OSI SYSTEMS INC - Quarter Report: 2013 December (Form 10-Q)

Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended December 31, 2013

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission File Number 000-23125

 

 

OSI SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

12525 Chadron Avenue

Hawthorne, California 90250

(Address of principal executive offices) (Zip Code)

 

(310) 978-0516

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x		Accelerated filer o
Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

As of January 29, 2014, there were 19,933,073 shares of the registrant’s common stock outstanding.

 

 

Table of Contents

 

OSI SYSTEMS, INC.

 

INDEX

 

			PAGE
PART I — FINANCIAL INFORMATION			3
	Item 1 —	Condensed Consolidated Financial Statements	3
		Condensed Consolidated Balance Sheets at June 30, 2013 and December 31, 2013	3
		Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2012 and 2013	4
		Condensed Consolidated Statements of Comprehensive Income for the three and six months ended December 31, 2012 and 2013	5
		Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2012 and 2013	6
		Notes to Condensed Consolidated Financial Statements	7
	Item 2 —	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
	Item 3 —	Quantitative and Qualitative Disclosures about Market Risk	24
	Item 4 —	Controls and Procedures	25
PART II — OTHER INFORMATION			25
	Item 1 —	Legal Proceedings	25
	Item 1A —	Risk Factors	25
	Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	25
	Item 3	Defaults Upon Senior Securities	25
	Item 4	Mine Safety Disclosures	26
	Item 5	Other Information	26
	Item 6 —	Exhibits	26
Signatures			27

 

2

Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

(Unaudited)

 

		June 30,			December 31,
		2013			2013
ASSETS
Current Assets:
Cash and cash equivalents		$	34,697		$	39,899
Accounts receivable, net		206,817			164,006
Inventories		206,213			219,998
Prepaid expenses and other current assets		78,972			82,246
Total current assets		526,699			506,149
Property and equipment, net		249,029			271,468
Goodwill		83,743			92,046
Intangible assets, net		36,603			40,013
Other assets		23,722			25,594
Total assets		$	919,796		$	935,270
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Bank lines of credit		$	59,000		$	60,000
Current portion of long-term debt		1,797			2,971
Accounts payable		97,050			67,720
Accrued payroll and related expenses		28,503			28,289
Advances from customers		37,432			39,289
Accrued warranties		12,890			13,269
Deferred revenue		18,131			46,539
Other accrued expenses and current liabilities		26,610			28,206
Total current liabilities		281,413			286,283
Long-term debt		10,673			11,724
Advances from customers		75,000			62,500
Other long-term liabilities		74,259			81,507
Total liabilities		441,345			442,014
Commitments and contingencies (Note 8)
Stockholders’ Equity:
Preferred stock, $0.001 par value, 10,000,000 shares authorized; no shares issued or outstanding		—			—
Common stock, $0.001 par value, 100,000,000 shares authorized; 19,914,089 issued and outstanding at June 30, 2013 and 19,932,946 shares at December 31, 2013		285,001			276,938
Retained earnings		199,786			220,753
Accumulated other comprehensive loss		(6,336		)	(4,435		)
Total stockholders’ equity		478,451			493,256
Total liabilities and stockholders’ equity		$	919,796		$	935,270

 

See accompanying notes to condensed consolidated financial statements.

 

3

Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

		For the Three Months Ended December 31,						For the Six Months Ended December 31,
		2012			2013			2012			2013
Net revenues:
Products		$	145,086		$	173,974		$	293,950		$	317,450
Services		48,963			62,434			81,793			125,232
Total net revenues		194,049			236,408			375,743			442,682
Cost of goods sold:
Products		93,900			118,781			192,832			222,374
Services		30,061			36,688			51,468			71,423
Total cost of goods sold		123,961			155,469			244,300			293,797
Gross profit		70,088			80,939			131,443			148,885
Operating expenses:
Selling, general and administrative		36,829			45,556			76,754			87,770
Research and development		11,858			11,175			23,174			22,195
Impairment, restructuring and other charges		2,723			2,179			2,723			6,418
Total operating expenses		51,410			58,910			102,651			116,383
Income from operations		18,678			22,029			28,792			32,502
Interest and other expense, net		1,385			1,503			2,482			2,973
Income before income taxes		17,293			20,526			26,310			29,529
Provision for income taxes		4,872			5,953			7,550			8,562
Net income		$	12,421		$	14,573		$	18,760		$	20,967
Net income per share:
Basic		$	0.62		$	0.73		$	0.94		$	1.05
Diluted		$	0.60		$	0.71		$	0.91		$	1.02
Shares used in per share calculation:
Basic		19,999			19,961			19,952			19,966
Diluted		20,609			20,589			20,589			20,604

 

See accompanying notes to condensed consolidated financial statements.

