Form 10-K

Commission file number 333-42783

(Exact name of registrant as specified in its charter)

8023 Vantage Drive
San Antonio, Texas 78230
Telephone Number: (210) 524-9000
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:   NONE
Securities registered pursuant to Section 12(g) of the Act:   NONE

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 X

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).      Yes__     No X_

The aggregate market value of the voting and non voting common equity held by non-affiliates as of the last business day of the registrant's most recently completed second fiscal quarter was $3.1 million, based upon a per share price of $7.00, which was determined to be the fair market value of the Common Stock by the Board of Directors in August 2001. The registrant's common stock is not publicly traded.

As of March 24, 2003, there were 71,028,040 shares of the registrant's common stock outstanding, of which 70,480,072 were held by affiliates.

Documents Incorporated by Reference: None

The following terms used in this report are Company trademarks: AirMaxxis™, AtmosAir™, BariAir®, BariKare®, BariMaxx II™, BariMaxx™, DynaPulse®, FirstStep®, FirstStep® Advantage, FirstStep® Plus, FirstStep Select®, FirstStep Select® Heavy Duty, FluidAir Elite®, FluidAir® II, KinAir® III, KinAir® IV, KinAir MedSurg™, Maxxis® 300, Maxxis® 400, Mini V.A.C.®, ParaDyne®, PediDyne®, PlexiPulse®, PlexiPulse® AC, Pulse IC™, Pulse SC™, RIK®, Roto Rest®, Roto Rest® Delta, T.R.A.C.™, TheraPulse®, TheraPulse® II, TheraRest®, TriaDyne® II, TriaDyne Proventa™, TriCell®, V.A.C.®, V.A.C.® ATS™ and V.A.C.® Freedom™.

FORWARD LOOKING STATEMENTS

      KCI provides innovative therapies for wound healing and for the treatment and prevention of complications suffered by patients as the result of immobility. Over three thousand KCI employees assist in the design, manufacture, marketing, sales, rental and service of our innovative medical devices and therapeutic systems. Patients are treated using our therapies across all care settings including acute care hospital, extended care facilities and in patients' homes.

      Our customers generally prefer to rent our systems and purchase the disposables used for patient treatment taking advantage of our capability to provide rapid, high quality service and clinical support while avoiding the high initial capital outlay associated with purchasing the systems. We have a network of over 200 service centers in North America and Europe through which we distribute and service our products. In the United States, our network gives us the capability to deliver our products to any Level I domestic trauma center within four hours.

      In 2000, we began a process to transform KCI to an advanced-technology medical device company focused on innovative devices delivering exceptional therapeutic benefits. Approximately two-thirds of our year 2000 revenue came from rentals and sales of therapeutic systems that played a supportive role in treatment protocols. By 2002, 60% of our revenue came from rentals and sales of our higher-value advanced medical devices and systems, which provide primary therapies that fundamentally improve the clinical and economic outcomes for patients with complex or life-threatening conditions. Utilizing our proprietary V.A.C. technology, we introduced two new wound healing device platforms in 2002. The V.A.C. ATS, is an acute care device designed for the treatment of complex wounds such as dehisced surgical wounds, trauma wounds, partial thickness burns, and serious pressure ulcers, and to improve the outcomes of grafting procedures. The V.A.C. Freedom provides a platform specifically tailored to the needs of extended care and home care patients with complex or chronic wounds, including post-discharge treatment of acute care wounds, and the treatment of chronic pressure sores, arterial, venous and diabetic ulcers.

      Our clinically-effective therapeutic systems include specialty hospital beds, mattress replacement systems and overlays designed to address the complications of immobility. These complications include pressure sores, pneumonia and circulatory problems, which can increase per patient treatment costs by as much as $75,000. By preventing these complications or accelerating the healing process, our therapeutic systems, combined with on-site consultation by our clinically trained staff, can significantly improve patient outcomes while reducing the cost of patient care.

      Founded by James R. Leininger, M.D., an emergency room physician, to provide better care for his patients, Kinetic Concepts, Inc. was incorporated in Texas in 1976. Our principal offices are located at 8023 Vantage Drive, San Antonio, Texas 78230 and our telephone number is (210) 524-9000.

      On December 31, 2002, we settled our anti-trust lawsuit with Hillenbrand Industries, Inc. and Hill-Rom Company, a Hillenbrand subsidiary. Under the settlement, Hillenbrand agreed to pay KCI $250 million, $175 million of which Hillenbrand paid us on January 2, 2003. During the fourth quarter of 2002, we recorded a gain from the settlement, which net of legal expenses, added $173.3 million of pretax income and $106.4 million of net income to the 2002 results. Proceeds from this first settlement payment, net of taxes, were used to paydown indebtedness under our senior credit facility. Pursuant to the terms of the settlement, Hillenbrand will pay us an additional $75 million on January 2, 2004, unless certain conditions, such as bankruptcy or a change in control of KCI, has occurred. No

accrual has been made related to the $75 million payment to be received in January 2004. (See Note 17 of Notes to Consolidated Financial Statements regarding related subsequent event.)

      We continue to experience revenue growth in wound healing devices, as we have in each of the last 3 years. Driven by continued market penetration and the introduction of new V.A.C. ATS and V.A.C. Freedom platforms, wound healing device revenue increased 65% from the prior year to $313.4 million and now accounts for approximately 54% of total revenue. Both the U.S. and international business segments contributed to this growth. In 2002, worldwide wound healing device revenue from acute and extended care grew 60% and V.A.C. home care revenue grew approximately 70%.

      The home care market accounted for approximately 45% of the wound care device business and approximately 24% of total KCI revenue in 2002. V.A.C. systems are reimbursed by both governmental (Medicare and Medicaid) and non-governmental (insurance and managed care organization) or private payers. The reimbursement process for governmental payers requires extensive documentation but can routinely be billed electronically. Optimizing the reimbursement process for private payers requires extensive contract development and administration with several hundred payers, having widely varying requirements for documentation and administrative procedures. Beginning in 2002, we have aggressively pursued contracted and participating provider relationships with the leading third-party payer contracting and billing organizations, and upgraded our third-party payer contracting and billing organization and processes. As a result, over 60 million private insuranc e member lives are now covered by contract. Although the complexity of this business has resulted in a slower collection cycle relative to the rest of our business, our contracting and process refinement efforts have resulted in improved collections, with home care accounts receivable from third-party payers now stable, and days revenue outstanding 26% below the peak in the first half of 2002.

      We serve our customers through two geographical segments: KCI USA, Inc. and KCI International, Inc. (See Note 13 of Notes to Consolidated Financial Statements.)

      With approximately 1,440 employees, our KCI USA division serves the domestic acute care, extended care and home care markets with the full range of our products. Our sales and sales support staff of approximately 650 individuals are organized by care setting, and are generally responsible for the complete range of products for each account. Since physicians and nurses are critical to adoption and use of advanced medical devices, a major element of the sales force's responsibility is to introduce and train these medical practitioners in the applications of our products, including the specific knowledge necessary to assure that the use of KCI's devices results in optimal clinical and economic outcomes. In 2002, the sales organization made over 85,000 contacts with these targeted clinical decision-makers.

