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Table of Contents

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

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

 

For the quarterly period ended December 31, 2018

 

OR

 

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

 

For the transition period from                   to                 

 

Commission File Number 000-23125

 


 

OSI SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

33-0238801

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

12525 Chadron Avenue

Hawthorne, California 90250

(Address of principal executive offices) (Zip Code)

 

(310) 978-0516

(Registrant’s telephone number, including area code)

 

N/A

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

 


 

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

 

Indicate by check mark whether the registrant has submitted electronically 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 x No o

 

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 x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

 

Emerging growth company o

 

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. o

 

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

 

As of January 22, 2019, there were 18,071,408 shares of the registrant’s common stock outstanding.

 

 

 


Table of Contents

 

OSI SYSTEMS, INC.

 

INDEX

 

 

 

PAGE

 

 

 

PART I — FINANCIAL INFORMATION (Unaudited)

3

 

 

 

Item 1 —

Financial Statements

3

 

Condensed Consolidated Balance Sheets at June 30, 2018 and December 31, 2018

3

 

Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2017 and 2018

4

 

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended December 31, 2017 and 2018

5

 

Condensed Consolidated Statements of Stockholders’ Equity for the six months ended December 31, 2017 and 2018

6

 

Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2017 and 2018

7

 

Notes to Condensed Consolidated Financial Statements

8

Item 2 —

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

25

Item 3 —

Quantitative and Qualitative Disclosures about Market Risk

31

Item 4 —

Controls and Procedures

32

 

 

 

PART II — OTHER INFORMATION

33

Item 1 —

Legal Proceedings

33

Item 1A —

Risk Factors

33

Item 2 —

Unregistered Sales of Equity Securities and Use of Proceeds

33

Item 3 —

Defaults Upon Senior Securities

33

Item 4 —

Mine Safety Disclosures

33

Item 5 —

Other Information

33

Item 6 —

Exhibits

33

Signatures

 

34

 


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,

 

 

 

2018

 

2018

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

84,814

 

$

95,967

 

Accounts receivable, net

 

210,744

 

226,086

 

Inventories

 

313,552

 

315,200

 

Prepaid expenses and other current assets

 

41,587

 

43,949

 

Total current assets

 

650,697

 

681,202

 

Property and equipment, net

 

115,524

 

121,270

 

Goodwill

 

292,213

 

305,164

 

Intangible assets, net

 

142,001

 

140,202

 

Other assets

 

55,256

 

49,839

 

Total assets

 

$

1,255,691

 

$

1,297,677

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Bank lines of credit

 

$

113,000

 

$

149,000

 

Current portion of long-term debt

 

2,262

 

2,107

 

Accounts payable

 

106,892

 

98,339

 

Accrued payroll and related expenses

 

40,171

 

36,324

 

Advances from customers

 

55,761

 

69,410

 

Other accrued expenses and current liabilities

 

125,236

 

114,734

 

Total current liabilities

 

443,322

 

469,914

 

Long-term debt

 

248,980

 

253,184

 

Deferred income taxes

 

15,002

 

14,807

 

Other long-term liabilities

 

58,951

 

63,576

 

Total liabilities

 

766,255

 

801,481

 

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, 18,032,374 shares at June 30, 2018 and 18,020,907 shares at December 31, 2018

 

169,475

 

151,926

 

Retained earnings

 

334,745

 

363,254

 

Accumulated other comprehensive loss

 

(14,784

)

(18,984

)

Total stockholders’ equity

 

489,436

 

496,196

 

Total liabilities and stockholders’ equity

 

$

1,255,691

 

$

1,297,677

 

 

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,

 

 

 

2017

 

2018

 

2017

 

2018

 

Net revenues:

 

 

 

 

 

 

 

 

 

Products

 

$

181,393

 

$

225,402

 

$

347,046

 

$

407,882

 

Services

 

96,135

 

77,803

 

187,615

 

161,572

 

Total net revenues

 

277,528

 

303,205

 

534,661

 

569,454

 

Cost of goods sold:

 

 

 

 

 

 

 

 

 

Products

 

122,464

 

150,131

 

236,644

 

275,502

 

Services

 

53,434

 

42,730

 

105,116

 

87,695

 

Total cost of goods sold

 

175,898

 

192,861

 

341,760

 

363,197

 

Gross profit

 

101,630

 

110,344

 

192,901

 

206,257

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

60,098

 

67,097

 

115,745

 

128,804

 

Research and development

 

15,088

 

12,805

 

30,188

 

26,558

 

Impairment, restructuring and other charges

 

8,297

 

(1,265

)

9,427

 

2,931

 

Total operating expenses

 

83,483

 

78,637

 

155,360

 

158,293

 

Income from operations

 

18,147

 

31,707

 

37,541

 

47,964

 

Interest expense and other expense, net

 

(5,282

)

(5,620

)

(9,531

)

(10,952

)

Income before income taxes

 

12,865

 

26,087

 

28,010

 

37,012

 

Provision for income taxes

 

(59,816

)

(6,980

)

(64,804

)

(8,503

)

Net income (loss)

 

$

(46,951

)

$

19,107

 

$

(36,794

)

$

28,509

 

Earnings (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(2.47

)

$

1.06

 

$

(1.95

)

$

1.58

 

Diluted

 

$

(2.47

)

$

1.03

 

$

(1.95

)

$

1.53

 

Shares used in per share calculation:

 

 

 

 

 

 

 

 

 

Basic

 

18,971

 

18,085

 

18,874

 

18,088

 

Diluted

 

18,971

 

18,624

 

18,874

 

18,679

 

 

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,

 

 

 

2017

 

2018

 

2017

 

2018

 

Net income (loss)

 

$

(46,951

)

$

19,107

 

$

(36,794

)

$

28,509

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

326

 

(5,388

)

1,906

 

(4,215

)

Other

 

(93

)

9

 

(65

)

15

 

Other comprehensive income (loss)

 

233

 

(5,379

)

1,841

 

(4,200

)

Comprehensive income (loss)

 

$

(46,718

)

$

13,728

 

$

(34,953

)

$

24,309

 

 

See accompanying notes to condensed consolidated financial statements.

