OSI Systems, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the three months ended September 30, 2020, OSI Systems’ fiscal 2021 first quarter, compared with the three months ended September 30, 2019. The company designs and manufactures specialized electronic systems and components serving security and inspection, healthcare, defense, aerospace, and related markets through its Security, Healthcare, and Opt o electronics and Manufacturing divisions.
Financial performance and liquidity
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Net revenues | $254.9 million | $290.9 million | Down 12% |
| Gross profit | $95.8 million | $99.2 million | Down 3% |
| Gross margin | 37.6% | 34.1% | Up 350 bps |
| Income from operations | $16.7 million | $24.9 million | Down 33% |
| Net income | $9.3 million | $20.7 million | Down 55% |
| Diluted EPS | $0.51 | $1.10 | Down 54% |
| Cash provided by operating activities | $53.8 million | $24.8 million | Up $29.0 million |
- Products generated $182.7 million of revenue and services generated $72.2 million.
- Security revenue declined 29% to $134.8 million, primarily reflecting COVID-19-related delays in aviation and cargo programs and the expiration of a Mexico contract. Healthcare revenue increased 28% to $51.5 million, while Optoelectronics and Manufacturing revenue increased 11% to $68.6 million, including the effect of an acquired business.
- Operating expenses increased to $79.1 million from $74.3 million, largely because the prior-year period included a $2.1 million net benefit while the current period included $8.4 million of impairment, restructuring, and other charges.
- Current-period restructuring and unusual charges included $6.9 million related to exiting an expired Mexico turnkey contract and $1.5 million of other operational-efficiency costs.
- Cash and cash equivalents were $76.9 million at September 30, 2020, compared with $76.1 million at June 30, 2020. Approximately 76% of cash was held by foreign subsidiaries and subject to repatriation tax considerations.
- Net cash used in investing activities was $12.3 million, including $3.0 million for a July 2020 healthcare software acquisition, $3.8 million of capital expenditures, and $4.4 million for intangible and other assets.
- Net cash used in financing activities was $41.8 million, including $8.0 million of net debt repayments, $24.8 million of share repurchases, and $10.9 million of taxes paid on net share settlements.
Debt and liquidity
- The revolving credit facility has aggregate commitments of up to $535 million and matures in April 2024. At September 30, 2020, $51.0 million was drawn, $75.4 million of letters of credit were outstanding, and $408.6 million remained available. The company was in compliance with all covenants.
- Long-term debt was $270.3 million before the current portion, including $287.5 million principal amount of 1.25% convertible senior notes due September 2022, net of unamortized discount and issuance costs.
- Foreign subsidiary credit facilities had $57.4 million outstanding and $14.7 million available, primarily for letters of credit.
- Management stated that available cash, credit facilities, and operating cash flow should be sufficient for operational needs over the next 12 months and the foreseeable future.
Material changes versus the prior comparable period
- Revenue declined 12%, but gross margin improved materially because of better Healthcare economies of scale and operating efficiencies, as well as improved Security service margins.
- Security’s share of consolidated revenue fell from 65% to 53%, while Healthcare increased from 14% to 20% and Optoelectronics and Manufacturing increased from 21% to 27%.
- Security operating income fell to $8.9 million from $20.3 million. Healthcare operating income increased to $9.0 million from $2.8 million, while Optoelectronics and Manufacturing operating income was broadly stable at $8.7 million.
- Net income was adversely affected by the absence of the prior-year $6.2 million discrete tax benefit related to equity compensation. The current period included a $0.3 million benefit; excluding discrete items, effective tax rates were broadly comparable at 27.5% versus 27.9%.
- The company repurchased 320,136 shares for $24.8 million during the quarter. The authorized repurchase program was increased to 3.0 million shares in August 2020.
Guidance, outlook, commentary, risks, and unusual items
- The filing does not provide quantitative fiscal-year revenue or earnings guidance.
- Management reported increased demand for certain Healthcare products related to COVID-19, but continued disruption in Security aviation and cargo markets, service activity, customer deliveries, factory or site acceptance testing, and global manufacturing operations.
- Management noted that bookings began accelerating during the second half of the quarter, but the duration and ultimate effects of COVID-19 remain uncertain. Healthcare demand may also normalize or weaken after elevated fiscal 2020 capital purchases.
- The European Union’s deadline for airports to meet ECAC Standard 3 threat-detection requirements was moved to September 2021, with possible further changes. OSI stated that its real-time tomography product passed the Standard 3 requirement.
- Acquisition-related contingent consideration increased to $21.0 million at September 30, 2020, and the maximum remaining potential payments under capped arrangements were $35.1 million.
- The company is involved in shareholder securities litigation, derivative litigation, and SEC and DOJ investigations concerning securities trading and matters related to prior allegations. The company believes the lawsuits are without merit, is cooperating with the investigations, and has not accrued a loss because outcomes cannot currently be predicted or reasonably estimated.
- Environmental investigations continue at the Hawthorne, California facility. No liability was accrued because management does not consider an unfavorable outcome probable and reasonably estimable; an adverse resolution could nevertheless be material.
- Foreign exchange exposure increased with the initiation of forward contracts having aggregate notional amounts of $37.5 million. Reported unrealized gains and losses were not significant.
Important facts for investors to verify
- Whether COVID-19-related delays in Security, service activity, and customer acceptance materially affect subsequent-quarter revenue recognition and bookings.
- The sustainability of Healthcare demand and the improved consolidated gross margin.
- Progress, remaining costs, and expected benefits from the Mexico contract exit and other restructuring actions.
- Cash availability and repatriation constraints given that most reported cash was held outside the United States.
- Repayment or refinancing plans for the $287.5 million convertible notes due in September 2022.
- Developments in the shareholder lawsuits, SEC and DOJ investigations, environmental matters, and acquisition-related contingent obligations.
- The potential effects of LIBOR discontinuation on the revolving credit facility and future borrowing costs.