OSI Systems, Inc. (OSIS) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2015 OSI Systems Earnings Conference Call. My name is Glen, and I will be your event manager for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Alan Edrick, Chief Financial Officer. Please proceed, sir.

Good morning, 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' First Quarter Fiscal 2015 Conference Call. We'd like to extend a special welcome to anyone who is a first-time participant on our conference calls. Please note that this presentation is being webcast and is expected to remain on our website, located at www.osi-systems.com, for approximately 2 weeks. Earlier today, we issued a press announcing our first quarter fiscal year 2015 financial results. Before we discuss our financial and our operational highlights, I'd like to read the following statement. 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 during this call that may be deemed to be forward-looking statements under the Act. Forward-looking statements relate to the company's current expectations, beliefs, projections and similar expressions and are not guarantees of future performance or outcomes. Forward-looking statements involve uncertainties, risks, assumptions and contingencies, many of which are outside the company's control, that may cause actual results or outcomes to differ materially from those described in or implied by any forward-looking statement. Such statements include, without limitation, information provided regarding expected revenues and earnings in fiscal 2015 and statements regarding the expected overall financial and operational performance of the company and its operating divisions. The company wishes to caution participants on this call that numerous factors could cause actual results to differ materially from these forward-looking statements. These factors include the risk factors set forth in the company's last annual report on Form 10-K and other risks described in documents subsequently filed by the company 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 new information, subsequent events or otherwise. During today's call, we may refer to both GAAP and to non-GAAP financial measures of the company's operating and financial results. For information regarding non-GAAP financial measures and comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today's press release regarding our first quarter results, which has also been furnished to the SEC as an exhibit to our current report on Form 8-K. Before turning the call over to Deepak to discuss the business in more detail, I will provide a high-level overview of our financial performance. We will again touch on several themes that we have discussed during past conference calls. Let's begin. Highlights for our first quarter of fiscal 2015 are as follows: First, we reported record first quarter revenues of $218 million, a 6% year-over-year increase. The growth was driven by another solid quarter in our Security division, which grew 17% as a result of strong equipment sales, including partial fulfillment of the Foreign Military Sale contract to the U.S. Department of Defense. Second, we reported record Q1 non-GAAP diluted earnings per share, excluding restructuring and other charges, of $0.57, which represents 24% year-over-year growth. This marked the 20th quarter out of the last 21 that we achieved double-digit non-GAAP EPS growth. Third, we generated record Q1 free cash flow of $28 million and concluded the quarter with a strong balance sheet. And finally, yesterday, we announced the successful resolution of the open matter with the Department of Homeland Security, stemming from the TSA issues reported on last year. Before jumping into additional financial details, let me turn the call over to Deepak.

