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OSI Systems 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark one)

 

 

x

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

 

 

 

For the quarterly period ended March 31, 2011

 

 

 

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 0-23125

 


 

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 Number)

 

12525 Chadron Avenue

Hawthorne, California 90250

(Address of principal executive offices)

 

(310) 978-0516

(Registrant’s telephone number, including area code)

 


 

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 o  No x

 

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 o

 

Accelerated filer x

 

 

 

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 April 25, 2011, there were 19,051,818 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, 2010 and March 31, 2011

3

 

Condensed Consolidated Statements of Operations for the three and nine months ended March 31, 2010 and 2011

4

 

Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2010 and 2011

5

 

Notes to Condensed Consolidated Financial Statements

6

Item 2 —

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

13

Item 3 —

Quantitative and Qualitative Disclosures about Market Risk

19

Item 4 —

Controls and Procedures

20

 

 

PART II — OTHER INFORMATION

20

Item 1 —

Legal Proceedings

20

Item 1A —

Risk Factors

20

Item 6 —

Exhibits

20

Signatures

 

21

 

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)

 

 

 

June 30,

 

March 31,

 

 

 

2010

 

2011

 

ASSETS

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

51,989

 

$

39,630

 

Accounts receivable

 

132,728

 

136,357

 

Other receivables

 

2,859

 

4,042

 

Inventories

 

125,930

 

159,870

 

Deferred income taxes

 

17,262

 

16,446

 

Prepaid expenses and other current assets

 

18,433

 

15,605

 

Total current assets

 

349,201

 

371,950

 

Property and equipment, net

 

51,515

 

52,064

 

Goodwill

 

63,941

 

70,332

 

Intangible assets, net

 

31,975

 

33,657

 

Other assets

 

16,482

 

24,292

 

 

 

 

 

 

 

Total assets

 

$

513,114

 

$

552,295

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Current portion of long-term debt

 

$

12,743

 

$

221

 

Accounts payable

 

49,673

 

76,076

 

Accrued payroll and employee benefits

 

23,953

 

20,353

 

Advances from customers

 

25,325

 

20,648

 

Accrued warranties

 

10,930

 

14,056

 

Deferred revenue

 

7,698

 

9,760

 

Other accrued expenses and current liabilities

 

14,272

 

15,522

 

Total current liabilities

 

144,594

 

156,636

 

Long-term debt

 

23,366

 

2,814

 

Other long-term liabilities

 

31,444

 

35,327

 

 

 

 

 

 

 

Total liabilities

 

199,404

 

194,777

 

Commitment and contingencies (Note 7)

 

 

 

 

 

Shareholders’ Equity:

 

 

 

 

 

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

 

 

 

Common stock, $0.001 par value—authorized, 100,000,000 shares; issued and outstanding, 18,326,133 at June 30, 2010 and 19,047,932 shares at March 31, 2011

 

244,026

 

258,676

 

Retained earnings

 

76,681

 

98,055

 

Accumulated other comprehensive income (loss)

 

(6,997

)

787

 

Total shareholders’ equity

 

313,710

 

357,518

 

Total liabilities and shareholders’ equity

 

$

513,114

 

$

552,295

 

 

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 amount data)

(Unaudited)

 

 

 

For the Three Months Ended
March 31,

 

For the Nine Months Ended
March 31,

 

 

 

2010

 

2011

 

2010

 

2011

 

Revenues

 

$

145,401

 

$

174,931

 

$

429,783

 

$

472,671

 

Cost of goods sold

 

92,184

 

112,678

 

275,734

 

303,497

 

Gross profit

 

53,217

 

62,253

 

154,049

 

169,174

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

34,789

 

37,116

 

101,679

 

103,050

 

Research and development

 

9,129

 

12,436

 

27,471

 

33,509

 

Restructuring and other charges

 

946

 

905

 

1,553

 

2,064

 

Total operating expenses

 

44,864

 

50,457

 

130,703

 

138,623

 

Income from operations

 

8,353

 

11,796

 

23,346

 

30,551

 

Interest expense and other income, net

 

175

 

612

 

(1,214

)

(484

)

Income before provision for income taxes

 

8,528

 

12,408

 

22,132

 

30,067

 

Provision for income taxes

 

2,416

 

3,642

 

6,558

 

8,691

 

Net income

 

$

6,112

 

$

8,766

 

$

15,574

 

$

21,376

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.34

 

$

0.46

 

$

0.88

 

$

1.14

 

Diluted

 

$

0.33

 

$

0.45

 

$

0.85

 

$

1.10

 

Shares used in per share calculation:

 

 

 

 

 

 

 

 

 

Basic

 

18,066

 

18,978

 

17,737

 

18,721

 

Diluted

 

18,772

 

19,687

 

18,219

 

19,424

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(Unaudited)

 

 

 

For the Nine Months Ended
March 31

 

 

 

2010

 

2011

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

15,574

 

$

21,376

 

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

 

 

 

 

 

Depreciation and amortization

 

13,208

 

13,819

 

Stock based compensation expense

 

3,685

 

4,284

 

Provision for (recovery of) losses on accounts receivable

 

(417

)

761

 

Equity in earnings of unconsolidated affiliates

 

(402

)

(391

)

Deferred income taxes

 

(1,703

)

1,071

 

Other

 

120

 

170

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(2,493

)

(1,686

)

Other receivables

 

249

 

(961

)

Inventories

 

22,079

 

(30,188

)

Prepaid expenses and other current assets

 

(6,231

)

(2,101

)

Accounts payable

 

(14,501

)

24,078

 

Accrued payroll and related expenses

 

429

 

(4,061

)

Advances from customers

 

17,870

 

(6,019

)

Accrued warranties

 

70

 

2,839

 

Deferred revenue

 

(1,334

)

1,451

 

Other accrued expenses and current liabilities

 

(6,344

)

204

 

Net cash provided by operating activities

 

39,859

 

24,646

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Acquisition of property and equipment

 

(12,367

)

(7,506

)

Acquisition of businesses-net of cash acquired

 

(3,241

)

(5,558

)

Acquisition of intangible and other assets

 

(2,225

)

(2,897

)

Net cash used in investing activities

 

(17,833

)

(15,961

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Repayment of bank lines of credit

 

(4,000

)

 

Payments on long-term debt

 

(9,527

)

(32,546

)

Payments of capital lease obligations

 

(495

)

(710

)

Proceeds from exercise of stock options and employee stock purchase plan

 

11,751

 

9,912

 

Net cash used in financing activities

 

(2,271

)

(23,344

)

EFFECT OF EXCHANGE RATE CHANGES ON CASH

 

1,410

 

2,300

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

21,165

 

(12,359

)

CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD

 

25,172

 

51,989

 

CASH AND CASH EQUIVALENTS - END OF PERIOD

 

$

46,337

 

$

39,630

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Interest paid

 

$

1,885

 

$

1,062

 

Income taxes paid

 

$

5,756

 

$

5,673

 

 

See accompanying notes to condensed consolidated financial statements.

