think abroad, they're all catching up where most there is sort of high-level, latest-generation technologies and screening. But like you said, on the cargo side and the ports and then the vehicles at borders and whatnot, it feels like this is still, although there have been more mandates to improve, there's still a significant amount of runway for growth there for you guys, right, where it's very unpenetrated. Can you give us sort of a sense of where we stand today and where we could be in 10 years in terms of penetration there?
Yeah, Larry, we completely agree with your assessment. We do believe it's highly underpenetrated. As mentioned, kind of in the early innings so far, the adoption is growing, certainly in places like the U.S. and Mexico. The U.S., the CBP, U.S. Customs and Border Protection, is very active. There are significant opportunities for additional expansion and growth, which we think we're extremely well positioned for. Mexico has been quite active. And we've been sort of the dominant player in the security detection market in the Mexico region. The Middle East is very aggressively increasing their overall security detection as well.
So we believe that as you look out over the next three, five, 10 years, as you mentioned, big opportunities to continue to penetrate markets globally in really all the areas that we participate in, not just the ports and borders and critical infrastructure, but aviation and checkpoints in general throughout the world.
And coming back to the aviation piece, historically, you guys have not participated much in the U.S., or at least within the last 20 years or so. Just curious, going forward, there is a supposed replacement market that's been kind of pushed out through the years. But I think it still looms out there as an opportunity. Curious if you can give us your thoughts on that and the opportunity for OSI to participate?
Yeah. Larry, you're astutely pointing out there's a big opportunity coming out here in the United States for the checked baggage market, sometimes called the hold baggage market, that should be starting in a few years. It was originally slotted to start earlier, but as you mentioned, it has been pushed out, but it's expected to start in a few years and go on for a multi-year period. These are replacements of machines that are past what was generally considered sort of their useful life, being put into place not long after 9/11 in many cases. We didn't participate in that original procurement because we didn't have a product way back then. Subsequent to that time, we've developed what we believe to be one of the industry's best check baggage machines that we call RTT.
We've had great success selling RTT internationally in places like Paris and Rome and Oslo and a number of other locations really throughout the world. The U.S. represents a sizable opportunity. We're excited to get into that mix when the procurement starts, hopefully in the next few years, which will be a multi-year process. Of course, after that occurs, then you get the service revenue tail for the next decade while those products are out there. Big opportunities for us to get into the U.S. checked baggage market.
And you mentioned in your prepared comments as well just now. You kind of reaffirmed sort of the recurring or the underappreciated portion of your business, the recurring piece and the service and maintenance component, which is higher margin. And I bring that up because maybe you could just give us just your thoughts. You had this significant acceleration in product sales and large orders on the security side the last two, three years. That gives you some good visibility, I think, going out for the next few quarters. There's some concern in the market beyond that that there'll be a little bit of a slowdown or somewhat of a cliff in terms of sales growth. But can you just discuss that and some of the offset that as a piece of that, well, large orders become recurring at somewhat higher margin?
Can you maybe just kind of discuss that dynamic a little bit?
Sure. Sure. Good questions. And we kind of heard the same thing a year ago that many thought that we were well positioned for fiscal 2024. But we're highly concerned about what that might mean for fiscal 2025. And yes, our fiscal 2024 showed dynamic growth. And as we moved into fiscal 2025, we've continued that momentum with strong growth in our Q1 and good guidance for fiscal 2025. We think we're operating at new baseline levels. And we expect to be growing from here. We certainly don't see a cliff. These are our new baseline levels. And our plans are to continue to grow from this point forward. We think we're in excellent shape to do so. You mentioned the strong recurring revenues.
Yes, we've had a much bigger installed base through the large sales that we've had and been deploying over the last year or so and will be continuing to deploy, and with that large installed base comes even larger service revenues, so with those service revenues, the nice part about service revenues are they're generally higher margin than product revenues and are very sticky, so it provides good recurring revenue for the next decade or so after the product is out there. In addition to the basic field service revenues, we have turnkey service revenues. We're one of the only companies in the world that provides what we call security as a service, a different version of a SaaS model for turnkey, which has all been quite successful for us. We rolled out another one in Uruguay earlier this year and hope to do more.
