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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the fiscal year ended December 31, 1997 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the period from __________ to __________
Commission file number 333-18687
ALARIS MEDICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3800335
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
10221 Wateridge Circle, San Diego, California 92121
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (619) 458-7000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
----------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. YES: X NO:
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
No common stock is held by nonaffiliates of the registrant.
As of March 23, 1998, the registrant had 1,000 shares of common stock
outstanding.
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PART I
ITEM 1. BUSINESS
Background
ALARIS Medical Systems, Inc. ("ALARIS Medical Systems") designs,
manufactures, distributes and services intravenous infusion therapy and
periodic patient monitoring instruments and related disposables and
accessories. On November 26, 1996, IMED Corporation ("IMED"), then a
wholly-owned subsidiary of Advanced Medical, Inc., ("Advanced Medical")
acquired all of the outstanding stock of IVAC Holdings, Inc. ("IVAC
Holdings") and its subsidiaries including IVAC Medical Systems, Inc. In
connection with the acquisition, IMED and IVAC Medical Systems, Inc. were
merged into IVAC Holdings (the "Merger"), which then changed its name to
ALARIS Medical Systems, Inc. Additionally, Advanced Medical changed its name
to ALARIS Medical, Inc. ("ALARIS Medical"). The acquisition was accounted for
as a purchase. ALARIS Medical Systems and its subsidiaries are collectively
referred to as the "Company." ALARIS Medical Systems was incorporated on
October 14, 1994 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"). In addition, the Company is a
leader in the international infusion systems market. The Company, based on
installed base of infusion pumps, has a number one or two market position in
eleven Western European countries, the number three market position in
Germany and Italy, 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 fluids, generally
pharmaceuticals or nutritionals, accurately and safely to patients, consist
of single and multi-channel infusion pumps and controllers, and proprietary
and non-proprietary disposable administration sets (plastic tubing and pump
interfaces). In addition, the Company is a leading provider of patient
monitoring products that measure and monitor temperature, pulse 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 direct sales
force consisting of over 200 salespersons and through more than 150
distributors to over 5,000 hospitals worldwide. The Company's United States
sales and sales to customers located outside the United States accounted for
approximately 63% and 37%, respectively, of the Company's sales for 1997. For
the year ended December 31, 1997, the Company had sales of approximately
$359.1 million.
Infusion Systems. The Company offers a wide variety of infusion pumps
designed to meet the varying price and technological requirements of its
broad array of customers. 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 system, a versatile, user-friendly single
and dual channel infusion pump for use in general medical and surgical
settings; the MedSystem III instrument ("MS III"), a compact, lightweight,
programmable three channel infusion pump targeted for the hospital critical
care and transport applications; and the 560/570 Series,
------------------------
The Company has registered or applied to register the following
trademarks: IMED-Registered Trademark-, Accuset-Registered Trademark-,
Graviset-Registered Trademark-, Microset-Registered Trademark-,
Flo-Stop-Registered Trademark-, Gemini-Registered Trademark-, Gemini
PC-1-Registered Trademark-, Gemini PC-2-Registered Trademark-, Gemini
PC-4-Registered Trademark-, Gemini PC-2TX-Registered Trademark-,
Autotaper-Registered Trademark-, Versataper-Registered Trademark-,
ReadyMED-Registered Trademark-, VersaSafe-Registered Trademark-,
IVAC-Registered Trademark-, IVAC MEDICAL SYSTEMS-TM-, CORE-CHECK-Registered
Trademark-, DYNAMIC MONITORING-TM-, MEDSYSTEM III-Registered Trademark-,
PCAM-TM-, SIGNATURE EDITION-TM-, TEMP-PLUS-Registered Trademark-,
VITAL-CHECK-Registered Trademark-, ACCUSLIDE-TM-, and Smart-Site-TM-
SAFSITE-Registered Trademark- is a registered trademark of B. Braun, Inc.
2
consisting of single channel infusion pumps designed for the price-conscious
customer. In addition, the Company offers the ReadyMED ambulatory infusion
pump ("ReadyMED"), which is compact, lightweight and disposable, for use in
the alternate site market and a variety of syringe infusion pumps for use
primarily outside the United States.
The Company manufactures higher margin proprietary disposable
administration sets which can only be used with the Company's large volume
infusion pumps. Since the useful life of the Company's infusion pumps is
typically seven to ten years, the Company's industry-leading installed base
allows it to generate stable, predictable and recurring revenues from sales
of disposable administration sets. 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
has introduced 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
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,
1997, the Company's infusion systems sales were $306.2 million, representing
approximately 85% of the Company's total sales.
Patient Monitoring Products. The patient monitoring products market
consists of discrete market niches, each of which has different competitive
dynamics. The Company primarily operates in the United States, Canada and
Western Europe in two market niches of the patient monitoring products
market: (i) hospital thermometry systems and (ii) stand-alone, non-invasive,
multi-parameter patient monitoring products which measure a combination of
pulse, temperature and blood pressure. The Company's large base of installed
hospital thermometry instruments allows it to generate stable, predictable
and recurring revenues from sales of related disposable probe covers. In
1997, the Company manufactured and sold over 595 million proprietary
disposable probe covers. For the year ended December 31, 1997, the Company's
patient monitoring products sales were $33.4 million, representing
approximately 9% of the Company's total sales.
At December 31, 1996, the Company's installed base of thermometry
instruments constituted approximately 42% of the United States hospital
electronic and infrared thermometry market, making the Company the largest
provider of hospital thermometry systems in the United States. The Company's
principal thermometry instruments are the TEMP-PLUS II electronic thermometer
and the CORE-CHECK infrared thermometer, both of which are widely used in
hospitals and alternate site settings. The Company is also the second largest
participant in the United States infrared thermometry market, the fastest
growing segment of the hospital thermometry market, and, at December 31,
1996, had approximately 31% of the United States hospital installed base. In
addition, the Company's hospital installed base of stand-alone, non-invasive,
multi-parameter patient monitoring products, which measure a combination of
pulse, temperature and blood pressure, is the second largest in this market
niche in the United States.
Industry
General. 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,
hospitals and other potential customers for the Company's products are
increasingly combining into group purchasing organizations ("GPOs") which may
be large and which effectively police 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 vital signs measurement
products, for a period of several years. See "-Marketing and Sales." These
trends have, in turn, led to downward pricing pressure on manufacturers of
medical products, including the Company, and greater use of alternate sites
for treatment. Growth in the alternate site market is also 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
3
therapy and increased acceptance by the medical community of, and patient
preference for, non-hospital treatment. As both the complexity of infusion
therapy treatments and the potency of drugs administered have increased, the
demand for technologically-advanced infusion systems has risen significantly.
In the patient monitoring products markets, similar trends of cost reduction
of health care delivery and technological innovation have resulted in the
creation of a number of new products and product areas, such as infrared
thermometry products, pulse oximetry and multi-parameter patient monitoring
products.
The Company believes that as the infusion system and patient
monitoring products 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 which, in turn, provides opportunities for
leading suppliers to increase market share and participate in strategic
alliances, joint ventures and acquisitions.
The United States hospital market consists of approximately 5,300
hospitals with a total of approximately 900,000 licensed beds and can be
divided into three major areas: critical care (e.g., adult, pediatric and
neonatal intensive care units), specialty units (e.g., oncology, ob/gyn,
coronary care and emergency room/trauma) and general medical/surgical. The
alternate site market encompasses all health care provided outside a hospital
and is comprised primarily of home health care, freestanding clinics, skilled
nursing facilities and long-term care facilities.
