ITEM 1. BUSINESS
BACKGROUND
ALARIS Medical, Inc. ("ALARIS Medical"), a holding company, operating through its consolidated subsidiaries, designs, manufactures, distributes and services intravenous infusion therapy and patient monitoring instruments and related disposables and accessories. ALARIS Medical was formed by the merger of two pioneers in infusion systems, IMED Corporation and IVAC Medical Systems, Inc., on November 26, 1996. ALARIS Medical and its subsidiaries are collectively referred to as the "Company." ALARIS Medical (formerly Advanced Medical, Inc.) was incorporated on September 28, 1988 under the laws of the State of Delaware.
OVERVIEW
The Company is a leading provider of infusion systems and related technologies to the United States hospital market, with the largest installed base of pump delivery lines ("channels"). The Company is also a leader in the International infusion systems market. Based on its installed base of infusion pumps, the Company has a number one or two market position in seven Western European countries, the number three market position in three others, the largest installed base of infusion pumps in Australia and Canada and a developing position in Latin America and Asia. The Company's infusion systems, which are used to deliver one or more fluids, primarily pharmaceuticals or nutritionals to patients, consist of single and multi-channel infusion pumps and dedicated and non-dedicated disposable administration sets (i.e., plastic tubing and pump interfaces). In addition, the Company is a leading provider of patient monitoring products that measure and monitor temperature, pulse, pulse oximetry and blood pressure, with the largest installed base of hospital thermometry systems in the United States.
ALARIS Medical has defined two strategic business units: North America, which includes the United States and Canada; and International, which includes all other international operations, including Europe, Asia, Australia and Latin America.
The North American and International operating units manufacture and market intravenous infusion therapy devices and patient monitoring products, primarily using a direct sales force for product distribution. The International unit also utilizes product distributors in areas where the Company does not have a direct sales force. Distributor sales accounted for 10.4% of International sales in 2000. Service of the Company's products represented approximately 5% of the Company's sales in 2000.
The Company sells a full range of products through the worldwide direct sales force consisting of over 250 salespersons and through more than 150 distributors to over 5,000 hospitals worldwide. Sales to customers located in and outside of North America accounted for approximately 68.6% and 31.4%, respectively, of the Company's sales for the year ended 2000. For the year ended December 31, 2000, the Company had sales of approximately $378.9 million.
- -------------------------------------------------------------------------------- The Company has registered or applied to register the following trademarks: AccuSlide(R), ALARIS(R), ALARIS Medical Systems(R), Asena(TM), COREoCHECK(R), Gemini(R), Gemini PC-1(R), Gemini PC-2(R), Gemini PC-2TX(R), Gemini PC-4(R), Guardrails(TM), IMED(R), IVAC(R), MEDLEY(TM), MedSystem III(R), Patient Solutions, Inc.(R), PCAM(R), Profiles(TM), ReadyMED(R), Signature Edition(R), SmartSite(R), TURBOoTEMP(TM), VersaSafe(R), VITALoCHECK(R)
INFUSION SYSTEMS. The Company offers a wide variety of infusion pumps designed to meet the varying price and technological requirements of its diverse customer base. These infusion pumps include the Gemini series, consisting of single, dual and four channel infusion pumps designed for use in all hospital settings by customers with sophisticated technological requirements; the Signature Edition Family, a versatile, user-friendly single and dual channel infusion pump for use in critical and general medical and surgical settings; the MedSystem III instrument (the "MS III"), a compact, lightweight, programmable three channel infusion pump targeted for the hospital critical care setting and patient transport applications. A single channel pump has only one fluid delivery line to the patient, while a multi-channel pump has two or more fluid delivery lines. Multi-channel pumps are used to service only a single patient. Generally, where more than one fluid delivery line is required for a patient, purchasing a multi-channel pump is less costly than purchasing an equivalent number of single channel pumps. In addition, the Company offers the ReadyMED ambulatory infusion pump ("ReadyMED"), which is compact, lightweight and disposable for use in the alternate-site market, as well as a broad range of syringe infusion pumps for use primarily outside the United States.
The Company also manufactures and sells dedicated disposable administration sets which are required to be used with the Company's large volume infusion pumps. Since the useful lives of the Company's infusion pumps typically range between seven to ten years, the Company's industry-leading installed base allows it to generate predictable and recurring revenues from sales of disposable administration sets. For the year ended December 31, 2000, the Company sold approximately 79.0 million dedicated and non-dedicated disposable administration sets representing sales of $237.1 million or 62.6% of sales. Disposable administration sets sales for 2000 for the North America and International business units were $165.6 million and $71.5 million, respectively. Many of the Company's disposable administration sets offer protection features designed to prevent the unregulated flow of fluids into a patient's blood stream ("free flow"). In addition, the Company also has several enhancements to its disposable administration sets, including needle-free access systems that are designed to reduce the risk to health care providers of diseases, such as AIDS and hepatitis, that may be transmitted through accidental needlesticks and, in the case of the SmartSite needleless system, to eliminate patient exposure to latex which can cause severe allergic or anaphylactic shock reactions. These features continue to provide the Company's customers with the latest cost-effective technology for the Company's installed base of infusion pumps. For the year ended December 31, 2000, the Company's infusion systems sales (pumps and disposables) were $326.2 million, representing approximately 86.1% of sales.
PATIENT MONITORING PRODUCTS. The Company's patient monitoring products compete in discrete market niches, each with different competitive dynamics. The Company primarily operates in the United States, Canada and Western Europe in two patient monitoring products markets: (I) hospital thermometry systems and (ii) stand-alone, non-invasive, multi-parameter instruments used to measure and monitor a combination of vital signs. For the year ended December 31, 2000, the Company's patient monitoring product sales were approximately $31.1 million, representing approximately 8% of the Company's total sales. Patient monitoring sales for North America and International for 2000 were $27.0 million and $4.1 million, respectively.
The Company's principal thermometry instruments, the electronic thermometer and the infrared tympanic thermometer, are both widely used in hospitals and alternate site settings. The Company believes it is the second largest participant in the United States infrared thermometry market. The Company's large base of installed hospital thermometry instruments allows it to generate predictable and recurring revenues from sales of related dedicated disposable probe covers. In 2000, the Company sold over 583 million dedicated disposable probe covers into its worldwide installed base. In addition, the Company participates in the hospital market of stand-alone, non-invasive, multi-parameter instruments through its VITALOCHECK product line, which measures and monitors a combination of temperature, pulse, blood pressure and pulse oximetry.
INDUSTRY
GENERAL. In the United States, the Company sells its products primarily in two markets: the hospital market and the alternate-site market. The United States hospital market consists of approximately 5,000 hospitals with a total of approximately 950,000 licensed beds. Within this market, cost containment measures both imposed and proposed by federal and state regulators and private payors, combined with increased utilization review and case management, have led to greater financial pressure on hospitals. In response to these cost-containment pressures, many hospitals and other potential customers for the Company's products participate in group purchasing organizations ("GPOs") which may be large and which monitor compliance with exclusive purchase commitments. GPOs may enter into exclusive purchase commitments with as few as one or two providers of infusion systems and/or patient monitoring products, for a period of several years. Historically, this has led to downward pricing pressure on manufacturers of medical products, including the Company, and greater use of care settings outside the hospital (i.e., the alternate-site setting) for treatment. See "--Marketing and Sales."
The alternate-site market encompasses all health care provided outside the hospital and comprises primarily home health care, freestanding clinics, skilled nursing facilities and long-term care facilities. The market for infusion systems used in the alternate site has experienced a greater growth rate than that of the hospital market. This growth is primarily attributable to advances in technology that have facilitated the provision of care outside of the hospital, an increased number of illnesses and diseases considered to be treatable with home infusion therapy and increased acceptance by the medical community of, and patient preference for, non-hospital treatment.
The Company also sells its products internationally. The Western European infusion therapy market, which includes infusion pumps, controllers, and disposable intravenous sets, is believed to be in excess of $400 million annually. Unlike the U.S. market, syringe pumps represent a significant share of total infusion pump placements in the international market. The Company expects the trend toward utilization of syringe pumps to continue as hospitals favor the lower cost associated with syringe pumps and focus on administering pharmaceuticals and nutritionals to patients in higher concentrations. The majority of revenues in the international market are derived from hospitals; the alternate-site market is in a developmental stage.
The Company believes that as the worldwide infusion systems and patient monitoring markets continue to mature, providers of goods and services in these markets will need to increase the scale of their operations and broaden the scope of their product lines in order to leverage worldwide sales, service and research and development infrastructures. These trends are driving industry consolidation both in the United States and internationally which, in turn, provide opportunities for leading suppliers to increase market share and participate in strategic alliances, joint ventures and acquisitions.
INFUSION SYSTEMS. Intravenous infusion therapy generally involves the delivery of one or more fluids, primarily pharmaceuticals or nutritionals, to a patient through an infusion line inserted into the circulatory system. Over the past 20 years, as both the reliance on intravenous drug therapy and the potency of the drugs administered have increased, the need for extremely precise administration and monitoring of intravenous fluids has risen significantly.
Infusion systems are differentiated based on a number of characteristics including size, weight, number of delivery channels, programmability, mechanism of infusion, cost and service. One of the key differences among infusion systems is the level of control that such systems afford to both medical staffs and patients.
Infusion pumps are volumetric devices that regulate flow by electronically measuring a specific volume of a fluid. Infusion pumps administer precise, volumetrically measured quantities of fluids over a wide range of infusion rates by using positive pressure to overcome the resistance of the infusion tubing and the back pressure generated by the patient's circulatory system. Syringe pumps operate by gradually depressing the plunger on a standard disposable syringe, thereby delivering a more concentrated dose of
medication at a very precise rate of accuracy. Disposable pumps are single use products designed for use primarily in alternate-site settings.
The infusion systems sold in the markets in which the Company competes consist of single and multi-channel infusion pumps and disposable administration sets. As treatment regimens have become more complex and as the critically ill constitute an increasing percentage of hospital patients, the average hospital patient now requires a greater number of intravenous lines and more potent therapeutics, thereby creating a greater need for technologically-advanced infusion systems.
All infusion pumps require the use of disposable administration sets. A set consists of a plastic interface and tubing and may have a variety of features such as volume control, pumping segments or cassette pumping systems for more accurate delivery, clamps for flow regulation and multiple ports for injecting medication and delivery of more than one solution. Almost all of these sets, including those manufactured by the Company, are compatible only with their particular manufacturer's line of infusion systems. The introduction, however, of the SmartSite needleless system has provided the Company with an opportunity to aggressively compete in the gravity extension set segment of the market with innovative, cost-effective needle-free gravity sets.
PATIENT MONITORING PRODUCTS. The Company's patient monitoring products compete in discrete market niches, each with different competitive dynamics. The Company primarily operates in the United States, Canada and Western Europe in two patient monitoring product markets: (I) hospital thermometry systems and (ii) stand-alone, non-invasive, multi-parameter instruments used to measure and monitor a combination of vital signs.
The two major instrument types in the hospital thermometry market are electronic and infrared devices. The Company offers electronic and infrared instruments but does not compete in the smaller glass thermometry market. As with the infusion therapy market, the hospital thermometry market has disposable products that are used in conjunction with instruments and, consequently, the existence of an installed base is important for generating ongoing disposable product sales.
PRODUCTS AND SERVICES
The Company manufactures and markets both single and multi-channel infusion pumps and disposable administration sets. The Company's infusion pumps include large volume infusion pumps such as its Gemini series, Signature Edition Family, MedSystem III, and syringe infusion pumps such as P1000, P3000, PCAM, P6000, P7000 and Asena GS, GH and CC, which are sold primarily in Western Europe, and disposable pumps such as the ReadyMED for use in the alternate-site setting. The Company's large volume infusion pumps require the use of higher margin dedicated disposable administration sets. The Company also sells non-dedicated disposable administration sets, including several needleless devices, for use in many infusion applications. The Company also manufactures and markets hospital thermometry instruments and related disposable probe covers, and stand-alone, non-invasive, multi-parameter instruments which measure and monitor a combination of temperature, pulse and blood pressure and other vital signs. The table below summarizes the key features and market introduction dates with respect to the Company's products.
ALARIS INFUSION SYSTEMS
LARGE VOLUME INFUSION PUMPS. The Company's large volume infusion pumps are either single or multi-channel and are used in both the general care and critical care settings. The Signature Edition Gold family of infusion pumps includes a single channel and dual channel pump, incorporates intuitive user interface and advanced software capabilities, and is designed for use primarily in hospitals. The Signature Edition Gold line of infusion pumps features cost-effectiveness, ease of use, reliability and innovative features, such as: patented AccuSlide flow regulator designed to minimize the chance of free flow; precision flow designed to improve flow continuity and minimize hemodynamic changes; and Advanced Infusion Management (AIM), designed to provide unique early warning assessment tools for enhanced intravenous site management. Other standard features include: an easy-to-use drug library, which provides dose and/or rate calculation; multi-step, which allows the clinicians to pre-program up to 9 steps for drug delivery; and patented "learn-teach" communication link capability for biomedical engineers.
The Gemini infusion pump series, which consists of single, dual and four channel pumps, is based on a flexible hardware and software technology platform. This technology platform has enabled the Company over time to offer incremental feature enhancements based on evolving customer needs. The Gemini series currently offers the following features: free flow protection (which the Company pioneered); independent channel operation; ability to switch from pump to controller mode without changing the disposable administration set; programmability to automatically taper-up and taper-down infusion rates to facilitate delivery of complex drug-dosing regimens; capability to operate in either micro mode (0.1 to 99.9 mL/hr) for use with neonatal patients, among others, or macro mode (1 to 999 mL/hr) for use with adult patients; drug dose calculation; pressure monitoring; pressure history and volume/time dosing; and nuisance alarm (alarms with no clinical significance) reduction.
The MedSystems III (MS III) instrument is a compact, lightweight, programmable, three channel, infusion pump used primarily in the critical care market and patient transport applications. The MS III predecessor product line was acquired from Siemens Infusion Systems, Ltd. in September 1993. Since that time, significant resources have been invested in the MS III pump. The Company believes that as a result of such investment, the MS III is one of the smallest, most versatile and most technologically advanced multi-channel pumps currently on the market.
The Company has developed the MEDLEY Patient Care System, a modular system, which can currently be configured as a one-to-four channel infusion device, including sensitive monitoring capabilities. Over time, additional modules and capabilities are planned. The MEDLEY Patient Care System incorporates advanced programming capabilities in a small configuration that is simpler to operate. A modular, building-block design is intended to allow the user to configure the various features of the modular infusion pump to unique therapy regimens and is expected to result in better asset utilization. Limited market introduction is expected in 2001.
SYRINGE PUMPS. The Company offers syringe pumps, which are small-volume fluid delivery systems used in neonatal care, oncology, anesthesia, critical care and labor and delivery. While these infusion pumps represent a relatively small portion of the industry installed base in the United States, such pumps are widely used in Europe, where they constitute approximately 60% of the infusion pump market. Syringe pumps are more widely used in Europe because of the general practice of European doctors to administer medications in smaller volumes of fluid. The Company believes that it is one of the two largest suppliers of syringe pumps in Western Europe, with a number one or number two installed base market share in seven countries and the number three installed base market position in three others.
The Company's PCAM patient controlled analgesia infusion pump allows patients to control the delivery of pain medication. Designed for general care settings, the PCAM syringe infusion pump is one of the most advanced patient controlled analgesia infusion pumps on the European market today, with pre-programmed and user programmable drug delivery protocols, comprehensive patient history logging and an ergonomically designed handset with status indicator.
The Company's syringe pump product line also includes the P7000 syringe pump which has been available internationally since 1996 and the P6000 syringe pump which was introduced to the European Market during the second quarter of 1997.
In the third quarter of 1999, the Company introduced the Asena syringe pumps, representing the first component of the Asena Patient Care System. One of the components of the Asena Patient Care System is the DOCStat docking station. The station features a unique mounting system, known as Medical Device Interface, which allows a syringe pump to be mounted to a pole, rectangular bar or docking station without adaptors.
AMBULATORY PUMPS. The ReadyMED pump is a compact, lightweight disposable pump for the intravenous administration of antibiotics in the alternate-site market. The ReadyMED is designed to offer a number of advantages over drug delivery systems currently in use for this purpose. Traditional systems require the patient to attach a small intravenous bag and tubing set, through which the antibiotics are administered, to a catheter placed in the patient's circulatory system. Since traditional systems are gravity driven, the bag must remain on an intravenous solution pole during infusion, thereby restricting the patient's movement. The ReadyMED, available in multiple sizes, provides a rapid, safe, ease-of-use delivery method for the home patient. In addition, since the ReadyMED pump is small and uses positive pressure, the patient is able to carry the device in a pocket or wear it on a belt. The Company sells the ReadyMED pump through its alternate-site sales force and distribution network in the United States.
DISPOSABLE ADMINISTRATION SETS. Disposable administration sets consist of a plastic pump interface and tubing and have a variety of features, such as volume control, pumping segments or cassette pumping
systems for more accurate delivery, clamps for flow regulation and multiple entry ports for injecting medication and delivery of more than one application. Components such as burettes and filters may also be added for critical drugs or special infusion. In addition, most of the Company's disposable administration sets offer protection features designed to prevent free flow. Each of the Company's current large volume infusion pumps uses only dedicated disposable administration sets designed by the Company for that particular pump.
NEEDLE-FREE ACCESS PRODUCTS. There is increasing pressure by regulatory agencies, such as the Occupational Safety and Health Administration ("OSHA") and the FDA, for more stringent control of needles in hospitals. OSHA requires that hospitals must put in place systems to reduce the potential for accidental needlesticks. The FDA recommends using needle-free systems or protected needle systems to replace hypodermic needles for accessing intravenous lines. The Company's needleless access products are designed to permit access to the Company's disposable administration sets without the use of needles, thus reducing the potential for accidental needlesticks. The SmartSite needleless system offers a fully integrated, cost-effective design and eliminates the need for separate caps and additional cannula components. The SmartSite needleless system is latex-free and therefore reduces the risk of exposure of patients and health care workers to latex which can cause severe allergic or anaphylactic shock reactions. The VersaSafe system utilizes a blunt, plastic cannula combined with a split-septum "Y" site. The Company has a non-exclusive license, which expires in May 2003, to the VersaSafe system which was a cooperative development effort. The Company's needle-free access products have received strong interest from customers and provide the Company with an opportunity for incremental revenues in what has previously been perceived as a commodity market.
