<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
- --- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
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 1-11885
--------------
ALLEGIANCE CORPORATION.
----------------------
(Exact name of registrant as specified in its charter)
Delaware 36-4095179
------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1430 Waukegan Road, McGaw Park, Illinois 60085
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(847) 689-8410
-------------------------------
(Registrant's telephone number,
including area code)
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
--- ---
The number of shares of the registrant's Common Stock, $1 par value, outstanding
as of November 7, 1997, the latest practicable date, was 58,031,229 shares.
<PAGE>
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Allegiance Corporation
Condensed Consolidated Statements of Income (A) (Unaudited)
(in millions, except per share data)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $1,083.3 $1,094.2 $3,214.2 $3,295.3
Costs and expenses
Cost of goods sold 856.8 863.5 2,544.5 2,609.8
Selling, general and administrative expenses 163.5 161.1 486.3 502.4
Research & development 2.1 1.7 6.5 5.8
Goodwill amortization 5.5 9.3 16.2 27.7
Interest expense 15.9 - 52.2 -
Benefit curtailment gains - (35.9) - (35.9)
Other (income) expense 3.3 (3.6) 5.7 (5.4)
- ------------------------------------------------------------------------------------------------------------------------
Total costs and expenses 1,047.1 996.1 3,111.4 3,104.4
- ------------------------------------------------------------------------------------------------------------------------
Income before income taxes 36.2 98.1 102.8 190.9
Income tax expense 13.2 37.6 36.8 73.1
- ------------------------------------------------------------------------------------------------------------------------
Net income $ 23.0 $ 60.5 $ 66.0 $ 117.8
========================================================================================================================
Net income per common share $ 0.40 N/A $ 1.16 N/A
Average number of common shares outstanding 58.0 N/A 56.7 N/A
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(A) Financial information is presented on a historical basis. Pro forma results
are summarized in Note 3 to "Notes to Condensed Consolidated Financial
Statements."
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
3
Allegiance Corporation
Condensed Consolidated Balance Sheets
(in millions, except par value and shares)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
September 30, December 31,
1997 1996
--------------- ------------
(Unaudited)
<S> <C> <C> <C>
Current assets Cash and equivalents $ 20.4 $ 22.9
Accounts receivable (net of allowance for
doubtful accounts of $26.5 and $26.4 at
September 30, 1997 and December 31, 1996,
respectively) 481.1 515.1
Notes and other current receivables 14.8 32.4
Inventories 619.0 628.5
Deferred income taxes 113.8 122.8
Prepaid expenses 13.9 13.8
------------------------------------------------------------------------------------
Total current assets 1,263.0 1,335.5
------------------------------------------------------------------------------------
Property, At cost 1,531.4 1,519.1
plant and Accumulated depreciation and amortization (739.9) (681.2)
equipment ------------------------------------------------------------------------------------
Net property, plant and equipment 791.5 837.9
- -----------------------------------------------------------------------------------------------------------------------
Other assets Goodwill and other intangibles 550.2 514.5
Other 88.6 111.3
------------------------------------------------------------------------------------
Total other assets 638.8 625.8
- -----------------------------------------------------------------------------------------------------------------------
Total assets $2,693.3 $2,799.2
=======================================================================================================================
Current
liabilities Accounts payable and accrued liabilities $ 729.3 $ 698.1
- -----------------------------------------------------------------------------------------------------------------------
Long-term debt 873.8 1,106.6
- -----------------------------------------------------------------------------------------------------------------------
Deferred income taxes 106.3 107.4
- -----------------------------------------------------------------------------------------------------------------------
Other non-current liabilities 38.7 59.4
- -----------------------------------------------------------------------------------------------------------------------
Equity Common stock, par value $1.00, authorized
200,000,000 shares, outstanding 58,085,655
shares at September 30, 1997 and 54,977,000
at December 31, 1996 58.1 55.0
Additional contributed capital 68.1 1.5
Retained earnings 818.2 769.2
Cumulative foreign currency adjustment 0.8 2.0
------------------------------------------------------------------------------------
Total equity 945.2 827.7
- -----------------------------------------------------------------------------------------------------------------------
Total liabilities and equity $2,693.3 $2,799.2
=======================================================================================================================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
4
Allegiance Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in millions)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Nine months ended
September 30,
1997 1996
------- --------
(Brackets denote cash outflows)
<S> <C> <C> <C>
Cash flow provided Net income $ 66.0 $ 117.8
by operations Adjustments
Depreciation and amortization 94.7 112.4
Deferred income taxes 6.7 21.9
Benefit curtailment gains - (35.9)
Other 6.9 0.2
Changes in balance sheet items
Accounts and notes receivable 54.7 55.2
Inventories 10.8 39.6
Accounts payable and other current liabilities 54.5 (43.7)
Restructuring program payments (20.7) (30.3)
Other (11.6) (18.4)
-------------------------------------------------------------------------------------------
Cash flow provided by operations 262.0 218.8
- --------------------------------------------------------------------------------------------------------------------
