OSI SYSTEMS INC - Quarter Report: 2016 March (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 March 31, 2016

 

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 April 26, 2016, there were 18,895,330 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, 2015 and March 31, 2016	3
	Condensed Consolidated Statements of Operations for the three and nine months ended March 31, 2015 and 2016	4
	Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended March 31, 2015 and 2016	5
	Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2015 and 2016	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2 —	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3 —	Quantitative and Qualitative Disclosures about Market Risk	25
Item 4 —	Controls and Procedures	26
PART II — OTHER INFORMATION		27
Item 1 —	Legal Proceedings	27
Item 1A —	Risk Factors	27
Item 2 —	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3 —	Defaults Upon Senior Securities	27
Item 4 —	Mine Safety Disclosures	27
Item 5 —	Other Information	27
Item 6 —	Exhibits	28
Signatures		29

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share amounts)

 

					(Unaudited)
		June 30,			March 31,
		2015			2016
ASSETS
Current Assets:
Cash and cash equivalents		$	47,593		$	97,425
Accounts receivable, net		178,519			159,787
Inventories		230,421			291,092
Deferred taxes		44,887			43,466
Prepaid expenses and other current assets		40,101			53,057
Total current assets		541,521			644,827
Property and equipment, net		225,703			187,204
Goodwill		98,167			122,297
Intangible assets, net		50,413			58,373
Other assets		63,870			62,601
Total assets		$	979,674		$	1,075,302
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Bank lines of credit		$	—		$	125,000
Current portion of long-term debt		2,801			2,759
Accounts payable		61,932			84,655
Accrued payroll and related expenses		33,169			29,818
Advances from customers		41,389			59,918
Deferred revenue		47,787			34,796
Income taxes payable		9,610			7,595
Other accrued expenses and current liabilities		52,593			61,442
Total current liabilities		249,281			405,983
Long-term debt		8,556			6,770
Deferred income taxes		65,435			68,887
Other long-term liabilities		74,623			61,543
Total liabilities		397,895			543,183
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 — authorized, 100,000,000 shares; issued and outstanding, 19,716,507 shares at June 30, 2015 and 18,893,137 shares at March 31, 2016		279,212			212,371
Retained earnings		312,831			333,087
Accumulated other comprehensive loss		(10,264		)	(13,339		)
Total stockholders’ equity		581,779			532,119
Total liabilities and stockholders’ equity		$	979,674		$	1,075,302

 

See accompanying notes to condensed consolidated financial statements.

 

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OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(amounts in thousands, except per share data)

(Unaudited)

 

		For the Three Months Ended March 31,						For the Nine Months Ended March 31,
		2015			2016			2015			2016
Net revenues:
Products		$	155,915		$	148,730		$	503,224		$	419,398
Services		59,460			62,074			188,377			188,795
Total net revenues		215,375			210,804			691,601			608,193
Cost of goods sold:
Products		107,019			102,929			340,809			290,036
Services		35,752			37,816			114,672			112,063
Total cost of goods sold		142,771			140,745			455,481			402,099
Gross profit		72,604			70,059			236,120			206,094
Operating expenses:
Selling, general and administrative		37,970			39,233			130,046			122,767
Research and development		12,559			12,945			38,469			37,871
Impairment, restructuring and other charges		3,620			4,537			6,425			15,634
Total operating expenses		54,149			56,715			174,940			176,272
Income from operations		18,455			13,344			61,180			29,822
Interest and other expense, net		(812		)	(666		)	(2,508		)	(2,083		)
Income before income taxes		17,643			12,678			58,672			27,739
Provision for income taxes		4,415			3,335			15,954			7,483
Net income		$	13,228		$	9,343		$	42,718		$	20,256
Net income per share:
Basic		$	0.67		$	0.48		$	2.16		$	1.03
Diluted		$	0.64		$	0.47		$	2.08		$	1.00
Shares used in per share calculation:
Basic		19,801			19,336			19,810			19,604
Diluted		20,529			19,941			20,515			20,261

 

See accompanying notes to condensed consolidated financial statements.

