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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES AND EXCHANGE ACT TO 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended August 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _______
Commission File Number 0-20212
ARROW INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 23-1969991
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
2400 BERNVILLE ROAD
READING, PENNSYLVANIA 19605
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
TELEPHONE NUMBER: (610) 378-0131
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Title of Each Class: On Which Registered:
-------------------- --------------------
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, No Par Value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.[ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 under the Exchange Act) YES X NO
--- ---
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of October 1, 2004 was approximately $794,812,068
The number of shares of Registrant's Common Stock outstanding on October
1, 2004 was 43,785,357.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its Annual Meeting of
Shareholders to be held on January 19, 2005, which will be filed with the
Securities and Exchange Commission within 120 days after August 31, 2004, are
incorporated by reference in Part III of this report.
ITEM 1. BUSINESS
CERTAIN OF THE INFORMATION CONTAINED IN THIS FORM 10-K, INCLUDING THE
DISCUSSION WHICH FOLLOWS IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" FOUND IN ITEM 7 OF THIS REPORT, CONTAIN
FORWARD-LOOKING STATEMENTS. FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS,
CAREFULLY REVIEW THIS REPORT, INCLUDING ITEM 1. BUSINESS - CERTAIN RISKS
RELATING TO ARROW, AS WELL AS OTHER INFORMATION CONTAINED IN ARROW
INTERNATIONAL, INC.'S PERIODIC REPORTS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION, OR THE SEC.
Arrow International, Inc. (together with its subsidiaries, "Arrow" or
the "Company") was incorporated as a Pennsylvania corporation in 1975. Arrow
develops, manufactures and markets a broad range of clinically advanced,
disposable catheters, heart assist devices and related products for critical and
cardiac care. The Company's critical care products are used principally for
central vascular access in the administration of fluids, drugs and blood
products, patient monitoring and diagnostic purposes. These products are used by
anesthesiologists, critical care specialists, surgeons, cardiologists,
nephrologists, emergency and trauma physicians and other health care providers.
Arrow's cardiac care products are used by interventional cardiologists, cardiac
surgeons, interventional radiologists and electrophysiologists for such purposes
as the diagnosis and treatment of heart and vascular disease and to provide
short-term cardiac assist following cardiac surgery, serious heart attack or
balloon angioplasty.
Arrow's critical care products, the first of which were originally
introduced in 1977, accounted for approximately 85.0%, 85.0% and 83.0% of net
sales in fiscal 2004, 2003 and 2002, respectively. The majority of these
products are vascular access catheters and related devices which consist
principally of the following: the Arrow-Howes(TM) Multi-Lumen Catheter, a
catheter equipped with three or four channels, or lumens, that enables the
simultaneous administration of multiple critical care therapies through a single
puncture site; double-and single-lumen catheters, which are designed for use in
a variety of clinical procedures; percutaneous sheath introducers, which are
used as a means for inserting cardiovascular and other catheterization devices
into the vascular system during critical care procedures; radial artery
catheters, which are used for measuring arterial blood pressure and taking blood
samples; FlexTip Plus(TM) epidural catheters, which are designed to minimize
indwelling complications associated with conventional epidural catheters; and
Percutaneous Thrombolytic Devices, which are designed for clearance of
thrombosed hemodialysis grafts in chronic hemodialysis patients. Many of the
Company's vascular access catheters are treated with the ARROWg+ard(TM) or
ARROWg+ard Blue Plus(TM) antiseptic surface treatments to reduce the risk of
catheter related infection. ARROWg+ard Blue Plus(TM) is a stronger, longer
lasting formulation of ARROWg+ard(TM) and provides antimicrobial treatment of
the interior lumens and hubs of each catheter. Many of the Company's procedure
kits also feature its sharps safety devices to protect against inadvertent
needle sticks.
The Company's critical care product line also includes custom tubing
sets used to connect central venous catheters to blood pressure monitoring
devices and drug infusion systems, and the HemoSonic(TM) 100 and 200, a
hemodynamic monitoring device that continuously measures descending aortic blood
flow using a non-invasive esophageal ultrasound probe.
In November 2002, the Company expanded its critical care product line
with the acquisition of Diatek, Inc., a company that develops, manufactures and
markets chronic hemodialysis catheters. When acquired, Diatek was marketing in
select U.S. markets the Cannon Catheter(TM), an implanted hemodialysis catheter
for long-term access that is used to facilitate dialysis treatment. Previously,
the Company sold acute, or short-term, catheters for hemodialysis treatment. The
catheters acquired in connection with its purchase of Diatek complement and
broaden the Company's product line in this field (see Item 8. Notes to
Consolidated Financial Statements - Note 5). On November 7, 2003, the Company
received authorization to CE-mark the Cannon Catheter(TM), enabling it to market
this product line within the European Economic Area and other international
markets.
In March 2003, the Company further expanded its critical care product
line with the acquisition of Klein-Baker Medical, Inc., a company that develops,
manufactures and markets the NeoCare(R) product line of specialty catheters and
related procedure kits for use by neonatal intensive care units. The NeoCare(R)
product line was marketed in select areas of the U.S. and the Company intends to
expand the sale of these products into additional U.S. and international markets
and to develop additions to the basic product line. This acquisition may also
serve as the base for possible further expansion of the Company's pediatric
product line (see Item 8. Notes to Consolidated Financial Statements - Note 5).
Arrow's cardiac care products accounted for approximately 15.0%, 15.0%
and 17.0% of net sales in fiscal 2004, 2003 and 2002, respectively. These
products include cardiac assist products, such as intra-aortic balloon, or IAB,
pumps and catheters, which are used primarily to augment temporarily the pumping
capability of the heart following cardiac surgery, serious heart attack or
balloon angioplasty. The Company's IAB products include the AutoCat(TM)2 WAVE
IAB pump and associated LightWAVE(TM) catheter system, which utilize fiber optic
pressure-sensing catheter instrumentation and provide automation of the pumping
process for the broadest range of patients, including those with severely
arrhythmic heartbeats. The Company also recently introduced the Ultraflex 7.5
Fr. IAB catheter, which is the smallest IAB in the market and employs the
Company's proprietary wire reinforced technology. In the spring of 2004, the
Company commenced marketing in Europe of the Arrow LionHeart(TM), a fully
implantable Left Ventricular Assist System, or LVAS, capable of taking over the
entire work load of the left ventricle.
The Company's cardiac care product line also includes electrophysiology
products, which are used primarily to map the electrical signals which activate
the heart. The Berman(TM) Angiographic Catheter is used for pediatric cardiac
angiographic procedures and the Super Arrow-Flex(TM) sheath provides a
kink-resistant passageway for the introduction of cardiac and other catheters
into the vascular system. In addition, as further discussed below under
"Research and Product Development," the Company is currently developing the
CorAide(TM) LVAS, a small non-pulsatile centrifugal flow ventricular assist
device.
(2)
SALES AND MARKETING
Arrow markets its products to physicians and hospitals through a
combination of direct selling, independent distributors and group purchasing
organizations. Within each hospital, marketing efforts are targeted to those
physicians, including critical care specialists, cardiologists,
anesthesiologists, interventional radiologists, electrophysiologists and
surgeons, most likely to use the Company's products. Arrow's products are
generally sold in the form of pre-sterilized procedure kits containing the
catheters and virtually all of the related medical components and accessories
needed by the clinician to prepare for and perform the intended medical
procedure. Additional sales revenue is derived from equipment provided for use
in connection with certain of the Company's disposable products.
In fiscal 2004, 2003 and 2002, 64.6%, 65.7% and 65.5%, respectively, of
the Company's net sales were to U.S. customers. In this market, approximately
91.0% of the Company's fiscal 2004 revenue was generated by its direct sales
force. The remainder resulted from shipments to independent distributors. For
the majority of such distributors, the Company's products represent a principal
product line. Direct selling generally yields higher gross profit margins than
sales made through independent distributors.
Internationally, the Company sells its products through direct sales
subsidiaries serving markets in Japan, Germany, the Netherlands, France, Spain,
Greece, Africa, Canada, Mexico, the Czech Republic, Slovakia, Switzerland,
Portugal and Italy. As of October 1, 2004, independent distributors in 94
additional countries sell the Company's products in the remainder of the world.
To support growth in international sales, the Company operates a 40,000
square foot manufacturing facility in Chihuahua, Mexico and has leased 22,500
square feet of additional manufacturing space in Mexico since fiscal 2002. The
Company also operates an 88,000 square foot manufacturing and product
development facility in the Czech Republic, which was expanded in fiscal 2003.
During fiscal 2004, the Company's Board of Directors authorized the initiation
of a multi-year capital investment plan to increase its worldwide manufacturing
capacity and rationalize its production operations. The first phase of this
effort will include the construction of additional manufacturing facilities in
the Czech Republic and in Chihuahua, Mexico, which is expected to commence in
fiscal 2005.
Revenues, profitability and long-lived assets attributable to
significant geographic areas are presented in Note 16 to the Company's
Consolidated Financial Statements included in Item 8.
In general, Arrow does not produce against a backlog of customer orders.
Production is based primarily on the level of inventories of finished products
and projections of future customer demand with the objective of shipping from
stock upon receipt of orders. No single customer accounts for more than 10% of
the Company's sales. Purchase of the Company's products by hospitals and
physicians has not been materially influenced by seasonal factors.
Government and private sector initiatives to limit the growth of health
care costs, including price regulation, competitive pricing, coverage and
payment policies, and managed-care arrangements, are continuing in the United
States and in many other countries where the Company does business. As a result
of these changes, the marketplace has placed increased emphasis on the delivery
of more cost-effective medical therapies. Government programs, including
Medicare and Medicaid, private health care insurance and managed-care plans have
attempted to control costs by limiting the amount of reimbursement such third
party payors will pay to hospitals, other medical institutions and physicians
for particular products, procedures or treatments. The increased emphasis on
health care cost containment has resulted in reduced growth in demand for
certain of the Company's products in markets in the U.S. where Arrow has 80% or
greater market share, and protecting that market share has affected the
Company's pricing in some instances. The Company also continues to face pricing
pressures in certain product lines in both European and Japanese markets as
governments strive to curtail increases in health care costs. The Company
anticipates that the U.S. Congress, state legislatures, foreign governments and
the private sector will continue to review and assess alternative health care
delivery and payment systems. The Company cannot predict what additional
legislation or regulation, if any, relating to the health care industry may be
enacted in the future or what impact the adoption of any federal, state or
foreign health care reform, private sector reform or market forces may have on
its business. There can be no assurance that any such reforms will not have a
material adverse effect on the Company's business, financial condition or
results of operations.
