<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
- -------
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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
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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 October 30, 1998, the latest practicable date, was 112,545,385 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 Nine months ended
September 30, September 30,
1998 1997 1998 1997
---------------- --------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales $1,147.1 $1,083.3 $3,370.3 $3,214.2
Costs and expenses
Cost of goods sold 886.3 856.8 2,618.3 2,544.5
Selling, general and administrative expenses 181.9 163.5 528.4 486.3
Research & development 2.6 2.1 7.4 6.5
Goodwill amortization 5.9 5.5 17.4 16.2
Interest expense 14.7 15.9 45.8 52.2
Other expense 3.3 3.3 7.0 5.7
- --------------------------------------------------------------------------------------------------------------------------
Total costs and expenses 1,094.7 1,047.1 3,224.3 3,111.4
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes 52.4 36.2 146.0 102.8
Income tax expense 19.4 13.2 54.0 36.8
Net income $ 33.0 $ 23.0 $ 92.0 $ 66.0
Comprehensive income $ 31.7 $ 22.8 $ 90.4 $ 65.3
==========================================================================================================================
Net income per common share
Basic $ 0.29 $ 0.20 $ 0.81 $ 0.58
Diluted $ 0.28 $ 0.19 $ 0.78 $ 0.57
Average number of common shares outstanding
Basic 112.7 116.0 113.8 113.4
Diluted 118.6 119.2 117.8 115.9
- --------------------------------------------------------------------------------------------------------------------------
</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>
- ------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
1998 1997
--------------------- --------------------
<S> <C> <C> <C>
(Unaudited)
Current assets Cash and equivalents $ 37.4 $ 31.6
Accounts receivable (net of allowance for
doubtful accounts of $26.5 at September 30,
1998 and $24.1 at December 31, 1997) 487.9 510.8
Notes and other current receivables 31.4 17.3
Inventories 655.3 586.9
Deferred income taxes 106.1 97.9
Prepaid expenses 15.8 17.9
--------------------------------------------------------------------------------------------
Total current assets 1,333.9 1,262.4
--------------------------------------------------------------------------------------------
Property,
Plant and At cost 1,498.0 1,543.5
equipment Accumulated depreciation and amortization (768.4) (748.9)
--------------------------------------------------------------------------------------------
Net property, plant and equipment 729.6 794.6
- -----------------------------------------------------------------------------------------------------------------------------
Other assets Goodwill and other intangibles 557.6 553.8
Other 132.3 85.8
--------------------------------------------------------------------------------------------
Total other assets 689.9 639.6
- -----------------------------------------------------------------------------------------------------------------------------
Total assets $2,753.4 $2,696.6
=============================================================================================================================
Current
liabilities Accounts payable and accrued liabilities $ 803.2 $ 713.6
- -----------------------------------------------------------------------------------------------------------------------------
Long-term debt 838.1 900.7
- -----------------------------------------------------------------------------------------------------------------------------
Deferred income taxes 100.1 99.2
- -----------------------------------------------------------------------------------------------------------------------------
Other non-current liabilities 91.7 45.9
- -----------------------------------------------------------------------------------------------------------------------------
Equity Common stock, par value $1.00, authorized
200,000,000 shares, issued 116,231,721 shares
at September 30, 1998 and December 31, 1997 116.2 116.2
Additional contributed capital 1.8 8.3
Retained earnings 910.7 837.3
Common stock in treasury, at cost, 4,249,117
shares in 1998 and 1,498,258 shares in 1997 (106.5) (25.2)
Cumulative foreign currency adjustment (1.9) 0.6
--------------------------------------------------------------------------------------------
Total equity 920.3 937.2
- -----------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity $2,753.4 $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>
- -----------------------------------------------------------------------------------------------
Nine months ended
September 30,
(Brackets denote cash outflows) 1998 1997
---- ----
<S> <C> <C> <C>
Cash flow provided Net income $92.0 $66.0
by operations Adjustments
Depreciation and amortization 92.8 94.7
Deferred income taxes (8.4) 6.7
Gain on asset dispositions, net (6.9) -
Other 8.1 6.9
Changes in balance sheet items
Accounts and notes receivable 7.6 54.7
Inventories (71.8) 10.8
Accounts payable and other current liabilities 79.3 33.8
Other 18.0 (11.6)
--------------------------------------------------------------------------
