**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-K**

** **
| **(Mark One)** |
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|           |
| **ý**     | **Annual Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934.** |
|           |   |
|           | **For  the fiscal year ended December 31, 2002 or** |
|           |   |
| **o**          | **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.**

(Exactname of registrant as specified in its charter)

** **

| **Delaware**                                                                |   | **13-3800335**                           |
|-----------------------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)            |   | (I.R.S. Employer  Identification Number) |
|                                                                        |   |                                     |
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| **10221 Wateridge Circle, San Diego,  California**                          |   | **92121**                                |
| (Address of principal  executive offices)                                   |   | (Zip Code)                               |
|                                                                        |   |                                     |
| Registrant’s telephone  number, including area code **(858) 458-7000** |
|                                                                        |   |                                     |

 

Securities registeredpursuant to Section 12(b) of the Act:

**None**

Securities registeredpursuant to Section 12(g) of the Act:

**None**

 

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Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months, and (2) has been subject to such filingrequirements for the past 90 days.  YES:  ý  NO:  o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 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 informationstatements incorporated by reference in Part III of this Form 10-K or any amendmentto this Form 10-K.  ý

 

No common stock is held by nonaffiliates of the registrant.

 

The registrant is an accelerated filer (as defined in Rule 12b-2 of theAct). Yeso  Noý

 

As of February 28, 2003,the registrant had 100 shares of Common Stock outstanding.

 

**Documents Incorporated By Reference**

 

Portions of ALARIS Medical, Inc.’s Proxy Statement for the AnnualMeeting of Stockholders to be held on April 30, 2003(“Proxy Statement”), are incorporated by reference as described in Part III.

 

 

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**FORWARD-LOOKING STATEMENTS**

 

Certainof the matters discussed in this report, including, without limitation, mattersdiscussed under Item 1, “Business” and Item 7, “Management’s Discussion and Analysis of Financial Condition andResults of Operations,”may constitute forward–looking statements within the meaning of Section21E of the Securities Exchange Act of 1934, as amended.  Certain of these forward–lookingstatements can be identified by the use of forward–looking terminologysuch as “believes,”“expects,”“may,”“will,”“should,”“seeks,”“approximately,”“intends,”“plans,”“estimates,” or “anticipates” or the negative of these terms or other comparableterminology, or by discussions of strategy, plans or intentions.  Statements contained in this report that arenot historical facts are forward-looking statements.  Without limiting the generality of the preceding statement, allstatements in this report concerning or relating to estimated and projectedearnings, margins, costs, expenditures, cash flows, growth rates and financialresults are forward-looking statements. In addition, through our senior management, from time to time we makeforward-looking statements concerning our expected future operations andperformance and other developments. Such forward-looking statements are necessarily estimates reflecting ourbest judgment based upon current information and involve a number of risks anduncertainties.  Other factors may affectthe accuracy of these forward–looking statements and our actual resultsmay differ materially from the results anticipated in these forward–lookingstatements.  While it is impossible toidentify all such factors, factors that could cause actual results to differmaterially from those estimated by us include, but are not limited to, thosefactors or conditions described under Item 7: “Management’s Discussion and Analysis of Financial Condition andResults of Operations—CriticalAccounting Policies and Estimates” and “Factors That Could Affect Future Financial Condition andResults,” and generalconditions in the economy and capital markets.

 

 

 

We have registered,applied to register or are using the following trademarks referred to in thisdocument: AccuSlideâ, ALARISâ,ALARIS Medical Systemsâ, AsenaTM,CORE·CHECKâ, Flo-Stopâ, Geminiâ,Gemini PC-1â, Gemini PC-2â,Gemini PC-2TXâ, Gemini PC-4â,Guardrails®, IMEDâ, IVACâ,Medication Safety at the Point of CareTM, MedleyTM,MedSystem IIIâ, Patient Solutions, Inc.â,PCAMâ, ReadyMEDâ,Signature Editionâ, SmartSiteâ,SmartSiteâ Plus,   TURBO·TEMP®, VersaSafeâand VITAL·CHECKâ.

 

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**PART I**

 

**ITEM 1.  BUSINESS**

 

**Background**

 

ALARIS Medical Systems,Inc. (“ALARIS Medical Systems” or “ALARIS”) was formed by the merger of twopioneers in infusion systems, IMED Corporation (then an ALARIS Medical, Inc.subsidiary) and IVAC Medical Systems, Inc. on November 26, 1996. ALARIS Medical Systems, a wholly-owned subsidiary ofALARIS Medical, Inc. (“ALARIS Medical” or “Holdings”), formerly AdvancedMedical, Inc., was incorporated on October 14, 1994 under the laws of the Stateof Delaware.  ALARIS Medical Systems and itssubsidiaries are collectively referred to as the “Company”, “we”, “our” and“us.”

 

**Overview**

 

We develop and provide practical solutions for Medication Safety at the Point of Care*.*  We design, manufacture and marketintravenous (IV) medication delivery and infusion therapy devices, needle-freedisposables and related monitoring equipment in the United States andinternationally.  Our proprietaryGuardrails safety software, our other “smart” technologies and our “smart”services help to reduce the risks and costs of medication errors, help tosafeguard patients and clinicians and also gather and record clinicalinformation for review, analysis and transcription.  Our intravenous infusion systems are used to deliver to patientsone or more fluids, primarily pharmaceuticals or nutritionals, and consist ofmedication safety systems, single and multi–channel large volume infusionpumps, syringe pumps and dedicated and non-dedicated disposable administrationsets.

 

We have oneof the largest installed bases of large volume pump delivery lines in theUnited States hospital market, representing approximately 32% of such installedlines.  We also believe that we have thenumber one or number two market position in the large volume pump segment orthe syringe pump segment, or both segments, in Belgium, France, Italy, TheNetherlands, Norway, Spain, Sweden, the United Kingdom, Australia, Canada, NewZealand and South Africa.  In addition,we are a leading provider of patient monitoring products that measure andmonitor temperature, with a substantial installed base of hospital thermometrysystems in the United States.  We alsoprovide products which measure and monitor pulse, pulse oximetry and bloodpressure.  We sell our productsprimarily to the hospital market through a worldwide direct sales force of over200 salespersons and more than 100 distributors to over 5,000 hospitals in morethan 120 countries worldwide.  For theyear ended December 31, 2002, we had total sales of $460.3 million and netincome of $20.4 million.

 

Ourintravenous infusion systems require the use of disposable administration sets,which represent a significant portion of our sales.  For the year ended December 31, 2002, we sold 112.4 milliondisposable administration sets, representing sales of $281.0 million, or61.1% of total sales.  In North America,each of our current large volume infusion pumps uses only dedicated disposableadministration sets, which consist of plastic tubing and pump interfaces,designed and manufactured by or for us for that particular pump.

 

We generate arecurring revenue stream from sales of our higher margin, dedicated, as well asnon-dedicated, disposable administration sets and components to customers usingour systems.  Many of our disposableadministration sets feature our proprietary SmartSite Needle-Free System, whichis designed to reduce caregiver risks associated with accidental needlesticks.

 

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We operatethrough two geographical business units:

 

•                         Our North American business unitdevelops, manufactures and provides medication safety systems, infusion therapydevices, patient vital signs monitoring products and related disposables,primarily using a direct sales force for product distribution.  Sales to North American customers generated$317.7 million (69.0% of total sales) and $40.2 million of Incomefrom Operations (55.0% of total Income from Operations) for the year endedDecember 31, 2002.

 

•                         Our Internationalbusiness unit develops, manufactures and provides infusion therapy devices,patient vital signs monitoringproducts and related disposables in Europe, Asia, the Middle East, Australia,New Zealand, South Africa and Latin America using both a direct sales force andproduct distributors in areas where we do not have a direct sales force.  Sales to distributors accounted for 16.8% ofInternational sales in 2002.  Sales toInternational customers generated $142.6 million (31.0% of total sales)and $32.9 million of Income from Operations (45.0% of total Income from Operations) for the year ended December 31, 2002.

 

**Our Industry**

 

Infusiontherapy generally involves the delivery of one or more fluids, primarilypharmaceuticals or nutritionals, to a patient through an infusion line insertedinto the circulatory system.  Infusionsystems are differentiated based on a number of characteristics including size,weight, number of delivery channels, programmability, and mechanism ofinfusion, cost and equipment service. Recently, embedded software that helps prevent medication errors hasbecome a significantdifferentiating feature.

 

The infusionsystems sold in the markets in which we compete consist of single and multi–channelinfusion pumps and disposable administration sets.  Large volume pumps are volumetric devices that regulate flow byelectronically measuring a specific volume of a fluid.  These pumps administer precise,volumetrically measured quantities of fluids over a wide range of infusionrates by using positive pressure to overcome the resistance of the infusiontubing and the back pressure generated by the patient’s circulatory system.  Syringe pumps operate by graduallydepressing the plunger on a standard disposable syringe, thereby delivering amore concentrated dose of medication at a very precise rate of accuracy.  Disposable pumps are single use productsdesigned for use primarily in alternate-site settings.  Disposable administration sets act as theinterface between the pump and the patient. They consist of plastic tubing and pump interfaces and are eitherdedicated (designed and manufactured for use only with a particular pump) ornon-dedicated (usable with various pumps of one or more manufacturers), or forIV procedures when pumps are not used.

 

The totaladdressable worldwide infusion therapy market is estimated to exceed$1 billion annually, approximately $600 million of which representsthe current U.S. market.  The U.S.hospital market consists of over 5,000 hospitals with a total of over 950,000beds.  Within this market, costcontainment measures imposed and proposed by federal and state regulators andprivate payers, combined with increased utilization review and case management,have led to greater financial pressure on hospitals.  In response to these cost-containment pressures, most hospitalsin the United States participate in group purchasing organizations (GPOs).  GPOs typically enter into exclusive purchasecommitments with one or two providers of infusion systems and/or patientmonitoring products for a three to seven year term.  We have long-term contracts with most major GPOs in the UnitedStates.  In addition, we have long-termsupply contracts with the U.S. Federal government and other U.S. governmentalentities.  Nearly 80% of our U.S. salesare covered by such GPO and government contracts.  The existence of GPOs limits the pricing flexibility of manufacturersof medical products, including ALARIS.

 

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Thealternate-site market encompasses all healthcare provided outside the hospitaland comprises primarily home healthcare, freestanding clinics, skilled nursingfacilities and long-term care facilities. Growth in this market is primarily attributable to advances intechnology that have facilitated the provision of care outside of the hospital,an increased number of illnesses and diseases considered to be treatable withhome infusion therapy and increased acceptance by the medical community of, andpatient preference for, non-hospital treatment.

 

TheInternational infusion systems market is much more regionalized and fragmentedthan the U.S. market.  We believe thatthe International infusion therapy market, which includes infusion pumps,controllers and disposable intravenous sets, is in excess of $500 millionannually.  Unlike the U.S. market,syringe pumps represent a significant share of total infusion pump placementsin the International market.  We expectthe trend toward utilization of syringe pumps to continue internationally ashospitals favor the use of syringe pumps for administering pharmaceuticals andnutritionals to patients in higher concentrations and the associated lowercost.  The majority of revenues in theInternational market are derived from hospitals, while the alternate-sitemarket is in a developmental stage.

 

Over the pastseveral years, the healthcare community, particularly in the U.S., hasincreasingly focused on patient and caregiver safety involving intravenoustherapy and use of needles in hospitals. Since the release of the Institute of Medicine Report in 1999 statingthat more than 50,000 people die annually in the United States from medicalerrors, there has been a growing emphasis on preventing errors in the delivery of healthcare.  A large percentage of the most costlymedical errors in the United States are medication errors related to powerfuldrugs that are delivered, or infused, directly into a patient’s vein. A study published in 2002 in the Archives of Internal Medicine entitled,“Medication ErrorsObserved in 36 Health Care Facilities,” found that medication errors occur in nearly 1 of every 5doses given to patients in the typical U.S. hospital.

 

As treatment regimens have become more complex and asthe critically ill constitute an increasing percentage of hospital patients,the average hospital patient now requires a greater number of intravenous linesand more potent therapeutics, thereby creating a greater need fortechnologically–advanced infusion systems.  As the reliance on intravenous therapy and the potency of thedrugs administered have increased in recent years, the need for preciseadministration and monitoring of intravenous fluids has risen significantly andthe incidence of costly intravenous medication errors has become a significantconcern.  According to a 1995 *Journalof American Medical Association* article, 51.4% of hospitalmedication errors are administration errors. In addition, research by David M. Bates, M.D. of Brigham and Women’sHospital in Boston, Massachusetts, has shown that a significant portion ofpreventable hospital medication errors that cause harm are associated withintravenous administration of drugs.

 

Reducingerrors at the point of administration is the most immediately available,cost-effective solution to reducing harm from medication errors.  We have pioneered the first and mostcomprehensive solution to dramatically reduce IV medication errors with ourproprietary IV-infusion safety net, the Guardrails safety software.  The Guardrails safety software helps protectpatients from infusion programming errors by allowing hospitals to configurecare-specific profiles with pre-defined drug dose limits and other parametersto meet the particular needs of multiple patient care areas within thehospital.

 

In additionto concerns about intravenous medication errors, there is increasing pressureby regulatory agencies in the United States, such as the Occupational Safetyand Health Administration, or OSHA, and the United States Food and DrugAdministration, or FDA, as well as some states, for more stringent control ofneedles in hospitals to reduce the risk to healthcare workers and patientsassociated with the transmission of blood–borne diseases.  OSHA requires hospitals to put in placesystems to reduce the potential for accidental needlesticks and the FDArecommends using needle-free systems or protected needle systems to replacehypodermic needles for accessing intravenous lines.  Health care workers suffer from an estimated 590,000 needlestickinjuries each year resulting in 35 U.S. workers per

 

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year contracting HIV and an additional2,400 infected with the hepatitis B and C annually.  Federal OSHA data suggests the cost of needlestick treatment tobe $1.3 billion to $2.3 billion, according to the Service EmployeesInternational Union (1998).

 

The U.S. “Needlestick Safety and Prevention Act” is intended to increase protection forhealth care workers against needlestick injuries by requiring that health carefacilities implement the use of “safer medical devices” to minimize accidental needlesticks.  The legislation requires that frontlineworkers be involved in the evaluation, selection and implementation of new safetydevices.  Our SmartSite Needle-FreeSystem has a proven track record among clinicians and health care workers, withover 1,330 acute care hospitals nationwide utilizing the SmartSite Needle-Freetechnology, which helps protect against risks associated with accidentalneedlesticks.  We also offerdisposable administration sets with safety features designed to prevent theunregulated flow of fluids into a patient’s blood stream.

 

Patientmonitoring instruments are used to measure temperature, pulse, blood pressure,and other vital signs.  Instruments soldin this market have varying levels of technological sophistication and are usedin a variety of diagnostic and healthcare settings.  Ourpatient monitoring products compete in discrete market niches, each withdifferent competitive dynamics.  Weoperate primarily in two patient monitoring products markets:hospital thermometry systems and stand–alone,non-invasive,multi–parameterinstruments.

 

**Products and Services**

 

We manufacture and market medication safety systems, singleand multi-channel infusion pumps and dedicated and non-dedicated disposableadministration sets, many of which feature our proprietary SmartSiteNeedle-Free System, for use with infusion applications.  Our Medley Medication Safety System, withits proprietary Guardrails safety software, represents the next generation of “smart” medication safety technology at thepoint of care.  This system permitsintegration of administration, monitoring and clinical best practice guidelinesfrom a single platform.  Our infusionpumps include large volume infusion pumps such as the Gemini series, SignatureEdition Family, MedSystem III, Asena GW, and syringe infusion pumps such asP1000, P3000, PCAM, P6000, P7000 and Asena GS, GH and CC, which are soldprimarily in Western Europe, and disposable pumps such as the ReadyMED for usein the alternate-site setting.  Ourlarge volume infusion pumps usually require the use of higher margin dedicateddisposable administration sets.  We alsosell non-dedicated disposable administration sets, including several needlelessdevices, for use in many infusion applications.  We also manufacture and market hospital thermometry instrumentsand related disposable probe covers, and stand-alone, non-invasive,multi-parameter instruments which measure and monitor a combination oftemperature, pulse and blood pressure and other vital signs.  Aside from our extensive range of medicationsafety and IV pump products and systems, we offer a comprehensive group ofvalue—added servicesand programs, including hardware and software technical services, clinicaleducation, implementation services, pharmacy facilitation of databasedevelopment and software maintenance programs.

 

## **ALARISInfusion Systems**

 

Weoffer a wide variety of infusion systems designed to meet the varying price andtechnological requirements of our diverse worldwide customer base.  For the year ended December 31, 2002, ourinfusion systems sales (pumps, software licenses and disposable administrationsets) were $404.9 million, representing 88.0% of total sales.  Of this amount, infusion pumps (includingrelated software licenses) and disposables accounted for $123.9 millionand $281.0 million of total sales during that period, respectively.  Disposable administration sets for 2002 forthe North America and International business units were $197.3 million and$83.7 million, respectively.

 

Our infusion systems include thefollowing:

 

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**The Medley Medication Safety System, acomputer at the point of care.**  Several years ago,we and our customers identified the need for an integrated technology platformthat could redefine the accuracy and safety of drug infusion instruments, whilesimultaneously improving documentation and capital asset utilization.  We responded with the Medley System, thefirst patient care system of its kind approved for use in the UnitedStates.  The Medley System is a modular medicaltechnology platform that utilizes a point-of-care computer to integrate infusion,patient monitoring and an institution’s clinical best practice guidelines to achieve optimaloutcomes.  We shipped the first MedleySystem in May 2001 and we implemented full market release in January 2002.

 

The MedleySystem offers several key advantages over traditional infusion instruments:

 

•                         *The Guardrails safety software* is designed for the prevention of IVmedication errors.  In effect, theGuardrails safety software provides an automatic safety net for infusionprogramming at the critical point of IV infusion delivery to the patient.  The Guardrails safety software functions inour “smart” intravenous infusion devices as acomputerized “brain” that performs a “test of reasonableness” at programming an IV infusion.  The Guardrails Software alerts the clinicianthat a dose is outside the pre-established dosage limits for that medication,thus helping to prevent a wrong dose from being administered to the patient.

 

•                         *Modular medical technology* gives an institution an expandable,integrated system to improve patient care. The building blocks of the Medley System consist of a Point of Care Unitfor programming, one or more infusion pumps or other modules and relateddedicated disposables.  The first moduleapproved for use with the Medley System was the large volume pump, which can beconfigured, as needed, as a one to four channel infusion device.  Unlike traditional infusion pumps which aresold with a fixed number of channels (one to four), each of the Medley Systemmodules represents a single channel which can be added to other modules toaddress particular needs in a hospital setting.

 

•                         *Advanced programming capabilities* allow product line extension, such asthe Medley Pulse Oximetry Module, which was launched in late 2001, and theMedley Syringe Pump Module, which we plan to introduce in 2003.  We are also in the process of developingdata management functionality and a patient–controlled analgesia (PCA)module.

 

•                         *Improved hospital capital asset utilization* enabling a hospital to add to a MedleyPoint of Care Unit only those modules and number of lines needed for aparticular patient’scare.  Therefore, rather than investingin fixed numbers of single and multi–channel pumps, a hospital canpurchase a number of the Medley System modules which can be used with any ofits Medley Point of Care Units. Additionally, standardized interfaces for multiple modules allow foreasier training of healthcare staff.

 

•                         *The Guardrails Continuous Quality Improvement (CQI) StandardPackage* allows ahospital to access and download the archived Guardrails Alerts from the MedleyPoint of Care Unit.  The resultant datafiles are stored within the Guardrails CQI relational database and providequery and reporting capabilities for the Guardrails safety software.  This PC-based application provides thehospital with a basic standard reporting package that can then be utilized inthe medication administration and quality improvement process to monitor eventsoutside best practice guidelines.

 

With theMedley System, our customers are able to tailor the treatment to the patient,which should reduce the cost of care, improve patient outcomes, assurecompliance with customer–established clinical practice guidelines andpromote “bestpractice” standardsof medical treatment.

 

**Large Volume Pumps.** We sell various single channel and multi–channel large volumeinfusion pumps in North America and other markets where medical practicerequires large amounts of hydration

 

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during infusion therapy.  A single channel pump has only one fluiddelivery line to the patient, while a multi–channel pump has two or morefluid delivery lines.  Our large volumepumps service only a single patient and are used in both the general care andcritical care settings.  We also offerlarge volume pumps for alternate-site and hospital ambulatory use.  Generally, when a patient requires more thanone fluid delivery line, purchasing a multi–channel pump is more costefficient than purchasing an equivalent number of single channel pumps.  A large volume pump module is also availablefor the Medley System.

 

Our selectionof large volume infusion pumps includes:

 

•                         The SignatureEdition Gold Infusion System line, a versatile, user-friendly line of infusionpumps, which includes a single channel and dual channel pump and incorporatesintuitive user interface and advanced software capabilities, is designed foruse primarily in hospitals.  This linecontains the following innovative features: a patented AccuSlide flow regulator, designed to minimize unregulatedflow of fluids into a patient’s blood stream; precisionflow capability, designed to improve flow continuity and minimize hemodynamicchanges; and Advanced Infusion Management (AIM), designed to provide uniqueearly warning assessment tools for enhanced intravenous site management.  Other standard features include aneasy-to-use drug library, which permits dose and/or rate calculation; amulti-step feature, which allows the clinicians to pre-program up to nine stepsfor drug delivery; and a patented “learn–teach” communication link capability for biomedical engineers.

 

In the fourth quarter of 2002, we expanded the market for ourGuardrails safety software by making it available to existing and new customersof the Signature Edition Gold Infusion System. As with our Medley System, the Guardrails safety software provides anautomatic safety net for infusion device programming by concentrating onmedication error-prevention at the critical point of intravenous delivery tothe patient.  Institutions which choosethis option can configure unique care-specific profiles with pre-defined drugdose limits and other delivery parameters to meet the particular needs ofmultiple patient care areas.

 

•                         The Gemini Series, which consists ofsingle, dual and four channel pumps, is based on a flexible hardware andsoftware technology platform and is designed for use in all hospitalsettings.  This technology platform hasenabled us over time to offer incremental feature enhancements based onevolving customer needs.  The Geminiseries currently offers the following features:  the Flo-Stop mechanism which is designed to minimize unregulatedflow of fluids into a patient’s bloodstream; independent channel operation; ability toswitch from pump to controller mode without changing the disposableadministration set; programmability to automatically taper-up and taper-downinfusion 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 withneonatal patients, among others, or macro mode (1 to 999 mL/hr) for use withadult patients; drug dose calculation; pressure monitoring; pressure historyand volume/time dosing; and nuisance alarm (alarms with no clinical significance)reduction.

 

•                         The MedSystem III instrument is acompact, lightweight, programmable, three channel infusion pump used primarilyin the critical care market and patient transport applications.  The MedSystem III device is one of thesmallest, most versatile and most technologically advanced multi–channelpumps currently on the market.

 

•                         The Asena GW instrument is a small,lightweight single channel pump for nutritional and hydration therapy.  It is intended to be used as part of theAsena patient care system and as such can be mounted into the ALARIS DedicatedDocking Station (ALARIS DDS) or the ALARIS Intelligent Docking Station (ALARISIDS).

 

•                         The 570 Series is a single channel pumpused for general and critical care use.

 

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•                         The 597/598 Series is a simple to use,single channel pump with an easy-to-read control panel coupled with a large LEDdisplay.  The 597/598 Series islightweight, compact and robust enough to be used in any patient situation andis frequently used for delivery of nutritional products, for general care andalternate site use.

 

**Syringe Pumps.** We also sell a broad range of syringe infusion pumps which are usedprimarily in neonatal care, oncology, anesthesia and critical care.  Syringe pumps deliver a smaller amount offluid in more concentrated amounts, and are used where medical practice doesnot require large levels of hydration in connection with infusion therapy.  While syringe pumps represent a relativelysmall portion of the industry installed base in the U.S. market, they arewidely used in Western Europe, where they constitute approximately 60% of theinfusion pump market.  Syringe pumps aremore widely used in Western Europe because of the general practice of administeringmedications in smaller volumes of fluid. We believe that we are one of the two largest suppliers of syringe pumpsin Western Europe. We believe we hold a number one or number twoinstalled base market share in eight of the nine western European countries inwhich we sell directly to end customers. In addition, we believe that we have anumber one or number two installed base market share in Australia, Canada, NewZealand and South Africa.

 

Our selectionof syringe pumps includes:

 

•                         The Asena family of syringe pumps, theintroduction of which was begun in the third quarter of 1999, is a family ofcompact, lightweight, high-featured pumps with modular mounting andcommunications capability.  In thefourth quarter of 2001, we introduced the Asena patient care system, whichcombines the ALARIS DDS, the Asena syringe pump and the Asena GW large volumepump.  In 2002, we addedthe ALARIS IDS which adds certain communication capabilities to the ALARIS DDS. The docking stations feature a versatile mounting system, known as amedical device interface, which allows a syringe pump to be mounted to a pole,a Draeger bar, the ALARIS DDS or ALARIS IDS without adapters.

 

•                         The P-Series syringe pumps may be used ina variety of hospital settings, such as neonatal, non-critical care andanesthesia applications.

 

•                         The PCAM pump, an analgesia infusionpump, allows patients to control the delivery of pain medication.  Designed for general care settings, the PCAMsyringe infusion pump is one of the most advanced patient controlled analgesiainfusion pumps on the European market today, with pre-programmed and userprogrammable drug delivery protocols, comprehensive patient history logging andan ergonomically designed handset with status indicator.

 

**Ambulatory Pumps.** We also offer the ReadyMED ambulatory infusion pump for alternate-siteand hospital ambulatory use.  TheReadyMED infusion pump is a compact, lightweight and disposable pump used inthe intravenous administration of antibiotics in the alternate-site market,offering several key advantages over traditional systems.  Traditional systems are gravity driven andrequire a patient to use a small intravenous bag and tubing set that mustremain on an intravenous solution pole during infusion, thereby restricting thepatient’smovement.  In contrast, our ReadyMEDpump uses positive pressure and thereby allows the patient to carry the devicein a pocket or wear it on a belt.  Wesell the ReadyMED pump through our alternate-site sales force and distributionnetwork in the United States.

 

**Disposable Administration Sets andNeedle-Free Access Products.**  Our intravenousinfusion systems require the use of disposable administration sets, whichrepresent a significant portion of our sales. For the year ended December 31, 2002, we sold 112.4 million disposableadministration sets, representing sales of $281.0 million, or 61.1% oftotal sales.  Sales of disposableadministration sets for the year ended December 31, 2002 for the North Americanand International business units were $197.3 million and $83.7

 

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million,respectively.  Withthe exception of certain models of the Asena GW family, all of our currentlarge volume infusion pumps use only dedicated disposable administration sets,designed and manufactured by or for us for that particular pump.  We manufacture and sell dedicated andnon-dedicated disposable administration sets for use with our infusion pumpsystems.  We generate a predictable andrecurring revenue stream from sales of our higher margin, dedicated, as well asnon-dedicated, disposable administration sets and components to customers usingour systems.

 

Ourneedle-free products are designed to permit access to disposable administrationsets without the use of needles.  TheSmartSite Needle-Free System allows health care institutions to comply withthe “Needlestick Safety and Prevention Act,” signed into Federal Law in November2000, and addresses health care workers’ safety concerns by allowing them to access IV lineswithout needles.  Our disposable administration setsutilizing our SmartSite Needle-Free System offer a fully integrated,cost-effective design, which eliminates the need for separate caps andadditional cannula components.  These safetyfeatures help reduce the risk to healthcare providers of accidentalneedlesticks, which can result in the transmission of diseases, such as AIDSand hepatitis C.  Our introduction ofthe SmartSite needle-free system has provided us with an opportunity to competeaggressively in the gravity extension set segment of the market withinnovative, cost-effective, needle-free gravity sets.

 

These safetyfeatures continue to provide our customers with the latest cost-effectivetechnology for our installed base of infusion pumps.  Our needle-free access products have received strong interestfrom customers and provide us with an opportunity for incremental revenues.

 

**ALARIS Patient Monitoring Products**

 

We operateprimarily in two patient monitoring product markets:  hospital thermometry systems and related disposables and standalone, non-invasive, multi–parameter instruments.  These products are widely used in hospitaland alternate-site settings.  For theyear ended December 31, 2002, sales of our patient monitoring instruments and relateddedicated disposables were approximately $31.7 million or 6.9% of totalsales.  Patient monitoring sales forNorth America and International for the year ended December 31, 2002 were $26.2million and $5.5 million, respectively.

 

**Thermometry Systems.** We are a leader in hospital thermometry systems, which consist ofthermometers and disposable probe covers, and maintain a strong market positionin the United States.  Our largeinstalled base of hospital thermometry instruments allows us to generate predictableand recurring revenues from sales of our related dedicated disposable probecovers, which are the only probe covers which can be used with our thermometryinstruments.  For the year endedDecember 31, 2002, we sold over 577 million dedicated disposable probe covers.

 

Our primarythermometry product is the electronic thermometer. Supplementing our TEMP·PLUS II product line, we introduced in 1999 the TURBO·TEMP thermometer, an improved, cost-effective andtechnologically advanced electronic thermometer designed to provide a fastertemperature reading.  We alsomanufacture and market the CORE·CHECK system, a thermometer that measurestemperature by detecting the emission of infrared energy in the ear.

 

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**Other PatientMonitoring Products.**  We also sell stand–alone,non-invasive, multi–parameter patient monitoring products which measure acombination of pulse, pulse–oximetry, temperature and blood pressure.

 

Since 1997, the VITAL·CHECK Vital Signs Monitor series has been marketed in U.S.and Canadian hospitals under a private label agreement with itsmanufacturer.  The VITAL·CHECK 4400 series;marketed in the United States through an exclusive license agreement, measuresnon-invasiveblood pressure, pulse oximetry, pulse andtemperature.InAugust2001, we released theVITAL·CHECK4500Vital Signs Monitor series (successor to the VITAL·CHECK 4200series) with non-invasive blood pressure, heart rate and temperature monitoringfeatures.  Both monitor series utilizeour IVAC thermometer technology.

 

**Customer Service**

 

We provide repair service for our products at certain of ourfacilities around the world or on-site at our customers’facilities and elsewhere through third–party contractors.  Customers may elect to enter into serviceagreements or to receive service on a time-and-materials basis.  We also train customers as to the use of ourproducts and maintain a technical support help-line to answer customers’ questions.  We believe that the availability of such service helps maintainstrong customer relations.  Repair andother services represented approximately 5% of our sales for the year endedDecember 31, 2002.

 

**Marketing and Sales**

 

We havehistorically focused our sales efforts on the hospital market, which is stillour primary market.  We also sell to thealternate-site market, which includes home healthcare, freestanding clinics,skilled nursing facilities and long-term care facilities.  Our sales strategy emphasizes increasinginstrument placements and the number of units installed in order to increasesales of our proprietary disposable administration sets and probe covers.  Sales representatives work closely withon-site primary decision–makers, which include physicians, pharmacists,nurses, materials managers, biomedical staff and administrators.  We have over 5,000 hospital customersworldwide and sell our products through a combined direct sales forceconsisting of over 200 salespersons and through more than 100distributors.  No single hospital customeris material to our business or operations. The International unit utilizes product distributors in areas where wedo not have a direct sales force. Distributor sales accounted for 16.8% of International sales for theyear ended December 31, 2002.

 

Our domesticmarketing efforts are supported by a staff of nurses and pharmacists whoconsult with customers and provide ongoing clinical support in the evaluation,installation and use of our products. We believe our sales force in the United States and internationally playa vital role in the effective introduction of new products.

