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 related markets. Its reporting segments are Security, Healthcare, and Optoelectronics and Manufacturing. The filing covers the three months ended September 30, 2018, the first quarter of fiscal 2019, compared with the three months ended September 30, 2017, the first quarter of fiscal 2018. The financial statements are unaudited.
Key financial metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net revenues | $266.2 million | $257.1 million | +4% |
| Gross profit | $95.9 million | $91.3 million | +5% |
| Gross margin | 36.0% | 35.5% | +50 bps |
| Income from operations | $16.3 million | $19.4 million | -16% |
| Operating margin | 6.1% | 7.5% | Down |
| Net income | $9.4 million | $10.2 million | -7% |
| Diluted EPS | $0.50 | $0.52 | -4% |
| Cash flow from operations | $(2.8) million | $35.1 million | Down $37.9 million |
Revenue growth was driven by Security and Optoelectronics and Manufacturing, partially offset by Healthcare. Product revenue increased to $182.5 million from $165.7 million, while service revenue declined to $83.8 million from $91.5 million.
- Security: Revenue increased 5% to $170.0 million; operating income increased to $23.1 million from $22.7 million.
- Healthcare: Revenue decreased 16% to $38.3 million; the segment recorded an operating loss of $1.9 million versus income of $0.8 million.
- Optoelectronics and Manufacturing: Revenue increased 20% to $70.9 million; operating income increased 32% to $6.8 million.
Operating expense increased 11% to $79.7 million. SG&A increased $6.0 million, while restructuring and other charges increased to $4.2 million from $1.1 million, including $3.6 million of legal fees related to class-action litigation and government investigations. Interest and other expense increased to $5.3 million from $4.2 million because of higher revolving-facility borrowings and higher interest rates.
Liquidity, cash flow, debt, and balance sheet
- Cash and cash equivalents were $86.4 million at September 30, 2018, compared with $84.8 million at June 30, 2018. Approximately 59% was held by foreign subsidiaries.
- Operating cash flow was negative $2.8 million, primarily because working capital increased to support revenue growth. Inventories rose to $344.0 million from $313.6 million at June 30, and accounts receivable increased to $222.2 million from $210.7 million.
- Investing cash outflow was $30.5 million, including $17.5 million for an optoelectronics acquisition and $7.9 million of capital expenditures.
- Financing cash inflow was $34.6 million, including $53.0 million of net revolving-credit borrowings, partly offset by $7.8 million of share repurchases and $12.6 million of taxes paid related to equity award settlements.
- The revolving credit facility has a $525 million commitment and matures in December 2021. Borrowings were $166.0 million, letters of credit were $59.1 million, and reported available borrowing capacity was $299.9 million. The company stated that it was in compliance with all covenants.
- Long-term debt, net of discounts and issuance costs, was $253.3 million, including $249.7 million of convertible notes. Current debt was $2.3 million. The filing also reports $60.4 million outstanding under foreign subsidiary credit facilities.
- Management expects available cash, credit facilities, and operating cash flow to meet operational needs for the next 12 months and the foreseeable future.
Material changes versus the prior comparable period
- Revenue increased 4%, but operating income declined 16% and net income declined 7% because of higher SG&A, legal and other charges, and interest expense.
- Healthcare weakened materially because of lower patient monitoring and cardiology sales, reduced anesthesia activity, and continuing product-launch difficulties.
- Operating cash flow declined from $35.1 million provided to $2.8 million used, reflecting higher inventories, receivables, and other working-capital needs.
- The company adopted ASC 606 on July 1, 2018 using the modified retrospective method. The filing states that adoption had an immaterial cumulative effect and increased reported Q1 FY2019 revenue by $3.4 million and net income by $0.1 million versus the former revenue-recognition guidance.
- The company completed two acquisitions: an optoelectronics solutions business for $17.5 million plus up to $1.0 million of earnout consideration, and a small Security services company for approximately $0.8 million plus up to approximately $5.0 million of contingent consideration.
- The company repurchased 104,146 shares for approximately $7.8 million at an average price of $75.32 per share. Approximately 746,877 shares remained authorized for repurchase at September 30, 2018.
Outlook, risks, contingencies, and unusual items
The filing does not provide specific quantitative revenue or earnings guidance. Management cited continued uncertainty from global economic conditions, delayed or deferred customer purchasing, foreign-exchange movements, trade policies and tariffs, government spending and procurement decisions, and healthcare-industry conditions. The company also noted that the potential 2020 European Union hold-baggage screening deadline could be delayed, affecting related Security opportunities.
- Legal and regulatory investigations: The company faces securities-related lawsuits and shareholder derivative actions following a short-seller report alleging FCPA compliance issues. The SEC and DOJ are investigating FCPA compliance and trading in company securities. Management stated that outcomes, penalties, remedial measures, and potential losses cannot currently be predicted or estimated.
- Environmental contingency: The company continues investigating historical soil and groundwater contamination at its Hawthorne, California facility. No liability was accrued because an unfavorable outcome was not considered probable and reasonably estimable; an adverse resolution could be material.
- Acquisition obligations: The maximum potential future contingent acquisition payments were $36.0 million, and the recorded contingent consideration liability increased to $21.1 million.
- Tax uncertainty: The company continued evaluating the Tax Act, including GILTI and related provisions. The accounting for the Tax Act was expected to be completed in the quarter ended December 31, 2018, and future adjustments could materially affect the tax provision and effective tax rate.
- Unusual charges: Q1 FY2019 included $3.6 million of legal costs, $0.3 million of acquisition-related costs, and $0.3 million of employee termination costs.
Important facts for investors to verify
- Whether Healthcare product-launch issues and lower demand persist and affect consolidated margins and earnings.
- The status and potential financial consequences of the SEC and DOJ investigations and related shareholder litigation.
- Working-capital trends, particularly inventory growth and the return to positive operating cash flow.
- Revolving-credit utilization, interest-rate exposure, covenant compliance, and the company’s ability to manage debt-funded acquisitions and repurchases.
- The final accounting and tax effects of ASC 606, the Tax Act, GILTI, and FDII.
- Revenue conversion and timing for the approximately $191.2 million of remaining performance obligations, of which approximately 47% was expected to be recognized within 12 months.
- Potential contingent acquisition payments, environmental exposure, and other unaccrued legal or regulatory losses.