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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[_]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER: 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 60085
MCGAW PARK, ILLINOIS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
Registrant's telephone number, including area code: (847) 689-8410
Securities registered pursuant to Section 12(b) of the Act:
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<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
<S> <C>
Common Stock, $1.00 par value New York Stock Exchange
Chicago Stock Exchange
Series A Junior Participating Preferred Stock New York Stock Exchange
Purchase Rights (currently traded with Common Chicago Stock Exchange
Stock)
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Securities registered pursuant to Section 12(g) of the Act: NONE
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 ((S)229.405 of this chapter) 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. [X]
The registrant estimates that the aggregate market value of the registrant's
Common Stock held by non-affiliates of the registrant (based on the per share
closing sale price of $25.375 on March 6, 1997, and for the purpose of this
computation only, the assumption that all registrant's directors and executive
officers are affiliates) was approximately $1.4 billion. Determination of
stock ownership by non-affiliates was made solely for the purpose of
responding to this requirement and registrant is not bound by this
determination for any other purpose.
As of March 6, 1997, 55,403,778 shares of the registrant's Common Stock were
outstanding.
The following documents are incorporated into this Form 10-K by reference:
Annual Report to Stockholders for fiscal year ended December 31, 1996
(Part II).
Proxy Statement for Annual Meeting of Stockholders to be held on May 15,
1997 (Part III).
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PART I
ITEM 1. BUSINESS
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"). Unless the context
otherwise indicates, as used in this Report, the terms "Allegiance" and the
"Company" mean the Allegiance Business of Baxter for periods prior to the
Distribution Date and Allegiance Corporation and its consolidated subsidiaries
for the periods following the Distribution Date, and all references to
"Baxter" include Baxter International Inc. and its consolidated subsidiaries
as of the relevant date.
OVERVIEW
Allegiance is America's largest provider of health-care products and cost-
management services for hospitals and other health-care providers. These
integrated businesses recorded total sales of approximately $4.4 billion in
1996.
The economics of health care are undergoing rapid and fundamental change,
particularly in the United States, which is Allegiance's largest current
market. In the past, doctors and nurses were paid for their services with few
cost constraints. Today, large employers, insurance companies and HMOs are
negotiating set fees for patient care. For United States hospitals and health
systems, Allegiance's main customers, the pressure to reduce costs has never
been greater. At the same time, demand for health services is continuing to
climb with the dramatic growth of aging populations in the United States and
abroad. This environment offers opportunities for Allegiance, which has
invested in integrated product and service programs that help medical
professionals cope with health care's new economics and demographic trends.
The health-care distribution market in the United States has experienced
intense competition and a resultant erosion in its margins in recent years in
response to the growth of managed care and increased consolidation among
health-care providers. Allegiance has responded by integrating its market-
leading distribution capabilities with a broad product offering, high levels
of customer service, and innovative cost-management services.
DISTRIBUTION SERVICES
Allegiance is a leading distributor of medical and laboratory products in
the United States. Allegiance can supply any of more than 200,000 different
products to its customers. Most items are available for shipment the same day
the customer requests them. Allegiance has 60 United States distribution
centers that deliver products to locations across the United States every day.
Each order can be tracked electronically. Allegiance has made substantial
investments in information systems to enhance its operations and improve
customer service. In addition to its own surgical and respiratory therapy
products, Allegiance distributes an array of products from more than 2,000
manufacturers to a wide variety of health-care settings. Products range from
full lines of laboratory equipment and operating room supplies to children's
gift packs with coloring books and crayons.
Allegiance divides its distributed products into two categories:
medical/surgical products ("med/surg") and laboratory products. It is the
industry leader in both product categories. Allegiance's med/surg portfolio
comprises a broad array of products, including sutures, endoscopy instruments,
needles and syringes, wound-care products, electrodes, face masks, bed pans,
wash basins, blood-pressure cuffs, stethoscopes, waste-disposal bags, and
others. Increasingly, these products are being delivered just-in-time in
ready-to-use quantities. In some cases, Allegiance delivers the products
directly to patient floors. Allegiance distributes products not only to
hospitals, but increasingly to surgery centers, physician clinics,
distributors, long-term and sub-acute care facilities,
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home-care companies, and other health-care providers. Laboratory products--
used primarily to perform diagnostic tests--are sold principally to medical
laboratories and other health-care providers. These products include test
tubes, pipettes, slides, and equipment such as microscopes, centrifuges, and
scales.
The ValueLink(R) Service
Allegiance's ValueLink(R) "stockless" inventory service provides just-in-
time deliveries of products in small, ready-to-use quantities to hospitals and
health-care networks, primarily in metropolitan areas. Allegiance was the
first to bring just-in-time distribution to the health-care industry and it
remains the leader.
The ValueLink(R) service helps hospitals reduce inventory levels and
operating expenses. Orders from hospitals are transmitted electronically and
products are delivered several times a day, sometimes directly to patient
floors. In some ValueLink(R) accounts, Allegiance personnel work at the
hospital 24 hours a day, stocking shelves as needed.
Through the ValueLink(R) service, Allegiance also delivers labor-saving,
made-to-order packages containing virtually every sterile and non-sterile
product needed to perform dozens of medical procedures, from open-heart bypass
surgery to a hernia repair.
Strategic Supplier Relationships
In 1995, Allegiance began consolidating its distribution service around a
carefully selected group of preferred suppliers seeking to reduce the number
of suppliers that furnish identical items. This "best-value" products strategy
is designed to strengthen Allegiance's relationships with fewer preferred
suppliers, resulting in savings to Allegiance and better service to its
customers. Allegiance is also continuing to streamline its distribution
network to reduce costs, improve service, and strengthen the growing number of
cost-management relationships with health-care providers and systems.
Supply-Chain Management
Supply-chain management requires precise knowledge and planning of customer
demand. Given Allegiance's size and scope, advanced information systems, and
balance of self-manufactured and externally supplied products, Allegiance is
well-positioned to maximize service to customers and minimize inventory levels
and variability. To accelerate this process, Allegiance has made and continues
to make major investments in information technology that uses EDI, or
electronic data interchange, to exchange purchasing and inventory data with
many of its suppliers and largest customers. Management believes this
integrated distribution and product offering strengthens Allegiance's
financial and competitive position. In 1995, Allegiance opened a National Drop
Ship Center in McGaw Park, Illinois, from which it distributes less frequently
ordered items. By consolidating such products in one facility, the amount of
regional inventory variability has decreased and Allegiance has achieved lower
system-wide inventory levels.
Serving Health Care Outside Hospitals
Health care increasingly is being delivered outside hospitals as health-care
providers integrate into regional networks. Many procedures previously
performed in hospital operating rooms are now performed in surgery centers,
and some procedures that had been performed in surgery centers are now taking
place in physician clinics. To reach these and other alternate-site
customers--surgery centers, physician clinics, sub-acute and long-term care
facilities, and home-care providers--Allegiance has developed the capability
to deliver smaller orders more frequently. Allegiance is also entering into
relationships with dealers that specialize in serving these fast-growing
markets. For some very small, or geographically remote customers, Allegiance
provides service through its Network Sales organization. This sales and
customer-service unit conducts business via the telephone, distributing in
some cases by commercial carrier.
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PRODUCT OFFERING
Allegiance has differentiated itself by integrating its product offering
with its distribution and cost-management services. Allegiance offers the
industry's broadest range of medical and laboratory products, representing
more than 2,000 suppliers in addition to its own line of surgical and
respiratory therapy products.
Increasingly, Allegiance is working with health professionals to reduce the
variety and number of products they buy under agreements that provide
incentives for Allegiance to help customers save money. In return, customers
purchase a greater portion of their supplies from Allegiance. Allegiance
custom-assembles products into procedure-based modules. Allegiance's
distribution system delivers the customized packages as they are needed.
Allegiance operates 22 manufacturing plants, producing products used in
surgery and other medical procedures. All Allegiance plants are ISO 9000
certified.
Allegiance has several major product lines, most of which hold leading sales
positions:
Custom-Sterile(TM) Products and the PBDS(TM) Service
Allegiance's leading Custom-Sterile(TM) products and Procedure Based
Delivery System(TM) (PBDS(TM)) service help health-care providers save time
and money by assembling customer-designated supplies into single packages for
specific procedures. Custom-Sterile(TM) packs contain sterile, disposable
supplies made by Allegiance and other manufacturers. They are used to perform
dozens of procedures, from open-heart surgery and childbirth to treating cuts
and bruises. Customers can select items for these packs from a database of
approximately 30,000 products from nearly 800 manufacturers. PBDS(TM) modules
contain Custom-Sterile(TM) packs along with non-sterile supplies.
Convertors(R) Products
The Convertors(R) product line is a leading brand of single-use surgical
drapes, gowns, and apparel. These products provide barrier protection for
patients, doctors, and clinical staff during surgery, childbirth, and other
procedures. Many of Allegiance's Convertors(R) products are included in Custom
Sterile(TM) packs. Convertors(R) also provides clean-room apparel and
equipment covers for industrial manufacturers.
Gloves
Allegiance is the world's largest manufacturer and marketer of medical
gloves. Allegiance produces natural rubber latex surgical and exam gloves in
Malaysia, as well as in the United States. Allegiance also manufactures vinyl
exam gloves in the United States.
Medi-Vac(R) Products
Allegiance is the world's leading producer of fluid suction and collection
systems. The Medi-Vac(R) line consists of disposable suction canisters and
liners, suction tubing, and supporting hardware and accessories. These
products are used in the operating room to remove fluids and debris from the
body during surgery. Outside the operating room, the products are used when
fluid must be removed from a patient. The Medi-Vac(R) product line also
includes wound-drainage tubing and reservoirs used to remove fluid from closed
wounds to prevent infection and promote healing. Medi-Vac(R) autotransfusion
systems collect blood for reinfusion to the patient after filtration, allowing
patients to receive their own blood instead of transfusions from donors.
Respiratory Therapy Products
Allegiance is a leading manufacturer of respiratory therapy products, which
are used primarily to deliver oxygen to patients suffering from respiratory
distress. This product line includes ventilator circuits (tubing used to
connect patients to ventilator machines), oxygen masks, cannulae, and suction
catheters used to clear the trachea.
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V. Mueller
Allegiance's V. Mueller product line comprises a broad range of stainless-
steel surgical instruments and related products and services. The business was
established in 1895 and is known worldwide for the quality of its instruments.
Allegiance's V. Mueller division manufactures about a third of its product
line; other products are sourced from contract manufacturers. V. Mueller
products include clamps, needle-holders, retractors, specialty scissors, and
forceps. The business unit also manufactures and markets the cost-saving
Genesis(TM) container system--complete instrument sets, assembled to order,
sterilized and ready for use in reusable metal containers.
Special Procedure Products
Allegiance provides specialty biopsy needles for extracting samples of bone
marrow and soft tissue, and a variety of specialty procedure trays. These
include lumbar puncture trays, for measuring pressure and taking samples of
cerebrospinal fluid; thoracentesis trays, for withdrawing fluid from chest or
abdominal cavities, or from joints or cysts; amniocentesis trays, for
obtaining amniotic fluid to assess the condition of fetuses; and other
diagnostic trays and products used by obstetricians and gynecologists.
Other Products
Allegiance manufactures and markets a range of other leading products. It is
the world's largest producer of natural rubber latex urinary drainage
catheters, and it manufactures endotracheal tubes for respiration, anesthesia,
and other therapies. Allegiance produces a broad line of hot and cold packs
used to provide localized temperature therapy for orthopedic injuries and for
patients recovering from childbirth and surgical procedures. It also
manufactures and markets a broad line of patient-preparation, hair-removal,
and skin-care products such as clippers, razors, and basins, as well as
special soaps, sponges, and scrub brushes for surgeons and other operating
room personnel.
COST-MANAGEMENT SERVICES
Reducing costs while improving quality of care is the most significant
challenge facing health-care providers today. Through its shared-risk/shared-
savings programs, Allegiance aligns its goals with those of its customers.
Under these agreements, which Allegiance introduced to the health-care
industry in late 1994, Allegiance and its customers agree to share the savings
if supply and related costs fall below an agreed upon target, or share the
overage if these costs exceed the target. As of December 31, 1996, Allegiance
had 26 shared-risk/shared-savings agreements with individual hospitals or
hospital systems. Alternatively, these shared-risk/shared-savings agreements
covered 58 250-bed equivalent facilities in 1996. In shared-risk/shared-
savings accounts, Allegiance assigns a clinical project manager to work with a
hospital's clinical staff to identify supply usage patterns, reduce variation
by standardizing procedures and products, and eliminate unnecessary supplies.
Product standardization involves the selection and use of one preferred brand
from many options. Savings are realized from selecting the "best-value"
product, cost efficiencies from increased volume for the selected brand and
dealing with fewer vendors. Procedure standardization involves helping
clinical staff reach consensus on what supplies should be used in a given
procedure, then packaging and distributing the products. A typical assignment
for a clinical project manager lasts 24 months. Hospitals ultimately buy fewer
supplies, but a greater total portion of their supplies come from Allegiance.
Sales of Allegiance's surgical products, for example, have grown in these
accounts, while the hospitals' total supply costs have decreased. To the
extent that savings do not materialize from these efforts, Allegiance is
obligated to reimburse the customer for a portion of the shortfall.
Much of the savings generated in these cost-management accounts come from
the implementation of PBDS(TM) modules, which contain Allegiance's self-
manufactured products, "best-value" products from preferred suppliers, and
other third-party distributed products. These modules reduce hospital labor,
purchasing, and other product and product-management costs. Rather than
ordering products separately for a procedure, customers can order a single
catalog number. Rather than nurses having to locate and assemble individual
products for a procedure, the products arrive in one package. Additional
savings are achieved when PBDS(TM) modules are delivered just-in-time, direct
to the point of use through Allegiance's ValueLink(R) service.
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In addition, Allegiance offers customers professional consulting services,
including modules derived from Allegiance's proprietary database of "best-
demonstrated practices," to help hospitals improve their clinical operations,
reduce lengths of stay and improve clinical outcomes. Allegiance also offers,
through its ACCESS(TM) program, the expertise and services of leaders in other
industries such as waste management, asset management, real estate and
facility management, and forms and information management.
Each of Allegiance's manufacturing units also offers programs to help
customers control costs. There are programs to help health-care providers
standardize and select the most cost-effective drapes, gowns, gloves, and
other products for various procedures; identify the most cost-effective mix of
products to include in custom procedure kits; sterilize, repair, and refurbish
surgical instruments; and process reusable laundry, linen, and textiles. The
Right Choice(TM) glove-management program, for example, helps health-care
providers select the most cost-effective glove for various procedures while
ensuring appropriate patient care and worker safety.
On January 2, 1997, Allegiance acquired West Hudson & Co. Inc., a privately-
owned health-care consulting firm with 1996 annual sales of $38.1 million.
Allegiance paid approximately $30.5 million in cash and $10.5 million in stock
with contingent payments to be paid over the next four years. This acquisition
is consistent with Allegiance's strategic direction of providing cost-
management services.
CONTRACTUAL ARRANGEMENTS; BUYING GROUPS
A substantial portion of Allegiance's products are sold through contracts
with purchasers. Some of these contracts have terms of more than one year and
include limits on price increases. In the case of hospitals, clinical
laboratories, and other facilities, these contracts may provide the customer
with incentives to purchase particular products or categories of products.
Some of these contracts are entered into with hospital buying groups seeking
to achieve economies of scale in consolidating multiple hospitals' purchases
from Allegiance.
For the last three years, sales to customers who are members of two large
hospital buying groups, Premier, Inc. ("Premier") and VHA Inc. ("VHA"), as a
percentage of total sales, were 27 percent and 20 percent, respectively in
1996, 27 percent and 16 percent, respectively in 1995, and 23 percent and 13
percent, respectively in 1994. Premier and VHA each comprise a group of
health-care organizations that benefit from the pricing and other benefits
available to members of the group. Certain members of each group are free to
purchase from the vendors of their choice. Although the loss of the
relationship with either group could have a significant impact on sales to
members of the group, the loss of such group would not necessarily mean the
loss of all sales from all members of such group. No other buying group or
single customer currently accounts for more than 10 percent of Allegiance's
revenue.
SALES AND MARKETING
Allegiance conducts its selling efforts through its subsidiaries. These
subsidiaries have their own sales forces and direct their own sales efforts.
In the United States, Allegiance uses a "team selling" approach with many of
its hospitals, health systems, and multi-hospital group customers. This
approach relies on an account manager to coordinate the various Allegiance
Businesses' sales efforts. The account manager is responsible for all sales
and service contacts with a given customer, acting as a focal point, and
assembling cross-functional teams as needed to meet that customer's needs.
Allegiance manages its field sales and service organization on a regional
basis. The regional sales organizations are designed to develop strong
strategic relationships with customers. In addition, sales are made to
independent distributors, dealers, and sales agents. Outside of the United
States, Allegiance products are primarily distributed through Baxter.