Investment Capital expenditures (51.1) (55.5)
transactions Acquisitions (net of cash received) (55.1) (20.8)
Proceeds from asset dispositions 36.3 (12.8)
-------------------------------------------------------------------------------------------
Investment transactions, net (69.9) (89.1)
- --------------------------------------------------------------------------------------------------------------------
Financing Payments to Baxter International Inc. - (1,268.6)
transactions Decrease in debt with maturities of three
months or less, net (196.9) -
Issuances of debt 35.0 1,151.3
Redemption of debt (75.0) -
Common stock cash dividends (16.9) -
Common stock issued under Shared Investment Plan 54.8 -
Common stock issued under employee benefit plans 7.0 -
Purchase of treasury stock (2.6) -
-------------------------------------------------------------------------------------------
Financing transactions, net (194.6) (117.3)
- --------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and equivalents (2.5) 12.4
Cash and equivalents at beginning of period 22.9 0.8
- --------------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 20.4 $ 13.2
====================================================================================================================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
5
Allegiance Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Company background
- -- ------------------
Allegiance Corporation ("Allegiance" or the "company") was incorporated in
Delaware in June 1996. On September 30, 1996 (the "Distribution Date"), Baxter
International Inc. ("Baxter") and its subsidiaries transferred to Allegiance and
its subsidiaries the United States health-care distribution business, surgical
and respiratory therapy business and health-care cost management business, as
well as certain foreign operations (the "Allegiance Business") in connection
with a spin-off of the Allegiance Business by Baxter. The spin-off was effected
on the Distribution Date through a distribution of common stock of Allegiance to
Baxter stockholders (the "Distribution"). The Distribution of approximately 54.8
million shares of Allegiance stock, based on an exchange ratio of one for five,
was made to those who were Baxter stockholders on the record date of September
26, 1996. No historical earnings per share data is presented prior to October 1,
1996, as the Allegiance Business' earnings were part of Baxter's consolidated
results through the close of business on September 30, 1996.
2. Financial information
- -- ---------------------
The unaudited interim condensed consolidated financial statements of Allegiance
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. These interim
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
company's 1996 Annual Report to Stockholders and Annual Report on Form 10-K for
the year ended December 31, 1996.
In the opinion of management, the interim condensed consolidated financial
statements reflect all adjustments necessary for a fair presentation of the
interim periods. All such adjustments are of a normal, recurring nature. The
results of operations for the interim period are not necessarily indicative of
the results of operations to be expected for the full year.
<PAGE>
6
3. Pro forma financial information
- -----------------------------------
The following unaudited pro forma combined statements of income present the
combined results of Allegiance assuming that the transactions contemplated by
the Distribution had been completed as of January 1, 1996. The unaudited pro
forma information has been prepared utilizing the historical consolidated
financial statements of Allegiance. All pro forma adjustments were
substantially consistent with those disclosed in the company's 1996 Annual
Report to Stockholders and Annual Report on Form 10-K for the year ended
December 31, 1996 (in millions, except per share data).
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, 1996 September 30, 1996
------------------ ------------------
<S> <C> <C>
Net sales $1,092.8 $3,294.8
Costs and expenses
Cost of goods sold 864.5 2,612.1
Selling, general and administrative expenses 168.9 513.8
Research & development 1.7 5.8
Interest expense, net 22.5 67.5
Goodwill amortization 9.3 27.7
Other (income) expense (4.6) (5.4)
-------- --------
Total costs and expenses 1,062.3 3,221.5
-------- --------
Income before income taxes 30.5 73.3
Income tax expense 11.6 27.5
-------- --------
Net income $18.9 $45.8
======== ========
Net income per common share $0.34 $0.83
Average number of common
shares outstanding 54.9 54.9
======== ========
</TABLE>
4. Inventories
- ---------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
September 30, December 31,
(in millions) 1997 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 56.4 $ 52.8
Work in process 48.4 46.4
Finished products 514.2 529.3
- --------------------------------------------------------------------------------------------
Total inventories $619.0 $628.5
============================================================================================
</TABLE>
5. Restructuring charges
- -------------------------
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
Divestitures
Employee- and asset Other
(in millions) related costs write-downs costs Total
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1996 balance $24.0 $22.0 $ 20.1 $ 66.1
- -----------------------------------------------------------------------------------------------------------------
Utilization:
Cash (7.9) - (12.8) (20.7)
Non-cash - (2.4) - (2.4)
- -----------------------------------------------------------------------------------------------------------------
September 30, 1997 balance $16.1 $19.6 $ 7.3 $ 43.0
=================================================================================================================
</TABLE>
Cash outflows pertain primarily to employee-related costs for severance,
outplacement assistance, relocation, implementation teams and facility
consolidations. Since the inception of the restructuring program, approximately
2,500 positions have been eliminated. The remaining expenditures will occur
throughout 1997 and 1998, as implementation team projects and facility closures
and consolidations are completed as planned.
