OMCL 2012.9.30 10Q Q3-12
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, 2012
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.)
 
1201 Charleston Road
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 November 1, 2012 was 33,179,043.



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Table of Contents
OMNICELL, INC.
 
FORM 10-Q

Table of Contents


 
 
Page
 number
 
 
 
 
 
 
 
 
 
 
 
 

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

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
September 30,
2012
 
December 31,
2011
 
(unaudited)
 
(1)
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
54,818

 
$
191,762

Short-term investments

 
8,107

Accounts receivable, net of allowances of $417 and $443 at September 30, 2012 and December 31, 2011, respectively
53,109

 
38,661

Inventories
26,400

 
18,107

Prepaid expenses
13,948

 
10,495

Deferred tax assets
11,197

 
10,352

Other current assets
7,046

 
6,107

Total current assets
166,518

 
283,591

Property and equipment, net
32,185

 
17,306

Non-current net investment in sales-type leases
10,628

 
8,785

Goodwill
112,683

 
28,543

Other intangible assets
86,234

 
4,231

Non-current deferred tax assets

 
11,677

Other assets
13,754

 
9,716

Total assets
$
422,002

 
$
363,849

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
18,635

 
$
11,000

Accrued compensation
8,130

 
7,328

Accrued liabilities
12,206

 
8,901

Deferred service revenue
19,994

 
19,191

Deferred gross profit
19,587

 
14,210

Total current liabilities
78,552

 
60,630

Non-current deferred service revenue
19,649

 
18,966

Non-current deferred tax liabilities
21,575

 

Other long-term liabilities
5,713

 
1,339

Total liabilities
125,489

 
80,935

Stockholders’ equity:
 

 
 

Total stockholders’ equity
296,513

 
282,914

Total liabilities and stockholders’ equity
$
422,002

 
$
363,849

 
 
 
 
 
(1)  Information derived from our December 31, 2011 audited Consolidated Financial Statements.
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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OMNICELL, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 

 
 

 
 

 
 

Product revenues
$
67,446

 
$
49,790

 
$
175,239

 
$
138,583

Services and other revenues
16,885

 
14,649

 
48,619

 
44,021

Total revenues
84,331

 
64,439

 
223,858

 
182,604

Cost of revenues:
 

 
 

 
 

 
 

Cost of product revenues
30,636

 
22,429

 
79,532

 
59,995

Cost of services and other revenues
7,608

 
7,562

 
23,114

 
22,704

Total cost of revenues
38,244

 
29,991

 
102,646

 
82,699

Gross profit
46,087

 
34,448

 
121,212

 
99,905

Operating expenses:
 

 
 

 
 

 
 

Research and development
5,545

 
6,019

 
17,538

 
16,139

Selling, general and administrative
29,316

 
23,635

 
86,382

 
73,713

Total operating expenses
34,861

 
29,654

 
103,920

 
89,852

Income from operations
11,226

 
4,794

 
17,292

 
10,053

Interest and other income (expense), net
34

 
(191
)
 
57

 
(66
)
Income before provision for income taxes
11,260

 
4,603

 
17,349

 
9,987

Provision for income taxes
4,340

 
1,609

 
6,703

 
3,736

Net income
$
6,920

 
$
2,994

 
$
10,646

 
$
6,251

Net income per share-basic
$
0.21

 
$
0.09

 
$
0.32

 
$
0.19

Net income per share-diluted
$
0.20

 
$
0.09

 
$
0.31

 
$
0.18

Weighted average shares outstanding:
 

 
 

 
 

 
 

Basic
33,193

 
33,209

 
33,316

 
33,132

Diluted
34,068

 
34,219

 
34,241

 
34,100

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

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OMNICELL, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
6,920

 
$
2,994

 
$
10,646

 
$
6,251

Other comprehensive income, net of tax and reclassification adjustments:
 
 
 
 
 
 
 
   Unrealized loss on securities:
 
 
 
 
 
 
 
   Unrealized holding (losses) gains arising during the period

 
2

 
(1
)
 
2

  Changes in fair value of foreign currency forward hedges

 

 
65

 

  Foreign currency translation adjustment
70

 

 
54

 

Other comprehensive income
70

 
2

 
118

 
2

Comprehensive income
$
6,990

 
$
2,996

 
$
10,764

 
$
6,253


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


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OMNICELL, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Nine Months Ended September 30,
 
2012
 
2011
Cash flows from operating activities:
 

 
 
Net income
$
10,646

 
$
6,251

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

 
 

Depreciation and amortization
9,247

 
5,820

Loss on disposal of fixed assets
28

 

Provision for (recovery of) receivable allowance
410

 
(527
)
Share-based compensation expense
6,781

 
7,254

Income tax benefits from employee stock plans
1,638

 
3,208

Excess tax benefits from employee stock plans
(2,336
)
 
(3,553
)
Provision for excess and obsolete inventories
509

 
564

Foreign currency remeasurement loss

 
140

Deferred income taxes
(1,084
)
 
(270
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable, net
(7,103
)
 
(3,286
)
Inventories
2,924

 
(7,835
)
Prepaid expenses
(3,453
)
 
1,316

Other current assets
921

 
(953
)
Net investment in sales-type leases
(1,493
)
 
917

Other assets
(13
)
 
759

Accounts payable
2,131

 
1,180

Accrued compensation
802

 
(669
)
Accrued liabilities
(1,719
)
 
308

Deferred service revenue
2,117

 
3,224

Deferred gross profit
5,377

 
442

Other long-term liabilities
1,147

 
339

Net cash provided by operating activities
27,477

 
14,629

Cash flows from investing activities:
 

 
 
Purchases of short-term investments

 
(8,097
)
Maturities of short-term investments
8,122

 
8,143

Acquisition of intangible assets and intellectual property
(303
)
 
(136
)
Software development for external use
(3,118
)
 
(3,523
)
Purchases of property and equipment
(9,560
)
 
(6,808
)
Business acquisition, net of cash acquired
(156,312
)
 

Net cash used in investing activities
(161,171
)
 
(10,421
)
Cash flows from financing activities:
 

 
 

Proceeds from issuance of common stock under employee stock purchase and stock option plans
6,777

 
6,607

Stock repurchases
(12,363
)
 
(10,560
)
Excess tax benefits from employee stock plans
2,336

 
3,553

Net cash used in financing activities
(3,250
)
 
(400
)
Effect of exchange rate changes on cash and cash equivalents

 
(140
)
Net (decrease) increase in cash and cash equivalents
(136,944
)
 
3,668

Cash and cash equivalents at beginning of period
191,762

 
175,635

Cash and cash equivalents at end of period
$
54,818

 
$
179,303

Supplemental disclosure of non-cash operating activity:
 

 
 

Acquisition consideration accrued but not paid
$
(1,482
)
 
$

Satisfaction of acquired legal contingency with indemnification asset

 
(1,200
)
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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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 medication control systems together with related consumables and services, and medical/surgical supply control systems, with related services, which are sold in our principal market, the healthcare industry. Our market is located primarily in the United States.

On May 21, 2012, we completed our acquisition of MedPak Holdings, Inc. (“MedPak”). MedPak is the parent company of MTS Medication Technologies, Inc. (“MTS”), a worldwide provider of medication adherence packaging systems. This acquisition aligns us with the long-term trends of the healthcare market to manage the health of patients across the continuum of care. We can now serve both the acute care and non-acute markets. Omnicell and MTS bring capabilities to each other that strengthen the product lines and expand the medication management coverage of both companies. Please refer to Note 14, “Business Acquisition” for more information regarding the transaction.
 
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 its subsidiaries as of September 30, 2012, the results of their operations and comprehensive income for the three months and nine months ended September 30, 2012 and 2011 and their cash flows for the nine months ended September 30, 2012 and 2011. 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, 2011.
 
Our results of operations, comprehensive income and cash flows for the three months and nine months ended September 30, 2012 are not necessarily indicative of results that may be expected for the year ending December 31, 2012, or for any future period. 

Use of estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
 
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.
  
Reclassifications. Certain reclassifications have been made to the prior year consolidated balance sheet to conform to the current period presentation, including reclassification of net receivable credit balances by customer from accounts receivable to customer advances. None of these reclassifications are material to the consolidated financial statements.

Foreign currency translation. We translate the assets and liabilities of our non-U.S. dollar functional currency subsidiaries into U.S. dollars using exchange rates in effect at the end of each period. Revenue and expenses for these subsidiaries are translated using rates that approximate those in effect during the period. Gains and losses from these translations are recorded as foreign currency translation adjustments and included in accumulated other comprehensive income in stockholders’ equity.
 
Fair value of financial instruments. We value our financial assets and liabilities on a recurring basis using the fair value hierarchy established in Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures.
 
