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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | 12 Months Ended
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Jun. 30, 2015
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business—OSI Systems, Inc., together with its subsidiaries (the “Company”), is a vertically integrated designer and manufacturer of specialized electronic systems and components for critical applications. The Company sells its products in diversified markets, including homeland security, healthcare, defense and aerospace. The Company has three reporting segments: (i) Security, providing security inspection systems, turnkey security screening solutions and related services; (ii) Healthcare, providing patient monitoring, diagnostic cardiology, anesthesia systems and defibrillator products, and related services and (iii) Optoelectronics and Manufacturing, providing specialized electronic components and electronic manufacturing services for the Security and Healthcare divisions as well as to external original equipment manufacturing clients for applications in the defense, aerospace, medical and industrial markets, among others. Through its Security division, the Company provides security screening products and related services globally. These products fall into the following categories: baggage and parcel inspection; cargo and vehicle inspection; hold (checked) baggage screening; people screening; radiation detection; and explosive and narcotics trace detection. In addition to these products, the Company provides site design, installation, training and technical support services to its customers. The Company also provides turnkey security screening solutions, which can include the construction, staffing and long‑term operation of security screening checkpoints for its customers. Through its Healthcare division, the Company designs, manufactures, markets and services patient monitoring, diagnostic cardiology, anesthesia delivery and ventilation systems, defibrillator products, and related supplies and accessories worldwide. These products are used by care providers in critical care, emergency and perioperative areas within hospitals as well as physicians’ offices, medical clinics and ambulatory surgery centers amongst others. Through its Optoelectronics and Manufacturing division, the Company designs, manufactures and markets optoelectronic devices and provides electronics manufacturing services worldwide for use in a broad range of applications, including aerospace and defense electronics, security and inspection systems, medical imaging and diagnostic products, telecommunications, computer peripherals, industrial automation systems, automotive diagnostic systems, gaming systems and consumer products. This division provides products and services to original equipment manufacturers and end users as well as to the Company’s own Security and Healthcare divisions. Consolidation—The Consolidated Financial Statements include the accounts of OSI Systems, Inc. and its wholly‑owned and majority‑owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Investments in joint ventures over which the Company has significant influence but does not have voting control are accounted for using the equity method. Investments over which the Company does not have significant influence are accounted for using the cost method. Use of Estimates—The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and costs of sales during the reporting period. The most significant of these estimates and assumptions for the Company relate to contract revenue, profit and loss recognition, fair values of assets acquired and assumed in business combinations, market values for inventories reported at lower of cost or market, stock-based employee compensation expense, income taxes, accrued product warranty costs, and the recoverability, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts will differ from these estimates and could differ materially. Reclassifications—Certain reclassifications have been made to prior year amounts within the consolidated balance sheet and consolidated statement of cash flows to conform to the current year’s presentation. Cash Equivalents—The Company considers all highly liquid investments purchased with maturities of approximately three months or less as of the acquisition date to be cash equivalents. Accounts Receivable—Billed receivables include outstanding trade receivables. Unbilled receivables primarily include earned but unbilled revenue. Allowance for doubtful accounts involves estimates based on management’s judgment, review of individual receivables and analysis of historical bad debts. The Company monitors collections and payments from its customers and maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Components of accounts receivable consisted of:
|  | June 30, |
|  | 2014 |  | 2015 |
Billed receivables |  | $ | 189,489 |  | $ | 181,805 |
Unbilled receivables |  |  | 1,975 |  |  | 2,614 |
Less allowance for doubtful accounts |  |  | (5,691) |  |  | (5,900) |
Total |  | $ | 185,773 |  | $ | 178,519 |
Inventories—Inventories are generally stated at the lower of cost (first‑in, first‑out) or market. The Company writes down inventory for slow‑moving and obsolete inventory based on assessments of future demands, 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. Property and Equipment—Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are charged while assets are used in service and are computed using the straight‑line method over the estimated useful lives of the assets taking into consideration any salvage value. Amortization of leasehold improvements is calculated on the straight‑line basis over the shorter of the useful life of the asset or the lease term. Leased capital assets are included in property and equipment. Amortization of property and equipment under capital leases is included with depreciation expense. In the event that property and equipment for turnke y screening operations are idle as a result of the early termination, non‑renewal or reduction in scope of the related project, such assets are assessed for impairment on a periodic basis. Goodwill and Other Intangible Assets and Valuation of Long‑Lived Assets—Goodwill