Analogic Corporation
ANALOGIC CORP (Form: 10-K, Received: 09/26/2014 14:25:30)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

Form 10-K

 

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

For the fiscal year ended July 31, 2014

OR

 

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

For the transition period from              to             

Commission File Number 0-6715

 

 

 

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Analogic Corporation

(Exact name of registrant as specified in its charter)

 

Massachusetts   04-2454372
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
8 Centennial Drive, Peabody, Massachusetts   01960
(Address of principal executive offices)   (Zip Code)

(978) 326-4000

(Registrant’s telephone number, including area code)

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

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $0.05 par value   NASDAQ Global Select Market

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

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   þ     No   ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   ¨     No   þ

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   þ     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.   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   þ

      Accelerated filer   ¨

Non-accelerated filer   ¨ (Do not check if a smaller reporting company)

   Smaller reporting company   ¨

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

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant at January 31, 2014 was approximately $1,160,243,000. As of September 19, 2014, there were 12,421,169 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant’s definitive proxy statement, which will be issued in connection with the 2014 Annual Meeting of Stockholders, are incorporated by reference in Part III of this Annual Report on Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page No.  

PART I

  

Item 1. Business

     2   

Item 1A. Risk Factors

     12   

Item 1B. Unresolved Staff Comments

     22   

Item 2. Properties

     22   

Item 3. Legal Proceedings

     23   

Item 4. Mine Safety Disclosures

     23   

             Executive Officers of the Registrant

     24   

PART II

  

Item  5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     25   

Item 6. Selected Consolidated Financial Data

     27   

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     28   

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

     47   

Item 8. Consolidated Financial Statements and Supplementary Data

     48   

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     48   

Item 9A. Controls and Procedures

     48   

Item 9B. Other Information

     49   

PART III

  

Item 10. Directors, Executive Officers and Corporate Governance

     50   

Item 11. Executive Compensation

     50   

Item  12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     50   

Item 13. Certain Relationships and Related Transactions, and Director Independence

     50   

Item 14. Principal Accountant Fees and Services

     50   

PART IV

  

Item 15. Exhibits and Financial Statement Schedules

     51   

SIGNATURES

     52   

CONSOLIDATED FINANCIAL STATEMENTS

     54   

INDEX TO EXHIBITS

     99   

 

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PART I

 

Item 1. Business

Throughout this Annual Report on Form 10-K, unless the context states otherwise, the words “we,” “us,” “our” and “Analogic” refer to Analogic Corporation and all of its subsidiaries taken as a whole, and “our board of directors” refers to the board of directors of Analogic Corporation.

Description of Business

Analogic Corporation (NASDAQ:ALOG) designs, manufactures, and commercializes innovative real-time guidance, diagnostic imaging and threat detection technologies to advance the practice of medicine and save lives. We operate and report along three business segments: Ultrasound, Medical Imaging, and Security Technology. Our Ultrasound business provides ultrasound guidance systems for the urology and surgery markets and is expanding into point of care areas such as anesthesia and emergency medicine. We sell our ultrasound products through our direct sales force in North America and Europe, as well as through a network of distributors to clinical practitioners throughout the world. Our Medical Imaging segment provides critical enabling medical imaging systems and subsystems for computed tomography, or CT, magnetic resonance imaging, or MRI and high-resolution digital mammography systems. We sell our Medical Imaging products primarily through longstanding relationships with well-known multinational medical OEMs and new entrants in emerging markets. Our Security Technology segment designs and manufactures automated threat detection systems for aviation baggage inspection applications utilizing advanced CT technology. We sell our security products primarily through multinational OEM partners. We were incorporated in the Commonwealth of Massachusetts in November 1967 and are headquartered in Peabody, Massachusetts.

Refer to Note 16 to the notes to Consolidated Financial Statements included in this Annual Report on Form 10-K as well as Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations for financial information regarding our segments. The following chart shows net revenue by segment in millions for fiscal years 2014, 2013 and 2012, respectively:

 

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Medical Imaging

Our Medical Imaging segment, which accounted for approximately 57% of our net revenue in fiscal year 2014, consists primarily of systems and sub-systems for medical imaging that are sold globally to OEM producers of CT, MRI, and digital mammography systems. Our products are designed and manufactured to achieve high reliability resulting in the lowest overall cost of ownership for our customers.

 

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Computed Tomography

Analogic has been at the forefront of developments in computed tomography equipment technology from the introduction of the first single slice CT systems in the early 1970s to today’s multi-slice volumetric scanners. We are an industry leader in the development and sale of CT detector systems, data acquisition systems, or DAS, data management systems, or DMS, and fully integrated CT systems that drive the image processing in OEM CT imaging scanners sold around the world.

Our CT product portfolio consists primarily of the following:

 

  1) Detector Subsystems – These subsystems convert the x-ray energy in a CT machine to analog signals for further processing in the DAS. The detectors use state-of-the-art scintillator materials and photodiodes coupled with advanced semiconductor technology to process these highly precise signals. These signals are then fed to a computer through a DAS for image reconstruction.

 

  2) DAS – These subsystems are used to process the signals created by the detectors and feed them as a digital stream to a reconstruction computer to create high resolution images. The DAS is designed with many multi-channel circuit boards that process the analog signals from the detectors and convert them into digital signals through an array of analog to digital, or A/D converters.

 

  3) DMS – This is the most critical sub-system of the CT system and consists of both the detector array and the DAS in one package. This system provides our OEM customers a higher level of integration that allows for lower cost and faster time to market.

 

  4) Integrated CT Systems – The components of the CT system (detectors, DAS, x-ray tube and power supplies) are mounted on a rotating ring assembly called a gantry. The ring enables the components of the CT systems to rotate around the patient at speeds up to 300 revolutions per minute for high resolution imaging. We provide integrated gantries with image and iterative reconstruction algorithms to our OEM customers as another level of integration to facilitate a smoother and faster time to market and improve manufacturing efficiency. Our Low Dose Imaging Software, or LISA, is available in our integrated CT systems to provide high quality imaging capability at up to 40% lower x-ray dose as compared with conventional image reconstruction. Low dose imaging in medical diagnostics is used to prevent damage to healthy tissue. Our designs also include non-contact power, data transfer and other innovative capabilities that provide high reliability, lower total cost of ownership and dose reduction/modulation.

 

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The detector, DAS and DMS products we sell are used in a wide range of CT systems, from dual slice count to the most advanced multi-slice (at least 256 slices) systems, enabling advanced diagnostics such as cardiac imaging. Our CT products are designed to allow our customers to remain at the forefront of this rapidly advancing field. By leveraging our experience in integrating CT components and technology, we have also developed higher-level integrated systems for the radiotherapy market primarily used for image guided radiation treatment of cancerous tumors.

Magnetic Resonance Imaging

For OEM producers of MRI equipment, we supply two key enabling sub-systems: gradient amplifiers and radio frequency, or RF amplifiers. We have developed a wide range of amplifier solutions for our customers ranging from low-magnetic-field systems (under 0.3 Tesla) to ultra high-magnetic-field systems (> 7.0 Tesla). Our ability to provide very high power levels with fast response, low noise and industry-leading reliability enables our OEM customers to deliver innovative technologies such as new, wide-bore (i.e. larger opening) MRI scanners addressing growing requirements related to obesity and patient comfort.

Our MRI product portfolio consists primarily of the following:

 

  1) Gradient Amplifiers – These high power systems are used to drive a set of coils located inside the MRI system and around the patient. The coils energize the atomic structure of a patients’ anatomy in order to create tissue and structure images. Gradient amplifiers must be designed at specific power levels for different MRI field strengths ranging from under 0.3 Tesla to 7.0 Tesla and higher.

 

  2) RF Amplifiers – These power systems are used to control another set of the coils within the MRI system that are used to read-back the signals from the anatomy generated by the gradient coils. These signals are then processed in a reconstruction computer to create images. The RF amplifiers must have a very high signal-to-noise ratio to produce the cleanest images.

 

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Digital Mammography

Our digital mammography products consist primarily of digital mammography selenium based detector plates, sold directly to OEM customers for breast cancer screening and diagnostic applications in mammography. These detector plates are used by OEMs in mammography systems to convert x-ray signals into high resolution 2-D and 3-D images of breast tissue to aid in the detection of breast cancer. Our detector plates for mammography applications are sold to medical OEMs for use in products worldwide. Our digital mammography product portfolio consists of the following:

 

  1) Large detector (AXS-2430) – Our large field of view detector plate, based on selenium technology, is used primarily for European and U.S. markets. The plate and power supply is designed to be easily adapted to many types of mammography systems. This detector plate is also compatible with systems that can perform tomosynthesis, which creates 3-D images through a series of exposures to more accurately detect lesions in the breast.

 

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  2) Small detector (AXS-1824) – Our small field of view detector plate uses the same selenium-based technology as the AXS-2430 detector and is manufactured primarily for the Asian markets.

 

  3) Screen Plus – Our large field of view detector plate, based on selenium technology, is optimized for 2D screening applications and used in mammography systems targeted for emerging markets.

 

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Other Products

Within our Medical Imaging segment, we also design and manufacture servo and stepper (motion control) devices, which we supply to OEM customers for use in computer-controlled automation systems primarily in the semiconductor and laboratory automation markets.

Ultrasound

Our Ultrasound segment principally designs and manufactures procedure-driven ultrasound systems and transducers under the BK and Sonix brand names. These products are primarily sold to clinical end-users in urology, surgery and point-of-care and accounted for approximately 30% of our net revenue in fiscal year 2014. Our ultrasound systems use acoustic waves to generate real-time images of the body’s internal anatomy that are used for interventional and medical diagnostic procedures, including guiding surgical procedures and guiding prostate cancer treatment employing procedures such as brachytherapy. In March 2013, to accelerate our expansion into the growing point-of-care market, we acquired Ultrasonix Medical Corporation, or Ultrasonix, a supplier of advanced ultrasound systems for point-of-care and general imaging applications with over 5,000 systems in the field.

Our product portfolio under the BK brand name consists of the FlexFocus TM mobile ultrasound systems used primarily for guiding procedures in urology and surgery, regional anesthesia and high-end point of care as well as general imaging applications. The Flex Focus product family has a unique, award-winning design in a small footprint that can be easily moved from room to room in a hospital or clinic. With its 19-inch high-resolution monitor, high performance imaging engine and comprehensive range of innovative transducers for procedure guidance, the FlexFocus provides a unique solution in the ultrasound market, where premium image quality, highly sensitive color Doppler and streamlined workflow are valued in a portable system. An optional battery pack enables up to four hours of plug-free imaging.

Our high-end FlexFocus systems include our Quantum Plus Technology TM which incorporates unique Vector Flow Imaging TM , or VFI mode, enabling enhanced visualization of blood flow, with sensitive color Doppler and spatial resolution. Key benefits to our FlexFocus systems also include tissue harmonic imaging for difficult-to-image patients. The ultrasound systems are available with a comprehensive range of specialized transducers that assist in addressing the clinical challenges of surgical, urologic, anesthesia and general imaging procedures.

 

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Our Sonix products are innovative, easy to use ultrasound systems used for a variety of point-of-care applications such as needle guidance for biopsies, aspirations and nerve blocks, and for musculoskeletal, vascular, and general imaging applications. The Sonix platform offers unique guidance technology to precisely locate the needle tip and trajectory for most needle guidance applications. Due to unique features that accelerate daily exams, Sonix systems are a leading choice for reproductive medicine specialists. The systems have a small footprint and feature a customizable touch screen interface that is designed to be easy to use especially for physicians that are new to ultrasound. Sonix diagnostic research systems are used by more than 200 universities and biomedical research organizations around the world.

 

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Our full ultrasound product portfolio

Our new Sonic Window ® handheld ultrasound device is a handheld ultrasound system for visualizing vasculature and guiding peripheral intravenous access, or PIV, that received U.S. Food and Drug Administration 510(k) clearance in April 2014. This ultra-compact ultrasound device provides direct visualization of structures beneath the skin. Unlike existing portable devices on the market today, the Sonic Window handheld is self-contained and does not require a cart or stand to operate. The small, lightweight device, which is the size of a TV remote control, requires only one hand for operation. We believe that that this unique technology can be expanded into clinical settings and other applications to address procedure guidance, and visualization needs in acute care settings and physician offices.

 

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Sonic Window ® – Handheld Ultrasound System

 

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We also design and manufacture advanced ultrasound transducers sold to OEM customers within our Ultrasound segment. Using our advanced acoustic design and manufacturing capability, we provide a variety of transducers to OEMs for both diagnostic and procedure driven applications such as cardiology, radiology, OB/GYN, surgery and interventional radiology.

Security Technology

Utilizing our advanced CT technology, the Security Technology segment designs and manufactures airport baggage screening systems and accounted for approximately 13% of our net revenue in fiscal year 2014. These systems generate 3-D images of objects contained within baggage and utilize highly sophisticated algorithms to provide threat analysis of materials contained within the bags.

Our certified checked baggage screening systems are sold through our commercial partners: L-3 Communications Security and Detection Systems, or L-3 and Smiths Detection, or Smiths, to the Transportation Security Agency, or TSA for installation in U.S. airports and to international airport authorities for installation at airports around the world.

We sell the following checked baggage systems through L-3.

 

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1)       eXaminer ® XLB (High Speed) – The XLB was the first certified explosives detection system, or EDS specifically optimized for high speed screening of checked baggage. Capable of scanning up to 1,200 bags per hour, the XLB keeps bags continuously moving through a meter-wide tunnel. Combining high-resolution helical CT with dual-energy imaging, the XLB offers superior detection capabilities and advanced 3-D imaging.

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2)       eXaminer 3DX (Medium Speed) – Our CT technology is utilized in the 3DX, a medium speed EDS that scans up to 550 bags per hour in-line and up to 330 bags in standalone configuration. The enhanced speed 3DX-ES scans up to 750 bags per hour in the in-line configuration. Both systems are designed to provide high levels of reliability and low false-alarm rates. With over 1,100 systems installed since 2003, the 3DX is one of most widely used checked baggage systems in the U.S.

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3)       eXaminer SX (Reduced Size) – The SX is a lower-cost, reduced size EDS designed for small and medium-sized airports. Able to scan up to 360 bags per hour in-line and up to 300 bags per hour in standalone configuration, the SX offers customers a reduced footprint system with high resolution 3-D imaging and low false-alarm rates.

eXaminer ® is a registered trademark of L-3.

 

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We also sell checked baggage systems through Smiths Detection. The HI-SCAN 10080 XCT is capable of screening up to 1,800 bags per hour in its approved configuration with a belt speed of 0.5 meters per second. The system offers a large one meter wide tunnel that meets the requirements of high speed in-line baggage handling systems and allows rapid, efficient scanning of larger items. The system is also well positioned for international sales as the market converts to CT level detection for checked baggage.

 

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Smiths Detection HI-SCAN 10080 XCT

We also market our COBRA ® brand checkpoint system directly to government agencies, and international airports. Our COBRA checkpoint CT system is the first system to achieve European Civil Aviation Conference Type-D and D+ Standard-2 approval. Standard 2 is the highest European performance standard for threat detection. The COBRA successfully met Standard-2 in Type-D operations, where liquids, aerosols and gels (LAGs) remain inside passenger carry-on bags, and Type D+ operations, where LAGs and complex electronics, such as laptops, remain inside passenger carry-on bags. The COBRA checkpoint CT system has also been approved by the United Kingdom’s Department for Transport as an Advanced Cabin Baggage X-ray system. The COBRA system in its Standard 2 configuration is currently on site at airports in Europe, being tested for operational effectiveness.

 

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COBRA check-point CT system

Other Products

Within our Security Technology segment, we also design and manufacture Rapid DNA Analysis systems. These systems, which we supply to our OEM customer, are designed to rapidly analyze multiple human DNA samples to provide “DNA fingerprints.” The analysis process yields results in about ninety minutes, a significant improvement over conventional technologies. Unlike conventional techniques, which require highly trained personnel working in a laboratory setting, our systems are designed for non-technical users in a variety of environments. These systems, which are being evaluated for adoption, have potential application in fields that benefit from the rapid identification of individuals, including law enforcement, defense, and immigration.

Competition

We are subject to competition based upon product design, performance, pricing, quality and service. We believe that our innovative engineering and product reliability have been important factors in our historical growth. While we try to maintain competitive pricing on those products that are directly comparable to products

 

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manufactured by others, in many instances, our products conform to more precise specifications and carry a higher price than similar products manufactured by others.

In our Medical Imaging segment, systems and subsystems are customized for the needs of our customers. In many cases, due to the limited number of companies with technology comparable to ours, we consider selection by our OEM customers for the design and manufacture of these products and our other medical products to be due more to the “make-or-buy” decision of the individual OEM customers than a function of other competitors in the field.

The Ultrasound segment participates in markets primarily focused in urology, surgery, anesthesia and other point-of-care markets. We compete in these markets based on image quality, ease of use, mobility, reliability and flexibility with a robust portfolio of specialized ultrasound transducers. Our competitors are companies and business units of large medical device companies, such as General Electric Corporation, or GE and Koninklijke Philips Electronics N.V., or Philips, that primarily focus on the conventional ultrasound markets, as well as smaller business units of large multi-national companies, such as Hitachi Medical Corporation and Fujifilm that sell under brands such as Aloka and SonoSite in our target markets. We also compete against newer global market entrants such as Mindray Medical International Limited, or Mindray.

In our Security Technology segment, competition is limited due to the high barriers of entry resulting from the cost of developing the design and manufacturing capability of CT technology. Our primary competitors are divisions of a small number of large companies, such as Morpho Detection (formerly GE’s security business), and Science Applications International Corp. (which acquired Reveal Imaging).

Marketing and Distribution

Our Medical Imaging and Security Technology segments directly sell to OEM customers, both domestically and abroad, primarily through our headquarters in the U.S. We also sell products through our subsidiaries in Canada, China, and the U.S.

Our Ultrasound segment globally distributes its products to end users both through a direct sales force and through a network of independent sales representatives and distributors located around the world. Our direct sales force, located in the U.S., Canada, Germany, Belgium, United Kingdom, Italy, and Scandinavia, accounted for approximately 56% of our Ultrasound revenue in fiscal year 2014, generated from product sales, service and application support. Our remaining Ultrasound revenue was generated through a network of generally non-exclusive, independent distributors in more than 60 other countries and sales of transducers to OEM customers both domestically and abroad.

Seasonal Aspect of Business

There are no material seasonal elements to our Medical Imaging or Security Technology segments, although plant closings in the summer, particularly in Europe, tend to decrease the procurement activities of certain customers during the first quarter of our fiscal year. Customer purchases in our Ultrasound segment have historically been higher in the second and fourth quarters of our fiscal year due in part to the timing of customer budgeting cycles.

