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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

x

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

For the quarterly period ended September 28, 2002
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: 0-27892

SIPEX Corporation

(408) 934-7500
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.

         There were 27,955,682 shares of the Registrant’s common stock issued and outstanding as of October 25, 2002.

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FORM 10-Q
THREE AND NINE MONTHS ENDED SEPTEMBER 28, 2002

INDEX

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Part I: FINANCIAL INFORMATION
Item 1: Financial Statements

SIPEX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)

See accompanying notes to condensed consolidated financial statements

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SIPEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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SIPEX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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SIPEX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation

         The consolidated financial statements include the accounts of Sipex Corporation (the “Company”) and all of its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated.

         The accompanying unaudited financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2001, included in the Company’s Form 10-K filing. The accompanying financial statements reflect all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of results for the interim periods presented and were prepared based upon the accounting policies disclosed in the Company’s Form 10-K. The results of operations for the three and nine month periods ended September 28, 2002 are not necessarily indicative of the results to be expected for the full fiscal year.

         Cash equivalents and short-term investments

         The Company considers all highly liquid debt instruments purchased with an original maturity of 90 days or less to be cash equivalents. Short-term investments consist of commercial paper, are classified as held-to-maturity and accounted for at amortized cost.

2. Significant Accounting Policies

         Recent Accounting Pronouncements

         The FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” effective for fiscal years beginning May 15, 2002 or later that rescinds FASB Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, FASB Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements, and FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. This Statement amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. We are currently examining the effect of this pronouncement on the results of operations and financial position of Sipex, but currently we believe the effect will not be material.

         On July 30, 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. Statement No. 146 is based on the fundamental principle that a liability for a cost associated with an exit or disposal activity should be recorded when it (1) is incurred, that is, when it meets the definition of a liability in FASB Concepts Statement No. 6, “Elements of Financial Statements", and (2) can be measured at fair value. The principal reason for issuing Statement 146 is the Board’s belief that some liabilities for costs associated with exit or disposal activities that entities record under current accounting pronouncements, in particular EITF Issue No. 94-3, do not meet the definition of a liability. Statement 146 nullifies Issue 94-3; thus, it will have a significant effect on practice because commitment to an exit or disposal plan no longer will be a sufficient basis for recording a liability for costs related to those activities. Statement No.146 is effective for exit and disposal activities initiated after December 31, 2002. Early application is encouraged; however, previously issued financial statements may not be restated. An entity would continue to apply the provisions of Issue 94-3 to an exit activity that it initiated under an exit plan that met the criteria of Issue 94-3 before the entity initially applied Statement 146. We are currently examining the effect of this pronouncement on the results of operations and financial position of Sipex.

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3. Goodwill Impairment

         The Company adopted SFAS 142 effective January 1, 2002 and is no longer amortizing goodwill, thereby eliminating annual goodwill amortization of approximately $376,000. Upon adoption of SFAS 142, the Company performed a goodwill impairment test and concluded that there was no indication of impairment and recorded no impairment at January 1, 2002.

         In the second quarter of 2002, the Company experienced significant changed circumstances resulting from the Company’s stock price decrease during the quarter, which reduced the Company’s fair value. These circumstances indicated that the Company’s goodwill might not be recoverable. As a result, the Company performed a goodwill impairment test in accordance with SFAS 142. The results of the impairment test indicated that the full amount of the Company’s goodwill of $3.0 million was not recoverable and was written off. The impairment charge in the second quarter of 2002 compared with the nine month goodwill amortization of $284,000 during the first nine months of 2001.

         The proforma effects of the adoption of SFAS 142 on net income and earnings per share for the Company for the three and nine months ended September 29, 2001 is as follows (in thousands):

4. Long-term Debt

         As of September 28, 2002, long-term debt consisted of a convertible secured note amounting to approximately $10,379,000.

         Bank Line-of-Credit:

         On April 16, 2002, the outstanding bank line of credit balance of $6.9 million was paid down to zero using proceeds from the private placement of Company common stock (see Note 8). On September 27, 2002, the Company terminated its line of credit agreement with its bank. The bank’s security interest in substantially all the Company’s assets was subsequently released.

         Convertible Secured Note:

         On September 27, 2002, Sipex sold a convertible secured note (the note) with an attached warrant to an affiliate of an existing commercial partner (largest distributor) of the Company for an aggregate cash amount of $12.0 million. The Company recorded the note at $10.4 million and the warrant at $1.6 million (recorded to paid in capital) based upon their estimated fair values at the date of issuance using the Black-Scholes option pricing model. The note pays a 5.75% coupon and is convertible after one year into Sipex common stock at a conversion price of $7.50 per share. Following the one year anniversary of the issuance of the note, the Company can require the conversion of the note in installments if for a period of time Sipex common stock trades at a price in excess of 150% of the conversion price of $7.50. The private placement also included a warrant to purchase 900,000 shares of Sipex common stock exercisable for a two-year period beginning on the one-year anniversary of the date of issuance. The exercise price for the warrant is equal to 110% of the average closing price for the 5 days preceding the closing or $2.9458. The note is secured by a Deed of Trust on the Company’s land and building at Milpitas, California.

