OSI Systems, Inc. (OSIS) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the OSI Systems Incorporated Fourth Quarter and Fiscal Year 2016 Conference Call. At this time, all participant lines are in a listen-only mode to reduce background noise. But later we will be holding a question-and-answer session after the prepared remarks and instructions will follow at that time. [Operator Instructions]. As a reminder, today's conference call is being recorded. I would now like to introduce your first speaker for today, Alan Edrick, Chief Financial Officer for OSI Systems. You have the floor sir.

Thank you. 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 fourth quarter and fiscal year end 2016 conference call. We would like to extend a warm 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 at least two weeks. Earlier today, we issued a press release announcing our fourth quarter and fiscal year 2016 financial results. Before we discuss our results, I would like to remind everyone that today's discussion contains forward-looking statements. I will now read the company's cautionary notice regarding 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 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, statements regarding pending acquisition of American Science & Engineering, 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 therein and 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 results, which is 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 for the fourth quarter of fiscal 2016. First, we reported fourth quarter revenues of $221 million, a 17% year-over-year decrease. We entered the quarter with a difficult comparison in our Healthcare Division, given record revenues in Q4 of fiscal 2015. As mentioned on our last conference call, we expected healthcare revenues to be up a little sequentially, but down significantly year-over-year. The fourth quarter results are consistent with this period. Revenues in the Security Division were significantly softer than anticipated, driven again by timing related items that Deepak will discuss in more depth. Revenues in our Opto division, however; were in line with our expectations. Second, we reported Q4 GAAP diluted earnings per share of $0.30. On a non-GAAP basis, which excludes impairment, restructuring and other charges, Q4 earnings per diluted share were $0.55, which was within the range we anticipated. The decrease in the prior year was primarily a result of the change in revenues just mentioned. Third, free cash flow, which we defined as operating cash flow, less capital expenditures was $10 million for the quarter. And fourth, our non-turnkey Q4 book-to-bill ratio was 1.0. For fiscal year 2016, bookings were up 7% over fiscal 2015 driven by the Security Division. Before diving into the numbers and discussing fiscal 2017 guidance, let me turn the call over to Deepak.

