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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark One)

ý ~~Quarterly~~QUARTERLY ~~Report~~REPORT ~~Pursuant~~PURSUANT toTO ~~Section~~SECTION 13 orOR 15(dD) ofOF ~~the~~THE ~~Securities~~SECURITIES ~~Exchange~~EXCHANGE ~~Act~~ACT ofOF 1934

For the quarterly period ended ~~March~~June 3130, 2002 or

o ~~Transition Report Pursuant to Section 13~~ or ~~15(d) of the Securities Exchange Act of 1934~~

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 333-18687

ALARIS MEDICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		13-3800335 (I.R.S. Employer Identification No.)
Delaware		13-3800335
10221 Wateridge Circle, San Diego, CA 92121 (Address of principal executive offices) (Zip Code)
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
(858) 458-7000 (Registrant's telephone number, including area code)
10221 Wateridge Circle, San Diego, CA		92121
(Former name, former address and former fiscal year, if changed since last report)
(Address of principal executive offices)		(Zip Code)

(858) 458-7000
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: ý No: o

On ~~April~~August 151, 2002, ~~100~~1,000 shares of Registrant's Common Stock were outstanding.

ALARIS MEDICAL SYSTEMS, INC.

INDEX

			Page
PART I. FINANCIAL INFORMATION
	Item 1—Financial Information:
		Condensed consolidated statement of operations for the three months ended March 31, 2002 and 2001(unaudited)	3
		Condensed consolidated statement of operations for the three and six months ended June 30, 2002 and 2001 (unaudited)	3
		Condensed consolidated balance sheet at March 31, 2002 (unaudited) and December 31, 2001	4
		Condensed consolidated balance sheet at June 30, 2002 (unaudited) and December 31, 2001	4
		Condensed consolidated statement of cash flows for the three months ended March 31, 2002 and 2001(unaudited)	5
		Condensed consolidated statement of cash flows for the six months ended June 30, 2002 and 2001 (unaudited)	5
		Condensed consolidated statement of changes in stockholder's equity for the period from December 31, 2001 to March 31, 2002 (unaudited)	6
		Condensed consolidated statement of changes in stockholder's equity for the period from December 31, 2001 to June 30, 2002 (unaudited)	6
		Notes to the condensed consolidated financial statements	7
	Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations		1516
	Item 3—Quantitative and Qualitative Disclosures About Market Risk		2427
PART II. OTHER INFORMATION
	Item 6—Exhibits and Reports on Form 8-K		2629

Form 10-—Q Part 1—Item 1 Financial Information ALARIS MEDICAL SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited) (Dollars in thousands)

ALARIS MEDICAL SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited) (Dollar amounts in thousands)

		Three Months Ended June 30,						Six Months Ended June 30,
		2002			2001			2002			2001
Sales		$	108,520		$	98,470		$	212,920		$	197,359
Cost of sales			54,390			49,920			107,078			100,979

Gross profit			54,130			48,550			105,842			96,380

Selling and marketing expenses			21,077			19,686			42,513			38,378
General and administrative expenses			10,030			12,553			19,470			24,183
Research and development expenses			7,580			6,897			13,782			13,628
Restructuring and other non-recurring items			—			1,156			(585	)		6,899

	Total operating expenses		38,687			40,292			75,180			83,088

Interest income from sales-type capital leases			1,122			1,377			2,311			2,653

	Income from operations		16,565			9,635			32,973			15,945

Other income (expenses):
	Interest income		269			585			482			1,219
	Interest expense		(9,884	)		(10,860	)		(19,764	)		(20,498	)
	Other, net		193			(202	)		(301	)		(1,141	)

Total other expense			(9,422	)		(10,477	)		(19,583	)		(20,420	)

Income (loss) from continuing operations before income taxes			7,143			(842	)		13,390			(4,475	)
Provision for (benefit from) income taxes			2,858			510			5,356			(290	)

Income (loss) from continuing operations			4,285			(1,352	)		8,034			(4,185	)

Discontinued operations:
	Gain on disposal of business (net of applicable income tax expense of $2,492)		—			—			—			3,737

Total income from discontinued operations			—			—			—			3,737

Net income (loss)		$	4,285		$	(1,352	)	$	8,034		$	(448	)

		Three Months Ended March 31,
		2002			2001
Sales		$	104,400		$	98,889
Cost of sales			52,688			51,059
Gross profit			51,712			47,830
Selling and marketing expenses			21,436			18,694
General and administrative expenses			9,441			11,628
Research and development expenses			6,202			6,731
Restructuring and other non-recurring items			(585	)		5,743
	Total operating expenses		36,494			42,796
Interest income from sales-type capital leases			1,189			1,276
	Income from operations		16,407			6,310
Other income (expenses):
	Interest income		214			635
	Interest expense		(9,880	)		(9,639	)
	Other, net		(494	)		(939	)
Total other expense			(10,160	)		(9,943	)
Income (loss) before income taxes			6,247			(3,633	)
Provision for (benefit from) income taxes			2,498			(800	)
Income (loss) from continuing operations			3,749			(2,833	)
Discontinued operations:
	Gain on disposal of business (net of applicable income tax expense of $2,492)		—			3,737
Net income		$	3,749		$	904

The accompanying notes are an integral part of these condensed consolidated financial statements.

ALARIS MEDICAL SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands, except per share data)

			March 31, 2002			December 31, 2001
			June 30, 2002			December 31, 2001
			(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	4746,~~815~~722		$	50,826
	Receivables, net			6574,~~764~~035			67,893
	Inventories			6965,~~245~~188			69,408
	Prepaid expenses and other current assets			31,~~738~~785			33,456
		Total current assets		~~214~~217,~~562~~730			221,583
Net investment in sales-type capital leases, less current portion				2220,~~852~~141			24,225
Property, plant and equipment, net				55,~~997~~758			57,607
Other non-current assets				2726,~~191~~541			28,013
Goodwill, net				142,570			142,570
Other intangible assets, net				91,~~805~~225			92,394
			$	~~554~~553,~~977~~965		$	566,392
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
	Accounts payable		$	2321,~~522~~680		$	23,856
	Accrued expenses and other current liabilities			5248,~~581~~384			51,733
		Total current liabilities		7670,~~103~~064			75,589
Long-term debt				350,000			350,000
Other non-current liabilities				4746,~~685~~387			47,676
		Total non-current liabilities		~~397~~396,~~685~~387			397,676
Contingent liabilities and commitments (note 11)
Stockholder's equity:
	Common stock and capital in excess of par value, authorized 3,000 common shares at $.01 par value; 100 issued and outstanding at March 31, 2002 and December 31, 2001			203,752			203,716
	Common stock and capital in excess of par value, authorized 3,000 common shares at $.01 par value; 100 issued and outstanding at June 30, 2002 and December 31, 2001			203,775			203,716
	Accumulated deficit			(9894,~~619~~984	)		(101,562	)
	Loan to Holdings (note 6)			(14,993	)		—
	Accumulated other comprehensive loss			(86,~~951~~284	)		(9,027	)
		Total stockholder's equity		8187,~~189~~514			93,127
			$	~~554~~553,~~977~~965		$	566,392

The accompanying notes are an integral part of these condensed consolidated financial statements.

ALARIS MEDICAL SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)

(Dollars in thousands)

			Three Months Ended March 31,
						Six Months Ended June 30,
			~~2002~~			~~2001~~2002			2001
Net cash provided by operating activities			$	16,369		$	25,309
Cash flows from operating activities:
Cash flows from investing activities:
	Net income (loss)					$	8,034		$	(448	)
	Net capital expenditures			(3,387	)		(2,637	)
		Adjustments to reconcile net income (loss) to net cash provided by operating activities:
	Patents, trademarks and other			(363	)		(157	)
			Depreciation and amortization				11,365			15,629
	Payments for product licenses and distribution rights			—			(625	)
			Net loss on disposal of property, plant and equipment				129			96
	Proceeds from sale of discontinued business			—			3,599
			Debt issue costs amortization				1,105			1,018
Net cash (used in) provided by investing activities				(3,750	)		180
			Accretion of paid-in-kind interest				—			423
Cash flows from financing activities:
			Gain on sale of Instromedix				—			(3,737	)
	Principal payments on long-term debt and capital lease obligations			—			(5,058	)
			(Increase) decrease in assets:
	Loan to Holdings (note 6)			(14,812	)		—
				Receivables, net			(3,905	)		13,147
	Dividends to Holdings			(806	)		(871	)
				Inventories			4,511			(3,727	)
Net cash used in financing activities				(15,618	)		(5,929	)
				Prepaid expenses and other current assets			1,708			1,151
Effect of exchange rate changes on cash				(12	)		(198	)
				Net investment in sales-type capital leases, non-current portion			4,084			(893	)
Net (decrease) increase in cash				(3,011	)		19,362
				Other non-current assets			(117	)		(149	)
Cash and cash equivalents at beginning of period				50,826			30,618
			Increase (decrease) in liabilities:
Cash and cash equivalents at end of period			$	47,815		$	49,980
				Accounts payable			(2,929	)		5,695
				Accrued expenses and other current liabilities			(3,866	)		4,931
				Other non-current liabilities			(1,289	)		1,196
	Net cash provided by operating activities					$	18,830		$	34,332
Cash flows from investing activities:
	Net capital expenditures						(6,435	)		(6,146	)
	Payments for product licenses and distribution rights						—			(625	)
	Patents, trademarks and other						(647	)		(268	)
	Loan to Holdings (note 6)						(14,812	)		—
	Net proceeds from sale of discontinued business						—			8,073
Net cash (used in) provided by investing activities							(21,894	)		1,034
Cash flows from financing activities:
	Principal payments on long-term debt and capital lease obligations						—			(9,994	)
	Deferred financing costs						—			(658	)
	Dividends to Holdings						(1,456	)		(1,239	)
Net cash used in financing activities							(1,456	)		(11,891	)
Effect of exchange rate changes on cash							416			(221	)
Net (decrease) increase in cash							(4,104	)		23,254
Cash and cash equivalents at beginning of period							50,826			30,618
Cash and cash equivalents at end of period						$	46,722		$	53,872

The accompanying notes are an integral part of these condensed consolidated financial statements.

ALARIS MEDICAL SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY (Unaudited) (~~Dollars~~Dollar amounts in thousands)

		Common Stock And Capital In Excess Of Par Value
								Loan Receivable From Holdings			~~Accumulated Other Comprehensive Loss~~
					Accumulated Deficit						Other Comprehensive Loss			Total Stockholder's Equity			Comprehensive Income
		Shares	Amount
Balance at December 31, 2001		100	$	203,716	$	(101,562	)	$	—		$	(9,027	)	$	93,127
Comprehensive income:
	Net income for the period	—		—		38,~~749~~034			—			—			38,~~749~~034		$	38,~~749~~034
	Equity adjustment from foreign currency translation	—		—		—			—			682,917			682,917			682,917
	Effects of cash flow hedges included in other comprehensive income (net of tax benefit of $5)	—		—		—						8			8			8
	Effects of cash flow hedges included in other comprehensive income (net of tax of $116)	—		—		—			—			(174	)		(174	)		(174	)
Comprehensive income																	$	310,~~825~~777
Tax benefit from exercise of Holdings stock options		—		3659		—			—			—			3659
Loan to Holdings (note 6)									(14,993	)					(14,993	)
Loan to Holdings (Note 6)									(14,993	)					(14,993	)
Dividends to Holdings		—		—		(~~806~~1,456	)		—			—			(~~806~~1,456	)
Balance at March 31, 2002		100	$	203,752	$	(98,619	)	$	(14,993	)	$	(8,951	)	$	81,189
Balance at June 30, 2002		100	$	203,775	$	(94,984	)	$	(14,993	)	$	(6,284	)	$	87,514

The accompanying notes are an integral part of these condensed consolidated financial statements.