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 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 systems are generally designed for
either critical care or general care use, with the latter group being used
both in hospitals and at alternate site facilities.
The United States infusion therapy market had sales of approximately
$1.5 billion in 1996 and has grown at an estimated compound annual growth
rate of approximately 3.8% from 1992 to 1996. There are two principal markets
for infusion systems: the hospital market and the alternate site market.
These markets had sales in the United States of approximately $1.1 billion
and $360 million, respectively, in 1996, and estimated annual compound growth
rates of approximately 1.6% and 12%, respectively, from 1992 to 1996.
Infusion systems include three major delivery technologies:
pumps/controllers, disposable ambulatory pumps and gravity delivery products.
In 1996, these three segments had sales in the United States of approximately
$800 million, $80 million and $350 million, respectively. While the Company
competes in the pumps/controllers and disposable pumps segments, it has never
competed in gravity delivery products because of the commodity nature of this
market.
Controllers typically are nonvolumetric devices that regulate flow by
electronically counting drops rather than by measuring a specific volume of
fluid. The Company does not currently market a traditional controller, but
some of its infusion pumps can be used in a controller mode. Infusion pumps
use positive pressure to overcome the resistance in the infusion tubing and
the back pressure generated by the patient's circulatory system. Infusion
pumps administer precise, volumetrically measured quantities of fluids more
accurately and over a wider range of infusion rates than controllers. For
this reason, infusion pumps are used more frequently than controllers to
administer expensive, critical or potent therapeutics. Syringe pumps operate
by gradually depressing the plunger on a standard disposable syringe, thereby
delivering a more
4
concentrated dose of medication at a very precise rate of accuracy.
Disposable pumps are single-use products designed for use primarily in
general care settings.
Historically, controllers have held a major share of the installed base
of infusion instruments, principally because they were significantly less
expensive than infusion pumps. As infusion pump prices declined and their
technological capabilities increased, the purchasing trend has been toward
infusion pumps. As of the end of 1996, infusion pumps represented
approximately 98%, and controllers represented approximately 2%, of the
installed base of infusion instruments in the United States hospital market
and less than 1% of the infusion instruments sold in 1996 were controllers.
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. As a result, United States sales
of channels relating to multi-channel infusion pumps have increased from
approximately 28% of total United States channels sold in 1991 to
approximately 39% of total United States channels sold in 1996.
All infusion pumps and controllers 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. Components such as burettes and filters may also be added
for critical drugs or special infusion. Almost all of these sets, including
those manufactured by the Company, are compatible only with their particular
manufacturer's line of infusion systems. Since these disposable
administration sets tend to have significantly higher margins than infusion
pumps, the establishment of an extensive installed base, such as the
Company's, is important for generating ongoing disposable administration set
sales and enhancing overall margins.
Patient Monitoring Products. Patient monitoring products are used to
measure and monitor pulse, temperature, blood pressure and respiration rate.
Products sold in this market have varying levels of technological
sophistication and are used in a variety of diagnostic and health care
settings. The patient monitoring products market consists of discrete market
niches, each of which has different competitive dynamics. The Company
competes in two niches - hospital thermometry systems, and stand-alone,
non-invasive, multi-parameter patient monitoring products which measure a
combination of pulse, temperature and blood pressure. In the United States,
these two market niches had sales of approximately $55.0 million and $140.0
million, respectively, in 1996.
The three major instrument types in the hospital thermometry market are
glass, electronic and infrared devices, which in 1996 accounted for
approximately 5%, 65% and 30%, respectively, of the United States hospital
market installed base. The Company offers electronic and infrared instruments
but does not compete in the glass thermometry market. Over the last several
years, there has been a shift toward increased use of infrared instruments
due primarily to their ease of use. While infrared thermometers constituted
only approximately 31% of the installed base in the United States in 1996,
sales of these products accounted for approximately 41% of total market sales
in 1996.
As with the infusion therapy market, the hospital thermometry market
has higher margin disposable products that are used in concert with
instruments and, consequently, the existence of an installed base is
important for generating ongoing disposable product sales and enhancing
overall margins.
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, the
Signature Edition system, MS III and 560/570 Seriespumps, syringe infusion
pumps
5
such as P1000, P3000, PCAM and P7000, which are sold primarily in Western
Europe, and the ReadyMED system. The Company's large volume infusion pumps
require the use of higher margin proprietary disposable administration sets.
The Company also sells non-proprietary disposable administration sets for use
with syringe infusion pumps manufactured by the Company and others.
Furthermore, the Company manufactures and markets hospital thermometry
instruments and related disposable probe covers, and stand-alone,
non-invasive, multi-parameter instruments which measure and monitor
temperature, pulse and blood pressure. In the United States hospital
electronic and infrared thermometry market, the Company had an installed base
market share of approximately 42% in 1996 and was the second largest supplier
of hospital thermometry products in the infrared market. In its niche of
stand-alone, non-invasive, multi-parameter instruments, the Company had an
installed base market share of approximately 14% in the United States in 1996.
The table set forth below summarizes the key features, actual or
estimated market introduction dates and predecessor product line information
with respect to the Company's product line and products in development.
Product Description Status
- --------------------- ------------------------------------------ --------------------------------
Large Volume Infusion
Pumps
Signature Edition Single and dual channel pump; incorporates Selectively marketed since
(Model 7100/7200) intuitive user interface; for critical and September 1995; full commercial
general care use availability in the United States
achieved in the first quarter of
1996; introduced in Europe during
the second half of 1997
Signature Edition GP Single channel pump using the Signature Edition Market introduction in 1997
(Model 7000) technology platform designed for the price-
conscious consumer; intended to be marketed
in the United States for general care and
alternate site markets
Gemini PC-1 Single channel instrument with pump and controller Marketed since 1988
capability; for use in all hospital settings
Gemini PC-2T Dual channel instrument with pump and controller Marketed since 1987
capability; for use in all hospital settings
Gemini PC-2TX Dual channel instrument with pump and controller Marketed since May 1994
capability; programmable drug delivery/dose
calculations and pressure history; for use in all
hospital settings
6
Product Description Status
- --------------------- ------------------------------------------ --------------------------------
Gemini PC-4 Four channel instrument with pump and controller Marketed since December 1992
capability; programmable drug delivery/dose
calculations and pressure history; for use in
critical care settings
Modular Infusion Pump Compact, flexible, lightweight modular infusion Market introduction planned for 1999
pump with an adjustable hardware and software
platform with advanced programming capabilities;
for use in all hospital and alternate site
settings
560/570 Series Single channel pump with largest installed base On market since 1983 and 1990,
worldwide; for general care use in the United respectively
States, and general and critical care use in
Europe
597/598 Series Single channel, multi-pump configuration of reduced On market in Europe since 1993
size and weight; used frequently for delivery of
nutritional products; sold in Europe; for general
care and alternate site use
MS III Three channel pump; smallest and lightest Originally introduced in late
multi-channel pump available on the United States 1980s by Siemens Infusion
market; for critical care use Systems, Ltd. as MiniMed;
reengineered since its
acquisition in 1993
Syringe Infusion Pumps
P1000, P2000, P3000, Preferred method of delivery in many markets Various models introduced between
P4000 outside the United States; for critical and late 1980s and early 1990s
non-critical care use
P7000 Syringe pump with advanced features for critical, Introduced to European market
non-critical and neonatal care use in markets during second quarter of 1996
outside the United States
P6000 Syringe pump using the P7000 technology platform Introduced to European market
designed for the price-conscious consumer in during the second half of 1997
markets outside the United States; for critical
and non-critical care use
