UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

 

 

FORM 10-K/A

(Amendment No. 1)

 

ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

Commission file number 000-16789

 

 

 

 

INVERNESS MEDICAL INNOVATIONS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

(781) 647-3900

(Registrant’s telephone number, including area code)

 

 

 

 

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934 (the “Exchange Act”):

 

 

Securities registered pursuant to Section 12(g) of the Exchange Act: None

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.  Yes x     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 x     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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 x     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 x

 

The aggregate market value of the voting common stock held by non-affiliates of the registrant based on the closing price of the registrant’s stock on the American Stock Exchange on June 30, 2006 (the last business day of the registrant’s most recently completed second fiscal quarter) was $690,432,458.

 

As of February 26, 2007, the registrant had 46,239,163 shares of common stock, par value $0.001 per share, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 2007 are incorporated by reference into Part III of this Form 10-K.

 

 

EXPLANATORY NOTE

 

We filed our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 on March 1, 2007 (the “Original Report”). We are filing this Amendment No. 1 on Form 10-K/A (the “Amended Report”) at the request of BDO Seidman, LLP (“BDO”) for the sole purpose of adding a reference regarding our adoption of SFAS 123(R) in BDO’s Report of Independent Registered Public Accounting Firm (the “Audit Report”) included on page F-2 of our Consolidated Financial Statements. As discussed in Note 15 to the Consolidated Financial Statements included in the Original Report, we adopted SFAS 123(R), or Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”, effective January 1, 2006. BDO’s conclusions in the Audit Report are unchanged and no change has been made to our Consolidated Financial Statements, or the notes thereto.

 

Item 15 “Exhibits, Financial Statement Schedules,” has been amended herein to the extent required to reflect the change to BDO’s Audit Report discussed above. The other Items of our Original Report are not amended hereby and are repeated herein only for the reader’s convenience.

 

The Amended Report speaks as of the date of the filing of the Original Report, March 1, 2007. All information contained in the Original Report, as amended by the Amended Report, is subject to updating and supplementing as provided in our reports filed with the Securities and Exchange Commission subsequent to the date of the Original Report.

 

PART I

 

This Annual Report on Form 10-K 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. You can identify these statements by forward-looking words such as “may,” “could,” “should,” “would,” “intend,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “continue” or similar words. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial condition or state other “forward-looking” information. We caution investors that all such forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from any projected results or expectations that we discuss in this report. You should therefore carefully review the risk factors and uncertainties discussed in Item 1A entitled “Risk Factors,” which begins on page 11 of this report, as well as those factors identified from time to time in our periodic filings with the Securities and Exchange Commission. We undertake no obligation to update any forward-looking statements.

 

Unless the context requires otherwise, references in this Annual Report on Form 10-K to “we,” “us,” “our,” or “our company” refer to Inverness Medical Innovations, Inc. and its subsidiaries.

 

 

GENERAL

 

We are a leading global developer, manufacturer and marketer of in vitro diagnostic products for the over-the-counter pregnancy and fertility/ovulation test market and the professional rapid diagnostic test markets. Our company, Inverness Medical Innovations, Inc., a Delaware corporation, was formed to acquire the women’s health, nutritional supplements and professional diagnostics businesses of its predecessor, Inverness Medical Technology, Inc., through a split-off and merger transaction, which occurred in November 2001. We became an independent, publicly traded company immediately after the split-off and our common stock is listed on the American Stock Exchange under the symbol “IMA.” Since the split-off, we have grown our businesses by leveraging our proprietary lateral flow immunoassay technology and our strong intellectual property portfolio, and by making selected strategic acquisitions. We have an experienced research and development team and a continuing commitment to product development, and have a demonstrated capability for introducing new and innovative products through internal research and development efforts. We are presently exploring new opportunities in a variety of professional diagnostic and consumer-oriented applications, including immuno-diagnostics with a focus on cardiology, infectious disease and women’s health.

 

Our objective is to be a leading provider of innovative rapid diagnostic products in cardiology to both consumer and professional diagnostic markets, while enhancing our current position as a leader in the professional rapid diagnostic test market though geographic and product line expansions and selective acquisitions. We plan to further expand our position in the consumer rapid diagnostic test product market, including the over-the-counter pregnancy and fertility/ovulation test market, through our pending joint venture with The Procter & Gamble Company, which is discussed further below.

 

Our principal executive offices are located at 51 Sawyer Road, Suite 200, Waltham, Massachusetts 02453 and our telephone number is (781) 647-3900. Our website is www.invmed.com and we make available through this site, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission, or the SEC. These reports may be accessed through our website’s investor information page. We also make our code of ethics and certain other governance documents and policies available through this site.

 

RECENT DEVELOPMENTS

 

Agreement with The Procter & Gamble Company to Form Consumer Diagnostics Joint Venture

 

In December 2006, we signed a definitive agreement with The Procter & Gamble Company, or P&G, to form a 50/50 joint venture for the development, acquisition, manufacturing, marketing and sale of existing and to-be-developed consumer diagnostic products outside of the fields of cardiology and diabetes. In connection with this agreement, we will be contributing our related consumer diagnostic and monitoring assets, other than manufacturing and core intellectual property assets, to a new joint venture entity, and P&G will be acquiring its interest in the joint venture in consideration for a cash payment of $325.0 million to us. P&G will retain an option to require us to purchase its interest in the joint venture at fair market value during a 60-day period beginning on the fourth anniversary of the closing. Our primary role in the collaboration will be to develop and manufacture consumer diagnostic products, while P&G’s primary role will be to market, sell and distribute existing and to-be-developed products. We will retain all rights with respect to the development and sale of cardiology diagnostic products and our professional point-of-care diagnostic businesses.

 

Following the completion of the transaction and the formation of the joint venture, we will cease to consolidate the operating results of our consumer diagnostics business, which represented $171.6 million of net product revenue in 2006 and instead will account for our 50% interest in the results of the joint venture under the equity method. In our capacity as the manufacturer of products for the joint venture, we will supply products to the joint venture and we will record revenue on those sales. No gain on the proceeds that we receive from P&G through the formation of the joint venture will be recognized in our financial statements until P&G’s option to require us to purchase its interest in the joint venture at fair market value expires.

 

The transaction is expected to close in the first half of 2007, subject to the satisfaction of customary closing and other conditions.

 

Sale of 6,900,000 Shares of Common Stock

 

We recently raised net proceeds of approximately $261.3 million through an underwritten public offering of 6,900,000 shares of our common stock. In January 2007, we sold 6,000,000 shares to the public at $39.65 per share, and in February 2007, our underwriters exercised in full an option to purchase an additional 900,000 shares to cover over-allotments. Net proceeds include deductions for underwriting discounts and commissions and take into effect the reimbursement by the underwriters of a portion of our offering expenses. Of this amount, we used $44.9 million to repay principal outstanding and accrued interest on our term loan under our senior credit facility, with the remainder of the net proceeds retained for working capital and other general corporate purposes, including the financing of potential acquisitions or other investments.

 

Acquisition of First Check

 

In February 2007, we acquired substantially all of the assets of First Check Diagnostics LLC (“First Check”), a privately-held diagnostics company, for approximately $24.5 million in cash. In addition, we will pay an earn-out to First Check equal to the incremental revenue growth of the acquired products for 2007 and for the first nine months of 2008, as compared to the immediately preceding comparable periods.

 

First Check is the market leader in the rapidly-growing field of home testing for drugs of abuse, including marijuana, cocaine, methamphetamines and opiates. In addition, it offers tests, also sold through retail channels, for alcohol abuse, cholesterol monitoring and colon cancer screening.

 

Segments

 

Our major reportable segments are consumer diagnostic products, vitamins and nutritional supplements and professional diagnostic products. Below are discussions of each of these reportable segments. Financial information about our reportable segments is provided in Note 18 of the “Notes to Consolidated Financial Statements,” which are included elsewhere in this report.

 

Products

 

Consumer Diagnostic Products.  Our current consumer diagnostic products primarily target the worldwide over-the-counter pregnancy and fertility/ovulation test market. There are numerous pregnancy self-tests on the market, which are typically urine-based tests and provide results in less than five minutes. Our pregnancy and fertility/ovulation tests display visual results in approximately one minute or three minutes depending on the product. Fertility/ovulation prediction tests inform women of the best time to conceive a baby by detecting the surge of the luteinizing hormone, which precedes ovulation. Fertility/ovulation prediction tests, which are generally disposable stick tests similar to pregnancy stick tests, are easy to use and are widely accepted for home use by professional fertility care providers and the general public. Our fertility/ovulation prediction test kits provide 24 to 36 hours notice of when ovulation is likely to occur. By identifying the days when a woman is most fertile, these products assist couples in planning conception.

 

To serve these markets we offer premium branded products, value branded products and private label diagnostic products. Our premium branded Clearblue home pregnancy and fertility/ovulation prediction tests are global leaders in terms of both sales and technology. We also offer Clearblue Easy Digital pregnancy and fertility/ovulation prediction tests. Our Clearblue Easy Digital pregnancy test was launched in June 2003 as the first consumer pregnancy test to display test results in words, as opposed to displaying results with colored lines that require interpretation. During 2006 we introduced, under the Clearblue Easy Digital brand, the first one piece digital pregnancy test, which contains both the absorbent wick and the digital read technology in a single disposable stick. To supplement our premium line of traditional Clearblue fertility/ovulation disposable stick tests, we also offer the Clearblue Easy Fertility Monitor, the only hormone-based reusable monitoring device available for home use to assist women attempting to conceive. This product, which is sold primarily in the United States and Canada, not only detects the surge of the luteinizing hormone, or LH, which causes ovulation, but it is also the only fertility/ovulation prediction device that identifies additional days when a woman may conceive by detecting a rise in estrogen levels that precedes the LH surge.

 

Our Fact plus and Accu-Clear branded pregnancy and fertility/ovulation prediction products are marketed to value-oriented consumers. We also sell Crystal Clear, the leading brand pregnancy test in Australia. We are also a major supplier of private label home pregnancy detection and fertility/ovulation prediction products and we currently supply Johnson & Johnson, who recently acquired the consumer healthcare business of Pfizer, with both the digital and non-digital versions of its e.p.t brand pregnancy tests. We also sell Persona, a diagnostic monitoring device that provides for a natural method of contraception by allowing the user to monitor her menstrual cycle, in foreign countries, primarily in Germany and the United Kingdom.

 

In February 2007, we acquired First Check, the market leading brand of over-the-counter drugs of abuse tests for at-home testing for marijuana, cocaine, methamphetamines and opiates. We also acquired

over-the-counter tests for alcohol abuse, cholesterol monitoring, and colon cancer screening which are also sold under the First Check brand.

 

Vitamins and Nutritional Supplements.  We market a wide variety of vitamins and nutritional supplements primarily within the United States. Most growth in this market is attributed to new products that generate attention in the marketplace. Well-established market segments, where competition is greater and media commentary less frequent, are generally stable. Slow overall growth in the industry has resulted in retailers reducing shelf space for nutritional supplements and has forced many under-performing items out of distribution, including several broad product lines. Sales growth of private label products has generally outpaced the overall industry growth, as retailers continue to add to the number of private label nutritional products on their shelves.

 

Our subsidiary, Inverness Medical Nutritionals Group, or IMN, is a national supplier of private label vitamin and nutritional products for major drug and food chains and also manufactures bulk vitamins, minerals, nutritional supplements and over-the-counter drug products under contract for unaffiliated brand name distributors. IMN also manufactures an assortment of vitamin, mineral and nutritional supplement products for sale under Inverness Medical brand names.

 

Our Inverness Medical branded nutritional products are high quality products sold at moderate prices through national and regional drug stores, groceries and mass merchandisers. These branded products include Stresstabs, a B-complex vitamin with added antioxidants; Ferro-Sequels, a time-release iron supplement; Protegra, an antioxidant vitamin and mineral supplement; Posture-D, a calcium supplement; SoyCare, a soy supplement for menopause; ALLBEE, a line of B-complex vitamins; and Z-BEC, a zinc supplement with B-complex vitamins and added antioxidants.

 

Professional Diagnostic Products.  Professional diagnostic products are designed to assist medical professionals in both preventative and interventional medicine. These products provide for qualitative or quantitative analysis of a patient’s body fluids or tissue for evidence of a specific medical condition or disease state or to measure response to therapy. Our current professional diagnostic products consist primarily of laboratory and point-of-care tests in the areas of women’s health, infectious disease, cardiovascular disease and drugs of abuse. The market for rapid diagnostic products consists primarily of small and medium sized, non-centralized laboratories and testing locations such as physician office laboratories, specialist mobile clinics, emergency rooms and some rapid-response laboratories in larger medical centers. We distinguish the professional point-of-care rapid diagnostic test market from clinical diagnostic markets that consist of large, centralized laboratories that offer a wide range of highly-automated laboratory services in hospital or related settings.

 

We believe that the demand for infectious disease diagnostic products is growing faster than many other segments of the immunoassay market due to the increasing incidence of certain diseases or groups of diseases, including viral hepatitis, respiratory syncytial virus (RSV), influenza, tuberculosis, acquired immunodeficiency syndrome and other sexually transmitted diseases. We also believe that, in general, the ability to deliver faster, accurate results at reasonable prices drives demand for professional diagnostic products. This means that while there is growing demand for faster, more efficient automated equipment from large hospitals and major reference testing laboratories, there is also growing demand by point-of-care facilities and smaller laboratories for fast, high-quality, inexpensive, self-contained diagnostic kits. As the speed and accuracy of such products improve, we believe that these products will play an increasingly important role in achieving early diagnosis, timely intervention and therapy-monitoring outside of acute medicine environments.

 

Our professional diagnostics products, which are generally marketed under the trade name, Inverness Medical Professional Diagnostics, include:

 

 

 

Methods of Distribution

 

Consumer Diagnostic Products.  We market and sell our consumer diagnostic products under our own brand names as well as under store brands. Our customers include retail drug stores, drug wholesalers, groceries and mass merchandisers in North America, Europe and Japan such as Walgreens, CVS, Wal-Mart and Boots. Our Clearblue products are marketed as premium products and compete intensively with other premium brand name products. Persona is also marketed as a premium product in Europe. Marketing of premium branded products focuses on brand awareness as well as feature and performance differentiation. We achieve this through radio, television and print advertising. Our Fact plus and Accu-Clear brand products are value-oriented brands which are not currently advertised. Our consumer diagnostic products are marketed in the United States, the United Kingdom and parts of Western Europe using our own sales managers and a network of sales representatives. In other areas of the world, our consumer diagnostic products are sold though distribution contracts. Private label and contract manufacturing arrangements accounted for 34% of our consumer diagnostics business’ net product sales for 2006.

 

Vitamins and Nutritional Supplements.  We primarily market and sell our vitamins and nutritional supplements in the United States through private label arrangements with retail drug stores, groceries, mass merchandisers and warehouse clubs who sell our products under their store brands. We also sell a variety of branded products to the retail drug stores, groceries and mass merchandisers. To a lesser extent, we provide contract manufacturing services to third parties. Our two largest customers during 2006, based on net product sales, together accounted for almost 63% of our net product sales for this segment. Our rights to the trademarks Stresstabs, Ferro-Sequels, Posture-D, Protegra, ALLBEE and Z-BEC are limited to use in the United States, but we are not restricted from marketing the formulations sold under those brand names in other areas of the world.

 

Professional Diagnostic Products.  In the United States, the United Kingdom, Germany, Spain, Portugal, France and Israel, we distribute our professional diagnostic products to hospitals, reference laboratories, physician’s offices and other point-of-care settings through our own sales forces and distribution networks. We have also recently acquired distribution operations in Australia, Italy, Canada and Japan. In all other major

markets around the world we utilize third party distributors to sell our products. We also distribute products for other parties, primarily in Germany, Spain, Portugal, France, Italy and Canada.

 

Under the terms of our acquisition of our Determine products from Abbott Laboratories in June 2005, Abbott distributes our Determine products, which are sold outside of the United States, for up to 32 months in order to allow us time to obtain various marketing or sales licenses in the many countries where these products are sold. Abbott acts as our exclusive distributor, although we have certain rights to terminate the distribution arrangement on a country by country basis in the future. We also sell these products to Abbott as the exclusive supplier of its global “Access to HIV Care” program, through which Abbott provides free or low-cost testing products for HIV testing in underdeveloped countries around the world.

 

Manufacturing

 

Consumer Diagnostic Products.  We manufacture nearly all of our disposable consumer diagnostic products at our facilities in Shanghai, China and Bedford, England. These facilities are ISO certified and registered with the United States Food and Drug Administration, or the FDA. We use our Bedford facility to manufacture the diagnostic test portion of our Clearblue Easy Digital products, and the non-digital and digital e.p.t pregnancy tests for Johnson & Johnson. We purchase the electronic portion of our digital pregnancy and ovulation prediction tests, our Clearblue Easy Fertility Monitor and Persona to our specifications from third party suppliers in Europe and China. Because most components of our consumer diagnostic products are produced to our specifications, some of our suppliers are single source suppliers with few, if any, alternative sources immediately available.

