UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

ý          Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2005

OR

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

COMMISSION FILE NUMBER 001-16789

INVERNESS MEDICAL INNOVATIONS, INC.

(Exact Name Of Registrant As Specified In Its Charter)

51 SAWYER ROAD, SUITE 200

WALTHAM, MASSACHUSETTS 02453

(Address of principal executive offices)

(781) 647-3900

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý     No o

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

Yes ý     No o

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

Yes o    No ý

 The number of shares outstanding of the registrant’s common stock as of November 4, 2005 was 27,371,965.

INVERNESS MEDICAL INNOVATIONS, INC.

FORM 10-Q

For the Quarterly Period Ended September 30, 2005

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Readers can identify these statements by forward-looking words such as “may,” “could,” “should,” “would,” “intend,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “continue” or similar words.  There are a number of important factors that could cause actual results of Inverness Medical Innovations, Inc. and its subsidiaries to differ materially from those indicated by such forward-looking statements.  These factors include, but are not limited to, the risk factors detailed in this quarterly report on Form 10-Q and other risk factors identified from time to time in our periodic filings with the Securities and Exchange Commission.  Readers should carefully review the factors discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Certain Factors Affecting Future Results” and “Special Statement Regarding Forward-Looking Statements” beginning on pages 28 and 53, respectively, in this quarterly report on Form 10-Q and should not place undue reliance on our forward-looking statements.  These forward-looking statements are based on information, plans and estimates at the date of this report.  We undertake no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

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

TABLE OF CONTENTS

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PART I - FINANCIAL INFORMATION

ITEM 1.                           FINANCIAL STATEMENTS

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(in thousands, except per share amounts)

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

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INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(in thousands, except per share amounts)

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

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INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)

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

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INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(1)         Basis of Presentation of Financial Information

        The accompanying consolidated financial statements of Inverness Medical Innovations, Inc. and its subsidiaries are unaudited. In the opinion of management, the unaudited consolidated financial statements contain all adjustments considered normal and recurring and necessary for their fair presentation. Interim results are not necessarily indicative of results to be expected for the year. These interim financial statements have been prepared in accordance with the instructions for Form 10-Q and therefore do not include all information and footnotes necessary for a complete presentation of operations, financial position, and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Our audited consolidated financial statements for the year ended December 31, 2004 included information and footnotes necessary for such presentation and were included in our annual report on Form 10-K/A, Amendment No. 1, filed with the Securities and Exchange Commission (“SEC”) on August 26, 2005. These unaudited consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2004.

(2)         Cash and Cash Equivalents

We consider all highly liquid cash investments with original maturities of three months or less at the date of acquisition to be cash equivalents.  At September 30, 2005, our cash equivalents consisted of money market funds.

(3)         Inventories

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

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(4)         Employee Stock-Based Compensation Arrangements

For all periods presented in the accompanying unaudited consolidated financial statements, we accounted for our employee stock-based compensation arrangements using the intrinsic value method under the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and in accordance with Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 44, Accounting for Certain Transactions Involving Stock Compensation.  We have elected to use the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure.

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

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

The weighted average fair value under the Black-Scholes option pricing model of options granted to employees during the three months ended September 30, 2005 and 2004 were $12.46 and $7.22, respectively. The weighted average fair value under the Black-Scholes option pricing model of options granted to employees during the nine months ended September 30, 2005 and 2004 were $12.04 and $8.72, respectively.

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(5)         Earnings Per Share

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

We had the following potential dilutive securities outstanding on September 30, 2005: (a) options and warrants to purchase an aggregate of 4.7 million shares of common stock at a weighted average exercise price of $18.04 per share and (b) 104,000 shares of common stock held in escrow. These potential dilutive securities were not included in the computation of diluted loss per share for the three and nine months ended September 30, 2005 because the effect of including the number of such potential dilutive securities would be antidilutive.

We had the following potential dilutive securities outstanding on September 30, 2004: (a) options and warrants to purchase an aggregate of 4.1 million shares of common stock at a weighted average exercise price of $15.96 per share and (b) convertible promissory notes that are convertible into an aggregate of 344,000 shares of common stock.  These potential dilutive securities were not included in the computation of diluted loss per share for the three and nine months ended September 30, 2004 because the effect of including the number of such potential dilutive securities would be antidilutive.

