UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------
FORM 10-Q
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended May 31, 2004
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.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-1969991
- ------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2400 Bernville Road, Reading, Pennsylvania 19605
- ------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 378-0131
--------------
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 under the Exchange Act) Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Shares outstanding at July 9, 2004
--------- ----------------------------------
Common Stock, No Par Value 43,765,703
ARROW INTERNATIONAL, INC.
Form 10-Q Index
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at May 31, 2004
and August 31, 2003 3-4
Consolidated Statements of Income 5-6
Consolidated Statements of Cash Flows 7-8
Consolidated Statements of Comprehensive Income 9
Notes to Consolidated Financial Statements 10-22
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23-37
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 37-39
Item 4. Controls and Procedures 39
PART II.OTHER INFORMATION
Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds 40
Item 6. Exhibits and Reports on Form 8-K 41
Signature 42
Exhibit Index 43
Certifications 44-47
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ARROW INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
May 31, August 31,
2004 2003
-------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 83,683 $ 46,975
Accounts receivable, net 84,105 82,467
Inventories 95,482 90,449
Prepaid expenses and other 9,738 14,978
Deferred income taxes 8,410 7,011
-------------- --------------
Total current assets 281,418 241,880
-------------- --------------
Property, plant and equipment 295,231 276,294
Less accumulated depreciation (161,626) (147,861)
-------------- --------------
133,605 128,433
-------------- --------------
Goodwill 42,698 42,732
Intangible and other assets, net 51,216 48,836
Prepaid pension costs 29,977 32,016
-------------- --------------
Total other assets 123,891 123,584
-------------- --------------
Total assets $ 538,914 $ 493,897
============== ==============
See accompanying notes to consolidated financial statements
Continued
3
ARROW INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS, Continued
(In thousands, except share amounts)
(Unaudited)
May 31, August 31,
2004 2003
-------------- --------------
LIABILITIES
Current liabilities:
Current maturities of long-term debt $ 3,122 $ 300
Notes payable 31,197 28,431
Accounts payable 14,925 11,727
Cash overdrafts 1,318 1,506
Accrued liabilities 17,356 21,600
Accrued compensation 11,081 10,684
Accrued income taxes 4,495 3,718
-------------- --------------
Total current liabilities 83,494 77,966
-------------- --------------
Long-term debt - 3,735
Accrued post-retirement benefit obligations 14,773 13,409
Deferred income taxes 7,714 8,141
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, no par value;
5,000,000 shares authorized;
none issued - -
Common stock, no par value;
100,000,000 shares authorized;
52,957,626 shares issued 45,661 45,661
Additional paid-in capital 9,876 5,840
Retained earnings 433,208 403,004
Less treasury stock at cost:
9,263,912 and 9,672,124 shares,
respectively (60,793) (63,472)
Accumulated other comprehensive income
(expense) 4,981 (387)
-------------- --------------
Total shareholders' equity 432,933 390,646
-------------- --------------
Total liabilities and
shareholders' equity $ 538,914 $ 493,897
============== ==============
See accompanying notes to consolidated financial statements
4
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
For the three months ended
------------------------------------
May 31, May 31,
2004 2003
-------------- --------------
Net sales $ 108,779 $ 96,949
Cost of goods sold 56,249 47,756
-------------- --------------
Gross profit 52,530 49,193
-------------- --------------
Operating expenses:
Research, development and engineering 8,201 6,329
Selling, general and administrative 27,068 22,649
-------------- --------------
Operating income 17,261 20,215
-------------- --------------
Other (income) expenses:
Interest expense, net of amount capitalized 287 139
Interest income (334) (85)
Other, net 45 (1,211)
-------------- --------------
Other (income) expenses, net (2) (1,157)
-------------- --------------
Income before income taxes 17,263 21,372
Provision for income taxes 5,611 6,946
-------------- --------------
Net income $ 11,652 $ 14,426
============== ==============
Basic earnings per common share $ 0.26 $ 0.33
============== ==============
Diluted earnings per common share $ 0.26 $ 0.33
============== ==============
Cash dividends per common share $ 0.090 $ 0.040
============== ==============
Weighted average shares outstanding
used in computing basic earnings
per common share 46,634,448 43,231,246
============== ==============
Weighted average shares outstanding
used in computing diluted earnings
per common share 44,474,481 43,667,492
============== ==============
See accompanying notes to consolidated financial statements
5
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
For the nine months ended
------------------------------------
May 31, May 31,
2004 2003
-------------- --------------
Net sales $ 320,174 $ 278,545
Cost of goods sold 155,644 140,170
-------------- --------------
Gross profit 164,530 138,375
-------------- --------------
Operating expenses:
Research, development and engineering 21,428 18,810
Selling, general and administrative 81,254 64,570
-------------- --------------
Operating income 61,848 54,995
-------------- --------------
Other (income) expenses:
Interest expense, net of amount capitalized 888 365
Interest income (631) (256)
Other, net 59 (1,060)
-------------- --------------
Other expenses, net 316 (951)
-------------- --------------
Income before income taxes 61,532 55,946
Provision for income taxes 19,998 18,182
-------------- --------------
Net income $ 41,534 $ 37,764
============== ==============
Basic earnings per common share $ 0.95 $ 0.87
============== ==============
Diluted earnings per common share $ 0.94 $ 0.86
============== ==============
Cash dividends per common share $ 0.260 $ 0.115
============== ==============
Weighted average shares outstanding
used in computing basic earnings
per common share 43,494,449 43,445,314
============== ==============
Weighted average shares outstanding
used in computing diluted earnings
per common share 44,220,664 43,762,486
============== ==============
See accompanying notes to consolidated financial statements
6
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
For the nine months ended
------------------------------------
May 31, May 31,
2004 2003
-------------- --------------
Cash flows from operating activities:
Net income $ 41,534 $ 37,764
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 14,072 14,317
Amortization 3,620 3,095
Abandonment of facility expansion plan 1,658 -
Deferred income taxes (1,829) 6,857
401(K) plan stock contribution 616 530
Unrealized holding gain on foreign currency options - 286
Write-off of Lionheart(TM)inventory 3,140 -
Write-off of Lionheart(TM)manufacturing equipment 558 -
Increase (decrease) in provision for postretirement
benefit obligation 1,349 1,739
Decrease (increase) in prepaid pension costs 2,038 (2,887)
Changes in operating assets and liabilities, net of effects
from acquisitions
Accounts receivable, net 1,673 3,663
Inventories (6,341) 3,770
Prepaid expenses and other 5,483 (933)
Accounts payable and accrued liabilities (3,069) (6,118)
Accrued compensation 188 1,771
Accrued income taxes 661 1,657
-------------- --------------
Total adjustments 23,817 27,747
-------------- --------------
Net cash provided by operating activities 65,351 65,511
Cash flows from investing activities:
Capital expenditures (17,553) (11,284)
(Increase) decrease in intangible and other assets (5,492) (792)
Cash paid for businesses acquired - (36,142)
-------------- --------------
Net cash used in investing activities (23,045) (48,218)
Cash flows from financing activities:
(Decrease) increase in notes payable (217) (1,509)
Principal payments of long-term debt (300) (300)
Reduction of long-term debt (614)
(Decrease) increase in book overdrafts (188) (2,006)
Dividends paid (10,859) (4,791)
Proceeds from stock options exercised 5,570 572
Purchase of treasury stock - (13,846)
-------------- --------------
Net cash used in financing activities (6,608) (21,880)
Effect of exchange rate changes on cash
and cash equivalents 1,010 1,089
Net change in cash and cash equivalents 36,708 (3,498)
Cash and cash equivalents at beginning of year 46,975 33,103
-------------- --------------
Cash and cash equivalents at end of period $ 83,683 $ 29,605
============== ==============
See accompanying notes to consolidated financial statements
Continued
7
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(In thousands)
(Unaudited)
For the nine months ended
------------------------------------
May 31, May 31,
2004 2003
-------------- --------------
Supplemental schedule of noncash investing and financial activities:
The Company assumed liabilities in conjunction with the purchase of certain assets as follows:
Estimated fair value of assets acquired $ - $ 48,856
Liabilities assumed - 12,714
-------------- --------------
Cash paid for assets $ $ 36,142
============== ==============
Cash paid for businesses acquired:
Working capital $ - $ 11,517
Property, plant and equipment - 1,960
Goodwill and intangible assets - 26,665
Notes payable and current maturities
of long-term debt
Long-term debt - (4,000)
-------------- --------------
$ $ 36,142
============== ==============
Treasury Stock issued for 401(k) plan contribution $ 616 $ 530
============== ==============
Intangible assets acquired by issuing treasury stock $ 530 $ -
============== ==============
Dividends declared but not paid $ 3,932 $ 1,730
============== ==============
See accompanying notes to consolidated financial statements
8
ARROW INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
For the three months ended
--------------------------------
May 31, May 31,
2004 2003
-------------- --------------
Net income $ 11,652 $ 14,426
Other comprehensive income (expense):
Currency translation adjustments (439) 3,417
Unrealized holding gain on foreign currency
option contracts - 82
-------------- --------------
Other comprehensive income (expense) (439) 3,499
-------------- --------------
Total comprehensive income $ 11,213 $ 17,925
============== ==============
For the nine months ended
--------------------------------
May 31, May 31,
2004 2003
-------------- --------------
Net income $ 41,534 $ 37,764
Other comprehensive income (expense):
Currency translation adjustments 5,368 6,269
Unrealized holding gain on foreign currency
option contracts - 286
-------------- --------------
Other comprehensive income (expense) 5,368 6,555
-------------- --------------
Total comprehensive income $ 46,902 $ 44,319
============== ==============
See accompanying notes to consolidated financial statements
9
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 1 - Basis of Presentation:
These unaudited consolidated financial statements include all adjustments,
consisting only of normal recurring accruals, which management considers
necessary for a fair presentation of the consolidated financial position,
results of operations, and cash flows of Arrow International, Inc. (the
"Company") for the interim periods presented. Results for the interim periods
are not necessarily indicative of results for the entire year. Such statements
are presented in accordance with the requirements of Form 10-Q and do not
include all disclosures normally required by generally accepted accounting
principles or those normally made on Form 10-K. These statements should be read
in conjunction with the consolidated financial statements and notes thereto
contained in the Company's Annual Report to Stockholders for the fiscal year
ended August 31, 2003.
