OSI Systems, Inc. (OSIS) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the OSI Systems’ Fourth Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s program is being recorded. I would now like to introduce your host for today’s program, Alan Edrick, Chief Financial Officer. Please go ahead.

Good morning, and thank you for joining us. I’m Alan Edrick, Executive Vice President and CFO of OSI Systems, and I am here today with Deepak Chopra, our President and CEO. Welcome to the OSI Systems’ fourth quarter and year end fiscal 2015 conference call. We’d like to extend a special welcome to anyone who is a first-time participant on our conference calls. Earlier today, we issued a press release announcing our fourth quarter and 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 2016 and statements regarding the expected overall financial and operational performance of the company and each of 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 conference call, we may refer to both GAAP and non-GAAP financial measures of the company's operating and financial 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 fourth quarter and year-end results, which has also 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 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 get to it. Financial highlights for our fourth quarter of fiscal 2015 are as follows: First, we reported record Q4 revenues of $267 million, a 2% year-over-year increase as compared to a tough comp in the prior year period. The top line growth was driven by our healthcare division which had an outstanding quarter delivering a 29% increase in sales which included 21% organic growth. For the year, OSI sales were $958 million also a new record. Second, we’ve reported record Q4 non-GAAP diluted earnings per share excluding restructuring and other charges of $1.22. This marks the 23rd quarter out of the last 24 that we achieved non-GAAP EPS growth. Third, we generated free cash flow of $12 million in the quarter bringing the full-year total to a record $90 million or 20% higher than last year. We concluded the quarter with a very solid balance sheet. And finally our backlog heading into fiscal 2016 is strong. We achieved in equipment and related service book-to-bill ratio or in other words a non-turnkey book-to-bill ratio of $1.2 in Q4 and as subsequently booked several high profile security wins already in fiscal 2016. Before jumping into additional financial details and discussing our fiscal 2016 guidance. Let me turn the call over to Deepak.

