UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

INVERNESS MEDICAL INNOVATIONS, INC.

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

The number of shares outstanding of the registrant’s common stock, par value of $0.001 per share, as of August 4, 2006 was 32,969,939.

 

 

INVERNESS MEDICAL INNOVATIONS, INC.

FORM 10-Q

For the Quarterly Period Ended June 30, 2006

     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 Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the fiscal year ending December 31, 2005 and other risk factors identified herein or from time to time in our periodic filings with the Securities and Exchange Commission. Readers should carefully review these factors as well as the “Special Statement Regarding Forward-Looking Statements” beginning on page 41, 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):			3
a) Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2006 and 2005			3
b) Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005			4
c) Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005			5
d) Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 3. Quantitative and Qualitative Disclosures About Market Risk			42
Item 4. Controls and Procedures			43
PART II. OTHER INFORMATION
Item 1A. Risk Factors			44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			44
Item 4. Submission of Matters to a Vote of Security Holders			44
Item 6. Exhibits			45
SIGNATURE			46
EX-31.1 SECTION 302 CERTIFICATION OF THE C.E.O.
EX-31.2 SECTION 302 CERTIFICATION OF THE C.F.O.
EX-32.1 SECTION 906 CERTIFICATION OF THE C.E.O. & C.F.O.

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

(unaudited)

(in thousands, except per share amounts)

		Three Months Ended June 30,								Six Months Ended June 30,
		2006				2005				2006				2005
Net product sales		$	136,597			$	97,773			$	259,350			$	187,472
License and royalty revenue			3,116				4,498				8,184				6,719
Net revenue			139,713				102,271				267,534				194,191
Cost of sales			91,217				67,558				166,784				127,289
Gross profit			48,496				34,713				100,750				66,902
Operating expenses:
Research and development (Note 11)			13,114				5,360				23,724				12,592
Sales and marketing			22,690				17,666				43,512				34,696
General and administrative			17,678				16,242				33,516				30,357
Loss on dispositions, net (Note 10)			3,191				—				3,191				—
Operating (loss) income			(8,177	)			(4,555	)			(3,193	)			(10,743	)
Interest expense, including amortization of original issue discounts and write-off of deferred financing costs (Note 12)			(6,882	)			(4,960	)			(12,603	)			(9,972	)
Other income (expense), net			5,301				14,872				4,873				19,783
(Loss) income before provision for income taxes			(9,758	)			5,357				(10,923	)			(932	)
Provision for income taxes			798				2,854				2,263				4,367
Net (loss) income		$	(10,556	)		$	2,503			$	(13,186	)		$	(5,299	)
Net (loss) income per common share – basic (Note 5)		$	(0.33	)		$	0.11			$	(0.42	)		$	(0.24	)
Net (loss) income per common share – diluted (Note 5)		$	(0.33	)		$	0.10			$	(0.42	)		$	(0.24	)
Weighted average common shares – basic (Note 5)			32,445				23,127				31,141				22,040
Weighted average common shares – diluted (Note 5)			32,445				24,627				31,141				22,040

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

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

(unaudited)

(in thousands, except per share amounts)

		June 30, 2006				December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents		$	42,164			$	34,270
Accounts receivable, net of allowances of $8,917 at June 30, 2006 and $9,748 at December 31, 2005			91,968				70,476
Inventories			76,138				71,209
Deferred tax assets			845				844
Prepaid expenses and other current assets			18,591				17,534
Total current assets			229,706				194,333
Property, plant and equipment, net			79,847				72,211
Goodwill			388,620				322,210
Other intangible assets with indefinite lives			67,437				63,742
Core technology and patents, net			64,397				64,050
Other intangible assets, net			97,612				60,489
Deferred financing costs, net and other non-current assets			11,277				13,013
Other investments			9,318				456
Deferred tax assets			655				662
Total assets		$	948,869			$	791,166
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	1,372			$	2,367
Current portion of capital lease obligations			559				542
Accounts payable			50,550				42,155
Accrued expenses and other current liabilities			74,853				64,746
Total current liabilities			127,334				109,810
Long-term liabilities:
Long-term debt, net of current portion			274,264				258,617
Capital lease obligations, net of current portion			695				978
Deferred tax liabilities			20,761				18,881
Other long-term liabilities			6,241				5,572
Total long-term liabilities			301,961				284,048
Commitments and contingencies (Note 15)
Series A redeemable convertible preferred stock, $0.001 par value:
Authorized: 2,667 shares
Issued: 2,527 shares at June 30, 2006 and December 31, 2005
Outstanding: none at June 30, 2006 and December 31, 2005			—				—
Stockholders’ equity:
Preferred stock, $0.001 par value
Authorized: 2,333 shares
Issued: none at June 30, 2006 and December 31, 2005			—				—
Common stock, $0.001 par value
Authorized: 50,000 shares
Issued and outstanding: 32,895 at June 30, 2006 and 27,497 shares at December 31, 2005			33				27
Additional paid-in capital			648,376				515,147
Notes receivable from stockholders			(14,691	)			(14,691	)
Accumulated deficit			(123,413	)			(110,227	)
Accumulated other comprehensive income			9,269				7,052
Total stockholders’ equity			519,574				397,308
Total liabilities and stockholders’ equity		$	948,869			$	791,166

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

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

(unaudited)

(in thousands)

		Six Months Ended June 30,
		2006				2005
Cash Flows from Operating Activities:
Net loss		$	(13,186	)		$	(5,299	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Interest expense related to amortization and write-off of non-cash original issue discount and deferred financing costs			1,398				899
Non-cash (income) loss related to currency			(217	)			592
Non-cash stock-based compensation expense			2,544				140
Depreciation and amortization			17,972				12,685
Deferred income taxes			1,252				1,276
Impairment of long-lived assets			9,143				2,493
Other non-cash items			(1,199	)			(2,491	)
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, net			(9,295	)			14,407
Inventories			914				(2,308	)
Prepaid expenses and other current assets			992				(5,629	)
Accounts payable			4,864				364
Accrued expenses and other current liabilities			(12,470	)			11,646
Other non-current liabilities			644				433
Net cash provided by operating activities			3,356				29,208
Cash Flows from Investing Activities:
Purchases of property, plant and equipment			(9,202	)			(9,135	)
Proceeds from sale of property, plant and equipment			2,120				151
Cash paid for acquisitions and transactional costs, net of cash acquired			(77,931	)			(74,696	)
Increase (decrease) in other assets			1,109				(788	)
Net cash used in investing activities			(83,904	)			(84,468	)
Cash Flows from Financing Activities:
Cash paid for financing costs			(582	)			(2,058	)
Proceeds from issuance of common stock, net of issuance costs			83,573				2,222
Net proceeds under revolving lines of credit			8,817				49,172
Net borrowing (repayments) of notes payable			(2,581	)			20,086
Principal payments of capital lease obligations			(272	)			(237	)
Net cash provided by financing activities			88,955				69,185
Foreign exchange effect on cash and cash equivalents			(513	)			(1,795	)
Net increase in cash and cash equivalents			7,894				12,130
Cash and cash equivalents, beginning of period			34,270				16,756
Cash and cash equivalents, end of period		$	42,164			$	28,886
Supplemental Disclosure of Non-cash Activities:
Fair value of stock issued for acquisitions and intellectual property		$	47,117			$	57,962

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 accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these consolidated financial statements do not include all of the information and footnotes necessary for a complete presentation of financial position, results of operations and cash flows. Our audited consolidated financial statements for the year ended December 31, 2005 included information and footnotes necessary for such presentation and were included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2006. 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, 2005.