 

4

Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(amounts in thousands)

(Unaudited)

 

		For the Three Months Ended December 31,						For the Six Months Ended December 31,
		2012			2013			2012			2013
Net income		$	12,421		$	14,573		$	18,760		$	20,967
Other comprehensive income (loss):
Foreign currency translation adjustment		(571		)	471			4,739			1,779
Other		114			30			(339		)	122
Other comprehensive income (loss)		(457		)	501			4,400			1,901
Comprehensive income		$	11,964		$	15,074		$	23,160		$	22,868

 

See accompanying notes to condensed consolidated financial statements.

 

5

Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(Unaudited)

 

		For the Six Months Ended December 31,
		2012			2013
Cash flows from operating activities:
Net income		$	18,760		$	20,967
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		10,809			26,417
Stock based compensation expense		7,147			10,721
Provision for losses on accounts receivable		445			977
Deferred income taxes		212			(62		)
Other		182			101
Changes in operating assets and liabilities—net of business acquisitions:
Accounts receivable		17,663			46,781
Inventories		(6,985		)	(8,768		)
Prepaid expenses and other assets		11,373			(5,649		)
Accounts payable		37,876			(32,798		)
Accrued payroll and related expenses		(4,874		)	(464		)
Advances from customers		(13,900		)	(10,648		)
Accrued warranties		(2,728		)	(5		)
Deferred revenue		(3,567		)	27,542
Other accrued expenses and liabilities		(9,597		)	(139		)
Net cash provided by operating activities		62,816			74,973
Cash flows from investing activities:
Acquisition of property and equipment		(117,616		)	(41,702		)
Acquisition of businesses		(5,787		)	(10,087		)
Acquisition of intangible and other assets		(2,039		)	(2,467		)
Net cash used in investing activities		(125,442		)	(54,256		)
Cash flows from financing activities:
Net borrowings on bank lines of credit		15,000			1,000
Proceeds from long-term debt		11,100			2,841
Payments on long-term debt		(375		)	(1,562		)
Proceeds from exercise of stock options and employee stock purchase plan		2,974			1,501
Repurchase of common shares		(9,928		)	(12,056		)
Taxes paid related to net share settlements of equity awards		(2,397		)	(8,230		)
Net cash provided by (used in) financing activities		16,374			(16,506		)
Effect of exchange rate changes on cash		1,650			991
Net increase (decrease) in cash and cash equivalents		(44,602		)	5,202
Cash and cash equivalents-beginning of period		91,452			34,697
Cash and cash equivalents-end of period		$	46,850		$	39,899
Supplemental disclosure of cash flow information:
Cash paid, net during the period for:
Interest		$	1,858		$	2,878
Income taxes		$	5,615		$	8,716

 

See accompanying notes to condensed consolidated financial statements.

 

6

Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of Presentation

 

Description of Business

 

OSI Systems, Inc., together with its subsidiaries (the “Company”), is a vertically integrated designer and manufacturer of specialized electronic systems and components for critical applications and provider of security screening services. The Company sells its products and services in diversified markets, including homeland security, healthcare, defense and aerospace.

 

The Company has three reporting segments: (i) Security, providing security inspection systems, turnkey security screening solutions and related services; (ii) Healthcare, providing patient monitoring, diagnostic cardiology and anesthesia systems, and related services and (iii) Optoelectronics and Manufacturing, providing specialized electronic components and electronic manufacturing services for the Security and Healthcare divisions as well as to external original equipment manufacturing clients for applications in the defense, aerospace, medical and industrial markets, among others.

 

Through its Security division, the Company designs, manufactures and markets security inspections systems and security screening, threat detection and non-intrusive inspection products and related services globally. These products fall into the following categories: baggage and parcel inspection systems; cargo and vehicle inspection systems; hold (checked) baggage screening systems; people screening systems and radiation detection systems. In addition to these products, the Company provides site design, installation, training and technical support services to its customers. The Company also provides turnkey security screening solutions, which can include the construction, staffing and long term operation of security screening checkpoints for its customers.

 

Through its Healthcare division, the Company designs, manufactures and markets patient monitoring, diagnostic cardiology and anesthesia delivery and ventilation systems, and related services worldwide. These products are used by care providers in critical care, emergency and perioperative areas within hospitals as well as physicians’ offices, medical clinics and ambulatory surgery centers.

 

Through its Optoelectronics and Manufacturing division, the Company designs, manufactures and markets optoelectronic devices and provides electronics manufacturing services worldwide for use in a broad range of applications, including aerospace and defense electronics, security and inspection systems, medical imaging and diagnostic products, telecommunications, test and measurement devices, industrial automation systems, automotive diagnostic products and consumer products. This division provides products and services to original equipment manufacturers and end users as well as to the Company’s own Security and Healthcare divisions.