ALARIS MEDICAL SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Dollars in thousands)

NOTE 1—BUSINESS AND STATEMENT OF ACCOUNTING POLICY

The Company:

ALARIS Medical Systems, Inc. ("ALARIS Medical Systems"), develops practical solutions for medication safety at the point of care. ALARIS Medical Systems designs, manufactures, ~~distributes~~ and ~~services~~markets intravenous ~~infusion~~(IV) medication ~~therapy~~delivery and ~~patient monitoring~~infusion ~~instruments~~therapy ~~and~~devices, ~~related~~needle-free disposables and ~~accessories~~patient monitoring equipment. ALARIS Medical Systems was formed 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 of ALARIS Medical, Inc. ("Holdings"), formerly Advanced Medical, Inc., was incorporated on October 14, 1994 under the laws of the State of Delaware. ALARIS Medical Systems and its subsidiaries are collectively referred to as the "Company" or "ALARIS."

Statement of accounting policy:

The accompanying financial statements have been prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures herein are adequate to make the information not misleading.

In the opinion of the Company, the accompanying financial statements contain all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the Company's financial position as of ~~March~~June 3130, 2002, the results of its operations for the three and six months ended ~~March~~June 3130, 2002 and 2001, and its cash flows for the ~~three~~six months ended ~~March~~ June 3130, 2002 and 2001.

Use of estimates:

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of revenues, costs and expenses, assets, liabilities and related disclosure of contingent amounts. While we believe our estimates and assumptions are reasonable, the inherent nature of estimates is that actual results will likely be different from the estimates made.

Shipping and handling fees and costs:

The Company records costs ~~associated~~for ~~with~~ shipping and handling revenue for customer sales as a selling and marketing expense. Shipping and handling costs for customer ~~sales~~ sales for the three and six months ended ~~March~~June 3130, 2002 were $1,917 and ~~2001~~$3,790, respectively. Shipping and handling costs for customer sales for the three and six months ended June 30, 2001, were $12,~~873~~474 and $14,~~980~~454, respectively.

Reclassifications:

Certain prior period amounts have been reclassified to conform to the current period presentation.

NOTE 2—GOODWILL AND OTHER INTANGIBLE ASSETS—ADOPTION OF FASB STATEMENTS 141 AND 142

Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Intangible Assets ("FAS 142") and No. 141, Business Combinations ("FAS 141"),

~~which~~NOTE ~~were~~2—GOODWILL ~~issued~~AND byOTHER ~~the~~INTANGIBLE ~~Financial~~ASSETS—ADOPTION ~~Accounting~~OF ~~Standards~~FASB ~~Board in July 2001. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed~~STATEMENTS annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). FAS 141 ~~requires~~AND all business combinations initiated after June 30, 2001 to be accounted for using the purchase method and eliminates the pooling-of-interests-method of accounting. Intangible assets that do not meet certain defined criteria in FAS 141 for recognition apart from goodwill shall be reclassified as goodwill as of the date FAS 142 is initially applied in its entirety. As required by FAS 142, the Company has completed an assessment of the categorization of its existing intangible assets and goodwill in accordance with the new criteria and has reported them appropriately on the condensed consolidated balance sheet. In accordance with FAS 141, the Company reclassified its workforce, net of its related deferred tax liability, as goodwill. The Company performed a transitional goodwill impairment test and determined the asset not to be impaired.

~~Upon adoption~~Effective ~~of FAS~~January ~~142~~1, 2002, the Company ~~determined~~adopted ~~that~~Statement ~~intangible~~of ~~assets~~Financial ~~related~~Accounting toStandards ~~the~~No. 142, Goodwill and Intangible Assets ("~~IVAC~~FAS 142") ~~tradename~~ and ~~trademarks~~No. 141, ~~had~~Business anCombinations ~~indefinite~~("FAS 141"), ~~life~~which ~~and~~were issued by the Financial Accounting Standards Board in ~~accordance~~July 2001. ~~with~~ Under FAS 142, ~~should~~goodwill ~~not~~and beintangible ~~amortized~~assets aswith ~~there~~indefinite lives are no ~~legal,~~longer ~~regulatory,~~amortized ~~contractual,~~but ~~economic~~are reviewed annually (or more ~~other~~frequently ~~factors~~if impairment indicators arise) for impairment. Separable intangible assets that ~~limit~~are ~~the~~not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). FAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method and eliminates the pooling-of-interests-method ~~these~~of ~~intangible~~accounting. Intangible assets tothat do not meet certain defined criteria in FAS 141 for recognition apart from goodwill shall be reclassified as goodwill as of the ~~reporting~~date ~~units~~FAS 142 is initially applied in its entirety. As ~~of March~~required by FAS 31142, ~~2002~~the ~~there~~Company ~~was~~has nocompleted ~~impairment~~an ~~loss~~assessment ~~associated~~of ~~with~~the ~~such~~categorization ~~indefinite-lived~~of its existing intangible assets and goodwill in accordance with the new criteria and has reported them appropriately on the condensed consolidated balance sheet. In accordance with FAS 141, the Company reclassified its workforce, net of its related deferred tax liability, as ~~their~~goodwill. ~~fair~~The ~~value~~Company ~~exceeds~~performed a transitional goodwill impairment test and determined the ~~carrying~~asset ~~amount~~not to be impaired.

Upon adoption of FAS 142, the Company determined that intangible assets related to the "IVAC" tradename and trademarks had an indefinite life and in accordance with FAS 142, should not be amortized as there are no legal, regulatory, contractual, economic or other factors that limit the useful life of these intangible assets to the reporting units. As of June 30, 2002, there was no impairment loss associated with such indefinite-lived intangible assets as their fair value exceeds the carrying amount.

Intangible assets with finite lives will continue to be amortized over the expected economic lives of the intangible assets. The Company reassessed the useful lives of its intangible assets and determined no change in useful lives to be required for its finite-lived assets.

Under these standards, the Company ceased amortizing goodwill totaling $142,570, including $2,714 ($4,523 before tax effect) of its workforce previously classified as an other intangible asset, and trademarks totaling $74,750 as of January 1, 2002. Adoption of the new standards resulted in not recognizing $2,301 and $4,602, respectively, in amortization expense for the ~~quarter~~three and six months ended ~~March~~June 3130, 2002, that would have been recognized had the previous standards been in effect.

The following table presents the impact of FAS 141 and FAS 142 on income from operations and net (loss) income, as if they had been in effect for the ~~quarter~~three ~~ended~~and six months ~~March~~ended June 3130, 2001 ~~(in thousands)~~.

		Three Months Ended March 31, 2001
		Three Months Ended June 30, 2001			Six Months Ended June 30, 2001
Income from operations, as reported		$	69,~~310~~635		$	15,945
	Goodwill amortization		1,425			2,850
	Workforce amortization		126			252
	Tradename and trademark amortization		750			1,500
Pro forma operating income		$	811,~~611~~936		$	20,547
Loss from continuing operations, as reported		$	(21,~~833~~352	)	$	(4,185	)
	Goodwill amortization		1,425			2,850
	Workforce amortization		126			252
	Tradename and trademark amortization		750			1,500
	Tax effect		(350	)		(700	)
Pro forma loss from continuing operations		$	(882	)
Pro forma income (loss) from continuing operations		$	599		$	(283	)
Net income, as reported		$	904
	Net loss, as reported	$	(1,352	)	$	(448	)
	Goodwill amortization		1,425			2,850
	Tradename and trademark amortization		750
	Workforce amortization		126			252
	Tax effect		(350	)
	Tradename and trademark amortization		750			1,500
Pro forma net income		$	2,729
	Tax effect		(350	)		(700	)
Pro forma net income		$	599		$	3,454

Acquired other intangible assets were as follows:

				March 31, 2002						December 31, 2001
			June 30, 2002						December 31, 2001
			Gross Amount	~~Gross Amount~~		Accumulated Amortization	~~Accumulated Amortization~~		Gross Amount	~~Gross Amount~~		Accumulated Amortization	~~Accumulated Amortization~~
Patents			$	$28,946	~~28,946~~	$	$17,341	~~16,946~~	$	$28,946	~~28,946~~	$	$16,550	~~16,550~~
Distribution rights and license agreements				8,578	~~8,578~~		3,708	~~3,523~~		8,578	~~8,578~~		3,330	~~3,330~~
	Subtotal other intangible assets, net (subject to amortization)			$37,524	~~37,524~~		$21,049	~~20,469~~		$37,524	~~37,524~~		$19,880	~~19,880~~
Acquired other intangible assets (not subject to amortization):
IVAC tradename and trademarks		~~IVAC tradename and trademarks~~		90,000	~~90,000~~		15,250	~~15,250~~		90,000	~~90,000~~		15,250	~~15,250~~
	Other intangible assets, net		$	$127,524	~~127,524~~	$	$36,299	~~35,719~~	$	$127,524	~~127,524~~	$	$35,130	~~35,130~~

For the ~~three~~quarter ~~months~~ ended ~~March~~June 3130, 2002 and 2001, amortization expense for other intangible assets, net was $~~589~~580 and $1,~~339~~341, respectively. For the six months ended June 30, 2002 and 2001, amortization expense for other intangible assets, net was $1,169 and $2,680, respectively. The estimated future annual amortization expense for other intangible assets, net is as follows:


2002 (A)	$	1,~~762~~182
2003		2,219
2004		2,182
2005		2,182
2006		2,130
2007		1,774

(A): Amount represents remaining estimated amortization expense for 2002.

