OSI Systems, Inc.
OSI SYSTEMS INC (Form: 10-Q, Received: 01/30/2014 13:52:37)

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

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

 

For the quarterly period ended December 31, 2013

 

OR

 

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

 

For the transition period from              to             

 

Commission File Number 000-23125

 


 

OSI SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

33-0238801

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

12525 Chadron Avenue

Hawthorne, California 90250

(Address of principal executive offices) (Zip Code)

 

(310) 978-0516

(Registrant’s telephone number, including area code)

 

N/A

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

 


 

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

 

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

 

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

 

Large accelerated filer  x

 

Accelerated filer  o

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  o

(Do not check if a smaller reporting company)

 

 

 

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

 

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

 

 

 



Table of Contents

 

OSI SYSTEMS, INC.

 

INDEX

 

 

PAGE

 

 

PART I — FINANCIAL INFORMATION

3

 

 

 

Item 1 —

Condensed Consolidated Financial Statements

3

 

 

Condensed Consolidated Balance Sheets at June 30, 2013 and December 31, 2013

3

 

 

Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2012 and 2013

4

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended December 31, 2012 and 2013

5

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2012 and 2013

6

 

 

Notes to Condensed Consolidated Financial Statements

7

 

Item 2 —

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17

 

Item 3 —

Quantitative and Qualitative Disclosures about Market Risk

24

 

Item 4 —

Controls and Procedures

25

 

 

PART II — OTHER INFORMATION

25

 

Item 1 —

Legal Proceedings

25

 

Item 1A —

Risk Factors

25

 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

25

 

Item 3

Defaults Upon Senior Securities

25

 

Item 4

Mine Safety Disclosures

26

 

Item 5

Other Information

26

 

Item 6 —

Exhibits

26

Signatures

27

 

2



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

(Unaudited)

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2013

 

ASSETS

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

34,697

 

$

39,899

 

Accounts receivable, net

 

206,817

 

164,006

 

Inventories

 

206,213

 

219,998

 

Prepaid expenses and other current assets

 

78,972

 

82,246

 

Total current assets

 

526,699

 

506,149

 

Property and equipment, net

 

249,029

 

271,468

 

Goodwill

 

83,743

 

92,046

 

Intangible assets, net

 

36,603

 

40,013

 

Other assets

 

23,722

 

25,594

 

Total assets

 

$

919,796

 

$

935,270

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Bank lines of credit

 

$

59,000

 

$

60,000

 

Current portion of long-term debt

 

1,797

 

2,971

 

Accounts payable

 

97,050

 

67,720

 

Accrued payroll and related expenses

 

28,503

 

28,289

 

Advances from customers

 

37,432

 

39,289

 

Accrued warranties

 

12,890

 

13,269

 

Deferred revenue

 

18,131

 

46,539

 

Other accrued expenses and current liabilities

 

26,610

 

28,206

 

Total current liabilities

 

281,413

 

286,283

 

Long-term debt

 

10,673

 

11,724

 

Advances from customers

 

75,000

 

62,500

 

Other long-term liabilities

 

74,259

 

81,507

 

Total liabilities

 

441,345

 

442,014

 

Commitments and contingencies (Note 8)

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

Preferred stock, $0.001 par value, 10,000,000 shares authorized; no shares issued or outstanding

 

 

 

Common stock, $0.001 par value, 100,000,000 shares authorized; 19,914,089 issued and outstanding at June 30, 2013 and 19,932,946 shares at December 31, 2013

 

285,001

 

276,938

 

Retained earnings

 

199,786

 

220,753

 

Accumulated other comprehensive loss

 

(6,336

)

(4,435

)

Total stockholders’ equity

 

478,451

 

493,256

 

Total liabilities and stockholders’ equity

 

$

919,796

 

$

935,270

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

 

 

For the Three Months Ended
December 31,

 

For the Six Months Ended
December 31,

 

 

 

2012

 

2013

 

2012

 

2013

 

Net revenues:

 

 

 

 

 

 

 

 

 

Products

 

$

145,086

 

$

173,974

 

$

293,950

 

$

317,450

 

Services

 

48,963

 

62,434

 

81,793

 

125,232

 

Total net revenues

 

194,049

 

236,408

 

375,743

 

442,682

 

Cost of goods sold:

 

 

 

 

 

 

 

 

 

Products

 

93,900

 

118,781

 

192,832

 

222,374

 

Services

 

30,061

 

36,688

 

51,468

 

71,423

 

Total cost of goods sold

 

123,961

 

155,469

 

244,300

 

293,797

 

Gross profit

 

70,088

 

80,939

 

131,443

 

148,885

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

36,829

 

45,556

 

76,754

 

87,770

 

Research and development

 

11,858

 

11,175

 

23,174

 

22,195

 

Impairment, restructuring and other charges

 

2,723

 

2,179

 

2,723

 

6,418

 

Total operating expenses

 

51,410

 

58,910

 

102,651

 

116,383

 

Income from operations

 

18,678

 

22,029

 

28,792

 

32,502

 

Interest and other expense, net

 

1,385

 

1,503

 

2,482

 

2,973

 

Income before income taxes

 

17,293

 

20,526

 

26,310

 

29,529

 

Provision for income taxes

 

4,872

 

5,953

 

7,550

 

8,562

 

Net income

 

$

12,421

 

$

14,573

 

$

18,760

 

$

20,967

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.62

 

$

0.73

 

$

0.94

 

$

1.05

 

Diluted

 

$

0.60

 

$

0.71

 

$

0.91

 

$

1.02

 

Shares used in per share calculation:

 

 

 

 

 

 

 

 

 

Basic

 

19,999

 

19,961

 

19,952

 

19,966

 

Diluted

 

20,609

 

20,589

 

20,589

 

20,604

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(amounts in thousands)

(Unaudited)

 

 

 

For the Three Months Ended
December 31,

 

For the Six Months Ended
December 31,

 

 

 

2012

 

2013

 

2012

 

2013

 

Net income

 

$

12,421

 

$

14,573

 

$

18,760

 

$

20,967

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(571

)

471

 

4,739

 

1,779

 

Other

 

114

 

30

 

(339

)

122

 

Other comprehensive income (loss)

 

(457

)

501

 

4,400

 

