<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(MARK ONE)
[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 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from ___________ to ___________
Commission File Number: 333-18687
-------------------
ALARIS MEDICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3800335
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10221 Wateridge Circle, San Diego, CA 92121
- ---------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(619) 458-7000
- ---------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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 ____
On November 5, 1998, the registrant had 1,000 shares of common stock
outstanding.
Page 1 of 30
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ALARIS MEDICAL SYSTEMS, INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1 - Financial Statements:
Page
Condensed consolidated balance sheet at
December 31, 1997 and September 30, 1998. . . . . . . . . . . . . . . 3
Condensed consolidated statement of operations for three and
nine months ended September 30, 1997 and 1998 . . . . . . . . . . . . 4
Condensed consolidated statement of cash flows for the
nine months ended September 30, 1997 and 1998 . . . . . . . . . . . . 5
Condensed consolidated statement of changes in
stockholder's equity for the period from
December 31, 1997 to September 30, 1998 . . . . . . . . . . . . . . . 6
Notes to the condensed consolidated financial statements. . . . . . . 7
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . . . . 14
PART II. OTHER INFORMATION
Item 1 - Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 27
Item 6 - Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . 28
2
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FORM 10 - Q
PART 1 - ITEM 1
FINANCIAL INFORMATION
ALARIS MEDICAL SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,918 $ 44,774
Receivables, net . . . . . . . . . . . . . . . . . . . . . . . . . . 83,406 89,544
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61,666 78,297
Prepaid expenses and other current assets. . . . . . . . . . . . . . 23,319 21,933
------------ -------------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . 175,309 234,548
Net investment in sales-type leases, less current portion. . . . . . . 30,404 21,100
Property, plant and equipment, net . . . . . . . . . . . . . . . . . . 55,365 60,032
Other non-current assets . . . . . . . . . . . . . . . . . . . . . . . 15,749 17,403
Intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . 286,279 313,224
------------ -------------
$563,106 $646,307
------------ -------------
------------ -------------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current portion of long-term debt. . . . . . . . . . . . . . . . . . $ 14,559 $ 12,517
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . 23,927 21,352
Accrued expenses and other current liabilities . . . . . . . . . . . 51,739 62,939
----------- -----------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . 90,225 96,808
----------- -----------
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415,419 402,689
Other non-current liabilities. . . . . . . . . . . . . . . . . . . . . 18,515 25,498
----------- -----------
Total non-current liabilities. . . . . . . . . . . . . . . . . . . . . 433,934 428,187
----------- -----------
Contingent liabilities and commitments (Note 7)
Stockholder's equity:
Common stock and other stockholder's equity:
Common stock and capital in excess of par value, authorized 3,000
common shares at $.01 par value; 1,000 issued and outstanding
at December 31, 1997 and September 30, 1998 . . . . . . . . . . . 98,503 203,929
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . (55,930) (79,522)
Equity adjustment for foreign currency translation . . . . . . . . . (3,626) (3,095)
------------ -------------
Total stockholder's equity . . . . . . . . . . . . . . . . . . . . . . 38,947 121,312
------------ -------------
$563,106 $646,307
------------ -------------
------------ -------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
3
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ALARIS MEDICAL SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
1997 1998 1997 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Sales. . . . . . . . . . . . . . . . . . . . . . . $ 86,830 $ 94,227 $ 256,897 $ 271,881
Cost of sales. . . . . . . . . . . . . . . . . . . 42,400 46,672 136,731 138,025
---------- ---------- ---------- ----------
Gross margin . . . . . . . . . . . . . . . . . . . 44,430 47,555 120,166 133,856
---------- ---------- ---------- ----------
Selling and marketing expenses . . . . . . . . . . 15,896 17,877 47,805 52,106
General and administrative expenses. . . . . . . . 8,825 10,063 26,917 28,880
Research and development expenses. . . . . . . . . 4,534 5,126 12,725 14,126
Purchased in-process research and development. . . -- 22,800 -- 28,334
Integration and other non-recurring charges. . . . 1,693 1,112 16,457 1,112
---------- ---------- ---------- ----------
Total operating expenses . . . . . . . . . . . 30,948 56,978 103,904 124,558
---------- ---------- ---------- ----------
Lease interest income. . . . . . . . . . . . . . . 1,226 1,186 3,417 3,407
---------- ---------- ---------- ----------
Income (loss) from operations. . . . . . . . . 14,708 (8,237) 19,679 12,705
---------- ---------- ---------- ----------
Other income (expenses):
Interest income. . . . . . . . . . . . . . . . 55 509 345 654
Interest expense . . . . . . . . . . . . . . . (10,954) (10,374) (32,004) (31,523)
Other, net . . . . . . . . . . . . . . . . . . (46) 14 (495) (667)
---------- ---------- ---------- ----------
Total other expense. . . . . . . . . . . . . . . . (10,945) (9,851) (32,154) (31,536)
---------- ---------- ---------- ----------
Income (loss) before income taxes. . . . . . . . . 3,763 (18,088) (12,475) (18,831)
Provision for (benefit from) income taxes. . . . . 2,200 2,800 (4,200) 3,200
---------- ---------- ---------- ----------
Net income (loss). . . . . . . . . . . . . . . . . $1,563 $(20,888) $(8,275) $(22,031)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
</TABLE>
4
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ALARIS MEDICAL SYSTEMS, INC
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Net cash provided by operating activities. . . . . . . . . . . . . . . $ 5,292 $ 31,148
----------- -----------
Cash flows from investing activities:
Net capital expenditures . . . . . . . . . . . . . . . . . . . . . . . (15,107) (16,795)
Acquisitions and license of technology . . . . . . . . . . . . . . . . -- (36,510)
----------- -----------
Net cash used in investing activities. . . . . . . . . . . . . . . . . (15,107) (53,305)
----------- -----------
Cash flows from financing activities:
Principal payments on long-term debt . . . . . . . . . . . . . . . . . (3,935) (20,228)
Proceeds from term loan borrowing. . . . . . . . . . . . . . . . . . . -- 30,000
Proceeds under revolving credit facility . . . . . . . . . . . . . . . 18,800 34,800
Repayments under revolving credit facility . . . . . . . . . . . . . . (7,500) (60,000)
Principal payments on acquired debt. . . . . . . . . . . . . . . . . . -- (4,822)
Debt issue costs . . . . . . . . . . . . . . . . . . . . . . . . . . . (662) (890)
Dividends to ALARIS Medical. . . . . . . . . . . . . . . . . . . . . . (1,860) (1,561)
Capital contributions. . . . . . . . . . . . . . . . . . . . . . . . . 1,595 82,639
----------- -----------
Net cash provided by financing activities. . . . . . . . . . . . . . . 6,438 59,938
----------- -----------
Effect of exchange rate changes on cash. . . . . . . . . . . . . . . . (783) 75
----------- -----------
Net (decrease) increase in cash. . . . . . . . . . . . . . . . . . . . (4,160) 37,856
Cash at beginning of period. . . . . . . . . . . . . . . . . . . . . . 9,148 6,918
----------- -----------
Cash at end of period. . . . . . . . . . . . . . . . . . . . . . . . . $ 4,988 $ 44,774
----------- -----------
----------- -----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
</TABLE>
5
<PAGE>
ALARIS MEDICAL SYSTEMS, INC
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN
STOCKHOLDER'S EQUITY (UNAUDITED)
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
EQUITY
COMMON STOCK ADJUSTMENT
CAPITAL IN EXCESS OF FOR FOREIGN
PAR VALUE ACCUMULATED CURRENCY
SHARES AMOUNT DEFICIT TRANSLATION TOTAL
------ ------ --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997 . . . . . . . . . . . . . 1,000 $ 98,503 $(55,930) $ (3,626) 38,947
Dividends to ALARIS Medical. . . . . . . . . . . . . . (1,561) (1,561)
Capital contribution (Note 5). . . . . . . . . . . . . 105,291 105,291
Equity adjustment for foreign
currency translation . . . . . . . . . . . . . . . . 531 531
Tax benefit for ALARIS Medical . . . . . . . . . . . .
stock options. . . . . . . . . . . . . . . . . . . . 135 135
Net loss for the period. . . . . . . . . . . . . . . . (22,031) (22,031)
------ -------- --------- ----------- ---------
Balance at September 30, 1998. . . . . . . . . . . . . 1,000 $203,929 $(79,522) $ (3,095) $121,312
------ -------- --------- ----------- ---------
------ -------- --------- ----------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
6
<PAGE>
ALARIS MEDICAL SYSTEMS, INC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(DOLLARS IN THOUSANDS)
NOTE 1 -- BUSINESS AND STATEMENT OF ACCOUNTING POLICY
THE COMPANY:
ALARIS Medical Systems, Inc. ("ALARIS Medical Systems"), formerly IMED
Corporation ("IMED"), designs, manufactures, distributes and services
intravenous infusion therapy and patient monitoring instruments and related
disposables and accessories. On November 26, 1996, IMED, then a wholly-owned
subsidiary of ALARIS Medical, Inc., ("ALARIS Medical"), formerly Advanced
Medical, Inc. ("Advanced Medical") acquired all of the outstanding stock of IVAC
Holdings, Inc. ("IVAC Holdings") and its subsidiaries including IVAC Medical
Systems, Inc. (Note 2). In connection with the acquisition, IMED and IVAC
Medical Systems, Inc. were merged into IVAC Holdings (the "Merger"), which then
changed its name to ALARIS Medical Systems, Inc. The acquisition was accounted
for as a purchase. ALARIS Medical Systems and its subsidiaries are collectively
referred to as the "Company."