      Our KCI USA division has a national 24-hour, seven day-a-week customer service communications system, which allows us to quickly and efficiently respond to our customers' needs. The domestic division distributes our medical devices and therapeutic systems to approximately 3,400 acute care hospitals and 4,400 extended care facilities through a network of 136 domestic service centers and also directly serves the home care market through our service center network. The KCI USA network gives us the ability to deliver our products to any major Level I domestic trauma center within four hours.

      The KCI USA division accounted for approximately 77%, 78%, and 73% of our total revenue in the years ended December 31, 2002, 2001 and 2000, respectively.

      During 2002, our KCI International division had direct operations in 15 foreign countries including Germany, Austria, the United Kingdom, Canada, France, the Netherlands, Switzerland, Australia, Italy, Denmark, Sweden, Ireland, Belgium, Spain and South Africa. The international division distributes our medical devices and therapeutic systems through a network of 115 service and distribution centers, including our 15 country headquarters. Our international corporate office is located in Amsterdam, Netherlands. International manufacturing and engineering operations are based in the United Kingdom. In addition, our International division serves the demands of a growing global market through relationships with approximately 50 active independent distributors in Latin America, the Middle East, Asia and Eastern Europe. The KCI International division consists of 1,000 employees who are responsible for all sales, service and administrative functions within the various countries we serve.

      Our KCI International division accounted for approximately 23%, 22% and 27% of our total revenue in the years ended December 31, 2002, 2001 and 2000, respectively.

      Our advanced medical devices and therapeutic systems address five principal clinical applications.

      Over half of our revenue is generated from medical devices for wound healing and tissue repair. Of the more than 10 million wounds treated by doctors, hospitals and clinics each year, approximately 10%-15% are complex, life threatening or difficult-to-treat conditions. KCI is the leading provider of advanced technology platforms used to treat these wounds.

      In the acute care setting, serious trauma wounds, surgically created wounds (particularly dehisced wounds), amputations (especially those resulting from complications of diabetes), burns covering a large portion of the body and serious pressure ulcers present special challenges to the physician. In addition, when surgeons use skin grafts to close wounds, a substantial portion are not fully effective - the grafts do not fully "take". Physicians and hospitals seek a therapy, which addresses the special needs of these wounds quickly, with high levels of clinical and cost effectiveness. Given the high cost and infection risk of treating these patients within inpatient settings, the ability to rapidly achieve healthy wound beds and reduce bacterial levels in the wound are particularly important. Our V.A.C. Classic and V.A.C. ATS platforms are custom designed to meet these needs.

      In the extended care and home care settings, different types of wounds - with different treatment implications - present the most significant challenges. Although a substantial number of acute wounds require post-discharge treatment, a majority of the challenging wounds in the home setting are non-healing chronic wounds. These wounds often involve physiologic and metabolic complications that interfere with the body's normal wound healing processes. Diabetic, arterial and venous insufficiency wounds and pressure ulcers arising from immobility are slow-to-heal wounds. The wounds develop due to a patient's compromised vascular and tissue repair capabilities. Because of these conditions, patients often fail to progress in healing for many months, and sometimes for several years. Normal therapies are slow to heal these wounds and often fail. The costs, both human and financial, are high. Physicians and nurses look for therapies that can "jump-sta rt" the healing process and overcome the obstacles of the patients' compromised conditions. They also seek therapies, which are operationally efficient, especially in the home, where full-time skilled care is not available. In addition, because so many of these patients are ambulatory, they desire therapies which are minimally disruptive to their lives. Payers require faster healing and lower overall costs.

Our V.A.C., Mini V.A.C., and especially the V.A.C. Freedom platforms are custom designed to meet these needs.

      Patients in intensive care units, or ICU, are being treated aggressively for life-threatening conditions. Many suffer from pulmonary complications, due directly to their conditions or stemming from their compromised conditions and immobility. Others suffer from conditions such as Acute Respiratory Distress Syndrome, which result in mortality rates of 30-40% or more. Some are in such acute distress that their organ systems are at risk of failure. Many are on some type of life-support. Because of the aggressive treatments required to address these life-threatening conditions, daily patient care costs in the ICU are high relative to treating other conditions. Our kinetic therapy systems are designed to meet the special needs of these patients and have been shown in independent clinical studies to reduce the incidence of nosocomial pneumonia, intubation time and length of stay in the ICU.

      Our pressure relief and pressure reduction therapy systems provide therapy in the treatment of pressure sores, burns, ulcers, skin grafts and other skin conditions. Our surfaces also help prevent the formation of pressure sores, which develop in certain immobile individuals. Our beds and surfaces reduce the amount of pressure at any point on a patient's skin by using surfaces supported by air, silicon beads, foam or a viscous fluid. Our products also help to reduce shear, a major factor in the development of pressure ulcers, by reducing the amount of friction between the skin surface and the surface of the bed. In addition to providing pressure relief, some of our products provide a pulsing of the surface cushions known as pulsation therapy, which helps improve blood and lymphatic flow to the skin. Some of our products further promote healing and reduce nursing time by providing an automated "wound care" turn of approximately 25 degrees. This "nurs e assist" feature replaces the need for nurses to manually turn and position patients.

      We also offer a unique line of bariatric products, which are designed to accommodate obese individuals by providing the support they need and enabling hospital staff to care for them in a safe and dignified manner. Our bariatric care products are used generally for patients weighing from 300 to 600 pounds, but can accommodate patients weighing up to 1,000 pounds. These individuals are often unable to fit into standard-sized beds and wheelchairs. Our most sophisticated bariatric care products can serve as a bed, chair, weight scale and x-ray table, and provide therapeutic functions like those in our wound treatment and prevention systems. Moreover, treating obese patients is a significant staffing issue for many health care facilities because moving and handling obese patients increases the risk of worker's compensation claims by health care workers. We believe that these products enable health care personnel to treat these patients in a manner, whic h is safer for hospital personnel and more dignified for the patient.

      Many patients who have had hip or knee surgeries, or have diabetes or other conditions that reduce circulation, suffer from compromised vascular systems. We offer a family of non-invasive vascular compression devices that promote venous and/or lymphatic return through either sequential or intermittent compression therapy. Compression therapy has been clinically proven to improve circulation, decrease swelling in the lower extremities and reduce the incidence of blood clots. The therapy is accomplished by wrapping an inflatable cuff around a foot, leg or arm and then automatically inflating and deflating the cuff at prescribed intervals.

      We offer a wide range of products in each clinical application to meet the specific needs of different subsets of the market, providing innovative, cost effective, outcome driven therapies across multiple care settings.

      We introduced two new wound healing platforms in 2002, bringing our current total to four. All four platforms incorporate our proprietary V.A.C. technology, which has been demonstrated to accelerate wound healing and reduce the cost of treating patients with complex or non-healing wounds. V.A.C. platforms are physiologically and metabolically active devices, reducing negative factors (for example, bacteria, edema and matrix metalloproteinases) which interfere with wound healing and stimulating positive healing processes (for example, re-vascularization, normal lymphatic function and the growth of fibroblasts, endothelial cells and vascular smooth muscle cells). The net effect is to accelerate granulation of the wound bed and closure of the wound.

      Each of our platforms is targeted to meet the needs of specific care settings and wound or patient requirements.

