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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
   FORM 10-K
 FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (Mark One) x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
  OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
 Commission file number: 0-18338 I-FLOW CORPORATION 
  Delaware
    
    33-0121984(State or Other Jurisdiction
of Incorporation or Organization)
    
    (IRS Employer Identification No.)
 20202 Windrow Drive, Lake Forest, CA
    
    92630(Address of Principal Executive Offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (949) 206-2700 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $0.001 per share 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 x No o 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 amendment to
this Form 10-K. o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes x No o The aggregate market value of the common stock of the registrant held by
non-affiliates as of June 30, 2003 (the last trading day of the second fiscal
quarter) was $106,265,316, based on a closing price of $7.43 on the Nasdaq
Stock Market on such day. The number of shares of the registrants common
stock outstanding at March 5, 2004 was 18,424,951. DOCUMENTS INCORPORATED BY REFERENCE The information required by Part II, Item 5 and Part III of this annual report
on Form 10-K is incorporated by reference to portions of the registrants proxy
statement for its annual meeting of stockholders to be held on May 25, 2004,
which proxy statement will be filed with the Securities and Exchange Commission
no later than 120 days after the end of the registrants fiscal year ended
December 31, 2003.




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TABLE OF CONTENTS



|                                                                   |                                                                                                         |  |  |  |  |  |  | 
|------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                                            
|                                                                   | Item 1. Business                                                                                       
|                                                                   | Item 2. Properties                                                                                     
|                                                                   | Item 3. Legal Proceedings                                                                              
|                                                                   | Item 4. Submission of Matters to a Vote of Security Holders                                            
|PART II                                                           
|                                                                   | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                          
|                                                                   | Item 6. Selected Financial Data                                                                        
|                                                                   | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations          
|                                                                   | Item 7A. Quantitative and Qualitative Disclosures about Market Risk                                    
|                                                                   | Item 8. Financial Statements and Supplementary Data                                                    
|                                                                   | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           
|                                                                   | Item 9A. Controls and Procedures                                                                       
|PART III                                                          
|                                                                   | Item 10. Directors and Executive Officers of the Registrant                                            
|                                                                   | Item 11. Executive Compensation                                                                        
|                                                                   | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|                                                                   | Item 13. Certain Relationships and Related Transactions                                                
|                                                                   | Item 14. Principal Accountant Fees and Services                                                        
|PART IV                                                           
|                                                                   | Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.                             
|Independent Auditors Report                                      
|CONSOLIDATED BALANCE SHEETS                                       
|CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE OPERATIONS
|CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY                   
|CONSOLIDATED STATEMENTS OF CASH FLOWS                             
|Notes to Consolidated Financial Statements                        
|SIGNATURES                                                        
|INDEX TO EXHIBITS                                                 
|EXHIBIT 10.12                                                     
|EXHIBIT 10.13                                                     
|EXHIBIT 21.1                                                      
|EXHIBIT 23.1                                                      
|EXHIBIT 31.1                                                      
|EXHIBIT 31.2                                                      
|EXHIBIT 32.1                                                      



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PART I 
 Item 1. Business The Company I-Flow Corporation (the Company or I-Flow) designs, develops, manufactures
and markets technically advanced, low-cost ambulatory drug delivery systems
that seek to redefine the standard of care by providing life enhancing, cost
effective solutions for pain management and infusion therapy. The Companys
products are used in hospitals and other settings, including free-standing
surgery centers and physicians offices. Since it began in 1985, I-Flow Corporation has established a reputation in the
medical and health care industry as an innovator in drug delivery technology.
Through product innovation and strategic acquisitions, the Company has emerged
as a leader in pain management, offering highly effective therapeutic delivery
systems for physicians and their patients. I-Flows suite of pain management
products provides reliable and simple regional anesthesia techniques that
eliminate many of the side effects customarily associated with narcotics and
general anesthesia. Patients who use I-Flows pain management products
generally recover more rapidly after surgery, which results in shorter hospital
stays and reduced costs. I-Flow currently manufactures a line of compact, portable infusion pumps,
catheters and pain kits that administer medication directly to the wound site
as well as administer local anesthetics, chemotherapies, antibiotics,

diagnostic agents, nutritional supplements and other medications. The Company
has continued to introduce into the market reliable, lightweight, portable
infusion pumps which enable patients to live ambulatory and, therefore, more
productive lifestyles. I-Flow sells and distributes its products throughout
the United States, Canada, Europe, Asia, Mexico, Brazil, Australia, New Zealand
and the Middle East. InfuSystem, Inc., a wholly owned subsidiary of
I-Flow Corporation (InfuSystem), is primarily engaged in the rental of
infusion pumps on a month-to-month basis for the treatment of cancer. The Company was incorporated in the State of California in July 1985. On July
30, 2001, the Company changed its state of incorporation to Delaware by merging
into a wholly owned subsidiary incorporated in Delaware. The Companys
corporate offices are located at 20202 Windrow Drive, Lake Forest, California
92630. I-Flows telephone number is (949) 206-2700 and its website is
www.iflo.com. Acquisitions On January 14, 2000, the Company acquired all of the outstanding stock of
Spinal Specialties, Inc. (Spinal Specialties), a designer and manufacturer of
custom spinal, epidural and nerve block infusion kits based in San Antonio,
Texas. Spinal Specialties provides a line of custom, disposable products for
chronic and acute pain management that are tailored to the specific needs of a
particular hospital, anesthesiologist or pain clinic. I-Flow sold Spinal
Specialties on November 1, 2003. Divestitures On November 1, 2003, the Company sold Spinal Specialties to Integra
LifeSciences Holdings Corporation for approximately $6,000,000 in cash, with
net cash proceeds to the Company of approximately $5,000,000. The business of Spinal
Specialties is discussed above. 2




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The Products

I-Flow offers health care professionals an array of cost-effective drug
delivery devices designed to meet the needs of todays managed care environment
in both hospital and alternate site settings. The I-Flow family of products is
focused on three primary market segments  Regional Anesthesia, Intravenous
(IV) Infusion Therapy and Oncology Infusion Services.

Regional Anesthesia

Acute Pain Kits

I-Flows acute pain kit product line includes the ON-Q® Post-Operative Pain
Relief System, the PainBuster® Pain
Management System and the C-blocTM
Continuous Nerve Block System. I-Flows ON-Q and PainBuster systems offer
continuous wound site pain management, which is considered to be one of the
most ideal treatments for post-operative pain. This approach represents a
significant improvement over traditional methods of post-operative pain
management because fewer narcotics, which have negative side effects, are used.
I-Flows C-bloc system combines the advantages of a custom nerve block kit
with the added feature of a disposable infusion pump. Studies have shown that
ON-Q, when used for the treatment of post-operative pain, reduced average pain
scores, reduced the use of narcotics for pain control following surgery, and
decreased the average length of hospital stays.

The Companys SoakerTM Catheters (2.5 and 5 versions) were granted United
States Food and Drug Administration (the FDA) permission for use for pain
management of large surgical incisions in November 1999 and March 2000,
respectively. The Soaker Catheter, which attaches to I-Flows diverse line of
infusion systems, provides the continuous, even infusion of a non-narcotic,
local anesthetic directly along surgical incisions for post-operative pain
management.

IV Infusion Therapy

Elastomerics

I-Flows product line of elastomeric pumps delivers medication from an elastic
balloon that does not rely on gravity for proper delivery. These pumps are
small enough to fit into a patients pocket or be clipped to a patients
clothing. This easy-to-use technology provides health care professionals with
a device that is both safe and simple enough for patients to use for
self-administration of medication. These characteristics provide patients with
better mobility and a quicker transition to rehabilitation. The Companys
elastomeric line of products can be used for antibiotic therapy, pain
management medications, chemotherapy or other medications. Elastomeric
products include the Companys patented Homepump Eclipse® and the Homepump
Eclipse C Series.

Non-Electric IV Bag Delivery Systems

I-Flows non-electric products provide a safe and easy-to-use system for
controlled infusion. Pumps in this category are drug delivery systems that
consist of a reusable mechanical infuser and specially designed administration
sets. The pumps provide precise delivery of medications that require slow and
continuous infusion. I-Flows products in this area include the Paragon® and
Sidekick® ambulatory infusion pumps and the Rely-A-Flow® Gravity Set.

Electronic Pumps

The Companys ambulatory electronic infusion products include the I-Flow VIP
pump, which has barcode features that can be used with the Companys VOICELINK®
Remote Programming System. The VOICELINK system enables caregivers to monitor
and program the devices for their patients with a touch-tone phone. The system
is designed to provide accurate and safe remote programming and delivery of up
to four individually customized protocols. Revenues from these products have
declined and the Company
expects to phase out its electronic pump products for the IV Infusion Therapy
market during the first quarter of 2004.

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Oncology Infusion Services

InfuSystem provides ambulatory infusion pump systems and supplies to oncology
offices and chemotherapy clinics. Pumps from a variety of manufacturers are
offered to customers primarily on a rental basis. InfuSystems revenues are
primarily derived from billings to third party insurers.

The Markets

The Company sells into three market segments: Regional Anesthesia, IV Infusion
Therapy and Oncology Infusion Services. Over the last three years, I-Flow
significantly expanded its product line and distribution capabilities to
establish itself as a leading participant in the regional anesthesia market.
Management believes that this expansion, coupled with the Companys innovations
in pain management and infusion technologies, has placed I-Flow in a position
for future potential growth. The Company operates in two reportable operating
segments: manufacturing and marketing medical infusion pumps and rentals of
medical infusion pumps. The rental operating segment principally consists of
the activities of InfuSystem within the Oncology Infusion Services market
segment. See Note 9 in Notes to Consolidated Financial Statements.

The Company believes that the hospital market for I-Flows simple, portable
regional anesthesia technologies is largely untapped at this time. The Company
estimates that there are more than 70 million operative procedures performed in
the United States every year. I-Flow believes that its ON-Q and PainBuster
systems could be used in more than 15 million of these
procedures because there is an incision, a surgeon can visualize the
insertion of a catheter and pain management is a concern for patients. The Company
estimates that the current penetration by all competitors in this market
combined is less than two percent.

The alternate site health care industry has generally supported the need for
ambulatory infusion devices. An ambulatory pump enables a patient to leave the
hospital earlier, making it attractive to cost-conscious hospitals and to
patients who favor home treatment. I-Flows sales in the IV Infusion Therapy
market include the Companys intravenous elastomeric pumps, mechanical infusion
devices and, to a lesser extent, electronic infusion pumps and disposables.

The Company participates in the Oncology Infusion Services market through the
activities of InfuSystem which provides infusion pump rentals and related
disposable products, primarily for chemotherapy.

The following table sets forth a summary of the Companys revenues by market
segment, expressed as percentages of the Companys total net revenues for each
fiscal year:

Net Revenues by Market Segment
    
    2003
    
    2002
    
    2001Regional Anesthesia
    
    
    34
    %
    
    
    25
    %
    
    
    18
    %IV Infusion Therapy
    
    
    38
    %
    
    
    45
    %
    
    
    48
    %Oncology Infusion Services
    
    
    28
    %
    
    
    30
    %
    
    
    34
    %


Competition

The drug infusion industry is highly competitive. The Company competes in this
industry primarily based on price, service and product performance. Some of
the Companys competitors have greater name recognition and significantly
greater resources than the Company for research and development, manufacturing,
marketing and sales. As a result, they may be better able to compete for
market share, even in areas in which the Companys products may be superior.
The industry is subject to rapid technological changes and there can be no
assurance that the Company will be able to maintain any existing technological
advantage long enough to establish its products in the market or to achieve and
sustain profitability. In the Regional Anesthesia market segment, the
Companys products compete primarily against the conventional use of narcotics
for the treatment of post-operative pain.

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The number of current known market participants, including the Company, and the
Companys current estimated competitive position in terms of revenue for each
of its product lines is noted in the table below.

|                                             |  |                 |    |                       |  |  |   | 
|-------------------------------------------- |  | --------------- | -- | --------------------- |  |  | - | 
|                                             |  | Number of Known |    | Companys            
|                                             |  | Market          |    | Estimated Competitive
|U.S. Market
Description                      |  | Participants*   |    | Position             
|Regional Anesthesia                          |  |                 |    |                       |  |  |   | 
|Acute Pain Kits (wound site pain management) |  |                 | 10 |                       |  |  | 1 | 
|IV Infusion Therapy                          |  |                 |    |                       |  |  |   | 
|Elastomerics                                 |  |                 | 3  |                       |  |  | 1 | 
|Non-electric IV Bag Delivery Systems         |  |                 | 4  |                       |  |  | 2 | 
|Electronic Pumps                             |  |                 | 7  |                       |  |  | 7 | 
|Oncology Infusion Services                   |  |                 | ** |                       |  |  | 1 | 



|*** |  | Includes the Company 

 The Oncology Infusion Services market is highly fragmented with numerous local competitors.
|--- |  | -------------------------------------------------------------------------------------------------------------------

Sales and Distribution

The Company currently distributes its products in the United States through its
internal sales force as well as through a number of national and regional
medical product distributors. The Company relies on regional United States
medical product distributors for approximately 7% of its revenue. There are no
distribution contracts for the entire I-Flow product line with any of these
distributors.

In
January 2002, we began to build a direct sales force in the United
States to sell ON-Q. As of December 31, 2002, we had 36 people
in our sales organization. As of December 31, 2003, we had 99
people in our sales organization. Our sales organization is comprised
of inside and outside salespeople, nurses, and customer service
representatives.

In 1998, the Company entered into an agreement with B. Braun Medical S.A.
(France), a manufacturer and distributor of pharmaceuticals and infusion
products, to distribute I-Flows elastomeric infusion pumps in Western Europe,
Eastern Europe, the Middle East, Asia Pacific, South America and
Africa. The agreement is renewable on an annual basis. For
the years ended December 31, 2003, 2002 and 2001, sales to B. Braun Medical
S.A. accounted for 10%, 12% and 9% of the Companys total revenues,
respectively. The Company entered into a separate agreement with B. Braun
Medical, Inc., a national United States distributor, to distribute I-Flows
elastomeric pumps to B. Braun Medical, Inc.s IV Infusion Therapy customers in
the United States. The agreement is renewable on a bi-annual basis. For the years ended December 31, 2003, 2002 and 2001, sales
to B. Braun Medical, Inc., accounted for 7%, 6% and 9% of the Companys total
revenues, respectively.

In 1999, the Company entered into an agreement with dj Orthopedics LLC
(formerly DonJoy, a division of Smith & Nephew, Inc.), a leading provider of
orthopedic braces, to distribute the Companys PainBuster Pain Management
System exclusively in the United States and Canada for orthopedic surgery
applications. The agreement, as amended, called for dj Orthopedics to make
minimum purchases through 2001 in order to maintain exclusive distribution
rights. Under the terms of the agreement, dj Orthopedics exclusive right to
sell into the orthopedic post-operative wound site pain management market
converted into a non-exclusive right to sell into this market as of January 1,
2002. The agreement expired on December 31, 2003.

In June 1999, the Company entered into an agreement with Ethicon Endo-Surgery,
Inc., a Johnson & Johnson subsidiary (Ethicon Endo-Surgery), under which
Ethicon Endo-Surgery became the exclusive distributor in the United States of
I-Flows ON-Q Post-Operative Pain Relief System for all surgical applications
other than orthopedics. This multi-year agreement required Ethicon
Endo-Surgery to meet minimum purchase commitments to maintain exclusive
distribution rights. The agreement was terminated by mutual agreement in
October 2001. Under the terms of the termination agreement, Ethicon
Endo-Surgery ceased selling the ON-Q Post-Operative Pain Relief System
effective January 1, 2002. At that time, the Company regained exclusive United
States distribution rights to the ON-Q Post-Operative Pain Relief System, and
began selling the products through I-Flows direct sales organization. In
2004, the Company changed the name of its ON-Q Post-Operative Pain Relief
System to ON-Q Painbuster to consolidate the brand identity of its products.

The Company sells several of its products into the international market and has
agreements with distributors in a number of countries. Currently, the
Company sells its products through distributors in Canada, Brazil, the Benelux
Countries, Germany, England, Ireland, Italy, Mexico, Spain, Korea, Australia,
New Zealand and Israel.

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Aggregate revenues from countries outside of the
United States represented approximately 20%, 26% and 24% of the Companys total
revenues for the years ended December 31, 2003, 2002 and 2001, respectively.
The Company does not have any capital investments in any foreign operations
except for its manufacturing plant in Mexico. Total revenues attributable to each geographic area in which the Company has
sales is as follows: Sales to unaffiliated customers:
    
    2003
    
    2002
    
    2001United States
    
    $
    37,503,000
    
    
    $
    25,697,000
    
    
    $
    23,116,000Europe
    
    
    7,588,000
    
    
    
    7,202,000
    
    
    
    5,897,000Asia / Pacific Rim
    
    
    969,000
    
    
    
    1,095,000
    
    
    
    987,000Other
    
    
    983,000
    
    
    
    669,000
    
    
    
    531,000All Foreign Countries in the Aggregate
    
    
    9,540,000
    
    
    
    8,966,000
    
    
    
    7,415,000
 Backlog The Company did not have a significant backlog of unfilled orders as of
December 31, 2003 or December 31, 2002. Manufacturing and Operations A majority of the Companys products are manufactured by its Mexican
subsidiary, Block Medical de Mexico, S.A. de C.V. (Block Medical). This
plant has been in operation since 1994 and has historically manufactured, and
is currently manufacturing, all of the Companys disposable IV Infusion Therapy
devices and elastomeric Regional Anesthesia products. The Company currently
intends to maintain the plant in Mexico and to manufacture a substantial
portion of its products there. The Company regularly reviews the use of
outside vendors for production versus internal manufacturing, and considers
factors such as the quality of the products received from outside vendors, the
costs of the products, timely delivery and employee utilization. Product Development The Company has focused its product development efforts on products in
post-operative pain relief and ambulatory infusion systems markets. In each of
the years ended December 31, 2003, 2002 and 2001, the Company incurred expenses
of approximately $2,361,000, $2,104,000 and $2,238,000, respectively, for
product development. Patents and Trademarks The Company has filed patent applications in the United States for
substantially all of its products. The Company currently holds approximately
40 patents, including patents that relate to both the ON-Q Post-Operative Pain
Relief System and the Soaker Catheter. The Companys patents generally expire
between 2009 to 2015, with significant patents expiring in 2009. The
Company has also filed for intellectual property right protection in all
foreign countries from which it derives significant revenue. In the opinion of
management, there are no limitations on the Companys intellectual property
that would have a material adverse effect on the Company. All of the Companys product names are either registered trademarks or have
trademark applications pending. There can be no assurance that pending patent
or trademark applications will be approved or that any patents will provide
competitive advantages for the Companys products or will not be challenged or
circumvented by competitors or others. Regulations Governing the Companys Products and Manufacturing Operations I-Flows activities are regulated by the Food, Drug and Cosmetic Act (the
Act). Under the Act, the Company is required, among other matters, to
register its facilities and to list its devices with the FDA, to file notice of
its intent 6




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to market new products under Section 510(K) of the Act, to track the
location of certain of its products and to report any incidents of death or
serious injury relating to its products. To date, there have been no
reportable conditions found during any FDA inspection. Failure to comply with
any of these regulations can result in civil and criminal penalties being
imposed upon the Company and/or the recall, seizure or injunction of products. The State of California also has similar regulations. Each year the Company is
subject to production-site inspections in order to maintain its manufacturing
license. State regulations also specify the standards for the storage and
handling of certain chemicals and disposal of their wastes. The Company is also required to comply with federal, state and local
environmental laws. To date, there has been no significant environmental issue
affecting the Companys capital expenditures, earnings or competitive position
and there is currently no significant use of hazardous materials in the
manufacture of its products. Products intended for export are subject to additional regulations, including
compliance with ISO 9000. In May 1995, the Company received ISO 9001
certification, which indicates that I-Flows products meet specified uniform
standards of quality and testing. The Company was also granted permission to
use the CE mark on its products, which reflects approval of the Companys
products for export into 18 member countries of the European Community. In
December 1996, the Block Medical operations, including its Mexico facility,were added to the Companys ISO certification and the Company received
permission to use the CE mark on the products manufactured by Block Medical. Employees As of March 1, 2004, the Company and its subsidiaries had a total of 255
full-time employees in the United States and an additional 265 employees in
Mexico. None of the Companys employees in the United States or Mexico are
covered by a collective bargaining agreement. The Company considers its
relationship with its employees to be good. From time to time, the Company
also uses temporary employees. These temporary employees are usually engaged
to manufacture the Companys products. Available Information Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and amendments to those reports filed with or furnished to the
Securities and Exchange Commission pursuant to Section 13(a) or 15(d) of the
Exchange Act of 1934, as amended, are available free of charge through our web
site at www.iflo.com as soon as reasonably practicable after we electronically
file or furnish the reports with or to the Securities and Exchange Commission. 
 Item 2. Properties The Companys headquarters are located in Lake Forest, California, where the
Company leases a 51,000 square foot building. The Company entered a lease for
the building in 1997 and it has a term of 10 years. The Company has the option
to extend the lease for an additional five years, which the Company currently
intends to exercise. The Company also leases a plant in Tijuana, Mexico for
the manufacture of its ambulatory infusion devices. The plant lease was
entered into in 2000 and has a term of five years. The plant currently
operates at approximately 60% of capacity. Additionally, the Companys
Infusystem subsidiary entered into leases in July 2002 for 8,120 square feet of
general office space and 3,000 square
feet of warehouse space in Madison Heights, Michigan. Both leases have a term
of five years. The Company believes that its facilities are adequate to meet
its current needs. 7




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Item 3. Legal Proceedings As of March 1, 2004, the Company was involved in legal proceedings in the
normal course of operations. Although the ultimate outcome of the proceedings
cannot be currently determined, in the opinion of management any resulting
future liability will not have a material adverse effect on the Company and its
subsidiaries, taken as a whole. 
 Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the three
months ended December 31, 2003. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth information concerning the executive officers of
the Company as March 1, 2004. There are no family relationships between any of
the executive officers or directors of the Company. The executive officers are
chosen annually at the first meeting of the board of directors following the
annual meeting of stockholders and, subject to the terms of any employment
agreement, serve at the will and pleasure of the board of directors. Name
    
    Age
    
    PositionDonald M. Earhart
    
    
    59
    
    
    President, Chief Executive Officer and
Chairman of   the BoardJames J. Dal Porto
    
    
    50
    
    
    Executive Vice President, Chief Operating
Officer,    Director and SecretaryJames R. Talevich
    
    
    53
    
    
    Chief Financial Officer and Treasurer
 Donald M. Earharthas been Chairman of the Board since March 1991 and Chief
Executive Officer since July 1990. Mr. Earhart joined the Company as President
and Chief Operating Officer in June 1990. Mr. Earhart, who holds a Bachelor of
Engineering degree from Ohio State University and a Masters Degree in Business
Administration from Roosevelt University, has over 25 years experience in the
medical products industry. Prior to joining the Company, from 1986 to 1990,
Mr. Earhart was a corporate officer and the President of the Optical Division
of Allergan, Inc. Prior to his employment at Allergan, he was a corporate
officer and Division President of Bausch and Lomb and was an operations manager
of Abbott Laboratories. He has also served as an engineering consultant at
Peat, Marwick, Mitchell & Co. and as an engineer with Eastman Kodak Company. James J. Dal Portojoined the Company as Controller in October 1989. Mr. Dal
Porto was promoted to Treasurer in October 1990, to Vice President of Finance
and Administration in March 1991, to Executive Vice President and Chief
Financial Officer in March 1993 and to Chief Operating Officer in February
1994. Mr. Dal Porto served as Financial Planning Manager and Manager of
Property Accounting and Local Taxation at CalComp, a high technology
manufacturing company, from 1984 to 1989. Mr. Dal Porto holds a B.S. in
Economics from the University of California, Los Angeles and a M.B.A. from
California State University, Northridge. James R. Talevichjoined the Company as Chief Financial Officer in August 2000.
Prior to joining the Company, he was Chief Financial Officer of Gish
Biomedical, Inc., a publicly held medical device company, from 1999 to 2000 and
Chief Financial Officer of Tectrix Fitness Equipment, Inc., a privately held
manufacturing company, from 1995 to 1999. Prior to 1995, he held financial
management positions
with Mallinckrodt Medical, Inc., Sorin Biomedical, Inc., a medical products
subsidiary of Fiat S.p.A., Pfizer, Inc., Sensormedics Corporation, a privately
held medical device company, Baxter Travenol Laboratories, Inc. and KPMG Peat
Marwick. Mr. Talevich holds a B.A. in Physics from California State
University, Fullerton and a M.B.A. from the University of California at Los
Angeles, and is a Certified Public Accountant. 8




