RIVER HOLDING CORP, 10-Q, 1998-11-09

RIVER HOLDING CORP
10-Q, 1998-11-09
SURGICAL & MEDICAL INSTRUMENTS & APPARATUS

Previous: AVALON FUND OF ANN ARBOR INC, 497, 1998-11-09

Next: HUDSON RESPIRATORY CARE INC, 10-Q, 1998-11-09

<PAGE>

================================================================================

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 25, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period from __________ TO __________

Commission file number - 333-56135

__________________

RIVER HOLDING CORP.
(Exact name of registrant as specified in its charter)

__________________

DELAWARE 95-4674065
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

599 LEXINGTON AVENUE, 18TH FLOOR 10022
New York, New York (Zip Code)
(Address of Principal Executive Offices)

(212) 958-2555
(Registrant's telephone number, including area code)

NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since
last report).

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes [_] No [_] (Not applicable at this time)

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.

Yes [_] No [_]

The number of shares of Common Stock, $.01 par value, outstanding (the only
class of common stock of the Company outstanding) was 6,312,500 on October 31,
1998.

================================================================================
<PAGE>
RIVER HOLDING CORP. AND SUBSIDIARIES

Quarter Ended September 25, 1998

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements of River Holding Corp.(Unaudited):

Consolidated Balance Sheet as of September 25, 1998 ........................ 2

Consolidated Statements of Operations for the Three Months
and Six Months Ended September 25, 1998..................................... 4

Consolidated Statements of Cash Flows for the Six Months
Ended September 25, 1998.................................................... 5

Notes to Consolidated Financial Statements.................................. 6

Consolidated Financial Statements of Hudson Respiratory Care Inc. (Unaudited):

Consolidated Balance Sheets as of December 26, 1997 and
September 25, 1998......................................................... 10

Consolidated Statements of Operations for the Three Months Ended
September 26, 1997 and September 25, 1998 and for the Nine Months
Ended September 26, 1997 and September 25, 1998............................ 12

Consolidated Statements of Cash Flows for the Nine Months
Ended September 26, 1997 and September 25, 1998............................ 13

Notes to Consolidated Financial Statements................................. 15

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................... 19

Item 3. Quantitative and Qualitative Disclosures About Market Risks......................... 31

PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 32
Item 2. Changes in Securities............................................................... 32
Item 3. Defaults Upon Senior Securities..................................................... 32
Item 4. Submission of Matters to a Vote of Security Holders................................. 32
Item 5. Other Information................................................................... 32
Item 6. Exhibits and Reports on Form 8-K.................................................... 32

SIGNATURE............................................................................................... 33
</TABLE>

1
<PAGE>

RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------
CONSOLIDATED BALANCE SHEET
--------------------------
ASSETS
------
(Dollar Amounts in Thousands)

<TABLE>
<CAPTION>
SEPTEMBER 25,
1998
-------------------------
(UNAUDITED)
<S> <C>
CURRENT ASSETS:
Cash and short-term investments........................................................... $ 1,306
Accounts receivable, less allowance for doubtful accounts of $391......................... 18,963
Inventories............................................................................... 17,412
Other assets.............................................................................. 1,260
--------
Total current assets................................................................... 38,941
--------

PROPERTY, PLANT AND EQUIPMENT, net of accumulated depreciation and amortization 47,845
--------

OTHER ASSETS:
Deferred tax asset........................................................................ 15,369
Deferred financing costs, net............................................................. 12,153
Intangible assets, net.................................................................... 4,457
Other assets.............................................................................. 344
Goodwill, net............................................................................. 140,009
--------
172,332
--------
$259,118
========
</TABLE>

The accompanying notes are an integral part of this consolidated balance sheet.

2
<PAGE>

RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------
CONSOLIDATED BALANCE SHEET
--------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
(Dollar Amounts in Thousands)

<TABLE>
<CAPTION>
SEPTEMBER 25,
1998
-------------------------
(UNAUDITED)
<S> <C>
CURRENT LIABILITIES:
Notes payable to bank............................................................... $ 1,000
Accounts payable.................................................................... 5,364
Accrued liabilities................................................................. 10,575
--------
Total current liabilities......................................................... 16,939
--------

SENIOR SUBORDINATED NOTES PAYABLE...................................................... 115,000
--------
NOTES PAYABLE TO BANK, net of current portion.......................................... 37,000
--------
Total liabilities................................................................... 168,939
--------

MINORITY INTEREST...................................................................... -
--------
MANDATORILY REDEEMABLE PREFERRED STOCK, $100 par value: Authorized--300,000 shares;
issued and outstanding--300,000; liquidation preference: $30,000................... 29,000
Accrued preferred stock dividend, payable-in-kind................................... 1,648
--------
30,648
--------
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, no par value:
Authorized--15,000,000 shares; issued and outstanding--6,312,500 shares............. 63,125
Retained earnings................................................................... (3,594)
--------
59,531
--------
$259,118
========
</TABLE>

The accompanying notes are an integral part of this consolidated balance sheet.

3
<PAGE>

RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------

CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------

(Dollar Amounts in Thousands)

<TABLE>
<CAPTION>
Three Six Months
Months Ended Ended
------------------ -------------
Sept. 25, Sept. 25,
1998 1998
------------------ -------------
(unaudited) (unaudited)
<S> <C> <C>
NET SALES...................................................... $ 22,130 $ 44,562
COST OF SALES.................................................. 12,113 24,794
------------- -------------
Gross Profit................................................... 10,017 19,768
------------- -------------

OPERATING EXPENSES:
Selling...................................................... 2,489 4,862
Distribution................................................. 1,251 2,500
General and administrative................................... 2,772 5,375
Research and development..................................... 475 941
Amortization of goodwill..................................... 1,190 2,380
------------- -------------
8,177 16,058
------------- -------------
Income from operations......................................... 1,840 3,710
------------- -------------
OTHER INCOME AND (EXPENSES):
Interest expense............................................. (3,488) (6,708)
Other, net................................................... (513) (247)
------------- -------------
(4,001) (6,955)
------------- -------------
Loss before benefit for income taxes........................... (2,161) (3,245)
BENEFIT FOR INCOME TAXES (Note 5).............................. 865 1,299
------------- -------------
Net loss....................................................... (1,296) (1,946)
Preferred stock dividends...................................... 872 1,648
------------- -------------
Net loss available to common shareholders...................... $ (2,168) $ (3,594)
============= =============
</TABLE>

The accompanying notes are an integral part of this consolidated statement.

4
<PAGE>

RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
------------------------------------
(Dollar Amounts in Thousands)

<TABLE>
<CAPTION>
Six Months Ended
September 25,
1998
------------------
(unaudited)
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................................................................... $ (1,946)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization..................................................................... 6,368
Changes in assets and liabilities, net of amounts acquired or assumed:
Increase in accounts receivable................................................................... (222)
Increase in inventories........................................................................... (603)
Increase in other current assets.................................................................. (507)
Increase in other assets.......................................................................... (279)
Decrease in other non-current assets.............................................................. 975
Increase in accounts payable...................................................................... 2,282
Increase in accrued liabilities................................................................... 4,882
-------------
Net cash provided by operating activities....................................................... 10,950
-------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Hudson Respiratory Care Inc.......................................................... (248,000)
Acquisition of Gibeck, Inc.......................................................................... (3,352)
Increase in intangible assets....................................................................... (271)
Purchases of property, plant and equipment.......................................................... (2,429)
-------------
Net cash used in investing activities........................................................... (254,052)
-------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable to bank.................................................................. (2,000)
Proceeds from senior subordinated notes............................................................. 115,000
Proceeds from borrowings on bank credit facility.................................................... 40,000
Increase in financing costs......................................................................... (717)
Sale of common and preferred stock, net of transaction costs........................................ 92,125
-------------
Net cash provided by financing activities....................................................... 244,408
-------------

NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS....................................................... 1,306
CASH AND SHORT-TERM INVESTMENTS, beginning of period.................................................. --
-------------
CASH AND SHORT-TERM INVESTMENTS, end of period........................................................ $ 1,306
=============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the quarter for:
Interest........................................................................................... $ 2,377
=============

Income taxes....................................................................................... $ 1,659
=============
</TABLE>

The accompanying notes are an integral part of this consolidated statement.

5
<PAGE>

RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------

September 25, 1998
------------------
(unaudited)

1. Financial Statements. The condensed consolidated financial statements
--------------------
included herein have been prepared by River Holding Corp. ("Holding") and Hudson
Respiratory Care, Inc. (the "Company"), without audit, and include all
adjustments which are, in the opinion of management, necessary for a fair
presentation of the financial position at September 25, 1998, the results of
operations for the three-month and six-month periods ended September 25, 1998,
and the cash flows for the six-month period ended September 25, 1998 pursuant to
the rules and regulations of the Securities and Exchange Commission (SEC). All
such adjustments are of a normal recurring nature. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. Although Holding believes that
the disclosures in such financial statements are adequate to make the
information presented not misleading, these consolidated financial statements
should be read in conjunction with the consolidated balance sheet of Holding as
of March 27, 1998 and with the Company's 1997 audited financial statements and
the notes thereto included in Holding's Form S-4 filed with the SEC
(Registration No. 333-56135). The results of operations for the period
presented are not necessarily indicative of the results for a full year.

2. Recapitalization and Basis of Accounting. In April 1998, the Company
----------------------------------------
consummated a plan pursuant to which a majority of the Company was sold to
Holding in accordance with an agreement and plan of merger (the
Recapitalization).