 

Basis of Presentation

 

The condensed consolidated financial statements include the accounts of OSI Systems, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to interim financial reporting guidelines and the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company’s management, the condensed consolidated financial statements include all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the periods presented. These condensed consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2013, filed with the Securities and Exchange Commission on August 16, 2013. The results of operations for the three and six months ended December 31, 2013 are not necessarily indicative of the operating results to be expected for the full 2014 fiscal year or any future periods.

 

Per Share Computations

 

The Company computes basic earnings per share by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. The Company computes diluted earnings per share by dividing net income available to common stockholders by the sum of the weighted average number of common and dilutive potential common shares outstanding. Potential common shares consist of the shares issuable upon the exercise of stock options and stock awards or units under the treasury stock method.  During the three and six months ended December 31, 2012 and 2013, stock options or stock awards or units were excluded from the calculations because they were antidilutive were de minimis.

 

7

Table of Contents

 

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):

 

		Three Months Ended December 31,						Six Months Ended December 31,
		2012			2013			2012			2013
Net income available to common stockholders		$	12,421		$	14,573		$	18,760		$	20,967
Weighted average shares outstanding for basic earnings per share calculation		19,999			19,961			19,952			19,966
Dilutive effect of stock awards		610			628			637			638
Weighted average shares outstanding for diluted earnings per share calculation		20,609			20,589			20,589			20,604
Basic net income per share		$	0.62		$	0.73		$	0.94		$	1.05
Diluted net income per share		$	0.60		$	0.71		$	0.91		$	1.02

 

Cash Equivalents

 

The Company considers all highly liquid investments purchased with maturities of approximately three months or less as of the acquisition date to be cash equivalents.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist primarily of cash, marketable securities, derivative instruments, accounts receivable, accounts payable and debt instruments. The carrying values of financial instruments, other than long-term debt instruments, are representative of their fair values due to their short-term maturities. The carrying values of the Company’s long-term debt instruments are considered to approximate their fair values because the interest rates of these instruments are variable or comparable to current rates offered to the Company.

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. “Level 1” category includes assets and liabilities at the quoted prices in active markets for identical assets and liabilities.  “Level 2” category includes assets and liabilities from observable inputs other than quoted market prices. “Level 3” category includes assets and liabilities whose valuation techniques are unobservable and significant to the fair value measurement.  There were no assets or liabilities where “Level 3” valuation techniques were used, and there were no assets and liabilities measured at fair value on a non-recurring basis.

 

The following is a summary of the inputs used in valuing investments carried at fair value (in thousands):

 

		Level 1			Level 2			June 30, 2013			Level 1			Level 2			December 31, 2013
Equity securities		316			—			316			215			—			215
Insurance company contracts		—			13,914			13,914			—			16,483			16,483
Interest rate contract		—			66			66			—			62			62
Total		$	316		$	13,980		$	14,296		$	215		$	16,545		$	16,760

 

Derivative Instruments and Hedging Activity

 

The Company’s use of derivatives consists of an interest rate swap agreement.  The interest rate swap agreement was entered into to improve the predictability of cash flows from interest payments related to variable, LIBOR-based debt for the duration of the term loan.  The interest rate swap matures in October 2019.  The interest rate swap is considered an effective cash flow hedge, and, as a result, the net gains or losses on such instrument were reported as a component of Other comprehensive income in the condensed consolidated financial statements and are reclassified as net income when the hedge transaction settles.

 

8

Table of Contents

 

Revenue Recognition

 

The Company recognizes revenue from sales of products upon shipment when title and risk of loss passes, and when terms are fixed and collection is probable. Revenue from services includes after-market services, installation and implementation of products, and turnkey security screening services. The portion of revenue for the sale attributable to installation is deferred and recognized when the installation service is provided. In an instance where terms of sale include subjective customer acceptance criteria, revenue is deferred until the Company has achieved the acceptance criteria. Concurrent with the shipment of the product, the Company accrues estimated product return reserves and warranty expenses. Critical judgments made by management related to revenue recognition include the determination of whether or not customer acceptance criteria are perfunctory or inconsequential. The determination of whether or not customer acceptance terms are perfunctory or inconsequential impacts the amount and timing of revenue recognized. Critical judgments also include estimates of warranty reserves, which are established based on historical experience and knowledge of the product under warranty.

 

Revenue from certain turnkey services agreements is included in revenue from services and is recognized based upon proportional performance, measured by the actual number of hours incurred divided by the total estimated number of hours for the project. The impact of changes in the estimated hours to service the agreement is reflected in the period during which the change becomes known.

