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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended June 30, 2004;

OR

For the transition period from              to             

Commission File Number 0-23125

OSI SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

Registrant’s Telephone Number, Including Area Code: (310) 978-0516

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock, no par value

(Title of Class)

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.  x

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)    Yes  x    No  ¨

As of December 31, 2003 (the last day of the Registrant’s second quarter of fiscal year 2004), the aggregate market value of the shares of the Registrant’s Common Stock held by non-affiliates was approximately $256,983,000, based on the last sales price of the Registrant’s Common Stock on the NASDAQ National Market on such date. Shares of Common Stock held by each officer and director and by each person who owns more than 5% or more of the outstanding Common Stock of the Registrant have been excluded in that such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares of the Registrant’s Common Stock outstanding as of September 9, 2004 was 16,240,290.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement relating to the 2004 Annual Meeting of Stockholders (to be filed subsequently) are incorporated by reference into Part III.

TABLE OF CONTENTS

PART I

General

OSI Systems, Inc. and its subsidiaries is a vertically integrated, worldwide provider of security and inspection systems, medical monitoring and imaging systems, and optoelectronic devices and value-added subsystems. Our company was incorporated in 1987 in California. Our principal office is located at 12525 Chadron Avenue, Hawthorne, California 90250.

We design, manufacture and market security and inspection systems worldwide to end users under trade names including “Rapiscan,” “Ancore,” “PFNA,” “Eagle,” “Metor,” and “Secure.” These systems are used to inspect people, baggage, cargo, vehicles and other objects for weapons, explosives, drugs and other contraband. These systems are also used for the safe, accurate and efficient verification of cargo manifests for the purpose of assessing duties and monitoring the export and import of controlled materials.

In March 2004, we significantly enhanced our medical monitoring and imaging systems activities through the acquisition of Spacelabs Medical, Inc. (“Spacelabs Medical”), a global manufacturer and distributor of patient monitoring and clinical information systems for use primarily in hospitals. Spacelabs Medical’s principal products encompass patient monitoring systems, network and connectivity solutions, ambulatory blood pressure monitors and medical data services. As a result, in the medical field, we now design, develop, manufacture, and market patient monitoring products, network connectivity solutions, ambulatory blood pressure monitors, and related services under trade names including “Spacelabs,” “Ultracare,” and “Ultraview.” We also continue to design, develop, manufacture and market arterial hemoglobin saturation monitors and sensors, including hand-held and wireless monitoring tools under trade names including “Dolphin” and “NuCat,” and peripheral bone densitometers under trade names including “DTX-200” and “DTU-One.”

Our optoelectronic devices and value-added subsystems are used in a broad range of applications, including aerospace and defense electronics, security and inspection systems, medical diagnostics, fiber optics, telecommunications, gaming, office automation, computer peripherals and industrial automation. We design and manufacture optoelectronic devices and value-added subsystems for others through original equipment manufacturer arrangements, as well as for our own security and medical equipment businesses.

In fiscal year 2004, revenues from the sale of security and inspection systems amounted to $117.8 million, or approximately 48% of our revenues. Revenues from the sale of medical imaging and monitoring systems amounted to $60.7 million, or approximately 24% of our revenues. The revenues of Spacelabs Medical from March 19, 2004, the date of acquisition, amounting to $47.2 million, are included in the medical imaging and monitoring systems revenues. Revenues from the sale of optoelectronic devices and value-added subsystems amounted to $68.6 million, or approximately 28% of revenues. Additional information concerning reporting segments is available in Note 14 to our financial statements.

Industry Overview

We sell our security and inspection systems and medical monitoring and imaging systems primarily to end-users, while we design and manufacture our optoelectronic devices and value-added subsystems primarily for original equipment manufacturers.

Security and Inspection Systems.    A variety of technologies are currently used worldwide in security and inspection applications, including: computed tomography systems, single energy x-ray equipment, dual energy x-ray equipment, metal detectors, x-ray machines employing backscatter detection technology, trace detection

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products, and cargo inspection systems using x-rays, gamma rays, or thermal neutron analysis. We believe that the market for security and inspection products will continue to be affected by the threat of terrorist incidents and by new government mandates and appropriations for security and inspection products in the United States and internationally. We also anticipate a growing market for the use of our products in non-security applications such as customs manifest verification and agricultural products inspection.

In the 1970s, principally in response to civilian airline hijackings, the U.S. Government established security standards by setting guidelines for the screening of carry-on baggage for weapons. The United Nations later mandated these standards for adoption by all of its member states. We believe that to date the imposition of these standards has resulted in the installation of over 10,000 x-ray inspection systems in airports worldwide. Additionally, since 1998, the United Kingdom Department of Transport has required that the United Kingdom’s commercial airports deploy systems for 100% screening of international checked baggage. The European Civil Aviation Conference, an organization of 41 member states, has also 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 air transportation regulatory authorities in the U.S. to establish and implement strict security measures and to deploy advanced technologies for the detection of explosives. Then, in July 1996, in response to a White House commission report on aviation safety and security, the U.S. Government enacted additional legislation appropriating $144 million for the initial deployment of advanced security and inspection technology at major U.S. airports.

The September 11, 2001 terrorist attacks on the World Trade Center and the Pentagon using hijacked airliners has since led to nation-wide shifts in transportation and facilities security policies. Shortly following these attacks, Congress passed the Aviation and Transportation Security Act and integrated many U.S. security-related agencies, including the Federal Aviation Administration, into the U.S. Department of Homeland Security. As a result of these and other changes, sales of our security and inspection products have grown as compared to pre-September 11, 2001 levels.

Worldwide trends toward increased international trade and transportation of goods and people have resulted in a growing demand for cargo, port and border inspection technologies. Projects recently installed or currently underway include system installations in Hong Kong, Jamaica, Mexico, Romania, South Korea, Taiwan, the United Arab Emirates, and the United States. These sites contain various cargo inspection product offerings including fixed and relocatable high-energy x-ray, mobile gamma-ray, hybrid x-ray/thermo neutron analysis and pulsed fast neutron analysis scanning systems. We anticipate a growing demand from governments and commercial enterprises for increasingly sophisticated solutions to screening vehicles, trucks, ocean-going cargo, and air pallet containers.

Medical Monitoring and Imaging Systems.    Though a well established market, healthcare is a rapidly growing sector of the U.S. and European economies. An aging population that is requiring a growing number of critical care beds is, in part, fueling this growth.

Many factors such as a severe nationwide nursing shortage, stricter government requirements affecting the staffing and accountability, and shrinking reimbursements from health insurance organizations are forcing healthcare providers to do more with less—improving patient safety and economic efficiencies with fewer resources. Our medical monitoring and imaging systems group designs, manufactures and markets products that respond to these new economic forces by helping hospitals reduce costs while maintaining or improving the quality of care their physicians and nurses are able to deliver.

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In March 2004, we significantly enhanced our medical monitoring and imaging systems activities through the acquisition of Spacelabs Medical, a global manufacturer and distributor of patient monitoring and clinical information systems for use primarily in hospitals. As a result of the Spacelabs Medical acquisition, our total number of employees increased from approximately 1,450 to approximately 2,205, or 52%. Our Spacelabs Medical subsidiary designs, manufactures and markets patient monitoring solutions for critical care, emergency and perioperative areas of the hospital, wired and wireless networks and connectivity solutions, ambulatory blood pressure monitors and medical data services, all aimed at providing caregivers with instant patient information. By making critical patient information more readily accessible both inside and outside the hospital, delays in decision-making can be reduced, length of stay can be shortened, and treatment errors can be minimized.

Through our Dolphin Medical Inc. (“Dolphin Medical”) and Osteometer MediTech USA, Inc. (“Osteometer”) subsidiaries, we design, manufacture, and market next-generation pulse oximetry instruments and compatible pulse oximetry sensors as well as x-ray and ultrasound densitometers, which are used to diagnose osteoporosis as well as to provide follow-up bone density measurements. Our pulse oximetry technologies are used to non-invasively monitor oxygenation levels in a patient’s blood.

Optoelectronic Devices and Value-Added Subsystems.    Our optoelectronic devices and value-added subsystems are used for a wide variety of applications ranging from complex monitoring, measurement and positioning functions, such as in industrial robotics where our optoelectronic devices and value-added subsystems are used to detect the exact position, motion or size of another object, to simple functions, such as the detection of paper in the print path of a laser printer. Because optoelectronic devices and value-added subsystems can be used in a wide variety of measurement control and monitoring applications, they are used in a broad array of industrial applications and are key components in the telecommunications and fiber optics industries.

We believe 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, we see a trend among original equipment manufacturers to increasingly outsource the design and manufacture of optoelectronic devices and value-added subsystems to fully-integrated, independent manufacturers, like us, who may have greater specialization, broader expertise, and the flexibility to respond in shorter time periods than most original equipment manufacturers can accomplish in-house. We believe that our level of vertical integration, substantial engineering resources, expertise in the use and application of optoelectronic technology, and low-cost international manufacturing operations enable us to compete effectively in the market for optoelectronic devices and value-added subsystems. Our optoelectronic devices and value-added subsystems are also used in our security and inspection systems and medical monitoring and imaging products.

We have also penetrated several related markets that depend on our optoelectronic device and subsystem technologies. For example, we sell a series of high-speed photodetectors for use in fiber optic systems such as Gigabit Ethernet, Fiber Channel, and other telecommunication and data communication applications. Through system engineering, product development, rapid prototyping, and volume manufacturing, we develop, manufacture and market laser-based weapons simulation systems for the defense industry. Products include tactical engagement simulation systems, man worn laser detectors, small arms transmitters, controller guns and a variety of targeting systems. We also develop, manufacture, and sell laser-based remote sensing devices that are used in agricultural and mapping applications, as well as to detect and classify vehicles in toll and traffic management systems. Finally, our optoelectronic devices and subsystems group recently added “box build” manufacturing services and PC board assembly capabilities utilizing state-of-the-art automated surface mount technology lines for use by customers in the medical electronics, automotive diagnostic electronics, telecommunications, and digital audio systems industries, among others.

Growth Strategy

Our primary objectives are to be a leading provider of security and inspection products, cutting-edge medical monitoring and imaging systems and specialized optoelectronic products, to enhance our position in the

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international inspection and detection marketplace, to capitalize on our research to provide reliable and cost-optimized medical devices, and to leverage our expertise in the optoelectronic technology industry by entering into new markets. Key elements of this strategy include:

Capitalizing on the Growing Market for Security and Inspection Systems.    We believe that heightened attentiveness to terrorist and other security threats may continue to drive growth in the market for security and inspection systems, not only in transportation security, but in facilities security, event security and materials inspection as well. In addition, the trend toward increased international transportation of goods and people may result in growth in the market for cargo inspection systems. Package screening by freight forwarders also represents a potential growing sector, as new regulations in Europe require such screening, and awareness of the need for such screening grows in the U.S. We intend to continue to expand our sales and marketing efforts both domestically and internationally, and to capitalize on opportunities to replace service and upgrade existing security installations.

Developing New Security and Inspection Technologies.    We intend to continue to develop new security and inspection systems such as our proprietary pulsed fast neutron analysis and real time tomography products. These and the other technological advances we make allow us to offer customers the broadest variety of advanced security solutions. In addition, through research and development and selective acquisitions, we may enhance and expand our current product offerings to better address new applications and security industry demands.

Improving Existing Medical Diagnostic Technologies.    In March 2004, we significantly enhanced our medical monitoring and imaging systems activities through the acquisition of Spacelabs Medical, a global manufacturer and distributor of patient monitoring and clinical information systems for use primarily in hospitals. Spacelabs Medical develops medical monitoring and imaging systems aimed at lowering false alarm rates, thereby reducing time demands on physicians and nurses, and improving patient identification accuracy, thereby reducing physician and nursing errors. In connection with these efforts, Spacelabs Medical and our Dolphin Medical subsidiary are also pursuing cable-free medical sensors and other wireless solutions that will allow for medical monitoring, patient data, transmission, alarm notifications, and other information to be instantly transmitted at any time to any location. We also continue to improve and develop our medical diagnostic tools aimed at bone metabolic diseases, such as osteoporosis, and patient monitors and accessories that utilize pulse oximetry technologies. Overall, our efforts at improving our existing medical diagnostic technologies will continue to concentrate on the development of devices that make it possible for institutions from large hospitals to small clinics and physicians’ offices to obtain accurate, precise, reliable and cost-effective results.

Leveraging the Optoelectronic Design and Manufacturing Expertise to Address New Applications.    We believe that one of our primary competitive strengths is our expertise in designing and manufacturing, at cost-effective rates, specialized optoelectronic devices and value-added subsystems for our own end products both in security and medical businesses and for the products of our original equipment manufacturer customers. Our optoelectronic devices and subsystems group currently designs and manufactures devices and subsystems for numerous customers serving hundreds of applications.

Acquiring New Companies and Technologies.    We have developed expertise in our various lines of business and other areas through internal research and development efforts and also through selective acquisitions.

In 1987, we formed Opto Sensors (Singapore) PTE Ltd. to manufacture optoelectronic devices and value-added subsystems.

