UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 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, 2005
OR
[ ] 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|_|
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 under the Exchange Act). YES |_| NO|X|
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of February 28, 2005 was approximately 902,957,871.
The number of shares of the Registrant's Common Stock outstanding on
October 1, 2005 was 44,639,367.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its Annual Meeting of
Shareholders to be held on January 18, 2006 which will be filed with the
Securities and Exchange Commission within 120 days after August 31, 2005, are
incorporated by reference in Part III of this report.
(2)
PART I
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.
Critical Care Products. Arrow's critical care products, the first of
which were originally introduced in 1977, accounted for approximately 85.0% of
net sales in each of fiscal 2005, 2004 and 2003. 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. During
fiscal 2005, the Company introduced its Arrow Select Kits in certain geographic
regions, which serve the Company's customers by providing configured kits to
meet their specific needs. These kits can be assembled from any of the Company's
product lines and are configured according to a customer's specifications. As
long as a customer can meet annual minimum consumption and release quantities,
the Company will provide a customized solution for that customer.
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), a hemodynamic
monitoring system 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). In November 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. During fiscal 2005, the Company introduced several new dialysis access
products, including the Edge(TM), a chronic hemodialysis catheter that has a
V-tip design similar to that of the Cannon Catheter(TM), but is placed in the
patient through an alternative method, and the Simplicity Micro-Puncture
Introducer Set, a new dialysis access product to be used in combination with the
Company's chronic hemodialysis catheters.
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 Neo[heart]Care product line of specialty catheters
and related procedure kits for use by neonatal intensive care units. As
previously reported, on December 3, 2004, the Company announced a voluntary
nationwide recall of all of the Neo[heart]Care Neo[heart]PICC 1.9 FR
Peripherally Inserted Central Catheters (the "NeoPICC Catheters"). As part of
its previously announced plans to rationalize its global manufacturing
operations, the Company decided to accelerate the integration of the
Neo[heart]Care manufacturing operations into its existing manufacturing
structure. In order to facilitate this integration and to address inspectional
observations issued by the U.S. Food and Drug Administration, or the FDA, the
Company temporarily ceased the manufacture, shipment and sale of its entire
Neo[heart]Care product line, including the NeoPICC Catheters, until it completes
the implementation of all corrective actions. In fiscal 2004, sales of
Neo[heart]Care products represented 1.8% of the Company's total net sales.
Shipments of the Neo[heart]Care product line, other than the NeoPICC Catheters,
are presently expected to resume in calendar 2006. Shipment of the NeoPICC
Catheters will resume after receipt of FDA clearance of a new 510(k) premarket
notification for these products, which is also presently expected to occur in
calendar year 2006. See Notes to Consolidated Financial Statements - Note 21 in
Item 8 of this report and "Certain Risks Relating to Arrow - Stringent
Government Regulation" included elsewhere in this item 1.
(3)
Cardiac Care Products. Arrow's cardiac care products accounted for
approximately 15.0% of net sales in each of fiscal 2005, 2004 and 2003. 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, and the Ultraflex 7.5 Fr. catheter, which is the smallest
IAB in the market and employs the Company's proprietary, wire reinforced
technology.
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) Left Ventricular Assist System, or LVAS, a small non-pulsatile,
centrifugal flow ventricular assist device.
As previously reported, on April 6, 2005, the Company's Board of
Directors decided to discontinue the development, sales and marketing programs
related to the Arrow LionHeart LVAS.
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 2005, 2004 and 2003, 61.1%, 64.6% and 65.7%, respectively, of
the Company's net sales were to U.S. customers. In this market, approximately
92.0% of the Company's fiscal 2005 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. The Company's acquisitions of some
of its distributors in key U.S. and international markets during the past
several years have resulted in sales and gross profit growth.
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, Austria,
Switzerland, Portugal and Italy. As of October 1, 2005, independent distributors
in 92 additional countries sell the Company's products in the remainder of the
world.
To support growth in international sales, the Company owns and 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 owns and 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 includes the construction or acquisition of additional
manufacturing facilities in the Czech Republic and in Chihuahua, Mexico, which
commenced in the first quarter of fiscal 2005 and is on going.
Revenues 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 of this report.
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. As previously reported, increased
demand for the Company's products over the last several years has limited its
ability to supply products at the required unit volumes given its existing
manufacturing capacity level. As a result, the Company has been actively
addressing the root causes of these capacity constraints that have resulted in
backorders on several products by continuing to expand its worldwide
manufacturing capacity and improve the efficiency of its processes and
technology on a priority basis as part of its previously reported "Project
Operational Excellence." No single customer accounts for more than 10% of the
Company's sales. Purchases of the Company's products by hospitals and physicians
have not been materially influenced by seasonal factors.
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.
(4)
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.
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
Neo[heart]Care(R) product line in March 2003 have allowed it to market Diatek's
Cannon Catheter(TM) hemodialysis catheter product and, until the temporary
cessation of the Neo[heart]Care(R) product line in January 2005, specialty
catheters and related procedure kits for use in neonatal intensive care units.
Research and development expenses totaled $29.7 million (6.5% of net
sales), $30.4 million (7.0% of net sales) and $28.2 million (7.4% of net sales)
in fiscal 2005, 2004 and 2003, 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 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 WAVE(TM) intra-aortic balloon pump and associated LightWAVE(TM)
catheter system in the U.S. and Europe. The Company's AutoCAT(R)2 WAVE(TM) 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.
The Company continues to market and make improvements to its
AutoCAT(R)2 WAVE(TM) IAB pump and associated LightWAVE(TM) catheter system. The
growing interest in this product has resulted in increased customer feedback,
providing the Company with valuable information for making additional product
enhancements. As a result of this customer feedback, the Company has upgraded
the software for this product and implemented related hardware changes, which it
believes will increase the overall competitiveness of the device. During the
course of fiscal 2005, sales of the AutoCAT(R)2 WAVE(TM) slowed as the Company
implemented these customer-suggested improvements, even though net sales of the
device increased by 48.3% in fiscal 2005 as compared to fiscal 2004. The Company
believes that many customers were delaying their purchases of the AutoCAT(R)2
WAVE and related LightWAVE catheters until the release of the new software
upgrade, which occurred in the first quarter of fiscal 2006. Development of this
product is an ongoing process, with product improvements constantly being made
and introduced as the underlying technology advances and the Company learns more
about customer requirements. The Company is currently undertaking another
upgrade of the AutoCAT 2 WAVE software, which is presently expected to be
released in mid-2006.
Although the Company is encouraged by the early sales results of its
AutoCAT(R)2 WAVE and related LightWAVE catheter system, the selling cycle for
IAB pumps is long and involves a number of decision-makers in any given
hospital. As a result, the Company is cautiously optimistic about this product's
future sales growth. The Company continues to believe that this new technology
represents a major step forward in IAB pumping and, should enable the Company to
gain market share based on its superior performance across a range of cardiac
requirements.
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 moving blood as its lubricating system.
Arrow considers the CorAide 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.
During fiscal 2005, the Company continued its previously reported
European clinical trials of the CorAide(TM)LVAS. The clinical trial results to
date have been encouraging, showing that the CorAide is operating as expected.
Since the resumption of the European clinical trials in February 2005, there
have been no issues with hemolysis, thrombosis or with the performance of the
device itself. In addition, the device has provided patients with a much
improved quality of life, in many cases allowing them to live at home. The
Company recognizes that while the clinical investigators are pleased with the
performance of the device, these results are relatively preliminary and the
number of patients is small, making it too early in the trial process to draw
definitive conclusions regarding the long-term viability of the device. The
Company plans to continue these clinical trials throughout fiscal year 2006.
(5)
The Company views the CorAide(TM) LVAS as a long-term development
program. The current 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 believes that the CorAide(TM)'s smaller size,
less invasive surgical approach and inherently simpler design promises better
opportunities for broader market acceptance than currently marketed LVAS
devices.
HemoSonic. During fiscal 2005, the Company continued to support its
HemoSonic(TM) cardiac output monitoring system that continuously measures
descending aortic blood flow using a non-invasive esophageal ultrasound probe.
The Company is currently developing a second generation version of the device
that will have a more extensive feature set, which the Company believes will be
more user-friendly and better able to meet the needs of a broader range of
clinicians. Market evaluation of the second generation device is expected to
begin in calendar year 2006.
LionHeart(TM)LVAS. As announced on April 7, 2005, the Company's Board of
Directors decided to discontinue the development, sales and marketing programs
related to its Arrow LionHeart LVAS, a fully implantable device providing
long-term cardiac assist for patients having insufficient left ventricular heart
function. This decision was based on the Company's review of ventricular assist
technology trends, its experience in marketing the device in Europe, the input
it received from the medical community, as well as the data and analysis of the
outside consultants it retained to analyze the long-term commercial opportunity
for this product. In addition, the Company thoroughly assessed the significant
additional time and investment required to maximize the potential of the
LionHeart. Based on consideration of all of these factors, the Board determined
that the LionHeart was not economically viable for the Company, as it would not
realize adequate returns for its shareholders in an acceptable period of time.
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 improve 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 AutoCAT(R)2WAVE(TM), it is exploring alternative
vendors for most of these items.
As previously reported, in April 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 includes the construction or acquisition of
additional manufacturing facilities in Zdar, Czech Republic and in Chihuahua,
Mexico, which commenced in the first quarter of fiscal 2005 and is ongoing.
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 sheath and catheter
products, CorAide(TM) left ventricular assist device, esophageal ultrasound
probe jacket and intra-aortic balloon pump products.
In addition, Arrow is a party to several license agreements with
unrelated third parties pursuant to which it has obtained, under 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 2006.
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.
From time to time, the Company is subject to legal actions involving
patent and other intellectual property claims. The Company is currently a
defendant in a lawsuit in the United States District Court in the Southern
District of New York, in which the plaintiffs, Thierry Pourchez and Bard Access
Systems Inc., allege 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 later in calendar 2005 or early
2006, although the Company cannot presently predict the precise timing. Based on
information presently available to the Company, the Company believes that its
products do not infringe any valid claim of the plaintiffs' patent and that,
consequently, it has meritorious legal defenses with respect to this action.
Although the ultimate outcome of this action is not expected to have a material
adverse effect on the Company's business
(6)
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.
The Company is currently a plaintiff in a patent infringement lawsuit
in the United States District Court in Baltimore, Maryland against Datascope
Corp. of Montvale, New Jersey. The Company manufactures and sells the
Arrow-Trerotola(TM) Percutaneous Thrombolytic Device (PTD(R)), which is used to
mechanically declot native arterio-venous fistulae and synthetic hemodialysis
grafts. The PTD was invented by Dr. Scott Trerotola while working at Johns
Hopkins University. Johns Hopkins University, the owner of two patents covering
the PTD, is also a plaintiff and the Company is the exclusive licensee of the
Trerotola patents. The Company has alleged that Datascope infringes these two
patents. A trial is anticipated during calendar year 2006.
The Company also commenced a patent infringement lawsuit in the
United States District Court in Boston, Massachusetts against Spire Corporation
of Bedford, Massachusetts. The Company is the owner of United States Patent No.
6,872,198, which covers a method of inserting a double-Y-shaped multi-lumen
catheter. The Company has alleged that the use of Spire's Pourchez RetrO(TM)
High Flow Kink-Resistant Catheter infringes this patent. The case is at the
beginning of the discovery phase, and trial is anticipated during calendar year
2007.
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.
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, marketing and distribution of 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, operating restrictions, withdrawal of
marketing clearances or approvals, and civil and criminal penalties, including
exclusion under Medicaid or Medicare, 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.
Through the Medical Device User Fee and Modernization Act of 2002, the
FDA increased its oversight of businesses involved with the reprocessing of
single use medical devices, or SUDs. The regulation was amended to require
reprocessing labeling, clarify submission pathways and define the requirements
for validation of cleaning, sterilizing and functional performance of
reprocessed SUDs. The improved guidance to reprocessors facilitates the
reprocessing business and may result in increased competition and price erosion.
On occasion, the Company has received notifications, including warning
letters, from the FDA of alleged deficiencies in the Company's compliance with
FDA requirements. In addition, from time to time the Company has recalled, or
issued safety alerts on, certain of its products, including its voluntary recall
in December 2004 of NeoCare's NeoPICC Catheters.
In June and August 2005, the Company received three warning letters from
the FDA. The first letter related to the FDA's March 31 to April 11, 2005
inspection of the Company's Mount Holly, New Jersey facility, where it
manufactures the Arrow Trerotola PTD(TM) Percutaneous Thrombolytic Device (the
"PTD"). The other two letters related to the Company's Neo[heart]Care
manufacturing operations following the FDA's December 2 to December 22, 2004
inspection of the Company's Reading, Pennsylvania facility with respect to
oversight of its Neo[heart]Care manufacturing operations and the FDA's December
6 to December 20, 2004 inspection of the Company's San Antonio, Texas facility
where it formerly manufactured Neo[heart]Care's NeoPICC Catheters prior to its
termination of operations at this facility and integration of such operations
into other existing facilities. The warning letters referred to Form 483
inspectional observations that the FDA had previously issued concerning the
PTD's and Neo[heart]Care's non-conformance with certain Quality System
Regulations for medical devices. The Company previously responded to these
observations with specific actions to correct this non-compliance, including, as
previously reported, the temporary cessation of the manufacture and sale of its
entire Neo[heart]Care product line and, with respect to the PTD, the
implementation and enhancement of procedures relating to non-conforming product,
production and process control, and inspection of finished product, as well as
related additional training of operation personnel. The Company responded to the
warning letters within the required time periods, describing the specific
follow-on corrective actions it has taken, and reiterating its commitment to
enhancing its good manufacturing practices and quality systems
(7)
As part of its Project Operational Excellence program, in February 2005
the Company engaged Quintiles Consulting, a provider of global consulting
services to the medical device, pharmaceutical and biologics industries, to
assist its project teams in implementing rigorous compliance procedures that in
many respects are expected to exceed those meeting existing regulatory
requirements, with the objective of achieving the highest practicable levels of
product quality assurance. As announced on November 2, 2005, to further support
the Company's continuing efforts to enhance its quality system compliance and
address the FDA's concerns, Arrow named Kenneth E. Imler, who had been the lead
consultant from Quintiles working on-site at the Company in connection with the
enhancement of its compliance procedures, to the newly created position of
Senior Vice President of Regulatory Affairs and Quality Assurance. Mr. Imler
will manage and oversee the Company's Regulatory Affairs and Quality Assurance
systems, programs and personnel.
To date, no FDA warning letter, recall or safety alert has had a
material adverse effect on the Company, but there can be no assurance that any
such event 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 that
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.
Health Care Cost Containment and Third Party Reimbursement
Government and private sector initiatives to limit the growth of health
care costs, including price regulation, competitive pricing, insurance 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.
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. Although 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
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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. Although 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. 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, 2005, the Company had approximately 3,700 full-time
employees, of which 274 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 that it
files 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 its
CorAide(TM) 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.
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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, which must be
gathered, analyzed and submitted to the FDA periodically for up to several
years. These data collection requirements can be burdensome.
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 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, operating restrictions, withdrawal of clearances or
approvals, and civil and criminal penalties, including exclusion under Medicaid
or Medicare, 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 payors. 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
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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
pricing of the Company's products.
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
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. In addition,
certain of the Company's patents are due to expire within the next two years and
the Company may be unsuccessful in its efforts to extend these patents through
improvement patents or modifications. The failure to maintain its patents could
have a material adverse effect on the Company. 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. The Company expends significant resources to monitor and
enforce its intellectual property rights. However, it may not be able to detect
infringement and its competitive position in the industry could be materially
adversely affected.
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 for
significant royalties or 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 terrorist actions; fluctuations in currency
exchange rates; foreign exchange controls that restrict or prohibit repatriation
of funds; export and import restrictions or prohibitions; delays from customs
brokers or government agencies; changes in foreign medical reimbursement
policies and programs; 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
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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.
Supply Interruptions
Raw materials and purchased components relating to the Company's business
have typically been available within the lead times required by the Company.
