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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2019

OR

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

Graphic

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)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $0.001 par value

OSIS

The NASDAQ Global Select Market

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  No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes No 

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

Large accelerated filer 

   

Accelerated filer 

Non-accelerated filer 

Smaller reporting company 

Emerging growth company 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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

As of January 24, 2020, there were 18,305,020 shares of the registrant’s common stock outstanding.

Table of Contents

OSI SYSTEMS, INC.

INDEX

PAGE

PART I — FINANCIAL INFORMATION

3

Item 1 —

Financial Statements (Unaudited)

3

Condensed Consolidated Balance Sheets at June 30, 2019 and December 31, 2019

3

Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2018 and 2019

4

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended December 31, 2018 and 2019

5

Condensed Consolidated Statements of Stockholders’ Equity for the three and six months ended December 31, 2018 and 2019

6

Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2018 and 2019

8

Notes to Condensed Consolidated Financial Statements

9

Item 2 —

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

27

Item 3 —

Quantitative and Qualitative Disclosures about Market Risk

35

Item 4 —

Controls and Procedures

35

PART II — OTHER INFORMATION

35

Item 1 —

Legal Proceedings

35

Item 1A —

Risk Factors

35

Item 2 —

Unregistered Sales of Equity Securities and Use of Proceeds

36

Item 3 —

Defaults Upon Senior Securities

36

Item 4 —

Mine Safety Disclosures

36

Item 5 —

Other Information

36

Item 6 —

Exhibits

36

Signatures

37

2

Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(amounts in thousands, except share amounts and par value)

June 30, 

December 31, 

    

2019

    

2019

ASSETS

CURRENT ASSETS:

Cash and cash equivalents

$

96,316

$

95,056

Accounts receivable, net

 

238,440

 

257,385

Inventories

 

273,711

 

252,535

Prepaid expenses and other current assets

 

32,432

 

43,313

Total current assets

 

640,899

 

648,289

Property and equipment, net

 

127,385

 

129,588

Goodwill

 

307,108

 

309,429

Intangible assets, net

 

132,954

 

127,464

Other assets

 

56,518

 

87,156

Total assets

$

1,264,864

$

1,301,926

LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES:

Bank lines of credit

$

88,000

$

91,000

Current portion of long-term debt

 

804

 

837

Accounts payable

 

93,500

 

106,344

Accrued payroll and related expenses

 

43,521

 

38,185

Advances from customers

 

43,227

 

32,640

Other accrued expenses and current liabilities

 

112,956

 

114,930

Total current liabilities

 

382,008

 

383,936

Long-term debt

 

257,752

 

262,326

Deferred income taxes

 

7,979

 

7,532

Other long-term liabilities

 

65,398

 

90,416

Total liabilities

 

713,137

 

744,210

Commitments and contingencies (Note 9)

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; issued and outstanding, 18,167,020 shares at June 30, 2019 and 18,267,574 shares at December 31, 2019

 

168,913

 

133,566

Retained earnings

 

399,541

 

441,270

Accumulated other comprehensive loss

 

(16,727)

 

(17,120)

Total stockholders’ equity

 

551,727

 

557,716

Total liabilities and stockholders’ equity

$

1,264,864

$

1,301,926

See accompanying notes to condensed consolidated financial statements.

3

Table of Contents

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(amounts in thousands, except per share data)

Three Months Ended December 31, 

Six Months Ended December 31, 

    

2018

    

2019

    

2018

    

2019

    

Net revenues:

Products

$

225,402

$

223,772

$

407,882

$

433,533

Services

 

77,803

 

81,570

 

161,572

 

162,661

Total net revenues

 

303,205

 

305,342

 

569,454

 

596,194

Cost of goods sold:

Products

 

150,131

 

148,709

 

275,502

 

295,051

Services

 

42,730

 

45,860

 

87,695

 

91,159

Total cost of goods sold

 

192,861

 

194,569

 

363,197

 

386,210

Gross profit

 

110,344

 

110,773

 

206,257

 

209,984

Operating expenses:

Selling, general and administrative

 

67,097

 

63,902

 

128,804

 

126,079

Research and development

 

12,805

 

14,881

 

26,558

 

29,127

Restructuring and other charges (benefit), net

 

(1,265)

 

(929)

 

