OSI Systems, Inc. (OSIS) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the OSI Systems’ Q1 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will have 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 afternoon, and thank you for joining us. I’m Alan Edrick, Executive Vice President and CFO of OSI Systems. 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. Please note that this presentation is being webcasts and is expected to remain in our website located at www.osi-systems.com for approximately two weeks. Deepak Chopra could not join this today due to an unavoidable scheduling conflict. Earlier today, we issued a press release announcing our first quarter fiscal year 2016 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 financial and operational performance of the company and its operating divisions. The company wishes to caution participants on this conference 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. Before discussing 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. Highlights for our first quarter of fiscal 2016 are as follows: First, we reported Q1 revenues of $200 million, and diluted EPS of $0.53 due to higher revenues in our Security and Opto divisions associated with certain prior year contracts that created challenging comps, first quarter revenues and earnings were down as compared to the prior year as was expected. Second, though sales were lighted than Q1 of last year, bookings were exceptional. Led by our security division, Q1 bookings totaled $454 million for a book to bill ratio of 2.3. It is our present policy to include five years expected revenues from bookings in the backlog. As a result, not all of the bookings from long-term contracts are entered into the reported backlog of $722 million which was up 13% since the end of fiscal 2015. Third, we generated free cash flow of approximately $22 million in Q1. This free cash flow was primarily used for stock repurchases. Now let's dive into business as in greater detail starting with the security division, Rapiscan Systems. Revenues of $96 million were predictably lower than the prior year quarter in which there were nearly $24 million in revenues from the large foreign military sales order and the Glasgow 2014 games. Excluding these prior year revenues, security revenues increased approximately 7%. Rapiscan bookings were an impressive $353 million led by the Albania turnkey services contract and several cargo orders. We were pleased to reach agreement with the government of Albania on certain contract changes which led to the commencement of activities. We expect to ramp up to our full run rate this fiscal year. This 15-year contract for turnkey cargo and vehicle security screen services at various checkpoints throughout the country is valued at approximately €200 million. Initial site operations are going smoothly and we look forward to increasing revenues from this contract throughout this fiscal year as new sites come online. Following Puerto Rico and Mexico, this is the third major turnkey services program now in operation. Similar to that of Mexico, Albania's service cost is based on a fixed amount per site per month. The turnkey services pipeline continues to be robust as potential customers are increasingly recognizing the value proposition we demonstrate in our ability to cater our offerings to best suit the needs of our customers. Excluding turnkey, Q1 bookings in the core security business were strong resulting in a 1.9 book to bill ratio leading to the highest non-turnkey security backlog in over four years. As we have reported, we were one of four suppliers selected to provide medium energy cargo and vehicle inspection systems under a five-year indefinite delivery indefinite quantity contract valued at up to $293 million by the U.S. Customs and Border Protection Agency. And we were pleased to become the first supplier to receive a significant delivery order from this IDIQ contracts as we were awarded a $19 million contract to provide our Eagle M25 cargo and vehicle inspection systems. Other significant Q1 wins included a follow on order for approximately $15 million from a Middle East customer to provide additional baggage and parcel inspection and Eagle cargo and vehicle inspection systems, further our TT wins for sec baggage from several customers and multiple other cargo and baggage inspection orders. Also, I'm happy to announce that the Rapiscan MP100 backpack radiation detection systems was named winner of the best nuclear/radiation detection solution at the Government Security News 2015 security awards. The MP100 is the newest addition to Rapiscan radiation detection portfolio and applies its latest design principles and technology in a high performance portable radiation detection solution. At airports we see a healthy pipeline of potential customer for Rapiscan's RTT. There is a significant market opportunity to replace the current installed base of check baggage machines in Europe to meet the European screening requirement standards. Our state-of-the-art products combined with our ability to provide service and support in over 150 countries make us a compelling candidate for airport tenders in Europe and in other regions that follow the European standards. We continue to look for opportunities to streamline our business and increase efficiencies throughout Rapiscan. Going forward, we believe the security division is well-positioned for long-term success. Now let's move to the healthcare division, Spacelabs, where we had an 8% increase in revenues and delivered a stronger operating margin than the prior year first quarter. This was led by the performance in the U.S. and Europe driven primarily by our patient monitoring and cardiology product lines. We've contracted with leading group purchasing organizations or called GPOs for our patient monitoring products and look forward to adding our other product lines in due course. Over the last several years we've significantly upgraded the healthcare products portfolio with enhanced