Cash flow provided by operations 210.7 262.0
- -----------------------------------------------------------------------------------------------
Investment Capital expenditures (47.5) (51.1)
transactions Acquisitions (net of cash received) (24.3) (55.1)
Proceeds from asset dispositions 34.6 36.3
--------------------------------------------------------------------------
Investment transactions, net (37.2) (69.9)
- -----------------------------------------------------------------------------------------------
Financing Issuances of debt 50.0 35.0
transactions Redemptions of debt (50.0) (75.0)
Decrease in debt with maturities of three
months or less, net (62.6) (196.9)
Common stock cash dividends (17.2) (16.9)
Common stock issued under Shared Investment Plan - 54.8
Common stock issued under employee benefit plans 21.3 7.0
Purchases of common stock in treasury (109.2) (2.6)
--------------------------------------------------------------------------
Financing transactions, net (167.7) (194.6)
- -----------------------------------------------------------------------------------------------
Increase (decrease) in cash and equivalents 5.8 (2.5)
Cash and equivalents at beginning of period 31.6 22.9
- -----------------------------------------------------------------------------------------------
Cash and equivalents at end of period $37.4 $20.4
===============================================================================================
</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 reclassifications have been made to conform prior year
financial statements to the 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 periods 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. In the third quarter of 1998, the company's
board of directors approved a two-for-one common stock split which became
effective on August 25, 1998 through a stock dividend. Accordingly, all
references to number of shares and per share amounts of the company's common
stock have been retroactively restated.
<TABLE>
<CAPTION>
Reconciliation of Basic and Diluted EPS 1998 1997
--------------------------------------- -----------------------------------------
three months ended September 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 $33.0 112.7 $0.29 $23.0 116.0 $0.20
Additional shares assuming
exercise of stock options
and stock purchase plan
subscriptions 5.9 3.2
- -------------------------------------------------------------------------------------------------------------------------------
Diluted EPS $33.0 118.6 $0.28 $23.0 119.2 $0.19
===============================================================================================================================
Reconciliation of Basic and Diluted EPS 1998 1997
--------------------------------------- -----------------------------------------
nine months ended September 30, Net Per share Net Per share
in millions, except per share data income Shares amount income Shares amount
- -------------------------------------------------------------------------------------------------------------------------------
Basic EPS $92.0 113.8 $0.81 $66.0 113.4 $0.58
Additional shares assuming
exercise of stock options
and stock purchase plan
subscriptions 4.0 2.5
- -------------------------------------------------------------------------------------------------------------------------------
Diluted EPS $92.0 117.8 $0.78 $66.0 115.9 $0.57
===============================================================================================================================
</TABLE>
<PAGE>
6
3. Inventories
- ---------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
September 30, December 31,
(in millions) 1998 1997
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 53.6 $ 52.3
Work in process 49.6 44.2
Finished products 552.1 490.4
- --------------------------------------------------------------------------------------------------------------
Total inventories $655.3 $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 (2.1) - (3.3) (5.4)
Non-cash - (8.5) - (8.5)
Reversal - (5.5) - (5.5)
- --------------------------------------------------------------------------------------------------------------
September 30, 1998 $11.7 $ 3.0 $ - $14.7
==============================================================================================================
</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.
As of September 30, 1998, all of the major strategic actions associated with
facility closures have been substantially completed. As a result of facility
closures and consolidations being finalized at costs lower than originally
anticipated, $5.5 million of unused restructuring reserves was reversed to
income in the third quarter of 1998. The remaining spending is expected to
occur in the fourth quarter of 1998.
5. Long-term debt
- ------------------
In the second quarter of 1998, the company commenced a commercial paper program
that provides for up to $750 million in aggregate maturity value of commercial
paper to be issued at any given time. Commercial paper with an aggregate
maturity value of $105 million was outstanding as of September 30, 1998. These
borrowings are classified as non-current, consistent with the company's intent
to refinance these obligations on a long-term basis.
