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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

OR

Commission file number 0-28194

DIGENE CORPORATION

Registrant’s telephone number, including area code (301) 944-7000

(Former name, former address and former fiscal year, if changed since last report)

     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 [X] No [   ]

     Indicate by check mark whether Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes [X] No [   ]

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

DIGENE CORPORATION

INDEX TO FORM 10-Q

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PART I. Consolidated Financial Information

Item 1. Consolidated Financial Statements

DIGENE CORPORATION
CONSOLIDATED BALANCE SHEETS

See accompanying notes.

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DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.

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DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.

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DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The consolidated financial statements of Digene Corporation (the “Company” or “Digene”) for the three-month periods ended September 30, 2003 and 2002 are unaudited and include all adjustments which, in the opinion of management, are necessary to present fairly the results of operations for the periods then ended. All such adjustments are of a normal recurring nature. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended June 30, 2003 filed with the Securities and Exchange Commission.

The results of operations for any interim period are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year.

2. Inventories

Inventories are stated at the lower of cost or market.

Inventories consist of the following:

3. Stock-Based Compensation

The Company recognizes expense for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, compensation cost is recognized for the excess of the estimated fair value of the stock at the grant date over the exercise price, if any. The Company accounts for equity instruments issued to non-employees in accordance with EITF 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods, or Services.

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In accordance with Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, the effect on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation is as follows:

These pro forma amounts are not necessarily indicative of future effects of applying the fair value-based method due to, among other things, the vesting period of the stock options and the fair value of the additional stock options issued in future years.

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4. Comprehensive Income

Comprehensive income for the three months ended September 30, 2003 and 2002 was as follows:

5. Warranties

The Company offers its customers extended warranties on its equipment. The revenues from these extended warranties are deferred and are recognized evenly over the life of the extended warranty. Changes in the Company’s deferred extended warranty revenue during the period are as follows:

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the related Notes thereto included elsewhere in this report and in our Annual Report on Form 10-K for the year ended June 30, 2003. Some of the information that follows are not statements of historical fact, but merely reflect our intent, belief or expectations regarding the anticipated effect of events, circumstances and trends. Such statements should be considered as forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We believe that our expectations are based on reasonable assumptions within the bounds of our knowledge of our business and operations. Factors that might cause or contribute to differences between our expectations and actual results include: uncertainty of market acceptance of our products by the worldwide medical community; our ability to scale up our manufacturing to the extent product sales increase; dependence on third-party reimbursement from government entities, managed care organizations, and private insurance plans; risk that other companies may develop and market HPV tests competitive with our own; uncertainty regarding patents and propriety rights in connection with our products and products in development; uncertainty as to ongoing litigation; our limited sales and marketing experience; the extent of future expenditures for sales and marketing programs; uncertainty of clinical trial results for our products in development; delay in or failure to obtain regulatory approvals for our products in development; uncertainty of future profitability and cash generation from operations; our ability, if necessary, to obtain requisite additional financing to fund our operations beyond fiscal year 2004; risks inherent in international transactions, including those relating to our expansion in Europe and elsewhere; and other factors as set forth under the caption “Additional Considerations” in our Annual Report on Form 10-K for the year ended June 30, 2003.

Overview

Since our incorporation in 1987, we have devoted substantially all of our resources to developing, manufacturing and marketing our proprietary gene-based testing systems using our patented Hybrid Capture^® technology for the screening, monitoring and diagnosis of human diseases. Since our inception, we have incurred substantial operating losses, resulting principally from expenses associated with our research and development programs, including preclinical studies, clinical trials and regulatory submissions for our products, the expansion of our manufacturing facilities and our global sales and marketing activities.

Our revenues to a significant extent have been derived from the sales of our HPV Tests, which, for fiscal year 2003, accounted for 81% of total revenues and, for the three months ended September 30, 2003, accounted for 84% of total revenues. We expect that the growing acceptance of our HPV tests in both the United States and abroad will continue to drive the growth in revenues from our HPV Tests and testing services in the future.