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(6)         Comprehensive Income or Loss

Comprehensive income or loss represents net income or loss plus other comprehensive income or loss items.  Our other comprehensive income or loss includes primarily foreign currency translation adjustments.  For the three and nine months ended September 30, 2005, we generated a comprehensive loss of $8.9 million and $20.3 million, respectively, and for the three and nine months ended September 30, 2004, we generated comprehensive income of $2.6 million and $12.9 million, respectively.

(7)         Business Combinations

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

(a)       Acquisition of Biostar

On September 30, 2005, we acquired Thermo BioStar, Inc. (“BioStar”), a leading developer and manufacturer of high-performance, rapid diagnostic tests, including tests for the detection of infectious diseases.  The preliminary aggregate purchase price was $53.0 million which consisted of $52.5 million in cash and $0.5 million in estimated direct acquisition costs.

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

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

The acquisition of BioStar is accounted for as a purchase under SFAS No. 141, Business Combinations. Accordingly, the operating results of BioStar will be included in the accompanying consolidated financial statements since the acquisition date as part of our professional diagnostic products reporting units and business segment.  We will make an election under Section 338 of the Internal Revenue Code to treat this acquisition as an asset acquisition for tax purposes.  As a result, goodwill generated from this acquisition will be deductible for tax purposes.

(b)       Acquisition of IDT

On September 30, 2005, we acquired Innogenetics Diagnostica Y Terapeutica, S.A.U. (“IDT”), a Spanish distributor of diagnostic products.  The preliminary aggregate purchase price was $20.6 million which consisted of $11.8 million in cash, a working capital adjustment payment to be determined and paid during the fourth quarter, estimated to be approximately $8.6 million, and $0.2 million in estimated direct acquisition costs.

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

The above values for the assets acquired and subsequent amortization and liabilities assumed are based on preliminary management estimates. Final purchase price allocation may differ from the above. Management is also in the process of determining the useful lives of the acquired intangibles as listed above.

The acquisition of IDT is accounted for as a purchase under SFAS No. 141. Accordingly, the operating results of IDT will be included in the accompanying consolidated financial statements since the acquisition date as part of our professional diagnostic products reporting units and business segment.  Goodwill generated from this acquisition is not deductible for tax purposes.

(c)        Acquisition of Determine

On June 30, 2005, we acquired the Determine/DainaScreen assets of Abbott Laboratories’ rapid diagnostic business (the “Determine business”). The Determine business produces diagnostic tests that are designed to provide rapid qualitative results for detecting several diseases, including hepatitis, HIV 1/2 and syphilis. The preliminary aggregate purchase price was $58.0 million, which consisted of $56.5 million in cash and $1.5 million in estimated direct acquisition costs.

        The aggregate purchase price was preliminarily allocated to the assets to be acquired at the date of acquisition as follows:

The above values for the assets acquired are based on preliminary management estimates due to the timing of the acquisition. Final purchase price allocation may differ from the above. Management is also in the process of determining the useful lives of the acquired intangibles as listed above. We estimate the useful lives of the manufacturing know how to be 10 years and customer related intangible asset to be 6 years and included them in other intangible assets, net, in the accompanying consolidated balance sheets.

The acquisition of the Determine business is accounted for as a purchase under SFAS No. 141.  Accordingly, the operating results of the Determine business will be included in the accompanying consolidated financial statements since the acquisition date as part of our professional diagnostic products reporting units and business segment.  Goodwill generated from this acquisition is not deductible for tax purposes.

(d)       Acquisition of Binax

On March 31, 2005, we acquired Binax, Inc. (“Binax”), a privately held developer, manufacturer and distributor of rapid

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diagnostic products for infectious disease testing, primarily related to the respiratory system.  The preliminary aggregate purchase price was $44.7 million which consisted of $9.0 million in cash, 1.4 million shares of our common stock with an aggregate fair value of $35.2 million and $0.5 million in estimated direct acquisition costs. The terms of the acquisition agreement also 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 next five years. This contingent consideration will be accounted for as an increase in the preliminary aggregate purchase price and goodwill if and when the contingency occurs.

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

The above values for the assets acquired and subsequent amortization and liabilities assumed are based on preliminary management estimates. Final purchase price allocation may differ from the above. Management is also in the process of determining the useful lives of the core technology and intangible assets as listed above. We estimate the useful lives of the core technology to be 15 years and customer related intangible asset  to be 7 years and included them in core technology and patents, net, and other intangible assets, net, respectively, in the accompanying consolidated balance sheets.

The acquisition of Binax is accounted for as a purchase under SFAS No. 141. Accordingly, the operating results of Binax will be included in the accompanying consolidated financial statements since the acquisition date as part of our professional diagnostic products reporting units and business segment.  Goodwill generated from this acquisition is not deductible for tax purposes.

