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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, 1997
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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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 $34.875 on February 28, 1998, and for the purpose of
this computation only, the assumption that all registrant's directors and
executive officers are affiliates) was approximately $2.0 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 February 28, 1998, 57,440,974 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, 1997
(Part II).
Proxy Statement for Annual Meeting of Stockholders to be held on May 7,
1998 (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 their U.S. health-care distribution business, surgical
and respiratory therapy business and health-care cost-saving 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 occurred on the
Distribution Date through a distribution of Allegiance common stock to Baxter
stockholders (the "Distribution"). Unless the context indicates otherwise, 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. 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-
saving services for hospitals and other health-care providers. These
integrated businesses recorded total sales of approximately $4.4 billion in
1997.
The economics of health care are changing rapidly, 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 U.S. 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 continues to climb with the growth of aging
populations in the United States and throughout much of the industrialized
world. This environment offers opportunities for Allegiance, which has
invested in integrated product and service programs that help medical
professionals cope with health care's economic and demographic trends.
The health-care distribution market in the United States has experienced
intense competition and a resultant erosion in margins in recent years in
response to the growth of managed care and increased consolidation among
health-care providers. Allegiance has responded and stabilized its margins by
integrating its market-leading distribution capabilities with a broad product
offering, including an increasing amount of self-manufactured products; high
levels of customer service; and innovative cost-saving services.
PRODUCT OFFERING
Allegiance has differentiated itself by integrating its product offering
with its distribution and cost-saving services. Allegiance offers the
industry's broadest range of medical and laboratory products, representing
more than 2,800 suppliers in addition to its own line of surgical and
respiratory therapy products.
Allegiance works 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 operates 22 domestic and international manufacturing plants,
producing products used in surgery and other medical procedures. All
Allegiance plants are required to be ISO 9000 certified.
Allegiance has several major product lines, most of which hold leading sales
positions:
Custom-Sterile(TM) Products and PBDS(TM) Pathways
Allegiance's leading Custom-Sterile(TM) products and PBDS(TM) Pathways
service help health-care providers save time and money by assembling customer-
designated supplies into 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 minor wound closure. 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.
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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 surgical and exam gloves made from natural rubber
latex and synthetic materials such as neoprene and vinyl.
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. In
1997, Allegiance acquired a line of surgical devices from Surgin Surgical
Instrumentation, Inc. The acquisition broadens Allegiance's line of Medi-
Vac(R) fluid suction and collection products for the growing area of
laparoscopic, or less-invasive, surgery.
Respiratory Therapy Products
Allegiance is a leading manufacturer and marketer of respiratory therapy
products, which are used primarily to deliver oxygen and medication to
patients with breathing disorders. 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. In 1997,
Allegiance acquired a line of respiratory-care devices and supplies from
Kendall Healthcare Products Company. This acquisition extends Allegiance's
leadership in respiratory care with new products that are used widely in
patients' homes, nursing homes and hospitals to treat asthma, pneumonia,
emphysema, bronchitis and other respiratory conditions.
V. Mueller
Allegiance's V. Mueller product portfolio comprises a broad range of
specialty surgical instruments, instrument reprocessing products, and
sterilization packaging, including the Genesis(TM) Container System. V.
Mueller is rapidly expanding its Capital Asset Service's programs that assist
customers in reducing their overall equipment costs. The V. Mueller business
was established in 1895 and is known worldwide for the quality of its products
and services. V. Mueller has two dedicated manufacturing facilities and an
extensive global finished-product sourcing network.
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 urinary drainage catheters, and it
manufactures endotracheal tubes for respiration, anesthesia, and other
therapies. The Company 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. Allegiance also
manufactures and markets a broad line of patient-preparation, hair-removal,
and skin-care products such as clippers and razors, as well as special soaps,
sponges and scrub brushes for surgeons and other operating room personnel.
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DISTRIBUTION SERVICES
Allegiance is a leading distributor of medical, surgical, and laboratory
products in the United States. Allegiance can supply any of more than 300,000
different products to its customers. Most items are available for shipment the
same day the customer requests them. Allegiance has 49 U.S. distribution
centers that deliver products throughout the United States. 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
2,800 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.
In late 1997, one of Allegiance's international subsidiaries combined
distribution operations with MDS Inc. of Toronto to create a new company,
Source Medical Corporation, which is now Canada's largest supplier of medical
products. Through Source Medical Corporation, Allegiance owns or leases 14
distribution centers throughout Canada. Also in 1997, Allegiance, through an
international subsidiary, purchased the production and distribution companies
of SOHO Holding B.V., a leading supplier of medical and surgical products in
the Netherlands.
Allegiance divides its distributed products into two categories: medical-
surgical products ("med-surg") and laboratory products. Allegiance 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 many
others. Increasingly, these products are delivered just-in-time in ready-to-
use quantities. In some cases, Allegiance delivers the products directly to
patient floors. Allegiance distributes products to hospitals, surgery centers,
physician clinics, other distributors, long-term and sub-acute care
facilities, home-care companies, and other health-care providers. Laboratory
products -- used primarily to perform diagnostic tests -- are sold principally
to hospitals, independent laboratories and other health-care providers. These
products include test tubes, pipettes, slides, and equipment such as
microscopes, automated diagnostic 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 provides its Custom-
Sterile(TM) Products and its PBDS(TM) Pathways Service, which 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
Since 1995, Allegiance has been consolidating its distribution service
around a carefully selected group of preferred suppliers in order to reduce
the number of suppliers that furnish identical items. This "Best Value
Products" strategy is strengthening Allegiance's relationships with suppliers,
resulting in savings to Allegiance and better service for its customers.
Allegiance also is continuing to streamline its distribution network to reduce
costs, improve service, and strengthen its growing number of cost-saving
relationships with health-care providers.
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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 is making major
investments in information technology that uses EDI, or electronic data
interchange, to exchange purchasing and inventory data with its suppliers and
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 and managed care pushes patients
into lower-cost settings for treatment. 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 non-hospital customers, Allegiance
has developed the capability to deliver smaller orders more frequently.
Allegiance also enters into relationships with dealers that specialize in
serving these markets. For some 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. In 1997, Allegiance formed the Care
Continuum business, an organization focused on growing the Company's direct
sales outside the hospital.
COST-SAVING SERVICES
Reducing costs while improving quality of care is the most significant
challenge facing health-care providers today. Through its cost-savings
programs, Allegiance aligns its goals with those of its customers. Under many
of 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. In mid 1997, Allegiance also began
offering cost-saving consulting on a fee-for-service basis. As of December 31,
1997, Allegiance had 46 cost-savings agreements with hospitals or hospital
systems. Alternatively, these agreements covered 126 250-bed equivalent
facilities in 1997. In these 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 among Allegiance's Best Value Products, 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-savings accounts come from the
implementation of PBDS(TM) Pathways 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) Pathways 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 a range of professional consulting
services. The Company's proprietary database of best demonstrated practices
helps hospitals improve their clinical operations, reduce lengths of stay and
improve clinical outcomes. Consistent with its strategic direction of
providing cost-saving services, Allegiance acquired West Hudson & Co. Inc., a
privately-owned health-care consulting firm in January 1997. 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. Allegiance's
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.
CONTRACTUAL ARRANGEMENTS; BUYING GROUPS
A substantial portion of Allegiance's products are sold through contracts
with group purchasing organizations. 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 that are members of two large
hospital buying groups, Premier, Inc. ("Premier") and VHA Inc. ("VHA"), as a
percentage of total sales, were 28 percent and 20 percent, respectively, in
1997, 27 percent and 20 percent, respectively, in 1996, and 27 percent and 16
percent, respectively, in 1995. 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 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 sales
from all members of the 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 a Strategic Account Executive to coordinate the various
Allegiance Businesses' sales efforts. The Strategic Account Executive 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 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. To
support future business opportunities overseas, the Company also formed new
subsidiaries in Belgium, Spain, Italy and Switzerland in late 1997.
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 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.
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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 consolidation and increased
competition among health-care manufacturers and 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-saving 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 objective of providing superior service to 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.
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, results 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. All Allegiance plants are required to be ISO 9000
certified.
GOVERNMENT REGULATION
Most of the products manufactured or sold by Allegiance in the United States
are subject to regulation by the U.S. Food and Drug Administration ("FDA"), as
well as by other federal and state agencies. The FDA regulates the
introduction and advertising of new medical products and related manufacturing
procedures, labeling, and record-keeping. The FDA has the power to seize
adulterated or misbranded medical products, 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 expenditures for environmental protection
related to the Allegiance Business were made during 1996 and 1997. See "Item
3--Legal Proceedings."
RELATIONSHIP WITH BAXTER
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 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.
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Allegiance and Baxter entered into various agreements to govern certain of
the ongoing relationships between Baxter and Allegiance after the
Distribution, which provided mechanisms for an orderly transfer of the
Allegiance Business from Baxter to Allegiance, and facilitated an orderly
transition to the status of two separate, publicly traded companies.
Reorganization Agreement
Baxter and Allegiance entered into a reorganization agreement (the
"Reorganization Agreement") in 1996 as part of the spin-off of the Allegiance
Business. 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) designed principally
to place financial responsibility for the obligations and 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 Allegiance products and operations whether 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 Baxter and Allegiance
will indemnify each other in the event certain liabilities arise under the
Securities Exchange Act of 1934.
The Reorganization Agreement also 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
does not expect these limitations to 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 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.
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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"). As required by the Reorganization Agreement, 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 were 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 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
In 1996, Baxter's principal domestic operating subsidiary, Baxter Healthcare
Corporation ("BHC"), and an Allegiance subsidiary 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 Baxter's 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, billing and collections, and retains title to the
products until shipment to the customer. In certain situations, Allegiance
acts as a full-service 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. Such additional services may include aggregating
Baxter's products with others to be sold as "kits" for a given medical
procedure or other cost-saving services that assist the customer in reducing
product consumption, improving utilization of assets, improving logistics, and
reducing or eliminating costs.
The initial terms of the Domestic Distribution Agreements, which began in
1996, range from three years (Renal and Biotechnology) to five years (I.V.
Systems and Cardiovascular). The agreements may be renewed by 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. 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
8
<PAGE>
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
of 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 Distribution.
Similarly, the service levels and performance standards remain as they were
prior to the Distribution.
