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ALOG > SEC Filings for ALOG > Form 10-Q on 11-Mar-2014All Recent SEC Filings

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Form 10-Q for ANALOGIC CORP


11-Mar-2014

Quarterly Report


Item 2. 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 unaudited condensed consolidated financial statements and notes thereto included elsewhere in this report. 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, research and development 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 materially from the projected results. See Part I, Item 1A. Risk Factors of our Annual Report on Form 10-K for fiscal year 2013 as filed with the U.S Securities and Exchange Commission, or SEC, on September 30, 2013 for a discussion of the primary risks and uncertainties known to us.

We report our financial condition and results of operations on a fiscal year basis ending July 31. The three months ended January 31, 2014 and 2013 represent the second quarters of fiscal years 2014 and 2013, respectively.

Our Management's Discussion and Analysis is presented in six sections as follows:

Executive Summary

Results of Operations

Liquidity and Capital Resources

Commitments, Contractual Obligations, and Off-balance Sheet Arrangements

Recent Accounting Pronouncements

Critical Accounting Policies

Executive Summary

Introduction

We are 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, which primarily includes systems and subsystems for computed technology, or CT, and magnetic resonance imaging, or 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, which includes ultrasound systems and transducers used primarily in the urology, surgery (including robotic assisted surgery), anesthesia, and point-of-care markets.

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


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Financial Results

The following table summarizes our financial results achieved:



                                             For the Three Months Ended                               For the Six Months Ended
                                                     January 31,                  Percentage                 January 31,                 Percentage
(in millions, except per share amounts)       2014                 2013             Change            2014                2013             Change
Total net revenue                         $      141.4         $      138.6                 2 %    $     251.5         $     258.4                -3 %
Gross profit                              $       61.1         $       55.4                10 %    $     104.0         $     100.5                 4 %
Gross margin                                        43 %                 40 %                               41 %                39 %
Income from operations                    $       13.1         $       13.8                -5 %    $       7.7         $      21.2               -64 %
Operating margin                                     9 %                 10 %                                3 %                 8 %
Net income                                $       19.3         $        9.8                97 %    $      15.5         $      14.2                 9 %
Diluted net income per share              $       1.53         $       0.78                96 %    $      1.23         $      1.13                 9 %

Outlook

With the current challenges in our global markets, we now expect fiscal year 2014 total revenue and operating margin to be approximately consistent with fiscal year 2013.

For a discussion of seasonal aspects of our business please refer to Part 1, Item 1. Business of our fiscal year 2013 Form 10-K filed with the SEC on September 30, 2013.

Results of Operations

Three and six months ended January 31, 2014 compared to the three and six months ended January 31, 2013

Net revenue

Product revenue

Product revenue by segment is summarized as follows:

                                          For the Three Months Ended                              For the Six Months Ended
                                                  January 31,                 Percentage                 January 31,                Percentage
(in millions)                              2014                2013             Change             2014               2013            Change
Medical Imaging                        $        78.4       $        77.5                1 %    $      137.6       $      149.7               -8 %
Ultrasound                                      40.1                40.5               -1 %            74.8               72.1                4 %
Security Technology                             20.9                14.8               41 %            35.5               23.5               51 %
Total product revenue                  $       139.4       $       132.8                5 %    $      247.9       $      245.3                1 %

Medical Imaging

During the three months ended January 31, 2014, our Medical Imaging product revenue increased slightly versus the prior period due to product revenue growth in our three primary modalities of CT, MRI and Mammography. This revenue growth was offset by the end of life of an older generation CT subsystem and the exit of our legacy patient monitoring product line.

During the six months ended January 31, 2014, our Medical Imaging product revenue decreased versus the prior period largely due to the end of life of an older generation CT subsystem, the exit of our legacy patient monitoring product line, and the timing of OEM customer purchases.

Ultrasound

During the three months ended January 31, 2014, our Ultrasound product revenue decreased by $0.4 million versus the prior year comparable period. Our direct Ultrasound business experienced an increase of approximately 16% as compared to the prior year comparable period, due primarily to growth in our primary markets of urology and surgery sales in the U.S. and our expansion into the point-of-care ultrasound market following our March 2013 acquisition of Ultrasonix. This growth was offset by weakness in the European healthcare market along with a decline in Ultrasound OEM probe sales. Ultrasonix revenue totaled $6.3 million for the three months ended January 31, 2014.