 

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OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(amounts in thousands)

(Unaudited)

 

		For the Three Months Ended March 31,						For the Nine Months Ended March 31,
		2015			2016			2015			2016
Net income		$	13,228		$	9,343		$	42,718		$	20,256
Other comprehensive loss, net of tax:
Foreign currency translation adjustment		(3,775		)	(599		)	(8,909		)	(3,263		)
Other		109			79			309			188
Other comprehensive loss		(3,666		)	(520		)	(8,600		)	(3,075		)
Comprehensive income		$	9,562		$	8,823		$	34,118		$	17,181

 

See accompanying notes to condensed consolidated financial statements.

 

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OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(Unaudited)

 

		For the Nine Months Ended March 31,
		2015			2016
Cash flows from operating activities:
Net income		$	42,718		$	20,256
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		45,448			42,544
Stock based compensation expense		18,135			13,582
Impairment charges		—			8,741
Other		5,449			1,571
Changes in operating assets and liabilities—net of business acquisitions:
Accounts receivable		19,817			21,442
Inventories		(29,414		)	(53,974		)
Prepaid expenses and other assets		(11,003		)	(17,746		)
Accounts payable		14,212			21,813
Advances from customers		(8,871		)	(201		)
Deferred revenue		(9,797		)	(12,890		)
Other		1,002			(4,902		)
Net cash provided by operating activities		87,696			40,236
Cash flows from investing activities:
Acquisition of property and equipment		(10,113		)	(8,965		)
Acquisition of businesses, net of cash acquired		(14,687		)	(19,565		)
Acquisition of intangible and other assets		(5,335		)	(4,256		)
Net cash used in investing activities		(30,135		)	(32,786		)
Cash flows from financing activities:
Net borrowings (repayments) on bank lines of credit		(18,000		)	125,000
Proceeds from long-term debt		1,406			583
Payments on long-term debt		(2,485		)	(2,209		)
Proceeds from exercise of stock options and employee stock purchase plan		3,237			6,132
Repurchase of common shares		(23,391		)	(73,368		)
Taxes paid related to net share settlements of equity awards		(7,050		)	(13,187		)
Net cash provided by (used in) financing activities		(46,283		)	42,951
Effect of exchange rate changes on cash		(1,068		)	(569		)
Net increase in cash and cash equivalents		10,210			49,832
Cash and cash equivalents-beginning of period		38,831			47,593
Cash and cash equivalents-end of period		$	49,041		$	97,425
Supplemental disclosure of cash flow information:
Cash paid, net during the period for:
Interest		$	1,554		$	1,563
Income taxes		$	23,246		$	20,075

 

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, diagnostic cardiology, anesthesia systems and defibrillator products, 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 products and related services worldwide. These products fall into the following categories: baggage and parcel inspection; cargo and vehicle inspection, hold (checked) baggage screening, people screening, radiation detection and explosive and narcotics 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 may 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, diagnostic cardiology, anesthesia delivery and ventilation systems, defibrillator products, 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 among others. The defibrillators are also used in public facilities.

 

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 management in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded in accordance with SEC rules and regulations. Accordingly, the condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the condensed consolidated financial statements reflect all adjustments of a normal and recurring nature that are considered necessary for a fair presentation of the results for the interim 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, 2015. The results of operations for the three and nine months ended March 31, 2016 are not necessarily indicative of the operating results to be expected for the full 2016 fiscal year or any future periods.

 

Use of Estimates

 

The preparation of financial statements in conformity with 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 include, but are not limited to, revenue recognition, fair values of assets acquired and liabilities assumed in business combinations, collectability of accounts receivable, market values for inventories reported at lower of cost or market, stock-based compensation expense, income taxes, accrued product warranty costs, contingent liabilities, 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 likely differ from these estimates and could differ materially.

 

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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 or unit awards under the treasury stock method.