STATEMENT OF ACCOUNTING POLICY:
The accompanying financial statements have been prepared by the Company without
audit pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to those rules and
regulations, although the Company believes that the disclosures herein are
adequate to make the information not misleading.
In the opinion of the Company, the accompanying financial statements contain all
adjustments, consisting of normal recurring adjustments, necessary for a fair
statement of the Company's financial position as of September 30, 1998, and the
results of its operations and its cash flows for the nine months ended September
30, 1997 and 1998.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the period. Actual results could differ from those estimates.
7
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NOTE 2 -- THE MERGER
On November 26, 1996, IMED acquired all of the outstanding stock of IVAC
Holdings and its subsidiaries including IVAC Medical Systems, Inc., in exchange
for $390,000 plus acquired cash of $7,225 less total debt assumed aggregating
$173,314 plus related expenses. The Merger was financed with $204,200 in bank
debt and $200,000 in senior subordinated notes. Subsequent to the acquisition,
IVAC Medical Systems, Inc. and IMED were merged into IVAC Holdings, which
subsequently changed its name to ALARIS Medical Systems, Inc. In connection
with the Merger, ALARIS Medical contributed $19,588 to IMED.
The acquisition was accounted for as a purchase, whereby the purchase price,
including related expenses, was allocated to identified assets, including
intangible assets, purchased research and development and liabilities based upon
their respective fair values. The excess of the purchase price over the value of
identified assets and liabilities, in the amount of $132,482, was recorded as
goodwill and is being amortized over its estimated life of thirty years.
NOTE 3 -- ACQUISITIONS AND LICENSES
On July 17, 1998, pursuant to an agreement with ALARIS Medical, ALARIS Medical
Systems, Instromedix and its shareholders dated June 24, 1998, ALARIS Medical
Systems acquired all of the outstanding common stock of Instromedix
("Instromedix") and subsequently merged Instromedix with and into itself. The
total consideration for the Instromedix acquisition included (i) $51.0 million
in cash, subject to certain adjustments, (ii) the assumption of indebtedness of
Instromedix of approximately $5.5 million and (iii) the payment of certain
seller transaction expenses in the amount of $1.0 million. The acquisition
payment was funded with $30.0 million of ALARIS Medical Systems' bank term debt
and proceeds from an ALARIS Medical debt offering. On July 28, 1998, ALARIS
Medical completed the sale of $109.9 million of 11-1/8% Senior Discount Notes
(the "Senior Discount Notes"), due 2008, receiving net proceeds of $106.3
million. A portion of the net proceeds of the sale of the notes was also used
to repay certain borrowings under the bank credit facility.
The acquisition was accounted for as a purchase, whereby the purchase price,
including related expenses, was allocated to identified assets and liabilities,
based upon their respective fair values. The allocation included acquired
in-process research and development of $22.8 million, which was immediately
written-off, and other identifiable intangible assets of $21.1 million, which
are being amortized over their estimated weighted-average useful lives of 10
years. The excess of the purchase price over the value of identified assets and
liabilities, in the amount of $18.0 million, was recorded as goodwill and is
being amortized over its estimated life of ten years.
The Company is using the Instromedix purchased in-process research and
development to create new cardiac disease diagnosis, monitoring and
management products which will become part of the Arrhythmia Event Recorders
and LifeSigns System product suites over the next several years. The nature
of the efforts required to develop the purchased in-process technology into
commercially viable products principally relate to designing, prototyping,
verification and testing activities that are necessary to establish that the
product can be produced to meet its design specifications, including
functions, features and technical performance requirements. The Company
expects to incur a total of approximately $4.0 million to complete the
projects, of which $0.5 million is expected to be incurred in the fourth
quarter of 1998, while $3.0 million and $0.5 million are expected to be
incurred during 1999 and 2000, respectively. The Company anticipates that
products in the Arrhythmia Event Recorders product suite using the purchased
in-process technology will be released during 1999, while products under the
LifeSigns System product suite will be released during 2000. The Company
expects that the purchased in-process research and
8
<PAGE>
development will be successfully developed, but there can be no assurance that
commercial viability of the products will be achieved.
During the second quarter of 1998, the Company acquired the net assets of
Patient Solutions, Inc. ("PSI") for $5.3 million. PSI was a wholly owned
subsidiary of Invacare Corporation and was focused on the development of an
ambulatory pump for use in the alternate site market. The transaction was
accounted for as a purchase with the net assets acquired recorded at their
estimated fair values. The rights to the pump under development were valued at
$4.4 million and were recorded as a non-recurring charge included in purchased
in-process research and development. The nature of the efforts required to
develop the purchased in-process technology into a commercially viable product
principally relate to designing, prototyping, verification and testing
activities that are necessary to establish that the product can be produced to
meet its design specifications, including functions, features and technical
performance requirements. The Company expects to incur a total of $0.7 million
to complete the project, of which $0.2 million is projected to be incurred in
1998 and $0.5 million in 1999. It is anticipated that the pump will be released
during 1999. The Company expects that the purchased in-process research and
development will be successfully developed, but there can be no assurance that
commercial viability of the pump will be achieved.
Also during the second quarter, the Company licensed technology from Caesarea
Medical Electronics Limited ("Caesarea") for a pole mounted volumetric infusion
pump being designed for developing international markets. At the time of
license, the development of the applications and functionality required by the
Company had not reached technological feasibility and no alternative uses were
identified. As a result, the initial license payment and related expenses of
approximately $1.2 million were recorded as purchased in-process research and
development during the second quarter. Under the terms of the license agreement,
the Company is obligated to pay additional consideration to Caesarea upon timely
completion of certain development milestones and delivery of specified numbers
of assembly kits. The milestones, which primarily relate to different product
releases, require completion by various dates through the first half of 1999
with the first significant milestones expected to be met during the fourth
quarter of 1998. If all such milestones are reached, the additional
consideration will be up to a maximum of $4.0 million, excluding royalties. The
Company expects that the purchased in-process research and development will be
successfully developed, but there can be no assurance that commercial viability
of the pump will be achieved.
NOTE 4 -- INVENTORIES
<TABLE>
<CAPTION>
Inventories comprise the following: DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Raw materials $ 24,144 $ 36,524
Work-in-process 8,363 5,116
Finished goods 29,159 36,657
------------ -------------
$ 61,666 $ 78,297
------------ -------------
------------ -------------
</TABLE>
NOTE 5 -- DEBT
In July 1998, in connection with the Instromedix acquisition, the Company
amended its bank credit facility ("The Credit Facility Amendment"). The Credit
Facility Amendment, among other things, approved the Instromedix acquisition and
ALARIS Medical's Senior Discount Note offering, increased the revolving credit
facility to $60.0 million and provided the Company an additional $30.0 million
under the Tranche D term debt. The Company used the $30.0 million term debt
borrowing, along with
9
<PAGE>
approximately $3.0 million from the revolving credit line, to fund the
initial payments required upon closing the Instromedix acquisition.
On July 28, 1998, subsequent to closing the Instromedix acquisition, ALARIS
Medical issued $189.0 million of Senior Discount Notes, issued at a discount
from their principal amount at maturity to generate gross proceeds to the
Company of $109.9 million. Upon receipt of net proceeds of $106.3 million,
ALARIS Medical paid its remaining obligations of approximately $22.7 million
to the Instromedix shareholders and contributed the remaining net proceeds of
approximately $82.6 million, after issuance costs, to ALARIS Medical Systems,
as required under the Credit Facility Amendment. ALARIS Medical Systems then
repaid the amount outstanding under its revolving credit line.