2,931

 

(3,028)

Total operating expenses

 

78,637

 

77,854

 

158,293

 

152,178

Income from operations

 

31,707

 

32,919

 

47,964

 

57,806

Interest expense and other expense, net

 

(5,620)

 

(4,844)

 

(10,952)

 

(9,580)

Income before income taxes

 

26,087

 

28,075

 

37,012

 

48,226

Provision for income taxes

 

(6,980)

 

(7,089)

 

(8,503)

 

(6,497)

Net income

$

19,107

$

20,986

$

28,509

$

41,729

Earnings per share:

Basic

$

1.06

$

1.15

$

1.58

$

2.28

Diluted

$

1.03

$

1.12

$

1.53

$

2.22

Shares used in per share calculation:

Basic

 

18,085

 

18,312

 

18,088

 

18,285

Diluted

 

18,624

 

18,682

 

18,679

 

18,783

See accompanying notes to condensed consolidated financial statements.

4

Table of Contents

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(amounts in thousands)

Three Months Ended December 31, 

Six Months Ended December 31, 

    

2018

    

2019

    

2018

    

2019

Net income

$

19,107

$

20,986

$

28,509

$

41,729

Other comprehensive income (loss):

Foreign currency translation adjustment

 

(5,388)

 

2,640

 

(4,215)

 

(412)

Other

 

9

 

9

 

15

 

19

Other comprehensive income (loss)

(5,379)

2,649

(4,200)

(393)

Comprehensive income

$

13,728

$

23,635

$

24,309

$

41,336

See accompanying notes to condensed consolidated financial statements.

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OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(amounts in thousands, except share data)

Three Months Ended December 31, 2018

Accumulated

Common

Other

    

Number of

    

    

Retained

    

Comprehensive

    

Shares

Amount

Earnings

Loss

Total

Balance—September 30, 2018

 

18,153,123

$

156,760

$

344,147

$

(13,605)

$

487,302

Exercise of stock options

 

40,361

520

520

Vesting of RSUs

 

16,623

Stock-based compensation

 

8,163

8,163

Repurchase of common stock

(184,170)

(13,185)

(13,185)

Taxes paid related to net share settlement of equity awards

 

(5,030)

(332)

(332)

Net income

 

19,107

19,107

Other comprehensive loss

 

(5,379)

(5,379)

Balance—December 31, 2018

18,020,907

$

151,926

$

363,254

$

(18,984)

$

496,196

Three Months Ended December 31, 2019

Accumulated

Common

Other

    

Number of

    

    

Retained

    

Comprehensive

    

Shares

Amount

Earnings

Loss

Total

Balance—September 30, 2019

18,357,464

$

141,049

$

420,284

$

(19,769)

$

541,564

Exercise of stock options

32,656

1,200

1,200

Vesting of RSUs

26,219

Stock-based compensation

5,844

5,844

Repurchase of common stock

(140,823)

(13,732)

(13,732)

Taxes paid related to net share settlement of equity awards

(7,942)

(795)

(795)

Net income

20,986

20,986

Other comprehensive income

2,649

2,649

Balance—December 31, 2019

 

18,267,574

$

133,566

$

441,270

$

(17,120)

$

557,716

Six Months Ended December 31, 2018

Accumulated

Common

Other

    

Number of

    

    

Retained

    

Comprehensive

    

Shares

Amount

Earnings

Loss

Total

Balance—June 30, 2018

 

18,032,374

$

169,475

$

334,745

$

(14,784)

$

489,436

Exercise of stock options

 

49,395

 

789

 

 

 

789

Vesting of RSUs

 

356,705

 

 

 

 

Shares issued under employee stock purchase program

 

39,293

 

2,020

 

 

 

2,020

Stock-based compensation

 

 

13,626

 

 

 

13,626

Repurchase of common stock

(288,316)

(21,029)

(21,029)

Taxes paid related to net share settlement of equity awards

 

(168,544)

 

(12,955)

 

 

 

(12,955)

Net income

 

 

 

28,509

 

 

28,509

Other comprehensive loss

 

 

 

 

(4,200)

 

(4,200)

Balance—December 31, 2018

18,020,907

$

151,926

$

363,254

$

(18,984)

$

496,196

See accompanying notes to condensed consolidated financial statements.