 

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Material Customers

We had four customers during fiscal year 2014 and three customers during fiscal years 2013 and 2012, as set forth in the table below, who accounted for 10% or more of our net revenue.

 

     Year Ended July 31,  
         2014             2013             2012      

Philips

     16     15     14

L-3

     11     12     12

Toshiba Corporation (“Toshiba”)

     12     10     10

Siemens AG

     11     *        *   

 

Note (*): Total net revenue was less than 10% in this fiscal year.

Philips’, Toshiba’s, and Siemens’ revenues were primarily in the Medical Imaging segment and L-3’s revenue was in the Security Technology segment.

Our ten largest customers as a group accounted for 66%, 68% and 68% of our net product and engineering revenue for fiscal years 2014, 2013 and 2012, respectively.

The following table summarizes the net accounts receivable due from our customers with net accounts receivable balances greater than or equal to 10% of our total net accounts receivable balance:

 

     As of
July 31,
    2014    
    As of
July 31,
    2013    
 

Philips

     16     18

L-3

     16     16

Toshiba

     11     *   

 

Note (*): Total net accounts receivable was less than 10% in this fiscal year

Our OEM business involves large customers whose placement of large orders can vary based on timing. Our backlog, which consists of cancellable and non-cancellable orders primarily shippable within twelve months, was $144.0 million and $157.0 million as of July 31, 2014 and 2013, respectively. The decrease in backlog was primarily due to timing of customer orders and fewer engineering projects in our Medical Imaging segment as well as lower balance of high-speed units within our Security Technology segment. These decreases were partially offset by an increase in customer orders within our Ultrasound segment.

Government Contracts

We do a significant amount of business with agencies of the U.S. Federal Government through our Security Technology segment, either directly or as a subcontractor. Our contracts with government agencies, and the government contracts of other parties under which we serve as a subcontractor, are subject to termination at the election of the government agency. While none of our government contracts or subcontracts provide for renegotiation of profits at the election of the government, it is possible that the government agency could request, and that we could under certain circumstances agree to, the renegotiation of the payments provided for under such contracts. However, we have not in the past renegotiated significant payment terms under our government contracts or subcontracts.

Sources of Raw Materials and Components

In general, our products are composed of internally-designed electronic and mechanical elements, including proprietary integrated circuits, printed circuit boards, detectors, power supplies, and displays manufactured by us and others in accordance with our specifications. We order raw materials and components to complete our customers’ orders, and some of these raw materials and components are ordered from sole-source suppliers. We

 

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believe that most items procured from third-party suppliers are available from more than one source. However, if a given component ceases to be available, it might become necessary for us to modify a product design to adapt to a substitute component, or to purchase new tooling to enable a new supplier to manufacture the component, either of which could result in additional expense and/or delay in product sales. Also, from time to time the availability of certain electronic components has been disrupted. Accordingly, we carry a safety stock of raw materials and components in an effort to ensure our ability to make timely delivery to our customers.

Patents and Licenses

We hold patents of varying duration issued in the U.S., which cover technologies that we have developed. In many instances, we hold corresponding foreign patents. We regularly file U.S. patent applications and, where appropriate, foreign patent applications. We also file continuations to cover both new and improved methods, apparatus, processes, designs and products.

We rely on a combination of trade secret, copyright and trademark laws, as well as contractual agreements to safeguard our proprietary rights in technology and products. In seeking to limit access to sensitive information to the greatest practical extent, we routinely enter into confidentiality and assignment of invention agreements with each of our employees, and confidentiality agreements with our key customers and vendors.

We believe that any legal protection afforded by patent and copyright laws is of secondary importance as a factor in our ability to compete. Future prospects are more a function of the continuing level of excellence and creativity of our engineers in developing products that satisfy customer needs, and the marketing skills and managerial competence of our personnel in selling those products. Moreover, we believe that market positioning and rapid market entry are important to the success of our products. Our management believes that the loss of any individual patent would not have a material effect on our competitive position.

Research and Product Development

Research and product development, or R&D is a significant element of our business. We maintain a constant and comprehensive R&D program directed toward the creation of new products, the improvement and refinement of our present products, and the expansion of their applications. Certain R&D projects are funded by our customers, typically OEM customers, and such funding is generally treated as engineering revenue, with the associated costs classified as engineering cost of sales. The costs of internally-funded R&D efforts are included within operating expenses. We have been increasing our development of base platforms to enable scalable solutions OEMs can bring to market more quickly and with less up-front development costs.

We evaluate developing technologies in areas where we have technological or marketing expertise for possible investment or acquisition. We intend to continue to invest in R&D and focus our internal and external investments in fields that we believe will offer the greatest potential for near and long-term growth. We are committed to investing in products that have a demonstrable clinical impact and value to the healthcare system and through which we can benefit from our core competencies and global infrastructure.

The cost of customer-funded R&D, which is classified as engineering cost of sales, amounted to:

 

     Years Ended July 31,  
(in millions)        2014              2013              2012      

Customer-funded R&D

   $ 6.9       $ 20.2       $ 21.1   

The cost of internally-funded R&D included in operating expenses amounted to:

 

     Years Ended July 31,  
(in millions)        2014              2013              2012      

Internally-funded R&D

   $ 73.8       $ 64.0       $ 57.2   

 

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Environment

Our manufacturing facilities are subject to numerous environmental laws and regulations, particularly with respect to industrial waste and emissions. Compliance with these laws and regulations has not had a material impact on our capital expenditures, earnings, or competitive position.

Employees

As of July 31, 2014, we employed approximately 1,700 employees. A limited number of employees at our Denmark facility are covered by a works council. We consider our relations with our employees to be generally good.

Financial Information about Foreign and Domestic Operations and Export Revenue

Revenues are attributed to countries based on the location of our customers. For OEM sales, our customer’s location may differ from the location of where the ultimate completed systems are sold by the OEM into the market.

 

     Years Ended July 31,  
(in millions)        2014                    2013                    2012             

Net Revenue:

               

Domestic

   $ 183.8         36   $ 209.6         38   $ 199.5         39

Foreign

     333.7         64     340.8         62   $ 317.1         61
  

 

 

      

 

 

      

 

 

    

Total net revenue

   $ 517.5         $ 550.4         $ 516.6      
  

 

 

      

 

 

      

 

 

    

Refer to Note 16 to the notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for financial information regarding our domestic and foreign revenue and long lived assets.

Available Information

Our website address is www.analogic.com . The information on our website is not incorporated by reference into this document and should not be considered to be a part of this document. Our website address is included in this document as an inactive textual reference only.

We make available free of charge through our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Annual Form SD and amendments to the reports as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission, or the SEC.

 

Item 1A. Risk Factors

This Annual Report on Form 10-K contains statements, which, to the extent that they are not a recitation of historical facts, constitute “forward-looking statements” pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In some cases these forward-looking statements can be identified by the use of words such as “may,” “could,” “should,” “would,” “expect,” “project,” “predict,” “potential” or the negative of these words or comparable words. Investors are cautioned that all forward-looking statements, including without limitation, statements about product development, market and industry trends, strategic initiatives, regulatory approvals, sales, profits, expenses, price trends, R&D expenses and trends, and capital expenditures, involve risk and uncertainties, and actual events and results may differ materially from those indicated in any forward-looking statement as a result of a number of important factors, including those discussed below and elsewhere in this Form 10-K.

You should carefully consider the risks described below before making an investment decision with respect to our common stock. Additional risks not presently known to us, or that we currently deem immaterial, may also impair our business. Any of these could have a material and negative effect on our business, financial condition, or results of operations.

 

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A significant portion of our revenue currently comes from a small number of customers. Any decrease in revenue from these customers could harm our operating results.

We depend on a small number of customers for a large portion of our business, and changes in our customers’ orders could have a significant impact on our operating results. If a major customer significantly reduces the amount of business it does with us, there would be an adverse impact on our operating results.

We had four customers during fiscal year 2014 and three customers during fiscal years 2013 and 2012, as set forth in the table below, who accounted for 10% or more of our net revenue.

 

     Year Ended July 31,  
         2014             2013             2012      

Philips

     16     15     14

L-3

     11     12     12

Toshiba Corporation (“Toshiba”)

     12     10     10

Siemens AG

     11     *        *   

 

Note (*): Total net revenue was less than 10% in this fiscal year.

Philips’, Toshiba’s, and Siemens’ revenues were primarily in the Medical Imaging segment and L-3’s revenue was in the Security Technology segment.

Our ten largest customers as a group accounted for 66%, 68%, and 68% of our net product and engineering revenue for fiscal years 2014, 2013 and 2012, respectively

The following table summarizes the net accounts receivable due from our customers with net accounts receivable balances greater than or equal to 10% of our total net accounts receivable balance:

 

     As of     As of  
         July 31,             July 31,      
     2014     2013  

Philips

     16     18

L-3

     16     16

Toshiba

     11     *   

 

Note (*): Total net accounts receivable was less than 10% in this fiscal year

Although we seek to broaden our customer base, we will continue to depend on sales to a relatively small number of major customers. Because it often takes significant time to replace lost business, it is likely that our operating results would be adversely affected if one or more of our major customers were to cancel, delay, or reduce significant orders in the future. Our customer agreements typically permit the customer to discontinue future purchases after timely notice.

In addition, we generate significant accounts receivable in connection with the products we sell and the services we provide to our major customers. Although our major customers are large corporations, if one or more of our customers were to become insolvent or otherwise be unable to pay for our products and services, our operating results and financial condition could be adversely affected.

Competition from existing or new companies in the Medical Imaging and Security Technology industries could cause us to experience downward pressure on prices, fewer customer orders, reduced margins, loss of new business opportunities, and the loss of market share.

We operate in a highly competitive industry. We are subject to competition based on product design, performance, pricing, quality, and service offerings, and we believe our innovative engineering and product reliability have been important factors in our historical growth. While we try to maintain competitive pricing on those products which are directly comparable to products manufactured by others, in many instances our products conform to more precise specifications and may carry a higher price than analogous products manufactured by others.

 

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Our competitors include divisions of larger, more diversified organizations as well as specialized companies. Some of them have greater resources and larger staffs than we have. A number of our existing and potential OEM customers have the ability to design and manufacture internally the products that we manufacture for them. We face competition from the R&D groups and manufacturing operations of our existing and potential customers, who continually compare the benefits of internal research, product development, and manufacturing with the costs and benefits of outsourcing.

We depend on our suppliers, some of which are the sole-source for certain components, and our production could be substantially curtailed if these suppliers were not able to meet our demands and alternative sources were not available.

We order raw materials and components to complete our customers’ orders, and some of these raw materials and components are ordered from sole-source suppliers. Although we work with our customers and suppliers to minimize the impact of shortages in raw materials and components, we sometimes experience short-term adverse effects due to price fluctuations and delayed shipments. In the past, there have been industry-wide shortages of electronics components. If a significant shortage of raw materials or components were to occur, we might have to delay shipments or pay premium pricing, which could adversely affect our operating results. In some cases, supply shortages of particular components could substantially curtail our production of products using these components. We are not always able to pass on price increases to our customers. Accordingly, some raw material and component price increases could adversely affect our operating results. We also depend on a small number of suppliers to provide many of the other raw materials and components that we use in our business. Some of these suppliers are affiliated with customers or competitors, and others are small companies. If we were unable to continue to purchase these raw materials and components from our suppliers, our operating results could be adversely affected. Because many of our costs are fixed, our margins depend on the volume of output at our facilities, and a reduction in volume could adversely affect our margins.

We rely on successful performance by and relationships with suppliers. This reliance could have a material adverse effect on our results of operations and financial condition.

We have formed arrangements with suppliers for various services and components. We have formed these arrangements because it is commercially more efficient to outsource these services and purchase these components than it would be for us to perform these services or manufacture these components, which in some cases require, among other things, a high degree of technical skill and advanced equipment that is not practical or cost-effective for us to develop or acquire. As a result, if one of our suppliers were to experience quality problems, capacity constraints, decreased yields, or delivery delays, or were to raise prices significantly, we could face product liability claims, product shortages, decreased revenues or lost customers, which could adversely affect our operating results.

If we were to be left with excess inventory, our operating results could be adversely affected.

Because of long lead times and specialized product designs, in certain cases we purchase components and manufacture products in anticipation of customer orders based on customer forecasts. For a variety of reasons, such as decreased end-user demand for our products, inadequate or inaccurate forecasts, or other issues that might impact production planning, our customers might not purchase all the products that we have manufactured or for which we have purchased components. In any such event, we would attempt to recoup material and manufacturing costs by means such as returning components to our vendors, disposing of excess inventory through other channels, or requiring our OEM customers to purchase or otherwise compensate us for such excess inventory. Some of our significant customer agreements do not give us the ability to require our OEM customers to do this. To the extent that we were unsuccessful in recouping our material and manufacturing costs, our gross margin and operating results could be adversely affected. Moreover, carrying excess inventory would reduce the working capital we have available to continue to operate and grow our business.

 

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Uncertainties and adverse trends affecting our industry or any of our major customers could adversely affect our operating results.

Our business operates primarily within three business segments: Medical Imaging, Ultrasound, and Security Technology. The medical and security technology equipment markets in which our segments operate are subject to changes in technology, pricing, and profit margins and have been historically subject to cyclical downturns characterized by diminished product demand, rapid declines in average selling prices, and production over-capacity. In addition, changes in government policy and regulations relating to the purchase or use of medical and security-related capital equipment could also affect our sales. Our customers’ markets are also subject to economic cycles and are likely to experience recessionary periods in the future. The economic conditions affecting our industry in general or any of our major customers in particular, might adversely affect our operating results.

In Security Technology, our OEM customers’ purchasing dynamics are generally affected by the level of government funding, the expansion and/or upgrade of airport terminals, the timing of government tenders and the fluctuations in airline passenger volume.

Our customers’ or our delay in obtaining or inability to obtain any necessary U.S. or foreign regulatory clearances or approvals for products could have a material adverse effect on our business.

Our products in the Medical Imaging and Ultrasound segments are finished medical devices or are components used by our customers in the production of finished medical devices that are subject to a high level of regulatory oversight. A delay in obtaining or inability to obtain any necessary U.S. or foreign regulatory clearances or approvals for products could have a material adverse effect on our business. The process of obtaining clearances and approvals can be costly and time-consuming. There is a further risk that any approvals or clearances, once obtained, might be withdrawn or modified. Medical devices cannot be marketed in the U.S. without clearance from the U.S. Food and Drug Administration, or FDA. Medical devices sold in the U.S. must also be manufactured in compliance with FDA rules and regulations, which regulate the design, manufacturing, packaging, storage, and installation of medical devices. Moreover, medical devices are required to comply with FDA regulations relating to investigational research and labeling. States may also regulate the manufacturing, sale, and use of medical devices. Medical devices are also subject to approval and regulation by foreign regulatory and safety agencies. Our products must also meet the requirements of these governments and agencies for approval and distribution. As with the U.S., foreign governments or agencies can withdraw or modify their approvals.

Our business strategy includes the pursuit of acquisitions or business combinations, which, if consummated, could be difficult to integrate, disrupt our business, dilute stockholder value, or divert management attention.

As part of our business strategy, we may seek attractive acquisitions and other business combinations. Acquisitions are typically accompanied by a number of risks, including the difficulty of integrating the operations and personnel of the acquired companies, the potential disruption of our ongoing business and distraction of management, expenses related to the acquisition, and potential unknown or underestimated liabilities associated with acquired businesses. If we do not successfully complete acquisitions, we could incur substantial expenses and devote significant management time and resources without generating any benefit to us. In addition, substantial portions of our available cash might be utilized as consideration for these acquisitions.

 

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Our annual and quarterly operating results are subject to fluctuations, which could affect the market price of our common stock.

Our annual and quarterly results could vary significantly depending on various factors, many of which are beyond our control, and may not meet the expectations of securities analysts or investors. If this occurs, the price of our common stock could decline. These factors include:

 

   

variations in the timing and volume of customer orders;

 

   

introduction and market acceptance of our customers’ or our own new products;

 

   

changes in demand for our customers’ or our own existing products;

 

   

the timing of our expenditures in anticipation of future orders;

 

   

effectiveness in managing our manufacturing processes;

 

   

changes in competitive and economic conditions generally in our or our customers’ markets;

 

   

changes in the cost or availability of components or skilled labor;

 

   

changes in our effective tax rate;

 

   

fluctuations in manufacturing yields;

 

   

foreign currency and commodity price exposures;

 

   

investor and analyst perceptions of events affecting us, our competitors, and/or our industry; and

 

   

changes in laws or regulatory requirements affecting the health care or aviation security industries or our products.

A delay in anticipated sales beyond the end of a particular quarter could have a significant effect on our operating results for that quarter. In addition, most of our operating expenses do not vary directly with net revenue and are difficult to adjust in the short term. As a result, if revenue for a particular quarter was below our expectations, we could not proportionately reduce operating expenses for that quarter. Hence, the revenue shortfall could have a disproportionate adverse effect on our operating results for that quarter.

Loss of any of our key personnel could hurt our business because of their industry experience and their technological expertise.

We operate in a highly competitive industry and depend on the services of our key senior executives and our technological experts. The loss of the services of one or several of our key employees or an inability to attract, train, and retain qualified and skilled employees, specifically engineering and operations personnel, could result in the loss of customers or otherwise inhibit our ability to operate and grow our business successfully.

If we fail to effectively manage our growth or, alternatively, our spending during economic downturns, our business could be disrupted, which could harm our operating results.

Our ability to offer our products and implement our business plan in evolving markets successfully requires an effective planning and management process. We must effectively manage our spending and operations to ensure our competitive position during economic downturns, and must preserve our future opportunities when the economy improves. A failure to manage our spending and operations effectively could disrupt our business and harm our operating results. A growth in sales, combined with the challenges of managing geographically dispersed operations, can place a significant strain on our management systems and resources, and growth in future operations could continue to place such a strain. The failure to manage our growth effectively could disrupt our business and harm our operating results.

 

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If we are unable to maintain our expertise in research and product development, manufacturing processes, and marketing new products, we might not be able to compete successfully.

We believe that our future success depends upon our ability to provide research and product development, provide manufacturing services that meet the changing needs of our customers, and market new products. This requires that we successfully anticipate and respond to technological changes in design and manufacturing processes in a cost-effective and timely manner. As a result, we continually evaluate the advantages and feasibility of new product designs and manufacturing processes. We may not be able to develop and introduce new and improved products in a timely or efficient manner. New and improved products, if developed, may not achieve price and profitability targets or market acceptance. Commercialization of new products may prove challenging, and we may be required to invest more time and money than expected to introduce these products into the market successfully. Once introduced, new products may adversely impact orders and sales of our existing products, or make them less desirable or even obsolete.