ASC 820 describes three levels of inputs that may be used to measure fair value, as follows:
 
Level 1 inputs, which include quoted prices in active markets for identical assets or liabilities;
 
Level 2 inputs, which include observable inputs other than Level 1 inputs, such as quoted prices for similar assets

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or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability; and
 
Level 3 inputs, which include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the underlying asset or liability. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.
 
At September 30, 2012 and December 31, 2011, our financial assets, measured at fair value on a recurring basis, utilizing Level 1 inputs included cash equivalents. For these items, quoted market prices are readily available and fair value approximates carrying value. At December 31, 2011, we had a short-term investment in California revenue anticipation notes, measured at fair value on a recurring basis, the valuation inputs of which were classified as Level 2. We do not currently have any material financial instruments, measured at fair value on a recurring basis, utilizing Level 3 inputs.

Classification of marketable securities. Securities held as investments for the indefinite future pending future spending requirements are classified as “Available-for-sale” and are carried at their fair value, with any unrealized gain or loss recorded to other comprehensive income until realized. At September 30, 2012 and December 31, 2011, we held $31.9 million and $177.3 million, respectively, of money market mutual funds classified as Available-for-sale cash equivalents. At December 31, 2011, we held $8.1 million of non-U.S. Government securities classified as Available-for-sale short-term investments. We do not hold securities for purposes of trading. Marketable securities for which we have the intent and ability to hold to maturity are classified as “Held-to-maturity” and are carried at their amortized cost, including accrued interest. We had no Held-to-maturity securities at September 30, 2012 and December 31, 2011.

Accounting for derivatives and hedging activities. Commencing with our May 21, 2012 acquisition of MTS, we use derivative financial instruments to limit exposure to changes in foreign currency exchange rates. We account for derivatives pursuant to ASC 815, Derivatives and Hedging. The ASC 815 guidance establishes accounting and reporting standards for derivative instruments and requires that all derivatives be recorded at fair value on the balance sheet. Changes in the fair value of derivative financial instruments are either recognized in other comprehensive income (a component of shareholders’ equity) or net income depending on whether the derivative is being used to hedge changes in cash flows or fair value.

Segment information. Beginning with the May 21, 2012 acquisition of MTS, we manage our business on the basis of two operating segments: Acute Care, which primarily includes products and services sold to hospital customers, and Non-Acute Care, which primarily includes products and services sold to customers outside of hospital settings. The historical Omnicell results were reported as a single segment and reporting unit, primarily comprising the Acute Care segment. MTS primarily comprises the Non-Acute Care segment and reporting unit.
 
Revenue recognition. We earn revenues from sales of our medication control systems together with related consumables and services, and medical/surgical supply control systems with related services, which are sold in our principal market, which is the healthcare industry. Our customer arrangements typically include one or more of the following deliverables:
 
Products — Software-enabled equipment that manages and regulates the storage and dispensing of pharmaceuticals, consumable blister cards and packaging equipment and other medical supplies.
Software — Additional software applications that enable incremental functionality of our equipment.
Installation — Installation of equipment as integrated systems at customers’ sites.
Post-installation technical support — Phone support, on-site service, parts and access to unspecified software upgrades and enhancements, if and when available.
Professional services — Other customer services, such as training and consulting.
 
We recognize revenue on our equipment when the earnings process is complete, based upon our evaluation of whether the following four criteria have been met:
Persuasive evidence of an arrangement exists. We use signed customer contracts and signed customer purchase orders as evidence of an arrangement for leases and sales. For service engagements, we use a signed services agreement and a statement of work to evidence an arrangement.
Delivery has occurred. Equipment and software product delivery is deemed to occur upon successful installation and receipt of a signed and dated customer confirmation of installation letter, providing evidence that we have delivered what a customer ordered. In instances of a customer self-installed installation, product delivery is deemed to have occurred upon receipt of a signed and dated customer confirmation letter. If a sale does not require installation, we recognize revenue on

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delivery of products to the customer, including transfer of title and risk of loss, assuming all other revenue criteria are met. We recognize revenue from sales of products to distributors upon delivery, assuming all other revenue criteria are met since we do not allow for rights of return or refund. Assuming all other revenue criteria are met, we recognize revenue for support services ratably over the related support services contract period. We recognize revenue on training and professional services as they are performed.
Fee is fixed or determinable. We assess whether a fee is fixed or determinable at the outset of the arrangement based on the payment terms associated with the transaction. We have established a history of collecting under the original contract without providing concessions on payments, products or services.
Collection is probable. We assess the probability of collecting from each customer at the outset of the arrangement based on a number of factors, including the customer’s payment history and its current creditworthiness. If, in our judgment, collection of a fee is not probable, we defer the revenue until the uncertainty is removed, which generally means revenue is recognized upon our receipt of cash payment assuming all other revenue criteria are met. Our historical experience has been that collection from our customers is generally probable.
 
In arrangements with multiple deliverables, assuming all other revenue criteria are met, we recognize revenue for individual delivered items if they have value to the customer on a standalone basis. Effective for new or modified arrangements entered into beginning on January 1, 2011, the date we adopted the revised revenue recognition guidance for arrangements with multiple deliverables on a prospective basis, we allocate arrangement consideration at the inception of the arrangement to all deliverables using the relative selling price method. This method requires us to determine the selling price at which each deliverable could be sold if it were sold regularly on a standalone basis. When available, we use vendor-specific objective evidence (“VSOE”) of fair value as the selling price. VSOE represents the price charged for a deliverable when it is sold separately or for a deliverable not yet being sold separately, the price established by management with the relevant authority. We consider VSOE to exist when approximately 80% or more of our standalone sales of an item are priced within a reasonably narrow pricing range (plus or minus 15% of the median rates). We have established VSOE of fair value for our post-installation technical support services and professional services. When VSOE of fair value is not available, third-party evidence (“TPE”) of fair value for similar products and services is acceptable; however, our offerings and market strategy differ from those of our competitors, such that we cannot obtain sufficient comparable information about third parties’ prices. If neither VSOE nor TPE are available, we use our best estimates of selling prices (“BESP”). We determine BESP considering factors such as market conditions, sales channels, internal costs and product margin objectives and pricing practices. We regularly review and update our VSOE, TPE and BESP information and obtain formal approval by appropriate levels of management.
 
The relative selling price method allocates total arrangement consideration proportionally to each deliverable on the basis of its estimated selling price. In addition, the amount recognized for any delivered items cannot exceed that which is not contingent upon delivery of any remaining items in the arrangement.
 
We also use the residual method of allocating the arrangement consideration in certain circumstances. We use the residual method to allocate total arrangement consideration between delivered and undelivered items for any arrangements entered into prior to January 1, 2011 and not subsequently materially-modified. The use of the residual method is required by software revenue recognition rules that applied to sales of most of our products and services until the adoption of the new revenue recognition guidance. We also use the residual method to allocate revenue between the software products that enable incremental equipment functionality and thus are not deemed to deliver its essential functionality, and the related post-installation technical support, as these products and services continue to be accounted for under software revenue recognition rules. Under the residual method, the amount allocated to the undelivered elements equals VSOE of fair value of these elements. Any remaining amounts are attributed to the delivered items and are recognized when those items are delivered.
 
A portion of our sales are made through multi-year lease agreements. Under sales-type leases, we recognize revenue for our hardware and software products net of lease execution costs such as post-installation product maintenance and technical support, at the net present value of the lease payment stream once our installation obligations have been met. We optimize cash flows by selling a majority of our non-U.S. government leases to third-party leasing finance companies on a non-recourse basis. We have no obligation to the leasing company once the lease has been sold. Some of our sales-type leases, mostly those relating to U.S. government hospitals, are retained in-house. Interest income in these leases is recognized in product revenue using the interest method.

We recognize revenue on the sale of consumable blister cards when title and risk of loss to the products shipped has transferred to the customer. Revenue related to these products is reported net of discounts provided to customers.
 
Accounts receivable and notes receivable (net investment in sales type leases). We actively manage our accounts receivable to minimize credit risk. We typically sell to customers for which there is a history of successful collection. New

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customers are subject to a credit review process, which evaluates that customer’s financial position and ability to pay. We continually monitor and evaluate the collectability of our trade receivables based on a combination of factors. We record specific allowances for doubtful accounts when we become aware of a specific customer’s impaired ability to meet its financial obligation to us, such as in the case of bankruptcy filings or deterioration of financial position.
 
Uncollectible amounts are charged off against trade receivables and the allowance for doubtful accounts when we make a final determination that there is no reasonable expectation of recovery. Estimates are used in determining our allowances for all other customers based on factors such as current trends, the length of time the receivables are past due and historical collection experience. While we believe that our allowance for doubtful accounts receivable is adequate and that the judgment applied is appropriate, such estimated amounts could differ materially from what will actually be uncollectible in the future.
 
