<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
- ----- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
_____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission file number 1-11885
-------------
ALLEGIANCE CORPORATION.
----------------------
(Exact name of registrant as specified in its charter)
Delaware 36-4095179
------------------------------------- ---------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1430 Waukegan Road, McGaw Park, Illinois 60085
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(847) 689-8410
---------------------------
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No___
---
The number of shares of the registrant's Common Stock, $1 par value, outstanding
as of April 30, 1998, the latest practicable date, was 57,092,950 shares.
<PAGE>
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
Allegiance Corporation
Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)
(in millions, except per share data)
- --------------------------------------------------------------------------------
Three months ended
March 31,
1998 1997
---- ----
<S> <C> <C>
Net sales $1,103.4 $1,055.9
Costs and expenses
Cost of goods sold 862.5 836.1
Selling, general and administrative expenses 171.5 161.0
Research & development 2.4 2.0
Goodwill amortization 5.7 5.3
Interest expense 15.2 18.9
Other expense 1.4 0.2
- --------------------------------------------------------------------------------
Total costs and expenses 1,058.7 1,023.5
- --------------------------------------------------------------------------------
Income before income taxes 44.7 32.4
Income tax expense 16.5 11.4
- --------------------------------------------------------------------------------
Net income $28.2 $21.0
Comprehensive income $28.0 $20.6
- --------------------------------------------------------------------------------
Net income per common share
Basic $0.49 $0.38
Diluted $0.48 $0.37
Average number of common shares outstanding
Basic 57.4 55.3
Diluted 59.2 56.4
================================================================================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
3
Allegiance Corporation
Condensed Consolidated Balance Sheets
(in millions, except par value and shares)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
March 31, December 31,
1998 1997
---- ----
(Unaudited)
<S> <C> <C> <C>
Current assets Cash and equivalents $ 22.8 $ 31.6
Accounts receivable (net of
allowance for doubtful accounts
of $25.3 and $24.1 at March 31,
1998 and December 31, 1997,
respectively) 485.2 510.8
Notes and other current
receivables 12.0 17.3
Inventories 630.2 586.9
Deferred income taxes 86.4 97.9
Prepaid expenses 22.5 17.9
----------------------------------------------------------------------------------
Total current assets 1,259.1 1,262.4
----------------------------------------------------------------------------------
Property, At cost 1,553.1 1,543.5
plant and Accumulated depreciation and
equipment amortization (769.8) (748.9)
----------------------------------------------------------------------------------
Net property, plant and equipment 783.3 794.6
- ---------------------------------------------------------------------------------------------------------------------
Other assets Goodwill and other intangibles 569.7 553.8
Other 89.8 85.8
----------------------------------------------------------------------------------
Total other assets 659.5 639.6
- ---------------------------------------------------------------------------------------------------------------------
Total assets $2,701.9 $2,696.6
=====================================================================================================================
Current
liabilities Accounts payable and accrued liabilities $ 725.6 $ 713.6
- ---------------------------------------------------------------------------------------------------------------------
Long-term debt 887.1 900.7
- ---------------------------------------------------------------------------------------------------------------------
Deferred income taxes 98.8 99.2
- ---------------------------------------------------------------------------------------------------------------------
Other non-current liabilities 45.9 45.9
- ---------------------------------------------------------------------------------------------------------------------
Equity Common stock, par value $1.00,
authorized 200,000,000 shares,
issued 58,115,860 shares in 1998
and 1997 58.1 58.1
Additional contributed capital 62.5 66.4
Retained earnings 859.7 837.3
Common stock in treasury, at cost, 998,090
shares in 1998 and 749,129 shares in
1997 (36.1) (25.2)
Cumulative foreign currency adjustment 0.3 0.6
----------------------------------------------------------------------------------
Total equity 944.5 937.2
- ---------------------------------------------------------------------------------------------------------------------
Total liabilities and equity $2,701.9 $2,696.6
=====================================================================================================================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
4
Allegiance Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in millions)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Three months ended
March 31,
1998 1997
---- ----
(Brackets denote cash outflows)
<S> <C> <C> <C>
Cash flow provided Net income $ 28.2 $ 21.0
by operations Adjustments
Depreciation and amortization 28.8 31.2
Deferred income taxes 11.0 5.1
Other 2.7 2.1
Changes in balance sheet items
Accounts and notes receivable 31.4 44.7
Inventories (43.2) 2.1
Accounts payable and other current liabilities 6.9 (3.1)
Restructuring program payments (2.6) (8.3)
Other (3.5) (11.9)
