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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

                    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 o  Not Applicable x 

                    Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

Yes o Not Applicable x

                    Indicate by check mark whether the Registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).

Yes o No x

                    As of March 14, 2003 the number of shares of Common Stock, $.01 par value, outstanding (the only class of common stock of the registrant outstanding) was 10,654,293.  The registrant’s Common Stock is not traded in a public market.

                    Aggregate market value of the registrant’s voting and nonvoting Common Stock:  Not Applicable.

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HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES

Fiscal Year Ended December 31, 2002

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PART I

Item 1.         Business

                    This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  These statements include without limitation the words “believes,” “anticipates,” “estimates,” “intends,” “expects,” and words of similar import.  All statements other than statements of historical fact included under “Item 1. Business,” “Item 2. Properties,” “Item 3. Legal Proceedings” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” include forward-looking information and may reflect certain judgments by management. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of Hudson Respiratory Care Inc. or the respiratory care and anesthesia products industries to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.  These potential risks, uncertainties and other factors include, but are not limited to, those identified in the “Risk Factors” section of this Form 10-K located at the end of “Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

General

                    Hudson Respiratory Care Inc. (“Hudson RCI” or the “Company”) is a leading manufacturer and marketer of disposable medical products utilized in the respiratory care and anesthesia segments of the domestic and international health care markets.  The Company offers one of the broadest respiratory care and anesthesia product lines in the industry, including such products as oxygen masks, humidification systems, nebulizers, cannulae and tubing.  In the United States, the Company markets its products to a variety of health care providers, including hospitals and alternate site service providers such as outpatient surgery centers, long-term care facilities, physician offices and home health care agencies.  Internationally, the Company sells its products to distributors that market to hospitals and other health care providers.  The Company’s products are sold to over 5,400 distributors and alternate site service providers throughout the United States and in more than 90 countries worldwide.  The Company has supplied the disposable respiratory care market for over 55 years and enjoys strong brand name recognition and leading market positions. 

                    The Company manufactures and markets approximately 1,650 respiratory care and anesthesia products.  The Company believes that its broad product offering represents a competitive advantage over suppliers with more limited product offerings, as health care providers seek to reduce medical supply costs and concentrate purchases among fewer vendors.  The Company also benefits competitively in the United States from its extensive relationships with leading group purchasing organizations  (“GPOs”), as large purchasing organizations play an increasingly important role in hospitals’ purchasing decisions.

                    The Company maintains three manufacturing facilities and two distribution facilities in the United States, one manufacturing facility and one assembly operation in Mexico, an assembly operation in Malaysia and sales and marketing offices in the United States, Sweden, the United Kingdom, France and Germany.

                    Hudson Oxygen Therapy Sales Company (“Hudson Oxygen”), Hudson RCI’s predecessor, was founded in 1945. In 1988, Hudson Oxygen formed Industrias Hudson, a subsidiary that oversees the Company’s assembly operation in Mexico.  In 1989, Hudson Oxygen merged with Respiratory Care Inc. to form Hudson RCI.  In April 1998, the Company consummated a recapitalization, pursuant to which it became a majority-owned subsidiary of River Holding Corp. (“Holding”).  In the past four years, the Company has completed a number of strategic acquisitions in order to expand its product line and geographic penetration, most significantly with the July 1999 acquisition of Hudson RCI AB (formerly Louis Gibeck AB), a Swedish company that manufactures and markets medical devices under the Gibeck brand.  Hudson RCI’s principal executive offices are located at 27711 Diaz Road, P.O. Box 9020, Temecula, California 92589, and its telephone number is (909) 676-5611.

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Industry Overview

                    The worldwide market for disposable respiratory care and anesthesia products consists of the domestic hospital market, the alternate site market and the international market.  Respiratory care and anesthesia principally involve the delivery of oxygen or anesthesia from a gas source, such as a mechanical ventilator or respirator, to the patient’s pulmonary system.  The gas is typically delivered to the patient through specialized tubing connecting to a cannula, mask or endotracheal tube.  In addition, it is often clinically desirable to humidify or medicate the gas prior to delivery to the patient.  The market for respiratory care and anesthesia products, including disposable products, is expected to be positively impacted by demographic trends, both domestically and internationally.  In the United States, changes in demographics, including an aging population, increased incidence and awareness of respiratory illnesses and heightened focus on cost-efficient treatment, have had a positive impact on the domestic respiratory care and anesthesia markets.  There has been an increasing incidence of respiratory illnesses (such as asthma and emphysema), due in part to an increasingly susceptible aging population, environmental pollution, smoking-related illnesses and communicable diseases with significant respiratory impact, such as tuberculosis, HIV and influenza.  The Company believes that the international respiratory care and anesthesia markets will experience many of the trends currently affecting domestic markets.  In addition, many international markets have high incidences of communicable respiratory diseases and are becoming increasingly aware of the clinical and economic value of single-use, disposable products.

                    The market for respiratory care and anesthesia products is also affected by trends involving the health care market in general.  In particular, the overall trend towards cost containment and infection control has increased the desirability of disposable products relative to reusable products, and has influenced pricing, product utilization, distribution channels, purchasing decisions and health care delivery methods.

                    Efforts to contain rising health care costs have increased the preference for disposable medical products that improve the productivity of health care professionals and reduce overall provider costs.  Health care organizations are evaluating modes of treatment that are less labor and/or technology intensive as a means of decreasing the cost of care, which can often result in increased disposable usage.  In particular, increased utilization of disposable products can decrease labor and other costs associated with sterilizing and reprocessing reusable products.  In addition, the risks of transmission of infectious diseases such as HIV, hepatitis and tuberculosis, and related concerns about the occupational safety of health care professionals, have also contributed to an increased preference for disposable single-use medical products.

                    Cost containment has caused consolidation throughout the health care product supply channel, which has favored reliable manufacturers with large, high quality product offerings and competitive pricing.  In an effort to contain costs, service providers have consolidated and affiliated with GPOs, which take advantage of group buying power to obtain lower supply prices. This, in turn, has led to consolidation among distributors, who seek to provide “one-stop shopping” for these large buying groups.  Distributors have also sought to concentrate purchases among fewer vendors in an effort to reduce supply costs.  Since selection as a contracted GPO provider and strong relationships with distributors are critical to many health care manufacturers, they have responded to these trends by providing a broad range of integrated products, combined with reliable delivery and strong after-sales support.

                    Cost containment has also caused a migration of the decision making function with respect to supply acquisition from the clinician to the administrator.  As clinicians lose influence and purchasing agents, materials managers and upper level administrative management become more involved in the purchasing decision, a greater emphasis may be placed on price relative to product features and clinical benefits.

                    As a result of cost containment, health care is increasingly provided outside of traditional hospital settings through lower cost alternate health care sites, such as outpatient surgery centers, long-term care facilities, physician offices and patients’ homes.  Growth of the alternate site market is also attributable to advances in technology that have facilitated the delivery of care outside of the hospital, an increased number of illnesses and diseases considered to be

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treatable outside of the hospital and increased acceptance by the medical community of, and patient preference for, non-hospital treatment.

Products

                    The Company manufactures and markets products for use in respiratory care and anesthesia.  The products for each market are similar and often overlap, as do the distribution channels.

                    The Company groups its products into four clinical categories: (i) oxygen therapy; (ii) aerosol therapy; (iii) humidification and filtration; and (iv) airway management.  Although the Company’s sales efforts differ depending on the clinical use of its products, management focuses on geographical segments for strategic decision making.

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Sales, Marketing and Distribution

                    The Company’s main focus for operational management and strategic decisions is based on geographical segments.  These are defined as the Domestic and European operations, each having their own, distinct management team.

                    The Company has sales offices in Temecula, California, Sweden, Germany, France and the United Kingdom and two distribution facilities in the United States and one in Europe.  Additionally, the Company contracts with a third-party distribution facility in Charlotte, North Carolina.  The Company also employs sales representatives in Thailand, China, Mexico, Chile and Australia.  While a majority of the Company’s domestic hospital sales are made to distributors, the Company’s marketing efforts are focused on the health care service provider.  In the alternate site market, the Company both sells and markets directly to the service provider. Internationally, the Company sells its products to distributors that market to hospitals and other health care providers.  See Note 10 to “Item 8. Financial Statements and Supplementary Schedules” for information with respect to international sales.  The Company’s U.S. sales personnel currently call on approximately 5,900 hospitals and surgery centers, over 50 hospital distributors and over 3,000 alternate site customers.  Due to consolidation and cost pressures among the Company’s customer base, the Company’s target call point at the health care provider has been moving away from the clinician to include a purchasing manager or corporate executive.

                    In the current US hospital market environment, GPO and Integrated Delivery Network (“IDN”) relationships are an essential part of access to the Company’s target markets and the Company has entered into preferred supplier arrangements with eight national GPOs.  The Company is typically positioned as either a sole supplier of respiratory care disposables to the GPO, or as one of two suppliers.  While these arrangements set forth pricing and terms for various levels of purchasing, they do not obligate either party to purchase or sell a specific amount of product.  In addition, GPO affiliated hospitals often purchase products from other suppliers notwithstanding the existence of sole or dual source GPO arrangements.  Further, these arrangements are terminable at any time, but in practice usually run for two to three years.  The Company enjoys longer terms with three of its major GPOs, Novation LLC, Consorta and HealthTrust Purchasing Group.  The Company’s most significant GPO relationships are with AmeriNet Inc., Broadlane, Consorta, Med Assets, HealthTrust Purchasing Group and Novation LLC. 

                    Health care providers have responded to pressures to reduce their costs by merging with other members of their industry.  The acquisition of a customer of the Company often results in the renegotiation of contracts, the granting of price concessions or in the loss of the customer.  Alternatively, to the extent a customer of the Company grows through acquisition activity, the Company may benefit from increased sales to the larger entity.

                    The Company markets its products primarily through consultative dialogue with health care providers, targeted print and web site advertising, trade shows, selective promotional arrangements with distributors and the Company’s heater lease program.  To support sales of the entire line of humidification and ventilation products, the Company leases

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heaters to domestic customers without charge.  The revenues from the sale of products used in connection with the operation of the heaters covers the amortization of the heater cost under the leases.  The net book value of heaters was $6.9 million and $6.0 million at December 31, 2002 and December 31, 2001, respectively

                    The Company utilizes a network of over 50 hospital distributors, as well as over 2,900 alternate site distributors and end-users, to reach its markets.  A number of these distributors carry competing product lines, but many are moving to select single supply sources for particular product groups.  The Company has been selected as the FOCUS preferred vendor of respiratory disposables for Owens & Minor Inc.  Such status gives preference to the shipping of the Company’s products versus competing product lines.  Owens & Minor Inc. is the Company’s largest distributor, accounting for approximately $32.7 million or approximately 19.1% of total fiscal 2002 net sales, $30.4 Million or 19.4% of total fiscal 2001 net sales and $32.2 million or 20.2% of total fiscal 2000 net sales. The Company provides a price list to its distributors which details base acquisition prices.  Distributors receive orders from the service providers and charge the contract pricing (which is determined by their GPO affiliation or individual contract price) plus a service margin.  As is customary within the industry, the Company rebates the difference between base acquisition price and the specific contract price to the distributor.  The Company’s international distributors outside of the European Union (“EU”), Middle East and Africa place their orders directly with dedicated international customer service representatives.  Customer orders are shipped from one of two warehouse locations.  Sales strategies and marketing plans are tailored to each clinical product group with involvement of the distributor.  Region and territory sales managers are responsible for the launch of products into their markets, including related support and training.  The Company utilizes a network of approximately 120 international distributors, typically on an exclusive basis by product category or market/country within each market. Customers within Europe, the Middle East and Africa are serviced by the Company’s Sweden office.