ALARIS Medical is required to register and is in the process of registering,
the Senior Discount Notes with the Securities and Exchange Commission. If
such registration is not completed by November 26, 1998, ALARIS Medical will
incur additional interest on the Senior Discount Notes. For the first 90 day
period that such registration is not completed, additional interest of $0.05
per one thousand dollars of principal outstanding under the Senior Discount
Notes, or approximately $0.1 million, will accrue. It is unlikely that
ALARIS Medical will receive the required approval from the Securities and
Exchange Commission for such registration process prior to November 26, 1998,
but management does believe such process should be completed before the
expiration of the following 90 day period.
NOTE 6 -- COMPREHENSIVE INCOME (LOSS)
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." This Statement requires
that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. This
Statement also requires that an entity classify items of other comprehensive
earnings by their nature in an annual financial statement. For example, other
comprehensive earnings may include foreign currency translation adjustments,
minimum pension liability adjustments, and unrealized gains and losses on
marketable securities classified as available-for-sale. Annual financial
statements for prior periods will be reclassified, as required. ALARIS Medical
Systems' total comprehensive losses were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Net income (loss) . . . . . . . . . . . . . . . . . $ 1,563 $ (20,888)
Other comprehensive (loss) income:
Foreign currency translation adjustments . . . . (599) 899
------------ ------------
Comprehensive income (loss) $ 964 $ (19,989)
------------ ------------
------------ ------------
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1997 1998
------------ ------------
Net loss. . . . . . . . . . . . . . . . . . . . . . $ (8,275) $ (22,031)
Other comprehensive (loss) income:
Foreign currency translation adjustments . . . (3,133) 531
------------ ------------
Comprehensive loss. . . . . . . . . . . . . . . . . $ (11,408) $ (21,500)
------------ ------------
------------ ------------
</TABLE>
10
<PAGE>
NOTE 7 -- CONTINGENCIES AND LITIGATION
GOVERNMENT REGULATION AND FIELD CORRECTIONS
The United States Food and Drug Administration (the "FDA"), pursuant to the
Federal Food, Drug, and Cosmetic Act (the "FDC Act"), regulates the
introduction of medical devices into commerce, as well as testing
manufacturing procedures, labeling, adverse event reporting and
record-keeping with respect to such products. The process of obtaining
market clearances from the FDA for new products can be time-consuming and
expensive and there can be no assurance that such clearances will be granted
or that FDA review will not involve delays adversely affecting the marketing
and sale of products. Enforcement of the FDC Act depends heavily on
administrative interpretation and there can be no assurance that
interpretations made by the FDA or other regulatory bodies will not have a
material adverse effect on the business, financial condition, results of
operations or cash flows. The FDA and state agencies routinely inspect the
Company to determine whether the Company is in compliance with various
requirements relating to manufacturing practices, testing, quality control,
complaint handling, medical device reporting and product labeling. Such
inspections can result in such agencies requiring the Company to take certain
corrective actions for non-complying conditions observed during the
inspections. A determination that the Company is in violation of the FDC Act
could lead to the imposition of civil sanctions, including fines, recall
orders, orders for repair or refund or product seizures and criminal
sanctions. Since 1994, the Company has on sixteen occasions temporarily
removed products from the market that were found not to meet performance
standards. None of such recalls materially interfered with the Company's
operations and all such product lines, except the Model 599 Series infusion
pump, were subsequently returned to the market. The Company continues,
however, to sell administration sets and replacement parts for the Model 599
Series infusion pump. In addition, the Company has initiated a voluntary
safety alert of its Model 597/598 and Model 599 Series infusion pumps.
Moreover, the Company has initiated a voluntary field correction of
approximately 50,000 of its Gemini PC-1 and PC-2 infusion pumps because
failure of specific electrical components on the power regulator printed
circuit board may result in improper regulation of the battery charge
voltage, which may cause the battery to overheat. The Company recorded a
charge of $2,500 to cost of sales for the quarter ended March 31, 1997 on
account of this voluntary field correction. The Company initiated a
voluntary field correction of its Signature Edition infusion pumps to correct
a malfunction of an electronic line filter component (which malfunction may
occur when a user fails to follow the Company's written cleaning instructions
and can result in an electrical short). The Company is not aware of the
occurrence of any injury incidents relating to a malfunction of this type.
Further, in November 1998, the Company initiated a voluntary safety alert
regarding the Signature Edition infusion pumps advising to check for the
proper installation of a spring in the pumping mechanism assembly. In the
third quarter of 1998, the Company initiated a recall of its Gemini PC-4
infusion pumps to correct certain electro-mechanical problems which may cause
one or more channels of the device to audibly and visibly alarm and
temporarily cease operation. Although there can be no assurance, the Company
believes that these voluntary field corrections, along with adjustments and
corrections that may be made to various Company products from time to time as
an ordinary part of the business of the Company, will not have a material
adverse effect on the business, financial condition, results of operations or
cash flows.
LITIGATION
The Company is a defendant in a lawsuit filed in June 1996 by Sherwood
Medical, Inc. against IVAC Holdings which alleges infringement of two patents
by reason of certain activities including the sale by IVAC Holdings of
disposable probe covers for use with the Company's infrared tympanic
thermometer. The lawsuit seeks injunctive relief, treble damages and the
recovery of costs and attorney fees. Trial commenced on November 10, 1998.
The Company believes it has sufficient defenses to all claims, including the
defenses of noninfringement and invalidity and
11
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intends to vigorously defend this action. However, there can be no assurance
that the Company will successfully defend all claims made by Sherwood and the
failure of the Company to successfully prevail in this lawsuit could have a
material adverse effect on the Company's operations, financial condition and
cash flows.
The Company is a defendant in a lawsuit filed on April 20, 1998 and served on
October 28, 1998, by Becton Dickinson and Company ("Becton") against ALARIS
Medical Systems, Inc., which alleges infringement of a patent licensed to
Becton by reason of certain activities, including the sale of the Company's
SmartSite Needle Free System. The lawsuit seeks injunctive relief, damages
and the recovery of costs and attorney fees. The Company believes it has
sufficient defenses to all claims, and intends to vigorously defend this
action. However, there can be no assurance that the Company will
successfully defend all claims made by Becton and the failure of the Company
to successfully prevail in this lawsuit could have a material adverse effect
on the Company's operations, financial condition and cash flows.
UNITED STATES CUSTOMS SERVICE MATTER
During the years 1988 through 1995, Cal Pacifico acted as the Company's United
States customs broker and importer of record with respect to the importation
into the United States of finished products ("Finished Products") assembled at
the Company's two maquiladora assembly plants in Tijuana, Mexico. In May 1995,
Cal Pacifico received a pre-penalty notice from the United States Customs
Service ("Customs") to the effect that Customs intended to assess additional
duties and substantial penalties against Cal Pacifico for its alleged failure,
during the years 1988 through 1992, to comply with certain documentary
requirements regarding the importation of goods on behalf of its clients,
including the Company. Customs recently assessed additional duties with respect
to Cal Pacifico's importation of goods on behalf of its clients, including the
importation of the Company's Finished Products, for the years 1993 and 1994, and
it is anticipated that Customs will issue a pre-penalty notice to Cal Pacifico
in respect of these years as well (collectively with the amounts referred to in
the immediately preceding sentence, the "Disputed Amounts"). The Company has
been advised by its special Customs counsel that, under applicable law, no
person, by fraud, gross negligence or negligence, may (i) import merchandise
into the commerce of the United States by means of any material and false
document, statement or act, or any material omission, or (ii) aid or abet any
other person to import merchandise in such manner. No proceeding has been
initiated by Customs against the Company in respect of the matters which are the
subject of the proceeding against Cal Pacifico. Since Cal Pacifico was the
Company's United States customs broker and importer of record during each of the
foregoing years, the Company believes that it is unlikely that Customs will
assess against the Company any portion of the Disputed Amounts.
Cal Pacifico is contesting Customs' assessment of the Disputed Amounts. Cal
Pacifico's challenge to the assessment of the Disputed Amounts is in its
preliminary stages. Given the present posture of Cal Pacifico's challenge, and
the inherent uncertainty of contested matters such as this, it is not possible
for the Company to express an opinion as to the likelihood that Cal Pacifico
will prevail on its challenge. Cal Pacifico or Customs has not informed the
Company as to the specific amount of the Disputed Amounts.
