UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
- ----- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the transition period from to
---- ----
Commission file number 1-11885
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ALLEGIANCE CORPORATION.
----------------------
(Exact name of registrant as specified in its charter)
Delaware 36-4095179
- ------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1430 Waukegan Road, McGaw Park, Illinois 60085
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(847) 689-8410
-------------------------------
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The number of shares of the registrant's Common Stock, $1 par value, outstanding
as of August 6, 1997, the latest practicable date, was 57,990,622 shares.
-2-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Allegiance Corporation
Condensed Consolidated Statements of Income (Unaudited)
(in millions, except per share data)
- ---------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
1997 1996 1997 1996
-------- -------- -------- --------
Net sales $1,075.0 $1,086.1 $2,130.9 $2,201.1
Costs and expenses
Cost of goods sold 851.6 857.0 1,687.7 1,746.3
Selling, general and administrative expenses 161.8 175.5 322.8 341.3
Research & development 2.4 2.1 4.4 4.1
Goodwill amortization 5.4 9.2 10.7 18.4
Interest expense 17.4 - 36.3 -
Other (income) expense 2.2 (0.8) 2.4 (1.8)
- ---------------------------------------------------------------------------------------------------------------------
Total costs and expenses 1,040.8 1,043.0 2,064.3 2,108.3
- ---------------------------------------------------------------------------------------------------------------------
Income before income taxes 34.2 43.1 66.6 92.8
Income tax expense 12.2 16.4 23.6 35.5
- ---------------------------------------------------------------------------------------------------------------------
Net income $ 22.0 $ 26.7 $ 43.0 $ 57.3
=====================================================================================================================
Net income per common share $ 0.39 N/A $ 0.77 N/A
Average number of common shares outstanding 56.7 N/A 56.1 N/A
- ---------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-3-
Allegiance Corporation
Condensed Consolidated Balance Sheets
(in millions, except par value and shares)
- -------------------------------------------------------------------------------
June 30, December 31,
1997 1996
----------- ------------
(Unaudited)
Current assets Cash and equivalents $ 31.9 $ 22.9
Accounts receivable
(net of allowance for
doubtful accounts of
$25.3 and $26.4 at June
30, 1997 and December
31, 1996, respectively) 453.5 515.1
Notes and other current
receivables 16.4 32.4
Inventories 622.2 628.5
Deferred income taxes 109.6 122.8
Prepaid expenses 15.2 13.8
-------------------------------------------------
Total current assets 1,248.8 1,335.5
-------------------------------------------------
Property, plant At cost 1,521.3 1,519.1
and equipment Accumulated depreciation
and amortization (718.4) (681.2)
-------------------------------------------------
Net property, plant and
equipment 802.9 837.9
- ------------------------------------------------------------------------------
Other assets Goodwill and other
intangibles 548.4 514.5
Other 88.7 111.3
-------------------------------------------------
Total other assets 637.1 625.8
- ------------------------------------------------------------------------------
Total assets $2,688.8 $2,799.2
==============================================================================
Current
liabilities Accounts payable and
accrued liabilities $ 679.6 $ 698.1
- ------------------------------------------------------------------------------
Long-term debt 936.6 1,106.6
- ------------------------------------------------------------------------------
Deferred income taxes 105.3 107.4
- ------------------------------------------------------------------------------
Other non-current
liabilities 41.3 59.4
- ------------------------------------------------------------------------------
Equity Common stock, par value
$1.00, authorized
200,000,000 shares,
outstanding 57,946,394
shares at June 30, 1997
and 54,977,000 at
December 31, 1996 57.9 55.0
Additional contributed
capital 65.8 1.5
Retained earnings 801.1 769.2
Cumulative foreign
currency adjustment 1.2 2.0
-------------------------------------------------
Total equity 926.0 827.7
- ------------------------------------------------------------------------------
Total liabilities and
equity $2,688.8 $2,799.2
==============================================================================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-4-
Allegiance Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in millions)
- -------------------------------------------------------------------------------------------------
Six months ended
June 30,
1997 1996
------- ------
(Brackets denote cash outflows)
Cash flow provided Net income $ 43.0 $ 57.3
by operations Adjustments
Depreciation and amortization 62.5 73.2
Deferred income taxes 10.1 15.6
Other 5.3 (0.3)
Changes in balance sheet items
Accounts and notes receivable 80.5 68.5
Inventories 6.5 24.1
Accounts payable and other current liabilities (7.5) (87.5)
Restructuring program payments (15.6) (21.4)
Other (4.4) 6.2
-----------------------------------------------------------------------
Cash flow provided by operations 180.4 135.7
- -------------------------------------------------------------------------------------------------