RAW MATERIALS SUPPLIERS
Raw materials essential to Allegiance's business are purchased worldwide in
the ordinary course of business from numerous suppliers. The vast majority of
these materials are generally available, and no serious shortages
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or delays have been encountered. Certain raw materials used in producing some
of Allegiance's products, including its natural rubber latex products, are
available only from a small number of suppliers. In some of these situations,
Allegiance has long-term supply contracts with its suppliers, although it does
not consider its obligations under such contracts to be material. Allegiance
does not always recover cost increases through customer pricing due to
contractual limits and market pressure on such price increases.
PATENTS AND TRADEMARKS
Allegiance does not consider any one or more of the patents and trademarks it
holds or the licenses granted to or by it with respect to any patent or
trademark to be essential to its businesses.
COMPETITION
Allegiance has substantial competition in all of its markets. The changing
health-care environment in recent years has led to increasingly intense
competition among health-care suppliers. Competition is focused on price,
service, and product performance. Pressure in these areas is expected to
continue.
The future financial success of health-care product and service companies,
such as Allegiance, will depend on their ability to work with customers to help
them provide quality care while enhancing their competitiveness through cost-
management initiatives. Management believes it can help its customers achieve
savings by automating supply-ordering procedures; optimizing distribution
networks; improving utilization, materials management and labor productivity;
achieving economies through product and procedure standardization; and
performing certain non-clinical services on an outsourced basis. Allegiance
further believes its strategy of providing unmatched service to its health-care
customers and achieving the best overall cost in the delivery of health-care
products and services is compatible with any anticipated realignment of the
U.S. health-care system that may ultimately occur.
QUALITY CONTROL
Allegiance places great emphasis on providing quality products and services
to its customers. An integrated network of quality systems, including control
procedures that are developed and implemented by technically trained
professionals, result in rigid specifications for raw materials, packaging
materials, labels, sterilization procedures, and overall process control. The
quality systems integrate the efforts of raw material and finished goods
suppliers to provide the highest value to customers. On a statistical sampling
basis, a quality assurance organization tests components and finished goods at
different stages in the manufacturing process to assure that exacting standards
are met.
GOVERNMENT REGULATION
Most of the products manufactured or sold by Allegiance in the United States
are subject to regulation by the Food and Drug Administration ("FDA"), as well
as by other federal and state agencies. The FDA regulates the introduction and
advertising of new drugs and devices as well as manufacturing procedures,
labeling, and record-keeping with respect to drugs and devices. The FDA has the
power to seize adulterated or misbranded drugs and devices, to require the
manufacturer to remove them from the market, and to publicize relevant facts.
From time to time, Allegiance has removed products from the market that were
found not to meet acceptable standards. This may occur with respect to
Allegiance in the future. Product regulatory laws also exist in most other
countries where Allegiance does or will do business.
Allegiance's environmental policies mandate compliance with all applicable
regulatory requirements concerning environmental quality and contemplate, among
other things, appropriate capital expenditures for environmental protection.
Various immaterial capital expenditures for environmental protection related to
the Allegiance Business were made during 1995 and 1996. See "Item 3--Legal
Proceedings."
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RELATIONSHIP WITH BAXTER
Allegiance and Baxter have entered into various agreements to govern certain
of the ongoing relationships between Baxter and Allegiance after the
Distribution, to provide mechanisms for an orderly transfer of the Allegiance
Business from Baxter to Allegiance, and to facilitate an orderly transition to
the status of two separate, publicly traded companies.
Allegiance has significant continuing relationships with Baxter as an agent,
distributor, customer, and supplier for a wide array of health-care products
and services, and for certain administrative support services. Allegiance is
Baxter's primary agent in distributing Baxter's intravenous solutions,
cardiovascular devices, and other products in the United States and provides
Baxter with certain administrative services including credit, collection and
cash application, accounts payable, information technology, and
telecommunications. Baxter distributes Allegiance's products in many countries
around the world and provides various administrative services to Allegiance.
Baxter does not have any ownership interest in Allegiance.
Reorganization Agreement
Baxter and Allegiance have entered into a reorganization agreement (the
"Reorganization Agreement"). Subject to certain exceptions, the Reorganization
Agreement provides for certain cross-indemnities (including an indemnity of
Baxter by Allegiance with respect to certain guarantees by Baxter in
connection with certain Allegiance agreements and certain financial
guarantees) principally designed to place financial responsibility for the
liabilities of the Allegiance Business with Allegiance and financial
responsibility for the obligations and liabilities of Baxter's retained
businesses and its other subsidiaries with Baxter. Specifically, Allegiance
has agreed to assume liability for, and to indemnify Baxter against, any and
all liabilities associated with the Allegiance Business, including any
litigation, proceedings or claims relating to the products and operations
thereof whether or not the underlying basis for such litigation, proceedings
or claims arose prior to or after the Distribution Date. Baxter has agreed to
indemnify Allegiance against any and all liabilities associated with Baxter's
retained businesses. Specifically, Baxter has retained liability for, and
agreed to indemnify Allegiance against, proceedings or claims relating to
allegations of disease transmission through blood products and silicon-gel
mammary implants.
Pursuant to the Reorganization Agreement, Allegiance assumed all
environmental liabilities that arise from or are attributable to the
operations of the Allegiance Business, including, but not limited to, off-site
waste-disposal liabilities. Allegiance also has agreed to indemnify Baxter
against any and all such environmental liabilities relating to the Allegiance
Business. Baxter has agreed to indemnify Allegiance against any and all
environmental liabilities associated with the retained Baxter businesses. In
addition, the Reorganization Agreement provides that each of Baxter and
Allegiance will indemnify the other in the event of certain liabilities
arising under the Securities Exchange Act of 1934.
The Reorganization Agreement provides, among other things, that, in order to
avoid potentially adverse tax consequences relating to the Distribution, for a
period of two years after the Distribution, Allegiance will not: (i) cease to
engage in an active trade or business within the meaning of the Internal
Revenue Code of 1986, as amended (the "Code"); (ii) issue or redeem any share
of stock of Allegiance, except for certain issuances and redemptions for the
benefit of Allegiance's employees or to effect acquisitions by Allegiance in
the ordinary course of business or in connection with the issuance of any
convertible debt by Allegiance or in accordance with the requirements for
permitted purchases of Allegiance stock as set forth in Section 4.05(l)(b) of
Revenue Procedure 96-30 issued by the Internal Revenue Service (the "IRS"); or
(iii) liquidate or merge with any other corporation, unless, with respect to
(i), (ii) or (iii) above, either (a) an opinion is obtained from counsel to
Baxter, or (b) a ruling is obtained from the IRS, in either case to the effect
that such act or event will not adversely affect the federal income tax
consequences of the Distribution to Baxter, its stockholders who received
Allegiance common stock or Allegiance. Allegiance expects that these
limitations will not significantly constrain its activities or its ability to
respond to unanticipated developments.
The Reorganization Agreement provides that if, as a result of certain
transactions occurring after the Distribution Date involving either the stock
or assets of either Allegiance or any of its subsidiaries, or any
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combination thereof, the Distribution fails to qualify as tax-free under the
provisions of Section 355 of the Code, then Allegiance shall indemnify Baxter
for all taxes, liabilities, and associated expenses, including penalties and
interest, incurred as a result of such failure of the Distribution to qualify
under Section 355 of the Code. The Reorganization Agreement further provides
that if the Distribution fails to qualify as tax-free under the provisions of
Section 355 of the Code, other than as a result of a transaction occurring
after the Distribution Date involving either the stock or assets of Allegiance
or any of its subsidiaries, or any combination thereof, then Allegiance shall
not be liable for such taxes, liabilities, or expenses.
The Reorganization Agreement also provides for the allocation of benefits
between Baxter and Allegiance under existing insurance policies after the
Distribution Date for claims made or occurrences prior to the Distribution
Date and sets forth procedures for the administration of insured claims. In
addition, the Reorganization Agreement provides that Baxter will use its
reasonable efforts to maintain directors' and officers' insurance at
substantially the level of Baxter's current directors' and officers' insurance
policy for a period of six years with respect to the former directors and
officers of Baxter who are directors and officers of Allegiance for acts
relating to periods prior to the Distribution Date.
In addition, the Reorganization Agreement addresses the treatment of
employee benefit matters and other compensation arrangements for certain
former and current Allegiance employees and their beneficiaries and
dependents, as well as certain former employees of certain former Allegiance
businesses and their beneficiaries and dependents (collectively, the
"Allegiance Participants"). The Reorganization Agreement provides that the
account balances (including outstanding loans) of all Allegiance Participants
in the Baxter International Inc. and Subsidiaries Incentive Investment Plan
(the "IIP"), and the plan assets related to such liabilities be transferred to
Allegiance's new retirement savings plan. The Reorganization Agreement also
generally provides that Allegiance assumes all liabilities for benefits under
any welfare plans related to Allegiance Participants, other than certain
claims incurred on or before the Distribution Date. Moreover, the
Reorganization Agreement provides that, effective as of the Distribution Date,
Allegiance is responsible for all other liabilities to Allegiance Participants
(including unfunded supplemental retirement benefits), other than certain
accruals under the Baxter Defined Benefit Excess Plan.
Tax Sharing Agreement
Baxter and Allegiance have entered into a tax sharing agreement (the "Tax
Sharing Agreement") which allocates tax liabilities and responsibility for tax
audits for periods prior to, and subsequent to the Distribution Date. The Tax
Sharing Agreement also allocates consolidated alternative minimum tax and
other tax credit carry-forwards as of the Distribution Date between Baxter and
Allegiance.
Agency, Services and Distribution Agreements
Baxter's principal domestic operating subsidiary, Baxter Healthcare
Corporation ("BHC"), and an Allegiance subsidiary have entered into an Agency,
Services and Distribution Agreement (the "Domestic Distribution Agreements")
for each of Baxter's four primary domestic business units, I.V. Systems,
Renal, Cardiovascular, and Biotechnology, pursuant to which Baxter supplies
products to Allegiance, and Allegiance, as agent or distributor for Baxter,
provides physical distribution and various sales and sales support services to
Baxter. The Domestic Distribution Agreements cover substantially all of the
existing products of each of the foregoing business units.
In most instances, Allegiance acts as Baxter's agent for the physical
distribution of Baxter's products in return for a fee. In such situations,
Baxter maintains the contractual relationship with the customer, manages
sales, order-taking, and billing and collections, and retains title to the
products until shipment to the ultimate customer. In certain situations,
Allegiance acts as a full-service, value-added distributor for Baxter products
with a direct contractual relationship with the ultimate customer. In these
situations, Allegiance provides additional sales, sales support, and other
customer and product-related services to the customer and purchases the
products from Baxter at specified prices. In addition, Baxter pays to
Allegiance the fee described above. Such additional
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services may include aggregating Baxter's products with others to be sold as
"kits" for a given medical procedure or other cost-management services which
assist the customer in reducing product consumption, improving utilization of
assets, improving logistics, and reducing or eliminating operating costs.
The initial term of the Domestic Distribution Agreements range from three
years (Renal and Biotechnology) to five years (I.V. Systems and
Cardiovascular). The agreements may be renewed upon expiration upon the mutual
agreement of the parties. In the event of a Change In Control of one of the
parties to the Domestic Distribution Agreements or certain of their
affiliates, the other party to such agreement has the right, subject to
certain notice periods and other restrictions, to terminate all, or in certain
cases only the affected portion, of such agreement prior to its normal
expiration. In the case of a Change In Control involving a competitor of the
non-affected party, the notice period required for termination may be shorter
than if such a competitor was not involved. For purposes of these agreements,
a "Change In Control" includes the acquisition of more than 30 percent of the
stock of either party or one of its affiliates, certain mergers or
consolidations involving either party or one of its affiliates, the
acquisition by either party of certain significant subsidiaries, and, in the
case of an affiliate of either of the parties, the disposition of
substantially all of its business and assets.
Under the Domestic Distribution Agreements, Baxter is required within the
Territory to distribute all covered I.V. Systems and Cardiovascular products
(including any line extensions of such products) through Allegiance, subject
to certain exceptions. In addition, Allegiance may not market, promote or
solicit orders for any product that competes with any covered I.V. Systems or
Cardiovascular product. Allegiance may however take orders for stock and sell
competing products in response to customer requests. For purposes of the
Domestic Distribution Agreements, the "Territory" is defined as the 50 states
comprising the United States and the District of Columbia. Allegiance's right
to distribute the covered products is limited to the Territory.
The compensation received by Allegiance under the Domestic Distribution
Agreements generally approximates or is based upon the internal business unit
revenue and expense allocations that were in effect between the Baxter
business units and the Allegiance Business prior to the date of the
Distribution. Similarly, the service levels and performance standards remain
as they were prior to the date of the Distribution.
In addition to the Domestic Distribution Agreements, Baxter and Allegiance
have entered into agreements pursuant to which Baxter has agreed to distribute
Allegiance's surgical and other products outside of the United States and to
distribute certain surgical products to the long-term, sub-acute, and home-
care markets within the United States.
Services Agreements
Baxter and Allegiance have entered into several services agreements, to be
effective from and after the Distribution Date, pursuant to which Baxter
provides to Allegiance, and Allegiance provides to Baxter, certain
administrative services necessary for the conduct of Baxter's and Allegiance's
businesses. Services provided to Baxter by Allegiance include credit,
collection and cash application, accounts payable, telecommunications, and
information technology services. Services provided to Allegiance by Baxter
include payroll, sales and use tax, human resources (including international
expatriate services), research and development, travel, property management,
and other services. These agreements have varying terms and, subject to
certain exceptions, are generally terminable by either party upon 12 months or
less notice. Under certain circumstances involving a Change In Control the
agreements may be terminated earlier than normal. The agreements may be
renewed upon expiration or by mutual agreement of the parties. The prices at
which such services are provided generally are equal to or based on the actual
cost of rendering such services.
In addition, Baxter leases from Allegiance, for a term of ten years, a
217,000 square foot office building at Allegiance's McGaw Park, Illinois
headquarters site. The leased building will continue to be occupied by
Baxter's Renal Division. Allegiance subleases from Baxter all or a substantial
part of an 85,000 square foot office building located in Deerfield, Illinois.
This building is part of a three building complex leased by Baxter, and
Allegiance's sublease is for the remainder of the current term of Baxter's
lease. Baxter and Allegiance may also
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lease or sublease to each other miscellaneous office or other space for use in
connection with various services performed for one another pursuant to the
agreements described above.
EMPLOYEES
As of December 31, 1996, Allegiance employed approximately 20,700 people.
EXECUTIVE OFFICERS OF THE REGISTRANT
Following are the names and ages, as of March 1, 1997, of the executive
officers of the Company, and one or both of its two principal direct
subsidiaries, Allegiance Healthcare Corporation and Allegiance Healthcare
International Inc., their positions and summaries of their backgrounds and
business experience.
LESTER B. KNIGHT, age 38, has been chairman of the board and chief executive
officer of Allegiance since June 1996. From 1992 to September 1996, he was an
executive vice president of Baxter. He was elected a corporate vice president
of Baxter in 1990. Mr. Knight joined Baxter in 1981.
JOSEPH F. DAMICO, age 43, has been president and chief operating officer of
Allegiance since June 1996. From 1992 to September 1996, he was a corporate
vice president of Baxter. From 1979 to 1992, he held various positions at
Baxter, including vice president and general manager of the Custom Sterile
unit and president of the Convertors/Custom Sterile business.
WILLIAM L. FEATHER, age 50, has been senior vice president, general counsel
and secretary of Allegiance since June 1996. From January 1996 to September
1996, he was associate general counsel for Baxter Healthcare Corporation's
United States Healthcare business. Between 1986 and 1996, he held various
positions at Baxter, including corporate counsel, senior counsel, and
assistant general counsel.
PETER B. MCKEE, age 58, has been senior vice president and chief financial
officer of Allegiance since June 1996. From 1993 until he joined Baxter
Healthcare Corporation in May 1996, Mr. McKee was a senior vice president and
chief financial officer at FoxMeyer Health Corporation, a pharmaceutical
distributor, subsidiaries of which filed a petition under Chapter 11 of the
United States Bankruptcy Code in August 1996. Prior to that, he was a partner
and principal owner of InterSolve Group Corporation, a managerial consulting
firm.
KATHY BRITTAIN WHITE, age 47, has been senior vice president and chief
information officer of Allegiance since June 1996. She joined Baxter as its
chief information officer in 1995. From 1993 to 1995, she was vice president,
information systems and services for AlliedSignal Corporation. Prior to that,
she was vice president, corporate services, for Guilford Mills, Inc.
RICHARD C. ADLOFF, age 39, has been corporate vice president and controller
of Allegiance since June 1996. From 1994 to September 1996, he was vice
president of finance for Baxter Healthcare Corporation's United States
Healthcare business. From 1980 to 1994, he held various positions in
accounting and finance at Baxter and American Hospital Supply Corporation.
