##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005
 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number 0-28194 DIGENE CORPORATION 
  Delaware
    
    52-1536128(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 1201 Clopper Road
Gaithersburg, Maryland
    
    20878(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code (301) 944-7000 (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ       No o Indicate by check mark whether Registrant is an accelerated filer (as defined in Rule 12b-2 of
the Securities Exchange Act of 1934). Yes þ       No o Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date. Class
    
    Shares outstanding as of
May 5, 2005(Common Stock, par value $.01 per share)
    
    20,028,418




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##### 



DIGENE CORPORATION INDEX TO FORM 10-Q PagePart I. Consolidated Financial Information:Item 1. Consolidated Financial StatementsConsolidated Balance Sheets-
March 31, 2005 and June 30, 2004
    
    3Consolidated Statements of Operations-
Three and nine months ended March 31, 2005 and 2004
    
    4Consolidated Statements of Cash Flows-
Three and nine months ended March 31, 2005 and 2004
    
    5Notes to Consolidated Financial Statements
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    13Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    22Item 4. Controls and Procedures
    
    22Part II. Other Information:Item 1. Legal Proceedings
    
    23Item 6. Exhibits
    
    25SignaturesExhibit Index
 2




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##### 



PART I. Consolidated Financial Information
Item 1. Consolidated Financial Statements DIGENE CORPORATION
CONSOLIDATED BALANCE SHEETS March 31,
    
    
    June 30,2005
    
    
    2004(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,755,241
    
    
    $
    4,079,519Short-term investments
    
    
    30,740,673
    
    
    
    44,653,599Accounts receivable, less allowance of approximately $594,000 and $600,000
at March 31, 2005 and June 30, 2004, respectively
    
    
    18,987,696
    
    
    
    17,545,133Inventories
    
    
    7,312,369
    
    
    
    8,109,987Prepaid expenses and other current assets
    
    
    3,718,574
    
    
    
    2,392,048Deferred tax asset, current
    
    
    1,122,689
    
    
    
    1,047,766Total current assets
    
    
    72,637,242
    
    
    
    77,828,052Property and equipment, net
    
    
    10,372,660
    
    
    
    9,561,794Intangible assets, net
    
    
    900,515
    
    
    
    900,515Deposits and other assets
    
    
    1,373,859
    
    
    
    1,249,971Deferred tax asset, net
    
    
    14,458,276
    
    
    
    13,729,916Total assets
    
    $
    99,742,552
    
    
    $
    103,270,248LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    5,809,589
    
    
    $
    5,423,628Accrued expenses
    
    
    4,123,182
    
    
    
    3,771,141Accrued payroll
    
    
    4,265,000
    
    
    
    5,387,129Current portion of long-term debt
    
    
    116,138
    
    
    
    1,459,890Total current liabilities
    
    
    14,313,909
    
    
    
    16,041,788Deferred rent
    
    
    804,730
    
    
    
    479,078Long-term debt, less current portion
    
    
    598,750
    
    
    
    685,940Minority interest
    
    
    287,021
    
    
    
    Stockholders 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, 20,023,180
and 19,883,918 shares issued and outstanding at March 31, 2005
and June 30, 2004, respectively
    
    
    200,232
    
    
    
    198,839Additional paid-in capital
    
    
    140,757,589
    
    
    
    139,637,245Deferred stock compensation
    
    
    
    
    
    
    (164,031
    )Accumulated other comprehensive income
    
    
    1,330,877
    
    
    
    537,688Accumulated deficit
    
    
    (58,550,556
    )
    
    
    (54,146,299
    )Total stockholders equity
    
    
    83,738,142
    
    
    
    86,063,442Total liabilities and stockholders equity
    
    $
    99,742,552
    
    
    $
    103,270,248
 3 See accompanying notes.