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In fiscal 2003, our gross margins improved substantially over the prior fiscal year. In the current fiscal year, we believe that we will be able to sustain gross margins consistent with, or better than, fiscal 2003 as we continue to scale up our manufacturing operations and realize expanded margins as a result of our direct distribution efforts in Europe.

We believe that increasing our investment in sales and marketing and focusing our investment in research and development is essential to allow us to capitalize more fully on the potential of our HPV Test and our core technology. We expect to invest heavily in our European distribution operation during fiscal 2004 and beyond while also expanding our direct sales organization in the United States. We expect to moderately increase our expenditures in the development of our next-generation Hybrid Capture platforms and clinical trial activities for human papillomavirus screening in fiscal 2004 as compared to fiscal 2003.

Our sales and marketing expenditures have been and will continue to be focused on accelerating the adoption of human papillomavirus testing worldwide. We intend to capitalize on the growing acceptance of our HPV Tests in the United States and internationally by physicians, laboratories and health insurance providers by materially increasing expenditures on sales and marketing over the next several quarters. The increase in expenditures will be primarily directed at expanded direct sales and marketing efforts in Europe and the United States.

We expect our general and administrative expenses will increase to provide adequate infrastructure to support greater sales and marketing activities and more focused research and development activities, to pay the anticipated expenses associated with our ongoing litigation matters and to support the overall growth of our business.

We anticipate that the increase in our gross margins will more than offset these increases in expenditures, and we expect the operating profits which we experienced for the first time at the end of fiscal 2003 to continue through fiscal 2004. There can be no assurance that we will meet this goal.

Results of Operations

Product sales increased 57% to approximately $19,492,000 for the three-month period ended September 30, 2003 from approximately $12,397,000 for the corresponding period in 2002. The increase was due primarily to a 66% growth in sales of our HPV Tests and testing services over such sales in the corresponding period in 2002. The majority of the growth in HPV products sales was in the United States (61% over such sales in the corresponding period in 2002).

Other revenues include research and development contract revenues, equipment rental revenues and licensing revenues. Other revenues decreased 43% to approximately $126,000 for the three-month period ended September 30, 2003 from approximately $220,000 for the corresponding period in 2002. The decrease was due primarily to the partial recognition of equipment sales in Europe during the three-months ended September 30, 2002, which were initially deferred in the fourth quarter of fiscal 2002, related to the Company’s distribution contract with Roche Molecular Systems, Inc. (“Roche”). In fiscal 2003 the Company entered into an agreement and repurchased equipment from Roche.

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Cost of product sales increased by 7% to approximately $3,386,000 for the three-month period ended September 30, 2003 from approximately $3,175,000 for the corresponding period in 2002. Gross margin product sales increased to 83% for the three-month period ended September 30, 2003 from 74% for the corresponding period in 2002. The increase in gross margin percentage was due primarily to increased sales of our test products, particularly HPV Tests, principally in the United States. In addition, European margins increased due to substantially lower sales of equipment, which have lower margins than our test products, and pricing increases arising from our ability to sell directly to lab customers as a result of our change to a primarily direct sales approach in the region. The cost of product sales for the three-months ended September 30, 2002 included a charge of approximately $375,000 for damaged products taken as a result of a refrigeration equipment failure, which represented the loss in excess of the expected insurance claims.

Research and development expenses increased 40% to approximately $2,855,000 for the three-month period ended September 30, 2003 from approximately $2,040,000 for the corresponding period in 2002. The majority of the increase was due to a 305% increase in professional services expenses to $754,000, primarily related to costs incurred in preparation for compliance with the European Union In Vitro Diagnostic Directive (or “IVDD”) regulations and costs related to clinical trials. Our research and development activities focus on our platform technology, including different or modified uses of such technology, and improvements to our diagnostic test and equipment products. Because our research and development expenditures tend to benefit multiple product offerings, we do not account for research and development expenses on a per-product or per-disease target basis.