(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 June 30, 2006, 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):

		June 30, 2006				December 31, 2005
Raw materials		$	29,296			$	25,488
Work-in-process			21,945				17,812
Finished goods			24,897				27,909
		$	76,138			$	71,209

(4) Stock-Based Compensation

     Effective January 1, 2006, we began recording compensation expense associated with stock options and other forms of equity compensation in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123-R, Share-Based Payment, as interpreted by SEC Staff Accounting Bulletin No. 107. Prior to January 1, 2006, we accounted for stock options according to the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, and therefore no related compensation expense was recorded for awards granted with no intrinsic value. We adopted the modified prospective transition method provided for under SFAS No. 123-R, and consequently have not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock options now includes: (i) amortization related to the remaining unvested portion of all stock option awards granted prior to January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123, and (ii) amortization related to all stock option awards granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123-R. In addition, we record expense over the offering period in connection with shares issued under our employee stock purchase plan. The compensation expense for stock-based compensation awards includes an estimate for forfeitures and is recognized over the expected term of the options using the straight-line method.

     In accordance with SFAS No. 123-R, as of June 30, 2006, our results of operations reflected compensation expense for new stock options granted and vested under our stock incentive plan and employee stock purchase plan during the three and six months ended June 30, 2006 and the unvested portion of previous stock option grants which vested during the first six months of 2006. Stock-based compensation expense in the amount of $1.2 million (or $1.1 million net of tax effects) and $2.5 million (or $2.3 million net of tax effects) was reflected in the consolidated statement of operations for the three and six months ended June 30, 2006, respectively, as follows (in thousands):

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

		Three Months Ended				Six Months Ended
		June 30,				June 30,
		2006				2006
Cost of sales		$	86			$	195
Research and development			287				557
Sales and marketing			155				343
General and administrative			698				1,449
		$	1,226			$	2,544

     Prior to our adoption of SFAS No. 123-R, we reported all tax benefits resulting from the exercise of stock options as operating cash flows in our consolidated statements of cash flows. In accordance with SFAS No. 123-R, for the three and six months ended June 30, 2006, the presentation of our cash flows has changed from prior periods to report the excess tax benefits from the exercise of stock options as financing cash flows. For the three and six months ended June 30, 2006, no excess tax benefits were generated from option exercises.

     For stock options granted prior to the adoption of SFAS No. 123-R, if expense for stock-based compensation had been determined under the fair value method for the three and six months ended June 30, 2005, our income (loss) per common share would have been adjusted to the following pro forma amounts (in thousands, except for per share data):

		Three Months Ended				Six Months Ended
		June 30,				June 30,
		2005				2005
Net income (loss) – as reported		$	2,503			$	(5,299	)
Stock-based employee compensation – as reported			140				140
Pro forma stock-based employee compensation			(1,387	)			(2,973	)
Net income (loss) – pro forma		$	1,256			$	(8,132	)
Net income (loss) per common share – basic:
Net income (loss) per common share – as reported		$	0.11			$	(0.24	)
Stock-based employee compensation – as reported			0.00				0.00
Pro forma stock-based employee compensation			(0.06	)			(0.13	)
Net income (loss) per common share – pro forma		$	0.05			$	(0.37	)
Net income (loss) per common share – diluted:
Net income (loss) per common share – as reported		$	0.10			$	(0.24	)
Stock-based employee compensation – as reported			0.00				0.00
Pro forma stock-based employee compensation			(0.05	)			(0.13	)
Net income (loss) per common share – pro forma		$	0.05			$	(0.37	)

     Our stock option plans provide for grants of options to employees to purchase common stock at the fair market value of such shares on the grant date of the award. The options vest over a four year period, beginning on the date of grant, with a graded vesting schedule of 25% at the end of each of the four years. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing method. We use historical data to estimate the expected price volatility and the expected forfeiture rate. For the three and six months ended June 30, 2006, we have chosen to employ the simplified method of calculating the expected option term, which averages an award’s weighted average vesting period and its contractual term. The contractual term of our stock option awards is ten years. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant with a remaining term equal to the expected term of the option. We have not made any dividend payments nor do we have plans to pay dividends in the foreseeable future. The following assumptions were used to estimate the fair value of options granted during the three and six months ended June 30, 2006 and 2005 using the Black-Scholes option-pricing model:

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2006				2005				2006				2005
Stock Options:
Risk-free interest rate			4.00	%			3.78%-4.09	%			4.00%-4.38	%			3.58-4.09	%
Expected dividend yield			—				—				—				—
Expected life		6.25 years				5 years				6.25 years				5 years
Expected volatility			42	%			45	%			42	%			45	%

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2006				2005				2006				2005
Employee Stock Purchase Plan:
Risk-free interest rate			4.55	%			3.71	%			4.55	%			3.71	%
Expected dividend yield			—				—				—				—
Expected life		182 days				182 days				182 days				182 days
Expected volatility			38.98	%			38.15	%			33.19	%			36.92	%

A summary of the stock option activity for the six months ended June 30, 2006 is as:

										Weighted
										Average
						Weighted				Remaining				Aggregate
						Average				Contractual				Intrinsic
		Options				Exercise Price				Term				Value
														(in thousands)
Options outstanding, January 1, 2006			3,901,726			$	18.82
Granted			229,500			$	26.00
Exercised			( 228,192	)		$	15.64
Forfeited or expired			( 220,190	)		$	21.17
Options outstanding, June 30, 2006			3,682,844			$	19.32			6.68 years				$	33,242
Options exercisable, June 30, 2006			2,484,599			$	16.93			5.73 years				$	28,515

     The weighted average fair value under the Black-Scholes option pricing model of options granted to employees during the six months ended June 30, 2006 and 2005 were $12.46 and $11.92 per share, respectively.

     As of June 30, 2006, there was $10.8 million, net of estimated forfeitures representing the fair value of unvested stock options. This cost is expected to be recognized over a weighted-average period of 2.55 years.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

(5) Net Income (Loss) Per Common Share

     The following table sets forth the computation of basic and diluted net income (loss) per common share (in thousands, except per share amounts):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2006				2005				2006				2005
Numerator:
Net income (loss) – basic and diluted		$	(10,556	)		$	2,503			$	(13,186	)		$	(5,299	)
Denominator:
Denominator for basic net income (loss) per common share – weighted average shares			32,445				23,127				31,141				22,040
Effect of dilutive securities:
Employee stock options			—				1,113				—				—
Warrants			—				283				—				—
Restricted stock and escrow shares			—				104				—				—
Dilutive potential common shares			—				1,500				—				—
Denominator for dilutive income (loss) per common share – adjusted weighted average shares			32,445				24,627				31,141				22,040
Net income (loss) per common share — basic		$	(0.33	)		$	0.11			$	(0.42	)		$	(0.24	)
Net income (loss) per common share — diluted		$	(0.33	)		$	0.10			$	(0.42	)		$	(0.24	)

     We had potential dilutive securities outstanding on June 30, 2006 consisting of options and warrants to purchase an aggregate of 4.4 million shares of common stock at a weighted average exercise price of $18.93 per share. These potential dilutive securities were not included in the computation of diluted net loss per common share for the three and six months ended June 30, 2006, because the effect of including the number of such potential dilutive securities would be antidilutive.

