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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-K (Mark One)  [X]
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 2004 OR  [  ]
    
    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 0-28194 DIGENE CORPORATION 
  Delaware
    
    52-1536128(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)1201 Clopper RoadGaithersburg, Maryland
    
    20878(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (301) 944-7000 Securities registered pursuant to Section 12(g) of the Act:
    
    Common Stock, par value $.01 per share(Title of Class)
 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [  ] As of December 31, 2003, the aggregate market value of the voting stock
held by non-affiliates of the registrant was approximately $599,174,040. Such
aggregate market value was computed by reference to the closing price of the
Common Stock as reported on the NASDAQ National Market on December 31, 2003. As of September 3, 2004, 19,893,076 shares of the registrants Common
Stock were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference in this
Report on Form 10-K: 1) The registrants definitive Proxy Statement for its Annual Meeting of
Stockholders to be filed not later than 120 days after the close of the fiscal
year (incorporated into Part III).




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Table of Contents PagePART IItem 1.
    
    Business
    
    
    1Risk Factors
    
    
    25Item 2.
    
    Properties
    
    
    34Item 3.
    
    Legal Proceedings
    
    
    34Item 4.
    
    Submission of Matters to a Vote of Our Stockholders
    
    
    35PART IIItem 5.
    
    Market for Our Common Equity and Related Stockholder Matters
    
    
    37Item 6.
    
    Selected Consolidated Financial Data
    
    
    38Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    39Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    49Item 8.
    
    Financial Statements and Supplementary Data
    
    
    50Item 9.
    
    Changes In and Disagreements With Accountants On Accounting and Financial Disclosure
    
    
    76Item 9A.
    
    Controls and Procedures
    
    
    76Item 9B.
    
    Other Information
    
    
    76PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    77Item 11.
    
    Executive Compensation
    
    
    77Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    77Item 13.
    
    Certain Relationships and Related Transactions
    
    
    77Item 14.
    
    Principal Accountant Fees and Services
    
    
    77PART IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    78
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PART I ITEM 1. BUSINESS Overview We develop, manufacture and market our proprietary gene-based diagnostic
tests for the screening, monitoring and diagnosis of human diseases. Our
primary focus is in womens cancers and infectious diseases. We have applied
our proprietary Hybrid Capture® technology to develop a successful diagnostic
test for human papillomavirus (HPV), which is the primary cause of cervical
cancer and is found in greater than 99% of all cervical cancer cases. We have
created, and are continuing to expand, the worldwide market for HPV testing. Our patented Hybrid Capture platform has been optimized for
high-throughput, cost-effective cervical cancer screening and other gynecologic
applications. Hybrid Capture is a signal amplification technology that
combines the convenience of a direct probe test with the sensitivity of an
amplification test, requires minimal sample preparation and provides
reproducible, objective test results. Our HPV testing products, which are the only FDA-approved tests for the
detection of human papillomavirus, are each a reproducible, objective test for
the primary cause of cervical cancer. Our HPV testing products are not limited
by the subjective nature or visual limitations of cytology and can be used to
predict the risk of developing cervical cancer. On
March 31, 2003, the FDA approved the use of our hc2 High-Risk HPV DNA
Test, also called the DNAwithPap Test, as a primary adjunctive cervical cancer
screening test to be performed in conjunction with the Pap test for women age
30 and older. We intend to establish it as the primary screen for cervical
disease, initially in conjunction with the Pap test and later independent of
the Pap test. The DNAwithPap Test, together with the Pap test, has excellent
diagnostic capabilities. Internationally, we are working to replace the Pap
test with our HPV testing products for stand-alone primary cervical cancer
screening. Our
hc2 HPV Test is also FDA-approved as a follow-up to an equivocal Pap
test result for all women, independent of age. In addition to our HPV test products, our diagnostic test products
portfolio includes gene-based tests for the detection of chlamydia, gonorrhea,
cytomegalovirus and hepatitis B virus. We also develop and sell to clinical
laboratories the equipment, instrumentation and accessories used to perform
clinical specimen testing with our diagnostic tests. In May 2004, the FDA
approved the use of our Rapid Capture® System, an automated processing system
that performs over 350 tests in a single six and one-half hour laboratory
shift, for use with our diagnostic tests for human papillomavirus, chlamydia
and gonorrhea. On July 31, 2003, The American College of Obstetricians and Gynecologists
(ACOG) published new recommendations for cervical cancer screening that include
the use of an FDA-approved high-risk HPV DNA test for women age 30 and older.
Our DNAwithPap Test is the only FDA-approved high-risk HPV DNA test. The new ACOG recommendations provide two options for women age 30 and
older:  
    
    The combined use of a cervical cytology test and an
FDA-approved test for high-risk types of HPV. Under this option
women age 30 and older receive both a cervical cytology test and a
genetic test that looks for certain high-risk types of the HPV known to




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cause cancer (an HPV DNA test). Once a woman tests negative on
both tests she should be rescreened with the combined tests no more
frequently than every three years. If only one of the tests is
negative, however, more frequent screening will be necessary.  
    
    Testing using cervical cytology alone. If a woman age
30 or older has negative results on three consecutive annual
cervical cytology tests, then she may be rescreened with cervical
cytology alone every two to three years. The ACOG recommendations stressed that more frequent cervical cancer
screening may be required for higher-risk women who are infected with HIV, are
immunosuppressed (such as those receiving organ transplants), were exposed to
diethylstilbestrol, or DES, in utero, or were previously diagnosed with
cervical cancer. Regardless of the frequency of cervical cancer screening,
annual gynecologic examinations, including pelvic exams, are still recommended. During our fiscal year that ended June 30, 2004, we focused our efforts on
the commercial launch of our DNAwithPap Test, with emphasis in the United
States and Europe, and the receipt of approval for, and commercial launch of,
our Rapid Capture system in the United States. Our goal is to become a global leader in gene-based testing systems for
womens cancers and infectious diseases. Our strategy is to leverage our
position as a pioneer in the human papillomavirus testing market and our Hybrid
Capture technology to develop additional tests for the early detection of
disease. We have established relationships with clinical laboratories,
physicians and other healthcare professionals, developed primarily through our
HPV test product marketing efforts, which will help us to sell our products. Diagnostic Testing Diagnostic tests are used to inform physicians of the presence of a
disease or a disease-causing agent and provide critical information necessary
for treatment. Diseases today are primarily classified based on physiological
symptoms and indirect measurements that are obtained using conventional
diagnostic methods and often bear little relationship to the underlying
mechanism or cause of the disease. In many cases, conventional diagnostic tests also lack the clinical
sensitivity and specificity to provide definitive diagnoses during the early
stages of disease. Sensitivity is typically the measure of a tests ability to
accurately detect the presence of disease. A false negative test result occurs
when a patient who has disease is given a negative or normal diagnosis.
Specificity is typically the measure of a tests ability to exclude the
possibility of disease when it is not present. A false positive test result
occurs when a patient who does not have disease is given a positive or abnormal
diagnosis. We believe sensitivity and specificity can be greatly enhanced by
using gene-based information. We expect gene-based diagnostic tests will create a fundamental shift in
both the practice of medicine and the economics of the diagnostics industry.
Gene-based diagnostic tests will create an increased emphasis on preventative
molecular medicine. Physicians will be able to use these tests for the early
detection of disease and to treat patients on a personalized basis, allowing
them to select the most effective therapy with the fewest negative side
effects. We believe the higher accuracy and sensitivity of our tests may reduce the
overall patient management costs and eliminate costs associated with late
diagnosis of disease, equivocal test results and false negative diagnoses.
This potential for cost reduction arises because the higher accuracy reduces
the need for follow-up exams, allows healthcare resources to be focused on
patients who have, or are at a higher risk of developing, disease and avoids
the expenditure of resources on those patients at least risk.
In addition, the simple form and automation capabilities of our tests
allow ease of laboratory use, reducing overall processing costs. 2




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Traditional Diagnostic Testing in Cervical Cancer Screening.Worldwide,
cervical cancer affects over 400,000 women annually and, after breast cancer,
is the second most common malignancy found in women. The treatment of cervical
cancer after it reaches the advanced stage may require chemotherapy, radiation
treatment or surgery, including hysterectomy. If detected in the precancerous
stage, a vast majority of cervical cancer cases are preventable. The United
States has a relatively low incidence of cervical cancer due to widespread use
of cervical cancer screening and significant expenditures on screening
infrastructure, which includes sophisticated laboratory facilities, highly
trained cytotechnologists and extensive regulatory oversight. Nonetheless,
approximately 4,100 women in the United States die annually of this preventable
disease. Outside the United States, limited resources and underdeveloped or
non-standardized testing infrastructure often lead to underdiagnosis of
cervical disease, resulting in a significantly higher incidence of cervical
cancer. Pap tests have been the principal means of cervical cancer screening since
the 1940s. Approximately 60 million Pap tests are performed annually in the
United States, and we believe that an additional 60 to 100 million are
performed annually in the rest of the world. Pap test results fall into three
categories: normal, abnormal and equivocal, or ASC-US (Atypical Squamous Cells
of Undetermined Significance). An equivocal classification is given to Pap
test results that cannot be definitively classified as either normal or
abnormal; this classification occurs in approximately 5% to 7% of all cases. Women with normal Pap test results do not undergo follow-up treatment
beyond routine Pap testing. Diagnostic alternatives for women with abnormal
Pap tests are HPV testing and a colposcopic examination (visual examination of
the cervix with the aid of a colposcope). Many women also undergo biopsy at
the time of colposcopy, and may go on to have any suspected lesions ablated
(physically removed with a scalpel or cauterizing instrument). Women with
equivocal Pap test results may undergo repeat Pap testing or HPV testing. In
the United States we believe approximately 75% of women with equivocal Pap test
results receive HPV testing using our HPV testing products. Although the use of the Pap test has been successful in reducing deaths
due to cervical cancer in the United States, Pap testing has significant
limitations, including false negative diagnoses, failure to identify cervical
disease in a significant number of women, limited predictive value and
inability to detect the presence of the cancer-causing types of HPV, the
primary cause of cervical cancer. Consequently, Pap testing does not allow the
clinician to identify women with no overt signs of cervical disease but who are
at higher risk for developing cervical disease or cervical cancer in the
future. HPV Testing in Cervical Cancer Screening.In August 1999, the Journal of
Pathology reported that human papillomavirus, a sexually transmitted virus, is
the primary cause of cervical cancer and that 99.7% of cervical cancers contain
cancer-causing human papillomavirus. Persistent infection with cancer-causing
human papillomavirus types is a necessary precursor to virtually all cervical
cancer. A test positive for human papillomavirus is more meaningful with
increasing age because human papillomavirus infection is more likely to be
persistent in more mature women. Clinical studies have shown that
approximately 20% of women age 30 and older with cancer-causing human
papillomavirus have high-grade cervical disease. Additionally, women age 30
and older with persistent human papillomavirus infection and who do not have
cervical disease are at significant risk of developing cervical disease in the
future. On April 24, 2002, the Journal of the American Medical Association,
(JAMA), published Consensus Guidelines recommending testing for human
papillomavirus in the management of women with ASC-US Pap test results. These
2001 Consensus Guidelines were sponsored by the American Society for
Colposcopy and Cervical Pathology (ASCCP), and state that for managing women
with 3




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ASC-US results, HPV testing is the preferred approach when it can be
performed directly from a liquid-based pap test, also known as reflex HPV
testing, or when the HPV testing specimen can be collected during the initial
office visit. According to the 2001 Consensus Guidelines, Reflex HPV DNA
testing offers significant advantages since women do not need an additional
clinical examination for specimen collection, and 40% to 60% of women will be
spared a colposcopic examination. Moreover, women testing negative for HPV DNA
can be rapidly assured that they do not have a significant lesion. As we described above, on July 31, 2003, The American College of
Obstetricians and Gynecologists (ACOG) published new recommendations for
cervical cancer screening that include the use of an FDA-approved high-risk HPV
DNA test for women age 30 and older. The benefits of using our DNAwithPap Test
in conjunction with the Pap test as a primary screen for cervical cancer for
women age 30 and older also have been recognized by other important medical
organizations. During fiscal 2004 the American Cancer Society (ACS), the
Association of Reproductive Health Professionals and the International Agency
for Research on Cancer, which is part of the World Health Organization, issued
cervical cancer screening guidelines incorporating adjunctive screening with an
FDA-approved high-risk HPV test. We believe our DNAwithPap Test, when used in conjunction with the Pap test
for women age 30 and over, or as a follow-up to an equivocal Pap test for all
women independent of age, enhances cervical cancer screening by overcoming the
shortcomings of the Pap test alone. Our DNAwithPap Test:  
    
    demonstrates increased sensitivity for high-grade cervical disease,
reducing false negative diagnoses and increasing the number of women
diagnosed with disease;
    
    detects the presence of the cancer-causing types of HPV and allows
the clinician to identify women with no overt signs of cervical disease
but who are at higher risk for developing cervical disease or cervical
cancer in the future;
    
    is a reproducible and objective process that reduces or eliminates
the subjectivity inherent with Pap testing; and
    
    with its increased clinical performance, may also permit the
healthcare professional to contain or reduce costs associated with
cervical cancer screening by more accurately identifying women with
cervical disease or at increased risk for cervical disease, permitting
healthcare professionals to more accurately direct diagnostic screening
and follow-up medical intervention. 4




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Our Products The following table describes the diagnostic test kit products and
principal instrumentation we market and sell. Product
    
    Infection
    
    Market
    
    Marketed SinceDiagnostic
Tests:DNAwithPap Test (1)
    
    HPV
    
    United States
    
    June 2003hc2 High-Risk HPV DNATest (1)(2)
    
    HPV
    
    Worldwide, primarily U.S., Europe
and Asia/Pacific
    
    March 2000 in U.S. July 2003 in Europehc2 HPV Test (3)
    
    HPV
    
    Worldwide, primarily
Europe, Canada,
Asia/Pacific and
Latin/South America
    
    March 1995hc2 CT Test
    
    Chlamydia
    
    Worldwide, primarily
U.S., Europe, Japan,
South America and
Canada
    
    1998 in Europe
October 1999 in U.S.hc2 GC Test
    
    Gonorrhea
    
    Worldwide, primarily
U.S., Europe, Japan,
South America and
Canada
    
    1999hc2 CT/GC Test
    
    Chlamydia and
Gonorrhea from same
sample
    
    Worldwide, primarily
U.S., Europe, Japan,
South America and
Canada
    
    1999 in Europe
March 2000 in U.S.hc1 CMV Test
    
    Cytomegalovirus
    
    U.S., Asia/Pacific (4)
    
    September 1998hc2 HBV Test
    
    Hepatitis B virus
    
    Asia, primarily
Korea; U.S. (for
research use only)
(4)
    
    1995Instrumentation and Accessories:Rapid Capture System
    
    HPV, Chlamydia and
Gonorrhea
    
    U.S.; expected to be
marketed in Europe in
March 2005
    
    May 2004Hybrid Capture
Microplate System
    
    All hc2 assay targets
    
    Worldwide
    
    1995
   (1)
    
    Contains high-risk HPV probes only.(2)
    
    Outside of the United States this test is marketed under the name DNAPap
and in this Form 10-K when we refer to the DNAwithPap Test we also mean
the DNAPap Test.(3)
    
    Contains high-risk and low-risk HPV probes.(4)
    
    In December 2003 we ceased all marketing in Europe and Canada of our
diagnostic test products for Hepatitis B virus and cytomegalovirus. Our HPV Tests.There are more than 70 distinct human papillomavirus
types, approximately 23 of which are specific to the female genital tract.
Human papillomavirus types that infect the genital tract can be divided into
two categories, high-risk and low-risk, which indicate the chances of
developing cervical cancer. Cancer-causing human papillomavirus types have
been found in more than 99% of cervical cancers. Our hc2 HPV Test contains individual RNA probes that are mixed into
cocktails of the significant cancer-causing, high-risk papillomavirus types
(types 16, 18, 31, 33, 35, 39, 45, 51, 52, 56, 58, 59 and 68), and low-risk
human papillomavirus types which are not linked to the development of cervical
cancer 5




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(types 6, 11, 42, 43 and 44). Our DNAwithPap Test (also sold under the
name hc2 High-Risk HPV DNA Test) contains individual RNA probes of the
significant cancer-causing, high-risk human papillomavirus types (types 16, 18,
31, 33, 35, 39, 45, 51, 52, 56, 58, 59 and 68). All of our HPV test products
use a signal amplification process to detect small amounts of the human
papillomavirus collected from the cervix. Each test kit consists of RNA probes
to specific human papillomavirus types, antibodies, detection reagents and
96-well microplates coated with antibodies. Each of our HPV test products is prescribed by a gynecologist or other
healthcare professional. The healthcare professional collects the specimen by
inserting the collection brush into the cervix, rotating the brush to collect
cells, removing it and placing it into the transport tube device. The device
is then sent to the laboratory, where specialized software programs provided
with our Hybrid Capture 2 systems produce results processed by a lab
technician. The laboratory subsequently reports the test results to the
physician using standard reporting procedures and the physician advises the
woman of the test results and the appropriate follow-up treatment. The entire
process can be completed in one day but is typically performed in two to three
days. When our test is used with an FDA-approved liquid-based Pap test, the
entire process is the same except that only one specimen is collected for both
our HPV test and the Pap test, permitting the laboratory to perform follow-up
human papillomavirus testing (reflex testing) without the need for additional
specimen collection should the woman have an equivocal or abnormal Pap test
result. Clinical studies have shown that our HPV test products, used in
conjunction with the Pap test, have excellent diagnostic capabilities and a
high negative predictive value. Negative predictive value is a measure of how
often a test result indicating no disease is actually correct. This high
negative predictive value assures women and their physicians that, with a
negative result, they can be virtually certain that neither cervical cancer nor
its cause is present, alleviating patient anxiety and reducing healthcare
costs. Since infection with HPV is necessary for the development of effectively
all cervical cancer, HPV testing with our HPV test products identifies women at
high risk for the development of cervical disease and cervical cancer. This
predictive nature of human papillomavirus testing permits healthcare
professionals to classify women who test negative for human papillomavirus as
being unlikely to develop cervical disease in the foreseeable future. This may
safely permit increased screening intervals, within the current guidelines, for
such women, saving costs for the healthcare provider and permitting the
allocation of resources to those women who currently have cervical disease or
are at significant risk for developing cervical disease in the future. Our Chlamydia and Gonorrhea Tests.Chlamydia is the most common bacterial
sexually transmitted disease in the United States and is a major health problem
worldwide, with approximately 89 million new cases reported annually. Genital
chlamydia infection, if left untreated, has serious potential consequences,
including infertility, ectopic pregnancy, cervicitis and pelvic inflammatory
disease. Gonorrhea, with approximately 62 million new cases reported annually
worldwide, is the second-most common bacterial sexually transmitted disease in
the United States and may result in severe genital complications in both women
and men if left untreated. If properly detected, both chlamydia and gonorrhea
are easily treatable with low-cost antibiotic therapy. Nevertheless, routine
and broad-based screening for chlamydia and gonorrhea has been limited by the
insufficient sensitivity of some culture methods, the invasive and cumbersome
specimen collection methods frequently used and the time and cost associated
with performing these tests. Our chlamydia and gonorrhea tests are prescribed and performed by a
gynecologist or other healthcare professional using the same methods used to
perform our HPV tests. We are the first to provide a test cleared by the FDA
(our hc2 CT/GC Test) for the simultaneous detection of chlamydia and gonorrhea
infections, in addition to human papillomavirus, from a single patient sample.
We believe the ability to perform multiple tests from a single patient specimen
provides greater convenience to patients 6




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and their physicians and reduces healthcare costs by decreasing the
frequency of patient visits and testing. Clinical studies on women have
indicated that our hc2 CT Test is capable of detecting chlamydia in up to 98%
of the cases in which the bacterium is present and our hc2 GC Test is capable
of detecting gonorrhea in up to 92% of the cases in which the bacterium is
present. We also offer our hc2 CT/GC Test which can be used to test for both
infections from the same sample. Our Blood Virus Tests.Blood viruses, such as hepatitis B virus and
cytomegalovirus, are leading causes of morbidity and death. Antiviral
therapies have been developed to treat the diseases caused by these viruses.
To maximize the efficacy of these expensive and sometimes toxic therapies,
physicians rely on viral load monitoring to measure the level of virus present
in the patient. By measuring viral load and identifying patients who are not
responding to therapy early in their treatment, physicians can tailor antiviral
therapies through monitoring of individual responses, recognize when a patient
develops drug resistance and project how quickly the infection will progress to
chronic disease. Rapid, accurate and ongoing detection of blood viruses and
monitoring of viral load are essential for effective patient management. We have developed unique testing products using our Hybrid Capture
technology to detect the presence of cytomegalovirus (CMV) and hepatitis B
virus (HBV). Our hc1 CMV Test is the only DNA test cleared for the detection
of cytomegalovirus by the FDA, and our hc2 HBV Test is used in the United
States for research use only. Except in the United States, where our hc2 HBV
Test is used for research use only, our CMV and HBV tests products are
prescribed by a gastroenterologist, transplant surgeon or other healthcare
professional. The healthcare professional draws a blood specimen from the
patient. The specimen is then sent to the laboratory, where specialized
software programs provided with our Hybrid Capture 1 and Hybrid Capture 2
systems process the results. The laboratory subsequently reports the test
results to the physician using standard reporting procedures and the physician
advises the patient of the test results and the appropriate follow-up
treatment. Depending on the level of hepatitis B virus in the patients blood,
antiviral therapy will be presented, modified or discontinued. For transplant
patients, the level of cytomegalovirus in the blood is used to determine the
presence or absence of cytomegalovirus infection. Patients with active
cytomegalovirus infections are prescribed antiviral therapy. Transplant
patients are typically monitored once per week for cytomegalovirus DNA for
twelve weeks following the initial organ transplant. Our Instrumentation and Accessory Products.We manufacture
instrumentation and accessories for performing our tests in clinical
laboratories. For our hc1 and hc2 tests, we offer a manual Hybrid Capture
system that includes a DML 2000 luminometer, plate washers, microplate heaters
and additional accessories. We also offer our Rapid Capture system, which is
an automated pipetting and microplate handling platform developed for high
volume diagnostic testing using our Hybrid Capture technology. Using our Rapid
Capture system, a single laboratory technician can perform over 350 tests in a
single laboratory shift. Our HPV test products are approved, and our chlamydia
and gonorrhea tests products are 510(k)-cleared, by the FDA for use with the
Rapid Capture system. 7




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Regulatory Approvals Receipt and maintenance of regulatory authorization to market and sell our
products is vital to our success. The following table summarizes the
regulatory approvals and clearances we have received to date for our principal
products. Product
    
    Regulatory Statushc2 High-Risk HPV
DNA Test
    
    FDA approved in March 2003 for adjunctive screening with
Pap for women age 30 and older; FDA approved in March
2000 for follow-up to an equivocal Pap test for all
women; CE-marked for use either as an adjunctive or
stand-alone primary screen in the European Union;
registered for use in Mexico, Japan (January 2004) and
Canada; and pending registrations in Argentina, Chile
and the Russian Federation. Marketed under the name
DNAwithPap Test in the United States and DNAPap in the
rest of the world.hc2 HPV Test
    
    FDA approved in March 1999 for detection of HPV; FDA
approved in March 1995 for follow-up to an equivocal Pap
test for all women; CE-marked for use either as an
adjunctive or stand-alone primary screen in the European
Union; registered for use in Mexico, Japan (January
2004) and Canada; and pending registrations in
Argentina, Chile and the Russian Federation.hc2 CT Test
    
    FDA 510(k) marketing clearance granted in October 1999;
CE-marked for use in the European Union; and marketing
clearance obtained in Brazil and Argentina (1999), and
in Japan (October 2001).hc2 GC Test
    
    FDA 510(k) marketing clearance granted in November 1999;
CE-marked for use in the European Union; and marketing
clearance obtained in Brazil and Argentina (1999), and
in Japan (October 2001).hc2 CT/GC Test
    
    FDA 510(k) marketing clearance granted in November 1999;
CE-marked for use in the European Union; and marketing
clearance obtained in Brazil and Argentina (1999), and
in Japan (October 2001).hc2 HBV Test
    
    Current Drug License in India.hc1 CMV Test
    
    FDA 510(k) marketing clearance granted in September 1998.Rapid Capture System
    
    FDA 510(k) marketing clearance for chlamydia and
gonorrhea testing granted in September 2001 and for HPV
testing in May 2004; CE-mark is pending in the European
Union.Hybrid Capture
Microplate System
    
    U.S. commercialization authority provided de factoas
part of the diagnostic test kit FDA approvals and clearances; original CE mark certification completed as
part of the diagnostic test kits.
 In addition to seeking regulatory authorizations for our own products, we
work with other companies to seek regulatory approval for use of these
companies specimen collection products to provide the specimens necessary to
perform our diagnostic tests. We received FDA approval in 1997 for the use of
our hc2 HPV Test using Cytyc Corporations Thin Prep Pap® Test sample
collection system. In April 2002, we submitted a pre-market approval (PMA)
supplement with the FDA seeking approval of the use of our hc2 HPV Test with
TriPath Imaging, Inc.s SurePath Test Pack sample collection system. In July
2002, we received notice from the FDA that the PMA supplement was not
approvable as submitted. We worked with TriPath during fiscal 2004 to complete
additional clinical studies and submitted the results of these studies to the
FDA for pre-market approval in August 2004. In December 2003, we submitted
510(k) pre-market notifications to the FDA for clearance to use the Cytyc 8




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Corporation ThinPrep® vial as a specimen for testing with our chlamydia
and gonorrhea test products. We continue to work with the FDA to complete
additional clinical studies that will permit completion of the review of these
notifications. Clinical Validation of HPV Testing in Cervical Cancer Screening Over the last several years, many general population screening studies
using our HPV test products have been conducted by prominent medical
professionals and academic and government institutions throughout the world,
including the National Cancer Institute, Columbia University and the Cleveland
Clinic Foundation. Many of these studies assessed the usefulness of our HPV
test products in comparison to the Pap test for women age 30 and older. These
studies, including a meta-analysis of multiple studies that was published in
the August 2003 Archives of Pathology and Laboratory Medicine, demonstrate the
superior performance of our HPV test products when used for primary general
population screening alone, or in combination with Pap test, to detect
underlying cervical disease as compared with the Pap test alone. These studies
show that women age 30 and older who test negative for human papillomavirus and
have normal Pap test results are not likely to currently have cervical disease
and are at low risk of developing cervical disease in the future. Women age 30
and older who test positive for high-risk human papillomavirus are at
significant risk of developing cervical disease. Clinical evidence and medical practice guidelines published in medical
journals and presented at important medical meetings have validated the
usefulness of our products and technology platform and the role of human
papillomavirus in cervical cancer. The more recent studies and medical
practice guidelines published are: Publication
    
    Date
    
    FindingsObstetrics & Gynecology
    
    April 2004
    
    A study authored by the
Harvard School of Public
Health and Columbia
University used
computerized modeling to
compare various cervical
cancer screening scenarios
and found that screening
women age 30 and older
with both a Pap test and
an HPV DNA test reduces
cervical cancer incidence
by up to 93% and results
in a 30% cost savings
compared to the
traditional annual Pap
test.The Lancet
    
    December 2003
    
    A study involving 11,085
women concluded that in
women age 30 and older,
the HPV DNA test is more
effective than the Pap
test alone in identifying
women with cervical cancer
or its precursors.Cancer Causes and Control
    
    July 2003
    
    A study involving 7,868
women in Mexico
demonstrated the high
sensitivity (98.0%) and
excellent negative
predictive value (99.9%)
of our hc2 High-Risk HPV
DNA Test in combination
with the Pap test and
concluded that HPV testing
from clinician-collected
samples is an effective
alternative that can be
used to increase the
sensitivity of cervical
cancer screening in
Mexico.British Journal of Cancer
    
    May 2003
    
    A study of 8,101 women age
30 and over in Germany
found that the use of our
hc2 High-Risk HPV DNA Test
in conjunction with the
Pap test was 100%
sensitive for detecting
high-grade cervical
disease and cancer and
also had a negative
predictive value of 100%.
 9




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Organization
    
    Date
    
    Practice GuidelinesThe International Agency
for Research on Cancer
    
    May 2004
    
    Issued an assessment of
available medical
technologies for
screening women for
cervical cancer, which
concluded that there is
sufficient evidence that
testing for HPV can
reduce cervical cancer
incidence and mortality
rates.The National Cancer
Institute, the American
Cancer Society and the
American Society of
Colposcopy and Cervical
Pathology
    