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RISK FACTORS I. Risk Factors Relating to Our Business and the Industry in Which We Operate We have experienced net losses in prior years and have an accumulated deficit.
Future losses are possible. As of December 31, 2003, our accumulated deficit was approximately $15,083,000.
We had net income (losses) of $1,267,000, ($3,035,000) and $457,000 for the
years ended December 31, 2001, 2002 and 2003, respectively. We may not achieve
or maintain profitability in the future, and further losses may arise. For example, during the year ended December 31, 2003, our total costs and
expenses increased by an amount greater than the increase in revenues, compared
to the year ended December 31, 2002. There can be no assurance that our future
revenue growth, if any, will be greater than the growth of our costs and
expenses. If the increase in our total costs and expenses continues to be
greater than any increase in our revenues, we will not be profitable. 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. During the year ended December 31, 2003, our operating activities used cash of
$1,070,000 and our investing activities provided $1,003,000 in the same period.
As of December 31, 2003, we had cash on hand of $15,185,000 and net accounts
receivable of $12,392,000. We believe our current funds, together with
possible additional borrowings on our existing lines of credit and other bank
loans, are sufficient to provide for our projected needs to maintain operations
for at least the next 12 months. This estimate, however, is based on assumptions that
may prove to be wrong. If our assumptions are wrong or if we experience
further losses, we may be required to curtail our operations and to seek
additional financing. Any additional equity financings may be dilutive to our existing stockholders
and involve the issuance of securities that may have rights, preferences or
privileges senior to those of our current stockholders. A debt financing, if
available, may involve restrictive covenants on our business that could limit
our operational and financial flexibility, and the amount of debt incurred
could make us more vulnerable to economic downturns or operational difficulties
and limit our ability to compete. Furthermore, financing may not be available
when needed and may not be on terms acceptable to us. We have invested substantial resources into the sales and marketing of the
ON-Q® Post-Operative Pain Relief System. If this product does not achieve
significant clinical acceptance or if our direct sales strategy is not
successful, our financial condition and operating results will be adversely
affected. Our current strategy assumes that the ON-Q Post-Operative Pain Relief system
will be used in a significant number of surgical cases, ultimately becoming the
standard of care for many common procedures. We have invested, and continue to
invest, a substantial portion of our resources into the establishment of a
direct sales force for the sales and marketing of ON-Q. During the year ended
December 31, 2003, we invested approximately $16,800,000 in the sales and
marketing of ON-Q. A failure of ON-Q to achieve and maintain a significant
market presence, or the failure to successfully implement our direct sales
strategy, will have a material adverse effect on our financial condition and
results of operations. Our products are highly regulated by a number of governmental agencies. Any
changes to the existing rules and regulations of these agencies may adversely
impact our ability to manufacture and market our products. Our activities are regulated by the Food, Drug and Cosmetic Act. Under the
Food, Drug and Cosmetic Act, we are required, among other matters, to register
our facilities and to list our devices with the United States Food and Drug
Administration (the FDA), to file notice of our intent to market certain new
products under Section 510(K) of the Food, Drug and Cosmetic Act, to track the
location of certain of our products, and to report any incidents of death or
serious injury relating to our products. If we fail to comply with any of
these regulations, or if the FDA subsequently disagrees with the manner in
which we sought to comply with these regulations, we could be subjected 9




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to
substantial civil and criminal penalties and a recall, seizure, or injunction
with respect to the manufacture or sale of our products. Each state also has similar regulations. For example, in California, we are
subject to annual production-site inspections in order to maintain our
manufacturing license. State regulations also specify standards for the
storage and handling of certain chemicals and disposal of their wastes. We are
also required to comply with federal, state, and local environmental laws. Our
failure to comply with any of these laws could expose us to material
liabilities. Products intended for foreign export are subject to additional regulations,
including compliance with ISO 9000. In May 1995, we received ISO 9001
certification, which indicates that our products meet specified uniform
standards of quality and testing. We also were granted permission to use the
CE mark on certain of our products, which reflects approval of our products for
export into 18 member countries of the European Community. In December 1996,
the operations of Block Medical de Mexico, S.A. de C.V., a wholly owned
subsidiary (Block Medical), including its manufacturing facility, were added
to our ISO certification and we received permission to use the CE mark on all
disposable elastomeric products manufactured by us. If we fail to comply with
foreign regulations or to maintain ISO certification or CE approval, the sale
of our products could be suspended in one or more of our foreign markets. Furthermore, federal, state, local or foreign governments may enact new laws,
rules and regulations that may adversely impact our ability to manufacture and
market infusion devices by, for example, increasing our costs. Any impairment
of our ability to market our infusion devices or other products could have a
material adverse effect on our financial condition and results of operations. Our compliance with laws frequently involves our subjective judgment. If we
are wrong in any of our interpretations of the laws, we could be subjected to
substantial penalties for noncompliance. In the ordinary course of business, management frequently makes subjective
judgments with respect to complying with the Food, Drug and Cosmetic Act, as
well as other applicable state, local and foreign laws. If any of these
regulatory agencies disagrees with our interpretation of, or objects to the
manner in which we have attempted to comply with, the applicable law, we could
be subjected to substantial civil and criminal penalties and a recall, seizure
or injunction with respect to the manufacture or sale of our products. These
types of actions against us or our products could have a material adverse
effect on our financial condition and results of operations. Our intangible assets are subject to potential impairment charges that could
adversely affect our results of operations. As of December 31, 2003, $2,639,000 of our assets consisted of goodwill, an
intangible asset acquired through the acquisition of our wholly owned
subsidiary, InfuSystem, Inc. (InfuSystem). The determination of the value of
such intangible assets requires management to make estimates and assumptions
that affect our financial statements. For example, we review the
recoverability of the carrying value of goodwill on an annual basis or more
frequently if an event occurs or circumstances change to indicate that an
impairment of goodwill has possibly occurred. We compare fair value of our
reporting units to book value, as well as consider other factors, to determine
whether or not any potential impairment of goodwill exists. In fiscal year
2002, and as a result of the adoption of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets(SFAS 142) effective
January 1, 2002, we wrote-off $3,474,000 of goodwill related to past
acquisitions other than InfuSystem. We cannot guarantee that there will be no
additional impairment in the future related to InfuSystem or other acquisitions
we may make in the future. Any impairment charge will adversely affect our
results of operations. Our customers frequently receive reimbursement from private insurers and
governmental agencies. Any change in the overall reimbursement system
may adversely impact our business. The health care reimbursement system is in a constant state of change. Changes
often create financial incentives and disincentives that encourage or
discourage the use of a particular type of product, therapy or clinical
procedure. Market acceptance and sales of our products may be adversely
affected by changes or trends within the reimbursement system. Changes to the
health care system that favor technologies other than ours or that reduce 10




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reimbursements to providers or treatment facilities that use our products may
adversely affect our ability to sell our products profitably. Hospitals, alternate care site providers and physicians are heavily dependent
on payment for their services by private insurers and governmental agencies.
Changes in the reimbursement system could adversely affect our participation in
the industry. Our products fall into the general category of infusion devices
and related disposable products with regard to reimbursement issues. Except
for payments made to our InfuSystem subsidiary, the majority of reimbursements
are not paid directly to us. Rather, healthcare providers will often request
that their patients health insurance providers provide them with some form of
reimbursement for the disposables that are consumed in the patients therapy. We believe that the current trend in the insurance industry (both private and
governmental) has been to eliminate cost-based reimbursement and to move
towards fixed or limited fees for service, thereby encouraging healthcare
providers to use the lowest cost method of delivering medications. This trend
may discourage the use of our products, create downward pressure on our average
prices, and, ultimately, negatively affect our revenues. Changes in reimbursement rates may adversely impact InfuSytems revenues. InfuSystem depends primarily on third-party reimbursement for the collection of
its revenues. InfuSytem is paid directly by private insurers and governmental
agencies, often on a fixed fee basis, for infusion services provided by
InfuSystem to patients. InfuSystems revenues comprised 28% of our
consolidated revenues for the year ended December 31, 2003. If the average
fees allowable by private insurers or governmental agencies were reduced, the
negative impact on revenues of InfuSystem could have a material adverse effect
on our financial condition and results of operations. Changes in reimbursement rates may adversely impact the revenue that we earn
from our developing billing strategy for ON-Q. Historically, we have charged healthcare providers for each ON-Q unit that they
purchase from us. Recently, we, through our InfuSystem subsidiary, have begun
to bill private insurers for the use of ON-Q in ambulatory surgery centers,
rather than charging these centers for the purchase price of each ON-Q unit.
If this sales strategy is successful, we expect to increase our use of this
sales strategy for ambulatory surgery centers. Any reduction in the average
fees allowable by private insurers for the use of ON-Q in ambulatory surgery
centers could negatively affect our ability to generate revenue from the
centers and this could have a material adverse effect on our financial
condition and results of operations. Our industry is intensely competitive and changes rapidly. If we are unable to
maintain a technological lead over our competitors, our business operations
will suffer. The drug infusion industry is highly competitive. We compete in this industry
based primarily on price, service and product performance. Some of our
competitors have significantly greater resources than we do for research and
development, manufacturing, marketing and sales. As a result, they may be
better able to
compete for market share, even in areas in which our products may be superior.
We continue our efforts to introduce clinically effective, cost-efficient
products into the market, but the industry is subject to technological changes
and we may not be able to maintain any existing technological advantage long
enough to establish our products and to sustain profitability. If we are
unable to effectively compete in our market, our financial condition and
results of operations will materially suffer. We rely on independent suppliers for parts and materials necessary to assemble
our products. Any delay or disruption in the supply of parts may prevent us
from manufacturing our products and negatively impact our operations. While we perform final assembly and testing of our completed infusion systems,
certain component parts, as well as molded products, are obtained from outside
vendors based on our specifications. The loss or breakdown of our
relationships with these outside vendors could subject us to substantial delays
in the delivery of our products to 11




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customers. Significant delays in the
delivery of our products could result in possible cancellation of orders and
the loss of customers. Furthermore, we have numerous suppliers of components
and materials that are sole-source suppliers. Because these suppliers are the
only vendors with which we have a relationship for that particular component or
material, we may be unable to produce and sell products if one of these
suppliers becomes unwilling or unable to deliver components or materials
meeting our specifications. Our inability to manufacture and sell products to
meet delivery schedules could have a material adverse effect on our reputation
in the industry, as well as our financial condition and results of operations. If one of our products proves to be defective or is misused by a healthcare
practitioner or patient, we may be subject to claims of liability that could
adversely affect our financial condition and the results of our operations. A defect in the design or manufacture of our products, or a failure of our
products to perform for the use that we specify, could have a material adverse
effect on our reputation in the industry and subject us to claims of liability
for injuries and otherwise. Misuse of our product by a practitioner or patient
that results in injury could similarly subject us to claims of liability. We
currently have in place product liability insurance in the amount of $5,000,000
for liability losses, including legal defense costs. Any substantial
underinsured loss would have a material adverse effect on our financial
condition and results of operations. Furthermore, any impairment of our
reputation could have a material adverse effect on our sales, revenues, and
prospects for future business. We are dependent on our proprietary technology and the patents, copyrights, and
trademarks that protect our products. If competitors are able to independently
develop products of equivalent or superior capabilities, the results of our
operations could be adversely impacted. We rely substantially on proprietary technology and capabilities. We have
filed patent applications in the United States for substantially all of our
products. As of December 31, 2003, we held approximately 40 patents, including
patents that relate to both the ON-Q Pain Relief System and the Soaker
Catheter. We have also filed for intellectual property rights protection in
all foreign countries in which we currently derive significant revenue. Our
patents generally expire between 2009 and 2015, with the most significant
patents expiring in 2009. Without sufficient intellectual property protection,
our competitors may be able to sell products identical to ours and cause a
downward pressure on the selling price of our products. There can be no assurance that pending patent or trademark applications will be
approved or that any patents will provide competitive advantages for our
products or will not be challenged or circumvented by competitors. Our
competitors may also independently develop products with equivalent or superior
capabilities or otherwise obtain access to our capabilities. We manufacture the majority of our products in Mexico. Any difficulties or
disruptions in the operation of our plant may adversely impact our operations. The majority of our products are manufactured by Block Medical, a wholly owned
subsidiary. We may encounter difficulties with the uncertainties inherent in
doing business in a foreign country, including economic, political and
regulatory uncertainties. Our stockholders equity may also be adversely
affected by unfavorable translation adjustments arising from differences in
exchange rates from period to period. In addition, we have not and currently
do not hedge or enter into derivative contracts in an effort to address foreign
exchange risk. If there are difficulties or problems in our Mexico facility,
or other disruptions in our production and delivery process affecting product
availability, these difficulties could have a material adverse effect on our
business, financial condition and results of operations. 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. In the year ended December 31, 2003, sales to customers in foreign countries
comprised approximately 20% of our revenues. Our foreign business is subject
to economic, political and regulatory uncertainties and risks that are unique
to each area of the world. Fluctuations in exchange rates may also affect the
prices that our foreign 12




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##### Table of Contents



customers are willing to pay, and may put us at a price
disadvantage compared to other competitors. Potentially volatile shifts in
exchange rates may negatively affect our financial condition and operations. 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. During the year ended December 31, 2003, sales to B. Braun Medical S.A.
(France) and B. Braun Medical, Inc., a national distributor in the United
States, accounted for approximately 10% and 7%, respectively, of our net
revenues. Any deterioration in our relationship with B. Braun Medical S.A. or
B. Braun Medical, Inc. could cause a material decline in our overall sales and
a material adverse effect on our business. The preparation of our financial statements in accordance with accounting
principles generally accepted in the United States requires us to make
estimates, judgments, and assumptions that may ultimately prove to be
incorrect. The accounting estimates and judgments that management must make in the
ordinary course of business affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the periods presented. If the underlying estimates
are ultimately proven to be incorrect, subsequent adjustments could have a
material adverse effect on our operating results for the period or periods in
which the change is identified. Additionally, subsequent adjustments could
require us to restate our financial statements. Restating financial statements
could result in a material decline in the price of our stock. II. 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. Our common stock has been traded publicly since February 13, 1990, and since
then has had only a few market makers. The average daily trading volume for
our shares during the month of February 2004 was approximately 297,000 shares.
There can be no assurance that a more active or established trading market for
our common stock will develop or, if developed, will be maintained. The market price of our common stock has been and is likely to continue to be
highly volatile. Market prices for securities of biotechnology and medical
device companies, including ours, have historically been highly volatile, and
the market has from time to time experienced significant price and volume
fluctuations that appear unrelated to the operating performance of particular
companies. The following factors, among others, can have a significant effect
on the market price of our securities:  
    
    announcements of technological innovations, new products, or
clinical studies by us or others;
    
    government regulation;
    
    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. The realization of any of the risks described in these Risk Factors could
have a negative effect on the market price of our common stock. In the future, our common stock may be removed from listing on the Nasdaq
quotation system and may not qualify for listing on any stock exchange, in
which case it may be difficult to find a market in our stock. 13




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If our common stock is no longer traded on a national trading market, it may be
more difficult for you to sell shares that you own, and the price of our common
stock would likely be negatively affected. Currently, our common stock is
traded on the Nasdaq National Market. Nasdaq has a number of continued listing
requirements, including a minimum trading price requirement. Failure to comply
with any Nasdaq continued listing requirement could cause our common stock to
be removed from listing on Nasdaq. Should this occur, we may not be able to
secure listing on other exchanges or quotation systems, and this would have a
material adverse effect on the price and liquidity of our common stock. 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. Sales of our common stock in the public market, or the perception that such
sales could occur, could result in a decline in the market price of our common
stock and make it more difficult for us to complete future equity financings.
A substantial number of shares of our common stock and shares of common stock
subject to outstanding warrants may be resold pursuant to currently effective
registration statements. As of December 31, 2003, there were:  
    
    18,305,787 shares of common stock that have been issued in
registered offerings and are freely tradable in the public markets;
    
    250,011 shares of common stock underlying warrants which have
been registered for resale under a Registration Statement on Form
S-3 (Registration No. 333-109096);
    
    147,000 shares of vested and unvested restricted common stock
that have been issued under our restricted stock plans; and
    
    an aggregate of 3,237,412 shares of common stock that may be
issued on the exercise of stock options outstanding under our equity
incentive plans.
    
    In addition, pursuant to a registration statement on Form S-3,
declared effective February 17, 2004, we registered an aggregate
amount of $50,000,000 of our equity securities for issuance from time
to time. We cannot estimate the number of shares of common stock that may actually be
resold in the public market because this will depend on the market price for
our common stock, the individual circumstances of the sellers, and other
factors. If stockholders sell large portions of their holdings in a relatively
short time, for liquidity or other reasons, the market price of our common
stock could decline significantly. Anti-takeover devices may prevent a sale, or changes in the management, of
I-Flow. We have in place several anti-takeover devices, including a stockholder rights
plan, that may have the effect of delaying or preventing a sale, or changes in
the management, of I-Flow. For example, one anti-takeover device provides for
a board of directors that is separated into three classes, with their terms in
office staggered over three year periods. This has the effect of delaying a
change in control of the board of directors without the cooperation of the
incumbent board. In addition, our bylaws do not allow stockholders to call a
special meeting of stockholders or act by written consent, and also require
stockholders to give written notice of any proposal or director nomination to
us within a specified period of time prior to any stockholder meeting. We may also issue shares of preferred stock without stockholder approval and
upon terms that our board of directors may determine in the future. The
issuance of preferred stock could have the effect of making it more difficult
for a third party to acquire a majority of our outstanding stock, and the
holders of such preferred stock could have voting, dividend, liquidation, and
other rights superior to those of holders of our common stock. We do not pay dividends and this may negatively affect the price of our stock. I-Flow has not paid dividends on its common stock and does not anticipate
paying dividends on its common stock in the foreseeable future. The future
price of our common stock may be depressed because we do not pay dividends. 14




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PART II 
 Item 5. Market for Registrants Common Equity and Related Stockholder Matters Common Stock Information The Companys common stock trades on The Nasdaq National Market under the
symbol IFLO. Set forth below are the high and low sales prices for the
Companys common stock for each full quarter period within the two most recent
fiscal years. High
    
    Low20021st Quarter
    
    $
    3.37
    
    
    $
    2.592nd Quarter
    
    $
    3.12
    
    
    $
    2.003rd Quarter
    
    $
    2.55
    
    
    $
    1.144th Quarter
    
    $
    1.89
    
    
    $
    1.0620031st Quarter
    
    $
    2.90
    
    
    $
    1.552nd Quarter
    
    $
    7.75
    
    
    $
    2.473rd Quarter
    
    $
    11.49
    
    
    $
    6.504th Quarter
    
    $
    15.50
    
    
    $
    10.00
 American Stock Transfer & Trust Company is the Companys transfer agent for
its common stock. As of March 1, 2004, the Company had 312 stockholders of
record. The Company has not paid, and does not currently expect to pay in the
foreseeable future, cash dividends on its common stock. Information About Our Equity Compensation Plans The information regarding the securities authorized for issuance under the
Companys equity compensation plans required by Item 5 is incorporated by
reference to the Companys proxy statement for its 2004 annual meeting of
stockholders, which will be filed with the Securities and Exchange Commission
no later than 120 days after the end of the fiscal year ended December 31,
2003. 15




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##### Table of Contents



Item 6. Selected Financial Data The following
selected consolidated financial data have been derived from the
Companys audited consolidated financial statements. The information set forth below is not necessarily indicative of the
expectations of results for future operations and should be read in conjunction
with the consolidated financial statements and notes thereto appearing
elsewhere in this Annual Report on Form 10-K. Years Ended December 31,(Amounts in thousands, except per share amounts)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Consolidated Statements of Operations Data:(1) (2) (3)Revenues:Net product sales
    
    $
    34,021
    
    
    $
    24,370
    
    
    $
    20,168
    
    
    $
    21,537
    
    
    $
    19,272Rental income and other
    
    
    13,022
    
    
    
    10,293
    
    
    
    10,363
    
    
    
    8,469
    
    
    
    8,512Licensing fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,000Total revenues
    
    
    47,043
    
    
    
    34,663
    
    
    
    30,531
    
    
    
    30,006
    
    
    
    29,784Cost of revenues:Product cost of revenues
    
    
    13,192
    
    
    
    8,979
    
    
    
    8,734
    
    
    
    9,736
    
    
    
    9,427Rental cost of revenues
    
    
    4,018
    
    
    
    3,007
    
    
    
    3,182
    
    
    
    2,562
    
    
    
    2,397Total cost of revenues
    
    
    17,210
    
    
    
    11,986
    
    
    
    11,916
    
    
    
    12,298
    
    
    
    11,824Gross Profit
    
    
    29,833
    
    
    
    22,677
    
    
    
    18,615
    
    
    
    17,708
    
    
    
    17,960Operating expenses:Selling and marketing
    
    
    20,412
    
    
    
    11,760
    
    
    
    4,845
    
    
    
    4,615
    
    
    
    4,193General and administrative
    
    
    10,341
    
    
    
    8,099
    
    
    
    8,841
    
    
    
    7,736
    
    
    
    7,604Product development
    
    
    2,361
    
    
    

    2,104
    
    
    
    2,238
    
    
    
    2,001
    
    
    
    1,710Total operating expenses
    
    
    33,114
    
    
    
    21,963
    
    
    
    15,924
    
    
    
    14,352
    
    
    
    13,507Operating income (loss)
    
    
    (3,281
    )
    
    
    714
    
    
    
    2,691
    
    
    
    3,356
    
    
    
    4,453Interest expense (income), net
    
    
    46
    
    
    
    (6
    )
    
    
    44
    
    
    
    265
    
    
    
    404Income (loss) from continuing operations before income taxes and cumulative effect of a change in accounting principle
    
    
    (3,327
    )
    
    
    720
    
    
    
    2,647
    
    
    
    3,091
    
    
    
    4,049Income tax provision (benefit)
    
    
    (1,173
    )
    
    
    305
    
    
    
    1,067
    
    
    
    1,262
    
    
    
    (4,763
    )Income (loss) from continuing operations before cumulative effect
of a change in accounting principle
    
    
    (2,154
    )
    
    
    415
    
    
    
    1,580
    
    
    
    1,829
    
    
    
    8,812Discontinued operations:Income (loss) from discontinued operations, net of tax
    
    
    328
    
    
    
    24
    
    
    
    (313
    )
    
    
    (217
    )
    
    
    Gain on sale of discontinued operations, net of tax
    
    
    2,283
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income before cumulative effect of a change in accounting
principle
    
    
    457
    
    
    
    439
    
    
    
    1,267
    
    
    
    1,612
    
    
    
    8,812Cumulative effect of a change in accounting principle for goodwill
    
    
    