-------------------------------------------------------------------------------------------
Cash flow provided by operations 59.7 82.9
- --------------------------------------------------------------------------------------------------------------------
Investment Capital expenditures (12.2) (14.8)
transactions Acquisitions (net of cash received) (24.1) (36.5)
Proceeds from asset dispositions 1.8 -
-------------------------------------------------------------------------------------------
Investment transactions, net (34.5) (51.3)
- --------------------------------------------------------------------------------------------------------------------
Financing Decrease in debt with maturities of three
transactions months or less, net (13.4) (47.0)
Issuance of debt - 25.0
Common stock cash dividends (5.8) (5.6)
Common stock issued under employee benefit plans 8.2 2.0
Purchase of treasury stock (23.0) (2.6)
-------------------------------------------------------------------------------------------
Financing transactions, net (34.0) (28.2)
- --------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and equivalents (8.8) 3.4
Cash and equivalents at beginning of period 31.6 22.9
- --------------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 22.8 $ 26.3
====================================================================================================================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
5
Allegiance Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Financial information
- -------------------------
The unaudited interim condensed consolidated financial statements of Allegiance
Corporation ("Allegiance" or the "company") have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission. Accordingly,
certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These interim condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the company's 1997 Annual Report to
Stockholders and Annual Report on Form 10-K for the year ended December 31,
1997.
In the opinion of management, the interim condensed consolidated financial
statements reflect all adjustments necessary for a fair presentation of the
interim periods. All such adjustments are of a normal, recurring nature. The
results of operations for the interim period are not necessarily indicative of
the results of operations to be expected for the full year.
2. Earnings per share
- ----------------------
In 1997, the company adopted Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings per Share," ("EPS") which requires the presentation
of both basic and diluted EPS.
<TABLE>
<CAPTION>
Reconciliation of Basic and Diluted EPS 1998 1997
---------------------------------------- ------------------------------------------
three months ended March 31, Net Per share Net Per share
in millions, except per share data income Shares amount income Shares amount
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $28.2 57.4 $0.49 $21.0 55.3 $0.38
Additional shares assuming
exercise of stock option
and stock purchase plan
subscriptions (a) 1.8 1.1
- ---------------------------------------------------------------------------------------------------------------------------------
Diluted EPS $28.2 59.2 $0.48 $21.0 56.4 $0.37
=================================================================================================================================
</TABLE>
(a) Options to purchase 0.2 million shares at an average price per share of
$25.38 per share were outstanding during the three months ended March 31, 1997,
but were not included in the diluted EPS computation because the exercise price
exceeded the average market price for the period.
3. Inventories
- ---------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
March 31, December 31,
(in millions) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 53.0 $ 52.3
Work in process 55.1 44.2
Finished products 522.1 490.4
- --------------------------------------------------------------------------------
Total inventories $630.2 $586.9
================================================================================
</TABLE>
<PAGE>
6
4. Restructuring charge
- --------------------------
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
Divestitures
Employee- and asset Other
(in millions) related costs write-downs costs Total
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1997 balance $13.8 $17.0 $3.3 $34.1
- ------------------------------------------------------------------------------------------------------------
Utilization:
Cash 0.9 - 1.7 2.6
Non-cash - 0.7 - 0.7
- ------------------------------------------------------------------------------------------------------------
March 31, 1998 balance $12.9 $16.3 $1.6 $30.8
============================================================================================================
</TABLE>
Cash outflows pertain primarily to 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 reductions will occur throughout 1998, as
implementation team projects and facility closures and consolidations are
completed as planned.
5. Comprehensive income
- ------------------------
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which is effective for fiscal years beginning
after December 15, 1997 and requires reclassification of prior period financial
statements. SFAS No. 130, which the company adopted during the first quarter of
1998, requires the presentation of comprehensive income and its components in a
full set of general purpose financial statements. The company's comprehensive
income consists of net income and foreign currency translation adjustments.
Foreign currency translation adjustments, net of tax, amounted to $0.2 million
and $0.4 million for the three months ended March 31, 1998 and 1997,
respectively.
