TMCnet News
OSI SYSTEMS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) In this report, "OSI", the "Company", "we", "us", "our" and similar terms refer to OSI Systems, Inc. and wholly-owned subsidiaries. This management's discussion and analysis of financial condition as of September 30, 2014 and results of operations for the three-months ended September 30, 2013 and 2014 should be read in conjunction with management's discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended June 30, 2014. Forward-Looking Statements Certain statements contained in this Quarterly Report on Form 10-Q that are not related to historical results, including, without limitation, statements regarding our business strategy, objectives and future financial position, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and involve risks and uncertainties. These forward-looking statements may be identified by the use of forward-looking terms such as "anticipate," "believe," "expect," "may," "could," "likely to," "should," or "will," or by discussions of strategy that involve predictions which are based upon a number of future conditions that ultimately may prove to be inaccurate. Statements in this Quarterly Report on Form 10-Q that are forward-looking are based on current expectations and actual results may differ materially. These forward-looking statements should be considered in light of numerous risks and uncertainties described in this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K and other documents previously filed or hereafter filed by us from time to time with the Securities and Exchange Commission. Such factors, of course, do not include all factors that might affect our business and financial condition. Although we believe that the assumptions upon which our forward-looking statements are based are reasonable, such assumptions could prove to be inaccurate and actual results could differ materially from those expressed in or implied by the forward-looking statements. For example, the Company could 16 -------------------------------------------------------------------------------- Table of Contents be exposed to a variety of negative consequences as a result of delays related to the award of domestic and international contracts; delays in customer programs; unanticipated impacts of sequestration and other provisions of the Budget Control Act of 2011 as modified by the Bipartisan Budget Act of 2013; changes in domestic and foreign government spending, budgetary, procurement and trade policies adverse to our businesses; market acceptance of our new and existing technologies, products and services; our ability to win new business and convert any orders received to sales within the fiscal year in accordance with our annual operating plan; enforcement actions in respect of any noncompliance with laws and regulations including export control and environmental regulations and the matters that are the subject of some or all of the Company's ongoing investigations and compliance reviews, contract and regulatory compliance matters, and actions, if brought, resulting in judgments, settlements, fines, injunctions, debarment and/or penalties as well as other risks and uncertainties, including but not limited to those detailed herein and from time to time in our Securities and Exchange Commission filings, which could have a material and adverse impact on the Company's business, financial condition and results of operation. All forward-looking statements contained in this Quarterly Report on Form 10-Q are qualified in their entirety by this statement. We undertake no obligation other than as may be required under securities laws to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Executive Summary We are a vertically integrated designer and manufacturer of specialized electronic systems and components for critical applications. We sell our products and provide related services in diversified markets, including homeland security, healthcare, defense and aerospace. We have three operating divisions: (a) Security, providing security and inspection systems, turnkey security screening solutions and related services; (b) Healthcare, providing patient monitoring, cardiology and anesthesia systems; and (c) Optoelectronics and Manufacturing, providing specialized electronic components for our Security and Healthcare divisions, as well as to external original equipment manufacturer clients for applications in the defense, aerospace, medical and industrial markets, among others. Security Division. Through our Security division, we provide security screening, threat detection and non-intrusive inspection products and services worldwide, and provide turnkey security screening solutions. These products and services are used to inspect baggage, cargo, vehicles and other objects for weapons, explosives, drugs, radioactive material and other contraband as well as to screen people. Revenues from our Security division accounted for 47% and 52% of our total consolidated revenues for the three months ended September 30, 2013 and 2014, respectively. As a result of the terrorist attacks of September 11, 2001, and subsequent attacks in other locations worldwide, security and inspection products have increasingly been used at a wide range of facilities other than airports, such as border crossings, railway stations, seaports, cruise line terminals, freight forwarding operations, sporting venues, government and military installations and nuclear facilities. We believe that our wide-ranging product portfolio together with our ability to provide turnkey screening solutions position us to competitively pursue security and inspection opportunities as they arise throughout the world. Currently, the U.S. federal Government is discussing various options to address sequestration and the U.S. federal Government's overall fiscal challenges and we cannot predict the outcome of these efforts. While we believe that national security spending will continue to be a priority, U.S. Government budget deficits and the national debt have created increasing pressure to examine and reduce spending across many federal agencies. We