The V.A.C. ATS was introduced in 2002 to meet the acute care requirements for a flexible, easy-to-use, high-capacity system that is effective with the largest and most challenging trauma and abdominal wounds. The V.A.C. ATS platform incorporates advanced user-assist features and controls to provide flexibility to customize the treatment protocol to the requirements of different wound types and physician preferences. It also incorporates our proprietary T.R.A.C. technology, which simplifies dressing changes and provides added functionality and control of the therapy at the interface with the wound site.

The V.A.C. Freedom, also introduced in 2002, was designed to meet the requirements for a robust, lightweight, high-performance device suitable for ambulatory patients. It also incorporates advanced user-assist features and the T.R.A.C. technology in a 3.2 lbs. package adapted for convenient unobtrusive use by patients whose wounds can now be healed without inhibiting their active lives. It includes special filters that reduce wound odor, a common and embarrassing problem for many ambulatory wound patients. Its controlled drawdown feature effectively reduces the pain involved in dressing changes. While the design of the V.A.C. Freedom platform addresses the treatment needs of chronic wound patients, its added capacity also makes it a better fit for patients with higher exudating acuity wounds.

The Mini V.A.C. was specially designed for patients who need high levels of mobility. At 2.2 lbs., it provides the best solution for patients needing advanced wound healing performance in a highly portable package. It is best suited for smaller and drier wounds (many diabetic, arterial and venous stasis ulcers) due to its smaller capacity.

The V.A.C. Classic, although it lacks the advanced features of KCI's newer products, provides all the original therapeutic functionality and wound healing capability of our other platforms. For those who do not require the advanced user and operational features of KCI's newer platforms, it provides our most economical advanced wound-healing package.

      Our kinetic therapy products include the TriaDyne Proventa, TriaDyne II, ParaDyne, Roto Rest Delta and PediDyne. The TriaDyne is used primarily in acute care settings and provides patients with three distinct therapies on an air suspension surface. The TriaDyne applies kinetic therapy by rotating the patient up to 45 degrees on each side and provides an industry-first feature of simultaneously turning the patient's torso and lower body in opposite directions while keeping the patient positioned in the middle of the bed. The TriaDyne also provides percussion therapy to loosen mucous buildup in the lungs and pulsation therapy to promote capillary and lymphatic flow. The TriaDyne is built on Stryker Corporation's critical care frame, which is well suited to an ICU environment. The ParaDyne provides therapies that are similar to the TriaDyne Proventa for customers who are trying to manage their costs by utilizing their existing hospital bed frames. The Roto Rest Delta is a specialty bed, which can rotate a patient up to 62 degrees on each side for the treatment of severe pulmonary complications. The Roto Rest has been shown to improve the care of patients suffering from multiple

trauma, spinal cord injury, severe pulmonary complications, respiratory failure and deep vein thrombosis.

      The KinAir III, KinAir MedSurg and KinAir IV have been shown to provide effective skin care therapy in the treatment of pressure sores, burns and post-operative skin grafts and flaps and to help prevent the formation of pressure sores and certain other complications of immobility. The FluidAir Elite and FluidAir II support the patient on a low-pressure surface of air-fluidized silicon beads providing pressure relief and shear relief for skin grafts or flaps, burns and pressure sores. The FirstStep family of overlays is designed to provide pressure relief and help prevent and treat pressure sores. Both the AtmosAir family and the TheraRest products are for-sale mattress replacement products for the prevention of pressure sores. The proprietary AtmosAir utilizes atmospheric pressure to deliver dynamic pressure relief. The RIK mattress and the RIK overlay are static, non-powered products that provide pressure relief using a patented viscous fluid and a patented anti-shear sheet.

      The TheraPulse and TheraPulse II (framed beds) and the DynaPulse (overlay) provide a more aggressive form of treatment through a continuous pulsating action which gently massages the skin to help improve capillary and lymphatic circulation in patients suffering from severe pressure sores, burns, skin grafts or flaps, swelling or circulatory problems.

      Our Bariatric products provide the proper support needed by obese patients and enable nurses to properly care for these patients in a safe and dignified manner. The most advanced product in this line is the BariAir therapy system, which can serve as a bed, cardiac chair or x-ray table. The BariAir provides low air loss pressure relief, continuous turn assist, percussion and step-down features designed for both patient comfort and nurse assistance. This product can be used for patients who weigh up to 850 pounds. We believe that the BariAir is the most advanced product of its type available today. The BariKare bed is the most frequently used of KCI's bariatric products. It provides a risk management platform for patients weighing up to 850 pounds and is used primarily in hospitals. In 1996, we introduced the FirstStep Select Heavy Duty overlay which, when placed on a BariKare, provides pressure-relieving therapy. Our AirMaxxis product provides a t herapeutic air surface for the home environment for patients weighing up to 650 pounds. The Maxxis 300 and 400 provide a home care bariatric bed frame for patients weighing up to 600 pounds and 1,000 pounds, respectively.

     The newest product in the KCI Surface Continuum is the BariMaxx II. The BariMaxx II provides a basic risk management platform for patients weighing up to 1,000 pounds for those customers looking for a set of features including built-in scales and an expandable frame at a lower cost. Additionally, the BariMaxx II side exit feature allows the caregiver to assist patients in a more traditional exit of the bed. This is an important factor in a patient's rehabilitation and prepares them for facility discharge. KCI's bariatric beds are now combined with an EZ-lift patient transfer system and other accessories such as wheelchairs, walkers and commodes to create a complete bariatric offering.

      The PlexiPulse, PlexiPulse AC, the Pulse IC and the Pulse SC are non-invasive vascular compression devices that aid venous return by pumping blood from the lower extremities to help prevent deep vein thrombosis ("DVT") and re-establish microcirculation. The pumping action is created by compressing specific parts of the foot, calf or thigh with specially designed inflatable cuffs

that are connected to a separate pump unit. The cuffs are wrapped around the foot, calf and/or thigh and are inflated in timed increments by the pump. The intermittent or sequential inflation compresses a group of veins in the lower limbs and boosts the velocity of blood flowing back toward the heart. This increased velocity has been clinically proven to prevent DVT, reduce edema and improve lower limb blood circulation. This portion of our business accounted for less than 10% of our total revenue in each of the last three years.

      We believe that the principal competitive factors within our markets are therapeutic efficacy, cost of care, clinical outcomes and service. Furthermore, we believe that a national presence with full distribution capabilities is important to serve large, sophisticated national and regional health care group purchasing organizations, or GPOs. We contract with all major proprietary and voluntary GPOs and hospital groups for all or some part of our product offering.

      The medical device industry is highly competitive and is characterized by rapid product development and technological change. In order to remain competitive with other companies in our industry, we must continue to develop cost-effective new products and technologies. In wound healing and tissue repair, we compete with other treatment methods offered by a number of companies in the advanced wound care business. These methods include classical advanced wound care dressings (hydrogels, hydrocolloids, alginates), skin substitutes and products containing growth factors. Although these products are the best available alternatives to our devices, they are also used in an adjunctive manner rather than solely in a competitive manner. Thus caregivers may use one of our V.A.C. platforms to prepare a healthy wound bed and reduce the wound size, and then use a hydrocolloid or a skin substitute to manage the wound to final closure.

      With respect to therapeutic surfaces for treatment of pulmonary complications in the ICU, wound treatment and prevention and bariatric care, our primary competitors are Hill-Rom Company, Huntleigh Healthcare and Pegasus HealthCare Group, a division of Pegasus Health & Risk Managers Pvt. Ltd. We also compete on a regional, local and market segment level with a number of smaller companies.