Key components of the Recapitalization include:

(1) common and preferred equity investments by Holding in consideration
for (i) an 80.8% ownership in the Company's common stock and (ii) preferred
stock with an initial liquidation preference of $30.0 million;

(2) issuance by the Company of 91/8% senior subordinated notes with a par
value of $115.0 million, maturing in 2008 (see Note 7);

(3) execution by the Company of a new term loan facility and revolving
loan facility (see Note 7);

(4) repayment of existing indebtedness;

(5) payment of amounts due under the Equity Participation Plan (the Equity
Participation Plan or EPP) (see Note 6);

(6) payment for common shares acquired from the existing shareholder; this
shareholder retained a 19.2% interest in the common shares outstanding;

(7) potential contingent payments based on 1998 performance, payable to
the continuing shareholder and former participants in the Equity Participation
Plan.

The Company has terminated the Equity Participation Plan and has adopted a
stock purchase plan. The Company also plans to adopt a stock option plan.
Additionally, Hudson's sole shareholder, who owned the remaining 21 percent of
Industrias Hudson, transferred this interest to the Company in consideration of
one dollar. Because of the commonality of ownership, the 21 percent minority
interest has been included in the financial statements for all periods
presented.

The investment by Holding was accounted for as a purchase and the purchase
price has been tentatively allocated as follows (amount in thousands):

6
<PAGE>

<TABLE>
<CAPTION>
Assets:
<S> <C>
Current assets and other......................................... $ 38,038
Property, plant and equipment.................................... 47,821
Deferred tax asset............................................... 15,076
Deferred financing costs......................................... 11,920
Goodwill......................................................... 142,389
------------
255,244

Less liabilities:
Current liabilities.............................................. 7,244
------------

Total purchase price paid........................................ $ 248,000
============
</TABLE>

The purchase price allocation is tentative pending further analysis of the
relative fair values of the assets acquired and liabilities assumed, and
analysis of the deferred tax asset. Goodwill is being amortized using a 30-year
life.

Holding has no operations apart from those conducted through the Company
and its subsidiaries. Accordingly, the results of operations of Holding include
activities only from the date of investment through September 25, 1998. For this
purpose, the operations for the Company's second quarter commencing March 27,
1998 have been included. The effect of including the period from March 27, 1998
to the acquisition is, in the opinion of management, not material to the results
of operations.

The minority interest in the Company was initially recorded at zero and the
Company's losses for the period ended September 25, 1998 have been solely
allocated to Holding.

3. Inventories. Inventories consisted of the following (amounts in
-----------
thousands):

<TABLE>
<CAPTION>
SEPTEMBER 25,
1998
----------------
<S> <C>
Raw materials.............................................................. $ 4,261
Work-in-process............................................................ 4,316
Finished goods............................................................. 8,835
-------------
$ 17,412
=============
</TABLE>

4. Comprehensive Income. In June 1997, FASB issued Statement of Financial
--------------------
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income." This
Statement requires that all items that meet the definition of components of
comprehensive income be reported in a financial statement for the period in
which they are recognized. This Statement is effective for fiscal years
beginning after December 15, 1997 and was adopted by Holding.

Holding had no comprehensive income adjustments for the period ended
September 25, 1998.

5. Income Taxes. Holding is a C corporation and the Company became a C
------------
corporation upon the occurrence of the Recapitalization discussed in Note 2.
The deferred tax asset results from different tax bases for financial reporting
and income tax purposes, primarily arising from the Recapitalization.

7
<PAGE>

The effective income tax rate for the period ended September 25, 1998
approximates the effective combined federal and state statutory rates.

6. Equity Participation Plan. In conjunction with the Recapitalization
-------------------------
discussed in Note 2 the Company paid additional amounts pursuant to the EPP.
This plan has now been terminated.

7. Long-Term Debt.
--------------

New Credit Facility

In connection with the Recapitalization, the Company entered into a new
credit agreement with a bank which provides for borrowings of up to
$100,000,000. This agreement consists of two separate facilities as follows:

Revolving credit -- maximum borrowings of $60,000,000 with a letter of
credit sublimit of $7,500,000. This facility must be prepaid upon payment
in full of the Term Loan facility.

Term loan -- maximum borrowings of $40,000,000, with quarterly installments
to be made through maturity.

Interest on the New Credit Facility is based, at the option of the Company,
upon either a eurodollar rate plus 2.25 percent, or a base rate plus 1.25
percent per annum. A commitment fee of 0.50 percent per annum will be charged
on the unused portion of the New Credit Facility. As of September 25, 1998 the
eurodollar and base rates were 5.50% and 8.25%, respectively.

The agreement provides the bank a first security interest in substantially
all of the properties and assets of the Company and a pledge of 65% of the stock
of Industrias Hudson, the Company's principal subsidiary. The agreement also
requires the Company to maintain certain financial ratios and financial
covenants, as defined in the agreement, the most restrictive of which prohibit
additional indebtedness and limit dividend payments to the Company's
stockholders. Total borrowings as of September 25, 1998 were $38,000,000 under
the Term Loan Facility and bear interest at 7.875 percent per annum. The New
Credit Facility will mature on the sixth anniversary of the closing of the
Recapitalization.

Senior Subordinated Notes

Also related to the Recapitalization, the Company issued under an Indenture
$115,000,000 of senior subordinated notes (the Notes). The Notes are fully
transferable and will be general unsecured obligations of the Company,
subordinated in right of payment to all existing and future Senior Debt of the
Company.

The Notes bear interest at a rate equal to 91/8 percent per annum from the
date of issuance of the Notes. Interest is payable semi-annually on April 15
and October 15 of each year, commencing October 15, 1998. The Notes will mature
on April 15, 2008 and will be redeemable at the option of the Company, in whole
or in part, on or after April 15, 2003.

8. Preferred Stock. Upon consummation of the Recapitalization, Holding issued
---------------
300,000 shares of Series B Senior Exchangeable Payable-In-Kind (PIK) Preferred
Stock subject to mandatory redemption at a liquidation preference of $100 per
share, plus accumulated and unpaid dividends, if any, on April 15, 2010.

Dividends on the preferred stock accrue at the rate per share of 111/2
percent per annum. Amounts due are payable in cash, except that on each
dividend payment date occurring on or prior to April 15, 2003, dividends may be
paid at Holding's option, by the issuance of additional shares of preferred
stock (including fractional shares). Dividends will be payable semi-annually on
April 15 and October 15 of each year commencing October 15, 1998. The preferred
stock ranks junior in right of payment to all obligations of Holding and its
subsidiaries. The payment made on October 15, 1998 was made by the issuance of
additional shares of preferred stock.

8
<PAGE>

9. Stockholders' Equity (Deficit). Stockholders' equity (deficit) reflects
------------------------------
the following (dollar amounts only in thousands):

<TABLE>
<CAPTION>
Common Stock
----------------------------
Number of Retained
Shares Amount Earnings Total
----------- -------- ---------- ---------
<S> <C> <C> <C> <C>
BALANCE, beginning............................................ -- $ -- $ -- $ --
Sale of common stock....................................... 6,312,500 63,125 -- 63,125
Net loss................................................... -- -- (3,594) (3,594)
--------- ------- ---------- ---------
BALANCE, September 25, 1998................................... 6,312,500 $63,125 $ (3,594) $ (59,531)
========= ======= ========== =========
</TABLE>

9
<PAGE>

HUDSON RESPIRATORY CARE INC. AND SUBSIDIARY
-------------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
ASSETS
------
(Dollar Amounts in Thousands)

<TABLE>
<CAPTION>
DECEMBER 26, SEPTEMBER 25,
1997 1998
-------------- --------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and short-term investments................................... $ 470 $ 1,306
Accounts receivable, less allowance for doubtful accounts of $258 21,282 18,963
and $391, at December 26, 1997 and September 25, 1998,
respectively
Inventories....................................................... 16,613 17,412
Other assets...................................................... 1,024 826
---------- ---------
Total current assets........................................... 39,389 38,507
---------- ---------
PROPERTY, PLANT AND EQUIPMENT, at cost:
Land............................................................ 2,044 2,044
Buildings....................................................... 13,369 14,818
Leasehold improvements.......................................... 1,322 1,322
Machinery and equipment......................................... 61,316 62,642
Furniture and fixtures.......................................... 2,128 2,277
Construction in progress........................................ 1,592 98
---------- ---------
81,771 83,201
Less--Accumulated depreciation and amortization............... 48,728 50,046
---------- ---------
33,043 33,155
---------- ---------

OTHER ASSETS:
Deferred tax asset................................................ 127 78,838
Deferred financing costs, net..................................... 119 12,153
Intangible assets, net............................................ 4,317 4,457
Other assets...................................................... 559 344
---------- ---------
5,122 95,792
---------- ---------
$ 77,554 $ 167,454
========== =========
</TABLE>

The accompanying notes are an integral part of these consolidated balance
sheets.

10
<PAGE>

HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------

CONSOLIDATED BALANCE SHEETS
---------------------------

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------

(Dollar Amounts in Thousands)

<TABLE>
<CAPTION>
DECEMBER 26, SEPTEMBER 25,
1997 1998
-------------- --------------
(UNAUDITED)
<S> <C> <C>
CURRENT LIABILITIES:
Notes payable to bank............................................ $ 4,000 $ 1,000
Accounts payable................................................. 3,842 5,364
Accrued liabilities.............................................. 5,244 10,575
Management bonus................................................. 20,000 --
-------- ---------
Total current liabilities..................................... 33,086 16,939
-------- ---------

SENIOR SUBORDINATED NOTES PAYABLE.................................. -- 115,000
-------- ---------
NOTES PAYABLE TO BANK, net of current portion...................... 16,250 37,000
-------- ---------
ACCRUED EQUITY PARTICIPATION PLAN COSTS............................ 5,703 --
-------- ---------
Total liabilities............................................. 55,039 168,939
-------- ---------

MANDATORILY REDEEMABLE PREFERRED STOCK, $100 par value:
Authorized--300,000 shares; issued and outstanding--300,000
shares at September 25, 1998; liquidation preference: $30,000.... -- 29,000
Accrued preferred stock dividend, payable-in-kind................ -- 1,648
-------- ---------
-- 30,648
-------- ---------

STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, no par value:
Authorized--15,000,000 shares, issued and outstanding--14,468,720
and 7,812,500 shares at December 26, 1997 and September 25, 1998 3,789 63,535
Cumulative translation adjustment................................ (345) (464)
Retained earnings................................................ 19,071 (95,204)
-------- ---------
22,515 (32,133)
-------- ---------
$ 77,554 $ 167,454
======== =========
</TABLE>

The accompanying notes are an integral part of these consolidated
balance sheets.

