VITAL SIGNS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2003.

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-18793

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VITAL SIGNS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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NEW JERSEY 11-2279807
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)

20 CAMPUS ROAD, TOTOWA, NEW JERSEY 07512; (973) 790-1330
(ADDRESS AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

TITLE OF EACH CLASS
Common Stock, no par value

Indicate by checkmark 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. [x] Yes [ ] No

Indicate by checkmark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

Indicate by checkmark whether the registrant is an accelerated filer (as
defined in Rule 13b-2 of the Exchange Act) [x] Yes [ ] No

Aggregate market value of voting stock held by non-affiliates as of
December 11, 2003 was approximately $184,008,917.

Number of shares of Common Stock outstanding as of December 11, 2003:
12,944,959.

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VITAL SIGNS, INC.
TABLE OF CONTENTS

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PART 1

ITEM 1. BUSINESS

INTRODUCTION

Vital Signs, Inc. was initially incorporated in New York in 1972 and
reincorporated in New Jersey in 1988. Unless otherwise indicated, references in
this Annual Report to 'Vital Signs, Inc.', 'Vital Signs', 'Company', 'we', 'us'
and 'our' refer to Vital Signs, Inc., and its consolidated subsidiaries. Vital
Signs' principal executive offices are located at 20 Campus Road, Totowa, New
Jersey 07512; its telephone number at that location is (973) 790-1330.

Vital Signs designs, manufactures and markets medical products for the
anesthesia, respiratory, critical care, sleep therapy and emergency markets. A
number of single-patient use products are increasing their share of the medical
products market primarily because of their cost advantages and improved patient
care features, including reducing the potential of transmitting infections from
one patient to another. With the acquisition of Breas Medical AB ('Breas') from
1997 to 2002, National Sleep Technologies, Inc. in 2000 (see below), and the
merger of HSI Medical Services Corporation in 2002, we have expanded our focus
into the sleep therapy and personal ventilation markets.

We pioneered the development and introduction of a variety of single-patient
use products. In 1975, we commenced the marketing of clear, non-conductive
anesthesia breathing circuits. The first clear plastic, single-use air-filled
cushion face mask for anesthesia delivery and resuscitation was launched by us
in 1981. We were the first organization to introduce a single-patient use manual
resuscitator in 1984. The first single-patient use laryngoscope system for use
in the anesthesia and critical care arenas was developed and launched by us in
1988. We have also developed a general anesthesia kit, which can combine over 20
disposable items in one convenient, cost-effective package, and the first
single-patient use infant resuscitation circuit with an adjustable pressure
limiting valve, used to protect the infant's lung against over pressurization.

We also offer products and services for the sleep disorder/personal
ventilation markets, which builds upon our airway management expertise. Our
products are used in the treatment of obstructive sleep apnea, a condition
caused by a blockage of the airway, usually the result of the soft tissue in the
rear of the throat collapsing and closing during sleep. We operate a number of
sleep diagnosis centers which test the need for sleep apnea products in
particular patients and tailor specific products for individual patients.

We deliver regulatory compliance services to FDA regulated companies
primarily to the pharmaceutical companies. In addition, we also offer services
to, medical device, diagnostic and biotechnology companies.

ACQUISITIONS -- 1997 TO PRESENT

In 1997, we acquired the outstanding stock of Marquest Medical Products,
Inc. ('Marquest'), and began manufacturing and distributing arterial blood gas
syringes and kits, small volume nebulizers and heated humidification circuits.

Through several transactions from 1997 to 1999, we acquired 53% of Breas
Medical, AB ('Breas'), a manufacturer of CPAP (continuous positive airway
pressure) machines and personal ventilators, based in Sweden. In May 2001 we
purchased another 41%. At that time substantially all of the minority interest
was held by Breas' management. In April of 2002 we purchased the remaining
minority shares, bringing our ownership to 100%. Breas has grown to be among the
market leaders in sleep and personal ventilation in Europe through its own
direct sales force in several European markets together with focused
distributors. The Breas products were introduced to the South American and Asian
markets in late 1999. In September 2000 we received FDA clearance to market the
Breas PV10'TM' CPAP device in the United States. In 2001 we received FDA
clearance to market the Breas H50'TM' heated humidifier in the United States. In
October 2003, we received FDA clearance for the Breas PV10i'TM' CPAP system for
sale in the United States for obstructive sleep apnea. The PV10i'TM' is a
self-adjusting Continuous

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Positive Airway Pressure (CPAP) device that uses a highly advanced, patented
technique to respond to changes in individual's breathing patterns. The device
can adjust treatment pressure appropriately, as patient needs change, before
apneic events occur. Traditional, constant CPAP devices must be set to a maximum
pressure that is usually higher than is required throughout the night which may
create discomfort for the user. With the PV10i, the mean treatment pressure is
lower. Clinical studies have demonstrated that patients prefer the lower
pressure provided by the PV10i to other devices available in the marketplace. We
plan to actively market Breas products in the United States in the near term,
and in conjunction with our development of certain patient interfaces.

In June 1998 and May 1999, we purchased $10.4 million of common stock and
convertible preferred stock of National Sleep Technologies, Inc. ('NST'). NST
provides sleep diagnostic testing services in the United States through free
standing labs and, through contracts with hospitals, in hospital facilities, for
patients suspected of suffering from sleep disorders, such as obstructive sleep
apnea. In 2000, we converted our investment in the preferred stock of NST into
common stock and assumed control of NST. On January 1, 2002, NST merged with HSI
Medical Services, Inc., ('HSI'), a subsidiary of the Johns Hopkins Health
System. In this merger, we received a controlling interest in the merged entity,
known as Sleep Services of America, Inc. ('SSA'). We held a 68% equity interest
in SSA, on both September 30, 2002 and 2003.

On March 28, 2002 we acquired Stelex Inc. ('Stelex'), a company engaged in
pharmaceutical technology services, through the merger of our wholly-owned
subsidiary, The Validation Group ('TVG'), and Stelex Inc. The surviving entity
is known as Stelex-TVG ('Stelex'). TVG had been engaged in process validation
for pharmaceutical companies. The merger enabled us to move into the technology
services area through the sale of dedicated software and the customization of
this software.

For additional information regarding our products, see 'Business --
Products' and for additional information regarding the accounting treatment of
the Breas, SSA and Stelex transactions, see 'Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Overview.'

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains, and from time to time we expect to
make, certain forward-looking statements regarding our business, financial
condition and results of operations. The forward-looking statements are
typically identified by the words 'anticipates', 'believes', 'expects',
'intends', 'forecasts', 'plans', 'future', 'strategy', or words of similar
import. In connection with the 'safe harbor' provisions of the Private
Securities Litigation Reform Act of 1995 (the 'Reform Act'), we intend to
caution investors that there are important factors that could cause our actual
results to differ materially from those projected in our forward-looking
statements, whether written or oral, made herein or that may be made from time
to time by or on behalf of us. Investors are cautioned that such forward-looking
statements are only predictions and that actual events or results may differ
materially from such statements. We undertake no obligation to publicly release
the results of any revisions to our forward-looking statements to reflect
subsequent events or circumstances or to reflect the occurrence of unanticipated
events.

We wish to ensure that any forward-looking statements are accompanied by
meaningful cautionary statements in order to comply with the terms of the safe
harbor provided by the Reform Act. Accordingly, we have set forth in Exhibit
99.1 to this Annual Report on Form 10-K a list of important factors, certain of
which are outside of management's control, that could cause our actual results
to differ materially from those expressed in forward-looking statements or
predictions made herein and from time to time by us. Reference is made to such
Exhibit 99.1 for a list of such risk factors.

ACQUISITION STRATEGY

Historically, we have made both product and business acquisitions. Although
no assurances can be given with respect to future acquisitions, our acquisition
strategy is focused upon the following principal objectives: (i) identification
and acquisition of companies and/or products in the anesthesia,
respiratory/critical care, emergency, homecare, sleep/ventilation and
pharmaceutical technology services markets with the goal of expanding our
product line and improving our market share positions,

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(ii) expansion to international markets, and (iii) acquiring unique research and
development capabilities. Such acquisitions may consume substantial amounts of
capital, both to fund the purchase price and to fund the working capital needs
of acquired companies and acquired product lines.

PRINCIPAL PRODUCTS AND SERVICES

Our primary products and services fall into four categories:

anesthesia;

respiratory/critical care;

sleep/personal ventilation (referred to as 'sleep'); and

pharmaceutical technology services.

We believe that our broad range of product offerings represents a
competitive advantage over suppliers with more limited product offerings. We
continue to supplement our existing products and services with new offerings
designed to meet the needs of health care professionals. For example, in
response to reports of allergic reactions to medical devices containing latex,
we manufacture a number of latex-free products. As a leading provider of
single-patient use airway management products for the anesthesia and
respiratory/critical care markets, we have developed a reputation with
physicians for providing quality products. We believe that brand recognition
helps drive demand for our products.

We have leveraged our airway management expertise by providing products and
services for the high growth sleep/personal ventilation and sleep services
markets. We offer products for the treatment of obstructive sleep apnea and
operate approximately 70 sleep diagnosis centers which test the need for sleep
apnea products.

Our principal products and services are described below:

ANESTHESIA PRODUCTS

Anesthesia Breathing Circuits. We offer a wide variety of single-patient use
anesthesia breathing circuits, which are used to carry oxygen and anesthesia to
a patient while under general anesthesia during surgery. Breathing circuits
connect the patient to the anesthesia machine and to various patient monitors.
The traditional system is referred to as a 'circuit' because it is comprised of
two tubes, one carrying inspiratory gases to a patient and the other carrying
expiratory gases away from the patient. Each breathing circuit consists of
flexible hoses, a breathing bag, and a 'Y' and elbow attachment. Since the
breathing circuit needs of hospitals vary significantly, we offer a large
variety of circuits designed to be compatible with anesthesia equipment
manufactured by numerous other companies. With the Marquest acquisition in 1997,
we began offering circuits that deliver heated humidification to patients.
Technological advances in the areas of gas sampling, temperature monitoring,
humidification and bacterial/viral filtration have provided us with
opportunities to expand our breathing circuit offerings.

Face Masks. In 1981, Vital Signs introduced the first clear plastic
air-filled cushion face mask for single patient anesthesia and respiratory use.
We believe that the soft air-filled cushion face mask provides a better seal on
most patients than other face masks, thus improving the delivery of anesthetic
gases and oxygen to the patient. A clear face mask also permits the clinician to
better observe certain patient problems, such as life-threatening aspiration,
while the patient is anesthetized. We offer various sizes and types of face
masks. We anticipate that the usage of single-patient use face masks in surgical
procedures internationally will continue to expand as single-patient use
products become increasingly accepted in international hospitals.

General Anesthesia Systems (GAS'TM'). We assemble and market General
Anesthesia Systems (generically considered customized anesthesia kits), which
can include more than 20 products, such as air-filled cushion face masks,
breathing circuits, blood pressure cuffs and temperature monitoring probes. In
marketing our GAS'TM' kits, our sales representatives use detailed
questionnaires to assist each customer in determining the particular products
the hospital desires in its anesthesia kits. We then assemble GAS'TM' kits to
meet the hospital's specific needs.

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Limb-[th]'TM'. In the first quarter of Fiscal 2001, we introduced
Limb-[th]'TM', a single limb breathing circuit used for general anesthesia,
transport and/or critical care situations. The single limb incorporates a
patented technology with a septum to separate inspiratory and expiratory gases.
It competes with the traditional two limb system and is an alternative to the
tube within a tube circuit.

PAXpress'TM'. In the first quarter of Fiscal 2001, we introduced a
pharyngeal airway (PAXpress), a single use airway device promoted as an
alternative to the LMA (laryngeal mask airway) device. The PAXpress'TM' is used
for airway management during general anesthesia procedures, and with just one
size, can accommodate all adults over 90 pounds.

INFUSABLE'r' Disposable Pressure Infusor. Invasive pressure monitoring has
been used since the early 1970's as a means of monitoring blood and other fluid
pressures of patients in certain critical care situations. The monitoring
process involves inserting a catheter into the artery of the patient, connecting
the catheter to a transducer (a device which converts the pressure impulse from
the patient's blood into an electrical signal), and transmitting the electrical
signal to a monitoring screen. The monitoring process uses a fluid filled
conduit to connect the catheter to the transducer. The fluid generally is a
saline solution forced into the system by a pressure infusor. Our INFUSABLE'r'
disposable pressure infusor consists of an inflatable bladder, a bulb to pump
air into the bladder and a patented pressure gauge. The Infusable'r' also has a
mesh netting into which a package of sterile fluid or 'solution bag' is placed.
The fluid is connected to the monitoring system and the pressure on the solution
bag is set at a pressure level designed to maintain the pressure required by the
monitoring system. The Infusable'r' is also designed to deliver blood or fluids
to a patient at a rapid rate usually under trauma conditions.

Vital View'TM' Single-Patient Use Fiberoptic Laryngoscope System. This
disposable system is designed to assist the anesthesiologist in correctly
placing an endotracheal tube within the trachea of the patient. Our Vital
View'TM' system has single-patient use blades which we believe offers several
advantages over traditional reusable metal blade laryngoscope systems, including
lowering the risk to both the patient and physician of infection associated with
reusable metal blades and handles. In addition, we believe that hospital capital
outlays for stocking emergency crash carts can be reduced by purchasing the
Vital View'TM' system rather than a reusable fiberoptic system.

THOMAS MEDICAL PRODUCTS

Thomas Medical Products, Inc. ('TMP'), a wholly-owned subsidiary of Vital
Signs, Inc., is an original equipment manufacturer ('OEM') and contract
development organization which relies upon its scientific, technical,
engineering, manufacturing and QA/Regulatory expertise in the disposable medical
device area. TMP manufactures devices which provide access primarily to the
vascular system by medical professionals and include products such as
introducers, sheaths, dilators, hemostasis valves and catheters. TMP's products
are sold primarily to other healthcare product providers to be used in their
products or as part of kits, or as a finished product. TMP is included in the
anesthesia business segment in Note 21 to the Notes to the Consolidated
Financial Statements. Revenue was $18.7 million, $16.5 million and $14.4 million
for TMP for each of the three years ended September 30, 2003, 2002 and 2001,
respectively.

RESPIRATORY AND CRITICAL CARE PRODUCTS

Gas-Lyte'r' and Quick-ABG'r'. We offer a broad line of disposable arterial
blood gas ('ABG') syringes and collection systems. Blood gas syringes are used
to collect blood for blood gas analyses routinely performed in hospitals on
patients suspected of having metabolic, respiratory or other cardiopulmonary
difficulties. The blood gas sample is processed through a blood gas analyzer.
Blood gas analyzers are manufactured by a wide range of manufacturers. We offer
our ABG products in both standard configurations and in kits that are customized
to meet a specific hospital's needs, and function with their blood gas
analyzers.

Code Blue II'TM'. Vital Signs was the first to offer single-patient use
manual resuscitators. Manual resuscitators are ventilation devices which are
squeezed by hand to force oxygen into a patient's lungs. They are used
throughout the hospital in a variety of settings. For example, patients on a
ventilator require the use of a resuscitator prior to tracheal suctioning
procedures. Another use is in providing

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oxygen while transporting the patient between the operating room and other
critical care units. In addition, resuscitators are typically placed
strategically throughout the hospital to provide assistance to patients who have
stopped breathing and require resuscitation. Code Blue II'TM' resuscitators are
sold in different sizes for infants, children and adults. These resuscitators
alleviate certain problems involved in mouth-to-mouth emergency resuscitation,
including the risk to both the rescuer and the individual of transmitting
infections. We believe that most reusable manual resuscitators are costly to
sterilize and require re-assembly, which may result in errors that compromise
proper function. In contrast, Code Blue II'TM' resuscitators are relatively
inexpensive and are delivered fully assembled.

Babysafe'TM' and Hyper Inflation Systems. We offer both Babysafe'TM' and
traditional hyperinflation systems used for infant resuscitation, a specialized
line of infant hyperinflation products (BabySafe'TM', PediBlue'TM' and
BabyBlue'TM' hyperinflation systems), used in labor and delivery rooms and in
neonatal intensive care units, where controlling the spread of infection is
particularly critical. BabySafe'TM' offers the ability to adjust and limit the
level of pressure that can be delivered during resuscitation. Oxygen can be
delivered without the risk of barotrauma. These systems are available in a
variety of configurations and sizes to meet the needs of infants.

CleenCuff'TM' and CUFF-ABLE'r' Blood Pressure Cuffs. We manufacture and sell
single patient use blood pressure cuffs which are wrapped around the arm of a
patient to obtain a blood pressure reading. Our single-patient use blood
pressure cuffs provide hospitals with an alternative to traditional reusable
blood pressure cuffs that can become contaminated by touch, with blood and other
body fluids. While all patients admitted to hospitals are candidates for their
own dedicated blood pressure cuff, we believe that to date the primary market
for disposable cuffs has been for cases where infection control is a high
priority. Our cuffs are sold in a variety of sizes (including neonatal) and are
adaptable to all manual and electronic blood pressure monitors that utilize
blood pressure cuffs.

Continuous Positive Airway Pressure ('CPAP') Systems. Our face mask CPAP
systems provide a less invasive and more comfortable way of providing oxygen to
certain patients than conventional ventilator-based systems. Our face mask CPAP
systems eliminate the need to insert an endotracheal tube into the patient's
trachea and then attach the patient to a ventilator. Mask CPAP systems are now
being used successfully in the pre-hospital setting to treat patients with
cardiogenic pulmonary edema. The system consists of a compact flow generator
connected to an air filled cushion face mask. The face mask is attached to a
single patient use PEEP (positive end expiratory pressure) valve designed to
maintain positive airway pressure in the lungs, thus allowing for more oxygen to
diffuse into the patient's blood system.

Misty Ox'r' Respiratory Products. The MistyOx'r' line consists of three
respiratory product lines that deliver hydration to a patient. The first is a
pre-filled bubble humidifier which delivers low flow and low concentration of
oxygen to patients, the second is a nebulizer which delivers medium to high flow
and high concentrations of oxygen to patients, and the third is the addition of
a regulated heater to the nebulizer. These products may be used by infants,
children and adults in many areas of the hospital, including emergency, recovery
and critical care.

ACTAR'r' and ACTAR D-Fib'TM' CPR Training Manikins. We manufacture a line of
patented cardiopulmonary resuscitation ('CPR') training manikins. The ACTAR'r'
manikin was re-designed in Fiscal 2000 to meet changing market demands. The new
Actar D-Fib incorporates additional functionality to meet the updated
requirements of the American Heart Association and the Red Cross. New features
include jaw thrust, abdominal thrust and anatomical landmarks for proper
defibrillation training. While maintaining the necessary features and anatomical
landmarks for CPR practices, our training manikins are far smaller and less
expensive than full size manikins typically used for CPR training. The smaller
size and affordable pricing enable each person in a CPR training class to
practice with his or her own manikin, rather than sharing a single demonstration
model.

Broselow/Hinkle'TM' Pediatric Emergency System. The Broselow/Hinkle'TM'
pediatric emergency system is the product of extensive clinical efforts by James
Broselow, M.D., and Alan Hinkle, M.D. to enable emergency care providers to
determine the proper dose of medication and appropriate equipment size for
infants in emergency situations. This system takes advantage of the direct
correlation between a pediatric patient's body length and the proper size of
emergency supplies and correct drug dosages. This patented system, licensed to
Vital Signs, consists of: a tape measure having eight color

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zones, a corresponding series of color-coded single-patient use emergency kits
or modules and a nylon organizer bag custom-designed to hold all the supplies
needed in either a trauma, cardiac or respiratory pediatric emergency. With this
system, emergency room and EMS personnel can be confident that all the supplies
necessary to manage a pediatric emergency are readily identified, available and
organized in a manner that minimizes reaction time.