Major terrorist attacks and threats have increased financial expectations that may not materialize.

Major terrorist attacks and threats have created increased interest in our security and inspection systems. However, the level of demand for our products is not predictable and may vary over time. We do not know what solutions will continue to be adopted by the U.S. Department of Homeland Security as a result of terrorism and whether our products will continue to be a part of the solutions. Additionally, should our products be considered as a part of future security solutions, it is unclear what the level of purchases may be and how quickly funding to purchase our products may be made available. These factors could adversely impact us and create unpredictability in our revenues and operating results.

We are exposed to risks associated with international operations and markets.

We source and manufacture certain components and systems outside the U.S., we market and sell products in international markets, and we have established offices and subsidiaries in Europe, Canada, and Asia. Our foreign revenue accounted for 64%, 62%, and 61% of our total net revenue for fiscal years 2014, 2013 and 2012, respectively. There are inherent risks in transacting business internationally, including:

 

   

changes in applicable laws and regulatory requirements;

 

   

export and import restrictions;

 

   

export controls relating to technology;

 

   

tariffs and other trade barriers;

 

   

intellectual property laws that offer less protection for our proprietary rights;

 

   

difficulties in staffing and managing foreign operations;

 

   

problems in collecting accounts receivable and longer payment cycles;

 

   

political instability;

 

   

fluctuations in currency exchange rates;

 

   

difficulties in managing employee relations;

 

   

difficulties in maintaining uniform standards, controls, procedures and policies across our global operations, including inventory management and financial consolidation;

 

   

expatriation controls; and

 

   

potential adverse tax consequences.

 

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There is significant uncertainty about the stability of global credit and financial markets. These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. Various macroeconomic factors such as unemployment rates, availability of credit, strength or weakness of real estate markets and other such factors may cause our customers to cancel, decrease or delay their existing or future orders for our products. We are unable to predict the impact of this instability and if economic conditions deteriorate, our business and results of operations could be materially and adversely affected.

We must comply with the U.S. Foreign Corrupt Practices Act and antitrust, anti-competition and similar laws in other jurisdictions and our failure to do so could lead to substantial liability. We could also face investigations by one or more government agencies that could be costly to respond to and divert the attention of key personnel from our business operations. An adverse outcome from any such investigation could subject us to fines or other penalties, which could adversely affect our business, financial condition and results of operations.

Any one or more of these factors may have a material adverse effect on our future international activities and, consequently, on our business and results of operations.

There are risks associated with our operations in China.

We conduct certain manufacturing operations at, and are transitioning additional manufacturing operations to, our facility in Shanghai, China in order to reduce costs and streamline our manufacturing operations. There are administrative, legal, and governmental risks to operating in China that could result in increased operating expenses or could hamper us in the development of our operations in China. The risks from operating in China that could increase our operating expenses and adversely affect our operating results, financial condition and ability to deliver our products and grow our business include, without limitation:

 

   

difficulties in staffing and managing foreign operations, particularly in attracting and retaining personnel qualified to design, sell, test and support our products;

 

   

difficulties in managing employee relations;

 

   

increases in the value of the Chinese Yuan, or CNY;

 

   

difficulties in coordinating our operations in China with those in the U.S., Canada, and Europe;

 

   

difficulties in enforcing contracts in China;

 

   

difficulties in protecting intellectual property;

 

   

diversion of management attention;

 

   

imposition of burdensome governmental regulations;

 

   

difficulties in maintaining uniform standards, controls, procedures and policies across our global operations, including inventory management and financial consolidation;

 

   

regional political and economic instability, which could have an adverse impact on foreign exchange rates in Asia and impair our ability to conduct our business in China; and

 

   

inadequacy of the local infrastructure to support our operations.

Our operations are vulnerable to interruption or loss due to natural disasters, epidemics, terrorist acts and other events beyond our control, which would adversely affect our business.

Although we perform manufacturing in multiple locations, we generally do not have redundant manufacturing capabilities in place for any particular product or component. As a result, we depend on our current facilities for the continued operation of our business. A natural disaster, pandemic, terrorist act, act of

 

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war, or other natural or manmade disaster affecting any of our facilities could significantly disrupt our operations, or delay or prevent product manufacturing and shipment for the time required to repair, rebuild, or replace our manufacturing facilities. This delay could be lengthy and we could incur significant expenses to repair or replace the facilities. Any similar natural or manmade disaster that affects a key supplier or customer could lead to a similar disruption in our business.

Our business could be harmed if we are unable to protect our intellectual property or if we become subject to intellectual property infringement claims.

We rely on a combination of trade secrets, patents, trademarks, copyrights and confidentiality procedures to protect our technology. Despite our efforts, the steps we have taken to protect our technology may be inadequate. Existing trade secret, patent, trademark and copyright laws offer only limited protection. Our patents could be invalidated or circumvented. In addition, others may develop substantially equivalent or superseding proprietary technology, or competitors may offer similar competing products, thereby substantially reducing the value of our proprietary rights. The laws of some foreign countries in which our products are or may be manufactured or sold may not protect our products or intellectual property rights to the same extent as do the laws of the U.S. The steps we have taken to protect our intellectual property may not be adequate to prevent misappropriation of our technology. Our inability to protect our intellectual property could have a negative impact on our operations and financial results.

We may also become subject to claims that we infringe the intellectual property rights of others in the future. We cannot ensure that, if made, these claims will not be successful. Any claim of infringement could cause us to incur substantial costs defending against the claim even if the claim is invalid, and could distract management from other business. Any judgment against us could require substantial payment in damages and could also include an injunction or other court order that could prevent us from offering certain products.

We rely significantly on information technology and any failure, inadequacy, interruption or security lapse of that technology could harm our ability to operate our business effectively.

We rely extensively on information technology systems to interact with our employees and our customers and to run our business effectively. These interactions include ordering and managing materials from suppliers, converting materials to finished products, shipping product to customers, processing transactions, summarizing and reporting results of operations, complying with regulatory, legal and tax requirements, and other processes necessary to manage our business. Our systems could become damaged or cease to function properly due to any number of causes, including issues caused by ongoing projects to improve our information technology systems and the delivery of services, failures of third-party service providers, catastrophic events, power outages, and security breaches. Any failure or malfunctioning of our information technology systems, errors or misuse by system users, or inadequacy of the systems in addressing the needs of our operations, could disrupt our ability to timely and accurately manufacture and ship products, which could have a material adverse effect on our business, financial condition and results of operations. Any such failure, errors, misuse or inadequacy could also disrupt our ability to timely and accurately process, report and evaluate key operations metrics and key components of our results of operations, financial position and cash flows. Any such disruptions would likely divert our management and key employees’ attention away from other business matters. Any disruptions or difficulties that may occur in connection with our information technology systems could also adversely affect our ability to complete important business processes such as the evaluation of our internal control over financial reporting and attestation activities.

We may be subject to information security breaches caused by illegal hacking, computer viruses, or acts of vandalism or terrorism. Our security measures or those of our third-party service providers may not detect or prevent such breaches. Any such compromise to our information security could result in an interruption in our operations, the unauthorized publication of our confidential business or proprietary information, the unauthorized release of customer, vendor, or employee data, the violation of privacy or other laws, and the exposure to litigation, any of which could harm our business and operating results.

 

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If our security and inspection systems fail to detect weapons, explosives or other devices that are used to commit a terrorist act, we could be exposed to product liability and related claims for which we may not have adequate insurance coverage.

Our business exposes us to potential product liability risks that are inherent in the development, manufacturing, sale and service of security inspection systems. Our customers use our security and inspection systems to help them detect items that could be used in performing terrorist acts or other crimes. The training, reliability and competence of the customers’ operators are crucial to the detection of suspicious items. In addition, our security and inspection systems are not designed to work under all circumstances. We test the reliability of our security and inspection systems during both their development and manufacturing phases. We also perform such tests if we are requested to perform installation, warranty or post-warranty servicing. However, our security inspection systems are advanced mechanical and electronic devices and therefore can malfunction.

As a result of the September 11, 2001, and 1993 World Trade Center terrorist attacks, and the potential for future attacks, product liability insurance coverage for such threats is extremely difficult and costly to obtain. It is possible, subject to the applicability of the Support Anti-terrorism by Fostering Effective Technologies Act of 2002, or SAFETY Act, that if we were found liable following a major act of terrorism, our insurance might not fully cover the claims for damages.

The SAFETY Act is a Federal law in the U.S. enacted to provide certain legal liability protections for providers of certain anti-terrorism technologies. If applicable to claims against Analogic, the SAFETY Act could mitigate some of this risk.

Our Security Technology segment depends in part on purchases of products and services by the U.S. Federal Government and its agencies, which purchases may be only partially funded, and are subject to potential termination and reductions and delays in government spending.

As an indirect subcontractor or team member with prime contractors and in other cases directly to the U.S. Federal Government and its agencies, our security and inspection systems are included in many different domestic programs. Over the lifetime of a program, the award of many different individual contracts and subcontracts could impact our products’ requirements. The funding of U.S. Federal Government programs are subject to Congressional appropriations. Although multiple-year contracts may be planned in connection with major procurements, Congress generally appropriates funds only on a single fiscal year basis. Consequently, programs are often only partially funded initially, and additional funds are committed only as Congress makes further appropriations and prime contracts receive such funding. The reduction or delay in funding or termination of a government program in which we are involved could result in a loss of or delay in receiving anticipated future revenues attributable to that program and contracts or orders received. The U.S. Federal Government could reduce or terminate a prime contract under which we are a subcontractor or team member irrespective of the quality of our products or services. The termination of a program or reduction in, or failure to commit additional funds to, a program in which we are involved could negatively impact our revenue and have a material adverse effect on our financial condition and results of operations.

Changes in laws affecting the health care industry could adversely affect our business, operations and financial condition.

In recent years, the healthcare industry has undergone significant changes driven by various efforts to reduce costs, including increased levels of managed care, cuts in Medicare, consolidation of healthcare distribution companies and collective purchasing arrangements by office-based healthcare practitioners. In addition, numerous governments have undertaken efforts to control healthcare costs through legislation and regulation. In the U.S. in March 2010, President Obama signed into law health care reform legislation in the form of the Patient Protection and Affordable Care Act, or PPACA. The PPACA could meaningfully change the way healthcare is developed, marketed and delivered, and may materially impact numerous aspects of our business, results of operations, and financial conditions. The implementation of health care reform and medical cost containment measures in the U.S. and in foreign countries in which we operate could:

 

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limit the use of our products and adversely affect the use of new therapies for which our products may be targeted;

 

   

reduce reimbursement available to our customers for using our products; and

 

   

decrease the price we might establish for our products and products that we may develop, which would result in lower product revenues to us.

In addition, because we operate in a highly regulated industry, other governmental actions may adversely affect our business, operations and financial condition, including:

 

   

changes in FDA and foreign regulations that may require additional safety monitoring, labeling changes, restrictions on product distribution or use, or other measures after the introduction of our products to market, which could increase our costs of doing business, or otherwise adversely affect the market for our products;

 

   

new laws, regulations and judicial decisions affecting pricing or marketing practices; and

 

   

changes in the tax laws relating to our operations.

We have identified transactions involving our Danish subsidiary BK Medical ApS (“BK Medical”) and certain of its distributors with respect to which we have raised questions as to compliance with law, and we may incur ongoing inquiry-related costs and/or governmental sanctions in connection with the matter.

As initially disclosed in our Annual Report on Form 10-K for the fiscal year ended July 31, 2011, we identified certain transactions involving our Danish subsidiary BK Medical ApS, or BK Medical, and certain of its foreign distributors, with respect to which we have raised questions concerning compliance with law, including Danish law and the U.S. Foreign Corrupt Practices Act, and our business policies. These have included transactions in which the distributors paid BK Medical amounts in excess of amounts owed and BK Medical transferred the excess amounts, at the direction of the distributors, to third parties identified by the distributors. We have terminated the employment of certain BK Medical employees and have wound down the relationships with the BK Medical distributors that were involved in the transactions. We have concluded that the transactions identified to date have been properly accounted for in our reported financial statements in all material respects. However, we have been unable to ascertain with certainty the ultimate beneficiaries or the purpose of these transfers. We have voluntarily disclosed this matter to the Danish Government, the U.S. Department of Justice, or DOJ, and the SEC and are cooperating with inquiries by the Danish Government, the DOJ and the SEC. We believe that the SEC and DOJ have substantially completed their investigation into the transactions at issue and that it is reasonably likely that one or both of these entities may seek to impose sanctions and/or penalties on us in connection with a resolution of their inquiries. We are unable to estimate the potential penalties and/or sanctions that may ultimately be assessed. During fiscal year 2014, we incurred inquiry-related costs of approximately $1.4 million in connection with this matter, as compared to $1.2 million in fiscal year 2013.

Compliance or the failure to comply with current and future environmental regulations could cause us significant expense.

We are subject to various environmental regulations. From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. We continue to evaluate the necessary steps for compliance with environmental regulations as they are enacted. These regulations include, for example, the Registration, Evaluation, Authorization and Restriction of Chemical substances, or REACH, the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment Directive, or RoHS and the Waste Electrical and Electronic Equipment Directive, or WEEE enacted in the European Union which regulate the use of certain hazardous substances in, and require the collection, reuse and recycling of waste

 

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from, certain products we manufacture. This and similar legislation that has been or is in the process of being enacted in Japan, China, Korea and various states of the U.S. may require us to redesign our products to ensure compliance with the applicable standards, for example by requiring the use of different types of materials. These redesigns or alternative materials may detrimentally impact the performance of our products, add greater testing lead-times for product introductions or have other similar effects. We believe we comply with all such legislation where our products are sold and we will continue to monitor these laws and the regulations being adopted under them to determine our responsibilities. In addition, we are monitoring legislation relating to the reduction of carbon emissions from industrial operations to determine whether we may be required to incur any material, additional material costs, or expenses associated with our operations. Our failure to comply with any of the foregoing regulatory requirements could result in our being directly or indirectly liable for costs, fines or penalties and third-party claims, and could jeopardize our ability to conduct business in the U.S. and foreign countries.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

As of July 31, 2014, we owned or leased the primary facilities described below:

 

Location

   Approximate Sq. Ft.     

Principal Use(s)

  

Principal
Segment(s)

Peabody, MA (1)

     Owned         514,000       Executive and administrative offices, manufacturing, R&D, customer service, and sales    All segments

State College, PA

     Owned         66,000       Administrative offices, manufacturing, R&D, customer service, and sales    Ultrasound

Canton, MA

     Leased         33,000       R&D, customer service, and sales    Medical Imaging

Herlev, Denmark (2)

     Owned         135,000       Administrative offices, R&D, customer service, and sales    Ultrasound

Shanghai, China (3)

     Owned         145,000       Administrative offices, manufacturing, customer service, and sales    Medical Imaging and Ultrasound

Montreal, Canada

     Leased         54,000       Administrative offices, manufacturing, R&D, customer service, and sales    Medical Imaging

Vancouver, Canada (4)

     Leased         31,000       Administrative offices, manufacturing, R&D, customer service, and sales    Ultrasound

 

(1) We own approximately 58 acres of land at this location, which can accommodate future expansion as required.
(2) We are not currently utilizing all the space of this facility. We have leased a portion of this facility and are currently in process of exploring various uses for the unused space.
(3) Our Shanghai, China facility, built on leased land, opened in April 2012.
(4) This property was assumed as part of the acquisition of Ultrasonix in March 2013.

We lease a number of other smaller facilities in locations such as the United Kingdom, Germany, Italy, Sweden and Belgium.

We believe that our existing facilities are generally adequate to meet our current needs, and that suitable additional or substitute space will be available on commercially reasonable terms when needed. Refer to Note 12 to the Consolidated Financial Statements included in this report for further information concerning certain leases.

 

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Item 3. Legal Proceedings

For a discussion of legal matters as of July 31, 2014, please read Note 11 to the notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K, which is incorporated into this item by reference.

 

Item 4. Mine Safety Disclosure

Not applicable.

 

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Executive Officers of the Registrant

Our current executive officers are:

 

Name

  Age    

Position

  Date Since Office
Has Been Held
 

James W. Green

    56      President and Chief Executive Officer     2007   

Michael L. Levitz

    41      Senior Vice President, Chief Financial Officer, and Treasurer     2009   

John J. Fry

    52      Senior Vice President, General Counsel, and Secretary     2007   

Mervat Faltas

    62      Senior Vice President and General Manager Medical Imaging Business     2010   

Farley Peechatka Jr.

    52      Senior Vice President and General Manager Ultrasound Segment     2011   

Our executive officers are elected annually by our board of directors and hold office until their successors are chosen and qualified, subject to earlier removal by the board of directors.

There are no arrangements or understandings between any of our executive officers and any other person(s) pursuant to which such executive officer was selected as an officer.

James W. Green has been our President and Chief Executive Officer since 2007. From 2005 to 2007, Mr. Green was Regional Vice President, California Division, of Quest Diagnostics Incorporated, a leading provider of diagnostic testing, information, and services. Before joining Quest, Mr. Green served as Senior Vice President & General Manager of Computed Tomography for Philips Medical Systems, a global leader in the business of developing, manufacturing, marketing, and servicing medical computed tomography systems.

Michael L. Levitz is our Senior Vice President, Chief Financial Officer, and Treasurer. Mr. Levitz joined us in July 2009. From October 2007 to July 2009, Mr. Levitz was Vice President and Controller of the Cytyc business unit of Hologic Inc., a developer, manufacturer, and supplier of premium diagnostic products, medical imaging systems, and surgical products focused on the healthcare needs of women. From September 2002 until Cytyc Corporation’s merger with Hologic Inc. in October 2007, Mr. Levitz served in various capacities at Cytyc Corporation, including Vice President and Corporate Controller. Mr. Levitz began his career in the audit practice of Arthur Andersen LLP and is a certified public accountant.

John J. Fry is our Senior Vice President, General Counsel, and Secretary. He joined us in November 2007. From April 2005 until joining us, Mr. Fry was a principal of the law firm Driggs, Hogg, & Fry Co., L.P.A. (formerly Driggs, Lucas, Brubaker & Hogg Co., L.P.A.), where his practice focused primarily on technology and intellectual property law. From August 1995 to April 2005, he held various legal positions at Philips Medical Systems (formerly Marconi Medical Systems and Picker International), including Senior Corporate Counsel and Intellectual Property Manager and counsel to Philips’ computed tomography business.

