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SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549




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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 0R 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|- |  | ------------------------------------------------------------------------------------

For the fiscal year ended      December 31, 2002

OR

|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 0R 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------

For the transition period from                      to

Commission file number 0-18338

I-FLOW CORPORATION

(Exact Name of Registrant as Specified in Its Charter)


|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|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                   

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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[  ]

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. [ x]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes[  ]   No[X]

The aggregate market value of the common stock of the registrant held by
non-affiliates as of June 28, 2002 (the last trading day of the second fiscal
quarter) was $32,981,465, based on a closing price of $2.34 on the Nasdaq Stock
Market on such day. The number of shares of the registrants common stock
outstanding at March 10, 2003 was 15,507,254.

Information required by Part III of this report on Form 10-K is incorporated by
reference to portions of the registrants definitive proxy statement for its
2003 Annual Meeting of Stockholders, which will be filed with the Securities
and Exchange Commission within 120 days after the end of the registrants
fiscal year ended December 31, 2002.



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TABLE OF CONTENTS



|                  |                                                                                               |  |  |  |  |  |  | 
|----------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I           
|                  | 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 
|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                      
|                  | Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|                  | Item 14. CONTROLS AND PROCEDURES                                                             
|PART IV          
|                  | Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                    
|SIGNATURES       
|INDEX TO EXHIBITS
|EXHIBIT 10.12    
|EXHIBIT 21       
|EXHIBIT 23.1     
|EXHIBIT 99.1     



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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 pain management and drug
delivery technology. Through product innovation and strategic acquisitions,
the Company has emerged as a leader in pain management, offering highly
effective therapies 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, needles 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, is primarily engaged in the rental of
infusion pumps on a month-to-month basis for the cancer infusion therapy
market. Spinal Specialties, Inc., another wholly owned subsidiary of I-Flow
Corporation, is primarily engaged in the manufacturing and marketing of custom
regional anesthesia kits with expanded capabilities in interventional radiology
products.

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.

Acquisitions

On February 11, 1998, the Company acquired all of the outstanding stock of
InfuSystems II, Inc. and Venture Medical, Inc. (collectively referred to as
InfuSystem). InfuSystem is a leading ambulatory infusion pump management
provider based in Madison Heights, Michigan. By delivering ambulatory pumps
and the related disposables from a variety of manufacturers to private medical
practices and clinics across the country, InfuSystem uses a distinctive
approach to service the cancer infusion therapy market.

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
the hospital, anesthesiologist and pain clinic.

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 hospital and alternate site settings. The I-Flow family of products is
focused on three primary market segments  Regional Anesthesia, IV Infusion
Therapy and Oncology Infusion Services.

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Regional Anesthesia

Chronic Pain Kits

This product line was created by I-Flows acquisition of Spinal Specialties,
and it includes custom spinal, epidural, discogram and nerve block kits. These
disposable products for chronic pain management are tailored to the specific
needs of the anesthesiologist, hospital and pain management clinic. The spinal
tray line can be combined with I-Flows infusion systems to create new products
for managing acute and chronic pain. During 2002, Spinal Specialties
introduced the OsteojectTM Bone Cement Delivery System.

Acute Pain Kits

The Acute Pain Kit product line
includes the ON-Q® Post-Operative Pain Relief
System, PainBuster® Pain Management System and
C-blocTM Continuous Nerve Block
System. I-Flows ON-Q and PainBuster Systems offer continuous wound site pain
management, which is considered 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
are used, there are fewer side effects. I-Flows C-bloc technology combines
the advantages of a custom nerve block kit with the added feature of a
disposable infusion pump. Recent studies have shown that C-bloc, when used for
continuous nerve block applications, significantly reduced pain scores and the
use of narcotics for pain control following shoulder surgeries.

The Companys SoakerTM Catheters (2.5 and 5 versions) were granted U.S. Food
and Drug Administration 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
a continuous, even infusion of a non-narcotic, local anesthetic directly along
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 the health care professional
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 patented Homepump Eclipse®, the Homepump Eclipse C
Series and the One-Step KVO.

Syringe Delivery Systems

I-Flows Syringe Delivery Systems are mechanical infusion devices designed to
provide accurate intravenous push delivery from a syringe. The systems are
cost-effective for both single and multiple doses and provide health care
professionals with a safe and accurate alternative to gravity or IV push
methods with a relatively easy learning curve for patients. I-Flows products
in this class include the Medi-SIS 20 and Medi-SIS 60 Syringe Infusion
Systems.

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 can provide precise delivery of medications requiring slow and
continuous infusions. I-Flows products in this class include
the Paragon® and
Sidekick® ambulatory infusion pumps and the
Rely-A-Flow® Gravity Set.

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Electronic Pumps

The Companys ambulatory
electronic infusion products include I-Flow VIP, with
barcode features which can be used with 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.

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 participates in 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 arena.
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 business segments:
manufacturing and marketing medical infusion pumps; and rentals of medical
infusion pumps. The rental business segment principally consists of the
activities of InfuSystem, Inc. within the Oncology Infusion Services market
segment. See Note 9 in Notes to Consolidated Financial Statements.

The hospital market for I-Flows simple, portable regional anesthesia
technologies is currently virtually untapped. There are more than 60 million
operative procedures performed in the U.S. every year. I-Flow estimates that
its ON-Q® and PainBuster® systems could be used in at least 15 million of those
procedures.

The alternate site health care industry has supported the need for ambulatory
infusion devices. An ambulatory pump enables a patient to leave the hospital
earlier, making it very 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 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 total net revenues:

|                           |  |      |    |      |  |      |    |   |  |  |    |  
|-------------------------- |  | ---- | -- | ---- |  | ---- | -- | - |  |  | -- | -
|Revenues by Market Segment |  | 2002 |    | 2001 |  | 2000
|                           |  |      |    |      |  |     
|Regional Anesthesia        |  |      | 32 | %    |  |      | 25 | % |  |  | 26 | %
|IV Infusion Therapy        |  |      | 41 | %    |  |      | 44 | % |  |  | 48 | %
|Oncology Infusion Services |  |      | 27 | %    |  |      | 31 | % |  |  | 26 | %

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 competitors have 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 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 and
to sustain profitability.

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The number of current competitors 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 |          | Company's            
|                        |                                              |             | Known     |          | Estimated Competitive
|U.S. Market Description |                                              | Competitors |           | Position
|                        |                                              |             |           |         
|Regional Anesthesia     |                                              |             |           |          |                       |  |   |  
|                        | Acute Pain Kits (Wound Site Pain Management) |             |           | 8        |                       |  |   | 1 | 
|                        | Chronic Pain Kits                            |             |           | 10       |                       |  |   | 7 | 
|IV Infusion Therapy     |                                              |             |           |          |                       |  |   |  
|                        | Elastomerics                                 |             | 3         |          |                       |  | 1 |  
|                        | Non-electric Syringe Delivery Systems        |             |           | 2        |                       |  |   | 2 | 
|                        | Non-electric IV Bag Delivery Systems         |             |           | 4        |                       |  |   | 2 | 
|                        | Electronic Pumps                             |             |           | 7        |                       |  |   | 7 | 

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 U.S. medical
product distributors for approximately 7% of its revenue. There are no
complete integrated contracts for the entire I-Flow product line with any of
these distributors.

During 1998, the Company entered into an agreement with B. Braun Celsa SA
(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. For
the years ended December 31, 2002, 2001 and 2000, sales to B. Braun Celsa SA
accounted for 12%, 9%, and 7% of the Companys total revenues, respectively.
The Company entered into a separate agreement with B. Braun Medical, Inc., a
national U.S. distributor, to distribute I-Flows elastomeric pumps to B. Braun
Medical, Inc.s full line IV Infusion Therapy customers in the United States.
For each of the years ended December 31, 2002, 2001 and 2000, sales to B. Braun
Medical, Inc., accounted for 6%, 9%, and 11% of the Companys total revenues,
respectively.

In May 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. I-Flows PainBuster pain management system provides continuous
infusion of a non-narcotic, local anesthetic directly into the intraoperative
site for post-operative pain management. 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 expires as of December 31,
2003.

In June 1999, the Company signed a distribution agreement with Ethicon
Endo-Surgery, Inc., a Johnson & Johnson subsidiary, under which Ethicon
Endo-Surgery became the exclusive distributor of I-Flows ON-Q® Post-Operative
Pain Relief System for all surgical applications excluding orthopedics. The
ON-Q® Post-Operative Pain Relief System infuses non-narcotic local anesthetics
directly into the operative site, the patients primary source of
post-operative pain. 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 U.S. distribution rights to the ON-Q®
Post-Operative Pain Relief System, and began selling the products on a direct
basis through I-Flows direct sales organization.

The Company sells several of its products into the international market and has
signed agreements with distributors in various countries. Currently, the
Company is selling 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 24%, 22% and 22% of the Companys total revenues for the years
ended December 31, 2002, 2001 and 2000, 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:       |  | 2002 |            | 2001 |  | 2000
|                                       |  |      |            |      |  |     
|United States                          |  | $    | 29,117,000 |      |  | $    | 25,890,000 |  |  | $ | 24,870,000 | 
|Europe                                 |  |      | 7,236,000  |      |  |      | 5,897,000  |  |  |   | 5,153,000  | 
|Asia                                   |  |      | 1,095,000  |      |  |      | 987,000    |  |  |   | 1,295,000  | 
|Other                                  |  |      | 669,000    |      |  |      | 531,000    |  |  |   | 648,000    | 
|All Foreign Countries in the Aggregate |  |      | 9,000,000  |      |  |      | 7,415,000  |  |  |   | 7,096,000  | 

The Company did not have a significant backlog of unfilled orders as of
December 31, 2002 or December 31, 2001.

Manufacturing and Operations

A substantial portion of the Companys products are manufactured by its Mexican
subsidiary, Block Medical de Mexico, S.A. de C.V. (Block). 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 tubing sets. 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, analyzing factors such as the quality of the products
received from vendors, the costs of the products, timely delivery and employee
utilization.

Product Development

The Company has focused its product development efforts on products in pain
relief and ambulatory infusion systems markets and, with the majority of its
new products, it is expanding its market to include hospitals. In each of the
years ended December 31, 2002, 2001 and 2000, the Company incurred expenses of
approximately $2,104,000, $2,238,000 and $2,001,000, respectively, for product
research and development.

Patents and Trademarks

The Company has filed U.S. patent applications for substantially all of its
products. The total number of patents now held by the Company is approximately
40 and includes patents relating to both the On-Q Pain Relief System and Soaker
catheter. The Companys patents generally expire between 2009 to 2015, with
the most 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.

Copyrights have been obtained for the
Vivus 4000® programming software. 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.

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 list its devices with the U.S. Food and Drug
Administration (the FDA), to file notice of its intent 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 inspections. Failure to comply

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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 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 operations, including its Mexico facility, were added
to the Companys ISO certification and permission was granted to use the CE
mark on the Block products.

Employees

As of March 1, 2003, the Company and its subsidiaries had a total of 188
full-time employees in the United States and an additional 194 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.i-flowcorp.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 the lease 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 Northern Mexico for the
manufacture of ambulatory infusion devices. The current plant lease was
entered into in 2000 and has a term of five years. The plant currently
operates at approximately 60% of capacity. The Companys Infusystem subsidiary
rents a building in Madison Heights, Michigan on a month-to-month basis.
Finally, the Company leases a building in San Antonio, Texas to manufacture the
Spinal Specialties regional anesthesia devices. The lease was entered into in
2002 and has a term of three years. Management believes that the above
properties provide the Company with sufficient space to continue to operate its
business as currently conducted.

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Item 3. LEGAL PROCEEDINGS

As of March 1, 2003, the Company was involved in legal proceedings in the
normal course of operations. Although the outcome of the proceedings cannot be
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, 2002.

EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth information concerning the executive officers of
the Company as of March 1, 2003. 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 |    | Position
|                               |  |     |    |         
|Donald M. Earhart              |  |     | 58 |          |  | President, Chief Executive Officer and   
|                               |  |     |    |          |  | Chairman of the Board                    
|Henry Tsutomu Tai, Ph.D., M.D. |  |     | 59 |          |  | Secretary and Director                   
|                              
|James J. Dal Porto             |  |     | 49 |          |  | Executive Vice President, Chief Operating
|                               |  |     |    |          |  | Officer and Director                     
|James R. Talevich              |  |     | 52 |          |  | Chief Financial Officer and Treasurer    

Donald M. Earhart has 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.

Henry Tsutomu Tai, Ph.D., M.D. is the initial progenitor of the Companys
product and business concept in multiple-drug infusion systems and founding
director. Dr. Tai has been on the board of directors since 1985, serving as
Chairman from 1985 to 1988. Dr. Tai has been the Secretary of the Company
since 1990. Dr. Tai has been a consultant in hematology and oncology since
1977. Dr. Tai holds a B.A. in Molecular Biology from Harvard University and a
Ph.D. in Molecular Biology and an M.D. from the University of Southern
California. He has done postdoctoral research in the molecular biology of
tumor virus DNA at the Weizman Institute of Science in Israel and at the
California Institute of Technology.

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James J. Dal Porto joined the Company in October 1989 to serve as Controller.
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. Talevich joined the Company as its Chief Financial Officer in August
2000. Prior to joining I-Flow, 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, a privately held
manufacturing company, from 1995 to 1999. Prior to 1996, 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.




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 Small Cap Market under the
symbol IFLO. The table below sets forth the high and low sales prices of the
Companys common stock as reported by Nasdaq.

|     |     |         |  |   |      |      |  |     |      |  |  | 
|---- | --- | ------- |  | - | ---- | ---- |  | --- | ---- |  |  | 
|     |     |         |  |   |      | High |  | Low
|     |     |         |  |   |      |      |  |    
|2001 |     |         |  |   |      |      |  |     |      |  |  | 
|     | 1st | Quarter |  | $ | 2.81 |      |  | $   | 1.38 | 
|     | 2nd | Quarter |  | $ | 3.20 |      |  | $   | 1.45 | 
|     | 3rd | Quarter |  | $ | 3.50 |      |  | $   | 1.93 | 
|     | 4th | Quarter |  | $ | 3.30 |      |  | $   | 2.10 | 
|2002 |     |         |  |   |      |      |  |     |      |  |  | 
|     | 1st | Quarter |  | $ | 3.37 |      |  | $   | 2.59 | 
|     | 2nd | Quarter |  | $ | 3.12 |      |  | $   | 2.00 | 
|     | 3rd | Quarter |  | $ | 2.55 |      |  | $   | 1.14 | 
|     | 4th | Quarter |  | $ | 1.89 |      |  | $   | 1.06 | 

American Stock Transfer & Trust Company is the Companys transfer agent for
its common stock. As of March 12, 2003, the Company had 387 shareholders of
record and, based upon information received from nominee holders, the Company
believes it has approximately 6,000 total beneficial holders. The
Company has not paid, and does not currently expect to pay in the
foreseeable future, cash dividends on its common stock.