In 1990, we acquired UDT Sensors, Inc. to broaden our expertise and capabilities in developing and manufacturing optoelectronic devices and value-added subsystems.

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In 1993, we acquired Rapiscan Security Products Limited in the United Kingdom and, through Rapiscan Security Products (U.S.A.), Inc., commenced our operations as a provider of security and inspection systems in the United States.

In 1993, we acquired Ferson Optics, Inc. (“Ferson Optics”) for its passive optic technologies.

In 1994, we commenced operations of Opto Sensors (Malaysia) Sdn. Bhd. to take advantage of lower manufacturing costs in Malaysia.

In 1994 we, together with an unrelated third party formed ECIL-Rapiscan Security Products Limited in India, for the purpose of the manufacture, assembly, service and testing of x-ray security and other products.

In 1997, we acquired Advanced Micro Electronics AS for its hybrid optoelectronic capabilities.

In 1998, we acquired Osteometer MediTech A/S, a Danish manufacturer of diagnostic scanners used for the early detection of symptoms of osteoporosis. In August 1999, we closed the operations of Osteometer in Denmark, and relocated certain of those operations to our Hawthorne, California facilities.

In 1998, we purchased the security products business of Metorex International Oy of Espoo, Finland. This acquisition brought a complete security metal detection product line to our security and inspection systems group.

In 1998, we acquired all the outstanding stock of Silicon Microstructures, Inc., a silicon pressure-sensor manufacturer, from Exar Corporation located in Fremont, California. On March 31, 2001, we sold all of the outstanding stock of Silicon Microstructures, Inc. to Elmos Semiconductor AG of Germany.

In 1998, we acquired substantially all of the assets and assumed certain liabilities of Corrigan Canada Ltd. in order to enhance the market presence of our security and inspection systems in Canada.

In 1998, we purchased a minority equity stake in Square One, Inc., a developer and manufacturer of infrared-based patient monitoring medical subsystems. In 2000, we acquired substantially all of Square One, Inc.’s assets.

In 1999, we acquired Aristo Medical Products, Inc. for its pulse oximeter probe technologies for use in the medical field.

In 1999, we formed OSI Medical, Inc., a developer of next generation pulse oximeter instruments and probes for use in the medical field.

In 2001, we contributed most of our medical monitoring and imaging systems to a newly formed subsidiary Dolphin Medical, for the purpose of consolidating our various medical devices into a single subsidiary. We merged OSI Medical, Inc. into Dolphin Medical in March 2002. In December 2003, we entered into a stock purchase and option agreement with Conmed Corporation, whereby Conmed Corporation purchased a 10% interest in, Dolphin Medical and an option to purchase all of the remaining assets and the business of Dolphin Medical. In addition, Conmed Corporation and Dolphin Medical entered into a distribution agreement, which provides Conmed Corporation with distribution rights for certain Dolphin Medical products within certain defined territories.

In July 2002, we acquired substantially all the assets of Thermo Centro Vision, Inc., an optoelectronic devices and value-added subsystems designer and manufacturer based in Ventura County, California. The acquisition was made through a newly formed, wholly owned subsidiary, Centro Vision, Inc.

In July 2002, we purchased a 6% interest in Imagis Technologies, Inc., a company that develops facial recognition software for security applications. Based on the continued trading of Imagis common stock below the original purchase price for a prolonged period of time, we recognized an other-than-temporary impairment of the carrying value of this investment.

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In August 2002, we purchased a minority equity interest in CXR Limited, a United Kingdom based research and development company that develops real time tomography systems. In June 2004, we increased our equity interest in CXR Limited to approximately 75%.

In November 2002, we acquired all the outstanding capital stock of Ancore Corporation (“Ancore”), a Santa Clara, California based privately held high-technology developer and provider of advanced inspection systems for aviation security, port and border inspection and counter-terrorism. Consideration paid for the acquisition consisted of a combination of our Common Stock and cash of approximately $10.4 million including professional fees associated with the acquisition. In addition, during the five years following the close, contingent consideration is payable based on sales of certain Ancore products. The contingent consideration is capped at $34.0 million.

In August 2003, we acquired the military, laser-based training business of Schwartz Electro-Optics, Inc. in a bankruptcy-court supervised auction. At the close of the transaction we paid approximately $3.7 million including professional fees associated with the acquisition. The acquisition was made through a newly formed, wholly owned subsidiary, OSI Defense Systems, LLC (“OSI Defense Systems”). The acquired business develops and manufactures tactical engagement simulation systems, man worn laser detectors, small arms transmitters, controller guns and a variety of targeting systems for the defense industry.

In October 2003, we acquired the assets of a manufacturing services company specializing in surface mount technology lines and PC board assembly operations for approximately $4.5 million including professional fees associated with the acquisition. The acquisition was made through a wholly owned subsidiary, OSI Electronics, Inc.

In November 2003, we acquired substantially all remaining assets of Schwartz Electro-Optics, Inc. in a bankruptcy-court supervised auction. We paid approximately $1.6 million, including the assumption of certain liabilities and bankers’ fees. The acquired assets comprise a business for the design, sales and manufacturing of laser-based systems used in traffic management, precision agricultural management, and precision mapping and surveying. The business, located in Orlando, Florida, now operates under the name OSI Laserscan. The acquisition was made through our wholly owned subsidiary, OSI Defense Systems.

In December 2003, we acquired substantially all of the assets of J&D Engineering (UK) Limited, a company registered in England and Wales. We paid approximately 367,000 pounds sterling (or approximately $649,000) including acquisition costs. A further 93,000 pounds sterling (or approximately $171,000) was paid during the quarter ended March 31, 2004. The acquired assets comprise a business for the design, manufacturing, and sale of, among other products, metal frames for x-ray scanners.

In January 2004, we completed the acquisition of Advanced Research & Applications Corp. (“ARACOR”), a privately held company located in Sunnyvale, California. Consideration for the acquisition consisted of an initial cash payment of approximately $17.6 million (net of cash acquired), including acquisition costs. Furthermore, during the seven years following the close, contingent consideration is payable based on ARACOR’s net revenues, provided certain requirements are met. The contingent consideration is capped at $30.0 million. The acquisition of ARACOR broadens our security product portfolio through ARACOR’s mobile x-ray inspection system, the Eagle, which is designed for container scanning at busy seaports.

In January 2004, minority shareholders of our RapiTec, Inc. (“RapiTec”) subsidiary accepted an offer by us to purchase all shares of RapiTec common stock held by them. As a result of the transaction, we now wholly own RapiTec. Consideration paid for the share purchase transaction consisted of an initial cash payment of approximately $820,000, of which $536,000 was allocated to goodwill. Subsequent to the year ended June 30, 2004, a second cash payment of approximately of $150,000 is due to the former minority shareholders of RapiTec, due to RapiTec meeting certain performance requirements. This amount will be recorded as goodwill.

In March 2004, we completed the acquisition of Spacelabs Medical, based in Issaquah, Washington, from Instrumentarium Corporation for approximately $47.9 million in cash (net of cash acquired), including

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acquisition costs. Spacelabs Medical is a leading global manufacturer and distributor of patient monitoring systems for critical care and anesthesia, wired and wireless networks, clinical information connectivity solutions, ambulatory blood pressure monitors, and medical data services. These are areas in which we have considerable interest as they represent a natural extension of our engineering and manufacturing expertise and will add to our presence in the medical device industry. The installed base of Spacelabs Medical’s patient monitoring systems consists of approximately 100,000 units worldwide, with 60,000 in the United States, 30,000 in Europe and 10,000 in Asia. In June 2004, we notified Instrumentarium Corporation’s parent, GE Medical Systems, of a working capital and retention bonus adjustment resulting in what we believe to be a downward adjustment of the purchase price in the amount of $25.9 million. In September 2004, GE Medical Systems responded that it believes the amount of the downward adjustments to be approximately $7.8 million. No amounts have been recorded in the financial statements in relation to the expected reduction in the purchase price. The amount of the final adjustment will be resolved by way of a process established in the purchase agreement.

Capitalizing on Vertical Integration.    Our vertical integration provides several advantages in our security and inspection, medical monitoring and imaging and optoelectronic devices and value-added subsystem product lines. These advantages include reduced manufacturing and delivery times, lower costs due to our access to competitive international labor markets, direct sourcing of raw materials and quality control. We also believe that we offer significant added value to our original equipment manufacturer 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, efficient pre-production, and short-run and high volume manufacturing. We believe that our vertical integration differentiates us from many of our competitors and provides value to our original equipment manufacturer customers who can rely on us to be an integrated supplier of optoelectronic devices and value-added subsystems. We intend to continue to leverage our vertically integrated services to create greater value for our customers in the design and manufacture of our products. We believe that this strategy better positions us for penetration into other end markets.

Capitalizing on Global Presence.    We operate from locations in North America, Europe and Asia. We view our international operations as providing an important strategic advantage over competitors in each of the security inspection, medical monitoring and imaging systems, and optoelectronic devices and subsystems market for three primary reasons. First, international manufacturing facilities allow us to take advantage of competitive labor rates in order to be a low cost producer. Second, our international offices strengthen our sales and marketing efforts and our ability to service and repair our systems by providing direct access to growing foreign markets and to our existing international customer base. Third, multiple manufacturing locations allow us to reduce delivery times to our global customer base. In the future, we intend to develop new sources of manufacturing and sales capabilities to maintain and enhance the benefits of our international presence.

Selectively Entering New Markets.    We intend to selectively enter new markets that complement our existing capabilities in the design, development and manufacture of security systems, medical products, and optoelectronic devices and value-added subsystems. We believe that by manufacturing other end products that rely on our existing technological capabilities, we will leverage our integrated design and manufacturing infrastructure to capture greater margins and to build a larger presence in those new end markets that present attractive competitive dynamics. We intend to achieve this strategy through internal growth and through selective acquisitions of end-product manufacturers.

Products and Technology

We design, develop, manufacture and sell products ranging from complex security and inspection systems to medical imaging and monitoring systems to discrete optoelectronic devices and value-added subsystems.

Security and Inspection Systems.    We design, manufacture and market security and inspection systems worldwide to end users under trade names including “Rapiscan,” “Ancore,” “PFNA,” “Eagle,” “Metor,” and “Secure.” These products are used to inspect people, baggage, cargo, vehicles and other objects for weapons,

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explosives, drugs and other contraband. These systems are also used for the safe, accurate and efficient verification of cargo manifests for the purpose of assessing duties and monitoring the export and import of controlled materials.

In recent years, and especially after the terrorist attacks of September 11, 2001, security and inspection products have increasingly been used at a wide range of facilities other than airports. Moreover, the non-security use of such equipment, such as manifest verification by customs agencies at border crossings, or agricultural products inspection, has also grown. As a result of the additional markets, we have successfully diversified sales channels for our security and inspection products. Of our security and inspection revenues, the percentage derived from the sale of inspection products to airlines and airports was approximately 24.5% in fiscal year 2002, 28.8% in fiscal year 2003 and 16.5 % in fiscal year 2004, and the balance of such revenues were derived from all other sales.

Many of our inspection and detection products combine the use of x-ray technology with our optoelectronic capabilities. Such products include 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 object, the dual-energy x-ray systems also measure the x-ray absorption of the inspected object’s contents at two x-ray energies to determine the atomic number, mass and other characteristics of the object’s contents. The various organic and non-organic substances in the inspected object appear to operators of the inspection systems in various colors and this visual information can be used to identify and differentiate the inspected materials. These inspection systems range in size from compact tabletop systems to large cargo, port and border inspection systems comprising entire buildings through which trucks, shipping containers or pallets are transported.

Some of our inspection products require an operator to monitor the images produced by the inspection equipment. Depending on the model, our 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 energy x-ray imaging systems, to high resolution, multi-color images produced by our computer enhanced dual-energy models. We believe that our Rapiscan 500 and 600 series machines provide one of the highest quality images currently available in the x-ray security and inspection industry.

We also manufacture inspection products that automatically and non-invasively detect explosives and other contraband through the use of pulsed fast neutron and thermal neutron technologies. Such technologies permit the operator to inspect cargo, vehicles, and small parcels based on the distinctive chemical composition of various forms of contraband. Our Pulsed Fast Neutron Analysis (“PFNA”) systems use a penetrating beam of fast neutrons to measure the elemental contents (oxygen, nitrogen, etc.) within scanned objects (cargo containers, trucks, etc.) and identify elemental signatures of explosives, drugs or other contraband. The PFNA system then displays to the system operator a three-dimensional image of the scanned object, identifying the location and type of contraband found. Our Thermal Neutron Analysis systems use a similar technology to detect bulk quantities of explosives and drugs concealed in trucks or cargo containers.

Our cargo, vehicle, port, and border screening applications utilize high-energy x-ray as well as gamma-ray and neutron technologies along with computer-enhanced imaging. Such cargo inspection product configurations currently include fixed-site, relocatable, rail, and mobile systems. These products are primarily used to verify the contents of trucks or cargo containers, and to detect the presence of contraband. They offer significant improvements over past methods of cargo screening, such as manual searches, as our cargo systems are faster, more thorough, and do not subject the cargo to pilferage. Entire shipping containers or trucks can be screened in seconds.