NOTE 3—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Foreign currency:

As ~~part~~ of ~~the strategy to manage the risk of foreign currency fluctuations~~June 30, ~~the Company enters into forward exchange contracts to hedge anticipated cash receipts and payments denominated in currencies other than the U.S. dollar for periods consistent with identified exposures~~2002, ~~but generally no longer than~~ the ~~end of the year for which the~~ Company's ~~has substantially~~only ~~completed~~derivatives ~~its annual business plan. Gains and losses related to qualifying hedges of these exposures are deferred and recognized~~ in ~~income~~place ~~when the underlying hedged transaction occurs. There~~ were ~~no gains or losses on~~ forward ~~exchange~~ contracts ~~for~~valued ~~the~~at ~~quarter~~negative ~~ended~~$111 ~~March 31,~~and ~~2002.~~designated ~~The~~as ~~Company~~hedges ~~also~~of ~~enters into foreign currency options to hedge~~ anticipated ~~transactions where~~cash ~~there~~flows isin avarious ~~high~~foreign ~~probability~~currencies ~~that~~and ~~anticipated exposures will materialize. Premiums on~~ foreign currency ~~options and any gains realized on such options that qualify as hedges are deferred and recognized in other income or expense when the underlying hedged transaction occurs. The~~ option ~~premium~~contracts ~~cost~~valued ~~represents~~at ~~the~~$177 ~~entire risk associated with these derivatives. For the quarter ended March 31, 2002, the net charge in other expense related~~ to ~~the~~hedge ~~option~~anticipated ~~program~~transactions ~~was $62, which consisted entirely of premium costs. At March 31, 2002, $13~~ ($8primarily ~~after tax) was included in accumulated other comprehensive loss, representing~~ the ~~market value of the unrealized hedged transactions, net of the related option premium cost~~Euro).

As part of ~~March 31, 2002,~~ the Company's ~~only~~risk ~~derivatives~~management strategy, management put in place ~~were~~a ~~forward~~hedging ~~contracts~~program ~~valued~~beginning atin ~~$346~~2001 under which the Company enters into forward foreign exchange and ~~designated~~currency option ascontracts ~~hedges~~to hedge a portion of ~~anticipated~~forecasted cash ~~flows~~receipts and payments denominated in ~~various~~currencies ~~foreign~~other than the U.S. dollar. These contracts are entered into to reduce the risk that the ~~currencies~~Company's earnings and cashflows resulting from certain forecasted transactions will be affected by changes in foreign currency ~~option~~exchange ~~contracts~~rates. ~~valued~~However, atthe ~~$234~~Company may be impacted by changes in foreign exchange rates related to ~~hedge~~the ~~anticipated~~unhedged portion of the forecasted transactions. The success of the hedging program depends, in part, on forecasts of Company transactions in various currencies (primarily the Euro). Hedges are placed for periods consistent with identified exposures, but generally no longer than the end of the year for which we have substantially completed our annual business plan. The Company may experience unanticipated foreign currency exchange gains or losses to the extent that there are timing differences between forecasted and actual activity during periods of currency volatility. However, since the critical terms of contracts designated as cash flow hedges are the same as the underlying forecasted transaction, changes in fair value of contracts should be highly effective in offsetting the change in value of the expected cash flows from the forecasted transaction. The ineffective portion of any changes in the fair value of option contracts designated as hedges is recognized immediately in earnings. The Company did not recognize material gains or losses resulting from either hedge ineffectiveness or changes in forecasted transactions during the first half of 2002.

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

For the three and six months ended June 30, 2002, the Company recognized net charges related to the designated cashflow hedges of forecasted transactions in the amounts of $136 and $198, respectively, in other expense, which consisted entirely of premium costs for option contacts. At June 30, 2002, $435 ($261 after tax) was included in accumulated other comprehensive loss. This represents the remaining option premium costs net of the market value of the open option contracts

that are used as cash flow hedges. This loss is expected to be charged to earnings over the next six months as the hedged transactions occur.

In addition to forecasted cashflow transactions, the Company hedges the majority of its net recognized foreign currency transactional exposures with forward foreign exchange contracts to reduce the risk that the Company's earnings and cashflows will be affected by changes in foreign currency exchange rates. These derivative instruments do not subject the Company's earnings or cash flows to material risk due to exchange rate movements because gains and losses on these contracts offset losses and gains on the assets and liabilities being hedged. These forward foreign exchange contracts are generally entered into for periods of one to six months. The loss on forward foreign exchange contracts for the six months ended June 30, 2002 was $1,247 and is included in other expense. This loss was substantially offset by unrealized gains on the underlying assets hedged. For the six months ended June 30, 2002, the net charge to other income and expense for all foreign exchange transactions, realized and unrealized, was $30.

NOTE 4—SALE OF INSTROMEDIX

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

The Asset Purchase Agreement and the other agreements executed in connection with the Sale required the Company to assist Buyer in setting up a fully independent headquarters and manufacturing facility in San Diego, California. Pursuant to these agreements, $5,000 of the $30,000 purchase price was placed in escrow. The Company received such escrowed amount, after certain offsets, upon completion of its obligations under the agreements in the first quarter of 2001 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 share~~ recorded in 2000.

NOTE 5—INVENTORIES

Inventories comprise the following:

	March 31, 2002		December 31, 2001
	June 30, 2002		December 31, 2001
Raw materials	$	4139,~~500~~298	$	40,546
Work-in-process		4,~~322~~852		4,993
Finished goods		2321,~~423~~038		23,869
	$	6965,~~245~~188	$	69,408

NOTE 6—LONG-TERM DEBT

Convertible Debentures of Holdings:

At December 31, 2001 Holdings had outstanding $15,969 of convertible debentures ("Convertible Debentures") which were retired at their scheduled maturity on January 15, 2002.

The indentures governing the 115/8% senior secured notes and the 93/4% senior subordinated notes permit ALARIS Medical Systems to ~~make~~use ~~distributions to Holdings if it has satisfied certain financial performance requirements. In addition, these indentures allow ALARIS Medical Systems to invest up to~~ $15,000 of its cash on hand to invest in a wholly owned unrestricted subsidiary. ALARIS Medical Systems made such investment ~~partially in December 2001~~ and the ~~remainder~~unrestricted insubsidiary ~~January 2002.~~used Ina ~~December 2001,~~portion of the ~~unrestricted~~proceeds ~~subsidiary, in~~of ~~open~~such ~~market~~investment ~~purchases,~~to ~~purchased~~acquire $183 in principal amount of the Convertible Debentures at an approximate 1% discount. ~~The~~in ~~bonds acquired by~~ the ~~unrestricted~~open ~~subsidiary~~market ~~were~~in ~~then acquired and retired by Holdings~~2001. AsIn ~~a result~~2002, the ~~total~~remaining ~~principal amount outstanding was reduced to~~ $1514,~~969~~812 ~~as of December 31, 2001. Holdings~~ was ~~able~~loaned to ~~complete~~Holdings, ~~the~~which ~~retirement~~used of the ~~$15,969 Convertible Debentures in January 2002 by using~~ proceeds of asuch loan and ~~from the unrestricted subsidiary of $14,812 along with cash~~ proceeds from ~~employee~~the ~~stock~~exercise ~~option exercises, including exercises by certain key executives~~ of ~~certain "callable"~~ stock options, ~~the granting of which was previously agreed~~ to byretire ~~Holdings in anticipation of~~ the ~~need~~$15,969 ~~to call some or all~~ of ~~these options to complete the~~ Convertible ~~Debenture~~ ~~retirement~~Debentures. InA ~~connection~~portion ~~with the exercise, three~~ of the ~~Company's~~ ~~executive~~stock ~~officers received interest-bearing, short-term loans, aggregating $620 from ALARIS Medical Systems. These loans were subsequently repaid in full.~~

option exercise proceeds resulted from the exercise by some of our executive officers of stock options. In connection with the exercise, three of our executive officers received interest-bearing, short-term loans, aggregating $620, from ALARIS Medical Systems. These loans were subsequently repaid in full. Holdings was entitled to require such executive officers to exercise such options in order to provide Holdings with sufficient funds to retire the Convertible Debentures. Such options were granted to these executive officers in anticipation of Holdings' need to require such exercise in order to complete the retirement of the Convertible Debentures.

The retirement of the Convertible Debentures resulted in notes payable from Holdings to the wholly-owned subsidiary of ALARIS Medical Systems of $14,993 which include a note issued in December, 2001 for $181 related to the purchase of the debentures and one issued in January, 2002, for $14,812.

The notes bear interest at a rate of 7¹/4% per annum, compounded semi-annually and are due on December 31, 2008. Due to the parent/subsidiary relationship between the borrowing and lending companies, the notes receivable have been recorded as a reduction of the consolidated ALARIS Medical Systems stockholder's equity. Because of this relationship, although the notes bear interest at 7¹/4%, interest income is not recorded in the ALARIS Medical Systems consolidated income statement.

NOTE 7—SEGMENT INFORMATION

The Company's segment performance is based on results of two geographical business segments within the same line of business—North America and International.

The Company is organized primarily based on geographic location with the United States and Canada drug infusion and patient monitoring business, and Mexico manufacturing activities, representing the North America segment. All other international operations, including Europe, Asia, Australia and Latin America, represent the International segment.

11 The accounting policies of the segments are the same as those described in the consolidated financial statements. The geographical data does not include intersegment revenues. All expenses associated with the corporate headquarters appear in the North America business unit. The Company evaluates the performance of its segments based on operating income and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Adjusted EBITDA represents income from operations before restructuring, other non-recurring items, depreciation and amortization. Adjusted EBITDA does not represent net income or cash flows from operations, as these terms are defined under generally accepted accounting principles, and should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity.

~~representing the North America segment. All other international operations, including Europe, Asia, Australia and Latin America, represent the International segment.~~ 12

The ~~accounting~~ ~~policies~~table ofbelow ~~the~~presents ~~segments~~information ~~are~~about ~~the~~reported same as those described in the consolidated financial statements. The geographical data does not include intersegment revenues, or charges allocating corporate headquarters costs to each of its operating segments. ~~The~~for ~~Company evaluates~~ the: performance of its segments based on operating income and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Adjusted EBITDA represents income from operations before restructuring, other non-recurring items, depreciation and amortization. Adjusted EBITDA does not represent net income or cash flows from operations, as these terms are defined under generally accepted accounting principles, and should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity.