However, there can be no assurance that they will continue to be available on
the same terms. The Company maintains single suppliers for certain of its
out-sourced components, and, although it is exploring alternative vendors for
most of these items, there can be no certainty that suitable alternative vendors
can be identified. Furthermore, the Company does not typically pursue regulatory
qualification of alternative sources due to the strength of its existing
supplier relationships and the time and expense associated with this regulatory
process. If the Company is unable to obtain these raw materials or there is a
significant increase in the price of materials or components, its business could
be harmed.
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, which is
owned by the Company, is 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 203,800 square
foot manufacturing and warehousing facility in Asheboro, North Carolina, which
was recently expanded in fiscal 2005 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
Neo[heart]Care(R) product line in March 2003, which the Company expects to sell
in fiscal 2006 as part of its plans 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 has acquired an additional
110,000 square foot manufacturing site near its existing plant in Chihuahua,
Mexico as part of its previously reported multi-year capital investment plan to
increase its worldwide manufacturing capacity and rationalize its production
operations, as further 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; and a
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19,000 square foot office center in Wyomissing, PA. The Company recently moved
its European Distribution Center, previously situated in Weesp, Netherlands, to
the Limberg region of Belgium and currently leases office and warehouse space at
both facilities. The Company also leases sales offices and warehouse space in
Canada, France, Germany, Japan, South Africa, Spain, Italy, Slovakia and Greece,
and sales office space in Mexico.
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 2005 through the solicitations of proxies or otherwise.
Executive Officers
The executive officers of Arrow and their ages and positions as of
November 1, 2005 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. 60 Chairman and Chief Executive Officer
James T. Hatlan 58 Senior Vice President - Manufacturing
Frederick J. Hirt 57 Senior Vice President-Finance and Chief Financial
Officer
Carl W. Staples 54 Senior Vice President-Human Resources
Kenneth E. Imler 56 Senior Vice President-Regulatory Affairs
and Quality Assurance
John C. Long 40 Vice President - Secretary and Treasurer
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. 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 in
several executive positions at ABC School Supply, Inc., a producer of materials
and equipment for public and private schools, including as 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. From
1972 to 1980, Mr. Hirt served in several accounting positions at the
international accounting firm of Coopers & Lybrand, the latest as audit manager.
Mr. Staples was elected Senior Vice President, Human Resources 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. Imler was elected Senior Vice President Regulatory Affairs and
Quality Assurance effective November 1, 2005. Prior to joining the Company, Mr.
Imler served as Principal Consultant for Quintiles Consulting, a leading quality
systems and regulatory
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consulting firm to the medical device, pharmaceutical and biologics industries,
from April 1999 to October 2005. As described in Item 1 of this report, the
Company engaged Quintiles in February 2005 to assist it in implementing rigorous
compliance procedures to achieve the highest practicable levels of product
quality assurance as part of its Project Operational Excellence program. From
March 1997 to April 1999, Mr. Imler served as President and principal of KEI
consulting, a private quality assurance and regulatory affairs consulting
company. From 1995 to 1997, Mr. Imler served as Director of Quality Assurance
and Regulatory Affairs for Medtronic Blood Management, a developer and
manufacturer of hemostasis and thrombosis in-vitro diagnostics and auto
transfusion systems. From 1993 to 1995, Mr. Imler served as Director of Quality
Assurance and Regulatory Affairs for COBE Renal Care, a developer and
manufacturer of renal dialysis equipment and disposables. From 1986 to 1993, Mr.
Imler served as Director of Quality Assurance and Regulatory Affairs for
Medtronic Heart Valve Division, a developer and manufacturer of biologic heart
valves and associated cardiac surgery devices. Prior to 1986, Mr. Imler held
various management positions in Quality Assurance and Regulatory Affairs at
SmithKline/Beckman Instruments, a developer and manufacturer of clinical
laboratory equipment and in-vitro diagnostics, and Behring Diagnostics, a
developer and manufacturer of in-vitro diagnostics.
Mr. Long has served as Vice President and Treasurer of the Company
since January 2003 and also as Secretary since April 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.
(15)
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.
Price per Share
=============================================
Quarter Ended High Low Dividends per Share
============================ ============================================= ===========================
August 31, 2005 $33.2400 $29.6000 $0.1500
May 31, 2005 $36.0200 $31.4800 $0.1500
February 28, 2005 $34.6800 $30.6000 $0.1500
November 30, 2004 $31.3000 $27.2100 $0.0900
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
As of October 1, 2005, there were approximately 489 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, 2005, 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 2005.
For the Fiscal Year Ended
August 31, 2005 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
(16)
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data for the years ended
August 31, 2005, 2004, 2003, 2002 and 2001 have been derived from the Company's
audited consolidated financial statements. The consolidated financial statements
of the Company as of August 31, 2005 and 2004 and for each of the three years in
the period ended August 31, 2005, 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 and the notes thereto, and Management's Discussion and Analysis of
Financial Condition and Results of Operations, included in Item 7 of this
report.
2005 2004 2003 2002 2001
------------ ----------- ------------ ------------ ------------
(In thousands, except per share amounts)
Consolidated Statement of Income Data:
Net sales $ 454,296 $ 433,134 $ 380,376 $ 340,759 $ 334,042
Cost of goods sold 240,457 208,687 190,246 169,625 158,573
Gross profit 213,839 224,447 190,130 171,134 175,469
Operating expenses
Research and development 29,692 30,374 28,170 26,165 25,209
Selling, general, and administrative 128,232 110,192 89,354 78,406 78,499
Restructuring charge 1,886 208 - - -
Special charges* - - 8,000 8,005 -
Total operating expenses 159,810 140,774 125,524 112,576 103,708
Operating income 54,029 83,673 64,606 58,558 71,761
Other expenses (income), net (795) 796 (2,312) 781 2,291
Income before income taxes 54,824 82,877 66,918 57,777 69,470
Provision for income taxes 15,311 26,935 21,248 18,777 22,925
----------- ----------- ------------ ------------ ------------
Net income $ 39,513 $ 55,942 $ 45,670 $ 39,000 $ 46,545
=========== =========== ============ ============ ============
Basic earnings per common share $ 0.89 $ 1.28 $ 1.05 $ 0.89 $ 1.06
========= ========= ========= ========= =========
Diluted earnings per common share $ 0.88 $ 1.26 $ 1.04 $ 0.88 $ 1.05
========= ========= ========= ========= =========
Cash dividends per common share $ 0.5400 $ 0.3500 $ 0.1950 $ 0.1375 $ 0.1275
Weighted average shares used in computing
basic earnings per common share 44,300 43,559 43,399 43,826 43,991
Weighted average shares used in computing
diluted earnings per common share 45,008 44,302 43,773 44,211 44,241
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.
(17)
2005 2004 2003 2002 2001
------------ ----------- ------------ ------------ ------------
(In thousands, except per share amounts)
Balance Sheet Data:
Working capital $238,606 $209,602 $163,914 $ 157,162 $ 110,227
Total assets $600,490 549,208 493,897 426,776 418,209
Notes payable and current maturities of
long-term debt 27,945 29,056 28,731 16,432 50,722
Long-term debt, excluding current maturities - - 3,735 300 600
Shareholders' equity 478,507 446,331 390,646 360,356 326,089
Certain prior period amounts in the table above have been reclassified to
conform to the fiscal 2005 presentation (see Notes to Consolidated Financial
Statements - Note 1 in Item 8 of this report).
* See Notes to Consolidated Financial Statements - Note 2 in Item 8 of this
report for a description of the special charges recorded in fiscal 2003. 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) LVAS, in Europe, the Company incurred $1,290 of
manufacturing variances related to systems being produced for market
introduction.
(18)
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, nephrologists,
emergency and trauma physicians, 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 and development
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 and development
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 enhance 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. 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 and sales growth by
increasing the efficiency and overall capacity of its manufacturing operations
while maintaining effective cost-containment programs. In this regard, in April
2004, the Company initiated a multi-year capital investment plan to increase its
worldwide manufacturing capacity to better meet customer demand and rationalize
its production operations, the first phase of which entails the construction and
acquisition of additional manufacturing facilities in the Czech Republic and
Mexico, and is ongoing. The Company is also in the process of consolidating
certain of its U.S.-based manufacturing operations, improving its production
technology by investing in new, state-of-the-art manufacturing equipment and
processes, and implementing enhanced good manufacturing practices and compliance
procedures to achieve the highest practicable levels of product quality
assurance, all as part of its Project Operational Excellence program. In
addition, in recent years, the Company has improved gross profit 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 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 believes that its
comprehensive manufacturing capability, which as described above is in the
process of being expanded, 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 2005 as
compared to fiscal 2004, and its operating results for fiscal 2004 as compared
to fiscal 2003. 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.
(19)
Results of Operations
The following table presents for the three years ended August 31, 2005
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
---------------------------------- -----------------------------------
2005 2004 2003
Year ended August 31, vs vs vs
----------------------------------
2005 2004 2003 2004 2003 2002
-------- -------- -------- --------- --------- ---------
Net sales 100.0 % 100.0 % 100.0 % 4.9 % 13.9 % 11.6 %
Gross profit 47.1 51.8 50.0 (4.7) 18.0 11.1
Operating expenses:
Research and development 6.5 7.0 7.4 (2.3) 7.8 7.6
Selling, general and
administrative 28.2 25.4 23.5 16.3 23.3 14.0
Restructuring charge 0.5 0.1 - 806.7 * *
Special charges** - - 2.1 - 0.0 0.0
-------------------------------------------------------------------------
Operating income 11.9 19.3 17.0 (35.5) 29.6 10.2
Other expenses (income), net (0.2) 0.1 (0.6) (199.9) (134.4) 396.0
Income before income taxes 12.1 19.2 17.6 (33.9) 23.9 15.7
Provision for income taxes 3.4 6.3 5.6 (43.2) 26.8 13.2
-------- -------- -------- --------- --------- ---------
Net income 8.7 % 12.9 % 12.0 % (29.3)% 22.3 % 17.2 %
* Not a meaningful comparison
** See Item 8. Financial Statements and Supplementary Data in this report for a
description of special charges
Fiscal 2005 Compared to Fiscal 2004
Net Sales
- ---------
Net sales increased by $21.2 million, or 4.9%, to $454.3 million in fiscal 2005
from $433.1 million in fiscal 2004 due primarily to an increase in critical care
sales, as well as an increase in cardiac care sales and a favorable foreign
exchange impact during fiscal 2005 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 sales for
fiscal 2005 of $5.5 million or 1.3% of total Company sales. Net sales represent
gross sales invoiced to customers, less certain related charges, discounts,
returns and rebates. The following is a summary of the Company's sales by
product platform:
Sales by Product Platform For the years ended
(in millions)
August 31, 2005 August 31, 2004
--------------- ---------------
Central venous catheters $235.2 $ 222.7
Specialty catheters 142.3 135.1
Non-Arrow distributed products 7.9 12.0
--- ----
Subtotal critical care 385.4 369.8
Cardiac care 68.9 63.3
---- ----
TOTAL $454.3 $ 433.1
====== =======
(20)
Sales of critical care products increased 4.2% to $385.4 million from $369.8
million in fiscal 2004 due primarily to increased sales of central venous
catheters and specialty catheters, offset by decreased sales of products
distributed by Stepic Medical, the Company's former New York City distributor,
the net assets of which it acquired in September 2002. Sales of central venous
catheters increased in fiscal 2005 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, offset in
part by decreased sales of neonatal products resulting from the Company's
previously reported decision in January 2005 to temporarily cease manufacturing,
shipping and selling of its Neo[heart]Care(R) product line until it completes
the integration of its Neo[heart]Care(R) manufacturing operations and
implementation of all corrective actions in response to previously reported FDA
compliance concerns. Sales of specialty catheters increased in fiscal 2005 due
to improved sales of arterial products, special procedure products, intravenous
and extension sets, and epidural products. Sales of cardiac care products
increased 8.8% to $68.9 million from $63.3 million in fiscal 2004 due primarily
to increased international sales of both intra-aortic balloon pumps and Super
Arrow-Flex(R) products. Total Company U.S. sales decreased 0.8% to $277.6
million from $279.9 million in the prior year principally as a result of
decreased sales of products distributed by Stepic Medical and decreased sales of
neonatal products for the reason described above, offset in part by increased
sales of specialty catheters. International sales increased by 15.3% to $176.7
million from $153.2 million in the prior year, principally as a result of
increased sales of central venous catheters, specialty catheters, IAB catheters
and pumps, Super Arrow-Flex(R) products and the effect of foreign currency
exchange rates, as noted above. International sales represented 38.9% of net
sales in fiscal 2005, compared to 35.4% in fiscal year 2004.
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 37% in
fiscal 2005 from 36% in the comparable prior year period for total Company
sales. The ARROWg+ard(R) conversion percentages for the U.S. market increased to
64% in fiscal 2005 from 62% in the comparable prior year period.
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 9% in
fiscal 2005 from 7% in the comparable prior year period for total Company sales.
The safety device procedure kit conversion percentages for the U.S. market in
fiscal 2005 increased to 17% from 14% in the comparable prior year period.
Gross Profit
- ------------
Gross profit decreased 4.7% to $213.8 million in fiscal 2005 from $224.4 million
in fiscal 2004. As a percentage of net sales, gross profit decreased to 47.1% in
fiscal 2005 compared to 51.8% in fiscal 2004. The decrease in gross margin was
due primarily to several items, including the following: (1) the recording of a
$12.4 million reserve in the fourth quarter of fiscal 2005 primarily for
inventory components in excess of 36 months forecasted usage (as well as
obsolete field service parts), consisting of $5.0 million of critical care
product raw materials, semi-finished and finished goods, $3.5 million of
Hemosonic components and $3.9 million of IAB inventories, which was due
primarily to a change in the fourth quarter of fiscal 2005 from an order point
to a Materials Requirement Planning system and an analysis in greater detail of
planned future usage as compared to inventory quantities on hand; as a result,
the Company was able to modify its estimates used to account for excess
inventory; (2) the recording of a provision to cost of sales of $4.6 million in
the second quarter of fiscal 2005 for inventory and manufacturing equipment
related to the Company's LionHeart LVAS as a consequence of the Board of
Directors' decision in April 2005 to discontinue the development, sales and
marketing programs related to the LionHeart; (3) incremental cost of sales of
$1.9 million in the second quarter of fiscal 2005 related to the Company's
voluntary early retirement program; (4) a $2.1 million write off of
manufacturing equipment no longer in use based on physical inventories in the
fourth quarter of fiscal 2005 of the Company's worldwide equipment; (5) lower
margins realized in fiscal 2005 on the sale of inventories of products acquired
as part of the Company's purchase of the net assets of AB Medica, the Company's
former Italian distributor, in September 2004, as further discussed below under
"Liquidity and Capital Resources - Investing Activities"; and (6) unfavorable
inventory adjustments in fiscal 2005 resulting from the scrapping of returned
goods and periodic cycle counting of inventories. This negative impact on
margins relative to the prior fiscal year was offset in part by the following:
(1) a $3.5 million reduction in depreciation expense in the fourth quarter of
fiscal 2005 for a correction of fixed asset lives related to manufacturing
equipment in the Company's non-U.S. facilities, as those lives were shorter than
those prescribed by the Company's policy; (2) higher margins resulting from
increased sales of the Company's procedure kits featuring its safety devices and
ARROWg+ard(R); (3) higher than average margins realized on increased sales of
renal access products during fiscal 2005 associated with the Company's
acquisition of Diatek in November 2002; and (4) higher cost of sales in fiscal
2004 due to the Company's write off of $3.1 million of inventory in the third
quarter of fiscal 2004 for certain LionHeart components that became obsolete
with the Company's decision during that quarter not to proceed with the
LionHeart Phase II U.S. clinical trials using the first generation LionHeart
power system.