Our cargo inspection systems currently include fixed site, relocatable, and mobile systems. Fixed-site systems consist of a permanent structure in which trucks or containers are subjected to high-energy x-ray, gamma-ray, or neutron inspection. Fixed site projects installed or currently under construction include systems in the United States, Hong Kong, Mexico, and Taiwan. Relocatable systems use similar technologies, but consist of

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structures that can be relocated among pre-positioned pads. Several relocatable systems were recently delivered to the Korean Customs Service. Mobile systems are truck-mounted systems using high-energy x-ray or gamma-ray for the inspection of vehicles or cargo containers. The mobile systems can be quickly deployed where needed. Mobile systems have been sold or are currently under production for customers including government agencies in the United States, Malaysia, and Romania.

Our security and inspection systems group also offers a line of walk-through metal detection and hand-held examination products for screening people in airports, amusement parts, banks, courthouses, government buildings, sports arenas, and other venues. Our walk-through metal detection systems utilize pulse induced magnetic fields combined with microprocessor based electronics, which provide uniform detection of ferrous and non-ferrous metallic objects. The technologies range from dual-channel crossed magnetic fields to multi-zone coil configurations. Our “Secure” brand product line, also for hands-off examination, uses extremely low dose backscatter x-ray imaging to detect contraband and weapons concealed underneath clothing and hair. The system provides enhance screening compared to metal detectors as it displays anomalies caused by very small amounts of metal as well as non-metallic items. As a result, our “Secure” products can simultaneously locate and detect conventional metal weapons, as well as ceramic knives, explosives, illicit drugs, precious metals, cameras, recording devices and other contraband or security threats.

The following table sets forth certain information related to the standard security and inspection products that we currently offer. We do, however, also customize our standard products to suit specific applications and customer requirements:

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Medical Monitoring and Imaging Systems.    In the medical field, we design, develop, manufacture, and market patient monitoring systems, network connectivity solutions, ambulatory blood pressure monitors, and related services under trade names including “Spacelabs,” “Ultracare” and “Ultraview.” We also design, develop, manufacture and market arterial hemoglobin saturation monitors and sensors, including hand-held and wireless monitoring tools under trade names including “Dolphin” and “NuCat” and peripheral bone densitometers under trade names including “DTX-200” and “DTU-One.”

Our “Ultraview” patient monitors are used in perioperative, critical care and emergency ward environments. We also offer patient monitors for virtually all applications in the hospital, including neonatal, pediatric and adult critical and emergency care, as well as anesthesia and sub-acute care. WinDNA, based on Citrix application server technology, is a feature of many of these products which allows clinicians to view and control Microsoft

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Windows applications on the patient monitor’s display, eliminating the need for separate terminals in the patient’s room. Attending nurses can thereby check laboratory results and other reports, enter orders, review protocols, and do charting right at the patient’s bedside. Inputs can be made using a mouse, keyboard, and touchscreen.

For electrocardiograph monitoring or multiparameter monitoring of ambulatory patients, we offer a digital telemetry system. The system operates between 608 and 614 MHz, a band not used for private land mobile radio, business radio services or broadcast analog and digital television. The “Ultraview” Digital Telemetry solution comprises a lightweight and compact transmitter that enables monitoring of heart rate, ST segment, arrhythmia and continuous SpO2 (Pulse Oximetry). The multiparameter transmitter also integrates with our “Ultralite” ambulatory blood pressure monitor for the transmission of non-invasive blood pressure values to a central station or a multi-disclosure and information system.

We are also a world leader in ambulatory blood pressure monitoring, which is a routine procedure in many European countries and is increasingly being used in the United States. Many physicians are using ambulatory blood pressure monitoring to detect “white coat” hypertension, a condition in which people experience elevated blood pressure in the doctor’s office but not in their daily lives. Hypertension affects approximately 50 million Americans and is particularly prevalent in the Medicare population. Ambulatory blood pressure monitoring is also used to adjust drug therapies for hypertensive patients. It is estimated that as many as 20% of the persons diagnosed with hypertension based on blood pressure measurements taken in their physicians’ offices are not actually hypertensive. Ambulatory blood pressure monitoring helps improve diagnostic accuracy and minimize the associated costs of treatment.

Our medical monitoring and imaging systems group also manufactures and distributes the “DTX-200”, a dual energy x-ray forearm densitometer, which is used to diagnose osteoporosis as well as to provide follow-up bone density measurements and the “DTU-One”, a calcaneus ultrasound scanner. The “DTU-One” is the first commercially available ultrasound scanner using imaging capability for the diagnosis of osteoporosis.

We develop next-generation pulse oximetry instruments and compatible pulse oximetry sensors under the “Dolphin One” product line. “Dolphin One” products include the “Voyager”, “Dolphin 2100” and “Dolphin 2150”. The Voyager is the first personal data assistant-based pulse oximetry product on the market. Our medical monitoring and imaging systems group also manufactures and distributes, under the “Dolphin 2000”, “Aristo” and “NuCat” product lines, sensors that are compatible with products made by other manufacturers of pulse oximetry technologies.

Finally, we believe that a substantial market exists for disposable supplies such as patient electrodes, specialty graph paper, sensors and connecting lead wires that are used with medical devices. As a result, we sell a broad line of such supplies as an adjunct to our medical device sales. In most cases, these products are obtained from original equipment manufacturers and are manufactured to our specifications.

The following table sets forth certain information related to the standard medical products we currently offer:

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Optoelectronic Devices and Value-Added Subsystems.    Optoelectronic devices generally consist of both active and passive components. Active components sense light of varying wavelengths and convert the light detected into electronic signals, whereas passive components amplify, separate or reflect light. The active components we manufacture consist of silicon, Gallium Arsenide, and Indium Gallium Arsenide photodetectors. Passive components include lenses, prisms, filters, mirrors and other precision optical products that are used by us in the manufacture of our optoelectronic products or are sold to others for use in telescopes, laser printers, copiers, microscopes and other detection and vision equipment. The devices we manufacture are both standard products and products customized for specific applications and are offered either as components or as subsystems.

In addition to the manufacture of standard and original equipment manufacturer products, we also specialize in designing and manufacturing customized optoelectronic devices and value-added 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 our optoelectronic devices) to complete end-products (for example, medical pulse oximeter probes that we manufacture and package on behalf of an original equipment manufacturer customer and then ship directly to the customer or the customer’s distributors). We manufacture subsystems for a variety of applications, such as fiber optics, 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 drives, and detection subsystems for submarines.

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We have recently developed two-dimensional back-illuminated detector technology for security, medical, and other industrial applications. This technology overcomes the limitations of conventional detectors by providing finer detector pitch density. We expect that this technology will be used in high-resolution multi-slice CT scanners and other applications requiring improved image resolution.

Markets, Customers and Applications

Security and Inspection Products.    Since entering the security and inspection products market in 1993, we have shipped over 10,000 x-ray systems and over 40,000 metal detectors to over 75 countries. The following is a representative list of certain customers and/or installations that have purchased our security and inspection products:

The market for most security and inspection products developed in response to civilian airline hijackings. Consequently, a significant portion of our security and inspection products was sold and continues to be sold for use at airports. Recently, however, our security and inspection products have been used for security purposes at locations in addition to airports, such as courthouses, office buildings, mailrooms, schools, prisons and high-profile locations such as Buckingham Palace, the Kremlin, and the Vatican. In addition, our security and inspection products are increasingly being used for non-security purposes, such as for cargo inspection to detect narcotics and contraband and to verify manifests, prevention of pilferage at semiconductor manufacturing facilities, quality assurance, and the detection of gold and currency. The September 11, 2001 terrorist attacks on the World Trade Center and the Pentagon using hijacked airliners likely will continue to cause increasing levels of airport security measures, which have resulted in an increase in sales of our security and inspection products as compared to previous levels.

In September 1998, we entered into an agreement with what was then known as the Federal Aviation Administration, now the Transportation Security Administration, for advanced contraband detection systems with threat image projection features. The systems began to ship to Category X airports (designated due to their high security priority) in the United States during fiscal year 1999. Systems were shipped each year since fiscal year 2000 and will continue to be shipped during fiscal year 2005. In addition, the Transportation Security Administration ordered Rapiscan shoe scanning x-ray technology to supplement airport checkpoint screening.

In April 2000, the U.S. Government awarded us a contract to provide x-ray screening systems at selected airports throughout the United States. Under the contract, the U.S. Government has the right to purchase from us

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up to 800 systems, for which the aggregate purchase price would be approximately $40 million. In fiscal years 2001 through 2004 our installed-base totaled approximately 750 systems under this contract. We expect to ship additional systems during fiscal year 2005.

Since 2001, we have completed the delivery of fixed site, relocatable, or mobile cargo inspection systems to governments and government agencies in Hong Kong, Malaysia, Romania, South Korea, Taiwan, and other locations.

Medical Monitoring and Imaging Systems.    Our medical monitoring and imaging systems are manufactured and distributed globally for use in critical care, emergency and perioperative areas within hospitals. We also provide wired and wireless networks and clinical information access solutions, ambulatory blood pressure monitors and medical data services. Our Spacelabs Medical subsidiary has an installed base of approximately 100,000 patient monitoring units and 30,000 ambulatory blood pressure monitors worldwide. Our medical monitoring and imaging systems business has distributors in over 70 countries and subsidiary or branch offices in the United States and internationally in Austria, Canada, Finland, France, Germany, Greece, India, Italy, Singapore, Malaysia, and the United Kingdom.

In March 2004, our medical monitoring and imaging systems group was awarded a contract to supply over 100 monitors to the Chi Mei Liu-Ying hospital in Liu-Ying, Taiwan. Chi Mei Liu-Ying is a branch hospital located approximately 60 kilometers from Chi Mei main hospital. The contract was awarded to us, in part, because our monitoring systems allowed these two hospitals to easily share data and information between their sites.

In June of 2004 we were awarded a contract to become the major supplier of patient monitoring equipment for the Shanghai SARS Center in Shanghai, China. The center is a new, approximately 500-bed facility, that will serve as a reference standard for communicable disease control hospitals engaged in the treatment and monitoring of SARS (Severe Acute Respiratory Syndrome) cases in China.

Also in June 2004, Spartanburg Regional Medical Center, located in Spartanburg, South Carolina, agreed to standardize its institution-wide patient monitoring equipment with our monitors as part of its ongoing commitment to patient care and safety. The new monitors, which can be customized for each patient’s needs, will enable clinicians to securely access live patient data when and where they need it. This means clinicians will be able to obtain a complete patient profile, including other information available through the central information system such as lab and radiology reports, and medical records, from multiple sources without leaving the patient.

The following is a representative list of certain customers and/or installations that have purchased our medical monitoring and imaging products:

Optoelectronic Devices and Value-Added Subsystems.    Our optoelectronic devices and value-added subsystems are used in a broad range of products by a variety of customers. The following table illustrates the

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major product categories for which we provide optoelectronic products and certain representative customers in each category. We expect that the list of product categories, the amount of business derived from each such product category, and the composition of our major customers will vary from period to period.

Marketing, Sales and Service

We market and sell our security and inspection products worldwide through a direct sales and marketing staff of approximately 60 employees located in the United States, Canada, Finland, Malaysia, Singapore, and the United Kingdom, in addition to a global network of independent sales representatives. This sales staff is supported by a service organization of approximately 90 persons located primarily in the United States, Finland, Malaysia, and the United Kingdom and a global network of independent distributors. We also support 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.

We market and sell and our medical monitoring and imaging products through a direct sales and marketing staff of approximately 225 sales personnel and 170 service personnel worldwide located in the United States, Austria, Canada, Finland, France, Germany, Greece, Italy, and Singapore, in addition to a global network of

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independent distributors. We also support these sales and customer service efforts by providing operator in service training, software updates and upgrades, and service training for customer biomedical staff and distributors.

We market and sell our optoelectronic devices and value-added subsystems, through both a direct sales and marketing staff of approximately 25 employees located in the United States, Singapore, Malaysia, and Norway and indirectly through a global network of independent sales representatives and distributors. Most of our in-house sales staff is based in the United States while most of our independent sales representatives and distributors are located abroad. This sales staff 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.

We consider our maintenance service operations to be an important element of our business. After the expiration of our standard product warranty periods, we are sometimes engaged by our customers to provide maintenance services for our security and inspection products through annual maintenance contracts. We provide a variety of service and support options for our medical monitoring and imaging systems customers, ranging from complete on-site repair and maintenance service and telephone support to parts exchange programs for customers with the internal expertise to perform a portion of their own service needs. We believe that our international maintenance service capabilities allow us to be competitive in selling our security and inspection products as well as our medical monitoring and imaging products. Furthermore, we believe that as our installed base of both our security and inspection and medical monitoring and imaging products increase, revenues generated from such annual maintenance service contracts and from the sale of replacement parts will increase.

Research and Development

Our security and inspection systems are designed at our facilities in Hawthorne, Santa Clara, and Sunnyvale, California and internationally in Finland, Malaysia, India and the United Kingdom. These products include mechanical, electrical, electronic, digital electronic and software subsystems, which are all designed by us. In addition to product design, we provide system integration services to integrate our products into turnkey systems at the customer site. We support cooperative research projects with government agencies and, on occasion, provide contract research for our customers and government agencies.

