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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1998
--------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 0R 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _________ to _________
COMMISSION FILE NUMBER 0-18338
I-FLOW CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 33-0121984
- ------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
20202 WINDROW DRIVE, LAKE FOREST, CA 92630
- ---------------------------------------- ---------------------------------
(Address of Principal Executive offices) (Zip code)
Registrant's telephone number, including area code: (949) 206-2700
- --------------------------------------------------------------------------------
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
--------------------------
(Title of class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
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The aggregate market value of the 12,848,542 shares of voting Common Stock of
the registrant held by non-affiliates of the registrant on March 1, 1999, based
on the last sale price of such stock on the Nasdaq Small Cap Market on such date
was $28,523,763.
Registrant's outstanding stock as of March 1, 1999 was 14,044,428 shares of
Common Stock and 301,250 shares of Series B Preferred Stock. The Series B
Preferred Stock is convertible by the holders thereof at any time into 321,343
shares of the Company's Common Stock and, except as otherwise provided by law or
the Certificate of Determination of Preferences of Series B Preferred Stock,
votes with the Common Stock as a single class on all matters submitted to
holders of Common Stock. All the Preferred Stock is held by affiliates.
Information required by Part III is incorporated by reference to portions of the
registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders, which
will be filed with the Securities and Exchange Commission within 120 days after
the close of the registrant's year ended December 31, 1998.
Certain information required by Parts II and IV is incorporated by reference to
portions of the registrant's Annual Report to Shareholders for the fiscal year
ended December 31, 1998.
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PART I
ITEM 1. BUSINESS
THE COMPANY
I-Flow Corporation (the "Company" or "I-Flow") designs, develops,
manufactures and markets technically advanced, ambulatory infusion systems that
administer antibiotics, analgesics, chemotherapeutic agents, hormones,
nutrients, hydration therapies and other medical treatments to patients. These
compact, portable devices simplify and improve patient care, while reducing
costs through innovative product design. They are used most frequently in the
home, hospitals and physician offices.
The Company was incorporated in the State of California in July 1985.
The Company's corporate offices are located at 20202 Windrow Drive, Lake Forest,
California 92630. The telephone number is (949) 206-2700 and its web site is
located at www.i-flowcorp.com.
ACQUISITION OF BLOCK MEDICAL, INC.
On July 3, 1996, the Company entered into an agreement for the purchase
of substantially all of the assets of Block Medical, Inc. ("Block"), a wholly
owned subsidiary of Hillenbrand Industries, Inc. Block was a San Diego,
California based manufacturer and marketer of ambulatory infusion devices. This
transaction consummated on July 22, 1996.
ACQUISITION OF INFUSYSTEMS II, INC. AND VENTURE MEDICAL, INC.
On February 9, 1998, the Company entered into an agreement and plan of
merger contemplating the merger of Infusystems II, Inc. and Venture Medical,
Inc. (collectively referred to as "InfuSystem") with and into a wholly-owned
subsidiary of I-Flow. The transactions contemplated by this agreement were
consummated on February 11, 1998.
InfuSystem is a leading ambulatory infusion pump management firm based
in Madison Heights, Michigan. By delivering pumps from a variety of
manufacturers to private medical practices and clinics across the country,
Infusystem uses a unique approach to service the cancer infusion therapy market.
InfuSystem specializes in providing ambulatory infusion pumps and the related
disposables used primarily for cancer treatments. InfuSystem currently serves
over 1,000 physicians and clinics out of approximately 3,500 physicians and
clinics in the cancer treatment market which are believed to be targets for
services relating to outpatient chemotherapy treatment.
THE PRODUCTS
I-Flow offers the health care professional a complete line of
cost-effective infusion therapy devices designed to meet the needs of today's
managed care environment both in the hospital and alternate site setting. The
I-Flow family of technically advanced infusion products is portable, reliable,
economical and versatile.
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ELASTOMERICS
The patented HOMEPUMP Eclipse(R) and HOMEPUMP Eclipse "C" Series are
durable, portable and compact elastomeric infusion systems designed to deliver
medications such as antibiotics, pain medication, and chemotherapy drugs in a
wide range of volumes and delivery times needed to meet today's sometimes
complex protocols. Sales of elastomeric infusion systems comprised approximately
47%, 59% and 31% of the Company's total revenues for the years ended December
31, 1998, 1997 and 1996, repectively. The HOMEPUMP Eclipse is a market leader in
elastomeric technology and provides the health care professional with a device
that is both safe and extremely easy to teach patients to self-administer.
