OSI SYSTEMS INC - Quarter Report: 2014 September (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 September 30, 2014

 

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.

 

 

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 October 23, 2014, there were 19,829,016 shares of the Registrant’s common stock outstanding.

 

 

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OSI SYSTEMS, INC.

 

INDEX

 

				PAGE
PART I —		FINANCIAL INFORMATION		3
Item 1 —		Condensed Consolidated Financial Statements		3
		Condensed Consolidated Balance Sheets at June 30, 2014 and September 30, 2014		3
		Condensed Consolidated Statements of Operations for the three months ended September 30, 2013 and 2014		4
		Condensed Consolidated Statements of Comprehensive Income for the three months ended September 30, 2013 and 2014		5
		Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2013 and 2014		6
		Notes to Condensed Consolidated Financial Statements		7
Item 2 —		Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3 —		Quantitative and Qualitative Disclosures about Market Risk		21
Item 4 —		Controls and Procedures		23
PART II — OTHER INFORMATION				23
Item 1 —		Legal Proceedings		23
Item 1A —		Risk Factors		23
Item 2 —		Unregistered Sales of Equity Securities and Use of Proceeds		23
Item 3 —		Defaults Upon Senior Securities		23
Item 4 —		Mine Safety Disclosures		23
Item 5 —		Other Information		23
Item 6 —		Exhibits		23
Signatures				24

 

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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,			September 30,
		2014			2014
ASSETS
Current assets:
Cash and cash equivalents		$	38,831		$	37,274
Accounts receivable, net		185,773			155,849
Inventories		234,138			264,394
Deferred taxes		73,510			73,362
Prepaid expenses and other current assets		46,978			52,122
Total current assets		579,230			583,001
Property and equipment, net		260,479			250,193
Goodwill		92,607			97,430
Intangible assets, net		43,615			47,628
Other assets		48,255			49,803
Total assets		$	1,024,186		$	1,028,055
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Bank lines of credit		$	24,000		$	30,000
Current portion of long-term debt		2,819			2,820
Accounts payable		74,460			80,552
Accrued payroll and related expenses		32,997			29,481
Advances from customers		38,493			43,873
Deferred revenue		60,677			55,958
Income taxes payable		20,556			24,956
Other accrued expenses and current liabilities		55,977			53,994
Total current liabilities		309,979			321,634
Long-term debt		10,436			11,267
Advances from customers		50,000			43,750
Deferred income taxes		73,161			73,978
Other long-term liabilities		48,397			55,257
Total liabilities		491,973			505,886
Commitments and contingencies (Note 7)
Stockholders’ equity:
Preferred stock, $0.001 par value — authorized, 10,000,000 shares; no shares issued or outstanding		—			—
Common stock, $0.001 par value — authorized, 100,000,000 shares; issued and outstanding, 19,942,923 shares at June 30, 2014 and 19,802,749 shares at September 30, 2014		287,434			268,713
Retained earnings		247,680			258,929
Accumulated other comprehensive loss		(2,901		)	(5,473		)
Total stockholders’ equity		532,213			522,169
Total liabilities and stockholders’ equity		$	1,024,186		$	1,028,055

 

See accompanying notes to condensed consolidated financial statements.

 

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OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

		For the Three Months Ended September 30,
		2013			2014
Net revenues:
Products		$	143,476		$	156,488
Services		62,798			61,909
Total net revenues		206,274			218,397
Cost of goods sold:
Products		103,593			107,424
Services		34,735			36,731
Total cost of goods sold		138,328			144,155
Gross profit		67,946			74,242
Operating expenses:
Selling, general and administrative		42,214			44,182
Research and development		11,020			12,670
Restructuring and other charges		4,239			726
Total operating expenses		57,473			57,578
Income from operations		10,473			16,664
Interest and other expense, net		(1,470		)	(864		)
Income before income taxes		9,003			15,800
Provision for income taxes		2,609			4,551
Net income		$	6,394		$	11,249
Net income per share:
Basic		$	0.32		$	0.57
Diluted		$	0.31		$	0.55
Shares used in per share calculation:
Basic		19,971			19,820
Diluted		20,620			20,529

 

See accompanying notes to condensed consolidated financial statements.