During the three-month period ended September 30, 2003, we focused our research and development activities in four areas: completing regulatory activities to add new claims and indications to existing products in the U.S. and abroad, support and improvement of existing product lines, new product development, and core research efforts for next-generation technologies.

The clinical validation of the procedural modification to our Hybrid Capture 2 assay, designed to improve test robustness, has concluded and was submitted to the U.S. Food and Drug Administration (“FDA”) in September 2003. The development and validation of our Rapid Capture^TM System for automated processing of Hybrid Capture HPV Tests has also concluded with the completion of a multi-center clinical trial and submission of a Pre-Market Approval Supplement in November 2003. Both claims will expand existing indications on our HPV Tests once approved by the FDA. Clinical trials to validate the use of chlamydia (“CT”)/gonorrhea (“GC”) testing from Cytyc Corporation’s ThinPrep^® specimens have also been completed.

We have completed the development of a software improvement for our Rapid Capture System to permit the simultaneous testing of multiple DNA-probes and to improve the related laboratory processes and procedures. We have also completed the development of instrumentation and protocols to allow for increased processing and throughput of specimens for HPV testing.

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Our ongoing product development efforts to discover innovative methods to improve specimen processing procedures and throughput, including procedures for the improved processing of PreservCyt^TM (Cytyc Corporation) specimens for high throughput HPV, CT, and GC testing are ongoing. We are continuing development efforts to expand HPV Testing capabilities to testing from additional liquid cytology media, including our Universal Collection Medium (“UCM^TM”) and SurePath^TM (TriPath Imaging) medium. Our UCM development efforts are ongoing; UCM is expected to allow simultaneous testing for HPV, CT/GC and of other genetic and cellular material from a single patient sample.

We are continuing and expanding several research programs with the goal of developing improved molecular diagnostic assay systems for the detection of HPV and other targets of interest in the area of women’s cancers and infectious diseases, and research is continuing on our next generation of Hybrid Capture technology.

Selling and marketing expenses increased 39% to approximately $8,413,000 for the three-month period ended September 30, 2003 from approximately $6,036,000 for the corresponding period in 2002. The increase was due primarily to personnel costs, which increased 38% to approximately $2,694,000; various marketing programs, which increased 7% to approximately $1,600,000; agency fees, which increased 89% to approximately $1,075,000; professional fees, which increased 193% to approximately $732,000 and includes approximately $225,000 of stock compensation expense; and conferences, which increased from approximately $4,000 to approximately $276,000. The increase in agency fees relates to our agreement with PDI, Inc. which has recruited a Digene-specific physician detailing sales organization dedicated to educating physicians about the benefits of the DNAwithPap^TM Test in the U.S.

General and administrative expenses increased 2% to approximately $4,169,000 for the three-month period ended September 30, 2003 from approximately $4,085,000 for the corresponding period in 2002. The increase was primarily attributed to personnel costs, which increased 63% to approximately $2,124,000. This increase was largely offset by a 31% decrease in professional fees, which decreased to $1,565,000 versus $2,262,000 for the same period in 2002, principally attributable to decreased legal fees associated with our litigation with Ventana Medical Systems, Inc. and with Enzo Biochem, Inc. and its subsidiary, Enzo Diagnostics, Inc.

Interest income decreased 50% to approximately $90,000 for the three-month period ended September 30, 2003 from approximately $179,000 for the corresponding period in 2002. The decrease was primarily due to lower interest rates in the first three months of fiscal 2004 compared to the corresponding period in fiscal 2003.

Other income (expense) consists primarily of foreign exchange gains and losses. For the three-month period ended September 30, 2003 Other expense was approximately $18,000 compared to Other income of approximately $56,000 for the corresponding period in 2002.

