OSI SYSTEMS, INC. In this report, "OSI", the "Company", "we", "us", "our" and similar terms refer
to
This management's discussion and analysis of financial condition as ofDecember 31, 2019 and results of operations for the three and six months endedDecember 31, 2019 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 endedJune 30, 2019 filed with theSEC . 27 Table of Contents Forward-Looking Statements
This report contains "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 (the "Exchange Act"). Forward-looking statements relate to current expectations, beliefs, and projections concerning matters that are not historical facts. Words such as "project," "believe," "anticipate," "plan," "expect," "intend," "may," "should," "will," "would," and similar words and expressions are intended to identify forward-looking statements. The expectations, beliefs, and projections reflected in the forward-looking statements may prove to be inaccurate, and actual results may differ materially from those reflected in such forward-looking statements. Important factors that could cause our actual results to differ materially from those expectations are disclosed in this report, our Annual Report on Form 10-K for the fiscal year endedJune 30, 2019 (including Part I, Item 1, "Business," Part I, Item 1A, "Risk Factors" and Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations"), and other documents filed by us from time to time with theSEC . 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, we could be exposed to a variety of negative consequences as a result of delays related to the award of domestic and international contracts; failure to secure the renewal of key customer contracts; delays in customer programs; delays in revenue recognition related to the timing of customer acceptance; unanticipated impacts of sequestration and otherU.S. Government budget control provisions; changes in domestic and foreign government spending, budgetary, procurement and trade policies adverse to our businesses; global economic uncertainty; unfavorable currency exchange rate fluctuations; effect of changes in tax legislation; 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; 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 our investigations and compliance reviews, contract and regulatory compliance matters, and actions, which if brought, could result in judgments, settlements, fines, injunctions, debarment or penalties, and other risks and uncertainties, including, but not limited to, those detailed herein and from time to time in our otherSEC filings, which could have a material and adverse impact on our business, financial condition and results of operations. All forward-looking statements contained in this report are qualified in their entirety by this statement. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties, and assumptions, the future events and trends discussed in this report may not occur, and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Investors should not place undue reliance on forward-looking statements as a prediction of actual results. 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 and turnkey security screening solutions; (b) Healthcare, providing patient monitoring and diagnostic cardiology systems; and (c) Optoelectronics and Manufacturing, providing specialized electronic components for our Security and Healthcare divisions, as well as to third parties for applications in the defense and aerospace markets, among others. Security Division. Through our Security division, we provide security screening products and services internationally, as well as turnkey security screening solutions. These products and services are used to inspect baggage, parcels, cargo, people, vehicles and other objects for weapons, explosives, drugs, radioactive and nuclear materials and other contraband. Revenues from our Security division accounted for 63% and 66% of our total consolidated revenues for the six months endedDecember 31, 2018 and 2019, respectively. 28 Table of Contents Healthcare Division. Through our Healthcare division, we design, manufacture, market and service patient monitoring and diagnostic cardiology systems internationally for sale primarily to hospitals and medical centers. Our products monitor patients in critical, emergency and perioperative care areas of the hospital and provide 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 16% and 14% of our total consolidated revenues for the six months endedDecember 31, 2018 and 2019, respectively. Optoelectronics and Manufacturing Division. Through our Optoelectronics and Manufacturing division, we design, manufacture and market optoelectronic devices and flex circuits and provide electronics manufacturing services internationally 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, automotive diagnostic systems, and consumer products. We also provide our optoelectronic devices and electronics manufacturing services to OEM customers, and our own Security and Healthcare divisions. Revenues from external customers in our Optoelectronics and Manufacturing division accounted for 21% and 20% of our total consolidated revenues for the six months endedDecember 31, 2018 and 2019, respectively. Trends and Uncertainties
The following is a discussion of certain trends and uncertainties that we believe have and may continue to influence our results of operations.
