OSI Systems, Inc. Form 10-Q Summary
Reporting period: Quarter and six months ended December 31, 2017, representing fiscal 2018 second quarter and year-to-date results. The financial statements are unaudited and prepared under U.S. GAAP.
Business context
OSI Systems designs and manufactures specialized electronic systems and components for homeland security, healthcare, defense, aerospace and related markets. Its segments are Security, Healthcare, and Optoelectronics and Manufacturing. The July 2017 acquisition of Smiths Group’s explosive trace detection business (“ETD”) is included primarily in Security.
Key financial metrics
| Metric | Three months ended Dec. 31, 2017 | Six months ended Dec. 31, 2017 | Prior comparable period |
|---|---|---|---|
| Net revenues | $277.5 million | $534.7 million | $242.5 million / $463.4 million |
| Gross profit | $101.6 million | $192.9 million | $82.6 million / $150.7 million |
| Gross margin | 36.6% | 36.1% | 34.1% / 32.5% |
| Operating income | $18.1 million | $37.5 million | $8.7 million / $10.8 million |
| Net income (loss) | $(47.0) million | $(36.8) million | $4.8 million / $5.5 million |
| Diluted EPS | $(2.47) | $(1.95) | $0.25 / $0.28 |
| Cash flow from operations | Not separately reported | $84.7 million | $18.3 million |
Revenue increased 14% in the quarter and 15% year to date. Security revenue rose 24% in the quarter and 27% year to date, including $19.7 million and $41.4 million, respectively, from ETD. Healthcare revenue increased 3% in the quarter and 1% year to date; Optoelectronics and Manufacturing revenue increased 2% in the quarter and declined 1% year to date.
The reported tax provision was $59.8 million for the quarter and $64.8 million year to date, including a provisional $56.2 million discrete charge related to the Tax Cuts and Jobs Act. Excluding discrete tax items, the effective tax rate was approximately 28.0% for the quarter and 28.2% year to date.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $212.0 million at December 31, 2017, compared with $169.7 million at June 30, 2017. Nearly all cash was held by foreign subsidiaries.
- Operating cash flow was $84.7 million, compared with $18.3 million in the prior-year period.
- Investing cash outflow was $117.5 million, including $84.4 million for acquisitions and $32.0 million for capital expenditures and intangible assets.
- Financing cash inflow was $75.1 million, primarily from $92.0 million of borrowings under the revolving credit facility.
- The revolving credit facility permits borrowings up to $525 million, matures in December 2021, and had $195.0 million outstanding, $36.8 million of letters of credit outstanding and $293.2 million available at December 31, 2017. The company reported compliance with all covenants.
- Long-term debt was $247.5 million, including $287.5 million principal amount of 1.25% convertible senior notes due 2022, net of unamortized discount and issuance costs, plus term loans and other debt. Foreign subsidiary letter-of-credit facilities had $61.9 million outstanding and $12.9 million available.
- Inventory increased to $281.0 million from $248.5 million at June 30, 2017. Total assets increased to $1.35 billion from $1.23 billion, while total liabilities increased to $816.7 million from $660.9 million.
Material changes versus prior comparable periods
- Gross margin expanded by 2.5 percentage points in the quarter and 3.6 percentage points year to date, primarily from favorable product and channel mix, economies of scale and contributions from acquired Security businesses.
- Operating income more than doubled in the quarter and increased substantially year to date despite higher SG&A and R&D expenses.
- Net income shifted to a loss because the Tax Act generated a $56.2 million discrete tax charge. Excluding discrete tax items, management reported a tax rate broadly comparable with the prior year.
- Interest and other expense increased to $5.3 million in the quarter and $9.5 million year to date, driven by higher borrowings, rising rates, acquisitions, the new convertible notes and non-cash note-related interest expense.
- Impairment, restructuring and other charges declined to $8.3 million in the quarter and $9.4 million year to date, versus $9.4 million and $19.4 million, respectively. Current-quarter charges included $3.1 million of impairments and $4.3 million of litigation and estimated settlement costs.
Outlook, risks and unusual items
- Management stated that available cash, credit facilities and operating cash flow are expected to meet operational needs for the next 12 months and the foreseeable future.
- A new two-year Mexican SAT security-screening contract was signed in January 2018. Management expects reduced net revenue beginning in the quarter ending March 31, 2018; SAT represented 12% of quarterly revenue and 12% of year-to-date revenue.
- On January 12, 2018, the company acquired an electronics component designer and manufacturer for approximately $21 million, plus up to $6 million of potential earnout consideration. The purchase-price allocation was not complete at filing.
- Management cited risks from delayed government and customer purchasing, global economic and oil-market uncertainty, healthcare product-launch issues, foreign currency movements, government budgets and policies, contract renewals, customer acceptance, and regulatory compliance.
- The company disclosed securities litigation following a short-seller report alleging Foreign Corrupt Practices Act compliance issues. The SEC and Department of Justice are investigating FCPA compliance and trading in company securities. Outcomes, potential penalties and losses could not be estimated.
- An Office of Inspector General investigation concerns AS&E’s historical discount practices and compliance with its General Services Administration contract. Management stated that an appropriate accrual had been recorded, but potential False Claims Act exposure could include treble damages and civil penalties.
- Management disclosed a material weakness in internal control over non-routine transactions, including business combinations. Remediation efforts were underway, but disclosure controls were not effective as of December 31, 2017.
- The ETD purchase-price allocation remained preliminary, and further adjustments could be material. Contingent acquisition obligations had a recorded fair value of $14.7 million and maximum capped future payments of $26.0 million.
Important facts for investors to verify
- Final measurement-period adjustments for the ETD acquisition and the purchase-price allocation for the January 2018 acquisition.
- Final tax effects of the Tax Act, including the provisional $56.2 million charge, foreign earnings repatriation and deferred tax liabilities.
- Progress and effectiveness of remediation for the material weakness in controls over non-routine transactions.
- Developments, accruals and potential financial consequences from the SEC, DOJ, shareholder litigation and GSA investigations.
- Revenue impact and profitability of the new Mexican SAT contract beginning in the March 2018 quarter.
- Debt utilization, interest-rate exposure, convertible-note terms and availability under the revolving credit facility.
- Cash accessibility, given that nearly all reported cash was held by foreign subsidiaries.