Omnicell, Inc.
OMNICELL, Inc (Form: 10-Q, Received: 11/10/2014 17:30:54)
Table of Contents

 
 
 
 
 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
——————————————————————————————————————
FORM  10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
OR
o
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 000-33043
——————————————————————————————————————

Omnicell, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
94-3166458
(State or other jurisdiction
 
(I.R.S. Employer
of incorporation or organization)
 
Identification No.)
 
590 East Middlefield Rd.
Mountain View, CA 94043
(650) 251-6100
(Address, including zip code, of registrant’s principal executive
offices and registrant’s telephone number, including area code)
——————————————————————————————————————  
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  x  No  o
 
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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x No  o
 
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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  o
 
Accelerated filer  x
 
 
 
Non-accelerated filer  o
 
Smaller reporting company  o
(Do not check if a 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  o  No  x
 
The number of shares of Registrant’s common stock (par value $0.001) outstanding as of October 31, 2014 was 35,604,480 .



Table of Contents

 
 
 
 
 

 
 
Page
  number
 
Financial Statements (unaudited)
 

 

 

 

 
Notes to Condensed Consolidated Financial Statements
 
 
 
 
 
 



Table of Contents

PART I — FINANCIAL INFORMATION
 
Item 1.
Financial Statements
 
OMNICELL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands)
 

 
September 30,
2014
 
December 31,
2013
 
ASSETS
 
Current assets:
 

 
 

 
Cash and cash equivalents
$
104,187

 
$
104,531

 
Accounts receivable, net of allowances of $1,247 and $490, respectively
95,167

 
58,597

 
Inventories
31,847

 
31,457

 
Prepaid expenses
18,221

 
18,883

 
Deferred tax assets
12,684

 
12,635

 
Other current assets
6,262

 
7,675

 
Total current assets
268,368

 
233,778

 
Property and equipment, net
37,688

 
35,254

 
Non-current net investment in sales-type leases
10,823

 
11,485

 
Goodwill
123,090

 
111,343

 
Intangible assets, net
84,075

 
81,602

 
Non-current deferred tax assets
975

 
1,102

 
Other assets
22,294

 
17,937

 
Total assets
$
547,313

 
$
492,501

 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
Current liabilities:
 

 
 

 
Accounts payable
$
23,202

 
$
16,471

 
Accrued compensation
13,071

 
19,604

 
Accrued liabilities
17,073

 
13,746

 
Deferred service revenue
22,672

 
22,626

 
Deferred gross profit
35,542

 
19,957

 
Total current liabilities
111,560

 
92,404

 
 
 
 
 
 
Non-current deferred service revenue
20,368

 
17,763

 
Non-current deferred tax liabilities
30,471

 
28,162

 
Other long-term liabilities
6,013

 
5,175

 
Total liabilities
168,412

 
143,504

 
Commitments and Contingencies (Note 11 and Note 12)
 
 
 
 
Stockholders’ equity:
 

 
 

 
Total stockholders’ equity
378,901

 
348,997

 
 
 
 
 
 
Total liabilities and stockholders’ equity
$
547,313

 
$
492,501

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


3

Table of Contents

OMNICELL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 

 
 

 
 

 
 

Product revenues
$
92,229

 
$
75,508

 
$
260,053

 
$
220,325

Services and other revenues
20,314

 
18,531

 
59,306

 
54,510

Total revenues
112,543

 
94,039

 
319,359

 
274,835

Cost of revenues:


 
 

 
 
 
 
Cost of product revenues
44,510

 
33,977

 
124,413

 
103,810

Cost of services and other revenues
8,487

 
8,022

 
24,865

 
24,250

Total cost of revenues
52,997

 
41,999

 
149,278

 
128,060

Gross profit
59,546

 
52,040

 
170,081

 
146,775

Operating expenses:


 
 

 
 
 


Research and development
7,078

 
6,561

 
19,670

 
21,665

Selling, general and administrative
38,871

 
34,762

 
114,302

 
100,866

Total operating expenses
45,949

 
41,323

 
133,972

 
122,531

Income from operations
13,597

 
10,717

 
36,109

 
24,244

Interest and other income (expense), net
(706
)
 
25

 
(1,003
)
 
(134
)
Income before provision for income taxes
12,891

 
10,742

 
35,106

 
24,110

Provision for income taxes
5,591

 
2,987

 
13,824

 
6,954

Net income
$
7,300

 
$
7,755

 
$
21,282

 
$
17,156

Net income per share-basic
$
0.20

 
$
0.22

 
$
0.60

 
$
0.50

Net income per share-diluted
$
0.20

 
$
0.21

 
$
0.58

 
$
0.48

Weighted average shares outstanding:
 

 
 

 
 
 
 
Basic
35,994

 
35,133

 
35,634

 
34,499

Diluted
36,832

 
36,190

 
36,617

 
35,466

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


4

Table of Contents

OMNICELL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited, in thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
7,300

 
$
7,755

 
$
21,282

 
$
17,156

Other comprehensive income:
 
 
 
 
 
 
 
   Change in fair value of foreign currency forward contracts

 

 

 
(65
)
  Foreign currency translation adjustment
(669
)
 
217

 
(550
)
 
21

Other comprehensive income (loss)
(669
)
 
217

 
(550
)
 
(44
)
Comprehensive income
$
6,631

 
$
7,972

 
$
20,732

 
$
17,112


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

5

Table of Contents


OMNICELL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
Nine Months Ended September 30,
 
2014
 
2013
Cash flows from operating activities:
 

 
 
Net income
$
21,282

 
$
17,156

Adjustments to reconcile net income to net cash provided by operating activities, net of business acquisition
 

 
 

Depreciation and amortization
14,705

 
13,732

Loss on disposal of fixed assets
221

 
289

Impairment of software development costs

 
1,759

Provision for receivable allowance
850

 
110

Share-based compensation expense
8,610

 
8,387

Income tax benefits from employee stock plans
4,065

 
1,707

Excess tax benefits from employee stock plans
(4,456
)
 
(2,827
)
Provision for excess and obsolete inventories
450

 
911

Deferred income taxes
1,307

 
(737
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable, net
(35,028
)
 
(9,004
)
Inventories
1,301

 
(4,713
)
Prepaid expenses
1,015

 
(1,661
)
Other current assets
1,412

 
(394
)
Non-current net investment in sales-type leases
677

 
1,313

Other assets
360

 
307

Accounts payable
5,420

 
6,462

Accrued compensation
(6,533
)
 
1,263

Accrued liabilities
(416
)
 
2,031

Deferred service revenue
2,650

 
(403
)
Deferred gross profit
15,585

 
4,434

Other long-term liabilities
838

 
615

Net cash provided by operating activities
34,315

 
40,737

Cash flows from investing activities:
 

 
 
Acquisition of intangible assets and intellectual property
(236
)
 
(225
)
Software development for external use
(7,925
)
 
(5,694
)
Purchases of property and equipment
(10,151
)
 
(7,817
)
Business acquisition, net of cash acquired
(19,749
)
 

Net cash used in investing activities
(38,061
)
 
(13,736
)
Cash flows from financing activities:
 
 
 
Proceeds from issuances under stock-based compensation plans
18,157

 
24,020

Employees' taxes paid related to restricted stock units
(2,023
)
 

Common stock repurchases
(17,052
)
 

Excess tax benefits from employee stock plans
4,456

 
2,827

Net cash provided by financing activities
3,538

 
26,847

Effect of exchange rate changes on cash and cash equivalents
(136
)
 
29

Net increase (decrease) in cash and cash equivalents
(344
)
 
53,877

Cash and cash equivalents at beginning of period
104,531

 
62,313

Cash and cash equivalents at end of period
$
104,187

 
$
116,190

Supplemental disclosure of non-cash investing activities
 
 
 
Business acquisition costs in accrued liabilities
$
860

 
$

Capital assets in accounts payable and accrued liabilities
$
444

 
$

Treasury stock in accrued liabilities
$
2,586

 
$

 


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Table of Contents

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

7

Table of Contents

OMNICELL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1.
Organization and Summary of Significant Accounting Policies
 
Description of the Company.   Omnicell, Inc. ("Omnicell," "our," "us," "we," or the "Company") was incorporated in California in 1992 under the name Omnicell Technologies, Inc. and reincorporated in Delaware in 2001 as Omnicell, Inc. Our major products are automated medication supply control systems and medical adherence solutions which are sold in our principal market, which is the healthcare industry. Our market is primarily located in the United States and Canada.
    