The ONE-STEP KVO(TM) is an elastomeric infusion device intended to be
used as an alternative to flushing and as a means to help prevent catheter
occlusions. There are several hundred million flushes performed on catheters in
the United States every year and the process is expensive, cumbersome and
difficult to perform correctly. The complication rates for PICC line catheters
exceed 20%, many of which are attributable to improper flushing techniques. The
ONE-STEP KVO not only helps prevent complications associated with flushing, but
it is significantly more cost effective and easy to use. The ONE-STEP KVO is
well suited for hospitals, skilled nursing facilities and home healthcare
environments.
In June 1998, the Company received permission from the Food and Drug
Administration ("FDA") to market its new disposable PainBuster(TM) infusion pain
management kit for orthopedic surgery applications. I-Flow's PainBuster pain
management system, which is based on the Company's elastomeric infusion
technology, provides continuous infusion of a non-narcotic, local anesthetic
directly into the intraoperative site for postoperative pain management.
In November 1998, the Company launched its new ON-Q(TM) pain management
infusion system for use with general surgery procedures. I-Flow received
permission to market this system from the FDA in October 1998.
SYRINGE DELIVERY SYSTEMS
The Medi-SIS 20 and Medi-SIS 60 Syringe Infusion Systems are designed to
provide an accurate intravenous ("IV") push delivery from a syringe. This
cost-effective syringe system delivers IV medications in single doses or in
multi-doses from one syringe over periods from 5 minutes to 12 hours. The
Medi-SIS Syringe Infusion System provides the healthcare professional with a
reusable, mechanical delivery system that can replace gravity based systems
while providing a low cost, accurate delivery with less teaching time required
for patients.
The Band-It Syringe Delivery System and the Band-It One Dose System
deliver a variety of medications such as antibiotics, diuretics, and other low
volume drugs. The Band-It utilizes a standard Becton-Dickinson 10 or 20 cc
syringe to infuse over 15 to 30 minutes, providing the lowest supply cost per
dose while still providing a safe and accurate alternative to gravity or IV push
methods.
NON-ELECTRONIC IV BAG DELIVERY SYSTEMS
The Liberty(R) 100, Liberty 250 and Liberty 1000 IV Bag Infusion Systems
deliver medications from standard Abbott Laboratories, Inc. or Baxter
International, Inc. IV bags. The Liberty System provides a safe, easy to use
means of providing a controlled infusion, eliminating the need to teach
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patients to count drops or use a roller clamp. The I-Flow Liberty system
encourages improved patient compliance, while providing a low cost means of
infusion delivery.
The PARAGON(R) ambulatory infusion pump provides accurate and cost
effective delivery of IV medications, including chemotherapy, heparin and
analgesics, which require precise and reliable delivery over extended periods of
time. The companion product, SIDEKICK, utilizes a patented spring technology to
deliver IV antibiotics over a shorter time period.
The Rely-A-Flow(R) Gravity Set eliminates roller clamps and reduces the
risk of over infusion using gravity. Flow control tubing precisely controls the
rate of infusion, providing a safe and cost-effective method for delivering
medications from standard IV fluid containers at a controlled rate of flow.
ELECTRONIC PUMPS
Verifuse(R), Verifuse Plus and the I-Flow VIP(TM) are the only infusion
devices available today that can be used with the VOICELINK(R). These electronic
infusion pumps are multi-therapy, ambulatory infusion devices with features
similar to pumps currently on the market.
With VOICELINK, the only piece of equipment a caregiver needs is a
telephone. There is no computer to carry and no special software to learn.
Remote programming and monitoring is as simple as dialing a telephone and
following the verbal instructions from a voice mail-like system. VOICELINK and a
standard touch tone telephone or cellular phone is all that is needed.
Vivus 4000(R) is the only ambulatory, multi-channel, multi-therapy
electronic infusion pump available. It provides accurate and safe remote
programming and delivery of four individual protocols regardless of complexity.
THE MARKET
Alternate site healthcare has grown significantly in the past few years.