 

5


Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(amounts in thousands, except share data)

 

 

 

Common

 

Accumulated
Other

 

 

 

 

 

Number of
Shares

 

Amount

 

Retained
Earnings

 

Comprehensive
Income (Loss)

 

Total

 

Balance—June 30, 2017

 

18,689,568

 

$

222,529

 

$

363,872

 

$

(17,188

)

$

569,213

 

Exercise of stock options

 

80,101

 

1,757

 

 

 

1,757

 

Vesting of RSUs

 

372,248

 

 

 

 

 

Shares issued under employee stock purchase program

 

37,488

 

1,961

 

 

 

1,961

 

Stock based compensation

 

 

5,487

 

 

 

5,487

 

Taxes paid related to net share settlement of equity awards

 

(220,571

)

(18,803

)

 

 

(18,803

)

Net income

 

 

 

10,157

 

 

10,157

 

Other comprehensive income

 

 

 

 

1,608

 

1,608

 

Balance—September 30, 2017

 

18,958,834

 

$

212,931

 

$

374,029

 

$

(15,580

)

$

571,380

 

Exercise of stock options

 

1,654

 

110

 

 

 

110

 

Vesting of RSUs

 

28,090

 

 

 

 

 

Stock based compensation

 

 

6,253

 

 

 

6,253

 

Taxes paid related to net share settlement of equity awards

 

(10,547

)

(951

)

 

 

(951

)

Net loss

 

 

 

(46,951

)

 

(46,951

)

Other comprehensive income

 

 

 

 

233

 

233

 

Balance—December 31, 2017

 

18,978,031

 

$

218,343

 

$

327,078

 

$

(15,347

)

$

530,074

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance—June 30, 2018

 

18,032,374

 

$

169,475

 

$

334,745

 

$

(14,784

)

$

489,436

 

Exercise of stock options

 

9,034

 

269

 

 

 

269

 

Vesting of RSUs

 

340,082

 

 

 

 

 

Shares issued under employee stock purchase program

 

39,293

 

2,020

 

 

 

2,020

 

Stock based compensation

 

 

5,463

 

 

 

5,463

 

Repurchase of common stock

 

(104,146

)

(7,844

)

 

 

(7,844

)

Taxes paid related to net share settlement of equity awards

 

(163,514

)

(12,623

)

 

 

(12,623

)

Net income

 

 

 

9,402

 

 

9,402

 

Other comprehensive income

 

 

 

 

1,179

 

1,179

 

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

 

 

See accompanying notes to condensed consolidated financial statements.

 

6


Table of Contents

 

OSI SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(amounts in thousands)

 

 

 

For the Six Months Ended
December 31,

 

 

 

2017

 

2018

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income (loss)

 

$

(36,794

)

$

28,509

 

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

41,656

 

28,283

 

Stock based compensation expense

 

11,740

 

13,626

 

Deferred income taxes

 

50,696

 

(3,308

)

Amortization of debt discount and issuance costs

 

4,262

 

4,469

 

Impairment charges

 

3,144

 

 

Other

 

885

 

1,015

 

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

 

 

 

 

 

Accounts receivable

 

12,054

 

(13,986

)

Inventories

 

(21,700

)

(2,265

)

Prepaid expenses and other assets

 

(6,273

)

(5,863

)

Accounts payable

 

(6,647

)

(9,166

)

Advances from customers

 

26,405

 

13,676

 

Accrued payroll and related expenses

 

12

 

(3,760

)

Other

 

5,261

 

(10,386

)

Net cash provided by operating activities

 

84,701

 

40,844

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Acquisition of property and equipment

 

(32,009

)

(12,640

)

Acquisition of businesses, net of cash acquired

 

(83,632

)

(18,259

)

Acquisition of intangible and other assets

 

(1,068

)

(611

)

Net cash used in investing activities

 

(116,709

)

(31,510

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Net borrowings on bank lines of credit

 

92,000

 

36,000

 

Proceeds from long-term debt

 

295

 

817

 

Payments on long-term debt

 

(1,249

)

(1,233

)

Proceeds from exercise of stock options and employee stock purchase plan

 

3,828

 

2,809

 

Payments of contingent consideration

 

(804

)

(1,328

)

Repurchase of common stock

 

 

(21,029

)

Taxes paid related to net share settlement of equity awards

 

(19,754

)

(12,955

)

Net cash provided by financing activities

 

74,316

 

3,081

 

Effect of exchange rate changes on cash

 

15

 

(1,262

)

Net increase in cash and cash equivalents

 

42,323

 

11,153

 

Cash and cash equivalents—beginning of period

 

169,650

 

84,814

 

Cash and cash equivalents—end of period

 

$

211,973

 

$

95,967

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid, net during the period for:

 

 

 

 

 

Interest

 

$

3,783

 

$

6,318

 

Income taxes

 

$

11,929

 

$

20,711

 

 

See accompanying notes to condensed consolidated financial statements.

 

7


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 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, diagnostic cardiology 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 globally. 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 worldwide. These products are used by care providers in critical care, emergency and perioperative areas within hospitals as well as physicians’ offices, medical clinics and ambulatory surgery centers, among others.

 

Through our Optoelectronics and Manufacturing segment, we design, manufacture and market optoelectronic devices and flex circuits and provide electronics manufacturing services worldwide 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 financial statements. In the opinion of management, the condensed consolidated financial statements reflect all adjustments of a normal and recurring nature that are considered necessary for a fair presentation of the results for the interim periods presented. These condensed consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018. The results of operations for the six months ended December 31, 2018 are not necessarily indicative of the operating results to be expected for the full 2019 fiscal year or any future periods.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. Actual amounts may differ from these estimates and could differ materially.

 

8


Table of Contents

 

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. In periods where a net loss is reported, basic and diluted net loss per share are the same since the effect of potential common shares is antidilutive and therefore excluded. 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 no impact on diluted earnings per share until 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.

 

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2017

 

2018

 

2017

 

2018

 

Net income (loss) available to common stockholders

 

$

(46,951

)

$

19,107

 

$

(36,794

)

$

28,509

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding—basic

 

18,971

 

18,085

 

18,874

 

18,088

 

Dilutive effect of equity awards

 

 

539

 

 

591

 

Weighted average shares outstanding—diluted

 

18,971

 

18,624

 

18,874

 

18,679

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

$

(2.47

)

$

1.06

 

$

(1.95

)

$

1.58

 

Diluted earnings (loss) per share

 

$

(2.47

)

$

1.03

 

$

(1.95

)

$

1.53

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares excluded from diluted earnings (loss) per share due to their anti-dilutive effect (in thousands)

 

684

 

126

 

753

 

81

 

 

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 $96.0 million at December 31, 2018. The majority of this amount was held by us and our subsidiaries in the United States, United Kingdom, Malaysia, India, and Mexico, and to a lesser extent in Canada, Singapore and Germany 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.

 

Fair Value of Financial Instruments

 

Our financial instruments consist primarily of cash and cash equivalents, marketable securities, derivative instruments, accounts receivable, accounts payable and debt instruments. The carrying values of financial instruments, other than long term debt instruments, are representative of their fair values due to their short term maturities. The carrying values of our long term debt instruments are considered to approximate their fair values because the interest rates of these instruments are variable or comparable to current rates available to 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. “Level 1” category includes assets and liabilities at quoted prices in active markets for identical assets and liabilities. “Level 2” category includes assets and liabilities from observable inputs other than quoted market prices. “Level 3” category includes assets and liabilities for which valuation techniques are unobservable and significant to the fair value measurement. As of June 30, 2018 and December 31, 2018, there were no assets where “Level 3” valuation techniques were used. 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.

 

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The fair values of the our financial assets and liabilities as of June 30, 2018 and December 31,2018 are categorized as follows (in thousands):

 

 

 

June 30, 2018

 

December 31, 2018

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Insurance company contracts

 

$

 

$

31,897

 

$

 

$

31,897

 

$

 

$

30,622

 

$

 

$

30,622

 

Interest rate contract

 

 

18

 

 

18

 

 

9

 

 

9

 

Total assets

 

$

 

$

31,915

 

$

 

$

31,915

 

$

 

$

30,631

 

$

 

$

30,631

 

Liabilities—contingent consideration

 

$

 

$

 

$

15,713

 

$

15,713

 

$

 

$

 

$

19,997

 

$

19,997

 

 

Derivative Instruments and Hedging Activity

 

Our use of derivatives consists of an interest rate swap agreement. The interest rate swap agreement was entered into to improve the predictability of cash flows from interest payments related to variable, LIBOR-based debt for the duration of the term loan described in Note 6. The interest rate swap matures in October 2019. The interest rate swap is considered an effective cash flow hedge and, as a result, the net gains or losses on such instrument were reported as a component of Other comprehensive income (loss) in the consolidated financial statements and are reclassified as net income when the hedge transaction settles.