 

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OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

 

		For the Three Months Ended September 30,
		2013			2014
Net income		$	6,394		$	11,249
Other comprehensive income (loss):
Foreign currency translation adjustment		1,308			(2,698		)
Other		92			126
Other comprehensive income (loss)		1,400			(2,572		)
Comprehensive income		$	7,794		$	8,677

 

See accompanying notes to condensed consolidated financial statements.

 

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OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

		For the Three Months Ended September 30,
		2013			2014
Cash flows from operating activities:
Net income		$	6,394		$	11,249
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		12,873			17,741
Stock based compensation expense		5,638			5,995
Other		193			69
Changes in operating assets and liabilities—net of business acquisitions:
Accounts receivable		6,305			30,159
Inventories		(16,092		)	(29,381		)
Accounts payable		(3,151		)	2,933
Accrued payroll and related expenses		(2,308		)	(4,008		)
Deferred revenue		(3,145		)	(3,382		)
Other		(460		)	78
Net cash provided by operating activities		6,247			31,453
Cash flows from investing activities:
Acquisition of property and equipment		(7,971		)	(3,136		)
Acquisition of businesses, net of cash acquired		(9,302		)	(10,869		)
Acquisition of intangible and other assets		(1,756		)	(1,063		)
Net cash used in investing activities		(19,029		)	(15,068		)
Cash flows from financing activities:
Net borrowings on bank lines of credit		20,000			6,000
Proceeds from long-term debt		2,769			516
Payments on long-term debt		(805		)	(815		)
Proceeds from exercise of stock options and employee stock purchase plan		1,501			209
Repurchase of common shares		(1,514		)	(18,373		)
Taxes paid related to net share settlement of equity awards		(7,481		)	(6,552		)
Net cash provided by (used in) financing activities		14,470			(19,015		)
Effect of exchange rate changes on cash		801			1,073
Net increase (decrease) in cash and cash equivalents		2,489			(1,557		)
Cash and cash equivalents-beginning of period		34,697			38,831
Cash and cash equivalents-end of period		$	37,186		$	37,274
Supplemental disclosure of cash flow information:
Cash paid, net during the period for:
Interest		$	1,174		$	696
Income taxes		$	4,001		$	1,735

 

See accompanying notes to condensed consolidated financial statements.

 

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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. The Company sells its products and provides related 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, 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 provides 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; radiation detection; and trace detection. 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, markets and services patient monitoring, cardiology and anesthesia delivery and ventilation systems, and related supplies and accessories 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 amongst others.

 

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, computer peripherals, industrial automation systems, automotive diagnostic systems, gaming systems 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. 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, 2014. The results of operations for the three months ended September 30, 2014 are not necessarily indicative of the operating results to be expected for the full 2015 fiscal year or any future periods.

 

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Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and costs of sales during the reporting period. The most significant of these estimates and assumptions for the Company relate to contract revenue, profit and loss recognition, fair values of assets acquired and liabilities assumed in business combinations, market values for inventories reported at lower of cost or market, stock-based employee compensation expense, income taxes, accrued product warranty costs, and the recoverability, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts will differ from these estimates and could differ materially.

 

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 restricted stock awards or units under the treasury stock method.  Stock awards to purchase 0.1 million shares of common stock for the three months ended September 30, 2014 were excluded from the calculation of diluted earnings per share because to do so would have been antidilutive, while during the three months ended September 30, 2013 no stock awards were excluded from the calculation.

 

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

 

		Three Months Ended September 30,
		2013			2014
Net income for diluted earnings per share calculation		$	6,394		$	11,249
Weighted average shares for basic earnings per share calculation		19,971			19,820
Dilutive effect of stock awards		649			709
Weighted average shares for diluted earnings per share calculation		20,620			20,529
Basic net income per share		$	0.32		$	0.57
Diluted net income per share		$	0.31		$	0.55

 

Reclassifications

 

Certain reclassifications have been made to prior year amounts within the condensed consolidated balance sheet and condensed consolidated statement of cash flows to conform to the current year’s presentation.

 

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.

 

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

 

		Level 1			Level 2			June 30, 2014			Level 1			Level 2			September 30, 2014
Equity securities		414			500			914			385			1,600			1,985
Insurance company contracts		—			17,383			17,383			—			18,077			18,077
Interest rate contract		—			28			28			—			61			61
Total		$	414		$	17,911		$	18,325		$	385		$	19,738		$	20,123

 

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.