(e)        Acquisition of Ischemia

On March 16, 2005, we acquired Ischemia Technologies, Inc. (“Ischemia”), a privately held, venture-backed company that developed, manufactures and markets the only FDA-cleared in vitro diagnostic test targeted on cardiac ischemia.  The preliminary aggregate purchase price was $27.3 million, which consisted of 968,000 shares of our common stock with an aggregate fair value of $22.8 million, estimated exit costs of $1.7 million to vacate Ischemia’s manufacturing and administrative facilities, which we recorded in accordance with Emerging Issues Task Force (“EITF”) Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination, estimated direct acquisition costs of $2.3 million and $0.5 million in assumed debt.

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

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The above values for the assets acquired and subsequent amortization and liabilities assumed are based on preliminary management estimates due to the timing of the acquisition. Final purchase price allocation may differ from the above values. We estimated the useful lives of the patents to be from 6 to 13 years and customer related intangible asset  to be 5.5 years and included them in core technology and patents, net, and other intangible assets, net, respectively, in the accompanying consolidated balance sheets.

The acquisition of Ischemia is accounted for as a purchase under SFAS No. 141.  Accordingly, the operating results of Ischemia have been included in the accompanying consolidated financial statements since the acquisition date as part of our professional diagnostic products reporting units and business segments. Goodwill generated from this acquisition is not deductible for tax purposes.

(f)           Acquisition of ACS

On January 24, 2005, we acquired the consumer pregnancy test business of Advanced Clinical Systems Pty Ltd (“ACS”). In acquiring ACS, we obtained the rights to the Crystal Clear brand.  Crystal Clear is the leading consumer pregnancy test in Australia and has a leading position in New Zealand.  The purchase price of ACS consisted of $4.6 million in cash and estimated direct acquisition costs of $0.3 million. The majority of the purchase price of ACS is allocated to the intangible asset, trademarks, with an average useful life of 7 years.

(g) Pro Forma Financial Information

        The following table presents selected unaudited financial information of our company, including Binax, Ischemia, the Determine business, BioStar and IDT as if the acquisitions of these businesses had occurred on January 1, 2004. Pro forma results exclude adjustments for ACS as the historical results of this acquisition do not materially affect our results of operations. The pro forma results are derived from the historical financial results of the acquired businesses for all periods presented and are not necessarily indicative of the results that would have occurred had the acquisitions been consumated on January 1, 2004.

(1)         Loss  per share amounts are computed as described in Note 5.

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(h) Restructuring Plans of  Acquisitions

In connection with our acquisitions of Ischemia, Ostex International, Inc. (“Ostex”), IVC Industries, Inc. (now operating as Inverness Medical Nutritionals Group or IMN) and certain entities, businesses and intellectual property of Unilever Plc (the “Unipath business”), we recorded restructuring costs as part of the respective aggregate purchase prices in accordance with EITF Issue No. 95-3.  The following table sets forth the restructuring costs and balances recorded in connection with the restructuring activities of these acquired businesses:

(1)         Represents foreign currency translation adjustment.

In connection with our acquisition of Ischemia in March 2005, we established a restructuring plan whereby we have exited the current facilities of Ischemia in Denver, Colorado, and combined its activities with our existing manufacturing and distribution facilities.  Total severance costs associated with involuntarily terminated employees are estimated to be $1.6 million, of which $1.3 million has been paid as of September 30, 2005.  We estimated costs to vacate the Ischemia facilities to be approximately $0.1 million, none of which has been paid as of September 30, 2005. We expect to pay the remaining costs during the remainder of 2005. The total number of involuntarily terminated employees was 17, of which all were terminated as of September 30, 2005. Although we believe our plan and estimated exit costs are reasonable, actual spending for exit activities may differ from current estimated exit costs, which might impact the final aggregate purchase price.

As a result of our acquisition of Ostex, we established a restructuring plan whereby we exited the facilities of  Ostex in Seattle, Washington, and combined the activities of Ostex with our existing manufacturing and distribution facilities.  The total number of employees to be terminated involuntarily under the restructuring plan is 38, of which all were terminated as of September 30, 2005.  Total severance costs associated with involuntarily terminated employees are $1.6 million, of which all have been paid as of September 30, 2005. Costs to vacate the Ostex facilities are $0.5 million, of which $0.2 million has been paid as of September 30, 2005.  Additionally, the remaining costs to exit operations, primarily facilities lease commitments, are $1.9 million, of which $1.4 million has been paid as of September 30, 2005.  Total unpaid exit costs amounted to $0.8 million as of September 30, 2005.