     We had the following potential dilutive securities outstanding on June 30, 2005: (a) options and warrants to purchase an aggregate of 4.7 million shares of common stock at a weighted average exercise price of $17.79 per share and (b) 104,000 shares of common stock held in escrow. These potential dilutive securities were not included in the computation of diluted net loss per share for the six months ended June 30, 2005, because the effect of including the number of such potential dilutive securities would be antidilutive. Such securities were included in the computation of diluted net income per common share for the three months ended June 30, 2005.

(6) Comprehensive Income (Loss)

     We account for comprehensive income as prescribed by SFAS No. 130, Reporting Comprehensive Income. In general, comprehensive income (loss) combines net income (loss) and other changes in equity during the year from non-owner sources. Our accumulated other comprehensive income, which is a component of shareholders’ equity, includes primarily foreign currency translation adjustments and is our only source of equity from non-owners. For the three and six months ended June 30, 2006, we generated a comprehensive loss of $11.4 million and $11.0 million, respectively, and for the three and six months ended June 30, 2005, we generated a comprehensive loss of $1.1 million and $11.4 million, respectively.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

(7) Stockholders’ Equity

     On February 8 and 9, 2006, we sold an aggregate 3,400,000 shares of our common stock at $24.41 per share to funds affiliated with 14 accredited institutional investors in a private placement. Proceeds from the private placement were approximately $79.3 million, net of issuance costs of $3.7 million. Of this amount, we repaid principal and interest outstanding under our senior credit facility of $74.1 million, with the remainder of the net proceeds retained for general corporate purposes.

     In connection with the February 2006 private placements of common stock, we registered the resale of the private placement shares by filing a registration statement on Form S-3 on May 30, 2006.

(8) Business Combinations

     All of the acquisitions discussed below resulted in the recognition of goodwill. Acquisitions are an important part of our growth strategy. When we acquire businesses, we seek to complement existing products and services, enhance or expand our product lines and/or expand our customer base. We determine what we are willing to pay for each acquisition partially based on our expectation that we can cost effectively integrate the products and services of the acquired companies into our existing infrastructure. In addition, we utilize the existing infrastructure of the acquired companies to cost effectively introduce our products to new geographic areas. All of these factors contributed to the acquisition prices of the acquired businesses discussed below that were in excess of the fair value of net assets acquired and the resultant goodwill.

Acquisitions

     (a) Acquisition of Innovacon and the ABON Facility

     On May 15, 2006, we acquired a newly-constructed manufacturing facility in Hangzhou, China (“ABON”) pursuant to the terms of our acquisition agreement with ACON Laboratories, Inc. and its affiliates. In connection with the acquisition of the new facility, we acquired ABON BioPharm (Hangzhou) Co., Ltd (“ABON”), the direct owner of the new factory and now our subsidiary. The preliminary aggregate purchase price was approximately $20.4 million which consisted of $8.8 million in cash and 417,446 shares of our common stock with an aggregate fair value of $11.6 million. The fair value of our common stock was determined based on the average market price of our common stock pursuant to Emerging Issues Task Force (“EITF”) Issue No. 99-12, Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination. In addition, pursuant to the acquisition agreement, we made an additional payment of $4.1 million in cash as a result of the amount of cash acquired, net of indebtedness assumed.

     On March 31, 2006, we acquired the assets of ACON Laboratories’ business of researching, developing, manufacturing, marketing and selling lateral flow immunoassay and directly-related products in the United States, Canada, Europe (excluding Russia, the former Soviet Republics that are not part of the European Union, Spain, Portugal and Turkey), Israel, Australia, Japan and New Zealand (“Innovacon”). The preliminary aggregate purchase price was approximately $91.2 million which consisted of $55.1 million in cash, 711,676 shares of our common stock with an aggregate fair value of $19.7 million, $6.4 million in estimated direct acquisition costs and an additional liability of $10.0 million payable to the sellers on the deferred payment date, pursuant to the purchase agreement. The fair value of our common stock was determined based on the average market price of our common stock pursuant to EITF Issue No. 99-12. In addition to the amounts described above, we will be required to make additional payments of approximately $71.2 million upon the completion of the permitting, validation and obtainment of operational capacity of the ABON facility and regulatory clearance in Spain and Portugal. $20 million of the remaining payments will be made through the issuance of our common stock, with the balance payable in cash. The timing and amount of any such payments is contingent upon the successful completion of various milestones, as defined in the acquisition agreement, and certain regulatory approvals.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

     The aggregate purchase price, which includes both the March 31, 2006 and May 15, 2006 closings discussed above, was preliminarily allocated to the assets acquired and liabilities assumed at the date of acquisition as follows (in thousands):

Cash		$	8,403
Accounts receivable			10,373
Inventories			4,510
Property, plant and equipment, net			10,274
Goodwill			53,391
Trademarks			5,000
Customer relationships			30,000
Supply agreements			5,000
Other assets			1,369
Accounts payable and accrued expenses			(4,550	)
Long-term debt			(8,125	)
		$	115,645

     The above values for the assets acquired and liabilities assumed are based on preliminary management estimates due to the timing of the acquisition. Final purchase price allocation may differ from the above. Management is also in the process of determining the useful lives of the core technology and intangible assets, as listed above.

     The acquisition of Innovacon and ABON are accounted for as purchases under SFAS No. 141. Accordingly, the operating results of Innovacon and ABON will be included in our consolidated financial statements from the acquisition date as part of our consumer and professional diagnostic products reporting units and business segments. Goodwill generated from this acquisition is not deductible for tax purposes.