 

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 turnkey services agreements is included in revenue from services. In certain agreements, revenue 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. Deferred revenue for such agreements arises when payments from customers are received in advance of revenue recognition.

 

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 provided.  During the three months ended September 30, 2014, the Company completed an acquisition that was not material.

 

Recent Accounting Updates Not Yet Adopted

 

In May 2014, the Financial Accounting Standards Board issued an accounting standards update amending revenue recognition requirements for multiple deliverable revenue arrangements. This update provides guidance on how revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services. This determination is made in five steps: (i) identify the contract with the customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The update is effective for annual reporting periods after December 15, 2016 and for interim reporting periods within that reporting period. Early adoption is not permitted. The Company has not yet adopted this update and is currently evaluating the impact it may have on its financial condition and results of operations.

 

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2. Balance Sheet Details

 

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

 

		June 30, 2014			September 30, 2014
Accounts receivable
Billed receivables		$	189,489		$	160,202
Unbilled receivables		1,975			2,552
Less allowance for doubtful accounts		(5,691		)	(6,905		)
Total		$	185,773		$	155,849

 

		June 30, 2014			September 30, 2014
Inventories
Raw materials		$	117,945		$	146,525
Work-in-process		33,394			44,743
Finished goods		82,799			73,126
Total		$	234,138		$	264,394

 

		June 30, 2014			September 30, 2014
Property and equipment, net
Land		$	13,651		$	13,651
Buildings and improvements		163,952			166,468
Leasehold improvements		9,744			10,058
Equipment and tooling		154,367			154,501
Furniture and fixtures		4,017			4,052
Computer equipment		17,466			17,810
Computer software		15,670			15,968
Construction in process		12,650			10,612
Total		391,517			393,120
Less: accumulated depreciation and amortization		(131,038		)	(142,927		)
Property and equipment, net		$	260,479		$	250,193

 

During the three months ended September 30, 2013 and 2014, depreciation expense was approximately $11.5 million and $16.9 million, respectively.

 

3. Goodwill and Intangible Assets

 

The changes in the carrying value of goodwill for the three-month period ended September 30, 2014 are as follows (in thousands):

 

		Security Division			Healthcare Division			Optoelectronics and Manufacturing Division			Consolidated
Balance as of June 30, 2014		$	29,507		$	37,237		$	25,863		$	92,607
Goodwill acquired or adjusted during the period		19			5,655			37			5,711
Foreign currency translation adjustment		(281		)	(283		)	(324		)	(888		)
Balance as of September 30, 2014		$	29,245		$	42,609		$	25,576		$	97,430

 

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Intangible assets consisted of the following (in thousands):

 

				June 30, 2014									September 30, 2014
		Weighted Average Lives		Gross Carrying Value			Accumulated Amortization			Intangibles Net			Gross Carrying Value			Accumulated Amortization			Intangibles Net
Amortizable assets:
Software development costs		9 years		$	21,165		6,716			14,449			$	21,275		$	6,855		$	14,420
Patents		20 years		6,566			765			5,801			6,814			804			6,010
Core technology		10 years		2,289			2,150			139			2,187			2,109			78
Developed technology		10 years		18,308			11,559			6,749			20,369			11,853			8,516
Customer relationships/backlog		7 years		11,419			7,011			4,408			10,070			4,032			6,038
Total amortizable assets				59,747			28,201			31,546			60,715			25,653			35,062
Non-amortizable assets:
Trademarks				12,069			—			12,069			12,566			—			12,566
Total intangible assets				$	71,816		$	28,201		$	43,615		$	73,281		$	25,653		$	47,628

 

Amortization expense related to intangibles assets was $1.4 million and $0.8 million for the three months ended September 30, 2013 and 2014, respectively. At September 30, 2014, the estimated future amortization expense was as follows (in thousands):

 

Fiscal Years
2015 (remaining 9 months)		$	2,994
2016		3,757
2017		3,913
2018		3,826
2019		3,582
2020		3,116
2021 and thereafter, including assets that have not yet begun to be amortized		13,874
Total		$	35,062

 

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 amount computed using the ratio that current revenues for a product bear to the total current and anticipated future revenues for that product. In the event that future revenues are not estimable, such costs are amortized on a straight line basis 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. During the three months ended September 30, 2013 and 2014, the Company capitalized software development costs in the amount of $1.2 million and $0.6 million, respectively.