Product Recall
- --------------
As previously reported, on December 3, 2004 the Company announced a voluntary
nationwide recall of all of its NEO[heart]PICC(R) 1.9 FR Peripherally Inserted
Central Catheters (the "NeoPICC Catheters") as a result of having received
several reports of adverse events involving the utilization of the NeoPICC
Catheters. The NeoPICC Catheter is part of the Company's Neo[heart]Care
product line of catheters and related procedure kits for neonatal intensive care
that it acquired from Klein Baker Medical, Inc. in March 2003. The Company
cooperated with the FDA in conducting the voluntary recall. As of November 14,
2005, the Company had not received any product liability claims in connection
with the product recall.
In the first quarter of fiscal 2005, the Company recorded a charge against net
sales of $0.5 million representing its issued sales credits as of January 7,
2005 and an estimate for those sales credits yet to be issued relating to
returned NeoPICC Catheters. As of August
(21)
31, 2005, the Company had issued sales credits totaling the full $0.5 million
and does not anticipate the need to issue any additional credits.
To address the inspectional observations of the FDA, the Company in January 2005
temporarily ceased the manufacture, shipment and sale of its entire Neo[heart]
Care product line, including the NeoPICC Catheters. In addition, the Company
moved its Neo[heart]Care manufacturing operations into its existing
manufacturing structure and suspended sales until it implements all corrective
actions related to the FDA's December 2004 inspections of the Company's
facilities in San Antonio, Texas and Reading, Pennsylvania. Shipments of the
Neo[heart]Care product line, other than the NeoPICC Catheters, are presently
expected to resume in calendar year 2006. Shipment of the NeoPICC Catheters will
resume after receipt of FDA clearance of a new 510(k) premarket notification for
these products, which is also presently expected to occur in calendar year 2006.
The Company's fiscal 2004 Neo[heart]Care product line sales were $7.6 million.
Inventories of NeoPICC Catheters at August 31, 2005 amounted to $0.3 million,
which the Company had fully reserved for as of August 31, 2005. Inventories of
other Neo[heart]Care products were approximately $1.4 million at August 31,
2005.
Research and Development
- ------------------------
Research and development expenses decreased by 2.3% to $29.7 million in fiscal
2005 from $30.4 million in the comparable prior year period. As a percentage of
net sales, these expenses decreased to 6.5% in fiscal 2005 compared to 7.0% in
fiscal 2004. The decrease in research and development expenses was primarily due
to decreased spending in fiscal 2005 on the LionHeart program, resulting from
the Company's Board of Director's decision to discontinue the development, sales
and marketing programs related to its LionHeart LVAS during the third quarter of
fiscal 2005, offset in part by increased expenditures for the Company's critical
care product line, including incremental research and development spending on
its ARROWg+ard(R) antiseptic treatment products and peripherally inserted
central catheter, or PICC, products, and increased expenditures for external
professional fees in connection with the Company's completion of its
investigation into the root causes for its recall of the NeoPICC Catheters.
Selling, General and Administrative
- -----------------------------------
Selling, general and administrative expenses increased by 16.3% to $128.2
million in fiscal 2005 from $110.2 million in the comparable prior year period,
and were 28.2% of net sales in fiscal 2005 compared to 25.4% in fiscal 2004.
This increase was due primarily to the following factors: (1) incremental
expenses related to the implementation of various special Company-wide programs,
including $5.0 million related to the Company's voluntary early retirement
program, $4.0 million related to the Company's review of its internal control
over financial reporting in compliance with Section 404 of the Sarbanes-Oxley
Act of 2002, $3.5 million incurred as a result of the Company's Project
Operational Excellence program, $1.3 million in connection with the Company's
corporate brand re-positioning program, and $0.5 million related to the
completion of a study by an outside consulting firm of the Company's LVAS
program during the first quarter of fiscal 2005; (2) increased costs of $2.0
million related to the settlement of a claim for indemnification related to a
divested business during the fourth quarter of fiscal 2005 which the Company
paid on November 4, 2005; (3) increased international costs, including $1.8
million related to the expansion of the Company's Italian direct sales
subsidiary following the Company's acquisition of AB Medica in September 2004,
$1.5 million resulting from the weakness of the U.S. dollar relative to
currencies of countries in which the Company operates direct sales subsidiaries,
and $0.9 million related to the continued enhancement of the Company's European
sales office; and (4) increased amortization expense of $1.0 million related to
the intangible asset included as part of the acquisition of AB Medica in
September 2004. These increases were offset in part by the following: (1)
decreased expenses of $2.7 million due to a reduction in the accrual for the
Company's income growth bonus plan for its executive officers and key management
employees; (2) decreased expenses of $1.2 million related to legal costs
associated with the Company's defense of patent litigation relating to certain
of its hemodialysis catheter products incurred in fiscal 2004; (3) the
non-recurrence of both a $1.3 million charge for severance and other costs
incurred in fiscal 2004 in connection with the reorganization of some of the
Company's operations and $0.6 million charge in fiscal 2004 for a write-off of
manufacturing equipment related to the LionHeart LVAS; and (4) decreased
expenses of $0.3 million related to the correction of fixed asset lives
associated with the Company's foreign sales subsidiaries.
Net Periodic Pension Cost
- -------------------------
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.
Restructuring Charges
- ---------------------
The Company recorded $1.9 million ($1.3 million after tax, or $0.03 diluted
earnings per share) of restructuring charges in fiscal 2005 compared to $0.2
million ($0.1 million after tax, or less than $0.01 diluted earnings per share)
in fiscal 2004 related primarily to severance payments associated with its
consolidation of operations at its Winston-Salem, North Carolina and San
Antonio, Texas facilities into other existing manufacturing facilities and
severance, lease termination and other costs associated with the relocation of
its European Distribution Center from Weesp, Netherlands to a more centralized
European location in the Limberg region of Belgium. See "-Liquidity and Capital
Resources - Investing Activities - Multi-Year Capital Investment Plan."
(22)
Operating Income
- ----------------
Principally due to the above factors, operating income decreased 35.5% to $54.0
million in fiscal 2005 from $83.7 million in fiscal 2004.
Other (Income) Expenses, Net
- ----------------------------
Other (income) expenses, net, was $0.8 million of income in fiscal 2005 as
compared to $0.8 million of expense in fiscal 2004, due in part to the Company
earning a higher amount of interest in fiscal 2005 on its investments of cash
balances. Aggregate foreign exchange losses were $0.1 million and $0.6 million
in fiscal 2005 and 2004, respectively. Foreign currency contracts resulted in
less than $0.1 million of gains in fiscal 2005 and $0.7 million of losses in
fiscal 2004.
Income Before Income Taxes
- --------------------------
As a result of the factors discussed above, income before income taxes decreased
in fiscal 2005 by 33.9% to $54.8 million from $82.9 million in fiscal 2004. The
Company's effective income tax rate in fiscal 2005 decreased to 27.9% from 32.5%
in fiscal 2004 due primarily to (1) a reduction in the income tax provision in
the fourth quarter of fiscal 2005 resulting from a shift in the mix of earnings
to the Czech Republic, which carries a lower tax rate due to a tax holiday
effective through August 2006, as further discussed below, (2) a reduction in
taxable income without a corresponding reduction in research and development tax
credits and the Extraterritorial Income Regime (the "ETI") tax deduction, and
(3) more favorable than expected fiscal 2004 research and development tax
credits resulting from the completion of the Company's analysis of these credits
during the second quarter of fiscal 2005. Partially offsetting these benefits
that reduced the effective income tax rate was the establishment of a $1.4
million accrual for state income taxes primarily related to taxation of its
intangible holding company.
U.S. Tax Matters
- ----------------
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 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 U.S. domestic manufacturers beginning in
the Company's fiscal year 2006. This new deduction begins at 3% of the Company's
U.S. domestic manufacturing income for the Company's fiscal years 2006 and 2007,
increasing to 6% for the Company's fiscal years 2008 to 2010 and achieves its
maximum rate of 9% for the Company's fiscal years 2010 and beyond. While the
Company is not yet able to make an exact calculation of the overall effect of
these changes, 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 to 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 fiscal 2006 and beyond.
Czech Republic Tax Holiday
- --------------------------
The effective tax rate for fiscal 2005 reflects the benefits of a tax holiday in
respect of the Company's Czech Republic operations. This tax holiday is
effective through August 2006 and is limited by the amount of capital
permanently invested in the Czech Republic by way of property, plant and
equipment purchased. This tax holiday resulted in a $2.8 million reduction in
the Company's income tax provision for fiscal 2005, or $0.05 basic and diluted
earnings per share.
Net Income
- ----------
Net income in fiscal 2005 decreased 29.3% to $39.5 million from $55.9 million in
fiscal 2004. As a percentage of net sales, net income represented 8.7% in fiscal
2005 compared to 12.9% in fiscal 2004.
Per Share Information
- ---------------------
Basic earnings per common share were $0.89 in fiscal 2005, down 30.5%, or $0.39
per share, from $1.28 in fiscal 2004. Diluted earnings per common share were
$0.88 in fiscal 2005, down 30.2%, or $0.38 per share, from $1.26 in fiscal 2004.
Weighted average shares of common stock outstanding used in computing basic
earnings per common share increased to 44,300,408 in fiscal 2005 from 43,559,410
in fiscal 2004, primarily as a result of an increase in stock option exercises
during fiscal 2005. Weighted average shares of common stock outstanding used in
computing diluted earnings per common share increased to 45,007,881 in fiscal
2005 from 44,301,960 in fiscal 2004 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 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. The following is a summary of the
Company's sales by product platform:
(23)
Sales by Product Platform For the years ended
(in millions)
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 Neo[heart]Care(R) product sales in the third and fourth fiscal
quarters of both years.
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 Neo[heart]Care(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.
Research and Development
- ------------------------
Research and development 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 and development 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 development expenditures in fiscal 2004
for the Company's critical care product line. These 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.
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
(24)
expenses of $3.4 million incurred in connection with the Company's acquisitions
in fiscal 2003 of Diatek, the Neo[heart]Care(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.
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 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.
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 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.
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
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.
(25)
Liquidity and Capital Resources
Operating Activities.
- ---------------------
Cash from Operations. 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 2005, net cash provided
by operations was $79.0 million, a decrease of $13.3 million, or 14.4% from the
prior year, due primarily to a decrease in net income, as described above under
"Fiscal 2005 Compared to Fiscal 2004," and the changes in certain working
capital and other accounts, including accrued post-retirement benefit
obligation, prepaid expenses, accounts receivable, accrued compensation,
inventory, accounts payable and accrued liabilities.
Accrued Post-Retirement Benefit Obligation. Accrued post-retirement benefit
obligation increased $5.3 million in 2005 compared to a $1.9 million increase in
fiscal 2004 primarily as a result of the recording of an additional minimum
liability for the Company's salaried employee pension plan as of August 31, 2005
due to the accumulated benefit obligation for the plan exceeding the fair value
of plan assets, which occurred in fiscal 2005 primarily because of a reduction
in the discount rate used to measure plan obligations as of August 31, 2005
compared to August 31, 2004 and the impact of the Company's Early Retirement
Program during fiscal 2005, which provided unreduced early retirement benefits
to eligible electing retirees.
Accounts Receivable. Accounts receivable increased $7.1 million in fiscal 2005
compared to a $1.5 million increase in fiscal 2004. Accounts receivable,
measured in days sales outstanding during the period, increased to 73 days at
August 31, 2005 from 71 days at August 31, 2004 due primarily to increased days
sales outstanding related to the Company's receivables from its Italian
customers, as described below.
As of August 31, 2005, the Company had an accounts receivable balance from its
Italian customers of $9.5 million, of which approximately 70% is related to
Italian government-backed hospital customers. The Company increased its direct
sales in this region following its acquisition of AB Medica in September 2004.
As of August 31, 2005, the days sales outstanding from customers in Italy was
286 days, which is significantly higher than that of the Company's overall
August 31, 2005 average customer days sales outstanding of 73 days. However,
according to information provided by Italy's National Health Service as of March
19, 2005, which represents the most recent data the Company has been able to
obtain, the average days sales outstanding for medical equipment supply
companies in the Italian market ranges from approximately 300 to 330 days, which
represents little change from the range of 285 to 318 days in 1990. The
Company's payment terms in this market are generally 90 days. The Company has
concluded that the Government of Italy typically delays payments to its
government-backed hospitals, which in turn has contributed to the increase in
the Company's overall days sales outstanding. The Italian government-backed
hospitals have historically paid customers 100% of their outstanding
receivables. As a result, the Company currently believes that the 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 all of 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 of August 31, 2005, the Company had recorded an allowance of less
than $0.1 million to reserve for specifically identified, potentially
uncollectible, private Italian customer balances.
As of August 31, 2005, the Company had an accounts receivable balance from its
Greek customers of $5.3 million, of which approximately 80% is related to Greek
government-backed hospital customers. As of August 31, 2005, the days sales
outstanding from customers in Greece was 518 days, which is significantly higher
than the Company's overall August 31, 2005 average customer days sales
outstanding of 73 days. However, according to information provided by the
Hellenic Association of Scientific and Medical Equipment Suppliers as of
February 1, 2005, which represents the most recent data the Company has been
able to obtain, the average days sales outstanding for medical equipment supply
companies in the Greek market is approximately 620 days. The Company's payment
terms in this market are generally 45 days. The Company has concluded that the
Government of Greece has been delaying payments to its government-backed
hospitals, which in turn has resulted in the Company's abnormally high days
sales outstanding for its receivables from Greek customers. The Greek Government
has announced a plan to resume payments on its trade debt, which should allow
its hospitals to repay their outstanding balances to their vendors. As of
October 31, 2005, the Greek Government had made four installments, the total of
which represents approximately 85% of its total obligation to its
government-backed hospitals and plans to fully repay the balance by the end of
calendar year 2005. The Government of Greece has initiated similar plans in the
past to reduce delinquent trade debt, which have resulted in the Company's
realization of a material portion of outstanding receivables following the
implementation of those plans. Therefore, 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. In addition, Greece
has also passed a law requiring a full payment of all outstanding obligations of
government-backed hospitals incurred after December 23, 2004. As of October 31,
2005, the Company had received $3.6 million against its outstanding receivables
from government-backed hospitals generated prior to December 24, 2004, of which
$2.9 million was received as of August 31, 2005. However, because the Company's
assessment is based in part on political factors beyond its control, the Company
cannot assure that all of 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 of August 31, 2005, the Company
had recorded an allowance of $0.3 million to reserve for both specifically
identified, potentially uncollectible, private Greek customer balances, as well
as an estimated amount for the Greek government's discount on the Company's
outstanding government-backed hospital customer balance.
(26)
The Company currently evaluates all of its trade receivables on a regular basis,
including those with its Greek and Italian customers, to ensure that each
receivable is recorded at net realizable value.
Prepaid Expenses. Prepaid expenses and other increased $1.1 million in fiscal
2005 compared to a $7.6 million decrease in fiscal 2004 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.
Accrued Compensation. Accrued compensation decreased $1.3 million in fiscal 2005
compared to a $3.5 million increase in fiscal 2004 due primarily to a (1)
reduction in the accrual in fiscal 2005 for the Company's income growth bonus
plan for its executive officers and key management employees, whereas the
Company had increased the same accrual in fiscal 2004, and (2) a decrease in the
Company's sales commission accrual based on lower sales performance against the
Company's objectives in fiscal 2005 as compared to fiscal 2004.
Inventories. Inventories decreased $0.7 million in fiscal 2005 compared to a
$5.6 million increase in fiscal 2004. The decrease in fiscal 2005 is primarily
due to (1) a reduction of inventory associated with the recording of a $12.4
million reserve in the fourth quarter of fiscal 2005 primarily for inventory
components in excess of 36 months forecasted usage (as well as obsolete field
service parts) consisting of $5.0 million of critical care product raw
materials, semi-finished and finished goods, $3.5 million of Hemosonic
components and $3.9 million of IAB inventories, which was due primarily to a
change in the fourth quarter of fiscal 2005 from an order point to a Materials
Requirement Planning system and an analysis in greater detail of planned future
usage to inventory quantities on hand; as a result, the Company was able to
modify its estimates used to account for excess inventory; and (2) a $2.9
million write off of LionHeart inventory as a result of the Company's decision
in April 2005 to discontinue this program. These decreases were offset in part
by (1) additional production and related manufacturing costs necessary to
support the Company's higher rate of sales, (2) incremental inventory value
booked as of August 31, 2005 as a result of the Company's change in the
accounting treatment related to its shipping terms, and (3) increased inventory
in connection with the anticipated introduction of the Company's enhanced
version of its AutoCAT(R)2 WAVE IAB and related LightWAVE catheter system. 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 in April 2004
not to proceed with U.S. clinical trials using the first generation
LionHeart(TM) power system and controller.
