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, 2024 and results of operations for the three months ended September 30, 2024 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, 2024 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 our expectations are disclosed in this report, our Annual Report on Form 10-K for the fiscal year ended June 30, 2024 (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; the impact of potential information technology, cybersecurity or data security breaches; changes in domestic and foreign government spending, budgetary, procurement and trade policies adverse to our businesses; the impact of the Russia-Ukraine conflict or conflicts in the Middle East, including the potential for broad economic disruption; global economic uncertainty; 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; contract and regulatory compliance matters, and actions, which if brought, could result in judgments, settlements, fines, injunctions, debarment or penalties; as well as other risks and uncertainties, including but not limited to those factors described in our other SEC filings. All forward-looking statements contained in this report are qualified in their entirety by this Section. Moreover, we operate in a very competitive and rapidly changing environment and 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. 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) 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; and (c) Healthcare, providing patient monitoring, cardiology and remote monitoring, and connected care systems and associated accessories. ​ Security Division . Security and inspection products are used in airports and at a wide range of other facilities such as border crossings, seaports, freight forwarding operations (to screen cargo before it is loaded onto airplanes and ships), government and military installations, sports and concert venues, correctional facilities, and other locations where the interdiction of criminal activities is paramount. The U.S. Department of Homeland Security has undertaken numerous initiatives to prevent terrorists from entering the 23 Table of Contents country, hijacking airplanes, and obtaining and transporting explosives, weapons and their components, and to prevent human trafficking, among other serious crimes. These initiatives, such as the Customs-Trade Partnership Against Terrorism, the U.S. Transportation Security Administration’s Air Cargo Screening Mandate and the U.S. Customs and Border Protection Container Security Initiative, have resulted in increased demand for security and inspection products, as have similar programs undertaken by governments around the world. Revenues from our Security division accounted for 59% and 65% of our total consolidated revenues for the three months ended September 30, 2023 and 2024, 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 also 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 28% and 24% of our total consolidated revenues for the three months ended September 30, 2023 and 2024, respectively. ​ Healthcare Division . Through our Healthcare division, we design, manufacture, market and service patient monitoring, cardiology and remote monitoring, 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 13% and 11% of our total consolidated revenues for the three months ended September 30, 2023 and 2024, 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. ​ 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. We are exposed to and impacted by global macroeconomic factors, U.S. and foreign government policies and foreign exchange fluctuations. There is uncertainty surrounding macroeconomic factors in the U.S. and globally characterized by supply chain disruptions, inflationary pressure, and labor shortages. Increasing diplomatic and trade friction between the U.S. and China has also created significant uncertainty in the global economy. These global macroeconomic factors, coupled with political unrest internationally and the volatile U.S. political climate, including uncertainty regarding the upcoming U.S. presidential election, have created uncertainty and impacted demand for certain of our products and services. Conflicts in Gaza and nearby regions have created political and economic uncertainty in the Middle East. Also, the continued conflict between Russia and Ukraine and the sanctions imposed in response to this conflict have increased global economic and political uncertainty. We do not know how long this uncertainty will continue. These factors could have a material adverse effect on our business, results of operations and financial condition. Global Trade. 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. Our Healthcare division experienced some increased demand for its patient monitoring products as a result of the COVID-19 pandemic during the earlier stages of the pandemic. Certain hospitals are facing significant financial pressure as supply chain constraints and inflation drive up operating costs, and higher interest rates make access to credit more expensive. Continuation of these macroeconomic conditions would likely have an adverse impact on hospitals’ spend on capital equipment and thereby could have a material adverse effect on our business, results of operations and financial condition. 