<PAGE>   1

                                                                      EXHIBIT 13









                                     I-FLOW CORPORATION


                                     1998 ANNUAL REPORT



<PAGE>   2

FINANCIAL HIGHLIGHTS


OPERATING RESULTS

<TABLE>
<CAPTION>
(Amounts in thousands, except                 Years Ended December 31,
   per share amounts)                     1998             1997          1996
                                        --------         --------      --------
<S>                                     <C>              <C>           <C>     
Revenue                                 $ 23,592         $ 17,742      $ 13,892

Operating income                         $ 1,854            $ 779       $(7,406)

Net income (loss) per share               $ 0.08           $ 0.02       $ (0.69)
                                        --------         --------      --------
</TABLE>



BALANCE SHEET

<TABLE>
<CAPTION>
                                                            December 31,
(Amounts in thousands)                                     1998          1997
                                                         --------      --------
<S>                                                      <C>           <C>     
ASSETS

Current assets                                           $ 13,427      $ 10,040
Property and equipment, net                                 3,427         2,231
Other assets                                                7,482         5,363
                                                         --------      --------
Total assets                                             $ 24,336      $ 17,634
                                                         --------      --------

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities                                       $ 6,839       $ 5,467
Long-term debt                                              2,680         1,579
Shareholders' equity                                       14,817        10,588
                                                         --------      --------

Total liabilities and shareholders' equity               $ 24,336      $ 17,634
                                                         --------      --------
</TABLE>

<PAGE>   3
TO OUR SHAREHOLDERS Fiscal 1998 was a year of outstanding growth and progress
for I-Flow. We achieved all of our primary strategic objectives for the year:
renewed top and bottom line growth; introduced our proprietary infusion
technology into new growth markets; restructured our distribution network to
facilitate future growth; diversified and grew the business by purchasing a
national infusion pump management company; and established strategic
relationships with world class healthcare companies that further enhance our
distribution capabilities both domestically and internationally.

With new applications for our technology and worldwide marketing capabilities,
I-Flow is better positioned than ever before to compete effectively in the
rapidly evolving healthcare industry. We now have the platform we need to build
on the Company's position as a leading supplier of innovative infusion systems
for an expanding range of applications worldwide.

FINANCIAL PERFORMANCE For the year ended December 31, 1998, revenue rose 33% to
a record $23.6 million from $17.7 million for 1997. Net income increased to $1.1
million, or $.08 per diluted share, compared to $365,000, or $.02 per diluted
share, for 1997.

I-Flow's balance sheet improved as well. At December 31, 1998, working capital
rose to $6.6 million from $4.6 million a year earlier, and shareholders' equity
increased 40% to $14.8 million.

NEW PRODUCTS In July, we launched our new PainBuster(TM) pain management system
for orthopaedic surgery to an enthusiastic reception in the marketplace. Based
on I-Flow's elastomeric infusion technology, this patented product provides a
continuous infusion of a non-narcotic, local anesthetic directly into the
operative site for postoperative pain management. PainBuster provides for
virtually pain-free orthopaedic surgery, controlling pain without the side
effects of narcotic pain relievers. As a result, it has the potential to reduce
the length of hospital stays and rehabilitation, thus reducing the total cost of
orthopaedic procedures.

In November, we released a similar product, the ON-Q(TM) Pain Management System
for general surgery. As with PainBuster, ON-Q provides continuous non-narcotic
pain relief for patients recovering from such general surgical procedures as
hernia repairs, appendix removals and gynecological surgeries. We expect ON-Q to
provide important advantages for patient comfort and rehabilitation to a
potential target market in the United States of over 35 million surgical
procedures annually. With more than 39 million surgeries performed annually in
the United States alone, the market potential for PainBuster and ON-Q is
substantial.

In December, we acquired the rights to market the Paragon(R) and SideKick(R)
infusion pumps in the United States and Puerto Rico. The Paragon infusion pump
provides accurate and cost-effective delivery of medications including
chemotherapy and a wide range of pain medications. The SideKick is normally used
to deliver antibiotics in outpatient settings. Both pumps are reusable and
reimbursable which can reduce the cost of patient care.

NEW MARKETING RELATIONSHIPS During the year, I-Flow entered into a five-year
distribution agreement with B. Braun Medical, Inc., a world leader in the
manufacture and distribution of pharmaceuticals and infusion products, to
distribute our elastomeric infusion products in the United States and Canada.
With this agreement, which covers our HOMEPUMP Eclipse(R) and One-Step KVO(TM)
products, the Company will benefit from the nationwide reach


                                       1
<PAGE>   4
of B. Braun's unparalleled national home care and hospital distribution network
and its direct sales force of 125 professionals.

In addition, we signed a five-year agreement with B. Braun Melsungen AG to
distribute our products internationally under a private label. With more than
$2.5 billion in annual sales, this leading medical products manufacturer has a
dominant market position in access ports and catheters in many key markets
outside the United States. This agreement, which includes most of the countries
in Europe, the Middle East, Asia Pacific, South America and Africa, greatly
strengthens our international distribution capabilities in the hospital and
alternate site markets.

In September, I-Flow signed a letter of understanding with DonJoy, a division of
Smith & Nephew, Inc., to market the PainBuster to orthopaedic surgeons. This
agreement gave DonJoy the exclusive distribution rights for PainBuster in the
United States and Canada for orthopaedic surgical procedures.

INFUSYSTEM ACQUISITION InfuSystem, the infusion pump management and distribution
business I-Flow acquired in February 1998, made an important contribution to
this year's sales and earnings improvement. InfuSystem is already accretive to
I-Flow's earnings, which is a substantial achievement. Revenues grew 11% as we
hired additional sales professionals to support the increased growth we
anticipate in this very profitable segment of our business in 1999. InfuSystem
is a contracted supplier of infusion devices to multiple managed care
organizations whose total covered lives are 48 million of the estimated 130
million patients enrolled in the United States.

OUTLOOK I-Flow dramatically expanded its product line and distribution
capability in 1998. Our platform for growth is in place. As a result, our
primary objectives for 1999 are clear: sustain the sales and earnings momentum
established in 1998; continue to develop new applications for our proprietary
infusion technology; establish distribution partners for the ON-Q Pain
Management System and other new products.

We are optimistic that we can meet these aggressive objectives in 1999. We will
continue to seek beneficial corporate relationships, as well as profitable,
innovative applications for our infusion technology. We believe this is the
right strategy for achieving our ultimate goal to increase your shareholder
value.

Thank you for the interest and support you have given your Company.

                                        Sincerely,




                                        Donald M. Earhart
                                        Chairman, President and 
                                        Chief Executive Officer


                                       2
<PAGE>   5
HOMECARE As the core of I-Flow's current business, homecare continues to be an
important market. I-Flow's ambulatory infusion systems are ideally suited for
outpatient settings where patient comfort and mobility are primary concerns. The
HOMEPUMP Eclipse is recognized as the market leader in the elastomeric segment
for the delivery of antibiotics and other non-critical drugs. The Company
believes that consolidation will continue in the homecare provider segment as
inefficient competitors are eliminated and mergers dominate the scene. For the
providers that remain, cost effective products that reduce nursing and
administrative labor will be paramount to their success. I-Flow's products are
ideally suited for this market because they are designed to be cost effective,
easy to install and patient friendly.

In late 1998, I-Flow reaquired the rights to market and sell the Paragon and
SideKick infusion pumps in the domestic market. These unique and cost effective
infusion devices are designed to deliver antibiotics and other critical drugs in
both the hospital and outpatient settings.

ONCOLOGY Recently acquired InfuSystem is a market leader in the oncology service
and distribution segments with customers in all 50 states. The business model
that the Company employs is a very cost effective and efficient one for
providing infusion therapy. Under the InfuSystem program, patients are managed
by the oncologist instead of the hospital or homecare provider. This is more
cost effective while providing additional revenues for the doctor. In addition,
the patient's therapy is managed by the physician assuring the highest quality
of care. With the increased pressures to reduce the cost of delivering quality
healthcare, the InfuSystem program benefits the patient, the doctor and the
insurance provider.

InfuSystem's fiscal 1998 revenues were up 11% over 1997 and an increased rate of
growth is expected for 1999. In the past, much of the company's revenue was from
Medicare patients, but in 1999, InfuSystem will increase its efforts to focus on
the managed care segment of their marketplace. The goal is to contract an
additional 12 million lives, for a total of 60 million of the estimated 130
million available, and be well positioned for further movement of Medicare
patients into managed care.

INTERNATIONAL I-Flow continues to have a strong international distributor
network. While the Asian economic downturn affected sales in 1998, international
sales were still more than 28 percent of I-Flow's revenues. International sales
were strengthened by restructuring HOMEPUMP Eclipse and C-Series distribution
with the signing of the agreement with B.Braun Melsungen AG. The Company
believes that this partnership will capture an increasing share of the fast
growing International market for cost effective infusion devices.

