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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, 1999;
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, 90250
California (Zip Code)
(Address of Principal Executive
Offices)
Registrant's Telephone Number, Including Area Code:
(310) 978-0516
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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 Which
Title of Each Class 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 Part 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 23, 1999, was
$30,538,303.
The number of shares of the registrant's Common Stock outstanding as of
September 23, 1999 was 9,733,915.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement relating to the 1999
Annual Meeting of Stockholders (to be filed subsequently) are incorporated by
reference into Part III.
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TABLE OF CONTENTS
Page
----
PART I
Item 1. Business................................................... 1
Item 2. Properties................................................. 16
Item 3. Legal Proceedings.......................................... 16
Item 4. Submission on Matters to a Vote of Security Holders........ 17
PART II
Item 5. Market for Registrant's Common Stock and Related
Stockholder Matters........................................ 18
Item 6. Selected Financial Data.................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 21
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk....................................................... 31
Item 8. Financial Statements and Supplementary Data................ 32
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure................................... 32
PART III
Item 10. Directors and Executive Officers of the Registrant......... 32
Item 11. Executive Compensation..................................... 32
Security Ownership of Certain Beneficial Owners and
Item 12. Management................................................. 32
Item 13. Certain Relationships and Related Transactions............. 32
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K........................................................ 33
PART I
ITEM 1. Business
General
The Company is a vertically integrated worldwide provider of devices,
subsystems and end-products based on optoelectronic and silicon pressure-sensor
microstructure technology. The Company designs and manufactures optoelectronic
and silicon pressure-sensor devices and value-added subsystems for original
equipment manufacturers ("OEMs") for use in a broad range of applications,
including security, medical diagnostics, telecommunications, gaming, 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," "Secure" and "Metor" brand names.
These products are used to inspect people, baggage, cargo and other objects for
weapons, explosives, drugs and other contraband. The Company has also, through
the acquisition of Osteometer MediTech A/S ("Osteometer"), expanded into the
manufacture and sale of bone densitometers, which are used to provide bone loss
measurements in the diagnosis of osteoporosis. In fiscal 1999, revenues from
the sale of optoelectronic and silicon pressure-sensor devices and subsystems
and medical imaging systems amounted to $55.5 million, or approximately 54.5%
of the Company's revenues, while revenues from sales of security and inspection
products amounted to $46.3 million, or approximately 45.5% 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 optoelectronic and silicon pressure-sensor devices and
subsystems are designed and manufactured primarily for sale to OEMs, while the
Company's security products and medical imaging systems are sold to end-users.
Optoelectronic and Silicon Pressure-Sensor 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, and medical imaging systems, 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.
Silicon pressure sensors and microstructures are based upon the same process
technologies as the optoelectronic components and are also used as components
in a variety of applications primarily in the
1
automotive, medical, and industrial markets. Typical applications include
pressure sensing in fuel vapor systems, engine controls, respiration and
aneasthesia machines, and industrial pressure transducers, and heating, venting
and air-conditioning markets. The Company sells its products in die form to
other sensor companies as well as packaged parts. A primary focus of the
companies' pressure products has been in the precision low-pressure segment of
the silicon sensor market, where the performance of its parts allow replacement
of non-silicon sensors with lower cost silicon components.
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, metal detectors,
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.
In the 1970s, principally in response to civilian airline highjackings, 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 since 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 in the future. 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 continuing to
fund procurements of $100 million annually for state-of-the-art detection
equipment at major U.S. airports. A portion of this funding is allocated for
TIP Ready X-ray (TRX) systems at security checkpoints throughout the nation.
Rapiscan, through FAA funding, has deployed some 40 TIP systems in the last two
years and is currently one of the vendors being evaluated for procurement
decisions.
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 and silicon pressure-sensor 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
2
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.") (Rapiscan U.S.A.
and Rapiscan U.K. are sometimes collectively referred to as "Rapiscan"),
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 Optics") 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 September 1998, the Company acquired Osteometer, a Danish manufacturer of
diagnostic scanners used to detect osteoporosis. The Company paid $7.9 million
in cash, including professional fees associated with the acquisition.
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. Due to the global decline in the bone densitometer
market, the Company recently announced the closure of Osteometer's
manufacturing facilities in Denmark. Currently, the Company intends to relocate
certain of these operations to the United States over the next several months.
The Company expects to incur additional expenses in connection with the
discontinuation of those operations and their intended relocation to the United
States, which will be recorded in future periods. The osteoporosis industry is
currently weak and is expected to remain so for at least the near-term.
In November 1998, the Company purchased the security products business of
Metorex International Oy ("Metorex Security") of Espoo, Finland. The Company
paid $4.7 million in cash, including professional fees associated with the
acquisition. In July 1999, the Company paid 4.4 million Finnish markka
(approximately $759,000), in lieu of contingent payments of up to $1.5 million,
based on future sales.
The acquisition of Metorex Security brings a complete security metal
detection product line to the Company. "Metor" brand security archway metal
detectors are among the most widely recognized such products in the world.
These metal detectors complement the x-ray screening systems supplied by
Rapiscan. Metorex Security continues to supply a large number of systems to the
U.S. Government, as well as to customers around the world. The products include
Metor 100 series archways, as well as Metor 200 series zonal archways. The
Company's MetorNet(TM) product allows monitoring and control of multisystem
installations.
In November 1998, the Company acquired all the outstanding stock of Silicon
Microstructures, Inc. ("SMI"), a silicon pressure-sensor manufacturer, from
Exar Corporation of Fremont, California. The Company paid $2.7 million in cash,
including professional fees associated with the acquisition. The Company may
pay up to an additional $3.9 million in cash, at a later date, based on future
sales. The designs and processes of SMI allow leveraging of the Company's
silicon wafer fabrication technologies to initially serve pressure-sensor
markets and extend into the future to a variety of products based on mechanical
structures in silicon.
In December 1998, the Company acquired most of the assets and assumed
certain liabilities of Corrigan Canada Ltd. ("Corrigan"), a Canadian security
products manufacturer, for approximately $476,000 in cash, including
professional fees associated with the acquisition.
In January 1999, the Company acquired Aristo Medical Products, Inc.
("Aristo") for approximately $277,000 in cash, including professional fees
associated with the acquisition. Aristo develops and manufactures new
generation pulse oximeter probes used in the medical field.
In August 1998, the Company invested $315,000, including professional fees
associated with the acquisition, in Square One Inc. ("Square One") for an
equity share of approximately 16%. Square One develops and manufactures
infrared-based patient monitoring medical subsystems.
3
During fiscal 1999, the Company invested $1,002,000, including professional
fees associated with the acquisition, in TFT Medical, Inc. ("TFT Medical")
(formerly known as Physiometrics, Inc.) for an equity share of approximately
40%. TFT Medical develops new generation pulse oximeter instruments and probes
for use in the medical field.
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.
Further Penetrate Existing Security and Inspection Markets and Expand into
Other Markets. For the year ended June 30, 1999, the Company continued to
expand sales of its security and inspection products beyond the traditional
focus on airports and airlines to include government buildings, customs
facilities, courthouses, school districts, departments of corrections and
businesses for their respective security and inspection needs. 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.
The Company believes that its 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.
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. Further leverage is obtained by extending the silicon
wafer fabrication processes to manufacture the pressure sensors and
microstructure processes of SMI. The Company intends to continue to leverage
its vertically integrated services to create greater value for its customers in
the design and manufacture 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 from locations in the
United States, Europe, Asia and Canada. 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 service 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
4
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.
Products and Technology
The Company designs, develops, manufactures and sells products based on its
core optoelectronic and silicon pressure-sensor technology. These products
range from discrete devices to value-added subsystems to complete x-ray
security and inspection products, and medical imaging systems.
Discrete Devices and Subsystems, and Medical Imaging Systems. Optoelectronic
and silicon pressure-sensor 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. A second group of
discrete devices are the pressure sensors and microstructures of SMI. These are
primarily manufactured in the same wafer fabrication facility as the
optoelectronic components, thereby achieving greater utilization and economy of
scale in this specialized facility. The same lithographic, furnace and metal
processes are combined with silicon etching to form precise miniature
electromechanical structures in silicon. SMI has developed specific structural
designs that concentrate stresses and provide higher signals and improved
performance over conventional silicon pressure sensors. 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
each of fiscal 1998 and fiscal 1999.
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.
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 ultrasound 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 ("PMA") from the FDA in Spring 1998. It has been the
experience of the Company and other similarly situated companies that FDA
approval on PMAs for ultrasound devices can take 12 to 18 months from date of
submission on average, but this is an estimate only and the Company does not
know when the FDA process will be completed or what the outcome will be.
5
Security and Inspection Equipment. The Company manufactures and sells a
range of security and inspection equipment that it markets under the
"Rapiscan," "Secure" and "Metor" brand names. To date, the security and
inspection equipment has principally been used at airports to inspect carry-on
and checked baggage for guns 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 1997, 1998 and 1999, approximately 27.3%, 22.0%, and 20.5% 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'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 100,000 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.
In the field of inspection of people, the Company's "Secure" brand product
line 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. The FAA is currently evaluating TRX (TIP Ready X-Ray)
systems for procurement and deployment. The Company is participating as a
finalist in the initial phase of this procurement.
6
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:
SELECTED
MODEL (technology) APPLICATIONS INSTALLATIONS
------------------ ------------ -------------
Rapiscan 19 Inspection of incoming package Embassies
(single energy)
Rapiscan 119 Post offices
(single energy) Courthouses
High risk office buildings
Manufacturing companies
Rapiscan 300 Series Inspection of hand carried baggage Airports
(160 kVx-ray source, Prisons
single Government buildings
energy and dual energy) Nuclear facilities
Rapiscan 500 Series- Airport hand carried and checked Airports
Standard baggage Cruise ships
Tunnel Pallet inspection Freight shippers
(single view and dual Customs inspections Border crossings
view Agriculture inspection
160 kV x-ray source,
single
energy and dual energy)
Rapiscan 500 Series- Large pallet inspection Airports
Large Customs inspections Freight shippers
Tunnel Border crossings
(single view and dual High risk seaport locations
view
320-450 kV (x-ray
source)
Rapiscan 500 Series-Mo- Mobile x-ray inspection Conventions and special events
bile Airports
Systems (x-ray van or Customs inspections
trailer) Border crossing
Rapiscan Series 2000 Fixed Site Cargo Inspection Systems Airports
Cargo Freight Shippers
Inspection Systems Border Crossings
Metor 100 Series Archway metal detection Airports
Government buildings
Conventions and special events
Metor 200 Series Zonal archway metal detection Airports
Prisons
Nuclear facilities
SECURE 1000 High Security Personnel Inspection Prisons
(non-intrusive personal Military Facilities
screening system)
SPEAR (Threat Image Performance Monitoring Any Rapiscan 500 Series
Projection ("TIP") System
Software)
7
Markets, Customers and Applications
Optoelectronic and Silicon Pressure-Sensor Devices and Subsystems. The
Company's optoelectronic and silicon pressure-sensor 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, 1999: (i) the major product
categories for which the Company provided optoelectronic and silicon pressure-
sensor 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.
Product Category Representative Major Customers
---------------- ------------------------------
Computed Tomography and X-Ray Imaging Picker International
InVision Technologies
Aerospace and Avionics EDO Barnes
Allied Signal
Honeywell Avionics
Litton Systems
Medical Monitoring Datascope
BCI
Analytical, Medical Diagnostics and
Particle Analyzers Abaxis
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)
Raytheon
Norsk Forsvarstekmol
Bar Code Scanners Symbol Technologies
Gaming Industry Bally Gaming
Automotive Motorola
Analog Microelectronics GMBH
Medical Siemens Elcma
Resmed Corp.
Endosonics Corp.
Industrial Honeywell Corp.
OJ Electronics
8
During fiscal 1999, the Company entered into a number of significant
agreements for the sale of the Company's optoelectronic and silicon pressure-
sensor devices and subsystems. Some of the principal agreements are the
following.
In fiscal 1998, the Company received a $2.3 million purchase commitment from
a U.S. defense systems manufacturer, for optoelectronic subsystems. These
subsystems were shipped during fiscal 1999 and will be finished shipping during
fiscal 2000.
