UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

______________________________________________________________________________________________



FORM 10-Q

 

______________________________________________________________________________________________

(Mark One)



For the quarterly period ended December 31, 2018

 



For the transition period from              to             



Commission File Number: 001-15317



______________________________________________________________________________________________



ResMed Inc.

(Exact name of registrant as specified in its charter)

______________________________________________________________________________________________



Delaware

(State or other jurisdiction of incorporation or organization)

98-0152841

(I.R.S. Employer Identification No.)



9001 Spectrum Center Blvd.

San Diego, CA 92123

United States of America

(Address of principal executive offices)



(858) 836-5000

(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  ☒    No  ☐



Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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  ☒    No  ☐



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

 



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Yes  ☐    No   ☐



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



At January 28, 2019, there were 143,300,009 shares of Common Stock ($0.004 par value) outstanding.  This number excludes 41,836,234 shares held by the registrant as treasury shares. 



 

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RESMED INC. AND SUBSIDIARIES



Index



 



 

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Item 1.  Financial Statements

RESMED INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets (Unaudited)

(In US$ thousands, except share and per share data)



 



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RESMED INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Income (Unaudited)

(In US$ thousands, except per share data)



 



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RESMED INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

(In US$ thousands)





 

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RESMED INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(In US$ thousands)



 



 

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(1)      Summary of Significant Accounting Policies



Organization and Basis of Presentation



ResMed Inc. (referred to herein as “we”, “us”, “our” or the “Company”) is a Delaware corporation formed in March 1994 as a holding company for the ResMed Group.  Through our subsidiaries, we design, manufacture and market equipment for the diagnosis and treatment of sleep-disordered breathing and other respiratory disorders, including obstructive sleep apnea.  Our manufacturing operations are located in Australia, Singapore, Malaysia, France, China and the United States.  Major distribution and sales sites are located in the United States, Germany, France, the United Kingdom, Switzerland, Australia, Japan, China, Norway and Sweden.



The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and the rules of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  In the opinion of management, all necessary adjustments, which consisted only of normal recurring items, have been included in the accompanying financial statements to present fairly the results of the interim periods. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending June 30, 2019.



The condensed consolidated financial statements for the three and six months ended December 31, 2018 and December 31, 2017 are unaudited and should be read in conjunction with the consolidated financial statements and notes thereto included in our Form 10-K for the year ended June 30, 2018.



Revenue Recognition



We adopted Accounting Standard Codification (“ASC”) Topic 606, “Revenue from Contracts with Customers” on July 1, 2018. We account for a contract with a customer when there is a legally enforceable contract, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. Our revenue relates primarily to the sale of our products that are therapy-based equipment. Some contracts include additional performance obligations such as the provision of extended warranties and data for patient monitoring. Our software as a service (“SaaS”) business offers software access with ongoing support and maintenance services as well as professional services such as training and consulting.



Disaggregation of revenue

The following table summarizes our net revenue disaggregated by product and region for the three and six months ended December 31, 2018 compared to December 31, 2017 (in millions):















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Performance obligations and contract balances

Revenue is recognized when performance obligations under the terms of a contract with a customer are satisfied; generally this occurs with the transfer of risk and/or control of our products are provided at a point in time. For most products, we transfer control and recognize a sale when products are shipped to the customer in accordance with the contractual shipping terms. For our SaaS business, revenue associated with professional services are recognized as they are provided. We defer the recognition of a portion of the consideration received when performance obligations are not yet satisfied. Consideration received from customers in advance of revenue recognition is classified as deferred revenue. Performance obligations resulting in deferred revenue relate primarily to extended warranties on our devices, the provision of data for patient monitoring, the provision of software access with maintenance and support over an agreed term and material rights associated with future discounts upon renewal of some SaaS contracts. Generally, deferred revenue will be recognized over a period of one to five years. The following table summarizes our contract balances at December 31, 2018 and June 30, 2018 (in thousands):













Transaction price determination

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. The amount of consideration received and revenue recognized varies with changes in marketing incentives (e.g., rebates, discounts, free goods) and returns offered to customers and their customers. When we give customers the right to return eligible products and receive credit, returns are estimated based on an analysis of historical experience. However, returns of products, excluding warranty related returns, are infrequent and insignificant. We adjust the estimate of revenue at the earlier of when the most likely amount of consideration can be estimated, the amount expected to be received changes, or when the consideration becomes fixed.