9



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##### Table of Contents



Equity Compensation Plan Information

The following table provides
information, as of December 31, 2002, about compensation plans
under which equity securities of the registrant are authorized for
issuance:

|                                                           |  |             |           |             |  |                        |      |                     |  |  |           |    
|---------------------------------------------------------- |  | ----------- | --------- | ----------- |  | ---------------------- | ---- | ------------------- |  |  | --------- | ---
|                                                           |  | Number of   |           |             |  |                        |      | Number of Shares of
|                                                           |  | Shares of   |           |             |  |                        |      | Common Stock       
|                                                           |  | Common      |           | Weighted -  |  | Remaining Available   
|                                                           |  | Stock to be |           | Average     |  | for Future Issuance   
|                                                           |  | Issued Upon |           | Exercise    |  | Under the
Companys   
|                                                           |  | Exercise of |           | Price of    |  | Stock Option Plans    
|                                                           |  | Outstanding |           | Outstanding |  | (excluding shares     
|                                                           |  | Options     |           | Options     |  | reflected in column 1)
|                                                           |  |             |           |             |  |                       
|Equity
compensation plans approved by Stockholders         |  |             | 4,463,921 |             |  | $                      | 2.18 |                     |  |  | 2,149,000 | (1)
|Stock
option grants not approved by Stockholders           |  |             | 40,000    | (2)         |  | $                      | 2.89 |                     |  |  |          |    
|Equity
compensation plans not approved by Stockholders (3) |  |             | 73,500    |             |  |                        |     |                     |  |  | 301,500   |    
|                                                           |  |             |           |             |  |                        |      |                     |  |  |           |    
|Total                                                      |  |             | 4,577,421 |             |  | $                      | 2.19 |                     |  |  | 2,450,500 |    
|                                                           |  |             |           |             |  |                        |      |                     |  |  |           |    



|(1) |  | All options available for future grant are authorized under the Companys
2001 Equity Incentive Plan.              
|--- |  | -------------------------------------------------------------------------------------------------------------------
|(2) |  | Stock options for the purchase of
40,000 shares were granted by the board of directors as inducements
to new hires.
|(3) |  | 2001 Restricted Stock Plan                                                                                         

Material Features of Non-Stockholder Approved Plan

On December 4, 2001, the Company adopted a Restricted Stock
Plan. The term of the plan is 10 years. The plan, as amended,
provides for the issuance of up to 375,000 shares. The plan provides
that the Company may, from time to time, grant shares of restricted
stock to employees of the Company or one of its subsidiaries.
Officers and employee-directors are not eligible to receive grants
under the plan. The plan, and offers and sales of securities under
the plan, are intended to meet the requirements of, and qualify
under, Rule 506 promulgated under the Securities Act of 1933, as
amended. Upon delivery of shares of restricted stock, the stockholder
generally has, subject to the restrictions contained in his or her
award agreement, all rights of a stockholder, including the right to
vote and receive dividends, if any. Shares granted under the plan
generally vest over a period of three years subject to accelerated
vesting based upon the achievement of individual performance goals.
The Company also has the right to repurchase shares if an
employees employment is terminated in some circumstances.
Shares of restricted stock may not be transferred unless and until
the shares have been issued and all restrictions on the shares have
lapsed, and such transfer is otherwise in compliance with federal and
state securities laws. See Note 5 of Notes to Consolidated
Financial Statements for additional information about the plan.

10



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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 consolidated statements of operations for the years ended December
31, 2002, 2001 and 2000 and consolidated balance sheets as of December 31,
2002 and 2001 which are included herein and have been audited by Deloitte &
Touche LLP, independent auditors. The Companys consolidated statements of
operations for the years ended December 31, 1999 and 1998 and the consolidated
balance sheets as of December 31, 2000, 1999 and 1998 which are not included
herein have also been audited by Deloitte & Touche LLP, independent auditors.
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)                                     |                                             | 2002                     |         | 2001   |                          | 2000   |        | 1999   |        | 1998  
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |       
|Consolidated
Statements of Operations Data:(1)(2)(3)                                 |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Revenues:                                                                            |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     | Net product sales                           |                          | $       | 27,824 |                          |        | $      | 22,942 |        |        | $      | 23,497 |        |        | $      | 19,272 |        |        | $      | 17,006 |       
|                                                                                     | Rental income and other                     |                          |         | 10,293 |                          |        |        | 10,363 |        |        |        | 8,469  |        |        |        | 8,512  |        |        |        | 6,586  |       
|                                                                                     | Licensing fees                              |                          |         |       |                          |        |        |       |        |        |        |       |        |        |        | 2,000  |        |        |        |       |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     |                                             | Total revenues           |         |        | 38,117                   |        |        |        | 33,305 |        |        |        | 31,966 |        |        |        | 29,784 |        |        |        | 23,592 |       
|Cost of revenues                                                                     |                                             |                          | 14,597  |        |                          |        | 14,011 |        |        |        | 13,710 |        |        |        | 11,824 |        |        |        | 10,219 |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Gross Profit                                                                         |                                             |                          | 23,520  |        |                          |        | 19,294 |        |        |        | 18,256 |        |        |        | 17,960 |        |        |        | 13,373 |       
|Operating expenses:                                                                  |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     | Selling and marketing                       |                          |         | 12,324 |                          |        |        | 5,504  |        |        |        | 5,115  |        |        |        | 4,193  |        |        |        | 4,178  |       
|                                                                                     | General and administrative                  |                          |         | 8,336  |                          |        |        | 9,385  |        |        |        | 8,150  |        |        |        | 7,604  |        |        |        | 5,834  |       
|                                                                                     | Product development                         |                          |         | 2,104  |                          |        |        | 2,238  |        |        |        | 2,001  |        |        |        | 1,710  |        |        |        | 1,507  |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     |                                             | Total operating expenses |         |        | 22,764                   |        |        |        | 17,127 |        |        |        | 15,266 |        |        |        | 13,507 |        |        |        | 11,519 |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Operating income                                                                     |                                             |                          | 756     |        |                          |        | 2,167  |        |        |        | 2,990  |        |        |        | 4,453  |        |        |        | 1,854  |       
|                                                                                     | Interest and other (income) expense, net    |                          |         | (6     | )                        |        |        | 44     |        |        |        | 265    |        |        |        | 404    |        |        |        | 684    |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Income before income taxes and
cumulative effect of a change in
accounting principle |                                             |                          | 762     |        |                          |        | 2,123  |        |        |        | 2,725  |        |        |        | 4,049  |        |        |        | 1,170  |       
|                                                                                     | Income tax provision (benefit)              |                          |         | 323    |                          |        |        | 856    |        |        |        | 1,113  |        |        |        | (4,763 | )      |        |        | 69     |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Net income before cumulative effect of a
change in accounting principle              |                                             |                          | 439     |        |                          | $      | 1,267  |        |        |        | 1,612  |        |        |        | 8,812  |        |        |        | 1,101  |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Cumulative effect of a change in
accounting principle                                |                                             |                          | (3,474  | )      |                          |        |       |        |        |        |       |        |        |        |       |        |        |        |       |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     | Net income (loss)                           |                          | $       | (3,035 | )                        |        |        | 1,267  |        |        | $      | 1,612  |        |        | $      | 8,812  |        |        | $      | 1,101  |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Net income per share before cumulative
effect of a change in accounting
principle:   |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     | Basic                                       |                          | $       | 0.03   |                          |        | $      | 0.08   |        |        | $      | 0.11   |        |        | $      | 0.61   |        |        | $      | 0.08   |       
|                                                                                     | Diluted                                     |                          | $       | 0.03   |                          |        | $      | 0.08   |        |        | $      | 0.10   |        |        | $      | 0.58   |        |        | $      | 0.08   |       
|Loss per share from cumulative effect of
a change in accounting principle            |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     | Basic                                       |                          | $       | (0.23  | )                        |        | $      |       |        |        | $      |       |        |        | $      |       |        |        | $      |       |       
|                                                                                     | Diluted                                     |                          | $       | (0.22  | )                        |        | $      |       |        |        | $      |       |        |        | $      |       |        |        | $      |       |       
|Net income (loss) per share:                                                         |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     | Basic                                       |                          | $       | (0.20  | )                        |        | $      | 0.08   |        |        | $      | 0.11   |        |        | $      | 0.61   |        |        | $      | 0.08   |       
|                                                                                     | Diluted                                     |                          | $       | (0.19  | )                        |        | $      | 0.08   |        |        | $      | 0.10   |        |        | $      | 0.58   |        |        | $      | 0.08   |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     | Weighted-average common shares outstanding: |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     |                                             |                          | Basic   |        |                          | 15,368 |        |        |        | 15,231 |        |        |        | 15,002 |        |        |        | 14,387 |        |        |        | 13,479 | 
|                                                                                     |                                             |                          | Diluted |        |                          | 15,879 |        |        |        | 15,749 |        |        |        | 15,647 |        |        |        | 15,116 |        |        |        | 13,711 | 
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Consolidated Balance Sheet Data:(2)                                                  |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                                                     | Working capital                             |                          | $       | 16,357 |                          |        | $      | 15,822 |        |        | $      | 14,441 |        |        | $      | 13,565 |        |        | $      | 6,588  |       
|                                                                                     | Total assets                                |                          |         | 33,361 |                          |        |        | 35,704 |        |        |        | 35,215 |        |        |        | 31,768 |        |        |        | 24,336 |       
|                                                                                     | Long-term obligations                       |                          |         | 1      |                          |        |        | 83     |        |        |        | 1,303  |        |        |        | 1,548  |        |        |        | 2,680  |       
|                                                                                     | Total shareholders equity                  |                          |         | 27,470 |                          |        |        | 29,769 |        |        |        | 27,618 |        |        |        | 24,670 |        |        |        | 14,817 |       
|                                                                                     |                                             |                          |         |        |                          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       



|(1) |  | Certain amounts previously reported have been reclassified to conform with the 2002 presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | In January 2000, the Company acquired Spinal Specialties, Inc. See Note 3 of Notes to Consolidated Financial
Statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|(3) |  | 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.

11



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##### Table of Contents



SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

(Amounts in thousands, except per share amounts)

|                                                                                            |  |             |        |         |  |          |        |         |  |   |        |  |  |   |        | 
|------------------------------------------------------------------------------------------- |  | ----------- | ------ | ------- |  | -------- | ------ | ------- |  | - | ------ |  |  | - | ------ | 
|2002                                                                                        |  | Mar. 31 (1) |        | June 30 |  | Sept. 30 |        | Dec. 31
|                                                                                            |  |             |        |         |  |          |        |        
|Total revenues                                                                              |  | $           | 8,550  |         |  | $        | 9,505  |         |  | $ | 9,639  |  |  | $ | 10,423 | 
|Gross profit                                                                                |  |             | 5,094  |         |  |          | 5,713  |         |  |   | 5,928  |  |  |   | 6,785  | 
|Income before income taxes and cumulative effect of
a change in accounting principle        |  |             | 228    |         |  |          | 177    |         |  |   | 177    |  |  |   | 180    | 
|Net income before cumulative effect of a change in
accounting principle                     |  |             | 136    |         |  |          | 106    |         |  |   | 107    |  |  |   | 90     | 
|Cumulative effect of a change in accounting principle                                       |  |             | (3,474 | )       |  |          |       |         |  |   |       |  |  |   |       | 
|Net income (loss)                                                                           |  |             | (3,338 | )       |  |          | 106    |         |  |   | 107    |  |  |   | 90     | 
|Net income per share before cumulative effect of a
change in accounting principle - basic   |  |             | 0.01   |         |  |          | 0.01   |         |  |   | 0.01   |  |  |   | 0.01   | 
|Net income (loss) per share - basic                                                         |  |             | (0.22  | )       |  |          | 0.01   |         |  |   | 0.01   |  |  |   | 0.01   | 
|Weighted-average common shares - basic                                                      |  |             | 15,366 |         |  |          | 15,363 |         |  |   | 15,368 |  |  |   | 15,389 | 
|Net income per share before cumulative effect of a
change in accounting principle - diluted |  |             | 0.01   |         |  |          | 0.01   |         |  |   | 0.01   |  |  |   | 0.01   | 
|Net income (loss) per share - diluted                                                       |  |             | (0.21  | )       |  |          | 0.01   |         |  |   | 0.01   |  |  |   | 0.01   | 
|Weighted-average common shares - diluted                                                    |  |             | 16,210 |         |  |          | 16,033 |         |  |   | 15,701 |  |  |   | 15,573 | 
|                                                                                            |  |             |        |         |  |          |        |         |  |   |        |  |  |   |        | 
|2001                                                                                        |  | Mar. 31     |        | June 30 |  | Sept. 30 |        | Dec. 31
|                                                                                            |  |             |        |         |  |          |        |        
|Total revenues                                                                              |  | $           | 7,992  |         |  | $        | 8,479  |         |  | $ | 7,991  |  |  | $ | 8,843  | 
|Gross profit                                                                                |  |             | 4,646  |         |  |          | 5,010  |         |  |   | 4,688  |  |  |   | 4,950  | 
|Income before income taxes                                                                  |  |             | 545    |         |  |          | 710    |         |  |   | 788    |  |  |   | 80     | 
|Net income                                                                                  |  |             | 316    |         |  |          | 399    |         |  |   | 411    |  |  |   | 141    | 
|Net income per share - basic                                                                |  |             | 0.02   |         |  |          | 0.03   |         |  |   | 0.03   |  |  |   | 0.01   | 
|Weighted-average common shares - basic                                                      |  |             | 15,010 |         |  |          | 15,249 |         |  |   | 15,293 |  |  |   | 15,319 | 
|Net income per share - diluted                                                              |  |             | 0.02   |         |  |          | 0.03   |         |  |   | 0.03   |  |  |   | 0.01   | 
|Weighted-average common shares - diluted                                                    |  |             | 15,503 |         |  |          | 15,642 |         |  |   | 15,956 |  |  |   | 15,954 | 



|    |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) |  | 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.

12



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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 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-K, 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 of America. As
such, 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 and Accounts Receivable

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. Also, the
Company records a provision for the estimated amount of future returns based on
historical experience and any notification received of pending returns. While
such returns have historically been insignificant, the Company cannot guarantee
that it will continue to experience the same return rates as 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 may experience significant extended payment terms with
certain of these third party payors, however, 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.