    
    
    
    (3,474
    )
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    457
    
    
    $
    (3,035
    )
    
    $
    1,267
    
    
    $
    1,612
    
    
    $
    8,812Per share of common stock, basic:Income (loss) from continuing operations before cumulative effect
of a change in accounting principle
    
    $
    (0.13
    )
    
    $
    0.03
    
    
    $
    0.10
    
    
    $
    0.12
    
    
    $
    0.61Income (loss) from discontinued operations, net of tax
    
    
    0.02
    
    
    
    
    
    
    
    (0.02
    )
    
    
    (0.01
    )
    
    
    Gain on sale of discontinued operations, net of tax
    
    
    0.14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income before cumulative effect of a change in accounting principle
    
    
    0.03
    
    
    
    0.03
    
    
    
    0.08
    
    
    
    0.11
    
    
    
    0.61Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    (0.23
    )
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    0.03
    
    
    $
    (0.20
    )
    
    $
    0.08
    
    
    $
    0.11
    
    
    $
    0.61Per share of common stock, diluted:Income (loss) from continuing operations before cumulative effect
of a change in accounting principle
    
    $
    (0.13
    )
    
    $
    0.03
    
    
    $
    0.10
    
    
    $
    0.12
    
    
    $
    0.58Income (loss) from discontinued operations, net of tax
    
    
    0.02
    
    
    
    
    
    
    
    (0.02
    )

    
    
    (0.02
    )
    
    
    Gain on sale of discontinued operations, net of tax
    
    
    0.14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income before cumulative effect of a change in accounting principle
    
    
    0.03
    
    
    
    0.03
    
    
    
    0.08
    
    
    
    0.10
    
    
    
    0.58Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    (0.22
    )
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    0.03
    
    
    $
    (0.19
    )
    
    $
    0.08
    
    
    $
    0.10
    
    
    $
    0.58Weighted-average common shares outstanding:Basic
    
    
    16,384
    
    
    
    15,368
    
    
    
    15,231
    
    
    
    15,002
    
    
    
    14,387Diluted
    
    
    16,384
    
    
    
    15,879
    
    
    
    15,749
    
    
    
    15,647
    
    
    
    15,116Consolidated Balance Sheet Data: (1) (2) (3)Working capital
    
    $
    31,467
    
    
    $
    16,657
    
    
    $
    15,822
    
    
    $
    14,441
    
    
    $
    13,565Total assets
    
    
    51,896
    
    
    
    33,061
    
    
    
    35,704
    
    
    
    35,215
    
    
    
    31,768Long-term obligations
    
    
    
    
    
    
    1
    
    
    
    83
    
    
    
    1,303
    
    
    
    1,548Total stockholders equity
    
    
    44,773
    
    
    
    27,470
    
    
    
    29,769
    
    
    
    27,618
    
    
    
    24,670
  (1)
    
    Certain amounts previously reported have been reclassified to conform with the 2003 presentation.(2)
    
    Effective January 1, 2002, the Company changed its method of accounting for
goodwill and other intangible assets as a result of adopting Statement of
Financial Accounting Standards No. 142, Accounting for Goodwill and Other
Intangible Assets. The Company recognized a transitional goodwill impairment
loss of $3,474,000 as a cumulative effect of a change in accounting principle
during the six months ended June 30, 2002. The amounts previously reported for
the first quarter of 2002 have been revised to include the $3,474,000
cumulative effect of this change in accounting principle. The effect of the
change on the first quarter 2002 results was to reduce net income by
$3,474,000, or $0.22 per diluted share, for the cumulative effect of this
accounting change.(3)
    
    In November 2003, the Company sold Spinal Specialties, Inc., a wholly owned
subsidiary. The operations of Spinal Specialties have been excluded from
continuing operations for all periods presented. See Note 3 of Notes to
Consolidated Financial Statements. 16




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##### Table of Contents



SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (Amounts in thousands, except per share amounts) 2003
    
    Mar. 31
    
    June 30
    
    Sept. 30
    
    Dec. 31 (3)Total revenues
    
    $
    10,135
    
    
    $
    11,383
    
    
    $
    11,822
    
    
    
    13,703
    
        $
    47,043Gross profit
    
    
    6,680
    
    
    
    7,351
    
    
    
    7,510
    
    
    
    8,292
    
    
    
    29,833Loss from continuing operations before income taxes
    
    
    (76
    )
    
    
    (98
    )
    
    
    (850
    )
    
    
    (2,303
    )
    
    
    (3,327
    )Loss from continuing operations
    
    
    (44
    )
    
    
    (56
    )
    
    
    (507
    )
    
    
    (1,547    )
    
    
    (2,154
    )Income from discontinued operations, net of tax
    
    
    61
    
    
    
    78
    
    
    
    121
    
    
    
    68
    
    
    
    328Gain on sale of discontinued operations, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,283
    
    
    
    2,283Net income (loss)
    
    
    17
    
    
    
    22
    
    
    
    (386
    )
    
    
    804
    
    
    
    457Per share of
common stock - basic and diluted:Loss from continuing operations
    
    
    0.00
    
    
    
    0.00
    
    
    
    (0.03
    )
    
    
    (0.09
    )
    
    
    Net income (loss)
    
    
    0.00
    
    
    
    0.00
    
    
    
    (0.02
    )
    
    
    0.04
    
    
    
    0Weighted-average common shares - basic and diluted
    
    
    15,434
    
    
    
    15,516
    
    
    
    16,445
    
    
    
    18,037
    
    
    
    
 2002
    
    Mar. 31 (2)
    
    June 30
    
    Sept. 30
    
    Dec. 31 (1)Total revenues
    
    $
    7,870
    
    
    $
    8,703
    
    
    $
    8,695
    
    
    $
    9,395
    
    
    $
    34,663Gross profit
    
    
    4,969
    
    
    
    5,521
    
    

    
    5,654
    
    
    
    6,533
    
    
    $
    22,677Income from continuing operations before income taxes
    
    
    271
    
    
    
    157
    
    
    
    129
    
    
    
    163
    
    
    $
    720Income from continuing operations before cumulative
effect of a change in accounting principle
    
    
    162
    
    
    
    94
    
    
    
    77
    
    
    
    82
    
    
    $
    415Income (loss) from discontinued operations, net of tax
    
    
    (26
    )
    
    
    12
    
    
    
    30
    
    
    
    8
    
    
    $
    24Cumulative effect of a change in accounting principle
    
    
    (3,474
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (3,474
    )Net income (loss)
    
    
    (3,338
    )
    
    
    106
    
    
    
    107
    
    
    
    90
    
    
    $
    (3,035
    )Per share of
common stock - basic:Income from continuing operations before cumulative
effect of a change in accounting principle
    
    
    0.01
    
    
    
    0.01
    
    
    
    0.01
    
    
    
    0.01Net income (loss)
    
    
    (0.22
    )
    
    
    0.01
    
    
    
    0.01
    
    
    
    0.01Weighted-average common shares - basic
    
    
    15,366
    
    
    
    15,363
    
    
    
    15,367
    
    
    
    15,389Per share of
common stock - diluted:Income from continuing operations before cumulative
effect of a change in accounting principle
    
    
    0.01
    
    
    
    0.01    
    
    
    0.00
    
    
    
    0.01Net income (loss)
    
    
    (0.21
    )
    
    
    0.01
    
    
    
    0.01
    
    
    
    0.01Weighted-average common shares - diluted
    
    
    16,210
    
    
    
    16,033
    
    
    
    15,701
    
    
    
    15,573
  (1)
    
    During the fourth quarter of 2002, the Company recorded approximately $750,000 of inventory variances as an increase
in inventory and a reduction of cost of sales due primarily to lower than planned production levels.(2)
    
    Effective January 1, 2002, the Company changed its method of accounting for
goodwill and other intangible assets as a result of adopting Statement of
Financial Accounting Standards No. 142, Accounting for Goodwill and Other
Intangible Assets. The Company recognized a transitional goodwill impairment
loss of $3,474,000 as a cumulative effect of a change in accounting principle
during the six months ended June 30, 2002. The amounts previously reported for
the first quarter of 2002 have been revised to include the $3,474,000
cumulative effect of this change in accounting principle. The effect of the
change on the first quarter 2002 results was to reduce net income by
$3,474,000, or $0.22 per diluted share, for the cumulative effect of this
accounting change.(3)
    
    In November 2003, the Company sold Spinal Specialties, Inc., a wholly owned
subsidiary. The operations of Spinal Specialties have been excluded from
continuing operations for all periods presented. See Note 3 of Notes to
Consolidated Financial Statements. 17




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements Statements by the Company in this report and in other reports and statements
released by the Company are and will be forward-looking in nature and express
the Companys current opinions about trends and factors that may impact future
operating results. Statements that use words such as believes,
anticipates, or expects or use similar expressions are intended to identify
forward-looking statements. Forward-looking statements are subject to risks
and uncertainties, which could cause actual results to differ materially from
those expected, and readers are cautioned not to place undue reliance on these
forward-looking statements. The Company undertakes no obligation to republish
revised forward-looking statements to reflect the occurrence of unanticipated
or subsequent events. Readers are also urged to carefully review and consider
the various disclosures made by the Company in this report which seek to advise
interested parties of the risks and other factors that affect the Companys
business. Interested parties should also review the Companys reports on Forms
10-Q and 8-K and other reports that are periodically filed with the Securities
and Exchange Commission. The risks affecting the Companys business include
reliance on the success of the home health care industry, the Companys success
in pursuing its direct sales strategy, the reimbursement system currently in
place and future changes to that system, competition in the industry, economic
and political conditions in foreign countries, currency exchange rates,
inadequacy of booked reserves, technological changes, and product availability.
All forward-looking statements, whether made in this report or elsewhere,
should be considered in context with the various disclosures made by the
Company about its business. Critical Accounting Policies I-Flow prepares its consolidated financial statements in conformity with
accounting principles generally accepted in the United States. Accordingly,
the Company is required to make estimates, judgments and assumptions that the
Company believes are reasonable based upon the information available. These
estimates and assumptions affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the periods presented. The critical accounting policies
which the Company believes are the most important to aid in fully understanding
and evaluating its reported financial results include the following: Revenue Recognition The Company recognizes revenue from product sales at the time of shipment and
passage of title. The Company offers the right of return for defective
products and continuously monitors and tracks product returns. The Company
records a provision for the estimated amount of future returns based upon
historical experience and any notification received of pending returns.
Although such returns have historically been insignificant, the Company cannot
guarantee that it will continue to experience the same return rates as it has
in the past. Any significant increase in product returns could have a material
adverse impact on the Companys operating results for the period or periods in
which the returns materialize. The Company recognizes rental revenues from medical pumps over the term of the
related agreement, generally on a month-to-month basis. Pump rentals are
billed at the Companys established rates, which often differ from
contractually allowable rates provided by third party payors such as Medicare,
Medicaid and commercial insurance carriers. The Company records net rental
revenues at the estimated realizable amounts from patients and third party
payors. The Company experiences significant extended payment terms with
certain of these third party payors, but it continuously monitors reimbursement
rates from third party payors and timing of payments. Any change in
reimbursement or collection rates could have a material impact on the Companys
operating results for the period or periods in which the change is identified. 18




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##### Table of Contents



Accounts Receivable The Company performs various analyses to evaluate accounts receivable balances.
It records an allowance for bad debts based upon the estimated collectibility
of the accounts such that the recorded amounts reflect estimated net realizable
value. The Company applies specified percentages to the accounts receivable
agings to estimate the amount that will ultimately be uncollectible and
therefore should be reserved. The percentages are increased as the accounts
age. If the actual uncollected amounts significantly exceed the estimated
allowance, the Companys operating results would be significantly and adversely
affected. Inventories The Company values inventory at the lower of the actual cost to purchase or
manufacture the inventory and the current estimated market value of the
inventory. The Company regularly reviews inventory quantities on hand and
records a provision for excess and obsolete inventory on specifically
identified items based primarily upon the estimated forecast of product demand
and production requirements for the next two years. A significant increase in
the demand for the Companys products could result in a short-term increase in
the cost of inventory purchases while a significant decrease in demand could
result in an increase in the amount of excess inventory quantities on hand.
Additionally, the Companys estimates of future product demand may prove to be
inaccurate. In which case, the Company may have understated or overstated the
provision required for excess and obsolete inventory. In the future, if
inventory is determined to be overvalued, the Company would be required to
recognize such costs in cost of goods sold at the time of such determination.
Likewise, if inventory is determined to be undervalued, the Company may have
over-reported cost of goods sold in previous periods and would be required to
recognize such additional operating income at the time of sale. Therefore,
although the Company seeks to ensure the accuracy of its forecasts of future
product demand, any significant unanticipated changes in demand or
technological developments could have a significant impact on the value of its
inventory and reported operating results. Deferred Taxes The Company recognizes deferred tax assets and liabilities based upon the
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities. The Company regularly reviews its deferred tax
assets for recoverability and establishes a valuation allowance based upon
historical taxable income, projected future taxable income and the expected
timing of the reversals of existing temporary differences. If the Company
operates at a profit in the future and generates sufficient future taxable
income, it could be required to reverse the current valuation allowance against
the deferred tax assets which would result in a substantial decrease in the
Companys effective tax rate. Likewise, if the Company is unable to operate at
a profit and unable to generate sufficient future taxable income, it could be
required to establish an additional valuation allowance against all or a
significant portion of its deferred tax assets, resulting in a substantial
increase in the Companys effective tax rate and a material adverse impact on
operating results. Intangible Assets Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets(SFAS 142), required the Company to cease amortizing
goodwill and indefinite life intangibles effective January 1, 2002. The
Companys business combinations have at various times resulted in the
acquisition of goodwill and other intangible assets, which may affect the
amount of future period amortization expense and impairment expense that the
Company may incur. The determination of the value of such intangible assets
requires management to make estimates and assumptions that affect its
consolidated financial statements. The Company reviews the recoverability of
the carrying value of goodwill on an annual basis or more frequently if an
event occurs or circumstances change to indicate that an impairment of goodwill
has possibly occurred. The Company compares fair value of its reporting units
to their carrying value, as well as other factors, to determine whether or not
any potential impairment of goodwill exists. If a
potential impairment exists, an impairment loss is recognized to the extent the
carrying value of goodwill exceeds the difference between the fair value of the
reporting unit and the fair value of its other assets and liabilities. The
Company cannot guarantee that there will be no impairment in the future. See
Note 2 to Consolidated Financial Statements. 19




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##### Table of Contents



Divestiture of Spinal Specialties The Company sold Spinal Specialties, Inc., a wholly owned subsidiary, on
November 1, 2003 to Integra LifeSciences Holdings Corporation for approximately
$6,000,000 in cash and net proceeds of approximately $5,000,000. Assets and
liabilities included in the sale consisted primarily of approximately $722,000
of accounts receivable, $1,155,000 of inventory, $400,000 of fixed assets, and
$313,000 of accounts payable and accrued liabilities. The Company recorded a
pretax gain on the sale of $2,999,000, a tax provision on the gain of $716,000,
and an after-tax gain of $2,283,000. The reported gain has been reduced by a charge
of $327,000 related to the acceleration of vesting of certain stock options
upon the closing of the sale. This amount has been accounted for as an
increase in common stock. The net income of Spinal Specialties prior to divestiture is presented in the
Companys Consolidated Statements of Operations and Comprehensive Operations as
income (loss) from discontinued operations, net of tax. Reported in income
(loss) from discontinued operations, net of tax, are net product sales from
Spinal Specialties of $3,795,000, $3,454,000 and $2,774,000 in 2003, 2002 and
2001, respectively, and income (loss) before taxes from Spinal Specialties of
$532,000, $42,000 and $(524,000) in 2003, 2002 and 2001,
respectively. Also reported in income (loss) from discontinued
operations, net of tax, is income
tax expense (benefit) of $204,000, $18,000 and $(211,000) for 2003,
2002, and 2001, respectively. Consolidated
Results of Operations for the Year Ended December 31, 2003
Compared to the Year Ended December 31, 2002 Revenue Net
revenues during the year ended December 31, 2003 were $47,043,000 compared
to $34,663,000 for the prior year, an increase of 36%. Net product revenues
increased 40% in 2003 to $34,021,000 compared to $24,370,000 in 2002. Rental
income, comprised of the revenues of the Companys InfuSystem subsidiary,
increased by 27% to $13,022,000 for the year ended December 31, 2003 from
$10,293,000 for the prior year. The Companys
product revenues during 2003 and 2002 were generated in two primary
market segments: Regional Anesthesia and IV Infusion Therapy. Regional Anesthesia product revenues for 2003, which
included revenue from the PainBuster and ON-Q Post-Operative Pain Relief
Systems and the Soaker Catheter, increased by 88% to $16,112,000 in 2003
compared to $8,582,000 for fiscal 2002. The increase was primarily due to
increased clinical usage of the ON-Q Post-Operative Pain Relief System by
surgeons in the United States. Average selling prices have remained
fairly constant throughout the year. Significant factors in the revenue increase and
trend toward the use of regional anesthesia for post-operative pain include the
progressive increase during 2003 in the size of the Companys direct sales
force and favorable results in published clinical studies. IV Infusion Therapy product sales, which included the Companys intravenous
elastomeric pumps, mechanical infusion devices and electronic infusion pumps
and disposables, increased 13% in 2003 to $17,909,000 from $15,788,000 in 2002.
The year-to-year increase primarily resulted from increased sales of IV
Infusion Therapy products to distributors in the United States. Pursuant to a
distribution agreement, B. Braun Medical, Inc. distributes I-Flows elastomeric
pumps to B. Braun Medical Inc.s IV Infusion Therapy customers in the United
States. The Company has a separate agreement with B. Braun Medical S.A.
(France), a manufacturer and distributor of pharmaceuticals and infusion
products, to distribute I-Flows elastomeric infusion pumps in Western Europe,
Eastern Europe, the Middle East, Asia Pacific, South America and Africa. Rental
revenues provided by the Companys InfuSystem
subsidiary within the Oncology Infusion Services market increased 27% to $13,022,000 in 2003 compared to $10,293,000 in
2002. The revenue increase is substantially due to InfuSystems co-marketing
activities with major pharmaceutical companies, which contributed to an
increased usage of new drugs and clinical protocols requiring the use of
ambulatory electronic pumps as opposed to oral application of chemotherapy
drugs. This increase in rental billings was slightly offset by changes to
initial estimates of contractual rental revenue of approximately $400,000
recorded during fiscal year 2003 as a result of lower reimbursement levels than
initially projected. InfuSystem revenues fluctuate based upon a number of
factors, including the number of client facilities utilizing the InfuSystem
pump management system, the number of contracts with managed care organizations
and the number of potential patients covered by those contracts, and periodic
fluctuations in the 20




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##### Table of Contents



prevalence of continuous infusional administration of
chemotherapy as opposed to oral administration of drug therapies. Cost of Revenue Cost of revenues was $17,210,000 during the year ended December 31, 2003
compared to $11,986,000 in the prior year, an increase of 44%. Cost of
revenues in 2003 included a write-down of $582,000 for tooling and inventory
related to the Companys declining electronic IV pump business. The write-down
consisted of $394,000 for excess and obsolete inventory and $188,000 for
tooling. The Company expects to phase out its electronic pump products for the
IV Infusion Therapy Market during the first quarter of 2004. As a percentage
of net product sales, product cost of revenue increased by approximately two
percentage points in 2003 to 39% due to the write-down of assets related
to the electronic IV pump business. Rental cost of revenues increased by
$1,011,000, or 34%, to $4,018,000 due to increases in operating supplies and material costs,
and increased depreciation expense due to the increasing size of the Companys
rental fleet of chemotherapy pumps. As a percentage of rental revenues, rental
cost of revenue increased by approximately two percentage points. Selling and Marketing Expenses Selling and marketing expenses for the year ended December 31, 2003 increased
$8,652,000, or 74%, from the prior year. This increase was primarily
attributable to increases in direct sales force salaries and commissions
($4,398,000), travel and entertainment ($865,000), non-cash compensation
expense related to the vesting of restricted stock granted to sales personnel
($327,000), increases in marketing expenses ($866,000) and other costs related
to the hiring and operation of an expanded direct sales force in the United
States during fiscal 2003 to support sales and marketing of the ON-Q
Post-Operative Pain Relief System. As a percentage of total revenues, selling
and marketing expenses increased by 9 percentage points, to 43%. The Company
intends to continue to invest significant resources to promote ON-Q during
2004. As of December 31, 2003, the Company employed 99 sales professionals in
support of its ON-Q sales effort, an increase of approximately 175% compared to
December 31, 2002. General and Administrative Expenses General and administrative expenses for the year ended December 31, 2003
increased $2,242,000 or 28% from the prior year. The increase is attributable
to increases in compensation ($881,000), provision for bad debts ($573,000),
investor relations ($84,000), telephone ($90,000), depreciation expense
($91,000) and other costs associated with the growth of the business. The
increase in compensation resulted from increased staffing and year-end bonuses.
The increase in the provision for bad debts includes a $279,000 accrual for
the estimated amount of uncollectible 2003 billings by the Companys rental
business and other bad debt reserves determined based upon the growth in the
Companys operations and analyses of the accounts receivable agings. As a
percentage of total revenues, general and administrative expenses decreased
for fiscal 2003 by one percentage point to 22%. Product Development Expenses Product development expenses include research and development for new products
and the cost of obtaining and maintaining regulatory approvals of products and
processes. Product development expenses for the year ended December 31, 2003
increased $257,000, or 12%, as compared to fiscal 2002. The
increase included a $90,000 write-down of the carrying value of patents related
to the Companys declining electronic IV pump business, and increased
compensation, consulting fees and outside services. The Company will continue
to incur product development expenses as it continues its efforts to introduce
new technology and cost-efficient products into the market. Product development
expense as a percentage of net product sales decreased by approximately two
percentage points to 7% during 2003 compared to 2002. Income Taxes During the year ended December 31, 2003, the Company recorded an income tax
benefit from continuing operations of $1,173,000, compared to income tax
expense of $305,000 recorded for the year ended December 31, 2002. The
Companys effective tax rate decreased to 35.9% in the year ended December 31,
2003 compared to 42.4% in 2002. The reduction in the effective tax rate is the
result of the method of taxation by the State of 21