P6000-TIVA Syringe pump designed for critical and non-critical Introduced during third quarter
care use 1997
P6000-TCI Syringe pump that incorporates Diprifusor module Introduced during fourth quarter
from Zeneca 1997
7
Product Description Status
- --------------------- ------------------------------------------ --------------------------------
PCAM (Patient Syringe pump used in markets outside the United Introduced internationally in
Controlled Analgesia States that allows patients to control the delivery first quarter of 1995
Pump) of pain medication
Ambulatory Pumps
ReadyMED Compact, disposable, lightweight ambulatory 100 mL marketed since July 1992
infusion pump designed for alternate site use and 50 mL and 250 mL introduced
in 1993
Rythmic Family of lightweight, self-contained portable Agreement with Micrel signed in
pumps for PCA, intermittent and continuous use second half of 1997, 1998
at home in international markets launch planned
Disposable Proprietary and non-proprietary administration On market and in development
Administration sets for use with each of the Company's existing
Sets and proposed infusion pumps
Needle-Free Access Products
SmartSite System Needle-free, capless, latex-free infusion system Introduced in 1996
component intended to increase safety of patients
and health care workers
VersaSafe Infusion system component utilizing a blunt cannula Marketed since 1994 through a
device combined with a split-septum "Y" site non-exclusive license
Patient Monitoring:
Thermometry Systems
TEMP-PLUS II Electronic thermometer; for general hospital and On market since mid-1980s
(Model 2080) alternate site use
TEMP-PLUS III Electronic thermometer; a 7-to-10-second version of Market introduction planned for
the Model 2080; intended for general hospital use 1998
CORE-CHECK Infrared tympanic thermometer that saves time, On market since 1991
(Model 2090) reduces patient interruption and lowers risk of
infection; for general hospital use
8
Product Description Status
- --------------------- ------------------------------------------ --------------------------------
Disposable Probe Proprietary covers for use with each of the On market since mid-1980s
Covers Company's existing and proposed thermometers
Other Patient Monitoring Products
VITAL-CHECK Continuous monitoring model that rapidly measures On market in the United States
(Model 4200) pulse, blood pressure and temperature; for general since late 1980s
hospital use
VITAL-CHECK Multiparameter non-invasive patient monitor Introduced during fourth quarter
(Model 4400) providing blood pressure, pulse oximetry of 1997
and temperature monitoring
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 large volume infusion pumps consist of volumetric
piston cassette pumps, which regulate the flow of fluid through a
syringe-like mechanism, and peristaltic pumps, which regulate fluid flow by
means of a multi-finger-like mechanism that alternately compresses sections
of the tubing contained in the pumping chamber. Peristaltic pumps represent
the largest portion of the Company's installed base of infusion pumps. The
Company discontinued manufacturing piston cassette pumps in the first quarter
of 1995.
The Signature Edition line of peristaltic infusion pumps includes a
single channel and dual channel pump. The Signature Edition line of infusion
pumps is designed for use primarily in hospitals. The Signature Edition line
of infusion pumps features include cost-effectiveness, ease of use,
reliability and innovative features, such as new safety features designed to
minimize the chance of free flow.
The Gemini peristaltic 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; programmable 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 Gemini PC-1 infusion pump is currently subject
to a voluntary recall initiated by the Company. See "-Government Regulation -
Product Regulation."
The MedSystem III instrument is a compact, lightweight, programmable,
three channel, peristaltic infusion pump used primarily in the critical care
market. The MedSystem III predecessor product line was acquired from Siemens
Infusion Systems, Ltd. in September 1993. Since such time, significant
resources have been invested to reengineer the MedSystem III pump. The
Company believes that as a result of this reengineering, the MedSystem III
system is one of the smallest, most versatile and most technologically
advanced multi-channel pumps currently on the market.
The 560/570 Series and the 597/598 Series are single channel
peristaltic infusion pumps that offer cost-effective solutions for drug
delivery in the general care setting. The Company believes that the 560/570
Series has the largest installed base of any individual infusion pump
worldwide.
9
During the fourth quarter of 1993, the Company commenced designing a
modular infusion pump, which can operate in a one to four channel mode, as
the basis for its next generation of infusion pumps. In addition to all of
the features available on the Gemini series, the modular infusion pump is
being designed to incorporate advanced programming capabilities in a smaller
infusion pump 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 specific situations resulting in lower cost operation and
greater asset utilization.
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 eleven countries and the number
three installed base market share in Germany and Italy. The Company is
currently evaluating customer interest and regulatory requirements in the
United States for syringe pumps.
In 1995, the Company introduced the PCAM patient controlled analgesia
infusion pump that allows patients to control the delivery of pain
medication. Designed for general care settings, the PCAM 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 continued to expand its syringe pump product line by
introducing the P7000 syringe pump to the international market during the
second quarter of 1996 and the P6000 syringe pump to the European Market
during the second quarter of 1997. Designed for critical, non-critical and
neonatal care settings, the P7000 offers several advanced features, including
an automatic dose rate calculator; a pre-programmable drug menu; a range of
pre-programmed infusion administration protocols; and an automatic pressure
reduction capability in response to administration set occlusions. The P6000
syringe pump, which is based on the P7000 syringe pump technology platform,
is designed for use in critical and non-critical care settings by the price
conscious consumer.
The Company has initiated a voluntary safety alert of its P1000, P2000,
P3000 and P4000 syringe pumps. These syringe pumps are marketed
internationally. See "-Government Regulation-Product Regulation."
Ambulatory Pumps. The ReadyMED pump is a disposable, compact,
ambulatory pump for the intravenous administration of antibiotics. ReadyMED
is designed to offer a number of advantages over systems currently in use for
this purpose. Traditional systems require the patient to attach a small bag
and tubing set, through which the antibiotics are administered, to a catheter
placed in the patient's circulatory system. The patient must eliminate all
air from the system and set a manual rate adjustment clamp, a process that
generally must be repeated every four to six hours. 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
pump is pre-filled (in 50 mL, 100 mL and 250 mL sizes) and pre-primed,
allowing infusion to be initiated when the patient simply opens a clamp. 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. In
March 1992, the Company entered into a five-year agreement with McGaw, Inc.
("McGaw") pursuant to which McGaw obtained the exclusive right to distribute
the 50 mL, 100 mL and 250 mL sizes of the ReadyMED pump in the United States
and Puerto Rican alternate site markets. The Company and McGaw amended their
distribution agreement during 1997, extending its term until March 31, 1998,
and converting McGaw's exclusive distribution right into a non-exclusive
distribution right. Effective April 1998, the Company will initiate direct
sales of ReadyMED through its alternate site sales force and distribution
network.
10
Disposable Administration Sets. The Company estimates that it has
approximately 212,000 single and multi-channel large volume infusion pumps
installed in the United States, each of which uses proprietary disposable
administration sets designed and manufactured only by the Company. 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
solution. Components such as burettes and filters may also be added for
critical drugs or special infusion. In addition, many of the Company's
disposable administration sets offer protection features designed to prevent
free flow. Each of the Company's current and proposed large volume infusion
pumps uses only 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 needle-free 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
VersaSafe system utilizes a blunt cannula device combined with a split-septum
"Y" site. The Company has a non-exclusive license, which expires in April
2000, to the VersaSafe system which was a cooperative development effort of
IMED, Elcam Plastic of Israel and Medical Associates Network. The Company's
SmartSite Needle-Free System, introduced in the third quarter of 1996, is a
component which is compatible with standard luer or luer-locking syringes and
disposable administration sets, thereby allowing users to integrate the
Needle-Free System into existing care practices. The Company's latest
needle-free access product, the SmartSite System, offers a fully integrated
design and eliminates the need for separate caps to maintain an infection
control barrier. The SmartSite 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 Company's needle-free
access products have received strong interest from customers and provide the
Company with an opportunity to increase revenues in what has previously been
a commodity market.