In addition to the Domestic Distribution Agreements, Baxter and Allegiance
entered into agreements under 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 also entered into several services agreements,
effective from and after the Distribution Date, under 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, human
resources (including international expatriate services), travel, property
management and other services. These agreements have varying terms and,
subject to certain exceptions, are generally terminable by either party on 12
months notice or less. Under certain circumstances involving a Change In
Control, the agreements may be terminated earlier. The agreements may be
renewed 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 leased from Allegiance, for a term of 10 years,
beginning in 1996, a 217,000-square-foot office building at Allegiance's McGaw
Park, Illinois, headquarters site. The leased building is occupied by Baxter's
Renal Division. Allegiance subleases from Baxter all or a substantial part of
an 85,000-square-foot office building 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 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, 1997, Allegiance employed approximately 19,800 people.
EXECUTIVE OFFICERS OF THE REGISTRANT
Following are the names and ages, as of March 2, 1998, of the executive
officers of the Company, or 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 39, 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. Tenure with the Company:
16 years.
9
<PAGE>
JOSEPH F. DAMICO, age 44, 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. Tenure with the
Company: 18 years.
WILLIAM L. FEATHER, age 51, 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
U.S. Healthcare business. Between 1986 and 1996, he held various positions at
Baxter, including corporate counsel, senior counsel, and assistant general
counsel. Tenure with the Company: 12 years.
PETER B. MCKEE, age 59, 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. Tenure with the Company: 2 years.
KATHY BRITTAIN WHITE, age 48, 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. Tenure
with the Company: 3 years.
RICHARD C. ADLOFF, age 40, 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 U.S. Healthcare
business. From 1980 to 1994, he held various positions in accounting and
finance at Baxter and American Hospital Supply Corporation. Tenure with the
Company: 17 years.
ROBERT B. DEBAUN, age 47, 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 U.S.
Distribution business. From 1981 to 1991, he held various positions, including
director of corporate staffing for American Hospital Supply Corporation;
director of corporate staffing and relocation; and vice president, human
resources, for Baxter's I.V. Systems business. Tenure with the Company: 16
years.
MARK J. EHLERT, age 44, 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 U.S. 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. Tenure with the Company: 22 years.
LEONARD G. KUHR, age 39, 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. Tenure with the Company: 19 years.
ROGER L. SISTERMAN, age 54, 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. Tenure with the Company: 20 years.
10
<PAGE>
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, the Netherlands and Mexico.
Allegiance owns or leases 49 distribution centers in the United States and 14
distribution centers in Canada through its interest in Source Medical
Corporation.
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
The information required by this Item is set forth in registrant's Annual
Report to Stockholders for the fiscal year ended December 31, 1997, under the
caption "Legal Proceedings" in "Notes to Consolidated Financial Statements,"
which information is incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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, 1997, under the
caption "Quarterly Financial Results and Market for the Company's Stock" in
"Notes to Consolidated Financial Statements," which information is
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, 1997, under the
caption "Five-Year Summary of Selected Financial Data," which information is
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, 1997 under the
caption "Management's Discussion and Analysis," which information is
incorporated herein by reference.
----------------
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and located 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, demand and market acceptance risks for new and existing
products, the impact of competitive products and pricing, product development
and liability risks, the Company's limited history as an operating company,
unforeseen changes in its existing agency and distribution arrangements,
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.
11
<PAGE>
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, 1997, 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 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 will be set forth in registrant's
Proxy Statement for the Annual Meeting of Stockholders to be held on May 7,
1998, under the caption "Election of Directors," which information is
incorporated herein by reference. This Proxy Statement will be filed with
the SEC on or about March 23, 1998.
(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 will be set forth in registrant's
Proxy Statement for the Annual Meeting of Stockholders to be held on May 7,
1998, under the caption "Compensation of Directors and Executive Officers,"
which information is incorporated herein by reference. This Proxy Statement
will be filed with the SEC on or about March 23, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be set forth in registrant's
Proxy Statement for the Annual Meeting of Stockholders to be held on May 7,
1998, under the caption "Ownership of the Capital Stock of the Company," which
information is incorporated herein by reference. This Proxy Statement will be
filed with the SEC on or about March 23, 1998.
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, 1997 and 1996;
12
<PAGE>
(iii)Consolidated Statements of Operations--years ended December 31,
1997, 1996 and 1995;
(iv)Consolidated Statements of Cash Flows--years ended December 31,
1997, 1996 and 1995;
(v)Consolidated Statements of Equity--years ended December 31, 1997,
1996 and 1995; 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 herein, which information is incorporated by reference.
(b) Reports on Form 8-K
Not applicable.
(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.
13
<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 16, 1998.
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 16, 1998 IN THE CAPACITIES INDICATED:
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ Lester B. Knight Chairman of the Board, Chief Executive
___________________________________________ Officer and Director (Principal Executive
Lester B. Knight Officer)
/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/ Kenneth D. Bloem Director
___________________________________________
Kenneth D. Bloem
/s/ Silas S. Cathcart Director
___________________________________________
Silas S. Cathcart
/s/ Connie R. Curran Director
___________________________________________
Connie R. Curran
/s/ Arthur F. Golden Director
___________________________________________
Arthur F. Golden
/s/ David W. Grainger Director
___________________________________________
David W. Grainger
/s/ Michael D. O'Halleran Director
___________________________________________
Michael D. O'Halleran
</TABLE>
14
<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 January 26, 1998 appearing in the 1997 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
January 26, 1998
S-1
<PAGE>
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(IN MILLIONS OF DOLLARS)
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO DEDUCTIONS BALANCE
BEGINNING COSTS AND FROM AT END OF
DESCRIPTION OF PERIOD EXPENSES RESERVES PERIOD
- ----------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Year ended December 31, 1997
Accounts receivable................. $26.4 $ 1.4 $(3.7) $24.1
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
</TABLE>
S-2
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
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)
10.5 Intentionally left blank.
10.6 Agency Services and Distribution Agreement dated as of September 30, 1996
between Allegiance Healthcare Corporation and Baxter Healthcare
Corporation(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(4)
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(5)
10.9 Rights Agreement, by and between Allegiance Corporation and the rights
agent named therein(1)
12.1 Statement regarding Computation of Actual and Pro Forma Ratio of Earnings
to Fixed Charges
13.1 Excerpts from 1997 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.
(4) Incorporated herein by reference to Exhibit 10.7 to the Company's fiscal
year end report on Form 10-K for the fiscal year ended December 31, 1996.
(5) Incorporated herein by reference to Exhibit 10.8 to the Company's fiscal
year end report on Form 10-K for the fiscal year ended December 31, 1996.
* Denotes each management contract or compensatory plan or arrangement
required to be filed as an exhibit to this report.
<PAGE>
EXHIBIT 12.1
COMPUTATION OF ACTUAL AND PRO FORMA RATIO OF EARNINGS TO FIXED CHARGES
(IN MILLIONS, EXCEPT RATIOS)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996(1)(2) 1996(1)
------------ ------------ ------------
<S> <C> <C> <C>
Pretax income (loss).................... $143.0 $100.0 $(545.5)
Minority interest in the loss of
majority-owned subsidiaries.......... (1.6) -- --
Undistributed loss of non-consolidated
subsidiaries......................... 1.7 -- --
Estimated interest portion of rents... 12.3 8.7 8.7
Interest costs........................ 67.5 86.4 86.4
------ ------ -------
Fixed charges......................... 79.8 95.1 95.1
------ ------ -------
Income (loss) as adjusted............... $222.9 $195.1 $(450.4)
Ratio of earnings to fixed charges...... 2.8 2.1 (4.7)
====== ====== =======
</TABLE>
- --------
(1) Amount includes pro forma adjustments. 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>
20 MANAGEMENT'S DISCUSSION AND ANALYSIS
This section describes material changes in the results of operations for
Allegiance Corporation ("Allegiance" or the "company") during the three years
ended December 31, 1997, and the company's financial condition at that date.
Material trends are discussed to the extent known and considered relevant.
OVERVIEW
On September 30, 1996 (the "Distribution Date"), Baxter International Inc.
("Baxter") and its subsidiaries transferred to Allegiance and its subsidiaries
their U.S. health-care distribution business, surgical and respiratory therapy
business and health-care cost-saving 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 occurred on the Distribution Date
through a distribution of Allegiance common stock to Baxter stockholders.
Allegiance operates in a single industry segment as a leading provider of
health-care products and services. Through its nationwide distribution network,
Allegiance distributes a wide offering of medical, surgical and laboratory
products, including its self-manufactured surgical and respiratory therapy
products, to hospitals, doctors' offices, surgery centers, home-care companies,
post-acute-care facilities and other caregivers outside the hospital. Allegiance
also provides integrated cost-saving services to its health-care customers
through inventory-management programs, customized packaging, and various
consulting services. The delivery of such a broad array of products and services
requires focused investments in cost-saving services, information systems, and
manufacturing and distribution efficiencies.
Health-care spending in the United States and abroad continues to rise. At the
same time, reimbursement for health-care services is being ratcheted down by
insurers and governments. As a result, hospitals are under increasing pressure
to contain costs while providing high-quality care to growing numbers of
patients. These forces, along with new medical technologies, are causing a shift
in health-care services to outpatient settings such as surgery centers, doctors'
offices and others. Demand for health care is expected to grow faster in the
years to come as the elderly segment of the population grows to record levels.
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. 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, are 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 in recent years,
including customer and competitor consolidations and cost-containment efforts,
are expected to continue.
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 all sites of care. Management believes it can help health-care
providers 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 superior service to its 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.
Allegiance Corporation 1997 Annual Report
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS 21
Results of Operations
DIVESTED BUSINESSES
Allegiance's historical results of operations in 1995 include revenues and
expenses related to certain divested businesses: the Industrial and Life
Sciences division ("Industrial") that was sold in September 1995 and the
diagnostics manufacturing businesses that were sold in December 1994. The
discussion on results of operations that follows includes comparisons to 1995
that exclude amounts related to these divestitures. Refer to Note 1 for 1995
financial data that excludes revenues and expenses associated with these
businesses.
<TABLE>
<CAPTION>
SALES PERCENTAGE
increase (decrease)
years ended December 31 (in millions, except percentages) 1997 1996 1995 1997 1996
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Geographic regions
United States $4,061.1 $4,097.0 $4,283.7 (0.9%) (4.4%)
International 289.7 290.2 291.3 (0.2) (0.4)
- ------------------------------------------------------------------------------------------------------------------
Total net sales $4,350.8 $4,387.2 $4,575.0 (0.8%) (4.1%)
- ------------------------------------------------------------------------------------------------------------------
Distributed products $2,742.7 $2,791.2 $3,003.5 (1.7%) (7.1%)
Self-manufactured products 1,608.1 1,596.0 1,571.5 0.8 1.6
- ------------------------------------------------------------------------------------------------------------------
Total net sales $4,350.8 $4,387.2 $4,575.0 (0.8%) (4.1%)
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The decline in net sales of Allegiance's domestic and distributed products in
both 1997 and 1996 resulted principally from planned reductions in sales of
lower-margin, distributed products in the United States.
