INVERNESS MEDICAL INNOVATIONS INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
ý	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2002
OR
o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to

COMMISSION FILE NUMBER 001-16789

INVERNESS MEDICAL INNOVATIONS, INC.
(Exact Name Of Registrant As Specified In Its Charter)

DELAWARE		04-3565120
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

51 SAWYER ROAD, SUITE 200
WALTHAM, MASSACHUSETTS 02453
(Address of principal executive offices)

(781) 647-3900
(Registrant's Telephone Number, Including Area Code)

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 ý No o

The number of shares outstanding of the registrant's common stock as of November 8, 2002 was 14,886,413.

INVERNESS MEDICAL INNOVATIONS, INC.

FORM 10-Q

For the Quarterly Period Ended September 30, 2002

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Readers can identify these statements by forward-looking words such as "may," "could," "should," "would," "intend," "will," "expect," "anticipate," "believe," "estimate," "continue" or similar words. There are a number of important factors that could cause actual results of Inverness Medical Innovations, Inc. and its subsidiaries to differ materially from those indicated by such forward-looking statements. These factors include, but are not limited to, the risk factors detailed in this quarterly report on Form 10-Q and other risk factors identified from time to time in our periodic filings with the Securities and Exchange Commission. Readers should carefully review the factors discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations—Certain Factors Affecting Future Results" and "Special Statement Regarding Forward-Looking Statements" beginning on pages 36 and 51, respectively, in this quarterly report on Form 10-Q and should not place undue reliance on our forward-looking statements. These forward-looking statements are based on information, plans and estimates at the date of this report. We undertake no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

Unless the context requires otherwise, references in this quarterly report on Form 10-Q to "we," "us," and "our" refer to Inverness Medical Innovations, Inc. and its subsidiaries.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
Item 1.		Consolidated Financial Statements (unaudited):
	a)	Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2001
	b)	Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001
	c)	Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001
	d)	Notes to Consolidated Financial Statements
Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures about Market Risk
Item 4.		Controls and Procedures
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings
Item 2.		Changes in Securities and Use of Proceeds
Item 6.		Exhibits and Reports on Form 8-K
SIGNATURE
CERTIFICATIONS

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

			Three Months Ended September 30,						Nine Months Ended September 30,
			2002			2001			2002			2001
Net product sales			$	52,162,253		$	11,159,028		$	139,137,609		$	34,290,388
License and other revenue				1,785,063			—			3,765,793			—

	Net revenue			53,947,316			11,159,028			142,903,402			34,290,388
Cost of sales				29,297,044			6,064,188			77,844,710			17,831,008

	Gross profit			24,650,272			5,094,840			65,058,692			16,459,380

Operating expenses:
	Charge related to asset impairment (Note 6)			—			—			12,681,581			—
	Research and development			3,597,035			377,508			10,538,788			1,032,194
	Sales and marketing			10,979,091			1,672,045			30,520,544			5,589,439
	General and administrative			6,193,343			3,061,666			20,036,525			6,877,801
	Stock-based compensation (Notes 4 and 7)*			—			—			10,169,105			—

		Total operating expenses		20,769,469			5,111,219			83,946,543			13,499,434

	Operating income (loss)			3,880,803			(16,379	)		(18,887,851	)		2,959,946
Interest expense, including amortization of original issue discount and beneficial conversion feature				(1,359,232	)		(203,792	)		(6,860,570	)		(927,372	)
Other expense, net				(709,482	)		(2,987	)		(1,786,595	)		(289,619	)

	Income (loss) from continuing operations before income taxes			1,812,089			(223,158	)		(27,535,016	)		1,742,955
Provision for income taxes				670,754			64,647			1,826,675			1,169,757

	Income (loss) from continuing operations			1,141,335			(287,805	)		(29,361,691	)		573,198
Income from discontinued operations, net of taxes of $38,135 and $741,613 for the three and nine months ended September 30, 2001, respectively				—			441,121			—			603,064

