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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES AND EXCHANGE ACT TO 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended August 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _______
Commission File Number 0-20212
ARROW INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 23-1969991
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
2400 BERNVILLE ROAD
READING, PENNSYLVANIA 19605
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
TELEPHONE NUMBER: (610) 378-0131
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Title of Each Class: On Which Registered:
-------------------- --------------------
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, No Par Value
(Title of Class)
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
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.[ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 under the Exchange Act) YES X NO
--- ---
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of October 1, 2004 was approximately $794,812,068
The number of shares of Registrant's Common Stock outstanding on October
1, 2004 was 43,785,357.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its Annual Meeting of
Shareholders to be held on January 19, 2005, which will be filed with the
Securities and Exchange Commission within 120 days after August 31, 2004, are
incorporated by reference in Part III of this report.
ITEM 1. BUSINESS
CERTAIN OF THE INFORMATION CONTAINED IN THIS FORM 10-K, INCLUDING THE
DISCUSSION WHICH FOLLOWS IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" FOUND IN ITEM 7 OF THIS REPORT, CONTAIN
FORWARD-LOOKING STATEMENTS. FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS,
CAREFULLY REVIEW THIS REPORT, INCLUDING ITEM 1. BUSINESS - CERTAIN RISKS
RELATING TO ARROW, AS WELL AS OTHER INFORMATION CONTAINED IN ARROW
INTERNATIONAL, INC.'S PERIODIC REPORTS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION, OR THE SEC.
Arrow International, Inc. (together with its subsidiaries, "Arrow" or
the "Company") was incorporated as a Pennsylvania corporation in 1975. Arrow
develops, manufactures and markets a broad range of clinically advanced,
disposable catheters, heart assist devices and related products for critical and
cardiac care. The Company's critical care products are used principally for
central vascular access in the administration of fluids, drugs and blood
products, patient monitoring and diagnostic purposes. These products are used by
anesthesiologists, critical care specialists, surgeons, cardiologists,
nephrologists, emergency and trauma physicians and other health care providers.
Arrow's cardiac care products are used by interventional cardiologists, cardiac
surgeons, interventional radiologists and electrophysiologists for such purposes
as the diagnosis and treatment of heart and vascular disease and to provide
short-term cardiac assist following cardiac surgery, serious heart attack or
balloon angioplasty.
Arrow's critical care products, the first of which were originally
introduced in 1977, accounted for approximately 85.0%, 85.0% and 83.0% of net
sales in fiscal 2004, 2003 and 2002, respectively. The majority of these
products are vascular access catheters and related devices which consist
principally of the following: the Arrow-Howes(TM) Multi-Lumen Catheter, a
catheter equipped with three or four channels, or lumens, that enables the
simultaneous administration of multiple critical care therapies through a single
puncture site; double-and single-lumen catheters, which are designed for use in
a variety of clinical procedures; percutaneous sheath introducers, which are
used as a means for inserting cardiovascular and other catheterization devices
into the vascular system during critical care procedures; radial artery
catheters, which are used for measuring arterial blood pressure and taking blood
samples; FlexTip Plus(TM) epidural catheters, which are designed to minimize
indwelling complications associated with conventional epidural catheters; and
Percutaneous Thrombolytic Devices, which are designed for clearance of
thrombosed hemodialysis grafts in chronic hemodialysis patients. Many of the
Company's vascular access catheters are treated with the ARROWg+ard(TM) or
ARROWg+ard Blue Plus(TM) antiseptic surface treatments to reduce the risk of
catheter related infection. ARROWg+ard Blue Plus(TM) is a stronger, longer
lasting formulation of ARROWg+ard(TM) and provides antimicrobial treatment of
the interior lumens and hubs of each catheter. Many of the Company's procedure
kits also feature its sharps safety devices to protect against inadvertent
needle sticks.
The Company's critical care product line also includes custom tubing
sets used to connect central venous catheters to blood pressure monitoring
devices and drug infusion systems, and the HemoSonic(TM) 100 and 200, a
hemodynamic monitoring device that continuously measures descending aortic blood
flow using a non-invasive esophageal ultrasound probe.
In November 2002, the Company expanded its critical care product line
with the acquisition of Diatek, Inc., a company that develops, manufactures and
markets chronic hemodialysis catheters. When acquired, Diatek was marketing in
select U.S. markets the Cannon Catheter(TM), an implanted hemodialysis catheter
for long-term access that is used to facilitate dialysis treatment. Previously,
the Company sold acute, or short-term, catheters for hemodialysis treatment. The
catheters acquired in connection with its purchase of Diatek complement and
broaden the Company's product line in this field (see Item 8. Notes to
Consolidated Financial Statements - Note 5). On November 7, 2003, the Company
received authorization to CE-mark the Cannon Catheter(TM), enabling it to market
this product line within the European Economic Area and other international
markets.
In March 2003, the Company further expanded its critical care product
line with the acquisition of Klein-Baker Medical, Inc., a company that develops,
manufactures and markets the NeoCare(R) product line of specialty catheters and
related procedure kits for use by neonatal intensive care units. The NeoCare(R)
product line was marketed in select areas of the U.S. and the Company intends to
expand the sale of these products into additional U.S. and international markets
and to develop additions to the basic product line. This acquisition may also
serve as the base for possible further expansion of the Company's pediatric
product line (see Item 8. Notes to Consolidated Financial Statements - Note 5).
Arrow's cardiac care products accounted for approximately 15.0%, 15.0%
and 17.0% of net sales in fiscal 2004, 2003 and 2002, respectively. These
products include cardiac assist products, such as intra-aortic balloon, or IAB,
pumps and catheters, which are used primarily to augment temporarily the pumping
capability of the heart following cardiac surgery, serious heart attack or
balloon angioplasty. The Company's IAB products include the AutoCat(TM)2 WAVE
IAB pump and associated LightWAVE(TM) catheter system, which utilize fiber optic
pressure-sensing catheter instrumentation and provide automation of the pumping
process for the broadest range of patients, including those with severely
arrhythmic heartbeats. The Company also recently introduced the Ultraflex 7.5
Fr. IAB catheter, which is the smallest IAB in the market and employs the
Company's proprietary wire reinforced technology. In the spring of 2004, the
Company commenced marketing in Europe of the Arrow LionHeart(TM), a fully
implantable Left Ventricular Assist System, or LVAS, capable of taking over the
entire work load of the left ventricle.
The Company's cardiac care product line also includes electrophysiology
products, which are used primarily to map the electrical signals which activate
the heart. The Berman(TM) Angiographic Catheter is used for pediatric cardiac
angiographic procedures and the Super Arrow-Flex(TM) sheath provides a
kink-resistant passageway for the introduction of cardiac and other catheters
into the vascular system. In addition, as further discussed below under
"Research and Product Development," the Company is currently developing the
CorAide(TM) LVAS, a small non-pulsatile centrifugal flow ventricular assist
device.
(2)
SALES AND MARKETING
Arrow markets its products to physicians and hospitals through a
combination of direct selling, independent distributors and group purchasing
organizations. Within each hospital, marketing efforts are targeted to those
physicians, including critical care specialists, cardiologists,
anesthesiologists, interventional radiologists, electrophysiologists and
surgeons, most likely to use the Company's products. Arrow's products are
generally sold in the form of pre-sterilized procedure kits containing the
catheters and virtually all of the related medical components and accessories
needed by the clinician to prepare for and perform the intended medical
procedure. Additional sales revenue is derived from equipment provided for use
in connection with certain of the Company's disposable products.
In fiscal 2004, 2003 and 2002, 64.6%, 65.7% and 65.5%, respectively, of
the Company's net sales were to U.S. customers. In this market, approximately
91.0% of the Company's fiscal 2004 revenue was generated by its direct sales
force. The remainder resulted from shipments to independent distributors. For
the majority of such distributors, the Company's products represent a principal
product line. Direct selling generally yields higher gross profit margins than
sales made through independent distributors.
Internationally, the Company sells its products through direct sales
subsidiaries serving markets in Japan, Germany, the Netherlands, France, Spain,
Greece, Africa, Canada, Mexico, the Czech Republic, Slovakia, Switzerland,
Portugal and Italy. As of October 1, 2004, independent distributors in 94
additional countries sell the Company's products in the remainder of the world.
To support growth in international sales, the Company operates a 40,000
square foot manufacturing facility in Chihuahua, Mexico and has leased 22,500
square feet of additional manufacturing space in Mexico since fiscal 2002. The
Company also operates an 88,000 square foot manufacturing and product
development facility in the Czech Republic, which was expanded in fiscal 2003.
During fiscal 2004, the Company's Board of Directors authorized the initiation
of a multi-year capital investment plan to increase its worldwide manufacturing
capacity and rationalize its production operations. The first phase of this
effort will include the construction of additional manufacturing facilities in
the Czech Republic and in Chihuahua, Mexico, which is expected to commence in
fiscal 2005.
Revenues, profitability and long-lived assets attributable to
significant geographic areas are presented in Note 16 to the Company's
Consolidated Financial Statements included in Item 8.
In general, Arrow does not produce against a backlog of customer orders.
Production is based primarily on the level of inventories of finished products
and projections of future customer demand with the objective of shipping from
stock upon receipt of orders. No single customer accounts for more than 10% of
the Company's sales. Purchase of the Company's products by hospitals and
physicians has not been materially influenced by seasonal factors.
Government and private sector initiatives to limit the growth of health
care costs, including price regulation, competitive pricing, coverage and
payment policies, and managed-care arrangements, are continuing in the United
States and in many other countries where the Company does business. As a result
of these changes, the marketplace has placed increased emphasis on the delivery
of more cost-effective medical therapies. Government programs, including
Medicare and Medicaid, private health care insurance and managed-care plans have
attempted to control costs by limiting the amount of reimbursement such third
party payors will pay to hospitals, other medical institutions and physicians
for particular products, procedures or treatments. The increased emphasis on
health care cost containment has resulted in reduced growth in demand for
certain of the Company's products in markets in the U.S. where Arrow has 80% or
greater market share, and protecting that market share has affected the
Company's pricing in some instances. The Company also continues to face pricing
pressures in certain product lines in both European and Japanese markets as
governments strive to curtail increases in health care costs. The Company
anticipates that the U.S. Congress, state legislatures, foreign governments and
the private sector will continue to review and assess alternative health care
delivery and payment systems. The Company cannot predict what additional
legislation or regulation, if any, relating to the health care industry may be
enacted in the future or what impact the adoption of any federal, state or
foreign health care reform, private sector reform or market forces may have on
its business. There can be no assurance that any such reforms will not have a
material adverse effect on the Company's business, financial condition or
results of operations.
RESEARCH AND PRODUCT DEVELOPMENT
Arrow is engaged in ongoing research and development to introduce
clinically advanced new products, to enhance the effectiveness, ease of use,
safety and reliability of its existing products and to expand the clinical
applications for which use of its products is appropriate. The principal focus
of the Company's research and development effort is to identify and analyze the
needs of physicians in critical and cardiac care medicine, and to develop
products that address these needs. The Company views ideas submitted by
physicians and other health care professionals as an important source of
potential research and development projects. The Company believes that these
end-users are often in the best position to conceive of new products and to
recommend ways to improve the performance of existing products. Many of the
Company's principal products and product improvements have resulted from
collaborative efforts with physicians, other health care professionals or other
affiliated entities. For certain proprietary ideas, the Company pays royalties
to such persons, and in many instances, incorporates such persons' names in the
tradename or trademark for the specific product. The Company also utilizes other
outside consultants, inventors and medical researchers to carry on its research
and development effort and sponsors research through medical associations and at
various universities and teaching hospitals.
(3)
Certain of the Company's strategic acquisitions and investments have
provided the basis for its introduction of significant new products. The Company
entered the field of cardiac care in 1994 with its acquisition of Kontron
Instruments and supplemented this acquisition with its acquisitions of the
cardiac assist divisions of Boston Scientific in 1997 and C.R. Bard, Inc. in
1998. The Company's acquisition of Sometec, S.A. in 1999 enabled it to introduce
to the market its innovative ultrasound hemodynamic monitoring device. More
recently, the Company's acquisition of Diatek, Inc. in November 2002 and the
NeoCare(R) product line in March 2003 have allowed it to market Diatek's Cannon
Catheter(TM) hemodialysis catheter product, as well as specialty catheters and
related procedure kits for use in neonatal intensive care units.
Research and development expenses totaled $30.4 million (7.0% of net
sales), $28.2 million (7.4% of net sales) and $26.2 million (7.7% of net sales)
in fiscal 2004, 2003 and 2002, respectively. Such amounts were used to develop
new products, improve existing products and implement new technology to produce
these products.
The Company's principal products currently under development are
described below. There can be no assurance that the U.S. Food and Drug
Administration, or the FDA, or any similar foreign government regulatory
authority will grant the Company authorization to market products under
development or, if such authorization is obtained, that such products will prove
competitive when measured against other available products.
AUTOCAT(R)2 WAVE. In January 2004, the Company introduced its
AutoCAT(R)2 WAVETM intra-aortic balloon pump and associated LightWAVE(TM)
catheter system in the U.S. and Europe. The Company's AutoCAT(R)2 WAVETM IAB
pump and associated LightWAVE(TM) catheter system utilizes fiber optic
pressure-sensing catheter instrumentation and provides total automation of the
pumping process for all patients, including those with severely arrhythmic
heartbeats. While initial customer response to this product has been positive,
during the second half of fiscal 2004, the selling process for this new
technology was slowed by ramp-up issues in manufacturing. During the period that
the Company was addressing these issues, it identified several areas where it
determined that the product could be improved. Those improvements have been made
and are now being clinically evaluated. These modifications are expected to
enhance the ease of use of the AutoCAT(R)2 WAVETM, which the Company believes
will provide a significant advantage over competing technologies. The Company
continues to believe that this new technology represents a major step forward in
intra-aortic balloon pumping and should enable the Company to gain market share
based on superior performance across a range of cardiac requirements.
During the first quarter of fiscal 2004, the Company also released its
UltraFlexTM 7.5 Fr intra-aortic balloon catheter. This catheter, the smallest
intra-aortic balloon catheter on the market, incorporates the Company's
proprietary tubing reinforcement technology to prevent kinking.
LIONHEART LVAS. The Arrow LionHeart(TM) LVAS is a fully implantable
device which provides long-term cardiac assist for patients having insufficient
left ventricular heart function. The device was developed by the Company in
cooperation with Pennsylvania State University's Hershey Medical School over the
course of 10 years, during which time it has undergone extensive preclinical
studies and testing. The Company believes that the LionHeart(TM), which is
capable of taking over the entire workload of the left ventricle, represents a
significant advance in mechanical circulatory assist technology. Because it is
the first fully implantable "destination therapy" device, the ability of the
patient to experience an improved quality of life for an extended period of time
may be enhanced. The device has no lines or cables protruding through the skin
to power the system, thus eliminating a potential source of infection. It is
fully implanted in the body and does not replace the heart, but assists in the
pumping function of the heart's left ventricle. The device is electrically
driven by a wearable battery pack that transmits power non-invasively through
the skin to charge internal batteries and power the blood pump. In addition, the
Arrow LionHeart(TM) enables patients to experience limited periods of untethered
movement with energy supplied from rechargeable batteries implanted as part of
the device.
The first human implant of the Arrow LionHeart(TM) took place in October
1999 at The Herzzentrum NRW (The Heart Center) in Bad Oeynhausen, Germany as
part of the European clinical investigation, sponsored by the Company, to
demonstrate the safety and performance of the LionHeart(TM) for the purpose of
obtaining a European Conformity (CE) mark. To date, three patients have lived on
the device for more than two years, with the longest surviving patient exceeding
three years on the device.
As previously reported, in November 2003, the Company received
authorization from its European Notified Body, TUV Product Services of Munich,
Germany, or TUV, to CE-mark the Arrow LionHeart(TM) in Europe, which allows the
Company to market the device within the European Economic Area for permanent
implantation or "destination therapy". The Company believes that the Arrow
LionHeart(TM) is the first fully implantable LVAS to receive CE-marking
authorization specifically for the destination therapy indication. Earlier in
fiscal 2004, the Company initiated its marketing program in Europe, which
includes the training of additional centers to implant the device, supplementing
those centers that were already participants in the European clinical trials,
and commenced initial sales of the product.
The Company expects to submit dossiers for the second generation
LionHeart(TM) external power system and controller and related electronic
components that are currently in the testing stage to TUV by the end of calendar
year 2004 and anticipates receiving approval for use of these new electronics in
the device approximately three months later, given that most of the device's
components have not changed, no additional clinical data is required and the
LionHeart(TM) quality system has already been certified by TUV. The Company's
European marketing plan for the LionHeart(TM) is based upon the receipt of this
approval and the CE-marking of the device's second generation electronics.
(4)
Although there are several other LVAS devices approved in Europe, they
are generally used in shorter term "bridge to transplant" applications. The
Company believes that the use of these other available LVAS devices for
destination therapy is currently small but emerging. No meaningful market for
destination therapy exists today. The Company believes that, due to the
prevalence of end-stage heart disease in many areas of the world, a market for
destination therapy will develop as devices such as the LionHeart(TM) are
increasingly commercialized. As a related matter, however, it is currently
unclear as to the extent to which health care systems, both public and private,
will reimburse patients for the relatively high costs associated with
destination therapy. Furthermore, continued implantation of these devices in a
greater number of patients is necessary to provide additional knowledge of the
ability of the typically older patients who suffer from end-stage heart disease
to successfully undergo the rigors of LVAS implantation surgery.
In February 2001, the Company received FDA, approval under an
Investigational Device Exemption, or IDE, to begin Phase I human clinical trials
in the United States of the LionHeart(TM). The Phase I trial was initially
limited to seven patients at up to five U.S. sites. In February 2001, the
Company announced the first U.S. human implant of the LionHeart(TM) under the
IDE. By August 2001, the Company had enrolled all seven U.S. patients in the
Phase I U.S. feasibility trial authorized under the IDE.
In December 2001, the FDA approved the Company's request to expand this
Phase I clinical trial for an additional seven patients to be implanted with the
LionHeart(TM) in the U.S. The first of these seven additional implants was
performed in July 2002. In May and October 2003, the second and third of these
additional implants were performed, bringing the total number of patients who
have received the LionHeart(TM) in the U.S. to ten. A total of eight U.S. sites
have been approved to perform the remaining four implants under the Phase I
trial, which the Company intends to complete upon successful implementation of
the device's second generation electronics, as described above.
As previously reported, the Company decided in the third quarter of
fiscal 2004 to defer completion of the LionHeart(TM) Phase I clinical trials and
commencement of the Phase II clinical trials, required by FDA to bring the
product to market in the U.S., until the Company is able to implement the second
generation product enhancements described above that are currently in the
testing phase. This decision resulted in the Company's write off of $3.1 million
in obsolete inventory and $0.6 million in manufacturing equipment in the third
quarter of fiscal 2004.
The Company's near-term focus for the LionHeart(TM) program continues to
be on obtaining optimal clinical results and on evaluating the second generation
product enhancements that are currently in development. The Company believes
that these enhancements should increase the patient population for whom the
device is suitable and provide improved quality of life for recipients. The
Company does not expect sales of the LionHeart(TM) to materially impact fiscal
2005 results.
The Company is continuing to evaluate its LionHeart(TM) program on a
regular basis and has engaged an outside consulting firm to provide additional
perspective on the long-term commercial opportunity for the device and
strategies for maximizing its potential.
CORAIDE LVAS. In April 2001, the Company entered into an agreement with
The Cleveland Clinic Foundation, or the CCF, for the exclusive license of the
CCF's patents in the field of non-pulsatile centrifugal flow ventricular assist
devices for the treatment of congestive heart failure and a related agreement
for continued research and development on the CorAide(TM) ventricular assist
device that had been a joint development effort of the CCF and the National
Institutes of Health.
The unique, magnetically suspended flow pumping mechanism of the
CorAide(TM) device uses the moving blood as its lubricating system. Arrow
considers the CorAide(TM) device to be one of the most promising continuous flow
bridge-to-transplant devices currently in development and believes it may
represent a future generation permanent ventricular assist device if human organ
systems prove to be adaptable to non-pulsatile blood flow over a long period of
time. In IN VIVO trials to date, the CorAide(TM) device has shown excellent
performance without the use of anticoagulant drug therapy. Moreover, its smaller
size, low power requirements and lower cost relative to other ventricular assist
devices currently under development provide a promising approach for
bridge-to-transplant patients.
The first human implant of a CorAide(TM) continuous flow ventricular
assist system took place in Germany in May 2003 as part of a clinical trial with
patients needing ventricular support prior to receiving a donor heart in order
to provide a better understanding of human tolerance for non-pulsatile flow
devices. As previously reported, the patient experienced unexpected elevated
levels of plasma-free hemoglobin, and the device was replaced with another
bridge device pending the availability of a donor heart. Subsequent analysis and
testing of the CorAide(TM) device, together with small modifications to it, have
provided insight into the probable causes of the elevated level of hemolysis
(plasma-free hemoglobin). The Company believes it has made significant progress
in its efforts to develop and test modifications to the CorAide(TM) device to
address the elevated levels of hemolysis experienced in the first implant of the
device. While the Company cannot be certain that these modifications will
resolve the problem, it believes that suitable improvements have been developed.
The Company expects that European clinical trials of the CorAide(TM) device
should resume later in calendar year 2004 although, due to the pioneering nature
of this program, it is difficult to predict precise timing.
The Company considers the CorAide(TM) development program to be
complementary to its ongoing program to develop and market the Arrow
LionHeart(TM) LVAS. The first version of the CorAide(TM) device is not fully
implantable and is intended to provide support for patients waiting for heart
transplantation or considered candidates for bridging to natural recovery of
ventricular function. The Company continues to believe that successful
development of the CorAide(TM) device would provide a lower cost, less invasive
and broader application approach to ventricular assist than pulsatile devices
that are currently available or under development.
(5)
HEMOSONIC. During fiscal 2004, the Company continued its development of
an improved version of its HemoSonicTM , a monitoring device that continuously
measures descending aortic blood flow using a non-invasive esophageal ultrasound
probe, that it believes will be more user-friendly and better able to meet the
needs of a broader range of physicians. The Company is currently in the final
stages of this development and expects to begin market testing of the new model
in fiscal 2005. The Company is also currently in the process of clinically
evaluating a number of product enhancements.
MANUFACTURING AND PRODUCTION TECHNOLOGY
Arrow has developed the core technologies that the Company believes are
necessary for it to design, develop and manufacture complex, high quality
catheter-related medical devices. This technological capability has enabled the
Company to develop internally many of the major components of its products and
reduce its unit manufacturing costs. To help further reduce manufacturing costs
and improve efficiency, the Company has increasingly automated the production of
its high-volume products and plans to continue to make significant capital
expenditures to promote efficiency and reduce operating costs.
Raw materials and purchased components essential to Arrow's business
have typically been available within the lead times required by the Company and,
consequently, procurement has not historically posed any significant problems in
the operation of the Company's business. Although the Company currently
maintains single suppliers for certain of its out-sourced components,
particularly those used in the LionHeart(TM) and AutoCAT(R)2WAVETM, it is
exploring alternative vendors for most of these items.
As previously announced, the Company's Board of Directors has authorized
the initiation of a multi-year capital investment plan to increase its worldwide
manufacturing capacity and rationalize its production operations. The first
phase of this effort will include the construction of additional manufacturing
sites in Zdar, Czech Republic and in Chihuahua, Mexico, which is expected to
commence in fiscal 2005.
PATENTS, TRADEMARKS, PROPRIETARY RIGHTS AND LICENSES
Arrow believes that patents and other proprietary rights are important
to its business. The Company also relies upon trade secrets, know-how,
continuing technological innovations and licensing opportunities to develop and
maintain its competitive position. Arrow currently holds numerous U.S. and
foreign patents and patent applications that relate to aspects of the technology
used in certain of the Company's products, including its radial artery catheter,
percutaneous sheath introducer, interventional diagnostic catheter products,
left ventricular assist device, esophageal ultrasound probe jacket and
intra-aortic balloon pump products. There can be no assurance that patent
applications owned by or licensed to the Company will result in the issuance of
patents or that any patents owned by or licensed to the Company will provide
competitive advantages for the Company's products or will not be challenged or
circumvented by others.
In addition, Arrow is a party to several license agreements with
unrelated third parties pursuant to which it has obtained, for varying terms,
the exclusive rights to certain patents held by such third parties in
consideration for royalty payments. Many of the Company's major products,
including its antiseptic surface treatment for catheters, have been developed
pursuant to such license agreements. All existing patents owned by or licensed
to the Company relating to any of its major products expire after fiscal 2005.
From time to time, the Company is subject to legal actions involving
patent and other intellectual property claims. In October 2003, the Company
reached a settlement in principle for $8.0 million, or $0.12 diluted earnings
per share, in two related lawsuits in which the plaintiffs had alleged that
certain of the Company's hemodialysis catheter products infringed patents owned
by or licensed to the plaintiffs. In December 2003, the terms of this settlement
were finalized and the Company paid the $8.0 million settlement in January 2004.
The Company had been obligated to pay royalties to the plaintiffs based on the
sales levels for these products. Upon the final settlement of these actions, the
Company no longer owes royalties to the plaintiff for any sales occurring after
August 28, 2004.
The Company is also currently a defendant in a lawsuit in which the
plaintiff alleges that the Company's Cannon-Cath(TM) split-tip hemodialysis
catheters, which were acquired as part of the Company's acquisition in November
2002 of specified assets of Diatek, Inc., infringe a patent owned by or licensed
to the plaintiffs. In November 2003, this lawsuit was stayed pending the U.S.
Patent and Trademark Office's ruling on its re-examination of the patent at
issue, which is not expected to occur until after calendar year 2004. The
Company has reserved $2.0 million for estimated legal fees related to this
lawsuit. The reserve amount represents the Company's responsibility to pay
one-half of these legal fees while the former owners of Diatek, Inc. are
responsible for payment of the other half. Based on information presently
available to the Company, the Company believes that its products do not infringe
any valid claim of the plaintiff's patent and that, consequently, it has
meritorious legal defenses with respect to this action and is vigorously
contesting it. Although the ultimate outcome of this action is not expected to
have a material adverse effect on the Company's business or financial condition,
whether an adverse outcome in this action would materially adversely affect the
Company's reported results of operations in any future period cannot be
predicted with certainty.
Arrow owns a number of registered trademarks in the United States and,
in addition, has obtained registration in many of its major foreign markets for
the trademark ARROW(R) and certain other trademarks.
(6)
GOVERNMENT REGULATION
As a developer, manufacturer and marketer of medical devices, Arrow is
subject to extensive regulation by, among other governmental entities, the FDA
and the corresponding state, local and foreign regulatory agencies in
jurisdictions in which the Company sells its products. These regulations govern
the introduction of new medical devices, the observance of certain standards
with respect to the manufacture, testing and labeling of such devices, the
maintenance of certain records, the tracking of such devices and other matters.
Failure to comply with applicable federal, state, local or foreign laws or
regulations could subject the Company to enforcement action, including product
seizures, recalls, withdrawal of marketing clearances or approvals, and civil
and criminal penalties, any one or more of which could have a material adverse
effect on the Company. In recent years, the FDA has pursued a more rigorous
enforcement program to ensure that regulated businesses, like the Company's,
comply with applicable laws and regulations. The Company believes that it is in
substantial compliance with such governmental regulations. However, federal,
state, local and foreign laws and regulations regarding the manufacture and sale
of medical devices are subject to future changes. There can be no assurance that
such changes or the FDA enforcement program will not have a material adverse
effect on the Company.
In October 2002, The Medical Device User Fee and Modernization Act of
2002 was enacted, which amended the FDA's regulations to provide, among other
things, the ability for the FDA to impose user fees for pre-market reviews of
medical devices. The Company's filings with the FDA for pre-market review are
subject to this fee structure. The precise amount of fees that the Company will
incur each year will be dependent upon the specific quantity and nature of its
filings.
On occasion, the Company has received notifications, including warning
letters, from the FDA of alleged deficiencies in the Company's compliance with
FDA requirements. The Company believes that it has been able to address or
correct such deficiencies. In addition, from time to time the Company has
recalled, or issued safety alerts on, certain of its products. No such warning
letter, recall or safety alert has had a material adverse effect on the Company,
but there can be no assurance that they would not have such an effect in the
future.
In the early to mid 1990s, the review time by the FDA to approve medical
devices for commercial release lengthened and the number of marketing clearances
and approvals decreased. In response to public and congressional concern, the
FDA Modernization Act of 1997 was adopted with the intent of bringing better
definition to the clearance process for new medical products. While FDA review
times have improved since passage of the 1997 Act, there can be no assurance
that the FDA review process will not continue to delay the Company's
introduction of new products in the U.S. in the future. In addition, many
foreign countries have adopted more stringent regulatory requirements which also
have added to the delays and uncertainties associated with the release of new
products, as well as the clinical and regulatory costs of supporting such
releases. It is possible that delays in receipt of, or failure to receive, any
necessary clearance or approval for the Company's new product offerings could
have a material adverse effect on the Company's business, financial condition or
results of operations.
