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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X]ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1998; OR
[_]TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934.
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-23125
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OSI SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 33-0238801
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
12525 CHADRON AVENUE HAWTHORNE, CALIFORNIA 90250
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 978-0516
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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Common Stock, No Par Value Nasdaq
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Indicate by check mark whether the registrant: (1) 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 at least the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Park III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant, based upon the closing sales price of the
Common Stock on the Nasdaq National Market on September 18, 1998, was
$40,554,480.
The number of shares of the registrant's Common Stock outstanding as of
September 18, 1998 was 9,694,165.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement relating to the 1998
Annual Meeting of Stockholders (to be filed subsequently) are incorporated by
reference into Part III.
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TABLE OF CONTENTS
PART I
Item 1. Business................................................ 1
Item 2. Properties.............................................. 13
Item 3. Legal Proceedings....................................... 13
Item 4. Submission on Matters to a Vote of Security Holders..... 14
PART II
Item 5. Market for Registrant's Common Stock and Related
Stockholder Matters..................................... 15
Item 6. Selected Financial Data................................. 16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 17
Item 8. Financial Statements and Supplementary Data............. 24
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................... 24
PART III
Item 10. Directors and Executive Officers of the Registrant...... 25
Item 11. Executive Compensation.................................. 25
Security Ownership of Certain Beneficial Owners and
Item 12. Management.............................................. 25
Item 13. Certain Relationships and Related Transactions.......... 25
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K................................................ 26
i
PART I
ITEM 1. BUSINESS
GENERAL
The Company is a vertically integrated worldwide provider of devices,
subsystems and end-products based on optoelectronic technology. The Company
designs and manufactures optoelectronic devices and value-added subsystems for
original equipment manufacturers ("OEMs") for use in a broad range of
applications, including security, medical diagnostics, telecommunications,
office automation, aerospace, computer peripherals and industrial automation.
In addition, the Company utilizes its optoelectronic technology and design
capabilities to manufacture security and inspection products that it markets
worldwide to end users under the "Rapiscan" and "SECURE" brand names. These
products are used to inspect baggage, cargo, people and other objects for
weapons, explosives, drugs and other contraband. In fiscal 1998, revenues from
the sale of optoelectronic devices and subsystems amounted to $50.1 million,
or approximately 53.4%, of the Company's revenues, while revenues from sales
of security and inspection products amounted to $43.8 million, or
approximately 46.6% of the Company's revenues. Unless the context otherwise
requires, the term the "Company" as used herein includes OSI Systems, Inc., a
California corporation, and its subsidiaries.
INDUSTRY OVERVIEW
The Company's products currently address two principal markets. The
Company's optoelectronic devices and subsystems are designed and manufactured
primarily for sale to OEMs, while the Company's security products are sold to
end-users.
Optoelectronic Devices and Subsystems. Optoelectronic devices consist of
both active components, such as silicon photodiodes that sense light of
varying wavelengths and convert the light detected into electronic signals,
and passive components, such as lenses, prisms, filters and mirrors. An
optoelectronic subsystem typically consists of one or more optoelectronic
devices that are combined with other electronic components for integration
into an end-product. Optoelectronic devices and subsystems are used for a wide
variety of applications ranging from simple functions, such as the detection
of paper in the print path of a laser printer, to complex monitoring,
measurement or positioning functions, such as in industrial robotics where the
subsystem is used to detect the exact position, motion or size of another
object. Because optoelectronic devices and subsystems can be used in a wide
variety of measurement, control and monitoring applications, optoelectronics
may be used in a broad array of industrial applications.
The Company believes that in recent years advances in technology and
reductions in the cost of key components of optoelectronic systems, including
computer processing power and memory, have broadened the market by enabling
the use of optoelectronic devices in a greater number of applications. In
addition, the Company believes that there is a trend among OEMs to
increasingly outsource the design and manufacture of optoelectronic subsystems
to fully integrated, independent manufacturers who may have greater
specialization, broader expertise, and the ability and flexibility to respond
in shorter time periods than the OEM could accomplish in-house. The Company
believes that its high level of vertical integration, substantial engineering
resources, expertise in the use and application of optoelectronic technology,
and low-cost international manufacturing operations enable it to compete in
the market for optoelectronic devices and subsystems.
Security and Inspection Products. A variety of products are currently used
worldwide in security and inspection applications. These products include
single energy x-ray equipment, dual energy x-ray equipment, trace detection
systems that detect particulate and chemical traces of explosive materials,
computer tomography ("CT"), scanners and x-ray machines employing backscatter
detection technology. To date, most of these products have been deployed
primarily at commercial airports worldwide. The Company believes that the
growth in the market for security and inspection products will continue to be
driven by the increased perception of threat fueled by recent terrorist
incidents, increased government mandates and appropriations, and the emergence
of a growing market for the non-security applications of its products.
1
In the 1970s, principally in response to civilian airline hijackings, the
U.S. Federal Aviation Administration ("FAA") established security standards by
setting guidelines for the screening of carry-on baggage for weapons such as
guns and knives. These standards were later mandated by the United Nations for
adoption by all of its member states. The Company believes that to date the
imposition of these standards has resulted in the installation of over 10,000
x-ray inspection systems installed in airports worldwide. Additionally, the
United Kingdom Department of Transport has required the United Kingdom's
commercial airports to deploy systems for 100% screening of international
checked baggage by the end of 1998, and the European Civil Aviation
Conference, an organization of 33 member states, has agreed to implement 100%
screening of international checked baggage by the year 2000. In the United
States, largely in response to the explosion of Pan Am Flight 103 in December
1988, Congress enacted the Aviation Security Improvement Act of 1990 which,
among other initiatives, directed the FAA to establish and implement strict
security measures and to deploy advanced technology for the detection of
various contraband, including explosives, drugs, and currency. In July 1996,
President Clinton formed the White House Commission on Aviation Safety and
Security (the "Gore Commission"), to review airline and airport security and
to oversee aviation safety. In response to the initial report released by the
Gore Commission, the United States enacted legislation that includes $144
million in appropriations for the initial deployment of advanced security and
inspection technology at major U.S. airports. The Clinton Administration is
proposing budgeting $100 million in fiscal 1999 for the purchase of state-of-
the-art detection equipment for rapid deployment in every major U.S. airport.
X-ray inspection equipment, such as that sold by the Company, is also
increasingly being used for a number of purposes not related to security.
Newer versions of x-ray inspection equipment combine x-ray inspection with
computer image enhancement capabilities and can be applied to various non-
security purposes such as the detection of narcotics, gold and currency, the
inspection of agricultural products, and the inspection of cargo by customs
officers and international shippers.
GROWTH STRATEGY
The Company's objectives are to be a leading provider of specialized
optoelectronic products, to enhance its position in the international
inspection and detection marketplace and to leverage its expertise in the
optoelectronic technology industry by entering into new end-product markets on
a selective basis. Key elements of this strategy include:
Leverage its Optoelectronic Design and Manufacturing Expertise to Address
New Applications. The Company believes that one of its primary competitive
strengths is its expertise in designing and manufacturing specialized
optoelectronic subsystems for its OEM customers in a cost-effective manner.
The Company currently designs and manufactures devices and subsystems for over
200 customers serving over 100 applications. The Company has developed this
expertise in the past through internal research and development efforts and
through selective acquisitions. In 1990, the Company acquired UDT Sensors,
Inc. ("UDT Sensors") to broaden its expertise and capabilities in developing
and manufacturing optoelectronic devices and subsystems. In 1993, the Company
acquired Rapiscan Security Products Limited ("Rapiscan U.K.") and, through
Rapiscan Security Products (U.S.A.), Inc. ("Rapiscan U.S.A."), commenced its
operations as a provider of security and inspection products in the United
States. Thereafter, in 1993, the Company acquired Ferson Optics, Inc.
("Ferson") for its passive optic technologies. In 1994, the Company commenced
operations of Opto Sensors (Malaysia) Sdn. Bhd. ("OSI Malaysia") to take
advantage of low cost manufacturing. In 1997, the Company acquired Advanced
Micro Electronics AS ("AME") for AME's hybrid optoelectronic capabilities.
In 1998, the Company expanded its operations in the field of optoelectronic
devices used for medical diagnostic applications. The Company acquired
Osteometer MediTech A/S ("Osteometer"), a Danish manufacturer of diagnostic
scanners used to detect osteoporosis. The Company also made investments in
other companies. See "Recent Developments" below.
The Company intends to continue to build this expertise in order to address
a greater number of applications. By expanding the number of potential
applications its products may serve, the Company intends to increase its
business with existing customers and attract new customers.
2
Further Penetrate Existing Security and Inspection Markets and Expand into
Other Markets. For the year ended June 30, 1998, approximately 22.0% of the
Company's security and inspection products were sold to airports or airlines
for security purposes, with the remainder of these products being sold to
other facilities for both security and non-security related purposes. The
Company intends to continue to expand its sales and marketing efforts both
domestically and internationally to capitalize on opportunities in its
existing markets for new installations as well as opportunities to replace,
service and upgrade existing security installations. In addition, through
research and development and selective acquisitions, the Company intends to
enhance and expand its current product offering to better address new
applications including automatic bomb detection and cargo scanning. In January
1998, the Company's subsidiary, Rapiscan U.S.A., acquired the "SECURE" product
line from Nicolet Imaging Systems, a division of ThermoSpectra Corporation
("ThermoSpectra"), relating to x-ray machines employing backscatter detection
technology, which are used to inspect people. See "Recent Developments" below.
The Company believes that this strategy will enable it to take advantage of
the growth its existing markets are experiencing and to benefit from
additional growth that these new and enhanced products will provide. The
Company believes that sales of its security and inspection products at
locations other than airports will constitute an increasingly larger portion
of its sales in the future.
Capitalize on Vertical Integration. The Company believes that it offers
significant added value to its OEM customers by providing a full range of
vertically integrated services including component design and customization,
subsystem concept design and application engineering, product prototyping and
development, and efficient pre-production, short-run and high volume
manufacturing. The Company believes that its vertical integration
differentiates it from many of its competitors and provides value to its OEM
customers, who can rely on the Company to be an integrated supplier of an
optoelectronic subsystem. In addition, the Company's vertical integration
provides several other advantages in both its optoelectronic devices and
subsystems and security and detection product lines. These advantages include
reduced manufacturing and delivery times, lower costs due to its access to
competitive international labor markets and direct sourcing of raw materials,
and quality control. The Company intends to continue to leverage its
vertically integrated services to create greater value for its customers in
the design and manufacturing of its products. The Company believes that this
strategy better positions the Company for penetration into other end markets.
Capitalize on Global Presence. The Company operates in three locations in
the United States, three in Europe and two in Asia. The Company views its
international operations as providing an important strategic advantage over
competitors in both the optoelectronic device and subsystem market and the
security and inspection market for three primary reasons. First, international
manufacturing facilities allow the Company to take advantage of competitive
labor rates in order to be a low cost producer. Second, its international
offices strengthen its sales and marketing efforts and its ability to maintain
and repair its systems by providing direct access to growing foreign markets
and to its existing international customer base. Third, multiple manufacturing
locations allow the Company to reduce delivery times to its global customer
base. In the future, the Company intends to develop new sources of
manufacturing and sales capabilities to maintain and enhance the benefits of
its international presence.
Selectively Enter New End Markets. The Company intends to selectively enter
new end markets that complement its existing capabilities in designing,
developing and manufacturing optoelectronic devices and subsystems, such as
the expansion during fiscal 1998 into optoelectronic products for medical
diagnostic applications. The Company believes that by manufacturing other end
products which rely on the technological capabilities of the Company, it can
leverage its existing integrated design and manufacturing infrastructure to
capture greater margins and build a significant presence in new end markets
which present attractive competitive market dynamics. The Company intends to
achieve this strategy through internal growth and through selective
acquisitions of end-product manufacturers.
3
RECENT DEVELOPMENTS
In furtherance of the Company's growth strategy, in January 1998 Rapiscan
U.S.A. acquired the "SECURE" product line from ThermoSpectra. The purchased
assets include, among other things, equipment, inventory, intellectual
property rights relating to x-ray machines and x-ray backscatter detection
technology (including patents and patent applications), business contracts and
purchase orders, for use in the manufacture and sale of security screening
products under the names "SECURE", "SECURE 1000", "SECURE 2000" and "Hands-Off
Security Screening".
Subsequent to the end of the fiscal year ended June 30, 1998, the Company
acquired one additional business and made investments in the aggregate amount
of approximately $800,000 in two other businesses. In September 1998, the
Company acquired Osteometer, a Danish manufacturer of densitometers for
scanning osteoporosis. Osteometer concentrates on the development of small,
cost optimized scanners making it possible for small clinics to offer their
patients a cost effective diagnosis of osteoporosis and is committed to the
development of scientifically and clinically validated devices that result in
accurate, precise, reliable and cost effective diagnosis. The acquisition is
the Company's largest to date.
PRODUCTS AND TECHNOLOGY
The Company designs, develops, manufactures and sells products based on its
core optoelectronic technology. These products range from discrete devices to
value-added subsystems to complete x-ray security and inspection products.
Discrete Devices and Subsystems. Optoelectronic devices generally consist of
both active and passive components. Active components sense light of varying
wavelengths and convert the light detected into electronic signals, whereas
passive components amplify, separate or reflect light. Active components
manufactured by the Company consist of silicon photodiodes and hybrid
photodetectors. Passive components include lenses, prisms, filters, mirrors
and other precision optical products that are used by the Company in the
manufacture of its optoelectronic products or are sold to others for use in
telescopes, laser printers, copiers, microscopes and other detection and
vision equipment. The devices manufactured by the Company are both standard
products and products customized for specific applications. Most of the
devices manufactured by the Company are incorporated by it into the subsystems
that it manufactures. The Company does, however, also sell its discrete
devices separately to OEMs. Direct sales of devices to third parties
constituted less than 10% of the Company's revenues in fiscal 1998.
In addition to the manufacture of discrete devices, the Company also
specializes in designing and manufacturing customized optoelectronic
subsystems for use in a wide range of products and equipment. An
optoelectronic subsystem typically consists of one or more optoelectronic
devices that are combined with other electronic components and packaging for
use in an end-product. The composition of a subsystem can range from a simple
assembly of various optoelectronic devices that are incorporated into other
subsystems (for example, a printed circuit board containing the Company's
optoelectronic devices), to complete end-products (for example, medical pulse
oximeter probes that are manufactured and packaged by the Company on behalf of
the OEM customer and then shipped directly to the customer or the customer's
distributors). Since the end of fiscal 1996, the Company has manufactured
subsystems for a variety of applications, including the following: imaging
electronics for medical CT scanners, disposable and reusable medical probes
for use with medical pulse oximetry equipment, components and subsystems for
laser gyroscopes used in military and commercial aviation, optoelectronic
subsystems for slot machines, laser subsystems in military helicopter gun
sighting equipment, positioning subassemblies for computer peripheral
equipment, alignment subsystems for laser heads in optical disc players, and
ultra-violet fire detection subsystems for submarines and surface ships.
Security and Inspection Equipment. The Company manufactures and sells a
range of security and inspection equipment that it markets under the
"Rapiscan" and "SECURE" brand names. To date, the security and inspection
equipment has principally been used at airports to inspect carry-on and
checked baggage for guns
4
and knives. However, inspection products are increasingly being used for both
security purposes at a wide range of facilities other than airports and for
other non-security purposes. For fiscal years 1996, 1997 and 1998,
approximately 33.1%, 27.3% and 22.0% respectively, of the Company's security
and inspection revenues were derived from the sale of inspection products to
airlines and airports, and the balance of such revenues were derived from all
other sales. The Company believes that sales of its inspection products for
use at non-airport locations will constitute an increasingly larger portion of
future revenues.
The Company's inspection and detection products combine the use of x-ray
technology with the Company's core optoelectronic capabilities. The base
models of its product line use single energy x-ray technology and are used for
identifying weapons with distinct shapes, such as guns and knives. The
Company's enhanced models combine dual- or multi-energy x-ray technology with
computer enhanced imaging technology to facilitate the detection of materials
such as explosives, narcotics, currency or other contraband. While all x-ray
systems produce a two-dimensional image of the contents of the inspected
material, the dual-energy x-ray systems also measure the x-ray absorption of
the inspected materials' contents at two x-ray energies to determine the
atomic number, mass and other characteristics of the object's contents. The
different organic and non-organic substances in the inspected material are
displayed in various colors. This information is then displayed to an operator
of the inspection equipment who can identify and differentiate the objects in
the inspected materials. These systems range in size from compact tabletop
systems to large cargo pallet inspection systems weighing over 1,000 lbs.