RESEARCH AND PRODUCT DEVELOPMENT
Arrow is engaged in ongoing research and development to introduce
clinically advanced new products, to enhance the effectiveness, ease of use,
safety and reliability of its existing products and to expand the clinical
applications for which use of its products is appropriate. The principal focus
of the Company's research and development effort is to identify and analyze the
needs of physicians in critical and cardiac care medicine, and to develop
products that address these needs. The Company views ideas submitted by
physicians and other health care professionals as an important source of
potential research and development projects. The Company believes that these
end-users are often in the best position to conceive of new products and to
recommend ways to improve the performance of existing products. Many of the
Company's principal products and product improvements have resulted from
collaborative efforts with physicians, other health care professionals or other
affiliated entities. For certain proprietary ideas, the Company pays royalties
to such persons, and in many instances, incorporates such persons' names in the
tradename or trademark for the specific product. The Company also utilizes other
outside consultants, inventors and medical researchers to carry on its research
and development effort and sponsors research through medical associations and at
various universities and teaching hospitals.
(3)
Certain of the Company's strategic acquisitions and investments have
provided the basis for its introduction of significant new products. The Company
entered the field of cardiac care in 1994 with its acquisition of Kontron
Instruments and supplemented this acquisition with its acquisitions of the
cardiac assist divisions of Boston Scientific in 1997 and C.R. Bard, Inc. in
1998. The Company's acquisition of Sometec, S.A. in 1999 enabled it to introduce
to the market its innovative ultrasound hemodynamic monitoring device. More
recently, the Company's acquisition of Diatek, Inc. in November 2002 and the
NeoCare(R) product line in March 2003 have allowed it to market Diatek's Cannon
Catheter(TM) hemodialysis catheter product, as well as specialty catheters and
related procedure kits for use in neonatal intensive care units.
Research and development expenses totaled $30.4 million (7.0% of net
sales), $28.2 million (7.4% of net sales) and $26.2 million (7.7% of net sales)
in fiscal 2004, 2003 and 2002, respectively. Such amounts were used to develop
new products, improve existing products and implement new technology to produce
these products.
The Company's principal products currently under development are
described below. There can be no assurance that the U.S. Food and Drug
Administration, or the FDA, or any similar foreign government regulatory
authority will grant the Company authorization to market products under
development or, if such authorization is obtained, that such products will prove
competitive when measured against other available products.
AUTOCAT(R)2 WAVE. In January 2004, the Company introduced its
AutoCAT(R)2 WAVETM intra-aortic balloon pump and associated LightWAVE(TM)
catheter system in the U.S. and Europe. The Company's AutoCAT(R)2 WAVETM IAB
pump and associated LightWAVE(TM) catheter system utilizes fiber optic
pressure-sensing catheter instrumentation and provides total automation of the
pumping process for all patients, including those with severely arrhythmic
heartbeats. While initial customer response to this product has been positive,
during the second half of fiscal 2004, the selling process for this new
technology was slowed by ramp-up issues in manufacturing. During the period that
the Company was addressing these issues, it identified several areas where it
determined that the product could be improved. Those improvements have been made
and are now being clinically evaluated. These modifications are expected to
enhance the ease of use of the AutoCAT(R)2 WAVETM, which the Company believes
will provide a significant advantage over competing technologies. The Company
continues to believe that this new technology represents a major step forward in
intra-aortic balloon pumping and should enable the Company to gain market share
based on superior performance across a range of cardiac requirements.
During the first quarter of fiscal 2004, the Company also released its
UltraFlexTM 7.5 Fr intra-aortic balloon catheter. This catheter, the smallest
intra-aortic balloon catheter on the market, incorporates the Company's
proprietary tubing reinforcement technology to prevent kinking.
LIONHEART LVAS. The Arrow LionHeart(TM) LVAS is a fully implantable
device which provides long-term cardiac assist for patients having insufficient
left ventricular heart function. The device was developed by the Company in
cooperation with Pennsylvania State University's Hershey Medical School over the
course of 10 years, during which time it has undergone extensive preclinical
studies and testing. The Company believes that the LionHeart(TM), which is
capable of taking over the entire workload of the left ventricle, represents a
significant advance in mechanical circulatory assist technology. Because it is
the first fully implantable "destination therapy" device, the ability of the
patient to experience an improved quality of life for an extended period of time
may be enhanced. The device has no lines or cables protruding through the skin
to power the system, thus eliminating a potential source of infection. It is
fully implanted in the body and does not replace the heart, but assists in the
pumping function of the heart's left ventricle. The device is electrically
driven by a wearable battery pack that transmits power non-invasively through
the skin to charge internal batteries and power the blood pump. In addition, the
Arrow LionHeart(TM) enables patients to experience limited periods of untethered
movement with energy supplied from rechargeable batteries implanted as part of
the device.
The first human implant of the Arrow LionHeart(TM) took place in October
1999 at The Herzzentrum NRW (The Heart Center) in Bad Oeynhausen, Germany as
part of the European clinical investigation, sponsored by the Company, to
demonstrate the safety and performance of the LionHeart(TM) for the purpose of
obtaining a European Conformity (CE) mark. To date, three patients have lived on
the device for more than two years, with the longest surviving patient exceeding
three years on the device.
As previously reported, in November 2003, the Company received
authorization from its European Notified Body, TUV Product Services of Munich,
Germany, or TUV, to CE-mark the Arrow LionHeart(TM) in Europe, which allows the
Company to market the device within the European Economic Area for permanent
implantation or "destination therapy". The Company believes that the Arrow
LionHeart(TM) is the first fully implantable LVAS to receive CE-marking
authorization specifically for the destination therapy indication. Earlier in
fiscal 2004, the Company initiated its marketing program in Europe, which
includes the training of additional centers to implant the device, supplementing
those centers that were already participants in the European clinical trials,
and commenced initial sales of the product.
The Company expects to submit dossiers for the second generation
LionHeart(TM) external power system and controller and related electronic
components that are currently in the testing stage to TUV by the end of calendar
year 2004 and anticipates receiving approval for use of these new electronics in
the device approximately three months later, given that most of the device's
components have not changed, no additional clinical data is required and the
LionHeart(TM) quality system has already been certified by TUV. The Company's
European marketing plan for the LionHeart(TM) is based upon the receipt of this
approval and the CE-marking of the device's second generation electronics.
(4)
Although there are several other LVAS devices approved in Europe, they
are generally used in shorter term "bridge to transplant" applications. The
Company believes that the use of these other available LVAS devices for
destination therapy is currently small but emerging. No meaningful market for
destination therapy exists today. The Company believes that, due to the
prevalence of end-stage heart disease in many areas of the world, a market for
destination therapy will develop as devices such as the LionHeart(TM) are
increasingly commercialized. As a related matter, however, it is currently
unclear as to the extent to which health care systems, both public and private,
will reimburse patients for the relatively high costs associated with
destination therapy. Furthermore, continued implantation of these devices in a
greater number of patients is necessary to provide additional knowledge of the
ability of the typically older patients who suffer from end-stage heart disease
to successfully undergo the rigors of LVAS implantation surgery.
In February 2001, the Company received FDA, approval under an
Investigational Device Exemption, or IDE, to begin Phase I human clinical trials
in the United States of the LionHeart(TM). The Phase I trial was initially
limited to seven patients at up to five U.S. sites. In February 2001, the
Company announced the first U.S. human implant of the LionHeart(TM) under the
IDE. By August 2001, the Company had enrolled all seven U.S. patients in the
Phase I U.S. feasibility trial authorized under the IDE.
In December 2001, the FDA approved the Company's request to expand this
Phase I clinical trial for an additional seven patients to be implanted with the
LionHeart(TM) in the U.S. The first of these seven additional implants was
performed in July 2002. In May and October 2003, the second and third of these
additional implants were performed, bringing the total number of patients who
have received the LionHeart(TM) in the U.S. to ten. A total of eight U.S. sites
have been approved to perform the remaining four implants under the Phase I
trial, which the Company intends to complete upon successful implementation of
the device's second generation electronics, as described above.
As previously reported, the Company decided in the third quarter of
fiscal 2004 to defer completion of the LionHeart(TM) Phase I clinical trials and
commencement of the Phase II clinical trials, required by FDA to bring the
product to market in the U.S., until the Company is able to implement the second
generation product enhancements described above that are currently in the
testing phase. This decision resulted in the Company's write off of $3.1 million
in obsolete inventory and $0.6 million in manufacturing equipment in the third
quarter of fiscal 2004.
The Company's near-term focus for the LionHeart(TM) program continues to
be on obtaining optimal clinical results and on evaluating the second generation
product enhancements that are currently in development. The Company believes
that these enhancements should increase the patient population for whom the
device is suitable and provide improved quality of life for recipients. The
Company does not expect sales of the LionHeart(TM) to materially impact fiscal
2005 results.
The Company is continuing to evaluate its LionHeart(TM) program on a
regular basis and has engaged an outside consulting firm to provide additional
perspective on the long-term commercial opportunity for the device and
strategies for maximizing its potential.
CORAIDE LVAS. In April 2001, the Company entered into an agreement with
The Cleveland Clinic Foundation, or the CCF, for the exclusive license of the
CCF's patents in the field of non-pulsatile centrifugal flow ventricular assist
devices for the treatment of congestive heart failure and a related agreement
for continued research and development on the CorAide(TM) ventricular assist
device that had been a joint development effort of the CCF and the National
Institutes of Health.
The unique, magnetically suspended flow pumping mechanism of the
CorAide(TM) device uses the moving blood as its lubricating system. Arrow
considers the CorAide(TM) device to be one of the most promising continuous flow
bridge-to-transplant devices currently in development and believes it may
represent a future generation permanent ventricular assist device if human organ
systems prove to be adaptable to non-pulsatile blood flow over a long period of
time. In IN VIVO trials to date, the CorAide(TM) device has shown excellent
performance without the use of anticoagulant drug therapy. Moreover, its smaller
size, low power requirements and lower cost relative to other ventricular assist
devices currently under development provide a promising approach for
bridge-to-transplant patients.
The first human implant of a CorAide(TM) continuous flow ventricular
assist system took place in Germany in May 2003 as part of a clinical trial with
patients needing ventricular support prior to receiving a donor heart in order
to provide a better understanding of human tolerance for non-pulsatile flow
devices. As previously reported, the patient experienced unexpected elevated
levels of plasma-free hemoglobin, and the device was replaced with another
bridge device pending the availability of a donor heart. Subsequent analysis and
testing of the CorAide(TM) device, together with small modifications to it, have
provided insight into the probable causes of the elevated level of hemolysis
(plasma-free hemoglobin). The Company believes it has made significant progress
in its efforts to develop and test modifications to the CorAide(TM) device to
address the elevated levels of hemolysis experienced in the first implant of the
device. While the Company cannot be certain that these modifications will
resolve the problem, it believes that suitable improvements have been developed.
The Company expects that European clinical trials of the CorAide(TM) device
should resume later in calendar year 2004 although, due to the pioneering nature
of this program, it is difficult to predict precise timing.
The Company considers the CorAide(TM) development program to be
complementary to its ongoing program to develop and market the Arrow
LionHeart(TM) LVAS. The first version of the CorAide(TM) device is not fully
implantable and is intended to provide support for patients waiting for heart
transplantation or considered candidates for bridging to natural recovery of
ventricular function. The Company continues to believe that successful
development of the CorAide(TM) device would provide a lower cost, less invasive
and broader application approach to ventricular assist than pulsatile devices
that are currently available or under development.