COMPETITION
Arrow faces substantial competition from a number of other companies in
the market for catheters and related medical devices and equipment, ranging from
small start-up enterprises to companies that are larger than Arrow with greater
financial and other resources. In addition, in response to concern about the
rising costs of health care, U.S. hospitals and physicians are placing
increasing emphasis on cost-effectiveness in the selection of products to
perform medical procedures. The Company believes that its products are competing
primarily on the basis of product differentiation, product quality and
cost-effectiveness, and that its comprehensive manufacturing capability enables
it to expedite the development and market introduction of new products and to
reduce manufacturing costs, thereby permitting the Company to respond more
effectively to competitive pricing in an environment where its ability to
increase prices is limited.
ENVIRONMENTAL COMPLIANCE
The Company is subject to various federal, state and local laws and
regulations relating to the protection of the environment. In the course of its
business, the Company is involved in the handling, storing and disposal of
materials which are classified as hazardous.
The Company believes that its operations comply in all material respects
with applicable environmental laws and regulations. While the Company continues
to make any necessary capital and operational expenditures for protection of the
environment, it does not anticipate that these expenditures will have a material
adverse effect on its business, financial condition or results of operations.
PRODUCT LIABILITY AND INSURANCE
The design, manufacture and marketing of medical devices of the types
produced by the Company entail an inherent risk of product liability. The
Company's products are used in surgical and intensive care settings with
seriously ill patients. While the Company believes that, based on claims made
against the Company in the past, the amount of product liability insurance
maintained by the Company is adequate, there can be no assurance that such
insurance will be available or in an amount sufficient to satisfy claims made
against the Company in the future or that the Company will be able to obtain
insurance in the future at satisfactory rates or in adequate amounts. The
Company's primary global product liability insurance policy is on a claims made
basis. For fiscal 2004, the Company's deductibles for its primary global product
liability insurance policy were increased to $2.5 million per occurrence from
$750,000 in fiscal 2003 for domestic product liability claims, with the
Company's annual exposure for such deductibles in any one policy year being
increased to $5.0 million in fiscal 2004 from $1.5 million in fiscal year 2003.
Effective for fiscal 2005, the Company's deductibles for its primary global
product liability insurance policy have been decreased to $2.0 million per
occurrence from $2.5 million in fiscal 2004 with the Company's annual aggregate
exposure for such deductibles being limited to $4.0 million for any one policy
year. The policy year runs from September 1 to August 31 and has a $10.0 million
aggregate limit. The Company also has
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additional layers of coverage insuring up to $35.0 million in annual aggregate
losses arising from claims that exceed the primary product liability insurance
policy limits. Product liability claims in the future, regardless of their
ultimate outcome, could result in costly litigation and could have a material
adverse effect on the Company's business, reputation, its ability to attract and
retain customers for its products and its results of operations.
EMPLOYEES
As of October 1, 2004, Arrow had approximately 3,500 full-time
employees, of which 269 were hourly-paid manufacturing employees at the
Company's Reading and Wyomissing, Pennsylvania facilities. These hourly-paid
employees are represented by the United Steelworkers of America AFL-CIO, Local
8467 (the "Union"). The Company and the Union are currently operating under a
three-year agreement that expires in August 2006. The Company has never
experienced an organized work stoppage or strike and considers its relations
with its employees to be good.
AVAILABLE INFORMATION
Arrow's internet address is: HTTP://WWW.ARROWINTL.COM. The Company makes
available, free of charge, on its internet website its annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other
information filed or furnished pursuant to the Securities Exchange Act of 1934
as soon as reasonably practicable after these filings have been made
electronically with the SEC. The Company's Code of Conduct, which applies to all
of its directors, officers and other employees, is also posted on its website.
Information contained on the Company's website is not incorporated by reference
in this report.
CERTAIN RISKS RELATING TO ARROW
FROM TIME TO TIME, IN BOTH WRITTEN REPORTS AND IN ORAL STATEMENTS BY THE
COMPANY'S SENIOR MANAGEMENT, EXPECTATIONS AND OTHER STATEMENTS ARE EXPRESSED
REGARDING THE COMPANY'S FUTURE PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE
INHERENTLY UNCERTAIN AND INVESTORS MUST RECOGNIZE THAT EVENTS COULD TURN OUT TO
BE DIFFERENT THAN SUCH EXPECTATIONS AND STATEMENTS. KEY FACTORS IMPACTING THE
COMPANY'S CURRENT AND FUTURE PERFORMANCE ARE DISCUSSED ELSEWHERE IN THIS REPORT
AND IN THE COMPANY'S OTHER FILINGS WITH THE SEC. IN ADDITION TO SUCH
INFORMATION, INVESTORS SHOULD CONSIDER THE FOLLOWING RISK FACTORS IN EVALUATING
THE COMPANY AND ITS BUSINESS, AS WELL AS IN REVIEWING FORWARD-LOOKING STATEMENTS
CONTAINED IN THIS REPORT AND IN THE COMPANY'S OTHER PERIODIC REPORTS FILED WITH
THE SEC AND IN ORAL STATEMENTS MADE BY ITS SENIOR MANAGEMENT. THE COMPANY'S
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS DUE
TO MATERIAL RISKS, UNCERTAINTIES AND CONTINGENCIES, INCLUDING, WITHOUT
LIMITATION, THOSE DISCUSSED BELOW.
Stringent Government Regulation
The Company's products are subject to extensive regulation by the FDA
and, in some jurisdictions, by state, local and foreign governmental
authorities. In particular, the Company must obtain specific clearance or
approval from the FDA before it can market new products or certain modified
products in the United States. In the United States, permission to distribute a
new device generally can be met either through a 510(k) premarket notification
or an application for a premarket approval, or PMA.
Under the FDA's requirements, if a manufacturer can establish that a
newly developed device is "substantially equivalent" to a legally marketed
predicate device, the manufacturer may seek marketing clearance from the FDA to
market the device by filing a 510(k) premarket notification with the FDA. With
the exception of one product, the Company has, to date, obtained FDA marketing
clearance for its products only through the 510(k) premarket notification
process. The 510(k) premarket notification must be supported by data
establishing the claim of substantial equivalence to the satisfaction of the
FDA. The process of obtaining a 510(k) clearance is normally three months or
less. However, this process may take several months to a year or longer.
If substantial equivalence cannot be established or if the FDA
determines that additional safety and effectiveness data is required to support
an approval, the FDA will require that the manufacturer submit a PMA application
that must be approved by the FDA prior to marketing the device in the United
States. The PMA application must be supported by extensive data, including
preclinical (laboratory) data and human clinical data, to demonstrate the safety
and efficacy of the device with respect to its intended use disclosed in the
application.
Certain of the Company's products under development, including the Arrow
LionHeartTM LVAS and the CorAideTM ventricular assist device require approval
through the more rigorous PMA application process. By regulation, the FDA has
180 days to review a PMA application and during that time an advisory committee
may evaluate the application and provide recommendations to the FDA. While the
FDA has approved PMA applications within the allotted time period, review more
often occurs over a significantly protracted period, usually 18 to 36 months,
and a number of devices have never been cleared for marketing.
The process of obtaining 510(k) clearances or PMAs can be time consuming
and expensive. There can be no assurance that the FDA will grant all such
clearances or approvals sought by the Company or that FDA review will not
involve delays adversely affecting the marketing and sale of its products. Both
a 510(k) premarket notification and a PMA application, if approved, may also
include significant limitations on the indicated uses for which a product may be
marketed. FDA enforcement policy prohibits the promotion of approved medical
devices for unapproved uses. In addition, product approvals can be withdrawn for
failure to comply with regulatory requirements or the occurrence of unforeseen
problems following initial marketing.
The FDA often requires post-market surveillance requirements for
significant risk devices, such as ventricular assist devices, that require
ongoing collection of clinical data during commercialization that must be
gathered, analyzed and submitted to the FDA periodically for up to several
years. These data collection requirements can be burdensome.
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The Company is also required to adhere to applicable U.S. and
international quality system regulations, which require that the Company
manufacture its products and maintain its records in a prescribed manner with
respect to design, test, and manufacturing and quality control activities. To
the extent that any quality issues are identified with respect to the Company's
products, the Company could be subject to substantial costs and write-offs,
which could materially impact its results of operations. In addition, the
Company is required to comply with FDA requirements for labeling and promotion
of its products.
Medical device laws are also in effect in many of the countries outside
the U.S. in which the Company does business. These laws range from comprehensive
device approval and quality system requirements for some or all of the Company's
products to simpler requests for product data, certifications or compliance with
packaging or labeling requirements. Many of the regulations applicable to the
Company's products in foreign countries are similar to those of the FDA and the
number, scope and stringency of these requirements are increasing, which is
adding to the delays and uncertainties associated with new product releases, as
well as the clinical and regulatory costs of supporting such releases. For
example, in the European Union, a single regulatory approval process has been
created, with approval represented by the CE-mark. Although the Company has to
date received authorization to CE-mark many of its more innovative products,
including the Arrow Lionheart(TM) LVAS and its Cannon Catheter(TM), there can be
no assurance that its other products under development will be able to meet this
stringent requirement for marketing a medical device in the European Union. In
addition, the Company is required to notify the FDA if it exports to certain
countries medical devices manufactured in the U.S. that have not been approved
by the FDA for distribution in the U.S.
Failure to comply with applicable federal, state, local or foreign laws
or regulations could subject the Company to enforcement action, including
product seizures, recalls, withdrawal of clearances or approvals, and civil and
criminal penalties, any one or more of which could have a material adverse
effect on its business, financial condition and results of operations. Federal,
state, local and foreign laws and regulations regarding the development,
manufacture and sale of medical devices are subject to future changes. There can
be no assurance that such changes will not have a material adverse effect on the
Company's business, financial condition and results of operations.
Significant Competition and Continual Technological Change
The markets for medical devices are highly competitive. The Company
currently competes with many companies in the development and marketing of
catheters and related medical devices. Some of the Company's competitors have
access to greater financial and other resources than it does.
Furthermore, the markets for medical devices are characterized by rapid
product development and technological change. Technological advances by one or
more of the Company's current or future competitors could render its present or
future products obsolete or uneconomical. The Company's future success will
depend upon its ability to develop new products and technology to remain
competitive with other developers of catheters and related medical devices. The
Company's business strategy emphasizes the continued development and
commercialization of new products and the enhancement of existing products for
the critical care and cardiac care markets. There can be no assurance that the
Company will be able to continue to successfully develop new products and to
enhance existing products, to manufacture these products in a commercially
viable manner, to obtain required regulatory approvals or to gain satisfactory
market acceptance for its products.
Health Care Cost Containment and Third Party Reimbursement
The Company's products are purchased principally by hospitals, hospital
networks and hospital buying groups. Although its products are used primarily
for non-optional medical procedures, the Company believes that the overall
escalating cost of medical products and services has led and will continue to
lead to increased pressures upon the health care industry to reduce the cost or
usage of certain products and services. In the United States, these cost
pressures have led to increased emphasis on the price and cost-effectiveness of
any treatment regimen and medical device. Third party payors, such as
governmental programs (e.g., Medicare and Medicaid), private insurance plans and
managed care plans, which are billed by hospitals for such health care services,
are increasingly negotiating the prices charged for medical products and
services and may deny reimbursement if they determine that a device was not used
in accordance with cost-effective treatment methods as determined by the payor,
was experimental, unnecessary or used for an unapproved indication. As a result,
even though a new medical device may have been approved by the FDA, the Company
may find limited demand for the device until reimbursement approval has been
obtained from governmental and private third party payers. In international
markets, reimbursement systems vary significantly by country. Many international
markets have government managed health care systems that control reimbursement
for certain medical devices and procedures and, in most such markets, there also
are private insurance systems which impose similar cost restraints. There can be
no assurance that hospital purchasing decisions or government or private third
party reimbursement policies in the United States or in international markets
will not adversely affect the profitability of the Company's products.
In keeping with the increased emphasis on cost-effectiveness in health
care delivery, the current trend among hospitals and other customers of medical
device manufacturers is to consolidate into larger purchasing groups to enhance
purchasing power. The medical device industry has also experienced some
consolidation, partly in order to offer a broader range of products to large
purchasers. As a result, transactions with customers tend to be larger, more
complex and involve more long-term contracts than in the past. The enhanced
purchasing power of these larger customers may also increase the pressure on
product pricing, although the Company is unable to estimate the potential impact
on it at this time. Several comprehensive health care reform proposals have
been, and continue to be, considered by the U.S. Congress. While none of these
proposals have to date been adopted, the intent of these proposals was,
generally, to expand health care coverage for the uninsured and reduce the rate
of growth of total health care expenditures. In addition, certain states have
made significant changes to their Medicaid programs and have adopted various
measures to expand coverage and limit costs. Several foreign countries in which
the Company does business are also considering, and in some countries have
already adopted, similar reforms to limit the growth of health care costs,
including price regulation. Implementation of government health care reform and
other efforts to control costs may limit the price of, or the level at which
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reimbursement is provided for, the Company's products. The Company anticipates
that the U.S. Congress, state legislatures, foreign governments and the private
sector will continue to review and assess alternative health care delivery and
payment systems. The Company cannot predict what additional legislation or
regulation, if any, relating to the health care industry may be enacted in the
future or what impact the adoption of any federal, state or foreign health care
reform, private sector reform or market forces may have on its business. There
can be no assurance that any such reforms will not have a material adverse
effect on the Company's business, financial condition or results of operations.
Dependence on Patents and Proprietary Rights
The Company owns numerous U.S. and foreign patents and has several U.S.
and foreign patent applications pending. The Company also has exclusive license
rights to certain patents held by third parties. These patents relate to aspects
of the technology used in certain of the Company's products. From time to time,
the Company is subject to legal actions involving patent and other intellectual
property claims. Successful litigation against the Company regarding its patents
or infringement of the patent rights of others could have a material adverse
effect on its business, financial condition and results of operations. In
addition, there can be no assurance that pending patent applications will result
in issued patents or that patents issued to or licensed-in by the Company will
not be challenged or circumvented by competitors or found to be valid or
sufficiently broad to protect its technology or to provide it with any
competitive advantage. The Company also relies on trade secrets and proprietary
technology that it seeks to protect, in part, through confidentiality agreements
with employees, consultants and other parties. There can be no assurance that
these agreements will not be breached, that the Company will have adequate
remedies for any breach, that others will not independently develop
substantially equivalent proprietary information or that third parties will not
otherwise gain access to its trade secrets.
There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Historically,
litigation has been necessary to enforce and defend certain patent and trademark
rights held by the Company. Future litigation may be necessary to enforce patent
and other intellectual property rights belonging to the Company, to protect its
trade secrets or other know-how owned by it, or to defend itself against claimed
infringement of the rights of others and to determine the scope and validity of
its and others' proprietary rights. Any such litigation could result in
substantial cost to and diversion of effort by the Company. Adverse
determinations in any such litigation could subject the Company to significant
liabilities to third parties, require it to seek licenses from third parties and
prevent it from manufacturing, selling or using certain of its products, any one
or more of which could have a material adverse effect on the Company's business,
financial condition and results of operations.
Risks Associated with International Operations
Because the Company generates significant sales outside of the United
States and many of its manufacturing facilities and suppliers are located
outside of the U.S., it is subject to risks generally associated with
international operations, such as: unexpected changes in regulatory
requirements; tariffs, customs, duties and other trade barriers; difficulties in
staffing and managing foreign operations; differing labor regulations; longer
payment cycles and problems in collecting accounts receivable; risks arising
from a specific country's or region's political or economic conditions,
including the possibility of any terrorist actions; fluctuations in currency
exchange rates; foreign exchange controls which restrict or prohibit
repatriation of funds; export and import restrictions or prohibitions; delays
from customs brokers or government agencies; differing protection of
intellectual property; and potentially adverse tax consequences resulting from
operating in multiple jurisdictions with different tax laws. Any one or more of
these risks could materially adversely impact the success of the Company's
international operations. As the Company's revenues from international
operations increase, an increasing portion of its revenues and expenses are
being denominated in currencies other than U.S. dollars and, consequently,
changes in exchange rates are having a greater effect on its operations.
Inventory management is a concern in international operations due to the
potential for rapidly changing business conditions and currency exposure. There
can be no assurance that such factors will not have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition, there can be no assurance that laws or administrative practices
relating to regulation of medical devices, labor, taxation, foreign exchange or
other matters of countries within which the Company operates will not change.
Any such change could also have a material adverse effect on the Company's
business, financial condition and results of operations.
Potential Product Liability
The Company's business exposes it to potential product liability risks
which are inherent in the design, manufacture and marketing of catheters and
related medical devices. The Company's products are often used in surgical and
intensive care settings with seriously ill patients. In addition, many of the
medical devices manufactured and sold by the Company are designed to be
implanted in the human body for long periods of time and component failures,
manufacturing flaws, design defects or inadequate disclosure of product-related
risks with respect to these or other products manufactured or sold by the
Company could result in an unsafe condition or injury to, or death of, the
patient. The occurrence of such a problem could result in product liability
claims and/or a recall of, or safety alert relating to, one or more of the
Company's products. There can be no assurance that the product liability
insurance maintained by the Company will be available or sufficient to satisfy
all claims made against it or that it will be able to obtain insurance in the
future at satisfactory rates or in adequate amounts. Product liability claims,
safety alerts or product recalls in the future, regardless of their ultimate
outcome, could result in costly litigation and could have a material adverse
effect on the Company's business, reputation, its ability to attract and retain
customers for its products and its results of operations. In recent years,
physicians, hospitals and other medical service providers who are users of the
Company's products have become subject to an increasing number of lawsuits
alleging medical malpractice. Medical malpractice suits often involve large
claims and substantial defense costs. The Company is subject to the risks
associated with any such medical malpractice lawsuits.
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Risks Associated with Derivative Financial Instruments
As a partial hedge against adverse fluctuations in exchange rates, the
Company periodically enters into foreign currency exchange contracts with
certain major financial institutions. By their nature, all such contracts
involve risk, including the risk of nonperformance by counterparties.
Accordingly, losses relating to these contracts could have a material adverse
effect upon the Company's business, financial condition and results of
operations. The Company's Foreign Currency Management Policy prohibits the use
of derivative instruments for speculative purposes.
Dependence on Key Management
The Company's success depends upon the continued contributions of key
members of its senior management team. Accordingly, loss of the services of one
or more of these key members of management could have a material adverse effect
on the Company's business. None of these individuals has an employment agreement
with the Company.
ITEM 2. PROPERTIES
Arrow's corporate headquarters and principal research center are located
in a 165,000 square foot facility in Reading, Pennsylvania. This facility, which
also includes manufacturing space, is located on 126 acres.
Other major properties owned by the Company include a 165,000 square
foot manufacturing and warehousing facility in Asheboro, North Carolina, which
is currently being expanded to accommodate increased production and shipping
requirements; a 145,000 square foot manufacturing facility in Wyomissing,
Pennsylvania; a 40,000 square foot manufacturing facility in Chihuahua, Mexico,
a 24,300 square foot manufacturing facility in San Antonio, Texas acquired in
connection with the Company's acquisition of the NeoCare(R) product line in
March 2003, which the Company intends to sell in order to consolidate certain of
its manufacturing operations; a 49,000 square foot manufacturing and warehouse
facility in Mount Holly, New Jersey; and an 88,000 square foot manufacturing and
research facility in the Czech Republic. The Company has also begun construction
of an additional manufacturing site in Zdar, Czech Republic and is in the
process of acquiring an additional manufacturing site near its existing plant in
Chihuahua, Mexico as part of its recently approved multi-year capital investment
plan to increase its worldwide manufacturing capacity and rationalize its
production operations, as described elsewhere in this report.
In addition, the Company leases a 55,000 square foot manufacturing
facility in Everett, Massachusetts; a 21,000 square foot sales office and
distribution center in Hicksville, New York; a 22,500 square foot manufacturing
facility in Camargo, Mexico; a 19,000 square foot office center in Wyomissing,
PA; and a 19,300 square foot manufacturing facility in Winston Salem, North
Carolina, which the Company plans to terminate in conjunction with the
consolidation of its North Carolina - based manufacturing operations. The
Company also leases sales offices and warehouse space in Canada, France,
Germany, Japan, South Africa, the Netherlands, Spain, Italy, Slovakia and
Greece, and sales office space in Mexico and Belgium.
The Company considers all of its facilities to be in good condition and
adequate to meet the present and reasonably foreseeable needs of the Company.
The Company believes that it will be able to renew all leases that it intends to
renew on commercially reasonable terms as they become due, or, if it is unable
to renew them, that suitable replacement space would be available on
commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to certain legal actions, including product
liability matters, arising in the ordinary course of its business. The Company
is also subject to legal actions involving patent and other intellectual
property claims. Based upon information presently available to the Company, the
Company believes it has adequate legal defenses or insurance coverage for these
actions and, except as set forth under Item 1. Business - Patents, Trademarks,
Regulatory Rights and Licenses, that the ultimate outcome of these actions would
not have a material adverse effect on the Company's business, financial
condition or results of operations.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of fiscal 2004 through the solicitations of proxies or otherwise.
EXECUTIVE OFFICERS
The executive officers of Arrow and their ages and positions as of
November 1, 2004 are listed below. All executive officers are elected or
appointed annually and serve at the discretion of the Board of Directors. There
are no family relationships among the executive officers of the Company.
Name Age Current Position
---- --- ----------------
Carl G. Anderson, Jr. 59 Chairman and Chief Executive Officer
Philip B. Fleck 60 President and Chief Operating Officer
Paul L. Frankhouser 59 Executive Vice President - Global Business
Development
James T. Hatlan 57 Senior Vice President - Manufacturing
Frederick J. Hirt 56 Senior Vice President-Finance and Chief Financial
Officer
Carl W. Staples 53 Senior Vice President-Human Resources
Philip M. Croxford 44 Group Vice President - Critical Care and
Cardiac Assist
John C. Long 39 Vice President - Secretary and Treasurer
Paul Cornelison 40 Vice President-Regulatory Affairs
and Quality Assurance
Mr. Anderson has served as Chairman and Chief Executive Officer of the
Company since September 1, 2003. Mr. Anderson succeeded Marlin Miller, Jr., who
retired from the Company on August 31, 2003 after serving as its Chairman of the
Board and Chief Executive Officer since it was founded in 1975. From January
2002 to August 31, 2003, Mr. Anderson served as Vice Chairman of the Board and
General Manager of the Company's Critical Care Division with responsibility for
worldwide sales, marketing, research and development of the Company's critical
care products. Mr. Anderson has served as a director of Arrow since January 1998
and, prior to his employment by the Company, served as President and Chief
Executive Officer of ABC School Supply, Inc., a producer of materials and
equipment for public and private schools, from May 1997 to December 2001. Mr.
Anderson served as Principal with the New England Consulting Group, a general
management and marketing consulting company, from May 1996 to May 1997, as Vice
President, General Manager, Retail Consumer Products of James River Corporation,
a multinational company engaged in the development, manufacture and marketing of
paper-based consumer products ("James River"), from August 1994 to March 1996,
and as Vice President, Marketing, Consumer Brands of James River from May 1992
to August 1994, and in various capacities with Nestle Foods Corporation, the
latest as Vice President, Division General Manager, Confections, from 1984 to
May 1992. Prior thereto, Mr. Anderson served in several marketing and management
capacities with Procter & Gamble from 1972 to 1984. Mr. Anderson also serves as
a director of Carpenter Technology Corporation, a manufacturer of specialty
steel.
Mr. Fleck has served as President and Chief Operating Officer of the
Company since January 1999. Mr. Fleck recently announced his retirement from the
Company, effective December 31, 2004, after serving in management capacities
with the Company and its predecessor for more than 33 years and making a major
contribution to the Company's success. Upon his retirement, Mr. Fleck will
continue to serve the Company as a consultant. From June 1994 to January 1999,
he served as Vice President - Research and Manufacturing of the Company. From
1986 to June 1994, Mr. Fleck served as Vice President - Research and Engineering
of the Company. From 1975 to 1986, Mr. Fleck served as Engineering Manager of
the Company.
Mr. Frankhouser has served as Executive Vice President - Global Business
Development of the Company since January 2002, with responsibility for worldwide
evaluation and acquisition of new business opportunities. Mr. Frankhouser
recently announced his retirement from the Company, effective January 31, 2005,
after serving in management capacities with the Company and its predecessor for
more than 41 years and making a major contribution to the Company's success.
Upon his retirement, Mr. Frankhouser will continue to serve the Company as a
consultant. From January 1999 to January 2002, Mr. Frankhouser served as
Executive Vice President of the Company, with responsibility for worldwide sales
and marketing. He served as Vice President-Marketing of the Company from 1986
until January 1999. From 1980 to 1986, Mr. Frankhouser served as Manager of
Marketing of the Company.
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Mr. Hatlan was elected Senior Vice President - Manufacturing effective
October 27, 2004 and served as Vice President - Strategic Planning of the
Company since September 2003. Prior to joining the Company, Mr. Hatlan served at
ABC School Supply, Inc., a producer of materials and equipment for public and
private schools, in several executive positions including Chairman from 1997 to
2002, and held various senior management positions at James River Corporation,
Tambrands Inc., and Procter & Gamble from 1972 to 1996.
Mr. Hirt was elected Senior Vice President - Finance and Chief Financial
Officer effective October 27, 2004 and served as Vice President - Finance and
Chief Financial Officer of the Company since August 1998. From August 1998 until
January 2003, he also served as Treasurer of the Company. Prior to joining the
Company, from 1980 to 1998, Mr. Hirt served in various capacities with Pharmacia
& Upjohn, Inc., the latest as Vice President, Accounting and Reporting.
Mr. Staples was elected Senior Vice President, Human Resource effective
October 27, 2004 and served as Vice President, Human Resources of the Company
since September 2002. Prior to joining the Company, Mr. Staples served as Vice
President Human Resources and in various other human resources capacities with
CIBA Specialty Chemicals, a manufacturer of specialty chemicals, from 1989
through August 2002. From 1974 to 1989, Mr. Staples served in various human
resources-related positions with Sara Lee Corporation, Bausch & Lomb
Incorporated, Rockwell International, and Union Carbide Corporation.
Mr. Croxford was elected Group Vice President - Critical Care and
Cardiac Assist effective October 27, 2004 and served as Vice President and
General Manager of the Company since August 2003. Prior to joining the Company,
Mr. Croxford served as Vice President/General Manager, Wound Management Business
Unit from March 1996 to August 2003 at Johnson & Johnson Medical and Ethicon,
Inc. and as Business Unit Director and various other senior marketing sales
positions at Smith & Nephew Plc from 1989 to March 1996.
Mr. Long has served as Vice President and Treasurer of the Company since
January 2003 and was also elected Secretary effective April 15, 2004, and served
as Assistant Treasurer from 1995 to January 2003. Prior to joining the Company,
Mr. Long served as Controller for the Jaindl Companies, a group of privately
held companies involved in agribusiness and real estate development, from 1989
to 1995. From 1986 to 1989, Mr. Long was employed in the Allentown office of
Concannon, Gallagher, Miller & Co., CPA's. Mr. Long also serves as a director of
American Bank Incorporated, a regional commercial bank.
Mr. Cornelison was elected to the position of Vice President-Regulatory
Affairs and Quality Assurance effective April 14, 2004 and served as Director of
Regulatory Affairs and Quality Assurance of the Company since August 2001. Prior
to joining the Company Mr. Cornelison served as Senior Regulatory Project
Director at the Regulatory Clinical Institute, a company offering specialized
consulting services to the medical industry, from December 2000 to August 2001.
OTHER INFORMATION
QUALIFIED TRADING PLANS. The Company's President and Chief Operating
Officer, Philip B. Fleck, and two of the Company's directors and founders,
Marlin Miller, Jr. and John H. Broadbent, Jr., have informed the Company that,
in order to diversify their investment portfolios while avoiding conflicts of
interest or the appearance of any such conflict that might arise from their
ongoing service to the Company, in the first quarter of fiscal 2005 they
established written plans in accordance with SEC Rule 10b5-1 for gradually
liquidating a portion of their personal holdings of the Company's common stock.
Each of these plans provide for weekly or other periodic stock sales and do not
prohibit Mr. Fleck, Mr. Miller or Mr. Broadbent from executing additional
transactions with respect to the Company's common stock.
(13)
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock has traded publicly on The Nasdaq Stock
Market under the symbol "ARRO" since June 9, 1992, the date that its common
stock was initially offered to the public. The table below sets forth the high
and low sale prices of the Company's common stock as reported by The Nasdaq
Stock Market and the quarterly dividends per share declared by the Company
during the last eight fiscal quarters. On August 15, 2003, the Company effected
a two-for-one split of its common stock while retaining the rate of its
quarterly cash dividends. All historical share and per share amounts in the
table below have been adjusted to reflect these actions.
Price per Share
======================================
Quarter Ended High Low Dividends per Share
======================== ====================================== =========================
August 31, 2004 $32.7200 $26.6100 $0.0900
May 31, 2004 $31.2800 $26.6200 $0.0900
February 29, 2004 $29.3700 $24.6100 $0.0900
November 30, 2003 $27.1000 $22.4300 $0.0800
August 31, 2003 $25.8000 $21.4100 $0.0800
May 31, 2003 $22.3100 $20.2350 $0.0400
February 28, 2003 $21.8750 $18.6450 $0.0400
November 30, 2002 $19.3750 $15.7500 $0.0350
As of October 1, 2004, there were approximately 519 registered
shareholders of the Company's common stock.
