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, 2004
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 (State or other jurisdiction of incorporation or organization)		04-3565120 (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 November 5, 2004 was 20,340,122.

INVERNESS MEDICAL INNOVATIONS, INC.
FORM 10-Q
For the Quarterly Period Ended September 30, 2004

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 42 and 58, 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.

We have registered or are using the following trademarks which appear in this quarterly report on Form 10-Q: Clearblue™, Clearblue Easy®, Fact plus®, Persona®, Clearview®, Wampole®, Testpack™, Signify®, Ferro-Sequels™, Stresstabs®, Protegra®, Posture®, SoyCare™, ALLBEE®, and Z-BEC®.

The following are registered trademarks of parties other than us: Abbott®, Abbott TestPack®, Abbott TestPack plus® and e.p.t®.

TABLE OF CONTENTS

		PAGE
PART I. FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (unaudited):
a)	Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003	3
b)	Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003	4
c)	Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003	5
d)	Notes to Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	59
Item 4.	Controls and Procedures	61
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	62
Item 6.	Exhibits	63
SIGNATURE		64

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 September 30,						Nine Months Ended September 30,
			2004			2003			2004			2003
												(restated)
Net product sales			$	94,698		$	69,278		$	269,629		$	196,182
License revenue				2,807			3,115			7,304			7,030

	Net revenue			97,505			72,393			276,933			203,212
Cost of sales (Note 11)				59,120			40,902			166,533			113,217

	Gross profit			38,385			31,491			110,400			89,995

Operating expenses:
	Research and development			7,850			6,413			23,265			17,055
	Sales and marketing			14,024			13,251			40,437			36,949
	General and administrative			13,053			7,637			38,510			24,013
	Stock-based compensation(1)			—			60			—			66

		Total operating expenses		34,927			27,361			102,212			78,083

	Operating income			3,458			4,130			8,188			11,912
Interest expense, including amortization of discounts and write-off of deferred financing costs (Note 8)				(4,846	)		(2,443	)		(17,157	)		(6,723	)
Other income, net				1,179			367			1,655			6,387

	(Loss) income before income taxes			(209	)		2,054			(7,314	)		11,576
Income tax provision				562			392			1,202			2,019

Net (loss) income			$	(771	)	$	1,662		$	(8,516	)	$	9,557

Net (loss) income available to common stockholders—basic (Note 5)			$	(771	)	$	1,519		$	(9,265	)	$	9,099

Net (loss) income available to common stockholders—diluted (Note 5)			$	(771	)	$	1,519		$	(9,265	)	$	9,581

Net (loss) income per common share—basic (Note 5)			$	(0.04	)	$	0.09		$	(0.47	)	$	0.62

Net (loss) income per common share—diluted (Note 5)			$	(0.04	)	$	0.08		$	(0.47	)	$	0.55

Weighted average shares—basic (Note 5)				20,296			16,301			19,813			14,719

Weighted average shares—diluted (Note 5)				20,296			18,176			19,813			17,435

(1): The charge for stock-based compensation for the three and nine months ended September 30, 2003 was 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, except per share amounts)

			September 30, 2004			December 31, 2003
						(restated)
ASSETS
Current assets:
	Cash and cash equivalents		$	18,944		$	24,622
	Accounts receivable, net of allowances of $8,734 at September 30, 2004 and $7,492 at December 31, 2003			57,665			55,418
	Inventories			57,668			47,043
	Deferred tax assets			1,178			1,178
	Prepaid expenses and other current assets			10,893			10,599

		Total current assets		146,348			138,860

	Property, plant and equipment, net			62,645			56,999
	Goodwill			228,184			233,792
	Other intangible assets with indefinite lives			50,092			38,119
	Core technology and patents, net			41,124			36,423
	Other intangible assets, net			26,428			27,743
	Deferred financing costs, net, and other non-current assets			8,795			7,457
	Deferred tax assets			5,036			4,075

		Total assets	$	568,652		$	543,468

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Current portion of long-term debt		$	52		$	14,055
	Current portion of capital lease obligations			458			457
	Accounts payable			35,225			38,006
	Accrued expenses and other current liabilities			45,066			41,122