In August 1998, 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 received
in fiscal 1998, $4.4 million was received in fiscal 1999 and the rest is
cancellable based on convenience and other terms of the agreement. The
subsystems are being delivered over a four-year period.
In September 1998, 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 began to be shipped
during fiscal 1999 and will be finished shipping during fiscal 2000. Due to the
worldwide decline in the oil exploration business, the Company and the customer
have subsequently agreed to reduce total shipments relating to the order, to
approximately $7.0 million.
Security and Inspection Products. Since entering the security and inspection
products market in 1993, the Company has shipped approximately 3,500 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
Japanese Embassies, worldwide Federal Reserve Bank
Malaysian Airport Berhad, Malaysia JFK International Airport
HAJ Terminal, Saudi Arabia Los Angeles County Courthouse
Dubai Airport, U.A.E. Los Angeles International Airport
United Kingdom Prison System, United
Kingdom Miami Airport
INFRAERO, airports, Brazil Orlando Airport
Chek Lap Kok International Airport,
Hong Kong Ronald Reagan National Airport
Pudong Shanghai International Airport,
P.R. China USAir
Airport Authority of Japan U.S. Government
Nagano Olympic Games 1998 California Department of Corrections
Kremlin, Russia U.S. Department of Corrections
Schiphol Airport, Netherlands Empire State Building
New Zealand Customs, New Zealand World Trade Center
Because the market for most security and inspection products developed in
response to civilian airline highjackings, 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.
9
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 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.
During fiscal 1999, 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 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 and the balance were shipped during
fiscal 1999. Some installations are to be completed and spare parts are
expected to ship in the future.
In September 1998, the Company entered into an agreement with the Federal
Aviation Administration for advanced contraband detection systems with Threat
Image Projection ("TIP") features. The systems began to be shipped to Category
X airports (designated due to their high security priority) in the United
States during fiscal 1999 and the remainder will be shipped during fiscal 2000.
In addition, the FAA ordered Rapiscan training computers to assist in the
instruction of advanced detection technologies to security personnel.
In January 1999, the Company entered into an agreement with the People's
Republic of China to upgrade and provide technical support for the Vehicle
Cargo X-ray System ("VCXS") operated by the Chinese customs authority at
Shenzhen, near Hong Kong. The VCXS system allows a fast, detailed inspection of
fully loaded trucks, and 20-foot and 40-foot containers in lieu of a full
manual search.
In March 1999, the Company was awarded a contract by BAA plc, the operator
of 11 airports around the world, including London's Heathrow Airport, the
busiest international airport in the world. Rapiscan U.K. will supply, install
and maintain approximately 100 x-ray systems used in screening cabin baggage
for explosives, weapons and other contraband. These systems feature advanced
detection software, including TIP. The agreement also provides for Rapiscan
U.K. to provide maintenance and support services on the installed systems for
five years.
Marketing, Sales and Service
The Company markets and sells its optoelectronic and silicon pressure-sensor
devices and subsystems, and medical imaging systems, worldwide through both a
direct sales and marketing staff of 30 employees and indirectly through a
network of approximately 47 independent sales representatives and distributors.
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 eight independent sales representatives. The Company
markets and sells its security and inspection products worldwide through a
direct sales and marketing staff of approximately 34 employees located in the
United States, Finland, Canada, the United Kingdom, Dubai, and Malaysia and
through a network of approximately 133 independent sales representatives.
10
The Company's optoelectronic and silicon pressure-sensor products and
medical imaging systems sales staff, located in the United States, Denmark 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 and medical imaging products sales
staff is supported by a service organization of approximately 32 persons,
located primarily in the United States, the United Kingdom, Finland 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 1998 and 1999, maintenance service revenues and replacement
part sales collectively represented 3.5%, and 3.6% respectively, of the
Company's revenues.
Research and Development
The Company's components and optoelectronic subsystems are designed and
engineered at the Company's facilities in either Hawthorne and Fremont,
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 and silicon pressure-sensor 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 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 a
program to be an important element of its business and operations. As of June
30, 1999, in addition to the engineers that the Company employed in
manufacturing, process design and applications development, the Company engaged
approximately 64 full-time engineers and technicians in research and
development. During fiscal 1998 and 1999, the Company's research and
development expenses were approximately $3.8 million and $5.7 million,
respectively. A significant portion of the increase in research and development
in fiscal 1999 is the result of acquisitions during that year. 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 and Espoo, Finland. These products include mechanical, electrical,
electronic, digital electronic and software subsystems, which are all designed
by the
11
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, Finland, Canada, Norway and Denmark, in addition to its manufacturing
facilities in Hawthorne and Fremont, California and Ocean Springs, Mississippi.
The Company recently announced that its facilities in Denmark will be closed.
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 only from single
vendors with whom the Company has ongoing relationships. The Company does,
however, qualify second sources for most 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 devices, 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.
12
Patents and Trademarks
In July 1999, as part of the settlement of an arbitration, the Company
entered into a nonexclusive patent license agreement with EG&G, Inc. ("EG&G")
for U.S. Patent No. 4,366,382, which expires in 2000. Under the fully paid up
license, for which the Company has paid $450,000, the Company 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 Company may be required to make additional payments of up to
$350,000, based on certain potential future orders and shipments.
In December 1998, as part of the settlement of certain litigation, the
Company and Lunar Corporation ("Lunar") made payments to each other which
resulted in a net payment to the Company of $400,000. As part of the
settlement, the parties entered into a license agreement pursuant to which the
Company, Rapiscan and UDT were granted a fully paid up worldwide, nonexclusive
license under U.S. Patent Nos. 4,626,688 (the "688 patent") and 5,138,167 (the
"167 patent") in the non-medical field. The Company paid Lunar $1.5 million for
this fully paid up license.
Prior to the Company's acquisition of Osteometer in September 1998,
Osteometer had also been involved in litigation with Lunar regarding the 688
and 167 patents. In December 1998, the parties to this litigation entered into
a settlement agreement. As a part of the settlement, the parties entered into a
license agreement pursuant to which Osteometer was granted a worldwide,
nonexclusive license under the 688 and 167 patents for certain bone
densitometers. Osteometer made an initial royalty payment of $250,000 with
respect to products manufactured prior to the entering into of this license
agreement and the Company will make royalty payments on future sales of the
licensed products. The license expires in December 2003 or the last to expire
of the licensed patents, whichever is later.
Rapiscan owns U.S. Patent No. 5,181,234 covering personnel screening systems
and manufactures the Secure 1000 in accordance to the patent. This patent was
issued in 1993 and expires in 2010. Rapiscan utilizes the trademarks
Rapiscan(R) and Secure(TM).
SMI owns U.S. Patent No. 5,812,047, which applies in connection with the
manufacture of silicon pressure-sensor devices. The patent expires in 2017. SMI
has other patent applications pending for various applications; it is unknown
at this time if these patents will be issued.
Metorex Security's "Metor" trademark is registered in 25 countries,
including the United States, the European Union countries and Japan. Metorex
Security has also registered the trademark "Metorscan" in the United States and
the European Union countries. Metorex Security utilizes four patents registered
in the United States (U.S. Patent Nos. 4605898, 5121105, 5047718, 4894619) and
other countries, including the European Union countries. These patents were
issued between 1986 and 1995, with expirations between 2002 and 2008. The
patents cover various improvements in metal detection systems.
The Company believes that the above patents and trademarks are important to
the Company's business. The loss of some of these patents or trademarks might
have a negative impact; however, the Company operates in a competitive
environment with a known customer base and relies mainly on providing value for
money with quality products and services to ensure continuing business.
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
13
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 and silicon pressure-sensor devices
and subsystems and medical imaging systems market or the security and
inspection market or that future competitive pressures will not materially and
adversely affect its business, financial conditions and results of operations.
In the optoelectronic and silicon pressure-sensors devices and subsystems
market, competition for optoelectronic devices and subsystems 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., 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 case of silicon pressure-sensors and microstructures, the Company
bases much of its current competitive position on pressure sensor performance,
particularly at low pressures, and process and manufacturing controls,
particularly in the automotive areas. Customer support and design expertise are
also very important. The Company believes that its primary silicon pressure-
sensor competitors include IC Sensors Division of EG&G, Inc., Novasensor
Division of Lucas Controls, Sensym ICT, and Motorola Semiconductor group.
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
14
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
optoelectronic and silicon pressure-sensor devices and subsystems, and medical
imaging systems, 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. The
only significant shipping delays which the Company has experienced are with
large cargo scanners. Such delays can occur for any of the following reasons:
(i) additional time necessary to conduct large cargo inspections at the factory
before shipment; (ii) the customer's needs to engage in timely special site
preparation to accommodate such a scanner, and as to which the Company has no
control or responsibility; and (iii) additional fine tuning of such scanners
once they are installed. The Company has experienced delays in shipping large
cargo scanners to one customer because of logistical delays by that customer;
however, all such delayed shipments of scanners to that customer were shipped
during fiscal 1999.
At June 30, 1999, the Company's backlog products totaled approximately $44.1
million, compared to approximately $46.9 million at June 30, 1998. Most of the
Company's backlog as of June 30, 1999 is expected to be shipped during the
fiscal year ending June 30, 2000. 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, 1999, the Company employed approximately 922 people, of whom
687 were employed in manufacturing, 64 were employed in research and
development, 75 were employed in finance and administration, 64 were employed
in sales and marketing, and 32 were employed in its service organization. Of
the total employees, approximately 433 were employed in the United States, 26
in Canada, 191 were employed in Europe, 271 were employed in Asia, and one was
employed in the Middle East. Thirty-two employees at AME and nine Metorex
Security employees in Finland are members of a union and have collective
bargaining rights. Other than the employees of AME and nine Metorex Security
employees in Finland, none of the Company's other employees is unionized. There
has never been a work stoppage or strike at the Company, and management
believes that its relations with its employees are good.
15
ITEM 2. Properties
The Company owns three buildings (approximately 88,000 square feet) which
comprise its principal facility in Hawthorne, California. This facility is used
for manufacturing, engineering, sales and marketing.
As of June 30, 1999, the Company leased all of its other facilities, as
reflected in the following table:
Approximate Lease
Location Description of Facility Square Footage Expiration
- -------- ----------------------- -------------- ----------
Hawthorne, California Manufacturing, engineering, sales and
marketing and service 41,600 2006
Ocean Springs, Manufacturing, engineering and sales and
Mississippi marketing 41,800 2001
Fremont, California Manufacturing, engineering, sales and
marketing and service 6,500 2001
Princeton, New Jersey Service and sales and marketing 2,900 2001
Georgetown, Canada Manufacturing, engineering, sales and
marketing and service 22,000 2003
Johor Bahru, Malaysia Manufacturing and sales 13,500 1999
Johor Bahru, Malaysia Manufacturing 21,000 2000
Singapore, Republic of
Singapore Administrative and materials procurement 3,000 2000
Crawley, United Kingdom Manufacturing, engineering, sales and marketing 18,700 2011
Hayes, United Kingdom Service 3,900 2003
Horten, Norway Manufacturing, engineering, sales and marketing 19,800 2008
Espoo, Finland Manufacturing, engineering, sales and marketing 13,300 2001
Horsholm, Denmark Manufacturing, engineering, sales and marketing 34,900 2009
The Company's lease of facilities in Johor Bahru, Malaysia covering
approximately 13,500 square feet will expire in November 1999 and it is
anticipated that this lease will be extended on terms yet to be negotiated. The
Company's lease of facilities in Johor Bahru, Malaysia covering approximately
21,000 square feet will expire in April 2000 and it is anticipated that this
lease will be extended on terms yet to be negotiated.
The Company's lease of facilities in Singapore will expire during fiscal
2000. The Company expects to renew this lease but has not yet begun
negotiations with respect thereto.
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
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 has paid 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
16
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.
The Company is also involved in routine litigation from time to time in the
course of conducting its business.
ITEM 4. Submission on Matters to a Vote of Security Holders
None.
17
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 years ended June 30, 1998 and 1999.