believe that the diversified product portfolio and international customer mix of our Security division position us well to withstand the impact of these uncertainties and even benefit from specific initiatives within various governments. However, depending on how future sequestration cuts are implemented and how the U.S. federal Government manages its fiscal challenges, we believe that these federal actions could have a material, adverse effect on our business, financial condition and results of operations. Healthcare Division. Through our Healthcare division, we design, manufacture, market and service patient monitoring, cardiology and anesthesia delivery and ventilation systems and related supplies and accessories worldwide for sale primarily to hospitals and medical centers. Our products monitor patients in critical, emergency and perioperative care areas of the hospital and provide such information, through wired and wireless networks, to physicians and nurses who may be at the patient's bedside, in another area of the hospital or even outside the hospital. Revenues from our Healthcare division accounted for 22% of our total consolidated revenues for each of the three months ended September 30, 2013 and 2014. 17 -------------------------------------------------------------------------------- Table of Contents The healthcare markets in which we operate are highly competitive. We believe that our customers choose among competing products on the basis of product performance, functionality, value and service. In addition, there is continued uncertainty regarding the ongoing debates related to the U.S. budget and debt ceiling and the Patient Protection and Affordable Care Act, amended by the Health Care and Education and Reconciliation Act of 2010 (the "Affordable Care Act"), in the U.S., any of which may impact hospital spending, reimbursement and fees which will be levied on certain medical device revenues and adversely affect our business and results of operations. In addition, hospital capital spending appears to have been impacted by strategic uncertainties surrounding the Affordable Care Act and economic pressures. We also believe that the worldwide economic slowdown has caused some hospitals and healthcare providers to delay purchases of our products and services. During this period of uncertainty, sales of our healthcare products may be negatively impacted. Although there are indications that a general economic recovery is underway, we cannot predict when the markets will fully recover or when the uncertainties related to the U.S. federal government will be resolved and, therefore, when this period of delayed and diminished purchasing will end. A prolonged delay could have a material adverse effect on our business, financial condition and results of operations. During the three months ended September 30, 2014, our Healthcare division completed a small acquisition that expands our customer base and geographic footprint, while leveraging our existing infrastructure. Optoelectronics and Manufacturing Division. Through our Optoelectronics and Manufacturing division, we design, manufacture and market optoelectronic devices and provide electronics manufacturing services globally for use in a broad range of applications, including aerospace and defense electronics, security and inspection systems, medical imaging and diagnostics, telecommunications, office automation, computer peripherals, industrial automation systems, automotive diagnostic systems, gaming systems and consumer products. We also provide our optoelectronic devices and electronics manufacturing services to original equipment manufacturers, as well as our own Security and Healthcare divisions. Revenues from external customers in our Optoelectronics and Manufacturing division accounted for approximately 31% and 26% of our total consolidated revenues for the three months ended September 30, 2013 and 2014, respectively. Results of Operations for the Three Months Ended September 30, 2013 (Q1 2014) Compared to Three Months Ended September 30, 2014 (Q1 2015) (amounts in millions) Net Revenues The table below and the discussion that follows are based upon the way in which we analyze our business. See Note 9 to the condensed consolidated financial statements for additional information about our business segments. Q1 % of Q1 % of 2014 Net Sales 2015 Net Sales $ Change % Change Security division $ 97.2 47 % $ 113.4 52 % $ 16.2 17 % Healthcare division 45.8 22 % 47.8 22 % 2.0 4 % Optoelectronics and Manufacturing division 71.3 35 % 69.1 31 % (2.2 ) (3 )% Less: inter-division sales (8.0 ) (4 )% (11.9 ) (5 )% (3.9 ) 49 % Total external revenues $ 206.3 $ 218.4 $ 12.1 6 % Revenues for the Security division for the three months ended September 30, 2014 increased primarily as a result of increased baggage and parcel inspection sales, new product launches and partial fulfillment of the $102 million Foreign Military Sale contract to the U.S. Department of Defense to supply multiple units of cargo and vehicle inspection systems and related training, spare parts, service and logistics support for Iraq. Revenues for the Healthcare division for the three months ended September 30, 2014 increased primarily due to the acquisition of a European cardiology equipment business during the first quarter of the current fiscal year and increased sales in our North American and Asian markets. These increases were partially offset by a decrease in organic sales in our Europe, Middle East and African region. Revenues for the Optoelectronics and Manufacturing division for the three months ended September 30, 2014 decreased 3% as a result of lower contract manufacturing sales in the current fiscal year. This decrease was primarily attributable to exceptionally high sales to a single customer during the first quarter of the prior fiscal year to whom we continue to sell but at a lower level. Gross Profit Q1 % of Net Q1 % of Net 2014 Sales 2015 Sales $ Change % Change Gross profit $ 67.9 32.9 % $ 74.2 34.0 % $ 6.3 9 % Gross profit during the three months ended September 30, 2014 increased as a result of increased sales and an improvement in gross margin. The gross margin increase was a result of the impact of lower revenues in our Optoelectronics and Manufacturing division, which has historically generated the lowest gross margins across the three divisions. 