 

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

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2015			2016			2015			2016
Net income for diluted earnings per share calculation		$	13,228		$	9,343		$	42,718		$	20,256
Weighted average shares outstanding for basic earnings per share calculation		19,801			19,336			19,810			19,604
Dilutive effect of stock awards		728			605			705			657
Weighted average shares outstanding for diluted earnings per share calculation		20,529			19,941			20,515			20,261
Basic net income per share		$	0.67		$	0.48		$	2.16		$	1.03
Diluted net income per share		$	0.64		$	0.47		$	2.08		$	1.00
Shares excluded from computation of diluted net income per share:
Weighted average stock options excluded from computation due to anti-dilutive effect		49			70			43			39

 

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 available 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 where “Level 3” valuation techniques were used.  As further discussed in Note 8 to the condensed consolidated financial statements, the Company’s contingent payment obligations related to acquisitions are valued in accordance with “Level 3” valuation techniques.  Such obligations were measured at fair value on a recurring basis.

 

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The fair values of our financial assets and liabilities as of June 30, 2015 and March 31, 2016 are categorized as follows (in thousands):

 

		June 30, 2015												March 31, 2016
		Level 1			Level 2			Level 3			Total			Level 1			Level 2			Level 3			Total
Assets:
Equity securities		$	291		$	2,150		$	—		$	2,441		$	317		$	—		—			$	317
Insurance company contracts		—			20,100			—			20,100			—			20,651			—			20,651
Interest rate contract		—			(41		)	—			(41		)	—			(22		)	—			(22		)
Total assets		$	291		$	22,209		$	—		$	22,500		$	317		$	20,629		$	—		$	20,946
Liabilities — Contingent payment obligations		$	—		$	—		$	17,175		$	17,175		$	—		$	—		$	21,832		$	21,832

 

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, London Interbank Offered Rate (“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.

 

Property and Equipment

 

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are charged while assets are used in service and are computed using the straight-line method over the estimated useful lives of the assets taking into consideration any estimated salvage value. Amortization of leasehold improvements is calculated on the straight-line method over the shorter of the useful life of the asset or the lease term. Leased capital assets are included in property and equipment. Amortization of property and equipment under capital leases is included with depreciation expense.  In the event that property and equipment are idle, as a result of excess capacity or the early termination, non-renewal or reduction in scope of a turnkey screening operation, such assets are assessed for impairment on a periodic basis or if any indicators of impairment exist. Certain fixed assets related to the Company’s turnkey security screening program in Mexico are not currently in use.  As of March 31, 2016, the net value of these assets is approximately $15 million, which is included in property and equipment in the condensed consolidated balance sheet.

 

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. Generally, revenue from services is recognized when the services are performed.  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 revenue recognition, 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. In instances where a contract calls for multiple deliverables and such deliverables qualify as separate units of accounting, the Company may recognize revenue based on the value of the respective deliverables identified in the underlying contract.

 

In connection with the agreement with the Servicio de Administración Tributaria (“SAT”) in Mexico, revenue is recognized based upon proportional performance, measured by the actual number of labor hours incurred divided by the total estimated number of labor hours for the project. The impact of changes in the estimated labor hours to service the agreement is reflected in the period during which the change becomes known. In this agreement, customer billings may be submitted for several separate deliverables including: monthly services, activation of services, training of customer personnel and consultation on the design and location of security scanning operations, among others.  In the event that payments received from the customer exceed revenue recognition, deferred revenue is recorded.  In the event that revenue recognition exceeds payments received from the customer, unbilled receivables are recorded.

 

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Revenues from out-of-warranty service maintenance contracts are recognized ratably over the term of such contracts. 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 depending on when the Company estimates the corresponding amortization to occur.

 

Business Combinations

 

The Company allocates the fair value of purchase consideration to the tangible and intangible assets acquired, and liabilities assumed based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customers, acquired technology, and trade names, useful lives and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.

