| I FLOW CORP /DE/ Item 1A Risk Factors |
| RISK FACTORS RELATING TO OUR BUSINESS AND THE INDUSTRY IN WHICH WE OPERATE We have experienced net losses in prior periods and have an accumulated deficit |
| As of December 31, 2005, our accumulated deficit was approximately dlra40dtta6 million |
| We had net income (losses) of (dlra8dtta4 million), (dlra17dtta1 million) and dlra0dtta5 million for the years ended December 31, 2005, 2004 and 2003, respectively |
| We may not achieve or maintain profitability in the future, and further losses may arise |
| For example, during the year ended December 31, 2004, our total costs and expenses increased by an amount greater than the increase in revenues, compared to the year ended December 31, 2003 |
| There can be no assurance that our future revenue growth, if any, will be greater than the growth of our costs and expenses |
| We have invested substantial resources into the sales and marketing of the ON-Q PainBuster |
| If this product does not achieve significant clinical acceptance or if our direct sales strategy is not successful, our financial condition and operating results will be adversely affected |
| Our current strategy assumes that the ON-Q PainBuster will be used in a significant number of surgical cases, ultimately becoming the standard of care for many common procedures |
| We have invested, and continue to invest, a substantial portion of our resources to establish and maintain a direct sales force to sell and market ON-Q During the year ended December 31, 2005, we invested approximately dlra48dtta8 million in the sales and marketing of ON-Q A failure of ON-Q to achieve and maintain a significant market presence, or the failure to successfully implement our direct sales strategy, will have a material adverse effect on our financial condition and results of operations |
| 8 _________________________________________________________________ [40]Table of Contents Our customers frequently receive reimbursement from private insurers and governmental agencies |
| Any change in the overall reimbursement system may adversely impact our business |
| The health care reimbursement system is in a constant state of change |
| Changes often create financial incentives and disincentives that encourage or discourage the use of a particular type of product, therapy or clinical procedure |
| Market acceptance and sales of our products may be adversely affected by changes or trends within the reimbursement system |
| Changes to the health care system that favor technologies other than ours or that reduce reimbursements to providers or treatment facilities that use our products may adversely affect our ability to sell our products profitably |
| Hospitals, alternate care site providers and physicians are heavily dependent on payment for their services by private insurers and governmental agencies |
| Changes in the reimbursement system could adversely affect our participation in the industry |
| Our products fall into the general category of infusion devices and related disposable products with regard to reimbursement issues |
| Except for payments made to our InfuSystem subsidiary, the majority of reimbursements are not paid directly to us |
| Rather, health care providers will often request that their patients’ health insurance providers provide them with some form of reimbursement for the disposables that are consumed in the patients’ therapy |
| We believe that the current trend in the insurance industry (both private and governmental) has been to eliminate cost-based reimbursement and to move towards fixed or limited fees for service, thereby encouraging health care providers to use the lowest cost method of delivering medications |
| This trend may discourage the use of our products, create downward pressure on our average prices, and, ultimately, negatively affect our revenues |
| Changes in reimbursement rates may adversely impact InfuSystem’s revenues |
| Our wholly owned subsidiary, InfuSystem, depends primarily on third-party reimbursement for the collection of its revenues |
| InfuSystem is paid directly by private insurers and governmental agencies, often on a fixed fee basis, for infusion services provided by InfuSystem to patients |
| InfuSystem’s oncology revenues comprised 28prca of our consolidated revenues for the year ended December 31, 2005 |
| If the average fees allowable by private insurers or governmental agencies were reduced, the negative impact on revenues of InfuSystem could have a material adverse effect on our financial condition and results of operations |
| Changes in reimbursement rates may adversely impact the revenue that we earn from our developing billing strategy for ON-Q Historically, we have charged health care providers for each ON-Q unit that they purchase from us |
| Currently, in many instances, we, through our InfuSystem subsidiary, bill private insurers for the use of ON-Q in ambulatory surgery centers, rather than charging these centers for the purchase price of each ON-Q unit |
| If this sales strategy is successful, we expect to increase our use of this sales strategy for ambulatory surgery centers |
| Any reduction in the average fees allowable by private insurers for the use of ON-Q in ambulatory surgery centers could negatively affect our ability to generate revenue from the centers and this could have a material adverse effect on our financial condition and results of operations |
| Our products are highly regulated by a number of governmental agencies |
| Any changes to the existing rules and regulations of these agencies may adversely impact our ability to manufacture and market our products |
| Our activities are regulated by the Food, Drug and Cosmetic Act |