11
<PAGE>

HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(Dollar Amounts in Thousands)

<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
----------------------------------------------------------
Sept. 26, Sept. 25, Sept. 26, Sept. 25,
1997 1998 1997 1998
--------------- -------------- ----------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>

NET SALES.............................................................. $ 21,813 $ 22,130 $ 70,906 $ 68,828
COST OF SALES.......................................................... 11,116 11,548 36,504 36,691
---------- ----------- ---------- ---------
Gross Profit........................................................... 10,697 10,582 34,402 32,137
---------- ----------- ---------- ---------
OPERATING EXPENSES:
Selling........................................................... 2,231 2,489 7,020 7,180
Distribution...................................................... 1,258 1,251 3,805 3,949
General and administrative........................................ 3,099 2,772 8,598 8,528
Research and development.......................................... 443 475 1,338 1,415
---------- ----------- ---------- ---------
7,031 6,987 20,761 21,072
---------- ----------- ---------- ---------
PROVISION FOR EQUITY PARTICIPATION PLAN AND BONUSES.................... 1,212 -- 4,866 63,939
PROVISION FOR RETENTION BONUSES........................................ -- -- -- 4,754
---------- ----------- ---------- ---------
Income (loss) from operations.......................................... 2,454 3,595 8,775 (57,628)
---------- ----------- ---------- ---------
OTHER INCOME AND (EXPENSES):
Interest expense.................................................. 456 3,488 1,406 7,127
Other, net........................................................ 10 513 (635) 663
---------- ----------- ---------- ---------
466 4,001 771 7,790
---------- ----------- ---------- ---------
Income (loss) before provision (benefit) for income taxes.............. 1,988 (406) 8,004 (65,419)
PROVISION (BENEFIT) FOR INCOME TAXES (Note 5).......................... 26 (163) 105 (77,140)
---------- ----------- ---------- ---------
Income before extraordinary items...................................... 1,962 (243) 7,899 11,721
EXTRAORDINARY ITEM--loss on extinguishment of debt (Note 7)............ -- -- -- 104
---------- ----------- ---------- ---------
Net income............................................................. 1,962 (243) 7,899 11,618
Preferred stock dividends.............................................. -- 872 -- 1,648
---------- ----------- ---------- ---------
Net income (loss) available to common shareholders..................... $ 1,962 $ (1,115) $ 7,899 $ 9,970
========== =========== ========== =========
Pro forma net income (loss) assuming C corporation status for
income tax purposes
(Note 5).......................................................... $ 1,167 $ (1,115) $ 4,802 $ (41,000)
========== =========== ========== =========
</TABLE>

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

12
<PAGE>

HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Dollar Amounts in Thousands)

<TABLE>
<CAPTION>
Nine Months Ended
----------------------------------------
September 26, September 25,

1997 1998
----------------------------------------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................................ $ 7,899 $ 9,970
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization................................................... 3,641 4,869
Writeoff of deferred financing fees............................................. -- 104
Gain on disposal of equipment................................................... -- (28)
Deferred tax asset benefit...................................................... -- (78,762)
Provision for equity participation plan (EPP)................................... 4,866 63,939
(Increase) decrease in accounts receivable...................................... 5,436 2,319
(Increase) decrease in inventories.............................................. (3,940) 72
Decrease in other current assets................................................ 183 250
(Increase) decrease in other assets............................................. (206) 215
Increase (decrease) in accounts payable......................................... (729) 1,522
Increase (decrease) in accrued liabilities...................................... (402) 7,057
Payments of EPP liabilities..................................................... -- (89,642)
------------- ----------
Net cash provided by (used in) operating activities........................ 16,748 (78,115)
------------- ----------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment............................................ (2,116) (2,730)
Proceeds from sale of property, plant and equipment................................... -- --
Acquisition of the assets of Gibeck, Inc.............................................. -- (3,352)
Increase in cash surrender value of life insurance.................................... (5) --
------------- ----------
Net cash used in investing activities.............................................. (2,121) (6,082)
------------- ----------

CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable to bank.................................................... (6,146) (43,250)
Proceeds from borrowings on bank credit facility...................................... -- 61,000
Additions to deferred financing costs................................................. (10) (12,563)
Redemption of stockholder interest.................................................... -- (127,624)
Shareholder distributions............................................................. (9,330) --
Proceeds from senior subordinated debt................................................ -- 115,000
Sale of common and preferred stock, net of transaction costs.......................... -- 92,125
------------- ----------
Net cash provided by (used in) financing activities................................ (15,486) 84,688
------------- ----------

Effect of exchange rate changes on cash................................................. (26) 345
------------- ----------

NET INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS.............................. (885) 836
CASH AND SHORT-TERM INVESTMENTS, beginning of period.................................... 1,419 470
------------- ----------
CASH AND SHORT-TERM INVESTMENTS, end of period.......................................... $ 534 $ 1,306
============= ==========
</TABLE>

13
<PAGE>

<TABLE>
<CAPTION>
Nine Months Ended
--------------------------------------------
September 26, September 25,

1997 1998
----------------- -------------------
(unaudited)
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the quarter for:
Interest.................................................................... $ 1,474 $ 2,377
======== =========
Income taxes................................................................ $ 201 $ 1,659
======== =========
</TABLE>

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

14
<PAGE>

HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------

September 25, 1998
------------------
(unaudited)

1. Financial Statements. The condensed consolidated financial statements
--------------------
included herein have been prepared by the Company, without audit, and include
all adjustments which are, in the opinion of management, necessary for a fair
presentation of the financial position at September 25, 1998, the results of
operations for the three-month and nine-months periods ended September 26, 1997
and September 25, 1998, and the cash flows for the nine-month periods ended
September 26, 1997 and September 25, 1998 pursuant to the rules and regulations
of the Securities and Exchange Commission (SEC). All such adjustments are of a
normal recurring nature. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. Although the Company believes that the disclosures in such
financial statements are adequate to make the information presented not
misleading, these consolidated financial statements should be read in
conjunction with the Company's 1997 audited financial statements and the notes
thereto included in its Form S-4 filed with the SEC (Registration No. 333-
56097). The results of operations for the three-month and nine-month periods
ended September 25, 1998 and September 26, 1997 are not necessarily indicative
of the results for a full year.

2. Recapitalization. In April 1998, the Company consummated a plan pursuant
----------------
to which a majority of the Company was sold in accordance with an agreement and
plan of merger (the Recapitalization).

Key components of the Recapitalization include:

(1) common and preferred equity investments in consideration for (i) an
80.8% ownership in the Company's common stock and (ii) preferred stock with an
initial liquidation preference of $30.0 million;

(2) issuance of 9 1/8% senior subordinated notes with a par value of
$115.0 million, maturing in 2008 (see Note 8);

(3) execution of a new term loan facility and revolving loan facility (see
Note 8);

(4) repayment of existing indebtedness;

(5) payment of amounts due under the Equity Participation Plan (the Equity
Participation Plan or EPP) (see Note 6);

(6) payment for common shares acquired from the existing shareholder; this
shareholder retained a 19.2% interest in the common shares outstanding;

(7) potential contingent payments based on 1998 performance, payable to
the continuing shareholder and former participants in the Equity Participation
Plan.

The Company effected a 245:1 stock split concurrent with the
Recapitalization. The stock split has been reflected in the stock amounts shown
herein.

15
<PAGE>

The Recapitalization resulted in no change to the carrying amounts of the
Company's assets and liabilities.

3. Inventories. Inventories consisted of the following:
-----------

<TABLE>
<CAPTION>
DECEMBER 26, SEPTEMBER 25,
1997 1998
-------------- ---------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Raw materials........................... $ 4,802 $ 4,261
Work-in-process......................... 4,681 4,316
Finished goods.......................... 7,130 8,835
--------- ---------
$ 16,613 $ 17,412
========= =========
</TABLE>

The Company had comprehensive income for the three-month and nine-month
periods ended September 25, 1998 and September 26, 1997 as follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------------- ---------------------------------------
SEPTEMBER 26, SEPTEMBER 25, SEPTEMBER 26, SEPTEMBER 25,
1997 1998 1997 1998
------------------- ----------------- ------------------- ------------------
<S> <C> <C> <C> <C>
(AMOUNTS IN THOUSANDS)
Net income........................................ $ 1,962 $ (1,115) $ 7,899 $ 9,970
Other comprehensive income:
Foreign currency translation gain (loss).......... (33) -- (26) (21)
--------- --------- -------- --------
Comprehensive income.............................. $ 1,929 $ (1,115) $ 7,873 $ 9,949
========== ========= ======== ========
</TABLE>

5. Income Taxes. The Company became a C corporation upon consummation of the
------------
transaction discussed in Note 2. Accordingly, the Company has presented pro
forma net income (loss) amounts to reflect a provision for income taxes at a
combined effective rate of approximately 40%, after consideration of permanent
differences between financial reporting and income tax amounts. The pro forma
amounts presented do not include the one-time effect of the conversion to C
corporation status reflected in the June 1998 financial statements.

The actual provision for income taxes for the three-month and nine-month
periods in 1998 reflect that the Company was a C corporation for a portion of
the period presented. The conversion from S corporation to C corporation
resulted in a one-time benefit of $78,526,000 in the quarter ended June 26,
1998.

