OSI SYSTEMS INC 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ​ In this report, “OSI”, the “Company”, “we”, “us”, “our” and similar terms refer to OSI Systems, Inc. together with our wholly-owned subsidiaries. ​ This management’s discussion and analysis of financial condition as of September 30, 2021 and results of operations for the three months ended September 30, 2021 should be read in conjunction with management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2021 filed with the SEC. ​ Forward-Looking Statements ​ This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements relate to our current expectations, beliefs, and projections concerning matters that are not historical facts. Words such as “project,” “believe,” “anticipate,” “plan,” “expect,” “intend,” “may,” “should,” “will,” “would,” and similar words and expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve uncertainties, risks, assumptions and contingencies, many of which are outside our control. Assumptions upon which our forward-looking statements are based could prove to be inaccurate, and actual results may differ materially from those expressed in or implied by such forward-looking statements. Important factors that could cause our actual results to differ materially from those expectations are disclosed in this report, our Annual Report on Form 10-K for the fiscal year ended June 30, 2021 (including Part I, Item 1, “Business,” Part I, Item 1A, “Risk Factors” and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”) and other documents filed by us from time to time with the SEC. Such factors, of course, do not include all factors that might affect our business and financial condition. We could be exposed to a variety of negative consequences as a result of delays related to the award of domestic and international contracts; failure to secure the renewal of key customer contracts; delays in customer programs; delays in revenue recognition related to the timing of customer acceptance; changes in domestic and foreign government spending, budgetary, procurement and trade policies adverse to our businesses; global economic uncertainty; impacts on our business related to or resulting from the COVID-19 pandemic such as material delays and cancellations of orders or deliveries thereon, supply chain disruptions, plant closures, or other adverse impacts on our ability to execute business plans ; unfavorable currency exchange rate fluctuations; effect of changes in tax legislation; market acceptance of our new and existing technologies, products and services; our ability to win new business and convert any orders received to sales within the fiscal year; enforcement actions in respect of any noncompliance with laws and regulations including export control and environmental regulations and the matters that are the subject of some or all of our investigations and compliance reviews, contract and regulatory compliance matters, and actions, which if brought, could result in judgments, settlements, fines, injunctions, debarment or penalties; and other risks and uncertainties, including but not limited to those detailed herein and from time to time in our other SEC filings, which could have a material and adverse impact on our business, financial condition and results of operation. Many of the referenced risks could be amplified by the magnitude and duration of the COVID-19 pandemic. All forward-looking statements contained in this report are qualified in their entirety by this statement. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties, and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur, and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Investors should not place undue reliance on forward-looking statements as a prediction of actual results. We undertake no obligation other than as may be required under securities laws to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. ​ Executive Summary ​ We are a vertically integrated designer and manufacturer of specialized electronic systems and components for critical applications. We sell our products and provide related services in diversified markets, including homeland security, healthcare, defense and aerospace. We have three operating divisions: (a) Security, providing security and inspection systems and turnkey security screening solutions; (b) Healthcare, providing patient monitoring, diagnostic cardiology and connected care systems and associated accessories; and (c) Optoelectronics and Manufacturing, providing specialized electronic components for our Security and Healthcare divisions, as well as to third parties for applications in the defense and aerospace markets, among others. ​ 22 Table of Contents Security Division . Through our Security division, we provide security screening products and services globally, as well as turnkey security screening solutions. These products and services are used to inspect baggage, parcels, cargo, people, vehicles and other objects for weapons, explosives, drugs, radioactive and nuclear materials and other contraband. Revenues from our Security division accounted for 53% and 54% of our total consolidated revenues for the three months ended September 30, 2020 and 2021, respectively. ​ Healthcare Division . Through our Healthcare division, we design, manufacture, market and service patient