Manufacturing and Assembly

                    The Company operates three manufacturing facilities in the United States, one in Tecate, Mexico and assembly facilities in Ensenada, Mexico and Kuala Lumpur, Malaysia.  While the Company believes that it is operating at a high utilization rate, existing facilities could support increased capacity with additional machinery and workers. The Company’s manufacturing facility in Temecula, California houses 77 injection molding machines.  During the past several years, many of the machines have been replaced with more efficient models, which have increased capacity.  Tubing is produced on 11 extrusion lines: six corrugated, four vinyl and one repellitizer/regrinder.  The Temecula facility uses approximately 17 million pounds of over 30 different kinds of resin annually; the most prominent are PVC, polyethylene, polypropylene and polystyrene.  Sterile prefilled humidification and nebulization products are manufactured using nine blow/fill/seal machines in the Company’s facility in Arlington Heights, Illinois.

                    The Company’s Argyle, New York facility houses two extrusion lines, four blow molding machines and three assembly lines designed to produce the SHERIDAN^® brand of endotracheal tubes.  The SHERIDAN^® product line was acquired in October 2000 from Tyco Healthcare Group LP (“Tyco”).  The Company leases approximately fifty percent of the Argyle facility from Tyco under a three-year lease ending in October 2003. During 2001, the Company made the decision to relocate the Argyle production facility to Tecate, Mexico.  The move began in 2002 and is anticipated to be complete by March 2003.  The Company will close the Argyle facility when the transition to the Tecate facility is completed and as a result, the Company has elected to terminate the lease for the Argyle facility as of March 31, 2003.  The Tecate facility currently houses three extrusion lines and five blow molding machines, which were transferred from the Argyle facility. Products historically manufactured in the Argyle manufacturing facility are manufactured in the Tecate facility.

                    The Company’s facility located in Ensenada, Mexico is primarily used for the assembly of certain products molded and/or extruded at the Temecula facility.  Each of the Tecate and the Ensenada facilities is a maquiladora, and therefore there are minimal tariffs associated with the transport of products and components across the United States-Mexico border.  The Company’s facility located in Kuala Lumpur, Malaysia assembles virtually all of the HME and filter products marketed by the Company.  The components assembled by the Malaysian operation are generally molded by outside vendors in Malaysia.

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                    The Company monitors the quality of its products at its manufacturing facilities by statistical sampling and visual and dimensional inspection.  The Company also inspects incoming raw materials for inconsistencies, rating its vendors on quality and delivery time.  The Company is routinely audited by the Food and Drug Administration (“FDA”) and has received no significant regulatory actions.  The Company is in substantial compliance with the GMP/QSR regulations of the FDA and the United States and Mexico operations have qualified for an “advanced notification” program allowing the Company to be informed of FDA inspections in advance.  The Company utilizes outside facilities for sterilization of products produced in Temecula, Argyle, Arlington Heights, Kuala Lumpur, Tecate and Ensenada.  Certain Arlington Heights products are manufactured in a sterile environment and are certified sterile as a result of the production process.  The Ensenada, Kuala Lumpur, Argyle and Arlington Heights facilities are certified as ISO 9002 compliant and the Temecula and Sweden facilities are certified as ISO 9001 compliant.

Suppliers and Raw Materials

                    The Company’s primary raw materials are various resins, which are formed into the Company’s products.  The top 10 purchased products in 2002 were tubing grade PVC, clear PVC, LDPE-EVA, polypropylene, pre-cut elastic, mask grade PVC, acrylic resin, hose-end grade PVC, manual resuscitator assembly, and breathing bag assembly.  The Company believes that it is able to purchase materials at a cost no higher than its competitors.  The Company believes that sufficient availability exists for its raw materials, as they consist of mainly readily available plastic resins.

Research and Development

                    The Company’s research and development department consists of fourteen people, including eight engineers.  The Company’s engineering efforts are split between developing new products and process improvements to its manufacturing operations.  The Company develops new products to expand its product line in anticipation of changes in demand.  Significant products introduced in the last five years include the line of heat-moisture exchangers; the SHERIDAN^® brand of endotracheal tubes, CONCHATHERM^® IV heated humidification system, expansion of the Company’s ventilator circuit and nebulizer line, a demand oxygen regulator and CONCHATHERM^® 2000, a heated humidification system for the sleep apnea market.  The Company constantly works to reduce costs through continuous process improvements.  The Company incurred research and development expenses of approximately $2.6 million, $2.0 million and $2.4 million in fiscal 2002, 2001 and 2000, respectively.

Competition

                    The U.S. medical supply industry is highly fragmented and characterized by intense competition.  The Company’s primary competitor in the respiratory care sector is Cardinal Health (formerly Allegiance Healthcare) and its primary competitors in the anesthesia sector include Tyco, Smiths Industries Medical Systems, Inc. (“SIMS”), and Vital Signs, Inc.  Many of the products manufactured by the Company are available from several sources, and many of the Company’s customers tend to have relationships with several manufacturers.  The Company competes on the basis of brand name, product design and quality, breadth of product line, service and price.

Patents and Trademarks

                    The Company has historically relied primarily on its technological and engineering abilities and on its design and production capabilities to gain competitive business advantages, rather than on patents or other intellectual property rights.  However, the Company does file patent applications on concepts and processes developed by the Company’s personnel.  The Company has 27 patents in the United States.  Many of the U.S. patents have corresponding patents issued in Canada, Europe and various other countries.

Government Regulation and Environmental Matters

                    The Company and its customers and suppliers are subject to extensive federal and state regulation in the United States, as well as regulation by foreign governments, and the Company cannot predict the extent to which future

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legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company.  Most of the Company’s products are subject to government regulation in the United States and other countries. In the United States, the Food, Drug and Cosmetic (“FD&C”) Act and other statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, marketing, advertising and promotion of such products.  Failure to comply with applicable requirements can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution.  Under the FD&C Act and similar foreign laws, the Company, as a marketer, distributor and manufacturer of health care products, is required to obtain the clearance or approval of Federal and foreign governmental agencies, including the FDA, prior to marketing, distributing and manufacturing certain of those products.  The Company may also need to obtain FDA clearance before modifying marketed products or making new promotional claims.  Delays in receipt of or failure to receive required approvals or clearances, the loss of previously received approvals or clearances, or failures to comply with existing or future regulatory requirements in the United States or in foreign countries could have a material adverse effect on the Company’s business.  Foreign sales are subject to similar requirements.

                    The Company is required to comply with pertinent sections of the Code of Federal Regulations, 21CFR GMP/QSR, which set forth requirements for, among other things, the Company’s manufacturing process, design control and associated record keeping, including testing and sterility.  Further, the Company’s plants and operations are subject to review and inspection by state, Federal and foreign governmental entities.  The distribution of the Company’s products may also be subject to state regulation.  The impact of FDA regulation on the Company has increased in recent years as the Company has increased its manufacturing operations.  The Company’s suppliers, including contract sterilization facilities, are also subject to similar governmental requirements.  There can be no assurance that changes to current regulations or additional regulations imposed by the FDA will not have an adverse impact on the Company’s business and financial condition in the future. The FDA also has the authority to issue special controls for devices manufactured by the Company.  In the event that such special controls were issued, the Company’s products would be required to conform, which could result in significant additional expenditures for the Company.

                    The Company is also subject to numerous federal, state and local laws and regulations relating to such matters as safe working conditions, manufacturing practices, fire hazard control and the handling and disposal of hazardous or infectious materials or substances and emissions of air pollutants.  The Company owns and leases properties, which are subject to environmental laws and regulations.  There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company’s business, financial condition or results of operations.  In addition, the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company.

Employees

                    As of March 14, 2003, the Company employed approximately 1,939 employees, substantially all of whom were full-time employees.  None of the Company’s employees are represented by unions and the Company considers its employee relations to be good.

Where You Can Find More Information

                    Although the Company is not subject to the reporting requirements of the Securities and Exchange Act of 1934, the Company files periodic reports with the Securities and Exchange Commission (“SEC”).  You may read and copy the periodic reports that the Company has filed or may file in the future at the SEC’s public reference facility in Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549.  Please call the SEC at 1-800-SEC-0330 for further information on the public reference room.  The SEC maintains a web site that contains periodic reports and other information regarding the registrants that file electronically with the SEC at http://www.sec.gov.

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Item 2.        Properties

                    The Company owns approximately 10 acres of land in Temecula, California on which its headquarters, one of three principal manufacturing centers totaling approximately 100,000 square feet are located.  Plastic and vinyl components and corrugated tubing are manufactured in Temecula and assembled into finished goods at a 77,000 square foot facility in Ensenada, Mexico.  The Company is currently in the process of expanding the Ensenada facility to 100,000 square feet and plans on completing that project in April 2003.  The Company owns the Ensenada facility and the underlying land is held in a 30-year trust that expires in August 2019.  The Company leases an 86,000 square foot manufacturing facility that manufactures prefilled sterile solutions in Arlington Heights, Illinois under a lease that expires in September 2005 with an option to extend an additional five years.  The Company leases a 73,000 square foot distribution warehouse in Elk Grove, Illinois under a lease that expires in May 2010.  The Company leases a 99,100 square foot distribution facility in Temecula, California under a lease that expires in September 2005.  The Company leases the 80,000 square foot warehouse facility adjacent to its headquarters is Temecula, California, which the Company sold in October 2002, under a lease that expires in October 2003. Upon the termination of this lease, the Company believes that it can consolidate operations previously conducted in that building into existing locations.  The Company leases sales and marketing offices in Stockholm, Sweden; Ashby de la Zouch, U.K.; Lyon, France; and Lohmar, Germany under leases that expire in October 2006, May 2006, April 2005 and April 2005, respectively.  The Company leases a 33,260 square foot facility in Kuala Lumpur, Malaysia, under a lease that expires in July 2004.  This facility primarily assembles finished products for the HME and filter product lines.  The Company also leases approximately fifty percent of an 80,218 square foot facility in Argyle, New York under a lease that expires in October 2003.  This facility manufacturers the SHERIDAN^® line of endotracheal tubes.  During 2001, the Company made a decision to relocate the endotracheal product line from its manufacturing plant in Argyle, New York to Tecate, Mexico by March 2003. The Company will close the Argyle facility and has elected to terminate the Argyle facility lease as of March 31, 2003.  The Company has acquired an approximately 99,000 square foot facility in Tecate, under a lease that expires in March 2005.  As of March 14, 2003, three of the five extrusion lines and five of the nine blow molding machines have been transferred to the Tecate facility.