(5)
HEMOSONIC. During fiscal 2004, the Company continued its development of
an improved version of its HemoSonicTM , a monitoring device that continuously
measures descending aortic blood flow using a non-invasive esophageal ultrasound
probe, that it believes will be more user-friendly and better able to meet the
needs of a broader range of physicians. The Company is currently in the final
stages of this development and expects to begin market testing of the new model
in fiscal 2005. The Company is also currently in the process of clinically
evaluating a number of product enhancements.
MANUFACTURING AND PRODUCTION TECHNOLOGY
Arrow has developed the core technologies that the Company believes are
necessary for it to design, develop and manufacture complex, high quality
catheter-related medical devices. This technological capability has enabled the
Company to develop internally many of the major components of its products and
reduce its unit manufacturing costs. To help further reduce manufacturing costs
and improve efficiency, the Company has increasingly automated the production of
its high-volume products and plans to continue to make significant capital
expenditures to promote efficiency and reduce operating costs.
Raw materials and purchased components essential to Arrow's business
have typically been available within the lead times required by the Company and,
consequently, procurement has not historically posed any significant problems in
the operation of the Company's business. Although the Company currently
maintains single suppliers for certain of its out-sourced components,
particularly those used in the LionHeart(TM) and AutoCAT(R)2WAVETM, it is
exploring alternative vendors for most of these items.
As previously announced, the Company's Board of Directors has authorized
the initiation of a multi-year capital investment plan to increase its worldwide
manufacturing capacity and rationalize its production operations. The first
phase of this effort will include the construction of additional manufacturing
sites in Zdar, Czech Republic and in Chihuahua, Mexico, which is expected to
commence in fiscal 2005.
PATENTS, TRADEMARKS, PROPRIETARY RIGHTS AND LICENSES
Arrow believes that patents and other proprietary rights are important
to its business. The Company also relies upon trade secrets, know-how,
continuing technological innovations and licensing opportunities to develop and
maintain its competitive position. Arrow currently holds numerous U.S. and
foreign patents and patent applications that relate to aspects of the technology
used in certain of the Company's products, including its radial artery catheter,
percutaneous sheath introducer, interventional diagnostic catheter products,
left ventricular assist device, esophageal ultrasound probe jacket and
intra-aortic balloon pump products. There can be no assurance that patent
applications owned by or licensed to the Company will result in the issuance of
patents or that any patents owned by or licensed to the Company will provide
competitive advantages for the Company's products or will not be challenged or
circumvented by others.
In addition, Arrow is a party to several license agreements with
unrelated third parties pursuant to which it has obtained, for varying terms,
the exclusive rights to certain patents held by such third parties in
consideration for royalty payments. Many of the Company's major products,
including its antiseptic surface treatment for catheters, have been developed
pursuant to such license agreements. All existing patents owned by or licensed
to the Company relating to any of its major products expire after fiscal 2005.
From time to time, the Company is subject to legal actions involving
patent and other intellectual property claims. In October 2003, the Company
reached a settlement in principle for $8.0 million, or $0.12 diluted earnings
per share, in two related lawsuits in which the plaintiffs had alleged that
certain of the Company's hemodialysis catheter products infringed patents owned
by or licensed to the plaintiffs. In December 2003, the terms of this settlement
were finalized and the Company paid the $8.0 million settlement in January 2004.
The Company had been obligated to pay royalties to the plaintiffs based on the
sales levels for these products. Upon the final settlement of these actions, the
Company no longer owes royalties to the plaintiff for any sales occurring after
August 28, 2004.
The Company is also currently a defendant in a lawsuit in which the
plaintiff alleges that the Company's Cannon-Cath(TM) split-tip hemodialysis
catheters, which were acquired as part of the Company's acquisition in November
2002 of specified assets of Diatek, Inc., infringe a patent owned by or licensed
to the plaintiffs. In November 2003, this lawsuit was stayed pending the U.S.
Patent and Trademark Office's ruling on its re-examination of the patent at
issue, which is not expected to occur until after calendar year 2004. The
Company has reserved $2.0 million for estimated legal fees related to this
lawsuit. The reserve amount represents the Company's responsibility to pay
one-half of these legal fees while the former owners of Diatek, Inc. are
responsible for payment of the other half. Based on information presently
available to the Company, the Company believes that its products do not infringe
any valid claim of the plaintiff's patent and that, consequently, it has
meritorious legal defenses with respect to this action and is vigorously
contesting it. Although the ultimate outcome of this action is not expected to
have a material adverse effect on the Company's business or financial condition,
whether an adverse outcome in this action would materially adversely affect the
Company's reported results of operations in any future period cannot be
predicted with certainty.
Arrow owns a number of registered trademarks in the United States and,
in addition, has obtained registration in many of its major foreign markets for
the trademark ARROW(R) and certain other trademarks.
(6)
GOVERNMENT REGULATION
As a developer, manufacturer and marketer of medical devices, Arrow is
subject to extensive regulation by, among other governmental entities, the FDA
and the corresponding state, local and foreign regulatory agencies in
jurisdictions in which the Company sells its products. These regulations govern
the introduction of new medical devices, the observance of certain standards
with respect to the manufacture, testing and labeling of such devices, the
maintenance of certain records, the tracking of such devices and other matters.
Failure to comply with applicable federal, state, local or foreign laws or
regulations could subject the Company to enforcement action, including product
seizures, recalls, withdrawal of marketing clearances or approvals, and civil
and criminal penalties, any one or more of which could have a material adverse
effect on the Company. In recent years, the FDA has pursued a more rigorous
enforcement program to ensure that regulated businesses, like the Company's,
comply with applicable laws and regulations. The Company believes that it is in
substantial compliance with such governmental regulations. However, federal,
state, local and foreign laws and regulations regarding the manufacture and sale
of medical devices are subject to future changes. There can be no assurance that
such changes or the FDA enforcement program will not have a material adverse
effect on the Company.
In October 2002, The Medical Device User Fee and Modernization Act of
2002 was enacted, which amended the FDA's regulations to provide, among other
things, the ability for the FDA to impose user fees for pre-market reviews of
medical devices. The Company's filings with the FDA for pre-market review are
subject to this fee structure. The precise amount of fees that the Company will
incur each year will be dependent upon the specific quantity and nature of its
filings.
On occasion, the Company has received notifications, including warning
letters, from the FDA of alleged deficiencies in the Company's compliance with
FDA requirements. The Company believes that it has been able to address or
correct such deficiencies. In addition, from time to time the Company has
recalled, or issued safety alerts on, certain of its products. No such warning
letter, recall or safety alert has had a material adverse effect on the Company,
but there can be no assurance that they would not have such an effect in the
future.
In the early to mid 1990s, the review time by the FDA to approve medical
devices for commercial release lengthened and the number of marketing clearances
and approvals decreased. In response to public and congressional concern, the
FDA Modernization Act of 1997 was adopted with the intent of bringing better
definition to the clearance process for new medical products. While FDA review
times have improved since passage of the 1997 Act, there can be no assurance
that the FDA review process will not continue to delay the Company's
introduction of new products in the U.S. in the future. In addition, many
foreign countries have adopted more stringent regulatory requirements which also
have added to the delays and uncertainties associated with the release of new
products, as well as the clinical and regulatory costs of supporting such
releases. It is possible that delays in receipt of, or failure to receive, any
necessary clearance or approval for the Company's new product offerings could
have a material adverse effect on the Company's business, financial condition or
results of operations.
COMPETITION
Arrow faces substantial competition from a number of other companies in
the market for catheters and related medical devices and equipment, ranging from
small start-up enterprises to companies that are larger than Arrow with greater
financial and other resources. In addition, in response to concern about the
rising costs of health care, U.S. hospitals and physicians are placing
increasing emphasis on cost-effectiveness in the selection of products to
perform medical procedures. The Company believes that its products are competing
primarily on the basis of product differentiation, product quality and
cost-effectiveness, and that its comprehensive manufacturing capability enables
it to expedite the development and market introduction of new products and to
reduce manufacturing costs, thereby permitting the Company to respond more
effectively to competitive pricing in an environment where its ability to
increase prices is limited.
ENVIRONMENTAL COMPLIANCE
The Company is subject to various federal, state and local laws and
regulations relating to the protection of the environment. In the course of its
business, the Company is involved in the handling, storing and disposal of
materials which are classified as hazardous.
The Company believes that its operations comply in all material respects
with applicable environmental laws and regulations. While the Company continues
to make any necessary capital and operational expenditures for protection of the
environment, it does not anticipate that these expenditures will have a material
adverse effect on its business, financial condition or results of operations.
PRODUCT LIABILITY AND INSURANCE
The design, manufacture and marketing of medical devices of the types
produced by the Company entail an inherent risk of product liability. The
Company's products are used in surgical and intensive care settings with
seriously ill patients. While the Company believes that, based on claims made
against the Company in the past, the amount of product liability insurance
maintained by the Company is adequate, there can be no assurance that such
insurance will be available or in an amount sufficient to satisfy claims made
against the Company in the future or that the Company will be able to obtain
insurance in the future at satisfactory rates or in adequate amounts. The
Company's primary global product liability insurance policy is on a claims made
basis. For fiscal 2004, the Company's deductibles for its primary global product
liability insurance policy were increased to $2.5 million per occurrence from
$750,000 in fiscal 2003 for domestic product liability claims, with the
Company's annual exposure for such deductibles in any one policy year being
increased to $5.0 million in fiscal 2004 from $1.5 million in fiscal year 2003.
Effective for fiscal 2005, the Company's deductibles for its primary global
product liability insurance policy have been decreased to $2.0 million per
occurrence from $2.5 million in fiscal 2004 with the Company's annual aggregate
exposure for such deductibles being limited to $4.0 million for any one policy
year. The policy year runs from September 1 to August 31 and has a $10.0 million
aggregate limit. The Company also has
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additional layers of coverage insuring up to $35.0 million in annual aggregate
losses arising from claims that exceed the primary product liability insurance
policy limits. Product liability claims in the future, regardless of their
ultimate outcome, could result in costly litigation and could have a material
adverse effect on the Company's business, reputation, its ability to attract and
retain customers for its products and its results of operations.
EMPLOYEES
As of October 1, 2004, Arrow had approximately 3,500 full-time
employees, of which 269 were hourly-paid manufacturing employees at the
Company's Reading and Wyomissing, Pennsylvania facilities. These hourly-paid
employees are represented by the United Steelworkers of America AFL-CIO, Local
8467 (the "Union"). The Company and the Union are currently operating under a
three-year agreement that expires in August 2006. The Company has never
experienced an organized work stoppage or strike and considers its relations
with its employees to be good.