Currently, all of the Company's inspection products require an operator to
monitor the images produced by the inspection equipment. Depending on the
model, the Company's products permit the operator to inspect the contents of
packages at varying image modes and magnifications. The images range from the
monochrome and pseudo-color images produced by single x-ray imaging systems,
to high resolution, multi-color images in the Company's computer enhanced
dual-energy models. The Company believes that its Rapiscan 500 Series provides
one of the highest quality images currently available in the x-ray security
and inspection industry.
The Company has also moved into the field of inspection of people with the
recent acquisition of the "SECURE" brand product line that uses x-ray systems
employing backscatter detection technology. SECURE 1000 is an electronic
screening system for hands off people screening. The system is based on an
extremely low dose of backscatter x-ray imaging to detect contraband and
weapons concealed underneath clothing and hair. The system provides better
screening than metal detectors as it detects very small amounts of metal as
well as non-metallic contraband.
In order to monitor the performance of operators of the x-ray baggage
screening systems that are used in the United States airports, the FAA has
implemented a computer-based training and evaluation program known as the
Screener Proficiency Evaluation And Reporting System ("SPEARS"). To
continuously monitor the effectiveness of the screening system and its
operator, test threat images, such as weapons, are projected into the images
of actual parcels being inspected. The results of these tests are available to
government agencies.
5
The following table sets forth certain information related to the standard
security and inspection products currently offered by the Company. The Company
does, however, also customize its standard products to suit specific
applications and customer requirements:
MODEL (TECHNOLOGY) APPLICATIONS SELECTED INSTALLATIONS
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Rapiscan 19 (single en-
ergy) Inspection of incoming package Embassies
Rapiscan 119 (single en- Post offices
ergy) Courthouses
High risk office buildings
Manufacturing companies
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Rapiscan 300 Series (160 Inspection of hand carried baggage Airports
kV x-ray source, single Prisons
energy and dual energy) Government buildings
Nuclear facilities
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Rapiscan 500 Series- Airport hand carried and checked baggage Airports
Standard Tunnel (single Pallet inspection Cruise ships
view and dual view 160 Customs inspections Freight shippers
kV x-ray source, single Agriculture inspection Border crossings
energy and dual energy)
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Rapiscan 500 Series- Large pallet inspection Airports
Large Tunnel (single Customs inspections Freight shippers
view and dual view 320- Border crossings
450 kV x-ray source) High risk seaport locations
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Rapiscan 500 Series- Mobile x-ray inspection Conventions and special events
Mobile Systems (x-ray Airports
van or trailer) Customs inspections
Border crossing
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SECURE 1000 (non-intru- High Security Personnel Inspection Prisons
sive personal screening Military Facilities
system)
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SPEAR (Threat Image Performance Monitoring Any Rapiscan 500 Series
Projection ("TIP") System
Software)
In addition to its x-ray security and inspection products, the Company also
markets three models of an archway walk-through metal detector and two models
of a hand-held metal detector. These products are used to detect metal weapons
such as guns and knives and are installed at airports and other locations,
including prisons and schools.
Rapiscan U.S.A. has entered into a non-exclusive patent license agreement
with EG&G, Inc. ("EG&G"). Under the license, Rapiscan U.S.A. is permitted to
make, use and sell or otherwise dispose of security and inspection products
that use an x-ray line scan system for baggage inspection purposes covered by
EG&G's patent. The patent, which expires in 2000, does not affect sales of the
Company's security and inspection products manufactured and sold outside of
the United States.
Medical Imaging Equipment. The Company has also moved into the field of
manufacturing and selling the DTX 200 (DEXACARE) and U.S. Food & Drug
Administration ("FDA")-approved forearm DEXA (Dual Energy X-Ray) densitometer,
which is used to diagnose osteoporosis as well as to provide follow-up bone
density measurements. The Company also produces the ultra-sound DTU-one, the
first commercially available scanner using imaging capability for the
diagnosis of osteoporosis. The DTU-one is currently not available for sale in
the United States, although the Company filed for pre-market approval from the
FDA in Spring 1998.
6
MARKETS, CUSTOMERS AND APPLICATIONS
Optoelectronic Devices and Subsystems. The Company's optoelectronic devices
and subsystems are used in a broad range of products by a variety of
customers. The following chart illustrates, for the year ended June 30, 1998:
(i) the major product categories for which the Company provided optoelectronic
products; and (ii) certain representative customers in each such category. The
Company expects that the list of product categories, the amount of business
derived from each such product category, and the composition of its major
customers will vary from period to period.
REPRESENTATIVE MAJOR
PRODUCT CATEGORY CUSTOMERS
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Computed Tomography and X-Ray Imaging Picker International
Hologic
InVision Technologies
Aerospace and Avionics Adcole
Allied Signal
Honeywell Avionics
Litton Systems
Medical Monitoring Datascope
BioChem International
Criticare Systems
Analytical, Medical Diagnostics and Particle Abaxis
Analyzers Leica
Coulter Corporation
Office Automation and Computer Peripherals Xerox
Eastman Kodak
Dr. Johannes Heidenhain
Construction, Industrial Automation and Exploration Schlumberger
Spectra Physics
Baumer Electric
Military/Defense and Weapons Simulations Lockheed Martin (Loral)
Hughes (HDOS)
Norsk Forsvarstekmol
Bar Code Scanners Symbol Technologies
OCLI
Gaming Industry Bally Gaming
Ardac
During fiscal 1998, the Company entered into a number of significant
agreements for the sale of the Company's optoelectronic devices and
subsystems. Some of the principal agreements are the following.
The Company entered into a Master Purchase Agreement with a long-term
customer, for $31.1 million of optical subsystems to be used in medical
products. Of this amount, $8.1 million represents a firm order and the rest is
cancellable based on convenience and other terms of the agreement. The
subsystems will be delivered over a four-year period and have begun to be
shipped.
The Company received a $2.3 million purchase commitment from a U.S. defense
systems manufacturer, for optoelectronic subsystems. These subsystems will be
shipped during fiscal years 1999 and 2000.
Subsequent to the end of the fiscal year, the Company received an order of
approximately $10.0 million from the seismic services division of the world's
largest oil services company. The contract is for hybrid optoelectronic
subsystems that will be incorporated into sea-floor scanning devices. These
systems will be shipped during fiscal years 1999 and 2000.
7
Security and Inspection Products. Since entering the security and inspection
products market in 1993, the Company has shipped approximately 2,500 units to
approximately 50 countries. The following is a list of certain customers
and/or installations that have purchased the Company's security and inspection
products since January 1993:
OVERSEAS DOMESTIC
-------- --------
Nanjing Airport; People's Republic of
China American Airlines
Prague Airport; Czech Republic Bush Intercontinental Airport
Gatwick Airport; England Continental Airlines
Heathrow Airport; England Delta Airlines
TNT Freight; England Federal Courthouses
Finnish Customs; Finland Federal Reserve Bank
Indian Customs; India JFK International Airport
Japanese Embassies; worldwide Los Angeles County Courthouse
Malaysian Airport Board; Malaysia Los Angeles International Airport
New Zealand Customs; New Zealand Miami Airport
Pakistan Airports; Pakistan Orlando Airport
Doha International Airport; Qatar Ronald Reagan National Airport
HAJ Terminal; Saudi Arabia USAir
Spanish Radio/Television; Spain U.S. Department of Corrections
Sri Lanka Government; Sri Lanka
Dubai Airport; U.A.E.
Ukraine Airport; Ukraine
United Kingdom Prison System; United
Kingdom
Because the market for most security and inspection products developed in
response to civilian airline hijackings, historically a large portion of the
Company's security and inspection products were sold and continue to be sold
for use at airports. Recently, however, the Company's security and inspection
products have been used for security purposes at locations in addition to
airports, such as courthouses, government buildings, mail rooms, schools,
prisons and at unique locations such as Buckingham Palace in London, England.
In addition, the Company's security and inspection products are increasingly
being used for non-security purposes, such as for cargo inspection to detect
narcotics and contraband, prevention of pilferage at semiconductor
manufacturing facilities, quality assurance for agricultural products, and the
detection of gold and currency.
During fiscal 1998, the Company entered into a number of significant
agreements for the development and sale of the Company's security and
inspection products. Some of the principal agreements are the following.
In December 1997, the Company's Indian joint venture, ECIL-Rapiscan Security
Products Limited ("ECIL Rapiscan"), in which the Company owns a 36.0%
interest, received a $2.9 million order for 63 x-ray machines to be used by
Indian Customs throughout India. This order was fully shipped during fiscal
1998.
In January 1998, the Company announced an order received for 21 x-ray
machines from a customer in the People's Republic of China. Also in April
1998, the Company received an order for six x-ray machines at Tom Bradley
International Terminal at Los Angeles International Airport, Los Angeles,
California; and the installation of the Company's FAA-approved Threat Image
Projection (TIP) software on existing x-ray machines at Ronald Reagan National
Airport in Washington, D.C., JFK International Airport in New York, New York
and Bush Intercontinental Airport in Houston, Texas.
In November 1996, the Company entered into a $14 million contract with a
foreign customer to deliver 16 large cargo scanners. Eight of these cargo
scanners were shipped during fiscal 1998, with the remainder to be shipped
during fiscal 1999 and beyond.
In May 1998, Rapiscan U.S.A. and the FAA entered into a Cooperative Research
and Development Agreement (the "CRDA"). Under the CRDA, the Company and the
FAA's Technical Center will jointly attempt to develop, over a three-year
period, effective enhanced automated baggage screening systems at airports,
using
8
Rapiscan's proprietary scanner technology and image processing ability.
Rapiscan U.S.A. will retain title in all inventions made solely by employees
of Rapiscan U.S.A. and the U.S. Government will have the option to retain
title to all inventions made solely by the employees of the U.S. Government or
jointly by employees of Rapiscan U.S.A. and the U.S. Government. If the U.S.
Government retains title to any inventions under the CRDA, the U.S. Government
will grant Rapiscan U.S.A. an exclusive license for any invention for use in
automated detection of explosives in baggage, and a non-exclusive license for
all other inventions developed under the CRDA, in exchange for a royalty based
on gross revenues from the licensed invention. If Rapiscan U.S.A. retains
title to any inventions under the CRDA, Rapiscan U.S.A. will grant the U.S.
Government a non-exclusive license with respect to such inventions. The party
retaining title to inventions developed under the CRDA has the option to file
a patent application with respect thereto. Rapiscan U.S.A. has the option to
own the copyright in all software, documentation and other works created in
whole or in part by employees of Rapiscan U.S.A. under the CRDA.
MARKETING, SALES AND SERVICE
The Company markets and sells its optoelectronic devices and subsystems
worldwide through both a direct sales and marketing staff of 25 employees and
indirectly through a network of approximately 20 independent sales
representatives and distributors, as of June 30, 1998. Most of the in-house
sales staff is based in the United States while most of the independent sales
representatives and distributors are located abroad. Since the acquisition of
AME in March 1997, the Company's marketing efforts in Europe have been
conducted through AME's sales and marketing staff and through a network of
approximately six independent sales representatives. The Company markets and
sells its security and inspection products worldwide through a direct sales
and marketing staff of approximately 19 employees located in the United
States, the United Kingdom, Dubai, and Malaysia and through a network of over
75 independent sales representatives, as of June 30, 1998.
The Company's optoelectronic products sales staff, located in the United
States and Norway, is supported by an applications engineering group whose
members are available to provide technical support. This support includes
designing applications, providing custom tooling and process integration,
defining solutions for customers and developing products that meet customer
defined specifications. The security and inspection products sales staff is
supported by a service organization of approximately 27 persons, as of June
30, 1998, located primarily in the United States, the United Kingdom and
Malaysia. The Company also supports these sales and customer relations efforts
by providing operator training, computerized training and testing equipment,
in- country service, software upgrades, service training for customer
technicians and a newsletter on security issues.
The Company considers its maintenance service operations to be an important
element of its business. After the expiration of the standard product warranty
period, the Company is often engaged by its customers to provide maintenance
services for its security and inspection products through annual maintenance
contracts. The Company believes that its international maintenance service
capabilities allow it to be competitive in selling its security and inspection
products. Furthermore, the Company believes that as its installed base of
security and inspection products increases, revenues generated from such
annual maintenance service contracts and from the sale of replacement parts
will increase. In fiscal 1997 and 1998, maintenance service revenues and
replacement part sales collectively represented 3.6% and 3.5%, respectively,
of the Company's revenues.
RESEARCH AND DEVELOPMENT
The Company's components and optoelectronic subsystems are designed and
engineered at the Company's offices in either Hawthorne, California, or
Horten, Norway. The subsystems that the Company manufactures are engineered by
the Company to solve specific application needs of its OEM customers. The
Company's customers typically request that the Company design custom
optoelectronic solutions for their specific needs when standard components or
subsystems are not available from other manufacturers of optoelectronic
devices. After an end-product has been conceptualized by the OEM, the Company
normally will involve its engineers to design the application, establish the
mechanical specifications for the application, create the appropriate
subsystem architecture for the application, and design the development,
production and assembly process for the manufacture of the ultimate subsystem.
However, because the Company has the engineering, tooling and manufacturing
capabilities to design and manufacture entire subsystems, and not just a
specific component, the
9
Company typically also designs, manufactures and assembles the entire
subsystem for the customer. Because the Company's engineers are able to
provide additional value and services to its customers through the entire
production process from concept to completion, the Company considers its
engineering personnel to be an important extension of its core sales and
marketing effort.
In addition to close collaboration with the Company's customers in the
design and development of optoelectronics-based products, the Company
maintains an active program for the development and introduction of new
products and enhancements and improvements to its existing products, including
the implementation of new applications of its technology. The Company seeks to
further develop its research and development program and considers such
program to be an important element of its business and operations. As of June
30, 1998, in addition to the engineers that the Company employed in
manufacturing, process design and applications development, the Company
engaged approximately 44 full-time engineers and technicians in research and
development. During fiscal 1997 and 1998, the Company's research and
development expenses were approximately $2.5 million and $3.8 million,
respectively. In order to fulfill its strategy of increasing its security and
inspection product lines and of enhancing the capabilities of its existing
products, the Company intends to continue to increase its research and
development efforts in the future.
The Company's security screening products are designed at Rapiscan U.S.A.'s
facilities in Hawthorne, California and Rapiscan U.K.'s facilities in Crawley,
England. These products include mechanical, electrical, electronic, digital
electronic and software subsystems, which are all designed by the Company. In
addition to product design, the Company provides system integration services
to integrate its products into turnkey systems at the customer site. The
Company supports cooperative research projects with government agencies and,
on occasion, provides contract research for its customers and government
agencies.
MANUFACTURING AND MATERIALS MANAGEMENT
The Company currently has manufacturing facilities in the United Kingdom,
Malaysia, Norway and Denmark, in addition to its manufacturing facilities in
Hawthorne, California and Ocean Springs, Mississippi. The Company's principal
manufacturing facility is in Hawthorne, California. However, most of the
Company's high volume, labor intensive manufacturing and assembly is generally
performed at its facilities in Malaysia. Since most of the Company's customers
currently are located in Europe and the United States, the Company's ability
to assemble its products in these markets and provide follow-on service from
offices located in these regions is an important component of the Company's
global strategy.
The Company seeks to focus its subsystem manufacturing resources on its core
competencies that enable it to provide value-added enhancements and
distinctive value. The Company believes that its manufacturing organization
has expertise in optoelectronic, electrical and mechanical manufacturing and
assembly of products for commercial applications and for high reliability
applications. High reliability devices and subsystems are those which are
designed, manufactured, screened and qualified to function under exceptionally
severe levels of environmental stress. The manufacturing techniques include
silicon wafer processing and fabrication, manufacture and assembly of
photodiodes, surface mounting (SMT) and manual thru-hole assembly, thick-film
ceramic processing, wire bonding, molding, assembly of components, testing,
and packaging. The Company also has the ability to manufacture plastic parts
and certain other parts that are either not available from third party
suppliers or that can be more efficiently or cost-effectively manufactured in-
house. The Company outsources certain manufacturing operations including its
sheet metal fabrication. The manufacturing process for components and
subsystems consists of manual tasks performed by skilled and semi-skilled
workers as well as automated tasks. The number of subsystems that the Company
manufacturers depends on the customers' needs and may range from a few
subsystems (such as an optoelectronic sun sensor for use in a satellite) to
many thousands (sensors used in laser printers and bar code readers).
The principal raw materials and subcomponents used in producing the
Company's optoelectronic devices and subsystems consist of silicon wafers,
ceramics, electronic subcomponents, light emitting diodes, phototransistors,
printed circuit boards, headers and caps, housings, cables, filters and
packaging materials. For cost, quality control and efficiency reasons, the
Company generally purchases raw materials and subcomponents
10
only from single vendors with whom the Company has ongoing relationships. The
Company does, however, qualify second sources for all of its raw materials and
subcomponents, or has identified alternate sources of supply. The Company
purchases the materials pursuant to purchase orders placed from time to time
in the ordinary course of business. The silicon-based optoelectronic devices
manufactured by the Company are critical components in most of its subsystems.