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##### Table of Contents



Michigan. This tax, which is
based upon the activity of InfuSystem only, was calculated in a way that
generated a current year tax for 2003, even though the overall activity of the
Company resulted in a loss. As a result, the overall benefit received from the
current year loss is reduced. Goodwill In
accordance with SFAS 142, the Company completed its adoption test for goodwill
impairment in June 2002 and concluded that consolidated goodwill in the amount
of $3,474,000 was impaired effective January 1, 2002. The Company recorded a
non-cash charge of approximately $3,474,000 to reduce the carrying value of its
goodwill which was recorded as a cumulative effect of a change in accounting
principle. See Note 2 to the Notes to Consolidated Financial Statements,
Goodwill and Other Intangible Assets. There was no
impairment in 2003. Consolidated Results of Operations for the Year Ended December 31, 2002
Compared to the Year Ended December 31, 2001 Revenue Net revenues from continuing operations during the year ended December 31, 2002
were $34,663,000 compared to $30,531,000 for the prior year, an increase of
14%. Net product revenues increased 21% in 2002 to $24,370,000 compared to
$20,168,000 in 2001. Rental income, comprised of the revenues of the Companys
InfuSystem subsidiary, decreased by 1% to $10,293,000 for the year ended
December 31, 2002 from $10,363,000 for the prior year. Regional Anesthesia revenues from continuing operations for 2002 and 2001
exclude revenues of $3,454,000 and $2,774,000, respectively, related to
discontinued operations, specifically the Companys former Spinal Specialties
subsidiary which was sold on November 1, 2003. Regional Anesthesia product
revenues for 2002, which included revenue from the PainBuster and ON-Q
Post-Operative Pain Relief Systems and the Soaker Catheter, increased by 57% to
$8,582,000 in 2002 compared to $5,467,000 for fiscal 2001. The increase was
primarily due to increased sales of ON-Q in the United States, which included
the effect of higher average selling prices related to a change in the
Companys method of distribution, effective January 1, 2002, from a single
United States distributor to a direct Company-employed sales force. The
increase from the prior year also included the effect of an inventory
repurchase of approximately $963,000 from Ethicon Endo-Surgery in December 2001
which was accounted for as a sales return. The repurchase was initiated in
connection with the termination of the Companys distribution agreement with
Ethicon Endo-Surgery, previously the Companys exclusive United States
distributor for the ON-Q Post-Operative Pain Relief System. Under the
termination agreement, the Company regained the exclusive United States
distribution rights to the ON-Q Post-Operative Pain Relief System effective
January 1, 2002. IV Infusion Therapy product sales, which included the Companys intravenous
elastomeric pumps, mechanical infusion devices and electronic infusion pumps
and disposables, increased 7% in 2002 to $15,788,000 from $14,701,000 in 2001.
The year-to-year increase resulted from increased sales of IV Infusion Therapy
products to international distributors. Revenues for Oncology Infusion Services provided by the Companys InfuSystem
subsidiary decreased 1% to $10,293,000 in 2002 compared to $10,363,000 in 2001
as noted above. InfuSystem revenues fluctuate based upon a number of factors,
including the number of client facilities utilizing the InfuSystem pump
management system, the number of contracts with managed care organizations and
the number of potential patients covered by those contracts, and periodic
fluctuations in the prevalence of continuous infusional administration of
chemotherapy as opposed to oral administration of drug therapies. No material
changes to initial estimates of contractual rental revenue were recorded during
the fiscal year. Cost of Revenue Cost of revenues was $11,986,000 during the year ended December 31, 2002
compared to $11,916,000 in the prior year, an increase of 1%. As a percentage
of total revenues, cost of revenues decreased by four percentage points to 35%
for the year ended December 31, 2002 compared to the prior year, primarily due
to higher average selling prices for the Companys ON-Q Post-Operative Pain
Relief System caused by the change in the manner of 22




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##### Table of Contents



distribution of those
products. As a percentage of net product sales, product cost of revenue
decreased by approximately six percentage points in 2002 to 37 percent,
primarily due to the change in distribution of the ON-Q Post-Operative Pain
Relief System from an OEM basis to direct sales. As a percentage of rental
revenues, rental cost of revenue decreased by approximately two percentage
points due to reduced direct operating costs. Selling and Marketing Expenses Selling and marketing expenses for the year ended December 31, 2002 increased
$6,915,000, or 143%, from the prior year. This increase was primarily
attributable to additional salaries, commissions, travel expenses, and
recruiting costs related to the hiring and operation of a new direct sales
force during fiscal 2002 necessary to support sales of the ON-Q Post-Operative
Pain Relief System. The increase in selling and marketing expenses in
2002 compared to the prior year related to the cost of the new direct
sales force amounted to $5,826,000. The remaining charge of $994,000
resulted from increased marketing expenses. As a percentage of total revenues, selling and marketing
expenses increased 18 percentage points to 34% in 2002 over the prior year. General and Administrative Expenses General and administrative expenses for the year ended December 31, 2002
decreased $742,000, or 8%, from the prior year. The total decrease included a
reduction of approximately $628,000 in goodwill amortization expense due to the
cessation of goodwill amortization effective January 1, 2002 in accordance with
SFAS 142. See New Accounting Pronouncements on page 25 and Note 2 to Notes
to Consolidated Financial Statements. The remainder of the decrease is
attributable to reduced employee bonus expense. As a percentage of total
revenues, general and administrative expenses decreased by approximately six
percentage points to 34% in 2002 compared to the prior year. Product Development Expenses Product development expenses include research and development for new products
and the cost of obtaining and maintaining regulatory approvals of products and
processes. Product development expenses for the year ended December 31, 2002
decreased $134,000 or 6% primarily due to reduced consulting expenses and
engineering project materials. Product development expense as a percentage of
net product sales decreased by approximately two percentage points to 9% during
2002 compared to 2001. Income Taxes During the year ended December 31, 2002, the Company recorded income tax
expense from continuing operations of $305,000, compared to income tax expense
of $1,067,000 recorded for the year ended December 31, 2001. The Companys
effective tax rate increased slightly to 42.4% in the year ended December 31,
2002 compared to 40.3% in 2001. Goodwill In accordance with SFAS 142, and as noted above, the Company completed a test
for goodwill impairment in June 2002 and concluded that consolidated goodwill
in the amount of $3,474,000 was impaired as of January 1, 2002. The Company
recorded a non-cash charge of approximately $3,474,000 to reduce the carrying
value of its goodwill which was recorded as a cumulative effect of a change in
accounting principle. See Note 2 to the Notes to Consolidated Financial
Statements, Goodwill and Other Intangible Assets. Liquidity and Capital Resources During the year ended December 31, 2003, cash of $1,070,000 was used in
operating activities consisting primarily of net income of $457,000,
which included income from
discontinued operations of $328,000, and the gain on the sale of Spinal Specialties
of $2,283,000, plus non-cash expenses of $3,952,000, less net changes in
operating assets and liabilities of $2,812,000 and net cash used in
discontinued operations of $56,000. The increases in accounts receivable
and inventory resulted from the overall increase in revenues. 23




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##### Table of Contents



During the year ended December 31, 2003, cash of $1,003,000 was provided by
investing activities of the Company. This amount was
primarily attributable to the sale of Spinal Specialties which resulted in net cash proceeds to
the Company of $5,044,000, partially offset by the acquisition of leasehold improvements,
furniture, fixtures, equipment and other assets of $3,671,000 for use
in the Company's operations. The Company anticipates capital expenditures of approximately
$3,000,000 in 2004 that will be paid for by existing cash and cash equivalents
and working capital balances. During the year ended December 31, 2003, cash of $13,556,000 was provided by
financing activities consisting primarily of $11,563,000 in net proceeds to the
Company from the sale of 1,666,740 shares of the Companys common stock in a
private placement transaction at a sales price of $7.50 per share. In
addition, the Company received $2,070,000 in proceeds from the exercise of
stock options and warrants which was partially offset by payments on capital
lease obligations of $77,000. As of December 31, 2003, the Company had cash and cash equivalents of
$15,185,000, net receivables of $12,392,000 and net working capital of
$31,467,000. Management believes the Companys funds, together with possible
borrowings on its existing lines of credit and other bank loans, are sufficient
to provide for its short and long-term needs for operations as currently
projected. The Company may decide to sell additional equity securities or to
increase its borrowings in order to fund an increase its expenditures for
selling and marketing expenses, to fund increased product development, to make
acquisitions, or for other purposes. The Company has a working capital line of credit with Silicon Valley Bank. The
line of credit facility expired in December 2003 and was renewed in January
2004. Under the terms of the original agreement, the Company could borrow up
to the lesser of $4,000,000 or the sum of 80% of eligible accounts receivable
plus 25% of eligible inventory, as defined, at the banks prime rate plus 0.50%
(a total rate of 4.5% at December 31, 2003). Under the terms of the renewed
agreement, the interest rate on the line of credit is the banks prime rate
(4.0% at December 31, 2003), and the borrowing limit remained unchanged. The
amended agreement expires on April 30, 2005. As of December 31, 2003, there
were no outstanding borrowings. The Company also had a term loan facility with Silicon Valley Bank that
provided for borrowings up to a maximum amount of $2,000,000 at the banks
prime rate plus 1.00%. There was no amount outstanding under the term loan as
of December 31, 2003. The term loan facility expired according to its terms in
December 2003 and was not renewed. The Companys InfuSystem subsidiary has a revolving line of credit with a bank
under which it may borrow up to the lesser of $3,500,000 or 80% of eligible
accounts receivable, as defined, at the banks prime rate less 0.25% (3.75% at
December 31, 2003). There were no outstanding borrowings under the line of
credit as of December 31, 2003 and there were funds available for borrowing of
$3,500,000. The credit line expires June 30, 2004. In addition, InfuSystem
has a loan facility under which it may borrow up
to $2,500,000 for the purchase of equipment. As of December 31, 2003, there
were no outstanding borrowings under the loan facility. The Companys lines of credit are collateralized by substantially all of the
Companys assets and require the Company to comply with certain covenants
principally relating to working capital and liquidity. As of December 31,
2003, the Company was in compliance with all such covenants. 24




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Contractual Obligations and Commercial Commitments As of December 31, 2003, future payments related to contractual obligations and
commercial commitments are as follows: Payment Due by PeriodLess than 1 year
    
    1 to 3 years
    
    3 to 5 years
    
    More than 5 years
    
    TotalCapital Lease Obligations
    
    $
    1,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    1,000Operating Lease
Obligations for
Facilities
    
    
    699,000
    
    
    
    1,144,000
    
    
    
    930,000
    
    
    
    1,499,000
    
    
    
    4,272,000Purchase Commitments
with Suppliers
    
    
    2,324,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,324,000Total Contractual
Obligations and
Commercial Commitments
    
    $
    3,024,000
    
    
    $
    1,144,000
    
    
    $
    930,000
    
    
    $
    1,499,000
    
    
    $
    6,597,000
 New Accounting Pronouncements In August 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 143, Accounting for
Obligations Associated with the Retirement of Long-Lived Assets(SFAS 143).
SFAS 143 establishes accounting standards for the recognition and measurement
of an asset retirement obligation and its associated asset retirement cost. It
also provides accounting guidance for legal obligations associated with the
retirement of tangible long-lived assets. SFAS 143 is effective for fiscal
years beginning after June 15, 2002, with early adoption permitted. The
Company adopted the provisions of SFAS 143 and such adoption did not have a
material impact on its consolidated results of operations and financial
position. In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities(SFAS 146), which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring)(EITF Issue
94-3). SFAS 146 requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred. Under EITF
Issue 94-3, a liability for an exit cost as defined in EITF Issue 94-3 was
recognized at the date of an entitys commitment to an exit plan. SFAS 146 also
establishes that the liability should initially be measured and recorded at
fair value. SFAS 146 is effective for exit and disposal activities initiated
after December 31,
2002 and such adoption did not have a material impact on the Companys
consolidated results of operations and financial position. In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees and Indebtedness of Others.FIN 45 elaborates on the
disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also requires that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, while the provisions of the disclosure
requirements are effective for financial statements of interim or annual
reports ending after December 15, 2002. The Company adopted the disclosure
provisions of FIN 45 during the fourth quarter of fiscal 2002 and such adoption
did not have a material impact on its consolidated financial statements. The
Company adopted the recognition provisions of FIN 45 on January 1, 2003 and
such adoption did not have a material impact on its consolidated financial
statements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure(SFAS 148). SFAS 148 amends
Statement No. 123, Accounting for Stock-Based Compensation(SFAS 123), to
provide alternative methods for voluntary transition to SFAS 123s fair value
method of accounting for stock-based employee compensation. SFAS 148 also
requires disclosure of the effects of an entitys accounting policy with
respect to stock-based employee compensation on reported net income (loss) and
earnings (loss) per share in annual and interim financials statements. The
provisions of SFAS 148 are effective in fiscal years 25




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##### Table of Contents



ending after December 15,
2002. The Company has evaluated the provisions of SFAS 148 and those
provisions did not have a material adverse impact on its consolidated financial
statements since the Company has not adopted the fair value method. See Note 1
to the Consolidated Financial Statements for calculation of pro forma net
income (loss). In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities. In general, a variable interest entity is a corporation,
partnership, trust or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN 46 requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the variable interest entitys activities or entitled to receive a
majority of the entitys residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. With respect to variable interest entities created
before January 31, 2003, in December 2003 the FASB issued FIN 46R which, among
other things, revised the implementation date to first fiscal years or interim
periods ending after March 15, 2004, with the exception of Special Purpose
Entities (SPE). The consolidated requirements apply to all SPEs in the
first fiscal year or interim period ending after December 15, 2003. As the
Company has determined that it does not have any SPEs to which these
interpretations apply, the Company will adopt FIN46R in the first quarter of
2004. The Company does not believe that the adoption of FIN 46R will have a
material impact on its financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity(SFAS 150).
SFAS 150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both debt and equity and
requires an issuer to classify the following instruments as liabilities in its
balance sheet:  
    
    a financial instrument issued in the form of shares that is
mandatorily redeemable and embodies an unconditional obligation that
requires the issuer to redeem it by transferring its assets at a
specified or determinable date or upon an event that is certain to
occur;
    
    a financial instrument, other than an outstanding share, that
embodies an obligation to repurchase the issuers equity shares, or is

indexed to such an obligation, and required the issuer to settle the
obligation by transferring assets; and
    
    a financial instrument that embodies an unconditional obligation
that the issuer must settle by issuing a variable number of its equity shares if the monetary value of the obligation is based solely or
predominantly on (1) a fixed monetary amount, (2) variations in
something other than the
fair value of the issuers equity shares, or (3) variations inversely
related to changes in the fair value of the issuers equity shares. In November 2003, the FASB issued FASB Staff Position (FSP) No. 150-3 which
deferred the effective dates for applying certain provisions of FSAS No. 150
related to mandatorily redeemable financial instruments of certain nonpublic
entities and certain mandatorily redeemable noncontrolling interests for public
and nonpublic entities. For public entities, SFAS No. 150 is effective for mandatorily redeemable
financial instruments entered into or modified after May 31, 2003 and is
effective for all other financial instruments as of the first interim period
beginning after June 15, 2003. For mandatorily redeemable noncontrolling interests that would not have to be
classified as liabilities by a subsidiary under the exception in paragraph 9 of
SFAS No. 150, but would be classified as liabilities by the parent, the
classification and measurement provisions of SFAS No. 150 are deferred
indefinitely. For other mandatorily redeemable non controlling interests that
were issued before November 5, 2003, the measurement provisions of SFAS No. 150
are deferred indefinitely. For those instruments, the measurement guidance for
redeemable shares and noncontrolling interests in other literature shall apply
during the deferral period. SFAS No. 150 is to be implemented by reporting a cumulative effect of a change
in accounting principle. The Company does not believe that the adoption of
SFAS No. 150 will have a material impact on its consolidated financial
statements. 26




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##### Table of Contents



Item 7A. Quantitative and Qualitative Disclosures about Market Risk The Companys financial instruments include cash and cash equivalents and
long-term debt. At December 31, 2003, the carrying values of the Companys
financial instruments approximated fair values based upon current market
prices and rates. The Company has a subsidiary in Mexico. As a result, the Company is exposed
to potential transaction gains and losses resulting from fluctuations in
foreign currency exchange rates. The Company has not and currently does not
hedge or enter into derivative contracts in an effort to address the foreign
exchange risk. 
 Item 8. Financial Statements and Supplementary Data Financial Statements The Independent Auditors Report and the Consolidated Financial Statements
listed in the Index to Consolidated Financial Statements in Item 15 are
filed as part of this report. Financial Statement Schedule SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS Balance at
    
    Charged to Costs
    
    
    
    
    
    Balance at End ofClassification
    
    Beginning of Period
    
    and Expenses
    
    Deductions (1)
    
    PeriodYEAR ENDED DECEMBER 31, 2001:Allowance for doubtful accounts
        $
    2,487,000
    
    
    $
    71,000
    
    
    $
    (41,000
    )
    
    $
    2,517,000Reserve for obsolete inventories
    
    
    1,508,000
    
    
    
    375,000
    
    
    
    (167,000
    )
    
    
    1,716,000YEAR ENDED DECEMBER 31, 2002:Allowance for doubtful accounts
    
    
    2,517,000
    
    
    
    134,000
    
    
    
    (676,000
    )
    
    
    1,975,000Reserve for obsolete inventories
    
    
    1,716,000
    
    
    
    193,000
    
    
    
    (188,000
    )
    
    
    1,721,000YEAR ENDED DECEMBER 31, 2003:Allowance for doubtful accounts
    
    
    1,975,000
    
    
    
    701,000
    
    
    
    (978,000
    )
    
    
    1,698,000Reserve for obsolete inventories
    
    
    1,721,000
    
    
    
    799,000
    
    
    
    (364,000
    )
    
    
    2,156,000
 The
above schedule has been restated to exclude discontinued operations.  (1)
    
    Deductions in all years reported represent reductions to the reserve
accounts and the related asset accounts. Specifically, deductions from
the reserve for allowance for doubtful accounts represent the write-off of
uncollectible accounts receivable balances. Deductions from the reserve
for obsolete inventories represent the write-off and disposal of specific
inventory items. Selected Quarterly Financial Data See information set forth above under the heading Selected Quarterly Financial
Data on page 17. 
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 27




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Item 9A. Controls and Procedures (a) The Company carried out an evaluation, under the supervision and with the
participation of its management, including its Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of
the Companys disclosure controls and procedures as of the end of the period
covered by this report. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Companys disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in the Companys periodic filings with the Securities
and Exchange Commission. (b) There was no change in the Companys internal control over financial
reporting that occurred during the Companys most recently completed fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, the Companys internal control over financial reporting. 
 PART III 
 Item 10. Directors and Executive Officers of the Registrant Except for information concerning our executive officers which is included in
this report under the heading Executive Officers of the Registrant, the
information required by Item 10 is incorporated by reference to the Companys
proxy statement for its 2004 annual meeting of stockholders, which will be
filed with the Securities and Exchange Commission no later than 120 days after
the close of the fiscal year ended December 31, 2003. 
 Item 11. Executive Compensation The information required by Item 11 is incorporated by reference to the
Companys proxy statement for its 2004 annual meeting of stockholders, which
will be filed with the Securities and Exchange Commission no later than 120
days after the close of the fiscal year ended December 31, 2003. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by Item 12 is incorporated by reference to the
Companys proxy statement for its 2004 annual meeting of stockholders, which
will be filed with the Securities and Exchange Commission no later than 120
days after the close of the fiscal year ended December 31, 2003. 
 Item 13. Certain Relationships and Related Transactions The information required by Item 13 is incorporated by reference to the
Companys proxy statement for its 2004 annual meeting of stockholders, which
will be filed with the Securities and Exchange Commission no later than 120
days after the close of the fiscal year ended December 31, 2003. 
 Item 14. Principal Accountant Fees and Services The information required by Item 14 is incorporated by reference to the
Companys proxy statement for its 2004 annual meeting of stockholders, which
will be filed with the Securities and Exchange Commission no later than 120
days after the close of the fiscal year ended December 31, 2003. 28




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##### Table of Contents



PART IV 
 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. Page in ThisReport(a)
    
    Documents filed as part of this report:(1) Financial StatementsThe documents described in the Index to Consolidated Financial
Statements are included in this report.
    
    
    F-1(2) Financial Statement Schedules included herein:Schedule II - Valuation and Qualifying Accounts
    
    
    27All other schedules are omitted, as the required information is
inapplicable.(3) ExhibitsThe list of exhibits contained in the accompanying Index to Exhibits
is
herein incorporated by reference.(b)
    
    Reports on Form 8-KOn November 3, 2003, the Company filed a current report on Form 8-K pursuant to
which the Company furnished a release regarding its third quarter financial
results for 2003 and a copy of the transcript of its earnings conference call
held on October 29, 2003. On November 17, 2003, the Company filed a current
report on Form 8-K to report that the Company had sold Spinal Specialties,
Inc., a wholly owned subsidiary. On December 10, 2003, the Company filed an
amended current report on Form 8-K/A to indicate that no pro
forma financial information was required to be filed pursuant to Item
7(b) of Form 8-K with respect to the sale of Spinal Specialties.
 29




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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                                        |  |      |     | 
|----------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                        |  | Page
|                                                                                                                        |  |     
|Independent Auditors Report                                                                                            |  |      | F-1 | 
|Consolidated Balance Sheets as of December 31, 2003 and 2002                                                            |  |      | F-2 | 
|Consolidated Statements of Operations and Comprehensive Operations
For the Years Ended December 31, 2003, 2002 and 2001 |  |      | F-3 | 
|Consolidated Statements of Stockholders Equity for the
Years Ended December 31, 2003, 2002 and 2001                    |  |      | F-4 | 
|Consolidated Statements of Cash Flows for the Years
Ended December 31, 2003, 2002 and 2001                              |  |      | F-5 | 
|Notes to Consolidated Financial Statements                                                                              |  |      | F-6 | 

30



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##### Table of Contents






Independent Auditors Report

To the Board of Directors and Stockholders of
    I-Flow Corporation:

We have audited the accompanying consolidated balance sheets of I-Flow
Corporation and subsidiaries (the Company) as of December 31, 2003 and 2002,
and the related consolidated statements of operations and comprehensive
operations, stockholders equity and cash flows for each of the three years in
the period ended December 31, 2003. Our audits also included the financial
statement schedule listed in the Index at Item 15(a)(2). These financial
statements and the financial statement schedule are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
financial statements and the financial statement schedule based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of I-Flow Corporation and
subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America. Also in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.

As discussed in Note 2 to the
consolidated financial statements, the Company changed its
method of accounting for goodwill and other intangible assets during 2002 as a
result of adopting Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets.

As discussed in Note 3 to the consolidated financial statements, on November 1,
2003, the Company completed the sale of its wholly-owned subsidiary, Spinal
Specialties, Inc. The consolidated statements of operations and comprehensive
operations and of cash flows referred to above have been restated to
reflect Spinal
Specialties, Inc. as a discontinued operation for all periods presented.