AVAILABLE INFORMATION
Arrow's internet address is: HTTP://WWW.ARROWINTL.COM. The Company makes
available, free of charge, on its internet website its annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other
information filed or furnished pursuant to the Securities Exchange Act of 1934
as soon as reasonably practicable after these filings have been made
electronically with the SEC. The Company's Code of Conduct, which applies to all
of its directors, officers and other employees, is also posted on its website.
Information contained on the Company's website is not incorporated by reference
in this report.
CERTAIN RISKS RELATING TO ARROW
FROM TIME TO TIME, IN BOTH WRITTEN REPORTS AND IN ORAL STATEMENTS BY THE
COMPANY'S SENIOR MANAGEMENT, EXPECTATIONS AND OTHER STATEMENTS ARE EXPRESSED
REGARDING THE COMPANY'S FUTURE PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE
INHERENTLY UNCERTAIN AND INVESTORS MUST RECOGNIZE THAT EVENTS COULD TURN OUT TO
BE DIFFERENT THAN SUCH EXPECTATIONS AND STATEMENTS. KEY FACTORS IMPACTING THE
COMPANY'S CURRENT AND FUTURE PERFORMANCE ARE DISCUSSED ELSEWHERE IN THIS REPORT
AND IN THE COMPANY'S OTHER FILINGS WITH THE SEC. IN ADDITION TO SUCH
INFORMATION, INVESTORS SHOULD CONSIDER THE FOLLOWING RISK FACTORS IN EVALUATING
THE COMPANY AND ITS BUSINESS, AS WELL AS IN REVIEWING FORWARD-LOOKING STATEMENTS
CONTAINED IN THIS REPORT AND IN THE COMPANY'S OTHER PERIODIC REPORTS FILED WITH
THE SEC AND IN ORAL STATEMENTS MADE BY ITS SENIOR MANAGEMENT. THE COMPANY'S
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS DUE
TO MATERIAL RISKS, UNCERTAINTIES AND CONTINGENCIES, INCLUDING, WITHOUT
LIMITATION, THOSE DISCUSSED BELOW.
Stringent Government Regulation
The Company's products are subject to extensive regulation by the FDA
and, in some jurisdictions, by state, local and foreign governmental
authorities. In particular, the Company must obtain specific clearance or
approval from the FDA before it can market new products or certain modified
products in the United States. In the United States, permission to distribute a
new device generally can be met either through a 510(k) premarket notification
or an application for a premarket approval, or PMA.
Under the FDA's requirements, if a manufacturer can establish that a
newly developed device is "substantially equivalent" to a legally marketed
predicate device, the manufacturer may seek marketing clearance from the FDA to
market the device by filing a 510(k) premarket notification with the FDA. With
the exception of one product, the Company has, to date, obtained FDA marketing
clearance for its products only through the 510(k) premarket notification
process. The 510(k) premarket notification must be supported by data
establishing the claim of substantial equivalence to the satisfaction of the
FDA. The process of obtaining a 510(k) clearance is normally three months or
less. However, this process may take several months to a year or longer.
If substantial equivalence cannot be established or if the FDA
determines that additional safety and effectiveness data is required to support
an approval, the FDA will require that the manufacturer submit a PMA application
that must be approved by the FDA prior to marketing the device in the United
States. The PMA application must be supported by extensive data, including
preclinical (laboratory) data and human clinical data, to demonstrate the safety
and efficacy of the device with respect to its intended use disclosed in the
application.
Certain of the Company's products under development, including the Arrow
LionHeartTM LVAS and the CorAideTM ventricular assist device require approval
through the more rigorous PMA application process. By regulation, the FDA has
180 days to review a PMA application and during that time an advisory committee
may evaluate the application and provide recommendations to the FDA. While the
FDA has approved PMA applications within the allotted time period, review more
often occurs over a significantly protracted period, usually 18 to 36 months,
and a number of devices have never been cleared for marketing.
The process of obtaining 510(k) clearances or PMAs can be time consuming
and expensive. There can be no assurance that the FDA will grant all such
clearances or approvals sought by the Company or that FDA review will not
involve delays adversely affecting the marketing and sale of its products. Both
a 510(k) premarket notification and a PMA application, if approved, may also
include significant limitations on the indicated uses for which a product may be
marketed. FDA enforcement policy prohibits the promotion of approved medical
devices for unapproved uses. In addition, product approvals can be withdrawn for
failure to comply with regulatory requirements or the occurrence of unforeseen
problems following initial marketing.
The FDA often requires post-market surveillance requirements for
significant risk devices, such as ventricular assist devices, that require
ongoing collection of clinical data during commercialization that must be
gathered, analyzed and submitted to the FDA periodically for up to several
years. These data collection requirements can be burdensome.
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The Company is also required to adhere to applicable U.S. and
international quality system regulations, which require that the Company
manufacture its products and maintain its records in a prescribed manner with
respect to design, test, and manufacturing and quality control activities. To
the extent that any quality issues are identified with respect to the Company's
products, the Company could be subject to substantial costs and write-offs,
which could materially impact its results of operations. In addition, the
Company is required to comply with FDA requirements for labeling and promotion
of its products.
Medical device laws are also in effect in many of the countries outside
the U.S. in which the Company does business. These laws range from comprehensive
device approval and quality system requirements for some or all of the Company's
products to simpler requests for product data, certifications or compliance with
packaging or labeling requirements. Many of the regulations applicable to the
Company's products in foreign countries are similar to those of the FDA and the
number, scope and stringency of these requirements are increasing, which is
adding to the delays and uncertainties associated with new product releases, as
well as the clinical and regulatory costs of supporting such releases. For
example, in the European Union, a single regulatory approval process has been
created, with approval represented by the CE-mark. Although the Company has to
date received authorization to CE-mark many of its more innovative products,
including the Arrow Lionheart(TM) LVAS and its Cannon Catheter(TM), there can be
no assurance that its other products under development will be able to meet this
stringent requirement for marketing a medical device in the European Union. In
addition, the Company is required to notify the FDA if it exports to certain
countries medical devices manufactured in the U.S. that have not been approved
by the FDA for distribution in the U.S.
Failure to comply with applicable federal, state, local or foreign laws
or regulations could subject the Company to enforcement action, including
product seizures, recalls, withdrawal of clearances or approvals, and civil and
criminal penalties, any one or more of which could have a material adverse
effect on its business, financial condition and results of operations. Federal,
state, local and foreign laws and regulations regarding the development,
manufacture and sale of medical devices are subject to future changes. There can
be no assurance that such changes will not have a material adverse effect on the
Company's business, financial condition and results of operations.
Significant Competition and Continual Technological Change
The markets for medical devices are highly competitive. The Company
currently competes with many companies in the development and marketing of
catheters and related medical devices. Some of the Company's competitors have
access to greater financial and other resources than it does.
Furthermore, the markets for medical devices are characterized by rapid
product development and technological change. Technological advances by one or
more of the Company's current or future competitors could render its present or
future products obsolete or uneconomical. The Company's future success will
depend upon its ability to develop new products and technology to remain
competitive with other developers of catheters and related medical devices. The
Company's business strategy emphasizes the continued development and
commercialization of new products and the enhancement of existing products for
the critical care and cardiac care markets. There can be no assurance that the
Company will be able to continue to successfully develop new products and to
enhance existing products, to manufacture these products in a commercially
viable manner, to obtain required regulatory approvals or to gain satisfactory
market acceptance for its products.
Health Care Cost Containment and Third Party Reimbursement
The Company's products are purchased principally by hospitals, hospital
networks and hospital buying groups. Although its products are used primarily
for non-optional medical procedures, the Company believes that the overall
escalating cost of medical products and services has led and will continue to
lead to increased pressures upon the health care industry to reduce the cost or
usage of certain products and services. In the United States, these cost
pressures have led to increased emphasis on the price and cost-effectiveness of
any treatment regimen and medical device. Third party payors, such as
governmental programs (e.g., Medicare and Medicaid), private insurance plans and
managed care plans, which are billed by hospitals for such health care services,
are increasingly negotiating the prices charged for medical products and
services and may deny reimbursement if they determine that a device was not used
in accordance with cost-effective treatment methods as determined by the payor,
was experimental, unnecessary or used for an unapproved indication. As a result,
even though a new medical device may have been approved by the FDA, the Company
may find limited demand for the device until reimbursement approval has been
obtained from governmental and private third party payers. In international
markets, reimbursement systems vary significantly by country. Many international
markets have government managed health care systems that control reimbursement
for certain medical devices and procedures and, in most such markets, there also
are private insurance systems which impose similar cost restraints. There can be
no assurance that hospital purchasing decisions or government or private third
party reimbursement policies in the United States or in international markets
will not adversely affect the profitability of the Company's products.
In keeping with the increased emphasis on cost-effectiveness in health
care delivery, the current trend among hospitals and other customers of medical
device manufacturers is to consolidate into larger purchasing groups to enhance
purchasing power. The medical device industry has also experienced some
consolidation, partly in order to offer a broader range of products to large
purchasers. As a result, transactions with customers tend to be larger, more
complex and involve more long-term contracts than in the past. The enhanced
purchasing power of these larger customers may also increase the pressure on
product pricing, although the Company is unable to estimate the potential impact
on it at this time. Several comprehensive health care reform proposals have
been, and continue to be, considered by the U.S. Congress. While none of these
proposals have to date been adopted, the intent of these proposals was,
generally, to expand health care coverage for the uninsured and reduce the rate
of growth of total health care expenditures. In addition, certain states have
made significant changes to their Medicaid programs and have adopted various
measures to expand coverage and limit costs. Several foreign countries in which
the Company does business are also considering, and in some countries have
already adopted, similar reforms to limit the growth of health care costs,
including price regulation. Implementation of government health care reform and
other efforts to control costs may limit the price of, or the level at which
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reimbursement is provided for, the Company's products. The Company anticipates
that the U.S. Congress, state legislatures, foreign governments and the private
sector will continue to review and assess alternative health care delivery and
payment systems. The Company cannot predict what additional legislation or
regulation, if any, relating to the health care industry may be enacted in the
future or what impact the adoption of any federal, state or foreign health care
reform, private sector reform or market forces may have on its business. There
can be no assurance that any such reforms will not have a material adverse
effect on the Company's business, financial condition or results of operations.
Dependence on Patents and Proprietary Rights
The Company owns numerous U.S. and foreign patents and has several U.S.
and foreign patent applications pending. The Company also has exclusive license
rights to certain patents held by third parties. These patents relate to aspects
of the technology used in certain of the Company's products. From time to time,
the Company is subject to legal actions involving patent and other intellectual
property claims. Successful litigation against the Company regarding its patents
or infringement of the patent rights of others could have a material adverse
effect on its business, financial condition and results of operations. In
addition, there can be no assurance that pending patent applications will result
in issued patents or that patents issued to or licensed-in by the Company will
not be challenged or circumvented by competitors or found to be valid or
sufficiently broad to protect its technology or to provide it with any
competitive advantage. The Company also relies on trade secrets and proprietary
technology that it seeks to protect, in part, through confidentiality agreements
with employees, consultants and other parties. There can be no assurance that
these agreements will not be breached, that the Company will have adequate
remedies for any breach, that others will not independently develop
substantially equivalent proprietary information or that third parties will not
otherwise gain access to its trade secrets.