Patient Monitoring Products. Patient monitoring instruments are used to
measure pulse, temperature and blood pressure. Products 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
believes that in 1997 its installed base comprised approximately 42% of the
United States hospital electronic and infrared thermometry market, thereby
making the Company the largest provider of hospital thermometry systems in
the United States. The Company's primary product is an electronic thermometer
which is widely used in hospitals and alternate site settings. The Company is
currently developing the TEMP-PLUS III instrument (formerly known as the
"Fast" 2080), an improved cost-effective and technologically-advanced
electronic thermometer designed to provide a temperature reading in
seven-to-ten seconds. The Company also manufactures and markets the
CORE-CHECK system, a thermometer that measures temperature by detecting the
emission of infrared energy in the ear. In the infrared market, the fastest
growing segment of the industry's market, the Company is currently the second
largest domestic participant, with a United States hospital installed base
market share of approximately 31% at December 31, 1996. The only disposable
probe covers which can be used with the Company's thermometry instruments are
those manufactured by the Company.
11
Other Patient Monitoring Products. The Company also produces
stand-alone, non-invasive, multi-parameter patient monitoring products which
measure a combination of pulse, temperature and blood pressure. The Company's
hospital installed base of these instruments is the second largest in the
United States.
In January 1997, the Company entered into two agreements with Criticare
Systems, Inc., a manufacturer of patient monitoring systems and non-invasive
sensors for use in the hospital and alternate site markets. Under these
agreements, Criticare Systems, Inc. obtained the right to use the Company's
electronic thermometry technology in certain monitoring systems to be
manufactured and distributed by both Criticare Systems, Inc. and the Company.
The Company also obtained exclusive distribution rights to certain of these
monitoring systems in the United States hospital market and in all Canadian
markets. The first of these exclusive systems is the Vital-Check 4400, which
provides non-invasive blood pressure, pulse oximetry and temperature
monitoring.
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. In addition, the Company
maintains its parts inventory at levels which enable it to deliver critical
supplies immediately and minimize back-ordered products. The Company believes
that the availability of such services is important for maintaining strong
customer relations.
Marketing and Sales
The Company has historically focused its sales efforts on the hospital
market. In response to the industry shift toward health care delivery outside
of the hospital, the Company has recently begun to expand 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.
The Company has contracts with ten GPOs. GPOs have emerged in response
to cost containment pressures and health care reform. GPOs often enter into
exclusive purchase commitments with as few as one or two providers of
infusion systems and/or vital signs measurement products for a period of
several years. If the Company is not one of the selected providers, it may be
precluded from making sales to members of a GPO for several years and, in
certain situations, the GPO may require removal of the Company's existing
installed infusion pumps, which would result in a loss of the related
disposable administration set sales. Even if the Company is one of the
selected providers, the Company may be at a disadvantage relative to other
selected providers which are able to offer volume discounts based on
"bundled" purchases or a broader range of medical equipment and supplies.
Further, the Company may be required to commit to pricing which has a
material adverse effect on net sales and profit margins. See "-Competition."
In January 1997, the Company entered into a five-year sole-source
supply contract with Premier Purchasing Partners, L.P. ("Premier"), an
affiliate of Premier, Inc., the nation's largest healthcare alliance GPO, for
tympanic and electronic thermometry instruments and related disposable probe
covers. Under this agreement, Premier agreed to purchase 80% of its needs for
such products from the Company. In addition, in March 1997, the Company
entered into a dual source supply agreement with Premier for the purchase of
large volume infusion pumps and associated disposable administration sets.
The dual source agreement is for a five year period with a two-year renewal
option. Premier had previously signed a seven-year supply contract with
Baxter International, Inc. covering a number of hospital supplies, including
a dual source award for large volume infusion pumps and disposable
administration sets.
12
In December 1997, the Company and Tenet Healthcare Corporation entered
into a ten-year, sole-source agreement for intravenous infusion pumps and
associated IV disposables. In addition, ALARIS Medical is named as one of two
approved sources by Tenet for needleless IV tubing sets and components, which
are included in the $100 million Tenet expects to spend on IV-related
equipment over the term of the contract.
No single account is material to the business or operations of the
Company.
The Company sells its products through a combined direct sales force
consisting of over 200 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.
International Operations
The Company markets products in approximately 120 countries through its
direct sales force, affiliates 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, on a pro forma basis as if the Merger had occurred at the
beginning of each period presented, the approximate amount of sales made to
customers in each of the geographic locations set forth below over the last
three fiscal years:
1995 1996 1997
------ ------ ------
(dollars in millions)
United States..................... $238.3 $224.6 $227.0
International..................... 114.4 121.7 132.1
------ ------ ------
Total sales..................... $352.7 $346.3 $359.1
The Company believes that sales of products to customers outside of the
United States represents a significant potential source of growth. As part of
its operating strategy, the Company intends to selectively pursue
international expansion opportunities, particularly in Europe, Japan,
Southeast Asia and Latin America.
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 Company.
Manufacturing
The Company manufactures its products at plants in San Diego,
California; Creedmoor, North Carolina; Tijuana, Mexico; and Hampshire,
England. The San Diego facilities are the primary manufacturing facilities
for infusion pumps and vital signs measurement instruments and also house a
service operation for installed infusion pumps and vital signs measurement
instruments. The Creedmoor, North Carolina facility houses a portion of the
current disposables operations and is a distribution center for North
American disposable finished products. Product release from sterilization is
done in San Diego,
13
California and Creedmoor, North Carolina. The Tijuana facilities primarily
focus on the manual assembly of disposables, and the England facility focuses
on the manufacturing of syringe pumps. 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. These systems result in establishing
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 the Company has not experienced any serious shortages
or material delays in obtaining these materials. 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 PC 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.
The Company has identified the reduction of production and operating
costs as a key component of its operating strategy. As part of this strategy,
the Company has reduced overall head count through termination and attrition.
The Company continues to focus on the following programs: (i) consolidating
supply sources and (ii) design improvements.
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, 1997, the Company expended
approximately $16.9 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
14
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 212 unexpired patents in the
United States and approximately 385 unexpired patents in foreign countries,
principally in Europe, Canada, Japan and Australia. Additional applications
are pending or in preparation. Within the next ten years, approximately 122
of the Company's United States patents and approximately 168 of the Company's
foreign patents will expire. 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 Company's results of operations, business or financial
condition.
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. In
addition, patent law has recently been revised to give effect to
international accords to which the United States has become a party. Pursuant
to such accords, the patent term has been changed from 17 years from date of
grant to 20 years from date of filing and certain provisions favoring United
States inventors over foreign inventors have been eliminated.
The United States patent code was recently amended. As a result,
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, medical activity does
not include "the use of a patented machine, manufacture or composition of
matter in violation of such patent." The aforesaid amendment does not apply
to patents issued before September 30, 1996. Legislation which would have
prohibited the issuance of patents directed to surgical and medical
procedures did not pass in the 104th Congress and no such legislation
presently is pending.