 

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, 2018 indicated that it is not more likely than not that the fair values of two of our three reporting units are less than their carrying amounts, including goodwill. Thus, we have determined that there is no goodwill impairment for these two reporting units.

 

For the third reporting unit, the results of our assessment of qualitative factors were not conclusive so we proceeded with a quantitative assessment to determine if the carrying amount of this reporting unit exceeds its fair value. The fair value of the reporting unit was calculated using the income approach. Under the income approach, the fair value of the reporting unit was calculated by estimating the present value of associated future cash flows. The analysis indicated that the estimated fair value of the third reporting unit substantially exceeded the carry amount, plus goodwill, of the reporting unit.  We applied a hypothetical 10 percent decrease to the fair value of the reporting unit, which at December 31, 2018, would not have indicated impairment. Therefore, we have determined that there is no goodwill impairment for this reporting unit.

 

Revenue Recognition

 

ASU 2014-09, Revenue from Contracts with Customers (Topic 606). In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09 and related amendments (“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 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 when the performance obligation is 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. On July 1, 2018, we adopted ASC 606 using the modified retrospective method, whereby the adoption does not impact any prior periods. We have identified contracts not yet completed as of July 1, 2018 and applied the new guidance on a prospective basis.

 

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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 after-market services, installation and implementation of products and turnkey security screening 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 customer deposits and deferred revenue as net sales after all revenue recognition criteria is met.

 

When determining revenue recognition for contracts, we use judgment based on our understanding of the obligations within 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 sale value is attributed to that obligation. When a contract contains multiple performance obligations the transaction value is first allocated using the observable price, which is generally a list price net of applicable discount or the price used to sell 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.

 

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 multiple-deliverable arrangements. In the event that customers are permitted to terminate such arrangements, the underlying contract typically requires payment for deliverables and reimbursement of costs incurred through the date of termination.

 

Effect of Adopting ASC 606. Adopting ASC 606 did not require any cumulative effect adjustment to retained earnings as of July 1, 2018 because the impact on retained earnings was immaterial. The impact to our condensed consolidated statements of operations is shown below for the three and six month periods ended December 31, 2018 and for the balance sheet as of December 31, 2018.

 

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Statement of Operations (in thousands)

 

 

 

Three Months Ended December 31, 2018

 

Six Months Ended December 31, 2018

 

 

 

Results
as Reported

 

Results
without
Adoption of
ASC 606

 

Effect of
Change

 

Results
as Reported

 

Results
without
Adoption of
ASC 606

 

Effect of
Change

 

Revenue

 

$

303,205

 

$

288,376

 

$

14,829

 

$

569,454

 

$

551,043

 

$

18,411

 

Cost of goods sold

 

192,861

 

185,133

 

7,728

 

363,197

 

354,290

 

8,907

 

Operating expenses

 

78,637

 

74,690

 

3,947

 

158,293

 

152,118

 

6,175

 

Income from operations

 

31,707

 

28,553

 

3,154

 

47,964

 

44,635

 

3,329

 

Interest and other expense, net

 

(5,620

)

(5,620

)

 

(10,952

)

(10,952

)

 

Income tax provision

 

(6,980

)

(6,445

)

(535

)

(8,503

)

(7,920

)

(583

)

Net income

 

$

19,107

 

$

16,488

 

$

2,619

 

$

28,509

 

$

25,763

 

$

2,746

 

 

Balance Sheet (in thousands)

 

 

 

December 31, 2018

 

 

 

Balances
as Reported

 

Balances
without
Adoption of
ASC 606

 

Effect of
Change

 

Assets

 

 

 

 

 

 

 

Accounts receivable, net

 

$

226,086

 

$

215,825

 

$

10,261

 

Inventories

 

315,200

 

324,134

 

(8,934

)

Other assets

 

756,391

 

756,975

 

(584

)

Liabilities

 

 

 

 

 

 

 

Current liabilities

 

469,914

 

471,917

 

(2,003

)

Other liabilities

 

331,567

 

331,567

 

 

Stockholders’ Equity

 

 

 

 

 

 

 

Retained earnings

 

363,254

 

360,508

 

2,746

 

 

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.

 

During the three and six months ended December 31, 2018, we recognized additional revenueas a result of adopting ASC 606.  This is primarily due to sales within our Security division where we met certain contractual performance obligations.  As a result, this increased net income and accounts receivable and reduced inventories.

 

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 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 contract assets and liabilities as of June 30, 2018 and December 31, 2018, including the change between the periods.

 

Contract Assets (in thousands)

 

 

 

June 30,
2018

 

December 31,
2018

 

Change

 

% Change

 

Unbilled revenue

 

$

13,087

 

$

19,997

 

$

6,910

 

53

%

 

Contract Liabilities (in thousands)

 

 

 

June 30,
2018

 

December 31,
2018

 

Change

 

% Change

 

Advances from customers

 

$

55,761

 

$

69,410

 

$

13,649

 

24

%

Deferred revenue—current

 

28,899

 

32,516

 

3,617

 

13

%

Deferred revenue—long-term

 

9,562

 

8,883

 

(679

)

(7

)%

 

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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, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was approximately $162.3 million. We expect to recognize revenue on approximately 50.5% of the remaining performance obligations over the next 12 months, and the remainder is expected to be recognized thereafter.

 

Practical Expedients. In cases where we are responsible for shipping after the customer has obtained control of the goods, we have elected to treat these 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. We also utilize the “as invoiced” practical expedient in certain cases where performance obligations are satisfied over time and the invoiced amount corresponds directly with the value we are providing to the customer.

 

Recently Adopted Accounting Pronouncements

 

Revenue Recognition

 

In May 2014, the FASB issued ASU 2014-09 and related amendments Revenue from Contracts with Customers (Topic 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. On July 1, 2018, we adopted ASC 606 using the modified retrospective method, whereby the adoption does not impact any prior periods.

 

Statement of Cash Flows

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The update was issued with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230 and other topics. We adopted this ASU effective July 1, 2018 using the retrospective approach and the initial adoption had no effect on our financial position, results of operations or liquidity.

 

Income Taxes

 

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Asset Transfers of Assets Other than Inventory. The new guidance eliminates the exception for intra-entity transfers other than inventory and requires the recognition of current and deferred income taxes resulting from such a transfer when the transfer occurs. We adopted this ASU effective July 1, 2018 using the modified retrospective transition method resulting in a reclassification in the balance sheet of $3 million to decrease prepaid expenses and other assets and increase deferred tax assets.