We offer our customers cash or product rebates based on volume or sales targets measured over quarterly or annual periods. We estimate rebates based on each customer’s expected achievement of its targets. In accounting for these rebate programs, we reduce revenue ratably as sales occur over the rebate period by the expected value of the rebates to be returned to the customer. Rebates measured over a quarterly period are updated based on actual sales results and, therefore, no estimation is required to determine the reduction to revenue. For rebates measured over annual periods, we update our estimates on a quarterly basis based on actual sales results and updated forecasts for the remaining rebate periods. We also offer discounts to customers as part of normal business practice and these are deducted from revenue when the sale occurs.



Many of our contracts have a single performance obligation which is the shipment of our therapy-based equipment. However, when the contract has multiple performance obligations, we generally use an observable price to determine the stand-alone selling price by reference to pricing and discounting practices for the specific product or service when sold separately to similar customers. Revenue is then allocated proportionately, based on the determined stand-alone selling price, to the performance obligation.



Accounting and practical expedient elections

We have elected to account for shipping and handling activities as a fulfillment cost within cost of sales, and record shipping and handling costs collected from customers in net revenue. We have also elected for all taxes assessed by government authorities that are imposed on and concurrent with revenue-producing transactions, such as sales and value added taxes, to be excluded from revenue.  We have adopted two practical expedients including the “right to invoice” practical expedient, which allows us to recognize revenue in the amount of the invoice when it corresponds directly with the value of performance completed to date and which is relevant for some of our SaaS contracts. The second practical expedient adopted permits relief from considering a significant financing component when the payment for the good or service is expected to be one year or less.



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Provision for Warranty



We provide for the estimated cost of product warranties at the time the related revenue is recognized. We determine the amount of this provision by using a financial model, which takes into consideration actual historical expenses and potential risks associated with our different products. We use this financial model to calculate the future probable expenses related to warranty and the required level of the warranty provision. Although we engage in product improvement programs and processes, our warranty obligation is affected by product failure rates and costs incurred to correct those product failures. Should actual product failure rates or estimated costs to repair those product failures differ from our estimates, we would be required to revise our estimated warranty provision.



New Accounting Pronouncements



(a)  Recently issued accounting standards not yet adopted



ASU No. 2016-02, “Leases”

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases” (Topic 842). Under the new guidance, lessees are required to recognize a right-of-use asset and a lease liability on the balance sheet for all leases, other than those that meet the definition of a short-term lease. This update will establish a lease asset and lease liability by lessees for those leases classified as operating under current GAAP. Leases will be classified as either operating or finance under the new guidance. Operating leases will result in straight-line expense in the income statement, similar to current operating leases, and finance leases will result in more expense being recognized in the earlier years of the lease term, similar to current capital leases.  For lessors, the update will more closely align lease accounting to comparable guidance in the new revenue standards described.



The new standard is effective for us beginning in the first quarter of the year ending June 30, 2020 and early application is permitted. ASU 2016-02 will be adopted on a modified retrospective transition basis. There is a practical expedient available that would permit any leases that existed at the date of adoption to continue to be accounted for in accordance with the previous GAAP, ASC 840. We are still evaluating whether we will adopt this practical expedient.