 

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We haveinfusion device and patient monitoring product contracts with GPOs in theUnited States, the U.S. federal government and other governmental entities,including the following:

 
| **Name**                                                                           |   | **Drug****Infusion**                  |   | **Thermometry** |   | **Needle****-Free** |   |
|------------------------------------------------------------------------------------|--------|---------------------------------------|--------|-----------------|--------|---------------------|--------|
|                                                                               |   | **(Year in which contract  expires)** |   |
| AmeriNet,  Inc.                                                                    |   | 2003                                  |   | 2003            |   | 2003                |   |
| Healthtrust  Purchasing Group, L.P. (f/k/a Columbia/HCA  Healthcare)               |   | 3⁄4                                |   | 2004            |   | 3⁄4              |   |
| Med Assets  HSCA, Inc. (f/k/a HSCA, In-Source  & Shared Services)              |   | 2005                                  |   | 2005            |   | 2005                |   |
| Managed  Health Care Associates, Inc. (f/k/a MedEcon).                             |   | 2003                                  |   | 2003            |   | 2003                |   |
| Novation,  LLC (VHA Inc.)                                                          |   | 2005                                  |   | 3⁄4          |   | 2005                |   |
| Premier  Purchasing Partners, L.P.                                                 |   | 2004*                                 |   | 2005            |   | 2004*               |   |
| Magnet,  Inc.                                                                      |   | 2003                                  |   | 2003            |   | 2003                |   |
| Tenet  Health Systems Medical, Inc. (Owned Facilities)                             |   | 2007                                  |   | 3⁄4          |   | 2007                |   |
| Broadlane,  Inc. (f/k/a Tenet Health Systems Medical, Inc. (Non-Owned  Facilities) |   | 2004                                  |   | 3⁄4          |   | 2004                |   |
| U.S.  Government/Federal Supplies Schedule                                         |   | 2006                                  |   | 2006            |   | 2006                |   |

 

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** On February 7, 2003, we submitted a contract renewal proposal at therequest of Premier Purchasing Partners,LP.*

 

**Manufacturing**

 

Our productsare manufactured at plants in San Diego, California; Creedmoor, North Carolina;Tijuana, Mexico; and Basingstoke, England. The San Diego, California facility is the primary manufacturing facilityfor infusion pumps and patient monitoring instruments.  The service operation for installed infusionpumps and patient monitoring instruments is also located in this facility.  The Creedmoor, North Carolina facilitymanufactures automated sub-assemblies used in our disposable products and is adistribution center for disposable finished products.  The Tijuana, Mexico facilities assemble a majority of thedisposable products distributed in North America, and the Basingstoke, Englandfacility manufactures syringe pumps and large volume pumps distributed to theInternational market.  Disposableproducts for International markets are currently supported through our Tijuana,Mexico and Creedmoor, North Carolina facilities, and a number of foreignmanufacturers.

 

We haveestablished procedures and other controls designed to ensure that manufacturedand purchased parts products perform as expected by our customer.  We also have in place a system designed toensure timely and effective corrective and preventative action to managenon-conformities reported by customers or detected within our operations.

 

Wepurchase raw materials worldwide in the ordinary course of business fromnumerous suppliers.  The vast majorityof these materials are generally available, and although we have notexperienced any material delays in obtaining these materials we have, onoccasion, experienced temporary delays for certain materials due to suppliershortages.  In some situations, we havelong-term supply contracts, although we purchase a significant amount of ourrequirements of certain raw materials by purchase order.

 

**Research and Development**

 

Webelieve that a well-targeted research and development program constitutes anessential part of our activities and is an integral part of our business.  We are actively engaged in research anddevelopment programs to develop and improve products.  These activities are performed in the United

 

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States and,to a lesser extent, in the UnitedKingdom.  For the year endedDecember 31, 2002, we expended approximately $30.4 million on in-houseresearch and development.  Substantiallyall of such amount was dedicated to the development of new products.

 

**Patents,Trademarks and Other Proprietary Rights**

 

We will be able to protect our proprietary rights fromunauthorized use by third parties only to the extent they are covered by validand enforceable patents, trademarks and copyrights or are effectivelymaintained as trade secrets. Accordingly, we rely heavily on patented and other proprietarytechnology to maintain our competitive position.  We seek to protect our proprietary rights in a manner thatbalances the costs of such protection against obtaining the greatest value forthe company.

 

Our policy is to file patent applications in the U.S. and foreigncountries in order to protect technology, inventions and improvements toinventions that are commercially important to our business.  As of December 31, 2002, we held morethan 230 patents in the United States and a comparable number of patents inforeign countries, mainly in Europe, Canada, Japan and Australia.

 

We sell our products under various trademarks.  We register those trademarks, in the U.S.and foreign countries, which we believe to be of sufficient importance to ourbusiness.  In addition, we seek copyrightprotection for the software and other original works we use in many of our products.  We also rely on trade secrets, unpatentedknow-how and continuing technological advancement to maintain our competitiveposition and seek protection, in part, through confidentiality and proprietaryinformation agreements.

 

We operate in an industry susceptible to significant patent legalclaims.  At any given time, we aregenerally involved, either as a plaintiff or defendant, in one or more patentinfringement actions.  Patent litigationcan result in significant payments or result in injunctions that can preventthe sale of products.  During 2002, wewere involved in one patent infringement lawsuit.  (See Item 3.  “LegalProceedings,” forinformation about that lawsuit.)

 

**Competition**

 

We facesubstantial competition in all of our markets. Some of our competitors have greater financial, research and developmentand marketing resources than we have. We estimate that our infusion pumps represent approximately 32% of theinstalled base of large volume infusion channels in the United States, with BaxterInternational, Inc., Abbott Laboratories, Inc. and B. BraunMedical, Inc., representing approximately 33%, 26% and 6% of suchchannels, respectively.  Our principalcompetitors in the United States offer volume discounts based on bundledpurchases of a broader range of medical equipment, pharmaceuticals and suppliesthan we sell, including infusion systems and intravenous solutions used withsuch systems.  In the Internationalmarket, our largest infusion system competitors include Graseby Medical Limited,Fresenius Medical Care AG and B. Braun Melsungen AG.  The patient monitoring products market is fragmented by producttype.  Our key competitors in the NorthAmerican market include Welch Allyn, Inc. and Sherwood–Davis &Geck in electronic and infrared thermometers, respectively.

 

One of ourbusiness strategies is to be recognized as the leader in intravenous medicationsafety solutions by developing or licensing technologically superior products,thereby providing customers with demonstrably superior clinical value throughbetter capital asset utilization and better patient outcomes.  We expect that this approach will improveour competitive position, as we believe that the competitive factors that aremost important in our markets are quality of products and services,technological innovation and the value proposition of improving patientoutcomes while reducing overall costs associated with patient care.

 

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**GovernmentRegulation**

 

***ProductRegulation*****.          **Our medical devices are subject to extensive regulation bynumerous federal, state and other government agencies, both within and outsidethe U.S.  In the U.S., the federalagencies that regulate our facilities, operations, personnel and productsinclude the Food and Drug Administration (FDA), the Environmental ProtectionAgency, the Occupational Health and Safety Administration, the Customs Service,the Department of Commerce, the Treasury Department and others.  State agencies also regulate our facilities,operations, personnel and products. Government agencies outside the U.S. also regulate public health,product manufacturing, environmental conditions, employment, export, customsand other aspects of our global operations. To varying degrees, each of these agencies requires us to comply withlaws and regulations governing the development, testing, manufacturing,labeling, marketing and distribution of our medical devices.

 

Unless exempt, the FDA classifies medical devices intothree classes based on the regulatory control deemed necessary by the FDA toreasonably ensure safety and effectiveness (from lowest to highest level ofregulatory control).  Our medicaldevices are Class II medical devices. The three classes are:

 

•                  *Class I*:  Subject to general controls, whichinclude:  company registration; devicelisting; manufacturing devices in accordance with the FDA’sGood Manufacturing Practices Quality System Regulation (which cover qualitymanagement and organization, device design, buildings, equipment, purchase andhandling of components, production and process controls, packaging and labelingcontrol, device evaluation, distribution, installation, complaint handling,servicing and records); labeling devices in accordance with FDA labelingregulations; and submission of a 510(k) premarket notification before marketinga device.

 

•                  *Class II*:  Subject to general controls (described inClass I above) and special controls. Special controls may include special labeling requirements, mandatoryperformance standards and post-market surveillance.

 

•                  *Class III*:  Subject to premarket approval, whichincludes filing a premarket approval application (PMA) requiring theindependent demonstration that the new medical device is safe and effective,typically by collecting human clinical data for the medical device.

 

Unless otherwise exempt, we must obtain marketing clearance underthe 510(k) premarket notification process before a new device can be marketedin the U.S.  A 510(k) premarketnotification is a marketing application submitted to the FDA to demonstratethat the medical device is safe and as effective as, or substantiallyequivalent to, a legally marketed device that was or is currently on the U.S.market.  In this process, we must submitdata that supports our equivalence claim. We must receive clearance from the FDA finding substantial equivalencebefore we can commercially distribute the new medical device.  Not all modifications to approved medicaldevices require a 510(k) submission. Modifications that affect the intended use or significantly affectsafety or effectiveness require a 510(k) submission.

 

Both before and after a product is commercially released, we haveongoing responsibilities under FDA regulations.  The FDA has the ability to review design and manufacturingpractices, labeling and recordkeeping for medical devices, manufacturers’required reports of adverse experience and other information to identifypotential problems with marketed medical devices.  If the FDA were to conclude that we are not in compliance withapplicable laws or regulations, or that any of our medical devices areineffective or pose an unreasonable health risk, the FDA could ban such medicaldevices, detain or seize adulterated or misbranded medical devices, orderrepair, replacement or refund of such devices and require us to notify healthprofessionals and others that the devices present unreasonable risks ofsubstantial harm to the public health. The FDA may also enjoin and restrain certain violations of

 

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applicable lawpertaining to medical devices or initiate action for criminal prosecution ofsuch violations.  The FDA alsoadministers certain controls over the export of medical devices from the U.S.

 

We export someof our products to countries outside the U.S. International sales of our medical devices which have not received FDAapproval are subject to the FDA’s exportrequirements.  Failure to comply withFDA’s exportrequirements could have a serious adverse effect on our ability to export suchproducts.  In addition, each foreigncountry where we export our medical devices subjects those devices to its ownregulatory and import requirements.

 

Our products aresubject to varying degrees of government regulation in the foreign countries inwhich we have operations, ranging from stringent design, testing,manufacturing, approval requirements and post-approval requirements to simpleregistration of our products.  However,as a general matter, foreign regulatory requirements for medical devices arebecoming increasingly stringent.  In theEuropean Union, a single regulatory approval process has been created andapproval is represented by the CE Mark. The European Union does not require medical device companies to comply withISO 9001 in order to obtain a CE mark. Instead, we have several compliance options, including having ourdevices tested or having a quality system designed to comply with the qualitysystem standard of our choice.  However,since many of our customers (hospitals, clinics, doctors, etc.) havehistorically wanted to know that they are buying medical devices from amanufacturer that has an ISO 9001 certified quality system, we, like mostmedical device manufacturers, often choose to use ISO standards to obtain a CEmark.

 

The process of obtaining regulatory clearance to distributemedical products can be costly and time consuming in virtually all of the majormarkets where we sell medical devices. We cannot assure that any new medical devices we develop will obtainnecessary clearance in a timely or cost-effective manner.

 

Government andprivate sector initiatives to limit the growth of healthcare costs, includingprice regulation, competitive pricing, coverage and payment policies andmanaged care arrangements, continue in many countries where we do business,including the U.S.  These changes arecausing the marketplace to put increased emphasis on the delivery of morecost-effective medical devices. Government programs, including Medicare and Medicaid, private healthcareinsurance and managed care plans have attempted to control costs by limitingthe reimbursement levels for particular procedures or treatments.  This has created an increasing level ofprice sensitivity among our customers. Some third-party payers must also approve coverage for new or innovativedevices before they will reimburse healthcare providers using those medicaldevices.  Even though a new medicaldevice may have been cleared for commercial distribution, we may find limiteddemand for the device until reimbursement approval has been obtained fromgovernmental and private third-party payers. Although we believe we are well-positioned to respond to changesresulting from the worldwide trend toward cost containment as a result of ourmanufacturing efficiencies and cost controls, uncertainty as to the nature ofany future legislation or changes makes it difficult for us to predict thepotential impact of these trends on future operating results.

 

***Anti-Remuneration Laws.***  The sale of our products is subject to theanti-remuneration or “anti-kickback” provisions of the Social Security Act of1935, as amended, which prohibit knowingly and willfully offering, paying,soliciting or receiving any remuneration, whether directly or indirectly, inreturn for purchasing or ordering items or services, or patient referrals toproviders of services, for which payment may be made in whole or in part byMedicare, Medicaid or other federally funded healthcare programs.  Violations of the statute are punishable bycivil and criminal penalties and the exclusion of the provider from futureparticipation in federally funded healthcare programs.  The Social Security Act contains exceptionsto these prohibitions for, among other things, properly reported discounts, andpayments of certain administrative fees to GPOs.  Because we sell some of our products to customers at prices belowlist price, we are engaged in giving discounts within the meaning of the SocialSecurity Act. We also pay administrative fees to certain purchasing agentswithin the meaning of the Social Security Act. We believe that our discounts and arrangements with purchasing agentsare in compliance with

 

15

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applicable legalrequirements.  Nevertheless, we cannotassure you that a court or regulatory body will agree with our interpretation.

 

Several states also have statutes or regulations prohibitingfinancial relationships with referral sources that are not limited to servicesfor which Medicare, Medicaid or other state or federal healthcare programpayment may be made.  A finding ofnon-compliance with these anti-remuneration laws by federal or state regulatoryofficials, including non-compliance with appropriate safe harbors, could have amaterial adverse effect on our business, financial condition, results ofoperations or prospects.

 

***Environmental Regulation*. **We arealso subject to various environmental laws and regulations, both within andoutside the U.S.  Like other medicaldevice companies, our operations involve the use of substances regulated underenvironmental laws, primarily in manufacturing and sterilizationprocesses.  While it is difficult toquantify the potential impact of compliance with environmental protection laws,we believe that we are in material compliance with current environmentalstandards and that continued compliance will not have a material impact on ourfinancial position, results of operations or liquidity.

 

**Employees**

 

As of January31, 2003, we employed 2,899 people, including 908 in the United States.

 

**Executive Officers of the Registrant**

 

*David L. Schlotterbeck*, age 55, has served as a member of our Board and as President andChief Executive Officer of ALARIS Medical and ALARIS Medical Systems sinceNovember 1, 1999.  From April 1999 to November 1999, Mr.Schlotterbeck served as President and Chief Operating Officer of the Companyand ALARIS Medical Systems. From 1997 to March 1998, Mr. Schlotterbeck served asPresident and Chief Operating Officer of Pacific Scientific Company, aninternational manufacturer of motion control, process measurement and safetyproducts that was formerly traded on the New York Stock Exchange.  In March 1988, Pacific Scientific Companywas acquired by Danaher Corporation.  From 1995 to 1997, Mr. Schlotterbeckserved as President and Chief Executive Officer of Vitalcom, Inc., amedical network manufacturer.  From 1991 to 1994, Mr. Schlotterbeckserved as Executive Vice President and Chief Operating Officer of Nellcor, Inc.,a medical device manufacturer subsequently acquired byMallinckrodt, Inc.  Mr. Schlotterbeck is a graduate of theGeneral Motors Institute with a B.S. in electrical engineering.  He holdsan M.S. in electrical engineering from Purdue University and completed theExecutive Institute at Stanford University in 1984.

 

*William C. Bopp*, age 59*,*has served as Senior Vice President and Chief Financial Officer of the Companyand ALARIS Medical Systems since November 1, 1999.  From March 1999 to November 1999, Mr. Boppserved as Vice President, ChiefFinancial Officer and Treasurer of the Company and ALARIS Medical Systems.  From 1995 to 1999, Mr. Bopp served asExecutive Vice President, Chief Financial Officer and a member of theboard of directors of C.R. Bard, Inc., a $1.2 billion developer,manufacturer and marketer of healthcare products, including vascular,urological and oncological and interventional products.  From 1980 to 1995, Mr. Bopp heldpositions of increasing responsibility with Bard.  Mr. Bopp is a graduateof Harvard College and holds an MBA, Finance, from the Harvard Business School.

 

*Frederic Denerolle*, age 43*,* has served as the Vice President andGeneral Manager of the International Business Unit of ALARIS Medical Systemssince January 2001.  From 1996 to2001, Mr. Denerolle was Executive Vice President of the InfusionTechnology Division of Fresenius Vial. Prior thereto, Mr. Denerolle held positions of increasing responsibilitywith Becton Dickinson, including General Manager of its Infusion Systembusiness from 1994 and 1996. Mr. Denerolle is a graduate in Business Administration from EcoleSupérieure de Commerce de Nantes.

 

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*Sally M. Grigoriev*, age 44, hasserved as the Vice President of Operations of ALARIS Medical Systems sinceDecember 2000.  From January 1995to December 2000, Ms. Grigoriev served as the Vice President of Quality andRegulatory Affairs for ALARIS Medical Systems. Prior to joining IVAC Medical Systems in January 1995, she servedas the Vice President of Quality and Regulatory Affairs at U.S. MedicalInstruments, Inc. and Block Medical, Inc. respectively.  While at Block Medical, Ms. Grigorievestablished and implemented Block Medical’s quality and regulatorysystems.  From 1982 to 1990, Ms. Grigorievheld various management positions in operations and quality assurance at IMEDCorporation.  Ms. Grigoriev holds aB.S. degree, Chemical Engineering, from the University of California, SantaBarbara.

 

*Robert F. Mathews*, age 39, hasserved as Vice President of Finance and Treasurer of ALARIS Medical and ALARISMedical Systems since February 2002.  From January 2001 to February2002, he served as Vice Presidentof Finance and Corporate Controller, and from July 1996 to January2001, he served as Corporate Controller of ALARIS Medical and ALARIS MedicalSystems.  From 1987 to 1996, Mr. Mathews held various positions ofincreasing responsibility with PriceWaterhouse, LLP, including Senior Manager,Business Advisory Services.  Mr. Mathewsis a certified public accountant and holds a B.S. degree in businessadministration from San Diego State University.

 

*William H. Murphy*, age 50, hasserved as Vice President of Quality and Regulatory Affairs of ALARIS MedicalSystems since December 2000.  Mr. Murphy joined ALARIS MedicalSystems in February 2000 as Director of Regulatory Affairs.  From 1996 to 1999, Mr. Murphy served asDirector of Regulatory Compliance of Nellcor Puritan Bennett Inc., whichhas subsequently been acquired by Mallinckrodt, Inc.  Previously, Mr. Murphy provided privateconsulting services in the area of regulatory compliance, quality systemdevelopment and process validation.  Mr. Murphy holds a B.S. degreefrom Augusta College.

 

*Stuart E. Rickerson,*age 54, hasserved as Vice President, General Counsel and Secretary of ALARIS Medical andALARIS Medical Systems since July 2001. In 1995, Mr. Rickerson founded Golden Triangle Ltd., a legalmanagement consulting firm, and served as its General Counsel until joiningALARIS Medical.  From 1991 to 1995, hewas Vice President, General Counsel and Secretary of Keene Corporation andserved as a member of its board of directors from 1991 to 1996.  Previously, Mr. Rickerson served asAssociate General Counsel of Philip Morris, Inc.; Vice President, GeneralCounsel and Secretary of Cardiac Pacemakers, Inc., then a subsidiary ofEli Lilly and Company and now part of Guidant Corporation; and in several legaland management positions of increasing responsibility with Eli Lilly andCompany.  Mr. Rickerson is agraduate of Princeton University and holds a J.D. from Georgetown University.

 

*Jake St. Philip*, age 50, hasserved as Vice President and General Manager, North America of ALARIS MedicalSystems since July 1998.  FromNovember 1996 to July 1998, he served as Vice President of Sales, North Americaof ALARIS Medical Systems.  From June1994 to November 1996, Mr. St. Philip served as Vice President of Sales, NorthAmerica of IVAC Medical Systems.  From 1981 to June 1994,Mr. St. Philip held various sales and marketing positions with IVACMedical Systems.  Previously, he held various sales positions ofincreasing responsibility with Johnson & Johnson andM&M/Mars.  Mr. St. Philip holds a B.S. degree in Marketing fromthe University of New Orleans and completed the Executive Program at StanfordUniversity in 1999.

 

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**ITEM 2. PROPERTIES**

 

We own or lease the following propertieswhich are material to our operations:

 
| **Location**              |   | **Approximate****SquareFootage** |   | **Purpose**                                                 |   | **Leased****orOwned** |   | **Lease****ExpirationDate** |   |
|---------------------------|--------|----------------------------------|--------|-------------------------------------------------------------|--------|-----------------------|--------|-----------------------------|--------|
| San Diego, California     |   | 160,000                          |   | Executive offices/Research & Development                |   | Leased                |   | 2006                        |   |
| San Diego, California     |   | 83,000                           |   | Manufacturing of instruments                                |   | Leased                |   | 2005                        |   |
| San Diego, California     |   | 6,000                            |   | Warehouse and distribution                                  |   | Leased                |   | 2004                        |   |
| Creedmoor, North Carolina |   | 120,000                          |   | Manufacturing of disposable sets                            |   | Owned                 |   | N/A                         |   |
| Tijuana, Mexico           |   | 41,000                           |   | Manufacturing of disposable products                        |   | Leased                |   | 2003                        |   |
| Tijuana, Mexico           |   | 49,000                           |   | Manufacturing of disposable products                        |   | Leased                |   | Open-ended term(1)          |   |
| Basingstoke, England      |   | 43,000                           |   | International headquarters and manufacturing of instruments |   | Leased                |   | 2012(2)                     |   |

 

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(1)                                  Cancelable by ALARISupon 180 days notice.

 

(2)                                  Lease contains theoption for the Company to terminate in 2007.

 

**ITEM 3. LEGAL PROCEEDINGS**

 

On December 5, 2000, we filed a lawsuit in the United StatesDistrict Court for the Southern District of California against Filtertek, Inc.,seeking a declaration that our needle-free system does not infringe a Filtertekpatent relating to a Filtertek needle-free device as well as seekingunspecified damages and equitable relief from Filtertek, for infringement of apatent relating to a needle-free system licensed to us on an exclusive basis byMedex, Inc.  On March 9, 2001,Filtertek filed a lawsuit in the United States District Court for the NorthernDistrict of Illinois seeking unspecified damages and equitable relief from usclaiming that our needle-free system infringes the Filtertek patent as well asseeking a declaration, against Medex only, that Filtertek’sneedle-free device does not infringe the needle-free system patent licensed tous by Medex.  We subsequently withdrewour claim for damages and equitable relief relating to the Medex patent.  As a result of motions made by the parties,the California action was transferred to the Illinois court.  The Court-appointed Special Master conducteda claims construction hearing and provided the Court with recommendations onhow the single claim of the Filtertek patent at issue should be construed,which the Court has since adopted.

 

We believe that we have meritorious defenses to all of Filtertek’sclaims and we intend to defend ourselves vigorously.  We have offered to submit to mediation or arbitration to expeditethe resolution of this case, but the parties have not reached agreement to doso.  On November 15, 2002, we moved fora summary adjudication of the claims. If that does not resolve all claims, we will press for a prompt trial ofthe remaining claims.  We cannot assureyou that our defenses will defeat all of Filtertek’s claims and the failure to do so couldhave a material adverse effect on our business, financial condition, results ofoperations and cash flows.

 

We are also involved in a number of legal proceedings arising inthe ordinary course of our business, none of which is expected to have amaterial adverse effect on our business, financial condition, results ofoperations or cash flows.  (See note 15 tothe consolidated financial statements.)

 

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**ITEM 4.   SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Not applicable.

 

**PART II**

 

**ITEM 5.   MARKET FOR THE REGISTRANT’S COMMON EQUITYAND RELATED STOCK-HOLDER MATTERS**

 

ALARISMedical Systems is a wholly-owned subsidiary of Holdings.  Thereis no established public trading market for ALARIS Medical Systems’ commonstock.

 

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**ITEM6.  SELECTED CONSOLIDATED FINANCIAL DATA**

 

Thefollowing selected financial data of ALARIS Medical Systems and its consolidated subsidiaries atDecember 31, 2002, 2001, 2000, 1999 and 1998, and for the years then ended,have been derived from the audited financial statements of ALARIS Medical Systemsand its consolidated subsidiaries,including the consolidated balance sheet at December 31, 2002 and 2001 and therelated consolidated statement of operations for the three-year period endedDecember 31, 2002 and notes thereto which appear elsewhere herein.  Beginning January 1, 2002, in accordancewith new accounting standards, goodwill and certain other intangibles are nolonger amortized.  As required byStatement of Financial Accounting Standards No. 142, prior years’ data in the following tables has notbeen restated and, therefore, contains amortization expense that is notincluded in current year information. Certain prior period amounts have been reclassified to conform tocurrent period presentation.  (See notes1, 2 and 4 to the consolidated financial statements.)

 
|                                                                         |   | **Year Ended  December 31,** |    |
|------------------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                         |   | **2002**                     |    | **2001** |   | **2000****(1)** |   | **1999(1)** |   | **1998 (1)** |   |
|                                                                         |   | **(dollars in thousands)**   |    |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| **Statement of Operations Data:**                                            |   |                         |    |   |   |   |   |   |   |   |   |
| Sales                                                                        |   | $                            | 460,333 |   | $ | 412,795 |   | $ | 378,948 |   | $ | 389,927 |   | $ | 373,795 |   |
| Cost of sales                                                                |   | 232,989                      |    | 211,601 |   | 202,964 |   | 199,923 |   | 186,077 |   |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Gross profit                                                                 |   | 227,344                      |    | 201,194 |   | 175,984 |   | 190,004 |   | 187,718 |   |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Total operating  expenses (2)                                                |   | (158,602                     | )       | (161,152 | ) | (138,849 | ) | (141,472 | ) | (136,184 | ) |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Interest income  from sales-type capital leases (3)                          |   | 4,345                        |    | 5,141 |   | 5,095 |   | 4,425 |   | 4,599 |   |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Income from  operations                                                      |   | 73,087                       |    | 45,183 |   | 42,230 |   | 52,957 |   | 56,133 |   |
| Interest income                                                              |   | 1,048                        |    | 1,979 |   | 1,313 |   | 1,373 |   | 1,129 |   |
| Interest expense                                                             |   | (39,529                      | )       | (41,650 | ) | (41,543 | ) | (39,903 | ) | (41,767 | ) |
| Other, net                                                                   |   | (1,050                       | )       | (3,959 | ) | (140 | ) | (1,668 | ) | (1,116 | ) |
| Income from continuing operationsbefore income taxes  and extraordinary item |   | 33,556                       |    | 1,553 |   | 1,860 |   | 12,759 |   | 14,379 |   |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Provision for income taxes                                                   |   | 13,201                       |    | 3,223 |   | 3,200 |   | 7,600 |   | 8,400 |   |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Income  (loss) from continuing operations before extraordinary item          |   | 20,355                       |    | (1,670 | ) | (1,340 | ) | 5,159 |   | 5,979 |   |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Discontinued  operations:                                                    |   |                         |    |   |   |   |   |   |   |   |   |
| Income (loss)  from discontinued operations (net of tax) (4)            |   | —                       |    | 270 |   | (1,308 | ) | (23,627 | ) | (25,178 | ) |
| Gain on disposal  of discontinued operations (net of tax) (4)           |   | —                       |    | 3,737 |   | 1,839 |   | — |   | — |   |
| Income (loss)  before extraordinary item                                     |   | 20,355                       |    | 2,337 |   | (809 | ) | (18,468 | ) | (19,199 | ) |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Extraordinary  item:  loss on debt extinguishment (net of tax)          |   | —                       |    | (443 | ) | — |   | — |   | — |   |
|                                                                         |   |                         |    |   |   |   |   |   |   |   |   |
| Net income  (loss)                                                           |   | $                            | 20,355  |   | $ | 1,894 |   | $ | (809 | ) | $ | (18,468 | ) | $ | (19,199 | ) |

 

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|                       |   | **December 31,**            |   |
|----------------------------|--------|-----------------------------|--------|
|                       |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                       |   | **(dollars in  thousands)** |   |
|                       |   |                        |   |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**    |   |                        |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents |   | $                           | 68,483 |   | $ | 50,826 |   | $ | 30,618 |   | $ | 23,539 |   | $ | 29,468 |   |
| Working capital            |   | 168,056                     |   | 145,994 |   | 118,814 |   | 127,943 |   | 148,144 |   |
| Total assets               |   | 568,515                     |   | 566,392 |   | 564,456 |   | 600,726 |   | 644,377 |   |
| Short-term debt  (5)       |   | —                      |   | — |   | 19,871 |   | 13,769 |   | 15,423 |   |
| Long-term debt  (5)        |   | 350,000                     |   | 350,000 |   | 344,905 |   | 382,678 |   | 399,623 |   |
| Net debt (5)               |   | 281,517                     |   | 299,174 |   | 334,158 |   | 372,908 |   | 385,578 |   |
| Stockholder’s  equity |   | 100,882                     |   | 93,127 |   | 95,056 |   | 101,121 |   | 123,118 |   |
|                            |        |                             |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)             Since the fourth quarter of 2000, we have been required toclassify shipping and handling revenues in sales.  These revenues were previously recorded in selling and marketingexpense, netted against the related cost. We have included such amounts in sales for the years ended December 31,2002, 2001 and 2000 and have conformed 1999 and 1998 statement of operationsdata to the current period presentation. (See note 1 to the consolidated financial statements.)

 

(2)             Operating expenses for the yearsended December 31, 2002, 2001, 2000, 1999 and 1998 include restructuring,integration and other non-recurring items of $(585), $6,889, $7,048, $2,887 and$139, respectively.  Additionally, in1998 we recorded $5,534 of purchased in-process research and development.

 

(3)             Interest income from sales-typecapital leases consists of interest income associated with contracts oragreements pursuant to which customers acquire our products under agreementsaccounted for as sales-type capital leases.

 

(4)             During thethird quarter of 2000, we sold the assets and certain liabilities of ourInstromedix® division which had been acquired in 1998 to Card GuardTechnologies, Inc.  For the yearended December 31, 2001, income from discontinued operations is $270 (net of$180 of tax expense).  Losses of $1,308,$23,627 and $25,178 from discontinued operations for the years endedDecember 31, 2000, 1999 and 1998 are net of applicable income tax benefitsof $872, $4,200 and $1,000, respectively. Results from discontinued operations for 1999 include a pretax charge of$19,200 resulting from the write-off of goodwill and other intangible assetsand approximately $4,600 in integration charges.  Results from discontinued operations in 1998 include a charge of$22,800 related to acquired in-process research and development.  A gain on disposal of $1,839 (net ofapplicable income tax expense of $1,226) was recorded in the third quarter of2000.  In the first quarter of 2001, wecompleted our obligations related to the Instromedix sale, resulting in therecognition of an additional gain on disposal of $3,737 (net of applicableincome tax expense of $2,492).  (See note4 to the consolidated financial statements.)

 

(5)             On July 28, 1998, ALARIS Medicalcompleted the sale of $109,892 of 11-1/8% SeniorDiscount Notes due 2008 (“Senior Discount Notes”), receiving net proceeds of$106,321.  A portion of the net proceedsof the sale of the Senior Discount Notes was also used to repay certainborrowings under ALARIS Medical Systems’ bank credit facility (the “Credit Facility”). In October 2001, ALARIS Medical Systems completed a private offering of$170,000 of 11-5/8% Senior Secured Notes due 2006 (“Senior Secured Notes”). ALARIS Medical Systems used the proceeds from the offering, along withexisting cash of approximately $10,000, to repay all amounts under the CreditFacility and to repurchase $20,000 aggregate principal amount of ALARIS MedicalSystems’ 9-3/4% SeniorSubordinated Notes due 2006.  Net debt is defined as total debt less cashand cash equivalents.  (See note6 to the consolidated financial statements.)