 

During the three months ended March 31, 2016, the Company acquired all of the outstanding shares of capital stock of a distributor and manufacturer of electronic components in the United Kingdom, and a distributor and manufacturer of flex circuit and touch panel design products in California. The combined purchase prices consisted of cash payments at closing of $17.5 million, holdbacks of $2.6 million for potential indemnity claims and $12.5 million for the fair value of contingent consideration.  The indemnity holdbacks are payable in fiscal 2017, if not used for indemnification claims. The combined purchase prices were allocated to the fair values of the net tangible and intangible assets.  The combined allocations of intangible assets consisted of $20.4 million of goodwill and $7.8 million of identifiable intangible assets, which was comprised of $1.2 million of technology, $5.5 million of customer relationships, $0.9 million of trademarks and trade names, and $0.2 million of non-compete covenants.

 

Recent Accounting Updates Not Yet Adopted

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update (“ASU”) 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 ASU is effective for fiscal years beginning after December 15, 2017 and for interim reporting periods within that reporting period. Earlier application is permitted only as of fiscal years beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company has not yet selected a transition method and is currently evaluating the impact this ASU may have on its financial condition and results of operations.

 

In July 2015, FASB issued an ASU amending some of the guidance on subsequent measurement of inventory. This ASU affects companies that are using first-in, first-out or average cost, or any other methods besides last-in, first out or the retail inventory method.  This ASU is effective for fiscal years beginning after December 15, 2016, including interim reporting periods within that reporting period.  The amendments in this ASU should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period.  The Company has not yet adopted this ASU and is currently evaluating the impact it may have on its financial condition and results of operations.

 

In September 2015, FASB issued an ASU simplifying measurement-period adjustments for acquisitions.  This update provides guidance on how an acquirer recognizes adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. This amendment requires the acquirer to recognize adjustments to the provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined rather than retrospectively.  This ASU is effective for fiscal years beginning after December 15, 2015, including interim periods within that reporting period.  The Company has not yet adopted this ASU and is currently evaluating the impact it may have on its financial condition and results of operations.

 

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In November 2015, FASB issued an ASU amending the classification of deferred taxes.  Deferred tax liabilities and assets will now be classified as non-current. Previously, the deferred income tax assets and liabilities had to be separated into current and non-current. The amendments in this ASU may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. If an entity applies the guidance prospectively, the entity should disclose in the first interim and first annual period of change, the nature of and reason for the change in accounting principle and a statement that prior periods were not retrospectively adjusted.  This ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within that reporting period.  Earlier application is permitted.  The Company has not yet adopted this ASU and its adoption is not expected to have a material effect on the Company’s financial statements.

 

In January 2016, FASB issued an ASU which affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. This guidance retains the current accounting for classifying and measuring investments in debt securities and loans, but requires equity investments to be measured at fair value with subsequent changes recognized in net income, except for those accounted for under the equity method or requiring consolidation. The guidance also changes the accounting for investments without a readily determinable fair value and that do not qualify for the practical expedient permitted by the guidance to estimate fair value. A policy election can be made for these investments whereby estimated fair value may be measured at cost and adjusted in subsequent periods for any impairment or changes in observable prices of identical or similar investments. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within that reporting period. Early application is permitted. The Company has not yet adopted this ASU and is currently evaluating the impact it may have on its financial condition and results of operations.

 

In February 2016, the FASB issued an ASU which affects the accounting for leases. The guidance requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. The amendment also will require qualitative and quantitative disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. This ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within that reporting period. Early application is 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.

 

In April and March 2016, the FASB issued an ASU clarifying the implementation guidance on licensing and the identification of performance obligations considerations, and the implementation guidance on principal versus agent considerations. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within that reporting period, with early adoption permitted as of the original effective date. The Company has not yet adopted this ASU and is currently evaluating the impact it may have on its financial condition and results of operations.

 

In March 2016, the FASB issued an ASU relating to employee share-based payment accounting. This guidance simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within that reporting period. The Company has not yet adopted this ASU and is currently evaluating the impact it may have on its financial condition and results of operations.

