##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the quarterly period ended September 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the transition period from            to
 Commission
file number: 000-18338
 I-FLOW CORPORATION
  Delaware
(State or Other Jurisdiction of 
Incorporation or Organization)
    
    33-0121984
(I.R.S. Employer Identification No.)20202 Windrow Drive, Lake Forest, CA
(Address of Principal Executive Offices)
    
    92630
(Zip Code)
 
 þ o
  o þ o
 o þ




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##### Table of Contents



I-FLOW CORPORATION
 FORM 10-Q
 FOR THE QUARTER ENDED SEPTEMBER 30, 2006
 Table of Contents
  
 PagePart I: Financial Information
    
    
    1Item 1. Financial Statements (Unaudited)
    
    
    1Condensed Consolidated Balance Sheets
    
    
    1Condensed Consolidated Statements of Operations and Comprehensive Operations
    
    
    2Condensed Consolidated Statements of Cash Flows
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    22Item 4. Controls and Procedures
    
    
    23Part II: Other Information
    
    
    24Item 1. Legal Proceedings
    
    
    24Item 1A. Risk Factors
    
    
    24Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    27Item 6. Exhibits
    
    
    27Signatures
    
    
    28EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1




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##### Table of Contents



PART
I  FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 I-FLOW CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (Unaudited)
 (Amounts in thousands)
 September 30,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    9,261
    
    
    $
    11,413Short-term investments
    
    
    15,079
    
    
    
    13,276Accounts receivable, less allowance for
doubtful accounts of $2,712 and $1,649
at September 30, 2006 and December 31,
2005, respectively
    
    
    16,823
    
    
    
    13,423Inventories
    
    
    14,446
    
    
    
    11,529Prepaid expenses and other current assets
    
    
    1,544
    
    
    
    1,206Deferred taxes
    
    
    10,814
    
    
    
    Current
assets  held for sale
    
    
    12,103
    
    
    
    11,790Total current assets
    
    
    80,070
    
    
    
    62,637Property, net
    
    
    2,649
    
    
    
    2,575Other intangible assets, net
    
    
    2,625
    
    
    
    2,655Other long-term assets
    
    
    174
    
    
    
    155Deferred taxes
    
    
    14,540
    
    
    
    Non-current
assets  held for sale
    
    
    13,453
    
    
    
    14,931Total assets
    
    $
    113,511
    
    
    $
    82,953LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    6,158
    
    
    $
    3,178Accrued payroll and related expenses
    
    
    4,599
    
    
    
    4,953Income taxes payable
    
    
    
    
    
    
    228Other current liabilities
    
    
    604
    
    
    
    926Current
liabilities  held for sale
    
    
    4,891
    
    
    
    3,619Total current liabilities
    
    
    16,252
    
    
    
    12,904Commitments and contingenciesStockholders equity:Preferred stock  $0.001 par value;
5,000 shares authorized; no shares
issued and outstanding
    
    
    
    
    
    
    Common stock  $0.001 par value; 40,000
shares authorized; 23,447 and 22,629
shares issued and outstanding at
September 30, 2006 and
December 31, 2005, respectively
    
    
    124,505
    
    
    
    110,890Accumulated other comprehensive loss
    
    
    (186
    )
    
    
    (242
    )Accumulated deficit
    
    
    (27,060
    )
    
    
    (40,599
    )Net stockholders equity
    
    
    97,259
    
    
    
    70,049Total liabilities and stockholders equity
    
    $
    113,511
    
    
    $
    82,953
  1




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##### Table of Contents



I-FLOW CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE OPERATIONS
 (Unaudited)
 (Amounts in thousands, except per share data)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net product sales
    
    $
    23,813
    
    
    $
    18,154
    
    
    $
    66,149
    
    
    $
    52,275Cost of revenues
    
    
    6,936
    
    
    
    5,124
    
    
    
    18,274
    
    
    
    13,989Gross profit
    
    
    16,877
    
    
    
    13,030
    
    
    
    47,875
    
    
    
    38,286Operating expenses:Selling and marketing
    
    
    13,761
    
    
    
    12,238
    
    
    
    42,296
    
    
    
    36,788General and administrative
    
    
    3,928
    
    
    
    3,401
    
    
    
    9,816
    
    
    
    9,383Product development
    
    
    617
    
    
    
    639
    
    
    
    1,764
    
    
    