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##### 



DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Ended
    
    
    Nine Months EndedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004(Unaudited)
    
    
    (Unaudited)Revenues:Product sales
    
    $
    29,153,356
    
    
    $
    23,136,402
    
    
    $
    81,406,520
    
    
    $
    63,325,850Other
    
    
    513,317
    
    
    
    429,082
    
    
    
    1,423,879
    
    
    
    971,678Total revenues
    
    
    29,666,673
    
    
    
    23,565,484
    
    
    
    82,830,399
    
    
    
    64,297,528Costs and expenses:Cost of product sales
    
    
    5,130,414
    
    
    
    4,339,132
    
    
    
    14,921,132
    
    
    
    11,447,236Royalty and technology
    
    
    1,290,865
    
    
    
    29,230
    
    
    
    3,954,503
    
    
    
    1,049,471Research and development
    
    
    3,265,291
    
    
    
    2,418,685
    
    
    
    9,128,124
    
    
    
    8,046,982Selling and marketing
    
    
    11,697,262
    
    
    
    9,191,831
    
    
    
    31,014,403
    
    
    
    25,804,901General and administrative
    
    
    5,614,028
    
    
    
    5,014,995
    
    
    
    14,536,618
    
    
    
    13,783,855Patent litigation settlement
    
    
    
    
    
    
    
    
    
    
    14,000,000
    
    
    
    Income (loss) from operations
    
    
    2,668,813
    
    
    
    2,571,611
    
    
    
    (4,724,381
    )
    
    
    4,165,083Other income (expense):Interest income
    
    
    200,656
    
    
    
    119,296
    
    
    
    539,174
    
    
    
    309,237Interest expense
    
    
    (2,012
    )
    
    
    (33,378
    )
    
    
    (27,474
    )
    
    
    (152,059
    )Other income (expense)
    
    
    (35,840
    )
    
    
    (5,327
    )
    
    
    (95,395
    )
    
    
    205,193Income (loss) before minority
interest and income taxes
    
    
    2,831,617
    
    
    
    2,652,202
    
    
    
    (4,308,076
    )
    
    
    4,527,454Minority interest
    
    
    (70,547
    )
    
    
    
    
    
    
    (287,021
    )
    
    
    Income (loss) before income taxes
    
    
    2,761,070
    
    
    
    2,652,202
    
    
    
    (4,595,097
    )
    
    
    4,527,454Provision for (benefit from)
income taxes
    
    
    1,195,722
    
    
    
    162,083
    
    
    
    (190,840
    )
    
    
    433,569Net income (loss)
    
    $
    1,565,348
    
    
    $
    2,490,119
    
    
    $
    (4,404,257
    )
    
    $
    4,093,885Basic net income (loss) per share
    
    $
    0.08
    
    
    $
    0.13
    
    
    $
    (0.22
    )
    
    $
    0.22Diluted net income (loss) per share
    
    $
    0.08
    
    
    $
    0.12
    
    
    $
    (0.22
    )
    
    $
    0.20Weighted average shares outstandingBasic
    
    
    20,000,382
    
    
    
    19,493,223
    
    
    
    19,942,787
    
    
    
    18,924,145Diluted
    
    
    20,641,488
    
    
    
    21,026,892
    
    
    
    19,942,787
    
    
    
    20,734,205
 4 See accompanying notes.




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##### 



DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months EndedMarch 31,2005
    
    
    2004(Unaudited)Operating activitiesNet income (loss)
    
    $
    (4,404,257
    )
    
    $
    4,093,885Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:Depreciation and amortization of property and
equipment
    
    
    3,403,011
    
    
    
    2,856,988Loss on disposal of fixed assets
    
    
    237,711
    
    
    
    Compensation expense related to stock options
    
    
    (89,219
    )
    
    
    318,725Deferred tax benefit
    
    
    (631,053
    )
    
    
    Minority interest
    
    
    287,021
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,180,486
    )
    
    
    (3,890,012
    )Inventories
    
    
    923,101
    
    
    
    (705,709
    )Prepaid expenses and other current assets
    
    
    (1,307,365
    )
    
    
    (113,671
    )Deposits and other assets
    
    
    (114,093
    )
    
    
    (179,977
    )Accounts payable
    
    
    87,077
    
    
    
    (1,349,387
    )Accrued expenses
    
    
    342,005
    
    
    
    (464,129
    )Accrued payroll
    
    
    (1,160,506
    )
    
    
    (507,025
    )Deferred rent
    
    
    325,652
    
    
    
    37,893Net cash (used in) provided by operating activities
    
    
    (3,281,401
    )
    
    
    97,581Investing activitiesPurchases of short-term investments
    
    
    (11,388,366
    )
    
    
    (20,419,247
    )Sales and maturities of short-term investments
    
    
    25,302,236
    
    
    
    22,995,950Capital expenditures
    
    
    (4,271,033
    )
    