Investment Capital expenditures (32.3) (33.0)
transactions Acquisitions (net of cash received) (43.4) (14.3)
Divestitures 17.2 -
Proceeds from asset dispositions 15.2 (10.0)
-----------------------------------------------------------------------
Investment transactions, net (43.3) (57.3)
- -------------------------------------------------------------------------------------------------
Financing Payments to Baxter International Inc. - (74.5)
transactions Decrease in debt with maturities of three months
or less, net (158.8) -
Issuances of debt 35.0 -
Redemption of debt (50.0) -
Common stock cash dividends (11.1) -
Common stock issued under Shared Investment Plan 54.8 -
Common stock issued under employee benefit plans 4.6 -
Purchase of treasury stock (2.6) -
-----------------------------------------------------------------------
Financing transactions, net (128.1) (74.5)
- -------------------------------------------------------------------------------------------------
Increase in cash and equivalents 9.0 3.9
Cash and equivalents at beginning of period 22.9 0.8
- -------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 31.9 $ 4.7
=================================================================================================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-5-
Allegiance Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Company background
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. No historical earnings per share data is presented prior to October 1,
1996, as the Allegiance Business' earnings were part of Baxter's consolidated
results through the close of business on September 30, 1996.
2. Financial information
The unaudited interim condensed consolidated financial statements of Allegiance
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. These interim
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
company's 1996 Annual Report to Stockholders and Annual Report on Form 10-K for
the year ended December 31, 1996.
In the opinion of management, the interim condensed consolidated financial
statements reflect all adjustments necessary for a fair presentation of the
interim periods. All such adjustments are of a normal, recurring nature. The
results of operations for the interim period are not necessarily indicative of
the results of operations to be expected for the full year.
-6-
3. Pro forma financial information
- ------------------------------------
The following unaudited pro forma combined statements of income present the
combined results of Allegiance assuming that the transactions contemplated by
the Distribution had been completed as of January 1, 1996. The unaudited pro
forma information has been prepared utilizing the historical consolidated
financial statements of Allegiance. All pro forma adjustments were
substantially consistent with those disclosed in the company's 1996 Annual
Report to Stockholders and Annual Report on Form 10-K for the year ended
December 31, 1996 (in millions, except per share data).
Three months ended Six months ended
June 30, 1996 June 30, 1996
------------- -------------
Net sales $1,089.9 $2,202.0
Costs and expenses
Cost of goods sold 860.4 1,747.6
Selling, general and administrative expenses 176.9 344.9
Research & development 2.1 4.1
Interest, net 22.5 45.0
Goodwill amortization 9.2 18.4
Other (income) expense 0.2 (0.8)
-------- --------
Total costs and expenses 1,071.3 2,159.2
-------- --------
Pretax income 18.6 42.8
Income tax expense 6.8 15.9
-------- --------
Net income $ 11.8 $ 26.9
======== ========
Net income per common share $ 0.21 $ 0.49
Average number of common
shares outstanding 54.9 54.9
======== ========
4. Inventories
- ----------------
- ---------------------------------------------------------------------------------------------
June 30, December 31,
(in millions) 1997 1996
- ---------------------------------------------------------------------------------------------
Raw materials $ 55.6 $ 52.8
Work in process 51.7 46.4
Finished products 514.9 529.3
- ---------------------------------------------------------------------------------------------
Total inventories $622.2 $628.5
=============================================================================================
5. Restructuring charges
- --------------------------
- --------------------------------------------------------------------------------------------------
Divestitures
Employee- and asset Other
(in millions) related costs write-downs costs Total
- --------------------------------------------------------------------------------------------------
December 31, 1996 balance $24.0 $22.0 $20.1 $ 66.1
- --------------------------------------------------------------------------------------------------
Utilization:
Cash (6.8) - (8.8) (15.6)
Non-cash - (0.9) - (0.9)
- --------------------------------------------------------------------------------------------------
June 30, 1997 balance $17.2 $21.1 $11.3 $ 49.6
==================================================================================================
Cash outflows pertain primarily to employee-related costs for severance,
outplacement assistance, relocation, implementation teams and facility
consolidations. Since the inception of the restructuring program, approximately
2,500 positions have been eliminated. The remaining expenditures will occur
throughout 1997 and 1998, as implementation team projects and facility closures
and consolidations are completed as planned.