 

4. Borrowings

 

The Company has a $450 million credit agreement maturing in May 2019. The credit agreement consists of a $450 million revolving credit facility, including a $375 million sub-limit for letters of credit. The Company has the ability to increase the facility by $200 million under certain circumstances. Borrowings under this facility bear interest at the London Interbank Offered Rate (“LIBOR”) plus a margin of 1.25% as of September 30, 2014. This margin is determined by the Company’s consolidated leverage ratio and may range from 1.25% to 2.0%. Letters of credit reduce the amount available to borrow by their face value. As of September 30, 2014, the unused portion of the facility bears a commitment fee of 0.20%, but can range from 0.20% to 0.35% based on the Company’s consolidated leverage ratio. 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, warranties, affirmative, negative and financial covenants, and conditions of default customary for financing agreements of this type. As of September 30, 2014, there was $30.0 million outstanding under the revolving credit facility and $100.1 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 and US dollars, to meet short-term working capital requirements and for the issuance of letters-of-credit. As of September 30, 2014, $11.6 million was outstanding under these letter-of-credit facilities, while no debt was outstanding. As of September 30, 2014, the total amount available under these credit facilities was $26.4 million, with a total cash borrowing sub-limit of $2.9 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.

 

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

 

		June 30, 2014			September 30, 2014
Term loans		$	10,921		$	11,607
Other long-term debt		2,334			2,480
		13,255			14,087
Less current portion of long-term debt		2,819			2,820
Long-term portion of debt		$	10,436		$	11,267

 

5. Stock-based Compensation

 

As of September 30, 2014, the Company maintained two share-based employee compensation plans (the “OSI Plans”): the 2012 Incentive Award Plan (“2012 Plan”) and the Amended and Restated 2006 Equity Participation Plan (“2006 Plan”). Upon stockholder approval 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 September 30,
		2013			2014
Cost of goods sold		$	269		$	205
Selling, general and administrative		5,303			5,763
Research and development		66			27
Stock-based compensation expense before taxes		$	5,638		$	5,995
Less: related income tax benefit		2,174			2,406
Stock-based compensation expense, net of estimated taxes		$	3,464		$	3,589

 

As of September 30, 2014, total unrecognized compensation cost related to share-based compensation grants were estimated at $1.4 million for stock options and $30.5 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 2.2 years with respect to the options and 1.9 years for grants of restricted stock and RSUs.

 

The following summarizes stock option activity during the three months ended September 30, 2014:

 

		Number of Options		Weighted- Average Exercise Price			Weighted-Average Remaining Contractual Term		Aggregate Intrinsic Value (in thousands)
Outstanding at June 30, 2014		1,022,991		$	26.60
Granted		42,476		$	68.03
Exercised		(4,154	)	$	50.27
Expired or forfeited		(2,623	)	$	56.94
Outstanding at September 30, 2014		1,058,690		$	28.09		5.6 years		$	36,839
Exercisable at September 30, 2014		949,969		$	24.35		5.2 years		$	36,297

 

A summary of restricted stock and RSU award activity during the three months ended September 30, 2014 is as follows:

 

		Shares		Weighted- Average Fair Value
Nonvested at June 30, 2014		661,400		$	54.78
Granted		277,536		64.63
Vested		(233,945	)	42.20
Forfeited		(6,821	)	37.39
Nonvested at September 30, 2014		698,170		63.08

 

As of September 30, 2014, there were 2,973,477 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 160,922 and 151,469 performance-based units during the three months ended September 30, 2013 and 2014, respectively. These performance-based restricted stock 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.

 

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6. 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 September 30,
		2013			2014
Service cost		$	293		$	264
Amortization of prior service cost		202			202
Net periodic pension expense		$	495		$	466

 

For the three months ended September 30, 2013 and 2014, the Company made contributions of $0.1 million and $1.0 million, respectively, to these defined benefit plans.

 

In addition, the Company maintains various defined contribution plans. For the three months ended September 30, 2013 and 2014, the Company made contributions of $1.0 million and $1.2 million, respectively, to these defined contribution plans.