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Bad Debts

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 related to product sales to estimate the amount that will ultimately be
uncollectible and therefore should be reserved. The percentages are increased
as the accounts age. The collectibility of accounts receivable related to
rental revenues from medical pumps is estimated based upon current and
historical collection and reimbursement rates for that business segment. If
the actual uncollected amounts significantly exceed the estimated allowance
then 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
continues to operate at a profit in the future and generate 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 its 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,required the Company to cease amortizing goodwill and
indefinite life intangibles effective January 1, 2002. Any goodwill and
indefinite life intangibles resulting from acquisitions completed after June
30, 2001 will not be amortized. 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 market
value to book value

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to determine whether or not any potential impairment of goodwill exists. The
Company cannot guarantee that there will be no additional impairment in the
future. See Note 2 to Consolidated Financial Statements.

Consolidated Results of Operations for the Year Ended December 31, 2002
Compared to the Year Ended December 31, 2001

Net revenues during the year ended December 31, 2002 were $38,117,000 compared
to $33,305,000 for the prior year, an increase of 14%. Net product revenues
increased 21% in 2002 to $27,824,000 compared to $22,942,000 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.

The Companys revenues during 2002 and 2001 were generated in three primary
market segments: regional anesthesia, IV infusion therapy, and oncology
infusion services. Regional anesthesia product revenues for 2002, which
included revenue from the PainBuster® and ON-Q® Post-Operative Pain Relief
Systems, the Soaker Catheters and Spinal Specialties products, increased by
46% to $12,036,000 in 2002 compared to $8,241,000 for fiscal 2001. The
increase was primarily due to increased U.S. sales of ON-Q, 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 U.S.
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, Inc. (Ethicon) 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, previously
the Companys exclusive U.S. distributor for the ON-Q
Post-Operative Pain Relief System.
Under the termination agreement, the Company regained the exclusive U.S.
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. The Company has an agreement with B.
Braun Celsa SA (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 Company has a separate agreement under which B. Braun Medical, Inc.
distributes I-Flows elastomeric pumps to B. Braun Medical Inc.s IV Infusion
Therapy customers in the United States.

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. 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 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.

Cost of revenues was $14,597,000 during the year ended December 31, 2002,
compared to $14,011,000 in the prior year, an increase of 4%. As a percentage
of total revenues, cost of revenues decreased by four percentage points 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 distribution of those
products.

Selling and marketing expenses for the year ended December 31, 2002 increased
$6,820,000 or 124% 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. As a percentage of total revenues, selling and marketing
expenses increased 16 percentage points over the prior year.

General and administrative expenses for the year ended December 31, 2002
decreased $1,049,000 or 11% from the prior year. The total decrease included a
reduction of approximately $837,000 in goodwill amortization expense due to the
cessation of goodwill amortization effective January 1, 2002 in accordance with
Statement of Financial

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Accounting Standards No. 142, Goodwill and Other Intangible Assets,(SFAS
142). See New Accounting Pronouncements on page 19, 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 compared to the prior
year by six percentage points.

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. 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 one percentage point
during 2002 compared to 2001.

During the year ended December 31, 2002, the Company recorded income tax
expense of $323,000, compared to income tax expense of $856,000 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.

In accordance with SFAS 142, 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.

Consolidated Results of Operations for the Year Ended December 31, 2001
Compared to the Consolidated Results of Operations for the Year Ended December 31, 2000

Net revenues during the year ended December 31, 2001 were $33,305,000 compared
to $31,966,000 for the prior year, an increase of 4%. Net product revenues
decreased 2% in 2001 to $22,942,000 compared to $23,497,000 in 2000, while
rental income increased 22% in 2001 to $10,363,000 compared to $8,469,000 in
2000. The increase in rental income is attributable to an increase in infusion
pump rentals for chemotherapy by the Companys InfuSystem subsidiary.

The Companys revenues during 2001 and 2000 were generated in three primary
market segments: regional anesthesia, IV infusion therapy, and oncology
infusion services. Regional anesthesia product revenues for 2001, which
included revenue from the PainBuster® and ON-Q® Pain Management Systems, the
Soaker Catheter and Spinal Specialties products, decreased by 1% to $8,241,000
in 2001 compared to $8,310,000 for fiscal 2000. The decrease from the prior
year resulted from an inventory repurchase of approximately $963,000 from
Ethicon Endo-Surgery, Inc. 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, previously the Companys
exclusive U.S. distributor for the ON-Q Pain Management System. Under the
termination agreement, the Company gained the exclusive U.S. distribution
rights to the ON-Q Pain Management 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, decreased 3% in 2001 to $14,701,000 from$15,187,000 in 2000.
This decrease resulted primarily from the timing of shipments to a specific
distributor and the negative effect on sales of the strong U.S. dollar relative
to other currencies. The Company has an agreement with B. Braun Celsa SA
(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
Company has a separate agreement under which B. Braun Medical, Inc. distributes
I-Flows elastomeric pumps to B. Braun Medical Inc.s IV Infusion Therapy
customers in the United States.

Revenues for oncology infusion services provided by the Companys InfuSystem
subsidiary increased 22% to $10,363,000 in 2001 compared to $8,469,000 in
2000. This increase is due to additional client facilities converting to the
InfuSystem pump management system as well as the negotiation of additional
contracts with managed care organizations. The additional managed care
contracts increase the proportion of patients at each client facility for which
InfuSystem is able to successfully bill and collect for pump services. The
fiscal year ended December 31,

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2000 was a transition year for InfuSystem. Its customer base was significantly
affected during the fiscal year by changes in medical insurance coverage
practices and procedures for patient medical reimbursement utilized by managed
care organizations and other healthcare payors. During this transition period,
InfuSystem essentially rebuilt its customer base by strengthening existing
managed care contracts and by adding new contracts with such leading healthcare
providers as the M.D. Anderson Cancer Center, Blue Cross/Blue Shield
Affiliates, U.S. Oncology, United Healthcare, Beech Street Corporation,
Nylcare, One Health Plan and Integrated Health Plan.

Cost of revenues was $14,011,000 during the year ended December 31, 2001,
compared to $13,710,000 in the prior year, an increase of 2%. As a percentage
of total revenues, cost of revenues decreased by one percentage point for the
year ended December 31, 2001 compared to the prior year.

Selling and marketing expenses for the year ended December 31, 2001 increased
$389,000 or 8% from the prior year. This increase was primarily attributable
to additional salaries and recruiting costs related to the building of a new
direct sales force during the end of fiscal 2001 necessary to support sales of
the ON-Q® Pain Management System during 2002. As a percentage of total
revenues, selling and marketing expenses increased by less than one percentage
point over the prior year.

General and administrative expenses for the year ended December 31, 2001
increased $1,235,000 or 15% from the prior year. This increase was primarily
due to higher professional fees, investor relations expenses, compensation and
various other costs associated with the growth in the business. As a
percentage of total revenues, general and administrative expenses increased
over the prior year by 3%.

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, 2001
increased $237,000 or 12% from the prior year due primarily to increased
efforts on the new pain management products. Product development expense has
remained relatively consistent as a percentage of net product sales during 2001
compared to 2000.

During the year ended December 31, 2001, the Company recorded income tax
expense of $856,000, compared to income tax expense of $1,113,000 recorded for
the year ended December 31, 2000. The Companys effective tax rate remained
relatively constant from year to year, decreasing from 40.8% in 2000 to 40.3 %
in 2001.

Liquidity and Capital Resources

During the year ended December 31, 2002, cash of $3,097,000 was provided by
operating activities consisting of a net loss of $3,035,000 plus non-cash
expenses of $6,052,000, and net changes in operating assets and liabilities of
$80,000.

The Company used cash for investing activities during the year ended December
31, 2002 by acquiring net leasehold improvements, furniture, fixtures,
equipment and other assets of $2,677,000 for use in its operations. In
addition, during fiscal 2002, there was a net cash outflow related to other
assets of $478,000, primarily related to investment in patents.

During the year ended December 31, 2002, cash of $163,000 was used in financing
activities consisting primarily of net payments on notes payable of $226,000
partially offset by $63,000 in proceeds from the exercise of stock options.

As of December 31, 2002, the Company had cash and cash equivalents of
$1,700,000, net receivables of $10,483,000, and net working capital of
$16,357,000. 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
increase its borrowings in order to increase its expenditures for selling and
marketing expenses, to fund increased product development, or for other
purposes.

The Company has a working capital line of credit with a bank expiring in
December 2003. Under the line of credit, the Company may borrow up to the
lesser of $4,000,000 or 80% of eligible accounts receivable and 25% of eligible

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inventory, as defined, at the banks prime rate plus 0.50% (4.75% at December
31, 2002). As of December 31, 2002, there were funds available for borrowing
of $3,200,000, and no amounts outstanding.

The Companys InfuSystem subsidiary has a revolving line of credit with a bank
under which it may borrow up to $2,500,000, or 80% of eligible accounts
receivable, as defined, at the banks prime rate less 0.25% (4.00% at December
31, 2002). There were no outstanding borrowings under the line of credit as of
December 31, 2002 and the entire amount was available for borrowing. The
credit line expires April 1, 2003. The Company intends to renew the line of
credit or seek replacement financing. In addition, InfuSystem has an unused
loan facility under which it may borrow up to $1,000,000 for the purchase of
equipment.

The lines of credit and the notes 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,
2002, the Company was in compliance with all such covenants.

Contractual Obligations and Commercial Commitments

As of December 31, 2002, future payments related to contractual obligations and
commercial commitments are as follows:

|                                                         |  |                      |           |              |  |              |           |               |  |       |           |  |  |   |           |  |  |   |           | 
|-------------------------------------------------------- |  | -------------------- | --------- | ------------ |  | ------------ | --------- | ------------- |  | ----- | --------- |  |  | - | --------- |  |  | - | --------- | 
|                                                         |  | Amount Due by Period
|                                                         |  |                     
|                                                         |  | Less than 1 year     |           | 1 to 3 years |  | 4 to 5 years |           | After 5 years |  | Total
|                                                         |  |                      |           |              |  |              |           |               |  |      
|Capital Lease Obligations                                |  | $                    | 77,000    |              |  | $            | 1,000     |               |  | $     |          |  |  | $ |          |  |  | $ | 78,000    | 
|Operating Lease
Obligations for
Facilities               |  |                      | 791,000   |              |  |              | 1,388,000 |               |  |       | 1,076,000 |  |  |   | 1,928,000 |  |  |   | 5,183,000 | 
|Purchase Commitments
with Suppliers                      |  |                      | 2,763,000 |              |  |              |          |               |  |       |          |  |  |   |          |  |  |   | 2,763,000 | 
|                                                         |  |                      |           |              |  |              |           |               |  |       |           |  |  |   |           |  |  |   |           | 
|Total Contractual
Obligations and
Commercial Commitments |  | $                    | 3,631,000 |              |  | $            | 1,389,000 |               |  | $     | 1,076,000 |  |  | $ | 1,928,000 |  |  | $ | 8,024,000 | 
|                                                         |  |                      |           |              |  |              |           |               |  |       |           |  |  |   |           |  |  |   |           | 

New Accounting Pronouncements



| |  | New Accounting Pronouncements In June 2001, the FASB issued SFAS No. 141,
Business Combinations(SFAS 141). SFAS 141 requires that all business
combinations initiated after June 30, 2001 be accounted for under the purchase
method. SFAS 141 superseded APB Opinion No. 16, Business Combinations, and
SFAS No. 38, Accounting for
Preacquisition Contingencies of Purchased Enterprisesand is effective for all
business combinations initiated after June 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Also in June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets(SFAS 142). SFAS 142 addresses the financial accounting and reporting
requirements for acquired goodwill and other intangible assets. The Company
adopted the provisions of SFAS 142 effective January 1, 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 annually thereafter. See Note 2 to
Consolidated Financial Statements.                                                                                                                                                                                                                                                                                          
|
| |  | In August 2001, the FASB issued 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 is currently evaluating the provisions of SFAS 143 but expects that
the provisions of SFAS 143 will not have a material impact on its consolidated
results of operations and financial position upon adoption.                                                                                                                                                                                                     
|
| |  | In October 2001, the FASB issued SFAS No. 144 Accounting for the Impairment or
Disposal of Long-Lived Assets(SFAS 144). SFAS 144 establishes a single
accounting model for the impairment or disposal of long-lived assets and new
standards for reporting discontinued operations. SFAS 144 superseded SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Ofand APB Opinion No. 30, Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions.The
provisions of SFAS 144 are effective in fiscal years beginning after December
15, 2001 and, in general, are to be applied prospectively. The Company adopted
the provisions of SFAS 144 on January 1, 2002 and such adoption did not have a
material impact on its consolidated results of operations and financial
position.
|
| |  | In July 2002, the FASB issued Statement of Financial Accounting Standards 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). 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                                                                                                                                               

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| |  | 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. The Company will apply SFAS 146 to exit and disposal
activities initiated after December 31, 2002.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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 is currently evaluating the recognition provisions of FIN 45 but
expects that they will not have a material adverse impact on its consolidated
financial statements upon adoption.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In December 2002, the FASB issued Statement of Financial Accounting Standards
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 will 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 financial statements for calculation of pro
forma net income (loss).
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In January 2003, the FASB issued FASB Interpretation No. 46 (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 does not have equity investors with voting
rights or has equity investors that do not provide sufficient financial
resources for the entity to support its activities. FIN 46 requires certain
variable interest entities to be consolidated by the primary beneficiary of the
entity if the entity investors in the entity do not have the characteristics of

a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003. The
consolidation requirements apply to older entities in the first fiscal year or
interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company
expects that the provisions of FIN 46 will not have a material impact on its
consolidated financial statements upon adoption since the Company currently has
no variable interest entities.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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, 2002, the carrying values of the Companys
financial instruments approximated fair values based upon current market
prices and rates.

It is the Companys current policy not to enter into derivative financial
instruments. The Company did not have any significant direct foreign currency
exposure at December 31, 2002.




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 14 are
filed as part of this report.