In 2012, we acquired Medication Technologies, Inc. ("MTS"), a provider of automated and semi-automated equipment to assist institutional and retail pharmacists in filling medication orders into blister cards, the primary method of medication control in non-acute care settings. MTS is part of our Medication Adherence segment which consists of all the products we sell to fulfill medication adherence needs through blister cards, blister card packaging equipment, and related software.
In August of 2014, we acquired Surgichem Limited ("Surgichem"), a provider of medication adherence solutions to the non-acute care market in the United Kingdom ("UK"). Surgichem supplies its monitored dosage systems to a network of over 3,200 independent pharmacies and UK pharmacy chains. Surgichem is expected to complement our Medication Adherence segment. For further information, please see Note 7, Business Acquisition.
Basis of presentation.   These interim condensed consolidated financial statements are unaudited but reflect, in the opinion of management, all adjustments, consisting of normal recurring adjustments and accruals, necessary to present fairly the financial position of Omnicell and our subsidiaries as of September 30, 2014 , the results of our operations and comprehensive income for the three and nine months ended September 30, 2014 and 2013 and our cash flows for the nine months ended September 30, 2014 and 2013. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2013 .
 
Our results of operations, comprehensive income for the three and nine months ended September 30, 2014 and cash flows for the nine months ended September 30, 2014 are not necessarily indicative of results that may be expected for the year ending December 31, 2014 , or for any future period. 

Use of estimates. GAAP requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management's best knowledge of current events and actions that may impact the company in the future, actual results may be different from the estimates. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management. Those policies are revenue recognition, share-based compensation, inventory valuation, valuation of goodwill and purchased intangibles, valuation of long-lived assets and accounting for income taxes.
 
Principles of consolidation.  The condensed consolidated financial statements include the accounts of our wholly-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

Concentration of credit risk.   Financial instruments that may potentially subject us to concentrations of credit risk consist principally of cash equivalents and accounts receivable. Cash equivalents are maintained with several financial institutions and may exceed the amount of insurance provided on such balances. The majority of our accounts receivable are derived from sales to customers for commercial applications. We perform ongoing credit evaluations of our customers’ financial condition and limit the amount of credit extended when deemed necessary but generally require no collateral. We maintain reserves for potential credit losses. Our products are broadly distributed and there was no single customer accounting for 10% or more of revenues in the three and nine months ended September 30, 2014 and 2013. Additionally, there was no single customer accounting for 10% or more of accounts receivable at September 30, 2014 or December 31, 2013 . We believe that we have no significant concentrations of credit risk at September 30, 2014 .

Dependence on suppliers.  We have a supply agreement with one primary supplier for construction and supply of several sub-assemblies and inventory management of sub-assemblies used in our hardware products. There are no minimum

8


purchase requirements. The contract may be terminated by either the supplier or by us without cause and at any time upon delivery of two months’ notice. Purchases from this supplier for the three months ended September 30, 2014 and 2013 totaled approximately $11.0 million and $8.6 million , respectively, and $28.2 million and $22.5 million for the nine months ended September 30, 2014 and 2013, respectively.

There have been no material changes in our significant accounting policies as of and for the three and nine months ended September 30, 2014 , compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2013 .


9


Recently Adopted Accounting Standards
In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (" ASU 2013-11") . ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. We adopted the amendments in ASU 2013-11 in the first quarter of 2014. This update did not have a significant impact on our financial position, operating results or cash flows.
Recently Issued Accounting Standards

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers: Topic 606 (" ASU 2014-09"). ASU 2014-09 supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing GAAP, including 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. Companies may use either of two methods: (i) full retrospective application to each prior reporting period presented with the option to elect certain practical expedients defined within ASU 2014-09; or (ii) modified retrospective application with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined per ASU 2014-09. ASU 2014-09 is effective for us in the first quarter of 2017 and we are currently evaluating the impact of our pending adoption on our consolidated financial statements.
    



10


Note 2.
Net Income Per Share
 
Basic net income per share is computed by dividing net income for the period by the weighted average number of shares outstanding during the period, less shares subject to repurchase. Diluted net income per share is computed by dividing net income for the period by the weighted average number of shares, less shares subject to repurchase, plus, if dilutive, potential common stock outstanding during the period. Potential common stock includes the effect of outstanding dilutive stock options, restricted stock awards and restricted stock units computed using the treasury stock method. Since their impact is anti-dilutive, we excluded 426,974 and 364,450 shares, respectively, from the calculations of diluted net income per share for the three and nine months ended September 30, 2014 and 465,301 and 1,178,755 shares, respectively, from the same calculations for the three and nine months ended September 30, 2013 .
 
The calculation of basic and diluted net income per share is as follows (in thousands, except per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Basic:
 

 
 

 
 
 
 
Net income
$
7,300

 
$
7,755

 
$
21,282

 
$
17,156

Weighted average shares outstanding — basic
35,994

 
35,133

 
35,634

 
34,499

Net income per share — basic
$
0.20

 
$
0.22

 
$
0.60

 
$
0.50

Diluted:
 

 


 
 
 
 
Net income
$
7,300

 
$
7,755

 
$
21,282

 
$
17,156

Weighted average shares outstanding — basic
35,994

 
35,133

 
35,634

 
34,499

Add: Dilutive effect of employee stock plans
838

 
1,057

 
983

 
967

Weighted average shares outstanding — diluted
36,832

 
36,190

 
$
36,617

 
35,466

Net income per share — diluted
$
0.20

 
$
0.21

 
$
0.58

 
$
0.48


11


Note 3.
Cash and Cash Equivalents and Fair Value of Financial Instruments
 
Cash and cash equivalents consist of the following significant asset investment classes as of September 30, 2014 and December 31, 2013 (in thousands):

 
September 30, 2014
 
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
Cash / Cash
Equivalents
 
Security
Classification
Cash
$
42,522

 
$

 
$

 
$
42,522

 
$
42,522

 
N/A
Money market fund
61,665

 

 

 
61,665

 
61,665

 
Available-for-sale
Total cash and cash equivalents
$
104,187

 
$

 
$

 
$
104,187

 
$
104,187

 
 

c
December 31, 2013
 
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
Cash / Cash
Equivalents
 
Security
Classification
Cash
$
38,823

 
$

 
$

 
$
38,823

 
$
38,823

 
N/A
Money market fund
65,708

 

 

 
65,708

 
65,708

 
Available-for-sale
Total cash and cash equivalents
$
104,531

 
$

 
$

 
$
104,531

 
$
104,531

 
 
 
The money market fund is a daily-traded cash equivalent with a price of $1.00 , making it a Level 1 asset class, and its carrying cost closely approximates fair value. As demand deposit (cash) balances vary with the timing of collections and payments, the money market fund can cover any surplus or deficit, and thus is considered available-for-sale. We did not hold any Level 2 and Level 3 assets or liabilities as of September 30, 2014 and December 31, 2013 .
    
The following table shows our financial assets measured at fair value, on a recurring basis, with money market funds recorded within cash and cash equivalents (in thousands):
 
Quoted Prices in Active
Markets for Identical
Instruments
  (Level 1)
 
Total Fair
Value
Money market fund at September 30, 2014
$
61,665

 
$
61,665

Money market fund at December 31, 2013
$
65,708

 
$
65,708


Note 4.
Inventories
 
Inventories consist of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Raw materials
$
11,158

 
$
10,765

Work in process
883

 
534

Finished goods
19,806

 
20,158

Total
$
31,847

 
$
31,457


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Note 5.
Property and Equipment
 
Property and equipment consist of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Equipment
$
42,738

 
$
40,180

Furniture and fixtures
5,663

 
5,260

Leasehold improvements
8,214

 
7,394

Software
25,536

 
20,199

Construction in process
3,935

 
2,649

Total property and equipment
86,086

 
75,682

Accumulated depreciation and amortization
(48,398
)
 
(40,428
)
Total property and equipment, net
$
37,688


$
35,254

 
Depreciation and amortization expense for property and equipment was approximately $2.9 million and $2.6 million for the three months ended September 30, 2014 and 2013 , respectively, and $8.2 million and $8.2 million for the nine months ended September 30, 2014 and 2013 , respectively.