monitoring, diagnostic cardiology and connected care systems globally for sale primarily to hospitals and medical centers. Our products monitor patients in critical, emergency and perioperative care areas of the hospital and provide information, through wired and wireless networks, to physicians and nurses who may be at the patient’s bedside, in another area of the hospital or even outside the hospital. Revenues from our Healthcare division accounted for 20% and 18% of our total consolidated revenues for the three months ended September 30, 2020 and 2021, respectively. ​ Optoelectronics and Manufacturing Division . Through our Optoelectronics and Manufacturing division, we design, manufacture and market optoelectronic devices and flex circuits and provide electronics manufacturing services globally for use in a broad range of applications, including aerospace and defense electronics, security and inspection systems, medical imaging and diagnostics, telecommunications, office automation, computer peripherals, industrial automation and consumer products. We provide our optoelectronic devices and electronics manufacturing services to OEM customers and to our own Security and Healthcare divisions. Revenues from external customers in our Optoelectronics and Manufacturing division accounted for 27% and 28% of our total consolidated revenues for the three months ended September 30, 2020 and 2021, respectively. ​ Trends and Uncertainties ​ The following is a discussion of certain trends and uncertainties that we believe have influenced, and may continue to influence, our results of operations. ​ Coronavirus Pandemic. The coronavirus disease 2019 (“COVID-19”) pandemic has dramatically impacted the global health and economic environment, with millions of confirmed cases, business slowdowns and shutdowns, and market volatility. The COVID-19 pandemic has caused, and is likely to continue to cause, significant economic disruptions and has impacted, and is expected to continue to impact, our operations and the operations of our suppliers, logistics providers and customers as a result of quarantines, facility closures and travel and logistics restrictions. Our ability to continue to operate without significant negative impacts will in part depend on our ability to protect our employees and our supply chain and to keep our manufacturing facilities open and operating effectively. We have endeavored to implement government and health authority recommendations to protect our employees worldwide. While we do not expect these pandemic-related impacts to be long-term, there is substantial uncertainty regarding the duration and ultimate impact of the COVID-19 pandemic. During the early stages of the pandemic, our Healthcare division experienced increased demand for certain products as a result of COVID-19. In our Security division, throughout the pandemic, receipt of certain orders has been delayed, most notably with respect to our aviation and cargo products, and our revenues have been adversely impacted as a result of the pandemic. As many customers of our Security division continue to be impacted by the pandemic, we have received and could receive further requests to delay deliveries of equipment and modify service arrangements or the scheduling of factory or site acceptance tests, which has impacted, and could further impact, timing of revenue recognition. In addition, as a result of COVID-19 related government regulations, certain of our global manufacturing facilities have had to limit operations and might have to limit operations in the future. If these business interruptions resulting from COVID-19 were to be prolonged or expanded in scope, our business, financial condition, results of operations and cash flows would be materially and adversely impacted. We intend to continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in our best interests and the best interests of our employees, suppliers and customers. ​ 23 Table of Contents Global Economic Considerations. Our products and services are sold in numerous countries worldwide, with a large percentage of our sales generated outside the United States. Therefore, we are exposed to and impacted by global macroeconomic factors, U.S. and foreign government policies and foreign exchange fluctuations. In addition to the COVID-19 pandemic, these other global macroeconomic factors, coupled with the U.S. political climate, have created uncertainty and impacted demand for certain of our products and services. We do not know how long this uncertainty will continue. These factors could have a material negative effect on our business, results of operations and financial condition. Global Trade. In addition to the COVID-19 pandemic, the current domestic and international political environment, including in relation to recent and further potential changes by the U.S. and other countries in policies on global trade and tariffs, have resulted in uncertainty surrounding the future state of the global economy and global trade. This uncertainty is exacerbated by sanctions imposed by the U.S. government against certain businesses and individuals in select countries. Continued or increased uncertainty regarding global trade due to these or other factors may require us to modify our current business practices and could have a material adverse effect on our