 

Revenues from out of warranty service maintenance contracts are recognized ratably over the term of such contract. For services not derived from specific maintenance contracts, revenues are recognized as the services are performed. Deferred revenue for such services arises from payments received from customers for services not yet performed. On occasion, the Company receives advances from customers that are amortized against future customer payments pursuant to the underlying agreements. Such advances are classified in the condensed consolidated balance sheets as either a current or long term liability dependent upon when the Company estimates the corresponding amortization to occur.

 

Business Combinations

 

During the normal course of business the Company makes acquisitions.  In the event that an individual acquisition (or an aggregate of acquisitions) is material, appropriate disclosure of such acquisition activity is disclosed.  During the six months ended December 31, 2013, the Company completed acquisitions that were immaterial both individually and in the aggregate.

 

2. Balance Sheet Details

 

The following tables provide details of selected balance sheet accounts (in thousands):

 

		June 30, 2013			December 31, 2013
Accounts receivable
Billed receivables		$	179,458		$	169,446
Unbilled receivables		34,636			1,493
Less allowance for doubtful accounts		(7,277		)	(6,933		)
Total		$	206,817		$	164,006

 

Unbilled receivables included earned but unbilled revenue.

 

		June 30, 2013			December 31, 2013
Inventories, net
Raw materials		$	117,416		$	116,943
Work-in-process		37,337			41,391
Finished goods		51,460			61,664
Total		$	206,213		$	219,998

 

		June 30, 2013			December 31, 2013
Property and equipment
Land		$	8,365		$	13,651
Buildings and improvements		102,187			161,109
Leasehold improvements		9,302			10,310
Equipment and tooling		135,437			151,869
Furniture and fixtures		3,551			3,937
Computer equipment		14,309			16,535
Computer software		15,209			15,521
Construction in process		48,713			10,585
Total		337,073			383,517
Less: accumulated depreciation and amortization		(88,044		)	(112,049		)
Property and equipment, net		$	249,029		$	271,468

 

9

Table of Contents

 

Construction in process consists primarily of costs related to infrastructure in Mexico that will be depreciated when assets are placed into service.

 

Depreciation expense was approximately $8.5 million and $23.8 million for the six months ended December 31, 2012 and 2013, respectively, and approximately $4.8 million and $12.3 million for the three months ended December 31, 2012 and 2013, respectively.

 

3. Goodwill and Intangible Assets

 

The changes in the carrying value of goodwill for the six month period ended December 31, 2013 are as follows (in thousands):

 

		Security			Healthcare			Optoelectronics and Manufacturing			Consolidated
Balance as of June 30, 2013		$	28,546		$	35,827		$	19,370		$	83,743
Goodwill acquired or adjusted during the period		784			1,018			5,481			7,283
Foreign currency translation adjustment		214			271			535			1,020
Balance as of December 31, 2013		$	29,544		$	37,116		$	25,386		$	92,046

 

Intangible assets consisted of the following (in thousands):

 

				June 30, 2013									December 31, 2013
		Weighted Average Lives		Gross Carrying Value			Accumulated Amortization			Intangibles Net			Gross Carrying Value			Accumulated Amortization			Intangibles Net
Amortizable assets:
Software development costs		7 years		$	17,350		$	5,396		$	11,954		$	19,106		$	6,293		$	12,813
Patents		13 years		5,400			635			4,765			6,060			699			5,361
Core technology		10 years		2,058			1,728			330			2,218			1,973			245
Developed technology		10 years		20,002			14,620			5,382			15,611			11,003			4,608
Customer relationships/ backlog		8 years		9,178			5,624			3,554			11,355			6,354			5,001
Total amortizable assets				53,988			28,003			25,985			54,350			26,322			28,028
Non-amortizable assets - Trademarks				10,618			—			10,618			11,985			—			11,985
Total intangible assets				$	64,606		$	28,003		$	36,603		$	66,335		$	26,322		$	40,013

 

Amortization expense related to intangibles assets was $2.3 million and $2.6 million for the six months ended December 31, 2012 and 2013, respectively. For the three months ended December 31, 2012 and 2013, amortization expense was $1.1 million and $1.2 million, respectively. At December 31, 2013, the estimated future amortization expense was as follows (in thousands):

 

Fiscal Years
2014 (remaining 6 months)		$	1,914
2015		3,097
2016		3,222
2017		3,134
2018		3,025
2019		2,924
2020 and thereafter, including assets that have not yet begun to be amortized		10,712
Total		$	28,028

 

10

Table of Contents

 

Software development costs for software products incurred before establishing technological feasibility are charged to operations. Software development costs incurred after establishing technological feasibility are capitalized on a product by product basis until the product is available for general release to customers at which time amortization begins. Annual amortization, charged to cost of goods sold, is the greater of (i) the amount computed using the ratio that current gross revenues for a product bear to the total current and anticipated future gross revenues for that product and (ii) the straight line method over the remaining estimated economic life of the product. Amortizable assets that have not yet begun to be amortized are included in thereafter in the table above. The Company capitalized software development costs in the amount of $1.8 million for both the six months ended December 31, 2012 and 2013, respectively, and $0.5 million for each of the three months ended December 31, 2012 and 2013.

