OSI Systems, Inc. Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2019, compared with the corresponding 2018 periods. The request metadata labels this as “2018 Q3,” but the filing is the fiscal 2019 third-quarter Form 10-Q. Results are unaudited and presented under U.S. GAAP.
Business context
OSI Systems designs and manufactures specialized electronic systems and components for homeland security, healthcare, defense, aerospace and industrial markets. Its three operating segments are Security, Healthcare, and Optoelectronics and Manufacturing. Security represented approximately 63% of nine-month revenue, Healthcare 16%, and Optoelectronics and Manufacturing 21% in fiscal 2019.
Key financial metrics
| Metric | Q3 FY2019 | Q3 FY2018 | 9M FY2019 | 9M FY2018 |
|---|---|---|---|---|
| Revenue | $304.3 million | $267.3 million | $873.7 million | $802.0 million |
| Gross profit | $111.3 million | $97.6 million | $317.6 million | $290.5 million |
| Gross margin | 36.6% | 36.5% | 36.3% | 36.2% |
| Operating income | $32.1 million | $7.7 million | $80.1 million | $45.3 million |
| Net income | $19.6 million | $2.6 million | $48.1 million | $(34.2) million |
| Diluted EPS | $1.05 | $0.13 | $2.58 | $(1.82) |
| Operating cash flow | Not separately provided | Not separately provided | $87.7 million | $115.8 million |
Q3 revenue increased 14%, while nine-month revenue increased 9%. Q3 operating margin improved to approximately 10.6% from 2.9%; nine-month operating margin improved to approximately 9.2% from 5.6%. The nine-month 2018 loss primarily reflected a $56.2 million discrete tax charge related to the Tax Cuts and Jobs Act.
Revenue and segment developments
- Security: Q3 revenue increased 14% to $193.5 million; nine-month revenue increased 9% to $552.1 million. Growth came primarily from cargo and vehicle inspection and explosive detection systems, partly offset by lower service revenue, reduced SAT Mexico contract revenue, and lower checkpoint equipment sales.
- Healthcare: Q3 revenue increased 12% to $48.9 million, driven by U.S. patient-monitoring sales. Nine-month revenue declined 2% to $138.7 million because of the anesthesia product-line exit and an underperforming sales-channel exit.
- Optoelectronics and Manufacturing: Q3 revenue increased 16% to $61.9 million; nine-month revenue increased 18% to $182.9 million, supported by commercial optoelectronics growth and contributions from acquisitions.
Cash flow, balance sheet, debt and liquidity
- Cash and cash equivalents were $107.6 million at March 31, 2019, up from $84.8 million at June 30, 2018. Approximately 78% of cash was held by foreign subsidiaries and may be subject to repatriation tax considerations.
- Nine-month operating cash flow was $87.7 million, down from $115.8 million in the prior-year period. Investing cash use was $40.8 million, including $20.9 million of capital expenditures and $18.3 million for business acquisitions.
- Financing cash use was $23.3 million. The company borrowed $11.0 million under its revolving facility and used $21.0 million for share repurchases and $13.7 million for taxes related to net share settlement of equity awards.
- At March 31, 2019, the company had $124.0 million outstanding under its revolving credit facility, $59.1 million of outstanding letters of credit, and $341.9 million of borrowing availability. The company was in compliance with its covenants.
- Long-term debt, net of discount and issuance costs, was $255.4 million, and current long-term debt was $1.7 million. The company also had $287.5 million principal amount of 1.25% convertible senior notes due 2022.
- On April 23, 2019, the revolving credit facility was amended to increase capacity from $525 million to $535 million, extend maturity to April 2024, and reduce applicable margin rates and unused commitment fees.
- Management expects cash on hand, operating cash flow and available credit facilities to fund operating needs for the next 12 months and the foreseeable future.
Material changes and unusual items
- The company adopted ASC 606 revenue recognition prospectively on July 1, 2018. Adoption increased reported nine-month revenue by $29.9 million and net income by $4.0 million versus amounts that would have been reported under the previous standard.
- Remaining performance obligations were approximately $178.4 million at March 31, 2019, with approximately 44% expected to be recognized over the following 12 months.
- Q3 operating expenses included a net $1.8 million credit from insurance reimbursement of certain legal costs. The prior-year quarter included $14.1 million of impairment, restructuring and other charges, including anesthesia-related impairments, settlement accruals and legal costs.
- Fiscal 2019 nine-month restructuring and other charges were $1.2 million, including employee termination, facility closure and acquisition costs, partially offset by a $2.8 million insurance-related legal-cost recovery.
- The company completed an optoelectronics acquisition for $17.5 million plus potential contingent consideration of up to $1.0 million and two smaller Security acquisitions. These acquisitions were not material individually or in aggregate.
- The company repurchased 288,316 shares for $21.0 million during the nine months but made no repurchases during Q3. No cash dividends were paid or planned in the foreseeable future.
Outlook, risks and contingencies
The filing does not provide specific quantitative revenue, earnings or margin guidance. Management expects available liquidity to support operations but highlights risks from contract awards and renewals, customer acceptance timing, government budgets and procurement policies, tariffs and trade restrictions, foreign exchange, Brexit-related uncertainty, healthcare-market conditions, product acceptance, and changing tax laws.
- The SEC and DOJ are investigating potential FCPA compliance matters following a 2017 short-seller report. The SEC has subpoenaed documents, and the company is cooperating. The company cannot predict potential actions, penalties or remedial measures.
- The SEC and DOJ are separately investigating trading in the company’s securities, including trading by executives, directors and employees. The company has taken action with respect to a senior-level employee.
- Several securities and shareholder derivative lawsuits allege securities-law violations or breaches of fiduciary duty related to the short-seller allegations. The company considers the claims without merit, but outcomes and potential losses cannot presently be estimated.
- Maximum potential future contingent acquisition payments under capped arrangements were $28.7 million at March 31, 2019; the recorded contingent consideration liability was $16.9 million.
- Environmental investigations continue at the Hawthorne, California facility. No liability was accrued because unfavorable outcomes were not considered probable and reasonably estimable, but an adverse resolution could be material.
- The company plans to adopt the new lease standard on July 1, 2019 and expects operating lease right-of-use assets and liabilities to approximate the present value of future lease commitments.
Investor verification items
- Verify the effect of ASC 606 on revenue timing, contract assets, customer advances, deferred revenue and future performance obligations.
- Monitor Security growth and the continuing decline in Healthcare nine-month revenue, including the impact of the anesthesia-product exit.
- Assess operating cash conversion, working-capital movements and the reduction in operating cash flow versus the prior year.
- Review debt maturities, convertible-note dilution terms, variable-rate exposure and continued compliance with credit-facility covenants.
- Track the SEC and DOJ FCPA and securities-trading investigations and related securities and derivative litigation, none of which had a determinable loss estimate at filing.
- Evaluate the concentration and repatriation considerations associated with foreign-held cash, as well as environmental and contingent acquisition obligations.