/s/ Deloitte & Touche LLP

DELOITTE & TOUCHE LLP
Costa Mesa, California
March 11, 2004

F-1



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##### Table of Contents






CONSOLIDATED BALANCE SHEETS

|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |   | 
|---------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---- | ------ | ------------ | - | ------------ | ------ | ------- | - | 
|                                                           |                                                                                                                                                                   |      |        | December 31, |   | December 31,
|(Amounts in thousands, except share and per share amounts) |                                                                                                                                                                   | 2003 |        | 2002        
|                                                           |                                                                                                                                                                   |      |        |             
|Assets                                                     |                                                                                                                                                                   |      |        |              |   |              |        |        
|Current assets:                                            |                                                                                                                                                                   |      |        |              |   |              |        |        
|                                                           | Cash and cash equivalents                                                                                                                                         |      | $      | 15,185       |   |              | $      | 1,700   |  
|                                                           | Accounts receivable, less allowance for doubtful accounts of $1,698
and $2,034 at December 31, 2003 and 2002, respectively                                        |      |        | 12,392       |   |              |        | 10,483  |  
|                                                           | Inventories, net                                                                                                                                                  |      |        | 6,815        |   |              |        | 7,046   |  
|                                                           | Prepaid expenses and other current assets                                                                                                                         |      |        | 652          |   |              |        | 477     |  
|                                                           | Deferred taxes                                                                                                                                                    |      |        | 3,546        |   |              |        | 2,541   |  
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  
|                                                           | Total current assets                                                                                                                                              |      |        | 38,590       |   |              |        | 22,247  |  
|Property, net                                              |                                                                                                                                                                   |      | 6,744  |              |   |              | 5,626  |        
|Goodwill                                                   |                                                                                                                                                                   |      | 2,639  |              |   |              | 2,639  |        
|Other intangible assets, net                               |                                                                                                                                                                   |      | 1,214  |              |   |              | 1,134  |        
|Other long-term assets                                     |                                                                                                                                                                   |      | 147    |              |   |              | 155    |        
|Deferred taxes                                             |                                                                                                                                                                   |      | 2,562  |              |   |              | 1,260  |        
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  
|Total assets                                               |                                                                                                                                                                   | $    | 51,896 |              |   | $            | 33,061 |        
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  
|Liabilities and Stockholders Equity                       |                                                                                                                                                                   |      |        |              |   |              |        |        
|Current liabilities:                                       |                                                                                                                                                                   |      |        |              |   |              |        |        
|                                                           | Accounts payable                                                                                                                                                  |      | $      | 3,570        |   |              | $      | 3,898   |  
|                                                           | Accrued payroll and related expenses                                                                                                                              |      |        | 2,961        |   |              |        | 1,349   |  
|                                                           | Income taxes payable                                                                                                                                              |      |        | 236          |   |              |        | 207     |  
|                                                           | Other current liabilities                                                                                                                                         |      |        | 356          |   |              |        | 136     |  
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  
|                                                           | Total current liabilities                                                                                                                                         |      |        | 7,123        |   |              |        | 5,590   |  
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  
|Other long-term liabilities                                |                                                                                                                                                                   |      |       |              |   |              | 1      |        
|Commitments and contingencies (Note 7)                     |                                                                                                                                                                   |      |        |              |   |              |        |        
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  
|Stockholders equity                                       |                                                                                                                                                                   |      |        |              |   |              |        |        
|                                                           | Preferred stock, $0.001 par value; 5,000,000 shares authorized; no
shares issued and outstanding                                                                  |      |        |             |   |              |        |        |  
|                                                           | Common stock, $0.001 par value; 40,000,000 shares authorized, 18,305,787
and
15,473,138 shares issued and outstanding at December 31, 2003 and 2002,
respectively |      |        | 60,049       |   |              |        | 43,106  |  
|                                                           | Accumulated other comprehensive loss                                                                                                                              |      |        | (192         | ) |              |        | (95     | )
|                                                           | Accumulated deficit                                                                                                                                               |      |        | (15,084      | ) |              |        | (15,541 | )
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  
|                                                           | Net stockholders equity                                                                                                                                          |      |        | 44,773       |   |              |        | 27,470  |  
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  
|Total liabilities and shareholders equity                 |                                                                                                                                                                   | $    | 51,896 |              |   | $            | 33,061 |        
|                                                           |                                                                                                                                                                   |      |        |              |   |              |        |         |  

See accompanying Notes to Consolidated Financial Statements.

F-2



---



##### Table of Contents






CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE OPERATIONS

|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|---------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------ | -------------------------- | ------ | ------------------------ | ------ | ---- | ------ | ------ | ------ | - | ------ | ---- | ------ | 
|                                                                                                                       |                                                                    |                            |        | Years ended December 31,
|                                                                                                                       |                                                                    |                            |        |                         
|(Amounts in thousands, except per share amounts)                                                                       |                                                                    | 2003                       |        | 2002                     |        | 2001
|                                                                                                                       |                                                                    |                            |        |                          |        |     
|Revenues:                                                                                                              |                                                                    |                            |        |                          |        |      |        |        |        |   |        |     
|                                                                                                                       |                                                                    | Net product sales          |        | $                        | 34,021 |      |        | $      | 24,370 |   |        | $    | 20,168 | 
|                                                                                                                       |                                                                    | Rental income and other    |        |                          | 13,022 |      |        |        | 10,293 |   |        |      | 10,363 | 
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|                                                                                                                       |                                                                    | Total revenues             |        |                          | 47,043 |      |        |        | 34,663 |   |        |      | 30,531 | 
|Cost of revenues:                                                                                                      |                                                                    |                            |        |                          |        |      |        |        |        |   |        |     
|                                                                                                                       |                                                                    | Product cost of revenues   |        |                          | 13,192 |      |        |        | 8,979  |   |        |      | 8,734  | 
|                                                                                                                       |                                                                    | Rental cost of revenues    |        |                          | 4,018  |      |        |        | 3,007  |   |        |      | 3,182  | 
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|                                                                                                                       |                                                                    | Total cost of revenues     |        |                          | 17,210 |      |        |        | 11,986 |   |        |      | 11,916 | 
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Gross profit                                                                                                           |                                                                    |                            | 29,833 |                          |        |      | 22,677 |        |        |   | 18,615 |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Operating expenses                                                                                                     |                                                                    |                            |        |                          |        |      |        |        |        |   |        |     
|                                                                                                                       |                                                                    | Selling and marketing      |        |                          | 20,412 |      |        |        | 11,760 |   |        |      | 4,845  | 
|                                                                                                                       |                                                                    | General and administrative |        |                          | 10,341 |      |        |        | 8,099  |   |        |      | 8,841  | 
|                                                                                                                       |                                                                    | Product development        |        |                          | 2,361  |      |        |        | 2,104  |   |        |      | 2,238  | 
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|                                                                                                                       |                                                                    | Total operating expenses   |        |                          | 33,114 |      |        |        | 21,963 |   |        |      | 15,924 | 
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Operating income (loss)                                                                                                |                                                                    |                            | (3,281 | )                        |        |      | 714    |        |        |   | 2,691  |     
|Interest expense (income), net                                                                                         |                                                                    |                            | 46     |                          |        |      | (6     | )      |        |   | 44     |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Income (loss) from continuing operations before income taxes and cumulative effect of a change in accounting principle |                                                                    |                            | (3,327 | )                        |        |      | 720    |        |        |   | 2,647  |     
|Income tax provision (benefit)                                                                                         |                                                                    |                            | (1,173 | )                        |        |      | 305    |        |        |   | 1,067  |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Income (loss) from continuing operations before cumulative
effect of a change in accounting principle                  |                                                                    |                            | (2,154 | )                        |        |      | 415    |        |        |   | 1,580  |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Discontinued operations:                                                                                               |                                                                    |                            |        |                          |        |      |        |        |        |   |        |     
|                                                                                                                       | Income (loss) from discontinued operations, net of tax             |                            |        | 328                      |        |      |        | 24     |        |   |        | (313 | )     
|                                                                                                                       | Gain on sale of discontinued operations, net of tax                |                            |        | 2,283                    |        |      |        |       |        |   |        |     |       
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Income before cumulative effect of a change in accounting
principle                                                    |                                                                    |                            | 457    |                          |        |      | 439    |        |        |   | 1,267  |     
|                                                                                                                       | Cumulative effect of a change in accounting principle for
goodwill |                            |        |                         |        |      |        | (3,474 | )      |   |        |     |       
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Net income (loss)                                                                                                      |                                                                    | $                          | 457    |                          |        | $    | (3,035 | )      |        | $ | 1,267  |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Per share of common stock, basic:                                                                                      |                                                                    |                            |        |                          |        |      |        |        |        |   |        |     
|Income (loss) from continuing operations before cumulative
effect of a change in accounting principle                  |                                                                    | $                          | (0.13  | )                        |        | $    | 0.03   |        |        | $ | 0.10   |     
|Income (loss) from discontinued operations, net of tax                                                                 |                                                                    |                            | 0.02   |                          |        |      |       |        |        |   | (0.02  | )   
|Gain on sale of discontinued operations, net of tax                                                                    |                                                                    |                            | 0.14   |                          |        |      |       |        |        |   |       |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Income before cumulative effect of a change in accounting
principle                                                    |                                                                    |                            | 0.03   |                          |        |      | 0.03   |        |        |   | 0.08   |     
|Cumulative effect of a change in accounting principle                                                                  |                                                                    |                            |       |                          |        |      | (0.23  | )      |        |   |       |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Net income (loss)                                                                                                      |                                                                    | $                          | 0.03   |                          |        | $    | (0.20  | )      |        | $ | 0.08   |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Per share of common stock, diluted:                                                                                    |                                                                    |                            |        |                          |        |      |        |        |        |   |        |     
|Income (loss) from continuing operations before cumulative
effect of a change in accounting principle                  |                                                                    | $                          | (0.13  | )                        |        | $    | 0.03   |        |        | $ | 0.10   |     
|Income (loss) from discontinued operations, net of tax                                                                 |                                                                    |                            | 0.02   |                          |        |      |       |        |        |   | (0.02  | )   
|Gain on sale of discontinued operations, net of tax                                                                    |                                                                    |                            | 0.14   |                          |        |      |       |        |        |   |       |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Income before cumulative effect of a change in accounting
principle                                                    |                                                                    |                            | 0.03   |                          |        |      | 0.03   |        |        |   | 0.08   |     
|Cumulative effect of a change in accounting principle                                                                  |                                                                    |                            |       |                          |        |      | (0.22  | )      |        |   |       |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Net income (loss)                                                                                                      |                                                                    | $                          | 0.03   |                          |        | $    | (0.19  | )      |        | $ | 0.08   |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Comprehensive Operations:                                                                                              |                                                                    |                            |        |                          |        |      |        |        |        |   |        |     
|Net income (loss)                                                                                                      |                                                                    | $                          | 457    |                          |        | $    | (3,035 | )      |        | $ | 1,267  |     
|Foreign currency translation adjustments                                                                               |                                                                    |                            | (97    | )                        |        |      | (96    | )      |        |   | (34    | )   
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 
|Comprehensive income (loss)                                                                                            |                                                                    | $                          | 360    |                          |        | $    | (3,131 | )      |        | $ | 1,233  |     
|                                                                                                                       |                                                                    |                            |        |                          |        |      |        |        |        |   |        |      |        | 

See accompanying Notes to Consolidated Financial Statements.

F-3



---



##### Table of Contents






CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |   |        |  
|--------------------------------------------- |  | ------------ | ------ | ------------- |  | ----------- | ------ | ------- |  | ----------- | ---- | - |  | - | ------- | - |  | - | ------ | -
|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |  
|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |  
|                                              |  |              |        |               |  |             |        |         |  | Accumulated |      |   |  |   |         |   |  |  
|                                              |  |              |        | Other         |  |            
|                                              |  | Common Stock |        | Comprehensive |  |             |        |         |  |             |      |  
|                                              |  |              |        | Income        |  | Accumulated |        |         |  |            
|(Amounts in thousands)                        |  | Shares       |        | Amount        |  | (Loss)      |        | Deficit |  | Net        
|                                              |  |              |        |               |  |             |        |         |  |            
|Balance, December 31, 2000                    |  |              | 15,052 |               |  | $           | 41,356 |         |  | $           | 35   |   |  | $ | (13,773 | ) |  | $ | 27,618 |  
|Exercise of common stock options              |  |              | 293    |               |  |             | 156    |         |  |             |      |   |  |   |         |   |  |   | 156    |  
|Tax benefit from exercise of stock options    |  |              |        |               |  |             | 129    |         |  |             |      |   |  |   |         |   |  |   | 129    |  
|Stock based compensation                      |  |              |        |               |  |             | 633    |         |  |             |      |   |  |   |         |   |  |   | 633    |  
|Foreign currency translation adjustment       |  |              |        |               |  |             |        |         |  |             | (34  | ) |  |   |         |   |  |   | (34    | )
|Net income                                    |  |              |        |               |  |             |        |         |  |             |      |   |  |   | 1,267   |   |  |   | 1,267  |  
|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |   |        |  
|Balance, December 31, 2001                    |  |              | 15,345 |               |  | $           | 42,274 |         |  | $           | 1    |   |  | $ | (12,506 | ) |  | $ | 29,769 |  
|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |   |        |  
|Balance, December 31, 2000                    |  |              | 15,052 |               |  | $           | 84,548 |         |  | $           | 2    |   |  | $ | (25,012 | ) |  | $ | 59,538 |  
|Exercise of common stock options              |  |              | 55     |               |  |             | 63     |         |  |             |      |   |  |   |         |   |  |   | 63     |  
|Tax benefit from exercise of stock options    |  |              |        |               |  |             | 17     |         |  |             |      |   |  |   |         |   |  |   | 17     |  
|Stock based compensation                      |  |              | 73     |               |  |             | 752    |         |  |             |      |   |  |   |         |   |  |   | 752    |  
|Foreign currency translation adjustment       |  |              |        |               |  |             |        |         |  |             | (96  | ) |  |   |         |   |  |   | (96    | )
|Net loss                                      |  |              |        |               |  |             |        |         |  |             |      |   |  |   | (3,035  | ) |  |   | (3,035 | )
|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |   |        |  
|Balance, December 31, 2002                    |  |              | 15,473 |               |  | $           | 43,106 |         |  | $           | (95  | ) |  | $ | (15,541 | ) |  | $ | 27,470 |  
|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |   |        |  
|Exercise of common stock options and warrants |  |              | 1,092  |               |  |             | 2,070  |         |  |             |      |   |  |   |         |   |  |   | 2,070  |  
|Tax benefit from exercise of stock options    |  |              |        |               |  |             | 2,000  |         |  |             |      |   |  |   |         |   |  |   | 2,000  |  
|Stock based compensation                      |  |              | 74     |               |  |             | 1,268  |         |  |             |      |   |  |   |         |   |  |   | 1,268  |  
|Sale of common stock, net                     |  |              | 1,667  |               |  |             | 11,563 |         |  |             |      |   |  |   |         |   |  |   | 11,563 |  
|Grant of common stock warrants                |  |              |        |               |  |             | 42     |         |  |             |      |   |  |   |         |   |  |   | 42     |  
|Foreign currency translation adjustment       |  |              |        |               |  |             |        |         |  |             | (97  | ) |  |   |         |   |  |   | (97    | )
|Net income                                    |  |              |        |               |  |             |        |         |  |             |      |   |  |   | 457     |   |  |   | 457    |  
|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |   |        |  
|Balance, December 31, 2003                    |  |              | 18,306 |               |  | $           | 60,049 |         |  | $           | (192 | ) |  | $ | (15,084 | ) |  | $ | 44,773 |  
|                                              |  |              |        |               |  |             |        |         |  |             |      |   |  |   |         |   |  |   |        |  

See accompanying Notes to Consolidated Financial Statements.

F-4



---



##### Table of Contents






CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |        |        |  
|------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | --------------------------------------------------------- | ------ | ----------------------- | ------ | ------ | ------ | ------ | ---- | ------ | ----- | ------ | ------ | -
|                                                                               |                                                                                                    |                                                                                        |                                                           |        | Year ended December 31,
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                        
|(Amounts in thousands)                                                         |                                                                                                    | 2003                                                                                   |                                                           | 2002   |                         | 2001  
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |       
|Cash flows from operating activities:                                          |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |      
|                                                                               | Net income (loss)                                                                                  |                                                                                        | $                                                         | 457    |                         |        | $      | (3,035 | )      |      | $      | 1,267 |       
|                                                                               | Income from discontinued operations                                                                |                                                                                        |                                                           | (328   | )                       |        | $      | (24    | )      |      | $      | 313   |       
|                                                                               | Gain on sale of subsidiary                                                                         |                                                                                        |                                                           | (2,283 | )                       |        |        |        |        |      |        |       |       
|                                                                               | Adjustments
to reconcile net income (loss) to net cash provided by (used in) operating activities: |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|                                                                               |                                                                                                    | Deferred taxes                                                                         |                                                           |        | (1,257                  | )      |        |        | 235    |      |        |       | 573    |       
|                                                                               |                                                                                                    | Depreciation and amortization                                                          |                                                           |        | 2,513                   |        |        |        | 2,020  |      |        |       | 2,405  |       
|                                                                               |                                                                                                    | Expense related to common stock warrants                                               |                                                           |        | 42                      |        |        |        |       |      |        |       |       |       
|                                                                               |                                                                                                    | Cumulative effect of a change in accounting principle                                  |                                                           |        |                        |        |        |        | 3,474  |      |        |       |       |       
|                                                                               |                                                                                                    | Loss on disposal of property                                                           |                                                           |        | 213                     |        |        |        | 8      |      |        |       | 3      |       
|                                                                               |                                                                                                    | Stock based compensation                                                               |                                                           |        | 941                     |        |        |        | 752    |      |        |       | 633    |       
|                                                                               |                                                                                                    | Provision for inventory obsolescence                                                   |                                                           |        | 799                     |        |        |        | 193    |      |        |       | 375    |       
|                                                                               |                                                                                                    | Provision for doubtful accounts receivable                                             |                                                           |        | 701                     |        |        |        | 134    |      |        |       | 71     |       
|                                                                               |                                                                                                    | Changes in operating assets and liabilities, net of effect of
discontinued operations: |                                                           |        |                         |        |        |        |        |      |        |       |        |       
|                                                                               |                                                                                                    |                                                                                        | Accounts receivable                                       |        |                         | (3,171 | )      |        |        | (690 | )      |       |        | 2,699  |  
|                                                                               |                                                                                                    |                                                                                        | Inventories                                               |        |                         | (1,360 | )      |        |        | (87  | )      |       |        | (2,898 | )
|                                                                               |                                                                                                    |                                                                                        | Prepaid expenses and other                                |        |                         | (243   | )      |        |        | (12  | )      |       |        | 26     |  
|                                                                               |                                                                                                    |                                                                                        | Accounts payable and accrued payroll and related expenses |        |                         | 1,636  |        |        |        | 12   |        |       |        | 870    |  
|                                                                               |                                                                                                    |                                                                                        | Income taxes payable                                      |        |                         | 30     |        |        |        | (51  | )      |       |        | (68    | )
|                                                                               |                                                                                                    |                                                                                        | Other liabilities                                         |        |                         | 296    |        |        |        | 31   |        |       |        | 9      |  
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Net cash provided by (used in) operating activities from continuing
operations |                                                                                                    |                                                                                        | (1,014                                                    | )      |                         |        | 2,960  |        |        |      | 6,278  |      
|Net
cash provided by (used in) operating activities of discontinued operations |                                                                                                    |                                                                                        | (56                                                       | )      |                         |        | 137    |        |        |      | (701   | )    
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Net cash (used in) provided by operating activities                            |                                                                                                    |                                                                                        | (1,070                                                    | )      |                         |        | 3,097  |        |        |      | 5,577  |      
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Cash flows from investing activities:                                          |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |      
|                                                                               |                                                                                                    | Capital expenditures                                                                   |                                                           |        | (3,671                  | )      |        |        | (2,634 | )    |        |       | (1,686 | )     
|                                                                               |                                                                                                    | Cash paid for acquisition, net of cash received                                        |                                                           |        |                        |        |        |        |       |      |        |       | (165   | )     
|                                                                               |                                                                                                    | Net Proceeds from sale of subsidiary                                                   |                                                           |        | 5,044                   |        |        |        |       |      |        |       |       |       
|                                                                               |                                                                                                    | Change in other assets                                                                 |                                                           |        | 12                      |        |        |        | (478   | )    |        |       | (417   | )     
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Net cash provided by (used in) investing activities from continuing
operations |                                                                                                    |                                                                                        | 1,385                                                     |        |                         |        | (3,112 | )      |        |      | (2,268 | )    
|Net cash used in investing activities from discontinued operations             |                                                                                                    |                                                                                        | (382                                                      | )      |                         |        | (43    | )      |        |      | (133   | )    
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Net cash provided by (used in) investing activities                            |                                                                                                    |                                                                                        | 1,003                                                     |        |                         |        | (3,155 | )      |        |      | (2,401 | )    
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Cash flows from financing activities:                                          |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |      
|                                                                               |                                                                                                    | Repayments on line of credit                                                           |                                                           |        |                        |        |        |        |       |      |        |       | (500   | )     
|                                                                               |                                                                                                    | Net proceeds from sale of common stock                                                 |                                                           |        | 11,563                  |        |        |        |        |      |        |       |        |       
|                                                                               |                                                                                                    | Principal
payments on debt                                                             |                                                           |        | (77                     | )      |        |        | (226   | )    |        |       | (1,975 | )     
|                                                                               |                                                                                                    | Proceeds from exercise of stock options and warrants                                   |                                                           |        | 2,070                   |        |        |        | 63     |      |        |       | 156    |       
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Net cash provided by (used in) financing activities                            |                                                                                                    |                                                                                        | 13,556                                                    |        |                         |        | (163   | )      |        |      | (2,319 | )    
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Effect of exchange rates on cash                                               |                                                                                                    |                                                                                        | (4                                                        | )      |                         |        | (112   | )      |        |      | (8     | )    
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Net increase (decrease) in cash and cash equivalents                           |                                                                                                    |                                                                                        | 13,485                                                    |        |                         |        | (333   | )      |        |      | 849    |      
|Cash and cash equivalents at beginning of year                                 |                                                                                                    |                                                                                        | 1,700                                                     |        |                         |        | 2,033  |        |        |      | 1,184  |      
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Cash and cash equivalents at end of year                                       |                                                                                                    | $                                                                                      | 15,185                                                    |        |                         | $      | 1,700  |        |        | $    | 2,033  |      
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|SUPPLEMENTAL CASH FLOW INFORMATION:                                            |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |      
|Interest paid                                                                  |                                                                                                    | $                                                                                      | 65                                                        |        |                         | $      | 11     |        |        | $    | 98     |      
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Income tax payments                                                            |                                                                                                    | $                                                                                      | 29                                                        |        |                         | $      | 139    |        |        | $    | 413    |      
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       
|Tax benefit from exercise of stock options                                     |                                                                                                    | $                                                                                      | 2,000                                                     |        |                         | $      | 17     |        |        | $    | 129    |      
|                                                                               |                                                                                                    |                                                                                        |                                                           |        |                         |        |        |        |        |      |        |       |       