Accrued Liabilities and Dividends. Accrued liabilities increased $12.1 million
in fiscal 2005 compared to a $5.6 million decrease in fiscal 2004. The increase
in fiscal 2005 was due primarily to (1) the establishment of a deferred revenue
account in fiscal 2005 as a result of the Company's change in the accounting
treatment related to its shipping terms, as further discussed below under
"Critical Accounting Policies and Estimates," resulting in the reversal of sales
and a corresponding increase in deferred revenue; (2) the accrual of $2.0
million in the fourth quarter of fiscal 2005 for the settlement of an
indemnification claim related to a divested business, which the Company paid on
November 4, 2005, and (3) an incremental accrual related to professional service
fees for external auditing and internal audit assistance associated with the
Company's implementation of Section 404 of the Sarbanes-Oxley Act of 2002. The
decrease in fiscal 2004 was 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. Accrued dividends increased $2.8 million in fiscal 2005 compared to a $0.4
million increase in fiscal 2004 due primarily to the accrual of the Company's
dividends at a higher rate during the fourth quarter of fiscal 2005 as compared
to the fourth quarter of fiscal 2004.
Prepaid Pension Costs. Prepaid pension costs decreased $8.1 million in fiscal
2005 compared to a $2.9 million decrease in fiscal 2004, primarily as a result
of the recording of an additional minimum liability for the Company's salaried
employee pension plan as of August 31, 2005 due to the accumulated benefit
obligation for the plan exceeding the fair value of plan assets, which occurred
in fiscal 2005 primarily because of a reduction in the discount rate used to
measure plan obligations as of August 31, 2005 compared to August 31, 2004 and
the impact of the Company's Early Retirement Program during fiscal 2005, which,
as described below, provided unreduced early retirement benefits to eligible
electing retirees. This recording of the additional minimum liability for the
Company's salaried employee pension plan resulted in the change from a prepaid
pension asset at August 31, 2004 to a liability balance at August 31, 2005.
Offsetting this decrease were payments in fiscal 2005 required to fund certain
of the Company's pension plans.
Early Retirement Program. As previously reported, 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 attained age 57 or older and had
at least five years of service with the Company as of January 31, 2005. The
program provided that each such eligible employee who made an election to retire
from the Company on or between November 10, 2004 and January 31, 2005 would (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 his or her stock
options issued under the Company's stock incentive plans, which were unvested as
of the effective date of his or her retirement, accelerated so as to vest and
become fully exercisable as of such date.
(27)
During the second quarter of fiscal 2005, the Company recorded $6.9 million in
total costs with respect to this program, of which $1.9 million was recorded to
cost of sales and $5.0 million to selling, general and administrative expenses.
Of the $6.9 million in total costs, $2.8 million was for pension and other
postretirement benefits and $3.0 million was a cash charge related to severance
and related costs. The remaining $1.1 million was incurred as a non-cash charge
for accelerated vesting of stock options held by participants in this program. A
total of 28 participants elected to participate in this program, including, as
previously reported, the Company's former President and Chief Operating Officer
and its Executive Vice President - Global Business Development.
Japanese Tax Assessment. In March 2004, the Company paid to the Japanese
Government approximately $10.0 million to settle a tax assessment related to a
Japanese audit of the Company's transfer pricing. The Company is utilizing
competent authority proceedings with the Internal Revenue Service in the U.S. to
recover a majority of this Japanese tax assessment, although there can be no
assurance that it will be successful in these efforts.
Investing Activities.
- ---------------------
Net cash used in the Company's investing activities increased to $44.3 million
in fiscal 2005 from $31.6 million in fiscal 2004, due primarily to the Company's
acquisition, as further discussed below, of AB Medica in the first quarter of
Fiscal 2005 and increased capital expenditures primarily in support of the
Company's multi-year capital investment plan, including related investments in
production technology and equipment, and development and implementation of
enhanced good manufacturing practices and quality systems, all as part of its
Project Operational Excellence, as further discussed below.
Acquisition of C.R. Bard Cardiac Assist Division. 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
completed its payment obligations to Belmont pursuant to the asset purchase
agreement and, as of August 31, 2005, 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.
Acquisition of Stepic Medical. 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,
2005, 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
==========
Acquisition of Diatek. 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, 2005, 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, 2005, 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 under the
terms of the asset purchase agreement relating to this transaction. Pursuant to
this agreement 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
(28)
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.
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
==========
Acquisition of Neo[heart]Care. On March 18, 2003, the Company purchased
substantially all of the assets of Klein Baker Medical, Inc., a company doing
business as Neo[heart]Care(R) in San Antonio, Texas, for approximately $16.5
million. Neo[heart]Care(R) develops, manufactures and markets specialty
catheters and related procedure kits to neonatal intensive care units. As of
August 31, 2005, pursuant to the asset purchase agreement, the Company had paid
$16.4 million in cash which 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 under the terms of the asset purchase agreement
relating to this transaction. 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. 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
============
Acquisition of IMA. 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, 2005, pursuant to the asset purchase agreement,
the Company had paid 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
==========
Acquisition of AB Medica. On September 3, 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 approximately $8.9 million, with additional amounts
payable contingent upon the sales levels of products under sales contracts
purchased by the Company. ABM had been one of the Company's distributors in
Italy since 1982. The asset purchase agreement included the purchase of customer
lists and distributorship rights, as well as the inventory and specified tender
contracts associated with the sale by ABM of the Company's products. The Company
began selling directly in Italy through its subsidiary, Arrow Italy S.p.A., in
the first quarter of fiscal 2005. As of August 31, 2005, pursuant to the asset
purchase agreement, the Company had paid $8.6 million in cash and recorded a
current liability of $0.3 million for additional payment installments. 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 $5.7 million,
consisting of customer lists and distributorship rights, are being amortized
over five years based on the anticipated period over which the Company expects
to benefit from the transaction. Included in the first quarter of fiscal 2005
was a $1.5 million charge, or $1.0 million against net income ($0.02 diluted
earnings per share), for the step-up of inventory purchased from ABM. The
results of operations of this business
(29)
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)
Inventories $ 3.2
Intangible assets 5.7
-------
Total purchase price $ 8.9
=======
Multi-Year Capital Investment Plan. As previously reported, in April 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. This plan is being initiated to support projections
for future growth and to integrate operations acquired in recent years. The
first phase of this effort includes the construction or acquisition of
additional manufacturing facilities in Zdar, Czech Republic and Chihuahua,
Mexico, which commenced in the first quarter of fiscal 2005 and is ongoing. The
Company currently anticipates the total cost of this capacity increase to be
between $22.0 million and $28.0 million over a three-year period. In addition,
the Company also anticipates spending between $13.0 million and $17.0 million
over the same three-year period for equipment related to this expansion of its
manufacturing capacity. As of August 31, 2005, the Company had spent $12.5
million in connection with this capital investment plan.
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 this consolidation
is expected to continue into the first half of fiscal 2006. To date, the Company
has accrued costs of $0.9 million in connection with this restructuring,
consisting primarily of severance payments, of which $0.8 million had been paid
as of August 31, 2005 and the remaining accrual balance is expected to be paid
later in fiscal 2006. Severance payments relate to approximately 53 employees
primarily in manufacturing at both facilities. All other restructuring costs are
expected to be paid during the remainder of fiscal 2006.
As part of its plans to rationalize its production operations and related
logistics in Europe, in November 2004 the Company determined to move its
European Distribution Center, previously 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 continued this re-location in the fourth quarter of fiscal 2005 and
estimates it will incur a total of $1.6 million related to this plan. As of
August 31, 2005, the Company had accrued costs of $1.2 million related to this
re-location, of which $0.7 million had been paid in fiscal 2005.
Project Operational Excellence. During the fourth quarter of fiscal 2005, the
Company continued to take additional steps in implementing its Project
Operational Excellence program designed to help it achieve operational process
excellence in four key areas: product quality, safety, customer service and
cost. This program includes (1) as discussed above under "Multi-Year Capital
Investment Plan," restructuring the Company's manufacturing to increase
production capacity and better align its production facilities with the
geographical markets they serve, (2) improving the effectiveness of the
Company's production technology by investing in new, state-of-the-art
manufacturing equipment and processes, and (3) developing and implementing
enhanced good manufacturing practices and quality systems to maintain and
establish process excellence.
In connection with the Company's efforts to enhance its good manufacturing
practices and quality system compliance, it has incurred $3.5 million of costs
in fiscal 2005 and anticipates spending an additional $1.6 million in fiscal
2006, half of which it expects to incur in the first quarter of fiscal 2006.
Financing Activities
--------------------
Financing activities used $9.8 million of net cash in fiscal 2005, compared to
$14.4 million in fiscal 2004, primarily as a result of an increase in proceeds
from stock option exercises and a decrease in the Company's need for borrowings
under its U.S. revolving credit facility, offset in part by an increase in
dividend payments as a result of the Company's increase in its quarterly
dividend during fiscal 2005. 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,
2005, 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 2005.
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, 2005 and
2004, the Company had a revolving credit facility providing a total of $65.0
million in available revolving credit for general business purposes, of which
$21.8 million and $17.8 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; 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
(30)
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, 2005 and 2004, 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 $32.0 and $32.3 million, of which $5.1
and $8.2 million were outstanding, as of August 31, 2005 and 2004, respectively.
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,
2005, the weighted average interest rate on short-term borrowings was 2.1% per
annum. Combined borrowings under these facilities increased $0.9 million during
fiscal year 2005, all of which was related to foreign borrowings.
Inflation and Seasonality.
- --------------------------
During the periods discussed above, the overall effects of inflation and
seasonality on the Company's business were not significant.
Contractual Obligations,
- ------------------------
A summary of all of the Company's contractual obligations and commercial
commitments as of August 31, 2005 were as follows:
Payments due
or
Commitment Expiration
by Period
--------------------------------------------------------------
Total Less More
Contractual Obligations and than 1 - 3 3 - 5 than 5
Commercial Commitments 1 year years years years
- ------------------------------------------- --------- --------- --------- --------- ----------
($ in Millions)
Current maturities of long-term debt $ 1.1 $ 1.1 $ - $ - $ -
Operating leases 11.5 3.7 4.5 2.5 0.8
Purchase obligations (1) 38.7 38.7 - - -
Other long-term obligations 0.6 0.1 0.1 0.1 0.3
Lines of credit (2) 26.9 26.9 - - -
Standby letters of credit 1.5 1.5 - - -
--------- --------- --------- --------- ----------
Total cash contractual obligations and
commercial commitments $80.3 $72.0 $4.6 $2.6 $ 1.1
========= ========= ========= ========= ==========
(1) Includes open purchase orders primarily relating to the purchase of 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 multi-year capital investment plan and other
initiatives related to its Project Operational Excellence, as discussed above,
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
(31)
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 and pervasive accounting policies used in
the preparation of the Company's consolidated financial statements.
Revenue Recognition:
During the course of the second quarter closing process and in conjunction with
its review of its internal controls, the Company determined that it had
misapplied the accounting treatment related to its shipping terms to U.S.
customers and international distributors. The Company does not have written
agreements with most customers and, as a result, in most of those cases,
shipping terms are only specified on the invoice, which states free-on-board, or
FOB, plant. While the Company does not pay for shipping in most cases or insure
the shipments, its practice has been to credit or replace lost or damaged
shipments. During the past few years, amounts in respect of these credits and
replacements have been less than 0.05% of sales to customers in the U.S. and to
international distributors. Nevertheless, interpretations of Staff Accounting
Bulletin No. 104, Revenue Recognition in Financial Statements (SAB 104), issued
by the SEC staff require that, because of its practice of replacing lost or
damaged shipments, the Company's sales to customers in the U.S. and to
international distributors are the equivalent of FOB destination orders.
The Company's assessment determined that delivery time to U.S. customers is two
business days and, to its international distributors, seven days for air and
truck shipments and 55 days for ocean vessel shipments. By applying the
appropriate accounting treatment as described above, the amount of sales
corresponding to these numbers of days in transit at the end of the quarter must
be recognized in the succeeding quarter when the shipments are delivered. As a
result, during the second quarter of fiscal 2005, the Company recorded $4.3
million as a reduction to sales and $2.2 million against gross profit, or $0.03
diluted earnings per share. These sales amounts, however, were recognized in the
third quarter of fiscal 2005. While these sales amounts were recognized in the
third quarter of fiscal 2005, a similar amount of days sales was excluded from
the end of the fourth quarter and the excluded amount would be recognized in the
subsequent quarter. Accordingly, the incremental effect on any future quarter
would be the difference between the adjustment at the beginning of the quarter
and the corresponding adjustment at the end of the quarter.
The Company's revenue recognition policy is as follows:
Revenue is recognized by the Company at the time its products are delivered and
title and risk of loss 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's practice
is to credit or replace lost or damaged shipments. 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.
(32)
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. During the fourth quarter of fiscal 2005,
the Company changed from an order point to a Materials Requirement Planning
system and compared in greater detail planned future usage to inventory
quantities on hand and, as a result, was able to modify its estimates used to
account for excess inventory. As a result of this modification of its estimates,
the Company recorded in the fourth quarter of fiscal 2005 a $12.4 million
reserve primarily for inventory components in excess of 36 months forecasted
usage (as well as obsolete field service parts), consisting of $5.0 million of
critical care raw materials, semi-finished and finished goods, $3.5 million of
HemoSonic components and $3.9 million of IAB inventories. Inventory in excess of
36 months of forecasted usage may be used in the future if production
requirements increase. For certain new products, the Company manufactures
inventory in anticipation of product launch. As of August 31, 2005, the Company
had $0.7 million of inventory related to its HemoSonic(TM) hemodynamic
monitoring devices. The Company is currently developing improvements to this
product that 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.
Income Taxes:
The Company's effective tax rate differs from the statutory rate primarily as a
result of research and development tax credits, deductions associated with the
extraterritorial income tax regime and a tax holiday in the Czech Republic.
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's
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
(33)
The Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 151, "Inventory Costs, an Amendment of
Accounting Research Bulletin (ARB) No. 43, Chapter 4", in November 2004. This
statement amends the guidance in ARB No. 43 Chapter 4 "Inventory Pricing" to
clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs and wasted material. SFAS No. 151 requires that those items be
recognized as current period charges regardless of whether they meet the
criterion of "so abnormal." In addition, this statement requires that allocation
of fixed production overheads to the costs of conversion be based on the normal
capacity of the production facilities. The provisions of this statement will be
effective for inventory costs incurred during fiscal years beginning after June
15, 2005. The Company has evaluated the impact that this statement will have on
its financial statements and anticipates that it will not be material to its
results of operations.
The FASB issued SFAS No. 123R, "Share-Based Payment", in December 2004. This
statement requires 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. This statement replaces the guidance in SFAS No. 123,
Accounting for Stock-Based Compensation, and APB No. 25, Accounting for Stock
Issued to Employees. This statement will be effective for financial statements
relating to fiscal periods beginning after June 15, 2005. In addition, the SEC
issued Staff Accounting Bulletin ("SAB") No. 107 "Share-Based Payment" in March
2005, which provides supplemental SFAS No. 123R application guidance based on
the views of the SEC. The Company has evaluated the various transitional methods
and the impact that this statement will have on its financial statements and
estimates it will result in a charge to net income of $0.7 million in the first
quarter of fiscal 2006 and $3.4 million for the full fiscal 2006.