Thank you, Alan. And again welcome to the OSI Systems earnings conference call. During the fourth quarter and throughout the fiscal 2016, the OSI team strived to achieve long-term strategic objectives, while working through certain challenges. We are glad to have 2016 behind us, and are optimistic about both our near and long-term prospects as we enter fiscal 2017 with a stronger organization and an increasing opportunity pipeline in many of our end markets. Let's talk more in detail about each business units, starting with our Security Division, Rapiscan. Revenues were $411 million for the full fiscal year were 15% lower than the same period year ago. Q4 revenues for Rapiscan were down 16% from the prior year. Throughout the year, we saw customers prolonging time to accept shipment on previously placed orders as well as deferring decisions on new purchase orders, which impacted the timing of book and ship orders and created general program delays on existing backlog. As an example, approximately $20 million plus of security backlog was planned to ship in Q4, but was delayed at the request of the customer. A few of the highlights for, Rapiscan's Q4. We continued to make progress in the high-speed CT checked baggage market, with a production ramp up as well as building out our service and logistics network. Of note, we notched another major win at an international airport, which we announced shortly after the end of Q4, where we will provide multiple systems of our RTT 110 real-time tomography explosive detection system. This order adds to our RTT wins that have included major airports such as Rome, Paris, and Oslo. We begin fiscal 2017 with a strong RTT backlog and expect significant revenue growth from this product line. For the U.S. market, we continue to remain on track to submit the RTT 110 for TSA certification. While general market activity was a little slower for checked baggage equipment over the past couple of quarters, the upcoming European Union deadlines and the U.S. replacement cycles are expected to fuel RTT sales over the next two to four years. In the baggage and parcel inspection arena, we saw good international order activity, especially in Asia. For the cargo inspection side of the business, we recognized several strategic international wins during the quarter. In June, we announced our pending acquisition of American Science and Engineering. As we indicated at the time the AS&E acquisition is consistent with the strategy to expand our security offerings as it would add proven, fixed, and mobile inspection platforms based on the Z Backscatter technology, including a large installed base of ZBV mobile cargo vans that are used both in the U.S. and internationally. And we plan to nurture and grow this product line. AS&E team also brings a team of software and hardware engineers and scientists that should enhance our product development capabilities. While we look forward to completing this transaction, it remains subject to the approval of AS&E's shareholders, antitrust approval, and other customary closing conditions. And until the transaction is consummated, we are limited what we can say. In turnkey services, our current programs in Albania, Mexico, and Puerto Rico continued to perform well and contribute significantly to our overall performance. This market represents a key growth driver for us. Going forward, as the potential turnkey pipeline continues to grow; we believe we are in excellent position to capture additional turnkey services opportunities. As mentioned in the previous calls, the timing is always little unpredictable. Looking ahead, we are pleased with our potential in the Security Division for both aviation and non-aviation markets, given the trends in our opportunity pipelines in these areas. In addition to multiple active opportunities we see for turnkey solutions, we also are looking at strong opportunities for RTT and cargo equipment in general. Moreover, our balanced exposure to major regions in the world creates multiple avenues from which new security opportunities can arise. We continue to see a buildup in demand for cargo inspection products in both U.S. and international. Moving to Healthcare. Spacelabs sales were $55 million in Q4, 30% lower year-over-year and sales were $211 million for the year, 17% lower than the prior year. These results were somewhat in line with the expectations that we discussed in our Q3 call. Fiscal 2016 was certainly a challenging year in the Healthcare Division, driven primarily by internal challenges from a new product rollout. This impacted sales from Q2, Q3, Q4 and is expected to carry over to Q1 of the current fiscal year. We have confronted the issues head on by making significant progress in revamping our product rollout process, and we anticipate being in a position to grow this division's revenue in fiscal 2017. As mentioned in a previous conference call, we have hired a new leader for our Healthcare Division in April and are encouraged by the increased level of focus and sense of urgency that has permeated throughout the organization. Spacelabs, having been around for over 50 years is a group that has endured many challenges successfully. Over the past several years, we have focused our efforts to develop new products, utilizing advanced technology, while enhancing user-centric features. We take internal missteps very seriously and thus have made course corrections promptly. Overall, I'm proud of the way the healthcare team has embraced the challenges and prepared itself to emerge stronger. Moving to Optoelectronics. In the fourth quarter, the Optoelectronics division generated revenues of $63 million which was a 7% decline from the same period in the prior year. However, we continue to improve the revenue profile towards a more favorable product mix as the operating margins improved to 9.3% for the fourth quarter, excluding restructuring and other charges, compared to 8.5% in Q4 of the prior year. This profit improvement demonstrates the impact of our efforts delivering higher operating margin on a lower revenue base. The two small acquisitions that we completed in Q3 are being integrated well. Going forward, our opportunity pipeline in Opto suggests that we will return to top-line growth in fiscal 2017, though we expect this to be weighted more towards the second half of the year. To conclude, with a strong balance sheet and experienced leadership team and identified opportunities, we look forward to driving growth in revenues and earnings per share in fiscal 2017. With that, I'm going to hand over the call back to Alan, to talk in detail about our financial performance and guidance before opening the call for questions. Thank you.