<PAGE>
7
6. Shared Investment Plan
- --------------------------
On May 2, 1997, the company received $54.8 million in cash from 141 members of
Allegiance's management who purchased approximately 2.4 million shares of the
company's stock. This plan was designed to directly align management and
stockholder interests. Under the terms of the voluntary program, Allegiance
managers used personal full-recourse loans to purchase the newly issued shares
at the closing price per share on May 2, 1997 of $23 1/4. The loans, borrowed
from several banks, are at market interest rates and are the personal
obligations of the participants. Allegiance has agreed to guarantee repayment
to the banks in the event of default by a participant. Allegiance may take all
actions necessary to obtain full reimbursement from the participant for amounts
paid by Allegiance, if any, to the banks in the future under its guarantee. The
participant break-even point - the future stock price that will cover both the
initial participant loans and the related interest over a five year period - is
$31 1/2.
7. Benefit curtailment gains
- -----------------------------
Prior to the Distribution, Allegiance participated in Baxter-sponsored non-
contributory, defined benefit pension plans covering substantially all domestic
employees as well as Baxter-sponsored contributory health-care and life
insurance benefits for substantially all domestic retired employees. Effective
on the Distribution Date, Allegiance did not replace these Baxter plans. The
pension liability related to Allegiance employees' service prior to the
Distribution Date remained with Baxter. Additionally, the post-retirement
liabilities for Allegiance employees that retired prior to the Distribution Date
also remained with Baxter. As a result, Allegiance recognized curtailment gains
of $35.9 million related to these plans as of September 30, 1996. Curtailment
gains have been excluded from Allegiance's pro forma financial information as
presented in Note 3.
8. Legal proceedings
- ---------------------
Upon the Distribution, Allegiance assumed the defense of litigation involving
claims related to the Allegiance Business, including certain claims of alleged
personal injuries as a result of exposure to natural rubber latex gloves
described below. Allegiance will be defending and indemnifying Baxter
Healthcare Corporation ("BHC"), as contemplated by the agreements between Baxter
and Allegiance, for all expenses and potential liabilities associated with
claims pertaining to this litigation. It is expected that Allegiance will be
named as a defendant in future litigation and may be added as a defendant in
existing litigation.
BHC was one of ten defendants named in a purported class action filed in August
1993, Kennedy, et al., v. Baxter Healthcare Corporation, et al., (Sup. Ct.,
Sacramento Co., Cal., #535632), on behalf of all medical and dental personnel in
the State of California who allegedly suffered allergic reactions to natural
rubber latex gloves and other protective equipment or who allegedly have been
exposed to natural rubber latex products. The case alleged that users of
various natural rubber latex products, including medical gloves made and sold by
BHC and other manufacturers, suffered allergic reactions to the products ranging
from skin irritation to systemic anaphylaxis. The Court granted defendants'
demurer to the class action allegations. On February 29, 1996, the California
Appellate Court upheld the trial court's ruling and the case was dismissed. On
April 8, 1994, a similar purported class action, Green, et al., v. Baxter
Healthcare Corporation, et al., (Cir. Ct., Milwaukee Co., WI, 94CV004977), was
filed against BHC and three other defendants. The class action allegations have
been withdrawn, but additional plaintiffs added individual claims. On July 1,
1996, BHC was served with a similar purported class action, Wolf v. Baxter
Healthcare Corp., et al., (Circuit Court, Wayne County, MI, 96-617844NP). BHC
was the only named defendant in that suit. On January 3, 1997, BHC was served
with a similar, nationwide proposed class action, Murray, et al., v. Baxter
Healthcare Corporation, et al., (U.S.D.C. Southern District of Indiana, IP96-
1889C). BHC and three other companies were named defendants. On April 11, 1997,
a similar proposed statewide class action, Delpit, et al. v. Ansell, Inc., et
al., (U.S.D.C. Eastern District of Louisiana, 97-1112), was filed on behalf of
users of latex
<PAGE>
8
gloves in the State of Louisiana. BHC and five other companies were named
defendants. On April 29, 1997, another similar proposed state-wide class action,
Cowart, et. al. v. Ansell, Inc., et. al., (Civil District Court, Parish of
Orleans, 97-7237), was filed on behalf of users of latex gloves. Baxter
International Inc. and three other companies were named defendants. On November
5, 1997, plaintiffs in the Wolf, Murray, Delpit and Cowart cases stipulated to
the dismissal of the class claims. On August 8, 1997, BHC was served with a writ
of summons in a case styled, Swartz v. Ach, Inc., et al., (Court of Common Pleas
of Jefferson County, Pennsylvania Civil Division, No.656-1997 C.D.) which
purports to be a similar class action directed against manufacturers,
distributors and sellers of natural rubber products. On October 9, 1996, the
plaintiff in a case pending in federal court filed a petition with the Judicial
Panel Multi District Litigation, In Re Latex Gloves Products Liability
Litigation, (MDL Docket No. 1148), seeking to transfer and consolidate the cases
involving claims related to natural rubber latex gloves pending in federal court
for pretrial proceedings and/or trial. On February 26, 1997, the Panel granted
the petition and ordered all cases pending in federal court to be transferred to
the Eastern District of Pennsylvania for coordinated or consolidated pretrial
proceedings. As of November 7, 1997, there are an additional 133 active lawsuits
involving BHC and/or the company containing similar allegations of sensitization
to natural rubber latex products. Allegiance intends to vigorously defend
against these actions. Since none of these cases has proceeded to a hearing on
the merits, Allegiance is unable to evaluate the extent of any potential
liability, and unable to estimate any potential loss.