Ambulatory infusion devices are one of the fastest growing segments in the
alternate site healthcare marketplace. An ambulatory pump allows patients to
leave the hospital earlier, making it very attractive to cost-conscious
hospitals and to patients who favor home treatment. Alternate site revenues for
infusion devices were estimated at $400 million in 1995 and are expected to
reach approximately $600 million by the year 2000. This field has been
identified by marketing research analysts as one of the fastest growing segments
in the U.S. healthcare market with revenues rising in excess of 20% annually.
Infusystem's market further extends the reach of I-Flow's products into
physician offices and clinics that specialize in cancer treatment. There are
over 7,000 physicians and clinics in the cancer treatment market, of which the
Company serves over 500. In addition, the Company also serves over 500 hospitals
and hospital outpatient centers. Two of I-Flow's newer products, the ONEoSTEP
KVO and the Medi-SIS Syringe Infusion System, are well suited for the hospital
market. There has been tremendous growth in the number of hospital outpatient
centers as hospitals attempt to broaden the geographic reach within their
communities.
COMPETITION
The IV drug and nutrient infusion segment of the alternate site
healthcare industry is highly competitive. The Company competes in this market
based on price, service and product performance. Some of the competitors have
significantly greater resources than the Company for research and
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development, manufacturing and marketing, and as a result may be better able to
compete for market share, even in areas in which the Company's products may be
superior. The industry is subject to technological changes and there can be no
assurance that the Company will be able to maintain any existing technological
lead long enough to establish its products and to sustain profitability.
The number of competitors and the Company's competitive position for
each of its product lines is noted in the table below.
<TABLE>
<CAPTION>
Estimated
Number of Competitive
MARKET DESCRIPTION Competitors Position
------------------------------------------ ----------- -----------
<S> <C> <C>
Electronic Ambulatory Infusion Pumps 7 4
Syringe Pumps 8 7
Elastomerics 3 1
Gravity Infusion Systems 10 8
Mechanical Infusion Systems 4 2
</TABLE>
The Company has focused its product development efforts on products in
the ambulatory infusion systems market and, with certain of its new products, it
is expanding its market to include hospitals. Amounts spent on Company-sponsored
product development activities are disclosed in the Statements of Operations in
the Financial Statements included elsewhere herein.
SALES AND DISTRIBUTION
Distribution of the Company's products in the United States is currently
managed directly through its internal sales force as well as through a number of
regional medical product distributors. As of March 1, 1999, the Company and its
recently acquired subsidiary, InfuSystem, had internal sales representatives
located throughout the United States. The Company relies on regional U.S.
medical product distributors for approximately 7% of its revenue. There are no
complete integrated contracts with any of these distributors. The Company is
actively pursuing additional distribution arrangements for its products.
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 Medical, 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 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 FDA to market the
PainBuster in the United States. I-Flow's PainBuster pain management system
provides continuous infusion of a non-narcotic, local anesthetic directly into
the intraoperative site for post-operative pain management. In September 1998,
the Company entered into a letter of understanding to distribute 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
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& 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, Paragon, 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.
The Company sells several of its products into the international market
and has signed agreements with distributors in various countries. Currently, the
Company is selling its products through distributors in Canada, Brazil, the
Benelux Countries, Germany, England, Ireland, Italy, Mexico, Spain, Korea,
Australia, New Zealand and Israel. Aggregate sales to countries outside of the
United States represented approximately 28%, 36% and 30% of the Company's
revenues for the years ended December 31, 1998, 1997 and 1996, respectively. The
Company does not have any capital investments in any foreign operations except
for its plant in Mexico.
Total revenue attributable to each geographic area into which the
Company has sales are 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
</TABLE>
MANUFACTURING AND OPERATIONS
Electromechanical assembly, calibration, pre and post-assembly, quality
assurance inspection and testing, and final packaging for all products have
historically been performed at I-Flow facilities by I-Flow employees using parts
and materials acquired from a variety of outside vendors. Printed circuit board
manufacture and component integration are performed externally, with I-Flow
obtaining custom circuit boards and then providing the electronic materials and
engineering specifications to an outside assembler. In July 1997, the Company
consolidated its U.S. operations to a new facility in Lake Forest, California.
