Business Context and Reporting Period
OSI Systems, Inc. filed this Form 10-K for the fiscal year ended June 30, 2017. The provided request metadata refers to “2016 Q4,” but the filing is an annual report for fiscal 2017, not a fiscal 2016 quarterly filing.
OSI Systems is a vertically integrated designer and manufacturer serving security and inspection, healthcare, defense, aerospace and industrial markets through three divisions: Security, Healthcare, and Optoelectronics and Manufacturing.
- Security revenue: $555.2 million, approximately 58% of consolidated revenue.
- Healthcare revenue: $200.0 million, approximately 21%.
- Optoelectronics and Manufacturing third-party revenue: $205.7 million, approximately 21%.
Financial Performance and Position
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $961.0 million | $829.7 million | +16% |
| Gross profit | $323.5 million | $276.9 million | +17% |
| Gross margin | 33.7% | 33.4% | +0.3 percentage points |
| Income from operations | $33.3 million | $38.4 million | -13% |
| Operating margin | 3.5% | 4.6% | Down |
| Net income | $21.1 million | $26.2 million | -19% |
| Diluted EPS | $1.07 | $1.30 | -18% |
| Cash flow from operations | $62.8 million | $59.2 million | +6% |
Fiscal 2017 revenue growth was led by Security, including $94.0 million of revenue from the acquired AS&E business, higher international RTT hold-baggage sales and expanded turnkey scanning operations. Healthcare revenue declined to $200.0 million, while Optoelectronics and Manufacturing revenue declined modestly because of lower OEM contract-manufacturing volumes.
Reported profitability was pressured by $46.7 million of impairment, restructuring and other charges, compared with $22.0 million in fiscal 2016. Charges included $17.5 million for impaired Mexico turnkey-program assets, $9.4 million for abandoned Security product lines, $8.0 million of AS&E integration termination costs and $5.6 million of acquisition-related transaction costs.
- Cash and cash equivalents: $169.7 million at June 30, 2017, versus $104.4 million in 2016.
- Working capital: $306.9 million, versus $187.5 million.
- Total debt: $347.1 million, versus $133.8 million.
- Revolving credit facility: $525 million commitment; $103.0 million drawn and $18.3 million of letters of credit outstanding.
- Available borrowing capacity under the revolving facility: $403.7 million.
- Convertible notes: $287.5 million principal amount of 1.25% notes due 2022, with a $238.8 million carrying value after discounts and issuance costs.
- Backlog: approximately $738 million at June 30, 2017, versus $623 million at June 30, 2016; approximately $227 million was not expected to be fulfilled in fiscal 2018.
Approximately 99% of cash and cash equivalents were held by foreign subsidiaries and were subject to repatriation tax considerations. The company stated that available cash, credit facilities and operating cash flow should fund operating needs for the next 12 months and the foreseeable future.
Material Changes Versus the Prior Comparable Period
- Revenue rebounded sharply after the 13% decline reported in fiscal 2016, primarily due to the AS&E acquisition and stronger Security activity.
- Security revenue increased 35% to $555.2 million; Healthcare declined 5%; Optoelectronics and Manufacturing declined 1%.
- Gross margin improved slightly, but operating margin declined because operating expenses rose to 30.2% of revenue from 28.7%.
- SG&A increased 16% to $192.6 million, primarily due to higher Security activity and AS&E costs. Research and development increased 2% to $51.0 million.
- Interest and other expense increased to $7.5 million from $2.9 million, reflecting higher borrowings and $2.5 million of non-cash convertible-note interest expense.
- Operating cash flow increased modestly, but investing cash use increased substantially to $200.7 million, including $191.2 million for acquisitions.
- The company repurchased 642,277 shares for approximately $48.5 million during fiscal 2017.
- AS&E, acquired in September 2016 for estimated consideration of $266.0 million, contributed $94.0 million of revenue and $8.7 million of pretax income from acquisition through year-end.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide a specific quantitative fiscal 2018 revenue or earnings forecast. Management expects continued opportunities in global security and inspection markets, but notes uncertainty related to government budgets, sequestration, international spending, healthcare purchasing and global economic conditions.
- The Mexican government turnkey security contract was scheduled to expire in January 2018 and generated approximately 12% of fiscal 2017 revenue. Non-renewal, reduced scope or unfavorable renewal terms could materially affect results and could impair related assets.
- AS&E was subject to a GSA Office of Inspector General investigation concerning discount practices and compliance with GSA Schedule pricing provisions. Potential outcomes include False Claims Act damages, civil penalties and additional legal costs; management stated that an appropriate accrual had been recorded.
- The company continues to investigate historical soil and groundwater contamination beneath its Hawthorne, California facility. No environmental liability was accrued because management did not consider an adverse outcome probable and reasonably estimable.
- Management identified, and the auditor reported, a material weakness in internal control over financial reporting related to management review controls for non-routine transactions, including business combinations. Remediation efforts were underway.
- Subsequent to year-end, OSI acquired the global explosive trace detection business from Smiths Group for an estimated $80.5 million, financed with cash and revolving credit borrowings.
- Subsequent to year-end, OSI agreed to acquire its leased Billerica, Massachusetts facility for approximately $20 million, with completion expected in the first quarter of fiscal 2018.
- Key ongoing risks include contract delays or cancellations, customer acceptance timing, government procurement and export controls, competition, foreign currency volatility, healthcare regulation and reimbursement pressure, cybersecurity, product liability, supply-chain concentration, litigation and acquisition integration.
Most Important Facts for Investors to Verify
- Whether the Mexico SAT contract was renewed, reduced or terminated after its scheduled January 2018 expiration, and the effect on revenue, cash flow and asset impairments.
- The final purchase accounting for AS&E and the integration savings achieved versus the estimated $18 million of annualized synergies.
- The resolution, accrual adequacy and potential exposure associated with the GSA investigation of AS&E.
- Progress in remediating the material weakness in internal control over non-routine transactions.
- Post-year-end leverage and liquidity after the $80.5 million explosive trace detection acquisition and the planned $20 million Billerica facility purchase.
- Whether Security growth can offset weakness in Healthcare and OEM contract manufacturing.
- The sustainability of operating cash flow given higher debt service, acquisition-related obligations, customer advances and the concentration of cash in foreign subsidiaries.