OSI Systems, Inc. Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2018. The request metadata identifies “2017 Q4,” but the supplied filing is the fiscal 2018 Form 10-K, filed August 27, 2018.
Business Context
OSI Systems designs and manufactures specialized electronic systems and components for homeland security, healthcare, defense and aerospace markets. Its three operating divisions are Security, Healthcare, and Optoelectronics and Manufacturing.
- Security: $690.0 million of revenue, approximately 63% of consolidated revenue.
- Healthcare: $189.4 million, approximately 18% of revenue.
- Optoelectronics and Manufacturing: $209.9 million of third-party revenue, approximately 19% of revenue.
International operations remained significant: approximately 58% of revenue came from shipments outside the United States in fiscal 2018. Direct U.S. government sales were approximately $157 million.
Financial Performance and Liquidity
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Revenue | $1,089.3 million | $961.0 million | Up 13% |
| Gross profit | $391.7 million | $323.5 million | Up 21% |
| Gross margin | 36.0% | 33.7% | Up 2.3 percentage points |
| Income from operations | $55.9 million | $33.3 million | Up 68% |
| Interest expense, net | $19.3 million | $9.6 million | Up $9.7 million |
| Income before taxes | $36.9 million | $25.8 million | Up 43% |
| Net income (loss) | $(29.1) million | $21.1 million | Declined $50.2 million |
| Diluted EPS | $(1.57) | $1.07 | Declined |
| Cash flow from operations | $133.1 million | $62.8 million | Up $70.3 million |
The reported net loss was primarily driven by a $66.0 million income tax provision, including a provisional $55.3 million discrete charge related to the 2017 Tax Act. Excluding the Tax Act and other discrete tax items, management estimated the fiscal 2018 effective tax rate at approximately 26.8%, compared with 27.6% in fiscal 2017.
Cash and cash equivalents declined to $84.8 million from $169.7 million. Fiscal 2018 cash uses included $43.2 million of capital expenditures, $103.8 million for acquisitions and $83.8 million for share repurchases and net settlement of equity awards.
Total debt was $364.2 million at June 30, 2018, compared with $347.1 million a year earlier. This included $113.0 million outstanding under a $525 million revolving credit facility and $287.5 million principal amount of 1.25% convertible senior notes due 2022. Letters of credit outstanding under the revolving facility were $58.2 million, leaving approximately $353.8 million of facility capacity. Management stated that the company was in compliance with its debt covenants and expected available liquidity, credit facilities and operating cash flow to meet needs for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Security revenue increased 24%, benefiting from the full-year contribution of AS&E and $76.5 million of revenue from the explosive trace detection business acquired in July 2017. The increase was partially offset by reduced revenue under the new Mexico SAT contract.
- Healthcare revenue declined 5%, primarily following the prior-year sale of a non-core European cardiology business and continued product-launch difficulties.
- Optoelectronics and Manufacturing revenue increased 2%, including $9.9 million from the January 2018 acquisition, partly offset by a $6.3 million decline in contract manufacturing revenue.
- SG&A increased 24% to $239.6 million and research and development increased 20% to $61.2 million, reflecting growth initiatives and acquisitions.
- Impairment, restructuring and other charges declined to $35.0 million from $46.7 million. Fiscal 2018 charges included an $18.1 million Healthcare product-line impairment and estimated settlement costs, $8.9 million of legal costs and estimated net settlements, and $7.8 million of asset impairments.
- Interest expense increased substantially because of higher borrowings, the convertible notes and non-cash debt discount amortization. Fiscal 2018 included $7.5 million of non-cash interest expense related to the notes.
- Backlog increased to approximately $976 million from $738 million. Approximately $329 million of the 2018 backlog was not reasonably expected to be fulfilled in fiscal 2019.
- The company repurchased 1,021,458 shares during fiscal 2018 and had authorization to repurchase an additional 851,023 shares at year-end.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide a specific numerical revenue or earnings forecast. Management expects continued opportunities from global security spending, European hold-baggage screening standards, healthcare demand and OEM outsourcing, but cautions that customer purchasing may be delayed by macroeconomic, political, budgetary and regulatory uncertainty.
- Government spending, sequestration, contract delays, customer acceptance testing and termination or non-renewal of government contracts could affect revenue timing and profitability.
- The company faces significant exposure to U.S. and foreign government investigations concerning FCPA compliance and securities trading, as well as related shareholder and derivative litigation. Outcomes, penalties and potential remedial measures were described as uncertain and not reasonably estimable.
- Healthcare operations are exposed to product-launch execution, FDA and foreign regulatory requirements, recalls, cybersecurity obligations, reimbursement pressure and healthcare-provider consolidation.
- International operations create exposure to foreign exchange, tariffs, sanctions, trade restrictions, political instability and changing data-protection requirements, including the EU GDPR.
- Fiscal 2018 included a provisional Tax Act charge that could be revised as tax filings, regulations and interpretations were finalized.
- The company continues to investigate soil and groundwater contamination beneath its Hawthorne, California facility. No environmental liability was accrued because management did not consider a loss probable and reasonably estimable.
- Acquisition-related obligations included $15.7 million of recorded contingent earnout liabilities and up to $29.9 million of maximum future contingent consideration under arrangements with caps.
- On July 31, 2018, after year-end, the company acquired an optoelectronics solutions business for $17.5 million plus up to $1 million of potential earnout consideration.
- Management reported effective disclosure controls and internal control over financial reporting as of June 30, 2018, following remediation of a previously identified material weakness.
Most Important Facts to Verify
- Whether the provisional $55.3 million Tax Act charge and the $35.5 million transition-tax component were subsequently finalized or adjusted.
- Current status and potential financial exposure from the SEC and DOJ FCPA and securities-trading investigations and related litigation.
- Progress, profitability and renewal prospects for the Mexico SAT turnkey screening program.
- Conversion, refinancing or cash-settlement requirements associated with the $287.5 million convertible notes due 2022.
- Quality of the $976 million backlog, including expected fulfillment timing, customer acceptance requirements, cancellation rights and margins.
- Healthcare product-line recovery, regulatory compliance and potential additional impairment or settlement costs.
- Post-filing performance of the acquired ETD and optoelectronics businesses and integration-related costs.
- Cash concentration outside the United States, repatriation restrictions and the effect of foreign exchange movements on operating income.