The FASB issued SFAS No. 154, "Accounting Changes and Error Corrections - a
replacement of Accounting Principles Board (APB) Opinion No. 20 and FASB
Statement No.3" in May 2005. This statement changes the requirements for the
accounting for and reporting of a change in accounting principle. SFAS No. 154
requires companies making a voluntary change in accounting principle to apply
that change retrospectively to prior periods financial statements, unless this
would be impracticable. This statement will be effective for fiscal years
beginning after December 15, 2005. The Company will comply with the provisions
of this statement for any future accounting changes or error corrections.
(34)
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 into U.S. dollars from foreign currencies 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, 2005 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, 2005 and 2004:
Fair Value of Foreign Currency
Forward Contracts
-----------------
(in millions)
August 31, 2005 August 31, 2004
--------------- ---------------
10% adverse rate movement $(0.9) $(0.5)
At August 31st rates - -
10% favorable rate movement $1.4 0.6
The Company had no foreign currency option contracts outstanding at
August 31, 2005 and 2004.
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. During fiscal 2005, 2004 and 2003, the percentage of
the Company's sales invoiced in currencies other than U.S. dollars was 27.1%,
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 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, 2005,
outstanding foreign currency forward contracts totaling the U.S. dollar
equivalent of $17.9 million mature at various dates through December 2005. As of
October 1, 2005, 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.
(35)
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.
(36)
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index To Consolidated Financial Statements
Page
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Management's Report on Internal Control 35
over Financial Reporting
Report of Independent Registered 36
Public Accounting Firm
Consolidated Balance Sheets at 37-38
August 31, 2005 and 2004
Consolidated Statements of Income 39
for the years ended August 31, 2005,
2004 and 2003
Consolidated Statements of Comprehensive 40
Income for the years ended August 31, 2005,
2004 and 2003
Consolidated Statements of Cash Flows 41-42
for the years ended August 31, 2005,
2004 and 2003
Consolidated Statements of Changes in 43-45
Shareholders' Equity for
the years ended August 31, 2005, 2004, and 2003
Notes to Consolidated Financial Statements 46-71
Schedule II - Valuation and Qualifying Accounts 72
(37)
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting. Internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with Generally Accepted
Accounting Principles ("GAAP"). It includes policies and procedures that:
o pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions
of the assets of the Company;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with GAAP, and that the Company's receipts and expenditures are being
made only in accordance with authorizations of management and
directors; and
o provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of our assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Management of the Company evaluated the effectiveness of its internal
control over financial reporting as of August 31, 2005, based on the criteria
established in a report entitled Internal Control - Integrated Framework, issued
by the Committee of Sponsoring Organizations of the Treadway Commission
("COSO"). Based on such evaluation and the criteria in the COSO framework, the
Company has concluded that its internal control over financial reporting was
effective as of August 31, 2005.
Management's assessment of the effectiveness of the Company's internal
control over financial reporting as of August 31, 2005 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as
stated in their report which appears on the following page.
(38)
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Arrow International, Inc.:
We have completed an integrated audit of Arrow International, Inc.'s 2005
consolidated financial statements and of its internal control over financial
reporting as of August 31, 2005 and audits of its 2004 and 2003 consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
Consolidated financial statements and financial statement schedule
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, 2005 and
2004, and the results of its operations and its cash flows for each of the three
years in the period ended August 31, 2005 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 financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and 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 of financial statements 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.
Internal control over financial reporting
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
August 31, 2005 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of August 31,
2005, based on criteria established in Internal Control - Integrated Framework
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting 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 effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
November 14, 2005
(39)
ARROW INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
August 31,
-------------------------------------------
2005 2004
------------------ -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 119,326 $ 94,176
Accounts receivable, less allowance for doubtful accounts
of $2,176 and $2,198 in 2005 and 2004, respectively 91,029 83,918
Inventories 95,356 96,084
Prepaid expenses and other 8,410 7,336
Deferred income taxes 16,338 8,562
------------------ -----------------
Total current assets 330,459 290,076
------------------ -----------------
Property, plant and equipment:
Land and improvements 6,887 5,808
Buildings and improvements 98,475 92,333
Machinery and equipment 193,215 186,404
Construction-in-progress 23,026 18,433
Property, plant and equipment held for sale, net 1,499 -
------------------ -----------------
323,102 302,978
Less accumulated depreciation (170,895) (166,000)
------------------ -----------------
152,207 136,978
Goodwill 42,772 42,698
Intangible assets, net of accumulated amortization of $27,841 and $24,294
in 2005 and 2004, respectively 43,674 40,440
Other assets 10,372 9,889
Prepaid pension costs 21,006 29,127
------------------ -----------------
Total assets $ 600,490 $ 549,208
================== =================
See notes to consolidated financial statements
(40)
ARROW INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS, continued
(In thousands, except share amounts)
August 31,
----------------------------------------
2005 2004
---------------- ----------------
LIABILITIES
Current liabilities:
Current maturities of long-term debt $ 1,054 $ 3,036
Notes payable 26,891 26,020
Accounts payable 17,391 14,791
Cash overdrafts 400 1,136
Accrued liabilities 24,571 12,513
Accrued dividends 6,693 3,940
Accrued compensation 12,908 14,171
Accrued income taxes 1,945 4,867
--------------- ---------------
Total current liabilities 91,853 80,474
Long-term debt - -
Accrued postretirement and pension benefit obligations 20,557 15,327
Deferred income taxes 9,573 7,076
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 2005 and 2004 45,661 45,661
Additional paid-in capital 27,404 12,771
Retained earnings 459,181 443,676
Less treasury stock at cost:
8,339,767 and 9,182,802 shares
in 2005 and 2004, respectively (54,728) (60,261)
Accumulated other comprehensive income 989 4,484
---------------- ----------------
Total shareholders' equity 478,507 446,331
---------------- ----------------
Total liabilities and shareholders' equity $ 600,490 $ 549,208
================ ================
See notes to consolidated financial statements
(41)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
for the years ended August 31,
---------------------------------------------------------------------
2005 2004 2003
-------------------- --------------------- --------------------
Net sales $ 454,296 $ 433,134 $ 380,376
Cost of goods sold 240,457 208,687 190,246
-------------------- --------------------- --------------------
Gross profit 213,839 224,447 190,130
-------------------- --------------------- --------------------
Operating expenses:
Research and development 29,692 30,374 28,170
Selling, general and administrative 128,232 110,192 89,354
Restructuring charge 1,886 208 -
Special charges - - 8,000
-------------------- --------------------- --------------------
159,810 140,774 125,524
-------------------- --------------------- --------------------
Operating income 54,029 83,673 64,606
-------------------- --------------------- --------------------
Other expenses (income):
Interest expense, net of amount capitalized 648 1,117 618
Interest income (1,770) (856) (1,821)
Other, net 327 535 (1,109)
-------------------- --------------------- --------------------
(795) 796 (2,312)
-------------------- --------------------- --------------------
Income before income taxes 54,824 82,877 66,918
Provision for income taxes 15,311 26,935 21,248
-------------------- --------------------- --------------------
Net income $ 39,513 $ 55,942 $ 45,670
==================== ===================== ====================
Basic earnings per common share $ 0.89 $ 1.28 $ 1.05
==================== ===================== ====================
Diluted earnings per common share $ 0.88 $ 1.26 $ 1.04
==================== ===================== ====================
Cash dividends per common share $ 0.5400 $ 0.3500 $ 0.1950
==================== ===================== ====================
Weighted average shares used in computing
basic earnings per common share 44,300,408 43,559,410 43,399,363
==================== ===================== ====================
Weighted average shares used in computing
diluted earnings per common share 45,007,881 44,301,960 43,773,253
==================== ===================== ====================
See notes to consolidated financial statements
(42)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (EXPENSE) INCOME
(In thousands)
for the years ended August 31,
---------------------------------------------------------
2005 2004 2003
---------------- ----------------- ----------------
Net income $ 39,513 $ 55,942 $ 45,670
Other comprehensive (expense) income:
Foreign currency translation adjustments (10,660) 4,802 3,309
Unrealized holding gain (loss) on foreign currency
option contracts - - 286
Minimum pension liability adjustment, net of tax
($4,455), $(42) and $(515), respectively) 7,165 69 827
---------------- ----------------- ----------------
Other comprehensive (expense) income (3,495) 4,871 4,422
---------------- ----------------- ----------------
Total comprehensive income (expense) $ 36,018 $ 60,813 $ 50,092
================ ================= ================
See notes to consolidated financial statements
(43)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
for the years ended August 31,
----------------------------------------------------
2005 2004 2003
-------------- --------------- -------------
Cash flows from operating activities:
Net income $ 39,513 $ 55,942 $ 45,670
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 16,026 19,086 18,850
Inventory reserve charge 12,419 - -
Fixed asset write off 2,427 - -
Special charges - - 8,000
Amortization 5,482 4,692 4,376
Abandonment of facility expansion plan - 1,658 -
LionHeart(TM) charges 4,903 3,698 3,569
Early retirement plan stock option charge 1,126 - -
401(k) plan stock contribution 883 816 713
Non-qualified stock option tax benefit 3,997 2,112 565
Stock compensation charge 54 - -
Loss (gain) on sale of property, plant and equipment 581 421 (71)
Deferred income taxes (871) (2,682) 10,145
Unrealized holding gain (loss) on foreign currency options - - 286
(Decrease) increase in provision for postretirement benefit obligation (7,960) 1,616 887
Decrease (increase) in prepaid pension costs 8,121 2,889 (13,702)
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable, net (6,929) 1,471 (302)
Inventories (10,044) (7,646) 5,710
Prepaid expenses and other (1,133) 7,711 (6,593)
Accounts payable and accrued liabilities 14,664 (3,816) (3,816)
Accrued compensation (1,283) 3,279 3,746
Accrued income taxes (2,988) 1,072 682
-------------- -------------- -------------
Total adjustments 39,475 36,377 33,045
-------------- --------------- -------------
Net cash provided by operating activities 78,988 92,319 78,715
-------------- --------------- -------------
Cash flows from investing activities:
Capital expenditures (33,741) (26,954) (16,714)
Proceeds from sale of property, plant and equipment 23 615 339
(Increase) in intangible and other assets (1,999) (5,274) (1,272)
Cash paid for businesses acquired, net (8,550) - (38,317)
-------------- --------------- -------------
Net cash used in investing activities (44,267) (31,613) (55,964)
-------------- --------------- -------------
Cash flows from financing activities:
Increase (decrease) in notes payable 43 (4,939) 11,554
Principal payments of long-term debt (1,925) (300) (300)
Reduction of current maturities of long-term debt (57) (699) (265)
(Decrease) increase in book overdrafts (736) (370) (1,191)
Dividends paid (21,255) (14,792) (6,522)
Proceeds from stock options exercised 14,106 6,685 1,210
Purchase of treasury stock - - (13,846)
-------------- --------------- -------------
Net cash used in financing activities (9,824) (14,415) (9,360)
-------------- --------------- -------------
Effects of exchange rate changes on cash and cash equivalents 253 910 481
Net change in cash and cash equivalents 25,150 47,201 13,872
Cash and cash equivalents at beginning of year 94,176 46,975 33,103
-------------- --------------- -------------
Cash and cash equivalents at end of year $ 119,326 $ 94,176 $ 46,975
============== =============== =============
See notes to consolidated financial statements
(44)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(In thousands)
for the years ended August 31,
-----------------------------------------------------
2005 2004 2003
---------------- -------------- ---------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest (net of amount capitalized) $ 836 $ 759 $ 547
Income taxes $ 14,284 $ 21,406 $ 13,759
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 $ 8,871 $ - $ 53,278
Liabilities assumed 321 - 14,961
--------------- ------------- --------------
Cash paid for assets $ 8,550 $ - $ 38,317
=============== ============= ==============
Cash paid for businesses acquired:
Working capital $ 3,221 $ - $ 10,323
Property, plant and equipment - - 1,960
Goodwill, intangible assets and in-process
research and development 5,650 - 30,034
Accrual for additional payments owed (321) - (4,000)
--------------- ------------- --------------
$ 8,550 - 38,317
=============== ============= ==============
Intangible assets acquired by issuing treasury stock $ - $ 529 $ -
=============== ============= ==============
Dividends declared but not paid $ 6,693 $ 3,940 $ 3,462
=============== ============= ==============
See notes to consolidated financial statements
(45)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended August 31, 2005, 2004 and 2003
(In thousands, except share and per share amounts)
Common Stock Treasury Stock
---------------------------- Retained -------------------------
Shares Amount Earnings Shares Amount
------------- ----------- ----------- ---------- ----------
Balance, August 31, 2004 52,957,626 $ 45,661 $ 443,676 9,182,802 $ (60,261)
Cash dividends on common
stock, $0.540 per share (24,008)
Purchase of treasury stock
Exercise of stock options (814,782) 5,293
Treasury stock issued to purchase
intangible assets
Treasury stock issued as contribution
to the Company's 401(k) Plan (28,253) 240
Stock option tax benefit (non-qualified
stock option)
Early retirement plan acceleration of stock
option vesting
Stock compensation
Unrealized holding gain on foreign
currency option contracts
Foreign currency translation adjustments
Minimum pension liability adjustment
Net income 39,513
------------- ----------- ---------- ---------- ----------
Balance, August 31, 2005 52,957,626 $45,661 $459,181 8,339,767 ($54,728)
============= =========== ========== ========== ==========
Accumulated Other Comprehensive Income (Expense)
-------------------------------------------------------------
Minimum Unrealized
Additional Pension Reclassification gain on Foreign
Paid In Liability Adjustment for Marketable Currency
Capital Adjustment Gains Securities Effects
----------- ---------- --------------- ------------ ------------
Balance, August 31, 2004 $ 12,771 $ - $ (1,173) $ 1,173 $ 4,484
Cash dividends on common
stock, $0.540 per share
Purchase of treasury stock
Exercise of stock options 8,813
Treasury stock issued to purchase
intangible assets
Treasury stock issued as contribution
to the Company's 401(k) Plan 643
Stock option tax benefit (non-qualified
stock option) 3,997
Early retirement plan acceleration of stock
option vesting 1,126
Stock compensation 54
Unrealized holding gain on foreign
currency option contracts (10,660)
Foreign currency translation adjustments
Minimum pension liability adjustment 7,165
Net income
----------- ---------- --------------- ------------ ------------
Balance, August 31, 2005 $27,404 $7,165 $(1,173) $1,173 $(6,176)
=========== ========== =============== ============ ============
See notes to consolidated financial statements
(46)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended August 31, 2005, 2004 and 2003
(In thousands, except share and per share amounts)
Common Stock Treasury Stock
--------------------------- ------------------------
Retained
Shares Amount Earnings Shares Amount
------------ ----------- ------------ --------- -----------
Balance, August 31, 2003 52,957,626 $ 45,661 $ 403,004 9,672,124 $ (63,472)
Cash dividends on common
stock, $0.350 per share (15,270)
Purchase of treasury stock
Exercise of stock options (439,348) 2,883
Treasury stock issued to purchase
intangible assets (20,000) 131
Treasury stock issued as contribution
to the Company's 401(k) Plan (29,974) 197
Stock option tax benefit (non-qualified
stock option)
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)
============ =========== ============ ========= ===========
Accumulated Other Comprehensive Income (Expense)
----------------------------------------------------------
Minimum Unrealized
Additional Pension Reclassification gain on Foreign
Paid In Liability Adjustment for Marketable Currency
Capital Adjustment Gains Securities Effects
---------- ---------- -------------- ----------- -----------
Balance, August 31, 2003 $ 5,840 $ (69) $ (1,173) $ 1,173 $ (318)
Cash dividends on common
stock, $0.350 per share
Purchase of treasury stock
Exercise of stock options 3,802
Treasury stock issued to purchase
intangible assets 398
Treasury stock issued as contribution
to the Company's 401(k) Plan 619
Stock option tax benefit (non-qualified
stock option) 2,112
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 $ 12,771 $ - $ (1,173) $ 1,173 $ 4,484
========== ========== ============== =========== ===========
See notes to consolidated financial statements
(47)
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the years ended August 31, 2005, 2004 and 2003
(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
stock, $0.195 per share (8,444)
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
========== ========== ========= ========= ======== =========
Accumulated Other Comprehensive Income (Expense)
------------------------------------------------
Minimum Unrealized
Pension Reclassification gain on Foreign
Liability Adjustment 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
(48)
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. During the fourth quarter of fiscal 2005,
the Company changed from an order point to a Materials Requirement Planning
system and compared in greater detail planned future usage to inventory
quantities on hand and, as a result, the Company was able to modify its
estimates used to account for excess inventory. As a result of this modification
of its estimates, the Company recorded a $12,419 reserve for inventory
components in excess of 36 months forecasted usage (as well as obsolete field
service parts), consisting of $5,055 of critical care product raw materials,
semi-finished and finished goods, $3,490 of HemoSonic components and $3,874 of
IAB inventories. Inventory in excess of 36 months of forecasted usage may be
used in the future if production requirements increase.