ALARIS PATIENT MONITORING PRODUCTS
Patient monitoring instruments are used to measure temperature, pulse, blood pressure, and other vital signs. Instruments sold in this market have varying levels of technological sophistication and are used in a variety of diagnostic and health care settings. The Company competes in two key niches: hospital thermometry systems and stand-alone, non-invasive, multi-parameter patient monitoring products.
THERMOMETRY. The Company is a leader in hospital thermometry systems, which consist of thermometers and disposable probe covers, and maintains a strong position in both the United States and Western Europe. The Company's primary product is an electronic thermometer which is widely used in hospitals and alternate-site settings. In 1999, the Company launched the TURBOoTEMP thermometer; an improved cost-effective and technologically advanced electronic thermometer designed to provide a faster temperature reading. The Company also manufactures and markets the COREoCHECK system, a thermometer that measures temperature by detecting the emission of infrared energy in the ear. In the infrared market, the Company believes it is the second largest participant. The only disposable probe covers which can be used with the Company's thermometry instruments are those manufactured by the Company.
OTHER PATIENT MONITORING PRODUCTS. The Company also produces stand-alone, non-invasive, multi-parameter patient monitoring products which measure a combination of pulse, pulse-oximetry, temperature and blood pressure.
In January 1997, the Company entered into an agreement with Criticare Systems, Inc., ("Criticare") a manufacturer of patient monitoring systems and non-invasive sensors for use in the hospital and alternate-site markets. Under this agreement, the Company obtained exclusive distribution rights to certain of these monitoring systems in the United States hospital market and in all Canadian markets. The VITALoCHECK 4400 family provides non-invasive blood pressure, pulse oximetry and temperature monitoring, using the Company's electronic thermometry technology.
In December 2000, under the A-Line brand name, the Company introduced a non-invasive monitoring device used to measure the level of consciousness during general anesthesia and to assess the
effects of anesthetics on brain activity. Using Auditory Evoked Potential ("AEP") signals, the monitor performs fast extraction of AEP signals, delivering near real-time measurements of the level of consciousness during general anesthesia and intravenous sedation. Level of consciousness monitoring enables anesthesiologists to directly assess the effects of anesthetics on brain activity. The Company's technology consists of a monitor that analyzes the brain's EEGs or brain waves and disposable sensors used to collect the data. The practice of level of consciousness monitoring is designed to improve the practice of anesthesiology by allowing for the minimal use of drugs, which should result in faster wake up times, reduced recovery time and reductions in the side effects associated with anesthesia. This is the first commercially available monitor for measuring the level of consciousness utilizing the AEP technology.
CUSTOMER SERVICE
The Company provides repair service for its products at its facilities in San Diego or on-site at the customer's facilities through third-party contractors. Customers may elect to enter into service agreements or to receive service on a time and materials basis. The Company also trains customers as to the use of its products and maintains a technical support help-line to answer customers' questions. The Company believes that the availability of such service helps maintain strong customer relations.
MARKETING AND SALES
The Company has historically focused its sales efforts on the hospital market, which is still its primary market. In response to the industry shift toward health care delivery outside of the hospital, the Company has expanded its selling efforts and products to the alternate-site market. The Company's sales strategy emphasizes increasing instrument placements and the number of units installed in order to increase sales of its proprietary disposable administration sets and probe covers. Sales representatives work closely with on-site primary decision-makers, which include physicians, pharmacists, nurses, materials managers, biomedical staff and administrators. The Company has over 5,000 hospital customers worldwide and sells its products through a combined direct sales force consisting of over 250 salespersons and through more than 150 distributors.
The Company's domestic marketing efforts are supported by a staff of nurses and pharmacists who consult with customers, providing ongoing clinical support in the evaluation, installation and use of the Company's products. The Company believes its sales force in the United States and internationally plays a key role in the effective introduction of new products.
The Company has a strong business portfolio of key infusion device and patient monitoring contracts with group purchasing organizations as set forth below:
No single account is material to the business or operations of the Company.
INTERNATIONAL OPERATIONS
The Company markets products in approximately 120 countries through its direct sales force and distributors. The primary markets for the Company's products outside the United States are Western Europe, Canada and Australia. The Company also has a developing position in Asia and Latin America. The principal products sold by the Company outside the United States are large volume and syringe infusion pumps and related disposable administration sets. The Company has manufacturing operations in England and Mexico. The Company has also contracted with a number of foreign manufacturers to provide certain of its sourcing needs. The following table sets forth, for each period presented, the approximate amount of sales made to customers by each business unit over the last three fiscal years:
The Company believes that sales of products to customers outside of the United States represent a potential source of growth. Foreign operations are subject to special risks that can materially affect the sales, profits and cash flows of the Company, including currency exchange rate devaluations and fluctuations, the impact of inflation, exchange controls, labor unrest, political instability, export duties and quotas, domestic and international customs and tariffs, unexpected changes in regulatory environments, potentially adverse tax consequences and other risks. Changes in certain exchange rates could have an adverse effect on the Company's ability to meet interest and principal obligations with respect to its United States dollar-denominated debt and could also have a material adverse effect on the business, financial condition, results of operations or prospects of the Company.
MANUFACTURING
The Company is focusing on low-cost manufacturing and manufactures its products at plants in San Diego, California; Creedmoor, North Carolina; Tijuana, Mexico; and Hampshire, England. The San Diego facility is the primary manufacturing facility for infusion pumps and patient monitoring instruments and also houses a service operation for installed infusion pumps and patient monitoring instruments. The Creedmoor facility manufactures high volume, high automation sub-assemblies and SmartSite needleless components and is a distribution center for North American disposable finished products. Product release from sterilization is done in San Diego and Creedmoor. The Tijuana facilities primarily focus on the manual assembly of disposables, and the Hampshire facility focuses on the manufacturing of syringe pumps which are sold primarily to the international market. Disposable products for international markets are currently supported through a number of foreign manufacturers.
The Company has designed and implemented an integrated network of quality systems, including control procedures that are planned and executed by technically trained professionals. Through these systems, the Company has established written specifications for raw materials, packaging, labels, sterilization and overall manufacturing process control. A substantial number of raw materials require certificates of analysis to help ensure that finished products conform to specifications. In addition, the Company regularly tests components and products at various stages of the manufacturing process to ensure compliance with applicable specifications.
The Company purchases raw materials worldwide in the ordinary course of business from numerous suppliers. The vast majority of these materials are generally available, and although the Company has not experienced any serious shortages or material delays in obtaining these materials it has, on occasion, experienced temporary delays for certain materials due to supplier shortages. In some situations, the Company has long-term supply contracts, although the Company purchases a significant amount of its
requirements of certain raw materials by purchase order. Although the Company is generally not dependent upon any single source of supply, it relies upon a limited number of suppliers for circuit boards and other parts which are used in certain of its infusion systems. The loss of any such supplier would result in a temporary interruption in the manufacturing of the Company's products. The Company believes, however, that these materials are available as needed from alternative sources.
RESEARCH AND DEVELOPMENT
The Company believes that a well-targeted research and development program constitutes an essential part of the Company's activities and is an integral part of its future success. The Company is actively engaged in research and development programs to develop and improve products. These activities are performed in the United States and, to a lesser extent, in the United Kingdom. For the year ended December 31, 2000, the Company expended approximately $21.6 million on in-house research and development. Substantially all of such amount was dedicated to the development of new products.
The Company intends to focus a significant portion of its research and development efforts on the development of new products. The Company is currently developing several new products and product line extensions.
PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS
The Company relies heavily on patented and other proprietary technology. The Company believes its issued and pending patents are important to its competitive position. There can be no assurance that patent applications submitted by the Company or its licensors will result in patents being issued or that, if issued, such patents and patents already issued will afford protection against competitors with similar technology. In addition, there can be no assurance that any patents issued to or licensed by the Company will not be infringed or designed around by others, that others will not obtain patents that the Company will need to license or design around, that the Company's products will not inadvertently infringe the patents of others, or that others will not manufacture and distribute similar products upon expiration of such patents. There can also be no assurance that key patents of the Company will not be invalidated or that the Company or its licensors will have adequate funds to finance the high costs of prosecuting or defending patent validity or infringement issues.
The Company's policy is to secure patent protection for significant inventions. The Company holds approximately 221 unexpired patents in the United States and approximately 402 unexpired patents in foreign countries, principally in Europe, Canada, Japan and Australia. The Company has 23 additional applications pending or in preparation in the United States and 180 foreign applications pending. Within the next ten years, approximately 140 of the Company's United States patents and approximately 253 of the Company's foreign patents will expire. Due to ongoing development activities, the Company does not believe that the expiration of any such patents will, individually or in the aggregate, have a material adverse effect on the business, financial condition, results of operations, or prospects of the Company.
The patent positions of medical device firms, including the Company, are uncertain and involve complex legal and factual questions for which certain legal principles are unresolved. The coverage claimed in a patent application can be significantly reduced before a patent is issued. Pursuant to international accords, the term of United States patents is 20 years from date of filing and certain provisions formerly favoring United States inventors over foreign inventors have been eliminated.
Under United States patent code, certain statutory remedies for patent infringement are no longer available for a medical practitioner's otherwise infringing performance of a medical activity. As defined in the United States patent code, a patent may not be enforced against a medical practitioner's performance, or the performance by a related health care entity of a "medical activity" which is defined as the performance of a medical or surgical procedure on a body. However, a "medical activity" does not include "the use of a
patented machine, manufacture or composition of matter in violation of such patent." Hence, remedies are still available against manufacturers and distributors. The aforesaid amendment does not apply to patents issued before September 30, 1996.
The Company sells its products under a variety of trademarks, some of which are considered by the Company to be of sufficient importance to warrant registration in the United States and various foreign countries in which the Company does business. The Company also relies on trade secrets, unpatented know-how and continuing technological advancement to maintain its competitive position. It is the Company's practice to enter into confidentiality agreements with key technical employees and consultants. There can be no assurance that these measures will prevent the unauthorized disclosure or use of the Company's trade secrets and know-how or that others may not independently develop similar trade secrets or know-how or obtain access to the Company's trade secrets, know-how or proprietary technology. In addition, the Company from time to time seeks copyright protection for the software used in certain of its products.
COMPETITION
The Company faces substantial competition in all of its markets. Many of the Company's competitors have greater financial, research and development and marketing resources than the Company. Some of the Company's principal competitors are able to offer volume discounts based on bundled purchases of a broad range of their medical equipment and supplies. The Company seeks to improve its competitive position in this area by developing or licensing technologically superior products. The Company expects the trend toward volume discounts to continue in the future. The Company believes that the competitive factors most important in its markets are quality of products and services, technological innovation and price.
The primary markets for the Company's products are relatively mature and highly competitive. In the United States, major competitors include Baxter International, Inc., Abbott Laboratories, Inc. and McGaw, Inc. The Company's success is therefore dependent on the development of new infusion technologies and products and the development of other markets for its products. The Company's older infusion therapy product lines have experienced declining sales and market share recently, primarily due to competitors who offer volume discounts based on bundled purchases of a broader range of medical equipment and supplies, as well as to the aging of the Company's core products. The Company's introduction of new products may offset future declines in sales and market share. There can be no assurance, however, that new products will be successfully completed or marketed for sale, will not necessitate upgrades or technical adjustments after market introduction, can be manufactured in sufficient volumes to satisfy demand, or will offset declines in sales and market share experienced with respect to existing products. See "Products and Services."
The European infusion systems market is much more regionalized and fragmented, with a few strong competitors in each regional market. Major competitors encountered in several markets include Graseby, Fresenius and B. Braun Melsungen AG. The Company is among the leaders in a number of Western European markets, with a number one or number two installed base market share in seven countries and the number three installed base market share in three others. The Western European countries in which the Company has a number one or number two installed base market share are Belgium, France, the Netherlands, Norway, Sweden, Spain, and the United Kingdom.
The patient monitoring products market is fragmented by product type. The Company's key competitors in the United States market are Welch Allyn, Inc. in electronic thermometer and Sherwood Davis & Geck in infrared thermometer.
GOVERNMENT REGULATION
PRODUCT REGULATION. The research, development, testing, production and marketing of the Company's products are subject to extensive governmental regulation in the United States at the federal,
state and local levels, and in certain other countries. Non-compliance with applicable requirements may result in recall or seizure of products, total or partial suspension of production, refusal of the government to allow clinical testing or commercial distribution of products, civil penalties or fines and criminal prosecution and/or repairing the device and/or refunding the purchase price.
The United States Food and Drug Administration ("FDA") regulates the development, production, distribution and promotion of medical devices in the United States. Virtually all of the products being developed, manufactured and sold by the Company in the United States (and products likely to be developed, manufactured or sold in the foreseeable future) are subject to regulation as medical devices by the FDA. Pursuant to the Federal Food, Drug, and Cosmetic Act (the "FDC Act"), a medical device is classified as a Class I, Class II or Class III device. Class I devices are subject to general controls, including registration, device listing, recordkeeping requirements, labeling requirements, "Quality Systems Regulation" ("QSR" as defined in FDA Quality System regulations), prohibitions on adulteration and misbranding, reporting of certain adverse events ("MDR") and in some instances, FDA marketing submissions. In addition to general controls, Class II devices may be subject to special controls that include a 510(k) notification and could include performance standards, postmarket surveillance, patient registries, guidelines, recommendations and other actions as the FDA deems necessary to provide reasonable assurance of safety and effectiveness. New Class III devices must meet the most stringent regulatory requirements and must be approved by the FDA before they can be marketed. Such premarket approval can involve extensive preclinical and clinical testing to prove safety and effectiveness of the devices.
Virtually all of the Company's products are Class II devices. Unless otherwise exempt, all Class II and Class III medical devices introduced to the market since 1976 are required by the FDA, as a condition of marketing, to secure 510(k) clearance or a Premarket Approval Application ("PMA"). A medical device will be cleared by the FDA under a 510(k) if it is found to be substantially equivalent to another legally marketed medical device that was on the U.S. market prior to May 28, 1976 or to a device that has previously received a 510(k) and is lawfully on the U.S. market ("predicate device"). In general, if a product is not substantially equivalent to a predicate device, and not otherwise exempt, the FDA must first reclassify the device or approve a PMA before it can be marketed. An approved PMA indicates that the FDA has determined the product has been demonstrated, through the submission of clinical data and manufacturing and other information, to be safe and effective for its labeled indications. The PMA process typically takes more than a year from submission and requires the submission of significant quantities of clinical data and supporting information. The process of obtaining a 510(k) clearance currently takes approximately six months from the date of submission. However, the review process for a particular product may be shorter or substantially longer depending upon the circumstances. Moreover, there can be no assurance that a 510(k) will be cleared. The 510(k) must include submission of supporting information, including labeling, and may be required to contain safety and efficacy data. Product modifications intended to be made to a cleared device or new product claims also may require submission and clearance of a new 510(k) application or submission and approval of a PMA, before the modified product can be distributed in interstate commerce. Although there can be no assurance, the Company believes that its proposed products under development will qualify for a clearance or approval.
The FDA conducts investigations regarding the safety or effectiveness of medical devices in connection with applications for clearances or approvals. If as a result of such investigation, the FDA determined that the Company's application was inadequate or non-compliant, that determination could impair the Company's ability to market a particular device or cause the Company to need to generate additional data to support submissions for such clearance or approval. Future products developed by the Company may require FDA clearance through either the 510(k), PMA, new drug approval application procedures or abbreviated new drug approval application procedures. There can be no assurance that marketing clearances or approvals will be obtained on a timely basis or at all. Delays in receiving such clearances or approvals could have a material adverse effect on the Company.
The FDA also regulates the commencement and conduct of any clinical investigations required by the agency in order to determine the safety and effectiveness of devices. This specifically includes investigations of devices not cleared or approved for marketing, and investigations involving new intended uses of previously cleared or approved devices. Clinical investigations are regulated by the FDA under the investigational device exemption ("IDE") regulations. The IDE regulations include significant requirements that must be met, including patient informed consent, criteria for selection of study investigators and monitors, review and approval of research protocols, reporting obligations to the FDA, recordkeeping and prohibitions against commercialization of investigational devices. A sponsor must obtain FDA approval of an IDE before starting the investigation, unless the device is found to be a non-significant risk device by the sponsor and each institutional review board ("IRB") that reviews the study. The FDA, however, has the authority to determine that a study designated as involving a non-significant risk device by the sponsor and IRBs involves a significant risk device and an IDE application must be submitted and approved before the study can resume. In addition, a study of a non-significant risk device must still comply with certain provisions of the IDE regulations, and meet other regulatory requirements. The violation of the IDE regulations can result in a variety of sanctions, such as warning letters, prohibition against additional clinical research, the refusal to accept data and criminal prosecution.
Devices manufactured by the Company in the United States are exported by the Company to other countries. Such devices, if not approved or cleared for sale in the United States, are subject to the FDA export requirements, and cannot be commercially distributed in the United States.
The Company's products are subject to varying degrees of government regulation in the countries in which the Company has operations, and the general trend is toward regulation of increasing stringency. The degree of government regulation affecting the Company varies considerably among countries, ranging from stringent design, testing, manufacturing, approval requirements, and post-approval requirements to more simple registration. In general the Company has not encountered material delays or unusual regulatory impediments in marketing its products internationally. The Company has received ISO 9001 or ISO 9002 certification for all of its manufacturing facilities regarding the quality of its manufacturing systems, a requirement for doing business in EC countries. Establishment of uniform regulations for the European Economic Area, the transition rule for which ended on June 16, 1998, subjected the Company to a single extensive regulatory scheme for all of the participating countries. The EU Medical Device Directive requires that medical devices marketed in participating countries have a "CE" mark affixed to the device certifying compliance with the applicable medical device requirements. The Company has been granted approval to affix the CE mark, pursuant to the EC Medical Device Directives, on substantially all of its products. CE marking does not necessarily preclude, however, additional restrictions on marketing in any individual country in the EC. The Company is required to classify its medical devices into one of four classes; meet certain essential requirements generally relating to device design, construction, labeling, manufacture and other standards; certify, for Class I devices, or in the case of a medium or high risk device, obtain certification from a recognized non-governmental body (notified body) that its device conforms to the applicable requirements. In addition, other regulatory requirements apply, including but not limited to registration, vigilance or adverse event reporting, recordkeeping, and labeling and promotional restrictions. Companies and medical devices in the EU are also subject to enforcement actions, including administrative, civil and criminal penalties.