ROBERT B. DEBAUN, age 46, has been corporate vice president human resources
of Allegiance since June 1996. From 1991 to September 1996, he was vice
president of human resources for Baxter Healthcare Corporation's United States
Distribution business. From 1981 to 1991, he held various positions, including
manager of college relations for American Hospital Supply Corporation; and as
director of corporate recruitment, director of corporate staffing and
relocation, and vice president, human resources, for Baxter's I.V. Systems
business.
MARK J. EHLERT, age 43, has been corporate vice president quality and
regulatory affairs of Allegiance since June 1996. From 1994 to September 1996,
he was vice president, quality and regulatory affairs for the United States
Sales and Distribution business of Baxter Healthcare Corporation. From 1975 to
1994, he held various positions at Baxter, including quality-control manager,
director of quality management, director of manufacturing for northern
Illinois I.V. Systems operations and general manager of the Singapore
manufacturing operations.
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GAIL GAUMER, age 44, has been corporate vice president cost-management
services and strategy of a subsidiary of Allegiance since June 1996. From 1995
to September 1996, she was president of marketing, strategy and business
development for Baxter Healthcare Corporation's United States Healthcare
business. From 1980 to 1995, she held various positions at Baxter, including
president of Renal-Europe, vice president of global marketing, planning and new
business development, and vice president and general manager for various Renal
businesses. Ms. Gaumer serves as a director of FemRx, Inc.
LEONARD G. KUHR, age 38, has been corporate vice president and treasurer of
Allegiance since June 1996. From 1995 to September 1996, he was vice president,
capital markets at Baxter. From 1979 to 1995, he held various positions at
Baxter and American Hospital Supply Corporation, including vice president and
controller of the Specialty Business group, vice president finance for the
Surgical Business, and various tax management positions for the corporate tax
function.
ROGER L. SISTERMAN, age 53, has been corporate vice president manufacturing
of Allegiance's operating subsidiaries since June 1996. From 1994 to September
1996, he was vice president of manufacturing and operations for Baxter
Healthcare Corporation. From 1977 to 1994, he held various positions at Baxter,
including director of materials management for Baxter's Pharmaseal division,
vice president of manufacturing for Baxter Custom Sterile and vice president
for Convertors/Custom Sterile.
ITEM 2. PROPERTIES
Allegiance owns or has long-term leases on substantially all of its major
manufacturing facilities. Allegiance maintains 22 manufacturing facilities in
the United States, France, Malaysia, Malta, and Mexico. Allegiance owns or
leases 60 distribution centers in the United States.
Allegiance maintains a continuing program for improving its properties,
including the retirement or improvement of older facilities and the
construction of new facilities. This program includes improvement of
manufacturing facilities to enable production and quality control programs to
conform with the current state of technology and government regulations.
ITEM 3. 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. In April 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 is the only named defendant in this 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
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District of Indiana, IP96-1889C). Baxter and three other companies are
defendants. On October 9, 1996, the plaintiff in a case pending in federal
court filed a petition with the Judicial Panel on Multi District Litigation,
In re Latex Gloves Products Liability Litigation, (MDL Docket No. 1148),
seeking to transfer and consolidate the cases 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 March 1, 1997, 80 additional lawsuits had been served on
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 December 31, 1996, 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 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The information required by this Item is set forth in registrant's Annual
Report to Stockholders for the fiscal year ended December 31, 1996 under the
caption "Notes to Consolidated Financial Statements," which information is
hereby incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth in registrant's Annual
Report to Stockholders for the fiscal year ended December 31, 1996 under the
caption "Five-Year Summary of Selected Financial Data," which information is
hereby incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The information required by this Item is set forth in registrant's Annual
Report to Stockholders for the fiscal year ended December 31, 1996 under the
caption "Management's Discussion and Analysis," which information is hereby
incorporated herein by reference.
----------------
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in the foregoing "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this Report
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 that
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. The Company undertakes no obligation to update publicly any
forward-looking statement whether as a result of new information, future
events or otherwise.
In addition to the risks and uncertainties of ordinary business operations,
the forward-looking statements of the Company contained in this Annual Report
on Form 10-K are also subject to the following risks and uncertainties:
United States Health-Care Environment
The United States health-care system continues to undergo fundamental
change. Competition for patients among health-care providers continues to
intensify. Increasingly, providers are looking for ways to better manage costs
in areas such as materials handling, supply utilization, product
standardization for specific procedures, and capital expenditures.
Accelerating cost pressures on hospitals in the United States and overseas
are resulting in increased out-patient and alternate-site health-care service
delivery and a focus on cost-effectiveness and quality. At the same time, the
elderly segment of the population in the United States and abroad is growing.
These forces increasingly shape the demand for, and supply of, medical care.
Many private health-care payors provide incentives for consumers to seek
lower-cost care outside the hospital. Many corporations' employee health plans
provide financial incentives for patients to use the most cost-effective forms
of treatment (managed care programs, such
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as health maintenance organizations, have become more common), and physicians
are being encouraged to provide more cost-effective treatments. In the past,
Allegiance's distribution network has been focused on traditional distribution
to hospitals.
The future financial success of health-care product and service companies,
such as Allegiance, will depend on their ability to assist health-care
providers to help them enhance their competitiveness and to provide products
to alternate sites as treatment moves outside the hospital. Management
believes it can help its customers achieve savings by automating supply-
ordering procedures; optimizing distribution networks; improving utilization;
materials management and labor productivity; achieving economies through
product and procedure standardization; and performing certain nonclinical
services on an outsourced basis. Management further believes its strategy of
providing unmatched service to its health-care customers and achieving the
best overall cost in its delivery of health-care products and services is
compatible with any anticipated realignment of the United States health-care
system that may ultimately occur. If customers do not respond favorably to the
Allegiance strategy, these changes could have a material adverse effect on
Allegiance's business, results of operations, and financial condition.
United States Competition
The changing health-care environment in recent years has led to increasingly
intense competition among health-care suppliers. Competition is focused on
price, service, and product performance. Pressure in these areas is expected
to continue. There has been substantial consolidation in Allegiance's customer
base and among its competitors. In recent years, Allegiance's overall price
increases have been lower than increases in the Consumer Price Index. Industry
trends and competition may inhibit Allegiance's ability to increase prices,
and may continue to depress Allegiance's margins in the future.
In part through its previously announced and ongoing restructuring program,
Allegiance plans to continue to increase its efforts to minimize costs and
better meet accelerating price competition. Allegiance believes that its cost
position will continue to benefit from improvements in manufacturing
technology and increased economies of scale. Allegiance continues to improve
the quality of its products and services. If Allegiance is unsuccessful in
maintaining its service and quality levels while decreasing costs, the
competitive environment may have a material adverse effect on Allegiance's
business, results of operations, and financial condition.
Revenues from Customers Purchasing through Buying Groups
For the last three years, sales to customers who are members of two large
hospital buying groups, Premier and VHA as a percentage of total sales, were
27 percent and 20 percent, respectively in 1996, 27 percent and 16 percent,
respectively in 1995, and 23 percent and 13 percent, respectively in 1994.
Premier and VHA each comprise a group of health-care organizations that
benefit from the pricing and other benefits available to members of the group.
Certain members of each group are free to purchase from the vendors of their
choice. Although the loss of the relationship with either group could have a
significant impact on sales to members of the group, the loss of such group
would not necessarily mean the loss of all sales from all members of such
group. No other buying group or single customer currently accounts for more
than 10 percent of Allegiance's revenue.
Financial Leverage
As of December 31, 1996, Allegiance had outstanding long-term indebtedness
in the amount of approximately $1.1 billion. Such indebtedness may limit
Allegiance's future financial flexibility.
Mutual Distribution Arrangements
Allegiance and Baxter are parties to various agency and distribution
arrangements pursuant to which Allegiance distributes certain Baxter products
in the United States and Baxter distributes certain Allegiance products in the
United States and internationally. The initial terms of these agreements range
from three to five
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years. Although the present intention of Allegiance and Baxter is that these
distribution arrangements continue as long as the relationship between the
parties is mutually beneficial, no assurance can be given that these
arrangements will be extended beyond their original expiration dates or will
not be terminated prior to their original terms.
Dependence on Administrative Services
Allegiance and Baxter rely on each other for the provision of certain
administrative services. Such services are provided, pursuant to contractual
arrangements that can be terminated by either party upon no more than 12
months notice, at rates intended to approximate the cost of providing such
services. No assurance can be given that such arrangements will continue in
the future, that the cost of arranging substitute service either internally or
from a third party would not increase the cost to the service recipient, or
that a service provider will not be forced to absorb a greater share of its
fixed overhead costs in the event of a termination of these arrangements.
Limited Operating History as an Independent Company
Allegiance has only been operating as an independent public company since
September 30, 1996. While Allegiance has been profitable as part of Baxter,
there is no assurance that as a stand-alone company profits will continue at
the same level.
Product Liability
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. Allegiance will be defending and indemnifying BHC as contemplated by
the Reorganization Agreement 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.
Allegiance believes that 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.
Environmental Contingencies
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 December 31, 1996, 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 approximately $3.9 million, which has been accrued
and reflected in Allegiance's consolidated financial statements.
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Government Regulation
Significant aspects of Allegiance's businesses are subject to state and
federal statutes and regulations governing, among other things, reimbursement
under federal and state medical assistance programs, medical waste-disposal,
dispensing of controlled substances, and workplace health and safety. In
addition, most of the products manufactured or sold by Allegiance in the
United States are subject to regulation by the FDA, as well as by other
federal and state agencies. The FDA has the power to seize adulterated or
misbranded drugs and devices, to require the manufacturer to remove them from
the market, and to publicize relevant facts. From time to time, Allegiance has
removed products from the market that were found not to meet acceptable
standards. This may occur with respect to Allegiance in the future. Product
regulatory laws exist in most other countries where Allegiance does or will do
business. There can be no assurance that federal, state or foreign governments
will not impose additional restrictions or adopt interpretations of existing
laws that could materially adversely affect Allegiance's business, results of
operations or financial condition.
International Expansion
Allegiance currently has international sales of self-manufactured surgical
products primarily in Canada, France, and Germany. Allegiance management
expects to increase its sales efforts internationally, which could expose it
to greater risks associated with government regulations and fluctuations in
foreign currency. There can be no assurance that Allegiance will be successful
in expanding its sales efforts internationally or employ a risk management
strategy that will completely eliminate its exposure to adverse movements in
foreign currency rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth in registrant's Annual
Report to Stockholders for the fiscal year ended December 31, 1996 under the
captions "Report of Independent Accountants," "Consolidated Balance Sheets,"
"Consolidated Statements of Operations," "Consolidated Statements of Cash
Flows," "Consolidated Statements of Equity," and "Notes to Consolidated
Financial Statements," which information is hereby incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Directors of the Company
The information required by this Item is set forth in registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 15,
1997, under the caption "Election of Directors," which information is
hereby incorporated herein by reference.
(b) Executive officers of the Company
Reference is made to "Executive Officers of the Registrant" in Part I.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 15, 1997,
under the captions "Compensation of Directors and Executive Officers" and
"Report of the Compensation and Nominating Committee of the Board of
Directors," which information is hereby incorporated herein by reference.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 15, 1997,
under the caption "Ownership of the Capital Stock of the Company," which
information is hereby incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1)Financial Statements
The following financial statements of Allegiance Corporation, are included
in Part II, Item 8:
(i) Report of Independent Accountants from Price Waterhouse LLP;
(ii) Consolidated Balance Sheets--as of December 31, 1996 and 1995;
(iii) Consolidated Statements of Operations--years ended December 31,
1996, 1995 and 1994;
(iv) Consolidated Statements of Cash Flows--years ended December 31,
1996, 1995 and 1994;
(v) Consolidated Statements of Equity--years ended December 31, 1996,
1995 and 1994; and
(vi) Notes to Consolidated Financial Statements.
(2)Financial Statement Schedules
(i) Report of Independent Accountants from Price Waterhouse LLP; and
(ii) Schedule II--Valuation and Qualifying Accounts.
(3)Exhibits
Exhibits required by Item 601 of Regulation S-K are listed in the
Exhibit Index hereto, which information is hereby incorporated by
reference.
(b) Reports on Form 8-K
A report on Form 8-K, dated November 1, 1996 was filed with the Securities
and Exchange Commission under Item 5, Other Events, to file information
disclosing the Company's change in its accounting policy for assessing
goodwill impairment.
(c) Exhibits
The exhibits filed as part of this Annual Report on Form 10-K are as
specified in Item 14(a)(3) herein.
(d) Financial Statement Schedules
The financial statement schedule filed as part of this Annual Report on
Form 10-K is as specified in Item 14(a)(2) herein.
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<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED ON MARCH 27, 1997.
Allegiance Corporation
/s/ Lester B. Knight
By: _________________________________
Lester B. Knight, Chairman of the
Board and
Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT ON MARCH 27, 1997 IN THE CAPACITIES INDICATED:
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ Lester B. Knight Chairman of the Board and Chief Executive
___________________________________________ Officer (Principal Executive Officer)
Lester B. Knight
/s/ Joseph F. Damico President, Chief Operating Officer and
___________________________________________ Director
Joseph F. Damico
/s/ Peter B. McKee Senior Vice President and Chief Financial
___________________________________________ Officer (Principal Financial Officer)
Peter B. McKee
/s/ Richard C. Adloff Corporate Vice President and Controller
___________________________________________ (Principal Accounting Officer)
Richard C. Adloff
/s/ Silas S. Cathcart Director
___________________________________________
Silas S. Cathcart
/s/ David W. Grainger Director
___________________________________________
David W. Grainger
/s/ Arthur F. Golden Director
___________________________________________
Arthur F. Golden
/s/ Michael D. O'Halleran Director
___________________________________________
Michael D. O'Halleran
/s/ Kenneth D. Bloem Director
___________________________________________
Kenneth D. Bloem
/s/ Connie R. Curran Director
___________________________________________
Connie R. Curran
</TABLE>
18
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors of
Allegiance Corporation
Our audits of the consolidated financial statements referred to in our report
dated February 3, 1997 appearing in the 1996 Annual Report to Stockholders of
Allegiance Corporation (which report and consolidated financial statements are
incorporated by reference in this Annual Report on Form 10-K) also included an
audit of the Financial Statement Schedule listed in Item 14(a) of this Form
10-K. In our opinion, this Financial Statement Schedule presents fairly, in
all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
Price Waterhouse LLP
Chicago, Illinois
February 3, 1997
S-1
<PAGE>
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(IN MILLIONS OF DOLLARS)
<TABLE>
<CAPTION>
ADDITIONS
--------- ----------------- ---------- -------
BALANCE CHARGED CHARGED BALANCE
AT TO COSTS TO OTHER DEDUCTIONS AT END
BEGINNING AND ACCOUNTS FROM OF
DESCRIPTION OF PERIOD EXPENSES (A) RESERVES PERIOD
- - ----------- --------- -------- -------- ---------- -------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996
Accounts receivable............. $18.2 $10.3 $-- $(2.1) $26.4
Year ended December 31, 1995
Accounts receivable............. $17.4 $ 2.6 $-- $(1.8) $18.2
Year ended December 31, 1994
Accounts receivable............. $12.7 $ 7.2 $1.2 $(3.7) $17.4
</TABLE>
- - --------
(A) Valuation accounts of acquired or divested companies and foreign currency
translation adjustments. Reserves are deducted from assets to which they
apply.
S-2
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
2.1 Reorganization Agreement between Baxter International Inc. and
Allegiance Corporation(1)
3.1 Certificate of Incorporation of Allegiance Corporation, including
Certificate of Designation relating to Series A Junior Participating
Preferred Stock of Allegiance Corporation(2)
3.2 Bylaws of Allegiance Corporation(1)
4.1 Indenture dated as of October 1, 1996 between Allegiance Corporation
and PNC Bank, Kentucky, Inc.(2)
4.2 Board Resolutions creating the 7.30% Notes due October 15, 2006, the
7.80% Debentures due October 15, 2016 and the 7.00% Debentures due
October 15, 2026(2)
10.1* Allegiance Corporation 1996 Outside Director Incentive Compensation
Plan(1)
10.2* Allegiance Corporation 1996 Incentive Compensation Plan(1)
10.3* Allegiance Corporation Change in Control Plan(1)
10.4* Retention Agreement for Ms. Gaumer(1)
10.5 Intentionally left blank.
10.6 Agency Services and Distribution Agreement dated as of September 30,
1996 between Allegiance Corporation and Baxter International Inc.(3)
10.7 $1.2 Billion Credit Agreement dated as of September 23, 1996 among
Allegiance Corporation and the financial institutions named
therein(1), as amended by the First Amendment to the Credit Agreement
dated January 30, 1997 among Allegiance Corporation and the financial
institutions named therein which is filed herewith
10.8 Amendment dated October 16, 1996 to the $1.2 Billion Credit Agreement
dated as of September 23, 1996 among Allegiance Corporation and the
financial institutions named therein which is filed herewith
10.9 Rights Agreement, by and between Allegiance Corporation and the rights
agent named therein(1)
11.1 Statement regarding Computation of Primary Earnings per Common Share
11.2 Statement regarding Computation of Fully Diluted Earnings per Common
Share
12.1 Statement regarding Computation of Pro Forma Ratio of Earnings to
Fixed Charges
13.1 Excerpts from 1996 Annual Report to Stockholders incorporated herein
by reference
21.1 Subsidiaries of Allegiance Corporation(1)
23.1 Consent of Price Waterhouse LLP
27.1 Financial Data Schedule
</TABLE>
- - --------
(1) Incorporated herein by reference to the exhibit of equivalent number to
the Company's Registration Statement on Form S-1, as amended, Registration
No. 333-12525.
