OSI Systems Inc

NASDAQ:OSIS

Earnings Call Transcript 2019-Q3

[Operator]

Good afternoon, and welcome to the OSI Systems Incorporated Third Quarter 2019 Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host Alan Edrick, Chief Financial Officer. [Technical difficulty] Edrick, the floor is yours.

[Alan Edrick, EVP and CFO]

Good afternoon and thank you for joining us. I'm Alan Edrick, Executive Vice President and CFO of OSI Systems. And I'm here today with Deepak Chopra, our President and CEO.

Welcome to the OSI Systems fiscal 2019 third quarter conference call. We would like to extend a welcome to anyone who is a first-time participant on our conference calls. Earlier today, we issued a press release announcing our fiscal 2019 third quarter and nine months financial results.

Before we discuss our results, I'd like to remind everyone that today's discussion contains forward-looking statements. In connection with this conference call, the company wishes to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to statements that may be deemed to be forward-looking under the securities laws. These forward-looking statements are based on management's current expectations, and are subject to uncertainties, risks, assumptions and contingencies, many of which are outside the company's control.

Such statements include without limitation, information regarding the expected financial and operational performance of the company and its operating divisions; including the company's expected revenues, earnings and growth.

Undue reliance should not be placed on forward-looking statements as actual results could differ materially from any forward-looking statements due to numerous factors, including factors described in the company's periodic reports filed with the SEC from time-to-time. All forward-looking statements made on this call are based on currently available information and speak only as of the date of this call. And the company undertakes no obligation to update any forward-looking statement that becomes untrue because of subsequent events or new information or otherwise.

During today's conference call, we may refer to both GAAP and a non-GAAP financial measure of the company's results. For information regarding non-GAAP measures and comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today's press release regarding our fiscal 2019 third quarter results, which has been furnished to the SEC as an exhibit to a current report on Form 8-K.

Before turning the call over to Deepak to discuss the company's general business and operations, I'll provide a high-level financial overview of the third fiscal quarter.

First, we reported third quarter revenues of $304 million, a 14% year-over-year increase. This represents an all-time record for the company driven by solid performance across our three divisions. In Security, we reported record Q3 revenues of $193 million representing 14% year-over-year growth. The Opto division sales increased 7% including contributions from recent acquisitions. Our healthcare division return to growth mode delivering 12% Q3 year-over-year sales increase.

Second, we reported record Q3 GAAP diluted earnings per share of $1.05 compared to $0.13 in the same prior year period. Non-GAAP Q3 EPS which excludes certain specified items was a record $1.17 per diluted share compared to $0.86 in Q3, fiscal 2018 as we leveraged the record revenues to accelerate earnings growth.

Third, our Q3 cash flow from operations was $46.9 million up 51% over the same period last year. Also subsequent to quarter end we amended our credit facility to improve the interest rate terms, extend the maturity through April 24 and increase the size of $535 million as well as various other improvements that we believe provide us with additional operational and financial flexibility.

Before diving more deeply into our financial results and discussing our updated fiscal 2019 guidance. Let me turn the call over to Deepak.

[Deepak Chopra, President and CEO]

Thank you, Alan and again good afternoon and welcome to the OSI Systems earnings conference call for the third quarter of fiscal 2019. All three divisions Security, Healthcare and Opto Electronics fired on all cylinders and contributed to record revenue and non-GAAP and GAAP earnings for the quarter. Q3 revenues grew by 14% and represent an all-time record for any quarter in the company's history. Alan will provide more detail on the financial performance on it.

Reviewing the highlights with the three divisions beginning with the security where revenues were $193 million also an all-time revenue record was 14% higher than the prior year of Q3. We saw strength demonstrated at both aviation and cargo during the quarter. We experienced robust growth in RTT 110, the Real Time Tomography explosive detection systems internationally and with a broad offering in cargo and vehicle inspection system globally at a very good quarter.