So the nice recurring revenue and higher margin is a big part of our future story.
Got it. And what about just the overall margin security segment? The outlook going forward, you've had a nice, pretty significant increase in sales. Margins have done nicely. We maybe thought they would be up a little bit higher. But again, that's potentially because of the mix on the product sales initially. But maybe you could discuss that, the opportunities for both mix improvement and some operating leverage in security.
Yeah. Our security operating margins have increased significantly over the years. We've seen those operating margins, the adjusted operating margins go up as a result of economies of scale leveraging a fixed cost base on higher revenues. We've seen it through productivity improvements, efficiency improvements, the mix as we move forward. And if we're able to successfully increase our service revenues as a percentage of our overall revenues, which is our plan, with service revenues carrying a higher margin, we think there's opportunities for further operating margin expansion. From period to period, we'll see some different margins. Sometimes there'll be a much more favorable mix. Sometimes there might be a little bit less favorable sort of product mix as opposed to what that means in margin. But overall, we're really proud of the operating margin improvement that we've shown over the years.
Our goal is always to continue to expand those operating margins.
Gotcha. Great. Maybe shifting gears a little bit to the Optoelectronics segment, somewhat sort of dual purpose, I guess, helps you internally. And you're somewhat vertically integrated there and also externally. On the external side, pretty good growth the last, if you look back over the last five-plus years, mid-single-digit growth. You've been able to expand margins. Maybe speak to the drivers of that on the Opto side. And then sort of a little bit of a slowdown in the last 12 months. What kind of caused that slowdown? And what do you think the outlook is going forward?
Yeah. We're really, really excited about the Opto business. And we're really pleased with the work our management team has done. We've driven what we believe to be near industry-leading margins in the overall Opto division, which is quite exciting for us. And the way we've been able to accomplish that is by improving our overall mix of customers and mix of products that are higher margin in nature. We like to do what we'll call sort of lower volume, higher mix, more value add, which can drive higher margins rather than the super high volume razor-thin margin that some of our competitors do. That's not our business. That's not what we want to be in. It's a very global business where we can start with some of our stuff in the United States.
When it gets to a little bit greater volume, we can move it to lower-cost manufacturing operations and share some of those benefits with our customers, which has been a very, very successful model for us. Over the past 12 months, we've seen a little bit lower revenue growth than we've historically seen in Opto. That's simply a function of many customers and many companies during the pandemic and subsequent to that, for risk mitigation purposes, increase their inventory purchases. So they're carrying higher inventory levels in order to abate some of the perceived concerns with supply chain. We did that as well. Now, as we've sort of been coming out of that over the last year, companies have been sort of right-sizing their inventory levels, as we have as well. That's just sort of changed the overall growth rate.
And I think we've mentioned on our last couple of calls, we see that sort of diminishing now. And as we move into calendar 2025 and beyond, we see a potential for accelerated growth for our Opto division. So quite excited about it. It's also a business that spits off very nice free cash flow for us.
Got it. And I just want to touch briefly on the health care segment. I know it's been part of your legacy business for quite some time. It's obviously become somewhat smaller relative to security and even Opto, quite frankly. But you did mention a new offering coming out on the monitor side. I think at the peak of this business, it has kind of done $25 million in operating profit. Now we're kind of running at a $10 million run rate-ish. The key driver is to kind of get us back at least to that $25 and maybe grow from there. Is it just a cyclical thing? Is it just a matter of getting your new products out, replacement cycle? What have been some of the issues lately and how you think we can get back to at least prior peak rates?