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During the six months ended January 31, 2014 our Ultrasound product revenue improved versus the prior year comparable period primarily driven by increased sales in our direct sales channel, including growth in our primary markets of urology and surgery as well as further expansion in the point-of-care market following our March 2013 acquisition of Ultrasonix. Ultrasonix revenue represented $11.6 million for the six months ended January 31, 2014. These increases were partially offset by lower OEM ultrasound probe sales and weakness in the European healthcare market.

Security Technology

During the three and six months ended January 31, 2014 our Security Technology product revenue growth versus the prior year comparable periods was driven by increased volume of medium-speed threat detection systems primarily for the U.S. market, and high-speed threat detection systems for CT-based explosives threat detection outside the U.S.

Engineering revenue

Engineering revenue by segment is summarized as follows:

                                         For the Three Months Ended                                   For the Six Months Ended
                                                 January 31,                   Percentage                    January 31,                   Percentage
                                          2014                 2013              Change              2014                 2013               Change
(in millions)
Medical Imaging                       $        1.2         $        3.2                -63 %      $       2.2         $         7.0                -69 %
Security Technology                            0.8                  2.6                -68 %              1.4                   6.1                -77 %
Total engineering revenue             $        2.0         $        5.8                -65 %      $       3.6         $        13.1                -73 %

Medical Imaging

The decrease in engineering revenue for the three and six months ended January 31, 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. Customer-funded engineering projects can vary substantially from period to period in terms of resource requirements, type, size, length of project, and profitability.

Security Technology

The decrease in engineering revenue for the three and six months ended January 31, 2014 versus the prior year comparable periods was due primarily to the timing of customer-funded engineering projects. Customer-funded engineering projects can vary substantially from period to period in terms of resource requirements, type, size, length of project, and profitability.

Gross margin

Product gross margin

Product gross margin is summarized as follows:

                                        For the Three Months Ended                               For the Six Months Ended
                                                January 31,                 Percentage                  January 31,                 Percentage
(in millions)                            2014                2013             Change              2014                2013            Change
Product gross profit                  $      60.6         $      55.4                 9 %     $      103.5         $     99.3                 4 %
Product gross margin                         43.5 %              41.7 %                               41.8 %             40.5 %

The improvement in product gross margin during the three months ended January 31, 2014 versus the prior year comparable period was due primarily to higher average selling prices in the period, a shift in product mix from lower margin OEM sales to higher margin direct sales within the Ultrasound business, and cost savings efforts including a ramp up of our manufacturing operation in Shanghai, China.

The improvement in product gross margin during the six months ended January 31, 2014 versus the prior year comparable period was due primarily to higher average selling prices in the period, a shift in product mix from lower margin OEM sales to higher margin direct sales within the Ultrasound business, cost savings efforts including a ramp up of our manufacturing operation in Shanghai, China, and a favorable adjustment within our Montreal based diagnostic mammography detection business related to the quality control inspection process. These gross margin improvements were partially offset by purchase accounting fair value adjustments to inventory associated with our March 2013 acquisition of Ultrasonix.


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Engineering gross margin

Engineering gross margin is summarized as follows:

                                          For the Three Months Ended                                  For the Six Months Ended
                                                 January 31,                    Percentage                  January 31,                   Percentage
(in millions)                             2014                 2013               Change              2014                2013              Change
Engineering gross profit               $       0.4                    -                 100 %      $       0.5          $     1.2                 -60 %
Engineering gross margin                      21.0 %               -0.4 %                                 13.6 %              9.1 %

The increase in the engineering gross margin in the three and six months ended January 31, 2014 versus the prior year comparable periods was primarily due to fewer higher margin customer-funded engineering projects in the period.