Paragon revenues are expected to continue growing through successful marketing
campaigns by partners like Fresinius in Germany and other local country
distributors in Europe. Kobayashi Medical Division and Insung Medical Company,
Ltd. give us a strong presence in Japan and Korea. The Paragon has been well
received in both Europe and the Far East by hospitals and homecare providers for
the delivery of pain medicines and chemotherapy drugs. Additional line
extensions and new product features are planned for release in early 1999, which
should stimulate continued revenue growth. Not only is strong growth expected
from existing products, but also from new products like the PainBuster and ON-Q
Pain Management Systems.

US HOSPITAL MARKET In 1999, the hospital market becomes a significant focus for
I-Flow. The Company's products have been making inroads in this large market for
infusion devices.


                                       3
<PAGE>   6
The One-Step KVO, the Medi-SIS, the PainBuster and ON-Q Pain Management Systems
are all presently being sold into this market.

    INFUSION The One-Step KVO is a catheter patency device that substantially
    eliminates the need for IV flushing, and reduces the occurrence of occluded
    catheters and other complications associated with catheter maintenance. The
    device offers both hospitals and homecare agencies significant cost
    reductions for catheter maintenance, especially if they are using prefilled
    syringes for flushing. I-Flow believes that this product could one day
    become the standard of care for a large number of infusion protocols.

    The Medi-SIS is a low cost syringe infusion pump which delivers antibiotics
    and other non-critical medications. With its multi-dosing capabilities, it
    competes favorably with gravity as a low cost alternative for drug delivery.
    Therefore, it is ideally suited for the hospital market where cost pressures
    are increasing.

    PAIN MANAGEMENT AND SURGERY The PainBuster and ON-Q Pain Management Systems
    are expected to continue to have a significant impact on I-Flow's growth. An
    important fear of most patients having surgery, is the expectation of pain
    after the operation. Today's typical treatment of postoperative pain has two
    significant drawbacks; (1) it is not always successful in alleviating the
    pain and (2) because of the negative side effects from the pain medications
    received, patients often have to extend their hospital stay. The PainBuster
    and ON-Q Pain Management Systems offer surgeons a new and better way to
    treat postoperative pain without the side effects associated with typical
    analgesics. Surgeons and patients alike have quickly accepted these products
    and the response from customers has been overwhelming.

I-Flow will continue to use surgical product distributors to sell and market
this new family of pain products. By partnering with leaders in the distribution
of surgical products, the PainBuster and ON-Q Pain Management Systems have a
chance to become the standard of care for pain management after surgery.

The alleviation of pain will also be important to I-Flow in areas other than
postoperative pain management. The Company believes there is a substantial
market for safe and easy to use devices that can deliver pain medications for
epidural, IV and regional anesthesia applications. I-Flow will continue to
invest an increasing amount of its resources to maximize this very important
opportunity.


                                       4
<PAGE>   7
SELECTED CONSOLIDATED FINANCIAL DATA                          I-Flow Corporation



<TABLE>
<CAPTION>
                                                           Year Ended December 31,
(Amounts in thousands, except               -------------------------------------------------------
  per share amounts)                          1998        1997        1996        1995      1994
                                            --------    --------    --------    --------   --------
<S>                                         <C>         <C>         <C>         <C>        <C>     
CONSOLIDATED STATEMENTS OF OPERATIONS 
  DATA:(1)                                         
Revenue:
  Net product sales                         $ 17,006    $ 17,678    $  9,153    $  9,737   $  6,321
  Rental income and other                      6,586          64         139          60         72
  Other fees                                      --          --       4,600         250        500
                                            --------    --------    --------    --------   --------
    Total revenue                             23,592      17,742      13,892      10,047      6,893

Cost of sales                                 10,219       8,450       3,954       4,422      4,062
                                            --------    --------    --------    --------   --------

Gross Profit                                  13,373       9,292       9,938       5,625      2,831

Expenses:
  Selling and marketing                        4,178       3,197       2,617       1,483      1,948
  General and administrative                   6,401       4,281       4,336       2,329      2,044
  Product development                            940       1,035       1,139         840        720
  Purchased in-process research
   and development costs                          --          --       4,900          --         --
  Goodwill writedown                              --          --       2,800          --         --
  Restructuring costs                             --          --       1,552          --         --
                                            --------    --------    --------    --------   --------
    Total expenses                            11,519       8,513      17,344       4,652      4,712
                                            --------    --------    --------    --------   --------
  Operating income (loss)                      1,854         779      (7,406)        973     (1,881)
  Interest income (expense)                     (684)       (334)         41          96        208
                                            --------    --------    --------    --------   --------
  Income (loss) before income taxes            1,170         445      (7,365)      1,069     (1,673)
  Income taxes                                    69          80          60          --         --
                                            --------    --------    --------    --------   --------
  Net income (loss)                         $  1,101    $    365    $ (7,425)   $  1,069   $ (1,673)
                                            --------    --------    --------    --------   --------
  Net income (loss) per share (2)           $   0.08    $   0.02    $  (0.69)   $   0.12   $  (0.20)
                                            --------    --------    --------    --------   --------

  Weighted average number of
    common and common equivalent
    shares outstanding (2)                    13,711      13,030      10,849       9,247      8,177
                                            --------    --------    --------    --------   --------

CONSOLIDATED BALANCE SHEET DATA:(3)(4)
  Working capital                           $  6,588    $  4,573    $  4,905    $  6,958   $  3,564
  Total assets                                24,336      17,634      17,234       9,107      6,209
  Long-term obligations                        2,680       1,579       2,884          --         --
  Total shareholders' equity                  14,817      10,588       9,597       7,728      4,181
                                            --------    --------    --------    --------   --------
</TABLE>

(1) Certain amounts previously reported have been reclassified to conform with
    the presentation at December 31, 1998.

(2) See Note 1 of Notes to Consolidated Financial Statements.

(3) In July 1996, the Company purchased substantially all of the assets of Block
    Medical, Inc. See Note 2 of Notes to Consolidated Financial Statements.

(4) In February 1998, the Company purchased substantially all of the assets of
    InfuSystems II, Inc. and Venture Medical, Inc. See Note 3 of Notes to
    Consolidated Financial Statements.


                                       5
<PAGE>   8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Certain disclosures made by the Company in this report and in other reports and
statements released by the Company are and will be forward-looking in nature,
such as comments which express the Company's opinions about trends and factors
which may impact future operating results. Disclosures which use words such as
the Company "believes," "anticipates," or "expects" or use similar expressions
are intended to identify forward-looking statements. Such statements are subject
to certain risks and uncertainties which could cause actual results to differ
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 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, as well as in the Company's period reports on Forms 10-K, 10-Q, and
8-K 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 reimbursement system currently in place, competition in the
industry, technological changes and product availability. Any such
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.


Consolidated Results of Operations - For the Year Ended December 31, 1998
Compared to the Year Ended December 31, 1997

Net revenues during the year ended December 31, 1998 were $23,592,000 compared
to $17,742,000 for the prior year, an increase of 33%. In February 1998, the
Company acquired InfuSystems II, Inc. and Venture Medical, Inc., both of which
were national ambulatory infusion pump management and distribution companies
based in Detroit, Michigan. These companies were merged into InfuSystem, Inc.
("InfuSystem"), a wholly owned subsidiary of the Company. Rental revenues
generated by InfuSystem of $6,468,000 for the period from February 11, 1998
(date of acquisition) through December 31, 1998, were included in net revenues
for the year ended December 31, 1998.

Net product revenues decreased from $17,678,000 in 1997 to $17,006,000 in 1998.
These revenues were adversely affected by the restructuring of the Company's
worldwide distribution network as well as existing distributor inventory levels
early in 1998, which caused a short-term decline in shipments of infusion
products to the Company's previous distribution partners. Additionally, net
sales in 1998 continued to be adversely affected by the economic difficulties in
Asia and, most particularly Korea.

During 1998, the Company entered into an agreement with B. Braun Melsungen AG, a
world leader in the manufacture and distribution 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 also recently entered into a similar agreement under which B. Braun of
America, Inc. will distribute I-Flow's elastomeric pumps to its full line IV
solution customers in the United States. These two new relationships generated
significant sales for the Company in the second half of 1998 and are expected to
generate significant sales


                                       6
<PAGE>   9
opportunities for the future. During the year ended December 31, 1998, combined
sales to these companies accounted for approximately 20% of the Company's net
revenues. I-Flow received permission in June 1998 from the Food and Drug
Administration ("FDA") to market the PainBuster in the United States. I-Flow's
PainBuster pain management system provides for the continuous infusion of a
non-narcotic, local anesthetic directly into the intraoperative site for
post-operative pain management. In September 1998, the Company entered into a
letter of understanding to distribute the PainBuster through Smith & Nephew,
Inc., a leading worldwide healthcare company offering a broad range of products
for the care and repair of bone, joints, skin and other soft tissue. During the
year ended December 31, 1998, sales of the PainBuster to Smith & Nephew were
approximately $2 million. In January 1999, DonJoy, the division of Smith &
Nephew that distributes the PainBuster, was spun-off and the letter of
understanding with Smith & Nephew expired on February 28, 1999. However, DonJoy
has continued to purchase the PainBuster in 1999 at the same terms of the
letter.