International sales volume was generally flat in all years presented. In 1997,
Allegiance was able to offset adverse foreign-exchange rates and lower sales in
European markets with incremental sales from a new venture in Canada, Source
Medical Corporation (See Note 6). During 1997 and 1996, international sales
comparisons were impacted unfavorably by Allegiance's selling arrangements in
some international markets. When Allegiance was part of Baxter, it marketed
products directly to customers. Since becoming an independent public company,
Allegiance sells products through Baxter as a distributor. This change reduced
Allegiance's direct selling influence and resulted in lower sales volume.
Growing its international business remains a strategic priority for Allegiance.
The increase in sales of self-manufactured products in 1997 resulted from the
favorable impact of a major agreement with Premier, Inc. ("Premier"), discussed
below, and an increase in cost-saving agreements (which generally result in
favorable growth of higher-margin, self-manufactured products), offset partially
by pricing pressures. Sales in 1996 also benefited from an increase in cost-
saving agreements, as well as an initial stocking order following an agreement
signed with General Medical Corporation, also offset partially by pricing
pressures. In both 1997 and 1996, domestic sales growth of self-manufactured
products was offset slightly by sales declines in international markets.
In November 1996, Allegiance signed a seven-year agreement with Premier to
supply its member hospitals with certain surgical and respiratory therapy
products. This agreement, which began to impact sales favorably in late 1997,
will continue to produce sales growth in 1998. Refer to Note 16 for a discussion
of customers who represent a significant amount of the company's sales over the
last three years, and the risks associated with potential loss of this business
in the future.
Allegiance Corporation 1997 Annual Report
<PAGE>
22 MANAGEMENT'S DISCUSSION AND ANALYSIS
GROSS MARGIN AND EXPENSE RATIOS
years ended December 31 (as a percentage of sales) 1997 1996 1995
- -----------------------------------------------------------------------------
Gross margin 20.9% 20.7% 20.8%
Selling, general and administrative expenses 15.1 15.3 15.2
- -----------------------------------------------------------------------------
The company has succeeded in maintaining a relatively flat gross margin since
1995, despite continued pricing pressure on its self-manufactured products. The
company has generally been able to offset this pressure with cost efficiencies
and a more profitable sales mix. In 1997, the increase in sales of self-
manufactured products, and planned reductions in lower-margin distributed
products, combined to more than offset pricing pressures from the Premier
contract and the general marketplace. Allegiance plans to continue its efforts
to maintain its gross margin rate by offsetting pricing pressures with
manufacturing and other cost efficiencies, boosting sales of cost-saving
services, managing its sales mix more effectively, and, when possible,
instituting price increases.
The company succeeded in reducing selling, general and administrative expenses
on an absolute basis by $13.0 million and as a percentage of sales in 1997
principally by reducing headcount through attrition, managing benefit costs and
implementing overall expense-control initiatives in both current and prior
periods. Total selling, general and administrative expenses were reduced by
$22.8 million in 1996 compared to 1995, excluding the divested businesses
discussed previously. Such costs as a percentage of sales, however, increased
slightly as the timing of expense-reduction initiatives lagged the planned
reduction in lower-margin product sales discussed earlier.
GOODWILL WRITE-DOWN AND OTHER NON-RECURRING ITEMS
In the fourth quarter of 1996, the company changed its method of assessing
goodwill impairment, resulting in a charge to operations of $550.0 million and a
reduction in goodwill amortization of $18.9 million in 1997 and $4.7 million in
1996. Refer to Note 2 for a discussion of the company's new policy. Allegiance
also incurred $95.5 million of other non-recurring costs in the 1996 fourth
quarter. Refer to Note 4 for a discussion of various items included in this
amount.
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 for more
information, including the cash and noncash utilization of the reserves and
headcount reductions to date.
Allegiance realized direct savings in manufacturing and administrative costs
from this program of approximately $170 million in 1997, $125 million in 1996,
and $95 million in 1995. Management believes that the program is on target to
achieve anticipated savings exceeding $175 million in 1998. The company
anticipates that these savings will continue to help offset potential gross
margin erosion and investments in cost-saving and other initiatives. Management
further believes that its remaining restructuring reserves are adequate to
complete the actions contemplated by the restructuring program and that future
cash expenditures related to the program would be funded from cash generated
from operations.
Allegiance Corporation 1997 Annual Report
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS 23
BENEFIT CURTAILMENT GAINS
Non-recurring gains of $35.9 million in 1996 are associated with the curtailment
of Baxter-sponsored benefit plans and are discussed in Note 12.
INTEREST EXPENSE
The increase in interest expense in 1997 resulted from a full year of borrowings
in 1997 compared to only fourth-quarter borrowings in 1996. Prior to September
30, 1996, Allegiance participated in a centralized cash-management program
administered by Baxter. No interest was charged to Allegiance.
OTHER INCOME AND EXPENSE
The company currently has foreign-currency forward and option contracts that
have been combined to hedge a portion of anticipated production costs expected
to be denominated in foreign currencies. The company recognizes realized and
unrealized gains and losses on these contracts in the period in which the change
occurs. Other income and expense for 1997 included $11.6 million of expense
related to these foreign-currency contracts.
Also included in other income and expense in 1997 was $5.9 million of income
associated with the reversal of excess reserves for facility shutdowns related
to the Industrial divestiture. These shutdown programs, substantially completed
in 1997, were finalized at a lower cost than originally anticipated.
The remaining change in other income and expense for 1997 versus 1996 was caused
by unfavorable foreign-exchange rates and losses related to certain equity
investments.
Other income for 1995, excluding the divested businesses discussed previously,
consisted primarily of net gains associated with the disposal or discontinuance
of minor, non-strategic businesses.
<TABLE>
<CAPTION>
PRETAX INCOME Percentage
increase (decrease)
years ended December 31 (in millions, except percentages) 1997 1996 1995 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Pretax income (loss) $143.0 $(427.9) $245.3 n/a n/a
Adjust for non-recurring items (1) - 609.6 (37.3) - -
Adjust for interest expense 67.5 18.9 - - -
- -------------------------------------------------------------------------------------------------------------
Adjusted pretax income $210.5 $ 200.6 $208.0 4.9% (3.6%)
- -------------------------------------------------------------------------------------------------------------
Adjusted pretax income as a percentage of sales 4.8% 4.6% 4.5% - -
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The 1996 non-recurring adjustments include the goodwill write-down, benefit
curtailment gains and other non-recurring items discussed previously. The 1995
non-recurring adjustments reflect net gains associated with the disposal or
discontinuance of minor, non-strategic businesses.
Allegiance Corporation 1997 Annual Report
<PAGE>
24 MANAGEMENT'S DISCUSSION AND ANALYSIS
Pretax income as a percentage of sales increased in 1997 over 1996, excluding
the impact of the goodwill write-down, interest expense and the non-recurring
gains from curtailment of certain benefit plans, all discussed previously.
Contributing to the increase were an improved gross margin rate and reductions
in selling, general and administrative expenses in 1997. Adjusted pretax income
as a percentage of sales was relatively consistent between 1996 and 1995.
<TABLE>
<CAPTION>
INCOME TAXES
years ended December 31 (in millions, except percentages) 1997 1996 1995
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income tax expense $52.1 $49.8 $94.4
Tax rate 36.4% n/a 38.5%
Adjust for non-recurring items (1) - 32.7 -
- ---------------------------------------------------------------------------------------
Adjusted income tax expense $52.1 $82.5 $94.4
Tax rate 36.4% 37.9% 38.5%
- ---------------------------------------------------------------------------------------
</TABLE>
(1) Amount represents the tax benefit associated with the 1996 non-recurring
adjustments discussed previously.
The 1997 tax rate was lower than the 1996 adjusted tax rate, due principally to
the positive impact on earnings of lower goodwill amortization, which is a non-
taxable item. The positive impact of goodwill amortization in 1997, however, was
offset partially by a larger proportion of earnings from higher tax
jurisdictions. The adjusted rate in 1996 was lower than the 1995 rate (which
excludes the divested businesses discussed previously) because of lower goodwill
amortization in 1996.
IMPACT OF INFLATION
In recent years, general inflationary trends have led to higher labor and
material costs for Allegiance. While not related directly to inflation,
Allegiance's revenue base in recent years has been affected adversely by lower
average selling prices on certain products. Changes in Medicare reimbursement
regulations, economic pressures in the U.S. hospital marketplace and increased
competition in certain product lines were the main factors. There is little
correlation between general inflation rates and Allegiance's pricing levels.
Management expects these market dynamics to continue.
YEAR 2000 ISSUES
Allegiance is currently implementing enterprise-wide software that will replace
our financial and business legacy systems. This software, which is Year 2000
compliant, will be in place company-wide by early 1999. All other system
replacements or upgrades will be completed in 1999. The company does not expect
the impact of internal Year 2000 issues to be material to the company's
business, operations or financial condition. Management is currently attempting
to assess how Year 2000 issues at its suppliers and customers could impact the
company's business. Based upon current information, the company does not expect
any widespread supplier and customer non-compliance that could have a material
adverse effect.
ADOPTION OF NEW ACCOUNTING STANDARDS
The company adopted Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share," at December 31, 1997. SFAS No. 128 requires presentation
on the face of the income statement of both basic and diluted earnings per
share. See Note 2.
Allegiance Corporation 1997 Annual Report
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS 25
Liquidity and Capital Resources
Allegiance's current assets exceeded current liabilities by $548.8 million at
December 31, 1997, versus an excess of $637.4 million at December 31, 1996.
Current assets at December 31, 1997, included accounts, notes and other current
receivables of $528.1 million and inventories of $586.9 million. These sources
of liquidity are convertible into cash over a relatively short period of time
and, thus, could be available to help Allegiance satisfy normal operating cash
requirements.
The company intends to fund its short- and long-term obligations as they mature
through cash flow from operations, existing credit facilities or issuance of
debt or equity. Management believes the company has credit facilities adequate
to support ongoing operational, capital, restructuring and litigation
requirements. Beyond that, Allegiance believes it has sufficient financial
flexibility to attract long-term capital on acceptable terms as may be needed to
support its growth objectives. To meet its net financing requirements in 1997,
the company borrowed from its various credit facilities, as required. Refer to
Note 7 for more information about the company's borrowings under credit
facilities and outstanding debt.