Financial Statement Schedule

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

|                                 |  |            |           |                  |  |            |         |        |  |                   |          |   |  |  |           | 
|-------------------------------- |  | ---------- | --------- | ---------------- |  | ---------- | ------- | ------ |  | ----------------- | -------- | - |  |  | --------- | 
|                                 |  | Balance at |           |                  |  |            |         |        |  |                   |          |   |  | 
|                                 |  | Beginning  |           | Charged to Costs |  |            |         |        |  | Balance at End of
|Classification                   |  | of Period  |           | and Expenses     |  | Deductions |         | Period
|                                 |  |            |           |                  |  |            |         |       
|YEAR ENDED DECEMBER 31, 2000:    |  |            |           |                  |  |            |         |        |  |                   |          |   |  |  |           | 
|Allowance for doubtful accounts  |  |            | 2,325,000 |                  |  |            | 425,000 |        |  |                   | (263,000 | ) |  |  | 2,487,000 | 
|Reserve for obsolete inventories |  |            | 1,668,000 |                  |  |            | 248,000 |        |  |                   | (386,000 | ) |  |  | 1,530,000 | 
|YEAR ENDED DECEMBER 31, 2001:    |  |            |           |                  |  |            |         |        |  |                   |          |   |  |  |           | 
|Allowance for doubtful accounts  |  |            | 2,487,000 |                  |  |            | 165,000 |        |  |                   | (72,000  | ) |  |  | 2,580,000 | 
|Reserve for obsolete inventories |  |            | 1,530,000 |                  |  |            | 439,000 |        |  |                   | (170,000 | ) |  |  | 1,799,000 | 
|YEAR ENDED DECEMBER 31, 2002:    |  |            |           |                  |  |            |         |        |  |                   |          |   |  |  |           | 
|Allowance for doubtful accounts  |  |            | 2,580,000 |                  |  |            | 135,000 |        |  |                   | (681,000 | ) |  |  | 2,034,000 | 
|Reserve for obsolete inventories |  |            | 1,799,000 |                  |  |            | 230,000 |        |  |                   | (190,000 | ) |  |  | 1,839,000 | 

Selected Quarterly Financial Data

See information set forth above under the heading Selected Quarterly Financial
Data on page 12.




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

Not applicable.

20



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##### Table of Contents






PART III




Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

There is incorporated herein by reference the information required by this
Item included in the Companys Proxy Statement for the 2003 Annual Meeting of
Stockholders under the captions Election of Directors and Section 16(a)
Beneficial Ownership Reporting Compliance, 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, 2002 and the information from the section
entitled Executive Officers of the Registrant in Part I of this report.




Item 11. EXECUTIVE COMPENSATION

There is incorporated herein by reference the information required by this Item
included in the Companys Proxy Statement for the 2003 Annual Meeting of
Stockholders under the captions Board Compensation, Executive Compensation,
Report of the Compensation Committee, Compensation Committee Interlock
Insider Participation and Stock Performance Graph 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, 2002.




Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

There is incorporated herein by reference the information required by this
Item included in the Companys Proxy Statement for the 2003 Annual Meeting of
Stockholders under the caption Principal Shareholders and Stock Ownership of
Management, 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,
2002.




Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

There is incorporated herein by reference the information required by this Item
included in the Companys definitive proxy statement for the 2003 annual
meeting of stockholders under the caption Indebtedness of Management, 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, 2002.




Item 14. CONTROLS AND PROCEDURES

Within the 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Companys
management, including the Companys Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Companys
disclosure controls and procedures as defined in Exchange Act Rule 13a-14.
Based upon that evaluation, the Companys 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 SEC filings. There have been no
significant changes in the Companys internal controls or in other factors that
could significantly affect these internal controls subsequent to the date of
our most recent evaluation.

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PART IV




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

| |  |  |  |  |  |              |  | 
| |  |  |  |  |  | ------------ |  | 
| |  |  |  |  |  | Page in This
| |  |  |  |  |  | Report      
| |  |  |  |  |  |             

|                                                                                   |                                                    |                                                                                                          |  |  |     |  |  | 
|---------------------------------------------------------------------------------- | -------------------------------------------------- | -------------------------------------------------------------------------------------------------------- |  |  | --- |  |  | 
|(a)     Documents filed as part of this report:                                    |                                                    |                                                                                                          |  | 
|                                                                                   |                                                    |                                                                                                          |  |  |     | 
|                                                                                   | (1) Financial Statements                           |                                                                                                          |  |  |    
|                                                                                   |                                                    | The 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                                                        |  |  | 20  | 
|                                                                                   |                                                    | All other schedules are omitted, as the required information is inapplicable                             |  |  |     | 
|                                                                                   | (3) Exhibits                                       |                                                                                                          |  |  |    
|                                                                                   |                                                    | The list of exhibits contained in the accompanying Index to Exhibits
is herein incorporated by reference |  |  |     | 
|                                                                                  
|(b)     Reports on Form 8-K                                                        |                                                    |                                                                                                          |  | 
|                                                                                  
|There were no reports on Form 8-K filed during the quarter ended December
31, 2002 |                                                    |                                                                                                          |  | 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                                        |  |     
|----------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                        |  | Page
|                                                                                                                        |  |     
|Independent Auditors Report                                                                                            |  | F-1 
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                                            |  | F-2 
|Consolidated Statements of Operations and Comprehensive Operations
For the Years Ended December 31, 2002, 2001 and 2000 |  | F-3 
|Consolidated Statements of Shareholders Equity for the
Years Ended December 31, 2002, 2001 and 2000                    |  | F-4 
|Consolidated Statements of Cash Flows for the Years
Ended December 31, 2002, 2001 and 2000                              |  | F-5 
|Notes to Consolidated Financial Statements                                                                              |  | F-6 

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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, 2002 and 2001,
and the related consolidated statements of operations and comprehensive
operations, shareholders equity and cash flows for each of the three years in
the period ended December 31, 2002. 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, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, 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 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.

|                                                              
|--------------------------------------------------------------
|/s/ Deloitte & Touche LLP                                     
|                                                              
|DELOITTE & TOUCHE LLP
Costa Mesa, California
February 27, 2003

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

|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |         |  
|---------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---- | ------------ | ------- | ------------ | - | ------ | ------- | -
|                                                           |                                                                                                                                                                   |      | December 31, |         | December 31,
|(Amounts in thousands, except share and per share amounts) |                                                                                                                                                                   | 2002 |              | 2001   
|                                                           |                                                                                                                                                                   |      |              |        
|Assets                                                     |                                                                                                                                                                   |      |              |         |              |   |        |        
|Current assets:                                            |                                                                                                                                                                   |      |              |         |              |   |        |        
|                                                           | Cash and cash equivalents                                                                                                                                         |      | $            | 1,700   |              |   | $      | 2,033   |  
|                                                           | Accounts receivable, less allowance for doubtful accounts of $2,034
and $2,580 at December 31, 2002 and 2001, respectively                                        |      |              | 10,483  |              |   |        | 10,010  |  
|                                                           | Inventories, net                                                                                                                                                  |      |              | 7,046   |              |   |        | 6,984   |  
|                                                           | Prepaid expenses and other current assets                                                                                                                         |      |              | 477     |              |   |        | 353     |  
|                                                           | Deferred taxes                                                                                                                                                    |      |              | 2,541   |              |   |        | 2,294   |  
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |         |  
|                                                           | Total current assets                                                                                                                                              |      |              | 22,247  |              |   |        | 21,674  |  
|Property, net                                              |                                                                                                                                                                   |      | 5,626        |         |              |   | 4,805  |        
|Goodwill                                                   |                                                                                                                                                                   |      | 2,639        |         |              |   | 6,113  |        
|Other intangible assets, net                               |                                                                                                                                                                   |      | 1,134        |         |              |   | 902    |        
|Other long-term assets                                     |                                                                                                                                                                   |      | 155          |         |              |   | 168    |        
|Deferred taxes                                             |                                                                                                                                                                   |      | 1,560        |         |              |   | 2,042  |        
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |         |  
|Total assets                                               |                                                                                                                                                                   | $    | 33,361       |         |              | $ | 35,704 |        
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |        
|Liabilities and Shareholders Equity                       |                                                                                                                                                                   |      |              |         |              |   |        |        
|Current liabilities:                                       |                                                                                                                                                                   |      |              |         |              |   |        |        
|                                                           | Accounts payable                                                                                                                                                  |      | $            | 3,898   |              |   | $      | 3,115   |  
|                                                           | Accrued payroll and related expenses                                                                                                                              |      |              | 1,349   |              |   |        | 1,875   |  
|                                                           | Income taxes payable                                                                                                                                              |      |              | 507     |              |   |        | 576     |  
|                                                           | Current portion of long-term debt                                                                                                                                 |      |              | 77      |              |   |        | 221     |  
|                                                           | Other liabilities                                                                                                                                                 |      |              | 59      |              |   |        | 65      |  
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |         |  
|                                                           | Total current liabilities                                                                                                                                         |      |              | 5,890   |              |   |        | 5,852   |  
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |         |  
|Long-term debt, less current portion                       |                                                                                                                                                                   |      | 1            |         |              |   | 83     |        
|Commitments and contingencies (Note 7)                     |                                                                                                                                                                   |      |              |         |              |   |        |        
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |        
|Shareholders 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, 15,473,138
and 15,344,550 shares issued and outstanding at December 31, 2002 and 2001,
respectively |      |              | 43,106  |              |   |        | 42,274  |  
|                                                           | Accumulated other comprehensive income (loss)                                                                                                                     |      |              | (95     | )            |   |        | 1       |  
|                                                           | Accumulated deficit                                                                                                                                               |      |              | (15,541 | )            |   |        | (12,506 | )
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |         |  
|                                                           | Net shareholders equity                                                                                                                                          |      |              | 27,470  |              |   |        | 29,769  |  
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |         |  
|Total liabilities and shareholders equity                 |                                                                                                                                                                   | $    | 33,361       |         |              | $ | 35,704 |        
|                                                           |                                                                                                                                                                   |      |              |         |              |   |        |         |  

See accompanying Notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE OPERATIONS

|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|------------------------------------------------------------------------------------ | -------------------------- | ---- | ------------------------ | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                                                                                     |                            |      | Years ended December 31,
|(Amounts in thousands, except per share amounts)                                     |                            | 2002 |                          | 2001   |  | 2000
|                                                                                     |                            |      |                          |        |  |     
|Revenues:                                                                            |                            |      |                          |        |  |      |        |        |  |   |        |       
|                                                                                     | Net product sales          |      | $                        | 27,824 |  |      | $      | 22,942 |  |   | $      | 23,497 | 
|                                                                                     | Rental income and other    |      |                          | 10,293 |  |      |        | 10,363 |  |   |        | 8,469  | 
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|                                                                                     | Total revenues             |      |                          | 38,117 |  |      |        | 33,305 |  |   |        | 31,966 | 
|Cost of revenues                                                                     |                            |      | 14,597                   |        |  |      | 14,011 |        |  |   | 13,710 |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Gross profit                                                                         |                            |      | 23,520                   |        |  |      | 19,294 |        |  |   | 18,256 |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Operating expenses                                                                   |                           
|                                                                                     | Selling and marketing      |      |                          | 12,324 |  |      |        | 5,504  |  |   |        | 5,115  | 
|                                                                                     | General and administrative |      |                          | 8,336  |  |      |        | 9,385  |  |   |        | 8,150  | 
|                                                                                     | Product development        |      |                          | 2,104  |  |      |        | 2,238  |  |   |        | 2,001  | 
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|                                                                                     | Total operating expenses   |      |                          | 22,764 |  |      |        | 17,127 |  |   |        | 15,266 | 
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Operating income                                                                     |                            |      | 756                      |        |  |      | 2,167  |        |  |   | 2,990  |       
|Interest expense (income), net                                                       |                            |      | (6                       | )      |  |      | 44     |        |  |   | 265    |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Income before income taxes and cumulative
effect of a change in accounting principle |                            |      | 762                      |        |  |      | 2,123  |        |  |   | 2,725  |       
|Income tax provision                                                                 |                            |      | 323                      |        |  |      | 856    |        |  |   | 1,113  |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Net income before cumulative effect of a change
in accounting principle              |                            |      | 439                      |        |  |      | 1,267  |        |  |   | 1,612  |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Cumulative effect of a change in accounting
principle for goodwill                   |                            |      | (3,474                   | )      |  |      |       |        |  |   |       |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Net income (loss)                                                                    |                            |      | (3,035                   | )      |  |      | 1,267  |        |  |   | 1,612  |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Net income per share, before cumulative effect
of a change in accounting principle   |                            |      |                          |        |  |      |        |        |  |   |        |       
|Basic                                                                                |                            | $    | 0.03                     |        |  | $    | 0.08   |        |  | $ | 0.11   |       
|Diluted                                                                              |                            |      | 0.03                     |        |  |      | 0.08   |        |  |   | 0.10   |       
|Loss per share from cumulative effect of a
change in accounting principle            |                            |      |                          |        |  |      |        |        |  |   |        |       
|Basic                                                                                |                            | $    | (0.23                    | )      |  | $    |       |        |  | $ |       |       
|Diluted                                                                              |                            |      | (0.22                    | )      |  |      |       |        |  |   |       |       
|Net income (loss) per share                                                          |                            |      |                          |        |  |      |        |        |  |   |        |       
|Basic                                                                                |                            | $    | (0.20                    | )      |  | $    | 0.08   |        |  | $ | 0.11   |       
|Diluted                                                                              |                            |      | (0.19                    | )      |  |      | 0.08   |        |  |   | 0.10   |       
|Comprehensive Operations:                                                            |                            |      |                          |        |  |      |        |        |  |   |        |       
|Net income (loss)                                                                    |                            | $    | (3,035                   | )      |  | $    | 1,267  |        |  | $ | 1,612  |       
|Foreign currency translation adjustments                                             |                            |      | (96                      | )      |  |      | (34    | )      |  |   | 9      |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 
|Comprehensive income (loss)                                                          |                            | $    | (3,131                   | )      |  | $    | 1,233  |        |  | $ | 1,621  |       
|                                                                                     |                            |      |                          |        |  |      |        |        |  |   |        |        | 