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Six Months Ended December 31, 2019

Accumulated

Common

Other

    

Number of

    

    

Retained

    

Comprehensive

    

Shares

Amount

Earnings

Loss

Total

Balance—June 30, 2019

 

18,167,020

$

168,913

$

399,541

$

(16,727)

$

551,727

Exercise of stock options

 

199,962

 

4,032

 

 

 

4,032

Vesting of RSUs

 

387,085

 

 

 

 

Shares issued under employee stock purchase program

 

34,837

 

2,065

 

 

 

2,065

Stock-based compensation

 

 

12,260

 

 

 

12,260

Repurchase of common stock

(266,874)

(26,994)

(26,994)

Taxes paid related to net share settlement of equity awards

 

(254,456)

 

(26,710)

 

 

 

(26,710)

Net income

 

 

 

41,729

 

 

41,729

Other comprehensive loss

 

 

 

 

(393)

 

(393)

Balance—December 31, 2019

18,267,574

$

133,566

$

441,270

$

(17,120)

$

557,716

See accompanying notes to condensed consolidated financial statements.

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OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(amounts in thousands)

Six Months Ended December 31, 

    

2018

    

2019

CASH FLOWS FROM OPERATING ACTIVITIES

Net income

$

28,509

$

41,729

Adjustments to reconcile net income to net cash provided by operating activities, net of effects from acquisitions:

Depreciation and amortization

 

28,283

 

26,961

Stock-based compensation expense

 

13,626

 

12,260

Deferred income taxes

(3,308)

(53)

Amortization of debt discount and issuance costs

4,469

4,646

Other

 

1,015

 

877

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

Accounts receivable

 

(13,986)

 

(19,455)

Inventories

 

(2,265)

 

19,930

Prepaid expenses and other assets

 

(5,863)

 

(17,646)

Accounts payable

(9,166)

12,739

Accrued payroll and related expenses

(3,760)

(5,381)

Advances from customers

 

13,676

 

(10,580)

Other

 

(10,386)

 

(6,400)

Net cash provided by operating activities

 

40,844

 

59,627

CASH FLOWS FROM INVESTING ACTIVITIES

Acquisition of property and equipment

 

(12,640)

 

(11,593)

Acquisition of businesses, net of cash acquired

 

(18,259)

 

(171)

Acquisition of intangible and other assets

 

(611)

 

(3,853)

Net cash used in investing activities

 

(31,510)

 

(15,617)

CASH FLOWS FROM FINANCING ACTIVITIES

Net borrowings on bank lines of credit

 

36,000

 

3,000

Proceeds from long-term debt

 

817

 

441

Payments on long-term debt

 

(1,233)

 

(480)

Proceeds from exercise of stock options and employee stock purchase plan

 

2,809

 

6,097

Payments of contingent consideration

(1,328)

(1,220)

Repurchases of common stock

 

(21,029)

 

(26,994)

Taxes paid related to net share settlement of equity awards

 

(12,955)

 

(26,710)

Net cash provided by (used in) financing activities

 

3,081

 

(45,866)

Effect of exchange rate changes on cash

 

(1,262)

 

596

Net change in cash and cash equivalents

 

11,153

 

(1,260)

Cash and cash equivalents—beginning of period

 

84,814

 

96,316

Cash and cash equivalents—end of period

$

95,967

$

95,056

Supplemental disclosure of cash flow information:

Cash paid, net during the period for:

Interest

$

6,318

$

4,242

Income taxes

$

20,711

$

9,668

See accompanying notes to condensed consolidated financial statements.

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OSI SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

Description of Business

OSI Systems, Inc., together with our subsidiaries, is a vertically integrated designer and manufacturer of specialized electronic systems and components for critical applications. We sell our products in diversified markets, including homeland security, healthcare, defense and aerospace.

We have three reporting segments: (i) Security, providing security inspection systems and related services, and turnkey security screening solutions; (ii) Healthcare, providing patient monitoring and diagnostic cardiology products and related services and (iii) Optoelectronics and Manufacturing, providing specialized electronic components and electronic manufacturing services for our Security and Healthcare divisions as well as to external original equipment manufacturer ("OEM") customers and end users for applications in the defense, aerospace, medical and industrial markets, among others.