We formed an implementation team during the year ended June 30, 2018 to oversee adoption of the new standard. The implementation team has established a project plan, collected copies of our lease agreements and implemented procedures to identify embedded leases. There are a number of steps in the team’s project plan that remain to be completed including: executing global education program, reviewing system outputs from lease data entry and balance calculations, evaluating the impact, and working through required changes to systems, business processes and controls to support the adoption of the new leases standard. While the formal impact assessment is ongoing, we expect this amendment will affect the way we account for operating leases where we are the lessee (as described above), require reassessment of how we account for revenue where we are the lessor and will result in increased disclosures for all lease arrangements. We are still evaluating the impact the standard will have on our financial statements.



(b)  Recently adopted accounting pronouncements



ASU No. 2014-09, “Revenue from Contracts with Customers”

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Since its initial release, the FASB has issued several amendments to the standard, which include clarification of accounting guidance related to identification of performance obligations, intellectual property licenses, and principal vs. agent considerations. ASU 2014-09 and all subsequent amendments (collectively, the “new revenue recognition standards”) replaced most existing revenue recognition guidance in U.S. GAAP during the current quarter when it became effective. The guidance also requires improved disclosures on the nature, amount, timing, and uncertainty of revenue that is recognized.



Effective July 1, 2018, we adopted the new revenue recognition standards and applied its provisions to all contracts using the modified retrospective method. Application of the new provisions did not have a material impact on our financial statements and no cumulative-effect adjustment was calculated or recognized. The comparative information has not been restated; however, if it were there would be no change in the accounting treatment. Refer to the “Revenue Recognition” section above for further details about our revenue recognition following adoption of the new revenue recognition standards.



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ASU No. 2016-01, "Financial Instruments - Overall"

In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments - Overall" (Topic 825-10). The amendments address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments, and require equity investments, other than equity-method investments, to be measured at fair value with changes in fair value recognized through net income. The amendments also simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment for impairment quarterly at each reporting period. We adopted ASU 2016-01 during the quarter ended September 30, 2018 and elected to apply the practical expedient for measuring equity investments that do not have readily determinable fair market.  Based on our elections, our strategic equity investments that do not have readily determinable fair values are measured at cost, less any impairments, plus or minus changes resulting from observable price changes in orderly transactions for identifiable or similar investments of the same issuer. The measurement alternative was applied prospectively and the adoption of ASU 2016-01 did not result in an adjustment to retained earnings.



ASU No. 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory”

In October 2016, the FASB issued Accounting Standard Update ASU No. 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory” (Topic 740). Under the new guidance, an entity is required to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs and eliminates the exception for an intra-entity transfer of an asset other than inventory. ASU 2016-16 became effective during the three months ended September 30, 2018 and is required to be adopted on a modified retrospective basis, with a cumulative-effect adjustment recorded directly to retained earnings for intra-entity transfers that occur before the adoption date. Accordingly, we recognized the following reclassifications upon adoption (in thousands):



 



(2)      Inventories



Inventories were comprised of the following at December 31, 2018 and June 30, 2018 (in thousands):

 

(3)      Property, Plant and Equipment



Property, plant and equipment were comprised of the following as of December 31, 2018 and June 30, 2018 (in thousands): 

 

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(4)      Goodwill

A reconciliation of changes in our goodwill by reportable segment is as follows (in thousands):

 

(5)      Other Intangible Assets 

Other intangible assets were comprised of the following as of December 31, 2018 and June 30, 2018 (in thousands):







Intangible assets consist of developed/core product technology, trade names, non-compete agreements, customer relationships, and patents, which we amortize over the estimated useful life of the assets, generally between two and fifteen years. There are no expected residual values related to these intangible assets.

 

(6)      Investments



Investments whereby we do not have significant influence or control over the investee are accounted for initially at cost. These investments include our holdings in privately held service and research companies that are not exchange traded and therefore not supported with observable market prices. We have determined that these investments do not have readily determinable fair values and are therefore revalued only when there are observable price changes in orderly transactions for identifiable or similar investments of the same issuer. We also estimate the fair value of our equity investments to assess whether impairment losses shall be recorded using Level 3 inputs. However, these investments are valued by reference to their net asset values that can be market supported and unobservable inputs including future cash flows. During the six months ended December 31, 2018 and 2017, we recognized $3.0 million and $2.3 million, respectively, of impairment losses related to our equity investments. The carrying amount of all investments at December 31, 2018 and June 30, 2018, was $62.9 million and $41.2 million, respectively. 