18 -------------------------------------------------------------------------------- Table of Contents Operating Expenses Q1 % of Net Q1 % of Net % 2014 Sales 2015 Sales $ Change Change Selling, general and administrative $ 42.2 20.5 % $ 44.2 20.3 % $ 2.0 5 % Research and development 11.0 5.3 % 12.7 5.8 % 1.7 15 % Restructuring and other charges 4.2 2.0 % 0.7 0.3 % (3.5 ) (83 )% Total operating expenses $ 57.4 27.8 % $ 57.6 26.4 % $ 0.2 0 % Selling, general and administrative. Selling, general and administrative (SG&A) expenses consist primarily of compensation paid to sales, marketing and administrative personnel, professional service fees and marketing expenses. SG&A for the three months ended September 30, 2014 increased primarily to support our 6% revenue growth. Research and development. Research and development (R&D) expenses include research related to new product development and product enhancement expenditures. R&D for the three months ended September 30, 2014 increased significantly as we invested in the next generation of products within our Security division, while R&D spending in our Healthcare and Optoelectronics and Manufacturing divisions was in line with the prior year. Restructuring and other charges. Restructuring and other charges consist of nonrecurring charges related to facility consolidation and other opportunities to become more efficient. In addition, during the past several quarters we have incurred costs related to contracts with the U.S. federal government and professional fees associated with defending against class action and derivative lawsuits filed against the Company. Restructuring and other charges for the three months ended September 30, 2014 decreased significantly as we incurred significant charges in the prior year including: $2.0 million in our Healthcare division related to a facility relocation, $0.6 million in our Optoelectronics and Manufacturing division related to employee severance as a result of a facility consolidation and a $1.6 million charge in our Security division related to a contract settlement with the U.S. federal government. In the current year, such charges were much lower and included $0.1 million in both our Healthcare and Optoelectronics and Manufacturing divisions related to capitalizing on efficiency opportunities, and $0.4 million in our Corporate segment related to the class action and derivative lawsuits. Other Income and Expenses Interest and other expense, net. For the three months ended September 30, 2014, interest and other expense, net amounted to $0.9 million as compared to $1.5 million in the comparable prior-year period. This decrease was primarily due to decreased interest expense related to lower average outstanding borrowings under our revolving credit facility as we have generated significant levels of free cash flow over the past several quarters, and the reduction in the cost of borrowing in connection with the amended credit facility completed in May 2014. Income taxes. For the three months ended September 30, 2014, our income tax provision was $4.6 million, compared to $2.6 million for the comparable prior-year period. Our effective tax rate for the three months ended September 30, 2014 was 28.8%, compared to 29.0% in the comparable prior-year period. The effective tax rate for a particular period varies depending on a number of factors including (i) the mix of income earned in various tax jurisdictions, each of which applies a unique range of income tax rates and income tax credits, (ii) changes in previously established valuation allowances for deferred tax assets (changes are based upon our current analysis of the likelihood that these deferred tax assets will be realized), (iii) the level of non-deductible expenses, (iv) certain tax elections and (v) tax holidays granted to certain of our international subsidiaries. 19 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Our principal sources of liquidity are our cash and cash equivalents, cash generated from operations and our credit facility. Cash and cash equivalents totaled $37.3 million at September 30, 2014, a decrease of $1.5 million from $38.8 million at June 30, 2014. During the three months ended September 30, 2014, we generated $31.5 million of cash flow from operations and received net proceeds from our credit facility of $6.0 million. These proceeds were used for the following: i) $3.1 million invested in capital expenditures, ii) $11.9 million for the acquisition of businesses and other assets and iii) $24.9 million for the repurchase of our common stock, including net share settlement of equity awards. If we continue to net settle equity awards, we will use additional cash to pay our tax withholding obligations in connection with such settlements. We currently anticipate that our available funds, credit facilities and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future. In addition, without repatriating earnings from non-U.S. subsidiaries, we anticipate that cash generated from operations will be able to satisfy our obligations in the U.S., including our outstanding lines of credit as accounting earnings in the U.S. are not necessarily indicative of cash flows since earnings are generally reduced by non-cash expenses including depreciation, amortization, and stock-based compensation. We have a five-year revolving credit facility that allows us to borrow up to $450 million at London Interbank Offered Rate (LIBOR) plus 1.25% depending upon our leverage ratio. As of September 30, 2014, there was $30.0 million outstanding under the revolving credit facility and $100.1 million outstanding under the letters-of-credit sub-facility. Cash Provided by Operating Activities. Cash flows from operating activities can fluctuate significantly from period to period, as net income, adjusted for non-cash items, and working capital fluctuations impact cash flows. During the three month ended September 30, 2014, we generated