-7-
6. Shared Investment Plan
- ---------------------------
On May 2, 1997, the company received $54.8 million in cash from 141 members of
Allegiance's management who purchased approximately 2.4 million shares of the
company's stock. This plan was designed to directly align management and
stockholder interests. Under the terms of the voluntary program, Allegiance
managers used personal full-recourse loans to purchase the newly issued shares
at the closing price per share on May 2, 1997 of $23 1/4. The loans, borrowed
from several banks, are at market interest rates and are the personal
obligations of the participants. Allegiance has agreed to guarantee repayment
to the banks in the event of default by a participant. Allegiance may take all
actions necessary to obtain full reimbursement from the participant for amounts
paid by Allegiance, if any, to the banks in the future under its guarantee. The
participant break-even point - the future stock price that will cover both the
initial participant loans and the related interest over a five year period - is
$31 1/2.
7. 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. On
April 8, 1994, a similar purported class action, Green, et al., v. Baxter
Healthcare Corporation, et al., (Cir. Ct., Milwaukee Co., WI, 94CV004977), was
filed against BHC and three other defendants. The class action allegations have
been withdrawn, but additional plaintiffs added individual claims. On July 1,
1996, BHC was served with a similar purported class action, Wolf v. Baxter
Healthcare Corp., et al., (Circuit Court, Wayne County, MI, 96-617844NP). BHC
is the only named defendant in that suit. On January 3, 1997, BHC was served
with a similar, nationwide proposed class action, Murray, et al., v. Baxter
Healthcare Corporation, et al., (U.S.D.C. Southern District of Indiana, IP96-
1889C). BHC and three other companies are defendants. On April 11, 1997, a
similar proposed statewide class action, Delpit, et al. v. Ansell, Inc., et al.,
(U.S.D.C. Eastern District of Louisiana, 97-1112), was filed on behalf of users
of latex gloves in the State of Louisiana. BHC and five other companies are
defendants. On April 29, 1997, another similar proposed state-wide class
action, Cowart, et. al. v. Ansell, Inc., et. al., (Civil District Court, Parish
of Orleans, 97-7237), was filed on behalf of users of latex gloves. Baxter
International Inc. and three other companies are defendants. On October 9,
1996, the plaintiff in a case pending in federal court filed a petition with the
Judicial Panel Multi District Litigation, In Re Latex Gloves Products Liability
Litigation, (MDL Docket No. 1148), seeking to transfer and
-8-
consolidate the cases involving claims related to natural rubber latex gloves
pending in federal court for pretrial proceedings and/or trial. On February 26,
1997, the Panel granted the petition and ordered all cases pending in federal
court to be transferred to the Eastern District of Pennsylvania for coordinated
or consolidated pretrial proceedings. As of August 6, 1997, there are an
additional 115 active lawsuits involving BHC and/or the company containing
similar allegations of sensitization to natural rubber latex products.
Allegiance intends to vigorously defend against these actions. Since none of
these cases has proceeded to a hearing on the merits, Allegiance is unable to
evaluate the extent of any potential liability, and unable to estimate any
potential loss.
