-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ct3zTH6St2y8vokEGuy8lMoz8O0Adrnai8TpzA21mcYKVS8CdKD3IHKFJejZkJWU JyiXps7n8cyN4F9EtD5knA== 0000950131-97-002110.txt : 19970508 0000950131-97-002110.hdr.sgml : 19970508 ACCESSION NUMBER: 0000950131-97-002110 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970327 SROS: CSX SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLEGIANCE CORP CENTRAL INDEX KEY: 0001017799 STANDARD INDUSTRIAL CLASSIFICATION: 8093 IRS NUMBER: 364095179 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-11885 FILM NUMBER: 97565199 BUSINESS ADDRESS: STREET 1: ONE BARTER PARKWAY CITY: DEERFIELD STATE: IL ZIP: 60015 BUSINESS PHONE: 8479483781 MAIL ADDRESS: STREET 1: 1430 WAUKEGAN RD STREET 2: MPA 2 CITY: MCGAW PARK STATE: IL ZIP: 60085 10-K 1 FORM 10-K - - ------------------------------------------------------------------------------- - - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . COMMISSION FILE NUMBER: 1-11885 ALLEGIANCE CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 36-4095179 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 1430 WAUKEGAN ROAD 60085 MCGAW PARK, ILLINOIS (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) Registrant's telephone number, including area code: (847) 689-8410 Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- Common Stock, $1.00 par value New York Stock Exchange Chicago Stock Exchange Series A Junior Participating Preferred Stock New York Stock Exchange Purchase Rights (currently traded with Common Chicago Stock Exchange Stock)
Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The registrant estimates that the aggregate market value of the registrant's Common Stock held by non-affiliates of the registrant (based on the per share closing sale price of $25.375 on March 6, 1997, and for the purpose of this computation only, the assumption that all registrant's directors and executive officers are affiliates) was approximately $1.4 billion. Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and registrant is not bound by this determination for any other purpose. As of March 6, 1997, 55,403,778 shares of the registrant's Common Stock were outstanding. The following documents are incorporated into this Form 10-K by reference: Annual Report to Stockholders for fiscal year ended December 31, 1996 (Part II). Proxy Statement for Annual Meeting of Stockholders to be held on May 15, 1997 (Part III). - - ------------------------------------------------------------------------------- - - ------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS Allegiance Corporation ("Allegiance" or the "Company") was incorporated in Delaware in June 1996. On September 30, 1996 (the "Distribution Date"), Baxter International Inc. ("Baxter") and its subsidiaries transferred to Allegiance and its subsidiaries the United States health-care distribution business, surgical and respiratory therapy business, and health-care cost-management business, as well as certain foreign operations (the "Allegiance Business") in connection with a spin-off of the Allegiance Business by Baxter. The spin-off was effected on the Distribution Date through a distribution of common stock of Allegiance to Baxter stockholders (the "Distribution"). Unless the context otherwise indicates, as used in this Report, the terms "Allegiance" and the "Company" mean the Allegiance Business of Baxter for periods prior to the Distribution Date and Allegiance Corporation and its consolidated subsidiaries for the periods following the Distribution Date, and all references to "Baxter" include Baxter International Inc. and its consolidated subsidiaries as of the relevant date. OVERVIEW Allegiance is America's largest provider of health-care products and cost- management services for hospitals and other health-care providers. These integrated businesses recorded total sales of approximately $4.4 billion in 1996. The economics of health care are undergoing rapid and fundamental change, particularly in the United States, which is Allegiance's largest current market. In the past, doctors and nurses were paid for their services with few cost constraints. Today, large employers, insurance companies and HMOs are negotiating set fees for patient care. For United States hospitals and health systems, Allegiance's main customers, the pressure to reduce costs has never been greater. At the same time, demand for health services is continuing to climb with the dramatic growth of aging populations in the United States and abroad. This environment offers opportunities for Allegiance, which has invested in integrated product and service programs that help medical professionals cope with health care's new economics and demographic trends. The health-care distribution market in the United States has experienced intense competition and a resultant erosion in its margins in recent years in response to the growth of managed care and increased consolidation among health-care providers. Allegiance has responded by integrating its market- leading distribution capabilities with a broad product offering, high levels of customer service, and innovative cost-management services. DISTRIBUTION SERVICES Allegiance is a leading distributor of medical and laboratory products in the United States. Allegiance can supply any of more than 200,000 different products to its customers. Most items are available for shipment the same day the customer requests them. Allegiance has 60 United States distribution centers that deliver products to locations across the United States every day. Each order can be tracked electronically. Allegiance has made substantial investments in information systems to enhance its operations and improve customer service. In addition to its own surgical and respiratory therapy products, Allegiance distributes an array of products from more than 2,000 manufacturers to a wide variety of health-care settings. Products range from full lines of laboratory equipment and operating room supplies to children's gift packs with coloring books and crayons. Allegiance divides its distributed products into two categories: medical/surgical products ("med/surg") and laboratory products. It is the industry leader in both product categories. Allegiance's med/surg portfolio comprises a broad array of products, including sutures, endoscopy instruments, needles and syringes, wound-care products, electrodes, face masks, bed pans, wash basins, blood-pressure cuffs, stethoscopes, waste-disposal bags, and others. Increasingly, these products are being delivered just-in-time in ready-to-use quantities. In some cases, Allegiance delivers the products directly to patient floors. Allegiance distributes products not only to hospitals, but increasingly to surgery centers, physician clinics, distributors, long-term and sub-acute care facilities, 1 home-care companies, and other health-care providers. Laboratory products-- used primarily to perform diagnostic tests--are sold principally to medical laboratories and other health-care providers. These products include test tubes, pipettes, slides, and equipment such as microscopes, centrifuges, and scales. The ValueLink(R) Service Allegiance's ValueLink(R) "stockless" inventory service provides just-in- time deliveries of products in small, ready-to-use quantities to hospitals and health-care networks, primarily in metropolitan areas. Allegiance was the first to bring just-in-time distribution to the health-care industry and it remains the leader. The ValueLink(R) service helps hospitals reduce inventory levels and operating expenses. Orders from hospitals are transmitted electronically and products are delivered several times a day, sometimes directly to patient floors. In some ValueLink(R) accounts, Allegiance personnel work at the hospital 24 hours a day, stocking shelves as needed. Through the ValueLink(R) service, Allegiance also delivers labor-saving, made-to-order packages containing virtually every sterile and non-sterile product needed to perform dozens of medical procedures, from open-heart bypass surgery to a hernia repair. Strategic Supplier Relationships In 1995, Allegiance began consolidating its distribution service around a carefully selected group of preferred suppliers seeking to reduce the number of suppliers that furnish identical items. This "best-value" products strategy is designed to strengthen Allegiance's relationships with fewer preferred suppliers, resulting in savings to Allegiance and better service to its customers. Allegiance is also continuing to streamline its distribution network to reduce costs, improve service, and strengthen the growing number of cost-management relationships with health-care providers and systems. Supply-Chain Management Supply-chain management requires precise knowledge and planning of customer demand. Given Allegiance's size and scope, advanced information systems, and balance of self-manufactured and externally supplied products, Allegiance is well-positioned to maximize service to customers and minimize inventory levels and variability. To accelerate this process, Allegiance has made and continues to make major investments in information technology that uses EDI, or electronic data interchange, to exchange purchasing and inventory data with many of its suppliers and largest customers. Management believes this integrated distribution and product offering strengthens Allegiance's financial and competitive position. In 1995, Allegiance opened a National Drop Ship Center in McGaw Park, Illinois, from which it distributes less frequently ordered items. By consolidating such products in one facility, the amount of regional inventory variability has decreased and Allegiance has achieved lower system-wide inventory levels. Serving Health Care Outside Hospitals Health care increasingly is being delivered outside hospitals as health-care providers integrate into regional networks. Many procedures previously performed in hospital operating rooms are now performed in surgery centers, and some procedures that had been performed in surgery centers are now taking place in physician clinics. To reach these and other alternate-site customers--surgery centers, physician clinics, sub-acute and long-term care facilities, and home-care providers--Allegiance has developed the capability to deliver smaller orders more frequently. Allegiance is also entering into relationships with dealers that specialize in serving these fast-growing markets. For some very small, or geographically remote customers, Allegiance provides service through its Network Sales organization. This sales and customer-service unit conducts business via the telephone, distributing in some cases by commercial carrier. 2 PRODUCT OFFERING Allegiance has differentiated itself by integrating its product offering with its distribution and cost-management services. Allegiance offers the industry's broadest range of medical and laboratory products, representing more than 2,000 suppliers in addition to its own line of surgical and respiratory therapy products. Increasingly, Allegiance is working with health professionals to reduce the variety and number of products they buy under agreements that provide incentives for Allegiance to help customers save money. In return, customers purchase a greater portion of their supplies from Allegiance. Allegiance custom-assembles products into procedure-based modules. Allegiance's distribution system delivers the customized packages as they are needed. Allegiance operates 22 manufacturing plants, producing products used in surgery and other medical procedures. All Allegiance plants are ISO 9000 certified. Allegiance has several major product lines, most of which hold leading sales positions: Custom-Sterile(TM) Products and the PBDS(TM) Service Allegiance's leading Custom-Sterile(TM) products and Procedure Based Delivery System(TM) (PBDS(TM)) service help health-care providers save time and money by assembling customer-designated supplies into single packages for specific procedures. Custom-Sterile(TM) packs contain sterile, disposable supplies made by Allegiance and other manufacturers. They are used to perform dozens of procedures, from open-heart surgery and childbirth to treating cuts and bruises. Customers can select items for these packs from a database of approximately 30,000 products from nearly 800 manufacturers. PBDS(TM) modules contain Custom-Sterile(TM) packs along with non-sterile supplies. Convertors(R) Products The Convertors(R) product line is a leading brand of single-use surgical drapes, gowns, and apparel. These products provide barrier protection for patients, doctors, and clinical staff during surgery, childbirth, and other procedures. Many of Allegiance's Convertors(R) products are included in Custom Sterile(TM) packs. Convertors(R) also provides clean-room apparel and equipment covers for industrial manufacturers. Gloves Allegiance is the world's largest manufacturer and marketer of medical gloves. Allegiance produces natural rubber latex surgical and exam gloves in Malaysia, as well as in the United States. Allegiance also manufactures vinyl exam gloves in the United States. Medi-Vac(R) Products Allegiance is the world's leading producer of fluid suction and collection systems. The Medi-Vac(R) line consists of disposable suction canisters and liners, suction tubing, and supporting hardware and accessories. These products are used in the operating room to remove fluids and debris from the body during surgery. Outside the operating room, the products are used when fluid must be removed from a patient. The Medi-Vac(R) product line also includes wound-drainage tubing and reservoirs used to remove fluid from closed wounds to prevent infection and promote healing. Medi-Vac(R) autotransfusion systems collect blood for reinfusion to the patient after filtration, allowing patients to receive their own blood instead of transfusions from donors. Respiratory Therapy Products Allegiance is a leading manufacturer of respiratory therapy products, which are used primarily to deliver oxygen to patients suffering from respiratory distress. This product line includes ventilator circuits (tubing used to connect patients to ventilator machines), oxygen masks, cannulae, and suction catheters used to clear the trachea. 3 V. Mueller Allegiance's V. Mueller product line comprises a broad range of stainless- steel surgical instruments and related products and services. The business was established in 1895 and is known worldwide for the quality of its instruments. Allegiance's V. Mueller division manufactures about a third of its product line; other products are sourced from contract manufacturers. V. Mueller products include clamps, needle-holders, retractors, specialty scissors, and forceps. The business unit also manufactures and markets the cost-saving Genesis(TM) container system--complete instrument sets, assembled to order, sterilized and ready for use in reusable metal containers. Special Procedure Products Allegiance provides specialty biopsy needles for extracting samples of bone marrow and soft tissue, and a variety of specialty procedure trays. These include lumbar puncture trays, for measuring pressure and taking samples of cerebrospinal fluid; thoracentesis trays, for withdrawing fluid from chest or abdominal cavities, or from joints or cysts; amniocentesis trays, for obtaining amniotic fluid to assess the condition of fetuses; and other diagnostic trays and products used by obstetricians and gynecologists. Other Products Allegiance manufactures and markets a range of other leading products. It is the world's largest producer of natural rubber latex urinary drainage catheters, and it manufactures endotracheal tubes for respiration, anesthesia, and other therapies. Allegiance produces a broad line of hot and cold packs used to provide localized temperature therapy for orthopedic injuries and for patients recovering from childbirth and surgical procedures. It also manufactures and markets a broad line of patient-preparation, hair-removal, and skin-care products such as clippers, razors, and basins, as well as special soaps, sponges, and scrub brushes for surgeons and other operating room personnel. COST-MANAGEMENT SERVICES Reducing costs while improving quality of care is the most significant challenge facing health-care providers today. Through its shared-risk/shared- savings programs, Allegiance aligns its goals with those of its customers. Under these agreements, which Allegiance introduced to the health-care industry in late 1994, Allegiance and its customers agree to share the savings if supply and related costs fall below an agreed upon target, or share the overage if these costs exceed the target. As of December 31, 1996, Allegiance had 26 shared-risk/shared-savings agreements with individual hospitals or hospital systems. Alternatively, these shared-risk/shared-savings agreements covered 58 250-bed equivalent facilities in 1996. In shared-risk/shared- savings accounts, Allegiance assigns a clinical project manager to work with a hospital's clinical staff to identify supply usage patterns, reduce variation by standardizing procedures and products, and eliminate unnecessary supplies. Product standardization involves the selection and use of one preferred brand from many options. Savings are realized from selecting the "best-value" product, cost efficiencies from increased volume for the selected brand and dealing with fewer vendors. Procedure standardization involves helping clinical staff reach consensus on what supplies should be used in a given procedure, then packaging and distributing the products. A typical assignment for a clinical project manager lasts 24 months. Hospitals ultimately buy fewer supplies, but a greater total portion of their supplies come from Allegiance. Sales of Allegiance's surgical products, for example, have grown in these accounts, while the hospitals' total supply costs have decreased. To the extent that savings do not materialize from these efforts, Allegiance is obligated to reimburse the customer for a portion of the shortfall. Much of the savings generated in these cost-management accounts come from the implementation of PBDS(TM) modules, which contain Allegiance's self- manufactured products, "best-value" products from preferred suppliers, and other third-party distributed products. These modules reduce hospital labor, purchasing, and other product and product-management costs. Rather than ordering products separately for a procedure, customers can order a single catalog number. Rather than nurses having to locate and assemble individual products for a procedure, the products arrive in one package. Additional savings are achieved when PBDS(TM) modules are delivered just-in-time, direct to the point of use through Allegiance's ValueLink(R) service. 4 In addition, Allegiance offers customers professional consulting services, including modules derived from Allegiance's proprietary database of "best- demonstrated practices," to help hospitals improve their clinical operations, reduce lengths of stay and improve clinical outcomes. Allegiance also offers, through its ACCESS(TM) program, the expertise and services of leaders in other industries such as waste management, asset management, real estate and facility management, and forms and information management. Each of Allegiance's manufacturing units also offers programs to help customers control costs. There are programs to help health-care providers standardize and select the most cost-effective drapes, gowns, gloves, and other products for various procedures; identify the most cost-effective mix of products to include in custom procedure kits; sterilize, repair, and refurbish surgical instruments; and process reusable laundry, linen, and textiles. The Right Choice(TM) glove-management program, for example, helps health-care providers select the most cost-effective glove for various procedures while ensuring appropriate patient care and worker safety. On January 2, 1997, Allegiance acquired West Hudson & Co. Inc., a privately- owned health-care consulting firm with 1996 annual sales of $38.1 million. Allegiance paid approximately $30.5 million in cash and $10.5 million in stock with contingent payments to be paid over the next four years. This acquisition is consistent with Allegiance's strategic direction of providing cost- management services. CONTRACTUAL ARRANGEMENTS; BUYING GROUPS A substantial portion of Allegiance's products are sold through contracts with purchasers. Some of these contracts have terms of more than one year and include limits on price increases. In the case of hospitals, clinical laboratories, and other facilities, these contracts may provide the customer with incentives to purchase particular products or categories of products. Some of these contracts are entered into with hospital buying groups seeking to achieve economies of scale in consolidating multiple hospitals' purchases from Allegiance. For the last three years, sales to customers who are members of two large hospital buying groups, Premier, Inc. ("Premier") and VHA Inc. ("VHA"), as a percentage of total sales, were 27 percent and 20 percent, respectively in 1996, 27 percent and 16 percent, respectively in 1995, and 23 percent and 13 percent, respectively in 1994. Premier and VHA each comprise a group of health-care organizations that benefit from the pricing and other benefits available to members of the group. Certain members of each group are free to purchase from the vendors of their choice. Although the loss of the relationship with either group could have a significant impact on sales to members of the group, the loss of such group would not necessarily mean the loss of all sales from all members of such group. No other buying group or single customer currently accounts for more than 10 percent of Allegiance's revenue. SALES AND MARKETING Allegiance conducts its selling efforts through its subsidiaries. These subsidiaries have their own sales forces and direct their own sales efforts. In the United States, Allegiance uses a "team selling" approach with many of its hospitals, health systems, and multi-hospital group customers. This approach relies on an account manager to coordinate the various Allegiance Businesses' sales efforts. The account manager is responsible for all sales and service contacts with a given customer, acting as a focal point, and assembling cross-functional teams as needed to meet that customer's needs. Allegiance manages its field sales and service organization on a regional basis. The regional sales organizations are designed to develop strong strategic relationships with customers. In addition, sales are made to independent distributors, dealers, and sales agents. Outside of the United States, Allegiance products are primarily distributed through Baxter. RAW MATERIALS SUPPLIERS Raw materials essential to Allegiance's business are purchased worldwide in the ordinary course of business from numerous suppliers. The vast majority of these materials are generally available, and no serious shortages 5 or delays have been encountered. Certain raw materials used in producing some of Allegiance's products, including its natural rubber latex products, are available only from a small number of suppliers. In some of these situations, Allegiance has long-term supply contracts with its suppliers, although it does not consider its obligations under such contracts to be material. Allegiance does not always recover cost increases through customer pricing due to contractual limits and market pressure on such price increases. PATENTS AND TRADEMARKS Allegiance does not consider any one or more of the patents and trademarks it holds or the licenses granted to or by it with respect to any patent or trademark to be essential to its businesses. COMPETITION Allegiance has substantial competition in all of its markets. The changing health-care environment in recent years has led to increasingly intense competition among health-care suppliers. Competition is focused on price, service, and product performance. Pressure in these areas is expected to continue. The future financial success of health-care product and service companies, such as Allegiance, will depend on their ability to work with customers to help them provide quality care while enhancing their competitiveness through cost- management initiatives. Management believes it can help its customers achieve savings by automating supply-ordering procedures; optimizing distribution networks; improving utilization, materials management and labor productivity; achieving economies through product and procedure standardization; and performing certain non-clinical services on an outsourced basis. Allegiance further believes its strategy of providing unmatched service to its health-care customers and achieving the best overall cost in the delivery of health-care products and services is compatible with any anticipated realignment of the U.S. health-care system that may ultimately occur. QUALITY CONTROL Allegiance places great emphasis on providing quality products and services to its customers. An integrated network of quality systems, including control procedures that are developed and implemented by technically trained professionals, result in rigid specifications for raw materials, packaging materials, labels, sterilization procedures, and overall process control. The quality systems integrate the efforts of raw material and finished goods suppliers to provide the highest value to customers. On a statistical sampling basis, a quality assurance organization tests components and finished goods at different stages in the manufacturing process to assure that exacting standards are met. GOVERNMENT REGULATION Most of the products manufactured or sold by Allegiance in the United States are subject to regulation by the Food and Drug Administration ("FDA"), as well as by other federal and state agencies. The FDA regulates the introduction and advertising of new drugs and devices as well as manufacturing procedures, labeling, and record-keeping with respect to drugs and devices. The FDA has the power to seize adulterated or misbranded drugs and devices, to require the manufacturer to remove them from the market, and to publicize relevant facts. From time to time, Allegiance has removed products from the market that were found not to meet acceptable standards. This may occur with respect to Allegiance in the future. Product regulatory laws also exist in most other countries where Allegiance does or will do business. Allegiance's environmental policies mandate compliance with all applicable regulatory requirements concerning environmental quality and contemplate, among other things, appropriate capital expenditures for environmental protection. Various immaterial capital expenditures for environmental protection related to the Allegiance Business were made during 1995 and 1996. See "Item 3--Legal Proceedings." 