Thank you, Alan, and again, good morning, and welcome to the OSI Systems' Earnings Conference Call for the First Quarter of Fiscal 2015. As Alan mentioned, we had a good start to fiscal 2015 and the first quarter, led by continued strong growth in our Security division. The results have placed us in a good position to build upon this momentum for the remainder of the year. Let us review the highlights for the quarter, starting with the Security division, Rapiscan Systems, where revenues increased 17% to $113 million. There were several accomplishments in the quarter that I would like to discuss. During the quarter, we continued to successfully deliver on the Foreign Military Sales contract from the Department of Defense to supply multiple units of cargo and vehicle inspection systems and related training spare parts service and logistic support to Iraq. In addition to the FMS contract, our overall equipment sales were robust as we experienced increased activity from several regions of the world. As an example, during the quarter, our Security inspection systems were utilized at the 2014 Glasgow Commonwealth games. In turnkey services, current programs continue to strongly contribute to Rapiscan's overall performance, and we continue to pursue a number of new opportunities for additional turnkey security solutions. We are optimistic about new turnkey customers coming about in the future. Our advanced CT hold baggage solution, the RTT, continues to be evaluated by the DSA for the inspection of checked-baggage at airports, and we are hopeful to receive certification by fiscal year end, but there is no guarantee. As you may know, RTT has already passed the European Civil Aviation Conference (ECAC) Standard 3 threat detection test for standard and large tunnel size configurations. We have a growing pipeline of potential RTT customers and expect new bookings over the course of this fiscal year. We are currently bidding on various standards for RTT internationally. As major airports around the world revitalize their screening infrastructure, our products with the latest technology for both checkpoint and checked-baggage inspection solutions are often leading candidates. Finally, as Alan mentioned, we announced yesterday that we reached an agreement with the Department of Homeland Security and entered into an addendum to our existing administrative agreement. The addendum is a result of a DHS review of issues uncovered and self-reported by Rapiscan last year, and has the effect of extending the administrative agreement. U.S. federal agencies are among our most valued customers, and we look forward to new opportunities to work with them and serve their needs. Going forward, we believe we are well positioned to continue delivering strong results from the Security division. Moving onto the Healthcare division. Spacelabs, where revenues increased by 4% in the quarter, and increase primarily attributable to a small, strategic acquisition completing during the quarter. Our patient monitoring business picked up in the North America market, but was offset by continued weakness in Europe. There was also several orders from customers coming late in the quarter that did not convert to sales in Q1 and got pushed to Q2. We continue to make headway with our recently launched Healthcare products and our new platform, the anesthesia workstation, Arkon. In our ongoing efforts to broaden our offering in Healthcare, we recently made an acquisition to enhance our cardiology product line. We acquired an international designer and manufacturer of our Automated External Defibrillator (AED). The acquired product line is marketed and sold only outside of U.S. AEDs, as you know, are used to revive individuals suffering from cardiac arrest and can be used at various settings, such as emergency rooms, hospitals, airports, shopping malls, cruise ships and public events. This acquisition expands our cardiology line and will allow us to develop new products resulting from the integration of our patient monitoring solutions with the AEDs. We look forward to integrating this new business over the next few quarters and anticipate it will be accretive to earnings in fiscal 2016. Moving to our Optoelectronics division, where revenues declined slightly from the prior fiscal year first quarter. Q1 2015 is a tough revenue growth comparison with Q1 2014 when we grew about 25%, which was including some significant sales to 1 customer who had launched an international channel for its products and needed to establish initial inventory levels. We also chose to phase out certain low-margin accounts. Therefore, we will focus on improving operating margins toward the Opto Division and a trend towards a more favorable product mix. I would like to thank our employees and they're delivering a good start to the new fiscal year and are excited about our future and look forward to the coming quarters. With that, I'm now going to hand over the call back to Alan to talk in detail about our financial performance before opening the call for questions. Thank you.