Through our Security segment, we provide security screening products and related services internationally. These products fall into the following categories: baggage and parcel inspection; cargo and vehicle inspection; hold (checked) baggage screening; people screening; radiation detection; and explosive and narcotics trace detection. In addition to these products, we also provide site design, installation, training and technical support services to our customers. We also provide turnkey security screening solutions, which can include the construction, staffing and long-term operation of security screening checkpoints for our customers.

Through our Healthcare segment, we design, manufacture, market and service patient monitoring and diagnostic cardiology systems and related supplies and accessories internationally. These products are used by care providers in critical care, emergency and perioperative areas within hospitals as well as physicians' offices, medical clinics and ambulatory surgery centers, among others.

Through our Optoelectronics and Manufacturing segment, we design, manufacture and market optoelectronic devices and flex circuits and provide electronics manufacturing services internationally for use in a broad range of applications, including aerospace and defense electronics, X-ray security and inspection systems and medical imaging, chemistry analysis and diagnostics instruments, telecommunications, scanners and industrial automations, automotive diagnostic systems, internet of things (IoT) and consumer wearable products. This division provides products and services to OEM customers and end users as well as to our Security and Healthcare divisions.

Basis of Presentation

The condensed consolidated financial statements include the accounts of OSI Systems, Inc. and our subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The condensed consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded in accordance with SEC rules and regulations applicable to interim unaudited financial statements. Accordingly, the condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for audited annual financial statements. In the opinion of management, the condensed consolidated financial statements reflect all adjustments of a normal and recurring nature that are considered necessary for a fair presentation of the results for the interim periods presented. These unaudited condensed consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019 filed with the SEC. The results of operations for the three and six months ended December 31, 2019 are not necessarily indicative of the operating results to be expected for the full 2020 fiscal year or any future periods.

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Use of Estimates

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

Earnings Per Share Computations

We compute basic earnings per share by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. We compute diluted earnings per share by dividing net income available to common stockholders by the sum of the weighted average number of common shares and dilutive potential common shares outstanding during the period. Potential common shares consist of the shares issuable upon the exercise of stock options and restricted stock unit awards under the treasury stock method. The underlying equity component of the 1.25% convertible senior notes due 2022 (the “Notes”) discussed in Note 6 to the condensed consolidated financial statements will have a net impact on diluted earnings per share when the average price of our common stock exceeds the conversion price because the principal amount of the Notes is intended to be settled in cash upon conversion. There was no dilutive effect of the Notes for the three and six months ended December 31, 2018 and 2019.

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, 

    

2018

    

2019

    

2018

    

2019

Net income available to common stockholders

$

19,107

$

20,986

$

28,509

$

41,729

Weighted average shares outstanding—basic

 

18,085

 

18,312

 

18,088

 

18,285

Dilutive effect of equity awards

 

539

 

370

 

591

 

498

Weighted average shares outstanding—diluted

 

18,624

 

18,682

 

18,679

 

18,783

Basic earnings per share

$

1.06

$

1.15

$

1.58

$

2.28

Diluted earnings per share

$

1.03

$

1.12

$

1.53

$

2.22

Shares excluded from diluted earnings per share due to their anti-dilutive effect

126

94

81

85

Cash and Cash Equivalents

We consider all highly liquid investments with maturities of three months or less as of the acquisition date to be cash equivalents.

Our cash and cash equivalents totaled $95.1 million at December 31, 2019. Of this amount, approximately 82% was held by our foreign subsidiaries and subject to repatriation tax considerations. These foreign funds were held primarily by our subsidiaries in Singapore, the United Kingdom, Malaysia and Canada and to a lesser extent in Mexico, Germany, India, and Albania among others. We have cash holdings that exceed insured limits for financial institutions; however, we mitigate this risk by utilizing high credit quality financial institutions throughout the world.

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Fair Value of Financial Instruments

Our financial instruments consist primarily of cash and cash equivalents, insurance company contracts, 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 our long-term debt instruments are considered to approximate their fair values, as the interest rates of these instruments are variable or comparable to current rates available to us.