Cal Pacifico has advised the Company that, should Cal Pacifico's challenge to
the assessment of the Disputed Amounts prove to be unsuccessful, it will seek
recovery from the Company, through arbitration, for any portion of the Disputed
Amounts which it is required to pay to Customs. As part of the settlement
agreement which resolved the Company's contract dispute with Cal Pacifico during
the second quarter of 1997, the Company paid Cal Pacifico $550, which is to be
applied toward Cal Pacifico's payment of Disputed Amounts. The $550 payment by
the Company is to be credited toward any portion of the Disputed Amounts which
the arbitrator determines the Company owes to Cal Pacifico. The actual amount so
determined by the arbitrator may be less or greater than $550. Although the
12
<PAGE>
ultimate outcome of such an arbitration proceeding cannot be guaranteed, the
Company believes that it has meritorious defenses to claims with respect to
Disputed Amounts which Cal Pacifico might raise against the Company. These
defenses would be based, among other factors, on the contractual relationship
between the Company and Cal Pacifico (including a defense with respect to the
availability of indemnification under the agreements between Cal Pacifico and
the Company), the conduct of Cal Pacifico with respect to both the Company and
Customs, and the compliance obligations of Cal Pacifico under applicable customs
laws. Inasmuch as Cal Pacifico's challenge before Customs is still pending and
any claim against the Company for indemnification would be based on Cal
Pacifico's ultimate lack of success in that challenge, and inasmuch as any
arbitration proceeding by which Cal Pacifico might seek indemnification has not
been filed nor has Cal Pacifico committed itself to the theories under which it
might seek indemnification or the recovery of damages from the Company, it is
not possible for the Company to express an opinion at this time as to the
likelihood of an unfavorable outcome in such a proceeding.
OTHER
The Company is also a defendant in various actions, claims, and legal
proceedings arising from its normal business operations. Management believes
they have meritorious defenses and intends to vigorously defend against all
allegations and claims. As the ultimate outcome of these matters is uncertain,
no contingent liabilities or provisions have been recorded in the accompanying
financial statements for such matters. However, in management's opinion, based
on discussions with legal counsel, liabilities arising from such matters, if
any, will not have a material adverse effect on consolidated financial position,
results of operations or cash flows.
13
<PAGE>
PART I - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
- -------------------------------------------------------------------------------
GENERAL
The Company is a leading provider of infusion systems and related technologies
to the United States hospital market, with the largest installed base of pump
delivery lines ("channels"). The Company is also a leader in the international
infusion systems market. The Company's infusion systems, which are used to
deliver one or more fluids, primarily pharmaceuticals or nutritionals, to
patients, consist of single and multi-channel infusion pumps and controllers,
and proprietary and non-proprietary disposable administration sets (i.e.,
plastic tubing and pump interfaces). In addition, the Company is a leading
provider of patient monitoring products that measure and monitor temperature,
pulse, pulse oximetry and blood pressure, with the largest installed base of
hospital thermometry systems in the United States.
In recent years, the cost containment pressures applicable to health care
providers have affected the Company's results of operations. In particular, in
order to reduce costs, certain hospitals have adopted a protocol increasing the
maximum time between disposable administration set changes from every 24 hours
to as much as every 72 hours. Notwithstanding this change in protocol, unit
sales volume of the Company's disposable administration sets increased in every
year since 1993, primarily as a result of the growth in its installed base of
infusion pumps. However, uncertainty remains with regard to future changes
within the healthcare industry. The trend towards managed care and economically
motivated buyers in the U.S. may result in continued pressure on selling prices
of products and compression on gross margins. The U.S. marketplace is
increasingly characterized by consolidation among healthcare providers and
purchasers of medical products. The Company's profitability is affected by the
increasing use of Group Purchasing Organizations ("GPOs") which are better able
to negotiate favorable pricing from providers of infusion systems, such as the
Company, and which police compliance with exclusive buying arrangements for
their members. These buying arrangements, in certain situations, also may result
in the GPO requiring removal of the Company's existing infusion pumps. The
Company expects that such GPOs will become increasingly more common and may have
an adverse effect on the Company's future profitability.
-14-
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected financial
information expressed as a percentage of sales:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1997 1998 1997 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 48.8 49.5 53.2 50.8
--------- -------- -------- --------
Gross margin 51.2% 50.5% 46.8% 49.2%
Selling and marketing expenses 18.3 19.0 18.6 19.2
General and administrative expenses 10.2 10.7 10.4 10.6
Research and development expenses 5.2 5.4 5.0 5.2
Purchased in-process research and development - 24.2 - 10.4
Integration and other non-recurring charges 1.9 1.2 6.4 0.4
Lease interest income 1.3 1.3 1.3 1.3
--------- -------- -------- --------
Income (loss) from operations 16.9 (8.7) 7.7 4.7
Interest expense (12.6) (11.0) (12.5) (11.6)
Other, net - .5 (0.1) -
--------- -------- -------- --------
Income (loss) before income taxes 4.3 (19.2) (4.9) (6.9)
Provision for (benefit from) income taxes 2.5 3.0 (1.6) 1.2
--------- -------- -------- --------
Net income (loss) 1.8% (22.2%) (3.3%) (8.1%)
--------- -------- -------- --------
--------- -------- -------- --------
OTHER DATA:
Adjusted EBITDA 28.8% 27.0% 24.8% 25.1%
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1997 1998 1997 1998
-------- -------- -------- --------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C>
Adjusted EBITDA (1) $ 25,013 $ 25,397 $ 63,648 $ 68,315
Inventory purchase price allocation adjustment (2) - (172) (1,607) (172)
Integration and other non-recurring expense (1,693) (1,112) (16,457) (1,112)
Depreciation and amortization (3) (8,612) (9,550) (25,905) (25,992)
Purchased in-process research and development (4) - (22,800) - (28,334)
Interest income 55 509 345 654
Interest expense (10,954) (10,374) (32,004) (31,523)
Other, net (46) 14 (495) (667)
(Provision for) benefit from income taxes (2,200) (2,800) 4,200 (3,200)
--------- -------- -------- --------
Net income (loss) $ 1,563 $(20,888) $ (8,275) $(22,031)
--------- -------- -------- --------
--------- -------- -------- --------
</TABLE>
- -----------------------
(1) Adjusted EBITDA represents income from operations before restructuring,
integration and other non-recurring charges, non-cash purchase accounting
charges and depreciation and amortization. Adjusted EBITDA does not
represent net income or cash flows from operations, as these terms are
defined under generally accepted accounting principles, and should not be
considered as an alternative to net income as an indicator of the
Company's operating performance or to cash flows as a measure of
liquidity. ALARIS Medical Systems has included information concerning
Adjusted EBITDA herein because it understands that such information is
used by investors as one measure of an issuer's historical ability
to service debt. Restructuring
-15-
<PAGE>
and other one-time non-recurring charges are excluded from Adjusted
EBITDA as ALARIS Medical Systems believes that the inclusion of these
items would not be helpful to an investor's understanding of ALARIS
Medical System's ability to service debt. ALARIS Medical System's
computation of Adjusted EBITDA may not be comparable to similar
titled measures of other companies.
(2) Amount represents that portion of the purchase accounting adjustments
made to adjust the acquired IVAC inventory in 1997 and Instromedix
inventory in 1998 to their estimated fair value on the acquisition
dates. Such amounts were charged to cost of sales during the first and
third quarters of 1997 and 1998, respectively.
(3) Depreciation and amortization excludes amortization of debt discount
and issuance costs included in interest expense.
(4) Amount represents that portion of the purchase accounting adjustments
related to the value assigned to the acquired in-process research and
development of projects acquired from PSI, Caesarea and Instromedix for
which technological feasibility had not been established and for which
there was no alternative future use.
The following table summarizes sales to customers located in the United States
and international locations:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
1997 1998 1997 1998
-------- -------- -------- --------
(IN MILLIONS) (IN MILLIONS)
<S> <C> <C> <C> <C>
U.S. sales $ 55.8 $ 62.0 $ 162.6 $ 171.6
International sales 31.0 32.2 94.3 100.3
-------- -------- -------- --------
Total sales $ 86.8 $ 94.2 $ 256.9 $ 271.9
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
For purposes of this discussion and analysis, the three months ended September
30, 1997 and 1998 are referred to as Third Quarter 1997 and Third Quarter 1998,
respectively, and the nine months ended September 30, 1997 and 1998 are referred
to as 1997 and 1998, respectively.
THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
SALES
Sales increased $7.4 million during Third Quarter 1998 as compared to Third
Quarter 1997. International sales increased $1.2 million, or 3.9% while United
States sales increased $6.2 million, or 11.1%. The increase in international
sales is primarily due to increases in drug infusion instrument revenue. The
majority of the Company's international sales are denominated in foreign
currency. Due to a stronger U.S. dollar in 1998 as compared to the actual
foreign currency exchange rates in effect during Third Quarter 1997, translation
of Third Quarter 1998 international sales were adversely impacted by $0.3
million. The increase in U.S. sales in Third Quarter 1998 as compared to Third
Quarter 1997 is due to increases in drug infusion disposable administration set
revenue of $2.4 million, patient monitoring revenue of $0.6 million, service
revenue of $0.1 million, and revenue of $3.7 million generated by Instromedix
products. These increases were partially offset by a decrease in drug infusion
instrument revenue of $0.6 million.
GROSS MARGIN
The gross margin percentage decreased from 51.2% in Third Quarter 1997 to 50.5%
in Third Quarter 1998. Third Quarter 1997 cost of sales benefited from high
production volumes and sales of drug infusion disposable administration sets
resulting in improved gross margin for such period. The higher
-16-
<PAGE>
volumes were due to the resolution of a third-party contract manufacturer
dispute which had shut down the Company's two maquiladora assembly plants in
Tijuana, Mexico during June of 1997. The Company did not experience similar
manufacturing efficiencies in Third Quarter 1998.
SELLING AND MARKETING EXPENSES
Selling and marketing expenses increased $2.0 million, or 12.5%, during Third
Quarter 1998 as compared to Third Quarter 1997. As a percentage of sales,
selling and marketing expenses increased from 18.3% in Third Quarter 1997 to
19.0% in Third Quarter 1998. This increase is primarily due to increases in
personnel and related costs associated with the addition of Instromedix and
Patient Solutions in 1998.
GENERAL AND ADMINISTRATIVE EXPENSES
Third Quarter 1998 general and administrative expenses increased $1.2 million or
14.0% from Third Quarter 1997. As a percentage of sales, general and
administrative expenses increased from 10.2% in 1997 to 10.7% in 1998. This
increase is primarily due to increased consulting and legal expenses, as well as
intangible amortization and other administrative expenses resulting from the
Instromedix and Patient Solutions acquisitions in 1998.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased approximately $0.6 million, or
13.0%, during Third Quarter 1998 as compared to Third Quarter 1997 primarily
due to increased activities necessary to complete development for new
projects acquired in 1998 through the Instromedix and Patient Solutions
acquisitions.
INTEGRATION AND OTHER NON-RECURRING CHARGES
In connection with the Instromedix acquisition, management, with the
assistance of consultants, is performing a review of the operating activities
of the acquired company and is assessing how to best integrate and leverage
Instromedix operations with ALARIS Medical Systems. During the Third Quarter
of 1998, the Company incurred $1.1 million in costs associated with this
integration, primarily in consulting fees of $0.8 million, retention bonuses
of $0.2 million and $0.1 million in other related costs.
The Company incurred $1.7 million in costs to integrate the IMED and IVAC
operations during the Third Quarter of 1997. These costs are in addition to
restructuring and integration charges of $15.3 million recorded in the fourth
quarter of 1996. The Third Quarter 1997 expense consisted primarily of
information systems conversion costs of $1.4 million and other integration
costs of $0.3 million.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the Instromedix acquisition, the assets and liabilities of
Instromedix were adjusted to their estimated fair values. As a result of
this process, during the Third Quarter, the Company incurred a one-time $22.8
million write-off related to the value assigned to the acquired in-process
research and development of Instromedix projects for which technological
feasibility had not been established and for which there was no alternative
future use. Such amount was determined with the assistance of a third party
appraiser based upon the present value of estimated future cash flow
contributions from the identified projects. The Company has continued to
invest in the development necessary to obtain technological feasibility of
these projects.
The Company is using the purchased in-process research and development to create
new cardiac disease diagnosis, monitoring and management products which will
become part of the Arrhythmia Event Recorders and LifeSigns System product
suites over the next several years. The nature of the efforts required to
develop the purchased in-process technology into commercially viable products
principally relate to designing, prototyping, verification and testing
activities that are necessary to establish that the product can be produced to
meet its design specifications, including functions, features and technical
-17-
<PAGE>
performance requirements. The Company expects to incur a total of
approximately $4.0 million to complete the projects, of which $0.5 million is
expected to be incurred in the fourth quarter of 1998, while $3.0 million and
$0.5 million are expected to be incurred during 1999 and 2000, respectively.
The Company anticipates that products in the Arrhythmia Event Recorders
product suite using the purchased in-process technology will be released
during 1999, while products under the LifeSigns System product suite will be
released during 2000. The Company expects that the purchased in-process
research and development will be successfully developed, but there can be no
assurance that commercial viability of the products will be achieved.
INCOME FROM OPERATIONS
Income from operations decreased $22.9 million during Third Quarter 1998 as
compared to Third Quarter 1997 primarily due to the $22.8 million write-off
of purchased in-process research and development costs, discussed above,
which was not incurred in Third Quarter 1997. After adjusting for the
one-time write-off, Third Quarter income from operations decreased $0.1
million as compared to Third Quarter 1997 due to increased gross margin
offset by increased operating expenses.
ADJUSTED EBITDA
Adjusted EBITDA increased $0.4 million during Third Quarter 1998 as compared
to Third Quarter 1997. As a percentage of sales, Adjusted EBITDA decreased
from 28.8%, or $25.0 million, for Third Quarter 1997 to 27.0%, or $25.4
million, for Third Quarter 1998 due to the reasons discussed above. Adjusted
EBITDA represents income from operations before non-recurring, non-cash
purchase accounting charges, integration charges and depreciation and
amortization. Adjusted EBITDA does not represent net income or cash flows
from operations, as these terms are defined under generally accepted
accounting principles, and should not be considered as an alternative to net
income or to cash flows as an indicator of the Company's operating
performance or to cash flows as a measure of liquidity. The Company has
included information concerning Adjusted EBITDA herein because it understands
that such information is used by investors as a measure of an issuer's
historical ability to service debt. Integration and other one-time
non-recurring charges are excluded from Adjusted EBITDA as the Company
believes that the inclusion of these items would not be helpful to an
investor's understanding of the Company's ability to service debt. The
Company's computation of Adjusted EBITDA may not be comparable to similar
titled measures of other companies.
INTEREST EXPENSE
Interest expense increased $0.6 million during Third Quarter 1998 due to
additional debt incurred to fund the Instromedix acquisition. In July, in
connection with the Instromedix acquisition, the Company increased term debt
borrowings $30.0 million, resulting in higher interest expense for the
quarter. (see Liquidity and Capital Resources).
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
SALES
Sales increased $14.9 million during 1998 as compared to 1997. International
sales increased $6.0 million, or 6.4% while United States sales increased
$8.9 million, or 5.5%. The increase in international sales is primarily due
to increases in drug infusion revenues of $5.4 million. The majority of the
Company's international sales are denominated in foreign currency. Due to a
stronger U.S. dollar in 1998 as compared to the actual foreign currency
exchange rates in effect during 1997, translation of 1998 international sales
were adversely impacted by $2.9 million. The increase in U.S. sales in 1998
as compared to 1997 is primarily due to increases in drug infusion disposable
administration set revenue of $5.6 million, patient-monitoring revenue of
$1.9 million, and revenue of $3.7 million generated by Instromedix products.
These increases were partially offset by a decrease in drug infusion
instrument revenue of $2.4 million.
-18-
<PAGE>
GROSS MARGIN
The gross margin percentage increased from 46.8% in 1997 to 49.2% in 1998
primarily due to $4.1 million of non-recurring costs included in 1997 cost of
sales. Exclusive of $1.6 million of non-recurring purchase accounting
inventory adjustments and $2.5 million related to a voluntary field
correction of certain Gemini PC-1 and PC-2 infusion pumps charged to cost of
sales during 1997, the gross margin percentage for 1997 was 48.4%. The
improvement over 1997 is due to overall higher margins on domestic and
international disposable administration sets and instruments as well as the
benefits realized from ongoing cost reduction efforts and purchasing
synergies.