High Low
------ ------
1998:
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
1999:
Quarter ended September 30, 1998............................ $11.63 $ 7.13
Quarter ended December 31, 1998............................. $ 8.75 $ 4.75
Quarter ended March 31, 1999................................ $12.13 $ 4.75
Quarter ended June 30, 1999................................. $ 6.13 $ 4.50
As of September 23, 1999, there were approximately 90 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.
18
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, 1999 and is
derived from the Consolidated Financial Statements of the Company. The
consolidated financial statements as of June 30, 1998 and June 30, 1999, and
for each of the years in the three-year period ended June 30, 1999, 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,
-------------------------------------------------------
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
(In thousands, except share and per share data)
Consolidated Statements
of Operations Data:
Revenues................ $ 49,815 $ 61,518 $ 77,628 $ 93,918 $ 101,763
Cost of goods sold...... 37,818 45,486 56,174 66,952 71,705
---------- ---------- ---------- ---------- ----------
Gross profit............ 11,997 16,032 21,454 26,966 30,058
Operating expenses:
Selling, general and
administrative....... 7,601 9,757 11,265 12,670 17,452
Research and
development.......... 1,591 1,663 2,504 3,790 5,711
Stock option
compensation(1)...... -- -- 856 -- --
Goodwill
Amortization......... -- -- 39 106 595
Asset impairment
charge(2)............ -- -- -- -- 5,189
In process research
and development (3).. -- -- -- -- 2,579
Restructuring costs
(4).................. -- -- -- -- 458
---------- ---------- ---------- ---------- ----------
Total operating
expenses........... 9,192 11,420 14,664 16,566 31,984
---------- ---------- ---------- ---------- ----------
Income (loss) from
operations............. 2,805 4,612 6,790 10,400 (1,926)
Interest expense
(income)............... 1,251 1,359 1,197 ( 600) (102)
---------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes and
minority Interest ..... 1,554 3,253 5,593 11,000 (1,824)
Provision (benefit) for
income taxes........... 413 1,111 1,416 2,752 (2,565)
---------- ---------- ---------- ---------- ----------
Income before minority
interest............... 1,141 2,142 4,177 8,248 741
Minority interest....... 17 117 -- -- --
---------- ---------- ---------- ---------- ----------
Net income.............. $ 1,158 $ 2,259 $ 4,177 $ 8,248 $ 741
========== ========== ========== ========== ==========
Net income available to
common
shareholders(5)........ $ 1,357 $ 2,308 $ 4,269 $ 8,248 $ 741
========== ========== ========== ========== ==========
Net income per
share(5)(6)............ $ 0.22 $ 0.38 $ 0.68 $ 0.92 $ 0.08
========== ========== ========== ========== ==========
Weighted average shares
outstanding(6)......... 6,172,901 6,134,669 6,263,963 8,955,919 9,828,971
Consolidated Balance
Sheet Data:
Cash and cash
equivalents............ $ 1,405 $ 581 $ 553 $ 22,447 $ 7,241
Working capital......... 12,117 6,044 10,800 52,417 41,468
Total assets............ 30,780 35,309 47,333 86,822 93,371
Total debt.............. 14,113 15,462 13,180 1,243 9,087
Total shareholders'
equity................. $ 4,951 $ 7,194 $ 16,809 $ 65,915 $ 65,782
- --------
(1) 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.
19
(2) Represents a charge resulting from the closure of the operations of
Osteometer in Denmark. The charge had the effect of decreasing income from
operations, net income and net income available to common shareholders by
$5,189,000, $1,635,000 and $1,635,000 respectively.
(3) Represents a charge resulting from acquired in process research and
development of Osteometer, Metorex Security and SMI. The charge had the
effect of decreasing income from operations, net income and net income
available to common shareholders by $2,579,000, $2,579,000 and $2,579,000
respectively.
(4) Represents a charge resulting from consolidating certain subsidiaries. The
charge had the effect of decreasing income from operations, net income and
net income available to common shareholders by $458,000, $391,000 and
$391,000 respectively.
(5) 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, 1994. Adjustments in each of the five years ended June
30, 1999 consist of: (i) the elimination of interest expense related to
converted subordinated debt of $216,000, $166,000, $92,000, $0, and $0 net
of income taxes, respectively; and (ii) the elimination of the minority
interest in the net loss of subsidiaries of $17,000, $117,000, $0, $0 and
$0, respectively.
(6) Assumes the conversion of 2,568,750 shares of preferred stock into
3,853,125 shares of Common Stock as of July 1, 1994. 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.
20
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 and silicon pressure-sensor
micro-structure technology. The Company designs and manufactures optoelectronic
and silicon pressure-sensor devices and value-added subsystems for OEMs for use
in a broad range of applications, including security, medical diagnostics,
telecommunications, gaming, 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," "Secure"
and "Metor" brand names. These products are used to inspect people, baggage,
cargo and other objects for weapons, explosives, drugs and other contraband.
The Company has also, through the acquisition of Osteometer, expanded into the
manufacture and sale of bone densitometers, which are used to provide bone loss
measurements in the diagnosis of osteoporosis. In fiscal 1999, revenues from
the sale of optoelectronic and silicon pressure-sensor devices and subsystems
and medical imaging systems amounted to $55.5 million, or approximately 54.5%
of the Company's revenues, while revenues from sales of security and inspection
products amounted to $46.3 million, or approximately 45.5% 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 Sensors' 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 Optics, 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. In fiscal 1999, the Company acquired Osteometer for the
purpose of expanding further into the field of optoelectronic medical devices
used for medical diagnostic purposes. Due to the global decline in the bone
densitometer market, the Company recently announced the closure of Osteometer's
manufacturing facilities in Denmark. Currently, the Company intends to relocate
certain of these operations to the United States over the next several months.
The Company expects to incur additional expenses in connection with the
discontinuation of those operations and
21
their intended relocation to the United States, which will be recorded in
future periods. Based on its assessment to date, the Company currently
estimates these expenses to be in the range of $2.0 million to $2.7 million. As
the Company continues to proceed with the closure and intended relocation of
these manufacturing facilities, it will be able to more accurately estimate the
range of these costs, which may change from the current estimate.
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.
In August 1998, the Company invested $315,000, including professional fees
associated with the acquisition, in Square One for an equity share of
approximately 16%. The Company's equity in the earnings of the investment,
since acquisition, has not been significant. Square One develops and
manufactures infrared-based patient monitoring medical subsystems.
During fiscal 1999, the Company invested $1,002,000, including professional
fees associated with the acquisition, in TFT Medical for an equity share of
approximately 40%. At June 30, 1999, the Company's equity in the losses of the
investment was $187,000. TFT Medical develops new generation pulse oximeter
instruments and probes for use in the medical field.
The Company engages in significant international operations. The Company
currently manufactures its optoelectronic and silicon pressure-sensor devices
and subsystems, and medical imaging systems, at its facilities in Hawthorne and
Fremont, California, Ocean Springs, Mississippi; Johor Bahru, Malaysia; Horten,
Norway; and Horsholm, Denmark. Its security and inspection products are
manufactured at its facilities in Crawley, England; Hawthorne, California;
Johor Bahru, Malaysia; and Espoo, Finland. As of June 30, 1999, the Company
marketed its products worldwide through approximately 64 sales and marketing
employees located in eight countries, and through approximately 180 independent
sales representatives. Revenues from shipments made outside of the United
States accounted for 42.2%, 49.4% and 48.5% of revenues for the fiscal years
1997, 1998 and 1999 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 1997, 1998 and
excluding the non-recurring asset impairment charge, in-process research and
development and restructuring costs for fiscal 1999 was 25.3%, 25.0% and 16.5%,
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. Because of a number of factors, primarily variable and changing
international taxation policies, including those in Malaysia, and utilization
of previously unrealized net operating loss, the Company is not able to
estimate its effective tax rate during the next fiscal year.
Certain competitive and industry trends include the following. Rapiscan
U.S.A. and its competitors in the security and inspection business have been
experiencing weakness in the domestic market, partly as a result of hesitation
by airlines to order security and inspection equipment pending a decision by
the FAA to buy 440 cabin-baggage scanners using current technology. The FAA has
leased, with an option to buy, ten such scanners from the Company. FAA trials
are continuing.
The incorporation of SMI's silicon pressure-sensor products into the
Company's operations has taken longer than originally anticipated. As a result,
costs of operations for SMI's operations have been higher than expected and may
continue as such for at least the next few quarters. The Company has
established an internal task force to oversee the incorporation of SMI's
operations into those of the Company.
The Company's subsystems optics business is conducted by Ferson Optics,
which manufactures passive components used in other products and systems
manufactured by outside parties and the Company. Because of
22
competitive market forces, primarily in Asia with significantly lower costs of
labor, sales of Ferson Optic's products to outside parties show little
opportunity of growth in the foreseeable future. The Company is actively
monitoring this situation and will consider implementing additional cost-saving
and cost-cutting measures, including use of subcontractors and consolidation of
manufacturing operations, in the future. Ferson Optics is a small portion of
the Company's business, contributing approximately $ 3.3 million, or
approximately 3.2% of total revenue in fiscal 1999.
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.
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,
-------------------
1997 1998 1999
----- ----- -----
Revenues................................................... 100.0% 100.0% 100.0%
Cost of goods sold......................................... 72.4 71.3 70.5
----- ----- -----
Gross profit............................................... 27.6 28.7 29.5
Operating expenses:
Selling, general and administrative...................... 14.5 13.5 17.1
Research and development................................. 3.2 4.0 5.6
Stock option compensation................................ 1.1 -- --
Good will amortization................................... 0.1 0.1 0.6
Asset impairment charge.................................. -- -- 5.1
In process research and development...................... -- -- 2.5
Restructuring Costs...................................... -- -- 0.5
----- ----- -----
Total operating expenses............................... 18.9 17.6 31.4
----- ----- -----
Income from operations..................................... 8.7 11.1 (1.9)
Interest expense (income).................................. 1.5 (0.6) (0.1)
----- ----- -----
Income before income taxes and minority interest........... 7.2 11.7 (1.8)
Provision for income taxes................................. 1.8 2.9 (2.5)
----- ----- -----
Net Income................................................. 5.4% 8.8% 0.7%
Comparison of Fiscal Year Ended June 30, 1999 to Fiscal Year Ended June 30,
1998
Revenues. Revenues consist of sales of optoelectronic and silicon pressure
sensor devices, subsystems and medical imaging systems as well as security and
inspection products. Revenues are recorded net of inter-company eliminations.
Revenues for the fiscal year ended June 30, 1999, increased by $7.8 million or
8.4% to $101.8 million from $93.9 million for the fiscal year ended June 30,
1998. Revenues for the sale of optoelectronics and silicon pressure sensor
devices, subsystems and medical imaging systems, net of intercompany
eliminations, increased by $5.4 million, or 10.7% to $55.5 million from $50.1
million for fiscal 1998. The increase was primarily due to an increase in sales
to the oil exploration industry and sales of medical imaging systems and
silicon pressure sensors through the acquisitions of Osteometer and SMI,
respectively. Due to the worldwide decline in the oil exploration business, the
Company expects declines in shipments to the oil exploration industry to
continue and has no plans to actively pursue this market after the completion
of its current contract. Revenues from the sale of security and inspection
products increased $2.5 million, or 5.7% to $46.3 million from $43.8 million
for fiscal 1998. The increase in revenues from the sale of security and
inspection products was primarily due to an increase in walk through metal
detection systems through the acquisition of Metorex Security, which was offset
in part by decrease in revenues due to weakness in the security and inspection
products market.
23
Gross Profit. Cost of goods sold consist of material, labor and
manufacturing overhead. Gross profit increased by $3.1 million, or 11.5% to
$30.1 million from $27.0 million for fiscal 1998. As a percent of revenues,
gross profit increased to 29.5% in fiscal 1999 from 28.7% in fiscal 1998. The
increase in gross profit was due to increased sales, change in product mix 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, 1999, such expenses increased by $4.8 million, or 37.7%
to $17.5 million from $12.7 million in fiscal 1998. As a percentage of
revenues, selling, general and administrative expenses increased to 17.1% in
fiscal 1999 from 13.5% in fiscal 1998. The increase in expenses was due
primarily to the inclusion of selling, general and administrative expenses of
recent acquisitions in the Company's consolidated financial statements,
exchange rate fluctuation losses due to currency translation relating to the
relatively strong U.S. dollar compared to European currencies and an increase
in marketing expenses to penetrate new markets for the Company's existing
products and was offset in part by the proceeds from the settlement of certain
material litigation. For the year ended June 30, 1999, $4.5 million of selling,
general and administrative expenses of recent acquisitions were included in the
Company's consolidated financial statements. The exchange rate losses for
fiscal 1999 were $743,000 compared to $39,000 for fiscal 1998.