Thank you, Alan, and again welcome to the OSI Systems’ earnings conference call. As Alan mentioned in the fourth quarter and for the full fiscal year, we delivered a record revenues and profit. During Q4, the healthcare division’s performance stood out leading to record divisional revenues along with significant margin expansion. With strong overall OSI bookings in Q4 and thereafter, we begin fiscal 2016 with a healthy backlog and a stronger organization which we believe position us well. Throughout the year, we continue to pursue excellence in each division, with the implementation of operational, strategic and talent management initiatives. As an example, we are happy to announce that Pak Chin, a former Honeywell executive joined our team as President of Rapiscan Systems. Ajay Mehra, who led Rapiscan to strong success over a number of years, is now focused exclusively on the solutions business reflecting the importance and the priority we have on growing our turnkey business, expanding service and solutions to security customers as well as developing service offerings to other markets. Under Mr. Mehra we’ve also created a healthcare solution initiative to replicate our success in security turnkey business. Let’s talk in more detail about each business, starting with our security division. Rapiscan where revenues were $481 million for the full fiscal year or 9% higher than the prior year with a strong operating margin of 15.2% excluding the effect of restructuring and other charges. Rapiscan’s revenues in Q4 were 7% lower than the prior year due to a tough comp as prior year Q4 sales, grew 45% in part from FMS revenues that Alan Edrick will discuss later on. Excluding the prior year FMS revenues, Rapiscan’s revenues increased 10% in the fourth quarter. A few of the highlights of Rapiscan in Q4, we continued to gain momentum in our real-time tomography, CT our latest checked-baggage product as we have had significant win at Rome airport, valued at approximately $27 million. This validates our platform following our win last year in Oslo, Norway and have subsequently booked additional international customers after the Rome win. As you can imagine we are very busy as the RFP activity for RTTs is very robust. In the European market, there are approximately 1,500 machines that will come up for replacement or upgrade as airport and air cargo customers strive to meet the European screening requirement standards by 2020. Our initial wins give us strong optimism for this market segment, for our growth. With respect to the U.S. market, we expect to submit the RTT110 for TSA certification testing, this fiscal year to complement the RTT80, which was TSA certified earlier this year. The RTT110 employs the same underlying technology as the RTT80, but offers a larger tunnel size and that is capable of screening larger items. Rapiscan had Q4 bookings of $142 million which represents 1.4 non-turnkey book-to-bill ratio or security in Q4. We received several orders for people screening, baggage and parcel and cargo and vehicle inspection systems as we announced wins totaling approximately $58 million in Q4 from the Middle East and Africa. We also received multiple orders or service and support contracts from the U.S. and international customers for our large install base. In turnkey services, our current programs continue to contribute strongly to our performance. Based on what we see in our pipeline of other potential turn-key customers, we continued to believe that we are in excellent position to capture additional opportunities. The turnkey services market represents an outstanding growth opportunity and as mentioned earlier, we have realigned some of our leading resources to focus exclusively on this. The growth engines for fiscal 2016 are the whole baggage or checked baggage market, where the RTT leading it, international cargo screening and turnkey opportunities. Overall, our pipeline and security continues to be very robust. Moving to healthcare, Spacelabs sales were $79 million for the quarter, a new record, or 29% higher than the same quarter in the prior year and $256 million for the year or 15% higher than the prior year. Alan Edrick will talk a little bit more detail on the mix. A few healthcare highlights on the quarter. Starting with a market, it appears that North American market is increasingly active, which provides confidence that the market over the few past years is improving. We announced several strategic wins at hospitals during the quarter and continue to penetrate the market with our latest technology in the patient monitoring, anesthesia, and cardiology product lines. In June, we launched our new telemetry system XTR, which offers a simple workflow for managing patients, intelligent arrhythmia analysis and advanced alarm management. This new product has already contributed to revenue growth. Finishing off the year in strong fashion, we are optimistic to continue the momentum through the coming quarters leading to nice growth in the healthcare division in fiscal 2016. We continue to invest in research and development to develop newer and newer products in this market. Moving to Optoelectronics, in the fourth quarter, the Optoelectronics division generated revenues of $68 million including the intercompany revenue, a slight decrease from the same period in the prior year. Year-over-year revenues were down by 6% as we focused on improving the business operations and margins including shifting towards a more favorable customer and profit mix. We have mentioned that in our previous calls of the strategy. To do that end, the operating margin increased 230 basis points for the quarter excluding restructuring and other charges compared to the prior year. In Q4, we also completed a facility consolidation of an EMS plant to our main facility in Hawthorne, California. These efforts are now behind us and we believe Opto growth is in an excellent position to return to top-line growth in fiscal 2016 with strong operating margins. To conclude, with a strong balance sheet and exciting prospects in each business units, we look forward to delivering growth in revenues and earnings per share in fiscal 2016. With that I’m going to hand the call back over to Alan to talk in detail about our financial performance and guidance before opening the call for questions. Thank you.