Because of the increase in claims filed and the ongoing defense costs that will
be incurred, the company believes it is probable that Allegiance will incur
significant expenses related to the defense of cases involving natural rubber
latex gloves. During the fourth quarter of 1996, the company was able to
determine the minimum amount of the potential range of defense costs expected to
be incurred related to existing cases. Consequently, the company recorded a
charge of $19.5 million in the fourth quarter of 1996 to provide the minimum
amount of the potential range of legal defense costs.
Allegiance believes a substantial portion of any potential liability and
remaining defense costs related to natural rubber latex gloves cases and claims
will be covered by insurance, subject to self-insurance retentions, exclusions,
conditions, coverage gaps, policy limits and insurer solvency. In 1996, Baxter
notified its insurance companies that it believes these cases and claims are
covered by Baxter's insurance. Most of the insurers have reserved their rights
(i.e., neither admitted nor denied coverage), and may attempt to reserve in the
future, the right to deny coverage, in whole or in part, due to differing
theories regarding, among other things, the applicability of coverage and when
coverage may attach. Upon resolution of any of the uncertainties concerning
these cases, the company may incur charges in excess of presently established
reserves. It is not expected that the outcome of these matters will have a
material adverse effect on Allegiance's overall business, cash flow, results of
operations or financial condition.
Under the U.S. Superfund statute and many state laws, generators of hazardous
waste sent to a disposal or recycling site are liable for cleanup of the site if
contaminants from that property later leak into the environment. The law
provides that potentially responsible parties may be held jointly and severally
liable for the cost of investigating and remediating a site. This liability
applies to the generator even if the waste was handled by a contractor in full
compliance with the law.
As of September 30, 1997, BHC had been identified as a potentially responsible
party for cleanup costs at ten hazardous waste sites, for which Allegiance has
assumed responsibility. Allegiance's largest assumed exposure is at the Thermo-
Chem site in Muskegon, Michigan. Allegiance expects the total cleanup costs for
this site to be between $44.0 million and $65.0 million, of which Allegiance's
share would be approximately $5.4 million. This amount, net of payments of
approximately $1.4 million, has been accrued and is reflected in Allegiance's
consolidated financial statements. The estimated exposure for the remaining
nine sites is
<PAGE>
9
approximately $3.9 million, which has been accrued and reflected in Allegiance's
consolidated financial statements.
The company is a defendant in, or has assumed the defense of, a number of other
claims, investigations and lawsuits. Upon resolution of any of these
uncertainties, the company may incur charges in excess of presently established
reserves. Based on the advice of counsel, management does not believe the
outcome of these matters or the environmental matters, individually or in the
aggregate, will have a material adverse effect on Allegiance's overall business,
cash flow, results of operations or financial condition.
9. Subsequent Event
- --------------------
On November 6, 1997, Allegiance's board of directors authorized the company to
repurchase up to three million shares of the company's common stock. Allegiance
expects to begin repurchasing shares this year and to complete the systematic
buyback program in approximately two years. The stock will be added to
Allegiance's treasury shares and used in the administration of the company's
employee stock purchase plan and other benefit programs.
<PAGE>
10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The following management discussion and analysis describes material changes in
the company's financial condition since December 31, 1996. Trends of a material
nature are discussed to the extent known and considered relevant. This
discussion should be read in conjunction with the consolidated financial
statements, related notes thereto and management's discussion and analysis of
financial condition and results of operations included in the company's 1996
Annual Report to Stockholders and Annual Report on Form 10-K for the year ended
December 31, 1996.
Certain statements in this discussion constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Statements indicating the company "plans," "expects," "estimates" or "believes"
are forward-looking statements that involve known and unknown risks, including,
but not limited to, general economic and business conditions, changing trends in
the health-care industry and customer profiles, competition, changes in
governmental regulations, and unfavorable foreign currency fluctuations.
Although Allegiance believes its expectations with respect to the forward-
looking statements are based upon reasonable assumptions within the bounds of
its knowledge of its business and operations, there can be no assurance that
actual results, performance or achievements of Allegiance will not differ
materially from any future results, performance or achievements expressed or
implied by such forward-looking statements. In accordance with "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, Allegiance
provides cautionary statements, detailed in Securities and Exchange Commission
filings, including, without limitation, the company's Form 10-K and 10-Qs, which
identify specific factors that would cause actual results or events to differ
materially from those described in the forward-looking statements. The company
undertakes no obligation to update publicly any forward-looking statement
whether as a result of new information, future events or otherwise.