 

Vitamins and Nutritional Supplements.  We manufacture substantially all of our vitamin and nutritional products at IMN’s facilities in Freehold and Irvington, New Jersey. IMN internally manufactures substantially all of its softgel requirements at the Irvington facility. Our Freehold facility manufactures in full compliance with Good Manufacturing Practices, or GMP, standards recently proposed by the FDA for the dietary supplement industry. Our Irvington facility manufactures to GMP standards applicable to drug makers and is registered with both the United States Drug Enforcement Agency, or the DEA, and the FDA.

 

Professional Diagnostic Products.  Approximately 40% of the professional diagnostic products that we sell, based on net product sales for the fiscal year ended December 31, 2006 were manufactured by third parties. We manufacture the remainder, including substantially all of our BinaxNOW, BioStar OIA, Clearview, Signify, SureStep and Inverness Medical TestPack products, ourselves at our facilities in Hangzhou and Shanghai, China; Bedford, UK; Yavne, Israel; Scarborough, Maine and Louisville, Colorado. We also manufacture our Determine HIV products, acquired from Abbott Laboratories in June 2005, at Abbott’s facility in Matsudo, Japan in space rented from Abbott under a manufacturing and support services agreement entered into in connection with the acquisition.

 

Research and Development

 

A significant portion our budget for research and development currently is allocated to the development of cardiovascular disease management products. On February 25, 2005, we entered into a co-development agreement with ITI Scotland Limited, or ITI, whereby ITI agreed to provide us with approximately £30.0 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. We agreed to invest £37.5 million in these programs over three years and we established a new research center in Stirling, Scotland where we conduct most of the funded research and development activities and where we will ultimately commercialize products arising from these efforts. ITI and Stirling will have exclusive rights to developed technology in their respective fields of use.

 

The remainder of our research and development efforts is focused on expanding our range of product offerings and enhanced features for our lines of consumer and professional diagnostic products. Our other research and development activities are carried out in Bedford, England; Jena, Germany; Scarborough, Maine; and Yavne, Israel.

 

Foreign Operations

 

Our business relies heavily on our foreign operations. Five of our nine current manufacturing facilities are outside the United States, including our facility in Hangzhou, China, our primary consumer diagnostic products manufacturing facilities in Bedford, England and Shanghai, China, and our manufacturing operation in Matsudo, Japan. Since late 2005, we have also focused significant effort on expanding our worldwide distribution network supporting our professional diagnostics business by acquiring distribution operations in Spain, Australia, Germany, Japan, Italy and Canada. Approximately 41% of our net revenues were generated from outside of the United States during 2006. Our Clearblue products, pregnancy tests in particular, have historically been much stronger brands outside the United States, with 64% of our net product sales of Clearblue products coming from outside the United States during 2006. Our Inverness Medical TestPack and Determine product lines are sold exclusively outside the United States.

 

Competitive Conditions

 

Consumer Diagnostic Products.  Competition in the pregnancy detection and fertility/ovulation prediction market is intense. Our competitors in the United States, and worldwide, are numerous and include, among others, large medical and consumer products companies with substantially greater resources than we have. However, we believe that we can continue to compete effectively in the consumer diagnostics market based on our research and development capabilities, advanced manufacturing expertise, diversified product positioning, global market presence and established wholesale and retail distribution networks. Our competitors for the sale of pregnancy test products worldwide include Church & Dwight, Johnson & Johnson, Omega Pharma, Princeton BioMeditech, Arax and Rohto, among others, although we currently supply Johnson & Johnson and others with their pregnancy test products. Our competitors for the sale of fertility/ovulation prediction tests include Church & Dwight and Princeton BioMeditech, among others. For both pregnancy and fertility/ovulation tests worldwide, we also face growing competition from manufacturers located in Asia. Competition among branded consumer diagnostic products is based on brand recognition and price. Products sold under well-established or “premium” brand names can demand higher prices and maintain high market shares due to brand loyalty. Our Clearblue brand qualifies as a premium brand worldwide with respect to both pregnancy tests and fertility/ovulation prediction products. Our Clearblue pregnancy tests are market leaders outside of the United States, as is our Crystal Clear brand in Australia, and our Clearblue fertility/ovulation prediction products are market leaders both in the United States and globally. Our Fact plus and Accu-Clear branded consumer products compete based on price and do not attempt to compete based on brand recognition. For private label manufacturers, competition is based primarily on the delivery of products at lower prices that have substantially the same features and performance as brand name products. The Clearblue Fertility Monitor and Persona are unique products and their competitors or markets are not easily defined. Our recently acquired First Check tests compete against over-the-counter diagnostic tests sold primarily by Phamatech, Inc., but also by other smaller competitors.

 

Vitamins and Nutritional Supplements.  The market for private label vitamins and nutritional supplements is extremely price sensitive, with quality, customer service and marketing support also being important. Many of the companies that mass market branded vitamins and nutritionals, including U.S. Nutrition, Pharmavite and Leiner Health Products, also sell to private label customers and constitute our major competitors for private label business. In addition, there are several companies, such as Perrigo Company, that compete only in the private label business.

 

In the branded nutritional supplements industry, competition is based upon brand name recognition, price, quality, customer service and marketing support. There are many companies, both small and large, selling vitamin products to retailers. A number of these companies, particularly manufacturers of nationally advertised brand name products, are substantially larger than we are and have greater financial resources. Among the major competitors of our branded products that are sold through groceries and other mass retailers are U.S. Nutrition, Wyeth, Pharmavite and GlaxoSmithKline.

 

Professional Diagnostic Products.  In the rapid membrane market, our main competitors are Becton Dickinson, Quidel and Genzyme Diagnostics. Some competitors in this market, such as Becton Dickinson, are large companies with substantially greater resources than we have. Other competitors in some product

segments, particularly drugs of abuse, are smaller yet aggressive companies. These competitors include WHPM and Princeton BioMeditech. Some automated immunoassay systems can be considered competitors when labor shortages force laboratories to automate or when the costs of such systems are lower. Such systems are provided by Abbott, Bayer, Roche Diagnostics, Beckman Coulter and other large diagnostic companies. In the infectious disease area, new technologies utilizing amplification techniques for analyzing molecular DNA gene sequences from companies such as Abbott, Roche and Gen-Probe are making in-roads into this market. Competition in this market is intense and is primarily based on price, breadth of line and distribution capabilities.

 

Our competitors in the ELISA diagnostics market include large corporations, such as Abbott Laboratories and Diagnostic Products Corporation, which manufacture state-of-the-art automated immunoassay systems and a wide array of diagnostic products designed for processing on those systems. These entities benefit from economies of scale and have the resources to design and manufacture state-of-the-art automated equipment. Other competitors in this market, DiaSorin and Diamedics in particular, are more similar in size to us and compete with us based on quality and service. In the United States and Canada, we focus on matching the instrumentation and product testing requirements of our customers by offering a wide selection of diagnostic products and test equipment.

 

The markets for our serology and our IFA and microbiology products are mature, and competition is based primarily on price and customer service. Our main competitors in serology and microbiology testing include Remel and Biokit. Our main competitors in IFA testing are Bio-Rad Laboratories, INOVA Diagnostics, Immuno Concepts, The Binding Site and DiaSorin. However, products in these categories also compete to a large extent against rapid membrane and ELISA products, which are often easier to perform and read and can be more precise.

 

We believe that our dedication to research and development and our strong intellectual property portfolio, coupled with our advanced manufacturing expertise, diversified product positioning, global market presence and established distribution networks, provide us with a competitive advantage in the point-of-care markets in which we compete.

 

Patents and Proprietary Technology; Trademarks

 

We have built a strong intellectual property portfolio in the area of lateral flow immunoassays, the technology which underlies many rapid diagnostic test formats including most one step home pregnancy and fertility/ovulation tests and most of our rapid membrane products for the point-of-care marketplaces that we serve. Through acquisitions and strategic licensing, we have obtained rights to the major patent families in this area of technology. We believe that these intellectual property rights give us a distinct advantage over our competitors and underpin our continuing success in this area. In addition, our intellectual property portfolio also includes an increasing number of other patents, patent applications and licensed patents protecting our vision of the technologies and products of the future. Our intellectual property portfolio consists of patents that we own and, in some cases, licenses to patents or other proprietary rights of third parties which may be limited in terms of field of use, transferability or may require royalty payments.

 

The medical products industry, including the diagnostic testing industry, historically has been characterized by extensive litigation regarding patents, licenses and other intellectual property rights. We believe that our recent successes in enforcing our intellectual property rights in the United States and abroad demonstrate our resolve in enforcing our intellectual property rights, the strength of our intellectual property portfolio and the competitive advantage that we have in this area. We have incurred substantial costs, both in asserting infringement claims against others and in defending ourselves against patent infringement claims, and may to incur substantial litigation costs as we continue to aggressively protect our technology and defend our proprietary rights.

 

Finally, we believe that certain of our trademarks are valuable assets that are important to the marketing of both our consumer and professional products. Many of these trademarks have been registered with the United States Patent and Trademark Office or internationally, as appropriate.

 

The medical products industry, including the diagnostic testing industry, places considerable importance on obtaining and enforcing patent and trade secret protection for new technologies, products and processes. Trademark protection is an important factor in the success of certain of our consumer and professional diagnostic product lines. Our success therefore depends, in part, on our abilities to obtain and enforce the patents and trademark registrations necessary to protect our products, to preserve our trade secrets and to avoid or neutralize threats to our proprietary rights from third parties. We cannot, however, guarantee our success in enforcing or maintaining our patent rights; in obtaining future patents or licensed patents in a timely manner or at all; or as to the breadth or degree of protection that our patents or trademark registrations or other intellectual property rights might afford us. For more information regarding the risks associated with our reliance on intellectual property rights see the risk factors discussed in Item 1A entitled “Risk Factors” on pages 11 through 24 of this report.

 

Government Regulation

 

Our research, development and clinical programs, as well as our manufacturing and marketing operations, are subject to extensive regulation in the United States and other countries. Most notably all of our products sold in the United States are subject to the Federal Food, Drug and Cosmetic Act, or the FDCA, as implemented and enforced by the U.S. Food and Drug Administration, or the FDA. All of our diagnostic products sold in the United States require FDA clearance to market under Section 510(k) of the FDCA, which may require pre-clinical and clinical trials. Foreign countries may require similar or more onerous approvals to manufacture or market these products. The marketing of our consumer diagnostic products is also subject to regulation by the U.S. Federal Trade Commission, or the FTC. In addition, we are required to meet regulatory requirements in countries outside the United States, which can change rapidly with relatively short notice.

 

The manufacturing, processing, formulation, packaging, labeling and advertising of our nutritional supplements are subject to regulation by one or more federal agencies, including the FDA, the U.S. Drug Enforcement Administration, or DEA, the FTC and the Consumer Product Safety Commission. These activities are also regulated by various agencies of the states, localities and foreign countries in which our nutritional supplements are now sold or may be sold in the future. In particular, the FDA regulates the safety, manufacturing, labeling and distribution of dietary supplements, including vitamins, minerals and herbs, as well as food additives, over-the-counter and prescription drugs and cosmetics. The GMP standards promulgated by the FDA are different for nutritional supplement, drug and device products. In addition, the FTC has jurisdiction along with the FDA to regulate the promotion and advertising of dietary supplements, over-the-counter drugs, cosmetics and foods.

 

Employees

 

As of January 31, 2007, we had approximately 2,561 employees, of which 1,056 employees are located in the United States. In addition, we utilize the services of temporary and contract employees, including approximately 1,000 contract employees leased from agencies in connection with our Chinese operations, as well as a number of consultants specializing in areas such as research and development, risk management, regulatory compliance, strategic planning and marketing.

 

 

The risks described below may materially impact your investment in our company or may in the future, and, in some cases already do, materially affect us and our business, financial condition and results of operations. You should carefully consider these factors with respect to your investment in our securities. This section includes or refers to certain forward-looking statements; you should read the explanation of the qualifications and limitations on such forward-looking statements beginning on pages 2 and 30 of this report.

 

Our business has substantial indebtedness, which could, among other things, make it more difficult for us to satisfy our debt obligations, require us to use a large portion of our cash flow from operations to repay and service our debt or otherwise create liquidity problems, limit our flexibility to adjust to market conditions, place us at a competitive disadvantage and expose us to interest rate fluctuations.

 

We currently have, and we will likely continue to have, a substantial amount of indebtedness. As of December 31, 2006, we had approximately $203.0 million in aggregate principal indebtedness outstanding, of which $53.0 million is secured indebtedness, and $110.0 million of additional borrowing capacity under the revolving portions of our credit facilities. In addition, subject to restrictions in our credit facilities and the indenture governing our $150.0 million in outstanding 8.75% senior subordinated notes, or the senior subordinated notes, we may incur additional indebtedness. During the fiscal years ended December 31, 2006 and 2005, we recorded $26.6 million and $21.8 million, respectively, of interest expense related to our indebtedness, which included $4.2 million and $2.3 million, respectively, in non-cash interest primarily related to amortization of debt origination costs.

 

Our substantial indebtedness could affect our future operations in important ways. For example, it could:

 

 

We expect to obtain the money to pay our expenses and to pay the principal and interest on the senior subordinated notes, our senior credit facility and our other debt from cash flow from our operations and from additional loans under our senior credit facility, subject to continued covenant compliance, and potentially from other debt or equity offerings. Our ability to meet our expenses thus depends on our future performance, which will be affected by financial, business, economic and other factors. We will not be able to control many of these factors, such as economic conditions in the markets in which we operate and pressure from competitors. We cannot be certain that our cash flow will be sufficient to allow us to pay principal and interest on our debt and meet our other obligations. If our cash flow and capital resources prove inadequate, we could face substantial liquidity problems and might be required to dispose of material assets or operations, restructure or refinance our debt, including the notes, seek additional equity capital or borrow more money. We cannot guarantee that we will be able to do so on terms acceptable to us. In addition, the terms of existing or future debt agreements, including the credit agreement governing our senior credit facility and the indenture governing the senior subordinated notes, may restrict us from adopting any of these alternatives.

 

We have entered into agreements governing our indebtedness that subject us to various restrictions that may limit our ability to pursue business opportunities.

 

The agreements governing our indebtedness, including the credit agreement governing our senior credit facility and the indenture governing the senior subordinated notes, subject us to various restrictions on our ability to engage in certain activities, including, among other things, our ability to:

 

 

These restrictions may limit our ability to pursue business opportunities or strategies that we would otherwise consider to be in our best interests. In particular, all acquisitions of other businesses, other than very small acquisitions, will require us to obtain our lenders’ consent under our senior credit facility. We have been required to obtain, and have obtained, our lenders’ consent under our senior credit facility in order to complete many of our acquisitions, including the Wampole Division of MedPointe Inc., or Wampole; Ostex International, Inc., or Ostex; Applied Biotech, Inc., or ABI; the rapid diagnostics business that we acquired from Abbott Laboratories, or the Abbott rapid diagnostics business; Ischemia, Inc., or Ischemia; Binax, Inc., or Binax; the Determine/DainaScreen business that we acquired from Abbott Laboratories in 2005, or the Determine business; Thermo BioStar Inc, or BioStar; and the rapid diagnostics business that we acquired from ACON Laboratories, Inc., or the Innovacon business.

 

Our senior credit facilities contain certain financial covenants that we may not satisfy which, if not satisfied, could result in the acceleration of the amounts due under these facilities and the limitation of our ability to borrow additional funds in the future.

 

The agreements governing our senior credit facility subject us to various financial and other covenants with which we must comply on an ongoing or periodic basis. These include covenants pertaining to fixed charge coverage, capital expenditures, various leverage ratios, minimum EBITDA and minimum cash requirements. If we violate any of these covenants, we may suffer a material adverse effect. Most notably, our outstanding debt under our senior credit facility could become immediately due and payable, our lenders could proceed against any collateral securing such indebtedness, and our ability to borrow additional funds in the future may be limited.

 

A default under any of our agreements governing our indebtedness could result in a default and acceleration of indebtedness under other agreements.

 

The agreements governing our indebtedness, including our senior credit facility and the indenture governing the senior subordinated notes, contain cross-default provisions whereby a default under one agreement could result in a default and acceleration of our repayment obligations under other agreements. If a cross-default were to occur, we may not be able to pay our debts or borrow sufficient funds to refinance them. Even if new financing were available, it may not be on commercially reasonable terms or terms that are acceptable to us. If some or all of our indebtedness is in default for any reason, our business, financial condition and results of operations could be materially and adversely affected.

 

We may not be able to satisfy our debt obligations upon a change of control, which could limit our opportunity to enter into a change of control transaction.