Note 2 - Inventories:
Inventories are summarized as follows:
May 31, August 31,
2004 2003
--------------- ---------------
Finished goods $ 31,667 $ 31,204
Semi-finished goods 25,195 22,223
Work-in-process 10,395 8,933
Raw Materials 28,225 28,089
--------------- ---------------
$ 95,482 $ 90,449
=============== ===============
Note 3 - Commitments and 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 also currently a defendant in a lawsuit in which the plaintiff
alleges that the Company's Cannon-Cath(TM) split-tip hemodialysis catheters,
which were acquired as part of the Company's acquisition in November 2002 of
specified assets of Diatek, Inc., infringe a patent owned by or licensed to the
plaintiffs. In November 2003, this lawsuit was stayed pending the U.S. Patent
and Trademark Office's ruling on its re-examination of the patent at issue,
which is not expected to occur until after fiscal 2004. 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.
10
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 3 - Commitments and Contingencies (continued):
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.
Note 4 - Accounting Policies:
The Company previously adopted the disclosure provisions of Financial Accounting
Standard (SFAS) No. 148, "Accounting for Stock-Based Compensation." As permitted
under SFAS No. 123, the Company continues to apply the existing accounting rules
under APB No. 25 and provide pro forma net income and pro forma earnings per
share disclosures for employee stock option grants made as if the fair value
method in measuring compensation costs for stock options granted subsequent to
December 15, 1995 had been applied.
Had compensation expense for stock options granted in fiscal 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 May 31, 2004 and 2003 would have been reduced to
the pro forma amounts indicated in the table below:
For the three months ended For the nine months ended
------------------------------ ------------------------------
May 31, May 31, May 31, May 31,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Net income applicable to common shareholders
As reported $ 11,652 $ 14,426 $ 41,534 $ 37,764
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (654) (489) (2,240) (1,220)
Pro forma $ 10,998 $ 13,937 $ 39,294 $ 36,544
Basic earnings per common share
As reported $ 0.26 $ 0.33 $ 0.95 $ 0.87
Pro forma $ 0.25 $ 0.32 $ 0.90 $ 0.84
Diluted earnings per common share
As reported $ 0.26 $ 0.33 $ 0.94 $ 0.86
Pro forma $ 0.25 $ 0.32 $ 0.89 $ 0.84
11
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 4 - Accounting Policies (continued):
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 nonvested options.
The Company has disclosed in Note 1 to its consolidated financial statements
included in its Annual Report on Form 10-K for the fiscal year ended August 31,
2003 those accounting policies that it considers to be significant in
determining its results of operations and financial position. There have been no
material changes to the critical accounting policies previously identified and
described in the Company's 2003 Form 10-K. The accounting principles utilized by
the Company in preparing its consolidated financial statements conform in all
material respects to 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
Certain prior period information has been reclassified for comparative purposes.
Note 5 - Segment Reporting:
The Company operates as a single reportable segment. The Company operates in
four main geographic regions, therefore, information by product category and
geographic areas is presented below.
12
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 5 - Segment Reporting (continued):
The following table provides quarterly information about the Company's sales by
product category:
Quarter ended Quarter ended
May 31, 2004 May 31, 2003
--------------------------------- ---------------------------------
Critical Cardiac Critical Cardiac
Care Care Care Care
--------------- --------------- --------------- ---------------
Sales to external
customers $ 93,000 $ 15,800 $ 82,400 $ 14,500
The following tables present quarterly information about geographic areas:
Quarter ended May 31, 2004
----------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Consolidated
------------- ------------- -------------- ------------ ---------------
Sales to unaffiliated
customers $ 70,200 $ 13,800 $ 19,200 $ 5,600 $ 108,800
Quarter ended May 31, 2003
----------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Consolidated
------------- ------------- -------------- ------------ ---------------
Sales to unaffiliated
customers $ 62,900 $ 13,100 $ 15,900 $ 5,000 $ 96,900
The following table provides year-to-date information about the Company's sales
by product category:
Nine Months ended Nine Months ended
May 31, 2004 May 31, 2003
--------------------------------- ---------------------------------
Critical Cardiac Critical Cardiac
Care Care Care Care
--------------- --------------- --------------- ---------------
Sales to external
customers $ 274,000 $ 46,200 $ 237,100 $ 41,400
13
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 5 - Segment Reporting (continued):
The following tables present year-to-date information about geographic areas:
Nine Months ended May 31, 2004
----------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Consolidated
------------- ------------- -------------- ------------ ---------------
Sales to unaffiliated
customers $ 207,600 $ 44,300 $ 51,800 $ 16,500 $ 320,200
Nine Months ended May 31, 2003
----------------------------------------------------------------------------------
United Asia and Other
States Africa Europe Foreign Consolidated
------------- ------------- -------------- ------------ ---------------
Sales to unaffiliated
customers $ 184,700 $ 37,600 $ 42,600 $ 13,600 $ 278,500
Note 6 - New Accounting Standards Not Yet Adopted:
The Financial Accounting Standards Board (FASB) issued a proposed Statement,
"Share-Based Payment, an Amendment of Financial Accounting Standards (FAS) No.
123 and 95" in March 2003. This exposure draft proposes that the cost of all
forms of equity-based compensation granted to employees, excluding employee
stock ownership plans, be recognized in a company's income statement and that
such cost be measured at the fair value of the stock options. If the proposed
statement is issued as a final standard, the exposure draft will replace the
guidance in FAS No. 123, Accounting for Stock-Based Compensation, and APB No.
25, Accounting for Stock Issued to Employees. The Company has not yet evaluated
the impact that this proposed statement may have on its financial statements.
Note 7 - Business Acquisitions:
On September 3, 2002, the Company purchased the net assets of its former New
York City distributor, Stepic Medical, from Horizon Medical Products for
$12,636, which includes the relief from $5,539 of accounts receivable that had
been due from this distributor. As of May 31, 2004, pursuant to the asset
purchase agreement, the Company has 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.
14
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 7 - Business Acquisitions (continued):
This acquisition has been 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 $102. Intangible assets acquired of $3,452 are being
amortized over a period of five years. The results of operations of this
business are included in the Company's consolidated financial statements from
the date of acquisition. The purchase price for this acquisition was allocated
as follows:
Accounts receivable $10,090
Inventories 6,830
Other current assets 25
Property, plant and equipment 116
Goodwill and intangible assets 3,554
Current liabilities (7,979)
-------------
Total purchase price $12,636
=============
On November 25, 2002, the Company purchased specified assets and assumed
specified liabilities of Diatek, Inc., a company in the business of the
development, manufacture and marketing of chronic hemodialysis catheters, for
approximately $10,935. As of May 31, 2004, pursuant to the asset purchase
agreement, the Company has paid $8,935 in cash and recorded a liability
classified as long-term of up to an additional $2,000 for potential purchase
price and related adjustments. As of May 31, 2004, this liability has been
reduced by $878 for legal costs paid by the Company, which are obligated to be
reimbursed by the former owners of Diatek, Inc. Pursuant to the asset purchase
agreement relating to this transaction, the Company is also required to make
royalty payments to Diatek's former owners based on the achievement of specified
annual sales levels of certain hemodialysis product lines. The Company is
accruing for any such royalty expenses as they are incurred. The Company intends
to exercise its right of set off under the asset purchase agreement with respect
to this obligation, enabling it to defer any such royalty payments until the
complete resolution of the Company's patent infringement lawsuit as described in
Note 3. As a result, the Company has not made any such royalty payments to date.