The retained in-house leases discussed above are considered financing receivables. Our credit policies and evaluation of credit risk and write-off policies are applied alike to trade receivables and the net-investment in sales-type leases. For both, an account is generally past due after thirty days. The financing receivables also have customer-specific reserves for accounts identified for specific impairment and a non-specific reserve applied to the remaining population, based on factors such as current trends, the length of time the receivables are past due and historical collection experience. The retained in-house leases are not stratified by portfolio or class. Financing receivables which are reserved are generally transferred to cash-basis accounting so that revenue is recognized only as cash is received. However, the cash basis accounts continue to accrue interest.

Sales of accounts receivable. We record the sale of our accounts receivables as “true sales” in accordance with accounting guidance for transfers and servicing of financial assets. During the three months ended September 30, 2012 and 2011, we transferred non-recourse accounts receivable totaling $14.6 million and $9.0 million, respectively, which approximated fair value, to third-party leasing companies. During the nine months ended September 30, 2012 and 2011, we transferred non-recourse accounts receivable totaling $42.5 million and $32.2 million, respectively, which approximated fair value, to third-party leasing companies. At September 30, 2012 and December 31, 2011, accounts receivable included $0.8 million and $0.2 million, respectively, due from third-party leasing companies for transferred non-recourse accounts receivable.
 
Concentration in revenues and in accounts receivable. There were no customers accounting for 10% or more of revenues in the three months ended September 30, 2012 or 2011. Additionally, there were no customers accounting for 10% or more of revenues in the nine months ended September 30, 2012 or 2011. There were no customers accounting for 10% or more of accounts receivable at September 30, 2012 or at December 31, 2011.
 
Accounting policy for shipping costs. Outbound freight billed to customers is recorded as product revenue. The related shipping and handling cost is expensed as part of selling, general and administrative expense. Such shipping and handling expenses totaled $1.2 million and $0.7 million for the three months ended September 30, 2012 and 2011, respectively. Shipping and handling expenses totaled $2.7 million and $2.1 million for the nine months ended September 30, 2012 and 2011, respectively. 

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 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, 2012 and 2011 were approximately $6.3 million and $4.9 million, respectively. Purchases from this supplier for the nine months ended September 30, 2012 and 2011 were approximately $17.8 million and $16.1 million, respectively.

Income taxes. We record an income tax provision for the anticipated tax consequences of the reported results of operations. In accordance with GAAP, the provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carry forwards. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply in the periods in which those tax assets and liabilities are expected to be realized. In the event that we determine all or part of the net deferred tax assets are not realizable in the future, we will record a valuation allowance that would be charged to earnings in the period such determination is made.
In accordance with ASC 740, Tax Provisions, we recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The calculation of tax liabilities

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involves significant judgment in estimating the impact of uncertainties in the application of GAAP and complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on our financial condition and operating results.
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 41.5% and 40.3% for the nine months ended September 30, 2012 and 2011, respectively. The 2012 annual effective tax rate differed from the statutory rate of 35% primarily due to the unfavorable impact of state income taxes, non-deductible equity charges, and other non-deductible expenditures, including non-deductible acquisition costs, all of which were partially offset by the domestic production activities deduction.
 
The 2011 annual effective tax rate differed from the statutory rate of 35%, 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. Our projected effective tax rate for 2012, after discrete items recorded through September 30, 2012 and 2011, were approximately 39.6% and 38.4%, respectively.

As of September 30, 2012, we had total gross unrecognized tax benefits of approximately $8.4 million, compared with approximately $5.8 million on December 31, 2011, representing an increase of approximately $2.6 million during the nine months ended September 30, 2012. Approximately $1.0 million of the increase was attributable to unrecognized tax benefits recorded as part of the MTS acquisition. Of the total unrecognized tax benefits, $7.1 million and $4.6 million as of September 30, 2012 and December 31, 2011, respectively, if recognized would reduce our effective tax rate in the period of recognition. Gross interest and penalties related to unrecognized tax benefit accrued were immaterial as of September 30, 2012 and December 31, 2011.

Recently adopted accounting pronouncements. In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-04, Fair Value Measurement, amending the fair value guidance in ASC 820, and thereby achieving substantially converged fair value measurement and disclosure requirements for GAAP and International Financial Reporting Standards (“IFRS”). The new guidance clarified some fair value measurement principles and expanded certain disclosure requirements. We adopted this guidance in the first quarter of 2012 without any impact to our financial position, operating results or cash flows.

Recently issued accounting pronouncement. In July 2012, FASB issued ASU 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-lived Intangible Assets for Impairment, which amends the guidance in ASC 350-30 on impairment testing of intangible assets with indefinite lives other than goodwill. This guidance gives an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that an indefinite-lived asset is impaired. An entity has the option to bypass the qualitative assessment and proceed directly to calculating the fair value of an intangible asset with an indefinite life. This update will be effective for us for interim and annual impairment tests performed beginning in the first quarter of fiscal 2013. We do not anticipate this update will have any significant impact on our financial position, operating results or cash flows, as this update does not change how we calculate impairment loss.

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, the total number of shares excluded from the calculations of diluted net income per share for the nine months ended September 30, 2012 and 2011 were 2,067,273 and 2,089,739, respectively.
 
The calculation of basic and diluted net income per share is as follows (in thousands, except per share amounts):

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Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
Basic:
 

 
 

 
 

 
 

Net income
$
6,920

 
$
2,994

 
$
10,646

 
$
6,251

Weighted average shares outstanding — basic
33,193

 
33,209

 
33,316

 
33,132

Net income per share — basic
$
0.21

 
$
0.09

 
$
0.32

 
$
0.19

Diluted:
 

 
 

 
 

 
 

Net income
$
6,920

 
$
2,994

 
$
10,646

 
$
6,251

Weighted average shares outstanding — basic
33,193

 
33,209

 
33,316

 
33,132

Add: Dilutive effect of employee stock plans
875

 
1,010

 
925

 
968

Weighted average shares outstanding — diluted
34,068

 
34,219

 
34,241

 
34,100

Net income per share — diluted
$
0.20

 
$
0.09

 
$
0.31

 
$
0.18


Note 3.
Cash and Cash Equivalents, Short-term Investments and Fair Value of Financial Instruments
 
Cash and cash equivalents and short-term investments consist of the following significant investment asset classes, with disclosure of amortized cost, gross unrealized gains and losses, and fair value as of September 30, 2012 and December 31, 2011 (in thousands):

 
September 30, 2012
 
 
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
Cash / Cash
Equivalents
 
Short-term
Investments
 
Security
Classification
Cash
$
22,911

 
$

 
$

 
$
22,911

 
$
22,911

 
$

 
N/A
Money market funds
31,907

 

 

 
31,907

 
31,907

 

 
Available for sale
Total cash, cash equivalents and short-term investments
$
54,818

 
$

 
$

 
$
54,818

 
$
54,818

 
$

 
 
 
 
December 31, 2011
 
 
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
Cash / Cash
Equivalents
 
Short-term
Investments
 
Security
Classification
Cash
$
14,452

 
$

 
$

 
$
14,452

 
$
14,452

 
$

 
N/A
Money market funds
177,310

 

 

 
177,310

 
177,310

 

 
Available for sale
Non-U.S. government securities
8,106

 
1

 

 
8,107

 

 
8,107

 
Available for sale
Total cash, cash equivalents and short-term investments
$
199,868

 
$
1

 
$

 
$
199,869

 
$
191,762

 
$
8,107

 
 
 
 
 
 
 

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.
 
The short term investments purchased in September 2011 were comprised of California revenue anticipation notes, which matured in June 2012. As this is the initial investment in a broader portfolio strategy for yield management, these are considered Available-for-sale. The notes were considered a Level 2 asset class, because their pricing is drawn from multiple market-related inputs, but in general not from same-day, same-security trades.
 
The following table displays the financial assets measured at fair value, on a recurring basis, with money market funds recorded within cash and cash equivalents and non-U.S Government securities in short-term investments (in thousands):

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Quoted Prices in Active
Markets for Identical
Instruments
 (Level 1)
 
Significant Other
 Observable Inputs
 (Level 2)
 
Significant
 Unobservable
Inputs
(Level 3)
 
Total Fair
Value
At September 30, 2012
 

 
 

 
 

 
 

Money market funds
$
31,907

 
$

 

 
$
31,907

Total
$
31,907

 
$

 

 
$
31,907

At December 31, 2011
 

 
 

 
 

 
 

Money market funds
$
177,310

 

 

 
$
177,310

Non U.S. Government securities

 
$
8,107

 

 
8,107

Total
$
177,310

 
$
8,107




$
185,417


Current assets and current liabilities are recorded at amortized cost, which approximates fair value due to the short-term maturities implied.