Research and Development. Research and development expenses include research
related to new product development and product enhancement expenditures. For
the year ended June 30, 1999, such expenses increased by $1.9 million, or 50.7%
to $5.7 million from $3.8 million in fiscal 1998. As a percentage of revenues,
research and development expenses increases to 5.6% in fiscal 1999 from 4.0% in
fiscal 1998. The increase in expenses was primarily due to the increase in
personnel cost resulting from the recent acquisitions. For the year ended June
30, 1999, $1.8 million of research and development expenses incurred by the
acquired companies were included in the Company's consolidated financial
statements.
Goodwill Amortization. Amortization of goodwill increased to $595,000 in
fiscal 1999 from $106,000 in fiscal 1998. The increase in amortization expense
was primarily due to amortization of goodwill associated with the acquisition
of Osteometer, Metorex Security and SMI. In the prior years, goodwill
amortization was included as a component of selling, general and administrative
expenses.
Asset Impairment Charge. The asset impairment charge relates to the closure
of the manufacturing facilities of Osteometer in Denmark. For the year ended
June 30, 1999, the asset impairment charge was $5.2 million, which includes the
write off of $3.7 million of goodwill and $1.5 million of other assets. Some of
these operations may be relocated to the United States over the next several
months. The Company expects to incur additional expenses in connection with the
discontinuation of those operations and their intended relocation to the United
States, which will be recorded in future periods.
In Process Research and Development. The Company used a total of $15.3
million for the acquisitions of Osteometer, Metorex Security and SMI, including
professional fees associated with these acquisitions. Out of the total of $15.3
million, the company incurred an aggregate of $2.6 million in in-process
research and development charges in fiscal 1999, related to these acquisitions.
In September 1998, the Company acquired the assets, including the developmental
technology, and assumed the liabilities of Osteometer. The Company paid $7.9
million in cash, including professional fees associated with the acquisition.
In November 1998, the Company acquired the assets, including developmental
technology, of Metorex Security. The Company paid $4.7 million in cash,
including professional fees associated with the acquisition, and in July 1999,
the Company paid $4.4 million Finnish markka (approximately $759,000), in lieu
of contingent payments up to $1.5 million, based on future sales. Also in
November 1998, the Company acquired the assets, including the developmental
technology, of SMI. The Company paid $2.7 million in cash, including
professional fees associated with the acquisition, and may pay up to $3.9
million in additional contingent purchase payments based on future sales.
Based on the valuations, the Company allocated the excess of the non-
contingent purchase price over the fair value of net tangible assets acquired
to goodwill and identified intangible assets. In performing this
24
allocation, the Company considered, among other factors, the attrition rate of
the active users of the technology at the date of acquisition and the research
and development projects in process at the date of acquisition. With regard to
the in-process research and development projects, the Company considered, among
other factors, the stage of development of each project at the time of
acquisition, the importance of each project to the overall development plan,
and the projected incremental cash flows from the projects when completed and
any associated risks. Associated risks include the inherent difficulties and
uncertainties in completing each project and thereby achieving technological
feasibility and risks related to the impact of potential changes in future
target markets. As of June 30,1999, with the exception of Osteometer, the above
mentioned research and development projects were progressing as planned.
Restructuring Costs. During fiscal 1999, the Company adopted a restructuring
plan to consolidate certain subsidiaries and, in connection therewith, the
Company recorded a non-recurring expense of $458,000. These costs were
associated primarily with the termination of certain employees, in the amount
of $395,000, and consolidation of certain subsidiaries, in the amount of
$63,000. All of the restructuring costs were incurred and recorded before March
31, 1999.
Income (loss) from operations. For the year ended June 30, 1999, loss from
operations was $1.9 million compared to income of $10.4 million in fiscal 1998.
Excluding, the non-recurring asset impairment charge, in process research and
development and restructuring costs of $8.2 million, income from operations for
the year ended June 30, 1999 decreased by $4.1 million or 39.4%, to $6.3
million from $10.4 million in fiscal 1998. Income from operations decreased due
to increased selling, general and administrative expenses, increased research
and development expenses and increased goodwill amortization and was partially
offset by increased gross profit.
Interest expense (income). For the year ended June 30, 1999, the Company
earned net interest income of $102,000 compared to net interest income of
$600,000 for fiscal 1998. The reduction in net interest income was due to
increased borrowing on the Company's lines of credit and a reduction in short
term investments used for working capital and acquisitions.
Provision (benefit) for income taxes. For the year ended June 30, 1999, the
Company had an income tax benefit of $2.6 million compared to provision for
income taxes of $2.7 million for fiscal 1998. Excluding, the non-recurring
asset impairment charge, in process research and development and restructuring
costs, provision for income taxes for the year ended June 30, 1999, was $1.1
million, compared to $2.8 million for fiscal 1998 and as a percentage of income
before provision for income taxes, provision for income taxes was 16.5% for the
year ended June 30, 1999 compared to 25.0% for fiscal 1998. The reduction in
the Company's effective tax rate was primarily due to a mix in income from U.S.
and foreign operations, utilization of previously unrealized foreign net
operating losses and a one year tax holiday in Malaysia for fiscal year ended
June 30, 1999.
Net Income. For the reasons outlined above, including the non-recurring
asset impairment charge, in process research and development and restructuring
costs, for the year ended June 30, 1999, the Company had a net income of
$741,000, compared to $8.2 million for fiscal 1998. Excluding, the non-
recurring asset impairment charge, in process research and development and
restructuring costs of $8.2 million ($4.7 million of net of taxes), net income
for the year ended June 30, 1999 decreased 35.2% to $5.3 million, compared to
$8.2 million for fiscal 1998.
Comparison of Fiscal Year Ended June 30, 1998 to 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
25
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 $1.4 million, or
12.5%, to $12.7 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 13.5% in fiscal 1998 from
14.5% 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 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.
Goodwill Amortization. Amortization of goodwill increased to $106,000 in
fiscal 1998 from $39,000 in fiscal 1997. The increase in goodwill was due to
the whole year's amortization in fiscal 1998 compared to a partial year's
amortization in fiscal 1997, as related to the acquisitions of minority
interests in Rapiscan and Ferson Optics, and the acquisition of AME.
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.
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
26
public offering. As of June 30, 1999, the Company's principal source of
liquidity consisted of $7.2 million in cash and several credit agreements
described below.
The Company's operations provided net cash of $80,000 during fiscal 1999,
compared to net cash used of $436,000 in fiscal 1998. The amount of net cash
provided by operations was offset in part primarily because of increase in
accounts receivable, other receivables, deferred income taxes, income taxes
receivable, reduction in accrued payroll and related expenses, income taxes
payable and advances from customers.
The net cash used in investing activities was $23.4 million and $8.0 million
for fiscal 1999 and 1998, respectively. In fiscal 1999, net cash used in
investing activities reflects primarily cash used in business acquisitions and
professional fees associated with these acquisitions of $16.0 million, cash
used in equity investments, purchase of marketable securities and the purchase
of property and equipment, and was partially offset by cash provided by sale of
property and equipment. In fiscal 1998, the net cash used in investing
activities was primarily the purchase of property and equipment. The Company
expects to purchase property and equipment in fiscal 2000 as required. The
Company has no significant capital spending or purchase commitment other than
in normal course of business and commitments under leases.
Net cash provided by financing activities was $7.5 million for fiscal 1999
compared to net cash provided by financing activities of $30.6 million for
fiscal 1998. In fiscal 1999, net cash provided by financing activities resulted
primarily from net proceeds from bank lines of credit and was partially offset
by payment of long term debt and purchase of treasury stock.
In March 1999, the Company announced a stock repurchase program of up to
2,000,000 of its Common Stock. Through June 30, 1999, the Company repurchased
85,000 shares at an average price of $5.15 per share. Subsequent to the end of
the fiscal year ended June 30, 1999, the Company repurchased an additional
247,500 shares (through September 23, 1999) at an average price of $4.72 per
share. The stock repurchase program did not have a material effect on the
Company's liquidity and is not expected to have a material effect on liquidity
in subsequent quarters.
The Company anticipates that current cash balances, anticipated cash flows
from operations and current borrowing arrangements will be sufficient to meet
its working capital, stock repurchase program and capital expenditure needs for
the foreseeable future.
In January 1997, the Company and its U.S. subsidiaries entered into a credit
agreement with Sanwa Bank California. The agreement, as amended and restated in
September 1999, provides for a $10.0 million line of credit, which includes
revolving line, letter of credit, acceptance and foreign exchange facilities.
In addition, the Company has a $3.0 million equipment line of credit for
capital purchases, a $3.0 million term loan 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 (7.75% at June
30, 1999) or, at the Company's option, at a fixed rate as quoted by the bank
upon request for specific advances. As of June 30, 1999, there were no amounts
outstanding under the line of credit or equipment line of credit and $8.5
million was outstanding under the acquisition line of credit. As of June 30,
1999, $66,000 was outstanding under letters of credit. The lines expire in
November 2000. Borrowings under the agreement are secured by liens on
substantially all of the assets of the Company's U.S. subsidiaries. The
agreement restricts the borrowers from incurring certain additional
indebtedness and from making capital expenditures greater than $5.0 million on
a consolidated basis (excluding assets acquired through acquisition) in any
fiscal year. In addition, the credit agreement contains certain covenants.
Among these, the Company is at all times required to maintain (on a
consolidated basis) a tangible net worth of at least $50.0 million; a ratio of
debt to tangible net worth of not more than 3.0 to 1; a ratio of cash, cash
equivalents and accounts receivable to current liabilities of not less than 0.8
to 1; and a debt coverage ratio of 2.0 to 1. The Company was in violation of a
covenant for the quarter ended June 30, 1999, due to the asset impairment
charge. The covenant was subsequently waived by the bank.
27
In November 1996, the Company and three of its 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 for a specific customer. The revolving credit
lines bear interest at the bank's prime rate (7.75% at June 30, 1999) plus 5.0%
per annum. As of June 30, 1999, there was outstanding approximately $850,000
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. The Company has
not yet decided how it will handle this facility upon its expiration.
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 $3.1 million at June 30, 1999) outstanding at any one time,
which amounts are secured by certain assets of Rapiscan U.K. At June 30, 1999,
no amounts were outstanding under the overdraft facility. Outstanding
borrowings bear interest at a base rate (7.75% at June 30, 1999) plus 1.5% per
annum. The agreement also provides for a 1.0 million Pounds Sterling
(approximately $1.6 million at June 30, 1999) facility for tender and
performance bonds and a 1.0 million Pounds Sterling (approximately $1.6 million
at June 30, 1999) 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, 1999, $277,000 was outstanding under the performance bond
facility and Rapiscan U.K. had purchased forward exchange contracts in the
amount of $200,000. The above facilities expire in January 2000 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
2.9 million Singapore dollars (approximately $1.7 million at June 30, 1999).
Borrowings under the line of credit bear interest at the bank's prime rate
(10.0% at June 30, 1999) plus 2.25%. The line of credit is terminable at any
time. As of June 30, 1999 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 certain 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 $636,000 at June 30, 1999). As of June 30, 1999, no
amounts were outstanding under this line of credit. Borrowings under the line
of credit bear interest at a variable rate, which was 10.1% at June 30, 1999.
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 $658,000 at June 30, 1999) for performance bonds and
standby letters of credit, and a 1.0 million Malaysian ringgits overdraft
facility (approximately $263,000 at June 30, 1999). Borrowings under the
overdraft facility bear interest at the bank's base lending rate (9.5% at June
30, 1999) plus 2.25%. At June 30, 1999, the amount outstanding under the
performance bond facility was $310,000 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 1999 and the
Company believes that they will be renewed on the same or similar terms.