Equity investments whereby we have significant influence but not control over the investee, and are not the primary beneficiary of the investee’s activities, are accounted for under the equity method. Under this method, we record our share of gains or losses attributable to equity method investments. The carrying amount of these investments at December 31, 2018 and December 31, 2017 was $21.6 million and $0.0, respectively, and is included in the non-current balance of other assets on the condensed consolidated balance sheets.



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We have determined that the fair value of our investments exceed their carrying values. Investments are included in the non-current balance of other assets on the condensed consolidated balance sheets. The following table shows a reconciliation of the changes in all of our investments during the six months ended December 31, 2018 and December 31, 2017 (in thousands):



 

(7)      Income Taxes



In accordance with ASC 740 Income Taxes, each interim reporting period is considered integral to the annual period, and tax expense is measured using an estimated annual effective tax rate. An entity is required to record income tax expense each quarter based on its annual effective tax rate estimated for the full fiscal year and use that rate to provide for income taxes on a current year-to-date basis, adjusted for discrete taxable events that occur during the interim period.



Our income tax returns are based on calculations and assumptions subject to audit by various tax authorities. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws.  We regularly assess the potential outcomes of examinations by tax authorities in determining the adequacy of our provision for income taxes. Any final assessment resulting from tax audits may result in material changes to our past or future taxable income, tax payable or deferred tax assets, and may require us to pay penalties and interest that could materially adversely affect our financial results. 



In connection with the audit by the Australian Taxation Office (“ATO”) for the tax years 2009 to 2013, we received Notices of Amended Assessments in March 2018. Based on these assessments, the ATO asserted that we owe $151.7 million in additional income tax and $38.4 million in accrued interest, of which $75.9 million was paid in April 2018 under a payment arrangement with the ATO. In June 2018, we received a notice from the ATO claiming penalties of 50% of the additional income tax that was assessed or $75.9 million. We do not agree with the ATO’s assessments and continue to believe we are more likely than not to be successful in defending our position. At December 31, 2018, we have recorded a receivable in prepaid taxes and other non-current assets for the amount paid as we ultimately expect this will be refunded by the ATO. We are also currently under audit by the ATO for the tax years 2014 to 2017.



On December 22, 2017, the SEC issued guidance under Staff Accounting Bulletin No. 118 (“SAB 118”), Income Tax Accounting Implications of the Tax Cuts and Jobs Act directing taxpayers to consider the impact of the U.S. legislation as “provisional” when it does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the change in tax law. In accordance with SAB 118, we recognized estimated income tax expense of $138.0 million during the year ended June 30, 2018 based on our best estimate and interpretation of the U.S. legislation.  During the six months ended December 31, 2018, we recorded an additional $1.2 million of tax expense relating to the transition tax.  Effective December 31, 2018, the accounting relating to the impact of U.S. legislation is no longer considered provisional.  However, further adjustments could be made to this calculation as a result of future legislation, amended tax returns, or tax examinations of the years impacted by the calculation.

 

(8)      Product Warranties



Changes in the liability for warranty costs, which is included in accrued expenses in our condensed consolidated balance sheets, for the six months ended December 31, 2018 and December 31, 2017, are as follows (in thousands):



 

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(9)      Debt

Debt at December 31, 2018 and June 30, 2018 consisted of the following (in thousands):



Credit Facility



On April 17, 2018, we entered into an amended and restated credit agreement (the “Revolving Credit Agreement”), as borrower, with lenders MUFG Union Bank, N.A., as administrative agent, joint lead arranger, joint book runner, swing line lender and letter of credit issuer, and Westpac Banking Corporation, as syndication agent, joint lead arranger and joint book runner. The Amended and Restated Credit Agreement, among other things, provided a senior unsecured revolving credit facility of $800.0 million, with an uncommitted option to increase the revolving credit facility by an additional $300.0 million.