The table below presents information about reported segments for the three months ended March 31:

Three months ended June 30,		North America		International		Total
2002
	Sales	$	77,459	$	31,061	$	108,520
	Operating income		9,922		6,643		16,565
	Adjusted EBITDA		13,863		8,355		22,218
2001
	Sales	$	68,775	$	29,695	$	98,470
	Operating income		4,769		4,866		9,635
	Adjusted EBITDA		12,102		6,582		18,684

		North America			International		Total
2002
	Sales	$	69,446		$	34,954	$	104,400
	Operating income		8,816			7,591		16,407
	Adjusted EBITDA		11,698			9,836		21,534
2001
	Sales	$	64,213		$	34,676	$	98,889
	Operating (loss) income		(1,539	)		7,849		6,310
	Adjusted EBITDA		10,129			9,659		19,788

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

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

			2002			2001
Adjusted EBITDA
	Total adjusted EBITDA		$	22,218		$	18,684
	Depreciation and amortization			(5,653	)		(7,893	)
	Interest, net			(9,615	)		(10,275	)
	Restructuring and other non-recurring charges			—			(1,156	)
	Other reconciling items			193			(202	)

		Consolidated income (loss) from continuing operations before income taxes	$	7,143		$	(842	)

				Three Months Ended March 31,
Six months ended June 30,			North America			International			Total
2002				~~2002~~			~~2001~~
Adjusted EBITDA
	Sales		$	146,905		$	66,015		$	212,920
	Total adjusted EBITDA			$	21,534		$	19,788
	Operating income			18,739			14,234			32,973
	Depreciation and amortization				(5,712	)		(7,735	)
	Adjusted EBITDA			25,562			18,191			43,753
	Interest (net)				(9,666	)		(9,004	)
2001
	Restructuring and other non-recurring items				585			(5,743	)
	Sales		$	132,988		$	64,371		$	197,359
	Other, net				(494	)		(939	)
	Operating income			3,230			12,715			15,945
		Consolidated income (loss) from continuing operations before income taxes		$	6,247		$	(3,633	)
	Adjusted EBITDA			22,232			16,241			38,473

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

			2002			2001
Adjusted EBITDA
	Total adjusted EBITDA		$	43,753		$	38,473
	Depreciation and amortization			(11,365	)		(15,629	)
	Interest, net			(19,282	)		(19,279	)
	Restructuring and other non-recurring items			585			(6,899	)
	Other reconciling items			(301	)		(1,141	)

		Consolidated income (loss) from continuing operations before income taxes	$	13,390		$	(4,475	)

NOTE 8—CASH FLOW INFORMATION

~~During~~For the ~~quarters~~six months ended ~~March~~June 3130, 2002 ~~and 2001~~, Federal, state and foreign income taxes paid, net of tax refunds, totaled $~~382~~4,366. Federal, state and foreign income taxes paid, net of tax refunds, resulted in a cash inflow of $~~662~~2,545 ~~respectively~~for the six months ended June 30, 2001. Interest paid during the ~~quarters~~six months ended ~~March~~June 3130, 2002 and 2001 totaled $021,127 and $317,~~092~~556, respectively.

NOTE 9—RESTRUCTURING AND OTHER NON-RECURRING ITEMS

The Company ~~recorded~~did anot record restructuring or non-recurring ~~benefit~~items during the second quarter of ~~$1,125~~2002. ~~during~~During the first quarter of 2002, the Company recorded a non-recurring benefit of $1,125 for an insurance settlement. The settlement related to damages and losses incurred at one of the Company's disposable products manufacturing plants in Mexico in 1993 as a result of flooding. The contingency related to the insurance settlement was resolved in the first quarter of 2002, when the Company received proceeds of $1,020 during the quarter and notification of an additional payment due of $105, which was received during April 2002.

12 During the first quarter of 2002, the Company initiated a plan to restructure its Central European technical services. In this connection, the Company recorded a charge of $540, which included $400 of severance costs for 21 positions affected by the relocation of the German operation and $140 related to lease termination. As of June 30, 2002, approximately $68 of severance costs has been paid to 13 employees. The restructuring is anticipated to be completed during the third quarter of 2002.

Restructuring and other non-recurring charges of $6,899 during the first six months of 2001 included $3,520 of legal, advisory and consultant expenses related to obtaining an amendment to the ~~insurance~~ALARIS ~~settlement~~Medical Systems' bank credit agreement. This amendment was ~~resolved~~completed in April 2001. The Company also recorded $3,379 in restructuring and other non-recurring charges during the first ~~quarter~~half of ~~2002,~~2001. ~~when~~These ~~the~~activities ~~Company~~related ~~received~~to ~~proceeds~~streamlining of ~~$1,020~~operations ~~during~~in the ~~quarter~~North American business and ~~notification~~resulted in the elimination of an71 ~~additional~~positions. ~~payment~~The ~~due~~restructuring and other non-recurring charges in the first six months of 2001 were composed of severance and related benefits of $~~105~~2, ~~which~~879 ~~was~~and ~~received~~consulting ~~during~~fees ~~April~~ of approximately $500. Adjusted EBITDA for the first half of 2002 and 2001 excludes the non-recurring items.

During the first quarter of 2002, the Company initiated a plan to restructure its Central European technical services. In this connection, the Company recorded a charge of $540 which included $400 of severance costs for 21 positions affected by the relocation of the German operation and $140 related to lease termination. The restructuring is anticipated to be completed during the third quarter of 2002. As of March 31, 2002, no payments have been made related to the restructuring.

Restructuring and other non-recurring charges of $5,743 in the first quarter of 2001 included $2,364 of legal, advisory and consultant expenses related to obtaining an amendment to the ALARIS Medical Systems bank credit agreement. This amendment was completed in April 2001. The Company also recorded $3,379 in restructuring and other non-recurring charges during the first quarter of 2001. These activities related to streamlining of operations in the North American business and resulted in the elimination of 71 positions. The restructuring and other non-recurring charges in the first quarter of 2001 were composed of severance and related benefits of $2,879 and consulting fees of approximately $500. Adjusted EBITDA for the first quarter of 2002 and 2001 excludes the non-recurring items.

NOTE 10—RELATED PARTY ARRANGEMENTS

Pursuant to ALARIS Medical Systems' tax sharing agreement with Holdings, for Federal income tax purposes, ALARIS Medical Systems is required to calculate its current income tax liability on a stand-alone basis as if it were not included in the Holdings consolidated income tax return. The resulting tax liability is payable to Holdings. The pro-forma income taxes payable recorded on ALARIS Medical Systems on a stand-alone basis at ~~March~~June 3130, 2002 and December 31, 2001 are $108,~~939~~125 and $11,426, respectively, and are recorded in other non-current liabilities as a payable to Holdings. Such amounts eliminate in the consolidated financial statements of Holdings.

NOTE 11—LITIGATION AND CONTINGENCIES

Litigation

On December 5, 2000, the Company filed a lawsuit in the United States District Court for the Southern District of California against Filtertek, Inc., seeking a declaration that the Company's own needle-free system does not infringe a Filtertek patent relating to a Filtertek needle-free device as well as seeking unspecified damages and equitable relief from Filtertek, for infringement of a patent relating to a needle-free system licensed to the Company on an exclusive basis by Medex, Inc. On March 9, 2001, Filtertek filed a lawsuit in the United States District Court for the Northern District of Illinois seeking unspecified damages and equitable relief from the Company claiming that the Company's needle-free system infringes the Filtertek patent and seeking, as well, a declaration, against Medex only, that Filtertek's needle-free device does not infringe the needle-free system patent licensed to the Company by Medex. The Company subsequently withdrew its 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 Illinois court granted the Company's motion to bifurcate discovery related to liability and damages. Discovery relating to liability recently ended, while discovery relating to damages is currently abated.

13 needle-free system infringes the Filtertek patent and seeking, as well, a declaration, against Medex only, that Filtertek's needle-free device does not infringe the needle-free system patent licensed to the Company by Medex. The Company subsequently withdrew its 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 Illinois court granted the Company's motion to bifurcate discovery related to liability and damages. Discovery relating to liability recently ended, while discovery relating to damages is currently abated. The Court appointed a Special Master to conduct a claims construction hearing. The Special Master has made recommendations to the Court on the construction of the single claim of the patent which is at issue and the Court is currently considering those recommendations.

The Company believes that it has meritorious defenses to all of Filtertek's claims and it intends to defend itself vigorously. The Company has offered to submit to mediation or arbitration to expedite the resolution of this case, but the Company and Filtertek have not reached agreement to do so. Based on the evidence to date, the Company intends to move for a summary adjudication of the claims. If that does not resolve all claims, the Company will press for a prompt trial of the remaining claims. There can be no assurance that the Company's defenses will defeat all of Filtertek's claims and the failure to do so could have a material adverse effect on the Company's business, financial condition, results of operations and cash flows.

United States Customs Service Matter

During the years 1988 through 1995, Cal Pacifico acted as the Company's United States customs broker and importer of record with respect to the importation into the United States of finished products assembled at the Company's two maquiladora assembly plants in Tijuana, Mexico. Cal Pacifico received a pre-penalty notice of intent from the United States Customs Service ("Customs") to assess additional duties and penalties against Cal Pacifico for its alleged failure to comply with certain documentary requirements regarding the importation of goods on behalf of its clients, including the Company. The Company believes that it is unlikely that Customs will assess any portion of the disputed amounts against the Company. Customs has not initiated any proceedings against the Company in respect of such matters. Nonetheless, Cal Pacifico advised the Company that it may seek recovery from the Company, through arbitration, for any portion of the disputed amounts which it is required to pay to Customs. The ultimate outcome of such proceeding cannot be predicted, nor is the Company able to estimate the possible loss resulting from such proceeding, should one occur. The Company believes that it has meritorious defenses to claims Cal Pacifico might raise against the Company. Although management does not believe it is probable that the Cal Pacifico dispute will result in a material claim against the Company, it will continue to monitor the matter.

Other

The Company is also a defendant in various actions, claims, and legal proceedings arising from its normal business operations. Management believes they have meritorious defenses and intends to vigorously defend against all allegations and claims. As the ultimate outcome of these matters is uncertain, no contingent liabilities or provisions have been recorded in the accompanying financial statements for such matters. However, in management's opinion, based on discussions with legal counsel, liabilities arising from such matters, if any, will not have a material adverse effect on the Company's business, financial condition, results of operations or cash flows.

1415

Part I—Item 2

Management's Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

Certain of the matters discussed in this report, including, without limitation, matters discussed under Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations," may constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Certain of these forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates," or "anticipates" or the negative of these terms or other comparable terminology, or by discussions of strategy, plans or intentions. Statements contained in this report that are not historical facts are forward-looking statements. Without limiting the generality of the preceding statement, all statements in this report concerning or relating to estimated and projected earnings, margins, costs, expenditures, cash flows, growth rates and financial results are forward-looking statements. In addition, through our senior management, from time to time we make forward-looking statements concerning our expected future operations and performance and other developments. Such forward-looking statements are necessarily estimates reflecting our best judgment based upon current information and involve a number of risks and uncertainties. Other factors may affect the accuracy of these forward-looking statements and our actual results may differ materially from the results anticipated in these forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to, those factors or conditions described under Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this report and under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates" and "Factors That Could Affect Future Financial Condition and Results" in our Form 10-K for the year ended December 31, 2001, and general conditions in the economy and capital markets.

~~General~~Overview

ALARIS was formed in 1996 by the merger of IMED Corporation and IVAC Medical Systems, Inc., two pioneers in the area of infusion technology, each with leading brand names and at least 30 years of operating history.