1,901

 

Comprehensive income

 

$

11,964

 

$

15,074

 

$

23,160

 

$

22,868

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(Unaudited)

 

 

 

For the Six Months Ended
December 31,

 

 

 

2012

 

2013

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

18,760

 

$

20,967

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

10,809

 

26,417

 

Stock based compensation expense

 

7,147

 

10,721

 

Provision for losses on accounts receivable

 

445

 

977

 

Deferred income taxes

 

212

 

(62

)

Other

 

182

 

101

 

Changes in operating assets and liabilities —net of business acquisitions :

 

 

 

 

 

Accounts receivable

 

17,663

 

46,781

 

Inventories

 

(6,985

)

(8,768

)

Prepaid expenses and other assets

 

11,373

 

(5,649

)

Accounts payable

 

37,876

 

(32,798

)

Accrued payroll and related expenses

 

(4,874

)

(464

)

Advances from customers

 

(13,900

)

(10,648

)

Accrued warranties

 

(2,728

)

(5

)

Deferred revenue

 

(3,567

)

27,542

 

Other accrued expenses and liabilities

 

(9,597

)

(139

)

Net cash provided by operating activities

 

62,816

 

74,973

 

Cash flows from investing activities:

 

 

 

 

 

Acquisition of property and equipment

 

(117,616

)

(41,702

)

Acquisition of businesses

 

(5,787

)

(10,087

)

Acquisition of intangible and other assets

 

(2,039

)

(2,467

)

Net cash used in investing activities

 

(125,442

)

(54,256

)

Cash flows from financing activities:

 

 

 

 

 

Net borrowings on bank lines of credit

 

15,000

 

1,000

 

Proceeds from long-term debt

 

11,100

 

2,841

 

Payments on long-term debt

 

(375

)

(1,562

)

Proceeds from exercise of stock options and employee stock purchase plan

 

2,974

 

1,501

 

Repurchase of common shares

 

(9,928

)

(12,056

)

Taxes paid related to net share settlements of equity awards

 

(2,397

)

(8,230

)

Net cash provided by (used in) financing activities

 

16,374

 

(16,506

)

Effect of exchange rate changes on cash

 

1,650

 

991

 

Net increase (decrease) in cash and cash equivalents

 

(44,602

)

5,202

 

Cash and cash equivalents-beginning of period

 

91,452

 

34,697

 

Cash and cash equivalents-end of period

 

$

46,850

 

$

39,899

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid, net during the period for:

 

 

 

 

 

Interest

 

$

1,858

 

$

2,878

 

Income taxes

 

$

5,615

 

$

8,716

 

 

See accompanying notes to condensed consolidated financial statements.

 

6



Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of Presentation

 

Description of Business

 

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

 

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

 

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

 

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

 

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

 

Basis of Presentation

 

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

 

Per Share Computations

 

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

 

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Table of Contents

 

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2012

 

2013

 

2012

 

2013

 

Net income available to common stockholders

 

$

12,421

 

$

14,573

 

$

18,760

 

$

20,967

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding for basic earnings per share calculation

 

19,999

 

19,961

 

19,952

 

19,966

 

Dilutive effect of stock awards

 

610

 

628

 

637

 

638

 

Weighted average shares outstanding for diluted earnings per share calculation

 

20,609

 

20,589

 

20,589

 

20,604

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share

 

$

0.62

 

$

0.73

 

$

0.94

 

$

1.05

 

Diluted net income per share

 

$

0.60

 

$

0.71

 

$

0.91

 

$

1.02

 

 

Cash Equivalents

 

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

 

Fair Value of Financial Instruments

 

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

 

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

 

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

 

 

 

Level 1

 

Level 2

 

June 30,
2013

 

Level 1

 

Level 2

 

December 31,
2013

 

Equity securities

 

316

 

 

316

 

215

 

 

215

 

Insurance company contracts

 

 

13,914

 

13,914

 

 

16,483

 

16,483

 

Interest rate contract

 

 

66

 

66

 

 

62

 

62

 

Total

 

$

316

 

$

13,980

 

$

14,296

 

$

215

 

$

16,545

 

$

16,760

 

 

Derivative Instruments and Hedging Activity

 

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

 

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Table of Contents

 

Revenue Recognition

 

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

 

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

 

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

 

Business Combinations

 

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

 

2. Balance Sheet Details

 

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

 

 

 

June 30,
2013

 

December 31,
2013

 

Accounts receivable

 

 

 

 

 

Billed receivables

 

$

179,458

 

$

169,446

 

Unbilled receivables

 

34,636

 

1,493

 

Less allowance for doubtful accounts

 

(7,277

)

(6,933

)

Total

 

$

206,817

 

$

164,006

 

 

Unbilled receivables included earned but unbilled revenue.

 

 

 

June 30,
2013

 

December 31,
2013

 

Inventories, net

 

 

 

 

 

Raw materials

 

$

117,416

 

$

116,943

 

Work-in-process

 

37,337

 

41,391

 

Finished goods

 

51,460

 

61,664

 

Total

 

$

206,213

 

$

219,998

 

 

 

 

June 30,
2013

 

December 31,
2013

 

Property and equipment

 

 

 

 

 

Land

 

$

8,365

 

$

13,651

 

Buildings and improvements

 

102,187

 

161,109

 

Leasehold improvements

 

9,302

 

10,310

 

Equipment and tooling

 

135,437

 

151,869

 

Furniture and fixtures

 

3,551

 

3,937

 

Computer equipment

 

14,309

 

16,535

 

Computer software

 

15,209

 

15,521

 

Construction in process

 

48,713

 

10,585

 

Total

 

337,073

 

383,517

 

Less: accumulated depreciation and amortization

 

(88,044

)

(112,049

)

Property and equipment, net

 

$

249,029

 

$

271,468

 

 

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

 

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

 

3. Goodwill and Intangible Assets

 

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

 

 

 

Security

 

Healthcare

 

Optoelectronics
and
Manufacturing

 

Consolidated

 

Balance as of June 30, 2013

 

$

28,546

 

$

35,827

 

$

19,370

 

$

83,743

 

Goodwill acquired or adjusted during the period

 

784

 

1,018

 

5,481

 

7,283

 

Foreign currency translation adjustment

 