 

5



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. The Company sells its products in diversified markets, including homeland security, healthcare, defense and aerospace.

 

The Company has three operating divisions: (i) Security, providing security inspection systems 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 for the Security and Healthcare divisions as well as for applications in the defense and aerospace markets, among others.

 

Through its Security division, the Company designs, manufactures, markets and services security and inspection systems worldwide, and provides turnkey security screening solutions. The Security division’s products are used to inspect baggage, cargo, vehicles and other objects for weapons, explosives, drugs and other contraband, and to screen people. These products and services are also used for the safe, accurate and efficient verification of cargo manifests for the purpose of assessing duties and monitoring the export and import of controlled materials.

 

Through its Healthcare division, the Company designs, manufactures, markets and services patient monitoring, diagnostic cardiology and anesthesia delivery and ventilation systems worldwide primarily under the “Spacelabs” trade name. These products are used by care providers in critical care, emergency and perioperative areas within hospitals as well as physician 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 diagnostics, telecommunications, office automation, computer peripherals and industrial automation. 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, 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 have been included. 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, 2010, filed with the Securities and Exchange Commission on August 27, 2010. The results of operations for the three months and nine months ended March 31, 2011, are not necessarily indicative of the operating results to be expected for the full fiscal year or any future periods.

 

6



Table of Contents

 

Per Share Computations

 

The Company computes basic earnings per share by dividing net income available to common shareholders 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 shareholders 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 or warrants under the treasury stock method. Stock options and warrants to purchase a total of 0.7 million and 0.1 million shares of common stock for the nine months ended March 31, 2010 and 2011, respectively, were not included in diluted earnings per share calculations because to do so would have been antidilutive, while no options or warrants were excluded from the calculation for the three months ended March 31, 2010 and 2011. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2010

 

2011

 

2010

 

2011

 

Net income available to common shareholders

 

$

6,112

 

$

8,766

 

$

15,574

 

$

21,376

 

Weighted average shares outstanding — basic

 

18,066

 

18,978

 

17,737

 

18,721

 

Dilutive effect of stock options and warrants

 

706

 

709

 

482

 

703

 

Weighted average of shares outstanding — diluted

 

18,772

 

19,687

 

18,219

 

19,424

 

 

Comprehensive Income

 

Comprehensive income is computed as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2010

 

2011

 

2010

 

2011

 

Net income

 

$

6,112

 

$

8,766

 

$

15,574

 

$

21,376

 

Foreign currency translation adjustments

 

(1,560

)

2,983

 

(1,765

)

6,778

 

Reversal of losses (gains) on derivatives and investments

 

(270

)

 

237

 

1,064

 

Other

 

(506

)

(169

)

(505

)

(59

)

Comprehensive income

 

$

3,776

 

$

11,580

 

$

13,541

 

$

29,159

 

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist primarily of cash, marketable securities, accounts receivable, accounts payable and debt instruments. The carrying values of financial instruments, other-than-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.  The Company has determined that all of its marketable securities fall into the “Level 1” category, which values assets at the quoted prices in active markets for identical assets; while the Company’s derivative instruments fall into the “Level 2” category, which values assets and liabilities from observable inputs other than quoted market prices. There were no assets or liabilities for which “Level 3” valuation techniques were used and there were no assets and liabilities measured at fair value on a non-recurring basis.

 

The fair values of such assets/ (liabilities) are:

 

 

 

June 30,
2010

 

March 31,
2011

 

Level 1

 

$

5,750

 

$

7,371

 

Level 2

 

(244

)

20

 

Total

 

$

5,506

 

$

7,391

 

 

Derivative Instruments and Hedging Activity

 

The Company’s use of derivatives consists primarily of foreign exchange contracts and interest rate swap agreements. As of March 31, 2011, the Company had outstanding a foreign currency forward contract of approximately $5.2 million to sell foreign currencies in anticipation of settlement in fiscal 2012 of sales denominated in that currency.  The forward contract is considered an effective cash flow hedge.  As a result, the net loss on such derivative contract has been reported as a component of other comprehensive income in the Condensed Consolidated Financial Statements and is reclassified as net earnings when the hedge transaction settles.

 

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.

 

7



Table of Contents

 

Recent Accounting Updates Not Yet Adopted

 

There are no recent accounting updates not yet adopted by the Company that are material.

 

2. Balance Sheet Details

 

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

 

 

 

June 30,
2010

 

March 31,
2011

 

Accounts receivable

 

 

 

 

 

Trade receivables

 

$

138,734

 

$

141,283

 

Less: allowance for doubtful accounts

 

(6,006

)

(4,926

)

Accounts receivable, net

 

$

132,728

 

$

136,357

 

 

 

 

June 30,
2010

 

March 31,
2011

 

Inventories, net

 

 

 

 

 

Raw materials

 

$

69,421

 

$

93,441

 

Work-in-process

 

20,847

 

30,989

 

Finished goods

 

35,662

 

35,440

 

Total

 

$

125,930

 

$

159,870

 

 

 

 

June 30,
2010

 

March 31,
2011

 

Property and equipment

 

 

 

 

 

Land

 

$

5,078

 

$

5,300

 

Buildings

 

8,618

 

9,417

 

Leasehold improvements

 

12,549

 

13,238

 

Equipment and tooling

 

62,861

 

67,147

 

Furniture and fixtures

 

4,753

 

4,896

 

Computer equipment

 

17,738

 

19,012

 

Software

 

13,859

 

14,593

 

Total

 

125,456

 

133,603

 

Less: accumulated depreciation and amortization

 

(73,941

)

(81,539

)

Property and equipment, net

 

$

51,515

 

$

52,064

 

 

3. Goodwill and Intangible Assets

 