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. ​ 24 Table of Contents Russia’s Invasion of Ukraine. The invasion of Ukraine by Russia and the sanctions imposed in response to this conflict have increased global economic and political uncertainty. This has the potential to indirectly disrupt our supply chain and access to certain resources. While we have not experienced significant adverse impacts to date and will continue to monitor for any impacts and seek to mitigate disruption that may arise, we have certain research and development activities within Ukraine for our Healthcare division which have been somewhat impacted. The conflict also has increased the threat of malicious cyber activity from nation states and other actors. Currency Exchange Rates. On a year-over-year basis, currency exchange rates negatively impacted reported sales by approximately 0.7% for the three months ended September 30, 2024 compared to the three months ended September 30, 2023, primarily due to the strengthening of the U.S. dollar against other foreign currencies in 2024. Any further strengthening of the U.S. dollar against foreign currencies would adversely impact our sales for the remainder of the fiscal year, and any weakening of the U.S. dollar against foreign currencies would positively impact our sales for the remainder of the fiscal year. Results of Operations for the Three Months Ended September 30, 2023 (Q1 Fiscal 2024) Compared to the Three Months Ended September 30, 2024 (Q1 Fiscal 2025) (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 12 to the condensed consolidated financial statements for additional information about our business segments. ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Q1 % of Q1 % of ​ ​ ​ Fiscal 2024 Net Revenues Fiscal 2025 Net Revenues $ Change % Change Security $ 164.6 ​ 59.0 % $ 224.3 ​ 65.2 % $ 59.7 ​ 36.3 % Optoelectronics and Manufacturing ​ ​ 76.8 ​ 27.5 ​ ​ 82.6 ​ 24.0 ​ ​ 5.8 ​ 7.6 ​ Healthcare ​ ​ 37.8 ​ 13.5 ​ ​ 37.1 ​ 10.8 ​ ​ (0.7) ​ (1.9) ​ Total net revenues $ 279.2 ​ 100 % $ 344.0 ​ 100.0 % $ 64.8 ​ 23.2 % ​ Revenues for the Security division during Q1 fiscal 2025 increased year-over-year due to increases in product and service revenues of approximately $52.1 million and $7.6 million, respectively. The increase in product revenues was primarily driven by growth in cargo and vehicle inspection systems, trace detections systems, checkpoint screening sales, and the acquired business further described in Note 2 to the condensed consolidated financial statements. The increase in service revenue was due primarily to an increase in the installed base of products. Revenues for the Optoelectronics and Manufacturing division during Q1 fiscal 2025 increased year-over-year as a result of an increase in revenues in our contract manufacturing business of approximately $7.4 million, offset by a decrease in revenues in our optoelectronics business of approximately $1.6 million. Revenues for the Healthcare division during Q1 fiscal 2025 decreased year-over-year due to lower product sales of $2.2 million, partially offset by an increase in service revenues of $1.5 million. 25 Table of Contents Gross Profit ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Q1 ​ % of ​ Q1 ​ % of ​ ​ Fiscal 2024 Net Revenues Fiscal 2025 Net Revenues Gross profit ​ $ 98.7 ​ 35.4 % $ 121.5 ​ 35.3 % ​ Gross profit is impacted by sales volume and changes in overall manufacturing-related costs, such as raw materials and component costs, warranty expense, provision for inventory, freight, and logistics. Gross profit increased approximately $22.8 million in Q1 fiscal 2025 as compared to the prior year driven by the increase in sales. Our cost of goods sold increased year-over-year primarily as a result of the increase in revenues. Operating Expenses ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Q1 % of Q1 ​ % of ​ ​ ​ ​ ​ ​ ​ Fiscal 2024 Net Revenues Fiscal 2025 Net Revenues $ Change % Change ​ Selling, general and administrative $ 59.8 21.4 % $ 72.2 ​ 21.0 % $ 12.4 ​ 20.7 % Research and development ​ 15.9 5.7 ​ ​ 17.8 ​ 5.2 ​ 1.9 ​ 11.9 ​ Impairment, restructuring and other charges, net ​ 0.5 0.2 ​ ​ 1.2 ​ 0.3 ​ 0.7 ​ 140.0 ​ Total operating expenses ​ $ 76.2 27.3 % $ 91.2 ​ 26.5 % $ 15.0 ​ 19.7 % ​ Selling, general and administrative . Our significant selling, general and administrative (“SG&A”) expenses include employee compensation, sales commissions, travel, professional services, marketing expenses, foreign currency translation, and depreciation and amortization expense. SG&A expense for Q1 fiscal 2025 was $12.4 million higher than in the same prior-year period primarily due to unfavorable foreign currency exchange rates and an increase in employee compensation in Q1 fiscal 2025 to support the growth of the Company as compared to the same prior-year period. Research and development . Research and development (“R&D”) expenses include research related to new product development and product enhancements. R&D expenses increased $1.9 million in Q1 fiscal 2025 as compared to Q1 fiscal 2024 driven by increased compensation costs to support new product development initiatives primarily in our Security division. Restructuring and other charges. Restructuring and other charges generally consist of costs relating to reductions in our workforce, facilities consolidation, costs related to acquisition activity, and other non-recurring charges. During Q1 fiscal 2025, restructuring and other charges consisted of $0.4 million for acquisition activity and $0.8 million related to employee terminations, and legal and other costs. During Q1 fiscal 2024, restructuring and other charges consisted of $0.2 million for acquisition activity and $0.3 million related to employee terminations, and legal and other costs. Interest and Other Expense, Net ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Q1 ​ % of ​ Q1 ​ % of ​ Fiscal 2024 Net Revenues Fiscal 2025 Net Revenues Interest and other expense, net ​ $ 5.7 2.0 % $ 7.4 2.2 % ​ Interest and other expense, net . For Q1 fiscal 2025, interest and other expense, net was $7.4 million as compared to $5.7 million in the same prior-year period. This increase was driven by higher average levels of borrowings primarily to support the increase in working capital associated with the growth in revenues and for the repurchase of approximately $80 million of common stock in July 2024. 