SELLING AND MARKETING EXPENSES
Selling and marketing expenses increased $4.3 million, or 9.0%, during 1998
as compared to 1997. As a percentage of sales, selling and marketing expenses
increased from 18.6% in 1997 to 19.2% in 1998. Domestic expenses increased by
$1.8 million, or 6.5%, from 1997 due to the addition of Instromedix and
Patient Solutions in 1998 as well as increases in personnel and freight costs
in 1998. International expenses increased $2.5 million from 1997 due to
increased sales, the investment in international direct operations in Italy
and Norway during the second half of 1997 and related increases in personnel
costs.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased $1.9 million, or 7.3%, during
1998 as compared to 1997. As a percentage of sales, general and
administrative expenses increased from 10.4% in 1997 to 10.6% in 1998.
Domestic expenses increased by $0.4 million due to additional domestic
amortization resulting from the Instromedix and Patient Solutions
acquisitions. International expenses increased by $1.5 million, primarily as
a result of the conversion of certain European dealer operations into direct
operations, expansion of the European headquarters and quality initiatives to
obtain required CE markings on products.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased approximately $1.4 million, or
11.0%, during 1998 as compared to 1997 primarily due to additional research
and development related to projects associated with the recently acquired
Instromedix and Patient Solutions, as well as increased activities associated
with the later development stages of various domestic and international
engineering projects for infusion systems and disposable administration sets.
INTEGRATION AND OTHER NON-RECURRING CHARGES
In connection with the Instromedix acquisition, management, with the
assistance of consultants, is performing a review of the operating activities
of the acquired company and is assessing how best to integrate and leverage
the Instromedix operations with ALARIS Medical Systems. During the first nine
months of 1998, the Company incurred $1.1 million in costs associated with
this integration, primarily in consulting fees of $0.8 million, retention
bonuses of $0.2 million and $0.1 million in other related costs.
The Company incurred $16.5 million in costs to integrate the IMED and IVAC
operations during the first nine months of 1997. These costs are in addition
to restructuring and integration charges of $15.3 million recorded in the
fourth quarter of 1996. The 1997 expense consists primarily of the write-off
of a product distribution and license agreement with a third party developer
of an ambulatory and alternate site infusion pump of $4.5 million,
maquiladora settlement and related costs of $4.1 million, information systems
conversion costs of $3.1 million, management consulting fees of $1.4 million,
severance of $0.2 million and other integration costs of $3.2 million. The
Company reviewed its products and related research and development activities
and market opportunities in order to focus on projects that will provide
greater competitive advantage and shareholder return. That review resulted
in the termination of the aforesaid product distribution and license
agreement. The $4.5 million charge related to such
-19-
<PAGE>
termination includes a $4.3 million non-cash charge representing the
write-off of the intangible asset associated with such agreement.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
During 1998, the Company recorded $28.3 million in purchased in-process
research and development write-offs as a result of certain business
acquisitions. In conjunction with the Instromedix acquisition, the assets
and liabilities of Instromedix were adjusted to their estimated fair values.
As a result of this process, the Company incurred a one-time $22.8 million
write-off related to the value assigned to the acquired in-process research
and development of Instromedix projects for which technological feasibility
had not been established and for which there was no alternative future use.
Such amount was determined with the assistance of a third party appraiser
based upon the present value of estimated future cash flow contributions from
the identified projects.
The Company is using the Instromedix purchased in-process research and
development to create new cardiac disease diagnosis, monitoring and
management products which will become part of the Arrhythmia Event Recorders
and LifeSigns System product suites over the next several years. The nature
of the efforts required to develop the purchased in-process technology into
commercially viable products principally relate to designing, prototyping,
verification and testing activities that are necessary to establish that the
product can be produced to meet its design specifications, including
functions, features and technical performance requirements. The Company
expects to incur a total of approximately $4.0 million to complete the
projects, of which $0.5 million is expected to be incurred in the fourth
quarter of 1998, while $3.0 million and $0.5 million are expected to be
incurred during 1999 and 2000, respectively. The Company anticipates that
products in the Arrhythmia Event Recorders product suite using the purchased
in-process technology will be released during 1999, while products under the
LifeSigns System product suite will be released during 2000. The Company
expects that the purchased in-process research and development will be
successfully developed, but there can be no assurance that commercial
viability of the products will be achieved.
In connection with the PSI acquisition and the technology license agreement
with Caesarea during the second quarter of 1998, the Company incurred a
one-time $5.5 million write-off related to the value assigned to the acquired
in-process research and development of the projects for which technological
feasibility had not been established and for which there was no alternative
future use. The Company has continued to invest in the development necessary
to obtain technological feasibility of these projects.
In connection with the PSI acquisition, the Company is using the acquired
in-process research and development to develop an ambulatory infusion pump
for use in the alternate-site market. The nature of the efforts required to
develop the purchased in-process technology into a commercially viable
product principally relate to designing, prototyping, verification and
testing activities that are necessary to establish that the product can be
produced to meet its design specifications, including functions, features and
technical performance requirements. The Company expects to incur a total of
$0.7 million to complete the project, of which $0.2 million is projected to
be incurred in 1998 and $0.5 million in 1999. It is anticipated that the
pump will be released during 1999. The Company expects that the purchased
in-process research and development will be successfully developed, but there
can be no assurance that commercial viability of the pump will be achieved.
Pursuant to the technology license agreement, the Company acquired certain
volumetric infusion pump technology from Caesarea. Caesarea is conducting
research and development on this in-process technology in order to create a
large volume infusion pump marketed primarily to consumers in emerging
international markets. The Company is required to make certain milestone
payments up to an aggregate of $4.0 million to Caesarea upon the attainment
of certain developmental milestones, which primarily relate to different
product releases. The Company anticipates that certain products using the
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<PAGE>
purchased in-process technology will be released during the fourth quarter of
1998, with additional product releases in subsequent periods through the
first half of 1999. The Company expects that the purchased in-process
research and development will be successfully developed, but there can be no
assurance that commercial viability of the pump will be achieved.
INCOME FROM OPERATIONS
Income from operations decreased $7.0 million during 1998 as compared to 1997
primarily due to non-recurring charges related to the write-off of $28.3
million in purchased in-process research and development charges in
connection with acquisitions and $1.1 million in integration charges related
to the Instromedix acquisition. The 1997 income from operations includes
integration and other non-recurring charges of charges of $20.6 million in
1997 related to the IVAC/IMED merger. After excluding non-recurring charges
from 1997 and 1998, the adjusted income from operations is $40.3 in 1997 as
compared to $42.2 in 1998. The increase in 1998 over 1997 is due primarily to
improved sales and gross margins.
ADJUSTED EBITDA
Adjusted EBITDA increased $4.7 million during 1998 as compared to 1997. As a
percentage of sales, Adjusted EBITDA increased from 24.8%, or $63.6 million,
for 1997 to 25.1%, or $68.3 million, for 1998 due to the reasons discussed
above. Adjusted EBITDA represents income from operations before non-recurring
non-cash purchase accounting charges, integration charges and depreciation
and amortization. Adjusted EBITDA does not represent net income or cash
flows from operations, as these terms are defined under generally accepted
accounting principles, and should not be considered as an alternative to net
income or to cash flows as an indicator of the Company's operating
performance or to cash flows as a measure of liquidity. The Company has
included information concerning Adjusted EBITDA herein because it understands
that such information is used by investors as a measure of an issuer's
historical ability to service debt. Integration and other one-time
non-recurring charges are excluded from Adjusted EBITDA as the Company
believes that the inclusion of these items would not be helpful to an
investor's understanding of the Company's ability to service debt. The
Company's computation of Adjusted EBITDA may not be comparable to similar
titled measures of other companies.
INTEREST EXPENSE
Interest expense increased $0.5 million or 1.5% during 1998 due to additional
financing obtained to fund the Instromedix acquisition. In connection with
the Instromedix acquisition, in July the Company increased the outstanding
bank term debt $30.0 million, resulting in increased interest expense for
1998. (see Liquidity and Capital Resources).
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity have been cash flow from
operations and borrowings under the bank facility. The Company expects to
continue to meet its liquidity needs including capital expenditure
requirements with cash flow from operations and remaining cash proceeds from
ALARIS Medical's issuance of Senior Discount Notes in July 1998. In addition
to operating expenses, the Company's primary historical use of funds has been
and its future use of funds will continue to be to fund capital expenditures
and strategic acquisitions and to pay debt service on outstanding
indebtedness. Additionally, the Company's credit facility permits it to
transfer to ALARIS Medical up to $1.5 million annually to fund ALARIS
Medical's operating expenses, additional amounts sufficient to meet annual
interest payment requirements of approximately $1.2 million and beginning in
2004, amounts sufficient to service the Senior Discount Notes.