For certain new products, the Company manufactures inventory in anticipation of
product launch. As of August 31, 2005, the Company had recorded $717 of
inventory related to its HemoSonic(TM) hemodynamic monitoring device. The
Company is currently developing improvements to this product that 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 second quarter of fiscal 2005, the
Company made a provision of $2,079 for LionHeart(TM) inventory in excess of
anticipated requirements and, in addition, wrote off its remaining investment in
the LionHeart(TM) program, which included $860 in components. 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 in April 2004 not to proceed in the U.S.
with Phase II human clinical trials using the first generation LionHeart(TM)
power system and controller.
(49)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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 an annual assessment
of impairment and potentially additional impairment assessments based 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.
Amortization expense of intangibles for fiscal 2005 was $5,482. Estimated
intangible amortization expense for each of the next five succeeding fiscal
years is as follows:
Year Ending August 31, Total
----------------------------------- ------------
2006 $5,482
2007 4,935
2008 3,951
2009 3,619
2010 1,975
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 5 - 40 years
Machinery and equipment 3 - 10 years
Computer software and hardware 3 - 5 years
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 fourth quarter of fiscal 2005, the Company recorded a
$2,427 write off of equipment no longer in use based on physical inventories of
the Company's worldwide equipment and also recorded a $3,804 reduction in
depreciation expense ($3,514 to cost of sales and $290 to selling, general and
administrative expenses) for the correction of fixed asset lives primarily for
manufacturing equipment in the Company's non-U.S. facilities, as those lives
were shorter than those prescribed by the Company's policy. In the second
quarter of fiscal 2005, the Company wrote off $2,824 in equipment and
components as a result of the Board of Directors' decision on April 6, 2005 to
discontinue the development, sales and marketing programs related to its Arrow
LionHeart(TM) Left Ventricular Assist System (LVAS). In the third quarter of
fiscal 2004, the Company recorded a write-off of $558 related to LionHeart
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
power system and controller.
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.
(50)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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.
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 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:
During the course of the closing process of the second quarter of fiscal 2005
and in conjunction with its review of its internal controls, the Company
determined that it had misapplied the accounting treatment related to its
shipping terms to U.S. customers and international distributors. The Company
does not have written agreements with most customers and, as a result, in most
of those cases, shipping terms are only specified on the invoice, which states
free-on-board, or FOB, plant. While the Company does not pay for shipping in
most cases or insure the shipments, its practice has been to credit or replace
lost or damaged shipments. During the past few years, amounts in respect of
these credits and replacements have been less than 0.05% of sales to customers
in the U.S. and to international distributors. Nevertheless, interpretations of
Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements
(SAB 104), issued by the SEC staff require that, because of its practice of
replacing lost or damaged shipments, the Company's sales to customers in the
U.S. and to international distributors are the equivalent of FOB destination
orders.
The Company's assessment determined that delivery time to U.S. customers is two
business days and, to its international distributors, seven days for air and
truck shipments and 55 days for ocean vessel shipments. By applying the
appropriate accounting treatment as described above, the amount of sales
corresponding to these numbers of days in transit at the end of the quarter must
be recognized in the succeeding quarter when the shipments are delivered. As a
result, during the second quarter of fiscal 2005, the Company recorded $4,279 as
a reduction to sales and $2,225 against gross profit, or $0.03 diluted earnings
per share. These sales amounts, however, were recognized in the third quarter of
fiscal 2005. While these sales amounts were recognized in the third quarter of
fiscal 2005, a similar amount of days sales was excluded from the end of the
fourth quarter and the excluded amount would be recognized in the subsequent
quarter. Accordingly, the incremental effect on any future quarter would be the
difference between the adjustment at the beginning of the quarter and the
corresponding adjustment at the end of the quarter.
The Company's revenue recognition policy is as follows:
(51)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Revenue is recognized by the Company at the time its products are delivered and
title and risk of loss 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's practice
is to credit or replace lost or damaged shipments. 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.
Income Taxes:
The Company's effective tax rate differs from the statutory rate primarily as a
result of research and development tax credits, foreign sales corporation
deductions associated with the extraterritorial income tax regime and a tax
holiday in the Czech Republic. 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's 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 $44,136 and $28,952 at August 31, 2005 and
2004, respectively.
Foreign Currency Translation/Transaction:
During fiscal 2005, 2004 and 2003, 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 $91, $558 and $99 for the fiscal years ended August 31,
2005, 2004 and 2003, 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.
(52)
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 certain 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 the provisions of SOP 98-1, net of amortization,
was $11,762 and $11,642 as of August 31, 2005 and 2004, respectively.
The Company also records certain costs of software in accordance with SFAS No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed." In accordance with the provisions of this statement, the
Company's costs incurred in the research and development of new software
components and enhancements to existing software components of certain of its
products are expensed as incurred until technological feasibility has been
established. After technological feasibility is established, any additional
software development costs are capitalized and amortized over the useful life of
the asset. Total cost capitalized under the provisions of SFAS No. 86, net of
amortization, was $2,786 and $2,605 as of August 31, 2005 and 2004,
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. In the second quarter of fiscal 2005, the Company wrote off
$341 to research and development expenses related to the impairment of certain
equipment as a result of the Company's decision to discontinue the development,
sales and marketing programs related to its Arrow LionHeart LVAS. 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 LionHeart(TM).
The Company also had $479 of capitalized costs related to its CorAide(TM)
ventricular assist device as of August 31, 2005.
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 2005, the
Company's deductibles for its primary global product liability insurance policy
decreased to $2,000 per occurrence from $2,500 in fiscal 2004 for domestic
product liability claims, with the Company's annual exposure for such
deductibles in any one policy year decreasing to $4,000 in fiscal 2005 from
$5,000 in fiscal year 2004. Effective for fiscal 2006, the Company's deductibles
for its primary global product liability insurance policy remain at $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 then current policy that maintains deductibles and
limits for unreported claims occurring prior to September 1, 2002 at existing
levels for five years.
(53)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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.
On October 27, 2004, the Company's Board of Directors approved a voluntary early
retirement program for all of the Company's salaried and non-exempt employees in
its three locations in the Reading, Pennsylvania area who attained age 57 or
older and had at least five years of service with the Company as of January 31,
2005. The program provided that each such eligible employee's stock options
issued under the Company's stock incentive plans, which were unvested as of the
effective date of his or her retirement, accelerated so as to vest and become
fully exercisable as of such date. As a result of the acceleration, options to
acquire 122,495 shares of the Company's common stock, which otherwise would have
vested over the next two years, became immediately exercisable. The Company's
pro forma disclosure includes the effect of this accelerated vesting as
calculated under SFAS No. 123 of $1,126.
Had compensation expense for stock options granted in fiscal 2005, 2004 and 2003
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, 2005, 2004 and 2003 would have been
reduced to the pro forma amounts indicated in the table below:
2005 2004 2003
----------------- ----------------- ----------------
Net income applicable to common shareholders
As reported $ 39,513 $ 55,942 $ 45,670
Add: Stock based employee compensation expense
included in reported net income, net of related
tax effects 771 36 -
Deduct: Total stock based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (1,672) (1,859) (1,329)
Pro forma $ 38,612 $ 54,119 $ 44,341
Basic earnings per common share
As reported $ 0.89 $ 1.28 $ 1.05
Pro forma $ 0.87 $ 1.24 $ 1.02
Diluted earnings per common share
As reported $ 0.88 $ 1.26 $ 1.04
Pro forma $ 0.86 $ 1.22 $ 1.01
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
$8,000
(54)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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 $8,000 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.
3. LionHeart(TM) Charges:
As announced on April 7, 2005, the Company's Board of Directors decided to
discontinue the development, sales and marketing programs related to its Arrow
LionHeart LVAS.
As reported on March 21, 2005, there were no sales of the Company's LionHeart
devices during either of the first two quarters of fiscal 2005. As a result, the
Company recorded a provision in its second quarter of fiscal 2005 of $2,079 for
LionHeart inventory in excess of anticipated requirements. In addition, the
Company wrote off in the second fiscal quarter its remaining investment in the
LionHeart program, which included $2,824 in equipment and components. The write
off of equipment was recorded in accordance with the provisions of SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." The Company
reached its conclusion that its LionHeart equipment was impaired based on the
completion of a study during the second fiscal quarter, which included the use
of future cash flow analyses to estimate the fair value of these assets. This
conclusion was confirmed by the Board of Directors' decision on April 6, 2005.
The total write off in the second quarter of fiscal 2005 related to the
LionHeart was $4,903, of which $4,562 was recorded to cost of sales and $341 to
research and development expenses.
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
work on the consolidation is expected to continue into the first half of fiscal
2006. Severance payments relate to approximately 53 employees primarily in
manufacturing at both facilities and the remaining accrual balance is expected
to be paid later in fiscal 2006. All other restructuring costs are expected to
be paid over the remainder of fiscal 2006. Restructuring charges related to this
manufacturing realignment are summarized in the table below:
For the
Estimate of Twelve For the Costs
Total Months Twelve expensed but
Expected Ended Months Ended not yet paid
Restructuring August 31, August 31, Total as of August
Charges 2004 2005 to Date 31, 2005
------- ---- ---- ------- --------
Severance and related
expenses $763 $208 $ 555 $763 $ 87
Property, plant and
equipment carrying
cost and costs of
disposal 32 - 48 48 -
Other, including
equipment and
inventory moving costs,
employee relocation
costs, and external
consulting fees 118 - 118 118 -
------ ---- ----- ---- ------
Total restructuring
charges $ 913 $208 $ 721 $929 $ 87
====== ==== ===== ==== ======
(55)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The Company has segregated its San Antonio, Texas facility and certain related
equipment as held for sale on the Company's consolidated balance sheet as of
August 31, 2005.
As part of its plans to rationalize its production operations and related
logistics in Europe, in November 2004, the Company determined to move its
European Distribution Center, previously 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 continued to implement this relocation in the fourth quarter of fiscal
2005 and expects to complete the relocation and related logistics by the end of
fiscal 2006, at an estimated total cost of $1,625. Restructuring charges related
to this distribution center relocation and related logistics are summarized
below:
Costs
For the expensed
Estimate of Twelve For the but not
Total Months Twelve yet paid
Expected Ended Months Ended as of
Restructuring August August 31, Total August 31,
Charges 31, 2004 2005 to Date 2005
------- -------- ------ ------- ----
Severance and related
expenses $ 880 - $ 618 $ 618 $ 337
Lease termination costs 254 - 227 227 140
Property, plant and
equipment carrying
cost and costs of disposal 112 - 38 38 -
Other, including
equipment and
inventory moving costs,
employee relocation costs,
and external consulting fees 379 - 282 282 -
----- ------- --------- ------ --------
Total restructuring
charges $ 1,625 - $ 1,165 $1,165 $ 477
======= ======= ========= ====== ========
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 included the relief from $5,539 of accounts receivable that had
been due from this distributor. As of August 31, 2005, 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:
(56)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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, 2005, 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, 2005, this liability had been reduced by $946 for legal
costs paid by the Company, which are obligated to be reimbursed by the former
owners of Diatek under the terms of the asset purchase agreement relating to
this transaction. Pursuant to this agreement ,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 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. 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 Neo?Care(R) in San
Antonio, Texas, for approximately $16,550. Neo?Care(R) develops, manufactures
and markets specialty catheters and related procedure kits to neonatal intensive
care units. As of August 31, 2005, pursuant to the asset purchase agreement, the
Company had paid $16,438 in cash, reduced by $112 for insurance premiums paid by
the Company, which are obligated to be reimbursed by the former owners of Klein
Baker Medical under the terms of the asset purchase agreement relating to this
transaction. 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. 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 included 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:
(57)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Accounts receivable $ 310
Inventories 744
Intangible assets 1,717
Current liabilities (621)
-------------
Total purchase price $ 2,150
=============
On September 3, 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
approximately $8,871, with additional amounts payable contingent upon the sales
levels of products under sales contracts purchased by the Company. ABM had been
one of the Company's distributors in Italy since 1982. The asset purchase
agreement included the purchase of customer lists, distributorship rights, as
well as the inventory and specified tender contracts associated with the sale by
ABM of the Company's products. The Company began selling directly in Italy
through its subsidiary, Arrow Italy S.p.A., in the first quarter of fiscal 2005.
As of August 31, 2005, pursuant to the asset purchase agreement, the Company had
paid $8,550 in cash and recorded a current liability of $321 for additional
payment installments. 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 $5,650, consisting of customer lists and distributorship rights, are being
amortized over five years based on the anticipated period over which the Company
expects to benefit from the transaction. Included in the first quarter of fiscal
2005 was a $1,467 charge, or $990 against net income for the step-up of
inventory purchased from ABM. 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)
Inventories $ 3,221
Intangible assets 5,650
-------
Total purchase price $ 8,871
=======
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.
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 with
non-material amendments thereto approved by the Company's Board of Directors on
October 27, 2004. 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.
(58)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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 2005 and
2003 fiscal years. During fiscal 2004, the Company recognized compensation
expense of $54 related to a grant that had an exercise price that was below the
market price of the underlying stock on the date of the grant.
In fiscal 2005, 2004 and 2003, the Company granted 185,000, 1,250,000 and 16,000
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
$29.08 to $33.59 for the options granted in fiscal 2005, from $25.00 to $25.80
for the options granted in fiscal 2004 and from $17.78 to $20.53 for the options
granted in fiscal 2003. 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 19, 2005, January 21, 2004 and January 15, 2003, the Company granted
27,000, 27,000 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 2005, 2004 and 2003 awards was $30.60, $26.42
and $20.53, 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, 2005, 2004 and 2003 is
summarized in the table below:
Weighted Weighted Weighted
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
FY 2005 Price FY 2004 Price FY 2003 Price
------------ ------------ ------------ ------------- ------------ ---------------
Outstanding at
September 1 3,084,152 $20.49 2,318,260 $16.82 2,414,510 $16.75
Granted 212,000 $30.71 1,277,000 $25.28 40,000 $20.11
Exercised (814,782) $17.31 (439,348) $15.20 (73,930) $16.48
Terminated (100,003) $22.04 (71,760) $19.19 (62,320) $16.63
------------ ------------ ------------
Outstanding at
August 31 2,381,367 $22.43 3,084,152 $20.49 2,318,260 $16.82
Exercisable at
August 31 1,122,266 $19.64 1,263,920 $16.45 1,293,686 $15.84
Stock options outstanding at August 31, 2005 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 - $17.50 290,260 3.45 $14.99 290,260 $14.99
$17.51 - $21.47 803,669 5.67 19.03 543,321 19.07
$21.48 - $26.42 1,075,438 8.06 25.33 288,685 25.41
$26.43 - $33.59 212,000 9.36 30.71 - -
--------------- --------------
2,381,367 1,122,266
(59)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The Company previously 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 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 2005,
2004 and 2003 was $5.99, $5.39 and $8.30, respectively. The fair value was
estimated as of the grant date using the Black-Scholes option pricing model with
the following average assumption:
2005 2004 2003
------------- --------------- ----------------
Risk-free interest rate 3.19% 2.90% 2.68%
Dividend yield 1.74% 1.42% 1.72%
Volatility factor 20.26% 21.38% 44.55%
Expected lives 5 years 4 years 5 years
7. Related Party Transactions:
During fiscal 2005 and 2004, the Company made purchases amounting to $123 and
$117, 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 $6,387, $5,929 and $5,344 for fiscal
years ended August 31, 2005, 2004 and 2003, respectively. Following is a
schedule by year showing future minimum rentals under operating leases.