SLEEP/PERSONAL VENTILATION PRODUCTS

We have designed our sleep products to deliver airflow to patients
undergoing therapy for the treatment of obstructive sleep apnea with the
objective of increasing patient comfort and acceptance of the treatment.
Continuous positive airway pressure is a common method for treating obstructive
sleep apnea. We have manufactured and distributed continuous positive airway
pressure systems for more than a decade for other respiratory applications and
actively entered the sleep apnea market in 1997 through our interest in Breas
Medical AB, a European manufacturer of personal ventilators for obstructive
sleep apnea and long term ventilation. To date, most of our sales of these
devices have been overseas. We received FDA clearance for our first home care
continuous positive airway pressure product in August 2000. We have designed our
ventilation systems to produce and deliver gases to a patient requiring
ventilation or oxygen therapy in both hospitals and the home. In addition, we
provide diagnostic and therapeutic services through our Sleep Services of
America subsidiary, which was created in January 2002 when we merged our
National Sleep Technologies subsidiary with the sleep diagnostic business of The
Johns Hopkins Health Systems Corporation.

Our principal products and service offerings in this category are set forth
below. Other than the Breas PV10'TM', Breas PV10i, and the Breas HA50'TM', all
of the products below are currently sold only outside of the U.S. We provide our
sleep diagnostic services exclusively in the U.S.

Sleep Products

CPAP Flow Generators are electromechanical devices which deliver continuous
positive airway pressure through a nasal mask to a patient suffering from
obstructive sleep apnea in order to keep the patient's airway open during
sleep. Given the importance of patient compliance in treating obstructive
sleep apnea, we have designed our products to be easy to use, lightweight,
small and quiet, making them relatively unobtrusive at the bedside. Our
Breas PV10i'TM' adds the additional functionality of raising and lowering
continuous positive airway pressure to accommodate various user sleep
stages and positions.

Humidification Systems are heated humidifiers for use with continuous
positive airway pressure or ventilation devices. Humidification is an
important factor in the function of the respiratory system. Our Breas
HA50'TM' has nine heating settings and is easy to clean.

Sleep Disorder Home Screening Devices are home-use systems for screening
for sleep disorders, including obstructive sleep apnea. Our Breas SC20'TM'
is a lightweight screening system for measuring and recording physiological
data during sleep. The system can record oxygen saturation, airflow, pulse,
breathing effort, snoring, limb movement and body position. The data is
downloaded to a personal computer where our analysis software provides an
indication of the presence of sleep apnea and other associated disorders.

Bi-Level CPAP such as our Breas PV101'TM' are electromechanical devices
which deliver two levels of continuous positive airway pressure to a
patient. It is used to treat more severe Obstructive Sleep Apnea and is
much more comfortable for the user. In October 2003, we received FDA
clearance for the Breas PV10i'TM' CPAP system for sale in the United States
for obstructive sleep apnea. The PV10i is a self-adjusting Continuous
Positive Airway Pressure (CPAP) device that uses a highly advanced,
patented technique to respond to changes in an individual's breathing
patterns. The device can adjust treatment pressure appropriately, as
patient needs change, before apneic events occur. Traditional, constant
CPAP devices must be set to a maximum pressure that is usually higher than
is required throughout the night creating discomfort for the user. With the
PV10i'TM', the mean treatment pressure is lower. Clinical studies

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have demonstrated that patients prefer the lower pressure provided by the
PV10i'TM' to other devices available in the marketplace.

Sleep Diagnostic Services. We provide diagnostic and therapeutic services
through our Sleep Services of America ('SSA') subsidiary. As of September
30, 2003, this business operated approximately 70 sleep centers in 7 states
and Washington, D.C., principally in the eastern U.S. SSA is dually
accredited by the Joint Commission on Accreditation of Healthcare
Organizations (JCAHO) in Ambulatory and Homecare. SSA has also received
America Academy of Sleep Medicine (AASM) accreditation for select sleep
centers. At these facilities which typically accommodate two patients per
night, we conduct sleep studies to determine whether the patients referred
to us suffer from sleep disorders. If a patient is determined to suffer
from sleep apnea, we can offer follow-up diagnostic and monitoring services
to the patient and may, under certain circumstances, be in a position to
sell our sleep products to the patient. A sleep study is the process of
recording various measurements used to identify different sleep stages and
classify various sleep problems. During sleep testing, the activities that
occur in a patient's body during sleep -- brain waves, muscle movements,
eye movements, breathing through the mouth and nose, snoring, heart rate,
and leg movements are monitored by small electrodes and sensors applied to
the patient. These functions can be normal while the individual is awake,
but abnormal during sleep. All of this information is transmitted from the
equipment being worn to a special recorder, which saves these measurements
for technicians to analyze. The referring physician receives a sleep report
which includes a physician interpretation of the data and a diagnosis of
the sleep-related problem, if any.

Ventilation Products

Ventilators are electromechanical devices used to assist a patient with
respiratory problems. We have designed our systems for use in a clinical
setting or at home. Our Breas PV501'TM' is designed for a patient requiring
twenty-four hour home care ventilation. Our Breas PV403'TM' pressure
support/volume control ventilator offers clinicians and patients a choice
of pressure support, pressure control, volume control and synchronized
intermittent mandatory ventilation.

PV102'TM' Bi-Level Ventilator. The PV102'TM' is an advanced Bi-Level
ventilator device which allows separate pressure levels for inspiratory and
expiratory phases of each individual breath. Ventilation can be matched to the
patient's own breathing pattern by setting levels which promote more comfortable
and more natural respiratory support. It can also be operated from an external
battery, so that it can be used during transportation and traveling.

PV403'TM' Mixed Lifesupport Ventilator. The PV403'TM' ventilator supports
the ventilation needs of patients suffering from respiratory insufficiency
diseases. Patients benefiting from the PV403'TM' may suffer from neuromuscular
(Duchene's), or other restrictive or obstructed diseases. The PV403'TM' is an
advanced mixed homecare ventilator which can provide both volume and pressure
ventilation. It has various settings that makes it very flexible to a broad band
of applications. It has both internal and external battery capability and are
well suited to be used in transport and traveling.

PV501'TM' Lifesupport Ventilator. The PV501'TM' is a fully functioning
volume ventilator. This life-sustaining device may be used on home ventilator
patients as well as the less acute, longer term ventilator patients that remain
inside a hospital. This ventilator is a cost effective alternative to the rather
narrow range of competitive products currently available in this field.

PHARMACEUTICAL TECHNOLOGY SERVICES

We deliver technology services to FDA regulated companies primarily in the
pharmaceutical sector. In addition, we also provide services from time to time
to medical device, diagnostic and biotechnology companies. We advise clients by
helping them establish and monitor processes designed to satisfy their
regulatory requirements set forth by the FDA. We also assist clients in creating
complete sets of documentation required by the regulations. Our focus has been
in the areas of development and validation of systems and processes used in the
manufacturing, information technology and infrastructure, research and
development, laboratory and quality assurance departments of our clients.

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As of September 30, 2003 our staff consisted of 112 professionals and our
range of consulting services includes computer systems validation, process
validation, equipment qualification, development and implementation of quality
control programs, regulatory auditing, development of software for regulated
environments, and customized training programs.

MARKET DATA

The following table sets forth, for each of the past three fiscal years, the
dollar amount and approximate percentage of total net revenue represented by our
four business segments: anesthesia, respiratory/critical care, sleep and our
pharmaceutical technology services:

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(1) Reflects an adjustment made during the second quarter of fiscal 2003. See
'Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Critical Accounting Principles and Estimates'.

(2) 'Other' relates primarily to one-time licensing revenue recorded in the
first quarter of fiscal 2002 in the anesthesia business segment. Income from
continuing operations related to this one-time licensing revenue was
$1,439,000 before taxes ($953,000 after taxes).

For additional information regarding these segments, see Note 21 to the
Consolidated Financial Statements.

SALES, MARKETING AND CUSTOMERS

U.S. SALES

We sell our anesthesia and respiratory/critical care products to hospitals
and surgery centers in the U.S. through our own sales force, which is led by our
Vice President of Sales. As of September 30, 2003, our U.S. sales force
consisted of:

57 sales representatives;

five regional sales managers;

one sales manager for pre-hospital sales; and

18 independent representatives for home care sales.

We market our anesthesia and respiratory/critical care products primarily to
hospitals and other health care providers. While we utilize national
distributors to deliver a portion of our anesthesia and respiratory/critical
care products in the U.S., the end-user hospitals and other health care
providers determine the channel through which they receive our products, either
directly from us or through a distributor of their choice. See Note 20 to the
Consolidated Financial Statements.

Many of our customers are members of group purchasing organizations. Group
purchasing organizations provide their members access to discounted prices on
products by negotiating discounts with manufacturers like us. Unlike
distributors, group purchasing organizations do not themselves make purchases,
carry inventory or physically handle product. We have agreements with several
leading group

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purchasing organizations, including AmeriNet, Broadlane, Consorta, Healthsouth,
Healthtrust, MedAssets (HSCA), Novation, and Premier. Our strategy is to more
fully penetrate our existing Group Purchasing Agreements and secure additional
agreements. Our U.S. sales force is aligned into teams geographically in order
to focus our efforts on sales penetration of regional shareholders of the Group
Purchasing Organizations.

In July 2003, we were awarded a three-year competitively bid dual-source
supply agreement with the group purchasing division of Premier, Inc., Chicago,
IL. The agreement, effective August 1, 2003, includes our anesthesia breathing
systems and breathing bags, face masks, filters and HCH (Hygroscopic Condensed
Humidifier), airways and gas sampling lines. Premier is a leading healthcare
alliance, collectively owned by more than 200 independent hospitals and
healthcare systems in the United States, which are affiliated with nearly 1,500
hospitals and other healthcare sites, offering group purchasing supply chain and
performance improvement services to nearly 1,500 member not for profit
hospitals. In 2002, contracted purchases by Premier members for all industry
wide products and services exceeded $17 billion.

Also in July 2003, we were awarded two three-year dual-source supply
agreements with AmeriNet, St. Louis, MO. The new agreements include our
anesthesia breathing systems, face masks, arterial blood gas kits, disposable
resuscitators, filters, HCH (Hygroscopic Condenser Humidifiers) and gas sampling
lines. AmeriNet represents more than 18,500 member facilities, including
hospitals, integrated delivery networks, long-term care facilities, surgery
centers, clinics, home care and emergency services. In 2002, contracted
purchases by members for all industry wide products and services exceeded $5.6
billion.

Again in July 2003, we were award a supply agreement with Novation, the
supply chain management company based in Irving, TX. This is Vital Signs' first
supply agreement with Novation. The agreement, effective June 1, 2003 for three
years with the option of Novation to extend for up to an additional two years
includes Vital Signs' HEPA filters, bacterial/viral filters, pulmonary function
filters and related accessories. Novation serves the purchasing needs of more
than 2,300 VHA Inc. and UHC (University HealthSystem Consortium) members, made
up of community-based hospitals and academic medical centers. Novation
agreements are also available to HealthCare Purchasing Partners International
(HPPI) who serve more than 5,400 members and clients. Novation managed more than
$21 billion in annual purchases for VHA, UHC and HPPI members in 2002.

As new products which can be sold by our U.S. sales force are developed, we
educate and train our sales force in the need, use, application and advantages
of our products. We also hold quarterly training sessions for all of our sales
people and conduct additional training as we deem appropriate.

As of September 30, 2003, our Sleep Services of America subsidiary had 5
sales people, each of whom supports a specific geographic region and is
responsible for maintaining relationships with existing hospital accounts,
assisting in the opening of new sleep centers and building occupancy at existing
sleep centers. We intend to continue to grow this business through initiatives
including the opening of new sleep laboratories, increasing utilization of
existing laboratories and continuing education to the community.

As of September 30, 2003, our Stelex subsidiary had a team of six sales
account managers, one sales manager, two marketing support personnel, and one
director of business development for our pharmaceutical technology service. Our
pharmaceutical technology services sales team is responsible for obtaining new
business in the continental U.S. and Puerto Rico. Our regulatory consulting team
calls on pharmaceutical and medical device companies regarding compliance with
FDA regulations. As of September 30, 2003, we also employed three sales people
to promote the video technology developed in the vioWorks'TM' division of our
Stelex subsidiary. Our vioWorks'TM' sales team sells online meetings,
presentation and multi-media conferencing via the Internet primarily to
pharmaceutical and medical device companies which are seeking to train their
sales forces and service organizations.

INTERNATIONAL SALES

For fiscal 2003, 2002 and 2001, international sales of $45.3 million, $38.3
million and $35.9 million, respectively, accounted for approximately 25%, 22%
and 22%, respectively, of our revenue. Our products are sold in over 55
countries worldwide. International net sales for our anesthesia and

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respiratory/critical care products for fiscal 2003, 2002 and 2001 were $18.8
million, $15.9 million, and $18.3 million, respectively. We sell our anesthesia
and respiratory/critical care products in European and other international
markets primarily through a strategic alliance with Rusch GmbH, a manufacturer
of medical devices. In October 2002, we entered an exclusive multi-year
strategic alliance and distribution agreement with Rusch International, to
distribute Vital Signs anesthesia, respiratory and critical care products in
those countries where Rusch has a direct sales force in the healthcare market.
Rusch represents us in 10 countries. We view this alliance as an alternative to
our historic approach of relying upon local distributors to sell anesthesia and
respiratory/critical care products in foreign countries. In the United Kingdom,
we have a sales manager and a direct sales force, which, as of September 30,
2003, consisted of six people. Our sleep/personal ventilation products are sold
internationally through Breas' direct sales force, which calls on home health
care distributors in France, Germany, Scandinavia, Spain and the United Kingdom,
and through an independent distribution network in other countries. As of
September 30, 2003, the Breas direct sales force consisted of 46 people.
International net sales for Breas for fiscal 2003, 2002, and 2001 were $26.5
million, $22.7 million, and $17.6 million, respectively.

MARKETING

Our marketing staff, which as of September 30, 2003 consisted of 13 people,
works closely with our sales forces, collects and analyzes customer responses to
new and existing products, participates in our product development program and
assists in product training. In addition, our marketing staff develops and helps
implement various internal and external promotional activities.

RESEARCH AND DEVELOPMENT

We believe that product development and innovation is an essential part of
our overall success. As of September 30, 2003, we employed 38 engineers,
scientists and technicians who are principally engaged in research and
development activities. We supplement their efforts with outside consultants
from time to time. The principal focus of our research and development
activities is to develop product solutions for health care problems,
specifically in the areas of anesthesia, respiratory/critical care and sleep.

We incorporate technical, manufacturing, operations, sales and marketing,
and clinical expertise within our research and development processes. Our
research and development staff works with health care providers to develop an
in-depth understanding of, and to be responsive to, product applications and
clinical needs, and works with our sales and marketing teams to better
understand industry trends. We believe that we are often able to reduce the
costs associated with new product development by utilizing our in-house
manufacturing capabilities to rapidly produce quantities of prototype products
suitable for trial use and sale.

In July 2003 we commenced a clinical study of the safety, efficacy and
benefits of our T-Wall'TM' Tube for airway management of premature infants. The
study will be conducted at the Children's Hospital of New York, part of the
Columbia-Presbyterian health network. The ultra-thin walled endotracheal tube,
T-Wall'TM' Tube, is an FDA 510(k) cleared device and is an integral part of a
low- resistance, low-dead space breathing system for use with neonates who
require mechanically assisted ventilation.

We expect to continue to rely principally on our internal staff to perform
research and development in our primary areas of expertise. Our research and
development expenses aggregated $5,871,000, $6,615,000 and $6,937,000 for fiscal
2003, 2002 and 2001, respectively.

PRODUCT LIABILITY EXPOSURE

We are exposed to potential product liability resulting from the use of our
products. We presently maintain product liability insurance coverage of
$20,000,000 in the aggregate. Our product liability policy generally protects us
against claims of bodily injury or property damage arising out of any products
manufactured, sold or distributed by us. If a judgment in a product liability
suit were entered against us or we entered into a settlement agreement in excess
of a policy limit or outside the scope of coverage, including for example,
punitive damages, our profitability and financial condition may be

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impacted significantly. We cannot assure you that our current level of insurance
will be sufficient to cover product liability claims or that such coverage will
remain available to us on satisfactory terms, if at all.

MANUFACTURING AND QUALITY CONTROL

We manufacture most of our products. Our manufacturing processes and systems
have allowed us to provide quality products, to react quickly to changes in
demand and to generate manufacturing efficiencies. We purchase resins, our
primary raw material used in a variety of our anesthesia and respiratory
products, in bulk. We believe that these capabilities allow us to contain costs,
control quality and maintain security of proprietary processes. For certain
products, our manufacturing function consists principally of assembling and
packaging components that we purchase from others. We continually evaluate our
manufacturing processes, with the objective of increasing automation,
streamlining production and enhancing efficiency in order to achieve cost
savings and improve quality.

We manufacture anesthesia breathing circuits, filters, blood pressure cuffs,
pressure infusors, arterial blood gas syringes, heated humidification circuits,
nebulizers, manual resuscitators, introducers, sleep therapy products and
ventilators. We perform tube extrusion, injection molding, radio frequency
welding, product assembly, product testing, packaging and distribution. In some
instances, plastic components incorporated in certain products are molded to our
specifications by outside custom injection molders who utilize molds that are
designed and, in most instances, owned by us. Our suppliers typically are
presented with written specifications to assure that components are manufactured
in conformity with our design.

As many of our products are utilized within the operating rooms and critical
care units of hospitals, we conduct quality control testing in all of our
facilities. Our quality systems are designed to meet the FDA's Quality Systems
Regulation. We are required to maintain records of all raw materials received
and used in the manufacturing process along with complete histories of all
devices manufactured. In order to distribute in Europe, our Quality Systems have
been certified to be in compliance with ISO 9001, EN46001 and ISO 13485
standards.

SIGNIFICANT SUPPLIERS

In 1980, we acquired the rights to our air-filled cushion anesthesia face
mask through a collaboration arrangement with Respironics, Inc. ('Respironics').
Face masks are used in a variety of our circuits and are sold individually to
customers. We purchase our face masks from Respironics, a single source which
manufactures the face mask in the People's Republic of China. Our supply
agreement with Respironics requires Respironics to supply air-filled cushion
face masks of various specifications to us on an exclusive basis for anesthesia
purposes, and obligates us to purchase all of our anesthesia face masks from
Respironics as long as Respironics is the low cost supplier. We have had a
series of supply agreements with Respironics for many years. The current supply
agreement with Respironics was renewed in 1999 to extend its term until 2006,
with an additional option to further extend the term of the agreement through
2011, providing us with a secure supplier relationship on this key product.

If the supply of face masks from Respironics should be interrupted for any
reason, we would seek to find alternative suppliers of face masks. In such
event, we may experience disruption in our business. No assurance can be given
that, in the event of such an interruption or cessation, we could, in fact,
maintain our required supply of face masks in a quantity and at a cost that
would not have a material adverse effect on our business and operating results.
Our policy is to maintain a stock of face masks in the United States to lessen
the impact of any temporary production or supply disruption.

SALES BACKLOG

Our objective is to ship all orders within relatively short time frames,
therefore, backlog is not significant to our business.

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COMPETITION

The markets in which we do business are highly competitive. The principal
bases for competition in our markets include product features, price, quality,
customer service, performance, market reputation, breadth of product offerings
and effectiveness of sales and marketing. We believe that our products compete
favorably with respect to these factors.

We compete on a product-by-product basis with various companies, many of
which have greater financial and marketing resources, broader product lines or
both. Our primary competitors in each of our product and service categories are
the following entities and their affiliates.