business, results of operations and financial condition. ​ Healthcare Considerations. As described above, our Healthcare division experienced some increased demand for its patient monitoring products as a result of the COVID-19 pandemic. Increased healthcare capital purchases made in prior periods may result in fewer capital purchases in subsequent periods. The pandemic may also impact our ability to manufacture product needed to timely fill orders if we experience supply chain disruptions or need to close any manufacturing facility due to employee COVID-19 cases or local government regulations. European Union Threat Detection Standards. The EU has implemented regulations for all airports within the EU that use explosive detection systems to have hold baggage screening systems that are compliant with the European Civil Aviation Conference (ECAC) Standard 3. The deadline for compliance with this mandate was initially set for September 2020. Given the uncertainty surrounding the COVID-19 pandemic, the EU revised the regulations, and the date by which airports using explosive detection systems for hold baggage screening must meet Standard 3 has been changed to March 2024, with certain larger airports required to meet earlier installation dates. Our Security division’s real time tomography (RTT) product has passed the ECAC explosive detection system Standard 3 threat detection requirement. Government Policies. Our results of operations and cash flows could be materially affected by changes in U.S. or foreign government legislative, regulatory or enforcement policies, including U.S. and foreign government policies to manage the COVID-19 pandemic, such as travel restrictions or site closures. ​ Changes in Costs and Supply Chain Disruptions. Our costs are subject to fluctuations, particularly due to changes in raw material, component, and logistics costs. Our manufacturing and supply chain operations, including freight and shipping activities, have been and may continue to be impacted by increased vendor costs as well as the current global supply chain bottleneck. This increased cost environment has been exacerbated by the COVID-19 pandemic. Although we strive to implement, achieve, and sustain cost containment measures, including supply chain optimization and general overhead and workforce optimization, if we are unable to mitigate the impact of increased costs through pricing or other actions, there could be a negative impact on our business, results of operations, and financial condition. Results of Operations for the Three Months Ended September 30, 2020 (Q1 Fiscal 2021) Compared to the Three Months Ended September 30, 2021 (Q1 Fiscal 2022) (amounts in millions) ​ Net Revenues ​ The table below and the discussion that follows are based upon the way in which we analyze our business. See Note 11 to the condensed consolidated financial statements for additional information about our business segments. ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Q1 % of Q1 % of ​ ​ ​ ​ ​ ​ Fiscal 2021 ​ Net Revenues ​ Fiscal 2022 ​ Net Revenues ​ $ Change ​ % Change ​ Security ​ $ 134.8 ​ 53 % $ 149.5 ​ 54 % $ 14.7 ​ 11 % Healthcare ​ 51.5 ​ 20 ​ ​ 50.6 18 ​ ​ (0.9) ​ (2) ​ Optoelectronics and Manufacturing ​ 68.6 ​ 27 ​ ​ 79.2 28 ​ ​ 10.6 ​ 15 ​ Total net revenues ​ $ 254.9 ​ 100 % $ 279.3 ​ 100 % $ 24.4 ​ 10 % ​ 24 Table of Contents Revenues for the Security division during the three months ended September 30, 2021 increased 11% year over year. Our product revenues increased by approximately $16 million as compared to the prior year comparable period where revenues were more adversely impacted by the COVID-19 pandemic. In addition, our service revenues decreased by approximately $1 million. ​ Revenues for the Healthcare division during the three months ended September 30, 2021 were relatively comparable year-over-year. Cardiology sales increased by approximately $2 million and service, supplies and accessories sales increased by approximately $1 million, while patient monitoring sales decreased by approximately $4 million. ​ Revenues for the Optoelectronics and Manufacturing division during the three months ended September 30, 2021 increased year-over year as a result of an increase in revenue in our contract manufacturing business of approximately $9 million and an increase in revenue of approximately $2 million in our optoelectronics business. ​ Gross Profit ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Q1 ​ % of ​ Q1 ​ % of ​ ​ Fiscal 2021 Net Revenues Fiscal 2022 Net Revenues ​ Gross profit ​ $ 95.8 ​ 37.6 % $ 99.3 35.6 % ​ Gross profit is impacted by sales volume, productivity, and changes in overall manufacturing-related costs, such as raw materials and component costs, warranty expense, provision for inventory, freight, and logistics. Our cost of goods sold increased year-over-year primarily as a result of the change in revenues. Gross profit as a percentage of net revenues during the quarter ended September 30, 2021 decreased on a year-over-year basis due to (i) an increase in revenues in the Optoelectronics and Manufacturing division (which has the lowest gross margin among our divisions) as a percentage of total net revenues, and (ii) a reduction in the Optoelectronics and Manufacturing and Security division gross margins due to a less favorable sales mix and increased