<TABLE>
<CAPTION>
years ended December 31 (in millions)
(brackets denote cash outflows) 1997 1996 1995
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flow provided by operations as stated
in the company's Consolidated
Statements of Cash Flows $327.6 $ 317.1 $ 253.3
Capital expenditures (81.3) (102.5) (111.9)
Common stock cash dividends (22.7) - -
- ----------------------------------------------------------------------------
"Free cash flow" $223.6 $ 214.6 $ 141.4
- ----------------------------------------------------------------------------
</TABLE>
The increase in cash flow from operations in 1997 resulted from improved
earnings and balance sheet management -- primarily inventories and accounts
receivable. The increase in cash flow from operations in 1996 resulted from
improved management of inventories and accounts payable.
Management emphasizes "free cash flow" as an internal measure of operating cash
flow after capital expenditures and dividends as reconciled in the table above.
Management's objective is to maximize "free cash flow," and incentive
compensation programs throughout the company include emphasis on management of
working capital and "free cash flow" targets. The "free cash flow" generated
during 1997 helped to fund $60.9 million in acquisitions and $35.8 million in
stock repurchases, and to pay down $210.7 million of long-term debt. The
company's long-term debt as a percentage of total capital declined from 57.2
percent at December 31, 1996, to 49.0 percent at December 31, 1997.
Capital expenditures consisted principally of improvements to existing
facilities, systems upgrades, productivity enhancing equipment and other cost-
reduction projects. Allegiance management expects 1998 investments in capital
expenditures to remain at levels consistent with 1997.
In 1997, the board of directors declared four consecutive quarterly dividends on
the company's common stock of $0.10 per share (annualized rate of $0.40 per
share).
Allegiance Corporation 1997 Annual Report
<PAGE>
26 MANAGEMENT'S DISCUSSION AND ANALYSIS
Acquisitions of $60.9 million in 1997, $23.8 million in 1996 and $5.4 million in
1995 were consistent with Allegiance's strategic direction and were made to
broaden product lines and service offerings or expand market coverage. See Note
6 for additional information related to the company's acquisitions.
Proceeds from asset dispositions of $35.2 million in 1997 related to the sale of
miscellaneous facilities and divestitures of minor investments inconsistent with
Allegiance's strategic direction. Divested investments in 1997 included
MedManagement, L.L.C., which is discussed in Note 6. The net use of cash of
$11.2 million in 1996 related to cash payments from the settlement of certain
programs associated with the divestitures of the Industrial and diagnostics
manufacturing businesses. The proceeds in 1995 of $626.0 million related to the
Industrial divestiture and the collection of notes receivable related to the
divestiture of the diagnostics manufacturing businesses.
Refer to Note 11 for a discussion of the $54.8 million in cash received in May
1997 from employees related to the company's Shared Investment Plan and the
$35.8 million spent to repurchase Allegiance common stock under a program
authorized by the company's board of directors in November 1997.
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 allergies to natural rubber latex gloves. See
Note 15. 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 15, 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.
- --------------------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
Certain statements in this discussion constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Statements indicating the company "plans," "expects," "estimates" or "believes"
are forward-looking statements that involve known and unknown risks, including,
but not limited to, general economic and business conditions, changing trends in
the health-care industry and customer profiles, competition, changes in
governmental regulations, and unfavorable foreign-currency fluctuations.
Although Allegiance believes its expectations with respect to the forward-
looking statements are based upon reasonable assumptions within the bounds of
its knowledge of its business and operations, there can be no assurance that
actual results, performance or achievements of Allegiance will not differ
materially from any future results, performance or achievements expressed or
implied by such forward-looking statements. In accordance with "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, Allegiance
provides cautionary statements, detailed in Securities and Exchange Commission
filings, including, without limitation, the company's Form 10-K and 10-Qs, which
identify specific factors that would cause actual results or events to differ
materially from those described in the forward-looking statements. The company
undertakes no obligation to update publicly any forward-looking statement
whether as a result of new information, future events or otherwise.
- --------------------------------------------------------------------------------
Allegiance Corporation 1997 Annual Report
<PAGE>
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS 27
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 conform to generally accepted accounting principles and
include some amounts that are estimates based on available information and
management's judgment of current conditions and circumstances. The company
engaged Price Waterhouse LLP, an independent public accounting firm, 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 systematically reviewed and revised to respond 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. This committee met four times in 1997 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, recommendations of the internal auditors and management's
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 President
and Chief Executive and Chief Financial and Controller
Officer Officer
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, 1997 and 1996, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, 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 in 1996 its method of assessing goodwill impairment. We concur with this
change in accounting.
/S/ Price Waterhouse LLP
Price Waterhouse LLP
Chicago, Illinois
January 26, 1998
Allegiance Corporation 1997 Annual Report
<PAGE>
28 CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
as of December 31 (in millions, except par value and shares) 1997 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CURRENT ASSETS Cash and equivalents $ 31.6 $ 22.9
Accounts receivable, net of allowance for
doubtful accounts of $24.1 in 1997 and $26.4 in 1996 510.8 515.1
Notes and other current receivables 17.3 32.4
Inventories
Raw materials 52.3 52.8
Work in progress 44.2 46.4
Finished products 490.4 529.3
---------------------------------------------------------------------------------------
Total inventories 586.9 628.5
Deferred income taxes 97.9 122.8
Prepaid expenses 17.9 13.8
---------------------------------------------------------------------------------------
Total current assets 1,262.4 1,335.5
- ------------------------------------------------------------------------------------------------------------
PROPERTY, PLANT Land 86.8 98.1
AND EQUIPMENT Buildings and leasehold improvements 369.2 397.4
Machinery and equipment 980.1 905.1
Equipment leased or rented to customers 23.5 19.0
Construction in progress 83.9 99.5
---------------------------------------------------------------------------------------
Total property, plant and equipment, at cost 1,543.5 1,519.1
Accumulated depreciation and amortization (748.9) (681.2)
---------------------------------------------------------------------------------------
Net property, plant and equipment 794.6 837.9
- ------------------------------------------------------------------------------------------------------------
OTHER ASSETS Goodwill and other intangibles 553.8 514.5
Other 85.8 111.3
---------------------------------------------------------------------------------------
Total other assets 639.6 625.8
---------------------------------------------------------------------------------------
Total assets $ 2,696.6 $2,799.2
============================================================================================================
CURRENT LIABILITIES Accounts payable, principally trade $ 423.2 $ 436.6
Employee compensation and withholdings 118.2 72.1
Restructuring 26.1 39.3
Property, payroll and other taxes 48.5 31.2
Other 97.6 118.9
---------------------------------------------------------------------------------------
Total accounts payable and current liabilities 713.6 698.1
- ------------------------------------------------------------------------------------------------------------
LONG-TERM DEBT AND LEASE OBLIGATIONS 900.7 1,106.6
- ------------------------------------------------------------------------------------------------------------
DEFERRED INCOME TAXES 99.2 107.4
- ------------------------------------------------------------------------------------------------------------
OTHER NON-CURRENT LIABILITIES 45.9 59.4
- ------------------------------------------------------------------------------------------------------------
EQUITY Common stock, $1 par value, authorized 200,000,000 shares, issued
58,116,000 shares in 1997 and 54,977,000 shares in 1996 58.1 55.0
Additional contributed capital 66.4 1.5
Retained earnings 837.3 769.2
Common stock in treasury, at cost, 749,000 shares in 1997 (25.2) -
Cumulative foreign-currency adjustment 0.6 2.0
---------------------------------------------------------------------------------------
Total equity 937.2 827.7
---------------------------------------------------------------------------------------
Total liabilities and equity $ 2,696.6 $2,799.2
============================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Allegiance Corporation 1997 Annual Report
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS 29
<TABLE>
<CAPTION>
years ended December 31 (in millions, except per share data) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATIONS Net sales $4,350.8 $4,387.2 $4,921.9
Costs and expenses
Cost of goods sold 3,442.6 3,479.2 3,877.7
Selling, general and administrative expenses 659.0 672.0 749.6
Research and development 9.2 8.1 6.6
Goodwill write-down and
other non-recurring items -- 645.5 76.0
Interest expense 67.5 18.9 --
Goodwill amortization 21.8 32.2 37.8
Benefit curtailment gains -- (35.9) --
Other income 7.7 (4.9) (301.8)
---------------------------------------------------------------------------------------------------------
Total costs and expenses 4,207.8 4,815.1 4,445.9
---------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 143.0 (427.9) 476.0
Income tax expense 52.1 49.8 203.4
---------------------------------------------------------------------------------------------------------
Net income (loss) $ 90.9 $ (477.7) $ 272.6
===================================================================================================================================
PER SHARE DATA Net income (loss) per common share
Basic $ 1.60 $ (8.70) $ 4.97
Diluted 1.56 (8.70) 4.97
===================================================================================================================================
SHARE DATA Average shares outstanding
Basic 56.9 54.9 54.8
Diluted 58.2 54.9 54.8
===================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
ALLEGIANCE CORPORATION 1997 ANNUAL REPORT
<PAGE>
30 CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
years ended December 31 (in millions, brackets denote cash outflows) 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CASH FLOW Income (loss) from operations $ 90.9 $ (477.7) $ 272.6
PROVIDED BY Adjustments
OPERATIONS Depreciation and amortization 126.0 145.2 164.6
Deferred income taxes 14.9 (13.7) 50.2
Gain on asset dispositions, net (pretax) (6.0) - (262.5)
Goodwill write-down and other
non-recurring charges - 645.5 76.0
Benefit curtailment gains - (35.9) -
Other 11.0 6.0 5.4
Changes in balance sheet items
Accounts receivable 41.5 (14.7) 73.0
Inventories 57.1 48.1 28.8
Accounts payable and
accrued liabilities 23.8 74.7 (120.2)
Restructuring program payments (27.0) (45.9) (62.0)
Other (4.6) (14.5) 27.4
-------------------------------------------------------------------------------------------------
Cash flow provided by operations 327.6 317.1 253.3
==========================================================================================================================
INVESTMENT Capital expenditures (81.3) (102.5) (111.9)
TRANSACTIONS Acquisitions (60.9) (23.8) (5.4)
Proceeds from asset dispositions 35.2 (11.2) 626.0
-------------------------------------------------------------------------------------------------
Investment transactions, net (107.0) (137.5) 508.7
==========================================================================================================================
FINANCING Issuances of debt 62.3 603.6 -
TRANSACTIONS Redemptions of debt (85.0) - -
Increase (decrease) in debt with maturities