The products acquired in the transaction are expected to complement the
Company's existing hemodialysis product line. This acquisition has been
accounted for using the purchase method of accounting. The purchase price for
this acquisition did not exceed the estimated fair value of the net assets
acquired and, therefore, no goodwill has been recorded by the Company in
connection therewith. Intangible assets acquired of $12,235, consisting
primarily of intellectual property rights, are being amortized over a period of
20 years based on the legal life of the underlying acquired technology. An
independent valuation firm was used to determine a fair market value of the
intangible assets acquired. The results of operations of this business are
included in the Company's consolidated financial statements from the date of
acquisition. The purchase price for this acquisition was allocated as follows:
15
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 7 - Business Acquisitions (continued):
Accounts receivable $ 176
Inventories 423
Property, plant and equipment 179
Intangible assets 12,235
Current liabilities (2,078)
-------------
Total purchase price $10,935
=============
On March 18, 2003, the Company purchased substantially all of the assets of
Klein-Baker Medical, Inc., a company doing business as NeoCare(R) in San
Antonio, Texas, for approximately $16,549, subject to post-closing adjustments.
NeoCare(R) develops, manufactures and markets specialty catheters and related
procedure kits to neonatal intensive care units. The Company believes that this
acquisition will further enhance its broad line of critical care related
products and may serve as the base for possible further expansion of the
Company's pediatric product line. As of May 31, 2004, pursuant to the asset
purchase agreement, the Company has paid $14,550 in cash and recorded a
liability classified as long-term debt of an additional $2,000 for potential
purchase price adjustments. This acquisition has been accounted for using the
purchase method of accounting. The excess of the purchase price over the
estimated fair value of the net assets acquired of $3,803 was recorded as
goodwill and will be evaluated for impairment on a periodic basis in accordance
with SFAS No. 142. Intangible assets acquired of $8,539 are being amortized over
a period of 25 years based on the anticipated period in which cash flows are
expected. An independent valuation firm was used to determine a fair market
value of the inventory and intangible assets acquired. The results of operations
of this business are included in the Company's consolidated financial statements
from the date of acquisition. The purchase price for this acquisition was
allocated as follows:
Accounts receivable $ 640
Inventories 2,009
Property, plant and equipment 1,666
Goodwill and intangible assets 12,342
Current liabilities (107)
-------------
Total purchase price $16,550
=============
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 periods presented.
16
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 8 - 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
Company's shareholders on January 19, 2000; and the 1999 Stock Incentive Plan
(the "1999 Plan"), which was approved by the Company's shareholders on June 19,
2000. The 1992 and 1999 Plans authorize the granting of stock options, stock
appreciation rights and restricted stock. The Directors Plan authorizes the
granting of a maximum of 300,000 non-qualified stock options. Under the
Directors Plan, members of the Board of Directors of the Company and its
subsidiaries are eligible to participate if they are not also employees or
consultants of the Company or its subsidiaries, and do not serve on the Board of
Directors as representatives of the interest of shareholders who have made an
investment in the Company. The Directors Plan authorizes an initial grant of an
option to purchase 10,000 shares of common stock upon each eligible director's
initial election to the Board of Directors and the grant of an additional option
to purchase 3,000 shares of common stock on the date each year when directors
are elected to the Board of Directors.
The Company follows the provision of Accounting Principles Board (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 three and nine months ended May 31, 2004 and May 31, 2003,
respectively.
In the three months ended May 31, 2004 and May 31, 2003, the Company granted
10,000 and 0 options, respectively, to key employees to purchase shares of the
Company's common stock pursuant to the 1999 Plan. The exercise price per share
was $25.00 for the options granted during the three months ended May 31, 2004.
During the nine months ended May 31, 2004 and May 31, 2003, the Company granted
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 $25.00 to $25.80 for the options granted during the nine
months ended May 31, 2004, and $17.78 to $20.53 for the options granted in the
same period 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. 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.
17
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 8 - Stock Option Plans (continued):
In the first nine months of each of fiscal 2004 and 2003, the Company granted
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 2004 and 2003 awards was $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. These options expire ten
years from the grant date. The options vest fully 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 three and nine month periods ended May 31, 2004
and 2003 is summarized in the tables below:
For the three months ended
---------------------------------------------------------------------
May 31, 2004 May 31, 2003
--------------------------------- --------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
-------------- -------------- -------------- --------------
Outstanding at March 1 3,284,852 $20.19 2,397,230 $16.87
Granted 10,000 $25.00 - -
Exercised (100,225) $15.54 (22,460) $16.59
Terminated (31,840) $19.48 (10,620) $17.11
-------------- --------------
Outstanding at May 31 3,162,787 $20.36 2,364,150 $16.87
Exercisable at May 31 1,271,292 $16.45 1,238,094 $15.95
18
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 8 - Stock Option Plans (continued):
For the nine months ended
---------------------------------------------------------------------
May 31, 2004 May 31, 2003
--------------------------------- --------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
-------------- -------------- -------------- --------------
Outstanding at September 1 2,318,260 $16.81 2,414,510 $16.75
Granted 1,277,000 $25.81 40,000 $20.12
Exercised (364,003) $15.24 (46,020) $16.18
Terminated (68,470) $19.04 (44,340) $17.23
-------------- --------------
Outstanding at May 31 3,162,787 $20.36 2,364,150 $16.87
Exercisable at May 31 1,271,292 $16.45 1,238,094 $15.95
Stock options outstanding at May 31, 2004 are summarized in the table below:
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Contractual Life Price Exercisable Price
- -------------------------- --------------- -------------------- ------------- -------------- ---------------
$12.56 - $17.50 731,138 4.59 $14.24 670,712 $14.22
$17.51 - $21.47 1,167,249 6.66 $18.87 600,580 $18.95
$21.48 - $26.42 1,264,400 9.29 $25.28 - -
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 made as if the fair value method in measuring
compensation cost for stock options granted subsequent to December 15, 1995 had
been applied.
19
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 8 - Stock Option Plans (continued):
The per share weighted average value of stock options granted in the first nine
months of fiscal 2004 and 2003 was $10.93 and $7.80, respectively. The fair
value was estimated as of the grant date using the Black-Scholes option pricing
model with the following average assumptions:
May 31, May 31,
2004 2003
------------ ------------
Risk-free interest rate 2.79% 1.81%
Dividend yield 1.44% 1.72%
Volatility factor 52.26% 48.88%
Expected lives 4 years 4 years
Note 9 - Warranty
The Company's primary warranty obligation relates to intra-aortic balloon pumps.
The Company offers a warranty of one year to its U.S. customers and two years to
its international customers. As of May 31, 2004, the Company's estimated product
warranty obligation is $808. Because this estimate is based primarily on
historical experience, actual costs may differ from the amounts estimated.
Note 10 - Retirement Benefits
Pension Plans:
The Company has three noncontributory pension plans that cover substantially all
employees. Benefits under the plans are based upon an employee's compensation
and years of service and, where applicable, the provisions of negotiated labor
contracts. It is the Company's policy to make contributions to these plans
sufficient to meet the minimum funding requirements of applicable laws and
regulations plus such additional amounts, if any, as the Company's actuarial
consultants advise to be appropriate. The projected unit credit method is
utilized for determination of actuarial amounts.
Plan assets consist principally of U.S. government securities, short-term
investments, other equity securities and cash equivalents.
On September 1, 2000, the Company established a Defined Benefit Supplemental
Executive Retirement Plan to provide pension benefits to selected executives and
retired executives/directors of the Company. The plan is unfunded and the
benefits provided under the plan are intended to be in addition to other
employee retirement benefits offered by the Company, including but not limited
to tax-qualified employee retirement plans.
20
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 10 - Retirement Benefits (continued):
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.