 

4. Borrowings

 

The Company has a $425 million credit agreement maturing November 2016. The credit agreement consists of a $425 million revolving credit facility, including a $375 million sub-limit for letters of credit. The Company has the ability to increase the facility by $100 million under certain circumstances. Borrowings under this facility bear interest at the London Interbank Offered Rate (LIBOR) plus a margin of 1.5% as of December 31, 2013. This margin is determined by the Company’s consolidated leverage ratio and may range from 1.5% to 2.0%. Letters of credit reduce the amount available to borrow by their face value. The unused portion of the facility bears a commitment fee of 0.25%. The Company’s borrowings under the credit agreement are guaranteed by the Company’s U.S.-based subsidiaries and are secured by substantially all of the Company’s and certain subsidiaries’ assets. The agreement contains various representations and warranties, affirmative and negative and financial covenants, and events of default customary for financing agreements of this type. As of December 31, 2013, there was $60.0 million outstanding under the revolving credit facility and $115.6 million outstanding under the letters-of-credit sub-facility.

 

Several of the Company’s foreign subsidiaries maintain bank lines-of-credit, denominated in local currencies, to meet short-term working capital requirements and for the issuance of letters-of-credit. As of December 31, 2013, $16.8 million was outstanding under these letter-of-credit facilities, while no debt was outstanding. As of December 31, 2013, the total amount available under these credit facilities was $25.7 million, with a total cash borrowing sub-limit of $3.2 million.

 

In September 2012, the Company entered into a term loan agreement for $11.1 million to fund the acquisition of land and a building in the state of Washington.  The loan, which bears interest at LIBOR plus 1.25%, is payable on a monthly basis over seven years.  Concurrent with entering into the floating rate loan, the Company entered into an interest rate swap agreement that effectively locks the interest rate of the loan to 2.2% per annum for the term of the loan.

 

Long-term debt consisted of the following (in thousands):

 

		June 30, 2013			December 31, 2013
Term loans		$	12,470		$	11,751
Other long-term debt		—			2,944
		12,470			14,695
Less current portion of long-term debt		1,797			2,971
Long-term portion of debt		$	10,673		$	11,724

 

5.  Impairment, restructuring and Other Charges

 

The following table summarizes the impairment, restructuring and other charges (in thousands):

 

		Security Division			Healthcare Division			Optoelectronics and Manufacturing Division			Corporate		Consolidated
Accrued balance as of June 30, 2013		$	1,043		$	1,639		$	66		—		$	2,748
Expensed during the period:
Facility closures (1)		—			2,009			625			—		2,634
Employee termination costs (2)		780			—			486			—		1,266
Charges related to contract issues with the TSA (3)		2,518			—			—			—		2,518
Total expensed during the period		3,298			2,009			1,111			—		6,418
Paid during the period		2,921			1,496			684			—		5,101
Accrued balance as of December 31, 2013		$	1,420		$	2,152		$	493		—		$	4,065

 

(1)         The facility relocation within the Healthcare Division began in fiscal 2013 and was completed during the first quarter of fiscal 2014.  The facility consolidations within the Optoelectronics and Manufacturing Division began during the first quarter of fiscal 2014 and are expected to be completed during the remainder of the year.

(2)         The employee termination costs within the Security Division were incurred as a result of management restructuring. The employee termination costs within the Optoelectronics and Manufacturing Division related to facility consolidations that began in the first quarter of fiscal 2014 and are expected to be completed during the remainder of the fiscal year.

(3)         These costs related to a contract settlement with the Transportation Security Administration (TSA) entered into in fiscal 2013 and a current contract issue with the TSA, and include costs for removal, storage and refurbishing costs for products previously sold to the TSA as required by the contract settlement, and legal costs for the issues.

 

11

Table of Contents

 

6. Stock-based Compensation

 

As of December 31, 2013, the Company maintained two share-based employee compensation plans (the “OSI Plans”): the 2012 Incentive Award Plan (“2012 Plan”) and the 2006 Equity Participation Plan (“2006 Plan”).  Upon the effective date of the 2012 Plan, the Company ceased to make grants under the 2006 Plan.