     (b) Acquisition of CLONDIAG

     On February 28, 2006, we acquired 67.45% of CLONDIAG chip technologies GmbH (“CLONDIAG”), a privately-held company located in Jena in Germany which has developed a multiplexing technology for nucleic acid and immunoassay-based diagnostics. Pursuant to the acquisition agreement, we are required to purchase the remaining 32.55% on or before August 31, 2006. The initial aggregate purchase price was $22.7 million, which consisted of $11.8 million in cash, 218,502 shares of our common stock with an aggregate fair value of $5.8 million and a $5.1 million payable to acquire the remaining 32.55% stock ownership. In the event that the value of the shares issued in connection with the acquisition is less than €4.87 million on December 29, 2006, we will be required to pay the sellers additional cash in the amount of the shortfall. The fair value of our common stock issued was determined pursuant to EITF Issue No. 99-12. Additionally, pursuant to the terms of the acquisition agreement, we have an obligation to settle existing employee bonus arrangements with the CLONDIAG employees totaling €1.1 million ($1.3 million). In connection with this obligation, we issued 24,896 shares of our common stock with a fair value of $0.7 million to the employees of CLONDIAG and a cash payment of $0.5 million. As of June 30, 2006, our remaining obligation was $0.1 million. This obligation increased our aggregate purchase price to $24.0 million as of June 30, 2006 and resulted in additional goodwill.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

     The terms of the acquisition agreement also provide for contingent consideration totaling approximately $8.9 million consisting of 224,316 shares of our common stock and approximately $3.0 million of cash or stock, in the event that four specified products are developed on CLONDIAG’s platform technology during the three years following the acquisition date. This contingent consideration will be accounted for as an increase in the aggregate purchase price, if and when the resolution of the contingency occurs.

     The aggregate purchase price was preliminarily allocated to the assets acquired and liabilities assumed at the date of acquisition as follows (in thousands):

Cash and cash equivalents		$	270
Accounts receivable			295
Inventories			90
Prepaid expenses and other current assets			390
Property, plant and equipment			1,774
Goodwill			22,518
Other assets			20
Accounts payable and accrued expenses			(1,317	)
		$	24,040

     The above values for the assets acquired and liabilities assumed are based on preliminary management estimates due to the timing of the acquisition. Final purchase price allocation may differ from the above values and will include an evaluation of whether certain in-process research and development projects have yet reached technical feasibility. The value of projects which have not yet reached technical feasibility, if any, will be expensed as in-process research and development when quantified.

     The acquisition of CLONDIAG is accounted for as a purchase under SFAS No. 141. Accordingly, the operating expenses of CLONDIAG, which consist principally of research and development activities, have been included in the accompanying consolidated financial statements since the acquisition date as part of our corporate and other business segment. Goodwill generated from this acquisition is not deductible for tax purposes.

     (c) Minority Interest

     On May 17, 2006, we acquired 49% of TechLab, Inc. (“TechLab”), a privately-held developer, manufacturer and distributor of rapid non-invasive intestinal diagnostics tests in the areas of intestinal inflammation, antibiotic associated diarrhea and parasitology. The aggregate purchase price was $8.8 million which consisted of 303,417 shares of our common stock with an aggregate fair value of $8.6 million and $0.2 million in estimated direct acquisition costs. The fair value of our common stock was determined based on the average market price of our common stock pursuant to EITF Issue No. 99-12. We account for our 49% investment in TechLab under the equity method of accounting, in accordance with APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. For the three months ended June 30, 2006, we recorded $0.1 million in other income, which represented our minority share of TechLab’s profit for the period.

     (d) Pro Forma Financial Information

     The following table presents selected unaudited financial information of our company, including Binax, Inc. (“Binax”), Ischemia Technologies, Inc. (“Ischemia”), the Determine/DainaScreen assets of Abbott Laboratories’ rapid diagnostic business (the “Determine business”), Thermo BioStar, Inc. (“BioStar”), Innogenetics Diagnostica Y Terapeutica, S.A.U. (“IDT”) and Innovacon as if the acquisitions of these entities had occurred on January 1, 2005. Pro forma results exclude adjustments for Advanced Clinical Systems Pty Ltd (“ACS”), CLONDIAG and ABON as these acquisitions did not materially affect our results of operations. The pro forma results are derived from the historical financial results of the acquired businesses for all periods presented and are not necessarily indicative of the results that would have occurred had the acquisitions been consummated on January 1, 2005.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2006				2005				2006				2005
		(in thousands, except for share amounts)								(in thousands, except for share amounts)
Pro forma net revenue		$	139,713			$	131,236			$	280,981			$	263,106
Pro forma net (loss) income		$	(10,556	)		$	7,055			$	(10,393	)		$	5,235
Pro forma net (loss) income per common share — basic and diluted (1)		$	(0.33	)		$	0.22			$	(0.33	)		$	0.17

     (e) Restructuring Plans of Acquisitions

     In connection with our acquisitions of BioStar, Ischemia, Ostex International, Inc. (“Ostex”), IVC Industries, Inc. (now operating as Inverness Medical Nutritionals Group or “IMN”) and certain entities, businesses and intellectual property of Unilever Plc (the “Unipath business”), we recorded restructuring costs as part of the respective aggregate purchase prices in accordance with EITF Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination.

     The following table sets forth the restructuring costs and accrual balances recorded on a cash basis in connection with the restructuring activities of these acquired businesses (in thousands):

		Balance at				Amounts								Balance at
		December 31, 2005				Paid				Other (1)				June 30, 2006
BioStar		$	83			$	(55	)		$	—			$	28
Ischemia			144				(71	)			—				73
Ostex			768				(58	)			—				710
IMN			127				(29	)			—				98
Unipath business			1,307				—				65				1,372
Total restructuring costs		$	2,429			$	(213	)		$	65			$	2,281

     During the fourth quarter of 2005, we established a restructuring plan in connection with our acquisition of BioStar and recorded restructuring costs of $0.5 million, of which $0.4 million related to impairment of fixed assets and $0.1 million related to severance costs associated with a headcount reduction. The total number of employees to be involuntarily terminated was nine, of which all were terminated as of June 30, 2006. Of the costs recorded during 2005, $28,000 remains unpaid as of June 30, 2006. Although we believe our plan and estimated exit costs are reasonable, actual spending for exit activities may differ from current estimated exit costs, which might impact the final aggregate purchase price.

     In connection with our acquisition of Ischemia in March 2005, we established a restructuring plan whereby we exited the current facilities of Ischemia in Denver, Colorado and combined its activities with our existing manufacturing and distribution facilities during the third quarter of 2005. Total severance costs associated with involuntarily terminated employees were estimated to be $1.6 million, of which $28,000 remains unpaid as of June 30, 2006. We estimated costs to vacate the Ischemia facilities to be approximately $135,000, of which $90,000 has been paid as of June 30, 2006. The total number of involuntarily terminated employees was 17, of which all were terminated as of June 30, 2006.

     As a result of our acquisition of Ostex, we established a restructuring plan whereby we exited the facilities of Ostex in Seattle, Washington, and combined the activities of Ostex with our existing manufacturing and distribution facilities. The total number of employees to be involuntarily terminated under the restructuring plan was 38, of which all were terminated as of June 30, 2006. Total severance costs associated with involuntarily terminated employees were $1.6 million, all of which has been paid as of June 30, 2006. Costs to vacate the Ostex facilities are $0.5 million, of which $0.2 million has been paid as of June 30, 2006. Additionally, the remaining costs to exit the operations, primarily facilities lease commitments, were $1.9 million, of which $1.5 million has been paid as of June 30, 2006. Total unpaid exit costs amounted to $0.7 million as of June 30, 2006.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

     Immediately after the close of the acquisition, we reorganized the business operations of IMN to improve efficiencies and eliminate redundant activities on a company-wide basis. The restructuring affected all cost centers within the organization, but most significantly responsibilities at the sales and executive levels, as such activities were combined with our existing business operations. Also, as part of the restructuring plan, we relocated one of IMN’s warehouses to a closer proximity of the manufacturing facility to improve efficiency. Of the $1.6 million in total exit costs, which includes severance costs for 47 involuntarily terminated employees and costs to vacate the warehouse, $1.5 million has been paid as of June 30, 2006.