Liquidity and Capital Resources

Since inception, our expenses have significantly exceeded our revenues, resulting in an accumulated deficit of approximately $75,033,000 at September 30, 2003. We have funded our

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operations primarily through the sale of equity securities and revenues from product sales and research and development contracts. At September 30, 2003, we had cash, cash equivalents and short-term investments aggregating approximately $37,794,000. We had negative cash flows from operations of approximately $1,534,000 for the three months ended September 30, 2003 due primarily to an increase in accounts receivable of approximately $1,938,000, due to increased sales, and a decrease in accounts payable due to our final payment under the Co-Promotion Agreement with Cytyc Corporation (“Cytyc”) which expired on June 30, 2003. Our negative cash flows from operations of approximately $5,257,000 for the three months ended September 30, 2002 were primarily the result of our scheduled payment to Cytyc under the Co-Promotion Agreement during that period and non-recurring payments to professionals related to our terminated merger transaction with Cytyc.

We anticipate that working capital requirements will increase moderately for the foreseeable future due to the investment necessary to support our European direct distribution operations, as well as increasing accounts receivable as a result of expected revenue growth. We have incurred negative cash flows from operations since our inception, and have expended, and expect to continue to expend in the future, substantial funds to complete our planned product development efforts, expand our sales and marketing activities and expand our manufacturing capabilities. We expect that our existing capital resources will be adequate to fund our operations through fiscal 2004. Our future capital requirements and the adequacy of available funds may change, however, based on numerous factors, including our degree of success in commercializing our products, progress in our product development efforts and the magnitude and scope of such efforts, progress with preclinical studies and clinical trials, progress in our regulatory affairs activities, the cost and timing of expansion of our manufacturing capabilities, the development and maintenance of effective sales and marketing activities, the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, competing technological and market developments, and the development and maturation of strategic alliances for the marketing of our products. To the extent that our existing capital resources and funds generated from operations are insufficient to meet current or planned operating requirements, we will be required to obtain additional funds through equity or debt financing, strategic alliances with corporate partners and others, or through other sources. We do not have any committed sources of additional financing, and there can be no assurance that additional funding, if necessary, will be available on acceptable terms, if at all. If adequate funds are not available, we may be required to delay, scale back or eliminate certain aspects of our operations or attempt to obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies, product candidates, products or potential markets. Under such conditions, our business, financial condition and results of operations will be materially adversely affected.

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We have summarized below our material contractual obligations as of September 30, 2003 (in thousands):

(1)  Includes debt payable to Roche Molecular Systems and Abbott Laboratories related to the repurchase of equipment in prior periods.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are subject to market risk associated with changes in foreign currency exchange rates and interest rates. Our exchange rate risk comes from our operations in Europe and South America. The net impact of foreign exchange activities on earnings was immaterial for the three-month periods ended September 30, 2003 and 2002, respectively. Interest rate exposure is primarily limited to the approximately $37,795,000 of cash, cash equivalents and short-term investments owned by us. Such investments are money market debt securities that generate interest income for us on cash balances. We do not actively manage the risk of interest rate fluctuations; however, such risk is mitigated by the relatively short-term nature of our investments. We do not consider the present rate of inflation to have a significant impact on our business.

Item 4. Controls and Procedures

Our management, under the supervision and with the participation of the principal executive officer and principal financial officer, have evaluated the effectiveness of our controls and procedures related to our reporting and disclosure obligations as of September 30, 2003, which is the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the principal executive officer and principal financial officer have concluded that these disclosure controls and procedures are sufficient to provide that (a) material information relating to us, including our consolidated subsidiaries, is made known to these officers by other employees of us and our consolidated subsidiaries, particularly material information related to the period for which this periodic report is being prepared; and (b) this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the rules and forms promulgated and adopted by the Securities and Exchange Commission.

There were no changes that occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonable likely to materially affect, our internal controls over financial reporting.