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5. Net Income (Loss) Per Share

         Net income (loss) per share-basic is based upon the weighted average number of common shares outstanding. Net income (loss) per share assuming dilution is based upon the weighted average number of common and common equivalent shares outstanding assuming dilution. Common equivalent shares, consisting of outstanding stock options and warrants, are included in the per share calculations where the effect of their inclusion would be dilutive.

         A reconciliation of basic weighted average common shares with weighted average shares assuming dilution is as follows (in thousands):

6. Valuation and Qualifying Accounts

         The Company had the following activity for the nine month period ended September 28, 2002 in the inventory and accounts receivable allowances:

7. Income Taxes

         In the second quarter of 2002, the Company established a full valuation allowance and incurred a tax charge of $33.8 million for its deferred tax assets, which included significant net operating loss and tax credit carryforwards. The valuation allowance was established as the Company no longer believes that it is more likely than not that the net operating loss and tax credit carryforwards will be realized in the carryforward period. This change in estimate during the second quarter of 2002 was based on updated evaluations considering historical taxable income levels and expectations of future taxable income. For the first nine months of 2001, the Company recorded an income tax benefit at a 39% effective rate. The Company recorded the tax benefit for the 2001 period and the related increase in deferred tax assets, as it believed it was more likely than not, considering the level of historical taxable income and expectations for future taxable income, that the operating loss would be utilized in the future to offset taxable income.

8. Stockholders’ Equity

         On April 16, 2002, the Company issued 3.0 million shares of common stock through a private placement of securities, resulting in proceeds to the Company of approximately $23.4 million, net of placement agent fees and other costs related to the issuance. Proceeds from the offering of $6.9 million were used to pay down the Company’s bank line of credit to zero and the balance of $16.5 million was used to provide funding for general corporate purposes.

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         On October 10, 2002, the Company made a Tender Offer to exchange options to purchase an aggregate of 2,495,052 shares of the Company’s common stock, whether vested or unvested, that have been granted under its 1996 Incentive Stock Option Plan, 1997 Stock Option Plan, 2000 Non-Qualified Stock Option Plan, 2002 Nonstatutory Stock Option Plan and certain stand-alone Option Plans that have exercise prices greater than $7.50 per share and that are held by eligible employees. The option exchange offer, including all withdrawal rights, expired at 5 p.m. Pacific Time, on Friday, November 8, 2002. Pursuant to the terms and conditions of the option exchange offer, a total of 60 eligible optionees participated in the option exchange program. On November 11, 2002, the Company accepted for cancellation options to purchase 570,174 shares of its common stock. Subject to the terms and conditions of the offer, the Company will grant new options to purchase 263,380 shares of its common stock on May 12, 2003 in exchange for the options tendered and accepted. The exercise price of the new options will be the fair market value of the Company's common stock on the new grant date. The new options will be vested as to 25% of the shares on the date of the new grant, and thereafter will vest as to 25% of the shares on each subsequent anniversary of the new option grant date.

9. Restructuring, Reorganization, Impairment and Facility Exit Costs

         Fiscal 2002

         Below is a summary of the activity related to restructuring costs:

         In the third quarter of 2002, Sipex incurred restructuring costs of $5.7 million, an impairment charge of $1.8 million and $1.6 million of reorganization charges. In September 2002, Sipex announced a plan to close the Company’s 4” wafer fabrication facility in San Jose, California and reduce the production output of the 6” wafer fabrication facility in Milpitas, California by moving to a modified five day per week work schedule from the seven day per week operation.

         Total third quarter restructuring charges related to these actions were $5.7 million, which consisted of $256,000 of severance costs related to an approximate 50 employee reduction in force at both manufacturing facilities, $1.9 million in net write-offs of inventory for the discontinued analog display and hybrid product families, $661,000 of facilities exit costs consisting principally of the remaining lease payments at the San Jose fabrication facility and $2.9 million of fabrication equipment which was written off. The fabrication equipment written off consisted of equipment on the Company’s 4” manufacturing product line, which was used mainly in the production of the discontinued analog display wafers and excess equipment on the Company’s 6” line. In addition to the restructuring charges, an impairment charge of $1.8 million was also incurred for the write down to fair value of the machinery and equipment at the San Jose fabrication facility which is scheduled to be closed by the end of the first quarter of 2003.

         Severance costs are planned to be paid mainly during the fourth quarter of 2002 for the Milpitas fabrication facility and during the first quarter of 2003 for the San Jose fabrication facility. Facility related costs extend out through the fourth quarter of 2004 for recurring lease costs.