13


Note 6.
Net Investment in Sales-Type Leases
 
Our sales-type leases are for terms generally up to five years . Sales-type lease receivables are collateralized by the underlying equipment. The components of our net investment in sales-type leases are as follows (in thousands):
 
September 30,
2014
 
December 31,
2013
Net minimum lease payments to be received
$
17,496

 
$
18,172

Less unearned interest income portion
(1,108
)
 
(1,455
)
Net investment in sales-type leases
16,388

 
16,717

Less current portion
(5,565
)
 
(5,232
)
Non-current net investment in sales-type leases
$
10,823

 
$
11,485


The minimum lease payments under sales-type leases as of September 30, 2014 were as follows (in thousands):
Remainder of 2014
$
1,614

2015
5,746

2016
4,412

2017
3,465

2018
1,889

Thereafter
370

Total
$
17,496


The following table summarizes the credit losses and recorded investment in sales-type leases, excluding unearned interest (in thousands):
 
Allowance for Credit Losses
 
Recorded Investment
in Sales-type Leases Gross
 
Recorded Investment
in Sales-type Leases Net
Credit loss disclosure for September 30, 2014:
 

 
 

 
 

Accounts collectively evaluated for impairment
$
151

 
$
16,539

 
$
16,388

Ending balances: September 30, 2014
$
151

 
$
16,539

 
$
16,388

 
 
 
 
 
 
Credit loss disclosure for December 31, 2013:
 

 
 

 
 

Accounts collectively evaluated for impairment
$
167

 
$
16,884

 
$
16,717

Ending balances: December 31, 2013
$
167

 
$
16,884

 
$
16,717

 
The following table summarizes the activity for the allowance for credit losses for the investment in sales-type leases (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

2014
 
2013
 
2014
 
2013
Allowance for credit losses, beginning of period
$
157

 
$
184

 
$
167

 
$
607

Current period provision (reversal)
(6
)
 
15

 
(16
)
 
34

Direct write-downs charged against the allowance

 

 

 
(413
)
Recoveries of amounts previously charged off

 
(25
)
 

 
(54
)
Allowance for credit losses, end of period
$
151


$
174

 
$
151

 
$
174

 
Note 7. Business Acquisition

On August 22, 2014, we completed our acquisition of Surgichem, a wholly-owned subsidiary of Bupa Care Homes (CFG) plc ("Bupa") pursuant to an Agreement by and among Omnicell, Bupa and MTS (the "Share Purchase Agreement"), under which MTS, a wholly-owned subsidiary of Omnicell, purchased the entire issued share capital of Surgichem, with Omnicell acting as guarantor of MTS' obligations thereunder (the "Acquisition"). As a result of the Acquisition, Omnicell paid

14


to Bupa $19.9 million in cash, subject to certain adjustments as provided for in the Share Purchase Agreement. Surgichem is in the process of being integrated with Omnicell’s existing UK business, MTS Medication Technologies Limited, a leading supplier of medication adherence packaging solutions.
The Surgichem acquisition primarily was to align Omnicell with the long term trends of the healthcare market to manage the health of patients across the continuum of care, specifically in the UK market. We acquired all outstanding shares of Surgichem.
We are accounting for the transaction under the acquisition method of accounting in accordance with the provisions of FASB Accounting Standards Codification ("ASC") Topic 805, Business Combinations . Under the acquisition method, the estimated fair value of the consideration transferred to purchase the acquired company is allocated to the assets acquired and the liabilities assumed based on their fair values. We have made significant estimates and assumptions in determining the allocation of the acquisition consideration. The acquisition consideration of $20.8 million is comprised of $19.9 million in cash at closing plus an estimated $0.9 million net working capital adjustment recorded in accrued liabilities, subject to review by Bupa and possible adjustment.
The purchase price allocation is subject to certain post-closing working capital adjustments for the acquired current assets and current liabilities of Surgichem on the acquisition date. The total consideration, and the allocation of consideration to the individual net assets is preliminary, as there are remaining uncertainties to be resolved, including the settlement of the final net working capital adjustment.
The total acquisition consideration was approximately $20.8 million and the preliminary acquisition price allocation was comprised of the following (in thousands):
 
 
Fair Value Acquired

Cash
 
$
153

Accounts receivable
 
2,462

Inventory
 
2,190

Deferred tax assets and other current assets
 
361

      Total current assets
 
$
5,166

Property and equipment
 
164

Intangibles
 
5,730

Goodwill
 
12,016

      Total assets
 
$
23,076

Current liabilities
 
1,191

Non-current deferred tax liabilities
 
1,104

Total purchase price
 
$
20,781


Acquired intangible assets . The fair value of $5.4 million for acquired customer relationships was determined based on an income approach using the discounted cash flow method. The fair value of $0.3 million for the trade name was determined using the relief-from-royalty approach. The intangible assets are being amortized over their estimated useful lives of 18 years for the customer relationships and just over one year for trade name.

Goodwill. Approximately $12.0 million has been allocated to goodwill, which represents sales of future products and services and the assembled workforce of Surgichem. In accordance with FASB ASC Topic 350, Intangibles - Goodwill and Other , goodwill will not be amortized, but instead will be tested for impairment at least annually or more frequently if certain indicators are present. In the event our management determines that the value of goodwill has become impaired, we will incur an accounting charge for the amount of impairment during the quarter in which the determination is made. We believe the Surgichem acquisition enhances Omnicell’s offerings and diversifies its revenue mix providing a more robust product and service solution to its current customers while expanding Omnicell’s international presence. We consider these factors as supporting the amount of goodwill recorded. Note that the amortization of intangible assets, and goodwill is not deductible for tax purposes. For the three months ended September 30, 2014 , we incurred approximately $0.2 million in acquisition related costs related to the Surgichem acquisition, offset by a $0.5 million expense reimbursement from Bupa. For the nine months ended September 30, 2014 , we incurred approximately $1.1 million in acquisition related costs related to the Surgichem acquisition, offset by a $0.5 million expense reimbursement from Bupa.These costs are included in selling, general and administrative expenses in our Condensed Consolidated Statement of Operations.


15


During the three months ended September 30, 2014 , the acquired Surgichem operations (consolidated since the August 22, 2014 acquisition date) generated approximately $1.4 million of revenue and impact on income from operations was $0.1 million .    
    
The total revenues of Surgichem for the nine months ended September 30, 2014 and 2013, were approximately $10.1 million (including the $1.4 million mentioned above) and $8.7 million , respectively. Results of operations for Surgichem have been included in our condensed consolidated financial statements subsequent to the date of acquisition and pro forma results of operations in accordance with authoritative guidance for prior periods have not been presented because the effect of the acquisition was not material to our prior period consolidated financial results.

Note 8. Goodwill and Intangible Assets
Goodwill
Goodwill is tested for impairment at least annually or more frequently if events or circumstances indicate that an impairment loss may have occurred, and we write down these assets when impaired. We perform our annual impairment tests during the fourth quarter of each fiscal year using the closing balance sheet as of the last day of the third quarter.
During the nine months ended September 30, 2014 , we noted no indications of impairment or triggering events to cause us to perform a goodwill impairment analysis.
Goodwill by reporting unit, which is the same for our operating segments, is as follows (in thousands):

16


 
Goodwill at December 31, 2013
 
Goodwill Acquired
 
Translation Adjustments
 
Goodwill at September 30, 2014
Reporting units:
 
 
 
 
 
 
 
Automation and Analytics
$
28,543

 
$

 
$

 
$
28,543

Medication Adherence
82,800

 
12,016

 
(269
)
 
94,547

Total
$
111,343

 
$
12,016

 
$
(269
)
 
$
123,090


Intangible Assets, net
 
There were no indefinite-lived intangible assets as of September 30, 2014 or December 31, 2013 . Finite-lived intangible assets consist of the following (in thousands):
 
September 30, 2014
 
December 31, 2013
 
 
 
Gross
 
 
 
Net
 
Gross
 
 
 
Net
 
 
 
Carrying
Amount
 
Accumulated
Amortization
 
Carrying
Amount
 
Carrying
Amount
 
Accumulated
Amortization
 
Carrying
Amount
 
Amortization
Life
Finite-lived intangibles:
 

 
 

 
 

 
 

 
 

 
 

 
 
Customer relationships
$
60,062

 
$
6,919

 
$
53,143

 
$
54,730

 
$
5,236

 
$
49,494

 
5-30 years
Acquired technology
27,580

 
3,700

 
23,880

 
27,580

 
2,598

 
24,982

 
3-20 years
Patents
1,658

 
338

 
1,320

 
1,493

 
254

 
1,239

 
20 years
Trade name
7,193

 
1,461

 
5,732

 
6,890

 
1,003

 
5,887

 
1-12 years
Non-compete agreements
60

 
60

 

 
60

 
60

 

 
3 years
Total finite-lived intangibles
$
96,553

 
$
12,478

 
$
84,075

 
$
90,753

 
$
9,151

 
$
81,602

 
 
 
Amortization expense for the intangible assets presented above was $1.2 million and $1.1 million for the three months ended September 30, 2014 and 2013 , respectively, and $3.3 million and $3.2 million for the nine months ended September 30, 2014 and 2013, respectively. The amortization of acquired technology is included within product cost of sales and amortization of other acquired intangibles is included within selling, general and administrative expenses.