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Board of Directors has authorized the repurchase of up to
a maximum of 4,000,000 shares under a share repurchase program announced on
March 23, 1999 (for up to 2,000,000 shares) and extended on April 6, 2000 (for
up to an additional 2,000,000 shares). As of August 31, 2004, the Company had
repurchased a total of 3,603,600 shares under this program for approximately
$57,532,444 since the program's inception in March 1999. However, no shares were
repurchased by the Company under the program (or otherwise) during fiscal 2004.
For the Fiscal Year Ended
August 31, 2004 Total Program to Date
- -------------------------------------------------- -----------------------------------------------------------------------
Total Number of Shares Purchased Maximum Number of Shares that
Total Number of Shares Average Price Paid as Part of Publicly Announced May Yet Be Purchased Under the
Purchased Per Share Program Program
- ------------------------- --------------------- ---------------------------------- --------------------------------
- - 3,603,600 396,400
(14)
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data for the years ended
August 31, 2004, 2003, 2002, 2001 and 2000 have been derived from the Company's
audited consolidated financial statements. The consolidated financial statements
of the Company as of August 31, 2004 and 2003 and for each of the three years in
the period ended August 31, 2004, together with the notes thereto and the
related report of PricewaterhouseCoopers LLP, an independent registered public
accounting firm are included in Item 8 of this report. The following data should
be read in conjunction with the Company's audited consolidated financial
statements, the notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations, which are included in Items 7 and
8 of this report.
2004 2003 2002 2001 2000
------------ ----------- ------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF INCOME DATA:
Net sales $ 433,134 $ 380,376 $ 340,759 $ 334,042 $ 325,714
Cost of goods sold 208,687 190,246 169,625 158,573 156,107
Gross profit 224,447 190,130 171,134 175,469 169,607
Operating expenses
Research, development and engineering 30,374 28,170 26,165 25,209 19,771
Selling, general, and administrative 110,192 89,354 78,406 78,499 74,921
Restructuring charge 208 - - - -
Special charges* - 8,000 8,005 - 3,320
Total operating expenses 140,774 125,524 112,576 103,708 98,012
Operating income 83,673 64,606 58,558 71,761 71,595
Other expenses (income), net 796 (2,312) 781 2,291 2,145
Income before income taxes 82,877 66,918 57,777 69,470 69,450
Provision for income taxes 26,935 21,248 18,777 22,925 23,266
------------ ----------- ------------ ------------ ------------
Net income $ 55,942 $ 45,670 $ 39,000 $ 46,545 $ 46,184
============ =========== ============ ============ ============
Basic earnings per common share $ 1.28 $ 1.05 $ 0.89 $ 1.06 $ 1.03
============ =========== ============ ============ ============
Diluted earnings per common share $ 1.26 $ 1.04 $ 0.88 $ 1.05 $ 1.03
============ =========== ============ ============ ============
Cash dividends per common share $ 0.3500 $ 0.1950 $ 0.1375 $ 0.1275 $ 0.1175
Weighted average shares used in computing
basic earnings per common share 43,559 43,399 43,826 43,991 44,901
Weighted average shares used in computing
diluted earnings per common share 44,302 43,773 44,211 44,241 45,038
All historical share and per share amounts have been adjusted to reflect
the two-for-one split of the Company's common stock effected on August 15, 2003.
(15)
2004 2003 2002 2001 2000
------------ ----------- ------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
BALANCE SHEET DATA:
Working capital $ 209,602 $ 163,914 $ 157,162 $ 110,227 $ 78,132
Total assets 549,208 493,897 426,776 418,209 385,814
Notes payable and current maturities of
long-term debt 29,056 28,731 16,432 50,722 60,481
Long-term debt, excluding current maturities - 3,735 300 600 900
Shareholders' equity 446,331 390,646 360,356 326,089 285,204
Certain prior period amounts in the table above have been reclassified
to conform to the fiscal 2004 presentation (see Item 8. Notes to Consolidated
Financial Statements - Note 1).
* See Item 8. Notes to Consolidated Financial Statements - Note 2 for a
description of the special charges recorded in fiscal 2003 and 2002. In the
first quarter of fiscal 2000, the Company recorded a non-cash pre-tax special
charge of $3,320 ($2,208 after-tax or $0.05 per basic and diluted common share)
related primarily to a write-down for the in-process research and development
acquired in connection with the Company's acquisition of Sometec, S.A. In
accordance with Financial Accounting Standard (FAS) No. 2 "Accounting for
Research and Development Costs" and Financial Accounting Standard Board (FASB)
Interpretation (FIN) No. 4 "Applicability of FAS No. 2 to Business Combinations
Accounted for by the Purchase Method", these costs were charged to expense at
the date of consummation of the acquisition.
(16)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION INCLUDES CERTAIN FORWARD-LOOKING STATEMENTS.
SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO A NUMBER OF FACTORS, INCLUDING
MATERIAL RISKS, UNCERTAINTIES AND CONTINGENCIES, WHICH COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS. FOR A
DISCUSSION OF IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS, SEE ITEM 1. BUSINESS - CERTAIN
RISKS RELATING TO ARROW AND THE COMPANY'S OTHER REPORTS FILED WITH THE SEC.
EXECUTIVE OVERVIEW
Arrow is a worldwide developer, manufacturer and marketer of a broad
range of clinically advanced, disposable catheters, heart assist devices and
related products for critical and cardiac care. The Company markets its products
to physicians and hospitals through a combination of direct selling, independent
distributors and group purchasing organizations. Within each hospital, marketing
efforts are targeted to those physicians, including critical care specialists,
cardiologists, anesthesiologists, interventional radiologists,
electrophysiologists and surgeons, most likely to use the Company's products.
The Company's largest geographical markets are the United States, Europe and
Japan.
The Company's revenues are generated from sales of its products, less
certain related charges, discounts, returns and other allowances. The Company's
costs and expenses consist of costs of goods sold; research, development and
engineering expense; selling, general and administration expense; and other
expenses (income). Costs of goods sold consist principally of costs relating to
the manufacture and distribution of the Company's products. Research,
development and engineering expense consists principally of expenses incurred
with respect to the Company's internal research, development and engineering
activities to introduce new products to market and enhancements to its existing
products, payments for third-party research and development activities, and
acquired in-process research and development costs arising from the Company's
acquisition activities. Selling, general and administrative expense consists
principally of costs associated with the Company's marketing and sales efforts
and administrative operations and commitments. Other expenses (income) consists
principally of interest expense on the Company's outstanding indebtedness,
interest income and other items, such as foreign currency exchange gains and
losses, which may impact the comparability of the Company's results of
operations between periods.
The Company's ability to grow its net income largely depends upon
generating increased sales of its products, particularly its higher margin
products, and further improving its operating efficiency. The Company's sales
growth is driven by its development and marketing of clinically advanced new
products and enhancements to its existing products to increase their
effectiveness, ease of use, safety and reliability, as well as to expand the
clinical applications for which their use is appropriate. In this regard, the
Company has strategically increased its spending on research and development in
each of fiscal 2004 and fiscal 2003 and expects to continue to increase its
research and development spending in fiscal 2005. The Company also anticipates
generating higher sales through selective acquisitions of new businesses,
products and technologies that complement its existing product lines, as it has
done from time to time in the past.
The Company is focused on improving operating margins by increasing the
efficiency of its manufacturing operations and maintaining effective
cost-containment programs. In this regard, the Company has recently initiated a
multi-year capital investment plan to increase its worldwide manufacturing
capacity and rationalize its production operations, the first phase of which
will entail development of additional manufacturing facilities in the Czech
Republic and Mexico, and is also in the process of consolidating certain of its
U.S.-based manufacturing operations. In addition, the Company has improved
operating margins through selective acquisitions of some of its distributors
and/or distribution rights in key U.S. and international markets, thereby
increasing the percentage of its sales generated by its direct sales force.
The Company faces substantial competition from a number of other
companies in the market for catheters and related medical devices and equipment,
ranging from small start-up enterprises to companies that are larger than Arrow
with greater financial and other resources. In addition, in response to concern
about the rising costs of health care, U.S. hospitals and physicians are placing
increasing emphasis on cost-effectiveness in the selection of products to
perform medical procedures. The Company believes that its comprehensive
manufacturing capability enables it to expedite the development and market
introduction of new products and to reduce manufacturing costs, thereby
permitting it to respond more effectively to competitive pricing in an
environment where its ability to increase prices is limited.
Management's discussion and analysis (MD&A) begins with an examination
of the material changes in the Company's operating results for fiscal 2004 as
compared to fiscal 2003, and its operating results for fiscal 2003 as compared
to fiscal 2002. The discussion then provides an examination of liquidity and
capital resources, focusing primarily on material changes in operating,
investing and financing activities as depicted in the Company's consolidated
statements of cash flows included in Item 8 of this report, information on the
Company's available credit facilities and a summary of its outstanding
contractual obligations. Finally, MD&A provides information on critical
accounting policies and estimates and new accounting standards.
(17)
RESULTS OF OPERATIONS
The following table presents for the three years ended August 31, 2004
Consolidated Statements of Income expressed as a percentage of net sales and the
period-to-period percentage changes in the dollar amounts of the respective line
items.
Period-to-Period
Percentage of Net Sales Percentage Change
---------------------------------- -----------------------------------
Year ended August 31, 2004 2003 2002
---------------------------------- vs vs vs
2004 2003 2002 2003 2002 2001
-------- -------- -------- --------- --------- ---------
Net sales 100.0 % 100.0 % 100.0 % 13.9 % 11.6 % 2.0 %
Gross profit 51.8 50.0 50.2 18.0 11.1 (2.5)
Operating expenses:
Research, development and
engineering 7.0 7.4 7.7 7.8 7.6 4.0
Selling, general and
administrative 25.4 23.5 23.0 23.3 14.0 0.1
Restructuring charge 0.1 - - * * *
Special charges** - 2.1 2.3 0.0 0.0 *
-------- -------- -------- --------- --------- ---------
Operating income 19.3 17.0 17.2 29.6 10.2 (18.4)
Other expenses (income), net 0.1 (0.6) 0.2 (134.4) 396.0 (65.9)
Income before income taxes 19.2 17.6 17.0 23.9 15.7 (16.8)
Provision for income taxes 6.3 5.6 5.6 26.8 13.2 (18.1)
-------- -------- -------- --------- --------- ---------
Net income 12.9 % 12.0 % 11.4 % 22.3 17.2 % (16.1) %
*Not a meaningful comparison
**See Item 8. Financial Statements and Supplementary Data for a
description of special charges
FISCAL 2004 COMPARED TO FISCAL 2003
NET SALES. Net sales increased by $52.7 million, or 13.9%, to $433.1
million in fiscal 2004 from $380.4 million in fiscal 2003 due primarily to an
increase in critical care product sales and a favorable foreign exchange impact
during fiscal 2004 as a result of the weakness of the U.S. dollar relative to
currencies of countries in which the Company operates direct sales subsidiaries.
This foreign exchange impact resulted in increased international sales for
fiscal 2004 of $10.7 million or 2.8% of total Company sales. Net sales represent
gross sales invoiced to customers, less certain related charges, discounts,
returns and other allowances. Revenue from sales is recognized at the time
products are shipped and title is passed to the customer. The following is a
summary of the Company's sales by product platform:
Sales by Product Platform
(in millions) For the years ended
August 31, 2004 August 31, 2003
--------------- ---------------
Central venous catheters * $ 222.7 $ 186.4
Specialty catheters 135.1 124.1
Stepic distributed products 12.0 13.0
------- -------
Subtotal critical care 369.8 323.5
Cardiac care 63.3 56.9
------- -------
TOTAL $ 433.1 $ 380.4
======= =======
*Includes Diatek product sales in the second, third and fourth fiscal quarters
of both years and NeoCare(R) product sales in the third and fourth fiscal
quarters of both years.
(18)
Sales of critical care products increased 14.3% to $369.8 million from
$323.5 million in fiscal 2003 due primarily to increased sales of central venous
catheters and specialty catheters. Sales of central venous catheters increased
in fiscal 2004 due primarily to a continued increase in the number of hospitals
that are purchasing the Company's procedure kits featuring its safety devices
and ARROWg+ard(R) antiseptic surface treatments, as well as increased sales of
renal access and neonatal products resulting from the Company's acquisitions of
Diatek and the NeoCare(R) product line in fiscal 2003. Sales of specialty
catheters increased in fiscal 2004 due to improved sales of arterial products,
epidural products and intravenous and extension sets. Sales of cardiac care
products increased 11.2% to $63.3 million from $56.9 million in fiscal 2003 due
primarily to increased sales of intra-aortic balloon pumps, especially in
international markets, and Super Arrow-Flex(R) products. Total Company U.S.
sales increased 12.0% to $279.9 million from $249.9 million in the prior year
principally as a result of increased sales of central venous and specialty
catheters. International sales increased by 17.4% to $153.2 million from $130.5
million in the prior year principally as a result of increased sales of central
venous catheters, specialty catheters and intra-aortic balloon pumps, and the
effect of foreign currency exchange rates, as noted above. International sales
represented 35.4% of net sales in fiscal 2004, compared to 34.3% in the prior
year.
The ARROWg+ard(R) conversion percentages, which are the number of units
sold with the ARROWg+ard(R) antiseptic surface treatments as a percentage of the
Company's total multilumen and hemodialysis unit sales, increased to 36% from
34% in the prior year for total Company sales. The ARROWg+ard(R) conversion
percentages for the U.S. market increased to 62% from 59% in the prior year.
The safety device procedure kits conversion percentages, which are the
number of units sold with the Company's procedure kits featuring its safety
devices as a percentage of the total number of units sold of the Company's
products that could potentially include safety device procedure kits, increased
to 7% in fiscal 2004 from 5% in the prior year for total Company sales. The
safety device procedure kit conversion percentages for the U.S. market in fiscal
2004 increased to 14% from 9% in the prior year.
GROSS PROFIT. Gross profit increased 18.0% to $224.4 million in fiscal
2004 from $190.1 million in fiscal 2003. As a percentage of net sales, gross
profit increased to 51.8% in fiscal 2004 compared to 50.0% in fiscal 2003. The
increase in gross margin was due primarily to (1) lower margins realized in
fiscal 2003 on the sale of inventories of products acquired as part of the
Company's purchase of the net assets of Stepic Medical, its former New York City
distributor, in September 2002; (2) higher margins resulting from increased
sales of the Company's procedure kits featuring its safety devices and
ARROWg+ard(R) antiseptic surface treatments; (3) higher than average margins
realized on the sale of renal access products associated with the Company's
acquisition of Diatek in November 2002; and (4) higher margins on products
distributed in Florida and certain southeastern states as a result of the
Company's acquisition of its former distributor, IMA, Inc., in July 2003, which
enabled the Company to conduct direct sales activity in this region. These
increases were offset in part by the Company's write-off of $3.1 million of
inventory in the third quarter of fiscal 2004 for certain LionHeart(TM)
components that became obsolete with the Company's previously announced decision
during the quarter not to proceed with the LionHeart(TM) Phase II U.S. clinical
trials using the first generation LionHeart(TM) power system and controller.
The increased emphasis on health care cost containment has resulted in
reduced growth in demand for certain of the Company's products in markets in the
U.S. where Arrow has 80% or greater market shares, and protecting that market
share has affected the Company's pricing in some instances. The Company also
continues to face pricing pressures in certain product lines in both European
and Japanese markets as governments strive to curtail increases in health care
costs. The Company intends to continue its efforts to mitigate the effect of
these pricing pressures through continued emphasis on cost reduction.
RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and
engineering expenses increased by 7.8% to $30.4 million in fiscal 2004 from
$28.2 million in the prior year. As a percentage of net sales, these expenses
decreased to 7.0% in fiscal 2004 compared to 7.4% in fiscal 2003. The increase
in research, development and engineering expenses was primarily due to higher
spending in fiscal 2004 on the Arrow LionHeart(TM) as a result of incremental
spending associated with the development of the LionHeart's second generation
electronics and increased research and engineering expenditures in fiscal 2004
for the Company's critical care product line. There increases were offset in
part by the fiscal 2003 write-off of $3.6 million related to development costs
for the second generation of external batteries used in the Arrow LionHeart(TM)
and decreased research and development spending on the CorAide(TM) continuous
flow ventricular assist system, the Company's joint research and development
program with The Cleveland Clinic Foundation. The Company currently anticipates
that research, development and engineering expenses related to the development
of second generation LionHeart(TM) components will be approximately $0.9 million
($0.6 million after tax, or $0.01 diluted earnings per share) in the first
quarter of fiscal 2005.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased by 23.3% to $110.2 million from $89.4 million in the previous
year, and were 25.3% of net sales in fiscal 2004 compared to 23.5% in fiscal
2003. This increase was due primarily to several factors: (1) increased expenses
of $3.4 million incurred in connection with the Company's acquisitions in fiscal
2003 of Diatek, the NeoCare(R) product line and IMA, Inc., its former Florida
distributor; (2) a $3.0 million increase in expenses related to the Company's
international operations as a result of the weakness of the U.S. dollar relative
to currencies of countries in which the Company operates direct sales
subsidiaries; (3) increased expenses of $1.7 million for the write-off of the
costs related to a previously planned building expansion of the Company's
headquarters in Reading, PA; (4) increased expenses of $1.3 million relating to
an increase in the accrual for the Company's income growth bonus plan for its
executive officers and key management employees; (5) an increase in expenses of
$1.1 million related to an increase in the vacation accrual due in part to an
incremental increase in the Company's vacation benefit for its employees
resulting from a modification to its vacation policy; and (6) an increase in
expenses of $0.9 million related to an increase in the accrual for the Company's
sales commission plan due to better sales performance against Company objectives
during the fourth quarter of fiscal 2004. These increases were offset in part by
a decrease in legal costs of $1.8 million associated with the Company's defense
of patent litigation relating to certain of its hemodialysis catheter products,
which, as previously reported, was settled in December 2003.
(19)
Net periodic pension cost is recorded in operating expenses in amounts
determined by the Company's actuaries and is based on management's estimates of
expected interest rates, expected rates of return on plan assets and expected
compensation increases. These estimates reflect management's best judgments in
the current circumstances. Actual results may differ from the estimates.
Interest rate assumptions are based on market rates at the beginning of the
Company's fiscal year. Expected rates of return on plan assets are based in part
on the Company's historical asset portfolio performance over the prior ten year
period and also on the estimated rate of return on plan assets in the future.
The Company's rate of compensation increase assumption is based on its
historical compensation percentage increases as well as its expected rate
increases in future periods.
SPECIAL AND OTHER CHARGES. The Company recorded a charge of $0.6 million
($0.4 million after tax, or $0.01 diluted earnings per share) in the third
quarter of fiscal 2004 for a write-off of manufacturing equipment relating to
the LionHeart(TM) and also recorded $0.2 million ($0.1 million after tax, or
less than $0.01 diluted earnings per share) of restructuring expenses related to
accrued severance payments associated with its consolidation of operations at
its Winston-Salem, North Carolina and San Antonio, Texas facilities into other
existing manufacturing facilities in the fourth quarter of fiscal year 2004.
The Company also incurred a special charge in the fourth quarter of
fiscal 2003 totaling $8.0 million ($5.4 million after tax, or $0.12 diluted
earnings per share) to establish a reserve for a proposed settlement in two
related patent infringement lawsuits, which, as discussed in Item 1 of this
report, relate to certain of the Company's hemodialysis catheter products.
OPERATING INCOME. Principally due to the above factors, operating income
increased 29.6% to $83.7 million in fiscal 2004 from $64.6 million in fiscal
2003.
OTHER EXPENSES (INCOME), NET. Other expenses (income), net, increased to
$0.8 million of expense in fiscal 2004 from $2.3 million of income in fiscal
2003, principally due to foreign currency transaction gains in the prior year
resulting from the translation of intercompany receivables denominated in the
functional currencies of the Company's international sales subsidiaries. In the
third quarter of fiscal 2003, the Company recapitalized its subsidiary in the
Czech Republic. This refinancing resulted in a temporarily unhedged foreign
currency position leading to a foreign currency transaction gain of $1.0
million. This foreign currency position was hedged later in the third quarter of
fiscal 2003. In addition, in fiscal 2003 the Company realized interest income
accruing on refunds related to amended federal tax returns, which claimed
additional research and development credits and depreciation of equipment.
Aggregate foreign exchange losses were $0.6 million and $0.1 million in fiscal
2004 and 2003, respectively. Foreign currency contracts resulted in $0.7 million
of losses in fiscal 2004 and $0.7 million of gains in fiscal 2003.
INCOME BEFORE INCOME TAXES. As a result of the factors discussed above,
income before income taxes increased in fiscal 2004 by 23.9% to $82.9 million
from $66.9 million in fiscal 2003. The Company's effective income tax rate
increased to 32.5% from 31.8% in fiscal 2003, primarily due to a favorable tax
settlement with the IRS in the fourth quarter of fiscal 2003 related to the
Company's research and development tax credits.
JAPANESE AND U.S. TAX MATTERS. In addition, the Company made a payment
in March 2004 of $10.0 million to settle a tax assessment related to an ongoing
Japanese government tax audit of the Company's transfer pricing with its
Japanese subsidiary. The Company intends to utilize competent authority
proceedings with the Internal Revenue Service in the U.S. to recover a majority
of this required Japanese tax payment. The Company believes that the amount
ultimately recovered through these proceedings has been fully provided for as of
August 31, 2004 and, therefore, will not adversely affect its future results of
operations.
On October 22, 2004 the President signed The American Jobs Creation Act
of 2004 (the Act). The Act included some of the most significant changes to
corporate taxation since 1996 and, among other things, eliminates the
Extraterritorial Income Regime (ETI) over a three year phase out period
beginning in 2005. However, the phase out will still allow the Company to obtain
a significant percentage of the ETI benefit for fiscal 2005 and 2006 with a
somewhat smaller benefit for fiscal 2007. The ETI will be totally phased out by
the Company's 2008 fiscal year end. Additionally, the Act provides for a
deduction for US domestic manufacturers beginning in the Company's fiscal year
2006. This new deduction begins at 3% of US domestic manufacturer's income for
the Company's fiscal years 2006 and 2007, increasing to 6% for the Company's
fiscal years 2008-2010 and achieves it's maximum rate of 9% for the Company's
fiscal years 2010 and beyond. While an exact calculation of the effects of these
changes has not been undertaken, management believes that the phased out repeal
of the ETI benefit during 2005 and 2006 and the phase in of the new
manufacturing deduction benefit from 2006-2011 should not have a material
adverse effect on the Company's effective tax rate, although it believes that
the net effect will be less of an income tax benefit to the Company for 2005 and
beyond.
NET INCOME. Net income in fiscal 2004 increased 22.3% to $55.9 million
from $45.7 million in fiscal 2003. As a percentage of net sales, net income
represented 12.9% in fiscal 2004 compared to 12.0% in fiscal 2003.
PER SHARE AND HISTORICAL SHARE INFORMATION. During the fourth quarter of
fiscal 2003, the Company approved the issuance, effective on August 15, 2003, of
an additional share of common stock for each share issued and outstanding on the
record date of August 1, 2003 while retaining the rate of its quarterly
dividend, which resulted in the doubling of its quarterly dividend to $0.08 per
share. All historical share and per share information in this report has been
adjusted to reflect these corporate actions.
(20)
Basic earnings per common share were $1.28 in fiscal 2004, up 21.9%, or
$0.23 per share, from $1.05 in fiscal 2003. Diluted earnings per common share
were $1.26 in fiscal 2004, up 21.2%, or $0.22 per share, from $1.04 in fiscal
2003. Weighted average shares of common stock outstanding used in computing
basic earnings per common share increased to 43,559,410 in fiscal 2004 from
43,399,363 in fiscal 2003 primarily as a result of an increase in stock option
exercises due to a higher market price of the Company's stock relative to
average outstanding option exercise prices during the fiscal year offset in part
by the Company's repurchases of shares during fiscal 2003 under its share
repurchase program, which resulted in a full impact on the weighted average
share calculation in fiscal 2004 compared to a partial impact in the prior year.
Weighted average shares of common stock outstanding used in computing diluted
earnings per common share increased to 44,301,960 in fiscal 2004 from 43,773,253
in fiscal 2003 primarily as a result of an increase in potentially dilutive
shares resulting from an increased share price and an increase in stock option
exercises for the reasons described above.
FISCAL 2003 COMPARED TO FISCAL 2002
NET SALES. Net sales increased by $39.6 million, or 11.6%, to $380.4
million in fiscal 2003 from $340.8 million in fiscal 2002 due primarily to an
increase in critical care product sales, including sales of products distributed
by the Company's new Stepic subsidiary formed in fiscal 2003 following the
Company's acquisition of the net assets of its former New York City distributor,
and a favorable foreign exchange impact during fiscal 2003 as a result of the
weakness of the U.S. dollar relative to currencies of countries in which the
Company operates direct sales subsidiaries, as further discussed below. The
following is a summary of the Company's sales by product platform:
Sales by Product Platform
(in millions) For the years ended
August 31, 2004 August 31, 2003
--------------- ---------------
Central venous catheters* $ 186.4 $ 164.1
Specialty catheters 124.1 115.0
Stepic distributed products 13.0 -
------- -------
Subtotal 323.5 279.1
Drug infusion pumps - 4.9
------- -------
Subtotal critical care 323.5 284.0
Cardiac care 56.9 56.8
------- -------
TOTAL $ 380.4 $ 340.8
======= =======
*Includes Diatek and NeoCare(R) product sales of $6.4 million in fiscal
2003.
Sales of critical care products increased 13.9% to $323.5 million from
$284.0 million in fiscal 2002, due primarily to increased sales of central
venous and specialty catheters offset by decreased sales of drug infusion
products as a result of the Company's divestiture of its implantable drug
infusion pump business in fiscal 2002, as discussed below. Sales of central
venous catheters increased in fiscal 2003 due primarily to an increase in the
number of hospitals that began purchasing the Company's recently introduced
procedure kits featuring its safety devices as well as increased sales of renal
access and neonatal products resulting from the Company's acquisitions of Diatek
and the NeoCare(R) product line, respectively. Sales of specialty catheters
increased in fiscal 2003 due to improved sales of epidural products, intravenous
and extension sets, percutaneous thrombolytic devices, and rapid infusion
catheters. Sales of cardiac care products increased to $56.9 million from $56.8
million in fiscal 2002, due primarily to increased sales of intra-aortic balloon
pump and diagnostic products offset by decreased sales to another medical device
manufacturer. International sales increased by 11.1% to $130.5 million from
$117.5 million in the prior year and represented 34.3% of net sales in fiscal
2003, compared to 34.5% in the prior year. As a result of the weakness of the
U.S. dollar relative to currencies of countries in which the Company operates
direct sales subsidiaries, net sales for fiscal 2003 increased $8.1 million.
In April 2002, the Company completed the sale of substantially all of
the assets of its implantable drug infusion pump business pursuant to an asset
purchase agreement dated as of March 1, 2002. As a result of this divestiture,
the Company reported no sales of implantable drug infusion pump products in
fiscal 2003 compared to $4.9 million of such sales in fiscal 2002.
GROSS PROFIT. Gross profit increased 11.1% to $190.1 million in fiscal
2003 from $171.1 million in fiscal 2002. As a percentage of net sales, gross
profit decreased to 50.0% in fiscal 2003 compared to 50.2% in fiscal 2002. The
decline in gross margin was due primarily to (1) lower margins realized on the
sale of inventories of products purchased as part of the Company's acquisition
of the net assets of Stepic Medical, its former New York City distributor, in
September 2002, and (2) the ongoing distribution by the Company's Stepic
subsidiary of lower margin products of other medical device manufacturers,
offset in part by (3) a $1.8 million charge against sales in fiscal 2002 related
to the Company's acquisition of Stepic Medical to reflect an increase in the
reserve for dealer rebates as a result of obtaining additional information
regarding Stepic's rebates, (4) higher than average margins realized on the sale
of renal access products associated with the Company's acquisition of Diatek in
November 2002, and (5) higher than average margins realized on the sale of
NeoCare(R) products associated with the acquisition of this business in March
2003.
(21)
The increased emphasis on health care cost containment has resulted in
reduced growth in demand for certain of the Company's products in markets in the
U.S. where Arrow has 80% or greater market shares, and protecting that market
share has affected the Company's pricing in some instances. The Company also
continues to face pricing pressures in certain product lines in both European
and Japanese markets as governments strive to curtail increases in health care
costs. The Company intends to continue its efforts to mitigate the effect of
these pricing pressures through continued emphasis on cost reduction.
RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and
engineering expenses in fiscal 2003 increased by 7.6% to $28.2 million from
$26.2 million in fiscal 2002. As a percentage of net sales, these expenses
decreased to 7.4% in fiscal 2003, compared to 7.7% in fiscal 2002. The increase
in research, development and engineering expenses was primarily due to a write
off of $3.6 million, or $0.05 diluted earnings per share, related to development
costs for the second generation of external batteries used in the Arrow
LionHeart(TM), the Company's LVAS, and increased research and development
spending on the CorAide(TM) continuous flow ventricular assist system, the
Company's joint research and development program with The Cleveland Clinic
Foundation. Offsetting these increases was lower research and development
spending relating to other aspects of the Arrow LionHeart(TM) program and lower
development expenditures for the Company's implantable drug infusion pump
product line as a result of the Company's divestiture of this business in April
2002.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by 14.0% to $89.4 million from $78.4 million
in the previous year, and were 23.5% of net sales in fiscal 2004 compared to
23.0% in fiscal 2000. These increases were due primarily to several factors: (1)
increased legal costs of $1.9 million associated with the Company's defense of
patent litigation relating to certain of its hemodialysis catheter products; (2)
increased expenses of $0.8 million relating to the strengthening of the
Company's international marketing; (3) selling, general and administrative
expenses of $6.5 million incurred in connection with the Company's acquisitions
of Stepic Medical, Diatek, the NeoCare(R) product line and IMA, as further
discussed below under "Liquidity and Capital Resources"; and (4) an increase in
selling, general and administrative expenses of $2.5 million as a result of the
weakness of the U.S. dollar relative to currencies of countries in which the
Company operates direct sales subsidiaries. These increases were offset in part
by a decrease in expenses of $3.5 million resulting from the divestiture of the
Company's implantable drug infusion pump business in April 2002. The Company
expects to incur additional legal costs in the first quarter of fiscal 2004 in
connection with the patent litigation relating to its hemodialysis catheter
products.
Net periodic pension cost is recorded in operating expenses in amounts
determined by the Company's actuaries and is based on management's estimates of
expected interest rates, expected rates of return on plan assets and expected
compensation increases. These estimates reflect management's best judgments in
the current circumstances. Actual results may differ from the estimates.
Interest rate assumptions are based on market rates at the beginning of the
Company's fiscal year. Expected rates of return on plan assets are based in part
on the Company's historical asset portfolio performance over the prior ten year
period and also the estimated rate of return on plan assets in the future. The
Company's rate of compensation increase assumption is based on its historical
compensation percentage increases as well as its expected rate increases in
future periods.
SPECIAL CHARGES. The Company incurred a special charge in its fourth
quarter of fiscal year 2003 totaling $8.0 million ($5.4 million after tax, or
$0.12 diluted earnings per share.) This special charge was recorded to establish
a reserve for a proposed settlement in two related patent infringement lawsuits,
which, as discussed above relate to certain of the Company's hemodialysis
catheter products.
OPERATING INCOME. Principally due to the above factors, operating income
increased 10.2% to $64.6 million in fiscal 2003 from $58.6 million in fiscal
2002.
OTHER EXPENSES (INCOME), NET. Other expenses (income), net, increased to
$2.3 million of income in fiscal 2003 from $0.8 million of expense in fiscal
2002, principally due to the two factors discussed below. Other expenses
(income) net, consists principally of interest expense and foreign exchange
gains and losses associated with the Company's direct sales subsidiaries. The
Company had foreign currency transaction gains resulting from the translation of
intercompany receivables denominated in the functional currencies of its
international sales subsidiaries. In the third quarter of fiscal 2003, the
Company recapitalized its subsidiary in the Czech Republic. This refinancing
resulted in a temporarily unhedged foreign currency position leading to a
foreign currency transaction gain of $1.0 million. This foreign currency
position was subsequently hedged in the third fiscal quarter. In addition, the
Company realized interest income accruing on refunds related to amended federal
tax returns, which claimed additional research and development credits and
depreciation of equipment. Aggregate foreign exchange losses were $0.1 million
and $0.2 million in fiscal 2003 and 2002, respectively. Gains relating to
foreign currency contracts were $0.7 million in fiscal 2003 and $0.1 million in
fiscal 2002.
INCOME BEFORE INCOME TAXES. As a result of the factors discussed above,
income before income taxes increased in fiscal 2003 by 15.7% to $66.9 million
from $57.8 million in fiscal 2002. The Company's effective income tax rate
decreased to 31.8% from 32.5% in fiscal 2002, primarily due to a favorable tax
settlement with the IRS in the fourth quarter of fiscal 2004 related to the
Company's research and development tax credits.
NET INCOME. Net income in fiscal 2003 increased 17.2% to $45.7 million
from $39.0 million in fiscal 2002. As a percentage of net sales, net income
represented 12.0% in fiscal 2003 compared to 11.4% in fiscal 2002.
(22)
PER SHARE AND HISTORICAL SHARE INFORMATION. During the fourth quarter of
fiscal 2003, the Company approved the issuance, effective on August 15, 2003, of
an additional share of common stock for each share issued and outstanding on the
record date of August 1, 2003 while retaining the rate of its quarterly
dividend, which resulted in the doubling of its quarterly dividend to $0.08 per
share. All historical share and per share information has been adjusted to
reflect these corporate actions.
Basic earnings per common share were $1.05 in fiscal 2003, up 18.0%, or
$0.16 per share, from $0.89 in fiscal 2002. Diluted earnings per common share
were $1.04 in fiscal 2003, up 18.2%, or $0.16 per share, from $0.88 in fiscal
2002. Weighted average shares of common stock outstanding used in computing
basic earnings per common share decreased to 43,399,363 in fiscal 2003 from
43,825,856 in fiscal 2002. Weighted average shares of common stock outstanding
used in computing diluted earnings per common share decreased to 43,773,253 in
fiscal 2003 from 44,211,082 in fiscal 2002. These decreases were primarily a
result of the Company's share repurchase program, which remains in effect.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. Arrow's primary source of funds continues to be
cash generated from operations, as shown in the Company's consolidated statement
of cash flows included in Item 8 of this report. For fiscal 2004, net cash
provided by operations was $92.3 million, an increase of $13.6 million, or 17.3%
from the prior year, due primarily to decreases in prepaid pension costs,
prepaid expense and other, and accounts receivable, offset in part by increases
in inventories and the net deferred tax asset.
Prepaid pension costs decreased $2.9 million in fiscal 2004 compared to
a $13.7 million increase in fiscal 2003, primarily as a result of payments made
in fiscal 2003 required to fund certain of the Company's pension plans.
Prepaid expenses and other decreased $7.6 million in fiscal 2004
compared to a $6.7 million increase in fiscal 2003 due primarily to the
Company's receipt in fiscal 2004 of $8.0 million (which was recorded as a
prepaid expense in the fourth quarter of fiscal 2003) for an income tax refund
related to the settlement of an Internal Revenue Service audit pertaining
primarily to depreciation and tax credits related to research and development
costs.
Accounts receivable increased $1.5 million in fiscal 2004 compared to a
$7.5 million increase in fiscal 2003. The fiscal 2003 increase was due primarily
to an increase in accounts receivable attributable to the Company's fiscal 2003
acquisition of Stepic Medical. Accounts receivable, measured in days sales
outstanding during the period, decreased to 71 days at August 31, 2004 from 79
days at August 31, 2003 due primarily to increased collection efforts by the
Company and an increase in the Company's provision for bad debts related to a
specific identification of potentially uncollectible accounts, which includes
accounts with its customers in Greece, as more fully explained below.
The Company as of August 31, 2004 had an accounts receivable balance
from its Greek customers of $5.5 million, of which approximately 90% is related
to Greek government-backed hospital customers. The days sales outstanding is
currently 558 days, which is significantly higher than that of the Company's
overall August 31, 2004 average customer days sales outstanding of 71 days.
However, as previously reported, according to the Hellenic Association of
Scientific and Medical Equipment Suppliers, the average days sales outstanding
for medical equipment supply companies in the Greek market is approximately 420
days. The Company's payment terms in this market are generally 45 days. The
Company believes that, in its efforts to fund the recently completed Summer
Olympic Games in Athens, the government of Greece has been delaying payments due
to its government-backed hospitals, which has in turn led to the Company's
increase in its days sales outstanding for its Greek customers. The Greek
government has announced a plan to resume its payments on its trade debt, which
should allow its hospitals to repay their outstanding balances to their vendors.
The government of Greece has initiated similar plans in the past to reduce
delinquent trade debt, which have resulted in the Company's material realization
on its outstanding receivables following the implementation of those plans. As a
result, the Company currently believes that this situation will be resolved and
that ultimate collectibility of these receivables, net of discounts, is not a
significant risk. However, because the Company's assessment is based in part on
political factors beyond its control, the Company cannot assure that these
receivables will be collected or when they will be collected, and will continue
to evaluate their collectibility and establish reserves when and to the extent
necessary. As a result of its most recent evaluation, the Company has recorded
expenses of $0.3 million in the fourth quarter of fiscal 2004 to reserve for
both specifically identified potentially uncollectible private Greek customer
balances and an estimated amount for the Greek government's discount on the
Company's outstanding government-backed hospital customer balance. The Company
currently evaluates all of its trade receivables on a regular basis, including
those with its Greek customers, to ensure that each receivable is recorded at
net realizable value.
Inventories increased $5.6 million in fiscal 2004 compared to a $4.5
million increase in fiscal 2003. The increase in fiscal 2004 is primarily due to
additional production and related manufacturing costs necessary to support the
Company's higher rate of sales growth. This increase was offset in part by a
decrease in the Company's inventory of $3.1 million related to its write-off in
fiscal 2004 of certain LionHeart(TM) components that became obsolete with its
decision on April 15, 2004 not to proceed with U.S. clinical trials using the
first generation LionHeart(TM) power system and controller. The increase in
fiscal 2003 was primarily attributable to inventory acquired in connection with
the Company's business acquisitions completed in fiscal 2003, as further
discussed below.
(23)
The net deferred income tax asset increased $1.5 million in fiscal 2004
compared to a $10.7 million decrease in fiscal 2003. The fiscal 2003 decrease
was due primarily to greater than anticipated tax deductions for fiscal 2002
relating to depreciation, pension expense and certain special charges.
Accrued compensation increased $3.5 million in fiscal 2004 due primarily
to the achievement and accrual in fiscal 2004 of certain senior management
bonuses at higher levels than in fiscal 2003, an increase in the Company's sales
commission accrual due to better sales performance against Company objectives in
fiscal 2004 as compared to fiscal 2003, and an increase in the vacation accrual
in fiscal 2004 due in part to an incremental increase in the Company's vacation
benefits for its employees resulting from a modification to its vacation policy.
Accrued liabilities decreased $5.1 million in fiscal 2004 compared to a
$9.5 million increase in fiscal 2003 due primarily, as previously reported, to
the Company's $8.0 million payment in January 2004 in settlement of two related
patent infringement lawsuits pertaining to certain of its hemodialysis catheter
products. This amount was previously reserved in the fourth quarter of fiscal
2003.
INVESTING ACTIVITIES. Net cash used in the Company's investing
activities decreased to $31.6 million in fiscal 2004 from $56.0 million in
fiscal 2003 due primarily to purchase price payments in connection with the
Company's business acquisitions completed in fiscal 2003, as further discussed
below, offset in part by higher capital expenditures in fiscal 2004 for certain
computer software and hardware required to upgrade the Company's information
infrastructure as well as costs incurred in fiscal 2004 to expand the Company's
finished goods warehouse and distribution center in Asheboro, North Carolina.
As part of the Company's 1998 purchase of assets of the cardiac assist
division of C.R. Bard, Inc., the Company also agreed to acquire specified assets
and assume specified liabilities of the Belmont Instruments Corporation for $7.3
million based on the achievement of certain milestones. The Company paid $2.3
million in fiscal 2000, $3.5 million in fiscal 2001 and $1.0 million in fiscal
2002 for achievement of milestones during those periods. During fiscal 2003, the
Company paid $0.5 million to Belmont for achievement of the final two
milestones, representing the seventh and eighth quarterly installments of
$250,000 payable by the Company (which payments commenced in April 2001). With
these two payments, the Company has completed its payment obligations to Belmont
pursuant to the asset purchase agreement and, as of August 31, 2004, no longer
owed any amounts to Belmont. The acquisition was accounted for using the
purchase method of accounting. The excess of the purchase price over the
estimated fair value of the net assets acquired was approximately $7.1 million.
The results of operations of this business are included in the Company's
consolidated financial statements from the date of acquisition.
On September 3, 2002, the Company purchased the net assets of its former
New York City distributor, Stepic Medical, from Horizon Medical Products for
$12.6 million, which includes the relief from $5.5 million of accounts
receivable that had been due from this distributor. As of August 31, 2004,
pursuant to the asset purchase agreement, the Company has paid in cash the
entire $12.6 million purchase price for this acquisition. Stepic Medical had
been the Company's distributor in the greater New York City area, eastern New
York State, and parts of Connecticut and New Jersey since 1977.
The excess of the purchase price over the estimated fair value of the
net assets acquired was approximately $0.1 million. Intangible assets acquired
of $3.5 million are being amortized over a period of five years. The results of
operations of this business are included in the Company's consolidated financial
statements from the date of acquisition. The purchase price for this acquisition
was allocated as follows:
(in millions)
Accounts receivable $ 10.1
Inventories 6.8
Other current assets -
Property, plant and equipment 0.1
Goodwill and intangible assets 3.5
Current liabilities (7.9)
----------
Total purchase price $ 12.6
==========
On November 25, 2002, the Company purchased specified assets and assumed
specified liabilities of Diatek, Inc., a company that had developed,
manufactured and marketed chronic hemodialysis catheters, for approximately
$10.9 million. As of August 31, 2004, pursuant to the asset purchase agreement,
the Company had paid $8.9 million in cash and recorded a liability classified as
debt of $2.0 million. As of August 31, 2004, this liability had been reduced by
$0.9 million for legal costs paid by the Company, which are obligated to be
reimbursed by the former owners of Diatek, Inc. Pursuant to the asset purchase
agreement relating to this transaction, the Company is also required to make
royalty payments to Diatek's former owners based on the achievement of specified
annual sales levels of certain hemodialysis product lines. The Company is
accruing for any such royalty expenses as they are incurred. The Company intends
to exercise its right of set off under the asset purchase agreement with respect
to this obligation, enabling it to defer any such royalty payments until the
complete resolution of the Company's patent infringement lawsuit as described in
Note 18 of the notes to consolidated financial statements included in Item 8 of
this report. As a result, the Company has not made any such royalty payments to
date. The purchase price for this acquisition did not exceed the estimated fair
value of the net assets acquired and, therefore, no goodwill has been recorded
by the Company in connection therewith. Intangible assets acquired of $12.2
million, consisting primarily of intellectual property rights, are being
amortized over a period of 20 years based on the legal life of the underlying
acquired technology. An independent valuation firm was used to determine a fair
market value of the intangible assets acquired.
(24)
The results of operations of this business are included in the Company's
consolidated financial statements from the date of acquisition. The purchase
price for this acquisition was allocated as follows:
(in millions)
Accounts receivable $ 0.2
Inventories 0.4
Property, plant and equipment 0.2
Intangible assets 12.2
Current liabilities (2.1)
----------
Total purchase price $ 10.9
==========
On March 18, 2003, the Company purchased substantially all of the assets
of Klein Baker Medical, Inc., a company doing business as NeoCare(R) in San
Antonio, Texas, for approximately $16.5 million. NeoCare(R) develops,
manufactures and markets specialty catheters and related procedure kits to
neonatal intensive care units. As of August 31, 2004, pursuant to the asset
purchase agreement, the Company had paid $14.5 million in cash and recorded a
liability classified as debt of $2.0 million. As of August 31, 2004, this
liability had been reduced by $0.1 million for insurance premiums paid by the
Company, which are obligated to be reimbursed by the former owners of Klein
Baker Medical, Inc. The excess of the purchase price over the estimated fair
value of the net assets acquired of $3.8 million was recorded as goodwill and is
evaluated for impairment on a periodic basis in accordance with SFAS No. 142.
Intangible assets acquired of $8.5 million are being amortized over a period of
25 years based on the anticipated period in which cash flows are expected. An
independent valuation firm was used to determine a fair market value of the
inventory and intangible assets acquired. The results of operations of this
business are included in the Company's consolidated financial statements from
the date of acquisition. The purchase price for this acquisition was allocated
as follows:
(in millions)
Accounts receivable $ 0.6
Inventories 2.0
Property, plant and equipment 1.7
Goodwill and intangible assets 12.3
Current liabilities (0.1)
-----------
Total purchase price $ 16.5
===========
On July 1, 2003, the Company purchased certain assets of its former
Florida-based distributor, IMA, Inc., for $2.2 million, which includes the
relief from $0.6 million of accounts receivable that had been due from this
distributor. As of August 31, 2004, pursuant to the asset purchase agreement,
the Company had paid in cash the entire $2.2 million for this acquisition. As a
result of this transaction, the Company is conducting direct sales activity in
the territory formerly covered by IMA, Inc. The purchase price for this
acquisition did not exceed the estimated fair value of the net assets acquired
and, therefore, no goodwill has been recorded by the Company in connection
therewith. Intangible assets acquired of $1.7 million are being amortized over a
period of five years. The results of operations of this business are included in
the Company's consolidated financial statements from the date of acquisition.
The purchase price for this acquisition was allocated as follows:
(in millions)
Accounts receivable $ 0.3
Inventories 0.8
Intangible assets 1.7
Current liabilities (0.6)
---------
Total purchase price $ 2.2
=========
In September 2004, the Company purchased certain assets of one of its
distributors in Italy, AB Medica S.p.A (ABM), for a total purchase price of up
to approximately $8.0 million to be completed in the first quarter of fiscal
2005 with various installments thereafter on account of ongoing tender contract
sales. ABM had been one of the Company's distributors in Italy since 1982. The
agreement includes the purchase of distributorship rights, customer lists, as
well as the inventory and specified tender contracts associated with the sales
of ABM of the Company's products. As a result of this transaction, the Company
is currently selling direct in Italy through its subsidiary, Arrow Italy S.p.A.
On October 27, 2004, the Company's Board of Directors approved a
voluntary early retirement program for all of the Company's salaried exempt and
non-exempt employees in its three locations in the Reading, Pennsylvania area
who attain age 57 or older and have at least five years of service with the
Company as of January 31, 2005. The program provides that each such eligible
employee who makes an election to retire from the Company on or between November
10, 2004 and January 31, 2005 will (1) receive payments equal to two weeks pay
for each year of his or her service with the Company and a lump sum payment of
$20,000, (2) be treated as if such employee retired under the salaried pension
plan at his or her normal retirement date without any additional years of
service being credited but without any reduction for early commencement of
benefits, and (3) have their stock options issued under the Company's stock
incentive plans, which are unvested as of the effective date of his or her
retirement, accelerated so as to vest and become fully exercisable as of such
date. The Company presently anticipates that the cash cost of this program will
be approximately $3.6 million, assuming full participation in the program, which
will be included in restructuring charges over the next two fiscal quarters as
employee elections under this program are received and the related costs are
incurred.
(25)
As previously announced, the Company's Board of Directors has authorized
the initiation of a multi-year capital investment plan to increase its worldwide
manufacturing capacity and rationalize its production operations. The first
phase of this effort will include additional manufacturing facilities in Czech
Republic and in Chihuahua, Mexico, which is expected to commence in fiscal 2005.
Based on preliminary estimates received from its contractors, the Company
currently anticipates the total cost of this construction to be between $20.0
million and $27.0 million over a three-year period. In addition, the Company
also anticipates spending between $10.0 million and $15.0 million over the next
three years for equipment related to this expansion of its manufacturing
capacity. The Company anticipates spending on capital expenditures to be between
$40 and $50 million in fiscal 2005.
As part of its plans to rationalize its operations in the United States,
in August 2004, the Company initiated the consolidation of its operations at its
Winston-Salem, North Carolina and San Antonio, Texas facilities into other
existing manufacturing facilities. The transitional work on the consolidation
has begun and is expected to continue into the third quarter of fiscal 2005. In
connection with this restructuring, the Company has accrued severance payments
of $0.2 million in the fourth quarter of fiscal 2004 in accordance with
Statement of Financial Accounting Standard No. 112, representing total actual
restructuring costs incurred through August 31, 2004. Severance payments relate
to approximately 53 employees primarily in manufacturing at both facilities
which are expected to be paid in fiscal 2005. All other restructuring costs,
estimated to be approximately $0.5 million, are expected to be paid in fiscal
2005 and fiscal 2006.
As part of its plans to rationalize its production operations in Europe,
in November 2004, the Company determined to move its European Distribution
Center, currently situated in Weesp, Netherlands, to a more centralized European
location in the Limberg region of Belgium, in order to have better access to
existing carrier transportation networks and allow for more cost-competitive
expansion of its European operations in the future. The Company anticipates that
this re-location will be completed in the second quarter of fiscal 2005 and will
cost up to approximately $2.0 million.
FINANCING ACTIVITIES. Financing activities used $14.4 million of net
cash in fiscal 2004, compared to $9.4 million in fiscal 2003, primarily as a
result of a decrease in the Company's need for borrowings under its U.S.
revolving credit facility and an increase in dividend payments resulting from
the Company's doubling of its quarterly dividend in connection with its
two-for-one stock split effective in the fourth quarter of fiscal 2003. These
amounts were offset in part by the Company's not using cash during fiscal 2004
to purchase shares of its common stock in the open market in connection with its
share repurchase program as it did during fiscal 2003 and an increase in
proceeds from stock option exercises due to a higher stock price relative to the
average outstanding option exercise prices during fiscal 2004. As disclosed in
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Securities, the Company's Board of Directors has authorized
the repurchase of up to a maximum of 4,000,000 shares under the share repurchase
program. As of August 31, 2004, the Company had repurchased a total of 3,603,600
shares under this program for approximately $57.5 million since the program's
inception in March 1999. However, no shares were repurchased by the Company
under the program (or otherwise) during fiscal 2004.
In addition, the Company made a payment in March 2004 of $10.0 million
to settle a tax assessment related to an ongoing Japanese government tax audit
of the Company's transfer pricing with its Japanese subsidiary. The Company
expects to utilize competent authority proceedings with the Internal Revenue
Service in the U.S. to recover a majority of this required Japanese tax payment.
The Company believes that any amount not ultimately recovered through these
proceedings has been fully provided for as of August 31, 2004, and, therefore,
will not adversely affect its future results of operations.
CREDIT FACILITIES. To provide additional liquidity and flexibility in
funding its operations, the Company from time to time also borrows amounts under
credit facilities and other external sources of financing. At both August 31,
2004 and 2003, the Company had a revolving credit facility providing a total of
$65.0 million in available revolving credit for general business purposes, of
which $17.8 million and $18.9 million was outstanding, respectively, all of
which is owed by its foreign subsidiaries. Under this credit facility, the
Company is required to comply with the following financial covenants: maintain a
ratio of total liabilities to tangible net worth (total assets less total
liabilities and intangible assets) of no more than 1.5 to 1 and a cash flow
coverage ratio of 1.25 to 1 or greater; a limitation on certain mergers,
consolidations and sales of assets by the Company or its subsidiaries; a
limitation on the Company's and its subsidiaries' incurrence of liens; and a
requirement that the lender approve the incurrence of additional indebtedness
unrelated to the revolving credit facility when the aggregate principal amount
of such new additional indebtedness exceeds $75.0 million. At August 31, 2004
and 2003, the Company was in compliance with all such covenants. Failure to
remain in compliance with these covenants could trigger an acceleration of the
Company's obligation to repay all outstanding borrowings under this credit
facility.
Certain other subsidiaries of the Company had revolving credit
facilities totaling the U.S. dollar equivalent of $32.3 and $18.0 million, of
which $8.2 and $9.4 million were outstanding as of August 31, 2004 and 2003,
respectively. This additional borrowing capacity includes an increase in the
Company's available credit line related to its Japanese subsidiary of $11.9
million, which was effected during the third quarter of fiscal 2004. In
addition, during fiscal 2003 the Company entered into a short-term note payable
with IMA, Inc. for $0.1 million related to a non-compete arrangement pursuant to
the Company's acquisition of this business on July 1, 2003, which the Company
paid in the fourth quarter of fiscal 2004.
Interest rate terms for both U.S. and foreign bank credit facilities are
based on either bids provided by the lender or the prime rate, London Interbank
Offered Rates (LIBOR) or Certificate of Deposit Rates, plus applicable margins.
Certain of these borrowings, primarily those with U.S. banks, are due on demand.
Interest is payable monthly during the revolving credit period. At August 31,
2004, the weighted average interest rate on short-term borrowings was 2.3% per
annum. Combined borrowings under these facilities decreased $2.4 million during
fiscal year 2004, all of which was related to foreign borrowings.
(26)
INFLATION. During the periods discussed above, the overall effects of
inflation and seasonality on the Company's business were not significant.
CONTRACTUAL OBLIGATIONS. A summary of all of the Company's contractual
obligations and commercial commitments as of August 31, 2004 were as follows:
PAYMENTS DUE
OR
COMMITMENT EXPIRATION
BY PERIOD
--------------------------------------------------
LESS MORE
CONTRACTUAL OBLIGATIONS AND THAN 1 - 3 3 - 5 THAN 5
COMMERCIAL COMMITMENTS TOTAL 1 YEAR YEARS YEARS YEARS
- ------------------------------------------- --------- --------- --------- --------- ----------
($ IN MILLIONS)
Long-term debt $ 3.0 $ 3.0 $ - $ - $ -
Operating leases 15.5 5.2 5.7 3.1 1.5
Purchase obligations (1) 33.0 33.0 - - -
Other long-term obligations 0.4 - 0.1 0.1 0.2
Lines of credit (2) 26.0 26.0 - - -
Standby letters of credit 1.4 1.4 - - -
--------- --------- --------- --------- ----------
Total cash contractual obligations and
commercial commitments $ 79.3 $ 68.6 $ 5.8 $ 3.2 $ 1.7
========= ========= ========= ========= ==========
(1) Includes open purchase orders primarily relating to the purchase of new raw
materials, equipment and certain consulting and information system services.
(2) Includes short-term indebtedness of the Company and its subsidiaries under
various revolving credit facilities, as discussed above.
OUTLOOK. Based upon its present plans, the Company believes that cash
generated from its operations and available credit resources, including its
ability to extend maturities of borrowings outstanding under its lines of credit
in the ordinary course consistent with past practice, will be adequate to repay
current portions of long-term debt, to finance currently planned capital
expenditures, including those pursuant to the Company's recently announced
multi-year capital investment plan discussed above, and to the extent the
Company determines to do so, repurchase of the Company's stock in the open
market, and to meet the currently foreseeable liquidity needs of the Company.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company has disclosed in Note 1 to its consolidated financial
statements included in Item 8 of this report those accounting policies that it
considers to be significant in determining its results of operations and
financial position. In all material respects, the accounting principles utilized
by the Company in preparing its consolidated financial statements are in
conformity with generally accepted accounting principles in the United States of
America.
The preparation of these consolidated financial statements requires the
Company's management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses, as well as the disclosure
of contingent assets and liabilities at the date of its financial statements.
The Company bases its estimates on historical experience, actuarial valuations
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 value of assets and liabilities that are not readily apparent from
other sources. Some of those judgments can be subjective and complex and,
consequently, actual results may differ from these estimates under different
assumptions or conditions. While for any given estimate or assumption made by
the Company's management there may be other estimates or assumptions that are
reasonable, the Company believes that, given the current facts and
circumstances, it is unlikely that applying any such other reasonable estimate
or assumption would materially impact the financial statements.
The Company's management believes the following critical accounting
policies affect its more significant estimates used in the preparation of the
Company's consolidated financial statements.
(27)
Revenue Recognition:
The Company's net sales represent gross sales invoiced to customers,
less certain related charges, including discounts, returns, rebates and other
allowances. Such charges are recognized against revenue on an accrual basis, at
the time when these costs are incurred. The Company offers sales discounts to
certain customers based on prior experience with those customers, business needs
and regional competition. Product returns are permitted. The accrual for product
returns is based on the Company's history of actual product returns. To date,
product returns have not been material. The Company grants sales rebates to
certain distributors upon achievement of agreed upon pricing for sales of the
Company's products to hospitals. Incurred but unpaid rebates are accrued by the
Company in the period in which they are incurred. The Company's rebate accrual
is based on its history of actual rebates paid. The Company's reserves for
rebates are reviewed at each reporting period and adjusted to reflect data
available at that time.
Accounts Receivable and Allowance for Doubtful Accounts:
Trade accounts receivable are recorded at the invoiced amount and do not
bear interest. The Company maintains an allowance for doubtful accounts for
estimated losses resulting from the inability of our customers to make required
payments. This allowance is used to state trade receivables at estimated net
realizable value. The Company relies on prior payment trends while giving
consideration to other criteria such as political risk, financial status and
other factors to estimate the cash which ultimately will be received. Such
amounts cannot be known with certainty at the financial statement date. The
Company regularly reviews individual past due balances over 90 days and over a
specific amount for collectability and maintains a specific allowance for
customer accounts that will likely not be collectible due to customer liquidity
issues. The Company also maintains an allowance for estimated future collection
losses on existing receivables, determined based on historical trends.