                    The Company believes that its current facilities are adequate for its present level of operations.

Item 3.        Legal Proceedings

                    The Company is not a party to any material lawsuits or other proceedings.  While the results of the Company’s other existing legal matters and proceedings cannot be predicted with certainty, management does not expect that the ultimate liabilities, if any, will have a material adverse effect on the financial position or results of operations of the Company.

Item 4.        Submissions of Matters to a Vote of Security Holders

None.

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PART II

Item 5.        Market for Registrant’s Common Equity and Related Stockholder Matters

                    There is no established public trading market for the Company’s Common Stock.  As of March 14, 2003, all of the outstanding Common Stock of the Company is held by two holders of record, Holding and the shareholder of the Company prior to the recapitalization.

                    In 2002, the Company issued non-qualified options to purchase an aggregate of 3,550,000 shares of Common Stock to its officers, directors and employees under the Company’s 2001 Nonqualified Stock Option Plan.  The issuances were exempt from the registration requirements of the Securities Act either by virtue of (i) an exemption provided by Rule 701 promulgated under the Securities Act or (ii) a “no sale” theory under Section 5 of the Securities Act, since none of the optionees provided any consideration for the grants (the sale of the underlying option shares occurs only when the option is exercised and the purchase price for the shares is paid to the Company).

                    In May 2002, the Company and HRC Holding issued debt securities to certain of the Company’s shareholders for an aggregate cash consideration of $20.0 million.  As additional consideration for the issuance of the debt securities, the Company issued warrants to purchase an aggregate of 20 million shares of its common stock to the holders of the debt securities.  The Company relied on Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering in issuing the securities as the purchasers were sophisticated and shareholders of the Company or Holding.

                    In October 2002, HRC Holding issued debt securities to certain of the Company’s shareholders for an aggregate cash consideration of $2.1 million.  As additional consideration for the issuance of the debt securities, the Company issued warrants to purchase an aggregate of 2.1 million shares of its common stock to the holders of the debt securities.  The Company relied on Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering in issuing the securities as the purchasers were sophisticated and shareholders of the Company or Holding. 

                    No underwriter was employed with respect to any sales of securities of the Company in the transactions described above.  No commissions or fees were paid with respect to any such sales.

                    The Company has not paid cash dividends to its shareholders in the past two years, and does not intend to pay cash dividends to its shareholders in the foreseeable future.  See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for a discussion of restrictions on the Company’s ability to pay cash dividends.

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Item 6.        Selected Financial Data

                    The selected fiscal year end historical financial data has been derived from the audited financial statements of the Company.  The information contained in this table as of December 31, 2002 and 2001, and for each of the three years in the period ended December 31, 2002 should be read in conjunction with “Management’s Discussion and Analysis and Results of Operations” and the Company’s audited consolidated financial statements and notes thereto included elsewhere in this report.

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Item 7.         Management’s Discussion and Analysis of Financial Condition and Results of Operations

                    The following discussion of the Company’s consolidated historical results of operations and financial condition should be read in conjunction with the consolidated financial statements of the Company and the notes thereto included elsewhere in this Annual Report on Form 10-K. 

General

                    The Company’s results of operations may fluctuate significantly from quarter to quarter as a result of a number of factors, including, among others, (i) the buying patterns of the Company’s distributors, GPOs and other purchasers of the Company’s products, (ii) forecasts regarding the severity of the annual cold and flu season, (iii) announcements of new product introductions by the Company or its competitors, (iv) changes in the Company’s pricing of its products and the prices offered by the Company’s competitors, (v) rate of overhead absorption due to variability in production levels and (vi) variability in the number of shipping days in a given quarter.

Recent Developments

                    On May 14, 2002, the Company amended and restated its Credit Facility to (i) waive all existing events of default; (ii) extend the final maturity of the term and revolving facilities under the Credit Facility to June 30, 2004;  (iii) amend existing term loan and acquisition facility amortization to $3.8 million in 2002, $9.3 million in 2003 and $37.0 million in 2004; and (iv) amend financial covenants to include only a limitation on capital expenditures and a minimum EBITDA test.  In connection with this amendment, the Company issued $12.0 million in senior unsecured notes to Holding’s majority stockholder in exchange for assumption of $12 million of bank term loans of the Company.  These senior unsecured notes bear interest at 12%, with interest and principal due upon maturity on December 31, 2004.  HRC Holding, Inc., a wholly owned subsidiary of the Company (“HRC Holding”), also issued $8 million in senior unsecured notes to Holding’s majority stockholder on similar terms to the notes issued by the Company to Holding’s majority stockholder.  HRC Holding used the proceeds from the issuance of the senior unsecured notes to buy intercompany receivables from the Company.  Proceeds received by the Company were used to pay the April 2002 interest due under the Senior Subordinated Notes; fund expenses associated with the Credit Facility and provide funds for general corporate purposes.

                    As additional consideration for assumption of the bank term loans and with issuance of the senior unsecured notes, the Company issued warrants to purchase 20 million shares of common stock at $1.00 per share to Holding’s majority stockholder.  The warrants expire on May 15, 2009.

                    In October 2002, the Company sold two ten-acre parcels and buildings in Temecula, California for cash consideration of approximately $7.5 million.  The Company will temporarily occupy one of the parcels for up to one year to efficiently transfer its operations out of the facility.  The Company believes that with planned decreases in inventory levels and the transfer of certain production to its Tecate, Mexico facility, the remaining space at its existing locations will be sufficient to support ongoing operations.  The Company recorded a gain of $2.3 million related to this sale.

                    In October 2002, HRC Holding issued an additional $2.1 million in senior unsecured notes to existing shareholders of the Company and Holding.  The notes bear interest at 12% annually with interest and principal due upon maturity on December 31, 2004.  HRC Holding used the proceeds from these notes to buy intercompany receivables from the Company.  Proceeds to the Company from sales of the receivables will be used to provide funds for ongoing working capital purposes.  As additional consideration for the issuance of the senior unsecured notes, the Company issued warrants to purchase 2.1 million shares of common stock at $1.00 per share.  The warrants expire on May 15, 2009.

                    In February 2003, a portion of the principal amount of the HRC senior unsecured notes issued in October 2002 were exchanged by the shareholders for an equal principal amount of the senior unsecured notes of the Company issued to Holding’s majority stockholder in May 2002.

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Critical Accounting Policies

                    Revenue Recognition:  The Company recognizes revenue, net of reserves when product is shipped and title passes to customer, as the earnings process is substantially complete at that time.  The Company establishes reserves for sales returns for shipping errors and damaged goods and other allowances based on historical experience.  The Company sells its products to its distributors without right of return based on a listed price.  Distributors charge the service providers, or the distributor's end customers, a contract price (which is determined by their GPO affiliation or individual contract price) plus a service margin.  As is customary within the industry, the Company rebates the difference between the list price and the specific contract price to the distributor. The Company records revenue and receivables net of rebatable amounts. Reserves for rebates are recorded based on historical experience.  In the event no rebate is payable, the amount is reversed and recognized as revenue.  Management performs extensive analyses on a routine basis utilizing historical data to monitor rebate trends including dealer and product specific rebate activity, percentage relationships between sales and rebates and rebate processing lags to ensure the adequacy of the Company’s reserve for rebatable amounts.

                    Accounts Receivable:  Management performs various analyses to evaluate accounts receivable balances to ensure that recorded amounts reflect estimated net realizable value.  Management applies specified percentages to the accounts receivable aging to estimate the amount that will ultimately be uncollectible and, therefore, should be reserved. The reserve percentages are increased as the accounts age.

                    Management establishes and monitors these percentages through extensive analyses of historical realization data, accounts receivable aging trends, other operating trends, and the extent of contracted business and business combinations.  Also considered are relevant business conditions, including general economic factors as they relate to the Company’s international customers. If indicated by such analyses, management may periodically adjust the uncollectible estimate and corresponding percentages.  Further, focused reviews of certain large and/or problematic payors are performed to determine if additional reserves are required.

                    Inventory: Inventories are stated at the lower of cost (first-in, first-out (“FIFO”) method) or market.  Management utilizes various analyses based on forecasts, historical sales and inventory levels to ensure that the current carrying value of inventory accurately reflects the current and expected requirements of the Company within a reasonable timeframe.  Management also utilizes the various analyses to determine required reserves for excess and obsolete inventory.  Management periodically reviews the reserves for excess and obsolete inventory for adequacy and makes required adjustments, if necessary.

                    Impairment of Goodwill and Other Intangibles:  The Company periodically reviews the recoverability of the carrying value of goodwill, intangibles and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.  Recoverability of these assets is determined by analysis of the asset’s fair value by comparing the forecasted future net cash flows from the operations to which the assets relate, based on management’s best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets.  If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets.

Recent Accounting Pronouncements

                    In June 2001, the FASB issued SFAS No. 141, “Business Combinations” (“SFAS 141”).  This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, “Business Combinations,” and SFAS No. 38, “Accounting for Preacquisition Contingencies of Purchased Enterprises.”  All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method.  Any acquisitions made by the Company after June 2001 will be recorded in accordance with SFAS 141.

Effective January 1, 2002 the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).

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SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, “Intangible Assets.”  This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements.  Goodwill is no longer amortized and is assessed at least annually for impairment using a fair value methodology.  The Company stopped amortizing goodwill, effective January 1, 2002, and as a result, no charges for goodwill amortization are included in the 2002 financial statements. The Company completed its transitional impairment test of goodwill as of December 31, 2002, which indicates no impairment of existing goodwill. Net income and loss for the year ended December 31, 2001, excluding amortization of goodwill would have been (in thousands) $140,181 compared to $143,671.  The change in goodwill for fiscal year ended December 31, 2002 is the result of changes in foreign currency exchange rates.  The Company operates in two reporting units; North American operations (known as the guarantor) and international operations (known as the non-guarantor). These two reporting units are identical to the operating segments described in Note 10 of  the “Notes to Consolidated Financial Statements.”

                    Also in June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”).  SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  It requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred.  When the liability is initially recorded, the entity capitalizes a disposal cost by increasing the carrying amount of the related long-lived asset.  Over time, the liability is accreted to its present value each period, and the capitalized disposal cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs gain or loss upon settlement.  SFAS 143 is effective January 1, 2003.  The Company does not expect the adoption of SFAS 143 to have a material impact on the Company’s financial statements.

                    Effective January 1, 2002, the Company adopted SFAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.”  This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets.  This statement supercedes SFAS No. 121, “Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of,” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of a Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business (as previously defined in that Opinion).  The adoption of SFAS 144 did not have a material impact on the Company’s financial statements.

                    In April 2002, the FASB issued SFAS 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections” (“SFAS 145”).  SFAS 145 updates and clarifies existing accounting pronouncements related to gains and losses from extinguishment of debt and requires that certain lease modifications be accounted for in the same manner as sale-leaseback transactions.  The Company will adopt the provisions of SFAS 145 as of January 1, 2003.  The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial statements.

                    In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. The Company will apply the provisions of SFAS 146 to all exit or disposal activities that are initiated after December 31, 2002.