REGULATION

MEDICAL DEVICE REGULATION

As a manufacturer of medical devices, we are subject to regulation by, among
other governmental entities, the FDA and the corresponding agencies of the
states and foreign countries in which we sell our products. We must comply with
a variety of regulations, including the Quality System Regulations of the FDA,
and are subject to periodic inspections by the FDA and applicable state and
foreign agencies. Enforcement of the Quality System Regulations has increased
significantly in recent years, and the FDA has publicly stated that compliance
will be more strictly scrutinized. If the FDA believes that its regulations have
not been fulfilled, it may invoke extensive enforcement powers. Noncompliance
with applicable requirements can result in, among other things, warning letters,
fines, injunctions, civil penalties, recall or seizure of products, total or
partial suspension of production, failure to receive pre-market clearances or
approvals, withdrawal of approvals and criminal prosecution. The FDA also has
the authority to require recall, repair, replacement or refund of the cost of
any device manufactured or distributed by us.

Medical devices are classified by the FDA into three classes that determine
the degree of regulatory control to which the manufacturer of the device is
subject, Class I being the least stringent and Class III being the most
stringent. Class I devices are subject to general controls, including reporting
certain types of device-related events to the FDA, labeling and adherence to the
Quality System Regulations. Class II devices are generally subject to general
and special controls including

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Section 510(k) clearance, performance standards, postmarket surveillance,
patient registries and FDA guidelines. Class III devices are those which must
receive pre-market approval by the FDA to ensure their safety and efficacy, such
devices include life-sustaining, life-supporting and certain implantable
devices, or new devices which have not been found to be substantially equivalent
to legally marketed Class I or Class II devices. The pre-market approval process
may take several years and requires the submission of extensive performance and
clinical information.

We believe that most of our products are either Class I or Class II
products. However, some of the devices manufactured by our Thomas Medical
Products subsidiary are Class III devices which are used for arterial closure
following angiography, angioplasty or stenting. Also some of our products in
development for use by patients with congestive heart failure may be classified
as Class III and, therefore, may be subject to the time-consuming and expensive
pre-market approval process. Many new medical devices, including most of our
products, and some modifications to existing medical devices, are subject to a
pre-market notification process pursuant to Section 510(k) of the Federal Food,
Drug, and Cosmetic Act. Furthermore, current FDA enforcement policy prohibits
the marketing of approved or cleared medical devices for unapproved or uncleared
uses. We cannot assure investors that we will be able to identify each
circumstance in which compliance with the pre-market notification process is
required.

After clearance or approval is given, the FDA or foreign regulatory agencies
may withdraw clearances or approvals or require us to change the device or its
manufacturing process or labeling, to supply additional proof of its safety and
effectiveness or to recall, repair, replace or refund the cost of the medical
device. The process of obtaining clearances or approvals to market products can
be costly and time consuming and can delay the marketing and sale of our
products.

Federal, state and foreign regulations regarding the manufacture and sale of
medical devices are subject to change. In the future, we cannot predict what
impact, if any, such changes might have on our business.

International sales of medical devices are subject to foreign government
regulations, which vary substantially from country to country. The time required
to obtain approval by a foreign country may be longer or shorter than that
required for FDA approval, and the requirements may differ significantly.

The European Union has adopted legislation, in the form of directives to be
implemented in each member state, concerning the regulation of medical devices
within the European Union. The directives include, among others, the Medical
Device Directive that establishes standards for regulating the design,
manufacture, clinical trials, labeling, and adverse event reporting for medical
devices. Under the Medical Device Directive, a Competent Authority is nominated
by the government of each member state to monitor and ensure compliance with the
Directive. The Competent Authority of each member state then nominates a
Notified Body to oversee the conformity assessment procedures set forth in the
Directive, under which manufacturers demonstrate that their devices comply with
the requirements of the Directive and are entitled to bear the 'CE' marking.
'CE' is an abbreviation for Conformite Europeene, or European Conformity, and
the CE marking, when placed on a product, indicates compliance with the
requirements of the applicable directive. Medical devices properly bearing the
CE marking may be commercially distributed throughout the European Union. We
have approval to affix the CE marking on all our major product lines. As new
products are introduced, we intend to take steps to gain approval for CE
marking. While no additional premarket approvals in individual European Union
countries are required prior to marketing of a device bearing the CE mark,
practical complications with respect to marketing introduction may occur. For
example, differences among countries have arisen with regard to labeling
requirements. Failure to maintain the CE mark will preclude us from selling our
products in the European Union.

Canada requires device manufacturers to obtain licenses for their products.
To obtain these licenses, the manufacturer's quality systems must be audited by
a Canadian approved third party and the manufacturer must obtain a certification
to CAN/CSA ISO-13485-98. Failure to obtain and retain these licenses would
preclude us from selling our products into Canada.

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HEALTH CARE REGULATION

As a provider of sleep diagnostic services, we are subject to regulation by
U.S. federal and state authorities aimed at combating fraud and abuse in the
health care industry. The federal government has enacted statutes and
corresponding regulations addressing kickbacks, self-referral, the submission of
false claims for reimbursement and the failure to follow physician
prescriptions. Many states have enacted similar statutes. The federal laws apply
in any case where we may provide a product or service that is reimbursable under
the Medicare or Medicaid programs, or where we are requesting reimbursement from
Medicare or Medicaid.

The federal government is authorized to impose criminal, civil and
administrative penalties on a health care provider who files a false claim for
reimbursement from Medicare or Medicaid. Even where a claim has not been
submitted to Medicare or Medicaid, criminal penalties may be imposed against the
provider if the government can show that the claims constitute mail fraud or
wire fraud. The government has increasingly been applying penalties in a
broadening range of circumstances, for example, in instances where reimbursement
has been made or sought for medically unnecessary services or for services that
fall below clinical standards for quality care.

The federal anti-kickback law prohibits the offering, solicitation, payment
or receipt of anything of value which is intended to induce the referral of
Medicare or Medicaid patients, or to induce the ordering of items or services
that are reimbursable under those programs. The federal anti-kickback law has
been interpreted to apply where one purpose of an arrangement is to induce
referrals -- it need not be the primary purpose of the arrangement. Arrangements
that meet certain so-called 'safe harbors' are deemed not to violate the federal
anti-kickback law; but the failure of a particular arrangement to meet a safe
harbor also does not necessarily mean that such an arrangement is illegal per
se.

The federal self-referral law, commonly referred to as the Stark Law,
prohibits a physician from referring a patient to another health care provider
for certain designated health products and services reimbursable by Medicare or
Medicaid including durable medical equipment -- if the referring physician has a
financial relationship with that provider. 'Financial relationship' has been
broadly defined in the applicable regulations to include both direct and
indirect relationships, and includes both ownership interests and compensation
as forms of financial relationships. As with the federal anti-kickback law's
safe harbors, the Stark Law and its regulations exclude certain arrangements
from the general prohibition, provided that specific criteria applicable to each
arrangement are met.

Our ability to sell our Breas products in our sleep centers is restricted by
strict federal regulations which prohibit us from diverging from a physician's
prescription. If a physician prescribes a continuous positive airway pressure
product other than a Breas product for a patient at one of our sleep centers, we
are prohibited by federal regulations from substituting a Breas product.

The penalties for violating these federal laws include criminal sanctions
and fines including treble damages and civil and administrative penalties, which
may include, but not be limited to, exclusion from the Medicare and Medicaid
programs, and the requirement to repay to the federal government any
reimbursement the provider has received in violation of the law.

Many states have enacted laws similar to the federal fraud and abuse laws.
There is a great degree of variability among these states in terms of the
applicability and requirements of each of their laws. For instance, some states'
laws are applicable only to services or products reimbursable under Medicaid,
while others' apply to all health care services regardless of the source of
payment. By way of further example, some states do not prohibit referrals to a
provider with which the referring physician has a financial relationship, but
only require that the patient be informed of the relationship before the
referral is made.

PRIVACY REGULATION

Certain of our business activities require that we collect and/or use
information about individuals and their medical conditions. As a result, we are
subject to regulations by both U.S. and foreign authorities intended to protect
the privacy of those individuals by requiring that we maintain the
confidentiality of their information.

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In 1996, the U.S. Congress enacted the Health Insurance Portability and
Accountability Act, which mandated, among other things, the promulgation of
regulations to address the privacy of health information and to reduce many of
the costs and administrative burdens of the health care industry. These
regulations have been developed by the U.S. Department of Health and Human
Services, and address three general areas: standardization of electronic
transactions, security of health information systems, and privacy of protected
health information. Collectively, these regulations are intended to establish
federal standards concerning the use, disclosure and protection of health
information which, by its nature, can be linked to specific individuals. In
addition to limited access to protected health information of our employees, our
SSA subsidiary collects protected health information of its clients.

In addition, the Health Insurance Portability and Accountability Act calls
for civil and criminal fines and penalties for the improper use and disclosure
of individually identifiable health information. The regulations continue to
evolve as the U.S. Department of Health and Human Services continues to receive
public comment and revise certain of the regulations, most notably those
addressing privacy. There is no meaningful history of enforcement efforts by the
federal government at this time. It is therefore not possible to ascertain the
likelihood of enforcement efforts in connection with the Health Insurance
Portability and Accountability Act regulations or the potential fines and
penalties that may result from the violation thereof.

Foreign governments are increasingly addressing concerns related to the
privacy of information collected about their citizens with laws and regulations
designed to protect the confidentiality of such information.

In addition, we are also subject to numerous federal, state and local laws
relating to such matters as safe working conditions, environmental protection
and fire hazard control. We cannot assure investors that we will not be required
to incur significant expenses to comply with such laws and regulations in the
future.

THIRD PARTY REIMBURSEMENT

The cost of medical care in the U.S. and many other countries is funded
substantially by government and private insurance programs. Although we do not
generally receive payment for our products or services directly from these
payors other than in connection with our sleep diagnostic services, our
continued success is dependent upon the ability of patients, hospitals and home
care distributors to obtain adequate reimbursement for our products and sleep
services. In most major markets, our products are purchased primarily by
hospitals, which are generally either government funded or which invoice
third-party payors directly, or otherwise invoice patients, who then seek
reimbursement from third-party payors. Other than our direct to hospital sales
and our sleep diagnostic services and any resulting sales of continuous positive
airway pressure equipment, our remaining sales are to distributors and
manufacturers of other medical products, who then sell to these customers. When
we provide sleep diagnostic services in our own sleep centers, patients are
generally covered by private insurance. In those instances, the patient is
responsible for his/her co-payment portion of the fee and we invoice the
patient's insurance company for the balance. In hospitals, we contract with the
hospital on a 'fee for service' basis and the hospital assumes the risk of
billing.

In the U.S., third-party payors include Medicare, Medicaid and private
health insurance providers. These payors may deny reimbursement if they
determine that a device has not received appropriate FDA clearance, is not used
in accordance with approved applications, or is experimental, medically
unnecessary or inappropriate. Third-party payors are also increasingly
challenging prices charged for medical products and services, and certain
private insurers have initiated reimbursement systems designed to reduce health
care costs. The trend towards managed health care and the growth of health
maintenance organizations, which control and significantly influence the
purchase of health care services and products, as well as ongoing legislative
proposals to reform health care, may all result in lower prices for our products
and services. We cannot assure you that our products and services will be
considered cost-effective by third-party payors, that reimbursement will be
available or continue to be available, or that payors' reimbursement policies
will not adversely affect our ability to sell our products and services on a
profitable basis, if at all.

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INTELLECTUAL PROPERTY

We primarily rely upon trade secrets and continuing technological
innovations to develop and maintain our competitive position. However, where
appropriate, we seek patent protection for inventions that we believe give our
products a competitive advantage. When deemed appropriate, we have enforced and
plan to continue to enforce and defend our patent rights. In an effort to
protect our trade secrets, we require certain employees, consultants and
advisors to execute proprietary information and invention assignment agreements
upon commencement of employment or consulting relationships with us.

Some of our patents relate to significant technologies that are utilized in
our anesthesia, respiratory/critical care and sleep therapy product lines. Our
ongoing success depends in part on our ability to maintain our patents, obtain
new patents, and develop new products and applications without infringing the
patent and other proprietary rights of third parties. There has been substantial
litigation involving the intellectual property rights of medical device
manufacturers. We have been involved in several such proceedings, often at
significant expense to us. We cannot assure you that any of our patents will not
be circumvented or challenged, that the rights granted by our patents will
provide competitive advantages or that any of our pending or future patent
applications will be issued with claims of the scope that we seek, if at all. If
challenged, we cannot assure you that our patents will be held valid or
enforceable. We cannot assure you that our products or proprietary rights do not
infringe the rights of third parties. If an infringement were established, we
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 these outcomes could have a material adverse effect on our
business. We may decide not to introduce a product in the United States or a
foreign country based upon the potential risk of patent infringement litigation.

EMPLOYEES

As of September 30, 2003, we had 1,204 full-time employees and 36 part-time
employees. We believe that our relations with our employees are good. None of
our employees are members of unions, although certain employees outside of the
U.S. have statutory benefits comparable to collective bargaining agreements. Our
full-time employees by department as of September 30, 2003 were:

Manufacturing and quality control........................... 652
Sales and marketing......................................... 142
Sleep center technical personnel............................ 170
Regulatory consultants...................................... 112
Research and development.................................... 38
Administration.............................................. 90
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Total................................................... 1,204
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-----

ITEM 2. PROPERTIES

We believe that our properties are adequate for our current needs. In
addition, we believe that adequate space can be obtained to meet our foreseeable
business needs. The following chart identifies the principal properties which we
own or lease.

The properties listed below relate to the anesthesia and
respiratory/critical care business segments, except for the Molnlyke, Sweden and
Glen Burnie, Maryland properties which relate to our sleep segment, and
Bensalem, Pennsylvania which relates to our pharmaceutical technology services
business segment.

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* We own this facility.

ITEM 3. LEGAL PROCEEDINGS

On December 6, 1999, a complaint was filed against us on behalf of the
former shareholders of our Vital Pharma subsidiary alleging breach of contract
for failure to pay earnout payments allegedly due under the stock purchase
agreement executed in connection with our purchase of Vital Pharma in December
1995. We have answered the complaint, filed counter-claims and moved to transfer
the case to arbitration. In August 2000, the court ordered the plaintiff to
submit such claims to binding arbitration and stayed all other proceedings
pending the outcome of the arbitration. The parties are in the final stages of
discovery in the arbitration proceeding. In November 2003, the arbitrator
ordered the parties to complete all outstanding discovery and to be prepared to
begin the hearing on January 6, 2004 and to conclude all hearing dates by the
middle of February 2004.

On May 7, 2003 a complaint was filed against the Company and two of its
officers by Joseph Bourgart, a former chief financial officer of the Company for
the period January 11, 2002 to November 2002. Plaintiff alleges that he was a
'whistleblower' within the meaning of the New Jersey Conscientious Employee
Protection Act, based on allegations of improper accounting practices. Plaintiff
asserts these allegations notwithstanding the fact that, in connection with the
filing of the Company's Quarterly Report on Form 10-Q for the Company's third
quarter of fiscal 2002 (the period ended June 30, 2002), he had executed a
certification pursuant to the Sarbanes-Oxley Act certifying that the Quarterly
Report on Form 10-Q for that period 'fully complies with the requirements of
Section 13(a) of the Securities and Exchange Act of 1934' and that 'the
information contained in the report fairly presents, in all material respects,
the consolidated financial condition of the Company...'. Furthermore, as the
Company's chief financial officer, Plaintiff signed the Company's Quarterly
Reports on Form 10-Q for the first quarter and second quarter of fiscal 2002
(ended December 31, 2001 and March 31, 2002, respectively). Less than one month
before Plaintiff's resignation, he participated in a meeting with the Company's
worldwide management team to review the accuracy of the Company's Annual Report
on form 10-K for the 2002 fiscal year. At that meeting he voiced no objections
to the 10-K, nor did he assert or even suggest that the report contained any
untrue statements or omitted to state any material fact. Of the items enumerated
in the complaint, most had already been reviewed with the Company's independent
accountants and the Company's Audit Committee prior to the Company's filing of
its quarterly report for the third quarter of fiscal 2002. The Company believes
that the filing of the complaint is a retaliatory action by Plaintiff who
voluntarily resigned without any severance payment after being confronted with
evidence of certain unethical and possibly illegal conduct. Nevertheless, in
accordance with the Sarbanes-Oxley Act, the issues raised in the complaint were
referred to the Audit Committee, which conducted its own independent analysis of
those matters.

On December 26, 2003 the Audit Committee reported to the Board of Directors
on the results of its investigation and determined that no evidence of fraud had
been discovered during the course of the investigation. The Audit Committee also
determined that any decision regarding the potential restatement of the
Company's

18

previously published financial statements is to be made by the Company's
management in concurrence with the Company's auditors. However, based upon the
results of the investigation, the Audit Committee does not recommend that any
restatement be made to the Company's previously published financial statements.
The Company is in agreement with the Audit Committee that no restatement is
required.

Additionally, as a result of the investigation the Audit Committee compiled
a list of areas in which the Committee believes the Company needs to improve its
record keeping, documentation, policies, procedures and financial controls. That
report will be delivered to the Board of Directors in the immediate future.
Management has given its commitment to undertake a program to effectuate these
recommendations.

On July 28, 2003 the defendants filed a motion for summary judgement to
dismiss the lawsuit. The motion asserts that Plaintiff resigned after being
confronted with proof of his unethical and possibly illegal conduct; that the
Plaintiff is not a 'whistleblower'; and that the Plaintiff has no basis for his
assertion of impropriety as he repeatedly represented in writing to the
Securities and Exchange Commission and the Company's auditors that the Company's
public filings were true and accurate in all material respects. Inasmuch as
Plaintiff approved and certified the accuracy of the Company's financial
statements to the investing public under penalty of criminal prosecution, the
Company has asserted that no reasonable jury could believe that Plaintiff had
reasonable belief that the Company engaged in improper accounting practices. The
Company strongly denies that it had engaged in improper conduct both as regards
its accounting practices and with regard to its treatment of the Plaintiff.

On May 16, 2003 the Company was served with a complaint answerable in
Belgium by its former distributor. The complaint alleges breach of contract and
seeks damages of 185,040 Euro (representing approximately $222,000 U.S. dollars
based on exchange rates in effect on September 30, 2003). The demand represents
salary and related costs for the distributor's employees associated with selling
the Company's product line and the value of the customer base inherited by the
new distributor. The Company has recorded a reserve for a possible settlement or
loss.

A first amended complaint was filed against the Company's Vital Pharma
subsidiary on September 8, 2003 in the U.S. District Court for the Northern
District of California related to the packaging services it provides to Lifecore
Biomedical, Inc. ('Lifecore'). The complaint asserts multiple theories of
negligence and product liability claims against the defendants for injuries
allegedly sustained through the use of Lifecore's Gynecare Intergel ('Intergel')
product during surgery. Lifecore manufactures the product, which is approved for
the purpose of reducing post-surgical adhesions. The Company's insurance carrier
has responded and has also notified Lifecore of its obligation under its
agreement with Vital Pharma to indemnify it for complaints related to product
defects.

We are also involved in other legal proceedings arising in the ordinary
course of business. We cannot predict the outcome of our legal proceedings with
certainty. However, based upon our review of pending legal proceedings, we do
not believe the ultimate disposition of our pending legal proceedings will be
material to our financial condition. Predictions regarding the impact of pending
legal proceedings constitute forward-looking statements. The actual results and
impact of such proceedings could differ materially from the impact anticipated,
primarily as a result of uncertainties involved in the proof of facts in legal
proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The annual meeting of our shareholders was held on September 29, 2003. At
that meeting, each of the nominees for election to the Board, as identified in
our proxy statement, were elected. The Board of Directors nominated 3 directors
whose terms will expire in 2006 and 2 directors whose terms will expire in 2004.
The nominees whose terms will expire in 2006 are Mr. Bershad, Mr. Dimun, and Mr.
Donnelly.
19

The nominees whose terms will expire in 2004 are Mr. Robbins and Mr. Schapiro.
The following number of shares were voted for and against each nominee.