Mervat Faltas has served as Senior Vice President and General Manager of our Medical Imaging segment since May 2010. She joined ANRAD Corporation, our Canadian subsidiary now known as Analogic Canada Corporation, in July 2005 as Vice President of Operations and was named President of ANRAD in January 2006. From May 2000 until June 2005, Mrs. Faltas served in various capacities at ITF Optical Technologies, a Montreal-based provider of fiber optic components for terrestrial and undersea communication networks, including as President and CEO. From 1990 to 2000, Mrs. Faltas held various positions at PerkinElmer Corporation, including General Manager of PerkinElmer’s Montreal operation.

Farley Peechatka Jr. has served as Senior Vice President and General Manager of our Ultrasound segment since May 2011. Mr. Peechatka joined us in November of 2002 as Vice President of Operations of our Sound Technology, Inc., or STI, subsidiary upon our acquisition of STI from Siemens Medical. Mr. Peechatka became President of STI in October 2008. Mr. Peechatka is a co-founder of Sound Technology, a leading provider of medical ultrasound transducers, and held multiple positions in the company, most recently as the Vice President of Operations and President. Prior to founding Sound Technology in 1987, he held engineering positions with Johnson & Johnson and GE ultrasound.

 

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PART II

 

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock trades on the NASDAQ Global Select Market under the symbol: ALOG. The following table sets forth the high and low sales prices per share of our common stock, as reported by the NASDAQ Global Select Market, for each quarterly period indicated in the table below:

 

Fiscal Year

   High      Low  

2014

     

First Quarter

   $ 96.30       $ 70.91   

Second Quarter

     98.00         82.36   

Third Quarter

     99.97         74.77   

Fourth Quarter

     80.33         65.63   

2013

     

First Quarter

   $ 84.71       $ 62.49   

Second Quarter

     79.85         66.05   

Third Quarter

     81.55         71.64   

Fourth Quarter

     82.87         68.86   

As of August 31, 2014, there were approximately 617 holders of record of our common stock. Because many of the shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of individual stockholders represented by these holders of record. Our board of directors declared cash dividends of $0.10 per share for each of the quarters of fiscal years 2014 and 2013. We intend to pay a regular quarterly cash dividend subject to, among other things, our results of operations, cash balances, future cash requirements, financial condition, and other factors that our board of directors may deem relevant. Our policy is to retain sufficient earnings to provide funds for the operation and expansion of our business.

The following table contains information about our purchases of our equity securities during the three months ended July 31, 2014.

 

Period

   Total Number of
Shares
Purchased (1) (2)
     Average Price Paid
per Share (2)
     Total Number of
Shares Purchased
as Part of Publicly
Announced  Plans or
Programs (2)
     Approximate Dollar Value
of Shares that May

Yet Be Purchased Under the
Plans or Programs (000’s)
 

5/1/2014-5/31/2014

     25,208       $ 74.39         25,208       $ 1,152   

6/1/2014-6/30/2014

     18,795         71.81         18,100         29,779   

7/1/2014-7/31/2014

     33,002         76.10         15,808         28,575   
  

 

 

    

 

 

    

 

 

    

Total

     77,005       $ 74.06         59,116       $ 28,575   
  

 

 

       

 

 

    

 

(1) Includes 695 and 17,194 shares of our common stock surrendered by employees in order to meet tax withholding obligations in connection with the vesting of restricted stock in June and July 2014, respectively. For purposes of determining the number of shares to be surrendered by employees to meet tax withholding obligations, the price per share deemed to be paid was the closing price of our common stock on the NASDAQ Global Select Market on the vesting date.
(2) During the fourth quarter of fiscal year 2014, we repurchased 59,116 shares of our common stock in open-market transactions for $4.4 million at an average purchase price of $74.06 per share. During the fourth quarter of fiscal year 2014, 40,433 shares were purchased under the repurchase program authorized by our board of directors that was publicly announced on December 8, 2011 and 18,683 shares were purchased under the repurchase program of up to $30.0 million of our common stock authorized by our board of directors that was publicly announced on June 3, 2014. The repurchase programs do not have a fixed expiration date.

 

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Comparison of Five-Year Cumulative Total Returns

The graph below compares the cumulative total stockholder return on our common stock with the cumulative total return of the Center for Research in Security Prices of the University of Chicago, or CRSP, Total Return Index for the NASDAQ Stock Market (US Companies), the Russell 2000 Index, and the CRSP Total Return Index for all NASDAQ stocks with SIC Codes related to our business in the areas of measuring instruments, photo goods, medical goods, optical goods, and timepieces. The graph assumes $100 invested on July 31, 2009, in our common stock and $100 invested at that time in each of the indexes. The comparison assumes that all dividends are reinvested.

 

LOGO

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

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Item 6. Selected Consolidated Financial Data

The following selected consolidated financial data are derived from our audited Consolidated Financial Statements and the notes thereto and should be read in connection with, and are qualified in their entirety by, our audited Consolidated Financial Statements and the notes thereto and other financial information included elsewhere in this Annual Report on Form 10-K.

 

     (In millions, except share and per share data)  
     Years Ended July 31,  
     2014      2013      2012      2011      2010  

Total net revenue

   $ 517.5       $ 550.4       $ 516.6       $ 473.6       $ 414.8   

Total cost of sales

     297.8         333.7         323.4         300.6         266.9   

Gross profit

     219.7         216.7         193.2         173.0         147.9   

Income from operations (A)

     29.1         45.4         40.0         20.7         21.3   

Income from continuing operations (B)

     34.5         31.1         43.1         16.6         15.8   

Income (loss) from discontinued operations, net of tax

     —           —           —           0.3         (0.2

Gain on disposal of discontinued operations, net of tax (C)

     —           —           —           0.9         —     
                                              

Net income

   $ 34.5       $ 31.1       $ 43.1       $ 17.8       $ 15.6   
                                              

Basic net income per share:

              

Income from continuing operations

   $ 2.78       $ 2.54       $ 3.51       $ 1.33       $ 1.26   

Income (loss) from discontinued operations, net of tax

     —           —           —           0.02         (0.02

Gain on disposal of discontinued operations, net of tax

     —           —           —           0.08         —     
                                              

Basic net income per share

   $ 2.78       $ 2.54       $ 3.51       $ 1.43       $ 1.24   
                                              

Diluted net income per share:

              

Income from continuing operations

   $ 2.72       $ 2.48       $ 3.42       $ 1.33       $ 1.25   

Income (loss) from discontinued operations, net of tax

     —           —           —           0.02         (0.02

Gain on disposal of discontinued operations, net of tax

     —           —           —           0.07         —     
                                              

Diluted net income per share

   $ 2.72       $ 2.48       $ 3.42       $ 1.42       $ 1.23   
                                              

Cash dividends declared per common share

   $ 0.40       $ 0.40       $ 0.40       $ 0.40       $ 0.40   

Weighted average shares outstanding (000’s):

              

Basic

     12,404         12,247         12,265         12,491         12,584   

Diluted

     12,667         12,569         12,576         12,572         12,655   

Cash, cash equivalents and marketable securities

   $ 114.5       $ 113.0       $ 187.0       $ 169.7       $ 169.3   

Working capital

     289.3         269.5         308.9         294.4         281.7   

Total assets

     614.3         587.8         558.0         521.6         485.8   

Long-term liabilities

     17.2         10.5         11.7         9.3         6.7   

Stockholders’ equity

     512.6         486.4         446.3         423.5         409.0   

 

(A) In fiscal year 2014, we recorded acquisition-related expenses of approximately $8.7 million associated with the acquisition of Ultrasonix, which includes $7.8 million of amortization of acquired intangibles. During fiscal year 2014, we also recorded pre-tax restructuring charges of $2.9 million under the fiscal year 2014 restructuring plan primarily for severance and personnel related costs for 48 involuntarily terminated employees and $0.6 million in relation to the fiscal year 2013 restructuring plan primarily for facility exit costs, all of which were recognized in our Consolidated Statement of Operations under restructuring.

In fiscal year 2013, we recorded $5.6 million of acquisition-related expenses associated with the acquisition of Ultrasonix which includes $3.9 million of amortization of acquired intangibles. During fiscal year 2013, we also recorded pre-tax restructuring charges of $3.5 million primarily for severance and personnel related costs for 115 involuntarily terminated employees and facility exit costs, all of which were recognized in our Consolidated Statement of Operations under restructuring.

 

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There were no restructuring charges in fiscal year 2012. In fiscal year 2011, we recorded a pre-tax restructuring charge of $7.1 million primarily for severance and personnel related costs for 155 employees that were involuntarily terminated, all of which were recognized in our Consolidated Statement of Operations under restructuring. Also, in fiscal year 2011, we recorded a net of tax bargain purchase gain of $1.0 million in operating expenses related to the acquisition of an OEM ultrasound transducer and probe business in November 2010.

(B) In fiscal year 2014, we received certain discrete tax benefits totaling $8.8 million associated with a change in classification of our Canadian operations. Further discrete tax benefits recognized amounted to $3.8 million, of which $1.1 million related to reversal and remeasurement of reserves as a result of a favorable IRS tax audit and $2.7 million associated with a US tax benefit for historical currency losses incurred as a result of operating offshore in a non-functional currency. We also recorded a loss on investments in PocketSonics of $0.5 million resulting from the acquisition of PocketSonics on September 20, 2013.

In fiscal year 2012, we recorded a gain on the sale of other investments on a pre-tax basis of $2.5 million related to the sale of our remaining 25% equity interest in a China-based affiliate. In addition, during fiscal year 2012, we received a refund of $12.0 million as a result of the completion of an U.S. Internal Revenue Service, or IRS, audit of U.S. Federal income tax returns for the fiscal years ended July 31, 2003, 2005 and 2008. The refund was largely the result of Federal research and experimentation credits that carryover from the fiscal years 1991 through 2000 into the audited returns. We recorded a tax benefit for this refund, including the related interest, in the Consolidated Statement of Operations of $10.0 million in fiscal year 2012. Related to the refund and interest were contingent professional fees of $2.7 million that were recorded in general and administrative expenses in the Consolidated Statement of Operations in fiscal year 2012. In connection with the conclusion of the IRS audit, we recorded a benefit from the reversal and re-measurement of related tax reserves of $2.3 million in the Consolidated Statement of Operations in fiscal year 2012.

(C) In fiscal year 2011, we recorded a gain of $0.9 million, net of taxes, in discontinued operations, for the sale of our hotel.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion provides an analysis of our financial condition and results of operations and should be read in conjunction with the audited Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report on Form 10-K. The discussion contains statements, which, to the extent that they are not a recitation of historical facts, constitute “forward-looking statements” pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, including statements about product development, market and industry trends, strategic initiatives, regulatory approvals, sales, profits, expenses, price trends, R&D expenses and trends, and capital expenditures, we make in this document or in any document incorporated by reference are forward-looking. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors, which may cause our actual results, performance, or achievements to differ from the projected results. Refer to “Risk Factors” in Item 1A for a discussion of the primary risks and uncertainties known to us at this time.

Our Management’s Discussion and Analysis is presented in seven sections as follows:

 

   

Business Overview

 

   

Fiscal Year 2014 Financial Highlights

 

   

Results of Operations

 

   

Liquidity and Capital Resources

 

   

Impact of Investigation Regarding our Danish Subsidiary

 

   

Recent Accounting Pronouncements

 

   

Critical Accounting Policies

 

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We report our financial condition and results of operations on a fiscal year basis ending July 31.

Business Overview

Analogic is a high technology company that designs and manufactures advanced medical imaging, ultrasound and security systems and subsystems sold to original equipment manufacturers, or OEMs, and end users primarily in the healthcare and airport security markets.

Our business is strategically aligned into three segments: Medical Imaging, Ultrasound, and Security Technology. Our business segments are described as follows:

 

   

Medical Imaging primarily includes systems and subsystems for CT and MRI medical imaging equipment as well as state-of-the-art, selenium-based detectors for screening of breast cancer and other diagnostic applications in mammography.

 

   

Ultrasound includes ultrasound systems and transducers primarily in the urology, surgery (including robotic assisted surgery), anesthesia and point-of-care markets.

 

   

Security Technology includes advanced threat detection CT systems utilizing our expertise in advanced imaging technology, primarily used in the checked baggage screening at airports worldwide.

The following table sets forth the percentage of total net revenue by reporting segment for fiscal years 2014, 2013 and 2012.

 

     Years Ended July 31,  
     2014     2013     2012  

Medical Imaging

     57     58     59

Ultrasound

     30     27     29

Security Technology

     13     15     12
                          

Total net revenue

     100     100     100
                          

Fiscal Year 2014 Financial Highlights

The following table is a summary of our financial results for the fiscal years ended July 31, 2014 and 2013. This summary is not a substitute for the detail provided in the following pages or the audited Consolidated Financial Statements and notes that appear elsewhere in this document.

 

       Years Ended July 31,       Percentage
Change
 
(in millions, except per share amounts)        2014             2013        

Total net revenue

   $ 517.5      $ 550.4        -6

Gross profit

   $ 219.7      $ 216.7        1

Gross margin

     42.4     39.4  

Income from operations

   $ 29.1      $ 45.4        -36

Operating margin

     5.6     8.2  

Net income

   $ 34.5      $ 31.1        11

Diluted net income per share

   $ 2.72      $ 2.48        10

During fiscal year 2014 our total net revenue decreased by 6% as compared to the prior year due primarily to declines in sales in our Security Technology and Medical Imaging segments of 15% and 7% respectively, offset by growth in sales in our Ultrasound segment of 2% in fiscal year 2014.

Gross profit and gross margin improved in fiscal year 2014 versus the prior year due to a shift in mix from lower margin OEM product and engineering revenues to higher margin direct sales within the Ultrasound

 

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business, higher average selling prices in the period, and more efficient manufacturing operations in Shanghai, China and Montreal, Canada. These gross margin improvements were partially offset by the amortization of fair value step-up adjustments to inventory associated with our March 2013 acquisition of Ultrasonix.

Income from operations decreased 36% in fiscal year 2014 from the prior year due primarily to the 6% decline in our revenues and the increase in operating expenses on lower customer-funded engineering projects and the full year effect of the acquisition of Ultrasonix. This was partially offset by gross profit margin improvement along with cost reduction actions taken during the fiscal year.

During fiscal year 2014, we incurred pre-tax restructuring charges of $3.5 million, of which $2.9 million was primarily related to severance and personnel related costs of 48 involuntarily terminated employees under the 2014 restructuring plan, all of which were recognized in our Consolidated Statement of Operations under restructuring.

During September 2013, we acquired all of the remaining stock of PocketSonics, a privately held ultrasound technology company based in Charlottesville, Virginia. The purchase price included base consideration of $11.1 million paid in cash at closing, fair value of contingent consideration of $1.9 million, and revaluation of the initial equity investment. We undertook this acquisition to further strengthen our competitive position in procedure guidance for point-of-care and other advanced guidance applications. The acquisition was funded from our existing cash on hand and has been accounted for as an acquisition of a business.

Results of Operations

Fiscal Year 2014 Compared to Fiscal Year 2013

Net Revenue

Product Revenue

Product revenue for fiscal year 2014 as compared with fiscal year 2013 is summarized in the table below.

 

     Years Ended July 31,      Percentage
Change
 
(in millions)        2014              2013         

Product Revenue:

        

Medical Imaging

   $ 291.3       $ 305.6         -5

Ultrasound

     152.3         149.6         2

Security Technology

     65.9         71.6         -8
      

Total product revenue

   $ 509.5       $ 526.8         -3
      

Medical Imaging

During fiscal year 2014, our Medical Imaging product revenue decreased $14.3 million versus the prior comparable period, of which $13.6 million resulted from the exit of our legacy patient monitoring product line at the end of fiscal year 2013.

Ultrasound

During fiscal year 2014, our Ultrasound product revenue increased $2.7 million versus the prior year comparable period mainly driven by higher sales in our direct sales channel, including our primary markets of urology and surgery as well as expansion in the point-of-care market following our March 2013 acquisition of Ultrasonix. Revenue from products acquired in the acquisition of Ultrasonix represented $23.7 million and $10.1

 

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million for the fiscal year 2014 and fiscal year 2013, respectively. These increases in sales in our direct channel were largely offset by $9.0 million in lower OEM Ultrasound probe sales during fiscal year 2014 and fulfillment delays related to order timing.

Security Technology

During fiscal year 2014, our Security Technology product revenue decreased $5.7 million versus the prior year comparable period primarily driven by fewer sales of high-speed threat detection systems largely on delays in government tenders outside the U.S., partially offset by greater demand for medium-speed threat detection systems primarily for the U.S. market.

Engineering Revenue

Engineering revenue for fiscal year 2014 as compared with fiscal year 2013 is summarized in the table below.

 

     Years Ended July 31,      Percentage
Change
 
(in millions)        2014              2013         

Engineering Revenue:

        

Medical Imaging

   $ 4.3       $ 13.0         -67

Ultrasound

     0.2         0.2         —     

Security Technology

     3.5         10.4         -66
      

Total engineering revenue

   $ 8.0       $ 23.6         -66
      

Our business model includes customer-funded engineering projects that integrate our core technologies within our customer’s product portfolios. These projects vary substantially from period to period in terms of resource requirements, type, size, length of project, and profitability.

Medical Imaging

The $8.7 million decrease in engineering revenue for the fiscal year 2014 versus the prior year comparable periods was due primarily to winding down of certain customer-funded engineering projects as products complete the development phase prior to movement into production. In addition, we have been increasing our development of base platforms to enable scalable solutions that OEMs can bring to market more quickly and with less up-front development cost. This has resulted in an increase in our product gross margin but a corresponding decrease in customer-funded engineering projects.

Security Technology

The $6.9 million decrease in engineering revenue for the fiscal year 2014 versus the prior year comparable periods was due primarily to the timing of customer-funded engineering projects.

Gross Margin

Product Gross Margin

Product gross margin for fiscal year 2014, as compared with fiscal year 2013, is summarized in the table below.

 

     Years Ended July 31,     Percentage
Change
 
(in millions)    2014     2013    

Product gross profit

   $ 218.6      $ 213.3        2.5

Product gross margin

     42.9     40.5  

 

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The improvement in product gross margin during fiscal year 2014 versus the prior year comparable period was due primarily to a shift in product mix from lower margin OEM sales to higher margin direct sales within the Ultrasound business, higher average selling prices in the period, and more efficient manufacturing operations in Shanghai, China and Montreal, Canada. Gross margin also improved in fiscal year 2014 due to lower purchase accounting fair value adjustments to inventory associated with our March 2013 acquisition of Ultrasonix.

Engineering Gross Margin

Engineering gross margin for fiscal year 2014, as compared with fiscal year 2013, is summarized in the table below.

 

    

  Years Ended July 31,  

    Percentage
Change
 
(in millions)        2014             2013        

Engineering gross profit

   $ 1.1      $ 3.4        -67.6

Engineering gross margin

     13.8     14.4  

The decrease in engineering gross profit in fiscal year 2014 versus the prior year comparable period was a result of lower engineering revenue as customer-funded engineering projects completed the development phase before moving into production. Engineering gross margin remained consistent compared to the prior year comparable period.