 

2. Balance Sheet Details

 

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

 

		June 30, 2015			March 31, 2016
Accounts receivable		$	184,419		$	165,406
Less allowance for doubtful accounts		(5,900		)	(5,619		)
Total		$	178,519		$	159,787

 

		June 30, 2015			March 31, 2016
Raw materials		$	131,373		$	139,631
Work-in-process		45,386			46,749
Finished goods		53,662			104,712
Total		$	230,421		$	291,092

 

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		Estimated
		Useful		June 30,			March 31,
		Lives		2015			2016
Land		N/A		$	14,419		$	14,498
Buildings, civil works and improvements		5 - 40 years		170,373			169,259
Leasehold improvements		1 - 20 years		9,991			9,086
Equipment and tooling		3 - 10 years		152,518			149,304
Furniture and fixtures		3 - 13 years		3,475			3,360
Computer equipment		1 - 5 years		17,147			18,381
Computer software		3 - 10 years		16,612			16,439
Construction in process		N/A		6,365			5,233
Total				390,900			385,560
Less accumulated depreciation and amortization				(165,197		)	(198,356		)
Property and equipment, net				$	225,703		$	187,204

 

Depreciation expense was approximately $12.5 million and $13.1 million for the three months ended March 31, 2015 and 2016, respectively, and approximately $42.7 million and $39.1 million for the nine months ended March 31, 2015 and 2016, respectively.

 

3. Goodwill and Intangible Assets

 

The changes in the carrying value of goodwill for the nine-month period ended March 31, 2016 were as follows (in thousands):

 

		Security			Healthcare			Optoelectronics and Manufacturing			Consolidated
Balance as of June 30, 2015		$	29,730		$	43,182		$	25,255		$	98,167
Goodwill acquired or adjusted during the period		1,634			—			23,554			25,188
Foreign currency translation adjustment		14			(312		)	(760		)	(1,058		)
Balance as of March 31, 2016		$	31,378		$	42,870		$	48,049		$	122,297

 

Intangible assets as of June 30, 2015 and March 31, 2016 were as follows (in thousands):

 

				June 30, 2015									March 31, 2016
		Weighted Average Lives		Gross Carrying Value			Accumulated Amortization			Intangibles Net			Gross Carrying Value			Accumulated Amortization			Intangibles Net
Amortizable assets:
Software development costs		7 years		$	24,631		$	7,500		$	17,131		$	21,522		$	3,330		$	18,192
Patents		17 years		7,206			994			6,212			8,033			1,191			6,842
Developed technology		11 years		13,397			4,528			8,869			15,449			5,537			9,912
Customer relationships/backlog		7 years		8,619			3,406			5,213			13,945			4,395			9,550
Total amortizable assets				53,853			16,428			37,425			58,949			14,453			44,496
Non-amortizable assets:
Trademarks				12,988			—			12,988			13,877			—			13,877
Total intangible assets				$	66,841		$	16,428		$	50,413		$	72,826		$	14,453		$	58,373

 

Amortization expense related to intangible assets was $0.8 million and $1.4 million for the three month periods ended March 31, 2015 and 2016, respectively. For the nine months ended March 31, 2015 and 2016, amortization expense was $2.7 million and $3.4 million, respectively. At March 31, 2016, the estimated future amortization expense was as follows (in thousands):

 

Fiscal Years
2016 (remaining 3 months)		$	2,271
2017		7,792
2018		7,711
2019		6,282
2020		6,254
2021		3,717
2022 and thereafter (including assets that have not yet begun to be amortized)		10,469
Total		$	44,496

 

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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, software development costs are amortized on a straight-line basis over the remaining estimated economic life of the product. For the three months ended March 31, 2015 and 2016, the Company capitalized software development costs in the amount of $0.9 million and $0.7 million, respectively.  For the nine-month periods ended March 31, 2015 and 2016, the Company capitalized software development costs in the amount of $2.2 million and $2.1 million, respectively.