technologies and strengthened our quality management systems which we believe positions us well going forward. Moving to the Optoelectronics division, where margins improved the revenues as expected were lower than the prior year. We have placed significant emphasis on improving productivity and this quarter's results show the progress. As we have mentioned on prior calls in fiscal 2015 we chose to phase out specific customer relationships and product offerings in this business. This has positioned Opto to deliver improved margins and overall profitability. Given the variety of markets and the OEM relationships that Opto has we believe there are multiple paths to grow. As we continue to strengthen the operations of Opto and improve efficiencies we are confident that our customers will benefit as we deliver high value solutions and show a willingness to invest in expanding our product offerings. We believe Opto is well-positioned to resume top line growth in the second half of fiscal 2016. As a whole, we continue to work towards achieving long-term revenue and earnings growth by expanding our product portfolio and entering new markets while maintaining our focus on further operating efficiencies and expanding margins. Now let's review the financial results for the first quarter of the fiscal year in a greater detail. Our overall revenues in the first quarter of fiscal 2016 decreased 8% as compared to over Q1 of fiscal 2015. As mentioned our healthcare division reported 8% sales growth driven by the strength in U.S. and Europe. This growth was offset by expected lighter sales in the security and Opto divisions due to the sales variance from the prior year as previously discussed. The 15% decrease in our year-over-year security division's revenues was primarily due to the difficult prior year comps we mentioned earlier. However, the solid backlog including significant bookings in security during the quarter was position the division for strong second half growth. And as expected our Opto division's revenues decreased by 9% primarily due to lower contract manufacturing sales as purchasings by a customer in the prior year included large international stocking orders. Even with lower revenues the Opto division has delivered another solid quarter of operating income. Our overall gross margin came in at 34%, which was the same as the prior year's level. As mentioned on previous calls the margin will fluctuate from period to period based on the revenue mix amongst other factors. Moving to OpEx. In Q1 of fiscal 2016, SG&A as a percentage of sales stayed flat with the comparable prior year quarter at 20%. In absolute dollars, SG&A decreased by $3.8 million or 9% with reduction in each of the divisions. We remain committed to increasing efficiencies and managing our cost structure prudently. We continue to invest significant resources in R&D to enhance both our security and our healthcare product offering. Our R&D spending, as a percentage of revenue, was in line with Q1 of the prior year on a relative basis and a little bit lower in absolute dollars. Our effective tax rate for Q1 of fiscal '16 was 27.5%. 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. As we move down to income statement, our Q1 diluted EPS was $0.53 compared to $0.55 in the comparable prior year period due mainly to the sales variance I have discussed. So let's now turn to a discussion of our operating margin. The Q1 operating margin was 7.8%, compared to 7.6% in the prior year. The security division reported an operating margin of 13.1% which was down from 15.2% in Q1 last year resulting primarily from the sales variance and product mix. Opto's operating margin improved significantly year-over-year to 8.9% representing the fourth consecutive sequential quarter of operating margin expansion. With respect to our healthcare division, as you may recall, the bottom line is extremely sensitive to the top line due to the high contribution margin. We were pleased to see a significant improvement year-over-year in the healthcare operating margin. Moving to cash flow, for Q1 of fiscal 2016, operating cash flow was $24.8 million. Capital expenditures totaled $2.5 million in Q1 while depreciation and amortization was $14.1 million. Capital expenditures are expected to accelerate throughout the remainder of the year. Days sales outstanding, or DSO, was 75 days in Q1 fiscal 2016 compared to 65 days last year. Our level of DSO frequently fluctuates significantly from period-to-period. We were active in our stock repurchase program acquiring approximately 459,000 shares at an average price of $75.24 and expanding a total of $34.5 million on repurchases. We are pleased to report that our board authorized a 500,000 share increase to our stock repurchase program resulting in a balance of approximately 980,000 shares authorized for repurchase. Our balance sheet is strong and our leverage ratio remains well below 1. Our credit facility continues to provide us to execute our business plan and nimbly response opportunities. Cash generated outside the U.S. was in part LEFT outside the U.S. To fund international expansion and we utilized our revolver to fund stock purchases among other items. Finally, we are reiterating our fiscal 2016 sales guidance of $985 million to $1,020 million, an earnings guidance of $3.75 to $4 per share excluding the impact of impairment, restructuring and other charges. As mentioned on our last conference call, the fiscal 2016 growth is expected to be generated in the second half of the fiscal year. We currently believe the sales and earnings guidance reflects reasonable estimates. Actual results could vary from the anticipated ranges. 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 security screening solutions and have allowed us to introduce innovative security, healthcare and Opto products and services to the market. We look forward to sharing our future progress on upcoming calls. Thank you for listening to this conference call. At this time, I would like to open the call to questions.