6 RELATIONSHIP WITH BAXTER Allegiance and Baxter have entered into various agreements to govern certain of the ongoing relationships between Baxter and Allegiance after the Distribution, to provide mechanisms for an orderly transfer of the Allegiance Business from Baxter to Allegiance, and to facilitate an orderly transition to the status of two separate, publicly traded companies. Allegiance has significant continuing relationships with Baxter as an agent, distributor, customer, and supplier for a wide array of health-care products and services, and for certain administrative support services. Allegiance is Baxter's primary agent in distributing Baxter's intravenous solutions, cardiovascular devices, and other products in the United States and provides Baxter with certain administrative services including credit, collection and cash application, accounts payable, information technology, and telecommunications. Baxter distributes Allegiance's products in many countries around the world and provides various administrative services to Allegiance. Baxter does not have any ownership interest in Allegiance. Reorganization Agreement Baxter and Allegiance have entered into a reorganization agreement (the "Reorganization Agreement"). Subject to certain exceptions, the Reorganization Agreement provides for certain cross-indemnities (including an indemnity of Baxter by Allegiance with respect to certain guarantees by Baxter in connection with certain Allegiance agreements and certain financial guarantees) principally designed to place financial responsibility for the liabilities of the Allegiance Business with Allegiance and financial responsibility for the obligations and liabilities of Baxter's retained businesses and its other subsidiaries with Baxter. Specifically, Allegiance has agreed to assume liability for, and to indemnify Baxter against, any and all liabilities associated with the Allegiance Business, including any litigation, proceedings or claims relating to the products and operations thereof whether or not the underlying basis for such litigation, proceedings or claims arose prior to or after the Distribution Date. Baxter has agreed to indemnify Allegiance against any and all liabilities associated with Baxter's retained businesses. Specifically, Baxter has retained liability for, and agreed to indemnify Allegiance against, proceedings or claims relating to allegations of disease transmission through blood products and silicon-gel mammary implants. Pursuant to the Reorganization Agreement, Allegiance assumed all environmental liabilities that arise from or are attributable to the operations of the Allegiance Business, including, but not limited to, off-site waste-disposal liabilities. Allegiance also has agreed to indemnify Baxter against any and all such environmental liabilities relating to the Allegiance Business. Baxter has agreed to indemnify Allegiance against any and all environmental liabilities associated with the retained Baxter businesses. In addition, the Reorganization Agreement provides that each of Baxter and Allegiance will indemnify the other in the event of certain liabilities arising under the Securities Exchange Act of 1934. The Reorganization Agreement provides, among other things, that, in order to avoid potentially adverse tax consequences relating to the Distribution, for a period of two years after the Distribution, Allegiance will not: (i) cease to engage in an active trade or business within the meaning of the Internal Revenue Code of 1986, as amended (the "Code"); (ii) issue or redeem any share of stock of Allegiance, except for certain issuances and redemptions for the benefit of Allegiance's employees or to effect acquisitions by Allegiance in the ordinary course of business or in connection with the issuance of any convertible debt by Allegiance or in accordance with the requirements for permitted purchases of Allegiance stock as set forth in Section 4.05(l)(b) of Revenue Procedure 96-30 issued by the Internal Revenue Service (the "IRS"); or (iii) liquidate or merge with any other corporation, unless, with respect to (i), (ii) or (iii) above, either (a) an opinion is obtained from counsel to Baxter, or (b) a ruling is obtained from the IRS, in either case to the effect that such act or event will not adversely affect the federal income tax consequences of the Distribution to Baxter, its stockholders who received Allegiance common stock or Allegiance. Allegiance expects that these limitations will not significantly constrain its activities or its ability to respond to unanticipated developments. The Reorganization Agreement provides that if, as a result of certain transactions occurring after the Distribution Date involving either the stock or assets of either Allegiance or any of its subsidiaries, or any 7 combination thereof, the Distribution fails to qualify as tax-free under the provisions of Section 355 of the Code, then Allegiance shall indemnify Baxter for all taxes, liabilities, and associated expenses, including penalties and interest, incurred as a result of such failure of the Distribution to qualify under Section 355 of the Code. The Reorganization Agreement further provides that if the Distribution fails to qualify as tax-free under the provisions of Section 355 of the Code, other than as a result of a transaction occurring after the Distribution Date involving either the stock or assets of Allegiance or any of its subsidiaries, or any combination thereof, then Allegiance shall not be liable for such taxes, liabilities, or expenses. The Reorganization Agreement also provides for the allocation of benefits between Baxter and Allegiance under existing insurance policies after the Distribution Date for claims made or occurrences prior to the Distribution Date and sets forth procedures for the administration of insured claims. In addition, the Reorganization Agreement provides that Baxter will use its reasonable efforts to maintain directors' and officers' insurance at substantially the level of Baxter's current directors' and officers' insurance policy for a period of six years with respect to the former directors and officers of Baxter who are directors and officers of Allegiance for acts relating to periods prior to the Distribution Date. In addition, the Reorganization Agreement addresses the treatment of employee benefit matters and other compensation arrangements for certain former and current Allegiance employees and their beneficiaries and dependents, as well as certain former employees of certain former Allegiance businesses and their beneficiaries and dependents (collectively, the "Allegiance Participants"). The Reorganization Agreement provides that the account balances (including outstanding loans) of all Allegiance Participants in the Baxter International Inc. and Subsidiaries Incentive Investment Plan (the "IIP"), and the plan assets related to such liabilities be transferred to Allegiance's new retirement savings plan. The Reorganization Agreement also generally provides that Allegiance assumes all liabilities for benefits under any welfare plans related to Allegiance Participants, other than certain claims incurred on or before the Distribution Date. Moreover, the Reorganization Agreement provides that, effective as of the Distribution Date, Allegiance is responsible for all other liabilities to Allegiance Participants (including unfunded supplemental retirement benefits), other than certain accruals under the Baxter Defined Benefit Excess Plan. Tax Sharing Agreement Baxter and Allegiance have entered into a tax sharing agreement (the "Tax Sharing Agreement") which allocates tax liabilities and responsibility for tax audits for periods prior to, and subsequent to the Distribution Date. The Tax Sharing Agreement also allocates consolidated alternative minimum tax and other tax credit carry-forwards as of the Distribution Date between Baxter and Allegiance. Agency, Services and Distribution Agreements Baxter's principal domestic operating subsidiary, Baxter Healthcare Corporation ("BHC"), and an Allegiance subsidiary have entered into an Agency, Services and Distribution Agreement (the "Domestic Distribution Agreements") for each of Baxter's four primary domestic business units, I.V. Systems, Renal, Cardiovascular, and Biotechnology, pursuant to which Baxter supplies products to Allegiance, and Allegiance, as agent or distributor for Baxter, provides physical distribution and various sales and sales support services to Baxter. The Domestic Distribution Agreements cover substantially all of the existing products of each of the foregoing business units. In most instances, Allegiance acts as Baxter's agent for the physical distribution of Baxter's products in return for a fee. In such situations, Baxter maintains the contractual relationship with the customer, manages sales, order-taking, and billing and collections, and retains title to the products until shipment to the ultimate customer. In certain situations, Allegiance acts as a full-service, value-added distributor for Baxter products with a direct contractual relationship with the ultimate customer. In these situations, Allegiance provides additional sales, sales support, and other customer and product-related services to the customer and purchases the products from Baxter at specified prices. In addition, Baxter pays to Allegiance the fee described above. Such additional 8 services may include aggregating Baxter's products with others to be sold as "kits" for a given medical procedure or other cost-management services which assist the customer in reducing product consumption, improving utilization of assets, improving logistics, and reducing or eliminating operating costs. The initial term of the Domestic Distribution Agreements range from three years (Renal and Biotechnology) to five years (I.V. Systems and Cardiovascular). The agreements may be renewed upon expiration upon the mutual agreement of the parties. In the event of a Change In Control of one of the parties to the Domestic Distribution Agreements or certain of their affiliates, the other party to such agreement has the right, subject to certain notice periods and other restrictions, to terminate all, or in certain cases only the affected portion, of such agreement prior to its normal expiration. In the case of a Change In Control involving a competitor of the non-affected party, the notice period required for termination may be shorter than if such a competitor was not involved. For purposes of these agreements, a "Change In Control" includes the acquisition of more than 30 percent of the stock of either party or one of its affiliates, certain mergers or consolidations involving either party or one of its affiliates, the acquisition by either party of certain significant subsidiaries, and, in the case of an affiliate of either of the parties, the disposition of substantially all of its business and assets. Under the Domestic Distribution Agreements, Baxter is required within the Territory to distribute all covered I.V. Systems and Cardiovascular products (including any line extensions of such products) through Allegiance, subject to certain exceptions. In addition, Allegiance may not market, promote or solicit orders for any product that competes with any covered I.V. Systems or Cardiovascular product. Allegiance may however take orders for stock and sell competing products in response to customer requests. For purposes of the Domestic Distribution Agreements, the "Territory" is defined as the 50 states comprising the United States and the District of Columbia. Allegiance's right to distribute the covered products is limited to the Territory. The compensation received by Allegiance under the Domestic Distribution Agreements generally approximates or is based upon the internal business unit revenue and expense allocations that were in effect between the Baxter business units and the Allegiance Business prior to the date of the Distribution. Similarly, the service levels and performance standards remain as they were prior to the date of the Distribution. In addition to the Domestic Distribution Agreements, Baxter and Allegiance have entered into agreements pursuant to which Baxter has agreed to distribute Allegiance's surgical and other products outside of the United States and to distribute certain surgical products to the long-term, sub-acute, and home- care markets within the United States. Services Agreements Baxter and Allegiance have entered into several services agreements, to be effective from and after the Distribution Date, pursuant to which Baxter provides to Allegiance, and Allegiance provides to Baxter, certain administrative services necessary for the conduct of Baxter's and Allegiance's businesses. Services provided to Baxter by Allegiance include credit, collection and cash application, accounts payable, telecommunications, and information technology services. Services provided to Allegiance by Baxter include payroll, sales and use tax, human resources (including international expatriate services), research and development, travel, property management, and other services. These agreements have varying terms and, subject to certain exceptions, are generally terminable by either party upon 12 months or less notice. Under certain circumstances involving a Change In Control the agreements may be terminated earlier than normal. The agreements may be renewed upon expiration or by mutual agreement of the parties. The prices at which such services are provided generally are equal to or based on the actual cost of rendering such services. In addition, Baxter leases from Allegiance, for a term of ten years, a 217,000 square foot office building at Allegiance's McGaw Park, Illinois headquarters site. The leased building will continue to be occupied by Baxter's Renal Division. Allegiance subleases from Baxter all or a substantial part of an 85,000 square foot office building located in Deerfield, Illinois. This building is part of a three building complex leased by Baxter, and Allegiance's sublease is for the remainder of the current term of Baxter's lease. Baxter and Allegiance may also 9 lease or sublease to each other miscellaneous office or other space for use in connection with various services performed for one another pursuant to the agreements described above. EMPLOYEES As of December 31, 1996, Allegiance employed approximately 20,700 people. EXECUTIVE OFFICERS OF THE REGISTRANT Following are the names and ages, as of March 1, 1997, of the executive officers of the Company, and one or both of its two principal direct subsidiaries, Allegiance Healthcare Corporation and Allegiance Healthcare International Inc., their positions and summaries of their backgrounds and business experience. LESTER B. KNIGHT, age 38, has been chairman of the board and chief executive officer of Allegiance since June 1996. From 1992 to September 1996, he was an executive vice president of Baxter. He was elected a corporate vice president of Baxter in 1990. Mr. Knight joined Baxter in 1981. JOSEPH F. DAMICO, age 43, has been president and chief operating officer of Allegiance since June 1996. From 1992 to September 1996, he was a corporate vice president of Baxter. From 1979 to 1992, he held various positions at Baxter, including vice president and general manager of the Custom Sterile unit and president of the Convertors/Custom Sterile business. WILLIAM L. FEATHER, age 50, has been senior vice president, general counsel and secretary of Allegiance since June 1996. From January 1996 to September 1996, he was associate general counsel for Baxter Healthcare Corporation's United States Healthcare business. Between 1986 and 1996, he held various positions at Baxter, including corporate counsel, senior counsel, and assistant general counsel. PETER B. MCKEE, age 58, has been senior vice president and chief financial officer of Allegiance since June 1996. From 1993 until he joined Baxter Healthcare Corporation in May 1996, Mr. McKee was a senior vice president and chief financial officer at FoxMeyer Health Corporation, a pharmaceutical distributor, subsidiaries of which filed a petition under Chapter 11 of the United States Bankruptcy Code in August 1996. Prior to that, he was a partner and principal owner of InterSolve Group Corporation, a managerial consulting firm. KATHY BRITTAIN WHITE, age 47, has been senior vice president and chief information officer of Allegiance since June 1996. She joined Baxter as its chief information officer in 1995. From 1993 to 1995, she was vice president, information systems and services for AlliedSignal Corporation. Prior to that, she was vice president, corporate services, for Guilford Mills, Inc. RICHARD C. ADLOFF, age 39, has been corporate vice president and controller of Allegiance since June 1996. From 1994 to September 1996, he was vice president of finance for Baxter Healthcare Corporation's United States Healthcare business. From 1980 to 1994, he held various positions in accounting and finance at Baxter and American Hospital Supply Corporation. ROBERT B. DEBAUN, age 46, has been corporate vice president human resources of Allegiance since June 1996. From 1991 to September 1996, he was vice president of human resources for Baxter Healthcare Corporation's United States Distribution business. From 1981 to 1991, he held various positions, including manager of college relations for American Hospital Supply Corporation; and as director of corporate recruitment, director of corporate staffing and relocation, and vice president, human resources, for Baxter's I.V. Systems business. MARK J. EHLERT, age 43, has been corporate vice president quality and regulatory affairs of Allegiance since June 1996. From 1994 to September 1996, he was vice president, quality and regulatory affairs for the United States Sales and Distribution business of Baxter Healthcare Corporation. From 1975 to 1994, he held various positions at Baxter, including quality-control manager, director of quality management, director of manufacturing for northern Illinois I.V. Systems operations and general manager of the Singapore manufacturing operations. 