     As a result of the acquisition of the Unipath business from Unilever Plc in 2001, we reorganized the operations of the Unipath business for purposes of improving efficiencies and achieving economies of scale on a company-wide basis. Such reorganization affected all major cost centers at the operations in England. Additionally, most business activities of the U.S. division were merged into our existing U.S. businesses. Total exit costs, which primarily related to severance and early retirement obligations for 65 involuntarily terminated employees, were $4.1 million. As of June 30, 2006, $1.4 million, adjusted for foreign exchange effect, in exit costs remained unpaid.

(9) Restructuring Plans

     (a) 2006 Restructuring Plans

     On May 22, 2006, we committed to a plan to cease operations at our manufacturing facility in San Diego, California and to write off certain excess manufacturing equipment at other impacted facilities. Additionally, on June 7, 2006, we committed to a plan to reorganize the sales and marketing and customer service functions in certain of our U.S. professional diagnostic companies. As a result of these restructuring plans, we recorded $9.7 million in restructuring charges during the three and six months ended June 30, 2006, of which $0.6 million related to severance charges, $6.4 million related to impairment charges on fixed assets and $2.7 million related to an impairment charge on an intangible asset related to these plans. The charges for the three and six months ended June 30, 2006 consisted of $7.0 million charged to cost of sales, $2.6 million charged to research and development and $0.1 million charged to general and administrative expenses, of which $2.6 million and $7.1 million was included in our consumer diagnostic and professional diagnostic products business segment, respectively.

     We expect to complete these plans during the first half of 2007. Including the charges recorded through June 30, 2006, we expect the total restructuring charge related to these plans to be approximately $13.6 million, with additional charges of $2.8 million relating to severance and $1.1 million relating to facility exit and closure costs. The total number of employees to be involuntarily terminated under these plans is 162, of which 2 have been terminated as of June 30, 2006. As of June 30, 2006, all restructuring costs remain unpaid.

     (b) 2005 Restructuring Plan

     On May 9, 2005, we committed to a plan to cease operations at our facility in Galway, Ireland. During the three months ended June 30, 2006, we recorded a net restructuring gain of $5.3 million, of which $0.1 million related to charges for severance, early retirement and outplacement services, $0.1 million related to facility closing costs and $5.5 million in foreign exchange gains as a result of recording a cumulative translation adjustment to other income relating primarily to this plan of termination. During the six months ended June 30, 2006, we recorded a net restructuring gain of $3.2 million, of which $0.4 million related to charges for severance, early retirement and outplacement services, $0.1 million related to an impairment charge of fixed assets, $0.6 million related to facility closing costs and $4.3 million in foreign exchange gains as a result of recording a cumulative translation adjustment to other income relating primarily to this plan of termination. The charges for the three and six months ended June 30, 2006 consisted of $0.7 million and $0.7 million, respectively charged to cost of goods sold, $0.2 million and $0.4 million, respectively, charged to general and administrative and $5.5 million and $4.3 million, respectively, in gains recorded to other expense. Of the $0.2 million and $1.1 million included in operating income for the three and six months ended June 30, 2006, $0.2 million and $0.9 million was included in our consumer diagnostic products business segment, respectively, and $0.2 million was included in our professional diagnostic products business segments for the six months ended June 30, 2006. Additionally, during the three and six months ended June 30, 2006, we recorded a $1.4 million gain on the sale of our CDIL facility in Ireland which has been recorded in loss on dispositions, net in our consolidated statements of operations and is included in our corporate and other business segment for these periods.

      Total restructuring charges since the commitment date were $1.9 million, consisting of $2.6 million related to severance, early retirement and outplacement services, $2.4 million related to impairment of fixed assets and inventory and $1.2 million related to facility closing costs, offset by $4.3 million related to net foreign exchange gains relating primarily to this plan of termination. Of the total $6.0 million restructuring charges recorded in operating income, $5.7 million and $0.3 million were included in our consumer diagnostic products and professional diagnostic products business segments, respectively. The plan of

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

termination is substantially complete as of June 30, 2006 and all 113 employees under this plan have been involuntarily terminated. All costs related to severance, early retirement, outplacement services and facility closing costs have been substantially paid as of June 30, 2006.

(10) Loss on Dispositions

     During the three and six months ended June 30, 2006, we recorded a net loss on dispositions of $3.2 million. Included in this net loss is a $4.6 million charge associated with management’s decision to dispose of our Scandinavian Micro Biodevices ApS (“SMB”) research operation, which is part of our professional diagnostic products and corporate and other business segments, of which $2.0 million is related to impaired assets, primarily goodwill associated with SMB, and a $2.6 million estimated loss on the sale of SMB. We expect the sale of this operation to be completed in the third quarter of 2006. The net loss on dispositions also includes an offsetting $1.4 million gain on the sale of an idle manufacturing facility in Galway, Ireland, as a result of our 2005 restructuring plan. This facility was associated with our consumer diagnostic products business segment.

(11) Co-Development Arrangement

     On February 25, 2005, we entered into a co-development agreement with ITI Scotland Limited (“ITI”), whereby ITI agreed to provide us with approximately £30 million over three years to partially fund research and development programs focused on identifying novel biomarkers and near-patient and home-use tests for cardiovascular and other diseases (“the programs”). We agreed to invest £37.5 million in the programs over three years from the date of the agreement. Through our subsidiary, Stirling Medical Innovations Limited (“Stirling”), we established a new research center in Stirling, Scotland, where we consolidated many of our existing cardiology programs and will ultimately commercialize products arising from the programs. ITI and Stirling will have exclusive rights to the developed technology in their respective fields of use. As of June 30, 2006, we had received approximately $26.8 million in funding from ITI. As qualified expenditures are made under the co-development arrangement, we recognize the fee earned during the period as a reduction of our related expenses, subject to certain limitations. For the three and six months ended June 30, 2006, we recognized $4.5 million and $8.9 million of reimbursements, respectively, of which $4.0 million and $7.9 million, respectively, offset our research and development spending and $0.5 million and $1.0 million, respectively, reduced our general, administrative and marketing spending incurred by Stirling. For the three and six months ended June 30, 2005, we recognized $7.0 million and $9.4 million of reimbursements, respectively, of which $6.9 million and $8.8 million, respectively, offset our research and development spending and $0.1 million and $0.6 million, respectively, reduced our general, administrative and marketing spending incurred by Stirling.