Thank you. [Operator Instructions]. And our first question comes from the line of Josephine Millward of The Benchmark Company. Your line is open.

Thank you. Hi, Alan.

Hi, Josephine.

Alan, given your strong bookings during the quarter, how should we think about the overall growth at your security business this year? And in terms of seasonality, if you can talk about seasonality and when do you expect Albania to be fully operational?

Sure, Josephine, good questions. I will maybe take them in inverse order. Albania we expect to be fully ramped during the course of this fiscal year, is moving up at a nice pace and we think will enter fiscal 2017 at a full ramp rate. So we’re very pleased with the progress that we’re making in Albania. With respect to the other parts of the security, the non-turnkey, very happy with the bookings. We believe the division is positioned nicely for growth and we believe that growth is going to occur in the second half of the fiscal year. As you know, the first half of the fiscal year had extraordinarily difficult comps for that part of the business namely from the revenues that we were able to recognize in the prior year related to the foreign military sale to Iraq.

Great. Just a quick follow-on, can you give us an update on timing of potential follow on for Military sales order from Iraq?

Sure, Josephine, yes, I mean while we think we are very well-positioned for follow on order, as you know in dealing with Iraq is very difficult to ever predict timing. So at this point, we would refrain from try and predict timing. But we think we are well-positioned if and when an order is placed.

Thank you.

Thank you. Our next question comes from the line of Jeff Martin from ROTH Capital Partners. Your line is open.

Thanks. Hi Alan.

Hi Jeff. How are you doing today?

I'm doing well, thanks. On the FMS looking back to last year I got a note of roughly $40 million from FMS in the December quarter last year, is that accurate in that period? Obviously, a tough comp which I think people largely recognize but just looking to quantify.

Sure, Jeff, that is confirm. That number is very close to what we recognized in the prior Q2.

Okay. And then on Optoelectronics you had 8.9% operating margin in the quarter, is that a sustainable margin to expect going forward or is that was there something anomalous to the first quarter with respect to the operating margin contribution?

Yes, Jeff, we focused quite a bit over the last 12 months or so on improving the Opto operating margins and we have had some nice success in that regard. I think each of the past four quarters we have seen a sequential operating margin improvement. 8.9% was particularly strong it was driven by sales in particular segments within Opto that carry higher margins. That being said, we think there is further opportunity to expand those margins in Opto. So while we may not expand on a sequential basis every quarter, we do think there is opportunities for further expansion there, and based on the product mix certain quarters maybe a little bit higher, certain quarters maybe a little bit lower.