10 GAIL GAUMER, age 44, has been corporate vice president cost-management services and strategy of a subsidiary of Allegiance since June 1996. From 1995 to September 1996, she was president of marketing, strategy and business development for Baxter Healthcare Corporation's United States Healthcare business. From 1980 to 1995, she held various positions at Baxter, including president of Renal-Europe, vice president of global marketing, planning and new business development, and vice president and general manager for various Renal businesses. Ms. Gaumer serves as a director of FemRx, Inc. LEONARD G. KUHR, age 38, has been corporate vice president and treasurer of Allegiance since June 1996. From 1995 to September 1996, he was vice president, capital markets at Baxter. From 1979 to 1995, he held various positions at Baxter and American Hospital Supply Corporation, including vice president and controller of the Specialty Business group, vice president finance for the Surgical Business, and various tax management positions for the corporate tax function. ROGER L. SISTERMAN, age 53, has been corporate vice president manufacturing of Allegiance's operating subsidiaries since June 1996. From 1994 to September 1996, he was vice president of manufacturing and operations for Baxter Healthcare Corporation. From 1977 to 1994, he held various positions at Baxter, including director of materials management for Baxter's Pharmaseal division, vice president of manufacturing for Baxter Custom Sterile and vice president for Convertors/Custom Sterile. ITEM 2. PROPERTIES Allegiance owns or has long-term leases on substantially all of its major manufacturing facilities. Allegiance maintains 22 manufacturing facilities in the United States, France, Malaysia, Malta, and Mexico. Allegiance owns or leases 60 distribution centers in the United States. Allegiance maintains a continuing program for improving its properties, including the retirement or improvement of older facilities and the construction of new facilities. This program includes improvement of manufacturing facilities to enable production and quality control programs to conform with the current state of technology and government regulations. ITEM 3. LEGAL PROCEEDINGS Upon the Distribution, Allegiance assumed the defense of litigation involving claims related to the Allegiance Business, including certain claims of alleged personal injuries as a result of exposure to natural rubber latex gloves described below. Allegiance will be defending and indemnifying Baxter Healthcare Corporation ("BHC"), as contemplated by the agreements between Baxter and Allegiance, for all expenses and potential liabilities associated with claims pertaining to this litigation. It is expected that Allegiance will be named as a defendant in future litigation and may be added as a defendant in existing litigation. BHC was one of ten defendants named in a purported class action filed in August 1993, Kennedy, et al., v. Baxter Healthcare Corporation, et al., (Sup. Ct., Sacramento Co., Cal., #535632), on behalf of all medical and dental personnel in the State of California who allegedly suffered allergic reactions to natural rubber latex gloves and other protective equipment or who allegedly have been exposed to natural rubber latex products. The case alleged that users of various natural rubber latex products, including medical gloves made and sold by BHC and other manufacturers, suffered allergic reactions to the products ranging from skin irritation to systemic anaphylaxis. The Court granted defendants' demurer to the class action allegations. On February 29, 1996, the California Appellate Court upheld the trial court's ruling and the case was dismissed. In April 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 this 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 11 District of Indiana, IP96-1889C). Baxter and three other companies are defendants. On October 9, 1996, the plaintiff in a case pending in federal court filed a petition with the Judicial Panel on Multi District Litigation, In re Latex Gloves Products Liability Litigation, (MDL Docket No. 1148), seeking to transfer and consolidate the cases pending in federal court for pretrial proceedings and/or trial. On February 26, 1997, the Panel granted the petition and ordered all cases pending in federal court to be transferred to the Eastern District of Pennsylvania for coordinated or consolidated pretrial proceedings. As of March 1, 1997, 80 additional lawsuits had been served on BHC and/or the Company containing similar allegations of sensitization to natural rubber latex products. Allegiance intends to vigorously defend against these actions. Since none of these cases has proceeded to a hearing on the merits, Allegiance is unable to evaluate the extent of any potential liability, and unable to estimate any potential loss. Because of the increase in claims filed and the ongoing defense costs that will be incurred, the Company believes it is probable that Allegiance will incur significant expenses related to the defense of cases involving natural rubber latex gloves. During the fourth quarter of 1996, the Company was able to determine the minimum amount of the potential range of defense costs expected to be incurred related to existing cases. Consequently, the Company recorded a charge of $19.5 million in the fourth quarter of 1996 to provide the minimum amount of the potential range of legal defense costs. 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. It is not expected that the outcome of these matters will have a material adverse effect on Allegiance's overall business, cash flow, results of operations or financial condition. Under the U.S. Superfund statute and many state laws, generators of hazardous waste sent to a disposal or recycling site are liable for cleanup of the site if contaminants from that property later leak into the environment. The law provides that potentially responsible parties may be held jointly and severally liable for the cost of investigating and remediating a site. This liability applies to the generator even if the waste was handled by a contractor in full compliance with the law. As of December 31, 1996, BHC had been identified as a potentially responsible party for cleanup costs at ten hazardous waste sites, for which Allegiance has assumed responsibility. Allegiance's largest assumed exposure is at the Thermo-Chem site in Muskegon, Michigan. Allegiance expects the total cleanup costs for this site to be between $44.0 million and $65.0 million, of which Allegiance's share would be approximately $5.4 million. This amount, net of payments of approximately $1.4 million, has been accrued and is reflected in Allegiance's consolidated financial statements. The estimated exposure for the remaining nine sites is approximately $3.9 million, which has been accrued and reflected in Allegiance's consolidated financial statements. The Company is a defendant in, or has assumed the defense of, a number of other claims, investigations and lawsuits. Upon resolution of any of these uncertainties, the Company may incur charges in excess of presently established reserves. Based on the advice of counsel, management does not believe the outcome of these matters or the environmental matters, individually or in the aggregate, will have a material adverse effect on Allegiance's overall business, cash flow, results of operations or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this Item is set forth in registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1996 under the caption "Notes to Consolidated Financial Statements," which information is hereby incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The information required by this Item is set forth in registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1996 under the caption "Five-Year Summary of Selected Financial Data," which information is hereby incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this Item is set forth in registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1996 under the caption "Management's Discussion and Analysis," which information is hereby incorporated herein by reference. ---------------- INFORMATION REGARDING FORWARD-LOOKING STATEMENTS Certain statements in the foregoing "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Report constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Statements indicating the Company "plans," "expects," "estimates" or "believes" are forward-looking statements that involve known and unknown risks, including, but not limited to, general economic and business conditions, changing trends in the health-care industry and customer profiles, competition, changes in governmental regulations, and unfavorable foreign currency fluctuations. Although Allegiance believes that its expectations with respect to the forward-looking statements are based upon reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of Allegiance will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. The Company undertakes no obligation to update publicly any forward-looking statement whether as a result of new information, future events or otherwise. In addition to the risks and uncertainties of ordinary business operations, the forward-looking statements of the Company contained in this Annual Report on Form 10-K are also subject to the following risks and uncertainties: United States Health-Care Environment The United States health-care system continues to undergo fundamental change. Competition for patients among health-care providers continues to intensify. Increasingly, providers are looking for ways to better manage costs in areas such as materials handling, supply utilization, product standardization for specific procedures, and capital expenditures. Accelerating cost pressures on hospitals in the United States and overseas are resulting in increased out-patient and alternate-site health-care service delivery and a focus on cost-effectiveness and quality. At the same time, the elderly segment of the population in the United States and abroad is growing. These forces increasingly shape the demand for, and supply of, medical care. Many private health-care payors provide incentives for consumers to seek lower-cost care outside the hospital. Many corporations' employee health plans provide financial incentives for patients to use the most cost-effective forms of treatment (managed care programs, such 13 as health maintenance organizations, have become more common), and physicians are being encouraged to provide more cost-effective treatments. In the past, Allegiance's distribution network has been focused on traditional distribution to hospitals. The future financial success of health-care product and service companies, such as Allegiance, will depend on their ability to assist health-care providers to help them enhance their competitiveness and to provide products to alternate sites as treatment moves outside the hospital. Management believes it can help its customers achieve savings by automating supply- ordering procedures; optimizing distribution networks; improving utilization; materials management and labor productivity; achieving economies through product and procedure standardization; and performing certain nonclinical services on an outsourced basis. Management further believes its strategy of providing unmatched service to its health-care customers and achieving the best overall cost in its delivery of health-care products and services is compatible with any anticipated realignment of the United States health-care system that may ultimately occur. If customers do not respond favorably to the Allegiance strategy, these changes could have a material adverse effect on Allegiance's business, results of operations, and financial condition. United States Competition The changing health-care environment in recent years has led to increasingly intense competition among health-care suppliers. Competition is focused on price, service, and product performance. Pressure in these areas is expected to continue. There has been substantial consolidation in Allegiance's customer base and among its competitors. In recent years, Allegiance's overall price increases have been lower than increases in the Consumer Price Index. Industry trends and competition may inhibit Allegiance's ability to increase prices, and may continue to depress Allegiance's margins in the future. In part through its previously announced and ongoing restructuring program, Allegiance plans to continue to increase its efforts to minimize costs and better meet accelerating price competition. Allegiance believes that its cost position will continue to benefit from improvements in manufacturing technology and increased economies of scale. Allegiance continues to improve the quality of its products and services. If Allegiance is unsuccessful in maintaining its service and quality levels while decreasing costs, the competitive environment may have a material adverse effect on Allegiance's business, results of operations, and financial condition. Revenues from Customers Purchasing through Buying Groups For the last three years, sales to customers who are members of two large hospital buying groups, Premier and VHA as a percentage of total sales, were 27 percent and 20 percent, respectively in 1996, 27 percent and 16 percent, respectively in 1995, and 23 percent and 13 percent, respectively in 1994. Premier and VHA each comprise a group of health-care organizations that benefit from the pricing and other benefits available to members of the group. Certain members of each group are free to purchase from the vendors of their choice. Although the loss of the relationship with either group could have a significant impact on sales to members of the group, the loss of such group would not necessarily mean the loss of all sales from all members of such group. No other buying group or single customer currently accounts for more than 10 percent of Allegiance's revenue. Financial Leverage As of December 31, 1996, Allegiance had outstanding long-term indebtedness in the amount of approximately $1.1 billion. Such indebtedness may limit Allegiance's future financial flexibility. Mutual Distribution Arrangements Allegiance and Baxter are parties to various agency and distribution arrangements pursuant to which Allegiance distributes certain Baxter products in the United States and Baxter distributes certain Allegiance products in the United States and internationally. The initial terms of these agreements range from three to five 14 years. Although the present intention of Allegiance and Baxter is that these distribution arrangements continue as long as the relationship between the parties is mutually beneficial, no assurance can be given that these arrangements will be extended beyond their original expiration dates or will not be terminated prior to their original terms. Dependence on Administrative Services Allegiance and Baxter rely on each other for the provision of certain administrative services. Such services are provided, pursuant to contractual arrangements that can be terminated by either party upon no more than 12 months notice, at rates intended to approximate the cost of providing such services. No assurance can be given that such arrangements will continue in the future, that the cost of arranging substitute service either internally or from a third party would not increase the cost to the service recipient, or that a service provider will not be forced to absorb a greater share of its fixed overhead costs in the event of a termination of these arrangements. Limited Operating History as an Independent Company Allegiance has only been operating as an independent public company since September 30, 1996. While Allegiance has been profitable as part of Baxter, there is no assurance that as a stand-alone company profits will continue at the same level. Product Liability Upon the Distribution, Allegiance assumed the defense of litigation involving claims related to the Allegiance Business, including certain claims of alleged personal injuries as a result of exposure to natural rubber latex gloves. Allegiance will be defending and indemnifying BHC as contemplated by the Reorganization Agreement 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. Allegiance believes that 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. It is not expected that the outcome of these matters will have a material adverse effect on Allegiance's overall business, cash flow, results of operations or financial condition. Environmental Contingencies Under the U.S. Superfund statute and many state laws, generators of hazardous waste sent to a disposal or recycling site are liable for cleanup of the site if contaminants from that property later leak into the environment. The law provides that potentially responsible parties may be held jointly and severally liable for the cost of investigating and remediating a site. This liability applies to the generator even if the waste was handled by a contractor in full compliance with the law. As of December 31, 1996, BHC had been identified as a potentially responsible party for cleanup costs at ten hazardous waste sites, for which Allegiance has assumed responsibility. Allegiance's largest assumed exposure is at the Thermo-Chem site in Muskegon, Michigan. Allegiance expects the total cleanup costs for this site to be between $44.0 million and $65.0 million, of which Allegiance's share would be approximately $5.4 million. This amount, net of payments of approximately $1.4 million, has been accrued and is reflected in Allegiance's consolidated financial statements. The estimated exposure for the remaining nine sites is approximately $3.9 million, which has been accrued and reflected in Allegiance's consolidated financial statements. 15 Government Regulation Significant aspects of Allegiance's businesses are subject to state and federal statutes and regulations governing, among other things, reimbursement under federal and state medical assistance programs, medical waste-disposal, dispensing of controlled substances, and workplace health and safety. In addition, most of the products manufactured or sold by Allegiance in the United States are subject to regulation by the FDA, as well as by other federal and state agencies. The FDA has the power to seize adulterated or misbranded drugs and devices, to require the manufacturer to remove them from the market, and to publicize relevant facts. From time to time, Allegiance has removed products from the market that were found not to meet acceptable standards. This may occur with respect to Allegiance in the future. Product regulatory laws exist in most other countries where Allegiance does or will do business. There can be no assurance that federal, state or foreign governments will not impose additional restrictions or adopt interpretations of existing laws that could materially adversely affect Allegiance's business, results of operations or financial condition. International Expansion Allegiance currently has international sales of self-manufactured surgical products primarily in Canada, France, and Germany. Allegiance management expects to increase its sales efforts internationally, which could expose it to greater risks associated with government regulations and fluctuations in foreign currency. There can be no assurance that Allegiance will be successful in expanding its sales efforts internationally or employ a risk management strategy that will completely eliminate its exposure to adverse movements in foreign currency rates. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item is set forth in registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1996 under the captions "Report of Independent Accountants," "Consolidated Balance Sheets," "Consolidated Statements of Operations," "Consolidated Statements of Cash Flows," "Consolidated Statements of Equity," and "Notes to Consolidated Financial Statements," which information is hereby incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Directors of the Company The information required by this Item is set forth in registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 15, 1997, under the caption "Election of Directors," which information is hereby incorporated herein by reference. (b) Executive officers of the Company Reference is made to "Executive Officers of the Registrant" in Part I. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is set forth in registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 15, 1997, under the captions "Compensation of Directors and Executive Officers" and "Report of the Compensation and Nominating Committee of the Board of Directors," which information is hereby incorporated herein by reference. 16 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is set forth in registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 15, 1997, under the caption "Ownership of the Capital Stock of the Company," which information is hereby incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1)Financial Statements The following financial statements of Allegiance Corporation, are included in Part II, Item 8: (i) Report of Independent Accountants from Price Waterhouse LLP; (ii) Consolidated Balance Sheets--as of December 31, 1996 and 1995; (iii) Consolidated Statements of Operations--years ended December 31, 1996, 1995 and 1994; (iv) Consolidated Statements of Cash Flows--years ended December 31, 1996, 1995 and 1994; (v) Consolidated Statements of Equity--years ended December 31, 1996, 1995 and 1994; and (vi) Notes to Consolidated Financial Statements. (2)Financial Statement Schedules (i) Report of Independent Accountants from Price Waterhouse LLP; and (ii) Schedule II--Valuation and Qualifying Accounts. (3)Exhibits Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index hereto, which information is hereby incorporated by reference. (b) Reports on Form 8-K A report on Form 8-K, dated November 1, 1996 was filed with the Securities and Exchange Commission under Item 5, Other Events, to file information disclosing the Company's change in its accounting policy for assessing goodwill impairment. (c) Exhibits The exhibits filed as part of this Annual Report on Form 10-K are as specified in Item 14(a)(3) herein. (d) Financial Statement Schedules The financial statement schedule filed as part of this Annual Report on Form 10-K is as specified in Item 14(a)(2) herein. 17 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED ON MARCH 27, 1997. Allegiance Corporation /s/ Lester B. Knight By: _________________________________ Lester B. Knight, Chairman of the Board and Chief Executive Officer PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT ON MARCH 27, 1997 IN THE CAPACITIES INDICATED:
SIGNATURE TITLE --------- ----- /s/ Lester B. Knight Chairman of the Board and Chief Executive ___________________________________________ Officer (Principal Executive Officer) Lester B. Knight /s/ Joseph F. Damico President, Chief Operating Officer and ___________________________________________ Director Joseph F. Damico /s/ Peter B. McKee Senior Vice President and Chief Financial ___________________________________________ Officer (Principal Financial Officer) Peter B. McKee /s/ Richard C. Adloff Corporate Vice President and Controller ___________________________________________ (Principal Accounting Officer) Richard C. Adloff /s/ Silas S. Cathcart Director ___________________________________________ Silas S. Cathcart /s/ David W. Grainger Director ___________________________________________ David W. Grainger /s/ Arthur F. Golden Director ___________________________________________ Arthur F. Golden /s/ Michael D. O'Halleran Director ___________________________________________ Michael D. O'Halleran /s/ Kenneth D. Bloem Director ___________________________________________ Kenneth D. Bloem /s/ Connie R. Curran Director ___________________________________________ Connie R. Curran
18 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors of Allegiance Corporation Our audits of the consolidated financial statements referred to in our report dated February 3, 1997 appearing in the 1996 Annual Report to Stockholders of Allegiance Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Price Waterhouse LLP Chicago, Illinois February 3, 1997 S-1 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (IN MILLIONS OF DOLLARS)
ADDITIONS --------- ----------------- ---------- ------- BALANCE CHARGED CHARGED BALANCE AT TO COSTS TO OTHER DEDUCTIONS AT END BEGINNING AND ACCOUNTS FROM OF DESCRIPTION OF PERIOD EXPENSES (A) RESERVES PERIOD - - ----------- --------- -------- -------- ---------- ------- Year ended December 31, 1996 Accounts receivable............. $18.2 $10.3 $-- $(2.1) $26.4 Year ended December 31, 1995 Accounts receivable............. $17.4 $ 2.6 $-- $(1.8) $18.2 Year ended December 31, 1994 Accounts receivable............. $12.7 $ 7.2 $1.2 $(3.7) $17.4