The goodwill acquired during the period within the Security and the Optoelectronics and Manufacturing divisions related to acquisitions of businesses that were considered immaterial individually and in the aggregate to the Company. The changes in the carrying value of goodwill for the nine month period ended March 31, 2011, are as follows (in thousands):

 

 

 

Security

 

Healthcare

 

Optoelectronics
and
Manufacturing

 

Consolidated

 

Balance as of June 30, 2010

 

$

16,566

 

$

35,403

 

$

11,972

 

$

63,941

 

Goodwill acquired during the period

 

3,863

 

 

1,760

 

5,623

 

Foreign currency translation adjustment

 

546

 

212

 

10

 

768

 

Balance as of March 31, 2011

 

$

20,975

 

$

35,615

 

$

13,742

 

$

70,332

 

 

8



Table of Contents

 

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

June 30, 2010

 

March 31, 2011

 

 

 

Weighted
Average
Lives

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Intangibles
Net

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Intangibles
Net

 

Amortizable assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Software development costs

 

5 years

 

$

11,877

 

$

3,954

 

$

7,923

 

$

13,436

 

$

4,524

 

$

8,912

 

Patents

 

9 years

 

1,630

 

388

 

1,242

 

2,498

 

434

 

2,064

 

Core technology

 

10 years

 

2,029

 

1,094

 

935

 

2,153

 

1,323

 

830

 

Developed technology

 

13 years

 

17,246

 

8,942

 

8,304

 

18,974

 

10,385

 

8,589

 

Customer relationships/ backlog

 

7 years

 

10,437

 

6,132

 

4,305

 

11,107

 

7,171

 

3,936

 

Total amortizable assets

 

 

 

43,219

 

20,510

 

22,709

 

48,168

 

23,837

 

24,331

 

Non-amortizable assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks

 

 

 

9,266

 

 

9,266

 

9,326

 

 

9,326

 

Total intangible assets

 

 

 

$

52,485

 

$

20,510

 

$

31,975

 

$

57,494

 

$

23,837

 

$

33,657

 

 

Amortization expense related to intangibles assets totaled $3.1 and $3.2 million for the nine months ended March 31, 2010 and 2011, respectively; and $1.0 million and $1.1 million for the three months ended March 31, 2010 and 2011, respectively. At March 31, 2011, the estimated future amortization expense was as follows (in thousands):

 

2011 (remaining 3 months)

 

$

1,089

 

2012

 

4,325

 

2013

 

4,027

 

2014

 

2,842

 

2015

 

1,455

 

2016

 

1,789

 

2017 and thereafter

 

8,804

 

Total

 

$

24,331

 

 

4. Borrowings

 

On October 15, 2010, the Company entered into a credit agreement with a syndicate of banks for a $250 million revolving credit facility.  This credit agreement replaced the prior agreement described below, which was repaid and terminated simultaneously with the close of the new agreement.  The new facility consists of a $250 million, five-year revolving credit facility, including a $155 million sub-limit for letters of credit.  Borrowings under this facility bear interest, based on the Company’s option, at either (i) London Interbank Offered Rate (LIBOR) plus margins that range from 2.00% to 2.50% or (ii) the sum of margins that range from 1.00% to 1.50% and the higher of (a) the bank’s prime rate, (b) the Fed Funds rate plus 0.5% or (c) LIBOR plus 1.0%.  The margins are determined by the Company’s consolidated leverage ratio.  The Company’s borrowings under the credit agreement are guaranteed by the Company’s U.S.-based subsidiaries and are secured by substantially all of the Company’s and certain subsidiaries’ assets. The agreement contains various representations, warranties, affirmative, negative and financial covenants, and conditions of default customary for financing agreements of this type, including restrictions on the Company’s ability to pay cash dividends. As of March 31, 2011, there was no debt outstanding under the revolving credit facility and $34.5 million was outstanding under the letter-of-credit facility.

 

Prior to the closing of the aforementioned revolving credit facility, the Company maintained a credit agreement with certain lenders allowing for a $74.5 million revolving credit facility (including a $64.5 million sub-limit for letters-of-credit) and an amortizing five-year term loan, which would have matured in July 2012.  Borrowings under the agreement bore interest at either (i) LIBOR plus margins that range from 2.00% to 2.50% or (ii) the sum of margins that range from 1.00% to 1.50% and the higher of (a) the bank’s prime rate or (b) Fed Funds rate plus 0.5%. The rates were determined based on the Company’s consolidated leverage ratio.  The Company’s borrowings under the credit agreement were guaranteed by the Company’s U.S.-based subsidiaries and secured by substantially all of the Company’s and certain subsidiaries’ assets. The agreement contained various representations, warranties, affirmative, negative and financial covenants, and conditions of default customary for financing agreements of this type, including restrictions on the Company’s ability to pay cash dividends.

 

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 March 31, 2011, $15.9 million was outstanding under these letter-of-credit facilities, while no debt was outstanding. As of March 31, 2011, the total amount available under these credit facilities was $21.8 million, with a total cash borrowing sub-limit of $4.2 million.

 

In fiscal 2005, the Company entered into a bank loan of $5.3 million to fund the acquisition of land and buildings in the U.K. The loan is payable over a 20-year period. The loan bears interest at British pound-based LIBOR plus 1.2%, payable on a quarterly basis. As of March 31, 2011, $3.0 million remained outstanding under this loan at an interest rate of 2.0% per annum.

 

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Table of Contents

 

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

 

 

 

June 30,
2010

 

March 31,
2011

 

Five-year term loan due in fiscal 2013

 

$

32,281

 

$

 

Twenty-year term loan due in fiscal 2024

 

3,015

 

3,035

 

Capital leases and other

 

813

 

 

 

 

36,109

 

3,035

 

Less current portion of long-term debt

 

12,743

 

221

 

Long-term portion of debt

 

$

23,366

 

$

2,814

 

 

5. Stock-based Compensation

 

As of March 31, 2011, the Company maintained an equity participation plan and an employee stock purchase plan.

 

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

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2010

 

2011

 

2010

 

2011

 

Cost of goods sold

 

$

89

 

$

111

 

$

229

 

$

281

 

Selling, general and administrative

 

1,130

 

1,358

 

3,279

 

3,827

 

Research and development

 

68

 

63

 

177

 

176

 

Total stock-based compensation expense

 

$

1,287

 

$

1,532

 

$

3,685

 

$

4,284

 

 

As of March 31, 2011, total unrecognized compensation cost related to non-vested share-based compensation arrangements granted was approximately $10.7 million. The Company expects to recognize these costs over a weighted-average period of 2.7 years.