	Income (loss) before extraordinary item and accounting change			1,141,335			153,316			(29,361,691	)		1,176,262
Extraordinary gain (Note 8(c))				—			—			8,505,989			—
Cumulative effect of a change in accounting principle (Note 6)				—			—			(12,148,205	)		—

	Net income (loss)		$	1,141,335		$	153,316		$	(33,003,907	)	$	1,176,262

(Loss) income available to common stockholders (Note 10):
	(Loss) income from continuing operations		$	(6,724,392	)	$	(287,805	)	$	(41,029,739	)	$	573,198

	Net (loss) income		$	(6,724,392	)	$	153,316		$	(44,671,955	)	$	1,176,262

(Loss) income per common share—basic and diluted (Note 10):
	(Loss) income from continuing operations		$	(0.65	)	$	(0.04	)	$	(4.74	)	$	0.09

	Net (loss) income		$	(0.65	)	$	0.02		$	(5.16	)	$	0.19

	Weighted average shares			10,355,725			6,455,570			8,653,333			6,310,991

*: The charge for stock-based compensation for the nine months ended September 30, 2002 was part of general and administrative expenses. There were no charges for stock-based compensation for the three months ended September 30, 2002 and the three and nine months ended September 30, 2001.

The accompanying notes are an integral part of these consolidated financial statements.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)

			September 30, 2002			December 31, 2001
ASSETS
Current assets:
	Cash and cash equivalents		$	16,832,663		$	52,023,531
	Accounts receivable, net of allowances of $5,008,555 at September 30, 2002 and $2,595,137 at December 31, 2001			41,070,614			21,576,203
	Inventory			35,096,598			14,781,990
	Deferred income taxes			1,466,786			1,466,786
	Prepaid expenses and other current assets			4,693,895			4,973,659

		Total current assets		99,160,556			94,822,169
Property, plant and equipment, net				46,084,980			20,526,228
Goodwill, net				97,668,549			85,375,217
Trademarks and other intangible assets, net				92,894,854			75,390,396
Deferred financing costs and other assets, net				5,118,434			2,407,134

		Total assets	$	340,927,373		$	278,521,144

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Current portion of long-term debt		$	5,188,616		$	20,819,383
	Accounts payable			25,730,809			10,264,023
	Accrued expenses and other current liabilities			45,601,415			42,716,768

		Total current liabilities		76,520,840			73,800,174

Long-term liabilities:
	Long-term debt			87,503,912			57,304,834
	Deferred income taxes			2,199,946			2,044,019
	Other liabilities			4,097,975			3,863,550

		Total long-term liabilities		93,801,833			63,212,403

Commitments and contingencies
Series A redeemable convertible preferred stock, $0.001 par value:
		Authorized—2,666,667 shares
		Issued—2,526,913 shares at September 30, 2002 and 1,995,000 shares at December 31, 2001
		Outstanding—323,060 shares at September 30, 2002 and 1,995,000 shares at December 31, 2001		8,752,883			51,894,435

Stockholders' equity:
	Preferred stock, $0.001 par value:
		Authorized—2,333,333 shares, none issued		—			—
	Common stock, $0.001 par value:
		Authorized—50,000,000 shares
		Issued and outstanding—14,881,806 at September 30, 2002 and 8,681,744 shares at December 31, 2001		14,882			8,682
	Additional paid-in capital			250,897,348			147,410,812
	Notes receivable from stockholders			(14,691,097	)		(14,691,097	)
	Deferred compensation			(18,600	)		(10,144,937	)
	Accumulated deficit			(79,290,529	)		(34,636,572	)
	Accumulated other comprehensive income			4,939,813			1,667,244

		Total stockholders' equity		161,851,817			89,614,132

		Total liabilities and stockholders' equity	$	340,927,373		$	278,521,144

The accompanying notes are an integral part of these consolidated financial statements.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

			Nine Months Ended September 30,
			2002			2001
Cash Flows from Operating Activities:
Net (loss) income			$	(33,003,907	)	$	1,176,262
Income from discontinued operations				—			(603,064	)