    1,934Total operating expenses
    
    
    18,306
    
    
    
    16,278
    
    
    
    53,876
    
    
    
    48,105Operating loss
    
    
    (1,429
    )
    
    
    (3,248
    )
    
    
    (6,001
    )
    
    
    (9,819
    )Interest income
    
    
    252
    
    
    
    241
    
    
    
    667
    
    
    
    714Loss from continuing operations before income taxes
    
    
    (1,177
    )
    
    
    (3,007
    )
    
    
    (5,334
    )
    
    
    (9,105
    )Income tax benefit
    
    
    (15,591
    )
    
    
    (907
    )
    
    
    (16,998
    )
    
    
    (2,146
    )Income (loss) from continuing operations
    
    
    14,414
    
    
    
    (2,100
    )
    
    
    11,664
    
    
    
    (6,959
    )Discontinued operations:Income (loss) from discontinued operations,
net of tax
    
    
    (826
    )
    
    
    1,612
    
    
    
    1,875
    
    
    
    3,817Net income (loss)
    
    $
    13,588
    
    
    $
    (488
    )
    
    $
    13,539
    
    
    $
    (3,142
    )Per share of common stock, basic:Income (loss) from continuing operations
    
    $
    0.62
    
    
    $
    (0.09
    )
    
    $
    0.50
    
    
    $
    (0.31
    )Income (loss) from discontinued operations, net
of tax
    
    
    (0.04
    )
    
    
    0.07
    
    
    
    0.08
    
    
    
    0.17Net income (loss)
    
    $
    0.58
    
    
    $
    (0.02
    )
    
    $
    0.58
    
    
    $
    (0.14
    )Per share of common stock, diluted:Income (loss) from continuing operations
    
    $
    0.59
    
    
    $
    (0.09
    )
    
    $
    0.48
    
    
    $
    (0.31
    )Income (loss) from discontinued operations, net
of tax
    
    
    (0.04
    )
    
    
    0.07
    
    
    
    0.08
    
    
    
    0.17Net income (loss)
    
    $
    0.55
    
    
    $
    (0.02
    )
    
    $
    0.56
    
    
    $
    (0.14
    )Weighted average shares:Basic
    
    
    23,429
    
    
    
    22,518
    
    
    
    23,159
    
    
    
    22,377Diluted
    
    
    24,544
    
    
    
    22,518
    
    
    
    24,325
    
    
    
    22,377Comprehensive Operations:Net income (loss)
    
    $
    13,588
    
    
    $
    (488
    )
    
    $
    13,539
    
    
    $
    (3,142
    )Foreign currency translation gain (loss)
    
    
    46
    
    
    
    4
    
    
    
    (44
    )
    
    
    64Unrealized gain (loss) on investment securities
    
    
    39
    
    
    
    (8
    )
    
    
    100
    
    
    
    (46
    )Comprehensive income (loss)
    
    $
    13,673
    
    
    $
    (492
    )
    
    $
    13,595
    
    
    $
    (3,124
    )
  2




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I-FLOW CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 (Amounts in thousands)
 Nine Months EndedSeptember 30,2006
    
    
    2005CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    13,539
    
    
    $
    (3,142
    )Adjustments to reconcile net loss to net cash used in operating activities:Income from discontinued operations, net of tax
    
    
    (1,875
    )
    
    
    (3,817
    )Deferred taxes
    
    
    (17,122
    )
    
    
    Stock-based compensation
    
    
    3,674
    
    
    
    2,198Depreciation and amortization
    
    
    1,066
    
    
    
    1,040Provision for doubtful accounts receivable
    
    
    224
    
    
    
    539Loss on property disposal
    
    
    34
    
    
    
    Write-off of inventory obsolescence
    
    
    121
    
    
    
    64Changes in operating assets and liabilities:Accounts receivable
    
    
    (3,624
    )
    
    
    (2,708
    )Inventories
    
    
    (3,038
    )
    
    
    (4,249
    )Prepaid expenses and other current assets
    
    
    (280
    )
    
    
    (387
    )Accounts payable, accrued payroll and related expenses
    
    
    2,634
    
    
    
    (131
    )Income taxes payable
    
    
    (292
    )
    
    
    170Other current liabilities
    
    
    (322
    )
    
    
    (37
    )Net cash used in operating activities from continuing operations
    
    
    (5,261
    )
    