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.The "Level 1" category includes assets and liabilities measured at quoted prices in active markets for identical assets and liabilities. The"Level 2" category includes assets and liabilities measured from observable inputs other than quoted market prices.The "Level 3" category includes assets and liabilities for which valuation inputs are unobservable and significant to the fair value measurement. As of June 30, 2019 and December 31, 2019, there were no assets in the "Level 3" category. Our contingent payment obligations related to acquisitions, which are further discussed in Note 9 to the condensed consolidated financial statements, are in the “Level 3” category for valuation purposes.

The fair values of our financial assets and liabilities are categorized as follows (in thousands):

June 30, 2019

December 31, 2019

    

Level 1

    

Level 2

    

Level 3

    

Total

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets:

Insurance company contracts

 

$

 

$

35,899

 

$

 

$

35,889

 

$

$

38,625

 

$

 

$

38,625

Liabilities:

Contingent consideration

$

$

$

16,577

$

16,577

$

$

$

16,671

$

16,671

Goodwill Impairment

Goodwill represents the excess purchase price over the estimated fair value of the assets acquired and liabilities assumed in a business combination. Goodwill is allocated to our segments based on the nature of the product line of the acquired business. The carrying value of goodwill is not amortized, but is annually tested for impairment during our second fiscal quarter and more frequently if there is an indicator of impairment. We assess qualitative factors of each of our three reporting units to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. The assessments conducted as of December 31, 2019 indicated that it is not more likely than not that the fair values of all three reporting units are less than their carrying amounts, including goodwill. Thus, we have determined that there is no goodwill impairment for all three reporting units.

Revenue Recognition

We recognize revenue under Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606”), which superseded all prior revenue recognition methods and industry-specific guidance. The core principle of ASC 606 is that an entity should recognize revenue to depict the transfer of control for promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the revenue recognition principles, an entity is required to identify the contract(s) with a customer, identify the performance obligations, determine the transaction price, allocate the transaction price to the performance obligations and recognize revenue as the performance obligations are satisfied (i.e., either over time or at a point in time). ASC 606 further requires that companies disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

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Product Sales. We recognize revenue from sales of products upon shipment or delivery when control of the product transfers to the customer, depending on the terms of each sale, and when collection is probable. In the circumstance where terms of a product sale include subjective customer acceptance criteria, revenue is deferred until we have achieved the acceptance criteria unless the customer acceptance criteria are perfunctory or inconsequential. We generally offer customers payment terms of less than one year. In cases when payment terms extend beyond one year, we consider whether the contract has a significant financing component.

Service Revenue. Revenue from services includes installation and implementation of products and turnkey security screening services and after-market services. Generally, revenue from services is recognized over time as the services are performed. Revenues from out of warranty service maintenance contracts are recognized ratably over the respective terms of such contracts. Deferred revenue for such services arises from payments received from customers for services not yet performed.

Contract Revenue. Sales agreements with customers can be project specific, cover a period of time, and can be renewable periodically. The contracts may contain terms and conditions with respect to payment, delivery, installation, services, warranty and other rights. In certain instances, we consider an accepted customer order, governed by a master sales agreement, to be the contract with the customer when legal rights and obligations exist. Contracts with customers may include the sale of products and services, as discussed in the paragraphs above. In certain instances, contracts can contain multiple performance obligations as discussed in the paragraph below. According to the terms of a sale contract, we may receive consideration from a customer prior to transferring goods to the customer, and we record these prepayments as a contract liability. We also record deferred revenue, typically related to service contacts, when consideration is received before the services have been performed. We recognize contract liabilities and deferred revenue as net sales after all revenue recognition criteria are met.

When determining revenue recognition for contracts, we use judgment based on our understanding of the obligations in each contract. We determine 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 recognition. Critical judgments also include estimates of warranty reserves, which are established based on historical experience and knowledge of the product under warranty.

Multiple Performance Obligations. Certain agreements with customers include the sale of capital equipment involving multiple elements that may include civil works to prepare a site for the installation of equipment, manufacture and delivery of equipment, installation and integration of equipment, training of customer personnel to operate the equipment and after-market service of the equipment. We generally separate multiple elements in a contract into separate performance obligations if those elements are distinct, both individually and in the context of the contract. If multiple promises comprise a series of distinct services which are substantially the same and have the same pattern of transfer, they are combined and accounted for as a single performance obligation.