See accompanying Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements



|1. |  | Nature of Operations and Summary of Significant Accounting Policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Nature of Operations-I-Flow Corporation (I-Flow or the Company) was
incorporated in California on July 17, 1985. On July 30, 2001, the Company
reincorporated in the State of Delaware by merging into a wholly owned
subsidiary incorporated in Delaware. The Company designs, develops,
manufactures and markets technically advanced, low-cost ambulatory infusion
systems that seek to redefine the standard of care by providing life enhancing,
cost effective solutions for pain management and infusion therapy. The
Companys products are used both in hospitals and alternate site settings.
I-Flow manufactures a growing line of compact, portable infusion pumps,
catheters and pain kits that administer medication directly to the wound site
as well as administer local anesthetic, chemotherapy, antibiotics, nutritional
supplements and other medications. InfuSystem, Inc., a wholly-owned
subsidiary, is primarily engaged in the rental of infusion pumps on a
month-to-month basis for the treatment of cancer.
|  
|   |  | Principles of Consolidation The consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and include the accounts of the Company and its
wholly-owned subsidiaries. All intercompany accounts and transactions have
been eliminated.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | Cash and Cash Equivalents-Cash and cash equivalents consist of cash in the
bank and money-market funds with immediate availability. The Company maintains
its cash and cash equivalents primarily with a single financial institution.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   |  | Inventories-Inventories are stated at the lower of cost (determined on a
first in, first out basis) or market. Inventories consisted of the following
as of December 31:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

|                         |  |      |            |      |  |   |            |  
|------------------------ |  | ---- | ---------- | ---- |  | - | ---------- | -
|                         |  | 2003 |            | 2002
|                         |  |      |            |     
|Raw Materials            |  | $    | 5,368,000  |      |  | $ | 5,566,000  |  
|Work in Process          |  |      | 765,000    |      |  |   | 527,000    |  
|Finished Goods           |  |      | 2,838,000  |      |  |   | 2,792,000  |  
|Reserve for Obsolescence |  |      | (2,156,000 | )    |  |   | (1,839,000 | )
|                         |  |      |            |      |  |   |            |  
|Total                    |  | $    | 6,815,000  |      |  | $ | 7,046,000  |  
|                         |  |      |            |      |  |   |            |  



| |  | Long Lived Assets The Company accounts for the impairment and disposition of
long-lived assets in accordance with Statement of Financial Accounting
Standards (SFAS) No. 144, Accounting for Impairment or Disposal of Long-Lived
Assets.This statement addresses financial accounting and reporting for the
impairment of long-lived assets and for the disposal of long-lived assets.
The Company adopted SFAS
No. 144 on January 1, 2002. In accordance with SFAS No. 144, long-lived assets
to be held are reviewed for events or changes in circumstances, which indicate
that their carrying value may not be recoverable. The Company periodically
reviews the carrying value of long-lived assets to determine whether or not an
impairment to such value has occurred. During the fourth quarter of 2003, the
Company determined that the carrying value of certain tooling and patents
related to the Companys electronic IV infusion pump products within the
manufacturing and marketing operating segment was impaired due to a cessation
of sales of the products to which the assets related. The write-down of the
tooling assets and patents resulted in charges of $188,000 to cost of sales and
$90,000 to product development expenses, respectively, in 2003. Also
see note 3.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Property Property is stated at cost and depreciated using the straight-line
method over the estimated useful lives of the related assets, ranging from two
to seven years. Leasehold improvements are amortized using the straight-line
method over the life of the asset or the remaining term of the lease, whichever
is shorter. Property consisted of the following as of December 31:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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|                                          |  |      |            |      |  |   |            |  
|----------------------------------------- |  | ---- | ---------- | ---- |  | - | ---------- | -
|                                          |  | 2003 |            | 2002
|                                          |  |      |            |     
|Furniture, fixtures and equipment         |  | $    | 8,243,000  |      |  | $ | 8,585,000  |  
|Rental and demonstration equipment        |  |      | 8,454,000  |      |  |   | 6,386,000  |  
|Accumulated depreciation and amortization |  |      | (9,953,000 | )    |  |   | (9,345,000 | )
|                                          |  |      |            |      |  |   |            |  
|Total                                     |  | $    | 6,744,000  |      |  | $ | 5,626,000  |  
|                                          |  |      |            |      |  |   |            |  



| |  | Goodwill Prior to the adoption of SFAS No. 142, Goodwill and Other Intangible
Assets, on January 1, 2002, the excess of cost over fair value of net assets
acquired was amortized on a straight-line basis over five to fifteen years.
Prior to the adoption of SFAS No. 142, the Company periodically evaluated the
recoverability of goodwill based upon the future undiscounted cash flows and
had determined that there was no impairment of goodwill. Effective January 1,
2002, goodwill is no longer amortized but is tested for impairment at least
annually. A transitional impairment charge of $3,474,000 was recognized upon
adoption of SFAS No. 142. See Note 2 to Notes to Consolidated Financial
Statements. The Company reviews the recoverability of the carrying value of
goodwill on an annual basis or more frequently if an event occurs or
circumstances change to indicate that an impairment of goodwill has possibly
occurred. The Company compares fair value of its reporting units to their
carrying value, as well as other factors, to determine whether or not any
potential impairment of goodwill exists. If a potential impairment exists, an
impairment loss is recognized to the extent the carrying value of goodwill
exceeds the difference between the fair value of the reporting unit and the
fair value of its other assets and liabilities.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Revenue Recognition Revenue from product sales is recognized at the time of
shipment and passage of title. Provision is made currently for estimated returns of defective products and warranty obligations. Amounts incurred have been
within managements expectations and historically insignificant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | Rental revenue from medical pumps is recorded as earned over the term of the
related rental agreements, normally on a month-to-month basis. Pump rentals
are billed at the Companys established rates, which often differ from
contractually allowable rates provided by third party payors such as Medicare,
Medicaid and commercial insurance carriers. Provision is made currently to
reduce revenue to the estimated allowable amount per such contractual rates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | Due to the nature of the industry and the reimbursement environment in which
the Company operates, certain estimates are required to record net revenues and
accounts receivable at their net realizable values. Inherent in these estimates
is the risk that they will have to be revised or updated as additional
information becomes available. Specifically, the complexity of many third-party
billing arrangements and the uncertainty of reimbursement amounts for certain
services from certain payors may result in adjustments to amounts originally
recorded. Because of continuing changes in the healthcare industry and
third-party reimbursement, it is possible that managements estimates could
change in the near term, which could have an impact on operations and cash
flows.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | Accounts Receivable Management performs periodic analyses to evaluate the net
realizable value of accounts receivable. Specifically, management considers
historical realization data, accounts receivable aging trends, other operating
trends and relevant business conditions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | Product Warranties
The Company maintains a reserve for estimated defective product
returns based upon historical activity. The Company does not provide an
explicit product warranty for its products and warranty claims have been
insignificant in the past.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | Income Taxes The Company accounts for income taxes in accordance with SFAS
No. 109, Accounting for Income Taxes, which requires that the Company recognize
deferred tax liabilities and assets based upon the differences between the
financial statement carrying amounts and the tax bases of assets and
liabilities, using enacted tax rates in effect in the years the differences are
expected to reverse. Deferred income tax benefit (expense) results from the
change in net deferred tax assets or deferred tax liabilities. A valuation
allowance is recorded when it is more likely than not that some or all or any
deferred tax assets will not be realized.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Accounting for Stock Based Compensation The Company accounts for employee
stock options using the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

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| |  | Issued to Employeesand Financial Accounting Standards Board (FASB)
Interpretation No. 28, Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans, and has adopted the disclosure-only
alternative of SFAS No. 123, Accounting for Stock-Based Compensation. Stock
options issued to consultants and vendors are accounted for at fair value.                                                                                                                                                                                                                
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Because the Company has adopted the disclosure-only provisions of SFAS No. 123,
no compensation cost has been recognized for stock option grants to employees
and non-employee directors with exercise prices equal to the fair market value
of the underlying shares at the grant date. Had compensation cost for the
Companys option plans been determined based upon the fair value of the options
at the grant date consistent with the provisions of SFAS No. 123, the Companys
net income (loss) and net income (loss) per share would have been the pro forma
amounts indicated below:

|                                                                                                                    |  |                          |        |      |  |      |        |   |  |   |       |  
|------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ | - |  | - | ----- | -
|                                                                                                                    |  | Years Ended December 31,
|                                                                                                                    |  |                         
|(Amounts in thousands, except per share amounts)                                                                    |  | 2003                     |        | 2002 |  | 2001
|                                                                                                                    |  |                          |        |      |  |     
|Net income (loss)  as reported                                                                                     |  | $                        | 457    |      |  | $    | (3,035 | ) |  | $ | 1,267 |  
|Stock-based employee compensation included in
net income (loss), net of tax                                         |  | $                        | 471    |      |  | $    | 397    |   |  | $ | 330   |  
|Total stock-based employee compensation expense
determined under fair value based method for
all awards, net of tax |  | $                        | (1,024 | )    |  | $    | (1,017 | ) |  | $ | (886  | )
|                                                                                                                    |  |                          |        |      |  |      |        |   |  |   |       |  
|Net income (loss)  pro forma                                                                                       |  | $                        | (96    | )    |  | $    | (3,655 | ) |  | $ | 711   |  
|                                                                                                                    |  |                          |        |      |  |      |        |   |  |   |       |  
|Basic earnings (loss) per share  as reported                                                                       |  | $                        | 0.03   |      |  | $    | (0.20  | ) |  | $ | 0.08  |  
|Basic earnings (loss) per share  pro forma                                                                         |  | $                        | (0.01  | )    |  | $    | (0.24  | ) |  | $ | 0.05  |  
|Diluted
earnings (loss) per share - as reported                                                                     |  | $                        | 0.03   |      |  | $    | (0.19  | ) |  | $ | 0.08  |  
|Diluted earnings (loss) per share  pro forma                                                                       |  | $                        | (0.01  | )    |  | $    | (0.23  | ) |  | $ | 0.05  |  
|                                                                                                                    |  |                          |        |      |  |      |        |   |  |   |       |  



| |  | The amounts in the above table related to stock-based employee compensation
included in net income (loss), net of tax relate to employee stock options only
and exclude compensation expense related to consultant stock options and
restricted stock.                                                                                                                                               
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 2003, 2002 and 2001: no dividend yield; expected
volatility 93% in 2003, 94% in 2002 and 90% in 2001; risk-free interest rate of
3.08% in 2003, 3.04% in 2002 and 4.75% in 2001; and expected lives of 5 years.
|
| |  | Earnings Per Share Pursuant to SFAS No. 128, Earnings Per Share, the Company
provides dual presentation of Basic and Diluted earnings per share (EPS).                                                                                                                                                                                                                                        
|
| |  | Basic net income (loss) per share is computed using the weighted average number
of common shares outstanding during the periods presented, excluding unvested
restricted stock which the Company has a right to repurchase in the event of
early termination of employment.                                                                                                                          
|
| |  | Diluted net income (loss) per share is computed using the weighted average
number of common and common equivalent shares outstanding during the periods
utilizing the treasury stock method for stock options and unvested restricted
stock.                                                                                                                                                         

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| |  | The following is a reconciliation between weighted average shares used in the
basic and diluted earnings per share calculations:
| |  | --------------------------------------------------------------------------------------------------------------------------------

|                               |                                                      |  |                          |            |      |  |      |            |  |  |  |            | 
|------------------------------ | ---------------------------------------------------- |  | ------------------------ | ---------- | ---- |  | ---- | ---------- |  |  |  | ---------- | 
|                               |                                                      |  | Years ended December 31,
|                               |                                                      |  |                         
|                               |                                                      |  | 2003                     |            | 2002 |  | 2001
|                               |                                                      |  |                          |            |      |  |     
|Basic net income per share     |                                                      |  |                          |            |      |  |      |            |  |  |  |           
|                               | Weighted-average number of common
shares outstanding |  |                          | 16,384,000 |      |  |      | 15,368,000 |  |  |  | 15,231,000 | 
|Effect of dilutive securities: |                                                      |  |                          |            |      |  |      |            |  |  |  |           
|                               | Stock options and unvested restricted stock          |  |                          |           |      |  |      | 511,000    |  |  |  | 518,000    | 
|                               |                                                      |  |                          |            |      |  |      |            |  |  |  |            | 
|Diluted net income per share   |                                                      |  |                          |            |      |  |      |            |  |  |  |           
|                               | Weighted-average number of common
shares outstanding |  |                          | 16,384,000 |      |  |      | 15,879,000 |  |  |  | 15,749,000 | 
|                               |                                                      |  |                          |            |      |  |      |            |  |  |  |            | 



| |  | Options to purchase 179,000, 2,426,164 and 1,851,492 shares of common stock
have been excluded from the treasury stock method calculation for diluted
weighted average common shares for the years ended December 31, 2003, 2002 and
2001, respectively, as their exercise prices exceeded the average market price
of the Companys common stock for these periods.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Comprehensive IncomePursuant to SFAS No. 130, Reporting Comprehensive
Income, the Company has included a calculation of comprehensive income (loss)
in its accompanying consolidated statements of operations and comprehensive
operations for the years ended December 31, 2003, 2002 and 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | Use of EstimatesThe preparation of financial statements in conformity with
generally accepted accounting principles necessarily requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these estimates.                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Foreign CurrencyThe financial position and results of operations of the
Companys foreign subsidiary are generally measured using the local currency as
the functional currency. Assets and liabilities of the subsidiary are
translated at the exchange rate in effect at each year-end. Income statement
accounts are translated at the average rate of exchange prevailing during the
year. Translation adjustments arising from differences in exchange rates from
period to period are included as a separate component within shareholders
equity. Realized gains or losses from foreign currency transactions are
included in operations as incurred and historically have not been significant.                                                                                                                                                                                                                         
|
| |  | New Accounting Pronouncements In August 2001, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 143, Accounting for Obligations Associated with the Retirement of
Long-Lived Assets(SFAS 143). SFAS 143 establishes accounting standards for
the recognition and measurement of an asset retirement obligation and its
associated asset retirement cost. It also provides accounting guidance for
legal obligations associated with the retirement of tangible long-lived
assets. SFAS 143 is effective for fiscal years beginning after June 15, 2002,
with early adoption permitted. The Company adopted the provisions of SFAS 143
and such adoption did not have a material impact on its consolidated results
of operations and financial position.                                                                                                       
|
| |  | In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities(SFAS 146), which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring)(EITF Issue
94-3). SFAS 146 requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred. Under EITF
Issue 94-3, a liability for an exit cost as defined in EITF Issue 94-3 was
recognized at the date of an entitys commitment to an exit plan. SFAS 146 also
establishes that the liability should initially be measured and recorded at
fair value. SFAS 146 is effective for exit and disposal

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| |  | activities initiated after December 31, 2002 and such adoption did not have a
material impact on the Companys consolidated results of operations and
financial position.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees and Indebtedness of Others.FIN 45 elaborates on the
disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also requires that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, while the provisions of the disclosure
requirements are effective for financial statements of interim or annual
reports ending after December 15, 2002. The Company adopted the disclosure
provisions of FIN 45 during the fourth quarter of fiscal 2002 and such adoption
did not have a material impact on its consolidated financial statements. The
Company adopted the recognition provisions of FIN 45 on January 1, 2003, and
such adoption did not have a material impact on its consolidated financial
statements.                                                                                                                                                                                                                                                                             
|
| |  | In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure (SFAS 148). SFAS 148 amends
Statement No. 123, Accounting for Stock-Based Compensation(SFAS 123), to
provide alternative methods for voluntary transition to SFAS 123s fair value
method of accounting for stock-based employee compensation. SFAS 148 also
requires disclosure of the effects of an entitys accounting policy with
respect to stock-based employee compensation on reported net income (loss) and
earnings (loss) per share in annual and interim financials statements. The
provisions of SFAS 148 are effective in fiscal years ending after December 15,
2002. The Company has evaluated the provisions of SFAS 148 and those
provisions did not have a material adverse impact on its consolidated financial
statements since the Company has not adopted the fair value method. See Note 1
to the Consolidated Financial Statements for calculation of pro forma net
income (loss).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities. In general, a variable interest entity is a corporation,
partnership, trust or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN 46 requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the variable interest entitys activities or entitled to receive a
majority of the entitys residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. With respect to variable interest entities created
before January 31, 2003, in December 2003 the FASB issued FIN 46R which, among
other things, revised the implementation date to first fiscal years or interim
periods ending after March 15, 2004, with the exception of Special Purpose
Entities (SPE). The consolidated requirements apply to all SPEs in the
first fiscal year or interim period ending after December 15, 2003. As the
Company has determined that it does not have any SPEs to which these
interpretations apply, the Company will adopt FIN46R in the first quarter of
2004. The Company does not believe that the adoption of FIN 46R will have a
material impact on its financial statements.
|
| |  | In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity(SFAS 150).
SFAS 150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both debt and equity and
requires an issuer to classify the following instruments as liabilities in its
balance sheet:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               



| |  |  | a financial instrument issued in the form of shares that is
mandatorily redeemable and embodies an unconditional obligation that
requires the issuer to redeem it by transferring its assets at a
specified or determinable date or upon an event that is certain to
occur;                                                                                                                                                                 
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | a financial instrument, other than an outstanding share, that
embodies an obligation to repurchase the issuers equity shares, or is
indexed to such an obligation, and required the issuer to settle the
obligation by transferring assets; and                                                                                                                                                                                            
|
| |  |  | a financial instrument that embodies an unconditional obligation
that the issuer must settle by issuing a variable number of its equity
shares if the monetary value of the obligation is based solely or
predominantly on (1) a fixed monetary amount, (2) variations in
something other than the fair value of the issuers equity shares, or
(3) variations inversely related to changes in the fair value of the
issuers equity shares.

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|   |  | In November 2003, the FASB issued FASB Staff Position (FSP) No. 150-3 which
deferred the effective dates for applying certain provisions of FSAS No. 150
related to mandatorily redeemable financial instruments of certain nonpublic
entities and certain mandatorily redeemable noncontrolling interests for public
and nonpublic entities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | For public entities, SFAS No. 150 is effective for mandatorily redeemable
financial instruments entered into or modified after May 31, 2003 and is
effective for all other financial instruments as of the first interim period
beginning after June 15, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | For mandatorily redeemable noncontrolling interests that would not have to be
classified as liabilities by a subsidiary under the exception in paragraph 9 of
SFAS No. 150, but would be classified as liabilities by the parent, the
classification and measurement provisions of SFAS No. 150 are deferred
indefinitely. For other mandatorily redeemable noncontrolling interests that
were issued before November 5, 2003, the measurement provisions of SFAS No. 150
are deferred indefinitely. For those instruments, the measurement guidance for
redeemable shares and noncontrolling interests in other literature shall apply
during the deferral period.                                                                                                                                                          
|  
|   |  | SFAS No. 150 is to be implemented by reporting and cumulative effect of a
change in accounting principle. The Company does not believe that the adoption
of SFAS No. 150 will have a material impact on its consolidated financial
statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | ReclassificationsCertain prior year amounts have been reclassified to
conform to the current year presentation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|2. |  | Goodwill and Other Intangible Assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|  
|   |  | SFAS 142 addresses the financial accounting and reporting requirements for
acquired goodwill and other intangible assets. The Company adopted the
provisions of SFAS 142 in January 2002. Under SFAS 142, the Company is no
longer required to amortize goodwill and other intangible assets with
indefinite lives. Instead, SFAS 142 requires that goodwill and intangible
assets deemed to have an indefinite useful life be reviewed for impairment upon
adoption of SFAS 142 and at least annually thereafter. Under SFAS 142,
goodwill impairment is deemed to exist if the net book value of a reporting
unit exceeds its estimated fair value. The Companys reporting units are
consistent with the operating segments underlying the reporting segments
identified in Note 9.  Operating Segments and Revenue Data.
|  
|   |  | In accordance with SFAS 142, the Company completed a test for impairment in
June 2002 and concluded that consolidated goodwill in the amount of $3,474,000
was impaired. The Company recorded a non-cash charge of $3,474,000 to reduce
the carrying value of its goodwill. Such charge is not included in operating
income and is reflected as a cumulative effect of a change in accounting
principle, effective January 1, 2002, in the accompanying Consolidated
Statements of Operations and Comprehensive Operations.                                                                                                                                                                                                                                                                                                  
|  
|   |  | The total impairment amount of $3,474,000 is attributable to the Companys
manufacturing and marketing operating segment, and represents the previously
unamortized goodwill resulting from the Companys purchase of substantially all
of the assets of Block Medical, Inc. on July 22, 1996, and the Companys
acquisition of all of the outstanding stock of Spinal Specialties, Inc. on
January 14, 2000. In calculating the impairment charge, the fair value of the
impaired reporting unit was estimated using a market multiple methodology. The
impairment of the goodwill associated with the manufacturing and marketing
operating segment resulted from the low profitability of the operating segment.                                                                                                          
|  
|   |  | The changes in carrying amount of goodwill by operating segment for the years
ended December 31, 2003 and 2002 are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|                                         |  |                   |            |         |  |       |           |  |  |   |            |  
|---------------------------------------- |  | ----------------- | ---------- | ------- |  | ----- | --------- |  |  | - | ---------- | -
|                                         |  | Manufacturing and |            |         |  |       |           |  |  |  
|                                         |  | Marketing         |            | Rentals |  | Total
|                                         |  |                   |            |         |  |      
|Balance as of January 1, 2002            |  | $                 | 3,474,000  |         |  | $     | 2,639,000 |  |  | $ | 6,113,000  |  
|Impairment loss                          |  |                   | (3,474,000 | )       |  |       |           |  |  |   | (3,474,000 | )
|                                         |  |                   |            |         |  |       |           |  |  |   |            |  
|Balance as of December 31,
2002 and 2003 |  |                   |           |         |  |       | 2,639,000 |  |  |   | 2,639,000  |  
|                                         |  |                   |            |         |  |       |           |  |  |   |            |  

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| |  | As of December 31, 2003, the remaining goodwill of $2,639,000 is attributable
to the Companys rentals operating segment and the Company has determined that
there was no impairment of this goodwill as of December 31, 2003.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The following schedule presents net income (loss) and per share amounts as if
the Company had adopted the non-amortization provisions of SFAS 142 effective
January 1, 2001.                                                  

|                                          |                                   |                       |         |                                  |   |      |            |       |   |   |           |      |         | 
|----------------------------------------- | --------------------------------- | --------------------- | ------- | -------------------------------- | - | ---- | ---------- | ----- | - | - | --------- | ---- | ------- | 
|                                          |                                   |                       |         | For the years ended December 31,
|                                          |                                   |                       |         |                                 
|                                          |                                   |                       |         | 2003                             |   | 2002 |            | 2001 
|                                          |                                   |                       |         |                                  |   |      |            |      
|Reported net income (loss)                |                                   | $                     | 457,000 |                                  |   | $    | (3,035,000 | )     |   | $ | 1,267,000 |     
|Add back:                                 |                                   |                       |         |                                  |   |      |            |       |   |   |           |     
|                                          |                                   | Goodwill amortization |         |                                  |  |      |            |       |  |   |           |      | 837,000 | 
|Less: Tax effect of goodwill
Amortization |                                   |                       |        |                                  |   |      |           |       |   |   | (162,000  | )   
|                                          |                                   |                       |         |                                  |   |      |            |       |   |   |           |     
|Adjusted net income (loss)                |                                   |                       | 457,000 |                                  |   |      | (3,035,000 | )     |   |   | 1,942,000 |     
|                                          |                                   |                       |         |                                  |   |      |            |       |   |   |           |     
|Basic earnings per share                  |                                   |                       |         |                                  |   |      |            |       |   |   |           |     
|                                          | Reported net income (loss)        |                       |         | 0.03                             |   |      |            | (0.20 | ) |   |           | 0.08 |        
|                                          | Goodwill amortization, net of tax |                       |         |                                 |   |      |            |      |   |   |           | 0.05 |        
|                                          |                                   |                       |         |                                  |   |      |            |       |   |   |           |     
|                                          | Adjusted net income (loss)        |                       | $       | 0.03                             |   |      | $          | (0.20 | ) |   | $         | 0.13 |        
|                                          |                                   |                       |         |                                  |   |      |            |       |   |   |           |     
|Diluted earnings per share                |                                   |                       |         |                                  |   |      |            |       |   |   |           |     
|                                          | Reported net income (loss)        |                       |         | 0.03                             |   |      |            | (0.19 | ) |   |           | 0.08 |        
|                                          | Goodwill amortization, net of tax |                       |         |                                 |   |      |            |      |   |   |           | 0.04 |        
|                                          |                                   |                       |         |                                  |   |      |            |       |   |   |           |     
|                                          | Adjusted net income               |                       | $       | 0.03                             |   |      | $          | (0.19 | ) |   | $         | 0.12 |        
|                                          |                                   |                       |         |                                  |   |      |            |       |   |   |           |     



| |  | Amortizable intangible assets in the accompanying consolidated balance sheets
are as follows:
| |  | ---------------------------------------------------------------------------------------------

|                 |  |                         |           |              |  |     |         |  |  |   |           | 
|---------------- |  | ----------------------- | --------- | ------------ |  | --- | ------- |  |  | - | --------- | 
|                 |  | As of December 31, 2003
|                 |  |                        
|                 |  | Carrying                |           | Accumulated  |  |     |         | 
|                 |  | Amount                  |           | Amortization |  | Net
|                 |  |                         |           |              |  |    
|Patents          |  | $                       | 1,960,000 |              |  | $   | 746,000 |  |  | $ | 1,214,000 | 
|Licensing Rights |  |                         | 150,000   |              |  |     | 150,000 |  |  |   |          | 
|                 |  |                         |           |              |  |     |         |  |  |   |           | 
|Total            |  | $                       | 2,110,000 |              |  | $   | 896,000 |  |  | $ | 1,214,000 | 
|                 |  |                         |           |              |  |     |         |  |  |   |           | 