    
    (10,460
    )Net cash provided by operating activities from discontinued operations
    
    
    5,705
    
    
    
    4,633Net cash provided by (used in) operating activities
    
    
    444
    
    
    
    (5,827
    )CASH FLOWS FROM INVESTING ACTIVITIES:Property acquisitions
    
    
    (775
    )
    
    
    (355
    )Purchases of investments
    
    
    (13,050
    )
    
    
    (12,013
    )Maturities of investments
    
    
    11,347
    
    
    
    22,690Sale of investments
    
    
    
    
    
    
    985Patent acquisitions
    
    
    (390
    )
    
    
    (1,422
    )Net cash (used in) provided by investing activities from continuing operations
    
    
    (2,868
    )
    
    
    9,885Net cash used in investing activities from discontinued operations
    
    
    (1,701
    )
    
    
    (6,019
    )Net cash (used in) provided by investing activities
    
    
    (4,569
    )
    
    
    3,866CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from exercise of stock options and warrants
    
    
    1,035
    
    
    
    989Net cash provided by financing activities from continuing operations
    
    
    1,035
    
    
    
    989Net cash provided by financing activities from discontinued operations
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    1,035
    
    
    
    989Effect of exchange rates on cash
    
    
    (44
    )
    
    
    64Net decrease in cash and cash equivalents
    
    
    (3,134
    )
    
    
    (908
    )Net increase(decrease) in cash and cash equivalents from discontinued
operations
    
    
    982
    
    
    
    (222
    )Cash and cash equivalents at beginning of period
    
    
    11,413
    
    
    
    9,161Cash and cash equivalents at end of period
    
    $
    9,261
    
    
    $
    8,031SUPPLEMENTAL CASH FLOW INFORMATION:Income tax payments
    
    $
    383
    
    
    $
    SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES:Property acquisitions
    
    $
    219
    
    
    $
    1.096
  3




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I-FLOW CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  1. Basis of Presentation and Summary of Significant Accounting Policies
 Basis
of Presentation
 Accounting for Impairment or Disposal of
Long-Lived Assets
  Use
of Estimates 
 Reclassifications
 New
Accounting Pronouncements Accounting for Uncertainty in Income Taxes
 Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements
 Fair Value Measurements ,
 Accounting
for Stock-Based Compensation  Share-Based Payment Accounting for Stock-Based Compensation Accounting for Stock Issued to
 4




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Employees Share-Based Payment
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,(Amounts in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Income (loss) from continuing operations:Selling and marketing
    
    $
    554
    
    
    $
    459
    
    
    $
    1,732
    
    
    $
    1,507General and administrative
    
    
    725
    
    
    
    227
    
    
    
    1,992
    
    
    
    691Subtotal
    
    
    1,279
    
    
    
    686
    
    
    
    3,724
    
    
    
    2,198Income (loss) from discontinued operations:Selling and administrative
    
    
    35
    
    
    
    71
    
    
    
    71
    
    
    
    194General and administrative
    
    
    40
    
    
    
    33
    
    
    
    102
    
    
    
    97Subtotal
    
    
    75
    
    
    
    104
    
    
    
    173
    
    
    
    291Total
    
    $
    1,354
    
    
    $
    790
    
    
    $
    3,897
    
    
    $
    2,489
 Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans, .
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Expected life (in years)
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0Risk-free interest rate
    
    
    4.67
    %
    
    
    3.89
    %
    
    
    4.67% - 5.07
    %
    
    
    3.70% - 4.17
    %Volatility
    
    
    56
    %
    
    
    60
    %
    
    
    56% - 57
    %
    
    
    60% - 89
    %Dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
  5




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##### Table of Contents



Stock Options
  Weighted-AverageWeighted-
    
    
    RemainingAverage
    
    
    Contractual
    
    
    AggregateExercise Price
    
    
    Term
    
    
    Intrinsic(Amounts in thousands, except per share and year amounts)
    
    Number of Shares
    
    
    per Share
    
    
    (in years)
    
    
    ValueOptions outstanding at December 31, 2005
    
    
    3,828
    
    
    $
    9.66Options granted
    
    
    222
    
    
    $
    13.46Options exercised
    
    
    (243
    )
    
    $
    4.86Options forfeited or expired
    
    
    (143
    )
    