(2) Incorporated herein by reference to the Exhibit of equivalent number to
the Company's quarterly report on Form 10-Q for the quarterly period ended
September 30, 1996.
(3) Incorporated herein by reference to Exhibit 10.1 to the Company's
quarterly report on Form 10-Q for the quarterly period ended September 30,
1996.
* Denotes each management contract or compensatory plan or arrangement
required to be filed as an exhibit to this report.
<PAGE>
January 30, 1997
Exhibit 10.7
Allegiance Corporation
1430 Waukegan Road
McGaw Park, Illinois 60085
Re: First Amendment to Credit Agreement
-----------------------------------
Ladies/Gentlemen:
Please refer to the Facility A Credit Agreement (the "Credit Agreement")
dated as of September 23, 1996 among Allegiance Corporation (the "Company"),
various Banks, The First National Bank of Chicago, as Syndication Agent,
NationsBank of Texas, N.A., as Documentation Agent, Morgan Guaranty Trust
Company of New York, as Syndication Agent, and Bank of America National Trust
and Savings Association, as Administrative Agent. Capitalized terms used
herein and not otherwise defined herein shall have the meanings assigned thereto
in the Credit Agreement.
The Company, the Agents and the Banks agree that the definition of
"Extraordinary Items" in Section 7.01(i) of the Credit Agreement is amended by
deleting the amounts "$50,000,000" therein and substituting the amount
"$100,000,000" therefor.
Except as amended above, all terms and provisions of the Credit Agreement
shall remain in full force and effect and are hereby ratified and confirmed in
all respects.
This letter amendment shall become effective when the Administrative Agent
has received counterparts hereof signed by the Company and the Majority Banks.
This letter amendment shall be deemed to be a contract made under the laws
of the State of Illinois, and for all purposes shall be construed in accordance
with the laws of the State of Illinois, without regard to the principles of
conflicts of laws.
Please evidence your agreement to the foregoing by signing and returning a
counterpart of this letter amendment.
<PAGE>
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION,
as Administrative Agent
By:_________________________________
Title:
BANK OF AMERICA ILLINOIS,
individually and as Swing-Line Bank
By:_________________________________
Title:
THE FIRST NATIONAL BANK OF CHICAGO,
individually and as Syndication Agent
and Co-Arranger
By:_________________________________
Title:
MORGAN GUARANTY TRUST COMPANY
OF NEW YORK,
individually and as Co-Syndication Agent
and Co-Arranger
By:_________________________________
Title:
NATIONSBANK OF TEXAS, N.A.,
individually and as Documentation Agent
and Co-Arranger
By:_________________________________
Title:
THE CHASE MANHATTAN BANK,
individually and as Co-Agent
By:_________________________________
Title:
-2-
<PAGE>
CREDIT LYONNAIS CHICAGO BRANCH,
individually and as Co-Agent
By:
-------------------------------------
Title:
CREDIT SUISSE, individually and
as Co-Agent
By:
-------------------------------------
Title:
By:
-------------------------------------
Title:
DEUTSCHE BANK AG
CHICAGO AND/OR CAYMAN ISLANDS
BRANCHES, individually and
as Co-Agent
By:
-------------------------------------
Title:
By:
-------------------------------------
Title:
THE SUMITOMO BANK, LIMITED,
CHICAGO BRANCH
individually and as Co-Agent
By:
-------------------------------------
Title:
TORONTO DOMINION (TEXAS), INC.,
individually and as Co-Agent
By:
-------------------------------------
Title:
-3-
<PAGE>
THE BANK OF TOKYO-MITSUBISHI, LTD.
CHICAGO BRANCH
By:_______________________________
Title:
CITIBANK, N.A.
By:_______________________________
Title:
CAISSE NATIONALE DE CREDIT
AGRICOLE
By:_______________________________
Title:
THE FUJI BANK, LIMITED
By:_______________________________
Title:
THE INDUSTRIAL BANK OF JAPAN, LIMITED
CHICAGO BRANCH
By:_______________________________
Title:
MELLON BANK, N.A.
By:_______________________________
Title:
THE NORTHERN TRUST COMPANY
By:_______________________________
Title:
-4-
<PAGE>
PNC BANK, NATIONAL ASSOCIATION
By:_______________________________
Title:
UNION BANK OF SWITZERLAND,
NEW YORK BRANCH
By:_______________________________
Title:
By:_______________________________
Title:
WACHOVIA BANK OF GEORGIA, N.A.
By:_______________________________
Title:
WELLS FARGO BANK, N.A.
By:_______________________________
Title:
Accepted and Agreed By:_______________________________
as of January 30, 1997: Title:
ALLEGIANCE CORPORATION
By:_______________________________
Title:
-5-
<PAGE>
EXHIBIT 10.8
[ALLEGIANCE CORPORATION LETTERHEAD]
October 16, 1996
Bank of America National Trust
and Savings Association, as
Administrative Agent for the
Banks parties to the Credit
Agreement referred to below
1455 Market Street, 12th Floor
San Francisco, California 94103
Attention: Agency Administrative Services
Unit #5596
Reference: The $1.2 billion Credit Agreement (Facility A) (the "Credit
Agreement") dated as of September 23, 1996 among Allegiance
Corporation, as Borrower, and Bank of America National Trust and
Savings Association, as Administrative Agent and other financial
institutions that are parties to this Credit Agreement
Ladies and Gentlemen:
The undersigned, Allegiance Corporation, refers to the above mentioned "Credit
Agreement", (the terms defined therein being used herein as therein defined),
and hereby gives you notice pursuant to Section 4.05 of the Agreement that the
undersigned requests a reduction of the Commitments in the aggregate amount of
$300 million effective October 23, 1996. After giving effect to such reduction,
the aggregate commitments will be $900 million.
If you have any questions concerning this matter, please call me at 847-578-
4420.
Very truly yours,
ALLEGIANCE CORPORATION
By: /s/ Leonard G. Kuhr
-------------------------------------
Corporate Vice President & Treasurer
cc: William Sweeney, BankAmerica
45094\021\10EX10-8.001
<PAGE>
EXHIBIT 11.1
COMPUTATION OF PRIMARY EARNINGS PER COMMON SHARE
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
HISTORICAL COMPUTATION (1)
Net loss available for common stock (2)............................ $(477.7)
Average common shares outstanding (3).............................. 54.9
Primary net loss per common share (2).............................. $ (8.70)
=======
</TABLE>
- - --------
(1) Historical computation of primary earnings per common share for the years
ended December 31, 1995 and 1994 is not considered meaningful as
Allegiance did not have common shares for these historical periods.
(2) Net loss in 1996 includes a charge of $550.0 million for the write-down of
goodwill, and other non-recurring costs of a pretax amount of $95.5
million primarily for facility consolidations and other asset write-downs.
(3) Common shares are based on the weighted average number of shares
outstanding subsequent to the distribution on September 30, 1996, assuming
the shares issued in connection with the distribution had been issued
January 1.
<PAGE>
EXHIBIT 11.2
COMPUTATION OF FULLY DILUTED EARNINGS PER COMMON SHARE
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
HISTORICAL COMPUTATION (1)
Net loss available for common stock (2)............................ $(477.7)
Weighted average number of common shares outstanding (3)........... 54.9
Additional shares assuming conversion of exercise of stock
options and stock purchase plan subscriptions..................... 1.6
-------
Average common shares outstanding.................................. 56.5
Fully diluted net loss per common share (2)........................ $ (8.45)
=======
</TABLE>
- - --------
(1) Historical computation of fully diluted earnings per common share for the
years ended December 31, 1995 and 1994 is not considered meaningful as
Allegiance did not have common shares for these historical periods.
(2) Net loss in 1996 includes a charge of $550.0 million for the write-down of
goodwill, and other non-recurring costs of a pretax amount of $95.5
million primarily for facility consolidations and other asset write-downs.
(3) Common shares are based on the weighted average number of shares
outstanding subsequent to the distribution on September 30, 1996, assuming
the shares issued in connection with the distribution had been issued
January 1.
<PAGE>
EXHIBIT 12.1
COMPUTATION OF PRO FORMA RATIO OF EARNINGS TO FIXED CHARGES
(IN MILLIONS, EXCEPT RATIOS)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996(2) 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Pro forma pretax income (1)............. $100.0 $(545.5) $101.8
Estimated interest portion of rents... 8.7 8.7 8.8
Pro forma interest charges (1)........ 86.1 86.1 90.0
------ ------- ------
Pro forma fixed charges............... 94.8 94.8 98.8
------ ------- ------
Pro forma income as adjusted............ 194.8 (450.7) 200.6
Pro forma ratio of earnings to fixed
charges................................ $ 2.1 $ (4.8) $ 2.0
====== ======= ======
</TABLE>
- - --------
(1) Historical ratio of earnings to fixed charges is not considered meaningful
as no interest costs were allocated from Baxter to Allegiance for the
historical periods presented prior to September 30, 1996. The unaudited
pro forma combined statements of income are presented in Note 3 to "Notes
to Consolidated Financial Statements."
(2) Excludes a charge of $550.0 million for the write-down of goodwill and
other non-recurring costs of a pretax amount of $95.5 million primarily
for facility consolidations and other asset write-downs.
<PAGE>
EXHIBIT 13.1
Management's Discussion and Analysis
The following management discussion and analysis describes material changes in
the results of operations of Allegiance Corporation ("Allegiance" or the
"company") during the three years ended December 31, 1996, and the company's
financial condition at that date. Trends of a material nature are discussed to
the extent known and considered relevant.
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. The company undertakes no obligation
to update publicly any forward-looking statement whether as a result of new
information, future events or otherwise.
OVERVIEW
On September 30, 1996 (the "Distribution Date"), Baxter International Inc.
("Baxter") and its subsidiaries transferred to Allegiance and its subsidiaries
the U.S. 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.
Allegiance operates in a single industry segment as a leading provider of
health-care products and services that assist its health-care customers manage
and reduce the total cost of providing high-quality patient care. Through its
nationwide distribution network, Allegiance distributes a wide offering of
medical, surgical and laboratory products, including its own self-manufactured
surgical and respiratory therapy products, to hospital and alternate-site
customers. Allegiance also provides cost-management services to its health-care
customers, including inventory-management programs, customized packaging, and
clinical procedure and process consulting. The delivery of such a broad array of
products and services requires focused investments in cost-management services,
information systems, and manufacturing and distribution efficiencies.
Accelerating cost pressures on hospitals in the United States and overseas are
resulting in increased outpatient and alternate-site health-care service
delivery and a focus on cost-effectiveness and quality. At the same time, the
elderly segment of the population in the United States and abroad is growing.
These forces increasingly shape the demand for, and supply of, medical care.
Many private health-care payers provide incentives for consumers to seek lower
cost care outside the hospital. Many corporations' employee health plans provide
financial incentives for patients to use the most cost-effective forms of
treatment (managed care programs such as health maintenance organizations, have
become more common), and physicians are being encouraged to provide more cost-
effective treatments. The fundamental changes that have occurred in the U.S.
health-care system over the past several years, including customer and
competitor consolidations, and cost-containment efforts, are expected to
continue in the future.
Hospitals and other providers are expected to continue to push for greater
efficiency, reduced excess capacity and lower costs. Allegiance management
believes this presents an opportunity for the company, which is well positioned
to help health-care providers enhance their competitiveness and to provide
products to alternate sites as treatment moves outside
22
<PAGE>
Management's Discussion and Analysis
the hospital. Management believes it can help its customers achieve savings by
automating supply-ordering procedures; optimizing distribution networks;
improving utilization, materials management and labor productivity; achieving
economies through product and procedure standardization; and performing certain
non-clinical services on an outsourced basis. Allegiance further believes its
strategy of providing unmatched service to its health-care customers and
achieving the best overall cost in the delivery of health-care products and
services is compatible with any anticipated realignment of the U.S. health-care
system that may ultimately occur.
RESULTS OF OPERATIONS
Allegiance's historical results of operations in 1995 and 1994 include revenues
and expenses related to certain divested businesses. The Industrial and Life
Sciences division was sold in September 1995 and the diagnostics manufacturing
businesses were sold in December 1994. See Notes 5 and 6 to "Notes to
Consolidated Financial Statements" for additional information related to these
divestitures. The following table presents selected financial data for
Allegiance excluding the revenue and expenses associated with these divested
businesses:
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1996 1995 1994
- - ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $4,387.2 $4,575.0 $4,313.7
Costs and expenses
Cost of goods sold 3,479.2 3,624.5 3,311.2
Selling, general and administrative expenses 672.0 694.8 704.9
Research and development 8.1 6.6 5.6
Goodwill write-down and other
non-recurring items 645.5 -- --
Interest expense 18.6 -- --
Goodwill amortization 32.2 36.8 36.7
Benefit curtailment gains (35.9) -- --
Other income (4.6) (33.0) (2.8)
- - ----------------------------------------------------------------------------------------------
Total costs and expenses 4,815.1 4,329.7 4,055.6
- - ----------------------------------------------------------------------------------------------
Pretax income (loss) (427.9) 245.3 258.1
Income tax expense 49.8 94.4 101.4
- - ----------------------------------------------------------------------------------------------
Net income (loss) $ (477.7) $ 150.9 $ 156.7
==============================================================================================
</TABLE>
SALES
The following tables summarize net sales, excluding the divested businesses
discussed previously, by major geographic region and by self-manufactured versus
distributed product:
<TABLE>
<CAPTION>
Percent
increase
(decrease)
years ended December 31 (in millions, except percentages) 1996 1995 1994 1996 1995
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Geographic regions
United States $4,097.0 $4,283.7 $4,042.7 (4.4%) 6.0%
International 290.2 291.3 271.0 (0.4) 7.5
- - --------------------------------------------------------------------------------------------------------------------------
Total net sales $4,387.2 $4,575.0 $4,313.7 (4.1%) 6.1%
==========================================================================================================================
Distributed product $2,791.2 $3,003.5 $2,758.9 (7.1%) 8.9%
Self-manufactured product 1,596.0 1,571.5 1,554.8 1.6 1.1
- - --------------------------------------------------------------------------------------------------------------------------
Total net sales $4,387.2 $4,575.0 $4,313.7 (4.1%) 6.1%
==========================================================================================================================
</TABLE>
23
<PAGE>
Management's Discussion and Analysis
The decline in Allegiance's domestic and distributed product net sales in 1996
principally resulted from the execution of plans to improve profitability by
reducing sales in lower-margin, distributed products in the United States.
Domestic and distributed product net sales growth in 1995 is due primarily to
increased sales volume in lower-margin, distributed products, resulting from
increased sales under certain distribution agreements and a large supply and
service contract signed with VHA Inc. in 1994.
The increase in sales of self-manufactured product in 1996 is the result of an
increase in cost-management agreements (which generally result in favorable
growth of higher-margin, self-manufactured products), partially offset by
pricing pressures. An initial stocking order resulting from an agreement signed
with General Medical Corporation in 1996 also contributed to the increase in
sales of self-manufactured product during the year.
International sales in 1996 were reduced slightly by unfavorable foreign-
exchange rates. Additionally, as an independent public company, Allegiance has
different selling arrangements in international markets that unfavorably
impacted sales in comparison to the prior year. The combination of these issues
resulted in relatively flat sales in 1996 as compared to 1995. International
sales growth in 1995 was the result of continued focus on the penetration of
surgical products into these international markets and favorable foreign-
exchange rates. Management expects to increase its selling efforts
internationally by increasing the penetration of surgical products into
international markets.
For the last three years, sales to customers who are members of two large
hospital buying groups, Premier, Inc. ("Premier") and VHA Inc. ("VHA"), as a
percentage of total sales, were 27 percent and 20 percent, respectively in 1996,
27 percent and 16 percent, respectively in 1995, and 23 percent and 13 percent,
respectively in 1994. Premier and VHA each comprise a group of health-care
organizations that benefit from the pricing and other benefits available to
members of the group. Certain members of each group are free to purchase from
the vendors of their choice. Although the loss of the relationship with either
group could have a significant impact on sales to members of the group, the loss
of such group would not necessarily mean the loss of all sales from all members
of such group. In November 1996, Allegiance signed a new seven-year agreement
with Premier to supply its member hospitals with certain surgical and
respiratory therapy products. This agreement is not expected to impact sales
until late 1997.