Year Ending August 31, Total
----------------------------------- ------------
2006 $ 3,697
2007 2,599
2008 1,842
2009 1,449
2010 1,046
Thereafter 832
------------
$11,465
============
9. Inventories:
Inventories are summarized as follows:
August 31,
---------------------------------------
2005 2004
-------------- ---------------
Finished goods $32,954 $29,036
Semi-finished goods 26,875 26,126
Work-in-process 11,699 9,493
Raw materials 23,828 31,429
-------------- ---------------
$ 95,356 $96,084
============== ===============
(60)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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, 2005 and 2004, the Company had
a revolving credit facility providing a total of $65,000 in available revolving
credit for general business purposes, of which $21,831 and $17,780 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; 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, 2005 and 2004, 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 $31,978 and $32,275, of which $5,060 and
$8,240 was outstanding, as of August 31, 2005 and 2004, respectively.
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,
2005 and 2004, the weighted average interest rates on short-term borrowings were
2.1% and 2.3% per annum, respectively. Combined borrowings under these
facilities increased $871 during fiscal year 2005.
11. Accrued Compensation:
The components of accrued compensation at August 31, 2005 and 2004 are as
follows:
2005 2004
-------------- -------------
Accrued vacation pay $ 5,422 $ 5,522
Accrued payroll 5,967 8,025
Other 1,519 624
-------------- -------------
$ 12,908 $14,171
============== =============
12. Accrued Liabilities:
The components of accrued liabilities of August 31, 2005 and 2004 are as
follows:
2005 2004
-------------- -------------
Accrued professional fees $ 7,600 $ 2,858
Other* 16,971 9,655
-------------- -------------
$ 24,571 $12,513
============== =============
* No individual items greater than 5% of total current liabilities.
13. Long-Term Debt:
(61)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Long-term debt consists of the following:
August 31,
------------------------------------------
2005 2004
---------------- ------------------
Note payable to Klein-Baker Medical, Inc. in March 2005, plus interest at a
variable rate based upon LIBOR plus 2.00%, offset by insurance premiums $ - $ 1,925
owed to the Company by the former owners of Klein-Baker Medical, Inc.
Note payable to Diatek, Inc. originally due 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. , as further
discussed in Note 5 in Notes to Consolidated Financial Statements. 1,054 1,111
---------------- ------------------
Total debt 1,054 3,036
Less current maturities 1,054 3,036
---------------- ------------------
$ - $ -
================ ==================
The Company has a U.S. dollar equivalent of irrevocable standby letters of
credit totaling $1,472 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, 2005.
Total interest costs for fiscal 2005, 2004 and 2003 were $648, $1,117 and $618,
respectively.
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:
2005
-----------------------------------------------------------------------------------------------------
Federal State Foreign Total
----------------------- -------------------- ---------------------- ------------------------
Current $ 11,370 $ 1,440 $ 3,328 $ 16,138
Deferred (980) (95) 248 (827)
---------------------- ------------------- --------------------- -----------------------
$ 10,390 $ 1,345 $ 3,576 $ 15,311
====================== =================== ===================== =======================
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
====================== =================== ===================== =======================
In fiscal 2005, the income tax provision was favorably impacted by the
impact of foreign tax rate differentials primarily related to a tax holiday in
the Czech Republic through August 2006, as further described below, and
(62)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
research and development tax credits and the Extraterritorial Income Regime tax
deduction. In addition, the Company established an accrual for state income
taxes primarily related to taxation of its intangible holding company.
Research and development tax credits were $1,000, $1,323, and $801 in fiscal
2005, 2004 and 2003, respectively.
The following deferred taxes and balance sheet classifications are recorded as
of August 31, 2005 and 2004:
Deferred tax assets (liabilities): 2005 2004
--------------- ---------------
Accounts receivable $ 1,005 $ 656
Inventories 13,261 6,198
Capital loss carryforward 3,392 3,392
Property, plant and equipment (12,527) (8,231)
Intangible assets 3,483 4,760
Accrued liabilities (9,142) (11,877)
Accrued compensation 1,438 1,402
Postretirement benefits other than pensions 5,855 5,186
-------------- ---------------
$ 6,765 $ 1,486
============== ===============
Balance Sheet classification:
Current deferred tax assets $ 16,338 $ 8,562
Non-current deferred tax assets/(liabilities) (9,573) (7,076)
-------------- ---------------
$ 6,765 $ 1,486
============== ===============
The Company has capital loss carryforwards related to marketable securities
sales of $8,845 at August 31, 2005 of which $8,480 and $365 expires on August
31, 2006 and August 31, 2007, respectively. 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 prior to the statutory
expiration of the carry forwards.
In addition, in March 2004, the Company made a payment to the Japanese
Government of approximately $10,000 to settle a tax assessment related to a
Japanese audit of the Company's transfer pricing. The Company is utilizing
competent authority proceedings with the Internal Revenue Service in the U.S. to
recover a majority of this Japanese tax assessment, although there can be no
assurance that it will be successful in these efforts.
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:
2005 2004 2003
------- ------- -------
Statutory federal income tax rate 35.0% 35.0 % 35.0%
State income taxes, net of federal benefit 2.2 1.6 1.0
Foreign statutory tax rates differential (3.2) (0.4) 0.8
Foreign sales corporation - ETI (Extra Territorial
Income Exclusion) deduction (4.9) (3.8) (4.2)
Research and development tax credit (1.8) (0.9) (1.6)
Other 0.6 1.0 0.8
------ ------ ------
Effective tax rate 27.9% 32.5% 31.8%
====== ====== ======
The effective tax rate for fiscal 2005 reflects the benefits of a tax holiday in
respect of the Company's Czech Republic operations. This tax holiday is
effective through August 2006 and is limited by the amount of capital
permanently invested in the Czech Republic by way of property, plant and
equipment purchased. This tax holiday resulted in a $2,800 reduction in the
Company's income tax provision for fiscal 2005.
15. Retirement Benefits:
(63)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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 $5,425 and $4,981 at
August 31, 2005 and 2004, 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.
Early Retirement Plan:
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 attained
age 57 or older and had at least five years of service with the Company as of
January 31, 2005. The program provided that each such eligible employee who made
an election to retire from the Company on or between November 10, 2004 and
January 31, 2005 would (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 his or her stock options issued under the Company's stock incentive plans,
that were unvested as of the effective date of his or her retirement,
accelerated so as to vest and become fully exercisable as of such date.
During fiscal 2005, the Company recorded $1,918 related to pension and $814
related to other post-retirement benefits related to the early retirement
program, which are not included in the net periodic benefit costs below. These
charges to expense and credit to prepaid pension and accrued postretirement
benefit obligations resulted from the Company's waiver in connection with the
early retirement program of the normal discount that customarily would have
applied to a participant's benefits if the participant had otherwise elected to
retire prior to his/her normal retirement date.
(64)
The following summarizes the Company's benefit obligations, changes in plan
assets and funded status:
Pension Benefits Other Benefits
----------------------------------- -------------------------------------
August 31, August 31,
2005 2004 2005 2004
---------------- --------------- ------------------ ---------------
Change in benefit obligation:
Benefit obligation at beginning of year $ 88,270 $ 75,482 $ 15,091 $ 13,013
Service cost 4,264 3,688 369 354
Interest cost 5,831 5,259 947 866
Amendments 69 2,578 1,638 (423)
Actuarial loss 14,375 3,577 6,080 1,417
Translation adjustment (16) -- -- --
Curtailments 58 -- -- --
Special termination benefits 1,437 -- 814 --
Benefits paid (4,138) (2,314) (883) (136)
--------- --------- --------- ---------
Benefit obligation at end of year $ 110,150 88,270 $ 24,056 15,091
========= ========= ========= =========
Pension Benefits Other Benefits
------------------------------------ -----------------------------------
August 31, August 31,
2005 2004 2005 2004
--------------- ---------------- --------------- ----------------
Change in plan assets:
Fair value of plan assets at beginning
of year $ 81,183 $ 78,227 $ -- $ --
Actual return on plan assets 8,352 5,018 -- --
Translation adjustment (6) -- -- --
Employer contributions 8,832 252 883 136
Refund of surplus (132) -- -- --
Benefits paid (4,138) (2,314) (883) (136)
--------- ---------- ---------- ----------
Fair value of plan assets at end of year $ 94,091 $ 81,183 $ -- $ --
========= ========= ========= =========
Pension Benefits Other Benefits
----------------------------------- -----------------------------------
August 31, August 31,
2005 2004 2005 2004
-------------- ----------------- --------------- ----------------
Funded status $ (16,059) $ (6,885) $ (24,056) $ (15,091)
Unrecognized net actuarial loss 33,273 21,533 10,910 4,937
Unrecognized prior service cost 11,160 11,687 566 (681)
Unrecognized transition obligation (asset) 164 (34) 484 533
Unrecognized plan acquisition differential -- 1,023 -- (404)
Contributions 22 -- -- --
--------- --------- --------- ---------
Prepaid (accrued) benefit cost $ 28,560 $ 27,324 $ (12,096) $ (10,706)
========= ========= ========= =========
(65)
Pension Benefits Other Benefits
----------------------------------- -----------------------------------
Amounts recognized in the statement August 31, August 31,
of financial position consist of: 2005 2004 2005 2004
-------------- ----------------- --------------- ----------------
Prepaid benefit cost $ 21,006 $ 29,127 $ - $ -
Accrued benefit liability (8,843) (4,981) (12,096) (10,706)
Contributions 22 - - -
Intangible asset 4,755 3,178 - -
Accumulated other comprehensive
Income 11,620 - - -
--------- ---------- ---------- ----------
Net amount recognized $ 28,560 $ 27,324 $ (12,096) $ (10,706)
========= ========= ========= =========
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 $50,776, $46,300 and $53,065 for 2005, respectively,
and $81,673, $69,449 and $80,694 for 2004, 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 $59,374, $49,872 and $41,026 for 2005, respectively,
and $6,597, $4,981 and $489 for 2004, respectively.
Plan Assumptions
Weighted average assumptions used in developing the benefit obligation and net
periodic benefit cost were as follows:
Other Benefits
-------------------------------------------
August 31,
Benefit obligation 2005 2004 2005 2004
----------- ----------- ---------- ------------
Discount rate 5.21% 6.25% 5.00% 6.25%
Expected return on plan assets 8.50% 8.50% N/A N/A
Rate of compensation increase 3.97% 4.00% 4.00% 4.00%
Health care cost trend rate:
Initial trend rate N/A N/A 9.00% 10.00%
Ultimate trend rate N/A N/A 5.00% 5.00%
Years until ultimate trend is reached N/A N/A 8 9
Pension Benefits Other Benefits
--------------------------------------- --------------------------------------
August 31, August 31,
Net periodic benefit cost 2005 2004 2003 2005 2004 2003
----------- ----------- --------- ---------- ------------ ---------
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
(66)
The asset allocation of the Company's pension plans at August 31, 2005 and
August 31, 2004, and the target allocation for fiscal 2006, 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, 2006 2005 2004
- ----------------------------- -------------------------------------------- ----------------------- ---------------------
Equity Securities (1) 35% - 65% 75% 63%
Debt Securities 15% - 25% 23% 26%
Alternatives (2) 10% - 35% 0% 0%
Cash 2% - 5% 2% 11%
-------------------------------------------- ----------------------- ---------------------
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 prescription drug benefit
at least as generous as the Medicare program for its Medicare-eligible retirees.
The Company has concluded that it is not eligible to receive this federal
subsidy.
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
- ------------------------------------------ -------------------------- -----------------------
2006 $ 3,995 $ 1,049
2007 4,169 1,134
2008 4,354 1,232
2009 4,554 1,294
2010 4,830 1,341
2011 - 2015 30,420 7,642
(67)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Pension Benefits Other Benefits
------------------------------------------ ----------------------------------------
Components of net periodic (benefit) August 31, August 31,
cost for the fiscal years ended 2005 2004 2003 2005 2004 2003
----------- ------------ ----------- ------------ --------- -----------
Service cost $ 4,264 $ 3,688 $ 2,743 $369 $ 354 $ 319
Interest cost 5,831 5,259 4,335 947 866 795
Expected return on plan assets (7,121) (6,958) (6,492) - - -
Amortization of prior service costs 1,197 1,090 666 (12) (117) (84)
Amortization of transition obligation (asset) (88) (107) (107) 49 49 49
Amortization of net actuarial (gain) loss 1,357 824 503 106 175 104
Plan acquisition differential - 150 150 - (29) (29)
----------- ------------ ----------- ------------ --------- -----------
Net periodic (benefit) cost $ 5,440 $ 3,946 $ 1,798 $ 1,459 $ 1,298 $ 1,154
=========== ============ =========== ============ ========= ===========
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 $ 154 $ (108)
Effect on postretirement benefit obligation $ 2,433 $ (1,625)
Savings Plan:
The Company has a defined contribution 401(k) 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 $1,272, $1,152 and $1,024 for fiscal 2005,
2004 and 2003, 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 $891, $815 and $716 for fiscal
2005, 2004 and 2003, respectively.
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 meeting 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-related products. Therefore, the Company continues to operate as a
single operating segment. The Company operates in four main geographic regions,
therefore, information about products and geographic areas is presented below.
(68)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The following table provides information about the Company's sales by product
category:
2005 2004 2003
----------------------------- ------------------------------ -----------------------------
Critical Cardiac Critical Cardiac Critical Cardiac
Care Care Care Care Care Care
-------------- ----------- ------------- ------------ ------------ ------------
Sales to External $385,400 $68,900 $ 369,800 63,300 $ 323,500 $ 56,900
customers
The following tables present information about geographic areas:
2005
- -------------------------------------------------------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Eliminations Consolidated
-------------- ---------- ------------ ---------- ------------ -------------
Sales to unaffiliated $277,600 $65,900 $85,600 $25,200 $ - $454,300
customers
Long-lived assets at
August 31* $104,212 $2,886 $30,898 $14,940 (729) $152,207
2004
- -------------------------------------------------------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Eliminations Consolidated
-------------- ---------- ------------ ---------- ------------ -------------
Sales to unaffiliated $ 279,900 $60,000 $ 71,400 $21,800 $ - $ 433,100
customers
Long-lived assets at
August 31* $ 103,991 $ 2,801 $ 25,148 $ 5,565 (527) $ 136,978
2003
- -------------------------------------------------------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Eliminations Consolidated
-------------- ---------- ------------ ---------- ------------ -------------
Sales to unaffiliated $ 249,900 $51,200 $ 60,400 $ 18,900 $ - $ 380,400
customers
Long-lived assets at
August 31* $ 99,783 $ 2,127 $ 22,159 $ 4,816 $ (452) $ 128,433
* Long-lived assets includes only tangible assets.
17. Financial Instruments:
During fiscal 2005 and 2004, the percentage of the Company's sales invoiced in
currencies other than U.S. dollars was 27.1% and 24.3%, 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.
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.