    $
    15.11Options outstanding at September 30, 2006
    
    
    3,664
    
    
    $
    9.99
    
    
    
    2.61
    
    
    $
    15,385Options vested and exercisable at September 30, 2006
    
    
    3,263
    
    
    $
    9.97
    
    
    
    2.52
    
    
    $
    14,064
 
    6




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Three Months Ended
    
    
    Nine Months Ended(Amounts in thousands, except per share amounts)
    
    September 30, 2005
    
    
    September 30, 2005Net loss
 as reported
    
    $
    (488
    )
    
    $
    (3,142
    )Stock-based employee and director compensation
included in net loss, net of tax
    
    
    786
    
    
    
    2,484Total stock-based employee and director
compensation expense determined under fair value
based method for all awards, net of tax
    
    
    (2,639
    )
    
    
    (7,951
    )Net loss
 pro forma
    
    $
    (2,341
    )
    
    $
    (8,609
    )Basic and
diluted net loss per share  as reported
    
    $
    (0.02
    )
    
    $
    (0.14
    )Basic and
diluted net loss per share  pro forma
    
    $
    (0.10
    )
    
    $
    (0.38
    )
 Restricted Stock and Restricted Stock Units
  7




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##### Table of Contents



Restricted Stock
    
    Restricted Stock UnitsWeighted-
    
    
    
    
    
    Weighted-Average Grant
    
    
    
    
    
    Average GrantNumber of
    
    Date Fair Value
    
    Number of
    
    Date Fair Value(Amounts in thousands, except per share amounts)
    
    Shares
    
    per Share
    
    Shares
    
    Per ShareNonvested shares outstanding at December 31, 2005
    
    
    
    
    
    $
    
    
    
    
    326
    
    
    $
    14.75Shares issued
    
    
    522
    
    
    
    13.89
    
    
    
    429
    
    
    
    13.65Shares vested or released
    
    
    
    
    
    
    
    
    
    
    (49
    )
    
    
    15.15Shares forfeited
    
    
    
    
    
    
    
    
    
    
    (83
    )
    
    
    14.57Nonvested shares outstanding at September 30, 2006
    
    
    522
    
    
    $
    13.89
    
    
    
    623
    
    
    $
    13.98
   2. Inventories
  September 30,
    
    
    December 31,(Amounts in thousands)
    
    2006
    
    
    2005Raw materials
    
    $
    7,904
    
    
    $
    6,654Work in process
    
    
    2,578
    
    
    
    1,881Finished goods
    
    
    3,964
    
    
    
    2,994Total
    
    $
    14,446
    
    
    $
    11,529
 3. Earnings (Loss) Per Share
 Earnings Per Share
   8




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Three Months Ended September 30,
    
    
    Nine Months Ended September 30,(Amounts in thousands, except per share amounts)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Numerator:Income (loss) from continuing operations
    
    $
    14,414
    
    
    $
    (2,100
    )
    
    $
    11,664
    
    
    $
    (6,959
    )Income (loss) from discontinuing operations, net of tax
    
    
    (826
    )
    
    
    1,612
    
    
    
    1,875
    
    
    
    3,817Net loss
    
    $
    13,588
    
    
    $
    (488
    )
    
    $
    13,539
    
    
    $
    (3,142
    )Denominators:Denominator for basic earnings per share:Weighted-average number of common shares outstanding
    
    
    23,429
    
    
    
    22,518
    
    
    
    23,159
    
    
    
    22,377Effect of dilutive securities:Stock options, nonvested restricted stock and
nonvested restricted stock units
    
    
    1,115
    
    
    
    
    
    
    
    1,166
    
    
    
    Denominator for diluted net income per share:Weighted-average number of common and common
equivalent shares outstanding
    
    
    24,544
    
    
    
    22,518
    
    
    
    24,325
    
    
    
    22,377Basic earnings per share:Income (loss) from continuing operations
    
    $
    0.62
    
    
    $
    (0.09
    )
    
    $
    0.50
    
    
    $
    (0.31
    )Income (loss) from discontinuing operations
    
    
    (0.04
    )
    
    
    0.07
    
    
    
    0.08
    
    
    
    0.17Net loss
    
    $
    0.58
    
    
    $
    (0.02
    )
    
    $
    0.58
    
    
    $
    (0.14
    )Diluted earnings per share:Income (loss) from continuing operations
    
    $
    0.59
    
    
    $
    (0.09
    )
    