Additionally, on April 17, 2018, ResMed Limited entered into a Syndicated Facility Agreement (the “Term Credit Agreement”), as borrower, with lenders MUFG Union Bank, N.A., as administrative agent, joint lead arranger and joint book runner, and Westpac Banking Corporation, as syndication agent, joint lead arranger and joint book runner. The Term Credit Agreement, among other things, provides ResMed Limited a senior unsecured term credit facility of $200.0 million. 



On November 5, 2018, we entered into a first amendment to the Revolving Credit Agreement to, among other things, increase the size of our senior unsecured revolving credit facility from $800.0 million to $1.6 billion, with an uncommitted option to increase the revolving credit facility by an additional $300.0 million.



Our obligations under the Revolving Credit Agreement are guaranteed by certain of our direct and indirect U.S. subsidiaries, and ResMed Limited’s obligations under the Term Credit Agreement are guaranteed by us and certain of our direct and indirect U.S. subsidiaries. The Revolving Credit Agreement and Term Credit Agreement contain customary covenants, including, in each case, a financial covenant that requires that we maintain a maximum leverage ratio of funded debt to EBITDA (as defined in the Revolving Credit Agreement and Term Credit Agreement, as applicable). The entire principal amounts of the revolving credit facility and term credit facility, and, in each case, any accrued but unpaid interest may be declared immediately due and payable if an event of default occurs, as defined in the Revolving Credit Agreement and the Term Credit Agreement, as applicable. Events of default under the Revolving Credit Agreement and the Term Credit Agreement include, in each case, failure to make payments when due, the occurrence of a default in the performance of any covenants in the respective agreements or related documents, or certain changes of control of us,  or the respective guarantors of the obligations borrowed under the Revolving Credit Agreement and Term Credit Agreement. 



The Revolving Credit Agreement and Term Credit Agreement each terminate on April 17, 2023, when all unpaid principal and interest under the loans must be repaid. Amounts borrowed under the Term Credit Agreement will also amortize on a semi-annual basis, with a $6.0 million principal payment required on each such semi-annual amortization date. The outstanding principal amounts will bear interest at a rate equal to LIBOR plus 0.75% to 1.50% (depending on the then-applicable leverage ratio) or the Base Rate (as defined in the Revolving Credit Agreement and the Term Credit Agreement, as applicable) plus 0.0% to 0.50% (depending on the then-applicable leverage ratio). At December 31, 2018, the interest rate that was being charged on the outstanding principal amounts was 3.3%.  An applicable commitment fee of 0.100% to 0.175% (depending on the then-applicable leverage ratio) applies on the unused portion of the revolving credit facility. At December 31, 2018, we were in compliance with our debt covenants and there was $1,197.5 million outstanding under the Revolving Credit Agreement and Term Credit Agreement.

 

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(10)      Stockholders’ Equity



Common Stock. Since the inception of our share repurchase programs and through December 31, 2018, we have repurchased a total of 41.8 million shares for an aggregate of $1.6 billion. During the six months ended December 31, 2018, we repurchased 200,000 shares at an aggregate purchase price of $22.8 million under our share repurchase program. During the three months ended December 31, 2018 we suspended our share repurchase program due to recent acquisitions. Accordingly, we did not repurchase any shares during this period. Shares that are repurchased are classified as treasury stock pending future use and reduce the number of shares outstanding used in calculating earnings per share. There is no expiration date for this program, and the program may be accelerated, suspended, reinstated, delayed or discontinued at any time at the discretion of our board of directors. At December 31, 2018,  12.9 million additional shares can be repurchased under the approved share repurchase program.



Preferred Stock.    In April 1997, the board of directors designated 2.0 million shares of our $0.01 par value preferred stock as Series A Junior Participating Preferred Stock. No shares were issued or outstanding at December 31, 2018 and June 30, 2018.



