<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 June 30, 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 July 31, 1998, the latest practicable date, was 56,522,474 shares.
<PAGE>
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Allegiance Corporation
Condensed Consolidated Statements of Income (Unaudited)
(in millions, except per share data)
<TABLE>
<CAPTION>
===========================================================================================================
Three months ended Six months ended
June 30, June 30,
1998 1997 1998 1997
---------------- --------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales $1,119.8 $1,075.0 $2,223.2 $2,130.9
Costs and expenses
Cost of goods sold 869.5 851.6 1,732.0 1,687.7
Selling, general and administrative
expenses 175.0 161.8 346.5 322.8
Research & development 2.4 2.4 4.8 4.4
Goodwill amortization 5.8 5.4 11.5 10.7
Interest expense 15.9 17.4 31.1 36.3
Other expense 2.3 2.2 3.7 2.4
- -----------------------------------------------------------------------------------------------------------
Total costs and expenses $1,070.9 $1,040.8 $2,129.6 $2,064.3
- -----------------------------------------------------------------------------------------------------------
Income before income taxes 48.9 34.2 93.6 66.6
Income tax expense 18.1 12.2 34.6 23.6
- -----------------------------------------------------------------------------------------------------------
Net income $ 30.8 $ 22.0 $ 59.0 $ 43.0
Comprehensive income $ 30.7 $ 21.9 $ 58.7 $ 42.5
===========================================================================================================
Net income per common share:
Basic $ 0.54 $ 0.39 $ 1.03 $ 0.77
Diluted $ 0.52 $ 0.38 $ 1.00 $ 0.75
Average number of common shares
outstanding:
Basic 56.9 56.7 57.1 56.1
Diluted 59.2 57.8 59.0 57.2
- -----------------------------------------------------------------------------------------------------------
Pro forma post-split:
Net income per common share:
Basic $ 0.27 $ 0.19 $ 0.52 $ 0.38
Diluted $ 0.26 $ 0.19 $ 0.50 $ 0.37
Average number of common shares
outstanding:
Basic 113.8 113.4 114.2 112.2
Diluted 118.4 115.6 118.0 114.4
- -----------------------------------------------------------------------------------------------------------
</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>
- -----------------------------------------------------------------------------------------------------------
June 30, December 31,
1998 1997
---- ----
(Unaudited)
<S> <C> <C>
Current assets Cash and equivalents $35.0 $31.6
Accounts receivable (net of allowance for
doubtful accounts of $27.2 and $24.1 at June
30, 1998 and December 31, 1997, respectively) 462.7 510.8
Notes and other current receivables 18.8 17.3
Inventories 643.7 586.9
Deferred income taxes 103.4 97.9
Prepaid expenses 17.4 17.9
----------------------------------------------------------------------------
Total current assets 1,281.0 1,262.4
----------------------------------------------------------------------------
Property, At cost 1,555.3 1,543.5
plant and Accumulated depreciation and
equipment amortization (786.5) (748.9)
----------------------------------------------------------------------------
Net property, plant and equipment 768.8 794.6
- -----------------------------------------------------------------------------------------------------------
Other assets Goodwill and other intangibles 564.9 553.8
Other 80.2 85.8
----------------------------------------------------------------------------
Total other assets 645.1 639.6
- -----------------------------------------------------------------------------------------------------------
Total assets $2,694.9 $2,696.6
===========================================================================================================
Current
liabilities Accounts payable and accrued liabilities $731.7 $713.6
- -----------------------------------------------------------------------------------------------------------
Long-term debt 888.8 900.7
- -----------------------------------------------------------------------------------------------------------
Deferred income taxes 99.2 99.2
- -----------------------------------------------------------------------------------------------------------
Other non-current liabilities 44.4 45.9
- -----------------------------------------------------------------------------------------------------------
Equity Common stock, par value $1.00, authorized
200,000,000 shares, issued 58,115,860 shares
at June 30, 1998 and December 31, 1997 58.1 58.1
Additional contributed capital 60.7 66.4
Retained earnings 884.7 837.3
Common stock in treasury, at cost, 1,662,849
shares in 1998 and 749,129 shares in 1997 (72.8) (25.2)
Cumulative foreign currency adjustment 0.1 0.6
----------------------------------------------------------------------------
Total equity 930.8 937.2
- -----------------------------------------------------------------------------------------------------------
Total liabilities and equity $2,694.9 $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>
- ------------------------------------------------------------------------------------------------
Six months ended
June 30,
(Brackets denote cash outflows) 1998 1997
---- ----
<S> <C> <C>
Cash flow provided Net income $59.0 $43.0
by operations Adjustments
Depreciation and amortization 59.3 62.5
Deferred income taxes (6.7) 10.1
Other 7.9 5.3
Changes in balance sheet items
Accounts and notes receivable 49.5 80.5
Inventories (55.4) 6.5
Accounts payable and other current liabilities 10.6 (23.1)
Other 6.0 (4.4)
-----------------------------------------------------------------------
Cash flow provided by operations 130.2 180.4
- ------------------------------------------------------------------------------------------------