Our medical monitoring and imaging systems are designed and engineered at our facilities in Issaquah, Washington while our medical diagnostic and imaging systems are designed and engineered at our facilities in Hawthorne, California. Such systems include mechanical, electrical, digital electronic and software subsystems, all of which are designed by us. We are also currently involved, both in the U.S. and abroad, in several research projects aimed at improving our medical systems and at expanding our current product line.

Our optoelectronic devices and value-added subsystems are primarily designed and engineered at our facilities in Camarillo, Hawthorne, Newbury Park, and Upland, California, Orlando, Florida, and Ocean Springs, Mississippi and internationally in India, Malaysia, and Norway. We engineer and manufacture subsystems to solve the specific application needs of our original equipment manufacturer customers. In addition, we offer entire subsystem design and manufacturing solutions. We consider our engineering personnel to be an important extension of our core sales and marketing efforts.

In addition to close collaboration with our customers in the design and development of our current products, we maintain an active program for the development and introduction of new products, enhancements and improvements to our existing products, including the implementation of new applications of our technology. We seek to further enhance our research and development program and consider such program to be an important element of our business and operations. As of June 30, 2003, in addition to the engineers that we employed in

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manufacturing, process design and applications development, we engaged approximately 255 full-time engineers, technicians and support staff in research and development. During fiscal year 2002, our research and development expenses were $6.4 million, in 2003 they were $8.9 million, in 2004 they were $14.6 million. The increase in 2004 reflects increased research and development spending for our security and inspection side of our business and inclusion of research and development expenses of our recent acquisitions of Spacelabs Medical and OSI Laserscan. In order to fulfill our strategy of enhancing our security and inspection product lines and of improving the capabilities of our existing products, we intend to continue to invest in our research and development efforts in the future.

Manufacturing and Materials Management

We currently have manufacturing facilities for our security and inspection systems in Hawthorne, Santa Clara, and Sunnyvale California and internationally in Canada, Finland, Malaysia, Singapore, and the United Kingdom. We have manufacturing facilities for our medical monitoring and imaging systems in Hawthorne, California and Issaquah, Washington and internationally in India, Malaysia, and Singapore. We have manufacturing facilities for our optoelectronic devices and value-added subsystems in Camarillo, Hawthorne, Newbury Park, and Upland, California and Ocean Springs, Mississippi and internationally in Malaysia, Singapore, and Norway. Our principal manufacturing facility is in Hawthorne, California. However, most of our high volume, labor intensive manufacturing and assembly is performed at our facility in Malaysia. Since most of our customers currently are located in Asia, Europe and the United States, our ability to assemble products in these markets and provide follow-on service from offices located in these regions is an important component of our global strategy.

Our global manufacturing organization has expertise in optoelectronic, microelectronic, and integrated value-added assemblies for commercial, medical, aerospace, and defense industry applications. Our manufacturing includes silicon wafer processing and fabrication, optoelectronic device assembly and screening, thin and thick film microelectronic hybrid assemblies, and surface mounted and thru-hole PCB electronic assemblies, and value-added services including complete turn-key and box-build manufacturing. We outsource certain manufacturing operations including our sheet metal fabrication and certain plastic components. The manufacturing process for components and subsystems consists of manual tasks performed by skilled and semi-skilled workers as well as automated tasks.

The principal raw materials and subcomponents used in producing our security and inspection systems consist primarily of x-ray generators, linear accelerators, detectors, data acquisition and computing devices, conveyor systems and video monitors. Substantially all of the optoelectronic devices, subsystems, and circuit card assemblies used in our inspection and detection systems are manufactured in-house. The x-ray generators used in our passenger and baggage screening inspection and detection systems are also manufactured in-house, while the x-ray generators and linear accelerators used in our large cargo screening inspection and detection systems are purchased from unaffiliated third party providers. We purchase the metal enclosures of the x-ray systems, x-ray tubes, computer hardware and certain standard mechanical parts from unaffiliated third party providers.

The principal raw materials and subcomponents used in producing our medical monitoring and imaging systems consist of printed circuit boards, housings, cables, filters and packaging materials. We purchase certain devices, including computers, peripheral accessories and remote displays from unaffiliated third party providers.

The principal raw materials and subcomponents used in producing our optoelectronic devices and value-added subsystems consist of silicon wafers, ceramics, electronic subcomponents, light emitting diodes, phototransistors, printed circuit boards, headers and caps, housings, cables, filters and packaging materials. The silicon-based optoelectronic devices manufactured by us are critical components in most of our subsystems. Since 1987, we have purchased substantially all of the silicon wafers we use to manufacture our optoelectronic devices from Wacker Siltronic Corp.

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Although to date none of our groups has experienced any significant shortages or material delays in obtaining any of its raw materials or subcomponents, there can be no assurance that they will not face such shortages or delays in one or more materials in the future. For cost, quality control and efficiency reasons, we generally purchase raw materials and subcomponents only from single vendors with whom we have ongoing relationships. We do, however, qualify second sources for most of our raw materials and critical components, or have identified alternate sources of supply. We purchase the materials pursuant to purchase orders placed from time to time in the ordinary course of business. Although to date we have not experienced any significant shortages or material delays in obtaining any of our raw materials or subcomponents, there can be no assurance that we will not face such shortages or delays in one or more of these materials in the future.

Patents, Trademarks, and Licenses

Trademarks. We have used, registered, and applied to register certain trademarks and service marks to distinguish our products, technologies and services from those of our competitors in the U.S. and in foreign countries. We enforce our trademark, service mark, and trade name rights in the U.S. and abroad.

Patents. We hold a number of U.S. and foreign patents relating to various aspects of our security and inspection products, medical imaging and monitoring systems, and optoelectronic devices and subsystems. Our current patents will expire at various times between 2006 and 2021. There can be no assurance that pending patent applications or other applications that may be filed will result in issued patents, or that any issued patents will survive challenges to their validity. Although we believe that our patents have value, there can be no assurance that our patents, or any additional patents that may be issued in the future, will provide meaningful protection from competition.

Licenses. In June 1999, as part of an arbitration settlement, we entered into a fully paid-up, nonexclusive patent license agreement with PerkinElmer, Inc., formerly known as EG&G, Inc. (“EG&G”) for U.S. Patent No. 4,366,382. The patent expired in September 2000. Subsequent to the end of the patent term, we have been free to use the technology without patent or license restriction. Under the license, for which we paid $450,000, we were 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.

In December 1998, as part of the settlement of certain litigation, we and Lunar Corporation (“Lunar”) entered into a license agreement pursuant to which we 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. Prior to our 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. We make royalty payments on sales of the licensed products.

We believe that our patents, trademarks, and licenses are important to our business. The loss of some of our patents, trademarks, or licenses might have a negative impact; however, we operate in a competitive environment with a known customer base and rely mainly on providing value for money with quality products and services to ensure continuing business.

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Environmental Regulations

We are 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 our products. Under such laws, we may become liable for the costs of removal or remediation of certain hazardous substances that have been or are being released on or in our facilities or that have been or are being disposed of off site as waste. Such laws may impose liability without regard to whether we knew of, or caused, the release of such hazardous substances. We have conducted Phase I environmental site assessments for each of our properties in the United States at which we manufacture products. The purpose of each such report is to identify, as of the date of such report, potential sources of contamination of the property from past and present activities or from nearby operations. In certain cases, we have conducted further environmental assessments consisting of soil and groundwater testing and other investigations deemed appropriate by independent environmental consultants. We believe that we are currently in compliance with all material environmental regulations in connection with our manufacturing operations, and that we have obtained all material environmental permits necessary to conduct our business. The amount of hazardous substances and wastes produced and generated by us may increase in the future depending on changes in our operations. Any failure by us to comply with present or future regulations could subject us 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 our business, financial condition and results of operations.

During one such investigation, we discovered soil and groundwater contamination at our Hawthorne, California facility. We filed the requisite reports concerning this problem with the appropriate environmental authorities in fiscal year 2001. We have not yet received any response to such reports, and no agency action or litigation is presently pending or threatened. We also have notified the prior owners of the facility and the present owners and tenants of adjacent properties concerning the problem and have requested from such parties agreements to toll of the statute of limitations with respect to actions against such parties with respect to the contamination in order that we may focus our attention on resolution of the contamination problem. Our site was previously used for semiconductor manufacturing similar to that presently conducted on the site by us, and it is not presently known who is responsible for the contamination and the remediation. The groundwater contamination is a known regional problem, not limited to our premises or our immediate surroundings.

We recently were informed of soil and groundwater remediation efforts at a facility that our Ferson Optics subsidiary previously leased in Ocean Springs, Mississippi. Ferson Optics occupied the facility until October 2003. We believe that the owner and previous occupants of the facility have primary responsibility for such remediation and have an agreement with the facility’s owner under which the owner is responsible for remediation of pre-existing conditions. However, we are unable at this time to ascertain whether Ferson Optics bears any exposure for remediation costs under statutes or regulations.

Competition

The markets in which we operate are highly competitive and characterized by evolving customer needs and rapid technological change. We compete with a number of other manufacturers, some of which have significantly greater financial, technical and marketing resources than we have. 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 may devote greater resources to the development, promotion and sale of their products than we do. There can be no assurance that we will be able to compete successfully against any current or future competitors in the security and inspection systems, medical imaging and monitoring, or optoelectronic devices and subsystems markets or, that future competitive pressures will not materially and adversely affect our business, financial conditions and results of operations.

In the security and inspection market, competition is based primarily on such factors as product performance, functionality and quality, the overall cost effectiveness of the system, prior customer relationships,

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technological capabilities of the products, price, local market presence, and breadth of sales and service organization. We believe that our principal competitors in the market for security and inspection products are the Security and Detection Systems division of L-3 Communications Corporation, the Smiths Detection division of Smiths Group plc, American Science and Engineering, Inc., Science Applications International Corporation, Control Screening L.L.C., CEIA SpA, Garrett Electronics, Inc., and Nuctech Company Limited. Competition could result in price reductions, reduced margins, and loss of our market share. In the airline and airport security and inspection market, particularly in the upgrade and replacement market, we also compete for potential customers based on existing relationships between our competitors and the customers. Certain of our competitors have been manufacturing inspection systems since the 1980s and have established strong relationships with airlines and airport authorities. We believe that the image quality and resolution of certain of our security and inspection products is superior to the image quality offered by most of our competitors’ x-ray based inspection products. Additionally, our true multi-zone metal detection technology provides the ability to detect small metallic objects and offer higher levels of discrimination in weapons-screening applications. Although we also have established relationships with a number of airport and airline customers, we can provide no assurance that we will be able to successfully compete in the future with existing competitors or with new entrants. In the large cargo inspection systems market, we compete for potential customers based on price, performance and the ability to design both standard and customized products. Several of our competitors have operated in this area for longer than we have. However, due to our recent successes in designing and delivering high-energy x-ray systems, we believe we have demonstrated our ability to compete effectively. Additionally, although our competitors in the large cargo inspection market each offer products in competition with one or more of our products, our ability to supply high-energy x-ray, gamma-ray, pulsed fast neutron analysis, and thermal neutron analysis systems means that we offer among the widest array of solutions available from a single supplier.

In the patient monitoring and imaging systems market, competition is also based on a variety of factors including product performance, functionality, value, and breadth of sales and service organization. We believe that our principal competitors in the market for patient monitoring and imaging systems are Criticare Systems, Inc., Philips Medical Systems, GE Medical Systems, Drägerwerk AG, Datascope Corp., Nihon Kohden Corporation and Nellcor, a division of Tyco International, Inc. Competition could result in price reductions, reduced margins, and loss of our market share. We believe that our patient monitoring products are easier to use than the products of many of our competitors because we offer a consistent user interface throughout many of our product lines. Furthermore, the monitors of our Spacelabs Medical subsidiary are backward/forward compatible, meaning that new Spacelabs Medical monitors can interface with existing Spacelabs Medical monitor models, thus offering investment protection to our customers. While some of our competitors are just now introducing portal technology, which allows remote access to data from the bedside monitor, central station or other point of care, we believe that our version is superior in bringing instant access to labs, radiology and charting at the point of care. Although we have established relationships with a number of large hospitals, there can be no assurance that we will be able to successfully compete in the future with existing competitors or with new entrants.

In the optoelectronic devices and subsystems market, competition for optoelectronic devices and value-added 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 production. We believe that our major competitors in the optoelectronic device and subsystem market are PerkinElmer, Inc. and Hamamatsu Corporation. Because we specialize in custom subsystems requiring a high degree of engineering expertise, we believe that we generally do not compete to any significant degree with any other large United States, European or Asian manufacturers of standard optoelectronic components.

Backlog

We measure our 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. We typically ship our security and

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inspection products, optoelectronic devices and value-added subsystems, and medical imaging and monitoring systems within one to several 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 may require several months to several years lead-time. The only significant shipping delays we have experienced are with large cargo scanners. Such delays for many reasons, including: (i) additional time necessary to conduct large cargo system inspections at the factory before shipment; (ii) the customer’s need to engage in timely special site preparation to accommodate such a scanner, over which we have no control or responsibility; (iii) additional fine tuning of such scanners once they are installed; (iv) design or specification changes by the customer; and (v) delays originating from other contractors on the project.