We ~~are~~develop apractical ~~leading~~solutions ~~developer,~~for ~~manufacturer~~medication ~~and~~safety ~~provider~~at the point of ~~infusion~~care. ~~systems~~We design, manufacture and ~~related~~market ~~technologies~~intravenous in(IV) medication ~~the~~delivery ~~United~~and ~~States~~infusion therapy devices, needle-free disposables and ~~internationally~~patient monitoring equipment. Our ~~intravenous~~"smart" ~~infusion~~technology, ~~systems~~tools and services are ~~used~~designed to ~~deliver~~ toreduce ~~patients~~the ~~one~~risks orand ~~more~~costs ~~fluids~~of medication errors, ~~primarily~~and ~~pharmaceuticals~~safeguard orpatients and ~~nutritionals~~clinicians. We provide our products, professional and ~~consist~~technical ofsupport ~~medication~~and ~~safety~~training ~~systems~~services to over 5,000 ~~single~~hospital and ~~multi-channel~~health ~~large~~care ~~volume~~systems, ~~infusion~~as ~~pumps,~~well ~~syringe~~as ~~pumps~~alternative ~~and~~care sites in more than 120 ~~dedicated~~countries ~~and~~through ~~non-dedicated~~a ~~disposable~~worldwide ~~administration~~direct ~~sets~~sales force and distributors. We have one of the largest installed ~~base~~bases of large volume pump delivery lines in the United States hospital market, representing approximately 3132% of such installed lines. We also believe that we have the number one or number two market position in the large volume 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 monitoring products that measure and monitor temperature, with a substantial installed base of hospital thermometry systems in the United States. We also provide products which measure and monitor pulse, pulse oximetry, ~~and~~ blood pressure. Weand ~~sell~~depth ~~our products primarily to the hospital market through a worldwide direct sales force~~ of ~~over~~consciousness ~~200~~during ~~salespersons and more than 100 distributors to over 5,000 hospitals in more than 120 countries worldwide~~anesthesia.

Critical Accounting Policies and Estimates

Our discussion and analysis of our operating results and financial condition is based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles.

On December 12, 2001, the Securities and Exchange Commission issued Release No. FR-60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies." Critical accounting policies are those that involve subjective or complex judgments, often as a result of the need to make estimates. The following areas all require the use of judgments and estimates: inventory valuation, allowances for uncollectible accounts receivable and estimated rebates, cost of field corrective actions, deferred tax asset valuation and carrying value of intangible assets. Estimates in each of these areas are based on historical experience and various judgments and assumptions that we believe are appropriate. Actual results may differ from these estimates. Our accounting practices are discussed in more detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and note 2 to our consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2001.

Results of Operations

The following table sets forth, for the periods indicated, selected financial information expressed 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 FAS 142, prior year data in the following tables has not been restated and, therefore, contains amortization expense that is

~~not~~Critical ~~included~~Accounting inPolicies ~~current~~and ~~year information (see note 2 to the condensed consolidated financial statements).~~ Estimates

		Three Months Ended March 31,
		2001		2002
Sales		100.0	%	100.0	%
Cost of sales		50.5		51.6
Gross margin		49.5	%	48.4	%
Selling and marketing expenses		20.5		18.9
General and administrative expenses		9.0		11.8
Research and development expenses		5.9		6.8
Restructuring and other non-recurring items		(0.6	)	5.8
Interest income from sales-type capital leases		1.1		1.3
Income from operations		15.8		6.4
Interest expense, net		(9.3	)	(9.1	)
Other, net		(0.5	)	(1.0	)
Income (loss) from continuing operations before income taxes		6.0		(3.7	)
Provision for (benefit from) income taxes		2.4		(.8	)
Income (loss) from continuing operations		3.6		(2.9	)
Gain on disposal of discontinued operations (net of tax)		—		3.8
Net income		3.6	%	0.9	%
Other Data:
	Adjusted EBITDA (1)	20.6	%	20.0	%

Our discussion and analysis of our operating results and financial condition is based upon our condensed consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles.

	Three Months Ended March 31,
	2002			2001
Adjusted EBITDA (1)	$	21,534		$	19,788
Restructuring and other non-recurring items		585			(5,743	)
Depreciation and amortization (2)		(5,712	)		(7,735	)
Interest income		214			635
Interest expense		(9,880	)		(9,639	)
Other, net		(494	)		(939	)
(Provision for) benefit from income taxes		(2,498	)		800
Income (loss) from continuing operations	$	3,749		$	(2,833	)

Critical accounting policies are those that involve subjective or complex judgments, often as a result of the need to make estimates. The following areas all require the use of judgments and estimates: inventory valuation, allowances for uncollectible accounts receivable and estimated rebates, cost of field corrective actions, deferred tax asset valuation and carrying value of intangible assets. Estimates in each of these areas are based on historical experience and various judgments and assumptions that we believe are appropriate. Actual results may differ from these estimates. Our accounting practices are discussed in more detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and note 2 to our consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2001.

~~service debt.~~ Results ~~Our computation~~ of ~~Adjusted EBITDA may not be comparable to similar titled measures of other companies.~~ Operations

	Three Months Ended June 30,				Six Months Ended June 30,
	2002		2001		2002		2001
Sales	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales	50.1		50.7		50.3		51.2

Gross margin	49.9		49.3		49.7		48.8
Selling and marketing expenses	19.4		20.0		20.0		19.4
General and administrative expenses	9.2		12.8		9.1		12.2
Research and development expenses	7.0		7.0		6.5		6.9
Restructuring and other non-recurring items	—		1.2		(0.3	)	3.5
Interest income from sales-type capital leases	1.0		1.4		1.1		1.3

Income from operations	15.3		9.7		15.5		8.1
Interest expense, net	(8.9	)	(10.4	)	(9.1	)	(9.8	)
Other, net	0.2		(0.2	)	(0.1	)	(0.6	)

Income (loss) from continuing operations before income taxes	6.6		(0.9	)	6.3		(2.3	)
Provision for (benefit from) income taxes	2.6		0.5		2.5		(0.2	)

Income (loss) from continuing operations	4.0		(1.4	)	3.8		(2.1	)
Gain on disposal of discontinued business (net of income taxes)	—		—		—		1.9

Net income (loss)	4.0	%	(1.4	)%	3.8	%	(0.2	)%

Other Data:
Adjusted EBITDA	20.5	%	19.0	%	20.5	%	19.5	%

	Three Months Ended June 30,						Six Months Ended June 30,
	2002			2001			2002			2001
Adjusted EBITDA (1)	$	22,218		$	18,684		$	43,753		$	38,473
Restructuring and other non-recurring items		—			(1,156	)		585			(6,899	)
Depreciation and amortization (2)		(5,653	)		(7,893	)		(11,365	)		(15,629	)
Interest income		269			585			482			1,219
Interest expense		(9,884	)		(10,860	)		(19,764	)		(20,498	)
Other, net		193			(202	)		(301	)		(1,141	)
(Provision for) benefit from income taxes		(2,858	)		(510	)		(5,356	)		290

Net income (loss) from continuing operations	$	4,285		$	(1,352	)	$	8,034		$	(4,185	)

(1): Adjusted EBITDA represents income from operations before restructuring, other non-recurring items, discontinued operations, interest, taxes, other, net, depreciation and amortization. Adjusted EBITDA does not represent net income or cash flows from operations, as these terms are defined under generally accepted accounting principles, and should not be considered as an alternative to net income as an indicator of our operating performance or to cash flows as a measure of liquidity.

We have included information concerning Adjusted EBITDA herein because we use such information as a measure of assessing cash flows and ability to service debt and understand that such information is used by investors as one measure of an issuer's ability to service debt. Restructuring and other one-time items are excluded from Adjusted EBITDA as we believe that the inclusion of these items would not be helpful to an investor's understanding of our ability to service debt. Our computation of Adjusted EBITDA may not be comparable to similar titled measures of other companies.

(2): Depreciation and amortization excludes amortization of debt discount and issuance costs included in interest expense.

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

		Three Months Ended March 31,
		Three Months Ended June 30,				Six Months Ended June 30,
		2002		2001		2002		2001
		(Dollars in millions)
		(in millions)				(in millions)
North America Business Unit
North America business unit
Infusion Instruments		$	12.5	$	9.4
Infusion instruments		$	18.3	$	13.3	$	30.7	$	22.7
Dedicated Disposables			33.8		33.3
Dedicated disposables			34.6		32.8		68.4		66.1
Other Disposables and Service			17.0		14.7
Other disposables and service			18.0		16.2		35.1		30.9
	Subtotal		6370.39		5762.43		134.2		119.7
Patient Monitoring			6.1		6.8
Patient monitoring			6.6		6.5		12.7		13.3
	North America Business Unit Total	$	69.4	$	64.2
	North America business unit total	$	77.5	$	68.8	$	146.9	$	133.0
International Business Unit
International business unit
Infusion Instruments		$	12.5	$	12.9
Infusion instruments		$	7.4	$	6.9	$	19.9	$	19.8
Dedicated Disposables			17.1		17.5
Dedicated disposables			17.5		17.9		34.5		34.8
Other Disposables and Service			4.2		3.1
Other disposables and service			4.5		3.7		8.8		7.4
	Subtotal		3329.84		3328.5		63.2		62.0
Patient Monitoring			1.2		1.2
Patient monitoring			1.6		1.2		2.8		2.4
	International Business Unit Total	$	35.0	$	34.7
	International business unit total	$	31.0	$	29.7	$	66.0	$	64.4
ALARIS Medical Systems Total		$	104.4	$	98.9
ALARIS Medical Systems, Inc. total		$	108.5	$	98.5	$	212.9	$	197.4

Three Months Ended ~~March~~June 3130, 2002 Compared with Three Months Ended ~~March~~June 3130, 2001

Sales

~~For~~Sales ~~the~~increased ~~three months ended March 31, 2002, sales were~~ $~~104~~10.40 million, an increase of ~~$5.5 million, or 6~~10% (8also 10% in constant currency as the favorable foreign currency benefit of a weaker U.S. dollar was less than 1% of consolidated sales) for the quarter ended June 30, ~~over~~2002 compared with the ~~prior~~ same quarter last year. North America sales ~~increased~~were $577.25 million, oran ~~8%,~~increase ~~and~~of ~~International sales increased~~ $08.37 million , or 113% ~~(6% in constant currency)~~, compared with the ~~prior~~second ~~year~~quarter of 2001. The ~~North America sales~~ increase iswas primarily due to higher volumes of ~~both~~ drug infusion instruments and disposable administration sets,. ~~resulting~~The ~~in an~~ increase ofin ~~$5.9 million over prior year~~ drug infusion ~~and~~ ~~service~~instruments ~~revenue. Contributing to the North America increase~~ was ~~$1.8 million~~primarily infrom sales of our new MEDLEY™ Medication Safety System of $6.2 million, which product was not ~~available~~sold ~~for sale~~ during the ~~first~~second quarter of 2001. ~~These~~International ~~increases~~ sales were ~~partially offset by lower volumes of patient monitoring instruments and disposables, resulting in a net decrease of~~ $31.70 million, ~~from~~an ~~the prior year patient monitoring sales. The International sales~~ increase ~~was due to higher volumes~~ of ~~non-dedicated~~5% ~~disposable~~(3% ~~administration sets and large volume pumps offset by lower syringe pump volumes and revenue compared with the prior year. International sales~~ in ~~the~~constant ~~prior year first quarter were very strong due to additional National Health System funding in the United Kingdom during that period, and sales continue to grow from this higher base~~currency). ~~The increase in large volume pump sales for the International business is primarily attributed to the Asena GW, a new product launched in late 2001.~~

1819

The increase was primarily due to increased volume of drug infusion syringe pumps and non-dedicated disposable administration sets compared with the same period in the prior year.