214

 

271

 

535

 

1,020

 

Balance as of December 31, 2013

 

$

29,544

 

$

37,116

 

$

25,386

 

$

92,046

 

 

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

June 30, 2013

 

December 31, 2013

 

 

 

Weighted
Average
Lives

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Intangibles
Net

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Intangibles
Net

 

Amortizable assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Software development costs

 

7 years

 

$

17,350

 

$

5,396

 

$

11,954

 

$

19,106

 

$

6,293

 

$

12,813

 

Patents

 

13 years

 

5,400

 

635

 

4,765

 

6,060

 

699

 

5,361

 

Core technology

 

10 years

 

2,058

 

1,728

 

330

 

2,218

 

1,973

 

245

 

Developed technology

 

10 years

 

20,002

 

14,620

 

5,382

 

15,611

 

11,003

 

4,608

 

Customer relationships/ backlog

 

8 years

 

9,178

 

5,624

 

3,554

 

11,355

 

6,354

 

5,001

 

Total amortizable assets

 

 

 

53,988

 

28,003

 

25,985

 

54,350

 

26,322

 

28,028

 

Non-amortizable assets - Trademarks

 

 

 

10,618

 

 

10,618

 

11,985

 

 

11,985

 

Total intangible assets

 

 

 

$

64,606

 

$

28,003

 

$

36,603

 

$

66,335

 

$

26,322

 

$

40,013

 

 

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

 

Fiscal Years

 

 

 

2014 (remaining 6 months)

 

$

1,914

 

2015

 

3,097

 

2016

 

3,222

 

2017

 

3,134

 

2018

 

3,025

 

2019

 

2,924

 

2020 and thereafter, including assets that have not yet begun to be amortized

 

10,712

 

Total

 

$

28,028

 

 

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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 greater of (i) the amount computed using the ratio that current gross revenues for a product bear to the total current and anticipated future gross revenues for that product and (ii) the straight line method over the remaining estimated economic life of the product. Amortizable assets that have not yet begun to be amortized are included in thereafter in the table above. The Company capitalized software development costs in the amount of $1.8 million for both the six months ended December 31, 2012 and 2013, respectively, and $0.5 million for each of the three months ended December 31, 2012 and 2013.

 

4. Borrowings

 

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

 

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

 

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

 

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

 

 

 

June 30,
2013

 

December 31,
2013

 

Term loans

 

$

12,470

 

$

11,751

 

Other long-term debt

 

 

2,944

 

 

 

12,470

 

14,695

 

Less current portion of long-term debt

 

1,797

 

2,971

 

Long-term portion of debt

 

$

10,673

 

$

11,724

 

 

5.  Impairment, restructuring and Other Charges

 

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

 

 

 

Security
Division

 

Healthcare
Division

 

Optoelectronics
and
Manufacturing
Division

 

Corporate

 

Consolidated

 

Accrued balance as of June 30, 2013

 

$

1,043

 

$

1,639

 

$

66

 

 

$

2,748

 

Expensed during the period:

 

 

 

 

 

 

 

 

 

 

 

Facility closures (1)

 

 

2,009

 

625

 

 

2,634

 

Employee termination costs (2)

 

780

 

 

486

 

 

1,266

 

Charges related to contract issues with the TSA (3)

 

2,518

 

 

 

 

2,518

 

Total expensed during the period

 

3,298

 

2,009

 

1,111

 

 

6,418

 

Paid during the period

 

2,921

 

1,496

 

684

 

 

5,101

 

Accrued balance as of December 31, 2013

 

$

1,420

 

$

2,152

 

$

493

 

 

$

4,065

 

 


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

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

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

 

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6. Stock-based Compensation

 

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

 

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2012

 

2013

 

2012

 

2013

 

Cost of goods sold

 

$

129

 

$

255

 

$

267

 

$

525

 

Selling, general and administrative

 

3,431

 

4,770

 

6,764

 

10,072

 

Research and development

 

54

 

58

 

116

 

124

 

Stock-based compensation expense before taxes

 

$

3,614

 

$

5,083

 

7,147

 

$

10,721

 

Less: related income tax benefit

 

1,372

 

1,963

 

2,209

 

4,138

 

Stock-based compensation expense, net of estimated taxes

 

$

2,242

 

$

3,120

 

$

4,938

 

$

6,583

 

 

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

 

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

 

 

 

Number of
Options

 

Weighted-
Average
Exercise
Price

 

Weighted-Average
Remaining Contractual
Term

 

Aggregate
Intrinsic Value
(in thousands)

 

Outstanding at June 30, 2013

 

1,019,733

 

$

26.33

 

 

 

 

 

Granted

 

10,294

 

$

70.59

 

 

 

 

 

Exercised

 

(1,169

)

$

39.97

 

 

 

 

 

Expired or forfeited

 

(1,917

)

$

53.89

 

 

 

 

 

Outstanding at December 31, 2013

 

1,026,941

 

$

26.70

 

6.1 years

 

$

27,410

 

Exercisable at December 31, 2013

 

835,329

 

$

22.19

 

5.5 years

 

$

25,825

 

 

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

 

 

 

Shares

 

Weighted-
Average
Fair Value

 

Nonvested at June 30, 2013

 

627,124

 

$

43.19

 

Granted

 

322,275

 

63.73

 

Vested

 

(267,402

)

38.70

 

Forfeited

 

(2,192

)

49.82

 

Nonvested at December 31, 2013

 

679,805

 

$

54.68

 

 

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

 

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

 

7. Retirement Benefit Plans

 

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2012

 

2013

 

2012

 

2013

 

Service cost

 

$

306

 

$

309

 

$

584

 

$

602

 

Amortization of prior service cost

 

230

 

202

 

460

 

404

 

Net periodic pension expense

 

$

536

 

$

511

 

$

1,044

 

$

1,006

 

 

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

 

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

 

8. Commitments and Contingencies

 

Legal Proceedings

 

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

 

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

 

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Contingent Acquisition Obligations

 

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

 

Advances from Customers

 

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

 

Environmental Contingencies

 

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

 

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

 

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

 

Indemnifications

 

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

 

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Table of Contents

 

Other Matters

 

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

 

Product Warranties

 

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

 

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2012

 