6. Legal proceedings
- ---------------------
Allegiance assumed the defense of litigation involving claims related to the
Allegiance businesses from Baxter Healthcare Corporation ("BHC"), 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 BHC, as contemplated by the agreements between Baxter International
Inc. ("Baxter") and Allegiance, for all expenses and potential liabilities
associated with claims pertaining to this litigation. It is expected that
Allegiance will be named as a defendant in future litigation and may be added as
a defendant in existing litigation.
BHC was one of ten defendants named in a purported class action filed in August
1993, Kennedy, et al., v. Baxter Healthcare Corporation, et al., (Sup. Ct.,
Sacramento Co., Cal., #535632), on behalf of all medical and dental personnel in
the State of California who allegedly suffered allergic reactions to natural
rubber latex gloves and other protective equipment or who allegedly have been
exposed to natural rubber latex products. The case alleged that users of
various natural rubber latex products, including medical gloves made and sold by
BHC and other manufacturers, suffered allergic reactions to the products ranging
from skin irritation to systemic anaphylaxis. The Court granted defendants'
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
<PAGE>
7
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 one such 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 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 April
30, 1998, there are an additional 234 active lawsuits involving BHC and/or the
company containing similar allegations of sensitization to natural rubber latex
products. Allegiance intends to vigorously defend against these actions. Since
none of these cases has proceeded to a hearing on the merits, Allegiance is
unable to evaluate the extent of any potential liability, and unable to estimate
any potential loss.
Because of the increase in claims filed and the ongoing defense costs that will
be incurred, the company believes it is probable that Allegiance will incur
significant expenses related to the defense of cases involving natural rubber
latex gloves. During the fourth quarter of 1996, the company 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 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.
<PAGE>
8
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 March 31, 1998, 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 already made
of $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.
<PAGE>
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following management discussion and analysis describes material changes in
the company's financial condition since December 31, 1997. Trends of a material
nature are discussed to the extent known and considered relevant. This
discussion should be read in conjunction with the consolidated financial
statements, related notes thereto and management's discussion and analysis of
financial condition and results of operations included in the company's 1997
Annual Report to Stockholders and Annual Report on Form 10-K for the year ended
December 31, 1997.
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 forwarding-looking statement
whether as a result of new information, future events or otherwise.
RESULTS OF OPERATIONS
Sales
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Three months ended
March 31, Percent
(in millions, except percentages) 1998 1997 increase
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Geographic region
United States $1,006.9 $ 990.5 1.7%
International 96.5 65.4 47.6
- --------------------------------------------------------------------------------------------------------
Total net sales $1,103.4 $1,055.9 4.5%
- --------------------------------------------------------------------------------------------------------
Product Category
Distributed product $ 684.7 $ 680.9 0.6%
Self-manufactured product 418.7 375.0 11.7
- --------------------------------------------------------------------------------------------------------
Total net sales $1,103.4 $1,055.9 4.5%
- --------------------------------------------------------------------------------------------------------
</TABLE>
The increase in Allegiance's domestic sales for the three months ended March 31,
1998 as compared to the same period in the prior year principally resulted from
the increase in sales of self-manufactured products discussed below, partially
offset by on-going reductions in sales of lower-margin, distributed products.
The increase in first quarter international sales was principally the result of
incremental sales from Source Medical Corporation, a Canadian venture
established in the fourth quarter of 1997. Excluding the incremental sales from
Source Medical, international sales grew approximately 9%
<PAGE>
10
(10% excluding the adverse effects of foreign exchange). This increase was
primarily the result of the new sales subsidiaries established in Belgium,
Italy, the Netherlands, Spain and Switzerland.
Incremental sales from Source Medical discussed above, partially offset by on-
going reductions in sales of lower-margin distributed products in the United
States contributed to the slight increase in distributed product sales for the
quarter ended March 31, 1998.