 

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**ITEM 7.****     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITIONAND RESULTSOF OPERATIONS**

 

*The following should be read in conjunction withthe consolidated financial statements of ALARIS Medical Systems and the related notes thereto includedelsewhere in this Annual Report*.  *Certainprior period amounts have been reclassified to conform to current periodpresentation.  (See notes 1, 2 and 4 tothe consolidated financial statements.)*

 

**Overview**

 

We develop and providepractical solutions for MedicationSafety at the Point of Care*.* We design, manufacture and market intravenous (IV) medication deliveryand infusion therapy devices, needle-free disposables and related monitoringequipment in the United States and internationally.  Our proprietary Guardrails safety software, our other “smart”technologies and our “smart” services help to reduce the risks and costs ofmedication errors, help to safeguard patients and clinicians and also gatherand record clinical information for review, analysis and transcription.  Our intravenous infusion systems are used todeliver to patients one or more fluids, primarily pharmaceuticals ornutritionals, and consist of medication safety systems, single and multi–channellarge volume infusion pumps, syringe pumps and dedicated and non-dedicateddisposable administration sets.

 

We have one of the largest installed bases of large volume pumpdelivery lines in the United States hospital market, representing approximately32% of such installed lines.  We alsobelieve that we have the number one or number two market position in the largevolume pump segment or the syringe pump segment, or both segments, in Belgium,France, Italy, The Netherlands, Norway, Spain, Sweden, the United Kingdom,Australia, Canada, New Zealand and South Africa.  In addition, we are a leading provider of patient monitoringproducts that measure and monitor temperature, with a substantial installedbase of hospital thermometry systems in the United States.  We also provide products which measure andmonitor pulse, pulse oximetry and blood pressure.  We sell our products primarily to the hospital market through aworldwide direct sales force of over 200 salespersons and more than 100distributors to over 5,000 hospitals in more than 120 countries worldwide.   ALARIS was formed in 1996 by the merger ofIMED Corporation and IVAC Medical Systems, Inc., two pioneers and leaders inthe area of infusion technology, each with leading brand names and at least 30years of operating history.

 

**Critical Accounting Policies and Estimates**

 

Ourdiscussion and analysis of our operating results and financial condition isbased upon our consolidated financial statements, which have been prepared inaccordance with United States generally accepted accounting principles.

 

Criticalaccounting policies are those that involve subjective or complex judgments,often as a result of the need to make estimates.  The estimates, judgments and assumptions used in the preparationof our financial statements affect the reported amounts of revenues, costs andexpenses, assets, liabilities and related disclosure of contingentamounts.  Our estimates are based onhistorical experience and various judgments and assumptions we believe areappropriate.  However, the inherentnature of estimates is that actual results will likely be different from theestimates made.

 

We believethat the following critical accounting policies require use of significantassumptions, judgments and estimates. The use of different assumptions, judgments or estimates could have amaterial effect on the reported amounts of revenue, costs and expenses, assetsand liabilities and the related disclosure of contingent amounts in ourfinancial statements.

 

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***Inventory is carried at the lower of cost or marketvalue***– If we determine that our inventoryrequires a reduction in value to bring its basis to the lower of cost or marketvalue, we record an inventory valuation allowance.  Establishing the allowance needed to comply with this policyrequires assessment of market conditions and future demand for products as wellas estimates as to market value of inventory. Estimates of market value require assessment of the impact oftechnological changes and estimates of salvage values if products or componentsare judged obsolete.  Any future changesin the estimated inventory valuation allowance could have a material adverseimpact on our financial condition and results of operations.

 

***Estimated cost of field corrective actions***– We establish reserves for estimated costs to completefield corrective actions when decisions are made or mandated to make suchrepairs.  As of December 31, 2002, we donot believe we have significant cost remaining to complete any known fieldcorrective actions, including those classified as FDA recalls.  Historically, we have had several fieldcorrective actions and the costs incurred related to these activities weresignificant.  These costs included laborand materials, as well as travel and lodging for repair technicians.  Estimates of the costs to complete theseactivities were often quite difficult to determine due to uncertaintysurrounding how many affected units were still in service and how many unitscustomers would fix without our assistance.

 

***Estimated allowance for uncollectible accounts receivable***–We establish reserves for bad debts based on historical collection experienceswithin the various markets in which we operate, number of days the accounts arepast due and any specific information that we become aware of such asbankruptcy or liquidity issues of customers.  Any future changes in the estimated allowance for uncollectible accountsreceivable could have a material adverse impact on our financial condition andresults of operations.

 

***Carrying value of intangible assets***– Under generally accepted accounting principles, we arerequired to write-down our intangible assets if such assets are determined tobe impaired.  Under current accountingstandards, an impairment of an intangible asset is considered to have occurredwhen the estimated undiscounted future cash flows related to the assets areless than the carrying value of the assets. Estimates of future cash flows involve consideration of numerousfactors, depending upon the specific asset being assessed.  With respect to intangible assets, relevantfactors include estimates of future market growth rates, product acceptance andlifecycles, selling prices and volumes, responses by competitors, manufacturingcosts and assumptions as to other operating expenses.  Beginning in 2002, we adopted a new accounting standard relatedto goodwill and other intangible assets. (See note 2 to the consolidated financial statements.)

 

Intangible assets with finite lives are amortized overtheir useful lives; intangible assets with indefinite lives are notamortized.  Upon adoption of thestandard in the first quarter of 2002, we determined that the intangible assetrelated to the “IVAC” trade name has an indefinite life and therefore, weceased amortization of this intangible asset. The indefinite life determination for this intangible asset was based onthe evidence that no legal, regulatory, contractual, competitive, economic orother factors limited its useful life. Although we cannot envision changes in the industry, technological orregulatory environment that would limit the useful life of the asset, there isno assurance that such changes will not take place.  Any future changes that would limit the useful life of this assetcould have a material adverse impact on our financial condition and results ofoperations as amortization expense would be required to be recognized.

 

***Valuation allowance for deferred tax assets***– We record a valuation allowance to reduce deferred incometax assets to the amount that is more likely than not to be realized.  Assessment of the realization of deferredincome tax assets requires that estimates and assumptions be made as to taxableincome of future periods.  Projection offuture period earnings is inherently difficult as it involves consideration ofnumerous factors such as our overall strategies and estimates of future marketgrowth rates, new product development and acceptance, product lifecycles,selling prices and volumes, responses

 

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by competitors, manufacturing costs andassumptions as to operating expenses and other industry specific and macro andmicro economic factors.  In addition,consideration is also given to ongoing and constantly evolving global tax lawsand our own tax minimization strategies. Any future changes in the estimated valuation allowance for deferred taxassets could have a material adverse impact on our financialcondition and results ofoperations.

 

**Results of Operations**

 

The followingtable sets forth, for the periods indicated selected financial informationexpressed as a percentage of sales. Beginning January 1, 2002, in accordance with new accounting standards,goodwill and certain other intangibles are no longer amortized.  As required by Statement of FinancialAccounting Standards No. 142, prior year’s data in the following table has not been restated and,therefore, contains amortization expense that is not included in current yearinformation.  (See note 2 to theconsolidated financial statements.)

 
|                                                   |   | **Year Ended  December 31,** |    |
|--------------------------------------------------------|--------|------------------------------|---------|
|                                                   |   | **2002**                     |    | **2001** |   | **2000** |   |
|                                                   |   | **(% of sales)**             |    | **(% of sales)** |   | **(% of sales)** |   |
|                                                   |   |                         |    |   |   |   |   |
| Sales                                                  |   | 100.0                        | %       | 100.0 | % | 100.0 | % |
| Cost of sales                                          |   | 50.6                         |    | 51.3 |   | 53.6 |   |
|                                                   |   |                         |    |   |   |   |   |
| Gross margin                                           |   | 49.4                         |    | 48.7 |   | 46.4 |   |
|                                                   |   |                         |    |   |   |   |   |
| Selling and  marketing expenses                        |   | 19.2                         |    | 19.3 |   | 19.1 |   |
| General and  administrative expenses                   |   | 8.7                          |    | 11.4 |   | 10.0 |   |
| Research and  development expenses                     |   | 6.6                          |    | 6.6 |   | 5.7 |   |
| Restructuring  and other non-recurring items           |   | (.1                          | )       | 1.7 |   | 1.9 |   |
| Interest income  from sales-type capital leases        |   | (.9                          | )  | (1.2 | ) | (1.4 | ) |
|                                                   |   |                         |    |   |   |   |   |
| Income from operations                                 |   | 15.9                         |    | 10.9 |   | 11.1 |   |
| Interest income                                        |   | .2                           |    | .5 |   | .3 |   |
| Interest expense                                       |   | (8.6                         | )       | (10.1 | ) | (11.0 | ) |
| Other, net                                             |   | (.2                          | )       | (.9 | ) | — |   |
|                                                   |   |                         |    |   |   |   |   |
| Income from continuing operations  before income taxes |   | 7.3                          |    | .4 |   | .4 |   |
| Provision for  income taxes                            |   | 2.9                          |    | .8 |   | .8 |   |
|                                                   |   |                         |    |   |   |   |   |
| Income  (loss) from continuing operations              |   | 4.4                          |    | (.4 | ) | (.4 | ) |
|                                                   |   |                         |    |   |   |   |   |
| Loss from  discontinued operations (net of tax)        |   | —                       |    | — |   | (.3 | ) |
| Gain on disposal  of business (net of tax)             |   | —                       |    | 1.0 |   | .5 |   |
| Total income  from discontinued operations             |   | —                       |    | 1.0 |   | .2 |   |
|                                                   |   |                         |    |   |   |   |   |
| Debt  extinguishment loss (net of tax)                 |   | —                       |    | (.1 | ) | — |   |
|                                                   |   |                         |    |   |   |   |   |
| Net income  (loss)                                     |   | 4.4                          | %       | .5 | % | (.2% | ) |

 

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Our salesresults are reported consistent with our two geographical business units:  North America and International.  The following table summarizes sales tocustomers by each geographical business unit.

 
|                               |   | **Year Ended December 31,** |   |
|------------------------------------|--------|-----------------------------|--------|
|                               |   | **2002**                    |   | **2001** |   | **2000** |   |
|                               |   | **(**in  millions)          |   |
| **North America business unit**    |   |                        |   |   |   |   |   |
|                               |   |                        |   |   |   |   |   |
| Infusion instruments               |   | $                           | 79.8   |   | $ | 63.6 |   | $ | 53.5 |   |
| Dedicated disposables              |   | 139.1                       |   | 131.3 |   | 128.9 |   |
| Other disposables and service      |   | 72.6                        |   | 62.5 |   | 50.5 |   |
| Subtotal                           |   | 291.5                       |   | 257.4 |   | 232.9 |   |
|                               |   |                        |   |   |   |   |   |
| Patient monitoring products        |   | 26.2                        |   | 28.2 |   | 27.0 |   |
| North America business unit total  |   | $                           | 317.7  |   | $ | 285.6 |   | $ | 259.9 |   |
|                               |   |                        |   |   |   |   |   |
| **International business unit**    |   |                        |   |   |   |   |   |
|                               |   |                        |   |   |   |   |   |
| Infusion instruments               |   | $                           | 44.1   |   | $ | 38.0 |   | $ | 35.6 |   |
| Dedicated disposables              |   | 73.2                        |   | 68.5 |   | 65.6 |   |
| Other disposables and service      |   | 19.8                        |   | 15.5 |   | 13.7 |   |
| Subtotal                           |   | 137.1                       |   | 122.0 |   | 114.9 |   |
|                               |   |                        |   |   |   |   |   |
| Patient monitoring products        |   | 5.5                         |   | 5.2 |   | 4.1 |   |
| International business unit total  |   | $                           | 142.6  |   | $ | 127.2 |   | $ | 119.0 |   |
|                               |   |                        |   |   |   |   |   |
| ALARIS Medical Systems, Inc. total |   | $                           | 460.3  |   | $ | 412.8 |   | $ | 378.9 |   |

 

**Year EndedDecember 31, 2002 Compared with Year Ended December 31, 2001**

 

***Sales.***  For the year endedDecember 31, 2002, sales were $460.3 million, an increase of $47.5 million, or12% (10% in constant currency) over the prior year.  Higher volumes of both drug infusion instruments and disposableadministration sets in North America resulted in an increase in revenues of$32.1 million, or 11%, over the prior year. The increase in infusion instruments was primarily due to sales of ourproprietary Guardrails safety software, primarily in the Medley MedicationSafety System.  We believe the increasein dedicated disposables was due to an increase in our installed base of infusiondevices.  The increase in otherdisposables and service was due to approximately $11.0 million in additional sales ofSmartSite non-dedicated disposables. The increases in drug infusion products in North America were partiallyoffset by lower volumes of patient monitoring instruments and disposablescompared with the prior year. International sales increased $15.4 million, or 12% (7% in constantcurrency), due to higher volumes and revenues of non-dedicated disposableadministration sets, large volume pumps and syringe pumps compared with theprior year.  The increase in largevolume pump sales for the International business is primarily attributed to theAsena GW, a new product launched in late 2001.

 

***Gross Profit.***  Gross profitincreased $26.2 million, or 13%, during 2002 compared with 2001 due to highersales and an increase in gross margin percentage.  The gross margin percentage increased to 49.4% in 2002 from 48.7%in 2001.  In both NorthAmerica and International, the improved margin percentage was due to increasedvolume and our continuing cost reduction efforts. International margins alsobenefited from a weaker U.S. dollar.

 

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***Selling and Marketing Expenses.*** Selling and marketing expenses increased $8.5 million, or 11%, duringthe year ended December 31, 2002, compared with the same period in 2001 as aresult of higher sales volume, as well as higher selling and marketing costsrelated to increased personnel and related activities supporting the NorthAmerica launch of the Medley Medication Safety System.  Also contributing to this increase werehigher marketing expenses related to the creation of new productstrategies.  These increases werepartially offset by reductions in our distribution costs over the prior year byconsolidating contracted distribution facilities, simplifying processes in oursupply chain and optimizing freight channels. As a percentage of sales, selling and marketing expenses decreased to19.2% for 2002 from 19.3% for 2001.

 

***General and Administrative Expenses.*** General and administrative expenses decreased $6.9 million, or 15%,during 2002 compared with 2001.  As apercentage of sales, general and administrative expense decreased to 8.7%during 2002 compared with 11.4% for 2001. This decrease was primarily due to a $9.2 million reduction in amortization expenseresulting from our adoption of new accounting requirements effective January 1,2002, under which our goodwill and certain other amortization expenseceased.  Had these accounting requirementsbeen in effect during 2001, general and administrative expense for such periodwould have been 9.2% of sales.  Increases in 2002 general and administrative expensesincluded $1.8 millionfor our businessprocess reengineering project, which we established to implement efficiencies throughout our administrative operations and to designa new enterprise-wide information system. These additional expenditures were generally offset by lower bonusexpense during 2002 compared with 2001.

 

***Research and Development Expenses.*** Research and development expenses increased approximately $3.3 million,or 12%, during 2002 compared with 2001. The increase was due to spending associated with new product development primarilyrelated to our medication safety strategy. This higher spending included increased salaries, benefits andconsulting costs.  As a percentage ofsales, spending on research and development was 6.6% for 2002, consistent with2001.

 

***Restructuring and Other Non-Recurring Items.*** During the first quarter of 2002, we recorded a non-recurring benefit of$1.1 million for an insurance settlement. The settlement related to damages and losses incurred at one of ourdisposable products manufacturing plants in Mexico in 1993 as a result offlooding.  The contingency related tothe insurance settlement was resolved in the first quarter of 2002, when wereceived proceeds of $1.0 million during the quarter and notification of anadditional payment due of $.1 million, which we received during April 2002.

 

Also duringthe first quarter of 2002, we initiated a plan to restructure our technicalservices operations in Central Europe. In this connection, we recorded a charge of $.5 million which included$.4 million for severance costs for 21 positions affected by the relocation ofthe German operation and $.1 million related to lease termination.  As of December 31, 2002, all severancepayments had beenmade to the identified employees.

 

During 2001,we recorded a charge of $3.4 million for restructuring and other non-recurringactivities.  These activities wererelated to streamlining of operations in the North America business unit andresulted in the elimination of 71 positions. The restructuring and other non-recurring charges were composed ofseverance and related benefits of $2.6 million and consulting fees of $.8million.  We also incurred non-recurringcharges of $3.5 million in 2001 related to obtaining an amendment to the CreditFacility.  The charges related to legal, advisory and other consultantexpenses incurred by ALARIS and our lenders, which we were required to pay.

 

***Income from Operations.*** Income from operations increased $27.9 million, or 62%, during 2002compared with 2001 primarily due to an increase in gross profit and loweramortization expense.

 

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***Interest Income. ***Interestincome decreased $.9 million, or 47%, due to lower interest rates earned oncash balances in 2002 compared with 2001.

 

***Interest Expense. ***Interestexpense decreased $2.1 million, or 5%, from 2001.  Thisdecrease resulted from lower overall interest rates on our outstandingindebtedness due to the replacement of ALARIS Medical Systems’ bank credit facility with the SeniorSecured Notes in October 2001.

 

***Other, net.***  Other, netdecreased $2.9 million during 2002 compared with 2001.  Our foreign currency transaction lossesdecreased $2.7 million in the current year and were partially offset by anincrease in cost of $.8 million related to our hedging program. During 2001, we received $.5 million of other income relating to thesale of a trade name which was not repeated in 2002.  Also in 2001, weterminated our interest rate swap agreement in association with the repaymentof our bank credit facility, resulting in a pre-tax charge of $1.6 million.

 

***Discontinued Operations.*** During the third quarter of 2000, we sold our Instromedix division toCard Guard Technologies, Inc. (Card Guard). The agreement with Card Guard provided that we would assist the buyer insetting up a fully independent headquarters and manufacturing facility.  During the first quarter of 2001, wecompleted our obligations related to the agreement and recorded a gain of $3.7million, net of taxes.

 

**Year Ended December 31, 2001 Compared with Year EndedDecember 31, 2000**

 

***Sales.***  For the year endedDecember 31, 2001, sales were $412.8 million, an increase of $33.9 million, or9% (11% in constant currency) over the prior year.  North America sales increased $25.8 million, or 10%, andInternational sales increased $8.1 million or 7% (13% in constant currency)compared with the prior year.  Theincrease in sales wasprimarily due to worldwide increased volumes of both drug infusion instrumentsand disposable administration sets.  Additionally,worldwide sales of patient monitoring instruments increased $3.1 million overthe prior year.

 

***Gross Profit.***  Gross profitincreased $25.2 million, or 14%, during 2001 compared with 2000 due to highersales and an increase in gross margin percentage.  The gross margin percentage increased to 48.7% in 2001 from 46.4%in 2000.  The improved margin percentagewas due to continuing manufacturing efficiencies and improvements, includingthe benefits from higher production volumes and related favorable utilization.

 

***Selling and Marketing Expenses.***  Sellingand marketing expenses increased $7.7 million, or 11%, during 2001 comparedwith 2000 due to higher sales volume, which resulted in increases in salescompensation and distribution costs and to increased selling and marketingexpense related to activities supporting the North American launch of the MedleyMedication Safety System.  These increases were partially offset bylower spending on worldwide sales meetings in 2001 versus 2000.  As a percentage of sales, selling andmarketing expenses increased to 19.3% for 2001 from 19.1% for 2000.

 

***General and Administrative Expenses.*** General and administrative expenses increased $9.3 million, or 25%,during 2001 compared with 2000.  As apercentage of sales, general and administrative expense increased to 11.4%during 2001 compared with 10.0% for 2000. The increase wasdue to higher costs for employee benefits, legal, insurance, consulting andinformation technology expenses.  Thehigher benefit costs included higher bonus accruals based on the success of ourturnaround.  Approximately $3.5 millionof these bonuses werenot repeated in fiscal year 2002. Goodwill and certain other intangible asset amortization expense ofapproximately $9.2 million was included in general and administration expensein 2001 and 2000.

 

***Research and Development Expenses.***  Researchand development expenses increased approximately $5.5 million, or 25%, during2001 compared with 2000.  The increase was due to

 

27

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spending associated with new productdevelopment primarily related to our product safety strategy.  This higher spending included increasedsalaries, benefits and consulting costs and was consistent with our strategic plans to increase the levelof investment in our new product pipeline. As a percentage of sales, spending on research and development increasedto 6.6% for 2001, compared with 5.7% for 2000.

 

***Restructuring and Other Non-Recurring Items.***  During2001, we recorded a charge of $3.4 million for restructuring and othernon-recurring activities.  Theseactivities were related to streamlining of operations in the North America businessunit and resulted in the elimination of 71 positions.  The restructuring and other non-recurring charges were composed of severance and relatedbenefits of $2.6 million and consulting fees of $.8 million.  During 2001, we determined that certaincosts related to the restructuring for 2001 would be lower than originallyestimated.  Based on this information,we adjusted the restructuring accrual by $.3 million.  We incurred an additional non-recurring consulting charge relatedto such activities during thefourth quarter, which totaled approximately $.3 million.

 

We alsoincurred non-recurring charges of $3.5 million in 2001 related to obtaining anamendment to the Credit Facility.  Thecharges relate to legal, advisory and other consultant expenses incurred byALARIS and our lenders, which we were required to pay.

 

Therestructuring and non-recurring costs of $7.0 million in 2000 were related toactivities that involved the manufacturing facilities in Creedmoor, North Carolina, Basingstoke,England and San Diego, California.

 

***Income from Operations.*** Income from operations increased $3.0 million, or 7%, during 2001compared with 2000 due to higher sales and gross profit offset by increasedoperating spending.

 

***Interest Income. ***Interestincome increased $.7 million, or 51%, due to higher cash balances maintained in2001 over 2000 which yielded greater interest income.

 

***Interest Expense***. Interest expense remained consistent with the prior year.

 

***Other, net***.  Other expenseincreased $3.8 million during 2001 compared with 2000.  In October 2001, we terminated our interestrate swap agreement in association with the repayment of our bank creditfacility, resulting in a pre-tax charge of $1.6 million.  During 2000, we received payments of $2.8million as a result of a favorable resolution of two trade name disputes.  We did not receive comparable payments in2001.

 

***Discontinued Operations.*** During the third quarter of 2000, we sold our Instromedix division toCard Guard.  The agreement with CardGuard provided that we would assist the buyer in setting up a fully independentheadquarters and manufacturing facility. During 2001, we completed our obligations related to the agreement andrecorded a net gain on disposal of $3.7 million, net of taxes.  Also during 2001, we assessed additionalreserves related to the discontinued business and determined the contingencywas no longer probable.  This change inestimate resulted in the release of a reserve of $.5 million ($.3 million netof tax).  During 2000, the loss fromdiscontinued operations for the Instromedix division was $1.3 million, net oftaxes.  Gain on sale of Instromedix recorded during 2000 was $1.8million, net of taxes.

 

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***Extraordinary Item: Debt extinguishment loss. ***During 2001, the Company recorded a total net extraordinaryloss of $.4 million related to two early extinguishments of debttransactions.  The early repayment ofthe ALARIS Medical Systems Credit Facility debt resulted in a charge of $2.8million ($1.7 million net of tax benefit) related to the write-off of the thenremaining unamortized debt issuance costs. The reacquisition of $20.0 million principal amount of SeniorSubordinated Notes at a discount to par and related write-off of unamortizeddebt issuance costs resulted in a net gain of $2.1 million ($1.2 million net oftax expense).

 

**Liquidity and Capital Resources**

 

We expect tocontinue to meet our short-term liquidity needs, including capital expenditurerequirements, with cash flow from operations and cash on hand.  We will continue to use our funds primarilyfor operating expenses, including planned expenditures for new research anddevelopment programs, capital expenditures and scheduled interest payments onoutstanding indebtedness.  Additionally,we anticipate using a portion of these funds to purchase some of our long-termdebt from time to time in open market or privately negotiated transactions tothe extent that the indentures governing such indebtedness permit us to do so.

 

At December31, 2002, we had $350.0 million combined outstanding indebtedness composed of$170.0 million of 11-5/8% senior secured notes due 2006 (“Senior Secured Notes”), which were issued on October 16, 2001and $180.0 million of 9-3/4% senior subordinated notes due 2006 (“Senior Subordinated Notes”). The Senior Secured Notes bear interest at 11-5/8%, payable semi-annuallyin arrears on June 1 and December 1, with all principal due at maturity onDecember 1, 2006.  The SeniorSubordinated Notes bear interest at 9-3/4%, payable semi-annually in arrears onJune 1 and December 1, with all principal due at maturity on December 1, 2006.

 

Holdings alsohad outstanding at December 31, 2002, $177.5 million accreted amount of its11-1/8% Senior Discount Notes due 2008 (“Senior Discount Notes”).

 

The Senior Discount Notesaccrete to $189.0 million principal amount on August 1, 2003.  Prior thereto, interest accruing on theSenior Discount Notes is added to the outstanding principal balance throughJuly 31, 2003.  Interest on the SeniorDiscount Notes accruing subsequent to July 31, 2003 is payable in cashsemi-annually in arrears on February 1 and August 1, commencing February 1,2004.  The indentures governing theSenior Secured Notes and the Senior Subordinated Notes permit ALARIS MedicalSystems to make distributions, or “restricted payments,” to ALARIS Medical ifat the time of the restricted payment, ALARIS Medical Systems satisfies the twoconditions described in the following paragraphs.  Additionally, payments to ALARIS Medical to fund up to $1.5million annually in ALARIS Medical operating or capital expenditures aredefined as restricted payments but do not require meeting these conditions.  Based on its operating results for the yearended December 31, 2002, ALARIS Medical Systems met the two required conditionsto make restricted payments for the first time in the first quarter of 2003.

 

The first condition which must be satisfied prior to making a restrictedpayment is that at the time of the distribution, ALARIS Medical Systems musthave a Fixed Charge Coverage Ratio (as calculated in accordance with theindentures as described below) of at least 2.5 to 1 calculated for the four completecalendar quarters preceding the distribution as though the distribution hadbeen made at the beginning of such period. The Fixed Charge Coverage Ratio is determined by dividingALARIS Medical Systems’Consolidated EBITDA (as defined in the indentures) by its Consolidated InterestExpense (as defined in the indentures). Based on ALARIS Medical Systems’ interest expense for the year ended December 31, 2002, theactual amount of interest expense included in the calculation of the FixedCharge Coverage Ratio was approximately $38.8 million.  As a result, the minimum requiredConsolidated EBITDA to meet the ratio for the year ended December31, 2002 was approximately $96.9million while the actual Consolidated EBITDA was approximately $97.6million.  Assuming no future changes tothe amount or

 

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terms of currentlyoutstanding debt of ALARIS Medical Systems, approximately $96.9 millionrepresents the minimum required Consolidated EBITDA for future four quartercalculations of the Fixed Charge Coverage Ratio.

 

Under the indentures, Consolidated EBITDA is defined as follows:  “With respect to any Personfor any period, the Consolidated Net Income of such Person and its RestrictedSubsidiaries for such period, plus, to the extent deducted in computingConsolidated Net Income: (i) provision for taxes based on income or profits ofsuch Person and its Restricted Subsidiaries for such period; (ii) ConsolidatedInterest Expense of such Person for such period; and (iii)  depreciation and amortization (includingamortization of goodwill and other intangibles) and all other non-cash charges(excluding any such non-cash charge to the extent that it represents an accrualof or reserve for cash charges in any future period or amortization of aprepaid cash expense that was paid in a prior period) of such Person and itsRestricted Subsidiaries for such period; and (iv) any extraordinary ornon-recurring loss and any net loss realized in connection with either an AssetSale or the extinguishment of indebtedness, in each case, on a consolidatedbasis determined in accordance with GAAP. Notwithstanding the foregoing, the provision for taxes based on theincome or profits of, and the depreciation and amortization and other non-cashcharges of, a Restricted Subsidiary of a Person shall be added to ConsolidatedNet Income to compute Consolidated EBITDA only to the extent (and in the sameproportion) that the Net Income of such Restricted Subsidiary was included incalculating the Consolidated Net Income of such Person.”

 

Consolidated EBITDA, per the indentures, as calculatedfor the year ended December 31, 2002 reconciled to ALARIS Medical Systems’consolidated net income was as follows:

 
|                                                               |   | **Year Ended  December 31, 2002** |   |
|--------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                               |   | **(dollars in thousands)**        |   |
|                                                               |   |                              |   |
| ALARIS Medical  Systems’ consolidated net income, as reported |   | $                                 | 20,355 |   |
| Provision for  income taxes                                        |   | 13,201                            |   |
| Interest expense                                                   |   | 39,529                            |   |
| Depreciation and  amortization                                     |   | 23,958                            |   |
| Non-cash items                                                     |   | 1,152                             |   |
| Less:  non-recurring gain                                          |   | (1,125                            | )      |
| Extraordinary/non-recurring  items                                 |   | 540                               |   |
| Consolidated  EBITDA, per indentures                               |   | $                                 | 97,610 |   |

 

The second condition which must be satisfied prior to making a restrictedpayment is that the distribution, together with certain other restrictedpayments previously made, may not exceed a sum determined byreference to ALARIS Medical Systems’ cumulative Consolidated Net Income (as defined in theindentures) for the period since January 1, 1997 and cash capital contributionsreceived after such date, less restricted payments made.  This condition provides that theConsolidated Net Income of ALARIS Medical Systems will be added to the amountavailable each quarter until such time as historical net losses of ($23.9 million through December 31, 2002) are exhausted.  Subsequent to such time, 50% of future ALARIS Medical Systems’ net income will be added to the amountavailable.  At December 31, 2002, theamount available for future restricted payments was $30.8 million.

 

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The following represents thechanges in the amount available for Restricted Payments pursuant to the ALARISMedical Systems’ indentures:

 
|                                                                 |   | **1997  through  2000**    |    | **Full Year  2001** |   | **Full Year  2002** |   |
|----------------------------------------------------------------------|--------|----------------------------|---------|---------------------|--------|---------------------|--------|
|                                                                 |   | **(dollars in thousands)** |    |
| Available for  Restricted Payments – beginning of period        |   | $                          | —  |                | $      | 28,850              |   | $ | 28,176 |   |
| ALARIS Medical  Systems’ net (loss) / income for the period (1) |   | (45,504                    | )       | 1,894               |   | 19,680              |   |
|                                                                 |   |                       |    |                |   |                |   |
| **Restricted Payments**  (2)                                         |   |                       |    |                |   |                |   |
|                                                                 |   |                       |    |                |   |                |   |
| Dividends to  ALARIS Medical for operating expenses                  |   | (4,228                     | )       | (1,210              | )      | (1,452              | )      |
| Interest payment  on Convertible Debentures                          |   | (4,684                     | )       | (1,171              | )      | (585                | )      |
| Due from ALARIS  Medical, Inc.                                       |   | —                     |    | —              |   | (170                | )      |
| Fund  unrestricted subsidiary to purchase Convertible Debentures     |   | —                     |    | (187                | )      | (14,813             | )      |
|                                                                 |   |                       |    |                |   |                |   |
| Cash capital  contributions received by ALARIS Medical Systems       |   | 83,266                     |    | —              |   | —              |   |
| Available for  Restricted Payments – end of period              |   | $                          | 28,850  |                | $      | 28,176              |   | $ | 30,836 |   |
| Change in Net  Loss:                                                 |   |                       |    |                |   |                |   |
| Cumulative net  loss – beginning of period                      |   | $                          | —  |                | $      | (45,504             | )      | $ | (43,610 | ) |
| ALARIS Medical  Systems’ net (loss) / income for the period     |   | (45,504                    | )       | 1,894               |   | 19,680              |   |
| Cumulative net  loss – end of period                            |   | $                          | (45,504 | )                   | $      | (43,610             | )      | $ | (23,930 | ) |

 

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(1)       The amountof net income included in determining the amount available for restrictedpayments is based on the “Net Income” definition per the indentures and isdifferent from the net income reported in accordance with generally acceptedaccounting principles.

(2)  The indentures allow certain “restrictedpayments” to be made without meeting the Fixed Charge Coverage Ratio.

 

The preceding description of the provisions of the indentures whichgovern restricted payments, including the defined terms, is a summary only andis qualified in its entirety by the text of the indentures, which ALARISMedical and ALARIS Medical Systems have previously filed with the Securitiesand Exchange Commission.  (See Item 15. “Exhibits,Financial Statement Schedules and Reports on Form 8-K.”)