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 Q1 fiscal 2025 and 2024, we recognized a provision for income taxes of $5.0 million and $3.9 million, respectively. The effective tax rates for Q1 fiscal 2025 and 2024 were 21.9% and 23.4%, respectively. During Q1 fiscal 2025 and 2024, we recognized a net discrete tax benefit of $0.5 million and $0.4 million, respectively, related to equity-based compensation under ASU 2016-09. 26 Table of Contents 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 $85.1 million at September 30, 2024, a decrease of $10.3 million, or 11%, from $95.4 million at June 30, 2024. 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 beyond that. In addition, we anticipate that cash generated from operations, without repatriating earnings from our non-U.S. subsidiaries, and our credit facilities will be sufficient to satisfy our obligations in the U.S. ​ In July 2024, we issued an aggregate of $350.0 million principal amount of 2.25% convertible senior notes due in August 2029 In connection with the issuance of the 2029 Notes, we repurchased 531,314 shares of our common stock for approximately $80 million. ​ Our credit facility comprises a term loan and a $600 million revolving credit facility, which includes a $300 million sub-facility for letters of credit. As of September 30, 2024, there was $133.8 million outstanding under the term loan, $259.0 million outstanding under our revolving credit facility and $77.1 million of outstanding letters of credit. As of September 30, 2024, the total amount available under our revolving credit facility was $263.9 million. See Note 8 to the consolidated financial statements for further discussion. 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 Q1 fiscal 2025, we used cash from operations of $37.2 million compared to cash provided by operations of $17.1 million in the comparable prior-year period. The net change in cash flows from operating activities was due primarily to a net increase in accounts receivable, inventories and other current assets in the Security division, partially offset by other changes in net working capital. Cash Used in Investing Activities . Net cash used in investing activities was $87.5 million for Q1 fiscal 2025 as compared to $9.6 million in the same prior-year period. We used $75.5 million for a business acquisition during the three-month period ended September 30, 2024. Capital expenditures in the three-month period ended September 30, 2024 were $7.7 million compared to $5.2 million in the same prior-year period. Expenditures for intangible and other assets in the three-month period ended September 30, 2024 were $4.4 million compared to $4.2 million in the same prior-year period. Cash Used in Financing Activities . Net cash provided by financing activities was $113.8 million during Q1 fiscal 2025, compared to $1.9 million used during the same prior-year period. The change in cash flows from financing activities was primarily due to net proceeds of $340.4 million from the 2029 Notes, partially offset by (1) net repayment of $125.0 million on our credit facility and (2) repurchase of common shares of $80.4 million. Taxes paid related to net share settlement of equity awards was $21.3 million during Q1 fiscal 2025 compared to $22.2 million in the same prior-year period. Borrowings ​ See Note 8 to the condensed consolidated financial statements for a detailed discussion regarding our revolving credit facility and other borrowings. ​ Cash Held by Foreign Subsidiaries ​ Our cash and cash equivalents totaled $85.1 million at September 30, 2024. Of this amount, approximately 81% was held by our foreign subsidiaries and subject to repatriation tax considerations. These foreign funds were held primarily by our subsidiaries in the, India, UK, Singapore, Canada and Malaysia and to a lesser extent in Mexico, Egypt, Indonesia, Albania, and Australia among other countries. 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. ​ 27 Table of Contents Issuer Purchases of Equity Securities ​ The following table contains information about the shares of common stock we purchased during the quarter ended September 30, 2024: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 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, 2024 531,314 ​ $ 150.57 531,314 1,190,556 August 1 to August 31, 2024 — ​ $ — — 1,190,556 September 1 to September 30, 2024 — ​ $ — — 1,190,556 ​ 531,314 ​ ​ ​ 531,314 ​ ​ (1) In September 2022, when there were 1,131,301 shares remaining authorized to repurchase under the then-existing share repurchase program, the Board of Directors renewed the authorization and revised the maximum number of shares to 2,000,000 shares authorized under the stock repurchase program. Upon repurchase, shares of common stock 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 first quarter of fiscal year 2025, 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, 2024. See Notes 1, 6, 8 and 10 to the condensed consolidated financial statements for additional information regarding our contractual obligations. ​ Recent Accounting Pronouncements ​ From time to time, new accounting pronouncements are issued by the FASB and other regulatory bodies that are adopted as of the specified effective dates. Unless otherwise discussed, management believes that the impact of recently issued standards, which are not yet effective, will not have a material impact on our Consolidated Financial Statements upon adoption. As discussed in Note 1, we are currently evaluating the potential impact on financial statement disclosures upon future adoption of ASU 2023 - 07 and ASU 2023 - 09. There were no new pronouncements adopted in the first quarter of fiscal year 2025. ​