Stock Options and Restricted Stock Units.    We have granted stock options and restricted stock units to personnel, including officers and directors, in accordance with the amended and restated ResMed Inc. 2009 Incentive Award Plan (as amended and restated, the “2009 Plan”).  The options have expiration dates of seven years from the date of grant and the options and restricted stock units vest over one to four years. 



At December 31, 2018, the maximum number of shares of our common stock authorized for issuance under the 2009 Plan was 51.1 million shares. The number of securities remaining available for future issuance under the 2009 Plan at December 31, 2018 was 16.4 million.

The following table summarizes option activity during the six months ended December 31, 2018:



The following table summarizes the activity of restricted stock units during the six months ended December 31, 2018:



Employee Stock Purchase Plan (the “ESPP”).    Under the ESPP, we offer participants the right to purchase shares of our common stock at a discount during successive offering periods. During the six months ended December 31, 2018 and December 31, 2017, we issued 129,000 and 148,000 shares to our employees associated with the ESPP, respectively. At December 31, 2018, the number of shares remaining available for future issuance under the ESPP is 2.4 million shares.



At the annual meeting of our stockholders in November 2018, our stockholders approved an amendment and restatement to the 2009 Plan to increase the number of shares of common stock that may be issued or transferred pursuant to awards under the 2009 Plan by 2.0 million shares, from 4.2 million to 6.2 million shares. The amendment also renamed the plan as “the ResMed Inc. 2018 Employee Stock Purchase

Plan,” and extended the term by ten years, so that the plan expires on November 15, 2028. The amendment became effective August 17, 2018, the date it was adopted by our board of directors.

 

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(11)      Earnings Per Share



Basic earnings per share is computed by dividing the net income available to common stockholders by the weighted average number of shares of common stock outstanding. For purposes of calculating diluted earnings per share, the denominator includes both the weighted average number of shares of common stock outstanding and the number of dilutive common stock equivalents such as stock options and restricted stock units.



Stock options and restricted units of 161,036 and 126,390 for the three months ended December 31, 2018 and December 31, 2017 and stock options and restricted units of 85,521 and 159,603 for the six months ended December 31, 2018 and December 31, 2017, respectively, were not included in the computation of diluted earnings per share as the effect would have been anti-dilutive.



Basic and diluted earnings per share for the three and six months ended December 31, 2018 and December 31, 2017 are calculated as follows (in thousands except per share data):

 



(12)      Fair Value Measurements



In determining the fair value measurements of our financial assets and liabilities, we consider the principal and most advantageous market in which we transact and consider assumptions that market participants would use when pricing the financial asset or liability. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.



The hierarchies of inputs are as follows:





The following table summarizes our financial assets and liabilities at December 31, 2018 and June 30, 2018, using the valuation input hierarchy (in thousands):



We determine the fair value of our financial assets and liabilities as follows:



Foreign currency hedging instruments – These financial instruments are valued using third-party valuation models based on market observable inputs, including interest rate curves, on-market spot currency prices, volatilities and credit risk.



Contingent consideration – These liabilities include the fair value estimates of additional future payments that may be required for some of our previous business acquisitions based on the achievement of certain performance milestones. Each potential future payment is valued using the estimated probability of achieving each milestone, which is then discounted to present value.



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The following is a reconciliation of changes in the fair value of contingent consideration for the six months ended December 31, 2018 and December 31, 2017 (in thousands):



We did not have any significant non-financial assets or liabilities measured at fair value on December 31, 2018 or June 30, 2018, except for our equity investments described at note 6 – Investments which are in non-controlled corporations without readily determinable market values.  Following the adoption of ASU 2016-01 “Financial Instruments – Overall” on July 1, 2018,  we have elected to initially measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes. The fair value is determined by using quoted prices for identical or similar investments of the same issuer, which are Level 2 inputs. This does not include our equity method investments which are not recorded at fair value.  