 

Asdescribed above, for the year ended December 31, 2002, ALARIS Medical Systemsmet the requirements under its debt agreements to make a restricted payment inthe first quarter of 2003.  As a result,in February 2003, ALARIS Medical Systems made distributions to ALARIS Medicalin the amount of $30.8 million.  ALARISMedical used a portion of such distributions to repurchase in a privatetransaction $25.0 million face amount of the Senior Discount Notes at a totalcost of $25.0 million representing a premium of $1.2 million or 4.7% over thethen accreted carrying value.  Suchpremium, along with a write-off of unamortized debt issue cost related to thepurchased amount of debt will be recorded as a charge of $1.5 million(approximately $1.0 million after tax) in the Company’s first quarter 2003operating results.

 

Due to the February 2003 SeniorDiscount Note repurchase and principal reduction discussed in the previousparagraph, semi-annual interest payments on these notes will be reduced fromthe originally scheduled $10.5 million to $9.1 million and ALARIS Medical’sconsolidated projected interest expense for 2003 will be reduced by $2.3million ($2.8 million on an annualized basis). After receivingrestricted payments from ALARIS Medical Systems in February 2003, and afterpurchasing the $25 million of

 

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Senior Discount Notes, ALARIS Medical, Inc.,on a stand alone basis, had a cash balance of approximately $8.2 million.  Based on projected 2003 first quarterearnings, we anticipate that in the second quarter of 2003, ALARIS MedicalSystems will meet the required tests to make additional restricted payments toALARIS Medical.  As a result, managementanticipates that in the second quarter of 2003, ALARIS Medical, Inc. will havecash available sufficient to meet the first scheduled semi-annual interestpayment, due February 1, 2004, on the Senior Discount Notes.

 

Although there can be no assurances thatALARIS Medical Systems will meet the required tests to make future restricted payments, based on projected ALARIS Medical Systems netincome and Consolidated EBITDA, we believe that ALARIS Medical Systems will continue to meet therequired Fixed Charge Coverage Ratio and, through its generation of net income,increase the amount available for restrictedpayments ineach successive calendar quarter.  As a result, management plans to continue tomake quarterly restricted payments from ALARIS Medical Systems to ALARISMedical to the extent of the amount available to do so under the indentures andsubject to cash availability. Management currently plans to use such payments from ALARIS MedicalSystems either for interest payments on the Senior Discount Notes or forperiodic repurchases by ALARIS Medical of additional Senior Discount Notes tothe extent such Senior Discount Notes are available for sale at prices whichALARIS Medical is willing to pay.

 

Additionally, the Company intends to seek a credit line of up to $20million for ALARIS Medical Systems during 2003.  Having such a credit line in place would allow ALARIS MedicalSystems the operating flexibility to use its cash balances, in excess of thatavailable to distribute to ALARIS Medical, to make open market purchases ofSenior Secured Notes.  Additionally, such line of credit could beused as a source of liquidity if other cash needs are identified.  Given the current market prices ofthe Senior Secured Notes, such repurchases would be at a premium to the bookvalue of the debt, resulting in losses on retirement.  However, due to the resulting elimination of future interest expenseon any retired debt, management currently believes this could be a prudent useof ALARIS Medical Systems’ available cash.  Management does not plan to draw on thepotential line of credit to fund such repurchases.

 

ALARISMedical’s ConvertibleDebentures were retired at their scheduled maturity on January 15, 2002.  The indentures governing the Senior SecuredNotes and the Senior Subordinated Notes permitted ALARIS Medical Systems to use$15 million of its cash on hand to invest in a wholly owned unrestrictedsubsidiary.  ALARIS Medical Systems madesuch investment and the unrestricted subsidiary used a portion of the proceedsof such investment to acquire $.2 million Convertible Debentures in the openmarket in 2001.  In 2002, the remaining$14.8 million was loaned to ALARIS Medical, which used the proceeds of suchloan and proceeds from the exercise of stock options to retire the ConvertibleDebentures.  A portion of the stockoption exercise proceeds resulted from the exercise by some of our executiveofficers of stock options.  Inconnection with the exercise, three of our executive officers receivedinterest-bearing, short-term loans, aggregating $.6 million, from ALARISMedical Systems.  These loans weresubsequently repaid in full.  ALARISMedical was entitled to require such executive officers to exercise suchoptions in order to provide ALARIS Medical with sufficient funds to retire theConvertible Debentures.  Such optionswere granted to these executive officers in anticipation of ALARIS Medical’s need to require such exercise in orderto complete the retirement of the Convertible Debentures.  (See note 6 to the consolidated financialstatements.)

 

ALARISMedical Systems is required over the next twelve months (through December 31,2003) to make interest payments on the Senior Secured Notes in the amount of$19.8 million ($9.9 million in June of 2003 and $9.9 million in December of2003) and interest payments on the Senior Subordinated Notes in the amount of$17.6 million ($8.8 million in June of 2003 and $8.8 million in December of2003).  On January 15, 2002, ALARISMedical made its final interest payment on the Convertible Debentures of $.6million.

 

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Although wehave no further principal amortization requirements until the maturity of theSenior Secured Notes and the Senior Subordinated Notes in December 2006,management is monitoring the capital markets for opportunities to improve ourcapital structure prior to such time.

 

The indenture governing the Senior Secured Notespermits ALARIS Medical Systems to use any proceeds of an ALARIS Medical equityoffering which are contributed to ALARIS Medical Systems to redeem up to 35% inaggregate principal amount of Senior Secured Notes, prior to December 1, 2003,at a redemption price equal to 111.625% of the principal amount thereof plusaccrued and unpaid interest.  Proceedsof an equity offering which are contributed to ALARIS Medical Systems wouldincrease the amount available to ALARIS Medical Systems (under the indenturesgoverning both the Senior Secured Notes and the Senior Subordinated Notes) tomake restricted payments.  Suchcontributed proceeds could be used by ALARIS Medical Systems to purchase SeniorSecured Notes.  Any offering proceedsnot so contributed could be used by ALARIS Medical to purchase Senior DiscountNotes.  Beginning August 1, 2003, theSenior Discount Notes are also callable at 105.563%, with the call pricedecreasing each subsequent August 1.

 

We anticipatethat we will refinance our remaining debt structure prior to December 2006since we believe that it is unlikely that ALARIS Medical Systems will generatesufficient cash flow from operations to repay the remaining Senior SecuredNotes and Senior Subordinated Notes at maturity in 2006 and to permit it tomake distributions to ALARIS Medical to enable it to repay the remaining SeniorDiscount Notes at maturity in 2008. Such refinancing may involve an offering of debt securities of ALARISMedical Systems or ALARIS Medical, or both, an offering of equity securities ofALARIS Medical to reduce the level of indebtedness of ALARIS Medical Systems orALARIS Medical, or both, or a combination of any of the foregoing.  The ability of ALARIS Medical Systems orALARIS Medical, or both, to obtain such debt or equity financing will bedependent upon many factors, including overall financial market and economicconditions and our operating performance and expectations at such time.

 

Should ALARISMedical Systems not repay its indebtedness at maturity in 2006, should ALARISMedical not repay the Senior Discount Notes in 2008, or should ALARIS MedicalSystems not be able to continue to make distributions to ALARIS Medical inorder to permit ALARIS Medical to make cash interest payments on the SeniorDiscount Notes, these events could have a material adverse effect on ourbusiness, financial condition and results of operations and could result in adefault by ALARIS Medical, ALARIS Medical Systems, or both, and possibleacceleration of all or a portion of such indebtedness, unless ALARIS Medical,ALARIS Medical Systems, or both, could refinance such indebtedness or obtainthe required funds from other sources.

 

In responseto customer requests to finance their payments related to equipment purchasesover time, we have identified an unrelated third party financing company toassist our customers in such area. Approximately $16 million in 2000 and 2001 and $27 million in 2002, ofdrug infusion equipment sales to North American customers have been financed bythis third party.  If such third partyfinancing source were no longer available to our customers, it could require usto find another party or to finance such customer purchases and require use ofour cash.  Additionally, our operating resultscould also be affected, as it is possible that customers could look to maketheir purchases from our competitors who might be able to finance suchpurchases at a lower cost of funds.

 

In December 2002, theCompany filed for a tax accounting change with the Internal Revenue Service(“IRS”) seeking approval of a more favorable income tax treatment for certainsales to third party distributors.  TheCompany anticipates this tax accounting change will be approved by the IRS,and, accordingly has reflected the benefit as a reduction in its estimatedcurrent income tax liability for 2002. This change resulted in an $8 million cash tax savings in 2002 with ananticipated refund for income taxes previously paid in 2002 of an additional $4million.  This change does not impactthe amount of the income tax expense included in the 2002 ConsolidatedStatement of Operations.  Althoughmanagement anticipates obtaining the requested approval from the IRS during2003, there can be no assurances that

 

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the IRS will approve the Company’srequest.  Should the tax treatment notbe approved by the IRS, the Company would be required to make tax payments,which it would have otherwise been able to defer indefinitely, of approximately$12 million plus interest.

 

As identifiedin the consolidated statement of cash flows, net cash provided by operatingactivities for year ended December 31, 2002 was $53.5 million compared with $56.8 millionprovided by operating activities in 2001. Net cash used in investing activities for the years ended December 31,2002 and 2001 was $34.4 million and $11.9 million, respectively.  Net cash used in investing activities forthe year ended December 31, 2001 included $8.1 million of net proceeds from thesale of a discontinued operation.  Cashused in investing activities also includes $18.1 million and$17.5 million in net capital expenditures for the years endedDecember 31, 2002 and 2001, respectively. We anticipate making capital expenditures of approximately $30 million in 2003.  Net cash used in financing activities forthe years ended December 31, 2002 and 2001 was $2.0 million and $24.4 million, respectively,and was primarily composed of principal payments on long-term debt.  During 2002, federal, state and foreigntaxes paid (net of refunds), related to continuing operations were $7.4million.

 

During 2002,we made cash payments of $.4 million for restructuring and other non-recurringactivities initiated in 2002.  Theseactivities related to restructuring our technical services operations inCentral Europe, which resulted in the elimination of 21 positions and $.5million charge to the income statement. Cash payments related to the activities were for severance cost of thepositions affected by the relocation of the German operation.

 

During 2001,we made cash payments of $3.3 million for restructuring and non-recurringcosts initiated in 2001.  Theseactivities related to efforts aimed at streamlining of operations in the NorthAmerican business unit and resulted in the elimination of 71 positions and a$3.4 million charge to the income statement. Cash payments related to these activities were primarily for severanceand related benefits and consulting.

 

The followingschedule summarizes our contractual obligations and commitments to make futurepayments as of December 31, 2002:

 
|                               |   | **Contractual Obligations & Commitments** |   |
|------------------------------------|--------|-----------------------------------------------|--------|
|                               |   | **(dollars in millions)**                     |   |
|                               |   |                                          |   |   |   |   |   |   |   |
| **Payments Due by Period**         |   | **Long-term****Debt**                         |   | **Operating****Leases** |   | **Interest****Payments** |   | **Total** | *** *** |
|                               |   |                                          |   |   |   |   |   |   |   |
| 2003                               |   | $                                             | — |   | $ | 6.4 |   | $ | 37.3 |   | $ | 43.7 |   |
| 2004                               |   | —                                        |   | 6.0 |   | 37.3 |   | 43.3 |   |
| 2005                               |   | —                                        |   | 5.9 |   | 37.3 |   | 43.2 |   |
| 2006                               |   | 350.0                                         |   | 2.0 |   | 37.3 |   | 389.3 |   |
| 2007                               |   | —                                        |   | 1.4 |   | — |   | 1.4 |   |
| Thereafter                         |   | —                                        |   | 5.4 |   | — |   | 5.4 |   |
|                               |   |                                          |   |   |   |   |   |   |   |
| Total Contractual Cash Obligations |   | $                                             | 350.0  |   | $ | 27.1 |   | $ | 149.2 |   | $ | 526.3 |   |

 

##### **Seasonality**

 

Infusioninstrument sales are typically highest in the fourth quarter due to salescompensation plans that reward the achievement of annual quotas and theseasonal characteristics of the industry, including hospital purchasingpatterns.  We anticipate that this trendwill continue but are unable to predict the effect, if any, from potentialhealthcare reform and increased competitive pressures.  Approximately 36% and 32% of our sales ofdrug infusion instruments occurred during the fourth quarters of 2002 and 2001,respectively.

 

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**Backlog**

 

The amount ofunfilled orders, believed to be firm, at December 31, 2002 and 2001 was $7.4million and $10.5 million, respectively.

 

**Foreign Operations and Currency Exchange Rates**

 

We havesignificant foreign operations and, as a result, are subject to various risksarising therefrom, including foreign currency risks.  This risk did not materially change during 2002.  Due to changes in foreign currency exchangerates during 2002 and 2001, primarily a weakening of the U.S. dollar againstmany European currencies in 2002, we recognized foreign currency transactiongains of $.2 million in 2002, compared with foreign currency transaction lossesof $2.5 million during 2001.  Such gainsand losses were recorded in other expense in the consolidated statement ofoperations.  For the years endedDecember 31, 2002 and 2001, approximately 32% and 34%, respectively, of oursales were denominated in currencies other than the U.S. dollar.  For the years ended December 31, 2002 and2001, approximately 30% and 27%, respectively, of our operating expenses weredenominated in currencies other than the U.S. dollar.  These foreign currencies are primarily those of Western Europe,Canada, Mexico and Australia. Additionally, substantially all of the receivables and payables of ourforeign subsidiaries are denominated in currencies other than the U.S.dollar.  During the first quarter of2001, we began entering into certain contracts to manage the risk of foreigncurrency fluctuations.  (See Item 7A, “Quantitative and Qualitative DisclosuresAbout Market Risk—Foreign Exchange Risk Management.”)

 

**Factors That Could AffectFuture Financial Condition and Results**

 

***Our and Holdings******’ substantial level of indebtedness couldhave a material adverse effect on our financial condition.***

 

We have a substantial amount of indebtedness.  At December 31, 2002, we and Holdings had$527.5 million combined outstanding indebtedness composed of obligations ofALARIS Medical and ALARIS Medical Systems. ALARIS Medical’s indebtedness consisted of $177.5million of Senior Discount Notes. ALARIS Medical Systems’ indebtedness consisted of $170.0 million of Senior SecuredNotes and $180.0 million of Senior Subordinated Notes.

 

Our high level of indebtedness could have important consequences,including the following:

 

•                                          it may bedifficult for us to satisfy our obligations with respect to our debt;

•                                          our ability to obtainadditional financing for working capital, capital expenditures, potentialacquisition opportunities or general corporate or other purposes may beimpaired;

•                                          a substantialportion of our cash flow from operations must be dedicated to the payment on ourindebtedness, reducing the funds available to us for other purposes; and

•                                          we may be morevulnerable to economic downturns, may be limited in our ability to respond tocompetitive pressures and may have reduced flexibility in responding tochanging business, regulatory and economic conditions.

 

We expect to continue to meet our short-term liquidity needs,including capital expenditure requirements, with cash flow from operations andcash on hand.  We will continue to useour funds primarily for operating expenses, including planned expenditures fornew research and development programs, capital expenditures, and scheduledinterest payments on outstanding indebtedness. Additionally, we anticipate using a portion of these fundsto purchase some of our long-term debt from time to time in open market orprivately negotiated transactions to the extent that the indentures coveringsuch indebtedness permit us to do so.  Although we have no further principalamortization

 

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requirementsuntil the maturity of the Senior Secured Notes and the Senior SubordinatedNotes in December 2006, management will continue to monitor the capital marketsprior to such time for opportunities to improve the Company’scapital structure.  Managementanticipates that the Company will refinance its remaining debt structure priorto December 2006 since it believes that it is unlikely that ALARIS MedicalSystems will generate sufficient cash flow from operations to repay theremaining Senior Secured Notes and Senior Subordinated Notes at maturity in2006 and to permit it to make distributions to ALARIS Medical to enable it torepay the Senior Discount Notes at maturity in 2008.  Such refinancing may involve an offering of debt securities ofALARIS Medical Systems or ALARIS Medical (or both), an offering of equitysecurities of ALARIS Medical to reduce the level of indebtedness of ALARISMedical Systems or ALARIS Medical (or both), or a combination of any of theforegoing.  The ability of ALARISMedical Systems or ALARIS Medical, or both, to obtain such debt or equityfinancing will be dependent upon many factors, including overall financialmarket and economic conditions and our operating performance and expectationsat such time.

 

Should ALARIS Medical Systems not repay its indebtedness atmaturity in 2006, should ALARIS Medical not repay the Senior Discount Notes in2008, or should ALARIS Medical Systems not be able to continue to makedistributions to ALARIS Medical in order to permit ALARIS Medical to make cashinterest payments on the Senior Discount Notes, these events could have amaterial adverse effect on our business, financial condition and results ofoperations and could result in a default by ALARIS Medical, ALARIS Medical Systemsor both, and possible acceleration of all or a portion of such indebtedness,unless ALARIS Medical, ALARIS Medical Systems or both could refinance suchindebtedness or obtain the required funds from other sources.

 

***The success of our businessstrategy depends in part upon market acceptance of our newest product andservice offerings, which focus on medication safety at the point of care, andour ability to maintain our technological leadership position in the medicationsafety area through the development of new products and services.***

 

In response to the recent emergence of patient safety as animportant health care issue, and as a result of the maturation and increasingcompetitiveness of the markets for traditional infusion pumps and patientmonitoring devices, we have increasingly focused our business strategy ondeveloping products and services which are designed to increase medicationsafety at the point of care.  In thefourth quarter of 2001, we introduced our Medley Medication SafetySystem and, in third quarter of 2002, we introduced our Guardrails safetysoftware for our Signature Edition large volume pump and our GuardrailsContinuous Quality Improvement (CQI) Event Tracker System.  We have made and will continue to makesignificant investments in the development of our products and services, but wecannot assure you that the demand for our new products and serviceswill justify such investments or that they will achieve widespread marketacceptance.  We may also be required todevote substantial resources to upgrading and enhancing our existing productsand services after market introduction. We cannot assure you that in the future we will successfully complete ormarket new products or services, or enhancements to existing ones.

 

Although our Medley Medication Safety System was the firstinfusion system of its kind approved for use in the United States, and we knowof no other comparable systems currently being marketed, we cannot assure youthat we can maintain our technological leadership in the area of medicationsafety.  Maintaining our technological leadership willbe important to the success of ourproducts and services, as will our ability to be responsive to pricing pressures andchanging business models.  Ifcompetitors introduce products, services or technologies that are better thanours or that gain greater market acceptance, or if new industry standardsemerge, our business, results of operations and financial condition could bematerially and adversely affected.  Ourcompetitors may succeed in developing medication safety products and serviceswhich may achieve equal or greater market acceptance than ours, which wouldcreate pricing pressure on our medication safety products and

 

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services.  Additionally, if we do not successfullyreposition our older products for sale to different markets, our introductionof new products and services will reduce sales of such older products.

 

Furthermore, a hospital’s decision to purchase ourMedley Medication Safety System is a significant business decision which ismade with great care.  The costs andtime commitments involved in negotiating purchasing contracts for our MedleyMedication Safety System and its component products and services may adverselyaffect our ability to consummate these sales or to consummate them in a timelymanner.  Failure to complete these salescould adversely affect our business, results of operations or financialcondition.  In addition, delays incompleting such contracts could create variability in our operating resultsfrom period to period, which could cause fluctuations in the trading prices ofour shares.

 

***We face substantial competitionin all of our markets.***

 

Our major competitors are Baxter International, Inc., AbbottLaboratories, Inc. and B. Braun Medical, Inc. in the United Statesmarket and Graseby Medical Limited, Fresenius Medical Care AG and B. BraunMelsungen AG in the International market. Some of these companies have greater financial, research and development,and marketing resources than we have. Some of our U.S. competitors are able to offer volume discounts based onbundled purchases of a broader range of medical equipment, pharmaceuticals andsupplies than we sell, including infusion systems and intravenous solutionsused with such systems.  We cannotassure you that such competition will not have a material adverse effect on ourbusiness, financial condition, results of operations or cash flows.

 

The primarymarkets for many of our current products are relatively mature and highlycompetitive.  We believe our success isdependent on the development of new infusion technologies and products, newproduct categories and the development of other markets for our products.  Our older infusion therapy product lineshave experienced declining sales and market share recently, primarily due tocompetitors who offer volume discounts based on bundled purchases of a broaderrange of medical equipment and supplies, as well as to the aging of theseproducts.  We intend to continue tointroduce new products in order to offset future declines in sales and marketshare of the mature segment of our current product line.  We cannot assure you that new products willbe successfully completed or marketed for sale, will not necessitate upgradesor technical adjustments after market introduction, can be manufactured insufficient volumes to satisfy demand, or will fully offset declines in salesand market share experienced with respect to existing products.

 

***There is a concentration ofbuying power among our U.S. customers, which may increase competition for salesand put downward pressure on pricing.***

 

Most sales in the U.S. hospital market are made to individualhospitals through long-term contracts with GPOs, which aggregate the buyingpower of their member hospitals and monitor compliance with purchasecommitments.  GPOs often enter intoexclusive purchase commitments with as few as one or two providers of infusionsystems and/or patient monitoring products for a period of several years.  If we are not one of the selected providers,we may be precluded from making sales to members of a GPO for several yearsand, in certain situations, the GPO may require removal of our existinginstalled infusion pumps, which would result in a loss of the relateddisposable administration set sales. Even if we are one of the selected providers, we may be at adisadvantage relative to other selected providers which are able to offervolume discounts based on bundled purchases of a broader range of medicalequipment and supplies.  Further, we maybe required to commit to pricing which has an adverse impact on our profitmargins.

 

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***Our inability to protect ourintellectual property positions could have a material adverse effect on ourperformance.***

 

We rely heavily on patents and other proprietary technology.  Our inability to protect these positionscould have a material adverse effect on our business, financial condition,results of operations or prospects.  Wecannot assure you that patent applications we submit will result in patentsbeing issued or that, if issued, such patents will afford protection againstcompetitors with similar technology.

 

Legal standards relating to the scope of claims are still evolvingin the courts and we cannot guarantee that our patents will be upheld as validand enforceable.  The U.S. Patent andTrademark Office may later modify or revoke our issued patents.  This may create uncertainty until the matteris resolved, which could take several months or more.  In addition, foreign patents may be more difficult to protect andthe remedies that are available against infringers may be less extensive thanin the United States.

 

Because U.S. patent applications are maintained in secrecy for atleast the first eighteen months after filing and because publication ofdiscoveries in the scientific or patent literature tends to lag behind actualdiscoveries, we cannot be certain that we were the first creator of theinventions covered by pending patent applications or the first to file patentapplications on such inventions.  Wecannot assure you that any of our pending patent applications will be allowed,or if allowed, that the scope of the claims allowed will be sufficient to protectour products.  Without establishing thispriority, we will be unable to patent our inventions and, in fact, a patent onthe invention may be awarded to another party. Interference or opposition proceedings instituted against us mayincrease the costs associated with the patent application process, delay theissuance of patents, or both.

 

In addition, we cannot assure you that any of our patents orlicensed patents will not be infringed or designed around by others, thatothers will not obtain patents that we will need to license or design around,that our products will not inadvertently infringe the patents of others, orthat others will not manufacture and distribute similar products uponexpiration of such patents.  We cannotassure you that our patents will not be invalidated or that we or our licensorswill have adequate funds to finance the high cost of prosecuting or defendingpatent validity or infringement issues. (See the discussion under Item 1, “Business—Patents, Trademarks and Other ProprietaryRights” and Item 3, “Legal Proceedings.”)

 

We sell our products under a variety of trademarks, some of whichwe consider to be of sufficient importance to register in the United States andvarious foreign countries in which we do business.  We also rely on trade secrets, unpatented know-how and continuingtechnological advancement to maintain our competitive position.  It is our practice to enter intoconfidentiality agreements with certain technical employees and consultants.

 

The legal protections afforded by trade secret, patent, copyrightand trademark laws, nondisclosure and other contractual provisions andtechnical measures provide only limited protection for our products andservices.     Monitoring unauthorized use of our products and services isdifficult and we cannot assure you that these measures will prevent theunauthorized disclosure or use of our trade secrets and know-how or that othersmay not independently develop similar trade secrets or know-how or obtainaccess to our trade secrets, know-how or proprietary technology, particularlyin foreign countries where the laws may not protect our proprietary rights asfully as in the United States.

 

***Non-compliance with governmentregulation could seriously harm our business.***

 

We are subject to extensive governmental regulation, and ourfailure to comply with these regulations can have serious consequences upon ourbusiness.  Government regulation is asignificant factor in the research, development, testing, production andmarketing of our products.  If we do notcomply with applicable regulatory requirements, we may need to recall productsor suspend production

 

38

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of them.  In addition, government regulators mayrefuse to allow the clinical testing or commercial distribution of our productsand we could face civil sanctions or criminal prosecution.  We cannot assure you that our existingproducts will consistently comply with such regulations or that any newproducts we develop will receive any necessary government approvals.  (See the discussion under Item 1, “Business–Government Regulation.”)

 

Our products are regulated as medical devices.  Medical devices are regulated by a varietyof governmental agencies, including those of the United States, the individualstates and those of other countries.  Inthe United States, the Federal Food, Drug, and Cosmetic Act, or FDC Act,authorizes the U.S. Food and Drug Administration, or FDA, to regulate theintroduction of medical devices into commerce. FDA requires us to register with it and to list our devices.  FDA has the authority to regulate themanufacturing, labeling, adverse event reporting, exporting and promotion, aswell as related record keeping, for such products.  FDA’s enforcement of the FDC Act depends to agreat extent on the agency’s interpretation of the FDC Act and regulations promulgatedthereunder.  We cannot assure you thatFDA’s interpretationswill not have a material adverse effect on our business, financial condition,results of operations or prospects.

 

Obtaining necessary new product clearances or approvals from FDAis important to our business and can be a time consuming and expensiveprocess.  We cannot assure you that suchclearances or approvals will be granted or that FDA’sreview of submissions or applications for the same will not involve delaysadversely affecting the marketing and sale of our products.

 

Certain states require licensing of medical device manufacturingfacilities.  Our manufacturing facilitylocated in the State of California has such a requirement.  We currently have a California MedicalDevice Manufacturing license for our facility in California.  This license must be renewed annually.  In order to retain this license, ourfacility in California must be in compliance with the FDC Act and theapplicable state laws.  

 

We also have manufacturing facilities in the United Kingdom andMexico which must meet the regulatory requirements imposed by thosecountries.  The European Union and othercountries are in the process of developing new approaches for regulatingmedical products which may result in lengthening the time required or changingthe requirements to obtain permission to market new devices.  These changes could have a material adverseeffect on our ability to market our devices in such countries and could hinderor delay the successful implementation of our planned international expansion.

 

***New, and future, federal and state regulations in theU.S. relating to patient privacy could impose burdens on us.***

 

Federal andstate laws regulate the confidentiality of certain patient health information,including patient records, and the use and disclosure of that “protected health information.” In particular, in December 2000, the U.S. Department of Health and HumanServices (HHS) published patient privacy rules under the Health InsurancePortability and Accountability Act of 1996 (HIPAA privacy rule) and, in August2002, published final modifications to the HIPAA privacy rule.  The HIPAA privacy rule applies only tohealth plans, health care clearinghouses and certain health careproviders.  However, the HIPAA privacyrule also conditions the disclosure of protected health information from healthcare providers to third parties, or “business associates,” who perform services for the health care providerinvolving the use of protected health information.

 

If demandfrom our customers for patient safety products and services with expandedfeatures continues in the future, and so long as it is consistent with ourbusiness models, we may expand the scope of the infusion-related patient datathat we access, collect and analyze on behalf of our health care providercustomers to include protected health information.  If that were to happen, we would need to comply with certainregulations under the HIPAA privacy rule as a “business associate” of those

 

39

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healthcare providers and would faceincreased obligations regarding any protected health information we wouldreceive on behalf of those providers. Those obligations would include agreeing, typically by contract, to usethat protected health information only for certain purposes, to safeguard thatinformation from misuse and to help those providers comply with their duties toprovide patients with access to their health information.

 

In addition,many states also regulate the privacy of health information and it is unclearhow the HIPAA privacy rule will interact with existing or emerging statelaw.  Further, HHS has also issued draftregulations governing the security of protected health information, whichimposes detailed requirements on business associates relating to the storage,utilization and transmission of health information (draft security rule).  We are evaluating the applicability of theHIPAA privacy rule and draft security rule to our existing and new products andservices and our compliance obligations. If we need to comply with the HIPAA privacy rule and/or draft securityrule in the future, additional compliance resources may be required.

 

***Governmental initiatives tocontain healthcare costs could adversely affect our profit margins.***

 

There have been a number of U.S. governmental initiatives toreduce healthcare costs.  Congress andvarious state legislatures periodically propose changes in law and regulationthat could affect a major restructuring of the healthcare industry.  Changes in governmental support ofhealthcare services, the prices for such services, or the regulations governingsuch services, as well as the growth of managed care organizations may all havea material adverse effect on our business, financial condition, results ofoperations or prospects.  The costs ofcomplying with possible new requirements may have a negative impact on ourfuture earnings.

 

Other governmental initiatives to contain healthcare costs focuson improving patient safety through the use of technologically advancedproducts and services.  The success ofour business strategy depends in part upon a continued emphasis by the government,as well as insurance companies, the public and the media, on patient safety,reducing the incidence of ADEs, enhancing patient care and improving medicaloutcomes.  If these concerns become lessof a priority, it could adversely affect our business strategy.

 

***We could face potential productliability claims relating to the use of our products.***

 

We face an inherent business risk of exposure to product liabilityclaims in the event that the use of our products is alleged to have resulted ininjury or other adverse effects. Products as complex as the Company’s sometimes containerrors, particularly in software components, that remain undetected, despiterigorous testing, until used in a variety of situations by many customers undervarying circumstances.  Such errors canresult in expensive product recalls, product liability claims or warrantyexpenditures.  There can be no assurancethat the Company will not be subject to any such expenses or product liabilityclaims, that such claims will not result in liability in excess of anyapplicable insurance coverage or that the Company’s insurance will cover any expenses orclaims made.  We currently maintainproduct liability insurance coverage but we cannot assure you that we will beable to obtain such insurance on acceptable terms in the future, if at all, orthat any such insurance will provide adequate coverage against potentialclaims.  Our insurance excludes coveragefor punitive damages.  Product liabilityclaims can be expensive to defend and can divert management and other personnelfor months or years regardless of the ultimate outcome.  An unsuccessful product liability defensecould have a material adverse effect on our business, financial condition, resultsof operations or prospects.

 

***Our software products couldresult in unforeseen liabilities.***

 

Our medication safety software is very complex.  As with complex software products offered byothers, our systems may contain errors, especially when first introduced.  Our Medley Medication Safety

 

40

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System,Guardrails safety software and Guardrails CQI Event Tracker System are intendedto assist healthcare providers who are providing patient care.  Therefore, users of our products likely havea greater sensitivity to system errors than users of software productsgenerally.  Failure of a customer’ssystem to perform in accordance with our documentation could constitute abreach of warranty and could require us to incur additional expense in order tomake the system comply with the documentation. If such failure is not remedied in a timely manner, it could constitutea material breach under a contract, allowing the client to cancel the contract,obtain refunds of amounts previously paid, or assert claims for significantdamages.

 

***We arecontrolled by our principal stockholder.***

 

We are controlled by Jeffry M. Picowerbecause he beneficially owns approximately 75% of Holdings' common stock through DecisionsIncorporated, JD Partnership, L.P. and JA Special Limited Partnership.  Mr. Picower is (1) the solestockholder and sole Director of Decisions, which is the sole general partnerof JD Partnership and (2) the sole general partner of JA Special.  Mr. Picower has the power to determinethe outcome of any action requiring the approval of the holders of ALARISMedical's common stock, includingthe election of all of our directors.