There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Historically,
litigation has been necessary to enforce and defend certain patent and trademark
rights held by the Company. Future litigation may be necessary to enforce patent
and other intellectual property rights belonging to the Company, to protect its
trade secrets or other know-how owned by it, or to defend itself against claimed
infringement of the rights of others and to determine the scope and validity of
its and others' proprietary rights. Any such litigation could result in
substantial cost to and diversion of effort by the Company. Adverse
determinations in any such litigation could subject the Company to significant
liabilities to third parties, require it to seek licenses from third parties and
prevent it from manufacturing, selling or using certain of its products, any one
or more of which could have a material adverse effect on the Company's business,
financial condition and results of operations.
Risks Associated with International Operations
Because the Company generates significant sales outside of the United
States and many of its manufacturing facilities and suppliers are located
outside of the U.S., it is subject to risks generally associated with
international operations, such as: unexpected changes in regulatory
requirements; tariffs, customs, duties and other trade barriers; difficulties in
staffing and managing foreign operations; differing labor regulations; longer
payment cycles and problems in collecting accounts receivable; risks arising
from a specific country's or region's political or economic conditions,
including the possibility of any terrorist actions; fluctuations in currency
exchange rates; foreign exchange controls which restrict or prohibit
repatriation of funds; export and import restrictions or prohibitions; delays
from customs brokers or government agencies; differing protection of
intellectual property; and potentially adverse tax consequences resulting from
operating in multiple jurisdictions with different tax laws. Any one or more of
these risks could materially adversely impact the success of the Company's
international operations. As the Company's revenues from international
operations increase, an increasing portion of its revenues and expenses are
being denominated in currencies other than U.S. dollars and, consequently,
changes in exchange rates are having a greater effect on its operations.
Inventory management is a concern in international operations due to the
potential for rapidly changing business conditions and currency exposure. There
can be no assurance that such factors will not have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition, there can be no assurance that laws or administrative practices
relating to regulation of medical devices, labor, taxation, foreign exchange or
other matters of countries within which the Company operates will not change.
Any such change could also have a material adverse effect on the Company's
business, financial condition and results of operations.
Potential Product Liability
The Company's business exposes it to potential product liability risks
which are inherent in the design, manufacture and marketing of catheters and
related medical devices. The Company's products are often used in surgical and
intensive care settings with seriously ill patients. In addition, many of the
medical devices manufactured and sold by the Company are designed to be
implanted in the human body for long periods of time and component failures,
manufacturing flaws, design defects or inadequate disclosure of product-related
risks with respect to these or other products manufactured or sold by the
Company could result in an unsafe condition or injury to, or death of, the
patient. The occurrence of such a problem could result in product liability
claims and/or a recall of, or safety alert relating to, one or more of the
Company's products. There can be no assurance that the product liability
insurance maintained by the Company will be available or sufficient to satisfy
all claims made against it or that it will be able to obtain insurance in the
future at satisfactory rates or in adequate amounts. Product liability claims,
safety alerts or product recalls in the future, regardless of their ultimate
outcome, could result in costly litigation and could have a material adverse
effect on the Company's business, reputation, its ability to attract and retain
customers for its products and its results of operations. In recent years,
physicians, hospitals and other medical service providers who are users of the
Company's products have become subject to an increasing number of lawsuits
alleging medical malpractice. Medical malpractice suits often involve large
claims and substantial defense costs. The Company is subject to the risks
associated with any such medical malpractice lawsuits.
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Risks Associated with Derivative Financial Instruments
As a partial hedge against adverse fluctuations in exchange rates, the
Company periodically enters into foreign currency exchange contracts with
certain major financial institutions. By their nature, all such contracts
involve risk, including the risk of nonperformance by counterparties.
Accordingly, losses relating to these contracts could have a material adverse
effect upon the Company's business, financial condition and results of
operations. The Company's Foreign Currency Management Policy prohibits the use
of derivative instruments for speculative purposes.
Dependence on Key Management
The Company's success depends upon the continued contributions of key
members of its senior management team. Accordingly, loss of the services of one
or more of these key members of management could have a material adverse effect
on the Company's business. None of these individuals has an employment agreement
with the Company.
ITEM 2. PROPERTIES
Arrow's corporate headquarters and principal research center are located
in a 165,000 square foot facility in Reading, Pennsylvania. This facility, which
also includes manufacturing space, is located on 126 acres.
Other major properties owned by the Company include a 165,000 square
foot manufacturing and warehousing facility in Asheboro, North Carolina, which
is currently being expanded to accommodate increased production and shipping
requirements; a 145,000 square foot manufacturing facility in Wyomissing,
Pennsylvania; a 40,000 square foot manufacturing facility in Chihuahua, Mexico,
a 24,300 square foot manufacturing facility in San Antonio, Texas acquired in
connection with the Company's acquisition of the NeoCare(R) product line in
March 2003, which the Company intends to sell in order to consolidate certain of
its manufacturing operations; a 49,000 square foot manufacturing and warehouse
facility in Mount Holly, New Jersey; and an 88,000 square foot manufacturing and
research facility in the Czech Republic. The Company has also begun construction
of an additional manufacturing site in Zdar, Czech Republic and is in the
process of acquiring an additional manufacturing site near its existing plant in
Chihuahua, Mexico as part of its recently approved multi-year capital investment
plan to increase its worldwide manufacturing capacity and rationalize its
production operations, as described elsewhere in this report.
In addition, the Company leases a 55,000 square foot manufacturing
facility in Everett, Massachusetts; a 21,000 square foot sales office and
distribution center in Hicksville, New York; a 22,500 square foot manufacturing
facility in Camargo, Mexico; a 19,000 square foot office center in Wyomissing,
PA; and a 19,300 square foot manufacturing facility in Winston Salem, North
Carolina, which the Company plans to terminate in conjunction with the
consolidation of its North Carolina - based manufacturing operations. The
Company also leases sales offices and warehouse space in Canada, France,
Germany, Japan, South Africa, the Netherlands, Spain, Italy, Slovakia and
Greece, and sales office space in Mexico and Belgium.
The Company considers all of its facilities to be in good condition and
adequate to meet the present and reasonably foreseeable needs of the Company.
The Company believes that it will be able to renew all leases that it intends to
renew on commercially reasonable terms as they become due, or, if it is unable
to renew them, that suitable replacement space would be available on
commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to certain legal actions, including product
liability matters, arising in the ordinary course of its business. The Company
is also subject to legal actions involving patent and other intellectual
property claims. Based upon information presently available to the Company, the
Company believes it has adequate legal defenses or insurance coverage for these
actions and, except as set forth under Item 1. Business - Patents, Trademarks,
Regulatory Rights and Licenses, that the ultimate outcome of these actions would
not have a material adverse effect on the Company's business, financial
condition or results of operations.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of fiscal 2004 through the solicitations of proxies or otherwise.
EXECUTIVE OFFICERS
The executive officers of Arrow and their ages and positions as of
November 1, 2004 are listed below. All executive officers are elected or
appointed annually and serve at the discretion of the Board of Directors. There
are no family relationships among the executive officers of the Company.
Name Age Current Position
---- --- ----------------
Carl G. Anderson, Jr. 59 Chairman and Chief Executive Officer
Philip B. Fleck 60 President and Chief Operating Officer
Paul L. Frankhouser 59 Executive Vice President - Global Business
Development
James T. Hatlan 57 Senior Vice President - Manufacturing
Frederick J. Hirt 56 Senior Vice President-Finance and Chief Financial
Officer
Carl W. Staples 53 Senior Vice President-Human Resources
Philip M. Croxford 44 Group Vice President - Critical Care and
Cardiac Assist
John C. Long 39 Vice President - Secretary and Treasurer
Paul Cornelison 40 Vice President-Regulatory Affairs
and Quality Assurance
Mr. Anderson has served as Chairman and Chief Executive Officer of the
Company since September 1, 2003. Mr. Anderson succeeded Marlin Miller, Jr., who
retired from the Company on August 31, 2003 after serving as its Chairman of the
Board and Chief Executive Officer since it was founded in 1975. From January
2002 to August 31, 2003, Mr. Anderson served as Vice Chairman of the Board and
General Manager of the Company's Critical Care Division with responsibility for
worldwide sales, marketing, research and development of the Company's critical
care products. Mr. Anderson has served as a director of Arrow since January 1998
and, prior to his employment by the Company, served as President and Chief
Executive Officer of ABC School Supply, Inc., a producer of materials and
equipment for public and private schools, from May 1997 to December 2001. Mr.
Anderson served as Principal with the New England Consulting Group, a general
management and marketing consulting company, from May 1996 to May 1997, as Vice
President, General Manager, Retail Consumer Products of James River Corporation,
a multinational company engaged in the development, manufacture and marketing of
paper-based consumer products ("James River"), from August 1994 to March 1996,
and as Vice President, Marketing, Consumer Brands of James River from May 1992
to August 1994, and in various capacities with Nestle Foods Corporation, the
latest as Vice President, Division General Manager, Confections, from 1984 to
May 1992. Prior thereto, Mr. Anderson served in several marketing and management
capacities with Procter & Gamble from 1972 to 1984. Mr. Anderson also serves as
a director of Carpenter Technology Corporation, a manufacturer of specialty
steel.
Mr. Fleck has served as President and Chief Operating Officer of the
Company since January 1999. Mr. Fleck recently announced his retirement from the
Company, effective December 31, 2004, after serving in management capacities
with the Company and its predecessor for more than 33 years and making a major
contribution to the Company's success. Upon his retirement, Mr. Fleck will
continue to serve the Company as a consultant. From June 1994 to January 1999,
he served as Vice President - Research and Manufacturing of the Company. From
1986 to June 1994, Mr. Fleck served as Vice President - Research and Engineering
of the Company. From 1975 to 1986, Mr. Fleck served as Engineering Manager of
the Company.
Mr. Frankhouser has served as Executive Vice President - Global Business
Development of the Company since January 2002, with responsibility for worldwide
evaluation and acquisition of new business opportunities. Mr. Frankhouser
recently announced his retirement from the Company, effective January 31, 2005,
after serving in management capacities with the Company and its predecessor for
more than 41 years and making a major contribution to the Company's success.
Upon his retirement, Mr. Frankhouser will continue to serve the Company as a
consultant. From January 1999 to January 2002, Mr. Frankhouser served as
Executive Vice President of the Company, with responsibility for worldwide sales
and marketing. He served as Vice President-Marketing of the Company from 1986
until January 1999. From 1980 to 1986, Mr. Frankhouser served as Manager of
Marketing of the Company.
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Mr. Hatlan was elected Senior Vice President - Manufacturing effective
October 27, 2004 and served as Vice President - Strategic Planning of the
Company since September 2003. Prior to joining the Company, Mr. Hatlan served at
ABC School Supply, Inc., a producer of materials and equipment for public and
private schools, in several executive positions including Chairman from 1997 to
2002, and held various senior management positions at James River Corporation,
Tambrands Inc., and Procter & Gamble from 1972 to 1996.