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, reduced net income by
approximately $1.3 million and $0.2
<PAGE>
7
million, and $1.6 million and $0.7 million for the three and nine months ended
September 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 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 October 30, 1998, there
are an additional 317 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
<PAGE>
8
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 and provides the minimum amount of this
potential range of defense costs expected to be incurred related to existing
cases.
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, management does not expect 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.
The company is a defendant in, or has assumed the defense of, a number of other
claims, investigations (including environmental matters) 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, would have a material adverse effect
on Allegiance's overall business, cash flow, results of operations or financial
condition.
8. Subsequent events
On October 9, 1998, the company announced that it entered into an Agreement and
Plan of Merger with Cardinal Health, Inc. ("Cardinal"), pursuant to which the
company will be merged with and into Cardinal and upon closing of the
transaction, will become a wholly owned subsidiary of Cardinal. Each outstanding
share of common stock of the company will be converted into 0.415 of a share of
Cardinal common stock (this ratio changed to 0.6225 of a share of Cardinal's
common stock as the result of the Cardinal 3-for-2 stock split that was
effective October 30, 1998). The combination will be structured as a tax-free
transaction, and will be accounted for as a pooling of interests. Management
expects the merger will be consummated, subject to shareholder and regulatory
approval, in the first half of 1999. Cardinal, a Fortune 200 company based in
Dublin, Ohio, is one of the country's leading health-care service companies,
providing pharmaceutical distribution, hospital pharmacy management systems
development, pharmaceutical packaging and repackaging, retail pharmacy
franchising and health-care information systems development.
On October 15, 1998, the company completed the cash purchase of all the
outstanding shares of International Medical Products Group B.V. ("IMP") for
$97.2 million. IMP is a leading manufacturer and distributor of surgical
supplies based in Zutphen, The Netherlands. The acquisition will be accounted
for as a purchase.
<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, the effects of year 2000 issues 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 Nine months ended
September 30, Percent September 30, Percent
(in millions, except percentages) 1998 1997 Increase 1998 1997 Increase
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Geographic region
United States $1,047.8 $1,013.9 3.3% $3,071.0 $3,011.9 2.0%
International 99.3 69.4 43.1 299.3 202.3 47.9
- ------------------------------------------------------------------------------------------------------
Total net sales $1,147.1 $1,083.3 5.9% $3,370.3 $3,214.2 4.9%
- ------------------------------------------------------------------------------------------------------
Product category
Distributed product $ 691.9 $ 673.0 2.8% $2,058.8 $2,028.6 1.5%
Self-manufactured product 455.2 410.3 10.9 1,311.5 1,185.6 10.6
- ------------------------------------------------------------------------------------------------------
Total net sales $1,147.1 $1,083.3 5.9% $3,370.3 $3,214.2 4.9%
- ------------------------------------------------------------------------------------------------------
</TABLE>
The increase in Allegiance's domestic sales for the three and nine months ended
September 30, 1998 as compared to the same periods in the prior year resulted
principally 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 nine months ended
September 30, 1998 as compared to the same periods in the prior year was the
result principally of incremental sales from Source Medical Corporation, a
Canadian joint venture established in the fourth quarter of 1997.
<PAGE>
10
Excluding the incremental sales from Source Medical, international sales grew
15.0% and 12.8% in the third quarter and first nine months of 1998,
respectively, (18.1% and 14.7% excluding the unfavorable effects of foreign
exchange for the three and nine months ended September 30, 1998, respectively).
This increase was due primarily 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, offset partially 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
third quarter and first nine months of 1998.