17


Estimated future amortization expense of finite-lived intangible assets are as follows (in thousands):
Remainder of 2014
$
1,289

2015
4,980

2016
4,355

2017
4,267

2018
4,113

Thereafter
65,071

Total
$
84,075



18


Note 9. Accrued Liabilities
 
Accrued liabilities consist of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Rebates and lease buyouts
$
4,202

 
$
1,699

Advance payments from customers
3,749

 
4,971

Accrued Group Purchasing Organization (GPO) fees(1)
3,314

 
2,324

Technology license purchase obligation, current portion
250

 
1,500

Taxes payable
3,159

 
1,664

Other
2,399

 
1,588

Total
$
17,073

 
$
13,746

 

(1) Fees paid pursuant to GPO agreements. Customers who buy our products pursuant to a GPO agreement obtain pre-negotiated contract terms and pricing.

19


Note 10. Deferred Gross Profit
 
Deferred gross profit consists of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Sales of medication and supply dispensing systems and packaging equipment(1)
$
48,669

 
$
29,040

Cost of revenues, excluding installation costs
(13,127
)
 
(9,083
)
Deferred gross profit
$
35,542

 
$
19,957


(1) Sales that have been delivered and invoiced and not yet installed, or sales that have been shipped and not invoiced and not yet installed.

Note 11. Commitments

We lease properties in California, Florida, Illinois, Tennessee, and the United Kingdom. We also have smaller rented offices in Ohio, the United Arab Emirates, the People's Republic of China and the Federal Republic of Germany.
 
At September 30, 2014 , the minimum payments under our operating leases for each of the five succeeding fiscal years were as follows (in thousands):
Remainder of 2014
$
1,448

2015
5,604

2016
5,192

2017
4,468

2018
4,298

Thereafter
16,976

Total
$
37,986

 
We purchase components from a variety of suppliers and use contract manufacturers to provide manufacturing services for our products. During the normal course of business, we issue purchase orders with estimates of our requirements several months ahead of the delivery dates. Our near-term commitments to our contract manufacturers and suppliers totaled $10.9 million as of September 30, 2014 .
    


20


Note 12. Contingencies
 
Legal Proceedings

On September 12, 2014, MV Circuit Design, Inc., an Ohio company, brought an action to correct the inventorship of certain patents owned by Omnicell, as well as related state-law claims against the Company in the Northern District of Ohio (Case No. 1:14-cv-02028-DAP) regarding allegations of fraud in the filing and prosecution of U.S. Patent Nos. 8,180,485, 8,773,270, 8,812,153, PCT/US2007/003765, PCT/US2011/063597, and PCT/US2011/0635505. Omnicell has been granted an extension to respond to the Original Complaint on November 14, 2014. No schedule has yet been set by the court. Omnicell is currently evaluating a response to this complaint and intends to defend the matter vigorously.
As required under ASC 450, " Contingencies ," we accrue for contingencies when we believe that a loss is probable and that we can reasonably estimate the amount of any such loss. We have not recorded any accrual for contingent liabilities associated with the legal proceedings described above based on our belief that any potential loss, while reasonably possible, is not probable. Further, any possible range of loss in these matters cannot be reasonably estimated at this time. We believe that we have valid defenses with respect to legal proceedings pending against us. However, litigation is inherently unpredictable, and it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of this contingency or because of the diversion of management's attention and the creation of significant expenses.
Guarantees
As permitted under Delaware law and our certificate of incorporation and bylaws, we have agreed to indemnify our directors and officers against certain losses that they may suffer by reason of the fact that such persons are, were or become our directors or officers. The term of the indemnification period is for the director’s or officer’s lifetime and there is no limit on the potential amount of future payments that we could be required to make under these indemnification agreements. We have purchased a directors’ and officers’ liability insurance policy that may enable us to recover a portion of any future payments that we may be required to make under these indemnification agreements. Assuming the applicability of coverage and the willingness of the insurer to assume coverage and subject to certain retention, loss limits and other policy provisions, we believe it is unlikely that we will be required to pay any material amounts pursuant to these indemnification obligations. However, no assurances can be given that the insurers will not attempt to dispute the validity, applicability or amount of coverage without expensive and time-consuming litigation against the insurers.
Additionally, we undertake indemnification obligations in our ordinary course of business in connection with, among other things, the licensing of our products and the provision of our support services. In the ordinary course of our business, we have in the past and may in the future agree to indemnify another party, generally our business affiliates or customers, against certain losses suffered or incurred by the indemnified party in connection with various types of claims, which may include, without limitation, claims of intellectual property infringement, certain tax liabilities, our gross negligence or intentional acts in the performance of support services and violations of laws. The term of these indemnification obligations is generally perpetual. In general, we attempt to limit the maximum potential amount of future payments that we may be required to make under these indemnification obligations to the amounts paid to us by a customer, but in some cases the obligation may not be so limited. In addition, we have in the past and may in the future warrant to our customers that our products will conform to functional specifications for a limited period of time following the date of installation (generally not exceeding 30 days) or that our software media is free from material defects. Sales contracts for certain of our medication packaging systems often include limited warranties for up to six months, but the periodic activity and ending warranty balances we record have historically been immaterial.
From time to time, we may also warrant that our professional services will be performed in a good and workmanlike manner or in a professional manner consistent with industry standards. We generally seek to disclaim most warranties, including any implied or statutory warranties such as warranties of merchantability, fitness for a particular purpose, title, quality and non-infringement, as well as any liability with respect to incidental, consequential, special, exemplary, punitive or similar damages. In some states, such disclaimers may not be enforceable. If necessary, we would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history. We have not been subject to any significant claims for such losses and have not incurred any material costs in defending or settling claims related to these indemnification obligations. Accordingly, we believe it is unlikely that we will be required to pay any material amounts pursuant to these indemnification obligations or potential warranty claims and, therefore, no material liabilities have been recorded for such indemnification obligations as of September 30, 2014 or December 31, 2013 .
Note 13. Stockholders’ Equity
 

21


Treasury Stock
 
2012 Stock Repurchase Program

On August 1, 2012, our Board of Directors established a stock repurchase program (the “2012 Repurchase Program”) authorizing share repurchases of up to $50.0 million of our common stock, with no termination date. The timing, price and volume of repurchases are to be based on market conditions, relevant securities laws and other factors. The stock repurchases may be made from time to time on the open market, in privately negotiated transactions or pursuant to a Rule 10b-18 plan. The 2012 Repurchase Program does not obligate us to repurchase any specific number of shares, and we may terminate or suspend the repurchase program at any time.

For the nine months ended September 30, 2014 , we repurchased a total of $19.6 million , or 721,101 shares, at an average cost of $27.23 , including commissions. Of the repurchase activity, $2.6 million settled in October of 2014. For details regarding the 2012 Repurchase Program, please refer to Note 15, Stockholders' Equity, of our Annual Report on Form 10-K for the year ended December 31, 2013.

From the inception of the 2012 Repurchase Program, we have repurchased a total of $40.6 million , or 1,605,746 shares at an average cost of $25.28 per share, including commissions. As of September 30, 2014 , the maximum dollar value of shares that may yet be purchased under the plan is $9.4 million .

