OSI Systems, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended December 31, 2020, representing fiscal Q2 2021. Comparisons are to the three and six months ended December 31, 2019. The financial statements are unaudited and prepared under U.S. GAAP.
Business context
OSI Systems designs and manufactures specialized electronic systems and components for security and inspection, healthcare, defense, aerospace, and other critical applications. Its operating divisions are Security, Healthcare, and Optoelectronics and Manufacturing. COVID-19 materially affected aviation, cargo, service activity, customer delivery schedules, and order timing, while increasing demand for certain healthcare products.
Key financial metrics
| Metric | Three months ended Dec. 31, 2019 | Three months ended Dec. 31, 2020 | Change |
|---|---|---|---|
| Net revenue | $305.3 million | $276.0 million | Down 10% |
| Gross profit | $110.8 million | $102.1 million | Down 8% |
| Gross margin | 36.3% | 37.0% | Up 0.7 points |
| Operating income | $32.9 million | $32.4 million | Down 2% |
| Operating margin | 10.8% | 11.7% | Up 0.9 points |
| Net income | $21.0 million | $20.0 million | Down 5% |
| Diluted EPS | $1.12 | $1.10 | Down 2% |
| Metric | Six months ended Dec. 31, 2019 | Six months ended Dec. 31, 2020 | Change |
|---|---|---|---|
| Net revenue | $596.2 million | $530.9 million | Down 11% |
| Gross profit | $210.0 million | $197.8 million | Down 6% |
| Gross margin | 35.2% | 37.3% | Up 2.1 points |
| Operating income | $57.8 million | $49.1 million | Down 15% |
| Operating margin | 9.7% | 9.2% | Down 0.5 points |
| Net income | $41.7 million | $29.4 million | Down 30% |
| Diluted EPS | $2.22 | $1.61 | Down 27% |
- Revenue by division, Q2: Security declined 28% to $145.2 million; Healthcare increased 31% to $54.9 million; and Optoelectronics and Manufacturing increased 25% to $75.9 million.
- Revenue by division, six months: Security declined 29% to $280.0 million; Healthcare increased 29% to $106.4 million; and Optoelectronics and Manufacturing increased 18% to $144.5 million.
- Operating expenses: Q2 operating expenses decreased 10% to $69.7 million, primarily due to lower SG&A and R&D costs. Six-month operating expenses decreased 2% to $148.8 million, despite $8.2 million of impairment, restructuring, and other charges.
- Taxes: The six-month effective tax rate increased to 27.7% from 13.5%, primarily because the prior-year period included a $6.9 million discrete tax benefit related largely to equity compensation. Excluding discrete items, the rates were 27.5% and 27.8%, respectively.
Cash flow, liquidity, and debt
- Cash provided by operating activities was $89.5 million for the six months ended December 31, 2020, compared with $59.6 million in the prior-year period.
- Investing cash outflow was $20.5 million, including $8.5 million of capital expenditures, $7.0 million for intangible and other assets, and $3.0 million for a business acquisition.
- Financing cash outflow was $75.4 million, including $41.0 million of net repayments on bank lines, $24.8 million of share repurchases, and $11.3 million of taxes paid on net share settlements.
- Cash and cash equivalents were $72.6 million at December 31, 2020, down from $76.1 million at June 30, 2020. Approximately 72% was held by foreign subsidiaries and was subject to repatriation tax considerations.
- The company reported $18.0 million outstanding under its $535 million revolving credit facility, $71.2 million of letters of credit, and $445.8 million of borrowing availability. It was in compliance with all facility covenants.
- Long-term debt totaled $272.6 million, including $287.5 million principal amount of 1.25% convertible senior notes due September 1, 2022, net of unamortized discount and issuance costs.
- Management expects available funds, operating cash flow, and credit facilities to be sufficient for operational needs over the next 12 months and the foreseeable future.
Material changes and unusual items
- The Security division was adversely affected by delayed aviation and cargo orders, equipment deliveries, installations, service activity, and the expiration of a Mexico turnkey contract in June 2020.
- The Healthcare division benefited from higher patient-monitoring-system and related supply sales associated with COVID-19 demand. Management cautioned that elevated healthcare capital purchases could reduce future demand.
- The company recorded $8.2 million of net impairment, restructuring, and other charges during the six months, including $7.2 million associated with exiting the expired Mexico turnkey contract. The prior-year comparable period recorded a $3.0 million net benefit, primarily from insurance recoveries.
- Remaining performance obligations were approximately $361.1 million at December 31, 2020; approximately 60% was expected to be recognized over the following 12 months.
- In July 2020, the Healthcare division acquired a software development company for $3.0 million plus up to $12.0 million of contingent consideration. The acquisition was not material to consolidated results.
- During the six months, the company repurchased 320,136 shares for $24.8 million; no shares were repurchased during the quarter ended December 31, 2020.
Outlook, risks, and contingencies
- COVID-19 could continue to cause customer delays, manufacturing restrictions, supply-chain interruptions, modified service arrangements, delayed acceptance testing, and timing shifts in revenue recognition.
- Key additional risks include global economic and trade uncertainty, government budget and procurement policies, foreign currency movements, tax-law changes, technology adoption, contract renewals, export and regulatory compliance, and the ability to convert orders into fiscal-year revenue.
- The company faces shareholder litigation related to allegations in a 2017 short-seller report and continuing SEC and DOJ investigations concerning securities trading and related disclosures. Management states that outcomes cannot currently be predicted or estimated and has not accrued for potential losses.
- Environmental investigations continue at the Hawthorne, California facility. No loss contingency has been accrued because management considers an unfavorable outcome not probable and reasonably estimable; an adverse resolution could nevertheless be material.
- Acquisition-related contingent consideration had a fair value of $19.6 million at December 31, 2020, while the remaining maximum potential payments under capped arrangements were $32.8 million.
- The EU deadline for airport compliance with ECAC Standard 3 was moved to September 2021, with possible further changes under discussion. The company’s real-time tomography product has passed the Standard 3 requirement.
- No material changes were reported to the annual-report risk factors. Management stated that disclosure controls were effective and that there were no material changes to internal control over financial reporting.
Investor verification items
- Verify whether aviation and cargo demand, Security bookings, Mexico contract effects, and service revenue recover in subsequent quarters.
- Monitor whether COVID-19-related healthcare demand remains elevated or produces a later capital-purchase slowdown.
- Reconcile cash availability with foreign cash concentration, letters of credit, revolving borrowings, covenant compliance, and the September 2022 convertible-note maturity.
- Assess the recurrence and cash impact of restructuring, litigation, investigation, environmental, warranty, and contingent-consideration obligations.
- Track the conversion of the $361.1 million remaining performance obligation balance into revenue and any customer acceptance or delivery delays.
- Separate underlying operating performance from the significant prior-year discrete tax benefit and current-period Mexico exit charges.