	Net (loss) income, excluding discontinued operations			(33,003,907	)		573,198
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
	Noncash interest expense related to amortization of original issue discount and beneficial conversion feature			2,802,021			—
	Noncash charge related to interest rate swap agreement			1,268,927			—
	Capitalized interest expense			315,322			—
	Noncash stock-based compensation expense			10,169,105			—
	Noncash portion of extraordinary item			(8,750,663	)		—
	Noncash charge related to asset impairment and cumulative effect of a change in accounting principle			24,829,786			—
	Other noncash gain			(18,668	)		—
	Depreciation and amortization			7,385,341			2,330,048
	Capital contribution from Inverness Medical Technology, Inc. related to income taxes for Inverness Medical, Inc.			—			75,000
	Changes in assets and liabilities, net of acquisition:
		Accounts receivable, net		(4,640,586	)		(393,700	)
		Inventory		(1,778,977	)		16,760
		Prepaid expenses and other current assets		2,271,172			(802,100	)
		Accounts payable		6,666,724			(1,445,396	)
		Accrued expenses and other current liabilities		(4,131,234	)		1,311,401
		Due to Inverness Medical Technology, Inc. and affiliates		—			1,251,692

	Net cash provided by continuing operations			3,384,363			2,916,903

	Net cash used in discontinued operations			—			(211,059	)

Cash Flows from Investing Activities:
Purchases of property, plant and equipment, net				(3,416,430	)		(2,152,441	)
Cash paid for purchase of the Wampole Division of MedPointe Inc.				(71,500,000	)		—
Cash paid for purchase of IVC Industries, Inc., net of cash acquired				(8,073,835	)		—
Cash paid for purchase of Unipath businesses				(5,537,266	)		—
(Increase) decrease in other assets				(283,501	)		337,688

	Net cash used in investing activities			(88,811,032	)		(1,814,753	)

Cash Flows from Financing Activities:
Cash paid for deferred financing costs				(2,052,123	)		(47,524	)
Proceeds from issuance of common stock, net of issuance costs				35,547,180			—
Proceeds from issuance of preferred stock, net of issuance costs				20,569,190			—
Net borrowings under revolving line of credit				2,040,181			—
Proceeds from borrowings under notes payable				35,000,000			52,000
Repayments of notes payable				(43,044,595	)		(3,342,550	)
Principal repayments on capital lease obligations				(329,681	)		—
Contribution from Inverness Medical Technology, Inc.				—			2,125,581

	Net cash provided by (used in) financing activities			47,730,152			(1,212,493	)

Foreign exchange effect on cash and cash equivalents				2,505,649			102,683

	Net decrease in cash and cash equivalents			(35,190,868	)		(218,719	)
	Cash and cash equivalents, beginning of period			52,023,531			3,071,477

	Cash and cash equivalents, end of period		$	16,832,663		$	2,852,758

The accompanying notes are an integral part of these consolidated financial statements.

				Nine Months Ended September 30,
				2002			2001
Supplemental Disclosure of Cash Flow Information:
	Interest paid			$	3,767,814		$	653,497

	Taxes paid			$	1,621,931		$	21,000

Supplemental Disclosure of Noncash Activities:
	On September 20, 2002, the Company acquired the Wampole Division from MedPointe Inc. (Note 5(a))—
		Accounts receivable		$	8,737,210		$	—
		Inventory			4,923,756			—
		Property, plant and equipment			2,061,422			—
		Intangible assets			57,069,525			—
		Other assets			967,202			—
		Accounts payable and accrued expenses			(2,259,115	)		—
		Cash paid for purchase of the Wampole Division			(71,500,000	)		—

			Assumed Liabilities	$	—		$	—

	On March 19, 2002, the Company acquired IVC Industries, Inc. (Note 5(b))—
		Accounts receivable		$	5,205,319		$	—
		Inventory			9,831,608			—
		Property, plant and equipment			23,016,267			—
		Other assets			1,754,639			—
		Accounts payable and accrued expenses			(13,076,289	)		—
		Cash paid for purchase of IVC Industries, Inc., net of cash acquired			(8,073,835	)		—