With the acquisition of substantially all the assets of Block in July
1996, the Company acquired Block's wholly owned subsidiary, a manufacturing
plant in Northern Mexico. This plant has been in operation since 1994 and has
historically performed, and is currently performing, the manufacture of all of
Block's disposable IV infusion devices and tubing sets. The Company intends to
maintain the plant in Mexico and to manufacture a substantial portion of its
products there. The Company regularly reviews the use of outside vendors for
production versus internal manufacturing, analyzing factors such as the quality
of the products received from vendors, the costs of the products, timely
delivery and employee utilization.
In each of the years ended December 31, 1998, 1997 and 1996, the Company
incurred expenses of approximately $940,000, $1,035,000 and $1,139,000,
respectively, for research and development.
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PATENTS AND TRADEMARKS
The Company has filed U.S. patent applications for substantially all of
its products. The total number of patents now held by the Company is
approximately 40. These patents generally expire between 2009 to 2015, with the
most significant patents expiring in 2009. The Company has also filed for
intellectual property right protection in all foreign countries from which it
has significant revenue. In the opinion of management, there are no related
limitations that would have a material adverse effect on the Company.
Copyrights have been obtained for the Vivus 4000 programming software.
The product names are either registered trademarks or trademark applications are
pending for most of the Company's products. There can be no assurance that
pending patent or trademark applications will be approved or that any patents
will provide competitive advantages for the Company's products or will not be
challenged or circumvented by competitors.
REGULATIONS GOVERNING THE COMPANY'S MANUFACTURING OPERATIONS
Development and manufacture of I-Flow products is governed by the Food,
Drug and Cosmetic Act. Under the act, the Company is required to register its
facilities and list its devices with the FDA, to file notice of intent to market
new products under section 510(k) of the act, to track the location of certain
of its products and to report any incidents of death or serious injury relating
to its products. To date, there have been no reportable conditions found during
any FDA inspections. Failure to comply with any of these regulations can result
in civil and criminal penalties upon the Company and/or the recall seizure, or
injunction of certain of its products.
In addition to the FDA, the State of California has a set of similar
regulations and requires production-site inspections to maintain the relevant
manufacturing license. State regulations also address the storage and handling
of certain chemicals and disposal of their wastes.
The Company is required to comply with federal, state and local
environmental laws, however, there is no significant effect of such on the
capital expenditures, earnings and competitive position of the Company as there
is no significant use of hazardous materials in the manufacture of the Company's
products.
Products intended for export are subject to additional regulations,
including compliance with ISO 9000. In May 1995, the Company received ISO 9001
certification, which indicates that I-Flow's products meet specified uniform
standards of quality and testing. The Company was also granted permission to use
the CE mark on its products, which reflects approval of the Company's products
for export into 18 member countries of the European Community. In December 1996,
the Block operations were added to the Company's ISO certification and
permission was granted to use the CE mark on the Block products.
The Company has passed all regulatory inspections and believes that it
is currently in compliance with all relevant federal, state and international
requirements in all material respects.
EMPLOYEES
As of March 1, 1999, the Company and its recently acquired subsidiary,
InfuSystem, had a total of 132 full-time employees in the United States and the
Company had 160 employees in its wholly-owned subsidiary in Mexico. None of the
Company's employees in the United States are covered by a collective bargaining
agreement with a union. The Company considers its relationship with its
employees to be very good. The Company also uses temporary employees as needed,
mainly in manufacturing.
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ITEM 2. DESCRIPTION OF PROPERTY
In July 1997, the Company entered into a ten-year noncancelable
operating lease for a new 51,000 square foot building in Lake Forest,
California, for its primary facility. The Company also leases a facility for its
manufacturing plant in Northern Mexico and a facility for the operation of its
newly acquired subsidiary in Detroit, Michigan. These facilities currently
operate at approximately 60% of capacity.
ITEM 3. LEGAL PROCEEDINGS
As of March 1, 1999, the Company was involved in legal proceedings
including governmental proceedings (see Note 7 of Notes to Consolidated
Financial Statements) in the normal course of operations. Although the outcome
of the proceedings cannot be determined as of March 1, 1999, in the opinion of
management any resulting future liability will not have a material adverse
effect on the Company, taken as a whole.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
three months ended December 31, 1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information concerning the executive
officers of the Company as of March 1, 1999. There are no family relationships
between any of the executive officers or directors of the Company. The executive
officers are chosen annually at the first meeting of the Board of Directors
following the annual meeting of shareholders and, subject to the terms of any
employment agreement, serve at the pleasure of the Board of Directors.
