OSI Systems, Inc. Form 10-Q Summary
Business context and reporting period
OSI Systems designs and manufactures specialized electronic systems and components for security, healthcare, defense, aerospace and industrial applications. Its reporting segments are Security, Healthcare, and Optoelectronics and Manufacturing. This unaudited Form 10-Q covers the quarter and six months ended December 31, 2016, representing fiscal 2017 second quarter and year-to-date results, compared primarily with the corresponding periods ended December 31, 2015.
Key financial metrics
| Metric | Three months ended Dec. 31, 2016 | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2016 | Six months ended Dec. 31, 2015 |
|---|---|---|---|---|
| Net revenues | $242.5 million | $197.3 million | $463.4 million | $397.4 million |
| Gross profit | $82.6 million | $68.1 million | $150.7 million | $136.0 million |
| Gross margin | 34.1% | 34.5% | 32.5% | 34.2% |
| Income from operations | $8.7 million | $0.8 million | $10.8 million | $16.5 million |
| Net income | $4.8 million | $0.1 million | $5.5 million | $10.9 million |
| Diluted EPS | $0.25 | $0.01 | $0.28 | $0.53 |
| Cash flow from operations | Not separately provided | Not separately provided | $18.3 million | $19.6 million |
Second-quarter revenue increased 23%, led by Security revenue of $139.5 million, up 49%, while Healthcare revenue declined 8% to $51.1 million and Optoelectronics and Manufacturing revenue increased 8% to $51.9 million. Year-to-date revenue increased 17%; Security represented 57% of consolidated revenue versus 48% in the prior-year period.
Second-quarter operating margin improved to approximately 3.6% from 0.4%, despite lower gross margin. Year-to-date operating margin declined to approximately 2.3% from 4.1%, reflecting higher restructuring, acquisition-related and impairment charges. Interest and other expense increased to $2.0 million in the quarter and $3.1 million year to date, primarily because of acquisition-related borrowings.
At December 31, 2016, cash and cash equivalents were $138.2 million, compared with $104.4 million at June 30, 2016. Total current assets were $652.6 million and total assets were $1.258 billion. Bank lines of credit were $349.0 million, current and long-term debt totaled approximately $356.5 million, and available borrowing under the revolving facility was approximately $153 million after letters of credit.
Material changes versus the prior comparable period
- OSI acquired American Science and Engineering, Inc. on September 9, 2016, for estimated consideration of $266.0 million. The acquisition added $29.1 million of second-quarter revenue and $43.2 million of year-to-date revenue, but contributed a $3.0 million pretax loss in the second quarter.
- The acquisition increased goodwill by approximately $116.8 million and added $74.8 million of preliminary identifiable intangible assets. Purchase accounting remained preliminary and could be materially adjusted during the measurement period.
- Year-to-date cash used in investing activities increased to $196.1 million from $9.7 million, principally because of $189.0 million spent on acquisitions. Financing activities provided $212.9 million, including $224.0 million of revolving-credit borrowings.
- Year-to-date impairment, restructuring and other charges increased to $19.4 million from $11.1 million. Fiscal 2017 charges included a $5.4 million product-line impairment, $7.8 million of AS&E-related employee termination costs, $4.0 million of acquisition costs and $0.8 million related to Healthcare facility consolidation.
- Healthcare revenue declined 10% year to date because of challenging hospital spending conditions and continuing issues associated with prior product launches. Healthcare reported a year-to-date operating loss of $2.5 million versus operating income of $6.3 million in the prior-year period.
- The Company amended its revolving credit facility in December 2016, increasing commitments from $450 million to $525 million and extending maturity to December 2021.
Guidance, outlook, commentary and risks
Management did not provide specific consolidated revenue or earnings guidance in the filing. Management expects available cash, operating cash flow and credit facilities to be sufficient for operational needs for the next 12 months and the foreseeable future. AS&E integration is expected to continue through fiscal 2019, with anticipated recurring annualized synergy savings of approximately $12 million. Healthcare facility consolidation is expected to be completed by the end of fiscal 2017, with estimated total costs of approximately $1.5 million and expected recurring annualized savings of approximately $3.0 million.
- Global economic uncertainty, a strong U.S. dollar and weakness in oil markets may delay customer purchases and reduce demand.
- Healthcare results remain exposed to product-launch execution issues, hospital spending trends and uncertainty surrounding U.S. healthcare policy.
- Security performance depends on government and international contracts, customer acceptance, airport screening standards and timing of turnkey projects. One Mexican government customer represented 12% of second-quarter revenue and 13% of year-to-date revenue.
- AS&E integration, acquisition accounting, employee terminations, facility consolidation and expected synergies involve execution and cost risks.
- Approximately 95% of reported cash was held by foreign subsidiaries and may be subject to additional U.S. tax if repatriated.
- The Company had $16.8 million of recorded contingent acquisition obligations, with maximum future contingent payments of $32.3 million under capped arrangements.
- The GSA is investigating AS&E discount practices and compliance with its GSA Schedule contract. The matter could result in False Claims Act damages, civil penalties and legal costs; management stated that an appropriate accrual had been recorded.
- Environmental contamination at the Hawthorne facility and other legal matters were not accrued because management considered unfavorable outcomes not probable and reasonably estimable, but adverse resolutions could be material.
- Unused fixed assets related to the Mexico turnkey program had a net carrying value of approximately $15 million at December 31, 2016.
Important facts for investors to verify
- Final purchase accounting for AS&E, including goodwill, intangible assets, tax obligations and other liabilities.
- Progress and total cost of AS&E integration, employee reductions and realization of the stated $12 million annualized synergies.
- Healthcare product-launch recovery, facility-consolidation savings and any further impairments or restructuring charges.
- Revolving-credit utilization, covenant compliance, interest-rate exposure and the effect of debt repayment requirements on liquidity.
- Status and potential financial exposure of the GSA investigation, environmental matters and shareholder derivative settlement.
- Sustainability of Security revenue growth, including AS&E contributions, RTT demand, Albanian turnkey services and customer concentration.
- Cash availability considering that most cash is held by foreign subsidiaries and potential repatriation-tax consequences.