In 1996, the Company sold the exclusive right and license to manufacture and
sell its SideKick(R), Paragon(R), and elite products in the United States and
Puerto Rico. The Company reacquired the rights in 1998 and has begun selling
these products in the United States.

Cost of sales of $10,219,000 was incurred during the year ended December 31,
1998, compared to $8,450,000 in the prior year. As a percentage of total
revenue, cost of sales decreased by four percentage points for the year ended
December 31, 1998 compared to the prior year. The increase in gross profit is
primarily the result of the addition of InfuSystem, Inc. in 1998. As primarily a
service business, InfuSystem has a considerably higher gross margin than the
Company's traditional manufacturing business. Without InfuSystem, Inc., the
gross margin would still have improved by approximately 2%, which is primarily
due to the introduction of the PainBuster in 1998.

Selling and marketing expenses for the year ended December 31, 1998 increased
over the prior year by $981,000 or 31%. This increase is primarily due to the
addition of InfuSystem. Without the InfuSystem selling and marketing expenses,
the Company's selling and marketing expenses for the year ended December 31,
1998 would have increased by only $30,000. As a percentage of sales, selling and
marketing expenses remained consistent from the prior year at approximately 18%.

General and administrative expenses for the year ended December 31, 1998
increased $2,120,000 or 50% from the prior year, primarily due to the addition
of InfuSystem. For the year ended December 31, 1998 InfuSystem incurred general
and administrative expenses of $1,974,000. Without the InfuSystem general and
administrative expenses, the Company's general and administrative expenses for
the year ended December 31, 1998 would have increased by only $146,000 or 3%. As
a percentage of sales, general and administrative expenses increased 3% compared
to the prior year due to higher fixed overhead expenses at InfuSystem and the
decrease in product sales.

Product development expenses for the year ended December 31, 1998 decreased from
the prior year by $95,000, or 9%. The decrease in the expenses was primarily due
to consolidation of the engineering efforts of Block Medical, Inc. with those of
the Company in late 1997. 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 has remained
consistent as a percentage of product sales but has decreased as a percentage of
total


                                       7
<PAGE>   10
sales due to the inclusion of InfuSystem's rental revenue, which has no
corresponding product development costs.

Consolidated Results of Operations - For the Year Ended December 31, 1997
Compared to the Year Ended December 31, 1996

Net product sales during the year ended December 31, 1997 were $17,678,000
compared to $9,153,000 for the prior year. In July 1996, the Company acquired
substantially all of the assets of Block Medical, Inc. ("Block"). Accordingly,
net product sales increased, as sales from Block were reported by the Company
for a full year in 1997 versus only a portion of the year in 1996. Additionally,
net product sales to international customers have increased substantially.
Export sales were $6,427,000, or 36% of total revenues, for the year ended
December 31, 1997 compared to $4,186,000, or 30% of total revenues, for the year
ended December 31, 1996.

In addition to revenue growth, the acquisition of Block has brought several
other strategic advantages to the Company, one of which is an expanded product
line with single-dose, one-time use infusion pumps and a new electronic device
with advanced remote programming technology. The acquisition has also increased
the Company's profitability through the use of its manufacturing plant in Mexico
and the corresponding reduction in direct labor costs.

Notwithstanding the year-to-year increase, net sales in 1997 were less than
anticipated due to lower than expected sales from one of the Company's primary
international distributors. This distributor was undergoing certain changes
within its internal organization and seeking to finalize the acquisition of a
major European homecare company in 1997. These changes within the distributor
created a shortfall in sales to the distributor that continued into early 1998.
Additionally, net sales were adversely affected by the economic difficulties in
Asia and, most particularly Korea. Sales of the Company's products in Korea
totaled approximately 7% of total sales for 1997 and 1996.

In March 1996, the Company sold the exclusive right and license to manufacture
and sell its SideKick, Paragon, and elite products in the United States and
Puerto Rico to SoloPak Pharmaceuticals, Inc. ("SoloPak"). Pursuant to the
agreement, SoloPak paid the Company $4.3 million in consideration of the license
and guaranteed royalties. The Company retained the right to sell the products
outside the United States and Puerto Rico.

Cost of sales of $8,450,000 were incurred during the year ended December 31,
1997, compared to $3,954,000 for the prior year. As a percentage of revenues,
cost of sales increased by 19% for the year ended December 31, 1997 compared to
the prior year. The decrease in gross profit is primarily the result of the lack
of licensing fees in 1997.

Selling and marketing expenses for the year ended December 31, 1997 increased
over the prior year by $580,000 or 22%. This increase was due primarily to the
Company's additional sales and marketing activity during 1997 relating to its
increased sales. With the acquisition of Block in mid-1996, the Company
significantly expanded its product line and sales efforts.

General and administrative expenses for the year ended December 31, 1997
increased from the prior year by $55,000 or 1%. These expenses primarily
represent costs for administrative personnel, facilities and other miscellaneous
items. These costs increased primarily as a result of increased operations
during 1997.


                                       8
<PAGE>   11
Product development expenses for the year ended December 31, 1997 decreased
compared to those for the prior year by $104,000 or 9%, primarily due to the
consolidation of the product development efforts of the Company with those of
Block in 1997.


Liquidity and Capital Resources

During the year ended December 31, 1998, funds of $2,032,000 were provided by
operating activities consisting of net income of $1,101,000 adjusted by non-cash
expenses of $2,685,000, less net changes in operating assets and liabilities,
net of the effect of business acquisitions of $1,754,000.

The Company used funds for investing activities during the year ended December
31, 1998 by acquiring net leasehold improvements, furniture, fixtures, equipment
and other assets of $688,000 for use in its operations. In addition, there was a
decrease in other assets of $488,000. The Company also paid $673,000 for the
InfuSystem acquisition during the year.

During the year ended December 31, 1998, funds of $1,020,000 were used in
financing activities consisting primarily of proceeds from borrowings on notes
payable of $2,558,000 offset by payments on the notes payable of $1,938,000 and
a net reduction on the line of credit of $1,607,000. The Company also paid a
cash dividend on preferred stock of $63,000 and had proceeds of $30,000 from the
exercise of stock options and warrants.

As of December 31, 1998, the Company had cash funds of $971,000 and net
receivables of $7,490,000. To date, the Company has financed its operations and
working capital requirements primarily through equity financings and bank
borrowings. Management believes the Company's funds are sufficient to provide
for its short and long-term projected needs for operations. However, the Company
may decide to sell additional equity or increase its borrowings in order to fund
increased product development or for other purposes.

The Company has a working capital line of credit with a bank expiring in May
1999. Under the line of credit, the Company may borrow up to the lesser of
$4,000,000 or 75% of eligible accounts receivable, as defined, at a bank's prime
rate plus .75% (8.5% at December 31, 1998). Under the line as of December 31,
1998, there were funds available for borrowing of $1,678,000 and there were no
borrowings outstanding.

In conjunction with the acquisition of Block, the Company entered into a
$4,000,000 note payable with a bank ($1,560,000 outstanding at December 31,
1998) due in equal monthly installments of principal of $83,333 plus interest at
the bank's prime rate plus 1% (8.75% at December 31, 1998) through July 2000. In
March 1998, the Company entered into an additional note payable with a bank for
$2,500,000 ($2,361,000 outstanding at December 31, 1998) due in equal monthly
installments of principal of $46,296 plus interest at the bank's prime rate plus
1% beginning in October 1998 through March 2003. Proceeds from the new note were
used to pay off the outstanding balance on the line of credit and for general
working capital. 


                                       9
<PAGE>   12

On February 9, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") with InfuSystems II, Inc. ("InfuSystem"), Venture Medical,
Inc. ("VMI") and the shareholders of InfuSystem and VMI, contemplating the
merger of InfuSystem and VMI with and into a wholly-owned subsidiary of the
Company. Pursuant to the Agreement, VMI and InfuSystem were merged (the
"Merger") with and into the subsidiary effective as of February 11, 1998. See
Note 3 in Notes to Consolidated Financial Statements. The 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 a bank's prime rate plus
 .5% (8.25% at December 31, 1998). There were borrowings of $1,979,000
outstanding under the line as of December 31, 1998.

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, 1998,
the Company was in compliance with all such covenants.

Year 2000 Compliance

Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, in less than a year, computer systems and/or
software used in many companies may need to be upgraded to comply with such
"Year 2000" requirements.

The Company has determined that it will be necessary to modify or replace
portions of its hardware and software so that its computer systems properly
utilize dates beyond December 31, 1999. The Company believes that with
modifications and conversions, the Year 2000 issue can be managed, and the
associated risks reduced or mitigated. The Company has received confirmation
from vendors of certain purchased software used for internal operations that
current releases or upgrades, if installed, are designed to be Year 2000
compliant. The Company is in the process of installing such upgrades to its
current systems and believes that substantially all of the upgrades will be
completed by mid-1999. The Company is also initiating communications with its
critical external relationships to determine the extent to which the Company may
be vulnerable to such parties' failure to resolve their own Year 2000 issues.
Where practicable, the Company will assess and attempt to mitigate its risks
with respect to failure of these entities to be Year 2000 ready. The effect, if
any, on the Company's results of operations from the failure of such parties to
be Year 2000 ready is not reasonably estimable.