2013

 

2012

 

2013

 

Balance at beginning of period

 

$

16,919

 

$

13,359

 

$

17,562

 

$

12,890

 

Additions and adjustments

 

58

 

869

 

690

 

2,536

 

Reductions for warranty repair costs

 

(1,965

)

(959

)

(3,240

)

(2,157

)

Balance at end of period

 

$

15,012

 

$

13,269

 

15,012

 

$

13,269

 

 

9. Income Taxes

 

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

 

10. Segment Information

 

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

 

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2012

 

2013

 

2012

 

2013

 

Revenues — by Segment:

 

 

 

 

 

 

 

 

 

Security division

 

$

91,863

 

$

106,588

 

$

174,779

 

$

203,741

 

Healthcare division

 

56,114

 

63,106

 

107,695

 

108,893

 

Optoelectronics and Manufacturing division, including intersegment revenues

 

57,277

 

76,358

 

114,424

 

147,669

 

Intersegment revenues elimination

 

(11,205

)

(9,644

)

(21,155

)

(17,621

)

Total

 

$

194,049

 

$

236,408

 

$

375,743

 

$

442,682

 

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2012

 

2013

 

2012

 

2013

 

Operating income (loss) — by Segment:

 

 

 

 

 

 

 

 

 

Security division

 

$

8,607

 

$

15,149

 

$

13,072

 

$

26,771

 

Healthcare division

 

6,915

 

9,226

 

10,796

 

7,228

 

Optoelectronics and Manufacturing division

 

5,457

 

2,121

 

10,290

 

6,886

 

Corporate

 

(2,438

)

(4,355

)

(5,687

)

(8,400

)

Eliminations (1)

 

137

 

(112

)

321

 

17

 

Total

 

$

18,678

 

$

22,029

 

$

28,792

 

$

32,502

 

 

 

 

June 30,
2013

 

December 31,
2013

 

Assets — by Segment:

 

 

 

 

 

Security division

 

$

499,539

 

$

496,534

 

Healthcare division

 

190,963

 

180,317

 

Optoelectronics and Manufacturing division

 

158,584

 

179,285

 

Corporate

 

75,496

 

83,903

 

Eliminations (1)

 

(4,786

)

(4,769

)

Total

 

$

919,796

 

$

935,270

 

 


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

 

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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. together with its wholly-owned subsidiaries.

 

This management’s discussion and analysis of financial condition as of December 31, 2013 and results of operations for the six-months ended December 31, 2012 and 2013 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, 2013.

 

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 be exposed to a variety of negative consequences as a result of one or more enforcement actions in respect of the matters that are the subject of some or all of the Company’s ongoing investigations and compliance review, including contract and regulatory compliance matters with the U.S. Government, and such actions, if brought, may result in judgments, settlements, fines,  injunctions, debarment and/or penalties, 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.

 

17



Table of Contents

 

Executive Summary

 

We are a vertically integrated designer and manufacturer of specialized electronic systems and components for critical applications, and provider of screening services.  We sell our products and provide related services in diversified markets, including homeland security, healthcare, defense and aerospace. We have three operating divisions: (i) Security, (ii) Healthcare and (iii) Optoelectronics and Manufacturing.

 

Security Division. Through our Security division, we design, manufacture and market security inspection systems worldwide for sale primarily to U.S. and foreign government agencies, and provide turnkey security screening solutions. These products and services are used to inspect baggage, cargo, vehicles and other objects for weapons, explosives, drugs and other contraband as well as to screen people. Revenues from our Security division accounted for 47% and 46% of our total consolidated revenues for the six months ended December 31, 2012 and 2013, 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. 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 the U.S. federal government and other foreign 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, diagnostic cardiology and anesthesia delivery and ventilation systems 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 29% and 25% of our total consolidated revenues for the six months ended December 31, 2012 and 2013, respectively.

 

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 potential impact of the recent shutdown of the U.S. federal government in October 2013 and 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, economic pressures, and negative media reports.  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, we anticipate lower sales of patient monitoring, diagnostic cardiology and anesthesia systems than what we have historically experienced, which may negatively impact our sales. 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.

 

Optoelectronics and Manufacturing Division. Through our Optoelectronics and Manufacturing division, we design, manufacture and market optoelectronic devices and provide electronics manufacturing services worldwide 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, automotive diagnostic systems, gaming systems and consumer products. We also provide our optoelectronic devices and value-added manufacturing services to our own Security and Healthcare divisions. External revenues from our Optoelectronics and Manufacturing division accounted for 24% and 29% of our total consolidated revenues for the six months ended December 31, 2012 and 2013, respectively.

 

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Table of Contents

 

During the six months ended December 31, 2013, our Optoelectronics and Manufacturing division completed two acquisitions relating to our contract manufacturing services business and allowed us to expand our customer base and geographic footprint, while leveraging our existing infrastructure.  These acquisitions were considered to be immaterial individually and in the aggregate.

 

Results of Operations for the Three Months Ended December 31, 2012 (Q2 2013) Compared to Three Months Ended December 31, 2013 (Q2 2014) (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 10 to the condensed consolidated financial statements for additional information about our business segments.

 

 

 

Q2
2013

 

% of
Net Sales

 

Q2
2014

 

% of
Net Sales

 

$ Change

 

% Change

 

Security division

 

$

91.8

 

47

%

$

106.6

 

45

%

$

14.8

 

16

%

Healthcare division

 

56.1

 

29

%

63.1

 

27

%

7.0

 

12

%

Optoelectronics and Manufacturing division

 

57.3

 

30

%

76.4

 

32

%

19.1

 

33

%

Less: inter-division sales

 

(11.2

)

(6

)%

(9.7

)

(4

)%

1.5

 

13

%

Total revenues

 

$

194.0

 

100

%

$

236.4

 

100

%

$

42.4

 

22

%

 

Revenues for the Security division for the three months ended December 31, 2013 increased $14.8 million, or 16%, to $106.6 million, from $91.8 million for the comparable prior-year period. The increase was primarily attributable to increases in revenue from our turnkey screening services in Mexico and sales of cargo equipment.