 

(13)      Legal Actions and Contingencies



Litigation

 

In the normal course of business, we are subject to routine litigation incidental to our business.  While the results of this litigation cannot be predicted with certainty, we believe that their final outcome will not, individually or in aggregate, have a material adverse effect on our consolidated financial statements taken as a whole.



Taxation Matters



As described in note 7 – Income Taxes, we received Notices of Amended Assessments from the ATO for the tax years 2009 to 2013. Based on these assessments, the ATO asserted that we owe $151.7 million in additional income tax and $38.4 million in accrued interest, of which $75.9 million was paid in April 2018 under a payment arrangement with the ATO. In June 2018, we received a notice from the ATO claiming penalties of 50% of the additional income tax that was assessed, or $75.9 million. We do not agree with the ATO’s assessments and we continue to believe we are more likely than not to be successful in defending our position. However, if we are not successful, we will not receive a refund of the $75.9 million paid in April 2018 and we would be required to pay the remaining $75.9 million in additional income tax, $38.4 million in accrued interest and $75.9 million in penalties, which would be recorded as income tax expense. We are also currently under audit by the ATO for the tax years 2014 to 2017.  



In connection with the recent U.S. Tax Act and the analysis of historical tax filings, we identified an administrative oversight in our prior year tax filing relating to a gain on an internal legal entity reorganization.  We have applied for relief from the U.S. Internal Revenue Service (“IRS”) and have amended the related tax returns required to correct the administrative oversight, which would indefinitely defer the recognition of this gain. We believe it is more likely than not that we will be granted this relief and therefore, have not recorded a reserve in relation to this matter during the six months ended December 31, 2018. As of December 31, 2018, we were awaiting communication from the IRS regarding the amended tax returns.



Contingent Obligations Under Recourse Provisions



We use independent financing institutions to offer some of our customers financing for the purchase of some of our products. Under these arrangements, if the customer qualifies under the financing institutions’ credit criteria and finances the transaction, the customers repay the financing institution on a fixed payment plan. For some of these arrangements, the customer’s receivable balance is with recourse, either limited or full, whereby we are responsible for repaying the financing company should the customer default. We record a contingent provision, which is estimated based on historical default rates. This is applied to receivables sold with recourse and is recorded in accrued expenses.



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The following table summarizes the amount of receivables sold with recourse during the six months ended December 31, 2018 and December 31, 2017(in thousands):





The following table summarizes the maximum exposure on outstanding receivables sold with recourse and provision for doubtful accounts at December 31, 2018 and June 30, 2018  (in thousands):



 

(14)      Business Combinations



MatrixCare

On November 13, 2018, we completed the acquisition of 100% of the shares in MatrixCare Inc. and its subsidiaries (“MatrixCare”), a provider of software solutions for skilled nursing, life plan communities, senior living and private duty, for base purchase consideration paid of $750.0 million.  This acquisition has been accounted for as a business combination using purchase accounting and included in our consolidated financial statements from November 13, 2018.  The acquisition was paid for using our revolving credit facility.

We have not finalized the purchase price allocation in relation to this acquisition as certain appraisals associated with the valuation of intangible assets and income tax positions are not yet complete. We do not believe that the completion of this work will materially modify the preliminary purchase price allocation. We expect to complete our purchase price allocation during the quarter ending June 30, 2019.  The cost of the acquisition was allocated to the assets acquired and liabilities assumed based on estimates of their fair values at the date of acquisition. The goodwill recognized as part of the acquisition is reflected in the Software as a Service segment and is not deductible for tax purposes. It mainly represents the synergies that are unique to our combined businesses and the potential for new products and services to be developed in the future.

The preliminary fair values of assets acquired and liabilities assumed, and the estimated useful lives of intangible assets acquired are as follows (in thousands):



A reconciliation of the base consideration to the net consideration is as follows (in thousands):





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Approximately $15.4 million of revenue and $1.0 million of loss  from operations of MatrixCare were included in the unaudited condensed consolidated statement of comprehensive income for the three and six months ended December 31, 2018. The loss from operations was negatively impacted by $3.0 million of amortization of acquired intangibles assets and fair value purchase price adjustment of $2.0 million to deferred revenue. Excluding the impact of these items, revenue was $17.4 million and income from operations was $4.0 million.