The Company is in the process of evaluating its own products for potential Year
2000 issues and making such products Year 2000 compliant. The vast majority of
the Company's electronic products are not date sensitive. The Company does not 
believe that there will be significant issues or costs associated to make its
products Year 2000 compliant; however, there can be no assurance that such 
products do not contain undetected errors or defects associated with year 2000
date functions.

The Company has been using both external and internal resources to reprogram or
replace its internal information systems for the Year 2000. To date, the amounts
incurred and expensed for developing and carrying out the plan have not had a
material effect on the Company's operations. The Company plans to complete Year
2000 modifications, including testing, by mid 1999. The total remaining cost for
addressing the Year 2000 issue is approximately $66,000, and is not expected to
be material to the Company's operations. All remaining Year 2000 costs will be
funded through operating cash flows. Although the Company is not aware of any
material operational issues or costs associated with preparing its internal
information systems for the Year 2000, there can be no assurances that the
Company will not experience serious unanticipated negative consequences and/or
material costs caused by undetected errors or defects in the


                                       10
<PAGE>   13
technology used in its internal systems, which are composed predominantly of
third party software and hardware.

Should the Company not be completely successful in mitigating internal and
external Year 2000 risks, this could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in other normal business activities. The Company believes that under a worst
case scenario, it could continue the majority of its normal business activities
on a manual basis.

The Company currently has no contingency plan in place in the event it does not
complete its program to resolve Year 2000 issues. The Company plans to evaluate
the status of completion mid-1999 and determine whether a contingency plan is
necessary.


                                       11
<PAGE>   14
INDEPENDENT AUDITORS' REPORT





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

We have audited the accompanying consolidated balance sheets of I-Flow
Corporation and subsidiaries (the Company) as of December 31, 1998 and 1997, 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, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. 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, 1998 and 1997, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.




DELOITTE & TOUCHE LLP
Costa Mesa, California
February 12, 1999




                                       12
<PAGE>   15

CONSOLIDATED BALANCE SHEETS                                   I-Flow Corporation


<TABLE>
<CAPTION>
                                                                         December 31,   December 31,
(Amounts in thousands, except share amounts)                                     1998           1997
                                                                             --------       --------
<S>                                                                          <C>            <C>     
ASSETS

Current assets: (Note 4)
    Cash and cash equivalents                                                $    971       $    715
    Accounts receivable, less allowance for doubtful accounts of $1,824
      and $463 at December 31, 1998 and 1997, respectively                      7,490          5,127
    Inventories, net (Note 1)                                                   4,328          4,058
    Prepaid expenses and other                                                    638            140
                                                                             --------       --------
    Total current assets                                                       13,427         10,040
                                                                             --------       --------

Property: (Note 4)
    Furniture, fixtures and equipment                                           4,354          3,982
    Rental and demonstration equipment                                          2,435            188
                                                                             --------       --------
    Total property                                                              6,789          4,170
    Less accumulated depreciation                                              (3,362)        (1,939)
                                                                             --------       --------
    Net property                                                                3,427          2,231
                                                                             --------       --------

Other assets: (Note 4)
    Goodwill and other intangibles, net (Notes 1, 2 & 3)                        7,223          4,432
    Notes receivable and other                                                    259            931
                                                                             --------       --------
    Total other assets                                                          7,482          5,363
                                                                             --------       --------
Total assets                                                                 $ 24,336       $ 17,634
                                                                             ========       ========

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
    Accounts payable                                                         $  1,300       $  1,828
    Accrued payroll and related expenses                                        1,453            895
    Deferred revenue                                                               --             58
    Current portion of long-term debt (Note 4)                                  2,083          1,000
    Line of credit (Note 4)                                                     1,979          1,500
    Other liabilities                                                              24            186
                                                                             --------       --------
    Total current liabilities                                                   6,839          5,467
                                                                             --------       --------

Long-term debt (Note 4)                                                         2,680          1,579

Commitments and contingencies (Note 7)
                                                                             --------       --------
Shareholders' equity (Note 5)

    Preferred stock, no par value; 5,000,000 shares authorized,
      301,250 and 656,250 Series B shares issued and outstanding at
      December 31, 1998 and 1997, respectively, aggregate preference
      on liquidation of $723 at December 31, 1998                                 686          1,494

    Common stock, no par value; 40,000,000 shares authorized,
      14,044,428 and 12,393,619 shares issued and outstanding at
      December 31, 1998 and 1997, respectively                                 37,735         33,853


    Common stock warrants                                                         615            615
    Cumulative other comprehensive income (loss)                                   --           (117)
    Accumulated deficit                                                       (24,219)       (25,257)
                                                                             --------       --------
    Total shareholders' equity                                                 14,817         10,588
                                                                             --------       --------
Total liabilities and shareholders' equity                                   $ 24,336       $ 17,634
                                                                             ========       ========
</TABLE>

See accompanying Notes to Consolidated Financial Statements 


                                       13
<PAGE>   16
CONSOLIDATED STATEMENTS OF OPERATIONS                         I-Flow Corporation
AND COMPREHENSIVE OPERATIONS


<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                -----------------------------------------
(Amounts in thousands, except per share amounts)                    1998             1997            1996
                                                                --------         --------         -------
<S>                                                             <C>              <C>              <C>    
Revenues:
    Net product sales                                           $ 17,006         $ 17,678        $  9,153
    Rental income and other                                        6,586               64             139
    Licensing and other fees                                           -                -           4,600
                                                                --------         --------         -------
    Total revenues                                                23,592           17,742          13,892
Cost of sales                                                     10,219            8,450           3,954
                                                                --------         --------         -------
Gross profit                                                      13,373            9,292           9,938
                                                                --------         --------         -------

Expenses (Notes 2, 7 & 8):
    Selling and marketing                                          4,178            3,197           2,617
    General and administrative                                     6,401            4,281           4,336
    Product development                                              940            1,035           1,139
    Purchased in-process research and development costs                -                -           4,900
    Goodwill writedown                                                 -                -           2,800
    Restructuring costs                                                -                -           1,552
                                                                --------         --------         -------
    Total expenses                                                11,519            8,513          17,344
                                                                --------         --------         -------

Operating income (loss)                                            1,854              779          (7,406)
Interest and other income (expense) (Notes 1 & 4)                   (684)            (334)             41
                                                                --------         --------         -------

Income (loss) before income taxes                                  1,170              445          (7,365)
Income taxes (Note 6)                                                 69               80              60
                                                                --------         --------         -------

Net income (loss) (Note 1)                                      $  1,101         $    365        $ (7,425)
                                                                ========         ========         =======

Net income (loss) per share, basic and diluted                  $   0.08         $ $ 0.02        $  (0.69)
                                                                ========         ========        ======== 
Comprehensive Operations:

Net income (loss)                                               $  1,101         $    365        $ (7,425)

Foreign currency translation adjustments                             117             (112)              -
                                                                --------         --------         -------
Comprehensive income (loss)                                     $  1,218         $    253        $ (7,425)
                                                                ========         ========        ======== 
</TABLE>

See accompanying Notes to Consolidated Financial Statements.


                                       14
<PAGE>   17
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY               I-Flow Corporation



<TABLE>
<CAPTION>
                                                                                                            Cumulative
                                            Preferred Stock       Common Stock       Common                   Other
                                          -----------------    ------------------    Stock    Accumulated   Comprehensive
(Amounts in thousands)                      Shares   Amount    Shares     Amount    Warrants    Deficit     Income (Loss)    Total
-------------------------------------     ------------------------------------------------------------------------------------------
<S>                                         <C>    <C>         <C>       <C>        <C>       <C>           <C>           <C>
Balance, January 1, 1996                     656   $ 1,494      9,259    $ 24,278   $  --       $(18,039)      $   (5)    $  7,728
Exercise of common stock warrants
    and options (net of costs of $78)                           2,336       6,635                                            6,635
Common stock and warrants issued
    for acquisition                                               433       2,000     615                                    2,615
Common stock issued for payment
    of preferred stock dividends                                   22          79                    (79)                         
Stock options granted  with exercise
    prices below market value                                                  44                                               44
Net loss                                                                                          (7,425)                   (7,425)
                                             ---   -------     ------    --------   -----       --------       ------     --------

Balance, December 31, 1996                   656     1,494     12,050      33,036     615        (25,543)          (5)       9,597
Exercise of common stock warrants
    and options                                                   323         738                                              738
Common stock issued for payment
    of preferred stock dividends                                   20          79                    (79)
Cumulative translation adjustment                                                                                (112)        (112)
Net income                                                                                           365                       365
                                             ---   -------     ------    --------   -----       --------       ------     --------

Balance, December 31, 1997                   656     1,494     12,393      33,853     615        (25,257)        (117)      10,588
Exercise of common stock warrants
    and options                                                    16          30                                               30
Conversion of preferred stock               (355)     (808)       379         808
Common stock issued for acquisition                             1,256       3,044                                            3,044
Preferred stock dividend                                                                             (63)                      (63)
Cumulative translation adjustment                                                                                 117          117
Net income                                                                                         1,101                     1,101
                                             ---   -------     ------    --------   -----       --------       ------     --------

Balance, December 31, 1998                   301   $   686     14,044    $ 37,735   $ 615       $(24,219)      $   --     $ 14,817
                                             ===   =======     ======    ========   =====       ========       ======     ========
</TABLE>

See accompanying Notes to Consolidated Financial Statements.