RESULTS OF OPERATIONS
Sales
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
(in millions, except percentages) 1997 1996 1997 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Geographic region
United States $1,013.9 $1,019.6 $3,011.9 $3,077.0
% decrease (0.6%) (2.1%)
International 69.4 74.6 202.3 218.3
% decrease (7.0%) (7.3%)
- ---------------------------------------------------------------------------------------------------------------
Total net sales $1,083.3 $1,094.2 $3,214.2 $3,295.3
% decrease (1.0%) (2.5%)
===============================================================================================================
Product category
Distributed product $ 673.0 $ 683.6 $2,028.6 $2,107.7
% decrease (1.6%) (3.8%)
Self-manufactured product 410.3 410.6 1,185.6 1,187.6
% decrease (0.1%) (0.2%)
- ---------------------------------------------------------------------------------------------------------------
Total net sales $1,083.3 $1,094.2 $3,214.2 $3,295.3
% decrease (1.0%) (2.5%)
===============================================================================================================
</TABLE>
The decline in Allegiance's domestic and distributed product net sales for the
three and nine months ended September 30, 1997 as compared to the same periods
in the prior year are principally the result of planned reductions in sales of
lower-margin, distributed products in the United States.
<PAGE>
11
International sales during the three and nine months ended September 30, 1997
as compared to the same periods in the prior year continued to be affected by
unfavorable foreign-exchange rates. In addition, the comparison to the prior
year continues to be unfavorably impacted by Allegiance's selling arrangements
in international markets. As part of Baxter, the company sold products directly
to customers. Subsequent to becoming an independent public company, Allegiance
sells products through Baxter as a distributor. Also contributing to the
decline were slower sales in the European markets as compared to the same
periods in the prior year.
Self-manufactured product sales during the three and nine months ended September
30, 1997 were relatively flat as compared to the same periods in the prior year.
Domestic growth in self-manufactured products was generally offset by sales
declines in international markets.
Costs and Expenses
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
(as a percentage of sales) 1997 1996 1997 1996
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross margin 20.9% 21.1% 20.8% 20.8%
Selling, general and administrative expenses 15.1 14.7 15.1 15.2
- ----------------------------------------------------------------------------------------------------------
</TABLE>
The company's gross margin remained relatively flat for the three and nine
months ended September 30, 1997 as compared to the same periods in the prior
year. Self-manufactured products continued to experience pricing pressure, which
the company has generally been able to offset with cost efficiencies and a more
profitable product mix. Allegiance plans to continue its efforts to stabilize
its gross margin by offsetting pricing pressures with manufacturing and other
cost efficiencies, managing its product mix more effectively, and, when
possible, instituting price increases.
Excluding the impact of a $6 million non-recurring reversal of the Company's
portion of an unearned incentive compensation program that was based on combined
results of Allegiance and Baxter businesses, selling, general and administrative
expenses as a percentage of sales would have been 15.3% for the three month
period ended September 30, 1996. Selling, general and administrative expenses
during the nine month period ended September 30, 1996 benefited from both the
non-recurring reversal of unearned compensation noted above and the non-
recurring reversal of $5.7 million of excess reserves. Excluding these items,
selling, general and administrative expenses as a percent of sales for the nine
months ended September 30, 1996, would have been 15.6%.
The reduction in selling, general and administrative expenses as a percent of
sales during the three and nine months ended September 30, 1997 as compared to
the 15.3% and 15.6%, respectively, in the same periods of the prior year,
resulted principally from lower headcount, lower benefit costs and overall
expense control initiatives implemented by management in both current and prior
periods. Management plans to continue to implement its expense reduction
initiatives.
<PAGE>
12
Goodwill
Goodwill expense for the three and nine months ended September 30, 1996 does
not reflect the quarterly benefit of $4.7 million of lower goodwill amortization
that resulted from the company's $550.0 million write-down of goodwill during
the fourth quarter of 1996.
Restructuring Program
In November 1993, Baxter initiated a restructuring program to improve
stockholder value and reduce costs. These strategic actions were designed in
part to make the Allegiance Business more efficient and responsive in addressing
the changes occurring in the U.S. health-care system. See Note 5 to "Notes to
the Condensed Consolidated Financial Statements" for discussions related to cash
and non-cash utilization of the reserves and headcount reductions to date.
Management believes that the program is on target to achieve anticipated savings
of approximately $155 million in 1997 and exceeding $155 million in 1998. The
company anticipates that these savings will continue to partially offset
potential future gross margin erosion and investments in cost-management
initiatives as well as stabilize selling, general and administrative expense
ratios. Management further believes that its remaining restructuring reserves
are adequate to complete the actions contemplated by the restructuring program
and that future cash expenditures related to the program will be funded from
cash generated from operations.
Benefit Curtailment Gains
Non-recurring gains associated with the curtailment of Baxter-sponsored non-
contributory, defined benefit pension plans amounted to $17.4 million, and the
curtailment of Baxter-sponsored contributory health-care and life-insurance
benefits amounted to $18.5 million as of September 30, 1996. Refer to Note 7 to
"Notes to Condensed Consolidated Financial Statements" for discussions of these
former plans.