                    In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure requirements for Guarantee, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”).  FIN 45 is an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34.  This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued.  FIN 45 also clarifies that a guarantor is required to recognize, at the inception

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of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee.  This interpretation also incorporates, without change, the guidance in FASB Interpretation No. 34, “Disclosure of Indirect Guarantees of Indebtedness of Others”, which is being superseded.  The Company will apply the guidance provided in FIN 45 for any guarantees issued after December 31, 2002 and has adopted disclosure requirements for the current reporting period.

                    In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure” (“SFAS 148”), an amendment of SFAS No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”).  SFAS 148 amends SFAS 123 to provide alternative methods for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, the statement amends the disclosure requirements of SFAS 123 to require prominent disclosures for both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the methods used on reported results.  The interim transition and annual disclosure requirements of SFAS 148 are effective for the Company’s fiscal year 2003.  The Company does not expect SFAS 148 to have a material impact on its consolidated results of operations or financial position.

                    In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), an interpretation of Accounting Research Bulletin No. 51.  FIN 46 requires that a company consolidate variable interest entities if that company is subject to a majority of the risk of loss from the entity’s activities or the company receives a majority of the entity’s residual returns.  FIN 46 also requires certain disclosure about variable interest entities in which the company has a significant interest, regardless of whether consolidation is required.  The Company will adopt the provisions of FIN 46 as of January 1, 2003, while the disclosure provisions will become effective for the interim period ending March 31, 2003.  The adoption of this interpretation is not expected to have a material effect on the Company’s consolidated financial statements.

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Results of Operations

                    The following tables set forth, for the periods indicated, certain income and expense items expressed in dollars and as a percentage of the Company’s net sales.

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Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

                    Net sales on a consolidated basis, were $172.0 million in 2002, an increase of $13.9 million or 8.8% from 2001.  Sales for the Domestic Hospital division increased by $6.6 million or 6.7%.  This increase was primarily the result of a weaker than normal flu season in 2001, the decision not to offer dealers purchase incentives at the end of 2001 and market share growth in 2002 in the Company’s core disposable product categories during 2002.  Sales to the Alternate Site Market increased by $0.6 million or 2.0%, primarily the result of overall growth in the marketplace.  Sales into Europe increased by $3.1 million or 15.5%, as the Company saw significant growth in sales to end users through its European subsidiaries as well as sales to dealers.  Sales to the Pacific Rim increased by $0.7 million or 6.4% primarily due to increased demand for the Company’s SHERIDAN^® endotracheal tube product line.  Sales to Latin America, Canada and the Company’s OEM customers were relatively flat, increasing by $0.5 million, $0.3 million and $0.3 million, respectively.  Additionally, $1.8 million of the increase in sales is attributable to favorable foreign exchange rates.

                    The Company’s gross profit for 2002 was $69.4 million, an increase of $20.4 million or 41.6% from 2001.  As a percentage of net sales, the Company’s gross margin for 2002 was 40.4% as compared to 31.0% for 2001, an increase of 9.4 margin points.  The margin increase was partially due to events in 2001 that had a negative impact on the 2001 margin and did not reoccur in 2002 including: (i) charges in the fourth quarter of 2001 relating to an initiative put in place to discontinue and dispose of less profitable products (3.2 margin points); (ii) sale of inventory in 2001 recorded a higher net realizable value rather than manufacturing cost as a result of the SHERIDAN^® acquisition (1.3 margin points) and (iii) higher levels of unabsorbed manufacturing costs in 2001 resulting from lower than expected demand and decreased inventories (0.8 margin points).  Additionally, the following items contributed to the improvement of the 2002 margin: (i) cost reduction programs implemented and recognized in 2002 (3.3 margin points); (ii) an improvement in shipping costs in 2002, resulting from specific cost reduction programs put into place (1.1margin points); (iii) favorable foreign currency exchange rates (0.6 margin points) and (iv) other cost decreases (0.9 margin points).  These increases in margin were offset by 2002 transition expenses relating to the relocation of the Argyle facility to Tecate (1.8 margin points).

                    Selling expenses were $20.4 million for 2002, unchanged from 2001.  As a percentage of sales, selling expenses were 11.8% in 2002 as compared to 12.9% in 2001. 

                    Distribution expenses were $9.2 million in 2002, representing a $1.4 million or 13.4% decrease from 2001.  As a percentage of sales, distribution expenses were 5.3% in 2002 versus 6.7% in 2001.  This decline is primarily the result of specific programs implemented by management designed to improve the efficiency of its distribution facilities, including reductions in labor and overtime, intracompany freight charges and rental expenses from the closure of the Atlanta distribution center in 2001.

                    General and administrative expenses, including provision for bad debts, were $18.5 million for 2002, a decrease of $8.2 million or 30.6% from 2001.  This decrease resulted primarily from the effect of impairment charges recorded in 2001 and severance costs related to the 2001 closure of the Atlanta distribution center. Additionally, the Company made a decision in 2001 to not pursue certain aged accounts receivable for collection and to allocate resources to other customer receivables and collection activities.  As a result, the Company increased its provision for write-offs by $2.2 million in 2001.

                    No amortization of goodwill was recorded in 2002, while $3.5 million was recorded in 2001.  This is the result of the Company’s adoption of SFAS 142, under which the Company ceased amortizing goodwill effective January 1, 2002.  As a result of significant losses in 2001, the Company assessed future cash flows and determined that goodwill was not recoverable and recorded a goodwill impairment charge of approximately $33.1 million in 2001.  No goodwill impairment charge was recorded in 2002.

                    As a result of the Company’s analysis of fixed assets in 2001, it was determined that certain machinery and

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equipment was no longer needed to support current business operations and had no value.  Additionally, certain software development costs incurred in 2001 related to the management information system failed to achieve their intended results and, as a result, were determined to have no future value.  As a result, the Company recorded an impairment charge of approximately $4.5 million in 2001. No fixed asset impairment charge was recorded in 2002.

                    Research and development expenses were $2.6 million in 2002 as compared to $2.0 million in 2001. The increase is primarily the result of increased spending on product development in 2002 through the use of outside consultants.

                    Interest expense was $20.9 million in 2002; a $0.3 million or 1.6% increase from 2001.  This increase was primarily due to increased notes to affiliates, which carry a higher interest rate than bank debt.  This was partially offset by a general decrease in bank debt interest rates.

                    The income tax provision in 2002 was $1.9 million in 2002, as compared to $69.8 million in 2001.  As a result of losses in 2001 and cumulative losses in recent years, the Company recorded a full valuation allowance of $68.9 million for deferred tax assets in 2001.  The income tax provision in 2002 relates primarily to foreign taxes.

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

                    Net sales, on a consolidated basis, were $158.1 million in 2001, a decrease of $1.2 million or 0.8% from 2000. On a consolidated basis, domestic hospital sales decreased by $4.5 million during 2001, or 4.9% as compared to 2000. The decrease in net sales is attributable to the following:  (i) reduced seasonal demand worldwide for certain products due to mild levels of flu-related illnesses and unusually warm weather in the fourth quarter of 2001; (ii) lower than normal demand from U.S. hospitals following the September 11, 2001 terrorist attacks in New York and Washington as a result of reduced hospital admissions and lower levels of elective surgeries; and (iii) a decision by the Company in 2001 not to offer purchasing incentives at year end to distributors.  Alternate site sales increased by $2.0 million or 8.8% due to market growth and lower prior year sales, which were the result of shipping difficulties encountered in 2000 relating to the implementation of the management information system. Original Equipment Manufacturing (“OEM”) sales decreased by $1.0 million or 16.3% during 2001, primarily due to changes in purchasing patterns from some of its OEM customers and their reduced demand as a result of the weak influenza season.  European sales increased slightly by $0.3 million or 1.5% as compared to 2000 as a result of incremental sales of the SHERIDAN^® product line (acquired in October 2000) as well as increased sales in certain European markets now served on a direct basis through the Company’s European distribution center located in the Netherlands.  Pacific Rim sales increased by $2.0 million or 21.5% as compared to 2000 as a result of incremental sales of the SHERIDAN^® product line and continued growth in the use of the Company’s products in this marketplace.

                    The Company’s gross profit for 2001 was $49.1 million, a decrease of $25.3 million or 34.0% from 2000.  As a percentage of net sales, the Company’s gross profit for 2001 was 31.0% as compared to 46.7% for 2000.  This decrease was primarily due to the following: (i) sale of inventory recorded a higher net realizable value rather than manufacturing cost as a result of the SHERIDAN^® acquisition; (ii) increased shipping costs as a result of shipping difficulties caused by problems associated with the new management information system; (iii) an unfavorable mix variance caused by higher sales of products with lower gross margins; (iv) higher level of unabsorbed manufacturing costs resulting from lower than expected demand and decreased inventories and (v) charges in the fourth quarter of 2001 relating to an initiative put in place to discontinue and dispose of less profitable products.

                    Selling expenses were $20.3 million for 2001, a $2.1 million or 11.4% increase over 2000.  This increase was primarily driven by additions to the sales and marketing departments to support recently acquired product lines, as well as an increase in fees associated with certain GPO’s.  As a percentage of sales, selling expenses were 12.9% in 2001 as compared to 11.5% in 2000. 

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                    Distribution expenses were $10.6 million in 2001, which represents a $0.5 million or 4.7% increase over 2000.  As a percentage of sales, distribution expenses were 6.7% in 2001 versus 6.3% in 2000.  This increase was a result of the establishment of the European distribution center in the first quarter of 2001.

                    General and administrative expenses were $23.9 million for 2001, an increase of $3.0 million or 14.3% over 2000.  This increase resulted primarily from increased staffing levels required to maintain acceptable customer service levels and operate the business with the new management information system, expenses related to the closure of the Atlanta distribution center, higher depreciation associated with the new management information system and other professional fees and charges related to implementing the new management information system.

                    Amortization of goodwill was $3.5 million in 2001, a $0.2 million or 5.1% increase over 2000.  The increase was the result of a full year of amortization related to the SHERIDAN^® acquisition made during the fourth quarter of 2000.  As a result of significant losses in the fourth quarter, the Company reassessed future cash flows and determined that goodwill was not recoverable.  Accordingly, the Company recorded a goodwill impairment charge of approximately $33.1 million.

                    Research and development expenses were $2.0 million in 2001 as compared to $2.4 million in 2000, the result of eliminating several positions in the Company’s facility operated by Hudson RCI AB, the Company’s Swedish subsidiary, during 2001.

                    Interest expense was $20.5 million in 2001, a $0.5 million or 2.6% decrease from 2000.  The decrease was primarily due to a general decrease in interest rates.

                    Income tax provision was $69.8 million for 2001 as compared to $3.2 million in 2000.  As a result of losses in the fourth quarter of 2001 and cumulative losses in recent years, the Company recorded a full valuation allowance of $68.9 million in 2001.

2001 Fourth Quarter Charges

                    The following is a summary of the charges incurred by the Company in the fourth quarter of 2001 (amounts in thousands):

                    As a result of significant losses in the fourth quarter and cumulative losses in recent years, the Company has reevaluated its ability to realize the future benefit of its net deferred tax assets held in light of the historical operating losses.  Accordingly, the Company recorded a full valuation allowance against its deferred tax assets of approximately $68.9 million.