Because of the increase in claims filed and the ongoing defense costs that will
be incurred, the company believes it is probable that Allegiance will incur
significant expenses related to the defense of cases involving natural rubber
latex gloves. During the fourth quarter of 1996, the company 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 June 30, 1997, 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.
-9-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following management discussion and analysis describes material changes in
the company's financial condition since December 31, 1996. Trends of a material
nature are discussed to the extent known and considered relevant. This
discussion should be read in conjunction with the consolidated financial
statements, related notes thereto and management's discussion and analysis of
financial condition and results of operations included in the company's 1996
Annual Report to Stockholders and Annual Report on Form 10-K for the year ended
December 31, 1996.
Certain statements in this discussion constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Statements indicating the company "plans," "expects," "estimates" or "believes"
are forward-looking statements that involve known and unknown risks, including,
but not limited to, general economic and business conditions, changing trends in
the health-care industry and customer profiles, competition, changes in
governmental regulations, and unfavorable foreign currency fluctuations.
Although Allegiance believes its expectations with respect to the forward-
looking statements are based upon reasonable assumptions within the bounds of
its knowledge of its business and operations, there can be no assurance that
actual results, performance or achievements of Allegiance will not differ
materially from any future results, performance or achievements expressed or
implied by such forward-looking statements. In accordance with the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995,
Allegiance provides cautionary statements, detailed in Securities and Exchange
Commission filings, including, without limitation, the company's Form 10-K and
10-Qs, which identify specific factors that would cause actual results or events
to differ materially from those described in the forward-looking statements.
The company undertakes no obligation to update publicly any forwarding-looking
statement whether as a result of new information, future events or otherwise.
RESULTS OF OPERATIONS
Sales
- -------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
(in millions, except percentages) 1997 1996 1997 1996
- -------------------------------------------------------------------------------
Geographic region
United States $1,007.5 $1,010.4 $1,998.0 $2,057.4
% decrease (0.3%) (2.9%)
International 67.5 75.7 132.9 143.7
% decrease (10.8%) (7.5%)
- -------------------------------------------------------------------------------
Total net sales $1,075.0 $1,086.1 $2,130.9 $2,201.1
% decrease (1.0%) (3.2%)
- -------------------------------------------------------------------------------
Product category
Distributed product $ 674.7 $ 691.7 $1,355.6 $1,424.1
% decrease (2.5%) (4.8%)
Self-manufactured product 400.3 394.4 775.3 777.0
% increase (decrease) 1.5% (0.2%)
- -------------------------------------------------------------------------------
Total net sales $1,075.0 $1,086.1 $2,130.9 $2,201.1
% decrease (1.0%) (3.2%)
- -------------------------------------------------------------------------------
-10-
The decline in Allegiance's domestic and distributed product net sales for the
three and six months ended June 30, 1997 as compared to the same periods in the
prior year principally resulted from the ongoing execution of plans to improve
profitability by reducing sales in lower-margin, distributed products in the
United States. During the second quarter of 1997, management partially offset
the decline noted above with increased net sales of self-manufactured product in
the United States discussed below, which resulted in domestic net sales being
relatively flat as compared to the three months ended June 30, 1996.
International sales during the three and six months ended June 30, 1997 as
compared to the same periods in the prior year continued to be reduced by
unfavorable foreign-exchange rates. In addition, the comparison to the prior
year continues to be unfavorably impacted by Allegiance's selling arrangements
in international markets. Prior to the company's spin-off from Baxter, the
company sold products directly to customers. Subsequent to becoming an
independent public company, Allegiance sells products through Baxter as a
distributor. During the three months ended June 30, 1997, slow sales in the
European markets also contributed to the international sales decline as compared
to the same period in the prior year.
The increase of self-manufactured product net sales during the three months
ended June 30, 1997 as compared to the same period in the prior year resulted
from increased sales volume in the U.S., offset slightly by U.S. pricing
pressures and the decline in international sales discussed above. This increase
during the second quarter of 1997 was offset by lower sales volume during the
first quarter resulting in relatively flat sales growth of self-manufactured
product for the six months ended June 30, 1997 as compared to the same period in
the prior year.