Interest Expense
Prior to September 30, 1996, Allegiance participated in a centralized cash-
management program administered by Baxter. No interest was charged by Baxter.
Upon the spin-off, amounts were borrowed to fund a $1,147.3 million distribution
to Baxter and for working capital requirements.
Other Income and Expense
The company currently has foreign currency forward contracts that hedge a
portion of anticipated production costs expected to be denominated in foreign
currencies. Accounting rules require that the impact of forward hedging
contracts for anticipated costs be recorded in the current period. Other expense
for the third quarter of 1997 includes $8.2 million related to these foreign
currency hedging contacts.
Also included in other expense is $5.9 million of income associated with the
reversal of excess reserves related to a previously divested business. Certain
divestiture reserves were established for facility shutdowns associated with
this divested business. These shutdown programs, substantially completed during
the third quarter of 1997, were finalized in a more cost effective manner than
originally anticipated.
The remaining change in other income and expense for the three and nine months
ended September 30, 1997 as compared to the same periods in the prior year was
caused by unfavorable foreign exchange rates and losses related to certain
equity investments of the company.
<PAGE>
13
Pretax Income
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
(in millions, except percentages) 1997 1996 1997 1996
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Pretax income $ 36.2 $ 98.1 $102.8 $190.9
% decrease (63.1%) (46.1%)
Adjust for goodwill expense - 4.7 - 14.1
Adjust for interest expense 15.9 - 52.2 -
Adjust for benefit curtailment gains - (35.9) - (35.9)
Adjust for other non-recurring items - (6.0) - (11.7)
- -----------------------------------------------------------------------------------------------------
Adjusted pretax income $ 52.1 $ 60.9 $155.0 $157.4
% decrease (14.4%) (1.5%)
- -----------------------------------------------------------------------------------------------------
</TABLE>
Adjusted for the goodwill write-down, interest expense, the non-recurring gains
from curtailment of certain benefit plans, and the other non-recurring items in
selling, general and administrative expenses, all discussed previously, pretax
income decreased for the three and nine months ended September 30, 1997 as
compared to the same periods in the prior year. The decline in adjusted pretax
income for the three-month period was primarily the result of the change in
other income and expense discussed above. For the nine months ended September
30, 1997 as compared to the prior year, reductions in selling, general and
administrative expenses generally offset the change in other income and expense.
Income Taxes
Allegiance's effective tax rate during the three and nine months ended September
30, 1997 was lower than the same periods in the prior year by 1.9 and 2.5
percentage points, respectively. The decrease was caused principally by the
positive impact on earnings of lower goodwill amortization, which is a non-
taxable item.
Net Income
The change in net income during the three and nine months ended September 30,
1997 as compared to the same periods in the prior year is consistent with the
changes in pretax income and income taxes discussed previously.
ADOPTION OF NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB")has issued Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share". SFAS No.
128 requires presentation on the face of the income statement of both basic and
diluted earnings per share ("EPS"). SFAS No. 128 is effective for financial
statements issued for periods ending after December 15, 1997, and requires
restatement of all prior period EPS data presented. The adoption of this
statement is not expected to materially affect either future or prior period EPS
data.
In July 1996, the FASB Emerging Issues Task Force ("EITF") issued EITF No. 96-
14, "Accounting for the Costs Associated with Modifying Computer Software for
the Year 2000," in which it reached a consensus that external and internal costs
specifically associated with modifying internal-use software for the year 2000
should be charged to expense as incurred. The company does not expect the future
impact of this EITF to have a material impact on results of operations.
<PAGE>
14
LIQUIDITY AND CAPITAL RESOURCES
Allegiance's current assets exceeded current liabilities by $533.7 million at
September 30, 1997 versus an excess of $637.4 million at December 31, 1996. This
decrease in working capital resulted from management's focused efforts to reduce
debt levels. Current assets at September 30, 1997 included accounts, notes and
other current receivables of $495.9 million and inventories of $619.0 million.
These sources of liquidity are convertible into cash over a relatively short
period of time and, thus, could be available to help Allegiance satisfy normal
operating cash requirements.
The company intends to fund its short- and long-term obligations as they mature
through cash flow from operations, existing credit facilities or issuance of
debt or equity. Management believes the company has credit facilities adequate
to support ongoing operational, capital, restructuring and litigation
requirements. Beyond that, Allegiance believes it has sufficient financial
flexibility to attract long-term capital on acceptable terms as may be needed to
support its growth objectives.
Cash Flow
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
Nine months ended
September 30,
(brackets denote cash outflows, in millions) 1997 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flow provided by operations as stated in the
company's Condensed Consolidated Statements
of Cash Flows $262.0 $218.8
Capital expenditures (51.1) (55.5)
Common stock cash dividends (16.9) -
- -------------------------------------------------------------------------------------------------
"Free cash flow" $194.0 $163.3
=================================================================================================
</TABLE>
This increase in cash flow provided by operations during 1997 resulted primarily
from improved balance sheet management (primarily accounts and notes
receivable), partially offset by the unadjusted decrease in net income discussed
previously.
