OSI Systems, Inc. Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2016. The request metadata refers to “2015 Q3,” but the filing covers fiscal 2016 Q3 and compares with the three and nine months ended March 31, 2015.
Business Context
OSI Systems designs and manufactures specialized electronic systems and components for homeland security, healthcare, defense, aerospace, medical and industrial applications. Its operating divisions are Security, Healthcare, and Optoelectronics and Manufacturing.
Financial Performance
| Metric | Three Months Ended March 31, 2016 | Year-over-Year Change | Nine Months Ended March 31, 2016 | Year-over-Year Change |
|---|---|---|---|---|
| Revenue | $210.8 million | Down 2% | $608.2 million | Down 12% |
| Gross profit | $70.1 million | Down 4% | $206.1 million | Down 13% |
| Gross margin | 33.3% | Down from 33.7% | 33.9% | Down from 34.1% |
| Operating income | $13.3 million | Down 28% | $29.8 million | Down 51% |
| Net income | $9.3 million | Down 29% | $20.3 million | Down 53% |
| Diluted EPS | $0.47 | Down from $0.64 | $1.00 | Down from $2.08 |
Quarterly operating margin was approximately 6.3%, compared with 8.6% in the prior-year quarter. Nine-month operating margin was approximately 4.9%, compared with 8.8%. The nine-month effective tax rate was 27.0%, broadly consistent with 27.2% in the prior-year period.
Segment Results and Material Changes
- Security: Quarterly revenue increased 11% to $110.6 million, helped by a $23 million Middle East equipment sale and Albania turnkey operations. Nine-month revenue decreased 14% to $300.7 million, primarily because the prior-year period included approximately $66 million more revenue from the U.S. Department of Defense Foreign Military Sales contract and approximately $9 million related to the Glasgow 2014 Commonwealth Games.
- Healthcare: Quarterly revenue declined 17% to $49.1 million and nine-month revenue declined 12% to $156.1 million. Management cited challenging hospital spending conditions and operational execution issues, and said it had reorganized the division and hired an industry veteran to lead it.
- Optoelectronics and Manufacturing: Quarterly revenue declined 6% to $61.3 million and nine-month revenue declined 8% to $184.4 million, primarily due to lower contract-manufacturing volumes and reduced sales to a large customer. Acquired businesses contributed approximately $4.2 million of quarterly revenue.
- Revenue mix shifted toward Security in the quarter, while the lower-margin mix and reduced Healthcare sales pressured consolidated gross margin.
Cash Flow, Liquidity and Capital Resources
- Cash and cash equivalents were $97.4 million at March 31, 2016, up from $47.6 million at June 30, 2015.
- Operating cash flow was $40.2 million for the nine months, down from $87.7 million, primarily due to lower profits and a $54.0 million increase in inventories.
- Investing cash outflow was $32.8 million, including $19.6 million for acquisitions and $9.0 million for capital expenditures.
- Financing cash flow was $43.0 million, reflecting $125.0 million of revolver borrowings, partly offset by $73.4 million of share repurchases and $13.2 million of taxes paid on net share settlements.
- Total outstanding lines of credit and current and long-term debt were $134.5 million at March 31, 2016, compared with $11.4 million at June 30, 2015.
- The company had a $450 million revolving credit facility maturing in May 2019. Borrowings bore interest at LIBOR plus 1.25% at March 31, 2016. The company reported $125.0 million outstanding under the revolver and $6.1 million of letters of credit.
- Approximately 96% of cash and investments were held by foreign subsidiaries and subject to potential repatriation tax considerations. Management expected available cash, credit facilities and operating cash flow to fund operational needs for at least the next 12 months.
Guidance, Outlook, Risks and Unusual Items
- Management stated that fiscal 2016 results had fallen below expectations. Delayed bookings and revenue timing, global economic conditions, lower oil prices, a strong U.S. dollar and weak demand in certain markets were identified as risks.
- Management expects customer purchasing delays or deferrals may continue, but did not quantify the potential impact or provide specific financial guidance.
- The company recorded $15.6 million of impairment, restructuring and other charges in the nine months, including $5.9 million of fixed-asset impairments, a $2.8 million minority-investment impairment, $1.8 million of legal settlement and related costs, and $1.4 million of acquisition transaction costs.
- Two acquisitions were completed during the quarter for combined closing cash payments of $17.5 million, plus $2.6 million of indemnity holdbacks and $12.5 million of contingent consideration. The acquisitions added $20.4 million of goodwill and $7.8 million of identifiable intangible assets.
- The company repurchased 1.2 million shares for $73.4 million during the nine months. In April 2016, the board authorized an additional one million-share repurchase program.
- The company disclosed shareholder derivative litigation, environmental contamination investigations at its Hawthorne facility, contingent acquisition obligations with a maximum capped future payment amount of $34 million, and a remaining $31.3 million customer advance related to the Mexican turnkey security project. No accrual was recorded for the environmental or derivative-action contingencies because management did not consider losses probable and reasonably estimable.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether Security bookings and revenue recover after the expiration of the major Foreign Military Sales equipment deliveries.
- Whether the Healthcare reorganization improves sales, margins and operating execution.
- Inventory levels, conversion of inventory shipments into recognized revenue, and the resulting effect on operating cash flow.
- Leverage, borrowing costs, covenant compliance and the company’s ability to fund buybacks and acquisitions without further material borrowing.
- The performance and integration of the two acquired businesses and the amount and timing of contingent acquisition payments.
- Potential exposure from environmental matters, derivative litigation, government-contract compliance and other unaccrued contingencies.
- The extent to which foreign cash can be used in the United States without additional tax costs.