OSI Malaysia has a loan agreement with Bank Utama, which provides for a
revolving line of credit of up to an amount of 1.5 million Malaysian ringgits
(approximately $395,000 as of June 30, 1999). Borrowings under the line of
credit bear interest at the bank's base lending rate (9.0% at June 30, 1999)
plus 1.75%. As of
28
June 30, 1999, 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 will expire in February
2000 and the Company believes that it will be renewed on the same or similar
terms.
Metorex Security has a loan agreement with a Finnish bank that provide for a
foreign currency overdraft facility up to 2.0 million Finnish markka
(approximately $347,000 at June 30, 1999). At June 30, 1999, approximately
$178,000 was outstanding under the overdraft facility. The agreement also
provides for 1.0 million Finnish Marks (approximately $174,000 at June 30,
1999) for tender and performance bonds. At June 30, 1999, approximately $26,000
was outstanding under the tender and performance bonds facility. Borrowings
under these facilities bear interest at the bank's prime lending rate (3% at
June 30, 1999) plus 1%. The above facilities expire in February 2000, and the
Company believes that they will be renewed at the same of similar terms.
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,
Denmark, Finland, Norway and Canada are maintained in Singapore dollars,
Malaysian ringgits, Pounds Sterling, Danish kroner, Finnish markka, Norwegian
kroner and Canadian dollars, 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 losses of approximately
$39,000 and $743,000 were included in income for fiscal 1998 and 1999,
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, 1999, 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 changes in monetary policy in Malaysia, including the pegging of the
Malaysian ringgit to the U.S. dollar, the Company believes that its foreign
currency exposure in Malaysia will not be significant 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.
Market Risk
The Company is exposed to certain market risks, which are inherent in the
Company's financial instruments and arise from transactions entered into in the
normal course of business. The Company may enter into derivative financial
instrument transactions in order to manage or reduce market risk in connection
with specific foreign currency denominated transactions. The Company does not
enter into derivative financial instrument transactions for speculative
purposes.
The Company has investments in the common stock of certain companies whose
securities are publicly traded. Therefore, the Company faces fluctuations in
the value of these investments as the market price of these investees'
securities changes. The aggregate amount of all such investments is
approximately $1.7 million. At June 30, 1999, the fair market value of all such
investments was approximately $1.2 million.
29
The Company is subject to interest rate risk on its short-term borrowings
under its bank lines of credit. Borrowings under these lines of credit do not
give rise to significant interest rate risk because these borrowings have short
maturities and are borrowed at variable interest rates. Historically, the
Company has not experienced material gains or losses due to interest rate
changes.
The Company from time to time enters into foreign currency forward contracts
to hedge certain foreign currency transactions and commitments. These contracts
were not significant at June 30, 1999 and had a notional value of approximately
$200,000 with a net unrealized gain of approximately $5,000.
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 of 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's Year 2000 project is being spearheaded by a special task
force comprised of a senior management team as well as other key personnel. The
task force meets on a regular basis to determine and implement the steps
necessary to insure that the Company becomes fully Year 2000 compliant.
Additionally, the Company has established task forces in each of its major
subsidiaries with designated Year 2000 management representation, which report
status to the Year 2000 committee. This mandate is in effect for foreign
subsidiaries as well as U.S. subsidiaries.
The Company has upgraded its critical database and believes that it is Year
2000 compliant. The financial records of the Company's principal U.S.
subsidiaries, Rapiscan U.S.A., UDT Sensors and SMI have also been upgraded and
are Year 2000 compliant. Following an assessment of the Company's financial
records system, it was determined that each subsidiary will have its own Year
2000 compliant system. The estimated completion date for this implementation is
on or before October 31, 1999. The Company has completed an upgrade of the
telephone systems, including voice-mail software, for Rapiscan U.S.A. and UDT
Sensors. The cost of these upgrades to date has not been material. The
Enterprise Resource Planning software used by several of the Company's
operating subsidiaries has been certified as Year 2000 compliant.
The Company is in the assessment and remediation phase of determining Year
2000 compliance of its own products, which are dependent on third party
suppliers and vendors for critical parts. The Company expects to complete this
assessment by September 30, 1999 and expects to be able to complete remediation
as required by October 31, 1999. Based on what the Company knows at this time,
DOS and Windows 95 are not Year 2000 compliant; therefore, the Company's
products which rely on these products are themselves not Year 2000 compliant.
The Company is in the process of acquiring and installing software, within the
Company's products, which is Year 2000 compliant. The Company's products which
are not presently Year 2000 compliant are not affected in terms of performance
in any material respect; however, archiving of information may be affected by
Year 2000 noncompliance. The Company's exposure exists with respect to its
products under warranty, which were manufactured prior to the software upgrade.
In such cases, the Company will offer its customers a software upgrade to a
Year 2000 compliant version. Until the assessment phase is completed, the
Company is not in a position to know if the costs of upgrading the software
used in the manufacture of its products or offering its customers such
upgrading will be material.
Based on current estimates, the Company expects to have completed by
September 30, 1999 a full assessment of all hardware, operating systems and
software applications in use in the Company's information systems, operations
and infrastructure on a worldwide basis. Some upgrading is expected to be
required. The costs of such assessment and upgrading are not expected to be
material. Required upgrading is expected to be completed on or before October
31, 1999. In addition, the Company is in the process of obtaining Year 2000
compliance statements from the manufacturers of the Company's hardware and
software products.
30
The Company believes that its greatest potential risks are associated with
(i) its information systems and systems embedded in its operations and
infrastructure; and (ii) its reliance on Year 2000 compliance by the Company's
vendors and suppliers. The Company is in the process of assessments of its
operations and infrastructure, and at present time no significant problems have
been identified. The Company has asked its critical vendors, suppliers and
customers to complete a Year 2000 survey to assess the status of their
compliance in order to assess the effect it could have on the Company. The
Company has completed distribution of surveys to its critical vendors and
suppliers and in the process of mailing follow-up requests to those vendors and
suppliers who failed to respond to the initial mailing. The Company has
distributed surveys to all of its critical customers and is in the process of
mailing follow-up requests to those customers who failed to respond to the
initial mailing. Due to slow responses from suppliers and customers, the
Company has not yet determined the full 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 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 all of its assessments, developed
remediation for all problems, developed all contingency plans, or completely
implemented or tested all of its remediation plans.
Based on the Company's current analysis and assessment of the state of its
Year 2000 compliance, the Company's most reasonably likely worst case scenario
involves delays in shipping of parts, including critical parts, by certain of
the Company's vendors and suppliers. Such delays could cause the Company to
experience delays in shipping its products. The Company is in process of
formulating contingency plans based on review of compliance surveys from its
vendors and suppliers. These plans could include, among other things,
increasing inventory of critical parts in late 1999 to insure an adequate
supply is on hand to minimize shipping delays by the Company of its products.
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. Additionally, whereas, the Company has made every effort to
obtain Year 2000 compliance status from its critical suppliers and customers it
cannot enforce responses. In those cases where risks could exist, the necessary
steps will be taken either by reserve funding, building inventory or alternate
sources prior to the end of 1999.
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 7A. Quantitative and Qualitative Disclosures about Market Risks
The information required by this item is incorporated herein by reference to
the section entitled "Market Risk" in Management's Discussion and Analysis of
Results of Operations and Financial Condition (Part II, Item 7).
31
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-23.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
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 1999 Annual
Meeting of Stockholders, which Proxy Statement will be filed with the
Securities and Exchange Commission on or about October 15, 1999.
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 1999 Annual
Meeting of Stockholders, which Proxy Statement will be filed with the
Securities and Exchange Commission on or about October 15, 1999.
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 1999 Annual
Meeting of Stockholders, which Proxy Statement will be filed with the
Securities and Exchange Commission on or about October 15, 1999.
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 1999 Annual
Meeting of Stockholders, which Proxy Statement will be filed with the
Securities and Exchange Commission on or about October 15, 1999.
32
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:
Independent Auditors' Report.......................................... F-1
Consolidated Balance Sheets at June 30, 1998 and 1999................. F-2
Consolidated Statements of Operations for the years ended June 30,
1997, 1998 and 1999.................................................. F-3
Consolidated Statements of Shareholders' Equity for the years ended
June 30, 1997, 1998 and 1999......................................... F-4
Consolidated Statements of Cash Flows for the years ended June 30,
1997, 1998 and 1999.................................................. 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, 1999.
33
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, 1999 /s/ Ajay Mehra
By: _________________________________
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, 1999
_____________________________ President and Chief Executive
Deepak Chopra Officer (Principal Executive
Officer)
/s/ Ajay Mehra Vice President, Chief September 28, 1999
_____________________________ Financial Officer (Principal
Ajay Mehra Financial and Accounting
Officer), Secretary and
Director
/s/ Steven C. Good Director September 28, 1999
_____________________________
Steven C. Good
/s/ Meyer Luskin Director September 28, 1999
_____________________________
Meyer Luskin
/s/ Madan G. Syal Director September 28, 1999
_____________________________
Madan G. Syal
34
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, 1999 and 1998, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended June 30, 1999. Our audits
also included the financial schedules 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 the Company as of June 30,
1999 and 1998, and the results of its operations and its cash flows for each of
the three years in the period ended June 30, 1999 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, California
September 23 , 1999
F-1
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1998 AND 1999
(Dollars in Thousands, Except Share Amounts)
1998 1999
------- -------
ASSETS (Note 4)
Current Assets:
Cash and cash equivalents (Note 1)......................... $22,447 $ 7,241
Investment securities available for sale (Note 1).......... 1,708
Accounts receivable, net of allowance for doubtful accounts
of $551 and $860 at June 30, 1998 and 1999, respectively
(Note 1).................................................. 24,254 29,330
Other receivables (Note 2)................................. 1,990 1,862
Inventory (Note 1)......................................... 21,705 24,481
Prepaid expenses........................................... 841 1,018
Deferred income taxes (Notes 1 and 6)...................... 1,381 1,108
Income taxes receivable (Notes 1 and 6).................... 1,853
------- -------
Total current assets..................................... 72,618 68,601
Property and Equipment, Net (Notes 1 and 4).................. 11,466 14,486
Intangible and Other Assets, Net (Notes 1, 2 and 3).......... 2,738 8,581
Deferred Income Taxes (Notes 1 and 6)........................ 1,703
------- -------
Total........................................................ $86,822 $93,371
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Bank lines of credit (Note 4).............................. $ 198 $ 8,678
Current portion of long-term debt (Notes 1, 5 and 12)...... 633 292
Accounts payable (Note 1).................................. 8,560 9,145
Accrued payroll and related expenses....................... 2,400 2,399
Income taxes payable (Notes 1 and 6)....................... 2,517 717
Advances from customers.................................... 1,808 996
Accrued warranties......................................... 1,948 1,984
Other accrued expenses and current liabilities............. 2,137 2,922
------- -------
Total current liabilities................................ 20,201 27,133
Long-Term Debt (Notes 1 and 5)............................... 412 117
Deferred Income Taxes (Notes 1 and 6)........................ 294 339
------- -------
Total liabilities........................................ 20,907 27,589
------- -------
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, 1998
and 1999, respectively Common stock, no par value;
authorized, 40,000,000 shares; issued and outstanding,
9,691,915 and 9,732,415 shares at June 30, 1998 and 1999,
respectively.............................................. 49,131 49,230
Treasury stock (Note 9).................................... (438)
Retained earnings.......................................... 17,419 18,160
Accumulated other comprehensive income (Note 1)............ (635) (1,170)
------- -------
Total shareholders' equity............................... 65,915 65,782
------- -------
Total........................................................ $86,822 $93,371
======= =======
See accompanying notes to consolidated financial statements.