Certain countries require the Company to obtain clearances for its products prior to marketing the products in those countries. In addition, certain countries impose product specifications, standards or other requirements which differ from or are in addition to those mandated in the United States. The EC and certain countries are in the process of developing new modes of regulating medical products which may result in lengthening the time required to obtain permission to market new products. These changes could have a material adverse effect on the Company's ability to market its products in such countries and would hinder or delay the successful implementation of the Company's planned international expansion.
The Company is registered as a medical device manufacturer with the FDA. In addition, the Company lists all of its devices with the FDA. The Company also has a Medical Device Manufacturing License from the State of California Department of Health Services, which is renewed annually, and the Company is subject to the regulatory requirements of that state as well as other states in which the Company does business. The FDA inspects the Company periodically to determine whether the Company is in compliance with the FDC Act and regulations, including regulations relating to MDR reporting, product labeling and promotion, and medical device QSRs governing design, manufacturing, testing, quality control, product packaging and storage practices. California conducts similar inspections related to the same requirements. Other states may also conduct inspections of aspects of the Company's business particular to that state. An inspection may result in a determination that the Company is not in compliance with certain FDA or state requirements, may require the Company to undertake corrective action, and could result in legal action against the Company and its products, including actions such as those described herein. The FDA's QSR regulations include new requirements such as design control, which may increase the cost of regulatory compliance for the Company. The MDR regulations promulgated by the FDA require the Company to provide information to the FDA on certain malfunctions, as well as serious injuries or deaths which may have been associated with the use of a product. The EC Medical Device Directives also require reporting of serious injuries or deaths which may be associated with the use of a medical device to the competent authority in the country where the incident occurred.
A determination that the Company is in material violation of the FDC Act or such FDA regulations could lead to the issuance of warning letters, imposition of civil or criminal sanctions against the Company, its officers and employees, including fines, recalls, repair, replacement or refund to the user of the cost of such products and could result in the Company losing its ability to contract with government agencies. In addition, if the FDA believes any of the Company's products violate the law and present a potential health hazard, the FDA could seek to detain and seize products, to require the Company to cease distribution and to notify users to stop using the product. The FDA could also refuse to issue or renew certificates to export the Company's products to foreign countries. Such actions could also result in an inability of the Company to obtain additional clearances or approvals to market its devices.
In October 1999, the Company received a warning letter from the FDA related to earlier inspections of the San Diego-based manufacturing facility. The letter stated that the Company would be required to submit to the FDA periodic certifications as to its state of compliance based on the outcome of inspections conducted by outside regulatory consultants employed by the Company. On April 29, 2000, the Company's president and chief executive officer, David L. Schlotterbeck, certified to the FDA that, to the best of his knowledge, the Company had initiated or completed all corrections called for in the report issued by the independent consultant. On July 10, 2000, the Company received correspondence from the FDA indicating that the certification adequately addressed the FDA's concerns and stated that the Company will be required to submit one additional certification scheduled for submission to the FDA in April 2001. In this connection, in August 2000 the FDA completed an inspection of the Company's San Diego-based manufacturing facility. The Company received correspondence from the FDA indicating that ALARIS' response actions adequately addressed their concerns.
Between 1997 and 1999, the Company on nine occasions initiated product recalls or issued safety alerts which FDA still considers active regarding its products regulated by the FDA. In each case this was done because the products were found not to meet the Company's specifications. The Company has submitted to the FDA a request for closure related to all nine of the recalls but has not received notice of closure from the FDA. Notice of closure of two additional recalls was received from the FDA during 2000.
The Company has four active field corrections related to its products manufactured and sold outside the United States. In the second quarter of 1999, the Company initiated three voluntary recalls of certain versions of its P series syringe pumps, which are manufactured in the United Kingdom and sold outside the United States, primarily in Europe. These voluntary recalls relate to software and hardware upgrades of the P series syringe pumps. In the first quarter of 2000, the Company stopped shipment of a large volume pump recently introduced in the international markets for redesign of its air-in-line sensing capability. The
Company plans to introduce the redesigned product into international markets and provide a field correction for existing units.
None of the recalls or field corrections materially interfered with the Company's operations and all such affected product lines continued or will continue to be marketed by the Company.
The costs incurred related to the Company's recall activities have historically been significant. These costs include labor and materials, as well as travel and lodging for repair technicians. Estimates of the costs to complete the recalls and safety alerts are often quite difficult to determine due to uncertainty surrounding how many affected units are still in service and how many units customers will fix without Company assistance. Due to these difficulties in estimating costs, it is possible that the actual costs to complete each individual recall or safety alert could differ significantly from management's current estimates to complete such recalls or safety alerts. Although there can be no assurances, the Company believes it has adequate reserves to cover the remaining estimated aggregate costs related to these active recalls.
ANTI-REMUNERATION LAWS. The sale of the Company's products is subject to the illegal remuneration/"anti-kickback" provisions of the Social Security Act of 1935, as amended (the "Social Security Act"), which prohibits knowingly and willfully the offering, receiving or paying of any remuneration, whether directly or indirectly, in return for inducing the purchase of items or services, or patient referrals to providers of services, for which payment may be made in whole or in part by Medicare, Medicaid or other federally funded health care programs. Violations of the statute are punishable by civil and criminal penalties and the exclusion of the provider from future participation in other federally funded health care programs. The Social Security Act contains exceptions to these prohibitions for, among other things, properly reported discounts, rebates and payments of certain administrative fees to GPOs. Because of the breadth of the statutory prohibitions, the lack of court decisions or other authority addressing the types of arrangements that are permissible under the law and the narrowness of statutory exceptions, the Secretary of Health and Human Services published regulations creating "safe harbors" identifying certain practices that will not be treated as violating the "anti-kickback" provisions of the Social Security Act. While failure to satisfy all of the criteria for a safe harbor does not necessarily mean that an arrangement is unlawful, engaging in a business practice for which there is a safe harbor may be regarded as suspect if the practice fails to meet each of the prescribed criteria of the appropriate safe harbor. The enumerated safe harbors include safe harbors which implement, and further refine, the statutory exceptions for discounts and payments to GPOs. Because the Company sells some of its products to customers at prices below list price and in various combinations, the Company is engaged in giving discounts within the meaning of the Social Security Act. The regulations require sellers to fully and accurately report all discounts and inform buyers of their obligations to report such discounts. The Company also pays administrative fees to certain purchasing agents within the meaning of the Social Security Act. In order to qualify for the GPO safe harbor, certain requirements must be met including disclosure of the existence of the GPO fee arrangement to GPO members and that members are neither wholly owned by the GPO nor subsidiaries of a parent corporation that wholly owns the GPO. Certain of the Company's discounts and arrangements with purchasing agents may not meet all the requirements of the appropriate safe harbors.
Several states also have statutes or regulations prohibiting financial relationships with referral sources that are not limited to services for which Medicare, Medicaid or other state or federal health care program payment may be made. A finding of non-compliance with these anti-remuneration laws by federal or state regulatory officials, including non-compliance with appropriate safe harbors, could have a material adverse effect on the Company.
COVERAGE AND REIMBURSEMENT. The Company's products are purchased or leased by health care providers or suppliers which submit claims for reimbursement for such products to third-party
payors such as Medicare, Medicaid and private health insurers. Although the Company has no knowledge that third-party payors will adopt measures that would limit coverage of, or reimbursement for, its products, any such measures that were applied to the Company's products could have a material adverse effect on the Company.
ENVIRONMENTAL MATTERS. The Company is subject to regulation by OSHA, the Environmental Protection Agency ("EPA") and their respective state and local counterparts, and under extensive and changing foreign, federal, state and local environmental standards, including those governing the handling and disposal of solid and hazardous wastes, discharges to the air and water, and the remediation of contamination associated with releases of hazardous substances. Such standards are imposed by, among other statutes, the Toxic Substances Control Act, the Clean Air Act, the Federal Water Pollution Control Act, the Resource Conservation and Recovery Act and the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"). The Company believes that it is currently in material compliance with current environmental standards. Nevertheless, the Company uses hazardous substances in its day-to-day operations and, as is the case with manufacturers in general, if a release of hazardous substances occurs on or from the Company's properties, the Company may be held liable and may be required to pay the cost of remedying the condition. The amount of any such liability could be material.
The Company has made, and will continue to make, expenditures to comply with current and future environmental standards. Although no material capital or operating expenditures relating to environmental controls are anticipated, there can be no assurance that changes in, additions to, or differing interpretations of statutory and regulatory requirements will not require material expenditures in the future.
The Company is subject to liability under CERCLA and analogous state laws for the investigation and remediation of environmental contamination at properties owned and/or operated by it and at off-site locations where it has arranged for the disposal of hazardous substances. Courts have determined that liability under CERCLA is, in most cases, joint and several, meaning that any responsible party could be held liable for all costs necessary for investigating and remediating a release or threatened release of hazardous substances. As a practical matter, liability at most CERCLA (and similar) sites is shared among all the solvent "potentially responsible parties" ("PRPs"). The most relevant factors in determining the probable liability of a party at a CERCLA site usually are the cost of the investigation and remediation, the relative amount of hazardous substances contributed by the party to the site and the number of solvent PRPs.
In 1997, the Company received a Notice of Intent to Sue from a citizen's group which claimed that the Company had violated California's Safe Drinking Water and Toxic Enforcement Act of 1986 ("Proposition 65") in the warning it provided with respect to DEHP, a plasticizer used in certain of the Company's IV sets. Proposition 65 requires, among other things, that warnings be given in connection with the exposure of consumers to products containing certain listed substances. The Company entered into a settlement agreement, pursuant to which the Company received a release and covenant not to sue from the group.
EMPLOYEES
As of February 28, 2001, the Company employed 2,597 people, including 772 in the United States. The Company has not experienced any work stoppages related to employment matters other than in connection with a contract dispute with Cal Pacifico.
Cal Pacifico was the operator of the Company's two maquiladora assembly plants in Tijuana, Mexico. For over eight years, the Company assembled disposable administration sets at these two plants, which utilized more than 1,200 workers employed by Cal Pacifico, under a contract with Cal Pacifico. A dispute originated in April 1997 when the Company, in accordance with the terms of such contract, informed Cal Pacifico that it would be terminating its contractual arrangements effective August 1, 1997. Cal Pacifico objected to such notification and proposed the systematic termination of the workforce. In response to such objection, the Company on June 6, 1997 hired substantially all of the workers at the plants directly. On June 11, 1997, Cal Pacifico locked the Company's administrative personnel and production
employees out of the plants and would not allow the Company access to its production equipment or inventory. On June 26, 1997, the Company entered into a settlement agreement with Cal Pacifico. As a result of the settlement agreement, the assembly plants resumed full operations on June 27, 1997. The Company now directly operates these plants with no assistance from or interaction with Cal Pacifico.
ALARIS Medical's operations are supported by persons employed by ALARIS Medical Systems and its subsidiaries. The Company's principal executive offices are located at 10221 Wateridge Circle, San Diego, California 92121.
EXECUTIVE OFFICERS OF THE REGISTRANT
DAVID L. SCHLOTTERBECK, age 53, became a Director, the President and the Chief Executive Officer of ALARIS Medical and ALARIS Medical Systems on November 1, 1999. Mr. Schlotterbeck joined ALARIS Medical Systems on April 19, 1999, as President and Chief Operating Officer. Previously, Mr. Schlotterbeck was President and Chief Operating Officer of Pacific Scientific Company, a former NYSE-traded company prior to its acquisition by Danaher Corporation in March 1998. He was President and COO of Pacific Scientific, an international manufacturer of motion control, process measurement and safety products, from 1997 to March 1998. From 1995 to 1997, he was President and CEO of Vitalcom, Inc., a medical network manufacturer. From 1991 to 1994, Mr. Schlotterbeck was Executive Vice President and COO for Nellcor, Inc., a medical device manufacturer subsequently acquired by Mallinckrodt, Inc. Mr. Schlotterbeck is a graduate of the General Motors Institute with a B.S. in electrical engineering. He holds an M.S. in electrical engineering from Purdue University, and completed the Executive Institute at Stanford University in 1984.
WILLIAM C. BOPP, age 57, became Senior Vice President and Chief Financial Officer of each ALARIS Medical and ALARIS Medical Systems on November 1, 1999. Mr. Bopp joined the companies on March 22, 1999 as Vice President and Chief Financial Officer. Prior to joining ALARIS, he was executive vice president and chief financial officer of C.R. Bard, Inc. since 1995. Since 1980, Mr. Bopp held positions of increasing responsibility with Bard, a $1.2 billion developer, manufacturer and marketer of health care products, including vascular, urological and oncological and interventional products. In addition to his most recent position, from 1995 until 1999, Mr. Bopp also served as a member of the board of directors of Bard. He is a graduate of Harvard College, Cambridge, MA, and completed his M.B.A., Finance, from the Harvard Business School.
JAKE ST. PHILIP, age 48, became Vice President and General Manager, North America, as of July 1998. He previously served as Vice President of Sales, North America of ALARIS Medical Systems as of November 1996. Prior thereto, Mr. St. Philip served as Vice President of Sales, North America of IVAC Medical Systems since June 1994. From 1981 to June 1994, Mr. St. Philip held various sales and marketing positions with IVAC Medical Systems. Additional prior experience includes sales positions with Johnson & Johnson and M&M/Mars. Mr. St. Philip holds a B.S. degree in Marketing from the University of New Orleans.
FREDERIC DENEROLLE, age 41, became Vice President and General Manager of the International Business Unit for ALARIS Medical Systems in January 2001. Prior to joining the Company, Mr. Denerolle held leadership positions in well-known International medical device companies. He was most recently the executive vice president/general manager of Fresenius' Infusion Technology Division. Mr. Denerolle is a graduate in Business Administration from Ecole Superieure de Commerce de Nantes, which includes MBA course work at Bowling Green State University.
SALLY M. GRIGORIEV, age 42, became the Vice President of Operations in December 2000. She previously served as the Vice President of Quality and Regulatory Affairs for ALARIS Medical Systems. Prior to joining IVAC Medical Systems in January 1995, she served as the Vice President of Quality and Regulatory Affairs at U.S. Medical Instruments, Inc. and Block Medical, Inc. respectively. While at Block Medical, she established and implemented all quality and regulatory systems. Ms. Grigoriev held various management positions at IMED Corporation from 1982 to 1990, including Principal Manufacturing
Engineer, Quality Engineering Manager, Manufacturing Engineering Manager and Quality Assurance Manager. Ms. Grigoriev holds a B.S. degree, Chemical Engineering, from the University of California, Santa Barbara.
WILLIAM H. MURPHY, age 48, became Vice President, Quality and Regulatory Affairs for ALARIS Medical Systems in December 2000. He previously served as director of regulatory affairs. Prior to ALARIS Medical, he held senior leadership positions at other leading medical device manufacturers including the Kendall Company, Hudson RCI and Nellcor Puritan Bennett. Mr. Murphy holds a B.S. degree from Augusta College.
There are no family relationships among the above executive officers.
ITEM 2.
ITEM 2. PROPERTIES
The Company has long-term leases on substantially all of its major facilities. The Company maintains an instrument manufacturing facility in San Diego, California where infusion pumps and patient monitoring instruments for both the North America and International business units are manufactured. The Company also maintains a facility in Hampshire, England where syringe pumps and products marketed for countries outside of the United States are manufactured. Disposable administration set manufacturing facilities for the North America and International business units are located in Tijuana, Mexico and high volume, high automation sub-assemblies and SmartSite needleless components are manufactured in Creedmoor, North Carolina. The disposable manufacturing facility in Creedmoor, North Carolina is owned by the Company. The disposable manufacturing facilities in Tijuana, Mexico are maintained under short-term lease agreements.
The Company's principal International sales offices are maintained under long-term leases in England, Germany, Spain, France, Sweden, Belgium, The Netherlands, Italy, Norway, South Africa, New Zealand and Australia. The North American sales office for Canada is also maintained under a long-term lease.
The Company's principal offices are located in San Diego, California and its International headquarters are located in Hampshire, England. These facilities are maintained under long-term lease arrangements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On December 5, 2000, the Company filed a lawsuit in the United States District Court for the Southern District of California, seeking unspecified damages and equitable relief from Filtertek Inc. ("Filtertek") alleging, among other things, that Filtertek's needle-free system (the "Filtertek System") infringes a patent relating to needle free technology (the "Medex Patent") licensed by Medex, Inc. ("Medex") to the Company on an exclusive basis and seeking, as well, a declaration that the Company's needle-free system (the "System") does not infringe a certain Filtertek patent (the "Filtertek Patent") relating to the Filtertek System or, if it does, that the Filtertek Patent is invalid.
On March 9, 2001, Filtertek filed a lawsuit in the United States District Court for the Northern District of Illinois, Western Division, seeking unspecified damages and equitable relief from the Company and Medex, alleging that the System violates the Filtertek Patent, and seeking, as well, a declaration, against Medex only, that the Filtertek System does not infringe the Medex Patent.
The Company believes that it has meritorious defenses to all Filtertek claims and intends to defend itself vigorously. However, there can be no assurance that such defenses will successfully defeat all of such claims. The failure to do so could have a material adverse effect on the Company's operations, financial condition and cash flows.