|                 |  |                         |           |              |  |     |         |  |  |   |           | 
|---------------- |  | ----------------------- | --------- | ------------ |  | --- | ------- |  |  | - | --------- | 
|                 |  | As of December 31, 2002
|                 |  |                        
|                 |  | Carrying                |           | Accumulated  |  |     |         | 
|                 |  | Amount                  |           | Amortization |  | Net
|                 |  |                         |           |              |  |    
|Patents          |  | $                       | 1,817,000 |              |  | $   | 713,000 |  |  | $ | 1,104,000 | 
|Licensing Rights |  |                         | 150,000   |              |  |     | 120,000 |  |  |   | 30,000    | 
|                 |  |                         |           |              |  |     |         |  |  |   |           | 
|Total            |  | $                       | 1,967,000 |              |  | $   | 833,000 |  |  | $ | 1,134,000 | 
|                 |  |                         |           |              |  |     |         |  |  |   |           | 



| |  | The Company amortizes patents and licensing rights over a period of seven and
five years, respectively. Amortization expense was $299,000 and $256,000 for
the years ended December 31, 2003 and 2002, respectively. Annual
amortization expense of intangible assets recorded as of December 31, 2003 is
expected to be approximately $230,000 in each of the next five fiscal years.
During the fourth quarter of 2003, the Company determined that the carrying
value of certain patents related to the Companys electronic IV infusion pump
products, within the manufacturing and marketing operating segment, were
impaired. The write-down of the patents resulted in a charge of $90,000 to
product development expense in 2003.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|3. |  | Divesture of Spinal Specialties                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Company sold Spinal Specialties, Inc., a wholly owned subsidiary, on
November 1, 2003 to Integra LifeSciences Holdings Corporation for approximately
$6,000,000 in cash and net proceeds of approximately $5,000,000. Assets and
liabilities included in the sale consisted primarily of approximately $722,000
of accounts receivable, $1,155,000 of inventory, $400,000 of fixed assets, and
$313,000 of accounts payable and accrued liabilities. The Company recorded a
pretax gain on the sale of $2,999,000, a tax provision on the gain of $716,000,
and an after-tax gain of $2,283,000. The reported gain includes the
effect of a charge
of $327,000 related to the acceleration of vesting of certain stock options
upon the closing of the sale. This amount has been accounted for as an
increase in common stock.
|  
|   |  | The net income of Spinal Specialties prior to divestiture is presented in the
Companys Consolidated Statements of Operations and Comprehensive Operations as
income (loss) from discontinued operations, net of tax. Reported in income
(loss) from discontinued operations, net of tax, are net product sales from
Spinal Specialties of $3,795,000, $3,454,000 and $2,774,000 in 2003, 2002 and
2001, respectively, and income (loss) before taxes from Spinal Specialties of
$532,000, $42,000 and $(524,000) in 2003, 2002 and 2001,
respectively. Also reported in income (loss) from discontinued
operations, net of tax, is income
tax expense (benefit) of $204,000, $18,000 and $(211,000) for 2003,
2002, and 2001, respectively.                                                                                       
|  
|4. |  | Lines of Credit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|  
|   |  | The Company has a working capital line of credit with Silicon Valley Bank. The
line of credit facility expired in December 2003 and was renewed in January
2004. Under the terms of the original agreement, the Company could borrow up
to the lesser of $4,000,000 or the sum of 80% of eligible accounts receivable
plus 25% of eligible inventory, as defined, at the banks prime rate plus 0.50%
(a total rate of 4.5% at December 31, 2003). Under the terms of the renewed
agreement, the interest rate on the line of credit is the banks prime rate
(4.0% at December 31, 2003), and the borrowing limit remained unchanged. The
amended agreement expires on April 30, 2005. As of December 31, 2003, there
were no outstanding borrowings.                                                                             
|  
|   |  | The Company also had a term loan facility with Silicon Valley Bank that
provided for borrowings up to a maximum amount of $2,000,000 at the banks
prime rate plus 1.00%. There was no amount outstanding under the term loan as
of December 31, 2003. The term loan facility expired according to its terms in
December 2003 and was not renewed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  
|   |  | The Companys InfuSystem subsidiary has a revolving line of credit with a bank
under which it may borrow up to the lesser of $3,500,000 or 80% of eligible
accounts receivable, as defined, at the banks prime rate less 0.25% (3.75% at
December 31, 2003). There were no outstanding borrowings under the line of
credit as of December 31, 2003 and there were funds available for borrowing of
$3,500,000. The credit line expires June 30, 2004. In addition, InfuSystem
has a loan facility under which it may borrow up to $2,500,000 for the purchase
of equipment. As of December 31, 2003, there were no outstanding borrowings
under the loan facility.                                                                                                                                                                
|  
|   |  | The Companys lines of credit are collateralized by substantially all of the
Companys assets and require the Company to comply with certain covenants
principally relating to working capital and liquidity. As of December 31,
2003, the Company was in compliance with all such covenants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

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|5. |  | Stockholders Equity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Preferred Stock- As of December 31, 2003, the Company was authorized to issue
5,000,000 shares of preferred stock with a par value of $0.001 per share, in
one or more series. There were no shares of preferred stock issued and
outstanding as of December 31, 2003, 2002 or 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|  
|   |  | On March 8, 2002, in connection with the adoption of a Stockholder Rights Plan
(discussed below), the Company filed a Certificate of Designation with the
State of Delaware designating 300,000 shares of preferred stock as Series A
Junior Participating Cumulative Preferred Stock (the Series A Preferred
Stock). The Series A Preferred Stock is nonredeemable and, unless otherwise
provided, is subordinate to any other series of the Companys preferred stock.
A holder of a share of Series A Preferred Stock is entitled to receive when, as
and if declared, the greater of (i) cash and non-cash dividends in an amount
equal to 100 times the dividends declared on each share of common stock or (ii)
a preferential annual dividend of $1.00 per preferred share ($0.01 per one
one-hundredth (1/100) of a preferred share). Each share of Series A Preferred
Stock has one hundred (100) votes per share (one vote per one one-hundredth
(1/100) of a preferred share), voting together with the shares of common stock.
In the event of any merger, consolidation or other transaction in which shares
of common stock are exchanged, the holder of a share of Series A Preferred
Stock shall be entitled to receive 100 times the amount received per common
share. The rights of the Series A Preferred Stock as to dividends, voting and
liquidation preferences are protected by antidilution provisions.
|  
|   |  | Stockholder Rights Plan -On February 26, 2002, the Board of Directors of the
Company adopted a Stockholder Rights Plan (the Rights Plan). The Rights Plan
provides for a dividend of one right (a Right) to purchase fractions of
shares of the Companys Series A Preferred Stock for each share of the
Companys common stock. Under certain conditions involving an acquisition by
any person or group of 15% or more of the common stock, the Rights permit the
holders (other than the 15% holder) to purchase the Companys common stock at a
50% discount upon payment of an exercise price of $30 per Right. In addition,
in the event of certain business combinations, the Rights permit the purchase
of the common stock of an acquirer at a 50% discount. Under certain
conditions, the Rights may be redeemed by the Board of Directors in whole, but
not in part, at a price of $0.001 per Right. The Rights have no voting
privileges and are attached to and automatically trade with the Companys
common stock. The Rights shall expire on February 26, 2012, unless earlier
redeemed or exchanged, unless the distribution date has previously occurred and
the Rights have separated from the shares of common stock, in which case the
Rights will remain outstanding for 10 years from the date they separate.                                                                                          
|  
|   |  | Common Stock- In December 2001 the Board of Directors of the Company approved
a restricted stock plan (the 2001 Restricted Stock Plan) pursuant to which
employees of the Company may be offered the opportunity to acquire common stock
of the Company. Shares granted under the plan generally vest, and the
restrictions on the shares lapse, over a period of three years, subject to
possible acceleration of vesting based upon the achievement of individual
performance goals. A total of 125,000 shares were authorized for issuance
under the 2001 Restricted Stock Plan. As of December 31, 2001, no shares were
issued under the 2001 Restricted Stock Plan. As of December 31, 2002, 73,500
shares were issued and outstanding under the 2001 Restricted Stock Plan, of
which 3,000 were vested. Compensation expense of $32,000 related to such
shares was recognized in 2002. As of December 31, 2003, 64,000 shares were
issued and outstanding under the plan of which 52,000 were vested (3,000 vested
in 2002 and 49,000 vested in 2003). Compensation expense of $83,000 related to
such shares was recognized in 2003. In 2003, the Board of Directors decided to
terminate all future grants under the 2001 Restricted Stock Plan. As of
December 31, 2003, deferred compensation expense related to the unvested shares
was approximately $12,000.                                                       
|  
|   |  | On May 29, 2003, the Board of Directors of the Company approved a new
restricted stock plan (the 2003 Restricted Stock Plan) pursuant to which
employees of the Company may be offered the opportunity to acquire                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

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| |  | common stock of the Company. Shares granted under the 2003 Restricted Stock
Plan generally vest, and the restrictions on the shares lapse, over a period of
three years, subject to possible acceleration of vesting based upon the
achievement of individual performance goals. The Board of Directors authorized
a total of 250,000 shares for issuance under the 2003 Restricted Stock Plan.
In July 2003, the Company issued 91,000 shares of restricted stock under the
2003 Restricted Stock Plan. As of December 31, 2003, 83,000 shares were issued
and outstanding under the plan (30,000 vested during 2003 and 167,000 shares
remained available for future issuances). Compensation expense of $276,000
related to such shares was recognized in 2003. As of December 31, 2003,
deferred compensation expense related to the unvested shares as of December 31,
2003 was approximately $311,000.                                                                                                                                                                                                                                                                                                    
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | In a private placement transaction completed on September 4, 2003, the Company
sold 1,666,740 shares of its common stock at $7.50 per share for net proceeds
to the Company of $11,563,000. Gross proceeds from the transaction were
$12,500,550. The Company also granted warrants entitling the stockholders that
participated in this private placement transaction to purchase up to 250,011
additional shares of common stock at an exercise price of $10.00 per share.
The warrants are exercisable for a period of five years. (See discussion
below).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Stock Options and Warrants- In connection with the sale of common stock in the
private placement transaction completed on September 4, 2003, the Company
granted the investors warrants to purchase up to 250,011 shares of common stock
at an exercise price of $10.00 per share. The estimated fair value of these
warrants on the grant date was $1,272,000 as calculated using the Black-Scholes
pricing model. These warrants are immediately exercisable and expire five
years from the date of grant. All of these warrants remain outstanding as of
December 31, 2003. The following weighted average assumptions were used to
calculate the fair value of these warrants using the Black-Scholes pricing
model: contractual life of five years; stock volatility of 87%; risk-free
interest rate of 2.73%; and no dividends during the term. The fair value of
the warrants is included in common stock in the accompanying balance sheet.                                                                                                                                                                                                                                                             
|
| |  | In May 2003 and in connection with an amendment to its existing line of credit
agreement, the Company granted warrants to a financial institution to purchase
15,625 shares of the Companys common stock at an exercise price of $3.84 per
share. The estimated fair value of these warrants on the grant date was
$42,000 as calculated using the Black-Scholes pricing model. These warrants
were immediately exercisable and expire seven years from the date of grant.
The following weighted average assumptions were used to calculate the fair
value of these warrants using the Black-Scholes pricing model: contractual life
of seven years, stock volatility of 75%, risk-free interest rate of 2.73%, and
no dividends during the term. The estimated fair value of these warrants of
$42,000 was recorded as interest expense over the term of the amended line of
credit agreement and is included in common stock in the accompanying
balance sheet. As of December 31, 2003, all of these warrants had been
exercised.                                                                                                                                                                          
|
| |  | The Company had a stock option plan approved by the shareholders in 1992 which
provided for the granting of options to non-employee directors (the 1992
Director Plan) to purchase up to 400,000 shares of the Companys common stock
at exercise prices not less than the fair market value of the Companys common
stock at the date of grant. Under the terms of the plan, options to purchase
10,000 shares of the Companys common stock were to be granted to each
non-employee director serving in such capacity as of the first business day of
January of each year as long as the plan remains in existence. Options granted
became exercisable in four equal installments, with one installment occurring
at the end of each calendar quarter subsequent to the date of grant. The
options expire at the earlier of five years from the date of grant or two years
after termination of the option holders status as a director. The 1992
Director Plan was terminated on May 23, 2002. Options granted under the 1992
Director Plan which were currently outstanding as of the date of plan
termination were unaffected by the plan termination and continued to vest under
their original terms.
|
| |  | In May 1996, the shareholders of the Company approved an equity incentive plan
(the 1996 Plan) which provided for the grant of stock options (including
incentive stock options or nonqualified stock options) and other stock-based
benefits to directors, officers, employees, consultants and advisors of the
Company and its affiliated entities. The maximum number of shares of common
stock which may be the subject of awards granted under the 1996 Plan could not
exceed 2,500,000 shares in the aggregate, subject to adjustments for stock
splits or other adjustments. Options granted become exercisable at such times
as determined by the Compensation Committee of the Board of Directors and
expired on various dates up to 10 years from the date of grant. The 1996 Plan
was terminated on May                                                                                                                                                                                                                                                                                                                                                                                            

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| |  | 17, 2001 concurrent with the shareholder approval of the I-Flow Corporation
2001 Equity Incentive Plan (the 2001 Plan). Options granted under the 1996
Plan that were outstanding as of the date of plan termination were unaffected
by the plan termination and continued to vest under their original terms.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | On May 17, 2001, the shareholders of the Company approved the I-Flow
Corporation 2001 Equity Incentive Plan (the 2001 Plan) which provides for the
grant of stock options (including incentive stock options or nonqualified stock
options), restricted stock, and other stock-based benefits to officers,
employees, consultants and advisors of the Company and its affiliated entities.
The 2001 Plan was amended on May 23, 2002 to make non-employee directors
eligible for grants under the plan. The maximum number of shares of Common
Stock which may be the subject of awards granted under the 2001 Plan, as
amended, may not exceed 3,000,000 shares in the aggregate, subject to
adjustments for stock splits or other adjustments as defined. Options granted
become exercisable at such times as determined by the Compensation Committee of
the Board of Directors and expire on various dates up to 10 years from the date
of grant.                                                                                                                       
|
| |  | Prior to the approval of the 2001 Plan, the Company issued options under the
1996 Plan to purchase an aggregate of 651,336 shares of its common stock to
certain key employees at exercise prices below fair market value at the date of
grant as deferred compensation for services rendered. In addition, as of
December 31, 2003 the Company has issued options under the 2001 Plan to
purchase an aggregate of 91,702 shares of its common stock to certain key
employees at exercise prices below fair market value at the date of grant as
deferred compensation. Compensation expense related to stock options and
restricted stock, including stock options granted to non-employees as discussed
below, aggregating $1,268,000, $752,000 and $633,000 has been recorded for each
of the years ended December 31, 2003, 2002 and 2001, respectively. As of
December 31, 2003, the remaining deferred compensation expense related to
unvested stock options was approximately $400,000 and will be amortized as the
related awards are earned and vested through 2007.



| |  | During fiscal year 2001, the Company granted options to non-employees to
purchase 15,000 shares of the Companys common stock in connection with
consulting services. These options have exercise prices equal to the fair
market value of the underlying shares at the date of grant and vest over one
year. The fair value of these options was determined using the Black-Scholes
Pricing Model with the following weighted-average assumptions: expected life,
contractual life of 5 years; 90% stock volatility; average risk-free interest
rate of 4.75%; and no dividends during the expected term.                                                                                                                                                                                                                                                                                                                 
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | During fiscal year 2003 and 2002, the Company granted options to non-employees
to purchase 22,000 and 48,600 shares of the Companys common stock,
respectively, in connection with consulting services. These options have
exercise prices equal to the fair market value of the underlying shares at the
date of grant and vest over one to five years. Of these options, 67,000 have
been accounted for as a variable award as the consultants performance was not
complete, and a performance commitment date had not been satisfied in
accordance with the provisions of EITF No. 96-18. During fiscal year 2003 and
2002, the Company recorded stock based compensation of $182,000 and $31,000,
respectively, related to these options calculated using the Black-Scholes
pricing model with the following weighted-average assumptions: expected life,
contractual life of 5 years; 79% volatility in 2003 and 94%

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| |  | volatility in 2002; average risk-free interest rate of 2.73% in 2003 and 3.04%
in 2002; and no dividends during the expected term.                                                                                                                              
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Stock-based compensation expense recognized in each of the years ended December
31, 2003, 2002 and 2001 related to stock options granted to employees, stock
options granted to consultants, and restricted stock granted to employees is
summarized as follows:

|                                                    |  |      |           |      |  |      |         |  |  |   |         | 
|--------------------------------------------------- |  | ---- | --------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                                                    |  | 2003 |           | 2002 |  | 2001
|                                                    |  |      |           |      |  |     
|Options to Employees                                |  | $    | 400,000   |      |  | $    | 689,000 |  |  | $ | 565,000 | 
|Options to Consultants                              |  |      | 182,000   |      |  |      | 31,000  |  |  |   | 68,000  | 
|Restricted Stock                                    |  |      | 359,000   |      |  |      | 32,000  |  |  |   | 0       | 
|Employee
Options Related to Discontinued Operations |  |      | 327,000   |      |  |      | 0       |  |  |   | 0       | 
|                                                    |  |      |           |      |  |      |         |  |  |   |         | 
|Total                                               |  | $    | 1,268,000 |      |  | $    | 752,000 |  |  | $ | 633,000 | 
|                                                    |  |      |           |      |  |      |         |  |  |   |         | 



| |  | Stock option activity for all plans is summarized as follows:
| |  | -------------------------------------------------------------

|                                                                                        |                                                          |  |           |            |          |   |           |      | 
|--------------------------------------------------------------------------------------- | -------------------------------------------------------- |  | --------- | ---------- | -------- | - | --------- | ---- | 
|                                                                                        |                                                          |  |           |            |          |   | Weighted-
|                                                                                        |                                                          |  |           |            |          |   | Average  
|                                                                                        |                                                          |  | Number of |            | Exercise
|                                                                                        |                                                          |  | Shares    |            | Price   
|                                                                                        |                                                          |  |           |            |         
|Balance, January 1, 2001 (2,140,504 exercisable at a weighted-average price of $2.31)   |                                                          |  | 3,503,093 |            |          |   | 2.49      |     
|                                                                                        | Granted (weighted-average fair value of $1.21 per share) |  |           | 1,402,629  |          |   |           | 1.43 | 
|                                                                                        | Canceled/Expired                                         |  |           | (356,784   | )        |   |           | 2.33 | 
|                                                                                        | Exercised                                                |  |           | (292,621   | )        |   |           | 2.04 | 
|                                                                                        |                                                          |  |           |            |          |   |           |     
|Balance, December 31, 2001 (2,397,074 exercisable at a weighted-average price of $2.34) |                                                          |  | 4,256,317 |            |          | $ | 2.18      |     
|                                                                                        | Granted (weighted-average fair value of $2.01 per share) |  |           | 976,302    |          |   | $         | 2.32 | 
|                                                                                        | Canceled/Expired                                         |  |           | (673,610   | )        |   | $         | 2.45 | 
|                                                                                        | Exercised                                                |  |           | (55,088    | )        |   | $         | 1.79 | 
|                                                                                        |                                                          |  |           |            |          |   |           |     
|Balance, December 31, 2002 (2,611,385 exercisable at a weighted-average price of $2.31) |                                                          |  | 4,503,921 |            |          | $ | 2.19      |     
|                                                                                        | Granted (weighted-average fair value of $4.50 per share) |  |           | 527,000    |          |   | $         | 6.02 | 
|                                                                                        | Canceled/Expired                                         |  |           | (711,069   | )        |   | $         | 2.63 | 
|                                                                                        | Exercised                                                |  |           | (1,082,440 | )        |   | $         | 2.02 | 
|                                                                                        |                                                          |  |           |            |          |   |           |     
|Balance, December 31, 2003 (1,680,888 exercisable at a weighted-average price of $2.25) |                                                          |  | 3,237,412 |            |          | $ | 2.77      |     
|                                                                                        |                                                          |  |           |            |          |   |           |     



| |  | Options to purchase 1,667,743 shares of the Companys Common Stock were
available for grant under the 2001 Plan as of December 31, 2002.   
| |  | -------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The following table summarizes information concerning outstanding and
exercisable options for all plans and grants as of December 31, 2003:

|                         |  |                     |           |                     |  |                |      |             |  |          |       |  |  |  |           |           |  |   |      | 
|------------------------ |  | ------------------- | --------- | ------------------- |  | -------------- | ---- | ----------- |  | -------- | ----- |  |  |  | --------- | --------- |  | - | ---- | 
|                         |  | Options Outstanding |           | Options Exercisable
|                         |  |                     |           |                    
|                         |  |                     |           |                     |  | Weighted-      |      |             |  |          |       |  |  |  |           |           |  |  
|                         |  |                     |           |                     |  | Average        |      |             |  |          |       |  |  |  |           | Weighted-
|                         |  | Number              |           | Remaining           |  | Weighted-      |      | Number      |  | Average 
|                         |  | Of Shares           |           | Contractual         |  | Average        |      | Of Shares   |  | Exercise
|Range of Exercise Prices |  | Outstanding         |           | Life in Years       |  | Exercise Price |      | Exercisable |  | Price   
|                         |  |                     |           |                     |  |                |      |             |  |         
|$1.04 - $1.04            |  |                     | 120,000   |                     |  |                | 5.00 |             |  | $        | 1.04  |  |  |  | 120,000   |           |  | $ | 1.04 | 
|$1.12 - $1.28            |  |                     | 769,450   |                     |  |                | 3.49 |             |  | $        | 1.27  |  |  |  | 278,232   |           |  | $ | 1.28 | 
|$1.33 - $1.75            |  |                     | 489,464   |                     |  |                | 2.93 |             |  | $        | 1.46  |  |  |  | 225,175   |           |  | $ | 1.54 | 
|$1.76 - $2.44            |  |                     | 212,037   |                     |  |                | 1.80 |             |  | $        | 1.94  |  |  |  | 169,895   |           |  | $ | 1.92 | 
|$2.47 - $2.47            |  |                     | 526,768   |                     |  |                | 3.01 |             |  | $        | 2.47  |  |  |  | 176,208   |           |  | $ | 2.47 | 
|$2.50 - $3.37            |  |                     | 851,948   |                     |  |                | 3.32 |             |  | $        | 3.05  |  |  |  | 673,643   |           |  | $ | 3.04 | 
|$3.52 - $14.99           |  |                     | 267,745   |                     |  |                | 4.11 |             |  | $        | 10.62 |  |  |  | 37,735    |           |  | $ | 3.96 | 
|                         |  |                     |           |                     |  |                |      |             |  |          |       |  |  |  |           |           |  |   |      | 
|Total                    |  |                     | 3,237,412 |                     |  |                | 3.28 |             |  | $        | 2.77  |  |  |  | 1,680,888 |           |  | $ | 2.25 | 
|                         |  |                     |           |                     |  |                |      |             |  |          |       |  |  |  |           |           |  |   |      | 