 

6. Retirement Benefit Plans

 

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

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2010

 

2011

 

2010

 

2011

 

Service cost

 

$

2

 

$

130

 

$

36

 

$

408

 

Interest cost

 

61

 

 

147

 

 

Amortization of net loss

 

165

 

112

 

317

 

335

 

Net periodic pension expense

 

$

228

 

$

242

 

$

500

 

$

743

 

 

For each of the three months ended March 31, 2010 and 2011, the Company made contributions of $0.1 million to these defined benefit plans. For the nine months ended March 31, 2010 and 2011, the Company made contributions of $0.3 million and $1.0 million, respectively, to these defined benefit plans.

 

In addition, the Company maintains various defined contribution plans. For the three months ended March 31, 2010 and 2011, the Company made contributions of $1.0 million and $0.9 million, respectively, to these defined contribution plans. For the nine months ended March 31, 2010 and 2011, the Company made contributions of $2.6 million and $3.3 million, respectively, to these defined contribution plans.

 

7. Commitments and Contingencies

 

Legal Proceedings

 

The Company is involved in various claims and legal proceedings arising out of 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 financial position, future 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 results of operations, financial position and/or liquidity could be material.

 

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Table of Contents

 

Contingent Acquisition Obligations

 

Under the terms and conditions of the purchase agreements associated with certain acquisitions, the Company may be obligated to make additional payments based on the achievement by the acquired operations of certain sales or profitability milestones.   Some of the purchase agreements the Company has entered into do not cap the total payments that may be earned or have a finite period for such payments. For acquisitions that occurred prior to fiscal year 2010, which were accounted for under Statement of Financial Accounting Standards 141, “Business Combinations,” the Company accounts for such contingent payments as an addition to the purchase price of the acquired company. For acquisitions accounted for under Accounting Standards Codification 805, “Purchase Price Allocations,” (“ASC 805”), the estimated fair value of these obligations is recorded as a liability in the condensed consolidated balance sheet with subsequent revisions reflected in the condensed consolidated statements of operations. As of June 30, 2010 and March 31, 2011, pursuant to ASC 805, $5.1 million and $9.2 million of contingent payment obligations, respectively, are included in other long-term liabilities in the accompanying condensed consolidated balance sheet.  During the three months ended March 31, 2010 and 2011, the fair values of these contingent obligations were revised and resulted in reductions of $0.7 million and $1.2 million, respectively.  Such reductions were recorded as other income in the condensed consolidated statements of operations.

 

Environmental Contingencies

 

The Company is subject to various environmental laws. The Company’s practice is to ensure that Phase I environmental site assessments are conducted 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. The Company filed the requisite reports concerning this problem with the appropriate environmental authorities in fiscal 2001. The Company has not yet received any response to such reports, and no agency action or litigation is presently pending or threatened. The Company’s site was previously used by other companies for semiconductor manufacturing similar to that presently conducted on the site, and it is not presently known who is responsible for the contamination or, if required, the remediation. The groundwater contamination is a known regional problem, not limited to the Company’s premises or its immediate surroundings.

 

The Company has also been informed of soil and groundwater evaluation efforts at a facility that its Ferson Technologies subsidiary previously leased in Ocean Springs, Mississippi. Ferson Technologies occupied the facility until October 2003. The Company believes that the owner and previous occupants of the facility have primary responsibility for any remediation that may be required and have an agreement with the facility’s owner under which the owner is responsible for remediation of pre-existing conditions. However, as site evaluation efforts are still in progress, and may be for some time, the Company is unable at this time to ascertain whether Ferson Technologies bears any exposure for remediation costs under applicable environmental regulations.

 

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

 

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 and anticipated experience. 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
March 31,

 

Nine Months Ended
March 31,

 

 

 

2010

 

2011

 

2010

 

2011

 

Balance at beginning of period

 

$

10,170

 

$

12,069

 

$

10,106

 

$

10,930

 

Additions

 

606

 

3,175

 

2,603

 

6,145

 

Reductions for warranty repair costs

 

(834

)

(1,188

)

(2,767

)

(3,019

)

Balance at end of period

 

$

9,942

 

$

14,056

 

$

9,942

 

$

14,056

 

 

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Table of Contents

 

8. Income Taxes

 

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

 

9. Segment Information

 

The Company operates in three identifiable industry segments: (i) Security, providing security and inspection systems, and turnkey security screening solutions; (ii) Healthcare, providing patient monitoring, diagnostic cardiology and anesthesia systems; and (iii) Optoelectronics and Manufacturing, providing specialized electronic components for affiliated end-products divisions, as well as for applications in the healthcare, defense and aerospace markets, among others. The Company also has a Corporate segment that includes executive compensation and certain other general and administrative expenses. Interest expense and certain expenses related to legal, audit and other professional service fees are not allocated to industry segments. Both the Security and Healthcare divisions comprise primarily end-product businesses, whereas the Optoelectronics and Manufacturing division comprises businesses that primarily supply components and subsystems to original equipment manufacturers, including to the businesses of the Security and Healthcare divisions. All intersegment sales are eliminated in consolidation.

 

The following table presents segment information (in thousands):

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2010

 

2011

 

2010

 

2011

 

Revenues — by Segment:

 

 

 

 

 

 

 

 

 

Security division

 

$

69,341

 

$

88,173

 

$

175,768

 

$

215,973

 

Healthcare division

 

45,910

 

51,114

 

149,920

 

152,837

 

Optoelectronics and Manufacturing division, including intersegment revenues

 

38,177

 

47,865

 

127,631

 

137,458

 

Intersegment revenues elimination

 

(8,027

)

(12,221

)

(23,536

)

(33,597

)

Total

 

$

145,401

 

$

174,931

 

$

429,783

 

$

472,671

 

 

 

 

 

 

 

 

 

 

 

Revenues — by Geography:

 

 

 

 

 

 

 

 

 

Americas

 

$

105,091

 

$

134,179

 

$

312,007

 

$

354,277

 

Europe

 

31,732

 

31,072

 

97,812

 

86,146

 

Asia

 