The tax provision (benefit) for the three and nine-month periods ended
September 25, 1998 consists of the following:

16
<PAGE>

<TABLE>
<CAPTION>
THREE NINE
MONTHS MONTHS
---------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Income taxes at combined statutory rate of 40 percent........................................... $ (162) $ (26,168)
Effect of earnings during S corporation period and S corporation state income tax
liability arising from Section 338(h)(10) election............................................. -- 27,554
Benefit of recordation of deferred tax asset upon conversion to C corporation status............ -- (78,526)
-------- ---------
$ (162) $ (77,140)
======== =========
</TABLE>

6. Equity Participation Plan. In March 1998, the Company paid previously-
-------------------------
accrued bonuses totaling $20 million, plus related payroll taxes. These payments
were funded by additional borrowings under the existing credit facility. The
provision for Equity Participation Plan costs were estimated on an interim basis
for periods prior to the Recapitalization based upon the expected provision for
the year as a percentage of income before the provision for Equity Participation
Plan costs.

In conjunction with the Recapitalization discussed in Note 2 the Company
paid additional amounts pursuant to the Equity Participation Plan. This plan has
now been terminated.

7. Extraordinary Item. In accordance with the Recapitalization, the Company
------------------
recorded an extraordinary loss on the extinguishment of the existing debt
related to the write-off of unamortized deferred finance fees of $104,000.

8. Long-Term Debt.
--------------

New Credit Facility

In connection with the Recapitalization, the Company has entered into a new
credit agreement with a bank which provides for borrowings of up to
$100,000,000. This agreement consists of two separate facilities as follows:

Revolving credit -- maximum borrowings of $60,000,000 with a letter of
credit sublimit of $7,500,000. This facility must be prepaid upon payment
in full of the Term Loan facility.

Term loan -- maximum borrowings of $40,000,000, with quarterly installments
to be made through maturity.

Interest on the New Credit Facility is based, at the option of the Company,
upon either a eurodollar rate plus 2.25 percent, or a base rate plus 1.25
percent per annum. A commitment fee of 0.50 percent per annum will be charged on
the unused portion of the New Credit Facility. As of September 25, 1998 the
eurodollar and base rates were 5.50% and 8.25%, respectively.

Total borrowings as of September 25, 1998 were $38,000,000 under the Term
Loan Facility and bear interest at 7.875 percent per annum. The New Credit
Facility will mature on the sixth anniversary of the closing of the
Recapitalization.

17
<PAGE>

Senior Subordinated Notes

Also related to the Recapitalization, the Company issued under an Indenture
$115,000,000 of senior subordinated notes (the Notes). The Notes are fully
transefable and are general unsecured obligations of the Company, subordinated
in right of payment to all existing and future senior debt, as defined, of the
Company.

The Notes bear interest at a rate equal to 9 1/8 percent per annum from the
date of issuance of the Notes. Interest is payable semi-annually on April 15 and
October 15 of each year, commencing October 15, 1998. The Notes will mature on
April 15, 2008 and will be redeemable at the option of the Company, in whole or
in part, on or after April 15, 2003.

9. Preferred Stock. Upon consummation of the Recapitalization, the Company
---------------
issued 300,000 shares of Senior Exchangeable Payable-In-Kind (PIK) Preferred
Stock subject to mandatory redemption at a liquidation preference of $100 per
share, plus accumulated and unpaid dividends, if any, on April 15, 2010.

Dividends on the preferred stock accrue at the rate per share of 11 1/2
percent per annum. Amounts due are payable in cash, except that on each dividend
payment date occurring on or prior to April 15, 2003, dividends may be paid at:
the Company's option, by the issuance of additional shares of preferred stock
(including fractional shares). Dividends will be payable semi-annually in
arrears on April 15 and October 15 of each year commencing October 15, 1998. The
preferred stock will rank junior in right of payment to all obligations of the
Company and its subsidiaries. The payment made on October 15, 1998 was made by
the issuance of additional shares of preferred stock.

10. Acquisitions. During the third quarter of 1998, the Company acquired
------------
certain assets of Gibeck, Inc. ("Gibeck") for a purchase price of $3,351,500.
Gibeck is engaged primarily in the business of manufacturing, marketing and
selling disposable anesthesia supplies. The acquisition was accounted for as a
purchase, and the purchase price was allocated as follows based on the relative
fair values of the assets acquired:

<TABLE>
<S> <C>
Inventory....................................................... $ 871,274
Machinery & Equipment........................................... 1,500,000
Goodwill........................................................ 980,226
----------
$3,351,500
==========
</TABLE>

11. Stockholders' Equity (Deficit). Stockholders' equity (deficit) reflects the
-----------------------------
following (dollar amounts only in thousands):

<TABLE>
<CAPTION>
Common Stock
------------------------- Cumulative
Number of Translation Retained
Shares Amount Adjustment Earnings Total
------------ ---------- ------------ ----------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE, December 26, 1997.......................... 14,468,720 $ 3,789 $ (345) $ 19,071 $ 22,515
Foreign currency translation adjustment............. -- -- (119) -- (119)
Stockholder redemption.............................. (12,968,720) (3,379) -- (124,245) (127,624)
Recapitalization investment......................... 6,300,000 63,000 -- -- 63,000
Issuance of common stock............................ 12,500 125 -- -- 125
Net income.......................................... -- -- -- 9,970 9,970
------------ ------- -------- ---------- ----------
BALANCE, September 25, 1998......................... 7,812,500 $63,535 $ (464) $ (95,204) $ (32,133)
============ ======= ======== ========== ==========
</TABLE>

18
<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

As River Holding Corp. ("Holding") is a holding company with no operations,
the following discussion relates to Hudson Respiratory Care Inc. (the "Company"
or "Hudson RCI"). The following discussion of the Company's consolidated
historical results of operations and financial condition should be read in
conjunction with the consolidated financial statements of the Company and the
notes thereto included elsewhere in this Form 10-Q. The following discussion and
analysis covers periods before completion of the Recapitalization, as described
below. See "Risk Factors" for a further discussion relating to the effect that
the transactions described herein may have on the Company.

FORWARD-LOOKING STATEMENTS

This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains certain "forward-looking statements" as defined
in the Private Securities Litigation Reform Act of 1995. Such statements
relating to events and financial performance are forward-looking statements
involving risks and uncertainties that are detailed from time to time in the
Company's Securities and Exchange Commission filings. See "Risk Factors" below.

GENERAL

The Company is a leading manufacturer and marketer of disposable medical
products utilized in the respiratory care and anesthesia segments of the
domestic and international health care markets. The Company's principal products
include oxygen masks, humidification systems, nebulizers, cannulae and tubing.
In the United States, the Company markets its products to a variety of health
care providers, including hospitals and alternate site service providers such as
outpatient surgery centers, long-term care facilities, physician offices and
home health care agencies. Internationally, the Company sells its products to
distributors who market to hospitals and other health care providers. In 1997,
63.6% of the Company's net sales were generated from the domestic hospital
market, 19.1% from the export market, 14.7% from alternate site provider market
and 2.7% from OEM and other markets. The Company's products are sold to over
2,500 distributors and alternate site service providers throughout the United
States and in more than 75 countries worldwide.

The Company developed and introduced disposable products for the anesthesia
market starting in 1995. Since that time, sales of anesthesia products have and
in 1997 contributed $6.5 million in net sales. Net sales from new respiratory
and anesthesia products introduced since 1992 represented approximately 18% of
the Company's total net sales in fiscal 1997. During the third quarter of 1998,
the Company acquired certain assets of Gibeck, Inc. ("Gibeck") for approximately
$3.35 million. Prior to the transaction, Gibeck was engaged primarily in the
business of manufacturing, marketing and selling disposable anesthesia supplies.
In addition to the sale of its self-manufactured products, Gibeck was the
exclusive North American distributor of its parent company's, Louis Gibeck, AB
("LGAB"), Heat Moisture Exchange ("HME") product line. As a result of the
transaction, Hudson RCI is now the exclusive North American distributor for the
LGAB HME products. In fiscal year 1997, Gibeck reported net sales of
approximately $12.3 million.

In 1994, the Company established a sales force dedicated to sales of the
Company's products to international markets. The international sales effort has
focused largely on major and growing markets for the Company's products. In
fiscal 1997, the Company's products were sold to health care providers and
distributors in more than 75 international markets representing $19.0 million in
net sales. With the increasing trend toward providing health care outside of
traditional hospital settings and the rapid growth of alternate site health care
providers, the Company established in 1995 an independent sales force dedicated
to this market. Sales of products to alternate site distributors and/or health
care providers represented approximately $14.6 million in net sales in fiscal
1997.

The Company's results of operations may fluctuate significantly from
quarter to quarter as a result of a number of factors, including, among others,
the buying patterns of the Company's distributors, general purchasing
organizations ("GPOs") and other purchasers of the Company's products, forecasts
regarding the severity of the annual cold and flu season, announcements of new
product introductions by the Company or its competitors, changes in the
Company's

19
<PAGE>

pricing of its products and the prices offered by the Company's competitors,
rate of overhead absorption due to variability in production levels and
variability in the number of shipping days in a given quarter.

Results for the second quarter of 1998 were adversely impacted because,
among other things, of the decrease in demand from hospitals affiliated with the
Premier GPO, as the Premier contract for respiratory supplies was awarded to a
competitor of the Company, and the discontinuance of a distribution-related
strategic alliance in Germany with an international health care supplier. As a
result, the Company was not in compliance with certain covenants under the New
Credit Facility, so certain of the financial covenants in the New Credit
Facility were amended.

THE RECAPITALIZATION

On April 7, 1998, Hudson RCI consummated its recapitalization pursuant to
an Agreement and Plan of Merger pursuant to which River Acquisition Corp., a
subsidiary of River Holding Corp. ("Holding") merged with and into Hudson RCI,
with Hudson RCI surviving as a majority-owned subsidiary of Holding (the
"Merger").