of three months or less, net (188.0) 507.4 -
Common stock cash dividends (22.7) - -
Common stock issued under
Shared Investment Plan 54.8 - -
Common stock issued under
employee benefit plans 13.3 1.7 -
Purchase of common stock in treasury (35.8) - -
Payments to Baxter International Inc. - (1,270.2) (764.0)
Other financing (10.8) - -
-------------------------------------------------------------------------------------------------
Financing transactions, net (211.9) (157.5) (764.0)
==========================================================================================================================
INCREASE (DECREASE) IN CASH AND EQUIVALENTS 8.7 22.1 (2.0)
CASH AND EQUIVALENTS AT BEGINNING OF YEAR 22.9 0.8 2.8
==========================================================================================================================
CASH AND EQUIVALENTS AT END OF YEAR $ 31.6 $ 22.9 $ 0.8
==========================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
ALLEGIANCE CORPORATION 1997 ANNUAL REPORT
<PAGE>
CONSOLIDATED STATEMENTS OF EQUITY 31
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1997 1996 1995
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
COMMON Balance, beginning of year $ 55.0 $ - N/A
STOCK September 30, 1996, distribution of common stock - 54.8
Stock issued under employee benefit plans 0.3 0.2
Stock issued under Shared Investment Plan 2.4 -
Stock issued for acquisitions 0.4 -
------------------------------------------------------------------------------------------
Balance, end of year 58.1 55.0
========================================================================================================
ADDITIONAL Balance, beginning of year 1.5 - N/A
CONTRIBUTED Stock issued under employee benefit plans 2.4 1.5
CAPITAL Stock issued under Shared Investment Plan 52.4 -
Stock issued for acquisitions 10.1 -
------------------------------------------------------------------------------------------
Balance, end of year 66.4 1.5
========================================================================================================
DIVISIONAL Balance, beginning of year - 1,767.5 $2,258.9
RETAINED Net income prior to September 30, 1996 - 117.8 272.6
EARNINGS Payments to Baxter International Inc. - (460.2) (764.0)
September 30, 1996, distribution of common stock - (1,425.1) -
------------------------------------------------------------------------------------------
Balance, end of year - - 1,767.5
========================================================================================================
EQUITY Balance, beginning of year - 810.0 810.0
INVESTMENT Payments to Baxter International Inc. - (810.0) -
OF PARENT ------------------------------------------------------------------------------------------
Balance, end of year - - 810.0
========================================================================================================
RETAINED Balance, beginning of year 769.2 - N/A
EARNINGS September 30, 1996, distribution of common stock - 1,370.3
Common stock dividends declared (22.8) (5.6)
Net loss subsequent to September 30, 1996 - (595.5)
Net income 90.9 -
------------------------------------------------------------------------------------------
Balance, end of year 837.3 769.2
========================================================================================================
COMMON Balance, beginning of year - - N/A
STOCK IN Purchases (35.8) -
TREASURY Stock issued under employee benefit plans 10.6 -
------------------------------------------------------------------------------------------
Balance, end of year (25.2) -
========================================================================================================
CUMULATIVE Balance, beginning of year 2.0 - -
FOREIGN- Currency fluctuations (1.4) 2.0 -
CURRENCY ------------------------------------------------------------------------------------------
ADJUSTMENT Balance, end of year 0.6 2.0 -
========================================================================================================
TOTAL EQUITY $937.2 $ 827.7 $2,577.5
========================================================================================================
</TABLE>
n/a - not applicable
The accompanying notes are an integral part of these consolidated financial
statements.
Allegiance Corporation 1997 Annual Report
<PAGE>
32 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 their U.S. health-care distribution business, surgical and
respiratory therapy business and health-care cost-saving 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 occurred on the
Distribution Date through a distribution of Allegiance common stock to Baxter
stockholders (the "Distribution"). The Distribution of approximately 54.8
million shares of Allegiance stock, based on a distribution ratio of one
Allegiance share for each five Baxter shares held, was made to Baxter
stockholders as of the record date of September 26, 1996.
Allegiance operates in a single industry segment as a leading provider of
health-care products and services. Through its nationwide distribution network,
Allegiance distributes a wide offering of medical, surgical and laboratory
products, including its self-manufactured surgical and respiratory therapy
products, to hospitals, doctors' offices, surgery centers, home-care companies,
post-acute-care facilities and other caregivers outside the hospital. Allegiance
also provides integrated cost-saving services to its health-care customers
through inventory-management programs, customized packaging, and various
consulting services.
Allegiance's historical results of operations in 1995 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 for additional
information.
The following table presents historical financial data for Allegiance
excluding the revenue and expenses associated with divested businesses:
<TABLE>
<CAPTION>
year ended December 31 (in millions) 1995
- -------------------------------------------------------------------------------
<S> <C>
Net sales $4,575.0
Costs and expenses
Cost of goods sold 3,624.5
Selling, general and administrative expenses 694.8
Research and development 6.6
Goodwill amortization 36.8
Other income (33.0)
- -------------------------------------------------------------------------------
Total costs and expenses 4,329.7
- -------------------------------------------------------------------------------
Pretax income 245.3
Income tax expense 94.4
- -------------------------------------------------------------------------------
Net income $ 150.9
===============================================================================
Basic and diluted net income per common share $ 2.75
===============================================================================
</TABLE>
2. Summary of Significant Accounting Policies
This summary of significant accounting policies is presented to help readers
understand and evaluate the consolidated financial statements. These policies
conform with generally accepted accounting principles and, except for the change
in accounting for goodwill impairment in 1996, have been applied consistently in
all material respects. The preparation of financial statements using 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 the Allegiance Business. These financial statements were prepared as if
Allegiance had operated as a free-standing entity for the periods presented. The
financial information prior to the Distribution Date, however, 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. Certain immaterial reclassifications have been made to the 1996 and
1995 financial statements and related footnotes so they conform to the 1997
presentation.
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of Allegiance and its
majority-owned subsidiaries. Certain operations outside the United States and
its territories, which are not material, 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 $67.1 million in 1997 and $7.4 million in 1996. Cash payments for income
taxes were $30.0 million in 1997 and $0.6 million in 1996. Cash payments for
income taxes relating to the Allegiance Business prior to the Distribution Date
were made by Baxter.
Allegiance Corporation 1997 Annual Report
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 33
INVENTORIES
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.
PROPERTY, PLANT AND EQUIPMENT
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 $96.0 million in 1997, $98.8 million in 1996 and
$106.3 million in 1995. Repairs and maintenance expenses were $26.8 million in
1997, $24.2 million in 1996 and $36.4 million in 1995.
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 accounting
policies established by Baxter for its consolidated group. 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 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 would continue to produce intense competition among health-care
suppliers, management re-evaluated its accounting policy for 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 reflects the challenges and
pressures that continue to be a fundamental part of the U.S. health-care system.
This accounting change resulted in a fourth quarter 1996 charge to
operations of $550.0 million and a reduction in 1996 goodwill amortization of
$4.7 million (9 cents per share, basic). This policy change will continue to
reduce goodwill amortization for the next 28 years by $18.9 million annually.
The company computes fair value using the price/earnings ("P/E") multiple
for a group of similar companies. This P/E multiple, calculated using 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. Based upon
management's assessment, the carrying value of goodwill at December 31, 1997, is
not impaired.
As of December 31, goodwill was $551.4 million in 1997 and $510.7 million
in 1996, net of accumulated amortization of $423.9 million and $400.8 million,
respectively.
Other intangible assets include purchased patents, trademarks and other
identified rights that are amortized on a straight-line basis over their legal
or estimated useful lives, whichever is shorter (not exceeding 20 years). As of
December 31, other intangible assets were $2.4 million in 1997 and $3.8 million
in 1996, net of accumulated amortization of $16.5 million and $18.3 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 1997 and future years will vary from these historical rates
depending on the company's current legal structure and tax elections. All income
tax expense accrued prior to the Distribution Date was settled with Baxter on a
current basis through Divisional Retained Earnings.
Allegiance has provided for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
DERIVATIVES
Gains and losses related to qualifying hedges are deferred as part of the
carrying amounts of the related assets or liabilities and are ultimately
recognized in income as part of the carrying amounts when the hedged transaction
occurs. Realized and unrealized changes in the fair value of the other
derivative financial instruments are recognized in income in the period in which
the change occurs.
Allegiance Corporation 1997 Annual Report
<PAGE>
34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
STOCK-BASED COMPENSATION
The company accounts 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, the
company recognizes no compensation expense for its fixed stock-option plans or
stock purchase plan. See Note 11.
EARNINGS PER SHARE
Basic net income (loss) 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. Earnings
per share ("EPS") data presented in 1995 assumes the shares issued at the
Distribution Date were outstanding. In 1997, the company adopted SFAS No. 128,
"Earnings per Share," which requires the presentation of both basic and diluted
EPS. No reconciliation for 1995 is presented because no potentially dilutive
stock plans existed prior to the Distribution.
RECONCILIATION OF BASIC AND DILUTED EPS
years ended December 31 (in millions, except per share data)
<TABLE>
<CAPTION>
Per share
1997 Net income Shares amount
- -----------------------------------------------------------------
<S> <C> <C> <C>
Basic EPS $ 90.9 56.9 $ 1.60
Additional shares
assuming exercise of
stock option and stock
purchase plan subscriptions 1.3(a)
- ------------------------------------------------------------------
Diluted EPS $ 90.9 58.2 $ 1.56
==================================================================
Per share
1996 Net loss Shares amount
- ------------------------------------------------------------------
Basic EPS $ (477.7) 54.9 $(8.70)
Additional shares
assuming exercise of
stock option and stock
purchase plan subscriptions ---(b)
- ------------------------------------------------------------------
Diluted EPS $ (477.7) 54.9 $(8.70)
==================================================================
</TABLE>
(a) Options to purchase 0.8 million shares at an average price of $29.35 per
share were outstanding during the year ended December 31, 1997, but were not
included in the diluted EPS computation because the exercise price exceeded the
average market price for the period.
(b) Options to purchase 0.8 million shares are excluded from the diluted EPS
computation because they are antidilutive to the net loss per share.