 

The Company recorded stock-based compensation expense in the condensed consolidated statements of operations as follows (in thousands):

 

		Three Months Ended December 31,						Six Months Ended December 31,
		2012			2013			2012			2013
Cost of goods sold		$	129		$	255		$	267		$	525
Selling, general and administrative		3,431			4,770			6,764			10,072
Research and development		54			58			116			124
Stock-based compensation expense before taxes		$	3,614		$	5,083		7,147			$	10,721
Less: related income tax benefit		1,372			1,963			2,209			4,138
Stock-based compensation expense, net of estimated taxes		$	2,242		$	3,120		$	4,938		$	6,583

 

As of December 31, 2013, total unrecognized compensation cost related to share-based compensation grants were estimated at $1.6 million for stock options and $24.3 million for restricted stock and restricted stock units (“RSUs”) under the OSI Plans.  The Company expects to recognize these costs over a weighted-average period of 1.7 years with respect to the options and 2.0 years for grants of restricted stock and RSUs.

 

The following summarizes stock option activity during the six months ended December 31, 2013:

 

		Number of Options		Weighted- Average Exercise Price			Weighted-Average Remaining Contractual Term		Aggregate Intrinsic Value (in thousands)
Outstanding at June 30, 2013		1,019,733		$	26.33
Granted		10,294		$	70.59
Exercised		(1,169	)	$	39.97
Expired or forfeited		(1,917	)	$	53.89
Outstanding at December 31, 2013		1,026,941		$	26.70		6.1 years		$	27,410
Exercisable at December 31, 2013		835,329		$	22.19		5.5 years		$	25,825

 

A summary of restricted stock and RSU award activity during the six months ended December 31, 2013 is as follows:

 

		Shares		Weighted- Average Fair Value
Nonvested at June 30, 2013		627,124		$	43.19
Granted		322,275		63.73
Vested		(267,402	)	38.70
Forfeited		(2,192	)	49.82
Nonvested at December 31, 2013		679,805		$	54.68

 

12

Table of Contents

 

As of December 31, 2013, there were 3,310,467 shares available for grant under the 2012 Plan.  Under the terms of that plan, restricted stock and RSUs granted from the pool of shares available for grant on or after December 12, 2012 reduce the pool by 1.87 shares for each share granted.  Restricted stock and RSUs forfeited and returned to the pool of shares available for grant increase the pool by 1.87 shares for each share forfeited.

 

The Company granted 178,500 and 160,922 performance-based awards during the six months ended December 31, 2012 and December 31, 2013 respectively. These performance-based restricted stock and RSU awards are contingent on the achievement of certain financial performance metrics. The payout can range from zero to 250% of the original number of shares or units awarded, which are converted into shares of the Company’s common stock.

 

7. Retirement Benefit Plans

 

The Company sponsors various retirement benefit plans including qualified and nonqualified defined benefit pension plans for its employees. The components of net periodic pension expense are as follows (in thousands):

 

		Three Months Ended December 31,						Six Months Ended December 31,
		2012			2013			2012			2013
Service cost		$	306		$	309		$	584		$	602
Amortization of prior service cost		230			202			460			404
Net periodic pension expense		$	536		$	511		$	1,044		$	1,006

 

For the three months ended December 31, 2012 and 2013, the Company made contributions of $0.1 million and $0.8 million, respectively, to these defined benefit plans. For the six months ended December 31, 2012 and 2013, the Company made contributions of $0.1 million and $0.9 million, respectively, to these defined benefit plans.

 

In addition, the Company maintains various defined contribution plans. For the three months ended December 31, 2012 and 2013, the Company made contributions of $0.8 and $1.0 million, respectively, to these defined contribution plans. For the six months ended December 31, 2012 and 2013, the Company made contributions of $1.8 million and $2.0 million, respectively, to these defined contribution plans.

 

8. Commitments and Contingencies

 

Legal Proceedings

 

On December 12, 2013, a putative class action complaint was filed against the Company and certain of its officers in the United States District Court for the Central District of California, captioned Roberti v. OSI Systems, Inc., et al., Case No. 2:13-cv-09174-MWF-VBK (the “Roberti Action”).  The Roberti Action purports to be brought on behalf of persons who purchased the Company’s common stock between January 24, 2012 and December 6, 2013.  The complaint generally asserts that defendants violated section 10(b) of the Securities Exchange Act of 1934 (the “Act”) and Rule 10b-5 promulgated thereunder and also that the individual defendants violated section 20(a) of the Act by misrepresenting or failing to disclose that the Company allegedly manipulated operational testing of its Advanced Imaging Technology by selectively picking the best sensors and thereby causing the testing not to be representative of the scanners already deployed at airports; that certain of the Company’s products allegedly raised strong privacy concerns and were subject to disqualification for use in airport security checkpoints; and that the Company allegedly manufactured its products with parts that violated contracts with TSA, thereby risking cancellation of the contracts.  Plaintiffs demand a jury trial and seek class certification, unspecified damages, an award of pre-judgment and post-judgment interest, attorneys’ and experts’ fees, costs, and other unspecified relief.  While the Company believes that the Roberti Action is without merit and intends to defend the litigation vigorously, it expects to incur costs associated with defending the Roberti Action. At this early stage of the litigation, the ultimate outcome of the Roberti Action is uncertain and the Company cannot reasonably assess the timing or outcome, or estimate the amount of loss, if any, or its effect, if any, on its financial statements.