The following summarizes the components of the net periodic benefit costs for
the three and nine months ended May 31, 2004:
Pension Benefits Other Benefits
---------------------------------------------- -------------------------------------------------
For the Three months For the Nine months For the Three months For the Nine months
ended ended ended ended
---------------------- --------------------- ------------------------ ----------------------
May 31, May 31, May 31, May 31, May 31, May 31, May 31, May 31,
2004 2003 2004 2003 2004 2003 2004 2003
--------- --------- -------- --------- ---------- ---------- --------- ---------
Service cost $ 916 $ 949 $2,560 $2,847 $ 74 $ 66 $280 $198
Interest cost 1,397 1,501 3,826 4,503 223 164 643 492
Expected return on plan
assets (1,763) (2,247) (5,170) (6,741) - - - -
Amortization of prior service
costs 303 230 759 690 (38) (17) (80) (51)
Amortization of transition
obligation (asset) (27) (37) (80) (111) 12 10 37 30
Amortization of net actuarial
(gain) loss 199 174 625 522 35 21 141 63
Plan acquisition differentia 38 52 113 156 (7) (6) (22) (18)
--------- --------- -------- --------- ---------- ---------- --------- ---------
Net periodic (benefit)
cost $1,063 $ 622 $2,633 $1,866 $299 $ 238 $999 $714
========= ========= ======== ========= ========== ========== ========= =========
Note 11 - LionHeart(TM) Charges
The Company incurred charges in the three months ended May 31, 2004 totaling
$3,698 ($2,496 after tax, or $0.06 diluted earnings per share.) These charges
resulted from the Company's previously announced 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 ($2,120 after tax or $0.05 diluted earnings per share) 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 ($376 after tax, or $0.01 per diluted earnings per share).
21
ARROW INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)
Note 12 - 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 three
and nine months ended May 31, 2004 and 2003.
For the Three For the Three
Months Ended Months ended
May 31, May 31,
2004 2003
------------------ -----------------
Net income $11,652 $14,426
Weighted average common shares outstanding 46,634 43,231
Incremental common shares issuable: stock options
and awards 840 436
------------------ -----------------
Weighted average common shares outstanding
assuming dilution 47,474 43,667
================== =================
Basic earnings per common share $0.26 $0.33
================== =================
Diluted earnings per common share $0.26 $0.33
================== =================
For the Nine For the Nine
Months Ended Months ended
May 31, May 31,
2004 2003
------------------ -----------------
Net income $41,534 $37,764
Weighted average common shares outstanding 43,494 43,445
Incremental common shares issuable: stock options
and awards 727 317
------------------ -----------------
Weighted average common shares outstanding
assuming dilution 44,221 43,762
================== =================
Basic earnings per common share $0.95 $0.87
================== =================
Diluted earnings per common share $0.94 $0.86
================== =================
22
ARROW INTERNATIONAL, INC.
Item 2. 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 IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE
FISCAL YEAR ENDED AUGUST 31, 2003 AND THE COMPANY'S OTHER PERIODIC REPORTS AND
OTHER DOCUMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
Results of Operations
THREE MONTHS ENDED MAY 31, 2004 COMPARED TO THREE MONTHS ENDED MAY 31, 2003:
Net sales for the three months ended May 31, 2004 increased by $11.9 million, or
12.3%, to $108.8 million from $96.9 million in the same period last year due
primarily to an increase in critical care product sales and a favorable foreign
exchange impact during the third quarter of 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 sales for the quarter of $2.2 million or 2.3%. Net sales
represent gross sales invoiced to customers, less certain related charges,
discounts, returns and other allowances. Revenue from sales is recognized at the
time products are shipped and title is passed to the customer. The following is
a summary of the Company's sales by product platform:
Sales by Product Platform
(In Millions) Quarter Ended
-------------
May 31, 2004 May 31, 2003
------------ ------------
Central Venous Catheters $ 55.5 $47.6
Specialty Catheters 34.4 31.5
Stepic Distributed products 3.1 3.3
------ -----
Subtotal Critical Care 93.0 82.4
Cardiac Care 15.8 14.5
------ -----
TOTAL $108.8 $96.9
====== =====
Sales of critical care products increased 12.9% to $93.0 million from $82.4
million in the comparable prior year period due primarily to increased sales of
central venous catheters and specialty catheters. Sales of central venous
catheters increased in the third quarter of fiscal 2004 due primarily to a
continued increase in the number of hospitals that are purchasing the Company's
procedure kits featuring its safety devices and ARROWg+ard(R) antiseptic surface
treatments as well as increased sales of renal access and neonatal products
resulting from the Company's acquisitions of Diatek and the NeoCare(R) product
line in fiscal 2003. Sales of specialty catheters increased in the third quarter
of fiscal 2004 due primarily to improved sales of arterial products, intravenous
and extension sets, and epidural products. Sales of cardiac care products
increased to $15.8 million from $14.5 million, an increase of 9.0% from the
comparable prior year period, 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 by 11.6% to $70.2
23
ARROW INTERNATIONAL, INC.
million in the third quarter of fiscal 2004 from $62.9 million in the comparable
prior year period principally as a result of increased sales of central venous
and specialty catheters. International sales increased by 13.5% to $38.6 million
from $34.0 million in the same prior year period principally as a result of
increased sales of central venous catheters and intra-aortic balloon pumps, and
the effect of foreign currency exchange rates, as noted above. International
sales represented 35.5% of net sales, compared to 35.1% in the same prior year
period.
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
35% in the comparable prior year period for total Company sales. The
ARROWg+ard(R) conversion percentages for the U.S. market increased to 63% from
59% 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 7% in the
three months ended May 31, 2004 from 5% in the comparable prior year period for
total Company sales. The safety device procedure kit conversion percentages for
the U.S. market in the three months ended May 31, 2004 increased to 14% from 10%
in the comparable prior year period.
Gross profit increased 6.7% to $52.5 million in the three months ended May 31,
2004, compared to $49.2 million in the same period of fiscal 2003. As a
percentage of net sales, gross profit decreased to 48.3% during the three months
ended May 31, 2004 from 50.7% in the comparable prior year period, due primarily
to the Company's write-off of $3.1 million of inventory in the third quarter of
fiscal 2004 for certain components relating to its LionHeart(TM) Left
Ventricular Assist System 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) external
power system and internal controller. This decline in margin was offset in part
by: (1) higher margins resulting from increased sales of the Company's procedure
kits featuring its safety devices and ARROWg+ard(R); (2) higher than average
margins realized on the sale of renal access products associated with the
Company's acquisition of Diatek in November 2002; and (3) 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.
Research, development and engineering expenses increased by 30.2% to $8.2
million in the three months ended May 31, 2004 from $6.3 million in the
comparable prior year period. As a percentage of net sales, these expenses
increased in the third quarter of fiscal 2004 to 7.5%, compared to 6.5% in the
same period in fiscal 2003, primarily as a result of increased research and
development expenditures for the Company's critical care product line as well as
increased spending on the Arrow LionHeart(TM), including incremental spending
associated with the development of the LionHeart(TM)'s second generation
electronics. These increases were offset in part by 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. A description of the current status of the Company's major
24
ARROW INTERNATIONAL, INC.
research and development programs is provided below under "Nine Months Ended May
31, 2004 Compared to Nine Months Ended May 31, 2003."
Selling, general and administrative expenses increased by 19.9% to $27.1 million
in the three months ended May 31, 2004 from $22.6 million in the comparable
prior year period and, as a percentage of net sales, increased to 24.9% in the
third quarter of fiscal 2004 from 23.4% in the comparable period of fiscal 2003.
This increase was due primarily to several factors, including (1) increased
selling, general and administrative expenses of $0.8 million incurred as a
result of the Company's acquisitions in fiscal 2003 of Diatek, the Neo?Care
product line and IMA, Inc., it's former Florida distributor, and (2) an increase
in selling, general and administrative expenses of $0.6 million 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 as well as incremental expenditures to strengthen the
Company's marketing and sales effort. These increases were offset in part by a
decrease in legal costs of $0.8 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.
The Company also recorded a charge of $0.6 million in the three months ended May
31, 2004 for a write-off of manufacturing equipment relating to the
LionHeart(TM). The Company's operating expenses for the three months ended May
31, 2004 also included approximately $1.3 million of severance and other costs
related to several reorganizations of the Company's operations.
Principally due to the above factors, operating income decreased in the third
quarter of fiscal 2004 by 14.4% to $17.3 million from $20.2 million in the
comparable prior year period.
Other expenses (income), net, decreased to $0.1 million of income in the third
quarter of fiscal 2004 from $1.2 million of income in the same prior year period
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.
As a result of the factors discussed above, income before income taxes decreased
in the third quarter of fiscal 2004 by 18.8% to $17.3 million from $21.3 million
in the comparable prior year period. For the third quarter of each of fiscal
2004 and 2003, the Company's effective income tax rate was 32.5%.
Net income in the third quarter of fiscal 2004 decreased by 20.0% to $11.6
million from $14.5 million in the comparable prior year period primarily as a
result of the above factors. As a percentage of net sales, net income
represented 10.7% in the three months ended May 31, 2004 compared to 14.9% in
the same period of fiscal 2003.