    February 2004
    
    Developed consensus
guidance on the most
effective way to use HPV
DNA testing for cervical
cancer screening,
published in Obstetrics
& Gynecology, that
recognized that testing
for high-risk HPV types
can identify more women
with pre-cancerous cell
changes than a single
Pap test and included
recommendations for
managing women with
conflicting test results
when HPV is present, but
the Pap test is normal.American Cancer Society
    
    January 2004
    
    Final cervical cancer
screening guidelines
that included a
recommendation that HPV
testing for high-risk
HPV types, together with
the Pap test, be used in
primary screening of
women age 30 and older.Association of Reproductive
Health Professionals
    
    September 2003
    
    Published the ACOG
screening
recommendations for the
combined use of an
FDA-approved high-risk
HPV test for women age
30 and older, with
either liquid-based or
conventional cytology
and reaffirmed the use
of HPV DNA testing for
the management of
abnormal or ASC-US Pap
tests results in all
women, regardless of
age.American College of
Obstetricians and
Gynecologists (ACOG)
    
    July 2003
    
    Published new
recommendations for
cervical cancer
screening that provide
two screening options
for women age 30 and
older, one of which is
the combined use of a
cervical cytology test
and an FDA-approved test
for high-risk types of
HPV.
 Our Markets and Competition The United States and Europe are the principal markets in which we sell
our products. In the United States we sell our products for the detection of
HPV, chlamydia, gonorrhea and cytomegalovirus and offer our Hepatitis B test
for research use only. In fiscal 2004 we also began selling our Rapid Capture
systems in the United States. In Europe we sell our products for the detection
of HPV, chlamydia and gonorrhea. With respect to the detection of HPV, we sell
our products for the two FDA-approved indications in the United States -
adjunctive screening with Pap for women age 30 and older, and follow-up testing
of equivocal or abnormal Pap test results. In Europe and the rest of the world
we offer our HPV test products for adjunctive screening with a Pap test, as
follow-up to equivocal Pap test results and as stand-alone primary cervical
cancer screening. In marketing our HPV test products for cervical cancer screening and
prevention, we compete with well-established procedures, such as Pap testing,
colposcopy and biopsy, that have a long history of use and are widely accepted
as an inexpensive (in the case of the Pap test) and, with regular use, adequate
screening tests for cervical cancer. Future technological advancements
designed to improve quality control over sample collection and preservation and
to reduce the Pap testings susceptibility to human error may serve to increase
physician reliance on the Pap test and solidify its market acceptance.
Further, when marketed as an adjunct to the Pap test for primary screening in
the United States, our DNAwithPap Test may be seen as adding unnecessary
expense to the accepted cervical cancer screening methodology.
Consequently, our HPV test products may not be able to attain significant
market acceptance as primary cervical cancer screening tests. 10




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Currently approximately 60 million Pap tests are performed annually in the
United States, and we believe that an additional 60 to 100 million are
performed annually in the rest of the world. We believe the portion of the
cervical cancer screening market in which we compete in the United States is
the potential HPV testing market, consisting of approximately 35 million annual
tests, either adjunctively with the Pap test, as follow-up testing for prior
abnormal or equivocal cervical cancer screening results or as follow-up to
treatment. Our estimate of the HPV testing market assumes some extension of
the screening intervals. At the end of fiscal 2004 we estimate our penetration
of this potential HPV testing market to be 9%. The size of our market may grow
assuming we pursue approvals for use of our HPV test products for stand-alone
primary cervical cancer screening. We are currently the only market
participant with FDA-approved HPV DNA test products. In the rest of the world we also compete to offer our HPV test products as
stand-alone primary screening for cervical cancer, both in countries where Pap
testing and cytology infrastructure are in place, and in developing countries
where cervical cancer screening is not routinely performed. We believe we currently hold a strong competitive position in our markets
because of our patented Hybrid Capture platform, the breadth of our rights to
high-risk HPV types, our ability to offer diagnostic tests for HPV, chlamydia
and gonorrhea from the same sample, our regulatory approval position, our
success in achieving reimbursement for our products and our relationships with
our customers. We believe all of these elements are important to successfully
market an HPV testing product. Current participants in the cervical cancer
screening market offering alternative products include current manufacturers of
liquid-based Pap tests, such as Cytyc Corporation and TriPath Imaging, and
Ventana Medical Systems, Inc., which markets an in situproduct not approved by
the FDA and large national laboratories which are developing home brew HPV
testing processes. We are also aware that other companies are working to
develop HPV testing capabilities. In the face of these potential competitors,
we continue to work to expand our strengths in the areas of technology,
regulatory approvals, reimbursement, product acceptance and customer
relationships. In June 2002, Insitut Pasteur announced that it had transferred its human
papillomavirus intellectual property estate to F. Hoffman-La Roche Ltd., which
included an assignment of a cross license agreement between Digene and Institut
Pasteur. Based on the human papillomavirus types to which Roche has announced
that it acquired access as a result of the transfer by Institut Pasteur, the
human papillomavirus types covered by Roches own patents and the human
papillomavirus types that are publicly available, and despite our continuing
exclusive access to several high-risk HPV types, we believe Roche has the
ability to develop a human papillomavirus test that would be competitive with
our HPV test products in the marketplace. We are aware that Roche has begun to
market an HPV testing product in Europe in the last few months. Roche is
substantially larger and better capitalized than we are and has existing
customer relationships in the gene-based probe diagnostics business. If Roche
receives FDA approval for a human papillomavirus test, we may not be able to
compete in a way that will allow us to substantially increase our share of the
HPV testing market. With respect to our other diagnostic test products, the medical
diagnostics and biotechnology industries are subject to intense competition.
Some of our products, such as our tests for chlamydia, gonorrhea, hepatitis B
virus and cytomegalovirus, compete against existing screening, monitoring and
diagnostic technologies, including tissue culture and antigen-based diagnostic
methodologies. Our competitors in the United States and abroad for gene-based
diagnostic probes include Roche Diagnostics, Abbott Laboratories, Bayer
Corporation, Chiron Corporation and Gen-Probe Incorporated. Other companies,
including large, well-capitalized pharmaceutical and biotechnology companies,
may enter the market for gene-based probe diagnostics in the future. We
believe the primary competitive factors in the 11




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market for gene-based probe diagnostics and other screening devices are
clinical performance and reliability, ease of use, cost, proprietary position,
the competitors share of the existing market, access to distribution channels,
regulatory approvals and availability of reimbursement. Our existing and potential competitors may be in the process of seeking
FDA or foreign regulatory approval for their respective products or may also
enjoy substantial advantages over us in terms of research and development
expertise, experience in conducting clinical trials, experience in regulatory
matters, manufacturing efficiency, name recognition, sales and marketing
expertise and distribution channels. In addition, many of these companies may
have established third-party reimbursement for their existing products. We may
not be able to continue to compete effectively against existing or future
competitors, which may have a material adverse effect on our business,
financial condition and results of operations. Sales and Marketing We focus our sales and marketing strategy on achieving broad market
acceptance of our gene-based diagnostic tests. Over the last several years,
the majority of our sales and marketing investments have been directed to the
launch of our hc2 High-Risk HPV DNA test in the United States for both
FDA-approved indications, to expand the use of our HPV testing products for
primary cervical cancer screening in the rest of the world, and to build demand
for our tests among the medical profession, public health officials and
consumers through a demand-creation marketing campaign. Increasing awareness of cervical cancer and our cost-effective solution is
the first step in the demand-creation marketing campaign for our HPV test
products. Our strategy has involved:  
    
    sponsoring, or participating in, major multi-center clinical
trials to establish the clinical utility and cost effectiveness of
our tests;
    
    promoting the publication of the results of these trials in
prestigious medical journals and communicating the results of these
trials to the public and physicians through media awareness programs;
    
    establishing widespread laboratory distribution for our HPV
test products through direct sales programs, strategic alliances with
major diagnostic companies and co-marketing programs with clinical
reference laboratories;
    
    working with managed care providers, national governments and
reimbursement agencies to establish reimbursement;
    
    supporting womens health advocacy groups to call for
widespread use of our HPV test products and educating consumers about
the benefits of human papillomavirus testing; and
    
    establishing a physician detailing sales organization in the
United States. 12




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The following table provides information regarding our revenues and
assets, including revenues from our principal products, our HPV test products.
For further information regarding our product sales, and profits and losses
from operations for the last three fiscal years, please see our consolidated
financial statements in Item 8 of this Form 10-K. Significant Product Revenues and Assets Fiscal 2002
    
    %
    
    Fiscal 2003
    
    %
    
    Fiscal 2004
    
    %($ in thousands)Product revenues from U.S. operations
    
    $
    30,070
    
    
    
    66
    %
    
    $
    45,603
    
    
    
    73
    %
    
    $
    65,655
    
    
    
    74
    %Product revenues from Non U.S. operations
    
    
    l5,680
    
    
    
    34
    %
    
    
    16,837
    
    
    
    27
    %
    
    
    23,160
    
    
    
    26
    %Revenues from HPV test products
worldwide
    
    
    34,034
    
    
    
    70
    %
    
    
    51,114
    
    
    
    82
    %
    
    
    74,581
    
    
    
    84
    %Assets located in U.S.
    
    
    61,921
    
    
    
    92
    %
    
    
    50,843
    
    
    
    80
    %
    
    
    92,506
    
    
    
    90
    %Assets located outside U.S.
    
    
    5,320
    
    
    
    8
    %
    
    
    12,532
    
    
    
    20
    %
    
    
    10,764
    
    
    
    10
    %
 North American Market There are five key elements to our initial DNAwithPap Test
commercialization plan that was substantially implemented in fiscal 2004.
First, we are working to formalize support of governmental agencies, medical
societies and physician groups and to communicate such support to physicians
and our customers. In July 2003, ACOG recommended the use of an FDA-approved
high-risk HPV test for cervical cancer screening of women age 30 and older. In
addition, several organizations, including the American Cancer Society, the
Association of Reproductive Health Professionals, the National Cancer Institute
and the American Society of Colposcopy and Cervical Pathology, recently
published patient management guidelines that included recommendations for HPV
testing. Second, we are partnering with womens advocacy groups to communicate
their support and to educate the public. Third, we have established formalized
programs to co-market, with our laboratory partners, the DNAwithPap Test to
physicians and payors. Fourth, we have implemented physician education
programs, which are driven by our physician detailing organization and
third-party organizations, working independently, to educate physicians and
women about the proper use of the combined tests. Finally, we have
established, and continue to work to establish, comprehensive health insurance
reimbursement, which builds on the first four parts of our strategy. These
five key elements of our DNAwithPap Test commercialization plan are coordinated
and balanced with our overall demand creation marketing plan. Our ability to secure adequate reimbursement from government payors,
third-party payors and managed care programs is an important element of our
sales and marketing plan. In the United States, all of our FDA-approved
products have some level of reimbursement coverage. We focus significant
efforts on obtaining reimbursement coverage for our HPV test products. In the
United States, the American Medical Association has assigned specific Current
Procedural Terminology (CPT) codes, necessary for reimbursement, for human
papillomavirus testing and the Centers for Medicare and Medicaid Services
(formerly the Health Care Financing Administration), has established Medicaid
and Medicare reimbursement for our HPV test products. We believe we have
nearly universal coverage from U.S. government payors, third-party payors and
managed care entities for our hc2 HPV Test as a follow-up test of equivocal Pap
test results. In addition, government payors, third-party payors and managed
care entities that provide health insurance coverage to over 175 million people
in the United States currently authorize reimbursement for the use of our
DNAwithPap Test to adjunctively screen women age 30 and older to assess the
presence or absence of significant, cancer-causing HPV types. Reimbursement
for this indication is now available from more than 75 payors. Most notably,
in fiscal 2004 we received reimbursement coverage for this indication from
Aetna, UnitedHealthcare, Cigna Healthcare and Anthem Blue Cross Blue Shield. In May 2003, we entered into an agreement with PDI, Inc., pursuant to
which PDI has established a physician detailing sales organization dedicated to
educating physicians about the benefits of the DNAwithPap Test in the United
States. The PDI sales force included 34 sales professionals at June 30, 13




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2004. Under the agreement, PDI manages the sales professionals, but we
are responsible for decisions regarding marketing, planning, strategy and
detailing of our products, as well as for conducting training programs for the
sales professionals. The term of the agreement has been extended until July
21, 2005. We currently market our products in the United States to clinical
reference laboratories through a direct sales force supported by technical and
customer service representatives. We market our HPV test products to
physicians, physician groups, university hospitals and medical centers through
direct efforts, and through joint marketing programs with clinical reference
laboratories. At the end of fiscal 2004, approximately 315 clinical reference
laboratories in the United States provided testing using our HPV test products.
The largest laboratory providers in the United States, such as Quest
Diagnostics, Laboratory Corporation of America (LabCorp) and ARUP Laboratories,
all have active programs for automatic follow-up human papillomavirus testing
of equivocal results from Cytyc Corporations ThinPrep Pap Test specimens and,
in fiscal 2004, entered into agreements with us to purchase DNAwithPap Test
products. International Markets Internationally, we continue to make progress in increasing the market
penetration of our hc2 High-Risk HPV DNA Test, marketed as
the DNAPapTM Test
outside of the United States, in cervical cancer screening programs throughout
Europe, Latin and South America and the Asia/Pacific region. We have direct
sales and marketing personnel in Europe and Brazil and also make extensive use
of independent distributors in all international markets where we offer our
products. In fiscal 2004, we increased overall international revenue from our
HPV test products by approximately 50% over the prior year. As we continue to grow the international sales of our products, we
anticipate that changes in the rate of exchange of foreign currencies into the
United States dollars may have an adverse impact on our revenues and results of
operations. We have established reimbursement for our marketed products in all major
European countries, Mexico, Brazil, Australia and all major Asian countries.
We also work with our distribution networks in smaller markets to establish
reimbursement from third-party payors in their respective territories and with
government and ministry officials to establish appropriate reimbursement
coverage for our marketed products. Europe.During fiscal 2004 we added additional subsidiary operating
companies in Spain, Italy and Switzerland. As of September 2004, we have
established distributor operations in 16 European countries and subsidiaries in
Germany, France, Italy, Spain, the United Kingdom and Switzerland. Although we
sustained losses from our European operations in fiscal 2004, we believe the
transition from a distributor sales model to direct sales will be key to
accelerating market penetration and allows for better control of our marketing
programs, higher test kit margins and improved customer support. In Germany,
our largest European market, approximately 170 laboratories perform our HPV
tests. Acceptance of our HPV test products in Europe continues to grow among
healthcare providers for use as both a primary and secondary cervical cancer
screen. We believe that our progress in Europe is due to our coordinated sales
and marketing programs, which include comprehensive physician and laboratory
education programs, direct-to-consumer public awareness campaigns and
government education efforts. In the United Kingdom, our hc2 High-Risk DNA HPV Test is being used in a
pilot program to incorporate HPV testing into the National Health Services
national cervical cancer screening program. In February 2004, the French
Ministry of Health approved reimbursement of testing for high-risk HPV types in
follow-up evaluation of women with equivocal Pap test results and stated its
intent to study use 14




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of HPV tests for routine, primary screening for cervical cancer in
conjunction with the Pap test. We are also working to secure reimbursement in
the Czech Republic, Denmark and Finland, and to add reimbursement approvals
from additional third party payors in Germany. In December 2003 we elected to stop marketing of our diagnostic test
products for Hepatitis B virus and cytomegalovirus in Europe with the
implementation of the CE marking requirements of the In Vitro Diagnostic
Directive. Latin and South America.In Brazil we market our products directly
through our majority-owned subsidiary, Digene do Brazil LTDA. The products we
market include our gene-based diagnostic test products and our proprietary
Universal Collection Medium (UCM), which enables both cytology and HPV DNA
testing to be done from one patient sample. This product was launched in March
2002 by Digene do Brazil LTDA. In November 2001, the Brazilian National Cancer
Institute initiated a study (the INCA study) evaluating the effectiveness of
both the hc2 High-Risk HPV DNA Test alone and in conjunction with our UCM. The
INCA study was completed in December 2002, and the results will be used to aid
the Brazilian Ministry of Health in its decision regarding the use of UCM and
the hc2 High-Risk DNA HPV Test throughout Brazil. In other countries in Latin and South America we contract with specific
product distributors to sell our products. Our primary markets are Mexico,
Chile and Costa Rica and secondary markets are Peru, Argentina, Panama and
Columbia. We believe we have significant potential for growth in Latin and
South America because there are no established cervical cancer screening
programs outside of Mexico, high cervical cancer rates in the population,
willingness to try new technologies and because we have the ability to market
and sell products that test for HPV, chlamydia and gonorrhea from the same
patient sample. The risks we face include the lack of direct control that
results from reliance on distributor relationships and the lack of education
about HPV in some countries. Asia/Pacific.The Asia/Pacific market encompasses approximately 770
million women age 30 to 60. We are concentrating our efforts in Korea, Japan,
China, Australia, Singapore and Hong Kong, and work through established
distributor arrangements. Some OB/GYN societies within the region have
recognized the potential role of HPV testing in cervical cancer screening, but
no organizations have published guidelines as of yet. Reimbursement is highly
varied in the Asia/Pacific region. In Japan there is reimbursement and
regulatory approval for marketing our hc2 HPV, chlamydia and gonorrhea tests,
including a January 2004 registration update to include an adjunctive primary
screening indication for our HPV test products. HPV testing is registered with
the Peoples Republic of China State Food and Drug Administration, and HPV
testing reimbursement has been established in Beijing, Shanghai and Guangzhou.
In Australia there are currently recommendations for post-disease treatment
management using our HPV test products, and reimbursement authorization from
the Commonwealth Minister of Health and Ageing. Historically the Asia/Pacific region suffers from a lack of current
screening infrastructure and cytology expertise, but the female population is
increasingly aware of the benefits of cervical cancer screening. Alternatives,
including liquid cytology and polymerase chain reaction (PCR) testing are
becoming increasingly available in the Asia/Pacific region. We have planned a
series of programs and activities focused on key markets in this region and
intend to coordinate speaker programs to help increase awareness of HPV testing
and its advantages, to conduct focused lobbying activities, along with direct
government contact, and may explore direct to consumer activities and
educational events. There are also opportunities in the region for sales of
our tests for chlamydia and gonorrhea. We also currently sell our
hc2 HBV test
products in Asia but are planning an eventual exit from the Hepatitis B testing
global market. 15




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Research and Development One of our key goals is to continually expand our core technology and
expertise in molecular diagnostics in order to remain at the forefront of DNA
testing for infectious diseases and to capture new high-growth and high-margin
market opportunities. To achieve this goal, we have invested aggressively in
research and development and particularly in clinical trials to validate the
performance of our products, product candidates and new indications for our
products. Our research and development programs are geared to deliver continuing
improvements in the detection of cervical cancer and its precursors and
sexually transmitted infections, including human papillomavirus, chlamydia and
gonorrhea; and we seek to enhance our technological strength in these areas.
We have developed our tests so that they can be performed on samples collected
for routine liquid-based Pap tests. Our research and development investments
are directed at productivity improvements for HPV testing, new indications for
our technology and associated regulatory approvals. In fiscal 2004, we focused
our research and development activities in four areas: core research efforts
for next-generation technologies; new product development activities;
completion of activities necessary to support regulatory submissions to seek
approvals to market our existing products for additional uses and indications
in the U.S. and abroad; and modification of the design or capabilities of our
product and equipment offerings. Our core research efforts for next-generation technologies include
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 on our next
generation of Hybrid Capture technology. These activities included work on
Hybrid Capture 3 and new molecular markers for use in conjunction with our HPV
test products Our new product development activities currently focus on the discovery of
innovative methods to improve specimen processing procedures and throughput to
expand the ability of laboratories to use our diagnostic tests. The activities
include procedures for the improved processing of Cytyc Corporations ThinPrep®
PreservCyt® Solution specimens and upgrades of our equipment offerings for high
throughput HPV, chlamydia and gonorrhea testing. We are also working to expand
HPV testing capabilities to allow testing from additional liquid cytology
media, including our proprietary UCM (Universal Collection Medium) and TriPath
Imaging, Inc.s SurePath medium, for which the clinical validation is ongoing.
UCM will allow simultaneous DNA testing for the infectious agents highlighted
above, liquid cytology capabilities, gene expression analysis and detection of
proteins by immunoassay methods We have also completed 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. In addition, in November 2003 we entered into a collaborative
product development and commercialization agreement with PATH (Program for
Appropriate Technology in Health) to develop a rapid batch HPV test product for
use in developing countries. Digene and PATH will jointly fund the efforts
subject to certain maximum funding obligations, and we will perform the product
development and commercialization activities. During the second half of fiscal
2004 we completed the establishment of a research team to pursue this program
and began active research into a rapid batch HPV test product candidate. With respect to regulatory submissions in fiscal 2004 we:  
    
    developed and completed the clinical validation of our
Rapid Capture System for semi-automated processing of our
hc2
High-Risk HPV DNA Tests. We initially submitted the Pre-Market
Approval Supplement to the FDA on November 5, 2003. We provided
follow-up data and information on April 1, 2004 to facilitate
completion of the FDAs review. We received this approval on May
4, 2004. We expect this claim will expand
existing indications for our hc2 High-Risk HPV DNA Test to allow
high-volume, semi-automated human papillomavirus DNA testing. 16




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
    
    developed and completed the clinical validation of the
use of chlamydia and gonorrhea testing using our hc2 CT/GC Tests
from Cytyc Corporations ThinPrep PreservCyt Solution specimens.
We submitted 510(k) pre-market notifications for each of our test
products for chlamydia and gonorrhea (each test separately, plus
our combined hc2 CT/GC Test) between November 2003 and January
2004. The FDAs review of these submissions is ongoing and we
continue to work with the FDA to provide the information needed
to facilitate completion of its review.  
    
    submitted, in April 2002, a pre-market approval (PMA)
supplement with the FDA seeking approval of the use of our
hc2
HPV Test with TriPath Imaging, Inc.s SurePath Test Pack sample
collection system. In July 2002, we received notice from the FDA
that the PMA supplement was not approvable as submitted. We
worked with TriPath during fiscal 2004 to complete additional
clinical studies and submitted the results of these studies to
the FDA for pre-market approval in August 2004. Finally, with respect to modification of the design or capabilities of our
diagnostic test products and equipment offerings, in fiscal 2004 we achieved
technical feasibility of our next generation platform proprietary DNA test for
ultra-sensitive detection of DNA targets in a highly multiplexed modality. We spent approximately $9,265,000, $10,262,000 and $10,744,000 on research
and development in fiscal 2002, 2003 and 2004 respectively. Facilities and Manufacturing We lease approximately 111,000 square feet of office and manufacturing
space in Gaithersburg, Maryland. Approximately 34% of such space is dedicated
to our manufacturing, quality control and shipping activities. We have an
option to expand the facility to add additional manufacturing space if needed.
We currently run one manufacturing and product shipment shift per workday and
have the capacity to add additional shifts as required. We anticipate that we
will begin to add one additional support shift per week by December 2004. We
believe that we currently have sufficient manufacturing capacity for our
existing demand and that our Gaithersburg facility will allow us to expand our
production capability to satisfy demand for the foreseeable future. Our lease
expires December 31, 2009 and we have the ability to extend the lease for two
five-year terms. We also lease office and sales operations facilities in the
United Kingdom, Germany, Switzerland, France, Italy and Spain, which run in
length from one year to five years. We also utilize a third-party warehouse
facility in Germany to support our European operations. We combine more than 200 biological reagents, inorganic and organic
reagents and kit components to manufacture our finished diagnostic test kits.
Biological reagents include DNA and RNA probes, antibodies and detection
reagents. These biological reagents are currently manufactured in our
Gaithersburg facility, which received validation approval from the FDA in
September 2000. We purchase many of these components and reagents, which are
readily available from a variety of manufacturers and outside suppliers. As
part of our quality assessment procedures, we periodically evaluate the
performance of our raw material suppliers, potential new alternative sources of
such materials, and the risks and benefits of reliance on our existing
suppliers. We have established a quality control program, including a set of standard
manufacturing and documentation procedures, intended to ensure that our
products are manufactured and tested in accordance with the FDAs Quality
System Regulations, which imposes current Good Manufacturing
Practice requirements. We received ISO 9001 certification in June 1999
and transitioned to ISO 13485 certification in July 2003. 17




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Several key components of our products come from, or are manufactured for
us by, a single supplier or limited number of suppliers. This applies in
particular to four items: chemiluminescent substrates included in our
diagnostic test kits (used to create a chemical reaction that causes light in
connection with our Hybrid Capture signal amplified molecular technology), our
Rapid Capture system that serves as the automation platform developed for
large-scale diagnostic testing using our Hybrid Capture technology, the 96-well
microplate used by laboratories to run our diagnostic test products and
cervical sampler brushes we sell as part of cervical sampler kits that we sell
with our HPV testing products. We have been able, to date, to enter into
long-term contracts with these single source or key suppliers. In some cases,
however, the supplier of a key component is not required to supply us with
specified quantities over longer periods of time or set-aside part of its
inventory for our forecasted requirements. We have not arranged for
alternative supply sources for these components and it may be difficult to find
alternative suppliers, if at all. If our product sales increase beyond the
forecast levels, or if our suppliers are unable or unwilling to supply us key
components on a timely basis, we may be unable to satisfy product demand. In addition, if any of the components of our products are no longer
available in the marketplace, we may be forced to further develop our products
or technology to incorporate alternate components. The incorporation of new
components into our products may require us to seek approvals from the FDA or
foreign regulatory agencies prior to commercialization. Intellectual Property Patents and other proprietary rights are essential to our business. Our
most significant patent rights relate to our Hybrid Capture technology and HPV
types. Hybrid Capture Technology Our Hybrid Capture technology combines two of the most significant
technologies in the life sciences industry, DNA/RNA probes and monoclonal
antibodies, to allow rapid, standardized gene-based testing in virtually any
laboratory setting. In May 2001, we received a United States patent for our
Hybrid Capture assay from the United States Patent and Trademark Office.
Foreign counterparts of this patent application have been granted to us in
Europe, Japan and Australia. We have also filed United States patent
applications relating to other aspects of our Hybrid Capture technology. The
earliest of these Hybrid Capture assay patents will expire in the United States
in 2018 and in Europe in 2012. We have an exclusive license with the
University of Hawaii for two patents covering monoclonal antibodies for the
detection of RNA:DNA hybrid complexes, the first of which will expire in 2005
and the second in 2006. We have exclusive rights to the chemiluminescent
substrates (used to create a chemical reaction that causes light in connection
with our Hybrid Capture signal amplified molecular technology) included in our
Hybrid Capture test products under our long-term supply agreement with Applied
Biosystems. Such agreement includes certain license rights to manufacture the
product in the event the manufacturer is not able to do so. We believe our Hybrid Capture patent estate provides us with significant
exclusivity, and that expiration of individual patents will not have a material
adverse impact on our business. We have not out-licensed our Hybrid Capture
technology to any third party and believe our know-how and the complexity of
our technology make it difficult for others to replicate our Hybrid Capture
technology. 18




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We are currently party to a patent infringement action with Enzo Biochem,
Inc. and its subsidiary Enzo Diagnostics, Inc., related to our Hybrid Capture
products. Please refer to Item 3. Legal Proceedings, for a discussion of
this litigation. Rights to HPV Types There are more than 70 distinct human papillomavirus types, approximately
23 of which are specific to the female genital tract. Human papillomavirus
types that infect the genital tract can be divided into two categories,
high-risk (potentially cancer-causing) and low-risk. Of the 23 HPV types
specific to the female genital tract, 13 are commonly recognized as high-risk.
High-risk HPV types have been found in more than 99% of cervical cancers. The following table provides information regarding the human
papillomavirus types included in our HPV test products. HPV Type(s)
    
    Summary Description
    
    Status
    
    PatentsHPV 16, 18, 31, 45,
51, 59
    
    In public domain;
Digene has
ownership of unique
genetic material
    
    high-risk
    
    Not applicable.HPV 33, 39
    
    Institut Pasteur
issued patents;
cross-licensed to
Digene
    
    high-risk
    
    Cross-license rights under
multiple patents for HPV 33
and HPV 39. U.S. and European
patents will expire between
2007 and 2017.HPV 35, 56
    