3. Pro Forma Financial Information
The following unaudited pro forma combined statements of operations present the
combined results of Allegiance assuming the transactions effected by the
Distribution and the significant divestitures discussed in Note 1 had been
completed as of January 1, 1995:
<TABLE>
<CAPTION>
years ended December 31
(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) 86.4 90.0
Goodwill amortization 32.2 36.8
Other (income) expense (c) (4.9) 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
========================================================================
Basic and diluted 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 revenues and expenses
associated with the divested businesses discussed in Note 1) comprise the
following:
(a) Pro forma adjustments of $11.4 million in 1996 and $12.1 million in 1995,
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 million in 1996 and $90.0 million in 1995,
reflect estimated interest expense the company would have incurred on 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 received 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.
Allegiance Corporation 1997 Annual Report
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 35
4. Non-Recurring Items
In addition to the goodwill write-down discussed in Note 2, 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 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, non-recurring charges in the fourth quarter of
1996 included $19.5 million for legal defense costs related to natural rubber
latex litigation cases. See Note 15.
<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
Utilization:
Cash (10.2) -- (16.8) (27.0)
Noncash -- (5.0) -- (5.0)
- --------------------------------------------------------------------------------
December 31, 1997 $ 13.8 $ 17.0 $ 3.3 $ 34.1
================================================================================
</TABLE>
In November 1993, Baxter's board of directors approved a series of strategic
actions designed in part to make the Allegiance Business more efficient and
responsive in addressing the changes occurring in the U.S. health-care system. 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 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 1999.
Included in the 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.
Throughout 1995, active discussions took place with the buyer of the diagnostics
businesses related to interpretations of and responsibility for the settlement
provisions contained in the purchase and sale and related agreements. The
divestiture also was significantly complicated by the settlement of 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 businesses.
In 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 charge of $76.0 million.
Cash outflows pertain primarily to employee-related costs for severance,
outplacement assistance, relocation, implementation teams and facility
consolidations. Since the inception of the restructuring program, approximately
2,500 positions have been eliminated. The remaining expenditures will occur in
1998 and 1999, as implementation team projects and facility closures and
consolidations are completed as planned.
Of the noncash restructuring expenditures, $3.4 million in 1997, $4.4
million in 1996 and $16.0 million in 1995 related to the divestiture of the
diagnostics manufacturing businesses. Noncash spending also included $1.6
million in 1997, $20.6 million in 1996 and $50.3 million in 1995, relating
primarily to fixed asset and inventory write-downs from the closure of
manufacturing facilities and consolidations of certain distribution facilities.
The 1997 restructuring reserve balance consisted substantially of current
reserves. The 1996 restructuring reserve balance consisted of $53.2 million of
current and $12.9 million of non-current reserves.
Allegiance Corporation 1997 Annual Report
<PAGE>
36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Acquisitions and Divestitures
ACQUISITIONS
A component of Allegiance's strategic direction is to make acquisitions that
build on cost-saving and other service offerings, broaden product lines or
expand market coverage. To this end, Allegiance acquired West Hudson & Co. Inc.,
a privately owned health-care consulting firm, on January 2, 1997 for $30.5
million in cash and $10.5 million in stock, with possible contingent payments
through 2000. In addition, the company made individually immaterial acquisitions
of $30.4 million in 1997, $23.8 million in 1996 and $5.4 million in 1995. During
1997, the company exchanged nonmonetary assets with a value of approximately
$10.5 million to acquire an interest in Source Medical Corporation, a new
venture in Canada. All acquisitions were accounted for as purchase transactions.
Had the acquisitions taken place January 1, consolidated results in the year of
acquisition would not have been materially different from reported results.
DIVESTITURES
In 1997, Allegiance sold its investment in MedManagement, L.L.C., generating net
proceeds of approximately $14.3 million. The remaining proceeds from asset
dispositions in 1997 related to the sale of miscellaneous facilities and
divestitures of minor investments deemed inconsistent with Allegiance's
strategic direction.
In 1996, the company paid $11.2 million related primarily to the divestitures
of its Industrial and Life Sciences division ("Industrial") discussed below and
its diagnostics manufacturing businesses discussed in Note 5. In 1995,
Allegiance disposed of several businesses or product lines resulting in a pretax
net gain of $262.5 million (aftertax net gain of $141.0 million). The majority
of this amount related to the $268.1 million gain on the sale of the Industrial
business to VWR Corporation for approximately $400.0 million in cash and $25.0
million in deferred payments. Allegiance continues to supply self-manufactured
products and supplies sold in non-health-care markets to VWR Corporation. In
addition to the approximately $400.0 million of proceeds from the Industrial
sale, the company received $199.9 million in 1995 for the divestiture of its
diagnostics manufacturing businesses. Remaining proceeds in 1995 of $26.1
million related to the disposition of minor investments that were inconsistent
with Allegiance's strategic direction. In most of these transactions, Allegiance
disposed of its entire interest in the investments.
7. Credit Facilities, Long-Term Debt and Lease Obligations
<TABLE>
<CAPTION>
as of December 31 Effective
(in millions, except percentages) interest rate 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Borrowings under credit facilities 5.95% $351.5 $ 562.1
- --------------------------------------------------------------------------------
7.30% notes due 2006 7.39 199.6 199.6
- --------------------------------------------------------------------------------
7.80% debentures due 2016 7.88 149.4 149.4
- --------------------------------------------------------------------------------
7.00% debentures due 2026,
7 year put option in 2003 7.11 199.9 199.9
- --------------------------------------------------------------------------------
Notes and capitalized lease
obligations, due 1998 through 2020 0.5 -
- --------------------------------------------------------------------------------
Total long-term debt and
lease obligations $900.9 $1,111.0
================================================================================
Current portion $ (0.2) $ (4.4)
- --------------------------------------------------------------------------------
Long-term portion $900.7 $1,106.6
================================================================================
</TABLE>
The company's unsecured revolving credit agreement, expiring in 2001, provides
for up to an aggregate of $900.0 million in borrowings. As of December 31, $80.0
million in 1997 and $260.0 million in 1996 were outstanding under this facility.
As of December 31, 1996, the company had an additional facility providing for
$150.0 million of borrowings. As of December 31, 1996, no amounts were
outstanding under this facility, which was terminated in 1997. In conjunction
with its credit 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,
$244.2 million in 1997 and $302.1 million in 1996, was outstanding under these
uncommitted facilities. Of the amounts outstanding under all facilities, $324.2
million in 1997 and $557.7 million in 1996 was classified as long-term debt, as
amounts are supported by a long-term credit facility and will continue to be
refinanced. Amounts borrowed under these facilities were used for working
capital requirements and to fund a $1,147.3 million distribution to Baxter in
1996. The company had year-end unamortized debt issuance costs of $4.0 million
in 1997 and $4.5 million in 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 $36.8 million in 1997, $26.0 million in
1996 and $26.4 million in 1995.
Allegiance Corporation 1997 Annual Report
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 37
FUTURE MINIMUM DEBT AND LEASE PAYMENTS
<TABLE>
<CAPTION>
Aggregate debt and
Operating capital lease
as of December 31 (in millions) leases maturities
- --------------------------------------------------------------------------------
<S> <C> <C>
1998 $ 32.0 $ 0.2
1999 27.0 0.2
2000 22.8 0.1
2001 15.2 351.5
2002 13.2 -
Thereafter 24.2 550.0
- --------------------------------------------------------------------------------
Total obligations and commitments $134.4 $902.0
================================================================================
Amounts representing interest, discounts,
premiums and deferred financing costs $ 1.1
- --------------------------------------------------------------------------------
Present value of long-term debt and
lease obligations $900.9
================================================================================
</TABLE>
8. 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 credit losses which have been within the
range of management's allowance for doubtful accounts.
The company actively evaluates the creditworthiness of the financial
institutions which are counterparties to derivative financial instruments, and
it does not expect any counterparties to fail to meet their obligations. The
credit exposure of the company's derivative financial instruments is represented
by the fair value of contracts with a favorable fair value at December 31, 1997.
FINANCIAL INSTRUMENT USE--SUBSEQUENT TO DISTRIBUTION DATE
Allegiance uses commodity contracts to hedge raw materials expected to be
denominated in foreign currency. These contracts generally cover a one-year
period and all gains and losses are deferred and recognized in cost of goods
sold with the underlying product costs. At December 31, the related notional
amounts of such contracts were $9.2 million in 1997 and $22.1 million in 1996.
These notional amounts do not represent amounts exchanged by the parties; rather
they are used as the basis to calculate the amounts due under the contracts.
These contracts qualify as hedges for accounting purposes in accordance with the
criteria established in SFAS No. 80 "Accounting for Futures Contracts." Cash
flows resulting from these commodity contracts are classified in the same
category as the items being hedged.
The company manages the impact of interest rate changes on earnings, cash
flows and borrowings to maintain fixed-rate debt as a percentage of total debt
between a minimum and maximum percentage. In 1997 and 1996, the company
evaluated its interest rate exposures and concluded it was not beneficial to use
financial instruments to hedge its interest positions.
The company uses financial instruments, as needed, to manage cash flow
volatility and earnings fluctuations associated with changes in foreign-exchange
rates. At December 31, 1997, the company had foreign-currency forward and option
contracts outstanding that hedged a portion of anticipated production costs
expected to be denominated in the Malaysian ringgit. The related amounts of
these contracts were $23.2 million for the forward contracts and $17.7 million
for the option contracts at December 31, 1997. The contracts settle monthly
through June 1998. The company recognizes realized and unrealized gains and
losses on these contracts in income in the period in which the change occurs
because the contracts are not qualifying hedges for accounting purposes. Net
expense during 1997 was $11.6 million. The company did not use derivative
instruments to manage its foreign-exchange exposures during 1996. Allegiance
does not use financial instruments for trading purposes.
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.
Prior to the Distribution Date, Baxter allocated to Allegiance the income and
expense associated with certain option contracts used to hedge anticipated costs
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.
FAIR VALUES OF FINANCIAL INSTRUMENTS
<TABLE>
<CAPTION>
Carrying Approximate
as of December 31, 1997 (in millions) value fair value
- -------------------------------------------------------------------------------
<S> <C> <C>
Short-term borrowings classified as long-term $351.5 $351.5
Other long-term debt and lease obligations 549.4 577.8
Commodity hedges - (3.4)
Foreign-currency forward contracts - (7.8)
Foreign-currency option contracts - 2.2
===============================================================================
</TABLE>
Allegiance Corporation 1997 Annual Report
<PAGE>
38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The carrying values of current assets and liabilities, including short-term
borrowings, which have been classified as long-term, approximated their fair
values at December 31, 1997 and 1996 due to their short-term maturities. The
carrying values of long-term borrowings and commodity hedges approximated their
fair values at December 31, 1996. The fair values of all other items noted in
the above table are based on quoted market prices for the same or similar
instruments.