                    As a result of significant losses in the fourth quarter, the Company assessed future cash flows and determined that goodwill was not recoverable.  Accordingly, the Company recorded a goodwill impairment charge of approximately $33.1 million.

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                    As a result of the Company’s analysis of fixed assets in the fourth quarter, it was determined that certain machinery and equipment was no longer needed to support current business operations and had no value.  Additionally, certain software development costs incurred in 2001 related to the management information system failed to achieve their intended results and, as a result, were determined to have no future value.  As a result, the Company recorded an impairment charge of approximately $4.5 million.

                    As a result of an analysis of product lines during the fourth quarter of 2001, the Company concluded that it would no longer support a certain number of individual products, resulting in the related inventories of those products no longer having value.  The Company recorded charges of $4.6 million related to the destruction of obsolete inventory resulting from this strategic decision.

                    The Company made a decision in the fourth quarter of 2001 to not pursue certain aged accounts receivable for collection and to allocate resources to other customer receivables and collection activities.  As a result, the Company increased its provision for write-offs based on analysis of those aged customer receivables.

                    The Company recorded a charge of approximately $0.9 million related to the fourth quarter closure of its Atlanta distribution center.  This charge primarily consisted of future rent commitments. 

                    During fiscal 2001, the Company made a decision to relocate from its manufacturing operation in Argyle, New York to Tecate, Mexico.  In addition, the Company made a decision to move certain product manufacturing from Temecula, California to Ensenada, Mexico.  The Company recorded approximately $0.9 million in severance costs related to the relocations.

Liquidity and Capital Resources

                    The Company’s primary sources of liquidity are cash flow from operations and borrowings under its working capital bank facility and, historically, investments from and loans to its shareholders.  Cash provided by operations totaled $6.3 million, $5.6 million and $10.4 million in 2002, 2001 and 2000, respectively.  The increase from 2001 to 2002 is attributable to higher profitability offset in part by increases in inventories and accounts receivable.  The Company had operating working capital (deficit) of $8.0 million and $(0.2) million as of the end of fiscal 2002 and 2001, respectively.  Inventories were $22.6 million and $25.2 million as of the end of fiscal 2002 and 2001, respectively.  The Company significantly reduced inventory levels in 2002 and 2001, to levels more consistent with the current operating requirements of the Company, but over time, the Company expects its level of inventories to increase as the Company’s sales in the

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international market increase.  Accounts receivable, net of allowances, were $24.2 million and $19.2 million at the end of fiscal 2002 and 2001, respectively.  In 2002 and 2001, the Company recorded bad debt expense of $0.8 million and $2.8 million, respectively.  The average days sales in accounts receivable outstanding was approximately 46 days for 2002, compared to 55 days for 2001 and 65 days for 2000.  The Company offers 30-day credit terms to its U.S. hospital distributors.  Alternate site and international customers typically receive 60 to 90 day terms and, as a result, as the Company’s alternate site and international sales have increased, the Company anticipates that the amount and aging of its accounts receivable will increase gradually over time as alternate site and international sales become a larger percentage of the Company’s total sales.

                    Net cash used in investing activities was $0.4 million, $9.0 million and $26.9 million in 2002, 2001 and 2000, respectively and was used primarily to finance customary purchases of property, plant and equipment in 2002 and 2001 and the SHERIDAN^® endotracheal tube product line acquisition in 2000.  In 2002, the company sold certain land and buildings at the Temecula location, realizing a $2.3 million gain on the transaction that offset capital expenditures. Capital expenditures, consisting primarily of new manufacturing equipment purchases, computer systems purchases, production of heaters, and expansion of the Ensenada facility, totaled $7.5 million, $9.0 million and $11.3 million 2002, 2001 and 2000, respectively. The higher levels of spending in 2000 relate to the acquisition and implementation of a new computer system. 

                    Net cash used in financing was $5.5 million in 2002, reflecting net pay down of bank debt, which was effected as part of an amendment to the Company’s Credit Facility in May 2002 as described more fully in “Recent Developments”.  Net cash provided by financing activity in 2001 was $7.3 million, reflecting net borrowings by the Company and the issuance of $3.0 million in Junior Preferred Stock and $100,000 in common stock.  Net cash used in financing was $16.2 million in 2000, reflecting proceeds borrowings on the Credit Facility, notes to affiliates and the issuance of common and preferred stock.

                    As of December 31, 2002, the Company had outstanding $223.9 million of indebtedness, consisting of $115.0 million of Subordinated Notes, borrowings of $55.6 million under the Company’s Credit Facility, $39.3 million in notes payable to affiliates and $14.0 million in borrowings under the bank facility of Hudson RCI AB, its Swedish subsidiary.

                    The following is a summary of the Company’s consolidated contractual obligations as of December 31, 2002:

                    The Credit Facility currently consists of a $40.0 million Term Loan Facility (of which as of December 31, 2002 $6.3 million remains and no further borrowings are available) and a $55.0 million Revolving Loan Facility of which up to $40.0 million (all of which has been borrowed and is outstanding) may be used for permitted acquisitions (“Acquisition Facility”) and up to $15 million (of which $9.3 is outstanding and $4.4 million is available for borrowing) (the “Working Capital Portion”) may be used for general corporate purposes (other than acquisitions). The Revolving Loan Facility has a letter of credit sub-limit of $7.5 million, of which $1.3 million is currently utilized. The Term Loan Facility and Acquisition Facility mature on June 30, 2004 and require principal amortization of $9.3 million in 2003 and $37.0 million in 2004.  The Revolving Loan Facility matures on June 30, 2004.

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                    Total borrowings as of December 31, 2002 and 2001 were $49.3 million and $55.0 million under the Revolving Loan Facility and Acquisition Facility and $6.3 million and $22.0 million under the Term Loan Facility, respectively.

                    As of December 31, 2002, the Company had $4.4 million available credit under the Revolving Credit Facility.  No additional borrowing was available under the Term Loan Facility at December 31, 2002.

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                    The interest rate under the Credit Facility is based, at the option of the Company, upon either a Eurodollar rate or a base rate (as defined) plus a margin during the period and for the applicable type of loan as follows:

                    For periods after June 2002, the margins set forth above are subject to pricing reductions depending on the Company’s then existing leverage ratio.

                    Borrowings under the Credit Facility are required to be prepaid, subject to certain exceptions, with (i) 75% (or 50% for years when the Company’s ratio of Debt to EBITDA (as defined) is less than 5:1) of Excess Cash Flow (as defined); (ii) 50% of the net cash proceeds of an equity issuance by Holding or the Company in connection with an initial public offering or 100% of the net cash proceeds of an equity issuance by Holding or the Company other than in connection with an initial public offering (subject in each case to certain exceptions); (iii) 100% of the net cash proceeds of the sale or other disposition of any properties or assets of Holding and its subsidiaries (subject to certain exceptions); (iv) 100% of the net proceeds of certain issuances of debt obligations of the Company and its subsidiaries and (v) 100% of the net proceeds from insurance recoveries and condemnations.

                    The Credit Facility is guaranteed jointly and severally by Holding and certain of the Company’s subsidiaries.  The Credit Facility is secured by a first priority lien in substantially all of the properties and assets of the Company and the guarantors now owned or acquired later, including a pledge of all of the capital stock of the Company owned by Holding and all of the shares held by the Company of its existing and future restricted subsidiaries, including its Mexican subsidiaries.

                    The Credit Facility contains covenants restricting the ability of Holding, the Company and the Company’s subsidiaries to, among others, (i) incur additional debt; (ii) declare dividends or redeem or repurchase capital stock; (iii) prepay, redeem or purchase debt; (iv) incur liens; (v) make loans and investments; (vi) make capital expenditures; (vii) engage in mergers, acquisitions and asset sales, and (viii) engage in transactions with affiliates.  Hudson RCI is also required to comply with financial covenants with respect to (a) limits on annual aggregate capital expenditures (as defined in the Credit Facility) and (b) a minimum EBITDA test.  The Company is currently in compliance with the terms and provisions of the Credit Facility.  As of March 14, 2003, there was approximately $7.7 million of availability on the revolving Loan Facility under the Credit Facility.

                    The Senior Subordinated Notes bear interest at the rate of 9-1/8%, payable semiannually on each April 15 and October 15, and will require no principal repayments until maturity in 2008.  The Senior Subordinated Notes are general unsecured obligations of the Company and contain covenants that place limitations on, among other things, (i) the ability of the Company, any subsidiary guarantors and other restricted subsidiaries to incur additional debt, (ii) the making of certain restricted payments including investments, (iii) the creation of certain liens, (iv) the issuance and sale of capital stock of restricted subsidiaries, (v) asset sales, (vi) payment restrictions affecting restricted subsidiaries, (vii) transactions with affiliates, (viii) the ability of the Company and any subsidiary guarantor to incur layered debt, (ix) the ability of

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Holding to engage in any business or activity other than those relating to ownership of capital stock of the Company and (x) certain mergers, consolidations and transfers of assets by or involving the Company.  The Company is currently in compliance with the terms and provisions of the Senior Subordinated Notes.

                    As of December 31, 2002, the Company and its subsidiaries had a total of $39.3 million in notes outstanding due to affiliates.  In August 2001, the Company issued approximately $15.0 million of new unsecured senior subordinated convertible notes to affiliates for $7.0 million in cash and an exchange of $8.0 million in existing short-term unsecured notes.  The new notes bear interest at 10% and are due in March 2005.  The interest may be paid or deferred to the due date at the option of the Company and the notes are convertible to the Company’s common stock at the demand of the holder.  The notes are subordinated to borrowings under the Credit Facility and the new senior unsecured notes discussed below and rank pari-passu with the Senior Subordinated Notes.  As part of the May 2002 amendment and restatement of the Credit Facility discussed above, the Company issued $12.0 million of the senior unsecured notes in exchange for $12.0 million of bank term loans purchased by affiliates of Holding’s majority stockholder.  Additionally, HRC Holding issued $8.0 million of unsecured senior notes to affiliates of Holding’s majority stockholder.  These notes bear interest at 12% annually with interest and principal due upon maturity on December 31, 2004.  In October 2002, HRC Holding issued an additional $2.1 million in new senior unsecured notes to existing shareholders of the Company and Holding, with the same terms and conditions as those issued by HRC Holding in May 2002.

                    The Company, through its wholly owned Swedish Subsidiary, Hudson RCI AB, has incurred bank debt in Sweden (the “HRCI AB Facility”) that totaled $14.0 million as of December 31, 2002.  The HRCI AB Facility, which is denominated in Swedish krona, bears interest at three-month STIBOR (the interest rate at or about 11:00 a.m. Stockholm time, two banking days before a draw-down date or the relevant interest period, quoted for deposits in krona) plus 1.25% to 1.85% (5.06% to 5.66% at December 31, 2002), matures in September 2005, and is guaranteed by Steamer Holding AB, Hudson RCI AB’s parent, and is secured by the common stock of Hudson RCI AB. As of December 31, 2002, Hudson RCI AB was in compliance with all terms and conditions of the Hudson RCI AB Bank Notes.