The increase in self-manufactured product sales during the three and nine months
ended September 30, 1998 as compared to the same periods in the prior year
resulted principally from the favorable impact of the company's long-term
agreement with Premier, Inc. and the company's continued focus on increasing
sales of self-manufactured products.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
(as a percentage of sales) 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross margin 22.7% 20.9% 22.3% 20.8%
Selling, general and administrative expenses 15.9% 15.1% 15.7% 15.1%
- ------------------------------------------------------------------------------------------------------------
</TABLE>
Gross margin increased by 1.8 and 1.5 percentage points for the three and nine
months ended September 30, 1998, respectively, as compared to the same periods
in the prior year. Approximately $5.0 million and $15.1 million for the three
and nine months ended September 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 22.3% and 21.9% for
the three and nine months ended September 30, 1998, respectively. The remaining
1.4 and 1.1 percentage point increases for the third quarter and first nine
months of 1998, respectively, is the result primarily of improvements in the
company's product mix, including the growth of self-manufactured product sales
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 nine months ended September 30, 1998 as compared to
the same periods in the prior year, was expected by the company and is primarily
due to the establishment of new sales subsidiaries in Europe. In the third
quarter, selling, general and administrative expenses included a $5.5 million
reversal of restructuring reserves discussed in Note 4 to "Notes to the
Condensed Consolidated Financial Statements", and certain incremental legal
costs. The reversal of the restructuring reserves, net of the incremental legal
costs, had no significant impact on the company's selling, general and
administrative expenses as a percent of sales for the quarter and nine-month
periods.
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, reversal of reserves
and headcount reductions to date.
<PAGE>
11
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 in cost-management and service initiatives. Management further
believes that its remaining restructuring reserves are adequate to complete the
actions contemplated by the restructuring program. The future cash expenditures
related to the program will be funded from cash generated from operations and
will primarily occur in the fourth quarter of 1998.
Interest Expense
The decrease in interest expense for the three and nine months ended September
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 nine months ended September 30, 1998 as
compared to the same period in the prior year was the result principally of
losses incurred on the company's minor investments in affiliates and a number of
individually immaterial asset dispositions.
Income Taxes
Allegiance's effective tax rate during the three and nine month periods ended
September 30, 1998 was 0.5 and 1.2 percentage points higher than the same
periods in the prior year, respectively. This increase was caused principally by
an increase in the amount of income sourced from higher rate jurisdictions.
ADOPTION OF NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS
130). FAS 130 requires presentation of comprehensive income and its components
in a full set of general-purpose financial statements. FAS 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 third
quarter and first nine months of 1998 and 1997.
On June 15, 1998, the 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 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 $530.7 million at
September 30, 1998 versus an excess of $548.8 million at December 31, 1997.
Current assets at September 30, 1998 included accounts, notes and other current
receivables of $519.3 million and inventories of $655.3
<PAGE>
12
million. These sources of liquidity are convertible into cash over a relatively
short period of time and could be available to satisfy normal operating cash
requirements.
During the second quarter of 1998, 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
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
$105 million was outstanding as of September 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 its commercial
paper program, or by issuing debt or equity. Management believes the company has
credit facilities and other short-term borrowing arrangements 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.
Cash Flow
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
Nine months ended
September 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 $210.7 $262.0
Capital expenditures (47.5) (51.1)
Common stock cash dividends (17.2) (16.9)
- --------------------------------------------------------------------------------------------
"Free cash flow" $146.0 $194.0
============================================================================================
</TABLE>
Cash flow provided by operations during the first nine months of 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 nine months of 1998, the company
experienced this moderation which resulted primarily 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 nine months ended September 30, 1998, enabled the company to fund
$24.3 million in acquisitions, repurchase 4.5 million shares of its common stock
on the open market for $109.2 million and pay down $62.6 million of long-term
debt.
<PAGE>
13
Investment Transactions
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Nine months ended
September 30,
(brackets denote cash outflows, in millions) 1998 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Capital expenditures $(47.5) $(51.1)
Acquisitions (24.3) (55.1)
Proceeds from asset dispositions 34.6 36.3
- ----------------------------------------------------------------------------------------------------------
Total investment transactions, net $(37.2) $(69.9)
==========================================================================================================
</TABLE>
Capital expenditure levels during the nine months ended September 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.
YEAR 2000
The company relies on information technology ("IT") systems to operate its
business. As a result, the company continuously seeks to improve its IT systems
in order to provide better service to its customers and to support the company's
growth objectives. Allegiance is currently implementing enterprise-wide software
that is year 2000 compliant and that will replace the existing financial and
business legacy systems. This software will be implemented company-wide by the
first half of 1999. The company has established a three-phased approach to
address year 2000 issues, including embedded technology ("Non-IT") utilized in
the company's facilities and equipment. The three phases included in the
company's approach are (1) identification, (2) compliance, and (3) validation.