represents the excess purchase price of net tangible and intangible assets acquired in business combinations over their estimated fair value. Goodwill is allocated to the Company’s segments based on the nature of the product line of the acquired business. The carrying value of goodwill is not amortized, but is annually tested for impairment during the Company’s second quarter and more often if there is an indicator of impairment. Intangible assets other than goodwill are amortized over their useful lives unless these lives are determined to be indefinite. The Company assesses qualitative factors of each of its reporting units to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. Such assessments indicated that it is not more likely than not that the fair value of each reporting unit is less than its carrying amount, including goodwill. Thus, the Company has determined that it is not necessary to proceed with the two‑step goodwill impairment test. There was no goodwill impairment for each of three fiscal years ended June 30, 2015. The Company evaluates long‑lived assets with finite lives for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Impairment is considered to exist if the total estimated future cash flows on an undiscounted basis are less than the carrying amount of the assets. If impairment does exist, the Company measures the impairment loss and records it based on the discounted estimate of future cash flows. In estimating future cash flows, the Company groups assets at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows from other asset groups. The Company’s estimate of future cash flows is based upon, among other things, certain assumptions about expected future operating performance, growth rates and other factors. The Company assesses qualitative factors that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. This assessment is performed annually to determine whether it is more likely than not that an indefinite-lived intangible asset has been impaired. Such assessments indicated that it is not more likely than not that an indefinite-lived intangible asset has been impaired. Thus, the Company has determined that it is not necessary to perform additional quantitative impairment tests. There was no impairment of indefinite-lived intangible assets for each of three fiscal years ended June 30, 2015. Income Taxes—Deferred income taxes are provided for temporary differences between the financial statement and income tax basis of the Company’s assets and liabilities, based on enacted tax rates. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Income tax accounting standards prescribe a two‑step process for the financial statement measurement and recognition of a tax position taken or expected to be taken in a tax return. The first step involves the determination of whether it is more likely than not (greater than 50 percent likelihood) that a tax position will be sustained upon examination, based on the technical merits of the position. The second step requires that any tax position that meets the more‑likely‑than‑not recognition threshold be measured and recognized in the financial statements at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The income tax accounting standards also provide guidance on the accounting for related interest and penalties, financial statement classification and disclosure. The cumulative effect of applying these standards is to be reported as an adjustment to the opening balance of retained earnings in the period of adoption. See Note 8 for additional information. Fair Value of Financial Instruments—The Company’s financial instruments consist primarily of cash, marketable securities, derivative instruments, accounts receivable, accounts payable and debt instruments. The carrying values of financial instruments, other than long‑term debt instruments, are representative of their fair values due to their short‑term maturities. The carrying values of the Company’s long‑term debt instruments are considered to approximate their fair values because the interest rates of these instruments are variable or comparable to current rates offered to the Company. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. “Level 1” category includes assets and liabilities at the quoted prices in active markets for identical assets and liabilities. “Level 2” category includes assets and liabilities from observable inputs other than quoted market prices. “Level 3” category includes assets and liabilities whose valuation techniques are unobservable and significant to the fair value measurement. There were no assets or liabilities where “Level 3” valuation techniques were used, and there were no assets and liabilities measured at fair value on a non‑recurring basis. The following is a summary of the investments carried at fair value (in thousands):
|  |  |  |  |  |  |  | June 30, |  |  |  |  |  |  |  | June 30, |
|  | Level 1 |  | Level 2 |  | 2014 |  | Level 1 |  | Level 2 |  | 2015 |
Equity securities |  |  | 414 |  |  | 4,671 |  |  | 5,085 |  |  | 291 |  |  | 6,024 |  |  | 6,315 |
Insurance company contracts |  |  | — |  |  | 17,383 |  |  | 17,383 |  |  | — |  |  | 20,100 |  |  | 20,100 |
Bonds |  |  | — |  |  | 1,695 |  |  | 1,695 |  |  | — |  |  | 1,972 |  |  | 1,972 |
Deriva tive contracts |  |  | — |  |  | 28 |  |  | 28 |  |  | — |  |  | (41) |  |  | (41) |
Total |  | $ | 414 |  | $ | 23,777 |  | $ | 24,191 |  | $ | 291 |  | $ | 28,055 |  | $ | 28,346 |