- - -------- (A) Valuation accounts of acquired or divested companies and foreign currency translation adjustments. Reserves are deducted from assets to which they apply. S-2 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 2.1 Reorganization Agreement between Baxter International Inc. and Allegiance Corporation(1) 3.1 Certificate of Incorporation of Allegiance Corporation, including Certificate of Designation relating to Series A Junior Participating Preferred Stock of Allegiance Corporation(2) 3.2 Bylaws of Allegiance Corporation(1) 4.1 Indenture dated as of October 1, 1996 between Allegiance Corporation and PNC Bank, Kentucky, Inc.(2) 4.2 Board Resolutions creating the 7.30% Notes due October 15, 2006, the 7.80% Debentures due October 15, 2016 and the 7.00% Debentures due October 15, 2026(2) 10.1* Allegiance Corporation 1996 Outside Director Incentive Compensation Plan(1) 10.2* Allegiance Corporation 1996 Incentive Compensation Plan(1) 10.3* Allegiance Corporation Change in Control Plan(1) 10.4* Retention Agreement for Ms. Gaumer(1) 10.5 Intentionally left blank. 10.6 Agency Services and Distribution Agreement dated as of September 30, 1996 between Allegiance Corporation and Baxter International Inc.(3) 10.7 $1.2 Billion Credit Agreement dated as of September 23, 1996 among Allegiance Corporation and the financial institutions named therein(1), as amended by the First Amendment to the Credit Agreement dated January 30, 1997 among Allegiance Corporation and the financial institutions named therein which is filed herewith 10.8 Amendment dated October 16, 1996 to the $1.2 Billion Credit Agreement dated as of September 23, 1996 among Allegiance Corporation and the financial institutions named therein which is filed herewith 10.9 Rights Agreement, by and between Allegiance Corporation and the rights agent named therein(1) 11.1 Statement regarding Computation of Primary Earnings per Common Share 11.2 Statement regarding Computation of Fully Diluted Earnings per Common Share 12.1 Statement regarding Computation of Pro Forma Ratio of Earnings to Fixed Charges 13.1 Excerpts from 1996 Annual Report to Stockholders incorporated herein by reference 21.1 Subsidiaries of Allegiance Corporation(1) 23.1 Consent of Price Waterhouse LLP 27.1 Financial Data Schedule
- - -------- (1) Incorporated herein by reference to the exhibit of equivalent number to the Company's Registration Statement on Form S-1, as amended, Registration No. 333-12525. (2) Incorporated herein by reference to the Exhibit of equivalent number to the Company's quarterly report on Form 10-Q for the quarterly period ended September 30, 1996. (3) Incorporated herein by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarterly period ended September 30, 1996. * Denotes each management contract or compensatory plan or arrangement required to be filed as an exhibit to this report. EX-10.7 2 FIRST AMENDMENT TO CREDIT AGREEMENT January 30, 1997 Exhibit 10.7 Allegiance Corporation 1430 Waukegan Road McGaw Park, Illinois 60085 Re: First Amendment to Credit Agreement ----------------------------------- Ladies/Gentlemen: Please refer to the Facility A Credit Agreement (the "Credit Agreement") dated as of September 23, 1996 among Allegiance Corporation (the "Company"), various Banks, The First National Bank of Chicago, as Syndication Agent, NationsBank of Texas, N.A., as Documentation Agent, Morgan Guaranty Trust Company of New York, as Syndication Agent, and Bank of America National Trust and Savings Association, as Administrative Agent. Capitalized terms used herein and not otherwise defined herein shall have the meanings assigned thereto in the Credit Agreement. The Company, the Agents and the Banks agree that the definition of "Extraordinary Items" in Section 7.01(i) of the Credit Agreement is amended by deleting the amounts "$50,000,000" therein and substituting the amount "$100,000,000" therefor. Except as amended above, all terms and provisions of the Credit Agreement shall remain in full force and effect and are hereby ratified and confirmed in all respects. This letter amendment shall become effective when the Administrative Agent has received counterparts hereof signed by the Company and the Majority Banks. This letter amendment shall be deemed to be a contract made under the laws of the State of Illinois, and for all purposes shall be construed in accordance with the laws of the State of Illinois, without regard to the principles of conflicts of laws. Please evidence your agreement to the foregoing by signing and returning a counterpart of this letter amendment. BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, as Administrative Agent By:_________________________________ Title: BANK OF AMERICA ILLINOIS, individually and as Swing-Line Bank By:_________________________________ Title: THE FIRST NATIONAL BANK OF CHICAGO, individually and as Syndication Agent and Co-Arranger By:_________________________________ Title: MORGAN GUARANTY TRUST COMPANY OF NEW YORK, individually and as Co-Syndication Agent and Co-Arranger By:_________________________________ Title: NATIONSBANK OF TEXAS, N.A., individually and as Documentation Agent and Co-Arranger By:_________________________________ Title: THE CHASE MANHATTAN BANK, individually and as Co-Agent By:_________________________________ Title: -2- CREDIT LYONNAIS CHICAGO BRANCH, individually and as Co-Agent By: ------------------------------------- Title: CREDIT SUISSE, individually and as Co-Agent By: ------------------------------------- Title: By: ------------------------------------- Title: DEUTSCHE BANK AG CHICAGO AND/OR CAYMAN ISLANDS BRANCHES, individually and as Co-Agent By: ------------------------------------- Title: By: ------------------------------------- Title: THE SUMITOMO BANK, LIMITED, CHICAGO BRANCH individually and as Co-Agent By: ------------------------------------- Title: TORONTO DOMINION (TEXAS), INC., individually and as Co-Agent By: ------------------------------------- Title: -3- THE BANK OF TOKYO-MITSUBISHI, LTD. CHICAGO BRANCH By:_______________________________ Title: CITIBANK, N.A. By:_______________________________ Title: CAISSE NATIONALE DE CREDIT AGRICOLE By:_______________________________ Title: THE FUJI BANK, LIMITED By:_______________________________ Title: THE INDUSTRIAL BANK OF JAPAN, LIMITED CHICAGO BRANCH By:_______________________________ Title: MELLON BANK, N.A. By:_______________________________ Title: THE NORTHERN TRUST COMPANY By:_______________________________ Title: -4- PNC BANK, NATIONAL ASSOCIATION By:_______________________________ Title: UNION BANK OF SWITZERLAND, NEW YORK BRANCH By:_______________________________ Title: By:_______________________________ Title: WACHOVIA BANK OF GEORGIA, N.A. By:_______________________________ Title: WELLS FARGO BANK, N.A. By:_______________________________ Title: Accepted and Agreed By:_______________________________ as of January 30, 1997: Title: ALLEGIANCE CORPORATION By:_______________________________ Title: -5- EX-10.8 3 AMENDMENT DATED 10/16/96 TO CREDIT AGREEMENT EXHIBIT 10.8 [ALLEGIANCE CORPORATION LETTERHEAD] October 16, 1996 Bank of America National Trust and Savings Association, as Administrative Agent for the Banks parties to the Credit Agreement referred to below 1455 Market Street, 12th Floor San Francisco, California 94103 Attention: Agency Administrative Services Unit #5596 Reference: The $1.2 billion Credit Agreement (Facility A) (the "Credit Agreement") dated as of September 23, 1996 among Allegiance Corporation, as Borrower, and Bank of America National Trust and Savings Association, as Administrative Agent and other financial institutions that are parties to this Credit Agreement Ladies and Gentlemen: The undersigned, Allegiance Corporation, refers to the above mentioned "Credit Agreement", (the terms defined therein being used herein as therein defined), and hereby gives you notice pursuant to Section 4.05 of the Agreement that the undersigned requests a reduction of the Commitments in the aggregate amount of $300 million effective October 23, 1996. After giving effect to such reduction, the aggregate commitments will be $900 million. If you have any questions concerning this matter, please call me at 847-578- 4420. Very truly yours, ALLEGIANCE CORPORATION By: /s/ Leonard G. Kuhr ------------------------------------- Corporate Vice President & Treasurer cc: William Sweeney, BankAmerica 45094\021\10EX10-8.001 EX-11.1 4 STATEMENT COMPUTATION PRIMARY EARNINGS EXHIBIT 11.1 COMPUTATION OF PRIMARY EARNINGS PER COMMON SHARE (IN MILLIONS, EXCEPT PER SHARE DATA)
DECEMBER 31, 1996 ------------ HISTORICAL COMPUTATION (1) Net loss available for common stock (2)............................ $(477.7) Average common shares outstanding (3).............................. 54.9 Primary net loss per common share (2).............................. $ (8.70) =======
- - -------- (1) Historical computation of primary earnings per common share for the years ended December 31, 1995 and 1994 is not considered meaningful as Allegiance did not have common shares for these historical periods. (2) Net loss in 1996 includes a charge of $550.0 million for the write-down of goodwill, and other non-recurring costs of a pretax amount of $95.5 million primarily for facility consolidations and other asset write-downs. (3) Common shares are based on the weighted average number of shares outstanding subsequent to the distribution on September 30, 1996, assuming the shares issued in connection with the distribution had been issued January 1. EX-11.2 5 STATE COMP FULLY DILUTED EARNINGS / SHARE EXHIBIT 11.2 COMPUTATION OF FULLY DILUTED EARNINGS PER COMMON SHARE (IN MILLIONS, EXCEPT PER SHARE DATA)
DECEMBER 31, 1996 ------------ HISTORICAL COMPUTATION (1) Net loss available for common stock (2)............................ $(477.7) Weighted average number of common shares outstanding (3)........... 54.9 Additional shares assuming conversion of exercise of stock options and stock purchase plan subscriptions..................... 1.6 ------- Average common shares outstanding.................................. 56.5 Fully diluted net loss per common share (2)........................ $ (8.45) =======
- - -------- (1) Historical computation of fully diluted earnings per common share for the years ended December 31, 1995 and 1994 is not considered meaningful as Allegiance did not have common shares for these historical periods. (2) Net loss in 1996 includes a charge of $550.0 million for the write-down of goodwill, and other non-recurring costs of a pretax amount of $95.5 million primarily for facility consolidations and other asset write-downs. (3) Common shares are based on the weighted average number of shares outstanding subsequent to the distribution on September 30, 1996, assuming the shares issued in connection with the distribution had been issued January 1. EX-12.1 6 STATE COMP RATIOS EARNINGS TO FIXED CHARGES EXHIBIT 12.1 COMPUTATION OF PRO FORMA RATIO OF EARNINGS TO FIXED CHARGES (IN MILLIONS, EXCEPT RATIOS)
DECEMBER 31, DECEMBER 31, DECEMBER 31, 1996(2) 1996 1995 ------------ ------------ ------------ Pro forma pretax income (1)............. $100.0 $(545.5) $101.8 Estimated interest portion of rents... 8.7 8.7 8.8 Pro forma interest charges (1)........ 86.1 86.1 90.0 ------ ------- ------ Pro forma fixed charges............... 94.8 94.8 98.8 ------ ------- ------ Pro forma income as adjusted............ 194.8 (450.7) 200.6 Pro forma ratio of earnings to fixed charges................................ $ 2.1 $ (4.8) $ 2.0 ====== ======= ======
- - -------- (1) Historical ratio of earnings to fixed charges is not considered meaningful as no interest costs were allocated from Baxter to Allegiance for the historical periods presented prior to September 30, 1996. The unaudited pro forma combined statements of income are presented in Note 3 to "Notes to Consolidated Financial Statements." (2) Excludes a charge of $550.0 million for the write-down of goodwill and other non-recurring costs of a pretax amount of $95.5 million primarily for facility consolidations and other asset write-downs. EX-13.1 7 1996 ANNUAL REPORT EXHIBIT 13.1 Management's Discussion and Analysis The following management discussion and analysis describes material changes in the results of operations of Allegiance Corporation ("Allegiance" or the "company") during the three years ended December 31, 1996, and the company's financial condition at that date. Trends of a material nature are discussed to the extent known and considered relevant. Certain statements in this discussion constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements indicating the company "plans," "expects," "estimates" or "believes" are forward-looking statements that involve known and unknown risks, including, but not limited to, general economic and business conditions, changing trends in the health-care industry and customer profiles, competition, changes in governmental regulations, and unfavorable foreign currency fluctuations. Although Allegiance believes its expectations with respect to the forward- looking statements are based upon reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of Allegiance will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. The company undertakes no obligation to update publicly any forward-looking statement whether as a result of new information, future events or otherwise. OVERVIEW On September 30, 1996 (the "Distribution Date"), Baxter International Inc. ("Baxter") and its subsidiaries transferred to Allegiance and its subsidiaries the U.S. health-care distribution business, surgical and respiratory therapy business and health-care cost-management business, as well as certain foreign operations (the "Allegiance Business") in connection with a spin-off of the Allegiance Business by Baxter. The spin-off was effected on the Distribution Date through a distribution of common stock of Allegiance to Baxter stockholders. Allegiance operates in a single industry segment as a leading provider of health-care products and services that assist its health-care customers manage and reduce the total cost of providing high-quality patient care. Through its nationwide distribution network, Allegiance distributes a wide offering of medical, surgical and laboratory products, including its own self-manufactured surgical and respiratory therapy products, to hospital and alternate-site customers. Allegiance also provides cost-management services to its health-care customers, including inventory-management programs, customized packaging, and clinical procedure and process consulting. The delivery of such a broad array of products and services requires focused investments in cost-management services, information systems, and manufacturing and distribution efficiencies. Accelerating cost pressures on hospitals in the United States and overseas are resulting in increased outpatient and alternate-site health-care service delivery and a focus on cost-effectiveness and quality. At the same time, the elderly segment of the population in the United States and abroad is growing. These forces increasingly shape the demand for, and supply of, medical care. Many private health-care payers provide incentives for consumers to seek lower cost care outside the hospital. Many corporations' employee health plans provide financial incentives for patients to use the most cost-effective forms of treatment (managed care programs such as health maintenance organizations, have become more common), and physicians are being encouraged to provide more cost- effective treatments. The fundamental changes that have occurred in the U.S. health-care system over the past several years, including customer and competitor consolidations, and cost-containment efforts, are expected to continue in the future. Hospitals and other providers are expected to continue to push for greater efficiency, reduced excess capacity and lower costs. Allegiance management believes this presents an opportunity for the company, which is well positioned to help health-care providers enhance their competitiveness and to provide products to alternate sites as treatment moves outside 22 Management's Discussion and Analysis the hospital. Management believes it can help its customers achieve savings by automating supply-ordering procedures; optimizing distribution networks; improving utilization, materials management and labor productivity; achieving economies through product and procedure standardization; and performing certain non-clinical services on an outsourced basis. Allegiance further believes its strategy of providing unmatched service to its health-care customers and achieving the best overall cost in the delivery of health-care products and services is compatible with any anticipated realignment of the U.S. health-care system that may ultimately occur. RESULTS OF OPERATIONS Allegiance's historical results of operations in 1995 and 1994 include revenues and expenses related to certain divested businesses. The Industrial and Life Sciences division was sold in September 1995 and the diagnostics manufacturing businesses were sold in December 1994. See Notes 5 and 6 to "Notes to Consolidated Financial Statements" for additional information related to these divestitures. The following table presents selected financial data for Allegiance excluding the revenue and expenses associated with these divested businesses:
years ended December 31 (in millions) 1996 1995 1994 - - ---------------------------------------------------------------------------------------------- Net sales $4,387.2 $4,575.0 $4,313.7 Costs and expenses Cost of goods sold 3,479.2 3,624.5 3,311.2 Selling, general and administrative expenses 672.0 694.8 704.9 Research and development 8.1 6.6 5.6 Goodwill write-down and other non-recurring items 645.5 -- -- Interest expense 18.6 -- -- Goodwill amortization 32.2 36.8 36.7 Benefit curtailment gains (35.9) -- -- Other income (4.6) (33.0) (2.8) - - ---------------------------------------------------------------------------------------------- Total costs and expenses 4,815.1 4,329.7 4,055.6 - - ---------------------------------------------------------------------------------------------- Pretax income (loss) (427.9) 245.3 258.1 Income tax expense 49.8 94.4 101.4 - - ---------------------------------------------------------------------------------------------- Net income (loss) $ (477.7) $ 150.9 $ 156.7 ==============================================================================================
SALES The following tables summarize net sales, excluding the divested businesses discussed previously, by major geographic region and by self-manufactured versus distributed product:
Percent increase (decrease) years ended December 31 (in millions, except percentages) 1996 1995 1994 1996 1995 - - -------------------------------------------------------------------------------------------------------------------------- Geographic regions United States $4,097.0 $4,283.7 $4,042.7 (4.4%) 6.0% International 290.2 291.3 271.0 (0.4) 7.5 - - -------------------------------------------------------------------------------------------------------------------------- Total net sales $4,387.2 $4,575.0 $4,313.7 (4.1%) 6.1% ========================================================================================================================== Distributed product $2,791.2 $3,003.5 $2,758.9 (7.1%) 8.9% Self-manufactured product 1,596.0 1,571.5 1,554.8 1.6 1.1 - - -------------------------------------------------------------------------------------------------------------------------- Total net sales $4,387.2 $4,575.0 $4,313.7 (4.1%) 6.1% ==========================================================================================================================
23 Management's Discussion and Analysis The decline in Allegiance's domestic and distributed product net sales in 1996 principally resulted from the execution of plans to improve profitability by reducing sales in lower-margin, distributed products in the United States. Domestic and distributed product net sales growth in 1995 is due primarily to increased sales volume in lower-margin, distributed products, resulting from increased sales under certain distribution agreements and a large supply and service contract signed with VHA Inc. in 1994. The increase in sales of self-manufactured product in 1996 is the result of an increase in cost-management agreements (which generally result in favorable growth of higher-margin, self-manufactured products), partially offset by pricing pressures. An initial stocking order resulting from an agreement signed with General Medical Corporation in 1996 also contributed to the increase in sales of self-manufactured product during the year. International sales in 1996 were reduced slightly by unfavorable foreign- exchange rates. Additionally, as an independent public company, Allegiance has different selling arrangements in international markets that unfavorably impacted sales in comparison to the prior year. The combination of these issues resulted in relatively flat sales in 1996 as compared to 1995. International sales growth in 1995 was the result of continued focus on the penetration of surgical products into these international markets and favorable foreign- exchange rates. Management expects to increase its selling efforts internationally by increasing the penetration of surgical products into international markets. For the last three years, sales to customers who are members of two large hospital buying groups, Premier, Inc. ("Premier") and VHA Inc. ("VHA"), as a percentage of total sales, were 27 percent and 20 percent, respectively in 1996, 27 percent and 16 percent, respectively in 1995, and 23 percent and 13 percent, respectively in 1994. Premier and VHA each comprise a group of health-care organizations that benefit from the pricing and other benefits available to members of the group. Certain members of each group are free to purchase from the vendors of their choice. Although the loss of the relationship with either group could have a significant impact on sales to members of the group, the loss of such group would not necessarily mean the loss of all sales from all members of such group. In November 1996, Allegiance signed a new seven-year agreement with Premier to supply its member hospitals with certain surgical and respiratory therapy products. This agreement is not expected to impact sales until late 1997. Gross Margin and Expense Ratios The following table summarizes Allegiance's gross margin and expense ratios, excluding the divested businesses discussed previously:
years ended December 31 (as a percent of sales) 1996 1995 1994 - - ---------------------------------------------------------------------- Gross margin 20.7% 20.8% 23.2% Selling, general and administrative expenses 15.3 15.2 16.3 - - ----------------------------------------------------------------------