    Digene issued
patents;
cross-licensed to
Institut Pasteur
    
    high-risk
    
    Digene holds one U.S. patent
to HPV 35 (expires May 2007)
and multiple patents related
to HPV 56 (expire between
October 2007 and May 2008).HPV 52
    
    Georgetown-issued
patents,
exclusively
licensed to Digene
    
    high risk
    
    License under multiple issued
patents. U.S. patent expires
in 2014, European patents in
October 2009 and Japanese
patent in 2009.HPV 58
    
    Kanebo issued
patent; exclusively
licensed to Digene
    
    high-risk
    
    Patent expires in February 2009HPV 68
    
    Institut Pasteur
issued U.S. patent,
exclusively
licensed to Digene
    
    high-risk
    
    Patent expires in February 2017HPV 6, 11
    
    In public domain;
Digene has
ownership of unique
genetic material
    
    low-risk
    
    Not applicable.HPV 42
    
    Institut Pasteur
issued patents;
cross-licensed to
Digene
    
    low-risk
    
    Cross-license rights under
multiple issued patents. U.S.
patents will expire between
2012 and 2016 and European
patents will expire between
2007 and 2012.HPV 43, 44
    
    Digene issued
patents;
cross-licensed to
Institut Pasteur
    
    low-risk
    
    Digene holds one U.S. patent
to HPV 43 (expires June 2006)
and one patent to HPV 44
(expires June 2007).
 Through our owned patents, license agreements described further below and
access to other HPV types, we have rights to or access to the 13 commonly
recognized highrisk human papillomavirus types. We believe we have access to
more highrisk HPV types than other companies currently offering or 19




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developing HPV tests. Some of these HPV types are the subject of multiple
patents. As our issued patents and exclusive license rights expire, or are
terminated, other companies will gain access to such highrisk HPV types, but
we do not believe the expiration of the earliest to expire patents will have a
material impact on us. We are party to a cross license agreement with Institut Pasteur, under
which we obtained a worldwide non-exclusive license to United States patents
and patent applications and corresponding foreign patents and patent
applications, relating to HPV types 33, 39 and 42. In return, we granted to
Institut Pasteur a worldwide non-exclusive license to our three owned United
States patents and corresponding foreign patents and applications relating to
HPV types 35, 43 and 56. We granted Institut Pasteur the right to extend the
scope of its non-exclusive license to include the United States patent and
corresponding patent applications relating to HPV type 44 at such time as
Institut Pasteur discovers and develops an additional HPV type which is
equivalent in value to HPV type 44. If such extension is granted, we will
receive a license to the new HPV type discovered and developed by Institut
Pasteur. Under the cross license agreement, Institut Pasteur has the right to
grant a sublicense of its rights under the cross license agreement, without the
right to grant further sublicenses, to Beckman Instruments (now known as
Beckman Coulter, Inc.) and to affiliates of Institut Pasteur. Under the cross
license agreement, both parties are restricted from granting any additional
licenses to the HPV types subject to the cross licenses but are entitled to
assign their rights, subject to all restrictions. We believe that the cross
license agreement terminates on the last to expire of the underlying patent
rights. Any prior termination of the cross license could have a material
adverse effect on our business, financial condition and results of operations.
In June 2002, we were notified by Institut Pasteur that it had transferred to
F. Hoffman-La Roche Ltd. the human papillomavirus intellectual property estate
of Institut Pasteur, which included an assignment of the cross license
agreement to Roche. 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. We
are currently party to a patent infringement action with Ventana Medical
Systems and Beckman Coulter related to these matters. Please see Item 3.
Legal Proceedings, for a description of such litigation. On April 5, 2000, we entered into an exclusive worldwide license with
Institut Pasteur relating to the genetic sequence of HPV types 68 and 70
(including the use of the United States patent relating thereto issued November
9, 1999 and expiring in 2017) and the detection of HPV types 68 and 70 using
DNA testing methods. Under the license we can use our rights to develop and
sell products using the licensed technology and pay royalties on such products.
The term of the license expires upon expiration of the licensed patent, except
that it continues for the commercial life of the products in countries where
there is no licensed patent. Through a license with Georgetown University, we obtained exclusive,
worldwide rights to a United States patent application (subsequently issued)
and corresponding foreign patents and patent applications relating to HPV type
52 and to a United States patent and corresponding foreign patents relating to
the use of the L1 gene sequence to detect specific human papillomavirus types.
Unless terminated earlier, the Georgetown license will terminate upon the last
to expire of the licensed patent rights. The L1 gene sequence-related patent
will expire in 2008 in the United States and in 2006 in Europe. We are
obligated to make royalty payments to Georgetown University based on the
percentage of net sales (as defined in the license agreement) of products
incorporating the licensed technologies. We are currently involved in
negotiations with Georgetown University related to a disagreement over the
calculation of such royalties. To date, such discussions have not resolved the
matter. We currently believe we can resolve this matter without a material
adverse effect on our results of operations or financial condition, but we
cannot assure you that such resolution will occur. 20




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Through a license with Kanebo, Ltd., we have obtained exclusive worldwide
rights (except for Japan where Kanebo retained the right to grant a
non-exclusive sublicense to Toray Industries, Inc.) to use human papillomavirus
type 58 provided by Kanebo to develop, manufacture, use, distribute and sell
products. Unless terminated earlier, the Kanebo license expires on the later
to occur of January 1, 2010 or the expiration of any patent relating to human
papillomavirus type 58 issued to Kanebo on its patent application. Other Intellectual Property In July 2001, Institut Pasteur notified us that Institut Pasteur was
granted a new U.S. patent concerning the Hepatitis B virus genome and requested
information from Digene regarding products that may use the technology
described in this patent. We exchanged information regarding
this request during the remainder of 2001 and early 2002. In July 2004,
Institut Pasteur contacted us to renew license discussions with respect to such
patent. To date, we have not resolved the matter. The use of trademarks is important to help promote name recognition for us
and our product offerings. We have developed a portfolio of trademarks for
which we are pursuing or have received registrations, in the U.S. and
elsewhere. We have programs in place to monitor any unauthorized use of our
trademarks, or the use of marks confusingly similar to our marks. To date we
have not experienced any significant issues related to our trademark estate. Our principal trademarks include: Registered Trademarks:
    
    Hybrid CaptureDigeneRapid CapturePending Trademark applications:
    
    DNAwithPapDNAPapCervical Samplerhc2hc2 High-Risk HPV DNA Test
 Government Regulation The medical devices marketed and manufactured by us are subject to
extensive regulation by the FDA and, in most instances, by foreign regulatory
authorities. Pursuant to the Federal Food, Drug, and Cosmetic Act, and the
related regulations, the FDA regulates product development, product testing,
product labeling, product storage, pre-market clearance or approval,
manufacturing, advertising, promotion, product sales and distribution of
medical devices. Noncompliance with applicable requirements can result in,
among other things, fines, injunctions, civil penalties, recalls or seizures of
products, total or partial suspension of production, failure of the government
to grant pre-market clearance or pre-market approval for devices, withdrawal of
marketing clearances and/or approvals and criminal prosecution. The FDA also
has the authority to request repair, replacement or refund of the cost of any
device that we manufacture or distribute. Before a new device can be introduced into the market, the manufacturer
generally must obtain pre-market approval (PMA) through the filing of a PMA
application or, if pre-market approval through the PMA requirements is not
necessary, pre-marketing clearance through the filing of a 510(k) notification
is required. In the United States, medical devices and diagnostics are classified into
one of three classes (class I, II or III), on the basis of the controls deemed
necessary by the FDA to reasonably assure their safety 21




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and effectiveness. Under FDA regulations, class I devices are subject to
general controls (for example, labeling and adherence to quality and safety
requirements, and class II devices are subject to general and special controls
(for example, performance standards, post-market surveillance, patient
registries and FDA guidelines). Generally, class III devices are those which
must receive pre-market approval by the FDA to ensure their safety and
effectiveness (for example, life-sustaining, life-supporting and implantable
devices, or new devices which have not been found substantially equivalent to
legally marketed devices). Our HPV test products are subject to PMA
requirements and our diagnostic tests for chlamydia, gonorrhea and
cytomegalovirus are subject to the 510(k) marketing clearance requirements.
The regulatory requirements for our instrumentation, including our manual
Hybrid Capture system and Rapid Capture system, are predicated upon the
diagnostic test products with which they are used. Generally, a PMA application must be filed for a proposed new device
unless the applicant can show, under FDA regulations, that the proposed device
is substantially equivalent to a legally marketed class I or class II device.
A PMA application must be supported by valid scientific evidence, including
preclinical and clinical trial data, to demonstrate the safety and
effectiveness of the device. The PMA application must also contain the results
of relevant bench tests, laboratory and animal studies, if applicable, a
complete description of the device and its components, and a detailed
description of the methods, facilities and controls used to manufacture the
device, in addition to device labeling and advertising literature. If a PMA application is accepted for filing, the FDA begins an in-depth
review of the submission. FDA review of a PMA application generally takes one
to two years from the date the PMA application is accepted for filing, but may
take significantly longer. The PMA review process includes a pre-approval
inspection of the manufacturers facilities to ensure that the facilities are
in compliance with the applicable quality and safety requirements. In
addition, an advisory committee made up of clinicians and/or other appropriate
experts is typically convened to evaluate the application and make
recommendations to the FDA as to whether the device should be approved. The
PMA process can be expensive, uncertain and lengthy. Modifications to a device that is the subject of an approved PMA, its
labeling or manufacturing process may require approval by the FDA of PMA
supplements or new PMAs. PMA supplements often require the submission of the
same type of information required for an initial PMA application, but limited
to the information necessary to support the proposed change. A 510(k) clearance will be granted if the submitted information
establishes that the proposed device is substantially equivalent to a legally
marketed class I or II medical device or to a pre-amendment class III medical
device (i.e., on the market on or before May 28, 1976) for which the FDA has
not called for compliance with PMA requirements. It generally takes from three
to six months from the date of submission to obtain a 510(k) clearance, but can
take twelve months or longer depending on any additional information requested
by the FDA. The FDA may determine that a proposed device is not substantially
equivalent to a legally marketed device or that additional information or data
is needed before a substantial equivalence determination can be made, either of
which could delay market introduction of a new product. A request for
additional data may require that clinical studies of the devices safety and
effectiveness be performed. Additionally, any modifications or enhancements
that could significantly affect the safety or effectiveness of the device or
that constitutes a major change to the intended use of the device will require
a new 510(k) notification or PMA application. Although clinical investigations of most devices are subject to the
investigational device exemption requirements, clinical investigations of in
vitrodiagnostic tests are exempt from such investigational device exemption
requirements if the investigations meet certain exemption criteria. As an in
vitrodiagnostic test manufacturer, we must establish distribution controls to
assure that in vitrodiagnostic tests distributed for the purpose of conducting clinical
investigations are used only for that purpose and are not improperly
commercialized. 22




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We
are exporting our hc2 HPV Test as a stand-alone primary cervical cancer
screening test prior to obtaining PMA approval for this use in the United
States. We are also exporting our hc2 HBV Test for clinical use abroad,
primarily in the Asia/Pacific region. Exportation of our
hc2 HPV Test as a
primary cervical cancer screening test and export of our
hc2 HBV Test can be
undertaken without prior FDA approval of a PMA provided, among other things,
that:  
    
    the marketing of these tests is not contrary to the laws of the country
to which they are intended for import,  
    
    they are manufactured in substantial conformance with the quality and
safety requirements, and  
    
    we have valid marketing authorization by any member country of the
European Union, Australia, Canada, Israel, Japan, New Zealand, Switzerland or
South Africa. We also must provide the FDA with simple notification indicating the
products exported and the countries to which they are exported. FDA approval
must be obtained for exports of products subject to the PMA requirements if
these export conditions are not met. Any products manufactured or distributed by us pursuant to FDA clearances
or approvals are subject to pervasive and continuing regulation by the FDA,
including recordkeeping requirements and reporting of adverse experiences with
the use of the device. Device manufacturers are required to register their
establishments and list their devices with the FDA and are subject to periodic
inspections by the FDA and certain state agencies. The Federal Food, Drug, and Cosmetic Act requires devices to be
manufactured in accordance with the applicable quality and safety requirements,
which impose certain procedural and documentation requirements on us with
respect to our manufacturing and quality assurance activities. Noncompliance
with the applicable quality and safety requirements can result in, among other
things, fines, injunctions, civil penalties, recalls or seizures of products,
total or partial suspension of production, failure of the government to grant
pre-market clearance or pre-market approval for devices, withdrawal of
marketing approvals and criminal prosecution. The FDA actively enforces regulations prohibiting the promotion of devices
for unapproved (off label) uses and the promotion of devices for which
pre-market clearance or approval has not been obtained. Any failure by us to
comply with these requirements can result in regulatory enforcement action by
the FDA and possible limitations on the promotion and/or sale of our products. Our products and we are subject to a variety of state laws and regulations
in those states and localities where our products are or will be marketed. Any
applicable state or local regulations may hinder our ability to market our
products in those states or localities. As a manufacturer we are also subject
to numerous federal and Maryland state and local laws relating to such matters
as safe working conditions, manufacturing practices, environmental protection,
fire hazard control and disposal of hazardous or potentially hazardous
substances. We may be required to incur significant costs to comply with such
laws and regulations in the future, particularly if substantial changes are
made to such laws or regulations. The introduction of our developmental stage test products in foreign
markets will also subject us to foreign regulatory clearances, which may impose
additional substantial costs and burdens. International sales of medical
devices are subject to the regulatory requirements of each country or 23




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defined economic region, such as the European Union. The regulatory
review process varies from country to country and many countries also impose
product standards, packaging requirements, labeling requirements and import
restrictions on devices. In addition, each country or economic region has its
own tariff regulations, duties and tax requirements. We must comply with similar registration requirements of foreign
governments and with import and export regulations when distributing our
products to foreign nations. Each foreign countrys regulatory requirements
for product approval and distribution are unique and may require the
expenditure of substantial time, money and effort. The regulation of medical
devices in a number of such jurisdictions, particularly in the European Union,
continues to develop and new laws or regulations may have a material adverse
effect on our business, financial condition and results of operations.
Noncompliance with state, local, federal, or foreign regulatory requirements
can result in fines, injunctions, civil penalties, recall or seizure of
products, total or partial suspension of production, delay or denial or
withdrawal of pre-market clearance or approval of devices and criminal
prosecution. We incurred significant expense in fiscal 2004 in completing our
activities to comply with the European Union In Vitro Diagnostics Directive.
By December 3, 2003, we completed all work necessary to comply with the
European Unions In Vitro Diagnostic Directive, which included labeling our
HPV, chlamydia and gonorrhea products with a CE mark to indicate compliance
with certain European Community requirements, including product standards, and
ensuring that our products meet those requirements. The approval by the FDA and foreign government authorities is
unpredictable and uncertain, and the necessary approvals or clearances may not
be granted on a timely basis or at all. Delays in receipt of, or a failure to
receive, such approvals or clearances could have a material adverse effect on
our business, financial condition and results of operations. Employees At June 30, 2004, we had 359 employees, including 65 in research and
development, 107 in manufacturing, including quality assurance, 106 in sales
and marketing and 81 in accounting, finance, administration and regulatory
affairs. At June 30, 2004, 52 of such employees were employed by our European
subsidiaries. We are not a party to any collective bargaining agreements, and
we believe our relationships with our employees are good. Principal Executive Offices We were incorporated as a Delaware corporation in 1987. Our principal
executive offices are located at 1201 Clopper Road, Gaithersburg, Maryland
20878. Available Information For more information about us, visit our web site at www.digene.com. Our
electronic filings with the U.S. Securities and Exchange Commission (including
our annual report on Form 10-K, quarterly reports on Form 10-Q and current
reports on Form 8-K, and any amendments to these reports) are available free of
charge through our web site as soon as reasonably practicable after we
electronically file with or furnish them to the U.S. Securities and Exchange
Commission. 24




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RISK FACTORS Investing in our securities involves a material degree of risk. Before
making an investment decision, you should carefully consider the risk factors
set forth below. We have incurred cumulative net losses to date and need to continue to spend
substantial funds. We may not remain profitable and may need to seek
additional financing. We have had substantial operating losses since incorporation in 1987. We
turned profitable during the fourth quarter of fiscal 2003, but prior to that
we never earned a profit. At June 30, 2004, our accumulated deficit was
approximately $54,146,000. Previous losses have resulted principally from:  
    
    expenses associated with our research and development programs;  
    
    our sales and marketing activities in the United States and internationally; and  
    
    other expenses, including administrative and facilities costs. Historically, our net losses were $6,480,997 in fiscal 2001, $9,396,616 in
fiscal 2002, and $4,323,511 in fiscal 2003. We had net income of approximately
$21,542,000, which included a deferred tax benefit of approximately
$14,898,000, in fiscal 2004 and we believe that our existing capital resources
will be sufficient to meet the anticipated cash needs of our current business
at least through calendar year 2005. However, if we incur operating losses
during or after fiscal 2005 or if one or more of the events described in these
Risk Factors actually occurs, we may have to obtain additional funds through
equity or debt financing, strategic alliances with corporate partners and
others, or through alternative sources. Any equity financing would dilute our
then-current stockholders. We do not have any committed sources of additional
financing. Additional funding, if necessary, may not be available on
acceptable terms, if at all. If adequate funds are not available, we may have
to delay, scale-back or eliminate aspects of our operations or attempt to
obtain funds through arrangements with collaborative partners or others. This
may result in the relinquishment of our rights to some of our technologies,
product candidates, products or potential markets. We will not be able to achieve significant increases in our revenues if our HPV
testing products and other diagnostic test products are not increasingly
accepted by physicians and laboratories. Our growth and success depend upon increasing market acceptance by
physicians and laboratories of our HPV test products as a primary cervical
cancer screening method, in conjunction with Pap tests, independent of Pap
tests, and as a follow-up screening method for women with equivocal Pap tests.
This requires acceptance of our HPV test products as a clinically useful and
cost-effective alternative to the Pap test and follow-up procedures, such as
repeat Pap tests, colposcopy and biopsy. We are a relatively new participant
in the cervical cancer screening market. Pap tests have been the principal
means of cervical cancer screening since the 1940s. Currently, approximately
60 million Pap tests are performed annually in the United States and we believe
that 60 to 100 million are performed annually in the rest of the world. Women
with normal Pap tests do not undergo follow-up treatment beyond routine Pap
testing. Follow-up testing and treatment is based on the classification of the
Pap test result. An equivocal, or ASC-US (Atypical Squamous Cells of
Undetermined Significance), classification is given to Pap test results that
cannot be definitively classified as either normal or abnormal; this
classification occurs in approximately 5% to 7% of all cases. HPV testing applies a new gene-based technology and testing approach that
is different from the cytology (reviewing cells under a microscope) approach of
the Pap test, which is a well-accepted method for cervical cancer screening.
We have expended, and need to continue to spend, significant resources to 25




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educate physicians and laboratories about the patient benefits that can
result from using our HPV test products in addition to the Pap test, and to
assist laboratory customers in learning how to perform our HPV test products.
Using our HPV test products along with the Pap test for primary screening in
the United States may be seen by some of these customers as adding unnecessary
expense to the generally accepted cervical cancer screening methodology and we
frequently need to provide information to counteract this impression on a
case-by-case basis. To date, we have been able to grow our revenues from sales
of our HPV test products from approximately $19,495,000 in fiscal 2001 to
approximately $74,581,000 in fiscal 2004. If we are not successful in
executing our marketing strategies, we will not be able to continue to grow our
revenues. Furthermore, technological advancements designed to improve quality
control over sample collection and preservation and to reduce the Pap tests
susceptibility to human error may increase physician reliance on the Pap test
and solidify its market position as the most widely used screen for cervical
cancer. Our products for the diagnosis of the presence of chlamydia and gonorrhea
compete with other FDA-cleared products that detect the presence of such
infectious diseases. Our marketing activities focus on providing information
regarding the accuracy and objective nature of these diagnostic tests, but such
activities are time-consuming and expensive. We believe the best way to
increase our revenues from these products is to educate laboratories and
physicians about the ability to run such tests from the same patient sample
collected for HPV testing. If we are not successful in executing our marketing
strategy we do not expect to significantly grow our revenues from these
products. Our test to identify and monitor the viral load of hepatitis B virus
is authorized for sale in the United States for research use only and,
internationally, is one of a number of alternatives available to detect the
presence of the hepatitis B virus. If more third-party health insurance payors do not adequately reimburse for our
HPV test products, the use of our HPV test products may not increase, thus
negatively affecting our ability to grow our revenues. A significant portion of the sales of our products in the United States
and other markets depend, in large part, on the availability of adequate
reimbursement to users of our tests from government insurance plans, including
Medicare and Medicaid in the United States, managed care organizations and
private insurance plans. We believe we have nearly universal coverage from
U.S. government payors, third-party payors and managed care entities for our
hc2 HPV Test as a follow-up test to categorize equivocal Pap test results. In
addition, government payors, third-party payors and managed care entities that
provide health insurance coverage to over 175 million people in the United
States currently authorize reimbursement for the use of our DNAwithPap Test to
adjunctively screen women age 30 and older to assess the presence or absence of
significant, cancer-causing HPV types. Reimbursement for this indication is
now available from more than 75 payors. Reimbursement coverage for the Pap
test is universal in the United States and in other markets where we sell our
HPV test products. Despite our success to date, third-party payors are often reluctant to
reimburse healthcare providers for the use of medical tests such as our HPV
test products that involve new technology. In addition, third-party payors are
increasingly limiting reimbursement coverage for medical diagnostic products
and, in many instances, are exerting pressure on diagnostic product suppliers
to reduce their prices. Thus, third-party reimbursement may not be
consistently available or financially adequate to cover the cost of our
products. This could limit our ability to sell our products, cause us to
reduce the prices of our products or otherwise adversely affect our operating
results. Because each third-party payor individually approves reimbursement,
obtaining such approvals is a time-consuming and costly process that requires
us to provide scientific and clinical support for the use of each of our
products to each payor separately with no assurance that such approval will be
obtained. 26




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This process can delay the broad market introduction of new products and
could have a negative effect on our revenues and operating results. We may incur more costs than expected in order to establish our own
infrastructure in Europe to market, sell, distribute and support our HPV test
products, and we may not achieve the desired increase in our profitability from
such market. In 2002 we made the decision to establish our own sales, marketing,
distribution, warehousing and customer support infrastructure in Europe for the
sale of our HPV test products and other products. Other companies selling medical
diagnostic products in Europe are larger and significantly better capitalized
than we are, and have had established European operations for a significantly
longer period than we have. We had previously used third-party distributors to
distribute and market our products in Europe, and our product inventory,
distribution and customer support services are still in the development
process. As of June 30, 2004, approximately $11,203,000, or 31%, of our sales
and marketing expenditures and approximately $5,561,000, or 29%, of our general
and administrative expenditures for fiscal 2004 related to our activities in
Europe. During the same period, approximately $12,865,000, or 17%, of our HPV
testing revenues were from sales in Europe. We expect to continue to expend
significant resources to grow and maintain our infrastructure as much as
possible given the resources at our disposal, but such resources may not be
sufficient to meaningfully increase our revenues in Europe. Our revenues and
operating results could be hurt by our inability to successfully grow and
maintain our distribution infrastructure or our inability to effectively market
our products in Europe. The decision to establish our own infrastructure in Europe has required us
to establish multiple subsidiary corporations in Europe. This subjects us to
the laws of multiple jurisdictions, including tax and employment laws, and the
laws governing the import, storage and distribution of our products. Any
failure to comply with these laws could have a material adverse impact on our
business and operations. The time and expense needed to obtain regulatory approval and respond to
changes in regulatory requirements could adversely affect our ability to
commercially distribute our products and generate revenue therefrom. Each of our products and product candidates are medical devices subject to
extensive regulation by the FDA under the Federal Food, Drug and Cosmetic Act.
Governmental bodies in other countries also have medical device approval
regulations which are becoming more extensive. Such regulations govern the
majority of the commercial activities we perform, including the indications for
which our products can be used, product development, product testing, product
labeling, product storage, use of our products with other products and the
manufacturing, advertising and promotion of our products for the approved
indications. Compliance with these regulations is expensive and
time-consuming. With respect to our HPV test products, we were the first
company to obtain approval of regulatory applications for human papillomavirus
testing in the United States and in many countries in Europe (our principal
markets), which adds to our expense and increases the degree of regulatory
review. The expense of submitting regulatory approval applications in multiple
countries as compared to our available resources impacts the decisions we make
about entering new markets. Each medical device that we wish to distribute commercially in the United
States will likely require either 510(k) clearance or pre-market approval from
the FDA prior to marketing the device for in vitro-diagnostic use. Clinical
trials related to our regulatory submissions take years to execute and are a
significant expense for us. The 510(k) clearance pathway usually takes from
three to twelve months, but can take longer. The pre-market approval pathway
is much more costly, lengthy and uncertain. It generally takes from one to
three years, but can also take longer. It took us more than four years to
receive pre-market approval to offer our current generation HPV test
product to test
for the presence of the human papillomavirus in women with equivocal Pap test
results and pre-market approval to use our 27




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DNAwithPap Test as a primary adjunctive cervical cancer screening test to
be performed in conjunction with the Pap test for women age 30 and older. With
respect to our ongoing efforts, in April 2002, we submitted a pre-market
approval (PMA) supplement with the FDA seeking approval of the use of our hc2
HPV Test with TriPath Imaging, Inc.s SurePath Test Pack sample collection
system. In July 2002, we received notice from the FDA that the PMA supplement
was not approvable as submitted. We worked with TriPath during fiscal 2004 to
complete additional clinical studies and submitted the results of these studies
to the FDA in August 2004 for pre-market approval. The regulatory time span
increases our costs to develop new products and increases the risk that we will
not succeed in introducing or selling new products in the United States. Our cleared or approved devices, including our diagnostic tests and
related equipment, are subject to numerous post-market requirements. We are
subject to inspection and marketing surveillance by the FDA to determine our
compliance with regulatory requirements. If the FDA finds that we have failed
to comply, it can institute a wide variety of enforcement actions, ranging from
a public warning letter to more severe sanctions such as:  
    
    fines, injunctions and civil penalties;  
    
    recall or seizure of our products;  
    
    operating restrictions, partial suspension or total shutdown of production;  
    
    denial of our requests for 510(k) clearance or pre-market approval of product candidates;  
    
    withdrawal of 510(k) clearance or pre-market approval already granted; and  
    
    criminal prosecution. Any enforcement action by the FDA may also affect our ability to
commercially distribute our products in the United States. Changes in existing requirements or adoption of new requirements or
policies could adversely affect our ability to sell our approved products or to
seek to introduce new products in other countries in the world. For example,
as of December 7, 2003, all in vitrodiagnostic products sold in the European
Union must bear the CE mark, which indicates compliance with the requirements
of the In Vitro Diagnostic Directive. We elected to obtain the CE mark for our
HPV test products, and chlamydia and gonorrhea tests. In December 2003 we
stopped offering our diagnostic tests for hepatitis B virus and cytomegalovirus
in the European Union countries, in large part as a result of the expense of
complying with the requirements of the In Vitro Diagnostic Directive (in
contrast to the expected revenue from these product offerings). Failure to
comply with regulatory requirements could have a material adverse effect on our
business, financial condition and results of operations. We may be required to
incur significant costs to comply with laws and regulations in the future, and
changes or additions to existing laws or regulations may have a material
adverse effect upon our business, financial condition and results of
operations. We may be sued for product liability claims or face product recalls for which
our insurance may be inadequate. We may be found liable if any of our products causes injury or fails to
accurately diagnose disease, i.e., provides a false negative or false
positive test result. We currently carry product liability insurance coverage
with a combined single limit of $10,000,000. This coverage may not be adequate
to protect us against future product liability claims. Product liability
insurance may not be available to us in the future on commercially reasonable
terms, if at all. 28