The increase in self-manufactured product sales during the three months ended
March 31, 1998 as compared to the same period in the prior year principally
resulted from the favorable impact of the company's agreement with Premier, Inc.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Three months ended March 31,
(as a percentage of sales) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Gross margin 21.8% 20.8%
Selling, general and administrative expenses 15.5 15.2
- --------------------------------------------------------------------------------
</TABLE>
Gross margin increased by 1.0 percentage point for the three months ended
March 31, 1998 as compared to the same period in the prior year. Approximately
$3.5 million of the increase in gross profit is the result of the favorable
impact of the devaluation in the Malaysian ringgitt on the company's
manufacturing costs. Excluding this foreign currency impact, gross margin for
the first quarter was 21.5%. The remaining 0.7 percentage point increase is the
result of improvements in the company's product mix, including self-manufactured
product and international sales growth. Allegiance plans to maintain the
stability of its gross margin by offsetting pricing pressures with manufacturing
and other cost efficiencies, managing its product mix more effectively, and,
when possible, instituting price increases.
The increase in selling, general and administrative expenses as a percent of
sales during the first quarter of 1998 as compared to the same period of the
prior year, resulted principally from the new sales subsidiaries established in
Europe.
Restructuring Program
In November 1993, Baxter initiated a restructuring program to improve
stockholder value and reduce costs. These strategic actions were designed in
part to make the Allegiance businesses more efficient and responsive in
addressing the changes occurring in the U.S. health-care system. See Note 4 to
"Notes to the Condensed Consolidated Financial Statements" for discussions
related to cash and non-cash utilization of the reserves and headcount
reductions to date.
Management believes that the program is on target to achieve anticipated
savings in excess of $155 million in 1998. The company anticipates that these
savings will continue to partially offset potential future gross margin erosion
and investments into cost-management and service 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 will be funded from cash generated from
operations.
<PAGE>
11
Interest Expense
As a result of lower average debt levels, interest expense for the three
months ended March 31, 1998 decreased by $3.7 million from the first quarter of
1997.
Other Income And Expense
The change in other income and expense for the three months ended March 31, 1998
as compared to the three months ended March 31, 1997 was principally the result
of losses incurred on a number of individually immaterial asset dispositions.
Income Taxes
Allegiance's effective tax rate during the period ended March 31, 1998 was 1.8
percentage points higher than the same period in the prior year. This increase
was caused principally by a larger proportion of earnings generated in higher
tax rate jurisdictions.
Net Income
The increase in net income for the three months ended March 31, 1998 as compared
to the same period in the prior year is principally the result of sales
increases, improved gross margins and lower interest expense.
ADOPTION OF NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income".
SFAS No. 130 requires presentation of comprehensive income and its components in
a full set of general-purpose financial statements. SFAS No. 130 is effective
for fiscal years beginning after December 15, 1997, and requires
reclassification of all prior period financial statements. The company has
reflected the adoption of this statement it its first quarter financial
statements for the three months ended March 31, 1998 and 1997.
LIQUIDITY AND CAPITAL RESOURCES
Allegiance's current assets exceeded current liabilities by $533.5 million at
March 31, 1998 versus an excess of $548.8 million at December 31, 1997. Current
assets at March 31, 1998 included accounts, notes and other current receivables
of $497.2 million and inventories of $630.2 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.
<PAGE>
12
Cash Flow
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Three months ended
March 31,
(brackets denote cash outflows, in millions) 1998 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flow provided by operations as stated in the
company's Condensed Consolidated Statements
of Cash Flows $ 59.7 $ 82.9
Capital expenditures (12.2) (14.8)
Common stock cash dividends (5.8) (5.6)
- ---------------------------------------------------------------------------------------------
"Free cash flow" $ 41.7 $ 62.5
=============================================================================================
</TABLE>
Cash flow provided by operations during 1997 was favorably impacted by improved
balance sheet management (primarily accounts and notes receivable). The company
expects that its ability to generate cash flow from improvements in balance
sheet management will moderate from what was experienced in 1997. During the
first quarter of 1998, the company experienced this moderation, which resulted
in a decrease in cash flow provided by operations over the corresponding period
in the prior year.
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 level of "free cash flow"
during the three months ended March 31, 1998 enabled the company to fund $24.1
million in acquisitions, repurchase over 600,000 shares of its common stock on
the open market for $23.0 million and pay down $13.4 million of long-term debt.
Investment Transactions
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Three months ended
March 31,
(brackets denote cash outflows, in millions) 1998 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Capital expenditures $(12.2) $(14.8)
Acquisitions (24.1) (36.5)
Proceeds from asset dispositions 1.8 -
- ---------------------------------------------------------------------------------------------
Total investment transactions, net $(34.5) $(51.3)
=============================================================================================
</TABLE>
Capital expenditure levels during the three months ended March 31, 1998 as
compared to the same period in 1997 are relatively consistent. Allegiance
management expects to invest in capital expenditures throughout 1998 at levels
consistent with 1997, principally for improvements to existing facilities,
manufacturing capacity expansion, system upgrades, productivity-enhancing
equipment and other cost reduction projects.