Additionally, one other proposal was put before the shareholders, relating
to the adoption of a stock investment plan to replace the Company's current
investment plan which expires in January 2004. The proposition passed by a vote
of 7,800,871 shares for; 1,310,580 shares against; 131,844 abstentions; and
571,023 shares not voted by brokers.

ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT

The Company's executive officers are as follows:

- ---------

* As of September 30, 2003.

-------------------

Terry D. Wall founded the Company in 1972 and has been President, Chief
Executive Officer and a director of the Company since that time. He has also
invested in and serves on the board of directors of certain healthcare
businesses'. He received a Bachelor of Science degree in 1963 from the
University of Maryland and a Master of Business Administration degree from Pace
University in 1975. For the foreseeable future, the Company will remain
dependent upon the efforts of Mr. Wall. The Company does not maintain key man
life insurance on Mr. Wall's life.

Mark H. Felix has served as an Executive Vice President of our company since
March 2002, with primary responsibility for global planning. From 1996 to 2002
he held positions of consultant, managing director, chief operating officer, and
chief executive officer for the U.S. operations of Rogen Incorporated, an
international business communications consulting firm. Prior to joining Rogen,
he held a variety of positions in the paper and forest products and banking
industries, having worked for Boise Cascade, Stone Consolidated and Chemical
Bank. He served as a Signals Intelligence Officer in the United States Marine
Corps. He holds BA degrees in Political Science and Psychology from the
University of Rochester and an MSBA from Boston University.

Frederick S. Schiff has served as our Chief Financial Officer since November
2002. Previously he was employed by Bristol-Myers Squibb (a pharmaceutical
company), serving as Senior Vice President and Chief Financial Officer from 2001
to April of 2002; as Senior Vice President, Financial Operations and Controller
from 2000 to 2001; and prior to that as Vice President, Financial Operations and
Controller from 1997 to 2000. He held other financial and accounting positions
within Bristol-Myers Squibb from 1982 to 1997. He holds a BA from New York
University and an MBA from Columbia University. Mr. Schiff is a certified public
accountant licensed in the State of New York.

Joseph J. Thomas has served as a director of the Company and President of
Thomas Medical Products, Inc. ('TMP') since the Company acquired TMP on October
1, 1992. Prior to the acquisition of TMP, Mr. Thomas was President of TMP from
1990 -- 1992. Mr. Thomas was President and General

20

Manager of Access Devices, Inc., (a catheter manufacturer) from 1982 to 1989 and
has held various research and development positions with various companies
including Johnson & Johnson.

Barry Wicker has served as a director and an Executive Vice President of the
Company since 1985 (with primary responsibility for sales and marketing). Mr.
Wicker joined the Company in 1978 as National Sales Manager and became Vice
President -- Sales in 1981. Prior to joining the Company, he held various
marketing and sales positions with The Foregger Co. over a 20 year period.

Each of the Company's executive officers serves as such at the pleasure of
the Board.

21

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

Our Common Stock (the 'Common Stock') is traded in the over-the-counter
market and quoted on the National Market System of the National Association of
Securities Dealers Automated Quotation System ('NASDAQ') under the symbol
'VITL'. The following table sets forth the high and low closing sales prices of
the Common Stock on the NASDAQ National Market System, and the cash dividends
declared per share of Common Stock, for the periods indicated:

As of September 30, 2003, there were approximately 333 holders of record of
the Common Stock. This number of record holders does not represent the actual
number of beneficial owners of shares of our Common Stock because shares are
frequently held in 'street name' by securities dealers and others for the
benefit of individual owners who have the right to vote their shares.

During fiscal 2003, the Company declared and paid cash dividends of $.19 per
share. We expect to continue to pay dividends on our Common Stock. However, the
declaration of dividends is subject to the discretion of our Board of Directors
and will depend upon various factors, including our financial condition, capital
requirements, loan agreement restrictions and earnings, as well as such other
factors as our board may deem relevant.

On November 4, 2003 the Board approved a $0.01 increase in the quarterly
dividend from $.05 per share to $0.06 per share payable on November 25, 2003 to
shareholders of record on November 17, 2003.

The following table gives information about the Company's Common Stock that
may be issued upon the exercise of options, warrants and rights under all of the
Company's existing equity compensation plans as of September 30, 2003, including
the Company's Investment Plan, as amended and restated as of May 30, 2001, 1991
Director Stock Option Plan and 1990 Employee Stock Option Plan, as amended and
restated as of December 1, 1997, and the 2002 Stock Incentive Plan. No warrants
or rights are outstanding under the foregoing plans.

In addition to options granted pursuant to Company benefit plans, the
Company, in fiscal 2003 has granted 102,700 stock options to employees
independent of any such plans. As such, these options represent contractual
commitments by the Company to the individual involved.

22

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data as of and for each of the five years ended
September 30, 2003 has been derived from consolidated financial statements that
have been audited by Goldstein Golub Kessler LLP, independent certified public
accountants. The information set forth below is not necessarily indicative of
the results of future operations and should be read in conjunction with our
consolidated financial statements and the related notes and 'Management's
Discussion and Analysis of Financial Condition and Results of Operations'
appearing elsewhere in this annual report.

Acquisitions occurring during the past five years, including National Sleep
Technologies (acquired in June 2000), Breas Medical AB (acquired from June 1997
through April 2002), HSI Medical Services, Inc. (acquired in January 2002), and
Stelex (acquired in April 2002) have been accounted for as purchases and,
accordingly, are only reflected herein for dates and periods on and after the
respective dates noted above.

In September 2002, our Board of Directors adopted a formal plan to sell our
Vital Pharma, Inc. subsidiary. Accordingly, we have classified the Vital Pharma
business as a discontinued operation. As such, the results of Vital Pharma have
not been included in any of the five years presented in the Selected Financial
Data schedule following. See Note 2 to the Company's Consolidated Financial
Statements. On October 30, 2003, the Company sold its Vital Pharma subsidiary to
Pro-Clinical, Inc. No further gain or loss was recorded on the sale. See Note 2
to the Consolidated Financial Statements.

For additional information regarding the NST, Breas, HSI and Stelex
acquisitions, see 'Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview.'

See Note 1 to the Consolidated Financial Statements for a discussion of the
effect of Statement of Financial Accounting Standards No. 142, 'Goodwill and
Other Intanglible Assets' on the amortization of goodwill and the subsequent
effect on net income.

23

SELECTED FINANCIAL DATA

INCOME STATEMENT DATA:

- ---------

(a) See our consolidated financial statements for a disclosure of the operating
results and of the discontinued operations of Vital Pharma.

24

BALANCE SHEET AND OTHER DATA:

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis of our financial condition and results
of operations should be read together with the 'Selected Consolidated Financial
Data' and our financial statements and the related notes appearing elsewhere in
this Annual Report. This discussion and analysis contains forward-looking
statements that involve risks, uncertainties and assumptions. The actual results
may differ materially from those anticipated in these forward-looking statements
as a result of many factors, including but not limited to those described in
Exhibit 99.1 to this annual report.

OVERVIEW

We are a leading designer, manufacturer and marketer of medical products.
Many of our products are single-patient use airway products. Our products
address the anesthesia and respiratory/critical care markets as well as the
sleep/personal ventilation markets and the pharmaceutical technology services
market. See Note 21 to the financial statements for segment information.

In fiscal 2002, we classified our Vital Pharma business as a discontinued
operation. Accordingly, the results of Vital Pharma are not included in
continuing operations in this 'Management's Discussion and Analysis of Financial
Condition and Results of Operations.' On October 30, 2003, the Company sold its
Vital Pharma subsidiary to Pro-Clinical, Inc. No further gain or loss was
recorded on the sale.

Our net revenue was derived from four business segments as follows during
the periods indicated:

- ---------

(1) Reflects an adjustment made during the second quarter of fiscal 2003. See
'Management's Discussion and Analysis of Financial Condition and Results of
Operations 'Critical Accounting Principles and Estimates.' This rebate
adjustment relates to our anesthesia and respiratory/critical care segment.

(2) 'Other' relates primarily to one-time licensing revenue relating to our
anesthesia segment recorded in the first quarter of fiscal 2002. See
'Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Critical Accounting Principles and Estimates'.

25

The percentage of our net revenue derived from each of our product lines was
as follows during the periods indicated:

We sell our products in over 55 countries worldwide. In the U.S., we sell
most of our anesthesia and respiratory/critical care products primarily to
hospitals using our direct sales force and certain major health care
distributors. Outside of the U.S., most of our anesthesia and
respiratory/critical care sales have been made through a strategic alliance
agreement with a medical device manufacturer, Rusch GmbH. Our sleep/ventilation
products are sold primarily outside of the U.S. through our direct sales force
and country-specific distributors.

We compensate our direct sales force principally though salary and
commission payments, included in selling, general and administrative expenses.
Sales to distributors are made at our established price. When the distributor
provides us with documentation verifying that the product has been shipped to an
end-user that is entitled to a price lower than our established price, we owe
the distributor a rebate equal to the difference between our established price
and the lower price to which that end-user is entitled. The allowance for
rebates is recorded at the time the Company records the revenue for the product
sold to the distributor. We record this sales rebate allowance as a reduction of
gross revenue.

RECENT ACQUISITIONS

As part of our strategic plan to expand significantly into the obstructive
sleep apnea field, we acquired our interests in our Breas Medical AB and Sleep
Services of America subsidiaries through a series of transactions over a period
of several years:

BREAS MEDICAL AB:

During the period from November 1997 through May 1, 2000, we acquired a 53%
ownership stake in Breas for $15.2 million.

On May 2, 2001, we purchased an additional 41% of Breas from two minority
shareholders, for an initial payment of $3.7 million, with an earnout based
on a formula of sales and profits.

The final earnout payment to the two minority shareholders for the
additional 41%, totaling $6.5 million, was made in April 2002.

Our final purchase, amounting to $1.7 million, for the remaining 6% of the
minority interest in Breas was completed in April 2002.

The total purchase price for Breas was approximately $27 million.

We accounted for our equity ownership in Breas under the equity accounting
method for the fiscal year ended September 30, 1998 and for the first eight
months of the following fiscal year. We reported our proportionate share of
Breas' net income of $292,000 in fiscal 1998 and $178,000 in fiscal 1999 in
other income/expense. Once we acquired a controlling position, we included
all of Breas' results in our consolidated financial statements for the four
months ended September 30, 1999, consisting of net revenue of $4.9 million
and income before minority interest of $458,000, and for all subsequent
periods. The portion of Breas that we did not own was recorded as a
minority interest, reducing our net income for each reporting period.

26

As part of the settlement of the earnout agreement with one of the minority
shareholders, who was also the former chief executive officer of Breas,
Breas acquired the former chief executive officer's ownership interest in
SPRL Percussionaire. The purchase price for that interest is included in
the $6.5 million payment. To complete the purchase of SPRL Percussionaire
additional payments in the form of an earnout agreement were to be made to
the founder of SPRL Percussionaire, and we accrued an amount due of
$1,015,000 in September 2002. In fiscal 2003 Breas entered into a
settlement agreement with the founder of SPRL Percussionaire and terminated
this earnout agreement obligation.

SLEEP SERVICES OF AMERICA:

In June 1998 through May 1999, we purchased $10.4 million of common stock
and convertible preferred stock of National Sleep Technologies, a company
engaged in the operation of diagnostic sleep centers.

In June 2000, we converted our preferred stock into common stock of
National Sleep Technologies; at that point, we owned 84% of the common
stock.

On January 1, 2002, our National Sleep Technologies business was merged
with HSI Medical Services Corporation, a subsidiary of The Johns Hopkins
Health System Corporation, to form Sleep Services of America. No cash was
contributed at that time. Instead, we received a 62% equity interest in
Sleep Services of America, an affiliate of Johns Hopkins Health System
Corporation received a 29% equity interest in Sleep Services of America and
the other minority shareholders of National Sleep Technologies received a
9% interest in Sleep Services of America.

Subsequent to the merger, we paid $600,000 to certain of the minority
shareholders to increase our ownership to 68%, and reduce the minority
ownership to 3%.

Initially, we reported our interest in National Sleep Technologies under
the equity accounting method. As a result, our share of National Sleep
Technologies' losses of $164,000 in fiscal 1998, $437,000 in fiscal 1999,
and $235,000 in fiscal 2000 was included in our other income/expenses for
our fiscal years 1998 and 1999 and for the first eight months of fiscal
2000. When we converted our preferred stock investment into common stock,
we began consolidating the results of National Sleep Technologies in our
consolidated financial statements. For the four months ended September 30,
2000, and the fiscal years ended September 30, 2001 and 2002, this business
produced $4.2 million, $12.8 million, and $16.4 million in net revenue,
respectively, and $443,000, $589,000 and $742,000 of net income,
respectively, all of which was included in our results of operations. The
portion of Sleep Services of America not owned by us is recorded as a
minority interest. See 'Results of Operations' for fiscal 2003 and 2002
revenue and operating income information.

STELEX-TVG:

On March 28, 2002, we acquired Stelex Inc. for $13.3 million in cash.
Stelex was a private company which, like our subsidiary, The Validation
Group, Inc., was engaged in regulatory compliance counseling. We structured
the transaction as a merger of Stelex into The Validation Group, renamed the
surviving corporation Stelex -- The Validation Group, Inc. and accounted for
the transaction as a purchase. The subsidiary now operates under the name
Stelex, Inc.

CRITICAL ACCOUNTING PRINCIPLES AND ESTIMATES

We have identified the following critical accounting principles that affect
the more significant judgments and estimates used in the preparation of our
consolidated financial statements. The preparation of our consolidated financial
statements in conformity with generally accepted accounting principles requires
us to make estimates and judgments that affect our reported amounts of assets
and liabilities, revenues and expenses, and related disclosures of contingent
assets and liabilities. On an ongoing basis, we evaluate our estimates,
including those related to asset impairment, revenue recognition, allowance for
doubtful accounts, and contingencies and litigation. We state these

27

accounting policies in the notes to our consolidated financial statements and at
relevant places in this discussion and analysis. These estimates are based on
the information that is currently available to us and on various other
assumptions that we believe to be reasonable under the circumstances. Actual
results could vary from these estimates under different assumptions or
conditions.

We believe that the following critical accounting principles affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements:

Through September 30, 2001, we amortized goodwill and intangibles on a
straight-line basis over their estimated lives. Upon our adoption of SFAS
No. 142 on October 1, 2001, we ceased amortizing goodwill and we perform an
annual impairment analysis based upon discounted cash flows to assess the
recoverability of the goodwill, in accordance with the provisions of SFAS
No. 142. We completed this impairment test during the three month period
ended March 31, 2003 and found no impairment. If we are required to record
impairment charges in the future, it would have an adverse impact on our
results of operations and financial condition.

We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments,
which results in bad debt expense. Our allowance for doubtful accounts was
$919,000 at September 30, 2003 and $638,000 at September 30, 2002. We
determine the adequacy of this allowance by evaluating individual customer
receivables, considering the customer's financial condition and credit
history and analyzing current economic conditions. If the financial
condition of our customers were to deteriorate, resulting in an impairment
of their ability to make payments, additional allowances may be required.

Our sales to U.S. distributors are made at our established price. Each
distributor subsequently provides us with documentation that our products
have been shipped to particular end-users (i.e. particular hospitals). In
general, the end-user is entitled, on a case by case basis, to a price
lower than our established price. Accordingly, we owe the distributor a
rebate -- the difference between the established price and the lower price
to which the end-user is entitled -- upon our receipt of the documentation
from the distributor. At the time that the distributor remits payment to us
for the products purchased, the distributor deducts an amount for the
related rebates.

The allowance for rebates is recorded at the time we record the revenue for
the product shipped to the distributor. The rebate is recorded as sales
allowance reducing gross revenue.

For several years, we utilized an historical moving average to estimate the
allowance for rebates. Based upon a review conducted in connection with our
filing of our Quarterly Report on Form 10Q for the quarter ended March 31,
2003, we concluded that the moving average estimate does not necessarily
result in the appropriate liability due to the distributor. Accordingly, we
have changed our method of estimating rebate claims to record the allowance
for rebates based upon the documentation provided by the distributor
adjusting from estimate to actual at the time of remittance.

We are subject to various claims and legal actions in the ordinary course
of our business. These matters frequently arise in disputes regarding the
rights to intellectual property, where it is difficult to assess the
likelihood of success and even more difficult to assess the probable ranges
of recovery. Although we currently are not aware of any legal proceeding
that is reasonably likely to have a material adverse effect on our
financial position and results of operations, if we become aware of any
such claims against us, we will evaluate the probability of an adverse
outcome and provide accruals for such contingencies as necessary.

We have established an allowance for inventory obsolescence. The allowance
was determined by performing an aging analysis of the inventory; based upon
this review, inventory is stated at the lower of cost (first in, first out
method) or its net realizable value. In the third quarter of fiscal 2003,
the Company wrote-off certain inventory amounting to $647,000. Our
inventory allowance for obsolescence was $981,000 at September 30, 2003 and
$438,000 at September 30, 2002.

Accounting Principles. For information regarding new accounting principles,
see Note 1 of our notes to consolidated financial statements.

28

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain statement
of income data as a percentage of our revenue.

COMPARISON OF RESULTS FOR THE YEAR ENDED SEPTEMBER 30, 2003 TO THE YEAR ENDED
SEPTEMBER 30, 2002

Net Revenue. Total net revenue increased 4.7%, from $174.0 million for the
year ended September 30, 2002 to $182.2 million for the year ended September 30,
2003. Of the 4.7% increase, 2.4% is attributable to favorable foreign exchange
rates. Increased sales volume was partially offset by a $3.3 million adjustment
recorded in the second quarter to the rebate allowance (see Note 1 to the
Consolidated Financial Statements). This rebate allowance adjustment is
attributable to our anesthesia and respiratory/critical care segments. Of our
total revenues, $136.9 million (or 75.1%) were derived from domestic sales and
$45.3 million (or 24.9%) were derived from international sales. Domestic
revenues increased 1.0%, from $135.4 million for the year ended September 30,
2002 to $136.9 million for the year ended September 30, 2003. The 1.0% increase
resulted from increases in our Anesthesia, Sleep and Pharmaceutical Technology
Services segments offsetting declines in our Respiratory/Critical Care segments,
and the above mentioned rebate adjustment (See Note 1 to the Consolidated
Financial Statements). International revenues increased 17.5% (6.1% increase
excluding foreign exchange), from $38.6 million for the year ended September 30,
2002 to $45.3 million for the year ended September 30, 2003, principally from
increased volumes related to our new distribution agreement entered into in
September 2002 with Rusch. Following are the net revenues by business segment
for the year ended September 30, 2003 compared to the year ended September 30,
2002.

REVENUE BY BUSINESS SEGMENT

- ---------

* 'Other' relates primarily to one-time licensing revenue recorded in the first
quarter of fiscal 2002 in the anesthesia business segment. Income from
continuing operations related to this one-time licensing revenue was
$1,439,000 before taxes ($953,000 after taxes).