In February 2000, the Company was notified that Amaris Software Entwicklungsgesellschaft mbH ("Amaris Software"), a German company, contends that the Company's use of the trademark "ALARIS" infringes Amaris Software's registered trademark "Amaris" that is the subject of a German trademark registration. In related proceedings, Amaris Software also filed an opposition in the German trademark office on August 30, 1998 against the Company's application for registration of its trademark ALARIS in Germany and an opposition in the Office for Harmonization of the Internal Market ("OHIM") in August 1998 against the Company's application for a European Community trademark registration for ALARIS. The Company prevailed in the opposition at the OHIM but the German opposition is still pending.
The Company has denied that the two marks are confusingly similar and contends that the Company's intended use of the trademark "ALARIS" is only with medical goods and services, which are outside Amaris Software's registration. The Company believes it has sufficient defenses to all claims by Amaris Software. However, there can be no assurance that the Company will successfully defend all claims made by Amaris Software.
The Company is also involved in a number of legal proceedings arising in the ordinary course of its business, none of which is expected to have a material adverse effect on the Company's business, financial condition, results of operations or cash flows of the Company. The Company maintains insurance coverage against claims in an amount which it believes to be adequate.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock was listed and traded on the American Stock Exchange (AMEX) under the symbol AMI. The following table sets forth the high and low reported sale prices for the Common Stock as reported by the stock exchanges for the quarters indicated, based on daily closing prices.
At April 2, 2001, there were 462 holders of record of the Common Stock.
ALARIS Medical has not paid any dividends on the Common Stock since its organization, and it is not contemplated that it will pay any dividends on the Common Stock in the foreseeable future. ALARIS Medical is prohibited from declaring and paying dividends on the Common Stock under its bank credit facility. In addition, the bank credit facility limits ALARIS Medical System's ability to declare and pay dividends and to make other distributions and payments to ALARIS Medical. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources."
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical consolidated financial data of ALARIS Medical at December 31, 2000, 1999, 1998, 1997 and 1996 for the years then ended, have been derived from ALARIS Medical's annual financial statements including the consolidated balance sheet at December 31, 2000 and 1999 and the related consolidated statement of operations for the three-year period ended December 31, 2000 and notes thereto which appear elsewhere herein. Certain prior period amounts have been reclassified to conform to current period presentation. (Notes 1 and 3 to the Consolidated Financial Statements.)
- --------------------------------- (1) ALARIS Medical was formed as a result of the merger of IMED Corporation and IVAC Medical Systems, Inc. in November 1996 ("the Merger"). As a result of the Merger, the Statement of Operations Data for 1996 is not comparable to the Statement of Operations Data for subsequent years.
(2) Beginning fourth quarter of 2000, the Company is required to classify shipping and handling revenues in sales. The Company has included such costs in sales for the year ended December 31, 2000 and has conformed 1999 and 1998 Statements of Operations Data to the current period presentation. Shipping and handling revenues were not segregated in earlier periods, therefore, 1997 and 1996 Statements of Operations Data is not comparable to later periods. (See Note 1 to the Consolidated Financial Statements.)
(3) Lease interest income consists of interest income associated with contracts or agreements pursuant to which a third party acquires infusion pumps under sales-type leases.
(4) As required by the Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), effective for periods ending after December 15, 1997, all prior period earnings per share data have been restated to conform with the provisions of the Statement. As a result, prior period numbers presented may not agree with the earnings per share data previously reported.
(5) In 1996, the Company entered into a $250,000 credit facility and also issued $200,000 of 9 3/4% senior subordinated notes due 2006. Additionally, convertible promissory notes in the aggregate principal amount of $37,500 were exchanged for 29,416 shares of common stock, including 3,333 shares issued as an inducement to convert, which resulted in $10,000 of debt conversion expense. ALARIS Medical also redeemed the remaining $21,924 principal amount of its 15% subordinated debentures due 1999 and recorded an extraordinary loss on
extinguishment of debt of $1,630 as a result of this transaction. On July 28, 1998, ALARIS Medical completed the sale of $109,892 of 11-1/8% Senior Discount Notes due 2008 (the "Senior Discount Notes"), receiving net proceeds of $106,321. A portion of the net proceeds of the sale of the Senior Discount Notes was also used to repay certain borrowings under the bank credit facility. For further discussion, see Note 5 to the Consolidated Financial Statements.
(6) Adjusted EBITDA represents income from operations before restructuring, integration and other non-recurring charges, non-cash purchase accounting charges and depreciation and amortization. Adjusted EBITDA does not represent net income or cash flows from operations, as these terms are defined under generally accepted accounting principles, and should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity. ALARIS Medical has included information concerning Adjusted EBITDA herein because it understands that such information is used by certain investors as one measure of an issuer's historical ability to service debt. Integration and other one-time non-recurring charges are excluded from Adjusted EBITDA as ALARIS Medical believes that the inclusion of these items would not be helpful to an investor's understanding of ALARIS Medical's ability to service debt. ALARIS Medical's computation of Adjusted EBITDA may not be comparable to similar titled measures of other companies.
(7) Amounts in 1996 and 1997 represent that portion of the purchase accounting adjustments made to adjust acquired inventory to its estimated fair value on the acquisition date. This adjustment to inventory was subsequently charged to cost of sales during December 1996 and the first quarter of 1997. The 1998 amount represents that portion of the purchase accounting adjustments made to adjust the 1998 acquired inventories to the estimated fair value on the acquisition dates which was subsequently charged to cost of sales.
(8) Depreciation and amortization excludes amortization of debt discount and issuance costs included in interest expense of $3,591, $3,324, $3,199, $3,125 and $1,332 for the years ended December 31, 2000, 1999, 1998, 1997 and 1996, respectively.
(9) During the third quarter of 2000, the Company sold the assets and certain liabilities of its Instromedix division to Card Guard Technologies, Inc., which had been acquired in 1998. Losses for discontinued operations for 2000, 1999 and 1998 are net of applicable income tax benefits of $872, $4,200 and $1,000, respectively. Discontinued operations for 1999 include a pretax charge of $19,200 resulting from the write-off of goodwill and other intangible assets and approximately $4,600 in integration charges. Discontinued operations in 1998 include a charge of $22,800 in write-offs related to in-process research and development. (See Note 3 to the Consolidated Financial Statements.)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS OF ALARIS MEDICAL AND THE RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS ANNUAL REPORT. CERTAIN PRIOR PERIOD AMOUNTS HAVE BEEN RECLASSIFIED TO CONFORM TO CURRENT PERIOD PRESENTATION. (NOTE 1 TO THE CONSOLIDATED FINANCIAL STATEMENTS.)
OVERVIEW
ALARIS Medical is a holding company for ALARIS Medical Systems. ALARIS Medical also identifies and evaluates potential acquisitions and investments, and performs various corporate functions. As a holding company, ALARIS Medical currently has no revenues to fund its operating and interest expense and relies on its existing cash, cash generated from operations of ALARIS Medical Systems and external financing to meet its obligations. Capitalized terms used but not defined herein have the meaning ascribed to them in the Notes to the Consolidated Financial Statements.
The Company is a leading provider of infusion systems and related technologies to the United States hospital market, with the largest installed base of pump delivery lines ("channels"). The Company is also a leader in the international infusion systems market. Based on installed base of infusion pumps, the Company has a number one or two market position in seven Western European countries, the number three market position in three countries, the largest installed base of infusion pumps in Australia and Canada and a developing position in Latin America and Asia. The Company's infusion systems, which are used to deliver one or more fluids, primarily pharmaceuticals or nutritionals, to patients, consist of single and multi-channel infusion pumps and dedicated and non-dedicated disposable administration sets (i.e., plastic tubing and pump interfaces). In addition, the Company is a leading provider of patient monitoring products that measure and monitor temperature, pulse, pulse oximetry and blood pressure, with the largest installed base of hospital thermometry systems in the United States.
The Company sells a full range of products through a worldwide direct sales force consisting of over 250 sales persons and through more than 150 distributors to over 5,000 hospitals worldwide. Sales by the Company's International business unit represented 31.4% of the Company's total sales for the year ended December 31, 2000. For the year ended December 31, 2000, the Company had sales of $378.9 million and Adjusted EBITDA of $80.4 million.
Historically, the Company's results of operations have been affected by the cost containment pressures applicable to health care providers. Notwithstanding cost containment pressures, unit sales volume of the Company's disposable administration sets increased in every year since 1993, primarily as a result of the growth in its worldwide installed base of infusion pumps. However, uncertainty remains with regard to future changes within the healthcare industry. The trend towards managed care and economically motivated buyers in the U.S. may result in continued pressure on selling prices of products and compression on gross margins. The U.S. marketplace is characterized by consolidation among healthcare providers and purchasers of medical products. The Company's profitability is affected by the use of Group Purchasing Organizations ("GPOs") which are better able to negotiate favorable pricing from providers of infusion systems, such as the Company, and which insure compliance with exclusive buying arrangements for their members. These buying arrangements, in certain situations, also may result in the GPO requiring removal of the Company's existing infusion pumps. As a result, GPOs may have an adverse effect on the Company's future profitability. Finally, the enactment of national health care reform or other legislation affecting payment mechanisms and health care delivery could affect the Company's future results of operations. It is impossible to predict the extent to which the Company may be affected by any such change in legislation.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected financial information expressed as a percentage of sales. Certain prior period amounts have been reclassified to conform to current period presentation. (Notes 1 and 3 to the Consolidated Financial Statements.)
The following table summarizes sales to customers by each business unit:
(A) The Company's sales results are reported consistent with the Company's two strategic business units: North America and International.
YEAR ENDED DECEMBER 31, 2000 COMPARED WITH YEAR ENDED DECEMBER 31, 1999
SALES. Sales decreased $11.0 million, or 3%, during 2000 compared with 1999. North America sales decreased $5.8 million, or 2.2% and International sales decreased $5.2 million or 4.2%. The decrease in North America sales in 2000 is primarily due to a decrease in drug infusion disposable administration set revenue of $3.0 million and patient monitoring instruments and disposable revenue of $3.1 million, partially offset by an increase in drug infusion instrument revenue of $1.1 million. Disposable set revenue was lower than a year ago in major markets worldwide. The Company estimates that about $3 million of its dedicated disposable sets were purchased in 1999 as safety stock in anticipation of possible Y2K problems at year-end. The Company believes that most of this customer inventory was worked-off in the first quarter of 2000, resulting in 1999 shipments and revenues that otherwise would have been shipped and recorded in 2000. The majority of the Company's international sales are denominated in foreign currency. Due to a stronger U.S. dollar in 2000 compared with the actual foreign currency exchange rates in effect during 1999, translation of 2000 international sales were adversely impacted by $10.0 million. Using constant exchange rates, International sales increased 4% due primarily to unit growth in syringe pumps and large volume pumps.
GROSS MARGIN. Gross margin decreased $14.0 million or 7% during 2000 compared with 1999. The gross margin percentage decreased from 48.7% in 1999 to 46.4% in 2000 due to changes in product mix and unfavorable manufacturing variances. Contributing to the margin decrease in 2000 was the overall worldwide mix of increased instrument sales and lower disposables sales, lower international sales which typically carry higher margins than U.S. sales and a stronger U.S. dollar.
SELLING AND MARKETING EXPENSE. Selling and marketing expenses decreased $3.4 million, or 5%, during 2000 compared with 1999 due to lower sales and the favorable effect on international expenses of a strong U.S. dollar. Additionally, the 1999 results included costs of approximately $2.1 million that were not repeated in 2000 for management consulting fees associated with developing and validating product strategies. As a percentage of sales, selling and marketing expenses decreased from 19.4% in 1999 to 19.1% in 2000.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense decreased $3.6 million, or 8%, during 2000 compared with 1999. This decrease is primarily due to lower amortization expense in 2000 resulting from certain intangible assets becoming fully amortized. These decreases were partially offset by increased information technology costs for the Company's new International operating system implemented in late 1999 and higher medical benefits costs than in the prior year. As a percentage of sales, general and administrative expense decreased from 10.8% for 1999 to 10.2% for 2000.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense decreased approximately $0.6 million, or 3%, during 2000. As a percentage of sales, research and development spending remained consistent with the prior year.
RESTRUCTURING, INTEGRATION AND OTHER NON-RECURRING CHARGES. Restructuring, integration and other non-recurring charges increased $4.2 million during 2000 compared with the prior year. The 2000 costs represent restructuring activities the Company initiated which totaled approximately $7.0 million. These actions are intended to save approximately $6 million per year when fully implemented and involve facilities in Creedmoor, N.C., Basingstoke, England and San Diego. The primary focus of this activity is in the Creedmoor manufacturing operation. This plant is being restructured to include disposables engineering, automated manufacturing of selected products and distribution operations. Manual assembly operations will be relocated to the Company's facilities in Tijuana, Mexico, and certain operations will be outsourced. Additionally, the Basingstoke and San Diego operations are being matched to the mix of requirements resulting from current and future product line rationalization efforts. The restructuring and other non-recurring charges of $7.0 million taken during the current period were composed of severance ($5.3 million), fixed asset write-offs ($1.0 million), termination of a product distribution agreement ($0.6 million) and closure of a foreign sales office ($0.1 million).
Integration and other non-recurring charges for 1999 includes a third quarter charge of $2.8 million for two patent license agreements related to patent infringement lawsuits (see Note 15 to the accompanying Consolidated Financial Statements).
LEASE INTEREST INCOME. Lease interest income during both periods consists of interest income associated with contracts or agreements pursuant to which a third party acquired infusion pumps under sales-type leases. Lease interest income increased $0.7 million in 2000 compared with 1999 due to increased sales activity associated with such leases.
INCOME FROM OPERATIONS. Income from operations decreased $10.0 million during 2000 compared with 1999 primarily due to lower sales and gross margins and restructuring charges, which were partially offset by lower operating spending.
INTEREST EXPENSE. Interest expense increased $3.0 million, or 5%, during 2000 primarily due to increased interest accretion on the Company's 11?% senior discount notes as well as higher interest rates in 2000 on the Company's other outstanding debt. Additionally, in conjunction with an $18.1 million debt repayment following the sale of Instromedix, the Company recorded a corresponding reduction of debt issuance costs, resulting in a $0.4 million interest expense charge in the current period.
OTHER EXPENSE. Other expense decreased $1.5 million during 2000 compared with 1999, primarily due to the favorable resolution of two tradename disputes resulting in payments to ALARIS Medical Systems of approximately $2.8 million during 2000. This income was partially offset by increases of $1.4 million in foreign currency transaction losses resulting from the strengthening of the U.S. dollar in 2000 compared with the actual foreign currency exchange rates in effect during 1999.
DISCONTINUED OPERATIONS. During the third quarter of 2000, the Company sold its Instromedix division to Card Guard Technologies, Inc., resulting in a gain of $1.8 million, net of applicable taxes. For the year ended December 31, 2000, operating losses of $1.3 million (net of tax) for the Instromedix division are included in discontinued operations. Discontinued operations in 1999 included a pretax charge of $19.2 million resulting from the write-off of goodwill and other intangible assets related to the Instromedix business unit and $4.6 million in integration charges related to the consolidation of Instromedix into the San Diego facility (see Note 3 to the accompanying Consolidated Financial Statements).
ADJUSTED EBITDA. Adjusted EBITDA decreased $6.8 million, or 8%, during 2000 compared with 1999. As a percentage of sales, Adjusted EBITDA decreased from 22.4%, or $87.2 million, for 1999 to 21.2%, or $80.4 million, for 2000 due to lower sales and gross margins and restructuring charges, which were partially offset by lower operating spending. Adjusted EBITDA represents income from operations before restructuring, integration and other non-recurring, non-cash purchase accounting charges and depreciation and amortization. Adjusted EBITDA does not represent net income or cash flows from operations, as these terms are defined under generally accepted accounting principles, and should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity. The Company has included information concerning Adjusted EBITDA herein because it understands that such information is used by certain investors as one measure of an issuer's historical ability to service debt. Restructuring, integration and other one-time non-recurring charges are excluded from Adjusted EBITDA as the Company believes that the inclusion of these items would not be helpful to an investor's understanding of the Company's ability to service debt. The Company's computation of Adjusted EBITDA may not be comparable to similar titled measures of other companies.
YEAR ENDED DECEMBER 31, 1999 COMPARED WITH YEAR ENDED DECEMBER 31, 1998
SALES. Sales increased $16.1 million, or 4%, during 1999 compared with 1998. North America sales increased $17.0 million, or 7% and International sales decreased $0.9 million or 1%. The majority of the Company's international sales are denominated in foreign currency. Due to a stronger U.S. dollar in 1999 compared with the actual foreign currency exchange rates in effect during 1998, translation of 1999 international sales were adversely impacted by $4.0 million. Using constant exchange rates, International sales increased 3% due primarily to increased volume of disposable administration sets. The increase in North America sales in 1999 is primarily due to an increase in drug infusion disposable administration set revenue of $11.3 million and drug infusion instrument revenue of $5.8 million. The increase in drug infusion disposable administration set revenue is due primarily to an increase in volume of the Company's SmartSite needle-free system administration sets.
GROSS MARGIN. Gross margin increased $2.3 million or 1% during 1999 compared with 1998. The gross margin percentage decreased from 50.2% in 1998 to 48.7% in 1999 due in part to a one-time charge of $2.5 million during the second quarter of 1999 associated with disposable manufacturing issues as well as a $1 million charge during the fourth quarter of 1999 to write-down slow moving and potentially obsolete inventory. Additionally, despite lower manufacturing costs due to increased volume, gross margin percentages declined on drug infusion instruments due to lower average selling prices in 1999 compared with 1998.