component, freight and travel costs. Our gross margin increased within the Healthcare division due to a more favorable sales mix. ​ Operating Expenses ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Q1 % of Q1 % of ​ ​ ​ ​ ​ ​ Fiscal 2021 ​ Net Revenues ​ Fiscal 2022 ​ Net Revenues ​ $ Change ​ % Change ​ Selling, general and administrative $ 58.6 23.0 % $ 57.3 20.5 % $ (1.3) (2.2) % Research and development ​ 12.1 4.7 ​ 14.8 5.3 ​ ​ 2.7 ​ 22.3 ​ Impairment, restructuring and other charges (benefit), net ​ 8.4 3.3 ​ 2.5 0.9 ​ ​ (5.9) ​ (70.2) ​ Total operating expenses ​ $ 79.1 31.0 % $ 74.6 26.7 % $ (4.5) ​ (5.7) % ​ Selling, general and administrative . Our significant selling, general and administrative (SG&A) expenses include employee compensation, sales commissions, travel, professional services, marketing expenses, and depreciation and amortization expense. SG&A expense for the three months ended September 30, 2021 decreased as compared to the same prior-year period due to a reduced provision for losses on accounts receivable of $4.3 million. This decrease was offset by an increase in compensation expense of $2.5 million and increased travel expense of $0.9 million. Research and development . Research and development (R&D) expenses include research related to new product development and product enhancements. The increase in R&D expense during the three months ended September 30, 2021 from the same prior-year period reflected an increase in compensation expense and outside services of approximately $3 million to support new product development initiatives primarily in our Security and Healthcare divisions. ​ Impairment, restructuring and other charges. Impairment, restructuring and other charges generally consist of charges relating to reductions in our workforce, facilities consolidation, impairment of assets, costs related to acquisition activity, legal charges and other non-recurring charges. During the three months ended September 30, 2021, impairment, restructuring and other charges consisted of $2.2 million for legal charges, $0.3 million in charges for employee terminations from operational efficiency activities, and an insignificant net benefit for facility closure and operational efficiency activities. During the three months ended September 30, 2020, we commenced exit activities associated with a turnkey contract in Mexico whereby we incurred non-recurring charges totaling $6.9 million comprised of exit costs of $2.5 million for employee terminations, facility closure and other exit costs of $1.1 million, direct transaction costs of $2.7 million and impairment of a right-of-use asset of $0.6 million. We also conducted other operational efficiency activit i es which resulted in employee termination and other costs of $1.5 million. ​ 25 Table of Contents Interest and other expense, net . For the three months ended September 30, 2021, interest and other expense, net was $2.0 million as compared to $4.2 million in the comparable prior-year period. This decrease was driven most significantly by our adoption of ASU 2020-06 (see Note 1 to the condensed consolidated financial statements for further discussion) and, to a lesser extent, lower average levels of borrowing under our revolving credit facility during the three months ended September 30, 2021 compared to the same period in the prior year. Interest expense during the three months ended September 30, 2020 included $2.2 million of non-cash interest expense, which was primarily related to the Notes. ​ Income taxes . The effective tax rate for a particular period varies depending on a number of factors, including (i) the mix of income earned in various tax jurisdictions, each of which applies a unique range of income tax rates and income tax credits, (ii) changes in previously established valuation allowances for deferred tax assets (changes are based upon our current analysis of the likelihood that these deferred tax assets will be realized), (iii) the level of non-deductible expenses, (iv) certain tax elections (v) tax holidays granted to certain of our international subsidiaries and (vi) discrete tax items. For the three months ended September 30, 2021, we recognized a provision for income taxes of $3.6 million compared to $3.2 million for the comparable prior-year period. The effective tax rates for the three months ended September 30, 2021 and 2020 were 15.9% and 25.3%, respectively. During the three months ended September 30, 2021, we recognized a net discrete tax benefit of $2.1 million compared to $0.3 million in the prior year for equity-based compensation under ASU 2016-09. ​ Liquidity and Capital Resources ​ Our principal sources of liquidity are our cash and cash equivalents, cash generated from operations and our credit facilities. Cash and cash equivalents totaled $54.7 million at September 30, 2021, a decrease of $25.9 million, or 32.1%, from $80.6 million at June 30, 2021. We currently anticipate that our available funds, credit facilities and cash flow from operations will be sufficient to meet our operational cash needs for the next 12 months and the foreseeable future. In addition, we anticipate that cash generated from operations, without repatriating earnings from our non-U.S. subsidiaries, and our credit facility will be sufficient to satisfy our obligations in the U.S. ​ We have a five-year revolving