Investment Capital expenditures (31.2) (32.3)
transactions Acquisitions (net of cash received) (24.3) (43.4)
Divestitures - 17.2
Proceeds from asset dispositions 5.4 15.2
-----------------------------------------------------------------------
Investment transactions, net (50.1) (43.3)
- ------------------------------------------------------------------------------------------------
Financing transactions Decrease in debt with maturities of three
months or less, net (61.8) (158.8)
Issuances of debt 50.0 35.0
Redemption of debt - (50.0)
Common stock cash dividends (11.6) (11.1)
Common stock issued under Shared Investment Plan - 54.8
Common stock issued under employee benefit plans 15.8 4.6
Purchases of treasury stock (69.1) (2.6)
-----------------------------------------------------------------------
Financing transactions, net (76.7) (128.1)
- ------------------------------------------------------------------------------------------------
Increase in cash and equivalents 3.4 9.0
Cash and equivalents at beginning of period 31.6 22.9
- ------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $35.0 $31.9
================================================================================================
</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. Certain immaterial prior year amounts have been reclassified to conform
with the six months ended June 30, 1998 presentation.
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.
The company's unaudited pro forma net income per common share for the three and
six months ended June 30, 1998 and 1997 give effect to a two-for-one stock
split, as set forth in Note 8 to these condensed consolidated financial
statements, as if the stock-split had occurred on January 1, 1997. This
unaudited pro forma (post-split) net income per common share information is not
necessarily indicative of the results that would have been reported had such
events actually occurred on the dates specified, nor is it indicative of the
company's future results.
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 June 30, 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 $30.8 56.9 $0.54 $22.0 56.7 $0.39
Additional shares assuming
exercise of stock option
and stock purchase plan
subscriptions 2.3 1.1
- ----------------------------------------------------------------------------------------------
Diluted EPS $30.8 59.2 $0.52 $22.0 57.8 $0.38
==============================================================================================
</TABLE>
<PAGE>
6
<TABLE>
<CAPTION>
Reconciliation of Basic and Diluted EPS 1998 1997
--------------------------------------- ----------------------------------------
six months ended June 30, 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 $59.0 57.1 $1.03 $43.0 56.1 $0.77
Additional shares assuming
exercise of stock option
and stock purchase plan
subscriptions 1.9 1.1
- ------------------------------------------------------------------------------------------------------------------------------
Diluted EPS $59.0 59.0 $1.00 $43.0 57.2 $0.75
==============================================================================================================================
</TABLE>
3. Inventories
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
June 30, December 31,
(in millions) 1998 1997
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 55.5 $ 52.3
Work in process 53.7 44.2
Finished products 534.5 490.4
- --------------------------------------------------------------------------------------------------------------
Total inventories $643.7 $586.9
==============================================================================================================
</TABLE>
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 $13.8 $17.0 $ 3.3 $34.1
- ---------------------------------------------------------------------------------------------------------------------
Utilization:
Cash (1.6) -- (2.8) (4.4)
Non-cash -- (5.0) -- (5.0)
- ---------------------------------------------------------------------------------------------------------------------
June 30, 1998 $12.2 $12.0 $ 0.5 $24.7
=====================================================================================================================
</TABLE>
Cash outflows pertain primarily to costs for severance, outplacement assistance,
relocation, and implementation teams. Since the inception of the restructuring
program, approximately 2,500 positions have been eliminated. The remaining
spending will occur throughout 1998, as implementation team projects and
facility closures and consolidations are completed as planned.
5. Long-term debt
In June 1998, the company commenced a commercial paper program, providing for
the issuance of up to $750 million in aggregate maturity value of commercial
paper at any given time. Commercial paper with an aggregate maturity value of
$142 million was outstanding as of June 30, 1998. These borrowings are
classified as noncurrent, consistent with the company's intent to refinance
these obligations on a long-term basis.
<PAGE>
7
6. 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 approximately
$0.1 and $0.1 million, and $0.3 and $0.5 million for the three and six months
ended June 30, 1998 and 1997, respectively.
7. 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 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 July 31, 1998,
<PAGE>
8
there are an additional 279 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. The company has established reserves for the expected defense
costs and on an ongoing basis, the company assesses the adequacy of these
reserves.
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.
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.