 

***We aresubject to certain risks associated with our foreign operations.***

 

A substantial portion of our sales andearnings are attributable to international sales and manufacturingoperations.  During the years endedDecember 31, 2002 and 2001, $148.9 million and $140.1 million,respectively, of our sales were generated internationally, representingapproximately 32% and 34% of our total sales during the respective periods.** **The value of our foreign salesand earnings is impacted by currency exchange rate fluctuations.  Changes in currency exchange rates couldhave a material adverse effect on our business, financial condition, results ofoperations or prospects.  Furthermore,international manufacturing and sales are subject to other inherent risks.  (See Item 7A, “Quantitative and Qualitative Disclosures About Market Risk—Foreign Exchange Risk Management.”)

 

***We aresubject to certain risks globally.***

 

Our operations are subject to special risksthat can materially affect our sales, profits and cash flows, including, amongother risks the following:

 

•                       exchange ratedevaluations and fluctuations,

•                       the impact ofinflation,

•                       exchange controls,

•                       labor unrest,

•                       restrictions ontransfer of funds,

•                       contractdisputes with critical suppliers,

•                       enforcing andcollecting accounts receivable under some countries’legal systems,

•                       politicaluncertainty or instability,

•                       import andexport duties and quotas, and domestic and international customs and tariffs,

•                       unexpectedchanges in regulatory environments, and

•                       potentiallyadverse tax consequences.

 

***Supplyrisks and shortages could harm our business.***

 

We purchase a significant amount of the rawmaterials we need by purchase order, and have, on occasion, experiencedtemporary delays due to supplier shortages. In addition, we rely on a limited number

 

41

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of suppliers for circuit boards and other parts which are used incertain of our infusion systems.  Theloss of any of these suppliers would temporarily disrupt or interrupt ourmanufacturing process and could affect our ability to manufacture in sufficientvolumes to satisfy demand.  Suchdisruption could materially and adversely affect our business, resultsof operations and financial condition.

 

***We may be adversely affected by environmental and safetyregulations to which we are subject.***

 

We must comply with U.S. and foreignenvironmental laws and regulations concerning emissions to air, waste waterdischarges and the generation, handling, storage, transportation and disposalof hazardous wastes, and with other federal, state and foreign laws andregulations.  We believe that we possessall material permits and licenses necessary for the continuing operation of ourbusiness and that our operations are in substantial compliance with the termsof all applicable environmental laws. We cannot assure you that we will operate at all times in complete compliancewith all such requirements.  We cannotassure you that the applicable regulatory body’s interpretation will not have a material adverse effect onour business, financial condition, results of operations or prospects.  We could be subject to potentiallysignificant civil or criminal fines and penalties for any noncompliance thatmay occur.  It is impossible to predictaccurately what effect these laws and regulations may have on us in the future.  (See the discussion under Item 1, “Business—Governmental Regulation—Environmental Regulation.”)

 

**ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**Foreign Exchange Risk Management**

 

As part ofour risk management strategy, we put in place a hedging program beginning in2001 under which we enter into forward foreign exchange and currency optioncontracts to hedge a portion of forecasted cash receipts and paymentsdenominated in currencies other than the U.S. dollar.  These contracts are entered into to reduce the risk that ourearnings and cash flows, resulting from certain forecasted transactions, willbe affected by changes in foreign currency exchange rates.  However, we may be impacted by changes inforeign exchange rates related to the unhedged portion of the forecastedtransactions.  The success of thehedging program depends, in part, on forecasts of our transactions in variouscurrencies (primarily the Euro).  Hedgesare placed for periods consistent with identified exposures, but generally nolonger than the end of the year for which we have substantially completed ourannual business plan.  We may experienceunanticipated foreign currency exchange gains or losses to the extent thatthere are timing differences between forecasted and actual activity duringperiods of currency volatility. However, since the critical terms of contracts designated as cash flowhedges are the same as the underlying forecasted transaction, changes in fairvalue of contracts should be highly effective in offsetting the present valueof changes in the expected cash flows from the forecasted transaction.  The ineffective portion of any changes inthe fair value of option contracts designated as hedges, if any, is recognizedimmediately in earnings.  We did notrecognize material gains or losses resulting from either hedge ineffectivenessor changes in forecasted transactions during 2002.

 

As a matterof policy, we will only enter into currency contracts with counterparties thathave at least an investment grade or equivalent credit rating from a majorrating agency.  The counterparties tothese contracts are major financial institutions.  We do not have significant exposure to any one counterparty.  We believe the risk of loss related tocounterparty default is remote and would only consist of the net market value gain(if any) of the underlying instrument. The contracts have varying maturities with none exceeding eighteenmonths.  Costs associated with enteringinto contracts are not expected to be material to our financial results.  Currency option and forward contracts arediscussed in note 3 to the consolidated financial statements.  (See Item 7, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Foreign Operations and Currency Exchange Rates.”)

 

42

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**Derivative Financial Instruments**

 

We addresscertain financial exposures through a controlled program of risk managementthat includes the use of derivative financial instruments.

 

During thefirst quarter of 2001, we began a foreign exchange risk management strategy asdescribed above.  Under the program, weutilize foreign currency options and forward contracts to reduce the effect ofexchange rate fluctuations.  Wecategorize these instruments as entered into for purposes other thantrading.  We do not utilize derivativeinstruments for trading or speculative purposes.  As of December 31, 2002, our only derivatives in place wereforward contracts valued at $.1 million and designated as hedges of anticipatedcash flows in various foreign currencies and foreign currency option contractsvalued at $.2 million to hedge anticipated transactions.  This amount is recorded as a current assetin our Consolidated Balance Sheet.  (Seenote 3 to the consolidated financial statements.)

 

**Market Risk**

 

We incuroption premium cost in connection with our currency hedging activities.  The option premium cost represents theentire risk associated with these derivatives. Option premium costs are reflected in the period the underlyingtransaction is recognized.

 

##### **AccountingStandards**

 

##### **ITEM 8.**  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA

 

The FinancialStatements are set forth on pages F-1 through F-37 of this Annual Report.

 

**ITEM 9.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE SAME**

 

Notapplicable.

 

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**PART III**

 

**ITEM 10.  DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

Informationregarding Directors is incorporated by reference to the section entitled “Election of Directors” in the ALARIS Medical Proxy Statement tobe filed with the Securities and Exchange Commission in connection with theAnnual Meeting of Stockholders to be held on April 30, 2003 (the “Proxy Statement”). Information regarding Executive Officers is set forth in Item 1 of PartI of this Report under the caption “Executive Officers of the Registrant.”

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

Theinformation required by this Item is incorporated by reference to the Proxy Statement under the heading “Executive Compensation.”

 

**ITEM 12.  SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT**

 

Theinformation required by this Item is incorporated by reference to the Proxy Statement under the heading “Security Ownership of Certain BeneficialOwners and Management.”

##### ** **

##### **ITEM 13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

Theinformation required by this Item is incorporated by reference to the Proxy Statement under the heading “Certain Relationships and RelatedTransactions.”

 

##### **ITEM 14.  CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controls and Procedures*

 

As of December 31, 2002, an evaluation was performed under thesupervision and with the participation of the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (asdefined in the Securities Exchange Act of 1934 Rules 13a-14[c] and 15d-14[c] ).  Based on that evaluation, the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,concluded that the Company’s disclosure controls and procedures were effective as ofDecember 31, 2002 to ensure that information required to be disclosed by theCompany in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Commission’srules and forms.

 

*Changes in Internal Controls*

 

There have been no significant changes (including corrective actionswith regard to significant deficiencies or material weaknesses) in our internalcontrols or in other factors that could significantly affect internal controlssubsequent to December 31, 2002.

 

44

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**PART IV**

 

**ITEM 15.  EXHIBITS,FINANCIAL STATEMENT SCHEDULES, AND REPORTS ONFORM 8-K**

 
| (a)    |   | The following documents are filed as  part of this report. |
|--------|--------|------------------------------------------------------------|
|   |   |                                                       |   |
|   |   | **1.**                                                     | ***Financial Statements:*** |
|   |   |                                                       |   |
|   |   |                                                       | The following financial statements of ALARIS Medical Systems,  Inc. and its subsidiaries are included on pages F-1 through F-37: |
|   |   |                                                       |   |
|   |   |                                                       | Report of Independent Accountants |
|   |   |                                                       |   |
|   |   |                                                       | Consolidated Statement of Operations for the years ended  December 31, 2002,2001  and 2000 |
|   |   |                                                       |   |
|   |   |                                                       | Consolidated Balance Sheet at December 31, 2002 and 2001 |
|   |   |                                                       |   |
|   |   |                                                       | Consolidated Statement of Cash Flows for  the years ended December 31, 2002,2001 and 2000 |
|   |   |                                                       |   |
|   |   |                                                       | Consolidated Statement of Changes in Stockholder's Equity for the period fromDecember 31, 1999 to December 31,  2002 |
|   |   |                                                       |   |
|   |   |                                                       | Notes to Consolidated Financial  Statements |
|   |   |                                                       |   |
|   |   | **2.**                                                     | ***Financial Statement Schedules:*** |
|   |   |                                                       |   |
|   |   |                                                       | Schedule II – Valuation and Qualifying Accounts and Reserves for the  three years endedDecember  31, 2002 |
|   |   |                                                       |   |
|   |   |                                                       | All other schedules have been omitted  because they are inapplicable, not required or the required information is  included in the financial statements or notes thereto. |
|   |   |                                                       |   |
|   |   | **3.**                                                     | ***Exhibits:*** |

 
| **Exhibit No.** |   | **Description  of Exhibit**                                                                                                                                                                                                                                                                                                               |   | **Status of Filing**                                                                                         |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                         |
| 2.3             |   | Asset Purchase Agreement dated August 17, 2000, by and among ALARIS Medical,  ALARIS Medical Systems, Card Guard Scientific Survival Ltd. and Card Guard  Technologies, Inc. (Registrant agrees to furnish supplementally to the  Commission upon request a copy of all omitted schedules and exhibits to the  Asset Purchase Agreement.) |   | Incorporated by reference to Exhibit 2(a to ALARIS Medical Systems’  Form 8-K dated September 15, 2000. |
|            |   |                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                         |
| 3.1             |   | Restated  Certificate of Incorporation of ALARIS Medical Systems, Inc.                                                                                                                                                                                                                                                                    |   | Incorporated  by reference to ALARIS Medical Systems’ Form 10-K for the year ended December  31, 2002.  |

 

45

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| **Exhibit No.** |   | **Description  of Exhibit**                                                                                                                                                             |   | **Status of Filing**                                                                                                                                                                                                     |
|-----------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                     |
| 3.2             |   | By-Laws  of ALARIS Medical Systems, Inc.                                                                                                                                                |   | Incorporated by reference to Exhibit 3.3 to the  Registration Statement on Form S-4 (333-18687 of ALARIS Medical Systems (the  “2001 S-4”.)                                                                    |
|            |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                     |
| 4.1             |   | Indenture  dated as of November 26, 1996, among IMED Corporation, IMED International  Trading Corp. and United States Trust Company of New York, as trustee  (including form of notes). |   | Incorporated by reference to Exhibit 10.2 to ALARIS Medical’s  Form 8-K dated  December 11, 1996.                                                                                                                   |
|            |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                     |
| 4.2             |   | Indenture Assumption Agreement dated as of  November 26, 1996, between IVAC Holdings, Inc. and United States Trust  Company of New York, as trustee.                                    |   | Incorporated by reference to Exhibit 4.2 to the Registration Statement  on Form S-4 (333-18687 of ALARIS Medical Systems, IVAC Overseas Holdings,  Inc. and IMED International Trading Corp. (the “1996 S-4”). |
|            |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                     |
| 4.3             |   | Supplemental Indenture dated as of November  26, 1996, between IVAC Overseas Holdings, Inc. and United States Trust  Company of New York, as trustee.                                   |   | Incorporated by reference to Exhibit 4.3 to  the 1996 S-4.                                                                                                                                                               |
|            |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                     |
| 4.4             |   | Indenture dated October 16, 2001, between ALARIS Medical Systems and  HSBC Bank USA, as trustee (including form of notes).                                                              |   | Incorporated by reference to Exhibit 4.4 to  the 2001 S-4.                                                                                                                                                               |
|            |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                     |
| 4.5             |   | Registration Rights Agreement, dated as of October 16, 2001, by and  among ALARIS Medical Systems, UBS Warburg LLC and Bear, Stearns & Co.  Inc.                                    |   | Incorporated by reference to Exhibit 4.5 to the 2001 S-4.                                                                                                                                                                |
|            |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                     |
| 10.1            |   | Addendum to Employment Letter dated April 13, 1999, by and between  David L. Schlotterbeck, ALARIS Medical and ALARIS Medical Systems.                                                  |   | Incorporated by reference to ALARIS Medical’s  Annual Report on Form10-K  for the year ended December 31, 1999.                                                                                                     |
|            |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                     |
| 10.2            |   | Addendum to the Employment Letter dated April 13, 1999, by and between  David L. Schlotterbeck, ALARIS Medical and ALARIS Medical Systems dated May  22, 2002.                          |   | Incorporated by reference to Exhibit 10.2 to ALARIS Medical Systems’ Form 10-Q for the quarterly period ended June 30, 2002.                                                                                   |

 

46

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| **Exhibit No.** |   | **Description  of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                                |   | **Status of Filing**                                                                                                                |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                                |
| 10.3            |   | Change  in Control Agreement, dated April 20, 2000, between ALARIS Medical and  William C. Bopp.  (The Company has  entered into identical agreements with each of the following officers: David  L. Schlotterbeck, Sally M. Grigoriev, Jake St. Philip, Stuart E. Rickerson,  Frederic Denerolle, William H. Murphy and Robert F. Mathews.  Such agreements are identical to the  Change in Control Agreement with Mr. Bopp and are not filed.) |   | Incorporated by reference to Exhibit 10.17 to ALARIS Medical’s  Form 10-Q for  the quarterly period ended March 31, 2000. |
|            |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                                |
| 10.4            |   | Non-Qualified Stock Option Agreement by and  between David L. Schlotterbeck, ALARIS Medical, Inc. and ALARIS Medical  Systems, Inc.                                                                                                                                                                                                                                                                                                                        |   | Incorporated by reference to Exhibit 10.4 to the 2001 S-4.                                                                          |
|            |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                                |
| 10.5            |   | Non-Qualified Stock Option Agreement by and  between ALARIS Medical, ALARIS Medical Systems and William C. Bopp.                                                                                                                                                                                                                                                                                                                                           |   | Incorporated by reference to Exhibit 10.5 to the 2001 S-4.                                                                          |
|            |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                                |
| 10.6            |   | Non-Qualified Stock Option Agreement by and  between ALARIS Medical, ALARIS Medical Systems and Stuart E. Rickerson.                                                                                                                                                                                                                                                                                                                                       |   | Incorporated by reference to Exhibit 10.6 to the 2001 S-4.                                                                          |
|            |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                                |
| 10.7            |   | Non-Qualified Stock Option Agreement by and  between ALARIS Medical, ALARIS Medical Systems and William H. Murphy.                                                                                                                                                                                                                                                                                                                                         |   | Incorporated by reference to Exhibit 10.7 to the 2001 S-4.                                                                          |
|            |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                                |
| 21              |   | List of Subsidiaries of ALARIS Medical.                                                                                                                                                                                                                                                                                                                                                                                                                    |   | Filed herewith.                                                                                                                     |
|            |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                                |
| 99.1            |   | Certification by David L. Schlotterbeck pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                         |   | Filed herewith.                                                                                                                     |
| 99.2            |   | Certification by William C. Bopp pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                 |   | Filed herewith.                                                                                                                     |

 

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(b)              Reports on Form 8-K.

 

None.

 

47

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized, in the City of SanDiego, State of California, on March 5, 2003.

 
|   | Alaris Medical Systems, Inc.  |
|--------|------------------------------------|
|   |                               |   |
|   | By:                                | /s/  David L. Schlotterbeck |   |
|   | Name:                              | David L. Schlotterbeck |
|   | Title:                             | President and Chief Executive Officer |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| **Name**                          |   | **Title(s)**                                    |
|-----------------------------------|--------|-------------------------------------------------|
|                              |   |                                            |
| /s/ Norman  M. Dean          |   | Director and Chairman of the Board              |
| Norman M. Dean                    |   |                                            |
|                              |   |                                            |
| /s/   David L. Schlotterbeck |   | Director, President and Chief Executive Officer |
| David L. Schlotterbeck            |   |                                            |
|                              |   |                                            |
| /s/   William C. Bopp        |   | Sr. Vice President and Chief Financial Officer  |
| William C. Bopp                   |   | (Principal Financial Officer)                   |
|                              |   |                                            |
| /s/   Robert F. Mathews      |   | Vice President – Finance and Treasurer     |
| Robert F.   Mathews          |   | (Principal Accounting Officer)                  |
|                              |   |                                            |
| /s/   Hank Brown             |   | Director                                        |
| Hank Brown                        |   |                                            |
|                              |   |                                            |
| /s/   Henry Green            |   | Director                                        |
| Henry Green                       |   |                                            |
|                              |   |                                            |
| /s/   Barry Shalov           |   | Director                                        |
| Barry Shalov                      |   |                                            |
|                              |   |                                            |
| /s/   William Tumber         |   | Director                                        |
| William Tumber                    |   |                                            |

 

48

----

 

**CERTIFICATION BY DAVID L. SCHLOTTERBECKPURSUANT TO**

**SECURITIES EXCHANGE ACT RULE 13a-14**

 

 

I, David L. Schlotterbeck, certify that:

 

1. I have reviewed this annual report onForm 10-K of ALARIS Medical Systems, Inc.;

 

2. Based on my knowledge, this annualreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3. Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4. The registrant’s other certifying officer and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

 

a) designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b) evaluated the effectiveness of theregistrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

c) presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officer and I havedisclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board ofdirectors (or persons performing the equivalent function):

 

a) all significant deficiencies in thedesign or operation of internal controls which could adversely affect theregistrant’s abilityto record, process, summarize and report financial data and have identified forthe registrant’sauditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material,that involves management or other employees who have a significant role in theregistrant’s internalcontrols; and

 

6. The registrant’s other certifying officer and I haveindicated in this annual report whether or not there were significant changesin internal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

Date: March 5, 2003

 

/s/ DAVID L. SCHLOTTERBECK

David L. Schlotterbeck

President and Chief Executive Officer

 

49

----

 

**CERTIFICATION BY WILLIAM C. BOPP PURSUANTTO**

**SECURITIES EXCHANGE ACT RULE 13a-14**

 

 

I, William C. Bopp, certify that:

 

1. I have reviewed this annual report onForm 10-K of ALARIS Medical Systems, Inc.;

 

2. Based on my knowledge, this annualreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3. Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4. The registrant’s other certifying officer and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

 

a) designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b) evaluated the effectiveness of theregistrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

c) presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officer and I havedisclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board ofdirectors (or persons performing the equivalent function):

 

a) all significant deficiencies in thedesign or operation of internal controls which could adversely affect theregistrant’s abilityto record, process, summarize and report financial data and have identified forthe registrant’sauditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material,that involves management or other employees who have a significant role in theregistrant’s internalcontrols; and

 

6. The registrant’s other certifying officer and I haveindicated in this annual report whether or not there were significant changesin internal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

Date: March 5, 2003

 

/s/ WILLIAM C. BOPP

William C. Bopp

Senior Vice President and Chief FinancialOfficer

 

50

----

 

**ALARIS MEDICAL SYSTEMS, INC.**

**Index to Consolidated FinancialStatements**

 
| **1.** | ***Financial  Statements:***                                                                                               |
|--------|----------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                       |
|   |                                                                                                                       |
|   | Report of Independent  Accountants                                                                                         |
|   |                                                                                                                       |
|   | Consolidated  Statement of Operations for the years ended December 31, 2002,2001 and 2000                                  |
|   |                                                                                                                       |
|   | Consolidated Balance Sheet  at December 31, 2002 and 2001                                                                  |
|   |                                                                                                                       |
|   | Consolidated  Statement of Cash Flows for the years ended December 31, 2002,2001 and 2000                                  |
|   |                                                                                                                       |
|   | Consolidated  Statement of Changes in Stockholder’s Equity for the period fromDecember  31, 1999 to December 31, 2002 |
|   |                                                                                                                       |
|   | Notes to  Consolidated Financial Statements                                                                                |
|   |                                                                                                                       |
| **2.** | ***Financial  Statement Schedules:***                                                                                      |
|   |                                                                                                                       |
|   | Schedule  II–Valuation and Qualifying Accounts and Reserves for the three years ended  December 31, 2002              |

 

F-1

----

 

### **REPORT OF INDEPENDENT ACCOUNTANTS**

 

To** **theBoard of Directors and Stockholders

of ALARIS Medical Systems, Inc.:

 

In our opinion, the consolidatedfinancial statements listed in the index appearing under Item 15(a) (1) on page 45 presentfairly, in all material respects, the financial position of ALARIS MedicalSystems, Inc. and its subsidiaries at December 31, 2002 and 2001, and the results of****their****operations and their****cashflows for each of the three years in the period ended December 31, 2002 in conformity withaccounting principles generally accepted in the United States of America.  In addition, in our opinion, the financialstatement schedule listed in the index appearing under Item 15(a)(2) on page 45presents fairly, in all material respects, the information set forth thereinwhen read in conjunction with the related consolidated****financial statements.  These financial statements and financialstatement schedule are the responsibility of the Company’s management; ourresponsibility is to express an opinion on these financial statements and financialstatement schedule based on our audits. We conducted our audits of these statements in accordance with auditingstandards generally accepted in the United States of America, which requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

As discussed in Notes 1 and 2 ofthe consolidated financial statements, as of January 1, 2002, the Company ceasedamortization of its goodwill and indefinite lived assets to conform with theprovisions of Statement of Financial Accounting Standards No. 142, “*Goodwill andOther Intangible Assets*.”

 

#### PricewaterhouseCoopersLLP

#### SanDiego, CA

#### February 25,2003

 

F-2

----

 

**ALARIS MEDICAL SYSTEMS, INC.**

**CONSOLIDATED STATEMENTOF OPERATIONS**

 

*(Dollar amounts in thousands, except share and per sharedata)*

 
|                                                                                                                                     |   | **Year Ended December 31,** |    |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|
|                                                                                                                                     |   | **2002**                    |    | **2001** |   | **2000** |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Sales                                                                                                                                    |   | $                           | 460,333 |   | $ | 412,795 |   | $ | 378,948 |   |
| Cost of sales                                                                                                                            |   | 232,989                     |    | 211,601 |   | 202,964 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Gross profit                                                                                                                             |   | 227,344                     |    | 201,194 |   | 175,984 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Selling and marketing expenses                                                                                                           |   | 88,562                      |    | 80,021 |   | 72,340 |   |
| General and administrative expenses                                                                                                      |   | 40,247                      |    | 47,182 |   | 37,891 |   |
| Research and development expenses                                                                                                        |   | 30,378                      |    | 27,060 |   | 21,570 |   |
| Restructuring and other non-recurring items                                                                                              |   | (585                        | )       | 6,889 |   | 7,048 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Total operating expenses                                                                                                                 |   | 158,602                     |    | 161,152 |   | 138,849 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Interest income from sales-type capital leases                                                                                           |   | 4,345                       |    | 5,141 |   | 5,095 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Income from operations                                                                                                                   |   | 73,087                      |    | 45,183 |   | 42,230 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Other income (expenses):                                                                                                                 |   |                        |    |   |   |   |   |
| Interest income                                                                                                                          |   | 1,048                       |    | 1,979 |   | 1,313 |   |
| Interest expense                                                                                                                         |   | (39,529                     | )       | (41,650 | ) | (41,543 | ) |
| Other, net                                                                                                                               |   | (1,050                      | )       | (3,959 | ) | (140 | ) |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Total other expense                                                                                                                      |   | (39,531                     | )       | (43,630 | ) | (40,370 | ) |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Income from continuing operations before income taxes                                                                                    |   | 33,556                      |    | 1,553 |   | 1,860 |   |
| Provision for income taxes                                                                                                               |   | 13,201                      |    | 3,223 |   | 3,200 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Income (loss) from continuing operations                                                                                                 |   | 20,355                      |    | (1,670 | ) | (1,340 | ) |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Discontinued operations:                                                                                                                 |   |                        |    |   |   |   |   |
| Income (loss) from operations of discontinuedbusiness [net of applicable income tax  expense (benefits) of$180 and ($872), respectively] |   | —                      |    | 270 |   | (1,308 | ) |
| Gain on disposal of business [net of applicableincome tax expense of $2,492 and  $1,226, respectively]                                   |   | —                      |    | 3,737 |   | 1,839 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Total income from discontinued operations                                                                                                |   | —                      |    | 4,007 |   | 531 |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Income (loss) before extraordinary item                                                                                                  |   | 20,355                      |    | 2,337 |   | (809 | ) |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Extraordinary item: Debt extinguishment loss [net of applicableincome tax benefit of $296] (note  6)                                     |   | —                      |    | (443 | ) | — |   |
|                                                                                                                                     |   |                        |    |   |   |   |   |
| Net income (loss)                                                                                                                        |   | $                           | 20,355  |   | $ | 1,894 |   | $ | (809 | ) |

 

*The accompanying notes are an integralpart of these consolidated financial statements.*

 

F-3

----

 

**ALARIS MEDICAL SYSTEMS, INC.**

**CONSOLIDATEDBALANCE SHEET**

** **

*(Dollars in thousands)*

 
|                                                                                                                                                        |   | **December 31,** |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------|---------|
|                                                                                                                                                        |   | **2002**         |    | **2001** |   |
|                                                                                                                                                        |   |             |    |   |   |
| **ASSETS**                                                                                                                                                  |   |             |    |   |   |
|                                                                                                                                                        |   |             |    |   |   |
| Current assets:                                                                                                                                             |   |             |    |   |   |
| Cash and cash equivalents                                                                                                                                   |   | $                | 68,483  |   | $ | 50,826 |   |
| Receivables, net                                                                                                                                            |   | 90,050           |    | 67,893 |   |
| Inventories                                                                                                                                                 |   | 56,924           |    | 69,408 |   |
| Prepaid expenses and other current assets                                                                                                                   |   | 22,289           |    | 33,456 |   |
|                                                                                                                                                        |   |             |    |   |   |
| Total current assets                                                                                                                                        |   | 237,746          |    | 221,583 |   |
|                                                                                                                                                        |   |             |    |   |   |
| Net investment in sales-type capital leases, less current  portion                                                                                          |   | 16,050           |    | 24,225 |   |
| Property, plant and equipment, net                                                                                                                          |   | 56,448           |    | 57,607 |   |
| Other non-current assets                                                                                                                                    |   | 25,627           |    | 28,013 |   |
| Goodwill, net                                                                                                                                               |   | 142,570          |    | 142,570 |   |
| Other intangible assets, net                                                                                                                                |   | 90,074           |    | 92,394 |   |
|                                                                                                                                                        |   |             |    |   |   |
|                                                                                                                                                        |   | $                | 568,515 |   | $ | 566,392 |   |
|                                                                                                                                                        |   |             |    |   |   |
| **LIABILITIES AND STOCKHOLDER’S EQUITY**                                                                                                               |   |             |    |   |   |
|                                                                                                                                                        |   |             |    |   |   |
| Current liabilities:                                                                                                                                        |   |             |    |   |   |
| Accounts payable                                                                                                                                            |   | $                | 19,139  |   | $ | 23,856 |   |
| Accrued expenses and other current liabilities                                                                                                              |   | 50,551           |    | 51,733 |   |
|                                                                                                                                                        |   |             |    |   |   |
| Total current liabilities                                                                                                                                   |   | 69,690           |    | 75,589 |   |
|                                                                                                                                                        |   |             |    |   |   |
| Long-term debt                                                                                                                                              |   | 350,000          |    | 350,000 |   |
| Other non-current liabilities                                                                                                                               |   | 47,943           |    | 47,676 |   |
|                                                                                                                                                        |   |             |    |   |   |
| Total non-current liabilities                                                                                                                               |   | 397,943          |    | 397,676 |   |
|                                                                                                                                                        |   |             |    |   |   |
| Contingent liabilities and commitments (notes 10 and 15)                                                                                                    |   |             |    |   |   |
|                                                                                                                                                        |   |             |    |   |   |
| Common stock and other stockholder’s equity:                                                                                                           |   |             |    |   |   |
| Common stock and capital in excess of par value, authorized  3,000common shares  at $.01 par value; 100 issued and outstandingat December 31, 2002 and 2001 |   | 203,857          |    | 203,716 |   |
| Accumulated deficit                                                                                                                                         |   | (83,244          | )       | (101,562 | ) |
| Loan to Holdings (note 6)                                                                                                                                   |   | (14,993          | )       | — |   |
| Accumulated other comprehensive loss                                                                                                                        |   | (4,738           | )       | (9,027 | ) |
|                                                                                                                                                        |   |             |    |   |   |
| Total stockholder’s equity                                                                                                                             |   | 100,882          |    | 93,127 |   |
|                                                                                                                                                        |   |             |    |   |   |
|                                                                                                                                                        |   | $                | 568,515 |   | $ | 566,392 |   |

 

*The accompanying notes are an integralpart of these consolidated financial statements.*

 

F-4

----

 

**ALARIS MEDICAL SYSTEMS, INC.**

**CONSOLIDATED STATEMENT OF CASH FLOWS**

 

*(Dollars in thousands)*

 
|                                                                                      |   | **Year Ended December 31,** |   |
|-------------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                      |   | **2002**                    |   | **2001** |   | **2000** |   |
| **Cash  flows from operating activities:**                                                |   |                        |   |   |   |   |   |
| Net income (loss)                                                                         |   | $                           | 20,355 |   | $ | 1,894 |   | $ | (809 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities: |   |                        |   |   |   |   |   |
| Depreciation and amortization                                                             |   | 23,958                      |   | 31,913 |   | 33,182 |   |
| Net loss on disposal of property, plant and equipment and write-off  ofintangibles        |   | 709                         |   | 273 |   | 1,726 |   |
| Debt issue costs amortization                                                             |   | 2,211                       |   | 2,349 |   | 3,114 |   |
| Accretion of paid-in-kind interest                                                        |   | —                      |   | 1,697 |   | — |   |
| Deferred tax expense (benefit), continuing operations                                     |   | 8,031                       |   | (2,091 | ) | (2,310 | ) |
| Gain on sale of Instromedix (note 4)                                                      |   | —                      |   | (3,737 | ) | (1,839 | ) |
| Extraordinary loss on extinguishment of debt (note 6)                                     |   | —                      |   | 443 |   | — |   |
| (Increase) decrease in assets:                                                            |   |                        |   |   |   |   |   |
| Receivables, net                                                                          |   | (18,011                     | )      | 11,544 |   | 2,638 |   |
| Inventories                                                                               |   | 13,413                      |   | (9,046 | ) | 14,131 |   |
| Prepaid expenses and other current assets                                                 |   | 782                         |   | (3,553 | ) | (4,802 | ) |
| Net investment in sales-type capital leases, non-current portion                          |   | 8,175                       |   | 1,695 |   | (1,513 | ) |
| Other non-current assets                                                                  |   | (649                        | )      | (187 | ) | (2,136 | ) |
| Increase (decrease) in liabilities:                                                       |   |                        |   |   |   |   |   |
| Accounts payable                                                                          |   | (6,321                      | )      | 1,832 |   | (2,960 | ) |
| Accrued expenses and other current liabilities                                            |   | (1,988                      | )      | 12,369 |   | (7,024 | ) |
| Other non-current liabilities                                                             |   | 2,825                       |   | 9,427 |   | 19,520 |   |
|                                                                                      |   |                        |   |   |   |   |   |
| Net cash provided by operating activities                                                 |   | 53,490                      |   | 56,822 |   | 41,918 |   |
|                                                                                      |   |                        |   |   |   |   |   |
| **Cash  flows from investing activities:**                                                |   |                        |   |   |   |   |   |
| Capital expenditures                                                                      |   | (18,225                     | )      | (17,642 | ) | (14,945 | ) |
| Patents, trademarks and other                                                             |   | (1,475                      | )      | (703 | ) | (1,093 | ) |
| Loan to Holdings (note 6)                                                                 |   | (14,812                     | )      | — |   | — |   |
| Payments for product licenses and distribution rights                                     |   | —                      |   | (1,801 | ) | (1,940 | ) |
| Proceeds from disposal of property, plant and equipment                                   |   | 86                          |   | 152 |   | 48 |   |
| Net proceeds from sale of discontinued business (note 4)                                  |   | —                      |   | 8,051 |   | 17,516 |   |
|                                                                                      |   |                        |   |   |   |   |   |
| Net cash used in investing activities                                                     |   | (34,426                     | )      | (11,943 | ) | (414 | ) |
|                                                                                      |   |                        |   |   |   |   |   |
| **Cash  flows from financing activities:**                                                |   |                        |   |   |   |   |   |
| Principal payments on long-term debt and capital lease obligations                        |   | —                      |   | (183,967 | ) | (31,652 | ) |
| Proceeds from issuance of long-term debt                                                  |   | —                      |   | 170,000 |   | — |   |
| Dividends to Holdings                                                                     |   | (2,037                      | )      | (2,367 | ) | (2,030 | ) |
| Debt issuance/deferred financing costs                                                    |   | —                      |   | (8,048 | ) | (650 | ) |
|                                                                                      |   |                        |   |   |   |   |   |
| Net cash used in financing activities                                                     |   | (2,037                      | )      | (24,382 | ) | (34,332 | ) |
|                                                                                      |   |                        |   |   |   |   |   |
| Effect of exchange rate changes on cash                                                   |   | 630                         |   | (289 | ) | (93 | ) |
|                                                                                      |   |                        |   |   |   |   |   |
| Net increase in cash                                                                      |   | 17,657                      |   | 20,208 |   | 7,079 |   |
| Cash and cash equivalents  at beginning of period                                         |   | 50,826                      |   | 30,618 |   | 23,539 |   |
|                                                                                      |   |                        |   |   |   |   |   |
| Cash and cash equivalents  at end of period                                               |   | $                           | 68,483 |   | $ | 50,826 |   | $ | 30,618 |   |