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Our products are a complex interaction of biochemical reagents, and it is
not uncommon for us to face manufacturing, raw material or supply chain
problems. We have initiated product recalls from time to time in the past and
additional product recalls may be necessary from time to time in the future,
either voluntarily on our part or at the direction of the FDA or other
government agencies. For example, in February 2003 we initiated a voluntary
recall involving our HPV and chlamydia diagnostic tests. This recall was
limited to certain product lots which were manufactured using a specific lot of
raw material that had the potential to cause false positive patient specimen
results. The root cause of this product performance issue related to an
undisclosed change made by a raw material supplier that our raw material
release testing procedure did not identify. Because this voluntary recall was
limited to a certain identified lot of raw material, we were able to supply our
customers with product manufactured from acceptable raw material lots. This
recall resulted in a charge of approximately $425,000 to cost of product sales
in one fiscal quarter. Although none of our past product recalls have had a
material adverse impact on our business, we believe future product recalls
could have a material adverse affect on our business, financial condition or
reputation. We are required to obtain and maintain royalty-bearing licenses to third party
patents or patent applications, and loss of such licenses, or the need to
obtain additional licenses, could materially adversely affect our ability to
commercialize our products. We have in-licensed patents to a number of cancer-causing human
papillomavirus types, which, together with the patents to cancer-causing human
papillomavirus types that we own, provide us with a competitive advantage. We
may lose this competitive advantage if these licenses terminate or if the
patents licensed thereunder expire or are declared invalid. Our products and manufacturing processes require access to biological
materials and other intellectual property that may be subject to patents and
patent applications held by third parties. In addition, we have licenses to
various patents covering intellectual property that we use in conjunction with
applications of our Hybrid Capture technology. Third parties may have claims
to these patents. An adverse outcome to such claims could subject us to
significant liabilities to third parties or require us to obtain
royalty-bearing licenses from third parties, cease sales of related products or
revise the applications or products which employ the patented technology. Any
licenses required for any such third party patents or proprietary rights may
not be made available to us on commercially reasonable terms, if at all.
Furthermore, we may be unable to make the necessary revisions to our
applications or products. We may discover that we need to obtain rights to an additional patent in
order to commercialize our products. We may be unable to obtain such rights on
commercially reasonable terms or at all, which could adversely affect our
ability to grow our business. For example, in October 1999, Enzo Biochem, Inc.
contacted us to determine whether one of our diagnostic tests for the presence
of gonorrhea might infringe Enzos United States Patent No. 4,900,659. We
evaluated this matter and its potential impact on our gonorrhea test. After
consultation with our patent counsel, we believe that Enzos United States
patent is invalid and not infringed. We have also consulted with German
counsel regarding Enzos European counterpart to this patent and believe that,
like the U.S. patent, the European counterpart patent is also invalid and not
infringed. It is possible that we could become involved in litigation with
Enzo and/or have to seek a license from Enzo regarding these patents. 29




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We may inadvertently infringe upon the intellectual property rights of third
parties, which could expose us to expensive intellectual property litigation,
impose a significant strain on our resources and prevent us from developing or
marketing our products. There have been substantial litigation and other proceedings regarding
patent and other intellectual property rights in the pharmaceutical and
biotechnology industries because of the uncertainties and complex legal,
scientific and factual questions related to the ownership and protection of
intellectual property. We have received inquiries regarding possible patent
infringements relating to, among other things, aspects of our Hybrid Capture
technology. We believe that the patents of others to which these inquiries
relate are either not infringed by our Hybrid Capture technology or are
invalid. However, we may be subject to further claims that our technology,
including our Hybrid Capture technology, or our products infringe the patents
or proprietary rights of third parties. We may also be forced to initiate
legal proceedings to protect our patent position or other proprietary rights.
These proceedings are often expensive and time-consuming, even if we were to
prevail. We are currently involved in two significant intellectual property litigation
matters which, if decided adversely to us, may affect our ability to sell our
products or result in substantial financial losses or harm to our reputation. 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 December 10, 2002, the Court granted our motion to
amend. On January 28, 2003, we filed a motion to file a second amended
complaint. On March 9, 2003 the Court granted our motion to amend. In the course of this litigation, Ventana and Beckman Coulter filed
motions seeking to compel arbitration of Digenes claims against them. After a
bench trial, the Court issued an order that Beckman Coulter has a right to
arbitrate Digenes claims against it, but that Ventana does not. The
arbitration process has not yet been initiated. The Court, as a matter of
judicial economy, has stayed the proceedings against Ventana pending the
outcome of any arbitration between Digene and Beckman Coulter. This litigation is expensive and we cannot assure you that we will be
successful. In addition, such litigation may result in financial losses or
harm to our reputation and diverts management resources from our core business. 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 30




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##### 



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. 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 our motion
to amend our counterclaims to include inequitable conduct claims. The Court had scheduled the trial in this matter to commence June 14,
2004. On June 10, 2004, the Court issued orders on various pretrial motions
filed by the parties, including an order on patent claim construction for U.S.
Patent No. 6,221,581. Although the Court did not adopt Digenes position on
certain matters of claim construction, Digene continues to believe that it does
not infringe any valid and enforceable claim of the U.S. Patent No. 6,221,581.
On June 14, 2004, at the joint request of the parties, the trial was continued.
No new trial date has been set. This litigation is expensive and we cannot assure you that we will be
successful. An adverse outcome in this litigation could subject us to
significant liabilities or require us to obtain royalty-bearing licenses, cease
sales of related products or revise the applications or products which employ
the technology at issue. We may not be able to obtain any such licenses on
commercially reasonable terms, if at all, or be able to revise such
applications or products. We have the only fully commercialized and FDA-approved test for the detection
of human papillomavirus, which provides us with a competitive advantage that
may be adversely impacted if other companies develop and commercialize
alternative human papillomavirus tests. Although we have the only fully commercialized and FDA-approved test for
the detection of human papillomavirus, a significant portion of our HPV-related
intellectual property is in the public domain, subject to patents that will
begin to expire in the next few years or not licensed to us on a sole and
exclusive basis. As a result, we believe other companies are developing or
will develop HPV detection tests in the next few years. For example, F. Hoffman-La Roche Ltd. (Roche) has publicly announced its
ongoing development of a test for the detection of human papillomavirus and in
April 2004 announced that it launched such test in Europe. In June 2002,
Institut Pasteur announced that it had transferred its human papillomavirus
intellectual property estate to Roche, which included an assignment of the
cross license between Digene and Institut Pasteur. Based upon the human
papillomavirus types to which Roche has announced that it acquired access as a
result of the transfer by Institut Pasteur, the human papillomavirus types
covered by Roches own patents and the human papillomavirus types that are
publicly available, and despite our continuing exclusive right to certain high
risk HPV types, we believe Roche may have the ability to develop a human
papillomavirus test that would be competitive with our HPV test products in our
principal markets. Roche has substantially greater resources than we do. We
may not be able to compete successfully against Roche if it markets a human
papillomavirus test competitive with our HPV Test. Ventana Medical Systems, Inc. is selling an in situdiagnostic test for
the detection of human papillomavirus. We believe Ventanas activities
infringe our intellectual property and we have initiated patent infringement
litigation against Ventana. If we are not successful in such litigation, and
if Ventana obtains FDA approval for a test competitive with our HPV
test products, we
may lose significant HPV testing revenue to Ventana. 31




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We are also aware that a significant number of laboratory organizations
and other companies are developing and using internally developed, or
home-brew, human papillomavirus tests. These tests, although not approved by
the FDA or similar non-U.S. regulatory authorities, do offer an alternative to
our HPV test products that could limit the laboratory customer base for our product. We
are monitoring these activities. Single suppliers or a limited number of suppliers provide key components of our
products. If these suppliers fail to supply these components, we may be unable
to manufacture sufficient product to satisfy demand which would negatively
impact our revenues. Several key components of our products come from, or are manufactured for
us by, a single supplier or limited number of suppliers. This applies in
particular to three components, chemiluminescent substrates (used to create a
chemical reaction that causes light in connection with our Hybrid Capture
signal amplified molecular technology), our Rapid Capture system that serves as
the automation platform developed for large-scale diagnostic testing using the
Hybrid Capture technology and the 96-well microplate used by laboratories to
run our diagnostic test products. We have been able, to date, to enter into
long-term contracts with these single source suppliers. In some cases,
however, the supplier of a key component is not required to supply us with
specified quantities over longer periods of time or set-aside part of its
inventory for our forecasted requirements. We have not arranged for
alternative supply sources for these components and it may be difficult to find
alternative suppliers, if at all. If our products sales increase beyond the
forecast levels, or if our suppliers are unable or unwilling to supply us
components on a timely basis, we may be unable to satisfy product demand. In addition, if any of the components of our products are no longer
available in the marketplace, we may be forced to further develop our products
or technology to incorporate alternate components. The incorporation of new
components into our products may require us to seek approvals from the FDA or
foreign regulatory agencies prior to commercialization. We may encounter difficulties expanding our manufacturing operations as demand
for our products increases, which would negatively impact our revenues. We
depend on a single facility for the manufacture of all of our diagnostic test
kits and any temporary stoppage at that site would have a material adverse
effect on our business. If product sales increase, we will have to scale-up our manufacturing
processes and facilities. We may encounter difficulties in scaling-up
manufacturing processes and may be unsuccessful in overcoming such
difficulties. In such circumstances, our ability to meet product demand may be
impaired or delayed. We have a single manufacturing facility located in Gaithersburg, Maryland.
This facility is subject, on an ongoing basis, to a variety of quality systems
regulations, international quality standards and other regulatory requirements,
including current good manufacturing practices requirements of the FDA. We may
encounter difficulties maintaining or expanding our manufacturing operations in
accordance with these regulations and standards, which could result in a delay
or termination of manufacturing or an inability to meet product demand. We face risks inherent in operating as a single facility for the
manufacture of our products. We do not have alternative production plans in
place or alternative facilities available if we experience prolonged facility
failure at our Gaithersburg, Maryland manufacturing facility. These risks
include unforeseen manufacturing delays or stoppage due to equipment, raw
material supply disruption, regulatory, environmental or other factors, and the
resulting inability to meet customer orders on a timely basis. For example,
our products and key raw material components require refrigeration to maintain
efficacy. During the summer of 2003, the Northeast and Mid-Atlantic (where our
facility is located) regions of the United States experienced loss of
electrical power for sustained periods. During that time, 32




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we discovered that such widespread electrical loss disrupted the ability
of our vendors to ship raw material components to us and disrupted the ability
of overnight express delivery companies to handle delivery of our products to
customers. Our then-current generator capacity was sufficient to maintain our
manufacturing and inventory operations, but such events caused us to re-assess
and upgrade our generator capacity and identify, where possible, alternative
sources for raw material components. If similar events occur for sustained
periods in the future, we may not be able to obtain and maintain adequate raw
material supplies, or manufacture and deliver our products sufficient to meet
then-current demand, which would have a substantial negative effect on our
business. Our international sales are subject to currency, market and regulatory risks
that are beyond our control. For fiscal 2004, we derived approximately 25% of our consolidated revenues
from the international sales of our products and services in foreign currencies
and we expect that international sales will continue to account for a large
portion of our sales. Changes in the rate of exchange of foreign currencies
into United States dollars have and may hurt our revenues and results of
operations. In particular, we sell products in, and derive revenues from, less
economically developed countries. Many of these countries have suffered from
economic and political crisis or instability, including countries in Latin
America, Asia and Eastern Europe. During such times, the value of local
currency in such countries has decreased, sometimes dramatically, negatively
impacting our average unit prices. At the same time, unit sales of our
products have also decreased in such countries. In the past, this has
adversely affected our revenues and operating results. Future economic and
political instability in foreign countries may affect demand for our products
and the value of the local currency, and thus, negatively affect our revenues
and results of operations. The extent and complexity of medical products regulation are increasing
worldwide, particularly in Europe, with regulation in some countries nearly as
extensive as in the United States. Further, we must comply with import and
export regulations when distributing our products to foreign nations. Each
foreign countrys regulatory requirements for product approval and distribution
are unique and may require the expenditure of substantial time, money and
effort. As a result, we may not be able to successfully commercialize our
products in foreign markets at or beyond the level of commercialization we have
already achieved. 33




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ITEM 2. PROPERTIES We have one manufacturing facility located in leased property in
Gaithersburg, Maryland. Our executive offices and research and development
activities are located at such site as well. The facility has a total of
approximately 111,000 square feet, of which approximately 34% is dedicated to
our manufacturing, quality control and shipping activities. The lease for the
facility, which began in March 1998, has a term of ten years, and we have two
options to extend the term for a five-year period each. We have an option to
expand the facility to add additional manufacturing space if needed. We
currently run one manufacturing and product shipment shift per workday and have
the capacity to add additional shifts as required. We believe that we
currently have sufficient manufacturing capacity for our existing demand and
that our Gaithersburg facility will allow us to expand our production
capability to satisfy demand for the foreseeable future. We also lease office and sales operations space in the United Kingdom,
Germany, Switzerland, France, Italy and Spain, pursuant to leases which run in
length from one year to five years. We currently have 52 employees in all such
locations and believe the current office and sales locations are adequate to
meet our needs. We believe we would be able to procure additional space, as
needed, on commercially reasonable terms in Europe to support our European
operations. We also utilize a third-party warehouse facility, pursuant to a
contract supplying us with dedicated space, in Germany to hold product and
equipment inventory necessary to support our European operations. We believe
this facility is adequate to satisfy demand for the foreseeable future. ITEM 3. 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 December 10, 2002, the Court granted our motion to
amend. On January 28, 2003, we filed a motion to file a second amended
complaint. On March 9, 2003 the Court granted our motion to amend. In the course of this litigation, Ventana and Beckman Coulter filed
motions seeking to compel arbitration of Digenes claims against them. After a
bench trial, the Court issued an order that Beckman Coulter has a right to
arbitrate Digenes claims against it, but that Ventana does not. The
arbitration process has not yet been initiated. The Court, as a matter of
judicial economy, has stayed the proceedings against Ventana pending the
outcome of any arbitration between Digene and Beckman Coulter. 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 34




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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. 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 our motion to amend our counterclaims to include
inequitable conduct claims. The Court had scheduled the trial in this matter to commence June 14,
2004. On June 10, 2004, the Court issued orders on various pretrial motions
filed by the parties, including an order on patent claim construction for U.S.
Patent No. 6,221,581. Although the Court did not adopt Digenes position on
certain matters of claim construction, Digene continues to believe that it does
not infringe any valid and enforceable claim of the U.S. Patent No. 6,221,581.
On June 14, 2004, at the joint request of the parties, the trial was continued.
No new trial date has been set. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF OUR STOCKHOLDERS Not applicable. 35




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EXECUTIVE OFFICERS OF DIGENE Name
    
    Age
    
    Positions with the CompanyEvan Jones(1)
    
    
    47
    
    
    Chief Executive Officer and Chairman of the BoardCharles M. Fleischman(2)
    
    
    46
    
    
    President, Chief Operating Officer and Chief Financial OfficerRobert McG. Lilley(3)
    
    
    59
    
    
    Senior Vice President, Global Sales and MarketingAttila T. Lorincz, Ph.D.(4)
    
    
    49
    
    
    Senior Vice President and Chief Scientific OfficerBelinda O. Patrick(5)
    
    
    48
    
    
    Senior Vice President, Manufacturing OperationsJoseph P. Slattery(6)
    
    
    39
    
    
    Senior Vice President, Finance and Information SystemsDonna Marie Seyfried(7)
    
    
    46
    
    
    Vice President, Business Development
   (1)
    
    Mr. Jones joined Digene in July 1990 as Chief Executive Officer. He was
elected to serve on the Board of Directors in July 1990 and became
Chairman of the Board in September 1995. He served as our President from
July 1990 to June 1999. From 1988 to September 1990, Mr. Jones was
President of Neomorphics, Inc. Between 1987 and 1990, he was first an
associate and then a partner with the CW Group, a health care venture
capital firm. From 1983 to 1987, Mr. Jones was employed by The
Perkin-Elmer Corporation. Mr. Jones is a member of the Board of Directors
of the Childrens Research Institute at the Childrens National Medical
Center. Mr. Jones received a B.A. in Biochemistry from the University of
Colorado and an M.B.A. from The Wharton School at the University of
Pennsylvania. Mr. Jones is a stepbrother of Mr. Whitehead, a member of
Digenes Board of Directors.(2)
    
    Mr. Fleischman has served as our President since June 1999, as Chief
Financial Officer since March 1996 and as Chief Operating Officer since
September 1995. He also served as our Executive Vice President from July
1990 to June 1999. From 1987 to 1990, he was a Vice President and then
Associate Director in the Investment Banking Group of Furman Selz (now ING
Group), New York, New York. From 1986 to 1987, Mr. Fleischman was a
founder and Managing Director of Intercapital Brokers, Ltd., London,
England. Mr. Fleischman is a member of the Board of Directors of the
Advanced Medical Technology Association (AdvaMed). Mr. Fleischman
received an A.B. in History from Harvard University and an M.B.A. from The
Wharton School at the University of Pennsylvania.(3)
    
    Mr. Lilley has served as our Senior Vice President, Global Sales and
Marketing since June 1999, and before that as our Vice President, Sales
and Marketing from July 1998 until June 1999, and as General Manager for
Digene Europe from March 1997 until July 1998. From September 1994 to
February 1997, Mr. Lilley was General Manager for Europe, Middle East &
Africa for Alltel Healthcare Information Services.(4)
    
    Dr. Lorincz has served as our Senior Vice President and Chief Scientific
Officer since January 2000. He previously served as our Vice President,
Research and Development and Scientific Director from January 1991 to
January 2000. His research career includes postdoctoral fellowships at
the University of California. He also serves on a number of advisory
committees.(5)
    
    Ms. Patrick has served as our Senior Vice President, Manufacturing
Operations since May 2001. Prior to joining Digene, Ms. Patrick served as
Vice President, Maryland Operations for Invitrogen Corporation from
September 2000 to January 2001 and for Life Technologies, Inc. from
February 1998 to September 2000. She previously served as Vice President,
Regulatory Affairs and Quality Assurance for Life Technologies, Inc. from
January 1995 to February 1998.(6)
    
    Mr. Slattery has served as our Senior Vice President, Finance and
Information Systems since September 2002. Previously, he served as our
Vice President, Finance from July 1999 to September 2002 and as Controller
from February 1996 to July 2000.(7)
    
    Ms. Seyfried has served as our Vice President, Business Development since
October 1996. Ms. Seyfried served as Senior Director, Business
Development of The Perkin-Elmer Corporation from March 1993 to September
1996. 36




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PART II ITEM 5. MARKET FOR OUR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS Since our initial public offering of common stock on May 22, 1996, our
common stock has been traded on the NASDAQ National Market under the symbol
DIGE. The following table sets forth, for the fiscal quarters indicated, the
high and low bid prices for our common stock, as reported by the NASDAQ
National Market. High
    
    LowFiscal 2004Fourth quarter
    
    $
    40.86
    
    
    $
    33.02Third quarter
    
    
    48.50
    
    
    
    29.33Second quarter
    
    
    46.24
    
    
    
    32.59First quarter
    
    
    49.45
    
    
    
    25.71Fiscal 2003Fourth quarter
    
    $
    29.05
    
    
    $
    18.21Third quarter
    
    
    18.00
    
    
    
    10.02Second quarter
    
    
    11.46
    
    
    
    7.03First quarter
    
    
    11.78
    
    
    
    6.22
 On September 3, 2004, the closing sale price for our common stock, as
reported by the NASDAQ National Market, was $25.40. As of September 3, 2004,
our common stock was held by 147 holders of record. We have never paid dividends on our common stock and do not anticipate
paying any cash dividends on our common stock in the foreseeable future. 37




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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data set forth below with respect to
Digenes Consolidated Statements of Operations for the fiscal years ended June
30, 2002, 2003 and 2004 and with respect to Digenes Consolidated Balance
Sheets at June 30, 2003 and 2004 are derived from the audited Consolidated
Financial Statements of Digene, which are included elsewhere in this Form 10-K.
Consolidated Statements of Operations data for the fiscal years ended June 30,
2000 and 2001 and Consolidated Balance Sheet data at June 30, 2000, 2001 and
2002 are derived from Consolidated Financial Statements of Digene not included
herein. The selected consolidated financial data set forth below is qualified
in its entirety by, and should be read in conjunction with, the Consolidated
Financial Statements, the related Notes thereto and Managements Discussion and
Analysis of Financial Condition and Results of Operations included elsewhere in
this Form 10-K. Fiscal Year Ended June 30,2000
    
    2001
    
    2002
    
    2003
    
    2004(in thousands, except per share income (loss))Consolidated Statement of Operations
Data:Revenues:Product sales(1)
    
    $
    22,287
    
    
    $
    32,706
    
    
    $
    45,750
    
    
    $
    62,440
    
    
    $
    88,815Distribution contract(1)
    
    
    
    
    
    
    838
    
    
    
    2,357
    
    
    
    
    
    
    
    Other revenues
    
    
    757
    
    
    
    653
    
    
    
    741
    
    
    
    662
    
    
    
    1,346Total revenues
    
    
    23,044
    
    
    
    34,197
    
    
    
    48,848
    
    
    
    63,102
    
    
    
    90,161Costs and expenses:Cost of product sales(1)
    
    
    7,919
    
    
    
    12,553
    
    
    
    12,938
    
    
    
    13,383
    
    
    
    16,717Research and development
    
    
    6,123
    
    
    
    8,120
    
    
    
    9,265
    
    
    
    10,262
    
    
    
    10,744Selling and marketing(1)
    
    
    10,652
    
    
    
    12,548
    
    
    
    19,835
    
    
    
    27,913
    
    
    
    36,623General and administrative
    
    
    6,346
    
    
    
    8,336
    
    
    
    14,024
    
    
    
    16,642
    
    
    
    19,298Abbott termination fee
    
    
    
    
    
    
    
    
    
    
    2,500
    
    
    
    
    
    
    
    Amortization of intangible assets
    
    
    150
    
    
    
    150
    
    
    
    150
    
    
    
    
    
    
    
    Total costs and expenses
    
    
    31,190
    
    
    
    41,707
    
    
    
    58,712
    
    
    
    68,200
    
    
    
    83,382Income (loss) from operations
    
    
    (8,146
    )
    
    
    (7,510
    )
    
    
    (9,864
    )
    
    
    (5,098
    )
    
    
    6,779Interest income
    
    
    1,050
    
    
    
    1,194
    
    
    
    729
    
    
    
    593
    
    
    
    459Interest expense
    
    
    
    
    
    
    (11
    )
    
    
    (32
    )
    
    
    (273
    )
    
    
    (184
    )Other income (expense)
    
    
    513
    
    
    
    (37
    )
    
    
    (20
    )
    
    
    678
    
    
    
    163Income (loss) from operations before
income taxes
    
    
    (6,583
    )
    
    
    (6,364
    )
    
    
    (9,187
    )
    
    
    (4,100
    )
    
    
    7,217Provision for (benefit from) income taxes
    
    
    184
    
    
    
    117
    
    
    
    210
    
    
    
    224
    
    
    
    (14,325
    )Net income (loss)
    
    $
    (6,767
    )
    
    $
    (6,481
    )
    
    $
    (9,397
    )
    
    $
    (4,324
    )
    
    $
    21,542
    (3)Basic net income (loss) per share(2)
    
    $
    (0.44
    )
    
    $
    (0.39
    )
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.13Diluted net income (loss) per share(2)
    
    $
    (0.44
    )
    
    $
    (0.39
    )
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.04Basic weighted average shares
outstanding(2)
    
    
    15,296
    
    
    
    16,557
    
    
    
    17,361
    
    
    
    18,136
    
    
    
    19,144Diluted weighted average shares
outstanding(2)
    
    
    15,296
    
    
    
    16,557
    
    
    
    17,361
    
    
    
    18,136
    
    
    
    20,806
 June 30,2000
    
    2001
    
    2002
    
    2003
    
    2004Consolidated Balance Sheet Data:Working capital
    
    $
    24,268
    
    
    $
    26,905
    
    
    $
    39,828
    
    
    $
    36,119
    
    
    $
    61,786Total assets
    
    
    35,785
    
    
    
    48,195
    
    
    
    67,241
    
    
    
    63,375
    
    
    
    103,270Long-term debt, less current maturities
    
    
    
    
    
    
    1,000
    
    
    
    3,690
    
    
    
    2,154
    
    
    
    686Accumulated deficit
    
    
    (55,487
    )
    
    
    (61,968
    )
    
    
    (71,365
    )
    
    
    (75,688
    )
    
    
    (54,146
    )Total stockholders equity
    
    
    29,425
    
    
    
    26,334
    
    
    
    39,639
    
    
    
    43,006
    
    
    
    86,063
  (1)
    
    Certain amounts have been reclassified to conform to current
presentation.  (2)
    
    Computed on the basis described in Note 2 of Notes to Consolidated
Financial Statements.  (3)
    
    A portion of the increase in net income primarily relates to the partial
reversal of the deferred tax valuation allowance approximating $14.9
million. 38




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##### 



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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 to such Consolidated Financial Statements also
included in this Form 10-K. 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; risk that other companies may develop and market tests for
human papillomavirus 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 need to obtain
third-party reimbursement approval from government entities, managed care
organizations, and private insurance plans; our ability to scale up our
manufacturing to the extent demand for our products increases; our limited
sales and marketing experience; the extent of future expenditures for sales and
marketing programs; delay in or failure to obtain regulatory approvals for our
products in development; uncertainty of clinical trial results 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 calendar year 2005; risks inherent in
international transactions, including those relating to our expansion in Europe
and elsewhere; and other factors as set forth under the caption Risk Factors
beginning on page 25. 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. We have been profitable since the
fourth quarter of fiscal 2003; however, from our inception until that time, we
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 diagnostic tests for the presence of human papillomavirus (HPV), which, for
fiscal 2004, accounted for 83% of total revenues. We expect that the growing
acceptance of HPV testing in cervical cancer screening programs, both in the
United States and internationally, will continue to drive the growth in
revenues from our HPV test products in the future. In fiscal 2004, our gross
margins on product sales increased to 81% as compared to 79% in fiscal 2003.
In fiscal 2005, we believe that we will be able to sustain gross margins
consistent with fiscal 2004. We believe that continuing to increase the investments we make in our
sales and marketing and in research and development activities is essential to
allow us to capitalize more fully on the potential of our HPV test products and
our core technology. During fiscal 2004 one significant area of investment was
in our European infrastructure and distribution operations, and we expect to
continue such investment in fiscal 2005. We are also expanding our sales
organization in the United States. We have increased our expenditures in the
development of our next-generation Hybrid Capture platforms and other research
and development programs related to HPV testing in fiscal 2004 as compared to
fiscal 2003 and expect to continue to increase such expenditures in fiscal
2005. 39




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##### 



Our sales and marketing expenditures have been and will continue to be
focused on accelerating the adoption of HPV testing worldwide. We intend to
capitalize on the expanded indications for use of our HPV test products and the
growing acceptance of our HPV test products in the United States and
internationally by physicians, laboratories and health insurance providers by
materially increasing expenditures for sales and marketing programs over the
next several quarters. This increase in expenditures will be primarily
directed at our markets in the United States and Europe. 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 costs
associated with our ongoing litigation matters and to support the overall
growth of our business. Although we anticipate increasing our expenditures as described above, we
anticipate that factors such as the impact of our ability to sustain our gross
margins will offset the impact such increased expenditures would have on our
operating profits. We expect the operating profits which we experienced for
the first time at the end of fiscal 2003 and continued throughout fiscal 2004
will continue through fiscal 2005. There can be no assurance that we will meet
this goal. Results of Operations Fiscal 2004
    
    % change
    
    Fiscal 2003
    
    % change
    
    Fiscal 2002($ in thousands)Product sales
    
    $
    88,815
    
    
    
    42
    %
    
    $
    62,440
    
    
    
    36
    %
    
    $
    45,750HPV test product revenue
    
    
    74,581
    
    
    
    46
    %
    
    
    51,114
    
    
    
    50
    %
    
    
    34,034Cost of product sales
    
    
    16,717
    
    
    
    25
    %
    
    
    13,383
    
    
    
    3
    %
    
    
    12,938Gross margin
    
    
    81
    %
    
    
    
    
    
    
    79
    %
    
    
    
    
    
    
    72
    %
 Comparison of Fiscal Year Ended June 30, 2004 to Fiscal Year Ended June
30, 2003 Product sales increased 42% as compared to fiscal 2003. The increase was
due primarily to a 46% growth in sales of our HPV test products to
approximately $74,581,000, and an increase in equipment sales of 129%, to
approximately $5,432,000, as compared to approximately $2,371,000 in fiscal
2003. The majority of the growth in our HPV test product revenue was in the
United States, which increased 45% to approximately $57,802,000, and in Europe,
which increased 57%, to approximately $12,865,000. In the United States, most
of the growth in our HPV test product sales related to the commercial launch of
our DNAwithPap Test for adjunctive cervical cancer screening with a Pap test
for women age 30 and older, an indication approved by the U.S. Food and Drug
Administration  (FDA) in March 2003. The increase in revenues from equipment sales
primarily related to sales of our Rapid Capture® System following the May 2004
FDA approval of the use of such automated system to perform our diagnostic
tests. The growth in product sales in Europe related to the success of our
subsidiary operating companies and distributor operations benefiting from our
coordinated sales and marketing programs, public awareness campaigns and
government education efforts. Other revenues include research and development contract revenues,
equipment rental revenues and licensing revenues. Other revenues increased
103% in fiscal 2004 to approximately $1,346,000 from approximately $662,000 in
fiscal 2003. The increase was due primarily to an increase of approximately
$505,000 in research and development contract revenue. 40