Gross margins were relatively flat in 1996 compared to 1995. This stabilization in gross margin resulted principally from the company's planned reduction in sales of lower-margin, distributed products discussed previously, which offset pricing pressures in Allegiance's higher-margin, self-manufactured products. The gross margin decline in 1995 resulted from general market conditions, growth in lower-margin sales of distributed products and the loss of a Columbia/HCA surgical supply contract. Allegiance plans to continue its efforts to stabilize its gross margin by offsetting pricing pressures with manufacturing cost efficiencies, managing its product mix more effectively, and, when possible, instituting price increases. 24 Management's Discussion and Analysis Total selling, general and administrative expenses declined $22.8 million in 1996 compared to 1995. However, such costs as a percent of sales increased slightly, due to the decline in sales discussed previously, as the timing of expense reduction initiatives that management implemented in both current and prior periods lagged the planned reduction in lower-margin product sales. The decline in the selling, general and administrative expense ratio between 1995 and 1994 resulted from initiatives taken in connection with the 1993 restructuring program and leverage on the growth in distributed products that occurred in 1995. Management plans to continue to improve this ratio through continued expense reduction initiatives. Goodwill Write-Down As part of Baxter, Allegiance followed the accounting policies established by Baxter for its consolidated group. At the Distribution Date, goodwill, net of accumulated amortization, was approximately $1,060.0 million. Baxter's policy was to evaluate the overall recoverability of goodwill using projected undiscounted cash flows. Subsequent to the Distribution Date, the market value of Allegiance's stock was substantially below its historical book value. As a result of this market value and management's expectations that cost-containment efforts in the health-care industry will continue to result in intense competitive pressures among health- care suppliers, management re-evaluated its accounting policy regarding goodwill impairment. In October 1996, the company's board of directors approved the adoption of a new policy for assessing goodwill impairment based upon a fair value approach. The company believes that fair value is a preferable method to assess goodwill as it is a more objective indicator of the company's inherent value as a separate publicly-traded entity and will be reflective of the challenges and pressures that continue to be a fundamental part of the U.S. health-care system. The change in the method of assessing goodwill impairment resulted in a fourth quarter charge of $550.0 million to operations and a reduction in goodwill amortization of $4.7 million (9 cents per share). This policy change will continue to reduce goodwill amortization expense by $18.9 million and $4.7 million on an annual and quarterly basis, respectively, for the next twenty-nine years. The company computes fair value based upon the price/earnings ("P/E") multiple for a group of similar companies. This P/E multiple, calculated based on actual quoted market prices per share and analysts' consensus earnings estimates for these companies, is applied to management's best estimate of earnings for Allegiance to arrive at an overall fair value of the company. Management will continue to utilize the same group of companies in order to determine this P/E multiple, provided that there are no significant changes in the underlying characteristics of such companies. Other Non-Recurring Costs In addition to the goodwill write-down discussed above, the company incurred $95.5 million of non-recurring costs in the fourth quarter of 1996. In conjunction with carving out the Allegiance Business into a separate entity, management re-evaluated the businesses and product lines in accordance with the company's strategies. As a result of this evaluation, the company divested and wrote-down assets of $62.8 million. This was principally a noncash charge that related primarily to the divestiture of the company's Interwoven business and facility consolidations. Other non-recurring charges of $13.2 million were for costs related to the company's spin-off from Baxter. These costs primarily included corporate identity, name change and communications costs, as well as certain incremental compensation costs. 25 Management's Discussion and Analysis In addition to the items noted above, non-recurring charges in the fourth quarter of 1996 included $19.5 million for legal defense costs related to natural rubber latex litigation cases. Refer to Note 16 to "Notes to Consolidated Financial Statements" for additional discussion. Restructuring Program In November 1993, Baxter initiated a restructuring program to improve shareholder value and reduce costs. These strategic actions were designed in part to make the Allegiance Business more efficient and responsive in addressing the changes occurring in the U.S. health-care system. See Note 5 to "Notes to Consolidated Financial Statements" for discussions related to cash and noncash utilization of the reserves. Since the announcement of the 1993 restructuring program, Allegiance management has implemented, or is in the process of implementing, all of the major strategic actions associated therewith and is satisfied the program is progressing on schedule and will meet established financial targets. During 1996, Allegiance utilized $86.6 million of restructuring reserves, including $61.6 million in cash payments. Cash outflows pertain primarily to employee- related costs for severance, outplacement assistance, relocation, implementation teams and facility consolidations. As of December 31, 1996, Allegiance had eliminated approximately 2,115 positions of the 2,300 positions expected to be affected by the program. The majority of the remaining reductions will occur in 1997, as facility closures and consolidations are completed as planned. In addition to improvements in the effectiveness of its sales force and the management of customer relations, Allegiance realized direct savings in manufacturing and administrative costs from this program of approximately $125.2 million, $95.0 million and $40.0 million in 1996, 1995 and 1994, respectively. Management believes the program is on target to achieve anticipated direct savings of approximately $155.0 million in 1997 and of at least $155.0 million in 1998. The company anticipates that these savings will continue to partially offset potential future gross margin erosion and investments into cost- management initiatives. Management further believes its remaining restructuring reserves are adequate to complete the actions contemplated by the restructuring program and that future cash expenditures related to the program will be funded by cash generated from operations. Benefit Curtailment Gains Non-recurring gains associated with the curtailment of Baxter-sponsored non- contributory, defined benefit pension plans amounted to $17.4 million, and the curtailment of Baxter-sponsored contributory health-care and life-insurance benefits amounted to $18.5 million. Refer to Note 13 to "Notes to Consolidated Financial Statements" for discussions of these former plans. Interest Expense Prior to September 30, 1996, Allegiance participated in a centralized cash- management program administered by Baxter. No interest was charged to Allegiance. Interest expense in 1996 related to amounts borrowed by Allegiance to fund a $1,147.3 million distribution to Baxter upon the spin-off and for working capital requirements. Other Income Other income for 1996 consisted primarily of revenue from miscellaneous, non- operating service fees. Other income for 1995 and 1994, excluding the divested businesses discussed previously, consisted primarily of net gains associated with the disposal or discontinuance of minor, non-strategic businesses. 26 Management's Discussion and Analysis Pretax Income The following table compares pretax income, excluding the divested businesses discussed previously, and non-recurring items:
Percent increase (decrease) years ended December 31 (in millions, except percentages) 1996 1995 1994 1996 1995 - - ------------------------------------------------------------------------------------------------------------------ Pretax income (loss), excluding divested businesses $(427.9) $245.3 $258.1 n/a (5.0%) Adjust for non-recurring items/(1)/ 609.6 (37.3) (11.4) - - Adjust for interest expense 18.6 - - - - - - ------------------------------------------------------------------------------------------------------------------ Adjusted pretax income $ 200.3 $208.0 $246.7 (4.3%) (15.2%) ================================================================================================================== Adjusted pretax income as a percent of sales 4.6% 4.6% 5.7% - - ==================================================================================================================
(1) The 1996 non-recurring adjustments include the goodwill write-down, benefit curtailment gains and other non-recurring items discussed previously. The 1995 and 1994 non-recurring adjustments reflect net gains associated with the disposal or discontinuance of minor, non-strategic businesses discussed previously. Excluding the non-recurring items noted above and adjusting for interest expense which did not impact earnings until the fourth quarter of 1996, pretax income decreased as a result of the decrease in net sales discussed previously. Pretax income remained flat as a percent of sales between 1996 and 1995. Excluding the non-recurring items noted above, the decrease in pretax income as a percent of sales between 1995 and 1994 was caused primarily by the 1995 gross margin decline discussed earlier. Income Taxes Allegiance's effective tax rate in 1996 was impacted by the non-recurring fourth quarter charges discussed previously. Excluding the divested businesses and the tax benefit of $32.7 million associated with the non-recurring costs, the effective tax rate would have been 37.9 percent in 1996 versus 38.5 percent in 1995. The decrease in this rate between 1996 and 1995 was caused principally by the positive impact on earnings of lower goodwill amortization, which is a non- taxable item, in the fourth quarter of 1996. The effective tax rate, excluding divested businesses, in 1995 decreased by 0.8 percentage points from 39.3% in 1994, primarily due to a larger proportion of earnings in lower tax jurisdictions. Net Income Excluding the divested businesses and the fourth quarter 1996 non-recurring costs, the declines in net income between 1994 and 1996 are consistent with the changes in pretax income and income taxes discussed previously. Impact of Inflation In recent years, Allegiance has experienced increases in its labor and material costs influenced, in part, by general inflationary trends. While not directly related to inflationary trends, Allegiance's revenue base over recent years has been adversely affected by lower average selling prices on certain products as a result of changes in Medicare reimbursement regulations, economic pressures in the U.S. hospital marketplace and increased competition in certain product lines. There is little correlation between general inflation rates directly affecting costs and expenses and Allegiance's pricing levels for products sold to health-care customers. Management expects these trends to continue. 27 Management's Discussion and Analysis Liquidity and Capital Resources Management assesses Allegiance's liquidity in terms of its overall ability to mobilize cash to support ongoing business levels and to fund its growth. Management believes it has sufficient cash flow from operations and financial flexibility to attract long-term capital to support normal operating activities and fund short- and long-term growth objectives. Allegiance's current assets exceeded current liabilities by $637.4 million at December 31, 1996, versus an excess of $679.7 million at December 31, 1995. Current assets at December 31, 1996, included accounts receivable and notes and other current receivables of $547.5 million and inventories of $628.5 million. These sources of liquidity are convertible into cash over a relatively short period of time and thus, could be available to help Allegiance satisfy normal operating cash requirements. Debt and Financial Instruments To meet its net financing requirements during the year ended December 31, 1996, including a $1,147.3 million distribution to Baxter, the company borrowed under its various credit facilities, as required. Refer to Note 8 to "Notes to Consolidated Financial Statements" for additional discussion. On October 15, 1996, Allegiance issued $200.0 million in aggregate principal amount of the company's 7.30 percent notes due October 15, 2006; $150.0 million in aggregate principal amount of the company's 7.80 percent debentures due October 15, 2016; and $200.0 million in aggregate principal amount of the company's 7.00 percent debentures due October 15, 2026. The net proceeds to the company from the sale of these securities were used to reduce the amounts outstanding under the company's credit facilities. The company received debt ratings of Baa3 on senior debt by Moody's, BBB- by Standard & Poor's and BBB by Duff & Phelps. Allegiance's long-term debt as a percent of total capital was 57.2 percent at December 31, 1996. Management plans to reduce this ratio over time. The company intends to fund its short- and long-term obligations as they mature through cash flow from operations, existing credit facilities or issuance of debt. Management believes the company has credit facilities adequate to support the company's ongoing operational, capital, restructuring and litigation requirements. Beyond that, Allegiance believes it has sufficient financial flexibility to attract long-term capital on acceptable terms as may be needed to support its growth objectives. Cash Flow from Operations Cash flow provided by operations was $317.1 million, $253.3 million and $422.2 million as of December 31, 1996, 1995 and 1994, respectively. The increase in cash flow from operations in 1996 resulted from improved balance sheet management -- primarily inventories and accounts payable. The decline in cash flow from operations in 1995 was primarily the result of a decline in earnings, resulting principally from the divestitures of the Industrial and Life Sciences division and the diagnostics manufacturing businesses.
Investment Transactions years ended December 31 (in millions) 1996 1995 1994 - - ---------------------------------------------------------------------- Capital expenditures $(102.5) $(111.9) $(122.4) Acquisitions (23.8) (5.4) (1.9) Proceeds from asset dispositions (11.2) 626.0 106.9 - - ---------------------------------------------------------------------- Total investment transactions, net $(137.5) $ 508.7 $ (17.4) ======================================================================
Capital expenditures consisted principally of improvements to existing facilities, system upgrades, productivity-enhancing equipment and other cost- reduction projects. Allegiance management expects 1997 investments in capital expenditures to remain at levels consistent with 1996. 28 Management's Discussion and Analysis The acquisitions summarized above involved no significant change to Allegiance's strategic direction, and were made for the purpose of broadening product lines and service offerings or expanding market coverage. The net use of cash related to asset dispositions in 1996 related primarily to cash payments from the settlement of certain programs associated with the divestitures of the Industrial and Life Sciences division and the diagnostics manufacturing businesses. The proceeds for 1995 related primarily to Allegiance's divestiture of its Industrial and Life Sciences division in September 1995 and the collection of notes receivable related to the December 1994 divestiture of Allegiance's diagnostics manufacturing businesses. The proceeds in 1994 related to the divestiture of the diagnostics manufacturing businesses. See Notes 5 and 6 to "Notes to Consolidated Financial Statements" for additional information related to these divestitures. In February 1997, the board of directors declared a quarterly dividend of 10 cents per share (annualized rate of 40 cents per share). The company intends to grow dividends at a rate lower than its anticipated growth in earnings per share. On January 2, 1997, Allegiance acquired West Hudson & Co. Inc., a privately- owned health-care consulting firm with 1996 annual sales of $38.1 million. Allegiance paid approximately $30.5 million in cash and $10.5 million in stock with contingent payments to be paid over the next four years. This acquisition is consistent with Allegiance's strategic direction of providing cost-management services. Litigation Upon the Distribution, Allegiance assumed the defense of litigation involving claims related to the Allegiance Business, including certain claims of alleged personal injuries as a result of exposure to natural rubber latex gloves. See Note 16 to "Notes to Consolidated Financial Statements." Under the U.S. Superfund statute and many state laws, generators of hazardous waste sent to a disposal or recycling site are liable for cleanup of the site if contaminants from that property later leak into the environment. The law provides that potentially responsible parties may be held jointly and severally liable for the cost of investigating and remediating a site. This liability applies to the generator even if the waste was handled by a contractor in full compliance with the law. As of December 31, 1996, Baxter Healthcare Corporation had been identified as a potentially responsible party for cleanup costs at ten hazardous waste sites, for which Allegiance has assumed responsibility. Allegiance's largest assumed exposure is at the Thermo-Chem site in Muskegon, Michigan. Allegiance expects the total cleanup costs for this site to be between $44.0 million and $65.0 million, of which Allegiance's share would be approximately $5.4 million. This amount, net of payments of approximately $1.4 million, has been accrued and is reflected in Allegiance's consolidated financial statements. The estimated exposure for the remaining nine sites is approximately $3.9 million, which has been accrued and reflected in Allegiance's consolidated financial statements. The company is a defendant in, or has assumed the defense of, a number of other claims, investigations and lawsuits. Upon resolution of any of the uncertainties described in Note 16 to "Notes to Consolidated Financial Statements," the company may incur charges in excess of presently established reserves. Based on the advice of counsel, management does not believe the outcome of these matters, individually or in the aggregate, will have a material adverse effect on Allegiance's overall business, cash flow, results of operations or financial condition. 29 Management's Responsibility for Financial Statements Management is responsible for the preparation of the company's consolidated financial statements and all related information appearing in this report. The statements and notes have been prepared in conformity with generally accepted accounting principles and include some amounts that are estimates based on currently available information and management's judgement of current conditions and circumstances. The company engaged Price Waterhouse LLP, independent public accountants, to examine the consolidated financial statements. Their report appears on this page. To provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition and that accounting records are reliable for preparing financial statements, management maintains a system of accounting controls, including an internal audit program. The system of accounting controls is improved in response to changes in business conditions, operations and recommendations made by the independent public accountants and the internal auditors. The Board of Directors has an Audit and Public Policy Committee whose members are not employees of the company. The committee met three times in 1996 with management, internal auditors and representatives of the company's independent public accountants to review the company's program of internal controls, audit plans and results, and recommendations of the internal and external auditors and management responses to those recommendations. /s/ Lester B. Knight /s/ Peter B. McKee /s/ Richard C. Adloff - - -------------------- ------------------ --------------------- Lester B. Knight Peter B. McKee Richard C. Adloff Chairman of the Board Senior Vice President Corporate Vice and Chief Executive and Chief Financial President and Officer Officer Controller Report of Independent Accountants To the Board of Directors and Stockholders of Allegiance Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of cash flows and of equity present fairly, in all material respects, the financial position of Allegiance Corporation and its subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in Note 2 to the consolidated financial statements, the company changed its method of assessing goodwill impairment in 1996. We concur with the change in accounting. /s/ Price Waterhouse LLP - - ------------------------ PRICE WATERHOUSE LLP Chicago, Illinois February 3, 1997 30 Consolidated Balance Sheets
as of December 31 (in millions, except par value and shares) 1996 1995 - - ---------------------------------------------------------------------------------------------------------------------------------- CURRENT ASSETS Cash and equivalents $ 22.9 $ 0.8 Accounts receivable, net of allowance for doubtful accounts of $26.4 in 1996 and $18.2 in 1995 515.1 486.7 Notes and other current receivables 32.4 59.2 Inventories 628.5 684.4 Deferred income taxes 122.8 129.1 Prepaid expenses 13.8 11.8 ------------------------------------------------------------------------------- Total current assets 1,335.5 1,372.0 - - ---------------------------------------------------------------------------------------------------------------------------------- PROPERTY, PLANT At cost 1,519.1 1,307.1 AND EQUIPMENT Accumulated depreciation and amortization (681.2) (428.9) ------------------------------------------------------------------------------- Net property, plant and equipment 837.9 878.2 - - ---------------------------------------------------------------------------------------------------------------------------------- OTHER ASSETS Goodwill and other intangibles 514.5 1,115.7 Other 111.3 77.8 ------------------------------------------------------------------------------- Total other assets 625.8 1,193.5 ------------------------------------------------------------------------------- Total assets $2,799.2 $3,443.7 - - ---------------------------------------------------------------------------------------------------------------------------------- CURRENT LIABILITIES Accounts payable and accrued liabilities $ 698.1 $ 692.3 - - ---------------------------------------------------------------------------------------------------------------------------------- LONG-TERM DEBT 1,106.6 - - - ---------------------------------------------------------------------------------------------------------------------------------- DEFERRED INCOME TAXES 107.4 109.8 - - ---------------------------------------------------------------------------------------------------------------------------------- OTHER NON-CURRENT LIABILITIES 59.4 64.1 - - ---------------------------------------------------------------------------------------------------------------------------------- EQUITY Divisional retained earnings - 1,767.5 Equity investment of parent - 810.0 Common stock, $1 par value, authorized 200,000,000 shares, issued 54,977,000 shares in 1996 55.0 - Additional contributed capital 1.5 - Retained earnings 769.2 - Cumulative foreign currency adjustment 2.0 - ------------------------------------------------------------------------------- Total equity 827.7 2,577.5 ------------------------------------------------------------------------------- Total liabilities and equity $2,799.2 $3,443.7 - - ---------------------------------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these consolidated financial statements.