See accompanying Notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY

|                                          |  |              |        |        |  |               |        |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   |        |  
|----------------------------------------- |  | ------------ | ------ | ------ |  | ------------- | ------ | ----------- |  | ------- | ---- | --- |  | ----------- | --- | - |  | - | ------- | - |  | - | ------ | -
|                                          |  |              |        |        |  |               |        |             |  |         |      |     |  | Accumulated |     |   |  |   |         |   |  |  
|                                          |  |              |        |        |  |               |        |             |  |         |      |     |  | Other       |     |   |  |   |         |   |  |  
|                                          |  | Common Stock |        | Common |  | Comprehensive |        |             |  |         |      |     |  |            
|                                          |  |              |        | Stock  |  | Income        |        | Accumulated |  |         |      |    
|(Amounts in thousands)                    |  | Shares       |        | Amount |  | Warrants      |        | (Loss)      |  | Deficit |      | Net
|                                          |  |              |        |        |  |               |        |             |  |         |      |    
|Balance, January 1, 2000                  |  |              | 14,692 |        |  | $             | 39,414 |             |  | $       | 615  |     |  | $           | 26  |   |  | $ | (15,385 | ) |  | $ | 24,670 |  
|Exercise of common stock options          |  |              | 182    |        |  |               | 406    |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   | 406    |  
|Common stock issued for acquisition       |  |              | 200    |        |  |               | 750    |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   | 750    |  
|Settlement of escrow shares               |  |              | (22    | )      |  |               | (67    | )           |  |         |      |     |  |             |     |   |  |   |         |   |  |   | (67    | )
|Tax impact from exercise of stock options |  |              |        |        |  |               | (145   | )           |  |         |      |     |  |             |     |   |  |   |         |   |  |   | (145   | )
|Stock based compensation                  |  |              |        |        |  |               | 383    |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   | 383    |  
|Foreign currency translation adjustment   |  |              |        |        |  |               |        |             |  |         |      |     |  |             | 9   |   |  |   |         |   |  |   | 9      |  
|Net income                                |  |              |        |        |  |               |        |             |  |         |      |     |  |             |     |   |  |   | 1,612   |   |  |   | 1,612  |  
|                                          |  |              |        |        |  |               |        |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   |        |  
|Balance, December 31, 2000                |  |              | 15,052 |        |  | $             | 40,741 |             |  | $       | 615  |     |  | $           | 35  |   |  | $ | (13,773 | ) |  | $ | 27,618 |  
|Exercise of common stock options          |  |              | 293    |        |  |               | 156    |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   | 156    |  
|Tax impact from exercise of stock options |  |              |        |        |  |               | 129    |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   | 129    |  
|Expiration of common stock warrants       |  |              |        |        |  |               | 615    |             |  |         | (615 | )   |  |             |     |   |  |   |         |   |  |   |        |  
|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 |  
|                                          |  |              |        |        |  |               |        |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   |        |  
|Exercise of common stock options          |  |              | 55     |        |  |               | 63     |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   | 63     |  
|Tax impact 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 |  
|                                          |  |              |        |        |  |               |        |             |  |         |      |     |  |             |     |   |  |   |         |   |  |   |        |  

See accompanying Notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |        |        |   |  |  |  |  |  |  |  | 
|-------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------ | --------------------------------------------------------- | ------ | ----------------------- | ---- | ------ | ----- | ------ | ------ | ------ | ----- | ------ | ------ | - |  |  |  |  |  |  |  | 
|                                                               |                                                                                          |                                                                                      |                                                           |        | Year ended December 31, |      |        |       |        |        |        |       |       
|(Amounts in thousands)                                         |                                                                                          | 2002                                                                                 |                                                           | 2001   |                         | 2000 |        |       |        |        |        |       |        |       
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |        |       
|Cash flows from operating activities:                          |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |      
|                                                               | Net income (loss)                                                                        |                                                                                      | $                                                         | (3,035 | )                       |      | $      | 1,267 |        |        | $      | 1,612 |       
|                                                               | Adjustments to reconcile net income (loss) to net cash provided by
operating activities: |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|                                                               |                                                                                          | Deferred taxes                                                                       |                                                           |        | 235                     |      |        |       | 573    |        |        |       | 951    |       
|                                                               |                                                                                          | Depreciation and amortization                                                        |                                                           |        | 2,089                   |      |        |       | 2,661  |        |        |       | 2,648  |       
|                                                               |                                                                                          | Cumulative effect of a change in accounting principle                                |                                                           |        | 3,474                   |      |        |       |       |        |        |       |       |       
|                                                               |                                                                                          | Loss on disposal of property                                                         |                                                           |        | 8                       |      |        |       | 3      |        |        |       | 10     |       
|                                                               |                                                                                          | Stock based compensation                                                             |                                                           |        | 752                     |      |        |       | 633    |        |        |       | 383    |       
|                                                               |                                                                                          | Change in inventory obsolescence reserve                                             |                                                           |        | 40                      |      |        |       | 269    |        |        |       | (138   | )     
|                                                               |                                                                                          | Change in allowance for doubtful accounts                                            |                                                           |        | (546                    | )    |        |       | 93     |        |        |       | 162    |       
|                                                               |                                                                                          | Changes in operating assets and liabilities, net of effect of business
acquisitions: |                                                           |        |                         |      |        |       |        |        |        |       |        |       
|                                                               |                                                                                          |                                                                                      | Accounts receivable                                       |        |                         | 70   |        |       |        | 2,380  |        |       |        | (3,696 | )
|                                                               |                                                                                          |                                                                                      | Inventories                                               |        |                         | (102 | )      |       |        | (3,092 | )      |       |        | (283   | )
|                                                               |                                                                                          |                                                                                      | Prepaid expenses and other                                |        |                         | (42  | )      |       |        | 19     |        |       |        | 235    |  
|                                                               |                                                                                          |                                                                                      | Accounts payable and accrued payroll and related
expenses |        |                         | 174  |        |       |        | 959    |        |       |        | (106   | )
|                                                               |                                                                                          |                                                                                      | Income taxes payable                                      |        |                         | (51  | )      |       |        | (68    | )      |       |        | (124   | )
|                                                               |                                                                                          |                                                                                      | Other liabilities                                         |        |                         | 31   |        |       |        | (120   | )      |       |        | 70     |  
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Net cash provided by operating activities                      |                                                                                          |                                                                                      | 3,097                                                     |        |                         |      | 5,577  |       |        |        | 1,724  |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Cash flows from investing activities:                          |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |      
|                                                               |                                                                                          | Capital expenditures                                                                 |                                                           |        | (2,677                  | )    |        |       | (1,819 | )      |        |       | (2,948 | )     
|                                                               |                                                                                          | Cash paid for acquisition, net of cash received                                      |                                                           |        |                        |      |        |       | (165   | )      |        |       | (584   | )     
|                                                               |                                                                                          | Change in other assets                                                               |                                                           |        | (478                    | )    |        |       | (417   | )      |        |       | (232   | )     
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Net cash used in investing activities                          |                                                                                          |                                                                                      | (3,155                                                    | )      |                         |      | (2,401 | )     |        |        | (3,764 | )    
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Cash flows from financing activities:                          |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |      
|                                                               |                                                                                          | Net proceeds (repayments) from line of credit                                        |                                                           |        |                        |      |        |       | (500   | )      |        |       | 412    |       
|                                                               |                                                                                          | Proceeds from issuance of note payable                                               |                                                           |        |                        |      |        |       |       |        |        |       | 812    |       
|                                                               |                                                                                          | Payments on notes payable                                                            |                                                           |        | (226                    | )    |        |       | (1,975 | )      |        |       | (1,604 | )     
|                                                               |                                                                                          | Proceeds from exercise of stock options and warrants                                 |                                                           |        | 63                      |      |        |       | 156    |        |        |       | 406    |       
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Net cash provided by (used in) financing activities            |                                                                                          |                                                                                      | (163                                                      | )      |                         |      | (2,319 | )     |        |        | 26     |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Effect of exchange rates on cash                               |                                                                                          |                                                                                      | (112                                                      | )      |                         |      | (8     | )     |        |        | 6      |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Net increase (decrease) in cash and cash equivalents           |                                                                                          |                                                                                      | (333                                                      | )      |                         |      | 849    |       |        |        | (2,008 | )    
|Cash and cash equivalents at beginning of year                 |                                                                                          |                                                                                      | 2,033                                                     |        |                         |      | 1,184  |       |        |        | 3,192  |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Cash and cash equivalents at end of year                       |                                                                                          | $                                                                                    | 1,700                                                     |        |                         | $    | 2,033  |       |        | $      | 1,184  |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|SUPPLEMENTAL CASH FLOW INFORMATION:                            |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |      
|Interest paid                                                  |                                                                                          | $                                                                                    | 11                                                        |        |                         | $    | 98     |       |        | $      | 256    |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Income tax payments                                            |                                                                                          | $                                                                                    | 139                                                       |        |                         | $    | 413    |       |        | $      | 245    |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Tax impact from exercise of stock options                      |                                                                                          | $                                                                                    | 17                                                        |        |                         | $    | 129    |       |        | $      | (145   | )    
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Settlement of escrow shares                                    |                                                                                          | $                                                                                    |                                                          |        |                         | $    |       |       |        | $      | 67     |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Liabilities issued and assumed in connection with acquisition: |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |      
|                                                               | Fair value of assets acquired (including intangibles)                                    |                                                                                      | $                                                         |       |                         |      | $      | 165   |        |        | $      | 2,222 |       
|                                                               | Cash outflows for business acquisition                                                   |                                                                                      |                                                           |       |                         |      |        | (165  | )      |        |        | (584  | )     
|                                                               | Common stock and warrants issued                                                         |                                                                                      |                                                           |       |                         |      |        |      |        |        |        | (750  | )     
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       
|Liabilities issued and assumed                                 |                                                                                          | $                                                                                    |                                                          |        |                         | $    |       |       |        | $      | 888    |      
|                                                               |                                                                                          |                                                                                      |                                                           |        |                         |      |        |       |        |        |        |       |       

See accompanying Notes to Consolidated Financial Statements.

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##### Table of Contents



Notes to Consolidated Financial Statements



|1. |  | 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 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 medical infusion pumps. Spinal Specialties, Inc., another
wholly owned subsidiary of I-Flow Corporation, is primarily engaged in the
manufacturing and marketing of custom regional anesthesia kits with expanded
capabilities in interventional radiology products.
|  
|   |  | 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, money-market funds and U.S. Treasury bills with an original maturity date
of 90 days or less.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | 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:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

|                |  |      |           |      |  |   |           | 
|--------------- |  | ---- | --------- | ---- |  | - | --------- | 
|                |  | 2002 |           | 2001
|                |  |      |           |     
|Raw Materials   |  | $    | 4,404,000 |      |  | $ | 4,553,000 | 
|Work in Process |  |      | 411,000   |      |  |   | 199,000   | 
|Finished Goods  |  |      | 2,231,000 |      |  |   | 2,232,000 | 
|                |  |      |           |      |  |   |           | 
|Total           |  | $    | 7,046,000 |      |  | $ | 6,984,000 | 
|                |  |      |           |      |  |   |           | 



| |  | 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.
SFAS No. 144 superseded SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and is effective
for fiscal years beginning after December 15, 2001. 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. The Company has determined that there
was no impairment at December 31, 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | 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:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

|                                          |  |      |            |      |  |   |            |  
|----------------------------------------- |  | ---- | ---------- | ---- |  | - | ---------- | -
|                                          |  | 2002 |            | 2001
|                                          |  |      |            |     
|Furniture, fixtures and equipment         |  | $    | 8,585,000  |      |  | $ | 6,837,000  |  
|Rental and demonstration equipment        |  |      | 6,386,000  |      |  |   | 5,494,000  |  
|Accumulated depreciation and amortization |  |      | (9,345,000 | )    |  |   | (7,526,000 | )
|                                          |  |      |            |      |  |   |            |  
|Total                                     |  | $    | 5,626,000  |      |  | $ | 4,805,000  |  
|                                          |  |      |            |      |  |   |            |  

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##### Table of Contents





| |  | Change in Accounting for Goodwill and Other Intangibles 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 on the future undiscounted cash
flows and had determined that there was no impairment of goodwill (see New
Accounting Pronouncements). The Companys other intangible assets include
patents and licensing rights and are being amortized using the straight-line
method over five to seven years. 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. See
Note 2 to Notes to Consolidated Financial Statements.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Revenue Recognition Revenue from product sales is recognized at the time of
shipment and passage of title. Provision is made currently for the amount of
estimated product returns 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. Such adjustments are typically identified and recorded at the point
of cash application, claim denial or account review.                                                                                                                                                                                                                                                         
|
| |  | 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. 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | During the fourth quarter of 2001, the Company repurchased inventory from
Ethicon Endo-Surgery, Inc. as part of the termination of a distribution
agreement. The repurchase was accounted for as a sales return, and
approximately $963,000 related to this transaction was included in accounts
payable as of December 31, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | 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 Issued to Employees
and 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.                                                                                                                                                                                                                                                                                                                                                    
|
| |  | The Company has adopted the disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. Accordingly, no compensation cost has
been recognized for stock option grants to employees and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

F-7



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| |  | 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 on 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)                                                                    |  | 2002                     |        | 2001 |  | 2000
|                                                                                                                    |  |                          |        |      |  |     
|Net income (loss)  as reported                                                                                     |  | $                        | (3,035 | )    |  | $    | 1,267 |   |  | $ | 1,612 |  
|Stock-based employee compensation included in
net income (loss), net of tax                                         |  | $                        | 397    |      |  | $    | 330   |   |  | $ | 220   |  
|Total stock based employee compensation expense
determined under fair value based method for
all awards, net of tax |  | $                        | (1,017 | )    |  | $    | (886  | ) |  | $ | (902  | )
|                                                                                                                    |  |                          |        |      |  |      |       |   |  |   |       |  
|Net income (loss)  pro forma                                                                                       |  | $                        | (3,655 | )    |  | $    | 711   |   |  | $ | 930   |  
|                                                                                                                    |  |                          |        |      |  |      |       |   |  |   |       |  
|Basic earnings (loss) per share  as reported                                                                       |  | $                        | (0.20  | )    |  | $    | 0.08  |   |  | $ | 0.11  |  
|Basic earnings (loss) per share  pro forma                                                                         |  | $                        | (0.24  | )    |  | $    | 0.05  |   |  | $ | 0.06  |  
|Diluted earnings (loss) per share  as reported                                                                     |  | $                        | (0.19  | )    |  | $    | 0.08  |   |  | $ | 0.10  |  
|Diluted earnings (loss) per share  pro forma                                                                       |  | $                        | (0.23  | )    |  | $    | 0.05  |   |  | $ | 0.06  |  
|                                                                                                                    |  |                          |        |      |  |      |       |   |  |   |       |  



| |  | 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 2002, 2001 and 2000: no dividend yield; expected
volatility 94% in 2002, 90% in 2001, and 94% in 2000; risk-free interest rate
of 3.04% in 2002, 4.75% in 2001, and 4.7% in 2000 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.                                                                                                                                                         
|
| |  | The following is a reconciliation between weighted average shares used in the
basic and diluted earnings per share calculations:                                                                                                                                                                                                                                                                     

|                               |                                                      |  |                          |            |      |  |      |            |  |  |  |            | 
|------------------------------ | ---------------------------------------------------- |  | ------------------------ | ---------- | ---- |  | ---- | ---------- |  |  |  | ---------- | 
|                               |                                                      |  | Years ended December 31,
|                               |                                                      |  | 2002                     |            | 2001 |  | 2000
|                               |                                                      |  |                          |            |      |  |     
|Basic net income per share     |                                                     
|                               | Weighted-average number of common shares outstanding |  |                          | 15,368,000 |      |  |      | 15,231,000 |  |  |  | 15,002,000 | 
|Effect of dilutive securities: |                                                      |  |                          |            |      |  |      |            |  |  |  |           
|                               | Stock options and unvested restricted stock          |  |                          | 511,000    |      |  |      | 518,000    |  |  |  | 645,000    | 
|                               |                                                      |  |                          |            |      |  |      |            |  |  |  |           
|Diluted net income per share   |                                                     
|                               | Weighted-average number of common
shares outstanding |  |                          | 15,879,000 |      |  |      | 15,749,000 |  |  |  | 15,647,000 | 
|                               |                                                      |  |                          |            |      |  |      |            |  |  |  |           