Gross Margin and Expense Ratios
The following table summarizes Allegiance's gross margin and expense ratios,
excluding the divested businesses discussed previously:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
years ended December 31 (as a percent of sales) 1996 1995 1994
- - ----------------------------------------------------------------------
Gross margin 20.7% 20.8% 23.2%
Selling, general and administrative expenses 15.3 15.2 16.3
- - ----------------------------------------------------------------------
</TABLE>
Gross margins were relatively flat in 1996 compared to 1995. This stabilization
in gross margin resulted principally from the company's planned reduction in
sales of lower-margin, distributed products discussed previously, which offset
pricing pressures in Allegiance's higher-margin, self-manufactured products. The
gross margin decline in 1995 resulted from general market conditions, growth in
lower-margin sales of distributed products and the loss of a Columbia/HCA
surgical supply contract. Allegiance plans to continue its efforts to stabilize
its gross margin by offsetting pricing pressures with manufacturing cost
efficiencies, managing its product mix more effectively, and, when possible,
instituting price increases.
24
<PAGE>
Management's Discussion and Analysis
Total selling, general and administrative expenses declined $22.8 million in
1996 compared to 1995. However, such costs as a percent of sales increased
slightly, due to the decline in sales discussed previously, as the timing of
expense reduction initiatives that management implemented in both current and
prior periods lagged the planned reduction in lower-margin product sales. The
decline in the selling, general and administrative expense ratio between 1995
and 1994 resulted from initiatives taken in connection with the 1993
restructuring program and leverage on the growth in distributed products that
occurred in 1995. Management plans to continue to improve this ratio through
continued expense reduction initiatives.
Goodwill Write-Down
As part of Baxter, Allegiance followed the accounting policies established by
Baxter for its consolidated group. At the Distribution Date, goodwill, net of
accumulated amortization, was approximately $1,060.0 million. Baxter's policy
was to evaluate the overall recoverability of goodwill using projected
undiscounted cash flows.
Subsequent to the Distribution Date, the market value of Allegiance's stock was
substantially below its historical book value. As a result of this market value
and management's expectations that cost-containment efforts in the health-care
industry will continue to result in intense competitive pressures among health-
care suppliers, management re-evaluated its accounting policy regarding goodwill
impairment. In October 1996, the company's board of directors approved the
adoption of a new policy for assessing goodwill impairment based upon a fair
value approach. The company believes that fair value is a preferable method to
assess goodwill as it is a more objective indicator of the company's inherent
value as a separate publicly-traded entity and will be reflective of the
challenges and pressures that continue to be a fundamental part of the U.S.
health-care system.
The change in the method of assessing goodwill impairment resulted in a fourth
quarter charge of $550.0 million to operations and a reduction in goodwill
amortization of $4.7 million (9 cents per share). This policy change will
continue to reduce goodwill amortization expense by $18.9 million and $4.7
million on an annual and quarterly basis, respectively, for the next twenty-nine
years.
The company computes fair value based upon the price/earnings ("P/E") multiple
for a group of similar companies. This P/E multiple, calculated based on actual
quoted market prices per share and analysts' consensus earnings estimates for
these companies, is applied to management's best estimate of earnings for
Allegiance to arrive at an overall fair value of the company. Management will
continue to utilize the same group of companies in order to determine this P/E
multiple, provided that there are no significant changes in the underlying
characteristics of such companies.
Other Non-Recurring Costs
In addition to the goodwill write-down discussed above, the company incurred
$95.5 million of non-recurring costs in the fourth quarter of 1996. In
conjunction with carving out the Allegiance Business into a separate entity,
management re-evaluated the businesses and product lines in accordance with the
company's strategies. As a result of this evaluation, the company divested and
wrote-down assets of $62.8 million. This was principally a noncash charge that
related primarily to the divestiture of the company's Interwoven business and
facility consolidations.
Other non-recurring charges of $13.2 million were for costs related to the
company's spin-off from Baxter. These costs primarily included corporate
identity, name change and communications costs, as well as certain incremental
compensation costs.
25
<PAGE>
Management's Discussion and Analysis
In addition to the items noted above, non-recurring charges in the fourth
quarter of 1996 included $19.5 million for legal defense costs related to
natural rubber latex litigation cases. Refer to Note 16 to "Notes to
Consolidated Financial Statements" for additional discussion.
Restructuring Program
In November 1993, Baxter initiated a restructuring program to improve
shareholder 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
Consolidated Financial Statements" for discussions related to cash and noncash
utilization of the reserves.
Since the announcement of the 1993 restructuring program, Allegiance management
has implemented, or is in the process of implementing, all of the major
strategic actions associated therewith and is satisfied the program is
progressing on schedule and will meet established financial targets. During
1996, Allegiance utilized $86.6 million of restructuring reserves, including
$61.6 million in cash payments. Cash outflows pertain primarily to employee-
related costs for severance, outplacement assistance, relocation, implementation
teams and facility consolidations. As of December 31, 1996, Allegiance had
eliminated approximately 2,115 positions of the 2,300 positions expected to be
affected by the program. The majority of the remaining reductions will occur in
1997, as facility closures and consolidations are completed as planned. In
addition to improvements in the effectiveness of its sales force and the
management of customer relations, Allegiance realized direct savings in
manufacturing and administrative costs from this program of approximately $125.2
million, $95.0 million and $40.0 million in 1996, 1995 and 1994, respectively.
Management believes the program is on target to achieve anticipated direct
savings of approximately $155.0 million in 1997 and of at least $155.0 million
in 1998. The company anticipates that these savings will continue to partially
offset potential future gross margin erosion and investments into cost-
management initiatives. Management further believes 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
by 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. Refer to Note 13 to "Notes to 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 to
Allegiance. Interest expense in 1996 related to amounts borrowed by Allegiance
to fund a $1,147.3 million distribution to Baxter upon the spin-off and for
working capital requirements.
Other Income
Other income for 1996 consisted primarily of revenue from miscellaneous, non-
operating service fees. Other income for 1995 and 1994, excluding the divested
businesses discussed previously, consisted primarily of net gains associated
with the disposal or discontinuance of minor, non-strategic businesses.
26
<PAGE>
Management's Discussion and Analysis
Pretax Income
The following table compares pretax income, excluding the divested businesses
discussed previously, and non-recurring items:
<TABLE>
<CAPTION>
Percent
increase (decrease)
years ended December 31 (in millions, except percentages) 1996 1995 1994 1996 1995
- - ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Pretax income (loss), excluding divested businesses $(427.9) $245.3 $258.1 n/a (5.0%)
Adjust for non-recurring items/(1)/ 609.6 (37.3) (11.4) - -
Adjust for interest expense 18.6 - - - -
- - ------------------------------------------------------------------------------------------------------------------
Adjusted pretax income $ 200.3 $208.0 $246.7 (4.3%) (15.2%)
==================================================================================================================
Adjusted pretax income as a percent of sales 4.6% 4.6% 5.7% - -
==================================================================================================================
</TABLE>
(1) The 1996 non-recurring adjustments include the goodwill write-down, benefit
curtailment gains and other non-recurring items discussed previously. The 1995
and 1994 non-recurring adjustments reflect net gains associated with the
disposal or discontinuance of minor, non-strategic businesses discussed
previously.
Excluding the non-recurring items noted above and adjusting for interest expense
which did not impact earnings until the fourth quarter of 1996, pretax income
decreased as a result of the decrease in net sales discussed previously. Pretax
income remained flat as a percent of sales between 1996 and 1995.
Excluding the non-recurring items noted above, the decrease in pretax income as
a percent of sales between 1995 and 1994 was caused primarily by the 1995 gross
margin decline discussed earlier.
Income Taxes
Allegiance's effective tax rate in 1996 was impacted by the non-recurring fourth
quarter charges discussed previously. Excluding the divested businesses and the
tax benefit of $32.7 million associated with the non-recurring costs, the
effective tax rate would have been 37.9 percent in 1996 versus 38.5 percent in
1995. The decrease in this rate between 1996 and 1995 was caused principally by
the positive impact on earnings of lower goodwill amortization, which is a non-
taxable item, in the fourth quarter of 1996.
The effective tax rate, excluding divested businesses, in 1995 decreased by 0.8
percentage points from 39.3% in 1994, primarily due to a larger proportion of
earnings in lower tax jurisdictions.
Net Income
Excluding the divested businesses and the fourth quarter 1996 non-recurring
costs, the declines in net income between 1994 and 1996 are consistent with the
changes in pretax income and income taxes discussed previously.
Impact of Inflation
In recent years, Allegiance has experienced increases in its labor and material
costs influenced, in part, by general inflationary trends. While not directly
related to inflationary trends, Allegiance's revenue base over recent years has
been adversely affected by lower average selling prices on certain products as a
result of changes in Medicare reimbursement regulations, economic pressures in
the U.S. hospital marketplace and increased competition in certain product
lines. There is little correlation between general inflation rates directly
affecting costs and expenses and Allegiance's pricing levels for products sold
to health-care customers. Management expects these trends to continue.
27
<PAGE>
Management's Discussion and Analysis
Liquidity and Capital Resources
Management assesses Allegiance's liquidity in terms of its overall ability to
mobilize cash to support ongoing business levels and to fund its growth.
Management believes it has sufficient cash flow from operations and financial
flexibility to attract long-term capital to support normal operating activities
and fund short- and long-term growth objectives. Allegiance's current assets
exceeded current liabilities by $637.4 million at December 31, 1996, versus an
excess of $679.7 million at December 31, 1995. Current assets at December 31,
1996, included accounts receivable and notes and other current receivables of
$547.5 million and inventories of $628.5 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.
Debt and Financial Instruments
To meet its net financing requirements during the year ended December 31, 1996,
including a $1,147.3 million distribution to Baxter, the company borrowed under
its various credit facilities, as required. Refer to Note 8 to "Notes to
Consolidated Financial Statements" for additional discussion.
On October 15, 1996, Allegiance issued $200.0 million in aggregate principal
amount of the company's 7.30 percent notes due October 15, 2006; $150.0 million
in aggregate principal amount of the company's 7.80 percent debentures due
October 15, 2016; and $200.0 million in aggregate principal amount of the
company's 7.00 percent debentures due October 15, 2026. The net proceeds to the
company from the sale of these securities were used to reduce the amounts
outstanding under the company's credit facilities. The company received debt
ratings of Baa3 on senior debt by Moody's, BBB- by Standard & Poor's and BBB by
Duff & Phelps. Allegiance's long-term debt as a percent of total capital was
57.2 percent at December 31, 1996. Management plans to reduce this ratio over
time.
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. Management believes the company has credit facilities adequate to support
the company's 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 from Operations
Cash flow provided by operations was $317.1 million, $253.3 million and $422.2
million as of December 31, 1996, 1995 and 1994, respectively. The increase in
cash flow from operations in 1996 resulted from improved balance sheet
management -- primarily inventories and accounts payable. The decline in cash
flow from operations in 1995 was primarily the result of a decline in earnings,
resulting principally from the divestitures of the Industrial and Life Sciences
division and the diagnostics manufacturing businesses.
<TABLE>
<CAPTION>
Investment Transactions
years ended December 31 (in millions) 1996 1995 1994
- - ----------------------------------------------------------------------
<S> <C> <C> <C>
Capital expenditures $(102.5) $(111.9) $(122.4)
Acquisitions (23.8) (5.4) (1.9)
Proceeds from asset dispositions (11.2) 626.0 106.9
- - ----------------------------------------------------------------------
Total investment transactions, net $(137.5) $ 508.7 $ (17.4)
======================================================================
</TABLE>
Capital expenditures consisted principally of improvements to existing
facilities, system upgrades, productivity-enhancing equipment and other cost-
reduction projects. Allegiance management expects 1997 investments in capital
expenditures to remain at levels consistent with 1996.
28
<PAGE>
Management's Discussion and Analysis
The acquisitions summarized above involved no significant change to Allegiance's
strategic direction, and were made for the purpose of broadening product lines
and service offerings or expanding market coverage.
The net use of cash related to asset dispositions in 1996 related primarily to
cash payments from the settlement of certain programs associated with the
divestitures of the Industrial and Life Sciences division and the diagnostics
manufacturing businesses. The proceeds for 1995 related primarily to
Allegiance's divestiture of its Industrial and Life Sciences division in
September 1995 and the collection of notes receivable related to the December
1994 divestiture of Allegiance's diagnostics manufacturing businesses. The
proceeds in 1994 related to the divestiture of the diagnostics manufacturing
businesses. See Notes 5 and 6 to "Notes to Consolidated Financial Statements"
for additional information related to these divestitures.
In February 1997, the board of directors declared a quarterly dividend of 10
cents per share (annualized rate of 40 cents per share). The company intends to
grow dividends at a rate lower than its anticipated growth in earnings per
share.
On January 2, 1997, Allegiance acquired West Hudson & Co. Inc., a privately-
owned health-care consulting firm with 1996 annual sales of $38.1 million.
Allegiance paid approximately $30.5 million in cash and $10.5 million in stock
with contingent payments to be paid over the next four years. This acquisition
is consistent with Allegiance's strategic direction of providing cost-management
services.
Litigation
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. See
Note 16 to "Notes to Consolidated Financial Statements."
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 December 31, 1996, 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 $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 16 to "Notes to Consolidated Financial Statements," 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,
individually or in the aggregate, will have a material adverse effect on
Allegiance's overall business, cash flow, results of operations or financial
condition.
29
<PAGE>
Management's Responsibility for Financial Statements
Management is responsible for the preparation of the company's consolidated
financial statements and all related information appearing in this report. The
statements and notes have been prepared in conformity with generally accepted
accounting principles and include some amounts that are estimates based on
currently available information and management's judgement of current conditions
and circumstances. The company engaged Price Waterhouse LLP, independent public
accountants, to examine the consolidated financial statements. Their report
appears on this page.
To provide reasonable assurance that assets are safeguarded against loss from
unauthorized use or disposition and that accounting records are reliable for
preparing financial statements, management maintains a system of accounting
controls, including an internal audit program. The system of accounting controls
is improved in response to changes in business conditions, operations and
recommendations made by the independent public accountants and the internal
auditors.
The Board of Directors has an Audit and Public Policy Committee whose members
are not employees of the company. The committee met three times in 1996 with
management, internal auditors and representatives of the company's independent
public accountants to review the company's program of internal controls, audit
plans and results, and recommendations of the internal and external auditors and
management responses to those recommendations.
/s/ Lester B. Knight /s/ Peter B. McKee /s/ Richard C. Adloff
- - -------------------- ------------------ ---------------------
Lester B. Knight Peter B. McKee Richard C. Adloff
Chairman of the Board Senior Vice President Corporate Vice
and Chief Executive and Chief Financial President and
Officer Officer Controller
Report of Independent Accountants
To the Board of Directors and Stockholders of Allegiance Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of cash flows and of equity present
fairly, in all material respects, the financial position of Allegiance
Corporation and its subsidiaries at December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1996, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 2 to the consolidated financial statements, the company
changed its method of assessing goodwill impairment in 1996. We concur with the
change in accounting.
/s/ Price Waterhouse LLP
- - ------------------------
PRICE WATERHOUSE LLP
Chicago, Illinois
February 3, 1997
30
<PAGE>
Consolidated Balance Sheets
<TABLE>
<CAPTION>
as of December 31 (in millions, except par value and shares) 1996 1995
- - ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CURRENT ASSETS Cash and equivalents $ 22.9 $ 0.8
Accounts receivable, net of allowance for
doubtful accounts of $26.4 in 1996 and $18.2 in 1995 515.1 486.7
Notes and other current receivables 32.4 59.2
Inventories 628.5 684.4
Deferred income taxes 122.8 129.1
Prepaid expenses 13.8 11.8
-------------------------------------------------------------------------------
Total current assets 1,335.5 1,372.0
- - ----------------------------------------------------------------------------------------------------------------------------------
PROPERTY, PLANT At cost 1,519.1 1,307.1
AND EQUIPMENT Accumulated depreciation and amortization (681.2) (428.9)
-------------------------------------------------------------------------------
Net property, plant and equipment 837.9 878.2
- - ----------------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS Goodwill and other intangibles 514.5 1,115.7
Other 111.3 77.8
-------------------------------------------------------------------------------
Total other assets 625.8 1,193.5
-------------------------------------------------------------------------------
Total assets $2,799.2 $3,443.7
- - ----------------------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES Accounts payable and accrued liabilities $ 698.1 $ 692.3
- - ----------------------------------------------------------------------------------------------------------------------------------
LONG-TERM DEBT 1,106.6 -
- - ----------------------------------------------------------------------------------------------------------------------------------
DEFERRED INCOME TAXES 107.4 109.8
- - ----------------------------------------------------------------------------------------------------------------------------------
OTHER NON-CURRENT LIABILITIES 59.4 64.1
- - ----------------------------------------------------------------------------------------------------------------------------------
EQUITY Divisional retained earnings - 1,767.5
Equity investment of parent - 810.0
Common stock, $1 par value, authorized 200,000,000 shares,
issued 54,977,000 shares in 1996 55.0 -
Additional contributed capital 1.5 -
Retained earnings 769.2 -
Cumulative foreign currency adjustment 2.0 -
-------------------------------------------------------------------------------
Total equity 827.7 2,577.5
-------------------------------------------------------------------------------
Total liabilities and equity $2,799.2 $3,443.7
- - ----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
31
<PAGE>
Consolidated Statements of Operations
<TABLE>
<CAPTION>
years ended December 31 (in millions, except per share data) 1996 1995 1994
- - ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATIONS Net sales $4,387.2 $4,921.9 $5,108.6
Costs and expenses
Cost of goods sold 3,479.2 3,877.7 3,731.1
Selling, general and administrative expenses 672.0 749.6 965.2
Research and development 8.1 6.6 39.8
Goodwill write-down and other
non-recurring items 645.5 76.0 -
Interest expense 18.6 - -
Goodwill amortization 32.2 37.8 40.7
Benefit curtailment gains (35.9) - -
Other income (4.6) (301.8) (6.3)
-----------------------------------------------------------------------------------------
Total costs and expenses 4,815.1 4,445.9 4,770.5
-----------------------------------------------------------------------------------------
Income (loss) before income taxes (427.9) 476.0 338.1
Income tax expense 49.8 203.4 123.2
-----------------------------------------------------------------------------------------
Net income (loss) $ (477.7) $ 272.6 $ 214.9
- - ------------------------------------------------------------------------------------------------------------
PER SHARE DATA Net income (loss) per common share $ (8.70) n/a n/a
-----------------------------------------------------------------------------------------
Average number of common shares outstanding 54.9 n/a n/a
- - ------------------------------------------------------------------------------------------------------------
</TABLE>
n/a - not applicable
The accompanying notes are an integral part of these consolidated financial
statements.