At June 30, 2004, our backlog totaled approximately $84.9 million, compared to approximately $53.0 million at June 30, 2003 and approximately $89.6 million at June 30, 2002. The increase in the backlog from June 30, 2003 to June 30, 2004 is primarily due to the acquisition of Spacelabs Medical in March 2004. Excluding Spacelabs Medical, the backlog as of June 30, 2004 was $63.0 million. We expect to ship most of our backlog as of June 30, 2004, during the fiscal year ending June 30, 2005. Sales orders underlying our backlog are firm orders. Any failure by us to meet an agreed-upon schedule could lead to the cancellation of the related order. Moreover, from time to time, we may agree to permit the cancellation of an order on a negotiated basis. 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 our revenues for any future period and cannot be considered a meaningful indicator of our performance on an annual or quarterly basis.

Employees

As of June 30, 2004, we employed approximately 2,205 people, of whom 1,070 were employed in manufacturing, 255 were employed in research and development, 250 were employed in finance and administration, 310 were employed in sales and marketing, and 320 were employed in our service organization. Of the total employees, approximately 1,470 were employed in the United States and Canada, 250 were employed in Europe, and 485 were employed in Asia. Twelve employees of our Advanced Microelectronics AS subsidiary in Norway and 11 of our Metorex Security Products, Oy subsidiary employees in Finland are union members and have collective bargaining rights; none of our other employees are unionized. We have never experienced a work stoppage or strike, and management believes that its relations with employees are good.

Available Information

Our Internet address is: http://www.osi-systems.com. We make available, free of charge through our Internet website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, and reports filed pursuant to Section 16 of the Exchange Act. We do so as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the Securities and Exchange Commission.

We own three buildings (approximately 88,000 square feet), which comprise our principal facility in Hawthorne, California. We use this facility for manufacturing, engineering, sales and marketing.

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As of June 30, 2004, we leased all of our other facilities. The following table lists our principal physical properties:

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We believe that our facilities are in good condition and are adequate to support our operations for the foreseeable future. We currently anticipate that we 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 we were not able to renew one or more of the leases, we believe that suitable substitute space is available to relocate any of the facilities. Accordingly, we do not believe that our failure to renew any of the leases that are scheduled to expire in the next few years will have a material adverse effect on our operations.

In March 2000, certain individuals filed a class action suit in Los Angeles Superior Court naming our Rapiscan Security Products (U.S.A.), Inc. (“Rapiscan”) subsidiary and others as defendants. The named plaintiffs are the wives of men incarcerated in California prisons. The plaintiffs allege that while attempting to visit their husbands in prison, as a condition to such visits, prison personnel have subjected them, and other members of the putative class, to scans by Rapiscan’s Secure 1000 product, as well as strip searches, and body cavity searches, all of which plaintiffs allege to have been illegal searches and have caused them emotional injuries. The other defendants in the action include the State of California, the California Department of Corrections, its Director and other Department of Corrections personnel. The complaint asserts, among other things, that these types of searches are illegal and intrusive and have caused emotional injury to the plaintiffs. In addition to alleging that we are responsible for illegal searches conducted by prison personnel, the complaint alleges that we were negligent, that the Secure 1000 product is defective in design and manufacture, that we have failed to properly train the prison personnel in using the Secure 1000 product, that we have failed to warn subjects that they might be subjected to illegal searches using the Secure 1000 product, and that the scans are more intrusive than manual searches. Plaintiffs seek general, special and punitive damages in unspecified amounts and declaratory relief against illegal searches. We believe that these claims against us have no merit and we intend to vigorously defend this suit.

In November 2002, L-3 Communications Corporation (“L-3”) brought suit against us for a declaratory judgment that L-3 had not breached its obligations to us concerning the acquisition of PerkinElmer, Inc’s Security Detection Systems Business. In February 2003, we answered and asserted counterclaims against L-3 for, among other things, fraud, breach of fiduciary duty, breach of contract and failure to negotiate in good faith. In March 2003, L-3 amended its complaint and asserted claims against us for breach of contract, failure to negotiate in good faith, and tortious interference. In its amended complaint, L-3 requested both a declaratory judgment that it had fulfilled its obligations and an award of damages for an unspecified amount. These actions are pending in the District Court for the Southern District of New York.

During 2003 and 2004, we were informed that Science Applications International Corporation (“SAIC”) had made statements to prospective buyers of our gamma ray mobile detection system product (“GaRDS”) that GaRDS infringed upon unspecified SAIC patents. In April 2004, we received a letter from SAIC specifying a patent upon which SAIC claimed the GaRDS infringed. Contrary to SAIC’s claim, the patent cited by SAIC actually distinguished the technology used in GaRDS as a different, pre-existing technology. We therefore filed a lawsuit in the U.S. District Court, Central District of California for declaratory judgment. SAIC has since counter-claimed for patent infringement, citing the same patent, and unfair competition.

In March 2004, certain individuals named us and our subsidiary, Spacelabs Medical, as well as a hospital located in Bexar County, Texas, in a petition claiming that the individuals suffered injuries in March 2003 caused, in part, by a defective monitoring system manufactured by Spacelabs Medical. The petition was filed in the 285^th Judicial District Court in Bexar County, Texas. The amount of the claim has not yet been specified.

In April 2004, certain individuals named our subsidiary, Spacelabs Medical, as well as several other defendants, in a petition that alleges, among other things, that a product possibly manufactured by Spacelabs Medical failed to properly monitor a hospital patient thereby contributing to the patient’s death in November 2001. The petition was filed in the 21^st Judicial District Court, Parish of Tangipahoa, Louisiana. The amount of the claim has not yet been specified.

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In August 2004, the former president of our subsidiary, Spacelabs Medical, submitted an arbitration claim alleging breach of a retention and severance agreement seeking approximately $1.5 million and punitive damages. The claim is currently pending before the CPR Institute for Dispute Resolution in Chicago, Illinois.

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

None.

PART II

Stock Market and Other Information

Our Common Stock is traded on the NASDAQ National Market under the symbol “OSIS”.

The following table sets forth the high and low sale prices of a share of our Common Stock as reported by the NASDAQ National Market on a quarterly basis for the fiscal years ended June 30, 2003 and June 30, 2004. The prices shown reflect inter-dealer prices, without retail markup, markdown or commission and may not necessarily represent actual transactions.

As of September 9, 2004 there were approximately 119 holders of record of our Common Stock. This number does not include beneficial owners holding shares through nominees or in “street” name.

Dividend Policy

We have not paid any cash dividends since the consummation of our initial public offering in 1997 and anticipate that we will retain any available funds for use in the operation of our business. We do not currently intend to pay any cash dividends in the foreseeable future. Our Board of Directors will determine the payment of future cash dividends, if any. Certain of our current bank credit facilities restrict the payment of cash dividends and future borrowing may contain similar restrictions.

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Equity Compensation Plans

The following table provides information concerning our equity compensation plans as of June 30, 2004.

Recent Sales of Unregistered Securities

In June 2004, we issued and sold an aggregate of 1,500,000 shares of our Common Stock in a private placement to institutional investors for an aggregate sales price of $32.3 million. After agent’s commissions, and expenses, net proceeds to us were $31.0 million. As part of the transaction, we issued to the investors warrants to purchase 337,500 additional shares of our Common Stock at an exercise price of $27.73 per share exercisable at any time in full or part no later than June 1, 2011. The fair value of the warrants was estimated at $6,152,000 using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected option life of seven years, dividend yield of 0%, volatility of 98% and a risk-free interest rate of 4.45%. The fair value of these warrants is included with the proceeds from the private placement under the common shares balance as of June 30, 2004. As part of the transaction, we agreed to file a registration statement on Form S-3 with the SEC.

The following table sets forth our selected consolidated financial data as of and for each of the five fiscal years ended June 30, 2004 and is derived from our Consolidated Financial Statements. The consolidated financial statements as of June 30, 2003 and June 30, 2004, and for each of the years in the three-year period ended June 30, 2004, and the report of independent registered public accounting firm thereon, are included elsewhere in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K.

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Forward-looking Statements.

The following discussion should be read in conjunction with our 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 our business strategy, objectives, and future financial position, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and involve risks and uncertainties. These forward-looking statements may be identified by the use of forward-looking terms such as “anticipate,” “believe,” “expect,” “may,” “should,” or “will,” or by discussions of strategy that involve risks and uncertainties. These forward-looking statements include assertions regarding anticipated future revenues, sales, operations, demand, competition, capital expenditures, credit arrangements, and other claims regarding matters that are not historical facts, involve predictions which are based upon a number of future conditions that ultimately may prove to be inaccurate.

Factors that may cause or contribute to such differences include those discussed in Risk Factors, Business, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as elsewhere in this Annual Report on Form 10-K. These factors, of course, do not include all factors that might affect our business and financial condition.

Although we believe that the assumptions upon which our forward-looking statements are based are reasonable, there can be no assurance that such assumptions will prove to be accurate and actual results could differ materially from those expressed in or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, changes in laws and regulations, accounting standards, taxation requirements and environmental laws in the United States and other countries; foreign currency fluctuations; market and general economic factors; competitive factors including other companies’

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pricing and marketing efforts; fluctuations in the cost and availability of raw materials and components and the ability to maintain favorable supplier arrangements and relationships; risks of obsolescence due to shifts in market demand; risks in the marketplace associated with new product introductions; our ability to achieve sales and earnings forecasts which are based on assumptions about sales volume and other items; our ability to integrate acquisitions and joint ventures into our existing operations and the availability of new acquisition and joint venture opportunities; the success of divestitures and other business combinations; our ability to achieve cost savings objectives; the impact of unforeseen economic and political changes in markets where we compete; our ability to maintain profit margins; 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 us 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. We undertake no obligation other than as may be required under securities laws to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Overview

We are a vertically integrated, worldwide provider of security and inspection systems, medical monitoring and imaging systems, and optoelectronic devices and value-added subsystems.

Our company was incorporated in 1987. Initially, we manufactured optoelectronic devices and value-added subsystems for customers in several industries, including makers of security and inspection systems and medical monitoring and imaging systems. Through acquisitions we have entered the security and medical products markets because we believe that vertical integration make us more competitive in these areas.

We design, manufacture and market security and inspection systems worldwide to end users under trade names including “Rapiscan,” “Ancore,” “PNFA,” “Eagle,” “Metor,” and “Secure.” These products are used to inspect people, baggage, cargo, vehicles and other objects for weapons, explosives, drugs and other contraband. These systems are also used for the safe, accurate and efficient verification of cargo manifests for the purpose of assessing duties and monitoring the export and import of controlled materials.

In the medical field, we design, develop, manufacture, and market patient monitoring products, network connectivity solutions, ambulatory blood pressure monitors, and related services under trade names including “Spacelabs,” “Ultracare,” and “Ultraview.” We also design, develop, manufacture and market arterial hemoglobin saturation monitors and sensors, including hand-held and wireless monitoring tools under trade names including “Dolphin” and “NuCat,” and peripheral bone densitometers under trade names including “DTX-200” and “DTU-One,” which are used in the early stage detection or diagnosis of osteoporosis.

Our optoelectronic devices and value-added subsystems are used in a broad range of applications, including aerospace and defense electronics, security and inspection systems, medical diagnostics, fiber optics, telecommunications, gaming, office automation, computer peripherals and industrial automation. We design and manufacture optoelectronic devices and value-added subsystems for others through original equipment manufacturer arrangements, as well as for our security and medical equipment businesses.

In fiscal year 2004, revenues from the sale of security and inspection products amounted to $117.8 million, or approximately 48% of our revenues, revenues from the sale of medical monitoring and imaging systems were $ 60.7 million or 24% of our revenues, while revenues from the sale of optoelectronic devices and value-added subsystems amounted to $68.6 million, or approximately 28% of our revenues.

We report segment information by geographic area. We are vertically integrated and our subsidiaries share common resources and facilities. Therefore, with the exception of external revenues, discrete financial information has not historically been available by product line at all operating locations. As a result of the changes in our structure and operations which have occurred, beginning in the first quarter of fiscal year 2005 we

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will have discrete financial information available by product line for all operating locations and therefore will begin reporting our segment information by product line. Further information concerning reporting segments is available in Note 14 to our financial statements.

Our security and inspection systems business continues to grow. In fiscal year 2004, this growth occurred despite the completion during the first quarter of our contract to manufacture pre-scanners and related electronics for Invision Technologies, Inc.’s CTX products. The Invision Technologies, Inc. contract contributed approximately $22 million to our sales in fiscal year 2003 (including approximately $19.6 million to our security and inspection side of our business) compared to approximately $300,000 in fiscal year 2004. We substantially offset this decrease in revenues with growth in both domestic and international sales of our conventional parcel security and our cargo inspection products.