SELLING AND MARKETING EXPENSE. Selling and marketing expenses increased $3.6 million, or 5%, during 1999 compared with 1998. As a percentage of sales, selling and marketing expenses increased from 19.3% in 1998 to 19.4% in 1999. This increase is primarily due to management consulting fees associated with developing product strategies and planning upcoming product introductions, higher compensation and clinical consultants costs associated with the increase in North America sales.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense increased $1.5 million, or 4%, during 1999 compared with 1998. The increase is due to activity associated with now concluded patent litigation and an increase in information technology costs for the Company's new domestic operating system implemented in late 1998. As a percentage of sales, general and administrative expense decreased from 10.9% for 1998 to 10.8% for 1999.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense increased approximately $2.9 million, or 15%, during 1999 primarily due to increased activities associated with the later development stages of various domestic and international engineering projects for infusion systems, electronic thermometry and disposable administration sets.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT. During the second quarter of 1998, the Company acquired the net assets of Patient Solutions, Inc. ("PSI"). PSI was a wholly owned subsidiary of Invacare Corporation and was focused on the development of an ambulatory pump for use in the alternate-site market. In connection with the PSI acquisition and the technology license agreement with Caesarea during the second quarter of 1998, the Company incurred a one-time $5.5 million write-off related to the value assigned to the acquired in-process research and development of the projects for which technological feasibility had not been established and for which there was no alternative future use. During the fourth quarter of 1999, as a result of the decision to discontinue work on the technology acquired from PSI, the Company recorded a charge to operations of approximately $0.9 million to write-off the remaining assets acquired from PSI.
Pursuant to the technology license agreement, the Company acquired certain volumetric infusion pump technology from Caesarea. Caesarea is conducting research and development on this in-process technology in order to create a large volume infusion pump marketed primarily to consumers in emerging international markets. The Company is required to make certain milestone payments up to an aggregate of $4.0 million to Caesarea upon the attainment of certain developmental milestones, which primarily relate to
different product releases. During 1999 and 1998, upon reaching such milestones, the Company made payments to Caesarea of $2.8 million and $0.8 million, respectively, and certain products using the purchased in-process technology were released during 1999.
INTEGRATION AND OTHER NON-RECURRING CHARGES. Integration and other non-recurring charges for 1999 includes a third quarter charge of $2.8 million related to two patent license agreements related to patent infringement lawsuits (see Note 15 to the accompanying Consolidated Financial Statements).
LEASE INTEREST INCOME. Lease interest income during both periods consists of interest income associated with contracts or agreements pursuant to which a third party acquired infusion pumps under sales-type leases. Lease interest income decreased $0.2 million in 1999 compared with 1998 due to a decrease in the amount outstanding under such leases.
INCOME FROM OPERATIONS. Income from operations decreased $3.1 million during 1999 compared with 1998 primarily due to the patent license agreements charges and the $2.5 million charge to cost of sales resulting from manufacturing issues related to infusion disposable products which were partially offset by 1998 non-recurring charges. After excluding the non-recurring charges from 1999 and 1998, income from operations for 1999 is $56.8 million compared with $60.1 million in 1998. The decrease in 1999 over 1998 is primarily due to increases in operating expenses discussed above, which were partially offset by higher gross margin dollars.
INTEREST EXPENSE. Interest expense increased $6.3 million, or 13%, during 1999 primarily due to additional financing obtained to fund the Instromedix acquisition. In connection with the Instromedix acquisition, in July 1998 the Company increased its outstanding bank term debt $30.0 million and completed the sale of $109.9 million 11? % Senior Discount Notes, due 2008. In 1999 the Company recorded a full year of interest expense for the additional financing, compared with five and one-half months of interest in 1998. The increase from Senior Discount Notes was partially offset by a decrease in interest expense on other long-term debt due to a decrease in the amount outstanding in 1999 compared with 1998, as well as lower interest expense on the Credit Facility in 1999 compared with 1998. (See Liquidity and Capital Resources.)
INTEREST INCOME. Interest income increased approximately $0.2 million during 1999 compared with 1998 due to earnings from the remaining cash proceeds from the Senior Discount Notes which were issued in July 1998 to fund the Instromedix acquisition.
OTHER EXPENSE. Other expense increased $0.6 million during 1999 compared with 1998, primarily due to an increase in foreign exchange loss of approximately $0.8 million during 1999 compared with 1998.
DISCONTINUED OPERATIONS. During the third quarter of 2000, the Company sold its Instromedix division to Card Guard Technologies, Inc. Operating losses of $23.6 million (net of tax) and $25.2 million (net of tax) for the Instromedix division are included in discontinued operations for 1999 and 1998, respectively. Discontinued operations in 1999 included a pretax charge of $19.2 million resulting from the write-off of goodwill and other intangible assets related to the Instromedix business unit and $4.6 million in integration charges related to the consolidation of Instromedix into the San Diego facility. Discontinued operations in 1998 included a charge of $22.8 million in write-offs related to in-process research and development.
ADJUSTED EBITDA. Adjusted EBITDA decreased $7.1 million, or 8%, during 1999 compared with 1998. As a percentage of sales, Adjusted EBITDA decreased from 25.2%, or $94.2 million, for 1998 to 22.4%, or $87.2 million, for 1999 due primarily to patent license agreement charges and the $2.5 million charge to cost of sales described above. Adjusted EBITDA represents income from operations before restructuring, integration and other non-recurring, non-cash purchase accounting charges and depreciation and amortization. Adjusted EBITDA does not represent net income or cash flows from operations, as these
terms are defined under generally accepted accounting principles, and should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity. The Company has included information concerning Adjusted EBITDA herein because it understands that such information is used by certain investors as one measure of an issuer's historical ability to service debt. Integration and other one-time non-recurring charges are excluded from Adjusted EBITDA as the Company believes that the inclusion of these items would not be helpful to an investor's understanding of the Company's ability to service debt. The Company's computation of Adjusted EBITDA may not be comparable to similar titled measures of other companies.
LIQUIDITY AND CAPITAL RESOURCES
ALARIS Medical expects to continue to meet its liquidity needs during 2001, including capital expenditure requirements, with cash flow from operations of ALARIS Medical Systems. ALARIS Medical Systems will continue to use its funds primarily for operating expenses, including planned expenditures for new research and development programs, capital expenditures and scheduled payments on outstanding indebtedness.
At December 31, 2000, the Company had outstanding indebtedness of $523.8 million. ALARIS Medical Systems has a credit facility with a group of banks and other lenders consisting of term loans and a revolving credit facility (the "Credit Facility"). Indebtedness under the Credit Facility bears interest at floating rates based, at the Company's option, on Eurodollar or prime rates. The indebtedness under the Credit Facility is secured by substantially all of the assets of ALARIS Medical Systems and is guaranteed by ALARIS Medical. At December 31, 2000, outstanding indebtedness under the Credit Facility was $164.8 million. In addition to indebtedness under the Credit Facility, at December 31, 2000, ALARIS Medical Systems also had outstanding $200 million of 9-3/4% Senior Subordinated Notes due 2006 (the "Notes") and ALARIS Medical had outstanding $16.2 million of 7-1/4% Convertible Subordinated Debentures due January 15, 2002 (the "Convertible Debentures"). In addition, ALARIS Medical had outstanding $142.9 million (including accretion) of 11-1/8% Senior Discount Notes due 2008 (the "Senior Discount Notes"). Interest accruing on the Senior Discount Notes is added to the outstanding principal balance through July 31, 2003. Interest accruing subsequent to July 31, 2003 is payable in cash semi-annually in arrears on February 1 and August 1, commencing February 1, 2004.
The Company projected not meeting certain 2001 financial covenants contained in the Credit Facility agreement. As a result, in April 2001 the Company obtained an amendment (the Amendment) to the terms of the Credit Facility. The Amendment included the following: (i) a provision providing for changes to certain financial performance covenants for each applicable period from March 31, 2001 through December 31 2003, (ii) a provision providing for increases to the interest rates on each of the debt tranches (See Note 5 to the Consolidated Financial Statements), (iii) a provision providing for a decrease in the line of credit from $60 million to $20 million, and (iv) a provision allowing ALARIS Medical Systems to borrow (as part of the Credit Agreement or otherwise) up to an additional $15 million from a lender it must first locate and to use the funds so borrowed to repurchase Convertible Debentures. The $15
million is the maximum that can be borrowed by ALARIS Medical Systems under the terms of the Notes and used for this purpose. The changes to the financial performance covenants were developed based on the Company's strategic plans and were designed to allow the Company access to the $20 million credit line.
The Credit Facility and the indenture governing the Notes (the "Notes Indenture") permit ALARIS Medical Systems to fund interest payments on the Convertible Debentures (in the case of the Credit Facility, so long as there exists no default or event of default thereunder). However, both the Credit Facility and the Notes Indenture prohibit ALARIS Medical Systems from making those distributions to ALARIS Medical which would enable it to fund such repayment, unless ALARIS Medical Systems has achieved certain financial performance targets. Since management does not believe that ALARIS Medical Systems will meet such tests, it is exploring various alternatives under which those repayment obligations could be satisfied. For example, management has had preliminary discussions with the administrative agent under the Credit Facility and has been informed that certain lenders have expressed interest in lending the allowed $15 million to ALARIS Medical Systems as part of the Credit Agreement. Management believes that the terms provided in the Amendment for this borrowing should be sufficient to obtain this borrowing. However, since no lender has yet actually agreed to do so, there can be no assurance that ALARIS Medical Systems will be able to borrow the $15 million it is seeking. In any event, a default by ALARIS Medical on all or any portion of its $16.2 million outstanding principal payment obligations under the Convertible Debentures, whether as a result of the Company's failure to obtain the funds necessary to purchase, or repay, all outstanding Convertible Debentures, or otherwise, would likely result in an event of default under, and possible acceleration of the obligations under, the Credit Facility, the Notes and the Senior Discount Notes.
Management believes that if the Company can successfully arrange for the repayment or purchase of the Convertible Debentures at, or prior to, maturity, it will generate cash flow from operations, together with its existing cash, sufficient, on both a long and short term basis, to fund its operations, make planned capital expenditures and make scheduled principal amortization and interest payments under the Credit Facility and interest payments on the Notes. However, on a long-term basis, the Company may not generate sufficient cash flow from operations to make scheduled interest payments on the Senior Discount Notes beginning in 2004, repay the Notes at maturity in 2006, or to repay the Senior Discount Notes at maturity in 2008. Accordingly, the Company may have to seek to refinance the Notes and the Senior Discount Notes at or prior to maturity or sell assets or raise equity capital to service its indebtedness in the long term. There can be no assurance that the Company would be successful in such efforts. Based on current interest rates and debt outstanding as of December 31, 2000, the Company is required over the next twelve months, to make principal and interest payments under its Credit Facility in the amount of $36.1 million and interest payments on the Notes and the Convertible Debentures in the amount of $19.5 million and $1.2 million, respectively. Annual principal amortization of the Company's indebtedness is $19.9 million, $42.2 million and $29.0 million for 2001, 2002 and 2003, respectively. In addition, the Company's ability to fund its operations, to make planned capital expenditures, to make scheduled principal and interest payments and to meet the financial performance covenants in the amended Credit Facility will depend on the Company's future operating performance, which is itself dependent on a number of factors, many of which the Company cannot control, including conditions affecting the Company's foreign operations, prevailing economic conditions, availability of other sources of liquidity, and financial, business, regulatory and other factors affecting the Company's business and operations.
Net cash provided by operating activities for the year ended December 31, 2000 was $39.9 million compared with $51.1 million provided by operating activities in 1999. Net cash used in investing activities for the year ended December 31, 2000 and 1999 was $0.4 million and $38.0 million, respectively. Net cash used in investing activities included net proceeds from the sale of Instromedix of $17.5 million in 2000, and $7.8 million in payments related to patent license agreements in 1999. Cash used in investing activities also includes $14.9 million and $25.9 million in net capital expenditures for the years ended December 31, 2000 and 1999, respectively. Net cash used by financing activities for the year ended December 31, 2000 and 1999 was $32.3 million and $18.9 million, respectively and was primarily composed of principal payments on long-term debt. In August 2000, in connection with the sale of Instromedix, the Company made a payment of $18.1 million under the Credit Facility, reducing the outstanding balance thereunder to $167.8 million from $185.9 million.
During 2000, the Company made cash payments of $4.2 million for restructuring activities initiated in 2000. These actions are intended to save approximately $6 million per year when fully implemented and involve facilities in Creedmoor, N.C., Basingstoke, England and San Diego. The primary focus of this activity is in the Creedmoor manufacturing operation. This plant is being restructured to include disposables engineering, automated manufacturing of selected products and distribution operations. Manual assembly operations will be relocated to the Company's facilities in Tijuana, Mexico, and certain operations will be outsourced. Additionally, the Basingstoke and San Diego operations are being matched to the mix of requirements resulting from current and future product line rationalization efforts. Approximately $1 million of the total estimated restructuring charge was non-cash. The majority of the restructuring charges are expected to be paid in 2001. At December 31, 2000, $1.8 million was accrued for such restructuring costs.
During 1999, the Company made cash payments of approximately $4.7 million related to Instromedix integration costs of which approximately $0.8 million was accrued at December 31, 1998. These integration activities primarily related to the assessment and review of Instromedix operating activities and strategy. In February 1999, as a result of this assessment, the Company announced its plans to consolidate the operations of Instromedix into its San Diego, California facilities. In connection with these relocation and integration activities, the Company incurred nonrecurring charges of approximately $4.6 million before related income tax benefits in 1999. Of this charge, approximately $0.6 million was accrued at December 31, 1999. Cash payments of $0.4 million were made in 2000 related to these activities and the remaining accrual of $0.2 million is expected to be paid during 2001.
As described in Note 15 to the Consolidated Financial Statements, the Company has entered into two patent license agreements. In connection with these agreements, the Company made a payment of $4.0 million during the third quarter of 1999 and a payment of $6.7 million in the fourth quarter of 1999. No future payments are required under these agreements.
The Company made capital expenditures of approximately $14.9 million and $26.1 million during the year ended December 31, 2000 and 1999, respectively. During the fiscal years 1996 through 1999, the Company made combined capital and operating expenditures of approximately $19.0 million related to the new enterprise-wide information system. The project was completed in 2000 with additional spending of approximately $0.5 million.
SEASONALITY
Infusion instrument sales are typically higher in the fourth quarter due to sales compensation plans which reward the achievement of annual quotas and the seasonal characteristics of the industry, including hospital purchasing patterns. First quarter sales are traditionally not as strong as the fourth quarter. The Company anticipates that this trend will continue but is unable to predict the effect, if any, from health care reform, increased competitive pressures. Approximately 31% and 34% of the Company's sales of drug infusion instruments occurred during the fourth quarters of 2000 and 1999, respectively.
BACKLOG
The backlog of orders, believed to be firm, at December 31, 2000 and 1999 was $13.8 million and $8.2 million, respectively.
FOREIGN OPERATIONS
The Company has significant foreign operations and, as a result, is subject to various risks, including without limitation, foreign currency risks. This risk has not materially changed during 2000. Due to changes in foreign currency exchange rates during 2000 and 1999, primarily a strengthening of the U.S. dollar, the Company's functional currency, against many European currencies, the Company recognized a foreign currency transaction loss of approximately $2.5 million and $1.1 million during 2000 and 1999, respectively. For the year ended December 31, 2000 and the year ended December 31, 1999, approximately 34% and 34% of the Company's sales and 33% and 29% of the Company's operating expenses were denominated in currencies other than the Company's functional currency. These foreign currencies are primarily those of Western Europe, Canada and Australia. Additionally, substantially all of the receivables and payables of the Company's foreign subsidiaries are denominated in currencies other than the Company's functional currency. As of December 31, 2000 the Company had not entered into foreign currency contracts for purposes of hedging or speculation. Beginning 2001, the Company will enter into certain contracts to manage the risk of foreign currency fluctuations. (See "Foreign Exchange Risk Management.")
HEALTH CARE REFORM
Heightened public awareness and concerns regarding the growth in overall health care expenditures in the United States may result in the enactment of legislation affecting payment mechanisms and health care delivery. Legislation which imposes limits on the number and type of medical procedures which may be performed or which has the effect of restricting a provider's ability to select specific devices or products for use in administrating medical care may adversely impact the demand for the Company's products. In addition, legislation which imposes restrictions on the price which may be charged for medical products may adversely affect the Company's results of operations. It is not possible to predict the extent to which the Company or the health care industry in general may be adversely affected by the aforementioned in the future.
FORWARD-LOOKING STATEMENTS
Forward-Looking Statements in this report are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Persons reading this report are cautioned that such forward-looking statements involve risks and uncertainties, including, without limitation, the effect of legislative and regulatory changes effecting the health care industry; the potential of increased levels of competition; technological changes; the dependence of the Company upon the success of new products and ongoing research and development efforts; restrictions contained in the instruments governing the Company's indebtedness; the significant leverage to which the Company is subject; and other matters referred to in this report.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVE FINANCIAL INSTRUMENTS
The Company addresses certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments. As of December 31, 2000, the Company had completed the preparatory steps to initiate a foreign exchange risk management program commencing with the upcoming fiscal period. Under the program, the Company will utilize foreign currency forward and option contracts to reduce the effect of foreign exchange rate fluctuations.
Consistent with its action in 1997 to reduce the effect of interest rate volatility as described in preceding paragraphs, the Company continued its use of interest rate swap derivatives during 2000. The swap agreement entered into in 1997 expired in 2000 and a new swap agreement was entered into during the second quarter of 2000 with a term extending through January of 2002. The Company categorizes these instruments as entered into for purposes other than trading.
FOREIGN EXCHANGE RISK MANAGEMENT
As part of the plan to manage the risk of foreign currency fluctuations, the Company anticipates entering into forward exchange contracts to hedge purchases, receivables and payables denominated in foreign currencies for periods consistent with identified exposures. The purpose of the hedging is to minimize the effect of foreign currency exchange rates on cashflows the Company receives from its foreign subsidiaries. All foreign currency contracts are denominated in the currencies of major industrial countries and are with large financial institutions rated as investment grade by a major rating agency. Gains and losses related to qualifying hedges of these exposures are deferred and recognized in operating income when the underlying hedged transaction occurs. The Company also enters into foreign currency options to hedge anticipated transactions where there is a high probability that anticipated exposures will materialize. Any gains realized on such options that qualify as hedges are deferred and recognized in operating income when the underlying hedged transaction occurs. Premiums on foreign currency options are amortized over the period being hedged. Foreign currency transactions that would not qualify as hedges would be marked to
market on a current basis with gains and losses recognized through income and reflected in foreign exchange gains and losses. In addition, any previously deferred gains and losses on hedges which are terminated prior to the transaction date would be recognized in current income when the hedge is terminated.