 

Upon the occurrence of a “change of control,” as defined in the indenture governing the senior subordinated notes, each holder of our senior subordinated notes will have the right to require us to purchase the notes at a price equal to 101% of the principal amount, together with any accrued and unpaid interest. Our failure to purchase, or give notice of purchase of, the senior subordinated notes would be a default under the indenture, which would in turn be a default under our senior credit facility. In addition, a change of control may constitute an event of default under our senior credit facility. A default under our senior credit facility would result in an event of default under our 10% subordinated notes and, if the lenders accelerate the debt under our senior credit facility, the indenture governing the senior subordinated notes, and may result in the acceleration of any of our other indebtedness outstanding at the time. As a result, if we do not have enough cash to repay all of our indebtedness or to repurchase all of the senior subordinated notes, we may be limited in the change of control transactions that we may pursue.

 

Our acquisitions may not be profitable, and the integration of these businesses may be costly and difficult and may cause disruption to our business.

 

Since commencing activities in November 2001, we have acquired and attempted to integrate, or we are in the process of integrating, into our operations Unipath Limited and its associated companies and assets, or the Unipath business, IVC Industries, Inc. (now doing business as Inverness Medical Nutritionals Group, or IMN), Wampole, Ostex, ABI, the Abbott rapid diagnostics business, Ischemia, Binax, the Determine business, BioStar, the Innovacon business and other smaller acquisitions. We have also made a number of smaller acquisitions. The ultimate success of all of our acquisitions depends, in part, on our ability to realize the anticipated synergies, cost savings and growth opportunities from integrating these businesses or assets into our existing businesses. However, the successful integration of independent businesses or assets is a complex, costly and time-consuming process. The difficulties of integrating companies and acquired assets include among others:

 

 

We may not accomplish the integration of our acquisitions smoothly or successfully. The diversion of the attention of our management from our current operations to the integration effort and any difficulties encountered in combining operations could prevent us from realizing the full benefits anticipated to result from these acquisitions and adversely affect our other businesses. Additionally, the costs associated with the integration of our acquisitions can be substantial. To the extent that we incur integration costs that are not anticipated when we finance our acquisitions, these unexpected costs could adversely impact our liquidity or force us to borrow additional funds. Ultimately, the value of any business or asset that we have acquired may not be greater than or equal to its purchase price.

 

If we choose to acquire or invest in new and complementary businesses, products or technologies instead of developing them ourselves, such acquisitions or investments could disrupt our business and, depending on how we finance these acquisitions or investments, could result in the use of significant amounts of cash.

 

Our success depends in part on our ability to continually enhance and broaden our product offerings in response to changing technologies, customer demands and competitive pressures. Accordingly, from time to time we may seek to acquire or invest in businesses, products or technologies instead of developing them ourselves. Acquisitions and investments involve numerous risks, including:

 

 

In addition, any future acquisitions or investments may result in:

 

 

We may not complete our pending joint venture transaction with P&G.

 

In December 2006, we announced that we had signed a definitive agreement with P&G to form a joint venture for the development, acquisition, manufacturing, marketing and sale of existing and to-be-developed consumer diagnostic products outside of the fields of cardiology and diabetes. The transaction is expected to close in the first half of 2007, subject to the satisfaction of customary closing and other conditions, such as that there be no material adverse change in our consumer diagnostics business, that the transaction be permitted under the indenture governing our senior subordinated notes or that we repay all of our outstanding senior subordinated notes and that we receive favorable tax rulings from the Swiss tax authorities, the receipt of regulatory approvals, and obtaining certain third-party consents to the transaction. There can be no assurance that all of these conditions will be satisfied. If these conditions are not satisfied or waived, we may be unable to complete the joint venture. In addition, in connection with the regulatory approval process or the FTC’s ongoing investigation relating to our acquisition of the Innovacon business, the terms of the joint venture may require modification, in which event we may not realize all of the benefits of the joint venture that we expect or the joint venture may not be completed at all.

 

Even if we complete the P&G joint venture transaction, we may not realize all of its intended benefits.

 

If we complete the P&G joint venture transaction, we may experience:

 

 

 

For any of these reasons or as a result of other factors, we may not realize the anticipated benefits of the joint venture. P&G will retain an option to require us to purchase its interest in the joint venture at fair market value during the 60-day period beginning on the fourth anniversary of the closing.

 

Additionally, in connection with the completion of the joint venture, we will transfer or sell substantially all of the assets of our consumer diagnostics business, other than our manufacturing and core intellectual property assets, in exchange for $325.0 million in cash and a 50% interest in the joint venture. Our management will have broad discretion over the use and investment of this cash. Cash flow that we derive from the combination of any reinvestment of the $325.0 million we received in cash in connection with the transaction and our 50% interest in the joint venture may be less than the cash flow we derived from the disposed of assets.

 

If goodwill and/or other intangible assets that we have recorded in connection with our acquisitions of other businesses become impaired, we could have to take significant charges against earnings.

 

In connection with the accounting for certain of our acquisitions, including the Unipath business, Wampole, Ostex, ABI, the Abbott rapid diagnostics product lines, Ischemia, Binax, the Determine business, BioStar, and the Innovacon business, we have recorded a significant amount of goodwill and other intangible assets. Under current accounting guidelines, we must assess, at least annually and potentially more frequently, whether the value of goodwill and other intangible assets has been impaired. Any reduction or impairment of the value of goodwill or other intangible assets will result in a charge against earnings which could materially adversely affect our reported results of operations in future periods.

 

We may experience manufacturing problems or delays, which could result in decreased revenues or increased costs.

 

Many of our manufacturing processes are complex and require specialized and expensive equipment. Replacement parts for our specialized equipment can be expensive and, in some cases, can require lead times of up to a year to acquire. In addition, our private label consumer diagnostic products business, and our private label and bulk nutritional supplements business in particular, rely on operational efficiency to mass produce products at low margins per unit. We also rely on numerous third parties to supply production materials and in some cases there may not be alternative sources immediately available.

 

In addition, during 2006 we closed two manufacturing facilities and are shifting the production of products from these facilities to China. We have shifted the production of additional products to our manufacturing facilities in China. Moving the production of products is difficult and involves significant risk. Problems establishing relationships with local materials suppliers; acquiring or adapting the new facility and its equipment to the production of new products; hiring, training and retaining personnel and establishing and maintaining compliance with governmental regulations and industry standards can cause delays and inefficiencies which could have a material negative impact on our financial performance. We also currently rely on approximately ten significant third-party manufacturers, as well as numerous other less significant manufacturers, to produce many of our professional diagnostic products and certain components of our consumer diagnostic products. In addition, we manufacture the products acquired with the Determine business from a facility in Matsudo, Japan that is made available to us by Abbott Laboratories, from whom we also receive support services related to this facility. Any event which negatively impacts our manufacturing facilities, our manufacturing systems or equipment, or our contract manufacturers or suppliers, including,

without limitation, wars, terrorist activities, natural disasters and outbreaks of infectious disease, could delay or suspend shipments of products or the release of new products or could result in the delivery of inferior products. Our revenues from the affected products would decline or we could incur losses until such time as we were able to restore our production processes or put in place alternative contract manufacturers or suppliers. Even though we carry business interruption insurance policies, we may suffer losses as a result of business interruptions that exceed the coverage available under our insurance policies.

 

We may experience difficulties that may delay or prevent our development, introduction or marketing of new or enhanced products.

 

We intend to continue to invest in product and technology development. The development of new or enhanced products is a complex and uncertain process. We may experience research and development, manufacturing, marketing and other difficulties that could delay or prevent our development, introduction or marketing of new products or enhancements. We cannot be certain that:

 

 

The factors listed above, as well as manufacturing or distribution problems, or other factors beyond our control, could delay new product launches. In addition, we cannot assure you that the market will accept these products. Accordingly, there is no assurance that our overall revenues will increase if and when new products are launched.

 

Our failure to meet strict regulatory requirements could require us to pay fines, incur other costs or even close our facilities.

 

Our facilities and manufacturing techniques generally must conform to standards that are established by government agencies, including those of European and other foreign governments, as well as the FDA, and, to a lesser extent, the U.S. Drug Enforcement Administration and local health agencies. These regulatory agencies may conduct periodic audits of our facilities or our processes to monitor our compliance with applicable regulatory standards. If a regulatory agency finds that we fail to comply with the appropriate regulatory standards, it may impose fines on us, delay or withdraw pre-market clearances or other regulatory approvals or if such a regulatory agency determines that our non-compliance is severe, it may close our facilities. Any adverse action by an applicable regulatory agency could impair our ability to produce our products in a cost-effective and timely manner in order to meet our customers’ demands. We may also be required to bear other costs or take other actions that may have a negative impact on our future sales and profits.

 

Regulatory agencies may also impose new or enhanced standards that would increase our costs as well as the risks associated with non-compliance. For example, we anticipate that the FDA may soon finalize and implement “good manufacturing practice,” or GMP, regulations for nutritional supplements. GMP regulations would require supplements to be prepared, packaged and held in compliance with certain rules, and might require quality control provisions similar to those in the GMP regulations for drugs. While our manufacturing facilities for nutritional supplements have been subjected to, and passed, third party inspections against anticipated GMP standards, the ongoing compliance required in the event that GMP regulations are adopted would involve additional costs and would present new risks associated with any failure to comply with the regulations in the future.

 

If we deliver products with defects, our credibility may be harmed, market acceptance of our products may decrease and we may be exposed to liability in excess of our product liability insurance coverage.

 

The manufacturing and marketing of consumer and professional diagnostic products involve an inherent risk of product liability claims. In addition, our product development and production are extremely complex and could expose our products to defects. Any defects could harm our credibility and decrease market acceptance of our products. In addition, our marketing of vitamins and nutritional supplements may cause us to be subjected to various product liability claims, including, among others, claims that the vitamins and nutritional supplements have inadequate warnings concerning side effects and interactions with other substances. Potential product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. In the event that we are held liable for a claim for which we are not indemnified, or for damages exceeding the limits of our insurance coverage, that claim could materially damage our business and our financial condition.

 

Our sales of branded nutritional supplements have been trending downward since 1998 due to the maturity of the market segments they serve and the age of that product line and we may experience further declines in sales of those products.

 

Our aggregate sales of all of our brand name nutritional products, including, among others, Ferro-Sequels, Stresstabs, Protegra, Posture, SoyCare, ALLBEE, and Z-BEC, have declined each year since 1998 through the year 2006, except in 2002 when they increased slightly as compared to 2001. We believe that these products have under-performed because they are, for the most part, aging brands with limited brand recognition that face increasing private label competition. The overall age of this product line means that we are subject to future distribution loss for under-performing brands, while our opportunities for new distribution on the existing product lines are limited. As a result, we do not expect significant sales growth of our existing brand name nutritional products and we may experience further declines in overall sales of our brand name nutritional products in the future.

 

Our sales of specific vitamins and nutritional supplements could be negatively impacted by media attention or other news developments that challenge the safety and effectiveness of those specific vitamins and nutritional supplements.

 

Most growth in the vitamin and nutritional supplement industry is attributed to new products that tend to generate greater attention in the marketplace than do older products. Positive media attention resulting from new scientific studies or announcements can spur rapid growth in individual segments of the market, and also impact individual brands. Conversely, news that challenges individual segments or products can have a negative impact on the industry overall as well as on sales of the challenged segments or products. Most of our vitamin and nutritional supplements products serve well-established market segments and, absent unforeseen new developments or trends, are not expected to benefit from rapid growth. A few of our vitamin and nutritional products are newer products that are more likely to be the subject of new scientific studies or announcements, which could be either positive or negative. News or other developments that challenge the safety or effectiveness of these products could negatively impact the profitability of our vitamin and nutritional supplements business.

 

We could suffer monetary damages, incur substantial costs or be prevented from using technologies important to our products as a result of a number of pending legal proceedings.

 

We are involved in various legal proceedings arising out of our consumer diagnostics, nutritional supplements and professional diagnostics business. Because of the nature of our business, we may be subject at any particular time to commercial disputes, consumer product claims or various other lawsuits arising in the ordinary course of our business, including employment matters, and expect that this will continue to be the case in the future. Such 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. An adverse ruling or rulings in one or more such lawsuits could, individually or in the aggregate, have a material adverse effect on our sales, operations or financial performance. In addition, we aggressively defend our patent and

other intellectual property rights. This often involves bringing infringement or other commercial claims against third parties. These suits can be expensive and result in counterclaims challenging the validity of our patents and other rights. We cannot assure you that these lawsuits or any future lawsuits relating to our businesses will not have a material adverse effect on us.

 

The profitability of our consumer products businesses may suffer if we are unable to establish and maintain close working relationships with our customers.

 

For the years ended December 31, 2006 and 2005, approximately 46% and 58%, respectively, of our net product sales were derived from our consumer products business, which consists of our consumer diagnostic products and vitamin and nutritional supplements segments. These businesses rely to a great extent on close working relationships with our customers rather than long-term exclusive contractual arrangements. Customer concentration in these businesses is relatively high, especially in our vitamin and nutritional supplements segment where two customers accounted for approximately 63% of sales during 2006. In addition, customers of our branded and private label consumer products businesses purchase products through purchase orders only and are not obligated to make future purchases. We therefore rely on our ability to deliver quality products on time in order to retain and generate customers. If we fail to meet our customers’ needs or expectations, whether due to manufacturing issues that affect quality or capacity issues that result in late shipments, we will harm our reputation and customer relationships and likely lose customers. Additionally, if we are unable to maintain close working relationships with our customers, sales of all of our products and our ability to successfully launch new products could suffer. The loss of a major customer and the failure to generate new accounts could significantly reduce our revenues or prevent us from achieving projected growth.

 

The profitability of our consumer products businesses may suffer if Johnson & Johnson, who recently acquired the consumer healthcare business of Pfizer, Inc., is unable to successfully market and sell its e.p.t pregnancy tests.

 

Under the terms of a manufacturing, packaging and supply agreement, with Johnson & Johnson, or JNJ, JNJ purchases its non-digital e.p.t pregnancy tests from us through June 6, 2009. Additionally, pursuant to the terms of a five-year supply agreement entered into in December 2003, as amended on June 1, 2005, we currently supply JNJ with a digital version of its e.p.t brand pregnancy tests on an exclusive basis. The amount of revenues or profits that we generate under these agreements will depend on the volume of orders that we receive from JNJ. As a result, if JNJ is unable to successfully market and sell its e.p.t pregnancy tests, or if other events adversely affect the volume of JNJ sales of its e.p.t pregnancy tests, then our future revenues and profit may be adversely affected.

 

Because sales of our private label nutritional supplements are generally made at low margins, the profitability of these products may suffer significantly as a result of relatively small increases in raw material or other manufacturing costs.

 

Sales of our private label nutritional supplements, which for the years ended December 31, 2006 and 2005, provided approximately 13% and 16%, respectively, of our net product sales, generate low profit margins. We rely on our ability to efficiently mass produce nutritional supplements in order to make meaningful profits from these products. Changes in raw material or other manufacturing costs can drastically cut into or eliminate the profits generated from the sale of a particular product. For the most part, we do not have long-term supply contracts for our required raw materials and, as a result, our costs can increase with little notice. The private label nutritional supplements business is also highly competitive such that our ability to raise prices as a result of increased costs is limited. Customers generally purchase private label products via purchase order, not through long-term contracts, and they often purchase these products from the lowest bidder on a product by product basis. The internet has enhanced price competition among private label manufacturers through the advent of on-line auctions, where customers will auction off the right to manufacture a particular product to the lowest bidder. The resulting margin erosion in our nutritionals business has resulted in a reduction in our overall gross margin over the last several years and contributed to our losses in 2006.

 

Our financial condition or results of operations may be adversely affected by international business risks.

 

Approximately 41% and 42% of our net revenue was generated from outside the United States for the year ended December 31, 2006 and 2005, respectively. A significant number of our employees, including manufacturing, sales, support and research and development personnel, are located in foreign countries, including England, Scotland, Japan, China, and Israel. Conducting business outside of the United States subjects us to numerous risks, including:

 

 

Because our business relies heavily on foreign operations and revenues, changes in foreign currency exchange rates and our ability to convert currencies may negatively affect our financial condition and results of operations.

 

Our business relies heavily on our foreign operations. Five of our manufacturing operations are conducted outside the United States, in Bedford, England; Hangzhou and Shanghai, China; Matsudo, Japan and Yavne, Israel. We have consolidated much of our cardiovascular related research and development in Scotland and we intend to establish a significant manufacturing operation there. Approximately 41% and 42% of our net revenue was generated from outside the United States for the years ended December 31, 2006 and 2005, respectively. Our Clearblue pregnancy test product sales have historically been much stronger outside the United States, with 64% of net product sales of these products coming from outside the United States during the year ended December 31, 2006. In addition, the Abbott rapid diagnostics business generates a majority of its sales outside the United States, and all of the revenues of the Determine business are derived outside of the United States. Because of our foreign operations and foreign sales, we face exposure to movements in foreign currency exchange rates. Our primary exposures are related to the operations of our European subsidiaries and our manufacturing facilities in China and Japan. These exposures may change over time as business practices evolve and could result in increased costs or reduced revenue and could impact our actual cash flow.