 

*The accompanying notes are an integralpart of these consolidated financial statements.*

 

F-5

----

 

**ALARIS MEDICAL SYSTEMS, INC.**

**CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER’S EQUITY**

 

*(Dollars in thousands)*

** **
|                                                                                          |   | **Common  Stock  And Capital  In Excess Of Par Value** | ** ** | **Accumulated****Deficit** |    | **Loan****Receivablefrom****Holdings** |   | **Accumulated****OtherCompre-hensiveLoss** |   | **Total  Stockholder’s E****quity** |    | **Compre- hensive  (Loss)****Income** |   |
|-----------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|------------|----------------------------|---------|----------------------------------------|--------|--------------------------------------------|--------|------------------------------------------|---------|---------------------------------------|--------|
|                                                                                          |   |                                                   |       |                       |    |                                   |
|                                                                                          |   |                                                   |       |                       |    |                                   |
|                                                                                          |   |                                                   |       |                       |    |                                   |
|                                                                                          |   | **Shares**                                             |       | **Amount**                 |    |                                   |   |                                       |   |                                     |
| Balance at December 31, 1999                                                                  |   | 100                                                    |       | $                          | 203,684 |                                   | $      | (98,250                                    | )      | $                                        | —  |                                  | $      | (4,313 | ) | $ | 101,121 |   |   |   |
|                                                                                          |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Comprehensive loss:                                                                           |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Net loss for the year                                                                         |   | —                                                 |       | —                     |    | (809                                   | )      | —                                     |   | —                                   |    | (809                                  | )      | $ | (809 | ) |
| Equity adjustment from foreigncurrency translation                                            |   | —                                                 |       | —                     |    | —                                 |   |                                       |   | (3,226                                   | )       | (3,226                                | )      | (3,226 | ) |
| Comprehensive loss                                                                            |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   | $ | (4,035 | ) |
| Dividends to Holdings                                                                         |   | —                                                 |       | —                     |    | (2,030                                 | )      | —                                     |   | —                                   |    | (2,030                                | )      |   |   |
|                                                                                          |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Balance at December 31, 2000                                                                  |   | 100                                                    |       | 203,684                    |    | (101,089                               | )      |                                       |   | (7,539                                   | )       | 95,056                                |   |   |   |
|                                                                                          |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Comprehensive loss:                                                                           |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Net income for the year                                                                       |   | —                                                 |       | —                     |    | 1,894                                  |   | —                                     |   | —                                   |    | 1,894                                 |   | $ | 1,894 |   |
| Equity adjustment from foreigncurrency translation                                            |   | —                                                 |       | —                     |    | —                                 |   |                                       |   | (1,401                                   | )       | (1,401                                | )      | (1,401 | ) |
| Effects of cash flow hedgesincluded in other comprehensiveloss (net of tax expense of $58)    |   | —                                                 |       | —                     |    | —                                 |   | —                                     |   | (87                                      | )       | (87                                   | )      | (87 | ) |
| Comprehensive loss                                                                            |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   | $ | 406 |   |
| Tax benefit from exercise of Holdingsstock options                                            |   | —                                                 |       | 32                         |    | —                                 |   |                                       |   | —                                   |    | 32                                    |   |   |   |
| Dividends to Holdings                                                                         |   | —                                                 |       | —                     |    | (2,367                                 | )      | —                                     |   | —                                   |    | (2,367                                | )      |   |   |
|                                                                                          |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Balance at December 31, 2001                                                                  |   | 100                                                    |       | 203,716                    |    | (101,562                               | )      | —                                     |   | (9,027                                   | )       | 93,127                                |   |   |   |
|                                                                                          |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Comprehensive loss:                                                                           |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Net income for the year                                                                       |   | —                                                 |       | —                     |    | 20,355                                 |   |                                       |   | —                                   |    | 20,355                                |   | $ | 20,355 |   |
| Equity adjustment from foreign currency translation                                           |   | —                                                 |       | —                     |    | —                                 |   | —                                     |   | 4,343                                    |    | 4,343                                 |   | 4,343 |   |
| Effects of cash flow hedges included in other comprehensive loss (net  of tax expense of $36) |   | —                                                 |       | —                     |    | —                                 |   | —                                     |   | (54                                      | )       | (54                                   | )      | (54 | ) |
| Comprehensive loss                                                                            |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   | $ | 24,644 |   |
| Tax benefit from exercise of Holdings stock options                                           |   | —                                                 |       | 141                        |    | —                                 |   |                                       |   | —                                   |    | 141                                   |   |   |   |
| Loan to Holdings (Note 6)                                                                     |   | —                                                 |       | —                     |    | —                                 |   | (14,993                                    | )      |                                     |    | (14,993                               | )      |   |   |
| Dividends to Holdings                                                                         |   | —                                                 |       | —                     |    | (2,037                                 | )      |                                       |   | —                                   |    | (2,037                                | )      |   |   |
|                                                                                          |   |                                                   |       |                       |    |                                   |   |                                       |   |                                     |    |                                  |   |   |   |
| Balance at December 31, 2002                                                                  |   | 100                                                    |       | $                          | 203,857 |                                   | $      | (83,244                                    | )      | $                                        | (14,993 | )                                     | $      | (4,738 | ) | $ | 100,882 |   |   |   |

 

*The accompanying notes are an integralpart of these consolidated financial statements.*

 

F-6

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**ALARIS MEDICAL SYSTEMS, INC.**

# **NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

*(Amountsin thousands, except per share data)*

 

# **NOTE 1**-BUSINESS, ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

# ** **

# **The Company:**

 

ALARIS Medical Systems, Inc. (“ALARIS MedicalSystems”), designs, manufactures, distributes and services intravenous infusiontherapy and patient monitoring instruments and related disposables andaccessories.  ALARIS Medical Systems wasformed by the merger of two pioneers in infusion systems, IMED Corporation(“IMED”) and IVAC Medical Systems (“IVAC”), Inc. on November 26, 1996. ALARIS Medical Systems, a wholly-owned subsidiary ofALARIS Medical, Inc. (“ALARIS Medical” or “Holdings”), formerly Advanced Medical,Inc., was incorporated on October 14, 1994 under the laws of the State ofDelaware.  ALARIS Medical Systems and its subsidiaries arecollectively referred to as the “Company” or “ALARIS.”

 

**Summary of Significant AccountingPolicies:**

 

**Consolidation:**

 

The financialstatements include the accounts of ALARIS Medical Systems and its subsidiaries.  All subsidiaries of ALARIS Medical Systemsare wholly owned.  The Company does nothave any equity method investments.  Allintercompany accounts and transactions have been eliminated in consolidation.

 

**Use of estimates:**

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of revenues, costs and expenses, assets,liabilities and related disclosure of contingent amounts.  Our estimates are based on historicalexperience and various judgments and assumptions we believe are appropriate.  However, the inherent nature of estimates isthat actual results will likely be different from the estimates made.  The more significant estimates made in thepreparation of these financial statements include:

 

**Revenue recognition:**

 

# **Revenue, net of an allowance forestimated returns and rebates, under any sales arrangement is recognized onlyif there is a completed agreement (executed written contract or purchaseorder); the fee is fixed, collectibility is probable, delivery of the productor service has been completed and transfer of title and risk of loss haveoccurred.  The Company frequently entersinto revenue arrangements with multiple deliverables, which are subject to theprovisions of Securities and Exchange Commission Staff Accounting Bulletin No.101,**“*RevenueRecognition in Financial Statements*” (SAB 101) and Emerging Issues Task Force Abstract IssueNo. 00-21, “*Revenue Arrangementswith Multiple Deliverables*” (EITF 00-21).  Forarrangements under EITF 00-21, revenue is divided among the separate units ofaccounting (deliverables) based on their relative fair value and is recognizedfor each deliverable in accordance with the applicable revenue recognitioncriteria.  However, in instances whenfair value exists only for the undelivered elements, the residual method isused to allocate total consideration.

# ** **

In addition to outright sales arrangements with multipledeliverables, the Company sells instruments via long-term agreements to anumber of customers under contracts which allow customers to acquireinstruments with no initial payment. The sales price for the instruments is recovered via surcharges appliedto minimum purchase commitments of related disposables.  These agreements are referred to herein andaccounted for as sales-type capital leases. The term of the financing is generally three to seven years, with annualinterest rates of 9% to 15%.  Underthese arrangements, revenue is then recognized for instruments upon delivery of the product. Unearnedfinance revenue on sales-type capital leases is calculated using the 

 

F-7

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inherent rateof interest on each agreement, the expected disposable shipment period and theprincipal balance financed, and is recognized as disposables are deliveredusing a reducing principal balance method which approximates the interestmethod.  Contract provisions includeliquidated damage clauses which are sufficient to recover the sales price ofthe instruments in the event of customer non-compliance.

# ** **

# **The Company also provides instruments tocustomers under contracts with no minimum commitment quantity for disposableproducts and terms ranging from one to five years.  No revenue is recognized upon the shipment of theinstruments.  A surcharge is applied todisposable products to recover the cost of the instruments and revenue isrecognized upon delivery of the disposables. The instruments are reclassified from inventory to property, plant andequipment upon shipment, depreciated over their estimated useful lives, (whichmanagement has determined to be over the life of the contract) and included incapital expenditures in the consolidated statement of cash flows.**

 

With theintroduction of ALARIS’Medley Medication Safety System and Guardrails safety software, the Companytransitioned from selling infusion devices which contain software incidental tothe product, to selling safety systems which contain software essential to thefunctionality of the product.  Theelements of safety system sales arrangements may contain:  infusion devices, disposables, software,software maintenance programs and professional services.  These multiple element arrangements aresubject to the provisions of Statement of Position 97-2 “*Software Revenue Recognition*,” (SOP 97-2) and total fees are allocated to each elementbased on vendor-specific objective evidence of fair value for each element orusing the residual method, when applicable. Vendor-specific objective evidence is generally based on the pricecharged when an element is sold separately, or if it has not yet been sold (asin the case of new products), when the fee is set by management with therequisite authority.  Allocated fees arerecognized separately for each element when it is delivered and our contractualobligation with relation to that element is complete.  Perpetual software license revenue is generally recognized uponshipment to the customer.  Softwaremaintenance revenue is recognized ratably over the contract period.  Vendor-specific objective evidence forsoftware maintenance is determined based on contract renewal price for suchmaintenance.  Rights to unspecifiedsoftware upgrades (on a when-and-if available basis) are included in softwaremaintenance.  New software products aresold separately and revenue is recognized upon delivery to the customer.  Professional service revenue is recognizedwhen services are rendered.  Suchservices are sold separately from ALARIS’ products and are not considered essential to the functionality of theproducts.

 

All product returns must be approved by ALARIS andhave historically not been significant. Rebates to end user customers and administrative fees paid to grouppurchasing organizations are recorded as a reduction to revenue at the time ofthe sale, based on the percent defined in the contractual arrangement.  Sales to certain third party distributors inthe United States are recognized when information is received from thedistributor on placement of our products to the end user customer and the finalnet purchase price is known.

 

**Concentrations of credit risk:**

 

The Company’s financial instruments that are subjectto concentrations of credit risk consist primarily of cash and cashequivalents, short-term investments and accounts receivable.  The Company’s policy is to place its cash and cash equivalents andshort-term investments with high quality financial institutions in order tolimit its credit exposure.  To date, theCompany has not experienced any credit losses associated with these financialinstruments.

 

F-8

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The Companyprovides a variety of financing arrangements for its customers.  The majority of the Company’s accounts receivable are from hospitalsthroughout the United States, Europe, Canada and Australia with credit terms ofgenerally 30 to 90 days, although various European markets pay much longer thanthe contractual terms.  The Companymaintains adequate reserves for potential credit losses and such losses havebeen within management’sestimates.

 

**Cash and cash equivalents:**

 

Cashequivalents include highly liquid, temporary cash investments having originalmaturity dates of three months or fewer.

 

In connection with its hedging program (note 3), the Company maintainsforeign exchange lines which are secured by cash equivalent investment accountswith banks providing the lines.  Theinvestment accounts serve as collateral for the foreign exchange lines.  At December 31, 2002, the Company maintaineda total balance in the accounts of $7,341.

 

**Inventories:**

 

Inventoriesare stated at the lower of cost, determined by the first-in, first-out (FIFO)method, or market.

 

**Property, plant and equipment:**

 

Property,plant and equipment are stated at cost. The Company capitalizes costs of computer software developed or obtainedfor internal use.  Capitalization beginswhen it is probable that the project will be completed, funding for the projecthas been committed and the project’s conceptual formulation and design is complete.  Capitalization ceases when the project issubstantially complete and ready for use. When assets are retired or sold, the assets and accumulated depreciationare removed from the respective accounts and any gain or loss isrecognized.  Depreciation andamortization for the majority of the Company’s assets is provided using the straight-line method basedupon the following estimated useful lives of the assets (or lease terms, ifshorter, for leasehold improvements). Beginning in the fourth quarter of 2002, due to a change in forecastedusage and estimated remaining life, depreciation on the Company’s enterprise-wide information system hasbeen accelerated and is provided using the sum-of-the-years-digits method withaneightyear life.  The effect on income before extraordinaryitems and net income was $126, net of tax, for the year ended December 31, 2002and there was no effect on earnings per share for the period.

 

| Building and leasehold improvements                  |   | 3 to 10 years  |   |
|------------------------------------------------------|--------|----------------|--------|
| Machinery and equipment                              |   | 3 to 10  years |   |
| Information technology (including computer software) |   | 3 to 10  years |   |
| Furniture and fixtures                               |   | 4 to 10 years  |   |
| Instruments at customers                             |   | 1 to 5  years  |   |

 

F-9

----

 

**Capitalized patent issuance and trademarkcosts:**

 

The Companycapitalizes patent issuance and trademark registration costs.  These costs are amortized using thestraight-line method over the estimated period of benefit, an average of sevenyears for the periods presented.  AtDecember 31, 2002 and 2001, the unamortized capitalized patent issuance andtrademark registration costs were $3,375 and $2,719, respectively.

 

The Companycapitalizes amounts paid to third parties for licenses to use certaintechnologies in its products.  Thedeferred costs are amortized over the estimated period of benefit using thestraight-line method.  The period ofamortization for capitalized patent licenses ranges from two to fifteen years.  In determining the amortization period,consideration is given to the term of the license agreement; the estimatedsales related to the product, the technological feasibility of the licensedproduct and whether or not the technology is exclusive.  At December 31, 2002 and 2001, theunamortized patent license agreement costs were $6,902 and $8,242.

 

**Intangible assets:**

 

The Companyhas recorded goodwill for the excess purchase price over the fair values oftangible and intangible assets acquired and liabilities assumed resulting fromacquisitions.  Upon adoption ofStatement of Financial Accounting Standards No. 141, “*Business Combinations”* (“FAS141”) and Statementof Financial Accounting Standards No. 142, “*Goodwilland Intangible Assets”* (“FAS142”) in January2002, the Company ceased amortization of goodwill (including acquiredworkforce) and a certain trademark.  Theremaining intangible assets are amortized over their expected useful lives.  (See note 2 “Goodwill and Other IntangibleAssets-Adoption of FASB Statements 141 and 142.”)

 

Intangibleassets are amortized as follows:

 

| Patents                                 |   | Straight-line |   | 8 years (weighted average)  |   |
|-----------------------------------------|--------|---------------|--------|-----------------------------|--------|
| Product licensing and distribution fee  |   | Straight-line |   | 15-18  years                |   |
| Trademark                               |   |          |   | Not amortized  (see note 2) |   |
| Goodwill (including acquired workforce) |   |          |   | Not amortized  (see note 2) |   |

 

**Impairment of long-lived assets:**

 

The Companyassesses potential impairments of long-lived assets and certain intangibles onan exception basis, when there is evidence that events or changes incircumstances may have made recovery of an asset’s carrying value unlikely.  An impairment loss is recognized when thesum of the expected, undiscounted future net cash flows is lessthan the carrying amount of the asset. The amount of impairment loss, if any, will generally be measured as thedifference between the net book value of the assets and their estimated fairvalues.  At December 31, 2002, no suchimpairment losses have been recorded.

 

In addition,goodwill and other intangible assets which are not amortized in accordance withFAS 142, “*Goodwill and IntangibleAssets,”* aretested for impairment annually during the first quarter of the Company’s fiscal year, or more frequently ifevents indicate possible impairment.  Animpairment loss is recognized if the carrying amount of the asset exceeds itsfair value.  For impairment testing,goodwill 

 

F-10

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($142,570 atDecember 31, 2002 and 2001) was allocated to the Company’s reportable segments as follows:  North America $98,209 and International$44,361.  The Company has not changedthe allocation of goodwill since adopting FAS 142.  At December 31, 2002, no impairment losses have been recorded.

 

**Debt issue costs:**

 

Debt issuecosts, net of amortization, aggregating $8,716 and $10,886 at December 31, 2002and 2001, respectively, are amortized using the interest method.

 

**Foreign currency translation:**

 

The accountsof foreign subsidiaries which use local currencies as functional currencies aretranslated into U.S. dollars using year-end exchange rates for assets andliabilities, historical exchange rates for equity and average exchange ratesduring the period for revenues and expenses. The gains or losses resulting from translations are excluded fromresults of operations and accumulated as a separate component of othercomprehensive income (loss).

 

**Research and development costs:**

 

Research anddevelopment costs are expensed as incurred.

 

**Software production costs:**

 

Some of theCompany’s productsinclude embedded software which is essential to the products’ functionality.  The Company capitalizes software production costs when theproject reaches technological feasibility and ceases capitalization when theproject is ready for release.  Softwareproduction costs are amortized using the greater of:  a) the ratio of current gross revenue for the related product tototal current and anticipated gross revenue for the related product or b) thestraight-line method over the remaining estimated economic life of theproduct.  Amortization begins when theproduct is available for general release to the customer.  Unamortized capitalized software productioncosts at December 31, 2002 and 2001 were $1,515 and $1,958, respectively, andare included in property, plant and equipment. Amortization expense was $443 and $259 for the years ended December 31,2002 and 2001, respectively.

 

**Fair value of financial instruments:**

 

The carryingamount of the Company’sfinancial instruments, including cash, trade receivables and payables,approximates their fair value due to their short-term maturities.  The fair values of the Company’s sales-type capital lease receivablesare estimated by discounting future cash flows using discount rates thatreflect the risk associated with similar types of loans.  The estimated fair values of the Company’s sales-****type capital leasereceivables approximate their carrying values. The fair value of the Company’s long-term debt is estimated based on current ratesoffered to the Company for debt of the same remaining maturities and the quotedmarket price for the notes.  At December31, 2001, there was no quoted market price for ALARIS Medical Systems’ senior secured notes; however, theCompany believed the estimated fair value of the senior secured notesapproximated its carrying value.

 

F-11

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The carryingvalues and fair values of the Company’s debt at December 31, 2002 and 2001 were as follows:

 
|                                      |   | **December 31, 2002** |       | **December 31, 2001** |       |
|-------------------------------------------|--------|-----------------------|------------|-----------------------|------------|
|                                      |   | **Carrying****Value** | ** ** | **Fair****Value**     | ** ** | **Carrying****Value** | ** ** | **Fair****Value** | ** ** |
|                                      |   |                  |       |                  |       |   |   |   |   |
| 9-3/4% senior subordinated notes due 2006 |   | $                     | 180,000    |                  | $          | 181,800 |   | $ | 180,000 |   | $ | 171,000 |   |
| 11-5/8% senior secured notes due 2006     |   | 170,000               |       | 191,250               |       | 170,000 |   | 170,000 |   |
|                                           |        |                       |            |                       |            |  |  |  |  |  |  |  |  |

 

**Product warranties and deferred service revenues:**

 

Generally, theCompany’s standardwarranty for infusion instruments is a one or two year warranty (based on thespecific product) that covers both parts and labor.  In some instances, a customer may elect to have parts-only warranty coverage,which adds a year to the coverage period and limits coverage to partsonly.  Patient monitoring productsgenerally have a 3 year parts and labor warranty.  For patient monitoring products the Company sells that are manufactured by a third party,the Company passes on to the customer the warranty provided by themanufacturer.  The Company provides forthe estimated cost of product warranties at the time revenue is recognized.  The Company’s product warranty liability reflects management’s best estimate of probable liabilityunder its product warranties. Management estimates the liability based on the Company’s stated warranty policies and practices,the historical frequency of claims, and the cost to replace or repair itsproducts under warranty.

 

The Company also engages in the sale of professionaland technical services for which revenue is deferred and recognized uponcompletion of the service. Additionally, the Company sells extended on-site service programs forwhich revenue is deferred and recognized over the service period.  Changes in the liability for productwarranty and deferred service revenue associated with these service programs forthe period ended December 31, 2002 was as follows (in thousands):

 
| **Product  warranties:**                          |   |   |   |
|---------------------------------------------------|--------|--------|--------|
| Balance at December 31, 2001                      |   | $      | 8,023  |   |
| Accruals for  warranties issued during the period |   | 9,697  |   |
| Accruals related  to pre-existing warranties      |   | (321   | )      |
| Settlements made  during the period               |   | (8,842 | )      |
| Balance at  December 31, 2002                     |   | $      | 8,557  |   |
|                                              |   |   |   |
| **Deferred service revenue:**                     |   |   |   |
| Balance  at December 31, 2001                     |   | $      | 7,763  |   |
| Amounts  added to accrual                         |   | 8,114  |   |
| Amounts  recorded as revenue during the period    |   | (1,816 | )      |
| Balance  at December 31, 2002                     |   | $      | 14,061 |   |

 

F-12

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**Income taxes:**

 

The Companyand its domestic subsidiaries file a consolidated Federal income tax returnwith its parent ALARIS Medical, Inc.   ALARIS Medical Systemsfiles income taxreturns in multiple states on either a stand-alone or combined basiswith its parent ALARIS Medical, Inc.  Foreign subsidiaries file income tax returnsin their respective local jurisdictions.

 

The Companyrecognizes deferred tax assets and liabilities based on the expected future taxconsequences of events that have been included in the financial statements andtax returns in different periods.  Underthis method, deferred tax liabilities and assets are determined based on thedifference between the financial statement and tax bases of assets andliabilities using enacted tax rates in effect for the year in which thedifferences are expected to reverse. The Company provides a reserve against its deferred tax assets when, inthe opinion of management, it is more likely than not that such assets will notbe realized.

 

**Segment information:**

 

The Companyuses the management approach to report segment information.  The management approach designates theinternal organization that is used by management for making operating decisionsand assessing performance as the source of the Company’s reportable segments.  The Company also discloses segmentinformation about products and services, geographic areas, and majorcustomers.  (See note 12.)

 

**Comprehensive income (loss):**

 

In addition to net income (loss), the Company reportscomprehensive income (loss) and its components, including foreign currencytranslation items currently recorded to stockholder’sequity.  Comprehensive income isdisplayed in the Consolidated Statement of Changes in Stockholder’s Equity and includes items not currentlyincluded in net income (loss). Comprehensive income (loss) does not have an impact on the Company’s results of operations.  At December 31, 2002, the accumulated equityadjustment from foreign currency translation was $4,597 and the accumulatedeffect of cash flow hedges, net of tax, was $141.

 

**Shipping and handling costs:**

 

Shipping andhandling costs for customer sales are classified as a selling and marketingexpense.  Shipping and handling costsfor customers for the years ended December 31, 2002, 2001 and 2000 were $7,803,$7,797 and $6,916, respectively.

 

**Stock-based compensation:**

 

The Companymeasures compensation expense for ALARIS Medical’s stock-based employee compensation plansusing the intrinsic value method and provides pro forma disclosures of netincome (loss) as if the fair value-based method had been applied in measuringcompensation expense.

 

At December31, 2002, Holdingshad several stock-based compensation plans from which incentive stock optionsmay be granted to key employees of the Company and non-qualified stock optionsmay be granted to key employees, directors, officers, independent contractorsand consultants.  The

 

F-13

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Company accountsfor options issued to employees, directors and officers under those plans underthe recognition and measurement principles of APB Opinion No. 25, “*Accounting for Stock Issued to Employees, and relatedInterpretations.”*  Generally, no stock-based employeecompensation cost is reflected in net income, as all options granted underthose plans have an exercise price equal to the market value of the underlyingcommon stock on the date of grant. Stock options issued to independent contractors and consultants underthose plans are accounted for using a fair value method and are remeasured tofair value at each period end until the earlier of the date that performance bythe counter party is complete or a performance commitment has been reached.

 

The following table illustrates the effect on net income andearnings per share if the company had applied the fair value recognitionprovisions of FASB Statement No. 123, “*Accountingfor Stock-Based Compensation,”* to stock-based employee compensation, assuming such standardhad been adopted January 1, 1995.

 
|                                                                                                                                             |   | **Year Ended December 31,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                                                                             |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                                                                                                                             |   |                        |   |   |   |   |   |
| Net income (loss), as reported                                                                                                                   |   | $                           | 20,355 |   | $ | 1,894 |   | $ | (809 | ) |
| Deduct:  Total stock-based employee compensationexpense  determined under fair value based methodfor all awards, net of related tax effects |   | (1,943                      | )      | (882 | ) | (1,685 | ) |
| Pro forma net income (loss)                                                                                                                      |   | $                           | 18,412 |   | $ | 1,012 |   | $ | (2,494 | ) |

 

 

These pro forma amounts may not be representative of future costs sincethe estimated fair value of stock options is amortized to expense over thevesting period and additional options may be granted in future years.  The fair value for these options wasestimated at the date of grant using the Black-Scholes option pricing modelwith the following weighted average assumptions for the years ended December31, 2002, 2001 and 2000, respectively—dividend yields of 0%,expected volatility of 75%, 90% and 85%, risk free interest rates of 3.4%, 4.4%and 5.2%, and expected lives of 3-7 years. The weighted average grant date fair value of options granted during2002 was $3.30.  The weighted averageexercise price of options granted during 2002 whose exercise price was greaterthan fair value, is $4.37.  The weightedaverage fair value of such options was $2.63.

 

TheBlack-Scholes option valuation model was developed for use in estimating thefair value of traded options which have no vesting restrictions and are fullytransferable.  In addition, optionvaluation models require the input of highly subjective assumptions includingthe expected stock price volatility. Because ALARIS Medical’s employee stock options have characteristics significantlydifferent from those of traded options, and because changes in subjective inputassumptions can materially affect the fair value estimates, in management’s opinion, the existing models do notnecessarily provide a reliable single measure of the fair value of its employeestock based compensation plans.  Tocomply with disclosure requirements, the Company has valued its options usingthe Black-Scholes option valuation model but plans to assess other valuationmodels and assumptionsthat may more accurately reflect the value of the Company’s stock options.

 

F-14

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**Recentpronouncements:**

 

In April 2002, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards No.145, “*Rescission of FASB Statements No. 4, 44 and 64, Amendment ofFASB Statement No. 13, and Technical Corrections*” (SFAS 145).  As a  result of  SFAS 145, gains and losses fromextinguishment of debt should be classified as extraordinary items only if theymeet the criteria in Accounting Principles Board Opinion No. 30, “*Reporting the Results of Operations—Reporting the Effects ofDisposal of A Segment of A Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions*” (APB 30).  Applying the provisions of ABP 30 will distinguish transactionsthat are part of an entity’s recurring operations from those that are unusual orinfrequent or that meet the criteria for classification as an extraordinaryitem.  Adoption of SFAS 145 related todebt extinguishment is required for fiscal years beginning after May 15, 2002.  Additionally, this statement requires thatcapital leases that are modified so that the resulting lease agreement isclassified as an operating lease be accounted for under the sale-leasebackprovisions of FASB Statement No. 98, “*Accountingfor Leases: Sale-Leaseback Transactions Involving Real Estate; Sales-TypeLeases of Real Estate; Definition of the Lease Term; Initial Direct Costs ofDirect Financing Leases.**”* Provisions of SFAS 145 relatedto leases are required to be adopted for transactions occurring after May 15,2002.  The adoption of SFAS is notexpected to have a material impact on the Company’s financial position or results ofoperations.

 

In June 2002, the FASB issued Statementof Financial Accounting Standards No. 146, “*Accounting for CostsAssociated with Exit or Disposal Activities”*(SFAS 146).  SFAS146 requires companies to recognize costs associated with exit or disposalactivities when they are incurred rather than at the date of a commitment to anexit or disposal plan.  SFAS 146 is tobe applied prospectively to exit or disposal activities initiated afterDecember 31, 2002.  The adoption of SFAS146 is not expected to have a material impact on the Company’s financial position or results ofoperations.

 

In November 2002, the FASB issuedInterpretation No. 45, “*Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others*” (FIN 45).  FIN 45 elaborates on the disclosures to be made by a guarantor inits interim and annual financial statements about its obligations under certainguarantees that it has issued.  It alsoclarifies that a guarantor is required to recognize, at the inception of aguarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee.  The initialrecognition and initial measurement provisions of the interpretation areapplicable on a prospective basis to guarantees issued or modified afterDecember 31, 2002 and the disclosure requirements in this interpretation areeffective for financial statements of interim or annual periods ending afterDecember 15, 2002.** **The FIN 45 disclosure requirements are included in note 1under “Productwarranties and deferred service revenues.”  The adoption ofFIN 45 is not expected to have a material impact on the Company’s financial position or results of operations.

 

F-15

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**NOTE 2 — GOODWILL AND OTHER INTANGIBLEASSETS — ADOPTION OFFASBSTATEMENTS 141AND 142**

 

EffectiveJanuary 1, 2002, the Company adopted FAS 141 and FAS 142 which were issued bythe Financial Accounting Standards Board in July 2001.  UnderFAS 142, goodwill and intangible assets with indefinite lives are nolonger amortized but are reviewed annually (or more frequently if impairmentindicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite liveswill continue to be amortized over their useful lives (but with no maximumlife).  FAS 141 requires allbusiness combinations initiated after June 30, 2001 to be accounted for usingthe purchase method and eliminates the pooling-of-****interests–method of accounting. Intangible assets that do not meet certain defined criteria inFAS 141 for recognition apart from goodwill shall be reclassified asgoodwill as of the date FAS 142 is initially applied in its entirety.  As required by FAS 142, the Companyhas completed an assessment of the categorization of its existing intangibleassets and goodwill in accordance with the new criteria and has reported themappropriately on the consolidated balance sheet.  In accordance with FAS 141, the Company reclassified itsworkforce, net of its related deferred tax liability, as goodwill.  The Company performed a transitionalgoodwill impairment test and determined the asset not to be impaired.