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##### 



Cost of product sales in fiscal 2004 increased 25% as compared to fiscal
2003 primarily due to increased product sales volume. Gross margins on product sales increased to 81% in fiscal 2004 from 79%
in fiscal 2003. Our gross margins in fiscal 2003 were impacted by costs of
approximately $425,000 associated with a voluntary product recall in fiscal
2003; costs of approximately $260,000 due to a fiscal 2003 increase in reserves
in anticipation of planned product discontinuations in Europe in December 2003,
other changes in our products offerings and charges of approximately $200,000,
after insurance proceeds, for a freezer failure in September 2002, which
resulted in damaged inventory. The fiscal 2004 gross margin also increased due
to approximately $500,000 of manufacturing efficiencies related to production
scale-ups, product consolidations and process improvements implemented during
fiscal 2004. These increases in gross margin were partially offset by
increased sales of equipment, which have lower gross margins than our
diagnostic test products. Research and development expenses increased 5% in fiscal 2004 to
approximately $10,744,000 from approximately $10,262,000 in fiscal 2003. The
increase in expenditures was due primarily to a 16% increase in personnel costs
to approximately $5,044,000 and a 12% increase in laboratory supplies to
approximately $1,108,000, partially offset by a decrease in professional
services of 26% to approximately $1,914,000. The decrease in professional
services was due largely to decreased expenditures in fiscal 2004, as compared
to the costs incurred in fiscal 2003, to obtain CE marking for our HPV,
chlamydia and gonorrhea diagnostic test products in accordance with the
European Union In Vitro Diagnostic Directive, which CE marking was successfully
accomplished in December 2003. Our research and development activities focus
on our platform technology, including substantial modifications of the design
or capabilities of our products and equipment offerings. Because our research
and development expenditures tend to benefit multiple product offerings, we do
not track and maintain research and development expenses on a per-product or
per-disease target basis. In fiscal 2004, we focused our research and development activities in four
areas: (1) core research efforts for next-generation technologies; (2) new
product development activities; (3) completion of activities necessary to
support regulatory submissions to seek approvals to market our existing
products for additional uses and indications in the U.S. and abroad; and (4)
modification of the design or capabilities of our product and equipment
offerings. Our core research efforts for next-generation technologies include
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 on our next
generation of Hybrid Capture technology. Our new product development activities currently focus on the discovery of
innovative methods to improve specimen processing procedures and throughput to
expand the ability of laboratories to use our diagnostic tests. The activities
include procedures for the improved processing of
PreservCyt® (Cytyc
Corporation) specimens and upgrades of our equipment offerings for high
throughput HPV, chlamydia and gonorrhea testing. We are also working to expand
HPV testing capabilities to allow testing from additional liquid cytology
media, including our proprietary Universal Collection Medium (UCM), which is
expected to allow simultaneous nucleic acid testing, protein analysis and
cytological testing of human papillomavirus DNA, chlamydia DNA and gonorrhea
DNA, and of other genetic and cellular material from a single patient sample,
and the SurePathTM (TriPath Imaging) medium, for which the clinical validation
is ongoing. We have also completed 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. In
addition, in November 2003 we entered into a collaborative product development
and commercialization agreement with PATH (Program for Appropriate Technology
in Health) to develop a rapid batch HPV test product for use in developing
countries. Digene and PATH will jointly fund the efforts subject to certain
maximum funding obligations, and Digene will perform the product development
and commercialization activities. During the second half of fiscal
2004 we completed the establishment of a research team to pursue this program
and began active research into a rapid batch HPV test product candidate. 41




---



##### 



With
respect to regulatory submissions in fiscal 2004 we:  
    



    developed and completed the clinical validation of our
Rapid Capture System for semi-automated processing of our hc2
High-Risk HPV DNA Tests. We initially submitted the Pre-Market
Approval Supplement to the FDA on November 5, 2003. We provided
follow-up data and information on April 1, 2004 to facilitate
completion of the FDAs review. We received this approval on May
4, 2004. We expect this claim will expand existing indications
for our hc2 High-Risk HPV DNA Test to allow high-volume,
semi-automated human papillomavirus DNA testing.
    
    developed and completed the clinical validation of the
use of chlamydia (CT) and gonorrhea (GC) testing using our hc2
CT/GC Tests from Cytyc Corporations ThinPrep PreservCyt Solution
specimens. We submitted 510(k) pre-market notifications for each
of our test products for chlamydia and gonorrhea (each test
separately plus our combined hc2 CT/GC Test) between November
2003 and January 2004. The FDAs review of these submissions is
ongoing and we continue to work with the FDA during this period
to provide the information needed to facilitate completion of its
review. Finally, with respect to modification of the design or capabilities of our
diagnostic test products and equipment offerings, in fiscal 2004 we achieved
technical feasibility of our next generation platform proprietary DNA test for
ultra-sensitive detection of DNA targets in a highly multiplexed modality. Selling and marketing expenses increased 31% in fiscal 2004 to
approximately $36,623,000 from approximately $27,913,000 in fiscal 2003. The
increase in fiscal 2004 was due primarily to personnel costs, which increased
39% to approximately $12,350,000; agency fees, which increased 131% to
approximately $5,458,000; professional services, which increased 38% to
approximately $2,982,000; and expenses related to the development of physician
conferences and education, which increased 922% to approximately $592,000.
These increases were partially offset by a decrease in royalties expense, which
decreased 39% to approximately $1,705,000, due primarily to the reversal of an
accrual of approximately $535,000 based on the reduced probability that a
specific royalty liability would materialize. The increase in personnel costs
relates to our increased hiring activities. The increase in agency fees
relates to costs under our physician detailing agreement with PDI, Inc. PDI
recruits and administers a Digene-specific physician detailing sales
organization dedicated to educating physicians about the benefits of the
DNAwithPap Test in the United States. The professional services increase is
due largely to the use of consultants to assist with the rapid growth of our
distribution infrastructure in Europe. Geographically, the majority of the increase in our selling and marketing
expenses for fiscal 2004, excluding royalties, was incurred in the United
States, which increased 57% to approximately $22,051,000 as compared to
approximately $14,032,000 in fiscal 2003, as we expanded our direct sales and
marketing activities in the United States to increase sales of our HPV test
products. We expect our selling and marketing expenses to increase during fiscal
2005 as we continue to expand our direct sales and marketing activities to
increase HPV test product sales, continue the build-up of our direct sales and
marketing operations in Europe and commercialize our CT/GC products. As part of
our commercialization program for the DNAwithPap Test, we have extended our
contract with PDI, Inc., dedicated to promoting the DNAwithPap Test to
physicians. We expect to continue to increase our investment in physician
education to promote the commercialization of the DNAwithPap Test. General and administrative expenses increased 16% in fiscal 2004 to
approximately $19,298,000 from approximately $16,642,000 in fiscal 2003. The
increase was due primarily to personnel costs, 42




---



##### 



which increased 19% to approximately $7,832,000; insurance, which
increased 44% to approximately $1,373,000, principally related to increased
costs for directors and officers insurance coverage; and professional fees,
which increased 6% to approximately $7,664,000, primarily related to costs
associated with legal matters, which increased 18% to approximately $6,057,000. Geographically, the majority of the increase in general and administrative
expenses for fiscal 2004 was incurred in Europe, which increased 126%, to
approximately $5,561,000, over the corresponding period in fiscal 2003 as we
invested in infrastructure required to support the direct distribution of our
products in Europe. Interest income decreased 23% to approximately $459,000 in fiscal 2004
from approximately $593,000 in fiscal 2003. The decrease was due to lower
interest rates in fiscal 2004 compared to the corresponding period in fiscal
2003. Interest expense decreased to approximately $184,000 in fiscal 2004
compared to approximately $273,000 in fiscal 2003 primarily due to the
reduction in our long-term debt due to Abbott Laboratories as quarterly principal payments
were made on an outstanding promissory note, which lowered the debt. Other income decreased to approximately $163,000 in fiscal 2004 compared
to $678,000 in fiscal 2003, due almost entirely to reduced foreign exchange
gains as exchange rate fluctuations were not as significant in fiscal 2004 as
they were in 2003. The net income tax benefit of approximately $14,325,000 in fiscal 2004 is
primarily related to the partial release of the valuation allowance previously
established against our deferred tax assets. We released approximately
$14,900,000 of valuation reserve in the fourth quarter of fiscal 2004. Based
upon projected future operating performances, we currently believe that we will
be able to utilize a portion of the value of our net operating loss
carryforward (NOL) through the reduction of future taxable income. During
fiscal 2004, the amount of valuation allowance we released was the estimated
amount to be utilized in the foreseeable future. As of June 30, 2004, we had
total NOL carryforwards of approximately $115 million; however, we did not
reverse the portion of the valuation allowance related to the potential tax
benefits from the exercise of stock options as realization of these benefits
are not likely at this time. Should realization of these benefits become more
likely than not, the benefit will be reflected as a reclassification to
stockholders equity. Comparison of Fiscal Year Ended June 30, 2003 to Fiscal Year Ended June
30, 2002 Product sales in fiscal 2003 increased 36% as compared to fiscal 2002.
The increase was due primarily to a 40% growth in sales of our HPV test
products to approximately $51,114,000, partially offset by a decrease in sales
of equipment and certain non-core products of approximately $1,691,000 (32%).
The majority of the growth in HPV product sales was in the United States (64%
over such sales in fiscal 2002) and in Europe (30% over such sales in fiscal
2002). During fiscal 2003, we did not recognize any revenue related to minimum
purchase guarantees under the Roche Distribution Contract, whereas in fiscal
2002 we recognized approximately $2,357,000. Please see Liquidity and Capital
Resources below for a description of the Roche Distribution Contract. Other revenues included research and development contract revenues,
equipment rental revenues and licensing revenues. Other revenues decreased
almost 11% in fiscal 2003 to approximately $662,000 from approximately $741,000
in fiscal 2002. The decrease was due primarily to reductions in research and
development services revenue of approximately $279,000 (82%) and licensing
revenue of approximately $84,000 (95%). The decrease was partially offset by
the recognition of $288,000 of 43




---



##### 



certain equipment sales to Roche in Europe, which were initially deferred
in the fourth quarter of fiscal 2002. Please see Liquidity and Capital
Resources below for a description of the Roche Distribution Contract. Cost of product sales in fiscal 2003 increased 3% as compared to fiscal
2002. Gross margins on product sales increased to 79% in fiscal 2003 from 72%
in fiscal 2002. The increase in gross margin percentage primarily related to
increased sales of our higher margin reagent test kits, particularly HPV tests
products, which represented 81%, or approximately $51,114,000, of product
revenue in fiscal 2003 compared to 75%, or approximately $34,034,000, in fiscal
2002, principally in the United States, as well as decreased sales of lower
margin equipment products that represented 4%, or approximately $2,401,000, of
product revenue in fiscal 2003 compared to 8%, or approximately $4,050,000, in
fiscal 2002. Cost of product sales was negatively impacted in fiscal 2003 because of a
voluntary product recall, resulting in a charge to Cost of product sales of
approximately $425,000 during February 2003. We initiated a voluntary recall
involving our hc2 HPV and chlamydia test products. This recall was limited to
certain product lots which were manufactured using a specific lot of raw
material that had the potential to cause false positive patient specimen
results. We informed the FDA of the recall. We conducted an investigation
into the root cause of this product performance issue for our Hybrid Capture 2
product line, and developed a raw material release testing corrective action
plan. On June 20, 2003, the FDA approved the modification of our lot release
testing procedures related to the component that relied on the raw material
found to have been contaminated. Because this voluntary recall was limited to
an identified lot of raw material, we were able to supply our customers with
product manufactured from acceptable raw material lots. In addition, we
expanded our ongoing quality improvement program to ensure continued
reliability as manufacturing volume increases to meet anticipated growth in
demand for our diagnostic test products. Research and development expenses increased 11% in fiscal 2003 to
approximately $10,262,000 from approximately $9,265,000 in fiscal 2002. The
increase in expenses was due primarily to a 305% increase in professional
services and clinical trial expenses, to approximately $2,593,000, partially
offset by a decrease in personnel costs, which decreased 11% to approximately
$4,364,000, and laboratory supplies, which decreased 29% to approximately
$815,000. The increase in professional services was due largely to costs
incurred of approximately $1,051,000, in preparation for compliance with the CE
marking requirements of the European Union In Vitro Diagnostic Directive. 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 track and
maintain research and development expenses on a per-product or per-disease
target basis. During fiscal 2003, we focused our research and development activities on
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, the development of several new products and core research efforts for
next-generation technologies. Work continued on the development of a Hybrid
Capture HPV test product application for our automated Rapid Capture System,
including accommodating the use of multiple DNA probes in a single run in
conjunction with our current product lines; the development of methods to
improve specimen processing procedures and throughput, including procedures for
the improved processing of Cytyc Corporations ThinPrep specimens for HPV,
chlamydia and gonorrhea testing; improved equipment for faster specimen
processing; and the development of our Universal Collection Medium. In
addition, verification was completed and clinical trials initiated for a method
for converting specimens collected in TriPath Imagings SurePath liquid
cytology medium; clinical trials occurred to validate chlamydia and gonorrhea
testing from Cytyc Corporations ThinPrep specimens, a 44




---



##### 



human papillomavirus application for our Rapid Capture System, and a
procedural modification to our hc2 assay designed to improve test robustness.
Work was completed on an HPV ThinPrep application using cervical specimens
collected with a brush/spatula device and the data were submitted to the FDA. Selling and marketing expenses increased 41% in fiscal 2003 to
approximately $27,913,000 from approximately $19,835,000 in fiscal 2002. The
increase in fiscal 2003 was due primarily to personnel costs, which increased
44% to approximately $8,776,000, and royalty expenses, which increased 34% to
approximately $2,814,000. In addition, depreciation expense increased 140% to
approximately $2,359,000 in fiscal 2003, due primarily to the May 2002
repurchase of equipment from Abbott Laboratories upon expiration of the
non-exclusive wind-down period of our distribution agreement with Abbott.
Additionally, professional services increased 79% to approximately $2,160,000,
due largely to the use of consultants to assist with the rapid growth of our
distribution infrastructure in Europe. Geographically, the majority of the increase in our selling and marketing
expenses for fiscal 2003, excluding royalties, was incurred in Europe, which
increased 79% to approximately $9,867,000 over the corresponding period in
fiscal 2002 as we established subsidiaries, hired employees and continued to
develop a distribution infrastructure. General and administrative expenses increased 19% in fiscal 2003 to
approximately $16,642,000 from approximately $14,024,000 in fiscal 2002. The
increase was due primarily to professional fees, which increased 26% to
approximately $7,222,000, primarily related to costs associated with legal
matters, which increased 42% to approximately $4,689,000; personnel costs,
which increased 34% to approximately $6,577,000; and insurance, which increased
84% to approximately $952,000, principally related to increased costs for
directors and officers insurance coverage. These increases were partially
offset by a decrease in bad debt expense of $526,000 during fiscal 2003 due to
strong collection efforts of outstanding receivables. Geographically, the majority of the increase in general and administrative
expenses for fiscal 2003 was incurred in Europe, which increased 618% to
approximately $2,461,000 over the corresponding period in fiscal 2002 due to
our change to direct distribution, and in the United States, which increased 4%
over the corresponding period in fiscal 2002 to approximately $13,869,000, due
primarily to the aforementioned litigation expenditures. Interest income decreased 19% in fiscal 2003 to approximately $593,000
from approximately $729,000 in fiscal 2002. The decrease was primarily due to
a decrease in average cash balances and lower interest rates in fiscal 2003
compared to the corresponding period in fiscal 2002. Interest expense increased to approximately $273,000 in fiscal 2003
compared to approximately $32,000 in fiscal 2002 due to interest on long-term
debt due to Abbott Laboratories as part of the repurchase of equipment at the
end of fiscal 2002 under a terminated distribution agreement, and interest on a
promissory note due to Roche Molecular Diagnostics as a result of the
repurchase of inventory from Roche in January 2003. Other income increased to approximately $678,000 in fiscal 2003 from a
loss of approximately $20,000 in fiscal 2002 primarily due to foreign exchange
gains and losses. Liquidity and Capital Resources Since inception, our expenses have significantly exceeded our revenues,
resulting in an accumulated deficit of approximately $54,146,000 at June 30,
2004. We have funded our operations primarily through the sale of equity
securities and revenues from product sales and research and 45




---



##### 



development contracts. At June 30, 2004, we had cash, cash equivalents
and short-term investments aggregating approximately $48,733,000. We had
positive cash flows from operations of approximately $2,064,000 for the year
ended June 30, 2004 compared to negative cash flows from operations of
approximately $1,834,000 for the year ended June 30, 2003. The increase in
cash provided from operations was due primarily to net income for fiscal 2004
of approximately $21,542,000, which included a deferred tax benefit of
$14,899,000, compared to a net loss of approximately $4,324,000 for fiscal
2003, partially offset by an increase of approximately $7,201,000 in the cash
used for net accounts receivable due to increased sales in fiscal 2004. Net cash used in investing activities for fiscal 2004 included
approximately $6,139,000 of capital expenditures. This included approximately
$2,829,000 of equipment placed at customer sites, which allows our customers to
run diagnostic tests using our reagent test kit products, and approximately
$1,804,000 of leasehold improvements, primarily at our headquarters facility in
Gaithersburg, Maryland. In fiscal 2005 we expect both of these types of
capital expenditures to be significant uses of working capital as we continue
to place equipment at customer sites, specifically Rapid Capture Systems, and
as we further expand our warehouse capacity at our Gaithersburg facility, for
which we may obtain alternative financing. On April 29, 2001, we entered into a letter agreement with Roche Molecular
Systems (the Roche Distribution Contract), which established Roche Molecular
Systems (Roche) as the co-exclusive distributor of our human papillomavirus
(HPV) products in Europe, Africa and the Middle East from May 1, 2001 through
June 30, 2002. In June 2002, we adopted as our sole strategy for the
distribution of our HPV products in Europe, Africa and the Middle East, a
combination of direct distribution through our European infrastructure and the
use of local distributors and agents. On June 30, 2002, the term of the Roche Distribution Contract expired,
subject to a non-exclusive wind-down period. Under the Roche Distribution
Contract, we had the option, exercisable within 30 days after December 31,
2002, to buy back from Roche equipment purchased from us by Roche and in use
for HPV testing in customers laboratories on June 30, 2002. In June 2002, as
part of our strategic decision, we decided that we would exercise the option to
repurchase the equipment. In recognition of the decision to repurchase the equipment, commencing in
the fourth quarter of 2002, we deferred recognition of equipment sold to Roche.
Equipment sold during this time period had a sales price of $2.3 million and a
cost of $1.4 million, which amounts were recorded as deferred revenue and
deferred costs, respectively. The deferred revenue and deferred costs were
being amortized over a four-year period to other revenue (as equipment rental)
and selling and marketing expenses, respectively. For fiscal 2002, we recorded
other revenue and selling and marketing expenses of $109,000 and $67,000,
respectively, related to the amortization of these balances. For fiscal 2003,
we recorded other revenue and selling and marketing expenses of $288,000 and
$177,000, respectively, related to the amortization of these balances prior to
the commencement of the repurchase. At December 31, 2002, when amortization
ceased, the remaining deferred revenue and deferred cost balances were
$1,904,000 and $1,169,000, respectively, for a remaining net credit as of
December 31, 2002 of $734,000. On December 20, 2002, we amended the Roche Distribution Contract to
terminate the wind-down period on December 31, 2002 and to establish the
procedures for our repurchase from Roche of HPV-related testing equipment
purchased from us by Roche under the Roche Distribution Contract. The
repurchase price for the equipment in use for HPV testing in customers
laboratories is the equipments December 31, 2002 depreciated value, which is
the net selling price less any amounts Roche recorded as depreciation based on
a straight-line basis over a four-year period. The repurchase price for the
equipment in inventory is a discount from the transfer price paid by Roche
under the Roche Distribution Contract. 46




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##### 



The parties consummated the HPV equipment repurchase on January 6, 2003,
subject to reconciliation. In January 2003 Digene and its affiliates paid
Roche an aggregate of approximately $2.6 million for the HPV equipment in
inventory and in use at customers laboratories in Europe. A portion of the
purchase price was paid by the issuance of a note payable due to Roche, which
was paid in one installment in January 2004, and the remainder of the purchase
price was paid in cash. A final settlement for the repurchased assets was
completed with Roche in June 2003. The total consideration paid to Roche for the fixed assets and inventory
after reaching a final settlement was $2,488,000, or $1,753,000 after
consideration of the remaining net credit of $734,000 mentioned above. 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. Prior to this fiscal year,
we had incurred negative cash flows from operations since our inception. We
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
calendar 2005. 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; our progress in product development
efforts and the magnitude and scope of such efforts; our success in increasing
and maintaining customer relationships; our ability to receive additional
regulatory approvals for our product offerings; the cost and timing of
expansion of our manufacturing capabilities; the effectiveness of our sales and
marketing activities; the cost of filing, prosecuting, defending and enforcing
patent claims and other intellectual property rights; and competitive market
developments. 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. 47




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##### 



We have summarized below our material contractual obligations as of June
30, 2004: (in thousands) Contractual
    
    
    
    
    
    Less than One Year
    
    One to Three Years
    
    Four to Five Years
    
    After Five YearsObligations
    
    Total
    
    (Fiscal 2005)
    
    (Fiscal 2006-2008)
    
    (Fiscal 2009-2010)
    
    (After Fiscal 2010)Long-term debt(1)
    
    $
    2,145,830
    
    
    $
    1,459,890
    
    
    $
    352,843
    
    
    $
    333,097
    
    
    $
    Physician detailing
agreement
    
    
    5,182,904
    
    
    
    5,182,904
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    
    17,816,572
    
    
    
    3,407,982
    
    
    
    9,568,452
    
    
    
    4,680,431
    
    
    
    159,707Total contractual
cash obligations
    
    $
    25,145,306
    
    
    $
    10,050,776
    
    
    $
    9,921,295
    
    
    $
    5,013,528
    
    
    $
    159,707
  (1)
    
    Includes debt payable to Abbott Laboratories related to the repurchase of
equipment in fiscal 2002. CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES We prepare our financial statements in conformity with accounting
principles generally accepted in the United States. Such accounting principles
require that our management make estimates and assumptions that affect the
amounts reported in our financial statements and accompanying notes. Our
actual results could differ materially from those estimates. The items in our
consolidated financial statements that have required us to make significant
estimates and judgments are as follows:  
    
    Inventory management.Our inventories are stated at the lower of
cost or market. Cost is determined using a weighted-average approach,
which approximates the first-in first-out method of inventory
management. We also record provisions for inventories which may not be
salable due to anticipated trends in sales volume and/or pricing and
our estimates of net realizable value. These provisions are determined
based on significant estimates.
    
    Revenue recognition.We recognize revenue from product sales when
there is persuasive evidence that an arrangement exists, delivery has
occurred, the price is fixed and determinable, and collectibility is
reasonably assured. We establish allowances for estimated
uncollectible amounts, product returns and discounts based on
historical default rates and specifically identified problem accounts.
Additionally, we defer approximately two percent of product sales as a
reserve for future warranty costs and recognize this deferred revenue
over one year, which is the standard warranty period for a majority of
our system components. At June 30, 2003 and 2004, the warranty reserve
was approximately $633,000 and $897,000, respectively, and,
historically, the warranty costs have been within management estimates.
    
    Accounting for employee stock options. We account for our employee
stock-based compensation in accordance with the provisions of APB No.
25, and related interpretations, which allow us to recognize
compensation costs for the excess of the fair value of the stock at the
grant date over the exercise price, if any. An alternative method of
accounting would apply the principles of SFAS No. 123, which require
the fair value of the stock option to be recognized at the date of
grant and amortized to compensation expense over the stock options
vesting period. 48




---



##### 



Had we applied the principles of SFAS No. 123 for our employee options,
our net loss would have been approximately $24,451,000 and $17,381,000
during our fiscal years ended June 30, 2002 and 2003, respectively, and
our net income would have been approximately $15,080,000 during our
fiscal year ended June 30, 2004, instead of our reported net losses which
approximated $9,397,000 and $4,324,000 during our fiscal years ended June
30, 2002 and 2003, respectively, and our reported net income of
approximately $21,542,000 during our fiscal year ended June 30, 2004.
    