 

Intense competition could reduce our market share or limit our ability to increase market share, which could impair the sales of our products and harm our financial performance.

 

The medical products industry is rapidly evolving and developments are expected to continue at a rapid pace. Competition in this industry, which includes both our consumer diagnostics and professional diagnostics businesses, is intense and expected to increase as new products and technologies become available and new competitors enter the market. Our competitors in the United States and abroad are numerous and include, among others, diagnostic testing and medical products companies, universities and other research institutions.

Our future success depends upon maintaining a competitive position in the development of products and technologies in our areas of focus. Our competitors may:

 

 

Also, the possibility of patent disputes with competitors holding foreign patent rights may limit or delay expansion possibilities for our diagnostics businesses in certain foreign jurisdictions. In addition, many of our existing or potential competitors have or may have substantially greater research and development capabilities, clinical, manufacturing, regulatory and marketing experience and financial and managerial resources.

 

The market for the sale of vitamins and nutritional supplements is also highly competitive. This competition is based principally upon price, quality of products, customer service and marketing support. There are numerous companies in the vitamins and nutritional supplements industry selling products to retailers such as mass merchandisers, drug store chains, independent drug stores, supermarkets, groceries and health food stores. As most of these companies are privately held, we are unable to obtain the information necessary to assess precisely the size and success of these competitors. However, we believe that a number of our competitors, particularly manufacturers of nationally advertised brand name products, are substantially larger than we are and have greater financial resources.

 

The rights we rely upon to protect the intellectual property underlying our products may not be adequate, which could enable third parties to use our technology and would reduce our ability to compete in the market.

 

Our success will depend in part on our ability to develop or acquire commercially valuable patent rights and to protect our intellectual property. Our patent position is generally uncertain and involves complex legal and factual questions. The degree of present and future protection for our proprietary rights is uncertain.

 

The risks and uncertainties that we face with respect to our patents and other proprietary rights include the following:

 

 

In addition to patents, we rely on a combination of trade secrets, nondisclosure agreements and other contractual provisions and technical measures to protect our intellectual property rights. Nevertheless, these measures may not be adequate to safeguard the technology underlying our products. If they do not protect our rights, third parties could use our technology and our ability to compete in the market would be reduced. In addition, employees, consultants and others who participate in the development of our products may breach their agreements with us regarding our intellectual property and we may not have adequate remedies for the breach. We also may not be able to effectively protect our intellectual property rights in some foreign countries. For a variety of reasons, we may decide not to file for patent, copyright or trademark protection or

prosecute potential infringements of our patents. We also realize that our trade secrets may become known through other means not currently foreseen by us. Despite our efforts to protect our intellectual property, our competitors or customers may independently develop similar or alternative technologies or products that are equal or superior to our technology and products without infringing on any of our intellectual property rights or design around our proprietary technologies.

 

Claims by other companies that our products infringe on their proprietary rights could adversely affect our ability to sell our products and increase our costs.

 

Substantial litigation over intellectual property rights exists in both the consumer and professional diagnostic industries. We expect that our products and products in these industries could be increasingly subject to third party infringement claims as the number of competitors grows and the functionality of products and technology in different industry segments overlaps. Third parties may currently have, or may eventually be issued, patents on which our products or technology may infringe. Any of these third parties might make a claim of infringement against us. Any litigation could result in the expenditure of significant financial resources and the diversion of management’s time and resources. In addition, litigation in which we are accused of infringement may cause negative publicity, have an impact on prospective customers, cause product shipment delays or require us to develop non-infringing technology, make substantial payments to third parties, or enter into royalty or license agreements, which may not be available on acceptable terms, or at all. If a successful claim of infringement was made against us and we could not develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our revenue may decrease and we could be exposed to legal actions by our customers.

 

We have initiated, and may need to further initiate, lawsuits to protect or enforce our patents and other intellectual property rights, which could be expensive and, if we lose, could cause us to lose some of our intellectual property rights, which would reduce our ability to compete in the market.

 

We rely on patents to protect a portion of our intellectual property and our competitive position. In order to protect or enforce our patent rights, we may initiate patent litigation against third parties, such as infringement suits or interference proceedings. Litigation may be necessary to:

 

 

Currently, we have initiated a number of lawsuits against competitors who we believe to be selling products that infringe our proprietary rights. These current lawsuits and any other lawsuits that we initiate could be expensive, take significant time and divert management’s attention from other business concerns. Litigation also puts our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally, we may provoke third parties to assert claims against us.

 

Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and, consequently, patent positions in our industry are generally uncertain. We may not prevail in any of these suits and the damages or other remedies awarded, if any, may not be commercially valuable. During the course of these suits, there may be public announcements of the results of hearings, motions and other interim proceedings or developments in the litigation. If securities analysts or investors perceive any of these results to be negative, our stock price could decline.

 

In December 2005, we learned that the Securities and Exchange Commission, or the SEC, had issued a formal order of investigation in connection with the previously disclosed revenue recognition matter at one of our diagnostic divisions. We cannot predict what the outcome of this investigation will be.

 

In December 2005, we learned that the SEC had issued a formal order of investigation in connection with the previously disclosed revenue recognition matter at one of our diagnostic divisions, and we subsequently received a subpoena for documents. We believe that we fully responded to the subpoena and we have continued to fully cooperate with the SEC’s investigation. We cannot predict whether the SEC will seek additional information or what the outcome of its investigation will be.

 

In March 2006, the Federal Trade Commission, or the FTC, opened a preliminary, non-public investigation into our acquisition of the Innovacon business to determine whether this acquisition may be anticompetitive. We cannot predict what the outcome of this investigation will be.

 

In March, 2006, the FTC opened a preliminary, non-public investigation into our then pending acquisition of the Innovacon business we acquired from ACON Laboratories to determine whether this acquisition may be anticompetitive, and we subsequently received a Civil Investigative Demand and a subpoena requesting documents. We believe that we have fully responded to the Civil Investigative Demand and we are continuing to produce documents in connection with the subpoena and to otherwise cooperate with the FTC’s investigation. We cannot predict whether the FTC will seek additional information or what the outcome of this investigation will be. The FTC generally has the power to commence administrative or federal court proceedings seeking injunctive relief or divestiture of assets. In the event that an order were to be issued requiring divestiture of significant assets or imposing other injunctive relief, our business, financial condition and results of operations could be materially adversely affected.

 

Non-competition obligations and other restrictions will limit our ability to take full advantage of our management team, the technology we own or license and our research and development capabilities.

 

Members of our management team have had significant experience in the diabetes field. In addition, technology we own or license may have potential applications to this field and our research and development capabilities could be applied to this field. However, in conjunction with our split-off from Inverness Medical Technology, Inc., or IMT, we agreed not to compete with IMT and Johnson & Johnson in the field of diabetes through 2011. In addition, our license agreement with IMT prevents us from using any of the licensed technology in the field of diabetes. As a result of these restrictions, we cannot pursue opportunities in the field of diabetes.

 

Our operating results may fluctuate due to various factors and as a result period-to-period comparisons of our results of operations will not necessarily be meaningful.

 

Factors relating to our business make our future operating results uncertain and may cause them to fluctuate from period to period. Such factors include:

 

 

Because our operating results may fluctuate from quarter to quarter, it may be difficult for us or our investors to predict our future performance by viewing our historical operating results.

 

Period-to-period comparisons of our operating results may not be meaningful due to our acquisitions.

 

We have engaged in a number of acquisitions in recent years which makes it difficult to analyze our results and to compare them from period to period, including our significant acquisitions of IVC Industries, Inc. in March 2002, Wampole in September 2002, Ostex in June 2003, ABI in August 2003, the Abbott rapid diagnostics product lines in September 2003, Binax and Ischemia in March 2005, the Determine business in June 2005, BioStar in September 2005, and the Innovacon business in March 2006. Period-to-period comparisons of our results of operations may not be meaningful due to these acquisitions and are not indications of our future performance. Any future acquisitions will also make our results difficult to compare from period to period in the future.

 

Our stock price may fluctuate significantly and stockholders who buy or sell our common stock may lose all or part of the value of their investment, depending on the price of our common stock from time to time.

 

Our common stock has only been listed on the American Stock Exchange since November 23, 2001 and we have a limited market capitalization. As a result, we are currently followed by only a few market analysts and a portion of the investment community. Limited trading of our common stock may therefore make it more difficult for you to sell your shares.

 

In addition, our share price may be volatile due to our operating results, as well as factors beyond our control. It is possible that in some future periods the results of our operations will be below the expectations of the public market. In any such event, the market price of our common stock could decline. Furthermore, the stock market may experience significant price and volume fluctuations, which may affect the market price of our common stock for reasons unrelated to our operating performance. The market price of our common stock may be highly volatile and may be affected by factors such as:

 

 

Anti-takeover provisions in our organizational documents and Delaware law may limit the ability of our stockholders to control our policies and effect a change of control of our company and prevent attempts by our stockholders to replace or remove our current management, which may not be in your best interests.

 

There are provisions in our certificate of incorporation and bylaws that may discourage a third party from making a proposal to acquire us, even if some of our stockholders might consider the proposal to be in their best interests, and prevent attempts by our stockholders to replace or remove our current management. These provisions include the following:

 

 

Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which, in general, imposes restrictions upon acquirers of 15% or more of our stock. Finally, the board of directors may in the future adopt other protective measures, such as a stockholder rights plan, which could delay, deter or prevent a change of control.

 

Because we do not intend to pay dividends on our common stock, you will benefit from an investment in our common stock only if it appreciates in value.

 

We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends on our common stock in the foreseeable future. In addition, our senior credit facility currently prohibits the payment of dividends and the indenture governing the terms of our senior subordinated notes restricts the amount of any dividends that we may pay. As a result, the success of your investment in our common stock will depend entirely upon any future appreciation. There is no guarantee that our common stock will appreciate in value or even maintain the price at which you purchased your shares.

 

 

None.

 

 

Our principal corporate administrative office, together with the administrative office for most of our United States operations, is housed in approximately 22,600 square feet of leased space located at 51 Sawyer Road, Waltham, Massachusetts. Our lease of this facility expires on May 31, 2008.

 

Our European consumer and professional diagnostics operations are currently administered from a 150,000 square foot facility located in Bedford, England. We also manufacture products for these operations

and conduct research and development activity at the Bedford facility. Our lease for this facility expires on September 27, 2021.

 

We also have manufacturing operations in Hangzhou and Shanghai, China; Scarborough, Maine; Louisville, Colorado; Yavne, Israel; Matsudo, Japan; Freehold and Irvington, New Jersey. We currently manufacture a portion of our professional diagnostic products, and some consumer diagnostic products, out of a newly constructed manufacturing facility of approximately 300,000 square feet in Hangzhou, China, which we own. We acquired this facility from ACON Laboratories, Inc. in May 2006. We currently manufacture a portion of our consumer diagnostic products out of approximately 25,000 square feet of space in Shanghai, China made available by our joint venture partner with the remainder manufactured at our Bedford, England facility. We manufacture certain of our professional diagnostic products out of a 64,000 square foot facility that we lease in Scarborough, Maine and out of a 75,000 square foot facility that we lease in Louisville, Colorado, portions of which we sublease to third parties. We house the development, manufacturing, administrative and marketing operations related to our Orgenics professional diagnostic products in a leased facility of approximately 10,000 square feet in Yavne, Israel. The products that we acquired from Abbott in June 2005 are manufactured by us in Matsudo, Japan in 19,000 square feet of space rented from Abbott under a manufacturing and support services agreement entered into in connection with the acquisition. We also own a 160,000 square foot manufacturing facility in Freehold, New Jersey and lease a 35,000 square foot facility in Irvington, New Jersey. These New Jersey facilities manufacture our vitamin and nutritional supplement products. Consistent with our previously announced timeline, we have recently ceased manufacturing operations at our manufacturing facility in San Diego, California.

 

We also have leases or other arrangements for administrative or sales offices, lab space and warehouses in various locations worldwide.

 

 

We currently are not a party to any material pending legal proceedings.

 

Because of the nature of our business, we may be subject at any particular time to consumer product claims or various other lawsuits arising in the ordinary course of our business, including employment matters, and expect that this will continue to be the case in the future. Such lawsuits generally seek damages, sometimes in substantial amounts, for personal injuries or other commercial or employment claims. In addition, we aggressively defend our patent and other intellectual property rights. This often involves bringing infringement or other commercial claims against third parties. These suits can be expensive and result in counterclaims challenging the validity of our patents and other rights.

 

In December 2005, we learned that the SEC had issued a formal order of investigation in connection with the previously disclosed revenue recognition matter at one of our diagnostic divisions, and we subsequently received a subpoena for documents. We believe that we fully responded to the subpoena and we will continue to fully cooperate with the SEC’s investigation. We cannot predict whether the SEC will seek additional information or what the outcome of its investigation will be.

 

In March, 2006, the FTC opened a preliminary, non-public investigation into our then pending acquisition of the business we acquired from ACON Laboratories to determine whether this acquisition may be anticompetitive, and we subsequently received a Civil Investigative Demand and a subpoena requesting documents. We believe that we have fully responded to the Civil Investigative Demand and we are continuing to produce documents in connection with the subpoena and to otherwise cooperate with the FTC’s investigation. We cannot predict whether the FTC will seek additional information or what the outcome of this investigation will be. The FTC generally has the power to commence administrative or federal court proceedings seeking injunctive relief or divestiture of assets. In the event that an order were to be issued requiring divestiture of significant assets or imposing other injunctive relief, our business, financial condition and results of operations could be materially adversely affected.

 

 

At a special meeting of stockholders held on December 15, 2006, the stockholders approved the matters set forth below. The stockholders approved and adopted (i) a proposal to increase the total number of shares of common stock that we are authorized to issue by 50,000,000 shares from 50,000,000 shares to 100,000,000 shares, and (ii) a proposal to increase the maximum number of shares of common stock available for issuance under the Inverness Medical Innovations, Inc. 2001 Stock Option and Incentive Plan from 6,074,081 to 8,074,081 shares.

 

The following table summarizes the votes for, against or withheld, with regard to each matter voted upon:

 

 

PART II

 

 

Market Information

 

Our common stock trades on the American Stock Exchange (AMEX) under the symbol “IMA.” The following table sets forth the high and low sales prices of our common stock on AMEX for each quarter during fiscal 2006 and 2005.

 

 

On February 26, 2007, there were 921 holders of record of our common stock.

 

Dividend Policy

 

We have never declared or paid any cash dividends on our common stock. We currently intend to retain earnings to support our growth strategy and do not anticipate paying cash dividends on our common stock in the foreseeable future. Payment of future dividends, if any, on our common stock will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion. In addition, restrictive covenants under our senior credit facility and the indenture governing the terms of the senior subordinated notes currently prohibit the payment of cash or stock dividends.

Stock Performance Graph

 

The following line graph compares the change in the cumulative total stockholder return on our common stock from December 31, 2001 through December 31, 2006. This graph assumes an investment of $100 on December 31, 2001 in our common stock, and compares its performance with the AMEX US Total Return Index and the AMEX Health Products & Services Total Return Index (the “Current Indices”). We currently pay no dividends. The Current Indices reflect a cumulative total return based upon the reinvestment of dividends of the stocks included in those indices. Measurement points are December 31, 2001 and the last trading day of each subsequent fiscal quarter through December 31, 2006.

 

The comparisons shown in the graph below are based upon historical data. We caution that the stock price performance shown in the graph below is not necessarily indicative of, nor is it intended to forecast, the potential future performance of our common stock.

 

 

Current Indices

 

 

The performance graph above shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (The “Exchange Act”), or otherwise subject to the liability of that section. This graph will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

 

 

The following tables set forth selected consolidated financial data of our company as of and for each of the years in the five-year period ended December 31, 2006 and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.

 

The selected consolidated financial data as of December 31, 2006 and 2005 and for each of the three years in the period ended December 31, 2006 have been derived from our consolidated financial statements which are included elsewhere in this Annual Report on Form 10-K and were audited by BDO Seidman, LLP, independent registered public accounting firm. The selected consolidated financial data as of December 31, 2004, 2003 and 2002 have been derived from our consolidated financial statements not included herein, which were audited by BDO Seidman, LLP.