32
<PAGE>
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
years ended December 31 (in millions) (Brackets denote cash outflows) 1996 1995 1994
- - -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOW Income (loss) from operations $ (477.7) $ 272.6 $ 214.9
PROVIDED BY Adjustments
OPERATIONS Depreciation and amortization 145.2 164.6 222.8
Deferred income taxes (13.7) 50.2 2.9
Gain on asset dispositions, net (pretax) - (262.5) (11.0)
Goodwill write-down and other
non-recurring charges 645.5 76.0 -
Benefit curtailment gains (35.9) - -
Other 6.0 5.4 1.9
Changes in balance sheet items
Accounts receivable (14.7) 73.0 8.0
Inventories 48.1 28.8 86.3
Accounts payable and
accrued liabilities 74.7 (120.2) (43.3)
Restructuring program payments (45.9) (62.0) (53.8)
Other (14.5) 27.4 (6.5)
-----------------------------------------------------------------------------------
Cash flow provided by operations 317.1 253.3 422.2
- - -----------------------------------------------------------------------------------------------------------
INVESTMENT Capital expenditures (102.5) (111.9) (122.4)
TRANSACTIONS Acquisitions (net of cash received) (23.8) (5.4) (1.9)
Proceeds from asset dispositions (11.2) 626.0 106.9
-----------------------------------------------------------------------------------
Investment transactions, net (137.5) 508.7 (17.4)
- - -----------------------------------------------------------------------------------------------------------
FINANCING Issuances of debt 603.6 - -
TRANSACTIONS Increase in debt with maturities
of three months or less, net 507.4 - -
Stock issued under employee
benefit plans 1.7 - -
Payments to Baxter International Inc. (1,270.2) (764.0) (402.0)
-----------------------------------------------------------------------------------
Financing transactions, net (157.5) (764.0) (402.0)
- - -----------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS 22.1 (2.0) 2.8
CASH AND EQUIVALENTS AT BEGINNING OF YEAR 0.8 2.8 -
- - -----------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS AT END OF YEAR $ 22.9 $ 0.8 $ 2.8
- - -----------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
33
<PAGE>
Consolidated Statements of Equity
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1996 1995 1994
- - ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
COMMON Balance, beginning of year $ -- n/a n/a
STOCK September 30, 1996, distribution of common stock 54.8
Stock issued under employee benefit plans 0.2
----------------------------------------------------------------------------------------
BALANCE, END OF YEAR 55.0
================================================================================================================
ADDITIONAL Balance, beginning of year -- n/a n/a
CONTRIBUTED Stock issued under employee benefit plans 1.5
CAPITAL ----------------------------------------------------------------------------------------
BALANCE, END OF YEAR 1.5
================================================================================================================
DIVISIONAL Balance, beginning of year 1,767.5 $2,258.9 $2,446.0
RETAINED Net income prior to September 30, 1996 117.8 272.6 214.9
EARNINGS Payments to Baxter International Inc. (460.2) (764.0) (402.0)
September 30, 1996, distribution of common stock (1,425.1) -- --
----------------------------------------------------------------------------------------
BALANCE, END OF YEAR -- 1,767.5 2,258.9
================================================================================================================
EQUITY Balance, beginning of year 810.0 810.0 810.0
INVESTMENT Payments to Baxter International Inc. (810.0) -- --
OF PARENT ----------------------------------------------------------------------------------------
BALANCE, END OF YEAR -- 810.0 810.0
================================================================================================================
RETAINED Balance, beginning of year -- n/a n/a
EARNINGS September 30, 1996, distribution of common stock 1,370.3
Common stock dividends declared (5.6)
Net loss subsequent to September 30, 1996 (595.5)
----------------------------------------------------------------------------------------
BALANCE, END OF YEAR 769.2
================================================================================================================
CUMULATIVE Balance, beginning of year -- -- --
FOREIGN Currency fluctuations 2.0 -- --
CURRENCY ----------------------------------------------------------------------------------------
ADJUSTMENT BALANCE, END OF YEAR 2.0 -- --
================================================================================================================
TOTAL EQUITY $ 827.7 $2,577.5 $3,068.9
================================================================================================================
</TABLE>
n/a - not applicable
The accompanying notes are an integral part of these consolidated financial
statements.
34
<PAGE>
Notes To Consolidated Financial Statements
1. Description of the Business
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.
Allegiance operates in a single industry segment as a leading provider of
health-care products and services that assist its health-care customers manage
and reduce the total cost of providing high-quality patient care. Through its
nationwide distribution network, Allegiance distributes a wide offering of
medical, surgical and laboratory products, including its own self-manufactured
surgical and respiratory therapy products, to hospital and alternate-site
customers. Allegiance also provides cost-management services to its health-care
customers through inventory-management programs, customized packaging, and
clinical procedure and process consulting.
Allegiance's historical results of operations in 1995 and 1994 include
revenues and expenses related to certain divested businesses. The Industrial and
Life Sciences division was sold in September 1995, and the diagnostics
manufacturing businesses were sold in December 1994. See Notes 5 and 6 to the
Consolidated Financial Statements for additional information related to these
divestitures.
The following table presents historical financial data for Allegiance
excluding the revenue and expenses associated with these divested businesses:
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1995 1994
- - ----------------------------------------------------------------------
<S> <C> <C>
Net sales $4,575.0 $4,313.7
Costs and expenses
Cost of goods sold 3,624.5 3,311.2
Selling, general and administrative expenses 694.8 704.9
Research and development 6.6 5.6
Goodwill amortization 36.8 36.7
Other income (33.0) (2.8)
- - ----------------------------------------------------------------------
Total costs and expenses 4,329.7 4,055.6
- - ----------------------------------------------------------------------
Pretax income 245.3 258.1
Income tax expense 94.4 101.4
======================================================================
Net income $ 150.9 $ 156.7
======================================================================
</TABLE>
2. Summary of Significant Accounting Policies
This summary of significant accounting policies is presented to assist the
reader in understanding and evaluating the consolidated financial statements.
These policies conform with generally accepted accounting principles and, except
for the change in the goodwill impairment policy, have been applied consistently
in all material respects. The preparation of financial statements in conformity
with generally accepted accounting principles requires management 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 differ from those estimates.
BASIS OF PRESENTATION
The accompanying financial statements for periods prior to the Distribution Date
include those assets, liabilities, revenues and expenses directly attributable
to Allegiance's operations. These financial statements have been prepared as if
Allegiance had operated as a free-standing entity for the periods presented. The
financial information prior to the Distribution Date does not necessarily
reflect what the financial position and results of operations of Allegiance
would have been had it operated as a stand-alone entity during the periods
covered, and may not be indicative of future operations or financial position.
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of Allegiance and its
majority-owned subsidiaries. Certain operations
35
<PAGE>
Notes To Consolidated Financial Statements
outside the United States and its territories, which are not significant, are
included in the consolidated financial statements on the basis of fiscal years
ending November 30.
Cash and Equivalents
Cash and equivalents include cash, cash investments and marketable securities
with an original maturity of three months or less. Cash payments for interest
were $7.4 million in 1996. Cash payments for income taxes were $0.6 million in
1996. Cash payments for income taxes relating to Allegiance's operations prior
to the Distribution Date were made by Baxter.
<TABLE>
<CAPTION>
Inventories
as of December 31 (in millions) 1996 1995
- - ------------------------------------------------------
<S> <C> <C>
Raw materials $ 52.8 $ 54.0
Work in process 46.4 49.0
Finished products 529.3 581.4
- - ------------------------------------------------------
Total inventories $628.5 $684.4
======================================================
</TABLE>
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Market for raw materials is based on replacement cost and for other
inventory classifications on net realizable value. Appropriate consideration is
given to deterioration, obsolescence and other factors in evaluating net
realizable value.
<TABLE>
<CAPTION>
Property, Plant and Equipment
as of December 31 (in millions) 1996 1995
- - --------------------------------------------------------------------
<S> <C> <C>
Land $ 98.1 $ 102.4
Buildings and leasehold improvements 397.4 396.0
Machinery and equipment 905.1 724.0
Equipment leased or rented to customers 19.0 13.7
Construction in progress 99.5 71.0
- - --------------------------------------------------------------------
Total property, plant and equipment, at cost 1,519.1 1,307.1
Accumulated depreciation and amortization (681.2) (428.9)
- - --------------------------------------------------------------------
Net property, plant and equipment $ 837.9 $ 878.2
====================================================================
</TABLE>
Property, plant and equipment are stated at cost. Depreciation and amortization
are provided for financial reporting purposes principally on the straight-line
method over the following estimated useful lives: buildings and leasehold
improvements, 20 to 50 years; machinery and other equipment, 3 to 20 years; and
equipment leased or rented to customers, 1 to 5 years. Leasehold improvements
are depreciated over the life of the related facility leases or the asset,
whichever is shorter. Straight-line and accelerated methods of depreciation are
used for income tax purposes.
Depreciation expense was $98.8 million in 1996, $106.3 million in 1995 and
$154.4 million in 1994. Repairs and maintenance expenses were $24.2 million in
1996, $36.4 million in 1995 and $30.0 million in 1994.
Goodwill and Other Intangible Assets
Goodwill represents the excess of cost over the fair value of net assets
acquired and is amortized on a straight-line basis over estimated useful lives
not exceeding 40 years. As part of Baxter, Allegiance followed the accounting
policies established by Baxter for its consolidated group. At the Distribution
Date, goodwill, net of accumulated amortization, was approximately $1,060.0
million. Baxter's policy was to evaluate the overall recoverability of goodwill
using projected undiscounted cash flows.
Subsequent to the Distribution Date, the market value of Allegiance's stock
was substantially below its historical book value. As a result of this market
value and management's expectations that cost-containment efforts in the health-
care industry will continue to result in intense competitive pressures among
health-care suppliers, management re-evaluated its accounting policy regarding
goodwill impairment. In October 1996, the company's board of directors approved
the adoption of a new policy for assessing goodwill impairment based upon a fair
value approach. The company believes that fair value is a preferable method to
assess goodwill as it is a more objective indicator of the company's inherent
value as a separate publicly-traded entity and will be reflective of the
challenges and pressures that continue to be a fundamental part of the U.S.
health-care system.
The change in the method of assessing goodwill impairment resulted in a
fourth quarter charge of $550.0 million to operations and a reduction in
goodwill amortization of $4.7 million (9 cents per share). This policy change
will continue to reduce goodwill amortization expense by $18.9 million and $4.7
million on an annual and quarterly basis, respectively, for the next 29 years.
The company computes fair value based upon the price/earnings ("P/E")
multiple for a group of similar companies.
36
<PAGE>
Notes To Consolidated Financial Statements
This P/E multiple, calculated based on actual quoted market prices per share and
analysts' consensus earnings estimates for these companies, is applied to
management's best estimate of earnings for Allegiance to arrive at an overall
fair value of the company. Management will continue to utilize the same group of
companies in order to determine this P/E multiple, provided that there are no
significant changes in the underlying characteristics of such companies.
Based upon management's assessment, the carrying value of goodwill at
December 31, 1996 is not impaired. As of December 31, 1996 and 1995, goodwill
was $510.7 million and $1,091.5 million, respectively, net of accumulated
amortization of $400.8 million and $369.1 million, respectively.
Other intangible assets include purchased patents, trademarks, deferred
charges and other identified rights that are amortized on a straight-line basis
over their legal or estimated useful lives, whichever is shorter (generally not
exceeding 17 years). As of December 31, 1996 and 1995, other intangibles were
$3.8 million and $24.2 million, respectively, net of accumulated amortization of
$18.3 million and $46.0 million, respectively.
Income Taxes
Allegiance's operations before the Distribution Date were included in Baxter's
consolidated U.S. federal and state income tax returns and in the tax returns of
certain Baxter foreign subsidiaries. The provision for income taxes prior to the
Distribution Date was determined as if Allegiance had filed separate tax returns
under its structure while part of Baxter. Accordingly, Allegiance's effective
tax rate in future years could vary from historical rates depending on the
company's current legal structure and tax elections. All income taxes prior to
the Distribution Date were settled with Baxter on a current basis through
Divisional Retained Earnings.
Provision has been made for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
Derivatives
Gains and losses on hedges of existing assets or liabilities are included in the
carrying amounts of these assets or liabilities and are ultimately recognized in
income as part of the carrying amounts. Gains and losses from qualifying hedges
of firm commitments or anticipated transactions also are deferred and are
recognized in income, or as adjustments of carrying amounts when the hedged
transaction occurs.
Stock-Option Plans
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does
not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The company has chosen to account for stock-
based compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related Interpretations. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of the company's
stock at the date of the grant over the amount an employee must pay to acquire
the stock. See Note 12 to the Consolidated Financial Statements.
Earnings Per Share
Net income per common share is based on the weighted average number of shares
outstanding subsequent to the Distribution, assuming the shares issued in
connection with the Distribution had been issued January 1, 1996. No historical
earnings per share data is presented for 1995 and 1994 because Allegiance's
earnings were part of Baxter's results, and the historical capital structure in
these periods is not comparable with Allegiance's capital structure after the
Distribution.
Reclassifications
Certain immaterial reclassifications have been made to conform the 1995 and 1994
financial statements and related footnotes to the 1996 presentation.
3. Pro Forma Financial Information
The following unaudited pro forma combined statements of operations present the
combined results of Allegiance assuming the transactions contemplated by the
Distribution and certain significant divestitures discussed in Note 1 to the
Consolidated Financial Statements had been completed as of January 1, 1995:
37
<PAGE>
Notes To Consolidated Financial Statements
<TABLE>
<CAPTION>
(unaudited, in millions, except per share data) 1996 1995
- - -----------------------------------------------------------------------
<S> <C> <C>
Net sales $4,386.7 $4,571.1
Costs and expenses
Cost of goods sold 3,481.5 3,624.7
Selling, general and administrative expenses /(a)/ 683.4 706.9
Research and development 8.1 6.6
Goodwill write-down and other
non-recurring items 645.5 -
Interest expense /(b)/ 86.1 90.0
Goodwill amortization 32.2 36.8
Other (income) expense /(c)/ (4.6) 4.3
- - -----------------------------------------------------------------------
Total costs and expenses 4,932.2 4,469.3
- - -----------------------------------------------------------------------
Pretax income (loss) (545.5) 101.8
Income tax expense /(d)/ 4.2 37.9
- - -----------------------------------------------------------------------
Net income (loss) $ (549.7) $ 63.9
=======================================================================
Net income (loss) per common share /(e)/ $ (10.01) $ 1.16
=======================================================================
Average number of common
shares outstanding 54.9 54.9
=======================================================================
</TABLE>
Significant pro forma adjustments (excluding the revenue and expenses associated
with the divested businesses discussed in Note 1) comprise the following:
(a) Pro forma adjustments of $11.4 and $12.1 million in 1996 and 1995,
respectively, principally reflect certain incremental corporate expenses that
are estimated to have occurred had the company operated on a stand-alone basis,
net of the estimated reduction in expenses related to changes in benefit plans.
(b) Pro forma adjustments of $67.5 and $90.0 million in 1996 and 1995,
respectively, reflect estimated interest expense the company would have incurred
on the incurrence of an estimated $1.2 billion of debt at a weighted average
interest rate of 7.5 percent.
