Haemonetics Corporation (HAE) - Description of business

Company Description
We design, manufacture and market automated systems and single-use disposables for the collection, processing and surgical salvage of blood as well as associated data management technology. In addition, we are engaged in marketing partnerships under which we sell other products supporting the blood collection and surgical industries. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Fiscal Year Our fiscal year ends on the Saturday closest to the last day in March. Fiscal year 2006 includes 52 weeks, 2005 included 52 weeks and fiscal year 2004 included 53 weeks. Principles of Consolidation The accompanying consolidated financial statements include all accounts including those of our subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could vary from the amounts derived from our estimates and assumptions. Reclassifications Certain reclassifications have been made to prior years’ amounts to conform to the current year’s presentation. Revenue Recognition Our revenue recognition policy is to recognize revenues from product sales, software and services in accordance with SAB No. 104, “Revenue Recognition in Financial Statements” which requires that revenues are recognized when persuasive evidence of an arrangement exists, product delivery, including customer acceptance, has occurred or services have been rendered, the price is fixed or determinable and collectibility is reasonably assured. Multiple element arrangements When more than one element such as equipment, disposables and services are contained in a single arrangement, we allocate revenue between the elements based on each element’s relative fair value, provided that each element meets the criteria for treatment as a separate unit of accounting. An item is considered a separate unit of accounting if it has value to the customer on a stand alone basis and there is objective and reliable evidence of the fair value of the undelivered items. The fair value of the undelivered elements is determined by the price charged when the element is sold separately, or in cases when the item is not sold separately, by the using other objective evidence as defined in Emerging Issues Task Force (EITF) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” Product Revenues Product sales consist of the sale of our equipment devices, the related disposables used in these devices and intravenous solutions manufactured for pharmaceutical companies.  On product sales to customers, revenue is recognized when both the title and risk of loss have transferred to the customer as determined by the shipping terms and all post delivery obligations have been achieved to the full satisfaction of the customer. Examples of common post delivery obligations are installation and training. For product sales to distributors, we recognize revenue for both equipment and disposables upon shipment of these products to our distributors. Our standard contracts with our distributors state that title to the equipment passes to the distributors at point of shipment to a distributor’s location. The distributors are responsible for shipment to the end customer along with installation, training and acceptance of the equipment by the end customer. All shipments to distributors are at contract prices and payment is not contingent upon resale of the product. Software Revenues Software sales consist of the sale of our donor management information technology developed by our subsidiary, 5D. In some cases, as services are essential to the functionality of our software, revenue is recognized in accordance with  SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”, which requires that the software license, configuration, training and implementation fees are recognized under the contract method of accounting using labor hours to measure the completion percentage. As the number of hours through completion may change, our revenues and profits are subject to revisions as the contract progresses. We recorded $10.3 million, $4.7 million and $6.6 million of software revenue in fiscal year 2006, 2005, and 2004, respectively. Service Revenues Service revenues are recognized ratably over the contractual periods and as the services are provided. Translation of Foreign Currencies All assets and liabilities of foreign subsidiaries are translated at the rate of exchange at year-end while sales and expenses are translated at an average rate in effect during the year. The net effect of these translation adjustments is shown in the accompanying financial statements as a component of stockholders’ equity. Foreign currency transaction gains and losses are included in other income, net on the consolidated statements of income. Cash and Cash Equivalents Cash equivalents include various instruments such as money market funds, U.S. government obligations and commercial paper with maturities of three months or less at date of acquisition. Cash and cash equivalents are recorded at cost, which approximates fair market value. Short Term Investments As of April 1, 2006 and April 2, 2005, we held no short term investments. As of April 3, 2004,  all our short term  investments, consisted of auction rate debt securities and were categorized as available for sale  under the provisions of  SFAS Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Accordingly, our investments in these securities are recorded at cost, which approximates fair value due to their variable interest rates, which typically reset every 28 to 35 days. Despite the long-term nature of the stated contractual maturities of these investments, we have the ability to liquidate these securities prior to their stated maturity date. As a result of the resetting variable rates, we had no cumulative gross unrealized or realized holding gains or losses from these investments during fiscal year 2005 or 2004. All income generated from these investments was recorded as interest income. Proceeds from these short term investments totaled approximately $88.5 million and $5.5 million during fiscal year 2005 and 2004, respectively. Allowance for Doubtful Accounts We establish a specific allowance for customers when it is probable that they will not be able to meet their financial obligation. Customer accounts are reviewed individually on a regular basis and appropriate reserves are established as deemed appropriate. We also maintain a general reserve using a percentage based upon an aging method. We establish percentages for balances not yet due and past due accounts based on past experience. Concentration of Credit Risk and Significant Customers Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents and accounts receivable. Sales to one unaffiliated Japanese customer, the Japanese Red Cross Society, amounted to $75.7 million, $91.0 million, and $87.6 million for 2006, 2005, and 2004, respectively. Accounts receivable balances attributable to this customer accounted for 15.4%, 18.7%, and 22.0% of our consolidated accounts receivable at fiscal year end 2006, 2005, and 2004, respectively. While the accounts receivable related to the Japanese Red Cross Society may be significant, we do not believe the credit loss risk to be significant given the consistent payment history by this customer. Certain other markets and industries can expose us to concentrations of credit risk. For example, in our commercial plasma business, we tend to have only a few customers in total but they are large in size. As a result, our accounts receivable extended to any one of these commercial plasma customers can be somewhat significant at any point in time. Cost Method Investment We account for our private equity investment in Arryx, Inc. (“Arryx”) in accordance with Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” using the cost method as we do not exercise significant influence over operating or financial policies of this entity. Each reporting period, we evaluate our investment for impairment if an event or circumstance occurs that is likely to have a significant adverse effect on the fair value of the investment. Examples of such events or circumstances include a significant deterioration in the business prospects of the investee; a significant adverse change in the economic or technological environment of the investee; and a significant doubt about the investee’s ability to continue as a going concern. If there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the cost method investment, the fair value of the investment is not calculated as it is not practicable to do so in accordance with paragraphs 14 and 15 of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments.”  If we identify an impairment indicator, we will estimate the fair value of the investment and compare it to its carrying value. We have determined there are no impairment indicators present during 2006 on our cost method investment with a carrying value of $5.0 million. This investment is classified as other long-term assets in our consolidated balance sheets. Property, Plant and Equipment Property, Plant and Equipment is recorded at historical cost. We provide for depreciation and amortization by charges to operations using the straight-line method in amounts estimated to recover the cost of the building and improvements, equipment, and furniture and fixtures over their estimated useful lives as follows:

Asset Classification

Estimated Useful Lives

Building

 

30 Years

Building and leasehold improvements

 

5-25 Years

Plant equipment and machinery

 

3-10 Years

Office equipment and information technology

 

3-8 Years

Haemonetics equipment

 

2-4 Years

Depreciation expense was $22.9 million, $25.5 million, and $28.3 million for fiscal years 2006, 2005, and 2004, respectively. Leasehold improvements are amortized over the lesser of their useful lives or the term of the lease. Maintenance and repairs are charged to operations as incurred. When equipment and improvements are sold or otherwise disposed of, the asset cost and accumulated depreciation are removed from the accounts, and the resulting gain or loss, if any, is included in the statements of income. Fully depreciated assets are removed from the accounts when they are no longer in use. Haemonetics equipment is comprised of medical devices installed at customer sites. These devices remain our property. Generally the customer has the right to use it for a period of time as long as they meet the conditions we have established, which among other things, generally include one or both of the following: ·                   Purchase and consumption of a certain level of disposable products ·                   Payment of monthly rental fees Periodically we review the useful lives of our devices and perform reviews to determine if a group of these devices is impaired. To conduct these reviews we estimate the future amount and timing of demand for these devices. Changes in expected demand can result in additional depreciation expense, which is classified as cost of goods sold. Any significant unanticipated changes in demand could impact the value of our devices and our reported operating results. Expenditures for normal maintenance and repairs are charged to expense as incurred. Accounting for Long-Lived Assets: Goodwill and Other Intangible Assets Intangible assets acquired in a business combination, including licensed technology, are recorded under the purchase method of accounting at their estimated fair values at the date of acquisition. Goodwill represents the excess purchase price over the fair value of the net tangible and other identifiable intangible assets acquired. We amortize our other intangible assets over their useful lives, as applicable. Goodwill and certain other intangible assets, determined to have an indefinite life, are not amortized. Instead these assets are reviewed for impairment at least annually in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” We perform our annual impairment test on January 1st (or the first business day immediately following that date). As we only have one reporting unit, the test is based on a fair value approach, which uses our market capitalization as the basis reduced by the excess of the fair market value of our long-term debt over its carrying value, as identified in our assessment of interest rate risk of the entity as a whole. The test showed no evidence of impairment to our goodwill and other indefinite lived assets for fiscal 2006 or 2005. We review our intangible assets and their related useful lives at least once a year to determine if any adverse conditions exist that would indicate the carrying value of these assets may not be recoverable. We conduct more frequent impairment assessments if certain conditions exist, including:  a change in the competitive landscape, any internal decisions to pursue new or different technology strategies, a loss of a significant customer, or a significant change in the market place including changes in the prices paid for our products or changes in the size of the market for our products. An impairment results if the carrying value of the asset exceeds the sum of the future undiscounted cash flows expected to result from the use and disposition of the asset. The amount of the impairment would be determined by comparing the carrying value to the fair value of the asset. Fair value is generally determined by calculating the present value of the estimated future cash flows using an appropriate discount rate. The projection of the future cash flows and the selection of a discount rate require significant management judgment. The key variables that management must estimate include sales volume, prices, inflation, product costs, capital expenditures and sales and marketing costs. For developed technology that has not been deployed we also must estimate the likelihood of both pursuing a particular strategy and the level of expected market adoption. During the third quarter, we recognized an impairment charge in research and development expenses of $3.8 million related to the excess of the carrying value over the fair market value of an intangible asset, related to platelet pathogen reduction technology. If the estimate of an intangible asset’s remaining useful life is changed, the remaining carrying amount of the intangible asset is amortized prospectively over the revised remaining useful life. Research and Development Expenses All research and development costs are expensed as incurred. Research and development expense was $26.5 million for fiscal year 2006, $20.0 million for fiscal year 2005 and $17.4 million for fiscal year 2004.  