 

For a discussion of certain factors that materially affect the comparability of the selected consolidated financial data or cause the data reflected herein not to be indicative of our future results of operations or financial condition, see Item 1A “Risk Factors” and Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

 

 

 

 

 

Forward-Looking Statements

 

This Annual Report on Form 10-K, including this Item 7, 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. You can identify these statements by forward-looking words such as “may,” “could,” “should,” “would,” “intend,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “continue” or similar words. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial condition or state other “forward-looking” information. Forward-looking statements in this Item 7 include, without limitation, statements regarding our expectations with respect to our pending joint venture with The Procter & Gamble Company, or P&G, the impact of our expanded distribution network, the impact of the consolidation of our manufacturing facilities on margins, the impact of improved margins on operating cash flow, new product introductions, research and development expenditures, anticipated growth in our professional diagnostics business, and our funding plans for our future working capital needs and commitments. Actual results or developments could differ materially from those projected in such statements as a result of numerous factors, including, without limitation, those risks and uncertainties set forth in Item 1A entitled “Risk Factors,” which begins on page 11 of this report, as well as those factors identified from time to time in our periodic filings with the Securities and Exchange Commission. We do not undertake any obligation to update any forward-looking statements. This report and, in particular, the following discussion and analysis of our financial condition and results of operations, should be read in light of those risks and uncertainties and in conjunction with our accompanying consolidated financial statements and notes thereto.

 

Overview

 

As a leading global manufacturer and supplier of rapid diagnostic products for consumer and professional markets, we are continually exploring new opportunities for our proprietary electrochemical and other technologies in a variety of professional diagnostic and consumer-oriented applications, including immuno-diagnostics with a focus on women’s health, cardiology and infectious disease. As part of this strategy, we are focused on opportunities, including acquisitions and strategic partnerships, aimed at expanding both our product offerings and our distribution capability in the rapid diagnostic marketplace. Our 2006 acquisition of 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, Australia, Japan and most of western Europe, or the Innovacon business, not only expanded our product offerings but had an immediate positive impact on our operating results. We have also continued to expand the worldwide distribution network supporting our professional diagnostics segment which will ultimately enable us to get our future cardiology diagnostic products to the professional users critical to market acceptance. Since the beginning of the fourth quarter of 2005, we have acquired distributors in Spain, Australia, Canada, Germany, Italy and Japan.

 

We are also focused on improving our margins through consolidation of certain of our manufacturing operations at lower cost facilities. Our acquisition of the Innovacon business also represents a key component of this strategy. To date we have benefited from the higher margins that this business enjoys. These margins result from the lower costs associated with manufacturing at the new 300,000 square foot manufacturing facility located in Hangzhou, China, or the ABON facility, which we acquired in May 2006 as part of the transaction with ACON Laboratories. In 2007, we expect to begin to see improved margins on some of our existing products as we move production of certain products from higher costs facilities to the ABON facility.

 

Our agreement with P&G to form a 50/50 joint venture for the development, manufacturing, marketing and sale of existing and to-be-developed consumer diagnostic products outside of the fields of cardiology and diabetes presents us an exciting and unique opportunity. By leveraging P&G’s marketing and distribution capabilities, we expect this partnership to simultaneously expand the reach of our over-the-counter diagnostic

products, while enabling enhanced focus on our rapidly growing professional diagnostics segment and, in particular, on our cardiology development programs.

 

We also continue to emphasize new product development. This requires substantial investment and involves significant inherent risk. We intend to continue to devote substantial resources to research and development activities. We will also continue to aggressively defend our substantial intellectual property portfolio, which underlies our emphasis on new product development, against potential infringers.

 

2006 Financial Highlights

 

Net revenue in 2006 of $569.5 million increased by $147.6 million, or 35%, from $421.9 million in 2005 primarily as a result of our acquisition of the Innovacon business and businesses acquired during 2005, most notably Binax and the Determine business acquired from Abbott Laboratories, higher license and royalty revenue and, to a lesser extent, organic growth.

 

Gross profit increased by $76.9 million, or 50%, to $229.2 million in 2006 from $152.3 million in 2005 principally as a result of increased license and royalty revenue and from gross profit earned on incremental revenue from acquired businesses, primarily in our professional diagnostic business. Gross profit from our nutritional supplements business also increased in 2006, principally as a result of improved factory utilization as a result of increasing revenue and cost reduction initiatives in our private label manufacturing business. Offsetting these increases were a variety of charges totaling $9.8 million associated with the closures of our ABI operation in San Diego, California and our manufacturing facility in Galway, Ireland and non-cash stock-based compensation expense. Gross profit in 2005 was adversely impacted by $8.1 million associated with the closing of our Galway, Ireland manufacturing facility and with charges associated with excess inventories and a product recall.

 

We continue to invest aggressively in research and development of new products and technologies as evidenced by our increased research and development expense of $53.7 million in 2006 from $31.0 million in 2005. Expenditures in 2006 and 2005 are reported net of $16.6 million and $17.2 million, respectively, arising from the co-development funding arrangement that we entered into with ITI Scotland in February 2005. Research and development expense before considering the co-development funding was $70.3 million in 2006 and $48.2 million in 2005, an increase of $22.1 million. The increase in spending resulted in part from expenditures of $8.9 million associated with our acquisitions of Clondiag and the Innovacon business, including a $5.0 million charge related to the write-off of in-process research and development projects that had not achieved technical feasibility as of the date of our acquisition of Clondiag. The remaining research and development spending primarily related to our continued significant investment in the development of products in the field of cardiology. Our co-development funding arrangement with ITI Scotland expires in March 2008 and we expect to receive approximately £10 million (or $19.6 million at December 31, 2006) of aggregate additional funding through the end of the arrangement.

 

Results of Operations

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

Net Product Sales.  Net product sales increased by $145.7 million, or 36%, to $552.1 million in 2006 from $406.5 million in 2005. Excluding the unfavorable impact of currency translation, net product sales in 2006 grew by approximately $143.5 million, or 35%, over 2005. Of the currency adjusted increase, revenue increased as a result of our acquisitions of: (i) Binax in March 2005, which contributed revenue of $9.6 million, (ii) the Determine business in June 2005, which contributed revenue of $15.9 million, (iii) BioStar in September 2005, which contributed revenue of $21.0 million, (iv) IDT in September 2005, which contributed $10.4 million, (v) the Innovacon business in March 2006, which contributed $54.9 million, and (vi) various less significant acquisitions, which contributed an aggregate of $1.9 million of such increase.

 

Net Product Sales by Business Segment.  Net product sales by business segment for 2006 and 2005 are as follows:

 

 

Consumer Diagnostic Products

 

The currency adjusted increase in net product sales from our consumer diagnostic products was $8.3 million, or 5.1%, comparing 2006 to 2005. Of the currency adjusted increase, $7.4 million resulted from our acquisition of the Innovacon business in March 2006.

 

Vitamins and Nutritional Supplements

 

Our vitamins and nutritional supplements net product sales increased by $6.6 million, or 9%, comparing 2006 to 2005. The increase was driven primarily by our private label business.

 

Professional Diagnostic Products

 

The currency adjusted increase in net product sales from our professional diagnostic products was $128.6 million, or 75.9%, comparing 2006 to 2005. Of the currency adjusted increase, revenue increased as a result of our acquisitions of: (i) Binax in March 2005, which contributed revenue of $9.6 million, (ii) the Determine business in June 2005, which contributed revenue of $15.9 million, (iii) BioStar in September 2005, which contributed revenue of $21.0 million, (iv) IDT in September 2005, which contributed revenue of $10.4 million, (v) the Innovacon business in March 2006, which contributed $47.5 million and (vi) various less significant acquisitions, which contributed an aggregate of $1.9 million of such increase. Organic growth, particularly from our highly differentiated respiratory products, also contributed to the growth.

 

Net Product Sales by Geographic Location.  Net product sales by geographic location for 2006 and 2005 are as follows:

 

 

Net product sales of $323.0 million and $234.2 million generated in the United States were approximately 59% and 58% of total net product sales for the year ended December 31, 2006 and 2005, respectively. The growth in net product sales in all geographic regions resulted from the various acquisitions discussed above, and organic growth.

 

License and Royalty Revenue.  License and royalty revenue represents license and royalty fees from intellectual property license agreements with third parties. License and royalty revenue increased by $1.9 million, or 13%, to $17.3 million in 2006 from $15.4 million in 2005. The increase primarily relates to royalty revenue received as a result of the settlement and licensing arrangements that we entered into with Quidel Corporation in April 2005 and Vedalab in November 2006.

 

Gross Profit and Margin.  Gross profit increased by $76.9 million, or 50%, to $229.2 million in 2006 from $152.3 million in 2005. Gross profit during 2006 benefited from higher than average margins earned on

revenue from our recently acquired businesses and from favorable product mix. Included in cost of sales during 2006 was a restructuring charge of $9.5 million related to the closure of our ABI operation in San Diego, California, along with the write-off of fixed assets at other facilities impacted by our 2006 restructuring plans and the closure of CDIL, our manufacturing facility in Galway, Ireland. Cost of sales during 2006 also included a $0.4 million charge for stock-based compensation related to our January 1, 2006 adoption of SFAS No. 123-R, Share-Based Payment. Cost of sales during 2005 included: (i) the inclusion in cost of sales of a $4.1 million charge principally associated with our decision to close our Galway, Ireland manufacturing facility, (ii) a charge of $2.4 million associated with a reserve established during the second quarter of 2005 at our Wampole subsidiary for excess quantities of certain raw materials and finished goods, including certain finished goods held at distributors but subject to rights of return, and (iii) a $1.6 million provision for returns and inventory reserve which was established as a result of our recall of the drugs of abuse diagnostic products during the first quarter of 2005, offset in part by the gross profit earned on increased professional diagnostics products revenue, as discussed above.

 

Cost of sales included amortization expense of $11.2 million and $7.2 million in 2006 and 2005, respectively.

 

Overall gross margin was 40% in 2006 compared to 36% in 2005. Overall gross margin in 2006 was adversely affected by the $9.5 million restructuring charge and $0.4 million stock-based compensation charge discussed above. Overall gross margin in 2005 was adversely affected by the $4.1 million charge associated with the CDIL closing, the $2.4 million Wampole inventory reserve, and the $1.6 million returns and inventory reserve associated with the drugs of abuse product recalls discussed above.

 

Gross Profit from Net Product Sales by Business Segment.  Gross profit from net product sales represents total gross profit less gross profit associated with license and royalty revenue. Gross profit from net product sales increased by $75.8 million to $217.3 million in 2006 from $141.5 million in 2005. Gross profit from net product sales by business segment for 2006 and 2005 is as follows:

 

 

Consumer Diagnostic Products

 

Gross profit from our consumer diagnostic product sales increased $6.1 million, or 8%, comparing 2006 to 2005. Cost of sales for 2006 included restructuring charges totaling $2.2 million related to the closure of our CDIL manufacturing facility and a $0.4 million charge for stock-based compensation. Included in cost of sales for 2005, and adversely effecting gross profit, was a $4.1 million charge principally associated with our decision to close our CDIL manufacturing facility.

 

As a percentage of our consumer diagnostic net product sales, gross profit was 48% for 2006 compared to 47% in 2005. The increase in gross profit from our consumer diagnostic product sales resulted from a change in product mix.

 

Vitamins and Nutritional Supplements

 

Gross profit in our vitamins and nutritional supplements business increased $2.3 million, or 84%, comparing 2006 to 2005. The increase is primarily the result of improved factory utilization and our cost reduction initiatives in our private label manufacturing business.

 

As a percentage of vitamin and nutritional supplements net product sales, gross profit for our vitamins and nutritional supplements business was 6% in 2006 compared to 4% in 2005.

 

Professional Diagnostic Products

 

Gross profit from our professional diagnostic products increased by $67.4 million, or 108%, comparing 2006 to 2005, principally as a result of gross profit earned on revenue from acquired businesses, as discussed above, offset by a $7.2 million restructuring charge to cost of sales associated with management’s decision to close our ABI operations in San Diego, California. Reducing gross profit for 2005 were a charge of $2.4 million associated with a reserve established during the second quarter of 2005 at our Wampole subsidiary for excess quantities of certain raw materials and finished goods, including certain finished goods held at distributors but subject to rights of return, and a $1.6 million provision for returns and inventory reserve which were established as a result of our recall of the drugs of abuse diagnostic products during the first quarter of 2005.

 

As a percentage of our professional diagnostic net product sales, gross profit from our professional diagnostic product sales was 43% in 2006, compared to 37% in 2005.

 

Research and Development Expense.  Research and development expense increased by $22.7 million, or 73%, to $53.7 million in 2006 from $31.0 million in 2005. Research and development expense in 2006 and 2005 is reported net of co-development funding of $16.6 million and $17.2 million, respectively, arising from the co-development funding arrangement that we entered into with ITI in February 2005. The year over year increase in research and development expense is primarily the result of increased spending related to our cardiology research programs, $8.9 million of spending related to our 2006 acquisitions, a $2.9 million charge related to the write-off of fixed assets impacted by our restructuring plans and a $1.4 million charge for stock-based compensation related to our January 1, 2006 adoption of SFAS No. 123-R. Included in the $8.9 million of additional spending related to recent acquisitions is a $5.0 million charge related to the write-off of in-process research and development projects that had not achieved technical feasibility as of the date of our acquisition of Clondiag.

 

Amortization expense of $3.3 million and $2.3 million was included in research and development expense for 2006 and 2005, respectively.

 

Research and development expense as a percentage of net product sales increased to 10% for 2006, from 8% for 2005.

 

Sales and Marketing Expense.  Sales and marketing expense increased by $22.3 million, or 31%, to $94.4 million in 2006, from $72.1 million in 2005. The increase in sales and marketing expense is primarily attributed to our expanded sales and marketing infrastructure to support the growth in our professional diagnostics business, with additional expense of approximately $16.0 million related to our acquisitions of Binax, the Determine business, BioStar and IDT during 2005 and our acquisitions of Clondiag and the Innovacon business during 2006. Approximately $1.3 million of the increase in sales and marketing expense resulted from our increased advertising efforts to promote our premium consumer diagnostic products in 2006. Sales and marketing for 2006 also included a charge of $0.7 million for stock-based compensation related to our January 1, 2006 adoption of SFAS No. 123-R.

 

Amortization expense of $6.8 million and $2.9 million was included in sales and marketing expense for 2006 and 2005, respectively.

 

Sales and marketing expense as a percentage of net product sales decreased to 17% for 2006, from 18% for 2005.

 

General and Administrative Expense.  General and administrative expense increased by $11.3 million, or 19%, to $71.2 million in 2006, from $60.0 million in 2005. Of the increase in general and administrative expense, approximately $12.2 million resulted from additional spending related to our acquisitions of Binax, the Determine business, BioStar and IDT which were completed during 2005 and to our 2006 acquisitions of Clondiag and the Innovacon business. The increase in general and administrative expense during 2006 was partially offset by a decrease in legal expenses of $4.7 million. Also included in general and administrative expense is a $3.0 million charge for stock-based compensation related to our January 1, 2006 adoption of SFAS No. 123-R.

 

Amortization expense included in general and administrative expense was $0.4 million for both 2006 and 2005.

 

General and administrative expense as a percentage of net revenue decreased to 13% for 2006, from 14% for 2005.

 

Loss on Dispositions, Net.  During 2006, we recorded a net loss on dispositions of $3.5 million. Included in this charge is a loss of $4.9 million associated with management’s decision to dispose of our Scandinavian Micro Biodevices ApS, or SMB, research operation. The $4.9 million charge includes a loss of $2.0 million on impaired assets, most of which represents goodwill associated with SMB, and a $2.9 million loss on the sale of SMB, which was finalized during the fourth quarter of 2006. The $4.9 million loss is offset by a $1.4 million gain on the sale of an idle manufacturing facility in Galway, Ireland, as a result of our 2005 restructuring plan.

 

Interest Expense.  Interest expense for 2006 includes interest charges, the write-off and amortization of deferred financing costs and the amortization of non-cash discounts associated with our debt issuances in 2004. Interest expense for 2005 includes interest charges, the write-off and amortization of deferred financing costs and the amortization of non-cash discounts associated with our debt issuances in 2004, and the change in market value of our interest rate swap agreement of $0.7 million which did not qualify as a hedge for accounting purposes. Interest expense increased by $4.8 million, or 22%, to $26.6 million in 2006, from $21.8 million in 2005. In 2006, we recorded a charge of $1.3 million related to prepayment penalties and the write-off of debt origination costs resulting from the early repayment of our $20.0 million, 10% subordinated promissory notes on September 8, 2006. In addition to the $1.3 million charge, higher applicable interest rates on the senior credit facility during 2006, compared to 2005, and an increase in the amortization of deferred financing costs related to the debt refinancings that occurred later in 2005 and during the first quarter of 2006, also contributed to the increase in interest expense for 2006.

 

Other Income (Expense), Net.  Other income (expense), net, includes interest income, realized and unrealized foreign exchange gains and losses, and other income and expense. The components and the respective amounts of other income (expense), net, are summarized as follows:

 

 

Other income (expense), net for 2006 includes a foreign exchange gain of $4.3 million associated with the closure of our Galway, Ireland manufacturing operation and $4.7 million in other income, related to the portion of our settlement with Vedalab relating to periods prior to 2006.