As a matter of policy, the Company will only enter into contracts with counterparties that have at least an investment grade or equivalent credit rating. The counterparties to these contracts are major financial institutions. The Company does not have significant exposure to any one counterparty. Management believes the risk of loss related to counterparty default is remote and in any event, would not be material. The contracts will have varying maturities with none exceeding twelve months. Costs associated with entering into contracts are not expected to be material to our financial results. The Company does not utilize derivative instruments for trading or speculative purposes. At December 31, 2000, there were no outstanding foreign currency option or forward contracts.
INTEREST RATE RISK MANAGEMENT
During the second quarter of 1997, the Company entered into an interest rate protection agreement ("swap") covering approximately 50% of its term loan borrowings through February 1, 2000. The swap fixed the interest rate charged on Credit Facility term borrowings resulting in a weighted average interest rate of 9.7% as of December 31, 1999. During the second quarter of 2000, the Company entered into a new swap with a notional amount of $100.0 million, expiring in February of 2002. The new swap effectively changed the Company's interest rate exposure on its floating rate Credit Facility term debt, resulting in a weighted average interest rate as of December 31, 2000 of 10.5%. A 10% increase (approximately one percentage point) in the applicable interest rate would result in a $0.3 million annual increase in interest expense.
As noted, the company enters into interest rate protection agreements ("swaps") to convert a portion of floating rate credit facility term debt to fixed rate. The present swap is an instrument that exchanges floating rate for fixed rate interest rate payments through January of 2002. Amounts currently due to or from the swap are recorded in interest expense in the period in which they accrue. The agreement affects interest payments for $100 million of principal of the outstanding credit facility term debt.
MARKET RISK
The Company will incur option premium cost in connection with its foreign currency hedging activities. The option premium cost represents the entire risk associated with these derivatives. Option premium costs are amortized over the life of the option contract.
The Company has not incurred any direct cost in connection with the swap agreement. However, since entering into the agreement, the fair value of the swap has become negative. At December 31, 2000 the negative market value of the swap is $1.6 million. Should the Company terminate the swap in advance of expiration, the cost to the Company could be material.
EURO TRANSITION
On January 1, 1999, the eleven member countries of the European Union began the transition to a common currency, the "Euro". The conversion rates between the Euro and the participating nations' currencies were fixed irrevocably as of January 1, 1999 with the participating national currencies to be removed from circulation between January 1 and June 30, 2002 and replaced by Euro notes and coinage. The Company is currently evaluating the effect of this transition and at the present time, management does not believe the Euro transition will have a materially adverse impact on its business.
ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, " Accounting for Derivative Instruments and Hedging Activities". This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 is effective for the Company's fiscal quarter beginning January 1, 2001 (date of transition) and will not require retroactive restatement of prior period financial statements. SFAS No. 133 requires the recognition of all derivative instruments as either assets or liabilities in the statement of financial position measured at fair value. Generally, increases or decreases in the fair value of derivative instruments will be recognized as gains or losses in earnings in the period of change. If certain conditions are met, where the derivative instrument has been designated as a fair value hedge, the hedged item may also be marked to market through earnings, thus creating an offset. If the derivative is designated and qualifies as a cash flow hedge, the changes in the fair value of the derivative instrument may be recorded on the balance sheet as other comprehensive income.
The new accounting standard has not significantly affected the Company's approach to managing interest rate and foreign currency risk. The Company plans to hedge against these exposures using forward exchange contracts, foreign currency options, interest rate swaps and options. These contracts have been designated as hedges of anticipated future cashflows and accordingly, will be marked to market through other comprehensive income (balance sheet adjustment) until such time as the related anticipated transactions affect earnings.
No foreign exchange hedging instruments were outstanding during 2000. The interest rate protection agreement entered into in 2000 had a negative market value of $1.6 million at December 31, 2000, which would be the cost for the company to terminate the swap as of that date. Under SFAS No. 133, a derivative designated as a hedge must meet an effectiveness test. If a hedged liability contains provisions permitting pre-payment, the effectiveness test must be based on the "long method". ALARIS uses the long method effectiveness test and has determined the swap is a highly effective hedge. Consequently, changes in the swap fair value will be reflected on the balance sheet as other comprehensive income.
Additional information on market risk is set forth under the subcaption "Liquidity and Capital Resources" contained under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements are set forth on pages through of this Annual Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding Directors is incorporated by reference to the section entitled "Election of Directors" in the ALARIS Medical, Inc. Proxy Statement to be filed with the Securities and Exchange Commission in connection with the Annual Meeting of Stockholders to be held on May 23, 2001 (the "Proxy Statement"). Information regarding Executive Officers is set forth in Item 1 of Part I of this Report under the caption "Executive Officers of the Registrant."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference in the Company's Proxy Statement under the heading "Executive Compensation."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference in the Company's Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference in the Company's Proxy Statement under the heading "Certain Relationships and Related Transactions."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report.
1. FINANCIAL STATEMENTS:
The following financial statements of ALARIS Medical, Inc. and its subsidiaries are included on pages through:
Report of Independent Accountants
Consolidated Balance Sheet at December 31, 2000 and 1999
Consolidated Statement of Operations for the years ended December 31, 2000, 1999 and 1998
Consolidated Statement of Cash Flows for the years ended December 31, 2000, 1999 and 1998
Consolidated Statement of Stockholders' Equity for the period from December 31, 1997 to December 31, 2000
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES:
Schedule II--Valuation and Qualifying Accounts and Reserves for the three years ended December 31, 2000
Schedule III--Condensed Financial Information of ALARIS Medical, Inc. as of December 31, 2000 and 1999 and for the three years ended December 31, 2000.
All other schedules have been omitted because they are inapplicable, not required or the required information is included in the financial statements or notes thereto.
3. EXHIBITS:
- -------------------------- * Filed as an exhibit to the Registration Statement on Form S-4 (333-18687) of the Company, IVAC Overseas Holdings, Inc. and IMED International Trading Corp. dated December 24, 1996.
(b) Report on Form 8-K.
None.
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, in the City of San Diego, State of California, on April 16, 2001.
ALARIS MEDICAL, INC.
By: /s/ DAVID L. SCHLOTTERBECK --------------------------------------------------------- Name: David L. Schlotterbeck Title: President 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 and in the capacities and on the dates indicated.
ALARIS MEDICAL, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of ALARIS Medical, Inc.:
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 39 present fairly, in all material respects, the financial position of ALARIS Medical, Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14(a)(2) on page 39 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, 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 our opinion.
As discussed in Note 5 to the consolidated financial statements, $16,125,000 of 7.25% convertible subordinated debentures mature on January 15, 2002.
PricewaterhouseCoopers LLP San Diego, CA April 13, 2001
ALARIS MEDICAL, INC CONSOLIDATED BALANCE SHEET - -------------------------------------------------------------------------------- (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ALARIS MEDICAL, INC. CONSOLIDATED STATEMENT OF OPERATIONS - -------------------------------------------------------------------------------- (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ALARIS MEDICAL, INC. CONSOLIDATED STATEMENT OF CASH FLOWS - -------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ALARIS MEDICAL, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------- (DOLLAR AND SHARE AMOUNTS IN THOUSANDS)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ALARIS MEDICAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1 - BUSINESS, ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY:
ALARIS Medical, Inc. ("ALARIS Medical"), operating through its consolidated subsidiaries, designs, manufactures, distributes and services intravenous infusion therapy and patient monitoring instruments and related disposables and accessories. ALARIS Medical was formed by the merger of two pioneers in infusion systems, IMED Corporation ("IMED") and IVAC Medical Systems, Inc. ("IVAC"), on November 26, 1996. ALARIS Medical (formerly Advanced Medical, Inc.) was incorporated on September 28, 1988 under the laws of the State of Delaware. The acquisition was accounted for as a purchase. ALARIS Medical and its subsidiaries are collectively referred to as the "Company."
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
CONSOLIDATION:
The financial statements include the accounts of ALARIS Medical and its greater than 50 percent-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities 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.
REVENUE RECOGNITION:
Revenue is recorded upon passage of title and transfer of risk of loss, net of an allowance for estimated returns. Service revenue is recognized when services are rendered. Additionally, the Company leases instruments to customers under non-cancelable sales-type capital leases and operating lease contracts with terms ranging generally from 1 to 6 years. The Company sells instruments via long-term financing arrangements to a number of customers under agreements which allow customers to acquire instruments with no initial payment. The sales price for the instruments is recovered via surcharges applied to minimum purchase commitments of related disposables. The term of the financing is generally three to five years, with interest at rates of 9% to 15%. Unearned finance revenue is calculated using the inherent rate of interest on each agreement, the expected disposable shipment period and the principal balance financed and is recognized as disposables are shipped using a reducing principal balance method which approximates the interest method. Contract provisions include liquidated damage clauses which are sufficient to recover the sales price of the instruments in the event of customer cancellation.
CONCENTRATIONS OF CREDIT RISK:
The Company provides a variety of financing arrangements for its customers. The majority of the Company's accounts receivable are from hospitals throughout the United States and Europe with credit terms of generally 30 days. The Company maintains adequate reserves for potential credit losses and such losses have been within management's estimates.
NOTE 1 - BUSINESS, ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVENTORIES:
Inventories are stated at the lower of cost, determined by the first-in, first-out (FIFO) method, or market.
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment is stated at cost. The Company capitalizes costs of computer software developed or obtained for internal use. Capitalization begins when it is probable that the project will be completed, funding for the project has been committed and the project conceptual formulation and design is complete. Capitalization ceases when the project is substantially complete and ready for use. Depreciation and amortization is provided using the straight-line method based upon the following estimated useful lives of the assets or lease terms, if shorter, for leasehold improvements, capitalized software, capital leases and instrument operating leases:
CAPITALIZED PATENT AND TRADEMARK COSTS:
The Company capitalizes patent issuance cost and trademark registration costs. These costs are amortized using the straight line method over seven years, the estimated period of benefit. At December 31, 2000 and 1999, the unamortized capitalized patent costs are $2,627 and $2,146, respectively.
INTANGIBLE ASSETS:
The Company has recorded goodwill for the excess purchase price over the estimated fair values of tangible and intangible assets acquired and liabilities assumed resulting from acquisitions. The excess purchase price over the estimated fair value of the net assets acquired has been assigned to goodwill. Additionally, the Company has recorded intangible assets related to purchases of patents, completed technology and product distribution rights.
Intangible assets are amortized as follows:
NOTE 1 - BUSINESS, ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
IMPAIRMENT OF LONG-LIVED ASSETS:
The Company assesses potential impairments of long-lived assets and certain identifiable intangibles including goodwill, on an exception basis, when there is evidence that events or changes in circumstances may have made recovery of an asset's carrying value unlikely. An impairment loss is recognized when the sum of the expected, undiscounted future net cash flows is less than the carrying amount of the asset.
DEBT ISSUE COSTS:
Debt issue costs aggregating $12,237 and $15,178 at December 31, 2000 and 1999, respectively, are amortized using the interest method, or straight-line when the results are not materially different from the interest method, over the respective terms of the debt agreements and are included in other non-current assets.
FOREIGN CURRENCY TRANSLATION:
The accounts of foreign subsidiaries which use local currencies as functional currencies are translated into U.S. dollars using year-end exchange rates for assets and liabilities, historical exchange rates for equity and average exchange rates during the period for revenues and expenses. The gains or losses resulting from translations are excluded from results of operations and accumulated as a separate component of other comprehensive income (loss).
RESEARCH AND DEVELOPMENT COSTS:
Research and development costs are expensed as incurred.
SOFTWARE PRODUCTION COSTS:
Some of the Company's products include embedded software which is essential to the products' functionality. The Company capitalizes software production costs when the project reaches technological feasibility and ceases capitalization when the project is ready for release. Software production costs are amortized using the straight-line method over a maximum of ten years or the expected life of the product, whichever is less. Amortization will begin when the product is available for general release to the customer. Unamortized capitalized software costs at December 31, 2000 and 1999 were $1,890 and $630, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying amount of the Company's financial instruments, including cash, trade receivables and payables, approximates their fair value due to their short-term maturities. The fair values of the Company's long-term lease receivables are estimated by discounting future cash flows using discount rates that reflect the risk associated with similar types of loans. The fair value of the Company's long-term debt is estimated based on comparison with similar issues or current rates offered to the Company for debt of the same remaining maturities and the quoted market price for the debentures. The estimated fair values of the Company's long-term lease receivables approximate their carrying values. There is no quoted market value for the bank debt which would enable the Company to determine the fair value. However, the Company believes the estimated fair value of the long-term bank debt approximates its carrying value. The carrying values and fair values of the Company's debentures at December 31, 2000 and 1999, were as follows:
NOTE 1 - BUSINESS, ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES:
The Company and its domestic subsidiaries file a consolidated Federal income tax return. Domestic subsidiaries file income tax returns in multiple states on either a stand-alone or combined basis. Foreign subsidiaries file income tax returns in their respective local jurisdictions.
The Company recognizes deferred tax assets and liabilities based on the expected future tax consequences of events that have been included in the financial statements and tax returns in different periods. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company provides a reserve against its net deferred assets when, in the opinion of management, it is more likely than not that such assets will not be realized.
STOCK-BASED COMPENSATION:
The Company measures compensation expense for its stock-based employee compensation plans using the intrinsic value method and provides pro forma disclosures of net income (loss) as if the fair value-based method had been applied in measuring compensation expense.
NET INCOME (LOSS) PER COMMON SHARE:
The Company's net income (loss) per common share assuming no dilution is computed using the weighted average number of common shares outstanding. The Company's net income (loss) per common share assuming dilution is computed using the weighted average number of common shares outstanding plus dilutive potential common shares using the treasury stock method at the average market price during the reporting period (Note 11).
RECLASSIFICATIONS:
Certain prior year period amounts have been reclassified to conform to the current period presentation. Due to the sale of the Instromedix division in the third quarter of 2000 (Note 3), the operating results of the Instromedix division have been reclassified to discontinued operations in the consolidated statements of operations. This reclassification also affects the International business segment, since sales and expenses related to international sales of Instromedix products were historically included in the International business unit. All prior period segment information has been restated to exclude Instromedix results.
NOTE 1 - BUSINESS, ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SEGMENT INFORMATION:
The Company uses the management approach to report segment information. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. The Company also discloses segment information about products and services, geographic areas, and major customers. (Note 13)
COMPREHENSIVE INCOME:
In addition to net income, the Company reports comprehensive income and its components including foreign currency translation items currently recorded to stockholders' equity. Comprehensive income is displayed in the Consolidated Statement of Stockholders' Equity and includes items not currently included in net income. Comprehensive income does not have an impact on the Company's results of operations.
SHIPPING AND HANDLING FEES AND COSTS:
In July 2000, The Financial Accounting Standards Board Emerging Issues Task Force ("EITF") reached a consensus that amounts billed to customers for shipping and handling costs should be included in sales. The classification of shipping and handling costs is considered an accounting policy decision that should be disclosed. If shipping and handling costs are significant and not included in cost of sales, companies should disclose both the amount of such costs and which line item on the income statement includes that amount. The Company is required to apply the consensus beginning fourth quarter 2000. The Company has historically included most amounts billed to customers for shipping and handling as a reduction of selling and marketing expense where such expenses are included. The Company has conformed prior period financials to reflect shipping and handling reimbursement in sales. The Company also records cost for shipping and handling revenue in selling and marketing expense. Shipping and handling costs for customer sales for the year ended December 31, 2000 was $6,916. Shipping and handling costs for customer sales for prior years is not available.
DERIVATIVES:
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133") which the Company is required to adopt January 1, 2001. This statement will require the Company to record all derivatives on the balance sheet at fair value, and to record most changes to the value of derivatives in income as the change occurs. Upon adoption of FAS 133 all existing derivatives must be recognized on the balance sheet at fair value. Under FAS 133 reporting, the Company's interest rate swap will be presented at fair value on the balance sheet. At December 31, 2000 the fair value of the swap was negative $1.6 million, which would be presented as a non-current liability under FAS 133 with the initial offsetting charge included in other comprehensive income. As it relates to the swap, the adoption of FAS 133 will not have an impact on the results of operations of the Company. FAS 133 also has extensive disclosure requirements. (See Liquidity and Capital Resources.)
NOTE 2 -- ACQUISITIONS AND LICENSES
On July 17, 1998, pursuant to an agreement with ALARIS Medical, ALARIS Medical Systems, Instromedix ("Instromedix") and its shareholders dated June 24, 1998, ALARIS Medical Systems acquired all of the outstanding common stock of Instromedix and subsequently merged Instromedix with and into itself. The total consideration for the Instromedix acquisition was approximately $58 million.
The acquisition was accounted for as a purchase, whereby the purchase price, including related expenses, was allocated to identified assets and liabilities, based upon their respective fair values. The allocation included acquired in-process research and development of $22,800, which was immediately written-off, and other identifiable intangible assets of $21,130, which were being amortized over their estimated weighted-average useful lives of ten years. The excess of the purchase price over the value of identified assets and liabilities, in the amount of $18,012, was recorded as goodwill and was being amortized over its estimated life of ten years. In the fourth quarter of 1999, the Company wrote-off the remaining carrying value of the Instromedix goodwill and certain other Instromedix intangible assets. In the third quarter of 2000, the Company sold the assets and certain liabilities of Instromedix to Card Guard Technologies, Inc. (Note 3).
During the second quarter of 1998, the Company acquired the net assets of Patient Solutions, Inc. ("PSI") for $5,250. PSI was a wholly owned subsidiary of Invacare Corporation and was focused on the development of an ambulatory pump for use in the alternate-site market. The transaction was accounted for as a purchase with the net assets acquired recorded at their estimated fair values. The rights to the pump under development were valued at $4,421 and were recorded as a non-recurring charge included in purchased in-process research and development. The nature of the efforts required to develop the purchased in-process technology into a commercially viable product principally relate to designing, prototyping, verification and testing activities that are necessary to establish that the product can be produced to meet its design specifications, including functions, features and technical performance requirements. During the fourth quarter of 1999, the Company discontinued development of the product and recorded a charge to operations of approximately $900 to write-off the remaining assets acquired from PSI.