                    In April 1998, the Company issued to Holding 300,000 shares of its 11-1/2% Senior PIK Preferred Stock due 2010 with an aggregate liquidation preference of $30.0 million, which has terms and provisions materially similar to those of the Holding Preferred Stock. Under the terms of the Senior PIK Preferred Stock, at the election of the Company, dividends may be paid in kind on or before April 15, 2003 and thereafter must be paid in cash. Holding has been advised by the holders of a majority of the shares of the Holding Preferred Stock that they are agreeable to amending the Holding Preferred Stock to extend from April 15, 2003 to April 15, 2004, the period during which dividends may be paid in kind on the Holding Preferred Stock. It is proposed that the terms of the Senior PIK Preferred Stock be amended in a similar manner. In August 2001, the Company issued 3,000 shares of Junior Convertible cumulative preferred stock (the “Junior Preferred Stock”) to Holding for cash consideration of $3.0 million.  The May 2002 Amended and Restated Credit Facility prohibits the Company from paying cash dividends on its Senior PIK Preferred Stock.

Factors Affecting Liquidity

                    As the result of a number of factors affecting the Company in fiscal 2000 and 2001 resulting from the implementation of the Company’s new information system, management undertook numerous actions during 2001 to improve the liquidity and operating performance of the Company.  Such actions included: (i) the elimination of a distribution warehouse; (ii) the elimination of non-essential management personnel; (iii) a reduction in inventory levels; and (iv) aggressive collections of accounts receivable and other cost reduction measures as management deemed necessary to fund the operations of the Company, meet anticipated capital expenditures and make required payments of principal and interest on its debt.  Based on these actions, as well as anticipated improved operating performance, management believes it will have sufficient sources of liquidity to meet its obligations for the remainder of 2003.  If the Company does not generate sufficient cash flow from operations in line with its current forecasts, the Company would have to initiate measures to raise cash through asset sales, additional debt or equity issuances and/or curtail operations.  The Company currently has no commitments for additional debt or equity and no assurance can be given as to whether or, on what terms, additional debt or equity investments could be secured if required.  Failure to achieve expected cash flows or, if necessary, to obtain additional debt or equity investment would have a material adverse affect on the Company.

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RISK FACTORS

Substantial Leverage; Shareholders’ Deficit

                    As of December 31, 2002, the Company had $223.9 million of outstanding indebtedness and a shareholders’ deficit of approximately $171.1 million.  This level of indebtedness may reduce the flexibility of the Company to respond to changing business and economic conditions.  In addition, subject to the restrictions in the Credit Facility and the indenture governing the Senior Subordinated Notes (the “Indenture”), the Company may incur additional senior or other indebtedness from time to time to finance acquisitions or capital expenditures or for other general corporate purposes.  See “—Liquidity and Capital Resources.”  The Credit Facility prohibits the payment of dividends by the Company to Holding to finance the payment of dividends on the Holding Preferred Stock.

                    The Company’s high degree of leverage may have significant consequences for the Company, including:  (i) the ability of the Company to obtain additional financing for working capital, capital expenditures, acquisitions or other purposes, if necessary, may be impaired; (ii) a substantial portion of the Company’s cash flow will be dedicated to the payment of interest and principal on its indebtedness and will not be available to the Company for its operations and future business opportunities; (iii) the covenants contained in the indenture and the Credit Facility limit the Company’s ability to, among other things, borrow additional funds, dispose of assets or make investments and may affect the Company’s flexibility in planning for, and reacting to, changes in business conditions; (iv) indebtedness under the Credit Facility is at variable rates of interest, which causes the Company to be vulnerable to increases in interest rates; and (v) the Company’s high degree of leverage may make it more vulnerable to a downturn in its business or the economy generally or limit its ability to withstand competitive pressures.  If the Company is unable to generate sufficient cash flow from operations in the future to service its indebtedness, it may be required to refinance all or a portion of its existing debt or to obtain additional financing.  There can be no assurance that any such actions could be effected on a timely basis or on satisfactory terms or that these actions would enable the Company to continue to satisfy its capital requirements.  The Company’s ability to meet its debt service obligations and to reduce its total indebtedness will be dependent upon the Company’s future performance, which will be subject to general economic conditions and to financial, business and other factors affecting the operations of the Company, many of which are beyond its control.  The terms of the Company’s indebtedness, including the Credit Facility and the Indenture, may also prohibit the Company from taking such actions.

Medical Cost Containment

                    In recent years, widespread efforts have been made in both the public and private sectors to control health care costs, including the prices of products such as those sold by the Company, in the United States and abroad.  Cost containment measures have resulted in increased customer purchasing power, particularly through the increased presence of GPOs in the marketplace and increased consolidation of distributors.  Health care organizations are evaluating ways in which costs can be reduced by decreasing the frequency with which a treatment, device or product is used.  Cost containment has also caused a shift in the decision-making function with respect to supply acquisition from the clinician to the administrator, resulting in a greater emphasis being placed on price, as opposed to features and clinical benefits. The Company has encountered significant pricing pressure from customers and believes that it is likely that efforts by governmental and private payers to contain costs through managed care and other efforts and to reform health systems will continue and that such efforts may have an adverse effect on the pricing and demand for the Company’s products. There can be no assurance that current or future reform initiatives will not have a material adverse effect on the Company’s business, financial conditions or results of operations.

                    The Company’s products are sold principally to a variety of health care providers, including hospitals and alternate site providers, that receive reimbursement for the products and services they provide from various public and private third party payors, including Medicare, Medicaid and private insurance programs.  As a result, while the Company does not receive payments directly from such third party payors, the demand for the Company’s products in any specific care setting is dependent in part on the reimbursement policies of the various payors in that setting.  In order to be reimbursed, the products generally must be found to be reasonable and necessary for the treatment of medical

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conditions and must otherwise fall within the payor’s list of covered services.  In light of increased controls on Medicare spending, there can be no assurance on the outcome of future coverage or payment decisions for any of the Company’s products by governmental or private payors.  If providers, suppliers and other users of the Company’s products are unable to obtain sufficient reimbursement, a material adverse impact on the Company’s business, financial condition or operations may result.

                    The Company expects that the trend toward cost containment that has impacted the domestic market will also be experienced in international health care markets, impacting the Company’s growth in foreign countries, particularly where health care is socialized.

Industry Consolidation; Customer Concentration

                    Cost containment has resulted in significant consolidation within the health care industry.  A substantial number of the Company’s customers, including group purchasing organizations, hospitals, national nursing home companies and national home health care agencies, have been affected by this consolidation.  The acquisition of any of the Company’s significant customers could result in the loss of such customers by the Company, thereby negatively impacting its business, financial condition and results of operations.  For example, in 1996, three GPOs that accounted for aggregate sales of approximately $11.0 million combined and, as a result of a decision of the combined entity to enter into a sole distributorship arrangement in 1997 with one of the Company’s competitors, the Company experienced a decrease in sales and may experience additional sales decreases in the future.  In addition, the consolidation of health care providers often results in the renegotiation of terms and in the granting of price concessions.  The Company’s customer relationships, including exclusive or preferential provider relationships, are terminable at will by either party without advance notice or penalty.  Because larger purchasers or groups of purchasers tend to have more leverage in negotiating prices, this trend has caused the Company to reduce prices and could have a material adverse effect on the Company’s business, financial condition or results of operations.  As GPOs and integrated health care systems increase in size, each relationship represents a greater concentration of market share and the adverse consequences of losing a particular relationship increases considerably.  For fiscal 2002, the Company’s eight largest group purchasing arrangements accounted for approximately 42.6% of net sales.  Distributors have also consolidated in response to cost containment.  For fiscal 2002, approximately 29.9% of the Company’s net sales were to two distributors, Owens & Minor Inc. and McKesson, which accounted for 19.1% and 10.8%, respectively, of the Company’s net sales.  The loss of the Company’s relationship with these distributors would have a material adverse effect on the Company’s business, financial condition and results of operations.

Government Regulation

                    The Company and its customers and suppliers are subject to extensive federal and state regulation in the United States, as well as regulation by foreign governments. The Company cannot predict the extent to which future legislative and regulatory developments concerning practices and products for the health care industry may affect the Company. Most of the Company’s products are subject to government regulation in the United States and other countries.  In the United States, the Federal Food, Drug, and Cosmetic Act, as amended (the “FD&C Act”), and other statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, marketing, advertising and promotion of such products.  Failure to comply with applicable requirements can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution.  Under the FD&C Act and similar foreign laws, the Company, as a marketer, distributor and manufacturer of health care products, is required to obtain the clearance or approval of Federal and foreign governmental agencies, including the Food and Drug Administration (“FDA”), prior to marketing, distributing and manufacturing certain of those products, which can be time consuming and expensive.  The Company may also need to obtain FDA clearance before modifying marketed products or making new promotional claims.  Delays in receipt of or failure to receive required approvals or clearances, the loss of previously received approvals or clearances, or failures to comply with existing or future regulatory requirements in the United States or in foreign countries could have a material adverse effect on the Company’s business.  Foreign sales are subject to similar requirements.

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                    The Company is required to comply with pertinent sections of the Code of Federal Regulations, 21CFR GMP/QSR, which set forth requirements for, among other things, the Company’s manufacturing process, design control and associated record keeping, including testing and sterility.  Further, the Company’s plants and operations are subject to review and inspection by state, federal and foreign governmental entities.  The distribution of the Company’s products may also be subject to state regulation.  The impact of FDA regulation on the Company has increased in recent years as the Company has increased its manufacturing operations.  The Company’s suppliers, including contract sterilization facilities, are also subject to similar governmental requirements.  There can be no assurance that changes to current regulations or additional regulations imposed by the FDA will not have an adverse impact on the Company’s business and financial condition in the future.  If the FDA believes that a company is not in compliance with applicable regulations, it can institute proceedings to detain or seize products, issue a recall, impose operating restrictions, enjoin future violations and assess civil and criminal penalties against the company, its officers or its employees and can recommend criminal prosecution to the Department of Justice.  Other regulatory agencies may have similar powers.  In addition, product approvals could be withdrawn due to the failure to comply with regulatory standards or the occurrence of unforeseen problems following initial marketing.  The FDA also has the authority to issue special controls for devices manufactured by the Company.  In the event that such additional special controls were issued, the Company’s products would be required to conform, which could result in significant additional expenditures for the Company. 

                    The Company is subject to numerous federal, state and local laws and regulations relating to such matters as safe working conditions, manufacturing practices, fire hazard control and the handling and disposal of hazardous or infectious materials or substances and emissions of air pollutants.  The Company owns and leases properties, which are subject to environmental laws and regulations.  There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company’s business, financial condition or results of operations.  In addition, the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company.

Risks related to Group Purchasing Organizations

                    A significant portion of the Company’s sales is generated through its relationship and contracts with various GPOs and IDNs. These contracts define the terms and conditions of the relationship between the Company, the GPOs and IDNs and their affiliated hospitals, but do not commit affiliated hospitals to purchase products from the Company.  The contracts are cancelable with appropriate notice by the Company, GPO or IDN.  There can be no assurance that these contracts will be renewed on terms substantially similar to the expiring contracts, if at all.