As part of our security and inspection systems growth strategy, we continue to invest in acquisitions to broaden our technology and product portfolio. In January 2004, we completed the acquisition of Advanced Research & Applications Corp. (“ARACOR”), a privately held company based in Sunnyvale, California for approximately $17.6 million (net of cash acquired). During seven years following the close, contingent consideration is payable to ARACOR’s former shareholders based on ARACOR’s net revenues, provided certain requirements are met. The contingent consideration is capped at $30.0 million. ARACOR’s “Eagle” product is a large, x-ray-based scanning system for inspecting containers at busy seaports. The Eagle was designed in partnership with U.S. Customs and U.S. Customs has issued a blanket purchase order for up to $40 million over the next 5 years. Including options exercised by U.S. Customs as well as other orders, ARACOR has to date received orders totaling approximately $14 million for the Eagle.

In December 2003, we acquired substantially all the assets of J&D Engineering (UK), Limited, a company registered in England and Wales for approximately $820,000. This acquisition has provided us with the ability to design and manufacture metal frames for our x-ray machines and other products.

In June 2004, we increased our investment in CXR Limited, a U.K. based research and development venture that develops real time tomography systems, to approximately $3.2 million (including a $1.1 million loan). As a result of our additional equity investment, we now own approximately 75% of CXR Limited.

As a result of these and other developments, we continue to believe that our security and inspection systems business offers a broad product line in the conventional and cargo security business, including x-ray, gamma-ray and neutron technologies and hybrid products built on these technologies and we continue to invest in our research and development for our security and inspection business.

In March 2004, we significantly enhanced our medical monitoring and imaging systems activities through the acquisition of Spacelabs Medical Inc. (“Spacelabs Medical”), a global manufacturer and distributor of patient monitoring and clinical information systems for use primarily in hospitals. Spacelabs Medical’s principal products encompass patient monitoring systems, network and connectivity solutions, ambulatory blood pressure monitors and medical data services. We completed the acquisition of Spacelabs Medical from Instrumentarium Corporation for approximately $47.9 million in cash (net of cash acquired), including acquisition costs. The final purchase price is subject to certain working capital adjustments. In June 2004, we notified Instrumentarium Corporation’s parent, GE Medical Systems, of a working capital and retention bonus adjustments resulting in what we believe to be a downward adjustment of the purchase price in the amount of $25.9 million. In September 2004, GE Medical Systems responded that it believes the amount of the downward adjustment to be approximately $7.8 million. No amounts have been recorded in the financial statements in relation to the expected reduction in the purchase price. The amount of the final adjustment will be resolved by way of a process established in the purchase agreement. Therefore, the final purchase price and the purchase price allocation may differ significantly from the preliminary estimates of these amounts.

Our other medical monitoring and imaging products are experiencing sales growth, especially our pulse oximetry products which compete directly with the products of Nellcor. In fiscal year 2004, we granted Conmed Corporation exclusive marketing and distribution rights to certain Dolphin Medical products in the

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United States and other territories for a period of five years. These products are receiving considerable interest as we have begun to introduce them in the United States and other countries worldwide where key Nellcor patents have recently expired. We also sold a 10% interest in our Dolphin Medical subsidiary to Conmed Corporation and granted an option to Conmed Corporation to purchase the remaining shares of Dolphin Medical. We received proceeds of $2.0 million related to the sale of the 10% interest, the grant of the option, and the grant of marketing and distribution rights to Conmed Corporation.

Our optoelectronic devices and subsystems product sales have weakened in certain areas. The growth that did occur in this area of our business was due to strategic acquisitions. In August 2003, we purchased the military, laser-based training business of Schwartz Electro-Optics, Inc. for $3.7 million. We believe the products lines we acquired from this company, now sold by our newly-formed OSI Defense Systems, L.L.C. (“OSI Defense Systems”) subsidiary, complement the defense product lines of our existing RapiTec, Inc. (“RapiTec”) subsidiary. Both OSI Defense Systems and RapiTec develop, manufacture, market, and sell tactical engagement simulation systems, man-worn laser detectors, small arms transmitters, controller guns and a variety of targeting systems for the defense industry.

In October 2003, we acquired the assets of a manufacturing services company specializing in surface mount technology lines and PC board assembly operations for approximately $4.5 million. The business, now operating as OSI Electronics, Inc. (“OSI Electronics”), has begun to provide our optoelectronic devices and subsystems group with increased manufacturing capacity and technologies to support internal needs as well as to offer a broad manufacturing platform to our existing customers.

In November 2003, we acquired substantially all of the remaining assets from Schwartz Electro-Optics, Inc., for approximately $1.6 million. The acquired assets consist of a business that designs, manufactures, markets and sells laser-based systems used in traffic and toll management, precision agricultural management, and precision mapping and surveying. This business now operates under the name OSI Laserscan and offers, among other products, a unique, patented laser range finder technology, which is gaining acceptance by traffic and toll management authorities, as well as precision agricultural management, mapping, and survey technologies.

Overall as a company, we continue to move towards the consolidation of our various businesses. We do so in order to generate manufacturing, sales force, and administrative related efficiencies and to increase productivity. We also continue to invest in critical areas such as sales, marketing, and research and development. Our gross margin is dependent on our product mix. With the inclusion of Spacelabs Medical revenues, our gross margin as a percentage of revenues has increased; however, our operating expenses as a percentage of revenues have also increased as Spacelabs Medical has higher operating expenses as a percentage of revenues. Our gross margin as a percentage of revenues is also offset by the inclusion of the results of OSI Electronics, a manufacturing service company which operates in an area where gross margins are traditionally low.

We engage in significant international operations. We currently manufacture our security and inspection products at our facilities in Hawthorne, Santa Clara, Sunnyvale, California, and internationally in Canada, Finland, Malaysia, Singapore and the United Kingdom. Our medical monitoring and imaging systems are currently manufactured at our facilities in Hawthorne, California, and Issaquah, Washington and internationally in India, Malaysia, and Singapore. Our optoelectronic devices and value-added subsystems are manufactured in Camarillo, Hawthorne, Newbury Park, and Upland, California, Ocean Springs, Mississippi, and internationally in Malaysia, Norway, and Singapore. As of June 30, 2004 we marketed our products worldwide through approximately 310 sales and marketing employees located in more than a dozen countries, in addition to a global network of independent sales representatives. Revenues from shipments made outside of the United States accounted for 52% of revenues in fiscal year 2002, 51% of revenues in fiscal year 2003, and 41% of revenues in fiscal year 2004. Information regarding our operating income or loss and identifiable assets attributable to each of our geographic areas is set forth in Note 14 in our Consolidated Financial Statements.

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Related-Party Transactions

In 1994, we, together with an unrelated company, formed ECIL-Rapiscan Security Products Limited, a joint venture organized under the laws of India. We own a 36% interest in the joint venture, our chairman and chief executive officer owns a 10.5% interest, and the president of our security and inspection products group owns a 4.5% ownership interest. Our initial investment was $108,000. For the year ended June 30, 2002, our equity earnings in the joint venture amounted to $154,000, for the year ended June 30, 2003 they amounted to $249,000, and for the year ended June 30, 2004 they amounted to $317,000, and are included in selling, general, and administrative expenses. During the year ended June 30, 2001, we increased our initial investment by $39,000. Our ownership interest remained at 36% as all the shareholders increased their respective investments proportionately. We, our chairman and chief executive officer, and the president of our security and inspection products group collectively control less than 50% of the board of directors voting power in the joint venture. As a result, we account for the investment under the equity method of accounting. The joint venture was formed for the purpose of the manufacture, assembly, service, and testing of x-ray security and other products. Some of our subsidiaries are suppliers to the joint venture partner, which in turn manufactures and sells the resulting products utilizing technology received from the subsidiary. The joint venture agreement provides for technology transfers between us and the joint venture, subject to certain restrictions. During the year ended June 30, 2002, we earned a technical fee from the joint venture in the amount of $35,000. We did not earn any technical fee during the years ended June 30, 2003 and 2004, as the technical agreement has expired.

We contracted with entities owned by members of our board of directors to provide messenger service, auto rental and printing services. Included in cost of sales, selling, general and administrative expenses for the years ended June 30, 2002, 2003 and 2004 are approximately $107,000, $101,000 and $70,000 for messenger service and auto rental; and $100,000, $104,000 and $73,000 for printing services; and $14,000, $0, and $0 for professional services, respectively. We contracted during fiscal year 2002 for professional services of $14,000 from a firm that has a partner serving as a member of our Board of Directors. We have discontinued the contract for professional services from that firm.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States. Our preparation of these consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets and liabilities, 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. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from such estimates under different assumptions or conditions. The following summarizes our critical accounting policies and significant estimates used in preparing our consolidated financial statements:

Revenue Recognition.    We recognize revenue upon shipment of products when title and risk of loss passes, and when terms are fixed and collection is probable. In accordance with the terms of Staff Accounting Bulletin No. 104, “Revenue Recognition” and EITF 00-21 “Revenue Arrangements with Multiple Deliverables,” where installation services, if provided, are essential to the functionality of the equipment, the portion of revenue for the sale attributable to installation is deferred and recognized when the installation services are provided. In an instance where terms of sale include subjective customer acceptance criteria, revenue is deferred until the acceptance criteria are met. Concurrent with the shipment of the product, we accrue estimated product return reserves and warranty expenses. Critical judgments made by management related to revenue recognition include the determination of whether or not customer acceptance criteria are perfunctory or inconsequential. The determination of whether or not the customer acceptance terms are perfunctory or inconsequential impacts the amount and timing of revenue recognized.

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We undertake projects that include the development and construction of large complex cargo inspection systems requiring installation and customization at the customer’s site. Sales under such long-term contracts are recorded under the percentage-of-completion method. Costs and estimated revenues are recorded as work is performed based on the percentage that incurred costs bear to estimated total costs utilizing the most recent estimates of costs. If the current contract estimate indicates a loss, provision is made for the total anticipated loss in the current period. Critical estimates made by management related to revenue recognition under the percentage-of-completion method include the estimation of costs at completion and the determination of the overall margin rate on the specific project.

Revenues from separate service maintenance contracts are recognized ratably over the term of the agreements. For other services, service revenues are recognized as the services are performed. Deferred revenue for services arises from advance payments received from customers for services not yet performed.

Accounts Receivable.    We perform ongoing credit evaluations of our customers and adjust credit limits based upon each customer’s payment history and current credit worthiness, as determined by credit information available at that time. We continuously monitor collections and payments from our customers and we maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventory.    Inventory is stated at the lower of cost or market; cost is determined on the first-in, first-out method. We write down inventory for slow-moving and obsolete inventory based on assessments of future demands for the next 12 to 36 months, market conditions and customers who may be experiencing financial difficulties. If these factors are less favorable than those projected, additional inventory write-downs may be required.

Deferred Tax Asset Valuation Allowance.    We record a valuation allowance to reduce our deferred tax assets when it is more likely than not, based upon currently available evidence and other factors, that we will not realize some portion or all of our deferred tax assets. We base our determination of the need for a valuation allowance on an on-going evaluation of past and current evidence including, among other things, historical earnings, estimates of future earnings, the backlog of customer orders and the expected timing of deferred tax asset reversals. We charge or credit adjustments to the valuation allowance to income tax expense in the period in which these determinations are made. If we determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase net income in the period this determination was made. Likewise, if we determine that we would not be able to realize all or part of our net deferred tax assets in the future, we would reduce net income and would establish a valuation allowance for the deferred tax asset in the period this determination was made.

Goodwill.    We account for goodwill and intangible assets in accordance SFAS No. 142 “Goodwill and Other Intangible Assets.” We assess impairment on an annual basis or on an interim basis if events occur or circumstances change that reduce the fair value of a reporting unit below its carrying value. This assessment requires the determination of the fair value of each reporting unit as compared to its carrying value. We determine the fair value of our reporting units on the income approach which requires the use of estimates of future revenues, cash flows, and capital expenditures as well as market trends and growth. We believe these estimates and assumptions to be reasonable, although they are inherently unpredictable and uncertain and actual results may differ from these estimates.

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Results of Operations

The following table sets forth certain income and expenditure items as a percentage of total revenues for the periods indicated.

Comparison of Fiscal Year Ended June 30, 2004 to Fiscal Year Ended June 30, 2003

Revenues.    Revenues consist of sales of security and inspection products, medical monitoring and imaging systems, and optoelectronic devices and value-added subsystems. Revenues are recorded net of inter-company eliminations. Revenues for the fiscal year ended June 30, 2004, increased by $64.4 million, or 35.3%, to $247.1 million from $182.6 million for the fiscal year ended June 30, 2003.

Revenues from the sale of security and inspection products decreased $3.0 million, or 2.5%, to $117.8 million from $120.8 million for fiscal year 2003. The decrease in revenues from the sale of security and inspection products was due to the decrease in sales of x-ray kits to Invision Technologies, Inc. of $19.6 million and was offset in part by increased sales of x-ray screening machines in the United States and the international market, increased sales of large cargo products in the international market, and inclusion of ARACOR’s revenues of $9.5 million. We acquired ARACOR in January 2004.

Revenues for the sale of medical monitoring and imaging systems increased by $49.8 million, or 458%, to $60.7 million from $10.9 million for fiscal year 2003. The increase in revenues from the sale of medical monitoring and imaging systems resulted primarily from the inclusion of $47.2 million in revenues of Spacelabs Medical, acquired in March 2004, with additional revenue growth in sales of pulse oximetry products.