Thank you, Deepak. We continue to deliver revenue and earnings growth by expanding our product portfolio and entering new markets while maintaining a relentless focus on further operating – to continue to expand margins. Let’s review the financial results for the fourth quarter and the fiscal year in greater detail. As mentioned before, our revenues in Q4 fiscal 2015 increased 2% over Q4 fiscal 2014, while full year revenues increased by 6%. The Q4 2015 revenue growth was driven by a 29% increase in the sales of our healthcare division, led by strong growth in North America and the inclusion of revenues from the cardiology business that we acquired in the first quarter of fiscal 2015, which contributed 8% of the quarter’s growth. In fiscal 2015, our healthcare division delivered record revenue in each of the North America and the emerging markets regions, while the European and Middle East region lags in part due to the impact of FX. Q4 sales in our Security division were strong, representing the third highest quarter on record. However with the tougher comp due to $23 million recognized in Q4 last year associated with the Foreign Military Sale to Iraq, revenues were down 7% year-over-year. For the year – for the full year, Rapiscan’s revenues were $481 million, up 9% over the prior year. And as expected, for Q4, Opto division’s external revenues were down 2%, yet the Opto division delivered significantly higher operating margin, which we will discuss later. We expect Opto to return to revenue growth as early as Q2 of fiscal 2016. Our Q4 gross margin came in at 33.5%, compared to 32.9% in Q4 of the prior year. The increase was driven by margin expansion in our healthcare division achieved primarily from economies of scale as well as margin expansion, our Opto division achieved through operational improvements. These factors more than offset the impact of a less favorable sales mix in the Security division. As mentioned on previous calls, the margin will fluctuate from period to period based on revenue mix amongst other factors. Moving to OpEx. SG&A as a percentage of sales was 15.6% in Q4. For the year, we leveraged the sales growth and saw SG&A decreased 50 basis points. We remain committed in each of our divisions to increasing efficiencies and managing our cost structure prudently. Our goal continues to be to hold the SG&A growth rate below the rate of sales growth. The results in individual quarters may vary such as it did this quarter. We continue to develop innovative technologies to broaden our offerings and enhance future growth and so continue to invest significant resources in R&D. Our R&D spending of $13.2 million in Q4 was up approximately 10% from the prior year primarily due to increased spending to support our next generation of products in our Security division. As mentioned on previous calls, we planned for a higher level of R&D spending in fiscal 2015. In fiscal 2016, we expect R&D to remain relatively stable as a percentage of sales. Our effective tax rate was 25.7% for Q4 and 26.7% for the full fiscal year. Our provision for income taxes is dependent on the mix of income from U.S. and foreign locations due to tax rate differences amongst countries as well as the impact of permanent taxable differences, tax selections and valuation allowances among other items. Moving down to income statement, our Q4 GAAP diluted EPS was $1.09 compared to $1.07 last year. The Q4 non-GAAP earnings per diluted share excluding restructuring and other charges were $1.22 compared to $1.19 in the comparable prior year period. For the full year, our non-GAAP diluted earnings per share were $3.53 compared to $3.13 in fiscal 2014 or 13% improvement. Let's now turn to a discussion of our operating margin excluding restructuring and other charges. The Q4 adjusted operating margin was 12.9%, which was comparable to the prior year. Leveraging strong sales, our healthcare division realized a significant uptick in operating margin from 11.7% last year to 17.3% in Q4 this year, a 560 basis point improvement. This was led by strength in our U.S. sales channel and our patient monitoring product line. Our Opto division, operating margin also increased significantly from 6.2% in Q4 last year to 8.5% this year. As discussed on several calls, we have been working diligently to improve the Opto division’s operating margin. These efforts continue to yield results aided by a favorable product mix in Q4. During the quarter, we completed the consolidation of one of our Opto manufacturing sites as Deepak just mentioned. Finally, the Security division reported an operating margin of 13.7%, which was about 50 basis points lower than last year, primarily due to the level of a mix of revenues, as earlier described, as well as higher R&D. Moving to cash flow, for Q4 fiscal 2015, we reported operating cash flow of $17.4 million. Capital expenditures were $5.9 million in the quarter while depreciation and amortization was $13.5 million. Days sales outstanding, or DSO, was 61 days in Q4 fiscal 2015 compared to 65 days last year. Our level of DSO often fluctuates from period-to-period due to the timing of sales and collections. Our balance sheet is strong and our leverage ratio remains well below one. Our credit facility continues to provide us with flexibility to execute our business plan and respond to opportunities. Finally, turning to our fiscal 2016 guidance. As discussed, fiscal 2015 revenues were $958 million, which included approximately $70 million from the FMS sale with Iraq. While there is a possibility of receiving follow on awards with the same customer, our guidance for fiscal 2016 does not include any material revenues for a follow-on order. Should we receive an award, we will likely update the guidance as appropriate. Excluding FMS revenues related to Iraq, including the possibility of a follow-on order, we anticipate continuing growth in fiscal 2016 as revenues are expected to be between $985 million and $1.20 billion, which represents 11% to 15% increase over the prior year. We generally provide overall company guidance rather than guidance by division or program. We can say our guidance incorporates annual growth in each division though individual quarters may vary. Given that challenging first half comps associated with the fulfillment of the FMS order in fiscal 2015 and the expected timing of deliveries from our current security backlog unlike fiscal 2015 where the growth rate was stronger in the first half than the second half; in fiscal 2016, we anticipate the growth rate to be significantly stronger in the second half than the first half. We expect fiscal 2016 non-GAAP diluted earnings per share excluding the impacts of impairment restructuring and other charges to be between $3.75 and $4 per share. We currently believe that sales and earnings guidance reflects reasonable estimates, however actual results could vary from the anticipated ranges because of the risks and uncertainties applicable to our business and industry, including the timing of certain awards and deliveries and because of other risks and uncertainties described in our SEC filings. 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 have 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 conference call. And at this time, we would like to open the call to questions.