During the first quarter of 1998, Allegiance spent $21.5 million to acquire
Bauer Medical Inc., a privately held manufacturer and marketer of single-use
biopsy devices, and Higman Healthcare, a privately held consulting firm
specializing in improving management of surgical services. On January 2, 1997,
Allegiance acquired West Hudson & Co. Inc., a privately-owned health-care
consulting firm, for $30.5 million in cash and $10.5 million in stock, with
possible contingent payments through 2000. All acquisitions are consistent with
Allegiance's
<PAGE>
13
strategic direction, and were made to broaden product lines and service
offerings or expand market coverage.
LITIGATION
Allegiance assumed the defense of litigation involving claims related to the
Allegiance businesses from BHC, including certain claims of alleged personal
injuries as a result of exposure to natural rubber latex gloves. See Note 6 to
"Notes to Condensed Consolidated Financial Statements" for a detailed
description of the status of Allegiance's litigation. 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 6 to
"Notes to Condensed Consolidated Financial Statements", Allegiance may incur
charges in excess of presently established reserves. Based on the advice of
counsel, management does not believe the outcome of these matters individually
or in the aggregate, will have a material adverse effect on Allegiance's overall
business, cash flow, results of operations or financial condition.
<PAGE>
14
PART II. OTHER INFORMATION
Allegiance Corporation
Item 4. Submission of Matters to a Vote of Security Holders
The company's 1997 annual meeting of stockholders was held on May 7, 1998 for
the purpose of electing directors and approving the adoption of the company's
1998 Incentive Compensation Program. Proxies for the meeting were solicited
pursuant to Section 14 (a) of the Securities Exchange Act of 1934, and there was
no solicitation in opposition to management's solicitation. All of management's
nominees for directors as listed in the proxy statement were elected with the
following vote:
<TABLE>
<CAPTION>
Number of Votes
-------------------------
In favor Withheld
---------- --------
<S> <C> <C>
Connie R. Curran 49,678,884 628,303
Joseph F. Damico 49,678,096 629,091
Arthur F. Golden 48,021,536 2,285,651
</TABLE>
The following directors' terms of office continued after the meeting:
Kenneth D. Bloem
David W. Grainger
Lester B. Knight
Silas S. Cathcart
Michael D. O'Halleran
The proposal to adopt the company's 1998 Incentive Compensation Program was
approved with the following vote:
<TABLE>
<CAPTION>
------------------------------------------
Number of Votes
------------------------------------------
In favor Against Abstained
---------- ---------- ---------
<S> <C> <C> <C>
Approval of proposal to adopt the
1998 Incentive Compensation
Program 31,647,359 13,149,293 224,885
</TABLE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit
Index hereto.
(b) Report on Form 8-K
Not applicable.
<PAGE>
15
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGIANCE CORPORATION
----------------------
(Registrant)
Date: May 12, 1998 By:
----------------------------------
Peter B. McKee
Senior Vice President and
Chief Financial Officer
<PAGE>
16
Exhibits Filed with Securities and Exchange Commission
<TABLE>
<CAPTION>
Number Description of Exhibit
- ------ ----------------------
<S> <C>
10.1 Amendment to Agency, Services and
Distribution Agreement between Allegiance
Healthcare Corporation and Baxter
Healthcare Corporation
27 Financial Data Schedule. *
</TABLE>
(All other exhibits are inapplicable.)
* Shown only in the original filed with the Securities and Exchange Commission.
Copies of the above exhibits not contained herein are available at a charge of
35 cents per page upon written request to the Investor Relations Department,
Allegiance Corporation, 1430 Waukegan Road, McGaw Park, IL 60085. Copies are
also available at a charge of at least 25 cents per page from the Public
Reference Section of the Securities and Exchange Commission, 450 Fifth Street
N.W., Washington, D.C., 20549.