 

Upon adoptionof FAS 142, the Company determined that an intangible asset related to the “IVAC” trade name had an indefinite life and in accordance withFAS 142, should not be amortized as there are no legal, regulatory,contractual, economic or other factors that limit the useful life of thisintangible asset to the reportingunits.  As of December 31, 2002, therewas no impairment loss associated with such indefinite-lived intangible assetas its fair valueexceeds the carrying amount.

 

Intangibleassets with finite lives will continue to be amortized over the expectedeconomic lives of the intangible assets. The Company reassessed the useful lives of its intangible assets anddetermined no change in useful lives to be required for its finite-livedassets.

 

Under thesestandards, the Company ceased amortizing goodwill totaling $142,570, including$2,714 ($4,523 before tax effect) of its workforce previously classified as another intangible asset, and trademarks totaling $74,750 as of January 1,2002.  Adoption of the new standardsresulted in not recognizing $9,204 in amortization expense for year endedDecember 31, 2002 that would have been recognized had the previous standardsbeen in effect.

 

F-16

----

 

The followingtable presents the impact of FAS 141 and FAS 142 on income from operations, netloss and loss per common share, as if they had been in effect for the yearsended December 31, 2001 and 2000.

 
|                                         |   | **Year Ended****December 31, 2001** |   | **Year Ended****December 31, 2000** |   |
|----------------------------------------------|--------|-------------------------------------|--------|-------------------------------------|--------|
|                                         |   |                                |   |                                |   |
| Income from operations, as reported          |   | $                                   | 45,183 |                                | $      | 42,230 |   |
| Goodwill amortization                        |   | 5,700                               |   | 5,700                               |   |
| Workforce amortization                       |   | 504                                 |   | 504                                 |   |
| Trade nameamortization                       |   | 3,000                               |   | 3,000                               |   |
| Pro forma income from operations             |   | $                                   | 54,387 |                                | $      | 51,434 |   |
|                                         |   |                                |   |                                |   |
| Loss from continuing operations, as reported |   | $                                   | (1,670 | )                                   | $      | (1,340 | ) |
| Goodwill amortization                        |   | 5,700                               |   | 5,700                               |   |
| Workforce amortization                       |   | 504                                 |   | 504                                 |   |
| Trade name amortization                      |   | 3,000                               |   | 3,000                               |   |
| Tax effect                                   |   | (1,400                              | )      | (1,400                              | )      |
| Pro forma income from continuing operations  |   | $                                   | 6,134  |                                | $      | (6,464 | ) |
|                                         |   |                                |   |                                |   |
| Net income (loss), as reported               |   | $                                   | 1,894  |                                | $      | (809 | ) |
| Goodwill amortization                        |   | 5,700                               |   | 5,700                               |   |
| Workforce amortization                       |   | 504                                 |   | 504                                 |   |
| Trade nameamortization                       |   | 3,000                               |   | 3,000                               |   |
| Tax effect                                   |   | (1,400                              | )      | (1,400                              | )      |
| Pro forma net income                         |   | $                                   | 9,698  |                                | $      | 6,995 |   |

 

Acquired other intangible assets were asfollows:

 
|                                                           |   | **December 31, 2002** |       | **December 31, 2001**           |       |
|----------------------------------------------------------------|--------|-----------------------|------------|---------------------------------|------------|
|                                                           |   | **Gross****Amount**   | ** ** | **Accumulated****Amortization** | ** ** | **Gross****Amount** | ** ** | **Accumulated****Amortization** | ** ** |
|                                                           |   |                  |       |                            |       |   |   |   |   |
| Patents                                                        |   | $                     | 29,021     |                            | $          | 18,135 |   | $ | 28,946 |   | $ | 16,550 |   |
| Distribution rights and license agreements                     |   | 8,462                 |       | 4,024                           |       | 8,578 |   | 3,330 |   |
|                                                           |   |                  |       |                            |       |   |   |   |   |
| Subtotal other intangible assets, net(subject to amortization) |   | 37,483                |       | 22,159                          |       | 37,524 |   | 19,880 |   |
|                                                           |   |                  |       |                            |       |   |   |   |   |
| Acquired other intangible assets(not subject to amortization): |   |                  |       |                            |       |   |   |   |   |
|                                                           |   |                  |       |                            |       |   |   |   |   |
| IVAC trade name                                                |   | 90,000                |       | 15,250                          |       | 90,000 |   | 15,250 |   |
|                                                           |   |                  |       |                            |       |   |   |   |   |
| Other intangible assets, net                                   |   | $                     | 127,483    |                            | $          | 37,409 |   | $ | 127,524 |   | $ | 35,130 |   |

 

F-17

----

 

For the yearsended December 31, 2002 and 2001, amortization expense for other intangibleassets, net was $2,279 and $5,352, respectively.  The estimated future annual amortization expense for otherintangible assets, net is as follows:

 
| **Fiscal Year** |   |   |   |
|-----------------|--------|--------|--------|
| 2003            |   | $      | 2,182  |   |
| 2004            |   | 2,182  |   |
| 2005            |   | 2,182  |   |
| 2006            |   | 2,130  |   |
| 2007            |   | 1,774  |   |
|                 |        |        |        |  |

 

# **NOTE 3 — DERIVATIVE INSTRUMENTSAND HEDGING ACTIVITIES**

 

**Foreign currency**

 

As ofDecember 31, 2002, the Company’s only derivatives in place were forward contracts valuedat $62 and designated as hedges of forecasted cash flows in various foreigncurrencies and foreign currency option contracts valued at $248 to hedgeanticipated transactions.

 

As part ofthe Company’s riskmanagement strategy, management put in place a hedging program beginning in 2001under which the Company enters into forward foreign exchange and currencyoption contracts to hedge a portion of forecasted cash receipts and paymentsdenominated in currencies other than the U.S. dollar.  These contracts are entered into to reduce the risk that theCompany’s earningsand cash flows, resulting from certain forecasted transactions, will beaffected by changes in foreign currency exchange rates.  However, the Company may be impacted bychanges in foreign exchange rates related to the unhedged portion of theforecasted transactions.  The success ofthe hedging program depends, in part, on forecasts of the Company’s transactions in various currencies(primarily the Euro).  Hedges are placedfor periods consistent with identified exposures, but generally no longer thanthe end of the year for which we have substantially completed our annualbusiness plan.

 

The Companymay experience unanticipated foreign currency exchange gains or losses to theextent that there are timing differences between forecasted and actual activityduring periods of currency volatility. However, since the critical terms of contracts designated as cash flowhedges are the same as the underlying forecasted transaction, changes in fairvalue of contracts should be highly effective in offsetting the present valueof changes in the expected cash flows from the forecasted transaction.  The ineffective portion of any changes inthe fair value of option contracts designated as hedges, if any, is recognizedimmediately in earnings.  The Companydid not recognize material gains or losses resulting from either hedgeineffectiveness or changes in forecasted transactions during the years endedDecember 31, 2002 and 2001.

 

The effectiveportion of any changes in the fair value of the derivative instruments,designated as cash flow hedges, is recorded in other comprehensive income (OCI)until the hedged forecasted transaction occurs.  Once the forecasted transaction occurs, the effective portion ofany related gains or losses on the cash flow hedge is reclassified from OCI toearnings.  In the event the hedgedforecasted transaction does not occur, or it becomes probable that it will notoccur, the ineffective portion of any gain or loss on the related cash flowhedge would be reclassified from OCI to earnings at that time.

 

F-18

----

 

For the yearsended December 31, 2002 and 2001, the Company recognized net charges related tothe designated cash flow hedges of forecasted transactions in the amounts of$883 and $108, respectively, in other expense, which consisted primarily ofpremium costs for option contacts.  AtDecember 31, 2002, $235 ($141 after tax) was included in accumulated othercomprehensive loss.  This represents theremaining option premium costs net of the fair value of the open optioncontracts that are designated as cash flow hedges.  This loss is expected to be charged to earnings during 2003 asthe hedged transactions occur.

 

In additionto forecasted cash flow transactions, the Company hedges the majority of itsnet recognized foreign currency transactional exposures with forward foreignexchange contracts to reduce the risk that the Company’s earnings and cash flows will beaffected by changes in foreign currency exchange rates.  These derivative instruments do not subjectthe Company’searnings or cash flows to material risk due to exchange rate movements becausegains and losses on these contracts offset losses and gains on the assets andliabilities being hedged.  These forwardforeign exchange contracts are generally entered into for periods of one to sixmonths.  The realized loss on foreignexchange transactions for the years ended December 31, 2002 and 2001 was $1,906and $1,756, respectively, and is included in other expense.  Under our hedging program, the losses in2002 were more than offset by unrealized gains of  $2,097 on the underlying assets. Losses in 2001 were offset only to a minor degree because our hedgingprogram was not fully implemented until the beginning of 2002.  For the year ended December 31, 2002, a netgain of $190 was included in other income and expense from all foreign exchangetransactions, realized and unrealized.

 

**NOTE 4 — SALE OF INSTROMEDIX**

 

On August 31,2000, pursuant to an Asset Purchase Agreement dated as of August 17, 2000, theCompany sold the assets and certain liabilities of its Instromedix division toCard Guard Technologies, Inc. (“Buyer”) for $30,000 in cash (the “Sale”).

 

The Asset Purchase Agreement and the other agreements executed inconnection with the sale required the Company to assist Buyer in setting up afully independent headquarters and manufacturing facility in San Diego,California.  Pursuant to theseagreements, $5,000 of the $30,000 purchase price was placed in escrow.  The Company received such escrowed amount,after certain offsets, upon completion of its obligations under the agreementsin the first quarter of 2001 and recognized a gain.  The total after-tax gain recorded related to the Sale was $5,576,with $3,737, or $.06 per share, recorded during 2001 and****$1,839, or $.03 per sharerecorded in 2000.  Approximately$18,000of the net cash proceeds from the Sale (after taxes and other estimated costs)was used to repay indebtedness under the bank credit facility.  Additionally, during the second quarter of2001, the Company received a $4,513 refund of Federal tax payments made in 2000related to the sale of Instromedix.

 

As a resultof the Sale, the Company’s consolidated statements of operations exclude theInstromedix results from continuing operations and reflect such operatingresults as discontinued operations.  Theoperating results for Instromedix for 2000 through the Sale date have beenreported as a loss from operations of discontinued business for the year endedDecember 31, 2000.  During 2001, theCompany assessed additional reserves related to the discontinued business anddetermined the contingency was no longer probable.  This change in estimate resulted in the release of a reserve of$450 ($270 net of tax) which is recorded in discontinued operations.  For the year ended December 31, 2000,Instromedix sales included in discontinued operations were $8,672.

 

F-19

----

 

##### **NOTE 5 —COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS**

 
|                                                                      |   | **December 31,** |   |
|---------------------------------------------------------------------------|--------|------------------|--------|
|                                                                      |   | **2002**         |   | **2001** |   |
| **Receivables, net:**                                                     |   |             |   |   |   |
| Trade receivables                                                         |   | $                | 85,145 |   | $ | 62,219 |   |
| Allowance for doubtful accounts                                           |   | (3,650           | )      | (2,842 | ) |
|                                                                      |   | 81,495           |   | 59,377 |   |
| Current portion of net investment in sales-type capital leases  (note 10) |   | 8,555            |   | 8,516 |   |
|                                                                      |   | $                | 90,050 |   | $ | 67,893 |   |
|                                                                      |   |             |   |   |   |
| **Inventories:**                                                          |   |             |   |   |   |
| Raw materials                                                             |   | $                | 27,946 |   | $ | 40,546 |   |
| Work-in-process                                                           |   | 2,322            |   | 4,993 |   |
| Finished goods                                                            |   | 26,656           |   | 23,869 |   |
|                                                                      |   | $                | 56,924 |   | $ | 69,408 |   |
| **Prepaid expenses and other current assets:**                            |   |             |   |   |   |
| Deferred income tax assets                                                |   | $                | 17,521 |   | $ | 28,110 |   |
| Other                                                                     |   | 4,768            |   | 5,346 |   |
|                                                                      |   | $                | 22,289 |   | $ | 33,456 |   |
| **Property, plant and equipment, net:**                                   |   |             |   |   |   |
| Land                                                                      |   | $                | 640    |   | $ | 640 |   |
| Building and leasehold improvements                                       |   | 17,912           |   | 16,991 |   |
| Machinery and equipment                                                   |   | 62,711           |   | 55,464 |   |
| Information technology                                                    |   | 34,274           |   | 28,791 |   |
| Furniture and fixtures                                                    |   | 7,946            |   | 7,188 |   |
| Instruments at customers                                                  |   | 38,190           |   | 28,785 |   |
| Construction-in-process                                                   |   | 4,802            |   | 7,620 |   |
|                                                                      |   | 166,475          |   | 145,479 |   |
| Accumulated depreciation and amortization                                 |   | (110,027         | )      | (87,872 | ) |
|                                                                      |   | $                | 56,448 |   | $ | 57,607 |   |

 

F-20

----

 

Depreciation expense was $19,595, $18,619 and $18,767 for 2002,2001 and 2000, respectively, including $1,811, $1,440 and $1,422 ofdepreciation on capitalized computer software in 2002, 2001 and 2000,respectively.  The net book value ofinstruments at customers at December 31, 2002 and 2001 was $7,770 and $6,897,respectively.

 
|                                                               |   | **December 31,** |   |
|--------------------------------------------------------------------|--------|------------------|--------|
|                                                               |   | **2002**         |   | **2001** |   |
| **Other non-current assets:**                                      |   |             |   |   |   |
| Capitalized patent issuance and trademark registration costs,  net |   | $                | 3,375  |   | $ | 2,719 |   |
| Patent license agreements, net                                     |   | 6,902            |   | 8,242 |   |
| Debt issue costs, net                                              |   | 8,716            |   | 10,886 |   |
| Other                                                              |   | 6,634            |   | 6,166 |   |
|                                                               |   | $                | 25,627 |   | $ | 28,013 |   |
| **Intangible assets, net:**                                        |   |             |   |   |   |
| Patents and completed technology                                   |   | $                | 29,021 |   | $ | 28,946 |   |
| Product licensing and distribution fees                            |   | 8,462            |   | 8,578 |   |
| Trademarks                                                         |   | 90,000           |   | 90,000 |   |
|                                                               |   | 127,483          |   | 127,524 |   |
| Accumulated amortization                                           |   | (37,409          | )      | (35,130 | ) |
|                                                               |   | $                | 90,074 |   | $ | 92,394 |   |

 

Amortization expense of intangible assetswas $4,363, $13,294 and $13,152 during 2002, 2001 and 2000, respectively.

 
|                                                |   | **December 31,** | ** ** |
|-----------------------------------------------------|--------|------------------|------------|
|                                                |   | **2002**         | ** ** | **2001** | ** ** |
| **Accrued expenses and other current liabilities:** |   |             |       |   |   |
| Compensation                                        |   | $                | 25,975     |   | $ | 28,886 |   |
| Warranty                                            |   | 7,622            |       | 7,338 |   |
| Interest                                            |   | 3,109            |       | 5,580 |   |
| Other                                               |   | 13,845           |       | 9,929 |   |
|                                                |   | $                | 50,551     |   | $ | 51,733 |   |
|                                                |   |             |       |   |   |
| **Other non-current liabilities:**                  |   |             |       |   |   |
| Deferred income tax liability                       |   | $                | 19,577     |   | $ | 22,135 |   |
| Deferred revenue                                    |   | 14,061           |       | 7,763 |   |
| Warranty                                            |   | 935              |       | 685 |   |
| Payable to Holdings (note 14)                       |   | 7,730            |       | 11,426 |   |
| Other                                               |   | 5,640            |       | 5,667 |   |
|                                                |   | $                | 47,943     |   | $ | 47,676 |   |

 

F-21

----

 

**NOTE 6 — LONG-TERM DEBT**

 

Long-term debt consists of the following:

 
|                                      |   | **December 31,** |    |
|-------------------------------------------|--------|------------------|---------|
|                                      |   | **2002**         |    | **2001** |   |
|                                      |   |             |    |   |   |
| 9-3/4% senior subordinated notes due 2006 |   | $                | 180,000 |   | $ | 180,000 |   |
| 11-5/8% senior secured notes due 2006     |   | 170,000          |    | 170,000 |   |
|                                      |   |             |    |   |   |
| Long-term debt                            |   | $                | 350,000 |   | $ | 350,000 |   |

 

**Senior secured notes:**

 

 ALARIS Medical Systemscompleted an offering of $170,000 of Senior Secured Notes on October 16, 2001.  Proceeds from the offering were $164,900,net of investment banking fees.  Theseproceeds, along with existing cash of approximately $10,000, were used to repayall amounts then outstanding under ALARIS Medical Systems’bank credit facility (“CreditFacility”)(approximately $157,400 including principal, accrued interest and cost toterminate a related interest rate swap agreement) and to repurchase $20,000aggregate principal amount of ALARIS Medical Systems’ 9-3/4% senior subordinated notes due2006 (“SeniorSubordinated Notes”)at a discount to par.  The terminationof the interest rate swap resulted in a loss of $1,577, which was recorded asother expense.

 

Theextinguishment of the Credit Facility debt resulted in a charge of $2,800($1,680 net of tax benefit) related to the write-off of the then remainingunamortized debt issuance costs.  Thereacquisition of $20,000 principal amount of Senior Subordinated Notes at adiscount to par and related write-off of unamortized debt issuance costsresulted in a net gain of $2,060 ($1,237 net of tax).  The gains and losses from the early retirement of debt have beenclassified as extraordinary items in the consolidated statement of operations.

 

The SeniorSecured Notes bear interest at 11-5/8%, payable semi-annually, with allprincipal due at maturity on December 1, 2006. The Company is not required to make mandatory redemption or sinking fundpayments with respect to the Senior Secured Notes prior to maturity.  Prior toDecember 1, 2003, the Company may redeem up to 35% in aggregate principalamount of Senior Secured Notes at a redemption price equal to 111.625% of theprincipal amount thereof plus accrued and unpaid interest with the cashproceeds of one or more public or private offerings of common stock of ALARISMedical, Inc.  On or after December 1,2005, ALARIS Medical Systems may redeem the Senior Secured Notes at 105.813% ofthe principal amount thereof, plus accrued and unpaid interest.  In the event of a change of control, asdefined in the indenture, holders of the Senior Secured Notes will have theright to require ALARIS Medical Systems to purchase their Senior Secured Notesat 101% of the principal amount thereof, plus accrued and unpaidinterest.

 

The SeniorSecured Notes rank senior to all other indebtedness of ALARIS Medical Systemsand are collateralized by all capital stock in the directly owned domesticsubsidiaries of ALARIS Medical Systems, except for those subsidiaries deemedunrestricted subsidiaries under the indentures, 65% of the capital stock in thedirectly owned foreign subsidiaries of ALARIS Medical Systems and substantiallyall other assets of ALARIS Medical Systems, including real property, equipment,intellectual property, inventory, personal property and general intangibles,other than accounts receivable.  TheSenior Secured Notes contain various restrictive covenants, including limitingthe ability of ALARIS Medical Systems and its restricted subsidiaries to incuradditional indebtedness or liens, make investments, sell assets, pay dividends,repurchase stock, enter into transactions with affiliates and consolidate,merge or sell all or substantially all of its assets.

 

F-22

----

 

**Senior subordinated notes:**

 

The SeniorSubordinated Notes bear interest at a rate of9-3/4% per annum, which is payable semi-annually on June 1 and December1 of each year.  The Company is notrequired to make mandatory redemption or sinking fund payments with respect tothe Senior Subordinated Notes prior to maturity.  The Senior Subordinated Notes are redeemable at the option ofALARIS Medical Systems, in whole or in part, at any time on or after December1, 2001 at the price of 104.875%, plus accrued and unpaid interest, with the redemptionprice declining each December 1 thereafter. For 2003 such redemption price is 101.625%.  On or after December 1, 2004, the redemption price is 100% of theprincipal amount thereof, plus accrued and unpaid interest.  In the event of a change of control, asdefined in the indenture, holders of the Senior Subordinated Notes will havethe right to require ALARIS Medical Systems to purchase their SeniorSubordinated Notes at 101% of the principal amount thereof, plus accrued andunpaid interest.  The SeniorSubordinated Notes are subject to certain restrictive and reporting covenants,including limiting the ability of ALARIS Medical Systems and its restrictedsubsidiaries to incur additional indebtedness or liens, make investments, sellassets, pay dividends, repurchase stock, enter into transactions withaffiliates and consolidate, merge or sell all or substantially all of itsassets.  On October 16, 2001, inconjunction with the issuance of the Senior Secured Notes, ALARIS MedicalSystems repurchased $20,000 aggregate principal amount of the SeniorSubordinated Notes at a discount to par. At December 31, 2002, the Company had outstanding $180,000 of SeniorSubordinated Notes.

 

**Senior discount notes of Holdings:**

 

In July 1998,ALARIS Medical completed the sale of $109,892 of 11-1/8% Senior Discount Notesdue 2008 (“SeniorDiscount Notes”),receiving net proceeds of $106,321.

 

The SeniorDiscount Notes accrete to $189,000 principal amount on August 1, 2003.  Prior thereto, interest accruing on theSenior Discount Notes is added to the outstanding principal balance throughJuly 31, 2003.  Interest on the SeniorDiscount Notes accruing subsequent to July 31, 2003 is payable in cashsemi-annually in arrears on February 1 and August 1, commencing February 1, 2004.  The indentures governing the Senior SecuredNotes and the Senior Subordinated Notes permit ALARIS Medical Systems to makedistributions, or “restrictedpayments,” to ALARISMedical if at the time of the restricted payment, ALARIS Medical Systems satisfiesthe two conditions described in the following paragraphs.  Additionally, payments to ALARIS Medical tofund up to $1,500 annually in ALARIS Medical operating or capital expenditures are defined as restricted payments butdo not require meeting these conditions.  Based on itsoperating results for the year ended December 31, 2002, ALARIS Medical Systemsmet the two required conditions to make restricted payments forthe first time in the first quarterof 2003.

 

The first condition which must be satisfied prior to making a restrictedpayment is that at the time of the distribution, ALARIS Medical Systems musthave a Fixed Charge Coverage Ratio (as calculated in accordance with theindentures as described below) of at least 2.5 to 1 calculated for the fourcomplete calendar quarters preceding the distribution as though thedistribution had been made at the beginning of such period.  The Fixed Charge Coverage Ratio will bedetermined by dividing ALARIS Medical Systems’Consolidated EBITDA (as defined in the indentures) by its Consolidated InterestExpense (as defined in the indentures). Based on the ALARIS Medical Systems interest expense for the year endedDecember 31, 2002, the actual amount of interest expense to be included in thecalculation of the Fixed Charge Coverage Ratio was approximately $38,800.  As a result, the minimum requiredConsolidated EBITDA to meet the ratio for 2002 was approximately $96,900 whilethe actual Consolidated EBITDA was approximately 

 

F-23

----

 

$97,600.  Assuming no futurechanges to the amount or terms of currently outstanding debt of ALARIS MedicalSystems, approximately $96,900 represents the minimum required ConsolidatedEBITDA for future four quarter calculations of the Fixed Charge Coverage Ratio.

 

Under the indentures, Consolidated EBITDA is defined as follows:  “With respect to any Personfor any period, the Consolidated Net Income of such Person and its RestrictedSubsidiaries for such period, plus, to the extent deducted in computingConsolidated Net Income: (i) provision for taxes based on income or profits ofsuch Person and its Restricted Subsidiaries for such period; (ii) ConsolidatedInterest Expense of such Person for such period; and (iii) depreciation andamortization (including amortization of goodwill and other intangibles) and allother non-cash charges (excluding any such non-cash charge to the extent thatit represents an accrual of or reserve for cash charges in any future period oramortization of a prepaid cash expense that was paid in a prior period) of suchPerson and its Restricted Subsidiaries for such period; and (iv) anyextraordinary or non-recurring loss and any net loss realized in connectionwith either an Asset Sale or the extinguishment of indebtedness, in each case,on a consolidated basis determined in accordance with GAAP.  Notwithstanding the foregoing, the provisionfor taxes based on the income or profits of, and the depreciation andamortization and other non-cash charges of, a Restricted Subsidiary of a Personshall be added to Consolidated Net Income to compute Consolidated EBITDA onlyto the extent (and in the same proportion) that the Net Income of suchRestricted Subsidiary was included in calculating the Consolidated Net Incomeof such Person.”

 

The second condition which must be satisfied prior to making a restrictedpayment is that the distribution, together with certain other restrictedpayments, may not exceed a sum determined by reference to ALARIS MedicalSystems’ cumulative Consolidated Net Income (as defined in theindentures) for the period since January 1, 1997 and cash capital contributionsreceived after such date, less restricted payments made.  This condition provides that the ConsolidatedNet Income of ALARIS Medical Systems will be added to the amount available eachquarter until such time as historical net losses (of $23,930 through December 31, 2002) are exhausted.  Subsequent to such time, 50% of future ALARIS Medical Systems’ net income will be added to the amountavailable.  At December 31, 2002, theamount available for future restricted payments was $30,836.

 

The preceding description of the provisions of the indentures whichgovern restricted payments, including the defined terms, is a summary only andis qualified in its entirety by the text of the indentures, which the Companyhas previously filed with the Securities and Exchange Commission.  (See Item 15, “Exhibits,Financial Statement Schedules and Reports on Form 8-K.”)

 

Asdescribed above, for the year ended December 31, 2002, ALARIS Medical Systemsmet the requirements under its debt agreements to make a restricted payment inthe first quarter of 2003.  As a result,in February 2003, ALARIS Medical Systems made distributions to ALARIS Medicalin the amount of $30,800.  ALARISMedical used a portion of such distributions to repurchase in a privatetransaction $25,000 face amount of the Senior Discount Notes at a total cost of$25,000 representing a premium of $1,171 or 4.7% over the then accretedcarrying value.  Such premium along witha write-off of unamortized debt issue cost related to the purchased amount ofdebt will be recorded as a charge of $1,545 (approximately $1,000 after tax) inthe Company’s first quarter 2003 operating results.

 

F-24

----

 

**Convertible Debentures of Holdings:**

 

ALARISMedical’s 7-1/4%convertible subordinated debentures (“Convertible Debentures”) were retired at their scheduled maturity on January 15,2002.

 

Theindentures governing ALARIS Medical Systems’ 11-5/8% senior secured notes and 9-3/4% seniorsubordinated notes permit ALARIS Medical Systems to use $15,000 of its cash onhand to invest in a wholly owned unrestricted subsidiary.  ALARIS Medical Systems made such investmentand the unrestricted subsidiary used a portion of the proceeds of suchinvestment to acquire $183 in principal amount of the Convertible Debentures atan approximate 1% discount in the open market in 2001.  In 2002, the remaining $14,812 was loaned toALARIS Medical, which used the proceeds of such loan and proceeds from theexercise of stock options to retire the $15,969 of Convertible Debentures.  A portion of the stock option exerciseproceeds resulted from the exercise by some of our executive officers of stockoptions.  In connection with theexercise, three of our executive officers received interest-bearing, short-termloans, aggregating $620, from ALARIS Medical Systems.  These loans were repaid in full in early 2002.  ALARIS Medical was entitled to require such executiveofficers to exercise such options in order to provide ALARIS Medical withsufficient funds to retire the Convertible Debentures.  Such options were granted to these executiveofficers in anticipation of ALARIS Medical’s need to require such exercise in order to complete theretirement of the Convertible Debentures.

 

Maturities of long-term debt during the years subsequent to December 31,2002 are as follows:

 

| 2003       |   | $       | —  |   |
|------------|--------|---------|---------|--------|
| 2004       |   | —  |    |
| 2005       |   | —  |    |
| 2006       |   | 350,000 |    |
| Thereafter |   | —  |    |
|       |   | $       | 350,000 |   |

 

F-25

----

 

**NOTE 7 — INCOME TAXES**

 

The provisionfor (benefit from) income taxes comprises the following:

 

**Continuing operations:**

 
|                                                               |   | **Year Ended December 31,** |   |
|--------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                               |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                                               |   |                        |   |   |   |   |   |
| Current:                                                           |   |                        |   |   |   |   |   |
| Federal                                                            |   | $                           | 1,173  |   | $ | 1,990 |   | $ | 5,335 |   |
| State                                                              |   | 269                         |   | 601 |   | — |   |
| Foreign                                                            |   | 3,728                       |   | 2,723 |   | 175 |   |
| Total current                                                      |   | 5,170                       |   | 5,314 |   | 5,510 |   |
|                                                               |   |                        |   |   |   |   |   |
| Deferred:                                                          |   |                        |   |   |   |   |   |
| Federal                                                            |   | 6,132                       |   | (993 | ) | (1,249 | ) |
| State                                                              |   | 665                         |   | (773 | ) | 96 |   |
| Foreign                                                            |   | 1,234                       |   | (325 | ) | (1,157 | ) |
| Total deferred                                                     |   | 8,031                       |   | (2,091 | ) | (2,310 | ) |
| Provision for (benefit from) income taxesfor continuing operations |   | $                           | 13,201 |   | $ | 3,223 |   | $ | 3,200 |   |

** **

**Discontinued operations:**

 
|                                                  |   | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------|--------|-----------------------------|------------|
|                                                  |   | **2002**                    | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                  |   |                        |       |   |   |   |   |
| Current:                                              |   |                        |       |   |   |   |   |
| Federal                                               |   | $                           | —     |   | $ | 891 |   | $ | 4,999 |   |
| State                                                 |   | —                      |       | 189 |   | 1,060 |   |
| Total current                                         |   | —                      |       | 1,080 |   | 6,059 |   |
|                                                  |   |                        |       |   |   |   |   |
| Deferred:                                             |   |                        |       |   |   |   |   |
| Federal                                               |   | —                      |       | 1,314 |   | (4,707 | ) |
| State                                                 |   | —                      |       | 278 |   | (998 | ) |
| Total deferred                                        |   | —                      |       | 1,592 |   | (5,705 | ) |
|                                                  |   |                        |       |   |   |   |   |
| Provision for income taxesfor discontinued operations |   | $                           | —     |   | $ | 2,672 |   | $ | 354 |   |

 

F-26

----

 

The principalitems accounting for the differences in income taxes computed at the U.S.statutory rate (35%) and the effective income tax rate for continuingoperations comprise the following:

 
|                                                           |   | **Year Ended December 31,** |   |
|----------------------------------------------------------------|--------|-----------------------------|--------|
|                                                           |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                                           |   |                        |   |   |   |   |   |
| Taxes computed at statutory rate                               |   | $                           | 11,745 |   | $ | 543 |   | $ | 651 |   |
| State income taxes, net of federal benefit                     |   | 538                         |   | (112 | ) | 62 |   |
| Effect of foreign operations                                   |   | 827                         |   | 610 |   | 481 |   |
| Amortization and write-off of non-deductible intangible assets |   | —                      |   | 1,995 |   | 1,995 |   |
| U.S. research credits                                          |   | (200                        | )      | (440 | ) | — |   |
| U.S. nondeductible expenses                                    |   | 291                         |   | 595 |   | 694 |   |
| Other, net                                                     |   | —                      |   | 32 |   | (683 | ) |
| Provision for income taxesfor continuing operations            |   | $                           | 13,201 |   | $ | 3,223 |   | $ | 3,200 |   |

 

Thecomponents of the net deferred tax assets included in the Consolidated BalanceSheet as of December 31, 2002 and 2001 are as follows:

 
|                             |   | **2002** |   | **2001** |   |
|----------------------------------|--------|----------|--------|----------|--------|
| Deferred tax assets:             |   |     |   |     |   |
| Accrued liabilities and reserves |   | $        | 19,225 |     | $      | 28,515 |   |
| Unearned income                  |   | 2,434    |   | 1,342    |   |
| Credit carryforwards             |   | 2,854    |   | 2,854    |   |
| Inventory                        |   | 6,246    |   | 5,928    |   |
| Net operating loss carryforwards |   | —   |   | 1,318    |   |
| Miscellaneous                    |   | 131      |   | 568      |   |
|                             |   | 30,890   |   | 40,525   |   |
| Valuation allowance              |   | (1,662   | )      | (1,662   | )      |
|                             |   |     |   |     |   |
| Total deferred tax assets        |   | 29,228   |   | 38,863   |   |
|                             |   |     |   |     |   |
| Deferred tax liabilities:        |   |     |   |     |   |
| Intangible assets                |   | 29,376   |   | 28,702   |   |
| Property, plant and equipment    |   | 209      |   | 2,151    |   |
| Miscellaneous                    |   | 1,700    |   | 2,035    |   |
|                             |   |     |   |     |   |
| Net deferred tax assets          |   | $        | (2,057 | )        | $      | 5,975 |   |

 

As ofDecember 31, 2002, the Company had foreign tax credit carryforwards ofapproximately $1,973andstate research and development tax credit carryforwards of approximately $1,516before federal tax effect.The foreign tax credits have expiration dates through 2006.