(c) Pro forma adjustments of $37.3 million in 1995 reflect non-recurring
payments related to the transfer of rights under various service agreements with
Alliant Foodservices Inc., to reflect only those ongoing business operations to
be included in the Distribution.
(d) Pro forma adjustments of $45.6 million in 1996 and $56.5 million in 1995
reflect the estimated tax benefit, at statutory rates, for pro forma
adjustments.
(e) Pro forma net income (loss) per common share is computed as if the average
number of common shares of Allegiance stock had been outstanding for the periods
presented.
4. Non-Recurring Items
In addition to the goodwill write-down discussed in Note 2 to the Consolidated
Financial Statements, the company incurred $95.5 million of non-recurring costs
in the fourth quarter of 1996. In conjunction with carving out the Allegiance
Business into a separate entity, management re-evaluated the businesses and
product lines in accordance with the company's strategies. As a result of this
evaluation, the company divested and wrote-down assets of $62.8 million. This
was principally a noncash charge that related primarily to the divestiture of
the company's Interwoven business and facility consolidations.
Other non-recurring charges of $13.2 million were for costs related to the
company's spin-off from Baxter. These costs primarily included corporate
identity, name change and communications costs, as well as certain incremental
compensation costs.
In addition to the items noted above, non-recurring charges in the fourth
quarter of 1996 included $19.5 million for legal defense costs related to
natural rubber latex litigation cases. Refer to Note 16 to the Consolidated
Financial Statements.
<TABLE>
<CAPTION>
5. Restructuring Programs
Divestitures
Employee- and asset Other
(in millions) related costs write-downs costs Total
- - -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Initial restructuring charge $102.5 $ 278.1 $103.4 $ 484.0
Utilization:
Cash (31.0) (22.0) (23.3) (76.3)
Noncash - (160.2) - (160.2)
- - -------------------------------------------------------------------------------
December 31, 1994 71.5 95.9 80.1 247.5
Utilization:
Cash (28.5) (42.8) (33.2) (104.5)
Noncash - (66.3) - (66.3)
Adjustment to reserve - 76.0 - 76.0
- - -------------------------------------------------------------------------------
December 31, 1995 43.0 62.8 46.9 152.7
Utilization:
Cash (19.0) (15.8) (26.8) (61.6)
Noncash - (25.0) - (25.0)
- - -------------------------------------------------------------------------------
December 31, 1996 $ 24.0 $ 22.0 $ 20.1 $ 66.1
===============================================================================
</TABLE>
In November 1993, Baxter's board of directors approved a series of strategic
actions to improve shareholder value and reduce costs. The strategic actions of
the program 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. In November 1993, a $484.0 million pretax provision was recorded to
cover costs associated with these restructuring initiatives. Since the
announcement of the 1993 restructuring program, Allegiance has
38
<PAGE>
Notes To Consolidated Financial Statements
implemented, or is in the process of implementing, all of the major strategic
actions associated with the restructuring program, which is expected to be
completed by 1998.
Included in the 1993 restructuring plan was the intent to divest the
diagnostics manufacturing businesses, and a valuation allowance was established
as a component of the restructuring charge. In December 1994, subject to certain
settlement provisions, the divestiture of these businesses was completed and net
proceeds were received of approximately $44.0 million in cash, $200.0 million in
installment notes (which were collected in cash during January 1995) and $40.0
million in face value of preferred stock. In addition, accounts receivable were
retained of approximately $85.0 million, which was collected from customers in
the normal course of business. Allegiance has retained the rights to distribute
all current diagnostics products in the United States.
Throughout 1995, active discussions took place with the buyer of the
diagnostics businesses related to interpretations of and responsibility relative
to the settlement provisions contained in the purchase and sale and related
agreements. The divestiture also was significantly complicated by a dispute
between the diagnostics manufacturing businesses and one of its major suppliers,
which ultimately led to a lower than expected final valuation of the business.
This dispute has been settled. In the third quarter of 1995, settlement
negotiations were completed with the buyer of the diagnostics businesses, and
adjustments to the purchase price were finalized along with a revision of cost
estimates to complete the divestiture. This resulted in an additional
restructuring charge of $76.0 million.
Employee-related costs include provisions for severance, outplacement
assistance, relocation and retention payments for employees in the affected
operations worldwide. Since the inception of the restructuring program,
approximately 2,115 of the 2,300 positions expected to be affected by the
program have been eliminated. The majority of the remaining reductions will
occur in 1997, as facility closures and consolidations are completed as planned.
The company used noncash restructuring reserves for divestitures and asset
write-downs totaling $160.2 million in 1994, $66.3 million in 1995 and $25.0
million in 1996. Of these amounts, $117.8 million in 1994, $16.0 million in 1995
and $4.4 million in 1996 related to the divestiture of the diagnostics
manufacturing businesses. Also included was $42.4 million in 1994, $50.3 million
in 1995 and $20.6 million in 1996, relating primarily to the closure of
manufacturing facilities and consolidations of certain distribution facilities.
The utilization of the noncash restructuring reserves relating to the
diagnostics divestiture primarily represents the excess of the net assets of the
businesses sold over the proceeds received. The utilization of the noncash
restructuring reserves relating to the manufacturing facility closures and
distribution facility consolidations primarily represents fixed asset and
inventory write-downs.
The 1996 restructuring reserve balance consisted of $53.2 million of
current and $12.9 million of non-current reserves. The 1995 restructuring
reserve balance consisted of $89.1 million of current and $63.6 million of non-
current reserves.
6. Acquisitions, Investments in Affiliates and Divestitures
Acquisitions
Allegiance invested $23.8 million in 1996, $5.4 million in 1995 and $1.9 million
in 1994, for acquisitions accounted for as purchase transactions and investments
in affiliated companies. Had the acquisitions taken place January 1,
consolidated results in the year of acquisition would not have been materially
different from reported results. These acquisitions were consistent with
Allegiance's strategic direction and were made to acquire technologies, broaden
product lines and expand market coverage.
Divestitures
In 1995, Allegiance disposed of several businesses or product lines which
resulted in a net gain of $141.0 million (net of $121.5 million in related
income tax expense). The majority of the net gain for 1995 related to the
divestiture of Allegiance's Industrial and Life Sciences division ("Industrial")
to VWR Corporation for approximately $400.0 million in cash and $25.0 million in
deferred payments, resulting in a gain of $268.1 million. As part of the
divestiture, Allegiance will continue to supply its self-manufactured products
and supplies sold in non-health-care markets to VWR Corporation under a long-
term distribution agreement. Allegiance disposed of or discontinued several
minor non-strategic or unprofitable product lines or investments that resulted
in a net gain of $8.5 million (net of $3.2 million in related income tax
expense) in 1994. The majority of these transactions resulted in the disposition
of Allegiance's entire interest in such product lines and investments.
In 1996, the company paid $11.2 million related to divestitures. These cash
payments were associated primarily with the divestitures of the Industrial and
Life Sciences division and the diagnostics manufacturing businesses discussed in
Note 5 to the
39
<PAGE>
Notes To Consolidated Financial Statements
Consolidated Financial Statements. Proceeds from divestitures were $626.0
million in 1995, and $106.9 million in 1994. Proceeds in 1995 included
approximately $400.0 million for the Industrial divestiture discussed
earlier. The divestiture of the diagnostics manufacturing businesses
resulted in proceeds of approximately $199.9 million in 1995 and $43.7
million in 1994.
7. Accounts Payable and Accrued Liabilities
<TABLE>
<CAPTION>
as of December 31 (in millions) 1996 1995
- - -------------------------------------------------------------------------------
<S> <C> <C>
Accounts payable, principally trade $436.6 $377.9
Employee compensation and withholdings 72.1 88.4
Restructuring 39.3 88.7
Property, payroll and other taxes 31.2 40.2
Other 118.9 97.1
- - -------------------------------------------------------------------------------
Accounts payable and accrued liabilities $698.1 $692.3
===============================================================================
8. Credit Facilities, Long-Term Debt and Lease Obligations
Effective
as of December 31 (in millions, except percentages) interest rate 1996
- - -------------------------------------------------------------------------------
Borrowings under credit facilities 6.01% $ 562.1
- - -------------------------------------------------------------------------------
7.30% notes due 2006 7.39 199.6
- - -------------------------------------------------------------------------------
7.80% debentures due 2016 7.88 149.4
- - -------------------------------------------------------------------------------
7.00% 30 put 7 debentures due 2026 7.11 199.9
- - -------------------------------------------------------------------------------
Total long-term debt $1,111.0
===============================================================================
Current portion $ (4.4)
- - -------------------------------------------------------------------------------
Long-term portion $1,106.6
===============================================================================
</TABLE>
As of December 31, 1996, the company's two unsecured revolving credit agreements
provided for up to an aggregate of $1,050.0 million in borrowings. One of the
credit facilities provides for borrowings up to an aggregate of $900.0 million
and expires in September 2001. At December 31, 1996, $260.0 million was
outstanding under this facility. The other credit facility provided for
borrowings up to an aggregate of $150.0 million and expired in September 1997.
There were no amounts outstanding under this facility at December 31, 1996, and
the company terminated this facility on January 23, 1997. In conjunction with
these facilities, the company is required to comply with certain financial tests
and maintain certain leverage ratios. The company also maintains other short-
term credit facilities. At December 31, 1996, $302.1 million was outstanding
under these uncommitted facilities. Of the amounts outstanding under all
facilities, $557.7 million has been classified as long-term debt at December 31,
1996, as amounts are supported by a long-term credit facility and will continue
to be refinanced. Amounts borrowed under these facilities were used to fund a
$1,147.3 million distribution to Baxter and for working capital requirements.
The company had unamortized debt issuance costs of $4.5 million at December 31,
1996. Such costs are being amortized over the life of the underlying debt.
Certain facilities and equipment are leased under operating leases, expiring at
various dates. Most of the operating leases contain renewal options. Total
expense for all operating leases was $26.0 million in 1996, $26.4 million in
1995 and $37.5 million in 1994.
Future Minimum Debt and Lease Payments
<TABLE>
<CAPTION>
Operating Aggregate debt
as of December 31 (in millions) leases maturities
- - --------------------------------------------------------------
<S> <C> <C>
1997 $21.3 $ 4.4
1998 17.1 -
1999 12.7 -
2000 10.2 -
2001 5.5 557.7
Thereafter 8.8 550.1
- - --------------------------------------------------------------
Total obligations and commitments $75.6 $1,112.2
==============================================================
Amounts representing interest,
discounts, premiums and
deferred financing costs - $ 1.2
==============================================================
Present value of long-term debt - $1,111.0
==============================================================
</TABLE>
9. Financial Instruments and Risk Management
Concentrations of Credit Risk
The company provides credit, in the normal course of business, to hospitals,
private and government institutions, health-care agencies, insurance agencies
and doctors' offices. The company performs ongoing credit evaluations of its
customers and maintains reserves for potential credit losses which, when
realized, have been within the range of management's allowance for doubtful
accounts.
40
<PAGE>
Notes To Consolidated Financial Statements
Financial Instrument Use - Prior to Distribution Date
Allegiance was considered in Baxter's overall risk management strategy prior to
the Distribution Date. As part of this strategy, Baxter used certain financial
instruments to reduce its exposure to adverse movements in foreign-exchange
rates, interest rates and certain commodity prices. The strategies of Baxter did
not utilize financial instruments for trading purposes.
As part of implementing its strategy prior to the Distribution Date, Baxter
allocated to Allegiance the income and expense associated with certain option
contracts used to hedge anticipated cost of production expected to be
denominated in foreign currencies. The terms of these financial instruments were
less than one year. Allocated net expense and the related notional amounts for
these options were immaterial in all years presented.
Financial Instrument Use - Subsequent to Distribution Date
Allegiance uses certain commodity contracts to hedge costs of production
expected to be denominated in foreign currency. At December 31, 1996, the
related notional amount of such contracts was $21.0 million. Net expense related
to these contracts was not material. Use of financial instruments was not for
trading purposes.
Subsequent to the Distribution Date, the company's objective is to manage the
impact of interest rate changes on earnings, cash flows and borrowings. The
company maintains fixed-rate debt as a percentage of total debt between a
minimum and maximum percentage, as part of an overall risk management strategy.
The company's foreign-exchange objective is to reduce cash flow volatility
and earnings fluctuations associated with foreign-exchange rate changes. It is
the company's policy to utilize financial instruments to manage risk associated
with interest rate, foreign-currency or commodity transactions only to the
extent necessary to meet its objectives. At December 31, 1996, the company
evaluated its interest and foreign-exchange exposures and concluded that it was
not beneficial to use financial instruments to hedge its current positions with
respect to interest or foreign-exchange exposures.
Fair Values of Financial Instruments
The carrying values of cash and cash equivalents, accounts receivable and
payable, and accrued liabilities, approximate fair value due to the short-term
maturities of these assets and liabilities.
Investments in affiliates are accounted for by both the cost and equity
methods and pertain to several minor equity investments in companies for which
fair values are determined by quoted market prices and others for which fair
values are not readily available, but are believed to approximate carrying
amounts.
The aggregate fair value of borrowings under credit facilities approximate
carrying amount, because of recent and frequent repricing based on market
conditions. The carrying values of long-term borrowings, lease obligations and
hedges approximate fair value at December 31, 1996. The fair value of long-term
debt is based on quoted market prices for the same or similar issues.
10. Related Party Transactions
Prior to the Distribution Date, Baxter provided to Allegiance certain legal,
treasury, insurance and administrative services. Charges for these services were
based on actual costs incurred by Baxter. In addition, Allegiance was the
primary distributor of Baxter's intravenous solutions, cardiovascular devices
and other products in the United States and also provided other services to
Baxter. Negotiated fees for these distribution services were generally under the
same terms and conditions granted to independent third parties. Additionally,
these fees were not materially different than the terms of the distribution
agreement subsequent to the Distribution. A summary of related party
transactions, all of which were with Baxter or Baxter affiliates, is shown in
the table below:
<TABLE>
<CAPTION>
From
Jan. 1 to
(in millions) Sept. 30, 1996 1995 1994
- - -------------------------------------------------------------------
<S> <C> <C> <C>
Allegiance provided:
Distribution services to Baxter
in the United States $160.4 $213.7 $206.0
Administrative services to Baxter 18.9 25.2 24.2
Allegiance received:
Administrative services
from Baxter $ 36.2 $ 48.3 $ 46.3
International distribution
services from Baxter 19.4 25.8 24.8
===================================================================
</TABLE>
Management believes the pre-Distribution Date basis used to allocate corporate
services was reasonable. However, the terms of these transactions may differ
from those that would have resulted from transactions among unrelated parties.
41
<PAGE>
Notes To Consolidated Financial Statements
Prior to the Distribution Date, Allegiance participated in a centralized
cash-management program administered by Baxter. Short-term advances from Baxter
or excess cash sent to Baxter were treated as adjustments to Divisional Retained
Earnings through the Distribution Date. No interest was charged on this balance.
Effective on the Distribution Date, Baxter and Allegiance entered into a
series of administrative-services agreements under which Baxter and Allegiance
will continue to provide, for a specified period of time, certain administrative
services that each entity historically has provided to the other. These
agreements require both parties to pay each other a fee that approximates the
actual costs of these services. Additionally, Allegiance has continuing
significant relationships with Baxter as a distributor, customer and supplier
for an array of health-care products and services.
11. Preferred Stock
The board of directors has authorized the issuance of two million shares of $.01
par value preferred stock. This stock can be issued in series with varying terms
as determined by the board of directors.
Preferred Stock Purchase Rights
During September 1996, common stockholders received a dividend of one preferred
stock purchase right (collectively, the "Rights") for each share of common stock
held of record. Each Right entitles the registered holder to purchase from the
company one one-hundredth of a share of Series A Junior Participating Preferred
Stock for $65 (subject to adjustment). The Rights will become exercisable (and
transferable apart from the common stock) on the earlier of (1) 10 days
following a public announcement that a person or group has acquired 15 percent
or more of the common stock, or (2) 10 business days following the commencement
of an offer to acquire 15 percent or more of the common stock.
If, after the Rights become exercisable, any person or group (the "Acquirer")
acquires 15 percent or more of the common stock (except pursuant to an offer for
all outstanding shares of common stock which the independent directors determine
to be fair to and otherwise in the best interests of the company and its
stockholders) each Right may be exercised for common stock (or, in certain
circumstances, cash, other property or securities) having a value of $130 or
equal to two times the exercise price of the Right, if adjusted. In specified
circumstances, each Right may be exercised for common stock of an acquiring
entity having a value of $130 or equal to two times the exercise price of the
Right, if adjusted. All Rights held by the Acquirer will be null and void. The
company may generally redeem the Rights at a price of $.01 per Right at any time
until 10 days following a public announcement that a person or group has
acquired 15 percent or more of the common stock. The Rights will expire at the
close of business on September 30, 2006, unless redeemed earlier.