In cases where obligations in a contract are distinct and thus require separation into multiple performance obligations, revenue recognition guidance requires that contract consideration be allocated to each distinct performance obligation based on its relative standalone selling price. The value allocated to each performance obligation is then recognized as revenue when the revenue recognition criteria for each distinct promise or bundle of promises has been met.

The standalone selling price for each performance obligation is an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the good or service. When there is only one performance obligation associated with a contract, the entire amount of consideration is attributed to that obligation. When a contract contains multiple performance obligations the standalone selling price is first estimated using the observable price, which is generally a list price net of applicable discount or the price used to sell the good or service in similar circumstances. In circumstances when a selling price is not directly observable, we will estimate the standalone selling price using information available to us including our market assessment and expected cost plus margin.

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The timetable for fulfilment of each of the distinct performance obligations can range from completion in a short amount of time and entirely within a single reporting period to completion over several reporting periods. The timing of revenue recognition for each performance obligation may be dependent upon several milestones, including physical delivery of equipment, completion of factory acceptance test, completion of site acceptance test, installation and connectivity of equipment, certification of training of personnel and, in the case of after-market service deliverables, the passage of time (typically evenly over the post-warranty period of the service deliverable).

We often provide a guarantee to support our performance under the contract which may contain one or more performance obligations. In the event that customers are permitted to terminate such arrangements, the underlying contract typically requires payment by the customer for deliverables and reimbursement of costs incurred through the date of termination.

We disaggregate revenue by reporting segment (Security, Optoelectronics and Manufacturing, and Healthcare) to depict the nature of revenue in a manner consistent with our business operations and to be consistent with other communications and public filings. Refer to Note 11 to our condensed consolidated financial statements for additional details of revenues by reporting segment.

Contract Assets and Liabilities. We enter into contracts to sell products and provide services, and we recognize contract assets and liabilities that arise from these transactions. We recognize revenue and corresponding accounts receivable according to ASC 606 and, at times, recognize revenue in advance of the time when contracts give us the right to invoice a customer. We may also receive consideration, per the terms of a contract, from customers prior to transferring goods to the customer. We record customer deposits as a contract liability. Additionally, we may receive payments, most typically for service and warranty contracts, at the onset of the contract and before the services have been performed. In such instances, we record a deferred revenue liability. We recognize these contract liabilities as sales after all revenue recognition criteria are met.

The table below shows the balance of our contract assets and liabilities as of June 30, 2019 and December 31, 2019, including the change between the periods (in thousands):

    

June 30, 

    

December 31, 

    

    

 

Contract Assets:

2019

2019

Change

% Change

 

Unbilled revenue

$

19,287

$

31,985

$

12,698

 

66

%

Contract Liabilities:

    

    

    

    

 

Advances from customers

$

43,227

$

32,640

$

(10,587)

(24)

%

Deferred revenue—current

 

33,641

 

30,171

 

(3,470)

(10)

%

Deferred revenue—long-term

 

9,506

 

8,351

 

(1,155)

(12)

%

Contract assets increased during the six months ended December 31, 2019 primarily due to satisfaction of performance obligations for explosive detection systems and cargo and vehicle inspection systems in our Security division which have not yet been billed to customers. The net decrease in contract liabilities were primarily due to satisfaction of performance obligations and application of payments against customer billings on cargo and vehicle system contracts in our Security division.

Remaining Performance Obligations. Remaining performance obligations related to ASC 606 represent the aggregate transaction price allocated to performance obligations under an original contract with a term greater than one year which are fully or partially unsatisfied at the end of the period. As of December 31, 2019, the aggregate amount of the transaction price allocated to remaining performance obligations was approximately $189.2 million. We expect to recognize revenue on approximately 51% of the remaining performance obligations over the next 12 months, and the remainder is expected to be recognized thereafter. During the six months ended December 31, 2019, we recognized revenue of $52.2 million from contract liabilities existing at the beginning of the period.

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Practical Expedients. In cases where we are responsible for shipping after the customer has obtained control of the goods, we have elected to treat the shipping activities as fulfillment activities rather than as a separate performance obligation. Additionally, we have elected to capitalize the cost to obtain a contract only if the period of amortization would be longer than one year. We only give consideration to whether a customer agreement has a financing component if the period of time between transfer of goods and services and customer payment is greater than one year.