    $
    0.48
    
    
    $
    (0.31
    )Income (loss) from discontinuing operations
    
    
    (0.04
    )
    
    
    0.07
    
    
    
    0.08
    
    
    
    0.17Net loss
    
    $
    0.55
    
    
    $
    (0.02
    )
    
    $
    0.56
    
    
    $
    (0.14
    )
   4. Goodwill and Other Intangible Assets
 Goodwill
and Other Intangible Assets
 9




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##### Table of Contents



As of September 30, 2006Carrying
    
    
    Accumulated(Amounts in thousands)
    
    Amount
    
    
    Amortization
    
    
    NetPatents
    
    $
    3,051
    
    
    $
    1,267
    
    
    $
    1,784Licensing Rights
    
    
    1,101
    
    
    
    260
    
    
    
    841Total
    
    $
    4,152
    
    
    $
    1,527
    
    
    $
    2,625
 As of December 31, 2005Carrying
    
    
    Accumulated(Amounts in thousands)
    
    Amount
    
    
    Amortization
    
    
    NetPatents
    
    $
    2,857
    
    
    $
    1,113
    
    
    $
    1,744Licensing Rights
    
    
    1,101
    
    
    
    190
    
    
    
    911Total
    
    $
    3,958
    
    
    $
    1,303
    
    
    $
    2,655
   5. Stockholders Equity
  6. Discontinued Operations
  10




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##### Table of Contents



Three Months Ended September 30,
    
    Nine Months Ended September 30,(Amounts in thousands)
    
    2006
    
    2005
    
    2006
    
    2005Operating revenues
    
    $
    7,825
    
    
    $
    8,641
    
    
    $
    23,508
    
    
    $
    21,444Operating income*
    
    
    44
    
    
    
    2,614
    
    
    
    4,429
    
    
    
    6,197Income taxes
    
    
    870
    
    
    
    1,002
    
    
    
    2,554
    
    
    
    2,380Income (loss) from discontinued operations*
    
    
    (826
    )
    
    
    1,612
    
    
    
    1,875
    
    
    
    3,817
 
 *
    
    Includes $1,661,000 and $1,828,000 of divestiture expenses recorded during the three and nine
months ended September 30, 2006, respectively.  September 30,
    
    
    December 31,(Amounts in thousands)
    
    2006
    
    
    2005Cash
    
    $
    1,481
    
    
    $
    2,463Accounts receivable, less allowance for
doubtful accounts of $1,793 and $1,723 at
September 30, 2006 and December 31, 2005,
respectively
    
    
    10,244
    
    
    
    8,921Inventories
    
    
    264
    
    
    
    188Prepaid expenses and other current assets
    
    
    114
    
    
    
    218Total current assets
    
    $
    12,103
    
    
    $
    11,790Property, net
    
    $
    11,279
    
    
    $
    12,292Goodwill
    
    
    2,174
    
    
    
    2,639Total noncurrent assets
    
    $
    13,453
    
    
    $
    14,931Accounts payable
    
    $
    1,213
    
    
    $
    662Accrued payroll and related expenses
    
    
    832
    
    
    
    1,663Accrued use taxes payable
    
    
    1,281
    
    
    
    1,173Income taxes payable
    
    
    (7
    )
    
    
    109Deferred
taxes*
    
    
    1,555
    
    
    
    Other liabilities
    
    
    17
    
    
    
    12Total current liabilities
    
    $
    4,891
    
    
    $
    3,619
 
 *
    
    The deferred tax liability consists primarily of depreciation and the basis adjustment in
accordance Emerging Issues Task Force (EITF) Issue No. 93-17, Recognition of Deferred Tax Assets
for a Parent Companys Excess Tax Basis in the Stock of a Subsidiary that is Accounted for as a
Discontinued Operation(EITF 93-17) (see Note 7 on Income Taxes). 7. Income Taxes
 Accounting for Income
Taxes
  September 30, 2006
    
    
    September 30, 2005Continuing
    
    
    Discontinuing
    
    
    Continuing
    
    
    Discontinuing(Amounts in thousands)
    
    Operations
    
    
    Operations
    
    
    Operations
    
    
    OperationsCurrent:Federal
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Foreign
    
    
    81
    
    
    
    
    
    
    
    
    
    
    
    State
    
    
    43
    
    
    
    173
    
    
    
