OSI SYSTEMS INC quarterly report, Q2 FY2019

OSI Systems, Inc. Form 10-Q Summary

Reporting period: Quarterly period ended December 31, 2018, representing the second quarter and first six months of fiscal 2019. Comparative periods ended December 31, 2017. The filing was signed January 25, 2019. OSI Systems designs and manufactures specialized electronic systems and components serving security, healthcare, defense, aerospace and related markets through its Security, Healthcare, and Optoelectronics and Manufacturing divisions.

Financial Performance and Position

Metric	Three months ended Dec. 31	Six months ended Dec. 31
Net revenue	$303.2 million, up 9%	$569.5 million, up 7%
Gross profit	$110.3 million; 36.4% margin	$206.3 million; 36.2% margin
Operating income	$31.7 million, up from $18.1 million	$48.0 million, up from $37.5 million
Net income	$19.1 million, versus a $47.0 million loss	$28.5 million, versus a $36.8 million loss
Diluted earnings per share	$1.03, versus a $2.47 loss	$1.53, versus a $1.95 loss
Operating cash flow	Not separately provided	$40.8 million, versus $84.7 million

Revenue growth was led by Security and Optoelectronics and Manufacturing. Healthcare revenue declined.
Product revenue increased to $225.4 million in the quarter from $181.4 million, while service revenue declined to $77.8 million from $96.1 million.
Quarterly operating margin improved to 10.5% from 6.5%; six-month operating margin improved to 8.4% from 7.0%.
Interest and other expense increased to $5.6 million for the quarter and $11.0 million year to date, primarily due to higher rates and, year to date, higher average debt balances.
The effective tax rate was 26.8% for the quarter and 23.0% year to date. The prior-year periods included a $56.2 million Tax Act-related charge, materially depressing prior-year net income.
At December 31, 2018, cash and cash equivalents were $96.0 million, accounts receivable were $226.1 million, inventories were $315.2 million, and total assets were $1.298 billion.
Bank lines of credit were $149.0 million, current debt was $2.1 million, and long-term debt was $253.2 million. The company had $317.1 million available under its $525 million revolving credit facility, subject to letters of credit and facility terms, and reported compliance with all covenants.
Cash used in investing was $31.5 million, including $18.3 million for acquisitions and $12.6 million for capital expenditures. Financing activities provided $3.1 million, including $36.0 million of revolving-credit borrowings and $21.0 million of share repurchases.

Material Changes Versus Prior Comparable Period

Security quarterly revenue increased 10% to $188.7 million, driven by cargo and vehicle inspection products and explosive detection systems, partly offset by lower services and turnkey revenue tied to the SAT Mexico contract.
Healthcare quarterly revenue declined 2% to $51.6 million; year-to-date revenue declined 8% to $89.8 million because of softness in patient monitoring and cardiology, reduced emphasis on anesthesia, and exit from an underperforming sales channel.
Optoelectronics and Manufacturing quarterly revenue increased 19% to $62.9 million and year-to-date revenue increased 19% to $121.0 million, reflecting acquisitions and strength in commercial optoelectronics.
SG&A increased 12% in the quarter and 11% year to date, primarily due to Security commissions, modified stock awards, and acquisition-related costs. R&D declined 15% in the quarter and 12% year to date.
Impairment, restructuring and other charges improved from $8.3 million of expense to a $1.3 million net credit in the quarter, and from $9.4 million to $2.9 million year to date. The current quarter included a $4.6 million insurance recovery of legal costs, partly offset by $3.3 million of Healthcare restructuring costs.
Cash flow from operations fell by $43.9 million year to date, primarily because of working-capital outflows and the absence of the prior-year deferred-tax benefit related to the Tax Act.
OSI adopted ASC 606 on July 1, 2018 using the modified retrospective method. For the quarter, reported revenue and net income were $14.8 million and $2.6 million higher, respectively, than under the previous method. Remaining performance obligations were approximately $162.3 million at December 31, 2018, with approximately 50.5% expected to be recognized over the next 12 months.
The company repurchased 288,316 shares for $21.0 million during the first six months and had 562,707 shares remaining under its authorization at December 31, 2018.

Outlook, Risks and Unusual Items

Management stated that cash, available credit facilities and operating cash flow are expected to be sufficient for operational needs over the next 12 months and the foreseeable future. No quantitative revenue or earnings guidance was provided.
Management cited uncertainty from the U.S. government shutdown, Brexit negotiations, global trade policies and tariffs, foreign-exchange movements, government procurement and spending, and possible delays in orders, payments, shipments and customer acceptance.
Healthcare results may remain pressured by product-launch difficulties, the anesthesia product-line de-emphasis and healthcare-industry uncertainty.
The company faces ongoing securities litigation and shareholder derivative actions following a December 2017 short-seller report concerning FCPA compliance. The SEC and DOJ are investigating FCPA-related matters and, separately, trading in company securities. The company cannot predict outcomes, penalties or potential losses and has not accrued for these matters.
OSI is investigating historical soil and groundwater contamination beneath its Hawthorne, California facility. No liability has been accrued because management considers an unfavorable outcome possible but not probable and reasonably estimable; an adverse resolution could be material.
Contingent acquisition consideration had a fair value liability of $20.0 million at December 31, 2018, with maximum potential future payments of $35.0 million under capped arrangements.
Approximately 73% of cash was held by foreign subsidiaries and may be subject to repatriation tax considerations. The company intends to permanently reinvest certain foreign earnings.
No goodwill impairment was identified as of December 31, 2018. The company reported effective disclosure controls and no material changes in internal control over financial reporting.

Investor Verification Points

Verify whether Security growth and the expected European Union airport screening opportunity offset continued weakness in service and turnkey revenue.
Monitor Healthcare restructuring, product launches, channel changes and the potential for further revenue or margin pressure.
Assess operating cash conversion, accounts receivable and inventory levels in light of the decline in year-to-date operating cash flow.
Review leverage, variable-rate exposure, covenant compliance and the December 2021 revolving-credit maturity.
Follow the SEC and DOJ investigations, related litigation and potential FCPA, securities-trading or other regulatory consequences.
Evaluate the effect of ASC 606 on reported revenue timing, contract assets, advances from customers and remaining performance obligations.
Track contingent acquisition payments, restructuring liabilities, environmental matters and foreign-currency exposure.