OSI Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2013, compared with the corresponding periods ended March 31, 2012. The filing is unaudited. OSI Systems designs and manufactures specialized electronic systems and components and provides security-screening services through its Security, Healthcare, and Optoelectronics and Manufacturing divisions.
Financial Performance and Position
| Metric | Q3 FY2013 | Q3 FY2012 | Nine months FY2013 | Nine months FY2012 |
|---|---|---|---|---|
| Total revenue | $198.4 million | $208.4 million | $574.2 million | $557.7 million |
| Gross profit | $71.8 million | $69.1 million | $203.3 million | $187.8 million |
| Gross margin | 36.2% | 33.2% | 35.4% | 33.7% |
| Operating income | $19.4 million | $18.2 million | $48.2 million | $44.1 million |
| Net income | $13.5 million | $12.6 million | $32.3 million | $29.6 million |
| Diluted EPS | $0.66 | $0.62 | $1.57 | $1.46 |
- Revenue mix: Q3 product revenue declined to $139.0 million from $180.3 million, while service revenue increased to $59.4 million from $28.1 million. For the nine-month period, product revenue declined to $433.0 million from $475.1 million, while service revenue increased to $141.2 million from $82.6 million.
- Segment performance: Q3 Security revenue declined 11% to $99.8 million, Healthcare revenue declined 9% to $51.4 million, and Optoelectronics and Manufacturing revenue increased 17% to $47.2 million. Nine-month revenue was approximately flat in Security, down 2% in Healthcare, and up 15% in Optoelectronics and Manufacturing.
- Cash flow: Nine-month operating cash flow was $57.2 million, down from $86.2 million. Investing cash outflow was $149.3 million, including $139.4 million of capital expenditures, primarily for the Mexico turnkey security program and a new Healthcare headquarters. Financing cash flow was $49.1 million.
- Liquidity: Cash and cash equivalents declined to $47.7 million at March 31, 2013, from $91.5 million at June 30, 2012. Working capital declined to $216.5 million from $322.5 million.
- Debt: Bank lines of credit and current and long-term debt totaled $67.9 million at March 31, 2013, compared with $3.0 million at June 30, 2012. The company had $55.0 million outstanding under its revolving facility and $185.6 million of letters of credit outstanding. Its principal credit agreement provides a $425 million revolving facility and matures in November 2016.
- Balance sheet: Total assets increased to $855.6 million from $749.9 million, primarily reflecting substantial property and equipment additions. Stockholders’ equity increased to $458.7 million from $434.1 million.
Material Changes Versus Prior Comparable Period
- Quarterly revenue decreased 5%, but nine-month revenue increased 3%, reflecting the timing and mix of large Security contracts.
- Profitability improved despite lower quarterly revenue. Q3 gross margin increased 300 basis points and nine-month gross margin increased 170 basis points, driven mainly by higher-margin turnkey security-screening services and the absence of the prior-year low-margin large hardware-integration contract.
- Operating expenses increased to $52.4 million in Q3 and $155.1 million for the nine-month period. SG&A increased, while R&D was broadly stable. Impairment, restructuring, and other charges increased to $5.0 million year-to-date from $0.9 million.
- Interest expense and other income, net, increased to $1.3 million in Q3 and $3.8 million year-to-date, primarily because of increased revolver borrowings, letters-of-credit utilization, and new mortgage debt.
- Cash generation was lower because the prior-year period included a $100 million customer advance related to the Mexico program, while current-year capital spending exceeded $139 million.
- Stock-based compensation expense increased to $11.5 million for the nine-month period from $5.3 million. The company repurchased shares and settled equity-award taxes using approximately $20.7 million of cash during the period.
Guidance, Outlook, Risks, and Unusual Items
- The filing does not provide specific revenue or earnings guidance. Management cautions that interim results are not necessarily indicative of full-year or future results.
- The six-year Mexican government turnkey security-screening contract remains a major growth and cash-use program. The company received a $100 million customer advance and must provide a guarantee until the advance is earned. The program required more than $100 million of capital spending during the period and may create significant cash-flow volatility.
- In November 2012, the company received a TSA show-cause letter concerning the Secure 1000SP system and ATR software. The company agreed to redeploy units previously sold to TSA and cease ATR software development. It recorded $2.7 million of impairment and other charges. The matter was not finally resolved because DHS disposition remained pending.
- Healthcare demand remained pressured by delayed purchases from hospitals and healthcare providers amid economic uncertainty. Management stated that the timing of a full market recovery cannot be predicted.
- Contingent consideration obligations from acquisitions had a maximum potential amount of $47 million; $15.6 million was recorded as a long-term liability under the applicable accounting guidance. Royalty payments may also be required through 2022 under an acquisition agreement.
- The company disclosed ordinary-course litigation, environmental contamination at its Hawthorne, California facility, product warranty exposure, government-contract risk, regulatory risk, foreign-exchange risk, cybersecurity and information-technology risk, and risks related to competition, acquisitions, supply constraints, and medical-device liability. No accrual was recorded for the environmental matter or disclosed legal proceedings because management considered unfavorable outcomes possible but not probable and reasonably estimable.
- Foreign-currency forward contracts of approximately $22.6 million and an interest-rate swap associated with the mortgage loan were outstanding at March 31, 2013.
- Management concluded that disclosure controls and procedures were effective as of March 31, 2013, and reported no material changes in internal control over financial reporting.
Most Important Facts to Verify
- Whether the Mexico turnkey program generates expected revenue and cash collections relative to its substantial capital and working-capital requirements.
- The ultimate DHS disposition of the TSA Secure 1000SP and ATR matter and whether additional charges will be required.
- Compliance with credit-facility covenants and the company’s ability to manage increased debt, letters of credit, and guarantees.
- Healthcare order trends, particularly in North America, Asia, Europe, the Middle East, and emerging markets.
- Realized margins and cash conversion as the revenue mix shifts toward turnkey services and Optoelectronics and Manufacturing.
- Potential costs associated with environmental remediation, contingent acquisition payments, product warranties, litigation, and government-contract obligations.