Mr. Hirt was elected Senior Vice President - Finance and Chief Financial
Officer effective October 27, 2004 and served as Vice President - Finance and
Chief Financial Officer of the Company since August 1998. From August 1998 until
January 2003, he also served as Treasurer of the Company. Prior to joining the
Company, from 1980 to 1998, Mr. Hirt served in various capacities with Pharmacia
& Upjohn, Inc., the latest as Vice President, Accounting and Reporting.
Mr. Staples was elected Senior Vice President, Human Resource effective
October 27, 2004 and served as Vice President, Human Resources of the Company
since September 2002. Prior to joining the Company, Mr. Staples served as Vice
President Human Resources and in various other human resources capacities with
CIBA Specialty Chemicals, a manufacturer of specialty chemicals, from 1989
through August 2002. From 1974 to 1989, Mr. Staples served in various human
resources-related positions with Sara Lee Corporation, Bausch & Lomb
Incorporated, Rockwell International, and Union Carbide Corporation.
Mr. Croxford was elected Group Vice President - Critical Care and
Cardiac Assist effective October 27, 2004 and served as Vice President and
General Manager of the Company since August 2003. Prior to joining the Company,
Mr. Croxford served as Vice President/General Manager, Wound Management Business
Unit from March 1996 to August 2003 at Johnson & Johnson Medical and Ethicon,
Inc. and as Business Unit Director and various other senior marketing sales
positions at Smith & Nephew Plc from 1989 to March 1996.
Mr. Long has served as Vice President and Treasurer of the Company since
January 2003 and was also elected Secretary effective April 15, 2004, and served
as Assistant Treasurer from 1995 to January 2003. Prior to joining the Company,
Mr. Long served as Controller for the Jaindl Companies, a group of privately
held companies involved in agribusiness and real estate development, from 1989
to 1995. From 1986 to 1989, Mr. Long was employed in the Allentown office of
Concannon, Gallagher, Miller & Co., CPA's. Mr. Long also serves as a director of
American Bank Incorporated, a regional commercial bank.
Mr. Cornelison was elected to the position of Vice President-Regulatory
Affairs and Quality Assurance effective April 14, 2004 and served as Director of
Regulatory Affairs and Quality Assurance of the Company since August 2001. Prior
to joining the Company Mr. Cornelison served as Senior Regulatory Project
Director at the Regulatory Clinical Institute, a company offering specialized
consulting services to the medical industry, from December 2000 to August 2001.
OTHER INFORMATION
QUALIFIED TRADING PLANS. The Company's President and Chief Operating
Officer, Philip B. Fleck, and two of the Company's directors and founders,
Marlin Miller, Jr. and John H. Broadbent, Jr., have informed the Company that,
in order to diversify their investment portfolios while avoiding conflicts of
interest or the appearance of any such conflict that might arise from their
ongoing service to the Company, in the first quarter of fiscal 2005 they
established written plans in accordance with SEC Rule 10b5-1 for gradually
liquidating a portion of their personal holdings of the Company's common stock.
Each of these plans provide for weekly or other periodic stock sales and do not
prohibit Mr. Fleck, Mr. Miller or Mr. Broadbent from executing additional
transactions with respect to the Company's common stock.
(13)
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock has traded publicly on The Nasdaq Stock
Market under the symbol "ARRO" since June 9, 1992, the date that its common
stock was initially offered to the public. The table below sets forth the high
and low sale prices of the Company's common stock as reported by The Nasdaq
Stock Market and the quarterly dividends per share declared by the Company
during the last eight fiscal quarters. On August 15, 2003, the Company effected
a two-for-one split of its common stock while retaining the rate of its
quarterly cash dividends. All historical share and per share amounts in the
table below have been adjusted to reflect these actions.
Price per Share
======================================
Quarter Ended High Low Dividends per Share
======================== ====================================== =========================
August 31, 2004 $32.7200 $26.6100 $0.0900
May 31, 2004 $31.2800 $26.6200 $0.0900
February 29, 2004 $29.3700 $24.6100 $0.0900
November 30, 2003 $27.1000 $22.4300 $0.0800
August 31, 2003 $25.8000 $21.4100 $0.0800
May 31, 2003 $22.3100 $20.2350 $0.0400
February 28, 2003 $21.8750 $18.6450 $0.0400
November 30, 2002 $19.3750 $15.7500 $0.0350
As of October 1, 2004, there were approximately 519 registered
shareholders of the Company's common stock.
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Board of Directors has authorized the repurchase of up to
a maximum of 4,000,000 shares under a share repurchase program announced on
March 23, 1999 (for up to 2,000,000 shares) and extended on April 6, 2000 (for
up to an additional 2,000,000 shares). As of August 31, 2004, the Company had
repurchased a total of 3,603,600 shares under this program for approximately
$57,532,444 since the program's inception in March 1999. However, no shares were
repurchased by the Company under the program (or otherwise) during fiscal 2004.
For the Fiscal Year Ended
August 31, 2004 Total Program to Date
- -------------------------------------------------- -----------------------------------------------------------------------
Total Number of Shares Purchased Maximum Number of Shares that
Total Number of Shares Average Price Paid as Part of Publicly Announced May Yet Be Purchased Under the
Purchased Per Share Program Program
- ------------------------- --------------------- ---------------------------------- --------------------------------
- - 3,603,600 396,400
(14)
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data for the years ended
August 31, 2004, 2003, 2002, 2001 and 2000 have been derived from the Company's
audited consolidated financial statements. The consolidated financial statements
of the Company as of August 31, 2004 and 2003 and for each of the three years in
the period ended August 31, 2004, together with the notes thereto and the
related report of PricewaterhouseCoopers LLP, an independent registered public
accounting firm are included in Item 8 of this report. The following data should
be read in conjunction with the Company's audited consolidated financial
statements, the notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations, which are included in Items 7 and
8 of this report.
2004 2003 2002 2001 2000
------------ ----------- ------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF INCOME DATA:
Net sales $ 433,134 $ 380,376 $ 340,759 $ 334,042 $ 325,714
Cost of goods sold 208,687 190,246 169,625 158,573 156,107
Gross profit 224,447 190,130 171,134 175,469 169,607
Operating expenses
Research, development and engineering 30,374 28,170 26,165 25,209 19,771
Selling, general, and administrative 110,192 89,354 78,406 78,499 74,921
Restructuring charge 208 - - - -
Special charges* - 8,000 8,005 - 3,320
Total operating expenses 140,774 125,524 112,576 103,708 98,012
Operating income 83,673 64,606 58,558 71,761 71,595
Other expenses (income), net 796 (2,312) 781 2,291 2,145
Income before income taxes 82,877 66,918 57,777 69,470 69,450
Provision for income taxes 26,935 21,248 18,777 22,925 23,266
------------ ----------- ------------ ------------ ------------
Net income $ 55,942 $ 45,670 $ 39,000 $ 46,545 $ 46,184
============ =========== ============ ============ ============
Basic earnings per common share $ 1.28 $ 1.05 $ 0.89 $ 1.06 $ 1.03
============ =========== ============ ============ ============
Diluted earnings per common share $ 1.26 $ 1.04 $ 0.88 $ 1.05 $ 1.03
============ =========== ============ ============ ============
Cash dividends per common share $ 0.3500 $ 0.1950 $ 0.1375 $ 0.1275 $ 0.1175
Weighted average shares used in computing
basic earnings per common share 43,559 43,399 43,826 43,991 44,901
Weighted average shares used in computing
diluted earnings per common share 44,302 43,773 44,211 44,241 45,038
All historical share and per share amounts have been adjusted to reflect
the two-for-one split of the Company's common stock effected on August 15, 2003.
(15)
2004 2003 2002 2001 2000
------------ ----------- ------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
BALANCE SHEET DATA:
Working capital $ 209,602 $ 163,914 $ 157,162 $ 110,227 $ 78,132
Total assets 549,208 493,897 426,776 418,209 385,814
Notes payable and current maturities of
long-term debt 29,056 28,731 16,432 50,722 60,481
Long-term debt, excluding current maturities - 3,735 300 600 900
Shareholders' equity 446,331 390,646 360,356 326,089 285,204
Certain prior period amounts in the table above have been reclassified
to conform to the fiscal 2004 presentation (see Item 8. Notes to Consolidated
Financial Statements - Note 1).
* See Item 8. Notes to Consolidated Financial Statements - Note 2 for a
description of the special charges recorded in fiscal 2003 and 2002. In the
first quarter of fiscal 2000, the Company recorded a non-cash pre-tax special
charge of $3,320 ($2,208 after-tax or $0.05 per basic and diluted common share)
related primarily to a write-down for the in-process research and development
acquired in connection with the Company's acquisition of Sometec, S.A. In
accordance with Financial Accounting Standard (FAS) No. 2 "Accounting for
Research and Development Costs" and Financial Accounting Standard Board (FASB)
Interpretation (FIN) No. 4 "Applicability of FAS No. 2 to Business Combinations
Accounted for by the Purchase Method", these costs were charged to expense at
the date of consummation of the acquisition.
(16)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION INCLUDES CERTAIN FORWARD-LOOKING STATEMENTS.
SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO A NUMBER OF FACTORS, INCLUDING
MATERIAL RISKS, UNCERTAINTIES AND CONTINGENCIES, WHICH COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS. FOR A
DISCUSSION OF IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS, SEE ITEM 1. BUSINESS - CERTAIN
RISKS RELATING TO ARROW AND THE COMPANY'S OTHER REPORTS FILED WITH THE SEC.
EXECUTIVE OVERVIEW
Arrow is a worldwide developer, manufacturer and marketer of a broad
range of clinically advanced, disposable catheters, heart assist devices and
related products for critical and cardiac care. The Company markets its products
to physicians and hospitals through a combination of direct selling, independent
distributors and group purchasing organizations. Within each hospital, marketing
efforts are targeted to those physicians, including critical care specialists,
cardiologists, anesthesiologists, interventional radiologists,
electrophysiologists and surgeons, most likely to use the Company's products.
The Company's largest geographical markets are the United States, Europe and
Japan.
The Company's revenues are generated from sales of its products, less
certain related charges, discounts, returns and other allowances. The Company's
costs and expenses consist of costs of goods sold; research, development and
engineering expense; selling, general and administration expense; and other
expenses (income). Costs of goods sold consist principally of costs relating to
the manufacture and distribution of the Company's products. Research,
development and engineering expense consists principally of expenses incurred
with respect to the Company's internal research, development and engineering
activities to introduce new products to market and enhancements to its existing
products, payments for third-party research and development activities, and
acquired in-process research and development costs arising from the Company's
acquisition activities. Selling, general and administrative expense consists
principally of costs associated with the Company's marketing and sales efforts
and administrative operations and commitments. Other expenses (income) consists
principally of interest expense on the Company's outstanding indebtedness,
interest income and other items, such as foreign currency exchange gains and
losses, which may impact the comparability of the Company's results of
operations between periods.
