OSI Systems Inc (OSIS) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the OSI Systems Incorporated fourth quarter and FY16 conference call.

(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 am 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 FY16 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 the pending acquisition of American Science and 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 has also been furnished to the SEC as an exhibit to a current report on Form 8-K.

Before turning the call over to Deepak to discuss the business in more detail, I will provide a high level overview of our financial performance for the fourth quarter of FY16. 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 FY15. 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 preview.

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 from the prior year was primarily a result of a change in revenues just mentioned.

Third, free cash flow, which we define 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 FY16, bookings were up 7% over FY15, driven by the Security division. Before diving into the numbers and discussing FY17 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 FY16, 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 FY17 with a stronger organization and an increasing opportunity pipeline in many of our end markets.

Let's talk more 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 a 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 FY17 with a strong RTT backlog, and expect significant revenue growth from this product line. For the US 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 US replacement cycle 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 our 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 our strategy to expand our security offerings, as it would add proven, fixed and mobile inspection platforms based on Z Backscatter technology, including a large install base of ZBV mobile cargo vans that are used both in the US 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 would enhance our product development capabilities.

While we look forward to completing this transaction, it remains subject to the approval of AS&E's shareholders, anti-trust 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 continue 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, and we believe we are in excellent position to capture additional turnkey services opportunities. As mentioned in the previous calls, the timing is always a 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 pipeline 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 US 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. FY16 was certainly a challenging year in the healthcare division, driven primarily by internal challenges from new product rollout. This impacted sales from Q through -- 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 FY17.

As mentioned in our 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 am 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 margin 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 FY17, 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 FY17. 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 FY16 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 150 basis points in 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 the 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 continue to make significant investments in research and development, in our Security and our Healthcare divisions to enhance our product portfolios. We remain focused on growth platforms and 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 FY16. Our provision for income taxes is dependent on the mix of income from US 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 a decrease in sales, the Company's adjusted operating margin 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 FY16, we reported operating cash flow of $[19] million. Capital expenditures were $8.7 million, while depreciation and amortization was $15.4 million. Day sales outstanding or DSO was 58 days for this quarter, as compared to 61 days in Q4 of last year. In Q4 inventory decreased [to] $18 million from Q3. Though days inventory is higher than we would like, it represents an opportunity in FY17 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 FY16, 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 in Healthcare, and timing issues in Security.

In light of the recent period of volatility, we have set our initial guidance for FY17 at a level that we believe with a high degree of confidence we can achieve. With this background, we anticipate FY17 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 their related tax effects.

This guidance does not incorporate any contribution from the pending acquisition of American Science and 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 screen solutions 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'd like to open the call to questions.

(Operator Instructions)

Larry Solow, CJS Securities.

Hi, good afternoon. In terms of the guidance and how it relates to Q4, it looks like certainly you're a little bit below the expectations on the security side. What gives you confidence that you'll get some rebound as we head out into FY17? 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 that we have 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's been a little bit of unpredictability, of getting pushed out from customers requesting the site is not ready, or they're making a decision a little later.

Also, we believe that our confidence for 2017 is based upon our backlog. Our pipeline is very strong. We have done very large RFQs out there in bidding in 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. But could, just to play devil's advocate, things shift even a couple of quarters? Well, you mentioned this $20 million in your prepared comments. Is that from one particular product, and do you have visibility that that's going to hit within 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 FY17, probably a little bit more weighted to Q2 than Q1.

Okay. And then on turnkey, it sounds like, without getting into the real specific details, it sounds like your queue of opportunities is big as it has been in some time. And hopefully things start -- it's just a matter of when you can close some deals. Is that a good assessment?

That's a good assessment. And again, I want to emphasize that most of these deals are -- a [majority] of the deals are cargo-based. So, even at the end it becomes a sale of equipment, or it turns into a turnkey.

Our pipeline is very robust and strong. And we also, what we feel is, we have demonstrated that this can work. So, we have a big headstart from our competitors.