 

Revenues for the Healthcare division for the three months ended December 31, 2013 increased $7.0 million, or 12%, to $63.1 million, from $56.1 million for the comparable prior-year period. The increase was primarily attributable to a $7.1 million, or 16%, increase in patient monitoring revenues primarily in North America and Europe.

 

Revenues for the Optoelectronics and Manufacturing division for the three months ended December 31, 2013 increased $19.1 million, or 33%, to $76.4 million, from $57.3 million for the comparable prior-year period. Excluding the impact of $5.6 million of revenue attributable to acquired businesses over the last twelve months, the growth was 24%.  This change was primarily attributable to increases in contract manufacturing sales to our customers in the consumer products business.  The Optoelectronics and Manufacturing division recorded intersegment sales of $9.7 million, compared to $11.2 million in the comparable prior-year period.  Such intersegment sales are eliminated in consolidation.

 

Gross Profit

 

 

 

Q2
2013

 

% of
Net Sales

 

Q2
2014

 

% of
Net Sales

 

Gross profit

 

$

70.1

 

36.1

%

$

80.9

 

34.2

%

 

Gross profit increased $10.8 million, or 15%, to $80.9 million for the three months ended December 31, 2013, from $70.1 million for the comparable prior-year period and was primarily attributable to a 22% increase in sales.  The gross margin decreased to 34.2% from 36.1% for the comparable prior-year period which was primarily attributable to: (i) the impact of increased revenues from our Optoelectronic and Manufacturing division which grew faster than our other two divisions, and which has historically generated the lowest gross margins across the three divisions; and (ii) the impact of the product mix within our Optoelectronics and Manufacturing division, since a significantly higher proportion of sales occurred in the contract manufacturing side of the division, which carries lower gross margins than the core optoelectronics business.  These negative impacts upon gross margin were partially offset by a change in product mix within our Security division to more revenues from turnkey screening services that improved margins.

 

Operating Expenses

 

 

 

Q2
2013

 

% of
Net Sales

 

Q2
2014

 

% of
Net Sales

 

$ Change

 

% Change

 

Selling, general and administrative

 

$

36.8

 

19.0

%

$

45.6

 

19.3

%

$

8.8

 

24

%

Research and development

 

11.9

 

6.1

%

11.1

 

4.7

%

(0.8

)

(7

)%

Impairment, restructuring and other charges

 

2.7

 

1.4

%

2.2

 

0.9

%

(0.5

)

(19

)%

Total operating expenses

 

$

51.4

 

26.5

%

$

58.9

 

24.9

%

$

7.5

 

15

%

 

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Table of Contents

 

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. For the three months ended December 31, 2013, SG&A expenses increased by $8.8 million, or 24%, to $45.6 million, from $36.8 million for the comparable prior-year period. This increase was primarily attributable to increased employee compensation costs to support our expanded businesses and increased professional fees in our Security division.  As a percentage of revenue, SG&A expenses were 19.3% for the three months ended December 31, 2013, compared to 19.0% for the comparable prior-year period.

 

Research and development . Research and development (R&D) expenses include research related to new product development and product enhancement expenditures. For the three months ended December 31, 2013, R&D expenses decreased by $0.8 million or 7%, to $11.1 million, from $11.9 million primarily as a result of engineering resources moving from R&D activities to support newly developed products in production in our Security division.

 

Impairment, restructuring and other charges .  During the three months ended December 31, 2013 we incurred $2.2 million of impairment, restructuring and other charges, which was comprised of: $1.3 million of employee termination costs and facility consolidation costs in our Security and Optoelectronics and Manufacturing divisions, as we continue to optimize our cost structure, and $0.9 million of costs in our Security division for professional fees related to an additional contract issue with the TSA. In the three months ended December 31, 2012, we also incurred impairment, restructuring and other charges of $2.7 million.  These charges were all incurred in our Security division in conjunction with the contract issue and settlement reached with the TSA in the prior year.

 

Other Income and Expenses

 

 

 

Q2
2013

 

% of Net
Sales

 

Q2
2014

 

% of Net
Sales

 

$ Change

 

%
Change

 

Interest and other expense, net

 

$

1.4

 

0.7

%

$

1.5

 

0.6

%

$

0.1

 

7

%

 

Interest and other expense, net . For the three months ended December 31, 2013, interest and other expense, net, amounted to $1.5 million, as compared to $1.4 million for the same prior-year period. The change was primarily due to increased interest expense related to higher average outstanding borrowings under our revolving credit facility to fund the investment in the Mexican turnkey services program.

 

Income taxes . For the three months ended December 31, 2013, our income tax provision was $6.0 million, compared to $4.9 million for the comparable prior-year period. Our effective tax rate for the three months ended December 31, 2013 was 29.0%, compared to 28.2% 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.

 

Results of Operations for the Six Months Ended December 31, 2012 (YTD Q2 2013) Compared to Six Months Ended December 31, 2013 (YTD Q2 2014) (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 10 to the condensed consolidated financial statements for additional information about our business segments.

 

 

 

YTD Q2
2013

 

% of
Net Sales

 

YTD Q2
2014

 

% of
Net Sales

 

$ Change

 

% Change

 

Security division

 

$

174.8

 

47

%

$

203.8

 

46

%

$

29.0

 

17

%

Healthcare division

 

107.7

 

29

%

108.9

 

25

%

1.2

 

1

%

Optoelectronics and Manufacturing division

 

114.4

 

30

%

147.6

 

33

%

33.2

 

29

%

Less: inter-division sales

 

(21.2

)

(6

)%

(17.6

)

(4

)%

3.6

 

17

%

Total revenues

 

$

375.7

 

100

%

$

442.7

 

100

%

$

67.0

 

18

%

 

Net revenues for the six months ended December 31, 2013 increased $67.0 million, or 18% to $442.7 million, from $375.7 million for the comparable prior-year period.

 

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Table of Contents

 

Revenues for the Security division for the six months ended December 31, 2013 increased $29.0 million, or 17%, to $203.8 million, from $174.8 million for the comparable prior-year period.  The increase was primarily attributable to increased revenue from our turnkey screening services in Mexico and sales of cargo equipment, which was partially offset by the decrease in equipment revenues associated with the London Olympic Games, which contributed approximately $23 million in revenues in the prior year period.