Global Economic Considerations. Global macroeconomic factors, coupled with theU.S. political climate, have created uncertainty and impacted demand for certain of our products and services primarily in our Security and Healthcare divisions. The current status and potential outcomes of Brexit negotiations has contributed to global economic uncertainty and could have an adverse impact on ourUK business, including our orders and sales operations and personnel in theUK . We do not know how long this uncertainty will continue. Therefore, we expect that there may be a period of delayed or deferred purchasing by our customers. These factors could have a material negative effect on our business, results of operations and financial condition. Our international operations provide a significant portion of our total revenue and expenses. Many of these revenues and expenses are denominated in currencies other than theU.S. dollar, and, as a result, may be significantly affected by changes in foreign exchange rates. Global Trade. The current domestic and international political environment, including existing and potential changes toU.S. and foreign policies related to global trade and tariffs, have resulted in uncertainty surrounding the future state of the global economy. Further, theU.S. government has announced that sanctions would be imposed against certain businesses and individuals in select countries. Additional changes may require us to modify our current business practices and could have a material adverse effect on our business, results of operations and financial condition in any particular reporting period. Healthcare Considerations. Our results of operations were adversely impacted in prior periods by difficulties associated with product launches in our Healthcare division. These issues may continue to adversely impact our results of operations for additional periods. Additionally, there have been numerous efforts advanced by the Trump administration andCongress to repeal and replace or modify the Affordable Care Act, which has created uncertainty in the healthcare industry that has adversely impacted, and may continue to adversely impact, our results of operations. European Union Threat Detection Standards.The EU has implemented regulations for all airports within the EU to have hold baggage screening systems that are compliant with theEuropean Civil Aviation Conference (ECAC) Standard 3 bySeptember 2020 . However, this deadline could potentially be delayed. Our Security division's real time tomography (RTT) product has passed the ECAC explosive detection system Standard 3 threat detection requirement. Government Policies. Our net income could be affected by changes inU.S. or foreign government tax policies, such as the Tax Act, the implications and uncertainties of which are described elsewhere in this report. We attempt to manage our currency exposure in certain countries. The LIBOR index is expected to be discontinued by the end of calendar year 2021. Under our credit facility, if the LIBOR index is discontinued, the terms of our revolving credit facility allow for a 29 Table of Contents
replacement rate to be determined in accordance with the Agreement. Changes in government policies in these areas might impact our financial condition and results of operations.
Mexico SAT Contract. Our contract with the Mexican government to provide a turnkey security screening solution at various locations throughout the country scheduled to expire inJanuary 2020 was extended untilMay 13, 2020 . While we are actively in discussions with the Mexican government for a potentially broader program, we cannot provide any assurance that this program will be continued and, if the program is continued, upon what terms. If the program is discontinued or continued upon modified terms, our results of operations could be materially affected.
Results of Operations for the Three Months Ended
Net Revenues
The table below and the discussion that follows are based upon the way in which
we analyze our business. See Note 11 to the condensed consolidated financial
statements for additional information about our business segments.
Q2 % of Q2 % of
2019 Net Revenues 2020 Net Revenues $ Change % Change
Security $ 188.7 62 % $ 202.4 66 % $ 13.7 7 %
Healthcare 51.6 17 42.0 14 (9.6) (19)Optoelectronics and Manufacturing 62.9 21 60.9
20 (2.0) (3)
Total net revenues $ 303.2 100 % $ 305.3 100 % $ 2.1 1 %
Revenues for the Security division during the three months ended December 31,
2019 increased on a year-over-year basis as a result of increased revenue from
cargo and vehicle inspection systems, checkpoint equipment and overall service
revenue for the division, partially offset by decreases in sales of explosive
detection systems and explosive trace detection products.