The Company's ability to grow its net income largely depends upon
generating increased sales of its products, particularly its higher margin
products, and further improving its operating efficiency. The Company's sales
growth is driven by its development and marketing of clinically advanced new
products and enhancements to its existing products to increase their
effectiveness, ease of use, safety and reliability, as well as to expand the
clinical applications for which their use is appropriate. In this regard, the
Company has strategically increased its spending on research and development in
each of fiscal 2004 and fiscal 2003 and expects to continue to increase its
research and development spending in fiscal 2005. The Company also anticipates
generating higher sales through selective acquisitions of new businesses,
products and technologies that complement its existing product lines, as it has
done from time to time in the past.
The Company is focused on improving operating margins by increasing the
efficiency of its manufacturing operations and maintaining effective
cost-containment programs. In this regard, the Company has recently initiated a
multi-year capital investment plan to increase its worldwide manufacturing
capacity and rationalize its production operations, the first phase of which
will entail development of additional manufacturing facilities in the Czech
Republic and Mexico, and is also in the process of consolidating certain of its
U.S.-based manufacturing operations. In addition, the Company has improved
operating margins through selective acquisitions of some of its distributors
and/or distribution rights in key U.S. and international markets, thereby
increasing the percentage of its sales generated by its direct sales force.
The Company faces substantial competition from a number of other
companies in the market for catheters and related medical devices and equipment,
ranging from small start-up enterprises to companies that are larger than Arrow
with greater financial and other resources. In addition, in response to concern
about the rising costs of health care, U.S. hospitals and physicians are placing
increasing emphasis on cost-effectiveness in the selection of products to
perform medical procedures. The Company believes that its comprehensive
manufacturing capability enables it to expedite the development and market
introduction of new products and to reduce manufacturing costs, thereby
permitting it to respond more effectively to competitive pricing in an
environment where its ability to increase prices is limited.
Management's discussion and analysis (MD&A) begins with an examination
of the material changes in the Company's operating results for fiscal 2004 as
compared to fiscal 2003, and its operating results for fiscal 2003 as compared
to fiscal 2002. The discussion then provides an examination of liquidity and
capital resources, focusing primarily on material changes in operating,
investing and financing activities as depicted in the Company's consolidated
statements of cash flows included in Item 8 of this report, information on the
Company's available credit facilities and a summary of its outstanding
contractual obligations. Finally, MD&A provides information on critical
accounting policies and estimates and new accounting standards.
(17)
RESULTS OF OPERATIONS
The following table presents for the three years ended August 31, 2004
Consolidated Statements of Income expressed as a percentage of net sales and the
period-to-period percentage changes in the dollar amounts of the respective line
items.
Period-to-Period
Percentage of Net Sales Percentage Change
---------------------------------- -----------------------------------
Year ended August 31, 2004 2003 2002
---------------------------------- vs vs vs
2004 2003 2002 2003 2002 2001
-------- -------- -------- --------- --------- ---------
Net sales 100.0 % 100.0 % 100.0 % 13.9 % 11.6 % 2.0 %
Gross profit 51.8 50.0 50.2 18.0 11.1 (2.5)
Operating expenses:
Research, development and
engineering 7.0 7.4 7.7 7.8 7.6 4.0
Selling, general and
administrative 25.4 23.5 23.0 23.3 14.0 0.1
Restructuring charge 0.1 - - * * *
Special charges** - 2.1 2.3 0.0 0.0 *
-------- -------- -------- --------- --------- ---------
Operating income 19.3 17.0 17.2 29.6 10.2 (18.4)
Other expenses (income), net 0.1 (0.6) 0.2 (134.4) 396.0 (65.9)
Income before income taxes 19.2 17.6 17.0 23.9 15.7 (16.8)
Provision for income taxes 6.3 5.6 5.6 26.8 13.2 (18.1)
-------- -------- -------- --------- --------- ---------
Net income 12.9 % 12.0 % 11.4 % 22.3 17.2 % (16.1) %
*Not a meaningful comparison
**See Item 8. Financial Statements and Supplementary Data for a
description of special charges
FISCAL 2004 COMPARED TO FISCAL 2003
NET SALES. Net sales increased by $52.7 million, or 13.9%, to $433.1
million in fiscal 2004 from $380.4 million in fiscal 2003 due primarily to an
increase in critical care product sales and a favorable foreign exchange impact
during fiscal 2004 as a result of the weakness of the U.S. dollar relative to
currencies of countries in which the Company operates direct sales subsidiaries.
This foreign exchange impact resulted in increased international sales for
fiscal 2004 of $10.7 million or 2.8% of total Company sales. Net sales represent
gross sales invoiced to customers, less certain related charges, discounts,
returns and other allowances. Revenue from sales is recognized at the time
products are shipped and title is passed to the customer. The following is a
summary of the Company's sales by product platform:
Sales by Product Platform
(in millions) For the years ended
August 31, 2004 August 31, 2003
--------------- ---------------
Central venous catheters * $ 222.7 $ 186.4
Specialty catheters 135.1 124.1
Stepic distributed products 12.0 13.0
------- -------
Subtotal critical care 369.8 323.5
Cardiac care 63.3 56.9
------- -------
TOTAL $ 433.1 $ 380.4
======= =======
*Includes Diatek product sales in the second, third and fourth fiscal quarters
of both years and NeoCare(R) product sales in the third and fourth fiscal
quarters of both years.
(18)
Sales of critical care products increased 14.3% to $369.8 million from
$323.5 million in fiscal 2003 due primarily to increased sales of central venous
catheters and specialty catheters. Sales of central venous catheters increased
in fiscal 2004 due primarily to a continued increase in the number of hospitals
that are purchasing the Company's procedure kits featuring its safety devices
and ARROWg+ard(R) antiseptic surface treatments, as well as increased sales of
renal access and neonatal products resulting from the Company's acquisitions of
Diatek and the NeoCare(R) product line in fiscal 2003. Sales of specialty
catheters increased in fiscal 2004 due to improved sales of arterial products,
epidural products and intravenous and extension sets. Sales of cardiac care
products increased 11.2% to $63.3 million from $56.9 million in fiscal 2003 due
primarily to increased sales of intra-aortic balloon pumps, especially in
international markets, and Super Arrow-Flex(R) products. Total Company U.S.
sales increased 12.0% to $279.9 million from $249.9 million in the prior year
principally as a result of increased sales of central venous and specialty
catheters. International sales increased by 17.4% to $153.2 million from $130.5
million in the prior year principally as a result of increased sales of central
venous catheters, specialty catheters and intra-aortic balloon pumps, and the
effect of foreign currency exchange rates, as noted above. International sales
represented 35.4% of net sales in fiscal 2004, compared to 34.3% in the prior
year.
The ARROWg+ard(R) conversion percentages, which are the number of units
sold with the ARROWg+ard(R) antiseptic surface treatments as a percentage of the
Company's total multilumen and hemodialysis unit sales, increased to 36% from
34% in the prior year for total Company sales. The ARROWg+ard(R) conversion
percentages for the U.S. market increased to 62% from 59% in the prior year.
The safety device procedure kits conversion percentages, which are the
number of units sold with the Company's procedure kits featuring its safety
devices as a percentage of the total number of units sold of the Company's
products that could potentially include safety device procedure kits, increased
to 7% in fiscal 2004 from 5% in the prior year for total Company sales. The
safety device procedure kit conversion percentages for the U.S. market in fiscal
2004 increased to 14% from 9% in the prior year.
GROSS PROFIT. Gross profit increased 18.0% to $224.4 million in fiscal
2004 from $190.1 million in fiscal 2003. As a percentage of net sales, gross
profit increased to 51.8% in fiscal 2004 compared to 50.0% in fiscal 2003. The
increase in gross margin was due primarily to (1) lower margins realized in
fiscal 2003 on the sale of inventories of products acquired as part of the
Company's purchase of the net assets of Stepic Medical, its former New York City
distributor, in September 2002; (2) higher margins resulting from increased
sales of the Company's procedure kits featuring its safety devices and
ARROWg+ard(R) antiseptic surface treatments; (3) higher than average margins
realized on the sale of renal access products associated with the Company's
acquisition of Diatek in November 2002; and (4) higher margins on products
distributed in Florida and certain southeastern states as a result of the
Company's acquisition of its former distributor, IMA, Inc., in July 2003, which
enabled the Company to conduct direct sales activity in this region. These
increases were offset in part by the Company's write-off of $3.1 million of
inventory in the third quarter of fiscal 2004 for certain LionHeart(TM)
components that became obsolete with the Company's previously announced decision
during the quarter not to proceed with the LionHeart(TM) Phase II U.S. clinical
trials using the first generation LionHeart(TM) power system and controller.
The increased emphasis on health care cost containment has resulted in
reduced growth in demand for certain of the Company's products in markets in the
U.S. where Arrow has 80% or greater market shares, and protecting that market
share has affected the Company's pricing in some instances. The Company also
continues to face pricing pressures in certain product lines in both European
and Japanese markets as governments strive to curtail increases in health care
costs. The Company intends to continue its efforts to mitigate the effect of
these pricing pressures through continued emphasis on cost reduction.
RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and
engineering expenses increased by 7.8% to $30.4 million in fiscal 2004 from
$28.2 million in the prior year. As a percentage of net sales, these expenses
decreased to 7.0% in fiscal 2004 compared to 7.4% in fiscal 2003. The increase
in research, development and engineering expenses was primarily due to higher
spending in fiscal 2004 on the Arrow LionHeart(TM) as a result of incremental
spending associated with the development of the LionHeart's second generation
electronics and increased research and engineering expenditures in fiscal 2004
for the Company's critical care product line. There increases were offset in
part by the fiscal 2003 write-off of $3.6 million related to development costs
for the second generation of external batteries used in the Arrow LionHeart(TM)
and decreased research and development spending on the CorAide(TM) continuous
flow ventricular assist system, the Company's joint research and development
program with The Cleveland Clinic Foundation. The Company currently anticipates
that research, development and engineering expenses related to the development
of second generation LionHeart(TM) components will be approximately $0.9 million
($0.6 million after tax, or $0.01 diluted earnings per share) in the first
quarter of fiscal 2005.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased by 23.3% to $110.2 million from $89.4 million in the previous
year, and were 25.3% of net sales in fiscal 2004 compared to 23.5% in fiscal
2003. This increase was due primarily to several factors: (1) increased expenses
of $3.4 million incurred in connection with the Company's acquisitions in fiscal
2003 of Diatek, the NeoCare(R) product line and IMA, Inc., its former Florida
distributor; (2) a $3.0 million increase in expenses related to the Company's
international operations as a result of the weakness of the U.S. dollar relative
to currencies of countries in which the Company operates direct sales
subsidiaries; (3) increased expenses of $1.7 million for the write-off of the
costs related to a previously planned building expansion of the Company's
headquarters in Reading, PA; (4) increased expenses of $1.3 million relating to
an increase in the accrual for the Company's income growth bonus plan for its
executive officers and key management employees; (5) an increase in expenses of
$1.1 million related to an increase in the vacation accrual due in part to an
incremental increase in the Company's vacation benefit for its employees
resulting from a modification to its vacation policy; and (6) an increase in
expenses of $0.9 million related to an increase in the accrual for the Company's
sales commission plan due to better sales performance against Company objectives
during the fourth quarter of fiscal 2004. These increases were offset in part by
a decrease in legal costs of $1.8 million associated with the Company's defense
of patent litigation relating to certain of its hemodialysis catheter products,
which, as previously reported, was settled in December 2003.