F-8



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| |  | 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, 2002, 2001 and 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | 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.                                                                                                                                                                                                                                                                                                   
|
| |  | New Accounting Pronouncements In June 2001, the FASB issued SFAS No. 141,
Business Combinations(SFAS 141). SFAS 141 requires that all business
combinations initiated after June 30, 2001 be accounted for under the purchase
method. SFAS 141 superseded APB Opinion No. 16, Business Combinations, and
SFAS No. 38, Accounting for
Preacquisition Contingencies of Purchased Enterprisesand is effective for all
business combinations initiated after June 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Also in June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets(SFAS 142). SFAS 142 addresses the financial accounting and reporting
requirements for acquired goodwill and other intangible assets. The Company
adopted the provisions of SFAS 142 effective January 1, 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 annually thereafter. See Note 2 to
Consolidated Financial Statements.                                                                                                                                                                                                                                                                                          
|
| |  | In August 2001, the FASB issued 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 is currently evaluating the provisions of SFAS 143 but expects that
the provisions of SFAS 143 will not have a material impact on its consolidated
results of operations and financial position upon adoption.                                                                                                                                                                                                     
|
| |  | In October 2001, the FASB issued SFAS No. 144 Accounting for the Impairment or
Disposal of Long-Lived Assets(SFAS 144). SFAS 144 establishes a single
accounting model for the impairment or disposal of long-lived assets and new
standards for reporting discontinued operations. SFAS 144 superseded SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Ofand APB Opinion No. 30, Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions.The
provisions of SFAS 144 are effective in fiscal years beginning after December
15, 2001 and, in general, are to be applied prospectively. The Company adopted
the provisions of SFAS 144 on January 1, 2002 and such adoption did not have a
material impact on its consolidated results of operations and financial
position.
|
| |  | In July 2002, the FASB issued Statement of Financial Accounting Standards 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). 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                                                                                                                                               

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| |  | 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. The Company will apply SFAS 146 to exit and disposal
activities initiated after December 31, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | 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 is currently evaluating the recognition provisions of FIN 45 but
expects that they will not have a material adverse impact on its consolidated
financial statements upon adoption.                                                                                                                                                                                         
|
| |  | In December 2002, the FASB issued Statement of Financial Accounting Standards
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 these provisions will 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 FASB Interpretation No. 46 (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
certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the entity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. The consolidation requirements apply to older entities
in the first fiscal year or interim period beginning after June 15, 2003.
Certain of the disclosure requirements apply in all financial statements issued
after January 31, 2003, regardless of when the variable interest entity was
established. The Company expects that the provisions of FIN 46 will not have a
material impact on its consolidated financial statements upon adoption since
the Company currently has no variable interest entities.
|
| |  | 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 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 generally consistent with the operating segments underlying the
reporting segments identified in Note 9.- Business Segments. This methodology
differs from the Companys previous policy, as permitted under accounting
standards existing at that time, of using undiscounted cash flows on an
enterprise-wide basis to determine if goodwill is recoverable.

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| |  | 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 business 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
segment resulted from the low profitability of the business segment.
|
| |  | The changes in carrying amount of goodwill by segment for the years ended
December 31, 2002 and 2001 are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

|                                |  |                   |            |         |  |       |           |   |  |   |            |  
|------------------------------- |  | ----------------- | ---------- | ------- |  | ----- | --------- | - |  | - | ---------- | -
|                                |  | Manufacturing and |            |         |  |      
|                                |  | Marketing         |            | Rentals |  | Total
|                                |  |                   |            |         |  |      
|Balance as of January 1, 2001   |  | $                 | 3,910,000  |         |  | $     | 2,875,000 |   |  | $ | 6,785,000  |  
|Goodwill acquired               |  |                   | 165,000    |         |  |       |           |   |  |   | 165,000    |  
|Amortization of goodwill        |  |                   | (601,000   | )       |  |       | (236,000  | ) |  |   | (837,000   | )
|                                |  |                   |            |         |  |       |           |   |  |   |            |  
|Balance as of December 31, 2001 |  |                   | 3,474,000  |         |  |       | 2,639,000 |   |  |   | 6,113,000  |  
|Impairment loss                 |  |                   | (3,474,000 | )       |  |       |           |   |  |   | (3,474,000 | )
|                                |  |                   |            |         |  |       |           |   |  |   |            |  
|Balance as of December 31, 2002 |  | $                 |           |         |  |       | 2,639,000 |   |  | $ | 2,639,000  |  
|                                |  |                   |            |         |  |       |           |   |  |   |            |  



| |  | As of December 31, 2002, the remaining goodwill of $2,639,000 is attributable
to the Companys rentals business segment and the Company has determined that
there was no impairment of this goodwill as of January 1, 2002 or December 31,
2002. 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, 2000.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                  |  |   |            |                                  |  |      |           |      |  |   |           |   |  | 
|--------------------------------- |  | - | ---------- | -------------------------------- |  | ---- | --------- | ---- |  | - | --------- | - |  | 
|                                  |  |   |            | For the years ended December 31,
|                                  |  |   |            | 2002                             |  | 2001 |           | 2000
|                                  |  |   |            |                                  |  |      |           |     
|Reported net income (loss)        |  | $ | (3,035,000 | )                                |  | $    | 1,267,000 |      |  | $ | 1,612,000 |  
|Add back:                         |  |   |            |                                  |  |      |           |      |  |   |           |  
|Goodwill amortization             |  |   |           |                                  |  |      | 837,000   |      |  |   | 1,064,000 |  
|Less: Tax effect of goodwill      |  |   |            |                                  |  |      |           |      |  |   |           |  
|amortization                      |  |   |           |                                  |  |      | (162,000  | )    |  |   | (263,000  | )
|                                  |  |   |            |                                  |  |      |           |      |  |   |           |  
|Adjusted net income (loss)        |  |   | (3,035,000 | )                                |  |      | 1,942,000 |      |  |   | 2,413,000 |  
|                                  |  |   |            |                                  |  |      |           |      |  |   |           |  
|Basic earnings per share          |  |   |            |                                  |  |      |           |      |  |   |           |  
|Reported net income (loss)        |  |   | (0.20      | )                                |  |      | 0.08      |      |  |   | 0.11      |  
|Goodwill amortization, net of tax |  |   |           |                                  |  |      | 0.05      |      |  |   | 0.05      |  
|                                  |  |   |            |                                  |  |      |           |      |  |   |           |  
|Adjusted net income (loss)        |  | $ | (0.20      | )                                |  | $    | 0.13      |      |  | $ | 0.16      |  
|                                  |  |   |            |                                  |  |      |           |      |  |   |           |  
|Diluted earnings per share        |  |   |            |                                  |  |      |           |      |  |   |           |  
|Reported net income (loss)        |  |   | (0.19      | )                                |  |      | 0.08      |      |  |   | 0.10      |  
|Goodwill amortization, net of tax |  |   |           |                                  |  |      | 0.04      |      |  |   | 0.05      |  
|                                  |  |   |            |                                  |  |      |           |      |  |   |           |  
|Adjusted net income               |  | $ | (0.19      | )                                |  | $    | 0.12      |      |  | $ | 0.15      |  
|                                  |  |   |            |                                  |  |      |           |      |  |   |           |  

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##### Table of Contents



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

|                 |  |                         |           |              |  |     |         |  |  |   |           | 
|---------------- |  | ----------------------- | --------- | ------------ |  | --- | ------- |  |  | - | --------- | 
|                 |  | 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 | 
|                 |  |                         |           |              |  |     |         |  |  |   |           | 

|                 |  |                         |           |              |  |     |         |  |  |   |         | 
|---------------- |  | ----------------------- | --------- | ------------ |  | --- | ------- |  |  | - | ------- | 
|                 |  | As of December 31, 2001
|                 |  |                        
|                 |  | Carrying                |           | Accumulated  |  |     |         | 
|                 |  | Amount                  |           | Amortization |  | Net
|                 |  |                         |           |              |  |    
|Patents          |  | $                       | 1,457,000 |              |  | $   | 615,000 |  |  | $ | 842,000 | 
|Licensing Rights |  |                         | 150,000   |              |  |     | 90,000  |  |  |   | 60,000  | 
|                 |  |                         |           |              |  |     |         |  |  |   |         | 
|Total            |  | $                       | 1,607,000 |              |  | $   | 705,000 |  |  | $ | 902,000 | 
|                 |  |                         |           |              |  |     |         |  |  |   |         | 



|   |  | The Company amortizes patents and licensing rights over a period of seven and
five years, respectively. Amortization expense was $256,000 and $214,000 for
the years ended December 31, 2002 and 2001, respectively. Amortization
expense of intangible assets is expected to be approximately $230,000 in each
of the next five fiscal years.                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|3. |  | Acquisition of Spinal Specialties, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | On January 14, 2000, the Company acquired Spinal Specialties, Inc., a designer
and manufacturer of custom spinal, epidural and nerve block infusion kits based
in San Antonio, Texas, for $1.5 million. The purchase price included $584,000
in cash and 200,000 shares of I-Flow common stock with a fair value of $3.75
per share for a total stock value of approximately $750,000. An additional
$165,000 of contingent purchase price was paid in January 2001. The
transaction was recorded using the purchase method of accounting and resulted
in the recording of $1,905,000 in goodwill.                                                                                                                                                                    
|  
|4. |  | Lines of Credit and Long-Term Debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|  
|   |  | The Company has a line of credit, expiring in December 2003, under which it may
borrow up to the lesser of $4,000,000 or 80% of eligible accounts receivable
and 25% of eligible inventories, as defined. There was $3,200,000 available
for borrowing under the line and no balance outstanding as of December 31,
2002. Interest is payable monthly at the banks prime rate plus 0.50%
(4.75% at December 31, 2002).                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | Additionally, the Companys wholly-owned subsidiary, InfuSystem, has a line of
credit agreement, expiring April 1, 2003. Under the terms of this line of
credit agreement, Infusystem may borrow up to the lesser of $2,500,000 or 80%
of its eligible accounts receivable, as defined. There was $2,500,000
available for borrowing under the line as of December 31, 2002. There were no
amounts outstanding under the line of credit as of December 31, 2002. The
Company intends to renew the line of credit or seek replacement financing.
Interest is payable monthly at the banks prime rate less 0.25% (4.00% at
December 31, 2002). In addition, InfuSystem has an unused facility under which
it may borrow up to $1,000,000 for the purchase of equipment.

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| |  | The Companys long-term debt consists of the following at December 31:
| |  | ----------------------------------------------------------------------

|                                                                                                                                                                                    |  |      |        |      |  |   |         | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | - | ------- | 
|                                                                                                                                                                                    |  | 2002 |        | 2001
|                                                                                                                                                                                    |  |      |        |     
|Capital Lease Obligationsunder which
interest is payable monthly at rates from 0
to 12.3%, due on various dates;
collateralized by the related assets
purchased by InfuSystem, Inc. |  |      | 78,000 |      |  |   | 260,000 | 
|Other                                                                                                                                                                               |  |      |       |      |  |   | 44,000  | 
|                                                                                                                                                                                    |  |      |        |      |  |   |         | 
|Total                                                                                                                                                                               |  |      | 78,000 |      |  |   | 304,000 | 
|Less current portion                                                                                                                                                                |  |      | 77,000 |      |  |   | 221,000 | 
|                                                                                                                                                                                    |  |      |        |      |  |   |         | 
|Total long-term debt                                                                                                                                                                |  | $    | 1,000  |      |  | $ | 83,000  | 
|                                                                                                                                                                                    |  |      |        |      |  |   |         | 



| |  | The lines of credit and the notes 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,
2002, the Company was in compliance with all such
covenants.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Future principal payments on long-term
debt are as follows:                                                                                                                                                                                                                                      

|                        |  |   |        | 
|----------------------- |  | - | ------ | 
|Year ended
December 31:
|                       
|2003                    |  | $ | 77,000 | 
|2004                    |  |   | 1,000  | 
|                        |  |   |        | 
|Total                   |  | $ | 78,000 | 
|                        |  |   |        | 



|5. |  | Shareholders Equity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Preferred Stock- As of December 31, 2002, 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, 2002, 2001 or 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|  
|   |  | 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 (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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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| |  | 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 ten years from the date they separate.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Common Stock- In December 2001 the Board of Directors of the Company approved
a Restricted Stock Plan pursuant to which employees of the Company may be
offered the opportunity to acquire common stock of the Company. A total of
125,000 shares were authorized for issuance under the plan. As of December 31,
2001, no shares were issued under the plan. As of December 31, 2002, 73,500
shares were issued and outstanding under the plan of which 3,000 were vested.
The remaining unvested shares vest over a period of three years subject to
acceleration of vesting based upon the achievement of individual performance
goals. Compensation expense of $32,000 related to such shares was recognized
in 2002. On February 27, 2003, the Board of Directors of the Company approved
an amendment to the Restricted Stock Plan authorizing an additional 250,000
shares for issuance under the plan, for a total of 375,000 shares authorized
for issuance under the plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | Stock Options and Warrants- During the year ended December 31, 2001, warrants
to purchase 250,000 shares of the Companys common stock expired unexercised
and the $615,000 original valuation of the warrants was reclassified to common
stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | 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 as discussed below. The shares available under the
1996 Plan could either be authorized and unissued shares or shares reacquired
by the Company through open market purchases or otherwise. Under the terms of
the 1996 Plan, if any award granted under the 1996 Plan expired, terminated or
was forfeited before the exercise thereof or the payment in full thereof, the
shares covered by the unexercised or unpaid portion became available for new
grants under the 1996 Plan. Options granted became exercisable at such times
as determined by the Compensation Committee of the Board of Directors and
expired on various dates up to ten years from the date of grant. The 1996 Plan
was terminated on May 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 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.
|
| |  | 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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

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| |  | 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. The shares available under the 2001 Plan may either be authorized
but unissued shares or shares reacquired by the Company through open market
purchases or otherwise. If any award granted under the 2001 Plan expires,
terminates or is forfeited before the exercise thereof or the payment in full
thereof, the shares covered by the unexercised or unpaid portion will become
available for new grants under the 2001 Plan. 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 ten years from the date of
grant.                                                                                                                                                                                
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The Company had 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, 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 $752,000, $633,000 and $383,000 has been recorded for each
of the years ended December 31, 2002, 2001 and 2000, respectively. The
remaining deferred compensation as of December 31, 2002 was approximately
$740,000 and will be amortized as the related awards are earned and vested
through 2007.                 
|
| |  | During fiscal year 2000, the Company granted options to nonemployees to
purchase 36,000 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 generally vest
over one year. The fair value of these options using the Black-Scholes
Pricing Model with the following weighted-average assumptions  expected life,
contractual life or 5 years, 79% stock volatility, average risk-free interest
rate of 4.7%, and no dividends during the expected term - was $50,000, of which
$40,000 and $10,000 was recorded as expense during the years ended December 31,
2001 and December 31, 2000, respectively.                                                                                                                                                                                                                                 
|
| |  | During fiscal year 2001, the Company granted options to nonemployees 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 generally vest
over one year. The fair value of these options using the Black-Scholes
Pricing Model with the following weighted-average assumptions  expected life,
contractual life or 5 years, 90% stock volatility, average risk-free interest
rate of 4.75%, and no dividends during the expected term - was $13,000, of
which $5,000 was recorded as expense during the year ended December 31, 2002,
and $4,000 was recorded as expense during the year ended December 31, 2001.                                                                                                                                                                                                      
|
| |  | During fiscal year 2002, the Company granted options to nonemployees to
purchase 48,600 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 generally vest
over one to five years. Of these options, 45,000 have been accounted for as a
variable award as the consultants performance is not complete, and a
performance commitment date has not been satisfied in accordance with the
provisions of EITF No. 96-18. During fiscal year 2002, the Company has
recorded stock based compensation related to the options to purchase 48,600
shares of common stock of approximately $26,000 using the Black-Scholes pricing
model with the following weighted-average assumptions  expected life,
contractual life of 1 to 5 years, 94% volatility, average risk-free interest
rate of 3.04%, and no dividends during the expected term.