Pursuant to the Recapitalization, Holding contributed approximately $93.0
million in equity capital into Hudson RCI (the "Holding Equity Investment") and
a shareholder of Hudson RCI (the "Continuing Shareholder") retained common stock
of Hudson RCI with a value of approximately $15.0 million (the "Rollover
Equity"), based on the valuation of Hudson RCI used in the Recapitalization. In
the Merger, a portion of the Hudson RCI common stock was converted into the
right to receive approximately $131.1 million in cash, and management received
$88.3 million pursuant to the Company's Equity Participation Plan (the "Equity
Participation Plan" or "EPP"). Following the Holding Equity Investment, Holding
owned 80.8% of the outstanding common stock of Hudson RCI and the Continuing
Shareholder owned 19.2% of the outstanding common stock of Hudson RCI.

The Holding Equity Investment was comprised of $63.0 million of common
equity (the "Common Stock Investment") and $30.0 million of preferred equity
(the "Preferred Stock Investment"). The Common Stock Investment was funded with
a $55.0 million investment by affiliates of Freeman Spogli & Co. Incorporated
("FS&Co."), and an $8.0 million investment by management of Hudson RCI. The
Preferred Stock Investment was funded with proceeds from the sale of 11 1/2%
Senior Exchangeable PIK Preferred Stock due 2010 (the "Holding Preferred Stock")
with an aggregate liquidation preference of $30.0 million offered by Holding
(the "Preferred Stock Offering"). Immediately following consummation of the
Recapitalization, FS&Co. beneficially owned approximately 87.3% of the
outstanding common stock of Holding and management owned the remaining 12.7%.

In connection with the Recapitalization and concurrently with the Preferred
Stock Offering, Hudson RCI offered $115.0 million aggregate principal amount of
9 1/2% Senior Subordinated Notes due 2008 (the "Subordinated Notes") (the
"Subordinated Notes Offering," and together with the Preferred Stock Offering,
the "Offerings").

On April 7, 1998, Hudson RCI entered into an agreement (the "New Credit
Facility") providing for a $40.0 million secured term loan facility (the "Term
Loan Facility"), which was funded in connection with the consummation of the
Recapitalization, and a $60.0 million revolving loan facility (the "Revolving
Loan Facility") which will be available for Hudson RCI's future capital
requirements and to finance acquisitions.

The Offerings and the application of the net proceeds therefrom, repayment
of existing Hudson RCI debt payments to the Continuing Shareholder under the
Recapitalization Agreement and to management, the Holding Equity Investment and
the related borrowings under the New Credit Facility are collectively referred
to herein as the "Recapitalization."

The Company and the shareholders that received distributions in the
Recapitalization made an election under Section 338(h)(10) of the Internal
Revenue Code of 1986, as amended, to treat the Recapitalization as an asset
purchase for tax purposes, which will have the effect of significantly
increasing the basis of the Company's assets, thus increasing depreciation and
amortization expenses and other deductions for tax purposes and reducing the
Company's taxable income in 1998 and subsequent years. The Recapitalization
resulted in no change in the basis of the Company's assets and liabilities for
financial reporting purposes.

20
<PAGE>

RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
Three Month Period Ended Nine Month Period Ended
(unaudited) (unaudited)
---------------------------- -------------------------
Sept. 26, Sept. 25, Sept. 26, Sept. 25,
1997 1998 1997 1998
------------ ----------- -------------------------
(dollars in thousands) (dollars in thousands)
<S> <C> <C> <C> <C>
Net sales................................................... $ 21,813 $ 22,130 $ 70,906 $ 68,828
Cost of sales............................................... 11,116 11,548 36,504 36,691
------------ ----------- ----------- ----------
Gross profit................................................ 10,697 10,582 34,402 32,137
Selling expenses............................................ 2,231 2,489 7,020 7,180
Distribution expenses....................................... 1,258 1,251 3,805 3,949
General and administrative expenses......................... 3,099 2,772 8,598 8,528
Research and development expenses........................... 443 475 1,338 1,415
Provision for equity participation plan..................... 1,212 -- 4,866 63,939
Provision for retention payments............................ -- -- -- 4,754
------------ ----------- ----------- ----------
Total operating expenses.................................... 8,243 6,987 25,627 89,765
------------ ----------- ----------- ----------
Operating income (loss)..................................... 2,454 3,595 8,775 (57,628)
Add back: Provision for equity participation plan.......... 1,212 -- 4,866 63,939
Add back: Provision for retention payments.................. -- -- -- 4,754
------------ ----------- ----------- ----------

Operating income before provisions for equity............... $ 3,666 $ 3,595 $ 13,641 $ 11,065
participation plan and retention payments.................. ============ =========== =========== ==========

<CAPTION>
Three Month Period Ended Nine Month Period Ended
---------------------------- -------------------------
Sept. 26, Sept. 25, Sept. 26, Sept. 25,
1997 1998 1997 1998
------------ ----------- -------------------------
<C> <C> <C> <C>
Net sales................................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales............................................... 51.0 52.2 51.5 53.3
------ ------- ------ -----
Gross profit.............................................. 49.0 47.8 48.5 46.7
Selling expenses............................................ 10.2 11.3 9.9 10.4
Distribution expenses....................................... 5.8 5.7 5.4 5.7
General and administrative expenses......................... 14.2 12.5 12.1 12.4
Research and development expenses........................... 2.0 2.1 1.9 2.1
Provision for equity participation plan..................... 5.6 -- 6.9 92.9
Provision for retention payments............................ -- -- -- 6.9
------ ------- ------ -----
Total operating expenses.................................... 37.8 31.6 36.1 130.4
------ ------- ------ -----
Operating income (loss)..................................... 11.3 16.2 12.4 (83.7)
Add back: Provision for equity participation plan.......... 5.6 -- 6.9 92.9
Add back: Provision for retention payments.................. -- -- -- 6.9
------ ------- ------ -----
Operating income before provisions for equity............... 16.8% 16.2% 19.2% 16.1%
participation plan and retention payments.................. ====== ======= ====== =====
</TABLE>

21
<PAGE>

Three Months Ended September 25, 1998 Compared to Three Months Ended
September 26, 1997

Net sales, reported net of accrued rebates, were $22.1 million in the third
quarter of 1998, an increase of $0.3 million or 1.5% from the same quarter in
1997. Export sales increased by $0.2 million or 5.6% primarily due to the
availability of common European ("CE") compliant labeled product, which was not
available in the second quarter of 1998. Alternate site sales increased $0.2
million or 5.1% as the Company continued to focus its sales efforts on this
growing market. Canadian sales increased by $0.3 million or 172% as a national
contract for supplying a portion of the Company's product line was awarded to
the Company in the first quarter of 1998. OEM sales, which are primarily sales
to other companies that either resell the product or incorporate it into their
products increased by $0.4 million or 6.9% primarily due to cyclical orders by
certain customers in the third quarter of 1998 that did not occur in the third
quarter of 1997. Partially offsetting these gains was a $0.7 million or 5.1%
decrease in sales to domestic hospitals. This decrease was primarily due to the
decrease in demand by hospitals affiliated with the Premier GPO, as the Premier
contract for respiratory products was awarded to a competitor in February 1997.

The Company's gross profit for the third quarter of 1998 was $10.6 million,
a decline of $0.1 million or 0.9% from the third quarter of 1997. As a
percentage of sales, the Company's gross profit margin was 47.8% as compared to
49.0% in the third quarter of 1997. This decline was primarily due to an
unfavorable product mix variance resulting from the sales of more products with
a lower profit margin.

Selling expenses, consisting primarily of sales force salaries, were $2.5
million for the third quarter of 1998, an increase of $0.3 million or 11.6% from
the third quarter of 1997. The primary cause of this increase was increased
compensation paid to the sales force and increases in fees paid to certain GPOs
resulting from higher sales volumes to those GPOs. As a percentage of sales,
selling expenses increased to 11.2% in the third quarter of 1998 as compared to
10.2% for the same quarter in 1997.

Distribution expenses, consisting primarily of freight charges from the
Company's warehouses to its domestic customers, were $1.3 million in the third
quarter of 1998, the same level as the third quarter of 1997. As a percentage
of sales, distribution expenses were 5.7% for the third quarter of 1998 as
compared to 5.8% for the same quarter in 1997.

General and administrative expenses consist primarily of salaries and other
expenses for corporate management, finance, accounting, regulatory and human
resources. General and administrative expenses for the third quarter of 1998
were $2.8 million, a decrease of $0.4 million or 10.6% from the third quarter of
1997. This decline was due primarily to the elimination of the Company aircraft
as well as other expenses eliminated as a result of the Recapitalization. As a
percentage of sales, general and administrative expenses were 12.5% in 1998
compared to 14.2% in 1997.

Research and development expenses for the third quarter of 1998 were $0.5
million, an increase of $32,000 over the third quarter of 1997.

The provision for Equity Participation Plan consists of accrued expenses
and payments made to executives under the Equity Participation Plan. In the
second quarter of 1998, as a result of the Recapitalization, the Equity
Participation Plan was discontinued. Accordingly, no expense was recorded in the
third quarter of 1998 while $1.2 million was recorded in the third quarter of
1997.

Interest expense was $3.5 million in the third quarter of 1998, an increase
of $3.0 million over the third quarter of 1997. This increase was due to higher
debt levels during the third quarter of 1998 as a result of the
Recapitalization.

Income tax expense reflects termination of the Company's S corporation
status upon the Recapitalization. The Company now provides for federal and state
income taxes as a C corporation, although actual payments are expected to be
substantially less than provided amounts due to the tax basis in assets provided
by the Section 338(h)(10) election.