Sales of anesthesia products increased 5.7% from $71.8 million for the year
ended September 30, 2002 to $75.9 million for the year ended September 30,
2003. This increase was due to volume growth in anesthesia circuits including
our Limb-[th]'TM', a patented anesthesia circuit, which increased 74% to $4.8
million, increased international revenues and increased revenue in our Thomas
Medical Products subsidiary, which increased 13% to $18.7 million. Domestic
sales of anesthesia products increased 3.7%,

29

from $67.3 million for the year ended September 30, 2002 to $69.8 million for
the year ended September 30, 2003, principally due to the aforementioned
Limb-[th]'TM' and Thomas Medical Product increases, offset by the above
mentioned rebate adjustment. International sales of anesthesia products
increased 36.0%, from $4.5 million to $6.1 million, principally from increased
volumes related to our new distribution agreement entered into in September
2002 with Rusch.

Sales of respiratory/critical care products decreased 2.0%, from $46.8
million for the year ended September 30, 2002 to $45.8 million for the year
ended September 30, 2003. This was due primarily to lower domestic sales volumes
which declined 6.3%, from $35.4 million to $33.2 million, due principally to a
highly competitive market. International sales of respiratory/critical care
products increased 12.4% from $11.3 million for the year ended September 30,
2002 to $12.7 million for the year ended September 30, 2003 principally from
increased volumes related to our new distribution agreement entered into in
September 2002 with Rusch.

Our sleep segment revenues increased 15.0% (an increase of 4.1% excluding
favorable foreign exchange), from $39.6 million for the year ended September 30,
2002 to $45.6 million for the year ended September 30, 2003. Sleep Services of
America's revenues increased 10.7% from $16.4 million for the year ended
September 30, 2002 to $18.2 million for the year ended September 30, 2003. This
growth was due primarily to the merger of our National Sleep Technologies
subsidiary with a subsidiary of Johns Hopkins Health System in the second
quarter of fiscal 2002. Our Breas subsidiary increased revenues 18.1% (an
increase of 0.2% excluding favorable foreign exchange) from $23.2 million for
the year ended September 30, 2002 to $27.4 million for the year ended September
30, 2003. Breas' relatively flat revenues resulted from increased competition in
the market place.

Service revenues in the Pharmaceutical Technology Services segment increased
27.7%, from $14.2 million for the year ended September 30, 2002 to $18.1 million
for the year ended September 30, 2003, primarily due to the acquisition of
Stelex Inc, in the second quarter of fiscal 2002.

Cost of Goods Sold and Services Performed. Cost of goods sold and services
performed increased 5.5% from $86.8 million for the year ended September 30,
2002 to $91.6 million for the year ended September 30, 2003.

Cost of goods sold increased 4.4%, from $68.8 million for the year ended
September 30, 2002 to $71.9 million for the year ended September 30, 2003. The
$3.1 million increase results primarily from an increase of approximately $2.3
million at our Breas subsidiary due to foreign exchange rate changes; the
write-off of certain inventory amounting to $1.1 million resulting from our
continuing evaluation of inventory; and $243,000 representing a twelve-month
volume related expense adjustment from a supplier. These increases were
partially offset by approximately $500,000 of savings realized from cost
improvement projects at our New Jersey and Colorado plants.

Cost of services performed increased 9.8%, from $18.0 million for the year
ended September 30, 2002 to $19.7 million for the year ended September 30, 2003,
reflecting the increased pharmaceutical technology outsourcing services achieved
with the acquisition of Stelex Inc. in the second quarter of fiscal 2002 and the
increased volume in sleep services revenue resulting from the merger in the
second quarter of fiscal 2002 of our National Sleep Technologies subsidiary with
the Johns Hopkins Health System subsidiary.

Gross Profit. Our gross profit increased 3.8%, from $87.2 million for the
year ended September 30, 2002 to $90.6 million for the year ended September 30,
2003. Our overall gross profit margin was 49.7% for the year ended September 30,
2003 and 50.1% for the year ended September 30, 2002. In addition to the items
noted above in cost of goods sold and cost of services, the decrease in gross
margin percentage primarily reflects the increase in rebate expense (see Note 1
to the Consolidated Financial Statements); charges for the write off of certain
inventory (see Note 3 to the Consolidated Financial Statements) and, to a lesser
extent, the lower gross margin realized from a change in mix attributable to the
increase in revenues of our Sleep and Pharmaceutical Technology Services
segments, which operate at a lower gross margin. For gross profit information
related to our four segments, refer to Note 21 to the Consolidated Financial
Statements.

30

OPERATING EXPENSES

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 16.1%, from $44.2 million for the year ended
September 30, 2002 to $51.3 million for the year ended September 30, 2003. The
$7.1 million increase primarily reflects $3.0 million associated with additional
employee levels and other expense resulting from the acquisition of Stelex Inc;
an increase of approximately $1.3 million in selling, general and administrative
expenses at our Breas subsidiary due to foreign exchange rate changes; increases
of $1.0 million in business and health insurance costs; $651,000 in accounting
and legal expenses (including $550,000 for accounting and legal expenses
applicable to a complaint filed against the company by a former Chief Financial
Officer of the Company and related matters ((see Note 16 to the Consolidated
Financial Statements)); a $186,000 charge for data processing charges for the
past year; and increased other expense of approximately $824,000, primarily
relating to compensation expense.

Research and Development Expenses. Research and development expenses
decreased by approximately $744,000, or 11.2%, from $6.6 million for the year
ended September 30, 2002 to $5.9 million for the year ended September 30, 2003.

Impairment charge for China operations. During the third quarter of fiscal
2002, the Company recognized an impairment charge of $1,578,000 related
principally to its Chinese distributor based on an evaluation of its business in
China. At that time, the Company believed that it would be able to renegotiate
its agreement with its Chinese distributor to preserve some of its business in
that country. In May of 2003, the Company retained counsel in China to commence
certain legal actions against its distributor in China to collect its
receivable, and in the third quarter of fiscal 2003 wrote-off all amounts due
from this distributor, amounting to $553,000. In September 2003, the Company
received $420,000 in cash from this distributor and the Company is in the
process of receiving certain inventory. Accordingly, in the fourth quarter of
fiscal 2003, the Company recorded that payment as income. See Note 14 to the
Consolidated Financial Statements.

Reversal of litigation accrual. In September 1996, a patent infringement
action was filed in Japan against an OEM medical device distributor in
connection with the sale in Japan of Marquest Medical Products, Inc.'s ABG
syringe product line. In July 1999 the Court indicated at a hearing that, based
on one exhibit submitted by the plaintiff, the Marquest ABG syringe products
appeared to infringe the plaintiff's patent, and requested that the plaintiff
submit an updated proof of damages. In July 1999, plaintiff filed an updated
proof of damages of approximately $6.5 million, plus interest and costs. On June
23, 2000 the Court entered a judgment against the Company's distributor for Yen
336,872,689 ($2,887,645) plus five- percent annual interest. The distributor
(which has patent indemnification protection from the Company's Marquest
subsidiary) appealed the judgement to the Tokyo Supreme Court. On March 28,
2002, the appellate court ruled in favor of the distributor, thereby ending the
litigation and ending the Company's exposure with respect to this proceeding.
The Company reversed the $5,006,000 accrual associated with this litigation
during the year ended September 30, 2002.

Other Expense/(Income) -- Net. Other expense(income) increased $412,000 from
$305,000 for the year ended September 30, 2002 to $717,000 for the year ended
September 30, 2003. This was primarily due to a $322,000 charge relating to the
costs for a discontinued public offering and $151,000 of closure expenses for
Breas sales offices and other increases of $60,000, offset by a reduction of
$121,000 for product contributions to charitable organizations.

OTHER ITEMS

Interest Income and Expense. Interest income increased 2.5%, from $638,000
for the year ended September 30, 2002 to $654,000 during the year ended
September 30, 2003, resulting from increased amount of cash available for
investment, offset by the decrease in available interest rates.

Interest expense increased $731,000, from $179,000 for the year ended
September 30, 2002 to $910,000 during the year ended September 30, 2003. This
was primarily due to $690,000 of interest charges in connection with the IRS
examination of the Company's 1997, 1998 and 1999 Federal Income Tax returns and
$70,000 for the refiling of certain state income tax returns (see Note 18 to the

31

Consolidated Financial Statements). These increases were partially offset by
reduced interest relating to decreased levels of debt.

Provision for Income Taxes. The provision for income tax expense for the
year ended September 30, 2003 and 2002 was $12.8 million and $13.2 million,
reflecting effective tax rates of 39.7% and 33.1% for these periods,
respectively. Included in the provision for the year ended September 30, 2003 is
an additional provision of $1.2 million resulting from an examination, in the
Internal Revenue Service's normal course, of the Company's 1997, 1998 and 1999
Federal income tax returns and an additional incremental tax expense of $297,000
for certain state tax returns for prior periods which have been or are in the
process of being re-filed. The Internal Revenue Service completed its
examination in the fourth quarter of fiscal 2003. See Note 18 to the
Consolidated Financial Statements.

Discontinued Operations. In September 2002, we adopted a formal plan to sell
our Vital Pharma, Inc. subsidiary, a fully integrated contract manufacturer that
utilizes blow-fill-seal technology. Accordingly, effective September 2002 the
results for Vital Pharma have been reclassified as a discontinued operation for
all periods presented. Based upon an appraisal of Vital Pharma's assets and
several non-binding bids received for its Vital Pharma business, the Company
lowered its investment in Vital Pharma to $2,500,000 and expensed an additional
$5,333,000 ($3,402,000 after tax) which is included in discontinued operations.
Consequently, the loss from operations, net of tax benefits, of Vital Pharma for
the year ended September 30, 2003 was $4,968,000, which represents an additional
loss of $3,513,000 over the loss from operations of Vital Pharma of $1,455,000
experienced in the year ended September 30, 2002. On October 30, 2003, the
Company sold its Vital Pharma subsidiary to Pro-Clinical, Inc. No gain or loss
was recorded on the sale.

COMPARISON OF RESULTS FOR THE YEAR ENDED SEPTEMBER 30, 2001 TO THE YEAR ENDED
SEPTEMBER 30, 2002

Net Revenue. Net revenue increased 6.7% from $163.1 million for the fiscal
year ended September 30, 2001 to $174.0 million for the fiscal year ended
September 30, 2002. This increase was primarily due to growth in our anesthesia,
pharmaceutical technology services and sleep businesses.

REVENUE BY BUSINESS SEGMENT

*'Other' relates primarily to one-time licensing revenue recorded in the
first quarter of fiscal 2002 in the anesthesia business segment. Income from
continuing operations related to this one-time licensing revenue was $1,439,000
before taxes ($953,000 after taxes).

Sales of anesthesia products increased 4.0%, from $69.0 million for the
year ended September 30, 2001 to $71.8 million for the year ended September 30,
2002. This increase was due primarily to volume growth in anesthesia circuit
sales (including sales of related products) led by our new anesthesia breathing
circuit, Limb-[th]'TM'.

Sales of respiratory/critical care products decreased 10.4%, from $52.2
million for the year ended September 30, 2001 to $46.8 million for the year
ended September 30, 2002, due primarily to the discontinuance of a product line
and lower international sales.

Sales in our sleep business increased 30.4%, from $30.4 million for the year
ended September 30, 2001 to $39.6 million for the year ended September 30, 2002,
due primarily to growth in sales of continuous positive airway pressure systems
and the merger of National Sleep Technologies with HSI

32

Medical Services, a subsidiary of The Johns Hopkins Health System Corporation,
to form Sleep Services of America, effective January 1, 2002.

Pharmaceutical technology services increased 23.2%, from $11.5 million for
the year ended September 30, 2001 to $14.1 million for the year ended September
30, 2002, primarily due to the acquisition of Stelex.

Cost of Goods Sold and Services Performed. Cost of goods sold increased
7.5%, from $64.0 million for the year ended September 30, 2001 to $68.8 million
for the year ended September 30, 2002. This increase was primarily due to
increased sales volume. Also included in this cost in the year ended September
30, 2002 is a one-time charge of $319,000 for the writedown of certain inventory
relating to our Breas subsidiary.

Cost of services performed increased 27.7%, from $14.1 million for the year
ended September 30, 2001 to $18.0 million for the year ended September 30, 2002,
reflecting increased volume in sleep services revenue resulting from the merger
with HSI, Inc. in January 2002.

Gross Profit. Our gross profit increased 2.5%, from $85.1 million for the
year ended September 30, 2001 to $87.2 million for the year ended September 30,
2002. Our gross profit margin decreased from 52.1% for the year ended September
30, 2001 to 50.1% for the year ended September 30, 2002, resulting from the
growth in our sleep and pharmaceutical technology services businesses, which
realize a lower gross margin, and the writedown amounting to $319,000 of the
carrying value of certain inventory at our Breas subsidiary. For information
regarding the gross profit of each segment, see Note 21 to the Notes to the
Consolidated Financial Statements.

OPERATING EXPENSES

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 7.7%, from $41.1 million for the year ended
September 30, 2001 to $44.2 million for the year ended September 30, 2002. The
increase in such expenses was primarily due to additional headcount resulting
from the merger of National Sleep Technologies with HSI Medical Services and the
acquisition of Stelex Inc.

Research and Development Expenses. Research and development expenses
decreased 4.6%, from $6.9 million for the year ended September 30, 2001 to $6.6
million for the year ended September 30, 2002, due to lower expenditures in our
anesthesia/respiratory business, partially offset by higher expenditures in our
Breas subsidiary.

Impairment and Other Charges (Credits). During the year ended September 30,
2002, we reversed $5.0 million in litigation accruals as a result of the
successful conclusion of a patent infringement suit. This litigation predated
our 1997 acquisition of Marquest. At the time of this acquisition, we were
advised that Marquest had potential liability as the indemnitor of a distributor
which was being sued for patent infringement in Japan. We recorded a sizable
liability at the time of the Marquest acquisition and increased that liability
during the pendency of the litigation as a result of a lower court decision
against us. The accruals were reversed during the quarter ended March 31, 2002
when the Tokyo Supreme Court ruled in favor of our distributor, thereby ending
the legal proceeding.

Offsetting this benefit was an impairment charge of $1,578,000 related
principally to our Chinese subsidiary, based on an evaluation of its business.

During the year ended September 30, 2001, the Company recorded impairment
charges of $2.1 million relating to the writedown of certain investments. These
impairments and other charges (credits) all relate to the Company's anesthesia
and respiratory/critical care business segments.

Goodwill Amortization. We amortized $1,120,000 of goodwill for the fiscal
year ended September 30, 2001. As a result of the adoption of SFAS No. 142, we
did not amortize any goodwill during the year ended September 30, 2002 or
thereafter.

Other (Income) Expense -- Net. Other (income) expense included in operating
income, changed $695,000, or by 178.2% from a net other income of $390,000 for
the year ended September 30, 2001 to a net expense of $305,000 for the year
ended September 30, 2002. Included in the fiscal 2001 operating income amount
was $773,000 relating to an arbitration award in our favor.

33

OTHER ITEMS

Interest Income and Interest Expense. Interest income decreased 34.6%, from
$976,000 during the year ended September 30, 2001 to $638,000 during the year
ended September 30, 2002, reflecting the general reduction experienced in
interest rates. Interest expense decreased 82.6% from $1,028,000 during the year
ended September 30, 2001 to $179,000 during the year ended September 30, 2002
reflecting the payment by Vital Signs, Inc. of debt owed by our subsidiaries.

Provision for Income Taxes. The provision for income tax expense for the
year ended September 30, 2002 was $13.2 million as compared to $9.8 million for
the year ended September 30, 2001, reflecting effective tax rates of 33.1% and
28.7% for these periods, respectively. The increase in the effective tax rate
primarily reflects the reduction of certain tax credits for research and
development, and a lower benefit from our foreign sales corporation.

Discontinued Operations. In September 2002, we adopted a formal plan to sell
our Vital Pharma, Inc. subsidiary, a fully integrated contract manufacturer that
utilizes blow-fill-seal technology. Accordingly, the results for Vital Pharma
have been reclassified as a discontinued operation for all periods presented.
The loss from operations of Vital Pharma for the year ended September 30, 2002
was $1,455,000. The loss from operations of Vital Pharma of $14,267,000
experienced in the year ended September 30, 2001, included the impairment of
assets relating to Vital Pharma's machine division of $12.9 million, net of tax
benefit.

LIQUIDITY AND CAPITAL RESOURCES

Historically, our primary liquidity requirements have been to finance
business acquisitions and to support operations. We have funded these
requirements principally through internally generated cash flow. At September
30, 2003, we had no long-term debt. We have reclassified our Industrial Revenue
Bonds payable of $1,690,000 as a current liability, as we decided to prepay in
full our obligation on these bonds on December 1, 2003 and have done so. We have
a $20 million line of credit with JP Morgan Chase Bank. There were no amounts
outstanding on the JP Morgan Chase Bank line of credit at September 30, 2003.

Vital Signs continues to rely upon cash flows from its operations. During
the year ended September 30, 2003, cash and cash equivalents increased by $26.4
million. Operating activities provided $33.4 million net cash, of which $35.4
million was provided by continuing operations, offset by $1.9 million of cash
used in our discontinued operations at Vital Pharma. Investing activities used
$4.5 million, of which $3.7 million was used for capital expenditures, $518,000
for capitalized software, and $397,000 for capitalized patent costs, and
$186,000 was provided through the sale of available for sale securities.
Financing activities used $4.6 million, consisting of: $2.5 million paid for
dividends; $2.6 million used to repurchase 100,300 shares of the Company's stock
and $265,000 used to pay down debt. These amounts were offset by $746,000 of
cash received upon the exercise of stock options.

Cash and cash equivalents were $55.7 million at September 30, 2003 as
compared to $29.3 million at September 30, 2002 (see Note 1 to the Company's
Consolidated Financial Statements). At September 30, 2003 our working capital
was $98.5 million as compared to $86.6 million at September 30, 2002. At
September 30, 2003 our current ratio was 6.5 to 1, as compared to 7.6 to 1 at
September 30, 2002.

Our capital investments vary from year to year, based in part on capital
demands of newly acquired businesses. Capitalized costs include additions to
property, plant and equipment, as well as capitalized software development costs
and capitalization of patent costs. Capitalized costs were $4.7 million, $3.9
million and $1.9 million during fiscal 2003, 2002 and 2001, respectively. In
fiscal 2003 capitalized costs were approximately $4.7 million, and included
expenditures for equipment used as part of cost improvement projects at our New
Jersey facility ($1.6 million), Colorado facility ($1.5 million), California
facility ($380,000) and Thomas Medical Products facility ($229,000), and the
capitalized costs of software development ($518,000) and patents ($397,000).

We expect that our capitalized costs in the future will depend in part upon
the capital requirements of any businesses that we acquire. We are in the
process of evaluating our information processing capabilities and potential
upgrades or replacements to these systems. Additional capital expenditures

34

will be required for these purposes. Non-capital expenditures related to these
items may also be incurred.

Our current policy is to retain working capital and earnings for use in our
business, subject to the payment of certain cash dividends. Such funds may be
used for product development, product acquisitions and business acquisitions,
among other things. We regularly evaluate and negotiate with domestic and
foreign medical device companies regarding potential business or product line
acquisitions or licensing arrangements.

Our Board of Directors has authorized the expenditure of up to $20 million
for the repurchase of Vital Signs' stock. Through September 30, 2003, we had
repurchased 100,300 shares for $2,583,000, before commissions of $4,000, at an
average price of $25.71. Any purchases under Vital Signs' stock repurchase
program may be made from time-to-time in the open market, through block trades
or otherwise. Depending on market conditions and other factors, these purchases
may be commenced or suspended at any time or from time-to-time without prior
notice.

Our Board of Directors has approved $2.5 million in dividends (amounting to
$.19 per share) in the current fiscal year. On November 4, 2003 the Board
approved a $0.01 increase in the quarterly dividend from $.05 per share to $0.06
per share payable on November 25, 2003 to shareholders of record on November 17,
2003.