Note 14. Stock Option Plans and Share-Based Compensation
Share-Based Plans
Equity Incentive Plan
For a detailed explanation of our stock plan and subsequent changes please refer to Note 16, Stock Option Plans, Share-Based Compensation and 401(k) Plan, of our Annual Report on Form 10-K for the year ended December 31, 2013.
At September 30, 2014 , 2,238,383 shares of common stock were reserved for future issuance our 2009 Equity Incentive Plan, as amended (the "2009 Plan"), and $5.8 million of total unrecognized compensation cost related to non-vested stock options was expected to be recognized over a weighted average period of 2.6 years .
 A summary of option activity under the 2009 Plan for the nine months ended September 30, 2014 is presented below:
Options:
 
Number of Shares
 
Weighted-Average
  Exercise Price
 
 
(in thousands)
 
 
Outstanding at December 31, 2013
 
3,143

 
$15.82
Granted
 
397

 
$26.14
Exercised
 
(786
)
 
$14.44
Forfeited
 
(72
)
 
$18.96
Expired
 
(12
)
 
$19.88
Outstanding at September 30, 2014
 
2,670

 
$17.66
Vested and expected to vest at September 30, 2014
 
2,638

 
$17.60
Exercisable at September 30, 2014
 
1,612

 
$15.47
    
The aggregate intrinsic value of options exercised under our stock plans for the three and nine months ended September 30, 2014 was $2.5 million and $10.4 million , respectively, determined as of the date of option exercise.

Restricted Stock and Restricted Stock Units
 
A summary of activity of both restricted stock and restricted stock units ("RSUs") for the nine months ended September 30, 2014 is presented below:

22


 
Restricted Stock
 
Restricted Stock Units
 
Number of
Shares
 
Weighted-Average
Grant Date
Fair Value Per
Share
 
Number of
Shares
 
Weighted-Average
Grant Date
Fair Value Per
Share
 
(in thousands)
 
 
 
(in thousands)
 
 
Non-vested, December 31, 2013
52

 
$18.43
 
362

 
$17.15
Granted
38

 
$25.16
 
127

 
$25.73
Vested
(54
)
 
$17.78
 
(118
)
 
$16.70
Forfeited

 

 
(18
)
 
$16.15
Non-vested, September 30, 2014
36

 
$26.47
 
353

 
$20.42

The fair value of restricted stock is the product of the number of shares granted and the closing market price of our common stock on the grant date. Our unrecognized compensation cost related to non-vested restricted stock is approximately $6.8 million and is expected to be recognized over a weighted-average period of 2.5 years .
Performance-Based Restricted Stock Units
Performance-based restricted stock units ("PSUs") are an element of our executive compensation plans. In 2012, we granted 125,000 PSUs to our executive officers, of which 62,500 became eligible for vesting upon the achievement of a certain level of shareholder return for 2012 as described below. In 2013, we granted 137,500 PSUs to our executive officers, all of which became eligible for vesting upon the achievement of a certain level of shareholder return for the period from January 1, 2013 through February 28, 2014, as described below. In 2014, we granted 152,500 PSUs to our executive officers, all, none or a portion of which may become eligible for vesting depending on the level of shareholder return for 2014 and eligible for further time-based vesting based on the ranking of our total shareholder return. For a more detailed explanation of our PSUs and subsequent changes, please refer to Note 16, Stock Option Plans, Share-Based Compensation and 401(k) Plan on our Annual Report on Form 10-K for the year ended December 31, 2013.
Our unrecognized compensation cost related to non-vested performance-based restricted stock units at September 30, 2014 was approximately $1.8 million and is expected to be recognized over a weighted-average period of 1.3 years . For the three months ended September 30, 2014 and 2013, we recognized $0.5 million and $0.4 million , respectively, of compensation expense for the PSUs. For the nine months ended September 30, 2014 and 2013, we recognized $1.5 million and $1.2 million , respectively, of compensation expense for the PSUs.
The following table shows the percent of PSUs granted in 2012 eligible for further time-based vesting based on our percentile placement:
Percentile Placement of Our Total Shareholder Return
% of PSUs Eligible for Time-
Based Vesting
Below the 35th percentile
—%
At least the 35th percentile, but below the 50th percentile
50%
At least the 50th percentile
100%
On January 22, 2013, the Compensation Committee of our Board of Directors ("the Compensation Committee") confirmed 35.3% as the percentile rank of Omnicell's 2012 total stockholder return. This resulted in 50% of the 2012 PSU awards, or 62,500 shares, as eligible for further time-based vesting. The eligible performance-based restricted stock unit awards will vest as follows: 25% of the eligible shares vested immediately on January 22, 2013 with the remaining eligible awards vesting in equal increments, semi-annually, over the subsequent three year period beginning on June 15th and December 15th of the year after the date of grant and each subsequent year. Vesting is contingent upon continued service.

23


The following table shows the percent of PSUs granted in 2013 eligible for further time-based vesting based on our percentile placement:
Percentile Placement of Our Total Shareholder Return
% of PSUs Eligible for Time-
Based Vesting
Below the 35th percentile
—%
At least the 35th percentile, but below the 50th percentile
50%
At least the 50th percentile
100%
    
On March 20, 2014, the Compensation Committee confirmed 63.94% as the percentile rank of Omnicell's 2013-2014 total stockholder return. This resulted in 100% of the 2013 PSU awards, or 137,500 shares, as eligible for further time-based vesting. The eligible performance-based restricted stock unit awards will vest as follows: 25% of the eligible shares vested immediately on March 20, 2014 with the remaining eligible awards vesting in equal increments, semi-annually, over the subsequent three year period beginning on June 15th and December 15th of the year after the date of grant and each subsequent year. Vesting is contingent upon continued service.
On February 5, 2014, the Compensation Committee approved PSU awards of 132,500 shares. If the minimum performance threshold is met as determined by the Compensation Committee in 2015, the eligible performance-based restricted stock unit awards will vest as follows: 25% of the eligible shares will vest immediately, with the remaining eligible awards vesting in equal increments, semi-annually, over the subsequent three year period beginning on June 15th and December 15th of the year after the date of grant and each subsequent year. Vesting is contingent upon continued service.
The following table shows the percent of PSUs granted in 2014 eligible for further time-based vesting based on our percentile placement:
Percentile Placement of Our Total Shareholder Return
% of PSUs Eligible for Time-
Based Vesting
Below the 35th percentile
—%
At least the 35th percentile, but below the 50th percentile
50%
At least the 50th percentile
100%
A summary of activity of the PSUs for the nine months ended September 30, 2014 is presented below:
Performance-based Stock Units
Number of Shares
 
Weighted-Average
Grant Date
Fair Value Per
Share
 
(in thousands)
 
 
Non-vested, December 31, 2013
225

 
$13.32
   Granted
155

 
$14.36
   Vested
(74
)
 
$13.66
   Forfeited
(28
)
 
$3.07
Non-vested, September 30, 2014
278

 
$14.84
1997 Employee Stock Purchase Plan
 
We have an Employee Stock Purchase Plan (the “ESPP”) under which eligible employees can purchase shares of our common stock based on a percentage of their compensation, but not greater than 15% of their earnings; provided, however, an eligible employees' right to purchase shares of our common stock may not accrue at a rate which exceeds $25,000 of the fair market value of such shares for each calendar year in which such rights are outstanding. The purchase price per share is equal to the lower of 85% of the fair market value of the common stock at the beginning of a 24-month offering period or the end of each six-month purchasing period.

At the 2009 Annual Meeting of Stockholders, the stockholders approved an amendment to the ESPP, which added 2,622,426 shares to the reserve for future issuance. As of September 30, 2014 , there were 619,616 shares reserved for future issuance under the ESPP. For the three months ended September 30, 2014 , 227,275 shares of common stock were purchased under the ESPP. For the nine months ended September 30, 2014 , 481,284 shares of common stock were purchased under the ESPP.


24


As of September 30, 2014 , our unrecognized compensation cost related to the shares to be purchased under our ESPP was approximately $2.6 million and is expected to be recognized over a weighted average period of approximately 1.0 year .

Share-based Compensation
 
We account for share-based awards granted to employees and directors, including employee stock option awards, restricted stock, PSUs and RSUs issued pursuant to the 2009 Plan and employee stock purchases made under our ESPP using the estimated grant date fair value method of accounting in accordance with ASC 718, Stock Compensation .

We value options and ESPP shares using the Black-Scholes-Merton option-pricing model. Restricted stock and time-based RSUs are valued at the grant date fair value of the underlying common shares. The PSUs are valued via Monte Carlo simulation.