Since 1987, the Company has purchased substantially all of the silicon wafers
it uses to manufacture its optoelectronic devices from Wacker Siltronic Corp.
Although to date the Company has not experienced any significant shortages or
material delays in obtaining any of its raw materials or subcomponents, there
can be no assurance that the Company will not face such shortages or delays in
one or more of these materials in the future.
Substantially all of the optoelectronic, subsystems, circuit boards and x-
ray generators used in the Company's inspection and detection systems are
manufactured in-house. The metal shells of the x-ray inspection systems, and
certain standard mechanical parts are purchased from various third-party
unaffiliated providers.
ENVIRONMENTAL REGULATIONS
The Company is subject to various federal, state and local environmental
laws, ordinances and regulations relating to the use, storage, handling, and
disposal of certain hazardous substances and wastes used or generated in the
manufacturing and assembly of the Company's products. Under such laws, the
Company may become liable for the costs of removal or remediation of certain
hazardous substances that have been or are being released on or in its
facilities or that have been or are being disposed of off site as wastes. Such
laws may impose liability without regard to whether the Company knew of, or
caused, the release of such hazardous substances. In the past, the Company has
conducted a Phase I environmental assessment report for each of the properties
in the United States at which it currently manufactures products. The purpose
of each such report was to identify, as of the date of that report, potential
sources of contamination of the property. In certain cases, the Company has
received a Phase II environmental assessment report consisting of further soil
testing and other investigations deemed appropriate by an independent
environmental consultant. The Company believes that it is currently in
compliance with all material environmental regulations in connection with its
manufacturing operations, and that it has obtained all environmental permits
necessary to conduct its business. The amount of hazardous substances and
wastes produced and generated by the Company may increase in the future
depending on changes in the Company's operations. Any failure by the Company
to comply with present or future regulations could subject the Company to the
imposition of substantial fines, suspension of production, alteration of
manufacturing process or cessation of operations, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
COMPETITION
The markets in which the Company operates are highly competitive and
characterized by evolving customer needs and rapid technological change. The
Company competes with a number of other manufacturers, many of which have
significantly greater financial, technical and marketing resources than the
Company. In addition, these competitors may have the ability to respond more
quickly to new or emerging technologies, adapt more quickly to changes in
customer requirements, have stronger customer relationships, have greater name
recognition, and devote greater resources to the development, promotion and
sale of their products than does the Company. There can be no assurance that
the Company will be able to compete successfully against any current or future
competitors in either the optoelectronic devices and subsystem markets or the
security and inspection markets or that future competitive pressures will not
materially and adversely affect its business, financial conditions and results
of operations.
In the optoelectronic device and subsystem market, competition is based
primarily on such factors as expertise in the design and development of
optoelectronic devices, product quality, timeliness of delivery, price,
customer technical support, and on the ability to provide fully integrated
services from application development and design through volume subsystem
production. The Company believes that its major competitors in the
optoelectronic device and subsystem market are EG&G Electro-Optics, a division
of EG&G, Inc., Optek
11
Technology Inc., Hamamatsu Corporation, and Honeywell Optoelectronics, a
division of Honeywell, Inc. Because the Company specializes in custom
subsystems requiring a high degree of engineering expertise, the Company
believes that it generally does not compete to any significant degree with any
other large United States, European or Asian manufacturers of standard
optoelectronic components. Competition for the Company's medical imaging
products comes principally from Lunar Corporation, Hologic, Inc. and Norland
Medical Systems, Inc.
In the security and inspection market, competition is based primarily on
such factors as product performance, functionality and quality, the over-all
cost effectiveness of the system, prior customer relationships, technological
capabilities of the products, price, local market presence, and breadth of
sales and service organization. The Company believes that its principal
competitors in the market for security and inspection products are EG&G
Astrophysics, a division of EG&G, Inc., Heimann Systems GmbH, InVision
Technologies, Inc., Vivid Technologies, American Science and Engineering,
Inc., Barringer Technologies Inc., Control Screening L.L.C., and Thermedics
Detection, Inc. Competition could result in price reductions, reduced margins,
and loss of market share by the Company. The Company believes that the
principal competitor for its products using x-ray backscatter detection
technology is American Science & Engineering, Inc. In the airline and airport
security and inspection market, particularly in the upgrade and replacement
market, the Company also competes for potential customers based on existing
relationships between its competitors and the customers. Certain of the
Company's competitors have been manufacturing inspection systems since the
1980s and have established strong relationships with airlines and airport
authorities. The Company believes that the image quality and resolution of
certain of its security and inspection products is superior to the image
quality offered by most of its competitors' x-ray based inspection products.
Although the Company also has established relationships with a number of
airport and airline customers, no assurance can be given that the Company will
be able to successfully compete in the future with existing competitors or
with new entrants.
BACKLOG
The Company measures its backlog as orders for which purchase orders or
contracts have been signed, but which have not yet been shipped and for which
revenues have not yet been recognized. The Company typically ships its
optoelectronics devices and subsystems as well as its security and inspection
products within one to three months after receiving an order. However, such
shipments may be delayed for a variety of reasons including any special design
or engineering requirements of the customer. In addition, large orders (more
than ten machines) of security and inspection products typically require more
lead time. Large cargo scanning machines require six to twelve months lead
time.
At June 30, 1998, the Company's backlog products totalled approximately
$46.9 million, compared to approximately $52.7 million at June 30, 1997. Most
of the Company's backlog as of June 30, 1998 is expected to be shipped during
the fiscal year ending June 30, 1999. Any failure of the Company to meet an
agreed upon schedule could lead to the cancellation of the related order.
Variations in the size of the order, the product mix, and delivery
requirements of the customer order may result in substantial fluctuations in
backlog from period to period. Backlog as of any particular date should not be
relied upon as indicative of the Company's revenues for any future period and
cannot be considered a meaningful indicator of the Company's performance on an
annual or quarterly basis.
EMPLOYEES
As of June 30, 1998, the Company employed approximately 753 people, of whom
571 were employed in manufacturing, 44 were employed in research and
development, 67 were employed in finance and administration, 44 were employed
in sales and marketing, and 27 were employed in its service organization. Of
the total employees, approximately 451 were employed in the United States, 131
were employed in Europe, 170 were employed in Asia, and one was employed in
the Middle East. Thirty employees at AME are members of a union and have
collective bargaining rights. Other than the employees of AME, none of the
Company's other employees are unionized. There has never been a work stoppage
or strike at the Company, and management believes that its relations with its
employees are good.
12
ITEM 2. PROPERTIES
In June 1998, the Company exercised an option and purchased two buildings
comprising its principal Hawthorne, California, facility for approximately
$2.95 million. The Company had previously leased these facilities. The Company
also purchased one additional building and a parking lot in Hawthorne,
California, adjacent to its executive offices, to house the operations of UDT
Sensors. The purchase price for this building and the parking lot was
approximately $1.26 million. The Company paid the aggregate purchase price for
both purchases with cash on hand.
As of June 30, 1998, the Company leased all of its other facilities, as
reflected in the following table:
APPROXIMATE
SQUARE LEASE
LOCATION DESCRIPTION OF FACILITY FOOTAGE EXPIRATION
- -------- ----------------------- ----------- ----------
Hawthorne, California Manufacturing, engineering, sales 41,600 2006
and marketing and service
Ocean Springs, Missis- Manufacturing, engineering and 41,800 2001
sippi sales and marketing
Johor Bahru, Malaysia Manufacturing and sales 13,500 1999
Johor Bahru, Malaysia Manufacturing 10,500 1999
Horten, Norway Manufacturing, engineering, 19,800 2008
marketing and sales
Singapore, Republic of Administrative and materials 3,000 2000
Singapore procurement
Crawley, United Kingdom Manufacturing, engineering, sales 18,700 2011
and marketing
Hayes, United Kingdom Service 3,900 2003
Previously, the operations of Rapiscan U.S.A. were located in leased
premises in Long Beach, California. Beginning April 1998, the Company
consolidated these operations into newly leased space in Hawthorne,
California. The Long Beach lease expired in September 1998.
AME terminated the lease on its previously-leased facility without
significant cost, and relocated its operations to a new facility in Horten,
Norway, in July 1998, which is included in the above table.
The Company believes that its facilities are in good condition and are
adequate to support its operations for the foreseeable future. The Company
currently anticipates that it will be able to renew the leases that are
scheduled to expire in the next few years on terms that are substantially the
same as those currently in effect. However, even if the Company were not able
to renew one or more of the leases, the Company believes that suitable
substitute space is available to relocate any of the facilities. Accordingly,
the Company does not believe that its failure to renew any of the leases that
are scheduled to expire in the next few years will have a material adverse
effect on the Company's operations.
ITEM 3. LEGAL PROCEEDINGS
On January 21, 1997, Rapiscan U.S.A. filed a complaint in the U.S. District
Court for the Central District of California against Lunar Corporation
("Lunar") in response to claims by Lunar that certain security inspection
products produced by Rapiscan U.S.A. infringe U.S. Patent No. 4,626,688 (the
"'688 patent"), which patent is owned by the University of Alabama Research
Foundation ("UAB") and licensed exclusively to Lunar. The complaint seeks a
declaratory judgment that the products produced by Rapiscan U.S.A. do not
infringe the '688 patent, that the '688 patent is invalid, and that the patent
may not be enforced against Rapiscan U.S.A. for a number of equitable and
legal reasons. The complaint also asserts related non-patent claims including
fraud and the breach of an oral agreement whereby Lunar would compensate
Rapiscan U.S.A. for assisting Lunar in its enforcement of the '688 patent and
seeks compensatory and punitive damages for these claims.
On January 23, 1997, Lunar and UAB filed suit against the Company, Rapiscan
U.S.A. and UDT Sensors in the U.S. District Court for the Western District of
Wisconsin. Lunar and UAB asserted patent infringement,
13
contributory infringement and inducement thereof. Lunar and UAB seek damages
in an unspecified amount and an injunction preventing the Company, Rapiscan
U.S.A. and UDT Sensors from further making, using, selling and offering for
sale products including the dual energy detector allegedly covered by the '688
patent. The Wisconsin lawsuit has been transferred to the U.S. District Court
for the Central District of California and has been consolidated with the
lawsuit brought by Rapiscan U.S.A.
On August 31, 1998, the parties participated in a mandatory settlement
conference and are now finalizing the language of the settlement.
In October 1994, UDT Sensors entered into a Consent Judgment and a Criminal
Plea and Sentencing Agreement (collectively, the "Consent Agreements") with
the United States of America. The charges contained in the Consent Agreements
relate to high-reliability optoelectronic subsystems that UDT Sensors
manufactured for use in military aircraft, attack helicopters and submarines.
In the Consent Agreements, UDT Sensors agreed that it had not tested 100% of
these products as required by the applicable military specifications. Under
the terms of the Consent Agreements, UDT Sensors agreed to pay a total of $1.5
million, plus interest, in five annual installments ending on March 31, 1999.
UDT Sensors was placed on probation for the five-year period ending March 31,
2000 with respect to sales of optoelectronic subsystems for use by the U.S.
Department of Defense. Probation does not, however, prohibit UDT Sensors from
selling optoelectronic products to the United States, and UDT Sensors has,
since the date of the Consent Agreements, continued to manufacture and sell
the same optoelectronic, products for use in military aircraft, attack
helicopters and submarines. In addition, in order to ensure that UDT Sensors
complies with all Federal procurement laws, UDT Sensors agreed to implement
programs and practices to establish and monitor complying contracting
procedures, and agreed to file periodic reports evidencing such practices and
programs.
On January 18, 1996, Robert Praski and Sonia Praski filed a lawsuit against
the Company, Ferson and others in the United States District Court for the
Southern District of Mississippi, alleging wrongful termination of the
Praskis' employment by Ferson. The Complaint was served on February 9, 1998.
An Amended Complaint For Damages and Other Relief was filed on April 14, 1998.
The plaintiffs alleged that irregularities occurred at Ferson, including the
falsification of test data, quality control reports and shipping records,
resulting in approximately $560,000 in overpayments in the aggregate by the
U.S. Government to Ferson and/or the Company.
The plaintiffs alleged that approximately 32,000 individual instances of
such overcharges and false claims occurred. The plaintiffs sought, based upon
the statutory civil penalty of $10,000 for each false claim under Title 31 USC
3729 et seq., more popularly known as the False Claims Act, approximately $320
million in civil damages on behalf of the U.S. Government. In addition, the
plaintiffs sought for themselves actual damages of $100,000 and punitive
damages of $2 million for their wrongful termination, together with litigation
costs and reasonable attorney fees.
The Company has filed a motion to dismiss the suit, which is pending. Even
though the court has not yet ruled on the Company's motion to dismiss, Sonia
Praski voluntarily has filed a Notice of Dismissal of her claims against all
of the defendants, thereby leaving Robert Praski as the sole plaintiff. The
Company believes that the case is frivolous and without merit. If the motion
to dismiss is not granted by the court, the Company will vigorously defend the
lawsuit. Both the Company and its counsel believe that the Company will
prevail. The U.S. Government investigated the allegations and declined to
intervene in the case or bring any charges against any of the defendants.
Except for the foregoing, the Company is not a party to any material pending
legal proceedings other than routine litigation incidental to its business.
ITEM 4. SUBMISSION ON MATTERS TO A VOTE OF SECURITY HOLDERS
None.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Stock Market and Other Information
The Company's common stock has been traded on the Nasdaq National Market
under the symbol "OSIS" since October 2, 1997. Prior to such date, there was
no public trading market for the Company's equity securities.
The following table sets forth the high and low sale prices of a share of
the Company's Common Stock as reported by the Nasdaq National Market on a
quarterly basis for the Company's fiscal year ended June 30, 1998.
1998: HIGH LOW
- ----- ------ ------
Quarter ended December 31, 1997................................. $16.00 $10.88
Quarter ended March 31, 1998.................................... $16.00 $11.13
Quarter ended June 30, 1998..................................... $12.50 $ 9.25
As of September 18, 1998, there were approximately 85 holders of record of
the Company's Common Stock. This number does not include beneficial owners
holding shares through nominee or "street" name.
Dividend Policy
The Company has not paid any dividends since the consummation of its initial
public offering in 1997 and anticipates that it will retain any available
funds for use in the operation of its business, and does not currently intend
to pay any cash dividends in the foreseeable future. Future cash dividends, if
any, will be determined by the Board of Directors. The payment of cash
dividends by the Company is restricted by certain of the Company's current
bank credit facilities, and future borrowing may contain similar restrictions.
Transfer Agent and Registrar
U.S. Stock Transfer Corp. of Glendale, California, serves as transfer agent
and registrar of the Company's Common Stock.
Use of Proceeds
The Company's Registration Statement for its initial public offering of
securities (File No. 333-29179) became effective on October 1, 1997. Of the
total net proceeds to the Company from the offering in the amount of
approximately $41,000,000, the following amounts were used from the date of
the offering through June 30, 1998.
CATEGORY OF USE AMOUNT
--------------- -----------
Construction of plant, building and facilities.................. $ --
Purchase and installation of machinery and equipment............ --
Purchase of real estate......................................... 4,211,000
Acquisition of other businesses................................. 750,000
Repayment of indebtedness....................................... 14,100,000
Working capital................................................. 3,490,000
Temporary investments........................................... 18,449,000
Other purposes.................................................. --
-----------
Total......................................................... $41,000,000
===========
15
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data of the
Company as of and for each of the five fiscal years ended June 30, 1998 and is
derived from the Consolidated Financial Statements of the Company. The
consolidated financial statements as of June 30, 1997 and June 30, 1998, and
for each of the years in the three-year period ended June 30, 1998, and the
auditor's report thereon, are included elsewhere herein. The following data
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements and notes thereto included elsewhere in this Report.