During the quarter we announced RTT orders with two key European airport customers totaling approximately $18 million. Also shortly after the quarter end, we announced $10 million follow-on RTT order from a prominent international airport in Europe. For the checkpoint CT we are getting traction with the 920 CT internationally. The overall opportunity pipeline at airports and cargo facilities is quite strong and our sales and operations team is ramping up for expected increased demand as we move into fiscal 2020.

Given our worldwide presence we're focused on leveraging our service and logistics capabilities to capture additional opportunities especially as our installed base continues to grow significantly. During the quarter, we announced a contract valued at $12 million for operations and maintenance services from the NATO Support and Procurement Agency. Under this contract, we're responsible for operating and continuing service of Rapiscan systems and ASNE [ph] cargo, vehicle parcel and personal explosive and contraband detection systems.

On the integrated services and turnkey front, as we mentioned on our last call, we entered into a 10-year contract to provide a complete turnkey screening solution for the port of Santo Tomás de Castilla in Guatemala for which we're in the process of constructing civil works. In the near future we expect our install our cargo screening systems at the spot. Integrate our proprietary search, scan image management and analysis software and be ready for operations later this calendar year.

The Guatemala contract along with the existing Mexico, Puerto Rico and Albania turnkey screening service contracts are all going well and they provide a nice showcase of our capabilities to potential new turnkey customers. We look forward to continued success in cargo systems as we help our customers protect borders and ports and prevent the movement of illegal drugs and contraband. As an example, our cargo screening equipment is utilized on both sides of Mexico - US border.

During Q3, Customs and Border Protection announced the largest [indiscernible] drug bust in US history near Nogales, Arizona. In March, we served as a title sponsor for the second year in a row for the Rapiscan systems classic, a PGA Champions Tour event in Biloxi, Mississippi. At this event we provided security for the safety of players, attendees and other service providers. In addition, we held several industry workshops that were focused on the topics of air cargo and airport security.

All event attendees had the opportunity to see a demonstration of a product portfolio for people, baggage and parcel screening. It was a great opportunity to broaden awareness of our brand. Q3 was an excellent quarter for the security division and while certain bookings got pushed to future periods we've already landed some key orders in April and the pipeline continues to robust both internationally and domestic US towards a strong fiscal 2020.

Moving into the healthcare division, Spacelabs showed significant improvement as revenues were 12% higher than the prior year's Q3 and resulted in significant operating income growth. The change in leadership and organization has improved performance and the overall progress in execution at this division. We saw strong bookings and sales in the US for patient monitoring and also growth in the cardiology product line which is mostly sold in Europe.

During the quarter, we announced three significant orders from the US hospitals totaling $19 million for patient monitoring. These large orders are a sign of effective execution by the division sales team and a positive indication of the overall market health. We look forward to continuing the momentum in Q4 and into fiscal 2020. Moving to our Opto electronics and manufacturing division, Q3 overall revenues were $71 million up 7% including inter-company from the prior year with a strong operating margin.

We see ample opportunities for growth with OEMs across numerous industries. We also continue to seek acquisitions that help us strengthen our position in the marketplace and broaden our product offering in this division. In summary, we enter in Q4 with a healthy backlog and great visibility in our pipeline and expect to deliver a strong finish to this fiscal year. As always I would like to thank our employees, customers and stockholders for their continued support.

With that, I'm going to turn the call back over to Alan to talk in more detail about our financial results before we open the call for questions. Thank you.

[Alan Edrick, EVP and CFO]

Thank you Deepak. Now I'll review financial results for the third fiscal quarter in some greater detail. As mentioned previously, our revenues in Q3 of fiscal 2019 were up 14% year-over-year. Q3 revenues in the security division increased by 14% driven by growth in both the cargo and vehicle inspection in RTT product lines. The Opto division continued its steady performance growing external revenues, 16% year-over-year about half of that growth due to the performance of a recently acquired business and the balance due to strong sales in our core Opto Electronics business.