    Income taxes. We provide for income taxes in accordance with the
liability method. Under this method, deferred tax assets and
liabilities are determined based on differences between financial
reporting and tax basis of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. We recognized an income tax
benefit of $14,324,947 for the year ended June 30, 2004, primarily
related to the reversal of a portion of the valuation allowance
previously established for our deferred tax asset. Realization of
total deferred tax assets is contingent upon the generation of future
taxable income. Due to the uncertainty of realization of these tax
benefits, in fiscal 2004 we have provided a valuation allowance for the
portion of the net operating loss carryforward and the research and
development credits related to the exercise of stock options and the
amount of net operating loss carryforwards and credits expected to
expire unused. We review our deferred tax asset on a quarterly basis
to determine if a valuation allowance is required, primarily based on
our estimates of future taxable income. Changes in our assessment of
the need for a valuation allowance could give rise to a valuation
allowance and an expense in the period of change. Substantially all of
the remaining deferred tax asset valuation allowance, if released,
will be reflected as a direct increase to stockholders equity and
will not impact the consolidated statement of operations. ITEM 7A. 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 years ended June 30, 2002, 2003
and 2004. Interest rate exposure is primarily limited to the $48.7 million of
cash, cash equivalents and short- and long-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. 49




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##### 



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA DIGENE CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
    
    
    51Consolidated Balance Sheets
    
    
    52Consolidated Statements of Operations
    
    
    53Consolidated Statements of Stockholders Equity
    
    
    54Consolidated Statements of Cash Flows
    
    
    55Notes to Consolidated Financial Statements
    
    
    56
 50




---



##### 



REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders
Digene Corporation We have audited the accompanying consolidated balance sheets of Digene
Corporation as of June 30, 2003 and 2004, and the related consolidated
statements of operations, stockholders equity, and cash flows for each of the
three years in the period ended June 30, 2004. Our audits also included the
financial statement schedule listed in the Index at Item 15. These financial
statements and schedule are the responsibility of the Companys management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Digene
Corporation at June 30, 2003 and 2004, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
June 30, 2004, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP
 McLean, Virginia
August 5, 2004 51




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##### 



DIGENE CORPORATION CONSOLIDATED BALANCE SHEETS June 30,2003
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    7,883,129
    
    
    $
    4,079,519Short-term investments
    
    
    26,408,994
    
    
    
    44,653,599Accounts receivable, less allowance of approximately $432,000
and $600,000 at June 30, 2003 and 2004, respectively
    
    
    10,344,597
    
    
    
    17,545,133Inventories, net
    
    
    7,073,920
    
    
    
    8,109,987Prepaid expenses and other current assets
    
    
    2,189,225
    
    
    
    2,392,048Deferred tax asset, current
    
    
    
    
    
    
    1,047,766Total current assets
    
    
    53,899,865
    
    
    
    77,828,052Property and equipment, net
    
    
    7,515,104
    
    
    
    9,561,794Intangible assets, net
    
    
    900,515
    
    
    
    900,515Deposits and other assets
    
    
    1,059,666
    
    
    
    1,249,971Deferred tax asset
    
    
    
    
    
    
    13,729,916Total assets
    
    $
    63,375,150
    
    
    $
    103,270,248LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    7,489,700
    
    
    $
    5,423,628Accrued expenses
    
    
    3,467,629
    
    
    
    3,771,141Accrued payroll
    
    
    4,182,327
    
    
    
    5,387,129Current portion of long-term debt
    
    
    2,640,363
    
    
    
    1,459,890Total current liabilities
    
    
    17,780,019
    
    
    
    16,041,788Deferred rent
    
    
    434,908
    
    
    
    479,078Long-term debt, less current portion
    
    
    2,154,244
    
    
    
    685,940Stockholders equity:Preferred Stock, $0.10 par value, 1,000,000 shares authorized,
no shares issued and outstanding
    
    
    
    
    
    
    Common Stock, $0.01 par value, 50,000,000 shares authorized, 18,325,208
and 19,883,918 shares issued and outstanding at June 30, 2003 and
2004, respectively
    
    
    183,252
    
    
    
    198,839Additional paid-in capital
    
    
    118,535,272
    
    
    
    139,637,245Deferred stock compensation
    
    
    (380,633
    )
    
    
    (164,031
    )Accumulated other comprehensive income
    
    
    356,415
    
    
    
    537,688Accumulated deficit
    
    
    (75,688,327
    )
    
    
    (54,146,299
    )Total stockholders equity
    
    
    43,005,979
    
    
    
    86,063,442Total liabilities and stockholders equity
    
    $
    63,375,150
    
    
    $
    103,270,248
 See accompanying notes. 52




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##### 



DIGENE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended June 30,2002
    
    2003
    
    2004Revenues:Product sales
    
    $
    45,750,124
    
    
    $
    62,440,415
    
    
    $
    88,815,293Distribution contract
    
    
    2,357,239
    
    
    
    
    
    
    
    Other
    
    
    740,414
    
    
    
    661,481
    
    
    
    1,345,275Total revenues
    
    
    48,847,777
    
    
    
    63,101,896
    
    
    
    90,160,568Costs and expenses:Cost of product sales
    
    
    12,937,556
    
    
    
    13,383,086
    
    
    
    16,716,387Research and development
    
    
    9,264,548
    
    
    
    10,262,138
    
    
    
    10,743,763Selling and marketing
    
    
    19,835,304
    
    
    
    27,912,724
    
    
    
    36,623,243General and administrative
    
    
    14,024,276
    
    
    
    16,642,100
    
    
    
    19,297,782Abbott termination fee
    
    
    2,500,000
    
    
    
    
    
    
    
    Amortization of intangible assets
    
    
    150,086
    
    
    
    
    
    
    
    Total costs and expenses
    
    
    58,711,770
    
    
    
    68,200,048
    
    
    
    83,381,175Income (loss) from operations
    
    
    (9,863,993
    )
    
    
    (5,098,152
    )
    
    
    6,779,393Other income (expense):Interest income
    
    
    729,681
    
    
    
    593,331
    
    
    
    459,170Interest expense
    
    
    (32,217
    )
    
    
    (272,810
    )
    
    
    (183,945
    )Other income (expense)
    
    
    (19,981
    )
    
    
    677,585
    
    
    
    162,463Total other income (expense)
    
    
    677,483
    
    
    
    998,106
    
    
    
    437,688Income (loss) from operations before income taxes
    
    
    (9,186,510
    )
    
    
    (4,100,046
    )
    
    
    7,217,081Provision for (benefit from) income taxes
    
    
    210,106
    
    
    
    223,465
    
    
    
    (14,324,947
    )Net income (loss)
    
    $
    (9,396,616
    )
    
    $
    (4,323,511
    )
    
    $
    21,542,028Basic net income (loss) per share
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.13Diluted net income (loss) per share
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.04Weighted average shares outstandingBasic
    
    
    17,360,725
    
    
    
    18,135,689
    
    
    
    19,144,021Diluted
    
    
    17,360,725
    
    
    
    18,135,689
    
    
    
    20,806,078
 See accompanying notes. 53




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##### 



DIGENE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AccumulatedCommon Stock
    
    Additional
    
    
    
    
    
    Other
    
    
    
    
    
    TotalPaid-In
    
    Deferred Stock
    
    Comprehensive
    
    Accumulated
    
    StockholdersShares
    
    Amount
    
    Capital
    
    Compensation
    
    Income
    
    Deficit
    
    EquityBalance at June 30, 2001
    
    
    16,755,339
    
    
    $
    167,553
    
    
    $
    88,199,211
    
    
    $
    (64,274
    )
    
    $
    
    
    
    $
    (61,968,200
    )
    
    $
    26,334,290Exercise of Common Stock
options
    
    
    541,281
    
    
    
    5,413
    
    
    
    5,244,020
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,249,433Issuance of Common Stock in
connection with private
placement financing
    
    
    588,235
    
    
    
    5,882
    
    
    
    14,913,658
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,919,540Issuance of Common Stock in
connection with Abbott
agreement
    
    
    87,873
    
    
    
    879
    
    
    
    2,499,121
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,500,000Compensatory stock options
earned by non-employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,137
    
    
    
    
    
    
    
    
    
    
    
    32,137Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,396,616
    )
    
    
    (9,396,616
    )Balance at June 30, 2002
    
    
    17,972,728
    
    
    
    179,727
    
    
    
    110,856,010
    
    
    
    (32,137
    )
    
    
    
    
    
    
    (71,364,816
    )
    
    
    39,638,784Comprehensive loss:Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    356,415
    
    
    
    
    
    
    
    356,415Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,323,511
    )
    
    
    (4,323,511
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,967,096
    )Exercise of Common Stock
options
    
    
    209,623
    
    
    
    2,096
    
    
    
    2,079,691
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,081,787Issuance of Common Stock to
Roche
    
    
    142,857
    
    
    
    1,429
    
    
    
    4,998,571
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,000,000Issuance of Common Stock
options to non-employees
    
    
    
    
    
    
    
    
    
    
    601,000
    
    
    
    (601,000
    )
    
    
    
    
    
    
    
    
    
    
    Compensatory stock options
earned by non-employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    252,504
    
    
    
    
    
    
    
    
    
    
    
    252,504Balance at June 30, 2003
    
    
    18,325,208
    
    
    $
    183,252
    
    
    $
    118,535,272
    
    
    $
    (380,633
    )
    
    $
    356,415
    
    
    $
    (75,688,327
    )
    
    $
    43,005,979Comprehensive income:Foreign currency
translation, net of income
tax expense of $173,979
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    260,968
    
    
    
    
    
    
    
    260,968Unrealized loss on available
for-sale securities, net of
income tax benefit of $53,130
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (79,695
    )
    
    
    
    
    
    
    (79,695
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,542,028
    
    
    
    21,542,028Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,723,301Exercise of Common Stock
options
    
    
    1,558,710
    
    
    
    15,587
    
    
    
    20,882,723
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,898,310Compensatory stock options
earned by non-employees
    
    
    
    
    
    
    
    
    
    
    219,250
    
    
    
    216,602
    
    
    
    
    
    
    
    
    
    
    
    435,852Balance at June 30, 2004
    
    
    19,883,918
    
    
    $
    198,839
    
    
    $
    139,637,245
    
    
    $
    (164,031
    )
    
    $
    537,688
    
    
    $
    (54,146,299
    )
    
    $
    86,063,442
 See accompanying notes. 54




---



##### 



DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended June 30,2002
    
    2003
    
    2004Operating activitiesNet income (loss)
    
    $
    (9,396,616
    )
    
    $
    (4,323,511
    )
    
    $
    21,542,028Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:Abbott termination fee
    
    
    2,500,000
    
    
    
    
    
    
    
    Write-off note receivable
    
    
    406,500
    
    
    
    
    
    
    
    Depreciation and amortization of property and equipment
    
    
    1,769,567
    
    
    
    3,293,454
    
    
    
    3,914,062Amortization of intangible assets
    
    
    150,086
    
    
    
    
    
    
    
    Amortization of discount on note payable
    
    
    
    
    
    
    
    
    
    
    35,603Loss on disposal of fixed assets
    
    
    
    
    
    
    22,925
    
    
    
    178,036Compensation expense related to stock options
    
    
    32,137
    
    
    
    252,504
    
    
    
    435,852Deferred tax benefit
    
    
    
    
    
    
    
    
    
    
    (14,898,531
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (3,306,936
    )
    
    
    (1,343,013
    )
    
    
    (7,200,536
    )Inventories
    
    
    (431,971
    )
    
    
    259,177
    
    
    
    (1,036,067
    )Prepaid expenses and other current assets
    
    
    (509,497
    )
    
    
    6,039
    
    
    
    (202,823
    )Deferred costs
    
    
    (1,412,524
    )
    
    
    
    
    
    
    Deposits and other assets
    
    
    (110,699
    )
    
    
    (233,725
    )
    
    
    (190,305
    )Accounts payable
    
    
    3,236,220
    
    
    
    993,294
    
    
    
    (2,066,072
    )Accrued expenses
    
    
    2,919,216
    
    
    
    (2,161,077
    )
    
    
    303,512Accrued payroll
    
    
    998,659
    
    
    
    1,317,891
    
    
    
    1,204,802Deferred revenues
    
    
    (5,600,431
    )
    
    
    
    
    
    
    Deferred rent
    
    
    119,492
    
    
    
    81,832
    
    
    
    44,170Net cash provided by (used in) operating activities
    
    
    (8,636,797
    )
    
    
    (1,834,210
    )
    
    
    2,063,731Investing activitiesPurchases of short-term investments
    
    
    (35,755,094
    )
    
    
    (29,940,689
    )
    
    
    (52,712,116
    )Sales of short-term investments
    
    
    14,592,392
    
    
    
    33,671,809
    
    
    
    34,334,686Capital expenditures
    
    
    (1,542,601
    )
    
    
    (3,763,786
    )
    
    
    (6,138,788
    )Net cash used in investing activities
    
    
    (22,705,303
    )
    
    
    (32,666
    )
    
    
    (24,516,218
    )Financing activitiesNet proceeds from issuance of Common Stock
    
    
    14,919,540
    
    
    
    
    
    
    
    Exercise of Common Stock options
    
    
    5,249,433
    
    
    
    2,081,787
    
    
    
    20,898,310Principal payments of long-term debt
    
    
    
    
    
    
    (1,428,492
    )
    
    
    (2,684,380
    )Net cash provided by financing activities
    
    
    20,168,973
    
    
    
    653,295
    
    
    
    18,213,930Effect of currency translations
    
    
    
    
    
    
    (356,415
    )
    
    
    434,947Net decrease in cash and cash equivalents
    
    
    (11,173,127
    )
    
    
    (1,569,996
    )
    
    
    (3,803,610
    )Cash and cash equivalents at beginning of year
    
    
    20,626,252
    
    
    
    9,453,125
    
    
    
    7,883,129Cash and cash equivalents at end of year
    
    $
    9,453,125
    
    
    $
    7,883,129
    
    
    $
    4,079,519Supplemental cash flow informationInterest paid
    
    $
    13,000
    
    
    $
    374,000
    
    
    $
    163,000Income taxes paid
    
    $
    72,000
    
    
    $
    149,000
    
    
    $
    345,000
 See accompanying notes. 55




---



##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Nature of Operations Digene Corporation (the Company or Digene) was incorporated as a Delaware
corporation in 1987. The Company develops, manufactures and markets its
proprietary gene-based testing systems for the screening, monitoring and
diagnosis of human diseases. The Company has applied its proprietary Hybrid
Capture® technology to develop a diagnostic test for human papillomavirus
(HPV), which is the primary cause of cervical cancer and is found in greater
than 99% of all cervical cancer cases. Digenes product portfolio also
includes gene-based tests for the detection of chlamydia, gonorrhea, hepatitis
B virus (HBV), and cytomegalovirus (CMV). On June 28, 1996, the Company entered into a joint venture agreement with a
Brazilian national to establish Digene do Brasil LTDA, a majority-owned
subsidiary of the Company. In October 1997, the Company established Digene B.V., a Netherlands limited
liability company, to act as the Companys European distributor; in 1999 Digene
B.V. was made dormant. On March 3, 1998, the Company established a
wholly-owned Delaware subsidiary, Digene Europe, Inc., for the marketing of the
Companys products in Europe. In 2003 Digene Europe, Inc. became inactive as a
result of changes in the Companys distribution plans and assumption of the
marketing activities in Europe by the Companys newly-formed European entities.
On July 1, 1998, the Company acquired Viropath B.V., a company with limited
liability, registered in Amsterdam, The Netherlands. Viropath B.V. was
liquidated in 2004 after existing patents were assumed by the Company. On April 26, 2002, the Company established a wholly-owned subsidiary, Digene UK
(Holdings) Limited, to be a holding company for its European subsidiaries.
Digene UK (Holdings) Limited owns all the outstanding shares of Digene (UK)
Limited, Digene Deutschland GmbH, Digene (France) SAS and Digene Italia s.r.l.,
which were organized in April, May, August and October 2002, respectively, and
of Digene Diagnostics S.L. (Spain), which was organized in June of 2003. In
July 2002, the Company also organized Digene (Switzerland) Sarl, all of the
outstanding shares of which are owned by Digene. Through these newly formed
entities and the use of local distributors and agents, Digene markets and
distributes the Companys products throughout Europe. 2. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements include the accounts of
Digene and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. Use of Estimates The preparation of the consolidated financial statements in conformity with
United States generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. Foreign Currencies The local currency is the functional currency for most of the Companys
international subsidiaries and, as such, assets and liabilities are translated
into U.S. dollars at year-end exchange rates. Income and expense items are
translated at average exchange rates during the year. Translation adjustments
resulting from this process are charged or credited to other comprehensive
income (expense). Certain transaction gains and losses on intercompany
activity for which settlement is not planned in the foreseeable future are
charged to cumulative translation adjustment included in stockholders equity
in accumulated other comprehensive income in the accompanying balance sheets. 56




---



##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Segment Information The Company operates one business segment that develops, manufactures and
markets proprietary gene-based tests for the detection, screening and
monitoring of human diseases. Revenue by geographic location is presented in
Note 11. Cash and Cash Equivalents Cash equivalents, which are stated at cost, consist of highly liquid
investments with original maturities of three months or less. Substantially
all cash equivalents are held in short-term money market accounts with large
high-quality institutions. Short-Term Investments Short-term investments consist of corporate and various government agency debt
securities, most of which mature in approximately one year or less. For
investments with maturities over one year, management has the intent and
ability to sell these securities for working capital purposes should the need
arise. Management classifies the Companys short-term investments as
available-for-sale. Such securities are stated at market value, with any
material unrealized holding gains or losses reported, net of any tax effects,
as accumulated other comprehensive income (loss), which is a separate component
of stockholders equity. Realized gains and losses and declines in value
judged to be other than temporary, if any, are included in operations. A
decline in the market value of any available-for-sale security below cost that
is deemed to be other than temporary results in a reduction in fair value,
which is charged to earnings and a new cost basis for the security is
established. Premiums and discounts are amortized or accreted over the life of
the related available-for-sale security. Dividend and interest income are
recognized when earned. The cost of securities sold is calculated using the
specific identification method. The Company places all investments in highly
rated financial institutions. Trade Receivables Trade receivables are reported in the consolidated balance sheets at
outstanding principal less any charge offs and the allowance for doubtful
accounts. The Company charges off uncollectible receivables against the
allowance for doubtful accounts when the likelihood of collection is remote.
Generally, the Company considers receivables past due 30 days subsequent to the
billing date; however, the Company may extend credit terms up to 180 days. The
Company performs ongoing credit evaluations of its customers and generally
extends credit without requiring collateral. The Company maintains an
allowance for doubtful accounts, which is determined based on historical
experience, existing economic conditions and managements expectations of
losses. Losses have historically been within managements expectations. As of
June 30, 2003 and 2004, the Company had an allowance for doubtful accounts of
approximately $432,000 and $600,000, respectively. Concentration of Credit Risk and Financial Instruments The Company places its cash and cash equivalents with financial institutions
and its short-term investments consist of U.S. government agency and high-grade
corporate debt securities. Management believes that the financial risks
associated with its cash and cash equivalents and short-term investments are
minimal. The fair value of the Companys accounts receivable, accounts payable and
accrued liabilities approximate their carrying amount due to the relatively
short maturity of these items. The fair value of debt approximates its
carrying amount as of June 30, 2003 and 2004 based on rates currently available
to the Company for debt with similar terms and maturities. Significant Suppliers Several key components of the Companys products come from, or are manufactured
for the Company by, a single supplier or limited number of suppliers. This
applies in particular to three components, chemiluminescent substrates (used to
create a chemical reaction that causes light in connection with the Hybrid
Capture signal amplified 57




---



##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS molecular technology), the Rapid Capture System that serves as the automation
platform developed for large-scale diagnostic testing using the Hybrid Capture
technology and the 96-well microplate used by laboratories to run the Companys
diagnostic test products. Inventories Inventories are stated at the lower of cost or market on a standard cost basis,
which approximates average cost. The estimated reserve is based on
managements review of inventories on hand compared to estimated future usage
and sales, shelf-life and assumptions about the likelihood of obsolescence. Property and Equipment Property and equipment, including leasehold improvements, are stated at cost
and depreciated or amortized using the straight-line method over the estimated
useful lives of three to ten years. Leasehold improvements are amortized over
the lesser of the related lease term or the useful life. Repairs and
maintenance expenditures are charged to operations as incurred. Intangible Assets Intangible assets arose from the Companys acquisition of Viropath B.V. in
1998. The excess of the purchase price over the identifiable tangible net
assets acquired of approximately $1.5 million was being amortized on a
straight-line basis over ten years until June 2002. On July 1, 2002, the
Company adopted Statement of Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets, which requires that goodwill and
intangible assets deemed to have an indefinite useful life be reviewed for
impairment upon the adoption of SFAS 142 and annually thereafter. The Company
has ceased the amortization of the intangible assets effective July 1, 2002,
and instead reviews intangible assets in the fourth quarter of each fiscal year
for evidence of impairment, and will adjust the recorded value, if necessary.
The Company reviewed the value of the intangible assets in the fourth quarter
of fiscal year 2004 and did not note any circumstances which would warrant an
adjustment to the recorded value. Accumulated amortization expense
approximated $600,000 as of June 30, 2004. If goodwill and other intangible assets had been accounted for in accordance
with SFAS No. 142, Goodwill and Other Intangible Assets, from the date of
acquisition, net income (loss) and EPS would be as follows: Year Ended June 30,2002
    
    2003
    
    2004Net income (loss), as reported
    
    $
    (9,396,616
    )
    
    $
    (4,323,511
    )
    
    $
    21,542,028Amortization expense
    
    
    150,086
    
    
    
        
    
    
    
        Pro forma net income (loss)
    
    $
    (9,246,530
    )
    
    $
    (4,323,511
    )
    
    $
    21,542,028Net income (loss) per shareBasic - as reported
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.13Basic - pro forma
    
    $
    (0.53
    )
    
    $
    (0.24
    )
    
    $
    1.13Diluted - as reported
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.04Diluted - pro forma
    
    $
    (0.53
    )
    
    $
    (0.24
    )
    
    $
    1.04
 58




---



##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Impairment of Long-Lived Assets and Recoverability of Intangibles The Company periodically evaluates the recoverability of the carrying value of
its long-lived assets and identifiable intangibles whenever events or changes
in circumstances indicate that the carrying value of the asset may not be
recoverable. Examples of events or changes in circumstances that indicate that
the recoverability of the carrying value of the assets should be assessed
include, but are not limited to, the following: a significant decrease in the
market value of an asset, a significant change in the extent or manner in which
an asset is used or a significant physical change in an asset, a significant
adverse change in legal factors or in the business climate that could affect
the value of an asset or an adverse action or assessment by a regulator, an
accumulation of costs significantly in excess of the amount originally expected
to acquire or construct an asset, and/or a current period operating or cash
flow loss combined with a history of operating or cash flow losses or a
projection or forecast that demonstrates continuing losses associated with an
asset used for the purpose of producing revenue. The Company considers
historical performance and anticipated future results in its evaluation of
potential impairment. Accordingly, when indicators of impairment are present,
the Company would evaluate the carrying amount of these assets in relation to
the operating performance of the business and estimated future undiscounted
cash flows associated with the asset. If a write-down is required, the Company
would prepare a discounted cash flow analysis to determine the amount of the
write-down. No such impairment losses have been recognized to date. Revenue Recognition The Company recognizes revenue in accordance with the provisions of Staff
Accounting Bulletin No. 104, Revenue Recognition in Financial Statements,
whereby revenue is not recognized until it is realized or realizable and
earned. Revenue is recognized when all of the following criteria are met:
persuasive evidence of an arrangement exists, delivery has occurred or services
have been rendered, the price to the buyer is fixed and determinable and
collectibility is reasonably assured. Revenues from product sales are
recognized upon delivery, usually upon shipment. Allowances are established
for estimated uncollectible amounts, product returns and discounts. In
addition, the Company defers approximately two percent of product sales as a
reserve for future warranty costs and recognizes this deferred revenue over one
year, which is the standard warranty period for a majority of its system
components. At June 30, 2003 and 2004, the warranty reserve was approximately
$633,000 and $897,000, respectively, and, historically, the warranty costs have
been within management estimates. Product sales include the sales associated with the delivery of the Companys
proprietary instrument platforms for performing its diagnostic tests. In some
cases, the Company has provided its instrumentation to customers without
requiring them to purchase the equipment or enter into an equipment lease or
rental contract. In these cases, the Company recovers the cost of providing
the instrumentation in the amounts it charges for its diagnostic assays,
generally under purchase and supply contracts with durations of three or more
years. Other revenue consists of research and development contracts, equipment rental
and the licensing of various technologies. Research and development revenue is
recorded as earned based on the performance requirements of the contract.
Revenue associated with performance milestones is recognized based upon the
achievement of the milestones, as defined in the respective agreements. Revenue
under research and development cost reimbursement contracts is recognized as
the related costs are incurred. Advance payments received in excess of amounts earned are classified as
deferred revenue until earned. Cost of Product Sales Cost of product sales reflects the costs applicable to products delivered for
which product sales revenue is recognized in accordance with the Companys
revenue recognition policy. The Company follows SFAS No. 2,
Accounting for
Research and Development Costs in classifying costs between cost of product
sales and research and development costs. Shipping Costs The Companys shipping and handling costs are included in cost of product sales
for all periods presented. 59




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Research and Development The Company expenses its research and development costs as incurred. Research
and development costs include salaries and related benefits, outside services,
material and supplies and allocations of facility and support costs. Selling and Marketing In some cases, the Company has provided its instrumentation to customers
without requiring them to purchase the equipment or enter into an equipment
lease or rental contract. The costs associated with the instruments are
charged to selling and marketing on a straight-line basis over the estimated
useful life of the instrument, which ranges from three to five years. During
the years ended June 30, 2002, 2003 and 2004, these costs were $900,585,
$2,268,287, and $2,615,841, respectively. The costs to maintain these systems
are charged to operations as incurred. Advertising Costs The Company expenses advertising costs as incurred. Advertising costs amounted
to approximately $963,000, $855,000 and $871,000, during the years
ended June 30, 2002, 2003 and
2004 respectively. Income Taxes The Company provides for income taxes in accordance with the liability method.
Under this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. A valuation allowance
is recorded against the deferred tax asset when it is more likely
than not that some or all of the deferred tax asset will not be
realized. Substantially all of the
remaining deferred tax asset valuation allowance, if released, will be
reflected as a direct increase to stockholders equity and will not impact the
consolidated statement of operations. Net Income (Loss) Per Share The Company follows the provisions of SFAS No. 128, Earnings Per Share, which
require the Company to present basic and diluted income (loss) per share. The
Companys basic income (loss) per share is calculated by dividing the net
income (loss) by the weighted average number of shares of Common Stock
outstanding during all periods presented. The Companys diluted income (loss)
per share is calculated by dividing net income (loss) available to common
shareholders by the weighted average number of common shares outstanding after
giving effect to all dilutive potential common shares that were outstanding
during the period. Potential common shares are not included in the computation
of diluted earnings per share if they are antidilutive. Comprehensive Income (Loss) SFAS No. 130, Reporting Comprehensive Income, requires the presentation of
comprehensive income or loss and its components as part of the consolidated
financial statements. The Companys comprehensive income (loss) includes net
income (loss) as well as additional other comprehensive net income (loss). For
the year ended June 30, 2002, the Companys net loss approximated its
comprehensive loss; accordingly, no separate disclosure of comprehensive loss
is required. For the years ended June 30, 2003 and 2004, other comprehensive
income (loss) included gains and losses on long-term intercompany transactions,
translation gains and losses incurred when converting its subsidiaries
financial statements from their functional currency to U.S. dollars, and
unrealized holding gains and losses on available-for-sale investments and are
reflected net of tax. Stock-Based Compensation The Company accounts for its stock-based compensation 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 60




---



##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Conjunction with Selling, Goods, or Services. Accordingly, the estimated
fair value of the equity instrument is recorded on the earlier of the
performance commitment date or the date the services required are completed. In accordance with SFAS
No. 148, Accounting for Stock-Based Compensation 
Transition and Disclosure (SFAS No. 148) the effect on net loss and net loss
per share if the Company had applied the fair value recognition provisions of
SFAS No. 123 Accounting for Stock-Based Compensation(SFAS No. 123) to
stock-based employee compensation is as follows: Year ended June 30,2002
    
    2003
    
    2004Net income (loss), as reported
    
    $
    (9,396,616
    )
    
    $
    (4,323,511
    )
    
    $
    21,542,028Add: Stock-based non-employee
compensation included in
reported net income (loss)
    
    
    32,137
    
    
    
    252,504
    
    
    
    435,852Deduct: Stock-based employee
compensation expense if SFAS
No. 123 had been applied to
all grants, net of taxes
    
    
    (15,086,236
    )
    
    
    (13,310,256
    )
    
    
    (6,897,933
    )Pro forma net income (loss)
    
    $
    (24,450,715
    )
    
    $
    (17,381,263
    )
    
    $
    15,079,947Net income (loss) per shareBasic  as reported
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.13Basic  pro forma
    
    $
    (1.41
    )
    
    $
    (0.96
    )
    
    $
    0.79Diluted  as reported
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.04Diluted pro forma
    
    $
    (1.41
    )
    
    $
    (0.96
    )
    
    $
    0.73
 Pro forma information regarding net income and loss per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing fair value model. The following weighted-average assumptions
were used: Year Ended June 30,2002
    
    2003
    
    2004Dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    79
    %
    
    
    80
    %
    
    
    78
    %Risk-free interest rate
    
    
    5.4
    %
    
    
    2.8
    %
    
    
    3.7
    %Expected life of the option term (in years)
    
    
    5.9
    
    
    
    6.3
    
    
    
    5.9
 The effect of applying SFAS No. 123 on a pro forma net loss as stated above is
not likely to be representative of the effect on reported net loss for future
years due to, among other things, the vesting period of the stock options and
the fair value of additional options to be granted in future years. In
managements opinion, existing stock option valuation models do not provide a
reliable single measure of the fair value of the employee stock options that
have vesting provisions and are not transferable. In addition, option
valuation models require the input of highly subjective assumptions, and
changes in such subjective assumptions can materially affect the fair value
estimate of employee stock options. Reclassifications Certain prior year amounts have been reclassified to conform to current year
presentation. 61




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. Other Balance Sheet Information Inventories Inventories consist of the following: June 30,2003
    
    2004Finished goods
    
    $
    5,132,328
    
    
    $
    5,516,411Work in process
    
    
    2,897,539
    
    
    
    3,668,683Raw materials
    
    
    1,461,347
    
    
    
    1,207,4159,491,214
    
    
    
    10,392,509Reserve
    
    
    (2,417,294
    )
    
    
    (2,282,522
    )$
    7,073,920
    
    
    $
    8,109,987
 Property and Equipment Property and equipment consist of the following: June 30,2003
    
    2004Furniture, fixtures and office equipment
    
    $
    2,321,487
    
    
    $
    3,348,037Machinery and equipment
    
    
    4,391,288
    
    
    
    4,700,011Customer-use assets
    
    
    8,072,858
    
    
    
    9,998,546Leasehold improvements
    
    
    201,079
    
    
    
    2,005,45514,986,712
    
    
    
    20,052,049Accumulated depreciation and amortization
    
    
    (7,471,608
    )
    
    
    (10,490,255
    )$
    7,515,104
    
    
    $
    9,561,794
 Customer-use assets represent the Companys proprietary instrument platforms
placed at customer sites, to which title and risk of loss is retained by the
Company, for the customers use in performing the diagnostic tests sold by the
Company. 62




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Short-term Investments Short-term investments at June 30, 2004 and 2003 were as follows: June 30, 2004Amortized
    
    Unrealized
    
    Unrealized
    
    FairAvailable for Sale
    
    Cost
    
    Gains
    
    Losses
    
    ValueU.S. Treasury and agencies
    
    $
    34,162,108
    
    
    $
    658
    
    
    $
    (86,409
    )
    