During fiscal years 2006 and 2005, we recognized impairment charges in research and development expenses of $3.8 million and $1.7 million, respectively,  due to the excess of the carrying value over the fair market value of intangible assets. Accounting for Shipping and Handling Costs Shipping and handling costs are included in costs of goods sold with the exception of $5.6 million for fiscal year 2006, $4.9 million for fiscal year 2005, and $5.1 million for fiscal year 2004 that are included in selling, general and administrative expenses. Income Taxes The income tax provision is calculated for all jurisdictions in which we operate. This process involves estimating actual current taxes due plus assessing temporary differences arising from differing treatment for tax and accounting purposes that are recorded as deferred tax assets and liabilities. Deferred tax assets are periodically evaluated to determine their recoverability and a valuation allowance is established with a corresponding additional income tax provision recorded in our consolidated statements of income if their recovery is not considered likely. The provision for income taxes could also be materially impacted if actual taxes due differ from our earlier estimates. As of April 1, 2006, a $0.4 million valuation allowance existed on our balance sheet. The total net deferred tax asset as of April 1, 2006 was $12.4 million. We file income tax returns in all jurisdictions in which we operate. We establish reserves to provide for additional income taxes that may be due in future years as these previously filed tax returns are audited. These reserves have been established based on management’s assessment as to the potential exposure attributable to permanent differences and interest applicable to both permanent and temporary differences. All tax reserves are analyzed periodically and adjustments are made as events occur that warrant modification. Foreign Currency We enter into forward exchange contracts to hedge the probable cash flows from forecasted inter company foreign currency denominated revenues, principally Japanese Yen and Euro. The purpose of our hedging strategy is to lock in foreign exchange rates for twelve months to minimize, for this period of time, the unforeseen impact on our results of operations of fluctuations in foreign exchange rates. We also enter into forward contracts that settle within 35 days to hedge certain inter-company receivables denominated in foreign currencies. These derivative financial instruments are not used for trading purposes. The forward exchange contracts are recorded at fair value and are included in other current assets or other current liabilities on our consolidated balance sheets. The gains or losses on the forward exchange contracts designated as hedges are recorded in net revenues on our consolidated statements of income when the underlying hedge transaction effects earning. The cash flows related to the gains and losses on these foreign currency hedges are classified in the consolidated statements of cash flows as part of cash flows from operating activities.  In the event the hedged forecasted transaction does not occur, or it becomes probable that it will not occur, the Company would reclassify the effective portion of any gain or loss on the related cash flow hedge from other comprehensive income to earnings at that time. The ineffective portion of a derivative’s change in fair value is recognized currently in other income, net on our consolidated statements of income. Accounting for Stock-Based Compensation We have adopted the disclosure only provisions for employee stock-based compensation under SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” and continue to account for employee stock-based compensation using the intrinsic value method under APB Opinion No. 25, “Accounting for Stock Issued to Employees.”  Under APB Opinion No. 25, no accounting recognition is given to options granted to employees and directors at fair market value until they are exercised. Upon exercise, net proceeds, including tax benefits realized, are credited to equity. Had compensation costs under our stock-based compensation plans been determined based on the fair value model of SFAS No. 123, as amended by SFAS No.148, the effect on our earnings per share would have been as follows:

April 1, 2006

April 2, 2005

April 3, 2004

(in thousands, except per share amounts)

Net income (as reported):

 

$

69,076

 

$

39,639

 

$

29,320

 

 

 

 

 

 

 

 

 

Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of tax

 

(5,974

)

(5,852

)

(5,602

)

Pro Forma Net Income:

 

$

63,102

 

$

33,787

 

$

23,718

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

 

 

 

 

 

As Reported

 

$

2.61

 

$

1.55

 

$

1.20

 

Pro forma

 

$

2.38

 

$

1.32

 

$

0.97

 

 

 

 

 

 

 

 

 

Diluted

 

 

 

 

 

 

 

As Reported

 

$

2.51

 

$

1.52

 

$

1.19

 

Pro forma

 

$

2.29

 

$

1.29

 

$

0.96

 

For purposes of the pro forma disclosure, any compensation cost on fixed awards with pro rata vesting is recognized on a straight-line basis over the award’s vesting period and the fair value of each option is estimated on the date of grant using the Black-Scholes single option-pricing model with the following weighted average assumptions:

April 1, 2006

April 2, 2005

April 3, 2004

Volatility

 

31.3

%

31.7

%

29.0

%

Risk-Free Interest Rate

 

4.1

%

4.2

%

3.6

%

Expected Life of Options

 

5 yrs.

 

7 yrs.

 

7 yrs.

 

The weighted average grant date fair value of options granted during 2006, 2005, and 2004 was approximately $14.82, $11.41, and $8.81, respectively. The fair values of shares purchased under the Employee Stock Purchase Plan are estimated using the Black-Scholes single option-pricing model with the following weighted average assumptions:  

April 1, 2006

April 2, 2005

April 3, 2004

Volatility

 

22.4

%

36.5

%

32.5

%

Risk-Free Interest Rate

 

4.0

%

1.7

%

1.3

%

Expected Life of Options

 

6 mos.

 

6 mos.

 

6 mos.

 

The weighted average grant date fair value of the six-month option inherent in the Purchase Plan was $9.97, $7.15, and $4.95 in fiscal year 2006, 2005, and 2004, respectively. Recent Accounting Pronouncements In May 2005, the FASB issued FASB Statement No.  154, “Accounting Changes and Error Corrections”, (“SFAS No. 154”) to replace APB Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements.”  SFAS No. 154 applies to the reporting of voluntary changes in accounting principles. APB Opinion No. 20 required that most voluntary changes in accounting principle be recognized by including the cumulative effect of the change in the current period in which the change is made. SFAS No. 154 requires that the effect of the change be reported retrospectively to prior periods unless it is impracticable to determine 1) the period by period effect of the change and/or 2) the cumulative effect of the change. When it is impracticable to determine the period by period effect of the change, the Statement requires that the effect of the change be applied to the balances of assets and liabilities in the earliest period for which retrospective application is practical and the offset be made to retained earnings or other appropriate equity account. In the case where it is impracticable to determine the cumulative effect of applying a change, the Statement requires that the new accounting principle be applied prospectively from the earliest practicable date. This statement is effective for our fiscal year 2007. On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004), “Share-Based Payment”, (“SFAS No. 123R”) which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”  SFAS No.123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statements based on their fair values. The disclosure only approach permitted by SFAS No. 123 and elected by us, is no longer an alternative effective for our fiscal year 2007 beginning on April 2, 2006. Alternative phase-in methods are allowed under Statement No. 123(R). The Company adopted Statement No. 123(R) on its effective date of April 2, 2006 using the “modified-prospective method.” Under this method, compensation cost is recognized (a) based on the requirements of Statement No. 123(R) for all share-based payments granted on or after April 2, 2006 and (b) based on the requirements of Statement No. 123 for all unvested awards that were granted to employees prior to January 1, 2006. The Company expects to apply the Black-Scholes valuation model in determining the fair value of share-based payments to employees, which will then be amortized on a straight-line basis. Accordingly, the adoption of SFAS No. 123R’s fair value method will have a negative impact on our results of operations, although it will have no material impact on our overall financial position. The impact of adoption of Statement No. 123(R) cannot be quantified at this time because it will depend on the level of share-based payments granted in the future, expected volatilities, lives and service periods, among other factors, present at the grant date. However, had Statement No. 123(R) been effective in prior periods, the impact of that standard would have approximated the impact of Statement No. 123 and net income and net income per share would have been reported at the amounts reported in the Accounting for Stock Based Compensation disclosure. 3.   OTHER INTANGIBLE ASSET ACQUISITIONS AND DISPOSITIONS Other Technology During the third quarter of fiscal year 2006, we amended our license arrangement with a private company to expand our exclusive, world wide field of use from the use of their technology in blood processing applications to the use of their technology in all healthcare applications. We paid $3.0 million for the expanded field of use. The license is classified as “Other Technology” in the table below and is assigned an estimated useful life of 10 years. In connection with the development of our next generation Donor apheresis platform, the Company capitalized $2.0 million in software development costs. All costs capitalized were incurred after a detailed design of the software was developed and research and development activities on the underlying device were completed. We will begin to amortize these costs in our fiscal year 2009 when the device is released for sale. Customer contracts and related relationships With the victory of our arbitration claim against Baxter International during the third quarter of fiscal 2006, we retired an intangible customer relationship asset that was satisfied in full as a result of the award. Total cost of this retired asset was $2.9 million and accumulated amortization was $0.9 million, for a net carrying value of $2.0 million prior to retirement. 4.   PRODUCT WARRANTIES We provide a warranty on parts and labor for one year after the sale and installation of each device. We also warrant our disposable products through their use or expiration. We estimate our potential warranty expense based on our historical warranty experience, and we periodically assess the adequacy of our warranty accrual and make adjustments as necessary.