16,605

 

21,901

 

43,500

 

65,845

 

Intersegment revenues elimination

 

(8,027

)

(12,221

)

(23,536

)

(33,597

)

Total

 

$

145,401

 

$

174,931

 

$

429,783

 

$

472,671

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss) — by Segment:

 

 

 

 

 

 

 

 

 

Security division

 

$

7,096

 

$

8,177

 

$

13,198

 

$

17,292

 

Healthcare division

 

1,706

 

2,274

 

9,009

 

10,536

 

Optoelectronics and Manufacturing division

 

1,504

 

4,284

 

8,222

 

11,975

 

Corporate

 

(2,390

)

(2,805

)

(8,359

)

(8,053

)

Eliminations (1)

 

437

 

(134

)

1,276

 

(1,199

)

Total

 

$

8,353

 

$

11,796

 

$

23,346

 

$

30,551

 

 

 

 

June 30,
2010

 

March 31,
2011

 

Assets — by Segment:

 

 

 

 

 

Security division

 

$

221,019

 

$

242,231

 

Healthcare division

 

138,739

 

146,582

 

Optoelectronics and Manufacturing division

 

85,170

 

108,822

 

Corporate

 

72,731

 

60,404

 

Eliminations (1)

 

(4,545

)

(5,744

)

Total

 

$

513,114

 

$

552,295

 

 


(1)         Eliminations within operating income primarily reflect the change in the elimination of intercompany profit in inventory not-yet-realized; while the 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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Table of Contents

 

Item 2.                                    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Statement

 

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 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. Forward-looking statements involve 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. 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.

 

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, 2010.

 

Recent Accounting Pronouncements

 

We describe recent accounting pronouncements in Item 1 — “Condensed Consolidated Financial Statements — Notes to Condensed Consolidated Financial Statements.”

 

Executive Summary

 

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

 

Security Division. Through our Security division, we design, manufacture, market and service security and inspection systems, and provide turnkey security screening solutions worldwide for sale primarily to U.S. federal, state and local government agencies as well as to foreign customers. 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 46% and 41% of our total consolidated revenues for the nine months ended March 31, 2011 and 2010, 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.

 

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Table of Contents

 

Healthcare Division. Through our Healthcare division, we design, manufacture, market and service patient monitoring, diagnostic cardiology and anesthesia systems 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 32% and 35% of our total consolidated revenues for the nine months ended March 31, 2011 and 2010, 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. 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 products than we have historically experienced, resulting in a negative impact on our sales. Although there are indications that a recovery is underway, we cannot predict when the markets will fully recover 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 value-added manufacturing services worldwide for use in a broad range of applications, including aerospace and defense electronics, security and inspection systems, medical imaging and diagnostics, computed tomography, fiber optics, telecommunications, office automation, computer peripherals and industrial automation. 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 22% and 24% of our total consolidated revenues for the nine months ended March 31, 2011 and 2010, respectively.

 

Results of Operations

 

Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010.

 

Net Revenues

 

The table below and the discussion that follows are based upon the way in which we analyze our business. See Note 9 to the condensed consolidated financial statements for additional information about our business segments.

 

(in millions)

 

Q3
2010

 

% of
Net Sales

 

Q3
2011

 

% of
Net Sales

 

$ Change

 

% Change

 

Security division

 

$

69.3

 

48

%

$

88.2

 

51

%

$

18.9

 

27

%

Healthcare division

 

45.9

 

32

%

51.1

 

29

%

5.2

 

11

%

Optoelectronics and Manufacturing division

 

38.2

 

26

%

47.8

 

27

%

9.6

 

25

%

Intersegment revenues

 

(8.0

)

(6

)%

(12.2

)

(7

)%

(4.2

)

53

%

Total revenues

 

$

145.4

 

100

%

$

174.9

 

100

%

$

29.5

 

20

%

 

Net revenues for the three months ended March 31, 2011, increased $29.5 million, or 20%, to $174.9 million, from $145.4 million for the comparable prior-year period.

 

Revenues for the Security division for the three months ended March 31, 2011, increased $18.9 million, or 27%, to $88.2 million, from $69.3 million for the comparable prior-year period. The increase was primarily attributable to: (i) a $15.3 million, or 27% increase in equipment sales mainly driven by a $7.3 million increase in sales of our baggage and parcel inspection, hold baggage screening and people screening equipment, as well as a $7.0 million increase in sales of our cargo and vehicle inspection equipment; and (ii) a $3.5 million or 29% increase in revenue related to contracts to service such equipment.  The increase in service revenue was due to the growing installed equipment base, from which we derive service revenues as warranty periods expire.

 

Revenues for the Healthcare division for the three months ended March 31, 2011, increased $5.2 million, or 11%, to $51.1 million, from $45.9 million for the comparable prior-year period.  The increase was primarily attributable to a $6.4 million, or 20% increase in patient monitoring product revenues, partially offset by a $1.1 million, or 12% decrease in cardiology product revenues.

 

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Table of Contents

 

Revenues for the Optoelectronics and Manufacturing division for the three months ended March 31, 2011, increased by $9.6 million, or 25%, to $47.8 million, from $38.2 million for the comparable prior-year period.  This increase was primarily attributable to: (i) a $6.3 million increase in commercial optoelectronics sales, consisting of a $4.5 million increase in sales to external customers as well as $1.8 million increase in intersegment sales, primarily to our Security division and (ii) a $3.4 million increase in contract manufacturing sales attributable to: (a) a $1.0 million increase in sales to external customers and (b) a $2.4 million increase in intersegment sales, primarily to our Healthcare division. The Optoelectronics and Manufacturing division recorded intersegment sales of $12.2 million, compared to $8.0 million in the comparable prior-year period.  This increase in intersegment sales is consistent with the sales growth of our Security and Healthcare divisions during the quarter. Such intersegment sales are eliminated in consolidation.

 

Gross Profit

 

(in millions)

 

Q3
2010

 

% of
Net Sales

 

Q3
2011

 

% of
Net Sales

 

Gross profit

 

$

53.2

 

36.6

%

$

62.3

 

35.6

%

 

Gross profit increased $9.1 million, or 17%, to $62.3 million for the three months ended March 31, 2011, from $53.2 million for the comparable prior-year period, primarily as a result of a 20% increase in revenue.  The gross margin during the period declined by 1%, due primarily to relatively faster growth within our Security and Optoelectronics and Manufacturing divisions (which generate lower gross margin than our Healthcare division) when compared to the growth in our Healthcare division.