Inventory:
Cost is determined by the "first-in, first-out" (FIFO) method. The
Company uses a materials management program for identifying, redeploying and/or
destroying slow-moving, inactive or potentially obsolete inventory. An
adjustment to fair market value is recorded for all inventory specifically
identified as slow-moving, inactive or potentially obsolete based on a periodic
assessment performed by the Company's management. For certain new products, the
Company manufactures inventory in anticipation of product launch. As of August
31, 2004, the Company had $4.3 million of inventory related to its HemoSonic(TM)
100 and 200 hemodynamic monitoring devices, which is significantly greater than
the net sales of this product in fiscal 2004. The Company is currently
developing changes to this product which it believes should enhance the demand
for this product in the marketplace. The Company's inventory is evaluated on an
ongoing basis and is adjusted as necessary to accurately reflect current
conditions.
Impairment of Goodwill:
Goodwill is tested for impairment on an annual basis or upon the
occurrence of certain circumstances or events. The Company determines the fair
market value of its reporting unit using quoted market rates and cash flow
techniques. The fair market value of the reporting unit is compared to its
carrying value to determine if an impairment loss should be calculated. If the
book value of the reporting unit exceeds its fair value, an impairment loss is
indicated. The loss is calculated by comparing the fair value of the goodwill to
the book value of the goodwill. Fair value of goodwill is determined by
subtracting the fair value of the identifiable assets of the reporting unit from
the fair value of the reporting unit. If the book value of the goodwill exceeds
the fair value of goodwill, an impairment loss is recorded.
Product Liability:
The Company provides reserves for product liability by utilizing loss
estimates prepared by the primary product liability insurance carrier with
adjustments, as appropriate, based upon management's perspective on the ultimate
projected claim, giving consideration to the perspective of outside counsel and
other relevant factors. The Company's evaluation of its reserve is based on
industry standards while taking into consideration the Company's specific claims
experience. The Company records a reserve regarding a particular claim when a
loss is known or considered probable and the amount can be reasonably estimated.
If a loss is not probable or a probable loss cannot be reasonably estimated, a
reserve is not recorded. The Company's primary global product liability
insurance policy is on a claims made basis.
Employee Benefit Plans:
The Company uses several actuarial and other statistical factors which
attempt to anticipate future events in calculating its expense and liability
related to these plans. These factors include assumptions about discount rate,
expected return on plan assets and rate of future compensation increases, as
determined by the Company within specified guidelines. In addition, the
Company's actuarial consultants also utilize subjective assumptions, such as
withdrawal and mortality rates, to estimate these factors. The actuarial
assumptions used by the Company may differ materially from actual results due to
changing market and economic conditions, higher or lower withdrawal rates, or
longer or shorter life spans of participants. These differences, depending on
their magnitude, could have a significant impact on the amount of pension
expense recorded by the Company in any particular period.
(28)
Income Taxes:
The Company's effective tax rate differs from the statutory rate
primarily as a result of research and development tax credits, the foreign sales
corporation deduction and the extraterritorial income tax regime. Because the
Company operates in a number of domestic and foreign tax jurisdictions, the
statutory rates within these various jurisdictions are considered in determining
the Company's overall effective tax rate. Management judgment is required to
determine the Company's consolidated provision for income tax expense, deferred
income tax balances and any valuation allowances associated with deferred tax
assets. The Company's management also considers open statutory periods, current
and anticipated audits, and the impact that any adverse adjustments would have
on the Company's current and prospective overall effective tax rate.
The Company regularly reviews its deferred tax assets for recoverability
and to date has not established valuation allowances. The Company deems all
undistributed earnings of foreign subsidiaries permanently invested and,
accordingly, has not established a tax provision for any repatriation of
retained earnings in these entities.
NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board (FASB) issued a proposed
Statement, "Share-Based Payment, an Amendment of Financial Accounting Standards
(FAS) No. 123 and 95" in March 2003. This exposure draft proposes that the cost
of all forms of equity-based compensation granted to employees, excluding
employee stock ownership plans, be recognized in a company's income statement
and that such cost be measured at the fair value of the stock options. In
October 2004, the FASB delayed the effective date of this proposed statement,
which, if issued as a final standard, would replace the guidance in FAS No. 123,
Accounting for Stock-Based Compensation, and APB No. 25, Accounting for Stock
Issued to Employees. The proposed statement will be effective for financial
statements relating to fiscal periods beginning after June 15, 2005.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Due to the global nature of its operations, the Company is subject to
the exposures that arise from foreign exchange rate fluctuations. Such exposures
arise from transactions denominated in foreign currencies, primarily from
translation of results of operations from outside the United States,
intercompany loans, and intercompany purchases of inventory. The Company is also
exposed to interest rate changes.
The Company's objective in managing its exposure to foreign currency
fluctuations is to minimize earnings and cash flow volatility associated with
foreign exchange rate changes. The Company enters into various contracts that
change in value as foreign exchange rates change to protect the value of its
existing foreign currency assets, liabilities, commitments, and anticipated
foreign currency revenues to meet these objectives. The contracts involve
Japanese yen and other foreign currencies. The gains and losses on these
contracts are offset by changes in the value of the related exposures in the
Company's income statement. It is the Company's policy to enter into foreign
currency transactions only to the extent exposures exist and not to enter into
foreign currency transactions for speculative purposes.
The fair value of all the Company's foreign currency forward contracts
outstanding at August 31, 2004 was less than $0.1 million. The following
analysis estimates the sensitivity of the fair value of all foreign currency
forward contracts to hypothetical 10% favorable and unfavorable changes in spot
exchange rates at August 31, 2004 and 2003:
Fair Value of Foreign Currency
Forward Contracts
-----------------
(in millions)
August 31, 2004 August 31, 2003
--------------- ---------------
10% adverse rate movement $(0.5) $(0.4)
At August 31st rates - -
10% favorable rate movement 0.6 0.6
The Company had no foreign currency option contracts outstanding at
August 31, 2004 and 2003.
Any gains and losses on the fair value of forward and option contracts
would be largely offset by losses and gains on the underlying transactions or
anticipated transactions. These offsetting gains and losses are not reflected in
the above analysis.
(29)
During fiscal 2004, 2003 and 2002, the percentage of the Company's sales
invoiced in currencies other than U.S. dollars was 24.3%, 22.7% and 21.9%,
respectively. In addition, a part of the Company's cost of goods sold is
denominated in foreign currencies. The Company enters into foreign currency
forward contracts and foreign currency option contracts, which are derivative
financial instruments, with major financial institutions to reduce the effect of
these foreign currency risk exposures, primarily on U.S. dollar cash inflows
resulting from the collection of intercompany receivables denominated in foreign
currencies and to hedge anticipated sales in foreign currencies to foreign
subsidiaries. Such transactions occur throughout the year and are probable, but
not firmly committed. Foreign currency forward contracts are marked to market
each accounting period, and the resulting gains or losses on these contracts are
recorded in Other (Income) / Expense of the Company's consolidated statements of
income. Realized gains and losses on these contracts are offset by changes in
the U.S. dollar value of the foreign denominated assets, liabilities and
transactions being hedged. The premiums paid on the foreign currency option
contracts are recorded as assets and amortized over the life of the option.
Other than the risk associated with the financial condition of the
counterparties, the Company's maximum exposure related to foreign currency
options is limited to the premiums paid. The total premiums authorized to be
paid in any fiscal year cannot exceed $1.0 million pursuant to the terms of the
Foreign Currency Management Policy Statement approved by the Company's Board of
Directors in fiscal 2001. Gains and losses on purchased option contracts result
from changes in intrinsic or time value. Both time value and intrinsic value
gains and losses are recorded in shareholders' equity (as a component of
comprehensive income) until the period in which the underlying sale by the
foreign subsidiary to an unrelated third party is recognized, at which point
those deferred gains and losses are recognized in net sales. By their nature,
all such contracts involve risk, including the risk of nonperformance by
counterparties. Accordingly, losses relating to these contracts could have a
material adverse effect upon the Company's business, financial condition and
results of operations. Based upon the Company's knowledge of the financial
condition of the counterparties to its existing foreign currency forward
contracts, the Company believes that it does not have any material exposure to
any individual counterparty. The Company's policy prohibits the use of
derivative instruments for speculative purposes. As of October 1, 2004,
outstanding foreign currency forward contracts totaling the U.S. dollar
equivalent of $10.4 million mature at various dates through November 2004. As of
October 1, 2004, the Company had no foreign currency option contracts
outstanding. The Company expects to continue to utilize foreign currency forward
contracts and foreign currency option contracts to manage its exposure, although
there can be no assurance that the Company's efforts in this regard will be
successful.
The Company's exposure to credit risk consists principally of trade
receivables. Hospitals and international dealers account for a substantial
portion of trade receivables and collateral is generally not required. The risk
associated with this concentration is limited due to the Company's ongoing
credit review procedures.
Additional Quantitative and Qualitative disclosures about market risk
(e.g., interest rate and foreign currency exchange risk) are set forth in Note
17 of the Notes to Consolidated Financial Statements included in Item 8 of this
report.
(30)
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Registered 32
Public Accounting Firm
Consolidated Balance Sheets at
August 31, 2004 and 2003 33-34
Consolidated Statements of Income
for the years ended August 31, 2004,
2003 and 2002 35
Consolidated Statements of Comprehensive
Income for the years ended August 31, 2004,
2003 and 2002 36
Consolidated Statements of Cash Flows
for the years ended August 31, 2004,
2003 and 2002 37-38
Consolidated Statements of Changes in
Shareholders' Equity for the years ended
August 31, 2004, 2003, and 2002 39-41
Notes to Consolidated Financial Statements 42-64
Schedule II - Valuation and Qualifying Accounts 65
(31)
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
of Arrow International, Inc.:
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Arrow
International, Inc. and its subsidiaries (the "Company") at August 31, 2004 and
2003, and the results of its operations and its cash flows for each of the three
years in the period ended August 31, 2004 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the accompanying index
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
These financial statements and the financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and the financial statement schedule based
on our audits. We conducted our audits of these statements in accordance with
the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
Philadelphia, Pennsylvania
November 5, 2004
(32)
ARROW INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
August 31,
------------------------------------
2004 2003
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 94,176 $ 46,975
Accounts receivable, less allowance for doubtful accounts
of $2,198 and $1,112 in 2004 and 2003, respectively 83,918 82,467
Inventories 96,084 90,449
Prepaid expenses and other 7,336 14,978
Deferred income taxes 8,562 7,011
------------- -------------
Total current assets 290,076 241,880
------------- -------------
Property, plant and equipment:
Land and improvements 5,808 5,748
Buildings and improvements 92,333 88,767
Machinery and equipment 186,404 163,479
Construction-in-progress 18,433 18,300
------------- -------------
302,978 276,294
Less accumulated depreciation (166,000) (147,861)
------------- -------------
136,978 128,433
Goodwill 42,698 42,732
Intangible assets, net of accumulated amortization of $24,294 and
$19,453 in 2004 and 2003, respectively 40,440 43,928
Other assets 9,889 4,908
Prepaid pension costs 29,127 32,016
------------- -------------
Total assets $ 549,208 $ 493,897
============= =============
See notes to consolidated financial statements
(33)
ARROW INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS, continued
(In thousands, except share amounts)
August 31,
------------------------------------
2004 2003
------------- -------------
LIABILITIES
Current liabilities:
Current maturities of long-term debt $ 3,036 $ 300
Notes payable 26,020 28,431
Accounts payable 14,791 11,727
Cash overdrafts 1,136 1,506
Accrued liabilities 16,453 21,600
Accrued compensation 14,171 10,684
Accrued income taxes 4,867 3,718
------------- -------------
Total current liabilities 80,474 77,966
Long-term debt - 3,735
Accrued postretirement and pension benefit obligations 15,327 13,409
Deferred income taxes 7,076 8,141
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, no par value;
5,000,000 shares authorized;
none issued - -
Common stock, no par value;
100,000,000 shares authorized;
issued 52,957,626 shares in 2004 and 2003 45,661 45,661
Additional paid-in capital 12,771 5,840
Retained earnings 443,676 403,004
Less treasury stock at cost:
9,182,802 and 9,672,124 shares
in 2004 and 2003, respectively (60,261) (63,472)
Accumulated other comprehensive (expense) 4,484 (387)
------------- -------------
Total shareholders' equity 446,331 390,646
------------- -------------
Total liabilities and shareholders' equity $ 549,208 $ 493,897
============= =============
See notes to consolidated financial statements
(34)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
for the years ended August 31,
----------------------------------------------------
2004 2003 2002
---------------- ---------------- ----------------
Net sales $ 433,134 $ 380,376 $ 340,759
Cost of goods sold 208,687 190,246 169,625
---------------- ---------------- ----------------
Gross profit 224,447 190,130 171,134
---------------- ---------------- ----------------
Operating expenses:
Research, development and engineering 30,374 28,170 26,165
Selling, general and administrative 110,192 89,354 78,406
Restructuring charge 208 - -
Special charges - 8,000 8,005
---------------- ---------------- ----------------
140,774 125,524 112,576
---------------- ---------------- ----------------
Operating income 83,673 64,606 58,558
---------------- ---------------- ----------------
Other expenses (income):
Interest expense, net of amount capitalized 1,117 618 627
Interest income (856) (1,821) (235)
Other, net 535 (1,109) 389
---------------- ---------------- ----------------
796 (2,312) 781
---------------- ---------------- ----------------
Income before income taxes 82,877 66,918 57,777
Provision for income taxes 26,935 21,248 18,777
---------------- ---------------- ----------------
Net income $ 55,942 $ 45,670 $ 39,000
================ ================ ================
Basic earnings per common share $ 1.28 $ 1.05 $ 0.89
================ ================ ================
Diluted earnings per common share $ 1.26 $ 1.04 $ 0.88
================ ================ ================
Cash dividends per common share $ 0.3500 $ 0.1950 $ 0.1375
================ ================ ================
Weighted average shares used in computing
basic earnings per common share 43,559,410 43,399,363 43,825,856
================ ================ ================
Weighted average shares used in computing
diluted earnings per common share 44,301,960 43,773,253 44,211,082
================ ================ ================
All historical share and per share amounts have been adjusted to reflect the
two-for-one split of the Company's common stock effected on August 15, 2003.
See notes to consolidated financial statements
(35)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
for the years ended August 31,
----------------------------------------------------
2004 2003 2002
---------------- ---------------- ----------------
Net income $ 55,942 $ 45,670 $ 39,000
Other comprehensive income (expense):
Foreign currency translation adjustments 4,802 3,309 5,470
Unrealized holding (loss) gain on foreign currency
option contracts - 286 (400)
Unrealized holding loss on securities, net of tax
($0, $0 and $399, respectively) - - (642)
Reclassification adjustment for gains on securities
included in net income, net of tax ($0, $0 and
$653, respectively) - - (1,050)
Minimum pension liability adjustment, net of tax ($(42),
$(515) and $557, respectively) 69 827 (874)
---------------- ---------------- ----------------
Other comprehensive income (expense) 4,871 4,422 2,504
---------------- ---------------- ----------------
Total comprehensive income $ 60,813 $ 50,092 $ 41,504
=============== ================ ================
See notes to consolidated financial statements
(36)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
for the years ended August 31,
---------------------------------------------------
2004 2003 2002
--------------- ---------------- ----------------
Cash flows from operating activities:
Net income $ 55,942 $ 45,670 $ 39,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 19,086 18,850 18,581
Special charges - 8,000 8,005
Amortization 4,692 4,376 3,112
Abandonment of facility expansion plan 1,658 - -
Write-off of Lionheart(TM) inventory 3,140 - -
Write-off of Lionheart(TM) manufacturing equipment 558 - -
LionHeart(TM) second generation external batteries write-off - 3,569 -
401(K) plan stock contribution 816 713 739
Non-qualified stock option tax benefit 2,112 565 -
Gain on sale of securities - - (1,703)
Loss (gain) on sale of property, plant and equipment 421 (71) (176)
Deferred income taxes (2,682) 10,145 (3,233)
Unrealized holding gain (loss) on foreign currency options - 286 (400)
Realized holding gain on securities - - 1,052
Loss on sale of implantable drug infusion pump business - - 1,226
Increase (decrease) in provision for postretirement benefit obligation 1,616 887 (607)
Decrease (increase) in prepaid pension costs 2,889 (13,702) (2,193)
Changes in operating assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net 1,471 (302) 6,822
Inventories (7,646) 5,710 4,174
Prepaid expenses and other 7,711 (6,593) 1,123
Accounts payable and accrued liabilities (3,816) (3,816) 2,141
Accrued compensation 3,279 3,746 59
Accrued income taxes 1,072 682 117
--------------- ---------------- ----------------
Total adjustments 36,377 33,045 38,839
--------------- ---------------- ----------------
Net cash provided by operating activities 92,319 78,715 77,839
--------------- ---------------- ----------------
Cash flows from investing activities:
Capital expenditures (26,954) (16,714) (21,618)
Proceeds from sale of property, plant and equipment 615 339 571
(Increase) in intangible and other assets (5,274) (1,272) (6)
Cash paid for businesses acquired, net - (38,317) -
Proceeds from sale of business - - 13,000
Proceeds from sale of securities - - 2,540
--------------- ---------------- ----------------
Net cash used in investing activities (31,613) (55,964) (5,513)
--------------- ---------------- ----------------
Cash flows from financing activities:
(Decrease) Increase in notes payable (4,939) 11,554 (34,698)
Principal payments of long-term debt, including current maturities (300) (300) (300)
Reduction of long-term debt (699) (265) -
(Decrease) increase in book overdrafts (370) (1,191) 733
Dividends paid (14,792) (6,522) (5,920)
Proceeds from stock options exercised 6,685 1,210 3,346
Purchase of treasury stock - (13,846) (5,758)
--------------- ---------------- ----------------
Net cash used in financing activities (14,415) (9,360) (42,597)
--------------- ---------------- ----------------
Effects of exchange rate changes on cash and cash equivalents 910 481 406
Net change in cash and cash equivalents 47,201 13,872 30,135
Cash and cash equivalents at beginning of year 46,975 33,103 2,968
--------------- ---------------- ----------------
Cash and cash equivalents at end of year $ 94,176 $ 46,975 $ 33,103
=============== ================ ================
See notes to consolidated financial statements
(37)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(In thousands)
for the years ended August 31,
---------------------------------------------------
2004 2003 2002
--------------- ---------------- ----------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized) $ 759 $ 547 $ 635
Income taxes $ 21,406 $ 13,759 $ 19,969
Supplemental schedule of noncash investing and financing activities:
The Company assumed liabilities in conjunction with the purchase of
certain assets as follows:
Estimated fair value of assets acquired $ - $ 53,278 $ -
Liabilities assumed - 14,961 -
--------------- ---------------- ----------------
Cash paid for assets $ - $ 38,317 $ -
=============== ================ ================
Cash paid for businesses acquired:
Working capital $ - $ 10,323 $ -
Property, plant and equipment - 1,960 -
Goodwill, intangible assets and in-process
research and development - 30,034 -
Long-term debt - (4,000) -
--------------- ---------------- ----------------
$ - $ 38,317 $ -
=============== ================ ================
Treasury Stock issued for 401(k) Plan contribution $ 816 $ 713 $ 739
=============== ================ ================
Intangible assets acquired by issuing treasury stock $ 529 $ - $ 464
=============== ================ ================
Non-qualified stock option tax benefit $ 2,112 $ 565 $ -
=============== ================ ================
Dividends declared but not paid $ 3,940 $ 3,462 $ 1,538
=============== ================ ================
See notes to consolidated financial statements
(38)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended August 31, 2004, 2003 and 2002
(In thousands, except share and per share amounts)
Common Stock Treasury Stock
------------------------- -----------------------
Additional
Retained Paid In
Shares Amount Earnings Shares Amount Capital
------------ ----------- ----------- ---------- ----------- -----------
Balance, August 31, 2003 52,957,626 $ 45,661 $ 403,004 9,672,124 $ (63,472) $ 5,840
Cash dividends on common
stock, $0.350 per share (15,270)
Purchase of treasury stock
Exercise of stock options (439,348) 2,883 3,802
Treasury stock issued to purchase
intangible assets (20,000) 131 398
Treasury stock issued as contribution
to the Company's 401(k) Plan (29,974) 197 619
Stock option tax benefit (non-qualified
stock option) 2,112
Unrealized holding gain on foreign
currency option contracts
Foreign currency translation adjustments
Minimum pension liability adjustment
Net income 55,942
------------ ----------- ----------- ---------- ----------- -----------
Balance, August 31, 2004 52,957,626 $ 45,661 $ 443,676 9,182,802 $ (60,261) $ 12,771
============ =========== =========== ========== =========== ===========
(CONT'D)
Accumulated Other Comprehensive Income (Expense)
------------------------------------------------------------
Minimum Reclassification Unrealized
Pension Adjustment gain on Foreign
Liability for Marketable Currency
Adjustment Gains Securities Effects
------------ ---------------- -------------- -----------
Balance, August 31, 2003 $ (69) $ (1,173) $ 1,173 $ (318)
Cash dividends on common
stock, $0.350 per share
Purchase of treasury stock
Exercise of stock options
Treasury stock issued to purchase
intangible assets
Treasury stock issued as contribution
to the Company's 401(k) Plan
Stock option tax benefit (non-qualified
stock option)
Unrealized holding gain on foreign
currency option contracts
Foreign currency translation adjustments 4,802
Minimum pension liability adjustment 69
Net income
------------ ---------------- -------------- -----------
Balance, August 31, 2004 $ - $ (1,173) $ 1,173 $ 4,484
============ ================ ============== ===========
All historical share and per share amounts have been adjusted to reflect the two-for-one split of the
Company's common stock effected on August 15, 2003.
See notes to consolidated financial statements
(39)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended August 31, 2004, 2003 and 2002
(In thousands, except share and per share amounts)
Common Stock Treasury Stock
------------------------- -----------------------
Additional
Retained Paid In
Shares Amount Earnings Shares Amount Capital
------------ ----------- ----------- ---------- ----------- -----------
Balance, August 31, 2002 52,957,626 $ 45,661 $ 365,778 9,015,988 $ (50,328) $ 4,054
Cash dividends on common (8,444)
stock, $0.195 per share
Purchase of treasury stock 766,000 (13,846)
Exercise of stock
options (73,930) 477 733
Treasury stock issued to purchase
intangible assets
Treasury stock issued as contribution
to the Company's 401(k) Plan (35,934) 225 488
Stock option tax benefit
(non-qualified stock option) 565
Unrealized holding gain on foreign
currency option contracts
Foreign currency translation
adjustments
Minimum pension liability adjustment
Net income 45,670
------------ ----------- ----------- ---------- ----------- -----------
Balance, August 31, 2003 52,957,626 $ 45,661 $ 403,004 9,672,124 $ (63,472) $ 5,840
============ =========== =========== ========== =========== ===========
(CONT'D)
Accumulated Other Comprehensive Income (Expense)
------------------------------------------------------------
Minimum Reclassification Unrealized
Pension Adjustment gain on Foreign
Liability for Marketable Currency
Adjustment Gains Securities Effects
------------ ---------------- -------------- -----------
Balance, August 31, 2002 $ (896) $ (1,173) $ 1,173 $ (3,913)
Cash dividends on common
stock, $0.195 per share
Purchase of treasury stock
Exercise of stock
options
Treasury stock issued to purchase
intangible assets
Treasury stock issued as contribution
to the Company's 401(k) Plan
Stock option tax benefit
(non-qualified stock option)
Unrealized holding gain on foreign
currency option contracts 286
Foreign currency translation
adjustments 3,309
Minimum pension liability adjustment 827
Net income
------------ ---------------- -------------- -----------
Balance, August 31, 2003 $ (69) $ (1,173) $ 1,173 $ (318)
============ ================ ============== ===========
All historical share and per share amounts have been adjusted to reflect the two-for-one split of the Company's common stock
effected on August 15, 2003.
See notes to consolidated financial statements
(40)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended August 31, 2004, 2003 and 2002
(In thousands, except share and per share amounts)
Common Stock Treasury Stock
------------------------- -----------------------
Additional
Retained Paid In
Shares Amount Earnings Shares Amount Capital
------------ ----------- ----------- ---------- ----------- -----------
Balance, August 31, 2001 52,957,626 $ 45,661 $ 332,806 8,954,826 $ (45,995) $ 930
Cash dividends on common (6,028)
stock, $0.1375 per share
Purchase of treasury stock 317,000 (5,758)
Exercise of stock options (200,200) 1,116 2,230
Treasury stock issued to purchase
intangible assets (20,000) 112 352
Treasury stock issued as contribution
to the Company's 401(k) Plan (35,638) 197 542
Reclassification adjustment
for gains included in net income,
net of tax of $653
Unrealized gain on marketable
securities, net of tax of $399
Unrealized holding gain on foreign
currency option contracts
Foreign currency translation adjustments
Minimum pension liability adjustment
Net income 39,000
------------ ----------- ----------- ---------- ----------- -----------
Balance, August 31, 2002 52,957,626 $ 45,661 $ 365,778 9,015,988 $ (50,328) 4,054
============ =========== =========== ========== =========== ===========
(CONT'D)
Accumulated Other Comprehensive Income (Expense)
------------------------------------------------------------
Minimum Reclassification Unrealized
Pension Adjustment gain on Foreign
Liability for Marketable Currency
Adjustment Gains Securities Effects
------------ ---------------- -------------- -----------
Balance, August 31, 2001 $ (22) $ (123) $ 1,815 $ (8,983)
Cash dividends on common
stock, $0.1375 per share
Purchase of treasury stock
Exercise of stock options
Treasury stock issued to purchase
intangible assets
Treasury stock issued as contribution
to the Company's 401(k) Plan
Reclassification adjustment
for gains included in net income,
net of tax of $653 (1,050)
Unrealized gain on marketable
securities, net of tax of $399 (642)
Unrealized holding gain on foreign
currency option contracts (400)
Foreign currency translation adjustments 5,470
Minimum pension liability adjustment (874)
Net income
------------ ---------------- -------------- -----------
Balance, August 31, 2002 (896) (1,173) 1,173 (3,913)
============ ================ ============== ===========
All historical share and per share amounts have been adjusted to reflect the two-for-one split of the Company's common stock
effected on August 15, 2003.
See notes to consolidated financial statements
(41)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
1. Summary of Significant Accounting Policies:
General:
Arrow International, Inc. develops, manufactures and markets a broad range of
clinically advanced, disposable catheters and related products for critical and
cardiac care medical procedures. The Company's products are used primarily by
anesthesiologists, critical care specialists, surgeons, emergency and trauma
physicians, cardiologists, interventional radiologists, electrophysiologists,
pain management specialists and other health care providers.
Principles of Consolidation:
The accompanying consolidated financial statements include the accounts of Arrow
International, Inc. and its wholly-owned subsidiaries (collectively, the
"Company"). All significant intercompany transactions have been eliminated in
consolidation. Certain prior period amounts have been reclassified for
comparative purposes.
Cash and Cash Equivalents:
The Company considers all highly liquid debt instruments purchased with a
maturity of 90 days or less to be cash equivalents. The carrying amount of cash
and cash equivalents approximate fair value.
Use of Estimates:
The preparation of these consolidated financial statements requires the
Company's management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses, as well as the disclosure
of contingent assets and liabilities at the date of its financial statements.
The Company bases its estimates on historical experience, actuarial valuations
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 value of assets and liabilities that are not readily apparent from
other sources. Some of those judgments can be subjective and complex and,
consequently, actual results may differ from these estimates under different
assumptions or conditions. While for any given estimate or assumption made by
the Company's management there may be other estimates or assumptions that are
reasonable, the Company believes that, given the current facts and
circumstances, it is unlikely that applying any such other reasonable estimate
or assumption would materially impact the financial statements.
Inventory:
The Company values its inventories at the lower of cost or market. Cost is
determined by the "first-in, first-out" (FIFO) method. The Company uses a
materials management program for identifying, redeploying and/or destroying
slow-moving, inactive or potentially obsolete inventory. An adjustment to fair
market value is recorded for all inventory specifically identified as
slow-moving, inactive or potentially obsolete based on a periodic assessment
performed by the Company's management. For certain new products, the Company
manufactures inventory in anticipation of product launch. As of August 31, 2004,
the Company had recorded $4,277 of inventory related to its HemoSonic(TM) 100
and 200 hemodynamic monitoring device, which is significantly greater than the
net sales of this product in fiscal 2004. The Company is currently developing
changes to this product which it believes should enhance the demand for this
product in the marketplace. The Company's inventory is evaluated on an ongoing
basis and is adjusted as necessary to accurately reflect current conditions. In
the third quarter of fiscal 2004, the Company recorded an inventory write-off of
$3,140 charged to cost of goods sold for certain LionHeart(TM) components that
became obsolete with the Company's decision on April 15, 2004 not to proceed in
the U.S. with Phase II human clinical trials using the first generation
LionHeart(TM) power system and controller.