BHC had been identified as a potentially responsible party for cleanup costs at
a number of hazardous waste sites, for which Allegiance has assumed
responsibility. As of June 30, 1998, five of those sites remain active claims.
The remainder have been settled or no claim is reasonably anticipated.
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 four sites is
approximately $3.6 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.
8. Subsequent events
- ---------------------
On July 22, 1998, the company's board of directors approved the following
actions:
<PAGE>
9
A two-for-one common stock split to be distributed in the form of a stock
dividend, payable on August 25, 1998, to shareholders of record at the close of
business August 10, 1998. Pro forma basic and diluted net income per common
share, giving retroactive effect to the stock split, have been provided for all
periods presented in the accompanying condensed consolidated statements of
income.
A new stock repurchase program to purchase up to six million shares (post-split)
of the company's outstanding common stock. The Company expects to complete the
new program over the next several years. The stock repurchased will be added to
Allegiance's treasury shares and primarily used in the administration of the
company's employee-stock purchase plan and other benefit programs.
A five percent increase in cash dividend to 5.25 cents (post-split) per common
share (21 cents annualized), payable October 1, 1998 to stockholders of record
on September 10, 1998.
<PAGE>
10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The following management discussion and analysis describes material changes in
the company's financial condition since December 31, 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 the "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 Six months ended
June 30, Percent June 30, Percent
(in millions, except percentages) 1998 1997 increase 1998 1997 increase
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Geographic region
United States $1,016.3 $1,007.5 0.9% $2,023.2 $1,998.0 1.3%
International 103.5 67.5 53.3 200.0 132.9 50.5
- --------------------------------------------------------------------------------------------------
Total net sales $1,119.8 $1,075.0 4.2% $2,223.2 $2,130.9 4.3%
- --------------------------------------------------------------------------------------------------
Product category
Distributed product $ 682.2 $ 674.7 1.1% $1,366.9 $1,355.6 0.8%
Self-manufactured product 437.6 400.3 9.3 856.3 775.3 10.4
- --------------------------------------------------------------------------------------------------
Total net sales $1,119.8 $1,075.0 4.2% $2,223.2 $2,130.9 4.3%
- --------------------------------------------------------------------------------------------------
</TABLE>
The increase in Allegiance's domestic sales for the three and six months ended
June 30, 1998 as compared to the same periods 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 international sales for the three and six months ended June 30,
1998 as compared to the same periods in the prior year was principally the
result of incremental sales from Source Medical Corporation, a Canadian venture
established in the fourth quarter of 1997. Excluding the incremental
<PAGE>
11
sales from Source Medical, international sales grew approximately 13.9% and
11.7% for the second quarter and first half of 1998, respectively, (15.9% and
12.9% excluding the unfavorable effects of foreign exchange for the three and
six months ended June 30, 1998, respectively). This increase was primarily due
to the establishment of new international sales subsidiaries in Belgium, Italy,
the Netherlands, Spain and Switzerland, and growth in sales of self-manufactured
product through other European sales subsidiaries.
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
second quarter and first half of 1998.
The increase in self-manufactured product sales during the three and six months
ended June 30, 1998 as compared to the same periods in the prior year
principally resulted from the favorable impact of the company's seven year
agreement with Premier, Inc. and the company's continued focus on increasing
sales of self-manufactured products.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
(as a percentage of sales) 1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross margin 22.4% 20.8% 22.1% 20.8%
Selling, general and administrative expenses 15.6% 15.1% 15.6% 15.1%
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
Gross margin increased by 1.6 and 1.3 percentage points for the three and
six months ended June 30, 1998, respectively, as compared to the same periods in
the prior year. Approximately $5.4 and $10.1 million for the three and six
months ended June 30, 1998, respectively, of the increase in gross profit is the
result of the favorable impact of the devaluation in the Malaysian ringgit on
the company's manufacturing costs. Excluding this favorable foreign currency
impact, gross margins would have been approximately 21.9% and 21.6% for the
three and six months ended June 30, 1998, respectively. The remaining 1.1 and
0.8 percentage point increases for the second quarter and first half of 1998,
respectively, is the result of improvements in the company's product mix,
including the growth of self-manufactured products in both domestic and
international markets and by offsetting pricing pressures with manufacturing and
other cost efficiencies.
The increase in selling, general and administrative expenses as a percent of
sales during the three and six months ended June 30, 1998 as compared to the
same periods in the prior year, was expected by the company and resulted
principally from the establishment of new sales subsidiaries 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
<PAGE>
12
actions contemplated by the restructuring program and that future cash
expenditures related to the program will be funded from cash generated from
operations.
Interest Expense
The decrease in interest expense for the three and six months ended June 30,
1998 as compared to the same periods in the prior year, is the result of the
company maintaining lower debt levels during 1998.