 

Revenues for the Healthcare division for the six months ended December 31, 2013 increased $1.2 million, or 1%, to $108.9 million, from $107.7 million for the comparable prior-year period.  The increase was primarily attributable to a $3.0 million, or 4%, increase in patient monitoring revenues partially offset by a $2.5 million decrease in anesthesia revenues associate with our older product line as we introduce our new anesthesia system.

 

Revenues for the Optoelectronics and Manufacturing division for the six months ended December 31, 2013 increased $33.2 million, or 29%, to $147.6 million, from $114.4 million for the comparable prior-year period. Excluding the impact of $10.8 million of revenue attributable to acquired businesses over the last twelve months, the growth was 20%.  This change was primarily attributable to increases in contract manufacturing sales to customers in the consumer products business, which was partially offset by declines in our core optoelectronics business.  The Optoelectronics and Manufacturing division recorded intersegment sales of $17.6 million, compared to $21.2 million in the comparable prior-year period.  Such intersegment sales are eliminated in consolidation.

 

Gross Profit

 

 

 

YTD Q2
2013

 

% of
Net Sales

 

YTD Q2
2014

 

% of
Net Sales

 

Gross profit

 

$

131.4

 

35.0

%

$

148.9

 

33.6

%

 

Gross profit increased $17.5 million, or 13%, to $148.9 million for the six months ended December 31, 2013, from $131.4 million for the comparable prior-year period and was attributable to an 18% increase in sales.  The gross margin decreased to 33.6% from 35.0% for the comparable prior-year period, which was primarily attributable to:(i) the impact of increased revenues from our Optoelectronic and Manufacturing division which grew faster than our other two divisions, and which has historically generated the lowest gross margins across the three divisions; and (ii) the impact of the product mix within our Optoelectronic and Manufacturing division, since a significantly higher proportion of sales occurred in the contract manufacturing side of the division, which carries lower gross margins than the core optoelectronics business.  These negative impacts upon gross margin were partially offset by a change in product mix within our Security division to more revenues from turnkey screening services that improved margins.

 

Operating Expenses

 

 

 

YTD Q2
2013

 

% of
Net Sales

 

YTD Q2
2014

 

% of
Net Sales

 

$ Change

 

% Change

 

Selling, general and administrative

 

$

76.8

 

20.4

%

$

87.8

 

19.8

%

$

11.0

 

14

%

Research and development

 

23.1

 

6.2

%

22.2

 

5.0

%

(0.9

)

(4

)%

Impairment, restructuring and other charges

 

2.7

 

0.7

%

6.4

 

1.5

%

3.7

 

137

%

Total operating expenses

 

$

102.6

 

27.3

%

$

116.4

 

26.3

%

$

13.8

 

13

%

 

Selling, general and administrative Selling, general and administrative expenses consist primarily of compensation paid to sales, marketing and administrative personnel, professional service fees and marketing expenses. For the six months ended December 31, 2013, SG&A expenses increased by $11.0 million, or 14%, to $87.8 million, from $76.8 million for the comparable prior-year period. This increase was primarily attributable to increased employee compensation costs to support our expanded business and increased professional fees in our Security division.  As a percentage of revenue, SG&A expenses were 19.8% for the six months ended December 31, 2013, compared to 20.4% for the comparable prior-year period.

 

Research and development Research and development expenses include research related to new product development and product enhancement expenditures. For the six months ended December 31, 2013, expenses decreased by $0.9 million, or 4%, to $22.2 million, from $23.1 million primarily as a result of engineering resources moving from R&D activities to support newly developed products in production in our Security division.

 

Impairment, restructuring and other charges .  During the six months ended December 31, 2013, we incurred $6.4 million of impairment, restructuring and other charges, which was comprised of: (i) $1.9 million in our Security and our Optoelectronics and Manufacturing divisions for employee termination costs and costs related to facility consolidations; (ii) $2.0 million in our Healthcare division related to our move into a new building to serve as the division’s headquarters and primary manufacturing facility; and (iii) $2.5 million of costs incurred within our Security division related to contract issues with the TSA.  During the six months ended December 31, 2012, we incurred impairment, restructuring and other charges of $2.7 million.  These charges were all incurred in our Security division in conjunction with a contract issue and settlement reached with the TSA.

 

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Table of Contents

 

Other Income and Expenses

 

 

 

Q2
2013

 

% of Net
Sales

 

Q2
2014

 

% of Net
Sales

 

$ Change

 

%
Change

 

Interest and other expense, net

 

$

2.5

 

0.7

%

$

3.0

 

0.7

%

$

0.5

 

20

%

 

Interest and other expense, net .  For the six months ended December 31, 2013, interest and other expense, net, amounted to $3.0 million as compared to $2.5 million for the same prior-year period.  The change was primarily due to increased interest expense related to higher average outstanding borrowings under our revolving credit facility to fund the investment in the Mexican turnkey services program and the mortgage debt associated with the acquisition of a building in September 2012 for which there was a six month impact of the interest expense in fiscal 2014 as compared to three months in the comparable prior-year period.

 

Income taxes .  For the six months ended December 31, 2013, our income tax provision was $8.6 million, compared to $7.5 million for the comparable prior-year period. Our effective tax rate for the six months ended December 31, 2013, was 29.0% compared to 28.7% 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.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity are our cash and cash equivalents, cash generated from operations and our credit facility. Our total debt, net of cash and cash equivalents, decreased $2.0 million to $34.8 million as of December 31, 2013 from $36.8 million as of June 30, 2013.  During the six months ended December 31, 2013, we generated $75.0 million of cash flow from operations.  These proceeds were used for the following: $41.7 million invested in capital expenditures, $12.6 million for the acquisition of businesses and other assets and $ 20.3 million for the repurchase of our common stock, including net share settlement of equity awards.  If we continue to net settle equity awards, we will use additional cash to pay our tax withholding obligations in connection with such settlements. We currently anticipate that our available funds, credit facilities and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future.

 

We have a five-year revolving credit facility that allows us to borrow up to $425 million at London Interbank Offered Rate (LIBOR) plus 1.5% depending upon our leverage ratio. As of December 31, 2013, there was $60.0 million outstanding under the revolving credit facility and $115.6 million outstanding under the letters-of-credit sub-facility.