Goodwill, Intangible and Other Assets:
Goodwill represents the excess of the cost over the fair value of net assets
acquired in business combinations. Currently, the Company operates as a single
reporting unit. Goodwill is not amortized and is subject to the impairment rules
of Statement of Financial Accounting Standards No. 142 (SFAS 142) which the
Company adopted effective as of September 1, 2001. Goodwill is tested for
impairment on an annual basis or upon the occurrence of certain circumstances or
events. The Company determines the fair market value of its reporting unit using
quoted market rates and cash flow techniques. The fair market value of the
reporting unit is compared to the carrying value of the reporting unit to
determine if an impairment loss should be calculated. If the book value of the
reporting unit exceeds the fair value of the reporting unit, an impairment loss
is indicated. The loss is calculated by comparing the fair value of the goodwill
to the book value of the goodwill. If the book value of the goodwill exceeds the
fair value of goodwill, an impairment loss is recorded. Fair value of goodwill
is determined by subtracting the fair value of the identifiable assets of a
reporting unit from the fair value of the reporting unit.
Intangible Assets, net include certain assets acquired from business
acquisitions and investments and are being amortized using the straight-line
method over their estimated period of benefits, from 5-25 years. The Company's
management reviews the carrying amount of intangible assets at each balance
sheet date to assess the continued recoverability based on future gross cash
flows and operating results from the related asset, future asset utilization and
changes in market conditions. In accordance with SFAS 144 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of",
long-lived assets and certain identifiable intangibles to be held and used or
disposed of are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If an evaluation is required and a market value is not
determinable, the estimated future undiscounted cash flows associated with the
asset would be compared to the asset's carrying amount to determine if a write
down to a new basis is required. Impairment will be recorded based on an
estimate of future discounted cash flows.
(42)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Amortization expense of intangibles for fiscal 2004 was $4,692. Estimated
intangible amortization expense for each of the next five succeeding fiscal
years is as follows:
Year Ending August 31, Total
----------------------------------- ------------
2005 $ 4,238
2006 4,090
2007 3,597
2008 2,377
2009 2,241
Property, Plant and Equipment:
Property, plant and equipment are stated at cost and are depreciated over the
estimated useful lives of the assets using the straight-line method. The useful
lives for property, plant and equipment are as follows:
Land improvements 5 years
Buildings and leasehold improvements up to 40 years
Machinery and equipment 3 - 10 years
Computer software and hardware 5 years
During fiscal 2004, the Company wrote off costs of $1,658 related to a
previously planned building expansion of its corporate headquarters and
principal research center in Reading, Pennsylvania facility, which decision was
based primarily on opportunities within the Reading real estate market to lease
required additional office space.
Upon retirement, sale or other disposition, the cost and accumulated
depreciation are eliminated from the accounts and any gain or loss is included
in operations. In the third quarter of fiscal 2004, the Company recorded a
write-off of $558 related to LionHeart(TM) manufacturing equipment charged to
selling, general and administrative expenses resulting from the Company's
previously announced decision not to proceed with the U.S. Phase II human
clinical trials using the first generation LionHeart(TM) power system and
controller.
Capitalized Interest:
Interest is capitalized as part of the historical cost of certain property,
plant and equipment constructed by the Company for its own use. The amount of
interest capitalized is based on a weighted average of the interest rates of
outstanding borrowings during the construction period.
Marketable Equity Securities:
Marketable equity securities are carried at fair market value, with unrealized
holding gains and losses, net of tax, reported as accumulated other
comprehensive income (expense) within shareholders' equity. As stated in Note
21, during fiscal 2002, the Company sold its remaining marketable equity
securities.
Financial Instruments:
The Company complies with the provisions of Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133), as amended by SFAS 138. SFAS 133 requires that all
derivative financial instruments, such as foreign exchange contracts, be
recognized in the financial statements and measured at fair value regardless of
the purpose or intent for holding them. Changes in the fair value of derivative
financial instruments are either recognized periodically in income or
shareholders' equity (as a component of comprehensive income / (expense)),
depending on whether the derivative is being used to hedge changes in fair
value, cash flows or foreign currency.
The Company enters into foreign currency forward contracts, which are derivative
financial instruments, with major financial institutions to reduce the effect of
these foreign currency risk exposures, primarily on U.S. dollar cash inflows
resulting from the collection of intercompany receivables denominated in foreign
currencies. The Company classifies a portion of certain intercompany receivables
as long-term investments. The foreign exchange translation effect related to
these long-term receivables is reported as accumulated other comprehensive
income / (expense) within shareholders' equity.
Foreign currency forward contracts are marked to market each accounting period,
and the resulting gains or losses on these contracts are recorded in other
income / (expense) of the Company's consolidated statements of income. Gains and
losses on these contracts are offset by changes in the U.S. dollar value of the
foreign denominated assets, liabilities and transactions being hedged. The
Company does not use financial instruments for trading or speculative purposes.
From time to time, the Company also purchases foreign currency option contracts
to hedge anticipated sales in foreign currencies to foreign subsidiaries. The
option premiums paid are recorded as assets and amortized over the life of the
option. Other than the risk associated with the financial condition of the
counterparties, the Company's maximum exposure related to foreign currency
options is limited to the premiums paid. The total premiums authorized to be
paid in any fiscal year cannot exceed $1,000 pursuant to the terms of the
Foreign Currency Management Policy Statement approved by the Company's Board of
Directors in fiscal 2001. Gains and losses on purchased option contracts result
from changes in intrinsic or time value. Both time value and intrinsic value
gains and losses are recorded in shareholders' equity (as a
(43)
component of comprehensive income/(expense)) until the period in which the
underlying sale by the foreign subsidiary to an unrelated third party is
recognized, at which point those deferred gains and losses are recognized in net
sales.
Revenue Recognition:
Revenue is recognized by the Company at the time its products are shipped and
title has passed to its customer. The Company's net sales represent gross sales
invoiced to customers, less certain related charges, including discounts,
returns, rebates and other allowances. Such charges are recognized against
revenue on an accrual basis. The Company offers sales discounts to certain
customers based on prior experience with these customers, business needs and
regional competition. Product returns are permitted. The accrual for product
returns is based on the Company's history of actual product returns. To date,
product returns have not been material. The Company grants sales rebates to
certain distributors upon achievement of agreed upon pricing for sales of the
Company's products to hospitals. Incurred but unpaid rebates are accrued by the
Company in the period in which they are incurred. The Company's rebate accrual
is based on its history of actual rebates paid. The Company's reserves for
rebates are reviewed at each reporting period and adjusted to reflect data
available at that time. If necessary, the Company will adjust these estimated
reserves, which will impact the amount of net product sales revenue recognized
by the Company in the period of the adjustments.
Accounts Receivable and Allowance for Doubtful Accounts:
Trade accounts receivable are recorded at the invoiced amount and do not bear
interest. The Company maintains an allowance for doubtful accounts for estimated
losses resulting from the inability of our customers to make required payments.
This allowance is used to state trade receivables at estimated net realizable
value. The Company relies on prior payment trends while giving consideration to
other criteria such as political risk, financial status and other factors to
estimate the cash which ultimately will be received. Such amounts cannot be
known with certainty at the financial statement date. The Company regularly
reviews individual past due balances over 90 days and over a specific amount for
collectability and maintains a specific allowance for customer accounts that
will likely not be collectible due to customer liquidity issues. The Company
also maintains an allowance for estimated future collection losses on existing
receivables, determined based on historical trends.
Income Taxes:
The Company's effective tax rate differs from the statutory rate primarily as a
result of research and development tax credits, the foreign sales corporation
deduction and the extraterritorial income tax regime. Because the Company
operates in a number of domestic and foreign tax jurisdictions, the statutory
rates within these various jurisdictions are considered in determining the
Company's overall effective tax rate. Management judgment is required to
determine the Company's consolidated provision for income tax expense, deferred
income tax balances and any valuation allowances associated with deferred tax
assets. The Company's management also considers open statutory periods, current
and anticipated audits, and the impact that any adverse adjustments would have
on the Company's current and prospective overall effective tax rate.
Deferred tax assets and liabilities are recorded when differences exist between
the financial statement carrying amounts and the tax bases of assets or
liabilities. The Company regularly reviews its deferred tax assets for
recoverability and to date has not established valuation allowances. The Company
deems all undistributed earnings of foreign subsidiaries permanently invested
and, accordingly, has not established a tax provision for any repatriation of
retained earnings in these entities. Undistributed earnings of the Company's
foreign subsidiaries amounted to $28,952 and $25,920 at August 31, 2004 and
2003, respectively.
Foreign Currency Translation: During fiscal 2004, 2003 and 2002, the Company's
foreign subsidiaries used their local currency as the functional currency. All
assets and liabilities are translated at year-end exchange rates and the
adjustments are recorded within accumulated other comprehensive income /
(expense) within shareholders' equity. All income and expense accounts are
translated at average rates and adjustments from the translation are recorded in
accumulated other comprehensive income/ (expense) within shareholders' equity.
Foreign currency transaction gains and losses resulting from intercompany
receivables denominated in the local currencies are included in other
income/(expense) in the consolidated statement of income, and were $558, $99 and
$156 for the fiscal years ended August 31, 2004, 2003 and 2002, respectively.
Employee Benefit Plans:
The Company sponsors pension, post-retirement, medical and life insurance plans
covering substantially all of its employees who meet the applicable eligibility
requirements. The Company uses several actuarial and other statistical factors
which attempt to anticipate future events in calculating its expense and
liability related to these plans. These factors include assumptions about
discount rate, expected return on plan assets and rate of future compensation
increases, as determined by the Company within specified guidelines. In
addition, the Company's actuarial consultants also utilize subjective
assumptions, such as withdrawal and mortality rates, to estimate these factors.
The actuarial assumptions used by the Company may differ materially from actual
results due to changing market and economic conditions, higher or lower
withdrawal rates, or longer or shorter life spans of participants. These
differences, depending on their magnitude, could have a significant impact on
the amount of pension expense recorded by the Company in any particular period.
(44)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Earnings/(Loss) Per Share:
Basic earnings/(loss) per common share is computed by dividing net income/(loss)
available to common shareholders by the weighted-average number of common shares
outstanding during the period. Diluted earnings/(loss) per share is computed by
dividing net income/(loss) available to common shareholders by the
weighted-average number of shares that would have been outstanding if the
potentially dilutive common shares had been issued. The diluted earnings/(loss)
per share does not assume the exercise of options that would have an
antidilutive effect on earnings/(loss) per share.
Computer Software Costs:
The Company records the costs of computer software in accordance with "Statement
of Position (SOP) 98-1", "Accounting for the Costs of Computer Software
Development or Obtained for Internal Use" issued by the Accounting Standards
Executive Committee of the Institute of Certified Public Accountants (AcSec).
This statement requires that certain internal-use computer software costs are to
be capitalized and amortized over the useful life of the asset. Total cost
capitalized under this policy, net of amortization, was $11,642 and $9,544 as of
August 31, 2004 and 2003, respectively.
Research and Development:
Research and development costs are expensed as incurred. Research and
development costs consist of direct and indirect internal costs related to
specific projects as well as fees paid to other entities which conduct certain
research activities on behalf of the Company. The costs of materials (whether
from the Company's normal inventory or acquired specially for research and
development activities) and equipment or facilities that are acquired or
constructed for research and development activities and that have alternative
future uses (in research and development projects or otherwise) are capitalized
as tangible assets when acquired or constructed. The cost of such materials
consumed in research and development activities and the depreciation of such
equipment or facilities used in those activities are recorded as research and
development costs. As of August 31, 2004, the Company had $4,035 of capitalized
costs related to the Arrow LionHeart(TM), the Company's LVAS, of which $1,617
represents inventory intended for commercial use. In the fourth quarter of
fiscal 2003, the Company wrote off $3,569 related to development costs for the
second generation of external batteries used in the Arrow LionHeart(TM). The
Company also had $563 of capitalized costs related to its CorAide(TM)
ventricular assist device as of August 31, 2004.
Product Liability:
Costs for attorney's fees and indemnification associated with injuries resulting
from the use of the Company's products are provided for in estimating reserves.
The Company provides reserves for product liability by utilizing loss estimates
prepared by the primary product liability insurance carrier with adjustments, as
appropriate, based upon management's perspective on the ultimate projected
claim, giving consideration to the perspective of outside counsel and other
relevant factors. The Company records a reserve regarding a particular claim
when a loss is known or considered probable and the amount can be reasonably
estimated. If a loss is not probable or a probable loss cannot be reasonably
estimated, a reserve is not recorded. The Company's primary global product
liability insurance policy is on a claims made basis. For fiscal 2004, the
Company's deductibles for its primary global product liability insurance policy
were increased to $2,500 per occurrence from $750 in fiscal 2003 for domestic
product liability claims, with the Company's annual exposure for such
deductibles in any one policy year being increased to $5,000 in fiscal 2004 from
$1,500 in fiscal year 2003. Effective for fiscal 2005, the Company's deductibles
for its primary global product liability insurance policy have been decreased to
$2,000 per occurrence with the Company's annual aggregate exposure for such
deductibles being limited to $4,000 for any one policy year. The policy year
runs from September 1 to August 31 and has a $10,000 aggregate limit. The
Company also has additional layers of coverage insuring up to $35,000 in annual
aggregate losses arising from claims that exceed the primary product liability
insurance policy limits. Because deductibles were due to increase when the
Company renewed its product liability insurance policy in September 2002, the
Company elected to exercise a provision in its current policy that maintains
deductibles and limits for unreported claims occurring prior to September 1,
2002 at existing levels for five years.
Stock Option Plans:
As permitted under SFAS No. 123, the Company continues to apply the existing
accounting rules under Accounting Principles Board (APB) No. 25, as amended by
SFAS No. 148, and provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants made as if the fair value method in
measuring compensation costs for stock options granted subsequent to December
15, 1995 had been applied.
(45)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Had compensation expense for stock options granted in fiscal 2004, 2003 and 2002
been recorded based on the fair market value at the grant date, the Company's
net income and basic and diluted earnings per share, net of related income tax
effects, for the periods ended August 31, 2004, 2003 and 2002 would have been
reduced to the pro forma amounts indicated in the table below:
2004 2003 2002
----------------- ----------------- ----------------
Net income applicable to common shareholders
As reported $ 55,942 $ 45,670 $ 39,000
Add: Stock based employee compensation expense
included in reported net income, net of related
tax effects 36 - -
Deduct: Total stock based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (1,859) (1,329) (1,553)
Pro forma $ 54,119 $ 44,341 $ 37,447
Basic earnings per common share
As reported $ 1.28 $ 1.05 $ 0.89
Pro forma $ 1.24 $ 1.02 $ 0.85
Diluted earnings per common share
As reported $ 1.26 $ 1.04 $ 0.88
Pro forma $ 1.22 $ 1.01 $ 0.85
The pro forma effects are not representative of the effects on reported net
income for future years, as most of the stock option awards granted by the
Company vest in cumulative increments over a period of either four or five
years. The information provided in the table above includes the impact of both
vested and non-vested options.
2. Special Charges:
The Company incurred a special charge in its fourth quarter of fiscal year 2003
totaling $8,000. This special charge was recorded to establish a reserve for a
proposed settlement in two related patent infringement lawsuits, which, as
previously disclosed, related to certain of the Company's hemodialysis catheter
products. In October 2003, the Company reached a settlement in principle for
$8.0 million in two related lawsuits in which the plaintiffs had alleged that
certain of the Company's hemodialysis catheter products infringed patents owned
by or licensed to the plaintiffs. In December 2003, the terms of this settlement
were finalized and the Company paid the $8.0 million settlement in January 2004.
The Company had been obligated to pay royalties to the plaintiffs based on the
sales levels for these products. Upon the final settlement of these actions, the
Company no longer owes royalties to the plaintiff for any sales occurring after
August 28, 2004.
The Company recorded special charges in the fourth quarter of fiscal 2002
amounting to a total of $8,005 relating to the matters described below.
Intangible assets in the aggregate amount of $4,715 were written off relating to
purchased technologies the Company has decided not to support for (1) Pullback
Atherectomy Catheterization (PAC), (2) Intra-aortic balloon (IAB) pumping
software and (3) microwave ablation technology . The Company's special charge
relating to the PAC resulted from its discontinuation of support for this
development project due to changes in the market outlook for this device. The
special charge related to the IAB pumping software resulted from the Company's
decision to evaluate a new pump which would not utilize this software. The
special charge relating to microwave ablation resulted from the Company's
decision to discontinue its efforts to further develop this technology for
treating liver ablation. Also included in the special charge is the write-off of
an investment of $2,000 in a developer and manufacturer of systems to measure
certain cardiac functions due to the developer's uncertain access to future
financing and unfavorable financial condition. Finally, due to a delay in
obtaining CE mark approval to sell the Arrow LionHeart(TM), in Europe, the
Company incurred $1,290 of manufacturing variances related to systems being
produced for market introduction.
(46)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
3. LionHeart(TM) Charges:
The Company incurred charges in the third quarter of fiscal 2004 totaling $3,698
resulting from its decision on April 15, 2004 to delay commencement of the Arrow
LionHeart(TM) Phase II U.S. clinical trials. The charges consist primarily of an
inventory write-off of $3,140 recorded to cost of goods sold for certain
LionHeart(TM) components that became obsolete with the Company's decision not to
proceed with the clinical trials using the first generation LionHeart(TM) power
system and controller. The other charge was for a LionHeart(TM) manufacturing
equipment write-off of $558 recorded to selling, general and administrative
expenses.
4. Restructuring Charges:
In August 2004, the Company initiated the consolidation of its operations at its
Winston-Salem, North Carolina and San Antonio, Texas facilities into other
existing manufacturing facilities. These steps are part of the Company's overall
manufacturing realignment and capacity increases announced in June 2004. The
transitional work on the consolidation has begun and is expected to continue
into the spring of 2005. In connection with this restructuring, the Company has
accrued severance payments of $208 in the fourth quarter of fiscal year 2004 in
accordance with Statement of Financial Accounting Standard No. 112, which amount
represents total actual restructuring costs incurred through August 31, 2004.
Severance payments relate to approximately 53 employees primarily in
manufacturing which are expected to be paid in fiscal 2005. All other
restructuring costs are expected to be paid in fiscal 2005 and fiscal 2006.
Restructuring charges related to this manufacturing realignment are summarized
in the table below:
Estimate of total expected
restructuring charges 2004
-------------------------------------------------- -----------------
Severance and related expenses $ 642
Property, plant and equipment carrying cost and
costs of disposal 445
Other 100
-----------------
Total estimated restructuring charges $ 1,187
5. Business Acquisitions:
On September 3, 2002, the Company purchased the net assets of its former New
York City distributor, Stepic Medical, from Horizon Medical Products for
$12,636, which includes the relief from $5,539 of accounts receivable that had
been due from this distributor. As of August 31, 2004, pursuant to the asset
purchase agreement, the Company had paid in cash the entire $12,636 purchase
price for this acquisition. Stepic Medical had been the Company's distributor in
the greater New York City area, eastern New York State, and parts of Connecticut
and New Jersey since 1977.
The excess of the purchase price over the estimated fair value of the net assets
acquired was approximately $102. Intangible assets acquired of $3,452 are being
amortized over a period of five years. The results of operations of this
business are included in the Company's consolidated financial statements from
the date of acquisition. The purchase price for this acquisition was allocated
as follows:
Accounts receivable $ 10,090
Inventories 6,830
Other current assets 25
Property, plant and equipment 116
Goodwill and intangible assets 3,554
Current liabilities (7,979)
--------------
Total purchase price $ 12,636
==============
On November 25, 2002, the Company purchased specified assets and assumed
specified liabilities of Diatek, Inc., a company that had developed,
manufactured and marketed chronic hemodialysis catheters, for approximately
$10,935. As of August 31, 2004, pursuant to the asset purchase agreement, the
Company had paid $8,935 in cash and recorded a liability classified as debt of
$2,000. As of August 31, 2004, this liability had been reduced by $889 for legal
costs paid by the Company, which are obligated to be reimbursed by the former
owners of Diatek, Inc. Pursuant to the asset purchase agreement relating to this
transaction, the Company is also required to make royalty payments to Diatek's
former owners based on the achievement of specified annual sales levels of
certain hemodialysis product lines. The Company is accruing for any such royalty
expenses as they are incurred. The Company intends to exercise its right to set
off under the asset purchase agreement with respect to this obligation, enabling
it to defer any such royalty payments until the complete resolution of the
Company's patent infringement as described in Note 18. As a result, the Company
has not made any
(47)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
such royalty payments to date. The purchase price for this acquisition did not
exceed the estimated fair value of the net assets acquired and, therefore, no
goodwill has been recorded by the Company in connection therewith. Intangible
assets acquired of $12,235, consisting primarily of intellectual property
rights, are being amortized over a period of 20 years based on the legal life of
the underlying acquired technology. An independent valuation firm was used to
determine a fair market value of the intangible assets acquired. The results of
operations of this business are included in the Company's consolidated financial
statements from the date of acquisition. The purchase price for this acquisition
was allocated as follows:
Accounts receivable $ 176
Inventories 423
Property, plant and equipment 179
Intangible assets 12,235
Current liabilities (2,078)
--------------
Total purchase price $ 10,935
==============
On March 18, 2003, the Company purchased substantially all of the assets of
Klein-Baker Medical, Inc., a company doing business as NeoCare(R) in San
Antonio, Texas, for approximately $16,550. NeoCare(R) develops, manufactures
and markets specialty catheters and related procedure kits to neonatal intensive
care units. As of August 31, 2004, pursuant to the asset purchase agreement, the
Company had paid $14,550 in cash and recorded a liability classified as debt of
$2,000. As of August 31, 2004, this liability had been reduced by $75 for
insurance premiums paid by the Company, which are obligated to be reimbursed by
the former owners of Klein Baker Medical, Inc. The excess of the purchase price
over the estimated fair value of the net assets acquired of $3,803 was recorded
as goodwill and is evaluated for impairment on a periodic basis in accordance
with SFAS No. 142. Intangible assets acquired of $8,539 are being amortized over
a period of 25 years based on the anticipated period in which cash flows are
expected. An independent valuation firm was used to determine a fair market
value of the inventory and intangible assets acquired. The results of operations
of this business are included in the Company's consolidated financial statements
from the date of acquisition. The purchase price for this acquisition was
allocated as follows:
Accounts receivable $ 640
Inventories 2,009
Property, plant and equipment 1,666
Goodwill and intangible assets 12,342
Current liabilities (107)
-------------
Total purchase price $ 16,550
=============
On July 1, 2003, the Company purchased certain assets of its former
Florida-based distributor, IMA, Inc., for $2,150, which includes the relief from
$621 of accounts receivable that had been due from this distributor. As of
August 31, 2004, pursuant to the asset purchase agreement, the Company had paid
in cash the entire $2,150 for this acquisition. As a result of this transaction,
the Company is conducting direct sales activity in the territory formerly
covered by IMA, Inc. The purchase price for this acquisition did not exceed the
estimated fair value of the net assets acquired and, therefore, no goodwill has
been recorded by the Company in connection therewith. Intangible assets acquired
of $1,717 are being amortized over a period of five years. The results of
operations of this business are included in the Company's consolidated financial
statements from the date of acquisition. The purchase price for this acquisition
was allocated as follows:
Accounts receivable $ 310
Inventories 744
Intangible assets 1,717
Current liabilities (621)
-------------
Total purchase price $ 2,150
=============
As part of the Company's 1998 purchase of assets of the cardiac assist division
of C.R. Bard, Inc. the Company also agreed to acquire specified assets and
assume specified liabilities of the Belmont Instruments Corporation for $7,295
based on the achievement of certain milestones. The Company paid $2,250 in
fiscal 2000, $3,545 in fiscal 2001 and $1,000 in fiscal 2002 for achievement of
milestones during these periods. During fiscal 2003, the Company paid $500 to
Belmont for achievement of the final two milestones. representing the seventh
and eighth quarterly installments of $250 payable by the Company (which payments
commenced in April 2001). With these two payments, the Company has completed its
payment obligations to Belmont pursuant to the asset purchase agreement and, as
of August 31, 2004, no longer owed any amounts to Belmont.
Pro forma amounts are not presented as the acquisitions described above did not
have any material effect on the Company's results of operations or financial
condition for any of the years presented.
(48)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
6. Stock Option Plans:
The Company has adopted three stock plans, the 1992 Stock Incentive Plan (the
"1992 Plan"), which was adopted on April 1, 1992, the Directors Stock Incentive
Plan, as amended (the "Directors Plan"), which was approved by the Company's
shareholders on January 17, 1996 with amendments thereto approved by the
shareholders on January 19, 2000, and the 1999 Stock Incentive Plan, (the "1999
Plan"), which was approved by the shareholders on June 19, 2000. The 1992 and
1999 Plans authorize the granting of stock options, stock appreciation rights
and restricted stock. The Directors Plan authorizes the granting of a maximum of
300,000 non-qualified stock options. Under the Directors Plan, members of the
Board of Directors of the Company and its subsidiaries are eligible to
participate if they are not also employees or consultants of the Company or its
subsidiaries, and do not serve on the Board of Directors as representatives of
the interest of shareholders who have made an investment in the Company. The
Directors Plan authorizes an initial grant of an option to purchase 10,000
shares of common stock upon each eligible director's initial election to the
Board of Directors and the grant of an additional option to purchase 3,000
shares of common stock on the date each year when directors are elected to the
Board of Directors.
The Company follows the provision of APB No. 25, "Accounting for Stock Issued to
Employees", and related interpretations, which require compensation expense for
options to be recognized only if the market price of the underlying stock
exceeds the exercise price on the date of grant. Accordingly, the Company has
not recognized compensation expense for its options granted during the 2003 and
2002 fiscal years. During fiscal 2004, the Company recognized compensation
expense of $54 related to a grant which had an exercise price that was below the
market price of the underlying stock on the date of the grant.
In fiscal 2004, 2003 and 2002, the Company granted 1,250,000, 16,000 and
1,108,830 options, respectively, to key employees to purchase shares of the
Company's common stock pursuant to the 1999 Plan. The exercise price per share
ranged from $25.00 to $25.80 for the options granted in fiscal 2004, from $17.78
to $20.53 for the options granted in fiscal 2003 and from $18.37 to $21.47 for
the options granted in fiscal 2002. These amounts represent the fair market
value of the common stock of the Company on the respective dates that the
options were granted, with the exception of a fiscal 2004 grant discussed above.
The options expire ten years from the grant date. The options vest ratably over
either four or five years, at one year intervals from the grant date and, once
vested, are exercisable at any time.
On January 21, 2004, January 15, 2003 and January 16, 2002, the Company granted
27,000, 24,000 and 24,000 options, respectively, to its directors to purchase
shares of the Company's common stock pursuant to the Directors Plan. The
exercise price per share for the 2004, 2003 and 2002 awards was $26.42, $20.53
and $20.62, respectively, which was equal to the fair market value of the common
stock of the Company on the respective dates that the options were granted. The
options expire ten years from the grant date. The options fully vest one year
from the grant date and, once vested, are exercisable at any time.
The numbers of shares underlying option awards under the Company's stock plans
and the exercise prices applicable to such awards have in each case been
adjusted to reflect the two-for-one split of the Company's common stock effected
on August 15, 2003.
Stock option activity for the years ended August 31, 2004, 2003 and 2002 is
summarized in the table below:
Weighted Weighted Weighted
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
FY 2004 Price FY 2003 Price FY 2002 Price
------------ ------------ ------------ ------------- ------------ ---------------
Outstanding at September 1 2,318,260 $16.82 2,414,510 $16.75 1,581,720 $15.33
Granted 1,277,000 $25.28 40,000 $20.11 1,132,830 $18.73
Exercised (439,348) $15.20 (73,930) $16.48 (200,200) $16.79
Terminated (71,760) $19.19 (62,320) $16.63 (99,840) $16.52
------------ ------------ ------------
Outstanding at
August 31 3,084,152 $20.49 2,318,260 $16.82 2,414,510 $16.76
Exercisable at
August 31 1,263,920 $16.45 1,293,686 $15.84 930,360 $15.45
(49)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Stock options outstanding at August 31, 2004 are summarized in the table below:
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Contractual Life Price Exercisable Price
- -------------------------- --------------- -------------------- ------------- -------------- ---------------
$12.56 - $17.50 675,298 4.34 $14.27 675,298 $14.27
$17.51 - $21.47 1,145,454 6.43 $18.87 588,622 $18.95
$21.48 - $26.42 1,263,400 9.07 $25.28 - -
--------------- --------------
3,084,152 1,263,920
The Company has adopted the disclosure provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation". As permitted under SFAS 123, the Company
continues to apply the existing accounting rules under APB No. 25 and provide
pro forma net income and pro forma earnings per share disclosures for employee
stock option grants made as if the fair value method in measuring compensation
cost for stock options granted subsequent to December 15, 1995 had been applied.
The per share weighted average value of stock options granted in fiscal 2004,
2003 and 2002 was $5.39, $8.30 and $9.08, respectively. The fair value was
estimated as of the grant date using the Black-Scholes option pricing model with
the following average assumption:
2004 2003 2002
------------- ------------- -------------
Risk-free interest rate 2.90% 2.68% 2.98%
Dividend yield 1.42% 1.72% 0.74%
Volatility factor 21.38% 44.55% 22.07%
Expected lives 4 years 5 years 4 years
7. Related Party Transactions:
During fiscal 2004 and 2003, the Company made purchases amounting to $117 and
$121, respectively, of products from Precision Medical Products, Inc. ("PMP"), a
former subsidiary of Arrow Precision Products, Inc. ("Precision"), currently
owned by certain former management employees of Precision, including T. Jerome
Holleran, who serves as PMP's Chairman and as a Director of the Company.