    
    (4,919,736
    )Net cash provided by (used in) investing activities
    
    
    9,642,837
    
    
    
    (2,343,033
    )Financing activitiesExercise of common stock options
    
    
    1,374,987
    
    
    
    19,236,123Principal payments of long-term debt
    
    
    (1,430,942
    )
    
    
    (2,283,975
    )Net cash (used in) provided by financing activities
    
    
    (55,955
    )
    
    
    16,952,148Effect of exchange rate changes on cash
    
    
    370,241
    
    
    
    501,576Net increase in cash and cash equivalents
    
    
    6,675,722
    
    
    
    15,208,272Cash and cash equivalents at beginning of period
    
    
    4,079,519
    
    
    
    7,883,129Cash and cash equivalents at end of period
    
    $
    10,755,241
    
    
    $
    23,091,401
 5 See accompanying notes.




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##### 



DIGENE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation The consolidated financial statements of Digene Corporation (the Company or Digene) for the
three- and nine-month periods ended March 31, 2005 and 2004 are unaudited and include all
adjustments which, in the opinion of management, are necessary to present fairly the financial
position and results of operations for the periods then ended. All such adjustments are of a
normal recurring nature, except for the patent litigation settlement (see Note 6). These
consolidated financial statements should be read in conjunction with the consolidated financial
statements and notes thereto included in our Annual Report on Form 10-K for the year ended June 30,
2004 filed with the Securities and Exchange Commission. The results of operations for any interim period are not necessarily indicative of the results of
operations for any other interim period or for a full fiscal year. Certain prior year amounts have been reclassified to conform to current year presentation. 2. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which requires
all companies to measure compensation cost for all share-based payments at fair value, including
employee stock options, effective for annual periods beginning after June 15, 2005.
SFAS 123R provides two adoption methods. The first method is a modified prospective transition
method whereby a company would recognize share-based employee costs from the beginning of the
fiscal period in which the recognition provisions are first applied as if the fair-value-based
accounting method had been used to account for all employee awards granted, modified, or settled
after the effective date and to any awards that were not fully vested as of the effective date.
Measurement and attribution of compensation cost for awards that are unvested as of the effective
date of SFAS 123R would be based on the same estimate of the grant-date fair value and the same
attribution method used previously under Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (SFAS 123). The second adoption method is a modified
retrospective transition method whereby a company would recognize employee compensation cost for
periods presented prior to the adoption of SFAS 123R in accordance with the original provisions of
SFAS 123; that is, an entity would recognize employee compensation costs in the amounts reported in
the pro forma disclosures provided in accordance with SFAS 123. A company would not be permitted
to make any changes to those amounts upon adoption of SFAS 123R unless those changes represent a
correction of an error. For periods after the date of adoption of SFAS 123R, the modified
prospective transition method described above would be applied. The Company currently expects to
adopt SFAS 123R on July 1, 2005, using the modified prospective method, although the Company
continues to review its options for adoption under this new pronouncement. The Company is evaluating the impact of SFAS 123R on its financial statements together with
strategies to manage the impact of equity-based compensation expense on its financial statements in
a manner consistent with the impact on peer companies. The Company cannot make assurances that
these strategies will be comparable to peer companies. Proforma historical expense, which is not
likely to be representative of future expense, is included in Note 5. 6




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In December 2004 the
FASB also issued Statement of Financial Accounting Standards No. 151, Inventory Costs (SFAS 151). SFAS 151
requires abnormal amounts of inventory costs related to idle facility, freight handling and wasted
material expenses to be recognized as current period charges. Additionally, SFAS 151 requires that
allocation of fixed production overheads to the costs of conversion be based on the normal capacity
of the production facilities. The standard is effective for fiscal years beginning after June 15,
2005. The Company believes the adoption of SFAS 151 will not have a material impact on its
consolidated financial statements. 3. Other Balance Sheet Information Inventories Inventories are stated at the lower of cost or market. Inventories consist of the following: March 31,
    
    
    June 30,2005
    
    
    2004(unaudited)Finished goods
    
    $
    4,646,790
    
    
    $
    5,516,411Work in process
    
    
    3,520,441
    
    
    
    3,668,683Raw materials
    
    
    1,210,680
    
    
    
    1,207,4159,377,911
    
    
    
    10,392,509Reserve
    
    
    (2,065,542
    )
    