| Under the Act, we are required, among other matters, to register our facilities and to list our devices with the FDA, to file notice of our intent to market certain new products under Section 510(k) of the Food, Drug and Cosmetic Act, to track the location of certain of our products, and to report any incidents of death or serious injury relating to our products |
| If we fail to comply with any of these regulations, or if the FDA subsequently disagrees with the manner in which we sought to comply with these regulations, we could be subjected to substantial civil and criminal penalties and a recall, seizure, or injunction with respect to the manufacture or sale of our products |
| Each state also has similar regulations |
| For example, in California, we are subject to annual production-site inspections in order to maintain our manufacturing license |
| State regulations also specify standards for the storage 9 _________________________________________________________________ [41]Table of Contents and handling of certain chemicals and disposal of their wastes |
| We are also required to comply with federal, state, and local environmental laws |
| Our failure to comply with any of these laws could expose us to material liabilities |
| Products intended for export are subject to additional regulations, including compliance with ISO 13485 |
| We first received ISO 13485 certification in July 2000, which indicates that our products meet specified uniform standards of quality and testing |
| In 2005, we achieved ISO 13485 certification under the 2003 revision of the standard |
| We have also been granted permission to use the CE mark on our products, which reflects approval of our products for export into the 28 member countries of the European Community |
| The certification and permission to use the CE mark on our products also apply to the Block Medical operations, including its Mexico facility |
| Failure to comply with these additional regulations could result in our inability to export products to the European Community |
| Furthermore, federal, state, local or foreign governments may enact new laws, rules and regulations that may adversely impact our ability to manufacture and market infusion devices by, for example, increasing our costs |
| Any impairment of our ability to market our infusion devices or other products could have a material adverse effect on our financial condition and results of operations |
| Our compliance with laws frequently involves our subjective judgment |
| If we are wrong in any of our interpretations of the laws, we could be subjected to substantial penalties for noncompliance |
| In the ordinary course of business, management frequently makes subjective judgments with respect to complying with the Food, Drug and Cosmetic Act, as well as other applicable state, local and foreign laws |
| If any of these regulatory agencies disagrees with our interpretation of, or objects to the manner in which we have attempted to comply with, the applicable law, we could be subjected to substantial civil and criminal penalties and a recall, seizure or injunction with respect to the manufacture or sale of our products |
| These types of actions against us or our products could have a material adverse effect on our financial condition and results of operations |
| We may need to raise additional capital in the future to fund our operations |
| We may be unable to raise funds when needed or on acceptable terms |
| During the year ended December 31, 2005, our operating activities used cash of dlra5dtta9 million and our investing activities provided cash of dlra11dtta7 million |
| As of December 31, 2005, we had cash and equivalents of dlra13dtta9 million, short-term investments of dlra13dtta3 million and net accounts receivable of dlra22dtta3 million |
| We believe our current funds, together with possible additional borrowings on our existing lines of credit and other bank loans, are sufficient to provide for our projected needs to maintain operations for at least the next 12 months |
| This estimate, however, is based on assumptions that may prove to be wrong |
| If our assumptions are wrong or if we experience further losses, we may be required to reduce our operations or seek additional financing |
| Any additional equity financings may be dilutive to our existing stockholders and involve the issuance of securities that may have rights, preferences or privileges senior to those of our current stockholders |
| A debt financing, if available, may involve restrictive covenants on our business that could limit our operational and financial flexibility, and the amount of debt incurred could make us more vulnerable to economic downturns or operational difficulties and limit our ability to compete |
| Furthermore, financing may not be available when needed and may not be on terms acceptable to us |
| Our intangible assets are subject to potential impairment charges that could adversely affect our results of operations |
| As of December 31, 2005, dlra2dtta6 million of our assets consisted of goodwill, an intangible asset acquired through the acquisition of InfuSystem |
| The determination of the value of intangible assets requires management to make estimates and assumptions that affect our financial statements |
| For example, we review the recoverability of the carrying value of goodwill on an annual basis or more frequently if an event occurs or circumstances change to indicate that an impairment of goodwill has possibly occurred |
| We compare the fair value of our reporting units to book value, as well as consider other factors, to determine whether or not any potential impairment of goodwill exists |