Revenues for the Healthcare division during the three months ended
Revenues for the Optoelectronics and Manufacturing division during the three
months ended
Gross Profit
Q2 % of Q2 % of
2019 Net Revenues 2020 Net Revenues
Gross profit $ 110.3 36.4 % $ 110.8 36.3 %
Gross profit as a percentage of net revenues during the three months endedDecember 31, 2019 was comparable to the prior year An increase in the gross margin within the Optoelectronics and Manufacturing division, due primarily to operational efficiencies and product mix, was offset by lower gross margin in the Healthcare division as a result of lower net revenues leading to less manufacturing utilization. Operating Expenses Q2 % of Q2 % of 2019 Net Revenues 2020 Net Revenues $ Change % Change Selling, general and administrative$ 67.1 22.1 %$ 63.9 20.9 %$ (3.2) (4.8) % Research and development 12.8 4.2 14.9 4.9 2.1 16.2 Restructuring and other charges (benefit), net (1.3) (0.4) (0.9) (0.3) 0.4 (26.6) Total operating expenses$ 78.6 25.9 %$ 77.9 25.5 %$ (0.7) (1.0) % 30 Table of Contents 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 expense for the three months endedDecember 31, 2019 was lower than the prior comparable period primarily due to reduced compensation costs. Research and development. Research and development (R&D) expenses include research related to new product development and product enhancements. The increase in R&D spending during the three months endedDecember 31, 2019 from the same prior-year period reflected increased spending in our Security division primarily to support new product development. Restructuring and other charges (benefit). Restructuring and other charges generally consist of charges related to reductions in our workforce, facility consolidation, costs related to acquisition activity, legal charges and other non-recurring charges. The net benefit in the second fiscal quarter of 2019 was primarily due to a recovery of certain legal costs through insurance reimbursement which was partially offset by employee termination and business exit costs for restructuring activities in our Healthcare division. The net benefit in the second fiscal quarter of 2020 was primarily due to a further recovery of certain legal costs through insurance reimbursement, partially offset by additional legal fees and severance costs for headcount reductions. Other Income and Expenses Interest and other expense, net. For the three months endedDecember 31, 2019 , interest and other expense, net was$4.8 million as compared to$5.6 million in the comparable prior-year period. This decrease was driven primarily by lower levels of borrowing under our revolving credit facility as well as lower average interest rates during the three months endedDecember 31, 2019 compared to the same period in the prior year. Interest expense in the current-year period included$2.2 million of non-cash interest expense primarily related to the Notes (see Note 6 to the condensed consolidated financial statements for further discussion) compared to$2.0 million during the comparable prior-year period. Income taxes. 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. For the three months endedDecember 31, 2019 , we recognized a provision for income taxes of$7.1 million compared to$7.0 million for the comparable prior-year period. The effective tax rate for the three months endedDecember 31, 2018 and 2019 was 26.8% and 25.3%, respectively. During the three months endedDecember 31, 2018 and 2019, we recognized discrete tax benefits primarily for equity-based compensation under ASU 2016-09 of$0.4 million and$0.7 million , respectively. Excluding the net impact of these discrete tax benefits, our effective tax rate for the three months endedDecember 31, 2018 and 2019 was 28.3% and 27.7%, respectively. Results of Operations for the Six Months Ended December 31, 2018 (YTD Q2 2019) Compared to the Six Months Ended December 31, 2019 (YTD Q2 2020) (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 11 to the condensed consolidated financial statements for additional information about our business segments. YTD Q2 % of YTD Q2 % of 2019 Net Revenues 2020 Net Revenues $ Change % Change Security$ 358.6 63 %$ 391.4 65 %$ 32.8 9 % Healthcare 89.8 16 82.2 14 (7.6) (8)
Optoelectronics and Manufacturing 121.1 21 122.6
21 1.5 1
Total net revenues $ 569.5 100 % $ 596.2 100 % $ 26.7 5 %
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Revenues for the Security division during the six months endedDecember 31, 2019 increased on a year-over-year basis as a result of increased product revenue from cargo and vehicle inspection systems, explosive detection systems and checkpoint equipment, partially offset by decreases in sales of explosive trace detection products. Service revenue for the Security division increased slightly compared to the prior comparable period.