 

Operating Expenses

 

(in millions)

 

Q3
2010

 

% of
Net Sales

 

Q3
2011

 

% of
Net Sales

 

$ Change

 

% Change

 

Selling, general and administrative

 

$

34.8

 

23.9

%

$

37.1

 

21.2

%

$

2.3

 

7

%

Research and development

 

9.1

 

6.3

%

12.5

 

7.2

%

3.4

 

37

%

Restructuring and other charges

 

0.9

 

0.6

%

0.9

 

0.5

%

 

%

Total operating expenses

 

$

44.8

 

30.8

%

$

50.5

 

28.9

%

$

5.7

 

13

%

 

Selling, general and administrative expenses. 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 March 31, 2011, SG&A expenses increased by $2.3 million, or 7%, to $37.1 million, from $34.8 million for the comparable prior-year period. This increase in spending was primarily attributable to an increase in costs to support the 27% revenue growth in our Security division.  As a percentage of revenues, SG&A expenses were 21.2% for the three months ended March 31, 2011, compared to 23.9% for the comparable prior-year period. This decrease was a result of our ability to leverage our sales and administrative infrastructure.

 

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 March 31, 2011, such expenses increased $3.4 million, or 37%, to $12.5 million, from $9.1 million for the comparable prior-year period. As a percentage of revenues, R&D expenses were 7.2% for the three months ended March 31, 2011, compared to 6.3% for the comparable prior-year period. This increase in R&D expenses resulted from an increase in R&D investment in our Security and Healthcare divisions in support of multiple new product introductions.

 

Restructuring and other charges.  In response to the challenging worldwide economic conditions, we continued to optimize our cost structure during the third quarter of fiscal 2011.  In conjunction with these efforts, we incurred non-recurring restructuring and other charges of $0.8 million in our Healthcare division, primarily for employee severance during the three months ended March 31, 2011.  We also incurred restructuring charges of $0.1 million in our Corporate segment as compared to $0.9 million for the comparable prior-year period.

 

Interest and other income, net. For the three months ended March 31, 2011, interest and other income, net, amounted to $0.6 million, as compared to $0.2 million for the same prior-year period.  This $0.4 million improvement primarily resulted from a $1.2 million reduction, during the three months ended March 31, 2011, in a contingent acquisition liability, compared to a $0.7 million reduction in the prior year period.

 

Income taxes. For the three months ended March 31, 2011, our income tax provision was $3.6 million, compared to $2.4 million for the comparable prior-year period. Our effective tax rate for the three months ended March 31, 2011, was 29.4%, compared to 28.3% in the comparable prior-year period. Our provision for income taxes is dependent on the mix of income from U.S. and foreign locations due to tax rate differences among such countries as well as due to the impact of permanent taxable differences.

 

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Table of Contents

 

Nine Months Ended March 31, 2011 Compared to Nine Months Ended March 31, 2010.

 

Net Revenues

 

The table below and the discussion that follows are based upon the way in which we analyze our business. See Note 9 to the condensed consolidated financial statements for additional information about our business segments.

 

(in millions)

 

YTD Q3
2010

 

% of
Net Sales

 

YTD Q3
2011

 

% of
Net Sales

 

$ Change

 

% Change

 

Security division

 

$

175.8

 

41

%

$

216.0

 

46

%

$

40.2

 

23

%

Healthcare division

 

149.9

 

35

%

152.8

 

32

%

2.9

 

2

%

Optoelectronics and Manufacturing division

 

127.6

 

30

%

137.5

 

29

%

9.9

 

8

%

Intersegment revenues

 

(23.5

)

(6

)%

(33.6

)

(7

)%

(10.1

)

(43

)%

Total revenues

 

$

429.8

 

100

%

$

472.7

 

100

%

$

42.9

 

10

%

 

Net revenues for the nine months ended March 31, 2011, increased $42.9 million, or 10%, to $472.7 million, from $429.8 million for the comparable prior-year period.

 

Revenues for the Security division for the nine months ended March 31, 2011, increased $40.2 million, or 23%, to $216.0 million, from $175.8 million for the comparable prior-year period.  The increase was primarily attributable to: (i) a $34.1 million, or 25%, increase in equipment sales, mainly driven by a $26.4 million increase in our baggage and parcel inspection, hold baggage screening and people screening equipment as well as a $4.3 million increase in sales of cargo and vehicle inspection equipment and (ii) a $6.1 million, or 17%, increase in revenue related to contracts to service such equipment.  The increase in service revenue was due to the growing installed equipment base, from which we derive service revenues as warranty periods expire.

 

Revenues for the Healthcare division for the nine months ended March 31, 2011, increased $2.9 million, or 2%, to $152.8 million, from $149.9 million for the comparable prior-year period. The increase was primarily attributable to: (i) a $4.1 million increase in patient monitoring product revenues and (ii) a $1.3 million increase in anesthesia product revenues.  These increases were partially offset by a $2.1 million decrease in cardiology product revenues.

 

Revenues for the Optoelectronics and Manufacturing division for the nine months ended March 31, 2011, increased $9.9 million, or 8%, to $137.5 million, from $127.6 million for the comparable prior-year period.  This increase was primarily attributable to an $18.5 million increase in commercial optoelectronic revenues from external customers as well from intersegment sales, primarily to the Security division, offset by an $8.6 million decrease in contract manufacturing revenues mainly driven by an expected winding down of a large, defense-industry related contract. The Optoelectronics and Manufacturing division recorded intersegment sales of $33.6 million, compared to $23.5 million in the comparable prior-year period.  This increase in intersegment sales is consistent with the sales growth of our Security and Healthcare divisions during the period. Such intersegment sales are eliminated in consolidation.

 

Gross Profit

 

(in millions)

 

YTD Q3
2010

 

% of
Net Sales

 

YTD Q3
2011

 

% of
Net Sales

 

Gross profit

 

$

154.0

 

35.8

%

$

169.2

 

35.8

%

 

Gross profit increased $15.2 million, or 10%, to $169.2 million for the nine months ended March 31, 2011, from $154.0 million for the comparable prior-year period. The gross margin was unchanged at 35.8% for the nine months ended March 31, 2011 and the comparable prior-year period.  Gross margin remained constant because improvements in gross margin stemming from increased manufacturing efficiencies following recent facility consolidation and operational improvement initiatives were offset by a less favorable mix of product sales, as sales by our Healthcare division, which generates the highest gross margin across the three divisions, did not increase at the same rate as sales by our Security and Optoelectronics and Manufacturing divisions.