    37
    
    
    
    195Subtotal
    
    
    124
    
    
    
    173
    
    
    
    37
    
    
    
    195Deferred:Federal
    
    
    (14,827
    )
    
    
    2,183
    
    
    
    (1,936
    )
    
    
    1,985State
    
    
    (2,295
    )
    
    
    198
    
    
    
    (247
    )
    
    
    200Subtotal
    
    
    (17,122
    )
    
    
    2,381
    
    
    
    (2,183
    )
    
    
    2,185Total income tax (benefit) provision
    
    $
    (16,998
    )
    
    $
    2,554
    
    
    $
    (2,146
    )
    
    $
    2,380
 11




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##### Table of Contents



Recognition of Deferred Tax Assets for a Parent
Companys Excess Tax Basis in the Stock of a Subsidiary that is Accounted for as a Discontinued
Operation
 12




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##### Table of Contents



September 30, 2006
    
    
    September 30, 2005Continuing
    
    
    Discontinuing
    
    
    Continuing
    
    
    DiscontinuingOperations
    
    
    Operations
    
    
    Operations
    
    
    OperationsTax at federal statutory rate
    
    
    (35.0
    %)
    
    
    35.0
    %
    
    
    (35.0
    %)
    
    
    35.0
    %State income taxes, net of federal benefit
    
    
    (3.6
    %)
    
    
    3.2
    %
    
    
    (3.9
    %)
    
    
    3.2
    %Foreign operations
    
    
    1.5
    %
    
    
    0.0
    %
    
    
    (0.0
    %)
    
    
    0.0
    %Valuation allowance
    
    
    (280.1
    %)
    
    
    0.0
    %
    
    
    12.1
    %
    
    
    0.0
    %Nondeductible charges
    
    
    2.0
    %
    
    
    0.3
    %
    
    
    2.6
    %
    
    
    0.2
    %Basis difference
    
    
    0.0
    %
    
    
    19.2
    %
    
    
    0.0
    %
    
    
    0.0
    %Other
    
    
    (3.5
    %)
    
    
    0.0
    %
    
    
    0.6
    %
    
    
    0.0
    %Total
    
    
    (318.7
    %)
    
    
    57.7
    %
    
    
    (23.6
    %)
    
    
    38.4
    %
   September 30,
    
    
    December 31,(Amounts in thousands)
    
    2006
    
    
    2005Net operating losses
    
    $
    16,113
    
    
    $
    15,356Amortization of goodwill and other intangibles
    
    
    1,804
    
    
    
    2,050Reserves not currently deductible
    
    
    9,202
    
    
    
    9,056State taxes
    
    
    (1,464
    )
    
    
    (1,320
    )Credits
    
    
    1,512
    
    
    
    1,512Depreciation
    
    
    142
    
    
    
    (1,512
    )Total deferred income taxes
    
    
    27,309
    
    
    
    25,142Valuation allowance
    
    
    (1,955
    )
    
    
    (25,142
    )Net deferred income taxes
    
    $
    25,354
    
    
    $
    
   13




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##### Table of Contents



8. Commitments and Contingencies
     14




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##### Table of Contents



Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Forward-Looking Statements
  Overview
   15




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##### Table of Contents



Discontinued Operations of InfuSystem
 Accounting for Impairment or Disposal of Long-Lived Assets
 Three Months Ended September 30,
    
    Nine Months Ended September 30,(Amounts in thousands)
    
    2006
    
    2005
    
    2006
    
    2005Operating revenues
    
    $
    7,825
    
    
    $
    8,641
    
    
    $
    23,508
    
    
    $
    21,444Operating income*
    
    
    44
    
    
    
    2,614
    
    
    
    4,429
    
    
    
    6,197Income taxes
    
    
    870
    
    
    
    1,002
    
    
    
    2,554
    
    
    
    2,380Net income from discontinued operations*
    
    
    (826
    )
    
    
    1,612
    
    
    
    1,875
    
    
    
    3,817
 
   Results of Operations
 Revenue
    16




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##### Table of Contents



Cost of Revenues
   Selling and Marketing Expenses
      17




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##### Table of Contents



General and Administrative Expenses
     Product Development Expenses
  Interest Income, Net
  Income Taxes
  18




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##### Table of Contents



Recognition of Deferred Tax
Assets for a Parent Companys Excess Tax Basis in the Stock of a Subsidiary that is Accounted for
as a Discontinued Operation .
 Liquidity and Capital Resources
       19