Basic and diluted earnings per common share were $0.26 in the three months ended
May 31, 2004, down 21.2%, or $0.07 per share, from $0.33 in the comparable prior
year period. Weighted average common shares outstanding used in computing basic
earnings per common share increased to 43,634,448 in the third quarter of fiscal
2004 from 43,231,246 in the comparable prior year period primarily as a result
25
ARROW INTERNATIONAL, INC.
of an increase in stock option exercises due to a higher market price of the
Company's stock relative to average outstanding option exercise prices during
the fiscal year offset in part by the Company's repurchases of shares during
fiscal 2003 under it's share repurchase program, which resulted in a full impact
on the weighted average share calculation in the third quarter of fiscal 2004
compared to a partial impact in the comparable prior year period. Weighted
average shares of common stock outstanding used in computing diluted earnings
per common share increased to 44,474,481 in the third quarter of fiscal 2004
from 43,667,492 in the comparable prior year period 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 decreased above.
NINE MONTHS ENDED MAY 31, 2004 COMPARED TO NINE MONTHS ENDED MAY 31, 2003:
Net sales for the nine months ended May 31, 2004 increased by $41.7 million, or
15.0%, to $320.2 million from $278.5 million in the same period last year, due
primarily to an increase in critical care product sales and a favorable foreign
exchange impact during the nine months ended May 31, 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 sales for the nine months ended May 31, 2004 of $8.8
million or 3.2%. The following is a summary of the Company's sales by product
platform:
Sales by Product Platform
(in millions) Nine months ended
-----------------
May 31, 2004 May 31, 2003
------------ ------------
Central Venous Catheters $164.9 $135.6
Specialty Catheters 99.9 91.8
Stepic Distributed products 9.2 9.7
------ ------
Subtotal Critical Care 274.0 237.1
Cardiac Care 46.2 41.4
------ ------
TOTAL $320.2 $278.5
====== ======
Sales of critical care products increased 15.6% to $274.0 million for the nine
months ended May 31, 2004 from $237.1 million in the comparable prior year
period due primarily to increased sales of central venous catheters and
specialty catheters. Sales of central venous catheters increased in the nine
months ended May 31, 2004 due primarily to a continued increase in the number of
hospitals that are purchasing the Company's procedure kits featuring its safety
devices and ARROWg+ard(R) antiseptic surface treatments, as well as increased
sales of renal access and neonatal products resulting from the Company's
acquisitions of Diatek and the NeoCare(R) product line in fiscal 2003. Sales of
specialty catheters increased in the nine months ended May 31, 2004 due to
improved sales of arterial products, epidural products, intraveneous and
extension sets, and Percutaneous Thrombolytic Devices. Cardiac care product
sales increased by 11.6% to $46.2 million from $41.4 million in comparable prior
year period 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 12.4% to $207.6 million for the nine months ended
May 31, 2004 from $184.7 million in the comparable prior year period principally
as a result of increased sales of central venous and specialty catheters.
International sales increased by 20.0% to $112.6 million from $93.8 million in
the comparable prior year period 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 35.2% of net sales for the nine months ended May 31, 2004
compared to 33.7% in the same prior year period.
26
ARROW INTERNATIONAL, INC.
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% from
35% in the comparable prior year period for total Company sales. The
ARROWg+ard(R) conversion percentages for the U.S. market increased to 62% from
58% 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 7% in the
nine months ended May 31, 2004 from 5% in the comparable prior year period for
total Company sales. The safety device procedure kit conversion percentages for
the U.S. market in the nine months ended May 31, 2004 increased to 13% from 9%
in the comparable prior year period.
Gross profit increased 18.9% to $164.5 million in the nine months ended May 31,
2004, compared to $138.4 million in the same period of fiscal 2003. As a
percentage of net sales, gross profit increased to 51.4% during the nine months
ended May 31, 2004 from 49.7% in the comparable period of fiscal 2003. The
increase in gross margin was due primarily to: (1) lower margins realized in the
nine months ended May 31, 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); (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, development and engineering expenses increased by 13.8% to $21.4
million in the nine months ended May 31, 2004 from $18.8 million in the
comparable prior year period. As a percentage of net sales, these expenses
decreased to 6.7% compared to 6.8% in the same period in fiscal 2003. The
increase in research, development and engineering expenses was primarily due to
increased research and engineering expenditures for the Company's critical care
product line, in addition to higher spending on the Arrow LionHeart(TM),
including incremental spending associated with the development of the
LionHeart(TM)'s second generation electronics. These increases were offset in
part by decreased research and development spending on the CorAide(TM)
continuous flow ventricular assist system. The Company currently anticipates
that research, development and engineering expenses related to the development
of second generation LionHeart(TM) components will be approximately $1.4 million
in the fourth quarter of fiscal 2004.
As previously reported in November 2003, the Company received authorization to
CE mark the Arrow LionHeart(TM) in Europe, which allows the Company to market
27
ARROW INTERNATIONAL, INC.
the device within the European Economic Area for permanent implantation or
"destination therapy". Earlier in fiscal 2004, the Company initiated its
marketing program in Europe, which includes the training of additional centers
to implant the device supplementing those centers that were already participants
in the clinical trails, and commenced initial sales of the product. The Company
expects to submit dossiers for the second generation LionHeart(TM) external
power system and internal controller to the Company's European Notified Body,
TUV Product Services of Munich, Germany, in the fall of 2004 and anticipates
receiving an approval for use of these electronics in the device approximately
three months later, given that many of its components have not changed, no
additional clinical data is required and the LionHeart(TM) quality system has
already been certified by TUV. The Company's European marketing plan for the
LionHeart(TM) is based upon the timely receipt of this approval and the
CE-marking of the device's second generation electronics.
The Company's near-term focus for the LionHeart(TM) program continues to be on
obtaining optimal clinical results and on evaluating the second generation
product enhancements which are currently in development. The Company believes
that these enhancements should increase the patient population for whom the
device is suitable and provide improved quality of life for recipients. As
previously reported, the Company expects that revenues generated from initial
sales of the Arrow LionHeart(TM) will be absorbed by increased marketing and
clinical support costs and will not contribute to earnings during fiscal 2004.
As previously reported, the Company decided in the third quarter of fiscal 2004
to defer commencement in the U.S. of the LionHeart(TM) Phase II clinical trials,
required by the Food and Drug Administration to bring the product to market in
the U.S., until the Company is able to implement second generation product
enhancements currently in the testing phase. As disclosed above, this decision
resulted in the Company's write off of $3.1 million in obsolete inventory and
$0.6 million in manufacturing equipment in the third quarter of fiscal 2004.
The Company believes it has made significant progress in its efforts to develop
and test modifications to the CorAide(TM) continuous flow ventricular assist
device to resolve elevated levels of hemolysis (plasma-free hemoglobin)
experienced in the first implant of the device. While the Company cannot be
certain that these modifications will resolve the problem, at this juncture, it
believes that suitable improvements have been developed to address the hemolysis
issue. The Company is cautiously optimistic that European clinical trials of the
CorAide(TM) device should resume later in calendar 2004, although due to the
pioneering nature of this program, it is difficult to predict precise timing.
In January 2004, the Company introduced its AutoCAT(R)2 WAVETM intra-aortic
balloon pump and associated LightWAVETM catheter system in the U.S. and Europe.
While customer response to this new product has been positive, during the third
quarter of fiscal 2004, the selling process was slowed somewhat by ramp-up
issues in manufacturing. Although the Company does not believe these
manufacturing delays will affect the long-term growth of this product, it does
anticipate a potential lingering impact in the fourth quarter of fiscal 2004.
The Company continues to believe that this new technology, which utilizes fiber
optic pressure-sensing catheter instrumentation and provides total automation of
the pumping process for all patients, represents a major step forward in
intra-aortic balloon pumping and should enable the Company to gain market share
based on superior performance across a range of cardiac requirements.
28
ARROW INTERNATIONAL, INC.
Selling, general and administrative expenses increased by 25.9% to $81.3 million
during the nine months ended May 31, 2004 from $64.6 million in the comparable
prior year period. As a percentage of net sales, these expenses increased to
25.4% in the first nine months of fiscal 2004 from 23.2% in the comparable prior
year period. This increase was due primarily to several factors, including: (1)
increased selling, general and administrative expenses of $3.5 million incurred
in connection with the Company's acquisitions in fiscal 2003 of Diatek, the
NeoCare product line and IMA, Inc., it's former Florida distributor; (2) an
increase in selling, general and administrative expenses of $2.5 million 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 selling, general and administrative
expense 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 selling, general and administrative expenses of $1.4 million relating
to an increase in the accrual for the Company's income growth bonus plan for its
executive officers and key management employees; and (5) an increase in selling,
general and administrative expenses of $1.0 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 as a result of a modification to its vacation
policy. These increases were offset in part by a decrease in legal costs of $1.2
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.