 

Operating Expenses

 

(in millions)

 

YTD Q3
2010

 

% of
Net Sales

 

YTD Q3
2011

 

% of
Net Sales

 

$ Change

 

% Change

 

Selling, general and administrative

 

$

101.7

 

23.7

%

$

103.0

 

21.8

%

$

1.3

 

1

%

Research and development

 

27.5

 

6.4

%

33.5

 

7.1

%

6.0

 

22

%

Restructuring and other charges

 

1.5

 

0.3

%

2.1

 

0.4

%

0.6

 

40

%

Total operating expenses

 

$

130.7

 

30.4

%

$

138.6

 

29.3

%

$

7.9

 

6

%

 

16



Table of Contents

 

Selling, general and administrative expenses. For the nine months ended March 31, 2011, SG&A expenses increased by $1.3 million, or 1%, to $103.0 million, from $101.7 million for the comparable prior-year period.  This $1.3 million increase in spending was primarily attributable to an increase in SG&A costs to support the 23% revenue growth in the Security division, partially offset by reductions in spending as a result of cost containment initiatives and restructuring activities focused on our Healthcare division. As a percentage of revenues, SG&A expenses were 21.8% for the nine months ended March 31, 2011, compared to 23.7% for the comparable prior-year period.  We achieved this decrease by effectively leveraging our sales and administrative infrastructure and maintaining the benefits of cost containment initiatives and restructuring activities undertaken in recent years.

 

Research and development. R&D expenses include research related to new product development and product enhancement expenditures. For the nine months ended March 31, 2011, such expenses increased $6.0 million, or 22%, to $33.5 million, from $27.5 million for the comparable prior-year period. As a percentage of revenues, research and development expenses were 7.1% for the nine months ended March 31, 2011, compared to 6.4% for the comparable prior-year period. The increase in R&D expenses for the nine month period ended March 31, 2011, primarily resulted from an increase in R&D investment in our Security and Healthcare divisions, in support of multiple new product introductions.

 

Restructuring and other charges. In response to the worldwide economic downturn, we initiated an aggressive cost-cutting plan in the first half of fiscal 2009 to reduce our fixed cost structure.  During the nine months ended March 31, 2011, we continued this effort to further increase our operating efficiencies.  In conjunction with these efforts, we incurred non-recurring restructuring and other charges of $1.2 million in our Healthcare division, primarily for employee severance, and $0.9 million in our Corporate segment, primarily for costs associated with the termination and repayment of our prior credit facility.  In the prior year period, we incurred restructuring charges of $1.6 million.

 

Other Income and Expenses

 

(in millions)

 

YTD Q3
2010

 

% of
Net Sales

 

YTD Q3
2011

 

% of
Net Sales

 

$ Change

 

% Change

 

Interest and other income, net

 

$

1.2

 

0.3

%

$

0.5

 

0.4

%

$

(0.7

)

(58

)%

 

Interest and other income, net. For the nine months ended March 31, 2011, interest and other income, net, amounted to ($0.5) million as compared to ($1.2) million for the same prior-year period.  This improvement was attributable to reduced average debt levels outstanding as well as a reduction in the liability for contingent acquisition consideration during the nine months ended March 31, 2011.

 

Income taxes. For the nine months ended March 31, 2011, our income tax provision was $8.7 million, compared to $6.6 million for the comparable prior-year period. Our effective tax rate for the nine months ended March 31, 2011, was 28.9%, compared to 29.6% in the comparable prior-year period. Our provision for income taxes is dependent on the mix of income from U.S. and foreign locations due to tax rate differences among such countries as well the impact of permanent taxable differences.

 

Liquidity and Capital Resources

 

To date, we have financed our operations primarily through cash flow from operations, proceeds from equity issuances and our credit facilities. Cash and cash equivalents totaled $39.6 million at March 31, 2011, a decrease of $12.4 million from $52.0 million at June 30, 2010. As further discussed below, the principal use of cash during the nine-months ended March 31, 2011 was the early pay down of a $32.5 million term loan associated with the termination of our prior credit facility. The changes in our working capital and cash and cash equivalent balances during the nine months ended are described below.

 

(in millions)

 

June 30,
2010

 

March 31,
2011

 

% Change

 

Working capital

 

$

204.6

 

$

215.3

 

5

%

Cash and cash equivalents

 

52.0

 

39.6

 

(24

)%

 

Working Capital. Working capital increased primarily due to: (i) a $33.9 million increase in inventory mainly in our Security division, to support anticipated growth in shipments; (ii) a $12.5 million decrease in the current portion of long term debt due to the repayment and termination of our former credit agreement, simultaneously with our entering into a new $250 million credit agreement in October 2010; (iii) a $4.7 million decrease in advances from customers and (iv) a $3.6 million increase in accounts receivables.  These increases to working capital were partially offset by: (i) a $26.4 million increase in accounts payable, driven in part by the increase in inventory as previously noted; (ii) a $12.4 million decrease in cash and cash equivalents mainly driven by the repayment of our debt facility; (iii) a $3.1 million increase in accrued warranties and (iv) a $2.8 million decrease in prepaid expenses and other current assets.

 

17



Table of Contents

 

(in millions)

 

YTD Q3
2010

 

YTD Q3
2011

 

$ Change

 

Cash provided by operating activities

 

$

39.9

 

$

24.6

 

$

(15.3

)

Cash used in investing activities

 

(17.8

)

(16.0

)

1.8

 

Cash used in financing activities

 

(2.3

)

(23.3

)

(21.0

)

 

Cash Provided by Operating Activities. Cash flows from operating activities can fluctuate significantly from period to period, as net income, tax timing differences, customer collections, vendor payments and other items can significantly impact cash flows. Net cash provided by operations for the nine months ended March 31, 2011, was $24.6 million, a decrease of $15.3 million from the $39.9 million provided in the comparable prior-year period. This reduction in net cash provided was primarily due to the changes in working capital in the current-year period versus the prior-year period resulting in: (i) a $52.3 million increase in the change in inventory, reflecting both a build-up of inventory mainly in our Security and Optoelectronics and Manufacturing divisions to support growth as well as improvements realized in the prior fiscal year from inventory reduction initiatives and (ii) a $23.9 million decrease in advances received from customers.  These unfavorable changes in cash flow were partially offset by the following favorable changes in working capital: (i) a $38.6 million increase in cash from accounts payable, which largely corresponds with the aforementioned inventory buildup; (ii) a $6.5 million increase in cash from other accrued expenses and current liabilities; (iii) a $4.1 million increase in cash from prepaid expenses and other current assets and (iv) a $11.0 million increase in net income for the nine months ended March 31, 2011, after giving consideration to non-cash operating items including depreciation and amortization, stock-based compensation and deferred taxes, among others, for both periods.