Note 4.
Inventories
 
Inventories consist of the following (in thousands):
 
September 30,
2012
 
December 31,
2011
Raw materials
$
9,290


$
7,666

Work in process
526


14

Finished goods
16,584


10,427

Total
$
26,400


$
18,107


Note 5.
Property and Equipment
 
Property and equipment consist of the following (in thousands):

September 30,
2012

December 31,
2011
Equipment
$
32,373


$
25,101

Furniture and fixtures
2,262


1,811

Leasehold improvements
4,234


3,692

Purchased software
21,500


20,641

Capital in process
6,608


2,283


66,977


53,528

Accumulated depreciation and amortization
(34,792
)

(36,222
)
Property and equipment, net
$
32,185


$
17,306

 
Depreciation and amortization of property and equipment totaled approximately $2.2 million and $1.5 million for the three months ended September 30, 2012 and 2011, respectively. Depreciation and amortization of property and equipment totaled approximately $5.7 million and $4.3 million for the nine months ended September 30, 2012 and 2011, respectively.

Note 6.
Net Investment in Sales-Type Leases
 
Our sales-type leases are for terms generally ranging 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):

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September 30,
2012
 
December 31,
2011
Net minimum lease payments to be received
$
16,395

 
$
15,063

Less unearned interest income portion
1,378

 
1,229

Net investment in sales-type leases
15,017

 
13,834

Less current portion(1)
4,389

 
5,049

Non-current net investment in sales-type leases(2)
$
10,628

 
$
8,785

 
 
 
 
 
(1)     A component of other current assets. This amount is net of allowance for doubtful accounts of $0.5 million as of September 30, 2012 and $0.1 million as of December 31, 2011.
(2)     Net of allowance for doubtful accounts of $0.1 million as of September 30, 2012 and $0.1 million as of December 31, 2011.

The minimum lease payments under sales-type leases as of September 30, 2012 were as follows (in thousands):
2012 (remaining three months)
$
1,087

 
2013
5,152

 
2014
4,028

 
2015
2,973

 
2016
1,927

 
2017
1,055

 
Thereafter
173

 
Total
$
16,395

 


The following table summarizes the credit losses and recorded investment in sales-type leases, excluding unearned interest, as of September 30, 2012 and December 31, 2011 (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, 2012 :
 

 
 

 
 

Accounts individually evaluated for impairment
$
518

 
$
518

 
$

Accounts collectively evaluated for impairment
119

 
15,136

 
15,017

Ending balances: September 30, 2012
$
637

 
$
15,654

 
$
15,017

Credit loss disclosure for December 31, 2011 :
 

 
 

 
 

Accounts individually evaluated for impairment
$
178

 
$
178

 
$

Accounts collectively evaluated for impairment
106

 
13,940

 
13,834

Ending balances: December 31, 2011
$
284

 
$
14,118

 
$
13,834

 
The following table summarizes the activity for the allowance for credit losses for the investment in sales-type leases for the three months and nine months ended September 30, 2012 and 2011 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Allowance for credit losses, beginning of period
$
659

 
$
353

 
$
284

 
$
411

Current period provision (reversal)
4

 
(7
)
 
426

 
(16
)
Direct write-downs charged against the allowance

 

 

 

Recoveries of amounts previously charged off
(26
)
 
(24
)
 
(73
)
 
(73
)
Allowance for credit losses, end of period
$
637

 
$
322

 
$
637

 
$
322

 

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Note 7.
Goodwill and Other Intangible Assets
 
Under ASC 350, Intangibles - Goodwill and Other, goodwill and intangible assets with an indefinite life are not subject to amortization. Rather, we evaluate these assets for impairment at least annually or more frequently if events or changes in circumstances suggest that the carrying amount may not be recoverable. Historically, there has been no cumulative impairment of goodwill.

Activity in Goodwill by reporting units, which are the same as our operating segments, for the nine months ended September 30, 2012 consists of the following (in thousands):
 
Goodwill at December 31, 2011
 
Goodwill acquired
 
Goodwill at September 30, 2012
Reporting units:
 
 
 
 
 
Acute Care
$
28,543

 
$

 
$
28,543

Non-Acute Care

 
84,140

 
84,140

Total
$
28,543

 
$
84,140

 
$
112,683


The goodwill acquired reflects the May 21, 2012 acquisition of MedPak by Omnicell. MedPak is the parent company of MTS, a worldwide provider of medication adherence packaging systems. The acquired goodwill was assigned to the new reporting unit called Non-Acute Care, created as a result of the MTS acquisition.

There were no indefinite-life intangibles at either September 30, 2012 or December 31, 2011. Finite-life intangible assets at these dates consist of the following (in thousands):
 
September 30, 2012
 
December 31, 2011
 
 
 
Gross
 
 
 
Net
 
Gross
 
 
 
Net
 
 
 
Carrying
Amount
 
Accumulated
Amortization
 
Carrying
Amount
 
Carrying
Amount
 
Accumulated
Amortization
 
Carrying
Amount
 
Amortization
Life
Finite-lived intangibles:
 

 
 

 
 

 
 

 
 

 
 

 
 
Customer relationships
$
54,330

 
$
2,539

 
$
51,791

 
$
4,230

 
$
1,591

 
$
2,639

 
5-30 years
Acquired technology
27,580

 
760

 
26,820

 
980

 
175

 
805

 
3-20 years
Patents
1,192

 
214

 
978

 
889

 
190

 
699

 
20 years
Trade name
6,890

 
265

 
6,625

 
90

 
37

 
53

 
3-12 years
Non-compete agreements
60

 
40

 
20

 
60

 
25

 
35

 
3 years
Total finite-lived intangibles
$
90,052

 
$
3,818

 
$
86,234

 
$
6,249

 
$
2,018

 
$
4,231

 
 
 
Amortization expense totaled $1.1 million and $0.2 million for the three months ended September 30, 2012 and 2011, respectively. Amortization expense totaled $1.8 million and $0.5 million for the nine months ended September 30, 2012 and 2011, respectively. The amortization of acquired technology is included within product cost of sales; other acquired intangibles are usually amortized within selling, general and administrative expenses.

Estimated annual expected amortization expense of the finite-lived intangible assets at September 30, 2012 was as follows (in thousands):
2012 (remaining three months)
$
1,062

2013
4,235

2014
4,195

2015
4,172

2016
3,821

2017
3,786

Thereafter
64,963

Total
$
86,234


Note 8.
Accrued Liabilities
 

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Table of Contents

Accrued liabilities consist of the following (in thousands):

September 30,
2012

December 31,
2011
Advance payments from customers
$
3,001

 
$
3,390

Accrued Group Purchasing Organization (GPO) fees
2,271


2,437

Acquisition consideration payable
1,482

 

Rebates and lease buyouts
2,175


1,748

Taxes payable
855

 
925

Other
2,422


401

Total
$
12,206


$
8,901

 

Note 9.
Deferred Gross Profit
 
Deferred gross profit consists of the following (in thousands):

September 30,
2012

December 31,
2011
Sales of medication and supply dispensing systems and packaging equipment, which have been delivered and invoiced but not yet installed
$
28,984


$
24,181

Cost of revenues, excluding installation costs
(9,397
)

(9,971
)
Deferred gross profit
$
19,587


$
14,210


Note 10.
Commitments
 
At September 30, 2012, the minimum payments under our operating leases for each of the five succeeding fiscal years were as follows (in thousands):
2012 (remaining three months)
$
1,518

2013
5,595

2014
5,367

2015
5,187

2016
4,908

2017
4,217

Thereafter
20,301

Total
$
47,093

 
Commitments under operating leases relate primarily to leasehold property and office equipment.

 In October 2011, we entered into a lease agreement for approximately 100,000 square feet of office space. Pursuant to the lease agreement, the landlord has constructed a single, three-story building of rentable space located at 590 Middlefield Road in Mountain View, California which we will lease and which will serve as our headquarters. The term of the lease agreement is for a period of 10 years, and will commence in November 2012, with a base lease commitment of approximately $40.0 million. We have two options to extend the term of the lease agreement at market rates. Each extension is for an additional 60 month term.

In March 2012, we entered into a lease agreement for approximately 46,000 square feet of manufacturing, distribution and office space located at 735 Sycamore Drive in Milpitas, California which commenced in October 2012. The term of the lease agreement is for a period of 60 months, with a base lease commitment of approximately $1.8 million and a single 60 month extension option.

Commencing with the acquisition of MTS, we assumed responsibility for its 132,500 square feet of manufacturing, warehousing and office space in St. Petersburg, Florida. The remaining term of the original 12 year lease agreement is through September 30, 2016 with a remaining base lease commitment of approximately $3.7 million. We have two options to extend the term of the lease agreement at market rates. Each extension is for an additional 60 month term.

In Leeds, United Kingdom, we lease an office and distribution center. The remaining term of the original 10 year

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Table of Contents

lease agreement is through June 8, 2021, with no extension options. The remaining base lease commitment, converted from British Pounds at the current conversion rate, is approximately $1.2 million. We also have smaller rented offices in Strongsville, Ohio and Germany.