<TABLE>
<CAPTION>
Name (Age) Position
---------- --------
<S> <C>
Donald M. Earhart (54) President, Chief Executive Officer and
Chairman of the Board
Henry Tsutomu Tai, Ph.D., M.D. (55) Secretary and Director
James J. Dal Porto (45) Executive Vice President, Chief Operating
Officer and Director
Gayle L. Arnold (37) Chief Financial Officer and Treasurer
</TABLE>
DONALD M. EARHART, former Corporate Officer and President of the Optical
Division of Allergan, Inc. (from 1986 to 1990), has been Chairman of the Board
since March 1991, and Chief Executive Officer since July 1990. Mr. Earhart
joined the Company as President and Chief Operating Officer in June 1990. Mr.
Earhart, who holds a Bachelor of Engineering degree from Ohio State University
and a Masters Degree in Business Administration from Roosevelt University, has
over 24 years experience in the medical products industry. Prior to his
employment at Allergan, he was a Corporate Officer and Division President of
Bausch and Lomb, and was an operations manager of Abbott Laboratories. He has
also served as an engineering consultant at Peat, Marwick, Mitchell & Co., and
as an engineer with Eastman Kodak Company. Mr. Earhart currently serves on the
Board of Directors of Abacus Investments, Ltd.
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HENRY TSUTOMU TAI, PH.D., M.D. is the initial progenitor of the
Company's product and business concept in multiple-drug infusion systems and
founding director. Dr. Tai was Chairman of the Board from 1985 to 1988, and has
been a director and Secretary of the Company since 1990. Dr. Tai has been a
consultant in hematology and oncology since 1977. Dr. Tai holds a Bachelor of
Arts degree in Molecular Biology from Harvard University, a Ph.D. in Molecular
Biology and a M.D. from the University of Southern California. He has done
postdoctoral research in the molecular biology of tumor virus DNA at the Weizman
Institute of Science in Israel and at the California Institute of Technology.
JAMES J. DAL PORTO joined the Company in October 1989 to serve as
Controller. Mr. Dal Porto was promoted to Treasurer in October 1990, to Vice
President of Finance and Administration in March 1991, to Executive Vice
President, Chief Financial Officer in March 1993 and to Chief Operating Officer
in February 1994. Mr. Dal Porto served as Financial Planning Manager and Manager
of Property Accounting and Local Taxation at CalComp, a high technology
manufacturing company, from 1984 to 1989. Mr. Dal Porto holds a Bachelor of
Science degree in Economics from the University of California, Los Angeles, and
a Masters in Business Administration from California State University,
Northridge.
GAYLE L. ARNOLD joined the Company in April 1991 to serve as Controller,
was promoted to Vice President, Finance in February 1994 and given the
additional office of Treasurer in May 1996. Prior to joining the Company, Ms.
Arnold served as a Manager with the accounting firm, Deloitte & Touche LLP where
she was employed from 1984 to 1991. Ms. Arnold is a Certified Public Accountant
and holds a Bachelor of Business Administration degree from the University of
Texas, Austin.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock trades on The Nasdaq Small-Cap Market under
the symbol "IFLO." The Company's Series B Preferred Stock is not publicly
traded, but is convertible by the holder at any time into shares of Common
Stock. The table below sets forth the high and low sales prices of the Company's
Common Stock as reported by The Nasdaq Small-Cap Market. As of March 1, 1999,
the Company's closing stock price was $2.22.
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1997
----
1st Quarter $5.88 $4.00
2nd Quarter $4.31 $3.88
3rd Quarter $5.00 $3.91
4th Quarter $5.13 $2.56
1998
----
1st Quarter $3.69 $2.50
2nd Quarter $2.69 $1.75
3rd Quarter $2.31 $1.38
4th Quarter $2.00 $1.13
</TABLE>
American Stock Transfer & Trust Company is the Company's transfer agent
for its Common Stock. As of March 1, 1999, the Company had approximately 500
shareholders of record, and based upon information received from nominee
holders, the Company believes it has in excess of 9,000 total beneficial
holders.
The Company has not paid, and does not currently expect to pay in the
foreseeable future, cash dividends on its Common Stock.
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 (the
"Effective Time"). In the Merger, all of the outstanding shares of Common Stock
of VMI and InfuSystem were exchanged for 987,074 shares of Common Stock of the
Company. In accordance with the terms of the Agreement, 59,395 shares of the
Company's Common Stock were issued to Amherst Capital Partners, L.L.C.