31 Consolidated Statements of Operations
years ended December 31 (in millions, except per share data) 1996 1995 1994 - - ------------------------------------------------------------------------------------------------------------ OPERATIONS Net sales $4,387.2 $4,921.9 $5,108.6 Costs and expenses Cost of goods sold 3,479.2 3,877.7 3,731.1 Selling, general and administrative expenses 672.0 749.6 965.2 Research and development 8.1 6.6 39.8 Goodwill write-down and other non-recurring items 645.5 76.0 - Interest expense 18.6 - - Goodwill amortization 32.2 37.8 40.7 Benefit curtailment gains (35.9) - - Other income (4.6) (301.8) (6.3) ----------------------------------------------------------------------------------------- Total costs and expenses 4,815.1 4,445.9 4,770.5 ----------------------------------------------------------------------------------------- Income (loss) before income taxes (427.9) 476.0 338.1 Income tax expense 49.8 203.4 123.2 ----------------------------------------------------------------------------------------- Net income (loss) $ (477.7) $ 272.6 $ 214.9 - - ------------------------------------------------------------------------------------------------------------ PER SHARE DATA Net income (loss) per common share $ (8.70) n/a n/a ----------------------------------------------------------------------------------------- Average number of common shares outstanding 54.9 n/a n/a - - ------------------------------------------------------------------------------------------------------------
n/a - not applicable The accompanying notes are an integral part of these consolidated financial statements. 32 Consolidated Statements of Cash Flows
years ended December 31 (in millions) (Brackets denote cash outflows) 1996 1995 1994 - - ----------------------------------------------------------------------------------------------------------- CASH FLOW Income (loss) from operations $ (477.7) $ 272.6 $ 214.9 PROVIDED BY Adjustments OPERATIONS Depreciation and amortization 145.2 164.6 222.8 Deferred income taxes (13.7) 50.2 2.9 Gain on asset dispositions, net (pretax) - (262.5) (11.0) Goodwill write-down and other non-recurring charges 645.5 76.0 - Benefit curtailment gains (35.9) - - Other 6.0 5.4 1.9 Changes in balance sheet items Accounts receivable (14.7) 73.0 8.0 Inventories 48.1 28.8 86.3 Accounts payable and accrued liabilities 74.7 (120.2) (43.3) Restructuring program payments (45.9) (62.0) (53.8) Other (14.5) 27.4 (6.5) ----------------------------------------------------------------------------------- Cash flow provided by operations 317.1 253.3 422.2 - - ----------------------------------------------------------------------------------------------------------- INVESTMENT Capital expenditures (102.5) (111.9) (122.4) TRANSACTIONS Acquisitions (net of cash received) (23.8) (5.4) (1.9) Proceeds from asset dispositions (11.2) 626.0 106.9 ----------------------------------------------------------------------------------- Investment transactions, net (137.5) 508.7 (17.4) - - ----------------------------------------------------------------------------------------------------------- FINANCING Issuances of debt 603.6 - - TRANSACTIONS Increase in debt with maturities of three months or less, net 507.4 - - Stock issued under employee benefit plans 1.7 - - Payments to Baxter International Inc. (1,270.2) (764.0) (402.0) ----------------------------------------------------------------------------------- Financing transactions, net (157.5) (764.0) (402.0) - - ----------------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND EQUIVALENTS 22.1 (2.0) 2.8 CASH AND EQUIVALENTS AT BEGINNING OF YEAR 0.8 2.8 - - - ----------------------------------------------------------------------------------------------------------- CASH AND EQUIVALENTS AT END OF YEAR $ 22.9 $ 0.8 $ 2.8 - - ----------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these consolidated financial statements.
33 Consolidated Statements of Equity
years ended December 31 (in millions) 1996 1995 1994 - - ---------------------------------------------------------------------------------------------------------------- COMMON Balance, beginning of year $ -- n/a n/a STOCK September 30, 1996, distribution of common stock 54.8 Stock issued under employee benefit plans 0.2 ---------------------------------------------------------------------------------------- BALANCE, END OF YEAR 55.0 ================================================================================================================ ADDITIONAL Balance, beginning of year -- n/a n/a CONTRIBUTED Stock issued under employee benefit plans 1.5 CAPITAL ---------------------------------------------------------------------------------------- BALANCE, END OF YEAR 1.5 ================================================================================================================ DIVISIONAL Balance, beginning of year 1,767.5 $2,258.9 $2,446.0 RETAINED Net income prior to September 30, 1996 117.8 272.6 214.9 EARNINGS Payments to Baxter International Inc. (460.2) (764.0) (402.0) September 30, 1996, distribution of common stock (1,425.1) -- -- ---------------------------------------------------------------------------------------- BALANCE, END OF YEAR -- 1,767.5 2,258.9 ================================================================================================================ EQUITY Balance, beginning of year 810.0 810.0 810.0 INVESTMENT Payments to Baxter International Inc. (810.0) -- -- OF PARENT ---------------------------------------------------------------------------------------- BALANCE, END OF YEAR -- 810.0 810.0 ================================================================================================================ RETAINED Balance, beginning of year -- n/a n/a EARNINGS September 30, 1996, distribution of common stock 1,370.3 Common stock dividends declared (5.6) Net loss subsequent to September 30, 1996 (595.5) ---------------------------------------------------------------------------------------- BALANCE, END OF YEAR 769.2 ================================================================================================================ CUMULATIVE Balance, beginning of year -- -- -- FOREIGN Currency fluctuations 2.0 -- -- CURRENCY ---------------------------------------------------------------------------------------- ADJUSTMENT BALANCE, END OF YEAR 2.0 -- -- ================================================================================================================ TOTAL EQUITY $ 827.7 $2,577.5 $3,068.9 ================================================================================================================
n/a - not applicable The accompanying notes are an integral part of these consolidated financial statements. 34 Notes To Consolidated Financial Statements 1. Description of the Business Allegiance Corporation ("Allegiance" or the "company") was incorporated in Delaware in June 1996. On September 30, 1996 (the "Distribution Date"), Baxter International Inc. ("Baxter") and its subsidiaries transferred to Allegiance and its subsidiaries the United States health-care distribution business, surgical and respiratory therapy business and health-care cost-management business, as well as certain foreign operations (the "Allegiance Business") in connection with a spin-off of the Allegiance Business by Baxter. The spin-off was effected on the Distribution Date through a distribution of common stock of Allegiance to Baxter stockholders (the "Distribution"). The Distribution of approximately 54.8 million shares of Allegiance stock, based on an exchange ratio of one for five, was made to those who were Baxter stockholders on the record date of September 26, 1996. Allegiance operates in a single industry segment as a leading provider of health-care products and services that assist its health-care customers manage and reduce the total cost of providing high-quality patient care. Through its nationwide distribution network, Allegiance distributes a wide offering of medical, surgical and laboratory products, including its own self-manufactured surgical and respiratory therapy products, to hospital and alternate-site customers. Allegiance also provides cost-management services to its health-care customers through inventory-management programs, customized packaging, and clinical procedure and process consulting. Allegiance's historical results of operations in 1995 and 1994 include revenues and expenses related to certain divested businesses. The Industrial and Life Sciences division was sold in September 1995, and the diagnostics manufacturing businesses were sold in December 1994. See Notes 5 and 6 to the Consolidated Financial Statements for additional information related to these divestitures. The following table presents historical financial data for Allegiance excluding the revenue and expenses associated with these divested businesses:
years ended December 31 (in millions) 1995 1994 - - ---------------------------------------------------------------------- Net sales $4,575.0 $4,313.7 Costs and expenses Cost of goods sold 3,624.5 3,311.2 Selling, general and administrative expenses 694.8 704.9 Research and development 6.6 5.6 Goodwill amortization 36.8 36.7 Other income (33.0) (2.8) - - ---------------------------------------------------------------------- Total costs and expenses 4,329.7 4,055.6 - - ---------------------------------------------------------------------- Pretax income 245.3 258.1 Income tax expense 94.4 101.4 ====================================================================== Net income $ 150.9 $ 156.7 ======================================================================
2. Summary of Significant Accounting Policies This summary of significant accounting policies is presented to assist the reader in understanding and evaluating the consolidated financial statements. These policies conform with generally accepted accounting principles and, except for the change in the goodwill impairment policy, have been applied consistently in all material respects. 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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. BASIS OF PRESENTATION The accompanying financial statements for periods prior to the Distribution Date include those assets, liabilities, revenues and expenses directly attributable to Allegiance's operations. These financial statements have been prepared as if Allegiance had operated as a free-standing entity for the periods presented. The financial information prior to the Distribution Date does not necessarily reflect what the financial position and results of operations of Allegiance would have been had it operated as a stand-alone entity during the periods covered, and may not be indicative of future operations or financial position. BASIS OF CONSOLIDATION The consolidated financial statements include the accounts of Allegiance and its majority-owned subsidiaries. Certain operations 35 Notes To Consolidated Financial Statements outside the United States and its territories, which are not significant, are included in the consolidated financial statements on the basis of fiscal years ending November 30. Cash and Equivalents Cash and equivalents include cash, cash investments and marketable securities with an original maturity of three months or less. Cash payments for interest were $7.4 million in 1996. Cash payments for income taxes were $0.6 million in 1996. Cash payments for income taxes relating to Allegiance's operations prior to the Distribution Date were made by Baxter.
Inventories as of December 31 (in millions) 1996 1995 - - ------------------------------------------------------ Raw materials $ 52.8 $ 54.0 Work in process 46.4 49.0 Finished products 529.3 581.4 - - ------------------------------------------------------ Total inventories $628.5 $684.4 ======================================================
Inventories are stated at the lower of cost (first-in, first-out method) or market. Market for raw materials is based on replacement cost and for other inventory classifications on net realizable value. Appropriate consideration is given to deterioration, obsolescence and other factors in evaluating net realizable value.
Property, Plant and Equipment as of December 31 (in millions) 1996 1995 - - -------------------------------------------------------------------- Land $ 98.1 $ 102.4 Buildings and leasehold improvements 397.4 396.0 Machinery and equipment 905.1 724.0 Equipment leased or rented to customers 19.0 13.7 Construction in progress 99.5 71.0 - - -------------------------------------------------------------------- Total property, plant and equipment, at cost 1,519.1 1,307.1 Accumulated depreciation and amortization (681.2) (428.9) - - -------------------------------------------------------------------- Net property, plant and equipment $ 837.9 $ 878.2 ====================================================================
Property, plant and equipment are stated at cost. Depreciation and amortization are provided for financial reporting purposes principally on the straight-line method over the following estimated useful lives: buildings and leasehold improvements, 20 to 50 years; machinery and other equipment, 3 to 20 years; and equipment leased or rented to customers, 1 to 5 years. Leasehold improvements are depreciated over the life of the related facility leases or the asset, whichever is shorter. Straight-line and accelerated methods of depreciation are used for income tax purposes. Depreciation expense was $98.8 million in 1996, $106.3 million in 1995 and $154.4 million in 1994. Repairs and maintenance expenses were $24.2 million in 1996, $36.4 million in 1995 and $30.0 million in 1994. Goodwill and Other Intangible Assets Goodwill represents the excess of cost over the fair value of net assets acquired and is amortized on a straight-line basis over estimated useful lives not exceeding 40 years. As part of Baxter, Allegiance followed the accounting policies established by Baxter for its consolidated group. At the Distribution Date, goodwill, net of accumulated amortization, was approximately $1,060.0 million. Baxter's policy was to evaluate the overall recoverability of goodwill using projected undiscounted cash flows. Subsequent to the Distribution Date, the market value of Allegiance's stock was substantially below its historical book value. As a result of this market value and management's expectations that cost-containment efforts in the health- care industry will continue to result in intense competitive pressures among health-care suppliers, management re-evaluated its accounting policy regarding goodwill impairment. In October 1996, the company's board of directors approved the adoption of a new policy for assessing goodwill impairment based upon a fair value approach. The company believes that fair value is a preferable method to assess goodwill as it is a more objective indicator of the company's inherent value as a separate publicly-traded entity and will be reflective of the challenges and pressures that continue to be a fundamental part of the U.S. health-care system. The change in the method of assessing goodwill impairment resulted in a fourth quarter charge of $550.0 million to operations and a reduction in goodwill amortization of $4.7 million (9 cents per share). This policy change will continue to reduce goodwill amortization expense by $18.9 million and $4.7 million on an annual and quarterly basis, respectively, for the next 29 years. The company computes fair value based upon the price/earnings ("P/E") multiple for a group of similar companies. 36 Notes To Consolidated Financial Statements This P/E multiple, calculated based on actual quoted market prices per share and analysts' consensus earnings estimates for these companies, is applied to management's best estimate of earnings for Allegiance to arrive at an overall fair value of the company. Management will continue to utilize the same group of companies in order to determine this P/E multiple, provided that there are no significant changes in the underlying characteristics of such companies. Based upon management's assessment, the carrying value of goodwill at December 31, 1996 is not impaired. As of December 31, 1996 and 1995, goodwill was $510.7 million and $1,091.5 million, respectively, net of accumulated amortization of $400.8 million and $369.1 million, respectively. Other intangible assets include purchased patents, trademarks, deferred charges and other identified rights that are amortized on a straight-line basis over their legal or estimated useful lives, whichever is shorter (generally not exceeding 17 years). As of December 31, 1996 and 1995, other intangibles were $3.8 million and $24.2 million, respectively, net of accumulated amortization of $18.3 million and $46.0 million, respectively. Income Taxes Allegiance's operations before the Distribution Date were included in Baxter's consolidated U.S. federal and state income tax returns and in the tax returns of certain Baxter foreign subsidiaries. The provision for income taxes prior to the Distribution Date was determined as if Allegiance had filed separate tax returns under its structure while part of Baxter. Accordingly, Allegiance's effective tax rate in future years could vary from historical rates depending on the company's current legal structure and tax elections. All income taxes prior to the Distribution Date were settled with Baxter on a current basis through Divisional Retained Earnings. Provision has been made for income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Derivatives Gains and losses on hedges of existing assets or liabilities are included in the carrying amounts of these assets or liabilities and are ultimately recognized in income as part of the carrying amounts. Gains and losses from qualifying hedges of firm commitments or anticipated transactions also are deferred and are recognized in income, or as adjustments of carrying amounts when the hedged transaction occurs. Stock-Option Plans SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The company has chosen to account for stock- based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the company's stock at the date of the grant over the amount an employee must pay to acquire the stock. See Note 12 to the Consolidated Financial Statements. Earnings Per Share Net income per common share is based on the weighted average number of shares outstanding subsequent to the Distribution, assuming the shares issued in connection with the Distribution had been issued January 1, 1996. No historical earnings per share data is presented for 1995 and 1994 because Allegiance's earnings were part of Baxter's results, and the historical capital structure in these periods is not comparable with Allegiance's capital structure after the Distribution. Reclassifications Certain immaterial reclassifications have been made to conform the 1995 and 1994 financial statements and related footnotes to the 1996 presentation. 3. Pro Forma Financial Information The following unaudited pro forma combined statements of operations present the combined results of Allegiance assuming the transactions contemplated by the Distribution and certain significant divestitures discussed in Note 1 to the Consolidated Financial Statements had been completed as of January 1, 1995: 37 Notes To Consolidated Financial Statements
(unaudited, in millions, except per share data) 1996 1995 - - ----------------------------------------------------------------------- Net sales $4,386.7 $4,571.1 Costs and expenses Cost of goods sold 3,481.5 3,624.7 Selling, general and administrative expenses /(a)/ 683.4 706.9 Research and development 8.1 6.6 Goodwill write-down and other non-recurring items 645.5 - Interest expense /(b)/ 86.1 90.0 Goodwill amortization 32.2 36.8 Other (income) expense /(c)/ (4.6) 4.3 - - ----------------------------------------------------------------------- Total costs and expenses 4,932.2 4,469.3 - - ----------------------------------------------------------------------- Pretax income (loss) (545.5) 101.8 Income tax expense /(d)/ 4.2 37.9 - - ----------------------------------------------------------------------- Net income (loss) $ (549.7) $ 63.9 ======================================================================= Net income (loss) per common share /(e)/ $ (10.01) $ 1.16 ======================================================================= Average number of common shares outstanding 54.9 54.9 =======================================================================
Significant pro forma adjustments (excluding the revenue and expenses associated with the divested businesses discussed in Note 1) comprise the following: (a) Pro forma adjustments of $11.4 and $12.1 million in 1996 and 1995, respectively, principally reflect certain incremental corporate expenses that are estimated to have occurred had the company operated on a stand-alone basis, net of the estimated reduction in expenses related to changes in benefit plans. (b) Pro forma adjustments of $67.5 and $90.0 million in 1996 and 1995, respectively, reflect estimated interest expense the company would have incurred on the incurrence of an estimated $1.2 billion of debt at a weighted average interest rate of 7.5 percent. (c) Pro forma adjustments of $37.3 million in 1995 reflect non-recurring payments related to the transfer of rights under various service agreements with Alliant Foodservices Inc., to reflect only those ongoing business operations to be included in the Distribution. (d) Pro forma adjustments of $45.6 million in 1996 and $56.5 million in 1995 reflect the estimated tax benefit, at statutory rates, for pro forma adjustments. (e) Pro forma net income (loss) per common share is computed as if the average number of common shares of Allegiance stock had been outstanding for the periods presented. 4. Non-Recurring Items In addition to the goodwill write-down discussed in Note 2 to the Consolidated Financial Statements, the company incurred $95.5 million of non-recurring costs in the fourth quarter of 1996. In conjunction with carving out the Allegiance Business into a separate entity, management re-evaluated the businesses and product lines in accordance with the company's strategies. As a result of this evaluation, the company divested and wrote-down assets of $62.8 million. This was principally a noncash charge that related primarily to the divestiture of the company's Interwoven business and facility consolidations. Other non-recurring charges of $13.2 million were for costs related to the company's spin-off from Baxter. These costs primarily included corporate identity, name change and communications costs, as well as certain incremental compensation costs. In addition to the items noted above, non-recurring charges in the fourth quarter of 1996 included $19.5 million for legal defense costs related to natural rubber latex litigation cases. Refer to Note 16 to the Consolidated Financial Statements.