    $
    34,076,357Corporate debt securities
    
    
    10,624,316
    
    
    
    
    
    
    
    (47,074
    )
    
    
    10,577,242Total - Short-term investments
    
    $
    44,786,424
    
    
    $
    658
    
    
    $
    (133,483
    )
    
    $
    44,653,599
 June 30, 2003Amortized
    
    Unrealized
    
    Unrealized
    
    FairAvailable for Sale
    
    Cost
    
    Gains
    
    Losses
    
    ValueU.S. Treasury and agencies
    
    $
    20,246,183
    
    
    $
    9,572
    
    
    $
    (11,482
    )
    
    $
    20,244,273Corporate debt securities
    
    
    6,162,811
    
    
    
    12,828
    
    
    
    (74
    )
    
    
    6,175,565Total - Short-term investments
    
    $
    26,408,994
    
    
    $
    22,400
    
    
    $
    (11,556
    )
    
    
    26,419,838
 SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities,
requires that available-for-sale securities be recorded at market
value. The Companys Short-term investments are recorded in the Consolidated Balance Sheet at fair
value. As illustrated in the June 30, 2003 table above, amortized cost
approximates market value. The unamortized discount was included with
Short-term investments in the June 30, 2003 Consolidated Balance Sheet. The following table summarizes the maturities of the Companys Short-term investments at
June 30, 2004: Amortized
    
    FairMaturity
    
    Cost
    
    ValueLess than one year
    
    $
    32,906,562
    
    
    $
    32,859,821Due in one to two years
    
    
    11,879,862
    
    
    
    11,793,778Total
    
    $
    44,786,424
    
    
    $
    44,653,599
 The Companys gross proceeds from the sale of Short-term investments and the resulting
realized gains and realized losses that have been included in its Consolidated
Statement of Operations are as follows: Year Ended June 30,2002
    
    2003
    
    2004Gross proceeds
    
    $
    4,828,083
    
    
    $
    5,410,773
    
    
    $
    89,827,194Realized gains
    
    
    498
    
    
    
    640
    
    
    
    Realized losses
    
    
    (394
    )
    
    
    (32
    )
    
    
    (19
    )
 63




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Accounts Payable Accounts payable consist of the following: June 30,2003
    
    2004Trade payables
    
    $
    4,911,020
    
    
    $
    4,261,514Cytyc co-promotion agreement
    
    
    2,298,399
    
    
    
    Other
    
    
    280,281
    
    
    
    1,162,114$
    7,489,700
    
    
    $
    5,423,628
 4. Long-term Debt In February 2000, the Company received an equipment loan facility of $1,000,000
from the State of Maryland to finance a portion of the costs of equipment
installed at the Companys facility in Gaithersburg, Maryland. Approximately
$503,000 of fixed asset additions, previously financed with cash, was converted
to this facility during July 2000. The remaining $497,000 of the facility was
drawn down in the year ended June 30, 2001 for additional capital expenditures.
The repayment of this loan is secured by a lien on property and equipment
purchased using the proceeds from the loan facility. The loan bears interest
at 1% per annum and the Company began making quarterly principal payments in
October 2002, with all unpaid principal and interest due by December 31, 2009. In June 2002, in
conjunction with the termination of Abbott Laboratories rights with
respect to the Companys HPV and chlamydia and gonorrhea products under the
Abbott Agreement as discussed in Note 7, the Company repurchased equipment it
sold to Abbott. In order to satisfy this obligation, the Company issued a
promissory note to Abbott for $4,033,904. The note bears interest at 7% per
annum and the Company is required to make quarterly installment payments of
$336,159 which commenced on July 1, 2002 and will end on April 1, 2005. In January 2003, as part
of the repurchase of certain equipment from Roche Molecular Systems,
Inc. under the Roche Distribution Contract as discussed in Note 7, the Company
issued a promissory note to Roche with a principal amount of $1,225,663 which
was paid in its entirety on January 6, 2004. There was no stated interest rate
for this note and, accordingly, the Company has imputed interest at its current
borrowing rate and recorded a discount on this note payable, which was
amortized to interest expense over the term of the note. At June 30, 2004, future
minimum principal payments on all long-term debt
obligations are as follows: 2005
    
    $
    1,459,8902006
    
    
    116,4292007
    
    
    117,6142008
    
    
    118,8002009
    
    
    120,020Thereafter
    
    
    213,077$
    2,145,830
 64




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. Income Taxes Significant components of the provision for (benefit from) income taxes attributable to
operations consist of the following: Year Ended June 30,2002
    
    2003
    
    2004Current:Federal
    
    $
    
    
    
    $
    
    
    
    $
    State
    
    
    
    
    
    
    
    
    
    
    397,780Foreign
    
    
    210,106
    
    
    
    223,465
    
    
    
    175,804Total current
    
    
    210,106
    
    
    
    223,465
    
    
    
    573,584Deferred:Federal
    
    
    
    
    
    
    
    
    
    
    (12,832,429
    )State
    
    
    
    
    
    
    
    
    
    
    (2,066,102
    )Foreign
    
    
    
    
    
    
    
    
    
    
    Total deferred
    
    
    
    
    
    
    
    
    
    
    (14,898,531
    )Total provision for (benefit from) income taxes
    
    $
    210,106
    
    
    $
    223,465
    
    
    $
    (14,324,947
    )
 Income tax expense related to earnings of consolidated subsidiaries located
outside of the United States is provided at tax rates of the respective country
in which the subsidiaries are located. If the Company repatriates its
investment, then additional taxes may be incurred. No provision has been
reflected in the consolidated financial statements for the potential additional
taxes as the Company has no specific plans for a repatriation of these
investments. The components of income (loss) from operations before income taxes are as
follows: Year Ended June 30,2002
    
    2003
    
    2004United States
    
    $
    (9,249,838
    )
    
    $
    5,635,918
    
    
    $
    21,545,679Foreign
    
    
    63,328
    
    
    
    (9,735,964
    )
    
    
    (14,328,598
    )$
    (9,186,510
    )
    
    $
    (4,100,046
    )
    
    $
    7,217,081
 Items which caused recorded income taxes attributable to continuing operations
to differ from taxes computed using the statutory federal income tax rate are
as follows: Year Ended June 30,2002
    
    2003
    
    2004Tax (benefit) expense at statutory rates
    
    $
    (3,123,000
    )
    
    $
    (1,394,000
    )
    
    $
    2,472,152Effect of:State income tax, net
    
    
    (335,000
    )
    
    
    129,000
    
    
    
    685,712Foreign tax
    
    
    210,106
    
    
    
    223,465
    
    
    
    175,804Stock options
    
    
    (1,604,000
    )
    
    
    (708,000
    )
    
    
    Foreign
(income) loss
    
    
    (22,000
    )
    
    
    3,310,000
    
    
    
    5,439,136Other
    
    
    1,503,000
    
    
    
    (466,000
    )
    
    
    571,176Change in valuation allowance
    
    
    3,581,000
    
    
    
    (871,000
    )
    
    
    (23,668,927
    )Provision
for (benefit from) income taxes
    
    $
    210,106
    
    
    $
    223,465
    
    
    $
    (14,324,947
    )
 For the year ended June 30, 2004, the change in the valuation allowance
includes the partial reversal of the deferred tax valuation allowance of
approximately $14.9 million discussed below, and the utilization of net
operating loss carryforwards of approximately of $8.8 million. 65




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Companys net deferred tax assets are as follows: June 30,2003
    
    2004Net operating loss carryforwards
    
    $
    37,013,163
    
    
    $
    43,977,001Research and development credits
    
    
    2,746,073
    
    
    
    2,808,099Patent costs, net
    
    
    220,933
    
    
    
    183,231Research and development deferral, net
    
    
    269,304
    
    
    
    204,437Murex customer lists
    
    
    550,486
    
    
    
    486,352Reserves
    
    
    2,045,398
    
    
    
    1,593,161AMT credit
    
    
    
    
    
    
    41,920Other
    
    
    2,472,941
    
    
    
    2,247,810Deferred tax assets
    
    
    45,318,298
    
    
    
    51,542,011Valuation allowance
    
    
    (45,318,298
    )
    
    
    (36,643,480
    )Net deferred tax assets
    
    $
    
    
    
    $
    14,898,531
 The Company recognized an income tax benefit of $14,324,947 for the year ended
June 30, 2004 and an income tax expense of $223,465 for the year ended June 30,
2003. During fiscal 2004, the Company revised its estimate of the
valuation allowance previously established for the Companys
deferred tax asset, resulting in an approximately $14.9 million
income tax benefit. The income tax expense recorded
against this benefit in fiscal 2004 related to state income taxes on the U.S.
operations and income taxes on the foreign operations. The income tax expense
in fiscal year 2003 primarily related to the Companys foreign operations. At June 30, 2004, the Company had tax net operating loss carryforwards for
income tax purposes of approximately $115.9 million. Approximately $90.9
million of the net operating loss carryforwards is attributable to exercised
stock options, the benefit of which, if realized, will directly increase
additional paid-in capital. Substantially all of the remaining valuation allowance at June 30, 2004 related
to the net operating loss attributable to exercised stock options. At June 30,
2004, the Company also had research and development credit carryforwards of
approximately $2.8 million. In 1990, the Company experienced a change in
ownership pursuant to Section 382 of the Internal Revenue Code, which will
cause the utilization of pre-change losses and credits to be limited. Subject
to this limitation, the Companys net operating loss carryforwards and tax
credits expire, if unused, at various dates from 2005 through 2023. Realization of total deferred tax assets is contingent upon the generation of
future taxable income. Due to the uncertainty of realization of these tax
benefits, the Company did not reverse the portion of the valuation allowance
for the net operating loss carryforwards and the research and development
credits that are related to the exercise of stock options, and the amount of
net operating loss carryforwards and research and development credits expected
to expire unused. Prior to fiscal 2004, the Company had experienced significant operating losses
and operated in an industry subject to rapid technological change. Therefore,
the Company believed that there was sufficient uncertainty regarding its
ability to generate future taxable income and use the Companys net operating
loss and tax credit carryforwards such that a full valuation allowance for
deferred tax assets was required for the year ended June 30, 2003.
Substantially all of the remaining deferred tax asset valuation
allowance, if released, will be reflected as a direct increase to stockholders equity and
will not impact the consolidated statement of operations. The Company reviews its
deferred tax asset on a quarterly basis to determine if a
valuation allowance is required, primarily based on its estimates of future
taxable income. Changes in the Companys assessment of the need for a
valuation allowance could give rise to adjustments to the valuation allowance
and an expense in the period of change. 66




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. Stockholders Equity Common Stock On January 28, 2002, the Company issued 87,973 shares of Common Stock, valued
at $2.5 million, to Abbott Laboratories in consideration for the acquisition of
Abbotts exclusive marketing and distribution rights for the Companys
chlamydia and gonorrhea products that were initially provided for in the Abbott
Agreement. The Company accounted for the issuance of these shares as a
non-cash charge to operations in its Consolidated Statement of Operations for
the year ended June 30, 2002. On January 30, 2002, the Company completed a private placement of 588,235
shares of Common Stock to certain institutional investors at $25.50 per share.
The net proceeds to the Company were approximately $14.9 million. Under the
Roche Distribution Contract, Roche made a non-refundable payment of $5.0
million to the Company in fiscal 2001, which was recorded as a deferred
liability on the Consolidated Balance Sheet as of June 30, 2002. On July 1,
2002, consistent with the provisions of the Roche Distribution Contract, this
payment was converted into 142,857 shares of Digene common stock at a
conversion price of $35 per share. The following table presents the calculation of basic and diluted net income
(loss) per share: 2002
    
    2003
    
    2004Numerator:Net income (loss)
    
    $
    (9,396,616
    )
    
    $
    (4,323,511
    )
    
    $
    21,542,028Denominator:Weighted average shares
outstanding - basic
    
    
    17,360,725
    
    
    
    18,135,689
    
    
    
    19,144,021Dilutive
securities - stock options
    
    
    
    
    
    
    
    
    
    
    1,662,057Weighted average shares
outstanding -  diluted
    
    
    17,360,725
    
    
    
    18,135,689
    
    
    
    20,806,078Basic net income (loss) per share
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.13Diluted net income (loss) per share
    
    $
    (0.54
    )
    
    $
    (0.24
    )
    
    $
    1.04
 For the period ended June 30, 2004, outstanding stock options to purchase
approximately 129,000 shares of common stock were not included in the
computation of diluted net income per share because their effect would have
been antidilutive since the exercise prices of such stock options were greater
than the average share price of the Companys stock for the applicable period.
None of the stock options outstanding for the periods ended June 30, 2002 and
2003, were included in the computation of diluted net loss per share because
the effect on net loss would have been antidilutive. Common Stock Options In March 1996, the Company adopted the Digene Corporation Omnibus Plan (the
Omnibus Plan). Pursuant to the Omnibus Plan, officers or other employees of
the Company may receive options to purchase Common Stock. The Omnibus Plan is
administered by the Compensation Committee. A maximum of 2,000,000 shares have
been authorized to cover grants and awards under the Omnibus Plan. In October 1996, the Company adopted the Digene Corporation Directors Stock
Option Plan (the Directors Plan). Pursuant to the Directors Plan,
directors of the Company may receive options to purchase Common Stock.
Additionally, immediately following the Companys Annual Meeting of
Stockholders, each non-employee director of the Company automatically is
granted an option to purchase 10,000 shares of Common Stock under the
Directors 67




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Plan. The Directors Plan is administered by the Board of
Directors. A maximum of 500,000 shares have been authorized to cover grants
and awards under the Directors Plan. In September 1997, the Company adopted the Digene Corporation 1997 Stock Option
Plan (the 1997 Stock Option Plan). Pursuant to the 1997 Stock Option Plan,
consultants and other non-employees of the Company may receive options to
purchase Common Stock. The 1997 Stock Option Plan is administered by the
Compensation Committee. A maximum of 500,000 shares have been authorized to
cover grants and awards under the 1997 Stock Option Plan. In October 1999, the Company adopted the Digene 1999 Incentive Plan (the 1999
Plan). Pursuant to the 1999 Plan, employees of the Company and its
subsidiaries may receive options to purchase Common Stock and other Common
Stock awards. The 1999 Plan is administered by the Compensation Committee. A
maximum of 4,900,000 shares have been authorized to cover grants and awards
under the 1999 Plan. As of June 30, 2004, 1,935,430 shares were available for grant or award under
the Omnibus Plan, the Directors Plan, the 1997 Stock Option Plan and the 1999
Plan. Of these, 1,580,930 shares are available for grant or award to officers
and employees under the Omnibus Plan and the 1999 Plan. The terms of all stock options granted may not exceed ten years. The exercise
price of options granted, as determined by the Compensation Committee,
approximates fair market value of common stock at the time of the grant. Common Stock options activity is as follows: Year Ended June 30,2002
    
    2003
    
    2004Weighted-
    
    
    
    
    
    Weighted-
    
    
    
    
    
    Weighted-Average
    
    
    
    
    
    Average
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    Exercise
    
    
    
    
    
    ExerciseShares
    
    Price
    
    Shares
    
    Price
    
    Shares
    
    PriceOutstanding at beginning of
year
    
    
    3,129,275
    
    
    $
    16.32
    
    
    
    3,265,862
    
    
    $
    20.62
    
    
    
    4,051,013
    
    
    $
    17.95Options granted
    
    
    770,500
    
    
    
    31.39
    
    
    
    1,096,000
    
    
    
    8.88
    
    
    
    888,200
    
    
    
    31.91Options exercised
    
    
    (541,281
    )
    
    
    9.70
    
    
    
    (209,623
    )
    
    
    9.93
    
    
    
    (1,558,710
    )
    
    
    13.41Options canceled or expired
    
    
    (92,632
    )
    
    
    29.03
    
    
    
    (101,226
    )
    
    
    22.64
    
    
    
    (146,485
    )
    
    
    23.12Outstanding at end of year
    
    
    3,265,862
    
    
    
    20.62
    
    
    
    4,051,013
    
    
    
    17.95
    
    
    
    3,234,018
    
    
    
    23.74Options exercisable at year-end
    
    
    1,647,089
    
    
    
    13.16
    
    
    
    2,119,687
    
    
    
    16.90
    
    
    
    1,322,233
    
    
    
    25.00
 The following table summarizes information about fixed-price stock options
outstanding at June 30, 2004: Options Outstanding
    
    Options ExercisableAverage
    
    Weighted-
    
    
    
    
    
    Weighted-Remaining
    
    Average
    
    
    
    
    
    AverageRange of
    
    Number
    
    Contractual
    
    Exercise
    
    Number
    
    ExerciseExercise Prices
    
    Outstanding
    
    Life
    
    Price
    
    Exercisable
    
    Price$  0.00-$10.00
    
    
    809,898
    
    
    
    7.4
    
    
    $
    7.33
    
    
    
    251,065
    
    
    $
    8.08$10.01-$20.00
    
    
    403,232
    
    
    
    6.8
    
    
    
    14.54
    
    
    
    221,042
    
    
    
    13.32$20.01-$30.00
    
    
    606,000
    
    
    
    8.5
    
    
    
    27.01
    
    
    
    59,067
    
    
    
    27.94$30.01-$40.00
    
    
    1,362,888
    
    
    
    8.9
    
    
    
    33.88
    
    
    
    785,059
    
    
    
    33.32$40.01-$47.63
    
    
    52,000
    
    
    
    7.6
    
    
    
    46.98
    
    
    
    6,000
    
    
    
    44.253,234,018
    
    
    
    
    
    
    
    
    
    
    
    1,322,233
 68




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The weighted-average fair values of the options granted during the years ended
June 30, 2002, 2003 and 2004 were $22.36, $6.50 and $15.94 respectively. The Company issued 25,000 stock options to a non-employee during the year ended
June 30, 2003. These stock options have a vesting period of 30 months. The fair
value of these stock options has been recorded as deferred compensation and is
being amortized over the performance period. Under variable plan accounting,
the value of the unvested stock options will be re-measured and recognized in
operations at each reporting date until fully vested. 7. Commitments and Contingencies Lease Commitments The Company leases a facility in Gaithersburg, Maryland, comprising a total of
approximately 111,000 square feet for its corporate headquarters and
manufacturing operations. The lease for the Gaithersburg facility has a
ten-year term and the Company has two consecutive rights to extend the term of
the lease for five years each. The Company also leases office and sales
operations facilities in the United Kingdom, Germany, Switzerland, France,
Brazil, Italy and Spain, which leases run in length from one year to five
years. The Company also utilizes dedicated space in a third-party warehouse
facility in Germany to support its European operations. Future minimum rental
commitments under these and other operating lease agreements, including the
agreements mentioned above, are as follows as of June 30, 2004: 2005
    
    $
    3,407,9822006
    
    
    3,329,2082007
    
    
    3,185,5312008
    
    
    3,053,7132009
    
    
    3,078,651Thereafter
    
    
    1,761,487$
    17,816,572
 Rent expense under these leases was $2,926,098, $3,174,602, and $3,448,493 for
the years ended June 30, 2002, 2003 and 2004, respectively. The Companys access to various probes, diagnostic techniques and a key product
component were acquired under agreements requiring the Company to pay future
royalties on future net sales on certain products. For the years ended June
30, 2002, 2003 and 2004, total royalties amounted to $2,093,434, $2,813,556,
and $1,704,837, respectively. Repurchase of Equipment under prior Marketing and Distribution Agreements Effective May 7, 1999, the Company entered into a Marketing and Distribution
Agreement (Abbott Agreement) with Abbott Laboratories (Abbott). The Abbott
Agreement called for Abbott to assume sales and marketing responsibility for
all of the Companys Hybrid Capture products in Europe, Africa and the Middle
East and for the Companys Hybrid Capture 2 chlamydia and gonorrhea tests in
the United States. Abbott acted as the exclusive distributor of the Companys
HPV and HBV products in Europe, Africa and the Middle East through April 30,
2001. On April 30, 2001, the Company terminated Abbotts rights with respect to the
Companys HPV products under the terms of the Abbott Agreement. This
termination provided for a twelve-month non-exclusive wind-down distribution
period for HPV products. In addition on April 30, 2001, the Company converted
the distribution rights for the HBV products under the Abbott Agreement to
non-exclusive until December 31, 2003. On January 28, 2002, in accordance with an amendment to the Abbott Agreement,
the Company terminated Abbotts exclusive rights to market, sell and distribute
the Companys chlamydia and gonorrhea products 69




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS worldwide, subject to a
non-exclusive wind-down period for Abbotts activities with respect to such
products in Europe, Africa and the Middle East that ended April 30, 2002. In
connection with this amendment, the Company issued 87,873 shares of Common
Stock to Abbott in a private placement transaction representing an agreed upon
termination fee paid to Abbott of $2.5 million. At the expiration of the
non-exclusive wind-down period the Company repurchased Digene equipment placed
with customers by Abbott. Such repurchase was completed in June 2002. On April 29, 2001, the Company entered into an agreement (the Roche
Distribution Contract) with Roche Molecular Systems, Inc. (Roche). Under
the Roche Distribution Contract, Roche acted as a co-exclusive distributor for
the Companys HPV products in Europe, Africa and the Middle East from May 1,
2001 through June 30, 2002 and the parties agreed to evaluate opportunities for
a broader relationship. Roche guaranteed combined minimum purchases of
equipment and HPV products over the term of the Roche Distribution Contract.
The minimum purchase guarantee was funded and accounted for as follows: For the Year Ended June 30,2001
    
    2002(in thousands)Beginning deferred revenue
    
    $
    
    
    
    $
    7,792Prepayments from Roche
    
    
    9,728
    
    
    
    7,272Product sales revenue from:Roche
    
    
    
    
    
    
    (5,947
    )Abbott
    
    
    (1,098
    )
    
    
    (6,760
    )Other revenue to Digene
    
    
    (838
    )
    
    
    (2,357
    )Ending deferred revenue
    
    $
    7,792
    
    
    $
    
 Under the terms of the Roche Distribution Contract, Digene was required to
remit to Roche the total amount the Company received from sales made to Abbott,
subject to certain limitations. Accordingly, the Consolidated Balance Sheet as
of June 30, 2002 includes an amount payable to Roche of approximately $1.9
million, representing the balance of product sales revenue from Abbott which
was owed to Roche. On April 30, 2001, in accordance with the provisions of the Roche Distribution
Contract, Roche made a non-refundable payment of $5.0 million to the Company,
which was recorded as a deferred liability in the June 30, 2002 Consolidated
Balance Sheet. The Company and Roche did not enter into the broader
relationship referred to above and, therefore, in accordance with the
provisions of the Roche Distribution Contract, on July 1, 2002, the $5.0
million payment was converted into 142,857 shares of Common Stock of the
Company at $35 per share. In June 2002, the Company adopted as its sole strategy for the distribution of
its products in Europe, Africa and the Middle East, a combination of direct
distribution through its European infrastructure and the use of local
distributors and agents. On June 30, 2002, the term of the Roche Distribution
Contract expired, subject to a non-exclusive wind-down period. Under the Roche
Distribution Contract, the Company had the option, exercisable within 30 days
after December 31, 2002, to buy back from Roche equipment purchased from the
Company by Roche and in use for HPV testing in customers laboratories on June
30, 2002. In June 2002, as part of its strategic decision, the Company decided
that it would exercise the option to repurchase the equipment. In recognition of the decision to repurchase the equipment, commencing in the
fourth quarter of 2002, the Company deferred recognition of revenue from
equipment sold to Roche. Equipment sold during this time period had a sales
price of $2.3 million and a cost of $1.4 million, which amounts were recorded
as deferred revenue and deferred costs, respectively. The deferred revenue and
deferred costs were being amortized over a four-year period to other revenue
(as equipment rental) and selling and marketing expenses, respectively. For
the year ended June 30, 2002, the Company recorded other revenue and selling
and marketing expenses of $109,000 and $67,000, respectively related to the
amortization of these balances. For the year ended June 30, 2003, the Company
recorded other revenue and selling and marketing expenses of $288,000 and
$177,000, respectively, related to the amortization of these balances prior to
the commencement of the repurchase. At December 31, 2002, when amortization
ceased, the 70




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS remaining deferred revenue and deferred cost balances were
$1,904,000 and $1,169,000, respectively, for a remaining net credit as of
December 31, 2002 of $734,000. On December 20, 2002, Roche and Digene amended the Roche Distribution Contract
to terminate the wind-down period on December 31, 2002 and to establish the
procedures for Digenes repurchase from Roche of HPV-related testing equipment
purchased from Digene by Roche under the Roche Distribution Contract. The
repurchase price of the equipment in use for HPV testing in customers
laboratories is the equipments December 31, 2002 depreciated value, which is
the net selling price less any amounts Roche recorded as depreciation based on
a straight-line basis over a four-year period. The repurchase price for the
equipment in inventory is a discount from the transfer price paid by Roche
under the Roche Distribution Contract. The parties consummated the HPV equipment repurchase on January 6, 2003,
subject to reconciliation. In January 2003 Digene and its affiliates paid
Roche an aggregate of approximately $2.6 million for the HPV equipment in
inventory and in use at customers laboratories in Europe. A portion of the
purchase price was paid by the issuance of a note payable due to Roche, which
was paid in one installment in January 2004, and the remainder of the purchase
price was paid in cash. A final settlement for the repurchased assets was
completed with Roche in June 2003. The total consideration paid by Digene to Roche for the fixed assets and
inventory after reaching a final settlement was $2,488,000, or $1,753,000 after
consideration of the remaining net credit of $734,000 mentioned above. Tender Offer and Co-Promotion Agreement On February 19, 2002, the Company, Cytyc Corporation (Cytyc) and Cruiser,
Inc., a wholly-owned subsidiary of Cytyc, entered into an Agreement and Plan of
Merger (the Merger Agreement), which provided for, among other things: (i)
the commencement by Cytyc of a stock and cash tender offer for all of the
outstanding shares of Digene (the Offer); and (ii) following consummation of
the Offer, the merger of Cruiser, Inc. with and into Digene. The closing of the
transaction was subject to the receipt of all necessary regulatory approvals
and other customary closing conditions. The transaction was reviewed by the
U.S. Federal Trade Commission (FTC) under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended. On June 30, 2002, Digene delivered to Cytyc a formal notice of Digenes
termination of the Merger Agreement following receipt of a notice from the FTC
informing Digene and Cytyc that, if the parties sought to close the
transactions contemplated by the Merger Agreement, the FTC would seek an
injunction to block the closing. Under the terms of the Merger Agreement, each
of Cytyc or Digene had the right to terminate the Merger Agreement. For the
year ended June 30, 2002, the Company incurred incremental costs of
approximately $3.0 million for merger related expenditures such as legal
services, accounting fees and consultancy. These costs were charged to
operations as incurred. In January 2001, the Company entered into an exclusive co-promotion agreement
with Cytyc for the promotion of the Companys hc2 High-Risk HPV DNA Test for
use with Cytycs ThinPrep® Pap Test in the United States and Puerto Rico. The
companies jointly promoted the benefits of testing for HPV with the Digene hc2
High-Risk HPV DNA Test directly from Cytycs ThinPrep Pap Test sample
collection vial. Subject to FDA approval, the companies intended to co-promote
the combined products as the most effective primary screening method for
cervical cancer. The original term of the agreement expired June 30, 2002 and
was allowed to automatically renew until June 30, 2003. This agreement was not
renewed at June 30, 2003. In accordance with the co-promotion agreement, Digene
paid Cytyc for its co-promotion activities based on a product sales-derived
formula. For the years ended June 30, 2002 and 2003, the Company recorded
expenses of approximately $1.8 million and $2.3 million, respectively, related
to payments due to Cytyc for these co-promotion activities. For the year ended
June 30, 2004, there were no expenses incurred. 71