cash from operations of $31.5 million compared to $6.2 million in the prior year period. Cash flow from operating activities during the first quarter of fiscal 2015 primarily consisted of net income of $11.2 million, adjusted for certain non-cash items, including total depreciation and amortization of $17.7 million, stock-based compensation expense of $6.0 million, and the net negative impact of changes in operating assets and liabilities on cash of $3.6 million. The year-over-year increase in cash from operations primarily resulted from improved profitability and the impact of changes in working capital as the prior year changes in working capital used $18.9 million of cash. Cash Used in Investing Activities. Net cash used in investing activities was $15.1 million for the three months ended September 30, 2014 as compared to $19.0 million used for the three months ended September 30, 2013. During the three months ended September 30, 2014, we made $3.1 million in capital expenditures compared to $8.0 million during the comparable prior-year period. This decrease is primarily a result of the timing of capital expenditures in support of our turnkey screening program in Mexico. In the three months ended September 30, 2014, we also used cash of $10.9 million for acquisitions of businesses as compared to $9.3 million in the comparable prior-year period. Cash Provided by (Used in) Financing Activities. Net cash used in financing activities was $19.0 million for the three months ended September 30, 2014, compared to $14.5 million provided by financing activities for the three months ended September 30, 2013. During the three months ended September 30, 2014, we repurchased $24.9 million of our common stock including net share settlement of equity awards compared to $9.0 million for the same period in the prior year. Also, during the current year we drew down $6.0 million from our credit facility as compared to $20.0 million in the prior year. Borrowings Outstanding lines of credit and current and long-term debt totaled $44.1 million at September 30, 2014, an increase of $6.8 million from $37.3 million at June 30, 2014. See Note 4 to the condensed consolidated financial statements for further discussion. Cash Held by Foreign Subsidiaries Our cash, cash equivalents, and investments totaled $37.3 million at September 30, 2014. Of this amount, approximately 66% was held by our foreign subsidiaries and subject to repatriation tax considerations. These foreign funds were located primarily in Malaysia and the United Kingdom, and to a lesser extent in Mexico, India, Singapore, China, Germany and Canada amongst others. We intend to permanently reinvest a significant portion of our earnings from foreign operations, and we currently do not anticipate that we will need this cash in foreign countries to fund our U.S. operations. In the event that funds from foreign operations are needed to fund operations in the United States and if U.S. taxes have not been previously provided on the related earnings, we would provide for and pay additional U.S. taxes at the time we change our intention with regard to the reinvestment of those earnings. 20 -------------------------------------------------------------------------------- Table of Contents Issuer Purchases of Equity Securities The following table presents the shares acquired during the quarter ended September 30, 2014: Maximum number (or appropriate Total number of dollar value) shares (or units) of shares (or units) purchased as that may Total number of Average price part of publicly yet be purchased shares (or units) paid per share announced plans or under the plans or purchased (or unit) programs programs (3) July 1, 2014 to July 31, 2014 159,542 (1)(2) $ 65.19 159,474 1,059,721 August 1, 2014 to August 31, 2014 47,548 (1)(2) $ 66.44 29,642 1,030,079 September 1, 2014 to September 30, 2014 171,183 (1)(2) $ 66.39 87,884 942,195 378,273 $ 65.89 277,000 -------------------------------------------------------------------------------- (1) A total of 68 shares, 17,906 shares and 83,299 shares of common stock were tendered to satisfy minimum statutory tax withholding obligations related to the vesting of restricted shares for the months July, August and September 2014, respectively. (2) For the three months ended September 30, 2014, a total of 277,000 shares of common stock were purchased under the stock repurchase program at an average price of $66.30 per share. (3) In March 1999, our Board of Directors authorized a stock repurchase program of up to 2,000,000 shares. In September 2004, our Board of Directors authorized an additional 1,000,000 shares for repurchase pursuant to this program. In April 2013, our Board of Directors authorized an additional 1,000,000 shares for repurchase pursuant to this program. This program does not have an expiration date. Upon repurchase, the shares are restored to the status of authorized but unissued and we record them as a reduction in the number of shares of common stock issued and outstanding in our consolidated financial statements. Dividend Policy We have not paid cash dividends on our common stock in the past and have no plans to do so in the foreseeable future. Certain of our current bank credit facilities restrict the payment of cash dividends and future borrowings may contain similar restrictions. Contractual Obligations We presented our contractual obligations in our Annual Report on Form 10-K for the fiscal year ended June 30, 2014. See Note 7 to the condensed consolidated financial statements for further discussion regarding significant changes in those obligations during the first three months of fiscal 2015. Off Balance Sheet Arrangements As of September 30, 2014, we did not have any significant off balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions and select accounting policies that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Our critical accounting policies are detailed in our Annual Report on Form 10-K for the year ended June 30, 2014. Please refer Note 1 to our condensed consolidated financial statements for discussion concerning recent accounting updates not yet adopted. |