                                       15
<PAGE>   18

CONSOLIDATED STATEMENTS OF CASH FLOWS                         I-Flow Corporation


<TABLE>
<CAPTION>
                                                                                         Year ended December 31,
                                                                                  ----------------------------------
(Amounts in thousands)                                                                1998         1997         1996
--------------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>          <C>          <C>      
Cash flows from operating activities:
    Net income (loss)                                                             $  1,101     $    365     $ (7,425)
    Adjustments to reconcile net income (loss) to net cash provided by
          (used) in operating activities:
        In-process research and development costs                                       --           --        4,900
        Restructuring costs                                                             --       (1,208)       1,552
        Goodwill writedown                                                              --           --        2,800
        Depreciation and amortization                                                2,414        1,167        1,154
        Compensation expense for stock option grants                                   136          150           44
        Change in inventory obsolescence reserve                                        85          368         (567)
        Change in allowance for doubtful accounts                                       50          338         (413)
        Changes in operating assets and liabilities, net of effect of business
          acquisitions:
            Accounts receivable                                                       (559)        (951)        (506)
            Inventories                                                                329       (1,074)         227
            Prepaid expenses and other                                                (348)           1          (24)
            Accounts payable and accrued payroll and related expenses                 (956)         146          798
            Deferred revenue                                                           (58)        (371)         (87)
            Other liabilities                                                         (162)         113           23
                                                                                  --------     --------     -------- 
Net cash provided by (used in) operating activities                                  2,032         (956)       2,476
                                                                                  --------     --------     -------- 

Cash flows from investing activities:
        Capital expenditures                                                          (688)        (906)        (659)
        Cash paid for acquisition, net of cash received                               (673)          --      (15,803)
        Change in other assets                                                         488         (279)        (126)
                                                                                  --------     --------     -------- 
Net cash used in investing activities                                                 (873)      (1,185)     (16,588)
                                                                                  --------     --------     -------- 

Cash flows from financing activities:
        Net (repayments) proceeds from line of credit                               (1,607)       1,500           --
        Proceeds from issuance of note payable                                       2,558           --        4,000
        Payments on note payable                                                    (1,938)        (921)        (500)
        Cash dividend on preferred stock                                               (63)
        Proceeds from exercise of stock options and warrants                            30          738        6,635
                                                                                  --------     --------     -------- 
Net cash (used in) provided by financing activities                                 (1,020)       1,317       10,135
                                                                                  --------     --------     -------- 

Effect of exchange rates on cash                                                       117         (112)          --
                                                                                  --------     --------     -------- 
Net increase (decrease) in cash and cash equivalents                                   256         (936)      (3,977)
Cash and cash equivalents at beginning of year                                         715        1,651        5,628
                                                                                  --------     --------     -------- 

Cash and cash equivalents at end of year                                          $    971     $    715     $  1,651
                                                                                  ========     ========     ========

SUPPLEMENTAL CASH FLOW INFORMATION:

Interest paid                                                                     $    698     $    365     $    175
                                                                                  --------     --------     -------- 
Income tax payments                                                               $     69     $     80     $     35
                                                                                  --------     --------     -------- 
Preferred stock dividend paid in Common Stock                                     $     --     $     79     $     79
                                                                                  --------     --------     -------- 
Non cash preferred stock conversion                                               $    808     $     --     $     --
                                                                                  --------     --------     -------- 

Liabilities issued and assumed in connection with acquisition:
    Fair value of assets acquired (including intangibles)                         $  8,783     $     --     $ 18,928
    Less receivable from acquired entity                                              (684)          --           --
    Cash outflows for business acquisition                                            (673)          --      (15,803)
    Common stock and warrants issued                                                (3,044)          --       (2,615)
                                                                                  --------     --------     -------- 
Liabilities issued and assumed                                                    $  4,382     $     --     $    510
                                                                                  ========     ========     ========
</TABLE>

See accompanying Notes to Consolidated Financial Statements.


                                       16
<PAGE>   19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations - I-Flow Corporation ("the Company") was incorporated on
July 17, 1985 and is engaged in the manufacturing and marketing of ambulatory
infusion systems for use in the intravenous administration of drugs, nutrients
and similar medical treatments. The Company sells its products primarily to
customers in the home health care industry. InfuSystem, Inc., a wholly-owned 
subsidiary is primarily engaged in the rental of medical infusion pumps. The 
rentals are on a month-to-month basis and are treated as operating leases.

Principles of Consolidation - The accompanying consolidated financial statements
include the accounts of the Company and it's 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, 1998 and 1997:


<TABLE>
<CAPTION>
                                   December 31, 1998           December 31, 1997
                                   -----------------           -----------------
<S>                                <C>                         <C>
Raw Materials                            $ 3,507,000                 $ 3,235,000
Work in Process                              172,000                     359,000
Finished Goods                             1,869,000                   1,599,000
Reserve for Obsolescence                 (1,220,000)                 (1,135,000)
                                         ----------                  ---------- 

Total                                    $ 4,328,000                 $ 4,058,000
                                         ===========                 ===========
</TABLE>

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.

Long Lived Assets - The Company accounts for the impairment and disposition of
long-lived assets in accordance with Statement of Financial Accounting Standards
No. 121 (SFAS 121), Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of. In accordance with SFAS 121, 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 and has determined that
there was no impairment at December 31, 1998.

Goodwill and Other Intangibles - Goodwill represents the excess purchase cost
over the net assets acquired and is amortized over five to fifteen years using
the straight-line method. Other intangible assets include patents, acquired
workforce value and acquired technology which are being amortized using the
straight-line method over two to seven years. Accumulated amortization of
goodwill and other intangibles amounted to $2,314,000 and $1,466,000 as


                                       17
<PAGE>   20

of December 31, 1998 and 1997, respectively. The Company periodically evaluates
the recoverability of goodwill based on projected undiscounted operating cash
flows and evaluates the recoverability of other intangible assets based on the
requirements of SFAS 121.

Revenue Recognition - Revenue from product sales is recognized at the time of
shipment. Provision is made currently for estimated product returns and warranty
obligations, both of which have historically been insignificant.

Fees for non-cancelable licensing agreements with no minimum quantity or other
performance requirements are recognized as revenue upon execution of the related
agreement, assuming collection is probable. Fees for licensing agreements that
include minimum quantity or other performance requirements are recognized as
revenue ratably over the license period or as such criteria is met.

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.

Accounting for Stock Based Compensation - The Company accounts for stock-based
compensation awards to employees using the intrinsic value method in accordance
with Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock
Issued to Employees. (See Note 5)

Earnings Per Share - Pursuant to SFAS No. 128, Earnings Per Share, ("SFAS No.
128"), the Company provides dual presentation of "Basic" and "Diluted" earnings
per share ("EPS"). SFAS No. 128 replaced "Primary" and "Fully diluted" EPS under
Accounting Principles Board ("APB") Opinion No. 15.

Basic EPS excludes dilution from common stock equivalents and is computed by
dividing income available to common stockholders by the weighted average number
of common shares outstanding for the period. Diluted EPS reflects the potential
dilution from common stock equivalents, such as the Company's convertible
preferred stock and outstanding stock options, calculated using the treasury
stock method. Common stock equivalents have not been included in calculating
diluted EPS where inclusion would be anti-dilutive.



                                       18
<PAGE>   21

The following is a reconciliation between the components of the basic and
diluted earnings per share calculations:

<TABLE>
<CAPTION>
                                                              December 31,
                                                  ------------------------------------
                                                        1998         1997         1996
                                                  ----------   ----------   ----------
<S>                                               <C>          <C>         <C>         
  Net income (loss)                               $1,101,000   $  365,000  ($7,425,000)
  Less preferred stock dividends                     (63,000)     (79,000)     (79,000)
                                                  ----------   ----------   ----------

  Net income (loss) available to common
  shareholders                                    $1,038,000   $  286,000  ($7,504,000)
                                                  ----------   ----------   ----------

  Basic net income (loss) per  share
     Weighted average number of
        Shares outstanding                        13,479,000   12,210,000   10,849,000
     Effect of dilutive securities:
        Stock options                                232,000      820,000            -
                                                  ----------   ----------   ----------
  Diluted net income (loss) per share
     Weighted average number of
        Shares outstanding                        13,711,000   13,030,000   10,849,000
                                                  ----------   ----------   ----------
</TABLE>

Comprehensive Income (Loss) - 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 for the years ended
December 31, 1998, 1997 and 1996.