Revenues for the Healthcare division during the six months ended
Revenues for the Optoelectronics and Manufacturing division during the six months endedDecember 31, 2019 were slightly higher than the prior comparable period due primarily to higher sales from our contract manufacturing business. Gross Profit YTD Q2 % of YTD Q2 % of 2019 Net Revenues 2020 Net Revenues Gross profit$ 206.3 36.2 %$ 210.0 35.2 % Gross profit as a percentage of net revenues during the six months endedDecember 31, 2019 decreased on a year-over-year basis as a result of a reduction in gross margin in the Security division, due largely to an unfavorable mix of revenues driven by higher equipment sales growth relative to service revenue growth. Service revenues in the Security division generally carry higher gross margins than equipment sales. The decrease in net revenues from the Healthcare division also had a negative impact on overall gross profit as a percentage of net revenues since sales from our Healthcare division generally have higher gross margins than our other divisions. These impacts on gross margin were partially offset by an increase in the gross margin within the Optoelectronics and Manufacturing division due to favorable sales mix and operational efficiencies. Operating Expenses YTD Q2 % of YTD Q2 % of 2019 Net Revenues 2020 Net Revenues $ Change % Change Selling, general and administrative$ 128.8 22.6 %$ 126.1 21.1 %$ (2.7) (2.1) %
Research and development 26.6 4.7 29.1 4.9 2.5 9.7 Restructuring and other charges (benefit), net 2.9 0.5 (3.0) (0.5) (5.9) (203.3) Total operating expenses$ 158.3 27.8 %$ 152.2 25.5 %$ (6.1) (3.9) % 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 expense for the six months endedDecember 31, 2019 was lower than the prior comparable period due in large part to lower amortization expense for acquisition related intangible assets and miscellaneous smaller items. Research and development. Research and development (R&D) expenses include research related to new product development and product enhancements. The increase in R&D spending during the six months endedDecember 31, 2019 from the same prior-year period reflected increased spending in our Security division primarily to support new product development. Restructuring and other charges (benefit). In the first half of fiscal 2019, we incurred restructuring and other charges of$3.6 million related to employee termination and business exit costs and$0.3 million in acquisition costs, which were partially offset by a net$1.0 million recovery of certain legal costs as a result of insurance reimbursements. The net benefit in the first half of fiscal year 2020 was primarily due to a further net recovery of$3.5 million for certain legal costs through insurance reimbursements, partially offset by$0.5 million in severance costs for headcount reductions. 32 Table of Contents Other Income and Expenses Interest and other expense, net. For the six months endedDecember 31, 2019 , interest and other expense, net was$9.6 million as compared to$11.0 million in the comparable prior-year period. This decrease was driven primarily by lower levels of borrowing under our revolving credit facility as well as a lower average interest rate during the six months endedDecember 31, 2019 compared to the same period in the prior year. Interest expense in the current-year period included$4.4 million of non-cash interest expense largely related to the Notes (see Note 6 to the condensed consolidated financial statements for further discussion) compared to$3.9 million during the comparable prior-year period. Income taxes. For the six months endedDecember 31, 2019 , we recognized a provision for income taxes of$6.5 million compared to$8.5 million for the comparable prior-year period. The effective tax rate for the six months endedDecember 31, 2018 and 2019 was 23.0% and 13.5%, respectively. During the six months endedDecember 31, 2018 and 2019, we recognized discrete tax benefits primarily for equity-based compensation under ASU 2016-09 of$1.9 million and$6.9 million , respectively. Excluding the net impact of these discrete tax benefits, our effective tax rate for the six months endedDecember 31, 2018 and 2019 was 28.2% and 27.8%, respectively.