Costs and Expenses
- ---------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
(as a percentage of net sales) 1997 1996 1997 1996
- ---------------------------------------------------------------------------------
Gross margin 20.8% 21.1% 20.8% 20.7%
Selling, general and administrative
expenses 15.1 16.2 15.1 15.5
- ---------------------------------------------------------------------------------
The company's gross margin remained relatively flat for the three and six months
ended June 30, 1997 as compared to the same periods in the prior year. Self-
manufactured products continued to experience pricing pressure, which the
company has generally been able to offset with cost efficiencies and a more
profitable product mix. Allegiance plans to continue its efforts to stabilize
its gross margin by offsetting pricing pressures with manufacturing and other
cost efficiencies, managing its product mix more effectively, and, when
possible, instituting price increases.
In 1996, selling, general, and administrative expense for the first six months
benefited from a $5.7 million non-recurring reversal of excess reserves.
Excluding this item, selling, general and administrative expenses as a percent
of net sales for the six months ended June 30, 1996, would have been 15.8%. The
reduction in selling, general and administrative expenses as a percent of sales
during the three and six months ended June 30, 1997 as compared to the same
periods of the prior year, resulted principally from lower headcount, lower
benefit costs and overall expense control initiatives implemented by management
in both current and prior periods. Management plans to continue to implement
its expense control initiatives.
-11-
Goodwill
Goodwill expense for the three and six months ended June 30, 1996 does not
reflect the quarterly benefit of $4.7 million of lower goodwill amortization
that resulted from the company's $550.0 million write-down of goodwill during
the fourth quarter of 1996.
Restructuring Program
In November 1993, Baxter initiated a restructuring program to improve
stockholder value and reduce costs. These strategic actions were designed in
part to make the Allegiance Business more efficient and responsive in addressing
the changes occurring in the U.S. health-care system. See Note 5 to "Notes to
the Condensed Consolidated Financial Statements" for discussions related to cash
and non-cash utilization of the reserves and headcount reductions to date.
Management believes that the program is on target to achieve anticipated savings
of approximately $155 million in 1997 and exceeding $155 million in 1998. The
company anticipates that these savings will continue to partially offset
potential future gross margin erosion and investments into cost-management
initiatives as well as help leverage selling, general and administrative expense
ratios. Management further believes that its remaining restructuring reserves
are adequate to complete the actions contemplated by the restructuring program
and that future cash expenditures related to the program will be funded from
cash generated from operations.
Interest Expense
Prior to September 30, 1996, Allegiance participated in a centralized cash-
management program administered by Baxter. No interest was charged by Baxter.
Upon the spin-off, amounts were borrowed to fund a $1,147.3 million distribution
to Baxter and for working capital requirements.
Other Income And Expense
The change in other income and expense for the three and six months ended June
30, 1997 as compared to the same periods in the prior year was caused by
unfavorable foreign exchange rates and losses related to certain equity
investments of the company.
Pretax Income
- ------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
(in millions, except percentages) 1997 1996 1997 1996
- ------------------------------------------------------------------------------
Pretax income, as reported $ 34.2 $43.1 $ 66.6 $92.8
% decrease (20.6%) (28.2%)
Adjust for goodwill expense - 4.7 - 9.4
Adjust for interest expense 17.4 - 36.3 -
Adjust for non-recurring item - - - (5.7)
- ------------------------------------------------------------------------------
Adjusted pretax income $ 51.6 $47.8 $102.9 $96.5
% increase 7.9% 6.6%
- ------------------------------------------------------------------------------
Adjusted for the goodwill write-down and interest expense discussed previously
which did not impact earnings until the fourth quarter of 1996, pretax income
increased for the three months ended June 30, 1997 as compared to the same
period in the prior year as a result
-12-
of the reductions in selling, general and administrative expenses noted above,
partially offset by the decline in gross margin noted above.
Excluding the $5.7 million non-recurring reversal of excess reserves discussed
above that occurred during the six months ended June 30, 1996, and adjusting for
the goodwill write-down and interest expense discussed previously, pretax income
for the six months ended June 30, 1997 increased as a result of the improved
gross margins and the reduction in selling, general and administrative expenses
noted above.