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 $6.3 million as of September 30, 2012.

At September 30, 2012, we have recorded $3.5 million for uncertain tax positions under long term liabilities, in accordance with GAAP, summarized under Note 1, “Organization and Summary of Significant Accounting Policies.” As these liabilities do not reflect actual tax assessments, the timing and amount of payments we might be required to make will depend upon a number of factors. Accordingly, as the timing and amount of payment cannot be estimated, the current balance of the uncertain tax position liabilities has not been included in the table of commitments above.
Note 11.
Contingencies
 
Legal Proceedings    

We may from time to time become involved in certain legal proceedings in the ordinary course of business. We are not a party to any legal proceedings that management believes may have a material impact on Omnicell’s financial position or results of operations.

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

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indemnification obligations as of September 30, 2012 or December 31, 2011.
Note 12.
Stockholders’ Equity
 
Treasury Stock
 
In February 2008, our Board of Directors authorized a stock repurchase program, the “2008 Repurchase Program”, for the repurchase of up to $90.0 million of our common stock. All repurchased shares were recorded as treasury stock and were accounted for under the cost method. None of the repurchased shares have been retired. The timing, price and volume of the repurchases have been based on market conditions, relevant securities laws and other factors. The stock 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.

On August 1, 2012, our Board of Directors established a new 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 will 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 stock repurchase program does not obligate Omnicell to repurchase any specific number of shares, and Omnicell may terminate or suspend the repurchase program at any time.

During the three months ended September 30, 2012, we repurchased 393,031 shares through the 2008 Repurchase Program at an average cost of $13.49 per share, including commissions, compared to 505,137 shares repurchased in the three months ended June 30, 2012 at an average cost of $13.98 per share, including commissions. For the nine months ended September 30, 2012, we repurchased 898,168 shares at an average cost of $13.76 per share, including commissions. In the three months ended September 30, 2011, we repurchased 182,784 shares through the 2008 Repurchase Program at an average cost of $14.01 per share, including commissions, For the nine months ended September 30, 2011, we repurchased 741,959 shares at an average cost of $14.23, including commissions.
 
From the inception of the 2008 Repurchase Program in February 2008 through September 30, 2012, we have repurchased a total of 5,853,975 shares at an average cost of $15.37 per share through open market purchases. As of September 30, 2012, we have completed the 2008 Repurchase Program having repurchased $90.0 million of our common stock.

Through September 30, 2012, we have not repurchased any shares through the 2012 Repurchase Program and therefore had $50.0 million of authorized funds to repurchase shares under the 2012 Repurchase Program.

Note 13.
Stock Option Plans and Share-Based Compensation
 
Stock Option Plans
 
At September 30, 2012, a total of 1,817,936 shares of common stock were reserved for future issuance under our 2009 Equity Incentive Plan (the “2009 Plan”). At September 30, 2012, $6.5 million of total unrecognized compensation cost related to non-vested stock options was expected to be recognized over a weighted average period of 2.7 years.
 
A summary of aggregate option activity for the nine months ended September 30, 2012 is presented below:
Options:
 
Number of Shares
 
Weighted-
 Average
 Exercise Price
 
 
(in thousands)
 
 
Outstanding at December 31, 2011
 
4,693

 
$
13.36

Granted
 
473

 
$
15.15

Exercised
 
(362
)
 
$
8.61

Forfeited
 
(65
)
 
$
13.71

Expired
 
(100
)
 
$
21.58

Outstanding at September 30, 2012
 
4,639

 
$
13.73

Exercisable at September 30, 2012
 
3,513

 
$
13.60


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Table of Contents

 
Restricted Stock and Time-based Restricted Stock Units
 
The non-employee members of our Board of Directors are granted restricted stock on the day of our annual meeting of stockholders and such shares of restricted stock vest on the date of the subsequent year’s annual meeting of stockholders, provided such non-employee director remains a director on such date. Restricted stock units (“RSUs”) are granted to certain of our employees and generally vest over a period of four years and are expensed ratably on a straight-line basis over the vesting period. The fair value of both restricted stock and RSUs granted pursuant to our stock option plans is the product of the number of shares granted and the grant date fair value of our common stock. Our unrecognized compensation cost related to non-vested restricted stock at September 30, 2012 was approximately $0.6 million and is expected to be recognized over a weighted-average period of 0.6 years. Expected future compensation expense relating to RSUs outstanding on September 30, 2012 is $4.9 million over a weighted-average period of 2.6 years.
 
A summary of activity of both restricted stock and RSUs for the nine months ended September 30, 2012 is presented below:
 
Restricted Stock
 
Restricted Stock Units
 
 
 
Weighted -
 
 
 
Weighted -
 
Number of
Shares
 
Average
Grant Date
Fair Value Per
Share
 
Number of
Shares
 
Average
Grant Date
Fair Value Per
Share
 
(in thousands)
 
 
 
(in thousands)
 
 
Non-vested, December 31, 2011
68

 
$
14.71

 
287

 
$
13.03

Granted
67

 
$
14.19

 
218

 
$
14.80

Vested
(68
)
 
$
14.71

 
(86
)
 
$
12.76

Forfeited

 

 
(16
)
 
$
14.46

Non-vested, September 30, 2012
67

 
$
14.19

 
403

 
$
13.98


Performance-based Restricted Stock Units
 
In 2011, we began incorporating performance-based restricted stock units (“PSUs”) as an element of our executive compensation plans. Our unrecognized compensation cost related to non-vested performance-based restricted stock units at September 30, 2012 was approximately $1.0 million and is expected to be recognized over a weighted-average period of 1.4 years.

The accounting guidance for awards with market conditions differs from that for awards with service conditions only or service and performance conditions. Because the grant date fair value of an award containing market conditions is calculated as the expected value, averaging over all possible outcomes, the measured expense is amortized over the service period, regardless of whether the market condition is ever actually met. PSU expense of $0.2 million and $0.1 million was recognized for the three months ended September 30, 2012 and 2011, respectively. PSU expense of $0.8 million and $0.4 million was recognized for the nine months ended September 30, 2012 and 2011, respectively.

The fair value of a PSU award is the average of trial-specific values of the award over each of one million Monte Carlo trials. Each trial-specific value is the market value of the award at the end of the one-year performance period discounted back to the grant date. The market value of the award for each trial at the end of the performance period is the product of (a) the per share value of Omnicell stock at the end of the performance period and (b) the number of shares that vest. The number of shares that vest at the end of the performance period depends on the percentile ranking of the total shareholder return for Omnicell stock over the performance period relative to the total shareholder return of each of the other companies in the NASDAQ Healthcare Index (the “Index”) as shown in the tables below.

Vesting for the PSU awards is based on the percentile placement of our total shareholder return among the companies listed in the Index and time-based vesting. We calculate total stockholder return based on the one year annualized rates of return reflecting price appreciation plus reinvestment of dividends. Stock price appreciation is calculated based on the average closing prices of the applicable company’s common stock for the 20 trading days ending on the last trading day of the year prior to the date of grant as compared to the average closing prices for the 20 trading days ended on the last trading day of the year of grant.


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The following table shows the percent of PSUs granted in 2011 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, but below the 65th percentile
100%
At least the 65th percentile, but below the 75th percentile (1)
110% to 119%
At or above the 75th percentile
120%
 
 
 
 
 
 
(1)               The actual percentage of PSUs eligible for further time-based vesting is based on straight-line interpolation, where, for example, if the ranking is the 70th percentile, then the vesting percentage is 115%.
On January 17, 2012, the Compensation Committee of our Board of Directors confirmed 76.3% as the percentile rank of Omnicell’s 2011 total stockholder return. This resulted in 120% of the 2011 PSU awards, or 120,000 shares, becoming eligible for further time-based vesting. The eligible PSU awards will vest as follows: 25% of the eligible awards for the first year vested immediately on January 17, 2012 with the remaining eligible awards vesting in equal increments, semi-annually, over the subsequent 36 month 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 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%
After the last trading day of 2012, the Compensation Committee of our Board of Directors will determine the percentile rank of Omnicell’s total stockholder return and the number of performance-based restricted stock unit awards eligible for further time-based vesting. The eligible performance-based restricted stock unit awards will vest as follows: 25% of the shares on the date of the Compensation Committee of our Board of Directors meeting in 2013 when the Committee reviews the performance-based metrics and determines if they were met or not, with the remaining shares vesting on a semi-annual basis over a period of 36 months commencing on June 15, 2013 if Omnicell meets certain stock performance objectives compared to the Index. The actual number of shares that vest may be 0% to 100% of the numbers reflected above, depending upon Omnicell’s performance. Vesting is contingent upon continued service.
During the nine months ended September 30, 2012, in addition to the 125,000 PSUs granted in 2012, an additional 7,500 PSUs vested as a result of Omnicell’s 2011 total stockholder return which caused 120% of the 2011 PSUs to become eligible for further time-based vesting.
A summary of activity of the PSUs for the nine months ended September 30, 2012 is presented below:

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Weighted -
Average
Grant Date
Fair Value Per
Performance-based Stock Units
Number of Shares
 
Share
 
(in thousands)
 
 

Non-vested, December 31, 2011
100

 
$
11.15

Granted
133

 
$
10.94

Vested
(45
)
 
$
11.15

Forfeited

 

Non-vested, September 30, 2012
188

 
$
11.00

 
Employee Stock Purchase Plan
 
We have an Employee Stock Purchase Plan (“ESPP”), under which employees can purchase shares of our common stock based on a percentage of their compensation, but not greater than 15% of their earnings, up to a maximum of $25,000 of fair value per year. The purchase price per share must be equal to the lower of 85% of the fair value of the common stock at the beginning of a 24-month offering period or the end of each six-month purchasing period. As of September 30, 2012, 3,782,844 shares had been issued under the ESPP. As of September 30, 2012 there were a total of 1,548,711 shares reserved for future issuance under the ESPP. For the three months and nine months ended September 30, 2012, 180,018 shares and 377,849 shares, respectively, of common stock were purchased under the ESPP.
 