Investments in affiliates are accounted for by both the cost and equity
methods and pertain to several minor 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.
9. 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
- -----------------------------------------------------------
<S> <C> <C>
Allegiance provided:
Distribution services to Baxter
in the United States $160.4 $213.7
Administrative services to Baxter 18.9 25.2
Allegiance received:
Administrative services
from Baxter $ 36.2 $ 48.3
International distribution
services from Baxter 19.4 25.8
===========================================================
</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.
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
would continue to provide, for a specified period of time, certain
administrative services that each entity historically had 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, agent, customer and
supplier for an array of health-care products and services.
10. Preferred Stock
The board of directors has authorized two million shares of $.01 par value
preferred stock that can be issued in series with varying terms as determined by
the board of directors. No shares of preferred stock have been issued.
PREFERRED STOCK PURCHASE RIGHTS
In 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 or obtained
the right to acquire 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
Allegiance 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
circum-
Allegiance Corporation 1997 Annual Report
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 39
stances, each Right may be exercised for common stock of an acquiring entity
having a value of $130. 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 the Rights become transferable apart from the common stock. The
Rights will expire at the close of business on September 30, 2006, unless
redeemed earlier.
11. Common Stock
EMPLOYEE STOCK PURCHASE PLAN
The company has an employee stock purchase plan under which the sale of two
million shares 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. Under this
plan, the company sold to employees 545,673 shares at an average price per share
of $17.88 in 1997 and 93,159 shares at an average price per share of $15.66 in
1996. At December 31, 1997 and 1996, subscriptions of 576,492 shares and 888,661
shares were outstanding. The weighted average fair value for each purchase right
was $7.13 in 1997 and $4.79 in 1996.
INCENTIVE COMPENSATION PLANS
The company has various incentive plans for employees under which the grant of
approximately 9.7 million shares of its common stock has been authorized. At
December 31, 1997, there were approximately 264,000 shares remaining to be
issued under this authorization.
The company granted restricted common stock under this authorization in the
amount of 86,203 shares in October 1996 and 4,047 shares in August 1997 to
provide compensation to selected employees. All outstanding restricted shares
are subject to future employment and vest two years from the grant date. In
1997, 1,727 shares were forfeited. There has been no other activity related to
restricted shares.
Various stock-option plans are also included under this authorization. Other
than the Shared Investment Plan discussed below, all outstanding options under
these plans have been granted at 100 percent of market value on the dates of
grant, have a 10 year term and vest equally over three years from the grant
date. The average remaining life of options outstanding at December 31, 1997 was
8.9 years. The exercise prices range from $18.38 to $29.38.
On May 2, 1997, the company received $54.8 million in cash from 141 members of
Allegiance's management who purchased approximately 2.4 million shares of the
company's stock. The company granted one-day options for the shares, which were
immediately exercised, from the approximately 9.7 million share authorization
discussed above. This Shared Investment Plan was designed to align management
and stockholder interests. Under terms of the voluntary program, Allegiance
managers used personal full-recourse loans to purchase the newly issued shares
at the closing price per share on May 2, 1997 of $23 1/4. The loans, borrowed
from several banks, are at market interest rates and are the personal
obligations of the participants. Allegiance has agreed to guarantee repayment to
the banks in the event of default by a participant. Allegiance may take all
actions necessary to obtain full reimbursement from the participant for amounts
paid by Allegiance, if any, to the banks in the future under its guarantee.
<TABLE>
<CAPTION>
FIXED STOCK-OPTION TRANSACTIONS
for the years ended December 31
Weighted
average
1997 Shares exercise price
- ----------------------------------------------------------------------
<S> <C> <C>
Beginning of year 6,417,601 $19.96
Granted 3,493,770 24.78
Exercised (2,503,995) 23.07
Forfeited (580,441) 20.56
- ----------------------------------------------------------------------
Stock options outstanding, end of year 6,826,935 $21.23
- ----------------------------------------------------------------------
Stock options exercisable, end of year 1,878,278 $19.93
- ----------------------------------------------------------------------
Weighted average fair value of each
option granted during the year $11.99
======================================================================
</TABLE>
<TABLE>
<CAPTION>
Weighted
average
1996 Shares exercise price
- ----------------------------------------------------------------------
<S> <C> <C>
Inception of plans -- --
Granted 6,459,329 $19.95
Exercised -- --
Forfeited (41,728) 18.38
- ----------------------------------------------------------------------
Stock options outstanding, end of year 6,417,601 $19.96
- ----------------------------------------------------------------------
Stock options exercisable, end of year -- --
- ----------------------------------------------------------------------
Weighted average fair value of each
option granted during the year $ 7.83
======================================================================
</TABLE>
Allegiance Corporation 1997 Annual Report
<PAGE>
40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 in accordance with the provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation:" net income would have been $75.7
million in 1997; basic and diluted net income per share would have been $1.33
and $1.30, respectively, in 1997; net loss for 1996 would have been $480.5
million; and basic and diluted net loss per share would have been $8.75 in 1996.
The fair value of each option-grant is estimated on the date of grant using the
Black-Scholes option-pricing model and the following assumptions:
<TABLE>
<CAPTION>
<S> <C> <C>
Weighted Average Assumptions
years ended December 31 1997 1996
- --------------------------------------------------------------------------------------------
Dividend yield 1.13% -- 1.45% 1.45%
Expected volatility 28.8% -- 62.8% 29.8% -- 32.9%
Risk-free interest rate 4.9% -- 6.6% 5.1% -- 6.5%
Expected life 1 month-7 years 1 month-7 years
============================================================================================
</TABLE>
NON-EMPLOYEE DIRECTOR PROGRAM
The company granted 94,998 shares in October 1996 to non-employee directors.
These options, granted at an exercise price of $18.38, were granted at 100
percent of market value on the date of grant, have a 10-year term and vest in
May 1998. There has been no activity related to these shares. The fair value of
each grant is estimated at $7.29.
OTHER
On November 6, 1997, Allegiance's board of directors authorized the company to
repurchase up to 3 million shares of the company's common stock. Allegiance
repurchased 1 million shares ($35.8 million) in 1997 and is authorized to
repurchase the remaining 2 million shares in a systematic manner over
approximately two years. The stock is held in treasury and will be used in the
administration of the company's employee stock purchase plan and other benefit
programs.
12. Retirement and Other Benefit Programs
Most U.S. employees are eligible to participate in a qualified 401(k) plan.
Participants may contribute to the plan up to 12 percent of their base-pay
earnings during the year (limited in 1997 to $9,500 per individual), and
Allegiance matches participants' contributions, up to 3 percent of base-pay
earnings. Matching contributions made by Allegiance were $7.8 million in 1997,
$9.4 million in 1996 and $11.4 million in 1995.
In addition to the matching contribution discussed above, eligible employees
at December 31, 1997, received a contribution to their respective fixed
retirement accounts in an amount equal to 3 percent of their base-pay earnings
during the year. Expense related to this benefit in 1997 was $10.6 million.
Contributions in excess of 3 percent can be made at management's discretion. No
additional contributions were made for 1997.
Certain employees as of December 31, 1997, who participated in Baxter-
sponsored defined benefit plans prior to the Distribution Date are eligible to
receive a contribution to their respective transition retirement account in an
amount ranging from 2 to 8 percent of their base-pay earnings during the year,
depending on benefit service points. This transitional benefit will be provided
to eligible employees through 2003. Expense related to this benefit in 1997 was
$5.0 million.
The liability associated with post-employment benefits such as disability-
related and workers' compensation payments was $18.8 million and $17.5 million
at December 31, 1997 and 1996, respectively.
RETIREMENT AND OTHER BENEFIT PROGRAMS--
PRIOR TO DISTRIBUTION DATE ONLY
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 benefit plans 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 in the third quarter of 1996.
Allegiance Corporation 1997 Annual Report
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 41
Pension expense associated with the Baxter-sponsored plans prior to being
frozen was $17.2 million for the nine months ended September 30, 1996, and $17.2
million for the year ended December 31, 1995.
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.
13. Other (Income) Expense
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1997 1996 1995
- -----------------------------------------------------------------
<S> <C> <C> <C>
Asset dispositions, net $(7.7) $ - $(262.5)
Foreign exchange 6.4 1.0 0.3
Foreign-currency hedging contracts 11.6 - -
Other (2.6) (5.9) (39.6)
- -----------------------------------------------------------------
Total other (income) expense $ 7.7 $(4.9) $(301.8)
=================================================================
</TABLE>
14. Income Taxes
INCOME (LOSS) BEFORE INCOME TAX EXPENSE BY CATEGORY
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1997 1996 1995
- -----------------------------------------------------------------
<S> <C> <C> <C>
United States $103.4 $(491.9) $433.9
International 39.6 64.0 42.1
- -----------------------------------------------------------------
Income (loss) before
income taxes $143.0 $(427.9) $476.0
=================================================================
</TABLE>
INCOME TAX EXPENSE BY CATEGORY
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1997 1996 1995
- -----------------------------------------------------------------
<S> <C> <C> <C>
Current
U.S.
Federal $28.3 $ 48.6 $124.1
State and local 7.8 11.4 34.2
International 1.0 3.5 (5.1)
- -----------------------------------------------------------------
Current income tax expense 37.1 63.5 153.2
- -----------------------------------------------------------------
Deferred
U.S.
Federal 14.2 (9.4) 38.0
State and local 3.8 (1.4) 8.4
International (3.0) (2.9) 3.8
- -----------------------------------------------------------------
Deferred income tax expense (benefit) 15.0 (13.7) 50.2
- -----------------------------------------------------------------
Total income tax expense $52.1 $ 49.8 $203.4
=================================================================
</TABLE>
Income tax expense prior to the Distribution Date was calculated as if
Allegiance had been a stand-alone entity.