Income Taxes
Allegiance's effective tax rate during the three and six months ended June 30,
1997 was lower than the same periods in the prior year by 2.4 and 2.8 percentage
points, respectively. The decrease was caused principally by the positive
impact on 1997 earnings of lower goodwill amortization, which is a non-taxable
item.
Net Income
Excluding the non-recurring reversal of excess reserves and adjusting for
goodwill and interest expense, the change in net income during the three and six
months ended June 30, 1997 as compared to the same periods in the prior year is
consistent with the changes in pretax income and income taxes discussed
previously.
ADOPTION OF NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") has issued Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share". SFAS No.
128 requires presentation on the face of the income statement of both basic and
diluted earnings per share ("EPS"). SFAS No. 128 is effective for financial
statements issued for periods ending after December 15, 1997, and requires
restatement of all prior period EPS data presented. The adoption of this
statement is not expected to materially affect either future or prior period EPS
data.
In July 1996, the FASB Emerging Issues Task Force ("EITF") issued EITF No.
96-14, "Accounting for the Costs Associated with Modifying Computer Software for
the Year 2000," in which it reached a consensus that external and internal costs
specifically associated with modifying internal-use software for the year 2000
should be charged to expense as incurred. The company does not expect the
future impact of this EITF to have a material impact on results of operation.
LIQUIDITY AND CAPITAL RESOURCES
Allegiance's current assets exceeded current liabilities by $569.2 million at
June 30, 1997 versus an excess of $637.4 million at December 31, 1996. This
decrease in working capital resulted primarily from management's focused efforts
to prepay debt. Current assets at June 30, 1997 included accounts, notes and
other current receivables of $469.9 million and inventories of $622.2 million.
These sources of liquidity are convertible into cash over a relatively short
period of time and, thus, could be available to help Allegiance satisfy normal
operating cash requirements.
The company intends to fund its short- and long-term obligations as they mature
through cash flow from operations, existing credit facilities or issuance of
debt or equity. Management believes the company has credit facilities adequate
to support ongoing operational, capital, restructuring and litigation
requirements. Beyond that, Allegiance
-13-
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
- -------------------------------------------------------------------------
Six months ended
June 30,
(brackets denote cash outflows, in millions) 1997 1996
- -------------------------------------------------------------------------
Cash flow provided by operations as
stated in the company's Condensed
Consolidated Statements of Cash Flows $180.4 $135.7
Capital expenditures (32.3) (33.0)
Common stock cash dividends (11.1) -
- -------------------------------------------------------------------------
"Free cash flow" $137.0 $102.7
=========================================================================
This increase in cash flow provided by operations during 1997 resulted primarily
from improved balance sheet management (primarily accounts and notes
receivable), partially offset by the unadjusted decrease in earnings discussed
previously.
Management emphasizes "free cash flow" as an internal measure of operating cash
flow after capital expenditures and dividends as reconciled in the table above.
Management's objective is to maximize "free cash flow", and incentive
compensation programs throughout the company include emphasis on management of
working capital and the attainment of "free cash flow" targets. The level of
"free cash flow" during the six months ended June 30, 1997 enabled the company
to pay down $173.8 million of long-term debt and funded the acquisition of West
Hudson & Co. Inc., which is discussed below.
Investment Transactions
- -------------------------------------------------------------------------
Six months ended
June 30,
(brackets denote cash outflows, in millions) 1997 1996
- -------------------------------------------------------------------------
Capital expenditures $(32.3) $(33.0)
Acquisitions (43.4) (14.3)
Divestitures 17.2 -
Proceeds from asset dispositions 15.2 (10.0)
- -------------------------------------------------------------------------
Total investment transactions, net $(43.3) $(57.3)
=========================================================================
Capital expenditure levels during the six months ended June 30, 1997 as compared
to the same period in 1996 are relatively consistent. Allegiance management
expects to invest in capital expenditures throughout 1997 at levels consistent
with 1996, principally for improvements to existing facilities, system upgrades,
productivity-enhancing equipment and other cost reduction projects.