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##### Table of Contents



New Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes
 Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements
 Fair Value Measurements ,
 Critical Accounting Policies
  20




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##### Table of Contents



Revenue Recognition
    Accounts Receivable
  Inventories
  21




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##### Table of Contents



Deferred Taxes
   Stock-Based Compensation
 Share-Based Payment
 
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 Interest Rate Risk
   Foreign Currency
  22




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##### Table of Contents



Item 4. CONTROLS AND PROCEDURES
   23




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##### Table of Contents



PART II  OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
  
 Item 1A. RISK FACTORS
  RISK FACTORS RELATING TO OUR BUSINESS AND THE INDUSTRY IN WHICH WE OPERATE
 The pending sale of InfuSystem, Inc. to HAPC, Inc. may not be consummated.
  
    
    our cash flow and financial condition could be adversely affected if the Company is
unable to complete the transaction;
    
    the current stock price of our common stock may reflect a market assumption that the
sale of InfuSystem will occur, and, thus, a failure to complete the transaction could
result in a negative perception by the stock market of us generally and a decline in the
market price of our common stock;
    
    our business could be adversely affected if we are unable to retain key customers, our
employees at InfuSystem or attract replacements; and
    
    the value of our deferred tax assets could be impaired if the Company is unable to
complete the transaction.
 We have experienced net losses in prior periods and have an accumulated deficit. Future losses are
possible.
  Changes in third-party reimbursement rates may adversely impact InfuSystems revenues.
  24




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##### Table of Contents



We are dependent on our Medicare Supplier Number.
  Our revenues are heavily dependent on physicians acceptance of infusion therapy as a preferred
therapy since a significant percentage of patients are treated with oral medications. If new oral
medications are introduced or future clinical studies demonstrate that oral medications are as
effective or more effective than infusion therapy, our business could be adversely affected.
  Our growth strategy includes expansion into infusion treatment for cancers other than the
colorectal type. There can be no assurance that infusion-based regimens for these other cancers
will become accepted or that we will be successful in penetrating these different markets.
  We may need to raise additional capital in the future to fund our operations. We may be unable to
raise funds when needed or on acceptable terms.
  25




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##### Table of Contents



Additional financings may be dilutive to stockholders, involve the issuance of securities that are
more senior to our stock or impose operational restrictions.
  A significant portion of our sales is to customers in foreign countries. We may lose revenues,
market share, and profits due to exchange rate fluctuations and other factors related to our
foreign business.
   We currently rely on two distributors for a significant percentage of our sales. If our
relationship with these distributors were to deteriorate, our sales may materially decline.
  RISK FACTORS RELATED SPECIFICALLY TO OUR COMMON STOCK
 The average trading volume for our common stock is relatively low when compared to most larger
companies. As a result, there may be less liquidity and more volatility associated with our common
stock, even if our business is doing well.
   
    
    announcements of technological innovations, new products, or clinical studies by us or others;
    
    government regulation;
    
    changes in the coverage or reimbursement rates of private insurers and governmental agencies;
 26




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##### Table of Contents




    
    developments in patent or other proprietary rights;
    
    future sales of substantial amounts of our common stock by existing stockholders or by us; and
    
    comments by securities analysts and general market conditions.
  Future sales of our common stock by existing stockholders could negatively affect the market price
of our stock and make it more difficult for us to sell stock in the future.
  
    
    22,925,443 shares of common stock that are freely tradable in the public markets;
 
    
    521,931 shares of restricted stock that are subject to outstanding awards under our 2001
Equity Incentive Plan;
 
    
    215,109 shares of common stock underlying outstanding warrants which have been registered for
resale under a Registration Statement on Form S-3 (Registration No. 333-109096); and
 
    
    an aggregate of 4,287,116 shares of common stock that are subject to outstanding awards under
our various equity incentive plans, including shares of restricted stock units and stock
options.
  
 Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 Item 6. EXHIBITS
  27




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##### Table of Contents



SIGNATURES
  I-FLOW CORPORATIONDate: November 7, 2006
    
    /s/ Donald M. Earhart

Donald M. EarhartChairman, President and Chief Executive Officer(On behalf of the registrant)Date: November 7, 2006
    
    /s/ James R. TalevichJames R. TalevichChief Financial Officer(As principal financial officer)
 28




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##### Table of Contents



INDEX TO EXHIBITS
 Exhibit No.
    