12. Common Stock
Employee Stock Purchase Plan
Subsequent to the Distribution Date, the company adopted an employee stock
purchase plan under which the sale of its common stock has been authorized. The
purchase price is the lower of 85 percent of the closing market price on the
date of subscription or 85 percent of the closing market price on the date of
purchase. Expiration dates for these subscriptions run from October 1 to
December 31, 1998. The weighted average subscription price was approximately
$15.66 at December 31, 1996. Stock purchase plan transactions for the year ended
December 31, 1996, are summarized below:
<TABLE>
<CAPTION>
Shares subscribed 1996
- - ------------------------------------------
<S> <C>
Inception of plan 0
Subscriptions 981,820
Purchases (93,159)
Cancellations 0
- - ------------------------------------------
End of year 888,661
- - ------------------------------------------
Subscription price per
share outstanding,
end of year $14.45 - $23.48
==========================================
</TABLE>
Stock-Option Plans
The company has various stock-option plans for employees and non-employee
directors. All outstanding options under these plans have been granted at 100
percent of fair market value on the dates of grant and expire in 2006. At
December 31, 1996, the weighted average option price was about $19.91, and no
shares can be exercised until October 1998 or later.
Stock-option transactions for the year ended December 31, 1996, are
summarized on the following page:
42
<PAGE>
Notes To Consolidated Financial Statements
<TABLE>
<CAPTION>
Option shares outstanding 1996
- - ------------------------------------------------
<S> <C>
Inception of plans 0
Granted 6,554,327
Exercised 0
Cancelled/Expired (41,728)
- - ------------------------------------------------
End of year 6,512,599
- - ------------------------------------------------
Option price per share
outstanding, end of year $18.38 - $22.88
================================================
</TABLE>
Restricted Stock
In October 1996, the company granted 86,203 shares of restricted common stock to
provide incentive compensation to selected employees. There was no activity
related to these shares during the period. All outstanding shares are subject to
future employment and vest in October 1998.
SFAS No. 123
No compensation cost has been recognized for the stock-option or stock purchase
plans noted above. Had compensation cost been determined based on the fair value
at the date of grant consistent with the provisions of SFAS No. 123, the
company's net loss and net loss per share in 1996 would have been $480.5 million
and $8.75. The fair value of each option-grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants: dividend yield of 1.45 percent; expected volatility
ranging from 29.8 percent to 32.9 percent; risk-free interest rate ranging from
5.1 percent to 6.5 percent; and expected lives ranging from one month to 7
years.
13. Retirement and Other Benefit Programs
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 who retired before the Distribution Date
also remained with Baxter. As a result, Allegiance recognized curtailment gains
of $35.9 million related to these plans during the third quarter.
Pension expense associated with the Baxter-sponsored plans prior to its being
frozen was $17.2 million for the nine months ended September 30, 1996, and $17.2
million and $22.2 million for the years ended December 31, 1995 and 1994,
respectively. The assumed discount rate applied to benefit obligations to
determine pension expense was 7.25 percent for the period ended September 30,
1996, and 9.0 percent for the years ended December 31, 1995 and 1994. The
assumed long-term rate of return on assets was 9.5 percent.
Expense associated with retiree benefits prior to the Distribution Date was
$5.0 million for the nine months ended September 30, 1996, and $9.4 million in
1995 and 1994. Allegiance does not fund health-care and life-insurance plans for
employees retiring subsequent to the Distribution Date.
The liability associated with postemployment benefits such as disability-
related and workers' compensation payments was $17.5 million for 1996, $14.4
million for 1995, and $13.5 million for 1994.
Most U.S. employees are eligible to participate in a qualified 401(k) plan.
Participants may contribute up to 12 percent of their annual compensation
(limited in 1996 to $9,500 per individual) to the plan and Allegiance matches
participants' contributions, up to 3 percent of compensation. Matching
contributions made by Allegiance were $9.4 million in 1996, $11.4 million in
1995, and $13.7 million in 1994.
14. Other Income
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1996 1995 1994
- - -------------------------------------------------------------------
<S> <C> <C> <C>
Asset dispositions, net $ - $(262.5) $(11.7)
Foreign exchange 1.0 0.3 5.4
Other (5.6) (39.6) -
- - -------------------------------------------------------------------
Total other income $(4.6) $(301.8) $ (6.3)
===================================================================
</TABLE>
15. Income Taxes
Income (Loss) Before Tax Expense by Category
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1996 1995 1994
<S> <C> <C> <C>
- - -----------------------------------------------------------------
U.S. $(491.9) $433.9 $291.8
International 64.0 42.1 46.3
- - -----------------------------------------------------------------
Income (loss) before
income tax expense $(427.9) $476.0 $338.1
=================================================================
</TABLE>
43
<PAGE>
Notes To Consolidated Financial Statements
Income Tax Expense by Category
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1996 1995 1994
- - -----------------------------------------------------------------
<S> <C> <C> <C>
Current
U.S.
Federal $ 48.6 $124.1 $ 90.7
State and local 11.4 34.2 26.4
International 3.5 (5.1) 3.3
- - -----------------------------------------------------------------
Current income tax expense 63.5 153.2 120.4
- - -----------------------------------------------------------------
Deferred
U.S.
Federal (9.4) 38.0 (5.3)
State and local (1.4) 8.4 4.4
International (2.9) 3.8 3.7
- - -----------------------------------------------------------------
Deferred income tax expense (benefit) (13.7) 50.2 2.8
- - -----------------------------------------------------------------
Income tax expense $ 49.8 $203.4 $123.2
=================================================================
</TABLE>
Income tax expense prior to the Distribution Date was calculated
as if Allegiance were a stand-alone entity.
Deferred Tax Assets and Liabilities
<TABLE>
<CAPTION>
as of December 31 (in millions) 1996 1995 1994
- - ------------------------------------------------------------------------
<S> <C> <C> <C>
Deferred tax assets
Accrued expenses $ 93.8 $ 70.0 $ 59.5
Restructuring and non-
recurring costs 62.4 56.9 77.4
Other - 0.1 0.1
- - ------------------------------------------------------------------------
Total deferred tax assets 156.2 127.0 137.0
- - ------------------------------------------------------------------------
Deferred tax liabilities
Asset-basis differences 125.8 106.7 46.2
Other 4.8 1.0 (0.2)
- - ------------------------------------------------------------------------
Total deferred tax liabilities 130.6 107.7 46.0
- - ------------------------------------------------------------------------
Net deferred tax assets $ 25.6 $ 19.3 $ 91.0
========================================================================
</TABLE>
In 1996, $7.4 million of deferred tax assets were transferred to Baxter, related
primarily to spin-off costs assumed by Baxter. In 1995, $21.5 million of
deferred tax assets were transferred to Baxter. The deferred tax assets related
to the asset-basis difference associated with preferred stock received in
connection with the divestiture of the diagnostics manufacturing businesses.
Since agreements entered into with the buyer of the diagnostics manufacturing
businesses require that the preferred stock be retained by Baxter for a
prescribed period of time, the related deferred tax assets were transferred to
Baxter.
Under a tax sharing agreement with Baxter, Allegiance will pay for increases
and be reimbursed for decreases to the net deferred tax assets transferred on
the Distribution Date. Such increases or decreases may result from audit
adjustments to Baxter's prior period tax returns.
Reconciliation of Income Tax Expense (Benefit)
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1996 1995 1994
- - ------------------------------------------------------------------
<S> <C> <C> <C>
Income tax expense (benefit)
at statutory rate $(149.8) $166.4 $118.4
Tax-exempt operations (19.6) (17.4) (22.8)
Nondeductible goodwill
and non-recurring costs 213.5 28.1 13.9
State and local taxes 6.5 27.0 15.4
Foreign tax expense (2.0) (0.8) (2.4)
Other factors 1.2 0.1 0.7
- - ------------------------------------------------------------------
Income tax expense $ 49.8 $203.4 $123.2
==================================================================
</TABLE>
The company has manufacturing operations outside the United States that benefit
from reductions in local tax rates under tax incentives that will continue at
least through 1998. U.S. federal income taxes, net of available foreign tax
credits, on unremitted foreign earnings would have been approximately $36.4
million as of December 31, 1996.
16. 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
44
<PAGE>
Notes To Consolidated Financial Statements
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. In April 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 is the only named defendant
in this 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). Baxter and three other
companies are defendants. On October 9, 1996, the plaintiff in a case pending in
federal court filed a petition with the Judicial Panel on Multi District
Litigation, In re Latex Gloves Products Liability Litigation, (MDL Docket No.
1148), seeking to transfer and consolidate the cases 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 March 1, 1997, 80 additional lawsuits had been served on 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 December 31, 1996, 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 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.
45
<PAGE>
Notes To Consolidated Financial Statements
17. Industry and Geographic Information
Allegiance operates in a single industry segment as a leading provider of
medical, surgical and laboratory products, and services that help its customers
manage quality and cost in providing patient care. Through its nationwide
distribution network, Allegiance distributes a wide offering of health-care
products, including its own self-manufactured surgical and respiratory therapy
products, to hospital and alternate-site customers. Allegiance also provides
cost-management services to its health-care customers through inventory-
management programs, customized packaging, and clinical procedure and process
consulting.
International sales from self-manufactured products are primarily in Canada,
France and Germany. Additionally, the company has manufacturing operations in
Malaysia, Mexico, France and Malta. The majority of raw materials used for the
manufacture of natural rubber latex gloves is found in Malaysia. None of these
geographic locations represents 10 percent or more of the company's net sales or
identifiable assets.
For the last three years, sales to customers who are members of two large
hospital buying groups, Premier, Inc. ("Premier") and VHA Inc. ("VHA"), as a
percentage of total sales, were 27 percent and 20 percent, respectively in 1996,
27 percent and 16 percent, respectively in 1995, and 23 percent and 13 percent,
respectively in 1994. Premier and VHA each comprise a group of health-care
organizations that benefit from the pricing and other benefits available to
members of the group. Certain members of each group are free to purchase from
the vendors of their choice. Although the loss of the relationship with either
group could have a significant impact on sales to members of the group, the loss
of such group would not necessarily mean the loss of all sales from all members
of such group.
18. Subsequent Event
On January 2, 1997, Allegiance acquired West Hudson & Co. Inc., a privately-
owned health-care consulting firm with 1996 annual sales of $38.1 million.
Allegiance paid approximately $30.5 million in cash and $10.5 million in stock
with contingent payments to be paid over the next four years. This acquisition
is consistent with Allegiance's strategic direction of providing cost-management
services.
19. Quarterly Financial Results and Market for the Company's Stock
(Unaudited)
<TABLE>
<CAPTION>
First Second Third Fourth Total
(unaudited, in millions, except per share data) quarter quarter quarter quarter year
- - ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1996
Net sales $1,115.0 $1,086.1 $1,094.2 $1,091.9 $4,387.2
Gross profit 225.7 229.1 230.7 222.5 908.0
Net income (loss) /(1)/ 30.6 26.7 60.5 (595.5) (477.7)
Per common share:
Net income (loss) /(1)/ /(2)/ n/a n/a n/a (10.85) (8.70)
Dividends n/a n/a n/a .10 .10
Market price
High /(3)/ n/a n/a 18.63 27.88 27.88
Low /(3)/ n/a n/a 16.25 17.00 16.25
==============================================================================================================================
1995
Net sales $1,226.0 /(4)/ $1,259.4 /(4)/ $1,261.6 /(4)/ $1,174.9 $4,921.9
Gross profit 279.2 266.5 266.9 231.6 1,044.2
Net income 42.8 42.6 137.8 49.4 272.6
Per common share:
Net income /(2)/ n/a n/a n/a n/a n/a
Dividends n/a n/a n/a n/a n/a
Market price
High n/a n/a n/a n/a n/a
Low n/a n/a n/a n/a n/a
==============================================================================================================================
</TABLE>
n/a - not applicable
(1) Net loss for the fourth quarter includes a charge of $550.0 million for the
write-down of goodwill and other non-recurring costs of a pretax amount of
$95.5 million primarily for facility consolidations and other asset write-
downs.
(2) Earnings per share data is not applicable as Allegiance's earnings were
part of the results of Baxter International Inc. through September 30,
1996.
(3) Allegiance stock traded on a "when issued" basis from September 24, 1996 to
September 30, 1996.
(4) Data includes certain businesses that were divested in 1995.
Allegiance common stock is listed on the New York Stock Exchange and the Chicago
Stock Exchange. The New York Stock Exchange is the principal market on which the
company's common stock is traded. At January 31, 1997, there were approximately
58,000 holders of record of the company's common stock.
46
<PAGE>
Five-Year Summary of Selected Financial Data
<TABLE>
<CAPTION>
years ended December 31 1996/(1)/ 1995/(2)/ 1994/(2)/ 1993/(2)/(3)/ 1992/(2)/
- - -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATIONS Net sales $4,387.2 4,921.9 5,108.6 5,019.3 4,860.9
(in millions) Net income (loss) $ (477.7) 272.6 214.9 (68.4) 242.8
Depreciation and amortization $ 145.2 164.6 222.8 221.0 196.2
- - -----------------------------------------------------------------------------------------------------------------------------------
CAPITAL EMPLOYED Working capital $ 637.4 679.7 1,054.9 928.1 862.2
(in millions) Capital expenditures $ 102.5 111.9 122.4 273.1 278.2
Total assets $2,799.2 3,443.7 4,031.4 4,576.2 4,275.7
Long-term obligations $1,106.6 - - - -
- - -----------------------------------------------------------------------------------------------------------------------------------
PER COMMON Average number of common shares
SHARE/(4)/ outstanding (in millions) 54.9 n/a n/a n/a n/a
Net income (loss) $ (8.70) n/a n/a n/a n/a
Cash dividends declared $ 0.10 n/a n/a n/a n/a
Market price - high $ 27.88 n/a n/a n/a n/a
Market price - low $ 16.25 n/a n/a n/a n/a
- - -----------------------------------------------------------------------------------------------------------------------------------
PRODUCTIVITY Employees at year-end 20,700 21,300 21,100 26,900 22,900
MEASURES Sales per year-end employee $211,942 231,075 242,114 186,591 212,266
Net income (loss) per employee $(23,077) 12,798 10,185 (2,543) 10,603
- - -----------------------------------------------------------------------------------------------------------------------------------
FINANCIAL RETURNS Net income (loss) as a percent of sales (10.9)% 5.5 4.2 (1.4) 5.0
AND STATISTICS Long-term debt as a percent of total
year-end capital 57.2% - - - -
===================================================================================================================================
</TABLE>
n/a - not applicable
(1) Net loss for 1996 includes a charge of $550.0 million for the write-down of
goodwill and other non-recurring costs of a pretax amount of $95.5 million
primarily for facility consolidations and other asset write-downs.
(2) Data includes certain businesses that were divested in 1994 and 1995.
(3) Net loss includes a provision for restructuring charges of a pretax amount
of $484.0 million.
(4) Earnings per share data is not applicable as Allegiance's earnings were
part of the results of Baxter International Inc. through September 30,
1996.
47
<PAGE>
EXHIBIT 23.1
CONSENT OF PRICE WATERHOUSE LLP
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-12753) of Allegiance Corporation of our report
dated February 3, 1997 appearing in the Annual Report to Stockholders which is
incorporated in this Annual Report on Form 10-K. We also consent to the
incorporation by reference of our report on the Financial Statement Schedule,
which appears in this Form 10-K.
PRICE WATERHOUSE LLP
Chicago, Illinois
March 27, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
the Consolidated Balance Sheet as of December 31, 1996 and Consolidated
Statement of Operations for the year ended December 31, 1996 and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 23
<SECURITIES> 0
<RECEIVABLES> 541<F1>
<ALLOWANCES> 26
<INVENTORY> 629
<CURRENT-ASSETS> 1,336
<PP&E> 1,519
<DEPRECIATION> 681
<TOTAL-ASSETS> 2,799
<CURRENT-LIABILITIES> 698
<BONDS> 1,107
<COMMON> 55
0
0
<OTHER-SE> 773
<TOTAL-LIABILITY-AND-EQUITY> 2,799
<SALES> 4,387
<TOTAL-REVENUES> 4,387
<CGS> 3,479
<TOTAL-COSTS> 4,815<F2>
<OTHER-EXPENSES> (5)
<LOSS-PROVISION> 10
<INTEREST-EXPENSE> 19
<INCOME-PRETAX> (428)<F2>
<INCOME-TAX> 50
<INCOME-CONTINUING> (478)<F2>
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (478)<F2>
<EPS-PRIMARY> (8.70)<F2><F3>
<EPS-DILUTED> 0<F4>
<FN>
<F1> Gross
<F2> Net loss includes a charge of $550 million for the write-down of goodwill
and other non-recurring costs of a pretax amount of $96 million, primarily
for facility consolidations and other asset write-downs.
<F3> Common shares are based on the weighted average number of shares
outstanding subsequent to the distribution on September 30, 1996, assuming
the shares issued in connection with the distribution had been issued
January 1.
<F4> Information not applicable.
</FN>
</TABLE>