Operating expenses

Operating expenses are summarized as follows:

                                           For the Three Months Ended                                         Percentage of Net
                                                  January 31,                      Percentage                      Revenue
(in millions)                             2014                   2013                Change               2014                  2013
Research and product development      $        20.0          $        16.1                  24 %                14 %                 12 %
Selling and marketing                          14.7                   11.9                  24 %                10 %                  8 %
General and administrative                     13.0                   13.6                  -4 %                 9 %                 10 %
Restructuring                                   0.3                      -                 100 %                 0 %                  0 %
Total operating expenses              $        48.0          $        41.6                  15 %                33 %                 30 %

                                           For the Six Months  Ended                                          Percentage of Net
                                                  January 31,                      Percentage                      Revenue
(in millions)                             2014                   2013                Change               2014                  2013
Research and product development      $        38.9          $        30.2                  29 %                15 %                 12 %
Selling and marketing                          29.2                   23.5                  24 %                12 %                  9 %
General and administrative                     27.9                   25.5                   9 %                11 %                 10 %
Restructuring                                   0.3                      -                 100 %                 0 %                  0 %
Total operating expenses              $        96.3          $        79.2                  22 %                38 %                 31 %

Operating expenses for the three and six months ended January 31, 2014 increased by $6.4 million, or 15% and $17.1 million, or 22%, versus the prior year comparable periods, respectively.

Research and product development expenses are related to new product development projects that are not funded by our customers. These expenses increased by $3.9 million during the three months ended January 31, 2014 versus the prior comparable period due primarily to the reduction in customer-funded engineering projects, which resulted in an increase of $3.0 million in expenses. Additionally, $1.1 million is attributable to incremental engineering expenses resulting from our March 2013 acquisition of Ultrasonix, and $0.9 million is attributable to severance during the period as we aligned our resources with expected customer-funded engineering requirements. This severance was not included within restructuring as it was in addition to our fiscal year 2013 restructuring plan. These increases were partially offset by $0.9 million reduction in performance-based compensation accruals.

Research and product development expenses increased $8.7 million during the six months ended January 31, 2014 versus the prior year comparable period due to the reduction in customer-funded engineering projects, which resulted in an increase of $6.3 million in expenses. Additionally, $2.0 million is attributable to incremental engineering expenses resulting from our March 2013 acquisition of Ultrasonix, $0.9 million is attributable to severance during the period as we aligned our resources with expected customer funded engineering requirements, and $0.6 million is due to higher merit-based compensation in the three months ended October 31, 2013. These increases were partially offset by $0.9 million reduction in performance-based compensation accruals.


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Selling and marketing expenses increased by $2.8 million during the three months ended January 31, 2014, versus the prior year comparable period due to $3.6 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 accruals.

Selling and marketing expenses increased $5.7 million during the six months ended January 31, 2014 versus the prior comparable period due primarily to $7.2 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 accruals.

General and administrative expenses declined by $0.6 million during the three months ended January 31, 2014 versus the prior comparable period. This decline was primarily the result of a reduction in performance-based compensation accruals partially offset by general and administrative expenses of $0.5 million attributable to the inclusion of Ultrasonix in our operating results in the current period.

General and administrative expenses increased by $2.4 million during the six months ended January 31, 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 $0.9 million of incremental depreciation expense, $0.8 million in incremental legal fees (including $0.6 million of BK Medical inquiry costs), and $0.3 million in medical device taxes. These increases were partially offset by a reduction of $0.9 million in performance-based compensation accruals.

During fiscal year 2013, we implemented a restructuring plan that involved the involuntary termination of 124 employees, as well as consolidation of manufacturing and certain support activities conducted at the Ultrasonix facility in Vancouver, into operations at our existing facilities, closure of the Ultrasonix sales subsidiary in Paris, France, closure of our Englewood, Colorado facility as we consolidate manufacturing and development activities into our State College, Pennsylvania facility, and optimization of our operations in Montreal, Canada and Peabody Massachusetts. There was no restructuring expense for the same period of fiscal year 2013. We expect to incur an additional $0.2 million restructuring expense to complete this program by the fourth quarter of fiscal year 2014. Expense incurred during the three and six month periods ended January 31, 2014 was $0.3 million and $0.3 million, respectively, of which $0.6 related to the closure in January 2014 of the Englewood, Colorado facility, net of the estimated present value of future sublease income. The six months ended January 31, 2014, was offset by a favorable adjustment of less than $0.1 million that we incurred during the three months ended October 31, 2013.