F-2
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
(Dollars in Thousands, Except Share and Per Share Amounts)
1997 1998 1999
------- ------- --------
Revenues (Note 1)................................... $77,628 $93,918 $101,763
Cost Of Goods Sold.................................. 56,174 66,952 71,705
------- ------- --------
Gross Profit........................................ 21,454 26,966 30,058
------- ------- --------
Operating Expenses:
Selling, general and administrative expenses
(Notes 10 and 11)................................ 11,265 12,670 17,452
Research and development (Note 1)................. 2,504 3,790 5,711
Stock option compensation (Note 8)................ 856
Goodwill amortization (Note 1).................... 39 106 595
Asset impairment charge (Note 3).................. 5,189
In process research and development (Note 3)...... 2,579
Restructuring costs (Note 1)...................... 458
------- ------- --------
Total operating expenses........................ 14,664 16,566 31,984
------- ------- --------
Income (Loss) From Operations....................... 6,790 10,400 (1,926)
Interest Expense (Income) (Notes 4, 5 and 10)....... 1,197 (600) (102)
------- ------- --------
Income (Loss) Before Provision for Income Taxes..... 5,593 11,000 (1,824)
Provision (Benefit) for Income Taxes (Notes 1 and
6)................................................. 1,416 2,752 (2,565)
------- ------- --------
Net Income.......................................... $ 4,177 $ 8,248 $ 741
======= ======= ========
Earnings Per Common Share (Note 1).................. $ 1.72 $ 0.94 $ 0.08
======= ======= ========
Earnings Per Common Share--
Assuming dilution (Note 1)........................ $ 0.68 $ 0.92 $ 0.08
======= ======= ========
See accompanying notes to consolidated financial statements.
F-3
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
(Dollars in Thousands, Except Share Amounts)
Preferred Common Treasury Accumulated
------------------- ----------------- ----------------- Other
Number Number Number Retained Comprehensive Comprehensive
of Shares Amount of Shares Amount of Shares Amount Earnings Income Income Total
---------- ------- --------- ------- --------- ------ -------- ------------- ------------- -------
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
acquisition...... 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
Comprehensive
income:
Net income....... 4,177 $4,177 4,177
Other
comprehensive
income--
translation
adjustment....... 145 145 145
------
Comprehensive
income........... $4,322
---------- ------- --------- ------- ------- ------- ====== -------
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
Tax benefit of
stock options
exercised........ 318 318
Comprehensive
income:
Net income....... 8,248 $8,248 8,248
Other
comprehensive
income--
translation
adjustment....... (906) (906) (906)
------
Comprehensive
income........... $7,342
---------- ------- --------- ------- ------- ------- ====== -------
Balance, June 30,
1998.............. 9,691,915 49,131 17,419 (635) 65,915
Exercise of stock
options.......... 40,500 99 99
Treasury stock
purchased........ (85,000) $(438) (438)
Comprehensive
income:
Net income....... 741 $ 741 741
Other
comprehensive
income--
translation
adjustment....... (49) (49) (49)
Unrealized loss
on available for
sale securities.. (486) (486) (486)
------
Comprehensive
income........... $ 206
---------- ------- --------- ------- ------- ----- ------- ------- ====== -------
Balance, June 30,
1999.............. -- $ -- 9,732,415 $49,230 (85,000) $(438) $18,160 $(1,170) $65,782
========== ======= ========= ======= ======= ===== ======= ======= =======
See accompanying notes to financial statements.
F-4
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
(Dollars in Thousands)
1997 1998 1999
------- ------- --------
Cash Flows from Operating Activities:
Net income........................................ $ 4,177 $ 8,248 $ 741
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for losses on accounts receivable....... 389 122 86
In-process research and development............... 2,579
Depreciation and amortization..................... 2,302 2,330 3,681
Asset impairment charge........................... 5,189
Stock option compensation......................... 856
Deferred income taxes............................. (900) (314) (1,384)
Gain on sale of property and equipment............ (13) (498)
Changes in operating assets and liabilities, net
of business acquisition:
Accounts receivable.............................. (1,980) (9,481) (4,273)
Other receivables................................ (1,530) 462 (570)
Inventory........................................ (4,573) (3,995) (395)
Prepaid expenses................................. 96 (325) (194)
Accounts payable................................. 1,026 1,352 318
Accrued payroll and related expenses............. (60) 840 (660)
Income taxes payable............................. 1,005 884 (1,775)
Advances from customers.......................... 1,448 (603) (928)
Increase in prepaid income taxes receivable...... (1,853)
Accrued warranty................................. 574 989 (26)
Other accrued expenses and current liabilities... 527 (932) 42
------- ------- --------
Net cash provided by (used in) operating
activities..................................... 3,357 (436) 80
------- ------- --------
Cash Flows from Investing Activities:
Increase in investment securities................. (2,194)
Cash paid for equity investments.................. (1,202)
Proceeds from sale of property and equipment...... 46 861
Additions to property and equipment............... (2,182) (7,487) (4,607)
Cash paid for business acquisition, net of cash
acquired......................................... (848) (750) (16,041)
Other assets...................................... 23 194 (188)
------- ------- --------
Net cash used in investing activities........... (3,007) (7,997) (23,371)
------- ------- --------
Cash Flows from Financing Activities:
Net proceeds from (repayment of) bank lines of
credit........................................... 1,014 (8,797) 8,495
Payments on senior subordinated debt.............. (350)
Payments on long-term debt........................ (3,983) (2,411) (669)
Proceeds from issuance of long-term debt.......... 2,647
Proceeds from initial public offering and exercise
of stock options and warrants.................... 146 41,764 99
Treasury stock.................................... (438)
------- ------- --------
Net cash (used in) provided by financing
activities..................................... (526) 30,556 7,487
------- ------- --------
Effect of Exchange Rate Changes on Cash............ 148 (229) 598
------- ------- --------
Net (Decrease) Increase in Cash Equivalents........ (28) 21,894 (15,206)
Cash and Cash Equivalents, Beginning of Year....... 581 553 22,447
------- ------- --------
Cash and Cash Equivalents, End of Year............. $ 553 $22,447 $ 7,241
======= ======= ========
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest.......................................... $ 1,197 $ 452 $ 572
Income taxes...................................... $ 1,511 $ 1,869 $ 2,475
See accompanying notes to consolidated financial statements.
F-5
OSI SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
(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,
were issued 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
====
During the year ended June 30, 1999, the Company completed the following
acquisitions:
In September 1998, the Company acquired all of the capital stock of
Osteometer MediTech A/S ("Osteometer")
In November 1998, the Company acquired the security business of Metorex
International Oy ("Metorex Security")
In November 1998, the Company acquired all of the capital stock of
Silicon Microstructures, Inc. ("SMI")
In December 1998, the Company acquired most of the assets of Corrigan
Canada Ltd. ("Corrigan")
In January 1999, the Company purchased the product line of Aristo
Medical Products, Inc. ("Aristo")
In conjunction with the acquisitions, assets were acquired and liabilities
assumed as follows:
Metorex
Osteometer Security SMI Corrigan Aristo
---------- -------- ------ -------- ------
Fair value of assets acquired.... $ 3,675 $ 914 $ 806 $1,117 $250
Goodwill and identified
intangible assets............... 3,984 3,597 1,470 110 27
In process research and
development..................... 1,957 204 418
Liabilities assumed.............. (1,731) (751)
------- ------ ------ ------ ----
Cash paid........................ $ 7,885 $4,715 $2,694 $ 476 $277
======= ====== ====== ====== ====
F-6
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
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 and silicon
pressure-sensor microstructure technology. The Company designs and manufactures
optoelectronic and pressure-sensor devices and value-added subsystems for
original equipment manufacturers ("OEMs") in a broad range of applications,
including security, medical diagnostics, telecommunications, gaming, 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 and medical
imaging systems that it markets worldwide to end users. The Company markets its
security and inspection products under the "Rapiscan," "Secure" and "Metor"
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 was 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 $1,566,000 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.
Investment Securities
The Company's investment securities are composed of equity securities that
have been classified as available-for-sale securities. The equity securities
are carried at their fair market value based upon the quoted market prices of
those investments at June 30, 1999. Unrealized gains and losses on equity
securities are included in accumulated other comprehensive income.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to credit risk
consist primarily of cash, cash equivalents and accounts receivable. At June
30, 1999, approximately 62% 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.
F-7
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
Inventory at June 30, 1998 and 1999 consisted of the following (in
thousands):
1998 1999
------- -------
Raw materials................................................ $12,200 $11,963
Work-in-process.............................................. 6,030 8,000
Finished goods............................................... 3,475 4,518
------- -------
Total........................................................ $21,705 $24,481
======= =======
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.
Property and equipment at June 30, 1998 and 1999 consisted of the following
(in thousands):
1998 1999
------- -------
Land and buildings.......................................... $ 4,211 $ 4,211
Equipment................................................... 9,046 11,969
Leasehold improvements...................................... 2,768 4,133
Tooling..................................................... 1,953 2,198
Furniture and fixtures...................................... 824 1,107
Computer.................................................... 2,202 3,042
Vehicles.................................................... 142 200
------- -------
Total....................................................... 21,146 26,860
Less accumulated depreciation and amortization.............. 9,680 12,374
------- -------
Property and equipment, net................................. $11,466 $14,486
======= =======
Intangibles and Other Assets
Intangible and other assets at June 30, 1998 and 1999 consisted of the
following (in thousands):
1998 1999
------ ------
Software development costs.................................... $ 588 $ 588
Goodwill and identified intangible assets..................... 2,142 6,942
Joint venture and equity investments.......................... 108 1,311
Deposits...................................................... 168 102
Other......................................................... 422 721
------ ------
Total......................................................... 3,428 9,664
Less accumulated amortization................................. 690 1,083
------ ------
Intangible and other assets, net.............................. $2,738 $8,581
====== ======
F-8
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
At June 30, 1998 and 1999, goodwill and identified intangible assets
consisted of the following as a result of the following acquisitions (in
thousands):
1998 1999
------ ------
Acquisition of minority interests............................. $1,554 $1,554
Acquisition of Advanced Micro Electronics AS.................. 588 588
Acquisition of Metorex Security............................... 3,193
Acquisition of SMI............................................ 1,470
Acquisition of Corrigan....................................... 110
Acquisition of Aristo......................................... 27
------ ------
$2,142 $6,942
====== ======
Goodwill and identified intangible assets are amortized on a straight-line
basis over periods ranging from 12 to 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 that 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 three years ended June 30, 1999.
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. Impairment losses for Osteometer have been
disclosed in Note 3 to the financial statements.
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 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, 1999, there was approximately $200,000 in outstanding foreign exchange
contracts. The estimated fair value of these contracts, based on quoted market
prices from banks, closely approximated their carrying value at June 30, 1999.
F-9
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
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,
Denmark, Finland, Canada and the United Kingdom are maintained in Singapore
dollars, Malaysian ringgits, Norwegian kroner, Danish kroner, Finnish markka,
Canadian dollars 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 gains (losses) of
approximately $68,000, $(39,000) and $(743,000) were included in income for the
years ended June 30, 1997, 1998 and 1999, respectively.
Restructuring Costs
The Company adopted a restructuring plan in the quarter ended March 31,
1999. In terms of the plan the Company recorded $458,000 of restructuring costs
associated primarily with the termination of certain employees and integration
of certain activities of subsidiaries. All of the restructuring costs have been
incurred and recorded before March 31, 1999.
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
No. 128 in the accompanying financial statements for all periods presented.
Earnings per common share are computed using the weighted average number of
shares outstanding during the period. Earnings per common share--assuming
dilution are 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 1997 period common equivalent shares from
convertible debt and preferred stock, calculated using the treasury stock and
if converted methods.
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, 1997
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------ ---------
Earnings per common share................. $4,177,000 2,430,347 $1.72
=====
Income available to common stockholders
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
========== ========= =====
F-10
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
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 conversion................... $8,248,000 8,955,919 $0.92
========== ========= =====
Year Ended June 30, 1999
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------ ---------
Earnings per common share
Income available to common stockholders... $ 741,000 9,706,218 $0.08
=====
Effect of dilutive securities
Convertible subordinated debt
Convertible preferred stock
Options, treasury stock method............ 122,753
---------- ---------
Earnings per common share--assuming
dilution
Income available to common stockholders
and assumed conversions.................. $ 741,000 9,828,971 $0.08
========== ========= =====
Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which revises
the accounting for derivative financial instruments. This statement requires
that all derivative instruments be recorded on the balance sheets at their fair
values. Changes in the fair value of derivatives will be recorded in income or
other comprehensive income. The Company is currently analyzing the impact of
this statement, which is required to be adopted in 2001, and does not expect it
to have a material impact on the Company's financial position or results of
operations.