		Total current liabilities		80,801			93,640

Long-term liabilities:
	Long-term debt, net of current portion			198,128			159,838
	Capital lease obligations, net of current portion			1,477			1,831
	Deferred tax liabilities			11,511			9,118
	Other long-term liabilities			4,981			3,307

		Total long-term liabilities		216,097			174,094

Commitments and contingencies
Series A redeemable convertible preferred stock, $0.001 par value:
	Authorized—2,667 shares
	Issued—2,527 shares at September 30, 2004 and December 31, 2003
	Outstanding—none at September 30, 2004 and 208 shares at December 31, 2003			—			6,185

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—20,325 shares at September 30, 2004 and 19,640 shares at December 31, 2003		20			20
	Additional paid-in capital			353,060			341,703
	Notes receivable from stockholders			(14,691	)		(14,691	)
	Accumulated deficit			(78,557	)		(69,296	)
	Accumulated other comprehensive income			11,922			11,813

		Total stockholders' equity		271,754			269,549

		Total liabilities and stockholders' equity	$	568,652		$	543,468

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)

			Nine Months Ended September 30,
			2004			2003
						(restated)
Cash Flows from Operating Activities:
Net (loss) income			$	(8,516	)	$	9,557
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
	Interest expense related to amortization and/or write-off of noncash original issue discount and deferred financing costs			4,380			1,133
	Noncash gains related to interest rate swap and currency hedge agreements			(326	)		(54	)
	Noncash stock-based compensation expense			—			66
	Depreciation and amortization			15,089			10,930
	Deferred income taxes			—			371
	Other noncash items			(70	)		(4	)
	Changes in assets and liabilities, net of acquisitions:
		Accounts receivable, net		(1,717	)		(3,051	)
		Inventories		(9,274	)		(3,668	)
		Prepaid expenses and other current assets		(189	)		(2,937	)
		Accounts payable		(3,386	)		353
		Accrued expenses and other current liabilities		6,963			(6,817	)
		Increase in other long-term liabilities		489			—

	Net cash provided by operating activities			3,443			5,879

Cash Flows from Investing Activities:
Purchases of property, plant and equipment				(15,403	)		(8,427	)
Proceeds from sale of property, plant and equipment				184			151
Payments for acquisitions and intellectual property				(12,275	)		(76,141	)
Increase in other assets				(1,129	)		(44	)

	Net cash used in investing activities			(28,623	)		(84,461	)

Cash Flows from Financing Activities:
Cash paid for financing costs				(5,333	)		(3,772	)
Proceeds from issuance of common stock, net of issuance costs				1,416			3,985
Proceeds from issuance of senior subordinated notes				150,000			—
Proceeds from borrowings under senior credit facility				—			58,643
Net (repayments) proceeds from revolving lines of credit				(31,099	)		18,524
Repayments of notes payable				(94,764	)		(5,875	)
Principal payments of capital lease obligations				(362	)		(521	)

	Net cash provided by financing activities			19,858			70,984

Foreign exchange effect on cash and cash equivalents				(356	)		1,767

	Net decrease in cash and cash equivalents			(5,678	)		(5,831	)
	Cash and cash equivalents, beginning of period			24,622			30,668

	Cash and cash equivalents, end of period		$	18,944		$	24,837

Supplemental Disclosure of Noncash Activities:
Dividends, redemption interest and amortization of beneficial conversion feature related to preferred stock			$	749		$	458

Fair value of stock issued for acquisitions and intellectual property			$	3,002		$	75,305

Fair value of assumed and fully-vested stock options and warrants for acquisitions			$	—		$	1,752

Conversion of preferred stock into common stock			$	6,934		$	—

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 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 in conformity with accounting principles generally accepted in the United States of America ("GAAP"). Our audited consolidated financial statements for the year ended December 31, 2003 included information and footnotes necessary for such presentation and were included in our annual report on Form 10-K/A filed with the Securities and Exchange Commission on April 22, 2004. These unaudited consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2003.