Operating Expenses

Operating expenses are summarized as follows:

 

     Years Ended July 31,      Percentage of Net Revenue  
(in millions)        2014              2013                  2014                     2013          
Operating Expenses:           

Research and product development

   $ 73.8       $ 64.0         14.3     11.6

Selling and marketing

     59.2         51.3         11.4     9.3

General and administrative

     54.1         52.5         10.4     9.6

Restructuring

     3.5         3.5         0.7     0.6
   

Total operating expenses

   $  190.6       $  171.3         36.8     31.1
   

Operating expenses for the fiscal year 2014 increased $19.3 million, or 11.3% versus the prior year comparable period.

Research and product development expenses increased $9.8 million during fiscal year 2014 versus the prior year comparable period due to the reduction in customer-funded engineering projects, which resulted in an increase of $7.1 million in expenses. Additionally, $2.5 million is attributable to incremental engineering expenses resulting from our March 2013 acquisition of Ultrasonix and $0.7 million is attributable to severance during the period as we decreased our headcount and related expenses during fiscal year 2014 to align our resources with expected customer funded engineering requirements.

Selling and marketing expenses increased $7.9 million during fiscal year 2014 versus the prior year comparable period due primarily to $9.2 million of incremental point-of-care sales and marketing expenses resulting from our March 2013 acquisition of Ultrasonix, offset by a reduction in performance-based compensation expense.

General and administrative expenses increased by $1.6 million during fiscal year 2014 versus the prior year comparable period primarily due to general and administrative expenses of $1.2 million attributable to the inclusion of Ultrasonix in our operating results, approximately $1.4 million of incremental depreciation expense

 

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and $1.3 million in incremental accounting and legal costs (including $0.2 million of incremental BK Medical inquiry costs). These increases were partially offset by a reduction of $2.4 million in performance-based compensation expense.

Fiscal Year 2014 Restructuring Plan – During the fourth quarter of fiscal year 2014, we incurred pre-tax charges of $2.9 million, primarily relating to severance and personnel related costs for 48 involuntarily terminated employees associated with restructuring activities, including optimization of our operations in Peabody, Massachusetts, which are recognized in our Consolidated Statement of Operations under restructuring. The $2.9 million charge was recorded in the operating results of our Medical Imaging, Ultrasound, and Security Technology segments, with charges of $1.9 million, $0.5 million and $0.5 million, respectively.

Fiscal Year 2013 Restructuring Plan – During fiscal year 2013, we completed our acquisition of (i) all of the issued and outstanding shares of capital stock of Ultrasonix Medical Corporation, a Nevada corporation, and customer lists and intangibles related solely to sales destined to the U.S. and (ii) all of the outstanding equity securities of Ultrasonix Medical Corporation, which we refer to as Ultrasonix, a privately held company located in Vancouver, Canada, pursuant to a “plan of arrangement” under Canadian law. Ultrasonix is a supplier of advanced ultrasound systems for point-of-care and general imaging applications with over 5,000 systems installed worldwide. We undertook the acquisition to accelerate our expansion into the point-of-care ultrasound market. The purchase price, net of cash acquired, of $79.9 million, was finalized in July 2013. During fiscal year 2013, we incurred pre-tax charges of $3.5 million, primarily relating to severance and personnel related costs of 115 involuntarily terminated employees, as well as for facility exit costs associated with restructuring activities, including the consolidation of manufacturing and certain support activities currently conducted at the Ultrasonix facility in Vancouver, into operations at our existing facilities, closure of the Ultrasonix sales subsidiary in Paris, France, the transition costs associated with the planned closure of our Englewood, Colorado facility, as we consolidated manufacturing and development activities into our State College, Pennsylvania facility, and optimization of our operations in Montreal, Canada and Peabody Massachusetts, all of which were recognized in our Consolidated Statement of Operations under restructuring. Our pre-tax charges were included in the operating results of our Medical Imaging segment, Ultrasound segment and Security Technology segment. During fiscal year 2014, we incurred an additional $0.6 million restructuring and related charges with respect to the fiscal year 2013 restructuring plan related to facility exit costs. Of the total pre-tax charges of $0.6 million, we incurred $(0.2) million, $0.9 million, and $(0.1) million included in the operating results of our Medical Imaging, Ultrasound and Security Technology segments, respectively.

Restructuring and related charges, including actions associated with acquisitions, by segment are as follows:

 

     Years Ended July 31,  
(in millions)        2014              2013      

Medical Imaging

   $ 1.7       $ 1.1   

Ultrasound

   $ 1.4         2.2   

Security Technology

   $ 0.4         0.2   
                   

Restructuring and related charges

   $ 3.5       $ 3.5   
                   

Other Expense, Net

 

     Years Ended July 31,  
(in millions)        2014             2013      

Other expense, net:

    

Interest income, net

   $ 0.3      $ 0.4   

Loss on investment

   $ (0.5     —     

Other

   $ 0.1        (1.7
                  

Total other expense, net

   $ (0.1   $ (1.3
                  

 

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Total other expenses, net during fiscal year 2014 was primarily comprised of interest income, net, of $0.3 million and the recognition of a $0.5 million loss related to our 10% pre-acquisition equity interest in PocketSonics recognized upon the completion of the acquisition of the remaining equity in PocketSonics in September 2013. Please refer to Note 3. Business Combinations to our Consolidated Financial Statements included in this report for further information about this acquisition.

Total other expenses, net during fiscal year 2013 predominantly comprised of $1.5 million of foreign currency transaction exchange losses primarily by our foreign subsidiaries in Denmark and China.

Provision for Income Taxes

The following table presents the provision for income taxes and our effective tax rate for the fiscal years ended July 31, 2014 and 2013:

 

     Years Ended July 31,  
(in millions)        2014             2013      

(Benefit from) provision for income taxes

   $ (5.4   $ 13.0   

Effective tax rate

     -19     29

Our effective income tax rate is based upon the composition of the income in different countries, and adjustments, if any, in the applicable quarterly periods for tax consequences, benefits, resolutions of tax audits, other tax contingencies or other discrete items.

Our effective tax rate before discrete items for fiscal year 2014 is lower than the statutory rate of 35%, primarily due to lower foreign tax rates and tax credits in the U.S. and Canada. The tax provision for fiscal year 2014 includes certain discrete tax benefits totaling $12.9 million. The discrete tax benefit for fiscal year 2014 consists primarily of a reduction in a net deferred tax liability of $8.8 million associated with a change in classification of our Canadian operations, a $2.7 million benefit associated with a U.S. deduction for historical currency losses incurred as a result of operating offshore in a non-functional currency, and a $1 million reduction in uncertain tax positions primarily associated with federal tax credits for research and development, or R&D credits, following the conclusion of an Internal Revenue Service, or IRS, review for fiscal year 2009, along with $0.4 million of other items.

The effective tax rate for fiscal year 2013 was lower than the statutory rate of 35% due primarily to the reversal of tax reserves on U.S. federal and state tax returns as a result of the expiration of applicable statutes of limitations of $0.6 million including interest, the impact from retroactive extension of the U.S. R&D credit of $0.5 million, ongoing benefits of U.S. R&D credits, U.S. deductions for manufacturing activity, and lower foreign tax rates as compared to the U.S. statutory rate of 35%.

Net Income and Diluted Net Income Per Share

Net income and diluted net income per share from operations for fiscal years 2014 and 2013 were as follows:

 

     Years Ended July 31,  
(In millions except per share data)        2014             2013      

Net Income

   $ 34.5      $ 31.1   

% of net revenue

     6.7     5.7

Diluted net income per share

   $ 2.72      $ 2.48   

The increase in net income for fiscal year 2014 versus the prior year was due to a net tax benefit from income taxes in fiscal year 2014 as compared to fiscal year 2013, which offset lower income from operations during the period due to a decrease in customer-funded engineering projects and an increase in operating expenses resulting from the fiscal year 2013 acquisition of Ultrasonix.

 

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Fiscal Year 2013 Compared to Fiscal Year 2012

Net Revenue

Product Revenue

Product revenue for fiscal year 2013 as compared with fiscal year 2012 is summarized in the table below.

 

(in millions)    Years Ended July 31,      Percentage
Change
 
       2013              2012         

Product Revenue:

        

Medical Imaging

   $ 305.6       $ 290.7         5

Ultrasound

     149.6         151.2         -1

Security Technology

     71.6         52.8         35
                      

Total product revenue

   $ 526.8       $ 494.7         6
                      

Medical Imaging

During fiscal year 2013, as compared to the prior year, product revenue increased $14.9 million largely due to growing global demand for high-power MRI subsystems. Product revenue from our other product lines in this segment were flat overall compared to the prior year, as a slight decrease in CT sales was offset by increased sales of our mammography detectors.

Ultrasound

During fiscal year 2013, as compared to the prior year, product revenue decreased $1.6 million on lower OEM transducer sales, partially offset by higher sales through our direct sales channel. Sales in our direct channel included $10.1 million of revenue from our Ultrasonix products following the March 2, 2013 acquisition of Ultrasonix. Apart from the incremental revenues following the Ultrasonix acquisition, revenue in our direct channel was lower as compared to the prior year due to weakness in the ultrasound market as well as the temporary sales force disruption related to our continued sales force expansion as well as channel integration following the acquisition of Ultrasonix.

Security Technology

During fiscal year 2013, as compared to the prior year, product revenue increased $18.8 million due to strong shipments of high-speed threat detection systems as demand for CT-based explosives threat detection grew outside the U.S. These shipments included both increased sales of high-speed systems to L-3 as well as initial shipments of high-speed systems to Smiths following regulatory approval in fiscal year 2013 of their high-speed system incorporating our CT-based detection technology.

Engineering Revenue

Engineering revenue for fiscal year 2013 as compared with fiscal year 2012 is summarized in the table below.

 

(in millions)    Years Ended July 31,      Percentage
Change
 
       2013              2012         

Engineering Revenue:

        

Medical Imaging

   $ 13.0       $ 11.1         17

Ultrasound

     0.2         —           n/a   

Security Technology

     10.4         10.8         -3
                      

Total engineering revenue

   $ 23.6       $ 21.9         8
                      

 

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Our business model includes customer-funded engineering projects that integrate our core technologies within our customer’s product portfolios. These projects vary substantially from period to period in terms of resource requirements, type, size, length of project, and profitability.

Medical Imaging

The increase for fiscal year 2013 versus the prior year was primarily due to increased work on customer-funded engineering projects.

Ultrasound

The increase for fiscal year 2013 versus the prior year was primarily due to work on a customer-funded engineering project.

Security Technology

The decrease for fiscal year 2013 versus the prior year was due primarily to the timing of work performed on our Security Technology development projects.

Gross Margin

Product Gross Margin

Product gross margin for fiscal year 2013, as compared with fiscal year 2012, is summarized in the table below.

 

     Years Ended July 31,     Percentage
Change
 
(in millions)        2013             2012        
      

Product gross profit

   $ 213.3      $ 192.4        10.9

Product gross margin

     40.5     38.9  

Product gross profit increased significantly in fiscal year 2013, versus the prior year comparable period, due to higher volume along with global manufacturing process and cost improvements in all three of our business segments. The increased product gross profit was driven by increased gross profit of $12.5 million on higher product revenue, lower scrap and production rework costs from improved vendor component quality inspection process in our digital mammography product line of approximately $4.1 million, lower manufacturing costs following the consolidation of our manufacturing operations of approximately $3.9 million, and cost savings of approximately $3.0 million as we ramp up production at our lower cost Shanghai operation, which opened in the latter half of fiscal 2012. Partially offsetting the lower costs were the amortization of intangible assets and the fair value inventory step-up adjustment of $3.0 million relating to our acquisition of Ultrasonix.

Engineering Gross Margin

Engineering gross margin for fiscal year 2013 as compared with fiscal year 2012 is summarized in the table below.

 

     Years Ended July 31,     Percentage
Change
 
      
(in millions)        2013             2012        

Engineering gross profit

   $ 3.4      $ 0.8        328.1

Engineering gross margin

     14.4     3.6  

 

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The increase in the engineering gross margin in fiscal year 2013, versus the prior year comparable period was primarily due to the mix of engineering projects worked on during each period as well as the impact of performance-based equity and cash incentive compensation, directly related to changes in operating results.

Operating Expenses

Operating expenses are summarized as follows:

 

     Years Ended July 31,      Percentage of Net Revenue  
(in millions)          2013                  2012                  2013                 2012        

Operating Expenses:

          

Research and product development

   $ 64.0       $ 57.2         11.6     11.1

Selling and marketing

     51.3         44.2         9.3     8.6

General and administrative

     52.5         51.8         9.6     10.0

Restructuring

     3.5         —           0.6     0.0
                                    

Total operating expenses

   $ 171.3       $ 153.2         31.1     29.7
                                    

Operating expenses for the fiscal year 2013 increased $18.1 million, or 11.8% versus the prior year comparable period.

Research and product development expenses increased in fiscal year 2013, versus the prior year comparable period, primarily due to approximately $5.3 million of incremental internal and contract personnel related expenses on internally-funded research and product development projects, and the addition of approximately $1.5 million of research and development costs from Ultrasonix following the March 2013 acquisition.

Selling and marketing expenses increased in fiscal year 2013, versus the prior year comparable period, primarily as a result of the acquisition of Ultrasonix in March 2013. The acquisition of Ultrasonix added approximately $5.3 million of selling and marketing expenses in fiscal year 2013. We also added selling and marketing expenses of approximately $1.7 million related to expansion of our existing sales force in North America.

General and administrative expenses increased in fiscal year 2013, versus the prior year comparable period, due primarily to approximately $1.1 million of partial-year operating expenses in the Ultrasonix Vancouver, Canada facility following the March 2013 acquisitions, $1.2 million of acquisition-related expenses, $1.0 million of incremental audit costs, and $0.4 million associated with the medical device tax under the Patient Protection and Affordable Care Act that went into effect in fiscal year 2013, partially offset, by a decrease of approximately $2.7 million in contingent consulting related to the income tax refund and related interest received in fiscal year 2012.

During March 2013, we completed our acquisition of (i) all of the issued and outstanding shares of capital stock of Ultrasonix Medical Corporation, a Nevada corporation, and customer lists and intangibles related solely to sales destined to the U.S. and (ii) all of the outstanding equity securities of Ultrasonix Medical Corporation, which we refer to as Ultrasonix, a privately held company located in Vancouver, Canada, pursuant to a “plan of arrangement” under Canadian law. Ultrasonix is a supplier of advanced ultrasound systems for point-of-care and general imaging applications with over 5,000 systems installed worldwide. We undertook the acquisition to accelerate our expansion into the point-of-care ultrasound market. The purchase price, net of cash acquired, was $79.9 million.

During fiscal year 2013, we incurred pre-tax charges of $3.5 million, primarily relating to severance and personnel related costs of 115 employees that were involuntarily terminated, the Ultrasonix manufacturing consolidation, the transition costs to begin the closure of the Englewood facility, optimization of our global operations and other charges under our approved plan of restructuring, all of which were recognized in our consolidated statement of operation under restructuring in fiscal year 2013.

 

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Restructuring and related charges, including actions associated with acquisitions, by segment are as follows:

 

     Years Ended July 31,  
(in millions)          2013                  2012        

Medical Imaging

   $ 1.1       $ —     

Ultrasound

     2.2         —     

Security Technology

     0.2         —     
                   

Restructuring and related charges

   $ 3.5       $ —     
                   

Other (Expense) Income, Net

 

     Years Ended July 31,  
  
(in millions)          2013                 2012        

Other (expense) income, net:

    

Interest income, net

   $ 0.4      $ 0.5   

Gain on sale of investments

     —          2.5   

Other

     (1.7     1.2   
                  

Total other (expense) income, net

   $ (1.3   $  4.2   
                  

Total other expense, net in fiscal year 2013 consisted primarily of foreign currency transaction exchange losses by our foreign subsidiaries of $1.5 million.

Total other income, net in fiscal year 2012 consisted of income of approximately $0.4 million from the resolution of obligations for a former facility in the third quarter of fiscal year 2012. The gain on sale of other investments in fiscal year 2012 of $2.5 million was from the sale of our 25% equity interest in our China-based affiliate. The book value of this investment was written down to $0 in fiscal year 2006. The other income of $1.2 million consisted primarily of foreign currency transaction exchange gains by our foreign subsidiaries.

Provision for Income Taxes

 

     Years Ended July 31,  
(in millions)          2013                 2012        

Provison for income taxes

   $ 13.0      $ 1.1   

Effective tax rate

     29     3

Our effective income tax rate is based upon the composition of the income in different countries, and adjustments, if any, in the applicable quarterly periods for tax consequences, benefits, resolutions of tax audits, tax contingencies or other discrete items.

The effective tax rate for fiscal year 2013 was lower than the statutory rate of 35% due primarily to the reversal of tax reserves on U.S. federal and state tax returns as a result of the expiration of applicable statutes of limitations of $0.6 million including interest, the one-time impact from retroactive extension of the U.S. R&D credit of $0.5 million, ongoing benefits of U.S. R&D credits, U.S. deductions for manufacturing activity, and lower foreign tax rates as compared to the U.S. statutory rate of 35%.

The effective tax rate for fiscal year 2012 of 3% was due primarily to a discrete benefit of $10.0 million from the receipt of an IRS tax refund, including the related interest, and reversal and re-measurement of related tax reserves of $2.3 million. The decrease in the effective rate in fiscal year 2012 was partially offset by the unfavorable impact of the expiration of the U.S. R&D credit on December 31, 2011.

 

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Net Income and Diluted Net Income Per Share

Net income and diluted net income per share for fiscal years 2013 and 2012 were as follows:

 

     Years Ended July 31,  
(in millions except per share data)        2013             2012      

Net Income

   $ 31.1      $ 43.1   

% of net revenue

     5.7     8.3

Diluted net income per share

   $ 2.48      $ 3.42   

The decrease in net income for fiscal year 2013 versus the prior year comparable period was primarily due to income in fiscal year 2012 related to the benefit from an IRS refund of $7.3 million, net of associated costs, and a pre-tax gain of $2.5 million from sale of an equity investment in fiscal year 2012, which offset improvements in our operating results in fiscal year 2013.

Liquidity and Capital Resources

Key liquidity and capital resources information is summarized in the table below.

 

(in millions)    July 31, 2014      July 31, 2013      Percentage Change  

Cash and cash equivalents (A)

   $ 114.5       $ 113.0         1

Working capital

   $ 289.3       $ 269.5         7

Stockholders’ equity

   $ 512.6       $ 486.4         5

 

(A) Includes approximately $57.9 million and $49.7 million of cash and cash equivalents held outside the U.S. as of July 31, 2014 and 2013, respectively.