(69)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
At August 31, 2005, the Company had foreign currency forward contracts to sell
foreign currencies which mature at various dates through November 2005. The
following table identifies foreign currency forward contracts to sell foreign
currencies at August 31, 2005 and 2004 as follows:
August 31, 2005 August 31, 2004
Notional Fair Market Notional Fair Market
Amounts Value Amounts Value
--------------- --------------- ---------------- -- -----------------
Foreign currency: (U.S. Dollar Equivalents)
Japanese yen $ 672 680 $ - $ -
Canadian dollars 584 590 - -
Euro 11,322 11,424 14,643 14,603
Mexican peso 905 912 1,379 1,393
African rand 444 470 445 450
-------------- -------------- --------------- ----------------
$ 13,927 14,076 $ 16,467 $ 16,446
============== ============== =============== ================
At August 31, 2005, the Company also had foreign currency forward contracts to
buy foreign currencies which mature at various dates through October 2005. The
following table identifies foreign currency forward contracts to buy foreign
currencies at August 31, 2005 and August 31, 2004 as follows:
August 31, 2005 August 31, 2004
--------------------------------- ------------------------------------
Notional Fair Market Notional Fair Market
Amounts Value Amounts Value
--------------- -------------- ----------------- ---------------
Foreign currency: (U.S. Dollar Equivalents)
Czech koruna $ 2,666 $ 2,727 $ 3,031 $ 2,996
Euro - - 7,305 7,306
Mexican peso - - 703 702
-------------- -------------- --------------- ----------------
$ 2,666 $ 2,727 $ 11,039 $ 11,004
============== ============== =============== ================
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 2005, the Company
recognized less than $0.1 million of intrinsic value losses against cost of
sales and did not recognize any time value losses, nor did it recognize any
intrinsic values losses against cost of sales during fiscal 2004. During fiscal
2003, the Company recognized intrinsic value gains of $294. The Company had no
foreign currency option contracts outstanding at August 31, 2005 and August 31,
2004.
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 is currently a defendant in a lawsuit in the United States District
Court in the Southern District of New York, in which the plaintiffs, Thierry
Pourchez and Bard Access Systems, Inc., allege 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
later in calendar year 2005 or early 2006, although the
(70)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Company cannot presently predict the precise timing. 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
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.
The Company is currently a plaintiff in a patent infringement lawsuit in the
United States District Court in Baltimore, Maryland against Datascope Corp. of
Montvale, New Jersey. The Company manufactures and sells the Arrow-Trerotola(TM)
Percutaneous Thrombolytic Device (PTD(R)), which is used to mechanically declot
native arterio-venous fistulae and synthetic hemodialysis grafts. The PTD was
invented by Dr. Scott Trerotola while working at Johns Hopkins University. Johns
Hopkins University, the owner of two patents covering the PTD, is also a
plaintiff, and the Company is the exclusive licensee of the Trerotola patents.
The Company has alleged that Datascope infringes these two patents. A trial is
anticipated during calendar year 2006.
The Company also commenced a patent infringement lawsuit in the United States
District Court in Boston, Massachusetts against Spire Corporation of Bedford,
Massachusetts. The Company is the owner of United States Patent No. 6,872,198,
which covers a method of inserting a double-Y-shaped multi-lumen catheter. The
Company has alleged that the use of Spire's Pourchez RetrO(TM) High Flow
Kink-Resistant Catheter infringes this patent. The case is at the beginning of
the discovery phase, and trial is anticipated during the 2007 calendar year.
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.
As previously reported, the Company had been in negotiations for the possible
settlement of a claim for indemnification in connection with its prior
disposition of a business. In August 2005, the Company and the plaintiff signed
a term sheet effectively obligating both parties to a $2,000 settlement. As a
result, the Company concluded that the settlement of the indemnification claim
was then probable in accordance with the provisions of SFAS No. 5, "Accounting
for Contingencies" and established a reserve for the pending settlement amount
in the fourth quarter of fiscal 2005. On November 4, 2005, the Company paid the
$2,000, which completed the settlement of the indemnification claim.
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 Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 151, "Inventory Costs, an Amendment of
Accounting Research Bulletin (ARB) No. 43, Chapter 4", in November 2004. This
statement amends the guidance in ARB No. 43 Chapter 4 "Inventory Pricing" to
clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs and wasted material. SFAS No. 151 requires that those items be
recognized as current period charges regardless of whether they meet the
criterion of "so abnormal." In addition, this statement requires that allocation
of fixed production overheads to the costs of conversion be based on the normal
capacity of the production facilities. The provisions of this statement will be
effective for inventory costs incurred during fiscal years beginning after June
15, 2005. The Company has evaluated the impact that this statement will have on
its financial statements and anticipates that it will not be material to its
results of operations.
The FASB issued SFAS No. 123R, "Share-Based Payment", in December 2004. This
statement requires 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. This statement replaces the guidance in SFAS No. 123,
Accounting for Stock-Based Compensation, and APB No. 25, Accounting for Stock
Issued to Employees. This statement will be effective for financial statements
relating to fiscal periods beginning after June 15, 2005. In addition, the SEC
issued SAB No. 107 "Share-Based Payment" in March 2005, which provides
supplemental SFAS No. 123R application guidance based on the views of the SEC.
The Company has evaluated the various transitional methods and the impact that
this statement will have on its financial statements and estimates it will
result in a charge to net income of $700 in the first quarter of fiscal 2006 and
$3,400 for the full fiscal 2006.
(71)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The FASB issued SFAS No. 154, "Accounting Changes and Error Corrections - a
replacement of Accounting Principles Board (APB) Opinion No. 20 and FASB
Statement No.3" in May 2005. This statement changes the requirements for the
accounting for and reporting of a change in accounting principle. SFAS No. 154
requires companies that make a voluntary change in accounting principle to apply
that change retrospectively to prior periods financial statements, unless this
would be impracticable. This statement will be effective for fiscal years
beginning after December 15, 2005. The Company will comply with the provisions
of this statement for any future accounting changes or error corrections.
21. Product Recall:
As previously reported, on December 3, 2004, the Company announced a voluntary
nationwide recall of all of its Neo[heart]PICC(R) 1.9 FR Peripherally Inserted
Central Catheters (the "NeoPICC Catheters") as a result of having received
several reports of adverse events involving the utilization of the NeoPICC
Catheters. The NeoPICC Catheter is part of the Company's Neo[heart]Care product
line of catheters and related procedure kits for neonatal intensive care that it
acquired from Klein Baker Medical, Inc. in March 2003. The Company cooperated
with the U.S. Food and Drug Administration, or the FDA, in conducting the
voluntary recall. As of November 14, 2005, the Company had not received any
product liability claims in connection with the product recall.
The Company sent recall notices to approximately 800 hospitals and 16 dealers.
In the first quarter of fiscal 2005, the Company recorded a charge against net
sales of $500, representing its issued sales credits as of January 7, 2005 and
an estimate for those sales credits yet to be issued relating to returned
NeoPICC Catheters. As of August 31, 2005, the Company had issued sales credits
totaling the full $500 and does not anticipate the need to issue any additional
credits.
To address the inspectional observations of the FDA, the Company in January 2005
temporarily ceased the manufacture, shipment and sale of its entire
Neo[heart]Care product line, including the NeoPICC Catheters. In addition, the
Company moved its Neo[heart]Care manufacturing operations into its existing
manufacturing structure and suspended sales until it implements all corrective
actions related to the FDA's December 2004 inspections of the Company's
facilities in San Antonio, Texas and Reading, Pennsylvania. Shipments of the
Neo[heart]Care product line, other than the NeoPICC Catheters, are presently
expected to resume in calendar year 2006. Shipment of the NeoPICC Catheters will
resume after receipt of FDA clearance of a new 510(k) premarket notification for
these products, which is also presently expected to occur in calendar year 2006.
The Company's fiscal 2004 Neo[heart]Care product line sales were $7,646.
Inventories of NeoPICC Catheters at August 31, 2005 amounted to $304, which the
Company has fully reserved for as of August 31, 2005. Inventories of other
Neo[heart]Care products were approximately $1,368 at August 31, 2005.
22. Early Retirement Program:
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 attained
age 57 or older and had at least five years of service with the Company as of
January 31, 2005. The program provided that each such eligible employee who made
an election to retire from the Company on or between November 10, 2004 and
January 31, 2005 would (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 his or her stock options issued under the Company's stock incentive plans,
which were unvested as of the effective date of his or her retirement,
accelerated so as to vest and become fully exercisable as of such date.
During fiscal 2005, the Company recorded $6,897 in total costs with respect to
this program, of which $1,883 was recorded to cost of sales and $5,014 to
selling, general and administrative expenses. Of the $6,897 in total costs,
$2,732 was related to pension and other postretirement benefits and $3,023 was a
cash charge related to severance and related costs. The remaining $1,142 was
incurred as a non-cash charge for accelerated vesting of stock options held by
participants in this program. A total of 28 participants elected into the
program.
(72)
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, 2005 are as follows:
Quarter
-------------------------------------------------------------------------------
11/30/04 2/28/05 5/31/05 8/31/05
---------------- --------------- ---------------- -----------------
Net sales $ 112,725 $ 109,209 $ 118,070 $ 114,292
Cost of goods sold 56,305 58,506 57,416 68,230
--------------- -------------- --------------- ----------------
Gross profit 56,420 50,703 60,654 46,062
Operating expenses
Research and development 7,919 7,126 6,623 8,024
Selling, general and
administrative 28,722 35,545 29,856 34,109
Restructuring Charge 391 930 450 115
Operating income 19,388 7,102 23,725 3,814
Other expenses (income) (291) (180) 267 (591)
Income before income
taxes 19,679 7,282 23,458 4,405
Provision for income taxes 6,396 1,928 7,624 (637)
Net income $ 13,283 $ 5,354 $ 15,834 $ 5,042
Basic earnings
per common share $ 0.30 $ 0.12 $ 0.36 $ 0.11
Diluted earnings
per common share $ 0.30 $ 0.12 $ 0.35 $ 0.11
Weighted average shares used in computing
basic earnings per
common share 43,836 44,214 44,548 44,598
Weighted average shares used in computing
diluted earnings per common share 44,526 45,010 45,277 45,210
(73)
ARROW INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
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 and development 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
(74)
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, 2005, 2004 and 2003:
2005 2004 2003
------------- ------------- ------------
Net income $39,513 $ 55,942 $ 45,670
Weighted average common shares outstanding 44,300 43,559 43,399
Incremental common shares issuable: stock options
and awards 708 743 374
------------- ------------- ------------
Weighted average common shares outstanding 45,008 44,302 43,773
assuming dilution ============= ============= ============
Basic earnings per common share $0.89 $1.28 $1.05
============= ============= ============
Diluted earnings per common share $0.88 $1.26 $1.04
============= ============= ============
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.
At August 31, 2005, there were 779 stock options outstanding to purchase shares
of common stock that were not included in the computation of earnings per share
assuming dilution because the options' exercise price was higher than the
average market price of the Company's common stock. All stock options
outstanding to purchase shares of common stock that were included in the
computation of earnings per share assuming dilution were those for which the
options' exercise price was less than the average market price of the Company's
common stock at August 31, 2004 and August 31, 2003, respectively.
25. Warranty:
The Company's primary warranty obligation relates to sales of its intra-aortic
balloon pumps, for which the Company offers a warranty of one year to its U.S.
customers and two years to its international customers. As of August 31, 2005
and August 31, 2004, the Company's total estimated product warranty obligation
was $660 and $740, respectively. Because this estimate is based primarily on
historical experience, actual costs may differ from the amounts estimated. The
change in warranty obligation for fiscal 2005 and 2004 is as follows:
For the Fiscal Years Ended
------------------------------
August 31, August 31,
2005 2004
------------- -----------
Balance as of September 1 $ 740 $ 427
Additional warranties issued 1,173 1,824
Expenditures / Expirations (1,253) (1,511)
-------- ----------
Balance as of August 31 $ 660 $ 740
======== ==========
(75)
SCHEDULE II
ARROW INTERNATIONAL, INC.
VALUATION AND QUALIFYING ACCOUNTS
Additions
----------------------------------
Charges /
Balance at (Credits) to Balance at
Beginning Cost and Charged End
Description of Period Expenses to Other Accounts Deductions(1) of Period
- ----------- --------- -------- ----------------- ------------- ---------
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
====== ====== ========== ====== ======
For the year ended August 31, 2005:
Accounts receivable:
Allowance for doubtful accounts $2,198 $1,010 $ -- $1,032 $2,176
====== ====== ========== ====== ======
(1) Deductions represent write-offs of accounts receivable.
(76)
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
Item 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure 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 defined in Rule
13a-15(e) under the Exchange Act) as of August 31, 2005. 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, and is accumulated and communicated to the Company's management,
including its CEO and CFO, to allow timely decisions regarding required
disclosure.
Management's Report on Internal Control Over Financial Reporting
The Company's management, including its CEO and CFO, is responsible for
establishing and maintaining adequate internal control over financial reporting
(as defined in Rule 13a-15(f) under the Exchange Act). Under the supervision and
with the participation of the Company's management, including its CEO and CFO,
the Company conducted an evaluation of the effectiveness of its internal control
over financial reporting based on the framework in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on that evaluation, the Company's management concluded that
its internal control over financial reporting was effective as of August 31,
2005.
Management's report on internal control over financial reporting and the
attestation report of the Company's independent registered public accounting
firm are included in Item 8 of this report under the captions entitled
"Management's Report on Internal Control over Financial Reporting" and "Report
of Independent Registered Public Accounting Firm".
Changes in Internal Control Over Financial Reporting
There have been no significant changes in the Company's internal control
over financial reporting that occurred during the three months ended August 31,
2005 that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
(77)
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 2006 Annual
Meeting of Shareholders to be held on January 18, 2006 (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" and is incorporated herein by reference.
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, 2005.
Equity Compensation Plan Information
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 warrants and rights warrants and rights reflected in column (a))
- ----------------------------------- -------------------------- -------------------------- ---------------------------
(a) (b) (c)
Equity compensation plans
approved by security
holders 2,381,367 $22.43 11,265,833
Equity compensation plans
not approved by security
holders - - -
Total 2,381,367 $22.43 11,265,833
(78)
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.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information regarding fees paid by the Company for accounting services
rendered by its registered public accounting firm, PricewaterhouseCoopers LLP,
Certified Public Accountants, will be included in the Proxy Statement and is
incorporated herein by reference.
(79)
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 79 through 83 of this report for a list
of the exhibits filed, furnished or incorporated by reference as part of this
report.
(80)
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 14, 2005
(81)
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 14, 2005
- ---------------------------------
(Carl G. Anderson, Jr.) Chief Executive Officer
(Principal Executive Officer)
/s/ Frederick J. Hirt Chief Financial Officer and November 14, 2005
- ---------------------------------
(Frederick J. Hirt) Senior Vice President of Finance
(Principal Financial and
Accounting Officer)
/s/ Marlin Miller, Jr. Director November 14, 2005
- ---------------------------------
(Marlin Miller, Jr.)
/s/ Raymond Neag Director November 14, 2005
- ---------------------------------
(Raymond Neag)
/s/ John H. Broadbent, Jr. Director November 14, 2005
- ---------------------------------
(John H. Broadbent, Jr.)
/s/ T. Jerome Holleran Director November 14, 2005
- ---------------------------------
(T. Jerome Holleran)
/s/ Richard T. Niner Director November 14, 2005
- ---------------------------------
(Richard T. Niner)
/s/ George W. Ebright Director November 14, 2005
- ---------------------------------
(George W. Ebright)
/s/ Alan M. Sebulsky Director November 14, 2005
- ---------------------------------
(Alan M. Sebulsky)
/s/ John E. Gurski Director November 14, 2005
- ---------------------------------
(John E. Gurski)
/s/ R. James Macaleer Director November 14, 2005
- ---------------------------------
(R. James Macaleer)
/s/ Anna M. Seal Director November 14, 2005
- ---------------------------------
(Anna M. Seal)
(82)
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").
(83)
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.
(84)
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.
(85)
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.
(86)
Exhibit Number Description of Exhibit Method of Filing
- ---------------- ----------------------------------------------- -----------------------------------------------------
10.33.1 Second Amendment to Loan Agreement, dated Incorporated by reference from Exhibit 10.33.1 to
June 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.
10.33.2 Fourth Amendment to Loan Agreement, dated May Incorporated by reference from Exhibit 10.33.2 to
27, 2005, among Wachovia Bank, National the May 31, 2005 Form 10-Q
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.
(87)
Exhibit Number Description of Exhibit Method of Filing
- ---------------- ----------------------------------------------- -----------------------------------------------------
32.2 Section 1350 Certification of the Chief Furnished herewith
Financial Officer.
(88)