[Operator Instructions] Our first question comes from the line of Jeff Martin from ROTH Capital Partners. Your question please.

Thanks. Good morning Deepak and Alan.

Good morning

Alan, could you help me just clarify the challenging comparison both in the first and fourth quarter, I have roughly $25 million between FMS and the Glasgow games challenging that the first quarter compare and $34 million for the second quarter, is that accurate?

Yes, Jeff, the numbers are directionally accurate, in the first quarter, that’s extremely close to what we reported last year for Glasgow and FMS. The FMS revenues in the second quarter of fiscal 2015 were actually a little bit higher than the number you mentioned. So that’s what contributed the comment saying the first half comparisons are little bit tougher and we are anticipating a higher growth rate in the second half of the fiscal year.

Okay, and then you anticipate growth in each of your divisions did I hear that correctly for the full year?

That is correct.

Okay. And then do you have a number for the foreign exchange impact on revenue in the quarter?

The FX impact on revenue on the quarter gave us a headwind of a couple percent in this past quarter, namely from the Euro and the pound compared to the prior year.

Okay. And then Deepak, yes, go ahead

So although there was a headwind on the top line it was not on the bottom line.

Okay, okay. And Deepak, could you go into the little bit more of an update on the pipeline for RTT in Europe?

Well as you know, that 2020 all the airports, Western European airports have to meet the new standards. So there is a lot of activity in the European airports in trying to put their plans together, together with their airport expansion plans, after replacement cycle and new additions for meeting these deadlines. So there were lot of activity and as I’d mentioned on my call that we are very fortunate we won the Oslo, Norway which is the major airport last year, we have announced the Rome airport and then we’ve had subsequent wins after that both in the European sector and the Asia Pacific sector.

Okay and then you mentioned submission of that RTT110 by the end of the fiscal year for certification in the U.S. I would imagine that would be a shorter certification process, given the 80 has already been improved is that the right way to think about that?

That’s the right way to look at it and as you know that the U.S. is not right now ready to replace all their machines, so that we think that by 2018, 2019, 2020 they’ll start doing the same thing, and we decided that there’s no point of carrying RTT80 and RTT110. We already have the certificate from TSA on the RTT80, since the rest of the world is moving onto the RTT110 and that’s what we are focusing on. We announced in the last call also that we are submitting for re-certification of the RTT110 and think that it will grow faster because of our experience with the RTT80.

Okay. And then, I’m curious to get your take on potential consolidation opportunities of the security market, particularly with some of the vendors in the U.S. as well as overseas?

Well you know that, we don’t want to comment on anything specific, but we are watching the industry and we’ve always said that that we have a very good appetite, we have a clean balance sheet, and what I call an organization which can digest it. So we continue to watch and look and we’ll continue to look at what is out there.

Okay. Great and then Alan, in terms of how would you think about unusual expenses and restructuring charges with Opto you referred to being mostly done there. With security and healthcare, is there more to go there? Should we expect some of those charges in fiscal 2016 or are those mostly behind?

Sure, Jeff. Yes, I think a lot of the heavy lifting is behind us. That being said, we have a mantra of continuous improvement. Wherever we think we can create opportunities for increased efficiencies, we always seek to do that. So while we’re not currently forecasting significant restructuring charges in fiscal 2016, we look – we will look for ways for further operating efficiencies.

Okay. And then can you help us get our arms around the savings that result on an annualized basis from the efforts that were implemented this year, this past year?

Yes, it’s a good question and there’s loads of different aspects of that, much of which was already have been incorporated into the numbers that occurred throughout fiscal 2015. I guess the one that happened later in the year which is a fair question would be the consolidation of the manufacturing facility that Deepak alluded to which was completed in the May timeframe. And we believe this consolidation could save us close to about $1 million a year going forward.

Okay. That’s very helpful. Thanks, guys.

Thank you. Our next question comes from the line Josephine Millward from The Benchmark Company. Your question please? Josephine you might have your phone on mute? [Operator Instructions] It appears that we have no further questions at this time. I would like to hand the program back for any further remarks.

Well. Thank you very much for listening to our call, we are very excited about fiscal 2016. And hope to talk to you with more update on October Q1 call. Thank you.