 

Recently Issued Accounting Pronouncements Not Yet Adopted

 

Leases

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This guidance requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by leases with terms of more than 12 months. The ASU also will require qualitative and quantitative disclosures designed to give financial statement readers information on the amount, timing, and uncertainty of cash flows arising from leases. This ASU is effective for us in the first quarter of fiscal 2020 with early adoption permitted. We have not yet adopted this ASU and are currently evaluating the impact it may have on our financial condition and results of operations.

 

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

 

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requirements for certain disclosures and requires additional disclosures under defined benefit pension plans and other postretirement 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 noncancellable 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.

 

2Business Combinations

 

Under ASU 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 price 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. During the measurement period, which is one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with corresponding adjustments to goodwill, as additional information becomes available. Upon the conclusion of the measurement period, any subsequent adjustments are reflected in reported earnings.

 

Fiscal Year 2019 Business Acquisitions

 

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, which may be earned over an 18-month period. 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 expected to be deductible for income tax purposes.

 

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 expected to be 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.

 

Fiscal Year 2018 Business Acquisitions

 

Acquisition of Explosive Trace Detection Business

 

On July 7, 2017, we acquired the global explosive trace detection business (“ETD”) from Smiths Group plc. This acquisition was a carve out from a larger entity. We financed the total purchase price of $80.5 million with a combination of cash on hand and borrowings under our revolving bank line of credit. Pro-forma results were not presented because, based on the date of the acquisition, there was not a material difference between pro-forma and actual results in the condensed consolidated financial statements of operations for the six months ended December 31, 2017 and 2018.

 

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Table of Contents

 

The valuation of certain assets and liabilities of ETD were performed by a third party valuation specialist. The final allocation was as follows:

 

Cash and cash equivalents

 

$

4

 

Accounts receivable

 

15,517

 

Inventories

 

11,678

 

Property and equipment

 

1,599

 

Intangible assets

 

30,370

 

Deferred tax asset

 

2,738

 

Other long-term assets

 

297

 

Accounts payable

 

(4,784

)

Accrued payroll and related expenses

 

(2,116

)

Deferred revenues—current

 

(924

)

Accrued warranties

 

(2,068

)

Advances from customers

 

(670

)

Other accrued expenses and current liabilities

 

(1,074

)

Deferred revenues—long term

 

(232

)

Net assets acquired

 

50,335

 

Goodwill

 

30,132

 

Total consideration

 

$

80,467

 

 

The goodwill is largely attributable to expected growth, intellectual capital and the assembled workforce of the ETD business. Intangible assets were recorded at estimated fair value, as determined by management based on available information, with assistance from a third party. The fair value attributed to the intangible assets acquired was based on estimates, assumptions and other information compiled by management, and valuations that utilized established valuation techniques. The value attributed to goodwill and intangible assets is partially non-deductible for income tax purposes. The following table summarizes the fair value of acquired identifiable intangible assets as of the acquisition date (amounts in thousands):

 

 

 

Weighted

 

 

 

 

 

Average

 

Fair

 

 

 

Lives

 

Value

 

 

 

 

 

 

 

Developed technology

 

10 years

 

$

14,210

 

Customer relationships/backlog

 

7 years

 

16,070

 

In-process research and development (“IPR&D”)

 

 

 

90

 

Total intangible assets

 

 

 

$

30,370

 

 

Other Fiscal Year 2018 Business Acquisitions

 

In July 2017, we (through our Security division) completed an acquisition of a privately held technology company. The acquisition was financed with cash on hand and was in an amount including potential earnout consideration determined to be insignificant by management.

 

In January 2018, we (through our Optoelectronics and Manufacturing division) acquired an electronics component designer and manufacturer for approximately $22 million, plus up to $6 million in contingent consideration which may be earned over a three-year period. The goodwill recognized for this business is not expected to be deductible for income tax purposes. The acquisition was financed with cash on hand and borrowings under our revolving bank line of credit.

 

3. Balance Sheet Details

 

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

 

 

 

June 30,
2018

 

December 31,
2018

 

 

 

 

 

 

 

Accounts receivable

 

$

225,336

 

$

240,749

 

Less allowance for doubtful accounts

 

(14,592

)

(14,663

)

Total

 

$

210,744

 

$

226,086

 

 

 

 

June 30,
2018

 

December 31,
2018

 

 

 

 

 

 

 

Raw materials

 

$

156,612

 

$

153,195

 

Work-in-process

 

89,468

 

86,582

 

Finished goods

 

67,472

 

75,423

 

Total

 

$

313,552

 

$

315,200

 

 

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Table of Contents

 

 

 

June 30,

 

December 31,

 

 

 

2018

 

2018

 

Land

 

$

16,569

 

$

16,555

 

Buildings, civil works and improvements

 

56,585

 

55,083

 

Leasehold improvements

 

9,681

 

10,144

 

Equipment and tooling

 

117,294

 

125,099

 

Furniture and fixtures

 

3,331

 

3,175

 

Computer equipment

 

18,759

 

17,863

 

Computer software

 

19,509

 

19,555

 

Computer software implementation in process

 

4,318

 

6,640

 

Construction in process

 

790

 

2,428

 

Total

 

246,836

 

256,542

 

Less accumulated depreciation and amortization

 

(131,312

)

(135,272

)

Property and equipment, net

 

$

115,524

 

$

121,270

 

 

Depreciation expense was $16.8 million and $5.2 million for the three months ended December 31, 2017 and 2018, respectively, and approximately $33.0 million and $10.3 million for the six months ended December 31, 2017 and 2018, respectively. The decrease in depreciation is primarily related to a transfer of assets.

 

In January 2018, we entered into a two-year agreement with the Mexican government to continue providing security screening services. Upon inception of the contract, we transferred certain fixed assets with a net book value of $29.5 million to the customer, and this remaining cost to obtain the contract is amortized on a straightline basis over the term of the contract as corresponding revenues are recognized. During the three and six months ended December 31, 2018, we recognized $3.7 million and $7.1 million, respectively, of amortization expense related to such assets. As of December 31, 2018, $13.7 million and $0.5 million, respectively, are recorded within Prepaid expenses and other current assets and Other assets.

 

4. Goodwill and Intangible Assets

 

The changes in the carrying value of goodwill for the six month period ended December 31, 2018 are as follows (in thousands):

 

 

 

 

 

 

 

Optoelectronics

 

 

 

 

 

 

 

 

 

and

 

 

 

 

 

Security

 

Healthcare

 

Manufacturing

 

 

 

 

 

Division

 

Division

 

Division

 

Consolidated

 

Balance as of June 30, 2018

 

$

191,810

 

$

40,157

 

$

60,246

 

$

292,213

 

Goodwill acquired or adjusted during the period

 

6,541

 

 

7,415

 

13,956

 

Foreign currency translation adjustment

 

(65

)

(102

)

(838

)

(1,005

)

Balance as of December 31, 2018

 

$

198,286

 

$

40,055

 

$

66,823

 

$

305,164

 

 

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

June 30, 2018

 

December 31, 2018

 

 

 

Weighted

 

Gross

 

 

 

 

 

Gross

 

 

 

 

 

 

 

Average

 

Carrying

 

Accumulated

 

Intangibles

 

Carrying

 

Accumulated

 

Intangibles

 

 

 

Lives

 

Value

 

