OSI Systems, Inc. Form 10-K Summary
Business context and reporting period
OSI Systems is a vertically integrated designer and manufacturer of specialized electronic systems and components serving security, healthcare, defense, aerospace and industrial markets. Its operating divisions are Security, Healthcare, and Optoelectronics and Manufacturing.
The filing is an annual report for the fiscal year ended June 30, 2016, filed August 19, 2016. The request metadata references “2015 Q4,” but the provided document is a fiscal 2016 Form 10-K. Fiscal 2015 is the primary comparable period.
Financial performance and liquidity
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Revenue | $829.7 million | $958.2 million | Down 13% |
| Gross profit | $276.9 million | $325.4 million | Down 15% |
| Gross margin | 33.4% | 34.0% | Down 60 basis points |
| Operating income | $38.4 million | $92.1 million | Down 58% |
| Operating margin | 4.6% | 9.6% | Down approximately 500 basis points |
| Net income | $26.2 million | $65.2 million | Down 60% |
| Diluted EPS | $1.30 | $3.17 | Down 59% |
| Cash flow from operations | $59.2 million | $105.1 million | Down 44% |
Revenue by division was $411.2 million for Security, $211.5 million for Healthcare, and $207.0 million of third-party revenue for Optoelectronics and Manufacturing. International shipments represented approximately 64% of revenue, compared with 57% in fiscal 2015.
Cash and cash equivalents increased to $104.4 million from $47.6 million. Working capital declined to $187.5 million from $255.0 million, primarily reflecting increased current debt and other current liabilities. Inventories increased to $273.3 million from $230.4 million, while accounts receivable declined to $141.7 million from $178.5 million.
Total debt increased to $133.8 million from $11.4 million. This included $125.0 million outstanding under a $450 million revolving credit facility and $8.8 million of long-term debt. Letters of credit outstanding under the principal facility totaled $6.2 million. Management stated that the company was in compliance with its credit covenants.
Fiscal 2016 investing cash uses included $17.7 million of capital expenditures, $19.9 million for acquisitions and $5.9 million for intangible and other assets. Financing activities included $87.1 million of common-stock repurchases and net share settlements, partially funded by revolving-credit borrowings.
Material changes versus the prior comparable period
- Security revenue declined 15%, primarily because the $66.4 million reduction in revenue from a Foreign Military Sale contract outweighed other activity, including the commencement of a turnkey scanning operation in Albania.
- Healthcare revenue declined 17% across most product lines and regions. Management cited difficult hospital spending conditions and lapses in operational execution.
- Optoelectronics and Manufacturing revenue declined 7%, mainly because organic contract-manufacturing sales decreased $26.8 million, including an $11.5 million reduction from one large customer. Acquired businesses contributed $8.8 million of revenue.
- Impairment, restructuring and other charges increased to $22.0 million from $9.9 million. Fiscal 2016 charges included $9.7 million of asset and minority-investment impairments, $3.5 million of acquisition costs, $2.9 million of legal settlements and related costs, and $5.2 million of facility-consolidation and severance costs.
- Operating expenses increased as a percentage of revenue to 28.7% from 24.3%, despite a 3% reduction in SG&A and a 3% reduction in research and development spending.
- Cash flow from operations fell by $45.9 million, driven by lower profits and increased inventory, including inventory built for anticipated Security and Healthcare sales and products shipped to customers pending revenue recognition.
- Backlog was approximately $623 million at June 30, 2016, compared with $638 million at June 30, 2015. Approximately $163 million was not reasonably expected to be fulfilled in fiscal 2017.
Guidance, outlook, risks and unusual items
The filing does not provide a specific fiscal 2017 revenue or earnings guidance range. Management expects available cash, operating cash flow and credit facilities to fund operating needs for the foreseeable future, but future liquidity depends on operating performance, acquisitions, capital expenditures, litigation, repurchases, research and development spending, covenant compliance and capital-market conditions.
On June 20, 2016, OSI Systems agreed to acquire American Science and Engineering, Inc. for $37.00 per share in cash, with an estimated purchase price of approximately $269 million. The transaction was expected to close by December 31, 2016, subject to shareholder approval, antitrust clearance and other customary conditions. Funding was expected to include AS&E cash of approximately $74 million and additional borrowing under OSI Systems’ revolving facility.
- Management cited economic weakness in China, a strong U.S. dollar and lower oil prices as factors contributing to customer purchasing delays and deferred demand.
- The Healthcare division continued to face challenges associated with significant product launches.
- The company is subject to extensive medical-device regulation. An August 2014 FDA warning letter concerning procedures and internal processes at the Snoqualmie, Washington facility remained a risk, with potential for additional regulatory action if corrective measures were not satisfactory.
- The company is investigating historical soil and groundwater contamination at its Hawthorne, California facility. No environmental loss contingency was accrued because management considered an unfavorable outcome possible but not probable and reasonably estimable.
- Three shareholder derivative actions were subject to a settlement term sheet, pending court approval. The filing states that no liability was admitted and no loss contingency was accrued for other ordinary-course legal matters because losses were not considered probable and reasonably estimable.
- The Mexican turnkey security-screening program remains individually material. The company had a $25.0 million customer advance outstanding and approximately $15 million of related fixed assets not currently in use at June 30, 2016.
- Approximately 96% of cash and cash equivalents was held by foreign subsidiaries, with potential U.S. tax implications if repatriated. Undistributed foreign earnings were approximately $577 million, with an estimated unrecognized deferred tax liability of approximately $202 million.
- Other significant risks include government-contract termination or compliance actions, foreign exchange exposure, competition, customer concentration, supply-chain dependence, cybersecurity, ERP implementation, product liability, regulatory compliance and acquisition integration.
Most important facts an investor should verify
- Whether the AS&E acquisition closed as planned, its final financing structure, purchase accounting, integration costs and resulting leverage.
- Fiscal 2017 revenue recovery and order timing after completion of the major Foreign Military Sale contract.
- Healthcare demand, product-launch execution, FDA warning-letter remediation and any subsequent regulatory actions.
- Inventory conversion, customer acceptance timing and the risk of additional inventory write-downs or delayed revenue recognition.
- Compliance with credit-facility covenants and available borrowing capacity after the AS&E transaction.
- Progress and potential cost of the Hawthorne environmental investigation and the status of derivative-litigation settlement approval.
- Exposure to international currencies, government budgets, the Mexican turnkey program and the concentration of cash held outside the United States.