The Company also recorded a charge of $0.6 million in the nine months ended May
31, 2004 for a write-off of manufacturing equipment relating to the LionHeart
(TM) .
Principally due to the above factors, operating income increased in the nine
months ended May 31, 2004 by 12.4% to $61.8 million from $55.0 million in the
comparable period of fiscal 2003.
Other expenses (income), net, was $0.3 million of expense in the nine months
ended May 31, 2004 as compared to $1.0 million of income in the same period of
the prior fiscal year 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.
As a result of the factors discussed above, income before income taxes increased
in the nine months ended May 31, 2004 by 10.0% to $61.5 million from $55.9
million in the comparable prior year period. For the first nine months of each
of fiscal 2004 and 2003, the Company's effective income tax rate was 32.5%.
Net income in the nine months ended May 31, 2004 increased 9.8% to $41.5 million
from $37.8 million in the nine months ended May 31, 2003. As a percentage of net
sales, net income represented 13.0% in the nine months ended May 31, 2004
compared to 13.6% in the same period of fiscal 2003.
Basic earnings per common share were $0.95 for the nine month period ended May
31, 2004, up 9.2%, or $0.08 per share, from $0.87 in the comparable prior year
period. Diluted earnings per common share were $0.94 for the nine month period
ended May 31, 2004, up 9.3%, or $0.08 per share, from $0.86 in the comparable
prior year period. Weighted average shares of common stock outstanding used in
29
ARROW INTERNATIONAL, INC.
computing basic earnings per common share increased to 43,494,449 in the nine
months ended May 31, 2004 from 43,445,314 in the comparable prior year period,
primarily as a result of an increase in stock option exercises due to a higher
market price of the Company's stock relative to average outstanding option
exercise during the fiscal year offset in part by the Company's repurchases of
shares during fiscal 2003 under its share repurchase program, which resulted in
a full impact in the nine months ended May 31, 2004 compared to a partial impact
in the comparable prior year period. Weighted average shares of common stock
outstanding used in computing diluted earnings per common share increased to
44,220,664 in the nine months ended May 31, 2004 from 43,762,486 in the
comparable prior period 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 decreased above.
LIQUIDITY AND CAPITAL RESOURCES
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
1 of this report. For the nine months ended May 31, 2004, net cash provided by
operations was $65.4 million, a decrease of $0.1 million from the comparable
prior year period due primarily to an increase in inventory and deferred taxes
offset by decreases in prepaid pension costs, prepaid expenses and accrued
liabilities, as more fully explained below. Accounts receivable, measured in
days sales outstanding during the period, decreased to 72 days at May 31, 2004
from 79 days at August 31, 2003 due primarily to increased collection efforts by
the Company.
The Company currently has an accounts receivable balance from its Greek
customers of $5.7 million, of which approximately 83% is related to Greek
government-backed hospital customers. The days sales outstanding is currently
465 days, which is significantly higher than that of the Company's overall May
31, 2004 average customer days sales outstanding of 72 days. However, according
to the Hellenic Association of Scientific and Medical Equipment Suppliers, the
average days sales outstanding for medical equipment supply companies in the
Greek market is approximately 420 days. The Company's payment terms in this
market are generally 45 days. The Company believes that, in its efforts to fund
the upcoming Summer Olympic Games in Athens, the government of Greece has been
delaying payments due to its government-backed hospitals, which has in turn led
to the Company's increase in its days sales outstanding for its Greek customers.
The Greek government has announced a plan to resume its payments on its trade
debt following the Olympic Games, which should allow its hospitals to repay
their outstanding balances to their vendors. The government of Greece has
initiated similar plans in the past to reduce delinquent trade debt, which have
resulted in the Company's material realization on its outstanding receivables
following the implementation of those plans. As a result, the Company currently
believes that this situation will be resolved and that ultimate collectibility
of these receivables, net of discounts, is not a significant risk. However,
because the Company's assessment is based in part on political factors beyond
its control, the Company cannot assure you that these receivables will be
collected or when they will be collected, and will continue to evaluate their
collectibility and establish reserves when and to the extent necessary. The
Company currently evaluates all of its trade receivables on a regular basis,
including those with its Greek customers, to ensure that each receivable is
recorded at net realizable value based on a variety of customary criteria.
30
ARROW INTERNATIONAL, INC.
Inventories increased $5.0 million in the nine months ended May 31, 2004 as
compared to a $7.0 million increase in the comparable period of fiscal 2003. The
increase in fiscal 2004 is primarily due to additional production and related
manufacturing costs necessary to support the Company's higher rate of sales
growth. The increase in fiscal 2003 was primarily attributable to inventory
acquired in connection with the Company's business acquisitions completed in the
nine months ended May 31, 2003, as further discussed below.
The net deferred income tax asset increased $1.8 million in the nine months
ended May 31, 2004 compared to a $6.9 million decrease in the same period of
fiscal 2003. The fiscal 2003 decrease was due primarily to greater than
anticipated tax deductions for fiscal 2002 relating to depreciation, pension
expense and certain special charges.
Prepaid pension costs decreased $2.0 million in the nine months ended May 31,
2004, compared to a $2.9 million increase in the comparable period of fiscal
2003, primarily as a result of payments made in fiscal 2003 required to fund
certain of the Company's pension plans.
Prepaid expenses and other decreased $5.2 million in the nine months ended May
31, 2004, compared to a $1.7 million increase in the same period of fiscal 2003,
due primarily to the Company's receipt in fiscal 2004 of $8.0 million (which
includes, as previously reported, $6.9 million received in December 2003) for an
income tax refund related to the settlement of an Internal Revenue Service audit
pertaining primarily to depreciation and tax credits related to research and
development costs.
Accounts payable increased $3.2 million in the nine months ended May 31, 2004,
compared to a $0.6 million increase in the same period of fiscal 2003, due
primarily to the transition to a new accounts payable system and the timing of
the Company's payments to its vendors.
Accrued liabilities decreased $4.2 million in the nine months ended May 31, 2004
as compared to a $1.0 million decrease in the same period of fiscal 2003 due
primarily, as previously reported, to the Company's $8.0 million payment in
January 2004 in settlement of two related patent infringement lawsuits
pertaining to certain of its hemodialysis catheter products. This amount was
previously reserved in the fourth quarter of fiscal 2003.
Net cash used in the Company's investing activities decreased to $23.0 million
in the nine months ended May 31, 2004 from $48.2 million in the comparable
period of fiscal 2003, due primarily to purchase price payments in connection
with the Company's business acquisitions completed in the nine months ended May
31, 2003, as further discussed below. Capital expenditures increased to $17.6
million in the nine months ending May 31, 2004 from $11.3 million in the
comparable prior year period primarily as a result of higher capital
expenditures in fiscal 2004 for certain computer software and hardware required
to upgrade the Company's information systems infrastructure as well as costs
incurred in fiscal 2004 to expand the Company's finished goods warehouse and
distribution center in Asheboro, North Carolina.
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 May 31, 2004, pursuant to the asset
purchase agreement, the Company had 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.
31
ARROW INTERNATIONAL, INC.
This acquisition has been 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 $0.1 million. Intangible assets acquired of $3.5
million are being amortized over a period of five years. The results of
operations of this business are included in the Company's consolidated financial
statements from the date of acquisition. The purchase price for this acquisition
was allocated as follows:
(in millions)
Accounts receivable $ 10.1
Inventories 6.8
Other current assets -
Property, plant and equipment 0.1
Goodwill and intangible assets 3.5
Current liabilities (7.9)
--------
Total purchase price $ 12.6
========
On November 25, 2002, the Company purchased specified assets and assumed
specified liabilities of Diatek, Inc., a company in the business of the
development, manufacture and marketing of chronic hemodialysis catheters, for
approximately $10.9 million. As of May 31, 2004, pursuant to the asset purchase
agreement, the Company had paid $8.9 million in cash and recorded a liability
classified as long-term of up to an additional $2.0 million for potential
purchase price and related adjustments. As of May 31, 2004, this liability has
been reduced by $0.9 million for legal costs paid by the Company which are
obligated to be reimbursed by the former owners of Diatek, Inc. Pursuant to the
asset purchase agreement relating to this transaction, the Company is also
required to make royalty payments to Diatek's former owners based on the
achievement of specified annual sales levels of certain hemodialysis product
lines. The Company is accruing for any such royalty expenses as they are
incurred. The Company intends to exercise its right of set off under the asset
purchase agreement with respect to this obligation, enabling it to defer any
such royalty payments until the complete resolution of the Company's patent
infringement lawsuit as described in Note 3 of the notes to consolidated
financial statements included in Item 1 of this report. As a result, the Company
has not made any such royalty payments to date. The products acquired in the
transaction are expected to complement the Company's existing hemodialysis
product line. This acquisition has been accounted for using the purchase method
of accounting. The purchase price for this acquisition did not exceed the
estimated fair value of the net assets acquired and, therefore, no goodwill has
been recorded by the Company in connection therewith. Intangible assets acquired
of $12.2 million, consisting primarily of intellectual property rights, are
being amortized over a period of 20 years based on the legal life of the
underlying acquired technology. An independent valuation firm was used to
determine a fair market value of the intangible assets acquired. 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:
32
ARROW INTERNATIONAL, INC.