Gross Profit

Gross profit increased $35.96 million, or 811%, during the quarter ended ~~March~~June 3130, 2002, compared with the same quarter last year. The gross margin percentage increased to 49.59% in the ~~first~~second quarter of 2002, from 4849.43% in the ~~first~~second quarter of 2001. The improved margin percentage was due to increased volume of disposables (which have higher margins than instruments) and to lower product costs resulting from continuing manufacturing efficiencies and improvements, including the benefits from higher production volumes and related favorable utilization.

Selling and Marketing Expenses

Selling and marketing ~~expense~~expenses increased $21.74 million, or 157%, during the quarter ended ~~March~~June 3130, 2002, compared with the same period in 2001~~, primarily~~ ~~due~~as toa result ~~increased~~of ~~selling costs resulting from~~ higher sales volume in the ~~first~~second quarter of 2002 compared with the prior year, ~~and~~as towell as higher sales and marketing costs related to increased personnel and related activities supporting the North America launch of the MEDLEY™ Medication Safety System. ~~These~~Also contributing to this increase were higher marketing expenses related to new product launch strategies. These increases were partially offset by reductions in our distribution costs over the prior year. As a percentage of sales, selling and marketing expenses ~~increased~~decreased to 2019.54% for the second quarter of 2002 from 1820.90% ~~for~~in the ~~first~~second quarter of 2001.

General and Administrative Expenses

General and administrative ~~expense~~expenses decreased $2.25 million, or 1920%, during the ~~quarter~~three months ended ~~March~~June 3130, 2002, compared with the ~~same~~three ~~period~~months ended June 30, 2001. As a percentage of sales, general and administrative expenses decreased to 9.2% in the ~~prior~~ ~~year~~second quarter of 2002 from 12.8% in the second quarter of 2001. This decrease is was due to a $2.3 million reduction in amortization expense resulting from our ~~adopting~~adoption ~~Statement~~ of ~~Financial~~new ~~Accounting~~accounting ~~Standard~~requirements ~~No. 142, "Goodwill and Intangible Assets" and No. 141, "Business Combinations",~~ effective January 1, 2002, under which our goodwill and certain other amortization expense ceased. ~~Inflationary~~Had ~~cost~~the ~~increases~~newly ~~in general~~adopted ~~and~~accounting ~~administrative~~standards ~~expenses~~been ~~were~~in ~~generally~~effect ~~offset~~during bythe ~~lower~~second ~~bonus~~quarter ~~accruals.~~of ~~General~~2001, general and administrative expense ~~decreased~~for ~~from~~such ~~11.8% of sales during the first~~ quarter ofwould ~~2001~~have tobeen 910.04% of ~~sales~~ ~~for the first quarter of 2002~~sales. ~~Had~~Overall ~~the~~cost ~~newly~~increases ~~adopted accounting standards been~~ in ~~effect a year ago,~~ general and administrative ~~expense~~expenses ~~for~~were ~~2001~~generally ~~would~~offset ~~have~~by ~~been~~lower ~~9.4%~~bonus ~~of sales~~expense. (See note 2 to the condensed consolidated financial statements.)

Research and Development Expenses

Research and development ~~expense~~expenses ~~decreased~~increased approximately $0.57 million, or 810%, during the ~~quarter~~three months ended ~~March~~June 3130, 2002, ~~primarily~~compared ~~due~~with tothe ~~higher~~three ~~spending~~months ~~requirements~~ended ~~for~~June 30, ~~outside consulting in the prior year for the limited North America launch of the MEDLEY Medication Safety System in~~ 2001. ~~Research~~As ~~and development spending in the International business also decreased in 2002 as~~ a ~~result~~percentage of ~~the launch of Asena GW~~sales, ~~which~~spending ~~accounted~~on ~~for~~research ~~significant costs in the prior year. Research~~ and development ~~expense~~was ~~decreased to 5~~7.90% ~~of sales~~ for the ~~first~~second quarter of 2002, ~~compared~~which ~~with~~was ~~6.8%~~consistent ofwith ~~sales for~~ the ~~first~~prior ~~quarter~~year ~~of 2001~~period.

Restructuring and ~~Other~~ Non-~~recurring~~Recurring Items

We ~~recorded~~did anot incur any restructuring or non-recurring ~~benefit~~items ofin ~~$1.1 million during~~ the ~~first~~second quarter of 2002 ~~for an insurance settlement~~. ~~The~~We ~~settlement~~recorded ~~related to damages and losses incurred at one of our disposable products manufacturing plants in Mexico in 1993 as~~ a ~~result~~non-recurring ofcharge ~~flooding~~of $1.2 million ~~The contingency related to the insurance settlement was resolved~~ in the ~~first~~ second quarter of ~~2002,~~2001 ~~when~~for welegal ~~received~~and ~~proceeds~~advisory ofexpenses ~~$1.0 million~~related ~~during~~to ~~the~~obtaining ~~quarter and notification of~~ an ~~additional~~amendment ~~payment~~to ~~due~~ALARIS ofMedical ~~$.1 million,~~Systems' ~~which~~bank ~~was~~credit ~~received during April 2002~~agreement.

~~During the~~Income ~~first~~from quarter of 2002, we initiated a plan to restructure our Central European technical services. In this connection, we recorded a charge of $.5 million which included $.4 million of severance costs for 21 positions affected by the relocation of the German operation and $.1 million related to Operations

19 Income from operations increased $6.9 million during the three months ended June 30, 2002, compared with the three months ended June 30, 2001, primarily due to an increase in gross profit and lower amortization expense.

~~lease termination. The restructuring is anticipated to be completed during the third quarter of 2002. As of March 31, 2002, no payments have been made related to the restructuring.~~ 20

Restructuring and other non-recurring charges of $5.7 million in the first quarter of 2001 included $2.4 million of legal, advisory and consultant expenses related to obtaining an amendment to the ALARIS Medical Systems bank credit agreement. This amendment was completed in April 2001. We also recorded $3.3 million in restructuring and other non-recurring charges during the first quarter of 2001. These activities related to streamlining of operations in the North American business and resulted in the elimination of 71 positions. The restructuring and other non-recurring charges in the first quarter of 2001 were composed of severance and related benefits of $2.8 million and consulting fees of approximately $.5 million. Adjusted EBITDA for the first quarter of 2002 and 2001 excludes the non-recurring items.

Adjusted EBITDA

Adjusted EBITDA increased $13.75 million during the three months ended ~~March~~June 3130, 2002, compared with the three months ended ~~March~~June 3130, 2001. As a percentage of sales, Adjusted EBITDA increased from 2019.0%, or $1918.87 million, during the three months ended ~~March~~June 3130, 2001, to 20.65%, or $2122.52 million, during the three months ended ~~March~~June 3130, 2002, due to the reasons discussed above. (See note 1 under "Results of Operations.")

Interest Expense

Interest expense ~~increased~~decreased $1.20 million, or 39%, during the ~~quarter~~three months ended ~~March~~June 3130, 2002 compared with the ~~same~~three ~~period~~months inended ~~the prior year~~June 30, 2001. The ~~increase~~ decrease in interest is due to ~~higher~~lower overall interest rates onin ~~outstanding~~the ~~debt~~current ~~compared~~year ~~with~~over prior year.

Interest Income

Interest income decreased $0.43 million during the quarter ended ~~March~~June 3130, 2002 compared with the same quarter in 2001 due to lower interest rates earned on cash balances in 2002 compared with 2001.

Other, net

Other, ~~expense~~net ~~decreased~~increased to $0.42 million of income during the quarter ended ~~March~~June 3130, 2002, compared with ~~the same quarter in the prior year due to a decrease in foreign currency transaction losses of~~ $0.92 million. ~~During~~of ~~the~~expense ~~first~~for ~~quarter~~the ofsame period ~~2001,~~in wethe ~~received~~prior $year.~~5 million~~ ofThis ~~other~~improvement ~~income~~was ~~relating~~primarily due to ~~the~~changes ~~sale~~in ofcurrency arates ~~tradename.~~generating Weforeign ~~did~~currency ~~not~~transaction ~~receive comparable~~losses ~~income~~ in the ~~current~~prior year, ~~which~~and ~~partially~~gains ~~offset~~in the ~~decrease~~current ~~from foreign currency transaction losses~~quarter.

Six Months Ended June 30, 2002 Compared with Six Months Ended June 30, 2001

Sales

For the six months ended June 30, 2002, sales were $212.9 million, an increase of $15.6 million, or 8% (9% in constant currency) compared with $197.4 million reported for the same period in the prior year. Higher volumes of both drug infusion instruments and disposable administration sets in North America resulted in an increase in revenues of $13.9 million, or 10%, over the prior year. Contributing to the North America increase was $8.0 million in sales of our new MEDLEY™ Medication Safety System, which product was not sold during the first half of 2001. The increases in drug infusion products were partially offset by lower volumes of patient monitoring instruments and disposables compared with the prior year. International sales increased $1.6 million, or 3% (5% in constant currency), due to higher volumes of non-dedicated disposable administration sets and large volume pumps offset by lower syringe pump volumes and revenue compared with the prior year. The increase in large volume pump sales for the International business is primarily attributed to the Asena GW, a new product launched in late 2001.

Gross Profit

Gross profit increased $9.5 million, or 10%, during the six months ended June 30, 2002, compared with the six months ended June 30, 2001 due to higher sales and an increase in gross margin percentage. The gross margin percentage increased to 49.7% in the six months ended June 30, 2002, from 48.8% in the six months ended June 30, 2001. The improved margin percentage was due to increased volume of disposables (which have higher margins than instruments), higher overall margins on drug infusion instruments and patient monitoring products in North America, and to lower product costs resulting from continuing manufacturing efficiencies and improvements, including the benefits from higher production volumes and related favorable utilization.

Selling and Marketing Expenses

Selling and marketing expenses increased $4.1 million, or 11%, during the six months ended June 30, 2002, compared with the six months ended June 30, 2001, due to increased selling costs resulting from higher sales volume in the first six months of 2002 compared with the prior year and to higher sales and marketing costs related to increased personnel and related activities supporting the North America launch of the MEDLEY™ Medication Safety System. These increases were partially offset by reductions in our distribution costs over the prior year. As a percentage of sales, selling and marketing expenses increased to 20.0% for the first six months of 2002 from 19.4% for the same period in 2001.

General and Administrative Expenses

General and administrative expenses decreased $4.7 million, or 19%, during the six months ended June 30, 2002, compared with the six months ended June 30, 2001. As a percentage of sales, general and administrative expense decreased to 9.1% during the six months ended June 30, 2002 compared with 12.2% for the same period in the prior year. This decrease is due to a $4.6 million reduction in amortization expense resulting from our adoption of new accounting requirements effective January 1, 2002, under which our goodwill and certain other amortization expense ceased. Had these accounting requirements been in effect during the first two quarters of 2001, general and administrative expense for such period would have been 9.9% of sales. Overall cost increases in general and administrative expenses were generally offset by lower bonus expense. (See note 2 to the condensed consolidated financial statements.)