Immediately after the close of the acquisition of IMN, we reorganized the business operations to improve efficiencies and eliminate redundant activities on a company-wide basis.  The restructuring affected all cost centers within the organization, but most significantly responsibilities at the sales and executive levels, as such activities were combined with our existing business operations.  Also as part of the restructuring plan, we relocated one of IMN’s warehouses to a closer proximity of the manufacturing facility to improve efficiency.  Of the $1.6 million in total exit costs, which include severance costs of 47 involuntarily terminated employees and costs to vacate the warehouse, $1.5 million has been paid and $0.1 million remains unpaid as of September 30, 2005.

As a result of the acquisition of the Unipath business from Unilever Plc in 2001, we reorganized the operations of the Unipath business for purposes of improving efficiencies and achieving economies of scale on a company-wide basis.  Such reorganization affected all major cost centers at the operations in England.  Additionally, most business activities of the U.S. division were merged into our existing U.S. businesses. Total exit costs, which primarily related to severance and early retirement obligations of 65 involuntarily terminated employees, were $4.1 million.  As of September 30, 2005, $1.3 million, adjusted for foreign exchange effect, in exit costs remained unpaid.

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(8)   Restructuring Plan

On May 9, 2005, we committed to a plan to cease operations at our facility in Galway, Ireland. During the second quarter ended June 30, 2005, we recorded a $3.5 million restructuring charge, of which $0.9 million related to all expected severance, early retirement, outplacement services and $2.6 million related to impairment of fixed assets relating to this plan of termination. During the third quarter we recorded an additional $0.6 million restructuring charge all related to expected severance, early retirement and outplacement services. The total restructuring charge for the nine months ended September 30, 2005 is $4.1 million, which consisted of $3.5 million charged to cost of goods sold, $0.3 million charged to research and development and $0.3 million charged to general and administrative, was included in our consumer products business segment. The total number of employees to be involuntarily terminated is 109, of which 20 were terminated as of September 30, 2005.  As of September 30, 2005, of the $1.5 million related to expected severance, early retirement and outplacement services, $1.2 million remained unpaid. Including the charges recorded in the second and third quarter, we expect the total restructuring charge related to the closure of CDIL to be approximately $6.3 million, with additional charges relating principally to severance and facility closing costs of $1.9 million and $0.3 million, respectively, expected to be recorded in the fourth quarter of 2005 and first quarter of 2006.

(9)       Co-Development Arrangement

        On February 25, 2005, we entered into a co-development agreement with ITI Scotland Limited (“ITI”), whereby ITI  agreed to provide us with approximately £30 million (or $52.8 million at September 30, 2005) over three years to partially fund research and development programs focused on identifying novel biomarkers and near-patient and home use tests for cardiovascular and other diseases (“the programs”). We agreed to invest £37.5 million (or $66.1 million at September 30, 2005) in the programs over the next three years. Through our subsidiary, Stirling Medical Innovations Limited (“Stirling”), we established a new research center in Stirling, Scotland, where we will consolidate many of our existing cardiology programs and ultimately commercialize products arising from the programs. ITI and Stirling will have exclusive rights to the developed technology in their respective fields of use. As of September 30, 2005, we had received approximately $13.7 million in funding from ITI. As qualified expenditures are made under the co-development arrangement, we recognize the fee earned during the period as a reduction of our related expenses, subject to certain limitations. For the three and nine months ended September 30, 2005, we recognized $4.3 million and $13.7 million of reimbursements, respectively, of which $3.8 million and $12.6 million, respectively offset our research and development spending and $0.5 million and $1.1 million, respectively reduced our general, administrative and marketing spending incurred by Stirling, for the three and nine months ended September 30, 2005, respectively. Funds received from ITI in excess of amounts earned are included in accrued expenses and other current liabilities, the balance of which was $4.3 million as of September 30, 2005.