Internally, the company has substantially completed the identification and
compliance phases and is currently completing the validation phase. The
validation phase consists primarily of monitoring and testing of the new
enterprise-wide software and all other new components and interfaces that were
implemented or upgraded as part of the enterprise-wide software installation or
as a result of other identified year 2000 deficiencies. The company expects to
complete all phases of the year 2000 project during the first half of 1999. The
company is not currently aware of any significant exposure that would prevent
its IT and Non-IT systems from being year 2000 compliant on a timely basis.
Externally, the company has formally communicated with its significant
suppliers, customers, and other third parties ("external parties") to assess
their year 2000 readiness. The company is currently determining the potential
exposure to the company if the company's external parties fail to correct their
year 2000 issues in a timely manner. The company is currently in the compliance
and validation phases with its significant external parties, which includes
monitoring and testing of significant company interfaces with those external
parties, among other things. There can be no guarantee that such external
parties will achieve year 2000 compliance on a timely basis and failure by such
significant external parties to achieve compliance could have a material adverse
effect on the company.
<PAGE>
14
The company has not yet obtained information sufficient to quantify the
potential effects of possible internal and external year 2000 non-compliance, to
determine the likely worst-case scenarios or to develop contingency plans to
deal with such scenarios. However, as the company completes its year 2000
project during the first half of 1999, the appropriate contingency plans will be
developed and implementation will begin. There can be no assurances that the
company's internal and external contingency plans, once developed, will
substantially reduce the risk of year 2000 non-compliance. A significant
interruption in the company's business due to a year 2000 non-compliance issue
could have a material adverse effect on the company's financial position,
operations, and liquidity.
The company estimates that the total incremental costs of its year 2000 project
will be approximately $3.0 million, including costs totaling $0.1 million
incurred through September 30, 1998. This estimate excludes the company's
investment in its new enterprise-wide software which is year 2000 compliant. The
estimated costs of the year 2000 project are not expected to have a material
impact on the company's business, operations or financial condition in future
periods. The anticipated impact and total costs of the year 2000 project are
based on management's best estimates and information currently available.
EURO
On January 1, 1999, certain member countries of the European Union are scheduled
to establish fixed conversion rates between their existing currencies and the
European Union's common currency (Euro). The transition period for the
introduction of the Euro will be between January 1, 1999 and January 1, 2002.
The company is currently evaluating methods to address the issues involved with
the introduction of the Euro and based on the company's work to date, management
believes the Euro conversion will not have a material impact on the company's
financial condition or operations.
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
(including environmental matters) 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, would 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
A report on Form 8-K, dated October 8, 1998, was filed with the SEC under
item 5, Other Events, to file information regarding the company's
announcement that it entered into an Agreement and Plan of Merger with
Cardinal Health, Inc., dated as of October 8, 1998.
<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: November 12, 1998 By:
-------------------------
Peter B. McKee
Senior Vice President and
Chief Financial Officer
<PAGE>
17
Exhibits Filed with Securities and Exchange Commission
<TABLE>
<CAPTION>
Number Description of Exhibit
- --------- ----------------------
<S> <C> <C>
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.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
the condensed consolidated nine months ended September 30, 1998 and is qualified
in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 37
<SECURITIES> 0
<RECEIVABLES> 514<F1>
<ALLOWANCES> 27
<INVENTORY> 655
<CURRENT-ASSETS> 1,334
<PP&E> 1,498
<DEPRECIATION> 768
<TOTAL-ASSETS> 2,753
<CURRENT-LIABILITIES> 803
<BONDS> 838
0
0
<COMMON> 116
<OTHER-SE> 804
<TOTAL-LIABILITY-AND-EQUITY> 2,753
<SALES> 3,370
<TOTAL-REVENUES> 3,370
<CGS> 2,618
<TOTAL-COSTS> 3,224
<OTHER-EXPENSES> 7
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 46
<INCOME-PRETAX> 146
<INCOME-TAX> 54
<INCOME-CONTINUING> 92
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 92
<EPS-PRIMARY> 0.81
<EPS-DILUTED> 0.78
<FN>
<F1> GROSS
</FN>
</TABLE>