 

7. Commitments and Contingencies

 

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 $58 million as of September 30, 2014. 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 at the time of the acquisition in the condensed consolidated balance sheets with subsequent revisions reflected in the condensed consolidated statements of operations. As of June 30, 2014 and September 30, 2014, $23.2 million and $24.4 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 fully amortized in fiscal 2017.  As of September 30, 2014, $68.8 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 at its manufacturing facilities in North America, Asia Pacific, and Europe, and, to the extent practicable, on all new properties 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 at the Company’s Hawthorne, California facility, the Company discovered soil and groundwater contamination that it believes was the result of unspecified on- and off-site releases occurring prior to the Company’s occupancy. Historical usage of this site includes semiconductor and electronics manufacturing, dating back to the mid-1960s, as well as possible aircraft and related manufacturing dating to the early 1940s. Similar operations, including chemical manufacturing and storage, were conducted at neighboring sites throughout that period and into the 1990s. It is not presently known when the releases occurred or by whom they were caused, though Company records, in conjunction with data obtained from soil and groundwater surveys, support the Company’s assertion that these releases are historical in nature. Further, the groundwater contamination is a known regional issue, not limited to the Company’s premises or its immediate surroundings. The Company filed the requisite reports concerning this site with the appropriate environmental authorities upon discovery, and in cooperation with the local governing agency has provided additional historical information and conducted further site characterization studies. Recent soil and groundwater investigations, including the installation of groundwater monitoring wells, were completed in fiscal 2014. Results from these studies are being evaluated to determine the extent of the on-site releases and whether any soils remediation will be required. Periodic groundwater monitoring is expected to continue until such time as the governing authority requests further action.

 

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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 September 30, 2014.

 

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  September 30,
		2013			2014
Balance at beginning of period		$	12,890		$	11,923
Additions and adjustments		1,254			847
Reductions for warranty repair costs		(785		)	(870		)
Balance at end of period		$	13,359		$	11,900

 

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 (“Court”) captioned Roberti v. OSI Systems, Inc., et al., Case No. 2:13-cv-09174-MWF-VBK (the “Securities Class Action”). The Amended Complaint, filed on May 20, 2014, alleges that the Company and the individual defendants violated the Securities Exchange Act of 1934 by misrepresenting or failing to disclose facts concerning the status of Rapiscan’s efforts to develop Automated Threat Recognition software and the alleged use of unapproved parts in its baggage scanning systems in violation of its contract with the U.S. Transportation Security Administration (TSA). The Amended Complaint also asserts that the individual defendants allegedly sold stock based on material non-public information. Plaintiff demands a jury trial and seeks class certification, unspecified damages, an award of pre-judgment and post-judgment interest, attorneys’ and experts’ fees, costs, and other unspecified relief. On July 18, 2014, the Company filed a Motion to Dismiss the Amended Complaint. The Motion is scheduled to be heard on November 3, 2014.

 

On April 15, 2014, a shareholder derivative complaint was filed in the Court purportedly on behalf of the Company against the members of the Company’s Board of Directors (as individual defendants), captioned Hagan v. Chopra, et al., Case No. 2:14-cv-02910-ODW-PJW (the “Derivative Action”). The complaint generally asserts the same factual allegations as those at issue in the related Securities Class Action and purports to allege claims for breach of fiduciary duties and unjust enrichment against the individual defendants on behalf of the Company. The complaint seeks unspecified damages, restitution, injunctive relief, attorneys’ and experts’ fees, costs, expenses, and other unspecified relief. The Derivative Action is currently stayed pending the resolution of the Motion to Dismiss in the Securities Class Action.

 

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While the Company believes that the Securities Class Action and the Derivative Action are without merit and intends to defend the litigation vigorously, it expects to incur costs associated with defending the Securities Class Action and the Derivative Action. At this early stage of litigation, the ultimate outcomes of the Securities Class Action and the Derivative Action are uncertain and the Company cannot reasonably predict the timing or outcomes, or estimate the amount of loss, if any, or their 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.

 

Other Matters

 

On December 5, 2013, the Company’s Security division was notified by the 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. The upgraded X-ray generator component has since been approved for use by the TSA. The termination for default could result in a claim by the Government for compensation.  As of this date, no such claim has been made, and the Company does not know the likely amount of any such claim if it were to be made.  Also, as a result of this termination for default, the Security division was referred to the U.S. Department of Homeland Security (DHS) for further review. As a result of this review, in October 2014 the Security division entered into an Addendum to its Administrative Agreement dated June 21, 2013 with DHS.  Pursuant to the terms of the Addendum, the Security division has agreed, among other things, to extend the term of the Administrative Agreement by 24 months.