(in millions)
Accounts receivable $ 0.2
Inventories 0.4
Property, plant and equipment 0.2
Intangible assets 12.2
Current liabilities (2.1)
--------
Total purchase price $ 10.9
========
On March 18, 2003, the Company purchased substantially all of the assets of
Klein Baker Medical, Inc., a company doing business as NeoCare(R) in San
Antonio, Texas, for approximately $16.5 million, subject to post-closing
adjustments. NeoCare(R) develops, manufactures and markets specialty catheters
and related procedure kits to neonatal intensive care units. The Company
believes that this acquisition will further enhance its broad line of critical
care related products and may serve as the base for possible further expansion
of the Company's pediatric product line. As of May 31, 2004, pursuant to the
asset purchase agreement, the Company has paid $14.5 million in cash and
recorded a liability classified as long-term debt of an additional $2.0 million
for potential purchase price adjustments. This acquisition has been accounted
for using the purchase method of accounting. 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 will be evaluated for impairment on a periodic basis in
accordance with SFAS No. 142. Intangible assets acquired of $8.5 million are
being amortized over a period of 25 years based on the anticipated period in
which cash flows are expected. An independent valuation firm was used to
determine a fair market value of the inventory and intangible assets acquired.
The results of operations of this business are included in the Company's
consolidated financial statements from the date of acquisition. The purchase
price for this acquisition was allocated as follows:
(in millions)
Accounts receivable $ 0.6
Inventories 2.0
Property, plant and equipment 1.7
Goodwill and intangible assets 12.3
Current liabilities (0.1)
---------
Total purchase price $ 16.5
=========
Financing activities used $6.6 million of net cash in the nine months ended May
31, 2004, compared to $21.9 million in the comparable prior year period,
primarily as a result of a decrease in the Company's use of cash to purchase
shares of its common stock in the open market in connection with its share
repurchase program and an increase in proceeds from stock option exercises due
to a higher stock price relative to the average outstanding option exercise
prices during the nine months ended May 31, 2004. This was offset in part by an
increase in dividend payments primarily as a result of the Company's doubling of
its quarterly dividend in connection with its two-for-one stock split effective
in the fourth quarter of fiscal 2003. 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 May 31, 2004, the Company had repurchased a total of
3,603,600 shares under this program for approximately $57.5 million since the
program's inception in March 1999. No shares were repurchased by the Company
under the program (or otherwise) in the nine months ended May 31, 2004.
33
ARROW INTERNATIONAL, INC.
In addition, the Company made a payment in March 2004 of $10.0 million to settle
a tax assessment related to an ongoing Japanese government tax audit of the
Company's transfer pricing with its Japanese subsidiary. The Company intends to
utilize competent authority proceedings with the Internal Revenue Service in the
U.S. to recover a majority of this required Japanese tax payment. The Company
believes that any amount not ultimately recovered through these proceedings has
been fully provided for as of May 31, 2004, and, therefore, will not adversely
affect its future results of operations.
As previously announced, the Company's Board of Directors has authorized the
initiation of a multi-year capital investment plan to increase manufacturing
capacity and rationalize its production operations. The first phase of this
effort will include an additional manufacturing site near the Company's existing
plant in Hradec, Kralove in the Czech Republic and expansion of its plant in
Chihuahua, Mexico. Based on preliminary estimates received from its contractors,
the Company currently anticipates the total cost of this construction to be
between $22.0 and $27.0 million over a three - year period, of which
approximately 50% is expected to be incremental to the Company's customary
levels of capital expenditures. In addition, the Company also anticipates
spending between $10.0 and $15.0 million over the next three years for equipment
related to this expansion of its manufacturing capacity, which also includes
approximately 50% of incremental capital spending.
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 May 31, 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 $21.7 million was outstanding, all of
which is owed by its foreign subsidiaries. Under this credit facility, the
Company is required to comply with, among others, the following financial
covenants: maintain a ratio of total liabilities to tangible net worth (total
assets less total liabilities and intangible assets) of no more than 1.5 to 1
and a cash flow coverage ratio of 1.25 to 1 or greater; a limitation on certain
mergers, consolidations and sales of assets by the Company or its subsidiaries;
a limitation on the Company's and its subsidiaries' incurrence of liens; and a
requirement that the lender approve the incurrence of additional indebtedness
unrelated to the revolving credit facility when the aggregate principal amount
of such new additional indebtedness exceeds $75.0 million. At May 31, 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 $30.8 million, of which $9.4 million was
outstanding as of May 31, 2004. This additional borrowing capacity includes an
increase in the Company's available credit line related to its Japanese
subsidiary of $11.8 million during the third quarter of fiscal 2004. In
addition, during fiscal 2003, the Company entered into a short-term note payable
to IMA, Inc. for $0.1 million related to a non-compete arrangement pursuant to
the Company's acquisition of this business on July 1, 2003.
Interest rate terms for both U.S. and foreign bank credit facilities are based
on either bid 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. Combined
borrowings under these facilities increased $2.8 million and decreased $0.2
million during the nine months ended May 31, 2004 and May 31, 2003,
respectively.
34
ARROW INTERNATIONAL, INC.
A summary of all of the Company's contractual obligations and commercial
commitments as of May 31, 2004 were as follows:
PAYMENTS DUE
OR
COMMITMENT EXPIRATION
BY PERIOD
CONTRACTUAL OBLIGATIONS AND -----------------------------------------------------
COMMERCIAL COMMITMENTS MORE
---------------------- LESS THAN 1 - 3 3 - 5 THAN 5
($ IN MILLIONS) TOTAL 1 YEAR YEARS YEARS YEARS
----- ------ ----- ----- -----
Long-term debt $ 3.1 $ 3.1 $ - $ - $ -
Operating leases 12.7 4.8 4.7 1.3 1.9
Purchase obligations (1) 30.9 30.9 - - -
Other long-term obligations 0.4 - 0.1 0.1 0.2
Lines of credit (2) 31.2 31.2 - - -
Standby letters of credit 1.4 1.4 - - -
----- ----- ----- ----- -----
Total cash contractual obligations and
commercial commitments $ 79.7 $ 71.4 $ 4.8 $ 1.4 $ 2.1
====== ====== ===== ===== =====
(1) Includes open purchase orders primarily relating to the purchase of raw
materials, equipment and certain consulting and information systems
services.
(2) Includes short-term indebtedness of the Company and its subsidiaries under
various revolving credit facilities, as discussed above.
Based upon its present plans, the Company believes that cash generated from its
operations and available credit resources, including its ability to extend
maturities of borrowings outstanding under its lines of credit in the ordinary
course consistent with past practice, will be adequate to repay current portions
of long-term debt, to finance currently planned capital expenditures, including
those pursuant to the Company's recently announced multi-year capital investment
plan discussed above, and, to the extent the Company determines to do so,
repurchases of its stock in the open market, and to meet the currently
foreseeable liquidity needs of the Company.
During the periods discussed above, the overall effects of inflation and
seasonality on the Company's business were not significant.
Critical Accounting Policies and Estimates
The Company has disclosed in Note 1 to its consolidated financial statements and
in Management's Discussion and Analysis of Financial Condition and Results of
Operations included in its Annual Report on Form 10-K for the fiscal year ended
August 31, 2003 those accounting policies that it considers to be significant in
determining its results of operations and financial position. There have been no
material changes to the critical accounting policies previously identified and
described in the Company's 2003 Form 10-K. The accounting principles utilized by
the Company in preparing its consolidated financial statements confirm in all
material respects to generally accepted accounting principles in the United
States of America.
35
ARROW INTERNATIONAL, INC.
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.
New Accounting Standards Not Yet Adopted
The Financial Accounting Standards Board (FASB) issued a proposed Statement,
"Share-Based Payment, an Amendment of Financial Accounting Standards (FAS) No.
123 and 95" in March 2003. This exposure draft proposes that the cost of all
forms of equity-based compensation granted to employees, excluding employee
stock ownership plans, be recognized in a company's income statement and that
such cost be measured at the fair value of the stock options. If the proposed
statement is issued as a final standard, the exposure draft will replace the
guidance in FAS No. 123, Accounting for Stock-Based Compensation, and APB No.