Lease Accounting

Right of use (“ROU”) assets represent our right to use an underlying asset during the reasonably certain lease terms and lease liabilities represent our obligation to make lease payments arising from the leases. We recognize ROU lease assets and lease liabilities at lease commencement on our consolidated balance sheet based on the present value of lease payments over the lease term using a discount rate determined based on our incremental borrowing rate since the rate implicit in each lease is not readily determinable. We elected the package of practical expedients, which permits us to not reassess (1) whether any expired or existing contracts are or contain leases, (2) the lease classification of any expired or existing leases, and (3) any initial direct costs for any existing leases as of the effective date. We elected the practical expedient to account for each separate lease component of a contract and its associated non-lease components as a single lease component. We also elected the hindsight practical expedient, which allows us to use hindsight in determining the lease term. We do not record an ROU asset and corresponding lease liability for leases with an initial term of 12 months or less (“short-term leases”). The terms in our leases may include options to extend or terminate the lease. We recognize ROU assets and liabilities when it is reasonably certain that we will exercise those options. Judgment is required in our assessment as to whether renewal or termination options are reasonably certain to be exercised and factors such as contractual terms compared to current market rates, the importance of the facility and location to our operations, among others, are considered. Lease payments are made in accordance with the lease terms and lease expense, including short-term lease expense, is recognized on a straight-line basis over the lease term.

We lease facilities and certain equipment under various operating lease agreements. The majority of our lease arrangements are comprised of fixed payments while certain of our other leases provide for periodic rent increases. Our leases may contain escalation clauses and renewal options. Most of the leases require us to pay for certain other costs such as common area maintenance and property taxes. Rent expense for leases with periodic rent increases or escalation clauses is recognized on a straight-line basis over the minimum lease term. The lease agreements do not contain any material residual value guarantees or material restrictive covenants. We also have finance leases for fleet vehicles that are not material to the condensed consolidated financial statements.

The components of operating lease expense were as follows (in thousands):

Three Months Ended

Six Months Ended

    

December 31, 2019

    

December 31, 2019

Operating lease cost

$

2,597

$

5,246

Variable lease cost

 

176

314

Short-term lease cost

 

186

395

$

2,959

$

5,955

Supplemental balance sheet assets and liabilities related to operating leases were as follows (in thousands):

    

Balance Sheet Category

    

December 31, 2019

Operating lease ROU assets, net

 

Other assets

$

26,897

Operating lease liabilities, current portion

 

Other accrued expenses and current liabilities

$

8,159

Operating lease liabilities, long-term

 

Other long-term liabilities

 

19,084

Total operating lease liabilities

 

  

$

27,243

Weighted average remaining lease term

 

  

 

4.5 years

Weighted average discount rate

 

  

 

4.4%

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Supplemental cash flow information related to operating leases was as follows (in thousands):

Three Months Ended

Six Months Ended

    

December 31, 2019

    

December 31, 2019

Cash paid for operating lease liabilities

$

2,625

$

5,198

ROU assets obtained in exchange for new lease obligations

165

 

1,479

Maturities of operating lease liabilities under ASC 842 (defined below) at December 31, 2019 were as follows (in thousands):

    

December 31, 2019

Less than one year

$

9,109

1 – 2 years

 

7,024

2 – 3 years

 

4,499

3 – 4 years

 

3,301

4 – 5 years

 

2,539

Thereafter

 

3,594

 

30,066

Less: Imputed interest

 

(2,823)

Total lease liabilities

$

27,243

Maturities of minimum operating lease liabilities under non-cancelable leases under ASC 840 (defined below) at June 30, 2019 were as follows (in thousands):

    

June 30, 2019

Less than one year

$

9,802

1 – 2 years

 

8,082

2 – 3 years

 

5,473

3 – 4 years

 

3,397

4 – 5 years

 

2,954

Thereafter

 

4,583

Total lease liabilities

$

34,291

Recently Adopted Accounting Pronouncement

Leases

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (Topic 842) (“ASC 842”), which requires lessees to recognize ROU assets and lease liabilities, initially measured at present value of the lease payments, on its balance sheet for leases and classified as either financing or operating leases. We adopted ASC 842 on July 1, 2019, using the modified retrospective method, and we elected the package of practical expedients provided in ASC 842. In accordance with ASC 842, we did not restate comparative periods and instead reported comparative prior year periods under ASC 840, “Leases.”