 

8. 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.

 

9. 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, 2014.

 

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

 

		Three Months Ended September 30,
		2013			2014
Revenues(2) — by Segment:
Security division		$	97,153		$	113,439
Healthcare division		45,787			47,834
Optoelectronics and Manufacturing division, including intersegment revenues		71,311			69,086
Intersegment revenues elimination		(7,977		)	(11,962		)
Total		$	206,274		$	218,397

 

		Three Months Ended September 30,
		2013			2014
Operating income (loss) — by Segment:
Security division		$	11,622		17,259
Healthcare division		(1,998		)	62
Optoelectronics and Manufacturing division		4,765			4,327
Corporate		(4,045		)	(4,517		)
Eliminations(1)		129			(467		)
Total		$	10,473		$	16,664

 

		June 30, 2014			September 30, 2014
Assets — by Segment:
Security division		$	535,306		$	525,293
Healthcare division		190,612			203,284
Optoelectronics and Manufacturing division		169,084			165,407
Corporate		133,836			139,189
Eliminations(1)		(4,652		)	(5,118		)
Total		$	1,024,186		$	1,028,055

 

(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.

(2)        One customer accounted for 15% of total net revenues for the three months ended September 30, 2013 and 2014.  One customer accounted for 10% of the net receivables as of September 30, 2014.

 

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. and wholly-owned subsidiaries.

 

This management’s discussion and analysis of financial condition as of September 30, 2014 and results of operations for the three-months ended September 30, 2013 and 2014 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 year ended June 30, 2014.

 

Forward-Looking Statements

 

Certain statements contained in this Quarterly Report on Form 10-Q that are not related to historical results, including, without limitation, statements regarding our business strategy, objectives and future financial position, are 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, and involve risks and uncertainties. These forward-looking statements may be identified by the use of forward-looking terms such as “anticipate,” “believe,” “expect,” “may,” “could,” “likely to,” “should,” or “will,” or by discussions of strategy that involve predictions which are based upon a number of future conditions that ultimately may prove to be inaccurate. Statements in this Quarterly Report on Form 10-Q that are forward-looking are based on current expectations and actual results may differ materially. These forward-looking statements should be considered in light of numerous risks and uncertainties described in this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K and other documents previously filed or hereafter filed by us from time to time with the Securities and Exchange Commission. Such factors, of course, do not include all factors that might affect our business and financial condition. Although we believe that the assumptions upon which our forward-looking statements are based are reasonable, such assumptions could prove to be inaccurate and actual results could differ materially from those expressed in or implied by the forward-looking statements. For example, the Company could

 

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be exposed to a variety of negative consequences as a result of delays related to the award of domestic and international contracts; delays in customer programs; unanticipated impacts of sequestration and other provisions of the Budget Control Act of 2011 as modified by the Bipartisan Budget Act of 2013; changes in domestic and foreign government spending, budgetary, procurement and trade policies adverse to our businesses; 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 in accordance with our annual operating plan; enforcement actions in respect of any noncompliance with laws and regulations including export control and environmental regulations and the matters that are the subject of some or all of the Company’s ongoing investigations and compliance reviews, contract and regulatory compliance matters, and actions, if brought, resulting in judgments, settlements, fines, injunctions, debarment and/or penalties as well as other risks and uncertainties, including but not limited to those detailed herein and from time to time in our Securities and Exchange Commission filings, which could have a material and adverse impact on the Company’s business, financial condition and results of operation. All forward-looking statements contained in this Quarterly Report on Form 10-Q are qualified in their entirety by this statement. 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, turnkey security screening solutions and related services; (b) Healthcare, providing patient monitoring, cardiology and anesthesia systems; and (c) Optoelectronics and Manufacturing, providing specialized electronic components for our Security and Healthcare divisions, as well as to external original equipment manufacturer clients for applications in the defense, aerospace, medical and industrial markets, among others.