      Health care reform legislation will continue to increase pressure to reduce the cost of health care. We also believe it is likely that efforts by private payers to contain costs through managed care and other efforts and to reform health systems will continue in the future. The Balanced Budget Act of 1997 (the "BBA") significantly reduced the annual increases in federal spending for Medicare and Medicaid, changed the payment system for both skilled nursing facilities ("SNFs") and home health care services from cost-based to prospective payment systems and allowed states greater flexibility in controlling Medicaid costs at the state level. Although certain increases in reimbursement have subsequently been approved, the overall effect of the BBA continues to place increased pricing pressure on us and our customers. In particular, the changes in the method by which Medicare Part A reimburses SNFs has dramatically changed the manner in which our SNF customers make rental and purchase decisions.

     Certain portions of the BBA were amended by the Balanced Budget Refinement Act of 1999 (the "Refinement Act") and the Benefits Improvement and Protection Act of 2000 ("BIPA"). In essence, the Refinement Act and BIPA attempted to dampen the impact which the BBA had on the health care industry. Although there had been some payment relief under the Refinement Act and BIPA, that relief expired on September 30, 2002. Because that reimbursement relief was not carried over into 2003, our revenue from the extended care market could be adversely affected.

      We also believe it is likely that efforts by governmental and private payers to contain costs through managed care and other efforts and to reform health systems will continue in the future. For example, on February 11, 2003, the Centers for Medicare and Medicaid Services("CMS", formerly the Health Care Financing Administration) made effective an interim final rule implementing inherent reasonableness authority, which allows the agency and carriers to adjust payment amounts by up to 15% per year for certain items and services covered by Medicare Part B when the existing payment amount is determined to be grossly excessive or grossly deficient. The regulation lists factors that may be used by CMS and the carriers to determine whether an existing reimbursement rate is grossly excessive or grossly deficient and to determine what is a realistic and equitable payment amount. CMS may also make a smaller adjustment if they determine that an overall payment a djustment of less than 15% is necessary to produce a realistic and equitable payment amount. Using this authority, CMS and the carriers may reduce reimbursement levels for certain items and services covered by Medicare Part B.

      In addition, the BBA authorized CMS to explore possible ways of changing Medicare reimbursement rates so that they better reflect market levels. Specifically, the BBA authorized CMS to implement up to five competitive bidding demonstration projects by December 31, 2002 to evaluate how competitive bidding would impact Medicare program payments, access, diversity of product selection, and quality. Under competitive bidding, CMS would change its approach to reimbursing items and services covered by Medicare Part B from the current fee schedule amount to an amount that would be established through a bidding process between the agency and suppliers. Two demonstrations covering eight products have been completed and federal lawmakers are now considering expanding competitive bidding to the national level, which could reduce the number of suppliers providing items and services to Medicare beneficiaries and the amounts paid for such items and services. We do not know what impact inherent reasonableness and competitive bidding, if expanded to a national level, would have on us or the reimbursement for our products.

      The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") covers a variety of provisions which will impact our business including the privacy of patient health care information, the security of that information and the standardization of electronic data transactions for purposes of medical billing. The Department of Health and Human Services has promulgated regulations pursuant a legislative mandate in HIPAA, which will become effective during 2003. In order to ensure our compliance with the HIPAA regulations, KCI has established a multi-disciplinary HIPAA Compliance Team, which defined the legal requirements, reviewed KCI's prior HIPAA compliance efforts and developed a comprehensive compliance plan. We have designated a HIPAA Privacy Officer and HIPAA Information Security Officer to oversee the implementation of the compliance plan and monitor modifications to the current and proposed regulations. We expect to meet the privacy compliance requirement on schedule.

      HIPAA regulations regarding standardization of electronic data transactions will also impact our business. At the present time, we invoice a wide variety of third-party payers using a variety of standardized and individual code sets. When the mandated electronic transactions in the American National Standard Institute format is implemented in 2003, we will transition our products and our billing to standardized code sets. In some instances, it may be difficult for us to differentiate between products which are covered by a single code but have different prices. Therefore, we have applied to CMS for additional product codes to support our current billing practices. However, there can be no assurance that CMS will establish any or all of the requested codes. We are beginning to work with our vendors in order to make the transition to standardized code sets as smooth as possible. However, there can be no assurance that the transition to standardized code sets will not create billing difficulties or business interruptions for us.

      The many health care reform initiatives in the United States have caused health care providers to examine their cost structures and reassess the manner in which they provide health care services.

This review, in turn, has led many health care providers to merge or consolidate with other members of their industry in an effort to reduce costs or achieve operating synergies. A substantial number of our customers, including proprietary hospital groups, GPOs, hospitals, national nursing home companies and national home health care agencies, have been affected by this consolidation. An extensive service and distribution network and broad product line is key to servicing the needs of these larger provider networks. In addition, the consolidation of health care providers often results in the re-negotiation of contracts and in the granting of price concessions. Finally, as GPOs and integrated health care systems increase in size, each contract represents a greater concentration of market share and the adverse consequences of losing a particular contract increases considerably.

      The demand for our products in any specific care setting is dependent in part on the reimbursement policies of the various payers in that setting. In order to be reimbursed, products generally must be found to be reasonable and necessary for the treatment of medical conditions and must otherwise fall within the payers' recognized categories of covered items and services. Our products are rented and sold principally to hospitals and SNFs who receive reimbursement for the products and services they provide from various public and private third-party payers, including Medicare, Medicaid and private insurance programs. In the home care market, we furnish our products directly to patients in their homes. We then bill the patient's insurer (for example, Medicare, Medicaid, a managed care organization or private insurance company) for the products provided and, in some instances, bill the patient for a co-pay or deductible.

       The importance of reimbursement policies for the demand for our products was recently demonstrated by our experience with our V.A.C. technology in the home care setting. On October 1, 2000, we received Medicare Part B reimbursement codes, an associated coverage policy and allowable rates for the V.A.C. devices and V.A.C. disposables (canisters and dressings) in the home care setting. A significant portion of our wound healing device revenue is derived from home placements, which are reimbursed by both governmental (Medicare and Medicaid) and non-governmental (insurance and managed care organizations) third-party payers. The reimbursement process for home care placements requires extensive documentation, which has slowed the cash receipts cycle relative to the rest of the business.

      In light of increased scrutiny on Medicare spending, there can be no assurance on the outcome of future coverage or payment decisions for any of our products by governmental or private payers. (See "Business -- Market Outlook".)

      We are subject to various federal and state laws pertaining to health care fraud and abuse including prohibitions on the submission of false claims and the payment or acceptance of kickbacks or other remuneration in return for the purchase or rental of our products. The United States Department of Justice and the Office of the Inspector General of the United States Department of Health and Human Services have launched several enforcement initiatives which specifically target the long term care, home health and DME industries. Sanctions for violating these laws include criminal penalties and civil sanctions and possible exclusion from the Medicare, Medicaid and other federal health care programs. Although we believe our business arrangements comply with federal and state fraud and abuse laws, there can be no assurance that our practices will not be challenged under these laws in the future or that such a challenge would not have a material adverse effect on our business, financial condition or results of operations.