 The following table shows a summary of the share-based compensation expense included in the condensed consolidated statements of operations (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Cost of revenues
$
441

 
$
325

 
$
973

 
$
955

Research and development
407

 
405

 
1,156

 
1,019

Selling, general and administrative
2,313

 
2,080

 
6,481

 
6,449

Total share-based compensation expenses
$
3,161

 
$
2,810

 
$
8,610

 
$
8,423


Note 15. Segments
    
Prior to the first quarter of 2014, we organized our business into two operating business segments, the Acute Care and Non-Acute Care segments, which were based on the target customers for our products. The Acute Care segment primarily included products and services sold to hospital customers, and the Non-Acute Care segment primarily included products and services sold to customers outside of hospital settings.

In the first quarter of 2014, we realigned our segments based on the products we sell, regardless of who they are sold to because our business has evolved to be managed more on a product basis, rather than on a customer-type basis. It has become more difficult to determine whether a customer is a hospital or a blend of hospitals and non-acute care facilities. We are at a point where many of our Acute Care and Non-Acute Care customers are converging to provide services across the continuum of care. These customers seek automation and analytics products that function across the various facilities they manage. We find ourselves providing solutions across multiple types of care environments. These customers are also interested in obtaining higher levels of adherence to prescribed medication regimens that our blister card products provide.
Our two reportable segments are the Automation and Analytics segment and the Medication Adherence segment. The Automation and Analytics segment is organized around the design, manufacturing, selling and servicing of medication and supply dispensing systems, pharmacy inventory management systems, and related software. The Medication Adherence segment includes primarily the manufacturing and selling of consumable medication blister cards, packaging equipment and ancillary products and services.

Prior period amounts in the tables below have been recast to conform to the way we internally manage and monitor performance at the segment level during the current period.
We report segment information based on the management approach. The management approach designates the internal reporting used by the Chief Operating Decision Maker (the "CODM") for making decisions and assessing performance as the source of our operating segments. The CODM is our Chief Executive Officer. The CODM allocates resources to and assesses the performance of each operating segment, using information about its revenues, gross profit and income (loss) from operations. The CODM does not evaluate operating business segments using discrete asset information; accordingly, we do not report segment assets.
Since 1992, Omnicell has provided automation and business information solutions to healthcare facilities in general, but with a focus on acute care hospitals. We have developed product solutions that help optimize various workflows utilized in hospitals. We have also developed sophisticated sales, installation, and service capabilities to serve the specific and special needs of hospitals. As the healthcare market evolves, acute care facilities are beginning to merge operationally with non-acute

25


care facilities. The new healthcare organizations desire medication and supply inventory control and business analytics across the continuum of care environments they serve. Our Automation and Analytics segment represents the products we sell to fulfill these needs.
Since 1984, MTS has provided medication adherence solutions to the non-acute care market. In 2012, we acquired MTS. The solutions supplied by MTS provide automated and semi-automated equipment to assist institutional and retail pharmacists in filling medication orders into blister cards, the primary method of medication control in non-acute care settings. Completing the product solution are the consumables used by institutional and retail pharmacists to make the medication adherence package. MTS has developed process manufacturing capabilities as well as sales capabilities to market medication adherence solutions to institutional and retail pharmacies. As healthcare evolves, these medication adherence solutions are finding application in acute care settings as well. Our Medication Adherence segment represents all the products we sell to fulfill medication adherence needs through blister cards, blister card packaging equipment, and related software.
In August of 2014, we acquired Surgichem. Based in Stockport, UK, Surgichem is a provider of medication adherence packaging solutions to the UK care home and domiciliary care markets since 1989. Surgichem supplies its monitored dosage systems to a network of over 3,200 independent pharmacies and UK pharmacy chains. Surgichem is part of our Medication Adherence segment.
The contributions of our operating segments to net revenues and income from operations, and the reconciliation to total net income, were as follows (amounts in thousands):
 
Three Months Ended September 30, 2014
 
Three Months Ended September 30, 2013
 
Automation and Analytics
 
Medication Adherence
 
Total
 
Automation and Analytics
 
Medication Adherence
 
Total
Total revenues
$
89,546

 
$
22,997

 
$
112,543

 
$
75,110

 
$
18,929

 
$
94,039

Cost of revenues
38,412

 
14,585

 
52,997

 
30,240

 
11,759

 
41,999

Gross profit
$
51,134

 
$
8,412

 
$
59,546

 
$
44,870

 
$
7,170

 
$
52,040

Gross margin %
57.1
%
 
36.6
%
 
52.9
%
 
59.7
%
 
37.9
%
 
55.3
%
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
38,662

 
7,287

 
45,949

 
35,052

 
6,271

 
41,323

Income from operations
$
12,472

 
$
1,125

 
$
13,597

 
$
9,818

 
$
899

 
$
10,717

Operating margin %
13.9
%
 
4.9
%
 
12.1
%
 
13.1
%
 
4.7
%
 
11.4
%
 
 
 
 
 
 
 
 
 
 
 
 
Interest and other income (expense), net
 
 
 
 
(706
)
 
 
 
 
 
25

Income before provision for income taxes
 
 
 
 
12,891

 
 
 
 
 
10,742

Provision for income taxes
 
 
 
 
5,591

 
 
 
 
 
2,987

Net income
 
 
 
 
$
7,300

 
 
 
 
 
$
7,755



26


 
Nine Months Ended September 30, 2014
 
Nine Months Ended September 30, 2013
 
Automation and Analytics
 
Medication Adherence
 
Total
 
Automation and Analytics
 
Medication Adherence
 
Total
Total revenues
$
255,747

 
$
63,612

 
$
319,359

 
$
217,688

 
$
57,147

 
$
274,835

Cost of revenues
109,345

 
39,933

 
149,278

 
92,465

 
35,595

 
128,060

Gross profit
$
146,402

 
$
23,679

 
$
170,081

 
$
125,223

 
$
21,552

 
$
146,775

Gross margin %
57.2
%
 
37.2
%
 
53.3
%
 
57.5
%
 
37.7
%
 
53.4
%
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
112,572

 
21,400

 
133,972

 
101,425

 
21,106

 
122,531

Income from operations
$
33,830

 
$
2,279

 
$
36,109

 
$
23,798

 
$
446

 
$
24,244

Operating margin %
13.2
%
 
3.6
%
 
11.3
%
 
10.9
%
 
0.8
%
 
8.8
%
 
 
 
 
 
 
 
 
 
 
 
 
Interest and other income (expense), net
 
 
 
 
(1,003
)
 
 
 

 
(134
)
Income before provision for income taxes
 
 
 
 
35,106

 
 
 
 
 
24,110

Provision for income taxes
 
 
 
 
13,824

 
 
 
 
 
6,954

Net income
 
 
 
 
$
21,282

 
 
 
 
 
$
17,156



Segment depreciation and amortization, and capital expenditures were as follows (amounts in thousands):
 
Three Months Ended September 30, 2014
 
Three Months Ended September 30, 2013
 
Automation and Analytics
 
Medication Adherence
 
Total
 
Automation and Analytics
 
Medication Adherence
 
Total
Depreciation and amortization
$
3,460

 
$
1,854

 
$
5,314

 
$
2,805

 
$
1,683

 
$
4,488

Capital expenditures
$
2,635

 
$
785

 
$
3,420

 
$
1,311

 
$
745

 
$
2,056


 
Nine Months Ended September 30, 2014
 
Nine Months Ended September 30, 2013
 
Automation and Analytics
 
Medication Adherence
 
Total
 
Automation and Analytics
 
Medication Adherence
 
Total
Depreciation and amortization
$
9,402

 
$
5,303

 
$
14,705

 
$
8,351

 
$
5,381

 
$
13,732

Capital expenditures
$
8,802

 
$
1,953

 
$
10,755

 
$
3,329

 
$
4,478

 
$
7,807



Note 16. Impairment of Software Development Costs
    
2013 Impairment
    
As part of the continuing integration of MTS, in the first quarter of 2013, we reorganized our management team, including the software development department, within the Medication Adherence segment (formerly known as our Non-Acute segment). Through the end of the first quarter of 2013, the Medication Adherence segment had capitalized approximately $1.8 million of software development costs associated with a software solution under development which was intended to assist pharmacies in manual packaging of prescriptions. In connection with our financial statement close process for the quarter ended March 31, 2013, our management reassessed the viability of this project and the net realizable value of capitalized costs in light of its decision to change the related product road map and redesign this product based on evolving market demands. As part of this redesign process, new functionality and capabilities will need to be added to the product before commercialization. This redesign is intended to provide a more robust global platform providing larger scalability and significant functionality not contained in our current beta version. As such, we determined we can no longer support the technological feasibility of this project in conjunction with our software capitalization policy. Therefore, we charged these costs, in the amount of $1.8 million , ( $0.03 per diluted share, net of tax), to expense as a component of research and development in the accompanying condensed consolidated statement of operations.