We believe that the funds generated from operations, along with our current
working capital position and available bank credit, will be sufficient to
satisfy our capital requirements for at least the next twelve months. This
statement constitutes a forward-looking statement. Our liquidity could be
adversely impacted and our need for capital could materially change if costs are
substantially greater than anticipated, we were to undertake acquisitions
demanding significant capital, operating results were to differ significantly
from recent experience or adverse events were to affect our operations.

At September 30, 2003, 2002 and 2001, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. In addition, we do not engage
in trading activities involving non-exchange traded contracts. As such, we are
not materially exposed to any financing, liquidity, market or credit risk that
could arise if we had engaged in such relationships. We do not have
relationships or transactions with persons or entities that derive benefits from
their non-independent relationship with us or our related parties other than
what is disclosed in Note 22 of Notes to the Consolidated Financial Statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks, including the impact of material price
changes, changes in the market value of our investments, foreign currency
fluctuations and, to a lesser extent, interest rate changes. In the normal
course of business as described below, we employ policies and procedures with
the objective of limiting the impact of market risks on earnings and cash flows
and to lower our overall borrowing costs.

The impact of interest rate changes is not material to our financial
condition. We do not enter into interest rate transactions for speculative
purposes.

Our international net revenue represents approximately 24.9% of our total
net revenues. Our Breas subsidiary, located in Sweden, represents 58.5% of our
total international net revenues. We do not enter into any derivative
transactions, including foreign currency transactions, for speculative purposes.
The Company has not entered into any derivative instruments (i.e. foreign
exchange forward or option contracts) as of September 30, 2003.

Our risk involving price changes relate to raw materials used in our
operations. We are exposed to changes in the prices of resins and latex for the
manufacture of our products. We do not enter into commodity futures or
derivative instrument transactions. Except with respect to our single source of
supply for facemasks, it is our policy to maintain commercial relations with
multiple suppliers and when prices for raw materials rise to attempt to source
alternative supplies.

35

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following audited consolidated financial statements and related report
are set forth in this Annual Report on the following pages:

36

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors
VITAL SIGNS, INC.

We have audited the accompanying consolidated balance sheets of Vital Signs,
Inc. and Subsidiaries as of September 30, 2003 and 2002 and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended September 30, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Vital Signs,
Inc. and Subsidiaries as of September 30, 2003 and 2002 and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2003, in conformity with accounting principles generally accepted
in the United States of America.

GOLDSTEIN GOLUB KESSLER LLP

New York, New York
November 5, 2003, except
for the fourth paragraph
of Note 16, as to which the
date is December 26, 2003.

F-1

VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET

See Notes to Consolidated Financial Statements

F-2

VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME

See Notes to Consolidated Financial Statements

F-3

VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

See Notes to Consolidated Financial Statements

F-4

VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS

See Notes to Consolidated Financial Statements

F-5

NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRINCIPAL BUSINESS
ACTIVITIES

BUSINESS ACTIVITIES

Vital Signs, Inc. ('VSI') and its subsidiaries (collectively the 'Company')
design, manufacture and market single-patient use products for the anesthesia,
respiratory/critical care, and sleep/personal ventilation markets. In addition,
the Company has two subsidiaries that provide services, one for the diagnosis of
sleep disorders through its sleep clinics, and the other for pharmaceutical
technology services.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of VSI and its
majority-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated. For comparability, certain 2002 and 2001 amounts
have been reclassified, where appropriate, to conform to the financial statement
presentation used in 2003.

ACCOUNTS RECEIVABLE

Accounts receivable are reported at their outstanding unpaid principal
balances reduced by an allowance for doubtful accounts. The Company records
allowances based on certain percentages of aged receivables. The percentages are
based on historical payment experience and economic trends. The Company writes
off accounts receivable against the allowance when a balance is determined to be
uncollectible.

INVENTORY

Inventory, net of reserves for obsolete and slow moving goods, are stated at
the lower of cost (first-in, first-out method) or market.

DEPRECIATION

Depreciation and amortization of property, plant and equipment is provided
for by the straight-line method over the estimated useful lives of the related
assets.

INCOME TAXES

Income taxes are based upon amounts included in the Consolidated Statement
of Income. Deferred income taxes represent the tax effect of temporary
differences between the basis of assets and liabilities for income tax and
financial reporting purposes.

REVENUE RECOGNITION

For product sales, revenue is recognized in the same period as title to the
product passes to the customer. For service revenue, revenue is recorded when
the service is performed.

As also noted in Note 20, certain of the Company's sales are made through
national and regional medical supply distributors. During the second quarter of
fiscal 2003, the Company reviewed and adjusted its estimate for rebates due to
distributors. These rebates apply to the Company's anesthesia and
respiratory/critical care segments. As background, the Company's sales to
distributors, which represented 24%, 26%, and 27% of the Company's total revenue
in fiscal years 2003, 2002, and 2001, respectively, are made at the Company's
established price. Each distributor subsequently provides the Company with
documentation that the Company's products have been shipped to particular
end-users (i.e. particular hospitals). In general, the end-user is entitled, on
a case-by-case basis, to a price lower than the Company's established price.
Accordingly, the Company owes the distributor a rebate -- the difference between
the established price and the lower price to which the end user is entitled --
upon the Company's receipt of the documentation from the distributor. At the
time that the distributor remits

F-6

payment to the Company for the products purchased, the distributor deducts an
amount for the related rebates.

The allowance for rebates is recorded at the time the Company records the
revenue for the product shipped to the distributor. The rebate is recorded as a
sales allowance, as a reduction of net revenue.

The Company has, for several years, utilized an historical moving average to
estimate the allowance for rebates. Based on the Company's review in the second
quarter of fiscal 2003, the Company concluded that the moving average estimate
did not necessarily result in the appropriate liability due to the distributor.
Accordingly, the Company changed its method of estimating rebate claims to
record the allowance for rebates based upon the documentation provided by the
distributor of the shipments to the end-user (adjusting from estimate to actual
at the time of remittance), as well as estimates for inventory not yet sold by
the distributor. As a result of its review of the rebate allowance, the Company
recorded an additional allowance for rebates of $3,300,000 in the second quarter
of fiscal 2003 to assure that the Company has established an appropriate
allowance for rebate claims.

Rebates were $44.4 million in fiscal 2003 (including the $3.3 million
adjustment), $36.9 million in fiscal 2002, and $34.2 million in fiscal 2001.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets arising from business acquisitions are
accounted for under the purchase method of accounting, and are accounted for
under the Statement of Financial Accounting Standards ('SFAS') No. 142,
'Goodwill and Other Intangible Assets', which eliminated the amortization of
goodwill and certain other intangible assets for fiscal years beginning after
December 15, 2001. SFAS 142 was adopted by the Company, effective October 1,
2001. Prior year financial results included goodwill amortization, amortized
over periods up to 40 years using the straight-line method.

The following table presents what net income would have been had SFAS 142
been adopted in prior periods:

The Company reviews the carrying value of long-lived assets, including
goodwill, on a periodic basis, or whenever events or changes in circumstances
indicate that the amounts may not be recoverable. If the events or circumstances
indicate that the carrying amount of an asset may not be recoverable, the
Company estimates the future undiscounted cash flows expected to result from the
use of the asset and its eventual disposition. An impairment loss will be
recognized if the carrying value of the assets exceeds the estimated future
undiscounted cash flows of those assets.

The Company performs an annual impairment analysis based upon discounted
cash flows to assess the recoverability of the goodwill, in accordance with the
provisions of SFAS No. 142. The Company completed this annual impairment test
during the three-month period ended March 31, 2003 and found no impairment.

F-7

Goodwill consists of the following:

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. The Company believes it is
not exposed to any significant credit risk with respect to its highly liquid
investments in money market securities and its commercial banking facilities.

NET INCOME PER SHARE OF COMMON STOCK

Basic net income per common share is computed using the weighted average
number of shares outstanding. Diluted net income per common share is computed
using the weighted average number of shares outstanding adjusted for the
incremental shares attributed to outstanding options to purchase common stock.

The following table sets forth the computation of basic and diluted net
income per share:

MARKETABLE SECURITIES

As of September 30, 2003, the Company did not own any long term marketable
securities. Management determines the appropriate classification of securities
at the time of purchase and reevaluates such designation as of each balance
sheet date. The Company's marketable securities were debt securities and were
classified as available-for-sale. Available-for-sale securities are carried at
fair

F-8

value, with the unrealized gains and losses, net of tax, reported in a separate
component of stockholders' equity. The amortized cost of debt securities in this
category is adjusted for amortization of premiums and discounts to maturity.
Such amortization is included in operations.

Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities are included in
operations. The cost of securities sold is determined in accordance with the
specific identification method.

CAPITALIZED SOFTWARE

Software development costs are capitalized when technological feasibility is
established and are being amortized to cost of goods sold over the estimated
economic lives (generally three years) of the products that include such
software.

ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts in the financial statements. Actual
results could differ from those estimates.

ACCOUNTING FOR STOCK-BASED COMPENSATION

The Company measures stock-based compensation cost for its employees and
directors using Accounting Principles Board ('APB') Opinion No. 25, as is
permitted by SFAS No. 123, Accounting for Stock-Based Compensation, and complies
with the other provisions and the disclosure-only requirements of SFAS No. 123.
Accordingly, the Company recognizes compensation expense for options granted to
employees and directors as the difference, if any, between the market price of
the underlying common stock on the date of grant and the exercise price of the
option.

If the Company had elected to recognize compensation cost based on the fair
value of the options granted at the grant date as prescribed by SFAS No. 123,
the Company's net income and net income per common share for the years ended
September 30, 2003, 2002 and 2001, would approximate the pro forma amounts
indicated in the table below (dollars in thousands except per share amounts):

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for the years ended September 30, 2003, 2002 and 2001,
respectively: expected volatility of 50%, 50% and 36% respectively, risk-free
interest rate of 3.8%, 5.2%, and 4.8%, respectively, dividend yield rate of .7%,
..5%.and .6%, respectively, and all options have expected lives of 5 years.

TRANSLATION OF FOREIGN CURRENCY FINANCIAL STATEMENTS

The financial position and results of operations of the Company's foreign
subsidiaries are measured using local currency as the functional currency.
Assets and liabilities of these subsidiaries have been translated at current
exchange rates, and related revenue and expenses have been translated at average
monthly exchange rates. The aggregate effect of translation adjustments is
reflected as a separate component of stockholders' equity (accumulated other
comprehensive income (loss)) until there is a sale or liquidation of the
underlying foreign subsidiary.

F-9

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2002, the Financial Accounting Standards Board ('FASB') issued
SFAS No. 148, 'Accounting for Stock-Based Compensation -- Transition and
Disclosure, an amendment of FASB Statement No. 123.' SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, SFAS
No. 148 amends the disclosure requirements of SFAS No. 123 'Accounting for
Stock-Based Compensation', to require prominent disclosures in annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect in measuring compensation expense. The
disclosure requirements of SFAS No. 148 are effective for periods beginning
after December 15, 2002. The Company has not changed its accounting for
stock-based employee compensation, but is complying with the disclosure
requirements in SFAS No. 148.

In April 2003 the FASB issued SFAS No. 149, 'Amendment of Statement 133 on
Derivative Instruments and Hedging Activities.' SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, 'Accounting for Derivative Instruments and Hedging Activities'. The
Company does not believe that SFAS 149 will have a material effect on the
Company's financial position or results of operations.

In May 2003 the FASB issued SFAS No. 150, 'Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity'. This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). The Company does not believe
that SFAS 150 will have a material effect on the Company's financial position or
results of operations.

In November 2002, the Emerging Issues Task Force ('EITF') issued EITF 00-21,
'Revenue Arrangements with Multiple Deliverables.' This consensus provides
guidance in determining when a revenue arrangement with multiple deliverables
should be divided into separate units of accounting, and, if separation is
appropriate, how the arrangement consideration should be allocated to the
identified accounting units. The provisions of EITF 00-21 are effective for
revenue arrangements entered into in fiscal periods beginning after June 15,
2003. The Company does not believe that EITF 00-21 will have a material effect
on the Company's financial position or results of operations.

In January 2003, the FASB issued Interpretation No. 46, 'Consolidation of
Variable Interest Entities' (FIN 46). FIN 46 requires a variable interest entity
to be consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or entitled to
receive a majority of the entity's residual returns or both. FIN 46 also
requires disclosures about variable interest entities that a company is not
required to consolidate but in which it has a significant variable interest. The
consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003 and to all entities in the first fiscal
year beginning after December 15, 2003. Certain of the disclosure requirements
apply to all financial statements issued after January 31, 2003, regardless of
when the variable interest entity was established. Based on its assessment of
FIN 46, the Company has concluded that it currently has no investments in any
variable interest entities.

The Company does not believe that any other recently issued but not yet
effective accounting standards will have a material effect on the Company's
consolidated financial position or results of operations.

NOTE 2 -- ACQUISITIONS/DISPOSITIONS

As part of the Company's strategic plan to expand significantly into the
obstructive sleep apnea field, the Company embarked on three strategic
acquisitions in which an interest in a European sleep therapeutic business was
acquired in 1999 followed by the acquisitions of two sleep diagnostic businesses
in the United States in 2000 and 2002. The Company purchased an additional
interest in the European sleep therapeutic business during 2001 and 2002. The
financial details of these acquisitions are described below.

F-10

SLEEP SERVICES OF AMERICA, INC./NATIONAL SLEEP TECHNOLOGIES, INC.

The Company invested cash of $5.3 million in 1998 and $5.1 million in 1999
for common share ownership in National Sleep Technologies, Inc. ('NST'), a
privately held company. In 1999, the common share ownership in NST was
renegotiated into a convertible preferred stock investment. In the third quarter
of fiscal 2000, the Company converted its preferred stock holdings in NST into
common stock. Upon such conversion, the Company acquired an 84% ownership in
NST. The Company has reflected the operations of NST as a consolidated
subsidiary as of June 1, 2000. On January 1, 2002 NST completed its merger with
HSI Medical Services, Inc. ('HSI'), a subsidiary of the Johns Hopkins Health
System Corporation, with the merged entity known as Sleep Services of America,
Inc. ('SSA'). This transaction resulted in a 62% ownership of SSA by the
Company, with an affiliate of Johns Hopkins Health System Corporation
('Hopkins') receiving a 29% equity interest in SSA and the other minority
shareholders of NST receiving a 9% interest in SSA. In this transaction NST
issued 7,921,408 shares of its common stock with a fair value of approximately
$4,753,000, along with warrants to purchase 326,791 shares of NST's common stock
in exchange for all of the outstanding common stock of HSI. The assets acquired,
consisting principally of cash and property and equipment, amounted to
approximately $1.7 million and liabilities assumed, consisting principally of
accounts payable and accrued expenses, amounted to approximately $.4 million.
The excess of the purchase price over the fair value of the net assets acquired,
goodwill, in this transaction was approximately $3,561,000. Subsequently, the
Company paid approximately $600,000 for the purchase of shares of some of the
minority shareholders to increase its ownership to approximately 68% and reduce
the minority ownership (exclusive of Hopkins) to 3%. The above acquisitions have
been accounted for as purchases resulting in goodwill of approximately $12.8
million, which is not deductible for income tax purposes and which is included
in the sleep segment. The goodwill was recognized in accordance with SFAS No.
142 'Goodwill and Other Intangible Assets.'

BREAS MEDICAL AB

Through September 30, 2000, the Company had acquired a 53% interest in Breas
Medical AB ('Breas'), a European manufacturer of personal ventilators for
obstructive sleep apnea ('OSA') and other applications, for an aggregate
investment of approximately $15.2 million. The assets acquired amounted to
approximately $7 million and liabilities assumed amounted to approximately $2
million. This acquisition has been accounted for as a purchase, resulting in an
excess of purchase price over the fair value of net assets acquired of
approximately $11.5 million. As of May 2, 2001, the Company purchased an
additional 41% of Breas from two minority shareholders, bringing the Company's
ownership percentage to 94%. The Company paid approximately $3.7 million upon
signing a definitive agreement, with the balance payable based upon an earnout
agreement calculated from a multiple of Breas' sales and earnings for the twelve
month period ended March 31, 2002. The final payment to the two minority
shareholders of $6.5 million, based on the earnout agreement, for the additional
41% ownership interest was made in April 2002. At the same time the Company
purchased the remaining 6% interest from the other minority shareholders for
$1.7 million.

As part of the settlement of the earnout agreement with one of the minority
shareholders, who was also the former chief executive officer of Breas, Breas
acquired the former chief executive officer's ownership interest in SPRL
Percussionaire. The purchase price for that interest is included in the $6.5
million payment. To complete the purchase of SPRL Percussionaire additional
payments, in the form of an earnout agreement, were to be made to the founder of
SPRL Percussionaire, and the Company accrued an amount due of $1,015,000 in
September 2002. In fiscal 2003 Breas entered into a settlement agreement with
the founder of SPRL Percussionaire and terminated the obligation.

The total purchase price for Breas was approximately $27 million. Total
goodwill relating to the Breas transactions amounted to $19.9 million at
September 30, 2002 and was recognized in accordance with SFAS No. 142.

The Company has reflected the operations of Breas as a consolidated
subsidiary effective June 1, 1999.

F-11

STELEX -- THE VALIDATION GROUP, INC.

On March 28, 2002, the Company consummated the merger of Stelex Inc.
('Stelex') into the Company's wholly owned subsidiary, The Validation Group,
Inc. ('TVG'). The surviving entity is known as Stelex-TVG, Inc. The purchase
price for the acquisition of Stelex was approximately $13.7 million, including
costs of the acquisition of approximately $400,000. The assets acquired,
consisting principally of accounts receivable, amounted to $2.5 million and the
liabilities assumed as adjusted amounted to approximately $1.9 million,
consisting principally of amounts due to the former shareholders and deferred
revenue. The excess of the purchase price over the fair value of the net assets
acquired, goodwill, was approximately $13.1 million, which is deductible for
income tax purposes and which is included in the pharmaceutical technology
services segment. Goodwill was recognized in accordance with SFAS No. 142. The
results of operations of Stelex are included in the Company's results of
operations since March 28, 2002.

The following summary, pro forma, unaudited data of the Company reflects the
acquisitions of Breas and National Sleep Technologies, SSA and Stelex as if they
had occurred on October 1, 2000.

Such proforma data is not necessarily indicative of future results of
operations.

VITAL PHARMA, INC. -- DISCONTINUED OPERATIONS

In September 2002, the Company adopted a formal plan to sell its Vital
Pharma, Inc. subsidiary, and as such, has classified the Vital Pharma business
as a discontinued operation. Vital Pharma, a fully integrated contract
manufacturer that utilizes blow-fill-seal technology, represents a product line
that lies outside the Company's core business. The results of the discontinued
operations have been reported separately as discontinued operations in the
consolidated statement of income in accordance with SFAS No. 144 Accounting for
the Impairment or Disposal of Long-Lived Assets. The Company lowered its
investment in Vital Pharma to the amount it expects to recover in the sale and
recorded a loss on disposal of $5,333,000 in fiscal 2003.

On October 30, 2003, the Company sold its Vital Pharma subsidiary to
Pro-Clinical, Inc. The Company received $500,000 in cash and a three-year note
receivable from ProClinical for $2,000,000. The note accrues interest at 8%,
10%, and 12% in the first, second and third year of the note, respectively.
Interest is payable quarterly. Should ProClinical pay down the entire note in
the first twelve months, the note will be reduced by $300,000. Should
ProClinical pay down the entire note between the thirteenth and eighteenth
month, the note will be reduced by $200,000. The note is secured by a first lien
against all of the assets sold. No gain or further loss was recorded on the
sale.