Precision was related to the Company through common ownership until it was
dissolved on May 1, 2002.
8. Rent Expense:
The Company leases certain warehouses and production facilities, office
equipment and vehicles under leases with varying terms.
Rent expense under operating leases totaled $5,929, $5,344 and $4,467 for fiscal
years ended August 31, 2004, 2003 and 2002, respectively. Following is a
schedule by year showing future minimum rentals under operating leases.
Year Ending August 31, Total
----------------------------------- -------------
2005 $ 5,230
2006 3,725
2007 1,995
2008 1,582
2009 1,508
Thereafter 1,506
-------------
$ 15,546
=============
(50)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
9. Inventories:
Inventories are summarized as follows:
August 31,
---------------------------------------
2004 2003
-------------- ---------------
Finished goods $ 29,036 $ 31,204
Semi-finished goods 26,126 22,223
Work-in-process 9,493 8,933
Raw materials 31,429 28,089
-------------- ---------------
$ 96,084 $ 90,449
============== ===============
10. Credit Facilities:
To provide additional liquidity and flexibility in funding its operations, the
Company from time to time also borrows amounts under credit facilities and other
external sources of financing. At both August 31, 2004 and 2003, the Company had
a revolving credit facility providing a total of $65,000 in available revolving
credit for general business purposes, of which $17,780 and $18,918 was
outstanding, respectively, all of which is owed by its foreign subsidiaries.
Under this credit facility, the Company is required to comply with the following
financial covenants: maintain a ratio of total liabilities to tangible net worth
(total assets less total liabilities and intangible assets) of no more than 1.5
to 1 and a cash flow coverage ratio of 1.25 to 1 or greater; a limitation on
certain mergers, consolidations and sales of assets by the Company or its
subsidiaries; a limitation on the Company's and its subsidiaries' incurrence of
liens; and a requirement that the lender approve the incurrence of additional
indebtedness unrelated to the revolving credit facility when the aggregate
principal amount of such new additional indebtedness exceeds $75,000. At August
31, 2004 and 2003, the Company was in compliance with all such covenants.
Failure to remain in compliance with these covenants could trigger an
acceleration of the Company's obligation to repay all outstanding borrowings
under this credit facility.
Certain other subsidiaries of the Company had revolving credit facilities
totaling the U.S. dollar equivalent of $32,275 and $17,970, of which $8,240 and
$9,413 was outstanding as of August 31, 2004 and 2003, respectively. This
additional borrowing capacity includes an increase in the Company's available
credit line related to its Japanese subsidiary of $11,901, which was effected
during the third quarter of fiscal 2004. In addition, during fiscal 2003, the
Company entered into a short-term note payable with IMA, Inc. for $100 related
to a non-compete arrangement pursuant to the Company's acquisition of this
business on July 1, 2003, which the Company paid in the fourth quarter of fiscal
2004.
Interest rate terms for both U.S. and foreign bank credit facilities are based
on either bids provided by the lender or the prime rate, London Interbank
Offered Rates (LIBOR) or Certificate of Deposit Rates, plus applicable margins.
Certain of these borrowings, primarily those with U.S. banks, are due on demand.
Interest is payable monthly during the revolving credit period. At August 31,
2004 and 2003, the weighted average interest rates on short-term borrowings were
2.3% and 2.2% per annum, respectively. Combined borrowings under these
facilities decreased $2,411 during fiscal year 2004.
11. Accrued Compensation:
The components of accrued compensation at August 31, 2004 and 2003 are as
follows:
2004 2003
-------------- -------------
Accrued vacation pay $ 5,522 $ 4,359
Accrued payroll 8,025 5,664
Other 624 661
-------------- -------------
$ 14,171 $ 10,684
============== =============
(51)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
12. Accrued Liabilities:
The components of accrued liabilities of August 31, 2004 and 2003 are as
follows:
2004 2003
-------------- -------------
Accrued professional fees $ 2,858 $ 10,144
Other* 13,595 11,456
-------------- -------------
$ 16,453 $ 21,600
============== =============
* No individual items greater than 5% of total current liabilities.
13. Long-Term Debt:
Long-term debt consists of the following:
August 31,
------------------------------------------
2004 2003
---------------- ------------------
Note payable to Klein-Baker Medical, Inc. in March 2005, plus interest at a $ 1,925 $ 2,000
variable rate based upon LIBOR plus 2.00%, offset by insurance premiums
owed to the Company by the former owners of Klein-Baker Medical, Inc.
Note payable to Diatek, Inc. in November 2004, plus interest at a variable
rate based upon LIBOR plus 2.00%, offset by certain charges owed to the
Company by the former owners of Diatek, Inc. 1,111 1,735
Industrial Development Authority Bonds, $3,500 face amount, subject to mandatory
annual sinking fund payments of $300 from December 1999 through December 2003;
plus interest at a variable rate ranging from 1.33% to 1.62%
in 2004 and from 1.00% to 2.35% in 2003. - 300
---------------- ------------------
Total debt 3,036 4,035
Less current maturities 3,036 300
---------------- ------------------
$ - $ 3,735
================ ==================
The Company has a U.S. dollar equivalent of irrevocable standby letters of
credit totaling $1,405 related to subsidiary indebtedness and workers
compensation insurance coverage and foreign performance bonds. The annual
commitment fees associated with the letters of credit were 0.60% per annum at
August 31, 2004.
Total interest costs for fiscal 2004, 2003 and 2002 were $1,117, $618 and $845,
respectively, of which $0, $0 and $218, respectively, were capitalized.
At August 31, 2003, the carrying amount of long-term debt approximated fair
value.
(52)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
14. Income Taxes:
The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes". SFAS No. 109 requires recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been included in the financial statements or tax returns. The measurement
of deferred tax assets is reduced, if necessary, by a valuation allowance.
The provision (benefit) for income taxes consists of:
2004
-----------------------------------------------------------------------------------------------------
Federal State Foreign Total
----------------------- -------------------- ---------------------- ------------------------
Current $ 18,829 $ 1,818 $ 3,762 $ 24,409
Deferred 2,288 218 20 2,526
----------------------- -------------------- ---------------------- ------------------------
$ 21,117 $ 2,036 $ 3,782 $ 26,935
======================= ==================== ====================== ========================
2003
-----------------------------------------------------------------------------------------------------
Federal State Foreign Total
----------------------- -------------------- ---------------------- ------------------------
Current $ 14,928 $ 665 $ 2,829 $ 18,422
Deferred 2,799 267 (240) 2,826
----------------------- -------------------- ---------------------- ------------------------
$ 17,727 $ 932 $ 2,589 $ 21,248
======================= ==================== ====================== ========================
2002
-----------------------------------------------------------------------------------------------------
Federal State Foreign Total
----------------------- -------------------- ---------------------- ------------------------
Current $ 18,242 $ 772 $ 1,856 $ 20,870
Deferred (1,940) (300) 147 (2,093)
----------------------- -------------------- ---------------------- ------------------------
$ 16,302 $ 472 $ 2,003 $ 18,777
======================= ==================== ====================== ========================
Research and development tax credits were $750, $801 and $799 in fiscal 2004,
2003 and 2002, respectively.
The following deferred taxes and balance sheet classifications are recorded as
of August 31, 2004 and 2003:
Deferred tax assets (liabilities): 2004 2003
--------------- ---------------
Accounts receivable $ 656 $ 274
Inventories 6,198 5,294
Capital loss carryforward 3,392 3,392
Property, plant and equipment (8,231) (9,231)
Intangible assets 4,760 5,020
Accrued liabilities (11,877) (10,729)
Accrued compensation 1,402 1,095
Postretirement benefits other than pensions 5,186 3,755
--------------- ---------------
$ 1,486 $ (1,130)
=============== ===============
Balance Sheet classification:
Current deferred tax assets $ 8,562 $ 7,011
Non-current deferred tax assets/(liabilities) (7,076) (8,141)
--------------- ---------------
$ 1,486 $ (1,130)
=============== ===============
The Company has capital loss carryforwards related to marketable securities
sales of $8,845 at August 31, 2004 that expire on August 31, 2006. Management
considers projected future taxable income and tax planning strategies in
assessing the need for valuation allowances that reduce deferred tax assets.
Based upon historical taxable income and tax planning strategies that may be
implemented in the future, management believes it is more likely than not that
the Company will realize the benefits of these capital loss carryforwards as of
August 31, 2005.
(53)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
In addition, the Company made a payment in March 2004 of $10.0 million to settle
a tax assessment related to an ongoing Japanese government tax audit of the
Company's transfer pricing with its Japanese subsidiary. The Company expects to
utilize competent authority proceedings with the Internal Revenue Service in the
U.S. to recover a majority of this required Japanese tax payment. The Company
believes that the amount ultimately recovered through these proceedings has been
fully provided for as of August 31, 2004 and, therefore, will not adversely
affect its future results of operations.
The Company recorded the impact of changes in deferred tax assets associated
with the intercompany profits in the ending inventory of foreign subsidiaries as
a component of cost of sales through May 2002 in accordance with Accounting
Research Bulletin No. 51 ("ARB 51"). In order to record all income tax expense
or benefit in the income tax provision, beginning in June 2002, the impact of
these changes are classified as a component of deferred income tax expense.
The following is a reconciliation of the statutory federal income tax rate to
the Company's effective tax rate expressed as a percentage of income from
operations before income taxes:
2004 2003 2002
---------- ---------- ----------
Statutory federal income tax rate 35.0 % 35.0 % 35.0 %
State income taxes, net of federal benefit 1.6 1.0 0.5
Foreign statutory tax rates differential (0.4) 0.8 0.4
Foreign sales corporation - ETI (Extra Territorial
Income Exclusion) (3.8) (4.2) (3.4)
Research and development tax credit (0.9) (1.6) (0.8)
Other 1.0 0.8 0.8
---------- ---------- ----------
Effective tax rate 32.5 % 31.8 % 32.5 %
========== ========== ==========
15. Retirement Benefits:
Pension Plans:
The Company has three noncontributory pension plans that cover substantially all
employees. Benefits under the plans are based upon an employee's compensation
and years of service and, where applicable, the provisions of negotiated labor
contracts. It is the Company's policy to make contributions to these plans
sufficient to meet the minimum funding requirements of applicable laws and
regulations plus such additional amounts, if any, as the Company's actuarial
consultants advise to be appropriate. The projected unit credit method is
utilized for determination of actuarial amounts.
Plan assets consist principally of U.S. government securities, short-term
investments, other equity securities and cash equivalents.
On September 1, 2000, the Company established a Defined Benefit Supplemental
Executive Retirement Plan to provide pension benefits to selected executives and
retired executives/directors of the Company. The plan is unfunded and the
benefits provided under the plan are intended to be in addition to other
employee retirement benefits offered by the Company, including but not limited
to tax-qualified employee retirement plans. The accumulated benefit obligation
for this pension plan, which exceeds plan assets, was $4,981 and $3,952 at
August 31, 2004 and 2003, respectively.
Postretirement Benefits Other Than Pensions:
The Company provides limited amounts of postretirement health and life insurance
benefit plan coverage for some of its employees. The determination of the cost
of postretirement health benefit plans is based on comprehensive hospital,
medical, surgical and dental benefit provisions ("Other Benefits"). The
determination of the cost of postretirement life insurance benefits is based on
stated policy amounts.
(54)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The following summarizes the Company's benefit obligations, changes in plan
assets and funded status:
Pension Benefits Other Benefits
----------------------------------- -------------------------------------
August 31, August 31,
2004 2003 2004 2003
---------------- --------------- ------------------ ---------------
Change in benefit obligation:
Benefit obligation at beginning of year $ 75,482 $ 64,369 $ 13,013 $ 9,849
Service cost 3,688 2,743 354 319
Interest cost 5,259 4,335 866 795
Amendments 2,578 1,649 (423) -
Actuarial loss 3,577 4,679 1,417 2,594
Benefits paid (2,314) (2,293) (136) (544)
---------------- --------------- ------------------ ---------------
Benefit obligation at end of year $ 88,270 $ 75,482 $ 15,091 13,013
================ =============== ================== ===============
Pension Benefits Other Benefits
----------------------------------- -------------------------------------
August 31, August 31,
2004 2003 2004 2003
---------------- --------------- ------------------ ---------------
Change in plan assets:
Fair value of plan assets at beginning of year $ 78,227 $ 58,811 $ - $ -
Actual return on plan assets 5,018 6,234 - -
Employer contributions 252 15,475 136 544
Benefits paid (2,314) (2,293) (136) (544)
---------------- --------------- ------------------ ---------------
Fair value of plan assets at end of year $ 81,183 $ 78,227 $ - $ -
================ =============== ================== ===============
Pension Benefits Other Benefits
----------------------------------- -------------------------------------
August 31, August 31,
2004 2003 2004 2003
---------------- --------------- ------------------ ---------------
Funded status $ (6,885) $ 2,745 $ (15,091) $ (13,013)
Unrecognized net actuarial loss 21,533 17,401 4,937 3,695
Unrecognized prior service cost 11,687 9,924 (681) (375)
Unrecognized transition obligation (asset) (34) (296) 533 582
Unrecognized plan acquisition differential 1,023 1,173 (404) (433)
---------------- --------------- ------------------ ---------------
Prepaid (accrued) benefit cost $ 27,324 $ 30,947 $ (10,706) $ (9,544)
================ =============== ================== ===============
(55)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Pension Benefits Other Benefits
----------------------------------- -------------------------------------
Amounts recognized in the statement August 31, August 31,
of financial position consist of: 2004 2003 2004 2003
---------------- --------------- ------------------ ---------------
Prepaid benefit cost $ 29,127 $ 32,016 $ - $ -
Accrued benefit liability (4,981) (3,952) (10,706) (9,544)
Intangible asset 3,178 2,772 - -
Accumulated other comprehensive
Income - 111 - -
---------------- --------------- ------------------ ---------------
Net amount recognized $ 27,324 $ 30,947 $ (10,706) $ (9,544)
================ =============== ================== ===============
The projected benefit obligation, accumulated benefit obligation and fair value
of plan assets for the pension plans with plan assets in excess of accumulated
benefit obligations were $81,673, $69,449 and $80,694 for 2004, respectively,
and $71,517, $61,267 and $78,227 for 2003, respectively.
The projected benefit obligation, accumulated benefit obligation and fair value
of plan assets for the pension plans with accumulated benefit obligations in
excess of plan assets were $6,597, $4,981 and $489 for 2004, respectively, and
$3,965, $3,952 and $0 for 2003, respectively.
Plan Assumptions
Weighted average assumptions used in developing the benefit obligation and net
periodic benefit cost were as follows:
Pension Benefits Other Benefits
--------------------------------------- --------------------------------------
August 31, August 31,
Benefit obligation 2004 2003 2002 2004 2003 2002
----------- ----------- --------- ---------- ------------ ---------
Discount rate 6.25% 6.50% 7.00% 6.25% 6.50% 7.00%
Expected return on plan assets 8.50% 9.00% 11.00% N/A N/A N/A
Rate of compensation increase 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
Health care cost trend rate:
Initial trend rate N/A N/A N/A 10.00% 12.00% 8.00%
Ultimate trend rate N/A N/A N/A 5.00% 5.00% 5.00%
Years until ultimate trend is reached N/A N/A N/A 9 11 6
(56)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Pension Benefits Other Benefits
--------------------------------------- --------------------------------------
August 31, August 31,
Net periodic benefit cost 2004 2003 2002 2004 2003 2002
----------- ----------- --------- ---------- ------------ ---------
Discount rate 6.50% 7.00% 7.25% 6.50% 7.00% 7.25%
Expected return on plan assets 9.00% 11.00% 11.00% N/A N/A N/A
Rate of compensation increase 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
Health care cost trend rate:
Initial trend rate N/A N/A N/A 12.00% 8.00% 8.50%
Ultimate trend rate N/A N/A N/A 5.00% 5.00% 5.00%
Years until ultimate trend is reached N/A N/A N/A 11 6 7
The asset allocation of the Company's pension plans at August 31, 2004 and
August 31, 2003, and the target allocation for fiscal 2005, by asset category is
summarized in the table below:
Percentage of Plan Assets for the Years ended
Long-Term Range of Target Allocations August 31,
------------------------------------------------
Asset Category For the Year ended August 31, 2005 2004 2003
- ------------------------ --------------------------------------------------- ----------------------- ---------------------
Equity Securities (1) 35% - 65% 63% 61%
Debt Securities 15% - 25% 26% 16%
Alternatives (2) 10% - 35% 0% 0%
Cash 2% - 5% 11% 23%
--------------------------------------------------- ----------------------- ---------------------
Total 100% 100%
(1) Equity securities do not include any of the Company's common stock.
(2) Alternatives include Hedge Funds, Private Equity and Real Assets.
The Plan's investment strategy supports the objectives of its plans. These
objectives are to maximize returns in order to minimize contributions within
reasonable and prudent levels of risk, to achieve and maintain full funding of
the accumulated benefit obligation and the actuarial liability, to maintain
liquidity sufficient to pay current plan benefits, to seek investment managers
that outperform their respective counterparts, and to earn a nominal rate of
return, net of expenses. To achieve these objectives, the Company has
established a strategic asset allocation policy. The target allocations by asset
class are summarized above. Rebalancing occurs when the target ranges are
exceeded. Investments are diversified across classes and within each class to
minimize the risk of large losses. Periodic reviews are made of the liability
measurement, investment objectives, and the investment managers.
The expected long-term rate of return on plan assets is based on historical and
projected rates of return for current and planned asset classes in the plan's
investment portfolio. Assumed projected rates of return for each of the plan's
projected asset classes were selected after analyzing historical experience and
future expectations of the returns and volatility of the various asset classes.
Based on the target asset allocation for each asset class, the overall expected
rate of return for the portfolio was developed, adjusted for historical and
expected experience of active portfolio management results compared to the
benchmark returns and for the effect of expenses paid from plan assets. The
Company reviews this long-term assumption on an annual basis.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 was
signed into law on December 8, 2003. This Act introduces a Medicare
prescription-drug benefit beginning in 2006 as well as a federal subsidy to
sponsors of retiree health care plans that provide a benefit at least
"actuarially equivalent" to the Medicare benefit. Management has concluded that
the Company's plans are at least "actuarially equivalent" to the Medicare
benefit and, accordingly, has included the federal subsidy from the Act in the
normal year-end measurement process for other retiree benefit plans. The impact
of this subsidy to net periodic pension cost and to benefits paid in future
years is not expected to be material.
(57)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Total benefits expected to be paid to participants, which includes payments
funded from the Company's assets, are summarized in the table below:
Expected Benefits Payments Pension Benefits Other Benefits
- ------------------------------------------ -------------------------- -----------------------
2005 $ 3,147 $ 716
2006 3,346 754
2007 3,548 785
2008 3,803 818
2009 4,184 879
2010 - 2014 $ 28,239 $ 5,023
Pension Benefits Other Benefits
----------------------------------------- -----------------------------------------
Components of net periodic (benefit) August 31, August 31,
cost for the fiscal years ended 2004 2003 2002 2004 2003 2002
----------- ------------ ----------- ----------- ------------ -----------
Service cost $ 3,688 $ 2,743 $ 2,935 $ 354 $ 319 $ 233
Interest cost 5,259 4,335 4,062 866 795 544
Expected return on plan assets (6,958) (6,492) (7,094) - - -
Amortization of prior service costs 1,090 666 665 (117) (84) (84)
Amortization of transition obligation (asset) (107) (107) (107) 49 49 49
Amortization of net actuarial (gain) loss 824 503 (13) 175 104 (1,436)
Plan acquisition differential 150 150 150 (29) (29) (29)
----------- ------------ ----------- ----------- ------------ -----------
Net periodic (benefit) cost $ 3,946 $ 1,798 $ 598 $ 1,298 $ 1,154 $ (723)
=========== ============ =========== =========== ============ ===========
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plan. A one-percentage-point change in assumed
health care costs trend rates would have the following effects:
1-Percentage- 1-Percentage-
Point Increase Point Decrease
-------------- --------------
Effect on total of service and interest
cost components $ 282 $ (233)
Effect on postretirement benefit obligation $ 2,103 $ (1,763)
Savings Plan:
The Company has a defined contribution savings plan that covers substantially
all of its eligible U.S. employees. The purpose of the plan is generally to
provide additional financial security to employees during retirement.
Participants in the savings plan may elect to contribute, on a before-tax basis,
a certain percent of their annual earnings with the Company matching a portion
of these contributions. Expense under the plan related to the Company's matching
contribution was $1,152, $1,024 and $1,064 for fiscal 2004, 2003 and 2002,
respectively.
In fiscal 2001, this plan was amended to, among other things, permit the Company
to begin contributing to each eligible participant's 401(k) plan account an
additional amount equal to 1% of each participant's monthly compensation in the
form of vested shares of Arrow common stock. This stock contribution program
resulted in additional expense to the Company of $815, $716 and $718 for fiscal
2004, 2003 and 2002, respectively.
(58)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
16. Segment Reporting:
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", requires the reporting of certain financial information for each
operating segment. The Company has one operating segment as defined in this
standard based on the fact that its various business components do not possess
the defined characteristics that would meet the standard's definition of
operating segments. For instance, the Company's current management structure is
designed to operate the business as a whole, with no divisional
responsibilities. In addition, over 90% of the Company's net sales are generated
from catheter and catheter-based products. Therefore, the Company continues to
operate as a single reportable segment. The Company operates in four main
geographic regions, therefore, information about products and geographic areas
is presented below.
The following table provides information about the Company's sales by product
category:
2004 2003 2002
----------------------------- ------------------------------ -----------------------------
Critical Cardiac Critical Cardiac Critical Cardiac
Care Care Care Care Care Care
-------------- ----------- ------------- ------------ ------------ ------------
Sales to External $ 369,800 $ 63,300 $ 323,500 $ 56,900 $ 284,000 $ 56,800
customers
The following tables present information about geographic areas:
2004
- -------------------------------------------------------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Eliminations Consolidated
-------------- ---------- ------------ ---------- ------------ -------------
Sales to unaffiliated
customers $ 279,900 $60,000 $ 71,400 $21,800 $ - $ 433,100
Long-lived assets at
August 31* $ 308,236 $ 2,801 $ 41,754 $ 2,134 $ (124,920) $ 230,005
2003
- -------------------------------------------------------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Eliminations Consolidated
-------------- ---------- ------------ ---------- ------------ -------------
Sales to unaffiliated
customers $ 249,900 $51,200 $ 60,400 $ 18,900 $ - $ 380,400
Long-lived assets at
August 31* $ 298,113 $ 2,127 $ 38,984 $ 1,980 $ (121,203) $ 220,001
2002
- -------------------------------------------------------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Eliminations Consolidated
-------------- ---------- ------------ ---------- ------------ -------------
Sales to unaffiliated
customers $ 223,300 $48,100 $ 50,100 $ 19,300 $ - $ 340,800
Long-lived assets at
August 31* $ 266,966 $ 2,194 $ 38,364 $ 2,309 $ (113,181) $ 196,652
* Long-lived assets include both tangible and intangible assets.
17. Financial Instruments:
During fiscal 2004 and 2003, the percentage of the Company's sales invoiced in
currencies other than U.S. dollars was 24.3% and 22.7%, respectively. In
addition, a part of the Company's cost of goods sold is denominated in foreign
currencies. The Company enters into foreign currency forward contracts, which
are derivative financial instruments, with major financial institutions to
reduce the effect of these foreign currency risk exposures, primarily on U.S.
dollar cash inflows resulting from the collection of intercompany receivables
denominated in foreign currencies. Such transactions occur throughout the year
and are probable, but not firmly committed. Foreign currency forward contracts
are marked to market each accounting period, and the resulting gains or losses
on these contracts are recorded in other (income) / expense of the Company's
consolidated statements of income. Gains and losses on these contracts are
offset by the changes in the U.S. dollar value of the foreign denominated
assets, liabilities and transactions being hedged. The Company does not use
financial instruments for trading or speculative purposes. The Company expects
to continue to utilize foreign currency forward contracts to manage its
exposure, although there can be no assurance that the Company's efforts in this
regard will be successful.
(59)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The Company's exposure to credit risk consists principally of trade receivables.
Hospitals and international dealers account for a substantial portion of trade
receivables and collateral is generally not required. The risk associated with
this concentration is limited due to the Company's ongoing credit review
procedures.
At August 31, 2004, the Company had foreign currency forward contracts to sell
foreign currencies which mature at various dates through November 2004. The
following table identifies foreign currency forward contracts to sell foreign
currencies at August 31, 2004 and 2003 as follows:
August 31, 2004 August 31, 2003
Notional Fair Market Notional Fair Market
Amounts Value Amounts Value
--------------- --------------- --------------- ---------------
Foreign currency: (U.S. Dollar Equivalents)
Canadian dollars $ - $ - $ 424 $ 432
Euro 14,643 14,603 4,345 4,393
Mexican peso 1,379 1,393 627 626
African rand 445 450 396 404
--------------- --------------- --------------- ---------------
$ 16,467 $ 16,446 $ 5,792 $ 5,855
=============== =============== =============== ===============
At August 31, 2004, the Company also had foreign currency forward contracts to
buy foreign currencies which mature at various dates through October 2004. The
following table identifies foreign currency forward contracts to buy foreign
currencies at August 31, 2004 and August 31, 2003 as follows:
August 31, 2004 August 31, 2003
Notional Fair Market Notional Fair Market
Amounts Value Amounts Value
--------------- --------------- --------------- ---------------
Foreign currency: (U.S. Dollar Equivalents)
Czech koruna $ 3,031 $ 2,996 $ 672 $ 677
Euro 7,305 7,306 - -
Mexican peso 703 702 - -
--------------- --------------- --------------- ---------------
$ 11,039 $ 11,004 $ 672 $ 677
=============== =============== =============== ===============
From time to time, the Company purchases foreign currency option contracts to
hedge anticipated sales in foreign currencies to foreign subsidiaries. The
option premiums paid are recorded as assets and amortized over the life of the
option. Other than the risk associated with the financial condition of the
counterparties, the Company's maximum exposure related to foreign currency
options is limited to the premiums paid. During fiscal 2004, the Company did not
recognize any time value losses nor did it recognize any intrinsic values losses
against net sales. During fiscal 2003, the Company recognized intrinsic value
gains of $294. The Company had no foreign currency option contracts outstanding
at August 31, 2004 and August 31, 2003.
(60)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
18. Contingencies:
The Company is a party to certain legal actions, including product liability
matters, arising in the ordinary course of its business. From time to time, the
Company is also subject to legal actions involving patent and other intellectual
property claims.
The Company was a defendant in two related lawsuits alleging that certain of its
hemodialysis catheter products infringe patents owned by or licensed to the
plaintiffs. During the fourth quarter of fiscal 2003, the Company established a
reserve of $8,000 in anticipation of reaching a settlement for these two related
lawsuits. In October 2003, the Company reached a settlement in principle with
the plaintiffs for the reserved amount. In December 2003, the terms of the
settlement were finalized and the Company paid the $8,000 settlement in January
2004.
The Company is also currently a defendant in a lawsuit in which the plaintiff
alleges that the Company's Cannon-Cath(TM) split-tip hemodialysis catheters,
which were acquired as part of the Company's acquisition in November 2002 of
specified assets of Diatek, Inc., infringe a patent owned by or licensed to the
plaintiffs. In November 2003, this lawsuit was stayed pending the U.S. Patent
and Trademark Office's ruling on its re-examination of the patent at issue,
which is not expected to occur until after calendar year 2004. Based on
information presently available to the Company, the Company believes that its
products do not infringe any valid claim of the plaintiff's patent and that,
consequently, it has meritorious legal defenses with respect to this action.
Although the ultimate outcome of any of these actions is not expected to have a
material adverse effect on the Company's business or financial condition,
whether an adverse outcome in any of these actions would materially adversely
affect the Company's reported results of operations in any future period cannot
be predicted with certainty.
19. Stock Split:
During the fourth quarter of fiscal 2003, the Company approved a two-for-one
split of its common stock effected on August 15, 2003, which was distributed to
all stockholders of record on August 1, 2003. The Company retained the rate of
its quarterly cash dividends, which resulted in the doubling of its quarterly
dividend in the fourth quarter of fiscal 2003. The accompanying financial
statements and related footnotes, including all share and per share amounts,
have been adjusted to reflect these actions.
20. New Accounting Standards:
The FASB issued a proposed Statement, "Share-Based Payment, an Amendment of SFAS
No. 123 and 95" in March 2003. This exposure draft proposes that the cost of all
forms of equity-based compensation granted to employees, excluding employee
stock ownership plans, be recognized in a company's income statement and that
such cost be measured at the fair value of the stock options. In October 2004,
the FASB delayed the effective date of this proposed statement, which, if issued
as a final standard, would replace the guidance in SFAS No. 123, Accounting for
Stock-Based Compensation, and APB No. 25, Accounting for Stock Issued to
Employees. This proposed statement will be effective for financial statements
relating to fiscal periods beginning after June 15, 2005.