Note 17. Credit Agreement

27


     In September 2013, we entered into a credit agreement (the "Credit Agreement") with Wells Fargo Bank, National Association, as administrative agent, and the lenders from time to time thereto. The Credit Agreement provides for a $75.0 million revolving credit facility with a $10.0 million letter of credit sub-limit. Loans under the Credit Agreement mature on September 25, 2018. The Credit Agreement permits us to request one or more increases in the aggregate commitments provided that such increases do not exceed $25.0 million in the aggregate. We expect to use the proceeds from any revolving loans under the credit facility for general corporate purposes, including future acquisitions. Our obligations under the Credit Agreement are guaranteed by certain of our domestic subsidiaries and secured by substantially all of our and the subsidiary guarantors’ assets.
Amounts drawn under the Credit Agreement bear interest, at our election, at a Eurodollar rate plus a margin of 1.75% per annum, or an alternate base rate equal to the highest of (a) the prime rate, (b) the federal funds rate plus 0.50% , and (c) LIBOR for an interest period of one month plus 1.75% . We are required to pay a commitment fee of 0.25% per annum on the aggregate undrawn amount of the commitments under the credit facility.
The Credit Agreement contains customary affirmative and negative covenants, including, among other things, restrictions on indebtedness, liens, investments, mergers, dispositions, dividends and other distributions. The Credit Agreement contains financial covenants that require us to, among other things, maintain a maximum consolidated total leverage ratio and a minimum consolidated fixed charge coverage ratio, in each case, as of the last day of each fiscal quarter.
To date, we have not yet drawn any funds under the credit facility. We were in full compliance with all covenants at September 30, 2014 and for all periods since the commencement of the Credit Agreement.


28


Note 18. Income Taxes

We provide for income taxes for each interim period based on the estimated annual effective tax rate for the year, adjusting for discrete items in the quarter in which they arise. The annual effective tax rate before discrete items was 40.4% and 38.1% for the nine months ended September 30, 2014 and 2013, respectively. The increase in the estimated annual effective tax rate for the nine months ended September 30, 2014 compared to the same period in 2013 was primarily due to the expiration of the federal research and development credit as of December 31, 2013. The 2014 annual effective tax rate differed from the statutory rate of 35.0% primarily due to the unfavorable impact of state income taxes, non-deductible equity charges, and other non-deductible expenditures, which were partially offset by the domestic production activities deduction.

The 2013 annual effective tax rate differed from the statutory rate of 35.0% primarily due to the unfavorable impact of state income taxes, non-deductible equity charges, and other non-deductible expenditures, which were partially offset by the federal research and development credit claimed and the domestic production activities deduction.



29


Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements. The forward looking statements are contained principally in the sections entitled “Risk Factors” and “Management's Discussion and Analysis of Financial Condition and Results of Operations.” These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to, statements about:
our expectations regarding our future product bookings;
the extent and timing of future revenues, including the amounts of our current backlog;
the size or growth of our market or market share;
the opportunity presented by new products, emerging markets and international market;
our ability to align our cost structure and headcount with our current business expectations;
the operating margins or earnings per share goals we may set;
our ability to protect our intellectual property and operate our business without infringing upon the intellectual property rights of others;
our ability to generate cash from operations and our estimates regarding the sufficiency of our cash resources; and
our ability to acquire companies, businesses, products or technologies on commercially reasonable terms and integrate such acquisitions effectively.
In some cases, you can identify forward-looking statements by terms such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "will," "would" and similar expressions intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events, are based on assumptions and are subject to risks and uncertainties. We discuss many of these risks in this Quarterly Report on Form 10-Q in greater detail in Part II - Section 1A. “Risk Factors” below. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our estimates and assumptions only as of the date of this Quarterly Report on Form 10-Q. You should read our Annual Report on Form 10-K and the documents that we reference in the Annual Report on Form 10-K and have filed as exhibits, completely and with the understanding that our actual future results may be materially different from what we expect.  All references in this report to "Omnicell, Inc.," "Omnicell," "our," "us," "we," or the "Company" collectively refer to Omnicell, Inc., a Delaware corporation, and its subsidiaries.
Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.
Overview
We are a leading provider of comprehensive automation and business analytics software solutions for patient-centric medication and supply management across the entire healthcare continuum, from the acute care hospital setting to post-acute skilled nursing and long-term care facilities to the home. Our Omnicell Automation and Analytic customers worldwide have utilized medication automation, supply chain and analytics solutions to enable them to increase operational efficiency, reduce errors, deliver actionable intelligence and improve patient safety.

Omnicell Medication Adherence solutions, including the MTS brand, provide innovative medication adherence packaging solutions that can help reduce costly hospital readmissions and enable institutional and retail pharmacies worldwide to maintain high accuracy and quality standards in medication dispensing and administration while optimizing productivity and controlling costs.

We sell our product and consumable solutions together with related service offerings. Total revenue for the United States and Canada generated approximately 90% of our total revenues and we expect our revenues from international operations to increase in future periods as we continue to grow our international business. We have not sold in the past, and have no future plans to sell our products either directly or indirectly, to customers located in countries that are identified as state sponsors of terrorism by the U.S. Department of State, and are subject to economic sanctions and export controls.

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Prior to the first quarter of 2014, we managed our business in two customer-centric operating segments: Acute Care which primarily included products and services sold to hospital customers, and Non-Acute Care which primarily included products and services sold to customers outside of hospital settings.
In the first quarter of 2014, we began to manage our business according to two product segments because many of our Acute Care and Non-Acute Care customers are converging to provide services across the continuum of care. These customers seek Automation and Analytics products that function across the various facilities they manage and we find ourselves providing solutions across multiple types of care environments. These customers are also interested in obtaining higher levels of adherence to prescribed medication regimens that our blister card products provide. Our business has evolved to be managed more on a product basis and it has become more difficult to determine whether a customer is a hospital or a blend of hospitals and non-acute care facilities. Our two product segments are Automation and Analytics and Medication Adherence. The Automation and Analytics segment is organized around the design, manufacturing, selling and servicing of medication and supply dispensing systems, pharmacy inventory management systems, and related software. The Medication Adherence segment includes primarily the manufacturing and selling of consumable medication blister cards, packaging equipment and ancillary products and services.
Our Automation and Analytics segment has been the predominant market for our products since our inception in 1992 and today comprises approximately 80% of our overall business. The Medication Adherence segment became a significant portion of our business in May 2012, when we completed our acquisition of MTS Medication Technologies, Inc. ("MTS"), a worldwide provider of medication adherence packaging systems. The acquisition aligned us with the long-term trends of the healthcare market to manage the health of patients across the continuum of care. The combination of Omnicell and MTS brought capabilities to each other that strengthened the product lines and expanded the medication management coverage of both companies. As our business evolves, we will continue to assess our segments which could result in future modifications to the current presentation.
The healthcare market is experiencing a period of substantive change. The adoption of electronic healthcare records, new regulatory constraints, and changes in the reimbursement structure have caused healthcare institutions to re-examine their operating structures, re-prioritize their investments, and seek efficiencies. We believe our customers’ evolving operating environment creates challenges for any supplier, but also affords opportunities for suppliers that are able to partner with customers to help them meet the changing demands. We have invested in strategies which we believe have generated our revenue and earnings growth by directly supporting our customers’ initiatives. These strategies include:
Development of differentiated products. We invest in the development of products that we believe bring patient safety and workflow efficiency to our customers’ operations that they cannot get from other competing solutions. These differentiators may be as small as how a transaction operates or the information provided on a report or as large as the entire automation of a workflow that would otherwise be completed manually. We intend to continue our focus on differentiating our products, and we carefully assess our investments regularly as we strive to assure those investments provide the solutions most valuable to our customers.
Deliver our solutions to new markets . Areas of healthcare where work is done manually may benefit from our existing solutions. These areas include hospitals that continue to use manual operations, healthcare segments of the US market outside hospitals, and markets outside the United States. We weigh the cost of entering these new markets against the expected benefits, and focus on the markets that we believe are most likely to adopt our products.
Expansion of our solutions through acquisitions and partnerships. Our acquisitions have generally been focused on automation of manual workflows or on data analytics, which is the enhancement of data for our customers’ decision-making processes. We believe that expansion of our product lines through acquisition and partnerships to meet our customers changing and evolving expectations is a key aspect to our historical and future success.
Our investments have been consistent with the strategies outlined above. To differentiate our solutions from others available in the market, we began shipping a refresh of our product line in 2011, which we market as G4. The G4 refresh included multiple new products and an upgrade product that allowed existing customers to augment their installations to obtain the most current technology that we provide. The G4 product refresh has been a key contributor to our growth, with 54% of our automation and analytics installed base ordering upgrades to their existing systems since the announcement of G4. In addition to enhanced capabilities, we have focused on attaining the highest quality and service measurements for G4 in the industry, while marketing the solution to new and existing customers. Our research and development efforts today are designed to bring new products to market beyond the G4 product line that we believe will meet customer needs in years to come.
Consistent with our strategy to enter new markets, we have made investments in our selling, general and administrative expenses to expand our sales team and market to new customers. Our international efforts have focused primarily on three markets: China, where we made a Mandarin version of our automated dispensing systems available in 2011,