YEAR ENDED JUNE 30,
------------------------------------------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ----------
(In thousands, except share and per share data)
CONSOLIDATED STATEMENTS
OF OPERATIONS DATA:
Revenues................ $ 47,735 $ 49,815 $ 61,518 $ 77,628 $ 93,918
Cost of goods sold...... 36,037 37,818 45,486 56,174 66,952
---------- ---------- ---------- ---------- ----------
Gross profit............ 11,698 11,997 16,032 21,454 26,966
Operating expenses:
Selling, general and
administrative(1).... 7,974 7,601 9,757 11,304 12,776
Research and
development.......... 1,451 1,591 1,663 2,504 3,790
Stock option
compensation(2)...... -- -- -- 856 --
---------- ---------- ---------- ---------- ----------
Total operating
expenses........... 9,425 9,192 11,420 14,664 16,566
---------- ---------- ---------- ---------- ----------
Income from operations.. 2,273 2,805 4,612 6,790 10,400
Interest
expense/(income)....... 710 1,251 1,359 1,197 ( 600)
---------- ---------- ---------- ---------- ----------
Income before income
taxes and minority
interest............... 1,563 1,554 3,253 5,593 11,000
Provision for income
taxes.................. 814 413 1,111 1,416 2,752
---------- ---------- ---------- ---------- ----------
Income before minority
interest............... 749 1,141 2,142 4,177 8,248
Minority interest....... 38 17 117 -- --
---------- ---------- ---------- ---------- ----------
Net income.............. $ 787 $ 1,158 $ 2,259 $ 4,177 $ 8,248
========== ========== ========== ========== ==========
Net income available to
common shareholders(3). $ 995 $ 1,357 $ 2,308 $ 4,269 $ 8,248
========== ========== ========== ========== ==========
Net income per
share(3)(4)............ $ 0.16 $ 0.22 $ 0.38 $ 0.68 $ 0.92
========== ========== ========== ========== ==========
Weighted average shares
outstanding(4)......... 6,249,674 6,172,901 6,134,669 6,263,963 8,955,919
CONSOLIDATED BALANCE
SHEET DATA:
Cash and cash
equivalents............ $ 625 $ 1,405 $ 581 $ 553 $ 22,447
Working capital......... 2,280 12,117 6,044 10,800 52,417
Total assets............ 25,807 30,780 35,309 47,333 86,822
Total debt.............. 11,140 14,113 15,462 13,180 1,243
Total shareholders'
equity................. $ 3,128 $ 4,951 $ 7,194 $ 16,809 $ 65,915
- --------
(1) Fiscal 1994 includes a one time charge of $1.5 million incurred in
connection with the settlement of a governmental proceeding.
(2) Represents a charge resulting from the acceleration of the vesting periods
of outstanding stock options having exercise prices below the fair market
value on the date of grant. The charge had the effect of decreasing income
from operations, net income and net income available to common
shareholders by $856,000, $514,000 and $514,000, respectively.
(3) Gives effect to the conversion of certain subordinated debt into preferred
stock and Common Stock in October and November 1996, and the issuance of
Common Stock for the purchase of the remaining minority interests in
certain subsidiaries in October and December 1996 as if such transactions
occurred on July 1, 1992. Adjustments in each of the five years ended June
30, 1998 consist of: (i) the elimination of interest expense related to
converted subordinated debt of $246,000, $216,000, $166,000, $92,000 and
$0, net of income taxes, respectively; and (ii) the elimination of the
minority interest in the net loss of subsidiaries of $38,000, $17,000,
$117,000, $0 and $0, respectively.
(4) Assumes the conversion of 2,568,750 shares of preferred stock into
3,853,125 shares of Common Stock as of July 1, 1992. The preferred stock
had a liquidation preference of $1.00 per share, and was otherwise
entitled to the same voting, dividend and all other rights as the Common
Stock.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
consolidated financial statements and the notes thereto appearing elsewhere in
this Annual Report on Form 10-K. Certain statements contained herein that are
not related to historical results, including, without limitation, statements
regarding the Company's business strategy and objectives, future financial
position and estimated cost savings, 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. Although the Company believes that the assumptions
upon which these forward-looking statements are based are reasonable, there
can be no assurance that such assumptions will prove to be accurate and actual
results could differ materially from those discussed in the forward-looking
statements. Factors that could cause or contribute to such differences
include, but are not limited to, regulatory policies in the United States and
other countries, foreign currency fluctuations, market and general economic
factors, competitive factors including other companies' pricing and marketing
efforts, availability of third-party products at reasonable prices risks of
obsolescence due to shifts in market demand, litigation outcomes and such
other risks and uncertainties as are described in this Annual Report on Form
10-K and other documents previously filed or hereafter filed by the Company
from time to time with the Securities and Exchange Commission. All forward-
looking statements contained in this Annual Report on Form 10-K are qualified
in their entirety by this statement.
OVERVIEW
The Company is a vertically integrated worldwide provider of devices,
subsystems and end-products based on optoelectronic technology. The Company
designs and manufactures optoelectronic devices and value added subsystems for
OEMs for use in a broad range of applications, including security, medical
diagnostics, telecommunications, office automation, aerospace, computer
peripherals and industrial automation. In addition, the Company utilizes its
optoelectronic technology and design capabilities to manufacture security and
inspection products that it markets worldwide to end users under the
"Rapiscan" and "SECURE" brand names. These products are used to inspect
baggage, cargo, people and other objects for weapons, explosives, drugs and
other contraband. In fiscal 1998, revenues from the sale of optoelectronic
devices subsystems amounted to $50.1 million, or approximately 53.4% of the
Company's revenues, while revenues from sales of security and inspection
products amounted to $43.8 million, or approximately 46.6% of the Company's
revenues.
The Company was organized in May 1987. The Company's initial products were
optoelectronic devices and subsystems sold to customers for use in the
manufacture of x-ray scanners for carry-on airline baggage. In December 1987,
the Company formed Opto Sensors (Singapore) Pte Ltd. ("OSI Singapore") to
manufacture optoelectronic devices and subsystems. In April 1990, the Company
acquired UDT Senors' subsystem business. In February 1993, the Company
acquired the security and inspection operations of Rapiscan U.K. and, through
Rapiscan U.S.A., commenced its operations as a provider of security and
inspection products in the United States. In April 1993, the Company acquired
Ferson, a U.S. manufacturer of passive optic components. In July 1994, the
Company established OSI Malaysia to manufacture optoelectronic subsystems as
well as security and inspection products. In March 1997, the Company acquired
AME for the purpose of broadening its optoelectronic subsystem business in
Europe. The Company currently owns all of the outstanding shares of each of
these companies. In January 1998, the Company acquired the "SECURE" product
line from ThermoSpectra for the purpose of expanding into the area of
inspection of people. Subsequent to the end of the 1998 fiscal year, the
Company acquired Osteometer for the purpose of expanding further into the
field of optoelectronic medical devices used for medical diagnostic purposes.
In January 1994, the Company entered into a joint venture agreement with
Electronics Corporation of India, Limited ("ECIL"), an unaffiliated Indian
corporation, pursuant to which the Company and ECIL formed ECIL Rapiscan. The
joint venture was established for the purpose of manufacturing security and
inspection products in India from kits sold to ECIL by the Company. The
Company currently owns a 36.0% interest in ECIL Rapiscan. Subsequent to the
end of the 1998 fiscal year, the Company made investments in an aggregate
amount of approximately $800,000 in two other businesses.
17
The Company engages in significant international operations. The Company
currently manufactures its optoelectronic devices and subsystems at its
facilities in Hawthorne, California, Ocean Springs, Mississippi, Johor Bahru,
Malaysia, and Horten, Norway. Its security and inspection products are
manufactured at its facilities in Crawley, England, Hawthorne, California, and
Johor Bahru, Malaysia. As of June 30, 1998, the Company markets its products
worldwide through approximately 44 sales and marketing employees located in
five countries, and through approximately 102 independent sales
representatives. Revenues from shipments made outside of the United States
accounted for 38.0%, 42.2% and 49.4% of revenues for the fiscal years 1996,
1997 and 1998, respectively. Information regarding the Company's operating
income or loss and identifiable assets attributable to each of the Company's
geographic areas is set forth in Note 15 in the Company's Consolidated
Financial Statements.
The effective income tax rate for the Company for fiscal 1996, 1997 and 1998
was 34.2%, 25.3% and 25.0%, respectively. Certain products manufactured in the
United States and sold overseas are sold through a Foreign Sales Corporation
("FSC") organized by the Company in 1990. Export sales made through the FSC
are subject to federal tax advantages. If the tax advantages derived from
sales made through the FSC and certain existing state and federal tax credits
remain in effect, and if certain future foreign tax benefits are received as
anticipated, the Company believes that its effective income tax rate will be
below 32.0% during the next fiscal year.
The Company's products currently address two principal markets. The
Company's optoelectronic devices and subsystems are designed and manufactured
primarily for sale to OEMs, while the Company's security and inspection
products are sold to end-users. Two principal customers of the Company's
optoelectronic devices and subsystems are the Company's Rapiscan U.K. and
Rapiscan U.S.A. subsidiaries. Revenues from the sale of the Company's
optoelectronic devices and subsystems to these two subsidiaries are eliminated
from the Company's reported revenues. Revenues from the Company's principal
markets and intercompany eliminations are presented in the table below.
YEAR ENDED JUNE 30,
-------------------------
1996 1997 1998
------- ------- -------
(IN THOUSANDS)
Optoelectronic devices and subsystems............... $45,007 $51,554 $56,336
(Inter-company eliminations)........................ (6,392) (8,675) (6,216)
------- ------- -------
Unaffiliated optoelectronic devices and subsys-
tems............................................. 38,615 42,879 50,120
Security and inspection products.................... 22,903 34,749 43,798
------- ------- -------
Total revenues.................................. $61,518 $77,628 $93,918
======= ======= =======
In recent years, the Company has experienced increased revenues from its
security and inspection products, both in absolute dollars and as a percentage
of total Company revenues. The Company has recently initiated a program to
produce larger security and inspection products, including those for use in
inspecting cargo, which products are likely to have significantly higher
selling prices than most of the Company's products sold to date. Sales of
products with higher average selling prices may increase fluctuations in the
Company's quarterly revenues and earnings.
The Company recognizes revenues upon shipment. As the Company's product
offerings change to include sales of significantly larger systems, such as
cargo inspection products, the Company may adopt the percentage of completion
method of revenue recognition for certain products.
18
RESULTS OF OPERATIONS
The following table sets forth certain income and expenditure items as a
percentage of total revenues for the periods indicated.
YEAR ENDED JUNE
30,
-------------------
1996 1997 1998
----- ----- -----
Revenues................................................... 100.0% 100.0% 100.0%
Cost of goods sold......................................... 73.9 72.4 71.3
----- ----- -----
Gross profit............................................... 26.1 27.6 28.7
Operating expenses:
Selling, general and administrative...................... 15.9 14.6 13.6
Research and development................................. 2.7 3.2 4.0
Stock option compensation................................ -- 1.1 --
----- ----- -----
Total operating expenses............................... 18.6 18.9 17.6
----- ----- -----
Income from operations..................................... 7.5 8.7 11.1
Interest expense (income).................................. 2.2 1.5 (0.6)
----- ----- -----
Income before income taxes and minority interest........... 5.3 7.2 11.7
Provision for income taxes................................. 1.8 1.8 2.9
----- ----- -----
Income before minority interest............................ 3.5 5.4 8.8
Minority interest.......................................... 0.2 -- --
----- ----- -----
Net income................................................. 3.7% 5.4% 8.8%
===== ===== =====
COMPARISON OF THE FISCAL YEAR ENDED JUNE 30, 1998 TO THE FISCAL YEAR ENDED
JUNE 30, 1997
Revenues. Revenues consist of sales of optoelectronics devices and
subsystems as well as security and inspection products. Revenues are recorded
net of inter-company eliminations. Revenues for the fiscal year ended June 30,
1998 increased by $16.3 million, or 21.0% to $93.9 million from $77.6 million
for the fiscal year ended June 30, 1997. Revenues for the sale of
optoelectronics devices and subsystems, net of intercompany eliminations,
increased by $7.2 million, or 16.9% to $50.1 million from $42.9 million for
fiscal 1997. The increase was the result of increase in sales to medical
diagnostic and gaming industry and introduction of products that are sold for
use in the oil exploration field. Revenues from the sale of security and
inspection products increased by $9.0 million, or 26.0% to $43.8 million from
$34.7 million for fiscal 1997. The increase was due to an increase in sales of
the Company's Rapiscan Series 500 systems and large cargo inspection machines,
and continuing penetration in the security and inspection products market.
Gross Profit. Cost of goods sold consists of material, labor and
manufacturing overhead. Gross profit increased by $5.5 million, or 25.7% to
$27.0 million from $21.5 million for fiscal 1997. As a percentage of revenues,
gross profit increased to 28.7% in fiscal 1998 from 27.6% in fiscal 1997. The
increase in gross profit was due to increased sales and increased efficiencies
in manufacturing.
Selling, General and Administrative. Selling general and administrative
expenses consist primarily of compensation paid to sales, marketing, and
administrative personnel, professional service fees, and marketing expenses.
For the year ended June 30, 1998 such expenses increased by $1.5 million, or
13.0%, to $12.8 million from $11.3 million in fiscal 1997. This increase was
due primarily to an increase in payroll expenses and marketing expenses to
support revenue growth as well as an increase in legal expenses related
primarily to ongoing litigation matters. As a percentage of revenues, selling,
general and administrative expenses decreased to 13.6% in fiscal 1998 from
14.6% in fiscal 1997.
Research and Development. Research and development expenses include research
related to new product development and product enhancement expenditures. For
the year ended June 30, 1998, such expenses increased by $1.3 million, or
51.4%, to $3.8 million from $2.5 million in fiscal 1997. As a percentage of
revenues, research
19
and development expenses increased to 4.0% in fiscal 1998 from 3.2% in fiscal
1997. The increase was due primarily to acceleration of certain research and
development projects, continued enhancement of Rapiscan x-ray systems, and
increased efforts to develop product for cargo scanning and optoelectronic
devices and subsystems products.
Income from Operations. Income from operations for the year ended June 30,
1998 increased by $3.6 million, or 53.2%, to $10.4 million from $6.8 million
in fiscal 1997. Excluding the non-recurring, non-cash incentive compensation
expense of $856,000 incurred in connection with the acceleration of the
vesting period of stock options granted to certain employees and officers
during the year ended June 30, 1997, income from operations increased by $2.8
million or 36.0%, from $7.6 million last year. As a percentage of revenues,
income from operations increased to 11.1% from 8.7% last year and excluding
the non-cash compensation expense referenced above, it would have increased to
11.1% from 9.8%.
Interest Expense. For the year ended June 30, 1998, the Company earned net
interest income of $600,000 compared to net interest expense of $1.2 million
in fiscal 1997. The interest income was due to proceeds from the initial
public offering of the Company's common stock, in October 1997. A portion of
the proceeds was used to repay a majority of the Company's debt and the
remaining proceeds are invested in short-term investments.
Provision for Income Taxes. Provision for income taxes for fiscal 1998
increased by $1.3 million, or 94.4% to $2.8 million, from $1.4 million for
fiscal 1997. As a percentage of income before provision for income taxes,
provision for income taxes decreased to 25.0% from 25.3% for fiscal 1997.
Net Income. For the reasons outlined above, net income for the year ended
June 30, 1998 increased by $4.1 million, or 97.5%, to $8.2 million from $4.2
million in fiscal 1997. The non-cash compensation charge described above,
decreased net income by $514,000 in fiscal 1997.
COMPARISON OF THE FISCAL YEAR ENDED JUNE 30, 1997 TO THE FISCAL YEAR ENDED
JUNE 30, 1996
Revenues. Revenues consist of sales of optoelectronic devices and subsystems
as well as of security and inspection products. Revenues are recorded net of
all inter-company eliminations. Revenues for the fiscal year ended June 30,
1997 increased by $16.1 million, or 26.2%, to $77.6 million from $61.5 million
for the fiscal year ended June 30, 1996. Revenues from the sale of
optoelectronic devices and subsystems, net of intercompany eliminations,
increased by $4.3 million, or 11.0%, to $42.9 million from $38.6 million for
fiscal 1996. The increase was the result of increased orders from existing
customers, particularly in the medical diagnostics industry, and the expansion
of the Company's product base. Revenues from the sale of security and
inspection products increased by $11.8 million, or 51.7%, to $34.7 million
from $22.9 million for fiscal 1996. The increase was due mainly to the
continued acceptance of the Rapiscan Series 500 EPX System, which was
introduced in 1995, the growth in sales of the Rapiscan 119 tabletop model and
the introduction of large cargo inspection machines.
Gross Profit. Cost of goods sold consists of material, labor and
manufacturing overhead. Gross profit increased by $5.4 million, or 33.8%, to
$21.5 million from $16.0 million for fiscal 1996. As a percentage of revenues,
gross profit increased to 27.6% in fiscal 1997 from 26.1% in fiscal 1996.
Gross margin increased as a result of the fact that fixed costs did not
increase proportionally with the increase in revenues. In addition, gross
profit improved as a result of the Company continuing to increase the
production of product manufactured at its offshore facilities, thereby
capitalizing on lower labor and other manufacturing costs.
Selling, General and Administrative. Selling, general and administrative
expenses consist primarily of compensation paid to sales, marketing, and
administrative personnel, professional service fees, and marketing expenses.
For fiscal 1997, such expenses increased by $1.5 million, or 15.9%, to $11.3
million from $9.8 million in fiscal 1996. As a percentage of revenues,
selling, general and administrative expenses decreased to 14.6% from 15.9%.
The increase in expenses was due to increases in payroll expenses to support
revenue growth as well as to increases in legal expenses.