Thank you, Deepak. Let's review the financial results for the fourth quarter in greater detail. As mentioned previously, revenues in the fourth quarter of fiscal 2016 decreased 17% year-over-year, driven by the Security and Healthcare Divisions as Deepak previously described. Third-party revenues in our Opto division were down by 1%, while intercompany sales were down consistent with the performance of the other divisions and our efforts to right size inventory on hand. The Q4 gross margin was 32%, down a 150 basis points from the prior year due to the decrease in sales in our Healthcare Division, which generates the highest gross margin of our three divisions, although this was partially offset by an improved gross margin at the Opto division. As mentioned on previous calls, the gross margin will fluctuate from period-to-period based on product mix among other factors. Moving to operating expenses. In Q4, selling general and administrative expenses, or SG&A of $43.9 million were up by $2.2 million or 5%. On a full year basis, SG&A expenses were down by $5.1 million or 3%. As noted on previous calls, we remain committed in all of our divisions to increasing efficiencies and prudently managing our cost structure. R&D expenses of $11.9 million in Q4 were down year-over-year in absolute dollars, but increased to 5.4% from 4.9% as a percentage of sales. We continued to make significant investments in research and development in our Security and our Healthcare divisions to enhance their product portfolios. We remain focused on growth platforms in innovative product development, which we view as vital to the long-term success of our business. The company's effective tax rate was 23.9% for the fourth quarter and 26.3% for fiscal year 2016. Our provision for income taxes is dependent on the mix of income from U.S. and foreign jurisdictions, due to tax rate differences among countries, as well as the impact of permanent taxable differences, tax elections, and valuation allowances amongst other items. Q4 impairment, restructuring and other charges were $6.4 million which included severance costs, impairment charges, and acquisition and legal costs. Let's now turn to a discussion of our operating margin, excluding impairment restructuring and other charges. As would be expected with the decrease in sales, the company's adjusted operating margins declined to 6.7% in Q4. Because of strong contribution margins in our Healthcare division, as sales rise, the operating margin generally follows. But as we have previously communicated, the inverse is also true. With a 30% decrease in the Healthcare division's revenues, the division's adjusted operating margin declined to 6.6% in Q4 this year from 17.3% last year. We are pleased again to see strength in the Opto division as the adjusted operating margin increased to 9.3% in Q4 this year from 8.5% in Q4 last year, marking the seventh consecutive quarter that Opto's operating margins have improved on a year-over-year basis. Finally the Security division's adjusted operating margin was 9.6% in Q4 as compared to 13.7% in Q4 last year driven by the decrease in sales and the mix. Moving to cash flow and the balance sheet. For Q4 of fiscal 2016, we reported operating cash flow of $19 million; capital expenditures were $8.7 million, while depreciation and amortization was $15.4 million. Days sales outstanding or DSO was 58 days for this quarter as compared to 61 days in Q4 of last year. In Q4, inventory decreased $18 million from Q3, though days inventory is higher than we would like and represents an opportunity in fiscal 2017 to improve free cash flow by increasing turns. Our balance sheet remains strong and our gross and our net leverage ratios at June 30 were below 1. Our credit facility continues to provide the company with the flexibility necessary to execute our business plan. Finally, turning to the updated guidance. Prior to fiscal 2016 we had a strong track record over the past decade of delivering on the guidance provided. This past year was a struggle due to multiple, mostly unforeseen issues on a product rollout and Healthcare and timing issues in Security. In light of the recent period of volatility, we have set our initial guidance for fiscal 2017 at a level that we believe, with a high degree of confidence, we can achieve. With this background, we anticipate fiscal 2017 sales of $865 million to $895 million. In addition, we anticipate 23% to 37% growth and earnings per diluted share to $2.60 to $2.90, excluding the impact of impairment restructuring and other charges and the related tax effects. This guidance does not incorporate any contribution from the pending acquisition of American Science & Engineering, which we expect to incorporate on the first quarterly call following the close of the transaction. We currently believe that our sales and earnings guidance is based on reasonable estimates. Actual sales and earnings however could vary from this range because of the risks and uncertainties that affect our business and industries generally, including items that may not be entirely within our control, such as site readiness for product installations, customer acceptance, and the timing of orders in each division. Over the past decade, we've demonstrated a strong track record of producing sales and earnings growth with strong cash flow generation, while simultaneously investing in product development and innovation for the future. Our investments have enabled us to continue our leadership role in the turnkey screening solution market space and have allowed us to introduce innovative products and solutions to the market across our industries. Thank you for participating in this conference call. And at this time, we would like to open the call to questions.

[Operator Instructions]. We will be taking our first question from the line of Larry Solow from CJS Securities. Your line is open.

Hi good afternoon. Just on terms of the guidance and how it relates to Q4, it looks like certainly you're a little bit below your expectations on the security side. What gives you sort of confidence that will get some rebound as we head out into fiscal 2017, is it mostly on the RTT side or is it from several different products and do you have visibility on -- better visibility on that?

Good question. We want to emphasize it that we've gone into the next year with a very strong backlog. Bookings have been quite good, and as Alan mentioned, and I mentioned before that there has been a little bit of unpredictability of getting pushed out from customers requesting, the site is not ready or they are making their decision little later, also we believe that our confidence for 2017 is based upon our backlog. Our pipeline is very strong. We've done very large RFQs out there in bidding the last couple of months. And our RTT is basically driven by requirements that are regulated that in the next couple of years of the airports especially in Europe, they have to replace their equipment and our success rate in winning the tenders have been very good.

Absolutely. Could, I mean -- could just play devil's advocate things shift even a couple of quarters or -- well you mentioned this $20 million in your prepared comments, is that from one particular product? And do you have visibility that's going to hit the next couple of quarters, just as an example?

Larry, this is Alan. Yes that $20 million that Deepak referred to came from a few different product lines and a few different regions to multiple customers. That $20 million will of course ship and it looks like the bulk of it will ship in the first half of our fiscal 2017 probably a little bit more weighted to Q2 than Q1.

Okay. And then on turkey, it sounds like, we're not getting through real specific detail, it sounds like that queue of opportunities is bigger than it has been in sometime and hopefully, things are just a matter when you can close some deals that's a good assessment.

That's a good assessment and again I want to emphasize that most of these deals, most of the deals are cargo based. So even at the end it becomes a sale of equipment or it turns into a turnkey, now our pipeline is very robust and strong and also what we feel is we have demonstrated that this can work so, we have a big edge start from our competitors.