 

Security Division. Through our Security division, we provide security screening, threat detection and non-intrusive inspection products and services worldwide, and provide turnkey security screening solutions. These products and services are used to inspect baggage, cargo, vehicles and other objects for weapons, explosives, drugs, radioactive material and other contraband as well as to screen people. Revenues from our Security division accounted for 47% and 52% of our total consolidated revenues for the three months ended September 30, 2013 and 2014, respectively.

 

As a result of the terrorist attacks of September 11, 2001, and subsequent attacks in other locations worldwide, security and inspection products have increasingly been used at a wide range of facilities other than airports, such as border crossings, railway stations, seaports, cruise line terminals, freight forwarding operations, sporting venues, government and military installations and nuclear facilities. We believe that our wide-ranging product portfolio together with our ability to provide turnkey screening solutions position us to competitively pursue security and inspection opportunities as they arise throughout the world.

 

Currently, the U.S. federal Government is discussing various options to address sequestration and the U.S. federal Government’s overall fiscal challenges and we cannot predict the outcome of these efforts. While we believe that national security spending will continue to be a priority, U.S. Government budget deficits and the national debt have created increasing pressure to examine and reduce spending across many federal agencies. We believe that the diversified product portfolio and international customer mix of our Security division position us well to withstand the impact of these uncertainties and even benefit from specific initiatives within various governments. However, depending on how future sequestration cuts are implemented and how the U.S. federal Government manages its fiscal challenges, we believe that these federal actions could have a material, adverse effect on our business, financial condition and results of operations.

 

Healthcare Division. Through our Healthcare division, we design, manufacture, market and service patient monitoring,  cardiology and anesthesia delivery and ventilation systems and related supplies and accessories worldwide for sale primarily to hospitals and medical centers. Our products monitor patients in critical, emergency and perioperative care areas of the hospital and provide such 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 22% of our total consolidated revenues for each of the three months ended September 30, 2013 and 2014.

 

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The healthcare markets in which we operate are highly competitive. We believe that our customers choose among competing products on the basis of product performance, functionality, value and service. In addition, there is continued uncertainty regarding the ongoing debates related to the U.S. budget and debt ceiling and the Patient Protection and Affordable Care Act, amended by the Health Care and Education and Reconciliation Act of 2010 (the “Affordable Care Act”), in the U.S., any of which may impact hospital spending, reimbursement and fees which will be levied on certain medical device revenues and adversely affect our business and results of operations.  In addition, hospital capital spending appears to have been impacted by strategic uncertainties surrounding the Affordable Care Act and economic pressures.  We also believe that the worldwide economic slowdown has caused some hospitals and healthcare providers to delay purchases of our products and services.  During this period of uncertainty, sales of our healthcare products may be negatively impacted. Although there are indications that a general economic recovery is underway, we cannot predict when the markets will fully recover or when the uncertainties related to the U.S. federal government will be resolved and, therefore, when this period of delayed and diminished purchasing will end. A prolonged delay could have a material adverse effect on our business, financial condition and results of operations.

 

During the three months ended September 30, 2014, our Healthcare division completed a small acquisition that expands our customer base and geographic footprint, while leveraging our existing infrastructure.

 

Optoelectronics and Manufacturing Division. Through our Optoelectronics and Manufacturing division, we design, manufacture and market optoelectronic devices 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 systems, automotive diagnostic systems, gaming systems and consumer products. We also provide our optoelectronic devices and electronics manufacturing services to original equipment manufacturers, as well as our own Security and Healthcare divisions.  Revenues from external customers in our Optoelectronics and Manufacturing division accounted for approximately 31% and 26% of our total consolidated revenues for the three months ended September 30, 2013 and 2014, respectively.

 

Results of Operations for the Three Months Ended September 30, 2013 (Q1 2014) Compared to Three Months Ended September 30, 2014 (Q1 2015) (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 9 to the condensed consolidated financial statements for additional information about our business segments.

 

		Q1 2014			% of Net Sales		Q1 2015			% of Net Sales		$ Change			% Change
Security division		$	97.2		47	%	$	113.4		52	%	$	16.2		17	%
Healthcare division		45.8			22	%	47.8			22	%	2.0			4	%
Optoelectronics and Manufacturing division		71.3			35	%	69.1			31	%	(2.2		)	(3	)%
Less: inter-division sales		(8.0		)	(4	)%	(11.9		)	(5	)%	(3.9		)	49	%
Total external revenues		$	206.3				$	218.4				$	12.1		6	%

 

Revenues for the Security division for the three months ended September 30, 2014 increased primarily as a result of increased baggage and parcel inspection sales, new product launches and partial fulfillment of the $102 million Foreign Military Sale contract to the U.S. Department of Defense to supply multiple units of cargo and vehicle inspection systems and related training, spare parts, service and logistics support for Iraq.