21. Sale of Securities:
Proceeds from the Company's sale of marketable securities of a medical device
company available for sale were $2,540 for fiscal 2002. Gains on the sale of
these securities in fiscal 2002 amounted to $1,703 and were included in selling,
general and administrative expenses in the Company's consolidated statements of
income.
(61)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
22. Sale of Implantable Drug Infusion Pump Business:
On April 1, 2002, the Company completed the sale of substantially all of the
assets of its implantable drug infusion pump business for a sale price of
$13,000 in cash pursuant to an asset purchase agreement dated as of March 1,
2002. An estimated loss on the sale was recorded in the second quarter of fiscal
2002, during which period the Company's Board of Directors authorized the
transaction. The transaction was accounted for as a sale of a non-integrated
portion of a reporting unit, as defined by SFAS 142. After further adjustments
to the estimated loss were made in the third and fourth quarters of fiscal 2002,
the loss before tax on the transaction was $1,226 and was included in selling,
general and administrative expenses in the Company's consolidated statements of
income.
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
23. Summary of Quarterly Results (unaudited):
Quarterly financial results for the year ended August 31, 2004 are as follows:
Quarter
-------------------------------------------------------------------------------
11/30/03 2/29/04 5/31/04 8/31/04
---------------- --------------- ---------------- -----------------
Net sales $ 103,101 $ 108,294 $ 108,779 $ 112,960
Cost of goods sold 48,903 50,492 56,249 53,043
---------------- --------------- ---------------- -----------------
Gross profit 54,198 57,802 52,530 59,917
Operating expenses
Research, development
and engineering 6,844 6,383 8,201 8,946
Selling, general and
administrative 25,738 28,448 27,068 28,938
Restructuring Charge - - - 208
Operating income 21,616 22,971 17,261 21,825
Other expenses (income) 248 70 (2) 480
Income before income
taxes 21,368 22,901 17,263 21,345
Provision for income taxes 6,944 7,443 5,611 6,937
Net income $ 14,424 $ 15,458 $ 11,652 $ 14,408
Basic earnings
per common share $ 0.33 $ 0.36 $ 0.26 $ 0.33
Diluted earnings
per common share $ 0.33 $ 0.35 $ 0.26 $ 0.32
Weighted average shares used in computing
basic earnings per common share 43,344 43,504 43,634 43,753
Weighted average shares used in computing
diluted earnings per common share 43,983 44,203 44,474 44,544
(62)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Quarterly financial results for the year ended August 31, 2003 are as follows:
Quarter
----------------------------------------------------------------------------
11/30/02 2/28/03 5/31/03 8/31/03
-------------- -------------- --------------- -----------------
Net sales $ 88,839 $ 92,757 $ 96,949 $ 101,831
Cost of goods sold 45,395 47,019 47,756 50,076
-------------- -------------- --------------- -----------------
Gross profit 43,444 45,738 49,193 51,755
Operating expenses
Research, development
and engineering 6,072 6,409 6,329 9,360
Selling, general and
administrative 20,186 21,735 22,649 24,784
Special charge* - - - 8,000
Operating income 17,186 17,594 20,215 9,611
Other expenses (income) 277 (71) (1,157) (1,361)
Income before income
taxes 16,909 17,665 21,372 10,972
Provision for income taxes 5,495 5,741 6,946 3,066
Net income $ 11,414 $ 11,924 $ 14,426 $ 7,906
Basic earnings
per common share $ 0.26 $ 0.28 $ 0.33 $ 0.18
Diluted earnings
per common share $ 0.26 $ 0.27 $ 0.33 $ 0.18
Weighted average shares used in
computing basic earnings per
common share 43,722 43,384 43,231 43,263
Weighted average shares used in
computing diluted earnings per
common share 43,879 43,742 43,667 43,807
* In the fourth quarter of fiscal 2003, the Company recorded a special charge
(see Note 2 - "Special Charges" above).
All historical share and per share amounts have been adjusted to reflect the
two-for-one split of the Company's common stock effected on August 15, 2003.
(63)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
24. Earnings per Share:
The following is a reconciliation of weighted average common shares outstanding
assuming dilution used in the calculation of earnings per share for the fiscal
years ended August 31, 2004, 2003 and 2002:
2004 2003 2002
------------- ------------- ------------
Net income $ 55,942 $ 45,670 $ 39,000
Weighted average common shares outstanding 43,559 43,399 43,826
Incremental common shares issuable: stock options
and awards 743 374 385
------------- ------------- ------------
Weighted average common shares outstanding
assuming dilution 44,302 43,773 44,211
============= ============= ============
Basic earnings per common share $1.28 $1.05 $0.89
============= ============= ============
Diluted earnings per common share $1.26 $1.04 $0.88
============= ============= ============
All historical share and per share amounts have been adjusted to reflect the
two-for-one split of the Company's common stock effected on August 15, 2003.
25. Warranty:
The Company's primary warranty obligation relates to intra-aortic balloon pumps.
The Company offers a warranty of one year to its U.S. customers and two years to
its international customers. As of August 31, 2004, the Company's estimated
product warranty obligation is $740. Because this estimate is based primarily on
historical experience, actual costs may differ from the amounts estimated.
26. Subsequent Event (unaudited):
In September 2004, the Company purchased certain assets of one of its
distributors in Italy, AB Medica S.p.A (ABM), for a total purchase price of up
to approximately $8,000 to be completed in the first quarter of fiscal 2005 with
various installments thereafter on account of ongoing tender contract sales. ABM
had been one of the Company's distributors in Italy since 1982. The agreement
includes the purchase of distributorship rights, customer lists, as well as the
inventory and specified tender contracts associated with the sales of ABM of the
Company's products. As a result of this transaction, the Company is currently
selling direct in Italy through its subsidiary, Arrow Italy S.p.A.
On October 27, 2004, the Company's Board of Directors approved a voluntary early
retirement program for all of the Company's salaried exempt and non-exempt
employees in its three locations in the Reading, Pennsylvania area who attain
age 57 or older and have at least five years of service with the Company as of
January 31, 2005. The program provides that each such eligible employee who
makes an election to retire from the Company on or between November 10, 2004 and
January 31, 2005 will (1) receive payments equal to two weeks pay for each year
of his or her service and a lump sum payment of $20,000, (2) be treated as if
such employees retired under the salaried pension plan at his or her normal
retirement date without any additional years of service being credited but
without any reduction for early commencement of benefits, and (3) have their
stock options issued under the Company's stock incentive plans, which are
unvested as of the effective date of his or her retirement, accelerated so as to
vest and become fully exercisable as of such date. The Company presently
anticipates that the cash cost of this program will be approximately $3,600,
assuming full participation in the program, which will be included in
restructuring charges over the next two fiscal quarters as employee elections
under this program are received and the related costs are incurred.
As part of its plans to rationalize its production operations in Europe, in
November 2004, the Company determined to move its European Distribution Center,
currently situated in Weesp, Netherlands, to a more centralized European
location in the Limberg region of Belgium, in order to have better access to
existing carrier transportation networks and allow for more cost-competitive
expansion of its European operations in the future. The Company anticipates that
this re-location will be completed in the second quarter of fiscal 2005 and will
cost up to approximately $2,000.
(64)
SCHEDULE II
ARROW INTERNATIONAL, INC.
VALUATION AND QUALIFYING ACCOUNTS
Additions
----------------------------------
Charges /
Balance at (Credits) to Charged Balance at
Beginning Cost and to Other End
Description of Period Expenses Accounts Deductions(1) of Period
- ----------------------------------------- --------------- --------------- --------------- --------------- ---------------
For the year ended August 31, 2002:
Accounts receivable:
Allowance for doubtful accounts $ 965 $ 462 $ - $ 471 $ 956
=============== =============== =============== =============== ===============
For the year ended August 31, 2003:
Accounts receivable:
Allowance for doubtful accounts $ 956 $ 674 $ - $ 518 $ 1,112
=============== =============== =============== =============== ===============
For the year ended August 31, 2004:
Accounts receivable:
Allowance for doubtful accounts $ 1,112 $ 1,437 $ - $ 351 $ 2,198
=============== =============== =============== =============== ===============
(1) Deductions represent write-offs of accounts receivable. .
(65)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of the Company's management, including its Chief Executive
Officer, or CEO, and its Chief Financial Officer, or CFO, of the effectiveness
of the Company's disclosure controls and procedures as of August 31, 2004. Based
on that evaluation, the Company's management, including its CEO and CFO, have
concluded that the Company's disclosure controls and procedures are effective to
ensure that information required to be disclosed in the reports that the Company
files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. There have been no significant changes in the Company's
internal controls over financial reporting or in other factors identified in
connection with this evaluation that occurred during the three months ended
August 31, 2004 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
(66)
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
CODE OF ETHICS
The Company has adopted a code of ethics within the meaning of Item 406(b)
of SEC Regulation S-K, which applies to all of its officers, directors and
employees, including its principal executive officer, principal financial
officer, principal accounting officer and other members of its management
performing similar functions. This document is available free of charge on the
Company's website at WWW.ARROWINTL.COM.
Information regarding directors and nominees for directors of the Company,
as well as certain other information required by this item, will be included in
the Company's Proxy Statement to be issued in connection with its 2005 Annual
Meeting of Shareholders to be held on January 19, 2005 (the "Proxy Statement"),
and is incorporated herein by reference. The information regarding executive
officers required by this item is contained in Part I of this report under the
caption "Executive Officers".
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation of Arrow's directors and
executive officers will be included in the Proxy Statement and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
Information regarding beneficial ownership of the Company's common stock by
certain beneficial owners and by management of the Company will be included in
the Proxy Statement and is incorporated herein by reference.
The following table sets forth certain information regarding the Company's
equity compensation plans as of August 31, 2004.
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
Plan Category warranties and rights warrants and rights reflected in column (a))
- ----------------------------------- -------------------------- -------------------------- ---------------------------
(a) (b) (c)
Equity compensation plans
approved by security
holders 3,084,152 $20.49 11,379,110
Equity compensation plans
not approved by security
holders - - -
Total 3,084,152 $20.49 11,379,110
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions with
management of the Company will be included in the Proxy Statement and is
incorporated herein by reference.
(67)
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES (AMOUNTS IN THOUSANDS)
The Company's registered public accounting firm is PricewaterhouseCoopers
LLP, Certified Public Accountants. PricewaterhouseCoopers LLP has served as the
Company's independent registered public accounting firm since fiscal 1985.
AUDIT FEES
The aggregate fees for professional services rendered by
PricewaterhouseCoopers LLP in connection with its audit of the Company's annual
consolidated financial statements, statutory audits of the Company's foreign
subsidiaries, and reviews of the interim financial statements included in the
Company's quarterly reports on Form 10-Q were $815 and $646 for the fiscal years
ended August 31, 2004 and 2003, respectively.
AUDIT-RELATED FEES
In addition to fees disclosed under "Audit Fees" above, the aggregate fees
for professional services rendered by PricewaterhouseCoopers LLP for assurance
and related services that are reasonably related to the performance of the audit
and reviews of the Company's financial statements were $153 and $69 for the
fiscal years ended August 31, 2004 and 2003, respectively. Such services
included accounting consultations and audits in connection with acquisitions,
and additional assurance and related services for the Company's foreign
subsidiaries.
TAX FEES
The aggregate fees for professional services rendered by
PricewaterhouseCoopers LLP for tax compliance assistance in connection with the
tax preparation and tax computations for the Company's U.S. and foreign
subsidiaries were $210 and $315 for the fiscal years ended August 31, 2004 and
2003, respectively.
The aggregate fees for professional services rendered by
PricewaterhouseCoopers LLP for tax audit assistance and defense, including
transfer pricing for the Company's U.S. and foreign subsidiaries, were $310 and
$314 for the fiscal years ended August 31, 2004 and 2003, respectively,
The aggregate fees for professional services rendered by
PricewaterhouseCoopers LLP for miscellaneous tax planning and advice, including
U.S., State and International, for the Company's U.S. and foreign subsidiaries
were $42 and $110 for the fiscal years ended August 31, 2004 and 2003,
respectively.
ALL OTHER FEES
The aggregate fees for professional services rendered by
PricewaterhouseCoopers LLP for other services for the Company's U.S. and foreign
subsidiaries, consisting of consulting services for the defined benefit pension
plan, were $64 and $0 for the fiscal years ended August 31, 2004 and 2003,
respectively.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES
The Audit Committee of the Company's Board of Directors pre-approves on an
annual basis the audit, audit-related, tax and other non-audit services to be
rendered by the Company's accountants based on historical information and
anticipated requirements for the following fiscal year. The Audit Committee
pre-approves specific types or categories of engagements constituting audit,
audit-related, tax and other non-audit services as well as the range of fee
amounts corresponding to each such engagement. To the extent that the Company's
management believes that a new service or the expansion of a current service
provided by the Company's accountants is necessary or desirable, such new or
expanded services are presented to the Audit Committee for its review and
approval prior to the Company's engagement of its accountants to render such
services. No non-audit services were approved by the Audit Committee pursuant to
Rule 2-01, paragraph (c)(7)(i)(C) of SEC Regulation S-X during the fiscal year
ended August 31, 2004.
(68)
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1 The financial statements listed in the Index to Consolidated
Financial Statements under Item 8 of this report are filed as part of this
report.
2 Financial Statement Schedule II of the Company is filed as part of
this report.
Other statements and schedules are not presented because they are either
not required or the information required by statements or schedules is presented
elsewhere.
3 See Exhibit Index on pages 71 through 75 of this report for a list
of the exhibits filed, furnished or incorporated by reference as part of this
report.
(b) Reports on Form 8-K:
o Current Report on Form 8-K, dated June 23, 2004, reporting under Item
12. Results of Operations and Financial Condition, announcing the
Company's third quarter fiscal 2004 earnings.
o Current Report on Form 8-K, dated September 29, 2004, reporting under
Item 2.02. Results of Operations and Financial Condition, announcing
the Company's fourth quarter fiscal 2004 earnings.
o Current Report on Form 8-K, dated October 27, 2004, reporting under
Item 1.01. Entry into a Material Definitive Agreement, Item 5.02.
Departure of Director or Principal Officers, Elections of Directors,
Appointment of Principal Officers, and Item 5.03. Amendments to
Articles of Incorporation or By-laws; Change in Fiscal Year, relating
to the Company's approval of a new early retirement program, the
retirement of the Company's President and Chief Operating Officer and
certain amendments to the Company's By-Laws.
(69)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ARROW INTERNATIONAL, INC.
By: /s/ Frederick J. Hirt
-----------------------------------------
Frederick J. Hirt
Chief Financial Officer and
Senior Vice President of Finance
Dated: November 12, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signatures Title Date
---------- ----- ----
/s/ Carl G. Anderson, Jr. Director, Chairman and November 12, 2004
- --------------------------------- Chief Executive Officer
(Carl G. Anderson, Jr.) (Principal Executive Officer)
/s/ Frederick J. Hirt Chief Financial Officer and November 12, 2004
- --------------------------------- Senior Vice President of Finance
(Frederick J. Hirt) (Principal Financial and
Accounting Officer)
/s/ Marlin Miller, Jr. Director November 12, 2004
- ---------------------------------
(Marlin Miller, Jr.)
/s/ Raymond Neag Director November 12, 2004
- ---------------------------------
(Raymond Neag)
/s/ John H. Broadbent, Jr. Director November 12, 2004
- ---------------------------------
(John H. Broadbent, Jr.)
/s/ T. Jerome Holleran Director November 12, 2004
- ---------------------------------
(T. Jerome Holleran)
/s/ Richard T. Niner Director November 12, 2004
- ---------------------------------
(Richard T. Niner)
/s/ George W. Ebright Director November 12, 2004
- ---------------------------------
(George W. Ebright)
/s/ Alan M. Sebulsky Director November 12, 2004
- ---------------------------------
(Alan M. Sebulsky)
/s/ John E. Gurski Director November 12, 2004
- ---------------------------------
(John E. Gurski)
/s/ R. James Macaleer Director November 12, 2004
- ---------------------------------
(R. James Macaleer)
(70)
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT METHOD OF FILING
- ---------------- ----------------------------------------------- -----------------------------------------------------
3.1 Restated Articles of Incorporation of the Incorporated by reference from Exhibit 3.1 to the
Company. Company's Annual Report on Form 10-K for the fiscal
year ended August 31, 1992
3.2 By-laws of the Company, as amended and Incorporated by reference from Exhibit 3.2 to the
restated. Company's Current Report on Form 8-K dated October
27, 2004 (the "October 2004 Form 8-K").
4.1 Form of Common Stock certificate. Incorporated by reference from Exhibit 4.1 to the
Company's Registration Statement on Form S-1 File
No. 33-47163 (the "Registration Statement")
10.1 1992 Stock Incentive Plan. Incorporated by reference from Exhibit 10.1 to the
Company's Registration Statement
10.2 Arrow International, Inc. 401(k) Summary Plan Incorporated by reference from Exhibit 10.2 to the
Description (as Amended on June 1, 2001). Company's Quarterly Report on Form 10-Q for the
third quarter period ended May 31, 2002 (the "May
31, 2001 Form 10-Q")
10.3 Amended and Restated Retirement Plan for Incorporated by reference from Exhibit 10.3.2 to
Salaried Employees of the Company, effective the Company's Annual Report on Form 10-K for the
September 1, 1989, as amended. year ended August 31, 1993 (the "1993 Form 10-K")
10.4 Amended and Restated Restricted Stock Bonus Incorporated by reference from Exhibit 10.4 to the
Plan. Company's Registration Statement
10.5 Split Dollar Life Insurance Agreements, dated Incorporated by reference from Exhibit 10.5 to the
December 16, 1991, between the Company and Company's Registration Statement
James H. Miller, as Trustee under the
provisions of a certain Irrevocable Trust
Agreement with Marlin Miller, Jr. dated
December 13, 1991.
10.6 Split Dollar Life Insurance Agreements, dated Incorporated by reference from Exhibit 10.6 to the
December 16, 1991, between the Company and Company's Registration Statement
Raymond Neag Irrevocable Trust, dated October
11, 1991, Sevier J. Neag, Trustee.
10.7 Split Dollar Life Insurance Agreements, dated Incorporated by reference from Exhibit 10.7 to the
December 16, 1991, between the Company and Company's Registration Statement
Robert E. Gedney, as Trustee under the
provisions of a certain Irrevocable Trust
Agreement with John H. Broadbent, Jr. dated
December 13, 1991.
10.8 Split Dollar Life Insurance Agreements, dated Incorporated by reference from Exhibit 10.8 to the
December 16, 1991 between the Company and Company's Registration Statement
Donald M. Mewhort, as Trustee under Agreement
of Trust dated October 8, 1991, created by T.
Jerome Holleran, Settlor (the"Holleran Split
Dollar Life Insurance Agreements").
(71)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT METHOD OF FILING
- ---------------- ----------------------------------------------- -----------------------------------------------------
10.8.1 Assignment, dated April 24, 1992, of the Incorporated by reference from Exhibit 10.8.1 to
rights and obligations under the Holleran the Company's Registration Statement
Split Dollar Life Insurance Agreements from
the Company to Arrow Precision Products, Inc.
10.9 License Agreement, dated March 28, 1991, Incorporated by reference from Exhibit 10.11 to the
between Daltex Medical Sciences, Inc. and the Company's Registration Statement
Company.
10.9.1 Modification Agreement, dated October 25, Incorporated by reference Exhibit 10.11.1. to the
1995, to License Agreement between Daltex Company's Quarterly Report on Form 10-Q for the
Medical Sciences, Inc. and the Company third quarter period ended May 31, 1997 (the "May
31, 1997 Form 10-Q")
10.9.2 Second Modification Agreement, dated May 30, Incorporated by reference from Exhibit 10.11.2 to
1997, to License Agreement between Daltex the May 31, 1997 Form 10-Q
Medical Sciences, Inc. and the Company.
10.10 Agreement and Compromise and Release, dated Incorporated by reference from Exhibit 10.12 to the
November 30, 1988, between Michael A. Berman, Company's Registration Statement
Critikon, Inc. and the Company.
10.11 License Agreement, dated September 16, 1988, Incorporated by reference from Exhibit 10.14 to the
between J. Daniel Raulerson and the Company, Company's Registration Statement
as amended pursuant to Addendum to License
Agreement, dated November 27, 1989, between
J. Daniel Raulerson and the Company.
10.12 Stock Purchase Agreement, dated October 24, Incorporated by reference from Exhibit 10.16 to the
1990, among Robert E. Fischell, Standard Company's Registration Statement
Associates, Cymed Ventures, Inc., Arrow
International Investment Corp. and the
Company.
10.13 Settlement Agreement, dated September 30, Incorporated by reference from Exhibit 10.20 to the
1991, among Dr. Randolph M. Howes, Janice Company's Registration Statement
Kinchen Howes, Baham & Anderson, the Company
and Baxter Health Care Corporation and
related License Agreement, dated September
30, 1991, among Dr. Randolph M. Howes, Janice
Kinchen Howes, Baham & Anderson, the Company
and Baxter Health Care Corporation.
10.14 Agreement dated August 4, 2003 between the Incorporated by reference from Exhibit 10.14 to the
Company and United Steelworkers of America 2003 Form 10-K
AFL/CIO Local 8467.
10.15 Amended and Restated Retirement Plan for Incorporated by reference from Exhibit 10.23.2 to
Hourly-Rated Employees of the Wyomissing the 1993 Form 10-K
Plant of the Company, effective September
1,1989, as amended.
(72)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT METHOD OF FILING
- ---------------- ----------------------------------------------- -----------------------------------------------------
10.16 Amended and Restated Retirement Plan for Incorporated by reference from Exhibit 10.24.2 to
Hourly-Rated Employees of the North Carolina the 1993 Form 10-K
and New Jersey Plants of the Company,
effective September 1, 1989, as amended.
10.17.1 Installment Sale Agreement between Berks Incorporated by reference from Exhibit 10.25.10 to
County Industrial Development Authority and the Company's Registration Statement
the Company, dated as of December 1, 1988.
10.17.2 Indenture of Trust between Berks County Incorporated by reference from Exhibit 10.25.11 to
Industrial Development Authority and Bankers the Company's Registration Statement
Trust Company, as trustee, dated as of
December 1, 1988.
10.17.3 Irrevocable Direct Pay Letter of Credit, Incorporated by reference from Exhibit 10.25.12 to
dated December 28, 1988, issued for the the Company's Registration Statement
benefit of Bankers Trust Company, as trustee
under the Indenture of Trust, for the account
of the Company.
10.17.4 Letter of Credit Reimbursement Agreement Incorporated by reference from Exhibit 10.25.14 to
between the Company and Hamilton Bank, dated the Company's Registration Statement
as of December 1, 1988.
10.17.5 Accommodation Mortgage, Security Agreement Incorporated by reference from Exhibit 10.25.15 to
and Second Assignment of Installment Sale the Company's Registration Statement
Agreement, dated as of December 15, 1988, by
and among Berks County Industrial Development
Authority, the Company and Hamilton Bank.
10.18 Agreement, dated September 22, 1993, among Incorporated by reference from Exhibit 10.32 to the
Microwave Medical Systems, Inc., the Company 1993 Form 10-K
and Kenneth L. Carr.
10.19 Stock Purchase Agreement, dated as of January Incorporated by reference from Exhibit 2 to the
28, 1994 between Kontron Instruments Holding Company's Current Report on Form 8-K filed with the
N.V. and the Company. Securities and Exchange Commission on February 18,
1994
10.20 Loan Agreement between Arrow Japan KK and the Incorporated by reference from Exhibit 10.37 to the
Bank of Tokyo (with English translation). Company's Current Report on Form 8-K filed with the
Securities and Exchange Commission on April 10,
1995 ("the 1995 Form 8-K")
10.21 Thoratec Laboratories Corporation Incorporated by reference from Exhibit 10.38 to the
International Medical Products Distributor 1995 Form 8-K
Agreement, dated as of January 19, 1995,
between Thoratec Laboratories Corporation and
the Company.
10.22 Purchase Agreement, dated as of April 7, Incorporated by reference from Exhibit 10.39 to the
1995, among the Company, TLP Acquisition 1995 Form 8-K
Corp., Therex Corporation, Therex Limited
Partnership Holding Corporation and each of
the other persons signatory thereto.
(73)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT METHOD OF FILING
- ---------------- ----------------------------------------------- -----------------------------------------------------
10.23 Amendment, dated July 27, 1995, to License Incorporated by reference from Exhibit 10.43 to the
Agreement, dated October 24, 1990, between 1995 Form 10-K
Medical Innovative Technologies R&D Limited
Partnership and the Company.
10.24 Amendment, dated July 27, 1995, to Research Incorporated by reference from Exhibit 10.44 to the
and Development Agreement, dated October 24, 1995 Form 10-K
1990, between Medical Innovative Technologies
R&D Limited Partnership and the Company.
10.25 Directors Stock Incentive Plan Incorporated by reference from Exhibit 10.47 to the
1996 Form 10-K
10.26 Purchase Agreement, dated June 1, 1996, Incorporated by reference from Exhibit 10.48 to the
between Arrow Tray Products, Inc. (formerly 1996 Form 10-K
known as Endovations, Inc.) and the Company.
10.27 Purchase Agreement, dated August 3, 1998, Incorporated by reference from Exhibit 10.49 to the
between Medical Parameters, Inc. and the Company's Annual Report on Form 10-K for the fiscal
Company. year ended August 31, 1999 (the "1999 Form 10-K")
10.28 Asset Purchase Agreement, dated November 5, Incorporated by reference from Exhibit 10.52 to the
1997, between Arrow Interventional, Inc., 1999 Form 10-K
Boston Scientific Corporation and IABP
Corporation.
10.29 Mutual Release Agreement, dated July 20, Incorporated by reference from Exhibit 10.53 to the
1998, between Arrow International, Inc. and 1999 Form 10-K
Daltex Medical Sciences, Inc.
10.30 Exclusive License Agreement, dated February Incorporated by reference from Exhibit 10.54 to the
14, 1996 between Arrow International, Inc. 1999 Form 10-K
and Israel Schur, M.D.
10.31 Directors Stock Incentive Plan (as amended on Incorporated by reference from Exhibit 10.55 to the
January 19, 2000) 2000 Form 10-K
10.32 1999 Stock Incentive Plan Incorporated by reference from Exhibit 10.56 to the
2000 Form 10-K
10.32.1 1999 Stock Incentive Plan (as amended on Filed herewith
October 27, 2004)
10.33 Loan Agreement, dated April 12, 2001, among Incorporated by reference from Exhibit 10.57 to the
First Union National Bank, First Union May 31, 2001 Form 10-Q
National Bank, London Branch, and Arrow
International, Inc., Arrow Medical Products,
Ltd., Arrow Deutschland, GmbH, Arrow Iberia,
S.A., Arrow Internacional de Mexico S.A. de
C.V., Arrow Hellas Commercial A.E., Arrow
Holland Medical Products B.V., and Arrow
International CR, A.S.
(74)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT METHOD OF FILING
- ---------------- ----------------------------------------------- -----------------------------------------------------
10.33.1 Second Amendment to Loan Agreement dated June Incorporated by reference from Exhibit 10.33.1 to
30, 2003, among Wachovia Bank, National the 2003 Form 10-K
Association (f/k/a First Union National
Bank),Wachovia Bank, National Association,
London Branch (f/k/a First Union National
Bank, London Branch), and Arrow
International, Inc., Arrow Medical Products,
Ltd., Arrow Deutschland, GmbH, Arrow Iberia,
S.A., Arrow Internacional de Mexico S.A. de
C.V., Arrow Hellas Commercial A.E., Arrow
Holland Medical Products B.V., Arrow
International CR, A.S. and Arrow Italy S.R.L.
10.34 Arrow International, Inc. Defined Benefit Incorporated by reference from Exhibit 10.58 to the
Supplemental Executive Retirement Plan. May 31, 2001 Form 10-Q
10.34.1 Amendment No. 1 to the Arrow International, Incorporated by reference from Exhibit 10.34.1 to
Inc. Defined Benefit Supplemental Executive the 2003 Form 10-K
Retirement Plan
10.35 Certified Copy of Corporate Resolutions of Incorporated by reference from Exhibit 10.35 to the
the Company, dated October 27, 2004 October 2004 Form 8-K
authorizing and setting forth the terms of
the Company's Early Retirement Program
18 Preferability Letter of Incorporated by reference from Exhibit 18 to the
PricewaterhouseCoopers LLP. 1994 Form 10-K
21 Subsidiaries of the Company. Filed herewith
23 Consent of PricewaterhouseCoopers LLP. Filed herewith
31.1 Rule 13a-14(a)/15d-14(a) Certification of the Furnished herewith
Chief Executive Officer.
31.2 Rule 13a-14(a)/15d-14(a) Certification of the Furnished herewith
Chief Financial Officer.
32.1 Section 1350 Certification of the Chief Furnished herewith
Executive Officer.
32.2 Section 1350 Certification of the Chief Furnished herewith
Financial Officer.
(75)