22
<PAGE>

Nine Months Ended September 25, 1998 Compared to Nine Months Ended September 26,
1997

Net sales, reported net of accrued rebates were $68.8 million in the third
quarter of 1998, a decrease of $2.1 million or 2.9% from the same period in
1997. Domestic hospital sales declined by $3.6 million or 8.1%, due primarily to
the decreased demand by hospitals affiliated with the Premier GPO, as the
Premier contract for respiratory supplies was awarded to a competitor in
February 1997. This decline was partially offset by an increase in alternate
site sales of $0.9 million or 8.0% as the Company continued to focus its sales
efforts in this growing market.

The Company's gross profit for the first nine months of 1998 was $32.1
million, a decline of $2.3 million or 6.6% from the first nine months of 1997.
As a percentage of sales, the Company's gross profit margin was 46.7% for the
first nine months of 1998 as compared to 48.5% for the same period in 1997.
This decline was primarily due to lower sales volumes during the first nine
months of 1998 as compared to 1997 and due to the underabsorption of overhead
resulting from the Company's efforts to reduce inventories in combination with a
relatively consistent level of sales volumes. On an interim basis, the Company
allocates actual manufacturing costs between cost of sales and inventory based
on actual production levels. The Company decreased production and reduced
inventories by $0.3 million (exclusive of a large, one-time purchase of finished
goods in the third quarter of 1998) in the first nine months of 1998 as compared
to an increase in inventories of $4.0 million in the first nine months of 1997.
The decline in inventories caused approximately $0.9 million of additional
overhead to be charged to cost of sales in the first nine months of 1998. In
addition, the Company experienced an unfavorable product mix variance in the
third quarter of 1998.

Selling expenses were $7.2 million for the first nine months of 1998, an
increase of $0.2 million or 2.3% over the first nine months of 1997. As a
percentage of sales, selling expenses increased to 10.4% in 1998 as compared to
9.9% on 1997. This increase is primarily attributable to higher sales volumes
in the first nine months of 1997 as compared to 1998.

Distribution expenses were $3.9 million for the first nine months of 1998,
an increase of $0.1 million over the same time period in 1997. The increase is
primarily the result of increased freight rates from carriers. As a percentage
of sales, distribution expenses increased to 5.7% as compared to 5.4% in 1997.

General and administrative expenses for the first nine months of 1998 were
$8.5 million as compared to $8.6 million for the first nine months of 1997. The
Company incurred approximately $300,000 in legal fees in 1998 relating to the
successful defense of a patent infringement lawsuit. This increase was more than
offset by the elimination of certain recurring expenses as a result of the
Recapitalization. As a percentage of sales, general and administrative expenses
were 12.4% in 1998 as compared to 12.1% in 1997. This increase is due primarily
to lower sales volumes for the first nine months of 1998 as compared to 1997.

Research and development expenses for the first nine months of 1998 were
$1.4 million, a $76,000 increase over the first nine months of 1997.

In the first nine months of 1998, the provision for Equity Participation
Plan was $63.9 million, which included approximately $1.3 million in employer
taxes relating to the distribution made under the Equity Participation Plan.

The provision for retention payments, including related employer payroll
taxes, was $4.8 million in the first nine months of 1998. These payments were
made to substantially every employee in the Company and were intended to ensure
the continued employment of all employees after the Recapitalization. No future
payments are anticipated.

Interest expense was $7.1 million for the first nine months of 1998, an
increase of $5.7 million over the first nine months of 1997. The increase was
due to higher debt levels during the first nine months of 1998 as a result of
the Recapitalization.

Income tax expense reflects the effects of the termination of the Company's
S corporation status upon the Recapitalization. The Company now provides for
federal and state income taxes as a C corporation, although actual

23
<PAGE>

payments are expected to be substantially less than provided amounts due to the
tax basis in assets provided by the Section 338(h)(10) election.

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary sources of liquidity are cash flow from operations
and borrowing under its working capital facility. Cash provided by operations
before EPP payments totaled $16.7 million in the nine months ended September 26,
1997 and $11.6 million in the nine months ended September 25, 1998. The Company
had operating working capital, excluding cash and short-term debt, of $23.9
million at September 25, 1998. Inventories were $16.6 million and $17.4 million
at December 26, 1997 and September 25, 1998, respectively. In order to meet the
needs of its customers, the Company must maintain inventories sufficient to
permit same-day or next-day filling of most orders. Over time, the Company
expects its level of inventories to increase as the Company's sales in the
international market increase. Accounts receivable, net of allowances, were
$21.3 million and $19.0 million at December 26, 1997 and September 25, 1998,
respectively. The Company offers 30 day credit terms to its U.S. hospital
distributors. Alternate site and international customers typically receive 60 to
90 day terms and, as a result, as the Company's alternate site and international
sales have increased, the amount and aging of its accounts receivable have
increased. The Company anticipates that the amount and aging of its accounts
receivable will continue to increase. The Company is exploring the utilization
in 1999 of a distribution warehouse outside of the United States. While this
will have the effect of increasing the Company's investment in inventories, it
may also result in improved service to international customers as well as in
lower international accounts receivable than would otherwise be the case because
customers will receive products, and consequently pay for them, more quickly.

In connection with the Recapitalization, the Company made cash payments
under the Equity Participation Plan of $88.3 million in the nine months ended
September 25, 1998, which it funded with the proceeds of the debt and equity
transactions that were part of the Recapitalization.

During the nine months ended September 26, 1997, net cash used in investing
activities was $2.1 million, reflecting purchases of property. During the nine
months ended September 25, 1998, net cash used in investing activities was $6.1
million, primarily for capital expenditures and the acquisition of the assets of
Gibeck. The Company currently estimates that capital expenditures will be
approximately $6.0 million in each of 1998 and 1999, consisting primarily of
additional and replacement manufacturing equipment and new heater placements.

During the nine months ended September 26, 1997, net cash used in financing
activities was $15.5 million, consisting primarily of repayment of debt and
shareholder distributions. During the nine months ended September 25, 1998, net
cash provided by financing was $84.7 million reflecting net borrowing by the
Company.

The Company has outstanding $153.0 million of indebtedness, consisting of
$115.0 million of Subordinated Notes issued in connection with the
Recapitalization and borrowings of $38.0 million under the New Credit Facility
entered into in connection with the Recapitalization. The New Credit Facility
consists of a $40.0 million Term Loan Facility (all of which was funded in
connection with the Recapitalization) and a $60.0 million Revolving Loan
Facility. The Subordinated Notes bear interest at the rate of 9 1/8%, payable
semiannually, and will require no principal repayments until maturity. The Term
Loan Facility matures on the sixth anniversary of the initial borrowing and
requires principal repayments of between $3.0 million and $11.5 million each
year until maturity, commencing on June 30, 1999. The Revolving Loan Facility
matures on the sixth anniversary of the initial borrowing and bears interest
based on a spread over either a eurodollar or base rate.

In connection with the Recapitalization, the Company issued to Holding
300,000 shares of its 11 1/2% Senior PIK Preferred Stock due 2010 with an
aggregate liquidation preference of $30.0 million, which has terms and
provisions materially similar to those of the Holding Preferred Stock. At the
election of the Company, dividends may be paid in kind until April 15, 2003 and
thereafter must be paid in cash. At the election of Holding, dividends on the
Holding Preferred Stock may be paid in kind until April 15, 2003 and thereafter
must be paid in cash.

The Company believes that after giving effect to the Recapitalization and
the incurrence of indebtedness related thereto, based on current levels of
operations and anticipated growth, its cash from operations, together with other

24
<PAGE>

available sources of liquidity, including borrowings available under the
Revolving Loan Facility, will be sufficient over the next several years to fund
anticipated capital expenditures and acquisitions and to make required payments
of principal and interest on its debt, including payments due on the
Subordinated Notes and obligations under the New Credit Facility. The Company
intends to selectively pursue strategic acquisitions, both domestically and
internationally, to expand its product line, improve its market share positions
and increase cash flows. Financing for such acquisitions is available, subject
to limitations, under the New Credit Facility. Any significant acquisition
activity by the Company in excess of such amounts would require additional
capital, which could be provided through capital contributions or debt
financing. The Company has no commitments for such acquisition financing and to
the extent financing is unavailable, acquisitions may be delayed or not
completed.

YEAR 2000 COMPLIANCE

A significant percentage of software that runs on most computers relies on
two-digit date codes to perform computations and decision-making functions.
Commencing on January 1, 2000, these computer programs may fail from an
inability to interpret date codes properly, misinterpreting "00" as the year
1900 rather than 2000. The Company has completed the identification of all
necessary internal software changes to ensure that it does not experience any
loss of critical business functionality due to the Year 2000 issue. The Company
has already completed an assessment of all internal software, hardware and
operating systems. The Company does not believe that its systems will encounter
any material "Year 2000" problems. Since the internal Year 2000 issues
identified by the Company do not require any significant changes to hardware or
software, the Company does not believe that the cost to correct them will be
material. The Company plans to make all required enhancements to its software
during the second quarter of 1999. The Company's products are not subject to
Year 2000 problems.

The Company also relies, directly and indirectly, on the external systems
of various independent business enterprises, such as its customers, suppliers,
creditors, financial organizations, and of governments, for the accurate
exchange of data and related information. The Company could be affected as a
result of any disruption in the operation of the various third-party enterprises
with which the Company interacts. The Company is in the process of implementing
a program to assess and monitor the progress of these third parties in resolving
Year 2000 issues, and to determine whether any Year 2000 issues encountered by a
third party would pose a business risk to the Company. Toward this goal, the
Company is developing a survey to be sent to its key trading partners to assess
its Year 2000 risk based upon the Year 2000 issues of its partners. The Company
expects these that the surveys will be mailed by December 31, 1999 and the
assessment completed by mid-year 1999. The Company does not expect the cost of
this program to be material. The Company has begun to develop contingency plans
in the event a business interruption caused by Year 2000 problems should occur,
including investigating back-up suppliers. The Company cannot provide any
assurance that Year 2000 related systems issues of third parties will be
corrected in a timely manner or that the failure of these third parties to
correct these issues would not have a material adverse effect on the Company.