At September 30, 1998, the Company's outstanding indebtedness was $415.2
million, which includes $211.4 million of bank term debt under the credit
facility, $200.0 million of Senior Subordinated Notes due 2006 (the "Notes"),
which were issued in connection with the Merger. The bank debt bears interest
at floating rates based, at the Company's option, on Eurodollar or prime
rates. During the second quarter of
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<PAGE>
1997, the Company entered into an interest rate protection agreement covering
50% of its term loan borrowings. Such agreement fixed the interest rate
charged on such borrowings resulting in a weighted average fixed rate of 9.6%
on the principal balance covered. As a result, a one percent increase in the
rate of interest charged on indebtedness outstanding under the credit
facility at September 30, 1998 would result in additional annual interest
expense of approximately $1.1 million. During March 1998, the bank credit
facility was amended and the interest rates on the bank debt reduced. As a
result, the weighted average interest rate, including the effect of the
interest rate protection agreement, was reduced to 8.5% based on the amounts
outstanding at the time of the amendment. The Company incurred fees of
approximately $0.4 million related to such interest rate reductions.
In connection with obtaining the Merger financing, the Company also obtained
a $50.0 million revolving credit line as part of the credit facility. In July
1998, in connection with the Instromedix acquisition, the Company amended its
bank credit facility. The amendment provided for the banks' consent to the
Instromedix acquisition and increased the revolving credit facility to $60.0
million. At September 30, 1998, a $0.5 million letter of credit was committed
under this line of credit and $59.5 million was available.
The amended bank credit facility also provided the Company an additional
$30.0 million under the Tranche D term debt. The Company used the $30.0
million term debt borrowing, along with approximately $3.0 million from the
revolving credit line, to fund the initial payments required upon closing the
Instromedix acquisition. Subsequent to closing the Instromedix acquisition,
ALARIS Medical completed the sale of $109.9 million of 11 1/8% Senior
Discount Notes, due 2008, receiving net proceeds of approximately $106.3
million. Interest accruing on these notes is added to the outstanding
principal balance through July 31, 2003. Interest accruing subsequent to July
31, 2003 is payable in cash semi-annually in arrears on February 1 and August
1. Upon receipt of the net proceeds from the Senior Discount Notes, ALARIS
Medical paid its remaining obligations of approximately $22.7 million to the
Instromedix shareholders and contributed the remaining net proceeds of
approximately $82.6 million to ALARIS Medical Systems, as required under the
amended bank credit agreement. ALARIS Medical Systems then repaid the amount
outstanding under its revolving credit line.
Additionally, ALARIS Medical is required to register, and is in the process
of registering, the Senior Discount Notes with the Securities and Exchange
Commission. If such registration is not completed by November 26, 1998,
ALARIS Medical will incur additional interest on the Senior Discount Notes.
For the first 90 day period that such registration is not completed,
additional interest of $0.05 per one thousand dollars of principal
outstanding under the Senior Discount Notes, or approximately $0.1 million,
will accrue. It is unlikely that ALARIS Medical will receive the required
approval from the Security and Exchange Commission for such registration
process prior to November 26, 1998 but management does believe such process
should be completed before the expiration of the following 90 day period.
In connection with the Merger, the Company assumed IVAC's obligations to
Siemens Infusion Systems Ltd. ("SIS"). These obligations relate to the
payment of additional purchase consideration related to the acquisition of
the MiniMed product line (the predecessor product line to MS III). The
Company's remaining obligation to SIS is the greater of $3.0 million or 8% of
the prior year's MS III sales in 1999. The Company made the minimum 1998
payment of $3.0 million during the first quarter of 1998.
As a result of the Company's significant indebtedness, the Company expects to
incur significant interest expense in future periods. The Company believes
that cash provided by operations will be sufficient to meet its interest
expense obligations.
Annual principal amortization of the Company's indebtedness is $0.1 million
for the fourth quarter of 1998 and $15.5 million and $13.9 million for 1999
and 2000, respectively.
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<PAGE>
Although the Company is not a guarantor of ALARIS Medical's debt, ALARIS
Medical has no significant operations other than the operations of the
Company and is dependent upon the Company to fund its debt service
requirements and other operating expenses. At September 30, 1998, ALARIS
Medical had $112.0 million of Senior Subordinated Notes and $16.2 million of
outstanding Convertible Debentures. Interest of 11 1/8% accrues and is added
to the outstanding balance of the Senior Discount Notes through July 31,
2003. The Convertible Debentures provide for semi-annual interest payments
of approximately $0.6 million and mature on January 15, 2002. The Notes and
the credit facility permit ALARIS Medical Systems to fund interest payments
on the Convertible Debentures and to make limited distributions to ALARIS
Medical to fund operating expenses and to pay income taxes; provided that,
with respect to the credit facility, there exists no default or event of
default under the credit facility. The Notes and the credit facility,
however, restrict distributions to ALARIS Medical to fund the repayment of
the Convertible Debentures at maturity.
During the quarter ended September 30,1998, the Company made cash payments of
approximately $0.4 million related to merger and integration costs accrued at
December 31, 1997. Also during the third quarter of 1998, the Company
accrued approximately $1.1 million for integration costs related to
Instromedix, of which approximately $0.1 million was paid in cash. During
the quarter ended September 30, 1997 the Company made cash payments of
approximately $1.5 million related to merger and integration costs accrued at
December 31, 1996, as well as payments of approximately $1.7 million for
integration costs expensed during the third quarter of 1997.
During the Third Quarter of 1998, the Company made capital expenditures of
approximately $6.5 million and anticipates it will make capital expenditures
of approximately $25.0 million for the full year.
During the first quarter of 1998, the Company created a corporate development
function to assess product and company acquisitions, distribution alliances
and joint ventures which would expand Company technologies into unserved
markets. While there can be no assurances that the Company will complete
additional acquisitions, depending on the value of potential acquisitions,
the Company might fund such transactions through a variety of sources,
including existing cash, new or existing debt facilities or through the sale
of equity securities.
The Company believes that, based on current levels of performance, it will
generate cash flow from operations, together with its existing cash,
sufficient to fund its operations, make planned capital expenditures and make
required payments of principal and interest under its credit facility and
interest on the 9 3/4% Notes; however, the Company may not generate
sufficient cash flow from operations to repay the 9 3/4 % Notes at maturity
in the amount of $200.0 million, to make scheduled payments on the Senior
Discount Notes or to repay the Senior Discount Notes in the amount of $189.0
million at maturity. Accordingly, the Company may have to refinance the Notes
and the Senior Discount Notes at or prior to maturity or sell assets or raise
equity capital to repay such debt. Based on current interest rates, over the
next twelve months the Company is required to make principal and interest
payments under it's bank credit facility in the amount of $30.8 million and
interest payments on the 9 3/4% Notes and the 7 1/4% Convertible Debentures
in the amount of $19.5 million and $1.2 million, respectively. In addition,
the Company's ability to fund its operations, to make planned capital
expenditures and to make scheduled principal and interest payments will be
dependent on the Company's future operating performance, which is itself
dependent on a number of factors, many of which the Company cannot control,
including conditions affecting the Company's foreign operations, prevailing
economic conditions, availability of other sources of liquidity, and
financial, business, regulatory and other factors affecting the Company's
business and operations.
CONTINGENCIES AND LITIGATION
See Note 7 to the Consolidated Financial Statements.
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<PAGE>
YEAR 2000
Certain of the Company's infusion pumps contain software in which the
product's record keeping capabilities will be affected beyond the year 2000.
The Company believes that these issues will not interfere with the fluid
delivery functions of the products involved, nor will they affect the safety
of patients; however, there can be no assurance in this regard. Such record
keeping capabilities serve as a log of the products use and are primarily
used by the Company if needed in determining causes of product failures.
Management believes the Company has completed development of the corrective
software for all but one of its products and is offering such software for
sale to its customers. Corrective software for the one remaining product is
under development and will be available to customers in the first quarter of
1999. Costs of such development has not been and is not anticipated to be
material to the Company.
In addition to routine capital expenditures, and in connection with the
Merger, the Company has made significant expenditures for the acquisition of
enterprise-wide information system software and hardware and the related
design, testing and implementation. The new system is year 2000 compliant.