Amortization

 

Net

 

Value

 

Amortization

 

Net

 

Amortizable assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Software development costs

 

9 years

 

$

28,174

 

$

(9,423

)

$

18,751

 

$

29,215

 

$

(11,597

)

$

17,618

 

Patents

 

19 years

 

8,401

 

(1,618

)

6,783

 

8,243

 

(1,680

)

6,563

 

Developed technology

 

10 years

 

52,780

 

(9,706

)

43,074

 

54,582

 

(12,480

)

42,102

 

Customer relationships/backlog

 

7 years

 

63,398

 

(17,891

)

45,507

 

65,673

 

(20,494

)

45,179

 

Total amortizable assets

 

 

 

152,753

 

(38,638

)

114,115

 

157,713

 

(46,251

)

111,462

 

Non-amortizable assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks and trade names

 

 

 

25,596

 

 

25,596

 

26,450

 

 

26,450

 

IPR&D

 

 

 

2,290

 

 

2,290

 

2,290

 

 

2,290

 

Total intangible assets

 

 

 

$

180,639

 

$

(38,638

)

$

142,001

 

$

186,453

 

$

(46,251

)

$

140,202

 

 

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Amortization expense related to intangible assets was $4.5 million and $5.6 million for the three month periods ended December 31, 2017 and 2018, respectively. For the six months ended December 31, 2017 and 2018, amortization expense was $8.7 million and $10.9 million, respectively. At December 31, 2018, the estimated future amortization expense was as follows (in thousands):

 

2019 (remaining 6 months)

 

$

9,960

 

2020

 

19,634

 

2021

 

19,281

 

2022

 

14,670

 

2023

 

13,448

 

Thereafter, including assets that have not yet begun to be amortized

 

34,469

 

Total

 

$

111,462

 

 

Software development costs for software products incurred before establishing technological feasibility are charged to operations. Software development costs incurred after establishing technological feasibility are capitalized on a product-by-product basis until the product is available for general release to customers at which time amortization begins. Annual amortization, charged to cost of goods sold, is the amount computed using the ratio that current revenues for a product bear to the total current and anticipated future revenues for that product. In the event that future revenues are not estimable, such costs are amortized on a straight line basis over the remaining estimated economic life of the product. Amortizable assets that have not yet begun to be amortized are included in Thereafter in the table above. For the three months ended December 31, 2017 and 2018, we capitalized software development costs in the amount of $0.2 million and $0.6 million, respectively. For the six month periods ended December 31, 2017 and 2018, we capitalized software development costs in the amount of $0.3 million and $1.0 million, respectively.

 

5. Impairment, restructuring and other charges

 

Impairment

 

During the three and six months ended December 31, 2018, there were no impairment charges. During the three and six months ended December 31, 2017, we (i) abandoned a product line in our Security division that became redundant as a result of the ETD acquisition, (ii) abandoned a non-core product line in our Healthcare division, and (iii) abandoned certain trademarks in our Optoelectronics and Manufacturing division that were no longer used. As a result, $3.1 million of assets, including intangible and fixed assets, were written off as we determined that these assets have no value and were permanently impaired.

 

Restructuring and Other Charges

 

We endeavor to align our global capacity and infrastructure with demand by our customers and also to fully integrate acquisitions, and thereby improve operational efficiency. We intiated a restructuring during fiscal 2019 in our Healthcare division in order to realign the organization and enable further investment in priority areas, and we have incurred associated charges of approximately $3.3 million and $3.5 million for the three and six months ended December 31, 2018, respectively.

 

During the three and six months ended December 31, 2018, we recovered certain legal costs related to class action litigation and government investigations through insurance reimbursement.  This resulted in a net credit to restructuring and other charges in our Corporate segment of $4.6 million and $1.0 million for the three and six months ended December 31, 2018, respectively.

 

During the three and six months ended December 31, 2017, we incurred professional fees of $0.2 million and $0.9 million, respectively, to complete the ETD acquisition. During the three months ended December 31, 2017, we accrued $4.3 million of litigation and estimated settlement costs, $4.2 million of which was recorded in our Healthcare division.

 

The following table summarizes impairment, restructuring and other charges for the periods set forth below (in thousands):

 

 

 

Three Months Ended December 31, 2017

 

 

 

Security Division

 

Healthcare
Division

 

Optoelectronics and
Manufacturing
Division

 

Corporate

 

Total

 

Impairment charges

 

$

1,490

 

$

579

 

$

1,075

 

$

 

$

3,144

 

Acquisition-related costs

 

 

 

 

361

 

361

 

Employee termination costs

 

90

 

 

146

 

 

236

 

Facility closures/consolidation

 

11

 

243

 

 

 

254

 

Legal and accrued settlement costs, net

 

 

4,200

 

 

102

 

4,302

 

Total expensed

 

$

1,591

 

$

5,022

 

$

1,221

 

$

463

 

$

8,297

 

 

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Table of Contents

 

 

 

Three Months Ended December 31, 2018

 

 

 

Security Division

 

Healthcare
Division

 

Optoelectronics and
Manufacturing
Division

 

Corporate

 

Total

 

Acquisition-related costs

 

$

 

$

 

$

20

 

$

 

$

20

 

Employee termination costs

 

(46

)

1,227

 

26

 

 

1,207

 

Facility closures/consolidation

 

 

2,108

 

 

 

2,108

 

Legal and accrued settlement costs, net

 

 

 

 

(4,600

)

(4,600

)

Total expensed

 

$

(46

)

$

3,335

 

$

46

 

$

(4,600

)

$

(1,265

)

 

 

 

Six Months Ended December 31, 2017

 

 

 

Security Division

 

Healthcare
Division

 

Optoelectronics and
Manufacturing
Division

 

Corporate

 

Total

 

Impairment charges

 

$

1,490

 

$

579

 

$

1,075

 

$

 

$

3,144

 

Acquisition-related costs

 

 

 

 

1,181

 

1,181

 

Employee termination costs

 

330

 

 

146

 

 

476

 

Facility closures/consolidation

 

81

 

243

 

 

 

324

 

Legal and accrued settlement costs, net

 

 

4,200

 

 

102

 

4,302

 

Total expensed

 

$

1,901

 

$

5,022

 

$

1,221

 

$

1,283

 

$

9,427

 

 

 

 

Six Months Ended December 31, 2018

 

 

 

Security Division

 

Healthcare
Division

 

Optoelectronics and
Manufacturing
Division

 

Corporate

 

Total

 

Acquisition-related costs

 

$

 

$

 

$

287

 

$

 

$

287

 

Employee termination costs

 

 

1,418

 

133

 

 

1,551

 

Facility closures/consolidation

 

 

2,108

 

 

 

2,108

 

Legal and accrued settlement costs, net

 

 

 

 

(1,015

)

(1,015

)

Total expensed

 

$

 

$

3,526

 

$

420

 

$

(1,015

)

$

2,931

 

 

The changes in the accrued liability for restructuring and other charges for the six month period ended December 31, 2018 were as follows (in thousands):

 

 

 

Acquisition-
related Costs

 

Employee
Termination
Costs

 

Facility
Closure/
Consolidation
Cost

 

Legal
Charges

 

Total

 