Okay. And then just touching real quick on healthcare, can you just give us a quick update on where you stand, you have a new President running the division and has the monitor now is the -- is it feel like all the issues are hopefully behind at least the re-launch of it and just a matter of getting traction back in the market.

That's absolutely true. I did say it in my call that we've said it that Q4 was a transition time and it's going to extend into Q1 but we are going to put it behind and we think we've said it we are very confident that 2017 will show growth in the Healthcare department in growth.

Okay. And then the AS&E acquisition still about Q4 or calendar Q4, type of thing that what the target is even though you don't know for sure.

Well, you just answered your own question. We can't predict it. Basically get going through the various regulatory function answering questions. We feel still very good about it but we can't comment any on the timing.

Thank you. Our next question comes from the line of Josephine Millward from The Benchmark Company. Your line is open.

Hi, guys. What's your security backlog because your total backlog is actually down about 2% right from last year?

Josephine this is Alan. As you recall, with respect to Mexico, the backlog only goes in one direction. So if we take out -- if we take out Mexico our backlog is actually up. So the security group represents the bulk of that backlog and is approximately $0.5 billion.

Okay. And total security bookings from last year?

Total security bookings for the quarter or for the year?

For fiscal year 2016, because I think you mentioned it was up 6% or 7% year-over-year.

Yes, that's correct one second we will give you that answer here. The bookings for security were just under $400 million.

And Alan and Deepak can you talk about your assumptions for each business and your guidance it looks like you are assuming around roughly mid-single-digit growth for each business unit?

Josephine we provide guidance on an overall OSI Systems basis. As you may know from our past we don't break it down into each individual division.

Okay. What do you guys think of Brexit? How does that impact potentially impact your business? I believe you manufacture the RTT in the UK and you also have some revenue exposure there. And does it change the UK's commitment to upgrade check baggage by 2018?

Josephine, its Alan. I'll take the first part of that question and give the second part to Deepak. We're one of those unusual companies that has more costs in pounds than we typically have revenues in pounds. So with the devaluation of the pound, it actually helps us from an overall perspective when you translate it back into the P&L. The impact of Brexit, I guess, will also to see ultimately some are forecasting the economy to be slightly weaker there on an overall basis. With respect to checked baggage, let me give that one to Deepak.

Josephine on the checked baggage, it's regulatory driven. The timelines are fixed by EU and by Europe and England and other places. So I don't think so the British exit in a way has any impact on the regulatory decision on which the new technology has to be installed. We are very, very happy with the progress, as I mentioned on my call. We have won a very large share of the orders that have been out there tendered in the RTT and is very well received. Especially, in UK as Alan mentioned, we definitely have a price advantage too.

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

I was wondering if you could give us a little more detail on the turnkey pipeline. I mean, it's understandable that timing is always unpredictable. If I'm recalling correctly, Albania was your last win which was approximately three years ago. Just curious if you have specific visibility on near-term projects that could close or if this is just a long lead cycle that there isn't a ton of visibility on?

Jeff, the way you're saying, it is right. These are tough things to predict. All we can tell you is with the successes we've had and keep in mind, Albania is a good example. Although it's been three years, it also got sort of stopped when the election happened and then it got rejuvenated. We are working for most of these turnkey projects in areas where there is some unpredictability, both volatility in the economy, volatility in their requirements, volatility in just the need for protecting the infrastructure. The good news is that we said in the last conference call also, any place where you see that there are infrastructures -- even oil, in some ways, we can say oil economy hurts us, it's because of the price down. The other case, if the economy is based primarily in oil revenue, they got to protect that infrastructure, so they need turnkey kind of rate or they need the kind of solutions. So our pipeline continues to be very robust. We're getting a lot of inquiries of it, but I know what that is unfortunate, we can't predict any specific timing. All we can tell you is we have a full sales force working on it. We have a focused growth. We're doing show and tell, and we're very much optimistic about closing some deals.

Okay. Thank you for that. On the RTT side, are you able to give us a sense of how much RTT is in the security backlog? And how do you feel about shipments life-to-date versus where you thought it would be going back may be a year ago?

Well, I'll take the latter part then P&L. Firstly, we don't break down the backlog or anything for competitive reasons. I think, I said it in my call, we are expecting a very significant ramp up in revenue in 2017 for the RTT product line. With that, I want to again caution it and may be Alan you can add some color that this is a new way of products we shipped. And in many cases, like what we happen, we shipped product, it's out, but it's still on our inventory because the customer is not ready to sign up because the airport is not ready. So that thing is there. Our take is -- our backlog is very strong. We've announced some new orders. And we feel very optimistic and we're ramping up for a good revenue out in 2017. Alan?