Revenues for the sale of optoelectronic devices and value-added subsystems, increased by $17.7 million, or 35%, to $68.6 million from $50.9 million for fiscal year 2003. The increase in revenues from the sale of optoelectronic devices and value-added subsystems resulted from the inclusion of revenues from OSI Electronics, OSI Defense Systems, and OSI Laserscan totaling $24.0 million, offset in part by lower sales primarily from defense optoelectronics.

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Gross Profit.    Gross profit consists of revenues less cost of goods sold. Cost of sales consists of material, labor, and manufacturing overhead. Gross profit increased by $23.4 million, or 39.0%, to $83.4 million from $60.0 million for fiscal year 2003. As a percentage of revenues, gross profit increased to 33.7% in fiscal year 2004 from 32.8% in fiscal year 2003. The increase in gross margin as a percentage of revenues was driven by change in product mix, primarily due to the inclusion of Spacelabs Medical revenues which has higher gross margin compared to our other businesses and was offset in part by inclusion of OSI Electronics revenues which has lower gross margin compared to our other businesses.

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, 2004, such expenses increased by $25.0 million or 85.7%, to $54.2 million from $29.2 million for fiscal year 2003. The increase in selling, general, and administrative expenses was due primarily to increased sales and marketing expenses for the sales of security and inspection products of $2.6 million, legal cost related to our lawsuit with L-3 Communications Corporation (“L-3”) amounting to approximately $1.2 million, and the inclusion of selling, general, and administrative expenses of recent acquisitions (primarily Spacelabs Medical), totalling approximately $20.5 million.

Research and Development.    Research and development expenses include research related to new product development and product enhancement expenditures. For the year ended June 30, 2004, such expenses increased by $5.8 million, or 65.1%, to $14.6 million from $8.9 million in fiscal year 2003. As a percentage of revenues, research and development expenses increased to 5.9% in fiscal year 2004 from 4.8% in fiscal year 2003. The increase in expenses was due primarily to increased research and development spending for security and inspection products of $1.5 million and the inclusion of research and development expenses OSI Laserscan and Spacelabs Medical totaling approximately $4.0 million.

Management Retention Bonus.    Pursuant to the terms of the purchase agreement with Instrumentarium Corporation for the acquisition of Spacelabs Medical, we assumed management retention bonus obligations for key personnel of Spacelabs Medical, which could amount to $5.9 million. These retention bonuses vest over a two-year period which began October 2003. Included in other accrued expenses and current liabilities, we have accrued a total of $3.1 million, of which $2.0 million relates to the period prior to the acquisition of Spacelabs Medical. The remaining retention bonus of $2.8 million will be charged to operating income over the remaining vesting period.

Restructuring Charges.    In the fiscal year 2004, we consolidated manufacturing processes and facilities of certain optoelectronic devices and value-added subsystems and medical monitoring and imaging systems businesses. These consolidations resulted in a pre-tax charge of $1.1 million, consisting primarily of write-off of equipment and leasehold improvements of $993,000 that were retired during the year and charges related to the clean-up of a vacated facility of $60,000. These charges were calculated in accordance with SFAS No. 144, “Impairment or Disposal of Long-Lived Assets” and SFAS No. 146, “Accounting for Exit or Disposal Activities”.

Income from Operations.    Income from operations for fiscal year 2004 decreased by $9.6 million, or 43.6%, to $12.4 million from $22.0 million for fiscal year 2003. Income from operations decreased primarily due to increased selling, general, and administrative expenses and increased research and development expenses and was offset in part by an increase in revenues and in gross margins.

Gain on Sale of Marketable Securities.    Gain on sale of marketable securities for the years ended June 30, 2004 and 2003 consisted of a realized gain on the sale of marketable securities classified as available for sale.

Write down of equity investment.    In July 2002, we purchased from Imagis Technologies, Inc. (“Imagis”), 1,166,667 shares of its common stock (approximately 6% of its then-outstanding stock), and 2-year warrants to

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purchase 291,667 additional shares of Imagis common stock (approximately 1.5% of its then-outstanding stock) at a price of $1.50 per share, and certain ancillary rights, for an aggregate purchase price of $1.75 million. Imagis develops facial recognition software for security applications. We have designated the investment as available for sale. The investment, adjusted for changes in the market value of Imagis’ equity securities, is included under other assets in the accompanying consolidated financial statements. Based on the continued trading of Imagis common stock below the original purchase price for a prolonged period of time, we recognized an other-than-temporary impairment of the carrying value of this investment. For fiscal years 2004 and 2003 we recognized pre-tax charges of $247,000 and $1.4 million, respectively in our income statement.

Interest Income.    For fiscal year 2004, we earned interest income of $863,000 compared to $1.2 million for fiscal year 2003. The decrease in interest income for fiscal year 2004 was due to the decrease in interest earning deposits in the current year.

Interest Expense.    For fiscal year 2004, our interest expense was $283,000 compared to $380,000 for fiscal year 2003. The decrease in expense stems primarily from a decrease in borrowings in the current year compared to the prior year.

Provision for Income Taxes.    Provision for income taxes decreased to $3.3 million for fiscal year 2004, compared to $6.5 million for fiscal year 2003. As a percentage of income before provision for income taxes and minority interest, provision for income taxes was 25.3% for fiscal year 2004, compared to 29.1% for fiscal year 2003. The change in the effective income tax rate was due to a favorable determination of tax contingencies. Our tax rate is dependent upon the mix of income from U.S. and foreign operations.

Net Income.    For the reasons outlined above, the net income for the year ended June 30, 2004 was $10.0 million compared to $15.8 million for the year ended June 30, 2003.

Comparison of Fiscal Year Ended June 30, 2003 to Fiscal Year Ended June 30, 2002

Revenues.    Revenues consist of sales of security and inspection products, medical monitoring and imaging systems, and optoelectronic devises and value-added subsystems. Revenues are recorded net of inter-company eliminations. Revenues for the fiscal year ended June 30, 2003, increased by $58.4 million, or 47.0%, to $182.6 million from $124.2 million for the fiscal year ended June 30, 2002.

Revenues from the sale of security and inspection products increased $47.4 million, or 64.5%, to $120.8 million from $73.4 million for fiscal year 2002. The increase in revenues from the sale of security and inspection products was due to increased sales of x-ray screening machines in the United States and the international market, increased sales of large cargo products in the international market and inclusion of Ancore revenues of $7.5 million. We acquired Ancore in November 2002.

Revenue for the sale of medical monitoring and imaging systems increased $4.7 million, or 75.8%, to $10.9 million from $6.2 million for fiscal year 2002. The increase was primarily due to increased sales of pulse oximetry products.

Revenues for the sale of optoelectronic devises and value-added subsystems increased by $6.3 million, or 14.1%, to $50.9 million from $44.6 million for fiscal year 2002. The increase in revenue form the sale of optoelectronic devises and value-added subsystems was primarily due to the weapons simulation market and inclusion of Centro Vision’s revenues of $3.5 million. We acquired Centro Vision in July 2002.

Gross Profit.    Cost of goods sold consists of material, labor, and manufacturing overhead. Gross profit increased by $21.7 million, or 56.5%, to $60.0 million from $38.3 million for fiscal year 2002. As a percentage of revenues, gross profit increased to 32.8% in fiscal year 2003 from 30.8% in fiscal year 2002. The increase in gross profit was due primarily to increased security and inspection products shipments, which have a higher gross margin.

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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, 2003, such expenses increased by $7.5 million. The increase in expenses was due primarily to increased sales and marketing expenses for the sales of security and inspection systems and medical monitoring and imaging systems, of approximately $3.0 million, legal and professional fees of $1.0 million, administrative expenses of $1.5 million, foreign currency losses of $0.5 million, and inclusion of selling, general, and administrative expenses of Ancore and Centro Vision of $1.5 million. As a percentage of revenues, selling, general, and administrative expenses decreased to 16.0% in fiscal year 2003 from 17.4% in fiscal year 2002, as expenses were leveraged over a larger revenue base.

Research and Development.    Research and development expenses include research related to new product development and product enhancement expenditures. For the year ended June 30, 2003, such expenses increased by $2.4 million or 37.8%, to $8.9 million from $6.4 million in fiscal year 2002. The increase in expenses was due primarily to increased research and development spending for security and inspection products, inclusion of research and development expenses of Ancore and Centro Vision and was offset in part by costs of certain research and development personnel who worked directly on specific products and whose costs were charged to manufacturing overhead.

Goodwill Amortization.    For the year ended June 30, 2003, there was no amortization of goodwill. On July 1, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets, which changes the method of accounting for goodwill to a test of impairment and requires, among other things, the discontinuance of goodwill amortization. The amortization of goodwill was $402,000 for the year ended June 30, 2002.

Income from Operations.    Income from operations for fiscal year 2003 increased by $12.1 million, or 123.2%, to $22.0 million from $9.8 million for fiscal year 2002. Income from operations increased primarily due to an increase in revenue and in gross margin and was offset in part by increased selling, general, and administrative expenses and increased research and development expenses.

Gain on Sale of Marketable Securities.    Gain on sale of marketable securities for the year ended June 30, 2003, consisted of a realized gain on the sale of marketable securities classified as available for sale.

Write-off of deferred acquisition costs.    In fiscal year 2002, we entered into an agreement regarding a joint acquisition with L-3 of certain detection and security businesses then owned by PerkinElmer, Inc. (“PerkinElmer”). The transaction as contemplated would have resulted in our acquisition from L-3 of a certain portion of PerkinElmer’s detection and security businesses. L-3 completed the purchase of the entirety of the businesses from PerkinElmer in June 2002. In November 2002, L-3 terminated the L-3/OSI transaction prior to consummation. Because of L-3’s termination of the transaction, for the year ended June 30, 2003, we recorded a charge of $608,000 during the second quarter of fiscal year 2003 consisting of the write-off of deferred transaction-related expenses, primarily professional fees.

Write down of equity investment.    In July 2002, we purchased from Imagis 1,166,667 shares of its common stock (approximately 6% of its then-outstanding stock), and 2-year warrants to purchase 291,667 additional shares of Imagis common stock (approximately 1.5% of its then-outstanding stock) at a price of $1.50 per share, and certain ancillary rights, for an aggregate purchase price of $1.75 million. Imagis develops facial recognition software for security applications. We have designated the investment as available for sale. The investment, adjusted for changes in the market value of Imagis’ equity securities, is included under other assets in the accompanying consolidated financial statements. For the year ended June 30, 2003, based on the continued trading of Imagis common stock below the original purchase price for a prolonged period of time, we recognized an other than temporary impairment of the carrying value of this investment as of June 30, 2003 and recognized a pre-tax charge of $1.4 million in our income statement.

Interest (Expense) Income.    For the year ended June 30, 2003, we had a net interest income of $786,000 compared to net interest income of $161,000 for fiscal year 2002. The increase in net interest income for the

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fiscal year ended June 30, 2003 was due to decreased borrowing and interest income on the proceeds from private placements in November and December 2001, and October 2002. These proceeds are primarily invested in short-term instruments with an original maturity date of less than ninety days.

Provision for Income Taxes.    Provision for income taxes increased to $6.5 million for the fiscal year ended June 30, 2003, compared to $3.0 million for fiscal year 2002. As a percentage of income before provision for income taxes and minority interest, provision for income taxes was 29.1% for fiscal year 2003, compared to 30.0% for fiscal year 2002. The change in the effective income tax rate was due to a reduction in our deferred tax asset valuation allowance, partially offset by changes in the mix of income from U.S. and foreign operations.

Net Income.    For the reasons outlined above, the net income for the year ended June 30, 2003 was $16.0 million compared to $6.9 million for the year ended June 30, 2002.

Liquidity and Capital Resources

We have financed our operations primarily through cash provided by operations, through various term loans, discounting facilities, and credit lines extended to our different subsidiaries worldwide and from our private offerings. Cash and cash equivalents as of June 30, 2004 were $39.9 million, a decrease of $54.3 million from $94.2 million as of June 30, 2003. As of June 30, 2004, our principal source of liquidity consisted of $39.9 million in cash and several credit agreements described below.

Our operations used net cash of $10.4 million during fiscal year 2004 compared to net cash provided by operations of $21.6 million in fiscal year 2003. The amount of net cash used in operations reflects increases in accounts receivable, inventory, prepaid expenses, and a reduction in advances from customers and accrued warranties, offset in part by an increase in accounts payable and accrued payroll and related expenses. The increase in accounts receivable of $16.6 million was due to higher revenues and the increase in inventory of $15.1 million was due to product mix and anticipated higher revenues.

The net cash used in investing activities was $75.6 million during fiscal year 2004, compared to net cash used in investing activities of $14.9 million in fiscal year 2003. In fiscal year 2004, net cash used in investing activities reflects primarily cash used for the acquisitions of OSI Electronics, OSI Defense Systems, OSI Laserscan, J&D Engineering (UK) Limited, CXR Limited, ARACOR, and Spacelabs Medical totaling $77.5 million, and the purchase of property and equipment of $5.4 million. Cash used in investing activities also reflects proceeds from the sale of marketable securities of $5.3 million and a receipt of $2.0 million from Conmed Corporation under the terms of a stock purchase and sale agreement, in which Conmed Corporation purchased a 10% equity interest in our subsidiary, Dolphin Medical, and has an option to purchase all of the remaining assets and the business of Dolphin Medical. As part of these transactions, Conmed Corporation acquired rights to sell certain Dolphin Medical products in the United States and certain other territories.