20
Research and Development. Research and development expenses include research
related to new product development and product enhancement expenditures. For
fiscal 1997, such expenses increased by $841,000, or 50.6%, to $2.5 million
from $1.7 million in fiscal 1996. As a percentage of revenues, research and
development expenses increased to 3.2% from 2.7%. The increase was due
primarily to continued enhancement of the Rapiscan Series 500 EPX System and
efforts to develop products for cargo scanning. In addition, the Company
expended all research and development expenses in the 1997 period as incurred,
whereas certain of such expenses related to software products, the
technological feasibility of which had been established, were capitalized in
the 1996 period.
Income from Operations. Income from operations for fiscal 1997 increased by
$2.2 million, or 47.2%, to $6.8 million from $4.6 million for fiscal 1996.
Excluding the non-recurring non-cash incentive compensation expense of
$856,000 incurred in connection with the acceleration of the vesting period of
stock options granted to certain employees during fiscal 1997, income from
operations increased by $3.0 million, or 65.8%, to $7.6 million from $4.6
million. As a percent of revenues, income from operations increased to 8.7%
from 7.5%, and excluding the non-cash compensation expense referenced above,
it would have increased to 9.8% from 7.5%.
Interest Expense. Interest expense for fiscal 1997 decreased by $162,000, or
11.9%, to $1.2 million from $1.4 million for fiscal 1996. As a percentage of
revenues, interest expense decreased to 1.5% from 2.2%. The decrease was due
to the conversion of the Company's subordinated debt to preferred and common
stock during fiscal 1997, and to a decrease in the Company's borrowing
outstanding under its lines of credit.
Provision for Income Taxes. Provision for income taxes for fiscal 1997
increased by $305,000, or 27.5%, to $1.4 million from $1.1 million for fiscal
1996. As a percentage of income before provision for income taxes and minority
interest, provision for income taxes decreased to 25.3% from 34.2% in fiscal
1996. The decrease was a result of increases in the Company's export sales
through its FSC, which has the effect of reducing the tax rate on revenues
from foreign sales made from the United States, and the increased utilization
of research and development and certain state tax credits. In addition, the
Company has made the California Waters Edge election under California tax law,
which has the effect of exempting its foreign subsidiaries from California
taxes through fiscal 2003.
Net Income. For the reasons outlined above, net income for fiscal 1997,
increased $1.9 million, or 84.9%, to $4.2 million from $2.3 million in fiscal
1996. The compensation charge described above, decreased net income by
$514,000 in fiscal 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through cash provided by
operations, through various term loans, discounting facilities, and credit
lines extended to its different subsidiaries worldwide and from its public
offering. As of June 30, 1998, the Company's principal sources of liquidity
consisted of $22.4 million in cash and several credit agreements described
below.
The Company's operations used net cash of $436,000 during fiscal 1998. The
amount of net cash used by operations reflects increases in accounts
receivable, inventory, prepaid expenses, reduction in advances from customers
and other accrued expenses and liabilities. Net cash used in operations was
offset in part by a reduction of other receivables and increases in accounts
payable, accrued payroll and related expenses, income taxes payable and
warranty accrual. The increase in accounts receivable is due to an increase in
sales as well as the timing of shipments made upon completion of certain
contracts during fiscal 1998.
Net cash used by investing activities was $8.0 and $3.0 million for fiscal
1998 and 1997, respectively, in each case due primarily to purchase of
property and equipment in the amount of $7.5 million and $2.2 million,
respectively. In fiscal 1998, of the total property and equipment purchases,
approximately $708,000 was for the purchase of equipment to manufacture
products used in the oil exploration field and approximately $4.2 million was
for the purchase of three buildings in Hawthorne, California. The Company paid
$750,000 for the acquisition of the "SECURE" product line. The Company expects
to purchase property and equipment in fiscal 1999 as required. The Company has
no significant capital spending or purchase commitments other than in the
normal course of business and commitments under leases.
21
Net cash provided by financing activities was $30.6 million for fiscal 1998
compared to net cash used by financing activities of $526,000 for fiscal 1997.
In fiscal 1998, net cash provided by financing activities resulted primarily
from Company's initial public offering and was offset in part by repayment of
the majority of the Company's debt.
The Company anticipates that current cash balances, anticipated cash flows
from operations and current borrowing arrangements will be sufficient to meet
its working capital and capital expenditure needs for the foreseeable future.
In January 1997, the Company and its three U.S. subsidiaries entered into a
credit agreement with Sanwa Bank California. The agreement, as amended in May
1998, provides for a $10.0 million line of credit, which includes revolving,
letter of credit, acceptance and foreign exchange facilities. In addition, the
Company has a $3.0 million equipment line of credit for capital purchases and
a $15.0 million line of credit for acquisitions with certain restrictions.
Advances under the lines of credit bear interest at a rate equal to a variable
bank reference rate (8.5% at June 30, 1998) or, at the Company's option, at a
fixed rate as quoted by the bank upon request. As of June 30, 1998, there were
no amounts outstanding under the line of credit, equipment line of credit or
the acquisition line of credit. As of June 30, 1998, $124,000 was outstanding
under letters of credit. The lines expire in November 1999. Borrowings under
the agreement are secured by liens on substantially all of the Company's
assets. The agreement restricts the four borrowers from incurring certain
additional indebtedness and from making capital expenditures greater than $3.5
million in the U.S. in any fiscal year, except for the purchase of real
property to be occupied by the borrowers. In addition, the credit agreement
currently requires that the Company at all times maintain (on a consolidated
basis) a tangible net worth of at least $40.0 million, a ratio of debt to
tangible net worth of not more than 3.0 to 1, and a ratio of cash, cash
equivalents and accounts receivable to current liabilities of not less than
0.8 to 1. The Company is currently in compliance with all of these financial
conditions.
In November 1996, the Company and its three U.S. subsidiaries entered into
an agreement with Wells Fargo HSBC Trade Bank, N.A. The agreement was renewed
in January 1998 and, in August 1998, was extended until November 1999. As
currently in effect, the agreement provides for revolving lines of credit up
to a maximum of $2.1 million to be used to pay obligations incurred in
connection with export orders. Of this total amount, there is a sublimit of
$1.0 million for the purchase of foreign currency and a sublimit of $1.9
million for letters of credit. The revolving credit lines bear interest at the
bank's prime rate (8.5% at June 30, 1998) plus 5.0% per annum. As of June 30,
1998, there was outstanding approximately $1.9 million for standby letters of
credit. Borrowings under the agreement are secured by liens on certain of the
Company's assets. Covenants in connection with the agreement impose
restrictions and requirements related to, among other things, maintenance of
certain financial ratios, limitations on outside indebtedness, profitability,
payments of dividends and capital expenditures.
Rapiscan U.K. has a loan agreement with Midland Bank plc, which provides for
an overdraft facility up to a maximum amount of 2.0 million Pounds Sterling
(approximately $3.3 million at June 30, 1998) outstanding at any one time,
which amounts are secured by certain assets of Rapiscan U.K. At June 30, 1998,
no amounts were outstanding under the overdraft facility. Outstanding
borrowings bear interest at a base rate (7.5% at June 30, 1998) plus 1.5% per
annum. The agreement also provides for a 1.0 million Pounds Sterling
(approximately $1.7 million at June 30, 1998) facility for tender and
performance bonds and a 1.0 million Pounds Sterling (approximately $1.7
million at June 30, 1998) facility for the purchase of forward exchange
contracts. These facilities are secured by certain assets of Rapiscan U.K. and
the Company has guaranteed Rapiscan U.K.'s obligations under the performance
bond facility. As of June 30, 1998, $588,000 was outstanding under the
performance bond facility and Rapiscan U.K. had purchased forward exchange
contracts in the amount of $973,000. The above facilities expire in January
1999 and the Company believes that they will be renewed on the same or similar
terms.
OSI Singapore has a loan agreement with Indian Bank (Singapore), which
provides for an accounts receivable discounting facility for borrowing of up
to 2.6 million Singapore dollars (approximately $1.6 million
22
at June 30, 1998). Borrowings under the line of credit bear interest at the
bank's prime rate (8.5% at June 30, 1998) plus 1.50%. The line of credit is
terminable at any time. As of June 30, 1998 there were no amounts outstanding
under the line of credit. Borrowings under the line of credit are
collateralized by certain assets of OSI Singapore and are guaranteed by
Messrs. Deepak Chopra, Ajay Mehra and Thomas Hickman, officers of the Company.
Borrowings secured by intercompany receivables are guaranteed by the Company.
AME has a loan agreement with Christiania Bank OG Kreditkasse which provides
for a revolving line of credit for borrowings of up to 5.0 million Norwegian
kroner (approximately $666,000 at June 30, 1998), of which $198,000 was
outstanding as of June 30, 1998. Borrowings under the line of credit bear
interest at a variable rate, which was 5.9% at June 30, 1998. The agreement
also provides for a term loan which matures in June 2001 and bears interest at
an annual rate of 7.0%. At June 30, 1998 outstanding term loan borrowings
totalled approximately 2.4 million Norwegian kroner (approximately $312,000 at
June 30, 1998). Subsequent to the end of the fiscal year, the outstanding
amount of the term loan was paid in full.
OSI Malaysia has a loan agreement with the Hong Kong Bank Malaysia Berhad,
which provides for a bank guarantee line of credit for 2.5 million Malaysia
ringgits (approximately $604,000 at June 30, 1998) for performance bonds and
standby letters of credit, and a 1.0 million Malaysian ringgits overdraft
facility (approximately $242,000 at June 30, 1998). Borrowings under the
overdraft facility bear interest at the bank's base lending rate (12.3% at
June 30, 1998) plus 1.75%. At June 30, 1998, the amount outstanding under the
performance bond facility was $232,000 and there were no amounts outstanding
under the overdraft facility. Borrowings under this agreement are secured by
certain assets of OSI Malaysia. These lines expire in October 1998 and the
Company believes that they will be renewed on the same or similar terms.
In August 1997, Bank Utama agreed to provide a revolving line of credit to
OSI Malaysia up to an amount of 1.5 million Malaysian ringgits (approximately
$362,000 as of June 30, 1998). Borrowings under the line of credit bear
interest at the bank's base lending rate (12.2% at June 30, 1998) plus 2.5%.
As of June 30, 1998, no amounts were outstanding under this line of credit.
Borrowings under this agreement are secured by certain assets of OSI Malaysia
and are guaranteed by the Company. The line of credit was renewed for one year
and will expire in August 1999.
The Company believes that cash from operations, existing cash and lines of
credit will be sufficient to meet its cash requirements for the foreseeable
future.
FOREIGN CURRENCY TRANSLATION
The accounts of the Company's operations in Singapore, Malaysia, England and
Norway are maintained in Singapore dollars, Malaysian ringgits, Pounds
Sterling and Norwegian kroner, respectively. Foreign currency financial
statements are translated into U.S. dollars at current rates, with the
exception of revenues, costs and expenses, which are translated at average
rates during the reporting period. Gains and losses resulting from foreign
currency transactions are included in income, while those resulting from
translation of financial statements are excluded from income and accumulated
as a component of shareholder's equity. Transaction gains/(losses) of
approximately $68,000 and $(39,000) were included in income for fiscal 1997
and 1998, respectively.
IMPORTANCE OF INTERNATIONAL MARKETS
International markets provide the Company with significant growth
opportunities. However, the following events, among others, could adversely
affect the Company's financial results in subsequent periods: periodic
economic downturns in different regions of the world, changes in trade
policies or tariffs, and political instability. For the year ended June 30,
1998, overall foreign currency fluctuations relative to the U.S. dollar had an
immaterial effect on the Company's consolidated revenues and results of
operations. As a result of recent changes in monetary policy in Malaysia,
including the pegging of the Malaysian ringgit to the U.S. dollar, the
23
Company believes that its foreign currency exposure in Malaysia will be
immaterial in the foreseeable future. The Company continues to perform ongoing
credit evaluations of its customers' financial condition and, if deemed
necessary, the Company requires advance payments for sales. The Company is
monitoring economic and currency conditions around the world to evaluate
whether there may be any significant effect on its international sales in the
future.
INFLATION
The Company does not believe that inflation has had a material impact on its
results of operations.
YEAR 2000 COMPLIANCE
The Company has a comprehensive Year 2000 project designed to identify and
assess the risks associated with its information systems, products, operations
and infrastructure, suppliers, and customers that are not Year 2000 compliant,
and to develop, implement, and test remediation and contingency plans to
mitigate these risks. The project comprises four phases: (1) identification of
risks, (2) assessment of risks, (3) development of remediation and contingency
plans, and (4) implementation and testing. The Company's Year 2000 project is
currently in the assessment phase and, with respect to certain information
systems and products, is in the remediation phase. The Company believes that
its greatest potential risks are associated with its information systems and
systems embedded in its operations and infrastructure. The Company is at the
beginning stage of assessments for its operations and infrastructure, and
cannot predict whether significant problems will be identified. The Company
has not yet determined the extent of contingency planning that may be
required. Based on the status of the assessments made and remediation plans
developed to date, the Company is not in a position to state the total cost of
remediation of all Year 2000 issues. Costs identified to date have not been
material. The Company does not currently expect the total costs to be
material, and it expects to be able to fund the total costs through operating
cash flows. However, the Company has not yet completed its assessments,
developed remediation for all problems, developed any contingency plans, or
completely implemented or tested any of its remediation plans. As the Year
2000 project continues, the Company may discover additional Year 2000
problems, may not be able to develop, implement, or test remediation or
contingency plans, or may find that the costs of these activities exceed
current expectations and become material. In many cases, the Company is
relying on assurances from suppliers that new and upgraded information systems
and other products will be Year 2000 compliant. The Company plans to test such
third-party products, but cannot be sure that its tests will be adequate or
that, if problems are identified, they will be addressed in a timely and
satisfactory way. Because the Company uses a variety of information systems
and has additional systems embedded in its operations and infrastructure, the
Company cannot be sure that all of its systems will work together in a Year
2000 compliant fashion. Furthermore, the Company cannot be sure that it will
not suffer business interruptions, either because of its own Year 2000
problems or those of its customers or suppliers whose Year 2000 problems may
make it difficult or impossible for them to fulfill their commitments to the
Company. If the Company fails to satisfactorily resolve Year 2000 issues
related to its products in a timely manner, it could be exposed to liability
to third parties. The Company is continuing to evaluate Year 2000-related
risks and will take such further corrective actions as may be required.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements of the Company are submitted as a separate section
of this Annual Report on Form 10-K on pages F-1 through F-21.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by this item is hereby incorporated by reference
from the Registrant's definitive Proxy Statement relating to the 1998 Annual
Meeting of Stockholders, which Proxy Statement will be filed with the
Securities and Exchange Commission on or about October 16, 1998.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this item is hereby incorporated by reference
from the Registrant's definitive Proxy Statement relating to the 1998 Annual
Meeting of Stockholders, which Proxy Statement will be filed with the
Securities and Exchange Commission on or about October 16, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this item is hereby incorporated by reference
from the Registrant's definitive Proxy Statement relating to the 1998 Annual
Meeting of Stockholders, which Proxy Statement will be filed with the
Securities and Exchange Commission on or about October 16, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this item is hereby incorporated by reference
from the Registrant's definitive Proxy Statement relating to the 1998 Annual
Meeting of Stockholders, which Proxy Statement will be filed with the
Securities and Exchange Commission on or about October 16, 1998.
25
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) List of documents filed as part of Report
(1)FINANCIAL STATEMENTS INCLUDED IN ITEM 8:
Report of Independent Accountants...................................... F-1
Consolidated Balance Sheets at June 30, 1997 and 1998.................. F-2
Consolidated Statements of Operations for the years ended
June 30, 1996, 1997 and 1998.......................................... F-3
Consolidated Statements of Shareholders' Equity for the years ended
June 30, 1996, 1997 and 1998.......................................... F-4
Consolidated Statements of Cash Flows for the years ended
June 30, 1996, 1997 and 1998.......................................... F-5
Notes to Consolidated Financial Statements............................. F-7
(2)FINANCIAL STATEMENT SCHEDULES INCLUDED IN ITEM 8:
Schedule II - Valuation and Qualifying Accounts
No other financial statement schedules are presented as the required
information is either not applicable or included in the Consolidated
Financial Statements or notes thereto.
(3)EXHIBITS
The exhibits listed on the accompanying Exhibit Index are filed as part
of this Annual Report.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended June 30, 1998.
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
OSI SYSTEMS, INC.