The prior years' consolidated statements of income have been reclassified to
reflect the discontinued operations. During the quarter ended June 30, 2001, the
Company conducted a review by an outside appraiser to assess the carrying value
of the Company's investments. A major consulting firm was engaged to assist the
Company in an impairment analysis of Vital Pharma Inc., which had sustained
significant operating losses. The Company recorded a special charge relating to
Vital Pharma of approximately $18.2 million dollars. In the year ended September
30, 2002, the Company reclassified the special charge of $18.2 million to
discontinued operations.

F-12

Summarized selected financial information for the discontinued operations is
as follows:

The assets and liabilities attributable to discontinued operations are
stated separately as of September 30, 2003 and 2002 on the consolidated balance
sheet.

The major asset and liability categories attributable to discontinued
operations are as follows:

Cash flows of the discontinued operations consisted of the following for the
years ended September 30, 2003, 2002 and 2001:

NOTE 3 -- INVENTORY

Inventory consists of the following:

Reserves for obsolete and slow moving goods at September 30, 2003 and 2002
were $981 million and $438 million, respectively. Provisions charged to expense
were $864,000; $563,000 and $41,000 for fiscal 2003, 2002 and 2001,
respectively. Amounts written off against the reserve were $321,000, $303,000
and $498,000 for fiscal 2003, 2003 and 2001, respectively.

During the fourth quarter of fiscal 2003, in the normal course of business,
the Company recorded inventory charges of $390,000, which were expensed to cost
of goods sold. In the third quarter of fiscal 2003, as part of the Company's
continuing evaluation of its inventory, the Company wrote-off certain inventory
to cost of goods sold amounting to $647,000. Also, cost of goods sold included
$243,000 for the third quarter of fiscal 2003, representing a twelve-month
volume related expense adjustment from a supplier.

F-13

During the fourth quarter of fiscal 2002, the Company expensed to cost of goods
sold certain ventilator inventory relating to its Breas subsidiary in the amount
of $319,000.

NOTE 4 -- PREPAID EXPENSES

Prepaid expenses consist of the following:

NOTE 5 -- OTHER CURRENT ASSETS

Other current assets consist of the following:

Related party receivables at September 30, 2003 and 2002 consist of
unsecured promissory notes receivable dated November 30, 2001, from the CEO at
Thomas Medical Products who is also a Director of the Company, in the amount of
$637,350, and from his wife, an employee of Thomas Medical Products, in the
amount of $233,270, both bearing interest at 5.5% per annum and due on November
30, 2004, with the related accrued interest paid annually.

NOTE 6 -- MARKETABLE SECURITIES

The following is a summary of available-for-sale securities:

Realized gains and losses are determined on the basis of specific
identification. During the years ended September 30, 2003 and 2002, sales
proceeds for securities classified as available for sale securities were
$186,000 and $305,000, respectively. Stockholders' equity at September 30, 2003,
2002 and 2001 includes a change in unrealized holding gain (loss), net of
related tax effect, on available for sale securities of $3,000, $5,000 and
$17,000, respectively.

F-14

NOTE 7 -- PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment, at cost, consists of the following:

NOTE 8 -- CAPITALIZED SOFTWARE

Capitalized software consists of the following:

SFAS No. 86, 'Accounting for the Costs of Computer Software to be Sold,
Leased, or Otherwise Marketed,' requires capitalization of software development
costs incurred subsequent to establishment of technological feasibility and
prior to the availability of the product for general release to customers. In
fiscal 2003 and fiscal 2002 the Company capitalized $518,000 and $300,000,
respectively of software development costs, which primarily include personnel
costs. These costs are included in Property, Plant and Equipment. Amortization
of capitalized software costs begins when the product is available for general
release to customers and is computed on a straight line basis over the estimated
economic life (generally three years) and charged to cost of goods sold. For
fiscal years 2003 and 2002 amortization was $219,000 and $0.

NOTE 9 -- LONG-TERM DEBT

Long term debt consists of the following:

Based on the borrowing rates currently available to the Company for loans
with similar terms and average maturities, the fair value of the long-term debt
approximates the carrying amount.

The IRB is payable in varying installments with an interest rate of 8.625%
per annum through December 2009. The IRB agreement allows the Company the option
to prepay in whole or in part its obligation. The Company has decided that it
will prepay in full its obligation in December 2003, and has accordingly
classified the entire amount due, $1,690,000, as short term.

F-15

The Company has available a line of credit of $20,000,000 at September 30,
2003. No amounts were outstanding under this line.

NOTE 10 -- OTHER ASSETS

Other assets consist of the following:

NOTE 11 -- ACCRUED EXPENSES

Accrued expenses consist of the following:

NOTE 12 -- OTHER CURRENT LIABILITIES

Other current liabilities consist of:

NOTE 13 -- OTHER EXPENSE (INCOME) -- NET

Other operating expense (income) -- net consists of the following:

F-16

NOTE 14 -- IMPAIRMENT AND OTHER CHARGES (CREDITS)

CHINA

During the second quarter of fiscal 2003, the Company concluded that it
would be unable to collect its remaining receivable under normal terms from its
China distributor, and provided a reserve against the receivable balance of
$553,000. In May 2003, the Company retained counsel in China to commence certain
legal actions against its distributor in China to collect its receivable. In
September 2003, the Company received $420,000 in cash from this distributor and
also received the right to receive certain inventory. The Company is in the
process of receiving that inventory. Accordingly in the fourth quarter of fiscal
2003, the Company recorded the $420,000 payment as income, which reduced the net
impairment charge to $133,000 during the year ended September 30, 2003.

During the quarter ended June 30, 2002, the Company recorded an impairment
charge of $1,578,000 related principally to its Chinese subsidiary based on an
evaluation of its business.

JAPAN

In September 1996, a patent infringement action was filed in Japan against
an original equipment manufacturer ('OEM') medical device distributor in
connection with the sale in Japan of Marquest Medical Products, Inc.'s
('Marquest') ABG syringe product line. In July 1999 the Court indicated at a
hearing that, based on one exhibit submitted by the plaintiff, the Marquest ABG
syringe products appeared to infringe the plaintiff's patent, and requested that
the plaintiff submit an updated proof of damages. In July 1999, plaintiff filed
an updated proof of damages of approximately $6.5 million, plus interest and
costs. On June 23, 2000 the Court entered a judgment against the Company's
distributor for Yen 336,872,689 ($2,887,645) plus five percent annual interest.
The distributor (which has patent indemnification protection from the Company's
Marquest subsidiary) appealed the judgement to the Tokyo Supreme Court. On March
28, 2002, the appellate court ruled in favor of the distributor, thereby ending
the litigation and ending the Company's exposure with respect to this
proceeding. The Company reversed the $5,006,000 accrual associated with this
litigation in fiscal 2002.

OTHER

In the fiscal year ended September 30, 2001 special charges were taken for
various other impairments aggregating approximately $2.1 million.

NOTE 15 -- COMMITMENTS

LEASES

The Company has entered into noncancelable operating leases providing for
the lease of office and warehouse facilities, equipment and certain other
assets. Rent expense, aggregating $2,179,000, $1,980,000 and $1,752,000 has been
charged to operations for the years ended September 30, 2003, 2002, and 2001,
respectively. The Company's commitment under such leases is as follows:

F-17

EMPLOYMENT AGREEMENTS

The Company has entered into employment agreements, aggregating $1,647,000,
which expire at various dates through September 2005.

NOTE 16 -- CONTINGENT LIABILITIES

Various lawsuits, claims and proceedings have been or may be instituted or
asserted against the Company in the normal course of business, including those
pertaining to patent and trademark issues and product liability matters. Where
the Company has deemed a loss probable, the amount of the expected loss, has
been accrued. While the amounts claimed or expected to be claimed in other
matters may be substantial, the ultimate liability cannot now be determined
because of the inherent uncertainties surrounding the litigation and the
considerable uncertainties that exist. However, based on facts currently
available, management believes that the disposition of matters that are pending
or asserted will not have a materially adverse effect on the financial position
of the Company.

On December 6, 1999, a complaint was filed against the Company on behalf of
the former shareholders of our Vital Pharma subsidiary alleging breach of
contract for failure to pay earnout payments allegedly due under the stock
purchase agreement executed in connection with the Company's purchase of Vital
Pharma in December 1995. The Company has answered the complaint, filed
counter-claims and moved to transfer the case to arbitration. In August 2000,
the court ordered the plaintiff to submit such claims to binding arbitration and
stayed all other proceedings pending the outcome of the arbitration. The parties
are in the final stages of discovery in the arbitration proceeding. In November
2003, the arbitrator ordered the parties to complete all outstanding discovery
and to be prepared to begin the hearing on January 6, 2004 and to conclude all
hearing dates by the middle of February 2004.

On May 7, 2003 a complaint was filed against the Company and two of its
officers by Joseph Bourgart, a former chief financial officer of the Company for
the period January 11, 2002 to November 2002. Plaintiff alleges that he was a
'whistleblower' within the meaning of the New Jersey Conscientious Employee
Protection Act, based on allegations of improper accounting practices. Plaintiff
asserts these allegations notwithstanding the fact that, in connection with the
filing of the Company's Quarterly Report on Form 10-Q for the Company's third
quarter of fiscal 2002 (the period ended June 30, 2002), he had executed a
certification pursuant to the Sarbanes-Oxley Act certifying that the Quarterly
Report on Form 10-Q for that period 'fully complies with the requirements of
Section 13(a) of the Securities and Exchange Act of 1934' and that 'the
information contained in the report fairly presents, in all material respects,
the consolidated financial condition of the Company . . . '. Furthermore, as the
Company's chief financial officer, Plaintiff signed the Company's quarterly
reports on form 10-Q for the first quarter and second quarter of fiscal 2002
(ended December 31, 2001 and March 31, 2002, respectively). Less than one month
before Plaintiff's resignation, he participated in a meeting with the Company's
worldwide management team to review the accuracy of the Company's Annual Report
on form 10-K for the 2002 fiscal year. At that meeting he voiced no objections
to the 10-K, nor did he assert or even suggest that the report contained any
untrue statements or omitted to state any material fact. Of the items enumerated
in the complaint, most had already been reviewed with the Company's independent
accountants and the Company's Audit Committee prior to the Company's filing of
its quarterly report for the third quarter of fiscal 2002. The Company believes
that the filing of the complaint is a retaliatory action by Plaintiff who
voluntarily resigned without any severance payment after being confronted with
evidence of certain unethical and possibly illegal conduct. Nevertheless, in
accordance with the Sarbanes-Oxley Act, the issues raised in the complaint were
referred to the Audit Committee, which conducted its own independent analysis of
those matters.

On December 26, 2003 the Audit Committee reported to the Board of Directors
on the results of its investigation and determined that no evidence of fraud had
been discovered during the course of the investigation. The Audit Committee also
determined that any decision regarding the potential restatement of the
Company's previously published financial statements is to be made by the
Company's management in concurrence with the Company's auditors. However, based
upon the results of the investigation, the Audit Committee did not recommend
that any restatement be made to the Company's previously published financial
statements. The Company is in agreement with the Audit Committee that no
restatement is required.

On July 28, 2003 the defendants filed a motion for summary judgement to
dismiss the lawsuit. The motion asserts that Plaintiff resigned after being
confronted with proof of his unethical and possibly illegal conduct; that the
Plaintiff is not a 'whistleblower'; and that the Plaintiff has no basis for his
assertion of impropriety as he repeatedly represented in writing to the
Securities and Exchange Commission and the Company's auditors that the Company's
public filings were true and accurate in all material respects. Inasmuch as
Plaintiff approved and certified the accuracy of the Company's financial
statements to the investing public under penalty of criminal prosecution, the
Company has asserted that

F-18

no reasonable jury could believe that Plaintiff had reasonable belief that the
Company engaged in improper accounting practices. The Company strongly denies
that it had engaged in improper conduct both as regards its accounting practices
and with regard to its treatment of the Plaintiff.

On May 16, 2003 the Company was served with a complaint answerable in
Belgium by its former distributor. The complaint alleges breach of contract and
seeks damages of 185,040 Euro, (representing approximately $222,000 U.S. dollars
based on exchange rates in effect at September 30, 2003). The demand represents
salary and related costs for the distributor's employees associated with selling
the Company's product line and the value of the customer base inherited by the
new distributor. The Company has recorded a reserve for a possible settlement or
loss.

A first amended complaint was filed against the Company's Vital Pharma
subsidiary on September 8, 2003 in the U.S. District Court for the Northern
District of California related to the packaging services it provides to Lifecore
Biomedical, Inc. ('Lifecore'). The complaint asserts multiple theories of
negligence and product liability claims against the defendants for injuries
allegedly sustained through the use of Lifecore's Gynecare Intergel ('Intergel')
product during surgery. Lifecore manufactures the product, which is approved for
the purpose of reducing post-surgical adhesions. The Company's insurance carrier
has responded and has also notified Lifecore of its obligation under its
agreement with Vital Pharma to indemnify it for complaints related to product
defects.

We are also involved in other legal proceedings arising in the ordinary
course of business. We cannot predict the outcome of our legal proceedings with
certainty. However, based upon our review of pending legal proceedings, we do
not believe the ultimate disposition of our pending legal proceedings will be
material to our financial condition. Predictions regarding the impact of pending
legal proceedings constitute forward-looking statements. The actual results and
impact of such proceedings could differ materially from the impact anticipated,
primarily as a result of uncertainties involved in the proof of facts in legal
proceedings.

NOTE 17 -- STOCKHOLDERS' EQUITY

PREFERRED STOCK

The Company has authorized 10,000,000 shares of no par value preferred
stock. No shares were issued or outstanding at September 30, 2003 or 2002.

STOCK OPTIONS

Transactions relating to stock options are as follows:

The weighted average fair value per share calculated using the Black-Scholes
method for options granted during the years ended September 30, 2003, 2002, and
2001 amounted to $17.52, $21.42, and $11.69, respectively.

F-19

In 1994, the Company adopted a stock option and investment plan (covering a
maximum of 900,000 shares), whereby participants were granted two stock options
for each share of the Company's common stock that they acquired. The options are
granted at fair value at date of grant. Such stock options are subject to a
defined vesting schedule. Shares purchased by employees may be financed through
the Company.

The Company's Board of Directors and stockholders have approved the adoption
of the Vital Signs 2003 Investment Plan, which provides for the grant of options
to employees, officers and directors to purchase the Company's Common Stock. In
many respects, the 2003 Investment Plan is a renewal of the Company's prior
Investment Plan, which expires in January 2004. One million shares of the
Company's Common Stock have been authorized for share purchase and option
grants. Options may be granted at prices not less than fair value at the date of
grant. The options have a ten-year life. Options generally vest after a 2 year
period. As of September 30, 2003 no options had been granted under this plan.

In fiscal 2002, the Company's Board of Directors and stockholders approved
the adoption of the 2002 Stock Incentive Plan, which provides for the grant of
options to employees, officers, directors and consultants to purchase a maximum
of one million shares. Options may be granted at prices not less than fair value
at the date of grant. The options have a ten-year life. Options generally vest
ratably over a 5 year period commencing on the first anniversary of the grant
with respect to options granted under the 2002 Stock Incentive Plan and over 2
years with respect to the Company's options granted as part of its investment
plan and to directors. The 2002 Stock Incentive Plan expires on May 31, 2012. As
of September 30, 2003, 288,786 shares had been granted under this plan.

In addition to options granted pursuant to Company benefit plans, the
Company, in fiscal 2003 and 2002 has granted (net of lapsed shares) 102,700 and
42,000, respectively, stock options to employees independent of any such plans.
As such, these options represent contractual commitments by the Company to the
individual involved.

In connection with the plans described above and other plans which are no
longer in force, options covering 1,592,817 (excluding lapsed shares) have been
granted through September 30, 2003.

The following table summarizes information about fixed stock options
outstanding at September 30, 2003:

F-20

NOTE 18 -- INCOME TAXES

The provision for income taxes consists of the following components:

The breakdown of U.S. and Foreign income from continuing operations before
income taxes for the year ended September 30 was as follows:

The tax effect of temporary differences that give rise to the net short-term
deferred tax assets are presented below:

The tax effects of temporary differences that give rise to the net long-term
deferred tax assets are presented below:

At September 30, 2003, the Company has federal net operating loss
carryforwards of approximately $7,934,000 to offset future taxable income. These
net operating loss carryforwards expire from 2007

F-21

through 2010. The annual amount available to offset consolidated taxable income
is limited to approximately $1,887,000 under Section 382 of the Internal Revenue
Code. In addition, at September 30, 2003, the Company has available
approximately $19,508,000 of New Jersey net operating loss carryforwards to
offset future state taxable income. The New Jersey operating loss carryforwards,
as extended, expire in 2007 and 2008. Utilization of these net operating losses
has been suspended for deduction carryover for privilege periods beginning
during calendar years 2002 and 2003, but this suspension extends the seven-year
carryforward period by two years. The Company has established a valuation
allowance against the New Jersey Net Operating less carryforwards, based upon
management's estimate of future taxable earnings available to offset the net
operating loss.

The total provision for income taxes differs from that amount which would be
computed by applying the U.S. federal income tax rate to income before provision
for income taxes. The reasons for these differences are as follows:

Income taxes payable consist of the following:

At September 30, 2002, the Company had prepaid its Federal and State tax
obligation. Included in prepaid expenses at September 30, 2002, was $756,000 for
Federal and State prepaid taxes.

For the years ended September 30, 2003, 2002 and 2001, the Company
recognized for income tax purposes a tax benefit of $298,000, $2,172,000 and
$759,000, respectively, for compensation expense related to its stock option
plan for which no corresponding charge to operations has been recorded. Such
amount has been added to common stock in each year.

In connection with the routine Internal Revenue Service examination of the
Company's 1997, 1998 and 1999 Federal income tax returns, the Company increased
its tax provision in the second quarter of fiscal 2003 by $1,081,000, and
increased interest expense by $650,000 for the related interest due in the
second quarter, and $40,000 in the third quarter of fiscal 2003. On October 6,
2003, the Company finalized the Internal Revenue Service tax audit for the years
1997, 1998 and 1999 and recorded an additional tax provision in the fourth
quarter of fiscal 2003 of $113,000. Also, certain state tax returns for prior
periods have been re-filed, resulting in additional tax expense of $297,000 and
interest expense of $70,000 in the third quarter of fiscal 2003.

F-22

NOTE 19 -- ALLOWANCE FOR REBATES AND DOUBTFUL ACCOUNTS

Information relating to the allowance for rebates and doubtful accounts is
as follows:

(A) Charges represent estimated rebates deducted from gross revenues and
estimated provision for doubtful accounts.

(B) Deductions represent actual rebates credited to the wholesaler and the
write-off of uncollectible accounts.

See Note 1 to the Consolidated Financial Statements for a description of
rebates. In the fourth quarter of fiscal 2003, the Company increased its
reserves for bad debts (recorded in selling, general and administrative
expenses), in the normal course of business, by $367,000.

NOTE 20 -- SIGNIFICANT CUSTOMERS

A portion of the Company's hospital customers are serviced by national and
regional medical supply distributors. During fiscal years 2003, 2002 and 2001,
respectively, 24%, 26%, and 27% of the Company's net revenue were made in this
distribution channel. In each fiscal year 2003, 2002 and 2001, one of the larger
national distributors represented approximately 10%, 12%, and 13%, respectively,
of net revenue. The same customer represented approximately 8% and 14% of
outstanding accounts receivable at September 30, 2003 and 2002, respectively.

NOTE 21 -- SEGMENT INFORMATION

Vital Signs, Inc. sells single-patient use medical products to the
anesthesia, respiratory, critical care, sleep therapy and emergency markets. The
Company provides pharmaceutical technology services, principally to the
pharmaceutical companies and also, from time to time, to medical device,
diagnostic and biotechnology companies. The Company has aggregated its business
units into four reportable segments, anesthesia, respiratory/critical care,
sleep and pharmaceutical technology services. There are no material intersegment
sales. Anesthesia and Respiratory/Critical Care share certain manufacturing
facilities, sales and administration support; therefore the operating expenses,
total assets, and capital expenditures are not specifically identifiable.
However the Company has allocated operating expenses, total assets, and capital
expenditures on a net sales basis. Management evaluates performance on gross

F-23

profits and operating results of the four business segments. Summarized
financial information concerning the Company's reportable segments is shown in
the following table.