Can you shed any perspective real quick before Alan answers the first part of the question? Can you shed any perspective on maybe some waiting in terms of first, second, and third quarters of your current RTT backlog, just to help us get a sense of how to model the security segment by quarter end 2017?

Sure, Jeff. While we don't go into depth on the quarters just to give a little insight, we would expect that the RTT shipments will be more heavily weighed into our Q2 and our Q3. There will be shipments in Q1 as well. But the way it's looking as we sit here today, Q2 and Q3 are the big revenue quarters for RTT.

Okay, that's helpful. And then within your guidance of $2.60 to $2.90 EPS is there any restructuring charges contemplated in that within your guidance assumptions?

So our guidance excludes any restructuring and other charges. So that is -- that guidance is on a non-GAAP basis excluding restructuring and other.

Okay. But is there any planned restructuring charges in the period when you had a disproportionate amount in 2016 and then the second part of that question would be are there cost savings in 2017 that we should see us a result of those charges that would happened in 2016?

Yes. As a result of what we did in 2016; you'll see a benefit in 2017. There will be some further ongoing charges in 2017 as we're continuing to look for some efficiencies that we had planned. Those are not necessarily of a material nature. What could change that a bit, which is of course is not the subject of this discussion but as we close any acquisition there will of course be cost associated with closing the acquisition that would be absorbed into that line item at the appropriate time.

[Operator Instructions]. Our next question comes from the line of Juan Molta from B. Riley. Your line is open.

Hi, guys good afternoon. If you could please provide some color on the different product lines in the healthcare division how that's coming along? And what you’re seeing there as we go into next fiscal year, please?

Okay. This is Deepak here. As primarily, as we have mentioned before, more than 70% of our revenue or significant portion of our revenue is monitoring based and very much centric towards U.S. So that's the main focus on the product line. We do have cardiology and anesthesia but primarily people look at us as a patient-monitoring company, and that's where our focus is.

Okay. And I believe you said that you expect Opto to grow next fiscal year, top-line?

Yes.

And can you mention any verticals, particular any verticals of strength in Opto? Where you expect that growth to come from?

Well, we have a very broad portfolio. We're mostly to the OEMs. We sell it's the aerospace, defense, healthcare. We are not exposed to the consumer side industrials; semiconductor equipment, automotive. So it's a very broad portfolio and we work in a very large base of customers in all these industries. There is no one industry that talks that is very much that's like focused on.

Okay, very good and that was all the other questions have been addressed. Thank you very much.

Thank you. Ladies and gentlemen, I see no other questions in the queue. Pardon me. I got a queue up from Josephine Millward. Your line is open.

I would like to thank every --

Deepak?

Yes, sorry.

Just a follow-up. AS&E reported weaker-than-expected quarter again due to cargo shipment delays. Can you comment on what's going on there? And when we might see that issue result or is that to what you're experiencing as well?

Josephine, on the subject of the shipments, I think what we've reported on the cargo side, they're having the same kind of things because all of us are tied to the same market -- due to the timing of the shipments, but they also did very strong profits. And their bookings were pretty good.

Okay, great. Can you give us a sense of seasonality for the coming fiscal year in general?

There is Josephine, as far as I know, we've said before, there is no seasonality in this business, but volatility is may be a better word. And definitely, it plays that part and it's become a little bit more exasperated since last year, we have said that. The good news is we are very confidently saying it, we haven't seen any difference in the requirements or the demand for our products especially in security. And we haven't seen any losses either. I mean, it's tough to say that, but it's true. We've been very successful in RTT bookings. We've been very successful in cargo. Obviously, our services, we're patiently waiting and working on it. We're very, very proud about our product line.

Okay. Historically, security has been much stronger in the second half; do you think that trend is going to continue in the coming years?

I think the answer is yes just the way Alan has described that the RTT shipments in Q2 and in Q3 heavily weighted. And cargo, if you don't have any bookings, of a specific time, it takes six months to get the product out. So I would think that -- that second half would be stronger than first half, but may be not as different this time around might be little bit more balanced because we have a good backlog.

Thank you. [Operator Instructions]. Okay, I see no other questioners in the queue at this time. So, I'd like to turn the call back over to management for closing remarks.

I'd like to thank everyone for joining our call. And we look forward to speaking with you again on our next call. We are very, very comfortable with the change and the growth that we're expecting in 2017. It is true fact 2016 was a very challenging year and we are happy to put it behind us. Thank you very much ladies and gentlemen.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program. And you may all disconnect at this time. Everyone, have a great afternoon.