5. Restructuring Programs Divestitures Employee- and asset Other (in millions) related costs write-downs costs Total - - ------------------------------------------------------------------------------- Initial restructuring charge $102.5 $ 278.1 $103.4 $ 484.0 Utilization: Cash (31.0) (22.0) (23.3) (76.3) Noncash - (160.2) - (160.2) - - ------------------------------------------------------------------------------- December 31, 1994 71.5 95.9 80.1 247.5 Utilization: Cash (28.5) (42.8) (33.2) (104.5) Noncash - (66.3) - (66.3) Adjustment to reserve - 76.0 - 76.0 - - ------------------------------------------------------------------------------- December 31, 1995 43.0 62.8 46.9 152.7 Utilization: Cash (19.0) (15.8) (26.8) (61.6) Noncash - (25.0) - (25.0) - - ------------------------------------------------------------------------------- December 31, 1996 $ 24.0 $ 22.0 $ 20.1 $ 66.1 ===============================================================================
In November 1993, Baxter's board of directors approved a series of strategic actions to improve shareholder value and reduce costs. The strategic actions of the program were designed in part to make the Allegiance Business more efficient and responsive in addressing the changes occurring in the U.S. health-care system. In November 1993, a $484.0 million pretax provision was recorded to cover costs associated with these restructuring initiatives. Since the announcement of the 1993 restructuring program, Allegiance has 38 Notes To Consolidated Financial Statements implemented, or is in the process of implementing, all of the major strategic actions associated with the restructuring program, which is expected to be completed by 1998. Included in the 1993 restructuring plan was the intent to divest the diagnostics manufacturing businesses, and a valuation allowance was established as a component of the restructuring charge. In December 1994, subject to certain settlement provisions, the divestiture of these businesses was completed and net proceeds were received of approximately $44.0 million in cash, $200.0 million in installment notes (which were collected in cash during January 1995) and $40.0 million in face value of preferred stock. In addition, accounts receivable were retained of approximately $85.0 million, which was collected from customers in the normal course of business. Allegiance has retained the rights to distribute all current diagnostics products in the United States. Throughout 1995, active discussions took place with the buyer of the diagnostics businesses related to interpretations of and responsibility relative to the settlement provisions contained in the purchase and sale and related agreements. The divestiture also was significantly complicated by a dispute between the diagnostics manufacturing businesses and one of its major suppliers, which ultimately led to a lower than expected final valuation of the business. This dispute has been settled. In the third quarter of 1995, settlement negotiations were completed with the buyer of the diagnostics businesses, and adjustments to the purchase price were finalized along with a revision of cost estimates to complete the divestiture. This resulted in an additional restructuring charge of $76.0 million. Employee-related costs include provisions for severance, outplacement assistance, relocation and retention payments for employees in the affected operations worldwide. Since the inception of the restructuring program, approximately 2,115 of the 2,300 positions expected to be affected by the program have been eliminated. The majority of the remaining reductions will occur in 1997, as facility closures and consolidations are completed as planned. The company used noncash restructuring reserves for divestitures and asset write-downs totaling $160.2 million in 1994, $66.3 million in 1995 and $25.0 million in 1996. Of these amounts, $117.8 million in 1994, $16.0 million in 1995 and $4.4 million in 1996 related to the divestiture of the diagnostics manufacturing businesses. Also included was $42.4 million in 1994, $50.3 million in 1995 and $20.6 million in 1996, relating primarily to the closure of manufacturing facilities and consolidations of certain distribution facilities. The utilization of the noncash restructuring reserves relating to the diagnostics divestiture primarily represents the excess of the net assets of the businesses sold over the proceeds received. The utilization of the noncash restructuring reserves relating to the manufacturing facility closures and distribution facility consolidations primarily represents fixed asset and inventory write-downs. The 1996 restructuring reserve balance consisted of $53.2 million of current and $12.9 million of non-current reserves. The 1995 restructuring reserve balance consisted of $89.1 million of current and $63.6 million of non- current reserves. 6. Acquisitions, Investments in Affiliates and Divestitures Acquisitions Allegiance invested $23.8 million in 1996, $5.4 million in 1995 and $1.9 million in 1994, for acquisitions accounted for as purchase transactions and investments in affiliated companies. Had the acquisitions taken place January 1, consolidated results in the year of acquisition would not have been materially different from reported results. These acquisitions were consistent with Allegiance's strategic direction and were made to acquire technologies, broaden product lines and expand market coverage. Divestitures In 1995, Allegiance disposed of several businesses or product lines which resulted in a net gain of $141.0 million (net of $121.5 million in related income tax expense). The majority of the net gain for 1995 related to the divestiture of Allegiance's Industrial and Life Sciences division ("Industrial") to VWR Corporation for approximately $400.0 million in cash and $25.0 million in deferred payments, resulting in a gain of $268.1 million. As part of the divestiture, Allegiance will continue to supply its self-manufactured products and supplies sold in non-health-care markets to VWR Corporation under a long- term distribution agreement. Allegiance disposed of or discontinued several minor non-strategic or unprofitable product lines or investments that resulted in a net gain of $8.5 million (net of $3.2 million in related income tax expense) in 1994. The majority of these transactions resulted in the disposition of Allegiance's entire interest in such product lines and investments. In 1996, the company paid $11.2 million related to divestitures. These cash payments were associated primarily with the divestitures of the Industrial and Life Sciences division and the diagnostics manufacturing businesses discussed in Note 5 to the 39 Notes To Consolidated Financial Statements Consolidated Financial Statements. Proceeds from divestitures were $626.0 million in 1995, and $106.9 million in 1994. Proceeds in 1995 included approximately $400.0 million for the Industrial divestiture discussed earlier. The divestiture of the diagnostics manufacturing businesses resulted in proceeds of approximately $199.9 million in 1995 and $43.7 million in 1994. 7. Accounts Payable and Accrued Liabilities
as of December 31 (in millions) 1996 1995 - - ------------------------------------------------------------------------------- Accounts payable, principally trade $436.6 $377.9 Employee compensation and withholdings 72.1 88.4 Restructuring 39.3 88.7 Property, payroll and other taxes 31.2 40.2 Other 118.9 97.1 - - ------------------------------------------------------------------------------- Accounts payable and accrued liabilities $698.1 $692.3 =============================================================================== 8. Credit Facilities, Long-Term Debt and Lease Obligations Effective as of December 31 (in millions, except percentages) interest rate 1996 - - ------------------------------------------------------------------------------- Borrowings under credit facilities 6.01% $ 562.1 - - ------------------------------------------------------------------------------- 7.30% notes due 2006 7.39 199.6 - - ------------------------------------------------------------------------------- 7.80% debentures due 2016 7.88 149.4 - - ------------------------------------------------------------------------------- 7.00% 30 put 7 debentures due 2026 7.11 199.9 - - ------------------------------------------------------------------------------- Total long-term debt $1,111.0 =============================================================================== Current portion $ (4.4) - - ------------------------------------------------------------------------------- Long-term portion $1,106.6 ===============================================================================
As of December 31, 1996, the company's two unsecured revolving credit agreements provided for up to an aggregate of $1,050.0 million in borrowings. One of the credit facilities provides for borrowings up to an aggregate of $900.0 million and expires in September 2001. At December 31, 1996, $260.0 million was outstanding under this facility. The other credit facility provided for borrowings up to an aggregate of $150.0 million and expired in September 1997. There were no amounts outstanding under this facility at December 31, 1996, and the company terminated this facility on January 23, 1997. In conjunction with these facilities, the company is required to comply with certain financial tests and maintain certain leverage ratios. The company also maintains other short- term credit facilities. At December 31, 1996, $302.1 million was outstanding under these uncommitted facilities. Of the amounts outstanding under all facilities, $557.7 million has been classified as long-term debt at December 31, 1996, as amounts are supported by a long-term credit facility and will continue to be refinanced. Amounts borrowed under these facilities were used to fund a $1,147.3 million distribution to Baxter and for working capital requirements. The company had unamortized debt issuance costs of $4.5 million at December 31, 1996. Such costs are being amortized over the life of the underlying debt. Certain facilities and equipment are leased under operating leases, expiring at various dates. Most of the operating leases contain renewal options. Total expense for all operating leases was $26.0 million in 1996, $26.4 million in 1995 and $37.5 million in 1994. Future Minimum Debt and Lease Payments
Operating Aggregate debt as of December 31 (in millions) leases maturities - - -------------------------------------------------------------- 1997 $21.3 $ 4.4 1998 17.1 - 1999 12.7 - 2000 10.2 - 2001 5.5 557.7 Thereafter 8.8 550.1 - - -------------------------------------------------------------- Total obligations and commitments $75.6 $1,112.2 ============================================================== Amounts representing interest, discounts, premiums and deferred financing costs - $ 1.2 ============================================================== Present value of long-term debt - $1,111.0 ==============================================================
9. Financial Instruments and Risk Management Concentrations of Credit Risk The company provides credit, in the normal course of business, to hospitals, private and government institutions, health-care agencies, insurance agencies and doctors' offices. The company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses which, when realized, have been within the range of management's allowance for doubtful accounts. 40 Notes To Consolidated Financial Statements Financial Instrument Use - Prior to Distribution Date Allegiance was considered in Baxter's overall risk management strategy prior to the Distribution Date. As part of this strategy, Baxter used certain financial instruments to reduce its exposure to adverse movements in foreign-exchange rates, interest rates and certain commodity prices. The strategies of Baxter did not utilize financial instruments for trading purposes. As part of implementing its strategy prior to the Distribution Date, Baxter allocated to Allegiance the income and expense associated with certain option contracts used to hedge anticipated cost of production expected to be denominated in foreign currencies. The terms of these financial instruments were less than one year. Allocated net expense and the related notional amounts for these options were immaterial in all years presented. Financial Instrument Use - Subsequent to Distribution Date Allegiance uses certain commodity contracts to hedge costs of production expected to be denominated in foreign currency. At December 31, 1996, the related notional amount of such contracts was $21.0 million. Net expense related to these contracts was not material. Use of financial instruments was not for trading purposes. Subsequent to the Distribution Date, the company's objective is to manage the impact of interest rate changes on earnings, cash flows and borrowings. The company maintains fixed-rate debt as a percentage of total debt between a minimum and maximum percentage, as part of an overall risk management strategy. The company's foreign-exchange objective is to reduce cash flow volatility and earnings fluctuations associated with foreign-exchange rate changes. It is the company's policy to utilize financial instruments to manage risk associated with interest rate, foreign-currency or commodity transactions only to the extent necessary to meet its objectives. At December 31, 1996, the company evaluated its interest and foreign-exchange exposures and concluded that it was not beneficial to use financial instruments to hedge its current positions with respect to interest or foreign-exchange exposures. Fair Values of Financial Instruments The carrying values of cash and cash equivalents, accounts receivable and payable, and accrued liabilities, approximate fair value due to the short-term maturities of these assets and liabilities. Investments in affiliates are accounted for by both the cost and equity methods and pertain to several minor equity investments in companies for which fair values are determined by quoted market prices and others for which fair values are not readily available, but are believed to approximate carrying amounts. The aggregate fair value of borrowings under credit facilities approximate carrying amount, because of recent and frequent repricing based on market conditions. The carrying values of long-term borrowings, lease obligations and hedges approximate fair value at December 31, 1996. The fair value of long-term debt is based on quoted market prices for the same or similar issues. 10. Related Party Transactions Prior to the Distribution Date, Baxter provided to Allegiance certain legal, treasury, insurance and administrative services. Charges for these services were based on actual costs incurred by Baxter. In addition, Allegiance was the primary distributor of Baxter's intravenous solutions, cardiovascular devices and other products in the United States and also provided other services to Baxter. Negotiated fees for these distribution services were generally under the same terms and conditions granted to independent third parties. Additionally, these fees were not materially different than the terms of the distribution agreement subsequent to the Distribution. A summary of related party transactions, all of which were with Baxter or Baxter affiliates, is shown in the table below:
From Jan. 1 to (in millions) Sept. 30, 1996 1995 1994 - - ------------------------------------------------------------------- Allegiance provided: Distribution services to Baxter in the United States $160.4 $213.7 $206.0 Administrative services to Baxter 18.9 25.2 24.2 Allegiance received: Administrative services from Baxter $ 36.2 $ 48.3 $ 46.3 International distribution services from Baxter 19.4 25.8 24.8 ===================================================================
Management believes the pre-Distribution Date basis used to allocate corporate services was reasonable. However, the terms of these transactions may differ from those that would have resulted from transactions among unrelated parties. 41 Notes To Consolidated Financial Statements Prior to the Distribution Date, Allegiance participated in a centralized cash-management program administered by Baxter. Short-term advances from Baxter or excess cash sent to Baxter were treated as adjustments to Divisional Retained Earnings through the Distribution Date. No interest was charged on this balance. Effective on the Distribution Date, Baxter and Allegiance entered into a series of administrative-services agreements under which Baxter and Allegiance will continue to provide, for a specified period of time, certain administrative services that each entity historically has provided to the other. These agreements require both parties to pay each other a fee that approximates the actual costs of these services. Additionally, Allegiance has continuing significant relationships with Baxter as a distributor, customer and supplier for an array of health-care products and services. 11. Preferred Stock The board of directors has authorized the issuance of two million shares of $.01 par value preferred stock. This stock can be issued in series with varying terms as determined by the board of directors. Preferred Stock Purchase Rights During September 1996, common stockholders received a dividend of one preferred stock purchase right (collectively, the "Rights") for each share of common stock held of record. Each Right entitles the registered holder to purchase from the company one one-hundredth of a share of Series A Junior Participating Preferred Stock for $65 (subject to adjustment). The Rights will become exercisable (and transferable apart from the common stock) on the earlier of (1) 10 days following a public announcement that a person or group has acquired 15 percent or more of the common stock, or (2) 10 business days following the commencement of an offer to acquire 15 percent or more of the common stock. If, after the Rights become exercisable, any person or group (the "Acquirer") acquires 15 percent or more of the common stock (except pursuant to an offer for all outstanding shares of common stock which the independent directors determine to be fair to and otherwise in the best interests of the company and its stockholders) each Right may be exercised for common stock (or, in certain circumstances, cash, other property or securities) having a value of $130 or equal to two times the exercise price of the Right, if adjusted. In specified circumstances, each Right may be exercised for common stock of an acquiring entity having a value of $130 or equal to two times the exercise price of the Right, if adjusted. All Rights held by the Acquirer will be null and void. The company may generally redeem the Rights at a price of $.01 per Right at any time until 10 days following a public announcement that a person or group has acquired 15 percent or more of the common stock. The Rights will expire at the close of business on September 30, 2006, unless redeemed earlier. 12. Common Stock Employee Stock Purchase Plan Subsequent to the Distribution Date, the company adopted an employee stock purchase plan under which the sale of its common stock has been authorized. The purchase price is the lower of 85 percent of the closing market price on the date of subscription or 85 percent of the closing market price on the date of purchase. Expiration dates for these subscriptions run from October 1 to December 31, 1998. The weighted average subscription price was approximately $15.66 at December 31, 1996. Stock purchase plan transactions for the year ended December 31, 1996, are summarized below:
Shares subscribed 1996 - - ------------------------------------------ Inception of plan 0 Subscriptions 981,820 Purchases (93,159) Cancellations 0 - - ------------------------------------------ End of year 888,661 - - ------------------------------------------ Subscription price per share outstanding, end of year $14.45 - $23.48 ==========================================
Stock-Option Plans The company has various stock-option plans for employees and non-employee directors. All outstanding options under these plans have been granted at 100 percent of fair market value on the dates of grant and expire in 2006. At December 31, 1996, the weighted average option price was about $19.91, and no shares can be exercised until October 1998 or later. Stock-option transactions for the year ended December 31, 1996, are summarized on the following page: 42 Notes To Consolidated Financial Statements
Option shares outstanding 1996 - - ------------------------------------------------ Inception of plans 0 Granted 6,554,327 Exercised 0 Cancelled/Expired (41,728) - - ------------------------------------------------ End of year 6,512,599 - - ------------------------------------------------ Option price per share outstanding, end of year $18.38 - $22.88 ================================================