<PAGE>
Exhibit 10.1
AMENDMENT
TO
AGENCY, SERVICES, AND DISTRIBUTION
by and between
BAXTER HEALTHCARE CORPORATION
as Baxter
and
ALLEGIANCE HEALTHCARE CORPORATION
as Allegiance
<PAGE>
AMENDMENT TO
------------
AGENCY, SERVICES, AND DISTRIBUTION AGREEMENT
--------------------------------------------
This is an Amendment to the October 1, 1996, Agency, Services, and
Distribution Agreement (the "Agreement") by and between Baxter Healthcare
Corporation, a Delaware corporation with its principal offices at One Baxter
Parkway, Deerfield, Illinois 60015 (hereinafter called "Baxter") and Allegiance
Healthcare Corporation, a Delaware corporation with its principal offices at
1430 Waukegan Road, McGaw Park, Illinois 60085 (hereinafter called
"Allegiance").
Baxter and Allegiance desire to amend and do hereby amend the Agreement as
follows:
1. This Amendment is effective as of January 1, 1998.
2. Sections 1.1.3, 1.1.4, and 1.1.15 of the Agreement are deleted in their
entirety. New Section 1.1.4 is added as follows:
1.1.4 "Best Value Products" shall mean a select offering of
Allegiance-distributed and Allegiance-manufactured products which perform
consistently, offer the best value for the price, and provide good
economics throughout the supply chain. Best Value Products are specially
promoted externally to Allegiance customers and internally to Allegiance
sales personnel through financial incentives. All Best Value Products are
required to meet the following specific criteria: (a) the product must be a
market leader as demonstrated by sales volume or have the potential to
become a market leader; (b) the product must provide a return on managed
capital greater than 30% after tax; and (c) the product must meet a minimum
of silver status on the supplier scoreboard attached as Exhibit E.
Notwithstanding the foregoing criteria, the Products listed on Exhibits A
and B from time to time will be deemed Best Value Products; provided,
however, that endotracheal tubes, temperature probes, and heat and moisture
exchangers (whether with or without filters) identified on Exhibit A will
not be considered to be Best Value Products solely on account of their
being
<PAGE>
listed on Exhibit A. Nothing in this Section shall obligate Allegiance to
treat Products as Best Value Products for purposes of sales compensation or
customer incentives.
3. The penultimate sentence of Section 4.1.1 is deleted.
4. The parties desire to extend the Agreement for two additional years.
Accordingly, Section 5 of the Agreement deleted in its entirety and replaced
with the following:
5. Term. The initial Term of this Agreement shall begin on the effective
date of this Agreement and, except as otherwise provided in this Agreement,
end at the end of the day on December 31, 2003. On November first of each
calendar year beginning in 2000, the Term shall be extended automatically
for successive additional periods of one (1) year each, unless and until
either Allegiance or Baxter has given written notice to the other that the
Agreement will expire at the end of its then-current term.
5. Section 6, subsections 6.1, 6.3, 6.4, and 6.6.1 are deleted in their
entirety.
6. New Sections 6.1, 6.3, 6.4, and 6.19 are added to the Agreement as follows:
6.1 Fees. Baxter shall pay to Allegiance a service fee in the amounts set
forth on the attached Schedule 1 to this amendment for each of the calendar
years during the Term of the Agreement in consideration of performance by
Allegiance of its duties in respect of the Products in addition to amounts
otherwise set forth.
6.3 Fee Increase. If Contract Net Sales in any calendar year exceed by
more than $20 million the Target set forth on the attached Schedule 2 to
this amendment for such calendar year, then the service fee for that year
will be increased by an amount calculated by multiplying the percentage set
forth for that year on Schedule 2 by the amount of the Contract Net Sales
in excess of the Target.
<PAGE>
6.4 Fee Decrease. If Contract Net Sales in any calendar year are greater
than $20 million below the Target set forth on the attached Schedule 2 to
this amendment for such calendar year, then the service fee for that year
will be decreased by an amount calculated by multiplying the percentage set
forth for that year on Schedule 2 by the amount of the shortfall in
Contract Net Sales compared to the Target.
6.19 Sales Promotions. Baxter and Allegiance may agree from time to time
on Special Promotions and Programs subject to agreement on the scope, cost,
Product inclusions, duration, customers, and appropriate compensation of
Allegiance's sales reps to which such Special Promotions or Programs will
apply.
7. The first line of Section 6.14.1 is amended to replace the phrase "Sections
6.1 and 6.3" with the phrase "Section 6.1".