Other expenses, net

Other expenses, net is summarized as follows:

                                       For the Three Months Ended                       For the Six Months Ended
                                               January 31,                                     January 31,
(in millions)                         2014                     2013                   2014                     2013
Interest income, net             $          0.1           $          0.1         $          0.2           $          0.2
Other, net                                 (0.5 )                   (0.5 )                 (1.0 )                   (1.5 )
Total other expense, net         $         (0.4 )         $         (0.4 )       $         (0.8 )         $         (1.3 )

Net other expense during the three months ended January 31, 2014 was predominantly due to foreign currency exchange gains (losses) from our foreign subsidiaries. Net other expense during the six months ended January 31, 2014 was predominantly due to the recognition of a $0.5 million loss related to our 10% pre-acquisition equity interest in PocketSonics during the three months ended October 31, 2013 as well as current period foreign currency exchange losses. Please refer to Note 3. Business Combinations for further information about this acquisition.

Other income (expense), net during the three and six months ended January 31, 2013, consisted predominantly of foreign currency transaction exchange losses by our foreign subsidiaries in Denmark and China due primarily to the strengthening U.S. Dollar in the current period.

(Benefit from) provision for income taxes

The following table presents the (benefit from) provision for income taxes and our effective tax rate for the three and six months ended January 31, 2014 and 2013:

                                         For the Three Months Ended              For the Six Months Ended
                                                 January 31,                           January 31,
(in millions)                              2014                 2013             2014                2013
(Benefit from) provision for
income taxes                           $        (6.6 )         $   3.6        $      (8.6 )        $     5.7
Effective tax rate                               -52 %              27 %             -124 %               29 %


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

Our effective tax rate before discrete items for the three and six months ended January 31, 2014, respectively, 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 the three and six months ended January 31, 2014 includes certain discrete tax benefits totaling $10.2 million and $10.6 million, respectively. The discrete tax benefit for the three months ended January 31, 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, and a reduction in uncertain tax positions primarily associated with federal tax credits for research and development, or R&D, for $0.9 million following the conclusion of the Internal Revenue Service, or IRS, review for the fiscal year 2009, along with $0.5 million of other items. For the six months ended January 31, 2014, the discrete benefit also includes a reduction of our valuation allowance for Massachusetts R&D credits and federal amended return claims, partially offset by changes in statutory tax rates in the jurisdictions in which we operate.

The effective tax rate for the three and six months ended January 31, 2013 was lower than the federal statutory rate due primarily to lower foreign tax rates and the extension of the federal R&D tax credit.

The effective tax rate was lower in the three months ended January 31, 2014 versus the prior year comparable period due in part to the relative impact of discrete items on each period's pre-tax income, and the forecasted composition of the income in different countries. This decrease was offset in part by a lower federal R&D tax credit due to its expiration on December 31, 2013. The effective tax rate was lower in the six months ended January 31, 2014 versus the prior year comparable period, due to the impact of discrete items in fiscal year 2014.

The total amounts of gross unrecognized tax benefits, which excludes interest and penalties discussed below, as of January 31, 2014 and July 31, 2013 were as follows:

(in millions) January 31, 2014 July 31, 2013 Gross unrecognized tax benefits $ 6.5 $ 7.3

These unrecognized tax benefits, if recognized in a future period, the timing of which is not estimable, would favorably impact our effective tax rate. In the next four quarters, the statute of limitations for our fiscal year ended July 31, 2010 may expire for federal and state income taxes and for our fiscal year ended July 31, 2007 for foreign subsidiaries. It is reasonably expected that net unrecognized tax benefits, including interest, of approximately $0.9 million may be recognized.

We accrue interest and, if applicable, penalties for any uncertain tax positions. This interest and penalty expense is treated as a component of income tax expense. At January 31, 2014 and January 31, 2013, we had approximately $0.7 million and $0.7 million, respectively, accrued for interest and penalties on unrecognized tax benefits.

We do not provide for U.S. federal income taxes on undistributed earnings of consolidated foreign subsidiaries; as such earnings are intended to be indefinitely reinvested in those operations. Determination of the potential deferred income tax liability on these undistributed earnings is not practicable because such liability, if any, is dependent on circumstances that exist if and when remittance occurs. The circumstances that would affect the calculations would be the source location and amount of the distribution, the underlying tax rate already paid on the earnings, foreign withholding taxes and the opportunity to use foreign tax credits in the U.S.

We are subject to U.S. federal income tax as well as the income tax of multiple state and foreign jurisdictions. As of January 31, 2014, we have closed all years for U.S. federal income tax purposes through the year ended July 31, 2009.

Liquidity and Capital Resources

Key liquidity and capital resource information are summarized as follows:



                                        As of               As of
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