      U.S. Census Bureau statistics indicate that the 65-and-over age group is the fastest growing population segment and is expected to be approximately 40 million by the year 2010. Management of wounds and circulatory problems is crucial for elderly patients. These patients frequently suffer from

deteriorating physical conditions and their wound problems are often exacerbated by circulatory problems, incontinence and poor nutrition.

      The most critically ill patient population is cared for in the intensive care unit where they can receive the most intense medical and nursing interventions. Patients seen in the intensive care unit present with serious acute and chronic complications from a plethora of diseases and traumatic injuries. Often these patients can develop pulmonary complications such as acute respiratory distress syndrome (ARDS). Treating pulmonary complications requires special equipment and treatment modalities. In 2001, there were approximately 1.6 million ICU patients in the U.S. with pulmonary complications and approximately 10,000 with unstable spinal cord injuries. KCI provides specialized therapies including the RotoRest Delta for the treatment of unstable spine and TriaDyne Proventa for the treatment of pulmonary complications associated with immobility.

      Obesity is increasingly being recognized as a serious medical complication. In 2001, approximately 1,135,000 patients in U.S. hospitals had a principal or secondary diagnosis of obesity. Obese patients tend to have limited mobility and are therefore at risk for circulatory problems and skin breakdown.

      Innovation - through new products and significant enhancement to existing products - is essential to our success. It is one of the primary bases for competition, and is one of the most critical elements of our value to our customers. Our primary focus for innovation is to increase the clinical and economic benefit of our products to our customers and their patients. In addition, we strive to make our products user-friendly and increase operational efficiency, both of which, are critical in the demanding and sometimes short-staffed world of health care today. Significant investments in 2002 research and development include:

          - New wound healing devices and dressing types tailored to the needs of different care settings
              and wound types
          - New technologies in wound healing and tissue repair
          - New applications of V.A.C. technology and enhanced therapeutic effectiveness
              through settings improved understanding of V.A.C. various mechanisms of action
          - New therapeutic systems to address critical needs of Acute Respiratory Distress
              Syndrome (ARDS), cardiac arrest and stroke patients
          - Significant upgrades to several of our core therapeutic surfaces products

      In addition, we have initiated 11 clinical trials which are prospective, randomized, and controlled studies to demonstrate the benefits of our wound healing devices over current treatment protocols for a wide range of different wound types.

      Expenditures for research and development in each of the last three years ended December 31, were as follows (dollars in thousands):

      Our manufacturing process for our therapeutic systems and medical devices includes final assembly from components that are both internally produced and purchased from original equipment manufacturer suppliers. We contract for the manufacture of V.A.C. disposables through Avail Medical Products, Inc. ("Avail"), a leading contract manufacturer of sterile medical disposables.

      We entered into a sole-source agreement with Avail for our V.A.C. related disposable products, effective October 2002 for our U.S. related orders and which will commence in mid-2003 for our international related orders. This supply agreement has a three-year term. Approximately 13% of our total revenue is generated from the sale of these disposable supplies. The terms of the supply agreement provide that key indicators be provided to us that would alert us to Avail's inability to perform under the agreement. We, together with Avail, will maintain certain levels of on-hand supply. In the event that Avail is unable to fulfill the terms of this agreement, we have identified other suppliers that could provide such inventory to meet our needs. However, in the event that we are unable to replace a shortfall in supply, our revenue could be negatively impacted in the short term.

      We rely on a combination of patents, copyrights, trademarks, trade secret and other laws, and contractual restrictions on disclosures, copying and transferring title, including confidentiality agreements with vendors, strategic partners, co-developers, employees, consultants and other third parties, to protect our proprietary rights in our products, new developments, improvements and inventions. We seek patent protection in the United States and abroad. As of December 31, 2002, we had 104 issued U.S. patents relating to our existing and prospective lines of therapeutic systems and medical devices. We also have 64 pending U.S. Patent applications. Many of our specialized beds, medical devices and services are offered under proprietary trademarks and service marks. We have 45 registered trademarks and service marks in the United States Patent and Trademark Office. We also have agreements with third parties that provide for licensing of patented or pr oprietary technology, including royalty-bearing licenses and technology cross-licenses.

      As of March 1, 2003, we had approximately 3,400 employees. Approximately 960 of these employees are located in San Antonio, Texas and perform functions associated with Corporate, Manufacturing, Finance and Administration. Our employees are not represented by labor unions and we consider our employee relations to be good.

      Our products are subject to regulation by numerous governmental authorities, principally the United States Food and Drug Administration ("FDA") and corresponding state and foreign regulatory agencies. Pursuant to the Federal Food, Drug, and Cosmetic Act, and the regulations promulgated thereunder, the FDA regulates the clinical testing, manufacture, labeling, distribution and promotion of medical devices. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant pre-market clearance or pre-market approval for devices, withdrawal of marketing clearances or approvals and criminal prosecution. The FDA also has the authority to request repair, replacement or refund of the cost of any device that we manufacture or distribute that violates statutory or regulatory requirements.

      In the United States, medical devices are classified into one of three classes (Class I, II or III) on the basis of the controls deemed necessary by the FDA to reasonably ensure their safety and effectiveness. Although many Class I devices are exempt from certain FDA requirements, Class I devices are subject to general controls (for example, labeling, pre-market notification and adherence to Quality System Regulations). Class II devices are subject to general and special controls (for example, performance standards, post-market surveillance, patient registries and FDA guidelines). Generally, Class III devices are high-risk devices that receive greater FDA scrutiny to ensure their safety and effectiveness (for example, life-sustaining, life-supporting and implantable devices, or new

devices which have been found not to be substantially equivalent to legally marketed devices). Before a new medical device can be introduced in the market, the manufacturer must generally obtain FDA clearance ("510(k) Clearance") or pre-market approval. All of our current products have been classified as Class I or Class II devices, which typically are marketed, based upon 510(k) Clearance or related exemptions. A 510(k) Clearance will generally be granted if the submitted information establishes that the proposed device is "substantially equivalent" to a legally marketed medical device. In recent years, the FDA has been requiring a more rigorous demonstration of substantial equivalence than in the past.

      Devices that we manufacture or distribute are subject to pervasive and continuing regulation by the FDA and certain state agencies, including record keeping requirements and mandatory reporting of certain adverse experiences resulting from use of the devices. Labeling and promotional activities are subject to regulation by the FDA and, in certain circumstances, by the Federal Trade Commission. Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses and the FDA scrutinizes the advertising of medical devices to ensure that unapproved uses of medical devices are not promoted.

      Manufacturers of medical devices for marketing in the United States are required to adhere to applicable regulations setting forth detailed Quality System Regulation ("QSR") (formerly Good Manufacturing Practices) requirements, which include design, testing, control and documentation requirements. Manufacturers must also comply with Medical Device Reporting ("MDR") requirements that a company report certain device-related incidents to the FDA. We are subject to routine inspection by the FDA and certain state agencies for compliance with QSR requirements, MDR requirements and other applicable regulations.

      In October, 2002, an FDA inspector noted several noncompliance conditions after an inspection of our principal manufacturing facility. Although we believe we have adequately responded to the inspector's observations, there can be no assurance that the FDA will not initiate an enforcement action based upon this inspection observation. We are also subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. Changes in existing requirements or adoption of new requirements could have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that we will not incur significant costs to comply with laws and regulations in the future or that laws and regulations will not have a material adverse effect upon our business, financia l condition or results of operations.