Also during the second quarter of 1998, the Company licensed technology from Caesarea Medical Electronics Limited ("Caesarea") for a pole mounted volumetric infusion pump being designed for developing international markets. At the time of license, the development of the applications and functionality required by the Company had not reached technological feasibility and no alternative uses were identified. As a result, the initial license payment and related expenses of approximately $1,200 were recorded as purchased in-process research and development during the second quarter of 1998. Under the terms of the license agreement, the Company is obligated to pay additional consideration up to an aggregate of $4,000 to Caesarea upon timely completion of certain development milestones, which primarily relate to different product releases. In December 1998, upon completion of the first milestone, the Company paid $750 to Caesarea. During 1999 and 2000, upon completion of additional milestones, the Company made payments of $2,750 and $250, respectively. Due to the completed technology obtained at each milestone, the Company capitalized such payments and plans to capitalize future license fees and amortize such costs over the eighteen-year license period. Products using the purchased in-process technology were released during 1999 and the Company anticipates that additional releases will take place in 2001.
NOTE 3 - SALE OF INSTROMEDIX
On August 31, 2000, pursuant to an Asset Purchase Agreement dated as of August 17, 2000, the Company sold the assets and certain liabilities of its Instromedix division to Card Guard Technologies, Inc. ("Buyer") for $30,000 in cash ("the Sale").
The Asset Purchase Agreement and the other agreements executed in connection with the sale provide that the Company will assist Buyer in setting up a fully independent headquarters and manufacturing facility in San Diego, California. Pursuant to these agreements, $5,000 of the $30,000 purchase price was placed in escrow. The Company received such escrowed amount, after certain offsets, upon completion of its obligations under the agreements in the first quarter of 2001. The Company will recognize the gain associated with this contingent amount in 2001. During this transition period, the Company continued to manufacture Instromedix products for Buyer.
The total after tax gain to be recorded related to the Sale is estimated at approximately $5,600, with $1,839, or $.03 per share, recorded during the quarter ended September 30, 2000. The remainder of the gain will be recorded in 2001. The amount of gain to be recorded at such time is dependent upon the actual costs incurred by the Company to complete the transition activities and the amount actually received from the escrow.
Approximately $18,000 of the net cash proceeds from the Sale (after taxes and other estimated costs) was used to repay indebtedness under the ALARIS Medical Systems credit facility.
As a result of the Sale, the Company has reclassified its historically reported consolidated statements of operations to exclude the Instromedix results from continuing operations and report such operating results as discontinued operations. The gain on the sale and the Instromedix year 2000 operating results through the sale date have been reported as discontinued operations in the period ended December 31, 2000. For the years ended December 31, 2000, 1999 and 1998, Instromedix sales included in discontinued operations were $8,672, $14,386 and $8,430, respectively.
NOTE 4 - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
NOTE 4 - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS (CONTINUED)
Depreciation expense was $18,767, $17,168 and $18,638 for 2000, 1999 and 1998, respectively, including $1,422, $1,023 and $300 of depreciation on capitalized computer software in 2000, 1999 and 1998, respectively.
Amortization expense of intangible assets was $13,212, $15,752 and $15,448 during 2000, 1999 and 1998, respectively.
NOTE 4 - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS (CONTINUED)
NOTE 5 - NOTES PAYABLE AND LONG-TERM DEBT
Long-term debt consists of the following:
BANK CREDIT FACILITY:
In 1996, the Company entered into a $250,000 bank credit facility (the "Credit Facility") with a syndicate of financial institutions which consisted of $200,000 of term loans (Tranches A, B,C and D) and a $50,000 credit line maturing in 2002. In July 1998, in connection with the Instromedix acquisition, the Company amended the Credit Facility to, among other things, increase the revolving credit facility to $60,000 and provide the Company an additional $30,000 under the Tranche D term debt. The Company used the $30,000 term debt borrowing, along with approximately $2,000 from the revolving credit line, to fund the initial payments required upon closing the Instromedix acquisition. No principal balance was outstanding under the revolving credit facility as of December 31, 2000. The Credit Facility contains various operating and financial covenants, as well as certain covenants relating to reporting requirements. As of December 31, 2000, the Company was in compliance with all such covenants.
NOTE 5 - NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)
The Company projected not meeting certain 2001 financial covenants contained in the Credit Facility agreement. As a result, in April 2001 the Company obtained an amendment (the Amendment) to the terms of the Credit Facility. The Amendment included the following: (i) a provision providing for changes to certain financial performance covenants for each applicable period from March 31, 2001 through December 31 2003, (ii) a provision providing for increases to the interest rates on each of the debt tranches, (iii) a provision providing for a decrease in the line of credit from $60,000 to $20,000 and (iv) a provision allowing ALARIS Medical Systems to borrow (as part of the Credit Agreement or otherwise) up to an additional $15,000 from a lender it must first locate and to use the funds so borrowed to repurchase Convertible Debentures (as defined below). The $15,000 is the maximum that can be borrowed by ALARIS Medical Systems under the terms of the Notes (as defined below) and used for this purpose. The changes to the financial performance covenants were developed based on the Company's strategic plans and were designed to allow the Company access to the $20,000 credit line.
Effective December 1999, the Credit Facility was amended and interest rates increased to a Eurodollar rate plus 3.0% for the revolving credit facility and Tranche A loans and a Eurodollar rate plus 3.5% for Tranches B, C and D. Such total rates were 9.8% and 10.3%, respectively, as of December 31, 2000. As of December 31, 1999, the Company had a swap outstanding with commercial banks for a total notional principal amount of $85,775. That agreement effectively changed the Company's interest rate exposure on its floating rate debt through the agreements expiration in February, 2000. During the second quarter of 2000, the Company entered into a new swap agreement with a notional amount of $100,000, expiring in February of 2002. The new agreement effectively fixed the interest rate on $100,000 of the Company's floating rate Credit Facility debt, resulting in a weighted average interest rate as of December 31, 2000, of 10.5% on all Credit Facility debt.
As a result of the Amendment in April 2001, the interest rates under the Credit Facility were increased, and now include paid-in-kind interest (PIK), to the following rates effective April 1, 2000: Credit line and Tranche A borrowings - Eurodollar rates plus 6.50% including 2.00% PIK, Tranche B borrowings - Eurodollar rates plus 7.50% including 3.00% PIK, Tranche C borrowings - Eurodollar rates plus 8.00% including 3.50% PIK, and Tranche D borrowings - Eurodollar rates plus 8.25% including 3.75% PIK. The PIK interest is deferred in payment and added to the outstanding principal quarterly. Payment of PIK interest is required with the final principal payment on each tranche borrowing.
SENIOR SUBORDINATED NOTES:
In 1996, the Company issued $200,000 of senior subordinated notes due 2006 (the "Notes"). The Notes bear interest at a rate of 9.75% per annum, which is payable semi-annually on June 1 and December 1 of each year, commencing June 1, 1997. The Company is not required to make mandatory redemption or sinking fund payments with respect to the Notes prior to maturity. The Notes are redeemable at the option of the Company, in whole or in part, at any time on or after December 1, 2001 at the price of 104.875% with the redemption price declining thereafter. On or after December 1, 2004, the redemption price is 100% of the note's face (par) value. In the event of a change of control, as defined in the indenture, holders of the Notes will have the right to require the Company to purchase their Notes in cash in an amount equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase. The Notes are subject to certain restrictive and reporting covenants.
NOTE 5 - NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)
SENIOR DISCOUNT NOTES:
On July 28, 1998, ALARIS Medical completed the sale of $109,892 of 11-1/8% Senior Discount Notes (the "Senior Discount Notes"), due 2008, receiving net proceeds of $106,321. Upon receipt of the net proceeds, the Company paid its remaining obligations of approximately $22,700 to the Instromedix shareholders and contributed the remaining net proceeds of approximately $81,700, after issuance costs, to ALARIS Medical Systems, as required under the Credit Facility Amendment. ALARIS Medical Systems then repaid $27,500 outstanding under its revolving credit facility.
The Senior Discount Notes bear interest at a rate of 11-1/8% per annum. Interest accruing on these notes is added to the outstanding principal balance through July 31, 2003. Interest accruing beginning August 1, 2003 is payable in cash semi-annually in arrears on February 1 and August 1, commencing February 1, 2004. The notes will mature on August 1, 2008. The notes are senior in right of payment to all subordinated indebtedness of ALARIS Medical. While the Senior Discount Notes rank PARI PASSU in right of payment with all existing and future indebtedness of ALARIS Medical, they are effectively subordinated to the ALARIS Medical bank credit facility guarantee. On or prior to August 1, 2001, under certain conditions ALARIS Medical has the option to redeem a portion of the notes at 111.125% of the then accreted value. On or subsequent to August 1, 2001, the Company may redeem the notes at 105.6% of the then accreted value with the redemption price declining each year thereafter. Effective August 1, 2006, the redemption price is 100.0% of the then outstanding accreted value. In the event of a change of control, as defined in the indenture, holders of the Senior Discount Notes will have the right to require the Company to purchase their notes in cash in an amount equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase. The Senior Discount Notes are subject to certain restrictive and reporting covenants.
DEBENTURES:
At December 31, 2000, ALARIS Medical had outstanding $16,125 of 7.25% convertible subordinated debentures due 2002 (the "Convertible Debentures"). The Convertible Debentures are convertible at the option of the holder into common stock of the ALARIS Medical at any time prior to maturity at a conversion price of $18.14 per share, subject to adjustment in certain events. The Convertible Debentures mature on January 15, 2002, with interest payable semi-annually on each January 15 and July 15. The Convertible Debentures are redeemable at the option of the Company, in whole or in part, at any time on or after January 15, 2000 at the price of 101.45%. From January 15, 2001 through January 14, 2002, the redemption price is 100.725% of the Convertible Debentures face (par) value. Holders may require the Company to repurchase the Convertible Debentures, in whole or in part, in certain circumstances involving a change in control of the Company. The Convertible Debentures are subordinate to all existing or future senior indebtedness of the Company, and are also effectively subordinated to liabilities of the Company's subsidiaries. The indenture does not restrict the incurrence of senior indebtedness or other indebtedness by the Company or any subsidiary.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5 - NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)
The Credit Facility and the indenture governing the Notes (the "Notes Indenture") permit ALARIS Medical Systems to fund interest payments on the Convertible Debentures (in the case of the Credit Facility, so long as there exists no default or event of default thereunder). However, both the Credit Facility and the Notes Indenture prohibit ALARIS Medical Systems from making those distributions to ALARIS Medical which would enable it to fund such repayment, unless ALARIS Medical Systems has achieved certain financial performance targets. Since management does not believe that ALARIS Medical Systems will meet such tests, it is exploring various alternatives under which those repayment obligations could be satisfied. For example, management has had preliminary discussions with the administrative agent under the Credit Facility and has been informed that certain lenders have expressed interest in lending the allowed $15,000 to ALARIS Medical Systems as part of the Credit Agreement. Management believes that the terms provided in the Amendment for this borrowing should be sufficient to obtain this borrowing. However, since no lender has yet actually agreed to do so, there can be no assurance that ALARIS Medical Systems will be able to borrow the $15,000 it is seeking. In any event, a default by ALARIS Medical on all or any portion of its $16,125 outstanding principal payment obligations under the Convertible Debentures, whether as a result of the Company's failure to obtain the funds necessary to purchase, or repay, all outstanding Convertible Debentures, or otherwise, would likely result in an event of default under, and possible acceleration of the obligations under, the Credit Facility, the Notes and the Senior Discount Notes.
Maturities of long-term debt during the years subsequent to December 31, 2000 are as follows:
The Company's ability to fund its operations, to make planned capital expenditures, to make scheduled principal and interest payments and to meet the financial performance covenants in the amended Credit Facility will depend on the Company's future operating performance, which is itself dependent on a number of factors, many of which the Company cannot control, including conditions affecting the Company's foreign operations, prevailing economic conditions, availability of other sources of liquidity, and financial, business, regulatory and other factors affecting the Company's business and operations.
NOTE 6 - INCOME TAXES
The (benefit from) provision for income taxes comprises the following:
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6 - INCOME TAXES (CONTINUED)
The principal items accounting for the differences in income taxes computed at the U.S. statutory rate (35%) and the effective income tax rate for continuing operations comprise the following:
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6 - INCOME TAXES (CONTINUED)
The components of the net deferred tax assets included in the Consolidated Balance Sheet as of December 31, 2000 and 1999 are as follows:
As of December 31, 2000, the Company had federal and state net operating loss carryforwards of approximately $11,679 and $1,650 respectively. Additionally, as of December 31, 2000, the Company had a foreign tax credit carryforward and an alternative minimum tax credit carryforward of approximately $4,190 and $957 respectively, for federal tax purposes and research and development tax credits of approximately $1,814 and $702 for federal and state purposes, respectively. The federal and state net operating loss carryforwards expire from 2001 to 2012. The foreign tax credit expires from 2001 to 2005 and the research and development tax credits expire from 2005 to 2011.
As a result of certain changes in the Company's stock ownership which occurred during 1996, portions of the above described carryforwards are subject to annual income offset limitations on a prospective basis. Accordingly, approximately $11,679 of the federal net operating loss carryforward, approximately $957 of the federal alternative minimum tax credit carryforward and approximately $1,814 and $702 of the respective federal and state research and development credits are subject to a general annual income offset limitation of approximately $4,000. Additionally, certain built-in gains recognized by the Company will increase the annual utilization rate of the net operating losses. The Company also possesses certain unrealized built-in losses which will be subject to the annual utilization limitation when recognized.
NOTE 7 - STOCK OPTION PLANS
The Company maintains several stock option plans under which incentive stock options may be granted to key employees of the Company and non-qualified stock options may be granted to key employees, directors, officers, independent contractors and consultants.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7 - STOCK OPTION PLANS (CONTINUED)
The exercise price for incentive stock options generally may not be less than the underlying stock's fair market value at the grant date. The exercise price for non-qualified stock options granted to non-directors will not be less than the par value of a share of common stock, as determined by a committee appointed by the Board of Directors ("the Committee"). The exercise price for non-qualified stock options granted to directors may not be less than the underlying stock's fair market value at the grant date.
Options granted to non-directors generally vest and become exercisable as determined by the Committee. Options granted to directors generally vest and become exercisable over a three-year period. Options granted to non-directors generally expire upon the earlier of the termination of the optionee's employment, with vested options expiring one year after termination of employment, or ten years from the grant date. Options granted to directors generally expire upon the earlier of the date the optionee is no longer a director or five years from the grant date.
During 2000, the Company's stockholders approved an amendment to increase the number of options available for grant under the Company's 1996 Stock Option plan from 5,500 options to 9,500 options. Additionally, the 1996 plan was amended to allow for the issuance of up to 2,800 of the total 9,500 options, to certain key employees of the Company. These non-qualified options expire 10 years after grant and vest seven years after their grant date, or earlier, in percentages determined by the Committee, if and when certain target market prices for the Company's common stock, as determined by the Committee, are achieved. The vesting for these specific options granted is the earlier of December 23, 2006 or at the time market value of the Company's common stock reaches $7.00, $9.00 and $11.00 per share, these options will vest at 30%, 60% and 100%, respectively. At December 31, 2000, 2,376 of such options were outstanding.
STOCK OPTION ACTIVITY:
Activity for 2000, 1999 and 1998 with respect to these plans is as follows:
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7 - STOCK OPTION PLANS (CONTINUED)
At December 31, 2000, options for 3,488 shares were exercisable at $0.41-$6.75 under the plans and 2,709 shares were available for future grant. Additionally, as of December 31, 2000, 10,334 shares of common stock were reserved for issuance pursuant to the Company's stock option plans.
If the Company had elected to recognize compensation expense based upon the fair value at the grant date for awards under these plans, the Company's reported net loss would be increased to the pro forma amounts indicated below:
These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period and additional options may be granted in future years. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for the years ended December 31, 2000, 1999 and 1998, respectively; dividend yields of 0%, expected volatility of 85%, 164% and 186%, risk free interest rates of 5.2%, 5.2% and 4.6%, and expected lives ranging from 3 to 7 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because ALARIS Medical's employee stock options have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimates, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock based compensation plans.
The following table summarizes information about employee stock-based compensation plans outstanding at December 31, 2000:
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 8 - BENEFIT PLANS
PENSION PLANS:
The Company had a defined benefit pension plan (the "Plan") which covered substantially all of its U.S. employees as of December 31, 1993. On December 1, 1993, the Company's Board of Directors approved amendments to the Plan provisions which include, among other matters, cessation of benefit accruals after December 1, 1993. All earned benefits as of that date were preserved and the Company will continue to contribute to the Plan as necessary to fund earned benefits. No contributions to the Plan were required during 2000, 1999 or 1998 due to the prepaid position of the Plan during those years.
The following table sets forth the change in the benefit obligation and the change in the Plan assets during the years ended December 31, 2000 and 1999 and the Plan's estimated funded status and amounts recognized in the Company's balance sheet as of December 31, 2000 and 1999:
The components of net periodic benefit gain for the years ended December 31, 2000, 1999 and 1998 are as follows:
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9 - LEASES
LEASE RECEIVABLES:
The Company leases instruments to customers under capital and operating lease contracts with terms ranging generally from 1 to 6 years. Certain capital lease agreements obligate the lessee to purchase a specified annual minimum of disposable sets and payment of liquidating damages if the agreement is terminated by the lessee. Anticipated future minimum amounts due under operating leases and capital lease receivables as of December 31, 2000 are as follows:
The net investment in sales-type leases consists of the following:
LEASE COMMITMENTS:
The Company leases buildings and equipment under non-cancelable operating leases with terms ranging from approximately 2 to 13 years. Scheduled future minimum lease commitments as of December 31, 2000 are as follows:
Rental expense was $6,103, $6,023 and $5,451 during 2000, 1999 and 1998, respectively.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 10 - RESTRUCTURING, INTEGRATION AND OTHER NON-RECURRING CHARGES
The following summarizes the significant components of the Company's 2000, 1999 and 1998 restructuring, integration and other non-recurring charges included in the Consolidated Statement of Operations:
During the second quarter of 2000, the Company announced plans for restructuring activities which are anticipated to save approximately $6,000 per year when fully implemented and involve facilities in Creedmoor, N.C., Basingstoke, England and San Diego. The primary focus of this activity is in the Creedmoor manufacturing operation. This plant is being restructured to include disposables engineering, automated manufacturing of selected products and distribution operations. Manual assembly operations will be relocated to the Company's facilities in Tijuana, Mexico, and certain operations will be outsourced. Additionally, the Basingstoke and San Diego operations are being matched to the mix of requirements resulting from current and future product line rationalization efforts.
