OSI Systems, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2017; fiscal third quarter of 2017. The filing is unaudited and compares results with the periods ended March 31, 2016. The company designs and manufactures specialized electronic systems and components for security, healthcare, defense, aerospace and other critical applications through its Security, Healthcare, and Optoelectronics and Manufacturing divisions.
Financial Results and Position
| Metric | Q3 2017 | Q3 2016 | Year-to-date 2017 | Year-to-date 2016 |
|---|---|---|---|---|
| Net revenues | $245.1 million | $210.8 million | $708.5 million | $608.2 million |
| Gross profit | $86.0 million | $70.1 million | $236.7 million | $206.1 million |
| Gross margin | 35.1% | 33.3% | 33.4% | 33.9% |
| Income from operations | $19.7 million | $13.3 million | $30.5 million | $29.8 million |
| Net income | $14.0 million | $9.3 million | $19.5 million | $20.3 million |
| Diluted EPS | $0.72 | $0.47 | $1.00 | $1.00 |
- Revenue mix: Q3 Security revenue increased 31% to $144.8 million, Healthcare increased 1% to $49.7 million, and Optoelectronics and Manufacturing decreased 1% to $50.6 million. For the nine-month period, Security increased 36% to $408.0 million, Healthcare declined 6% to $146.4 million, and Optoelectronics and Manufacturing increased 2% to $154.1 million, based on the company’s segment presentation.
- Profitability: Q3 operating margin improved to approximately 8.0% from 6.3%. Year-to-date operating margin was approximately 4.3%, compared with 4.9% in the prior-year period. Q3 net margin was approximately 5.7%, compared with 4.4%.
- Operating expenses: Q3 SG&A increased 26% to $49.4 million, primarily due to AS&E and support for higher Security sales. Year-to-date SG&A increased 18% to $144.5 million. Year-to-date impairment, restructuring and other charges increased to $21.9 million from $15.6 million.
- Cash flow: Nine-month operating cash flow was $52.2 million, up from $40.2 million. Investing cash use was $194.5 million, including $191.2 million for acquisitions. Financing cash flow was $197.1 million, principally reflecting convertible-note proceeds and debt activity.
- Liquidity: Cash and equivalents were $158.5 million at March 31, 2017, up from $104.4 million at June 30, 2016. Approximately 96% of cash was held by foreign subsidiaries and may be subject to repatriation tax considerations.
- Debt: The company had $93.0 million outstanding under its revolving credit facility, $20.7 million of letters of credit, and $287.5 million principal amount of 1.25% convertible senior notes due 2022, recorded net of discount and issuance costs at $236.8 million. Revolver availability was approximately $411 million, and the company reported compliance with all covenants.
- Balance sheet: Total assets increased to $1.236 billion from $992 million, largely due to the AS&E acquisition. Goodwill increased to $241.7 million from $122.8 million and net intangible assets increased to $120.6 million from $56.3 million.
Material Changes Versus Prior Comparable Period
- OSI acquired American Science and Engineering, Inc. in September 2016 for an estimated $266.0 million. AS&E contributed $70.9 million of revenue and $4.7 million of pretax income from acquisition through March 31, 2017, including $27.7 million of Q3 revenue and $4.9 million of Q3 pretax income.
- The acquisition increased Security revenue and margins but also increased SG&A, financing costs, amortization, goodwill and integration obligations. AS&E integration costs totaled $14.4 million through March 31, 2017, including $8.0 million for eliminating 50 positions.
- The company issued $287.5 million of 1.25% convertible notes in February 2017. Net proceeds were used primarily to repay approximately $245 million of revolver borrowings and to repurchase 451,600 shares.
- Healthcare revenue declined year-to-date due to weaker hospital spending and continuing effects from prior product launches. Management stated that Q3 Healthcare sales increased 7% excluding the divested non-core European business.
- The company sold a Healthcare business for $12.8 million in Q3, recognizing a $2.1 million gain.
- Q3 impairment, restructuring and other charges declined to $2.5 million from $4.5 million, but year-to-date charges increased due mainly to a $5.4 million product-line impairment and AS&E integration costs.
- Healthcare facility consolidation had incurred $1.7 million through March 31, 2017. Management estimated total costs of approximately $2.0 million and recurring annualized savings of approximately $3.0 million upon completion.
Outlook, Risks and Unusual Items
The filing does not provide a specific numerical revenue or earnings guidance range. Management stated that available funds, credit facilities and operating cash flow are expected to meet operational needs for the next 12 months and the foreseeable future.
- Management expects AS&E integration, including manufacturing consolidation and workforce reductions, to be completed in fiscal 2019. It estimates approximately $16 million of recurring annualized savings from AS&E synergies, but cannot estimate total integration costs or total savings with certainty.
- Global economic uncertainty, a strong U.S. dollar, weak oil markets, delayed customer purchasing, government budget and procurement changes, contract delays, customer acceptance timing and foreign-currency movements could adversely affect results.
- Healthcare results remain exposed to hospital spending conditions, product-launch issues and uncertainty surrounding potential changes to the Affordable Care Act.
- The European Union’s requirement for airport hold-baggage screening systems to meet ECAC Standard 3 beginning in 2020 could create opportunity for the company’s RTT product, although the deadline could be delayed.
- AS&E is subject to a GSA Office of Inspector General investigation concerning discount practices and compliance with its GSA Schedule contract. The matter could result in False Claims Act claims, treble damages, civil penalties and legal costs. Management states that an appropriate accrual has been provided.
- Environmental contamination has been identified at the Hawthorne, California facility. No liability has been accrued because management does not consider a loss probable and reasonably estimable, but an adverse resolution could be material.
- Contingent acquisition payments had a maximum potential amount of $20.8 million at March 31, 2017; recorded contingent earn-out liabilities were $14.3 million.
- Approximately $15 million of fixed assets related to the Mexico turnkey screening program were not in use at March 31, 2017. The company also had $18.1 million of warranty provisions.
- Interest-rate and foreign-currency risks remain relevant. Management estimated that a 10% appreciation or depreciation of the U.S. dollar against applicable local currencies would change Q3 operating income by approximately $3.0 million in the opposite direction.
Important Facts for Investors to Verify
- Whether AS&E integration achieves the projected approximately $16 million of recurring annualized savings and whether additional costs or accounting adjustments arise during the measurement period.
- The outcome and financial exposure from the GSA investigation involving AS&E.
- The sustainability of Security growth excluding acquisition contributions and the timing of any ECAC Standard 3-related demand.
- Whether Healthcare revenue and margins recover following product-launch issues, hospital spending weakness and the divestiture.
- The effect of convertible-note amortization, interest expense, potential dilution and future share repurchases on earnings and cash flow.
- The availability and geographic location of cash, including potential repatriation taxes and continued compliance with credit-facility covenants.
- Potential liabilities related to environmental matters, contingent acquisition payments, warranties and other legal proceedings.