The increase in cash and cash equivalents from July 31, 2013 to July 31, 2014 was due primarily to net income during the period and the collection of receivables which was partially offset by the net cash payment of $10.6 million for the acquisition of PocketSonics in September 2013 and purchases of property, plant and equipment of $17.5 million, from existing cash on hand. The increase in stockholder’s equity from July 31, 2013 to July 31, 2014 was primarily driven by recorded net income in the period.

Cash and cash equivalents at July 31, 2014 and July 31, 2013 primarily consisted of demand deposits at highly rated banks and financial institutions. We believe that our cash equivalents were appropriately valued at July 31, 2014 and July 31, 2013 and we are not aware of any market events that would impact their valuation. This could change in the future should new developments arise in the credit markets.

The carrying amounts reflected in the Consolidated Balance Sheets of cash and cash equivalents, trade receivables, and trade payables approximate fair value at July 31, 2014, due to the short-term maturities of these instruments.

We have revolving credit facilities of up to $104 million available for direct borrowings. We did not have any borrowings outstanding under these credit facilities as of July 31, 2014 and 2013. For further details surrounding the revolving credit facilities, please refer to the Commitments, Contractual Obligations and Off-Balance Sheet Arrangements section.

 

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Cash Flows

The following table summarizes our sources and uses of cash over the periods indicated:

 

     Years Ended July 31,  
(in millions)    2014     2013     2012  

Net cash provided by operating activities

   $ 47.9      $ 41.4      $ 73.7   

Net cash used for investing activities

     (28.5     (104.7     (27.9

Net cash used for financing activities

     (18.2     (12.1     (26.5

Effect of exchange rate changes on cash

     0.3        1.4        (1.9
                          

Net increase (decrease) in cash and cash equivalents

   $ 1.5      $ (74.0   $ 17.4   
                          

Operating activities

The cash flows provided by operating activities during fiscal year 2014 primarily reflects our net income of $34.5 million, non-cash charge for depreciation and amortization of $22.1 million, and decrease in accounts receivable of $6.6 million, offset by an increase in inventory of $12.3 million related to increase in safety stock as we consolidate our manufacturing operations following the acquisition of Ultrasonix and support new product launches.

The cash flows provided by operating activities in fiscal year 2013 primarily reflects our net income of $31.1 million, non-cash charges for depreciation and amortization expenses of $17.3 million and increase in net working capital. The increase in working capital from fiscal year 2012 to fiscal year 2013 was mainly due to an increase in accounts receivable of $10.5 million due primarily to higher sales volumes in the three months ended July 31, 2013 as compared to the same period of fiscal year 2012, increase in inventory of $2.1 million from our acquisition of Ultrasonix and increase in accounts payable of $12.0 million.

The cash flows provided by operating activities in fiscal year 2012 primarily reflects our net income of $43.1 million, non-cash charges for depreciation and amortization of $17.8 million and net decrease in working capital of $2.5 million. Also contributing to the increase was a tax refund of $12.0 million.

Investing activities

The net cash used for investing activities during fiscal year 2014 was primarily driven by the acquisition of PocketSonics, net of cash acquired, of $10.6 million as well as purchases of property, plant and equipment of $17.5 million. Our capital expenditures are primarily related to infrastructure and test equipment investments to support our growth, but are lower as compared to the last two fiscal years due to the completion of infrastructure investments associated with our facilities in State College, Pennsylvania and Shanghai, China.

The net cash used for investing activities in fiscal year 2013 was driven by our March 2013 acquisition of Ultrasonix of $79.3 million and purchases of property, plant, and equipment of $25.6 million for our facility in State College, Pennsylvania, as well as global manufacturing and test capacity and other infrastructure investments to support our growth.

The net cash used for investing activities in fiscal year 2012 was due primarily to purchases of property, plant, and equipment of $30.6 million, of which approximately $15.6 million relates to the construction of our manufacturing facility in Shanghai, China and the purchase of a facility in State College, Pennsylvania. The capital spending was partially offset by the proceeds of $2.5 million received from the sale of our 25% equity interest in our China-based affiliate during fiscal year 2012.

Financing activities

The net cash used for financing activities during fiscal year 2014 primarily reflected $15.0 million used to repurchase common stock, $7.7 million of shares surrendered for taxes paid related to vested employee restricted stock, and $5.0 million of dividends paid to shareholders. This was partially offset by the cash received associated with the exercise of stock options and the employee stock purchase plan of $5.4 million.

 

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The net cash used for financing activities in fiscal year 2013 primarily reflects $7.9 million used to repurchase common stock, $4.7 million of shares surrendered for taxes paid related to vested employee restricted stock, and $5.1 million of dividends paid to shareholders, partially offset by $4.7 million of proceeds related to the issuance of stock primarily from the exercise of employee stock options and $2.1 million excess tax benefit from share-based compensation.

The net cash used for financing activities in fiscal year 2012 primarily reflected $23.3 million used to repurchase common stock and $5.0 million of dividends paid to stockholders.

We believe that our balances of cash and cash equivalents and cash flows expected to be generated by future operating activities will be sufficient to meet our cash requirements for at least the next 12 months.

Commitments, Contractual Obligations and Off-Balance Sheet Arrangements

Our contractual obligations at July 31, 2014, and the effect such obligations are expected to have on liquidity and cash flows in future periods are as follows:

 

(in millions)                                                 

Contractual Obligations

   Total      2015      2016      2017      2018      2019      Thereafter  

Operating leases

   $ 6.7       $ 2.6       $ 1.4       $ 0.9       $ 0.6       $ 0.6       $ 0.6   

Purchasing obligations

     60.1         59.8         0.3         —           —           —           —     

Pension

     5.0         0.3         0.4         0.4         0.4         0.4         3.1   
                                                                

Total Contractual Obligations

   $ 71.8       $ 62.7       $ 2.1       $ 1.3       $ 1.0       $ 1.0       $ 3.7   
                                                                

Restructuring

During fiscal year 2014 and fiscal year 2013, we incurred restructuring charges for improving our operational effectiveness to better leverage core competencies across the business. For a more detailed description of our restructuring efforts, including our plan to consolidate facilities, please refer to Note 4 to the Consolidated Financial Statements included in this report.

Related Party Transactions

On July 25, 2011, we entered into an agreement to sell our 25% interest in a China-based affiliate for $2.5 million. The book value of the interest in the China-based affiliate was written down to $0 in fiscal year 2006, and we, upon final approval of the transaction by the Chinese government and receipt of the proceeds, recorded a gain on sale of other investments of $2.5 million in fiscal year 2012. Sales to this China-based affiliate were $0 for fiscal year 2012.

In April 2010, we invested $1.9 million in PocketSonics, a start-up company with proprietary ultrasound technology. Prior to our acquisition of the remaining equity of PocketSonics, we expensed $0.9 million and $1.5 million for engineering services from this start-up company during fiscal years 2013 and 2012, respectively. See Note 3 Business Acquisitions for further discussion.

Financing Arrangements

On October 11, 2011, we entered into a $100.0 million five-year, revolving credit agreement, or Credit Agreement, with the financial institutions identified therein as lenders, which included Santander Bank, TD Bank, N.A., and HSBC Bank USA, National Association. The Credit Agreement is guaranteed by our material domestic subsidiaries as designated by us from time to time or as required under the Credit Agreement, and is supported by a pledge of 65% of the capital stock and equity equivalents of our principal international subsidiary. The credit facility does not require amortization of principal and may be reduced before maturity in whole or in part at our option without penalty.

 

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Borrowings under the Credit Agreement may be used for general corporate purposes, including permitted acquisitions. The amount of the facility can be increased under specified circumstances up to $150.0 million in aggregate. We are the sole borrower under the Credit Agreement.

Interest rates on borrowings outstanding under the credit facility would range from 1.25% to 2.00% above the LIBOR rate, or, if we do not elect the LIBOR rate, from 0.00% to 1.00% above the defined base rate (which is the highest of (1) the prime rate, (2) the federal funds rate plus 0.50% or (3) one-month LIBOR plus 1%, in each case based upon our leverage ratio. A quarterly commitment fee ranging from 0.20% to 0.35% per annum is applicable on the undrawn portion of the credit facility, based upon our leverage ratio.

The Credit Agreement limits our ability to, among other things: incur additional indebtedness; incur liens or guarantee obligations; pay dividends or make other distributions; make investments; dispose of assets; and engage in transactions with affiliates except on an arms-length basis. In addition, the Credit Agreement requires us to maintain the following financial ratios:

 

   

A leverage ratio, defined as consolidated funded indebtedness to consolidated trailing four quarters EBITDA of no greater than 2.75:1.00 at any time; and

 

   

An interest coverage ratio, defined as the ratio of consolidated trailing four quarters EBITDA to consolidated interest charges of no less than 3.00:1.00 at any time.

At July 31, 2014, our leverage ratio was 0.003 and our interest coverage ratio was not applicable as we had no attributable interest expense. As of July 31, 2014, we were in full compliance with all financial and operating covenants.

Any failure to comply with the financial or operating covenants of the credit facility would prevent us from being able to borrow and would also constitute a default, permitting the lenders to, among other things, accelerate repayment of outstanding borrowings, including all accrued interest and fees, and to terminate the credit facility. A change in control of us, as defined in the Credit Agreement, would also constitute an event of default, permitting the lenders to accelerate repayment and terminate the Credit Agreement.

In connection with entering into this facility, we incurred approximately $0.5 million of transactions costs, which are being expensed over the five-year life of the credit facility.

We currently have approximately $4.4 million in other revolving credit facilities with banks available for direct borrowings. We did not have any borrowings outstanding under credit facilities as of July 31, 2014 and 2013.

Tax related obligations

We have $6.9 million of unrecognized tax benefits for uncertain tax positions and $0.6 million of related accrued interest and penalties. We are unable to reasonably estimate the amount and period in which these liabilities might be paid. Note 15 to our Consolidated Financial Statements included in this Annual Report on Form 10-K provide additional information regarding matters relating to income taxes, including unrecognized tax benefits.

Asset retirement obligations

The ultimate cost of restoring our leased facilities is difficult to predict given uncertainties regarding the extent of the required restoration and the interpretation of applicable laws and regulations. Based upon our experience, current information and applicable laws, we believe that it is probable that we will incur costs, including asset retirement obligations, of approximately $1.1 million as of July 31, 2014, which is included in “Other liabilities” in our Consolidated Balance Sheet. All accruals have been recorded without giving effect to any possible future insurance proceeds.

Note 11 to our Consolidated Financial Statements provides additional information regarding environmental matters, including asset retirement obligations.

 

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Impact of Investigation Regarding our Danish Subsidiary

As initially disclosed in our Annual Report on Form 10-K for the fiscal year ended July 31, 2011, we identified certain transactions involving our Danish subsidiary BK Medical ApS, or BK Medical, and certain of its foreign distributors, with respect to which we have raised questions concerning compliance with law, including Danish law and the U.S. Foreign Corrupt Practices Act, and our business policies. These have included transactions in which the distributors paid BK Medical amounts in excess of amounts owed and BK Medical transferred the excess amounts, at the direction of the distributors, to third parties identified by the distributors. We have terminated the employment of certain BK Medical employees and have wound down the relationships with the BK Medical distributors that were involved in the transactions. We have concluded that the transactions identified to date have been properly accounted for in our reported financial statements in all material respects. However, we have been unable to ascertain with certainty the ultimate beneficiaries or the purpose of these transfers. We have voluntarily disclosed this matter to the Danish Government, the U.S. Department of Justice, or DOJ, and the SEC and are cooperating with inquiries by the Danish Government, the DOJ and the SEC. We believe that the SEC and DOJ have substantially completed their investigation into the transactions at issue and that it is reasonably likely that one or both of these entities may seek to impose sanctions and/or penalties on us in connection with a resolution of their inquiries. We are unable to estimate the potential penalties and/or sanctions that may ultimately be assessed. During fiscal year 2014, we incurred inquiry-related costs of approximately $1.4 million in connection with this matter, as compared to $1.2 million in fiscal year 2013.

Recent Accounting Pronouncements

Recently adopted

Testing indefinite-lived intangible assets for impairment

In July 2012, the Financial Accounting Standards Board, or FASB, issued an update regarding testing indefinite-lived intangible assets for impairment. This update gives an entity the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is more likely than not that the indefinite-lived intangible asset is not impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount. An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The guidance was effective for the interim period ended October 31, 2013. We adopted this standard in the first quarter of fiscal year 2014. The adoption of this standard did not have a material impact on our financial condition or results of operations.

Presentation of unrecognized tax benefits

In July 2013, the FASB issued an update, which is intended to eliminate the diversity in practice with regard to the financial statement presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance was effective for our interim period ending January 31, 2014. We adopted this standard in the first quarter of fiscal year 2014 and presented this information in Note 15 to Consolidated Financial Statements included in this Annual Report on Form 10-K. The adoption of this standard did not have a material impact on our financial condition or results of operations.

 

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Not yet effective

Revenue from contracts with customers

In May 2014, the FASB issued an update which provides guidance for revenue recognition. This update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. This update will supersede existing revenue recognition requirement and most industry-specific guidance. This update also supersedes some cost guidance, including revenue recognition guidance for construction-type and production-type contracts. The update’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. This update will be effective for us in the first quarter of fiscal year 2018. Early adoption is not permitted. We are currently evaluating the impact of the adoption of this update on our Consolidated Financial Statements.

Foreign currency matters

In March 2013, the FASB issued an update which amends guidance on foreign currency matters and consolidations to address diversity in practice related to the release of cumulative translation adjustments, or “CTA”, into earnings upon the occurrence of certain derecognition events. The update reflects a compromise between the CTA release guidance included within foreign currency matters and the loss of control concepts included within consolidation guidance. It precludes the release of CTA for derecognition events that occur within a foreign entity, unless such events represent a complete or substantially complete liquidation of the foreign entity. Derecognition events related to investments in a foreign entity result in the release of all CTA related to the derecognized foreign entity, even when a noncontrolling financial interest is retained. The update also amends guidance on business combinations and for transactions that result in a company obtaining control of a business in a step acquisition by increasing an investment in a foreign entity from one accounted for under the equity method to one accounted for as a consolidated investment. The update is effective for fiscal years beginning after December 15, 2013. This update should be applied prospectively and prior periods should not be adjusted. This update is not expected to have an impact on our financial condition or results of operations. Early adoption is permitted as of the beginning of an entity’s fiscal year.

Critical Accounting Policies

Management’s discussion and analysis of our financial condition and results of operations are based on our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Our most critical accounting policies, and the estimates involved in their application, have a significant impact on the preparation of these Consolidated Financial Statements. These policies involve significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expense, and related disclosures of contingent assets and liabilities. We continue to evaluate our estimates and judgments on an on-going basis. By their nature, the policies discussed below require management to make its most difficult and subjective estimates and judgments, often on matters that are inherently uncertain. Our estimates and judgments are based on our historical experience, terms of existing contracts, our observance of trends in the industry, information provided by our customers, and information available from other outside sources, as appropriate.

For a complete discussion of our significant accounting policies, refer to Note 1, Summary of business operations and significant accounting policies , to Consolidated Financial Statements, included in Item 15, Exhibits and Financial Statements Schedule, of this Annual Report on Form 10-K. We believe the following accounting policies require management to make the most difficult estimates and judgments in the preparation of our Consolidated Financial Statements and accordingly are critical to an understanding of our financial statements.

 

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Revenue Recognition

We provide engineering services to some of our customers on a contractual basis and recognize revenue using the percentage of completion method. We estimate the progress towards completion on contracts with a fixed-fee arrangement on a monthly basis utilizing costs incurred to date as a percentage of total estimated costs at completion of the project or on a milestone basis based on contractual terms, as appropriate. When total cost estimates exceed revenues, we accrue for the estimated losses immediately.

Our revenue recognition accounting methodology for engineering services with a fixed fee arrangement involves uncertainties because it requires management to make estimates of our total estimated costs at completion of projects. The timing of when revenue, profits, and loss reserves are recognized may fluctuate if changes to the estimates of costs at completion of projects are needed.

Allocation of Consideration in Multiple Element Revenue Arrangements

We allocate arrangement consideration to each deliverable in an arrangement based on its relative selling price. We determine selling price using vendor specific objective evidence, or VSOE, if it exists, and otherwise third party evidence, or TPE. If neither VSOE nor TPE of selling price exists for a unit of accounting, we use our best estimated selling price, or BESP. We generally expect that we will not be able to establish TPE due to the nature of the markets in which we compete, and, as such, we typically will determine selling price using VSOE or if not available, BESP. If we are unable to establish selling price using VSOE or TPE, and the order was received or materially modified after July 31, 2009, we use BESP in the allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact if the product or service were sold by us on a standalone basis.

Our determination of BESP involves a weighting of several factors based on the specific facts and circumstances of the arrangement. Specifically, we will consider the cost to produce the deliverable, the anticipated margin on that deliverable, the selling price and profit margin for similar parts, our ongoing pricing strategy and policies (as evident in the price list as established and updated on a regular basis), the value of any enhancements that have been built into the deliverable and the characteristics of the varying markets in which the deliverable is sold.

Inventory

We value our inventory at the lower of the cost of the inventory or market in a manner that approximates the first-in first-out method. Management assesses the recoverability of inventory based on types and levels of inventory held, product life cycles, and changes in technology. A variety of methodologies are used to determine the amount of inventory write-downs necessary to adjust excess and obsolete inventory. Write-downs are based on the age of the inventory, lower of cost or market, along with significant management judgments concerning future demands for the inventory and technological obsolescence. If actual demand for our products is less than our estimates, or we experience a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, additional write-downs for existing inventories might be recorded in future periods. Once recorded, inventory adjustments are not subsequently reversed until the inventory is used or disposed of. Inventory includes demo equipment utilized by the sales force in the field.

Our inventory write-downs involve uncertainties because the calculation requires management to make assumptions and to apply judgment regarding inventory aging, forecasted customer demand, and technological obsolescence.

Share-based compensation

We have share-based compensation plans, which include stock options, restricted stock awards, and an employee stock purchase plan. We estimate the fair value of stock options using the Black-Scholes valuation model and the fair value of our restricted stock awards, which include shares of restricted stock

 

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and restricted stock units, based on the quoted market price of our common stock or the use of a Monte-Carlo Simulation Model.

We recognize the associated share-based compensation expense for time-based awards on a straight-line basis over the vesting periods of the awards, net of estimated forfeitures. Forfeiture rates are estimated based on historical pre-vesting forfeitures and are updated on the vesting dates to reflect actual forfeitures. The amount of share-based compensation expense for performance-based unvested restricted stock awards that is recognized on a straight-line basis over the performance period is based upon the number of shares that management ultimately expects to vest.