The following table presents revenues by geographic area:

NOTE 22 -- RELATED PARTY

One of the Company's subsidiaries, Thomas Medical Products, provides product
development and manufacturing services to X-Site Medical, LLC ('X-Site'), a
company engaged in the development of arterial closure devices. Two of the
shareholders of X-Site are also shareholders and officers of the Company and
three additional shareholders of X-Site are independent members of the Company's
Board of Directors. Thomas Medical Products sales to X-Site were approximately
$363,000 $375,000 and $372,000 during the fiscal years ended September 30, 2003,
2002 and 2001, respectively, for these services. Amounts due from X-Site are
included in accounts receivable on the Company's consolidated balance sheet and
amounted to approximately $199,000 and $138,000 at September 30, 2003 and 2002,
respectively. In addition, in 2001 the Company provided certain accounting
services for X-Site, in which various suppliers of X-Site, including the
Company's subsidiary, were paid by the Company. X-Site, in turn, reimbursed the
Company. During the year ended September 30, 2001, X-Site reimbursed the Company
in the amount of approximately $854,000. The Company believes that the overall
terms of the above described arrangements with X-Site are no less favorable to
the Company than terms that would be available from similarly situated third
parties.

In August of 2001, the Company made several loans under the provisions of
its investment plan to the Chief Executive Officer/Chairman of the Board and a
Director/Officer of the Company in the amounts of $112,500 and $100,000,
respectively, at an interest rate of 6.75%. The loans were repaid in full in
fiscal 2003.

F-24

NOTE 23 -- EMPLOYEE BENEFIT PLANS:

The Company has established a savings incentive plan for substantially all
employees of the Company which is qualified under section 401(k) of the Internal
Revenue Code. The savings plan provides for contributions to an independent
trustee by both the Company and its participating employees. Under the plan,
employees may contribute up to 80% of their pretax base pay up to the dollar
limits set by law, $12,000 for each employee in calendar year 2003. The Company
matches 25% of the first 6% of participant contributions. Participants vest
immediately for their own contributions and for the Company's contributions.
Company contributions were approximately $388,000, $295,000, and $270,000, for
the years ended September 30, 2003, 2002 and 2001, respectively.

NOTE 24 -- QUARTERLY FINANCIAL DATA (UNAUDITED)

The following is a summary of the unaudited quarterly results of operations
for the years ended September 30, 2003 and 2002:

FISCAL YEAR ENDED SEPTEMBER 30, 2003

FISCAL YEAR ENDED SEPTEMBER 30, 2002

On May 7, 2003 a complaint was filed against the Company and two of its
officers. The Company's Audit Committee hired outside independent accountants
and legal counsel to investigate the matters alleged by the plaintiff, a former
CFO of the Company. Accounting and legal expenses totalling $550,000 ($262,000
and $288,000) during the third and fourth quarter, respectively, were incurred
and recorded in selling, general and administrative expenses in fiscal 2003 in
connection with the Audit Committee investigation and related proceedings.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

(a) Disclosure controls and procedures. As of the end of the Company's most
recently completed fiscal quarter covered by this report, the Company carried
out an evaluation, with the participation of the Company's management, including
the Company's Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the Company's disclosure controls and procedures pursuant to
Securities Exchange Act Rule 13a-15. Based upon that evaluation, the Company's
Chief Executive Officer and

F-25

Chief Financial Officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that information required to be disclosed
by the Company in the reports that it files or submits under the Securities
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SEC's rules and forms.

(b) Changes in internal controls over financial reporting. There have been
no changes in the Company's internal controls over financial reporting that
occurred during the Company's last fiscal quarter to which this report relates
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.

F-26

PART III

ITEM 10. DIRECTORS OF THE REGISTRANT

The following table presents certain information regarding the directors of
the Company:

(table continued on next page)

37

(table continued from previous page)

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(A) Ages are presented as of September 30, 2003.

(B) In each instance in which dates are not provided in connection with a
director's business experience, such director has held the position
indicated for at least the past five years. Messrs. Wall, Bershad and Dimun
have invested together (and previously served together as Board members) in
Bionx Implants, Inc. and have invested together in OmniSonics Medical
Technologies, Inc. (formerly Sonokinetics, Inc.). Mr. Wall and Mr. Donnelly
are also Board members of OmniSonics Medical Technologies, Inc. Messrs.
Wall, Dimun, MacCallum, Bershad and Thomas are investors and serve on the
Board of X-Site Medical, LLC. (See 'Related Party Transactions').
Omnisonics Medical Technologies, Inc. and X-Site Medical, LLC are private
companies.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors, executive officers and 10% shareholders to file with the Securities
and Exchange Commission certain reports regarding such persons' ownership of the
Company's securities. The Company is required to disclose any failures to file
such reports on a timely basis. With the exception of two inadvertent late
filings, the Company is not aware of any such untimely filings during the fiscal
year ended September 30, 2003. Directors Richard Robbins and Howard Donnelly
each filed their initial reports of beneficial ownership late, but promptly
after they were alerted to the filing requirement.

AUDIT COMMITTEE FINANCIAL EXPERT

The Company's Board of Directors has determined that Richard L. Robbins, the
Chairman of the Company's Audit Committee is an 'audit committee financial
expert' (as defined by Item 401(h) of the SEC's Regulation S-K and that Mr.
Robbins is an 'independent' (as that term is defined in Item 7(d) (3)(iv) of the
SEC's Schedule 14A) director.

CODE OF ETHICS

The Company has adopted a code of ethics which applies to the company's
principal executive officer, principal financial officer, principal accounting
officer or controller and persons performing similar functions. A copy of this
code of ethics is set forth as Exhibit 14.1 to this Annual Report on Form 10-K.
In addition, a copy of this code of ethics has been posted on the Company's
Website, which may be accessed on the Internet at www.vital-signs.com. Once at
this Website, you may review the code of ethics by clicking on 'Code of Ethics'
found on the home page.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth, for the fiscal years ended September 30,
2003, 2002 and 2001, the annual and long-term compensation of the Company's
Chief Executive Officer and the other individuals who served as executive
officers of the Company at the end of fiscal 2003 and received greater than
$100,000 in salary and bonus during fiscal 2003 (the 'Named Officers'):

38

SUMMARY COMPENSATION TABLE

- ---------

(A) Reflects bonuses in the fiscal year earned, which may not correspond with
the fiscal year paid. Bonuses earned in fiscal 2003 were awarded under the
Company's Well-Pay Policy and in conjunction with the Company's performance
incentive program. The Well-Pay Policy covers all Company personnel working
in the Company's headquarters in Totowa, New Jersey and in certain of the
Company's subsidiaries. Under the Policy, an additional day's pay is earned
by any employee having perfect attendance for the preceding month. In
addition, payments of $200 to $400 are earned by employees having perfect
attendance for one or more consecutive years.

(B) Comprised entirely of monthly car allowances.

(C) 'Compensation' reported under this column for the year ended September 30,
2003 includes: (i) contributions of $2,001, $2,996, $3,417, $0 and $2,039,
respectively, for Messrs. Wall, Wicker, Thomas, Schiff and Felix,
respectively, to the Company's 401(k) Plan on behalf of the Named Officers
to match pre-tax elective deferral contributions (included under 'Salary')
made by each Named Officer to that Plan and (ii) premiums of $2,278,
$1,402, $0,$68 and $172 respectively, with respect to life insurance
purchased by the Company for the benefit of Messrs. Wall, Wicker, Thomas,
Schiff and Felix, respectively.

(D) Effective October 1, 2001, Mr. Thomas and TMP entered into a three year
employment agreement, pursuant to which Mr. Thomas will be paid a base
salary of $168,451 in fiscal 2003, increased annually by the same
percentage increase as salaries generally increase for the Company. For
purposes of calculating the increase for fiscal 2003, that figure was 4%.
Mr. Thomas is guaranteed an annual bonus of $212,450 during the term. He is
also entitled to receive an additional bonus based on TMP's performance.
Mr. Thomas' wife is also an employee of TMP and TMP has entered into a
similar agreement with her. However, her base salary for fiscal 2003 is
$80,663 and her guaranteed annual bonus is $77,757. On November 30, 2001,
pursuant to unsecured promissory notes bearing interest at 5.5% per annum,
the Company loaned Mr. Thomas the sum of $637,350 and loaned his wife
$233,370. The notes are due on November 30, 2004.

STOCK OPTIONS

The following table contains information regarding the grant of stock
options to the Named Officers during the year ended September 30, 2003. In
addition, in accordance with rules adopted by the

39

Securities and Exchange Commission (the 'SEC'), the following table sets forth
the hypothetical gains or 'options spreads' that would exist for the respective
options assuming rates of annual compound price appreciation in the Company's
Common Stock of 5% and 10% from the date the options were granted to their final
expiration date.

The following table provides data regarding the number and value of shares
of the Company's Common Stock covered by both exercisable and non-exercisable
stock options held by the Named Officers at September 30, 2003. The closing
sales price of the Company's common stock on September 30, 2003 was $29.07. No
officers exercised stock options during fiscal 2003:

AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END VALUES

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information regarding the beneficial
ownership of the Common Stock as of September 30, 2003 by (i) each person who is
known by the Company to own beneficially more than five percent of the Common
Stock; (ii) trusts maintained for the benefit of the children of Terry D. Wall,
the Company's principal shareholder and chief executive officer; (iii) each
Named Officer (as defined herein) and director of the Company; and (iv) all
directors, and executive officers of the Company as a group. Unless otherwise
indicated, each of the named shareholders possesses sole voting and investment
power with respect to the shares beneficially owned. Shares covered by stock
options

40

are included in the table below only to the extent that such options may be
exercised by November 30, 2003.

- ---------

* Represents less than one percent.

(1) The business address of Mr. Wall and the above-mentioned trusts is c/o
Vital Signs, Inc., 20 Campus Road, Totowa, New Jersey 07512. The business
address of Mr. Dimun is c/o Nascent Enterprises, LLC, 46 Parsonage Hill
Road, Short Hills, New Jersey 07078.

(2) Includes 3,440,894 shares owned by Mr. Wall directly, 706,748 shares owned
by Carol Vance Wall, Mr. Wall's wife, 34,332 shares held in the Company's
401(k) plan on Mr. Wall's behalf and 103,952 shares covered by options
exercisable by Mr. Wall. Excludes shares held in trust for the benefit of
the Walls' minor children (which shares may not be voted or disposed of by
Mr. Wall or Carol Vance Wall) and shares held by a charitable foundation
established by Mr. Wall and Carol Vance Wall. Mr. Wall and Carol Vance Wall
have pledged 4,041,272 shares as collateral to a brokerage firm as security
for a loan made to them. Based on the closing sale price of the Common
Stock on September 30, 2003, the value of the shares held as collateral on
this loan represented more than 700% of the outstanding balance on this
loan as of September 30, 2003. Upon any default under this loan, the shares
collateralizing such loan may be sold in the market. The number of shares
so sold in the market may negatively impact the market price of the Common
Stock. Depending upon the number of shares sold and the number of shares
that could similarly be sold in connection with the loans described in the
next footnote, such sales could result in a change in control of the
Company.

(3) As trustee of the trusts maintained for the benefit of the minor children
of Terry D. Wall, Anthony J. Dimun has the power to vote and dispose of
each of the shares held in such trusts and thus is deemed to be the
beneficial owner of such shares under applicable regulations of the
Securities and Exchange Commission. Mr. Dimun is also deemed to be the
beneficial owner of 700 shares held in certain insurance trusts established
by Mr. Wicker. He is also deemed to be the beneficial owner of 79,700
shares held by the charitable foundation described above. Accordingly, the
shares reflected in the table above as shares beneficially owned by Mr.
Dimun include shares held by Mr. Dimun for such trusts and foundation,
20,644 shares owned by Mr. Dimun individually and 32,138 shares covered by
options exercisable by Mr. Dimun. The Trusts established for the Walls'
children have pledged their shares as collateral to a financial institution
to secure loans made to them. The Company has agreed to register such
shares for resale, at the trusts' expense, in the event that such financial
institution acquires such shares upon a default and thereafter desires to
sell such shares. Based on the closing sale price of our common stock on
September 30, 2003, the value of the shares
(footnotes continued on next page)

41

(footnotes continued from previous page)
held as collateral on these loans represented more than 400% of the
outstanding balance on these loans as of September 30, 2003. Upon any
default under these loans, the shares collateralizing such loans may be
sold in the market. The number of shares so sold in the market may
negatively impact the market price of the Common Stock. Depending upon the
number of shares sold and the number of shares that could similarly be sold
in connection with the loan described in the immediately preceding
footnote, such sales could result in a change in control of the Company.

(4) In a Schedule 13G filed with the Securities and Exchange Commission on
February 14, 2003, Putnam, LLC stated that it has shared voting power with
respect to 196,276 shares and shared dispositive power with respect to
720,876 shares. The Schedule 13G further states that the shares of Common
Stock reported consist of securities beneficially owned by subsidiaries of
Putnam, LLC which are registered investment advisors, which in turn include
securities beneficially owned by clients of such investment advisors, which
clients may include investment companies registered under the Investment
Company Act and/or employee benefit plans, pension funds, endowment funds
or other institutional clients.

(5) Includes 268,927 shares owned by Mr. Wicker directly, 13,454 shares held in
the Company's 401(k) plan on Mr. Wicker's behalf, and 55,884 shares covered
by options exercisable by Mr. Wicker. Excludes shares held in insurance
trusts maintained for the benefit of Mr. Wicker's children, which shares
may not be voted or disposed of by Mr. Wicker or his wife.

(6) Includes 24,267 shares owned by Mr. Bershad directly, 2,000 shares owned by
Mr. Bershad's wife as to which Mr. Bershad disclaims beneficial ownership,
and 86,522 shares covered by options exercisable by Mr. Bershad.

(7) These 3,750 shares are covered by options exercisable by Mr. Donnelly.

(8) These 2,500 shares are covered by options exercisable by Mr. MacCallum.

(9) These 4,000 shares are covered by options exercisable by Mr. Robbins.

(10) These 3,750 shares are covered by options exercisable by Mr. Schapiro.

(11) Includes 1,661 shares owned by Mr. Schiff directly and 12,500 shares
covered by options exercisable by Mr. Schiff.

(12) Includes 1,000 shares owned by Mr. Felix directly and 5,000 shares covered
by options exercisable by Mr. Felix.

(13) Includes 309,996 shares covered by options exercisable by the Company's
executive officers and directors, and 47,786 shares held in the Company's
401(k) plan; also includes shares held in trust by Mr. Dimun for Mr. Wall's
children and pursuant to certain insurance trusts established by Mr. Wicker
and shares held by a charitable foundation established by Terry and Carol
Vance Wall.

(14) Percent of class is based on 12,915,566 shares of Common Stock outstanding
on September 30, 2003.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Thomas Medical Products, Inc. ('TMP'), a subsidiary of the Company, provides
product development and manufacturing services to X-Site Medical, LLC
('X-Site'), a company engaged in the development of specialized cardiovascular
products. Thomas Medical Products sales to X-Site were approximately $363,000,
$375,000 and $372,000 during the fiscal years ended September 30, 2003, 2002 and
2001, respectively, for these services. In addition, in 2001 the Company
provided certain accounting services for X-Site, in which various suppliers of
X-Site, including the Company's subsidiary, were paid by the Company. X-Site, in
turn, reimbursed the Company. During the year ended September 30, 2001, X-Site
reimbursed the Company in the amount of approximately $854,000. Amounts due from
X-Site are included in accounts receivable on the Company's consolidated balance
sheet and amounted to approximately $199,000 and $138,000 at September 30, 2003
and 2002, respectively. The Company believes that the rates charged to X-Site
for such services are no less favorable to the Company than

42

those charged to similarly situated unrelated parties. Mr. Wall and his family
limited partnership own 37.6% of X-Site. Mr. Dimun, Mr. Bershad, through an
investment limited partnership Mr. Thomas and Mr. MacCallum own 3.9%, 4.3%, 2.1%
and less than 1% of X-Site, respectively.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

In accordance with the requirements of the Sarbanes-Oxley Act of 2002 (the
'Act') and the Audit Committee's charter, all audit and audit-related work and
all non-audit work performed by the independent accountants, Goldstein, Golub,
Kessler, LLP, ('GGK') and American Express Tax and Business Services, ('TBS'),
is approved in advance by the Audit Committee, including the proposed fees for
such work. The Audit Committee is informed of each service actually rendered
that was approved through its pre-approval process.

GGK, certified public accountants, has a continuing relationship with TBS,
from which it leases auditing staff who are full time, permanent employees of
TBS and through which its partners provide non-audit services. As a result of
this arrangement, GGK has no full time employees and therefore, none of the
audit services performed were provided by permanent full-time employees of GGK.
GGK manages and supervises the audit and audit staff, and is exclusively
responsible for the opinion rendered in connection with its examination.

Audit Fees. Audit fees billed or expected to be billed to Vital Signs, Inc.
by GGK for the audit of the financial statements included in Vital Sign's Annual
Report on Form 10-K, and reviews of the financial statements included in Vital
Sign's Quarterly Reports on Form 10-Q, for the years ended September 30, 2003
and 2002 totaled approximately $264,000 and $341,000, respectively.

Tax Fees. The Company was billed an aggregate of $62,000 and $35,000 by TBS
for the fiscal years ended September 30, 2003 and 2002, respectively, for Tax
services, principally advice regarding the preparation of income tax returns,
the routine examination by the Internal Revenue Service of our 1997, 1998 and
1999 Federal tax returns, tax advice and planning services related to income tax
returns.

All Other Fees. The Company was billed an aggregate of $189,000 and $189,000
by GGK for the fiscal years ended September 30, 2003 and 2002, respectively, for
permitted non-audit services, principally services related to the litigation
filed by Joseph Bourgart, a former chief financial officer of the Company,
described in Note 16 of our Consolidated Financial Statements in 2003 and
accounting services related to our public offering (which was subsequently
discontinued) in 2002, as well as advice on various other accounting topics
during both of these years.

Other Matters. The Audit Committee of the Board of Directors has considered
whether the provision of the Financial Information Systems Design and
Implementation Fees, Tax fees and all other fees are compatible with maintaining
the independence of the Company's principal accountant.

Applicable law and regulations provide an exemption that permits certain
services to be provided by our outside auditors even if they are not
pre-approved. We did not rely on this exemption at any time since the
Sarbanes-Oxley Act was enacted.

43

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a-1) The financial statements listed in the index set forth in Item 8 of
this Annual Report on Form 10-K are filed as part of this Annual
Report.

(a-2) All schedules have been omitted because they are not applicable or the
required information is included in the financial statements or notes
thereto.

(a-3) The following exhibits are incorporated by reference herein or annexed
to this Annual Report:

(table continued on next page)

44

(table continued from previous page)

EXHIBIT DESCRIPTION
- ------- ------------------------------------------------------------

45

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, this 12th day of
December, 2003.

VITAL SIGNS, INC.

By: /s/ FREDERICK S. SCHIFF
.................................
FREDERICK S. SCHIFF
CHIEF FINANCIAL OFFICER

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

46

STATEMENT OF DIFFERENCES
------------------------
The trademark symbol shall be expressed as............................. 'TM'
The registered trademark symbol shall be expressed as.................. 'r'
The Greek letter theta shall be expressed as........................... [th]