 

Revenues for the Healthcare division for the three months ended September 30, 2014 increased primarily due to the acquisition of a European cardiology equipment business during the first quarter of the current fiscal year and increased sales in our North American and Asian markets.  These increases were partially offset by a decrease in organic sales in our Europe, Middle East and African region.

 

Revenues for the Optoelectronics and Manufacturing division for the three months ended September 30, 2014 decreased 3% as a result of lower contract manufacturing sales in the current fiscal year.  This decrease was primarily attributable to exceptionally high sales to a single customer during the first quarter of the prior fiscal year to whom we continue to sell but at a lower level.

 

Gross Profit

 

		Q1 2014			% of Net Sales		Q1 2015			% of Net Sales		$ Change			% Change
Gross profit		$	67.9		32.9	%	$	74.2		34.0	%	$	6.3		9	%

 

Gross profit during the three months ended September 30, 2014 increased as a result of increased sales and an improvement in gross margin.  The gross margin increase was a result of the impact of lower revenues in our Optoelectronics and Manufacturing division, which has historically generated the lowest gross margins across the three divisions.

 

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Operating Expenses

 

		Q1 2014			% of Net Sales		Q1 2015			% of Net Sales		$ Change			% Change
Selling, general and administrative		$	42.2		20.5	%	$	44.2		20.3	%	$	2.0		5	%
Research and development		11.0			5.3	%	12.7			5.8	%	1.7			15	%
Restructuring and other charges		4.2			2.0	%	0.7			0.3	%	(3.5		)	(83	)%
Total operating expenses		$	57.4		27.8	%	$	57.6		26.4	%	$	0.2		0	%

 

Selling, general and administrative. Selling, general and administrative (SG&A) expenses consist primarily of compensation paid to sales, marketing and administrative personnel, professional service fees and marketing expenses. SG&A for the three months ended September 30, 2014 increased primarily to support our 6% revenue growth.

 

Research and development. Research and development (R&D) expenses include research related to new product development and product enhancement expenditures. R&D for the three months ended September 30, 2014 increased significantly as we invested in the next generation of products within our Security division, while R&D spending in our Healthcare and Optoelectronics and Manufacturing divisions was in line with the prior year.

 

Restructuring and other charges.  Restructuring and other charges consist of nonrecurring charges related to facility consolidation and other opportunities to become more efficient.  In addition, during the past several quarters we have incurred costs related to contracts with the U.S. federal government and professional fees associated with defending against class action and derivative lawsuits filed against the Company. Restructuring and other charges for the three months ended September 30, 2014 decreased significantly as we incurred significant charges in the prior year including: $2.0 million in our Healthcare division related to a facility relocation, $0.6 million in our Optoelectronics and Manufacturing division related to employee severance as a result of a facility consolidation and a $1.6 million charge in our Security division related to a contract settlement with the U.S. federal government. In the current year, such charges were much lower and included $0.1 million in both our Healthcare and Optoelectronics and Manufacturing divisions related to capitalizing on efficiency opportunities, and $0.4 million in our Corporate segment related to the class action and derivative lawsuits.

 

Other Income and Expenses

 

Interest and other expense, net.  For the three months ended September 30, 2014, interest and other expense, net amounted to $0.9 million as compared to $1.5 million in the comparable prior-year period.  This decrease was primarily due to decreased interest expense related to lower average outstanding borrowings under our revolving credit facility as we have generated significant levels of free cash flow over the past several quarters, and the reduction in the cost of borrowing in connection with the amended credit facility completed in May 2014.

 

Income taxes.  For the three months ended September 30, 2014, our income tax provision was $4.6 million, compared to $2.6 million for the comparable prior-year period. Our effective tax rate for the three months ended September 30, 2014 was 28.8%, compared to 29.0% in the comparable prior-year period.  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 and (v) tax holidays granted to certain of our international subsidiaries.

 

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