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 subsidiaries are generally measured using the local currency
as the functional currency. Assets and liabilities of the subsidiaries 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 in shareholders' equity. Realized gains or losses
from foreign currency transactions are included in operations as incurred.

Due to the highly inflationary environment in Mexico (as defined by SFAS No. 52,
Foreign Currency Transactions), the U.S. dollar served as the functional
currency for the Company's Mexican subsidiary during 1998 and 1997. As a result,
gains and losses from foreign currency transactions and from translation of the
Mexican financial statements were recognized currently as a component of other
income (expense). Such amounts were not significant for the years ended December
31, 1998 or 1997.

Reclassifications - Certain prior year amounts have been reclassified to conform
with the current year presentation.


                                       19
<PAGE>   22
2.      ACQUISITION OF BLOCK MEDICAL, INC.

On July 22, 1996, the Company purchased substantially all of the assets of Block
Medical, Inc. ("Block"). The assets were acquired for an aggregate purchase
price of approximately $18 million. The purchase price has been allocated to the
net assets acquired, in-process research and development, goodwill and other
intangibles. The amount allocated to in-process research and development of $4.9
million has been expensed as of the acquisition date. Consideration for the
purchase consisted of: $15,000,000 in cash, 433,018 shares of I-Flow Corporation
Common Stock with a value of $2,000,000 as of the date of closing, and a warrant
to purchase 250,000 shares of I-Flow Corporation Common Stock at an exercise
price of $4.62, expiring July 22, 2001, valued at $615,000 at the date of
closing. In addition, the Company incurred direct acquisition costs of $803,000.

The Company recorded a restructuring charge in 1996 of $1,552,000 to provide for
expenses related to consolidating Block's facilities with its own in 1997. The
$1,552,000 restructuring charge was comprised of approximately $788,000 in
severance and relocation expenses, $380,000 in moving expenses and $384,000 for
lease abandonment. The restructuring was completed during 1997 and there was no
restructuring reserve remaining as of December 31, 1997.

The unaudited consolidated pro forma results of operations for the year ended
December 31, 1996, as if the Block Medical acquisition had occurred at the
beginning of the year, are as follows:

<TABLE>
<CAPTION>
                                                                       1996
                                                                    -----------
<S>                                                                 <C>        
Total revenues                                                      $22,071,000

Net loss                                                            $(3,068,000)

Net loss per share                                                     $  (0.26)
                                                                    -----------
</TABLE>



The pro forma information presented above does not purport to be indicative of
the results that actually would have been obtained if the combined operations
had been conducted during the period presented and is not intended to be a
projection of future results.


3.      ACQUISITION OF INFUSYSTEM II, INC. AND VENTURE MEDICAL, INC.

On February 9, 1998, the Company entered into an Agreement and Plan of Merger
(the "Agreement") with InfuSystem II, Inc. ("InfuSystem"), Venture Medical, Inc.
("VMI") and the shareholders of InfuSystem and VMI, contemplating the merger of
InfuSystem and VMI with and into a wholly-owned subsidiary of the Company.
Pursuant to the Agreement, VMI and InfuSystem were merged (the "Merger") with
and into the subsidiary effective as of February 11, 1998.

In the Merger, all of the outstanding shares of Common Stock of VMI and
InfuSystem were exchanged for 987,074 shares of the Company's Common Stock,
valued at approximately $2.9 million plus 59,395 shares of the Company's Common
Stock valued at $177,000 as payment for related investment banker's fees. In
addition, the Company incurred direct acquisition costs of $673,000. The
transaction


                                       20
<PAGE>   23

was recorded using the purchase method of accounting and resulted in the
recording of approximately $3.5 million in goodwill.

At each of the six-month, one-year, eighteen-month and two-year anniversaries of
the closing, if the value of the Company's Common Stock at such time is less
than the value of its Common Stock as of the closing ($2.98 per share), then the
Company is obligated to pay additional amounts as merger consideration. Any
additional amounts are to be calculated pursuant to the formula set forth in the
Agreement. At the Company's election, it may pay such additional merger
consideration by the issuance of additional shares of its Common Stock, in cash,
or any combination thereof. In August 1998, the Company issued 209,675 shares of
its Common Stock pursuant to the valuation floor provision for the six-month
anniversary. Pursuant to APB 16, Business Combinations, there was no incremental
value ascribed to these additional shares for purchase accounting purposes. In
February 1999, the Company paid cash of $265,000 pursuant to the valuation floor
provision for the one-year anniversary.

As contemplated by the Agreement, shares of Common Stock issued in the Merger
(the "Escrowed Shares") were withheld and deposited in escrow. The Escrowed
Shares, or cash equal to the closing value of the Escrowed Shares, will be held
for a period of two years during which time they will be subject to claims by
the Company to satisfy the obligations of InfuSystem, VMI and the shareholders
of InfuSystem and VMI under the Agreement (subject to the possible earlier
release of a portion of the Escrowed Shares in connection with collection of
certain accounts receivable).

Since the acquisition was near the beginning of 1998, consolidated pro forma
results of operations for the year ended December 31, 1998 would not be
materially different from actual reported results, and thus are not included
herein. The unaudited consolidated pro forma results of operations for the year
ended December 31, 1997, as if the VMI and InfuSystem acquisition had occurred
at the beginning of that year, are as follows:

<TABLE>
<CAPTION>
                                                                       1997
                                                                    -----------
<S>                                                                 <C>        

Total revenues                                                       $23,358,000

Net loss                                                             $   (4,000)

Net loss per share                                                   $    (0.00)
                                                                    -----------
</TABLE>



The pro forma information presented above does not purport to be indicative of
the results that actually would have been obtained if the combined operations
had been conducted during the period presented and is not intended to be a
projection of future results.

4.     LINES OF CREDIT AND LONG TERM DEBT

<TABLE>
<CAPTION>
                                                             1998        1997
                                                          ----------  ----------
<S>                                                       <C>         <C>
Line of Credit under which the Company may borrow up
to the lesser of $4,000,000 or 75% of eligible
accounts receivable, as defined, ($1,678,000
available for borrowing as of December 31, 1998),
interest payable monthly at the banks prime plus .75%.    $        -  $1,500,000
                                                          ----------  ----------
</TABLE>


                                       21
<PAGE>   24

<TABLE>
<CAPTION>
                                                             1998        1997
                                                          ----------  ----------
<S>                                                       <C>         <C>

Line of Credit under which the Company may borrow up
to the lesser of $2,500,000 or 80% of eligible accounts
receivable, as defined, ($521,000 available for
borrowing as of December 31, 1998); interest payable 
monthly at the bank's prime rate plus .5%; due on 
demand; collateralized by all assets of InfuSystem         1,979,000           -

Note Payable due in equal monthly principal
installments of $83,333 plus interest at the bank's
prime rate plus 1% through July 2000; collateralized
by all assets of the Company.                              1,560,000   2,579,000

Note Payable due in equal monthly installments of
$46,296 plus interest at the banks prime rate plus
1%, through March 2003; collateralized by all assets
of the Company.                                            2,361,000           -

Installment Notes under which interest is payable
monthly at .5% over prime, due on various dates
between January and November 1999; collateralized by
all assets of InfuSystem, Inc.                               535,000           -

Other                                                        307,000           -
                                                          ----------  ----------

Total                                                      6,742,000   4,079,000

Less current portion                                       4,062,000   2,500,000
                                                          ----------  ----------

Total long-term debt                                      $2,680,000  $1,579,000
                                                          ==========  ==========
</TABLE>

The prime rate at the Company's banks was 7.75% at December 31, 1998. The notes
contain certain covenants, all of which the Company was in compliance with as of
December 31, 1998.

Future principal payments on long-term debt are as follows:

<TABLE>
<CAPTION>
  Year ended December 31:
  -----------------------                                             -----------
  <S>                                                                 <C>
  1999                                                                $2,083,000
  2000                                                                 1,335,000
  2001                                                                   602,000
  2002                                                                   587,000
  2003                                                                   156,000
  ----                                                                ----------
  Total                                                               $4,763,000
  ----                                                                ==========
</TABLE>


                                       22
<PAGE>   25
5.      SHAREHOLDERS' EQUITY, COMMON STOCK WARRANTS AND OPTIONS

As of December 31, 1998, the Company has 301,250 shares outstanding of its
Series B Preferred Stock, which is convertible at any time by the holders into
an aggregate of 321,323 shares of the Company's Common Stock (subject to
adjustment from time to time as a result of certain dilutive events). During the
year ended December 31, 1998, 355,000 shares of the Series B Preferred Stock was
converted into 378,678 shares of the Company's Common Stock. The preferred
shareholder is entitled to receive an annual dividend of 5% payable in cash or
in shares of Common Stock valued at 80% of the market value thereof on the
declaration date and entitled to a liquidation preference of $2.40 per share.