                    Recently, there has been intense scrutiny from the United States Senate involving potential restraint-of-trade activities practiced by GPOs and IDNs, particularly as it relates to issuance of long-term and/or sole-source contracts.  It has been a long-time practice of many GPOs and IDNs, including those with which the Company maintains contracts, to issue multiple-year contracts to only one vendor.  There can be no assurance that such sole-source and/or long-tem contracts will continue in the future and future regulatory decrees may require GPO’s to award contracts to multiple vendors and/or contracts for shorter time periods.  There can be no assurance that should sole-source and/or long-term contracts be eliminated, the Company could maintain its current level of market share with GPO and IDN affiliated hospitals.

Risks Related to International Sales; Foreign Operations

                    Sales made outside the United States represented approximately 27.4% of the Company’s 2002 net sales and the Company intends to increase international sales as a percentage of total net sales.  Foreign operations are subject to special risks that can materially affect the sales, profits, cash flows and financial position of the Company, including increased regulation, extended payment periods, competition from firms with more local experience, currency exchange rate fluctuations and import and export controls.  The Company has sales operations in Germany, Sweden, the United Kingdom, France and other countries where sales are made in local currency.  While the Company may choose to hedge

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its foreign currency exposures by attempting to purchase goods and services with the proceeds from sales in local currencies where possible, and purchase forward contracts to hedge receivables denominated in foreign currency, there can be no assurance that the Company’s hedging strategies will allow the Company to successfully mitigate its foreign exchange exposures.  The Company’s foreign exchange exposure has historically not been significant, and was not considered to be significant in fiscal 2002.

                    The Company also maintains a manufacturing and assembly facility in Ensenada and Tecate, Mexico and an assembly and distribution facility in Kuala Lumpur, Malaysia and, as a result, is subject to operational risks such as changing labor trends and civil unrest in those countries.  In the event the Company were required to transfer its foreign operations to the United States or were otherwise unable to benefit from its lower cost foreign operations, its business, financial condition and results of operations would be adversely affected.

Product Liability

                    The manufacturing and marketing of medical products entails an inherent risk of product liability claims.  Although the Company has not experienced any significant losses due to product liability claims and currently maintains umbrella liability insurance coverage, there can be no assurance that the amount or scope of the coverage maintained by the Company will be adequate to protect it in the event a significant product liability claim is successfully asserted against the Company.  In addition, the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company.

Dependence on Key Personnel; Management of Expanding Operations

                    The Company’s success, to a large extent, depends upon the continued services of its executive officers.  The loss of services of any of these executive officers could materially and adversely affect the Company. 

                    The Company’s plans to expand its business may place a significant strain on the Company’s operational and financial resources and systems.  To manage its expanding operations, the Company may be required to, among other things, improve its operational, financial and management information systems.  The Company may also be required to attract, train and retain additional highly qualified management, technical, sales and marketing and customer support personnel.  The process of locating such personnel with the combination of skills and attributes required to implement the Company’s strategy is often lengthy.  The inability to attract and retain additional qualified personnel could materially and adversely affect the Company.

Competition

                    The medical supply industry is characterized by intense competition.  Certain of the Company’s competitors have greater financial and other resources than the Company and may succeed in utilizing these resources to obtain an advantage over the Company.  The general trend toward cost containment in the health care industry has had the effect of increasing competition among manufacturers, as health care providers and distributors consolidate and as GPOs increase in size and importance.  The Company competes on the basis of brand name, product quality, breadth of product line, service and price.

Risks Generally Associated with Acquisitions

                    An element of the Company’s business strategy may be to pursue strategic acquisitions that either expand or complement the Company’s business.  Acquisitions involve a number of special risks, including the diversion of management’s attention to the assimilation of the operations and the assimilation and retention of the personnel of the acquired companies, and potential adverse effects on the Company’s operating results.  The Company may require additional debt or equity financing for future acquisitions, which may not be available on terms favorable to the Company, if at all.  In addition, the Credit Facility and the Indenture contain certain restrictions regarding acquisitions. The Indenture restricts acquisitions to those companies in the same line of business as the Company, and requires that all

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such acquired companies be designated Restricted Subsidiaries (as defined therein).  The Credit Facility restricts all acquisitions.  The inability of the Company to successfully finance, complete and integrate strategic acquisitions in a timely manner could have an adverse impact on the Company’s ability to effect a portion of its growth strategy.

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Patents and Trademarks

                    The Company has historically relied primarily on its technological and engineering abilities and on its design and production capabilities to gain competitive business advantages, rather than on patents or other intellectual property rights. However, the Company does file patent applications on concepts and processes developed by the Company’s personnel.  The Company has 27 patents in the United States.  Many of the U.S. patents have corresponding patents issued in Canada, Europe and various Asian countries.  The Company’s success will depend in part on its ability to maintain its patents, add to them where appropriate, and to develop new products and applications without infringing the patent and other proprietary rights of third parties and without breaching or otherwise losing rights in technology licenses obtained by the Company for other products.  There can be no assurance that any patent owned by the Company will not be circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company’s pending or future patent applications will be issued with claims of the scope sought by the Company, if at all.  If challenged, there can be no assurance that the Company’s patents (or patents under which it licenses technology) will be held valid or enforceable.  In addition, there can be no assurance that the Company’s products or proprietary rights do not infringe the rights of third parties.  If such infringement were established, the Company could be required to pay damages, enter into royalty or licensing agreements on onerous terms and/or be enjoined from making, using or selling the infringing product.  Any of the foregoing could have a material adverse effect upon the Company’s business, financial condition or results of operations.

Item 7A.     Quantitative and Qualitative Disclosure About Market Risk

                    Quantitative Disclosures.  With the continued growth in Europe, the Company has greater foreign currency exposure with respect to its international operations.  Until the Company’s acquisition of Hudson RCI AB in 1999, the Company’s only international exposure was its manufacturing operation in Mexico.  All sales were previously denominated in U.S. dollars.  Currently, the Company has operations in Germany, Sweden, France and the United Kingdom and other countries where sales are made in local currency. The Company may hedge its foreign currency exposures by attempting to purchase goods and services with the proceeds from sales in local currencies where possible.  The Company may also purchase forward contracts to hedge receivables denominated in foreign currency that are expected to be collected and converted into another currency.  However, there can be no assurance that the Company’s hedging strategies will allow the Company to successfully mitigate its foreign exchange exposures.

                    The Company has additional foreign currency exposure related to financing activities in currencies other than the local currency in which it operates.  Specifically, the Company is exposed to foreign currency risk related to the future financing instruments value that is denominated in foreign currencies.  At December 31, 2002, the net fair value liability of financial instruments with exposure to foreign currency risk was $14.0 million.  The potential loss in fair value of such financial instruments from a 10% adverse change in foreign currency exchange rates would be approximately $1.5 million.

                    The Company is exposed to certain market risks associated with interest rate fluctuations on its debt.  All debt arrangements are entered into for purposes other than trading.  The Company’s exposure to interest rate risk arises from financial instruments entered into in the normal course of business that, in some cases, relate to the Company’s acquisitions of related businesses.  Certain of the Company’s financial instruments are fixed rate, short-term investments which are held to maturity.  The Company’s fixed rate debt consists primarily of outstanding balances on the Senior Subordinated Notes and its variable rate debt relates to borrowings under the Credit Facility (see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources”).  With respect to the Company’s fixed rate debt, changes in interest rates generally affect the fair value of such debt, but do not have an impact on earnings or cash flows.  Because the Company generally cannot prepay its fixed rate debt prior to maturity, interest rate risk and changes in fair value should not have a significant impact on this debt until the Company is required to refinance.  With respect to variable rate debt, changes in interest rates affect earnings and cash flows, but do not impact fair value.  The impact on the Company’s interest expense in the upcoming year of a one-point interest rate change on the outstanding balance of the Company’s variable rate debt would be approximately $0.6 million.

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                    The following table presents the future principal cash flows and weighted-average interest rates expected on the Company’s existing long-term debt instruments.  The fair value of the Company’s fixed rate debt is estimated based on quoted market prices.

Expected Maturity Date
(as of December 31, 2002)

                    Qualitative Disclosures.  The Company’s primary exposure relates to (1) interest rate risk on long-term and short-term borrowings, (2) the Company’s ability to pay or refinance long-term borrowings at maturity at market rates, (3) the impact of interest rate movements on the Company’s ability to meet interest expense requirements and exceed financial covenants and (4) the impact of interest rate movements on the Company’s ability to obtain adequate financing to fund future acquisitions.  The Company manages interest rate risk on its outstanding long-term and short-term debt through the use of fixed and variable rate debt.  While the Company cannot predict or manage its ability to refinance existing debt or the impact interest rate movements will have on its existing debt, management evaluates the Company’s financial position on an ongoing basis.

Item 8.     Financial Statements

                    See the Index included at “Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.”

Item 9.     Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

                    On January 25, 2002, the Company dismissed Arthur Andersen LLP (“Andersen”) as its independent accountant.  Andersen provided both accounting and audit services to the Company, and was the primary consultant for the implementation of the Company’s SAP software platform.

                    The reports of Andersen on the Company’s financial statements for the past two fiscal years contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.

                    The Company’s Board of Directors approved the decision to change accountants on January 17, 2002, and the Audit Committee of the Board of Directors approved the decision to change accountants on January 25, 2002.

                    In connection with its audits for the two most recent fiscal years and through January 25, 2002, there have been no disagreements with Andersen on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Andersen, would have caused Andersen to make reference thereto in its report on the financial statements of the Company for such time periods, except as follows:

                    During the audit of its financial statements for the year ended December 31, 2000, the Company had a disagreement with Andersen regarding the reserves for accounts receivable (doubtful accounts and rebates) as of December 31, 2000.  Andersen informed the Company of its concerns as to the methodology utilized to establish the level

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of these reserves as well as that inadequate support had been provided for these reserves.  Upon further review and analysis by the Company, and continuing discussions with Andersen, these reserves were adjusted, and backup substantiation developed, to the satisfaction of Andersen, which issued its report on the Company’s financial statements for the year ended December 31, 2000.

                    Members of the Audit Committee of the Board of Directors of the Company met with Andersen to discuss these matters.  The Company believes that the concerns expressed by Andersen with respect to the foregoing issue have been addressed, as evidenced by the fact that Andersen has issued an unqualified report covering the Company’s 2000 financial statements, and that the Company now has policies and procedures in place to properly establish reserve balances, and substantiation, in respect of its accounts receivable in accordance with GAAP.  The Company has authorized Andersen to respond fully to the inquiries of the successor accountant concerning this matter. 

                    During the two most recent fiscal years and through January 25, 2002, except as described below, there have been no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.  Andersen informed the Company in a letter dated July 30, 2001 that the following material weaknesses in internal control existed during fiscal year ended December 31, 2000:

                    The Company did not prepare on a timely basis reconciliations for substantially all of the Company’s balance sheet accounts, and the Company’s internal process for review and approval of reconciliations was informal and inconsistent.

                    The Company’s support for the required reserves for accounts receivable (doubtful accounts and rebates) was initially inadequate; upon further review, adjustments required to properly state such reserves as of December 31, 2000 were material to the Company’s consolidated financial statements.