Research and Development Expenses

Research and development expenses increased approximately $0.2 million, or 1%, during the six months ended June 30, 2002, compared with the six months ended June 30, 2001. As a percentage of sales, spending on research and development decreased to 6.5% for the first six months of 2002, compared with 6.9% for the prior year comparative period.

Restructuring and Non-Recurring Items

We did not record restructuring or non-recurring items during the second quarter of 2002. 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 our disposable products manufacturing plants in Mexico in 1993 as a result of flooding. The contingency related to the insurance settlement was resolved in the first quarter of 2002, when we received proceeds of $1.0 million during the quarter and notification of an additional payment due of $0.1 million, which was received during April 2002.

During the first quarter of 2002, we initiated a plan to restructure our Central European technical services. In this connection, we recorded a charge of $0.5 million which included $0.4 million for severance costs for 21 positions affected by the relocation of the German operation and $0.1 million related to lease termination. As of June 30, 2002, approximately $0.1 million of severance costs has been paid to 13 employees. The restructuring is anticipated to be completed during the third quarter of 2002.

Restructuring and other non-recurring charges of $6.9 million during the six months ended June 30, 2001 included $3.5 million of legal, advisory, and other consultant expenses related to obtaining an amendment to the ALARIS Medical Systems bank credit agreement. This amendment was completed in April 2001. We also recorded $3.4 million for restructuring activities. These activities related to streamlining of operations in the North American business and resulted in the elimination of 70 positions. The restructuring charges were composed of severance and related benefits of $2.9 million

and consulting fees of $0.5 million. Adjusted EBITDA for the six months ended June 30, 2002 and 2001 excludes non-recurring items.

Adjusted EBITDA

Adjusted EBITDA increased $5.3 million during the six months ended June 30, 2002 compared with the six months ended June 30, 2001. As a percentage of sales, Adjusted EBITDA increased from 19.5%, or $38.5 million, during the six months ended June 30, 2001 to 20.5%, or $43.8 million, during the six months ended June 30, 2002 due to the reasons discussed above. (See note 1 under "Results of Operations.")

Interest Expense

Interest expense decreased $0.7 million, or 4%, during the six months ended June 30, 2002 compared with the six months ended June 30, 2001. The decrease in interest is due to lower overall interest rates in the current year over prior year.

Interest Income

Interest income decreased $0.7 million during the six months ended June 30, 2002 compared with the same period in 2001 due to lower interest rates earned on cash balances in 2002 compared with 2001.

Other, net

Other expense decreased $0.8 million during the six months ended June 30, 2002, compared with the same period in the prior year. Foreign currency transaction losses decreased $1.6 million and other income decreased approximately $0.5 million from the prior year. During the first quarter of 2001, we received $0.5 million of other income relating to the sale of a tradename. We did not receive comparable income in the current year.

Discontinued Operations

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

Liquidity and Capital Resources

We expect to continue to meet our short-term liquidity needs, including capital expenditure requirements, with cash flow from operations and cash on hand. We will continue to use our funds primarily for operating expenses, including planned expenditures for new research and development programs, capital expenditures and scheduled interest payments on outstanding indebtedness.

20 At June 30, 2002, we had $350.0 million outstanding indebtedness composed of $170.0 million of 115/8% senior secured notes due 2006 ("Senior Secured Notes"), which were issued on October 16, 2001 and $180.0 million of 93/4% senior subordinated notes due 2006 ("Senior Subordinated Notes"). The Senior Secured Notes bear interest at 115/8%, payable semi-annually in arrears beginning June 1, 2002, with all principal due at maturity on December 1, 2006. The Senior Subordinated Notes bear interest at 93/4%, payable semi-annually in arrears on June 1 and December 1, with all principal due at maturity on December 1, 2006.

At March 31, 2002, we had $350.0 million outstanding indebtedness composed of $170.0 million of 115/8% senior secured notes due 2006 ("Senior Secured Notes"), which were issued on October 16, 2001 and $180.0 million of 93/4% senior subordinated notes due 2006 ("Senior Subordinated Notes"). The Senior Secured Notes bear interest at 115/8%, payable semi-annually in arrears beginning June 1, 2002, with all principal due at maturity on December 1, 2006. The Senior Subordinated Notes bear interest at 93/4%, payable semi-annually in arrears on June 1 and December 1, with all principal due at maturity on December 1, 2006. 23

Holdings also had outstanding at ~~March~~June 3130, 2002, $~~163~~168.61 million accreted amount of its of 111/8% Senior Discount Notes due 2008 ("Senior Discount Notes"). As disclosed below, the Holdings Convertible Debentures were repaid at their scheduled maturity on January 15, 2002.

The Senior Discount Notes accrete to $189.0 million principal amount by August 1, 2003. Prior thereto, interest accruing on the Senior Discount Notes is added to the outstanding principal balance through July 31, 2003. Interest on the Senior Discount Notes accruing subsequent to July 31, 2003 is payable in cash semi-annually in arrears on February 1 and August 1, commencing February 1, 2004. The indentures governing the Senior Secured Notes and the Senior Subordinated Notes permit ALARIS Medical Systems to make distributions, or "restricted payments," to Holdings if at the time of the restricted payment, ALARIS Medical Systems satisfies the two conditions described in the following paragraphs. Management believes that when Holdings is required to begin making cash interest payments on the Senior Discount Notes in 2004, ALARIS Medical Systems will have satisfied these conditions.

The first condition which must be satisfied prior to making a restricted payment is that at the time of the distribution, ALARIS Medical Systems must have a Fixed Charge Coverage Ratio (as calculated in accordance with the indentures as described below) of at least 2.5 to 1 calculated for the four complete calendar quarters preceding the distribution as though the distribution had been made at the beginning of such period. The Fixed Charge Coverage Ratio will be determined by dividing ALARIS Medical Systems' Consolidated EBITDA (as defined in the indentures) by its Consolidated Interest Expense, (as defined in the indentures). Based on the interest rate on and the amount of debt outstanding at ALARIS Medical Systems at ~~March~~June 3130, 2002, the interest expense to be included in future calculations of the Fixed Charge Coverage Ratio is approximately $38.9 million. As a result, the minimum required Consolidated EBITDA to meet the ratio will be approximately $97.3 million.

The calculation of Consolidated EBITDA for purposes of the indentures is different from our calculation of Adjusted EBITDA described elsewhere in this report. Under the indentures, Consolidated EBITDA is defined as follows: "With respect to any Person for any period, the Consolidated Net Income of such Person and its Restricted Subsidiaries for such period, plus, to the extent deducted in computing Consolidated Net Income: (i) provision for taxes based on income or profits of such Person and its Restricted Subsidiaries for such period; (ii) Consolidated Interest Expense of such Person for such period; and (iii) depreciation and amortization (including amortization of goodwill and other intangibles) and all other non-cash charges (excluding any such non-cash charge to the extent that it represents an accrual of or reserve for cash charges in any future period or amortization of a prepaid cash expense that was paid in a prior period) of such Person and its Restricted Subsidiaries for such period; and (iv) any extraordinary or non-recurring loss and any net loss realized in connection with 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 provision for taxes based on the income or profits of, and the depreciation and amortization and other non-cash charges of, a Restricted Subsidiary of a Person shall be added to Consolidated Net Income to compute ~~Consolidated~~ Consolidated EBITDA only to the extent (and in the same proportion) that the Net Income of such Restricted Subsidiary was included in calculating the Consolidated Net Income of such Person. "

2124

Consolidated EBITDA, per the indentures, as calculated for the ~~quarter~~six months ended June 30, 2002 reconciled to those reported by ALARIS Medical Systems is as follows:

	Three months ended March 31, 2002
	Six Months Ended June 30, 2002
	(Dollars in thousands)
ALARIS Medical Systems consolidated net income	$	3,749
ALARIS Medical Systems consolidated net income, as reported	$	8,034
Provision for income taxes		25,~~498~~356
Interest expense		919,~~880~~764
Depreciation and amortization		511,~~712~~365
Non-cash items		60(1,596	)
Extraordinary/non-recurring items		540
Consolidated EBITDA, per indentures	$	2243,~~439~~463
Less insurance settlement	$	(1,125	)
Less non-cash items		~~(60~~1,596	)
Less interest income		(~~214~~482	)
Other, net		~~494~~301
ALARIS Medical Systems Adjusted EBITDA, as reported	$	2143,~~534~~753

The second condition which must be satisfied prior to making a restricted payment is that the distribution, together with certain other restricted payments, may not exceed a sum determined by reference to ALARIS Medical Systems' cumulative Consolidated Net Income (as defined in the indentures) for the period since January 1, 1997 and cash capital contributions ~~made~~received after such date, less restricted payments made. This condition provides that the Consolidated Net Income of ALARIS Medical Systems will be added to the amount available each quarter until such time as historical net losses of $3938.96 million are exhausted. Subsequent to such time, 50% of future ALARIS Medical Systems net income will be added to the amount available. At ~~March~~June 3130, 2002, the amount available for future restricted payments was $1316.69 million.

The preceding description of the provisions of the indentures which govern restricted payments, including the defined terms, is a summary only and is qualified in its entirety by the text of the indentures, which ALARIS Medical Systems has previously filed with the Securities and Exchange Commission.

Holdings' Convertible Debentures were retired at their scheduled maturity on January 15, 2002. The indentures governing the Senior Secured Notes and the Senior Subordinated Notes permitted ALARIS Medical Systems to use $15 million of ~~our~~its cash on hand to invest in a wholly owned unrestricted subsidiary. ALARIS Medical Systems made such investment and the unrestricted subsidiary used a portion of the proceeds of such investment to acquire $0.2 million Convertible Debentures in the open market in 2001. In 2002, the remaining $14.8 million was loaned to Holdings, which used the proceeds of such loan and proceeds from the exercise of stock options to retire the Convertible Debentures. A portion of the stock option exercise proceeds resulted from the exercise by some of our executive officers of stock options. In connection with the exercise, three of our executive officers received interest-bearing, short-term loans, aggregating $0.6 million, from ALARIS Medical Systems. These loans were subsequently repaid in full. Holdings was entitled to require such executive officers to exercise such options in order to provide Holdings with sufficient funds to retire the Convertible Debentures. Such options were granted to these executive officers in anticipation of Holdings' need to require such exercise in order to complete the retirement of the Convertible Debentures. (~~see~~See note 6 to the condensed consolidated financial statements).)

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ALARIS Medical Systems is required over the next twelve months (through ~~March~~June 3130, 2003) to make interest payments on the Senior Secured Notes in the amount of $2219.28 million and interest payments on the Senior Subordinated Notes in the amount of $17.6 million.

Although we have no further principal amortization requirements until the maturity of the Senior Secured Notes and the Senior Subordinated Notes in December 2006, management will continue to monitor the capital markets prior to such time for opportunities to improve ALARIS Medical Systems' and Holdings' capital structure. Management anticipates that ALARIS Medical Systems and Holdings will refinance their entire debt structure prior to December 2006 since it believes that it is unlikely that ALARIS Medical Systems will generate sufficient cash flow from operations to repay the Senior Secured Notes and the Senior Subordinated Notes at maturity in 2006 and to permit it to make distributions to Holdings to enable it to repay the Senior Discount Notes at maturity in 2008. Such refinancing may involve an offering of debt securities of ALARIS Medical Systems or Holdings, (or both), an offering of equity securities of Holdings to reduce the level of indebtedness of of ALARIS Medical Systems or Holdings, (or both), or a combination of any of the foregoing. The ability of ALARIS Medical Systems or Holdings, or both, to obtain such debt or equity financing will be dependent upon many factors, including overall financial market and economic conditions and our operating performance and expectations at such time.