Okay. Can you talk about expecting some second half growth in Opto, what are the drivers there?

Yes, the biggest drivers are some of the new contracts we have gotten. Our sales team in Opto has done an outstanding job. We have landed some new customers and the timing of those deliveries occur in the second half. Complementing that are the tough comps that we had in Opto from some of the changes we intentionally made in division are largely behind us as we head into the second half. So we feel quite good about that.

Okay. And then any developments with RTT certification with TSA?

Yes we expect to submit for certification this fiscal year. So we believe we’re on track for that. And our primary focus in RTT at this point is on sales outside the United States where we have certification; it’s going very well for us.

Great. And could you comment on the proposal or the request for proposal activity for RTT in Europe, and just give us an update there?

The pipeline for RTT activity is extremely strong. We’ve landed a number of major wins. There continues to be a high funnel of opportunities of RFPs out there. So we really look at RTT as a nice driver of growth for us for many years to come.

Or safe to say it is tracking well to your expectations?

That is safe to say, that is correct.

Okay. Thank you, Alan. Appreciate it.

Sure.

[Operator Instructions]. Our next question comes from the line of Les Sulewski from Sidoti and Company. Your line is open.

Hey good afternoon Alan. How are you?

I’m doing good, Les. Thank you.

Prior quarters you mentioned in your press release you stated you had restructuring charges; were they none this quarter or just was omitted? Any comment on that?

Yes. Over the past few years we have been looking at a lot of opportunities to streamline the business and get more efficient, which often time resulted in restructuring charges. This past quarter, the September quarter did not have any, which is why it shows zero. That being said, we are always looking for opportunities to improve, we have a mantra of continuous improvement. So that is very possible very likely that you will see restructuring charges in future quarters.

Okay. Also I think just rephrase the other question on the RTT in Europe, in previous quarters you mentioned a number of machines still left out there, do you have that number by any chance?

Yes, there is a large number of machines left out there I don’t think we probably didn’t mentioned any type of exact number because we’re not necessarily privy to the exact number of machines that are out there. But it’s safe to say it’s in the very early stages of the replacement cycle in Europe, we’re doing very well in the early innings and we’re excited about the potential for RTT in Europe really throughout this replacement cycle that is going to go on for several years.

Got it. On the IDIQ so there is about a say $270 million left given that you were allocated $19 million, do you know other suppliers that were allocated certain amounts closer to that $19 million. Are you the only one out there? And then any comment on how the remainder could get allocated?

Sure, good question. Our understanding is that we’re the only supplier who have been awarded any significant award. Each supplier may have been awarded a very nice small initial award but have any material amount which $19 million clearly was, we believe we are the only supplier who have been awarded that so far. We’re pleased with getting ready to fulfill that order in terms of calling how the $293 million maybe spent in terms of timing probably little bit premature for us to comment on that.

Are there any machines that you perhaps might not have to fill that order?

No, we believe we have the product portfolio that will enable us to fulfill that order yet such is provided.

Got it. Thank you. And just last one on any FX headwinds in the first quarter and perhaps in the second and then we might have some lapping in the second half but any comment on that?

Yes, there were some FX headwinds on the top line for us in the first quarter namely with the strength of the dollar relative to some other currencies. It probably affected us less than 2% for the first quarter. We will have to see how those FX headwinds begin to dissipate a little bit throughout the remaining of the fiscal year. We will have to see how – we will have to see what the volatility of the foreign exchange will tend to show us. But in the first quarter it was not as significant as it was for us in the last few quarters.

Got it. Thank you, Alan. Appreciate it.

Sure.

And I’m showing no further questions in the queue. I would like to turn the call back to you, Mr. Edrick, for closing remarks.

Great, thank you. While we like to thank everyone for joining our call today. We look forward to speaking with you on our next call. Thank you again, good bye.