The Company sells its products under a variety of trademarks, some of
which are considered by the Company to be of 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 intends
to improve its competitive position in this area by seeking acquisitions that
will allow or enhance its own "bundles" of devices and instruments. 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. The Company's success is therefore dependent on the
development of new infusion technologies and the development of other markets
for its products. The Company's older infusion therapy and thermometry
product lines have experienced declining sales and market share recently,
primarily due to competitors who
15
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." Moreover, there can be no assurance
that the Company's efforts to take advantage of opportunities it perceives in
the alternate site and international markets will be successful. In addition,
although the pace of technological change in the Company's industry
historically has been relatively slow, the Company is unable to predict the
pace of such change in the future. There can be no assurance that
technological change will not place one or more of the Company's existing or
proposed products at a significant competitive disadvantage. Additionally, to
the extent the Company does not successfully reposition existing products for
sale to different markets, the introduction of new products by the Company
will reduce sales of such existing products.
At December 31, 1996, on a pro forma basis, the Company had a market
share of approximately 40% of the installed base of infusion pump channels in
the United States. Major competitors in this market include Baxter
International, Inc., Abbott Laboratories, Inc. and McGaw, which in the
aggregate had a market share of approximately 55% of the installed base of
infusion pump channels in the United States at December 31, 1997.
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 eleven countries and the number three installed base market share in
Germany and Italy. The Western European countries in which the Company has a
number one or number two installed base market share are France, Denmark,
Finland, Norway, Sweden, the United Kingdom, Belgium, the Netherlands,
Luxembourg, Spain and Portugal.
The vital signs measurement products market is fragmented by product
type. The Company's key competitor in the United States electronic
thermometer market is Diatek and its key competitor in the infrared
thermometer market is Sherwood Medical Company.
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.
The 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 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" (as defined in FDA Quality System
regulations) ("QSR"), prohibitions on adulteration and misbranding, and
reporting of certain adverse events ("MDR"). In addition to general controls,
Class II devices may be subject to special controls that could include
performance standards, postmarket
16
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. The
Company is not currently developing, manufacturing or distributing any Class
III devices, although it may do so in the future. Unless otherwise exempt,
all medical devices introduced to the market since 1976 are required by the
FDA, as a condition of marketing, to secure a 510(k) premarket notification
clearance ("510(k)") or a Premarket Approval Application ("PMA"). A product
will be cleared by the FDA under a 510(k) if it is found to be substantially
equivalent in terms of safety, effectiveness and intended use to another
legally marketed medical device that was on the market prior to May 28, 1976
or to a product that has previously received a 510(k) and is lawfully on the
market. In general, if a product is not substantially equivalent to such a
medical device, and not otherwise exempt, the FDA must first approve a PMA
before it can be marketed. An approved PMA indicates that the FDA has
determined the product has been proven, 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)
currently takes, on average, 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 design details and
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, during which time the modified product
cannot be distributed in interstate commerce. Although there can be no
assurance, the Company believes that its proposed products under development
will qualify for the 510(k) procedure.
As part of its normal course of business, the FDA regularly conducts
investigations regarding the safety or efficacy of medical products,
including those manufactured by the Company, which may result in the
Company's inability to market a particular device or cause the Company to
need to generate additional data to support submissions for market clearance.
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 clinical
investigations to determine the safety and effectiveness of devices,
including 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 informed patient
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,
17
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 for sale in
the United States, are subject to the FDA export requirements, including
restriction on distribution in the United States.
The Company has received ISO 9000 certification for all of its
facilities regarding the quality of its manufacturing systems, a requirement
for doing business in EC countries. The Company has been granted approval to
affix the CE mark, pursuant to the EC Medical Device Directives, on certain
of its products. Approval to affix the CE mark to a product does not
necessarily preclude, however, additional restrictions on marketing in any
individual country in the EC.
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 other 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
and certain state agencies. These agencies inspect 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 GMPs governing design,
manufacturing, testing, quality control, product packaging and storage
practices. The FDA has recently revised the GMP regulations. These revised
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. 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 seek criminal sanctions or seek to close some or all of the
Company's manufacturing facilities. Such actions could also result in an
inability of the Company to obtain additional market clearances. Since 1992,
the Company has on sixteen occasions removed products from the market that
were found not to meet performance standards. None of such recalls materially
interfered with the Company's operations and all such affected product lines,
except the 599 Series infusion pumps (as noted below), were subsequently
returned to the market. One such product recall, a recent voluntary recall
related to the Company's Signature Edition infusion pumps, has not yet been
terminated or otherwise closed by the FDA and the FDA could take further
regulatory action against the Company, including actions such as those
described above. The Signature Edition infusion pumps were recalled because
of an unacceptable level of malfunction alarms due to less than expected
reliability of their pressure monitoring systems. The user of these pumps is
notified of such malfunction alarms by both a continuous audible signal and a
visual message. The Company has completed the upgrade and replacement, at no
charge to its customers, the current pressure monitoring system contained in
certain of the infusion pumps included within the Signature Edition product
line. This recall was completed at the
18
end of the second quarter of 1997. In addition, a voluntary recall of
approximately 645 Gemini PC-1 infusion pumps (limited to distribution outside
the United States) was initiated by the Company in June 1996. At this time,
the Company has completed required modifications.
In the first quarter of 1998 the Company will initiate a voluntary
field correction of approximately 50,000 of its Gemini model PC-1 and PC-2
infusion pumps because failure of specific electrical components on the power
regulator printed circuit board may result in improper regulation of the
battery charge voltage, which can cause the battery to overheat. Such
overheating could result in product failure and discharge of hydrogen gas
which may accumulate within the instrument's case. As an interim measure, the
Company has advised its customers of simple precautions that can be taken to
minimize the potential for an adverse incident pending completion of the
field correction. The Company is not aware of any injuries sustained in known
battery overcharging incidents.
As a result, the Company recorded a charge of $2.5 million to cost of
sales during the first quarter of 1997. Based on management's current
understanding of these incidents, the Company believes it has adequately
accrued for this matter. However, since the Company's analysis of this matter
is preliminary, there can be no assurances that it can be resolved for an
amount consistent with management's estimated cost.
In addition, the Company has initiated a voluntary safety alert of its
599 Series infusion pumps, which it discontinued selling in March 1997. This
safety alert advises customers to inspect and, if necessary, make an
adjustment to the infusion pump in order to prevent misloading of disposable
administration sets. The Company has initiated a product recall of certain MS
III disposable administration sets affecting 44,000 units. This recall
advises the user to return the affected product for replacement. The sets
were recalled due to a low level assembly defect which could result in
reverse flow.
The Company's manufacturing facilities in San Diego have been licensed
by the State of California Department of Health Services, Food and Drug
Branch, under the applicable GMP and other regulations.
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
similar state programs. Violations of the statute are punishable by civil and
criminal penalties and exclusion of the provider from future participation in
the Medicare and Medicaid programs. The Social Security Act contains
exceptions to these prohibitions for, among other things, properly reported
discounts and payment 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
19
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 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.
Health Care Reform. Because the cost of health care delivery has been
steadily rising and because the cost of a significant portion of medical care
in the United States and other countries is typically funded by governmental
insurance programs, there have been a number of government initiatives to
reduce health care costs. Congress and various state legislatures currently
are proposing changes in law and regulation that could effect major
restructuring of the health care industry. Although many of these proposals
may seek to maintain or expand access to health care services, the common
objective of the proposed legislation is to achieve cost containment in the
health care sector. Changes in governmental support of health care services,
the methods by which such services are delivered, the prices for such
services or the regulations governing such services or mandated benefits may
all have a material adverse effect on the Company. Even if the ultimate
impact of any such changes on net sales is positive, no assurance can be
given that the costs of complying with possible new requirements would not
have a negative impact on the Company's future earnings. No assurance can be
given that any such legislation will not have a material adverse effect on
the Company.
Environmental Matters. The Company is subject to regulation by OSHA,
the Environmental Protection Agency and their 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"). Although
there can be no assurances, 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
20
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.