    Exhibit2.1
    
    Stock Purchase Agreement, dated October 28, 2004, by and between
Integra LifeSciences Corporation and I-Flow 
Corporation (1)2.2
    
    Merger Agreement, dated July 27, 2001, by and between I-Flow
Corporation, a Delaware corporation, and I-Flow Corporation, a
California corporation (2)2.3
    
    Agreement and Plan of Merger, dated January 13, 2000, by and
among I-Flow Corporation, Spinal Acquisition Corp., Spinal
Specialties, Inc. and the Shareholders of Spinal Specialties,
Inc. (3)2.4
    
    Agreement and Plan of Merger, dated February 9, 1998, by and
among I-Flow Corporation, I-Flow Subsidiary, Inc., Venture
Medical, Inc., InfuSystems II, Inc. and the Shareholders of
Venture Medical, Inc. and InfuSystems II, Inc. (4)2.5
    
    Agreement for Purchase and Sale of Assets, dated July 3, 1996, by
and among I-Flow Corporation, Block Medical, Inc. and Hillenbrand
Industries, Inc. (5)2.6
    
    Stock Purchase Agreement, dated as of September 29, 2006, by and
among I-Flow Corporation, InfuSystem, Inc., HAPC, Inc. and
Iceland Acquisition Subsidiary, Inc. (including the Form of
Services Agreement, attached thereto as Exhibit A, the Form of
License Agreement attached thereto as Exhibit B and the Term
Sheet attached thereto as Exhibit C) (11)3.1
    
    Amended and Restated Certificate of Incorporation of I-Flow
Corporation, a Delaware Corporation (6)3.2
    
    Bylaws of I-Flow Corporation, a Delaware Corporation (2)3.3
    
    Certificate of Designation Regarding Series A Junior
Participating Cumulative Preferred Stock (7)4.1
    
    Specimen Common Stock Certificate (8)4.2
    
    Warrant Agreement, dated February 13, 1990, between the Company
and American Stock Transfer & Trust Company, as warrant agent (9)4.3
    
    Rights Agreement, dated as of March 8, 2002, by and between
I-Flow Corporation and American Stock Transfer & Trust Company,
as rights agent, which includes, as Exhibit A, the Form of Rights
Certificate, the Form of Assignment and the Form of Election to
Purchase (7)4.4
    
    Warrant to Purchase Stock, dated May 8, 2003, between I-Flow
Corporation and Silicon Valley Bank (10)4.5
    
    Registration Rights Agreement, dated May 8, 2003, between I-Flow
Corporation and Silicon Valley Bank (10)4.6
    
    Form of Warrant, dated September 4, 2003 (1)4.7
    
    Form of Registration Rights Agreement, dated September 4, 2003 (1)31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 200232.1
    
    Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 (1)
    
    Incorporated by reference to exhibit with this title filed with the Companys Quarterly
Report on Form 10-Q for the quarter ended September 30, 2003.(2)
    
    Incorporated by reference to exhibit with this title filed with the Companys Current Report
on Form 8-K filed on August 3, 2001.




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##### Table of Contents



(3)
    
    Incorporated by reference to exhibit with this title filed with the Companys Quarterly
Report on Form 10-Q for the quarter ended March 31, 2000.(4)
    
    Incorporated by reference to exhibit with this title filed with the Companys Current Report
on Form 8-K/A filed on March 6, 1998.(5)
    
    Incorporated by reference to exhibit with this title filed with the Companys Current Report
on Form 8-K dated July 22, 1996.(6)
    
    Incorporated by reference to exhibit with this title filed with the Companys Current Report
on Form 8-K dated May 29, 2002.(7)
    
    Incorporated by reference to exhibit with this title filed with the Companys Current Report
on Form 8-K filed on March 13, 2002.(8)
    
    Incorporated by reference to exhibit with this title filed with the Companys Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002.(9)
    
    Incorporated by reference to exhibit with this title filed with the Companys Annual Report
on Form 10-K for the fiscal year ended September 30, 1990.(10)
    
    Incorporated by reference to exhibit with this title filed with the Companys Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003.(11)
    
    Incorporated by reference to exhibit with this title filed with the Companys Current Report
on Form 8-K filed on October 4, 2006.