credit facility that allows us to borrow up to $535 million. As of September 30, 2021, there were $26.0 million of borrowings outstanding under the revolving credit facility and letters of credit outstanding totaled $79.4 million. ​ Cash Provided by (Used in) Operating Activities. Cash flows from operating activities can fluctuate significantly from period to period, as net income, adjusted for non-cash items, and working capital fluctuations impact cash flows. During the three months ended September 30, 2021, we used cash in operations of $11.0 million compared to generating $53.8 million in the same prior-year period. This decrease was driven by increases in inventory, lower collections of accounts receivable and customer advances and other changes in net working capital. ​ Cash Used in Investing Activities . Net cash used in investing activities was $7.8 million for the three months ended September 30, 2021 as compared to $12.3 million in the same prior-year period. Capital expenditures in the three-month period ended September 30, 2021 were $3.5 million compared to $3.8 million in the same prior-year period. Expenditures for intangible and other assets in the three-month period ended September 30, 2021 were $4.3 million compared to $4.4 million in the same prior-year period. In addition, during the three months ended September 30, 2020, we used cash of $3.0 million for the acquisition of a business. ​ Cash Used in Financing Activities . Net cash used in financing activities was $7.2 million during the three months ended September 30, 2021, compared to $41.8 million during the same prior-year period. The changes in cash used in financing activities primarily relate to (i) net proceeds from borrowings on bank lines of credit totaling $26.0 million in the three month period ended September 30, 2021 compared to net repayments of borrowings of $8.0 million in the same prior-year period and (ii) $34.8 million used for share repurchases and taxes paid related to the net share settlement of equity awards in the three month period ended September 30, 2021 compared to $35.7 million for the same prior-year period. ​ Borrowings ​ See Note 7 to the condensed consolidated financial statements for a detailed discussion regarding our revolving credit facility and our Notes. ​ Cash Held by Foreign Subsidiaries ​ Our cash and cash equivalents totaled $54.7 million at September 30, 2021. Of this amount, approximately 83% was held by our foreign subsidiaries and subject to repatriation tax considerations. These foreign funds were held primarily by our subsidiaries in the United 26 Table of Contents Kingdom, India, Malaysia, Singapore, and Canada, and to a lesser extent in Australia, Albania and Germany among others. We intend to permanently reinvest certain earnings from foreign operations, and we currently do not anticipate that we will need this cash in foreign countries to fund our U.S. operations. In the event we repatriate cash from certain foreign operations and if taxes have not previously been withheld on the related earnings, we would provide for withholding taxes at the time we change our intention with regard to the reinvestment of those earnings. ​ Issuer Purchases of Equity Securities ​ The following table contains information about the shares of common stock we purchased during the quarter ended September 30, 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Maximum number (or ​ ​ ​ ​ ​ ​ ​ ​ ​ approximate dollar ​ ​ ​ ​ ​ ​ ​ ​ ​ value) of ​ ​ ​ ​ ​ ​ ​ Total number of ​ shares (or ​ ​ ​ ​ ​ ​ ​ shares (or units) ​ units) ​ ​ ​ ​ ​ ​ ​ purchased as ​ that may ​ ​ Total number of ​ Average price ​ part of publicly ​ yet be purchased ​ ​ shares (or units) ​ paid per share (or ​ announced plans or ​ under the plans or ​ purchased unit) programs programs (1) July 1 to July 31, 2021 — ​ $ — — 2,547,995 August 1 to August 31, 2021 2,700 ​ ​ 99.24 2,700 2,545,295 September 1 to September 30, 2021 165,806 ​ ​ 96.31 165,806 2,379,489 ​ 168,506 ​ ​ ​ 168,506 ​ ​ (1) In April 2020, the Board of Directors authorized a share repurchase program of up to 1,000,000 shares of common stock. In August 2020, the Board of Directors increased the maximum number of shares to 3,000,000 shares authorized under the stock repurchase program. Upon repurchase, the shares are restored to the status of authorized but unissued shares, and we record them as a reduction in the number of shares of common stock issued and outstanding in our consolidated financial statements. ​ Contractual Obligations ​ During the three months ended September 30, 2021, there were no material changes outside the ordinary course of business to the information regarding specified contractual obligations contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2021. See Notes 1, 5, 7 and 9 to the condensed consolidated financial statements for additional information regarding our contractual obligations. ​ Off-Balance Sheet Arrangements ​ As of September 30, 2021, we did not have any significant off-balance sheet arrangements, other than those previously disclosed. ​ Recent Accounting Pronouncements ​ For information with respect to recent accounting pronouncements and the potential impact of those pronouncements on our condensed consolidated financial statements, see Note 1 to the condensed consolidated financial statements. ​