 

Cash Provided by Operating Activities. Cash flows from operating activities can fluctuate significantly from period to period, as net income, adjusted for non-cash items, and working capital fluctuations impact cash flows. During the six months ended December 31, 2013, we generated cash from operations of $75.0 million compared to $62.8 million in the prior year period, or an increase of $12.2 million.  Cash flow from operating activities during the first six months of fiscal 2014 primarily consisted of net income of $21.0 million, adjusted for certain non-cash items, including total depreciation and amortization of $26.4 million, stock-based compensation expense of $10.7 million and other non-cash operating items of $1.0 million, and the net positive impact of changes in working capital on cash of $15.9 million.  The $12.2 million increase in cash from operations primarily resulted from the impact of changes in net income after giving consideration to non-cash operating items as noted above, which increased by $21.6 million, partially offset by a $9.4 million decrease in changes in cash flow from changes in working capital. The primary driver of the change in cash flow from working capital was a $70.7 million decrease in the change in cash flow from accounts payables partially offset by a $31.1 million increase in the change in cash flow from deferred revenues and a $29.1 million increase in the change in cash flow from accounts receivable.

 

Cash Used in Investing Activities. Net cash used in investing activities was $54.3 million for the six months ended December 31, 2013 as compared to $125.4 million used for the six months ended December 31, 2012.  During the six months ended December 31, 2013, we invested $41.7 million in capital expenditures compared to $117.6 million during the comparable prior-year period.  This decrease is primarily a result of the timing of capital expenditures in support of our turnkey screening program in Mexico. In the six months ended December 31, 2013 we also used cash of $10.1 million for acquisitions of businesses and other assets as compared to $5.8 million in the comparable prior-year period.

 

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Table of Contents

 

Cash Provided by (Used in) Financing Activities. Net cash used by financing activities was $16.5 million for the six months ended December 31, 2013, compared to $16.4 million of cash provided by financing activities for the six months ended December 31, 2012. During the six months ended December 31, 2013, we received net proceeds from our credit facility and capital lease obligations of $3.8 million as compared to receiving $15.0 million in the prior year.  In addition we received proceeds from long term debt of $11.1 million in the form of a term loan to finance the acquisition of land and building in the six months ended December 31, 2012.   During the six months ended December 31, 2013, we repurchased $20.3 million of our common stock including net share settlement of equity awards compared to $12.3 million for the same period for the six months ended December 31, 2012.

 

Borrowings

 

Outstanding lines of credit and current and long-term debt totaled $74.7 million at December 31, 2013, an increase of $3.2 million from $71.5 million at June 30, 2013. See Note 4 to the condensed consolidated financial statements for further discussion.

 

Stock Repurchase Program

 

Our Board of Directors has authorized a stock repurchase program that provides for the repurchase of up to 4,000,000 shares of our common stock.  This program does not have an expiration date.  Upon repurchase, the shares are restored to the status of authorized but unissued, and we record them as a reduction in the number of shares of common stock issued and outstanding in our consolidated financial statements.

 

The following table presents the shares acquired during the quarter ended December 31, 2013:

 

 

 

Total number of
shares (or
units) purchased(1)

 

Average price
paid per share
(or unit)

 

Total number of
shares (or units)
purchased as
part of publicly
announced plans or
programs

 

Maximum number
(or appropriate dollar
value)
of shares (or units)
that may
yet be purchased
under the plans or
programs

 

October 1, 2013 to October 31, 2013

 

91,026

(2)

$

72.19

 

90,887

 

1,273,795

 

November 1, 2013 to November 30, 2013

 

62,023

(3)

$

73.17

 

54,600

 

1,219,195

 

December 1, 2013 to December 31, 2013

 

3,586

(4)

$

50.68

 

 

1,219,195

 

 

 

156,635

 

$

72.08

 

145,487

 

 

 

 


(1)                      Represents shares repurchased during the quarter ended December 31, 2013 under our stock repurchase programs, which was initially approved by our Board of Directors in March 1999 and amended in September 2004 and April 2013.

 

(2)                      In October 2013, a total of 139 shares of common stock were tendered to satisfy minimum statutory tax withholding obligations related to the vesting of restricted shares.

 

(3)                      In November 2013, a total of 7,423 shares of common stock were tendered to satisfy minimum statutory tax withholding obligations related to the vesting of restricted shares.

 

(4)                      In December 2013, a total of 3,586 shares of common stock were tendered to satisfy minimum statutory tax withholding obligations related to the vesting of restricted shares.

 

Dividend Policy

 

We have not paid cash dividends on our common stock in the past and have no plans to do so in the foreseeable future.  Certain of our current bank credit facilities restrict the payment of cash dividends and future borrowings may contain similar restrictions.

 

Contractual Obligations

 

We presented our contractual obligations in our Annual Report on Form 10-K for the fiscal year ended June 30, 2013.  See Note 8 to the condensed consolidated financial statements for further discussion regarding significant changes in those obligations during the first six months of fiscal 2014.

 

Off Balance Sheet Arrangements

 

As of December 31, 2013, we did not have any significant off balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

 

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Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions and select accounting policies that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Our critical accounting policies are detailed in our Annual Report on Form 10-K for the year ended June 30, 2013.

 

There are no recent accounting pronouncements that, if implemented, would impact us materially.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

For the six months ended December 31, 2013, no material changes occurred with respect to market risk as disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2013.

 

Market Risk

 

We are exposed to certain market risks, which are inherent in our financial instruments and arise from transactions entered into in the normal course of business. We may enter into derivative financial instrument transactions in order to manage or reduce market risk in connection with specific foreign-currency-denominated transactions. We do not enter into derivative financial instrument transactions for speculative purposes.

 

We are subject to interest rate risk on our short-term borrowings under our bank lines of credit. Borrowings under these lines of credit do not give rise to significant interest rate risk because these borrowings have short maturities and are borrowed at variable interest rates. Historically, we have not experienced material gains or losses due to interest rate changes.