Okay. And then, just touch real quick on healthcare. Could you just give us a quick update on where you stand? I know you have a new President [running] the division. Has the monitor now -- does it appear like all the issues are hopefully behind, at least the relaunch of it, and it's just a matter of getting some traction back in the market?

That's absolutely true. I did say it in my call, that we had said it, that Q4 was a transition time, and it's going to extend into Q1. But we're going to put it behind, and we think, we have said it, we are very confident that 2017 will show growth in the healthcare department [new growth].

Okay. And then the AS&E acquisition still about a Q4, a calendar Q4 type thing? Is 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, we're going through the various regulatory function, answering questions. We feel still very good about it, but we can't comment on the timing.

Fair enough. Great. Thanks, again.

Josephine Millward, The Benchmark Company.

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'll recall, with respect to Mexico, the backlog only goes in one direction. So 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 FY16, because I think you mentioned it was up 6% or 7% year over year?

Yes, that's correct. One second, and we'll 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 in your guidance? It looks like you're 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 it impact -- potentially impact your Business? I believe you manufacture the RTT in the UK, and you also have some revenue exposure there? (multiple speakers) And does this change the UK's commitment to upgrade checked baggage by 2018?

Josephine, it's 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, we'll all sort of 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 consider 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 it's very well received, especially in UK. As Alan mentioned, we definitely have a price advantage, too. (Multiple speakers)

That's helpful. Thank you.

Jeff Martin, Roth Capital Partners.

Thanks. Good afternoon, guys.

Good afternoon.

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 am 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, because of the price down. The other case, if the economy is based primarily on oil revenue, they've got to protect that infrastructure, so they need turnkey, or they need these kind of solutions.

So our pipeline continues to be very robust. We are getting a lot of inquiries of it, but I know what -- but 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 group]. We are doing show and tell, and we are 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 maybe a year ago?

Well, I'll take the latter part of it. Firstly, we don't break down the backlog or anything, for comparative reasons. I think I said 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 maybe Alan you can add some color, that this is a new way of products we ship. And in many cases, like what we happened, we ship product, it's out, but it's still in 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 are ramping up for a good revenue out in 2017.

Can you shed any perspective real quick, before Alan answers the first part of the question? Can you shed any perspective on maybe some weighting 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 in 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 weighted to 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? I mean, 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 as a result of those charges that would've 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, of course, is not the subject of this discussion, but as we close on the acquisition, there will, of course, be costs associated with closing the acquisition that would be absorbed into that line item at the appropriate time.

Right. Okay. Thanks very much, guys.

(Operator Instructions)

Juan Molta, B. Riley.

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, a significant portion of our revenue is monitoring-based, and very much centric towards US. 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 in the top line?

Yes.

Can you mention any verticals particularly -- any verticals of strength in Opto, of where you expect that growth to come from?

Well, we have a very broad portfolio. We have, 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 with a very large base of customers in all these industries. There is no one industry that is very much focused on.

Okay, very good. That was all. The other questions have been addressed. Thank you very much.

Thank you. Ladies and gentlemen, I see no other questioners in the queue. Oh, pardon me, I got a queue up from Josephine Millward.

I would like to thank everybody --

Deepak?

Yes, sorry.

Just a follow-up -- AS&E just reported a 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 resolved? Or is that related to what you're experiencing as well?

Josephine, on the subject of the shipments, I think what we have reported in the cargo side, they're having the same kind of things, because all the ports are tied to the same market, just due to its 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 for I know, and we've said before, there is no seasonality in this business. The volatility is maybe a better word, and definitely it plays that part, and it's become a little bit more exacerbated 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 are 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 year?

I think the answer is yes. Just the way Alan described that the RTT shipments are at Q2 and in Q3 heavily weighted. And in 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 second half would be stronger than first half, but maybe not as different this time around. Maybe a little bit more balanced, because we have a good backlog.

Thank you.

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 would 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 are expecting in 2017. It has proved fact 2016 was a very challenging year, and we're 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.