Thank you, Deepak. Our ongoing effort to deliver meaningful revenue and earnings growth through higher-margin growth initiatives and operating improvements continues to prove successful. Let's review in greater detail the financial results for the first quarter of the fiscal year before discussing our updated fiscal 2015 guidance. As mentioned earlier, our revenues in the first quarter increased 6% over Q1 of fiscal '14. This was primarily due to the 17% revenue growth in the quarter in our Security division resulting from strength in our core baggage and parcel inspection products, new product launches and the partial fulfillment of the large FMS contract entered into in June of 2014. Our Opto division's revenues decreased 3% as a result of lower contract manufacturing sales, given the tough comp that Deepak just alluded to, due to a large international stocking order in the prior year, offset partially by strong intercompany sales. Revenues in our Healthcare division increased a modest 4%, resulting from the acquisition of the cardiology business that Deepak just mentioned. While sales in North America to the hospital market improved, softness in Europe offset such gains. Healthcare bookings picked up with a book-to-bill ratio of 1.2 in Q1, providing a cautious degree of optimism. Our gross margin came in at 34%, an increase of 110 basis points as compared to Q1 in the prior year. This improvement was driven by a number of factors, including, one, the growth of Security revenues and a favorable product mix; and, two, the impact of the decrease in revenue in our Opto Division, which typically carries the lowest gross margin in the company's 3 divisions. As mentioned on previous calls, the margin will fluctuate from period-to-period based on revenue mix amongst other factors. Moving to OpEx. In Q1 of fiscal '15, SG&A as a percentage of sales decreased to 20.2% as compared to 20.5% in the prior year. In absolute dollars, the increase in SG&A of $2 million supported the 6% sales growth. Our goal continues to be to hold the SG&A growth rate below the rate of sales growth, though individual quarters may vary from this. We remain committed in all of our divisions to increasing efficiencies and managing our cost structure prudently. We continue to invest significant resources in R&D to enhance our Security and our Healthcare product offerings. Our R&D spending of $12.7 million in Q1 was up 15% from the prior year, mainly due to increased spending to support our next generation of products in our Security division. We expect an elevated level of R&D spending in fiscal '15 as we develop innovative technologies to broaden our product offerings and enhance future growth. Our effective tax rate for Q1 was 28.8% as compared to 29% in the same quarter of the prior year. Our provision for income taxes is dependent on a mix of income from U.S. and foreign locations, due to tax rate differences among countries, as well as the impact of permanent taxable differences, tax elections and valuation allowances, amongst other items. As we move down the income statement, our Q1 GAAP diluted EPS was $0.55, a new record, and the Q1 non-GAAP EPS per diluted share, which excludes restructuring and other charges, was $0.57, also a new record, compared to $0.46 in the comparable prior year period, a 24% improvement. I'll next turn to a discussion of our operating margin, excluding restructuring and other charges. The Q1 adjusted operating margin was 8% compared to 7.1% in the prior year. The Security division reported an operating margin of 15.2%, improving from 13.6% in Q1 last year. As mentioned in our previous calls, we expected to see a sequential increase in Opto's operating margin. This, again, proved to be true, as Opto's adjusted operating margin increased from 6.2% in Q4 to 6.5% in Q1. And finally, in Healthcare, given the flat organic sales, we recorded an awesome growth for the quarter [ph]. As you may recall, Healthcare is our highest contribution margin business, and thus the bottom line is extremely sensitive to revenue increases and decreases. For the company overall, adjusted EBITDA margins during Q1 increased year-over-year from 16.1% to 18.8%, driven mainly by strength in our Security division. Moving to cash flow. For Q1 of fiscal '15, we reported operating cash flow of $31.5 million; capital expenditures totaled approximately $3.1 million in Q1; while depreciation and amortization was $17.7 million. Days sales outstanding, or DSO, was 65 days in Q1 of fiscal '15 compared to 91 days last year. Our level of DSO frequently fluctuates significantly from period to period. We repurchased nearly 400,000 shares through our share repurchase program and had settlements totaling $24.9 million. Our balance sheet is strong, and our leverage ratio remains well below 1x. Our credit facility continues to provide the company with flexibility to execute our business plan. And finally, turning to our fiscal 2015 guidance. We are increasing our revenue guidance in fiscal '15 to be between $970 million and $995 million. We're slightly increasing our guidance for fiscal '15 non-GAAP diluted earnings per share, which excludes the impact of impairment, restructuring and other charges, to $3.53 to $3.76. We currently believe the sales and earnings guidance reflects reasonable estimates. However, actual sales and earnings could vary from this range because of the risks and uncertainties applicable to our business and industry. During the past few years, we have built a strong foundation for growth and have consistently delivered a strong bottom line, along with significant operating and free cash flow. Our investments have enabled us to become the leader in turnkey screening solutions and allowed us to introduce innovative products and services to the market. We look forward to sharing our progress on upcoming calls. Thank you for listening to this call, and at this time, we'd like to open the call to questions.

[Operator Instructions] And your first question comes from the line of Josephine Millward with Benchmark Company.

Can you give us your Security bookings during the quarter or a breakdown of your backlog between Security and non-Security?

Josephine, this is Alan. Our book-to-bill ratio for Security, excluding turnkey, was 0.9, so it was pretty healthy bookings. As you know, we don't break down the backlog specifically between the various divisions, but our backlog did approximate about $800 million.