F-15



---



##### Table of Contents





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

|                                                                                        |                                                          |  |           |           |                |   |           |      | 
|--------------------------------------------------------------------------------------- | -------------------------------------------------------- |  | --------- | --------- | -------------- | - | --------- | ---- | 
|                                                                                        |                                                          |  |           |           |                |   | Weighted-
|                                                                                        |                                                          |  | Number of |           | Average       
|                                                                                        |                                                          |  | Shares    |           | Exercise Price
|                                                                                        |                                                          |  |           |           |               
|Balance, January 1, 2000 (1,974,317 exercisable at a weighted-average price of $2.27)   |                                                          |  | 2,906,191 |           |                |   | 2.27      |     
|                                                                                        | Granted (weighted-average fair value of $2.57 per share) |  |           | 1,129,434 |                |   |           | 3.39 | 
|                                                                                        | Canceled/Expired                                         |  |           | (350,266  | )              |   |           | 3.19 | 
|                                                                                        | Exercised                                                |  |           | (182,266  | )              |   |           | 2.47 | 
|                                                                                        |                                                          |  |           |           |                |   |           |     
|Balance, December 31, 2000 (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      |     
|                                                                                        |                                                          |  |           |           |                |   |           |     



| |  | Options to purchase 2,149,000 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, 2002:

|                         |  |                     |           |                     |  |                |      |             |  |          |      |  |  |  |           |           |  |   |      | 
|------------------------ |  | ------------------- | --------- | ------------------- |  | -------------- | ---- | ----------- |  | -------- | ---- |  |  |  | --------- | --------- |  | - | ---- | 
|                         |  | 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   
|                         |  |                     |           |                     |  |                |      |             |  |         
|$0.25 - $1.12            |  |                     | 353,394   |                     |  |                | 3.00 |             |  | $        | 1.03 |  |  |  | 258,427   |           |  | $ | 1.01 | 
|$1.28 - $1.28            |  |                     | 1,065,561 |                     |  |                | 3.88 |             |  | $        | 1.28 |  |  |  | 359,097   |           |  | $ | 1.28 | 
|$1.38 - $2.18            |  |                     | 656,802   |                     |  |                | 2.10 |             |  | $        | 1.74 |  |  |  | 554,356   |           |  | $ | 1.76 | 
|$2.19 - $2.49            |  |                     | 691,913   |                     |  |                | 3.66 |             |  | $        | 2.47 |  |  |  | 73,373    |           |  | $ | 2.46 | 
|$2.50 - $2.89            |  |                     | 662,760   |                     |  |                | 2.43 |             |  | $        | 2.59 |  |  |  | 545,601   |           |  | $ | 2.54 | 
|$2.91 - $3.37            |  |                     | 881,195   |                     |  |                | 3.06 |             |  | $        | 3.25 |  |  |  | 661,423   |           |  | $ | 3.25 | 
|$3.38 - $4.00            |  |                     | 192,296   |                     |  |                | 1.69 |             |  | $        | 3.82 |  |  |  | 159,108   |           |  | $ | 3.80 | 
|                         |  |                     |           |                     |  |                |      |             |  |          |      |  |  |  |           |           |  |   |      | 
|Total                    |  |                     | 4,503,921 |                     |  |                | 3.05 |             |  | $        | 2.19 |  |  |  | 2,611,385 |           |  | $ | 2.31 | 
|                         |  |                     |           |                     |  |                |      |             |  |          |      |  |  |  |           |           |  |   |      | 



|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.

F-16



---



##### Table of Contents





| |  | The income tax provision (benefit) for the years ended December 31, 2002, 2001
and 2000 is summarized as follows:
| |  | -----------------------------------------------------------------------------------------------------------------

|                              |  |                          |          |      |  |      |         |  |  |   |           |  
|----------------------------- |  | ------------------------ | -------- | ---- |  | ---- | ------- |  |  | - | --------- | -
|                              |  | Years Ended December 31,
|                              |  | 2002                     |          | 2001 |  | 2000
|                              |  |                          |          |      |  |     
|Current:                      |  |                          |          |      |  |      |         |  |  |   |           |  
|Federal                       |  | $                        |         |      |  | $    | 203,000 |  |  | $ | 77,000    |  
|State                         |  |                          | 88,000   |      |  |      | 80,000  |  |  |   | 85,000    |  
|                              |  |                          |          |      |  |      |         |  |  |   |           |  
|                              |  |                          | 88,000   |      |  |      | 283,000 |  |  |   | 162,000   |  
|Deferred:                     |  |                          |          |      |  |      |         |  |  |   |           |  
|Federal                       |  |                          | 462,000  |      |  |      | 545,000 |  |  |   | 811,000   |  
|State                         |  |                          | (227,000 | )    |  |      | 28,000  |  |  |   | 276,000   |  
|Change in valuation allowance |  |                          |         |      |  |      |        |  |  |   | (136,000  | )
|                              |  |                          |          |      |  |      |         |  |  |   |           |  
|Subtotal                      |  |                          | 235,000  |      |  |      | 573,000 |  |  |   | 951,000   |  
|Total                         |  | $                        | 323,000  |      |  | $    | 856,000 |  |  | $ | 1,113,000 |  
|                              |  |                          |          |      |  |      |         |  |  |   |           |  



| |  | 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,
|      |                                            |  | 2002                     |      | 2001 |  | 2000
|      |                                            |  |                          |      |      |  |     
|      | Tax at federal statutory rate              |  |                          | 35.0 | %    |  |      | 35.0 | %  |  |      | 35.0 | % 
|      | State income taxes, net of federal benefit |  |                          | 11.3 | %    |  |      | 5.5  | %  |  |      | 6.5  | % 
|      | Foreign operations                         |  |                          | (5.0 | %)   |  |      | (2.3 | %) |  |      | (0.7 | %)
|      | Research credit                            |  |                          | (4.1 | %)   |  |      | (5.0 | %) |  |      | (1.1 | %)
|      | Goodwill amortization                      |  |                          | 0.0  | %    |  |      | 7.3  | %  |  |      | 5.3  | % 
|      | Nondeductible charges                      |  |                          | 5.4  | %    |  |      | 0.5  | %  |  |      | 0.0  | % 
|      | Change in valuation allowance              |  |                          |     |      |  |      |     |    |  |      | (5.0 | %)
|      | Other                                      |  |                          | (0.2 | %)   |  |      | (0.7 | %) |  |      | 0.8  | % 
|      |                                            |  |                          |      |      |  |      |      |    |  |      |      |   
|Total |                                            |  | 42.4                     | %    |      |  | 40.3 | %    |    |  | 40.8 | %   
|      |                                            |  |                          |      |      |  |      |      |    |  |      |      |   



| |  | As of December 31, 2002 and 2001, the Company had net deferred tax assets
comprised of the following:
| |  | -----------------------------------------------------------------------------------------------------

|                                               |  |              |            |      |  |   |            |  
|---------------------------------------------- |  | ------------ | ---------- | ---- |  | - | ---------- | -
|                                               |  | December 31,
|Deferred Tax Assets:                           |  | 2002         |            | 2001
|                                               |  |              |            |     
|Net operating losses                           |  | $            | 1,409,000  |      |  | $ | 1,402,000  |  
|Amortization of goodwill and other intangibles |  |              | 2,815,000  |      |  |   | 2,355,000  |  
|Reserves not currently deductible              |  |              | 2,514,000  |      |  |   | 1,717,000  |  
|State taxes                                    |  |              | (326,000   | )    |  |   | (245,000   | )
|Credits                                        |  |              | 978,000    |      |  |   | 998,000    |  
|Accrued compensation and related costs         |  |              |           |      |  |   | 551,000    |  
|Depreciation                                   |  |              | (140,000   | )    |  |   | (74,000    | )
|                                               |  |              |            |      |  |   |            |  
|Total deferred income taxes                    |  |              | 7,250,000  |      |  |   | 6,704,000  |  
|Valuation allowance                            |  |              | (3,149,000 | )    |  |   | (2,368,000 | )
|                                               |  |              |            |      |  |   |            |  
|Net deferred income taxes                      |  | $            | 4,101,000  |      |  | $ | 4,336,000  |  
|                                               |  |              |            |      |  |   |            |  

F-17



---



##### Table of Contents





|   |  | At December 31, 2002, the Company had federal net operating loss
carryforwards of approximately $4,145,000 which begin to expire in the year
2006. Due to certain tax regulations, future use of a portion of the net
operating loss carryforwards is limited to approximately $600,000 per year.
Tax credits for federal taxes of approximately $755,000 begin to expire in
2007.                                                                                                                                                                                                                                                                                                                                                    
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The net deferred tax assets of December 31, 2002 were offset by a valuation
allowance of $3,149,000. The increase in the valuation allowance in 2002 of
$781,000 relates to the deferred tax benefit on the goodwill write-down. As of
December 31, 2002, the future realization of the reserved portion of the net
deferred tax assets was determined by management to be unlikely, based on
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 5 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.
In April 2002, the Company entered into a noncancelable-operating lease for
approximately 9,000 square feet of office space in San Antonio, Texas. The
lease expires in March 2005.
|  
|   |  | Future minimum lease payments under these leases are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

|                         |  |   |           | 
|------------------------ |  | - | --------- | 
|Years Ended
December 31,
|                        
|2003                     |  |   | 791,000   | 
|2004                     |  |   | 794,000   | 
|2005                     |  |   | 594,000   | 
|2006                     |  |   | 574,000   | 
|2007                     |  |   | 502,000   | 
|Thereafter               |  |   | 1,928,000 | 
|                         |  |   |           | 
|Total                    |  | $ | 5,183,000 | 
|                         |  |   |           | 



| |  | Rent expense for the years ended December 31, 2002, 2001 and 2000 was $844,000,
$629,000 and $627,000, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The Company is also 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.

F-18



---



##### Table of Contents





|   |  | The terms of such obligations vary. Generally, 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, 2002.                                                                                                                                                                                                                                                                                                                                                                                                     
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|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
$102,000, $88,000 and $108,000 for the years ended December 31, 2002, 2001, and
2000, respectively. The Company does not provide post-retirement benefits to
its employees.                                                                                                                                                                                                                                                                                             
|  
|9. |  | Business Segments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | The Company operates in two business segments: manufacturing and marketing of
medical infusion pumps and rentals of medical infusion pumps. The rental
business segment principally consists of the activities of InfuSystem, Inc.
within the oncology infusion services market segment. The manufacturing and
marketing business segment consists of two major product groups, IV Infusion
Therapy products and Regional Anesthesia products. Revenues from sales of IV
Infusion Therapy products in 2002, 2001 and 2000 were $15,788,000, $14,701,000
and $15,187,000, respectively. Revenues from sales of Regional Anesthesia
products in 2002, 2001 and 2000 were $12,036,000, $8,241,000 and $8,310,000,
respectively. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies (Note 1).
|  
|   |  | Business segment information is as follows for the years ended December 31,
2002, 2001 and 2000:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

|                              |  |                   |            |         |  |              |            |  |  |   |            | 
|----------------------------- |  | ----------------- | ---------- | ------- |  | ------------ | ---------- |  |  | - | ---------- | 
|                              |  | Manufacturing and |            |         |  |              |            |  |  |  
|                              |  | Marketing         |            | Rentals |  | Consolidated
|                              |  |                   |            |         |  |             
|2002:                         |  |                   |            |         |  |              |            |  |  |   |            | 
|Revenues                      |  | $                 | 27,824,000 |         |  | $            | 10,293,000 |  |  | $ | 38,117,000 | 
|Operating income              |  |                   | (3,070,000 | )       |  |              | 2,314,000  |  |  |   | 756,000    | 
|Assets                        |  |                   | 22,078,000 |         |  |              | 11,283,000 |  |  |   | 33,361,000 | 
|Depreciation and amortization |  |                   | 1,138,000  |         |  |              | 951,000    |  |  |   | 2,089,000  | 
|Property additions            |  |                   | 1,691,000  |         |  |              | 986,000    |  |  |   | 2,677,000  | 
|                              |  |                   |            |         |  |              |            |  |  |   |            | 
|2001:                         |  |                   |            |         |  |              |            |  |  |   |            | 
|Revenues                      |  | $                 | 22,942,000 |         |  | $            | 10,363,000 |  |  | $ | 33,305,000 | 
|Operating income              |  |                   | 74,000     |         |  |              | 2,093,000  |  |  |   | 2,167,000  | 
|Assets                        |  |                   | 24,458,000 |         |  |              | 11,246,000 |  |  |   | 35,704,000 | 
|Depreciation and amortization |  |                   | 1,494,000  |         |  |              | 1,167,000  |  |  |   | 2,661,000  | 
|Property additions            |  |                   | 1,001,000  |         |  |              | 818,000    |  |  |   | 1,819,000  | 
|                              |  |                   |            |         |  |              |            |  |  |   |            | 
|2000:                         |  |                   |            |         |  |              |            |  |  |   |            | 
|Revenues                      |  | $                 | 23,497,000 |         |  | $            | 8,469,000  |  |  | $ | 31,966,000 | 
|Operating income              |  |                   | 1,426,000  |         |  |              | 1,564,000  |  |  |   | 2,990,000  | 
|Assets                        |  |                   | 23,631,000 |         |  |              | 11,584,000 |  |  |   | 35,215,000 | 
|Depreciation and amortization |  |                   | 1,646,000  |         |  |              | 1,002,000  |  |  |   | 2,648,000  | 
|Property additions            |  |                   | 860,000    |         |  |              | 2,088,000  |  |  |   | 2,948,000  | 
|                              |  |                   |            |         |  |              |            |  |  |   |            | 



| |  | Sales to major customers as a percentage of total revenues are shown in the
table below for the years ended December 31:
| |  | ------------------------------------------------------------------------------------------------------------------------

|                                           |  |      |    |      |  |      |   |   |  |  |    |  
|------------------------------------------ |  | ---- | -- | ---- |  | ---- | - | - |  |  | -- | -
|                                           |  | 2002 |    | 2001 |  | 2000
|                                           |  |      |    |      |  |     
|Customer A  elastomeric infusion products |  |      | 12 | %    |  |      | 9 | % |  |  | 7  | %
|Customer B  elastomeric infusion products |  |      | 7  | %    |  |      | 9 | % |  |  | 11 | %
|Customer C  elastomeric infusion products |  |      | 0  | %    |  |      | 8 | % |  |  | 11 | %
|                                           |  |      |    |      |  |      |   |   |  |  |    |  