Other Expense
The increase in other expense for the six months ended June 30, 1998 as compared
to the same period in the prior year was principally the result of losses
incurred on the company's minor investments in affiliates and on a number of
individually immaterial asset dispositions.
Income Taxes
Allegiance's effective tax rate during the three and six month periods ended
June 30, 1998 was 1.3 and 1.6 percentage points higher than the same periods in
the prior year, respectively. This increase was caused principally by a larger
proportion of earnings generated in higher tax rate jurisdictions.
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 in its condensed consolidated
statements of income for the second quarter and first half of 1998 and 1997.
On June 15, 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (FAS 133). FAS 133 is effective for all
fiscal quarters of all fiscal years beginning after June 15, 1999 (January 1,
2000, for the company). FAS 133 requires that all derivative instruments be
recorded on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. Management of the
company does not anticipate that the adoption of FAS 133 will have a material
effect on the Company's results of operations or its financial position.
LIQUIDITY AND CAPITAL RESOURCES
Allegiance's current assets exceeded current liabilities by $549.3 million at
June 30, 1998 versus an excess of $548.8 million at December 31, 1997. Current
assets at June 30, 1998 included accounts, notes and other current receivables
of $481.5 million and inventories of $643.7 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.
During the second quarter, the company's long-term debt was upgraded to a Baa2
rating by Moody's Investors Service ("Moody's"). Additionally, the company was
assigned debt ratings on short term debt of P-2 by Moody's and A-2 by Standard &
Poors Ratings Group, while Duff & Phelps Credit Rating Company affirmed its
short term rating of D-2. The company initiated a commercial paper
<PAGE>
13
program, providing for the issuance of up to $750 million in aggregate maturity
value of commercial paper. Commercial paper with an aggregate maturity value of
$142 million was outstanding as of June 30, 1998.
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. Allegiance believes it has sufficient financial flexibility to
attract long-term capital on acceptable terms as may be needed to support its
growth objectives.
<TABLE>
<CAPTION>
Cash Flow
- --------------------------------------------------------------------------------
Six months ended
June 30,
(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 $130.2 $180.4
Capital expenditures (31.2) (32.3)
Common stock cash dividends (11.6) (11.1)
- --------------------------------------------------------------------------------
"Free cash flow" $ 87.4 $137.0
================================================================================
</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 half 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 six months ended June 30, 1998 enabled the company to fund $24.3
million in acquisitions, repurchase over 1.6 million shares of its common stock
on the open market for $69.1 million and pay down $11.8 million of long-term
debt.
<TABLE>
<CAPTION>
Investment Transactions
- --------------------------------------------------------------------------------
Six months ended
June 30,
(brackets denote cash outflows, in millions) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Capital expenditures $(31.2) $(32.3)
Acquisitions (24.3) (43.4)
Divestitures - 17.2
Proceeds from asset dispositions 5.4 15.2
- --------------------------------------------------------------------------------
Total investment transactions, net $(50.1) $(43.3)
================================================================================
</TABLE>
<PAGE>
14
Capital expenditure levels during the six months ended June 30, 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 acquired 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 for a total of $21.5 million. During the first
quarter of 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.
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 7 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 7 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>
15
PART II. OTHER INFORMATION
Allegiance Corporation
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>
16
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: August 12, 1998 By: /s/ Peter B. McKee
--------------------------
Peter B. McKee
Senior Vice President and
Chief Financial Officer
<PAGE>
17
Exhibits Filed with Securities and Exchange Commission
Number Description of Exhibit
- ------ ----------------------
27 Financial Data Schedule.*
(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.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
the Condensed Consolidated Balance Sheet as of June 30, 1998 and the Condensed
Consolidated Statement of Income and Comprehensive Income and Cash Flows for the
six months ended June 30, 1998 and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 35
<SECURITIES> 0
<RECEIVABLES> 490<F1>
<ALLOWANCES> 27
<INVENTORY> 644
<CURRENT-ASSETS> 1,281
<PP&E> 1,555
<DEPRECIATION> 787
<TOTAL-ASSETS> 2,695
<CURRENT-LIABILITIES> 732
<BONDS> 889
0
0
<COMMON> 58
<OTHER-SE> 873
<TOTAL-LIABILITY-AND-EQUITY> 2,695
<SALES> 2,223
<TOTAL-REVENUES> 2,223
<CGS> 1,732
<TOTAL-COSTS> 2,130
<OTHER-EXPENSES> 4
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 31
<INCOME-PRETAX> 94
<INCOME-TAX> 35
<INCOME-CONTINUING> 59
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 59
<EPS-PRIMARY> 1.03
<EPS-DILUTED> 1.00
<FN>
<F1> GROSS
</FN>
</TABLE>