(12) Senior Credit Facility

     As of December 31, 2005, $89.0 million of borrowings were outstanding under our senior credit facility. On February 8 and 9, 2006, we sold an aggregate 3,400,000 shares of our common stock at $24.41 per share to funds affiliated with 14 accredited institutional investors in a private placement. Proceeds from the private placement were approximately $79.3 million, net of issuance costs of $3.7 million. Of this amount, we repaid principal and interest outstanding under our senior credit facility of $74.1 million, with the remainder of the net proceeds retained for general corporate purposes. On February 27, 2006, we borrowed $13.0 million under our European revolving line of credit to fund our acquisition of CLONDIAG.

     On March 31, 2006, we entered into an amendment to our third amended and restated credit agreement. The amendment increased the total amount of credit available to us under the credit agreement to $155.0 million, from $100.0 million, consisting of a new $45.0 million U.S. term loan, a $40.0 million U.S. revolving line of credit, reduced from $60.0 million under the credit agreement prior to the amendment, and a $70.0 million European revolving line of credit, increased from $40.0 million under the credit agreement prior to the amendment. On March 31, 2006, in connection with our acquisition of Innovacon, we incurred $58.0 million in indebtedness under the credit agreement when we received the proceeds of the entire U.S. term loan and drew an additional $13.0 million under the U.S. revolving line of credit. On May 12, 2006, in the connection with the acquisition of ABON, we drew $13.0 million under the U.S. revolving line of credit. Our aggregate indebtedness under the amended credit agreement was $99.0 million as of June 30, 2006.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

     We must repay the U.S. term loan in seven consecutive quarterly installments, beginning on September 30, 2006, in an amount equal to 0.25% of the aggregate $45.0 million of U.S. term loan commitments, with the final installment due on March 31, 2008 in the amount of the remaining principal balance of the U.S. term loan. We may repay any existing or future borrowings under the revolving lines of credit at any time, but no later than March 31, 2008. We are required to make mandatory prepayments in various amounts under the credit facilities if we sell assets not in the ordinary course of business above certain thresholds, issue stock or sell equity securities, issue subordinated debt or have excess cash flow.

     Borrowings under the revolving lines of credit and term loan bear interest at either (i) the London Interbank Offered Rate (“LIBOR”), as defined in the agreement, plus applicable margins or, at our option, (ii) a floating index rate (“Index Rate”), as defined in the agreement, plus applicable margins. Applicable margins, if we choose to use the LIBOR or the Index Rate, can range from 2.75% to 3.75% or 1.50% to 2.50%, respectively, for our revolving lines of credit depending on the quarterly adjustments that are based on our consolidated financial performance and 4% or 2.75%, respectively, on our term loan. As of June 30, 2006, the LIBOR and Index Rate applicable under our primary senior credit facility for the revolving lines of credit were 8.88% and 10.50%, respectively, and for the U.S. term loan were 9.13% and 10.5%, respectively. For the three and six months ended June 30, 2006, we recorded interest expense, including amortization of deferred financing costs, under these senior credit facilities in the aggregate amount of $2.7 million and $4.2 million, respectively. For the three and six months ended June 30, 2005, we recorded interest expense, including amortization of deferred financing costs, under these senior credit facilities in the aggregate amount of $0.7 million and $1.4 million, respectively. As of June 30, 2006, accrued interest related to the senior credit facility amounted to $0.6 million.

     Borrowings under the credit facilities remain secured by the stock of certain of our U.S. and foreign subsidiaries, substantially all of our intellectual property rights, substantially all of the assets of our businesses in the U.S. and a significant portion of the assets of our businesses outside the U.S.

(13) Defined Benefit Pension Plan

     Our subsidiary in England, Unipath Ltd., has a defined benefit pension plan established for certain of its employees. The net periodic benefit costs are as follows (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		2006				2005				2006				2005
Service cost		$	—			$	66			$	—			$	134
Interest cost			141				149				276				303
Expected return on plan assets			(117	)			(88	)			(229	)			(179	)
Realized gains			80				11				157				22
Net periodic benefit costs		$	104			$	138			$	204			$	280

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

(14) Financial Information by Segment

     Under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision-making group is composed of the chief executive officer and members of senior management. Our reportable operating segments are Consumer Diagnostic Products, Vitamins and Nutritional Supplements, Professional Diagnostic Products and Corporate and Other. Included in the operating loss of Corporate and Other are non-allocable corporate expenditures and expenses related to our research and development activities in the area of cardiology for the three and six months ended June 30, 2006, the latter of which amounted to $6.1 million, net of the ITI funding of $4.0 million (Note 11) and $12.2 million, net of $7.9 million of the ITI funding, respectively, and $1.9 million, net of the ITI funding of $6.9 million, and $6.3 million, net of $8.8 million of the ITI funding, respectively, for the three and six months ended June 30, 2005, respectively. Also included in the operating loss of Corporate and Other for the three and six months ended June 30, 2006 are a net loss on certain dispositions (Note 10) and $2.6 million related to the write-off of certain cardiology related fixed assets impacted by our restructuring plans (Note 9). Total assets in the area of cardiology, which are included in Corporate and Other in the tables below, amounted to $34.8 million at June 30, 2006 and $41.2 million at December 31, 2005.

     We evaluate performance of our operating segments based on net revenue and operating income (loss). Segment information for the three and six months ended June 30, 2006 and 2005 is as follows (in thousands):

		Consumer				Vitamins and				Professional				Corporate
		Diagnostic				Nutritional				Diagnostic				and
		Products				Supplements				Products				Other				Total
Three Months Ended June 30, 2006
Net revenue from external customers		$	45,532			$	22,094			$	72,087			$	—			$	139,713
Operating income (loss)		$	8,380			$	28			$	1,138			$	(17,723	)		$	(8,177	)
Three Months Ended June 30, 2005
Net revenue from external customers		$	42,795			$	18,918			$	40,518			$	40			$	102,271
Operating income (loss)		$	6,102			$	(1,291	)		$	(3,104	)		$	(6,262	)		$	(4,555	)
Six Months Ended June 30, 2006
Net revenue from external customers		$	88,846			$	41,097			$	137,591			$	—			$	267,534
Operating income (loss)		$	16,860			$	(1,049	)		$	10,554			$	(29,558	)		$	(3,193	)
Six Months Ended June 30, 2005
Net revenue from external customers		$	86,215			$	35,839			$	72,028			$	109			$	194,191
Operating income (loss)		$	13,043			$	(3,151	)		$	(5,590	)		$	(15,045	)		$	(10,743	)
Assets:
As of June 30, 2006		$	306,478			$	53,505			$	541,800			$	47,086			$	948,869
As of December 31, 2005		$	253,063			$	52,967			$	434,796			$	50,340			$	791,166

(15) Material Contingencies and Legal Settlements

     Due to the nature of our business, we may from time to time be subject to commercial disputes, consumer product claims or various other lawsuits arising in the ordinary course of our business, and we expect this will continue to be the case in the future. These lawsuits generally seek damages, sometimes in substantial amounts, for commercial or personal injuries allegedly suffered and can include claims for punitive or other special damages. In addition, we aggressively defend our patent and other intellectual property rights. This often involves bringing infringement or other commercial claims against third parties, which can be expensive and can results in counterclaims against us. We are currently not a party to any material legal proceedings.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

     As of June 30, 2006, we had outstanding material contingent contractual obligations related to our acquisitions of Binax and CLONDIAG. With respect to Binax, the terms of the acquisition agreement provide for $11.0 million of contingent cash consideration payable to the Binax shareholders upon the successful completion of certain new product developments during the five years following the acquisition. With respect to the acquisition of CLONDIAG, in the event that the value of the 218,502 shares of our common stock issued in connection with the acquisition is less than €4.87 million on December 29, 2006, we will be required to pay the sellers additional cash in the amount of the shortfall. In addition, the terms of the acquisition agreement provide for $8.9 million of contingent consideration, consisting of 224,316 shares of our common stock and approximately $3.0 million of cash or stock in the event that four specified products are developed on CLONDIAG’s platform technology during the three years following the acquisition date.