F-19



---



##### Table of Contents



| |  | All of the Companys rental revenue is domestic. Export sales of medical
products represented 24%, 22% and 22% of total revenue during 2002, 2001 and
2000, respectively. Total revenue by geographical region is summarized as
follows:
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 |                    |      |   |            |  |      |   |            |  |  |   |            | 
|-------------------------------- | ------------------ | ---- | - | ---------- |  | ---- | - | ---------- |  |  | - | ---------- | 
|Sales to unaffiliated customers: |                    | 2002 |   | 2001       |  | 2000
|                                 |                    |      |  
|                                 | United States      |      | $ | 29,117,000 |  |      | $ | 25,890,000 |  |  | $ | 24,870,000 | 
|                                 | Europe             |      |   | 7,236,000  |  |      |   | 5,897,000  |  |  |   | 5,153,000  | 
|                                 | Asia / Pacific Rim |      |   | 1,095,000  |  |      |   | 987,000    |  |  |   | 1,295,000  | 
|                                 | Other              |      |   | 669,000    |  |      |   | 531,000    |  |  |   | 648,000    | 
|                                 |                    |      |   |            |  |      |   |            |  |  |   |           
|                                 | Total              |      | $ | 38,117,000 |  |      | $ | 33,305,000 |  |  | $ | 31,966,000 | 
|                                 |                    |      |   |            |  |      |   |            |  |  |   |           

|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 ten year
period through bi-weekly payroll deductions. As of December 31, 2002, the
amount due to the Company under the note receivable is approximately $132,000,
the majority of which is included in other long-term assets in the accompanying consolidated balance sheets.
|   
|    |  | During fiscal 2001, the Company made an interest-free loan to the chief
executive officer of the Company totaling $250,000. This amount was repaid in
full during fiscal 2001.                                                                                                                                                                                                                                                                                                                            
|

F-20



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##### 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 30, 2003 |  | 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 30, 2002 on
behalf of the registrant and in the capacities indicated.

|                               |  |                                                 
|------------------------------ |  | ------------------------------------------------
|Signature                      |  | Title                                           
|                               |  |                                                 
|                              
|
|/s/ Donald M. Earhart          |  | Chairman, President and Chief Executive Officer 
|                               |  | (Principal Executive Officer)                   
|Donald M. Earhart              |  |                                                 
|                               |  |                                                 
|/s/ James J. Dal Porto         |  | Executive Vice President, Chief Operating       
|                               |  | Officer and Director                            
|James J. Dal Porto             |  |                                                 
|                               |  |                                                 
|/s/ James R. Talevich          |  | Chief Financial Officer (Principal Financial and
|                               |  | Accounting Officer)                             
|James R. Talevich              |  |                                                 
|                               |  |                                                 
|/s/ John H. Abeles             |  | Director                                        
|                               |  |                                                 
|John H. Abeles, M.D.           |  |                                                 
|                               |  |                                                 
|/s/ Jack H. Halperin           |  | Director                                        
|                               |  |                                                 
|Jack H. Halperin               |  |                                                 
|                               |  |                                                 
|/s/ Joel S. Kanter             |  | Director                                        
|                               |  |                                                 
|Joel S. Kanter                 |  |                                                 
|                               |  |                                                 
|/s/ Erik H. Loudon             |  | Director                                        
|                               |  |                                                 
|Erik H. Loudon                 |  |                                                 
|                               |  |                                                 
|/s/ Henry Tsutomu Tai          |  | Director and Secretary                          
|                               |  |                                                 
|Henry Tsutomu Tai, Ph.D., M.D. |  |                                                 





---



##### Table of Contents



CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Donald M. Earhart, certify that:



| | 1. |  | I have reviewed this annual report on Form 10-K of I-Flow
Corporation;                                                                                                                                                                                                                                           
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | Based on my knowledge, this report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
|
| | 3. |  | Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;            
|
| | 4. |  | The registrants other certifying officers and I are
responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for
the registrant and have:                                                                                           



| |  | a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this annual report is being prepared;
| |  | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this annual report (the Evaluation
Date); and                                                                                                  
|
| |  | c) |  | presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        



| | 5. |  | The registrants other certifying officers and I have
disclosed, based on our most recent evaluation, to the registrants
auditors and the audit committee of registrants board of directors
(or persons performing the equivalent functions):
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrants ability to record, process, summarize and report
financial data and have identified for the registrants auditors
any material weaknesses in internal controls; and
| |  | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                        



| | 6. |  | The registrants other certifying officers and I have
indicated in this annual report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: March 30, 2003

| |                                                                  
| | -----------------------------------------------------------------
| | /s/ Donald M. Earhart                                            
| |                                                                  
| | Donald M. Earhart
President, Chairman and Chief Executive Officer





---



##### Table of Contents



CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, James R. Talevich, certify that:



| | 1. |  | I have reviewed this annual report on Form 10-K of I-Flow
Corporation;                                                                                                                                                                                                                                           
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | Based on my knowledge, this report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
|
| | 3. |  | Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;            
|
| | 4. |  | The registrants other certifying officers and I are
responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for
the registrant and have:                                                                                           



| |  | a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this annual report is being prepared;
| |  | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this annual report (the Evaluation
Date); and                                                                                                  
|
| |  | c) |  | presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        



| | 5. |  | The registrants other certifying officers and I have
disclosed, based on our most recent evaluation, to the registrants
auditors and the audit committee of registrants board of directors
(or persons performing the equivalent functions):
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrants ability to record, process, summarize and report
financial data and have identified for the registrants auditors
any material weaknesses in internal controls; and
| |  | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                        



| | 6. |  | The registrants other certifying officers and I have
indicated in this annual report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: March 30, 2003

| |                                          
| | -----------------------------------------
| | /s/ James R. Talevich                    
| |                                          
| | James R. Talevich
Chief Financial Officer





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##### Table of Contents






INDEX TO EXHIBITS

Set forth below is a list of the exhibits included or incorporated by
reference as part of this report:

|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|Exhibit No. |  | Exhibit                                                                                                                                                                                                                                                                
|            |  |                                                                                                                                                                                                                                                                        
|2.1         |  | Merger Agreement by and between I-Flow Corporation, a
Delaware corporation, and I-Flow Corporation, a California
corporation, dated July 27, 2001 (1)                                                                                                                  
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|3.1         |  | Certificate of Incorporation of I-Flow Corporation, a
Delaware corporation (1)                                                                                                                                                                                         
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|3.2         |  | Bylaws of I-Flow Corporation, a Delaware Corporation (1)                                                                                                                                                                                                               
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|3.3         |  | Certificate of Designation Regarding Series A Junior
Participating Cumulative Preferred Stock (15)                                                                                                                                                                     
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|4.1         |  | Specimen Common Stock Certificate (2)                                                                                                                                                                                                                                  
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|4.2         |  | Warrant Agreement between the Company and American Stock
Transfer & Trust Company, as Warrant Agent, dated February
13, 1990 (3)                                                                                                                                       
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|4.3         |  | Form of Warrant dated July 22, 1996, issued in conjunction
with the acquisition of Block Medical, Inc. (16)                                                                                                                                                            
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|4.4         |  | 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
Form of Election to Purchase (15)
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|10.1        |  | 1987-1988 Incentive Stock Option Plan and Non-Statutory
Stock Option Plan Restated as of March 23, 1992 (5) *                                                                                                                                                          
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|10.2        |  | 1992 Non-Employee Director Stock Option Plan (6) *                                                                                                                                                                                                                     
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|10.3        |  | License and Transfer Agreement with SoloPak
Pharmaceuticals Inc., dated March 6, 1996 (7)                                                                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|10.4        |  | 1996 Stock Incentive Plan (8) *                                                                                                                                                                                                                                        
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|10.5        |  | Agreement for Purchase and Sale of Assets dated as of July
3, 1996 by and among I-Flow Corporation, Block Medical,
Inc. and Hillenbrand Industries, Inc. (4)                                                                                                           
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|10.6        |  | Lease Agreement between Industrial Developments International, Inc. as Landlord and I-Flow
Corporation as Tenant dated April 14, 1997 (9)                                                                                                                              
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|10.7        |  | Agreement and Plan of Merger by and among I-Flow Corporation, I-Flow Subsidiary, Inc., Venture
Medical, Inc., and InfuSystems II, Inc. and the Shareholders of Venture Medical, Inc. and
InfuSystems II, Inc. (10)                                                     
|            |  |                                                                                                                                                                                                                                                                         |  |  |  | 
|10.8        |  | Loan and Security Agreement between Silicon Valley Bank and I-Flow Corporation dated September 28,
1995 (11)                                                                                                                                                           





---



##### Table of Contents



|            |  |                                                                                                                                                                                               |  |  |  | 
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|Exhibit No. |  | Exhibit                                                                                                                                                                                      
|            |  |                                                                                                                                                                                              
|10.9        |  | Amendment to Loan Agreement between Silicon Valley Bank and
I-Flow Corporation dated March 2, 1998 (11)                                                                                      
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.10       |  | Agreement and Plan of Merger by and Among I-Flow Corporation, Spinal Acquisition Corp., Spinal
Specialties, Inc. and the Shareholders of Spinal Specialties, Inc. dated January 13, 2000 (12)
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.11       |  | I-Flow Corporation 2001 Equity Incentive Plan (2) *                                                                                                                                          
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.12       |  | Restricted Stock Plan of I-Flow Corporation                                                                                                                                                  
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.20       |  | Employment Agreement with Donald M. Earhart dated May 16, 1990 (13) *                                                                                                                        
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.21       |  | Amendment #1 to Employment Agreement with Donald M. Earhart dated June 21, 2001 (2)*                                                                                                         
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.22       |  | Promissory Note with Donald M. Earhart dated June 15, 2001 (2)                                                                                                                               
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.23       |  | Amended and Restated Employment Agreement with James J. Dal Porto dated June 21, 2001 (2) *                                                                                                  
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.24       |  | Employment Agreement with James R. Talevich dated June 30, 2000 (14) *                                                                                                                       
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.25       |  | Agreement Re: Change in Control with Donald M. Earhart dated June 21, 2001 (2) *                                                                                                             
|            |  |                                                                                                                                                                                               |  |  |  | 
|10.26       |  | Agreement Re: Change in Control with James J. Dal Porto dated June 21, 2001 (2) *                                                                                                            
|            |  |                                                                                                                                                                                               |  |  |  | 
|21          |  | List of Subsidiaries                                                                                                                                                                         
|            |  |                                                                                                                                                                                               |  |  |  | 
|23.1        |  | Independent Auditors Consent                                                                                                                                                                
|            |  |                                                                                                                                                                                               |  |  |  | 
|99.1        |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of
2002                                                                       



---

|*   |  | 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 Current Report on Form 8-K on August 3, 2001.                                                             
|   
|(2) |  | 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.                                        
|   
|(3) |  | Incorporated by reference to exhibit with this title filed with the
Companys Registration Statement (#33-32263-LA) declared effective
February 1, 1990.                                
|   
|(4) |  | Incorporated by reference to exhibit with this title filed with the
Companys Report on Form 8-K dated July 22, 1996.                                                                   
|   
|(5) |  | Incorporated by reference to exhibit with this title filed with the
Companys Post Effective Amendment to its Registration Statement
(#33-41207-LA) declared effective November 6, 1992.





---



##### Table of Contents



|(6)  |  | Incorporated by reference to exhibit with this title filed with the
Companys Form 10-K for its fiscal year ended December 31, 1991.                                          
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(7)  |  | Incorporated by reference to exhibit with this title filed with the
Companys Form 10-K for its fiscal year ended December 31, 1995.                                          
|    
|(8)  |  | Incorporated by reference to exhibit with this title filed with the
Companys Registration Statement (#333-16547) declared effective November
20, 1996.                       
|    
|(9)  |  | Incorporated by reference to exhibit with this title filed with the
Companys Report on Form 8-K dated April 14, 1997.                                                        
|    
|(10) |  | Incorporated by reference to exhibit with this title filed with the
Companys Report on Form 8-K dated February 9, 1998.                                                      
|    
|(11) |  | Incorporated by reference to exhibit with this title filed with the
Companys Form 10-K for its fiscal year ended December 31, 1997.                                          
|    
|(12) |  | 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.                             
|    
|(13) |  | Incorporated by reference to exhibit with this title filed with the
Companys Form 10-K for its fiscal year ended September 30, 1990.                                         
|    
|(14) |  | Incorporated by reference to exhibit with this title filed with the
Companys Form 10-K for its fiscal year ended December 31, 2000.                                          
|    
|(15) |  | Incorporated by reference to exhibit with this title filed with the
Companys Current Report on Form 8-K, filed with the Securities and
Exchange Commission on March 13, 2002.
|    
|(16) |  | Incorporated by reference to exhibit with this title filed with the
Companys Registration Statement on Form S-3, filed February 10, 1997.