In July 1996, the Company issued warrants for the purchase of 250,000 shares of
the Company's Common Stock in conjunction with the acquisition of Block
("Acquisition Warrants") (Note 2). The exercise price for these warrants was
equal to the fair market value of the Common Stock at the date of grant.
Additionally, in conjunction with the financing obtained for the acquisition
(Note 4), the Company issued warrants to the bank for the purchase of 60,000
shares of the Company's Common Stock at an exercise price of $5.00 per share,
expiring in July 2001.

During the year ended December 31, 1997, Series F Warrants to purchase 336,328
shares of Common Stock at exercise prices of $2.40 and $3.60 were exercised in a
cashless exchange for 56,814 shares of the Company's Common Stock. Series F
Warrants to purchase 270,704 shares of the Company's Common Stock at an exercise
price of $4.80 expired during the year. Also during the year, Series H Warrants
for 150,000 shares of the Company's Common Stock were exercised raising net
proceeds of $450,000.

The Company had an employee stock option plan (the 1987-1988 Plan) which
provided for granting options to employees, officers and consultants to purchase
up to 2,000,000 shares of the Company's Common Stock at exercise prices not less
than 100% of the fair market value of the Company's Common Stock at the date of
grant. 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.

In May 1996, the shareholders of the Company approved a new stock incentive plan
(the "1996 Plan") which provides 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 may 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 may either be authorized and unissued shares or shares reacquired by
the Company through open market purchases or otherwise. If any award granted
under the 1996 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 1996 Plan. The
1996 Plan provides for the granting of options to purchase shares of the
Company's Common Stock at a price equal to 85% of the quoted market price on the
date of grant. Options granted


                                       23
<PAGE>   26

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 has issued options outside of the option plans to purchase an
aggregate of 541,500 shares of its Common Stock to certain key employees at
exercise prices below fair market value for services rendered. Compensation
expense related to these options aggregating $136,000, $150,000 and $44,000 has
been recorded for each of the years ended December 31, 1998, 1997 and 1996,
respectively. All other terms of the options are the same as those issued under
the 1996 Plan.

The Company also has a stock option plan which provides for the granting of
options to non-employee directors 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 are 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 become 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 options holder's status as a director.

Stock option activity is summarized as follows:

<TABLE>
<CAPTION>
                                                                            Weighted
                                                           Number of         Average
                                                            Shares            Price
                                                           ----------       ---------
<S>                                                        <C>              <C>
 Balance, January 1, 1996 (1,462,687 exercisable at a
        weighted average price of $2.17)
                                                            2,478,888           $2.59
     Granted (weighted average fair value of $7.29)           753,372            4.55
     Canceled/Expired                                         (45,547)           3.53
     Exercised                                               (337,078)           2.13
                                                           ----------           -----

 Balance, December 31, 1996 (1,788,437 exercisable at
        a weighted average price of $2.74)
                                                            2,849,635            3.06
     Granted (weighted average fair value of $4.63)           218,000            4.61
     Canceled/Expired                                        (175,660)           3.98
     Exercised                                               (116,328)           2.48
                                                           ----------           -----

 Balance, December 31, 1997 (1,909,601 exercisable at                            3.17
        a weighted average price of $2.87)                  2,775,647 
                                                           ----------           -----
     Granted (weighted average fair value of $2.32)         1,616,918            2.00
     Canceled/Expired                                      (1,217,180)           4.36
     Exercised                                                (16,000)           1.63
                                                           ----------           -----

 Balance, December 31, 1998 (1,865,735 exercisable at
        a weighted average price of $2.21)                  3,159,385           $2.16
                                                           ----------           -----
</TABLE>

On February 5, 1998, the Board of Directors approved a program for the
cancellation and regrant of certain options, whereby all Directors and employees
could elect to relinquish their existing


                                       24
<PAGE>   27

options with exercise prices ranging from $3.56 to $5.44 per share, in return
for options to purchase 43% fewer shares at an exercise price of $2.50 per
share. Under this program options included above to purchase 1,115,000 shares at
prices ranging from $3.56 to $5.44 were cancelled and new options were granted
to purchase 635,550 shares at a price of $2.50, representing 85% of the quoted
market price on the date of regrant. Vesting on the new options began one year
from the date of grant and continue over the next four years.

Options to purchase 1,760,113 and 223,800 shares of the Company's Common Stock
were available for grant under the 1996 Plan and the non-employee director's
plan, respectively, as of December 31, 1998.

The following table summarizes information concerning outstanding and
exercisable options as of December 31, 1998:

<TABLE>
<CAPTION>
                                     Options Outstanding           Options Exercisable  
                           ------------------------------------  -----------------------
                                          Weighted
                                           Average     Weighted                 Weighted
                             Number       Remaining    Average      Number      Average
                            Of Shares    Contractual   Exercise   Of Shares     Exercise
Range of Exercise Prices   Outstanding  Life in Years   Price    Exercisable      Price   
------------------------   -----------  -------------  --------  -----------    --------
<S>                        <C>          <C>            <C>       <C>            <C>
$0.25 - $1.00                   83,000      4.41        $0.25          69,667      $0.25
$1.01 - $2.00                1,195,070      4.55        $1.41         787,462      $1.52
$2.01 - $3.00                1,382,265      4.63        $2.35         620,389      $2.36
$3.01 - $4.00                  261,470      3.31        $3.22         230,681      $3.20
$4.01 - $5.00                  213,580      2.77        $4.24         133,536      $4.34
$5.01 - $6.00                   24,000      3.11        $5.16          24,000      $5.16
                             ---------      ----        -----       ---------      -----

Total                        3,159,385      4.35        $2.16       1,865,735      $2.21
                             =========      ====        =====       =========      =====
</TABLE>


The Company has adopted the disclosure-only provisions of the SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, no compensation cost has
been recognized for stock option grants 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:

<TABLE>
<CAPTION>
                                                         Years Ended December 31,
                                                       -------------------------------
(Amounts in thousands, except per share amounts)        1998      1997         1996
                                                        ------    -------      ------- 
<S>                                                     <C>       <C>          <C>     
Net income (loss) - as reported                         $1,101    $   365      $(7,425)

Net income (loss) - pro forma                           $   56    $  (146)     $(8,057)

Earnings (loss) per share - as reported                 $ 0.08    $  0.02      $ (0.69)

Earnings (loss) per share - pro forma                   $ 0.00    $ (0.02)     $ (0.74)
                                                        ------    -------      ------- 
</TABLE>


                                       25
<PAGE>   28

The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants in 1998, 1997 and 1996: no dividend yield; expected volatility 76% in
1998, 52% in 1997 and 45% in 1996; risk-free interest rate of 5.0% in 1998, 6.0%
in 1997 and 6.5% in 1996; and expected lives of 5 years.



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.

Total taxes on income for the years ended December 31, 1998, 1997 and 1996 are
summarized as follows:

<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                              1998           1997           1996
                                              --------       ---------      ----------
<S>                                           <C>            <C>            <C>        
Current:

Federal                                       $ 24,000       $  79,000      $   49,000 
State                                            5,000           1,000          11,000 
Foreign                                         40,000               -              -  

Deferred:

Federal                                         (8,000)         68,000      (2,186,000)
State                                           (5,000)        710,000      (1,566,000)
Change in valuation allowance                   13,000        (778,000)      3,752,000 
                                              --------       ---------      ----------

 Total                                        $ 69,000       $  80,000      $   60,000
                                              ========       =========      ==========
</TABLE>

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 reconciliation of the effective income tax rate to the statutory federal
rate is as follows:


<TABLE>
<CAPTION>
                                                     Years Ended December 31,
                                               1998          1997           1996
                                               -----         -----          ------   
<S>                                            <C>           <C>            <C>
U.S. Federal statutory tax expense              35.0%         35.0%         (35.0%) 
State taxes,  net of Federal  benefit,   
   net of state valuation allowance              1.1%            -            0.1%
Research and development credits                (4.2%)        (6.7%)         (0.1%)  
Foreign income                                   0.6%            -              -
</TABLE>


                                       26
<PAGE>   29

<TABLE>
<S>                                            <C>           <C>            <C>
   Goodwill amortization                         5.6%            -              -
   Change in valuation allowance               (35.7%)       (15.3%)         34.9%  
   Other                                         3.5%          5.0%           0.2%   
                                               -----         -----          ------   

Total                                            5.9%         18.0%           0.1%
                                               =====         =====          ======   
</TABLE>



As of December 31, 1998 and 1997, the Company had a net deferred tax asset
comprised of the following:

<TABLE>
<CAPTION>
                                                           Years Ended December 31,
Deferred Tax Assets:                                        1998              1997
--------------------                                      ----------        ---------- 
<S>                                                       <C>               <C>        
Net operating loss carryforwards                          $4,517,000        $4,922,000 
Amortization of goodwill and other intangibles             3,010,000         3,090,000 
Reserves not currently deductible                          2,049,000           757,000 
Cash to accrual adjustment                                  (626,000)                - 
State taxes                                                 (484,000)         (410,000)
Credits                                                      782,000           493,000 
Deferred revenue                                                   -            25,000 
Accrued compensation and related costs                       229,000           214,000 
Depreciation                                                 166,000            73,000 
Other                                                              -             1,000 
                                                          ----------        ---------- 

     Subtotal                                              9,643,000         9,165,000 
Less valuation allowance                                  (9,643,000)       (9,165,000)
                                                          ----------        ---------- 
Total                                                     $        -        $        -
                                                          ==========        ========== 
</TABLE>


At December 31, 1998, net operating loss carryforwards amounted to approximately
$13,200,000 and $196,000 for federal and state purposes, respectively, and
expire beginning 2000 through 2009. Due to certain tax regulations, future use
of the net operating loss carryforwards may be limited. Tax credits for federal
taxes of $384,000 and state taxes of $398,000 begin to expire in 2007 and 2006,
respectively.