Net cash provided by financing activities was $30.5 million in fiscal year 2004, compared to $19.0 million for fiscal year 2003. Net cash provided by financing activities resulted primarily from the net proceeds received from the private placements totaling $31.0 million and exercise of stock options, offset in part by repayment on the term loan.

In June 2004, we issued and sold an aggregate of 1,500,000 shares of our Common Stock in a private placement to institutional investors for an aggregate sales price of $32.3 million. After placement agent commission and expenses, net proceeds to us were $31.0 million.

In March 1999, we announced a stock repurchase program of up to 2,000,000 shares of our Common Stock. No share repurchases occurred during fiscal years 2003 or 2004. Through June 30, 2004, we had repurchased 1,404,500 shares at an average price $4.37 per share. In September 2004, we repurchased 107,500 shares of our Common Stock at an average purchase price of $14.73 per share and we increased the number of shares available

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for repurchase under the stock repurchase program by 1,000,000 shares. As a result, 1,488,000 shares are available for repurchase under the program. The stock repurchase program did not have a material effect on our liquidity and is not expected to have a material effect on liquidity in subsequent quarters.

In December 2003, we negotiated and restated our credit agreement with Bank of the West, which provides for a $50.0 million line of credit that includes a revolving line, letter-of-credit, acceptance and foreign exchange facility. The agreement provides that the aggregate principal balance of all advances under the various facilities shall not exceed the total balance available under the line of credit. In addition, we have a $3.3 million term loan facility. Borrowings under the line of credit bear interest at the bank’s variable reference rate (4.22% at June 30, 2003 and 4.0% at June 30, 2004) at our option, at a fixed rate as quoted by the bank upon request for specific advances. Commitment fees are payable based on a rate of 0.125% of the unused borrowing facility.

The credit agreement expires in November 2005. Borrowings under the credit agreement are collateralized by substantially all of the assets of our U.S. subsidiaries. At June 30, 2004, there were no amounts outstanding under the line of credit. At June 30, 2004 approximately $3.4 million was issued and outstanding under letters of credit and $1.8 million was outstanding under the term loan (see Note 5). Covenants in connection with the credit agreement impose restrictions and requirements related to, among other things, maintenance of certain financial ratios. As of June 30, 2004, we were not in compliance with a covenant related to the increase in our tangible net worth as a percentage of net income for fiscal year 2004 and a covenant related to the value of intangible assets that could be acquired during fiscal year 2004. Bank of the West has waived these covenants.

Our wholly-owned subsidiary, Opto Sensors (Singapore) Pte. Ltd. (“Opto Singapore”) has a revolving line of credit agreement with a Singapore bank that provides for an accounts receivable discounting facility of up to 2.6 million Singapore dollars (approximately U.S. $1.4 million at June 30, 2004). Borrowings under the line of credit bear interest at the bank’s prime rate (5.0% at June 30, 2003 and 5.5% at June 30, 2004) plus 1.0%. Borrowings under the line of credit are collateralized by certain assets of Opto Singapore and are guaranteed by certain of our officers. Borrowings secured by inter-company receivables are guaranteed by us. At June 30, 2004, there were no amounts outstanding under the revolving line of credit. This facility expires in April 2005 and we believe that it will be renewed on the same or similar terms.

Advanced Micro Electronics, AS (“AME”) has a loan agreement with a Norwegian bank that provides for revolving line-of-credit borrowings up to 10.0 million Norwegian kroner (approximately U.S. $1.3 million at June 30, 2004). Borrowings under the line of credit bear interest at a variable rate, which was 5.5% and 4.25% at June 30, 2003 and 2004, respectively. Interest is payable quarterly. Borrowings under the line of credit are collateralized by certain AME assets. At June 30, 2004, 4.3 million Norwegian kroner (approximately U.S. $620,000) was outstanding under the line of credit. This facility expires in March 2005, and we believe that it will be renewed on the same or similar terms.

Our Rapiscan Security Products, Ltd, subsidiary (“Rapiscan UK”) has a loan agreement with a United Kingdom bank that provides for an overdraft facility up to a maximum amount of 2.0 million pounds sterling (approximately U.S. $3.6 million at June 30, 2004) outstanding at any one time, which amounts are secured by certain assets of Rapiscan U.K. At June 30, 2004 no amounts were outstanding under the overdraft facility. Outstanding borrowings bear interest at a base rate (3.75% at June 30, 2003 and 4.5% at June 30, 2004) plus 1.35% per annum. The agreement also provides for a 2.5 million pounds sterling (approximately U.S. $4.5 million at June 30, 2004) facility for tender and performance bonds and a 2.0 million pounds sterling (approximately U.S. $3.6 million at June 30, 2004) facility for the purchase of foreign exchange contracts. These facilities are secured by certain assets of Rapiscan U.K., and we have guaranteed Rapiscan U.K.’s obligation under these facilities up to $1.8 million. As of June 30, 2004 approximately $1.9 million was outstanding under the performance bond facility. These facilities expire in May 2005, and we believe that they will be renewed on the same or similar terms.

Our wholly-owned subsidiary Opto Sensors (Malaysia) Sdn. Bhd. (“Opto Malaysia”) has a loan agreement with a Malaysian bank that provides for a revolving line of credit up to 3.0 million Malaysian ringgits

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(approximately U.S.$789,000 at June 30, 2004). Borrowings under the line of credit bear interest at the bank’s base lending rate (6.0% and 6.0% at June 30, 2003 and 2004, respectively) plus 1.75%. Interest is payable monthly. At June 30, 2004, no amounts were outstanding under this line of credit. Borrowings under this agreement are secured by certain assets of the subsidiary and guaranteed by us. This facility expires in August 2005, and we believe that it will be renewed on the same or similar terms.

Opto Malaysia also has a loan agreement with a Malaysian bank that provides for 10.0 million Malaysian ringgits (approximately U.S. $2.6 million at June 30, 2004) under a performance bond facility. As of June 30, 2004, $1.1 million was outstanding under this facility. The agreement provides for overdraft borrowings up to 2.0 million Malaysian ringgits (approximately U.S. $526,000 at June 30, 2004). Borrowings under the overdraft facility bear interest at the bank’s base lending rate (6.0% at June 30, 2003 and 6.0% at June 30, 2004) plus 1.75%. At June 30, 2004 and 2003, no amounts were outstanding under the overdraft facility. Borrowings under this agreement are secured by certain assets of Opto Malaysia and are guaranteed by us. This facility expires in January 2005, and we believe that it will be renewed on the same or similar terms.

Metorex Security Products, Oy has a loan agreement with a Finnish bank that provides for 525,000 euros (approximately U.S. $640,000 at June 30, 2004) under a tender and performance bond facility. As of June 30, 2004 U.S. $571,000 was outstanding under this facility. The agreement also provides for a foreign currency overdraft facility up to 460,000 euros (approximately U.S. $561,000 at June 30, 2004). At June 30, 2004, 84,000 euros (approximately U.S $103,000) was outstanding under the facility. Borrowings under these facilities bear interest rate at the bank’s prime lending rate (4.0% at June 30, 2003 and 2.5% at June 30, 2004) plus 1.0%. These facilities expire in February 2006.

We believe that cash from operations, existing cash and lines of credit will be sufficient to meet our cash requirements for the foreseeable future.

The following is a summary of our contractual commitments at June 30, 2004 (in thousands):

New Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation Number 46, Consolidation of Variable Interest Entities (“FIN 46”), an interpretation of Accounting Research Bulletin No. 51. FIN 46 requires that variable interest entities be consolidated by a company if that company absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding a variable interest. In December 2003, the FASB issued FIN 46R, which made certain amendments to FIN 46. The provisions of FIN 46R are effective for the first interim or annual period ending after March 15, 2004 when certain conditions are met by a variable interest entity.

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We have adopted FIN 46R and have consolidated in our financial statements our investment in CXR Limited, which was previously accounted for under the equity method. The results and operations of this venture are not material to our financial position or results of operations. Creditors and other investors in the venture do not have any recourse to us.

In November 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities and how arrangement considerations should be measured and allocated to the separate units of accounting in the arrangement. The provisions of EITF Issue No. 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue No. 00-21 did not have a material effect on our financial position or result of operations.

In March 2004, the EITF reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 provides guidance for determining when an investment is other-than-temporarily impaired to be applied in reporting periods beginning after June 15, 2004 and contains disclosure requirements effective in annual financial statements for fiscal years ending after December 15, 2003 for investments accounted for under SFAS Nos. 115 and 124. For all other investments within the scope of this Issue, the disclosures are effective for fiscal years ending after June 15, 2004. The adoption of EITF Issue No. 03-1 did not have a material effect on our financial position or result of operations.

Market Risk

We are exposed to certain market risks, which are inherent in our financial instruments and arise from transactions entered into in the normal course of business. We may enter into derivative financial instrument transactions in order to manage or reduce market risk in connection with specific foreign-currency-denominated transactions. We do not enter into derivative financial instrument transactions for speculative purposes.

We are subject to interest rate risk on our short-term borrowings under our bank lines of credit. Borrowings under these lines of credit do not give rise to significant interest rate risk because these borrowings have short maturities and are borrowed at variable interest rates. Historically, we have not experienced material gains or losses due to interest rate changes.

Foreign Currency

We maintain the accounts of our operations in Canada, India, Malaysia, Norway, Singapore, and the United Kingdom in Canadian dollars, Indian rupees, Malaysian ringgits, Norwegian kroners, Singapore dollars, and U.K. pounds, respectively. We maintain the accounts of our operations in Austria, Finland, France, Germany, and Greece in euros. 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. We included transaction losses of approximately $475,000 in income for fiscal year 2003 and $377,000 in fiscal year 2004. A hypothetical 10% change in the relevant currency rates at June 30, 2003, would not have a material impact on our financial position or results of operations.

Our use of derivatives consists primarily of foreign exchange contracts and interest rate swaps. We purchase forward contracts to hedge foreign exchange exposure related to commitments to acquire inventory for sale. We do not use the contracts for trading purposes. As of June 30, 2004, there were no foreign exchange contracts outstanding. As of June 30, 2003, we had one foreign exchange contract with a notional amount of $1.2 million to hedge foreign exchange exposure on accounts receivable and accounts payable.

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Importance of International Markets

International markets provide us with significant growth opportunities. However, the following events, among others, could adversely affect our 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, 2004, overall foreign currency fluctuations relative to the U.S. dollar had an immaterial effect on our consolidated revenues and results of operations. As a result of monetary policy in Malaysia, including the pegging of the Malaysian ringgit to the U.S. dollar, we believe that our foreign currency exposure in Malaysia will not be significant in the foreseeable future. We continue to perform ongoing credit evaluations of our customers’ financial condition and, if deemed necessary, we require advance payments for sales. We monitor economic and currency conditions around the world to evaluate whether there may be any significant effect on our international sales in the future. Due to our overseas investments and the necessity of dealing with local currencies in our foreign business transactions, we are at risk with respect to foreign currency fluctuations.

Inflation

We do not believe that inflation has had a material impact on our results of operations.

Interest Rate Risk

All highly liquid investments with maturity of three months or less are classified as cash equivalent and recorded in the balance sheet at fair value. Short-term investments are comprised of high quality marketable securities. We have not historically used derivatives to hedge our interest rate risk. However, during the fiscal year 2002 we entered into interest rate swaps to convert a portion of our variable-interest-rate debt to a fixed-rate liability. As of June 30, 2004, all interest rate swaps had expired. The fair value of the swaps was ($90,000) as of June 30, 2003.

The carrying amount, principal maturity and estimated value of our investment portfolio and long-term debt exposure as of June 30, 2003 are as follows:

The carrying amount, principal maturity and estimated value of our investment portfolio and long-term debt exposure as of June 30, 2004 are as follows:

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RISK FACTORS

Investing in our Common Stock involves a significant degree of risk. Investors should carefully consider the following risk factors and all the other information contained in this report or incorporated by reference. If any of the following risks actually occurs, our business, financial condition and results of operations could suffer, in which case the trading price of our Common Stock may decline.

Risks Related to Our Business

Fluctuations in our operating results may cause our stock price to decline.

Given the nature of the markets in which we participate, we cannot reliably predict future revenues and profitability. Changes in competitive, market and economic conditions may cause us to adjust our operations. A high proportion of our costs are fixed, due in part to our significant sales, research and development, and manufacturing costs. Thus, small declines in revenue could disproportionately affect our operating results. Factors that may affect our operating results and the market price of our Common Stock include:

demand for and market acceptance of our products;

competitive pressures resulting in lower selling prices;

adverse changes in the level of economic activity in regions in which we do business;

adverse changes in industries, such as semiconductors and electronics, on which we are particularly dependent;

changes in the portions of our revenue represented by various products and customers;

delays or problems in the introduction of new products;