Balance as of June 30, 2018

 

$

 

$

837

 

$

399

 

$

14,065

 

$

15,301

 

Restructuring and other charges, net

 

287

 

1,551

 

2,108

 

(1,015

)

2,931

 

Payments and other adjustments

 

(287

)

(1,589

)

(2,078

)

(861

)

(4,815

)

Balance as of December 31, 2018

 

$

 

$

799

 

$

429

 

$

12,189

 

$

13,417

 

 

6. Borrowings

 

Revolving Credit Facility

 

In December 2016, we entered into an amendment to our revolving credit facility, which, among other things, increased the aggregate committed amount available to us from $450 million to $525 million and extended the maturity date to December 2021. The credit facility includes a $300 million sub limit for letters of credit. Under certain circumstances, we have the ability to increase the facility by the greater of $250 million or such amount as would not cause our secured leverage ratio to exceed a specified level. Borrowings under this facility bear interest at LIBOR, or a comparable rate in accordance with the terms of the credit agreement, plus a margin of 1.50% as of December 31, 2018, but this margin can range from 1.25% to 2.0% based on our consolidated net leverage ratio as defined in the credit facility. Letters of credit reduce the amount available to borrow by their face value. The unused portion of the facility bears a commitment fee of 0.20% as of December 31, 2018, but this fee can range from 0.20% to 0.30% based on our consolidated net leverage ratio as defined in the credit facility. Our borrowings under the credit agreement are guaranteed by certain of our U.S. based subsidiaries and are secured by substantially all of our assets and the assets of certain of our subsidiaries. The credit agreement contains various representations and warranties, affirmative, negative and financial covenants and conditions of default. As of December 31, 2018, there was $149.0 million of borrowings outstanding under the revolving credit facility and $58.9 million outstanding under the letters of credit sub-facility. The amount available to borrow under the credit facility as of December 31, 2018 was $317.1 million. Loan amounts under the revolving credit facility may be borrowed, repaid and re-borrowed during the term.

 

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Although the principal amount of each revolving loan is due and payable in full on the maturity date, we have the right to repay each revolving loan in whole or in part from time to time without penalty. It is our practice to routinely borrow and repay several times per year under this revolving credit facility. Therefore, borrowings under the credit facility are included in current liabilities. As of December 31, 2018, we are in compliance with all covenants under this credit facility.

 

1.25% Convertible Senior Notes Due 2022

 

In February 2017, we issued $287.5 million of the Notes in a private offering. The Notes are governed by an indenture dated February 22, 2017. The maturity for the payment of principal is September 1, 2022. The Notes bear interest at the rate of 1.25% payable in cash semiannually in arrears on each March 1 and September 1. The Notes are senior unsecured obligations and rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment to any of our unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries, as well as any of our existing and future indebtedness that may be guaranteed by our subsidiaries to the extent of such guarantees (including the guarantees of certain of our subsidiaries under our existing revolving credit facility).

 

The Notes are convertible prior to March 1, 2022 only upon specified events and during specified periods and are, thereafter convertible, at any time, in each case at an initial conversion rate of 9.3056 per $1,000 principal amount of the Notes, which is equal to an initial conversion price of approximately $107.46 per share or a 38.5% premium to our stock price at the time of the issuance. The conversion rate is subject to adjustment upon certain events. Upon conversion, the Notes may be settled, at our election, in shares of our common stock, cash or a combination of cash and shares of common stock. We have initially elected a combination settlement method to satisfy the conversion obligation, which allows us to settle the principal amount of the Notes in cash and to settle the excess conversion value, if any, in shares of common stock, and cash in lieu of fractional shares.

 

We may not redeem the Notes prior to March 6, 2020. Thereafter, we may redeem the Notes if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any period of 30 consecutive trading days. If we undergo a fundamental change, as defined in the indenture for the Notes, subject to certain conditions, holders of the Notes may require us to repurchase all or part of the Notes for cash at a price equal to 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date. The occurrence of a fundamental change will also result in the Notes becoming immediately convertible.

 

Pursuant to ASC 470-20, we allocated the $287.5 million gross proceeds of the Notes between liability and equity components. The initial $242.4 million liability component was determined based on the fair value of similar debt instruments excluding the conversion feature for similar terms and priced on the same day the Notes were issued. The initial $45.1 million equity component represents the debt discount and was calculated as the difference between the fair value of the debt and the gross proceeds of the Notes. Issuance costs of $7.7 million were allocated between debt ($6.5 million) and equity ($1.2 million) components with the portion allocated to the debt presented as an offset against long term debt in the consolidated balance sheet and is amortized as interest expense over the life of the Notes using the effective interest method. The total interest expense recognized for the three months and six months ended December 31, 2018 was $3.2 million and $6.3 million, respectively, which consisted of $0.9 million and $1.8 million of contractual interest expense, $2.0 million and $3.9 million of debt discount amortization and $0.3 million and $0.6 million of amortization of debt issuance costs. The total interest expense recognized for the three months and six months ended December 31, 2017 was $3.1 million and $6.1 million, respectively, which consists of $0.9 million and $1.8 million of contractual interest expense, $1.9 million and $3.7 million of debt discount amortization and $0.3 million and $0.6 million of amortization of debt issuance costs. As of December 31, 2018, the unamortized debt discount was $31.3 million which is being amortized over the remaining contractual term to maturity of the Notes using an effective interest rate of 4.50%. The unamortized debt issuance cost of $4.3 million as of December 31, 2018 is amortized on a straight-line basis, which approximates the effective interest method, over the life of the Notes. Based on our December 31, 2018 stock price of $73.30 per share, the “if-converted” value of the Notes did not exceed the principal amount.

 

Other Borrowings

 

Several of our foreign subsidiaries maintain bank lines of credit, denominated in local currencies and U.S. dollars, primarily for the issuance of letters of credit. As of December 31, 2018, $61.6 million was outstanding under these credit facilities. As of December 31, 2018, the total amount available under these credit facilities was $6.7 million.

 

In September 2012, we entered into a seven year term loan agreement for $11.1 million to fund the acquisition of land and a building in the state of Washington. The principal on the loan, together with interest at LIBOR plus 1.25%, is payable on a monthly basis over seven years. The outstanding balance on this loan as of December 31, 2018 was $1.3 million compared to a balance of $2.1 million as

 

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of June 30, 2018. Concurrent with entering into the floating rate loan, we entered into an interest rate swap agreement that effectively locks the interest rate of the loan at 2.2% per annum for the term of the loan.