April 1, 2006

April 2, 2005

Warranty accrual as of the beginning of the period

 

$

703

 

$

677

 

Warranty Provision

 

1,909

 

1,899

 

Warranty Spending

 

(1,936

)

(1,873

)

Warranty accrual as of the end of the period

 

$

676

 

$

703

 

5.   INVENTORIES, NET Inventories are stated at the lower of cost or market and include the cost of material, labor and manufacturing overhead. Cost is determined on the first-in, first-out basis. Inventories consist of the following:

April 1, 2006

April 2, 2005

(in thousands)

Raw materials

 

$

14,683

 

$

12,388

 

Work-in-process

 

5,528

 

6,067

 

Finished goods

 

34,360

 

34,633

 

 

 

$

54,571

 

$

53,088

 

6.   GOODWILL AND OTHER INTANGIBLE ASSETS The changes in the carrying amount of goodwill for fiscal year 2006, 2005, and 2004 are as follows (in thousands):

Carrying amount as of April 3, 2004

 

$

17,242

 

Earn-out payment

 

1,020

 

Effect of change in rates used for translation

 

(69

)

Carrying amount as of April 2, 2005

 

18,193

 

Earn-out payment

 

1,020

 

Effect of change in rates used for translation

 

(730

)

Carrying amount as of April 1, 2006

 

$

18,483

 

  Other Intangible Assets Other intangible assets include the value assigned to license rights and other technology, patents, customer contracts and relationships, software technology, and a trade name. The estimated useful lives for all of these intangible assets, excluding the trade name as it is considered to have an indefinite life, are 6 to 20 years. During fiscal year 2006, we recognized an impairment charge in research and development expenses of $3.8 million related to the excess of the carrying value over the fair market value of an intangible asset, related to platelet pathogen reduction technology. Fair market value was determined based on discounted cash flows analysis. The carrying value of the other technology was reduced to zero. The impairment was triggered by near term plans by most of the European market to adopt an alternate technology, bacterial detection. However, we will continue our development work related to platelet collection technology for the pathogen reduction market that may materialize longer term. Aggregate amortization expense for amortized other intangible assets for fiscal year 2006 is $6.1 million. Additionally, expected future amortization expenses on other intangible assets approximates $2.4 million per year for fiscal years 2007 through 2008, and $2.3 million per year for fiscal years 2009 through 2011. As of April 1, 2006

Gross Carrying Amount (in thousands)

Accumulated Amortization (in thousands)

Weighted Average Useful Life (in years)

Amortized Intangibles