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. Joint Ventures and Equity Investments
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 $183,000
consists of an initial investment of $108,000 and the Company's equity in the
earnings of the joint venture since inception of $75,000.
F-11
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
The joint venture was formed for the purpose of the manufacture, assembly,
service and testing of x-ray security and other products. Some of the Company's
subsidiaries are suppliers to the joint venture partner, which 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, 1998 and 1999, the Company earned a
technical fee from the joint venture in the amount of $144,000 and $107,000,
respectively. At June 30, 1999, $107,000 was unpaid and included in other
receivables in the accompanying consolidated financial statements.
In August 1998, the Company invested $315,000, including professional fees
associated with the investment, in Square One, Inc. The Company's investment
including goodwill of $242,000 is accounted for under the equity method and
included in other assets in the accompanying financial statements. The
Company's equity in the losses of the investment through June 30, 1999 was not
significant. Square One, Inc. develops and manufactures infrared-based patient
monitoring devices and subsystems.
During the year, the Company invested $1,002,000, including professional
fees associated with the acquisition, in TFT Medical, Inc. for an equity share
of 40.3%. The Company's investment of $1,002,000 includes goodwill of $740,000,
which is the excess of the purchase price over the Company's share of the net
assets acquired. At June 30, 1999, the Company's equity in the losses of the
investment is $187,000 and is included in selling, general and administrative
expenses. The investment and equity losses are included in other assets in the
accompanying financial statements. TFT Medical, Inc. develops new generation
pulse oximeter instruments and probes for use in the medical field.
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.
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).
On September 2, 1998, the Company acquired the capital stock of Osteometer,
a Danish manufacturer of bone densitometers for the diagnosing of osteoporosis.
The cash purchase price amounted to $7,885,000, including professional fees
associated with the acquisition. The acquisition has been accounted for by the
purchase method of accounting, and, accordingly, based on the valuation
obtained, the purchase price has been allocated to the assets acquired of
$3,675,000 and liabilities assumed of $1,731,000, in-process research and
development of $1,957,000 and identified intangible assets of $3,984,000.
Osteometer experienced continued losses due to the worldwide decline in the
bone densometer market. As a result of the aforementioned circumstances, the
Company recorded an asset impairment charge of $5,189,000, which included the
write-off of $3,735,000 of goodwill and $1,454,000 of other assets. The asset
impairment charge was calculated as the difference between the carrying amount
of the assets and the expected net realizable value of the assets.
F-12
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
Subsequent to the year ended June 30, 1999, the Company decided to close the
manufacturing facilities of Osteometer in Denmark within the next several
months and currently intends to relocate certain of these operations to the
U.S. facilities of the Company. The Company will incur additional costs related
to this closure and relocation in fiscal 2000. Based on its assessment to date,
the Company currently estimates these costs to be in the range of $2,000,000 to
$2,700,000. As the Company continues to proceed with the closure and intended
relocation of these manufacturing facilities, it will be able to more
accurately estimate the range of these costs, which may change from the current
estimate.
On November 4, 1998, the Company purchased the security products business of
Metorex Security of Espoo, Finland. The Company paid $4,715,000 in cash,
including professional fees associated with the acquisition. The Company may
pay up to an additional $1,500,000 in cash, at a later date, based upon future
sales. The acquisition has been accounted for by the purchase method of
accounting, and, accordingly, based on the valuation obtained, the purchase
price has been allocated to the assets acquired of $914,000, in-process
research and development of $204,000, and goodwill and identified intangible
assets of $3,597,000. Goodwill and identified intangible assets are amortized
over a period of 20 and 12 years, respectively.
On November 17, 1998, the Company acquired all the outstanding stock of SMI,
a silicon pressure sensor manufacturer, from Exar Corporation of Fremont,
California. The Company paid $2,694,000 in cash, including professional fees
associated with the acquisition. The Company may pay up to an additional
$3,900,000 million in cash, at a later date, based on future sales. The
acquisition has been accounted for by the purchase method of accounting, and,
accordingly, based on the valuation obtained, the purchase price has been
allocated to the assets acquired of $806,000, in-process research and
development of $418,000 and identified intangible assets of $1,470,000.
Identified intangible assets are amortized over a period of 12 years.
On December 11, 1998, the Company purchased most of the assets and assumed
certain liabilities of Corrigan, a Canadian security products manufacturer. The
Company paid $476,000 in cash, including professional fees associated with the
acquisition. 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 $1,117,000 and liabilities assumed of $751,000, 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 the net assets acquired
is being amortized over a period of 20 years.
On January 31, 1999, the Company purchased the product line of Aristo.
Aristo develops and manufactures new generation pulse oximeter probes for use
in the medical field. The purchase price amounted to $277,000 in cash,
including professional fees associated with the acquisition. 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 $250,000, based
on the estimated fair values of the assets at the date of acquisition. The
excess of the purchase price over the fair vale of the assets acquired is being
amortized over a period of 20 years.
F-13
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
4. Bank Agreements
At June 30, 1998 and 1999, line of credit borrowings consisted of the
following:
1998 1999
----- -------
Line of credit--U.S........................................... $ 8,500
Line of credit--Singapore
Line of credit--Norway........................................ $ 198
Line of credit--Rapiscan U.K..................................
Line of credit--Metorex Finland............................... 178
----- -------
Total bank lines of credit.................................... $ 198 $ 8,678
===== =======
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 and $3,000,000 term loan. Borrowings under the line of credit bear
interest at the bank's prime rate (7.75% at June 30, 1999) 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 2000. Borrowings under the senior loan agreement are collateralized by
substantially all of the assets of the Company's U.S. subsidiaries. At June 30,
1999, there was $8,500,000 outstanding under the acquisition line 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, 1999, approximately $66,000 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 was in violation of a covenant for the quarter ended
June 30, 1999, due to the asset impairment charge. The covenant was
subsequently waived by the bank.
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 bank's prime rate (7.75% at June 30, 1999)
plus 5%. Interest is payable on demand. Borrowings under the current agreement
are secured by certain of the Company's assets. At June 30, 1999, there were no
amounts outstanding under the revolving line of credit. The agreement also
provides a commitment for letters of credit for a specific customer up to
$1,885,000. At June 30, 1999, approximately $850,000 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. The above facility expires in
November 1999, and the Company has not yet decided how it will handle these
facilities upon their expiration.
Opto Sensors Pte. Ltd. ("OSP") has a loan agreement with a Singapore bank
that provides for a revolving line of credit up to 2,900,000 Singapore dollars
(approximately US $1,706,000 at June 30, 1999). Borrowings under the line of
credit bear interest at the bank's prime rate (10% at June 30, 1999) plus
2.25%. 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, 1999, 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
$636,000 at June 30, 1999). Borrowings under the line
F-14
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
of credit bear interest at a variable rate, which was 10.1% at June 30, 1999.
Interest is payable quarterly. Borrowings under the line of credit are
collateralized by certain AME assets. At June 30, 1999, there were no amounts
issued and outstanding under the line of credit.
Rapiscan U.K. has a loan agreement with a U.K. bank that provides for an
overdraft facility up to a maximum amount of 2,000,000 pounds sterling
(approximately US $3,140,000 at June 30, 1999) outstanding at any one time,
which amounts are secured by certain assets of Rapiscan U.K. At June 30, 1999,
no amounts were outstanding under the overdraft facility. Outstanding
borrowings bear interest at a base rate (7.5% at June 30, 1999) plus 1.5% per
annum. The agreement also provides for a 1,000,000 pounds sterling
(approximately US $1,570,000 at June 30, 1999) facility for tender and
performance bonds and a 1,000,000 pounds sterling (approximately US $1,570,000
at June 30, 1999) facility for the purchase of foreign exchange contracts.
These facilities are secured by certain assets of Rapiscan U.K., and the
Company has guaranteed Rapiscan U.K.'s obligation under the performance bond
facility. As of June 30, 1999, $277,000 was outstanding under the performance
bond facility, and Rapiscan U.K. had purchased forward exchange contracts in
the amount of $200,000. The above facilities expire in January 2000, 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
$395,000 at June 30, 1999). Borrowings under the line of credit bear interest
at the bank's base lending rate (9% at June 30, 1999) plus 1.75%. Interest is
payable monthly. No amounts were outstanding under this agreement at June 30,
1999. Borrowings under this agreement are secured by certain assets of the
subsidiary. The above facility expires in February 2000, and the Company
believes that it will be renewed on the same or similar terms.
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 $658,000 at June 30, 1999). As of June 30, 1999, $310,000 was
outstanding under the loan agreement. The agreement also provides for overdraft
borrowings up to 1,000,000 Malaysian ringgits (approximately US $263,000 at
June 30, 1999). Borrowings under the overdraft facility bear interest at the
bank's base lending rate (9.5% at June 30, 1999) plus 2.25%. At June 30, 1999,
there were no amounts outstanding under the facility. Borrowings under this
agreement are secured by certain assets of the subsidiary. The above facility
expires in October 1999, and the Company believes that it will be renewed on
the same or similar terms.
Metorex Security, Finland, has a loan agreement with a Finnish bank that
provides for a foreign currency overdraft facility up to 2,000,000 Finnish
markka (approximately US $347,000 at June 30, 1999). At June 30, 1999,
approximately $178,000 was outstanding under the overdraft facility. The
agreement also provides for 1,000,000 Finnish markka (approximately US $174,000
at June 30, 1999) for tender and performance bonds. At June 30, 1999,
approximately $26,000 was outstanding under the tender and performance bonds
facility. Borrowings under the facility bear interest at the bank's prime
lending rate (3% at June 30, 1999) plus 1%. The above facilities expire in
February 2000, and the Company believes that they will be renewed on the same
or similar terms.
F-15
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
5. Long-Term Debt
At June 30, 1998 and 1999, long-term debt consisted of the following (in
thousands):
1998 1999
----- ----
Term loan payable to a Norwegian bank, interest due quarterly at
a rate of 7%, principal due in monthly installments of $8,680.
The outstanding balance was paid in full in September 1998...... $ 312
Liability under settlement agreements, interest. Treasury bill
rate (5.055% at June 30, 1998). The outstanding balance was paid
in full in March 1999........................................... 400
Capital lease payable in monthly installments of $10,860 until
paid in full on November 1, 2000. Interest is due monthly at a
rate of 9.2%.................................................... 310 $158
Interest-free subsidy payable to a Danish government institution
based on future product sales of a particular product........... 174
Other............................................................ 23 77
----- ----
1,045 409
Less current portion of long-term debt........................... 633 292
----- ----
Long-term portion of debt........................................ $ 412 $117
===== ====
Fiscal year principal payments of long-term debt as of June 30, 1999 are as
follows (in thousands):
2000............................................................. $292
2001............................................................. 117
----
Total............................................................ $409
====
6. Income Taxes
For financial reporting purposes, income before provision for income taxes
and minority interest includes the following components (in thousands):
1997 1998 1999
------ ------- -------
Pre-tax income:
United States.................................... $2,655 $ 4,505 $ 1,838
Foreign.......................................... 2,938 6,495 (3,662)
------ ------- -------
Total pre-tax income (loss)........................ $5,593 $11,000 $(1,824)
====== ======= =======
The Company's provision for income taxes is composed of the following (in
thousands):
1997 1998 1999
------ ------ -------
Current:
Federal........................................... $1,256 $1,729 $(1,946)
State............................................. 24 246 290
Foreign........................................... 1,036 1,091 475
------ ------ -------
2,316 3,066 (1,181)
Deferred............................................ (900) (314) (1,384)
------ ------ -------
Total provision..................................... $1,416 $2,752 $(2,565)
====== ====== =======
F-16
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
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, 1999, undistributed earnings of the foreign subsidiaries
amounted to approximately $4,998,000. It is not practicable to determine the
amount of income or withholding tax that would be payable upon the remittance
of those earnings.