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, as described above.
 
The impact on our results for share-based compensation for the three months and nine months ended September 30, 2012 and 2011 was as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Cost of product and service revenues
$
275

 
$
358

 
$
776

 
$
1,108

Research and development expenses
232

 
333

 
686

 
1,005

Selling, general and administrative expenses
1,854

 
1,720

 
5,319

 
5,141

Total share-based compensation expenses
$
2,361

 
$
2,411

 
$
6,781

 
$
7,254

 

Note 14.
Business Acquisition

On May 21, 2012, we completed our merger with MedPak Holdings, Inc. (“MedPak”) pursuant to an Agreement and Plan of Merger (the “Merger Agreement”) under which Mercury Acquisition Corp, a newly formed Omnicell subsidiary, was merged with and into MedPak, with MedPak surviving the merger as a wholly-owned subsidiary of Omnicell. MedPak is the parent company of MTS.

Pursuant to the terms of the Merger Agreement, we paid approximately $158.3 million in cash after adjustments provided for in the Merger Agreement, of which approximately $13.5 million was placed in an escrow fund, which will be distributed to MedPak's stockholders (subject to claims that we may make against the escrow fund for indemnification and other claims following the closing). We had accrued a $1.8 million liability against this escrow fund as of June 30, 2012, based on additional estimated working capital adjustments as provided under the Merger Agreement.

As of September 30, 2012, the working capital adjustment has been finalized with a resulting reduction in goodwill of $0.3 million and a corresponding reduction in accrued liabilities, leaving a balance of $1.5 million. In October 2012, the

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portion of the escrow fund set aside for the working capital adjustment was disbursed with Omnicell receiving $0.3 million and Medpak's former stockholders receiving the remainder.

The MTS 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. We can now better serve both the acute care and non-acute care markets. Omnicell and MTS bring capabilities to each other that strengthen the product lines and expand the medication management coverage of both companies.
We are accounting for the transaction under the acquisition method of accounting in accordance with the provisions of FASB 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 revised acquisition consideration of $159.8 million is comprised of $158.3 million in cash at closing plus an estimated $1.5 million net working capital adjustment recorded in accrued liabilities, subject to review by the seller and possible adjustment.
The total consideration, and the allocation of consideration to the individual net assets is considered preliminary, as there are remaining uncertainties to be resolved, including the settlement of the final net working capital adjustment and the completion of an analysis of potential contingent payroll tax withholding obligations.
The total revised acquisition price was approximately $159.8 million and the preliminary acquisition price allocation is comprised of the following (in thousands):
 
 
Fair value acquired

 
Cash including restricted cash
 
$
2,000

 
Accounts receivable
 
7,403

 
Inventory
 
11,726

 
Deferred tax assets and other current assets
 
2,864

 
      Total current assets
 
23,993

 
Property and equipment
 
11,088

 
Intangibles
 
83,500

 
Goodwill
 
84,140

 
Other non-current assets
 
244

 
      Total assets
 
202,965

 
Current liabilities
 
(8,046
)
 
Non-current deferred tax liabilities
 
(33,898
)
 
Other non-current liabilities
 
(1,227
)
 
      Net assets acquired
 
$
159,794

 
 
 
 
 
      Cash consideration, fair value
 
$
159,794

 
 
 
 
 

Accounts receivable is presented at its fair value, comprised of total contractual obligations due of $7.6 million, of which $0.2 million is not expected to be collected. Based on an acquisition date valuation, the estimated fair values of acquired inventory and property and equipment exceeded their historical carrying values.

Identifiable intangible assets. Acquired technology relates to MTS’ products across all of its product lines that have reached technological feasibility, primarily the OnDemand technology. Trade name is primarily related to the MTS and OnDemand brand names. Customer relationships represent existing contracted relationships with pharmacies, institutional care facilities and others. Acquired technology, customer relationships, and trade names will be amortized on a straight-line basis over their estimated useful lives, which range from 12 to 30 years.

The estimated fair values of the acquired technology, trade names and customer relationships were primarily determined using either the relief-from-royalty or excess earnings methods. The interest rates utilized to discount net cash flows to their present values were determined after consideration of the overall enterprise rate of return and the relative risk and importance of the assets to the generation of future cash flows.

For income tax purposes, the historical tax bases of the acquired assets and assumed liabilities, along with the tax

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attributes of the MTS companies, will carryover. Because the transaction was a cash-for-stock transaction, there is no tax basis in the newly acquired intangible assets. Accordingly, the acquisition accounting includes the establishment of net deferred tax liabilities of $33.9 million, resulting from book tax basis differences related to the intangible assets acquired, as well as to the step up in the value of fixed assets and inventory to their estimated fair values at the time of acquisition.

Goodwill. Approximately $84.1 million has been allocated to goodwill. Goodwill represents the excess of the fair value of the consideration transferred over the fair value of the underlying net tangible and identifiable intangible assets on the acquisition date. In accordance with 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 MTS acquisition enhances our offerings and diversifies our 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.

Details of acquired intangibles are as follows (in thousands, except for years):
 
 
Fair value acquired

 
Useful Life (years)
 
First year amortization expense

 
Trade name
 
$
6,800

 
12
 
$
567

 
Customer relationships
 
50,100

 
 28 to 30
 
1,693

 
Acquired technology
 
26,600

 
20
 
1,330

 
Intangibles acquired
 
$
83,500

 
 
 
$
3,590

 
 
 
 
 
 
 
 
 
Weighted avg. life of intangibles
 
 
 
25.11
 
 
 
 
 
 
 
 
 
 
 

For the nine months ended September 30, 2012, we incurred approximately $3.2 million in acquisition-related costs in connection with the MTS acquisition. These costs are included in selling, general and administrative expenses on our Condensed Consolidated Statement of Operations.

During the three months ended September 30, 2012, the acquired MTS operations (consolidated since the May 21, 2012 acquisition date) generated revenue of approximately $18.3 million and net income of $1.9 million.    
    
The following represents unaudited pro forma revenue and net income as if MTS had been included in our consolidated results from January 1, 2011 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenues
$
84,331

 
$
82,468

 
$
252,601

 
$
239,715

Net income
$
6,920

 
$
3,785

 
$
13,515

 
$
9,841

 
 
 
 
 
 
 
 

The pro forma unaudited condensed consolidated operating results presented above were calculated after applying Omnicell's accounting policies and by adding together the historical operating statements of MTS and Omnicell, with certain adjustments, assuming an acquisition date of January 1, 2011. The adjustments include replacement of MTS historical depreciation and amortization expense with acquisition-accounting depreciation and amortization expense, based on the estimated fair values and useful lives determined from the allocation of total MTS acquisition consideration. Also reflected is the interest expense elimination effect of MTS on its debt (since it would have been paid off at acquisition) and the elimination of certain management fees to an affiliated party, offset in part by interest income foregone by Omnicell, by no longer having the acquisition consideration available as interest-bearing cash, cash equivalents and short-term investments.

The pro forma operating results do not include actual acquisition-related expenses by MTS and Omnicell as such amounts are considered nonrecurring. The total of all adjustments were tax effected using an estimated federal and state effective income tax rate.

The pro forma operating results do not include any assumption of operating synergies for the combined companies. These pro forma results are provided as required disclosures and should not be considered as a forecast for any future period, nor as representing what the actual operating results would have been if the acquisition, in fact, had occurred on January 1,

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2011.


Note 15. Segments

Beginning with the acquisition of MTS, we have organized our business into two operating business segments: Acute Care, which primarily includes products and services sold to hospital customers and Non-Acute Care, which primarily includes products and services sold to customers outside of hospital settings.