Restricted Stock In October 1996, the company granted 86,203 shares of restricted common stock to provide incentive compensation to selected employees. There was no activity related to these shares during the period. All outstanding shares are subject to future employment and vest in October 1998. SFAS No. 123 No compensation cost has been recognized for the stock-option or stock purchase plans noted above. Had compensation cost been determined based on the fair value at the date of grant consistent with the provisions of SFAS No. 123, the company's net loss and net loss per share in 1996 would have been $480.5 million and $8.75. The fair value of each option-grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants: dividend yield of 1.45 percent; expected volatility ranging from 29.8 percent to 32.9 percent; risk-free interest rate ranging from 5.1 percent to 6.5 percent; and expected lives ranging from one month to 7 years. 13. Retirement and Other Benefit Programs Prior to the Distribution, Allegiance participated in Baxter-sponsored non- contributory, defined benefit pension plans covering substantially all domestic employees as well as Baxter-sponsored contributory health-care and life- insurance benefits for substantially all domestic retired employees. Effective on the Distribution Date, Allegiance did not replace these Baxter plans. The pension liability related to Allegiance employees' service prior to the Distribution Date remained with Baxter. Additionally, the post-retirement liabilities for Allegiance employees who retired before the Distribution Date also remained with Baxter. As a result, Allegiance recognized curtailment gains of $35.9 million related to these plans during the third quarter. Pension expense associated with the Baxter-sponsored plans prior to its being frozen was $17.2 million for the nine months ended September 30, 1996, and $17.2 million and $22.2 million for the years ended December 31, 1995 and 1994, respectively. The assumed discount rate applied to benefit obligations to determine pension expense was 7.25 percent for the period ended September 30, 1996, and 9.0 percent for the years ended December 31, 1995 and 1994. The assumed long-term rate of return on assets was 9.5 percent. Expense associated with retiree benefits prior to the Distribution Date was $5.0 million for the nine months ended September 30, 1996, and $9.4 million in 1995 and 1994. Allegiance does not fund health-care and life-insurance plans for employees retiring subsequent to the Distribution Date. The liability associated with postemployment benefits such as disability- related and workers' compensation payments was $17.5 million for 1996, $14.4 million for 1995, and $13.5 million for 1994. Most U.S. employees are eligible to participate in a qualified 401(k) plan. Participants may contribute up to 12 percent of their annual compensation (limited in 1996 to $9,500 per individual) to the plan and Allegiance matches participants' contributions, up to 3 percent of compensation. Matching contributions made by Allegiance were $9.4 million in 1996, $11.4 million in 1995, and $13.7 million in 1994. 14. Other Income
years ended December 31 (in millions) 1996 1995 1994 - - ------------------------------------------------------------------- Asset dispositions, net $ - $(262.5) $(11.7) Foreign exchange 1.0 0.3 5.4 Other (5.6) (39.6) - - - ------------------------------------------------------------------- Total other income $(4.6) $(301.8) $ (6.3) ===================================================================
15. Income Taxes Income (Loss) Before Tax Expense by Category
years ended December 31 (in millions) 1996 1995 1994 - - ----------------------------------------------------------------- U.S. $(491.9) $433.9 $291.8 International 64.0 42.1 46.3 - - ----------------------------------------------------------------- Income (loss) before income tax expense $(427.9) $476.0 $338.1 =================================================================
43 Notes To Consolidated Financial Statements Income Tax Expense by Category
years ended December 31 (in millions) 1996 1995 1994 - - ----------------------------------------------------------------- Current U.S. Federal $ 48.6 $124.1 $ 90.7 State and local 11.4 34.2 26.4 International 3.5 (5.1) 3.3 - - ----------------------------------------------------------------- Current income tax expense 63.5 153.2 120.4 - - ----------------------------------------------------------------- Deferred U.S. Federal (9.4) 38.0 (5.3) State and local (1.4) 8.4 4.4 International (2.9) 3.8 3.7 - - ----------------------------------------------------------------- Deferred income tax expense (benefit) (13.7) 50.2 2.8 - - ----------------------------------------------------------------- Income tax expense $ 49.8 $203.4 $123.2 =================================================================
Income tax expense prior to the Distribution Date was calculated as if Allegiance were a stand-alone entity. Deferred Tax Assets and Liabilities
as of December 31 (in millions) 1996 1995 1994 - - ------------------------------------------------------------------------ Deferred tax assets Accrued expenses $ 93.8 $ 70.0 $ 59.5 Restructuring and non- recurring costs 62.4 56.9 77.4 Other - 0.1 0.1 - - ------------------------------------------------------------------------ Total deferred tax assets 156.2 127.0 137.0 - - ------------------------------------------------------------------------ Deferred tax liabilities Asset-basis differences 125.8 106.7 46.2 Other 4.8 1.0 (0.2) - - ------------------------------------------------------------------------ Total deferred tax liabilities 130.6 107.7 46.0 - - ------------------------------------------------------------------------ Net deferred tax assets $ 25.6 $ 19.3 $ 91.0 ========================================================================
In 1996, $7.4 million of deferred tax assets were transferred to Baxter, related primarily to spin-off costs assumed by Baxter. In 1995, $21.5 million of deferred tax assets were transferred to Baxter. The deferred tax assets related to the asset-basis difference associated with preferred stock received in connection with the divestiture of the diagnostics manufacturing businesses. Since agreements entered into with the buyer of the diagnostics manufacturing businesses require that the preferred stock be retained by Baxter for a prescribed period of time, the related deferred tax assets were transferred to Baxter. Under a tax sharing agreement with Baxter, Allegiance will pay for increases and be reimbursed for decreases to the net deferred tax assets transferred on the Distribution Date. Such increases or decreases may result from audit adjustments to Baxter's prior period tax returns. Reconciliation of Income Tax Expense (Benefit)
years ended December 31 (in millions) 1996 1995 1994 - - ------------------------------------------------------------------ Income tax expense (benefit) at statutory rate $(149.8) $166.4 $118.4 Tax-exempt operations (19.6) (17.4) (22.8) Nondeductible goodwill and non-recurring costs 213.5 28.1 13.9 State and local taxes 6.5 27.0 15.4 Foreign tax expense (2.0) (0.8) (2.4) Other factors 1.2 0.1 0.7 - - ------------------------------------------------------------------ Income tax expense $ 49.8 $203.4 $123.2 ==================================================================
The company has manufacturing operations outside the United States that benefit from reductions in local tax rates under tax incentives that will continue at least through 1998. U.S. federal income taxes, net of available foreign tax credits, on unremitted foreign earnings would have been approximately $36.4 million as of December 31, 1996. 16. Legal Proceedings Upon the Distribution, Allegiance assumed the defense of litigation involving claims related to the Allegiance Business, including certain claims of alleged personal injuries as a result of exposure to natural rubber latex gloves described below. Allegiance will be defending and indemnifying Baxter Healthcare Corporation ("BHC"), as contemplated by the agreements between Baxter and Allegiance, for all expenses and potential liabilities associated with claims pertaining to this litigation. It is expected that Allegiance will be named as a defendant in future litigation and may be added as a defendant in existing litigation. BHC was one of ten defendants named in a purported class action filed in August 1993, Kennedy, et al., v. Baxter Healthcare Corporation, et al., (Sup. Ct., Sacramento Co., Cal., #535632), on behalf of all medical and dental personnel in the State of California 44 Notes To Consolidated Financial Statements 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' demurer to the class action allegations. On February 29, 1996, the California Appellate Court upheld the trial court's ruling and the case was dismissed. In April 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 this 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). Baxter and three other companies are defendants. On October 9, 1996, the plaintiff in a case pending in federal court filed a petition with the Judicial Panel on Multi District Litigation, In re Latex Gloves Products Liability Litigation, (MDL Docket No. 1148), seeking to transfer and consolidate the cases pending in federal court for pretrial proceedings and/or trial. On February 26, 1997, the Panel granted the petition and ordered all cases pending in federal court to be transferred to the Eastern District of Pennsylvania for coordinated or consolidated pretrial proceedings. As of March 1, 1997, 80 additional lawsuits had been served on BHC and/or the company containing similar allegations of sensitization to natural rubber latex products. Allegiance intends to vigorously defend against these actions. Since none of these cases has proceeded to a hearing on the merits, Allegiance is unable to evaluate the extent of any potential liability, and unable to estimate any potential loss. Because of the increase in claims filed and the ongoing defense costs that will be incurred, the company believes it is probable that Allegiance will incur significant expenses related to the defense of cases involving natural rubber latex gloves. During the fourth quarter of 1996, the company was able to determine the minimum amount of the potential range of defense costs expected to be incurred related to existing cases. Consequently, the company recorded a charge of $19.5 million in the fourth quarter of 1996 to provide the minimum amount of the potential range of legal defense costs. 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. It is not expected that the outcome of these matters will have a material adverse effect on Allegiance's overall business, cash flow, results of operations or financial condition. Under the U.S. Superfund statute and many state laws, generators of hazardous waste sent to a disposal or recycling site are liable for cleanup of the site if contaminants from that property later leak into the environment. The law provides that potentially responsible parties may be held jointly and severally liable for the cost of investigating and remediating a site. This liability applies to the generator even if the waste was handled by a contractor in full compliance with the law. As of December 31, 1996, BHC had been identified as a potentially responsible party for cleanup costs at ten hazardous waste sites, for which Allegiance has assumed responsibility. Allegiance's largest assumed exposure is at the Thermo- Chem site in Muskegon, Michigan. Allegiance expects the total cleanup costs for this site to be between $44.0 million and $65.0 million, of which Allegiance's share would be approximately $5.4 million. This amount, net of payments of approximately $1.4 million, has been accrued and is reflected in Allegiance's consolidated financial statements. The estimated exposure for the remaining nine sites is approximately $3.9 million, which has been accrued and reflected in Allegiance's consolidated financial statements. The company is a defendant in, or has assumed the defense of, a number of other claims, investigations and lawsuits. Upon resolution of any of these uncertainties, the company may incur charges in excess of presently established reserves. Based on the advice of counsel, management does not believe the outcome of these matters or the environmental matters, individually or in the aggregate, will have a material adverse effect on Allegiance's overall business, cash flow, results of operations or financial condition. 45 Notes To Consolidated Financial Statements 17. Industry and Geographic Information Allegiance operates in a single industry segment as a leading provider of medical, surgical and laboratory products, and services that help its customers manage quality and cost in providing patient care. Through its nationwide distribution network, Allegiance distributes a wide offering of health-care products, including its own self-manufactured surgical and respiratory therapy products, to hospital and alternate-site customers. Allegiance also provides cost-management services to its health-care customers through inventory- management programs, customized packaging, and clinical procedure and process consulting. International sales from self-manufactured products are primarily in Canada, France and Germany. Additionally, the company has manufacturing operations in Malaysia, Mexico, France and Malta. The majority of raw materials used for the manufacture of natural rubber latex gloves is found in Malaysia. None of these geographic locations represents 10 percent or more of the company's net sales or identifiable assets. For the last three years, sales to customers who are members of two large hospital buying groups, Premier, Inc. ("Premier") and VHA Inc. ("VHA"), as a percentage of total sales, were 27 percent and 20 percent, respectively in 1996, 27 percent and 16 percent, respectively in 1995, and 23 percent and 13 percent, respectively in 1994. Premier and VHA each comprise a group of health-care organizations that benefit from the pricing and other benefits available to members of the group. Certain members of each group are free to purchase from the vendors of their choice. Although the loss of the relationship with either group could have a significant impact on sales to members of the group, the loss of such group would not necessarily mean the loss of all sales from all members of such group. 18. Subsequent Event On January 2, 1997, Allegiance acquired West Hudson & Co. Inc., a privately- owned health-care consulting firm with 1996 annual sales of $38.1 million. Allegiance paid approximately $30.5 million in cash and $10.5 million in stock with contingent payments to be paid over the next four years. This acquisition is consistent with Allegiance's strategic direction of providing cost-management services. 19. Quarterly Financial Results and Market for the Company's Stock (Unaudited)
First Second Third Fourth Total (unaudited, in millions, except per share data) quarter quarter quarter quarter year - - ------------------------------------------------------------------------------------------------------------------------------ 1996 Net sales $1,115.0 $1,086.1 $1,094.2 $1,091.9 $4,387.2 Gross profit 225.7 229.1 230.7 222.5 908.0 Net income (loss) /(1)/ 30.6 26.7 60.5 (595.5) (477.7) Per common share: Net income (loss) /(1)/ /(2)/ n/a n/a n/a (10.85) (8.70) Dividends n/a n/a n/a .10 .10 Market price High /(3)/ n/a n/a 18.63 27.88 27.88 Low /(3)/ n/a n/a 16.25 17.00 16.25 ============================================================================================================================== 1995 Net sales $1,226.0 /(4)/ $1,259.4 /(4)/ $1,261.6 /(4)/ $1,174.9 $4,921.9 Gross profit 279.2 266.5 266.9 231.6 1,044.2 Net income 42.8 42.6 137.8 49.4 272.6 Per common share: Net income /(2)/ n/a n/a n/a n/a n/a Dividends n/a n/a n/a n/a n/a Market price High n/a n/a n/a n/a n/a Low n/a n/a n/a n/a n/a ==============================================================================================================================
n/a - not applicable (1) Net loss for the fourth quarter includes a charge of $550.0 million for the write-down of goodwill and other non-recurring costs of a pretax amount of $95.5 million primarily for facility consolidations and other asset write- downs. (2) Earnings per share data is not applicable as Allegiance's earnings were part of the results of Baxter International Inc. through September 30, 1996. (3) Allegiance stock traded on a "when issued" basis from September 24, 1996 to September 30, 1996. (4) Data includes certain businesses that were divested in 1995. Allegiance common stock is listed on the New York Stock Exchange and the Chicago Stock Exchange. The New York Stock Exchange is the principal market on which the company's common stock is traded. At January 31, 1997, there were approximately 58,000 holders of record of the company's common stock. 46 Five-Year Summary of Selected Financial Data
years ended December 31 1996/(1)/ 1995/(2)/ 1994/(2)/ 1993/(2)/(3)/ 1992/(2)/ - - ----------------------------------------------------------------------------------------------------------------------------------- OPERATIONS Net sales $4,387.2 4,921.9 5,108.6 5,019.3 4,860.9 (in millions) Net income (loss) $ (477.7) 272.6 214.9 (68.4) 242.8 Depreciation and amortization $ 145.2 164.6 222.8 221.0 196.2 - - ----------------------------------------------------------------------------------------------------------------------------------- CAPITAL EMPLOYED Working capital $ 637.4 679.7 1,054.9 928.1 862.2 (in millions) Capital expenditures $ 102.5 111.9 122.4 273.1 278.2 Total assets $2,799.2 3,443.7 4,031.4 4,576.2 4,275.7 Long-term obligations $1,106.6 - - - - - - ----------------------------------------------------------------------------------------------------------------------------------- PER COMMON Average number of common shares SHARE/(4)/ outstanding (in millions) 54.9 n/a n/a n/a n/a Net income (loss) $ (8.70) n/a n/a n/a n/a Cash dividends declared $ 0.10 n/a n/a n/a n/a Market price - high $ 27.88 n/a n/a n/a n/a Market price - low $ 16.25 n/a n/a n/a n/a - - ----------------------------------------------------------------------------------------------------------------------------------- PRODUCTIVITY Employees at year-end 20,700 21,300 21,100 26,900 22,900 MEASURES Sales per year-end employee $211,942 231,075 242,114 186,591 212,266 Net income (loss) per employee $(23,077) 12,798 10,185 (2,543) 10,603 - - ----------------------------------------------------------------------------------------------------------------------------------- FINANCIAL RETURNS Net income (loss) as a percent of sales (10.9)% 5.5 4.2 (1.4) 5.0 AND STATISTICS Long-term debt as a percent of total year-end capital 57.2% - - - - ===================================================================================================================================
n/a - not applicable (1) Net loss for 1996 includes a charge of $550.0 million for the write-down of goodwill and other non-recurring costs of a pretax amount of $95.5 million primarily for facility consolidations and other asset write-downs. (2) Data includes certain businesses that were divested in 1994 and 1995. (3) Net loss includes a provision for restructuring charges of a pretax amount of $484.0 million. (4) Earnings per share data is not applicable as Allegiance's earnings were part of the results of Baxter International Inc. through September 30, 1996. 47 EX-23.1 8 CONSENT OF PRICE WATERHOUSE EXHIBIT 23.1 CONSENT OF PRICE WATERHOUSE LLP We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-12753) of Allegiance Corporation of our report dated February 3, 1997 appearing in the Annual Report to Stockholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears in this Form 10-K. PRICE WATERHOUSE LLP Chicago, Illinois March 27, 1997 EX-27 9 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the Consolidated Balance Sheet as of December 31, 1996 and Consolidated Statement of Operations for the year ended December 31, 1996 and is qualified in its entirety by reference to such financial statements. 1,000,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 23 0 541 26 629 1,336 1,519 681 2,799 698 1,107 55 0 0 773 2,799 4,387 4,387 3,479 4,815 (5) 10 19 (428) 50 (478) 0 0 0 (478) (8.70) 0 Gross Net loss includes a charge of $550 million for the write-down of goodwill and other non-recurring costs of a pretax amount of $96 million, primarily for facility consolidations and other asset write-downs. Common shares are based on the weighted average number of shares outstanding subsequent to the distribution on September 30, 1996, assuming the shares issued in connection with the distribution had been issued January 1. Information not applicable.
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