The acquisition is considered a material business combination and accordingly unaudited pro forma information presented below for the three and six months ended December 31, 2018 and December 31, 2017, include the effects of pro forma adjustments as if the acquisition of MatrixCare occurred on July 1, 2017.  The pro forma results were prepared using the acquisition method of accounting and combine our historical results and MatrixCare’s for the three and six months ended December 31, 2018 and 2017, including the effects of the business combination, primarily amortization expense related to the fair value of identifiable intangible assets acquired, interest expense associated with the financing obtained by us in connection with the acquisition, and the elimination of incurred acquisition-related costs.

The pro forma financial information presented below is not necessarily indicative of the results of operations that would have been achieved if the acquisition occurred at the beginning of the earliest period presented, nor is it intended to be a projection of future results.





The unaudited pro forma consolidated results for the three and six months ended December 31, 2018 and December 31, 2017 reflect primarily the following pro forma pre-tax adjustments:



Other acquisitions

During the six months ended December 31, 2018 we have completed the following acquisitions:



These acquisitions have been accounted for as business combinations using purchase accounting and are included in our consolidated financial statements from the acquisition dates. These acquisitions, individually and collectively, are not considered a material business combination and accordingly pro forma information is not provided.  The acquisitions were funded by drawing on our existing credit facility and through cash on-hand. 



We have not completed the purchase price allocation in relation to these acquisitions and expect to complete this during the quarter ending June 30, 2019.  We do not believe that the completion of this work will materially modify the preliminary purchase price allocation for these acquisitions. The cost of the share acquisitions was allocated to the assets acquired and liabilities assumed based on estimates of their fair values at the date of acquisition. The goodwill recognized as part of these acquisitions, which is predominantly not deductible for tax purposes, mainly represents the synergies that are unique to our combined businesses and the potential for new products and services to be

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developed in the future. Goodwill from these acquisitions has been reflected in the Software as a Service segment except for the goodwill resulting from the HB Healthcare acquisition, which has been recorded in the Sleep and Respiratory Care segment.



The fair values of assets acquired and liabilities assumed, and the estimated useful lives of intangible assets acquired are as follows (in thousands):

 

During the six months ended December 31, 2018, we recorded $6.1 million in acquisition related expenses and did not have material acquisition related expenses during the six months ended December 31, 2017.

 

(15)      Segment Information



We have determined that we have two operating segments, which are the sleep and respiratory disorders sector of the medical device industry (“Sleep and Respiratory Care”) and the supply of business management software-as-a-service to out-of-hospital health providers (“SaaS”). However, we have previously determined the SaaS segment as not material to our global operations in terms of revenue and profit, and therefore this has not been separately reported as a segment. Following our recent acquisitions, we have quantitatively and qualitatively reassessed our segment reporting and determined the SaaS segment is material to the group.



We evaluate the performance of our segments based on net sales and income from operations. The accounting policies of the segments are the same as those described in note 1 of our consolidated financial statements included in our Form 10-K for the year ended June 30, 2018, except for revenue recognition, which is described in note - 1 Summary of Significant Accounting Policies. Segment net sales and segment income from operations do not include inter-segment profits.



Certain items are maintained at the corporate level and are not allocated to the segments. The non-allocated items include corporate headquarters costs, stock-based compensation, amortization expense from acquired intangibles, acquisition related expenses, interest income, interest expense and other, net. We neither discretely allocate assets to our operating segments, nor does our Chief Operating Decision Maker evaluate the operating segments using discrete asset information.



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The table below presents information about our reportable segments (in millions):





















(16) Subsequent Event



On January 7, 2019 we completed the acquisition of 100% of the shares in Propeller Health, a digital therapeutics company providing connected health solutions for people living with chronic obstructive pulmonary disease and asthma for a total purchase consideration of $225.0 million.