The cumulative effect of the changes made to our July 1, 2019 consolidated condensed balance sheet for the adoption of the new lease standard was as follows (in thousands):

Balance at

Effect of Adoption

Balance at

Balance Sheet

    

June 30, 2019

    

of ASC 842

    

July 1, 2019

Assets

 

 

  

 

  

Other assets

$

56,518

$

30,066

$

86,584

Liabilities

 

 

 

Other accrued expenses and current liabilities

$

112,956

$

8,324

$

121,280

Other long-term liabilities

 

65,398

 

21,742

 

87,140

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The adoption of the new lease accounting guidance did not have a material impact to the condensed consolidated statement of operations or the condensed consolidated statement of cash flows for the six months ended December 31, 2019.

Recently Issued Accounting Pronouncements Not Yet Adopted

Income Taxes

On December 18, 2019, the FASB issued Accounting Standards Update 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12 removes certain exceptions to the general principles of ASC 740, and is intended to improve consistency and simplify GAAP in several other areas of ASC 740 by clarifying and amending existing guidance. ASU 2019-12 is effective for public business entities for annual reporting periods beginning after December 15, 2020, and interim periods within those reporting periods. Early adoption is permitted in any interim or annual period, with any adjustments reflected as of the beginning of the fiscal year of adoption. We are currently evaluating the potential impact of adoption of this guidance on our consolidated financial statements.

Retirement Benefit Plans

In August 2018, the FASB issued authoritative guidance under ASU 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans. This ASU eliminates requirements for certain disclosures and requires additional disclosures under defined benefit pension plans and other post-retirement plans. We are required to adopt this new guidance in the first quarter of fiscal 2021. We are currently evaluating the potential impact of the adoption of this guidance on our consolidated financial statements.

Intangibles

In August 2018, the FASB issued authoritative guidance under ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software: Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. This ASU requires implementation costs incurred by customers in cloud computing arrangements (i.e., hosting arrangements) to be capitalized under the same premises of authoritative guidance for internal-use software and deferred over the non-cancellable term of the cloud computing arrangements plus any option renewal periods that are reasonably certain to be exercised by the customer or for which the exercise is controlled by the service provider. We are required to adopt this new guidance in the first quarter of fiscal 2021. We are currently evaluating the potential impact of adoption of this guidance on our consolidated financial statements.

2. Business Combinations

Under ASC 805, Business Combinations, the acquisition method of accounting requires us to record assets acquired less liabilities assumed in an acquisition at their estimated fair values at the date of acquisition. Any excess of the total estimated purchase consideration over the estimated fair value of the assets acquired less liabilities assumed should be recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customers, acquired technology, trade names, useful lives and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. We may record adjustments to the assets acquired and liabilities assumed, with corresponding adjustments to goodwill, during the one-year post-acquisition measurement period as additional information becomes available. Upon the conclusion of the measurement period, any subsequent adjustments are reflected in reported earnings.

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Fiscal Year 2020 Business Acquisition

There were no acquisitions during the six months ended December 31,2019.

Fiscal Year 2019 Business Acquisitions

In January 2019, we (through our Security division) completed an acquisition of a privately held sales and services company. The acquisition was financed with cash on hand and was in an amount determined to be insignificant by management.

In August 2018, we (through our Security division) completed an acquisition of a privately held services company for approximately $0.8 million, plus up to approximately $5 million in contingent consideration, which may be earned over a five-year period. The acquisition was financed with cash on hand. The goodwill recognized for this business is not deductible for income tax purposes.

In July 2018, we (through our Optoelectronics and Manufacturing division) acquired an optoelectronics solutions business for $17.5 million, plus up to $1 million in potential contingent consideration. The acquisition was financed with cash on hand and borrowings under our existing revolving bank line of credit. The goodwill recognized for this business is deductible for income tax purposes.

These business acquisitions, individually and in the aggregate, were not material to our consolidated financial statements. Accordingly, pro-forma historical results of operations related to these businesses have not been presented.

3. Balance Sheet Details

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

<

June 30, 

December 31, 

Accounts receivable, net

    

2019

    

2019

Accounts receivable

$

253,504

$

272,285

Less allowance for doubtful accounts

 

(15,064)