The total costs of the Year 2000 program are anticipated to be less than
$100,000, none of which has been expended to date. The costs and time estimates
of the Year 2000 project are based on the Company's best estimates. There can be
no assurance that these estimates will be achieved and that planned results will
be achieved. Risk factors include, but are not limited to, the retention of
internal resources dedicated to the project and the successful completion of key
business partners' Year 2000 projects.

RECENT ACCOUNTING PRONOUNCEMENTS

Statement of Financial Accountings Standards ("SFAS") No. 129 Disclosure of
Information about Capital Structure was issued in February 1997 and was adopted
by the Company as of December 26, 1997. SFAS No. 130 Reporting Comprehensive
Income and SFAS No. 131 Disclosures about Segments of an Enterprise and Related
Information were issued in June 1997. SFAS No. 130 was adopted by the Company in
the first quarter of fiscal 1998. SFAS No. 131 will initially be adopted in the
Company's 1998 year-end financial statements. SFAS No. 133 Accounting for
Derivative Instruments and Hedging Activities was issued in June 1998. Because
the Company has no derivative instruments and does not engage in hedging
activities, SFAS No. 133 will not impact the Company.

25
<PAGE>

RISK FACTORS

SUBSTANTIAL LEVERAGE; SHAREHOLDERS' DEFICIT

As of September 25, 1998, Hudson RCI had $153.0 million of outstanding
indebtedness and a shareholders' deficit of $32.1 million. This level of
indebtedness is substantially higher than the Company's historical debt levels
and may reduce the flexibility of the Company to respond to changing business
and economic conditions. In addition, subject to the restrictions in the New
Credit Facility, the certificate of designation for the Holding Preferred Stock
(the "Certificate of Designation") and the indenture governing the Subordinated
Notes (the "Indenture"), the Company may incur additional senior or other
indebtedness from time to time to finance acquisitions or capital expenditures
or for other general corporate purposes. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources." The New Credit Facility, the Certificate of Designation and the
Indenture restrict, but do not prohibit, the payment of dividends by Hudson RCI
to Holding to finance the payment of dividends on the Holding Preferred Stock.

The Company's high degree of leverage may have significant consequences for
the Company and the holders of Holding Preferred Stock including: (i) the
ability of the Company to obtain additional financing for working capital,
capital expenditures, acquisitions or other purposes, if necessary, may be
impaired; (ii) a substantial portion of the Company's cash flow will be
dedicated to the payment of interest and principal on its indebtedness and will
not be available to the Company for its operations and future business
opportunities; (iii) the covenants governing the Holding Preferred Stock and
those contained in the Indenture and the New Credit Facility will limit the
Company's ability to, among other things, borrow additional funds, dispose of
assets or make investments and may affect the Company's flexibility in planning
for, and reacting to, changes in business conditions; (iv) indebtedness under
the New Credit Facility will be at variable rates of interest, which will cause
the Company to be vulnerable to increases in interest rates; (v) the Certificate
of Designation, the Indenture and the New Credit Facility contain financial and
restrictive covenants, the failure to comply with which may result in an event
of default which, if not cured or waived, could have a material adverse effect
on the Company; (vi) the indebtedness outstanding under the New Credit Facility
is secured and such indebtedness as well as indebtedness of Hudson RCI under the
Subordinated Notes matures prior to the mandatory redemption date or maturity of
the Holding Preferred Stock; (vii) the Company may be substantially more
leveraged than certain of its competitors, which may place the Company at a
competitive disadvantage; and (viii) the Company's high degree of leverage may
make it more vulnerable to a downturn in its business or the economy generally
or limit its ability to withstand competitive pressures. If the Company is
unable to generate sufficient cash flow from operations in the future to service
its indebtedness, it may be required to refinance all or a portion of its
existing debt or to obtain additional financing. There can be no assurance that
any such actions could be effected on a timely basis or on satisfactory terms or
that these actions would enable the Company to continue to satisfy its capital
requirements. The Company's ability to meet its debt service and preferred stock
dividend and redemption obligations and to reduce its total indebtedness will be
dependent upon the Company's future performance, which will be subject to
general economic conditions and to financial, business and other factors
affecting the operations of the Company, many of which are beyond its control.
The terms of the Company's indebtedness, including the New Credit Facility and
the Indenture, and the terms of the Holding Preferred Stock also may prohibit
the Company from taking such actions.

HOLDING'S ABILITY TO PAY DIVIDENDS; HOLDING COMPANY STRUCTURE

The ability of Holding to pay any dividends is subject to applicable
provisions of state law and its ability to pay cash dividends on the Holding
Preferred Stock will be subject to the terms of the New Credit Facility, which
restricts Holding's ability to pay dividends, and any other indebtedness of
Holding then outstanding. Under Delaware law, Holding is permitted to pay
dividends on its capital stock, including the Holding Preferred Stock, only out
of its surplus, or in the event that it has no surplus, out of its net profits
for the year in which a dividend is declared or for the immediately preceding
fiscal year. Surplus is defined as the excess of a company's total assets over
the sum of its total liabilities plus the par value of its outstanding capital
stock. In order to pay dividends in cash, Holding must have surplus or net
profits equal to the full amount of the cash dividend at the time such dividend
is declared. Holding cannot predict what the value of its assets or the amount
of its liabilities will be in the future and, accordingly, there can be no
assurance that Holding will be able to pay cash dividends on the Holding
Preferred Stock. In addition, Holding may be subject to Section 2115 of the
California Corporations Code. If so, under California law, certain provisions of
the

26
<PAGE>

California Corporations Code will be applicable to Holding, including those
relating to the payment of dividends. These provisions, which are more
restrictive than analogous provisions of Delaware law, would permit Holding to
pay dividends only if the amount of retained earnings immediately prior to the
dividend equals or exceeds the amount of the dividend, or if immediately after
payment of the dividend the sum of Holding's assets is 1 1/4 times its
liabilities and its current assets at least equal its current liabilities (or,
if Holding's average earnings before income taxes and interest expense for the
two preceding fiscal years was less than its average interest expense for those
fiscal years, Holding's current assets must be at least 1 1/4 times its current
liabilities).

Holding is a holding company, and its ability to pay dividends on the
Holding Preferred Stock is dependent upon the receipt of dividends from its
direct and indirect subsidiaries. Holding has no assets other than the capital
stock of Hudson RCI and the terms of the New Credit Facility, the Indenture and
the Certificate of Designation prohibit Holding from engaging in any business
activity other than owning the capital stock of Hudson RCI. Hudson RCI is a
party to the New Credit Facility and the Indenture, each of which imposes
restrictions on Hudson RCI's ability to pay dividends to Holding. The New Credit
Facility prohibits the Company from paying cash dividends before April 15, 2003,
and any payment of dividends will be subject to the satisfaction of certain
financial conditions set forth in the Indenture. The ability of Hudson RCI and
its subsidiaries to comply with such conditions may be affected by events that
are beyond the control of the Company. The breach of any such conditions could
result in a default under the Indenture and/or the New Credit Facility, and in
the event of any such default, the holders of the Subordinated Notes or the
lenders under the New Credit Facility could elect to accelerate the maturity of
all the Subordinated Notes or the loans under the New Credit Facility. If the
maturity of the Subordinated Notes or the loans under the New Credit Facility
were to be accelerated, all such outstanding debt would be required to be paid
in full before Hudson RCI or its subsidiaries would be permitted to distribute
any assets or cash to Holding. There can be no assurance that the assets of
Hudson RCI would be sufficient to repay all of such outstanding debt and to meet
Holding's obligations under the Holding Preferred Stock. Future borrowings by
Hudson RCI can be expected to contain restrictions or prohibitions on the
payment of dividends by Hudson RCI and its subsidiaries to Holding. In addition,
under California law, a subsidiary of a company is permitted to pay dividends on
its capital stock only if the amount of the subsidiary's retained earnings
immediately prior to the dividend equals or exceeds the amount of the dividend
or if immediately after payment of the dividend the sum of the subsidiary's
assets is 1 1/4 times its liabilities and its current assets at least equal its
current liabilities (or, if Holding's average earnings before income taxes and
interest expense for the two preceding fiscal years was less than its average
interest expense for those fiscal years, Holding's current assets must be at
least 1 1/4 times its current liabilities). California law does not permit the
board of directors of the subsidiary to revalue its assets to create retained
earnings. As of September 25, 1998, Hudson RCI had a retained deficit of $95.2
million. In addition, indebtedness outstanding under the New Credit Facility is
secured by substantially all of the assets of the Company (including the capital
stock of Hudson RCI owned by Holding). The Certificate of Designation for the
Holding Preferred Stock permits Holding to pay dividends in additional shares of
Holding Preferred Stock prior to April 15, 2003. Holding does not expect to pay
cash dividends prior to such time and there can be no assurance that Holding
will have the funds necessary to pay cash dividends on the Holding Preferred
Stock at any time.

MEDICAL COST CONTAINMENT

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

27
<PAGE>

The Company's products are sold principally to a variety of health care
providers, including hospitals and alternate site providers, that receive
reimbursement for the products and services they provide from various public and
private third party payors, including Medicare, Medicaid and private insurance
programs. As a result, while the Company does not receive payments directly from
such third party payors, the demand for the Company's products in any specific
care setting is dependent in part on the reimbursement policies of the various
payors in that setting. In order to be reimbursed, the products generally must
be found to be reasonable and necessary for the treatment of medical conditions
and must otherwise fall within the payor's list of covered services. In light of
increased controls on Medicare spending, there can be no assurance on the
outcome of future coverage or payment decisions for any of the Company's
products by governmental or private payors. If providers, suppliers and other
users of the Company's products are unable to obtain sufficient reimbursement, a
material adverse impact on the Company's business, financial condition or
operations may result.