8. Sections 8.1.1, 8.1.2, and 8.1.3 are deleted in their entirety and replaced
with the following:
8.1.1 The service fee for each year, subject to adjustment as set forth in
Sections 6.3 or 6.4 above, will be paid monthly, on the fifteenth day of
the following month, according to the following percentages:
January, February, March 7.5% of the service fee per month
April, May, June 8.0% of the service fee per month
July, August, September 8.5% of the service fee per month
October, November 9.0% of the service fee per month
December the balance due.
If at any time during the Term of this Agreement Baxter forecasts that
Contract Net Sales will be more than $20 million above or below the target
level set forth above, then the service fee and the remaining monthly
installments of the service fee paid to Allegiance for that year pursuant
to Sections 6.1 and 8.1.1 will be increased or decreased, as appropriate.
<PAGE>
8.1.2 Allegiance shall make payment to Baxter, at the aggregate Suggested
Sales Prices, for its aggregate purchases of Products sold by Allegiance
under the Distributor Model, net 30 days from the date of shipment of the
Product by Allegiance to the customer for Products on consignment to
Allegiance.
8.1.3 On or before the fifth business day of each calendar month during
the Term, Baxter shall report to Allegiance its Agency Net Sales for the
previous calendar month. Each business day during the Term, Allegiance
shall report to Baxter its aggregate sales and returns of Products for the
previous business day by code and by customer for Distributor Model and BCS
Kit Model transactions, and such reports shall also include, with respect
to Distributor Model transactions, the Suggested Sales Price and
Allegiance's actual purchase price of the Products.
9. Effective upon addition of new Schedules C-1 and D-1, in respect of Section
16.1.1, Baxter agrees not to exercise its right of termination in the event of a
Change of Control, as defined therein, unless the Change of Control involves a
Person which is, or is owned by or under common direct or indirect control by or
with any party identified on the attached Schedule 3 to this amendment.
The following sentence is added to the end of Section 16.1.1 of the
Agreement: In the event a Change of Control affecting Allegiance occurs and as
to which Baxter has agreed not to exercise its right of termination, this
Agreement shall expire no later than three (3) years following the effective
date of the Change of Control.
10. New Schedule C-1, setting forth performance standards in connection with
Allegiance's performance of its duties pursuant to Section 9, will be attached
hereto and made a part of the Agreement as soon as practicable.
11. New Schedule D-1, setting forth performance standards in connection with
Baxter's performance of its duties pursuant to Section 10, will be attached
hereto and made a part of the Agreement as soon as practicable.
<PAGE>
12. All other terms, conditions, and Exhibits of the Agreement remain in full
force and effect.
In Witness Whereof, the parties have by their duly authorized offices
executed this Agreement as of the date first above written.
BAXTER: ALLEGIANCE:
- ------ ----------
BAXTER HEALTHCARE CORPORATION ALLEGIANCE HEALTHCARE
CORPORATION
By:______________________________ By:______________________________
Name: David C. McKee Name: Joseph L. Damico
---------------------------- ----------------------------
Title: Corporate Vice President Title: President & COO
--------------------------- ---------------------------
Date: March 27, 1998 Date: March 26, 1998
---------------------------- ----------------------------
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from the
Condensed Consolidated Balance Sheet as of March 31, 1998 and the Condensed
Consolidated Statement of Income and Comprehensive Income for the three months
ended March 31, 1998 and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 23
<SECURITIES> 0
<RECEIVABLES> 510<F1>
<ALLOWANCES> 25
<INVENTORY> 630
<CURRENT-ASSETS> 1,259
<PP&E> 1,553
<DEPRECIATION> 770
<TOTAL-ASSETS> 2,702
<CURRENT-LIABILITIES> 726
<BONDS> 887
0
0
<COMMON> 58
<OTHER-SE> 886
<TOTAL-LIABILITY-AND-EQUITY> 2,702
<SALES> 1,103
<TOTAL-REVENUES> 1,103
<CGS> 863
<TOTAL-COSTS> 1,059
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1
<INTEREST-EXPENSE> 15
<INCOME-PRETAX> 45
<INCOME-TAX> 17
<INCOME-CONTINUING> 28
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 28
<EPS-PRIMARY> 0.49
<EPS-DILUTED> 0.48
<FN>
<F1> Gross
</FN>
</TABLE>