(10)  Senior Credit Facility

        On June 30, 2005, we amended and restated our existing Senior Credit Facility.  The amendment expanded our existing revolving credit facility capacity from $50.0 million to $80.0 million and added a $20.0 million term loan facility.  Upon completion of the amendment, we borrowed $58.0 million to finance our acquisition of Determine. In August, 2005, we sold 4,000,000 shares of our common stock to 3 accredited institutional investors in a private placement.  Net proceeds from the private placement were approximately $92.8 million.  Of this amount, we repaid principal and interest outstanding under Senior Credit Facility of $84.4 million, with the remainder of the net proceeds retained for general corporate purposes.  $20 million of the repayment was used to permanently reduce the outstanding term loan balance under the Senior Credit Facility.  The repayment of the term loan balance resulted in a non-cash write-off of deferred financing costs of $0.1 million during the third quarter of 2005. On September 29, 2005, we again amended the Senior Credit Facility to increase the total amount of credit available to us under the Senior Credit Facility, which consists of two revolving lines of credit, from $80.0 million to $100.0 million.  As of September 30, 2005, $74.0 million of borrowings were outstanding under the lines, with $26.0 million available for future borrowings, subject to continued covenant compliance.

(11)  Defined Benefit Pension Plan

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

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 (12)                       Financial Information by Segment

Under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.  Our chief operating decision making group is composed of the chief executive officer and members of senior management.  Our reportable operating segments are Consumer Diagnostic Products, Vitamins and Nutritional Supplements, Professional Diagnostic Products, and Corporate and Other. Included in the operating loss of Corporate and Other are non-allocable corporate expenditures and expenses related to our research and development activities in the area of cardiology for the three and nine months ended September 30, 2005, the latter of which amounted to $5.0 million, net of the ITI funding of $3.9 million (Note 9) and $11.2 million, net of $12.6 million of the ITI funding, respectively, and  $3.9 million and $12.1 million for the three and nine months ended September 30,  2004, respectively.  Total assets in the area of cardiology, which are included in Corporate and Other in the tables below, amounted to $50.4 million at September 30, 2005 and $8.6 million at December 31, 2004.

    We evaluate performance of our operating segments based on revenue and operating income (loss).  Segment information for the three and nine months ended September 30, 2005 and 2004 is as follows:

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(13) Material Contingencies, Settlements and Other Arrangements

On February 2, 2005, our IMN subsidiary received $8.4 million representing its pro rata share of the net funds which were disbursed in connection with the settlement of class action suits against several raw material suppliers.  The class action suits alleged that certain defendants unlawfully agreed to fix prices of certain vitamin products sold in the United States.  IMN’s recovery represented 7.3% of its approved purchases from the settling parties during the period in which the price fixing was alleged. The $8.4 million is included in other income, net, in the accompanying consolidated statement of operations for the nine months ended September 30, 2005.

On April 6, 2005, we entered into a binding settlement agreement of our pending litigation with Princeton BioMeditech Corporation (“PBM”) pursuant to which we paid $2.5 million in resolution of all pending litigation with PBM.  PBM also received an option to permanently settle certain claims against our subsidiary, Applied Biotech, Inc. (“ABI”), that are not part of any pending case in exchange for $1.8 million of collaborative research and development funding from us.  In connection with the settlement, the parties also entered into an agreement to form a joint venture pursuant to which both companies will make all their sales of existing drugs of abuse products (excluding sales to hospitals) (the “New Joint Venture”).  All products sold by the New Joint Venture will be manufactured by PBM.  The New Joint Venture will be owned equally by PBM and us and profits will be distributed in proportion to the trailing 12 month sales of products contributed to the venture.  In connection with this settlement arrangement, we recorded a $4.2 million charge which is included in other income, net, in the accompanying consolidated statement of operations for the nine months ended September 30, 2005.

On April 27, 2005, we entered into a settlement agreement with Quidel Corporation (“Quidel”) terminating all domestic and international intellectual property litigation with them. Under the settlement agreement, we received a net payment of $17.0 million and net future royalties from Quidel at 8.5%, in exchange for a license to all of our current and future patents which embody lateral flow technology for all diagnostic products other than for cardiology testing and for consumer/over-the-counter women’s health (except that diagnostics for women’s infectious diseases are within the licensed field of use). Quidel and its affiliates are granting a net royalty free cross-license of their current and future patents that embody lateral flow technology to us and all of our affiliates for all applications.  The payment of $17.0 million is included in our financial results for the nine months ended September 30, 2005, of which $15.0 million related to periods prior to 2005 and has been included in other income, net and the remainder has been recorded as license revenues.