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         The sale of the Company’s hybrid product family in the third quarter of 2002 included a minimum level of royalty payments to be paid annually to the Company for a three year period totaling $400,000. Revenue will be recognized as received for these royalties due to the length of time and related uncertainties affecting their ultimate receipt.

         Sipex also implemented a plan to reorganize the structure of the Company into six functional groups. Changes in management related to this reorganization resulted in a $1.6 million charge for severance and related costs to six former management employees. The majority of these costs are expected to be paid during the Company’s 2002 fourth quarter.

         In the fourth quarter of 2002, Sipex announced a plan to close its test operations in Billerica, Massachusetts, which will be transferred to current subcontractors in Malaysia. This restructuring will result in severance costs related to the termination of approximately 45 employees and will include the write off of test equipment and the accrual of other facility related costs.

         Fiscal 2001

         The following table summarizes the accrual activity in facility exit costs for the nine-month period ended September 29, 2001:

         In the second quarter of 2001, the Company recorded a restructuring charge of $494,000 for severance payments related to the reduction of the Company’s workforce by approximately 65 people as a result of the continued slowness in the semiconductor market. As of September 29, 2001, approximately $416,000 had been paid and the balance of the accrual for restructuring of $78,000 was paid in the fourth quarter of 2001.

         During the first quarter of 2001, Sipex accrued $40,000 for severance costs for an approximate 4% reduction in the Company’s workforce at the Company’s Milpitas facility, which was paid in the second quarter of 2001.

         At the end of the first quarter of 2001, Sipex sold the Calogic Fremont fabrication facility, which was planned for closure by the end of the quarter. As a result of the sale, the Company reduced both the facility exit related and employee termination portions of the accrual due to the assumption of the facility by the new owners who retained many of the employees to whom the Company had planned to pay severance costs.

         In the fourth quarter of 1999, Sipex announced a plan to close certain manufacturing facilities in California, which were acquired through a merger with Calogic. The remaining balance of the accrual as of December 31, 2000 was $506,000, consisting of $133,000 of employee termination costs and $373,000 of facility exit related costs.

10. Legal Proceedings

         Azzam Abdo filed an arbitration claim against the Company in the forum of the American Arbitration Association (No. 74-181-00291-01 SAT) stemming out of the Company’s acquisition by merger of Calogic in November of 1999. In the arbitration claim, Mr. Abdo asserted that he had a one-third ownership interest in an unincorporated division of Calogic and that he was entitled to a pay-out of one-third of the “assets” of the division because the merger took place. An arbitration was conducted in November 2002 and Mr. Abdo claimed an entitlement to $2,165,000, interest at 10% from November 1999 and costs. Sipex denied each of Mr. Abdo’s claims and vigorously defended against these claims in the arbitration. A decision is expected by approximately December 6, 2002. The results of any litigation or arbitration are inherently uncertain, and Sipex can offer no assurance that Sipex will prevail. If Sipex does not prevail, then we would be required to pay cash damages and our liquidity could be adversely affected.

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

         From time to time, information provided by us, statements made by our employees or information included in our filings with the Securities and Exchange Commission (including in this Form 10-Q) may contain statements which are not historical facts. Such statements are “forward-looking statements”, and are made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. In particular, certain statements contained in the Management’s Discussion and Analysis of Financial Condition and Results of Operations and Factors Affecting Future Results sections below that are not historical facts (including, but not limited to, statements concerning anticipated availability of cash for working capital and for capital expenditures, and statements regarding revenue recognition policies, including estimates of future returns) constitute “forward-looking” statements. Such statements are not promises or guarantees and are subject to risks and uncertainties that may cause our actual future results to differ materially from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below and the other risks discussed in our other filings with the Securities and Exchange Commission. The following discussion should be read in conjunction with the financial statements and notes to the financial statements included in this Form 10-Q, as well as the Management Discussion and Analysis of Financial Condition and Results of Operations contained in our most recent Form 10-K. We caution you not to place undue reliance on the forward-looking statements contained in this Form 10-Q, which speak only as of the date hereof. Sipex disclaims any obligation to publicly update or revise any such statements to reflect any change in expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

Overview

         We are a semiconductor company that designs, manufactures and markets, high performance, value-added analog integrated circuits, primarily for original equipment manufacturers doing business in the high growth markets of networking, computing and communications. Our product families: power management, serial interface, and optical storage constitute a broad, synergistic portfolio of standard analog ICs that address specific applications in desktop and portable computers, optical storage, handheld digital peripherals such as PDAs, cell phones and digital still cameras, and network and telecommunications infrastructure. The Company’s analog display family is being discontinued in the fourth quarter of 2002.

Results of Operations

         The table below presents the statements of operations for the three and nine month periods ended September 28, 2002 and September 29, 2001, as a percentage of net sales and provides the percentage increase of such items comparing the interim periods ended September 28, 2002 to the corresponding period from the prior fiscal year.