OSI Systems, Inc. — Form 10-Q Summary
Business context and reporting period
OSI Systems designs and manufactures specialized electronic systems and components for homeland security, healthcare, defense, aerospace and other critical applications. Its reporting segments are Security, Healthcare, and Optoelectronics and Manufacturing. This unaudited report covers the three months ended September 30, 2019, the first quarter of fiscal 2020, compared with the three months ended September 30, 2018.
Key financial metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net revenues | $290.9 million | $266.2 million | Up 9% |
| Gross profit | $99.2 million | $95.9 million | Up 3% |
| Gross margin | 34.1% | 36.0% | Down 1.9 percentage points |
| Income from operations | $24.9 million | $16.3 million | Up 53% |
| Operating margin | 8.6% | 6.1% | Improved |
| Net income | $20.7 million | $9.4 million | Up 121% |
| Diluted EPS | $1.10 | $0.50 | Up 120% |
| Cash flow from operations | $24.8 million | $(2.8) million | Improved by $27.7 million |
Revenue growth was led by Security revenue of $189.0 million, up 11%, followed by Healthcare revenue of $40.2 million, up 5%, and external Optoelectronics and Manufacturing revenue of $61.7 million, up 6%. Security represented approximately 65% of consolidated revenue, Healthcare 14%, and external Optoelectronics and Manufacturing 21%.
Gross margin declined primarily because of unfavorable Security product mix and lower service revenue, which generally carries higher margins. Operating expenses decreased to $74.3 million from $79.7 million because the prior-year period included $4.2 million of restructuring and other charges, while the current period recorded a $2.1 million net benefit. SG&A was broadly flat and research and development increased modestly.
The effective tax rate was negative 2.9%, compared with 13.9% in the prior-year period, reflecting a $6.2 million discrete tax benefit from equity-based compensation. Excluding discrete items, the effective tax rate was 27.9%, compared with 28.1%.
Liquidity, cash flow and debt
- Cash and cash equivalents were $85.1 million at September 30, 2019, down from $96.3 million at June 30, 2019. Approximately 71% of cash was held by foreign subsidiaries and subject to repatriation tax considerations.
- Operating cash flow was $24.8 million, compared with cash usage of $2.8 million in the prior-year quarter, primarily due to higher earnings and improved working capital.
- Investing cash outflow was $8.1 million, including $6.0 million of capital expenditures and $2.1 million for intangible and other assets. No acquisitions occurred in the current quarter.
- Financing cash outflow was $27.5 million, including $25.9 million of taxes paid related to net share settlements and $13.3 million of share repurchases, partly offset by $7.0 million of net revolving-credit borrowings.
- The revolving credit facility has $535 million of committed capacity and matures in April 2024. At quarter-end, $95.0 million was drawn, $49.4 million was outstanding under letters of credit, and $390.6 million was available to borrow. The company was in compliance with its covenants.
- Long-term debt, net of discount and issuance costs, totaled $260.8 million, primarily consisting of $287.5 million of 1.25% convertible senior notes due September 2022.
- Management stated that cash, operating cash flow and available credit facilities are expected to meet operational cash needs for the next 12 months and the foreseeable future.
Material changes versus the prior comparable period
- Revenue increased $24.6 million, led by higher Security sales of explosive detection systems and cargo and vehicle inspection systems.
- Security operating income declined to $20.3 million from $23.1 million despite higher revenue, reflecting lower margins and mix effects.
- Healthcare operating income improved to $2.8 million from a $1.9 million loss, supported by higher patient-monitoring sales, supplies, accessories and related services.
- Optoelectronics and Manufacturing operating income increased to $8.8 million from $6.8 million.
- Income from operations benefited from the shift from $4.2 million of prior-year restructuring and legal charges to a $2.1 million net benefit in the current quarter.
- The company adopted ASC 842 lease accounting on July 1, 2019. The adoption added approximately $30.1 million of right-of-use assets and $30.1 million of lease liabilities at adoption, with no material impact on current-quarter earnings or cash flow.
- The company repurchased 126,051 shares for $13.3 million during the quarter; 436,656 shares remained available under the repurchase authorization.
Guidance, outlook, risks and unusual items
The filing does not provide specific quantitative revenue or earnings guidance. Management expects available liquidity and credit resources to support operations, but cautions that quarterly results may not indicate full-year performance.
- Macroeconomic uncertainty, Brexit, foreign-exchange movements, tariffs, sanctions and changes in government procurement or defense spending could affect demand and reported results.
- Security results may be affected by delays or cancellations of government and international contracts, customer acceptance timing and the potential delay of European Union ECAC Standard 3 hold-baggage screening requirements.
- Healthcare results remain exposed to product-launch execution, healthcare-industry policy uncertainty and the company’s exit from its anesthesia product line.
- The company is defending consolidated shareholder securities litigation and derivative actions relating to allegations in a 2017 short-seller report. Outcomes and potential losses cannot currently be predicted or estimated.
- The SEC and DOJ are investigating trading in the company’s securities and related operations and disclosures. The company cannot predict whether penalties or remedial measures will result.
- Environmental investigations continue regarding historical soil and groundwater contamination at the Hawthorne facility. No liability has been accrued because an unfavorable outcome is not considered probable and reasonably estimable; an adverse resolution could nevertheless be material.
- Acquisition-related contingent consideration had a fair value of $16.6 million at September 30, 2019, with a maximum remaining potential payment of $26.8 million under agreements with caps.
- Remaining performance obligations were approximately $150.1 million at quarter-end, with approximately 49% expected to be recognized over the following 12 months.
Most important facts for investors to verify
- Whether Security revenue growth converts into improved margins, given the quarter’s unfavorable equipment and service mix.
- The sustainability of the unusually favorable tax rate, including the $6.2 million discrete equity-compensation tax benefit.
- Progress and potential exposure from the SEC and DOJ investigations and shareholder litigation.
- Availability under the revolving credit facility, covenant compliance and refinancing or settlement requirements for the 2022 convertible notes.
- Cash generation, working-capital trends and the concentration of cash held by foreign subsidiaries.
- Execution against the $150.1 million remaining performance-obligation balance and the timing of Security contract awards and customer acceptance.
- Potential costs associated with environmental matters, warranties, contingent acquisition payments and other legal contingencies.