(Registrant)
Date: September 28, 1998 By: /s/Ajay Mehra
_____________________________________
Ajay Mehra
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Deepak Chopra Chairman of the Board, September 28, 1998
____________________________________ President and Chief
Deepak Chopra Executive Officer (Principal
Executive Officer)
/s/ Ajay Mehra Vice President, Chief September 28, 1998
____________________________________ Financial Officer (Principal
Ajay Mehra Financial and Accounting
Officer), Secretary and
Director
/s/ Steven C. Good Director September 28, 1998
____________________________________
Steven C. Good
/s/ Meyer Luskin Director September 28, 1998
____________________________________
Meyer Luskin
/s/ Madan G. Syal Director September 28, 1998
____________________________________
Madan G. Syal
27
INDEX TO EXHIBITS
NUMBER EXHIBIT DESCRIPTION
3.1 Articles of Incorporation of the Company (1)
3.2 Amended and Restated Bylaws of the Company (1)
4.1 Specimen Common Stock Certificate (3)
10.1 1987 Incentive Stock Option Plan, as amended, and form of Stock
Option Agreement (1)
10.2 1997 Stock Option Plan and forms of Stock Option Agreements (2)
10.3 Employment Agreement dated April 1, 1997 between the Company and
Deepak Chopra (1)
10.4 Employment Agreement dated April 1, 1997 between the Company and
Ajay Mehra (1)
10.5 Employment Agreement dated March 1, 1993 between the Company and
Andreas F. Kotowski (3)
10.6 Employment Agreement dated April 1, 1997 between the Company and
Manoocher Mansouri Aliabadi (1)
10.7 Employment Agreement dated October 5, 1994 between the Company
and Anthony S. Crane (3)
10.8 Expatriate Employment Agreement dated July 11, 1995 between the
Company and Thomas K. Hickman (2)
10.9 Incentive Compensation Agreement dated December 18, 1996 between
the Company and Andreas F. Kotowski (1)
10.10 Form of Indemnity Agreement for directors and executive officers
of the Company (3)
10.11 Joint Venture Agreement dated January 4, 1994 among the Company,
Electronics Corporation of India, Limited and ECIL-Rapiscan
Security Products Limited, as amended (2)
10.12 Amendment Number Two to Lease, dated October 24, 1995 to lease
dated January 1, 1989 by and between KB Management Company, and
UDT Sensors, Inc.(1)
10.13 Lease Agreement dated July 4, 1986 by and between Electricity
Supply Nominees Limited and Rapiscan Security Products Limited
(as assignee of International Aeradio Limited) (3)
10.14 Lease Agreement dated January 17, 1997 by and between Artloon
Supplies Sdn. Bhd. and Opto Sensors (M) Sdn. Bhd.(1)
10.15 Credit Agreement entered into on November 1, 1996 by and between
Opto Sensors, Inc., UDT Sensors, Inc.,Rapiscan Security Products
(U.S.A.), Inc. and Ferson Optics, Inc., and Wells Fargo HSBC
Trade Bank (1)
10.16 License Agreement made and entered into as of December 19, 1994,
by and between EG&G, Inc. and Rapiscan Security Products, Inc.(1)
10.17 Stock Purchase Agreement dated March 5, 1997 between
Industriinvestor ASA and Opto Sensors, Inc.(1)
10.18 Lease dated September 24, 1997 between the Company and D.S.A.
Properties (4)
10.19 Credit Agreement entered into on May 22, 1998, by and between
Sanwa Bank California and Opto Sensors, Inc., UDT Sensors, Inc.,
Rapiscan Security Products (U.S.A.), Inc. and Ferson Optics,
Inc.(5)
10.20 Agreement of Purchase and Sale and Joint Escrow Instructions
dated as of June 23, 1998 by and between KB Chadron Building, LLC
and UDT Sensors, Inc. (5)
10.21 Agreement of Purchase and Sale and Joint Escrow Instructions
dated as of June 23, 1998 by and between Chadron II, LLC and UDT
Sensors, Inc. (5)
21.1 Subsidiaries of the Company (5)
23.1 Independent Auditors' Consent (5)
27.1 Financial Data Schedule (5)
99.1 Criminal Plea and Sentencing Agreement between UDT Sensors, Inc.
and U.S. Attorney's Office (2)
99.2 Agreement between UDT Sensors, Inc. and Department of Navy (2)
- --------
(1) Previously filed with the Company's Registration Statement filed June 13,
1997.
(2) Previously filed with the Company's Amendment No. 1 to the Registration
Statement filed August 1, 1997.
(3) Previously filed with the Company's Amendment No. 2 to the Registration
Statement filed August 15, 1997.
(4) Previously filed with the Company's Quarterly Report on Form 10-Q for the
quarterly period ended December 31, 1997.
(5) Filed herewith.
28
INDEPENDENT AUDITORS' REPORT
OSI Systems, Inc.:
We have audited the accompanying consolidated balance sheets of OSI Systems,
Inc. (the "Company") and its subsidiaries as of June 30, 1998 and 1997, and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the three years in the period ended June 30, 1998. Our
audits also included the financial statement schedule listed at Item 14. These
financial statements and financial statement schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of OSI Systems, Inc. and its
subsidiaries as of June 30, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
1998 in conformity with generally accepted accounting principles. Also, in our
opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, present fairly in
all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Los Angeles, Califiornia
September 11, 1998
F-1
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1997 AND 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
1997 1998
------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (Note 1).......................... $ 553 $22,447
Accounts receivable, net of allowance for doubtful accounts
of $586 and $551 at June 30, 1997 and 1998, respectively
(Note 1)................................................... 15,556 24,254
Other receivables (Note 2).................................. 2,346 1,990
Inventory (Note 1).......................................... 18,517 21,705
Prepaid expenses............................................ 537 841
Deferred income taxes (Notes 1 and 6)....................... 874 1,381
------- -------
Total current assets...................................... 38,383 72,618
PROPERTY AND EQUIPMENT, Net (Notes 1 and 4)................... 5,841 11,466
INTANGIBLE AND OTHER ASSETS, Net (Notes 1, 2 and 3)........... 3,109 2,738
------- -------
TOTAL......................................................... $47,333 $86,822
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank lines of credit (Note 4)............................... $ 9,100 $ 198
Current portion of long-term debt (Notes 1, 5 and 12)....... 1,240 633
Accounts payable (Note 1)................................... 7,712 8,560
Accrued payroll and related expenses........................ 1,607 2,400
Income taxes payable (Notes 1 and 6)........................ 1,804 2,517
Advances from customers..................................... 2,410 1,808
Accrued warranties.......................................... 965 1,948
Other accrued expenses and current liabilities.............. 2,745 2,137
------- -------
Total current liabilities................................. 27,583 20,201
LONG-TERM DEBT (Notes 1, 5 and 12)............................ 2,840 412
DEFERRED INCOME TAXES (Notes 1 and 6)......................... 101 294
------- -------
Total liabilities......................................... 30,524 20,907
------- -------
COMMITMENTS AND CONTINGENCIES (Notes 7 and 12)
SHAREHOLDERS' EQUITY (Notes 4, 8 and 9):
Preferred stock, no par value; authorized, 10,000,000
shares, no shares issued or outstanding at June 30, 1997
and 1998, respectively.....................................
Common stock, no par value; authorized, 40,000,000 shares,
issued and outstanding 6,156,528 and 9,691,915 shares at
June 30, 1997 and 1998, respectively....................... 7,367 49,131
Retained earnings........................................... 9,171 17,419
Cumulative foreign currency translation adjustment (Note 1). 271 (635)
------- -------
Total shareholders' equity................................ 16,809 65,915
------- -------
TOTAL......................................................... $47,333 $86,822
======= =======
See accompanying notes to consolidated financial statements.
F-2
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1996 1997 1998
------- ------- -------
REVENUES (Note 1)..................................... $61,518 $77,628 $93,918
COST OF GOODS SOLD.................................... 45,486 56,174 66,952
------- ------- -------
GROSS PROFIT.......................................... 16,032 21,454 26,966
OPERATING EXPENSES:
Selling, general and administrative expenses (Notes
10 and 11)......................................... 9,757 11,304 12,776
Research and development (Note 1)................... 1,663 2,504 3,790
Stock option compensation (Note 8).................. 856
------- ------- -------
Total operating expenses.......................... 11,420 14,664 16,566
------- ------- -------
INCOME FROM OPERATIONS................................ 4,612 6,790 10,400
INTEREST EXPENSE (INCOME) (Notes 4, 5 and 10)......... 1,359 1,197 (600)
------- ------- -------
INCOME BEFORE PROVISION FOR INCOME TAXES AND MINORITY
INTEREST............................................. 3,253 5,593 11,000
PROVISION FOR INCOME TAXES (Notes 1 and 6)............ 1,111 1,416 2,752
------- ------- -------
INCOME BEFORE MINORITY INTEREST IN NET LOSS OF
SUBSIDIARIES......................................... 2,142 4,177 8,248
MINORITY INTEREST IN NET LOSS OF SUBSIDIARIES (Note
1)................................................... 117
------- ------- -------
NET INCOME............................................ $ 2,259 $ 4,177 $ 8,248
======= ======= =======
EARNINGS PER COMMON SHARE (Note 1).................... $ 1.04 $ 1.72 $ 0.94
======= ======= =======
EARNINGS PER COMMON SHARE--ASSUMING DILUTION (Note 1). $ 0.38 $ 0.68 $ 0.92
======= ======= =======
See accompanying notes to consolidated financial statements.
F-3
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
CUMULATIVE
PREFERRED COMMON FOREIGN
------------------- ----------------- CURRENCY
NUMBER NUMBER RETAINED TRANSLATION
OF SHARES AMOUNT OF SHARES AMOUNT EARNINGS ADJUSTMENT TOTAL
---------- ------- --------- ------- -------- ----------- -----
BALANCE, JUNE 30, 1995.. 1,318,750 $ 1,514 1,842,007 $ 543 $ 2,735 $ 159 $ 4,951
Exercise of stock
options.............. 16,125 17 17
Translation
adjustment........... (33) (33)
Net income............ 2,259 2,259
---------- ------- --------- ------- ------- ----- -------
BALANCE, JUNE 30, 1996.. 1,318,750 1,514 1,858,132 560 4,994 126 7,194
Exercise of stock
options.............. 118,125 146 146
Conversion of debt.... 1,250,000 2,500 120,536 225 2,725
Minority interest
acquisitions......... 206,610 1,566 1,566
Conversion of
preferred stock...... (2,568,750) (4,014) 3,853,125 4,014
Stock option
compensation......... 856 856
Translation
adjustment........... 145 145
Net income............ 4,177 4,177
---------- ------- --------- ------- ------- ----- -------
BALANCE, JUNE 30, 1997.. 6,156,528 7,367 9,171 271 16,809
Initial public
offering (Note 9).... 3,330,000 40,938 40,938
Exercise of stock
options.............. 205,387 508 508
Translation
adjustment........... (906) (906)
Tax benefit of stock
options exercised.... 318 318
Net income............ 8,248 8,248
---------- ------- --------- ------- ------- ----- -------
BALANCE, JUNE 30, 1998.. $ 9,691,915 $49,131 $17,419 $(635) $65,915
========== ======= ========= ======= ======= ===== =======
See accompanying notes to consolidated financial statements.
F-4
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
1996 1997 1998
------ ------ -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................... $2,259 $4,177 $ 8,248
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Minority interest in net loss of subsidiaries........ (117)
Provision for losses on accounts receivable.......... 404 389 122
Depreciation and amortization........................ 2,014 2,302 2,330
Stock option compensation............................ 856
Deferred income taxes................................ (12) (900) (314)
Gain on sale of property and equipment............... (13) (13)
Changes in operating assets and liabilities, net of
business acquisition:
Accounts receivable................................. (858) (1,980) (9,481)
Other receivables................................... (194) (1,530) 462
Inventory........................................... (4,068) (4,573) (3,995)
Prepaid expenses.................................... (245) 96 (325)
Accounts payable.................................... 120 1,026 1,352
Accrued payroll and related expenses................ 707 (60) 840
Income taxes payable................................ 652 1,005 884
Advances from customers............................. 183 1,448 (603)
Accrued warranty.................................... 324 574 989
Other accrued expenses and current liabilities...... (1,151) 527 (932)
------ ------ -------
Net cash provided by (used in) operating
activities........................................ 5 3,357 (436)
------ ------ -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment......... 120 46
Additions to property and equipment.................. (1,612) (2,182) (7,487)
Cash paid for business acquisition, net of cash
acquired............................................ (848) (750)
Other assets......................................... (688) 23 194
------ ------ -------
Net cash used in investing activities.............. (2,180) (3,007) (7,997)
------ ------ -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (repayment of) bank lines of
credit.............................................. 1,502 1,014 (8,797)
Payments on senior subordinated debt................. (350)
Payments on long-term debt........................... (1,250) (3,983) (2,411)
Proceeds from issuance of long-term debt............. 1,097 2,647
Proceeds from initial public offering and exercise of
stock options and warrants.......................... 17 146 41,764
Proceeds from issuance of minority interest.......... 21
------ ------ -------
Net cash provided by (used in) financing
activities........................................ 1,387 (526) 30,556
------ ------ -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH............... (36) 148 (229)
------ ------ -------
NET (DECREASE) INCREASE IN CASH EQUIVALENTS........... (824) (28) 21,894
CASH EQUIVALENTS, BEGINNING OF PERIOD................. 1,405 581 553
------ ------ -------
CASH EQUIVALENTS, END OF PERIOD....................... $ 581 $ 553 $22,447
====== ====== =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION -
Cash paid during the period for:
Interest............................................. $1,346 $1,197 $ 452
Income taxes......................................... $ 377 $1,511 $ 1,869
See accompanying notes to consolidated financial statements.
F-5
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
During 1997, certain related parties converted $225 and $2,500
of senior subordinated debt into 120,536 and 1,250,000 shares
of common and preferred stock, respectively.
During October and December 1996, the Company acquired the
minority interest of its two majority-owned subsidiaries
through the issuance of 178,956 shares of common stock, at an
estimated fair value of $6.67 per share. An additional 27,654
shares, at an estimated fair value of $13.50 per share, are
issuable at June 30, 1997. The excess of the fair value of
the common stock of $1,566 over the book value of the
minority interests of $12 has been recorded as goodwill.
In 1997, the Company acquired all of the capital stock of
Advanced Micro Electronics AS.
In conjunction with the acquisition, liabilities were assumed
as follows:
Fair value of assets acquired............................... $2,350
Goodwill.................................................... 588
Cash paid for the capital stock............................. (916)
------
Liabilities assumed......................................... $2,022
======
In 1998, the Company acquired the "SECURE" product line from
ThermoSpectra.
In conjunction with the acquisition, assets were acquired as
follows:
Equipment................................................... $ 80
Patents..................................................... 20
Inventory................................................... 650
------
Cash paid..................................................... $ 750
======
See accompanying notes to consolidated financial statements.
F-6
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL--OSI Systems, Inc. (formerly Opto Sensors, Inc.) and its
subsidiaries (collectively, the "Company") is a vertically integrated,
worldwide provider of devices, subsystems and end-products based on
optoelectronic technology. The Company designs and manufactures optoelectronic
devices and value-added subsystems for original equipment manufacturers
("OEMs") in a broad range of applications, including security, medical
diagnostics, telecommunications, office automation, aerospace, computer
peripherals and industrial automation. In addition, the Company utilizes its
optoelectronic technology and design capabilities to manufacture security and
inspection products that it markets worldwide to end users under the
"Rapiscan" and "SECURE" brand names. These products are used to inspect
baggage, cargo, people and other objects for weapons, explosives, drugs and
other contraband.
CONSOLIDATION-- The consolidated financial statements include the accounts
of OSI Systems, Inc. and its majority-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
In October and December 1996, the Company purchased the minority interests of
its two majority-owned subsidiaries by exchanging 178,956 shares of common
stock for the minority shares of the subsidiaries. The Company also issued
additional shares of the Company's common stock to the selling shareholders of
one of the subsidiaries. The number of shares issued were based upon the pre-
tax net income of the subsidiary for the year ended June 30, 1997, and
amounted to 27,654 shares. These shares have been included in the number of
shares issued for minority interest acquisitions in the accompanying
consolidated statement of shareholders equity. The excess of the fair value of
the common stock issued of $1,554,000 over the carrying value of the minority
interest of $12,000 has been recorded as goodwill and is being amortized over
a period of 20 years.
For the purpose of the consolidated statements of cash flows, the Company
considers all highly liquid investments purchased with a maturity of three
months or less to be cash equivalents.
CONCENTRATIONS OF CREDIT RISK--Financial instruments that potentially
subject the Company to credit notes consist primarily of cash, cash
equivalents and accounts receivable. At June 30, 1998 approximately 75% of the
Company's cash and cash equivalents were held at one financial institution.
The Company performs ongoing credit valuations of its customers' financial
condition and provides an allowance for potential credit losses.
INVENTORY--Inventory is stated at the lower of cost or market; cost is
determined on the first-in, first-out method.
Inventory at June 30, 1997 and 1998 consisted of the following (in
thousands):
1997 1998
------- -------
Raw materials.............................................. $11,408 $12,200
Work-in-process............................................ 4,224 6,030
Finished goods............................................. 2,885 3,475
------- -------
Total...................................................... $18,517 $21,705
======= =======
PROPERTY AND EQUIPMENT--Property and equipment are stated at cost.