 

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

 

 

 

June 30,
2018

 

December 31,
2018

 

1.25% convertible notes due 2022:

 

 

 

 

 

Principal amount

 

$

287,500

 

$

287,500

 

Unamortized discount

 

(35,133

)

(31,251

)

Unamortized debt issuance costs

 

(4,897

)

(4,310

)

1.25% convertible notes due 2022, net of unamortized discount and debt issuance costs

 

247,470

 

251,939

 

Term loans

 

2,114

 

1,321

 

Other long-term debt

 

1,658

 

2,031

 

 

 

251,242

 

255,291

 

Less current portion of long-term debt

 

(2,262

)

(2,107

)

Long-term portion of debt

 

$

248,980

 

$

253,184

 

 

7. Stockholders’ Equity

 

Stock-based Compensation

 

As of December 31, 2018, we maintained the Amended and Restated 2012 Incentive Award Plan (the “2012 Plan”) and the Amended and Restated 2006 Equity Participation Plan (“2006 Plan”) as stock-based employee compensation plans. No further grants may be made under the 2006 Plan. In addition, pursuant to the acquisition of American Science and Engineering, Inc. (“AS&E”), we assumed two stock-based employee compensation plans: the AS&E 2005 Equity and Incentive Plan (“2005 AS&E Plan”) and the AS&E 2014 Equity and Incentive Plan (“2014 AS&E Plan”). No new equity grants will be made under the 2005 AS&E Plan or the 2014 AS&E Plan. The 2012 Plan, the 2006 Plan, the 2005 AS&E Plan and the 2014 AS&E Plan are collectively referred to as the “OSI Plans”.

 

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2017

 

2018

 

2017

 

2018

 

Cost of goods sold

 

$

247

 

$

150

 

$

487

 

$

356

 

Selling, general and administrative

 

5,849

 

7,833

 

10,960

 

12,945

 

Research and development

 

157

 

180

 

293

 

325

 

Stock-based compensation expense before taxes

 

$

6,253

 

$

8,163

 

$

11,740

 

$

13,626

 

Less: related income tax benefit

 

(1,935

)

(2,038

)

(3,627

)

(3,380

)

Stock-based compensation expense, net of estimated taxes

 

$

4,318

 

$

6,125

 

$

8,113

 

$

10,246

 

 

As of December 31, 2018, total unrecognized compensation cost related to stock-based compensation grants under the OSI Plans were estimated at $0.7 million for stock options and $24.7 million for RSUs. We expect to recognize these costs over a weighted average period of 2.2 years with respect to the stock options and 1.8 years for grants of RSUs.

 

The following summarizes stock option activity during the six months ended December 31, 2018:

 

 

 

Number of
Options

 

Weighted Average
Exercise Price

 

Weighted- Average
Remaining Contractual
Term

 

Aggregate
Intrinsic Value
(in thousands)

 

Outstanding at June 30, 2018

 

677,525

 

$

32.80

 

 

 

 

 

Granted

 

18,135

 

$

72.39

 

 

 

 

 

Exercised

 

(49,395

)

$

18.09

 

 

 

 

 

Expired or forfeited

 

(6,914

)

$

69.47

 

 

 

 

 

Outstanding at December 31, 2018

 

639,351

 

$

34.67

 

2.7 years

 

$

25,026

 

Exercisable at December 31, 2018

 

600,813

 

$

31.92

 

2.3 years

 

$

25,001

 

 

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Table of Contents

 

The following summarizes RSU award activity during the six months ended December 31, 2018:

 

 

 

Shares

 

Weighted-
Average
Fair Value

 

Nonvested at June 30, 2018

 

526,377

 

$

71.56

 

Granted

 

358,213

 

73.64

 

Vested

 

(356,705

)

71.02

 

Forfeited

 

(12,414

)

73.54

 

Nonvested at December 31, 2018

 

515,471

 

$

73.33

 

 

As of December 31, 2018, there were approximately 1.6 million shares available for grant under the 2012 Plan. Under the terms of the 2012 Plan, RSUs granted from the pool of shares available for grant reduce the pool by 1.87 shares for each award granted. RSUs forfeited and returned to the pool of shares available for grant increase the pool by 1.87 shares for each award forfeited.

 

We granted 117,346 and 97,514 performance-based RSUs during the six months ended December 31, 2017 and 2018, respectively. These performance based RSU awards are contingent on the achievement of certain performance metrics. The payout related to these awards can range from zero to 280% of the original number of shares or units awarded.

 

Share Repurchase Program

 

In March 2018, our Board of Directors authorized a share repurchase program of up to 1,000,000 shares. This program does not expire unless our Board of Directors acts to terminate the program. The timing and actual number of shares purchased depend on a variety of factors, including stock price, general business and market conditions and other investment opportunities and may be purchased through the open market. Upon repurchase, the shares are restored to the status of authorized but unissued, and we record them as a reduction in the number of shares of common stock issued and outstanding in our consolidated financial statements.

 

During the six months ended December 31, 2018, we repurchased 288,316 shares of our common stock, and as of December 31, 2018, there were 562,707 shares available to repurchase under the program.

 

8. Retirement Benefit Plans

 

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

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2017

 

2018

 

2017

 

2018

 

Service cost

 

$

216

 

$

98

 

$

432

 

$

196

 

Interest cost

 

8

 

8

 

16

 

16

 

Amortization of prior service cost

 

70

 

14

 

140

 

28

 

Net periodic pension expense

 

$

294

 

$

120

 

$

588

 

$

240

 

 

For the three months ended December 31, 2017, we made no contributions to these defined benefit plans. For the three months ended December 31, 2018, we made contributions of $1.0 million to these defined benefit plans. For each of the six months ended December 31, 2017 and 2018, we made contributions of $1.0 million to these defined benefit plans.

 

We also maintain various defined contribution plans. For the three months ended December 31, 2017 and 2018, we made contributions of $1.4 million and $1.3 million, respectively, to these defined contribution plans. For the six months ended December 31, 2017 and 2018, we made contributions of $3.0 million and $3.1 million, respectively, to these defined contribution plans.

 

9. Commitments and Contingencies

 

Contingent Acquisition Obligations

 

Under the terms and conditions of the purchase agreements associated with certain acquisitions, we may be obligated to make additional payments based on the achievement of certain sales or profitability milestones through the acquired operations. For agreements that contain contingent consideration caps, the maximum amount of such potential future payments is $35.0 million as of December 31, 2018. In addition, we are required to make royalty payments through 2022 based on the license of, or sales of products containing, the technology of CXR Limited, a company acquired in 2004.

 

We account for such contingent payments for acquisitions which occurred through the end of fiscal year 2009 as additions to the purchase price of the acquired business; and we made $1.3 million of such payments during the three and six months ended December

 

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Table of Contents

 

31, 2018. For acquisitions completed after fiscal 2009, pursuant to Financial Accounting Standard 141R, which was codified into ASC 805, the estimated fair value of these obligations is recorded as a liability at the time of the acquisition with subsequent revisions recorded in Selling, general and administrative expense in the consolidated financial statements. The estimated fair value measurements of contingent earn-out obligations are primarily based on unobservable inputs, which may include projected revenues, gross margins, operating income, and the estimated probability of achieving the earn-outs.

 

These projections and probabilities are used to estimate future contingent earnout payments, which are discounted back to present value to compute contingent earnout liabilities. The following table provides a roll-forward from June 30, 2018 to December 31, 2018 of the contingent consideration liability, which is included in Other accrued expenses and current liabilities, and Other long-term liabilities in our consolidated balance sheets:

 

Beginning fair value, June 30, 2018

 

$

15,713

 

Additions

 

5,173

 

Change in fair value

 

(889

)

Payments

 

 

Ending fair value, December 31, 2018

 

$

19,997

 

 

Environmental Contingencies

 

We are subject to various environmental laws. Our practice is to conduct appropriate environmental investigations at our manufacturing facilities in North America, Asia Pacific, and Europe, and, to the extent practicable, on all new properties in order to identify, as of the date of such investigation, potential areas of environmental concern related to past and present activities or from nearby operations. In certain cases, we have conducted further environmental assessments consisting of soil and groundwater testing and other investigations deemed appropriate by independent environmental consultants.

