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 June 30, 2003
OR
o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from 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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)

Yes ý No o

The number of shares outstanding of the registrant's common stock as of August 11, 2003 was 16,918,554.

INVERNESS MEDICAL INNOVATIONS, INC.

FORM 10-Q

For the Quarterly Period Ended June 30, 2003

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 31 and 46, 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

			PAGE
PART I. FINANCIAL INFORMATION
Item 1.		Consolidated Financial Statements (unaudited):
	a)	Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002	3
	b)	Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002	4
	c)	Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002	5
	d)	Notes to Consolidated Financial Statements	7
Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.		Controls and Procedures	50
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings	51
Item 2.		Changes in Securities and Use of Proceeds	51
Item 4.		Submission of Matters to a Vote of Security Holders	52
Item 6.		Exhibits and Reports on Form 8-K	52
SIGNATURE			54

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share amounts)

			Three Months Ended June 30,						Six Months Ended June 30,
			2003			2002			2003			2002
Net product sales			$	63,925		$	50,437		$	126,609		$	86,979
License revenue				1,792			1,275			3,915			1,981

	Net revenue			65,717			51,712			130,524			88,960
Cost of sales				37,043			31,103			72,315			49,531

	Gross profit			28,674			20,609			58,209			39,429

Operating expenses:
	Research and development			5,957			3,576			10,642			6,942
	Sales and marketing			12,157			9,134			23,698			18,562
	General and administrative			8,010			6,869			16,376			13,657
	Charge related to asset impairment			—			—			—			12,682
	Stock-based compensation(1) (Note 5)			—			24			6			10,169

		Total operating expenses		26,124			19,603			50,722			62,012

	Operating income (loss)			2,550			1,006			7,487			(22,583	)
Interest expense, including amortization of discounts				(2,125	)		(1,438	)		(4,366	)		(6,781	)
Other income (expense), net				5,948			(1,606	)		6,106			8,523

	Income (loss) before income taxes and accounting change			6,373			(2,038	)		9,227			(20,841	)
Provision for income taxes				771			650			1,627			1,156

	Income (loss) before accounting change			5,602			(2,688	)		7,600			(21,997	)
Cumulative effect of a change in accounting principle				—			—			—			(12,148	)

	Net income (loss)		$	5,602		$	(2,688	)	$	7,600		$	(34,145	)

Income (loss) available to common stockholders—basic (Note 6):
	Income (loss) before accounting change		$	5,461		$	(4,961	)	$	7,285		$	(25,799	)

	Net income (loss)		$	5,461		$	(4,961	)	$	7,285		$	(37,947	)

Income (loss) available to common stockholders—diluted (Note 6):
	Income (loss) before accounting change		$	5,610		$	(4,961	)	$	7,616		$	(25,799	)

	Net income (loss)		$	5,610		$	(4,961	)	$	7,616		$	(37,947	)

Income (loss) per common share—basic (Note 6):
	Income (loss) before accounting change		$	0.39		$	(0.58	)	$	0.52		$	(3.31	)

	Net income (loss)		$	0.39		$	(0.58	)	$	0.52		$	(4.87	)

Income (loss) per common share—diluted (Note 6):
	Income (loss) before accounting change		$	0.34		$	(0.58	)	$	0.46		$	(3.31	)

	Net income (loss)		$	0.34		$	(0.58	)	$	0.46		$	(4.87	)

Weighted average shares—basic				14,021			8,487			13,911			7,788

Weighted average shares—diluted				16,660			8,487			16,551			7,788

(1): The charges for stock-based compensation for all periods presented were classified as general and administrative expenses.
The accompanying notes are an integral part of these consolidated financial statements.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands)

			June 30, 2003			December 31, 2002
ASSETS
Current assets:
	Cash and cash equivalents		$	25,020		$	30,668
	Accounts receivable, net of allowances of $7,091 at June 30, 2003 and $7,047 at December 31, 2002			39,220			37,283
	Inventory			41,734			37,155
	Deferred tax assets			2,137			2,137
	Prepaid expenses and other current assets			7,934			6,456

		Total current assets		116,045			113,699
Property, plant and equipment, net				50,325			46,029
Goodwill				109,907			108,915
Trademarks and trade name with indefinite lives				31,719			31,719
Core technology and patents, net				24,628			25,805
Other intangible assets, net				50,905			22,374
Deferred financing costs, net, and other assets				4,031			4,908
Deferred tax assets				3,922			4,297

		Total assets	$	391,482		$	357,746

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Current portion of long-term debt		$	7,653		$	17,200
	Current portion of capital lease obligations			523			642
	Accounts payable			26,616			27,495
	Accrued expenses and other current liabilities			36,938			40,382

		Total current liabilities		71,730			85,719

Long-term liabilities:
	Long-term debt			94,611			84,533
	Capital lease obligations			2,064			2,238
	Deferred tax liabilities			9,605			9,365
	Other liabilities			3,880			3,936

		Total long-term liabilities		110,160			100,072

Commitments and contingencies
Series A redeemable convertible preferred stock, $0.001 par value:
	Authorized—2,667 shares
	Issued—2,527 shares at June 30, 2003 and December 31, 2002 Outstanding—323 shares at June 30, 2003 and December 31, 2002			9,367			9,051