7.      COMMITMENTS AND CONTINGENCIES

In June 1990, the Company entered into an employment agreement with the
President of the Company that expires on June 4, 2001. Under the terms of the
agreement, the President will receive a minimum base salary of $200,000 per year
for the term of this contract, with salary reviews conducted annually by the
Board of Directors.

In 1996, the Board of Directors approved a deferred compensation plan under
which certain key employees may be granted options under the 1996 Plan (Note 5)
for which the Company will pay 100% of the total exercise price upon exercise of
the options by the employee. These options will vest one-third upon the
expiration of each of the three years following the date of grant.


                                       27
<PAGE>   30

Compensation expense of $136,000, $150,000 and $44,000 relating to the plan was
recorded in 1998, 1997 and 1996, respectively.

In July 1997, the Company entered into a noncancelable operating lease for a new
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.


Future minimum lease payments under the lease are as follows:


<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
<S>                                                                  <C>
1999                                                                 $   386,000
2000                                                                     386,000
2001                                                                     386,000
2002                                                                     407,000
2003                                                                     428,000
Thereafter                                                             1,500,000
                                                                     -----------

Total                                                                $ 3,493,000
                                                                     ===========
</TABLE>


Rent expense for the years ended December 31, 1998, 1997 and 1996 was $541,000,
$401,000 and $291,000, respectively.

During 1997, InfuSystem underwent a Medicare Region B audit. As part of its
findings, Medicare Region B disagreed with the Company's definition of
intermittent use of infusion pumps and claimed that, as a result, Medicare
Region B had overpaid for certain patient rentals. The Company retained outside
counsel and believes that the Company's definition of intermittent use and the
related billings were appropriate based on applicable law. The Company also
believes that this position is supported by the policies and regulations of
other Medicare regions. However, in the event that Medicare Region B prevails,
the Company could be forced to refund applicable payments received from October
1, 1995 to the current time, plus penalties and interest, if assessed. If this
occurs, other Medicare regions could take the same position and request refunds
on amounts previously paid. In addition, a change in the ability to bill
intermittent use of pumps would result in a reduction of the Company's ongoing
revenue stream, as it would no longer be profitable to serve certain customers.
Although the Company believes it has meritorious defenses against the Medicare
Region B claim, the ultimate impact of the dispute, which could have a material
adverse impact on the Company, cannot be determined at the current time.
Management believes that the escrowed shares withheld as part of the InfuSystem
acquisition (Note 3) would be sufficient to offset any reasonably possible
exposure at no incremental cost to the Company.

The Company is also involved in litigation arising from the normal course of
operations. Although the liability at December 31, 1998 cannot be ascertained,
in the opinion of


                                       28
<PAGE>   31

management any resulting future liability will not have a material adverse
effect on the Company's financial position and results of operations.

8.      EMPLOYEE BENEFIT PLAN

The Company has a 401(k) retirement plan in which any full time employee may
participate. Employer contributions to the plan are discretionary. No employer
contributions were authorized during the years ended December 31, 1998, 1997 or
1996. The Company does not provide post-retirement benefits to its employees.

The Company's wholly owned subsidiary InfuSystem, Inc., has a 401(k) Profit
Sharing Plan which covers substantially all employees. The Company's
contributions to the plan are at the discretion of management and amounted to
$25,962 and $27,667 for the years ended December 31, 1997 and 1996,
respectively. There were no employer contributions for the year ended December
31, 1998.

9.      BUSINESS SEGMENTS

During 1998, the Company operated in two business segments: manufacturing and
marketing of medical infusion pumps and rentals of medical infusion pumps. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies (Note 1). There were no business
segments in previous years as the rental segment was acquired in fiscal 1998
(Note 3).

Business segment information is as follows for the year ended December 31, 1998:


<TABLE>
<CAPTION>
                                  Manufacturing
                                  and Marketing       Rentals       Consolidated
                                  --------------      ----------    ------------
<S>                               <C>                 <C>           <C>        
Revenues                             $17,124,000      $6,468,000     $23,592,000
Operating income                         722,000       1,132,000       1,854,000
Assets                                15,885,000       8,451,000      24,336,000
Depreciation and amortization          1,324,000       1,090,000       2,414,000
Property additions                       388,000         300,000         688,000
                                     -----------      ----------     -----------
</TABLE>


Sales to major customers as a percentage of total revenue are shown in the table
below.

<TABLE>
<CAPTION>
                                                1998           1997         1996
                                                ----           ----         ----
  <S>                                           <C>            <C>          <C>
  Customer A - elastomeric infusion                              -            -
     products                                   20%
  Customer B -  spring-driven
     infusion products                            -              -          31%
                                                ----           ----         ----
</TABLE>

A decision by a significant customer to substantially decrease or delay
purchases from the Company or the Company's inability to collect receivables
from these customers could have a material adverse effect on the Company's
financial condition and results of operations.


                                       29
<PAGE>   32
All of the Company's rental revenue is domestic. Export sales of medical
products represented 28%, 36% and 30% of total revenue during 1998, 1997 and
1996, respectively. Total revenue by geographical region is summarized as
follows:

<TABLE>
<CAPTION>
Sales to unaffiliated customers:             1998           1997            1996
--------------------------------          -----------     -----------      ----------
<S>                                       <C>             <C>              <C>
     United States                        $17,020,000     $11,484,000      $9,519,000
     Europe                                 5,032,000       3,953,000       2,690,000
     Asia                                   1,129,000       1,986,000       1,383,000
     Other                                    411,000         319,000         300,000
                                              
                                          -----------     -----------     -----------
     Total                                $23,592,000     $17,742,000     $13,892,000
                                          ===========     ===========     ===========
</TABLE>


<TABLE>
<S>                                      <C>
CORPORATE OFFICE                         STOCK REGISTRAR & TRANSFER AGENT
I-Flow Corporation                       American Stock Transfer & Trust Company
20202 Windrow Drive                      40 Wall Street
Lake Forest, California 92630            New York, NY  10005
(800) 448-3569                           (800) 937-5449 or (212) 936-5100
(949) 206-2700
                                         ANNUAL MEETING OF SHAREHOLDERS
LEGAL COUNSEL                            Thursday, May 13, 1999 at 9:30 a.m.
Gibson, Dunn & Crutcher LLP              at the Sutton Place Hotel
Jamboree Center, 4 Park Plaza            4500 MacArthur Drive
Irvine, CA 92614                         Newport Beach, California

INDEPENDENT AUDITORS                     FORM 10-K
Deloitte & Touche LLP                    A copy of I-Flow's annual report on
695 Town Center Drive                    Form 10-K filed with the Securities
Costa Mesa, California 92626             and Exchange Commission (excluding
                                         exhibits) will be furnished without
                                         charge to shareholders of record
INVESTOR RELATIONS COUNSEL               upon written request to:
Neil Berkman & Associates                Gayle L. Arnold
1900 Avenue of the Stars                 Chief Financial Officer
Suite 2850                               I-Flow Corporation
Los Angeles,  CA  90067                  20202 Windrow Drive
(310) 277-5162                           Lake Forest, California  92630
</TABLE>



SECURITIES INFORMATION

I-FLOW Corporation's Common Stock is traded on The Nasdaq Small Cap Stock Market
under the symbol IFLO. The high and low transaction prices for the Common Stock
as reported by Nasdaq are set forth in the following table.

<TABLE>
<CAPTION>
1998               High       Low           1997                High        Low
-------------     ------     -----          ----------------    -----      -----
<S>               <C>        <C>            <C>                 <C>        <C>  
First Quarter     $3.69      $2.50          First Quarter       $5.88      $4.00
</TABLE>


                                       30
<PAGE>   33

<TABLE>
<S>               <C>        <C>            <C>                 <C>        <C>  
Second Quarter    $2.69      $1.75          Second Quarter      $4.31      $3.88
Third Quarter     $2.31      $1.38          Third Quarter       $5.00      $3.91
Fourth Quarter    $2.00      $1.13          Fourth Quarter      $5.13      $2.56
</TABLE>

There were approximately 500 shareholders of record of I-Flow's Common Stock on
March 1, 1999.

The Company has not paid, and does not expect to pay in the foreseeable future,
cash dividends on its common stock.







                                       31