 

The Company is involved in various other claims and legal proceedings arising in the ordinary course of business. In the Company’s opinion after consultation with legal counsel, the ultimate disposition of such proceedings is not likely to have a material adverse effect on its business, financial condition, results of operations or cash flows.  The Company has not accrued for loss contingencies relating to such matters because the Company believes that, although unfavorable outcomes in the proceedings may be possible, they are not considered by management to be probable or reasonably estimable. If one or more of these matters are resolved in a manner adverse to the Company, the impact on the Company’s business, financial condition, results of operations and/or liquidity could be material.

 

13

Table of Contents

 

Contingent Acquisition Obligations

 

Under the terms and conditions of the purchase agreements associated with certain acquisitions, the Company may be obligated to make additional payments based on the achievement by the acquired operations of certain sales or profitability milestones. The maximum amount of such future payments under arrangements with contingent consideration caps is $51 million as of December 31, 2013. In addition, one of the purchase agreements the Company entered into requires royalty payments through 2022 based on the license of, or sales of products containing, the technology of CXR Limited, a company acquired in 2004. For acquisitions that occurred prior to fiscal year 2010, the Company accounts for such contingent payments as an addition to the purchase price of the acquired business. Otherwise, the estimated fair value of these obligations is recorded as a liability in the condensed consolidated balance sheets with subsequent revisions reflected in the condensed consolidated statements of operations. As of June 30, 2013 and December 31, 2013, $15.4 million and $20.8 million of contingent payment obligations, respectively, are included in Other long-term liabilities in the accompanying condensed consolidated balance sheets.

 

Advances from Customers

 

The Company receives advances from customers associated with certain projects.  In fiscal 2012, the Company entered into an agreement with the Mexican government to provide a turnkey security screening solution along the country’s borders, and in its ports and airports.  Associated with the agreement, the Company was provided an advance totaling $100 million.  The Company is obligated to provide a guarantee until the advance has been amortized.  As of December 31, 2013, $87.5 million of this advance remains outstanding.

 

Environmental Contingencies

 

The Company is subject to various environmental laws. The Company’s practice is to conduct appropriate environmental investigations for each of its properties in the United States at which the Company manufactures products in order to identify, as of the date of such report, potential areas of environmental concern related to past and present activities or from nearby operations. In certain cases, the Company has conducted further environmental assessments consisting of soil and groundwater testing and other investigations deemed appropriate by independent environmental consultants.

 

During one investigation, the Company discovered soil and groundwater contamination at its Hawthorne, California facility that the Company believes was the result of unspecified historical releases prior to the Company’s occupancy. This site had been used since the mid 1960’s by other companies for semiconductor manufacturing and was part of a large aircraft manufacturing complex during World War II. It is not presently known when the releases occurred or by whom they were caused. The groundwater contamination is a known regional problem, not limited to the Company’s premises or its immediate surroundings. The Company filed the requisite reports concerning this problem with the appropriate environmental authorities in fiscal 2001. The Company was contacted by the local governing agency with a request to provide additional historical information and further characterization of the site. Historical reports and site characterization work plans were completed in fiscal 2013 and further site characterization studies, including soil and groundwater investigations, are scheduled for fiscal 2014. These studies are necessary to determine the extent of the on-site releases and if any remediation of such contamination will be required.

 

The Company has not accrued for loss contingencies relating to the Hawthorne facility or any other environmental matters because it believes that, although unfavorable outcomes may be possible, they are not considered by the Company’s management to be probable and reasonably estimable. If one or more of environmental matters are resolved in a manner adverse to the Company, the impact on the Company’s business, financial condition, results of operations, financial position and/or liquidity could be material.

 

Indemnifications

 

In the normal course of business, the Company has agreed to indemnify certain parties with respect to certain matters. The Company has agreed to hold certain parties harmless against losses arising from a breach of representations, warranties or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. The Company has not recorded any liability for costs related to indemnification as of December 31, 2013.

 

14

Table of Contents

 

Other Matters

 

On December 5, 2013, the Company’s Security division was notified by the U.S. Transportation Security Administration (TSA) that a delivery order that it had received on September 26, 2013, for baggage and handling inspection systems was being terminated for default.  The termination resulted from the use of an upgraded X-ray generator component. While the component had been vetted by the Security division’s internal quality assurance, the Security division had not met the contractual requirement of obtaining the TSA’s approval in advance.  As a result of this termination for default, the Security division has been referred to the U.S. Department of Homeland Security for further review.  Although the results of this review cannot be determined at this time, among other consequences, the Security division could be barred from conducting future business with the U.S. federal government for a period of time.