 

We continue to investigate contamination of the soil and groundwater beneath our Hawthorne, California facility that resulted from unspecified on and off site releases occurring prior to our occupancy. We believe the releases are of a historical nature and not uncommon to the region in general. We continue to take voluntary actions, in cooperation with the local governing agency, to investigate the site in order to develop appropriate remedial actions. We have not accrued for loss contingencies relating to the Hawthorne facility or any other environmental matters because we believe that, although unfavorable outcomes are possible, they are not considered by our management to be probable and reasonably estimable. If one or more of these environmental matters are resolved in a manner adverse to us, the impact on our business, financial condition, results of operations and cash flow could be material.

 

Indemnifications and Certain Employment-Related Contingencies

 

In the normal course of business, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations and warranties or covenants, or intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our directors and certain of our officers. It is not possible to determine the maximum potential indemnification amount under these indemnification agreements due to a limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. We have not recorded any liability for costs related to contingent indemnification obligations as of December 31, 2018.

 

On December 31, 2017, we and Deepak Chopra, our Chief Executive Officer, entered into an amendment to Mr. Chopra’s employment agreement that, among other things, provides for a $13.5 million bonus payment to Mr. Chopra on or within 45 days of January 1, 2024 contingent upon Mr. Chopra’s continued employment with us through that date, subject to accelerated payout terms in the event of Mr. Chopra’s death or disability. The bonus is recorded in the financial statements over the remaining term of the employment agreement and is included in Other long-term liabilities.

 

Product Warranties

 

We offer our customers warranties on many of the products that we sell. 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, we record a provision for estimated warranty expenses with a corresponding increase in cost of goods sold. We periodically adjust this provision based on historical experience and anticipated expenses. We charge actual expenses of repairs under warranty, including parts and labor, to this provision when incurred. The warranty provision is included in Other accrued expenses and current liabilities in the consolidated balance sheets.

 

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Table of Contents

 

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

 

 

 

Six Months Ended December 31,

 

 

 

2017

 

2018

 

Balance at beginning of period

 

$

15,178

 

$

21,819

 

Additions

 

5,769

 

3,975

 

Acquisitions and adjustments

 

1,415

 

(581

)

Reductions for warranty repair costs

 

(3,619

)

(3,261

)

Balance at end of period

 

$

18,743

 

$

21,952

 

 

Legal Proceedings

 

In December 2017, a short seller released a report regarding our compliance with the FCPA. Following that report, we and certain of our executive officers have been named as defendants in several lawsuits in the United States District Court for the Central District of California (the “District Court”) that were filed in December 2017 and February 2018. Each of the complaints closely tracks the allegations set forth in the short seller’s report. All of the actions, which were consolidated by the District Court in March 2018 in an action captioned Arkansas Teacher Retirement System et al. v. OSI Systems, Inc. et al., No. 17 cv 08841, allege violations of Sections 10(b) and 20(a) of Exchange Act, relating to certain of our public statements and filings with the SEC, and seek damages and other relief based upon the allegations in the complaints. In April and May 2018, two shareholder derivative complaints were filed purportedly on behalf of the Company against the current members of our Board of Directors (as individual defendants), a former member of our Board of Directors, and our Chief Financial Officer. The first, captioned Riley v. Chopra et al., No. 18 cv 03371, was filed in the District Court, and the second, captioned Genesee County Employees’ Retirement System v. Chopra, et al., No. BC705958, was filed in the Superior Court of the State of California, County of Los Angeles. The complaints allege, among other things, breach of fiduciary duties relating to the allegations contained in the above mentioned short seller report. The complaints seek damages, restitution, injunctive relief, attorneys’ and experts’ fees, costs, expenses, and other unspecified relief. We believe that these actions are without merit and intend to defend them vigorously, and we expect to incur costs associated with defending against these actions. At this early stage of the litigations, the ultimate outcomes are uncertain and we cannot reasonably predict the timing or outcomes, or estimate the amount of loss, if any, or their effect, if any, on our financial statements.

 

Following the short seller report, both the SEC and the DOJ commenced investigations into our compliance with the FCPA. The SEC has subpoenaed documents from the Company, and we are responding to that subpoena and providing the same documents to the DOJ. At this time, we are unable to predict what, if any, action may be taken by the DOJ or SEC as a result of these FCPA related investigations, or any penalties or remedial measures these agencies may seek. In an unrelated matter, the SEC and DOJ are also conducting an investigation of trading in our securities and have each subpoenaed information regarding trading by executives, directors, and employees, as well as our operations and disclosures in and around the time of certain trades. With respect to these trading related matters, we have taken action with respect to a senior level employee. At this time, we are unable to predict what, if any, action may be taken by the DOJ or SEC as a result of these trading related investigations, or any penalties or remedial measures these agencies may seek. We place a high priority on compliance with our anti corruption and securities trading policies and are cooperating with each of the government investigations.

 

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

 

10. Income Taxes

 

The Tax Cuts and Jobs Act (the “Tax Act”) enacted in 2017 resulted in the U.S. Federal income tax rate being reduced from 35% to 21% effective January 1, 2018. During the measurement period, which is one year from the date of enactment, or the completion of all estimates made in connection with the Tax Act, companies are permitted to make additional income tax adjustments and revisions of estimates related to the Tax Act. During the quarter ended December 31, 2018, we concluded our analysis of the impact of the Tax Act and made no adjustments to the provisional amounts previously recorded.

 

The Tax Act subjects a U.S. corporation to tax on its GILTI (Global Intangible Low Income Tax), FDII (Foreign-Derived Tangible Income Taxes), and BEAT (Base Erosion Anti-abuse Tax). In the second quarter of fiscal 2019, we included the impact of these taxes in our forecast effective tax rate. Interpretive guidance on the accounting for GILTI states that an entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. In the fiscal quarter ended December 31, 2018, we made the accounting policy election to recognize GILTI as a period expense.

 

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The determination of the annual effective tax rate is based upon a number of significant estimates and judgments, including the estimated annual pretax income in each tax jurisdiction in which we operate, and the development of tax planning strategies during the year. In addition, as a global commercial enterprise, our tax expense can be impacted by changes in tax rates or laws, such as the Tax Act, the finalization of tax audits and reviews, and other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.

 

Our effective tax rate for the three and six months ended December 31, 2018 was 26.8% and 23.0%, respectively. Excluding certain discrete tax items, the adjusted non-GAAP effective tax rate for the three and six months ended December 31, 2018 was 28.3% and 28.2%, respectively. During the three and six month periods ended December 31, 2018, we recognized tax benefits for equity-based compensation of $0.4 million and $1.9 million, respectively, under ASU 2016-09. As a result of the enactment of the Tax Act  in December 2017, we recognized a charge of $56 million, or $2.96 per share, in the second quarter of fiscal 2018. Our reported tax rate, which includes the charge, was 465.0% for the second quarter of fiscal 2018, a