The growth in external revenues was partially offset by Opto's reduced inter-company sales during the quarter due to improvements in inventory management and our other divisions resulting in 7% increase overall in the Opto division revenues compared to the same period last year. And as Deepak mentioned we were pleased to see Spacelabs post 12% revenue growth driven by strong US patient monitoring sales and more modest growth in cardiology and supplies and accessories revenue.

The Q3 gross margin of 36.6% was comparable to the 36.5% in Q3 of last year. We saw gross margin expansion in our Opto and Healthcare divisions, with a slight year-over-year reduction in the security division gross margin. As mentioned on previous calls, our gross margin will fluctuate from period-to-period based on revenue mix among other factors.

Moving to operating expenses, SG&A expenses were up $7.5 million in Q3 over the same period of the prior year due to the growth of the company including the impact of fiscal 2019 acquisitions. We worked across all of our divisions to improve efficiencies and prudently manage our cost structure. R&D expenses in Q3 were $13.7 million down approximately $2 million from Q3 of the prior year due to reduced cost in our security division for ongoing engineering projects and in our healthcare division.

We remain focused on innovative product development which we view as vital to the long-term success of our business. Impairment, restructuring and other charges were net benefit of $1.8 million in Q3 of fiscal 2019 as compared to $14.1 million in charges in Q3 of fiscal 2018. The current year amount reflects the net insurance reimbursement of certain legal costs. Moving to taxes, excluding the impact of discrete tax items the company's effective tax rate was 28.6% in Q3 of fiscal 2019 compared to 28.2% in the prior fiscal year third quarter.

During the three months ended March 31, 2019 we recognized a discrete tax benefit of approximately $700,000 resulting in a reported effective tax rate of 26%. During the three months ended March 31, 2018 we recognized a discrete tax benefit of approximately $300,000 resulting in a reported effective tax rate of 18.1%. Let's now turn to a discussion of our non-GAAP adjusted operating margin which excludes impairment, restructuring and other charges and acquired amortization expense.

The company's non-GAAP adjusted operating margin improved to 11.2% in Q3, fiscal 2019 from 9.7% in Q3, fiscal 2018. This increase was driven by operating margin expansion in all three divisions. This growth was most notable in the healthcare division in which operating margins increased to 11.1% from 2.9% year-over-year primarily driven by revenue growth an effective operating expense management.

Moving to cash flow, in Q3 of this year we generated $46.9 million in operating cash flow compared to $31.1 million in Q3 of last fiscal year. The strong cash flow was driven by increased profits and improvements in working capital. Collections were strong as day sales outstanding decreased from 74 days in Q3, fiscal 2018 to 65 days in Q3, fiscal 2019. And with strong Q3 sales and improved inventory management inventory declined significantly on a sequential basis.

Capital expenditures in the quarter were $8.3 million which included investment for previously announced turnkey projects while depreciation and amortization was $14.1 million. Our balance sheet remains strong. We ended the quarter with net leverage of approximately1.5 as calculated under our recently amended revolving credit facility.

Finally turning to guidance, we are raising our fiscal year 2019 sales guidance to a range of $1.165 billion to $1.19 billion and increasing our fiscal year 2019 non-GAAP earnings per share guidance to a range of $4.10 to $4.30. Note, this guidance factors in anticipated startup cost associated with our new turnkey projects as well as not quite as favorable expected margin mix in the security division. This non-GAAP diluted EPS range excludes potential impairment, restructuring and other charges, amortization required intangible assets and non-cash interest expenses and their associated tax effects as well as any discrete tax items.

Additionally, we continue to evaluate the impact of tax reform on our effective tax rate which contains complex provisions. The effective tax rate is subject to significant volatility and will be updated as more analysis and information is available. We currently believe the sales in non-GAAP earnings guidance reflects reasonable estimates, actual sales and non-GAAP earnings however could vary from the anticipated ranges due to the risks and uncertainties specifically affecting our business and generally effecting industries in which we operate.