Deferred income tax assets (liabilities) at June 30, 1998 and 1999 consisted
of the following (in thousands):
1998 1999
------- -------
State income taxes........................................ $ 1,585 $ 1,892
Federal income tax credit carryforwards................... 358
Net operating loss carryforwards.......................... 1,208
Other assets.............................................. 644 1,483
------- -------
Total deferred income tax assets.......................... 2,229 4,941
------- -------
Depreciation.............................................. 67 (406)
Capitalized software development costs.................... (217) (217)
State income taxes........................................ (462) (772)
Revitalization zone deductions............................ (530)
Other liabilities......................................... (1,074)
------- -------
Total deferred income tax labilities (1,142) (2,469)
------- -------
Net deferred income taxes................................. $ 1,087 $ 2,472
======= =======
As of June 30, 1999, the Company has federal and state net operating loss
carryforwards of approximately $2,718,000 and $2,904,000, respectively. The
Company's federal and state net operating losses will begin to expire in the
tax years ending June 30, 2019 and 2004, respectively. The Company also has
federal research and experimental credit carryforwards and state research and
experimental and revitalization zone credit carryforwards of approximately
$343,000 and $1,892,000, respectively. The Company's federal and state credit
carryforwards will begin to expire in tax years ending June 30, 2019 and 2014,
respectively.
No valuation allowance for deferred tax assets was required for the years
ended June 30, 1998 and 1999, as management believes it is more likely than not
that the Company will generate sufficient taxable income to realize its
deferred tax assets.
The consolidated effective income tax rate differs from the federal
statutory income tax rate due primarily to the following:
1997 1998 1999
---- ----- ------
Provision for income taxes at federal statutory
rate................................................ 35.0% 35.0% (35.0)%
State income taxes (credits), net of federal
benefit............................................. (4.7) (1.1) (19.6)
Nontaxable earnings of FSC........................... (4.9) (1.3) (13.6)
Research and development tax credits................. (1.7) (1.7) (11.8)
Foreign income subject to tax at other than federal
statutory rate...................................... (1.0) (10.9) (95.6)
Foreign losses with no foreign tax benefits.......... 26.1
In process research and development.................. 7.9
Other................................................ 2.6 5.0 2.4
---- ----- ------
Effective income tax rate............................ 25.3% 25.0% (139.2)%
==== ===== ======
F-17
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
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, 1999 are as follows:
2000.......................................................... $1,549,000
2001.......................................................... 1,413,000
2002.......................................................... 1,062,000
2003.......................................................... 957,000
2004.......................................................... 818,000
2005 and thereafter........................................... 3,687,000
----------
Total......................................................... $9,486,000
==========
Total rent expense included in the accompanying consolidated financial
statements was $921,000, $1,013,000 and $1,968,000 for the years ended June 30,
1997, 1998 and 1999, respectively.
The Company is involved in various claims and legal proceedings arising out
of the conduct of its business. In the opinion of the Company's management
after consultation with outside legal counsel, the ultimate disposition of such
proceedings, will not have a materially adverse effect on the Company's
consolidated financial position or future results of operations.
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 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 five 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.
F-18
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
The following summarizes stock option activity for the years ended June 30,
1997, 1998 and 1999:
Option Price
Number --------------------
of Weighted
Options Average Total
-------- -------- -----------
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
Granted......................................... 180,250 7.43 1,339,000
Exercised....................................... (40,500) 2.43 (99,000)
Canceled........................................ (144,800) 10.29 (1,490,000)
-------- -----------
Outstanding, June 30, 1999...................... 807,862 8.87 $ 7,162,000
======== ===========
The following summarizes pricing and term information for options
outstanding as of June 30, 1999:
Options Outstanding Options Exercisable
---------------------------------------- ----------------------
Weighted Weighted Weighted
Number Average Average Exercisable Average
Range of Outstanding at Remaining Exercise at Exercise
Exercise Prices June 30, 1999 Contractual Life Price June 30, 1999 Price
--------------- -------------- ---------------- -------- ------------- --------
$2.00 35,250 0.6 $ 2.00 35,250 $ 2.00
2.33 to
3.33 137,175 2.3 2.74 137,175 2.74
6.56 to
7.00 124,000 4.5 6.89
10.00 to
11.01 151,000 4.0 10.11 37,750 10.11
11.50 to
13.50 360,437 3.0 12.03 180,218 12.03
------- -------
$2.00 to
13.50 807,862 3.2 $ 8.87 390,393 $ 7.67
======= =======
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, 1998 and 1999 pursuant to SFAS No. 123 was approximately
$1,054,000, $768,000 and $1,272,000, respectively. Had the Company adopted SFAS
No. 123, pro forma net income would have been $4,058,000, $7,787,000 and
$(213,000), and pro forma net income per share would have been $0.64, $0.87 and
$(0.02) for 1997, 1998 and 1999, 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 71% (1998 and 1997, 44% and 0%, respectively), a risk-free interest rate of
5.67% (1998 and 1997, 5.47% and 6.53%, respectively) 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.
F-19
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
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, 1998 and 1999.
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
approximately $41,000,000.
In March 1999, the Board of Directors instituted a treasury stock program
under which the Company is authorized to purchase up to a total of 2,000,000
shares for reissuance in future proceeds. The Company purchased 85,000 shares
at a cost of $438,000 during fiscal 1999. These shares are disclosed as
treasury stock in the accompanying financial statements.
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, 1997,
1998 and 1999 are approximately $111,000, $99,000 and $103,000 for messenger
service and auto rental; $82,000, $186,000 and $76,000 for printing services;
and $11,000, $13,000 and $4,000 for professional services, respectively. For
the year ended June 30, 1997, the Company paid a 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 had 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 $146,000 for the year ended June 30, 1997.
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. The final payment under this
settlement was made during the year ended June 30, 1999.
F-20
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
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, 1997, 1998 and
1999 was approximately $91,000, $138,000 and $106,000, respectively.
13. Subsequent Events
The acquisition of Metorex Security provided for additional future payments,
up to $1,500,000 in cash, based on future sales. In July 1999, the Company paid
4,400,000 Finnish markka (approximately US $759,000) in lieu of the future
contingent payments.
In July 1999, the Company entered into a non-exclusive patent license
agreement. The Company paid $450,000 for the patent license which expires in
2000. The Company may be required to make additional payments of up to $350,000
based on certain future orders and shipments.
Subsequent to the end of the year, the Company purchased 247,500 additional
shares under the treasury stock repurchase plan at a total cost of $1,167,125.
F-21
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
14. Unaudited Quarterly Results
The following table presents unaudited quarterly financial information for
the four quarters ended June 30, 1999:
Quarter Ended in Thousands
-----------------------------------------------
June
September 30, December 31, March 31, 30,
1998 1998 1999 1999
------------- ------------ --------- -------
(Unaudited)
Revenues..................... $21,404 $24,847 $24,606 $30,906
Costs of goods sold.......... 14,988 17,424 17,099 22,194
------- ------- ------- -------
Gross profit............. 6,416 7,423 7,507 8,712
------- ------- ------- -------
Operating expenses:
Selling, general and
administrative............ 3,363 3,386 5,104 5,599
Research and development... 1,024 1,559 1,537 1,591
In-process research and
development............... 2,579
Goodwill amortization...... 26 162 203 204
Asset impairment charge.... 5,189
Restructuring costs........ 458
------- ------- ------- -------
Total operating
expenses................ 4,413 7,686 7,302 12,583
------- ------- ------- -------
Income (loss) from
operations.................. 2,003 (263) 205 (3,871)
Interest (income) expense,
net......................... (167) (83) 125 23
------- ------- ------- -------
Income (loss) before
provision (benefit) for
income taxes................ 2,170 (180) 80 (3,894)
Provision (benefit) for
income taxes................ 510 423 (300) (3,198)
------- ------- ------- -------
Net income (loss)........ $ 1,660 $ (603) $ 380 $ (696)
======= ======= ======= =======
Earnings (loss) per common
share....................... $ 0.17 $ (0.06) $ 0.04 $ (0.07)
======= ======= ======= =======
Earnings (loss) per common
share--assuming dilution.... $ 0.17 $ (0.06) $ 0.04 $ (0.07)
======= ======= ======= =======
15. Segment Information
The Company has adopted SFAS No. 131, "Segment Disclosure." The Company has
reflected the provisions of SFAS No. 131 in the accompanying financial
statements for all periods presented. The Company believes that it operates in
two identifiable industry segments, namely optoelectronic and silicon pressure-
sensor devices and subsystems and medical imaging systems, and security and
inspection products. For the years ended June 30 1997, 1998 and 1999 external
revenues from optoelectronic and silicon pressure-sensor devices subsystems and
medical imaging systems were $42,879, $50,120 and $55,469, respectively.
Revenues from security and inspection systems were $34,749, $43,798 and $46,294
for the years ended June 30 1997, 1998 and 1999, respectively. Segment
information is provided by geographic area. As discussed in Note 1, the Company
is vertically integrated and is sharing common resources and facilities.
Therefore, with the exception of external revenues, therefore, meaningful
information is not available by industry or product segment.
F-22
OSI SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
YEARS ENDED JUNE 30, 1997, 1998 AND 1999
The Company's operating locations include the North America (United States
and Canada), Europe (United Kingdom, Denmark, Finland 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, 1997
---------------------------------------------------
North
America Europe Asia Eliminations Consolidated
-------- ------- ------- ------------ ------------
Revenues.................. $ 54,310 $18,915 $ 4,403 $ 77,628
Transfer between
geographical 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
======== ======= ======= ========= ========
Capital expenditure....... $ 1,561 $ 293 $ 328 $ 2,182
======== ======= ======= ========= ========
Depreciation.............. $ 1,503 $ 584 $ 215 $ 2,302
======== ======= ======= ========= ========
Year Ended June 30, 1998
---------------------------------------------------
North
America 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
======== ======= ======= ========= ========
Capital expenditure....... $ 6,313 $ 1,047 $ 127 $ $ 7,487
======== ======= ======= ========= ========
Depreciation.............. $ 1,435 $ 676 $ 113 $ $ 2,224
======== ======= ======= ========= ========
Year Ended June 30, 1999
---------------------------------------------------
North
America Europe Asia Eliminations Consolidated
-------- ------- ------- ------------ ------------
Revenues.................. $ 63,208 $33,874 $ 4,681 $101,763
Transfer between
geographical areas....... 7,387 7,434 13,485 $ (28,306)
-------- ------- ------- --------- --------
Net revenues.............. $ 70,595 $41,308 $18,166 $ (28,306) $101,763
======== ======= ======= ========= ========
Operating income (loss)... $ 2,064 $(6,942) $ 3,957 $ (1,005) $ (1,926)
======== ======= ======= ========= ========
Identifiable assets....... $160,335 $30,358 $13,515 $(110,837) $ 93,371
======== ======= ======= ========= ========
Capital expenditure....... $ 2,426 $ 1,767 $ 414 $ $ 4,607
======== ======= ======= ========= ========
Depreciation.............. $ 1,859 $ 975 $ 252 $ $ 3,086
======== ======= ======= ========= ========
F-23
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
of period expenses accounts (Recoveries) period
--------- ------------ -------- ------------ -------
Description
- -----------
Balance for doubtful
accounts:
Year Ended June 30,
1997.................. $276 $389 -- $ 79 $586
==== ==== ==== ==== ====
Year Ended June 30,
1998.................. $586 $122 -- $157 $551
==== ==== ==== ==== ====
Year Ended June 30,
1999.................. $551 $ 86 $295 $ 72 $860
==== ==== ==== ==== ====
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 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)
10.20 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)
10.21 Cooperative Research and Development Agreement dated May 13, 1998
between Rapiscan Security Products, Inc. and the Federal Aviation
Administration (portions of this exhibit have been omitted pursuant to
a request for confidential treatment filed with the Securities and
Exchange Commission, which request has been granted) (6)
10.22* Amended and Restated Credit Agreement entered into on September 2,
1999, by and between Sanwa Bank California and OSI Systems, Inc., UDT
Sensors, Inc., Ferson Optics, Inc., Rapiscan Security Products Inc.,
Metorex Security Products, Inc., Silicon Microstructures, Inc. and
Aristo Medical Products, Inc.
21* Subsidiaries of the Company
23* Independent Auditors' Consent
27* Financial Data Schedule
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)
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* Filed herewith
(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) Previously filed with the Company's Annual Report on Form 10-K, as amended
on Form 10-K/A, for the fiscal year ended June 30, 1998.
(6) Previously filed with the Company's quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1998.