The Acute Care segment is organized around the design, manufacturing, selling and servicing of medication and supply dispensing systems. The Non-Acute Care segment includes primarily the manufacturing and selling of consumable medication blister cards, packaging equipment and ancillary products and services, but also includes medication dispensing systems sold to non-acute care pharmacies and facilities. We report segment information based on the management approach. The management approach designates the internal reporting used by the Chief Operating Decision Maker (“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.

Since 1992, Omnicell has provided automation and business information solutions to 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 the acute care environment in hospitals. As the acute care market evolves, we see opportunities to provide medication adherence solutions, which were added to our product line through the acquisition of MTS, to the acute care market as well. A portion of our organization structure and management processes will continue to be structured to optimize sales and service of solutions to the acute care market.

Since 1984, MTS has provided medication adherence solutions to the non-acute care market. These solutions 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. A portion of our organization structure and management processes will continue to be structured to optimize the product, sales, and service of solutions to the non-acute care market.

During the three months ended September 30, 2012, we realigned our management reporting structure to report sales of Omnicell's dispensing systems and other related business transactions into long-term care pharmacies and facilities. Accordingly, the operations of this portion of our activities is now being reflected as a part of the Non-Acute Care segment for the three months and nine months ended September 30, 2012. The impact of this reporting structure change on the three months and nine months ended September 30, 2011 was immaterial to our overall reported results.
We believe that legislative changes and economic pressures to manage costs will cause healthcare organizations to manage the health of patients across the continuum of care regardless of the setting in which the care is provided. We believe we have the capabilities and market position to provide the tools needed by our customers to manage medications across the continuum of care. But we also believe that the inherent differences between medication management workflows in acute care settings and non-acute care settings will cause our product solutions and marketing strategies to be managed separately for these two customer segments.

For the three months and nine months ended September 30, 2012 and 2011, the contributions of our segments to net revenues and income from operations, and the reconciliation to total net income, were as follows (amounts in thousands):
    

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Three Months Ended September 30,
 
Three Months Ended September 30,
 
2012
 
2011
 
Acute Care
 
Non-Acute Care (1)
 
Total
 
Acute Care
 
Total
Net revenues from external customers
$
64,394

 
$
19,937

 
$
84,331

 
$
64,439

 
$
64,439

Cost of revenues
26,920

 
11,324

 
38,244

 
29,991

 
29,991

Gross profit
$
37,474

 
$
8,613

 
$
46,087

 
$
34,448

 
$
34,448

Gross margin %
58.2
%
 
43.2
%
 
54.7
%
 
53.5
%
 
53.5
%
 
 
 
 
 
 
 
 
 
 
Operating expenses
29,070

 
5,791

 
34,861

 
29,654

 
29,654

Income from operations
$
8,404

 
$
2,822

 
$
11,226

 
$
4,794

 
$
4,794

Operating margin %
13.1
%
 
14.2
%
 
13.3
%
 
7.4
%
 
7.4
%
 
 
 
 
 
 
 
 
 
 
Interest and other income (expense), net
 
 
 
 
34

 
 
 
(191
)
Income before provision for income taxes
 
 
 
 
11,260

 
 
 
4,603

Provision for income taxes
 
 
 
 
4,340

 
 
 
1,609

Net income
 
 
 
 
$
6,920

 
 
 
$
2,994

 
 
 
 
 
 
 
 
 
 

 
Nine Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
Acute Care
 
Non-Acute Care (1)
 
Total
 
Acute Care
 
Total
Net revenues from external customers
$
191,294

 
$
32,564

 
$
223,858

 
$
182,604

 
$
182,604

Cost of revenues
82,858

 
19,788

 
102,646

 
82,699

 
82,699

Gross profit
$
108,436

 
$
12,776

 
$
121,212

 
$
99,905

 
$
99,905

Gross margin %
56.7
%
 
39.2
%
 
54.1
%
 
54.7
%
 
54.7
%
 
 
 
 
 
 
 
 
 
 
Operating expenses
94,167

 
9,753

 
103,920

 
89,852

 
89,852

Income from operations
$
14,269

 
$
3,023

 
$
17,292

 
$
10,053

 
$
10,053

Operating margin %
7.5
%
 
9.3
%
 
7.7
%
 
5.5
%
 
5.5
%
 
 
 
 
 
 
 
 
 
 
Interest and other income (expense), net
 
 
 
 
57

 
 
 
(66
)
Income before provision for income taxes
 
 
 
 
17,349

 
 
 
9,987

Provision for income taxes
 
 
 
 
6,703

 
 
 
3,736

Net income
 
 
 
 
$
10,646

 
 
 
$
6,251

 
 
 
 
 
 
 
 
 
 
(1) Non-Acute Care segment includes MTS results from May 21, 2012, the date of acquisition.
 
 
 
 
 
 
 
 
 

For the nine months ended September 30, 2012, the Non-Acute Care cost of revenues included $1.7 million of acquisition-related charges primarily associated with the step-up to the estimated fair value of inventory acquired from MTS and consumed in the normal manufacturing cycle of our business. The Non-Acute Care operating expenses included $0.9 million of acquisition-related charges primarily associated with severance expenses. For the nine months ended September 30, 2012, the Acute Care operating expenses included $2.3 million of acquisition-related charges for transaction costs, required to be expensed under ASC 805 Business Combinations. As of September 30, 2012, we have not assigned assets to our operating segments.



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Note 16. Risk Management and Derivatives
We are exposed to global market risks, including the effect of changes in foreign currency exchange rates. We use derivatives to manage financial exposures that occur in the normal course of business but do not hold or issue derivatives for trading purposes.
Currency Forward Contracts
From time to time we enter into foreign currency forward contracts to protect our business from the risk that the eventual cash flows resulting from intercompany transactions between Omnicell and our foreign subsidiaries. These transactions primarily arise as a result of products manufactured in the U.S. and sold to foreign subsidiaries in U.S. dollars rather than the subsidiaries' functional currencies.
These forward contracts are considered to be financial derivative instruments and are recorded at fair value in the balance sheet. Changes in fair values of these financial derivative instruments are either recognized in other comprehensive income (a component of stockholders' equity) or net income depending on whether the derivative has been designated and qualifies as a hedging instrument. As of September 30, 2012, we had no foreign currency forward contracts outstanding.

Note 17. Subsequent Events
 
Investment in United Kingdom Distributor

On September 28, 2012, we entered into an agreement with our distributor in the United Kingdom to purchase 15% of the outstanding equity in the company for approximately $0.9 million in cash. In connection with the investment, Omnicell has the right, under certain circumstances, to appoint a member to our United Kingdom distributor's board of directors as well as certain other voting rights. As a result of these and other factors, we anticipate that we will be accounting for this investment using the equity method.


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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:
the extent and timing of future revenues, including the amounts of our current backlog, which represent firm orders that have not completed installation and therefore have not been recognized as revenue;
our ability to conduct acquisitions for strategic value and successfully integrate each one into our operations, including our acquisition of MTS;
the size and/or growth of our market or market-share;
the opportunity presented by new products or emerging markets;
our expectations regarding our future backlog levels;
the operating margins or earnings per share goals we may set;
our ability to align our cost structure and headcount with our current business expectations;
our ability to protect our intellectual property and operate our business without infringing upon the intellectual property rights of others; and
our ability to generate cash from operations and our estimates regarding the sufficiency of our cash resources.
 
In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “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 also 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 were incorporated in California in 1992 under the name Omnicell Technologies, Inc. and reincorporated in Delaware in 2001 as Omnicell, Inc. We are a leading provider of automated solutions for medication and supply management in healthcare. Our automation and analytics solutions are designed to enable healthcare facilities to acquire, manage, dispense and administer medications and medical-surgical supplies and are intended to enhance patient safety, reduce medication errors, reduce operating costs, improve workflow and increase operational efficiency. Approximately 2,700 hospitals utilize one or more of our products, of which more than 1,700 hospitals in the United States have installed our automated hardware/software solutions for controlling, dispensing, acquiring, verifying, tracking and analyzing medications and medical and surgical supplies. Approximately 6,000 institutional and retail pharmacies utilize our medication adherence packaging solutions.
 
We sell our medication control systems together with related consumables and services, and medical/surgical supply control systems and generate the majority of our revenue in the United States. However, we expect our revenue from our international operations to increase in future periods as we continue to grow our international business. Our sales force is organized by geographic region in the United States and Canada, and for a portion of our products in the United Kingdom and Germany. We also sell through distributors in Asia, Australia, Europe, the Middle East and South America. 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

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identified as state sponsors of terrorism by the U.S. Department of State, and are subject to economic sanctions and export controls.
 