Should ALARIS Medical Systems not repay its indebtedness at maturity in 2006, should Holdings not repay the Senior Discount Notes in 2008, or should ALARIS Medical Systems not be able to make distributions to Holdings commencing in 2004 in order to permit Holdings to make cash interest payments on the Senior Discount Notes, these events could have a material adverse effect on our business, financial condition and results of operations and could result in a default by Holdings, ALARIS Medical Systems, or both, and possible acceleration of all or a portion of such indebtedness, unless Holdings, ALARIS Medical Systems, or both, could refinance such indebtedness or obtain the required funds from other sources.

In response to customer requests to finance their payments related to equipment purchases over time, we have identified an unrelated third party financing company to assist our customers in such area. In recent years, $12 million to $16 million annually of drug infusion equipment sales to North American customers have been financed by this third party. If such third party financing source were no longer available to our customers, it could require us to find another party or to finance such customer purchases and require use of our cash. Additionally, our operating results could also be affected, as it is possible that customers could look to make their purchases from our competitors who might be able to finance such purchases at a lower cost of funds.

~~Net~~As identified in the condensed consolidated statement of cash flows, net cash provided by operating activities for the ~~three~~six months ended ~~March~~June 3130, 2002 was $1618.48 million compared with $2534.3 million provided by operating activities in the first ~~quarter~~six months of 2001. Net cash used byin investing activities for the ~~three~~six months ended ~~March~~June 3130, 2002 was $321.89 million. Net cash provided by investing activities for the ~~three~~ six months ended ~~March~~June 3130, 2001 was $1.20 million, which included $38.61 million of net proceeds from the sale of a discontinued operation. Net cash used in financing activities for the ~~three~~ six months ended ~~March~~June 3130, 2002 and 2001 was $151.65 million and $511.9 million, respectively., ~~Cash~~and ~~used in financing activities in 2002 included $14.8 million for the~~was ~~issuance~~composed of adividend ~~note~~payments ~~receivable~~ to Holdings asand ~~described~~principal ~~above.~~payments ~~(See~~on ~~note 6~~long-term ~~to the condensed consolidated financial statements~~debt.)

We made capital expenditures of approximately $36.5 million during the ~~three~~six months ended ~~March~~June 3130, 2002 and anticipate additional capital expenditures of approximately $1613.5 million during the remainder of 2002.

~~The following schedule summarizes our contractual obligations and commitments to make future payments as of March 31, 2002.~~ 26

23 The following schedule summarizes our contractual obligations and commitments to make future payments as of June 30, 2002.

Contractual Obligations & Commitments

Payments Due by Period	Long-term Debt		Operating Leases		Interest Payments		Total
2002 (A)	$	—	$	43.61	$	3918.87	$	4421.48
2003		—		6.2		37.3		43.5
2004		—		5.9		37.3		43.2
2005		—		5.9		37.3		43.2
2006		350.0		1.7		37.3		389.0
Thereafter		—		5.6		—		5.6
Total Contractual Cash Obligations	$	350.0	$	2928.94	$	~~189~~167.09	$	~~568~~546.93

(A): Amount represents remaining contractual obligation during 2002.

Backlog

The amount of unfilled orders, believed to be firm, at ~~March~~June 3130, 2002 and 2001 was $89.42 million and $1115.46 million, respectively. Included in the $9.2 million was $3.5 million of orders related to our MEDLEY Medication Safety System.

Foreign Operations

We have significant foreign operations and, as a result, are subject to various risks arising therefrom, including foreign currency risks. This risk did not materially change during the first ~~quarter~~six months of 2002. For the ~~quarters~~six months ended ~~March~~June 3130, 2002 and 2001, approximately 3533% and 3735%, respectively, of our sales ~~were denominated in currencies other than the U.S. dollar. For the quarters ended March 31, 2002~~ and ~~2001, approximately 31~~30% and 2526%, ~~respectively,~~ of our operating expenses were denominated 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 our foreign subsidiaries are denominated in currencies other than the U.S. dollar. During the first six months of 2002, the net effect of foreign currency transactions to the income statement was approximately thirty thousand dollars. Due to changes in foreign currency exchange rates during ~~2002~~the ~~and~~first six months of 2001, primarily a strengthening of the U.S. dollar against many European currencies, we recognized foreign currency transaction losses of $~~.4 million and $~~1.35 million ~~during 2002 and 2001, respectively~~. Such losses were recorded in other expense in the statement of operations. (See note 3 to the condensed consolidated financial statements.)

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Risk Management—Foreign ~~Exchange~~Currency ~~Risk~~Hedging ~~Management~~Program, Derivative Financial Instruments and Market Risk

As part of ~~the~~our risk management strategy, towe ~~manage~~put ~~the~~in ~~risk~~place ofa ~~foreign~~hedging ~~currency~~program ~~fluctuations,~~beginning in 2001 under which we enter into forward foreign exchange and currency option contracts to hedge ~~anticipated~~a portion of forecasted cash receipts and payments denominated in currencies other than the U.S. dollar. ~~for~~These ~~periods~~contracts ~~consistent~~are ~~with~~entered ~~identified~~into ~~exposures,~~to ~~but~~reduce ~~generally no longer than~~ the ~~end~~risk ofthat ~~the year for which we have substantially completed~~ our ~~annual business plan. Gains~~ earnings and ~~losses~~cashflows, ~~related~~resulting tofrom ~~qualifying~~certain ~~hedges~~forecasted oftransactions, ~~these~~will ~~exposures~~be ~~are~~affected ~~deferred~~by ~~and~~changes ~~recognized~~ in ~~income~~foreign ~~when~~currency ~~the~~exchange ~~underlying hedged transaction occurs~~rates. ~~Currently~~However, we ~~also~~ ~~enter~~may ~~into~~be ~~foreign~~impacted ~~currency~~by ~~options~~changes toin ~~hedge~~foreign ~~anticipated~~exchange ~~transactions~~rates ~~where~~related to ~~there~~the isunhedged aportion ~~high~~of ~~probability~~the ~~that~~forecasted ~~anticipated exposures will materialize~~transactions. ~~Premiums~~The onsuccess ~~foreign~~of ~~currency~~the ~~options~~hedging ~~and~~program ~~any gains~~depends, ~~realized~~in part, on ~~such~~forecasts ~~options~~of ~~that~~our ~~qualify~~transactions ~~as hedges are deferred and recognized~~ in ~~income~~various ~~when~~currencies (primarily the ~~underlying hedged transaction occurs~~Euro). InHedges ~~addition,~~are placed ~~any~~for ~~deferred~~periods ~~gains~~consistent ~~and~~with ~~losses~~identified onexposures, ~~hedges~~but ~~which are~~generally ~~terminated~~no ~~prior~~longer tothan the ~~transaction~~end ~~date~~of ~~would~~the beyear ~~recognized~~for inwhich ~~current~~we ~~income~~have ~~when~~substantially ~~the underlying hedged transaction occurs.~~

24 completed our annual business plan. We may experience unanticipated foreign currency exchange gains or losses to the extent that there are timing differences between forecasted and actual activity during periods of currency volatility. However, since the critical terms of contracts designated as cash flow hedges are the same as the underlying forecasted transaction, changes in fair value of contracts should be highly effective in offsetting the present value of changes in the expected cash flows from the forecasted transaction. The ineffective portion of any changes in the fair value of option contracts designated as hedges is recognized immediately in earnings. We did not recognize material gains or losses resulting from either hedge ineffectiveness or changes in forecasted transactions during 2002.

As a matter of policy, we will only enter into currency contracts with counterparties that have at least an investment grade or equivalent credit rating from a major rating agency. The counterparties to these contracts are major financial institutions. We do not have significant exposure to any one counterparty. ~~Management~~We ~~believes~~believe the risk of loss related to counterparty 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 twelve months.~~ Costs associated with entering into contracts are not expected to be material to our financial results. ~~Currency option and forward contracts are~~(See ~~discussed in~~ note 3 to the condensed consolidated financial statements.)

~~Derivative Financial Instruments~~ 28

We address certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments.

During the first quarter of 2001, we began a foreign exchange risk management strategy as described above. Under the program, we utilize foreign currency options and forward contracts to reduce the effect of exchange rate fluctuations. We categorize these instruments as entered into for purposes other than trading. We do not utilize derivative instruments for trading or speculative purposes. As of March 31, 2002 our only derivatives in place were forward contracts valued at $.3 million and designated as hedges of anticipated cash flows in various foreign currencies and foreign currency option contracts valued at $.2 million to hedge anticipated transactions (primarily the Euro). This amount is recorded as a current asset in our consolidated balance sheet (see note 3 to the condensed consolidated financial statements).

Market Risk

We incur option premium cost in connection with our currency hedging activities. The option premium cost represents the entire risk associated with these derivatives. Option premium costs are reflected in the period the underlying transaction is recognized.

Part II

Other Information

Item 6. Exhibits and Reports on Form 8-K

(a): Exhibits

10.2 Changes to the Employment Letter dated April 13, 1999 by and between David L. Schlotterbeck, ALARIS Medical and ALARIS Medical Systems are described in ALARIS Medical's Proxy Statement dated April 12, 2002 under the heading "Employment Contracts, Termination of Employment and Change-in-Control Arrangements." Incorporated by reference to ALARIS Medical's Proxy Statement dated April 12, 2002.

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.	Filed herewith
99.1	Certification 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 Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith

(b): Reports on Form 8-K

None.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	ALARIS MEDICAL SYSTEMS, INC. (Registrant)	~~ALARIS MEDICAL SYSTEMS, INC. (Registrant)~~
Date: May 1, 2002	By:	/s/ WILLIAM C. BOPP William C. Bopp Senior Vice President and Chief Financial Officer (Principal Financial Officer)
Date: August 8, 2002	By:	/s/ WILLIAM C. BOPP William C. Bopp Senior Vice President and Chief Financial Officer (Principal Financial Officer)
	By:	/s/ ROBERT F. MATHEWS Robert F. Mathews Vice President—Finance and Treasurer (Principal Accounting Officer)

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ALARIS MEDICAL SYSTEMS, INC.
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Form 10—Q Part 1—Item 1 Financial Information ALARIS MEDICAL SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited) (Dollars in thousands)
ALARIS MEDICAL SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEET (Dollar amounts in thousands, except per share data)
ALARIS MEDICAL SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (Dollars in thousands)
ALARIS MEDICAL SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY (Unaudited) (Dollar amounts in thousands)
ALARIS MEDICAL SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands)
Part I—Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations
Part II Other Information
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