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Contingencies The Company is involved in various claims and legal proceedings of a
nature considered normal to its business including protection of its owned and
licensed intellectual property. The Company records accruals for such
contingencies when it is probable that a liability has been incurred and the
amount can be reasonably estimated. These accruals are adjusted periodically
as assessments change or additional information becomes available. In March 2002, the Company filed an action for declaratory judgment against
Enzo Biochem, Inc. after receiving notification that the Company had allegedly
infringed one of Enzos patents. Enzo Diagnostics, Inc. subsequently filed a
complaint for patent infringement against the Company. The two cases have now
been consolidated. The Court had established June 14, 2004 as a trial date in
this matter. On June 10, 2004, the Court issued orders on various pretrial
motions filed by the parties, including an order on a Markman hearing on
patent claim construction for U.S. Patent No. 6,221,581. Although the Court
did not adopt Digenes position on certain matters of claim construction,
Digene continues to believe that it does not infringe any valid and enforceable
claim of the U.S. Patent No. 6,221,581, and continues to vigorously defend
against Enzos claim of patent infringement. On June 14, 2004, at the request
of the parties, the trial was continued. An adverse outcome to such
proceeding, however, could subject the Company to significant liabilities or
require the Company to obtain royalty-bearing licenses, cease sales of related
products or revise the applications or products which employ the technology.
Digene cannot provide assurances that any such licenses would be made available
to it on commercially reasonable terms, if at all, or that any such
applications or products revisions could be made or be feasible. In July 2001, Institut Pasteur notified the Company that Institut Pasteur was
granted a new U.S. patent concerning the Hepatitis B virus genome and requested
information from Digene regarding products that may use the technology
described in such new patent. The Company and Institut Pasteur exchanged
information regarding this request during the remainder of 2001 and early 2002.
In July 2004, Institut Pasteur contacted the Company to renew license
discussions with respect to such patent. To date, the parties have not
resolved the matter. Because the Company is planning an eventual
discontinuation of its Hepatitis B testing products, management currently
believes the Company can resolve this matter without a material adverse effect
on its results of operations or financial condition. Through a license with Georgetown University, the Company obtained exclusive,
worldwide rights to a United States patent application (subsequently issued)
and corresponding foreign patents and patent applications relating to HPV type
52 and to a United States patent and corresponding foreign patents relating to
the use of the L1 gene sequence to detect specific human papillomavirus types.
Unless terminated earlier, the Georgetown license will terminate upon the last
to expire of the licensed patent rights. The Company is obligated to make
royalty payments to Georgetown University based on the percentage of net sales
(as defined in the license agreement) of products incorporating the licensed
technologies. The Company continues to accrue and pay its royalty obligations
under this license. The Company is currently involved in negotiations with
Georgetown University related to a disagreement over the calculation of such
royalties. To date, such discussions have not resolved the matter. Management
currently believes that the Company can resolve this matter without a material
adverse effect on its results of operations or financial condition. 72




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. Warranties The Company reserves 2% of product sales for future standard warranty costs.
The reserve is amortized ratably over the one-year standard warranty. In
fiscal 2003 the Company began to offer its customers extended warranties on its
equipment. The revenue from these extended warranties is deferred and is
recognized evenly over the life of the extended warranty. Changes in the
Companys standard and deferred extended warranty reserves are as follows: For the Year Ended June 30,2003
    
    2004Beginning deferred revenue
    
    $
    490,432
    
    
    $
    691,450Warranties issued during the period
    
    
    1,312,281
    
    
    
    1,893,154Changes in liability for pre-existing
warranties during the period, including
expirations
    
    
    (1,111,263
    )
    
    
    (1,560,539
    )Ending deferred revenue
    
    $
    691,450
    
    
    $
    1,024,065
 9. Sale of a Product Line On March 24, 2000, the Company completed the sale of its Molecular Biology
Reagents (MBR) product line and related assets to KD Medical, Inc. This
transaction involved the sale of the Companys MBR product line and the
associated manufacturing equipment, as well as the raw material and finished
goods inventory for the product line. As consideration for this sale, the
Company received $200,000 in cash and a promissory note in the amount of
$400,000 payable in monthly installments of $20,000 plus 8% accrued interest
from July 1, 2000 through February 1, 2002. A gain of approximately $515,000
was recorded on the sale of this product line and was included in the other
income (expense) line of the Consolidated Statements of Operations for the year
ended June 30, 2000. In June 2002, the Company determined the balance
outstanding on the promissory note was uncollectible and took a charge against
operations for the unpaid principal and accrued interest of $406,500. 10. Retirement Plan The Company sponsors a 401(k) Profit Sharing Plan (the Plan), which covers
all employees who have completed 90 days of service. The Plan stipulates that
employees may elect an amount up to 100% of their total compensation to
contribute to the Plan. Employee contributions are subject to Internal Revenue
Service limitations. It is recommended that elective deferral contributions
not exceed between 80% and 90% of eligible pay to allow for withholding of
Social Security, Federal and state taxes. This maximum deferral percentage
will also allow for employer contributions, if any. All employees who have
completed 1,000 hours of service during the plan year and are employed by the
Company on the last day of the plan year are eligible to share in discretionary
Company contributions. Employees vest in such discretionary employer
contributions over five years. No contributions were made by the Company
during the years ended June 30, 2002 or 2003. As of June 30, 2004, the Company
recorded an accrual of approximately $50,000, for contributions to be made in
the next fiscal year. 11. Significant Customers and Geographic Information For the year ended June 30, 2002, two customers comprised 14% and 12% of total
revenues, respectively. For the year ended June 30, 2003, two customers
generated 18% and 10% of total revenue, respectively. For the year ended June
30, 2004, two customers generated 17% and 10% of total revenue, respectively.
As of June 30, 2003 and 2004, the Company recorded receivable balances of
$2,175,000 and $4,186,000, respectively, from these customers. 73




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company operates one business segment that develops, manufactures and
markets proprietary gene-based tests for the detection, screening and
monitoring of human diseases. Worldwide operations are summarized by
geographic region in the following table: 2002
    
    2003
    
    2004Assets
    
    Revenues
    
    Assets
    
    Revenues
    
    Assets
    
    RevenuesNorth America
    
    $
    61,961,002
    
    
    $
    30,591,741
    
    
    $
    50,845,853
    
    
    $
    46,279,902
    
    
    $
    92,526,699
    
    
    $
    67,169,751Europe
    
    
    4,381,207
    
    
    
    13,137,284
    
    
    
    11,310,693
    
    
    
    11,174,822
    
    
    
    9,789,249
    
    
    
    15,841,533Latin America
    
    
    899,120
    
    
    
    2,878,867
    
    
    
    1,170,898
    
    
    
    2,703,297
    
    
    
    928,048
    
    
    
    3,292,641Pacific Rim
    
    
    
    
    
    
    2,239,885
    
    
    
    47,706
    
    
    
    2,943,875
    
    
    
    26,252
    
    
    
    3,856,643$
    67,241,329
    
    
    $
    48,847,777
    
    
    $
    63,375,150
    
    
    $
    63,101,896
    
    
    $
    103,270,248
    
    
    $
    90,160,568
 74




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Quarterly Results of Operations (Unaudited) The following is a summary of quarterly results of operations for the fiscal
quarters (in thousands, except per share amounts): First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter2004Revenues
    
    $
    19,618
    
    
    $
    21,114
    
    
    $
    23,565
    
    
    $
    25,863Net income
    
    $
    655
    
    
    $
    948
    
    
    $
    2,490
    
    
    $
    17,448Basic net income per share
    
    $
    0.04
    
    
    $
    0.05
    
    
    $
    0.13
    
    
    $
    0.88Diluted net income per share
    
    $
    0.03
    
    
    $
    0.05
    
    
    $
    0.12
    
    
    $
    0.832003Revenues
    
    $
    12,616
    
    
    $
    14,450
    
    
    $
    16,982
    
    
    $
    19,054Net income (loss)
    
    $
    (2,624
    )
    
    $
    (1,340
    )
    
    $
    (619
    )
    
    $
    260Basic net income (loss) per share
    
    $
    (0.14
    )
    
    $
    (0.07
    )
    
    $
    (0.03
    )
    
    $
    0.01Diluted net income (loss) per share
    
    $
    (0.14
    )
    
    $
    (0.07
    )
    
    $
    (0.03
    )
    
    $
    0.01
 The sum of basic and diluted net income (loss) per share for the four quarters
in each of fiscal 2004 and 2003 may not equal basic and diluted net income (loss) per
share for the year due to the changes in the number of weighted-average shares
outstanding during the year. The increase in net income from approximately $2,490,000 in the third quarter
to approximately $17,488,000 in the fourth quarter in fiscal 2004 primarily relates to the
partial reversal of the deferred tax valuation allowance approximating $14.9
million. 75




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##### 



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE No change of accountants and/or disagreements on any matter of accounting
principles or financial statement disclosures has occurred within the last two
fiscal years. ITEM 9A. 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 June 30, 2004, which is the end of the period
covered by this Annual Report on Form 10-K. Based on that evaluation, the
principal executive officer and principal financial officer have concluded that
our disclosure controls and procedures are effective. There were no changes that occurred during the fiscal quarter ended June
30, 2004 that have materially affected, or are reasonable likely to materially
affect, our internal controls over financial reporting. ITEM 9B. OTHER INFORMATION All information required to be disclosed in a Current Report on Form 8-K
during the fourth quarter of our 2004 fiscal year has been reported. 76




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##### 



PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT  
    
    Directors. The information with respect to directors
required by this item is incorporated herein by reference to our
definitive Proxy Statement for our Annual Meeting of Stockholders,
scheduled to be held on October 27, 2004, which shall be filed with
the Securities and Exchange Commission within 120 days after the end
of Digenes fiscal year (the 2004 Proxy Statement).  
    
    Executive Officers. The information with respect to
executive officers required by this item is set forth in Part I of
this Form 10-K.  
    
    Code of Ethics. The information with respect to our Code of
Ethics for CEO and Senior Financial Executives and our Code of Business Conduct for all
employees required by this item is incorporated herein by reference
to the 2004 Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required under this item is incorporated herein by
reference to the 2004 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required under this item is incorporated herein by
reference to the 2004 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS No
information is required under this item. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is incorporated herein by reference
to the 2004 Proxy Statement. 77




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##### 



PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 
    
    Consolidated Financial Statements of Digene Corporation:Report of Independent Registered
Public Accounting Firm
Consolidated Balance Sheets as of June 30, 2004 and 2003

Consolidated Statements of Operations for the fiscal years
ended June 30, 2002, 2003 and 2004Consolidated Statements of Stockholders Equity for the
fiscal years ended June 30, 2002, 2003 and 2004

Consolidated Statements of Cash Flows for the fiscal years
ended June 30, 2002, 2003 and 2004

Notes to Consolidated Financial Statements
    
    Financial Statement Schedules:Schedule II - Valuation and Qualifying Accounts and ReservesAll other schedules for which provision is made in the
applicable accounting regulation of the Commission are not
required under the related instructions or are inapplicable
and therefore have been omitted.
    
    Exhibits:3.1
    
    
    
    Amended and Restated Certificate of Incorporation of Digene
(Incorporated by reference to Exhibit 3.1 of the Registrants
Registration Statement on Form S-1 (File No. 333-2968) dated March
29, 1996).3.2
    
    
    
    Amended and Restated Bylaws of Digene (Incorporated by
reference to Exhibit 3.2 of the Registrants Annual Report on Form
10-K for the fiscal year ended June 30, 1999).4.1
    
    
    
    Specimen Common Stock Certificate (Incorporated by
reference to Exhibit 4.1 of the Registrants Registration Statement
on Form S-1 (File No. 333-2968) dated March 29, 1996).10.1
    
    
    
    License Agreement dated December 1, 1983 between Bethesda
Research Laboratories, a division of Life Technologies, Inc. and
Georgetown University (Incorporated by reference to Exhibit 10.16 of
the Registrants Registration Statement on Form S-1 (File No.
333-2968) dated March 29, 1996).10.2
    
    
    
    Cross-License Agreement dated April 1, 1990 among Life
Technologies, Inc. and Institut Pasteur (Incorporated by reference
to Exhibit 10.15 of the Registrants Registration Statement on Form
S-1 (File No. 333-2968) dated March 29, 1996).10.3
    
    
    
    License Agreement dated December 19, 1990 between Digene and
Life Technologies, Inc. (Incorporated by reference to Exhibit 10.18
of the Registrants Registration Statement on Form S-1 (File No.
333-2968) dated March 29, 1996).10.4
    
    
    
    License Agreement dated September 1, 1995 between Digene and
Institut Pasteur (Incorporated by reference to Exhibit 10.14 of the
Registrants Registration Statement on Form S-1 (File No. 333-2968)
dated March 29, 1996).10.5
    
    
    
    License Agreement dated September 27, 1995 between Digene and
Kanebo, Ltd. (Incorporated by reference to Exhibit 10.28 of the
Registrants Registration Statement on Form S-1 (File No. 333-2968)
dated March 29, 1996).
 78




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##### 



10.6
    
    +
    
    License Agreement dated April 5, 2000 between Digene and
Institut Pasteur (Incorporated by reference to Exhibit 10.39 of
Digenes Annual Report on Form 10-K for the fiscal year ended June
30, 2000).10.7
    
    
    
    Amended and Restated Reseller Agreement dated December 10,
2003, between Digene Corporation and Applera Corporation, acting
through its Applied Biosystems Group (Incorporated by reference to
Exhibit 10.1 of Digenes Quarterly Report on Form 10-Q for the
quarter ended December 31, 2003).10.8
    
    ++
    
    Original Equipment Manufacturer Supply Agreement dated
January 23, 2001 between Digene and Qiagen Instruments AG
(Incorporated by reference to Exhibit 10.43 of Digenes Annual
Report on Form 10-K for the fiscal year ended June 30, 2001).10.9
    
    
    
    Registration Rights Agreement dated as of May 24, 1996
between Digene, Armonk Partners, Murex Diagnostics Corporation and
Certain Other Stockholders (Incorporated by reference to Exhibit
10.26 of the Registrants Registration Statement on Form S-1 (File
No. 333-2968) dated March 29, 1996).10.10
    
    
    
    Stock Purchase Agreement dated as of June 30, 1998 by and
among Digene and Stichting Researchfonds Pathologie, Ewald C.R.M.
Keijser, Christophorus J.L.M. Meijer and Jan M. M. Walboomers
(Incorporated by reference to Exhibit 10.37 of Digenes Annual
Report on Form 10-K for the fiscal year ended June 30, 1998).10.11
    
    
    
    Lease dated as of March 2, 1998 by and between Digene and
ARE - Metropolitan Grove I, LLC (Incorporated by reference to
Exhibit 10.1 of Digenes Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998).10.12
    
    !
    
    Amended and Restated 1996 Omnibus Plan (Incorporated by
reference to Exhibit 10.3 of Digenes Quarterly Report on Form 10-Q
for the quarter ended September 30, 2000).10.13
    
    
    
    Amended and Restated 1997 Stock Option Plan (Incorporated by
reference to Exhibit 10.1 of Digenes Quarterly Report on Form 10-Q
for the quarter ended September 30, 2000).10.14
    
    !
    
    Amended and Restated Directors Stock Option Plan
(Incorporated by reference to Exhibit 10.30 of Digenes
Annual Report on Form 10-K for the fiscal year ended
June 30, 2003).10.15
    
    !
    
    Amended and Restated 1999 Incentive Plan, as amended
(Incorporated by reference to Exhibit 10.1 of Digenes
Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003).10.16
    
    !
    
    Employment Agreement, dated February 19, 2002, between
Digene and Donna Marie Seyfried (Incorporated by
reference to Exhibit 99(e)(10) to Digenes
Solicitation/Recommendation Statement on Schedule
14D-9, File No. 005-46641, dated March 1, 2002).10.17
    
    !
    
    Noncompetition, Nondisclosure and Developments
Agreement, dated February 19, 2002, between Digene and
Donna Marie Seyfried (Incorporated by reference to
Exhibit 99(e)(11) to Digenes
Solicitation/Recommendation Statement on Schedule
14D-9, File No. 005-46641, dated March 1, 2002).10.18
    
    !
    
    Form of Employment Agreement between Digene and each of
Evan Jones and Charles M. Fleischman (Incorporated by
reference to Exhibit 10.2 of Digenes Quarterly Report
on Form 10-Q for the quarter ended March 31, 2003).10.19
    
    !
    
    Form of Employment between each of Digene and each of
the officers listed on Exhibit 10.19(a) (Incorporated
by reference to Exhibit 10.3 of Digenes Quarterly
Report on Form 10-Q for the quarter ended March 31,
2003).
 79




---



##### 



10.19(a)
    
    !
    
    Schedule of officers of Digene entering into Employment
Agreement (Incorporated by reference to Exhibit 10.3(a)
of Digenes Quarterly Report on Form 10-Q for the
quarter ended March 31, 2003).10.20
    
    !
    
    Form of Change in Control Employment Agreement between
Digene and each of Evan Jones and Charles M. Fleischman
(Incorporated by reference to Exhibit 10.4 of Digenes
Quarterly Report on Form 10-Q for the quarter ended
March 31, 2003).10.21
    
    !
    
    Form of Change in Employment Agreement between Digene
and each of the officers listed on Exhibit 10.21(a)
(Incorporated by reference to Exhibit 10.5 of Digenes
Quarterly Report on Form 10-Q for the quarter ended
March 31, 2003).10.21(a)
    
    !
    
    Schedule of officers of Digene entering into Change in
Control Employment (Incorporated by reference to
Exhibit 10.5(a) of Digenes Quarterly Report on Form
10-Q for the quarter ended March 31, 2003).21
    
    *
    
    Subsidiaries of the Registrant.23.1
    
    *
    
    Consent of Ernst & Young LLP, Independent Registered
Public Accounting Firm.31.1
    
    *
    
    Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer.31.2
    
    *
    
    Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financal Officer.32
    
    *
    
    Certification pursuant to Section
1350 of Chapter 63 of Title 18 of the United States Code.
   *
    
    Filed herewith.+
    
    Confidential treatment has been granted for certain portions thereof
pursuant to a Commission Order issued December 13, 2000. Such
provisions have been filed separately with the Commission.++
    
    Confidential treatment has been granted for certain provisions thereof
pursuant to a Commission Order issued November 30, 2001. Such
provisions have been filed separately with the Commission.!
    
    Constitutes a management contract or compensatory plan required to be
filed as an exhibit to this Form 10-K. 80




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##### 



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. DIGENE CORPORATIONSeptember 13, 2004
    
    By:
    
    /s/ Evan JonesChairman and Chief Executive Officer
 We, the undersigned directors and officers of Digene Corporation, do
hereby constitute and appoint each of Evan Jones and Charles M. Fleischman,
each with full power of substitution, our true and lawful attorney-in-fact and
agent to do any and all acts and things in our names and in our behalf in our
capacities stated below, which acts and things either of them may deem
necessary or advisable to enable Digene Corporation to comply with the
Securities Exchange Act of 1934, as amended, any rules, regulations and
requirements of the Securities and Exchange Commission, in connection with this
Annual Report on Form 10-K, including specifically, but not limited to, power
and authority to sign for any or all of us in our names, in the capacities
stated below, any amendment to this Form 10-K; and we do hereby ratify and
confirm all that they shall do or cause to be done by virtue hereof). Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated: Signature
    
    Title
    
    Date/s/Evan Jones

Evan Jones
    
    Chairman and Chief Executive
Officer (principal executive officer)
    
    September 13, 2004/s/Charles M. Fleischman

Charles M. Fleischman
    
    President, Chief Operating Officer,
Chief Financial Officer and
Director (principal financial officer)
    
    September 13, 2004/s/Joseph P. Slattery

Joseph P. Slattery
    
    Senior Vice President, Finance and
Information Systems
(principal accounting officer)
    
    September 13, 2004/s/John H. Landon

John H. Landon
    
    Director
    
    September 13, 2004/s/Joseph M. Migliara

Joseph M. Migliara
    
    Director
    
    September 13, 2004/s/Cynthia L. Sullivan

Cynthia L. Sullivan
    
    Director
    
    September 13, 2004/s/Kenneth Weisshaar

Kenneth Weisshaar
    
    Director
    
    September 13, 2004/s/John J. Whitehead

John J. Whitehead
    
    Director
    
    September 13, 2004
 81




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##### 



Schedule II  Valuation and Qualifying Accounts and Reserves
(in thousands) Balance atBeginning of
    
    
    
    
    
    
    
    
    
    Balance atClassification
    
    Period
    
    Additions
    
    Deductions
    
    End of PeriodAllowance for doubtful accounts:Year ended June 30, 2002
    
    
    281
    
    
    
    482
    
    
    
    (79
    )
    
    
    684Year ended June 30, 2003
    
    
    684
    
    
    
    144
    
    
    
    (396
    )(1)
    
    
    432Year ended June 30, 2004
    
    
    432
    
    
    
    199
    
    
    
    (31
    )
    
    
    600Reserve for inventory:Year ended June 30, 2002
    
    
    2,165
    
    
    
    384
    
    
    
    (1,341
    )
    
    
    1,208Year ended June 30, 2003
    
    
    1,208
    
    
    
    5,346
    
    
    
    (4,137
    )
    
    
    2,417Year ended June 30, 2004
    
    
    2,417
    
    
    
    1,422
    
    
    
    (1,556
    )
    
    
    2,283
   (1)
    
    Deductions represent accounts written off during the period less
recoveries of accounts previously written off.




---



##### 



EXHIBIT INDEX Exhibit No.
    
    
    
    Description3.1
    
    
    
    Amended and Restated Certificate of
Incorporation of Digene (Incorporated by
reference to Exhibit 3.1 of the Registrants
Registration Statement on Form S-1 (File No.
333-2968) dated March 29, 1996).3.2
    
    
    
    Amended and Restated Bylaws of Digene
(Incorporated by reference to Exhibit 3.2 of the
Registrants Annual Report on Form 10-K for the
fiscal year ended June 30, 1999).4.1
    
    
    
    Specimen Common Stock Certificate (Incorporated
by reference to Exhibit 4.1 of the Registrants
Registration Statement on Form S-1 (File No.
333-2968) dated March 29, 1996).10.1
    
    
    
    License Agreement dated December 1, 1983 between
Bethesda Research Laboratories, a division of
Life Technologies, Inc. and Georgetown
University (Incorporated by reference to Exhibit
10.16 of the Registrants Registration Statement
on Form S-1 (File No. 333-2968) dated March 29,
1996).10.2
    
    
    
    Cross-License Agreement dated April 1, 1990
among Life Technologies, Inc. and Institut
Pasteur (Incorporated by reference to Exhibit
10.15 of the Registrants Registration Statement
on Form S-1 (File No. 333-2968) dated March 29,
1996).10.3
    
    
    
    License Agreement dated December 19, 1990
between Digene and Life Technologies, Inc.
(Incorporated by reference to Exhibit 10.18 of
the Registrants Registration Statement on Form
S-1 (File No. 333-2968) dated March 29, 1996).10.4
    
    
    
    License Agreement dated September 1, 1995
between Digene and Institut Pasteur
(Incorporated by reference to Exhibit 10.14 of
the Registrants Registration Statement on Form
S-1 (File No. 333-2968) dated March 29, 1996).10.5
    
    
    
    License Agreement dated September 27, 1995
between Digene and Kanebo, Ltd. (Incorporated by
reference to Exhibit 10.28 of the Registrants
Registration Statement on Form S-1 (File No.
333-2968) dated March 29, 1996).10.6
    
    +
    
    License Agreement dated April 5, 2000 between
Digene and Institut Pasteur (Incorporated by
reference to Exhibit 10.39 of Digenes Annual
Report on Form 10-K for the fiscal year ended
June 30, 2000).10.7
    
    
    
    Amended and Restated Reseller Agreement dated
December 10, 2003, between Digene Corporation
and Applera Corporation, acting through its
Applied Biosystems Group (Incorporated by
reference to Exhibit 10.1 of Digenes Quarterly
Report on Form 10-Q for the quarter ended
December 31, 2003).10.8
    
    ++
    
    Original Equipment Manufacturer Supply Agreement
dated January 23, 2001 between Digene and Qiagen
Instruments AG (Incorporated by reference to
Exhibit 10.43 of Digenes Annual Report on Form
10-K for the fiscal year ended June 30, 2001).10.9
    
    
    
    Registration Rights Agreement dated as of May
24, 1996 between Digene, Armonk Partners, Murex
Diagnostics Corporation and Certain Other
Stockholders (Incorporated by reference to
Exhibit 10.26 of the Registrants Registration
Statement on Form S-1 (File No. 333-2968) dated
March 29, 1996).




---



##### 



Exhibit No.
    
    
    
    Description10.10
    
    
    
    Stock Purchase Agreement dated as of June 30,
1998 by and among Digene and Stichting
Researchfonds Pathologie, Ewald C.R.M. Keijser,
Christophorus J.L.M. Meijer and Jan M. M.
Walboomers (Incorporated by reference to Exhibit
10.37 of Digenes Annual Report on Form 10-K for
the fiscal year ended June 30, 1998).10.11
    
    
    
    Lease dated as of March 2, 1998 by and between
Digene and ARE - Metropolitan Grove I, LLC
(Incorporated by reference to Exhibit 10.1 of
Digenes Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998).10.12
    
    !
    
    Amended and Restated 1996 Omnibus Plan
(Incorporated by reference to Exhibit 10.3 of
Digenes Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000).10.13
    
    
    
    Amended and Restated 1997 Stock Option Plan
(Incorporated by reference to Exhibit 10.1 of
Digenes Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000).10.14
    
    !
    
    Amended and Restated Directors Stock Option
Plan (Incorporated by reference to Exhibit 10.30
of Digenes Annual Report on Form 10-K for the
fiscal year ended June 30, 2003).10.15
    
    !
    
    Amended and Restated 1999 Incentive Plan, as
amended (Incorporated by reference to Exhibit
10.1 of Digenes Quarterly Report on Form 10-Q
for the quarter ended September 30, 2003).10.16
    
    !
    
    Employment Agreement, dated February 19, 2002,
between Digene and Donna Marie Seyfried
(Incorporated by reference to Exhibit 99(e)(10)
to Digenes Solicitation/Recommendation
Statement on Schedule 14D-9, File No. 005-46641,
dated March 1, 2002).10.17
    
    !
    
    Noncompetition, Nondisclosure and Developments
Agreement, dated February 19, 2002, between
Digene and Donna Marie Seyfried (Incorporated by
reference to Exhibit 99(e)(11) to Digenes
Solicitation/Recommendation Statement on
Schedule 14D-9, File No. 005-46641, dated March
1, 2002).10.18
    
    !
    
    Form of Employment Agreement between Digene and
each of Evan Jones and Charles M. Fleischman
(Incorporated by reference to Exhibit 10.2 of
Digenes Quarterly Report on Form 10-Q for the
quarter ended March 31, 2003).10.19
    
    !
    
    Form of Employment between each of Digene and
each of the officers listed on Exhibit 10.19(a)
(Incorporated by reference to Exhibit 10.3 of
Digenes Quarterly Report on Form 10-Q for the
quarter ended March 31, 2003).10.19(a)
    
    !
    
    Schedule of officers of Digene entering into
Employment Agreement (Incorporated by reference
to Exhibit 10.3(a) of Digenes Quarterly Report
on Form 10-Q for the quarter ended March 31,
2003).10.20
    
    !
    
    Form of Change in Control Employment Agreement
between Digene and each of Evan Jones and
Charles M. Fleischman (Incorporated by reference
to Exhibit 10.4 of Digenes Quarterly Report on
Form 10-Q for the quarter ended March 31, 2003).10.21
    
    !
    
    Form of Change in Employment Agreement between
Digene and each of the officers listed on
Exhibit 10.21(a) (Incorporated by reference to
Exhibit 10.5 of Digenes Quarterly Report on
Form 10-Q for the quarter ended March 31, 2003).




---



##### 



Exhibit No.
    
    
    
    Description10.21(a)
    
    !
    
    Schedule of officers of Digene entering into
Change in Control Employment (Incorporated by
reference to Exhibit 10.5(a) of Digenes
Quarterly Report on Form 10-Q for the quarter
ended March 31, 2003).21
    
    *
    
    Subsidiaries of the Registrant.23.1
    
    *
    
    Consent of Ernst & Young LLP, Independent
Registered Public Accounting Firm.31.1
    
    *
    
    Rule 13a-14(a)/Rule 15d-14(a) Certification of
Chief Executive Officer.31.2
    
    *
    
    Rule 13a-14(a)/Rule 15d-14(a) Certification of
Chief Financial Officer.32
    
    *
    
    Certification pursuant to Section 1350 of
Chapter 63 of Title 18 of the United States
Code.
   *
    
    Filed herewith.+
    
    Confidential treatment has been granted for certain portions thereof
pursuant to a Commission Order issued December 13, 2000. Such
provisions have been filed separately with the Commission.++
    
    Confidential treatment has been granted for certain provisions thereof
pursuant to a Commission Order issued November 30, 2001. Such
provisions have been filed separately with the Commission.!
    
    Constitutes a management contract or compensatory plan required to be
filed as an exhibit to this Form 10-K.