In connection with our restatement for the year ended December 31, 2002, as discussed in our 2003 annual report on Form 10-K/A, we also restated our consolidated financial statements for the three months ended March 31, 2003 to reflect certain adjustments related to sales incentive allowances. Such adjustments are reflected in the accompanying consolidated financial statements for the nine months ended September 30, 2003.

(2) Cash and Cash Equivalents

We consider all highly liquid cash investments with original maturities of three months or less at the date of acquisition to be cash equivalents. At September 30, 2004, our 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:

(in thousands)	September 30, 2004		December 31, 2003
Raw materials	$	24,633	$	19,606
Work-in-process		14,212		12,631
Finished goods		18,823		14,806

	$	57,668	$	47,043

(4) Employee Stock-Based Compensation Arrangements

For all periods presented in the accompanying unaudited consolidated financial statements, we accounted for our employee stock-based compensation arrangements using the intrinsic value method under the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and in accordance with Financial Accounting Standards Board ("FASB") Interpretation ("FIN") No. 44, Accounting for Certain Transactions Involving Stock Compensation. We have elected to use the disclosure-only provisions of Statement of Financial Accounting Standards

("SFAS") No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure.

Had compensation expense for stock option grants to employees been determined based on the fair value method at the grant dates for awards under the stock option plans consistent with the method prescribed by SFAS No. 123, our net (loss) income would have been (increased) decreased to the pro forma amounts indicated as follows:

		Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands, except per share amounts)		Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands, except per share amounts)		2004			2003(b)			2004			2003(b)
											(restated)
Net (loss) income—as reported		$	(771	)	$	1,662		$	(8,516	)	$	9,557
Stock-based employee compensation—as reported (a)			—			15			—			16
Pro forma stock-based employee compensation			(1,563	)		(1,388	)		(4,368	)		(3,609	)

Net (loss) income—pro forma		$	(2,334	)	$	289		$	(12,884	)	$	5,964

(Loss) income per share—basic:
	Net (loss) income per share—as reported	$	(0.04	)	$	0.09		$	(0.47	)	$	0.62
	Stock-based employee compensation—as reported		—			—			—			—
	Pro forma stock-based employee compensation		(0.08	)		(0.08	)		(0.22	)		(0.25	)

	Net (loss) income per share—pro forma	$	(0.12	)	$	0.01		$	(0.69	)	$	0.37

(Loss) income per share—diluted:
	Net (loss) income per share—as reported	$	(0.04	)	$	0.08		$	(0.47	)	$	0.55
	Stock-based employee compensation—as reported		—			—			—			—
	Pro forma stock-based employee compensation		(0.08	)		(0.07	)		(0.22	)		(0.22	)

	Net (loss) income per share—pro forma	$	(0.12	)	$	0.01		$	(0.69	)	$	0.33

(a): Stock-based employee compensation expense, as reported, primarily represents the amortization of deferred compensation of certain stock options that were granted to employees below fair market value. This amount excludes stock-based compensation expense recognized in connection with stock options that were granted to non-employees.
(b): Pro forma stock-based employee compensation charge and related per share charge for the three and nine months ended September 30, 2003 have been adjusted to reflect estimated tax benefits associated with such charge.

We have computed the pro forma disclosures for stock options granted to employees after January 1, 1995 using the Black-Scholes option pricing model prescribed by SFAS No. 123. The assumptions used were as follows:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2004	2003	2004	2003
Risk-free interest rate	3.4-3.5%	2.6-3.5%	2.8-4.0%	2.3-3.5%
Expected dividend yield	—	—	—	—
Expected lives	5 years	5 years	5 years	5 years
Expected volatility	48%	53%	48%	56%

The weighted average fair value under the Black-Scholes option pricing model of options granted to employees during the three months ended September 30, 2004 and 2003 were $7.22 and $11.22, respectively. The weighted average fair value under the Black-Scholes option pricing model of options granted to employees during the nine months ended September 30, 2004 and 2003 were $8.72 and $10.34, respectively.

(5) Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:

		Three Months Ended September 30,