 

4. Borrowings

 

The Company has a $450 million revolving credit facility maturing May 2019.  The credit facility includes 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 LIBOR plus a margin of 1.25% as of March 31, 2016.  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.  The unused portion of the facility bears a commitment fee of 0.20% as of March 31, 2016 but this 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 certain of the Company’s U.S.-based subsidiaries and are secured by substantially all of the assets of the Company and certain subsidiaries. The agreement contains various representations and warranties, affirmative, negative and financial covenants, and conditions of default customary for financing agreements of this type. As of March 31, 2016, there was $125.0 million outstanding under the revolving credit facility and $6.1 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 U.S. dollars, to meet short-term working capital requirements and for the issuance of letters-of-credit. As of March 31, 2016, $34.2 million was outstanding under these letter-of-credit facilities, while no debt was outstanding. As of March 31, 2016, the total amount available under these credit facilities was $20.1 million, with a total cash borrowing sub-limit of $1.4 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, 2015			March 31, 2016
Term loans		$	8,935		$	7,406
Other long-term debt		2,422			2,123
		11,357			9,529
Less current portion of long-term debt		2,801			2,759
Long-term portion of debt		$	8,556		$	6,770

 

5. Impairment, restructuring and other charges

 

During the nine months ended March 31, 2016, the Company determined that certain fixed assets will not be used and are permanently impaired.  The Company also determined that it is more likely than not that a minority interest investment will not be recovered and that it is appropriate to impair the asset.

 

In addition, the Company accounts for certain nonrecurring charges related to restructuring activities, litigation or other charges as Impairment, restructuring and other charges in the condensed consolidated financial statements.

 

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

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2015			2016			2015			2016
Impairment of fixed assets		$	—		$	—		$	—		$	5,888
Impairment of minority interest investment		—			—			—			2,853
Total impairment charges		—			—			—			8,741
Employee termination costs		1,606			2,158			1,930			2,700
Charges related to government contract issues		1,848			496			3,614			496
Charges related to class action litigation		—			—			625			—
Legal settlement and related costs		—			125			—			1,843
Acquisition costs		—			1,438			—			1,438
Other		166			320			256			416
Total impairment, restructuring and other charges		$	3,620		$	4,537		$	6,425		$	15,634

 

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As of both June 30, 2015 and March 31, 2016, accrued restructuring and other charges were $3.4 million, and are included in Other accrued expenses in the condensed consolidated balance sheets.

 

6. Stockholders’ Equity

 

The Company has an active common stock repurchase program. During the nine-month period ended March 31, 2016, the Company repurchased 1,201,402 shares for $73.4 million under this program. During the nine-month period ended March 31, 2015, the Company repurchased 116,431 shares for $23.4 million under this program. At March 31, 2016, the Company had authorization from the Board of Directors to repurchase up to approximately 63,000 more shares. In April 2016, the Board of Directors authorized a new common stock repurchase program for the repurchase of an additional 1 million shares.

 

As of March 31, 2016, 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”). The Company no longer makes 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 March 31,						Nine Months Ended March 31,
		2015			2016			2015			2016
Cost of goods sold		$	278		$	302		$	773		$	899
Selling, general and administrative		5,718			4,456			17,206			12,475
Research and development		61			70			156			208
Stock-based compensation expense before taxes		$	6,057		$	4,828		$	18,135		$	13,582
Less: related income tax benefit		(2,344		)	(1,850		)	(7,105		)	(5,184		)
Stock-based compensation expense, net of estimated taxes		$	3,713		$	2,978		$	11,030		$	8,398

 

As of March 31, 2016, total unrecognized compensation cost related to share-based compensation grants were estimated at $0.9 million for stock options and $16.6 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 1.8 years.

 

The following summarizes stock option activity during the nine months ended March 31, 2016:

 

		Number of Options		Weighted- Average Exercise Price			Weighted-Average Remaining Contractual Term		Aggregate Intrinsic Value (in thousands)
Outstanding at June 30, 2015		1,012,650		$	27.30
Granted		33,088		$	74.48
Exercised		(106,974	)	$	28.03
Expired or forfeited		(5,347	)	$	65.21
Outstanding at March 31, 2016		933,417		$	28.67		4.2 years		$	34,753
Exercisable at March 31, 2016		858,961		$	25.31		3.9 years		$	34,545

 

The following summarizes restricted stock and RSU award activity during the nine months ended March 31, 2016:

 

		Shares		Weighted- Average Fair Value
Nonvested at June 30, 2015		659,906		$	63.75
Granted		332,701		73.12
Vested		(389,617	)	65.24
Forfeited		(48,312	)	67.66
Nonvested at March 31, 2016		554,678		$	67.99

 

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As of March 31, 2016, there were 2,792,149 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 award 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 award forfeited.