 

Other income (expense), net for 2005 includes the following items: (i) $15.0 million in other income, being the portion of our settlement with Quidel relating to periods prior to 2005, (ii) an $8.4 million gain from a legal settlement of class action suit against several raw material suppliers in our vitamins and nutritional supplements business (iii) $2.6 million of income related to the value of an option received under a licensing arrangement, (iv) a $2.7 million charge related to a legal settlement of a nutritional segment commercial dispute arising from a distribution arrangement entered into in September 1996, and (v) a $4.3 million charge related to a legal settlement with Princeton BioMeditech Corporation, or PBM.

 

Provision for Income Taxes.  Provision for income taxes decreased by $1.1 million, or 16%, to $5.7 million in 2006, from $6.8 million in 2005. The effective tax rate in 2006 was (52)%, compared to (55)% in 2005. The decrease in the provision for income taxes from 2005 to 2006 is primarily related to taxes on foreign income. The primary components of the 2006 provision for income taxes related to the recognition of U.S. deferred tax liabilities for temporary differences between the book and tax bases of goodwill and certain intangible assets with indefinite lives and to taxes on foreign income. The amount related to the U.S. deferred

tax liabilities is approximately $3.4 million. The primary components of the 2005 provision for income taxes related to the recognition of U.S. deferred tax liabilities for temporary differences between the book and tax bases of goodwill and certain intangible assets with indefinite lives and to taxes on foreign income. The amount related to the U.S. deferred tax liabilities is approximately $2.9 million.

 

Net (Loss) Income.  We incurred a net loss of $16.8 million in 2006, while we incurred a net loss of $19.2 million in 2005. Net loss per common share available to common stockholders was $0.49 per basic and diluted common share in 2006, as compared to net loss of $0.79 per basic and diluted common share in 2005. The net loss in 2006 and 2005 resulted from the various factors as discussed above. See Note 13 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for the calculation of net (loss) income per share.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

Net Product Sales.  Net product sales increased by $41.0 million, or 11%, to $406.5 million in 2005, from $365.4 million in 2004. Excluding the unfavorable impact of currency translation, net product sales in 2005 grew by approximately $41.8 million, or 11%, over 2004. Revenue increased as a result of our acquisitions in 2005: (i) Binax, acquired in March 2005, contributed $18.4 million of such increase, (ii) the Determine rapid diagnostics business, acquired in June 2005, contributed revenues of $17.2 million, (iii) BioStar, acquired in September 2005, contributed revenues of $6.9 million, and (iv) various less significant acquisitions contributed an aggregate of $9.7 million of such increase.

 

Net Product Sales by Business Segment.  Net product sales by business segment for 2005 and 2004 are as follows:

 

 

Consumer Diagnostic Products

 

The currency adjusted increase in net product sales from our consumer diagnostic products was $3.5 million, or 2%, comparing 2005 to 2004. Of the currency adjusted increase, $1.9 million resulted from our acquisition of the consumer pregnancy test business of Advanced Clinical Systems Pty Ltd, or ACS, in January 2005. Organic growth, principally in the U.S., accounted for the remaining growth.

 

Vitamins and Nutritional Supplements

 

Net product sales of our vitamins and nutritional supplements decreased by $2.5 million, or 3%, comparing 2005 to 2004. The decrease was primarily due to our brand name nutritional business. Our aggregate sales of all of our brand name nutritional products, including, among others, Ferro-Sequels, Stresstabs, Protegra, Posture, SoyCare, ALLBEE, and Z-BEC, have declined on an annual basis over the past several years. We believe that these products have under-performed because they are, for the most part, aging brands with limited brand recognition that face increasing private label competition.

 

Professional Diagnostic Products

 

The currency adjusted increase in net product sales from our professional diagnostic products was $40.8 million, or 31%, comparing 2005 to 2004. Of the currency adjusted increase, revenue increased as a result of our acquisitions in 2005: (i) Binax contributed $18.4 million of such increase, (ii) the Determine rapid diagnostics business contributed revenues of $17.2 million, (iii) BioStar contributed revenues of $6.9 million, and (iv) various less significant acquisitions contributed an aggregate of $7.8 million of such increase.

 

Net Product Sales by Geographic Location.  Net product sales by geographic location for 2005 and 2004 are as follows:

 

 

The growth in net product sales in all geographic regions resulted from the various acquisitions discussed above.

 

License and Royalty Revenue.  License and royalty revenue represents license and royalty fees from intellectual property license agreements with third parties. License and royalty revenue increased by $6.8 million, or 80%, to $15.4 million in 2005, from $8.6 million in 2004. The increase primarily related to royalty revenues received as a result of the settlement and licensing arrangement that we entered into with Quidel Corporation in April 2005.

 

Gross Profit and Margin.  Gross profit increased by $5.3 million, or 4%, to $152.3 million in 2005 from $147.0 million in 2004. The increase in gross profit was attributable to higher gross margins on the increased license and royalty revenue discussed above. Offsetting this increase was: (i) the inclusion in cost of sales of a $4.1 million charge principally associated with our decision to close our CDIL manufacturing facility, (ii) a charge of $2.4 million associated with a reserve established during the second quarter of 2005 at our Wampole subsidiary for excess quantities of certain raw materials and finished goods, including certain finished goods held at distributors but subject to rights of return, and (iii) a $1.6 million provision for returns and inventory reserve which was established as a result of our recall of the drugs of abuse diagnostic products during the first quarter of 2005, offset in part by the gross profit earned on increased professional diagnostics products revenue, as discussed above. Gross profit from our nutritional supplements business decreased $6.0 million from $8.8 million in 2004 to $2.7 million in 2005. Our private label nutritional supplements business suffered from excess capacity in the industry and increasing price competition.

 

Cost of sales included amortization expense of $7.2 million and $5.5 million in 2005 and 2004, respectively.

 

Overall gross margin was 36% in 2005, compared to 39% in 2004. Overall gross margin in 2005 was adversely affected by the $4.1 million charge associated with the CDIL closing, the $2.4 million Wampole inventory reserve, and the $1.6 million returns and inventory reserve associated with the drugs of abuse product recalls discussed above. Excluding these charges, gross margin was 38% for 2005.

 

Gross Profit from Net Product Sales by Business Segment.  Gross profit from net product sales represents total gross profit less gross profit associated with license and royalty revenue. Gross profit from total net product sales decreased by $0.3 million to $141.5 million in 2005, from $141.8 million in 2004. Gross profit from net product sales by business segment for 2005 and 2004 are as follows:

 

 

Gross profit from our consumer diagnostic product sales decreased by $6.4 million, or 8%, comparing 2005 to 2004. Included in cost of sales, and adversely effecting gross profit, was a $4.1 million charge principally associated with our decision to close our CDIL manufacturing facility.

 

Consumer Diagnostic Products

 

Gross profit from our consumer diagnostic product sales was 47% for 2005, compared to 52% in 2004. Excluding the $4.1 million CDIL closure charge discussed above, gross margin from our consumer diagnostic products segment was 50% in 2005. The remaining decrease in gross margin from our consumer diagnostic product sales resulted from a change in product mix.

 

Vitamins and Nutritional Supplements

 

Gross profit in our vitamins and nutritional supplements business decreased by $6.0 million, or 69%, comparing 2005 to 2004. Our private label nutritional supplements business suffered from excess capacity in the industry which led to increasing price competition and generally decreasing margins. Revenue decreases in our brand named nutritional products also contributed to lower gross profit in 2005 than 2004.

 

Professional Diagnostic Products

 

Gross profit from our professional diagnostic products increased by $12.2 million, or 24%, comparing 2005 to 2004, principally as a result of gross profit earned on revenues from acquired businesses, as discussed above. Reducing gross margin for 2005 were a charge of $2.4 million associated with a reserve established during the second quarter of 2005 at our Wampole subsidiary for excess quantities of certain raw materials and finished goods, including certain finished goods held at distributors but subject to rights of return, and a $1.6 million provision for returns and inventory reserve which were established as a result of our recall of the drugs of abuse diagnostic products during the first quarter of 2005. Excluding these charges, gross profit from our professional diagnostic products segment increased by $16.2 million comparing 2005 to 2004.

 

Gross margin from our professional diagnostic product sales was 37% in 2005, compared to 39% in 2004. Excluding the $2.4 million Wampole inventory reserve and the $1.6 million drugs of abuse charge discussed above, gross margin from our professional diagnostic product sales was 39% for 2005.

 

Research and Development Expense.  Research and development expense decreased by $1.0 million, or 3%, to $31.0 million in 2005 from $32.0 million in 2004. Research and development expense in 2005 is reported net of co-development funding of $17.2 million arising from the co-development funding arrangement that we entered into with ITI Scotland in February 2005. Research and development expense before considering the co-development funding was $48.2 million in 2005, an increase of $16.2 million from 2004.

 

The increase in spending resulted in part from expenditures of $5.0 million in our professional diagnostics business associated with our acquisitions of Binax, BioStar and Ischemia. The remaining research and development spending primarily related to our continued significant investment in the development of products in the field of cardiology.

 

Amortization expense of $2.3 million and $0.8 million was included in research and development expense for 2005 and 2004, respectively.

 

Research and development expense as a percentage of net product sales is 8% and 9% for 2005 and 2004, respectively.

 

Sales and Marketing Expense.  Sales and marketing expense increased by $14.1 million, or 24%, to $72.1 million in 2005 from $58.0 million in 2004. Acquisitions completed during 2005 accounted for $8.3 million of the increase. Approximately $1.8 million of the increase in sales and marketing expense resulted from our increased advertising efforts to promote our premium consumer diagnostic products in 2005. The remaining increase in sales and marketing expense resulted from our expanded sales and marketing infrastructure to support the anticipated growth in our professional diagnostics business.

 

Amortization expense of $2.9 million and $3.9 million was included in sales and marketing expense for 2005 and 2004, respectively.

 

Sales and marketing expense as a percentage of net product sales increased to 18% in 2005, from 16% in 2004. The increase in sales and marketing expense as a percentage of net product sales primarily resulted from

our investment in advertising efforts for our premium consumer diagnostic products and sales and marketing infrastructure to support our anticipated growth in the professional diagnostics business.

 

General and Administrative Expense.  General and administrative expense increased by $7.3 million, or 14%, to $60.0 million in 2005, from $52.7 million in 2004. Acquisitions completed during 2005 accounted for $4.2 million of the increase. The remaining increase in general and administrative expense resulted from an increase in consulting and legal spending, due to the formal order of investigation in connection with the previously disclosed revenue recognition matter at Wampole and our active pursuits and defenses in litigations, including our lawsuits and settlements with Quidel and PBM.

 

Amortization expense of $0.4 million and $0.2 million was included in general and administrative expense for 2005 and 2004, respectively.

 

General and administrative expense as a percentage of net revenue was consistent in 2005 and 2004 at 14%.

 

Interest Expense.  Interest expense includes interest charges, the write-off and amortization of deferred financing costs and the amortization of non-cash discounts associated with our debt issuances in 2004, and the change in market value of our interest rate swap agreement of $0.7 million which did not qualify as a hedge for accounting purposes. Interest expense decreased by $0.3 million, or 1%, to $21.8 million in 2005, from $22.1 million in 2004. In 2004, we recorded a charge of $3.8 million representing the write-off of deferred financing costs and prepayment fees and penalties related to the repayment of borrowings under our primary senior credit facility and certain subordinated notes with the proceeds from our $150.0 million bond offering in February 2004. Excluding such charge, interest expense increased $3.5 million in 2005. Such increase was primarily due to a higher average outstanding debt balance which was $215.3 million during 2005, compared to $194.4 million during 2004, primarily as a result of the borrowings to finance various acquisitions and operations, offset in part by funds raised from our sale of common stock in August 2005. Additionally, the 8.75% interest rate on the $150.0 million bonds, together with its 50 basis points interest penalty during a portion of the first quarter of 2005 due to the late registration of the related exchange offer, coupled with the impact of the increase in short-term interest rates which effected the borrowings under our senior credit facility, increased our average cash interest rate to 9.0% for 2005 from 8.8% for 2004. The bonds, which are due in 2012, provide us with a long-term fixed rate on a significant portion of our indebtedness, as compared to the variable rates under our senior credit facility.

 

Other Income (Expense), Net.  Other income (expense), net, includes interest income, realized and unrealized foreign exchange gains and losses, and other income and expense. The components and the respective amounts of other income (expense), net, are summarized as follows:

 

 

Included in other income (expense), net, for 2005 are the following items: (i) $15.0 million in income, being the portion of our settlement with Quidel relating to periods prior to 2005, (ii) an $8.4 million gain from a legal settlement of class action suit against several raw material suppliers in our vitamins and nutritional supplements business (iii) $2.6 million of income related to the value of an option received under a licensing arrangement, (iv) a $2.7 million charge related to a legal settlement of a nutritional segment commercial dispute arising from a distribution arrangement entered into in September 1996, and (v) a $4.3 million charge related to a legal settlement with PBM.

 

Included in other income (expense), net, for 2004 are the following items: (i) $0.5 million in income, of royalties received attributable to periods prior to 2004 associated with a license arrangement that had historically been underpaid, (ii) $0.9 million in release of a pre-acquisition legal contingency reserve upon reaching and signing a settlement agreement, and (iii) $0.5 million in litigation settlement gain.

 

Provision for Income Taxes.  Provision for income taxes increased by $4.5 million, or 200%, to $6.8 million in 2005 from $2.3 million in 2004. The effective tax rate in 2005 was (55)%, compared to (16)% in 2004. The increase in the provision for income taxes from 2004 to 2005 is primarily related to taxes on foreign income. The primary components of the 2005 provision for income taxes related to the recognition of U.S. deferred tax liabilities for temporary differences between the book and tax bases of goodwill and certain intangible assets with indefinite lives and to taxes on foreign income. The amount related to the U.S. deferred tax liabilities is approximately $2.9 million. In 2004, we recognized $0.8 million of benefit from the reduction of the valuation allowance related to net operating loss, or NOL, carryforward of two of our foreign subsidiaries due to our assessment that we would more likely than not realize the benefit of these NOLs.

 

Net (Loss) Income.  We incurred a net loss of $19.2 million in 2005, while we incurred a net loss of $16.6 million in 2004. After taking into account charges for redemption interest and amortization of a beneficial conversion feature related to our Series A redeemable convertible preferred stock, we had a net loss available to common stockholders of $17.3 million in 2004. Net loss per common share available to common stockholders was $0.79 per basic and diluted common share in 2005 as compared to net loss of $0.87 per basic and diluted common share in 2004. The net loss in 2005 and 2004 resulted from the various factors as discussed above. See Note 13 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for the calculation of net (loss) income per share.

 

Liquidity and Capital Resources

 

Based upon our current working capital position, current operating plans and expected business conditions, we believe that our existing capital resources, credit facilities and expected funding resulting from our co-development funding agreement with ITI will be adequate to fund our operations, including our outstanding debt and other commitments, as discussed below, for the next 12 months. In the long run we expect to fund our working capital needs and other commitments primarily through our operating cash flow, which we expect to improve as we improve our operating margins and grow our business through new product introductions and by continuing to leverage our strong intellectual property position. We also expect to rely on our credit facilities and the capital markets to fund a portion of our capital needs and other commitments. If we raise additional funds by issuing equity or convertible securities, dilution to then existing stockholders may result.

 

Summary of Changes in Cash Position

 

As of December 31, 2006, we had cash and cash equivalents of $71.1 million, a $36.8 million increase from December 31, 2005. Our primary sources of cash during 2006, included $235.0 million in proceeds from the issuance of our common stock, including common stock issues under employee stock option and stock purchase plans, $14.7 million in proceeds from the repayment of notes receivable and $34.3 million from operating activities during 2006. Our investing activities during 2006 used $178.8 million of cash and consisted primarily of $131.5 million of cash used for acquisitions, $12.6 million used for the purchase of available-for-sale securities, $13.2 million used for minority interest and other investments, $19.7 million used for capital equipment purchases, offset by $2.2 million of net proceeds from the sale of our Galway, Ireland facility and sales of capital equipment, and a $4.1 million decrease in other assets. Our non-equity financing activities, primarily related to our senior credit facility and the 10% subordinated promissory notes, used cash of $70.6 million during 2006. Fluctuations in foreign currencies favorably impacted our cash balance by $2.4 million during 2006.

 

Cash Flows from Operating Activities

 

Net cash provided by operating activities during 2006 was $34.3 million, an increase of $7.7 million over the prior year. Our net loss during 2006 of $16.8 million was funded by our net cash from operating activities, along with a $10.3 million increase in working capital as offset by $39.4 million of depreciation and amortization and $22.0 million of other non-cash items. The $10.3 million increase in working capital was primarily driven by an increase in our accounts receivable over prior year.

Cash Flows from Investing Activities

 

During 2006, we paid $131.5 million in cash for acquisitions and transaction-related costs, net of cash acquired, primarily with respect to our acquisitions of Clondiag and the Innovacon business.