| In fiscal year 2002, as a result of the adoption of SFAS Nodtta 142, Goodwill and Other Intangible Assets, effective January 1, 2002, we wrote-off dlra3dtta5 million of goodwill related to past acquisitions other than InfuSystem |
| 10 _________________________________________________________________ [42]Table of Contents We cannot guarantee that there will be no additional impairment in the future related to InfuSystem or other acquisitions we may make in the future |
| Any impairment charge will adversely affect our results of operations |
| Our industry is intensely competitive and changes rapidly |
| If we are unable to maintain a technological lead over our competitors, our business operations will suffer |
| The drug infusion industry is highly competitive |
| We compete in this industry based primarily on price, service and product performance |
| Some of our competitors have significantly greater resources than we do for research and development, manufacturing, marketing and sales |
| We continue our efforts to introduce clinically effective, cost-efficient products into the market, but the industry is subject to technological changes and we may not be able to maintain any existing technological advantage long enough to establish our products and to achieve or sustain profitability |
| If we are unable to effectively compete in our market, our financial condition and results of operations will materially suffer |
| We rely on independent suppliers for parts and materials necessary to assemble our products |
| Any delay or disruption in the supply of parts may prevent us from manufacturing our products and negatively impact our operations |
| Although we perform final assembly and testing of our completed infusion systems, certain component parts, as well as molded products, are obtained from outside vendors based on our specifications |
| The loss or breakdown of our relationships with these outside vendors could subject us to substantial delays in the delivery of our products to customers |
| Significant delays in the delivery of our products could result in possible cancellation of orders and the loss of customers |
| Furthermore, we have numerous suppliers of components and materials that are sole-source suppliers |
| Because these suppliers are the only vendors with which we have a relationship for that particular component or material, we may be unable to produce and sell products if one of these suppliers becomes unwilling or unable to deliver components or materials meeting our specifications |
| Our inability to manufacture and sell products to meet delivery schedules could have a material adverse effect on our reputation in the industry, as well as our financial condition and results of operations |
| Our success in the Oncology Infusion Services market is impacted by the availability of the chemotherapy drugs that are used in our infusion pump systems |
| InfuSystem, our subsidiary that operates within the Oncology Infusion Services market, derives its revenue from the rental of ambulatory infusion pump systems to oncology offices and chemotherapy clinics |
| A shortage in the availability of chemotherapy drugs that are used in the infusion pump systems, including a commonly-used chemotherapy drug known as 5-flourouracil (“5-FU”), could have a material adverse effect on our financial condition and results of operations |
| For instance, we believe a shortage of 5-FU in the fourth quarter of 2005 resulted in an unfavorable revenue impact of approximately dlra1dtta9 million |
| Because the availability of 5-FU is expected to be below normal for the near term, we anticipate the negative impact on revenue to continue at least into the first quarter of 2006 |
| If the availability of 5-FU does not return to normal, or if there are shortages in other commonly-used chemotherapy drugs, our revenue could continue to be negatively impacted in the future |
| We manufacture the majority of our products in Mexico |
| Any difficulties or disruptions in the operation of our plant may adversely impact our operations |
| The majority of our products are manufactured by our Block Medical subsidiary |
| We may encounter difficulties as a result of the uncertainties inherent in doing business in a foreign country, including economic, political and regulatory uncertainties |
| If there are difficulties or problems in our Mexico facility, or other disruptions in our production and delivery process affecting product availability, these difficulties could have a material adverse effect on our business, financial condition and results of operations |
| 11 _________________________________________________________________ [43]Table of Contents If one of our products proves to be defective or is misused by a health care practitioner or patient, we may be subject to claims of liability that could adversely affect our financial condition and the results of our operations |
| A defect in the design or manufacture of our products, or a failure of our products to perform for the use that we specify, could have a material adverse effect on our reputation in the industry and subject us to claims of liability for injuries and otherwise |
| Misuse of our product by a practitioner or patient that results in injury could similarly subject us to claims of liability |
| We currently have in place product liability insurance in the amount of dlra10 million for liability losses, including legal defense costs |
| Any substantial underinsured loss would have a material adverse effect on our financial condition and results of operations |
| Furthermore, any impairment of our reputation could have a material adverse effect on our sales, revenues, and prospects for future business |