 

Product Warranties

 

The Company offers its customers warranties on many of the products that it sells. These warranties typically provide for repairs and maintenance of the products if problems arise during a specified time period after original shipment. Concurrent with the sale of products, the Company records a provision for estimated warranty expenses with a corresponding increase in cost of goods sold. The Company periodically adjusts this provision based on historical experience and anticipated expenses. The Company charges actual expenses of repairs under warranty, including parts and labor, to this provision when incurred.

 

The following table presents changes in warranty provisions (in thousands):

 

		Three Months Ended December 31,						Six Months Ended December 31,
		2012			2013			2012			2013
Balance at beginning of period		$	16,919		$	13,359		$	17,562		$	12,890
Additions and adjustments		58			869			690			2,536
Reductions for warranty repair costs		(1,965		)	(959		)	(3,240		)	(2,157		)
Balance at end of period		$	15,012		$	13,269		15,012			$	13,269

 

9. Income Taxes

 

The provision for income taxes is determined using an effective tax rate that is subject to fluctuations during the year as new information is obtained.  The assumptions used to estimate the annual effective tax rate include factors such as the mix of pre-tax earnings in the various tax jurisdictions in which the Company operates, valuation allowances against deferred tax assets, increases or decreases in uncertain tax positions, utilization of research and development tax credits, changes in or the interpretation of tax laws in jurisdictions where the Company conducts business and certain tax elections. The Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of its assets and liabilities along with net operating loss and tax credit carryovers. The Company records a valuation allowance against its deferred tax assets to reduce the net carrying value to an amount that it believes is more likely than not to be realized. When the Company establishes or reduces the valuation allowance against its deferred tax assets, the provision for income taxes will increase or decrease, respectively, in the period such determination is made.

 

10. Segment Information

 

The Company has determined that it operates in three identifiable industry segments, (a) security and inspection systems (Security division), (b) medical monitoring and anesthesia systems (Healthcare division) and (c) optoelectronic devices and manufacturing (Optoelectronics and Manufacturing division). The Company also has a corporate segment (Corporate) that includes executive compensation and certain other general and administrative expenses, expenses related to stock issuances’ and legal and audit and other professional service fees not allocated to product segments. Both the Security and Healthcare divisions comprise primarily end-user businesses, while the Optoelectronics and Manufacturing division primarily supplies components and subsystems to original equipment manufacturers, including to the Security and Healthcare divisions. Sales between divisions are at transfer prices that approximate market values.  All other accounting policies of the segments are the same as described in Note 1, Summary of Significant Accounting Policies of the Form 10-K for the fiscal year ended June 30, 2013.

 

15

Table of Contents

 

The following tables present the operations and identifiable assets by industry segment (in thousands):

 

		Three Months Ended December 31,						Six Months Ended December 31,
		2012			2013			2012			2013
Revenues — by Segment:
Security division		$	91,863		$	106,588		$	174,779		$	203,741
Healthcare division		56,114			63,106			107,695			108,893
Optoelectronics and Manufacturing division, including intersegment revenues		57,277			76,358			114,424			147,669
Intersegment revenues elimination		(11,205		)	(9,644		)	(21,155		)	(17,621		)
Total		$	194,049		$	236,408		$	375,743		$	442,682

 

		Three Months Ended December 31,						Six Months Ended December 31,
		2012			2013			2012			2013
Operating income (loss) — by Segment:
Security division		$	8,607		$	15,149		$	13,072		$	26,771
Healthcare division		6,915			9,226			10,796			7,228
Optoelectronics and Manufacturing division		5,457			2,121			10,290			6,886
Corporate		(2,438		)	(4,355		)	(5,687		)	(8,400		)
Eliminations (1)		137			(112		)	321			17
Total		$	18,678		$	22,029		$	28,792		$	32,502

 

		June 30, 2013			December 31, 2013
Assets — by Segment:
Security division		$	499,539		$	496,534
Healthcare division		190,963			180,317
Optoelectronics and Manufacturing division		158,584			179,285
Corporate		75,496			83,903
Eliminations (1)		(4,786		)	(4,769		)
Total		$	919,796		$	935,270

(1)        Eliminations within operating income primarily reflect the change in the elimination of intercompany profit in inventory not-yet-realized. Eliminations in assets reflect the amount of intercompany profits in inventory as of the balance sheet date. Such intercompany profit will be realized when inventory is shipped to the external customers of the Security and Healthcare divisions.

 

16