					18,657,709			—
		Fair value of assumed and issued fully-vested stock options			(1,298,674	)		—

			Assumed liabilities	$	17,359,035		$	—

	Contingent consideration recorded by Inverness Medical, Inc. as additional goodwill and allocated to net assets of discontinued operations			$	—		$	2,000,000

The accompanying notes are an integral part of these consolidated financial statements.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(1) Basis of Presentation of Financial Information

The accompanying consolidated financial statements of Inverness Medical Innovations, Inc. and its subsidiaries (the "Company" or "Innovations") are unaudited. In the opinion of management, the unaudited consolidated financial statements contain all adjustments considered normal and recurring and necessary for their fair presentation. Interim results are not necessarily indicative of results to be expected for the year. These interim financial statements have been prepared in accordance with the instructions for Form 10-Q and therefore do not include all information and footnotes necessary for a complete presentation of operations, financial position, and cash flows of the Company in conformity with accounting principles generally accepted in the United States. The Company filed audited consolidated financial statements for the year ended December 31, 2001, which included information and footnotes necessary for such presentation and were included in its Annual Report on Form 10-K, as amended, filed with the Securities and Exchange Commission on April 2, 2002. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2001.

On November 21, 2001, pursuant to an Agreement and Plan of Split-Off and Merger dated May 23, 2001 (the "Merger Agreement"), Johnson & Johnson acquired Inverness Medical Technology, Inc. ("IMT") in a merger transaction and, simultaneously, Innovations, then a subsidiary of IMT, was split-off from IMT as a separate publicly traded company. Pursuant to the terms of the Merger Agreement and related agreements, immediately prior to the consummation of the transaction, IMT restructured its operations so that all of IMT's non-diabetes businesses (women's health, nutritional supplements and clinical diagnostics) were held by Innovations and Innovations' subsidiaries. At the closing of the transaction, all of the shares of Innovations common stock held by IMT were split-off from IMT in a pro rata distribution to IMT stockholders and IMT (which then consisted primarily of its diabetes care business) merged with and became a wholly-owned subsidiary of Johnson & Johnson.

Innovations was incorporated on May 11, 2001 for the purpose of receiving IMT's contribution of its women's health, nutritional supplements and clinical diagnostics businesses in connection with the transactions described in the Merger Agreement and related agreements. Innovations' historical consolidated financial statements include IMT subsidiaries and businesses that were contributed to Innovations as if such subsidiaries and businesses were historically organized in a manner consistent with the restructuring set forth in the Merger Agreement and related agreements. The primary subsidiaries and businesses that were contributed to Innovations by IMT are as follows:

•: Inverness Medical, Inc. ("IMI"), a U.S. corporation, and its wholly-owned subsidiary, Can-Am Care Corporation ("Can-Am"), a U.S. corporation
•: Cambridge Diagnostics Ireland Ltd. ("CDIL"), an Irish corporation
•: Orgenics, Ltd. ("Orgenics"), an Israeli corporation
•: The women's health business of Inverness Medical Europe GmbH ("IME"), a German corporation
•: Inverness Medical Benelux Bvba ("IMB"), a Belgian corporation
•: The women's health assets held by IMT, plus allocations to Innovations of IMT common expenditures

Innovations has consolidated the financial statements of the above individual legal entities and the newly acquired entities and businesses, as discussed below, along with the assets, liabilities, revenues and expenses of the businesses. For the period prior to the split-off and merger, the financial statements were combined in a manner consistent with the consolidated financial statements. All material intercompany transactions and balances have been eliminated.

Pursuant to the Merger Agreement and related agreements, on November 21, 2001, immediately prior to the split-off and merger, Innovations transferred to IMT those entities or businesses that conduct business in the diabetes segment, principally the Can-Am subsidiary of IMI and the diabetes businesses of CDIL and IMB. As a result, Innovations has presented the historical diabetes operations of its subsidiaries as discontinued operations in the accompanying consolidated statements of operations and cash flows for all 2001 periods presented under Accounting Principles Board ("APB") Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.