| We are dependent on our proprietary technology and the patents, copyrights, and trademarks that protect our products |
| If competitors are able to independently develop products of equivalent or superior capabilities, the results of our operations could be adversely impacted |
| We rely substantially on proprietary technology and capabilities |
| We have filed patent applications in the United States for substantially all of our products |
| We have also filed for intellectual property rights protection in all foreign countries for products from which we expect significant revenue |
| As of December 31, 2005, we held 130 patents, including approximately 40 United States patents and approximately 90 foreign patents |
| Our patents generally expire between 2006 and 2023 |
| Significant patents on our elastomeric balloon pump and Soaker Catheter expire in 2011 and 2019, respectively |
| Without sufficient intellectual property protection, our competitors may be able to sell products identical to ours and cause a downward pressure on the selling price of our products |
| There can be no assurance that pending patent or trademark applications will be approved or that any patents will provide competitive advantages for our products or will not be challenged or circumvented by competitors |
| Our competitors may also independently develop products with equivalent or superior capabilities or otherwise obtain access to our capabilities |
| In addition, we may become involved in potential litigation involving our proprietary technology, such as patents or copyrights infringement |
| Any negative outcome from such proceedings may have a material adverse effect on our financial condition and results of operations |
| A significant portion of our sales is to customers in foreign countries |
| We may lose revenues, market share, and profits due to exchange rate fluctuations and other factors related to our foreign business |
| For the year ended December 31, 2005, sales to customers in foreign countries comprised approximately 13prca of our revenues |
| Our foreign business is subject to economic, political and regulatory uncertainties and risks that are unique to each area of the world |
| Fluctuations in exchange rates may also affect the prices that our foreign customers are willing to pay, and may put us at a price disadvantage compared to other competitors |
| Potentially volatile shifts in exchange rates may negatively affect our financial condition and operations |
| Our stockholders’ equity may also be adversely affected by unfavorable translation adjustments arising from differences in exchange rates from period to period |
| In addition, we have not and currently do not hedge or enter into derivative contracts in an effort to address foreign exchange risk |
| We currently rely on two distributors for a significant percentage of our sales |
| If our relationship with these distributors were to deteriorate, our sales may materially decline |
| For the year ended December 31, 2005, sales to B Braun Medical SA and B Braun Medical Inc |
| accounted for 7prca and 6prca of the Company’s total revenues, respectively |
| Any deterioration in our relationship with B Braun Medical SA or B Braun Medical Inc |
| 12 _________________________________________________________________ [44]Table of Contents The preparation of our financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates, judgments, and assumptions that may ultimately prove to be incorrect |
| The accounting estimates and judgments that management must make in the ordinary course of business affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented |
| If the underlying estimates are ultimately proven to be incorrect, subsequent adjustments resulting from errors could have a material adverse effect on our operating results for the period or periods in which the change is identified |
| Additionally, subsequent adjustments from errors could require us to restate our financial statements |
| Restating financial statements could result in a material decline in the price of our stock |
| Failure to achieve and maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and our stock price |
| Section 404 of the Sarbanes-Oxley Act requires us to evaluate annually the effectiveness of our internal controls over financial reporting as of the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports |
| Section 404 also requires our independent auditor to attest to, and to report on, management’s assessment of our internal controls over financial reporting |
| Our management evaluated our internal controls over financial reporting as of December 31, 2005 in order to comply with Section 404 and concluded that our internal controls over financial reporting were effective |
| However, in the year ended December 31, 2004, we identified a material weakness and our independent registered public accounting firm expressed an adverse opinion on the effectiveness of our internal controls over financial reporting |
| We have since resolved the material weakness, but if we fail to implement and maintain adequate internal controls in the future, as such standards are modified, supplemented or amended from time to time, we cannot assure you that we or our independent accounting firm will be able to conclude in the future that we have effective internal controls over financial reporting in accordance with Section 404 |
| If we fail to achieve and maintain a system of effective internal controls, it could have a material adverse effect on our business and our stock price |
| RISK FACTORS RELATED SPECIFICALLY TO OUR COMMON STOCK The average trading volume for our common stock is relatively low when compared to most larger companies |