 

U.S. income taxes and foreign withholding taxes werenot provided for on undistributed earnings for certain non-U.S.subsidiaries.  The Company intends toreinvest these earnings indefinitely in operations outside the United States.

 

F-27

----

 

**ALARIS MEDICAL SYSTEMS, INC**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

***(Amounts inthousands, except per share data)***

** **

**NOTE 8 — STOCK OPTION PLANS**

 

ALARISMedical maintains stock option plans under which incentive stock options may begranted to key employees of the Company and non-qualified stock options may begranted to key employees, directors, officers, independent contractors andconsultants.

 

The exerciseprice for incentive stock options generally may not be less than the underlyingstock’s fair marketvalue at the grant date.  The exerciseprice for non-qualified stock options granted to employees is determined by theCompensation Committee of the Board of Directors.  The exercise price for non-qualified stock options granted tonon-employee directors may not be less than the underlying stock’s fair market value at the grant date.

 

Optionsgranted to employees vest and become exercisable as determined by the CompensationCommittee and as set forth in the respective grantee’s stock option agreement.  Options granted to non-employee directorsgenerally vest and become exercisable over a three-year period.  Beginning in 2002, options granted to employeesgenerally expire upon the earlier of the termination of the optionee’s employment, with vested optionsexpiring ninety days after termination of employment, or ten years from thegrant date.  Options granted tonon-employee directors generally expire upon the earlier of the date theoptionee is no longer a director or effective in 2002, ten years from the grantdate.  Options granted to non-employeedirectors in lieu of cash retainer are fully vested upon grant and terminateten years from the date of grant.

 

Of the total9,500 shares available for issuance upon exercise of stock options under the1996 Stock Option Plan, 2,800 shares are reserved for issuance pursuant to “performance options”. In December 2002, the Board of Directors amended (subject to stockholderapproval) the 1996 Stock Option Plan to make the remaining portion of these2,800 reserved shares available for option grants which are not subject to thevesting restrictioncontained in the performance options.  At December 31, 2002, 1,764 of such optionswere outstanding.  The vesting for thesespecific options granted is the earlier of seven years after the grant date or30% at the time market value of ALARIS Medical’s common stock reaches $7.00, another 40% when it reaches$9.00 and another 30% when it reaches $11.00 per share for 60 out of 66consecutive business days.

 

F-28

----

 

**Stock option activity**:

 

Activity for 2002, 2001 and 2000 with respect to these plans is asfollows:

 
|                             |   | **Shares****UnderlyingOptions** |   | **Option****Price PerShare**      |   |
|----------------------------------|--------|---------------------------------|--------|-----------------------------------|--------|
| Outstanding at December 31, 1999 |   | 7,967                           |   | $  1.78  –  $ 6.75 |   |
| Granted                          |   | 1,325                           |   | $  0.41  –  $ 2.81 |   |
| Exercised                        |   | (1                              | )      | $  1.81  –  $ 1.81 |   |
| Canceled                         |   | (1,666                          | )      | $  1.31  –  $ 6.75 |   |
|                             |   |                            |   |                              |   |
| Outstanding at December 31, 2000 |   | 7,625                           |   | $  0.41  –  $ 6.75 |   |
| Granted                          |   | 1,267                           |   | $  0.34  –  $ 3.30 |   |
| Exercised                        |   | (111                            | )      | $  0.41  –  $ 3.09 |   |
| Canceled                         |   | (2,150                          | )      | $  0.56  –  $ 6.75 |   |
|                             |   |                            |   |                              |   |
| Outstanding at December 31, 2001 |   | 6,631                           |   | $  0.34  –  $ 6.75 |   |
| Granted                          |   | 2,098                           |   | $  2.61  –  $ 7.00 |   |
| Exercised                        |   | (638                            | )      | $  0.41  –  $ 6.00 |   |
| Canceled                         |   | (528                            | )      | $  0.41  –  $ 6.13 |   |
| Outstanding at December 31, 2002 |   | 7,563                           |   | $  0.34  –  $ 7.00 |   |

 

At December 31, 2002, 2,897 shares were available for future grant and10,460 shares of common stock were reserved for issuance pursuant to theCompany’s stock option plans. At December 31, 2002, 2001 and 2000, shares exercisable were 3,650,3,176 and 3,488, respectively.

 

The following table summarizes information about employee stock-basedcompensation plans outstanding at December 31, 2002:

 

**OPTIONS OUTSTANDING AND EXERCISABLE BY PRICE RANGE ASOF DECEMBER 31, 2002**

 
| **Range of****ExercisePrices** |   | **Number****Outstanding** |   | **Weighted****AverageRemainingContractualLife-Years** |   | **Weighted****AverageExercisePrice** |   | **Number****Exercisable** |   | **Weighted****AverageExercisePrice** |   |
|--------------------------------|--------|---------------------------|--------|-------------------------------------------------------|--------|--------------------------------------|--------|---------------------------|--------|--------------------------------------|--------|
| $0.34 - $1.34                  |   | 1,137                     |   | 7.95                                                  |   | $                                    | 0.75   |                      | 623    |                                 | $      | 0.68 |   |
| $1.38 - $1.88                  |   | 1,041                     |   | 6.41                                                  |   | $                                    | 1.72   |                      | 574    |                                 | $      | 1.76 |   |
| $1.91 - $2.00                  |   | 1,232                     |   | 6.98                                                  |   | $                                    | 2.00   |                      | 3      |                                 | $      | 1.93 |   |
| $2.00 - $3.00                  |   | 1,905                     |   | 7.43                                                  |   | $                                    | 2.70   |                      | 618    |                                 | $      | 2.86 |   |
| $3.09 - $3.69                  |   | 1,272                     |   | 6.15                                                  |   | $                                    | 3.31   |                      | 1,189  |                                 | $      | 3.31 |   |
| $3.75 - $7.00                  |   | 976                       |   | 7.71                                                  |   | $                                    | 5.05   |                      | 643    |                                 | $      | 4.81 |   |
| $0.34 - $7.00                  |   | 7,563                     |   | 7.11                                                  |   | $                                    | 2.56   |                      | 3,650  |                                 | $      | 2.80 |   |

 

F-29

----

 

**NOTE 9 — BENEFIT PLANS**

** **

**Pension plans:**

 

The Companyhad a defined benefit pension plan (the “Plan”) which covered substantially all of its U.S. employees ofa predecessor company as of December 31, 1993. On December 1, 1993, the predecessor company’s Board of Directors approved amendmentsto the Plan provisions which include, among other matters, cessation of benefitaccruals after December 1, 1993.  Allearned benefits as of that date were preserved and the Company will continue tocontribute to the Plan as necessary to fund earned benefits.  No contributions to the Plan were requiredduring 2002, 2001 or 2000 due to the prepaid position of the Plan during thoseyears.

 

The followingtable sets forth the change in the benefit obligation and the change in thePlan assets during the years ended December 31, 2002 and 2001 and the Plan’s estimated funded status and amountsrecognized in the Company’s balance sheet as of December 31, 2002 and 2001:

 
|                                           |   | **December 31,** |   |
|------------------------------------------------|--------|------------------|--------|
|                                           |   | **2002**         |   | **2001** |   |
| **Change in benefit obligation:**              |   |             |   |   |   |
| Benefit obligation at beginning of year        |   | $                | 12,653 |   | $ | 11,185 |   |
| Service cost                                   |   | 281              |   | 313 |   |
| Interest cost                                  |   | 924              |   | 885 |   |
| Benefits paid                                  |   | (279             | )      | (288 | ) |
| Actuarial loss                                 |   | 822              |   | 558 |   |
| Benefit obligation at end of year              |   | $                | 14,401 |   | $ | 12,653 |   |
|                                           |   |             |   |   |   |
| **Change in Plan assets:**                     |   |             |   |   |   |
| Fair value of Plan assets at beginning of year |   | $                | 17,522 |   | $ | 19,302 |   |
| Actual return on Plan assets                   |   | (2,083           | )      | (1,492 | ) |
| Benefits paid                                  |   | (279             | )      | (288 | ) |
| Fair value of Plan assets at end of year       |   | $                | 15,160 |   | $ | 17,522 |   |
| Funded status                                  |   | $                | 759    |   | $ | 4,869 |   |
| Unrecognized actuarial loss (gain)             |   | 3,278            |   | (1,191 | ) |
| Prepaid benefit cost                           |   | $                | 4,037  |   | $ | 3,678 |   |

 

The components of net periodic benefit gain for the years ended December31, 2002, 2001 and 2000 are as follows:

 
|                                               |   | **December 31,** |   |
|----------------------------------------------------|--------|------------------|--------|
|                                               |   | **2002**         |   | **2001** |   | **2000** |   |
|                                               |   |             |   |   |   |   |   |
| Service cost                                       |   | $                | 281    |   | $ | 313 |   | $ | 308 |   |
| Interest cost                                      |   | 924              |   | 885 |   | 836 |   |
| Expected return on Plan assets                     |   | (1,563           | )      | (1,726 | ) | (1,702 | ) |
| Recognized actuarial gain                          |   | —           |   | (255 | ) | (357 | ) |
| Net periodic benefit gain                          |   | $                | (358   | ) | $ | (783 | ) | $ | (915 | ) |
| Assumptions used in the accounting are as follows: |   |             |   |   |   |   |   |
| Discount rates                                     |   | 7.00             | %      | 7.50 | % | 8.00 | % |
| Rates of increase in compensation levels           |   | NA               |   | NA |   | NA |   |
| Expected long-term rates of return on assets       |   | 9.00             | %      | 9.00 | % | 9.00 | % |

 

F-30

----

 

**Defined contribution plan:**

 

ALARISMedical Systems has a 401(k) plan that allows eligible employees to contributea portion of their compensation on a pretax and/or after-tax basis inaccordance with specified guidelines. ALARIS Medical Systems matches a percentage of the employeecontributions up to certain limits.  TheCompany’scontribution expense for the years ended December 31, 2002, 2001 and 2000 was$1,903, $1,668 and $1,827, respectively.

 

At December31, 2002, the 401(k) plan had total assets of $90,979 spread among teninvestment funds.  Plan participants canchoose to allocate their contributions and the Company matching contributionsto any one or number of the eight active investment choices.  Included in the plan is a fund which investssolely in the common stock of ALARIS Medical (the “Stock Fund”). The Stock Fund was established in 1998 and received participantcontributions until February 2001 when new contributions were no longerallowed.  At such time, the Stock Fundheld 1,480 shares of ALARIS Medical common stock.  Participants are still allowed to move their holdings out of theStock Fund.  At December 31, 2002, theStock Fund held 1,261 shares, or approximately 2.1% of the total sharesoutstanding, of ALARIS Medical common stock.

 

**NOTE 10 — LEASES**

 

**Lease receivables:**

 

Anticipated future minimum amounts due under customer agreementsaccounted for as sales-type capital leases as of December 31, 2002 are asfollows:

 
| **Year Ending December 31:** |   | **Sales-type****Capital Leases** |   |
|------------------------------|--------|----------------------------------|--------|
|                         |   |                             |   |
| 2003                         |   | $                                | 12,085 |   |
| 2004                         |   | 8,774                            |   |
| 2005                         |   | 6,567                            |   |
| 2006                         |   | 4,183                            |   |
| 2007                         |   | 1,721                            |   |
| Thereafter                   |   | 488                              |   |
| Total                        |   | $                                | 33,818 |   |

 

The netinvestment in sales-type capital leases consists of the following:

 
|                                                               |   | **December 31,** |   |
|--------------------------------------------------------------------|--------|------------------|--------|
|                                                               |   | **2002**         |   | **2001** |   |
|                                                               |   |             |   |   |   |
| Minimum lease payments                                             |   | $                | 33,818 |   | $ | 45,866 |   |
| Unguaranteed residual value of leased equipment                    |   | —           |   | 24 |   |
| Unearned interest income                                           |   | (7,998           | )      | (12,040 | ) |
| Allowance for estimated uncollectible lease receivables            |   | (1,215           | )      | (1,109 | ) |
| Net investment in sales-type capital leases                        |   | 24,605           |   | 32,741 |   |
| Current portion                                                    |   | (8,555           | )      | (8,516 | ) |
| Net investment in sales-type capital leases, less current  portion |   | $                | 16,050 |   | $ | 24,225 |   |

 

F-31

----

 

**NOTE 10 — LEASES (Continued)**

 

**Lease commitments:**

 

The Company leases buildings and equipment under non-cancelableoperating leases with terms ranging from approximately 2 to 13 years.  Scheduled future minimum lease commitmentsas of December 31, 2002 are as follows:

 

| **Year Ending December 31:** |   | **Operating Leases** |   |
|------------------------------|--------|----------------------|--------|
|                         |   |                 |   |
| 2003                         |   | $                    | 6,413  |   |
| 2004                         |   | 6,013                |   |
| 2005                         |   | 5,946                |   |
| 2006                         |   | 2,021                |   |
| 2007                         |   | 1,368                |   |
| Thereafter                   |   | 5,398                |   |
|                         |   | $                    | 27,159 |   |

 

Rentalexpense was $5,673, $5,634 and $6,103 during 2002, 2001 and 2000,respectively.  Certain facility leasescontain escalation clauses.  The Companyrecognizes rent expense on a straight-line basis over the lease term.

 

**NOTE 11 — RESTRUCTURING, INTEGRATION AND OTHER NON-RECURRINGCHARGES**

 

During thefirst quarter of 2002, the Company recorded a non-recurring benefit of $1,125for an insurance settlement.  The settlementrelated to damages and losses incurred at one of our disposable productsmanufacturing plants in Mexico in 1993 as a result of flooding.  The contingency related to the insurancesettlement was resolved in the first quarter of 2002, when we received proceedsof $1,000 during the first quarter and notification of an additional paymentdue of $125, which was received during April 2002.

 

Also duringthe first quarter of 2002, the Company initiated a plan to restructure ourtechnical services operations in Central Europe.  In this connection, the Company recorded a charge of $540 whichincluded $400 for severance costs for 21 positions affected by the relocationof the German operation and $140 related to lease termination.  As of December 31, 2002, all severancepayments have been made to the identified employees.

 

During 2001,the Company recorded a charge of $3,369 for restructuring and othernon-recurring activities.  Theseactivities were related to streamlining of operations in the North America businessunit and resulted in the elimination of 71 positions.  The restructuring and other non-recurring charges are composed ofseverance and related benefits of $2,562 and consulting fees of $807.  The Company also incurred non-recurringcharges of $3,520 in 2001 related to obtaining an amendment to the CreditFacility.  The charges related to legal,advisory and other consultant expenses incurred by ALARIS and its lenders,which the Company was required to pay.

 

During theyear ended December 31, 2000, the Company recorded a charge of $7,048 relatedto restructuring activities in themanufacturing facilities in Creedmoor, North Carolina, Basingstoke, England andSan Diego, California.  Of thischarge, $5,306 related to employee termination benefits, $601 related totermination of a product distribution agreement (including legal expenses),$117 related to the closure of a foreign sales office and $1,024 related tonon-cash charges for fixed asset write-offs.

 

F-32

----

 

**NOTE 12 — SEGMENT INFORMATION**

 

The Company’s segment performance is based on resultsof two geographical business segments within the same line of business ­ NorthAmerica and International.

 

The Companyis organized primarily based on geographic location with the United States andCanada drug infusion and patient monitoring business, and Mexico manufacturingactivities, representing the North American segment.  All other international operations, including Europe, Asia,Australia and Latin America, represent the International segment.

 

Theaccounting policies of the segments are the same as those described in the “Summary of Significant AccountingPolicies” (note1).  The geographical data does notinclude intersegment revenues.  Allexpenses associated with corporate headquarters appear in the North Americabusiness unit.  The Company evaluatesthe performance of its segments based on operating income and adjusted earningsbefore interest, taxes, depreciation, and amortization (EBITDA).  Adjusted EBITDA represents income fromoperations before restructuring, integration, extraordinary items, othernon-recurring charges, depreciation and amortization.  Adjusted EBITDA does not represent net income or cash flows fromoperations, as these terms are defined under generally accepted accountingprinciples.

 

The tablebelow presents information about reported segments for the years ended December31:

 
|                   |   | **North****America** |    | **International** |   | **Total** |   |
|------------------------|--------|----------------------|---------|-------------------|--------|-----------|--------|
| **2002**               |   |                 |    |              |   |      |   |
| Sales                  |   | $                    | 317,708 |              | $      | 142,625   |   | $ | 460,333 |   |
| Income from operations |   | 40,225               |    | 32,862            |   | 73,087    |   |
| Adjusted EBITDA        |   | 55,635               |    | 40,825            |   | 96,460    |   |
|                   |   |                 |    |              |   |      |   |
| **2001**               |   |                 |    |              |   |      |   |
| Sales                  |   | $                    | 285,630 |              | $      | 127,165   |   | $ | 412,795 |   |
| Income from operations |   | 21,342               |    | 23,841            |   | 45,183    |   |
| Adjusted EBITDA        |   | 53,127               |    | 30,858            |   | 83,985    |   |
|                   |   |                 |    |              |   |      |   |
| **2000**               |   |                 |    |              |   |      |   |
| Sales                  |   | $                    | 259,864 |              | $      | 119,084   |   | $ | 378,948 |   |
| Income from operations |   | 25,805               |    | 16,425            |   | 42,230    |   |
| Adjusted EBITDA        |   | 54,927               |    | 26,270            |   | 81,197    |   |

 

Reconciliation of total segment adjusted EBITDA to consolidated income(loss) from continuing operations before taxes:

** **
|                                                        |   | **2002** |       | **2001** |       | **2000** |       |
|-------------------------------------------------------------|--------|----------|------------|----------|------------|----------|------------|
| **Adjusted  EBITDA**                                        |   |     | ** ** |     | ** ** |     | ** ** |
| Total adjusted EBITDA for reportable segments               |   | $        | 96,460     |     | $          | 83,985   |       | $ | 81,197 |   |
| Depreciation and amortization                               |   | (23,958  | )          | (31,913  | )          | (31,919  | )          |
| Net interest                                                |   | (38,481  | )          | (39,671  | )          | (40,230  | )          |
| Restructuring and other non-recurring items                 |   | 585      |       | (6,889   | )          | (7,048   | )          |
| Other reconciling items                                     |   | (1,050   | )          | (3,959   | )          | (140     | )          |
| Income (loss) from continuing operationsbefore income taxes |   | $        | 33,556     |     | $          | 1,553    |       | $ | 1,860 |   |

 

F-33

----

 
|                         |   | **Sales** |    |
|------------------------------|--------|-----------|---------|
|                         |   | **2002**  |    | **2001** |   | **2000** |   |
|                         |   |      |    |   |   |   |   |
| **Product Line Information** |   |      |    |   |   |   |   |
| Drug Infusion                |   | $         | 404,918 |   | $ | 356,148 |   | $ | 326,141 |   |
| Patient Monitoring           |   | 31,754    |    | 33,383 |   | 31,088 |   |
| Service                      |   | 21,644    |    | 20,791 |   | 19,427 |   |
| Shipping and handling        |   | 2,017     |    | 2,473 |   | 2,292 |   |
|                         |   | $         | 460,333 |   | $ | 412,795 |   | $ | 378,948 |   |

 
|                          |   | **Sales** |       | **Long-Lived Assets** |       |
|-------------------------------|--------|-----------|------------|-----------------------|------------|
|                          |   | **2002**  |       | **2001**              |       | **2000** |   | **2002** |   | **2001** |   |
| **Geographical  Information** |   |      | ** ** |                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| United States                 |   | $         | 303,914    |                  | $          | 267,861 |   | $ | 246,289 |   | $ | 312,457 |   | $ | 327,949 |   |
| International (a)             |   | 156,419   |       | 144,934               |       | 132,659 |   | 18,312 |   | 16,860 |   |
|                          |   | $         | 460,333    |                  | $          | 412,795 |   | $ | 378,948 |   | $ | 330,769 |   | $ | 344,809 |   |

 

----

(a)    IncludesCanadian sales, which are included in the North America unit for segmentreporting purposes.

 

**NOTE 13 — CASH FLOW INFORMATION**

 

During theyear ended December 31, 2002, federal, state, and foreign taxes paid, net oftax refunds, totaled $7,406.  During theyear ended December 31, 2001, federal, state, and foreign taxes paid, net oftax refunds, resulted in a cash inflow of $1,918.  Federal, state and foreign income taxes paid during 2000 totaled$8,335.  Interest paid during 2002, 2001and 2000 totaled $39,783, $36,832 and $39,730, respectively.

 

**NOTE 14 — RELATED PARTYARRANGEMENTS**

 

Pursuant to ALARIS Medical Systems’ tax sharingagreement with Holdings, for Federal income tax purposes, ALARIS MedicalSystems is required to calculate its current income tax liability on astand-alone basis as if it were not included in the Holdings consolidatedincome tax return.  The resulting taxliability is payable to Holdings.  Thepro-forma income taxes payable recorded on ALARIS Medical Systems on a standalone basis at December 31, 2002and 2001 are $7,900 and $11,426, respectively, andare recorded in other non-current liabilities as a payable to Holdings.  Such amounts eliminate in the consolidatedfinancial statements.

 

**NOTE 15 — CONTINGENCIES AND LITIGATION**

 

##### **GovernmentRegulation**

 

The United States Food and Drug Administration (the “FDA”), pursuant to the Federal Food, Drug,and Cosmetic Act (the “FDCAct”), regulates theintroduction of medical devices into commerce, as well as testing manufacturingprocedures, labeling, adverse event reporting and record keeping with respectto such products.  The process of obtainingmarket clearances from the FDA for new products can be time consuming andexpensive and there can be no assurance that such clearances will be granted orthat FDA review will not involve delays adversely affecting the marketing andsale of products.  Enforcement of theFDC Act depends 

 

F-34

----

 

heavily onadministrative interpretation and there can be no assurance thatinterpretations made by the FDA or other regulatory bodies will not have amaterial adverse effect on the business, financial condition, results of operationsor cash flows.  The FDA and stateagencies routinely inspect the Company to determine whether theCompany is in compliance with variousrequirements relating to manufacturing practices, testing, quality control,complaint handling, medical device reporting and product labeling.  Such inspections can result in such agenciesrequiring the Company to take certain corrective actions for non-complyingconditions observed during the inspections.

 

A determination that the Company is in material violation of theFDC Act or such FDA regulations could lead to the issuance of warning letters,imposition of civil or criminal sanctions against the Company, its officers andemployees, including fines, recalls, repair, replacement or refund to the userof the cost of such products and could result in the Company losing itsability to contract with government agencies. In addition, if the FDA believes any of the Company’s products violate the law and present apotential health hazard, the FDA could seek to detain and seize products, torequire the Company to cease distribution and to notify users to stop using theproduct.  The FDA could also refuse toissue or renew certificates to export the Company’s products to foreign countries.  Such actions could also result in aninability of the Company to obtain additional clearances or approvals to marketits devices.

 

In the UnitedStates, the Company has initiated and carried out eleven field correctiveactions which the FDA considers product recalls from 1997 through 2001.  The Company has submitted to the FDArequests for closure related to each of these corrective actions but has notreceived notice of closure from the FDA. The Company has four active field corrective actions related to itsproducts manufactured and sold outside the United States.  In the second quarter of 1999, the Companyinitiated three corrective actions of certain versions of the P Series syringepumps, which are manufactured in the United Kingdom and sold outside the UnitedStates, primarily in Europe.  Thesecorrective actions relate to software and hardware upgrades of the P Seriessyringe pumps.  In the first quarter of2000, the Company stopped shipment of a large volume pump previously introducedin the International market for redesign of its air-in-line sensingcapability.  The Company introduced theredesigned product into the International market in the third quarter of 2001and provided a field correction for existing units.  None of these field corrective actions materially interfered withthe Company’soperations and the affected product lines continued or will continue to bemarketed by the Company.

 

Prior to2001, the Company incurred significant costs related to field corrective actions,including those classified by the FDA as recalls.  These costs include labor and materials, as well as travel andlodging for repair technicians. Estimates of the costs to complete these activities are often quitedifficult to determine due to uncertainty surrounding how many affected unitsare still in service and how many units customers will fix without ourassistance.  Due to these difficultiesin estimating costs, it is possible that the actual costs to complete eachindividual field corrective action could differ significantly from management’s current estimates to complete suchactivities.  Although there can be noassurances, the Company estimates the amounts required to cover theseactivities to be insignificant and believes it has adequate reserves to coverthe remaining estimated aggregate costs related to these activities.

 

**Litigation**

 

On December 5, 2000, the Company filed a lawsuit in theUnited States District Court for the Southern District of California againstFiltertek, Inc., seeking a declaration that the Company’sown needle-free system does not infringe a Filtertek patent relating to aFiltertek needle-free device as well as seeking unspecified damages andequitable relief from Filtertek, for infringement of a patent relating to a needle-free

 

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system licensed to the Company on an exclusive basis by Medex,Inc.  On March 9, 2001, Filtertekfiled a ** **lawsuit in theUnited States District Court for the Northern District of Illinois seekingunspecified damages and equitable relief from the Company claiming that theCompany’s needle-free system infringes theFiltertek patent as well as seeking a declaration, against Medex only, thatFiltertek’sneedle-free device does not infringe the needle-free system patent licensed tothe Company by Medex.  The Company subsequently withdrew itsclaim for damages and equitable relief relating to the Medex patent.  As a result of motions made by the parties,the California action was transferred to the Illinois court.  The Court-appointed Special Master conducteda claims construction hearing and provided the Court with recommendations onhow the single claim of the Filtertek patent at issue should be construed,which the Court has since adopted.

 

The Company believes that it has meritorious defenses to all ofFiltertek’s claims and it intends to defend itselfvigorously.  The Company has offered tosubmit to mediation or arbitration to expedite the resolution of this case, butthe parties have not reached agreement to do so.  On November 15, 2002, the Company moved for a summaryadjudication of the claims.  If thatdoes not resolve all claims, the Company will press for a prompt trial of theremaining claims.  There can be noassurance that the Company’s defenses will defeat all of Filtertek’s claims and the failure to do so couldhave a material adverse effect on the Company’s business, financial condition, results of operations andcash flows.

 

The Companyis also a defendant in various actions, claims and legal proceedings arisingfrom its normal business operations. Management believes the Company has meritorious defenses to these casesand intends to defend itself vigorously. As the ultimate outcome of these matters is uncertain, no contingentliabilities or provisions have been recorded in the accompanying financialstatements for such matters.  However,in management’sopinion, based on discussions with legal counsel, liabilities arising from suchmatters, if any, will not have a material adverse effect on the business,financial condition, results of operations or cash flows.

 

**Other Matters**

 

During theyears 1988 through 1995, Cal Pacifico acted as the Company’s United States customs broker andimporter of record with respect to the importation into the United States offinished products assembled at the Company’s two maquiladora assembly plants in Tijuana, Mexico.  Cal Pacifico received a pre-penalty noticeof intent from the United States Customs Service (“Customs”) to assess additional duties and penalties against CalPacifico for its alleged failure to comply with certain documentaryrequirements regarding the importation of goods on behalf of its clients,including the Company.  The Companybelieves that it is unlikely that Customs will assess any portion of thedisputed amounts against the Company. Customs has not initiated any proceedings against the Company in respectof such matters.  Nonetheless, CalPacifico advised the Company that it may seek recovery from the Company,through arbitration, for any portion of the disputed amounts which it isrequired to pay to Customs.  Theultimate outcome of such proceeding cannot be predicted, nor is the Companyable to estimate the possible loss resulting from such proceeding, should oneoccur.  The Company believes that it hasmeritorious defenses to claims Cal Pacifico might raise against theCompany.  Although management does notbelieve it is probable that the Cal Pacifico dispute will result in a materialclaim against the Company, it will continue to monitor the matter.

 

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**ALARIS MEDICAL SYSTEMS, INC.**

**Schedule II - Valuation and Qualifying Accounts and Reserves**

**For the Three Years Ended December 31, 2002**

 

*(Dollars in Thousands)*

 
|                                 |   | **Additions****Balance atbeginningof period** |   | **charged to****costs andexpenses** |   | **Deductions(1)** |   | **Balance at****end ofperiod** |   |
|--------------------------------------|--------|-----------------------------------------------|--------|-------------------------------------|--------|-------------------|--------|--------------------------------|--------|
| **Allowance for doubtful accounts:** |   |                                          |   |                                |   |              |   |                           |   |
| Year ended December 31, 2002         |   | $                                             | 2,842  |                                | $      | 845               |   | $                              | (37    | ) | $ | 3,650 |   |
| Year ended December 31, 2001         |   | 2,331                                         |   | 694                                 |   | (183              | )      | 2,842                          |   |
| Year ended December 31, 2000         |   | 3,119                                         |   | 450                                 |   | (1,238            | )      | 2,331                          |   |
|                                      |        |                                               |        |                                     |        |                   |        |                                |        |  |  |  |  |

 

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(1)             Represents accounts written-off as uncollectible, net ofcollections on accounts previously written-off.

 
|                         |   | **Additions****Balance atbeginningof period** |   | **charged to****costs andexpenses** |   | **Deductions** |   | **Balance at****end ofperiod** |   |
|------------------------------|--------|-----------------------------------------------|--------|-------------------------------------|--------|----------------|--------|--------------------------------|--------|
| **Tax valuation allowance:** |   |                                          |   |                                |   |           |   |                           |   |
| Year ended December 31, 2002 |   | $                                             | 1,662  |                                | $      | —         |   | $                              | -      |   | $ | 1,662 |   |
| Year ended December 31, 2001 |   | 2,029                                         |   | 1,131                               |   | (1,498         | )      | 1,662                          |   |
| Year ended December 31, 2000 |   | 2,029                                         |   | —                              |   | —         |   | 2,029                          |   |
|                              |        |                                               |        |                                     |        |                |        |                                |        |  |  |  |  |

 

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**EXHIBIT INDEX**

** **
| **Exhibit No.** |   | **Description  of Exhibit** |
|-----------------|--------|-----------------------------|
|            |   |                        |
| 21              |   |                        | List  of Subsidiaries of ALARIS Medical Systems, Inc. |
|            |   |                        |   |
| 99.1            |   |                        | Certification  by David L. Schlotterbeck Pursuant to 18 U.S.C. Section 1350,as Adopted Pursuant to Section 906 of  theSarbanes-Oxley Act of 2002. |
|            |   |                        |   |
| 99.2            |   |                        | Certification  by William C. Bopp Pursuant to 18 U.S.C. Section 1350,as Adopted Pursuant to Section 906 of  theSarbanes-Oxley Act of 2002. |

 

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