                    The Company’s consolidated financial statements were not prepared on a timely basis and eliminating entries were not initially well supported.

                    The Company had a shortage of accounting and finance personnel, and had retained accounting and finance personnel who lacked the appropriate expertise; as a result, the Company’s former Chief Financial Officer was responsible for a disproportionate amount of the Company’s financial reporting process, and the efficiency, timeliness and accuracy of the Company’s financial reporting was adversely impacted.

                    Members of the Audit Committee of the Board of Directors of the Company discussed these matters with Andersen.  Except as described above, these conditions did not result in any disagreements or differences in opinion between the Company and Andersen.  Andersen advised the Company in the July 30, 2001 letter that it understood that the Company had taken certain steps subsequent to December 31, 2000 to mitigate these material weakness conditions.

                    The Company provided Andersen with a copy of the disclosures made by the Company in this report and requested that Andersen furnish the Company with a letter addressed to the SEC stating whether or not Andersen agrees with the above statements, and if not, stating the respects in which it does not agree.  A copy of such letter was filed as an exhibit to the 8-K report filed by the Company on February 1, 2002, in which the Company initially reported this change in auditors.

New Independent Auditor

                    On January 31, 2002, the Company engaged Deloitte & Touche LLP (“Deloitte”) as the Company’s new principal independent auditor to audit the Company’s financial statements, to replace Andersen.  During the two most recent fiscal years and through January 31, 2002, the Company has not consulted with Deloitte regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on the Company’s financial statements; or (ii) any matter that was either the subject of a

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disagreement (as that term is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions to Item 304 of Regulation S-K), or a reportable event (as described in Item 304(a)(1)(v) of Regulation S-K). 

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PART III

Item 10.     Directors and Executive Officers of the Registrant

                    The following individuals are the executive officers and directors of Holding and Hudson RCI as of March 14, 2003:

                    Charles A. French is President, Chief Executive Officer and a Director of the Company.  Mr. French assumed these positions with both the Company and Holding in August 2001, and was a consultant to the Company since January 2001.  Prior to joining the Company, since 1989 he had been a private investor focused on healthcare and technology companies.  Previously, he held senior management positions at Spectramed, Inc., Caremark, Inc. and Bentley Laboratories, Inc.

                    Lougene Williams is a Senior Vice President of the Company responsible for its product development, quality assurance and manufacturing operations, having served in this capacity since January1996, and assumed the same position with Holding after consummation of the recapitalization in April 1998.  Prior to 1996, he was the Company’s Vice President, Manufacturing, having held a similar position with Respiratory Care Inc.  From 1976 to 1987, he held manufacturing management positions of increasing responsibility at various manufacturing plants of The Kendall Company.

                    Patrick G. Yount became the Company’s Vice President and Chief Financial Officer in March 2001. Prior to joining the company, he held the positions of Chief Financial Officer and Chief Operating Officer of Good Source Solutions – a nationwide distributor of specialty food items from February 1996 to September 2000. Prior to joining Good Source Solutions, he held positions as a senior member of the Merchant Banking Group for Banque Paribas in the San Francisco area from 1993 to 1996.

                    Ola G. Magnusson is a Senior Vice President and serves as President of Hudson RCI AB in Sweden. Mr. Magnusson joined the company in July1999 in connection with the acquisition of Louis Gibeck AB where he was the President and Chief Executive Officer since January 1996.  Prior to joining Louis Gibeck AB, Mr. Magnusson held several different positions, primarily in marketing with Pharmacia, a Swedish pharmaceutical company.

                    Jeffery D. Brown, Vice President of Marketing and Sales, assumed this position in January 2000.  From January 1997 to January 2000, Mr. Brown served as the Company’s Director of Sales.  From 1993 to 1997, Mr. Brown served as National Sales Manager and from 1991 to 1993, as Regional Sales Manager.  Mr. Brown has also held positions of National Account Manager from 1982 to 1991, and Territorial Sales Manager from 1980 to 1982.

                    Helen Hudson Lovaas is a director of the Company and became a director of Holding after consummation of the recapitalization in April 1998.  Mrs. Lovaas began her career at the Company in 1961.  She has been Chairman since

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1987, when she inherited ownership of the Company and served as Chief Executive Officer from 1987 until May 1997.  Mrs. Lovaas had served previously as the Vice President of Administration of Hudson Oxygen for 15 years.

                    Jon D. Ralph became a director of the Company and of Holding in connection with the recapitalization in April 1998.  Mr. Ralph joined Freeman Spogli in 1989 and became a Principal in January 1998.  Prior to joining Freeman Spogli, Mr. Ralph spent three years at Morgan Stanley & Co. Incorporated where he served as an analyst in the Investment Banking Division.  Mr. Ralph is also a director of Century Maintenance Supply, Inc., and The Pantry, Inc.

                    Charles P. Rullman became a director of the Company and of Holding in connection with the recapitalization in April 1998.  Mr. Rullman joined Freeman Spogli as a Principal in 1995.  From 1992 to 1995, Mr. Rullman was a General Partner of Westar Capital, a private equity investment firm specializing in middle-market transactions.  Prior to joining Westar, Mr. Rullman spent twenty years at Bankers Trust Company and its affiliate BT Securities Corporation where he was a Managing Director and Partner.  Mr. Rullman is also a director of The Pantry, Inc.

                    Ronald P. Spogli became a director of the Company and of Holding in connection with the recapitalization in April 1998.  He is a founding Principal of Freeman Spogli, which was founded in 1983.  Mr. Spogli is also a director of AFC Enterprises, Inc., Century Maintenance Supply, Inc., Advance Auto Parts and Gaylan’s Trading Co. Inc.

                    Sten Gibeck became a director of the Company and of Holding in connection with the July 1999 acquisition of Hudson RCI AB.  Mr. Gibeck has been employed by Hudson RCI AB since 1965, and since January 1997 has served as its Vice President of Research and Development.  From 1971 through December 1996, Mr. Gibeck served as the President of Hudson RCI AB.

                    Directors of the Company and Holding are elected annually and hold office until the next annual meeting of stockholders and until their successors are duly elected and qualified.

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Item 11.     Executive Compensation

                    The following table sets forth the compensation for each of the fiscal years in the three-year period ended December 31, 2002 of the following persons:

Summary Compensation Table

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Executive Employment Agreements

                    In May and June 2002, the Company entered into an employment agreement with all Named Executive Officers except Ola Magnusson.  The Named Executive Officers receive a base salary in an amount and on substantially the same terms and conditions as was being paid by the Company on that date and an annual cash bonus in accordance with the Company’s existing incentive programs.  Pursuant to the employment agreements, in the event that employment is terminated by the Company other than for cause (as such term is defined in the employment agreements), or if the Named Executive Officer resigns pursuant to a “qualifying resignation” (as such term is defined in the employment agreements), the Company will be required to pay the Named Executive Officer’s base salary for a period of 12 months (the “Severance Period”).  The employment agreements also provide for nondisclosure of confidential information, that the Named Executive Officer shall not engage in any prohibited activity (as such term is defined in the employment agreements) during the term of employment and that the Named Executive Officer will refrain from interfering with the Company’s contractual relationships or soliciting the Company’s employees during the Severance Period.

                    In June 2000, the Company entered into an agreement with Ola Magnusson.  With the exception of the severance period which is 18 months, the terms and conditions of the agreement were substantially similar to those entered into by the other Named Executive Officers.

Compensation of Directors

                    Directors of the Company receive no compensation as directors.  Directors are reimbursed for their reasonable expenses in attending meetings.

Management Bonus Plans

                    In 2002 and 2001, the Company offered a management bonus plan for its executives and senior management.  The plan is based on attainment of financial goals as well as individual performance objectives. The financial objectives were based on attainment of minimum EBITDA levels, and provided for bonus amounts to increase as EBITDA increases.  The Company periodically offers additional incentive compensation to individuals who demonstrate superior performance.  The Company has put a similar plan into place for 2003.

Retirement Plans

                    The Company has historically sponsored two programs that assist its United States based employees in planning for retirement.  The Company offered a defined contribution pension plan that was funded by the Company.  Employees must be at least 21 years of age and have completed two years of service to be eligible to participate in the pension plan.  The Company annually contributed an amount equal to 6% of a participating employee’s base earnings to a participant’s account, prorated for any part of a year that a participant was ineligible for a contribution.  The funding also included a proportionate share of any increase or decrease in the fair market value of the assets in the trust fund as of the immediately preceding last day of the plan year. During 2001, the Company determined that the pension plan for 1999 and 2000 was not fully funded. Accordingly, the Company recorded $350,000 in associated penalties and fully funded the plan through 2000.  The Company fully funded the 2001contribution in 2002.  During 2002, the Company froze the current pension plan and developed a new plan that provides for discretionary funding determined annually by the Board of Directors.  All other aspects of the new plan are substantially similar to the old plan.  In addition, employees may contribute to a 401(k) plan that allows matching contributions by the Company.  Employees must have six months of service to be eligible to participate in the 401(k) plan and may contribute up to 10% of their annual compensation, or 6% if the employee is a highly compensated participant.

Compensation Committee Interlocks and Insider Participation

                    The Board of Directors of the Company determines the compensation of the executive officers.  During fiscal 2002, certain members of the Board of Directors determined the compensation of the Company’s Chief Executive Officer

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and certain members of the Board of Directors and Mr. French determined the compensation of the Company’s other executive officers.

Stock Subscription Plans

                    In April 1998, Holding adopted an Employee Stock Subscription Plan and an Executive Stock Subscription Plan (collectively, the “Stock Subscription Plans”) pursuant to which executives of the Company purchased 800,000 shares of common stock of Holding valued at $10.00 per share.  The Stock Subscription Plans provide for a repurchase option in favor of Holding upon termination of employment at stated repurchase prices.  In addition, the Stock Subscription Plans provide for restrictions on the transferability of shares prior to the fifth anniversary of the recapitalization or the Company’s initial public offering.  The shares are also subject to a right of first refusal in favor of Holding as well as obligations to sell at the request of Freeman Spogli and co-sale rights if Freeman Spogli and Affiliates sells its shares to a third party.  No additional shares of Holding common stock were sold under the Stock Subscription Plans in fiscal 2001.

                    In 2001, the Board of Directors of the Company approved the adoption of a Stock Option Plan for eligible employees, officers and consultants of the Company.  The plan allows for the issuance of up to 5,000,000 shares of Company common stock pursuant to the exercise of incentive stock options or non-qualified options.  The exercise price of options granted under the plan shall be set at fair market value at the time of the grant as determined by the Board of Directors.  As of the date of this filing, 3,550,000 options covering shares have been granted at an exercise price of $1.00 per share, of which 2,625,000 are exercisable.

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Item 12.     Security Ownership of Certain Beneficial Owners and Management

                    The following table sets forth certain information, as of March 14, 2003, with respect to the beneficial ownership of capital stock of the Company by (i) each person who beneficially owns more than 5% of such shares, (ii) each of the Named Executive Officers, (iii) each director of Hudson RCI and (iv) all Named Executive Officers and directors of Hudson RCI as a group.