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$95.1 million as ofDecember 31, 2019 , a decrease of$1.3 million , or 1.3%, from$96.3 million as ofJune 30, 2019 . During the six months endedDecember 31, 2019 , we generated$59.6 million of cash flow from operations. We currently anticipate that our available funds, cash flow from operations and credit facilities will be sufficient to meet our operational cash needs for the next 12 months and the foreseeable future. Our current revolving credit facility allows us to borrow up to$535 million and matures inApril 2024 . As ofDecember 31, 2019 , there was$91.0 million outstanding under the revolving credit facility and$53.7 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 six months endedDecember 31, 2019 , we generated$59.6 million of cash from operations compared to$40.8 million in the same prior-year period. The increase in operating cash flow was driven by an improvement in working capital as well as higher net income. Cash Used in Investing Activities. Net cash used in investing activities was$15.6 million for the six months endedDecember 31, 2019 compared to$31.5 million used for the six months endedDecember 31, 2018 . During the six months endedDecember 31, 2019 , we used cash of$11.6 million for capital expenditures and$3.9 million for the acquisition of intangible and other assets. During the six months endedDecember 31, 2018 , we used cash of$17.5 million for the acquisition of an optoelectronics solutions business and$0.8 million for the acquisition of a Security services business and we used cash of$12.6 million for capital expenditures.
Cash (Used in) Provided by Financing Activities. Net cash used in financing activities was$45.9 million for the six months endedDecember 31, 2019 compared to net cash provided by financing activities of$3.1 million for the six months endedDecember 31, 2018 . During the six months endedDecember 31, 2019 , our primary uses in financing were$53.7 million for repurchases of our common shares and tax payments related to net share settlements of equity awards, partially offset by$3.0 million of net borrowings on our revolving credit facility and$6.1 million of proceeds from exercise of stock options and the employee stock purchase plan. During the six months endedDecember 31, 2018 , our primary source of financing was$36.0 million borrowed under our revolving credit facility. This source of funds was partially offset by$34.0 million used for share repurchases and taxes paid related to the net share settlement of
equity awards.
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Borrowings
See Note 6 to the condensed consolidated financial statements for a detailed discussion regarding our revolving credit facility and our Notes.
Cash Held by Foreign Subsidiaries
Our cash and cash equivalents totaled$95.1 million atDecember 31, 2019 . Of this amount, approximately 82% was held by our foreign subsidiaries and subject to repatriation tax considerations. These foreign funds were held primarily by our subsidiaries inSingapore , theUnited Kingdom ,Malaysia andCanada and to a lesser extent inMexico ,Germany ,India , andAlbania among others. We intend to permanently reinvest certain earnings from foreign operations, and we currently do not anticipate that we will need this cash in foreign countries to fund ourU.S. operations. In the event we repatriate cash from certain foreign operations and taxes have not previously been withheld on the related earnings, we would provide for withholding taxes at the time we change our intention with regard to the reinvestment of those earnings.
Issuer Purchases of
The following table contains information about the shares of common stock we
purchased during the quarter ended
Maximum number (or
approximate dollar
value) of
Total number of shares (or
shares (or units) units)
purchased as that may
Total number of Average price part of publicly yet be purchased
shares (or units) paid per share (or announced plans or under the plans or
Purchased unit) programs programs (1)
October 1 to October 31, 2019 13,894 $ 99.66 13,894 422,762
November 1 to November 30, 2019 114,556 97.14 114,556 308,206
December 1 to December 31, 2019 12,373
98.56 12,373 295,833
140,823 140,823
In
of up to one million shares. This program does not have an expiration date. (1) 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 the consolidated financial statements.
Contractual Obligations
During the six months ended December 31, 2019 , there were no material changes
outside the ordinary course of business in the information regarding specified
contractual obligations contained in our Annual Report on Form 10-K for the
fiscal year ended June 30, 2019 . See Notes 1, 6 and 9 to the condensed
consolidated financial statements for additional information regarding our
current contractual obligations.
Off-Balance Sheet Arrangements
As of
New Accounting Pronouncements
For information with respect to recent accounting pronouncements and the potential impact of those pronouncements on our condensed consolidated financial statements, see Note 1 to the condensed consolidated financial statements.
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