("Amherst"), investment banker for InfuSystem and VMI, as payment of Amherst's
fees and expenses in connection with the Merger. In August 1998, the Company
issued an additional 209,675 shares of its Common Stock pursuant to a valuation
floor provision for the six-month anniversary. The Company relied on the
exemption from registration provided by Section 4(2) of the Securities Act of
1933, as amended. The shares of Common Stock issued pursuant to the Merger
Agreement were included in the Registration Statement on form S-3 (Registration
No. 333-62929) filed by the Company in January 1999.
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ITEM 6. SELECTED FINANCIAL DATA
The table entitled "Selected Consolidated Financial Data" which appears
in the Company's 1998 Annual Report to Shareholders is incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" which appears in the Company's 1998 Annual
Report to Shareholders is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) Financial Statements
The financial statements, including the notes thereto, included in the
Company's 1998 Annual Report to Shareholders together with the section entitled
"Independent Auditors Report" are incorporated herein by reference.
(b) Financial Statement Schedules
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SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO ADDITIONS FOR BALANCE
BEGINNING COSTS AND BUSINESS AT END
CLASSIFICATION OF PERIOD EXPENSES ACQUISITION DEDUCTIONS OF PERIOD
- -------------- --------- -------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER
31, 1996:
Allowance for
doubtful accounts $509,000 $29,000 $413,000 $125,000
Reserve for obsolete
inventories 165,000 1,169,000 567,000 767,000
YEAR ENDED DECEMBER
31, 1997:
Allowance for
doubtful accounts 125,000 $338,000 463,000
Reserve for obsolete
inventories 767,000 612,000 244,000 1,135,000
YEAR ENDED DECEMBER
31, 1998:
Allowance for
doubtful accounts 463,000 316,000 1,311,000 266,000 1,824,000
Reserve for obsolete
inventories 1,135,000 323,000 238,000 1,220,000
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
There is incorporated herein by reference the information required by
this Item included in the Company's Proxy Statement for the 1999 Annual Meeting
of Shareholders under the captions "Election of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance," which will be filed with the
Securities and Exchange Commission no later than 120 days after the close of the
fiscal year ended December 31, 1998 and the information from the section
entitled "Executive Officers of the Registrant" following Part I, Item 4 of this
Report.
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ITEM 11. EXECUTIVE COMPENSATION
There is incorporated herein by reference the information required by
this Item included in the Company's Proxy Statement for the 1999 Annual Meeting
of Shareholders under the captions, "Board Compensation", "Executive
Compensation", "Report of the Compensation Committee", "Compensation Committee
Interlock Insider Participation" and "Stock Performance Graph" which will be
filed with the Securities and Exchange Commission no later than 120 days after
the close of the fiscal year ended December 31, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
There is incorporated herein by reference the information required by
this Item included in the Company's Proxy Statement for the 1999 Annual Meeting
of Shareholders under the caption "Principal Shareholders and Stock Ownership of
Management," which will be filed with the Securities and Exchange Commission no
later than 120 days after the close of the fiscal year ended December 31, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
14
<PAGE> 15
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
(1) Financial Statements
The following financial statements of the Company and independent
auditors' report are included in the Company's 1998 Annual Report to
Shareholders and are incorporated herein by reference:
<TABLE>
<CAPTION>
Annual Report
Page(s)
-------------
<S> <C>
Independent Auditors' Report 12
Financial Statements
Consolidated Balance Sheets, December 31, 1998 and 1997 13
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996 14
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1998, 1997 and 1996 15
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 16
Notes to Financial Statements 17
</TABLE>
The following are included herein:
<TABLE>
<CAPTION>
Page in This
Report
------------
<S> <C>
Independent Auditors' Report on Schedule 17
</TABLE>
The Financial Statements and Independent Auditor's Report listed in the
above index which are included in the Company's 1998 Annual Report to
Shareholders are hereby incorporated herein by reference. With exception
of the items referred to above and in Items 6, 7, and 8, the Company's
Annual Report to Shareholders for the fiscal year ended December 31,
1998 is not deemed filed as part of this Report.
(2) Financial Statement Schedules included herein:
<TABLE>
<CAPTION>
Page in This
Report
------------
<S> <C>
Schedule II - "Valuation and Qualifying Accounts" 13
</TABLE>
All other schedules are omitted as the required information is
inapplicable.