      We are subject to various federal and state laws pertaining to health care fraud and abuse including prohibitions on the submission of false claims and the payment or acceptance of kickbacks or other remuneration in return for the purchase or lease of our products. In particular, certain federal and state laws prohibit manufacturers, suppliers and providers from offering, giving or receiving kickbacks or other remuneration in connection with the ordering, or recommending purchase or rental, of health care items and services. The federal anti-kickback statute provides both civil and criminal penalties for, among other things, offering or paying any remuneration to induce someone to refer patients to, or to purchase, lease, or order (or arrange for or recommend the purchase, lease, or order of) any item or service for which payment may be made by a federal health care program or certain federally-funded state health care programs (for example, Medicaid). This statute also prohibits soliciting or receiving any remuneration in exchange for engaging in any of these activities. The prohibition applies whether the remuneration is provided directly or indirectly, overtly or covertly, in cash or in kind. Violations of the law can result in severe sanctions, including criminal, and/or civil fines, imprisonment and exclusion from participation in federal or state health programs such as Medicare, Medicaid and TRICARE. These provisions have been broadly interpreted to apply to certain relationships between manufacturers and suppliers, such as KCI, and hospitals, SNFs and other potential purchasers or sources of referral. Under current law, courts and the Office of Inspector General ("OIG") of the United States Department of Health and Human Services have stated, among

other things, that the law is violated where even one purpose (as opposed to a primary or sole purpose) of a particular arrangement is to induce purchases or patient referrals.

      The OIG has taken certain actions, which suggest that arrangements between manufacturers/suppliers of durable medical equipment or medical supplies and SNFs (or other providers) may be under continued scrutiny. In June 1995, the OIG issued a Special Fraud Alert setting forth fraudulent and abusive practices that the OIG had observed in the home health industry. Later that same year, OIG issued another Special Fraud Alert describing certain relationships between SNFs and suppliers that the OIG viewed as abusive under the federal anti-kickback statute. Furthermore, the OIG Work Plan for 2002 focused on arrangements between durable medical equipment manufacturers and/or suppliers. These initiatives create an environment in which there will continue to be significant scrutiny for compliance with federal and state fraud and abuse laws.

      Several states also have referral, fee splitting and other similar laws that may restrict the payment or receipt of remuneration in connection with the purchase or rental of medical equipment and supplies. State laws vary in scope and have been infrequently interpreted by courts and regulatory agencies, but may apply to all health care items or services, regardless of whether Medicaid or Medicare funds are involved.

      We are also subject to federal and state laws prohibiting the presentation (or the causing to be presented) of claims for payment (by Medicare, Medicaid, or other third-party payers) that are determined to be false, fraudulent, or for an item or service that was not provided as claimed. These false claims statutes include the Federal False Claims Act, which allows any person to bring suit alleging false or fraudulent Medicare or Medicaid claims or other violations of the statute and to share in any amounts paid by the entity to the government in fines or settlement. Such suits, known as qui tam actions have increased significantly in recent years. Healthcare companies must defend such actions, which may result in payment of fines or exclusion from the Medicare and/or the Medicaid programs as the result of an investigation arising out of the action.

      Due to the harmonization efforts of a variety of regulatory bodies worldwide, certification of compliance with the ISO 9000 series of International Standards ("ISO Certification") has become particularly advantageous and, in certain circumstances, necessary for many companies in recent years. We received ISO 9001 and EN46001 Certification in the fourth quarter of 1997 and Medical Device Agency registration in the fourth quarter of 2002 and therefore are certified to apply the CE mark for direct selling and distributing of our products within the European community. In addition, we received certification for ISO 13485 in the fourth quarter of 2002 and certification with Health Canada and therefore are certified to sell and distribute our products within Canada.

      We own and lease property that is subject to environmental laws and regulations. We are also subject to numerous federal, state and local laws and regulations relating to such matters as safe working conditions, manufacturing practices, fire hazard control and the handling and disposal of hazardous or potentially hazardous substances.

      Sales of medical devices outside of the United States are subject to regulatory requirements that vary widely from country to country. Pre-market clearance or approval of medical devices is required by certain countries. The time required to obtain clearance or approval for sale in a foreign country may be longer or shorter than that required for clearance or approval by the FDA and the requirements vary. Failure to comply with applicable regulatory requirements can result in loss of previously received approvals and other sanctions and could have a material adverse effect on our business, financial condition or results of operations.

     We believe that government and private efforts to contain or reduce health care costs are likely to continue. These trends may lead third-party payers to deny or limit reimbursement for our products, which could negatively impact the pricing and profitability of, or demand for, our products.

      Medicare is a federally-funded program that provides health coverage primarily to the elderly and disabled. Medicare is composed of three parts: Part A, Part B and Part C. Medicare Part A (hospital insurance) covers, among other things, inpatient hospital care, home health care and skilled nursing facility services. Medicare Part B (supplemental medical insurance) covers various services, including those services provided on an outpatient basis. Part B also covers medically necessary durable medical equipment and medical supplies. Medicare Part C, also known as "Medicare+Choice", offers beneficiaries a choice of various types of health care plans, including several managed care options. The Medicare program has established guidelines for the coverage and reimbursement of certain equipment, supplies and support services. In general, in order to be reimbursed by Medicare, a health care item or service furnished to a Medicare beneficiary must be reas onable and necessary for the diagnosis or treatment of an illness or injury or to improve the functioning of a malformed body part. Effective October 1, 2000, we received Medicare Part B reimbursement codes, an associated coverage policy and allowable rates for our V.A.C. platforms and related disposables in the home care setting.

      The methodology for determining the amount of Medicare reimbursement of our products varies based upon, among other things, the setting in which a Medicare beneficiary receives health care items and services. Most of our products are furnished in a hospital, skilled nursing facility or the beneficiary's home.

      With the establishment of the prospective payment system in 1983, acute care hospitals are generally reimbursed by Medicare for inpatient operating costs based upon prospectively determined rates. Under the prospective payment system , or PPS, acute care hospitals receive a predetermined payment rate based upon the Diagnosis-Related Group, or DRG, which is assigned to each Medicare beneficiary, regardless of the actual cost of the services provided. Certain additional or "outlier" payments may be made to a hospital for cases involving unusually high costs. Accordingly, acute care hospitals generally do not receive direct Medicare reimbursement under PPS for the distinct costs incurred in purchasing or renting our products. Rather, reimbursement for these costs is deemed to be included within the DRG-based payments made to hospitals for the treatment of Medicare-eligible inpatients who utilize the products. Since PPS payments are based on predetermin ed rates, and are often less than a hospital's actual costs in furnishing care, acute care hospitals have incentives to lower their inpatient operating costs by utilizing equipment and supplies, such as KCI's products, that will reduce the length of inpatient stays, decrease labor or otherwise lower their costs.

      The BBA has affected Medicare Part A in the acute care setting by reducing the annual DRG payment updates to be paid over the next four years. In addition, the BBA authorized CMS to enact regulations, which are designed to restrain certain hospital reimbursement activities, which are perceived to be abusive or fraudulent.