Stockholders' equity:
	Preferred stock, $0.001 par value:
		Authorized—2,333 shares, none issued		—			—
	Common stock, $0.001 par value:
		Authorized—50,000 shares
		Issued and outstanding—16,766 shares at June 30, 2003 and 14,907 shares at December 31, 2002		17			15
	Additional paid-in capital			280,075			251,457
	Notes receivable from stockholders			(14,691	)		(14,691	)
	Deferred compensation			(64	)		(48	)
	Accumulated deficit			(70,435	)		(77,720	)
	Accumulated other comprehensive income			5,323			3,891

		Total stockholders' equity		200,225			162,904

		Total liabilities and stockholders' equity	$	391,482		$	357,746

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

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)

			Six Months Ended June 30,
			2003			2002
Cash Flows from Operating Activities:
Net income (loss)			$	7,600		$	(34,145	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
	Interest expense related to amortization of noncash original issue discount, noncash beneficial conversion feature and deferred financing costs			648			3,794
	Noncash gain related to interest rate swap agreement			(87	)		—
	Noncash stock-based compensation expense			6			10,169
	Noncash gain related to early extinguishment of debt			—			(9,600	)
	Noncash charge related to asset impairment and cumulative effect of a change in accounting principle			—			24,830
	Depreciation and amortization			7,051			4,608
	Deferred income taxes			551			—
	Other noncash items			(2	)		191
	Changes in assets and liabilities, net of acquisitions:
		Accounts receivable, net		(453	)		(1,214	)
		Inventory		(3,256	)		(2,473	)
		Prepaid expenses and other current assets		(2,142	)		1,009
		Accounts payable		(1,737	)		5,614
		Accrued expenses and other current liabilities		(6,493	)		(10,964	)

	Net cash provided by (used in) operating activities			1,686			(8,181	)

Cash Flows from Investing Activities:
Purchases of property, plant and equipment				(5,555	)		(2,086	)
Proceeds from sale of property, plant and equipment				143			206
Cash paid for purchase of the Wampole Division of MedPointe Inc.				(1,387	)		—
Cash paid for purchase of IVC Industries, Inc., net of cash acquired				(312	)		(6,763	)
Cash paid for purchase of Ostex International, Inc., net of cash acquired				(1,607	)		—
Cash paid for purchase of Unipath business				(400	)		(4,560	)
Cash paid for purchase of intellectual property license				(515	)		—
Increase in other assets				(593	)		(130	)

	Net cash used in investing activities			(10,226	)		(13,333	)

Cash Flows from Financing Activities:
Cash paid for financing costs				(112	)		(535	)
Proceeds from issuance of common stock				809			34,958
Proceeds from issuance of preferred stock, net of issuance costs				—			20,569
Net proceeds from revolving line of credit				2,313			2,238
Repayments of notes payable				(2,651	)		(32,767	)
Principal payments of capital lease obligations				(340	)		(170	)

	Net cash provided by financing activities			19			24,293

Foreign exchange effect on cash and cash equivalents				2,873			2,319

	Net (decrease) increase in cash and cash equivalents			(5,648	)		5,098
	Cash and cash equivalents, beginning of period			30,668			52,024

	Cash and cash equivalents, end of period		$	25,020		$	57,122

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

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(UNAUDITED)
(in thousands)

				Six Months Ended June 30,
				2003			2002
Supplemental Disclosure of Cash Flow Information:
	Interest paid			$	3,994		$	2,298

	Taxes paid			$	670		$	495

Supplemental Disclosure of Noncash Activities:
	On March 19, 2002, the Company acquired IVC Industries, Inc.—
		Accounts receivable		$	—		$	5,205
		Inventory			—			9,832
		Property, plant and equipment			—			23,016
		Other assets			—			1,755
		Accounts payable and accrued expenses			—			(13,076	)
		Cash paid for purchase of IVC Industries, Inc., net of cash acquired			(312	)		(6,763	)

					(312	)		19,969
		Other accrued acquisition costs			312			(1,311	)
		Fair value of assumed and issued fully-vested stock options			—			(1,299	)

			Assumed liabilities	$	—		$	17,359

	On June 30, 2003, the Company acquired Ostex International, Inc.—
		Accounts receivable		$	1,292		$	—
		Inventory			969			—
		Property, plant and equipment			2,487			—
		Intangible assets			26,813			—
		Other assets			153			—
		Accounts payable and accrued expenses			(1,955	)		—
		Cash paid for purchase of Ostex International, Inc., net of cash acquired			(1,607	)		—

					28,152			—
		Fair value of common stock issued			(23,537	)		—
		Fair value of assumed and issued fully-vested stock options and warrants			(1,752	)		—

			Assumed liabilities	$	2,863		$	—

	Dividends, interest and amortization of beneficial conversion feature related to preferred stock			$	315		$	3,802

	Conversion of preferred stock to common stock			$	—		$	13,953

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

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(in thousands, except per share amounts)

(1) Basis of Presentation of Financial Information

The accompanying consolidated financial statements of Inverness Medical Innovations, Inc. and its subsidiaries (the "Company") 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, 2002, which included information and footnotes necessary for such presentation and were included in its Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 31, 2003. 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, 2002.

(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 June 30, 2003, 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:

		June 30, 2003			December 31, 2002
Raw materials		$	14,799		$	13,447
Work-in-process