(3) Exhibits
The list of exhibits contained in the accompanying Index to Exhibits is
herein incorporated by reference.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended
December 31, 1998
15
<PAGE> 16
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
I-FLOW CORPORATION
Dated: March 30, 1999 By: /s/ Donald M. Earhart
---------------------------------
Donald M. Earhart,
Chairman, President & CEO
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant in the
capacities indicated on March 30, 1999:
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
/s/ Donald M. Earhart Chairman, President and Chief Executive Officer
-------------------------------
Donald M. Earhart
/s/ James J. Dal Porto Executive Vice President, Chief Operating
------------------------------- Officer and Director
James J. Dal Porto
/s/ Gayle L. Arnold Chief Financial Officer (Principal Financial and
------------------------------- Accounting Officer)
Gayle L. Arnold
/s/ John H. Abeles Director
-------------------------------
John H. Abeles, M.D.
/s/ Jack H. Halperin Director
-------------------------------
Jack H. Halperin
/s/ Joel S. Kanter Director
-------------------------------
Joel S. Kanter
/s/ Erik H. Loudon Director
-------------------------------
Erik H. Loudon
/s/ Henry Tsutomu Tai Director and Secretary
-------------------------------
Henry Tsutomu Tai, Ph.D., M.D.
</TABLE>
16
<PAGE> 17
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
To the Board of Directors and Shareholders of I-Flow Corporation:
We have audited the consolidated financial statements of I-Flow Corporation as
of December 31, 1998 and 1997 and for each of the three years in the period
ended December 31, 1998, and have issued our report thereon dated February 12,
1999. Such financial statements and report are included in I-Flow Corporation's
Annual Report to Shareholders and are incorporated herein by reference. Our
audits also included the financial statement schedule of I-Flow Corporation
listed in Item 8. The financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
DELOITTE & TOUCHE, LLP
Costa Mesa, California
February 12, 1999
17
<PAGE> 18
INDEX TO EXHIBITS
Set forth below is a list of the exhibits included as part of this report:
<TABLE>
<CAPTION>
Exhibit No. Exhibit
- ----------- -------
<S> <C>
3.1 Restated Articles of Incorporation of the Company (2)
3.2 Certificate of Amendment to Restated Articles of Incorporation dated
June 14, 1991 (3)
3.3 Certificate of Amendment to Restated Articles of Incorporation dated
May 12, 1992 (5)
3.4 Certificate of Determination covering Company's Series B
Preferred Stock filed with the Secretary of State on
October 5, 1992 (5)
3.5 Restated Bylaws as of July 22, 1991 of the Company (3)
4.1 Specimen Common Stock Certificate (5)
4.2 Warrant Agreement between the Company and American Stock Transfer
& Trust Company, as Warrant Agent, dated February 13, 1990 (1)
4.3 Form of Warrant dated July 22, 1996, issued in conjunction with
the acquisition of Block Medical, Inc. (8)
10.1 Employment Agreement with Donald M. Earhart dated May 16, 1990 (2)(6)*
10.2 1987-1988 Incentive Stock Option Plan and Non-Statutory Stock Option
Plan Restated as of March 23, 1992 (5)(6) *
10.3 1992 Non-Employee Director Stock Option Plan (4)(6)
10.4 License and Transfer Agreement with SoloPak Pharmaceuticals Inc.,
dated March 6, 1996 (7)
10.5 1996 Stock Incentive Plan (6)(9)*
10.6 Agreement for Purchase and Sale of Assets dated as of July 3, 1996 by
and among I-Flow Corporation, Block Medical, Inc. and Hillenbrand
Industries, Inc. (8)
10.7 Employment Agreement with James J. Dal Porto dated September 6, 1996 (10)*
10.8 Lease Agreement Between Industrial Developments International, Inc. as
Landlord and I-Flow Corporation as Tenant dated April 14, 1997 (11)
10.9 Agreement and Plan of Merger by and among I-Flow Corporation, I-Flow
Subsidiary, Inc., Venture Medical, Inc., and Infusystems II, Inc. and
the Shareholders of Venture Medical, Inc. and InfuSystems II, Inc.