 

Foreign Currency

 

Our international operations are subject to certain opportunities and risks, including foreign currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments, and to fluctuations in foreign currencies. We conduct business in more than 20 countries. Due to our global operations, weaknesses in the currencies of some of these countries are often offset by strengths in others. Foreign currency financial statements are translated into U.S. dollars at period-end rates, with the exception of revenues, costs and expenses, which are translated at average rates during the reporting period. We include gains and losses resulting from foreign currency transactions in income, while we exclude those resulting from translation of financial statements from income and include them as a component of accumulated other comprehensive income (AOCI). Transaction gains and losses, which were included in our condensed consolidated statements of operations, amounted to a net zero impact from foreign exchange gains and losses during the three months ended December 31, 2012 and a loss of $0.2 million during the three months ended December 31, 2013, respectively.  We incurred a loss of $0.5 million and a loss of $0.9 million for the six months ended December 31, 2012 and 2013, respectively.  Furthermore, a 10% appreciation of the U.S. dollar relative to each of the local currencies would have resulted in a net increase in our operating income of approximately $2 million in the second quarter of fiscal 2014. Conversely, a 10% depreciation of the U.S. dollar relative to each of the local currencies would have resulted in a net decrease in our operating income of approximately $2 million in the second quarter of fiscal 2014.

 

Use of Derivatives

 

Our use of derivatives consists primarily of an interest swap agreement. As discussed in Note 1 to the condensed consolidated financial statements, we had an interest rate swap of $9.2 million outstanding as of December 31, 2013.

 

Importance of International Markets

 

International markets provide us with significant growth opportunities. However, as a result of our worldwide business operations, we are subject to various risks, including: international regulatory requirements and policy changes; difficulties in accounts receivable collection and the management of distributors; geopolitical and economic instability; currency exchange rate fluctuations; and tariff regulations. In response to these risks and others, we continue to perform ongoing credit evaluations of our customers’ financial condition and, if deemed necessary, we require advance payments for sales. Also, we monitor geopolitical, economic and currency conditions around the world to evaluate whether there may be any significant effect on our international sales in the future.

 

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Inflation

 

We do not believe that inflation had a material impact on our results of operations during the three and six months ended December 31, 2013.

 

Interest Rate Risk

 

We classify all highly liquid investments with maturities of three months or less as cash equivalents and record them on our balance sheet at fair value.

 

Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Based upon an evaluation of the effectiveness of disclosure controls and procedures, our Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures as defined under Exchange Act Rule 13a-15(e) and 15d-15(e) were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission and is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during the second quarter of fiscal 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations on Effectiveness of Controls and Procedures

 

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

 

PART II OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

Certain of the legal proceedings in which we are involved are discussed in Note 8, “Commitments and Contingencies,” to our Unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q, and are hereby incorporated by reference.

 

ITEM 1A. RISK FACTORS

 

The discussion of our business and operations in this Quarterly Report on Form 10-Q should be read together with the risk factors contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2013, filed with the Securities and Exchange Commission on August 16, 2013, which describe various risks and uncertainties to which we are or may become subject. There have been no material changes to the risk factors included in our Annual Report.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

See Stock Repurchase Program discussion under Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, which is hereby incorporated by reference.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

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ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

31.1

 

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

31.2

 

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

32.1

 

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

32.2

 

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

101.1

 

The following financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2013, as filed with the SEC on January 30, 2014, formatted in XBRL, as follows:

 

 

(i)
(ii)
(iii)
(iv)
(v)

 the condensed consolidated balance sheets
 the condensed consolidated statements of operations
 the condensed consolidated statements of comprehensive income
 the condensed consolidated statements of cash flows
 the notes to the condensed consolidated financial statements, tagged in summary and detail

 

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Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Hawthorne, State of California on the 30th day of January 2014.

 

 

OSI SYSTEMS, INC.

 

 

 

 

By:

/s/ Deepak Chopra

 

 

Deepak Chopra

 

 

President and Chief Executive Officer

 

 

 

 

By:

/s/ Alan Edrick

 

 

Alan Edrick

 

 

Executive Vice President and Chief Financial Officer

 

27


Exhibit 31.1

 

CERTIFICATION

 

Certification required by Rule 13a-14(a) or Rule 15d-14(a)

and under Section 302 of the Sarbanes-Oxley Act of 2002

 

I, Deepak Chopra, certify that:

 

1.          I have reviewed this Quarterly Report on Form 10-Q of OSI Systems, Inc.;

 

2.          Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.          Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.          The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.          The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: January 30, 2014

 

 

/s/ Deepak Chopra

 

Deepak Chopra

 

Chief Executive Officer

 


EXHIBIT 31.2

 

CERTIFICATION

 

Certification required by Rule 13a-14(a) or Rule 15d-14(a)

and under Section 302 of the Sarbanes-Oxley Act of 2002

 

I, Alan Edrick, certify that:

 

1.          I have reviewed this Quarterly Report on Form 10-Q of OSI Systems, Inc.;

 

2.          Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.          Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.          The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.          The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: January 30, 2014

 

 

/s/ Alan Edrick

 

Alan Edrick

 

Chief Financial Officer

 


EXHIBIT 32.1

 

CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of OSI Systems, Inc. (the “Company”) on Form 10-Q for the quarter ended December 31, 2013, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Deepak Chopra, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

(1)          The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

 

(2)          The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company at the dates and for the periods presented in the Report.

 

Date: January 30, 2014

 

 

/s/ Deepak Chopra

 

Deepak Chopra

 

Chief Executive Officer

 

The foregoing certification is being furnished solely pursuant to 18 U.S.C. Section 1350, is not being filed as part of the Report or as a separate disclosure document, and is not being incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, (whether made before or after the date of the Report) irrespective of any general incorporation language contained in such filing. The signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

 


EXHIBIT 32.2

 

CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of OSI Systems, Inc. (the “Company”) on Form 10-Q for the quarter ended December 31, 2013, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Alan Edrick, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

(1)          The Report fully complies with the requirements of Section 13(a) or 15(d) , as applicable, of the Securities Exchange Act of 1934, as amended; and

 

(2)          The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company at the dates and for the periods presented in the Report.

 

Date:  January 30, 2014

 

 

/s/ Alan Edrick

 

Alan Edrick

 

Chief Financial Officer

 

The foregoing certification is being furnished solely pursuant to 18 U.S.C. Section 1350, is not being filed as part of the Report or as a separate disclosure document, and is not being incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, (whether made before or after the date of the Report) irrespective of any general incorporation language contained in any such filing. The signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.