Depreciation and amortization are computed using the straight-line and
accelerated methods over lives ranging from three to ten years. Amortization
of leasehold improvements is calculated on the straight-line basis over the
shorter of the useful life of the asset or the lease term.
F-7
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
Property and equipment at June 30, 1997 and 1998 consisted of the following
(in thousands):
1997 1998
------- -------
Land and buildings........................................ $ 4,211
Equipment................................................. $ 7,545 9,046
Leasehold improvements.................................... 2,093 2,768
Tooling................................................... 1,967 1,953
Furniture and fixtures.................................... 666 824
Computer.................................................. 1,699 2,202
Vehicles.................................................. 176 142
------- -------
Total..................................................... 14,146 21,146
Less accumulated depreciation and amortization............ 8,305 9,680
------- -------
Property and equipment, net............................... $ 5,841 $11,466
======= =======
INTANGIBLES AND OTHER ASSETS--Intangible and other assets at June 30, 1997
and 1998 consisted of the following (in thousands):
1997 1998
------- -------
Software development costs................................ $ 588 $ 588
Goodwill.................................................. 2,142 2,142
Deposits.................................................. 320 168
Other..................................................... 444 530
------- -------
Total..................................................... 3,494 3,428
Less accumulated amortization............................. 385 690
------- -------
Intangible and other assets, net.......................... $ 3,109 $ 2,738
======= =======
Goodwill in the amount of $1,554,000 resulting from the acquisition of
minority interests and $588,000 resulting from the acquisition of Advanced
Micro Electronics AS (see Note 3) is being amortized, on a straight-line
basis, over a period of 20 years.
Software development costs incurred in the research and development of
software products are expensed as incurred until the technological feasibility
of the product has been established. After technological feasibility is
established, certain software development costs are capitalized. The software,
once developed, is a component which is included in x-ray security machines
when they are sold to customers. The Company amortizes these costs on a
straight-line basis over a two-year period. No software development costs were
capitalized during the two years ended June 30, 1998.
IMPAIRMENT OF LONG-LIVED ASSETS--The Company reviews long-lived assets,
including goodwill, for impairment whenever events or changes in circumstances
indicate that the carrying amount of the asset may not be recoverable. If the
sum of the expected future cash flows, undiscounted and without interest
charges, is less than the carrying amount of the asset, the Company recognizes
an impairment loss based on the estimated fair value of the asset.
INCOME TAXES--Deferred income taxes are provided for temporary differences
between the financial statement and income tax bases of the Company's assets
and liabilities, based on enacted tax rates. A valuation
F-8
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
allowance is provided when it is more likely than not that some portion or all
of the deferred income tax assets will not be realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS--The Company's financial instruments
consist primarily of cash, 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. The fair value of the Company's senior subordinated debt cannot be
determined due to the related-party nature of the obligations.
FOREIGN EXCHANGE INSTRUMENTS--The Company's use of derivatives is limited to
the purchase of foreign exchange contracts in order to minimize foreign
exchange transaction gains and losses. The Company purchases forward contracts
to hedge commitments to acquire inventory for sale and does not use the
contracts for trading purposes. As of June 30, 1998 there were approximately
$973,000 in outstanding foreign exchange contracts. The estimated fair value
of these contracts closely approximated their carrying value as of June 30,
1998.
REVENUE RECOGNITION--The Company recognizes revenue upon shipment of its
product.
FOREIGN CURRENCY TRANSLATION--The accounts of the Company's operations in
Singapore, Malaysia, Norway and the United Kingdom are maintained in Singapore
dollars, Malaysian ringgits, Norwegian kroner and U.K. pounds sterling,
respectively. Foreign currency financial statements are translated into U.S.
dollars at current rates, with the exception of revenues, costs and expenses,
which are translated at average rates during the reporting period. Gains and
losses resulting from foreign currency transactions are included in income,
while those resulting from translation of financial statements are excluded
from income and accumulated as a component of shareholders' equity.
Transaction (losses) gains of approximately $(123,000), $68,000 and $(39,000)
were included in income for the years ended June 30, 1996, 1997 and 1998,
respectively.
EARNINGS PER SHARE--The Company has adopted Statement of Financial
Accounting Standards ("SFAS") No. 128 "Earnings Per Share." The Company has
reflected the provisions of SFAS 128 in the accompanying financial statements
for all periods presented. Earnings per common share is computed using the
weighted average number of shares outstanding during the period. Earnings per
common share--assuming dilution, is computed using the weighted average number
of shares outstanding during the period and dilutive common stock equivalents
from the Company's stock option plans, and in the 1996 period common
equivalent shares from convertible debt and preferred stock, calculated using
the treasury stock and if converted methods.
For the years ending June 30, 1996 and 1997, pursuant to Securities and
Exchange Commission Staff Accounting Bulletin Topic 4D, common stock and stock
options issued or granted during the twelve month period prior to the date of
the initial filing of the Company's Form S-1 Registration Statement have been
included in the calculation of the weighted average number of shares
(denominator), using the treasury stock method as if they were outstanding for
each period.
F-9
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
The following table reconciles the numerator and denominator used in
calculating earnings per share and earnings per common share--assuming
dilution.
YEAR ENDED JUNE 30, 1996
------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------ ---------
Earnings per common share
Income available to common stockholders. $2,259,000 2,163,548 $1.04
=====
Effect of dilutive securities
Convertible subordinated debt........... 166,000 1,729,815
Convertible preferred stock............. 1,938,125
Options, treasury stock method.......... 96,571
Convertible minority shareholding....... (117,000) 206,610
---------- ---------
Earnings per common share--assuming
dilution
Income available to common stockholders
and assumed conversions................ $2,308,000 6,134,669 $0.38
========== ========= =====
YEAR ENDED JUNE 30, 1997
------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------ ---------
Earnings per common share
Income available to common stockholders. $4,177,000 2,430,347 $1.72
=====
Effect of dilutive securities
Convertible subordinated debt........... 92,000 2,098,125
Convertible preferred stock............. 1,689,815
Options, treasury stock method.......... 45,676
---------- ---------
Earnings per common share--assuming
dilution
Income available to common stockholders
and assumed conversions................ $4,269,000 6,263,963 $0.68
========== ========= =====
YEAR ENDED JUNE 30, 1998
-----------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Earnings per common share
Income available to common stockholders. $8,248,000 8,753,702 $0.94
=====
Effect of dilutive securities
Options, treasury stock method.......... 202,217
---------
Earnings per common share--assuming
dilution
Income available to common stockholders
and assumed
conversions............................ $8,248,000 8,955,919 $0.92
========== ========= =====
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS--In June 1997, the Financial
Accounting Standards Board issued SFAS No. 130, "Reporting for Comprehensive
Income" and No. 131, "Disclosure About Segments of an Enterprise and Related
Information." These statements are effective for financial statements issued
for periods
F-10
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
beginning after December 15, 1997. In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement is effective for financial statements
issued for periods beginning June 15, 1999. The Company has not yet analyzed
the impact of adopting these statements.
USE OF ESTIMATES--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
2. INVESTMENT IN JOINT VENTURE
In January 1995, the Company, together with an unrelated company, formed
ECIL-Rapiscan Security Products Limited, a joint venture organized under the
laws of India. The Company, the Company's chairman and the Company's chief
financial officer have a 36%, 10.5% and 4.5% ownership interest, respectively,
in the joint venture. The Company's investment of approximately $108,000 at
June 30, 1998 is included in other assets in the accompanying financial
statements and the Company's equity in the earnings of the joint venture,
since its inception, have been insignificant.
The joint venture was formed for the purpose of the manufacture, assembly,
service and testing of x-ray security and other products. One of the Company's
subsidiaries is a supplier to the joint venture partner, who in turn
manufactures and sells the resulting products to the joint venture utilizing
technology received from the subsidiary. The agreement provides for technology
transfer between the Company and the joint venture, subject to certain
restrictions.
During the years ended June 30, 1997 and 1998, the Company earned a
technical fee and dividend income from the joint venture in the amount of
$115,000 and $144,000, respectively. At June 30, 1998, $225,000 was unpaid and
included in other receivables in the accompanying consolidated financial
statements.
3. ACQUISITIONS
On March 3, 1997, the Company acquired the capital stock of Advanced Micro
Electronics AS ("AME") headquartered in Horten, Norway, from Industriinvestor
ASA. The cash purchase price amounted to $916,000. The acquisition has been
accounted for by the purchase method of accounting, and accordingly, the
purchase price has been allocated to the assets acquired of $2,350,000 and
liabilities assumed of $2,022,000, based on the estimated fair values of the
assets and liabilities at the date of acquisition. The excess of the purchase
price over the fair value of net assets acquired is being amortized over a
period of 20 years.
The results of operations of AME are included in the Company's consolidated
financial statements from the date of acquisition. Had the acquisition
occurred as of July 1, 1995, pro forma consolidated sales for the years ended
June 30, 1996 and 1997 would have been $65,371,000 and $79,871,000,
respectively. Consolidated pro forma net income and net income per share would
not have been materially different than the amounts reported for the
respective periods.
During fiscal 1998, the Company acquired the "SECURE" product line from
ThermoSpectra Corporation. The cash purchase price amounted to $750,000. The
purchased assets include, among other things, equipment, inventory, and
intellectual property rights relating to x-ray machines and x-ray backscatter
detection technology (including patents and patent applications).
F-11
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
4. BANK AGREEMENTS
At June 30, 1997 and 1998, line of credit borrowings consisted of the
following:
1997 1998
------ ----
Line of credit--U.S............................................. $6,577
Line of credit--Singapore....................................... 974
Line of credit--Norway.......................................... 586 $198
Line of credit--Rapiscan U.K.................................... 963
------ ----
Total bank lines of credit...................................... $9,100 $198
====== ====
The Company maintains a senior loan agreement with a U.S. bank, which
provides for a $10,000,000 revolving line of credit, a $3,000,000 equipment
line of credit and a $15,000,000 line of credit for acquisitions with certain
restrictions. Borrowings under the line of credit bear interest at the bank's
prime rate (8.5% at June 30, 1998) or, at the Company's option, at a fixed
rate as quoted by the bank upon request for specific advances and terms.
Interest is payable monthly, and the lines expire in November 1999. Borrowings
under the senior loan agreement are collateralized by substantially all of the
assets of the Company. At June 30, 1998, there were no amounts outstanding
under the revolving, equipment or acquisition lines of credit. The agreement
also provides a commitment for letters of credit up to $10,000,000 not to
exceed the available balance under the line of credit. At June 30, 1998,
approximately $124,000 was issued and outstanding under letters of credit.
Covenants in connection with the agreement impose restrictions and
requirements related to, among other things, maintenance of certain financial
ratios, limitations on outside indebtedness, rental expense and capital
expenditures.
The Company has a credit agreement with a U.S. bank that provides for
borrowings up to an amount of $2,084,903. Included in total borrowings is a
facility for the purchase of foreign currencies of $1,000,000. Borrowings
under the facility bear interest at the banks prime rate (8.5% at June 30,
1998) plus 5%. Interest is payable on demand, and the line expires in November
1999. Borrowings under the current agreement are secured by certain of the
Company's assets. At June 30, 1998, there were no amounts outstanding under
the revolving line of credit. The agreement also provides a commitment for
letters of credit up to $1,885,000. At June 30, 1998, approximately $1,885,000
was issued and outstanding under letters of credit. Covenants in connection
with the agreement impose restrictions and requirements related to, among
other things, maintenance of certain financial ratios, limitations on outside
indebtedness, profitability, payments of dividends and capital expenditures.
Opto Sensors Pte. Ltd. ("OSP") has a loan agreement with a Singapore bank
that provides for revolving line of credit borrowings up to 2,600,000
Singapore dollars (approximately US$1,625,000 at June 30, 1998). Borrowings
under the line of credit bear interest at the banks prime rate (8.5% at June
30, 1998) plus 1.5%. Interest is payable monthly, and borrowings are due on
demand. Borrowings under the line of credit are collateralized by certain
assets of OSP and are guaranteed by certain officers of the Company.
Borrowings secured by intercompany receivables are guaranteed by the Company.
At June 30, 1998, there were no amounts outstanding under the revolving line
of credit.
AME has a loan agreement with a Norwegian bank that provides for revolving
line of credit borrowings up to 5,000,000 Norwegian kroner (approximately
US$666,000 at June 30, 1998). Borrowings under the line of credit bear
interest at a variable rate, which was 5.9% at June 30, 1998. Interest is
payable quarterly. Borrowings under the line of credit are collateralized by
certain AME assets. At June 30, 1998, approximately $198,000 was issued and
outstanding under the line of credit.
F-12
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
Rapiscan U.K. has a loan agreement with a U.K. bank, which provides for an
overdraft facility up to a maximum amount of 2,000,000 Pounds Sterling
(approximately $3,300,000 at June 30, 1998) outstanding at any one time, which
amounts are secured by certain assets of Rapiscan U.K. At June 30, 1998, no
amounts were outstanding under the overdraft facility. Outstanding borrowings
bear interest at a base rate (7.5% at June 30, 1998) plus 1.5% per annum. The
agreement also provides for a 1,000,000 Pounds Sterling (approximately
$1,700,000 at June 30, 1998) facility for tender and performance bonds and a
1,000,000 Pounds Sterling (approximately $1,700,000 at June 30, 1998) facility
for the purchase of forward exchange contracts. These facilities are secured
by certain assets of Rapiscan U.K. and the Company has guaranteed Rapiscan
U.K.'s obligations under the performance bond facility. As of June 30, 1998,
$588,000 was outstanding under the performance bond facility and Rapiscan U.K.
had purchased forward exchange contracts in the amount of $973,000. The above
facilities expire in January 1999 and the Company believes that they will be
renewed on the same or similar terms.
A subsidiary has a loan agreement with a Malaysian bank that provides for a
revolving line of credit up to 1,500,000 Malaysian ringgits (approximately
US$362,000 at June 30, 1998). Borrowings under the line of credit bear
interest at the bank's base lending rate (12.2% at June 30, 1998), plus 2.5%.
Interest is payable on demand. No amounts were outstanding under this
agreement at June 30, 1998. Borrowings under this agreement are secured by
certain assets of the subsidiary and are guaranteed by the Company. The line
of credit was renewed for one year and will expire in August 1999.
A subsidiary has a loan agreement with a Malaysian bank that provides for
performance bonds and standby letters of credit of 2,500,000 Malaysian
ringgits (approximately US $604,000 at June 30, 1998). The agreement also
provides for overdraft borrowings up to 1,000,000 Malaysian ringgits
(approximately US$242,000 at June 30, 1998). Borrowings under the overdraft
facility bear interest at the bank's base lending rate (12.3% at June 30,
1998) plus 1.75%. At June 30, 1998, approximately $232,000 was issued and
outstanding under the performance bond facility and there were no amounts
outstanding under the overdraft facility. Borrowings under this agreement are
secured by certain assets of the subsidiary. These facilities expire on
October 1998 and the Company believes that they will be renewed on the same or
similar terms.