(16) Recent Accounting Pronouncements

     Recently Issued Standards

     In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided we have not yet issued financial statements, including for interim periods, for that fiscal year. We do not expect the adoption of SFAS No. 155 to have a material impact on our financial position, results of operations or cash flows.

     In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets — an Amendment of FASB Statement No. 140. SFAS No. 156 requires that all separately recognized servicing rights be initially measured at fair value, if practicable. In addition, this Statement permits an entity to choose between two measurement methods (amortization method or fair value measurement method) for each class of separately recognized servicing assets and liabilities. This new accounting standard is effective January 1, 2007. The adoption of SFAS No. 156 is not expected to have an impact on our financial position, results of operations or cash flows.

     In June 2006, the FASB ratified the consensus on EITF Issue No. 06-03, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement. The scope of EITF Issue No. 06-03 includes any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, sales, use, value added, Universal Service Fund (“USF”) contributions and some excise taxes. The Task Force affirmed its conclusion that entities should present these taxes in the income statement on either a gross or a net basis, based on their accounting policy, which should be disclosed pursuant to APB Opinion No. 22, Disclosure of Accounting Policies. If such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. The consensus on Issue No. 06-03 will be effective for interim and annual reporting periods beginning after December 15, 2006. We are currently evaluating the manner in which we record gross receipts taxes, USF contributions and miscellaneous other taxes and regulatory cost recovery fees. Should we need to change the manner in which we record gross receipts, it is not expected that the change would have a material impact on total operating revenue and expenses and operating income and net income would not be affected.

     In June 2006, the FASB issued FASB Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact of the adoption of FIN 48 on our financial statements, but it is not expected to be material.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

Recently Adopted Standards

     In November 2004, the FASB issued SFAS No. 151, Inventory Costs — an Amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage). In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on normal capacity of production facilities. As required by SFAS No. 151, we adopted this new accounting standard on January 1, 2006. The adoption of SFAS No. 151 did not have a material impact on our financial position, results of operations or cash flows.

     In December 2004, the FASB issued SFAS No. 123-R, Share-Based Payment, which addresses the accounting for transactions in which a company receives employee services in exchange for (a) equity instruments of the company or (b) liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under the original guidance of SFAS No. 123-R, we were to adopt the statement’s provisions for the interim period beginning after June 15, 2005. However, in April 2005, as a result of an action by the Securities and Exchange Commission, companies were allowed to adopt the provisions of SFAS No. 123-R at the beginning of their fiscal year that begins after June 15, 2005. Consequently, we adopted SFAS No. 123-R on January 1, 2006. See Note 4 for further discussion.

     In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. The statement requires a voluntary change in accounting principle be applied retrospectively to all prior period financial statements so that those financial statements are presented as if the current accounting principle had always been applied. APB Opinion No. 20 previously required most voluntary changes in accounting principle to be recognized by including in net income of the period of change the cumulative effect of changing to the new accounting principle. In addition, SFAS No. 154 carries forward, without change, the guidance contained in APB Opinion No. 20 for reporting a correction of an error in previously issued financial statements and a change in accounting estimate. SFAS No. 154 was effective for accounting changes and corrections of errors made after January 1, 2006. The adoption of SFAS No. 154 had no impact on our financial statements.

(17) Related Party Transaction

     On June 20, 2006, we issued 25,000 shares of our common stock as consideration for the acquisition of all of the capital stock of Innovative Medical Devices BVBA. The seller of the capital stock of Innovative Medical Devices BVBA is the spouse of the Vice President of our Consumer Diagnostics business unit.

(18) Guarantor Financial Information

     We issued $150.0 million in senior subordinated notes (the “Bonds”) to qualified institutional buyers in reliance on Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and outside the United States in compliance with Regulation S of the Securities Act. Our payment obligations under the Bonds are currently guaranteed by all of our domestic subsidiaries (the “Guarantor Subsidiaries”). The guarantee is full and unconditional. Separate financial statements of the Guarantor Subsidiaries are not presented because we have determined that they would not be material to investors in the Bonds. The following supplemental financial information sets forth, on a consolidating basis, the statements of operations and cash flows for the three and six months ended June 30, 2006 and 2005 and the balance sheets as of June 30, 2006 and December 31, 2005 for our company (the “Issuer”), the Guarantor Subsidiaries and our other subsidiaries (the “Non-Guarantor Subsidiaries”). The supplemental financial information reflects our investments and the Guarantor Subsidiaries’ investments in the Guarantor and Non-Guarantor Subsidiaries using the equity method of accounting.

     We have extensive transactions and relationships between various members of our consolidated group. These transactions and relationships include intercompany pricing agreements, intellectual property royalty agreements, and general and administrative and research and development cost sharing agreements. Because of these relationships, it is possible that the terms of these transactions are not the same as those that would result from transactions among unrelated parties.

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF OPERATIONS
For the Three Months Ended June 30, 2006
(unaudited)
(in thousands)

						Guarantor				Non-Guarantor
		Issuer				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Net product sales		$	5,906			$	83,422			$	63,351			$	(16,082	)		$	136,597
License and royalty revenue			—				82				3,034				—				3,116
Net revenue			5,906				83,504				66,385				(16,082	)			139,713
Cost of sales			6,942				63,626				37,008				(16,359	)			91,217
Gross profit			(1,036	)			19,878				29,377				277				48,496
Operating expenses:
Research and development			415				2,017				10,682				—				13,114
Sales and marketing			1,536				11,994				9,160				—				22,690
General and administrative			5,235				5,389				7,054				—				17,678
Loss on dispositions, net			—				—				3,191				—				3,191
Operating (loss) income			(8,222	)			478				(710	)			277				(8,177	)
Equity in earnings of subsidiaries, net of tax			99				—				—				(99	)			—
Interest expense, including amortization of original issue discounts and write-off of deferred financing costs			(4,082	)			(1,827	)			(6,942	)			5,969				(6,882	)
Other income (expense), net			2,221				3,857				5,276				(6,053	)			5,301
(Loss) income before provision for (benefit from) income taxes			(9,984	)			2,508				(2,376	)			94				(9,758	)
Provision for (benefit from) income taxes			572				489				(263	)			—				798
Net (loss) income		$	(10,556	)		$	2,019			$	(2,113	)		$	94			$	(10,556	)