Derivative Instruments and Hedging Activity—The Company’s use of derivatives consists of an interest rate swap agreement. The interest rate swap agreement was entered into to improve the predictability of cash flows from interest payments related to variable, LIBOR‑based debt for the duration of the term loan. The interest rate swap matures in October 2019. The interest rate swap is considered an effective cash flow hedge, and, as a result, the net gains or losses on such instrument were reported as a component of Other comprehensive income in the Consolidated Financial Statements and are reclassified as net income when the hedge transaction settles. Revenue Recognition—The Company recognizes revenue from sales of products upon shipment when title and risk of loss passes, and when terms are fixed and collection is probable. Revenue from services includes after‑market services, installation and implementation of products, and turnkey security screening services. The portion of revenue for the sale attributable to installation is deferred and recognized when the installation service is provided. In an instance where terms of sale include subjective customer acceptance criteria, revenue is deferred until the Company has achieved the acceptance criteria. Concurrent with the shipment of the product, the Company accrues 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 customer acceptance terms are perfunctory or inconsequential impacts the amount and timing of revenue recognized. Critical judgments also include estimates of warranty reserves, which are established based on historical experience and knowledge of the product under warranty. Revenue from turnkey services agreements is included in revenue from services. In certain agreements, revenue is recognized based upon proportional performance, measured by the actual number of hours incurred divided by the total estimated number of hours for the project. The impact of changes in the estimated hours to service the agreement is reflected in the period during which the change becomes known. Deferred revenue for such agreements arises when payments from customers are received in advance of revenue recognition. Revenues from out of warranty service maintenance contracts are recognized ratably over the term of such contract. For services not derived from specific maintenance contracts, revenues are recognized as the services are performed. Deferred revenue for such services arises from payments received from customers for services not yet performed. On occasion, the Company receives advances from customers that are amortized against future customer payments pursuant to the underlying agreements. Such advances are classified in the consolidated balance sheets as either a current or long‑term liability dependent upon when the Company estimates the corresponding amortization to occur. Freight—The Company records shipping and handling fees it charges to its customers as revenue and related costs as cost of goods sold. Research and Development Costs—Research and development costs are those costs related to the development of a new product, process or service, or significant improvement to an existing product, process or service. Such costs are charged to operations as incurred. Stock‑Based Compensation—Stock‑based compensation cost is measured at the grant date based on the estimated fair value of the award and is recognized as expense over the employee’s requisite service period for all stock‑based awards granted or modified. Certain restricted awards vest based on the achievement of pre‑established performance criteria. The fair value of performance‑based awards is estimated at the date of grant based upon the probability that the specified performance criteria will be met, adjusted for estimated forfeitures. Each quarter the Company updates the assessment of the probability that the specified performance criteria will be achieved and adjusts the estimate of the fair value of the performance‑based awards if necessary. The Company amortizes the fair value of performance‑based awards over the requisite service period for each separately vesting tranche of the award. See Note 7 to the Consolidated Financial Statements. Impairment, Restructuring and Other Charges—The Company consolidates processes and facilities of its subsidiaries to better align with demand by its customers and thereby improve its operational efficiencies. The associated charges, and other non‑recurring charges and impairment of assets, are recognized as impairment, restructuring and other charges in the Consolidated Financial Statements. See Note 5 for additional information about these charges. Credit Risk and Concentration—Financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, marketable securities and accounts receivable. The Company restricts investments in cash equivalents to financial institutions with high credit standing. Credit risk on accounts receivable is minimized as a result of the large and diverse nature of the Company’s worldwide customer base. As of June 30, 2014, one customer accounted for 13% of accounts receivable; while no customer accounted for greater than 10% of accounts receivable as of June 30, 2015. One customer accounted for 14% and 12% of revenues for the fiscal years ended June 30, 2014 and 2015, respectively. There were no customers accounting for more than 10% of revenues during fiscal 2013. The Company performs ongoing credit evaluations of its customers’ financial condition and maintains allowances for potential credit losses. The Company has a single‑source vendor to supply an integral component in its cargo product lines in the Security division. The Company also relies primarily on a vendor that provides key components to the Optoelectronics and Manufacturing division. While management believes that relying on key vendors improves the efficiency and reliability of business operations, relying on any one vendor for a significant aspect of business can have a significant negative impact on revenue and profitability if that vendor fails to perform at acceptable service levels for any reason, including financial difficulties of the vendor. Foreign Currency Translation—The Company transacts business in various foreign currencies. In countries where the functional currency of the underlying operations has been determined to be the local country’s currency, revenues and expenses of operations outside the United States are translated into United States dollars using average exchange rates while assets and liabilities of operations outside the United States are translated into United States dollars using period‑end exchange rates. The effects of foreign currency translation adjustments are included in stockholders’ equity as a component of accumulated other comprehensive income in the accompanying consolidated balance sheets. Transaction gains and losses, which were included in the Company’s consolidated statement of operations, amounted to a gain (loss) of approximately $1.8 million, $(1.8) million and $2.1 million for the fiscal years ended June 30, 2013, 2014 and 2015, respectively. Business Combinations—During the normal course of business the Company makes acquisitions. In the event that an individual acquisition (or an aggregate of acquisitions) is material, appropriate disclosure of such acquisition activity is provided. The acquisition method of accounting for business combinations requires the Company to use significant estimates and assumptions, including fair value estimates, as of the business combination date and to refine those estimates as necessary during the measurement period (defined as the period, not to exceed one year, in which we may adjust the provisional amounts recognized for a business combination) in a manner that is generally similar to the previous purchase method of accounting. Under the acquisition method of accounting the Company recognizes separately from goodwill the identifiable assets acquired, the liabilities assumed, and any noncontrolling interests in an acquiree, generally at the acquisition date fair value. The Company measures goodwill as of the acquisition date as the excess of consideration transferred, which the Company also measures at fair value, over the net of the acquisition date amounts of the identifiable assets acquired and liabilities assumed. Costs that the Company incurs to complete the business combination such as investment banking, legal and other professional fees are not considered part of consideration and the Company charges them to general and administrative expense as they are incurred. Under the acquisition method the Company also accounts for acquired company restructuring activities that the Company initiates separately from the business combination. Should the initial accounting for a business combination be incomplete by the end of a reporting period that falls within the measurement period, the Company reports provisional amounts in its financial statements. During the measurement period, the Company adjusts the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date and the Company records those adjustments to its financial statements. The Company applies those measurement period adjustments that the Company determines to be significant retrospectively to comparative information in its financial statements, including adjustments to depreciation and amortization expense. For further discussion regarding contingent earn outs that are included as part of the purchase price of an acquisition, please refer to footnote nine of the Consolidated Financial Statements. Earnings per Share—Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income available to common stockholders by the sum of the weighted average number of common and dilutive potential common shares outstanding. Potential common shares consist of the shares issuable upon the exercise of stock options under the treasury stock method. The following table sets forth the computation of basic and diluted earnings per share for the fiscal years ended June 30 (in thousands, except earnings per share data):
|  | 2013 |  | 2014 |  | 2015 |
Net income available to common stockholders |  | $ | 44,135 |  | $ | 47,894 |  | $ | 65,151 |
Weighted average shares outstanding—basic |  |  | 19,956 |  |  | 19,952 |  |  | 19,799 |
Dilutive effect of stock options |  |  | 612 |  |  | 635 |  |  | 727 |
Weighted average shares outstanding—diluted |  |  | 20,568 |  |  | 20,587 |  |  | 20,526 |
Basic earnings per share |  | $ | 2.21 |  | $ | 2.40 |  | $ | 3.29 |
Diluted earnings per share |  | $ | 2.15 |  | $ | 2.33 |  | $ | 3.17 |
Provision for Warranties—The Company offers its customers warranties on many of the products that it sells. These warranties typically provide for repairs and maintenance of the products if problems arise during a specified time period after original shipment. Concurrent with the sale of products, the Company records a provision for estimated warranty expenses with a corresponding increase in cost of goods sold. The Company periodically adjusts this provision based on historical experience and anticipated expenses. The Company charges actual expenses of repairs under warranty, including parts and labor, to this provision when incurred.
|  | Provision for |
|  | Warranties |
|  | (in thousands) |
Balance on June 30, 2012 |  | $ | 17,562 |
Warranty claims provision |  |  | 1,948 |
Settlements made |  |  | (6,620) |
Balance on June 30, 2013 |  | $ | 12,890 |
Warranty claims provision |  |  | 5,573 |
Settlements made |  |  | (6,540) |
Balance on June 30, 2014 |  | $ | 11,923 |
Warranty claims provision |  |  | 6,043 |
Settlements made |  |  | (5,228) |
Balance on June 30, 2015 |  | $ | 12,738 |
Recent Accounting Updates Not Yet Adopted—In May 2014, the Financial Accounting Standards Board issued an accounting standards update amending revenue recognition requirements for multiple deliverable revenue arrangements. This update provides guidance on how revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services. This determination is made in five steps: (i) identify the contract with the customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The effective date was amended in August 2015 for annual reporting periods after December 15, 2017 and for interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company has not yet selected a transition method and is currently evaluating the impact it may have on its financial condition and results of operations. In July 2015, the Financial Accounting Standards Board issued an accounting standards update amending some of the guidance on subsequent measurement of inventory. This standard affects companies that are using first-in, first-out (FIFO) or average cost, or any other methods besides last-in, first out (LIFO) or the retail inventory method. The amendments in this update are effective for fiscal years beginning after December 15, 2016, including interim reporting periods within that reporting period. The amendments in this update should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company has not yet selected a transition method and is currently evaluating the impact it may have on its financial condition and results of operations.

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