 

The Company granted 151,469 and 139,300 performance-based RSUs during the nine months ended March 31, 2015 and 2016, respectively. These performance-based RSUs 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.

 

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 March 31,						Nine Months Ended March 31,
		2015			2016			2015			2016
Service cost		$	249		$	213		$	779		$	638
Amortization of prior service cost		202			105			606			315
Net periodic pension expense		$	451		$	318		$	1,385		$	953

 

For each of the three months ended March 31, 2015 and 2016, there were no contributions made to these defined benefit plans. For the nine months ended March 31, 2015 and 2016, the Company made contributions of $1.0 million and $0.2 million, respectively, to these defined benefit plans.

 

In addition, the Company maintains various defined contribution plans. For each of the three months ended March 31, 2015 and 2016, the Company made contributions of $1.1 million to these defined contribution plans. For the nine months ended March 31, 2015 and 2016, the Company made contributions of $3.3 million and $3.4 million, respectively, to these plans.

 

8. 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 of certain sales or profitability milestones with respect to such acquired businesses. The maximum amount of such future payments under arrangements where contingent consideration is capped was $34 million as of March 31, 2016. In addition, one of the purchase agreements entered into by the Company requires payments to be made 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, 2015 and March 31, 2016, $17.2 million and $21.8 million, respectively, of contingent payment obligations were included in other liabilities in the condensed consolidated balance sheets. During the nine months ended March 31, 2016, additional contingent consideration of $12.5 million was recorded as a result of two acquisitions completed during the period, $0.8 million of contingent consideration was paid, and the liability was reduced by $7.1 million due to revaluation.

 

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 that is scheduled to become fully amortized by the end of fiscal 2017.  As of March 31, 2016, $31.3 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 investigation, 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.

 

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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, having occurred prior to the Company’s occupancy. Further, the groundwater contamination is a known regional issue, not limited to the Company’s premises or its immediate surroundings. The Company has filed all requisite reports with the appropriate environmental authorities and continues to cooperate with the local governing agency to develop a complete and accurate characterization of this site. Recent activities include the installation of groundwater monitoring wells, indoor air quality monitoring and additional soil and soil vapor studies. Results from these studies are being evaluated to determine the extent of the on-site releases as well as appropriate and cost-effective remedial action measures. Periodic groundwater monitoring is expected to continue until such time as the governing authority requests further action.

 

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 these environmental matters are resolved in a manner adverse to the Company, the impact on the Company’s business, financial condition, results of operations and cash flow 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 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 contingent indemnification obligations as of March 31, 2016.

 

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):

 

		Nine Months Ended March 31,
		2015			2016
Balance at beginning of period		$	11,923		$	12,738
Additions and adjustments		3,314			8,596
Reductions for warranty repair costs		(3,047		)	(7,361		)
Balance at end of period		$	12,190		$	13,973

 

Legal Proceedings

 

Three shareholder derivative complaints (the “Derivative Actions”) have been filed purportedly on behalf of the Company against the members of the Company’s Board of Directors (as individual defendants).  Hagan v. Chopra et al. was filed in the United States District Court for the Central District of California (the “Court”) on April 15, 2014, and was subsequently consolidated by the Court with City of Irving Benefit Plan v. Chopra et al., which was filed on December 29, 2014.  Kocen v. Chopra et al. was filed in the Delaware Court of Chancery on July 14, 2015.  The Derivative Actions generally assert claims for breach of fiduciary duties and unjust enrichment against the individual defendants on behalf of the Company. Plaintiffs in the Derivative Actions seek unspecified damages, restitution, injunctive relief, attorneys’ and experts’ fees, costs, expenses, and other unspecified relief.  While the Company

 

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