Management emphasizes "free cash flow" as an internal measure of operating cash
flow after capital expenditures and dividends as reconciled in the table above.
Management's objective is to maximize "free cash flow", and incentive
compensation programs throughout the company include emphasis on management of
working capital and "free cash flow" targets. The "free cash flow" generated
during the nine months ended September 30, 1997 enabled the company to pay down
$236.9 million of long-term debt and funded $51.1 million in acquisitions.
<PAGE>
15
Investment Transactions
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Nine months ended
September 30,
(brackets denote cash outflows, in millions) 1997 1996
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Capital expenditures $(51.1) $(55.5)
Acquisitions (55.1) (20.8)
Proceeds from asset dispositions 36.3 (12.8)
- --------------------------------------------------------------------------------------------------
Total investment transactions, net $(69.9) $(89.1)
==================================================================================================
</TABLE>
Capital expenditure levels during the nine months ended September 30, 1997 as
compared to the same period in 1996 are relatively consistent. Allegiance
management expects to invest in capital expenditures throughout 1997 at levels
consistent with 1996, principally for improvements to existing facilities,
system upgrades, productivity-enhancing equipment and other cost reduction
projects.
Consistent with Allegiance's strategic direction of providing cost-management
services, Allegiance acquired West Hudson & Co. Inc., a privately-owned health-
care consulting firm, on January 2, 1997 for $30.5 million in cash and $10.5
million in stock, with contingent payments to be paid over the next four years.
The remaining acquisitions during the nine months ended September 30, 1997, as
well as the acquisitions during the same period in 1996, are consistent with
Allegiance's strategic direction, and were made to broaden product lines and
service offerings or expand market coverage.
In April 1997, Allegiance sold substantially all of its investment in
MedManagement, L.L.C., which generated net proceeds of approximately $17.2
million. The remaining proceeds from asset dispositions during the nine months
ended September 30, 1997 related to the sale of miscellaneous facilities of
$17.6 million and divestitures of minor investments not consistent with
Allegiance's strategic direction. The net use of cash related to asset
dispositions for the nine months ended September 30, 1996 primarily related to
cash payments associated with the settlement of certain programs arising from
the divestitures of the Industrial and Life Sciences division and the
diagnostics manufacturing businesses.
Refer to Notes 6 and 9 to "Notes to Condensed Consolidated Financial Statements"
for a discussion of the $54.8 million in cash received in May 1997 relating to
the Shared Investment Plan and the stock repurchase program authorized by the
company's board of directors on November 6, 1997, respectively.
LITIGATION
See Note 8 to "Notes to Condensed Consolidated Financial Statements" for a
detailed description of the status of Allegiance's litigation.
Under the U.S. Superfund statute and many state laws, generators of hazardous
waste sent to a disposal or recycling site are liable for cleanup of the site if
contaminants from that property later leak into the environment. The law
provides that potentially responsible parties may be held jointly and severally
liable for the cost of investigating and remediating a site. This liability
applies to the generator even if the waste was handled by a contractor in full
compliance with the law.
As of September 30, 1997, Baxter Healthcare Corporation had been identified as a
potentially responsible party for cleanup costs at ten hazardous waste sites,
for which Allegiance has assumed responsibility. Allegiance's largest assumed
exposure is at the Thermo-Chem site in Muskegon, Michigan. Allegiance expects
the total cleanup costs for this site to be between
<PAGE>
16
$44.0 million and $65.0 million, of which Allegiance's share would be
approximately $5.4 million. This amount, net of payments of approximately $1.4
million, has been accrued and is reflected in Allegiance's consolidated
financial statements. The estimated exposure for the remaining nine sites is
approximately $3.9 million, which has been accrued and reflected in Allegiance's
consolidated financial statements.
The company is a defendant in, or has assumed the defense of, a number of other
claims, investigations and lawsuits. Upon resolution of any of the uncertainties
described in Note 8 to "Notes to Condensed Consolidated Financial Statements",
Allegiance may incur charges in excess of presently established reserves. Based
on the advice of counsel, management does not believe the outcome of these
matters individually or in the aggregate, will have a material adverse effect on
Allegiance's overall business, cash flow, results of operations or financial
condition.
<PAGE>
17
PART II. OTHER INFORMATION
Allegiance Corporation
Item 1. Legal Proceedings
Note 8 to "Notes to Condensed Consolidated Financial Statements" (Part I, Item I
of this Report) and "Litigation" set forth in Management's Discussion and
Analysis of Financial Condition and Results of Operations (Part I, Item 2 of
this Report) are incorporated herein by reference.
Item 5. Other Information
On November 6, 1997, the board of directors of the company approved a systematic
stock repurchase program to repurchase up to three million shares of common
stock to be used for employee benefit programs.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit
index hereto.