For performance-based awards with an earnings per share related target, management evaluates the probability of meeting the performance criteria at each balance sheet date and related compensation cost is amortized over the performance period on a straight-line basis because such awards vest only at the end of the measurement period. Changes to the probability assessment and the estimate of shares expected to vest will result in adjustments to the related share-based compensation expense that will be recorded in the period of the change. If the performance is not achieved, no compensation cost is recognized and any previously recognized compensation cost is reversed. For performance-based awards with a market condition related target, related compensation cost is amortized over the performance period on a straight-line basis, net of estimated forfeitures, regardless of whether the awards are ultimately earned.

Option-pricing models and generally accepted valuation techniques to value restricted stock awards with market conditions require management to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the future volatility of our stock price, expected dividend yield, future employee turnover rates and future employee stock option exercise behaviors. Performance-based non-vested restricted stock awards require management to make assumptions regarding the likelihood of achieving future company financial targets or personal performance goals. Changes in these assumptions can materially affect the fair value estimate and the amount of compensation expense we recognize.

Warranty Reserves

We estimate the costs of product warranties based on specific warranty claims, historical data, and engineering estimates, where applicable. Our warranty reserve involves uncertainties because the calculation requires management to make assumptions based on specific warranty claims, historical data, and engineering estimates, where applicable.

Business Combinations

We account for acquired businesses using the acquisition method of accounting, which requires that assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date. Transaction costs are expensed as incurred. Any excess of the consideration transferred over the fair values of the identifiable net assets acquired is recorded as goodwill. Any excess of the fair value of assets acquired over the purchase price is recorded as a bargain purchase gain in Other income (expense), net in the Consolidated Statements of Operations. This methodology involves uncertainties because it requires management to make assumptions and to apply judgment to estimate the fair value of acquired assets and liabilities. Management estimates the fair value of assets and liabilities based upon widely accepted valuation techniques, including discounted cash flows and market multiple analyses. Unanticipated events or circumstances may occur which could affect the accuracy of our fair value estimates, including assumptions regarding industry economic factors and business strategies.

Impairment of Goodwill and Indefinite Lived Intangible Assets

We evaluate goodwill and indefinite lived intangible assets for impairment annually and whenever events or changes in circumstances indicate the carrying value of the goodwill or other intangible assets may not be recoverable. We conduct our impairment evaluation by performing valuation analyses, which

 

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consider both the market approach and income approach for goodwill and the relief from royalty approach for the indefinite lived intangible assets Under the market approach, the fair value of the reporting unit is based on trading and acquisition multiples. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows. Under the relief from royalty approach, the fair value of the indefinite lived intangible asset is based on after tax royalty rate and discount rate applied to future forecasted sales. In the second quarter of fiscal year 2014, we completed our annual impairment testing of goodwill and indefinite lived intangible assets using the methodologies described herein, and determined there was no impairment.

The valuation analyses described above involve uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies. It is our policy to conduct impairment testing based on our current business strategy in light of present industry and economic conditions, as well as our future expectations.

Income Tax Contingencies

Our income tax returns, like those of most companies, are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities. In evaluating the exposures associated with our various tax filing positions, we record a liability for exposures subject to a minimum threshold of more likely than not before any benefit is recognized. A number of years may elapse before a particular matter, for which we have established a liability, is audited and fully resolved or clarified. We adjust our liability for unrecognized tax benefits and income tax provision in the period in which an uncertain tax position is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position or when more information becomes available.

Our liability for unrecognized tax benefits involves uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions.

Deferred Tax Valuation Allowances

We are required to estimate our income taxes in each of the jurisdictions within which we operate. This process involves assessing temporary differences resulting from different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the balance sheet. We must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance must be established.

Our effective income tax rate is affected by changes in tax law, the tax jurisdiction of new business ventures, the level of earnings and where they came from, and the results of tax audits. Our deferred tax valuation allowances involve uncertainties because the calculations require management to make assumptions based on historical data, future book income, and tax-planning strategies.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Certain of our foreign operations enter into transactions in currencies other than their functional currency, primarily the U.S. dollar and the Euro. We also have foreign currency exposure arising from the translation of our net equity investment in our foreign operations to U.S. dollars. We generally view our investments in foreign operations with functional currencies other than the U.S. dollar as long-term. The currencies to which we are exposed are the British pound, Canadian dollar, Chinese yuan, Danish kroner, Euro, and Japanese yen. 10% depreciation in the July 31, 2014 and 2013 functional currencies, relative to the U.S. dollar, would result in a reduction of stockholders’ equity of approximately $1.1 million and $1.2 million, respectively.

 

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We enter into forward contracts to hedge our foreign currency exposure in the Canadian dollar. These contracts have been designated as cash flow hedges, and the unrealized loss, net of tax, on these contracts is reported in within accumulated other comprehensive income (loss). Liability and asset derivatives designated as hedging instruments are presented in other assets and other liabilities, respectively, on our consolidated balance sheet. Realized (gains) losses on the cash flow hedges are recognized in income in the period when the payment of expenses is recognized. During fiscal year 2014 and 2013, we recorded approximately $(0.2) million and $0.1 million of realized (gains) losses included in cost of revenues and operating expenses in our Consolidated Statements of Operations. There are no outstanding forward contracts as of July 31, 2014.

We place our cash and cash equivalents in high quality financial instruments and, by policy, limit the amount of credit exposure to any one financial institution. Our cash includes cash equivalents, which we consider to be investments purchased with original maturities of three months or less. Total net interest income for fiscal years 2014 and 2013 was $0.3 million and $0.4 million, respectively. A 10% change in interest income or interest rate would not have a material impact on the fair value of our portfolio or on future earnings.

 

Item 8. Consolidated Financial Statements and Supplementary Data

The financial statements and supplementary data are listed under Part IV, Item 15 in this Annual Report on Form 10-K and are included at the end of this Annual Report on Form 10-K.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

 

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of July 31, 2014. The term “disclosure controls and procedures”, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to its management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions to be made regarding required disclosure. It should be noted that any system of controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met and that management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of July 31, 2014, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Management’s Annual Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures

 

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that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the interim or annual Consolidated Financial Statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management, with the participation of our chief executive officer and chief financial officer, conducted an evaluation of the effectiveness of our internal control over financial reporting as of July 31, 2014, based on the framework in Internal Control Integrated Framework (1992)  issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, our management concluded that, as of July 31, 2014, our internal control over financial reporting was effective based on those criteria.

The effectiveness of our internal control over financial reporting as of July 31, 2014 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

Changes in Internal Control Over Financial Reporting

There were no changes to our internal control over financial reporting during the fourth quarter ended July 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information

None.

 

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PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

We will file with the SEC a definitive proxy statement for our 2015 Annual Meeting of Stockholders not later than 120 days after the close of fiscal year 2014, or Proxy Statement. Certain information required by this item is incorporated herein by reference to the Proxy Statement under the captions “Proposal 1 – Election of Directors”, “Corporate Governance” and “Section 16(a) Beneficial Ownership Reporting Compliance”. Also refer to “Executive Officers of the Registrant” in Part I of this Annual Report on Form 10-K.

We have a code of ethics that applies to all of our employees and directors. This code (available on our website) satisfies the requirements set forth in Item 406 of Regulation S-K and applies to all relevant persons set forth therein. We intend to disclose on our website at www.analogic.com amendments to, and, if applicable, waivers of, our code of ethics.

 

Item 11. Executive Compensation

The information required by this item is incorporated herein by reference to the Proxy Statement under the captions “Executive Compensation”, “Director Compensation”, “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report”.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this item is incorporated herein by reference to the Proxy Statement under the captions “Security Ownership of Certain Beneficial Owners, Directors, and Management” and “Securities Authorized for Issuance Under Equity Compensation Plans”.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this item is incorporated herein by reference to the Proxy Statement under the captions “Corporate Governance” and “Certain Relationships and Related Transactions”.

 

Item 14. Principal Accountant Fees and Services

The information required by this item is incorporated herein by reference to the Proxy Statement under the caption “Independent Registered Public Accounting Firm’s Fees”.

 

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PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

                 Page
Number
 

(a)

        
     1.       Consolidated Financial Statements   
      Report of Independent Registered Public Accounting Firm      53   
      Consolidated Balance Sheets at July 31, 2014 and 2013      54   
      Consolidated Statements of Operations for the years ended July 31, 2014, 2013, and 2012      55   
     

Consolidated Statements of Comprehensive Income for the years ended July 31, 2014, 2013, and 2012

     56   
     

Consolidated Statements of Changes in Stockholders’ Equity for the years ended July 31, 2014, 2013, and 2012

     57   
      Consolidated Statements of Cash Flows for the years ended July 31, 2014, 2013, and 2012      58   
      Notes to Consolidated Financial Statements      59   
     2.       Financial Statement Schedule II – Valuation and Qualifying Accounts      98   
      Other schedules have been omitted because they are not required, not applicable, or the required information is furnished in the Consolidated Statements or notes hereto   

(b) The Index to Exhibits immediately following our Financial Statements and Financial Statement Schedule II is incorporated herein by reference.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    ANALOGIC CORPORATION
    By   / S /    J AMES W. G REEN        
Date: September 26, 2014      

James W. Green

President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Name

  

Title

 

Date

/ S /    J AMES W. G REEN        

James W. Green

  

President and Chief Executive Officer (Principal Executive Officer) and

Director

  September 26, 2014

/ S /    M ICHAEL L. L EVITZ        

Michael L. Levitz

  

Senior Vice President, Chief Financial Officer, and Treasurer (Principal Financial and Accounting Officer)

  September 26, 2014

/ S /    E DWARD F. V OBORIL        

Edward F. Voboril

  

Chairman of the Board

  September 26, 2014

/ S /    B ERNARD C. B AILEY        

Bernard C. Bailey

  

Director

  September 26, 2014

/ S /    J EFFREY P. B LACK        

Jeffrey P. Black

  

Director

  September 26, 2014

/ S /    J AMES J. J UDGE        

James J. Judge

  

Director

  September 26, 2014

/ S /    M ICHAEL T. M ODIC        

Michael T. Modic

  

Director

  September 26, 2014

/ S /    F RED B. P ARKS        

Fred B. Parks

  

Director

  September 26, 2014

/ S /    S OPHIE V. V ANDEBROEK        

Sophie V. Vandebroek

  

Director

  September 26, 2014

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Analogic Corporation

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a) (1) present fairly, in all material respects, the financial position of Analogic Corporation and its subsidiaries at July 31, 2014 and July 31, 2013, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of July 31, 2014 based on criteria established in Internal Control – Integrated Framework (1992)  issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Boston, Massachusetts

September 26, 2014

 

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ANALOGIC CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

     July 31,  
     2014      2013  
Assets      

Current assets:

     

Cash and cash equivalents

   $ 114,540       $ 113,033   

Accounts receivable, net of allowance for doubtful accounts of $800 and $598 as of July 31, 2014 and 2013, respectively

     106,436         113,150   

Inventory

     124,777         116,280   

Refundable and deferred income taxes

     18,599         7,803   

Other current assets

     9,422         10,147   
                   

Total current assets

     373,774         360,413   
                   

Property, plant and equipment, net

     114,165         110,983   

Intangible assets, net

     57,366         55,525   

Goodwill

     56,955         50,073   

Deferred income taxes

     7,475         5,439   

Other assets

     4,607         5,351   
                   

Total Assets

   $ 614,342       $ 587,784   
                   
Liabilities and Stockholders’ Equity      

Current liabilities:

     

Accounts payable

   $ 37,241       $ 32,138   

Accrued employee compensation and benefits

     16,305         22,264   

Accrued warranty

     5,968         6,501   

Accrued restructuring charges

     3,431         2,848   

Deferred revenue

     10,761         9,218   

Customer deposits

     3,046         3,256   

Accrued income taxes

     —           4,091   

Other current liabilities

     7,761         10,578   
                   

Total current liabilities

     84,513         90,894   
                   

Long-term liabilities:

     

Accrued income taxes

     5,211         5,031   

Deferred income taxes

     2,657         —     

Other long-term liabilities

     9,381         5,463   
                   

Total long-term liabilities

     17,249         10,494   
                   

Commitments, guarantees, and contingencies (Note 11)

     

Stockholders’ equity:

     

Common stock, $0.05 par value; 30,000,000 shares authorized and 12,372,992 shares issued and outstanding as of July 31, 2014; 30,000,000 shares authorized and 12,235,416 shares issued and outstanding as of July 31, 2013

     619         612   

Capital in excess of par value

     125,679         114,381   

Retained earnings

     378,477         362,255   

Accumulated other comprehensive income

     7,805         9,148   
                   

Total stockholders’ equity

     512,580         486,396   
                   

Total Liabilities and Stockholders’ Equity

   $ 614,342       $ 587,784   
                   

The accompanying notes are an integral part of these consolidated financial statements.

 

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ANALOGIC CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

     Years Ended July 31,  
     2014     2013     2012  

Net revenue:

      

Product

   $ 509,527      $ 526,725      $ 494,675   

Engineering

     8,021        23,638        21,896   
                          

Total net revenue

     517,548        550,363        516,571   
                          

Cost of sales:

      

Product

     290,951        313,458        302,288   

Engineering

     6,894        20,226        21,099   
                          

Total cost of sales

     297,845        333,684        323,387   
                          

Gross profit

     219,703        216,679        193,184   
                          

Operating expenses:

      

Research and product development

     73,828        63,990        57,230   

Selling and marketing

     59,157        51,268        44,238   

General and administrative

     54,147        52,527        51,753   

Restructuring

     3,483        3,519        —     
                          

Total operating expenses

     190,615        171,304        153,221   
                          

Income from operations

     29,088        45,375        39,963   
                          

Other (expense) income:

      

Interest income, net

     253        371        532   

(Loss) Gain on investments

     (484     —          2,500   

Other, net

     181        (1,649     1,204   
                          

Total other (expense) income, net

     (50     (1,278     4,236   
                          

Income before income taxes

     29,038        44,097        44,199   

(Benefit from) provision for income taxes

     (5,442     12,976        1,128   
                          

Net income

   $ 34,480      $ 31,121      $ 43,071   
                          

Net income per common share:

      

Basic

   $ 2.78      $ 2.54      $ 3.51   

Diluted

   $ 2.72      $ 2.48      $ 3.42   

Weighted average shares outstanding:

      

Basic

     12,404        12,247        12,265   

Diluted

     12,667        12,569        12,576   

Dividends declared and paid per share:

   $ 0.40      $ 0.40      $ 0.40   

The accompanying notes are an integral part of these consolidated financial statements.

 

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ANALOGIC CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

     Years Ended July 31,  
     2014     2013     2012  

Net income

   $ 34,480      $ 31,121      $ 43,071   

Other comprehensive income (loss), net of tax:

      

Foreign currency translation adjustment, net of tax

     (114     4,582        (7,605

Unrecognized gains (losses) on pension benefits, net of tax

     (1,332     2,409        (1,632

Unrealized gains (losses) on foreign currency forward contracts, net of tax

     103        (146     43   
                          

Total other comprehensive income (loss), net of tax

     (1,343     6,845        (9,194
                          

Total comprehensive income

   $ 33,137      $ 37,966      $ 33,877   
                          

The accompanying notes are an integral part of these consolidated financial statements.

 

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ANALOGIC CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Years Ended July 31, 2014, 2013, and 2012

(In thousands, except share data)

 

     Common Stock     Capital in Excess
of Par Value
    Retained
Earnings
    Accumulated  Other
Comprehensive
Income
    Total
Stockholders’
Equity
 
     Shares     Amount          

Balance, July 31, 2011

     12,535,007      $ 627      $ 85,407      $ 325,941      $ 11,497      $ 423,472   
                                                  

Shares issued for:

            

Stock options exercised

     35,922        2        1,624        —          —          1,626   

Stock grants and vesting of restricted stock units, net of shares traded for taxes

     8,019        —          2,004        —          —          2,004   

Stock purchase plan

     7,757        —          375        —          —          375   

Share-based compensation expense

     —          —          13,396        —          —          13,396   

Tax benefit from share-based compensation

     —          —          67        —          —          67   

Repurchase of common stock

     (423,981     (21     (2,651     (20,588     —          (23,260

Dividends declared ($0.40 per share)

     —          —          —          (5,238     —          (5,238

Net income for the year

     —          —          —          43,071        —          43,071   

Other comprehensive loss, net of tax

     —          —          —          —          (9,194     (9,194
                                                  

Balance, July 31, 2012

     12,162,724        608        100,222        343,186        2,303        446,319   
                                                  

Shares issued for:

            

Stock options exercised

     72,259        4        4,255        —          —          4,259   

Stock grants and vesting of restricted stock units, net of shares traded for taxes

     104,761        5        (3,126     —          —          (3,121

Stock purchase plan

     7,488        —          431        —          —          431   

Share-based compensation expense

     —          —          11,601        —          —          11,601   

Tax benefit from share-based compensation

     —          —          1,919        —          —          1,919   

Repurchase of common stock

     (111,816     (5     (921     (7,019     —          (7,945

Dividends declared ($0.40 per share)

     —          —          —          (5,033     —          (5,033

Net income for the year

     —          —          —          31,121        —          31,121   

Other comprehensive income, net of tax

     —          —          —          —          6,845        6,845   
                                                  

Balance, July 31, 2013

     12,235,416        612        114,381        362,255        9,148        486,396   
                                                  

Shares issued for:

            

Stock options exercised

     81,538        4        4,881        —          —          4,885   

Stock grants and vesting of restricted stock units, net of shares traded for taxes

     233,799        12        (7,634     —          —          (7,622

Stock purchase plan

     7,283        —          491        —          —          491   

Share-based compensation expense

     —          —          11,457        —          —          11,457   

Tax benefit from share-based compensation

     —          —          3,824        —          —          3,824   

Repurchase of common stock

     (185,044     (9     (1,721     (13,229     —          (14,959

Dividends declared ($0.40 per share)

     —          —          —          (5,029     —          (5,029

Net income for the year

     —          —          —          34,480        —          34,480   

Other comprehensive income, net of tax

     —          —          —          —          (1,343     (1,343
                                                  

Balance, July 31, 2014

     12,372,992      $ 619      $ 125,679      $ 378,477      $ 7,805      $ 512,580   
                                                  

The accompanying notes are an integral part of these consolidated financial statements.