These risk and uncertainties include items beyond our control such as site readiness or product installations, evolving government trade policies, customer acceptance of our products and the timing of orders in each division and other risk and uncertainties discussed in our SEC filings. We have continued to grow our business while investing in product development and making selective strategic acquisitions. These investments enable OSI to continue our leadership role with innovative products and solutions across our various industries.

Thank you for participating in this conference call and at this time, we would like to open the call to questions.

[Operator]

[Operator Instructions] our first question comes from the line of Larry Solow from CJS Securities. Your line is open.

[Stefanos Crist, CJS Securities]

This is Stefanos Crist calling for Larry. First question, so Jim Green joined OSI about a year ago and the year under his belt. Can you discuss some of the initiative in healthcare that's really driving the return to revenue growth?

[Deepak Chopra, President and CEO]

This is Deepak here. Fundamentally I've said in the last couple of calls, that we focused on what we call focus, focus on what we're known in the industry for, what is our real focus on the products and that's patient monitoring. So we deemphasized a money losing product line in the anesthesia area also we got out of a channel and some part of the world where it was not being very profitable. And we basically met our managing our cost, focus, execution and Jim Green had done a very good job of focusing company back to its core competency and patient monitoring, connectivity, telemetry, supplies and accessories and cardiology product line and that's what's happening.

[Stefanos Crist, CJS Securities]

Thank you so much and just one more question. Could you talk more about the opportunities on the US - Mexico border in terms of the wall?

[Deepak Chopra, President and CEO]

Well okay, let me try to answer that. I think we said in the last conference call also, the budget for non-intrusive equipment has gone up in the Congress and Customs and Border Patrol which is a responsible for looking after the borders is a very good customer of us. We're working diligently with them to do more at the Southern border and as I mentioned we have equipment on both sides of the border also. We have very good relationship with them and we look at it that the opportunities continue to be very robust and will continue to growth. Obviously we have a policy that till anything specific happens, we don't talk more than that.

[Stefanos Crist, CJS Securities]

Got it, all right. Thank you and congrats again.

[Operator]

Our next question comes from the line of Sheila Kahyaoglu from Jefferies.

[Sheila Kahyaoglu, Jefferies]

I guess Deepak in terms of the healthcare margins, how do we think about reducing cyclicality of that business as you focus on patient monitoring. What do we think about the casual runway of margins from here?

[Alan Edrick, EVP and CFO]

Sheila, this is Alan. I'll take that question. So we do see some seasonality in the healthcare business in general. But what we see is that the healthcare business has the highest contribution margins. So as our revenues increase there is a major contribution to the operating income in the operating margin level. So our operating margins are highly reflective of what's going on our top line. The majority of our sales are in the US which is also our highest margin area within healthcare. So believe that as we continue to grow the top line there's ample room for continued operating margin expansion as we go forward.

[Sheila Kahyaoglu, Jefferies]

Okay, thank you. And then I was wondering if you could expand upon the potential for the services offering. You guys mentioned in the prepared remarks, how do we think about that in just - the incident you guys mentioned in Arizona. How's that potentially driving your business? Thank you.

[Deepak Chopra, President and CEO]

Sheila, this is Deepak here. One of the things we've said for the last couple of years and we continue to talk about it. We are very, very positive on what we call integrated services and turnkey business model. That basically is, what we are, what we announced by the Guatemala, that's what we have in Mexico, that's with Puerto, that's with Albania and as more of those are being showcased to other customers from those regions people are beginning to get more confidence that this concept and operational mode is a successful viable economic partnership with the customer and a vendor.