The Company is currently involved in two such matters; one, at the
Seaboard Chemical site in Jamestown, North Carolina, and another at the
Caldwell Systems, Inc., site in Lenoir, North Carolina. In relation to the
Seaboard Chemical site, the Company has entered into a de micromis
administrative order on consent with the North Carolina Department of
Environment, Health and Natural Resources and a group of PRPs, settling its
liability for past and future response costs associated with the site. Under
the consent order, the Company receives a release from further liability
associated with the site, a covenant not to sue by the other PRPs entering
into the consent order, and protection under CERCLA against contribution
actions for matters addressed by the consent order. Protection from further
liability is conditioned on the absence of information indicating that the
Company disposed of a greater quantity of hazardous substances at the site
than currently known. Although there can be no assurance that such further
information does not exist, the Company believes the amount of its liability
at this site will be de minimis.
In relation to the Caldwell Systems site, the Company has agreed to
enter into a de micromis administrative order on consent with the US
Environmental Protection Agency (US EPA) and a group of PRPs, settling its
potential liability for past and future response costs associated with the
site. Under the consent order, the Company will receive a covenant not to sue
by the US EPA and by other PRPs entering into the consent order, and
protection under CERCLA against contribution actions for matters addressed by
the consent order.
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, 1998, the Company employed 2,588 people including
1,018 in the United States.
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.
21
ITEM 2. PROPERTIES
The Company has long-term leases on substantially all of its major
facilities. The Company maintains its primary instrument manufacturing
facilities in San Diego, California and Hampshire, England. Disposable
administration set manufacturing facilities are located in Creedmoor, North
Carolina and Tijuana, Mexico. The disposable manufacturing facility in
Creedmoor, North Carolina is owned by the Company. The disposable
manufacturing facilities in Tijuana, Mexico are maintained under one year
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, Canada and Australia.
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. LEGAL PROCEEDINGS
The Company is a defendant in a lawsuit filed in June 1996 by Sherwood
Medical Company ("Sherwood") against IVAC. The lawsuit, which is pending in
the United States District Court for the Southern District of California,
alleges infringement of two Sherwood patents by reason of certain activities
including the sale by IVAC of disposable probe covers for use with infrared
tympanic thermometers. The lawsuit seeks injunctive relief, treble damages
and the recovery of costs and attorney fees. The discovery phase of the
lawsuit has recently commenced. The Company is currently unable to quantify
its exposure in the lawsuit. The Company believes it has sufficient defenses
to all claims by Sherwood, including the defenses of noninfringement and
invalidity. However, there can be no assurance that the Company will
successfully defend all claims made by Sherwood and the failure of the
Company to successfully prevail in this lawsuit could have a material adverse
effect on the Company's operations, business and financial condition.
The Company is a defendant in a qui tam lawsuit filed by a former IMED
employee in the United States District Court for the Northern District of
Illinois. On November 15, 1996, an amended complaint was filed which alleges
fraud in the inducement, breach of employment contract, common law fraud and
violations of the Federal False Claims Act and Medicare Fraud and Abuse Act.
To date, the United States has declined to intervene in this action. The
Company believes it has sufficient defenses to all claims by the plaintiff.
However, there can be no assurance that the Company will successfully defend
all claims made in this lawsuit and the failure of the Company to prevail in
this lawsuit could have a material adverse effect on the Company's
operations, financial condition and cash flows.
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 operations, business or financial
condition. The Company maintains insurance coverage against claims in an
amount which it believes to be adequate.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
22
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCK-HOLDER
MATTERS
ALARIS Medical Systems is a wholly-owned subsidiary of ALARIS Medical.
There is no established public trading market for ALARIS Medical Systems'
common stock. In addition, the Company's 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."
23
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical consolidated financial data of ALARIS
Medical Systems at December 31, 1993, 1994, 1995, 1996 and 1997, and for the
years then ended, have been derived from ALARIS Medical Systems' annual
financial statements including the consolidated balance sheet at December 31,
1996 and 1997 and the related consolidated statement of operations for the
three-year period ended December 31, 1997 and notes thereto which appear
elsewhere herein.
Year Ended December 31,
-----------------------------------------------------
1993 1994 1995 1996 1997
--------- ---------- --------- -------- --------
(Dollar amounts in thousands)
Statement of Operations Data:
Sales.............................. $ 119,858 $ 112,122 $ 112,551 $ 136,371 $ 359,077
Cost of sales...................... 72,197 65,641 63,270 78,642 188,340
--------- --------- --------- --------- ---------
Gross margin....................... 47,661 46,481 49,281 57,729 170,737
Selling and marketing expense...... 18,882 16,850 16,567 22,273 65,797
General and administrative expense. 10,409 8,726 8,893 13,434 37,510
Research and development expense... 8,630 6,345 7,386 8,854 16,876
Purchased in-process research
and development (1)............... - - - 44,000 -
Restructuring, integration, and
other non-recurring charges (1)... 8,442 - - 15,277 19,767
--------- --------- --------- --------- ---------
Total operating expenses (1)....... (46,363) (31,921) (32,846) (103,838) (139,950)
Lease interest income (2).......... 2,627 2,449 2,333 2,501 4,559
--------- --------- --------- --------- ---------
Income (loss) from operations...... 3,925 17,009 18,768 (43,608) 35,346
Interest income.................... 33 12 28 184 433
Interest expense................... (4,159) (2,805) (2,052) (6,303) (43,123)
Other (expense) income, net........ (176) (261) (379) 323 (1,584)
--------- --------- --------- --------- ---------
(Loss) income before income taxes
and cumulative effect of change
in accounting principle........... (377) 13,955 16,365 (49,404) (8,928)
Provision (benefit) for income
taxes............................. 1,863 8,310 8,099 1,270 (1,900)
(Loss) income before cumulative
effect of change in accounting
principle......................... (2,240) 5,645 8,266 (50,674) (7,028)
Cumulative effect of change in
accounting principle (3).......... 768 - - - -
--------- --------- --------- --------- ---------
Net (loss) income.................. $ (1,472) $ 5,645 $ 8,266 $ (50,674) $(7,028)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
24
Year Ended December 31,
-----------------------------------------------------
1993 1994 1995 1996 1997
--------- ---------- --------- -------- --------
(in thousands)
Balance Sheet Data:
Cash............................... $ 981 $ 1,124 $ 436 $ 9,148 $ 6,918
Working (deficit) capital.......... (310) 30,189 25,753 84,469 85,084
Total assets....................... 130,602 122,983 122,597 586,141 563,106
Short-term debt (4)................ 16,690 - - - 14,559
Long-term debt (4)................. 19,017 19,647 11,353 423,941 415,419
Stockholder's equity............... 28,514 32,929 32,477 50,021 38,947
Adjusted EBITDA (5)................... $ 20,720 $ 23,715 $ 25,310 $ 29,023 $ 90,948
Inventory purchase price
allocation adjustment (6).......... - - - (4,014) (1,607)
Restructuring, integration and
other non-recurring charges........ (8,442) - - (15,277) (19,767)
Purchased in-process research
and development.................... - - - (44,000) -
Depreciation and amortization (7)..... (8,353) (6,706) (6,542) (9,340) (34,228)
Interest income....................... 33 12 28 184 433
Interest expense...................... (4,159) (2,805) (2,052) (6,303) (43,123)
Other, net............................ (176) (261) (379) 323 (1,584)
(Provision) benefit for income taxes.. (1,863) (8,310) (8,099) (1,270) 1,900
Cumulative effect of change in
accounting principle............... 768 - - - -
--------- ---------- --------- -------- --------
Net (loss) income..................... $ (1,472) $ 5,645 $ 8,266 $(50,674) $ (7,028)
--------- ---------- --------- -------- --------
--------- ---------- --------- -------- --------
________________________________
(1) In 1993 and 1996 ALARIS Medical Systems restructured its operations.