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF OPERATIONS
For the Six Months Ended June 30, 2006
(unaudited)
(in thousands)

						Guarantor				Non-Guarantor
		Issuer				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Net product sales		$	11,793			$	156,299			$	124,603			$	(33,345	)		$	259,350
License and royalty revenue			—				153				8,031				—				8,184
Net revenue			11,793				156,452				132,634				(33,345	)			267,534
Cost of sales			13,639				114,638				71,937				(33,430	)			166,784
Gross profit			(1,846	)			41,814				60,697				85				100,750
Operating expenses:
Research and development			1,398				3,945				18,381				—				23,724
Sales and marketing			2,838				22,078				18,596				—				43,512
General and administrative			10,387				9,265				13,864				—				33,516
Loss on dispositions, net			—				—				3,191				—				3,191
Operating (loss) income			(16,469	)			6,526				6,665				85				(3,193	)
Equity in earnings of subsidiaries, net of tax			7,370				—				—				(7,370	)			—
Interest expense, including amortization of original issue discounts and write-off of deferred financing costs			(8,161	)			(2,623	)			(9,466	)			7,647				(12,603	)
Other (expense) income, net			4,924				3,758				3,922				(7,731	)			4,873
(Loss) income before provision for income taxes			(12,336	)			7,661				1,121				(7,369	)			(10,923	)
Provision for income taxes			850				1,043				370				—				2,263
Net (loss) income		$	(13,186	)		$	6,618			$	751			$	(7,369	)		$	(13,186	)

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF OPERATIONS
For the Three Months Ended June 30, 2005
(unaudited)
(in thousands)

						Guarantor				Non-Guarantor
		Issuer				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Net product sales		$	6,498			$	58,444			$	48,736			$	(15,905	)		$	97,773
License and royalty revenue			—				95				4,403				—				4,498
Net revenue			6,498				58,539				53,139				(15,905	)			102,271
Cost of sales			6,768				48,950				28,638				(16,798	)			67,558
Gross profit			(270	)			9,589				24,501				893				34,713
Operating expenses:
Research and development			628				1,502				3,230				—				5,360
Sales and marketing			772				8,935				7,959				—				17,666
General and administrative			3,141				5,595				7,506				—				16,242
Operating (loss) income			(4,811	)			(6,443	)			5,806				893				(4,555	)
Equity in earnings of subsidiaries, net of tax			10,745				—				—				(10,745	)			—
Interest expense, including amortization of original issue discounts and write-off of deferred financing costs			(4,080	)			(327	)			(1,505	)			952				(4,960	)
Other income (expense), net			512				(2,520	)			17,832				(952	)			14,872
Income (loss) before provision for (benefit from) income taxes			2,366				(9,290	)			22,133				(9,852	)			5,357
Provision for (benefit from) income taxes			(137	)			418				2,533				40				2,854
Net income (loss)		$	2,503			$	(9,708	)		$	19,600			$	(9,892	)		$	2,503

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENT OF OPERATIONS
For the Six Months Ended June 30, 2005
(unaudited)
(in thousands)

						Guarantor				Non-Guarantor
		Issuer				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Net product sales		$	11,976			$	109,530			$	94,078			$	(28,112	)		$	187,472
License and royalty revenue			—				126				6,593				—				6,719
Net revenue			11,976				109,656				100,671				(28,112	)			194,191
Cost of sales			12,385				91,998				53,205				(30,299	)			127,289
Gross profit			(409	)			17,658				47,466				2,187				66,902
Operating expenses:
Research and development			770				2,617				9,205				—				12,592
Sales and marketing			1,252				16,112				17,332				—				34,696
General and administrative			6,449				9,217				14,691				—				30,357
Operating (loss) income			(8,880	)			(10,288	)			6,238				2,187				(10,743	)
Equity in earnings of subsidiaries, net of tax			14,653				—				—				(14,653	)			—
Interest expense, including amortization of original issue discounts and write-off of deferred financing costs			(8,324	)			(811	)			(2,848	)			2,011				(9,972	)
Other income, net			(2,563	)			6,140				18,156				(1,950	)			19,783
(Loss) income before provision for income taxes			(5,114	)			(4,959	)			21,546				(12,405	)			(932	)
Provision for income taxes			185				1,136				3,046				—				4,367
Net (loss) income		$	(5,299	)		$	(6,095	)		$	18,500			$	(12,405	)		$	(5,299	)

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES
CONSOLIDATING BALANCE SHEET
June 30, 2006
(unaudited)
(in thousands)

						Guarantor				Non-Guarantor
		Issuer				Subsidiaries				Subsidiaries				Eliminations				Consolidated
ASSETS
Current Assets:
Cash and cash equivalents		$	913			$	12,366			$	28,885			$	—			$	42,164
Accounts receivable, net of allowances			3,042				49,336				39,590				—				91,968
Inventories			6,807				41,775				33,655				(6,099	)			76,138
Deferred tax assets			—				1				844				—				845
Prepaid expenses and other current assets			2,006				2,916				13,669				—				18,591
Intercompany receivables			33,006				38,071				14,788				(85,865	)			—
Total current assets			45,774				144,465				131,431				(91,964	)			229,706
Property, plant and equipment, net			2,178				27,352				50,317				—				79,847
Goodwill			114,317				109,116				165,187				—				388,620
Other intangible assets with indefinite lives			—				21,120				46,317				—				67,437
Core technology and patents, net			19,381				14,194				30,822				—				64,397
Other intangible assets, net			37,998				33,436				26,178				—				97,612
Deferred financing costs, net, and other non-current assets			5,104				1,957				4,216				—				11,277
Deferred tax assets			256				(1	)			400				—				655
Investment in subsidiaries and other investments			359,499				(1,015	)			103				(349,269	)			9,318
Intercompany notes receivable			164,452				68,267				(1	)			(232,718	)			—
Total assets		$	748,959			$	418,891			$	454,970			$	(673,951	)		$	948,869
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	—			$	—			$	1,372			$	—			$	1,372
Current portion of capital lease obligations			—				528				31				—				559
Accounts payable			4,878				28,292				17,380				—				50,550
Accrued expenses and other current liabilities			22,898				18,425				33,530				—				74,853
Intercompany payables			27,710				28,369				29,789				(85,868	)			—
Total current liabilities			55,486				75,614				82,102				(85,868	)			127,334
Long-term liabilities:
Long-term debt, net of current portion			169,556				71,000				33,708				—				274,264
Capital lease obligations, net of current portion			—				641				54				—				695
Deferred tax liabilities			4,343				7,056				9,234				128				20,761
Other long-term liabilities			—				291				5,950				—				6,241
Intercompany notes payable			—				59,339				173,380				(232,719	)			—
Total long-term liabilities			173,899				138,327				222,326				(232,591	)			301,961
Stockholders’ equity			519,574				204,950				150,542				(355,492	)			519,574
Total liabilities and stockholders’ equity		$	748,959			$	418,891			$	454,970			$	(673,951	)		$	948,869