Sorry, I missed the book-to-bill, what -- did you say 0.9?

That's correct, excluding our turnkey business.

Okay. Can you give us an update on Mexico and how that's progressing, whether you expect to hit full run rates this year?

Josephine, I think what we said in the last conference call, Alan said that they are pretty much to the level of full operation. Obviously, there's going to be a little bit of improvement. But the present numbers basically reflect on going forward what the present expectations of the revenue is from the Mexico contract, unless there is any increase in the number of locations as they move forward. But we are looking at it as if we have reached to the full load. Alan, do you want to add to anything?

I think that's good assessment. Yes.

So just to clarify, so that's roughly $135 million a year for Mexico at almost a 100% run rate?

At a run rate based on where we're going today, it would be just a little bit south of that, yes.

Great. And last question is an update on Albania, whether there's -- we could hear about a resolution anytime soon?

Well, Josephine, you know our position. Anything that is not definite, we never talk about it. All we can say is we are continuing to work the issues out, and hopefully, we reach to an amiable conclusion.

And your next question comes from the line of Brian Ruttenbur with CRT Capital.

Couple of questions. First of all, housekeeping on Alan, the share buyback you bought 400,000 shares. What was the average price?

We haven't gotten to that specifically, Brian, but you could probably do the math a little bit. We spent roughly $25 million, and we bought just south of 400,000 shares. So you can see it'd be in the $60.

Right around $60. Right. Yes, right around $60. Okay, I didn't know if you had the exact calculation. The -- I guess, the buyback that you have in place right now account for, I believe, what, another $51 million? Is that right? Or $50 million?

Yes. We do have an authorized program for a number that's probably a little bit above the amount you just described.

Okay. And maybe turning over to Deepak, in terms of your plan for buybacks, you're going to generate at least, according to us on the Street, north of $100 million of free cash flow this year. Is there a plan to expand that buyback? Is there a plan to use leverage to increase the buyback?

Well, Brian, you know that it's a subject that we continue to look at it. And from time to time, we buy. I'm not going to go into any details. Obviously, we have a strong balance sheet and we look at all the opportunities, buyback, acquisitions, turnkey services and whatever. But we do look at it, Alan and I and the board are very sensitive to it, and from time to time, we are very much focused into this particular subject.

Okay. And then in terms of your acquisition, can you talk about how much you paid for that recent Healthcare acquisition?

Brian, this is Alan. We paid roughly $9 million.

$9 million. Okay. Is that why there was an increase in your bank line from last quarter to this quarter?

Yes. The increase in the bank line was just related to the timing: A little bit with the acquisition, a little bit would be the stock buyback we just talked about, and general working capital, yes.

Okay. And then in terms of the FMS order in Iraq. Can you -- I think you shipped last quarter, June, 11 units. Are you talking in number of units that you shipped this quarter or any kind of projections for the next couple of quarters?

Well, Brian, this is Alan. I guess, what we could describe is, as we said in the last call, the Q1 would be a bit less than the Q4. And that proved to be true. We recognized revenues of roughly $14 million, $15 million orders from FMS in Q1. And also as we mentioned last quarter, we thought Q2 would pick up. While we don't want to give a precise number, we do think it will be above the Q1 number.

Your next question comes from the line of Jeff Martin with ROTW Capital Partners (sic) [Roth Capital Partners].

Alan, can you give us an idea of what kind of revenue run rate that AED acquisition has at close? And what day did it close?

Would you repeat that again, Jeff?

What's the revenue run rate of the acquired AED business that you just bought?

About $16 million to $20 million, but it's basically varies. And I think, Alan, we are, what, 1 month into it?

Yes, Jeff, we've just had it a short time. We purchased it midway through the quarter.

Okay. And then is that a product you're going to bring into the domestic market?

No. Our plan for that product line is really on an international basis. So we're really focused on our distributor network and some of our channels outside the United States.

Okay. And then is your higher guidance essentially accounting for the acquisition?

That is correct.