During 1997, the Company incurred significant non-recurring integration
and other non-recurring expense resulting from the Merger. Operating
expenses for the years ended December 31, 1993, 1996 and 1997 include
restructuring, integration and other non-recurring charges of $8,442,
$15,277 and $19,767, respectively. Additionally, in 1996, the Company
recorded $44,000 of purchased in-process research and development in
connection with the Merger.
(2) 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.
(3) Reflects the adoption on January 1, 1993 of Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes."
(4) In connection with the Merger, the Company entered into a $250,000
credit facility and also issued $200,000 of 9 3/4% senior subordinated
notes due 2006.
(5) Adjusted EBITDA represents income from operations before restructuring,
integration and other non-recurring charges, non-cash purchase accounting
charges and depreciation and amortization. Adjusted EBITDA does not
represent net income or cash flows from operations, as these terms are
defined under generally accepted accounting principles, and should not be
considered as an alternative to net income as an indicator of the
Company's operating performance or to cash flows as a measure of
liquidity. ALARIS Medical Systems has included information concerning
Adjusted EBITDA herein because it understands that such information is
used by certain investors as one measure of an issuer's historical
ability to service debt. Restructuring and other one-time non-recurring
charges are excluded from Adjusted EBITDA as ALARIS Medical Systems
believes that the inclusion of these items would not be helpful to an
investor's understanding of ALARIS Medical Systems' ability to service
debt. ALARIS Medical Systems' computation of Adjusted EBITDA may not
be comparable to similar titled measures of other companies.
25
(6) Amount represents that portion of the purchase accounting adjustments
made to adjust the acquired IVAC inventory to its estimated fair value
on the Merger date which was charged to cost of sales during December 1996
and the first quarter of 1997.
(7) Depreciation and amortization excludes amortization of debt discount and
issuance costs included in interest expense of $314, $263, $248, $1,113
and $3,012 for the years ended December 31, 1993, 1994, 1995, 1996 and
1997, respectively.
26
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 Systems, Inc. and the related notes
thereto included elsewhere in this Annual Report.
Overview
As a result of the Merger on November 26, 1996, the operating results
reported for the year ended December 31, 1997 are not comparable to 1995 or
1996. The 1995 operating results and cash flows represent those of IMED. The
1996 operating results and cash flows include those of IVAC from November 27,
1996 through December 31, 1996.
The Company sells and services infusion systems primarily in the United
States, Western Europe, Canada, Australia, Latin America and the Middle East.
The Company generates revenues from the sale and/or lease of infusion pumps
and sales of associated proprietary disposable administration sets.
Additionally, as a result of the Merger, the Company now generates revenue
from the sale of patient monitoring products.
In recent years, the Company's results of operations have been affected
by the cost containment pressures applicable to health care providers. In
particular, in order to reduce costs, certain hospitals have adopted a
protocol increasing the maximum time between disposable administration set
changes from every 24 hours to as much as every 72 hours. Notwithstanding
this change in protocol, unit sales volume of the Company's disposable
administration sets increased in every year since 1993, primarily as a result
of the growth in its installed base of infusion pumps. However, uncertainty
remains with regard to future changes within the healthcare industry. The
trend towards managed care and economically motivated buyers in the U.S. may
result in continued pressure on selling prices of products and compression on
gross margins. The U.S. marketplace is increasingly characterized by
consolidation among healthcare providers and purchasers of medical products.
The Company's profitability is affected by the increasing use of Group
Purchasing Organizations ("GPOs") which are better able to negotiate
favorable pricing from providers of infusion systems, such as the Company,
and which police compliance with exclusive buying arrangements for their
members. These buying arrangements, in certain situations, also may result in
the GPO requiring removal of the Company's existing infusion pumps. The
Company expects that such GPOs will become increasingly more common and may
have an adverse effect on the Company's future profitability. Finally, the
enactment of national health care reform or other legislation affecting
payment mechanisms and health care delivery would affect the Company's future
results of operations. Although the final form of any such legislation is not
known, it is likely that any such legislation may impose limits on the number
and type of medical procedures which may be performed and may restrict a
provider's ability to select specific devices or products for use in
administering care which, in turn, could adversely impact demand and/or
pricing for the Company's infusion systems. It is impossible to predict the
extent to which the Company may be affected by any such change in legislation.
27
Results of Operations
The following table sets forth, for the periods indicated, selected
financial information expressed as a percentage of sales, as well as pro
forma year ended 1996 operating results in thousands of dollars. The pro
forma data is based on the historical operating results of ALARIS Medical
Systems, adjusted to give effect to the Merger as if it occurred on January
1, 1996. The data excludes non-recurring charges related to the Merger, as
well as the operating results of River Medical, Inc., a subsidiary of IVAC
which was divested prior to the consummation of the Merger.
The pro forma financial data is not necessarily indicative of the
Company's results of operations that might have occurred had such
transactions been completed at the beginning of the period specified, and do
not purport to represent what the Company's consolidated results of
operations might be for any future period.
Year Ended December 31,
-----------------------------------------------------------
As reported As reported Pro forma Pro forma As reported
1995 1996 1996 1996 1997
----------- ----------- --------- --------- -----------
(% of sales) (% of sales) (in thousands) (% of sales)
Sales.............................. 100.0% 100.0% $346,348 100.0% 100%
Cost of sales...................... 56.2 57.7 184,768 53.3 52.5
----- ----- -------- ----- -----
Gross margin....................... 43.8 42.3 161,580 46.7 47.5
Selling and marketing expenses..... 14.7 16.3 65,385 18.9 18.3
General and administrative
expenses.......................... 7.9 9.8 38,215 11.0 10.4
Research and development expenses.. 6.6 6.5 18,142 5.2 4.7
Purchased in-process research and
development....................... - 32.3 - - -
Restructuring, integration and other
non-recurring charges............. - 11.2 - - 5.5
Lease interest income.............. 2.1 1.8 4,601 1.2 1.2
----- ----- -------- ----- -----
Income (loss) from operations...... 16.7 (32.0) 44,439 12.8 9.8
Interest income.................... - .1 233 .1 .1
Interest expense................... (1.8) (4.6) (40,384) (11.6) (12.0)
Other, net......................... (.4) .3 110 - (.4)
----- ----- -------- ----- -----
Income (loss) before income taxes.. 14.5 (36.2) 4,398 1.3 (2.5)
Provision for (benefit from)
income taxes...................... 7.2 .9 4,100 1.2 (.5)
----- ----- -------- ----- -----
Net income (loss).................. 7.3% (37.1%) $ 298 .1% (2.0%)
----- ----- -------- ----- -----
----- ----- -------- ----- -----
Other Data:
Adjusted EBITDA................. 22.5% 21.3% $ 77,675 22.4% 25.3%
28
The following table summarizes sales to customers located in the United
States and international locations:
Year ended December 31,
---------------------------------------------------
As reported As reported Pro forma As reported
1995 1996 1996 1997
----------- ----------- --------- -----------
(in millions)
U.S. sales........................... $ 92.2 $ 100.2 $ 224.6 $ 227.0
International sales.................. 20.4 36.2 121.7 132.1
------- ------- ------- -------
Total sales....................... $ 112.6 $ 136.4 $ 346.3 $ 359.1
------- ------- ------- -------
------- ------- ------- -------
Year ended December 31, 1997 Compared to Year Ended December 31, 1996
Sales. Sales increased $222.7 million during 1997 as compared to 1996
due to the Merger. On a pro forma basis, sales increased $12.7 million, or
3.7%, during 1997 as compared to 1996. United States sales increased $2.4
million, or 1.1%, on a pro forma basis while international sales increased
$10.4 million, or 8.5%, on a pro forma basis. The increase in international
sales is primarily due to an increase in volume of drug infusion instruments
and disposable administration sets as well as the August 1996 repurchase of
IMED product European distribution rights from Pharmacia & Upjohn, Inc. which
has resulted in higher average selling prices for these products in 1997. The
majority of the Company's international sales are denominated in foreign
currency. Due to a stronger U.S. dollar in 1997 as compared to the actual
foreign currency exchange rates in effect during 1996, translation of 1997
international sales were adversely impacted by $7.1 million. The increase in
U.S. sales in 1997 as compared to 1996, on a pro forma basis, is primarily
due to an increase in drug infusion disposable administration set revenue.