Regarding the catch, yes with an [indiscernible] actual catch to our equipment. It was published on TV by the CBP and there's been other catches couple of months ago. There was a catch in Albania going into Italy for a very large catch there. So it's getting more publicity. We think that the services model and the integrated services is catching on and we are very proud about one fact that we have a very broad product portfolio and with our proprietary search scan software. It also plays very well into training the customer, into making more software enhancements to be specific to various things that at the border they want to catch. And the most important thing is, that we have the products, we have a good brand name and we have the software.

[Sheila Kahyaoglu, Jefferies]

Great, thank you.

[Operator]

Our next question comes from the line of Jeff Martin from Roth Capital. Your line is open.

[Jeff Martin, Roth Capital]

I'm wondering if you could elaborate on the prepared remark for staffing up for increased demand in 2020, are there specific areas you can highlight both from a product perspective and a geographic perspective?

[Deepak Chopra, President and CEO]

This is Deepak here. Basically with the growth that we've seen over the last couple of quarters in security especially both in the cargo product line and in the RTT. We are ramping up production capability both in the cargo facility in Boston and in England. In both the RTT facility and the cargo facility because as you know the timeline or the production, equipment, the inventory and all that stuff takes some time, so plus also manpower. So we're ramping up. We've increased production and in some cases just one example without giving any more personal [ph] information. There was some products in [indiscernible] that we were doing one a month, now we're doing five a month. So we've really increased the capacity.

[Jeff Martin, Roth Capital]

Yes, that's encouraging. Could you also elaborate on the comment regarding more to push outs from Q3 is that into Q4, is that beyond fiscal 2019?

[Deepak Chopra, President and CEO]

Well especially in the cargo business as you know you followed the company for some time. It can change from a month to a next month with quarter to the next month depending upon their international tenders, sites not readiness, customer changing the specification and step. So I would say that, it's pushed towards Q4 some we already booked, some will come into the next early part of next year. But I did make a comment that we are projecting right now though we've not given any guidance that we look at the opportunity in a pipeline for a strong fiscal 2020 is in the making.

[Jeff Martin, Roth Capital]

Great, that's it from me. Thanks guys.

[Operator]

[Operator Instructions] our next question comes from the line of Aman Gulani from B. Riley. Your line is open.

[Aman Gulani, B. Riley]

I just wanted to get an update on the replacement cycle in Europe. What percentage of the way to the conversion do you think you are roughly?

[Deepak Chopra, President and CEO]

As we've said before that 2020, 2021 are the deadlines. There's a lot of activity in Europe, we have also said in the last conference call in some of the orders we announced. We have been quite successful on getting some orders in the Europe sector. Basically we can't - because we don't know the data but if we have to guess our estimate about 30%, 35% has been bought so there's still lot of activity coming up in the next 12 months. On top of that, we've also said in the last couple of conference calls that it's not just Europe though there is no deadline requirements in Asia and Latin America and Middle East. But they're also upgrading their airports, so the demand continues to be quite strong in all over - geographically.

[Aman Gulani, B. Riley]

Got it, very helpful. Last question from me regarding the IDIQ contract for $450 million. Have you seen much activity on that front and just trying to get a feel for, there could be a material contributor in the near term?

[Deepak Chopra, President and CEO]

Well we did clarify it last year. firstly it's a customer we've had before, we have had an IDIQ before and going to emphasize it that all it basically says is that, it's a license to participate to bid and to be asked by the customer at the hospital to ask for our products and there is no guarantee that any specific dollar amount would be spent, but that's like a maximum limit that they can spend on the products they want to buy and there are one or two other companies also who also had the same IDIQ so that it's basically a focus that the government has this vehicle called indefinite delivery, indefinite quantity. This is just the max limit on which you can spend.

[Aman Gulani, B. Riley]

Got it, thank you. I'll pass it on.

[Operator]

There are no more questions at this time. Presenters you may continue.

[Deepak Chopra, President and CEO]

Well thank you very much. I appreciate and we want to wish everybody Happy Easter and looking forward to get in the next year of yearend call in August. Thanks for everybody's support.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.