OSI Systems, Inc. Form 10-Q Summary
Business context and reporting period
OSI Systems designs and manufactures specialized electronic systems and components for homeland security, healthcare, defense, aerospace and industrial markets. Its three segments are Security, Healthcare, and Optoelectronics and Manufacturing. The filing covers the three months ended September 30, 2015, the first quarter of fiscal 2016, compared with the first quarter of fiscal 2015. The financial statements are unaudited.
Key financial metrics
| Metric | Q1 FY2015 | Q1 FY2016 | Change |
|---|---|---|---|
| Net revenues | $218.4 million | $200.1 million | Down 8% |
| Gross profit | $74.2 million | $68.0 million | Down 8% |
| Gross margin | 34.0% | 34.0% | Flat |
| Operating income | $16.7 million | $15.7 million | Down 6% |
| Net income | $11.2 million | $10.8 million | Down 4% |
| Diluted EPS | $0.55 | $0.53 | Down 4% |
| Cash flow from operations | $31.5 million | $24.8 million | Down 21% |
Product revenue declined to $135.5 million from $156.5 million, while services revenue increased to $64.5 million from $61.9 million. The effective tax rate improved to 27.5% from 28.8%. Comprehensive income was $9.2 million, compared with $8.7 million, despite foreign currency translation losses of $1.6 million in the current quarter.
Segment performance and material changes
| Segment revenue | Q1 FY2015 | Q1 FY2016 | Change |
|---|---|---|---|
| Security | $113.4 million | $96.4 million | Down 15% |
| Healthcare | $47.8 million | $51.5 million | Up 8% |
| Optoelectronics and Manufacturing | $69.1 million | $62.5 million | Down 10% |
- Security revenue was pressured by prior-year contributions of approximately $15 million from a Foreign Military Sale contract and $9 million related to the Glasgow 2014 Commonwealth Games. Higher post-warranty service revenue partially offset the decline. Security operating income fell to $12.6 million from $17.3 million.
- Healthcare revenue benefited from stronger North American and EMEA sales and a full quarter from a prior-year European cardiology acquisition. Healthcare operating income increased to $2.9 million from $0.1 million.
- Optoelectronics and Manufacturing revenue declined because of lower contract manufacturing and commercial optoelectronics sales, including a difficult comparison against unusually high prior-year sales to a consumer-products customer. Operating income increased to $5.6 million from $4.3 million.
- Operating expenses decreased 9% to $52.3 million. SG&A declined primarily because of lower compensation, contingent consideration and legal expenses. No restructuring charges were recorded versus $0.7 million in the prior-year quarter.
Liquidity, debt and cash flow
- Cash and cash equivalents were $80.9 million at September 30, 2015, up from $47.6 million at June 30, 2015. Management stated that available funds, operating cash flow and credit facilities should meet operational needs for at least the next 12 months.
- Operating cash flow was $24.8 million. Investing cash outflow was $4.2 million, including $2.5 million of capital expenditures and $0.8 million for acquisitions.
- Financing activities provided $12.9 million, principally from $45.0 million of borrowings under the revolving credit facility. The company repurchased shares and settled equity-award withholding obligations for total cash use of approximately $34.5 million.
- Total outstanding lines of credit and current and long-term debt were $55.6 million at September 30, 2015, compared with $11.4 million at June 30, 2015. The revolving facility permits borrowings of up to $450 million and matures in May 2019; borrowings carried a LIBOR plus 1.25% margin at quarter-end.
- Approximately 82% of cash, cash equivalents and investments was held by foreign subsidiaries and could be subject to additional U.S. tax if repatriated.
Guidance, outlook, risks and unusual items
The filing does not provide specific quarterly or full-year revenue, earnings or margin guidance. Management continues to emphasize product development, international opportunities and the benefits of a diversified customer and market base.
- Key risks include delays in contract awards, customer acceptance and revenue recognition; government budget reductions and sequestration; changes in defense, security and healthcare spending; foreign currency volatility; international regulatory and geopolitical risks; product acceptance; and compliance with export, environmental and contract requirements.
- One customer, Mexico's Servicio de Administración Tributaria, represented 15% of consolidated revenue in both comparable quarters. The company also has a $43.8 million remaining customer advance related to its Mexican turnkey screening agreement.
- A securities class-action settlement requires a $15.0 million payment, expected to be funded fully by insurers. Preliminary court approval was obtained, but final approval and other conditions remained outstanding at the filing date.
- Derivative shareholder lawsuits remain pending; their outcomes and financial effects could not be estimated. The company has not accrued for those matters.
- Environmental contamination investigations continue at the Hawthorne, California facility. No liability was accrued because management considered a loss possible but not probable and reasonably estimable; an adverse resolution could be material.
- Contingent acquisition consideration had a maximum future exposure of $27 million, with $12.7 million recorded as a liability at September 30, 2015. During the quarter, approximately $0.8 million was paid and the liability was reduced by $3.7 million through revaluation.
- At September 30, 2015, approximately $19.9 million of net property and equipment related to the Mexican turnkey screening program was not currently in use and is subject to impairment assessment if indicators arise.
Investor verification items
- Verify whether Security revenue normalizes after the unusually strong prior-year FMS and Glasgow-related comparisons.
- Monitor the effect of $45 million of new revolving debt, variable interest rates and continued share repurchases on liquidity and leverage.
- Assess the sustainability of Healthcare growth and Optoelectronics margin improvement.
- Track final approval and insurer funding of the $15 million securities settlement and developments in the derivative litigation.
- Evaluate potential exposure from the Hawthorne environmental matter, Mexican idle assets, customer concentration and foreign cash repatriation taxes.