F-13
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
5.LONG-TERM DEBT
At June 30, 1997 and 1998, long-term debt consisted of the following (in
thousands):
1997 1998
------ -----
Term loan payable to a bank, interest due monthly at the bank's
prime rate (8.5% at June 30, 1997) plus 0.50%, principal due in
monthly installments of $52,083 until paid in full on March 31,
2001. Outstanding balances are collateralized by substantially
all of the assets of the Company. The outstanding balance was
paid in full in October 1997.................................... $2,344
Term loan payable to a Norwegian bank, interest due quarterly at
a rate of 7%, principal due in monthly installments of $8,680
until paid in full on June 1, 2001. Outstanding balances are
collateralized by certain assets of the subsidiary.............. 437 $ 312
Term loan payable to a bank, interest due monthly at the bank's
prime rate (8.5% at June 30, 1997) plus 2.25%, principal due in
monthly installments of $8,333 until paid in full on November
30, 1997. The outstanding balance was paid in full in November
1997............................................................ 41
Liability under settlement agreements, interest computed at the
52 week treasury bill rate (5.055% at June 30, 1998), principal
due $400,000 in 1999............................................ 700 400
Other............................................................ 558 333
------ -----
4,080 1,045
Less current portion of long-term debt........................... 1,240 633
------ -----
Long-term portion of debt........................................ $2,840 $ 412
====== =====
Fiscal year principal payments of long-term debt as of June 30, 1998 are as
follows (in thousands):
1999................................................................ $ 633
2000................................................................ 254
2001................................................................ 138
2002................................................................ 20
------
Total............................................................. $1,045
======
6.INCOME TAXES
For financial reporting purposes, income before provision for income taxes
and minority interest includes the following components (in thousands):
1996 1997 1998
------ ------ -------
Pretax income:
United States........................................ $1,965 $2,655 $ 4,505
Foreign.............................................. 1,288 2,938 6,495
------ ------ -------
Total pretax income.................................... $3,253 $5,593 $11,000
====== ====== =======
F-14
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
The Company's provision for income taxes is composed of the following (in
thousands):
1996 1997 1998
------ ------ ------
Current:
Federal.......................................... $ 510 $1,256 $1,729
State............................................ 21 24 246
Foreign.......................................... 592 1,036 1,091
------ ------ ------
1,123 2,316 3,066
Deferred........................................... (12) (900) (314)
------ ------ ------
Total provision.................................... $1,111 $1,416 $2,752
====== ====== ======
Deferred income tax assets (liabilities) At June 30, 1997 and 1998 consisted
of the following (in thousands):
1997 1998
------- -------
State income taxes....................................... $ 1,455 $ 1,585
Depreciation............................................. 67
Other.................................................... 301 644
------- -------
Total deferred income tax assets......................... 1,756 2,296
------- -------
Depreciation............................................. (43)
Capitalized software development costs................... (219) (217)
State income taxes....................................... (329) (462)
Revitalization zone deductions........................... (392) (530)
------- -------
Total deferred income tax liabilities.................... (983) (1,209)
------- -------
Net deferred income taxes................................ $ 773 $ 1,087
======= =======
The consolidated effective income tax rate differs from the federal
statutory income tax rate due primarily to the following:
1996 1997 1998
---- ---- -----
Provision for income taxes at federal statutory rate... 35.0% 35.0% 35.0%
State income taxes (credits), net of federal benefit... 0.2 (4.7) (1.1)
Nontaxable earnings of FSC............................. (5.7) (4.9) (1.3)
Research and development tax credits................... (1.7) (1.7)
Foreign income subject to tax at other than federal
statutory rate........................................ 1.1 (1.0) (10.9)
Other.................................................. 3.6 2.6 5.0
---- ---- -----
Effective income tax rate.............................. 34.2% 25.3% 25.0%
==== ==== =====
The Company does not provide for U.S. income taxes on the undistributed
earnings of the foreign subsidiaries, as it is the Company's intention to
utilize those earnings in the foreign operations for an indefinite period of
time. At June 30, 1998, undistributed earnings of the foreign subsidiaries
amounted to approximately $8,667,000. It is not practicable to determine the
amount of income or withholding tax that would be payable upon the remittance
of those earnings.
F-15
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
7. COMMITMENTS AND CONTINGENCIES
The Company leases some of its production and office facilities and certain
equipment under various operating leases. Most of these leases provide for
increases in rents based on the Consumer Price Index and include renewal
options ranging from two to ten years. Future minimum lease payments under
such leases as of June 30, 1998 are as follows:
1999.............................................................. $ 833,000
2000.............................................................. 745,000
2001.............................................................. 711,000
2002.............................................................. 630,000
2003.............................................................. 622,000
2004 and thereafter............................................... 3,145,000
----------
Total............................................................. $6,686,000
==========
Total rent expense included in the accompanying consolidated financial
statements was $901,000, $921,000 and $1,013,000 for the years ended June 30,
1996, 1997 and 1998, respectively.
The Company is involved in various claims and legal proceedings arising out
of the conduct of its business, including those relating to patent rights and
related licensing issues. The principal litigation involves claims that
certain technology used in the Company's scanners infringes on certain
existing patents and seeks damages in an unspecified amount and an injunction
barring the Company from making, using, selling or offering for sale certain
of its security and inspection products in the United States. The Company has
alleged that its security products do not infringe the patents, and that the
plaintiffs in the suit had previously granted the Company the right to market
its security and inspection products. In the event it is determined that the
Company's products infringe upon the rights of the plaintiffs and that the
Company does not have the right to use the technology in its products, the
Company could be prevented from marketing most of its security and inspection
products in the United States and could be required to pay a significant
amount of damages. On August 31, 1998, the parties participated in a mandatory
settlement conference and are now finalizing the language of the settlement.
On January 18, 1996 a former employee filed a lawsuit against the Company,
alleging wrongfull termination of employment by the Company. The plaintiff
alleged that irregularities occurred at the Company resulting in over payments
by the U.S. Government to the Company. The Company has filed a motion to
dismiss which is currently pending. If the motion to dismiss is not granted,
the Company will vigorously defend the lawsuit. Both the Company and its
counsel believe that the Company will prevail.
8. STOCK OPTIONS
The Company has two stock option plans. Under the 1987 plan, 1,050,000
shares of common stock have been reserved for the issuance of incentive stock
options to key employees, directors and officers of the Company. The price,
terms and conditions of each issuance are determined by the Board of
Directors, with the advice of and input from the Compensation Committee.
The 1997 plan was established in May 1997 and authorizes the grant of up to
850,000 shares of the Company's common stock in the form of incentive and
nonqualified options. Employees, officers and Directors are eligible under
this plan, which is administered by the Board of Directors, which determines
the terms and conditions of each grant with the advice of and input from the
Compensation Committee. The exercise price of
F-16
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
nonqualified options may not be less than 85% of the fair market value of the
Company's common stock at the date of grant. The exercise price of incentive
stock options may not be less than the fair market value of the Company's
common stock at the date of grant. The exercise price of incentive stock
options granted to individuals that own greater than 10% of the Company's
voting stock may not be less than 110% of the fair market value of the
Company's common stock at the date of grant.
Exercise periods for incentive and nonqualified options granted under this
plan may not exceed ten years from the grant date.
In November and December 1996, the Company granted stock options for the
purchase of 235,125 shares of the Company's common stock to certain employees
at prices below the $6.67 estimated fair market value at the date of grant.
The options were accelerated to vest immediately, and accordingly, the Company
has recorded compensation expense for the year ended June 30, 1997,
representing the excess of the fair value of the Company's common stock at the
date of grant over the option exercise prices.
The following summarizes stock option activity for the years ended June 30,
1996, 1997 and 1998:
OPTION PRICE
NUMBER ------------------
OF WEIGHTED
OPTIONS AVERAGE TOTAL
-------- -------- ---------
Outstanding, June 30, 1995........................ 297,375 1.57 $ 469,000
Granted........................................... 51,000 2.17 111,000
Exercised......................................... (16,125) 1.06 (17,000)
Canceled.......................................... (13,500) 1.60 (22,000)
-------- ---------
Outstanding, June 30, 1996........................ 318,750 1.70 541,000
Granted........................................... 669,611 8.88 5,947,000
Exercised......................................... (118,125) 1.24 (146,000)
Canceled.......................................... (9,750) 2.38 (23,000)
-------- ---------
Outstanding, June 30, 1997........................ 860,486 7.34 6,319,000
Granted........................................... 168,000 10.10 1,696,000
Exercised......................................... (205,387) 2.47 (508,000)
Canceled.......................................... (10,187) 9.34 (95,000)
-------- ---------
Outstanding, June 30, 1998........................ 812,912 9.12 7,412,000
======== =========
The following summarizes pricing and term information for options
outstanding as of June 30, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED WEIGHTED
OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
AT JUNE 30, CONTRACTUAL EXERCISE AT JUNE 30, EXERCISE
RANGE OF EXERCISE PRICES 1998 LIFE PRICE 1998 PRICE
------------------------ ----------- ----------- -------- ----------- --------
$ 2.00.................. 45,000 1.6 years $2.00 45,000 $2.00
2.33 to 3.33......... 173,175 3.2 2.70 160,988 2.75
10.00 to 11.01......... 168,000 5 10.10
11.50 to 13.50......... 426,737 4 12.09 106,684 11.50
------- -------
$ 2.00 to 13.50......... 812,912 3.9 $9.12 312,672 $5.63
======= =======
F-17
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." The estimated fair value of options
granted during 1997 and 1998 pursuant to SFAS No. 123 was approximately
$1,054,000 and $768,000, respectively. Had the Company adopted SFAS No. 123,
pro forma net income would have been $4,058,000 and $7,787,000, and pro forma
net income per share would have been $0.64 and $0.87 for 1997 and 1998,
respectively. The fair value of each option grant was estimated using the
Black-Scholes option-pricing model with the following weighted average
assumptions: dividend yield of zero and volatility of 44% (1997 0%), a risk
free interest rate of 5.47% (1997 6.33%) and expected option lives of five
years.
9. STOCKHOLDERS' EQUITY
In May 1997, the Company's Board of Directors authorized a 1.5-for-1 stock
split of the outstanding common stock. All share and per share numbers have
been adjusted to retroactively reflect the common stock split.
The preferred stock had a liquidation preference of $1.00 per share and was
otherwise entitled to the same voting, dividend and all other rights as the
common stock.
In June 1997, in order to simplify the capital structure of the Company,
holders of the preferred stock converted each preferred share into 1.5 shares
(post-split) of common stock.
In June 1997, the Company amended its articles of incorporation, which
articles authorize 10,000,000 shares of new preferred stock. Such preferred
stock has no par value, and no preferred shares are issued and outstanding at
June 30, 1997 and June 30, 1998, respectively.
In connection with the acquisition of the minority interest of a subsidiary
in November 1996 (see Note 1), the Company granted the selling
shareholders/employees options to purchase 45,486 shares of the Company's
common stock at $11.50 per share. The options vest over four years from the
date of grant.
The Company's Registration Statement for its initial public offering of
securities (File No. 333-29179) became effective on October 1, 1997, when the
Company issued 3,330,000 shares of its common stock for net proceeds of
$41,000,000.
10. RELATED-PARTY TRANSACTIONS
The Company contracts with entities affiliated by common ownership to
provide messenger service and auto rental and printing services. The Company
also contracts for professional services from a firm that has a partner
serving as a member of the Company's Board of Directors. Included in cost of
sales, selling, general and administrative expenses for the years ended June
30, 1996, 1997 and 1998 are approximately $83,000, $111,000 and $99,000 for
messenger service and auto rental; $63,000, $82,000 and $186,000 for printing
services; and $7,000, $11,000 and $13,000 for professional services,
respectively. For the year ended June 30, 1997, the Company paid an one time
consulting fee amounting to $100,000 to an entity that is a shareholder of the
Company.
Shareholders and other parties related to the Company have made loans to the
Company under agreements subordinating such loans to the Company's bank
borrowings (see Notes 4 and 5). Interest expense related to such borrowings
was approximately $263,000 and $146,000 for the years ended June 30, 1996 and
1997, respectively.
F-18
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
11. GOVERNMENT SETTLEMENT
During 1994, a subsidiary of the Company was notified that the U.S.
Department of Justice was conducting an investigation regarding the testing of
certain products that were sold by a subsidiary under government contracts. A
settlement of $1,500,000 was agreed to, and was accrued and charged to
operations in the year ended June 30, 1994. The settlement is being paid in
five increasing installments, with the unpaid principal balance bearing
interest at the 52-week Treasury bill rate. At June 30, 1998, the unpaid
balance of this settlement was $400,000 (see Note 5).
12. EMPLOYEE BENEFIT PLANS
OSI Systems, Inc. has a qualified employee retirement savings plan. The plan
provides for a contribution by the Company, which is determined annually by
the Board of Directors. In addition, the plan permits voluntary salary
reduction contributions by employees. The Company made no contributions to the
plan for the years ended June 30, 1998, 1997 and 1996. During 1995, a
subsidiary in the U.K. ("Rapiscan U.K.") transferred its existing employees
from their former owner's plan to a new plan, the Rapiscan U.K. Defined
Benefit Plan, which covers certain Rapiscan U.K. employees. The benefits under
this plan are based on years of service and the employees' highest 12 months'
compensation during the last five years of employment. Rapiscan U.K.'s funding
policy is to make the minimum annual contributions required by applicable
regulations based on an independent actuarial valuation sufficient to provide
for benefits accruing after that date. Pension expense for the years ended
June 30, 1996, 1997 and 1998 was approximately $91,000, $89,000 and $138,000,
respectively.
13. SUBSEQUENT EVENTS
On September 2, 1998, the Company acquired all the shares of Osteometer
MediTech A/S, a Danish manufacturer of diagnostic scanners to detect
osteoporosis, for $7,750,000 cash. The Company also made investments in the
aggregate amount of $800,000 in two other companies.
F-19
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
14. UNAUDITED QUARTERLY RESULTS
The following table presents unaudited quarterly financial information for
the four quarters ended June 30, 1998:
QUARTER ENDED IN THOUSANDS
--------------------------------------------
JUNE
SEPTEMBER 30, DECEMBER 31, MARCH 31, 30,
1997 1997 1998 1998
------------- ------------ --------- -------
(UNAUDITED)
Revenues......................... $22,961 $24,285 $21,893 $24,779
Costs of goods sold.............. 16,649 17,183 15,366 17,754
------- ------- ------- -------
Gross profit..................... 6,312 7,102 6,527 7,025
Operating expenses:
Selling, general and
administrative................ 3,099 3,293 3,106 3,278
Research and development....... 827 973 995 995
------- ------- ------- -------
Total operating expenses......... 3,926 4,266 4,101 4,273
------- ------- ------- -------
Income from operations........... 2,386 2,836 2,426 2,752
Interest expense (income), net... 411 (369) (303) (339)
------- ------- ------- -------
Income before provision for in-
come taxes...................... 1,975 3,205 2,729 3,091
Provision for income taxes....... 534 835 667 716
------- ------- ------- -------
Net income....................... $ 1,441 $ 2,370 $ 2,062 $ 2,375
======= ======= ======= =======
Earnings per common share........ $ 0.23 $ 0.25 $ 0.21 $ 0.25
======= ======= ======= =======
Earnings per common share--Assum-
ing dilution.................... $ 0.22 $ 0.24 $ 0.21 $ 0.24
======= ======= ======= =======
F-20
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
15. SEGMENT INFORMATION
The Company's operating locations include the United States, Europe (United
Kingdom and Norway) and Asia (Singapore and Malaysia). The Company's
operations and identifiable assets by geographical area are as follows (in
thousands):
YEAR ENDED JUNE 30, 1996
--------------------------------------------------
UNITED
STATES EUROPE ASIA ELIMINATIONS CONSOLIDATED
-------- ------- ------- ------------ ------------
Revenues.................... $ 42,403 $15,346 $ 3,769 $61,518
Transfer between geographi-
cal areas.................. 6,304 3,092 10,974 $(20,370)
-------- ------- ------- -------- -------
Net revenues................ $ 48,707 $18,438 $14,743 $(20,370) $61,518
======== ======= ======= ======== =======
Operating income............ $ 2,641 $ 1,278 $ 890 $ (197) $ 4,612
======== ======= ======= ======== =======
Identifiable assets......... $ 42,932 $10,179 $ 5,986 $(23,788) $35,309
======== ======= ======= ======== =======
YEAR ENDED JUNE 30, 1997
--------------------------------------------------
UNITED
STATES EUROPE ASIA ELIMINATIONS CONSOLIDATED
-------- ------- ------- ------------ ------------
Revenues.................... $ 54,310 $18,915 $ 4,403 $77,628
Transfer between geographi-
cal areas.................. 8,655 5,156 12,191 $(26,002)
-------- ------- ------- -------- -------
Net revenues................ $ 62,965 $24,071 $16,594 $(26,002) $77,628
======== ======= ======= ======== =======
Operating income............ $ 3,814 $ 1,849 $ 1,390 $ (263) $ 6,790
======== ======= ======= ======== =======
Identifiable assets......... $ 52,367 $15,066 $ 8,395 $(28,495) $47,333
======== ======= ======= ======== =======
YEAR ENDED JUNE 30, 1998
--------------------------------------------------
UNITED
STATES EUROPE ASIA ELIMINATIONS CONSOLIDATED
-------- ------- ------- ------------ ------------
Revenues.................... $ 56,710 $27,537 $ 9,671 $93,918
Transfer between
geographical areas......... 6,786 3,329 12,672 $(22,787)
-------- ------- ------- -------- -------
Net revenues................ $ 63,496 $30,866 $22,343 $(22,787) $93,918
======== ======= ======= ======== =======
Operating income............ $ 4,151 $ 2,686 $ 4,329 $ (766) $10,400
======== ======= ======= ======== =======
Identifiable assets......... $143,080 $16,254 $ 9,591 $(82,103) $86,822
======== ======= ======= ======== =======
******
F-21
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
---------------------
BALANCE (1) (2) BALANCE
AT CHARGED CHARGED DEDUCTIONS-- AT END
BEGINNING TO COSTS AND TO OTHER WRITE-OFFS OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS (RECOVERIES) PERIOD
- ----------- --------- ------------ -------- ------------ -------
Balance for doubtful
accounts:
Year Ended June 30, 1996. $ 53 $404 -- $181 $276
==== ==== === ==== ====
Year Ended June 30, 1997. $276 $389 -- $ 79 $586
==== ==== === ==== ====
Year Ended June 30, 1998. $586 $122 -- $157 $551
==== ==== === ==== ====