On June 16, 2005, we entered into a license arrangement with British BioCell International Limited (“British BioCell”).  As part of this agreement, we licensed to them our lateral flow intellectual property for use in certain defined areas not competitive with existing businesses in return for royalties on future sales totaling between 10% and 25% of net revenues, depending on the amounts of revenue earned.  As part of the arrangement, we also received an option to acquire 25% of British BioCell’s parent company, BBI Holdings, PLC, a UK public company.  We valued the option at $2.6 million using the Black-Scholes option pricing model and have included the value received in other income, net, for the nine months ended September 30, 2005. The investment, which is not readily convertible to cash, has been recorded at cost and will be evaluated at least annually for impairment, or more frequently, if events and circumstances indicate.

On September 23, 2005, an arbitrator issued a final award against our IMN subsidiary in favor of Sunlight Distribution, Inc. for damages in the amount of $1.8 million plus interest, fees and costs arising out of a distribution arrangement dated September 1996. We have accrued $2.7 million as of September 30, 2005 to provide for the final award. The corresponding expense was recorded in other income, net, for the nine months ended September 30, 2005.

(14) Recent accounting pronouncements

In November 2004, the FASB issued SFAS No. 151, Inventory Costs, An Amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and wasted materials should be recognized as current period charges in all circumstances. We are required to adopt SFAS No. 151 on January 1, 2006.  We do not expect the adoption of SFAS No. 151 to have a material impact on our consolidated financial statements.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS No. 123R.  SFAS No. 123R 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.  It eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25 and

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generally requires that such transactions be accounted for using a fair-value-based method.  As permitted by the current SFAS No. 123, we have been accounting for share-based compensation to employees using APB Opinion No. 25’s intrinsic value method and, as such, we generally recognize no compensation cost for employee stock options.  Under the original guidance of SFAS No. 123R, we were to adopt the statement’s provisions for the interim period beginning after June 15, 2005.  However, in April 2005, as a result of an action by the Securities and Exchange Commission, companies are allowed to adopt the provisions of SFAS No. 123R at the beginning of their fiscal year that begins after June 15, 2005.  Consequently, we will adopt SFAS No. 123R on January 1, 2006.  We expect that the requirement to expense stock options and other equity interests that have been or will be granted pursuant to our equity incentive program will significantly increase our operating expenses and result in lower earnings per share.  The adoption of SFAS No. 123R will have no impact on our cash flows.

In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary Assets, an Amendment of APB Opinion No. 29, “Accounting for Nonmonetary Transactions.”  SFAS No. 153 is based on the principle that exchange of nonmonetary assets should be measured based on the fair market value of the assets exchanged. SFAS No. 153 eliminates the exception of nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS 153 is effective for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005. We are currently evaluating the provisions of SFAS No. 153 and do not believe that the adoption of SFAS No. 153 will have a material impact on our consolidated financial statements.

In March 2005, the FASB issued FASB Interpretation No. 47 “Accounting for Conditional Asset Retirement Obligations,” which is an interpretation of FASB Statement No. 143, “Accounting for Asset Retirement Obligations.” The interpretation requires a liability for the fair value of a conditional asset retirement obligation be recognized if the fair value of the liability can be reasonably estimated. The interpretation is effective for years ending after December 15, 2005. The interpretation is not expected to have a material impact on our results of operations or financial position.

In May 2005, the FASB issued SFAS No. 154 “Accounting Changes and Error Corrections,” which replaces APB Opinion No. 20 “Accounting Changes,” and FASB Statement No. 3 “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date SFAS No. 154 was issued. At the present time, we do not believe that adoption of SFAS No. 154 will have a material effect on our financial position, results of operations or cash flows.

(15)  Guarantor Financial Information

      We issued $150.0 million in senior subordinated notes (the “Bonds”) to qualified institutional buyers in reliance on Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and outside the United States in compliance with Regulation S of the Securities Act.  Our payment obligations under the Bonds are currently guaranteed by all of our domestic subsidiaries (the “Guarantor Subsidiaries”).  The guarantee is full and unconditional.  Separate financial statements of the Guarantor Subsidiaries are not presented because we have determined that they would not be material to investors in the Bonds. The following supplemental financial information sets forth, on a consolidating basis, the statements of operations and cash flows for the three and nine months ended September 30, 2005 and 2004 and the balance sheets as of September 30, 2005 and December 31, 2004 for our company (the “Issuer”), the Guarantor Subsidiaries and our other subsidiaries (the “Non-Guarantor Subsidiaries”). The supplemental financial information reflects our investments and the Guarantor Subsidiaries’ investments in the Guarantor and Non-Guarantor Subsidiaries using the equity method of accounting.

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

17

INVERNESS MEDICAL INNOVATIONS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENT OF OPERATIONS

For the Three Months Ended September 30, 2005

(unaudited)

(in thousands)