(12)
10.10 Loan and Security Agreement between Silicon Valley Bank and I-Flow
Corporation dated September 28, 1995 (13)
10.11 Amendment to Loan Agreement between Silicon Valley Bank and I-Flow
Corporation dated March 2, 1998 (13)
13 1998 Annual Report to Shareholders (not deemed to be filed herein
except for certain portions which have been incorporated herein by
reference)
21 List of Subsidiaries
</TABLE>
18
<PAGE> 19
<TABLE>
<S> <C>
23.1 Independent Auditors' Consent
27 Financial Data Schedule
</TABLE>
- --------------
(1) Incorporated by reference to exhibit with this title filed with the
Company's Registration Statement (#33-32263-LA) declared effective
February 1, 1990.
(2) Incorporated by reference to exhibit with this title filed with the
Company's Form 10-K for its fiscal year ended September 30, 1990.
(3) Incorporated by reference to exhibit with this title filed with the
Company's Registration Statement (#33-41207-LA) declared effective
August 8, 1991.
(4) Incorporated by reference to exhibit with this title filed with the
Company's Form 10-K for its fiscal year ended December 31, 1991.
(5) Incorporated by reference to exhibit with this title filed with the
Company's Post Effective Amendment to its Registration Statement
(#33-41207-LA) declared effective November 6, 1992.
(6) Management contract or compensatory plan or arrangement required to be
filed as an exhibit pursuant to applicable rules of the Securities and
Exchange Commission.
(7) Incorporated by reference to exhibit with this title filed with the
Company's Form 10-K for its fiscal year ended December 31, 1995.
(8) Incorporated by reference to exhibit with this title filed with the
Company's Report on Form 8-K dated July 22, 1996.
(9) Incorporated by reference to exhibit with this title filed with the
Company's Registration Statement (#333-16547) declared effective
November 20, 1996.
(10) Incorporated by reference to exhibit with this title filed with the
Company's Form 10-K for its fiscal year ended December 31, 1996.
(11) Incorporated by reference to exhibit with this title filed with the
Company's Report on Form 8-K dated April 14, 1997.
(12) Incorporated by reference to exhibit with this title filed with the
Company's Report on Form 8-K dated February 9, 1998.
(13) Incorporated by reference to exhibit with this title filed with the
Company's Form 10-K for its fiscal year ended December 31, 1997.
* Compensation plan, contract or arrangement required to be filed as an
exhibit pursuant to applicable rules of the Securities and Exchange
Commission.
19
<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
<PAGE> 1
EXHIBIT 21
I-FLOW CORPORATION
LIST OF SUBSIDIARIES
<TABLE>
<CAPTION>
State of Juridiction
Name of Incorporation
- ---- --------------------
<S> <C>
Block Medical de Mexico, S.A. de C.V. Mexico
I-Flow International, Inc. U.S. Virgin Islands
Infusystem, Inc. California
</TABLE>
21
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-63500 and 333-16547 on Form S-8 and in Registration Statement Nos. 333-80384,
333-21493 and 333-62929 on Form S-3 of I-Flow Corporation of our reports dated
February 12, 1999, appearing, and incorporated by reference, in this Annual
Report on Form 10-K of I-Flow Corporation for the year ended December 31, 1998.
DELOITTE & TOUCHE LLP
Costa Mesa, California
March 30, 1999
22
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 971 715
<SECURITIES> 0 0
<RECEIVABLES> 9,314 5,590
<ALLOWANCES> (1,824) (463)
<INVENTORY> 4,328 4,058
<CURRENT-ASSETS> 13,427 10,040
<PP&E> 6,789 4,170
<DEPRECIATION> (3,362) (1,939)
<TOTAL-ASSETS> 24,336 17,634
<CURRENT-LIABILITIES> 6,839 5,467
<BONDS> 0 0
0 0
686 1,494
<COMMON> 38,350 34,468
<OTHER-SE> (24,219) (25,257)
<TOTAL-LIABILITY-AND-EQUITY> 24,336 17,634
<SALES> 17,006 17,678
<TOTAL-REVENUES> 23,592 17,742
<CGS> 10,219 8,450
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 11,519 17,344
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 684 334
<INCOME-PRETAX> 0 0
<INCOME-TAX> 69 80
<INCOME-CONTINUING> 1,101 365
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 1,101 365
<EPS-PRIMARY> .08 .02
<EPS-DILUTED> 0 0
</TABLE>