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the Middle Eastern countries of the Arabian Peninsula where new healthcare facility construction is taking place, and in the United Kingdom where, in the third quarter of 2012, we purchased 15% of our United Kingdom distributor’s outstanding equity for approximately $0.9 million in cash to accelerate the adoption of medication and supply automation. In connection with the investment, we have the right, under certain circumstances, to appoint a member to this company's board of directors as well as certain other voting rights and, therefore, we believe we have the ability to exert significant influence over this distributor's operations. Our proportionate equity share of the income of this distributor recognized in our financial statements for the three and nine months ended September 30, 2014 was immaterial. We have also expanded our sales efforts to medication adherence customers in the United States which has allowed us to sell our automated dispensing solutions and other products to this market.
Expansion of our solutions through acquisitions and partnerships include our acquisition of MTS in 2012 and our acquisition of Surgichem Limited ("Surgichem") in August 2014. Surgichem is a provider of medication adherence products in the United Kingdom. The Surgichem acquisition is expected to enable both Omnicell and Surgichem to sell their lines of proven multi- and single-dose products across a broader medication adherence packaging market in the United Kingdom. We have also developed relationships with major providers of hospital information management systems with the goal of enhancing the interoperability of our products with their systems. We believe that enhanced interoperability will help reduce implementation costs, time, and maintenance for shared clients, while providing new clinical workflows designed to enhance efficiency and patient safety.
We believe that the success of our three leg strategy of differentiated products, expansion into new markets, and acquisition and partnership in future periods will be based on, among other factors:
Our expectation that the overall market demand for healthcare services will increase as the population grows, life expectancies continue to increase, and the quality and availability of healthcare services increases;
Our expectation that the environment of increased patient safety awareness, increased regulatory control, increased demand for innovative products that improve the care experience, and increased need for workflow efficiency through the adoption of technology in the healthcare industry will make our solutions a priority in the capital budgets of healthcare facilities; and
Our belief that healthcare customers will continue to value a consultative customer experience from their suppliers.
Among other financial measures, we utilize product bookings to assess the current success of our strategies. Product bookings consist of all firm orders, as evidenced by a contract and purchase order for equipment and software, and by a purchase order for consumables. Equipment and software bookings are installable within 12 months and generally recorded as revenue upon customer acceptance of the installation. Consumables are recorded as revenue upon shipment to a customer or receipt by the customer, depending upon contract terms. Consumable bookings are generally recorded as revenue within one month.
In addition to product solution sales, we provide services to our customers. Our healthcare customers expect a high degree of partnership involvement from their technology suppliers throughout their ownership of the products. We provide extensive installation planning and consulting as part of every product sale and included in the initial price of the solution. Our customers' medication control systems are mission critical to their success and our customers require these systems to be functional at all times. To help assure the maximum availability of our systems, our customers typically purchase maintenance and support contracts in one, two or five year increments.
The growth in our Automation and Analytics revenue for the three and nine months ended September 30, 2014 was driven primarily by our success in consistently growing the number of our customer installations. Installed customers grew from 1,806 hospitals as of September 30, 2013 to 1,897 hospitals as of September 30, 2014 . To a lesser extent, but of equal importance, revenue growth was also driven by our success in upgrading installed customers to newer G4 technology, which is in line with our strategy of striving to deliver differentiated innovation in our solutions. Our larger installed base has provided growth opportunities and, as a result, our service revenues have also grown for the nine months ended September 30, 2014 .

The growth in our Medication Adherence revenue for the three and nine months ended September 30, 2014 was driven primarily by increased sales of our OnDemand medication packaging systems in the United States market and increased adoption of multi-medication adherence solutions used by patients in assisted living or home care in Europe. This growth is in line with our strategy to deliver solutions to markets outside the United States. On a geographic basis, the United States market did not contribute to, nor erode, the growth in our Medication Adherence business as the population of patients living in nursing homes in the United States has remained relatively constant over the past twelve months.
We strive to provide the best service possible, as measured by third party rating agencies and by our own surveys. Our long-term liabilities include long-term deferred service revenue of $20 million and $18 million as of September 30, 2014 and

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December 31, 2013, respectively. Our deferred service revenue will be amortized to service revenue as the service contracts are performed upon.
In the future, we expect our strategies to evolve as the business environment of our customers evolves, but our focus will remain on improving healthcare with solutions that improve patient and provider outcomes. We expect our investment in differentiated products, new markets, and acquisitions and partnerships to continue. For the remainder of 2014, we also intend to continue to manage our business to operating profit margins similar to what we have achieved in the nine months ended September 30, 2014 .

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Table of Contents

Results of Operations
The table below shows the components of our consolidated results of operations as percentages of total revenues for the three and nine months ended September 30, 2014 and 2013 (in thousands, except percentages):
 
Three Months Ended
 
September 30, 2014
 
September 30, 2013
 
$
 
% of
Revenue
 
$
 
% of
Revenue
Revenues:
 

 
 

 
 

 
 

Product revenue
$
92,229

 
82.0
 %
 
$
75,508

 
80.3
%
Service and other revenues
20,314

 
18.0
 %
 
18,531

 
19.7
%
Total revenues
112,543

 
100.0
 %
 
94,039

 
100.0
%
Cost of revenues:
 

 
 

 
 

 
 

Cost of product revenues
44,510

 
39.6
 %
 
33,977

 
36.1
%
Cost of service and other revenues
8,487

 
7.5
 %
 
8,022

 
8.5
%
Total cost of revenues
52,997

 
47.1
 %
 
41,999

 
44.6
%
Gross profit
59,546

 
52.9
 %
 
52,040

 
55.4
%
Operating expenses:
 

 
 

 
 

 
 

Research and development
7,078

 
6.3
 %
 
6,561

 
7.0
%
Selling, general and administrative
38,871

 
34.5
 %
 
34,762

 
37.0
%
Total operating expenses
45,949

 
40.8
 %
 
41,323

 
44.0
%
Income from operations
13,597

 
12.1
 %
 
10,717

 
11.4
%
Interest and other income (expense), net
(706
)
 
(0.6
)%
 
25

 
%
Income before provision for income taxes
12,891

 
11.5
 %
 
10,742

 
11.4
%
Provision for income taxes
5,591

 
5.0
 %
 
2,987

 
3.2
%
Net income
$
7,300

 
6.5
 %
 
$
7,755

 
8.2
%


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Table of Contents

 
Nine Months Ended
 
September 30, 2014
 
September 30, 2013
 
$
 
% of
Revenue
 
$
 
% of
Revenue
Revenues:
 

 
 

 
 

 
 

Product revenue
$
260,053

 
81.4
 %
 
$
220,325

 
80.2
 %
Service and other revenues
59,306

 
18.6
 %
 
54,510

 
19.8
 %
Total revenues
319,359

 
100.0
 %
 
274,835

 
100.0
 %
Cost of revenues:
 

 
 

 
 

 
 

Cost of product revenues
124,413

 
39.0
 %
 
103,810

 
37.8
 %
Cost of service and other revenues
24,865

 
7.7
 %
 
24,250

 
8.8
 %
Total cost of revenues
149,278

 
46.7
 %
 
128,060

 
46.6
 %
Gross profit
170,081

 
53.3
 %
 
146,775

 
53.4
 %
Operating expenses:
 

 
 

 
 

 
 

Research and development
19,670

 
6.2
 %
 
21,665

 
7.9
 %
Selling, general and administrative