DEFERRED TAX ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
years ended December 31 (in millions) 1997 1996 1995
- ---------------------------------------------------------------
<S> <C> <C> <C>
Deferred tax assets
Accrued expenses $102.4 $ 93.8 $ 70.0
Restructuring and
non-recurring costs 20.0 62.4 56.9
Other 1.4 - 0.1
- ---------------------------------------------------------------
Total deferred tax assets 123.8 156.2 127.0
- ---------------------------------------------------------------
Deferred tax liabilities
Asset-basis differences 113.2 125.8 106.7
Other - 4.8 1.0
- ---------------------------------------------------------------
Total deferred tax liabilities 113.2 130.6 107.7
- ---------------------------------------------------------------
Net deferred tax assets $ 10.6 $ 25.6 $ 19.3
===============================================================
</TABLE>
In 1996, $7.4 million of deferred tax assets were transferred
to Baxter, related primarily to spin-off costs assumed by 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) 1997 1996 1995
- -------------------------------------------------------------------
<S> <C> <C> <C>
Income tax expense (benefit)
at statutory rate $ 50.0 $(149.8) $166.4
Tax-exempt operations (15.7) (19.6) (17.4)
Nondeductible goodwill
and non-recurring costs 6.2 213.5 28.1
State and local taxes 7.6 6.5 27.0
Foreign tax expense (0.2) (2.0) (0.8)
Valuation allowance for losses
in unconsolidated subs 3.1 - -
Other factors 1.1 1.2 0.1
- -------------------------------------------------------------------
Income tax expense $ 52.1 $ 49.8 $203.4
===================================================================
</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 $52.3
million and $36.4 million as of December 31, 1997 and 1996.
Allegiance Corporation 1997 Annual Report
<PAGE>
42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. 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 10 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' demurrer
to the class action allegations. On February 29, 1996, the California Appellate
Court upheld the trial court's ruling and the case was dismissed. On April 8,
1994, a similar purported class action, Green, et al., v. Baxter Healthcare
Corporation, et al., (Cir. Ct., Milwaukee Co., WI, 94CV004977), was filed
against BHC and three other defendants. The class action allegations have been
withdrawn, but additional plaintiffs added individual claims. On July 1, 1996,
BHC was served with a similar purported class action, Wolf v. Baxter Healthcare
Corp., et al., (Circuit Court, Wayne County, MI, 96-617844NP). BHC is the only
named defendant in that suit. On January 3, 1997, BHC was served with a similar,
nationwide proposed class action, Murray, et al., v. Baxter Healthcare
Corporation, et al., (U.S.D.C. Southern District of Indiana, IP96-1889C). BHC
and three other companies are defendants. On April 11, 1997, a similar proposed
statewide class action, Delpit, et al. v. Ansell, Inc., et al., (U.S.D.C.
Eastern District of Louisiana, 97-1112), was filed on behalf of users of latex
gloves in the State of Louisiana. BHC and five other companies are defendants.
On April 29, 1997, another similar proposed state-wide class action, Cowart, et.
al. v. Ansell, Inc., et. al., (Civil District Court, Parish of Orleans, 97-
7237), was filed on behalf of users of latex gloves. Baxter International Inc.
and three other companies are defendants. On November 5, 1997, plaintiffs in
each of these cases stipulated to the dismissal of the class claims. On August
8, 1997, BHC was served with a writ of summons in a case styled, Swartz v. Ach,
Inc., et al., (Court of Common Pleas of Jefferson County, Pennsylvania Civil
Division, No.656-1997 C.D.) which purports to be a similar class action directed
against manufacturers, distributors and sellers of natural rubber products. On
October 9, 1996, the plaintiff in a case pending in federal court filed a
petition with the Judicial Panel Multi District Litigation, In Re Latex Gloves
Products Liability Litigation, (MDL Docket No. 1148), seeking to transfer and
consolidate the cases involving claims related to natural rubber latex gloves
pending in federal court for pretrial proceedings and/or trial. On February 26,
1997, the Panel granted the petition and ordered all cases pending in federal
court to be transferred to the Eastern District of Pennsylvania for coordinated
or consolidated pretrial proceedings. As of March 4, 1998, there are an
additional 200 active lawsuits and one claim involving BHC and/or the company
containing similar allegations of sensitization to natural rubber latex
products. Allegiance intends to vigorously defend against these actions. Since
none of these cases has proceeded to a hearing on the merits, Allegiance is
unable to evaluate the extent of any potential liability, and unable to estimate
any potential loss.
Because of the increase in claims filed and the ongoing defense costs that
will be incurred, the company believes it is probable that Allegiance will incur
significant expenses related to the defense of cases involving natural rubber
latex gloves. During the fourth quarter of 1996, the company recorded a charge
of $19.5 million to provide the minimum amount of the potential range of defense
costs expected to be incurred related to existing cases. On an ongoing basis,
the company assesses the adequacy of reserves and provides the minimum amount of
this potential range.
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
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 43
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. Based
upon the advice of counsel, 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, 1997, BHC had been identified as a potentially responsible
party for cleanup costs at ten hazardous waste sites, for which Allegiance has
assumed responsibility. Allegiance's largest assumed exposure is at the Thermo-
Chem site in Muskegon, Michigan. Allegiance expects the total cleanup costs for
this site to be between $44.0 million and $65.0 million, of which Allegiance's
share would be approximately $5.4 million. This amount, net of payments of
approximately $1.6 million, has been accrued and is reflected in Allegiance's
consolidated financial statements. The estimated exposure for the remaining nine
sites is approximately $3.8 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.
16. Industry and Geographic Information
Most of Allegiance's international sales are in Canada, France and Germany. The
company has international manufacturing operations in Malaysia, Mexico, France,
Malta and the Netherlands. The majority of raw materials used to manufacture
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 that are members of two large
hospital buying groups, Premier, Inc. ("Premier") and VHA Inc. ("VHA"), as a
percentage of total sales, were 28 percent and 20 percent, respectively, in
1997, 27 percent and 20 percent, respectively, in 1996, and 27 percent and 16
percent, respectively, in 1995. 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
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 sales from all members of the
group.
Allegiance Corporation 1997 Annual Report
<PAGE>
44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. 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>
1997
Net sales $1,055.9 $1,075.0 $1,083.3 $1,136.6 $4,350.8
Gross profit 219.8 223.4 226.5 238.5 908.2
Net income 21.0 22.0 23.0 24.9 90.9
Per common share:
Net income
Basic 0.38 0.39 0.40 0.43 1.60
Diluted 0.37 0.38 0.39 0.42 1.56
Dividends 0.10 0.10 0.10 0.10 0.40
Market price
High 26.38 28.38 31.63 35.44 35.44
Low 22.13 20.00 26.44 27.50 20.00
====================================================================================================
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)/
Basic 0.56 0.49 1.10 (10.85) (8.70)
Diluted 0.56 0.49 1.10 (10.85) (8.70)
Dividends n/a n/a n/a 0.10 0.10
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
====================================================================================================
</TABLE>
n/a - not applicable
(1) Net loss for the fourth quarter 1996 includes non-recurring pretax charges
of $550.0 million for the write-down of goodwill and $95.5 million
primarily for facility consolidations and other asset write-downs.
(2) Earnings per share data through September 30, 1996, assume the shares
issued in connection with the spin-off from Baxter International Inc. were
outstanding.
(3) Allegiance stock traded on a "when issued" basis from September 24, 1996,
to September 30, 1996.
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, 1998, there were approximately
43,925 holders of record of the company's common stock.
Allegiance Corporation 1997 Annual Report
<PAGE>
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA 45
<TABLE>
<CAPTION>
years ended December 31 1997 1996/(1)/ 1995/(2)/ 1994/(2)/ 1993/(2)(3)/
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATIONS Net sales $4,350.8 $4,387.2 $4,921.9 $5,108.6 $5,019.3
(in millions) Net income (loss) 90.9 (477.7) 272.6 214.9 (68.4)
Depreciation and amortization 126.0 145.2 164.6 222.8 221.0
- -------------------------------------------------------------------------------------------------------------------------------
CAPITAL EMPLOYED Working capital $ 548.8 $ 637.4 $ 679.7 $1,054.9 $ 928.1
(in millions) Capital expenditures 81.3 102.5 111.9 122.4 273.1
Total assets 2,696.6 2,799.2 3,443.7 4,031.4 4,576.2
Long-term debt and lease obligations 900.7 1,106.6 - - -
- -------------------------------------------------------------------------------------------------------------------------------
PER COMMON Average number of common shares
SHARE/(4)/ outstanding (in millions)
Basic 56.9 54.9 54.8 54.8 54.8
Diluted 58.2 54.9 54.8 54.8 54.8
Net income (loss)
Basic $ 1.60 $ (8.70) $ 4.97 $ 3.92 $ (1.25)
Diluted 1.56 (8.70) 4.97 3.92 (1.25)
Cash dividends declared 0.40 0.10 n/a n/a n/a
Market price--high 35.44 27.88 n/a n/a n/a
Market price--low 20.00 16.25 n/a n/a n/a
- -------------------------------------------------------------------------------------------------------------------------------
PRODUCTIVITY Employees at year-end 19,800 20,700 21,300 21,100 26,900
MEASURES Sales per year-end employee $219,737 $211,942 $231,075 $242,114 $186,591
Net income (loss) per employee 4,591 (23,077) 12,798 10,185 (2,543)
- -------------------------------------------------------------------------------------------------------------------------------
FINANCIAL RETURNS Net income (loss) as a percentage of sales 2.1% (10.9%) 5.5% 4.2% (1.4%)
AND STATISTICS Long-term debt as a percentage of total
year-end capital 49.0 57.2 - - -
===============================================================================================================================
</TABLE>
n/a--not applicable
(1) Net loss for 1996 includes non-recurring pretax charges of $550.0 million
for the write-down of goodwill and $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 prior to 1996 assume the shares issued in
connection with the spin-off from Baxter International Inc. were
outstanding.
Allegiance Corporation 1997 Annual Report
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
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 January 26, 1998 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 13, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1997 AND CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 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-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 32
<SECURITIES> 0
<RECEIVABLES> 535<F1>
<ALLOWANCES> 24
<INVENTORY> 587
<CURRENT-ASSETS> 1,262
<PP&E> 1,544
<DEPRECIATION> 749
<TOTAL-ASSETS> 2,697
<CURRENT-LIABILITIES> 714
<BONDS> 901
0
0
<COMMON> 58
<OTHER-SE> 879
<TOTAL-LIABILITY-AND-EQUITY> 2,697
<SALES> 4,351
<TOTAL-REVENUES> 4,351
<CGS> 3,443
<TOTAL-COSTS> 4,208
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1
<INTEREST-EXPENSE> 68
<INCOME-PRETAX> 143
<INCOME-TAX> 52
<INCOME-CONTINUING> 91
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 91
<EPS-PRIMARY> 1.60
<EPS-DILUTED> 1.56
<FN>
<F1> Gross
</FN>
</TABLE>