Consistent with Allegiance's strategic direction of providing cost-management
services, Allegiance acquired West Hudson & Co. Inc., a privately-owned health-
care consulting firm, on January 2, 1997 for $30.5 million in cash and $10.5
million in stock with contingent payments payable over the next four years. The
remaining acquisitions during the six months ended June 30, 1997, as well as the
acquisitions during the same period in 1996, are consistent with Allegiance's
strategic direction, and were made to broaden product lines and service
offerings or expand market coverage.
-14-
In April 1997, Allegiance sold substantially all of its investment in
MedManagement, L.L.C., which generated net proceeds of $17.2 million.
Cash proceeds from asset dispositions relate to the sale of miscellaneous
facilities during the six months ended June 30, 1997. The net use of cash
related to asset dispositions for the six months ended June 30, 1996 primarily
related to cash payments associated with the settlement of certain programs
arising from the divestitures of the Industrial and Life Sciences division and
the diagnostics manufacturing businesses.
Refer to Note 6 to "Notes to Condensed Consolidated Financial Statements" for a
discussion of the $54.8 million in cash received in May 1997 relating to the
Shared Investment Plan.
LITIGATION
See Note 7 to "Notes to Condensed Consolidated Financial Statements" for a
detailed description of the status of Allegiance's litigation.
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 June 30, 1997, 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 the
uncertainties described in Note 7 to "Notes to Condensed Consolidated Financial
Statements", Allegiance may incur charges in excess of presently established
reserves. Based on the advice of counsel, management does not believe the
outcome of these matters individually or in the aggregate, will have a material
adverse effect on Allegiance's overall business, cash flow, results of
operations or financial condition.
-15-
PART II. OTHER INFORMATION
Allegiance Corporation
Item 1. Legal Proceedings
Note 7 to "Notes to Condensed Consolidated Financial Statements" (Part I, Item I
of this Report) and "Litigation" set forth in Management's Discussion and
Analysis of Financial Condition and Results of Operations (Part I, Item 2 of
this Report) are incorporated herein by reference.
Item 4. Submission of Matters to a Vote of Security Holders
The company's 1996 annual meeting of stockholders was held on May 15, 1997 for
the purpose of electing directors. Proxies for the meeting were solicited
pursuant to Section 14 (a) of the Securities Exchange Act of 1934, and there was
no solicitation in opposition to management's solicitation. Both of
management's nominees for directors as listed in the proxy statement were
elected with the following vote:
Number of Votes
----------------------
In favor Withheld
----------- ----------
Silas S. Cathcart 47,795,175 225,311
Michael D. O'Halleran 47,794,046 226,440
The following directors' terms of office continued after the meeting:
Connie R. Curran
Joseph F. Damico
Arthur F. Golden
Kenneth D. Bloem
David W. Grainger
Lester B. Knight
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit
Index hereto.
(b) Report on Form 8-K
Not applicable.
-16-
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGIANCE CORPORATION
---------------------------
(Registrant)
Date: August 11, 1997 By:___________________________
Peter B. McKee
Senior Vice President and
Chief Financial Officer
-17-
Exhibits Filed with Securities and Exchange Commission
Number Description of Exhibit
- ------ ----------------------
10.1 Shared Investment Plan dated
May 2, 1997
11.1 Statement re computation of primary earnings
per common share.
11.2 Statement re computation of fully diluted
earnings per common share.
27 Financial Data Schedule. *
(All other exhibits are inapplicable.)
* Shown only in the original filed with the Securities and Exchange Commission.
- --------------------------------------------------------------------------------
Copies of the above exhibits not contained herein are available at a charge of
35 cents per page upon written request to the Investor Relations Department,
Allegiance Corporation, 1430 Waukegan Road, McGaw Park, IL 60085. Copies are
also available at a charge of at least 25 cents per page from the Public
Reference Section of the Securities and Exchange Commission, 450 Fifth Street
N.W., Washington, D.C., 20549.