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PART II. Other Information

Item 1. Legal Proceedings

On November 19, 2001, we filed an action for patent infringement against Ventana Medical Systems, Inc. The action was filed in the United States District Court for the District of Delaware. In the action, we allege that Ventana Medical Systems, Inc. has made, used, sold and/or offered for sale products embodying our patented inventions thereby infringing our United States Patent No. 4,849,332 entitled “Human Papilloma Virus 35 Nucleic Acid Hybridization Probes and Methods for Employing the Same” and our United States Patent No. 4,849,331 entitled “Human Papilloma Virus 44 Nucleic Acid Hybridization Probes and Methods for Employing the Same.” We are seeking a permanent injunction and monetary damages for past infringement. On September 25, 2002, Ventana Medical Systems, Inc. publicly announced that it had acquired Beckman Coulter, Inc.’s human papillomavirus business and corresponding assets, including the assignment of the human papillomavirus intellectual property portfolio acquired by Beckman Coulter, Inc. from Institut Pasteur through a 1991 sublicense agreement. On October 18, 2002, we filed a motion to amend our complaint to add Beckman Coulter, Inc. as a co-defendant, as well as additional claims against Ventana. On March 5, 2003, the Court granted our motion to amend. No trial date has been set in this matter.

On March 15, 2002, we filed an action for declaratory judgment against Enzo Biochem, Inc. The action was filed in the United States District Court for the District of Delaware. We filed this action after having received direct threats from Enzo Biochem of infringement of U.S. Patent No. 6,221,581 entitled “Processes for Detecting Polynucleotides, Determining Genetic Mutations or Defects in Genetic Material, Separating or Isolating Nucleic Acid of Interest from Samples, and Useful Compositions of Matter and Multihybrid Complex Compositions.” We are seeking a judgment that the patent is invalid and has not been infringed by us. On March 20, 2002, in response to our complaint, Enzo Biochem filed a motion to dismiss our complaint for lack of subject matter jurisdiction, based on assertions that Enzo Diagnostics, Inc. (a wholly owned subsidiary of Enzo Biochem), not Enzo Biochem, was the holder of the patent in question. On the same day, Enzo Diagnostics, Inc. also filed a complaint for patent infringement against us in the Delaware District Court. Enzo Diagnostics, Inc. asserts in its complaint that we have infringed U.S. Patent No. 6,221,581 through the manufacture, sale and offer for sale of our Hybrid Capture products. The two cases have now been consolidated and discovery has commenced. We have filed counterclaims against Enzo Biochem for various business-related tortious conduct. The Court has denied Enzo Biochem’s motion to dismiss our counterclaims and has granted Digene’s motion to amend our counterclaims to include inequitable conduct claims. We do not believe we are infringing such patent and will go forward with the action for declaratory judgment and continue vigorously defending against Enzo’s claim of patent infringement. The Court has indicated that a trial in this matter will be held on March 22, 2004.

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Item 4. Submission of Matters to a Vote of Security Holders

The following is a summary of the final voting results from the October 30, 2003 annual meeting of stockholders of Digene. The number of shares present in person or by proxy at the annual meeting were 17,215,173, or 92.8% of the outstanding shares of common stock.

     1.     Election of Directors.

     Two of Digene’s six directors had terms that expired and stood for re-election at the annual meeting for three year terms expiring in 2006. The two directors received a majority of the votes necessary for re-election and are listed below:

Name				Votes For				Withheld Authority
	John H. Landon				15,990,980				1,224,193
	John J. Whitehead				16,050,308				1,164,865

     The following directors’ terms continued after the meeting: Charles M. Fleischman, Evan Jones, Joseph M. Migliara and Cynthia Sullivan.

     2.     Approval of an Amendment to the Amended and Restated 1999 Incentive Plan.

     Digene proposed an amendment to its Amended and Restated 1999 Incentive Plan to increase the number of shares of common stock issuable under the Plan from 4,000,000 to 4,900,000 shares. The proposal received the affirmative vote of a majority of the votes present and entitled to be cast on the matter.

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Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits:

(b) Reports on Form 8-K:

Digene filed the following Current Reports on Form 8-K during the quarter ended September 30, 2003:

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SIGNATURES

Pursuant to the requirements 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.

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EXHIBIT INDEX

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