      Certain specialty hospitals (such as long-term care and children's hospitals) also use our products. Such specialty hospitals were exempt from the PPS and, subject to certain cost ceilings, were reimbursed by Medicare on a reasonable cost basis for inpatient operating and capital costs incurred in treating Medicare beneficiaries. Consequently, such hospitals may have received additional Medicare reimbursement for reasonable costs incurred in purchasing or renting our products. A final rule for rehabilitation hospital PPS became effective on January 1, 2002. A final ruling was published in October 2002 implementing PPS for long-term care hospitals, effective January 1, 2003. We cannot predict the impact of the rehabilitation hospital PPS or the long-term care hospital PPS on the health care industry or on our financial position or results of operations.

      On July 1 1998, reimbursement for SNFs under Medicare Part A changed from a cost-based system to a prospective payment system which is based on resource utilization groups ("RUGs"). Under the RUGs system, a Medicare patient in a SNF is assigned to a RUGs category upon admission to the facility. The RUGs category to which the patient is assigned depends upon the medical services and functional support the patient is expected to require. The SNF receives a prospectively determined daily payment based upon the RUGs category assigned to each Medicare patient. These payments are intended generally to cover all inpatient services for Medicare patients, including routine nursing care, capital-related costs associated with the inpatient stay and ancillary services. Effective July 2002, the daily payments were based on the national average cost. Although the Refinement Act and BIPA increased the payments for certain RUGs categories, certain provisions of the Refinement Act and BIPA covering these payment increases expired on September 30, 2002 and, in effect, the RUGs rates for the most common categories of SNF patients decreased. Because the RUGs system provides SNFs with fixed daily cost reimbursement, SNFs have become less inclined to use products which had previously been reimbursed as variable ancillary costs.

      Our products are also provided to Medicare beneficiaries in home care settings. Medicare, under the Part B program, reimburses beneficiaries, or suppliers accepting an assignment of the beneficiary's Part B benefit, for the purchase or rental of DME for use in the beneficiary's home or a home for the aged (as opposed to use in a hospital or skilled nursing facility setting). As long as the Medicare Part B coverage criteria are met, certain of our products, including air fluidized beds, air-powered flotation beds, alternating pressure air mattresses and our V.A.C. platforms and related disposables are reimbursed in the home setting under the DME category known as "Capped Rental Items". Pursuant to the fee schedule payment methodology for this category, Medicare pays a monthly rental fee (for a period not to exceed 15 months for products other than V.A.C., for which the base treatment period may not exceed four months) equal to 80% of the established all owable charge for the item. The patient (or his or her insurer) is responsible for the remaining 20%.

      The Medicaid program is a cooperative federal/state program that provides medical assistance benefits to qualifying low income and medically needy persons. State participation in Medicaid is optional and each state is given discretion in developing and administering its own Medicaid program, subject to certain federal requirements pertaining to payment levels, eligibility criteria and minimum categories of services. The Medicaid program finances approximately 50% of all care provided in nursing facilities nationwide. We sell or rent our products to nursing facilities for use in furnishing care to Medicaid recipients. We, along with the nursing facilities, may seek and receive Medicaid reimbursement directly from states for the incurred costs. However, the method and level of reimbursement, which generally reflects regionalized average cost structures and other factors, varies from state to state and is subject to each state's budget constraints. Cu rrent economic conditions have resulted in reductions in funding for many state Medicaid programs. Consequently, states are revising their policies for coverage of durable medical equipment in long term care facilities and the home. We cannot predict the impact of the policy changes on our Medicaid revenue.

      Many third-party private payers, including indemnity insurers, employer group health insurance programs and managed care plans, presently provide coverage for the purchase and rental of our products. The scope of coverage and payment policies varies among third-party private payers. Furthermore, many such payers are investigating or implementing methods for reducing health care costs, such as the establishment of capitated or prospective payment systems.

      We believe that government and private efforts to contain or reduce health care costs are likely to continue. These trends may lead third-party payers to deny or limit reimbursement for our products, which could negatively impact the pricing and profitability of, or demand for, our products.

contractual agreements will not be breached, that we will have adequate remedies for any such breaches, or that our trade secrets will not otherwise become known to or independently developed by others. We have trademarks, both registered and unregistered, that are maintained and enforced to provide customer recognition for our products in the marketplace. We cannot provide assurance that our trademarks will not be used by unauthorized third parties. We also have agreements with third parties that provide for licensing of patented or proprietary technology. These agreements include royalty-bearing licenses and technology cross-licenses. If we were to lose the rights to license this technology or our costs to license this technology were to materially increase, our business would suffer.

      If we are unable to develop new generations of products and enhancements to existing products, we may be unable to attract or retain customers. Our success is dependent upon the successful development, introduction and commercialization of new generations of products and enhancements to existing products. Our products are technologically complex and must keep pace with rapid and significant technological change, comply with rapidly evolving industry standards and compete effectively with new product introductions of our competitors. Accordingly, many of our products require significant planning, design, development and testing at the technological, product and manufacturing process levels. These activities require significant capital commitments and investments on our part, which we may be unable to recover.

      Our ability to successfully develop and introduce new products and product enhancements, and the associated costs, are also affected by our ability to:

          - properly identify customer needs;
          - prove feasibility of new products;
          - limit the time required from proof of feasibility to routine production;
          - limit the timing and cost of regulatory approvals;
          - accurately predict and control costs associated with inventory overruns caused by phase-in
              of new products and phase-out of old products;
          - price our products competitively;
          - manufacture and deliver our products in sufficient volumes on time, and accurately predict
              and control costs associated with manufacturing, installation, warranty and maintenance
              of the products;
          - manage customer demands for retrofits of both new and old products; and
          - anticipate and compete successfully with competitors' efforts.

      We cannot be sure that we will be able to successfully develop, manufacture and phase-in new products or product enhancements. Without the successful introduction of new products and product enhancements, we may be unable to attract and retain customers and our revenue and operating results will suffer. In addition, even if customers accept new products or product enhancements, the revenue from such products may not be sufficient to offset the significant costs associated with making such products available to customers.

      If we are unable to provide the significant education and training required for the health care market to accept our products, our business will suffer. In order to achieve market acceptance for our products, we are often required to educate healthcare professionals about the use of a new medical device, overcome objections to some of the effects of the device or its related treatment regimen and convince health care payers that the benefits of the device and its related treatment regimen outweigh its costs. For example, the complexity and dynamic nature of our products requires education of healthcare professionals regarding the benefits and the required departures from customary practices. We have expended and will continue to expend significant resources on marketing and educational efforts to create general awareness of our products and to encourage acceptance and adoption of our products. The timing of our competitors' introduction of pr oducts and the market acceptance of their products may also make this educational process more difficult. We cannot be sure that any products we develop will gain any significant market acceptance and market share among physicians, patients and health care payers even if required regulatory approvals are obtained.

      Healthcare reform and changes to third-party reimbursement could negatively impact demand for our products. There are widespread efforts to control health care costs in the United States and abroad, which likely will continue in the future. Our products are rented and sold to hospitals, skilled nursing facilities and durable medical equipment suppliers who receive reimbursement for the products and services they provide from various public and private third-party payers, including Medicare, Medicaid and private insurance programs. We also act as a DME supplier and as such, we furnish our products directly to customers and bill third-party payers. As a result, the demand for our products in any specific care setting is dependent, in part, on the reimbursement policies of the various payers in that setting. If reimbursement coverage for our products is altered or canceled under existing Medicare or Medi caid policies, demand for our products could be negatively impacted, which could have a material adverse affect on our financial condition and results of operations. In light of increased controls on Medicare and Medicaid spending, there can be no assurance on the outcome of future coverage or payment decisions for any of our products by governmental or private payers. (See "Business -- Reimbursement".)