F-17



---



##### Table of Contents





|6. |  | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                           
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Company accounts for income taxes under the provisions of SFAS No. 109
Accounting for Income Taxes. Under this method, deferred tax assets and
liabilities are established for temporary differences between the financial
reporting basis and the tax basis of the Companys assets and liabilities at
tax rates expected to be in effect when such assets or liabilities are realized
or settled.
|  
|   |  | The income tax provision (benefit) for the years ended December 31, 2003, 2002
and 2001 is summarized as follows:                                                                                                                                                                                                                                                                                      

|                                     |  |                          |            |      |  |      |          |   |  |   |           | 
|------------------------------------ |  | ------------------------ | ---------- | ---- |  | ---- | -------- | - |  | - | --------- | 
|                                     |  | Years Ended December 31,
|                                     |  |                         
|                                     |  | 2003                     |            | 2002 |  | 2001
|                                     |  |                          |            |      |  |     
|Current:                             |  |                          |            |      |  |      |          |   |  |   |           | 
|Federal                              |  | $                        |           |      |  | $    |         |   |  | $ | 414,000   | 
|State                                |  |                          | 84,000     |      |  |      | 70,000   |   |  |   | 80,000    | 
|                                     |  |                          |            |      |  |      |          |   |  |   |           | 
|                                     |  |                          | 84,000     |      |  |      | 70,000   |   |  |   | 494,000   | 
|Deferred:                            |  |                          |            |      |  |      |          |   |  |   |           | 
|Federal                              |  |                          | (1,161,000 | )    |  |      | 462,000  |   |  |   | 545,000   | 
|State                                |  |                          | (96,000    | )    |  |      | (227,000 | ) |  |   | 28,000    | 
|                                     |  |                          |            |      |  |      |          |   |  |   |           | 
|Subtotal                             |  |                          | (1,257,000 | )    |  |      | 235,000  |   |  |   | 573,000   | 
|Total income tax (benefit) provision |  | $                        | (1,173,000 | )    |  | $    | 305,000  |   |  | $ | 1,067,000 | 
|                                     |  |                          |            |      |  |      |          |   |  |   |           | 



| |  | The change in the net deferred tax
assets in 2003 includes the deferred income tax benefit of $1,257,000
and the tax benefit from the exercise of stock options of $2,000,000
offset by approximately $950,000 related to discontinued operations.                                                                                                                          
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | A deferred tax asset in the amount of $465,000 was acquired in conjunction with
the acquisition of InfuSystem II, Inc. and Venture Medical, Inc. in 1998. A
valuation allowance of $465,000 was established for the deferred tax asset. If
this deferred tax asset is realized, the benefit will first go to reduce any
unamortized goodwill remaining from the acquisition.
|
| |  | The reconciliations of the effective income tax rate to the federal statutory
rate of 35% are as follows:                                                                                                                                                                                                                                                                   

|      |                                            |  |                          |       |      |  |      |      |    |  |      |      |   
|----- | ------------------------------------------ |  | ------------------------ | ----- | ---- |  | ---- | ---- | -- |  | ---- | ---- | --
|      |                                            |  | Years Ended December 31,
|      |                                            |  |                         
|      |                                            |  | 2003                     |       | 2002 |  | 2001
|      |                                            |  |                          |       |      |  |     
|      | Tax at federal statutory rate              |  |                          | (35.0 | %)   |  |      | 35.0 | %  |  |      | 35.0 | % 
|      | State income taxes, net of federal benefit |  |                          | (2.5  | %)   |  |      | 11.3 | %  |  |      | 5.5  | % 
|      | Foreign operations                         |  |                          | (1.2  | %)   |  |      | (5.0 | %) |  |      | (2.3 | %)
|      | Research credit                            |  |                          | (1.4  | %)   |  |      | (4.1 | %) |  |      | (5.0 | %)
|      | Goodwill amortization                      |  |                          | 0.0   | %    |  |      | 0.0  | %  |  |      | 7.3  | % 
|      | Nondeductible charges                      |  |                          | 3.7   | %    |  |      | 5.4  | %  |  |      | 0.5  | % 
|      | Other                                      |  |                          | 1.1   | %    |  |      | (0.2 | %) |  |      | (0.7 | %)
|      |                                            |  |                          |       |      |  |      |      |    |  |      |      |   
|Total |                                            |  | (35.3                    | %)    |      |  | 42.4 | %    |    |  | 40.3 | %   
|      |                                            |  |                          |       |      |  |      |      |    |  |      |      |   

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##### Table of Contents





| |  | As of December 31, 2003 and 2002, the Company had net deferred tax assets
comprised of the following:
| |  | -----------------------------------------------------------------------------------------------------

|                                               |  |              |            |      |  |   |            |  
|---------------------------------------------- |  | ------------ | ---------- | ---- |  | - | ---------- | -
|                                               |  | December 31,
|                                               |  |             
|Deferred Tax Assets:                           |  | 2003         |            | 2002
|                                               |  |              |            |     
|Net operating losses                           |  | $            | 3,517,000  |      |  | $ | 1,409,000  |  
|Amortization of goodwill and other intangibles |  |              | 2,645,000  |      |  |   | 2,815,000  |  
|Reserves not currently deductible              |  |              | 3,138,000  |      |  |   | 2,514,000  |  
|State taxes                                    |  |              | (388,000   | )    |  |   | (326,000   | )
|Credits                                        |  |              | 1,052,000  |      |  |   | 978,000    |  
|Depreciation                                   |  |              | (407,000   | )    |  |   | (140,000   | )
|                                               |  |              |            |      |  |   |            |  
|Total deferred income taxes                    |  |              | 9,557,000  |      |  |   | 7,250,000  |  
|Valuation allowance                            |  |              | (3,449,000 | )    |  |   | (3,449,000 | )
|                                               |  |              |            |      |  |   |            |  
|Net deferred income taxes                      |  | $            | 6,108,000  |      |  | $ | 3,801,000  |  
|                                               |  |              |            |      |  |   |            |  



|   |  | At December 31, 2003, the Company had federal and state net operating loss
carryforwards of approximately $9,758,000 and $3,137,000, respectively, which
begin to expire in the year 2006. Due to certain tax regulations, future use
of a portion of the federal net operating loss carryforwards is limited to
approximately $600,000 per year. Tax credits for federal and state taxes of
approximately $776,000 and $276,000, respectively, begin to expire in 2007.                                                                                                                                                                                                                                                                                                                         
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The net deferred tax assets of December 31, 2003 were offset by a valuation
allowance of $3,449,000. As of December 31, 2003, the future realization of
the reserved portion of the net deferred tax assets was determined by
management to be unlikely, based upon current and projected taxable income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|7. |  | Commitments and Contingencies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|  
|   |  | In July 1997, the Company entered into a noncancelable-operating lease for a
51,000 square foot building for its primary facility. The lease agreement
contains certain scheduled rent increases (which are accounted for on a
straight-line basis) and expires in June 2007. There is an option to extend
the lease for an additional five years, which the Company currently intends to
exercise. In January 2000, the Company entered into a noncancelable-operating
lease for a facility in Tijuana, Mexico. The lease expires in December 2005.
Additionally, the Companys Infusystem subsidiary entered into leases in July
2002 for 8,120 square feet of general office space and 3,000 square feet of
warehouse space in Madison Heights, Michigan. Each lease has a term of five
years.
|  
|   |  | Future minimum lease payments under these leases are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

|                         |  |   |           | 
|------------------------ |  | - | --------- | 
|Years Ended December 31, |  |  
|                         |  |  
|2004                     |  | $ | 699,000   | 
|2005                     |  |   | 570,000   | 
|2006                     |  |   | 574,000   | 
|2007                     |  |   | 502,000   | 
|2008                     |  |   | 428,000   | 
|Thereafter               |  |   | 1,499,000 | 
|                         |  |   |           | 
|Total                    |  | $ | 4,272,000 | 
|                         |  |   |           | 



| |  | Rent expense for the years ended December 31, 2003, 2002 and 2001 was $833,000,
$844,000 and $629,000, respectively.
| |  | --------------------------------------------------------------------------------------------------------------------

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##### Table of Contents





|   |  | The Company is involved in litigation arising from the normal course of
operations. In the opinion of management, the ultimate impact of such
litigation will not have a material adverse effect on the Companys financial
position and results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Company from time to time enters into certain types of contracts that
contingently require the Company to indemnify parties against third party
claims. These contracts primarily relate to: (i) divestiture and acquisition
agreements, under which the Company may provide customary indemnifications to
either (a) purchasers of the Companys businesses or assets; or (b) entities
from whom the Company is acquiring assets or businesses; (ii) certain real
estate leases, under which the Company may be required to indemnify property
owners for environmental and other liabilities, and other claims arising from
the Companys use of the applicable premises; (iii) certain agreements with the
Companys officers, directors and employees, under which the Company may be
required to indemnify such persons for liabilities arising out of their
relationship with the Company; and (iv) Company license, consulting,
distribution and purchase agreements with its customers and other parties,
under which the Company may be required to indemnify such parties for
intellectual property infringement claims, product liability claims, and other
claims arising from the Companys provision of products or services to such
parties.
|  
|   |  | The terms of such obligations vary. A maximum obligation arising out of these
types of agreements is not explicitly stated and, therefore, the overall
maximum amount of these obligations cannot be reasonably estimated.
Historically, the Company has not been obligated to make significant payments
for these obligations and, thus, no liabilities have been recorded for these
obligations on its balance sheets as of December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|8. |  | Employee Benefit Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|  
|   |  | The Company has a 401(k) retirement plan in which any full time employee may
participate. The Company contributes $0.33 for each dollar of employee
contribution up to a maximum employer contribution of 1.32% of participants
annual salaries. The maximum employer contribution at 1.32% corresponds to an
employee contribution of 4% of annual salary. Such contributions totaled
$86,000, $102,000 and $88,000 for the years ended December 31, 2003, 2002, and
2001, respectively. The Company does not provide post-retirement benefits to
its employees.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|9. |  | Operating Segments and Revenue Data                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  
|   |  | The Company operates in two reportable operating segments: the manufacturing
and marketing of medical infusion pumps (the Manufacturing and Marketing
operating segment), and the rental and third party insurance billing of
electronic medical infusion pumps that are manufactured by companies other than
I-Flow Corporation (the Rentals operating segment). The Rentals operating
segment principally consists of the activities of InfuSystem, Inc. within the
Oncology Infusion Services market segment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  
|   |  | Management has chosen to organize the enterprise around differences in products
and services, which is the level at which the Companys chief operating
decision maker regularly reviews operating results to make decisions about
resource allocation and segment performance. The products within the
Manufacturing and Marketing operating segment are predominately assembled from
common subassembly components in an integrated manufacturing facility. The
Company believes it is most meaningful for the purposes of revenue analyses,
however, to group the product lines within the Manufacturing and Marketing
operating segment into two categories representing specific clinical
applications  IV Infusion Therapy and Regional Anesthesia. Revenues from
sales of IV Infusion Therapy products in 2003, 2002 and 2001 were $17,909,000,
$15,788,000 and $14,701,000, respectively. Revenues from sales of Regional
Anesthesia products in 2003, 2002 and 2001 were $16,112,000, $8,582,000 and
$5,467,000, respectively.                                                                                                                                                                                                                       

F-20



---



##### Table of Contents





| |  | The accounting policies of the two operating segments are the same as those
described in the summary of significant accounting policies (Note 1).
Operating segment information is as follows for the years ended December 31,
2003, 2002 and 2001:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                              |  |                   |            |         |  |              |            |  |  |   |            |  
|----------------------------- |  | ----------------- | ---------- | ------- |  | ------------ | ---------- |  |  | - | ---------- | -
|                              |  | Manufacturing and |            |         |  |              |            |  |  |  
|                              |  | Marketing         |            | Rentals |  | Consolidated
|                              |  |                   |            |         |  |             
|2003:                         |  |                   |            |         |  |              |            |  |  |   |            |  
|Revenues                      |  | $                 | 34,021,000 |         |  | $            | 13,022,000 |  |  | $ | 47,043,000 |  
|Operating
income (loss)       |  |                   | (5,404,000 | )       |  |              | 2,123,000  |  |  |   | (3,281,000 | )
|Assets                        |  |                   | 41,026,000 |         |  |              | 10,870,000 |  |  |   | 51,896,000 |  
|Depreciation and amortization |  |                   | 1,305,000  |         |  |              | 1,208,000  |  |  |   | 2,513,000  |  
|Property additions            |  |                   | 1,135,000  |         |  |              | 2,536,000  |  |  |   | 3,671,000  |  
|                              |  |                   |            |         |  |              |            |  |  |   |            |  
|2002:                         |  |                   |            |         |  |              |            |  |  |   |            |  
|Revenues                      |  | $                 | 24,370,000 |         |  | $            | 10,293,000 |  |  | $ | 34,663,000 |  
|Operating
income (loss)       |  |                   | (1,600,000 | )       |  |              | 2,314,000  |  |  |   | 714,000    |  
|Assets                        |  |                   | 21,778,000 |         |  |              | 11,283,000 |  |  |   | 33,061,000 |  
|Depreciation and amortization |  |                   | 1,069,000  |         |  |              | 951,000    |  |  |   | 2,020,000  |  
|Property additions            |  |                   | 1,648,000  |         |  |              | 986,000    |  |  |   | 2,634,000  |  
|                              |  |                   |            |         |  |              |            |  |  |   |            |  
|2001:                         |  |                   |            |         |  |              |            |  |  |   |            |  
|Revenues                      |  | $                 | 20,168,000 |         |  | $            | 10,363,000 |  |  | $ | 30,531,000 |  
|Operating income              |  |                   | 598,000    |         |  |              | 2,093,000  |  |  |   | 2,691,000  |  
|Assets                        |  |                   | 24,458,000 |         |  |              | 11,246,000 |  |  |   | 35,704,000 |  
|Depreciation and amortization |  |                   | 1,238,000  |         |  |              | 1,167,000  |  |  |   | 2,405,000  |  
|Property additions            |  |                   | 868,000    |         |  |              | 818,000    |  |  |   | 1,686,000  |  
|                              |  |                   |            |         |  |              |            |  |  |   |            |  



| |  | The Company had a major customer which accounted for 10%, 12%, and 9% of total
revenues for the years ended December 31, 2003, 2002, and 2001, respectively.                                                                            
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | All of the Companys rental revenue is domestic. Export sales of medical
products represented 20%, 26% and 24% of total revenue during 2003, 2002 and
2001, respectively. Total revenue by geographical region is summarized as
follows:

|                                 |  |      |            |      |  |      |            |  |  |   |            | 
|-------------------------------- |  | ---- | ---------- | ---- |  | ---- | ---------- |  |  | - | ---------- | 
|Sales to unaffiliated customers: |  | 2003 |            | 2002 |  | 2001
|                                 |  |      |            |      |  |     
|United States                    |  | $    | 37,503,000 |      |  | $    | 25,697,000 |  |  | $ | 23,116,000 | 
|Europe                           |  |      | 7,588,000  |      |  |      | 7,202,000  |  |  |   | 5,897,000  | 
|Asia / Pacific Rim               |  |      | 969,000    |      |  |      | 1,095,000  |  |  |   | 987,000    | 
|Other                            |  |      | 983,000    |      |  |      | 669,000    |  |  |   | 531,000    | 
|                                 |  |      |            |      |  |      |            |  |  |   |            | 
|Total                            |  | $    | 47,043,000 |      |  | $    | 34,663,000 |  |  | $ | 30,531,000 | 
|                                 |  |      |            |      |  |      |            |  |  |   |            | 



|10. |  | Related Party Transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | During June 2001, the Company loaned its chief executive officer $150,000 for
personal use. The unsecured note receivable due from the chief executive
officer bears interest at 5.58% per annum and is to be repaid over a 10 year
period through bi-weekly payroll deductions. As of December 31, 2003, the
amount due to the Company under the note receivable is approximately $120,000,
the majority of which is included in other long-term assets in the accompanying
consolidated balance sheets.

F-21



---



##### Table of Contents






SIGNATURES

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

|       |  |                |  |     |  |                                                
|------ |  | -------------- |  | --- |  | -----------------------------------------------
|       |  |                |  |     |  | I-FLOW CORPORATION                             
|       |  |                |  |     |  |                                                
|Dated: |  | March 15, 2004 |  | By: |  | /s/Donald M. Earhart                           
|       |  |                |  |     |  |                                                
|       |  |                |  |     |  | Donald M. Earhart                              
|       |  |                |  |     |  | Chairman, President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on March 9, 2004 on
behalf of the registrant and in the capacities indicated.

|                                                     |  |                                                                                   
|---------------------------------------------------- |  | ----------------------------------------------------------------------------------
|Signature                                            |  | Title                                                                             
|                                                     |  |                                                                                   
|/s/Donald M. Earhart

Donald M. Earhart              |  | Chairman, President and Chief Executive Officer
(Principal Executive Officer)     
|                                                     |  |                                                                                   
|/s/James J. Dal Porto

James J. Dal Porto            |  | Executive Vice President, Chief Operating
Officer, Director and Secretary         
|                                                     |  |                                                                                   
|/s/James R. Talevich

James R. Talevich              |  | Chief Financial Officer and Treasurer (Principal Financial and
Accounting Officer)
|                                                     |  |                                                                                   
|/s/John H. Abeles

John H. Abeles, M.D.              |  | Director                                                                          
|                                                     |  |                                                                                   
|/s/Jack H. Halperin

Jack H. Halperin                |  | Director                                                                          
|                                                     |  |                                                                                   
|/s/Joel S. Kanter

Joel S. Kanter                    |  | Director                                                                          
|                                                     |  |                                                                                   
|/s/Erik H. Loudon

Erik H. Loudon                    |  | Director                                                                          
|                                                     |  |                                                                                   
|/s/Henry Tsutomu Tai

Henry Tsutomu Tai, Ph.D., M.D. |  | Director                                                                          





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##### Table of Contents






INDEX TO EXHIBITS

|            |  |                                                                                                                                                                                                                                                                           
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Exhibit                                                                                                                                                                                                                                                                   
|            |  |                                                                                                                                                                                                                                                                           
|2.1         |  | Stock Purchase Agreement, dated October 28, 2003, 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)                                                                                                                  
|            |  |                                                                                                                                                                                                                                                                           
|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 (20)                                                                                                                                                                                                                                    
|            |  |                                                                                                                                                                                                                                                                           
|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)                                                                                                                                                                                                        
|            |  |                                                                                                                                                                                                                                                                           
|10.1        |  | Form of Securities Purchase Agreement, dated September 2, 2003 (1)                                                                                                                                                                                                        
|            |  |                                                                                                                                                                                                                                                                           
|10.2        |  | I-Flow Corporation Amended and Restated 2001 Equity Incentive Plan (11)*                                                                                                                                                                                                  
|            |  |                                                                                                                                                                                                                                                                           
|10.3        |  | 2003 Restricted Stock Plan of I-Flow Corporation (10)*                                                                                                                                                                                                                    
|            |  |                                                                                                                                                                                                                                                                           
|10.4        |  | 2001 Restricted Stock Plan of I-Flow Corporation (12)*                                                                                                                                                                                                                    
|            |  |                                                                                                                                                                                                                                                                           
|10.5        |  | 1996 Stock Incentive Plan (13)*                                                                                                                                                                                                                                           
|            |  |                                                                                                                                                                                                                                                                           
|10.6        |  | 1992 Non-Employee Director Stock Option Plan (14)*                                                                                                                                                                                                                        
|            |  |                                                                                                                                                                                                                                                                           
|10.7        |  | 1987-1988 Incentive Stock Option Plan and Non-Statutory Stock Option Plan, restated as of March 23, 1992 (15)*                                                                                                                                                            
|            |  |                                                                                                                                                                                                                                                                           
|10.8        |  | License and Transfer Agreement with SoloPak Pharmaceuticals Inc., dated March 6, 1996 (16)                                                                                                                                                                                
|            |  |                                                                                                                                                                                                                                                                           
|10.9        |  | Reserved.                                                                                                                                                                                                                                                                 
|            |  |                                                                                                                                                                                                                                                                           
|10.10       |  | Reserved.                                                                                                                                                                                                                                                                 





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##### Table of Contents



|      |  |                                                                                                                                                              
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.11 |  | Lease Agreement between Industrial Developments International, Inc. as Landlord and I-Flow Corporation as
Tenant dated April 14, 1997 (17)                   
|      |  |                                                                                                                                                              
|10.12 |  | Block Medical de Mexico lease agreement dated December 7, 1999                                                                                               
|      |  |                                                                                                                                                              
|10.13 |  | Amendment to Loan Agreement between Silicon Valley Bank and I-Flow Corporation dated January 30, 2004.                                                       
|      |  |                                                                                                                                                              
|10.14 |  | Amended and Restated Loan and Security Agreement between Silicon Valley Bank and I-Flow Corporation dated
May 8, 2003 (10)                                   
|      |  |                                                                                                                                                              
|10.15 |  | Loan Agreement, dated March 31, 2000, by and among InfuSystem, Inc., I-Flow Corporation and Old Kent Bank (10)                                               
|      |  |                                                                                                                                                              
|10.16 |  | First Amendment to Loan Agreement, dated April 1, 2002, by and among InfuSystem, Inc., I-Flow Corporation and
Fifth Third Bank (formerly Old Kent Bank) (10) 
|      |  |                                                                                                                                                              
|10.17 |  | Second Amendment to Loan Agreement, dated April 1, 2003, by and among InfuSystem, Inc., I-Flow Corporation and
Fifth Third Bank (formerly Old Kent Bank) (10)
|      |  |                                                                                                                                                              
|10.18 |  | Second Amended and Restated Promissory Note, dated April 1, 2003, between InfuSystem, Inc. and Fifth Third Bank
(formerly Old Kent Bank) (10)                
|      |  |                                                                                                                                                              
|10.19 |  | Promissory Note with Donald M. Earhart dated June 15, 2001 (8)*                                                                                              
|      |  |                                                                                                                                                              
|10.20 |  | Reserved.                                                                                                                                                    
|      |  |                                                                                                                                                              
|10.21 |  | Employment Agreement with Donald M. Earhart, dated May 16, 1990 (18)*                                                                                        
|      |  |                                                                                                                                                              
|10.22 |  | Amendment No. 1 to Employment Agreement with Donald M. Earhart, dated June 21, 2001 (8)*                                                                     
|      |  |                                                                                                                                                              
|10.23 |  | Amended and Restated Employment Agreement with James J. Dal Porto, dated June 21, 2001 (8)*                                                                  
|      |  |                                                                                                                                                              
|10.24 |  | Employment Agreement with James R. Talevich, dated June 30, 2000 (19) *                                                                                      
|      |  |                                                                                                                                                              
|10.25 |  | Agreement Re: Change in Control with Donald M. Earhart dated June 21, 2001 (8)*                                                                              
|      |  |                                                                                                                                                              
|10.26 |  | Agreement Re: Change in Control with James J. Dal Porto dated June 21, 2001 (8)*                                                                             
|      |  |                                                                                                                                                              
|10.27 |  | Agreement Re: Change in Control with James R. Talevich, dated June 21, 2001 (8)*                                                                             
|      |  |                                                                                                                                                              
|21.1  |  | List of Subsidiaries                                                                                                                                         
|      |  |                                                                                                                                                              
|23.1  |  | Independent Auditors Consent                                                                                                                                
|      |  |                                                                                                                                                              
|31.1  |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act on 2002                                                           
|      |  |                                                                                                                                                              
|31.2  |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act on 2002                                                           
|      |  |                                                                                                                                                              
|32.1  |  | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002                               



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|*   |  | Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(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 June 30, 2001.                              
|    
|(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 Quarterly Report on Form 10-Q for the quarter ended June 30, 2002.                              
|    
|(12) |  | Incorporated by reference to exhibit with this title filed with the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2002.                         
|    
|(13) |  | Incorporated by reference to exhibit with this title filed with the Companys Definitive Proxy Statement filed on March 27, 1996.                                             
|    
|(14) |  | Incorporated by reference to exhibit with this title filed with the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 1991.                         
|    
|(15) |  | Incorporated by reference to exhibit with this title filed with the Companys Post-Effective Amendment to its Registration Statement (No. 33-41207) filed on October 27, 1992.
|    
|(16) |  | Incorporated by reference to exhibit with this title filed with the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 1995.                         
|    
|(17) |  | Incorporated by reference to exhibit with this title filed with the Companys Current Report on Form 8-K dated April 14, 1997.                                                
|    
|(18) |  | 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.                        
|    
|(19) |  | Incorporated by reference to exhibit with this title filed with the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2000.                         
|    
|(20) |  | 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.