 

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ANALOGIC CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Years Ended July 31,  
     2014     2013     2012  

OPERATING ACTIVITIES:

      

Net income

   $ 34,480      $ 31,121      $ 43,071   

Adjustments to reconcile net income to net cash provided by operating activities:

      

(Benefit from) provision for deferred income taxes

     (5,412     1,006        (3,050

Depreciation and amortization

     22,057        17,275        17,775   

Change in fair value of contingent consideration

     125        (25     120   

Share-based compensation expense

     11,512        11,601        13,396   

Excess tax benefit from share-based compensation

     (3,982     (2,053     (184

Other

     —          1,188        —     

Write-down of inventory to net realizable value

     3,918        4,726        2,441   

Allowance for doubtful accounts

     203        345        200   

Loss (gain) on investment

     484        —          (2,500

Loss (gain) on disposal of property, plant and equipment

     17        (58     (14

Net changes in operating assets and liabilities, exclusive of acquisition related assets and liabilities:

      

Accounts receivable

     6,633        (10,523     (8,258

Inventory

     (12,347     (2,127     (7,206

Refundable income taxes

     (5,594     42        312   

Other current assets

     2,525        (123     2,525   

Accounts payable

     3,222        (11,991     1,548   

Accrued liabilities

     (9,100     (305     3,948   

Customer deposits

     (213     440        903   

Deferred revenue

     1,533        (2,885     4,170   

Accrued income taxes

     (3,175     854        3,850   

Other liabilities

     1,045        2,935        663   
                          

NET CASH PROVIDED BY OPERATING ACTIVITIES

     47,931        41,443        73,710   
                          

INVESTING ACTIVITIES:

      

Additions to property, plant, and equipment

     (17,517     (25,551     (30,606

Purchases of marketable securities in Rabbi Trust under the Non Qualified Deferred Compensation Plan

     (715     —          —     

Acquisition of business, net of cash acquired

     (10,561     (79,273     —     

Proceeds from the sale of other investments

     —          —          2,500   

Proceeds from the sale of property, plant, and equipment and other assets

     260        146        207   
                          

NET CASH USED FOR INVESTING ACTIVITIES

     (28,533     (104,678     (27,899
                          

FINANCING ACTIVITIES:

      

Issuance of stock pursuant to exercise of stock options, employee stock purchase plan, restricted stock plans, and non-employee director stock plan

     5,379        4,684        2,000   

Shares repurchased for taxes for vested employee restricted stock grants

     (7,680     (4,661     (471

Repayments of other credit facilities

     —          (3,014     —     

Borrowing of other credit facilities

     —          2,230        —     

Contingent consideration payment

     —          (340     —     

Excess tax benefit from share-based compensation

     3,982        2,053        184   

Repurchase of common stock

     (14,959     (7,945     (23,260

Dividends paid to shareholders

     (4,962     (5,114     (4,980
                          

NET CASH USED FOR FINANCING ACTIVITIES

     (18,240     (12,107     (26,527
                          

EFFECT OF EXCHANGE RATE CHANGES ON CASH

     349        1,364        (1,929
                          

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     1,507        (73,978     17,355   
                          

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

     113,033        187,011        169,656   
                          

CASH AND CASH EQUIVALENTS, END OF YEAR

   $ 114,540      $ 113,033      $ 187,011   
                          

Supplemental disclosures of cash flow information:

      

Income taxes paid, net of refunds

   $ 8,024      $ 11,339      $ (935

Fixed asset additions in accounts payable and accrued liabilities

   $ 705      $ 1,620      $ 1,755   

The accompanying notes are an integral part of these consolidated financial statements.

 

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ANALOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in millions, except share and per share data)

1. Summary of business operations and significant accounting policies

Throughout this Annual Report on Form 10-K, unless the context states otherwise, the words “we,” “us,” “our” and “Analogic” refer to Analogic Corporation and all of its subsidiaries taken as a whole, and “our board of directors” refers to the board of directors of Analogic Corporation.

Description of Business

Analogic Corporation (NASDAQ:ALOG) designs, manufactures, and commercializes innovative real-time guidance, diagnostic imaging and threat detection technologies to advance the practice of medicine and save lives. We operate and report along three business segments: Ultrasound, Medical Imaging, and Security Technology. Our Ultrasound segment provides ultrasound guidance systems for the urology and surgery markets and is expanding into point of care areas such as anesthesia and emergency medicine. We sell our ultrasound products through our direct sales force in North America and Europe, as well as through a network of distributors to clinical practitioners throughout the world. Our Medical Imaging segment provides critical enabling medical imaging systems and subsystems for computed tomography, or CT, magnetic resonance imaging, or MRI and high-resolution digital mammography systems. We sell our Medical Imaging products primarily through longstanding relationships with well-known multinational medical OEMs and new entrants in emerging markets. Our Security Technology segment designs and manufactures automated threat detection systems for aviation baggage inspection applications utilizing advanced CT technology. We sell our security products primarily through multinational OEM partners.

We were incorporated in the Commonwealth of Massachusetts in November 1967 and our headquarters is based in Peabody, Massachusetts.

On March 1, 2013, we completed the acquisition of Ultrasonix Medical Corporation (Ultrasonix). On September 20, 2013, we acquired PocketSonics, Inc. (PocketSonics). These acquisitions are more fully discussed in Note 3. The financial position, results of operations and cash flows of Ultrasonix and PocketSonics are included in our Consolidated Financial Statements from the date of acquisition.

Significant accounting policies

(a) Consolidation

Our consolidated financial statements include the accounts of us and our subsidiaries, all of which are wholly owned. Investments in companies in which ownership interests range from 10 to 50 percent and for which we exercise significant influence over the investee’s operating and financial policies, are accounted for using the equity method. All intercompany accounts and transactions have been eliminated in consolidation.

In determining whether we are the primary beneficiary of an entity and therefore required to consolidate, we apply a qualitative approach that determines whether we have both (1) the power to direct the economically significant activities of the entity and (2) the obligation to absorb losses of, or the right to receive benefits from, the entity that could potentially be significant to that entity. We have not been required to consolidate the activity of any entity due to these considerations.

(b) Cash and cash equivalents

We consider all highly liquid investments with an original maturity of three months or less at acquisition date to be cash equivalents.

 

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ANALOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(in millions, except share and per share data)

 

(c) Revenue recognition and accounts receivable

We recognize revenue related to product sales upon shipment provided that title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the sales price is fixed or determinable, collection of the related receivable is reasonably assured and customer acceptance criteria, if any, have been successfully demonstrated. For product sales with acceptance criteria that are not successfully demonstrated upon shipment, revenue is recognized upon customer acceptance, provided all other revenue recognition criteria have been met. Our sales contracts generally provide for the customer to accept title and risk of loss when the product leaves our facilities. When shipping terms or local laws do not allow for passage of title and risk of loss at the shipping point, we defer recognizing revenue until title and risk of loss transfer to the customer. We classify shipping and handling invoiced to customers as revenue and the related costs in cost of sales. Sales and other taxes collected from customers and subsequently remitted to government authorities are recorded as accounts receivable with a corresponding offset recorded to sales taxes payable. These balances are removed from the consolidated balance sheet when the cash is remitted to the tax authority. We include service revenue, related primarily to extended warranty contracts and repairs, in the product revenue line item of our Consolidated Statement of Operations, as it is deemed immaterial for separate classification.

Our transactions sometimes involve multiple elements (i.e., products and services). We do not recognize revenue for our product sales under industry specific software accounting guidance since our products contain both software and non-software components that function together to deliver the tangible product’s essential functionality. At the inception of an agreement, we allocate arrangement consideration to each deliverable qualifying as a separate unit of accounting in an arrangement based on its relative selling price. We determine selling price using vendor specific objective evidence, or VSOE, if it exists, and otherwise third party evidence, or TPE. If neither VSOE nor TPE of selling price exists for a unit of accounting, we use our best estimated selling price, or BESP. We generally expect that we will not be able to establish TPE due to the nature of the markets in which we compete, and, as such, we typically will determine selling price using VSOE or if not available, BESP.

VSOE is generally limited to the price charged when the same or similar product or service is sold separately or, if applicable, the stated substantive renewal rate in the agreement. If a product or service is seldom sold separately, it is unlikely that we can determine VSOE for the product or service. We define VSOE as a median price of recent standalone transactions that are priced within a narrow range, as defined by us, or stated renewal rates in contracts.

TPE is determined based on the prices charged by competitors of us for a similar deliverable when sold separately. As noted above, we typically are not able to use TPE, as we are usually not able to obtain sufficient information on competitor pricing to substantiate TPE.

If we are unable to establish selling price using VSOE or TPE, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact if the product or service were sold by us on a standalone basis.

Our determination of BESP involves a weighting of several factors based on the specific facts and circumstances of the arrangement. Specifically, we consider the cost to produce the deliverable, the anticipated margin on that deliverable, the selling price and profit margin for similar parts and our ongoing pricing strategy and policies.

We determine BESP for deliverables in future agreements based on the specific facts and circumstances of the arrangement. We analyze the selling prices used in our allocation of arrangement consideration at least

 

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ANALOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(in millions, except share and per share data)

 

annually. Selling prices are analyzed on a more frequent basis if a significant change in our business necessitates a more timely analysis or if we experience significant variances in our selling prices.

Maintenance or service revenues are recognized ratably over the term of the contract.

We provide engineering services to some of our customers on a contractual basis and recognize revenue using the percentage of completion method or the completed contract method. We estimate the progress towards completion on contracts with a fixed-fee arrangement on a monthly basis utilizing costs incurred to date as a percentage of total estimated costs at completion of the project or on a milestone basis based on contractual terms, as appropriate. Short-term unbilled receivables are included in accounts receivable and long-term unbilled receivables are included in noncurrent other assets in the consolidated balance sheet. Total unbilled receivables at July 31, 2014 and 2013 were $5.8 million and $4.9 million, respectively. At July 31, 2014 and 2013, the long-term portion of unbilled receivables of $0.0 million and $1.8 million, respectively, was included in non-current other assets. When total cost estimates exceed revenues, we accrue for the estimated losses immediately.

Deferred revenue is primarily comprised of maintenance and other service revenues for which payment has been received and for which services have not yet been performed. Revenue is also deferred in situations where collection of the receivable at the time of shipment is not reasonably assured. In situations where collection of the receivable is not reasonably assured, the inventory is expensed upon shipment and the revenue is deferred and recognized as the cash is received. Total deferred revenue at July 31, 2014 and 2013 was $11.8 million and $10.6 million, respectively. At July 31, 2014 and 2013, the long-term portion of deferred revenue of $1.1 million and $1.4 million, respectively, was included in non-current other liabilities.

We grant credit to domestic and foreign original equipment manufacturers, distributors, and end users, and perform ongoing credit evaluations of our customers’ financial condition. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon specific customer collection issues that have been identified.

(d) Use of estimates

The preparation of our consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America, requires us to make estimates and assumptions that may affect the reported amounts of assets, liabilities, equity, revenue and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and judgments and methodologies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which forms the basis for making judgments about the carrying value of assets and liabilities. Actual results may differ from those estimates under different assumptions or conditions.

(e) Inventories

We value inventory at the lower of cost or market using the first-in, first-out (FIFO) method. Management assesses the recoverability of inventory based on types and levels of inventory held, product life cycle, and changes in technology. A variety of methodologies are used to determine the amount of inventory write-downs necessary for excess and obsolete inventory. The write-downs are based upon the age of the inventory, lower of cost or market, along with other significant management judgments concerning future demands for the inventory. Once write-downs are recorded, they are not subsequently reversed, unless the inventory is used or disposed of. Inventory includes demo equipment utilized by the sales force in the field.

 

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ANALOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(in millions, except share and per share data)

 

(f) Income taxes

We account for income taxes under the asset and liability method, which requires recognition of deferred tax assets, subject to valuation allowances, and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of asset and liabilities for financial reporting and income tax purposes. A valuation allowance is established if it is more likely than not that all or a portion of the net deferred tax assets will not be realized. We do not provide for U.S. Federal income taxes on undistributed earnings of all consolidated foreign subsidiaries as such earnings are considered to be indefinitely reinvested in those operations. For disclosure purposes, calculations of the potential deferred income tax liability on these undistributed earnings is not practicable because such liability, if any, is dependent on circumstances existing if and when remittance occurs.

(g) Concentration of credit risk

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents, derivative instruments and accounts receivable. Cash and cash equivalents not required for working capital purposes are placed primarily in short-term bank deposits, money market funds, or demand notes of financial institutions or banks that meet stringent credit rating requirements or are collateralized by securities issued by the U.S. government or government agencies. We grant credit to domestic and foreign original equipment manufacturers, distributors, and end users, and perform ongoing credit evaluations on our customers’ financial condition. We do not require collateral or other security to be furnished by the counterparties to our derivative instruments.

(h) Property, plant, and equipment

Property, plant, and equipment is recorded at cost and depreciated using the straight-line method over their estimated useful lives. Leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the respective leases. Upon retirement or disposal, the cost of the asset disposed of and the related accumulated depreciation are removed from the accounts and any gain or loss is reflected in our Consolidated Statement of Operations. Expenditures for maintenance and repairs are charged to expense when incurred while the costs of significant improvements, which extend the life of the underlying asset, are capitalized.

Property, plant, and equipment consisted of the following:

 

     Estimated Useful  Lives
(Years)
   July 31,  
          2014     2013  

(in millions)

       

Property, plant, and equipment:

       

Land and land improvements

   N/A    $ 7.5      $ 7.4   

Building and improvements

   35 to 40      85.1        83.0   

Leasehold improvements

   lesser of useful life or the lease term      9.8        10.7   

Equipment and software

   3 to 7      129.2        118.9   

Furniture and fixtures

   3 to 7      7.3        9.4   
                       
        238.9        229.4   

Less accumulated depreciation and amortization

        (124.7     (118.4
                       

Total property, plant and equipment

      $ 114.2      $ 111.0   
                       

 

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ANALOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(in millions, except share and per share data)

 

Total depreciation and amortization of property, plant, and equipment was $14.3 million, $13.0 million, and $13.4 million for fiscal years 2014, 2013, and 2012, respectively. We did not capitalize any interest in fiscal years 2014, 2013 or 2012.

(i) Intangible assets and goodwill

Intangible assets consist of intellectual property, licenses, and certain identifiable intangible assets resulting from business combinations, including trade names, customer relationships, backlog, and developed technology. Intangible assets that have finite lives are amortized using either the straight-line method, or if reliably determinable, based on the pattern in which the economic benefit of the asset is expected to be utilized. Definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of assets may not be recoverable. Recoverability of these assets is measured by comparison of their carrying value to the future undiscounted cash flows the assets are expected to generate over their remaining economic life. If such assets are considered to be impaired, the impairment to be recognized in earnings equals the amount by which the carrying value of the assets exceeds their fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique. Evaluation of impairment of long-lived assets requires estimates of future operating results that are used in the preparation of the expected future undiscounted cash flows. Actual future operating results and the remaining economic lives of long-lived assets could differ from the estimates used in assessing the recoverability of these assets. These differences could result in impairment charges, which could have a material adverse impact on our results of operations.

An indefinite lived intangible asset, such as an in-process research and development, or IPR&D, asset, is tested for impairment annually or more frequently if indicators of impairment are present. We perform our annual review in our second quarter of each fiscal year. An indefinite lived intangible asset may be considered impaired if we determine that the carrying value exceeds the assets’ fair value. We may first perform a qualitative assessment to determine whether it is necessary to perform the quantitative impairment test or bypass the qualitative assessment and proceed directly to performing the quantitative impairment test. The quantitative impairment test is based on discounted estimated future cash flows. Assessing the impairment of an indefinite lived intangible asset requires us to make assumptions and judgments regarding the fair value of the asset using the relief from royalty valuation technique, which include management’s estimates of future growth rates and discount rates.

Goodwill is not amortized but is reviewed for impairment annually or more frequently whenever events or changes in circumstances indicate that the carrying value of the reporting unit may exceed its fair value. A reporting unit, for the purpose of the impairment test, is at or below the operating segment level, and constitutes a business for which discrete financial information is available and regularly reviewed by segment management. We perform our annual reviews in our second quarter of each fiscal year. We may first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less that it’s carrying value and as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. We may also elect to proceed directly to the two-step impairment test. If an initial qualitative assessment indicates that it is more likely than not that the carrying value of a reporting unit exceeds its estimated fair value, an additional quantitative evaluation is performed under the two-step impairment test. If based on the quantitative evaluation the fair value of the reporting unit is less than its carrying amount, we perform an analysis of the fair value of all assets and liabilities of the reporting unit. If the implied fair value of the reporting unit’s goodwill is determined to be less that its carrying amount, impairment is recognized for the difference.

Assessing the impairment of goodwill requires us to make assumptions and judgments regarding the fair value of our reporting units. We estimate the fair value of our reporting units using a combination of valuation

 

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ANALOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(in millions, except share and per share data)

 

techniques, including discounted cash flows and cash earnings multiples, and compare the values to our estimated overall market capitalization.

(j) Fair value of financial instruments

Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, and derivative instruments. The carrying amounts of our financial instruments approximate fair value due to their short-term nature. The fair values of marketable securities, if any, are estimated based on quoted market price for these securities. We did not have any marketable securities at July 31, 2014 and 2013.

(k) Asset retirement obligations

We establish asset retirement obligations (“AROs”) for the present value of estimated future costs to return certain of our facilities to their original condition. The recorded liabilities are accreted to the future value of the estimated restoration costs. The accretion of the liability and the depreciation of the capitalized cost is recognized over the estimated useful lives of the facilities.

(l) Impairment of long-lived assets

We evaluate the recoverability of our long-lived assets, recognizing the impairment of long-lived assets in the event the net book value of such assets exceeds the estimated future undiscounted cash flows attributable to such assets. If impairment is indicated, the asset is written down to its estimated fair value based on a discounted cash flow analysis or the market value. We review long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the estimated undiscounted cash flows of the asset group as compared to the recorded value of the asset group.

(m) Warranty costs

We provide for the estimated cost of standard product warranties at the time products are shipped. Although we engage in extensive product-quality programs and processes, our warranty obligations are affected by product failure rates and service delivery costs incurred to correct product failures. Should actual product failure rates or service delivery costs differ from our estimates (which are based on specific warranty claims, historical data, and engineering estimates, where applicable), revisions to the estimated warranty liability would be required. Such revisions could adversely affect our operating results. Generally, we warrant that our products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the products to our customer for a period ranging from 12 to 60 months from the date of delivery.

(n) Research and product development and capitalized software development costs

Research and product development costs are expensed as incurred and include primarily engineering salaries, incentive compensation, including share-based compensation, overhead and materials used in connection with research and product development activities. Research and product development costs related to non-recurring engineering projects funded by customers are included within engineering cost of sales if the project is accounted for under the percentage of completion method or under the completed contract method.

Software development costs incurred subsequent to establishing technological feasibility are capitalized when tec