25, Accounting for Stock Issued to Employees. The Company has not yet evaluated
the impact that this proposed statement may have on its financial statements.
Cautionary Statement Under The Private Securities Litigation Reform Act of 1995
Certain statements contained in this report or in other written or oral
statements made from time to time by the Company may contain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Act of 1934. Such statements may use words such as
"anticipate," "estimate," "expect," "believe," "may," "intend" and similar words
or terms. Although the Company believes that the expectations in such
forward-looking statements are reasonable, the Company cannot assure you that
such expectations will prove to have been correct. The forward-looking
statements are based upon a number of assumptions and estimates that, while
presented with specificity and considered reasonable by the Company, are
inherently subject to significant business, economic and competitive risks,
uncertainties and contingencies which are beyond the control of the Company, and
upon assumptions with respect to future business decisions which are subject to
change. Accordingly, the forward-looking statements are only an estimate, and
actual results will vary from the forward-looking statements, and these
variations may be material. The Company is not obligated to update any
forward-looking statement, but investors are urged to consult any further
disclosures the Company makes in the Company's filings with the Securities and
Exchange Commission. Consequently, the inclusion of the forward-looking
statements should not be regarded as a representation by the Company of results
that actually will be achieved. Forward-looking statements are necessarily
36
ARROW INTERNATIONAL, INC.
speculative in nature, and it is usually the case that one or more of the
assumptions in the forward-looking statements do not materialize. Investors are
cautioned not to place undue reliance on the forward-looking statements. The
Company cautions investors that the factors set forth below, which are described
in further detail in Item 1. Business - Certain Risks Relating to Arrow in the
Company's Annual Report on Form 10-K for the fiscal year ended August 31, 2003
and in its other filings with the Securities and Exchange Commission, could
cause the Company's results to differ materially from those stated in the
forward-looking statements. These factors include: (1) stringent regulation of
the Company's products by the U.S. Food and Drug Administration and, in some
jurisdictions, by state, local and foreign governmental authorities; (2) the
highly competitive market for medical devices and the rapid pace of product
development and technological change in this market; (3) pressures imposed by
the health care industry to reduce the cost or usage of medical products and
services; (4) dependence on patents and proprietary rights to protect the
Company's trade secrets and technology; (5) risks associated with the Company's
international operations; (6) potential product liability risks inherent in the
design, manufacture and marketing of medical devices; (7) risks associated with
the Company's use of derivative financial instruments; and (8) dependence on the
continued service of key members of the Company's management.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Financial Instruments:
During the nine month periods ended May 31, 2004 and 2003, the percentage of the
Company's sales invoiced in currencies other than U.S. dollars was 23.9% and
22.3%, respectively. In addition, a part of the Company's costs 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 risks exposures, primarily on U.S. dollar cash inflows
resulting from the collection of inter-company 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 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
37
ARROW INTERNATIONAL, INC.
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. 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. As of May 31, 2004, outstanding foreign currency forward contracts
totaling the U.S. dollar equivalent of $32.8 million mature at various dates
through September 2004. As of May 31, 2004, the Company had no foreign currency
option contracts outstanding. The Company expects to continue to utilize foreign
currency forward contracts and foreign currency option contracts to manage its
exposure, although there can be no assurance that the Company's efforts in this
regard will be successful.
The Company's exposure to credit risk consists principally of trade receivables.
Hospitals and international dealers account for a substantial portion of trade
receivables and collateral is generally not required. The risk associated with
this concentration is limited due to the Company's on-going credit review
procedures.
At May 31, 2004, the Company had foreign currency forward contracts to sell
foreign currencies which mature at various dates through September 2004. The
following table identifies foreign currency forward contracts to sell foreign
currencies at May 31, 2004 and August 31, 2003, as follows:
May 31, 2004 August 31, 2003
Notional Fair Market Notional Fair Market
Amounts Value Amounts Value
-------------- -------------- -------------- --------------
Foreign currency:
(U.S. Dollar Equivalents)
Japanese yen $ 491 $ 499 $ - $ -
Canadian dollar 509 513 424 432
Euro 16,162 16,019 4,345 4,393
Mexican peso 2,106 2,091 627 626
African rand 429 457 396 404
-------------- -------------- --------------- --------------
$ 19,697 $ 19,579 $ 5,792 $ 5,855
============== ============== =============== ==============
At May 31, 2004, the Company also had foreign currency forward contracts to buy
foreign currencies which mature at various dates through September 2004. The
following table identifies foreign currency forward contracts to buy foreign
currencies at May 31, 2004 and August 31, 2003, as follows:
May 31, 2004 August 31, 2003
Notional Fair Market Notional Fair Market
Amounts Value Amounts Value
-------------- -------------- -------------- --------------
Foreign currency:
(U.S. Dollar Equivalents)
Czech koruna $ 5,913 $ 6,097 $ 672 $ 677
Euro 7,366 7,338 - -
-------------- -------------- -------------- --------------
$ 13,279 $ 13,435 $ 672 $ 677
=============== ============== ============== ==============
38
ARROW INTERNATIONAL, INC.
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. 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 / (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. During the
three and nine month periods ended May 31, 2004, the Company did not recognize
any time value loses nor did it recognize any intrinsic value losses against net
sales. During the three and nine month periods ended May 31, 2003, the Company
did not recognize any time value losses but did recognize intrinsic value losses
against net sales of $82 and $294, respectively. The Company had no foreign
currency option contracts outstanding at May 31, 2004 and August 31, 2003.
Item 4. Controls and Procedures
An evaluation was performed under supervision and with the participation of the
Company's management, including its Chief Executive Officer, or CEO, and its
Chief Financial Officer, or CFO, of the effectiveness of the Company's
disclosure controls and procedures as of May 31, 2004. Based on that evaluation,
the Company's management, including its CEO and CFO, have concluded that the
Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. There have been no significant changes in
the Company's internal controls over financial reporting or in other factors
identified in connection with this evaluation that occurred during the three
months ended May 31, 2004 that have materially affected or are reasonably likely
to materially affect, the Company's internal control over financial reporting.
39
ARROW INTERNATIONAL, INC.
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
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 May 31, 2004, the Company had repurchased
a total of 3,603,600 shares under this program for approximately $57,532 since
the program's inception in March 1999. No shares were repurchased by the Company
under the program (or otherwise) in the three months ended May 31, 2004.
ISSUER PURCHAES OF EQUITY SECURITIES
For the Three Months Ended
May 31, 2004 Total Program to Date
- -------------------------------------------------- -----------------------------------------------------------------------
Total Number of Shares Purchased Maximum Number of Shares that
Total Number of Shares Average Price Paid as Part of Publicly Announced May Yet Be Purchased Under the
Purchased Per Share Program Program
- ------------------------- --------------------- ---------------------------------- --------------------------------
- - 3,603,600 396,400
40
ARROW INTERNATIONAL, INC.
Item 6. Exhibits and reports on Form 8-K
(a) Exhibits
See Exhibit Index on page 43 for a list of the Exhibits filed as
a part of this report.
(b) Reports on Form 8-K
o Current Report on Form 8-K, dated March 23, 2004,
reporting under Item 12. Results of Operations and
Financial Condition, announcing the Company's second
quarter fiscal 2004 earnings.
o Current Report on Form 8-K, dated April 15, 2004,
reporting under Item 5. Other Events and Regulation FD
Disclosure, announcing the Company's modifications in
its cardiac assist strategy and corporate governance
enhancements.
o Current Report on Form 8-K, dated June 23, 2004,
reporting under Item 12. Results of Operations and
Financial Condition, announcing the Company's third
quarter fiscal 2004 earnings.
41
ARROW INTERNATIONAL, INC.
SIGNATURE
Pursuant to the requirements 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.
Date: July 15, 2004 By: /s/ Frederick J. Hirt
----------------------------------
(signature)
Frederick J. Hirt
Chief Financial Officer and
Vice President of Finance
(Principal Financial Officer and
Chief Accounting Officer)
42
EXHIBIT INDEX
EXHIBIT DESCRIPTION
NUMBER OF EXHIBIT METHOD OF FILING
- ------ ---------- ----------------
31.1 Rule 13a-4(a) / 15d-4(a) Furnished herewith
Certification of the Chief Executive
Officer
31.2 Rule 13a-4(a) / 15d-4(a) Furnished herewith
Certification of the Chief Financial
Officer
32.1 Section 1350 Certification of the Furnished herewith
Chief Executive Officer
32.2 Section 1350 Certification of the Furnished herewith
Chief Financial Officer
43