 

On February 28, 2006, we acquired 67.45% ownership of Clondiag, a privately-held company located in Jena in Germany which has developed a multiplexing technology for nucleic acid and immunoassay-based diagnostics and, on August 31, 2006, we acquired the remaining 32.55%. The aggregate purchase price for Clondiag was $24.4 million, consisting of $17.7 million in cash, 243,398 shares of our common stock valued at $6.5 million, $0.1 million direct acquisition costs and a $0.1 million remaining obligation. The terms of the Clondiag acquisition also 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.

 

On March 31, 2006, we acquired the Innovacon business, although this acquisition involved several stages and payments during 2006. The aggregate purchase price for the acquisition of the Innovacon business, including the acquisition of the ABON facility in May 2006, was $184.1 million, consisting of cash payments totaling $112.0 million, 1,871,250 shares of our common stock valued at $53.0 million, $9.1 million in estimated direct acquisition costs and an additional liability of $10.0 million payable to the sellers on a deferred payment date. In connection with this acquisition, we also entered into an agreement for the purchase of ACON Laboratories’ lateral flow immunoassay sales and distribution business in all territories not included as part of the Innovacon business acquired during 2006. Under the terms of this agreement, in the event that this business achieves a specified level of profitability, we will acquire this business in 2009 for a formulaic price based on the revenues and earnings of the business. Alternatively, we may elect not to complete the acquisition of the business in exchange for a payment equal to 15% of the purchase price that would have been due had we elected to complete the acquisition.

 

In addition, on February 5, 2007, we acquired substantially all of the assets of First Check Diagnostics LLC, or First Check, a privately-held diagnostics company, for approximately $24.5 million in cash. In addition, we are obligated to pay an earn-out to First Check equal to the incremental revenue growth of the acquired products for 2007 and for the first nine months of 2008, as compared to the immediately preceding comparable periods.

 

During 2006, we purchased $12.6 million worth of marketable equity securities which we intend to hold indefinitely and therefore carry on our consolidated balance sheet as available-for-sale securities. These securities were recorded at their fair market value as of December 31, 2006.

 

Other cash investments made during 2006 include a 40% investment in Vedalab, a French manufacturer and supplier of rapid diagnostic tests in the professional markets. The aggregate purchase price was $9.7 million which consisted of $7.6 million in cash, 49,787 shares of our common stock with an aggregate fair value of $2.0 million and $0.1 million in estimated direct acquisition costs. Under the terms of the agreement, we also settled an on-going patent infringement claim with Vedalab, resulting in a settlement payment to us of $5.1 million.

 

Cash Flows from Financing Activities

 

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 August 23, 2006, we sold an aggregate 5,000,000 shares of our common stock at $30.25 per share to funds affiliated with 17 accredited institutional investors in a private placement. Proceeds from the private placement were approximately $145.5 million, net of issuance costs of $5.7 million. Of this amount, we used $41.3 million for payments related to our ABON acquisition, $5.3 million to purchase the remaining 32.55% of Clondiag, repaid principal outstanding under our senior credit facility of $54.0 million and repaid principal

and interest outstanding, along with a prepayment penalty, under our 10% subordinated promissory notes of $20.8 million, with the remainder of the net proceeds retained for general corporate purposes.

 

On January 31, 2007, we sold an aggregate 6,000,000 shares of our common stock at $39.65 per share through an underwritten public offering, and on February 5, 2007, our underwriters exercised in full an option to purchase an additional 900,000 shares to cover over-allotments. Proceeds from the offering were approximately $261.3 million, net of issuance costs of $12.3 million, which include deductions for underwriting discounts and commissions and take into effect the reimbursement by the underwriters of a portion of our offering expenses. Of this amount, we used $44.9 million to repay all principal and accrued interest owing on the term loan under our senior credit facility, with the remainder of the net proceeds retained for working capital and other general corporate purposes.

 

In December 2006, we signed a definitive agreement with P&G to form a 50/50 joint venture for the development, manufacturing, marketing and sale of existing and to-be-developed consumer diagnostic products outside of the fields of cardiology and diabetes. In connection with this agreement, we will contribute our related consumer diagnostic and monitoring assets, other than manufacturing and core intellectual property assets, to a new joint venture entity, and P&G will acquire its interest in the joint venture in consideration for a cash payment of $325.0 million. Our primary role in the collaboration will be to develop and manufacture consumer diagnostic products, while P&G’s primary role will be to market, sell, and distribute existing and to-be-developed products. We will retain all rights with respect to the development and sale of cardiology diagnostic products and our professional point of care diagnostic businesses. Following the completion of the transaction and the formation of the joint venture, we will cease to consolidate the operating results of our formerly wholly-owned consumer diagnostics business and instead will account for our 50% interest in the results of the joint venture under the equity method. In addition, because we will share control of the joint venture with P&G we may not have access to cash generated through the operations of the joint venture and, in certain circumstances, we could be required to provide working capital to the joint venture. Under the terms of our agreement with P&G, P&G can require us to repurchase its interest in the joint venture at market value after the fourth anniversary of the closing.

 

Our primary senior credit facility with a group of banks, as amended, consists of a $45.0 million U.S. term loan and revolving lines of credit in the aggregate amount of up to $110.0 million, subject to continuing covenant compliance. Our aggregate indebtedness under the senior credit facility was $44.8 million as of December 31, 2006, outstanding under the U.S. term loan. On February 1, 2007, we paid all remaining principal and accrued interest owing under our senior credit facility.

 

We may repay any future borrowings under the revolving lines of credit at any time but in no event later than March 31, 2008. We are required to make mandatory prepayments under our primary senior credit facility if we meet certain cash flow thresholds, issue equity securities or subordinated debt, or sell assets not in the ordinary course of our business above certain thresholds.

 

Borrowings under the revolving lines of credit bear interest at either (1) the London Interbank Offered Rate, or LIBOR, as defined in the credit agreement, plus applicable margins or, at our option, (2) a floating Index Rate, as defined in the credit 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, depending on the quarterly adjustments that are based on our consolidated financial performance. As of December 31, 2006, the applicable interest rate under the revolving lines of credit, including the applicable margin, ranged from 6.85% to 9.35%.

 

Borrowings under our primary senior credit facility are secured by the stock of our U.S. and European subsidiaries, substantially all of our intellectual property rights and the assets of our businesses in the U.S. and Europe, excluding those assets of our subsidiaries in Israel, China, Japan, Australia and Sweden, and the stock of Orgenics and certain smaller subsidiaries. Under the senior credit agreement, as amended, we must comply with various financial and non-financial covenants. The primary financial covenants pertain to, among other things, fixed charge coverage ratio, capital expenditures, various leverage ratios, earnings before interest, taxes, depreciation and amortization, or EBITDA, and a minimum cash requirement. Additionally, the senior credit

agreement currently prohibits us from paying dividends. We are currently in compliance with the covenants, as amended.

 

In February 2004, we completed the sale of $150.0 million of 8.75% senior subordinated notes, or bonds, due 2012 in a private placement to qualified institutional buyers. These bonds accrue interest from the date of their issuance, or February 10, 2004, at the rate of 8.75% per year. Interest on the bonds are payable semi-annually in arrears on each February 15 and August 15. As of December 31, 2006, accrued interest related to the bonds amounted to $4.9 million.

 

The bonds are unsecured and are subordinated in right of payment to all of our existing and future senior debt, including our guarantee of all borrowings under our primary senior credit facility. The bonds are effectively subordinated to all existing and future liabilities, including trade payables, of those of our subsidiaries that do not guarantee the bonds.

 

The bonds are guaranteed by all of our domestic subsidiaries that are guarantors or borrowers under our primary senior credit facility. The guarantees are general unsecured obligations of the guarantors and are subordinated in right of payment to all existing and future senior debt of the applicable guarantors, which includes their guarantees of, and borrowings under our primary senior credit facility.

 

The indenture governing the bonds contains covenants that will limit our ability and the ability of our subsidiaries to, among other things, incur additional indebtedness in the aggregate, subject to our interest coverage ratio, pay dividends or make other distributions or repurchase or redeem our stock, make investments, sell assets, incur liens, enter into agreements restricting our subsidiaries’ ability to pay dividends, enter into transactions with affiliates and consolidate, merge or sell all or substantially all of our assets. These covenants are subject to certain exceptions and qualifications.

 

As of December 31, 2006, we had an aggregate of $1.0 million in outstanding capital lease obligations which are payable through 2009.

 

Income Taxes

 

As of December 31, 2006, we had approximately $188.2 million of domestic net operating loss carryforwards and $45.9 million of foreign net operating loss, or NOL, carryforwards, respectively, which either expire on various dates through 2026 or can be carried forward indefinitely. These losses are available to reduce federal and foreign taxable income, if any, in future years. These losses are also subject to review and possible adjustments by the applicable taxing authorities. In addition, the domestic operating loss carryforward amount at December 31, 2006 included approximately $70.5 million of pre-acquisition losses at IMN, Ischemia, Ostex and ADC. The future benefit of these losses will be applied first to reduce to zero any goodwill and other non-current intangible assets related to the acquisitions, prior to reducing our income tax expense. Also included in our domestic NOL carryforwards at December 31, 2006 was approximately $2.6 million resulting from the exercise of employee stock options, the tax benefit of which, when recognized, will be accounted for as a credit to additional paid-in capital rather than a reduction of income tax.

 

Furthermore, all domestic losses are subject to the Internal Revenue Service Code Section 382 limitation and may be limited in the event of certain cumulative changes in ownership interests of significant shareholders over a three-year period in excess of 50%. Section 382 imposes an annual limitation on the use of these losses to an amount equal to the value of the company at the time of the ownership change multiplied by the long term tax exempt rate. We have recorded a valuation allowance against a portion of the deferred tax assets related to our net operating losses and certain of our other deferred tax assets to reflect uncertainties that might affect the realization of such deferred tax assets, as these assets can only be realized via profitable operations.

 

Off-Balance Sheet Arrangements

 

We had no material off-balance sheet arrangements as of December 31, 2006.

 

Contractual Obligations

 

The following table summarizes our principal contractual obligations as of December 31, 2006 and the effects such obligations are expected to have on our liquidity and cash flow in future periods.

 

 

 

 

As of December 31, 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, 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. The contingent considerations will be accounted for as increases in the aggregate purchase prices if and when the contingencies occur.

 

Critical Accounting Policies

 

The consolidated financial statements included elsewhere in this Annual Report on Form 10-K are prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The accounting policies discussed below are considered by our management and our audit committee

to be critical to an understanding of our financial statements because their application depends on management’s judgment, with financial reporting results relying on estimates and assumptions about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, management cautions that future events rarely develop exactly as forecast and the best estimates routinely require adjustment. In addition, the notes to our audited consolidated financial statements for the year ended December 31, 2006 included elsewhere in this Annual Report on Form 10-K include a comprehensive summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements.

 

Revenue Recognition

 

We primarily recognize revenue when the following four basic criteria have been met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collection is reasonably assured.

 

The majority of our revenue is derived from product sales. We recognize revenue upon title transfer of the products to third-party customers, less a reserve for estimated product returns and allowances. Determination of the reserve for estimated product returns and allowances is based on our management’s analyses and judgments regarding certain conditions, as discussed below in the critical accounting policy “Use of Estimates for Sales Returns and Other Allowances and Allowance for Doubtful Accounts.” Should future changes in conditions prove management’s conclusions and judgments on previous analyses to be incorrect, revenue recognized for any reporting period could be adversely affected.

 

In connection with the acquisition of the Abbott rapid diagnostics business in September 2003 and the Determine business in June 2005 from Abbott Laboratories, we entered into a transition services agreement with Abbott, whereby Abbott would continue to distribute certain of the acquired products for a period of up to 18 months following each acquisition, subject to certain extensions. During the transition period, we recognized revenue on sales of the products when title transferred from Abbott to third party customers.

 

We also receive license and royalty revenue from agreements with third-party licensees. Revenue from fixed fee license and royalty agreements are recognized on a straight-line basis over the obligation period of the related license agreements. License and royalty fees that the licensees calculate based on their sales, which we have the right to audit under most of our agreements, are generally recognized upon receipt of the license or royalty payments unless we are able to reasonably estimate the fees as they are earned. License and royalty fees that are determinable prior to the receipt thereof are recognized in the period they are earned.

 

Use of Estimates for Sales Returns and Other Allowances and Allowance for Doubtful Accounts

 

Certain sales arrangements require us to accept product returns. From time to time, we also enter into sales incentive arrangements with our retail customers, which generally reduce the sale prices of our products. As a result, we must establish allowances for potential future product returns and claims resulting from our sales incentive arrangements against product revenue recognized in any reporting period. Calculation of these allowances requires significant judgments and estimates. When evaluating the adequacy of the sales returns and other allowances, our management analyzes historical returns, current economic trends, and changes in customer and consumer demand and acceptance of our products. When such analysis is not available and a right of return exists the Company records revenue when the right of return is no longer applicable. Material differences in the amount and timing of our product revenue for any reporting period may result if changes in conditions arise that would require management to make different judgments or utilize different estimates.

 

Our total provision for sales returns and other allowances related to sales incentive arrangements amounted to $52.8 million, $51.2 million and $55.2 million, or 10%, 13% and 15%, respectively, of net product sales in 2006, 2005 and 2004, respectively, which have been recorded against product sales to derive our net product sales.

 

Similarly, our management must make estimates regarding uncollectible accounts receivable balances. When evaluating the adequacy of the allowance for doubtful accounts, management analyzes specific accounts

receivable balances, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms and patterns. Our accounts receivable balance was $100.4 million and $70.5 million, net of allowances for doubtful accounts of $8.4 million and $9.7 million, as of December 31, 2006 and December 31, 2005, respectively.

 

Valuation of Inventories

 

We state our inventories at the lower of the actual cost to purchase or manufacture the inventory or the estimated current market value of the inventory. In addition, we periodically review the inventory quantities on hand and record a provision for excess and obsolete inventory. This provision reduces the carrying value of our inventory and is calculated based primarily upon factors such as forecasts of our customers’ demands, shelf lives of our products in inventory, loss of customers and manufacturing lead times. Evaluating these factors, particularly forecasting our customers’ demands, requires management to make assumptions and estimates. Actual product sales may prove our forecasts to be inaccurate, in which case we may have underestimated or overestimated the provision required for excess and obsolete inventory. If, in future periods, our inventory is determined to be overvalued, we would be required to recognize the excess value as a charge to our cost of sales at the time of such determination. Likewise, if, in future periods, our inventory is determined to be undervalued, we would have over-reported our cost of sales, or understated our earnings, at the time we recorded the excess and obsolete provision. Our inventory balance was $78.3 million and $71.2 million, net of a provision for excess and obsolete inventory of $8.2 million and $7.7 million, as of December 31, 2006 and 2005, respectively.

 

Valuation of Goodwill and Other Long-Lived and Intangible Assets

 

Our long-lived assets include (1) property, plant and equipment, (2) goodwill and (3) other intangible assets. As of December 31, 2006, the balances of property, plant and equipment, goodwill and other intangible assets, net of accumulated depreciation and amortization, were $82.3 million, $439.4 million and $239.6 million, respectively.

 

Goodwill and other intangible assets are initially created as a result of business combinations or acquisitions of intellectual property. The values we record for goodwill and other intangible assets represent fair values calculated by accepted valuation methods. Such valuations require us to provide significant estimates and assumptions which are derived from information obtained from the management of the acquired businesses and our business plans for the acquired businesses or intellectual property. Critical estimates and assumptions used in the initial valuation of goodwill and other intangible assets include, but are not limited to: (i) future expected cash flows from product sales, customer contracts and acquired developed technologies and patents, (ii) expected costs to complete any in-process research and development projects and commercialize viable products and estimated cash flows from sales of such products, (iii) the acquired companies’ brand awareness and market position, (iv) assumptions about the period of time over which we will continue to use the acquired brand, and (v) discount rates. These estimates and assumptions may be incomplete or inaccurate because unanticipated events and circumstances may occur. If estimates and assumptions used to initially value goodwill and intangible assets prove to be inaccurate, ongoing reviews of the carrying values of such goodwill and intangible assets, as discussed below, may indicate impairment which will require us to record an impairment charge in the period in which we identify the impairment.

 

Where we believe that property, plant and equipment and intangible assets have finite lives, we depreciate and amortize those assets over their estimated useful lives. For purposes of determining whether there are any impairment losses, as further discussed below, our management has historically examined the carrying value of our identifiable long-lived tangible and intangible assets and goodwill, including their useful lives where we believe such assets have finite lives, when indicators of impairment are present. In addition, SFAS No. 142 requires that impairment reviews be performed on the carrying values of all goodwill on at least an annual basis. For all long-lived tangible and intangible assets and goodwill, if an impairment loss is identified based on the fair value of the asset, as compared to the carrying value of the asset, such loss would be charged to expense in the period we identify the impairment. Furthermore, if our review of the carrying values of the long-lived tangible and intangible assets with finite lives indicates impairment of such assets, we may

determine that shorter estimated useful lives are more appropriate. In that event, we will be required to record additional depreciation and amortization in future periods, which will reduce our earnings.