During the year ended December 31, 2000, the Company recorded a charge related to these activities of $7,048 included in restructuring and other non-recurring charges. Of this charge, $5,306 related to employee termination benefits, $601 related to termination of a product distribution agreement (including legal expenses), $117 related to the closure of a foreign sales office and $1,024 related to non-cash charges for fixed asset write-offs. The restructuring plans call for 154 manufacturing employees and 13 sales and administrative employees to be terminated. As of December 31, 2000, approximately $3,700 of employee termination costs have been paid to 150 employees. Additionally, approximately $400 has been paid for termination of a product distribution agreement and related legal costs year-to-date. The remaining restructuring accrual for these activities of $1,836 is comprised of approximately $1,600 for severance and related employee costs and $200 for termination of a product distribution agreement. The remaining restructuring charges are expected to be paid during the first quarter of 2001.
During 1999 the Company recorded a charge of $2,838 for two patent license agreements related to patent infringement lawsuits (Note 15).
The Company paid approximately $4,200, $2,900 and $100 during 2000, 1999, and 1998, respectively, for restructuring and integration activities.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 11 - EARNINGS (LOSS) PER SHARE
The Company's 7.25% Convertible Debentures were not included in the calculation of diluted earnings per share in 2000, 1999 and 1998 as they are antidilutive. For each of the years presented, the $16,152 of Convertible Debentures, if converted at an exercise price of $18.14 per share, would result in an increase of 890 common shares and an increase of $703, net of taxes, to net income, due to the reduction in interest expense. In accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share," diluted earnings (loss) per share from discontinued operations and total diluted earnings (loss) per share are calculated using the weighted average shares for continuing operations earnings (loss) per share. As a result of the application of this accounting convention, diluted net loss per share for prior periods may not agree with previously reported net diluted earnings (loss) per share. Loss per share for 1999 for continuing operations, discontinued operations and net loss per share are the same assuming no dilution and dilution as the Company experienced a net loss.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 12 - PARENT GUARANTOR OF SUBSIDIARY DEBT
All obligations of ALARIS Medical Systems under the Credit Facility (Note 5) are guaranteed by ALARIS Medical and each existing and subsequently formed or acquired domestic subsidiary of ALARIS Medical. Summarized financial information of ALARIS Medical Systems, the issuer of the Credit Facility, at December 31, 2000 and 1999 and for the years ended December 31, 2000, 1999 and 1998 is as follows:
NOTE 13 - SEGMENT INFORMATION
The Company segment performance is based on results of two business segments - North America and International. Due to the sale of the Instromedix division, the prior year's segment information has been conformed to present the Company's two reportable segments from continuing operations - North America and International. (Note 3).
NOTE 13 - SEGMENT INFORMATION (CONTINUED)
The accounting policies of the segments are the same as those described in the "Summary of Significant Accounting Policies" (Note 1). Segment data does not include intersegment revenues, or charges allocating corporate-headquarters costs to each of its operating segments. The Company evaluates the performance of its segments and allocates resources to them based on operating income and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Adjusted EBITDA represents income from operations before restructuring, integration and other non-recurring charges, non-cash purchase accounting charges and depreciation and amortization. Adjusted EBITDA does not represent net income or cash flows from operations, as these terms are defined under generally accepted accounting principles, and should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity.
The Company is organized primarily based on geographic location with the United States and Canada drug infusion and patient monitoring business representing the North American Segment. All other international operations including Europe, Asia, Australia and Latin America represent the International segment.
The table below presents information about reported segments for the years ended December 31:
Reconciliation of total segment adjusted EBITDA to consolidated income from continuing operations before taxes:
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13 - SEGMENT INFORMATION (CONTINUED)
(A) Includes Canadian sales which are included in the North America unit for segment reporting purposes. (B) Beginning fourth quarter of 2000, shipping and handling charges are required to be included in Sales (Note 1). Prior period information has been reclassified to conform to the change in reporting requirements for 2000. Segment information for 2000, 1999 and 1998, each include shipping and handling revenue for the respective 12-month period.
NOTE 14 - CASH FLOW INFORMATION
Federal, state and foreign income taxes paid during 2000, 1999 and 1998 totaled $8,335, $4,852 and $4,550 respectively. Interest paid during 2000, 1999 and 1998 totaled $40,901, $39,365 and $38,044, respectively.
Capital lease obligations of $461 were incurred in 1999 when the Company entered into various capital leases for new computer equipment.
NOTE 15- CONTINGENCIES AND LITIGATION
GOVERNMENT REGULATION
The United States Food and Drug Administration (the "FDA"), pursuant to the Federal Food, Drug, and Cosmetic Act (the "FDC Act"), regulates the introduction of medical devices into commerce, as well as testing manufacturing procedures, labeling, adverse event reporting and record-keeping with respect to such products. The process of obtaining market clearances from the FDA for new products can be time-consuming and expensive and there can be no assurance that such clearances will be granted or that FDA review will not involve delays adversely affecting the marketing and sale of products. Enforcement of the FDC Act depends heavily on administrative interpretation and there can be no assurance that interpretations made by the FDA or other regulatory bodies will not have a material adverse effect on the business, financial condition, results of operations or cash flows. The FDA and state agencies routinely inspect the Company to determine whether the Company is in compliance with various requirements relating to manufacturing practices, testing, quality control, complaint handling, medical device reporting and product labeling. Such inspections can result in such agencies requiring the Company to take certain corrective actions for non-complying conditions observed during the inspections.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15- CONTINGENCIES AND LITIGATION (CONTINUED)
A determination that the Company is in material violation of the FDC Act or such FDA regulations could lead to the issuance of warning letters, imposition of civil or criminal sanctions against the Company, its officers and employees, including fines, recalls, repair, replacement or refund to the user of the cost of such products and could result in the Company losing its ability to contract with government agencies. In addition, if the FDA believes any of the Company's products violate the law and present a potential health hazard, the FDA could seek to detain and seize products, to require the Company to cease distribution and to notify users to stop using the product. The FDA could also refuse to issue or renew certificates to export the Company's products to foreign countries. Such actions could also result in an inability of the Company to obtain additional clearances or approvals to market its devices.
In October 1999, the Company received a warning letter from the FDA related to earlier inspections of the San Diego based manufacturing facility. The letter stated that, the Company would be required to submit to the FDA periodic certifications as to its state of compliance based on the outcome of inspections conducted by outside regulatory consultants employed by the Company. On April 29, 2000 the Company's president and chief executive officer, David L. Schlotterbeck, certified to the FDA that, to the best of his knowledge, the Company has initiated or completed all corrections called for in the report issued by the independent consultant. On July 10, 2000, the Company received correspondence from the FDA indicating that the certification adequately addresses the FDA's concerns. In this connection, in August 2000 the FDA completed an inspection of the Company's San Diego based manufacturing facility. The Company will submit one additional certification to the FDA in April 2001.
Between 1997 and 1999, the Company on nine occasions initiated product recalls or issued safety alerts which FDA still considers active regarding its products regulated by the FDA. In each case this was done because the products were found not to meet the Company's specifications. The Company has submitted to the FDA a request for closure related to all nine of the recalls but has not received notice of closure from the FDA. Notice of closure of two additional recalls was received from the FDA during 2000.
The Company has four active field corrections related to its products manufactured and sold outside the United States. In the second quarter of 1999, the Company initiated three voluntary recalls of certain versions of its P series syringe pumps, which are manufactured in the United Kingdom and sold outside the United States, primarily in Europe. These voluntary recalls relate to software and hardware upgrades of the P series syringe pumps. In the first quarter of 2000, the Company stopped shipment of a large volume pump recently introduced in the international markets for redesign of its air-in-line sensing capability. The Company plans to introduce the redesigned product into international markets and provide a field correction for existing units.
None of the recalls or field corrections materially interfered with the Company's operations and all such affected product lines continued or will continue to be marketed by the Company.
The costs incurred related to the Company's recall activities have historically been significant. These costs include labor and materials, as well as travel and lodging for repair technicians. Estimates of the costs to complete the recalls and safety alerts are often quite difficult to determine due to uncertainty surrounding how many effected units are still in service and how many units customers will fix without Company assistance. Due to these difficulties in estimating costs, it is possible that the actual costs to complete each individual recall or safety alert could differ significantly from management's current estimates to complete such recalls or safety alerts. Although, there can be no assurances, the Company believes it has adequate reserves to cover the remaining estimated aggregate costs related to these active recalls.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15- CONTINGENCIES AND LITIGATION (CONTINUED)
LITIGATION
On December 5, 2000, the Company filed a lawsuit in the United States District Court for the Southern District of California, seeking unspecified damages and equitable relief from Filtertek Inc. ("Filtertek") alleging, among other things, that Filtertek's needle-free system (the "Filtertek System") infringes a patent relating to needle free technology (the "Medex Patent") licensed by Medex, Inc. ("Medex") to the Company on an exclusive basis and seeking, as well, a declaration that the Company's needle-free system (the "System") does not infringe a certain Filtertek patent (the "Filtertek Patent") relating to the Filtertek System or, if it does, that the Filtertek Patent is invalid.
On March 9, 2001, Filtertek filed a lawsuit in the United States District Court for the Northern District of Illinois, Western Division, seeking unspecified damages and equitable relief from the Company and Medex, alleging that the System violates the Filtertek Patent, and seeking, as well, a declaration, against Medex only, that the Filtertek System does not infringe the Medex Patent.
The Company believes that it has meritorious defenses to all Filtertek claims and intends to defend itself vigorously. However, there can be no assurance that such defenses will successfully defeat all of such claims. The failure to do so could have a material adverse effect on the Company's operations, financial condition and cash flows.
The Company was a defendant in a lawsuit filed in April, 1998, by Becton, Dickinson and Company ("Becton") against ALARIS Medical Systems, Inc., which alleged infringement of a patent licensed to Becton relating to the sale of the Company's SmartSite needleless system. In addition, the Company filed a lawsuit in December 1998 against Becton. The lawsuit alleged infringement of two patents, one owned by the Company and one licensed to the Company, relating to Becton's Atrium needle free valve. On October 13, 1999 the Company and Becton entered into a settlement agreement. In connection with this agreement, the Company paid a total of $6,700 during the fourth quarter of 1999. The Company will not be required to pay any future royalties on patents covered by the agreement.
The Company was a defendant in a lawsuit filed in June 1996 by Sherwood Medical Company ("Sherwood"), a unit of Tyco Healthcare Group ("Tyco"), against IVAC alleged infringement of two patents relating to disposable probe covers for use with the Company's infrared tympanic thermometer. On August 31, 1999 the Company and Tyco entered into a settlement agreement. In connection with this agreement, the Company made a one-time payment of $3,950 during the third quarter of 1999. ALARIS Medical Systems will not be required to pay any future royalties on patents covered by the agreement.
The two agreements resulted in a charge in 1999 of $2,838 included in restructuring, integration and other non-recurring costs with the remainder of the license payments capitalized as acquired technology.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15- CONTINGENCIES AND LITIGATION (CONTINUED)
UNITED STATES CUSTOMS SERVICE MATTER
During the years 1988 through 1995, Cal Pacifico acted as the Company's United States customs broker and importer of record with respect to the importation into the United States of finished products ("Finished Products") assembled at the Company's two maquiladora assembly plants in Tijuana, Mexico. In May 1995, Cal Pacifico received a pre-penalty notice from the United States Customs Service ("Customs") to the effect that Customs intended to assess additional duties and substantial penalties against Cal Pacifico for its alleged failure, during the years 1988 through 1992, to comply with certain documentary requirements regarding the importation of goods on behalf of its clients, including the Company. Customs recently assessed additional duties with respect to Cal Pacifico's importation of goods on behalf of its clients, including the importation of the Company's Finished Products, for the years 1993 and 1994, and it is anticipated that Customs will issue a pre-penalty notice to Cal Pacifico in respect to these years as well (collectively with the amounts referred to in the immediately preceding sentence, the "Disputed Amounts"). The Company has been advised by its special Customs counsel that, under applicable law, no person, by fraud, gross negligence or negligence, may (i) import merchandise into the commerce of the United States by means of any material and false document, statement or act, or any material omission, or (ii) aid or abet any other person to import merchandise in such manner. No proceeding has been initiated by Customs against the Company in respect of the matters which are the subject of the proceeding against Cal Pacifico. Since Cal Pacifico was the Company's United States customs broker and importer of record during each of the foregoing years, the Company believes that it is unlikely that Customs will assess against the Company any portion of the Disputed Amounts.
Cal Pacifico is contesting Customs' assessment of the Disputed Amounts. Given the present posture of Cal Pacifico's challenge, and the inherent uncertainty of contested matters such as this, it is not possible for the Company to express an opinion as to the likelihood that Cal Pacifico will prevail on its challenge. Cal Pacifico or Customs has not informed the Company as to the specific amount of the Disputed Amounts.
Cal Pacifico has advised the Company that, should Cal Pacifico's challenge to the assessment of the Disputed Amounts prove to be unsuccessful, it will seek recovery from the Company, through arbitration, for any portion of the Disputed Amounts which it is required to pay to Customs. As part of the settlement agreement which resolved the Company's contract dispute with Cal Pacifico during the second quarter of 1997, the Company paid Cal Pacifico $550, which is to be applied toward Cal Pacifico's payment of Disputed Amounts. The $550 payment by the Company is to be credited toward any portion of the Disputed Amounts which the arbitrator determines the Company owes to Cal Pacifico. The actual amount so determined by the arbitrator may be less or greater than $550. Although the ultimate outcome of such an arbitration proceeding cannot be guaranteed, the Company believes that it has meritorious defenses to claims with respect to Disputed Amounts which Cal Pacifico might raise against the Company. These defenses would be based, among other factors, on the contractual relationship between the Company and Cal Pacifico (including a defense with respect to the availability of indemnification under the agreements between Cal Pacifico and the Company), the conduct of Cal Pacifico with respect to both the Company and Customs, and the compliance obligations of Cal Pacifico under applicable customs laws. Inasmuch as Cal Pacifico's challenge before Customs is still pending and any claim against the Company for indemnification would be based on Cal Pacifico's ultimate lack of success in that challenge, and inasmuch as any arbitration proceeding by which Cal Pacifico might seek indemnification has not been filed nor has Cal Pacifico committed itself to the theories under which it might seek indemnification or the recovery of damages from the Company, it is not possible for the Company to express an opinion at this time as to the likelihood of an unfavorable outcome in such a proceeding.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15- CONTINGENCIES AND LITIGATION (CONTINUED)
OTHER
The Company is also a defendant in various actions, claims, and legal proceedings arising from its normal business operations. Management believes they have meritorious defenses and intends to vigorously defend against all allegations and claims. As the ultimate outcome of these matters is uncertain, no contingent liabilities or provisions have been recorded in the accompanying financial statements for such matters. However, in management's opinion, based on discussions with legal counsel, liabilities arising from such matters, if any, will not have a material adverse effect on the business, financial condition, results of operations or cash flows.
NOTE 16 - SUMMARIZED QUARTERLY DATA (UNAUDITED)
The following financial information reflects all normal recurring adjustments which are, in the opinion of management, necessary for a fair statement of the results of the interim periods. Summarized quarterly data for fiscal 2000 and 1999 is as follows:
- -------------------------------- (1) Income (loss) per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly net income (loss) per share will not necessarily equal the total for the year.
ALARIS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
ALARIS MEDICAL, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE THREE YEARS ENDED DECEMBER 31, 2000 - ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS)
- ------------------------- (1) Represents amount of allowance for doubtful accounts assigned to accounts receivables acquired in the Instromedix acquisition during the year ended December 31, 1998.
(2) Represents accounts written-off as uncollectible, net of collections on accounts previously written-off.
ALARIS MEDICAL, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF ALARIS MEDICAL, INC. CONDENSED BALANCE SHEET - ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS)
ALARIS MEDICAL, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF ALARIS MEDICAL, INC. CONDENSED STATEMENT OF OPERATIONS - ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS)
ALARIS MEDICAL, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF ALARIS MEDICAL, INC. CONDENSED STATEMENT OF CASH FLOWS - ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS)
ALARIS MEDICAL, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF ALARIS MEDICAL, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS)
NOTE 1--STATEMENT OF ACCOUNTING POLICY:
The accompanying condensed financial statements have been prepared by ALARIS Medical pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations. It is therefore suggested that these condensed financial statements be read in conjunction with the Consolidated Financial Statements and notes thereto.
NOTE 2--INVESTMENTS IN AND NET ADVANCES FROM SUBSIDIARIES:
ALARIS Medical accounts for its investments in subsidiaries using the equity method. Under the equity method, investments are carried at cost, adjusted for ALARIS Medical's proportionate share of their undistributed earnings or losses. At December 31, 2000 and 1999, investments in and net advances from subsidiaries is comprised of ALARIS Medical Systems common ownership interest and advances of $100,282 and $101,121 respectively.
NOTE 3--LONG-TERM DEBT:
The terms and maturities of ALARIS Medical's long-term debt are described in Note 5 to the Consolidated Financial Statements.
NOTE 4--CASH FLOW INFORMATION:
During 2000 and 1999, ALARIS Medical Systems made dividend payments of $2,030 and $2,437, respectively, to ALARIS Medical.
NOTE 5--CONTINGENCIES AND LITIGATION:
Contingencies and litigation are described in Note 15 to the Consolidated Financial Statements.
EXHIBIT INDEX