 

Cash Used in Investing Activities. Net cash used in investing activities was $16.0 million for the nine months ended March 31, 2011, compared to $17.8 million for the nine months ended March 31, 2010. During the nine months ended March 31, 2011, we invested $7.5 million in capital expenditures, as compared to $12.4 million during the comparable prior-year period. During the nine months ended March 31, 2011, we also paid $5.6 million for the acquisition of businesses, as compared to the $3.2 million during the comparable prior-year period.  During the nine months ended March 31, 2011, we paid $2.9 million for the acquisition of intangible assets such as software capitalization as compared to the $2.2 million during the comparable prior-year period.

 

Cash Used in Financing Activities. Net cash used in financing activities was $23.3 million for the nine months ended March 31, 2011, compared to $2.3 million for the nine months ended March 31, 2010. During the nine months ended March 31, 2011, we entered into a $250 million revolving credit facility with a syndicate of banks.  In connection with our entry into the new credit facility, we repaid $32.5 million in term loans issued under our former credit facility.  We also paid down our then-outstanding capital lease obligations by $0.7 million.  We received $9.9 million in proceeds from the exercise of stock options and the purchase of stock under our employee stock purchase plan, which partially offset the debt and capital lease payments.  In the prior-year period, we paid down our revolving lines of credit by $4.0 million and our other debt and capital leases by $10.0 million and we received $11.8 million in proceeds from the exercise of stock options and the purchase of stock under our employee stock purchase plan.

 

Borrowings

 

Outstanding lines of credit and current and long-term debt totaled $3.0 million at March 31, 2011, a decrease of $33.1 million from $36.1 million at June 30, 2010.  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 under which we can repurchase up to 3,000,000 shares of our common stock.  During the nine months ended March 31, 2011, we did not repurchase any shares under this program, and 711,205 shares remained available for repurchase under the program as of March 31, 2011.

 

Dividend Policy

 

We have never paid cash dividends on our common stock.

 

Contractual Obligations

 

We presented our contractual obligations in our Annual Report on Form 10-K for the fiscal year ended June 30, 2010. Except as discussed below, there have been no significant changes in those obligations during the first nine months of fiscal 2011.

 

18



Table of Contents

 

As a result of current and prior year acquisitions, we may have payment obligations based on the achievement by the acquired operations of certain sales and profitability milestones. Some of the purchase agreements we have entered into do not include a cap on the total payments that may be earned, or have a finite period for such payments. For acquisitions accounted for under Statement of Financial Accounting Standards 141, “Business Combinations,” we account for any such contingent payments as an addition to the purchase price of the acquired operations. For acquisitions accounted for under ASC 805, we record the estimated fair value of these obligations as a liability in the condensed consolidated balance sheet with subsequent revisions reflected in the condensed consolidated statements of operations. As of March 31, 2011, pursuant to ASC 805, $9.2 million of contingent payment obligations are included in other long-term liabilities in the accompanying condensed consolidated balance sheet.

 

Off Balance Sheet Arrangements

 

As of March 31, 2011, we did not have any significant off balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

 

Item 3.                                    Quantitative and Qualitative Disclosures about Market Risk

 

For the nine months ended March 31, 2011, 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, 2010.

 

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

 

We maintain the accounts of our operations in each of the following countries in the following currencies: Finland, France, Germany, Italy and Greece (Euros), Singapore (U.S. dollars), Malaysia (U.S. dollars), United Kingdom (U.K. pounds), Norway (Norwegian kroners), India (Indian rupees), Indonesia (Indonesian rupiah), Hong Kong (Hong Kong dollars), China (Chinese yuan), Canada (Canadian dollars), Australia (Australian dollars) and Cyprus (Cypriot pounds). 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 statement of operations, amounted to a loss of $1.6 million and $0.5 million during the three months ended March 31, 2010 and 2011, respectively.  For the nine months ended March 31, 2010 and 2011 we incurred transaction losses of $2.2 million and $1.5 million, 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 third quarter of fiscal 2011. 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 third quarter of fiscal 2011.

 

Use of Derivatives

 

Our use of derivatives consists primarily of foreign exchange contracts and interest rate swap agreements. As discussed in Note 1 to the condensed consolidated financial statements, we had a foreign currency forward contract of approximately $5.2 million outstanding as of March 31, 2011.

 

19



Table of Contents

 

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.

 

Inflation

 

We do not believe that inflation had a material impact on our results of operations during the three and nine months ended March 31, 2011.

 

Interest Rate Risk

 

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

 

Item 4.                                    Controls and Procedures

 

(a) Evaluation of Disclosure Controls and Procedures

 

As of March 31, 2011, the end of the period covered by this report, our management, including our Chief Executive Officer and our Chief Financial Officer, reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended). Such disclosure controls and procedures are designed to ensure that material information we must disclose in this report is recorded, processed, summarized and filed or submitted on a timely basis. Based upon that evaluation our management, Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of March 31, 2011.

 

(b) Changes in Internal Control over Financial Reporting

 

There were no changes in the Company’s internal control over financial reporting during the third quarter of fiscal 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II OTHER INFORMATION

 

Item 1.                                    Legal Proceedings

 

We are involved in various claims and legal proceedings arising out of the ordinary course of business. In our opinion, after consultation with legal counsel, the ultimate disposition of such proceedings will not have a material adverse effect on our financial position, future results of operations or cash flows.

 

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, 2010, filed with the Securities and Exchange Commission on August 27, 2010, which describe various risks and uncertainties to which we are or may become subject.

 

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

 

20



Table of Contents

 

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 27th day of April 2011.

 

 

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

 

21


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