 

Valuation of Goodwill

 

We have goodwill balances related to our consumer diagnostics and professional diagnostics reporting units, which amounted to $86.0 million and $353.4 million, respectively, as of December 31, 2006. As of September 30, 2006, we performed our annual impairment review on the carrying values of such goodwill using the discounted cash flows approach. Based upon this review, we do not believe that the goodwill related to our consumer diagnostics and professional diagnostics reporting units were impaired. Because future cash flows and operating results used in the impairment review are based on management’s projections and assumptions, future events can cause such projections to differ from those used at September 30, 2006, which could lead to significant impairment charges of goodwill in the future. No events or circumstances have occurred since our review as of September 30, 2006, that would require us to reassess whether the carrying values of our goodwill have been impaired.

 

Valuation of Other Long-Lived Tangible and Intangible Assets

 

Factors we generally consider important which could trigger an impairment review on the carrying value of other long-lived tangible and intangible assets include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner of our use of acquired assets or the strategy for our overall business; (3) underutilization of our tangible assets; (4) discontinuance of product lines by ourselves or our customers; (5) significant negative industry or economic trends; (6) significant decline in our stock price for a sustained period; (7) significant decline in our market capitalization relative to net book value; and (8) goodwill impairment identified during an impairment review under SFAS No. 142. Although we believe that the carrying value of our long-lived tangible and intangible assets was realizable as of December 31, 2006, future events could cause us to conclude otherwise.

 

Stock-Based Compensation

 

As of January 1, 2006, we account for stock-based compensation in accordance with SFAS No. 123-R, Share-Based Payment. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating our stock price volatility and employee stock option exercise behavior. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

 

Our expected volatility is based upon the historical volatility of our stock. We have chosen to utilize the simplified method to calculate the expected life of options which averages an award’s weighted average vesting period and its contractual term. As stock-based compensation expense is recognized in our consolidated statement of operations is based on awards ultimately expected to vest, the amount of expense has been reduced for estimated forfeitures. SFAS No. 123-R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. If factors change and we employ different assumptions in the application of SFAS No. 123-R, the compensation expense that we record in future periods may differ significantly from what we have recorded in the current period.

 

Accounting for Income Taxes

 

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure and assessing temporary differences resulting from differing treatment of items, such as reserves and accruals and lives assigned to long-lived and intangible assets, for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our

deferred tax assets will be recovered through future taxable income and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within our tax provision.

 

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a valuation allowance of $107.6 million as of December 31, 2006 due to uncertainties related to the future benefits, if any, from our deferred tax assets related primarily to our U.S. businesses and certain foreign net operating losses and tax credits. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance or reduce our current valuation allowance which could materially impact our tax provision.

 

In accordance with SFAS No. 109, Accounting for Income Taxes, and SFAS No. 5, Accounting for Contingencies, we established reserves for tax contingencies that reflect our best estimate of the transactions and deductions that we may be unable to sustain or that we could be willing to concede as part of a broader tax settlement. We are currently undergoing routine tax examinations by various state and foreign jurisdictions. Tax authorities periodically challenge certain transactions and deductions we reported on our income tax returns. We do not expect the outcome of these examinations, either individually or in the aggregate, to have a material adverse effect on our financial position, results of operations, or cash flows.

 

Loss Contingencies

 

In the section of this Annual Report on Form 10-K titled “Item 3 Legal Proceedings,” we have reported on material legal proceedings. In addition, because of 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 result in counterclaims against us.

 

We do not accrue for potential losses on legal proceedings where our company is the defendant when we are not able to reasonably estimate our potential liability, if any, due to uncertainty as to the nature, extent and validity of the claims against us, uncertainty as to the nature and extent of the damages or other relief sought by the plaintiff and the complexity of the issues involved. Our potential liability, if any, in a particular case may become reasonably estimable and probable as the case progresses, in which case we will begin accruing for the expected loss.

 

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 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 impact of EITF No. 06-03. 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, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 and we will be adopting the provisions of FIN 48 beginning with the first quarter of 2007. We continue to evaluate the impact that the adoption of FIN 48 will have, if any, on our consolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged. We continue to evaluate the impact that the adoption of SFAS No. 157 will have, if any, on our consolidated financial statements.

 

In December 2006, the FASB issued FASB Staff Position (“FSP”) No. EITF 00-19-2, Accounting for Registration Payment Arrangements. This FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with FASB Statement No. 5, Accounting for Contingencies.  The guidance in this FSP amends FASB Statement No. 133, Accounting for Derivative Financial Instruments and Hedging Activities, and No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity and FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others to include scope exceptions for registration payment arrangements. This FSP is effective immediately for registration payment arrangements and the financial instruments subject to those arrangements that are entered into or modified subsequent to the date of issuance of this FSP. For registration payment arrangements and financial instruments subject to those arrangements that were entered into prior to the issuance of this FSP, this guidance shall be effective for financial statements issued for fiscal years beginning after December 15, 2006, and interim periods within those fiscal years. We do not believe the adoption of EITF 00-19-2 will have a material impact on our consolidated financial statements.

 

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. As required by SFAS No. 123-R and the SEC, we adopted SFAS No. 123-R on January 1, 2006 (Note 15).

 

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections—A Replacement of APB Opinion No. 20 and FASB Statement No. 3, 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.

 

In September 2006, the SEC issued SEC Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements to provide guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. Under SAB No. 108, companies should evaluate a misstatement based on its impact on the current year income statement, as well as the cumulative effect of correcting such misstatements that existed in prior years existing in the current year’s ending balance sheet. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have a material impact on our financial position, results of operations or cash flows.

 

Effective December 31, 2006, we adopted the recognition provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB Statements No. 87, 88, 106, and 132(R). This Statement requires employers to recognize in their balance sheets the overfunded or underfunded status of defined benefit postretirement plans, measured as the difference between the fair value of plan assets and the benefit obligation (the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for other post-retirement plans). Employers must recognize the change in the funded status of the plan in the year in which the change occurs through other comprehensive income. This Statement also requires plan assets and obligations to be measured as of the employer’s balance sheet date. The measurement provision of this Statement will be effective for years beginning after December 15, 2008, with early application encouraged. We have not yet adopted the measurement provisions of this Statement and are in the process of determining the impact of the adoption on our consolidated financial statements.

 

Prior to the adoption of the recognition provisions of SFAS No. 158, we accounted for our defined benefit post-retirement plans under SFAS No. 87, Employers’ Accounting for Pensions. SFAS No. 87 required that a liability (minimum pension liability) be recorded when the accumulated benefit obligation liability exceeded the fair value of plan assets. Any adjustment is recorded as a non-cash charge to accumulated other comprehensive income in stockholders’ equity. Under SFAS No. 87, changes in the funded status were not immediately recognized, rather they were deferred and recognized ratably over future periods. Upon adoption of the recognition provisions of SFAS No. 158, we recognized the amounts of prior changes in the funded status of our postretirement benefit plans through accumulated other comprehensive income. As a result, we

recognized the following adjustments in individual line items of our consolidated balance sheet as of December 31, 2006:

 

 

The adoption of SFAS No. 158 had no effect on our consolidated statement of operations for the year ended December 31, 2006, or for any prior period presented.

 

As of December 31, 2006, included in accumulated other comprehensive income was unrecognized prior service costs of $6.8 million and unrecognized actuarial gain of $2.3 million. The estimated prior service cost and actuarial loss that will be recognized in net periodic postretirement benefit obligation expense during 2007 is $0 million and $0.1 million, respectively.

 

 

The following discussion about our market risk disclosures involves forward-looking statements. Actual results could differ materially from those discussed in the forward-looking statements. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.

 

Interest Rate Risk

 

We are exposed to market risk from changes in interest rates primarily through our investing and financing activities. In addition, our ability to finance future acquisition transactions or fund working capital requirements may be impacted if we are not able to obtain appropriate financing at acceptable rates.

 

Our investing strategy, to manage interest rate exposure, is to invest in short-term, highly liquid investments. Our investment policy also requires investment in approved instruments with an initial maximum allowable maturity of eighteen months and an average maturity of our portfolio that should not exceed six months, with at least $500,000 cash available at all times. Currently, our short-term investments are in money market funds with original maturities of 90 days or less. At December 31, 2006, our short-term investments approximated market value.

 

At December 31, 2006, we had revolving lines of credit available to us of up to $110.0 million and a term loan of $44.8 million, under our primary senior credit facility. As of December 31, 2006, no borrowings were outstanding under the line of credit. We may repay any future borrowings under the revolving lines of credit at any time but in no event later than March 31, 2008. Borrowings under the revolving lines of credit bear interest at either (i) the London Interbank Offered Rate, or LIBOR, as defined in the credit agreement, plus applicable margins or, at our option, (ii) a floating 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, depending on the quarterly adjustments that are based on our consolidated financial performance. On February 1, 2007, we paid the remaining principal balance outstanding of $44.8 million and accrued interests under our senior credit facility.

 

As of December 31, 2006, the LIBOR and Index rates applicable under our primary senior credit facility were 9.35% and 11%, respectively. Assuming no changes in our leverage ratio, which would affect the margin of the interest rate under the senior credit agreement, the effect of interest rate fluctuations on outstanding

borrowings under the revolving lines of credit as of December 31, 2006 over the next twelve months is quantified and summarized as follows:

 

 

Foreign Currency Risk

 

We face exposure to movements in foreign currency exchange rates whenever we, or any of our subsidiaries, enter into transactions with third parties that are denominated in currencies other than our, or its, functional currency. Intercompany transactions between entities that use different functional currencies also expose us to foreign currency risk. During 2006, the net impact of foreign currency changes on transactions was a loss of $2.7 million. Historically, we have not used derivative financial instruments or other financial instruments with original maturities in excess of three months to hedge such economic exposures. However, during 2005 we entered into forward exchange contracts totaling $24.9 million with monthly maturity dates of January 18, 2005 to February 15, 2006. Maturing forward exchange contracts were used to lock in U.S. dollar to British Pound Sterling (GBP) or U.S. dollar to Euro exchange rates and hedge anticipated intercompany sales. The change in value of the derivative was analyzed quarterly for changes in the spot and forward rates based on rates given by the issuing financial institution for each quarter end date. The effective portion of the gain or loss on the derivative is reported in other comprehensive income (“OCI”) during the period prior to the forecasted purchase or sale. For forecasted sales on credit, the amount of income ascribed to each forecasted period was reclassified from OCI to income or expense on the date of the sale. The income or cost ascribed to each period encompassed within the periods of the recognized foreign-currency-denominated receivable or payable was reclassified from OCI to income or expense at the end of each reporting period. The changes in the derivative instrument’s fair values from inception of the hedge were compared to the cumulative change in the hedged item’s fair value attributable to the risk hedged. Effectiveness was based on the change in the spot rates.

 

Gross margins of products we manufacture at our European plants and sell in U.S. dollar are also affected by foreign currency exchange rate movements. Our gross margin on total net product sales was 39% in 2006. If the U.S. dollar had been stronger by 1%, 5% or 10%, compared to the actual rates during 2006, our gross margin on total net product sales would have been 39.5%, 39.8% and 40.3%, respectively.

 

In addition, because a substantial portion of our earnings is generated by our foreign subsidiaries, whose functional currencies are other than the U.S. dollar (in which we report our consolidated financial results), our earnings could be materially impacted by movements in foreign currency exchange rates upon the translation of the earnings of such subsidiaries into the U.S. dollar. If the U.S. dollar had been stronger by 1%, 5% or 10%, compared to the actual average exchange rates used to translate the financial results of our foreign subsidiaries, our net revenue and net income would have been lower by approximately the following amounts:

 

 

 

The financial statements and supplementary data, except for selected quarterly financial data which are summarized below, are listed under Item 15.(a) and have been filed as part of this report on the pages indicated.

 

The following table presents selected quarterly financial data for each of the quarters in the years ended December 31, 2006 and 2005:

 

 

 

 

 

 

 

Not applicable.

 

 

Management’s conclusions regarding the effectiveness of our disclosure controls and procedures

 

Our management evaluated, with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this annual report on Form 10-K. Based on this evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective at that time. We and our management understand nonetheless that controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. In reaching their conclusions stated above regarding the effectiveness of our disclosure controls and procedures, our CEO and CFO concluded that such disclosure controls and procedures were effective as of such date at the “reasonable assurance” level.

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. Our company’s internal control over financial reporting is a process designed under the supervision of the CEO and CFO to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:

 

(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

 

(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of our company are being made only in accordance with authorizations of our management and directors; and

 

(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.

 

There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurances with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of our company’s internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission

(COSO). Based on management’s assessment and those criteria, management determined that the Company maintained effective internal control over financial reporting as of December 31, 2006.

 

In conducting management’s evaluation of the effectiveness of our company’s internal control over financial reporting, management excluded the acquisitions which were completed in 2006. The contribution from these acquisitions represented approximately 10.0% and 5.2% of net revenue and total assets, respectively, as of and for the year ended December 31, 2006. Refer to Note 4 of the accompanying consolidated financial statements for further discussion of our acquisitions and their impact on our consolidated financial statements.

 

As indicated in its Attestation Report included below, BDO Seidman, LLP, the independent registered public accounting firm that audited the financial statements included in this report, has attested to our management’s assessments regarding the effectiveness of our internal control over financial reporting as of December 31, 2006.

 

REPORT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders of

Inverness Medical Innovations, Inc. and Subsidiaries:

 

We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9a, that Inverness Medical Innovations, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006 based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Inverness Medical Innovations, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of Inverness Medical Innovations, Inc. and subsidiaries’ internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operation effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

As indicated in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of acquisitions completed in 2006 which are included in the 2006 consolidated financial statements of Inverness Medical Innovations, Inc. and subsidiaries and constituted approximately 10.0% and 5.2% of consolidated net revenue and consolidated total assets, respectively, as of and for the year ended December 31, 2006. Management did not assess the effectiveness of internal control over financial reporting at these entities because Inverness Medical Innovations, Inc. and subsidiaries acquired these entities during 2006. Refer to Note 4 of the accompanying consolidated financial statements for further discussion of these acquisitions and their impact on Inverness Medical Innovations, Inc. and subsidiaries’ consolidated financial statements. Our audit of internal control over financial reporting of Inverness Medical Innovations, Inc. and subsidiaries also did not include an evaluation of the internal control over financial reporting of the entities referred to above.

 

In our opinion, management’s assessment that Inverness Medical Innovations, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, is based on the criteria established in Internal Control—Integrated Framework issued by the

COSO. Also, in our opinion, Inverness Medical Innovations, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the COSO.

 

We have also audited, in accordance with the standards of the Public Accounting Oversight Board (United States) the consolidated financial statements of Inverness Medical Innovations, Inc. and subsidiaries and our report therein dated March 1, 2007 expressed an unqualified opinion.

 

 

Boston, MA

March 1, 2007

 

Changes in internal control over financial reporting

 

There was no change in our internal control over financial reporting that occurred during our fourth fiscal quarter of 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

Not applicable.

 

PART III

 

 

The information regarding directors, executive officers and corporate governance included in our definitive Proxy Statement to be filed pursuant to Regulation 14A in connection with our 2007 Annual Meeting of Shareholders (the Proxy Statement) is incorporated herein by reference.

 

 

The information regarding executive compensation included in the Proxy Statement is incorporated herein by reference.

 

 

The information regarding security ownership of certain beneficial owners and management and related stockholder matters included in the Proxy Statement is incorporated herein by reference.

 

 

The information regarding certain relationships and related transactions, and director independence included in the Proxy Statement is incorporated herein by reference.

 

 

The information regarding principal accounting fees and services included in the Proxy Statement is incorporated herein by reference.

 

PART IV

 

 

(a)  1. Financial Statements.

 

The financial statements listed below have been filed as part of this report on the pages indicated:

 

 

2.  Financial Statement Schedules.

 

All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission have been omitted because they are inapplicable or the required information is shown in the consolidated financial statements, or the notes, thereto, included herein.

3.  Exhibits.

 

 

 

 

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

INVERNESS MEDICAL INNOVATIONS, INC.

 

Date: March 26, 2007

Ron Zwanziger

Chairman, Chief Executive Officer and President

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

 

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

 

CONSOLIDATED FINANCIAL STATEMENTS

 

 

Table of Contents

 

 

 

The Board of Directors and Stockholders of
Inverness Medical Innovations, Inc. and Subsidiaries:

 

We have audited the accompanying consolidated balance sheets of Inverness Medical Innovations, Inc. and Subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As described in Note 15 of the financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”, effective January 1, 2006.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Inverness Medical Innovations, Inc. and Subsidiaries at December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Our report dated March 1, 2007, expressed an unqualified opinion on management’s assessment on the effectiveness of internal control over financial reporting and an unqualified opinion on the effectiveness of internal control over financial reporting.

 

 

Boston, Massachusetts

March 1, 2007