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

INDUSTRY CONSOLIDATION; CUSTOMER CONCENTRATION

Cost containment has resulted in significant consolidation within the
health care industry. A substantial number of the Company's customers, including
group purchasing organizations, hospitals, national nursing home companies and
national home health care agencies, have been affected by this consolidation.
The acquisition of any of the Company's significant customers could result in
the loss of such customers by the Company, thereby negatively impacting its
business, financial condition and results of operations. For example, in 1996,
three GPOs that accounted for aggregate sales of approximately $11.0 million
combined and, as a result of a decision of the combined entity to enter into a
sole distributorship arrangement in 1997 with one of the Company's competitors,
the Company has experienced some decrease in sales and may experience additional
sales decreases in the future. In addition, the consolidation of health care
providers often results in the renegotiation of terms and in the granting of
price concessions. The Company's customer relationships, including exclusive or
preferential provider relationships, are terminable at will by either party
without advance notice or penalty. Because larger purchasers or groups of
purchasers tend to have more leverage in negotiating prices, this trend has
caused the Company to reduce prices and could have a material adverse effect on
the Company's business, financial condition or results of operations. As GPOs
and integrated health care systems increase in size, each relationship
represents a greater concentration of market share and the adverse consequences
of losing a particular relationship increases considerably. For fiscal 1997, the
Company's ten largest group purchasing arrangements accounted for approximately
34% of the Company's total net sales. Distributors have also consolidated in
response to cost containment. For fiscal 1997, approximately 30% of the
Company's net sales were to a single distributor, Owens & Minor Inc. The loss of
the Company's relationship with this distributor would have a material adverse
effect on the Company's business, financial condition and results of operations.

GOVERNMENT REGULATION

The Company and its customers and suppliers are subject to extensive
federal and state regulation in the United States, as well as regulation by
foreign governments. Most of the Company's products are subject to government
regulation in the United States and other countries. In the United States, the
Federal Food, Drug, and Cosmetic Act, as amended (the "FDC Act"), and other
statutes and regulations govern or influence the testing, manufacture, safety,
labeling, storage, record keeping, marketing, advertising and promotion of such
products. Failure to comply with applicable requirements can result in fines,
recall or seizure of products, total or partial suspension of production,
withdrawal of existing product approvals or clearances, refusal to approve or
clear new applications or notices and criminal prosecution. Under the FDC Act
and similar foreign laws, the Company, as a marketer, distributor and
manufacturer of health care products, is required to obtain the approval of
federal and foreign governmental agencies, including the Food and Drug
Administration ("FDA"), prior to marketing, distributing and manufacturing
certain of those products, which can be time consuming and expensive. The
Company may also need to obtain FDA clearance before modifying marketed products
or making new promotional claims. Delays in receipt of or failure to receive
required approvals or clearances, the loss of previously received approvals or
clearances, or failures to comply with

28
<PAGE>

existing or future regulatory requirements in the United States or in foreign
countries could have a material adverse effect on the Company's business.
Foreign sales are subject to similar requirements.

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

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

RISKS RELATED TO INTERNATIONAL SALES; FOREIGN OPERATIONS

Sales made outside the United States represented approximately 19.1% of the
Company's 1997 net sales and the Company intends to increase international sales
as a percentage of total net sales. Foreign operations are subject to special
risks that can materially affect the sales, profits, cash flows and financial
position of the Company, including increased regulation, extended payment
periods, competition from firms with more local experience, currency exchange
rate fluctuations and import and export controls. Sales of the Company's
products are denominated in U.S. dollars. The destabilization of the economies
of several Asian countries in 1997 caused a decrease in demand for the Company's
products throughout Southeast Asia, and future sales in that region are
uncertain. In addition, adverse economic conditions in Asia could result in
"dumping" of products similar to those produced by the Company by other
manufacturers, both in Asian and other markets.

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

PRODUCT LIABILITY

The manufacturing and marketing of medical products entails an inherent
risk of product liability claims. Although the Company has not experienced any
significant losses due to product liability claims and currently maintains
umbrella liability insurance coverage, there can be no assurance that the amount
or scope of the coverage maintained by the Company will be adequate to protect
it in the event a significant product liability claim is successfully asserted

29
<PAGE>

against the Company. In addition, the Company cannot predict the extent to which
future legislative and regulatory developments concerning its practices and
products for the health care industry may affect the Company.

DEPENDENCE ON KEY PERSONNEL; MANAGEMENT OF EXPANDING OPERATIONS

The Company's success will, to a large extent, depend upon the continued
services of its executive officers. The loss of services of any of these
executive officers could materially and adversely affect the Company. While the
Company has employment agreements with it senior management team, these
agreements may be terminated by either party, with or without cause.

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

COMPETITION

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

RISKS GENERALLY ASSOCIATED WITH ACQUISITIONS

An element of the Company's business strategy is to pursue strategic
acquisitions that either expand or complement the Company's business.
Acquisitions involve a number of special risks, including the diversion of
management's attention to the assimilation of the operations and the
assimilation and retention of the personnel of the acquired companies, and
potential adverse effects on the Company's operating results. The Company may
require additional debt or equity financing for future acquisitions, which may
not be available on terms favorable to the Company, if at all. In addition, the
New Credit Facility and the Indenture contain certain restrictions regarding
acquisitions. The Indenture restricts acquisitions to those companies in the
same line of business as the Company, and requires that all such acquired
companies be designated Restricted Subsidiaries (as defined therein). The New
Credit Facility restricts all acquisitions with the exception of Permitted
Acquisitions (as defined therein), and limits, among other things, (i) the sum
that may be paid in connection with any single acquisition to $30.0 million,
(ii) the total amount outstanding of revolving credit indebtedness that can be
incurred for acquisition purposes to $40.0 million, and (iii) the line of
business of the acquired entity or assets. The inability of the Company to
successfully finance, complete and integrate strategic acquisitions in a timely
manner could have an adverse impact on the Company's ability to effect a portion
of its growth strategy.

PATENTS AND TRADEMARKS

The Company has historically relied primarily on its technological and
engineering abilities and on its design and production capabilities to gain
competitive business advantages, rather than on patents or other intellectual
property rights. However, the Company does file patent applications on concepts
and processes developed by the Company's personnel. The Company has 18 patents
in the U.S. and two patents pending. Many of the U.S. patents have corresponding
patents issued in Canada, Europe and various Asian countries. The Company is
currently preparing several patent applications covering intellectual property
associated with the closed suction catheter product and advanced humidification
devices. The Company's success will depend in part on its ability to maintain
its patents, add to them where appropriate, and to develop new products and
applications without infringing the patent and other

30
<PAGE>

proprietary rights of third parties and without breaching or otherwise losing
rights in technology licenses obtained by the Company for other products. There
can be no assurance that any patent owned by the Company will not be
circumvented or challenged, that the rights granted thereunder will provide
competitive advantages to the Company or that any of the Company's pending or
future patent applications will be issued with claims of the scope sought by the
Company, if at all. If challenged, there can be no assurance that the Company's
patents (or patents under which it licenses technology) will be held valid or
enforceable. In addition, there can be no assurance that the Company's products
or proprietary rights do not infringe the rights of third parties. If such
infringement were established, the Company could be required to pay damages,
enter into royalty or licensing agreements on onerous terms and/or be enjoined
from making, using or selling the infringing product. Any of the foregoing could
have a material adverse effect upon the Company's business, financial condition
or results of operations.

S CORPORATION STATUS

The Company elected to be treated as an S corporation for federal and state
income tax purposes for its taxable years beginning on or after January 1, 1987.
Unlike a C corporation, an S corporation is generally not subject to income tax
at the corporate level; instead, the S corporation's income is taxed on the
personal income tax returns of its shareholders. The Company's status as an S
corporation terminated upon consummation of the Recapitalization. If S
corporation status were denied for any periods prior to such termination by
reason of a failure to satisfy the S corporation election or eligibility
requirements of the Internal Revenue Code of 1986, as amended, the Company would
be subject to tax on its income as if it were a C corporation for these periods.
Such an occurrence would have a material adverse effect on the Company's
results.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Not applicable.

31
<PAGE>

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 2. CHANGES IN SECURITIES

On June 27, 1998, Holding sold 12,500 shares of its common stock to The
Parthenon Group for a total cash consideration to Holding of $125,000.

Holding believes that the transaction set forth above was exempt from the
registration and prospectus delivery requirements set forth in the Securities
Act in reliance on Section 4(2) thereof, because all of the sales were made in
transactions not involving a public offering.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

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

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

27.1 Financial Data Schedule

(b) Reports on Form 8-K

None.

32
<PAGE>

SIGNATURE

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

RIVER HOLDING CORP.,
a Delaware corporation

November 9, 1998 By: /s/ Jay R. Ogram
-------------------------------------
Jay R. Ogram
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)

<PAGE>

<ARTICLE> 5
<CIK> 0001061892
<NAME> RIVER HOLDING CORPORATION

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-25-1998
<PERIOD-END> SEP-25-1998
<CASH> 1,306
<SECURITIES> 0
<RECEIVABLES> 19,354
<ALLOWANCES> 391
<INVENTORY> 17,412
<CURRENT-ASSETS> 38,941
<PP&E> 47,845
<DEPRECIATION> 0
<TOTAL-ASSETS> 259,118
<CURRENT-LIABILITIES> 16,939
<BONDS> 152,000
30,648
0
<COMMON> 63,125
<OTHER-SE> (3,594)
<TOTAL-LIABILITY-AND-EQUITY> 258,118
<SALES> 44,562
<TOTAL-REVENUES> 0
<CGS> 24,794
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 10,683
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (6,708)
<INCOME-PRETAX> (6,955)
<INCOME-TAX> (1,299)
<INCOME-CONTINUING> (1,946)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,946)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0

</TABLE>