And then EPS is a little better just operationally?

That's correct, as well.

Okay. You had been, in the past, talking about ramping up production for Arkon. Are you still ramping that? Are you producing units? How's Arkon coming along?

The answer is yes. We continue to go into production, and we think that there'll be relatively more contribution into the revenue in the second half of this year compared to before with the Arkon product line.

Okay. And then in terms of the government mandated replacement of airport screening equipment, do you have any trends that are worth noting in terms of that starting to come more into light? Do you have expectations that, that will start to kick in more this year? What's your view there?

We just watch and see. All over the world, the U.S. is different than the rest of the world. We look at it very closely. But there is no specific trends that we look at, which is going to change anything differently significantly.

Okay. And then, Alan, I didn't catch the cash flow from operations number. Could you give that again, please?

Sure. It was $31.5 million.

[Operator Instructions] And your next question comes from the line of William Lee with Oppenheimer. William Lee - Oppenheimer & Co. Inc., Research Division: If I look at the margins in Rapiscan in the first quarter, it looks really strong. Can you maybe parse out how much of this is from the equipment sales? How much is from turnkey? And how should we think about the margins on the FMS businesses? Does this drive, in part, that improvement?

So Will, this is Alan. Thanks for the question. As you know, we don't break out our margins by our various product lines or business areas within the division. We were very pleased with the margin improvement in the Security business, and FMS certainly contributed to that. William Lee - Oppenheimer & Co. Inc., Research Division: Right, right. But if we think about in terms of Mexico, Mexico this quarter and last quarter were pretty much at full run rate. Is that fair?

The Mexico revenue was not significantly different in Q1 from Q4. That is a fair statement. William Lee - Oppenheimer & Co. Inc., Research Division: Okay. Great. And you also mentioned that CapEx this year is going to be elevated. How should we think about it? Is this something where it's going to be comparable to last year? Or is it still -- is it going to still be down year-over-year?

So Will, I think my comments referred to R&D, that R&D was a little bit higher than it was last year. CapEx, we anticipate to be down year-over-year, absent new turnkey wins, which we, of course, hope to win.

And your next question comes from the line of Josephine Millward with Benchmark.

Deepak, can you talk about your Security pipeline and the macroenvironment? As you know, most of your competitors appear to be struggling. If you can comment on that, your outlook in general.

Josephine, as Alan mentioned, our non-turnkey, our bookings from Q1 were very good, at 0.9 book-to-bill. We look at -- especially in the international sector, we are not seeing something what some of these other competitors have reported, and we basically attribute that to, we have a very broad product line and that has always been our strategy, and we have a very broad global reach. And that does help, and we look at it that the pipeline continues to be robust. Our guideline reflects that. We look at it that the international arena especially would be very difficult [ph].

Okay. The same [ph] on RTT, and you currently bidding on international projects, do you think we could see some deliveries this year, this fiscal year?

The answer is definitely, yes. There will be some deliveries. I just want to make sure that you don't -- because we already have booked orders. So what it means is that we will have deliveries, that's one part of your question. And we also said in my script that we expect, anticipate some new bookings in the RTT product line internationally in the remainder of the year.

That's great. One final question. I think, Alan, you mentioned that new product launch in Security was one of the growth drivers. Can you expand on that and talk about what the new product was in Security?

Sure, Josephine. We launched a product, a small product in the trace detection area called DETECTRA, which we are looking forward to getting some market penetration throughout that area. So it's a -- we call it a smaller product line, but it's an attractive product line that goes well into the sales mix and fits right into the bag of tricks for our sales channel and our distributors.

And just add to on to it, we also have introduced additional mobile cargo products in the low energy mode, and we are very excited about it.

At this time, we have no further questions. I will now turn the call over to Mr. Deepak Chopra for closing remarks.

Well, thank you very much. I would like to thank everyone for joining our call. We look forward to speaking with you again on our next call, and we continue to remain optimistic and very excited about our year end and are looking forward to talking to you next quarter call. Thank you.