We are short OSI Systems, Inc. (OSIS.US) because we think it is rotten to the core. We believe it obtained a major turnkey contract in Albania through corruption. It is likely that OSIS’s accounts are misstated as a result. We believe the pricing of its Mexico turnkey contract does not stand up to scrutiny. We estimate that the contract is so rich, it accounted for more than 50% of OSIS’s FY2017 EBITDA, despite being only 15% of revenue. Put another way, we estimate the Mexico contract’s EBITDA margin is approximately 55%, which would mean the rest of OSIS has an EBITDA margin of a paltry 7.5%. This contract is up for renewal in 2018, and non-renewal would seemingly have an enormous impact on OSIS’s profits. It also implies that there is significant room for price adjustment downward, which could have a material impact on profits. Former employees’ statements support our view that OSIS is rotting from the inside.

OSIS’s response to our December 6, 2017 report in no way changes our opinion that OSIS is rotten to the core. We see the Albania issue as important for three reasons – first, it’s illustrative of our view of the rot; second, it begs the question of how viable the turnkey model is without corruption, particularly in jurisdictions where corruption is a major issue; and third, OSIS’s response goes to what we see is a complete lack of management credibility.