Such increase is due to an increase in volume of the Company's SmartSite
Needle-Free System administration sets.
Gross Margin. The gross margin percentage increased from 42.3% in 1996
to 47.5% in 1997 primarily due to supplier price concessions resulting from
the Merger and favorable international margins due in part to the repurchase
of European distribution rights from Pharmacia & Upjohn, Inc. These were
partially offset by increased amortization expense resulting from the IVAC
purchase price allocated to certain intangible assets, $1.6 million of
non-recurring purchase accounting inventory adjustments, as well as $2.5
million related to a voluntary field correction of certain Gemini PC-1 and
PC-2 infusion pumps charged to cost of sales during 1997. The pro forma gross
margin percentage for 1996 was 46.7% compared to 48.7% for 1997, exclusive of
the purchase accounting inventory adjustment and product field correction
charges.
Selling and Marketing Expense. Selling and marketing expense increased
$43.5 million during 1997 primarily due to the Merger. On a pro forma basis,
selling and marketing expense increased approximately $0.4 million, or 0.6%,
during 1997. As a percentage of sales, on a pro forma basis, selling and
marketing expense decreased from 18.9% in 1996 to 18.3% in 1997. Domestic
expense decreased by $2.3 million, or 5.6%, from 1996 due to Merger-related
synergies. The decrease in domestic selling and marketing expense was more
than offset by increased international expenses of $2.7 million, or 10.9%,
due to increased international sales and associated increase in European
direct operations.
General and Administrative Expense. General and administrative expense
increased $24.1 million during 1997 primarily due to the Merger. On a pro
forma basis, general and administrative expense decreased by $0.7 million, or
1.8%, during 1997. As a percentage of sales, on a pro forma basis, general
and administrative expense decreased from 11.0% for 1996 to 10.4% for 1997
due to an increase in sales, as well as Merger-related synergies, including
lower labor and facilities expenses. International expenses increased by $0.6
million, or 9.1% as a result of an increase in the investment in direct
operations in Europe.
29
Research and Development Expense. Research and development expense
increased approximately $8.0 million during 1997 primarily due to the Merger.
On a pro forma basis, research and development expense decreased from $18.1
million, or 5.2% of sales, for 1996 to $16.9 million, or 4.7% of sales for
1997, primarily due to synergies realized in the Merger and realignment and
prioritization of research and development projects.
Purchased In-process Research and Development. In connection with the
Merger, the assets and liabilities of IVAC were adjusted to their estimated
fair values. As a result of this process, the Company incurred a one-time
$44.0 million write-off during 1996 related to the value assigned to the
acquired in-process research and development of IVAC projects for which
technological feasibility had not been established and for which there was no
alternative future use. Such amount was determined with the assistance of a
third party appraiser based upon the present value of estimated future cash
flow contributions from the identified projects. The Company has continued to
invest in the development necessary to obtain technological feasibility of
these projects. The project, which represents the most significant portion of
the acquired in-process research and development charge, is an improved cost
effective and technologically advanced electronic thermometer.
Restructuring, Integration and Other Non-recurring Charges. The Company
incurred $19.8 million in integration costs and other non-recurring expense
during 1997. These costs are in addition to restructuring and integration
charges of $15.3 million recorded in the fourth quarter of 1996. The 1997
expense consists primarily of information systems conversion costs of $4.8
million, the write-off of a product distribution and license agreement with a
third party developer of an ambulatory and alternate site infusion pump of
$4.5 million, maquiladora contract dispute settlement and related costs of
$4.1 million (see Note 10 to the Consolidated Financial Statements), the
write-off of drug infusion instrument tooling associated with the redesign
effort on a product in development of $1.7 million, facilities moving
expenses and Company name change costs of $1.6 million, management consulting
fees of $1.4 million, severance of $.2 million and other integration costs of
$1.5 million. The Company has reviewed its products and related research and
development activities and market opportunities in order to focus on projects
that will provide greater competitive advantage and stockholder return. That
review resulted in the termination of the aforesaid product distribution and
license agreement. The $4.5 million charge related to such termination
includes a $4.3 million non-cash charge representing the intangible asset
that had been recorded associated with such agreement.
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 $2.1 million or 82.3% for 1997 as compared to 1996
primarily due to the Merger. On a pro forma basis, lease interest income
decreased approximately 0.9% from 1996 to 1997.
Income (Loss) from Operations. Income from operations increased $79.0
million during 1997 primarily due to the 1996 operating results including
significant non-recurring purchase accounting charges. Additionally, due to
the Merger being completed on November 26, 1996, the 1996 operating results
include only one month of operating profit from the acquired business while
1997 includes a full year of profit contribution. This increase was partially
offset by expenses related to the field correction on the Gemini pumps in the
first quarter and the maquiladora business interruption in the second
quarter. On a pro forma basis, operating income decreased $9.1 million from
$44.4 million in 1996 to $35.3 million in 1997 primarily due to the $19.8
million of integration costs discussed above, offset by a $9.2 million
improvement in gross profit.
Adjusted EBITDA. Adjusted EBITDA increased $61.9 million during 1997
primarily due to the Merger. On a pro forma basis, as a percentage of sales,
Adjusted EBITDA increased from 22.4%, or $77.7 million, for 1996 to 25.3%, or
$90.9 million, for 1997 due to the reasons discussed above. Excluding the
$2.5 million charge to cost of sales during the first quarter of 1997,
Adjusted EBITDA would have increased to $93.4 million, an increase of $15.8
million or approximately 20.3%, as compared to pro forma 1996. Adjusted
EBITDA represents income from operations before non-recurring non-cash
purchase accounting charges, restructuring charges, integration charges and
depreciation and amortization. Adjusted EBITDA does not represent net income
or cash flows from operations, as these terms are defined under generally
accepted accounting principles, and should not be considered as an
alternative to net income or to cash flows as an indicator of the Company's
operating performance or to cash flows as a measure of liquidity. The Company
has included information concerning Adjusted EBITDA herein because it
understands that such information is used by investors as a measure of an
issuer's historical ability to service debt. Restructuring 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.
30
Interest Expense. Interest expense increased $36.8 million during 1997
primarily due to the Merger. In addition to interest on approximately $404.0
million of borrowings to finance the Merger and related debt refinancings,
higher interest expense was incurred in 1997 due to IMED's $11.0 million
purchase of the European distribution rights for IMED products in August
1996. This increase in interest expense was offset by reductions in interest
on $37.5 million of ALARIS Medical convertible debt which was converted to
common stock in connection with the Merger, as well as the redemption