(b) Report on Form 8-K
Not applicable.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGIANCE CORPORATION
--------------------------
(Registrant)
Date: November 12, 1997 By:
----------------------------
Peter B. McKee
Senior Vice President and
Chief Financial Officer
<PAGE>
18
Exhibits Filed with Securities and Exchange Commission
<TABLE>
<CAPTION>
Number Description of Exhibit
- ------ ----------------------
<C> <S>
11.1 Statement re computation of primary
earnings per common share.
11.2 Statement re computation of fully diluted
earnings per common share.
27 Financial Data Schedule. *
</TABLE>
99 Press release regarding stock repurchase program.
(All other exhibits are inapplicable.)
* Shown only in the original filed with the Securities and Exchange Commission.
- --------------------------------------------------------------------------------
Copies of the above exhibits not contained herein are available at a charge of
35 cents per page upon written request to the Investor Relations Department,
Allegiance Corporation, 1430 Waukegan Road, McGaw Park, IL 60085. Copies are
also available from the Public Reference Section of the Securities and Exchange
Commission (the "Commission"), 450 Fifth Street N.W., Washington, D.C., 20549
upon payment of certain fees prescribed by the Commission. The Commission also
maintains a World Wide Web site that contains reports, proxy and other
information regarding the company. The address of the web site is
http://www.sec.gov.
<PAGE>
19
EXHIBIT 11.1
COMPUTATION OF PRIMARY EARNINGS PER COMMON SHARE
(in millions, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1997 1997
---------------------- ---------------------
<S> <C> <C>
Historical Computation/(1)/
Net income available for common stock $23.0 $66.0
Average number of common shares outstanding 58.0 56.7
Primary net income per common share $0.40 $1.16
===== =====
</TABLE>
- -----------
/(1)/ Historical computation of primary earnings per common share for the three
and nine months ended September 30, 1996 is not considered meaningful as
Allegiance was not a public company during such historical periods.
<PAGE>
20
EXHIBIT 11.2
COMPUTATION OF FULLY DILUTED EARNINGS PER COMMON SHARE
(in millions, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1997 1997
------------------ ------------------
<S> <C> <C>
Historical Computation/(1)/
Net income available for common stock $23.0 $66.0
Average number of common
shares outstanding 58.0 56.7
Additional shares assuming conversion or
exercise of stock options and stock
purchase plan subscriptions 1.7 1.7
----- -----
Average common shares outstanding 59.7 58.4
Fully diluted net income per common share $0.39 $1.13
===== =====
</TABLE>
- ------------
(1) Historical computation of fully diluted earnings per common share for the
three and nine months ended September, 1996 is not considered meaningful as
Allegiance was not a public company during such historical periods.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from the
Condensed Consolidated Balance Sheet as of September 30, 1997 and Condensed
Consolidated Statement of Income for the nine months ended September 30, 1997
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 20
<SECURITIES> 0
<RECEIVABLES> 508<F1>
<ALLOWANCES> 27
<INVENTORY> 619
<CURRENT-ASSETS> 1,263
<PP&E> 1,531
<DEPRECIATION> 740
<TOTAL-ASSETS> 2,693
<CURRENT-LIABILITIES> 729
<BONDS> 874
0
0
<COMMON> 58
<OTHER-SE> 887
<TOTAL-LIABILITY-AND-EQUITY> 2,693
<SALES> 3,214
<TOTAL-REVENUES> 3,214
<CGS> 2,544
<TOTAL-COSTS> 3,111
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 52
<INCOME-PRETAX> 103
<INCOME-TAX> 37
<INCOME-CONTINUING> 66
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 66
<EPS-PRIMARY> 1.16
<EPS-DILUTED> 0<F2>
<FN>
<F1> Gross
<F2> Information not applicable
</FN>
</TABLE>
<PAGE>
Exhibit 99
ALLEGIANCE BOARD AUTHORIZES SHARE REPURCHASE
McGAW PARK, Ill., November 6, 1997 -- Allegiance Corporation (NYSE: AEH)
announced today that its board of directors has authorized the company to
repurchase up to 3 million shares of Allegiance common stock, or approximately 5
percent of the company's 58 million outstanding shares. The board also declared
the company's fifth consecutive regular quarterly divided.
Allegiance expects to begin repurchasing shares this year and to complete
the systematic buyback program in approximately two years.
"This program reflects our confidence in Allegiance's strategy and
performance," said Lester B. Knight, chairman and chief executive officer.
"We're able to undertake a program like this because of the exceptionally strong
free cash flow we've generated since the company became independent last year."
Last week, Allegiance announced it had generated $194 million of free cash flow
(cash flow after dividends and capital expenditures) in the first nine months of
1997, nearly twice the company's goal for the full year.
Allegiance said it will use free cash flow to repurchase the stock on the
open market or through privately negotiated transactions. The stock will be
added to Allegiance's treasury shares and used in the administration of the
company's employee-stock-purchase plan and other benefit programs.
"We will manage the repurchase program consistent with our goal of
maintaining Allegiance's strong investment-grade rating," Knight said.
Allegiance Corporation 1430 Waukegan Road McGaw Park, Illinois 60085-6787