| As a result, there may be less liquidity and more volatility associated with our common stock, even if our business is doing well |
| Our common stock has been traded publicly since February 13, 1990, and since then has had only a few market makers |
| The average daily trading volume for our shares during the month of February 2006 was approximately 295cmam000 shares |
| There can be no assurance that a more active or established trading market for our common stock will develop or, if developed, will be maintained |
| The market price of our common stock has been and is likely to continue to be highly volatile |
| Market prices for securities of biotechnology and medical device companies, including ours, have historically been highly volatile, and the market has from time to time experienced significant price and volume fluctuations that appear unrelated to the operating performance of particular companies |
| The following factors, among others, can have a significant effect on the market price of our securities: • announcements of technological innovations, new products, or clinical studies by us or others; • government regulation; • changes in the coverage or reimbursement rates of private insurers and governmental agencies; • developments in patent or other proprietary rights; • future sales of substantial amounts of our common stock by existing stockholders or by us; and • comments by securities analysts and general market conditions |
| 13 _________________________________________________________________ [45]Table of Contents The realization of any of the risks described in these “Risk Factors” could also have a negative effect on the market price of our common stock |
| Future sales of our common stock by existing stockholders could negatively affect the market price of our stock and make it more difficult for us to sell stock in the future |
| Sales of our common stock in the public market, or the perception that such sales could occur, could result in a decline in the market price of our common stock and make it more difficult for us to complete future equity financings |
| A substantial number of shares of our common stock and shares of common stock subject to outstanding options and warrants may be resold pursuant to currently effective registration statements |
| As of December 31, 2005, there were: • 22cmam628cmam657 shares of common stock that are freely tradable in the public markets; • 215cmam109 shares of common stock underlying outstanding warrants which have been registered for resale under a Registration Statement on Form S-3 (Registration Nodtta 333-109096); and • an aggregate of 4cmam153cmam912 shares of common stock that may be issued on the exercise of stock options outstanding under our equity incentive plans |
| We cannot estimate the number of shares of common stock that may actually be resold in the public market because this will depend on the market price for our common stock, the individual circumstances of the sellers, and other factors |
| If stockholders sell large portions of their holdings in a relatively short time, for liquidity or other reasons, the market price of our common stock could decline significantly |
| Anti-takeover devices may prevent a sale, or changes in the management, of I-Flow |
| We have in place several anti-takeover devices, including a stockholder rights plan, that may have the effect of delaying or preventing a sale, or changes in the management, of the I-Flow |
| For example, one anti-takeover device provides for a board of directors that is separated into three classes, with their terms in office staggered over three year periods |
| This has the effect of delaying a change in control of the board of directors without the cooperation of the incumbent board |
| In addition, our bylaws do not allow stockholders to call a special meeting of stockholders or act by written consent, and also require stockholders to give written notice of any proposal or director nomination to us within a specified period of time prior to any stockholder meeting |
| We may also issue shares of preferred stock without stockholder approval and on terms that our board of directors may determine in the future |
| The issuance of preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding stock, and the holders of such preferred stock could have voting, dividend, liquidation, and other rights superior to those of holders of our common stock |
| We do not pay dividends and this may negatively affect the price of our stock |
| We have not paid dividends on our common stock and do not anticipate paying dividends on our common stock in the foreseeable future |
| The future price of our common stock may be adversely impacted because we do not pay dividends |
| In the future, our common stock may be removed from listing on the Nasdaq quotation system and may not qualify for listing on any stock exchange, in which case it may be difficult to find a market in our stock |
| If our common stock is no longer traded on a national trading market, it may be more difficult for you to sell shares that you own, and the price of our common stock would likely be negatively affected |
| Currently, our common stock is traded on the Nasdaq National Market |
| Nasdaq has a number of continued listing requirements, including a minimum trading price requirement |
| Failure to comply with any Nasdaq continued listing requirement could cause our common stock to be removed from listing on Nasdaq |
| Should this occur, we may not be able to secure listing on other exchanges or quotation systems, and this would have a material adverse effect on the price and liquidity of our common stock |