      Third parties may claim we are infringing their intellectual property, and we could suffer significant litigation or licensing expenses or be prevented from selling our products. The markets in which we compete are characterized by a substantial amount of litigation over patent and other intellectual property rights. Our competitors, like companies in other high technology businesses, continually review other companies' products for possible conflicts with their own intellectual property rights. Determining whether a product infringes a third party's intellectual property rights involves complex legal and factual issues, and the outcome of this type of litigation is often uncertain. Third parties may claim that we are infringing their intellectual property rights, and we may be found to infringe those intellectual property rights. While we do not believe that any of our products infringe the valid intellectual property rights o f third parties, we may not be aware of intellectual property rights of others that relate to our products, services or technologies. From time to time, we have received notices from third parties alleging infringement of patent or other intellectual property rights relating to their products. Such claims are often, but not always, settled by mutual agreement satisfactorily without litigation. Any contest regarding patents or other intellectual property could be costly and time-consuming, and could divert our management and key personnel from our business operations. We cannot provide assurance that we will prevail in any such contest. If we are unsuccessful, we may be subject to significant damages or injunctions against development and sale of our products, or may be required to enter into costly royalty or license agreements. We cannot be certain that any licenses required would be made available on acceptable terms or at all.

     Our debt level and the restrictions imposed on us under our senior credit facility and the outstanding notes may hinder our ability to meet the substantial capital requirements of our business. Our substantial indebtedness under our senior credit facility and our outstanding notes has important consequences including, but not limited to, the following:

          - a substantial portion of our cash flow from operations is dedicated to debt service and
              will not be available for other purposes;
          - our future ability to obtain additional debt financing for working capital, capital expenditures
              or acquisitions may be limited; and
          - our level of indebtedness could limit our flexibility in reacting to changes in the industry and
              general economic conditions.

      Certain competitors currently operate on a less leveraged basis and have significantly greater operating and financing flexibility than we have.

      We believe we have adequate capital resources to meet our anticipated cash requirements for debt repayments, working capital and capital expenditures through 2004. However, due to the anticipated future growth in V.A.C. demand, slower payment cycles from certain payers and the increased capital expenditures and working capital required to support and maintain such growth, our ability to generate cash flow sufficient to meet our 2005 through 2007 debt amortization requirements may be negatively impacted. In such a case, we may attempt to raise additional capital through the refinancing of existing indebtedness, through the sale of additional debt or equity securities, or any combination of the foregoing, subject to the restrictions contained in the indenture governing our

outstanding notes and our senior credit agreement. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all. (See "Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources".)

      Restrictions imposed on us in connection with our outstanding indebtedness will limit our ability to raise additional capital or enter into certain transactions. The terms of our senior credit facility and our outstanding notes restrict, among other things, our ability to:

          - incur additional indebtedness;
          - incur liens;
          - announce or pay dividends or make certain other restricted payments;
          - consummate certain asset sales;
          - enter into certain transactions with affiliates;
          - incur indebtedness that is subordinate in right of payment to any senior debt and senior in
              right of payment to the notes;
          - merge or consolidate with any other person; or
          - sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our
               assets.

      Our senior credit facility also requires us to maintain specified financial ratios and satisfy certain financial condition tests. Our ability to meet those financial ratios and tests can be affected by events beyond our control, and there can be no assurance that we will meet those tests. A breach of any of these covenants could result in a default under our senior credit agreement and/or the indenture governing the notes. Upon the occurrence of an event of default under the senior credit agreement, the lenders could elect to declare all amounts outstanding under the senior credit agreement, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lenders could proceed against the collateral granted to them to secure that indebtedness. If the indebtedness under the senior credit facilities were to be accelerated, there can be no assurance that our assets would be sufficient to repay in full the indebtedness thereunder and our other indebtedness, including our notes.

      Because we depend upon a limited group of suppliers, and in some cases sole-source suppliers, for some product components, the loss of a supplier could reduce our ability to manufacture products, cause material delays in our ability to deliver products, or significantly increase our costs. We obtain some of the components included in our products from a limited group of suppliers, and in one case, a sole-source supplier. We have entered into a sole-source agreement with Avail for our V.A.C. disposable products, effective October 2002, for our U.S. related orders and mid-2003 for our International related orders. This supply agreement has a three-year term. If we lose any supplier (including any sole-source supplier), we would be required to obtain one or more replacement suppliers and may be required to conduct a significant level of product development to incorporate new parts into our products. We b elieve that we may be able to obtain alternative sources for such components when necessary, although the need to change suppliers or to alternate between suppliers might cause material delays in delivery or significantly increase costs. Disruptions or loss of any of our limited or sole-source disposables, components, or subassemblies, including the one referenced above, could adversely affect our business and financial results and could result in damage to customer relationships.

      A high percentage of our sales are international, and economic, political and other risks associated with international sales and operations could adversely affect our sales or make them less predictable. We have direct operations in 15 foreign countries. As a result, we must provide significant service and support on a worldwide basis. We also have strategic relationships with a number of additional distributors for sales and service of our products. If these strategic relationships are terminated and not replaced, our sales and/or ability to service our products in the territories serviced by these distributors could be adversely affected. We have invested substantial financial and management resources to develop an international infrastructure to meet the needs of our customers. We intend to continue to expand our presence in international markets, although we cannot be sure we will able to compet e successfully in international markets or meet the service and support needs of such customers. Accordingly, our future results could be harmed by a variety of factors, including:

          - the difficulties in enforcing agreements and collecting receivables through many foreign
              countries' legal systems;
          - the longer payment cycles associated with many foreign customers;
          - the possibility that foreign countries may impose additional withholding taxes or otherwise
              tax our foreign income, impose tariffs or adopt other restrictions on foreign trade;
          - fluctuations in exchange rates, which may affect product demand and adversely affect the
              profitability, in U.S. dollars, of products and services provided by us in foreign markets
              where payment for our products and services is made in the local currency;
          - our ability to obtain U.S. export licenses and other required export or import licenses or
              approvals;
          - changes in the political, regulatory, safety or economic conditions in a country or region; and
          - the protection of intellectual property in foreign countries may be more difficult to enforce.

      We may not be able to maintain or expand our business if we are not able to retain, hire and integrate sufficient qualified personnel. Our future success depends to a significant extent on the continued service of members of our key executive, technical, sales, marketing and engineering staff. It also depends on our ability to attract, expand, integrate, train and retain our management team, qualified engineering personnel and technical personnel. The loss of services of key employees could adversely affect our business. Competition for such personnel can be intense. We complete for key personnel with other medical equipment and software manufacturers and technology companies, as well as universities and research institutions. Because the competition for qualified personnel is intense, costs related to compensation could increase significantly if supply decreases or demand increases. If we are unable to hire, train or retain qualified perso nnel, we will not be able to maintain and expand our business.

      We face significant costs in order to comply with laws and regulations governing the healthcare industry, and failure to comply