Business Acquisition

On May 21, 2012, we completed our acquisition of MedPak pursuant to the Merger Agreement for $158.3 million in cash, subject to certain adjustments, and including $13.5 million in cash that was placed in an escrow fund at the closing of the transaction, of which approximately $0.3 million was released to Omnicell and approximately $2.0 million was released to the former MedPak stockholders pursuant to a final working capital adjustment recorded during the third quarter of 2012. Under the terms of the Merger Agreement, Mercury Acquisition Corp, a newly formed Omnicell subsidiary, was merged with and into MedPak, with MedPak surviving the merger as a wholly-owned subsidiary of Omnicell. MedPak is the parent company of MTS, a worldwide provider of medication adherence packaging systems and solutions. MTS primarily manufactures and sells consumable medication blister cards, packaging equipment and ancillary products throughout the United States, Canada, Europe and Australia. Its customers are predominantly institutional pharmacies that supply nursing homes, assisted living and correctional facilities with prescription medications for their patients. MTS manufactures its proprietary consumable blister cards and most of its packaging equipment in its own facilities. This manufacturing process uses integrated equipment for manufacturing the consumable medication blister cards. In addition, MTS utilizes the services of outside contract manufacturers for some of its packaging equipment. The consumable medication blister cards and packaging equipment are designed to provide a cost-effective method for pharmacies to dispense medications. MTS’ medication dispensing systems and products provide innovative methods for dispensing medications in disposable packages. MTS Medication Technologies Limited distributes products for MTS primarily in the United Kingdom. MTS Medication Technologies GmbH distributes products for MTS in Germany. MTS currently serves more than 6,000 institutional pharmacies in the long-term care and correctional markets, both domestically and internationally.

With the acquisition of MTS, we organized our business into two operating business segments: Acute Care and Non-Acute Care. The Acute Care segment is organized around the design, manufacturing, selling and servicing of medication and supply dispensing systems. The Non-Acute Care segment includes primarily the manufacturing and selling of consumable medication blister cards, packaging equipment and ancillary products. We report segment information based on the management approach. The management approach designates the internal reporting used by the Chief Operating Decision Maker (“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.

Operations During the Three Months and Nine Months Ended September 30, 2012
 
The consolidated results presented for the three months and nine months ended September 30, 2012 reflect the impact of the acquisition of MTS since May 21, 2012 as a part of the Non-Acute Care segment.

Revenues grew year-over-year for both product and services, with overall revenue growth of 30.9%, comparing $84.3 million for the third quarter of 2012 with $64.4 million for the third quarter of 2011. Overall revenue growth was 22.6% for the nine months ended September 30, 2012, comparing $223.9 million with $182.6 million for the same period in 2011. As a result of the acquisition of MTS, the Non-Acute Care segment contributed $19.9 million and $32.6 million in the three months and nine months ended September 30, 2012, respectively.

The Non-Acute Care segment for the third quarter of 2012 contributed $18.7 million and $1.2 million to the overall product and service revenue growth, respectively. The Acute Care segment contributed revenues of $64.4 million which were unchanged for the three months ended September 30, 2012 as compared to the same period in 2011. Overall product and service margins increased by $11.6 million, or 33.8% for the three months ended September 30, 2012 as compared to the same period in 2011. Product and service margins increased by $21.3 million, or 21.3% for the nine months ended September 30, 2012 as compared to the same period in 2011.

During the third quarter of 2012, we achieved 11.9% growth in total revenues from the second quarter of 2012, inclusive of a full quarter of Non-Acute Care growth of $19.9 million. Product revenue increased by $8.2 million, or 13.8%, while service revenue increased by $0.8 million, or 4.8%. Overall gross margins for the third quarter of 2012 increased to 54.7% from 52.2% in the second quarter of 2012. Product gross margins increased to 54.6% on revenue of $67.4 million as compared to 51.7% on revenue of $59.3 million in the second quarter of 2012. Service gross margins increased to 54.9% on revenue of $16.9 million as compared to 54.0% on revenue of $16.1 million in the second quarter of 2012. The overall increase in gross margins is primarily attributable to a favorable product mix in the Acute Care segment.


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We believe our solutions are attractive relative to our competition. In particular:
 
We have continued to differentiate ourselves through a strategy intended to create the best customer experience in healthcare;
We have delivered industry-leading products with differentiated product features that are designed to appeal to nurses and pharmacists, such as our G4 platform, the SavvyTM Mobile Medication System, SinglePointeTM, Anywhere RNTM and the OnDemand product line;
Through acquisitions, we have broadened our medication control product line to address the growing need for medication management across the continuum of care beyond hospitals; and
The market environment of increased patient safety awareness and increased regulatory control has driven our solutions to be a high priority in customers’ capital budgets.
 
We maintain a development staff with expertise in hospital logistics, pharmacy operations and computerized automated solutions, which allows us to deliver new innovations to the market. Our ability to grow revenue and maintain positive cash flow is dependent on our ability to obtain orders from customers, our ability to manufacture consumables to meet customer demand, the volume of installations we are able to complete, our ability to meet customers’ needs while providing a quality installation experience and our flexibility in manpower allocations among customers to complete installations on a timely basis. 

Cash, cash equivalents and short-term investments increased by $0.7 million during the three months ended September 30, 2012, to $54.8 million from $54.1 million at June 30, 2012. The change in cash, cash equivalents and short-term investments for the quarter was relatively unchanged from the prior quarter, with the increase in net income being offset by financing activities which included stock repurchases and shares issued under our stock option and employee stock purchase plans. Cash, cash equivalents and short-term investments decreased by $145.1 million during the nine months ended September 30, 2012, to $54.8 million from $199.9 million at December 31, 2011. Contributing to this decrease in cash, cash equivalents and short-term investments was $159.8 million used for the acquisition of MTS,including related transaction costs incurred during the quarter ended June 30, 2012 and year-to-date stock repurchase activity of $12.4 million to repurchase 898,168 shares of our common stock through our stock repurchase program. These expenditures were partially offset by $27.5 million in quarterly operating cash flow, reflecting improved net income and a decline in Acute Care inventories.

Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We regularly review our estimates and assumptions, which are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of certain assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions. We believe that the following critical accounting policies are affected by significant judgments and estimates used in the preparation of our condensed consolidated financial statements:
 
Revenue recognition;
Provision for allowances;
Valuation and impairment of goodwill, other intangible assets and other long lived assets;
Inventory;
Valuation of share-based awards; and
Accounting for income taxes.
 
During the nine months ended September 30, 2012, there were no significant changes in our critical accounting policies and estimates.
 
Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended December 31, 2011 for a more complete discussion of our other critical accounting policies and estimates.

Recently Adopted Accounting Pronouncements

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In May 2011, FASB issued ASU 2011-04, Fair Value Measurement, amending the fair value guidance in ASC 820, and thereby achieving substantially converged fair value measurement and disclosure requirements for GAAP and IFRS. The new guidance clarified some fair value measurement principles and expanded certain disclosure requirements. We adopted this guidance in the first quarter of 2012, without any impact to our financial position, operating results or cash flows.

Recently Issued Accounting Pronouncements

In July 2012, FASB issued ASU 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-lived Intangible Assets for Impairment, which amends the guidance in ASC 350-30 on impairment testing of intangible assets with indefinite lives other than goodwill. This guidance gives an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that an indefinite-lived asset is impaired. An entity has the option to bypass the qualitative assessment and proceed directly to calculating the fair value of an intangible asset with an indefinite life. This update will be effective for us for interim and annual impairment tests performed beginning in the first quarter of fiscal 2013. We do not anticipate this update will have any significant impact on our financial position, operating results or cash flows, as this update does not change how we calculate impairment loss. 

Results of Operations

The table below shows the components of our results of operations as percentages of total revenues for the three months and nine months ended September 30, 2012 and 2011 (in thousands, except percentages):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
$
 
% of
Revenue
 
$
 
% of
Revenue
 
$
 
% of
Revenue
 
$
 
% of
Revenue
Revenues:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Product revenue
$
67,446

 
80.0
%
 
$
49,790

 
77.3
 %
 
$
175,239

 
78.3
%
 
$
138,583

 
75.9
%
Service and other revenues
16,885

 
20.0
%
 
14,649

 
22.7
 %
 
48,619

 
21.7
%
 
44,021

 
24.1
%
Total revenues
84,331

 
100.0
%
 
64,439

 
100.0
 %
 
223,858

 
100.0
%
 
182,604

 
100.0
%
Cost of revenues:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Cost of product revenues
30,636

 
36.3
%
 
22,429

 
34.8
 %
 
79,532

 
35.5
%
 
59,995

 
32.9
%
Cost of service and other revenues
7,608

 
9.0
%
 
7,562

 
11.8
 %
 
23,114

 
10.3
%
 
22,704

 
12.4
%
Total cost of revenues
38,244

 
45.3
%
 
29,991

 
46.6
 %
 
102,646

 
45.8
%
 
82,699

 
45.3
%
Gross profit
46,087