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 and aerospace markets. Its divisions are Security, Healthcare, and Optoelectronics and Manufacturing. The filing covers the three and six months ended December 31, 2011, representing the second quarter and first six months of fiscal 2012. Financial statements are unaudited.
Key financial metrics
| Metric | Three months ended Dec. 31, 2011 | Year-over-year change | Six months ended Dec. 31, 2011 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $188.0 million | Up 11% | $349.3 million | Up 17% |
| Gross profit | $65.8 million | Up 10% | $118.7 million | Up 11% |
| Gross margin | 35.0% | Down from 35.4% | 34.0% | Down from 35.9% |
| Operating income | $18.3 million | Up 37% | $25.9 million | Up 38% |
| Net income | $12.3 million | Up 33% | $17.1 million | Up 35% |
| Diluted EPS | $0.61 | Up from $0.47 | $0.85 | Up from $0.65 |
- Six-month revenue growth was led by Security, up 26% to $161.6 million, and Optoelectronics and Manufacturing, up 20% to $82.0 million. Healthcare increased 4% to $105.7 million.
- Six-month operating expenses increased 5% to $92.8 million, while operating expenses as a percentage of revenue declined to 26.6% from 29.6%. Restructuring charges of $1.2 million in the prior-year period did not recur.
- The six-month effective tax rate increased to 30.0% from 28.6%; the quarterly rate was also 30.0%, compared with 28.1%.
- Cash provided by operating activities was $12.5 million, down from $19.5 million. Working-capital investment, particularly inventory and accounts receivable, reduced operating cash flow.
- Cash used in investing activities was $14.1 million, including $9.1 million of capital expenditures, $3.2 million for business acquisitions and approximately $2.1 million for intangible assets.
- Cash and cash equivalents were $52.9 million at December 31, 2011, versus $55.6 million at June 30, 2011. Working capital increased to $262.5 million from $244.3 million.
- Total debt was approximately $2.8 million at December 31, 2011. No borrowings were outstanding under the $250 million revolving credit facility, although $62.2 million was outstanding under its letter-of-credit facility and $14.9 million under foreign subsidiary letter-of-credit facilities.
Material changes versus the prior comparable period
- Security revenue benefited from higher conventional equipment sales, a $5.9 million contribution from a large ongoing prime-contractor and systems-integration contract, and increased service revenue.
- Healthcare growth was primarily driven by patient monitoring and anesthesia products, partly offset by lower cardiology revenue. European/Middle East/Africa sales declined during the six-month period.
- Optoelectronics and Manufacturing benefited from higher commercial optoelectronics and contract-manufacturing sales.
- Gross margin declined because the faster-growing Security and Optoelectronics businesses generally carry lower margins than Healthcare, and Security product mix was unfavorable.
- SG&A leveraged revenue growth, declining as a percentage of revenue. Research and development increased for the six-month period to support new product introductions.
- Inventory increased $36.2 million and accounts receivable increased $8.6 million from June 30, 2011, primarily to support Security growth and future order fulfillment.
- Goodwill increased to $77.1 million from $70.3 million, primarily from acquisition-related activity and adjustments. The filing describes the acquisition activity as immaterial individually.
- The credit agreement was amended in December 2011 to increase the letter-of-credit subfacility from $175 million to $200 million.
Guidance, outlook, risks and unusual items
The filing does not provide specific financial guidance. Management described continued opportunities in global security and inspection markets and growth from the installed equipment base and related service revenue. Management also stated that healthcare customers continued to delay purchases because of economic uncertainty; the timing of a full recovery remains unclear.
- International operations expose the company to regulatory, geopolitical, economic, collection, distributor, tariff and foreign-currency risks. A 10% appreciation or depreciation of the U.S. dollar against applicable local currencies was estimated to change quarterly operating income by approximately $2 million in the opposite direction.
- Foreign-currency forward contracts of approximately $6.2 million were outstanding at December 31, 2011. These contracts did not qualify as cash-flow hedges, and related gains or losses were recorded in earnings.
- Contingent consideration from acquisitions had a maximum potential payment of $62 million; $16.0 million was recorded in other long-term liabilities at December 31, 2011. Certain acquisition arrangements also require royalties through 2022.
- The company is involved in ordinary-course legal proceedings and has disclosed soil and groundwater contamination matters at or associated with former facilities. No amounts were accrued because unfavorable outcomes were not considered probable and reasonably estimable, but an adverse resolution could be material.
- Warranty liabilities increased to $15.4 million at December 31, 2011, from $14.5 million at June 30, 2011.
- The company had no significant off-balance-sheet arrangements and reported no material changes to previously disclosed risk factors. Management concluded that disclosure controls were effective.
- The company has never paid cash dividends and does not expect to do so in the foreseeable future.
Important facts for investors to verify
- Whether the large ongoing Security contract and related service revenue remain sustainable and how much revenue concentration or execution risk they create.
- Whether elevated Security inventory and accounts receivable convert into shipments and cash without material excess or collection losses.
- Whether gross-margin pressure from business and product mix persists as Security and Optoelectronics grow faster than Healthcare.
- The timing and amount of potential contingent acquisition payments, including the maximum $62 million exposure and the $16.0 million liability already recorded.
- The status and potential financial exposure of legal and environmental matters that were not accrued.
- The availability and utilization of the revolving credit and letter-of-credit facilities, including compliance with financial covenants and the amendment increasing the letter-of-credit subfacility to $200 million.