Sure. So some of the market dynamics that we've seen in the Healthcare business was when the pandemic first started in 2020, there was a great need for patient monitoring and some of our cardiology products. So we saw some customers pull forward planned purchases that might have been happening in subsequent years into earlier years. So we had a higher level of revenues and therefore profits kind of in the early years of the pandemic. As we moved past that, because some of the purchasing already occurred, it impacted some of those revenues in 2023 and 2024 and the like. What we believe will get us back to kind of the levels that you're describing is purely a function of the top line. As we launch some of our new platforms and new products, we believe there's substantial opportunities for top line growth.
Our Healthcare division represents the highest contribution margin of all of our three divisions. So as revenues get going, there's a very significant pull-through to our operating income and our operating margins. So as we start to show stronger revenue growth with the launch of some of the new platforms, I believe we should see much more substantial operating income in EBITDA.
OK. Great. Why don't we just shift gears last few minutes? You mentioned free cash flow and your outlook. Maybe you could talk a little bit more just on the free cash flow and the conversion. It's been a little choppy over the last few years. And I guess somewhat so high-class problem is you build out some of your inventory. But maybe you can discuss that and sort of the outlook for conversion on your free cash flow going forward.
Sure. So kind of if you look back over the years, we're a strong cash flow generating company. As we went into fiscal 2023 and 2024, the first part of 2025, we had some substantial programs. And with those programs, we needed to invest in working capital. So there were some significant investments in inventory, some significant investments in receivables as our revenues grew so significantly. And as a result, it put a temporary hiatus on the cash flow over the last couple of years. As we begin to normalize and move into calendar 2025 and beyond, we think there is substantial opportunity for very strong free cash flow conversion. We think we can convert our free cash flow well north of 100% of net income.
So it's really an exciting time from a cash flow perspective now as we enter calendar 2025 and beyond and kind of return to our historical legacy of generating a lot of free cash flow and perhaps in the shorter term generating maybe even a disproportionate high amount as our own working capital gets normalized as well.
Gotcha. And how about the balance sheet? Leverage is relatively modest. What are your thoughts there? And combined with priorities for free cash flow beyond sort of the CapEx or working capital usage this year, how do you view acquisitions? Historically, you guys certainly have been somewhat acquisitive. I wouldn't say crazy acquisitive, but somewhat so. Do you still see opportunities out there? What's your thoughts and the environment today?
Yeah. So you're right. Our balance sheet is in great shape. Our leverage is very modest with the cash flow that we're going to be generating. Absent acquisitions, there should be further deleveraging. That being said, you're right. Acquisitions have always been fundamental to part of our strategy. We're a disciplined buyer. You generally don't ever see us sort of overpaying for anything. The things we do are generally very strategic in nature, make good financial sense, often accretive right out of the gate. We believe that there's substantial opportunity to supplement our organic growth with inorganic growth. Might be greater opportunities to do it under the incoming administration as well and some of the planned changes that may be taking place there. So we would continue to view M&A as an essential part of our overall growth strategy and would expect to be pretty active there.
In terms of our capital allocation, we look at M&A. We look at stock buyback. We bought back about $80 million of stock in the Q1 of this fiscal year. And any excess cash we would use just to pay down our revolver. And the three are not necessarily mutually exclusive.
Gotcha. OK. Great. Just curious. You mentioned Ajay Mehra has taken over as CEO. I know he's been there for a long time, right? So I imagine not much change in the playbook you would expect under his direction.
Yeah. We're very excited to have Ajay take over as CEO. He took over effective January 1st here. He's been the leader of our security division for a number of years. He's had other roles within the company. He's helped lead the security division to become the largest security detection player in the industry today, in our opinion. So I think the selection of Ajay was a vote in continuity of what has been taking place within the company. But of course, with any new leadership, there'll be fresh ideas and fresh perspective. And we're looking forward to Ajay's leadership going forward.
Great. Excellent. I think we're just about out of time. I appreciate everybody joining. Anything you'd like to share before we end the session? Any closing remarks?
No, thank you, Larry. Thanks for having us here for this presentation and these meetings. We're quite excited at OSI Systems here as we enter calendar 2025, the second half of our fiscal 2025, and look forward to talking to many of you in the future.
Great. Thank you, everybody, for joining. Have a productive afternoon.