At the closing of the transactions set forth in the Merger Agreement and related agreements, IMT distributed to its stockholders one Innovations share for every five IMT shares held. In order for IMT to do so, Innovations declared a stock split, effected as a dividend. Accordingly, earnings per share information for the three and nine months ended September 30, 2001 represents the actual number of shares of Innovations common stock outstanding as of the date of its incorporation, effected for the fixed exchange ratio set forth in the Merger Agreement and related agreements and the related stock split (Note 10).

Innovations' consolidated statements of operations and cash flows for all 2001 periods presented also reflect the allocation of IMT's common expenditures. Such allocations have been made in accordance with Staff Accounting Bulletin ("SAB") No. 55, Allocation of Expenses and Related Disclosure in Financial Statements of Subsidiaries, Divisions or Lesser Business Components of Another Entity.

The accompanying consolidated statements of operations and cash flows for all 2001 periods presented reflect substantially all costs of doing business, including those incurred by IMT on Innovations' behalf. Costs that are clearly identifiable as being applicable to an Innovations subsidiary or business have been allocated to Innovations. The most significant costs included in this category include salary and benefits of certain employees and legal and other professional fees. Costs of centralized departments and corporate operations that serve all operations have been allocated, where such allocations would be material, using relevant allocation measures, such as estimated percentage of time worked for salary and benefits of certain executives and employees and square feet occupied for occupancy costs in shared facilities. Corporate costs that clearly relate to businesses or subsidiaries that were retained by IMT or that do not provide any significant direct or indirect benefit to Innovations have not been allocated to Innovations. For the period prior to the split-off and merger, Innovations accounted for income taxes using the separate return method, pursuant to Statement of Financial Accounting Standard ("SFAS") No. 109, Accounting for Income Taxes. IMT has historically charged interest on loans made to its subsidiaries. Accordingly, Innovations' consolidated statement of operations for the three and nine months ended September 30, 2001 reflect interest expense on amounts due to entities not included in Innovations' consolidated financial statements (primarily to IMT). Interest expense for the three and nine months ended September 30, 2001 also reflects amounts recorded on third-party notes payable when such notes relate specifically to Innovations' operations. Interest expense for the three and nine months ended September 30, 2001 does not include amounts recorded on general corporate borrowings of IMT. Innovations believes that the allocation methods described herein are reasonable and fairly reflect its financial position and results of operations for the period prior to the split-off and merger.

Since the split-off and merger, as described above, on September 20, 2002, the Company acquired the Wampole Division of MedPointe Inc. ("Wampole"), on March 19, 2002, the Company acquired IVC Industries, Inc. ("IVC") and on December 20, 2001, the Company acquired certain entities and businesses of Unilever Plc (the "Unipath business") (Note 5). Wampole develops and distributes point-of-care medical diagnostics products, IVC manufactures and distributes vitamins and nutritional supplements and the Unipath business manufactures and distributes women's health and clinical diagnostics products. The results of Wampole, IVC and the Unipath business are included in the consolidated financial statements of the Company since their respective acquisition dates. The Unipath business is comprised of the following entities and businesses:

•: Unipath Ltd. ("Unipath UK"), a British corporation, and its wholly-owned subsidiary, Unipath Management Ltd. ("UML"), also a British corporation
•: The women's health business of Unipath conducted in the United States ("Unipath US")
•: Unipath Diagnostics GmbH ("Unipath Germany"), a German corporation
•: Unipath Scandinavia AB ("Unipath Scandinavia"), a Swedish corporation
•: Unipath B.V. ("Unipath Netherlands"), a Dutch corporation
•: Unipath assets, primarily intellectual property, held by Unilever Plc, along with the related license revenue

Certain prior-year account balances have been reclassified to be consistent with the current year's presentation.

(2) Cash and Cash Equivalents

The Company considers all highly liquid cash investments with maturities of three months or less at the date of acquisition to be cash equivalents. At September 30, 2002, the Company's cash equivalents consisted of money market funds.

(3) Inventories

Inventories are stated at the lower of cost (first in, first out) or market and are comprised of the following:

		September 30, 2002			December 31, 2001
Raw materials		$