(19)
Net periodic pension cost is recorded in operating expenses in amounts
determined by the Company's actuaries and is based on management's estimates of
expected interest rates, expected rates of return on plan assets and expected
compensation increases. These estimates reflect management's best judgments in
the current circumstances. Actual results may differ from the estimates.
Interest rate assumptions are based on market rates at the beginning of the
Company's fiscal year. Expected rates of return on plan assets are based in part
on the Company's historical asset portfolio performance over the prior ten year
period and also on the estimated rate of return on plan assets in the future.
The Company's rate of compensation increase assumption is based on its
historical compensation percentage increases as well as its expected rate
increases in future periods.
SPECIAL AND OTHER CHARGES. The Company recorded a charge of $0.6 million
($0.4 million after tax, or $0.01 diluted earnings per share) in the third
quarter of fiscal 2004 for a write-off of manufacturing equipment relating to
the LionHeart(TM) and also recorded $0.2 million ($0.1 million after tax, or
less than $0.01 diluted earnings per share) of restructuring expenses related to
accrued severance payments associated with its consolidation of operations at
its Winston-Salem, North Carolina and San Antonio, Texas facilities into other
existing manufacturing facilities in the fourth quarter of fiscal year 2004.
The Company also incurred a special charge in the fourth quarter of
fiscal 2003 totaling $8.0 million ($5.4 million after tax, or $0.12 diluted
earnings per share) to establish a reserve for a proposed settlement in two
related patent infringement lawsuits, which, as discussed in Item 1 of this
report, relate to certain of the Company's hemodialysis catheter products.
OPERATING INCOME. Principally due to the above factors, operating income
increased 29.6% to $83.7 million in fiscal 2004 from $64.6 million in fiscal
2003.
OTHER EXPENSES (INCOME), NET. Other expenses (income), net, increased to
$0.8 million of expense in fiscal 2004 from $2.3 million of income in fiscal
2003, principally due to foreign currency transaction gains in the prior year
resulting from the translation of intercompany receivables denominated in the
functional currencies of the Company's international sales subsidiaries. In the
third quarter of fiscal 2003, the Company recapitalized its subsidiary in the
Czech Republic. This refinancing resulted in a temporarily unhedged foreign
currency position leading to a foreign currency transaction gain of $1.0
million. This foreign currency position was hedged later in the third quarter of
fiscal 2003. In addition, in fiscal 2003 the Company realized interest income
accruing on refunds related to amended federal tax returns, which claimed
additional research and development credits and depreciation of equipment.
Aggregate foreign exchange losses were $0.6 million and $0.1 million in fiscal
2004 and 2003, respectively. Foreign currency contracts resulted in $0.7 million
of losses in fiscal 2004 and $0.7 million of gains in fiscal 2003.
INCOME BEFORE INCOME TAXES. As a result of the factors discussed above,
income before income taxes increased in fiscal 2004 by 23.9% to $82.9 million
from $66.9 million in fiscal 2003. The Company's effective income tax rate
increased to 32.5% from 31.8% in fiscal 2003, primarily due to a favorable tax
settlement with the IRS in the fourth quarter of fiscal 2003 related to the
Company's research and development tax credits.
JAPANESE AND U.S. TAX MATTERS. In addition, the Company made a payment
in March 2004 of $10.0 million to settle a tax assessment related to an ongoing
Japanese government tax audit of the Company's transfer pricing with its
Japanese subsidiary. The Company intends to utilize competent authority
proceedings with the Internal Revenue Service in the U.S. to recover a majority
of this required Japanese tax payment. The Company believes that the amount
ultimately recovered through these proceedings has been fully provided for as of
August 31, 2004 and, therefore, will not adversely affect its future results of
operations.
On October 22, 2004 the President signed The American Jobs Creation Act
of 2004 (the Act). The Act included some of the most significant changes to
corporate taxation since 1996 and, among other things, eliminates the
Extraterritorial Income Regime (ETI) over a three year phase out period
beginning in 2005. However, the phase out will still allow the Company to obtain
a significant percentage of the ETI benefit for fiscal 2005 and 2006 with a
somewhat smaller benefit for fiscal 2007. The ETI will be totally phased out by
the Company's 2008 fiscal year end. Additionally, the Act provides for a
deduction for US domestic manufacturers beginning in the Company's fiscal year
2006. This new deduction begins at 3% of US domestic manufacturer's income for
the Company's fiscal years 2006 and 2007, increasing to 6% for the Company's
fiscal years 2008-2010 and achieves it's maximum rate of 9% for the Company's
fiscal years 2010 and beyond. While an exact calculation of the effects of these
changes has not been undertaken, management believes that the phased out repeal
of the ETI benefit during 2005 and 2006 and the phase in of the new
manufacturing deduction benefit from 2006-2011 should not have a material
adverse effect on the Company's effective tax rate, although it believes that
the net effect will be less of an income tax benefit to the Company for 2005 and
beyond.
NET INCOME. Net income in fiscal 2004 increased 22.3% to $55.9 million
from $45.7 million in fiscal 2003. As a percentage of net sales, net income
represented 12.9% in fiscal 2004 compared to 12.0% in fiscal 2003.
PER SHARE AND HISTORICAL SHARE INFORMATION. During the fourth quarter of
fiscal 2003, the Company approved the issuance, effective on August 15, 2003, of
an additional share of common stock for each share issued and outstanding on the
record date of August 1, 2003 while retaining the rate of its quarterly
dividend, which resulted in the doubling of its quarterly dividend to $0.08 per
share. All historical share and per share information in this report has been
adjusted to reflect these corporate actions.
(20)
Basic earnings per common share were $1.28 in fiscal 2004, up 21.9%, or
$0.23 per share, from $1.05 in fiscal 2003. Diluted earnings per common share
were $1.26 in fiscal 2004, up 21.2%, or $0.22 per share, from $1.04 in fiscal
2003. Weighted average shares of common stock outstanding used in computing
basic earnings per common share increased to 43,559,410 in fiscal 2004 from
43,399,363 in fiscal 2003 primarily as a result of an increase in stock option
exercises due to a higher market price of the Company's stock relative to
average outstanding option exercise prices during the fiscal year offset in part
by the Company's repurchases of shares during fiscal 2003 under its share
repurchase program, which resulted in a full impact on the weighted average
share calculation in fiscal 2004 compared to a partial impact in the prior year.
Weighted average shares of common stock outstanding used in computing diluted
earnings per common share increased to 44,301,960 in fiscal 2004 from 43,773,253
in fiscal 2003 primarily as a result of an increase in potentially dilutive
shares resulting from an increased share price and an increase in stock option
exercises for the reasons described above.
FISCAL 2003 COMPARED TO FISCAL 2002
NET SALES. Net sales increased by $39.6 million, or 11.6%, to $380.4
million in fiscal 2003 from $340.8 million in fiscal 2002 due primarily to an
increase in critical care product sales, including sales of products distributed
by the Company's new Stepic subsidiary formed in fiscal 2003 following the
Company's acquisition of the net assets of its former New York City distributor,
and a favorable foreign exchange impact during fiscal 2003 as a result of the
weakness of the U.S. dollar relative to currencies of countries in which the
Company operates direct sales subsidiaries, as further discussed below. The
following is a summary of the Company's sales by product platform:
Sales by Product Platform
(in millions) For the years ended
August 31, 2004 August 31, 2003
--------------- ---------------
Central venous catheters* $ 186.4 $ 164.1
Specialty catheters 124.1 115.0
Stepic distributed products 13.0 -
------- -------
Subtotal 323.5 279.1
Drug infusion pumps - 4.9
------- -------
Subtotal critical care 323.5 284.0
Cardiac care 56.9 56.8
------- -------
TOTAL $ 380.4 $ 340.8
======= =======
*Includes Diatek and NeoCare(R) product sales of $6.4 million in fiscal
2003.
Sales of critical care products increased 13.9% to $323.5 million from
$284.0 million in fiscal 2002, due primarily to increased sales of central
venous and specialty catheters offset by decreased sales of drug infusion
products as a result of the Company's divestiture of its implantable drug
infusion pump business in fiscal 2002, as discussed below. Sales of central
venous catheters increased in fiscal 2003 due primarily to an increase in the
number of hospitals that began purchasing the Company's recently introduced
procedure kits featuring its safety devices as well as increased sales of renal
access and neonatal products resulting from the Company's acquisitions of Diatek
and the NeoCare(R) product line, respectively. Sales of specialty catheters
increased in fiscal 2003 due to improved sales of epidural products, intravenous
and extension sets, percutaneous thrombolytic devices, and rapid infusion
catheters. Sales of cardiac care products increased to $56.9 million from $56.8
million in fiscal 2002, due primarily to increased sales of intra-aortic balloon
pump and diagnostic products offset by decreased sales to another medical device
manufacturer. International sales increased by 11.1% to $130.5 million from
$117.5 million in the prior year and represented 34.3% of net sales in fiscal
2003, compared to 34.5% in the prior year. As a result of the weakness of the
U.S. dollar relative to currencies of countries in which the Company operates
direct sales subsidiaries, net sales for fiscal 2003 increased $8.1 million.
In April 2002, the Company completed the sale of substantially all of
the assets of its implantable drug infusion pump business pursuant to an asset
purchase agreement dated as of March 1, 2002. As a result of this divestiture,
the Company reported no sales of implantable drug infusion pump products in
fiscal 2003 compared to $4.9 million of such sales in fiscal 2002.
GROSS PROFIT. Gross profit increased 11.1% to $190.1 million in fiscal
2003 from $171.1 million in fiscal 2002. As a percentage of net sales, gross
profit decreased to 50.0% in fiscal 2003 compared to 50.2% in fiscal 2002. The
decline in gross margin was due primarily to (1) lower margins realized on the
sale of inventories of products purchased as part of the Company's acquisition
of the net assets of Stepic Medical, its former New York City distributor, in
September 2002, and (2) the ongoing distribution by the Company's Stepic
subsidiary of lower margin products of other medical device manufacturers,
offset in part by (3) a $1.8 million charge against sales in fiscal 2002 related
to the Company's acquisition of Stepic Medical to reflect an increase in the
reserve for dealer rebates as a result of obtaining additional information
regarding Stepic's rebates, (4) higher than average margins realized on the sale
of renal access products associated with the Company's acquisition of Diatek in
November 2002, and (5) hi