The Company successfully implemented certain financial applications of the
new system and began utilizing such applications at the beginning of 1998.
The Company successfully converted the remainder of its domestic business
processes to the new system in September 1998. The Company believes the
primary information system for its international operations is not directly
affected by the year 2000. However, due to the increased significance of its
international operations, the Company will be converting the international
information systems to a system common with the domestic operations. The
international project is scheduled for completion in 1999. The international
system is also designed to properly process transactions denominated in euro
currency. Euro currency is a new monetary unit which certain European
countries can begin using in 1999.
In order to successfully provide product to its customers, the Company is
dependent upon the timely fulfillment of its supply orders from its chosen
vendors. The Company has identified potentially critical suppliers and
attempted to determine if such suppliers have identified and/or addressed
their own year 2000 issues by means of questionnaires. At this time, the
Company has not identified or been informed of any significant suppliers that
will not be able to fulfill the Company's orders. However, many of the
Company's key suppliers have acknowledged that they must make improvements to
their systems to properly deal with year 2000 orders and issues. As a
result, there can be no assurances that key suppliers will be able to timely
fill the Company's future orders. The Company is in the process of
evaluating what alternatives are available if key suppliers could not provide
required materials and supplies to the Company when ordered. While a formal
contingency plan related to this risk has not yet been completed by the
Company, alternatives would be to increase inventory levels of key supplies
and seek supplies from other vendors. The Company estimates that such
contingency plan will be completed by December 31, 1998. However, there can
be no assurance that all significant primary and back-up suppliers will be
able to fill the Company's orders due to their own year 2000 issues. Such
supplier failures could have a material adverse impact on the Company's
financial condition, results of operations and cash flows.
The Company has formed a committee to identify, evaluate and address year
2000 issues to which the Company might be exposed on a worldwide basis
including and in addition to the items previously described. The committee is
currently assessing the year 2000 readiness of certain key areas including,
but not limited to, Company operations (including non-information technology
systems) and third party suppliers. The committee has not yet completed this
assessment but it is not currently aware of any material year 2000 issues
related to other third parties with whom the Company conducts business or in
its non-information technology systems. The committee's assessment will
likely be a continuous process through the end of the calendar year 1998 and
into 1999. In addition to its customers, the Company conducts business with
and utilizes the services of numerous third parties including but not limited
to suppliers, distributors, telecommunication companies, financial
institutions, governmental agencies, and utility companies. The ability of
these third parties to adequately address their year 2000 issues is outside
the Company's control. Failure by some or all these parties to adequately
address their year 2000 issues could have a material adverse effect on the
Company. Given the number of parties with whom the Company transacts
business, it is reasonably likely some of these parties will not be able to
adequately solve their year 2000 issues in a timely manner. The Company does
not believe it has significant dependence on any one of these third parties
and accordingly does not believe that it is
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<PAGE>
reasonably likely that the Company will experience any material adverse
impacts related to year 2000 issues. However, due to the Company's inability
to control third party compliance with year 2000 issues, there can be no
assurances that such year 2000 issues will not have a material adverse effect
on the financial condition, results of operations or cash flows of the
Company.
During the fiscal years 1996 and 1997 the Company made combined capital and
operating expenditures of approximately $7.5 million related to the new
enterprise-wide information system, and expenditures of $4.5 million in the
nine months ended September 30, 1998. To complete the identified phases of
the project, the Company anticipates additional expenditures for the
remainder of 1998 and for 1999 of approximately $3.4 million and $3.5
million, respectively.
SEASONALITY
Infusion instrument sales are typically higher in the fourth quarter due to
sales compensation plans which reward the achievement of annual quotas and
the seasonal characteristics of the industry, including hospital purchasing
patterns. First quarter sales are traditionally not as strong as the fourth
quarter. The Company anticipates that this trend will continue but is unable
to predict the effect, if any, from health care reform and increased
competitive pressures.
BACKLOG
The backlog of orders, believed to be firm, at September 30, 1997 and 1998
was $7.9 million and $5.2 million, respectively.
FOREIGN OPERATIONS
As a result of the Merger, the Company has significant foreign operations.
Accordingly, the Company is subject to various risks, including without
limitation, foreign currency risks. Historically, the Company has not entered
into foreign currency contracts to hedge such exposure and such risk. Due to
changes in foreign currency exchange rates during 1998, primarily a
strengthening of the U.S. dollar against many European currencies, the
Company recognized a foreign currency transaction gain of approximately $0.1
million during Third Quarter 1998. For the year ended December 31, 1997 and
the nine months ended September 30, 1998, approximately 30% and 32% of the
Company's sales and 23% and 22% of the Company's operating expenses were
denominated in currencies other than the Company's functional currency,
respectively. These foreign currencies are primarily those of Western
Europe, Canada and Australia. Additionally, substantially all of the
receivables and payables of the Company's foreign subsidiaries are
denominated in currencies other than the Company's functional currency, and
no formal hedging program exists to manage fluctuations in foreign
currencies. The Company will evaluate hedging programs during 1998 to limit
the exposure to the Company resulting from changes in foreign currency
exchange rates.
HEALTH CARE REFORM
Heightened public awareness and concerns regarding the growth in overall
health care expenditures in the United States may result in the enactment of
legislation affecting payment mechanisms and health care delivery.
Legislation which imposes limits on the number and type of medical procedures
which may be performed or which has the effect of restricting a provider's
ability to select specific devices or products for use in administrating
medical care may adversely impact the demand for the Company's products. In
addition, legislation which imposes restrictions on the price which may be
charged for medical products may adversely affect the Company's results of
operations. It is not possible to predict the extent to which the Company or
the health care industry in general may be adversely affected by the
aforementioned in the future.
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<PAGE>
FORWARD-LOOKING STATEMENTS
Forward-Looking Statements in this report are made pursuant to the Safe
Harbor Provisions of the Private Securities Litigation Reform Act of 1995.
Persons reading this report are cautioned that such forward-looking
statements involve risks and uncertainties, including, without limitation,
the effect of legislative and regulatory changes effecting the health care
industry; the potential of increased levels of competition; technological
changes; the dependence of the Company upon the success of new products and
ongoing research and development efforts; restrictions contained in the
instruments governing the Company's indebtedness; the significant leverage to
which the Company is subject; and other matters referred to in this report.
-26-
<PAGE>
PART II
OTHER INFORMATION
- -------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS
See Note 7 to the Condensed Consolidated Financial Statements.
-27-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 -- Financial Data Schedule
-----------------------------------
(b) Reports on Form 8-K
A Report on Form 8-K was filed on July 30, 1998. The Agreement and Plan of
Merger entered into on June 24, 1998 by ALARIS Medical, Inc., ALARIS Medical
Systems, Inc., Herbert J. Semler and Shirley L. Semler, Instromedix, Inc.,
and other shareholders of Instromedix was reported. Also reported was
Summary Financial Data of Instromedix and news releases issued by ALARIS
Medical, Inc., dated June 20, 1998 and June 25, 1998.
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<PAGE>
SIGNATURES
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.
ALARIS MEDICAL SYSTEMS, INC.
-------------------------------------
(REGISTRANT)
Date: November 13, 1998 By: /s/ WILLIAM J. MERCER
----------------------------------
William J. Mercer
President, Chief Executive Officer
Chief Financial Officer
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<PAGE>
EXHIBIT INDEX
- -------------------------------------------------------------------------------
Exhibit
No.
-------
27 -- Financial Data Schedule
-30-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Condensed Consolidated Balance Sheet and Condensed Consolidated Statement of
Operations and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 44,774
<SECURITIES> 0
<RECEIVABLES> 77,018
<ALLOWANCES> (3,674)
<INVENTORY> 78,297
<CURRENT-ASSETS> 234,548
<PP&E> 106,073
<DEPRECIATION> (46,041)
<TOTAL-ASSETS> 646,307
<CURRENT-LIABILITIES> 96,808
<BONDS> 402,689
0
0
<COMMON> 0
<OTHER-SE> 121,312
<TOTAL-LIABILITY-AND-EQUITY> 646,307
<SALES> 271,881
<TOTAL-REVENUES> 271,881
<CGS> 138,025
<TOTAL-COSTS> 138,025
<OTHER-EXPENSES> 124,408
<LOSS-PROVISION> 150
<INTEREST-EXPENSE> 31,523
<INCOME-PRETAX> (18,831)
<INCOME-TAX> 3,200
<INCOME-CONTINUING> (22,031)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (22,031)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