    
    (2,282,522
    )$
    7,312,369
    
    
    $
    8,109,987
 Debt On September 29, 2004, the Company paid the remaining principal and interest of $1,026,028 to
satisfy its obligation under its note to Abbott Laboratories. Deferred Rent In December 2004, the Company increased deferred rent liability and related expense by
approximately $300,000 to record the previously unrecognized impact of lease escalation provisions. 4. Income Taxes During the fourth quarter of fiscal 2004 the Company reduced its estimate of the valuation
allowance previously established against the Companys deferred tax assets. The realization of
deferred tax assets are contingent upon the generation of future taxable income. Due to the
uncertainty of realization of certain tax benefits, the Company did not reverse the portion of the
valuation allowance established for the net operating loss carryforwards 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. The benefit from income taxes recorded for the nine months ended March 31, 2005 is based on the
Companys estimated annual effective tax rate. Items which caused recorded income taxes to differ
from taxes computed using the statutory federal income tax rate include state income taxes, foreign
losses not benefited, certain non-deductible expenses and research and development tax credits.
The change in the estimated annual effective tax rate from the quarter ended December 31, 2004, was
due to changes in projected operating results for the full fiscal year.   7




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##### 



5. Stockholders Equity Common Stock and Per Share Calculation In conjunction with stock option exercises, the Company issued 60,299 and 582,728 shares of common
stock for the three-month periods ended March 31, 2005 and 2004, and 139,262 and 1,413,342 shares
of common stock for the nine-month periods ended March 31, 2005 and 2004, respectively. The
Company received cash proceeds from the exercise of these stock options of approximately $476,000
and $8,122,000 for the three-month periods ended March 31, 2005 and 2004, respectively, and
$1,375,000 and $19,236,000 for the nine-month periods ended March 31, 2005 and 2004, respectively. The following table presents the calculation of basic and diluted net income (loss) per share: Three Months Ended
    
    
    Nine Months EndedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Numerator:Net income (loss)
    
    $
    1,565,348
    
    
    $
    2,490,119
    
    
    $
    (4,404,257
    )
    
    $
    4,093,885Denominator:Weighted average shares outstanding  basic
    
    
    20,000,382
    
    
    
    19,493,223
    
    
    
    19,942,787
    
    
    
    18,924,145Dilutive
securities - stock options
    
    
    641,106
    
    
    
    1,533,669
    
    
    
    
    
    
    
    1,810,060Weighted average shares outstanding  diluted
    
    
    20,641,488
    
    
    
    21,026,892
    
    
    
    19,942,787
    
    
    
    20,734,205Basic net income (loss) per share
    
    $
    0.08
    
    
    $
    0.13
    
    
    $
    (0.22
    )
    
    $
    0.22Diluted net income (loss) per share
    
    $
    0.08
    
    
    $
    0.12
    
    
    $
    (0.22
    )
    
    $
    0.20
 For the three-month periods ended March 31, 2005 and 2004, outstanding stock options to
purchase approximately 2,436,000 and 68,000 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, respectively. For the nine-month period ended March 31,
2004, outstanding stock options to purchase approximately 83,000 shares of common stock were not
included in the computation of diluted net income per share because their effect would have been
antidilutive. None of the stock options outstanding in the nine-month period ended March 31, 2005
were included in the computation of diluted net loss per share because the effect on net loss would
have been antidilutive. Stock-Based Compensation The Company recognizes expense for stock-based compensation arrangements in accordance with the
provisions of Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to
Employees, and related Interpretations. Accordingly, compensation cost is recognized for the
excess of the estimated fair value of the stock at the grant date over the exercise price, if any.
The Company accounts for equity instruments issued to non-employees in accordance with EITF 96-18,
Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods, or Services. For the three-month period ended March 31, 2004,
compensation expense of $20,290, and for the nine-month periods ended March 31, 2005 and 2004,
compensation expense of $(89,219) and $298,435 was recognized for the change in fair value of the
equity award to non-employees, respectively. No compensation expense was recognized for the change
in fair value of the equity award to non-employees for the three-month period ended March 31, 2005. 8




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##### 



In accordance with Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based
CompensationTransition and Disclosure, the effect on net income (loss) and net income (loss) per
share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based
employee compensation is as follows: Three Months Ended
    
    
    Nine Months EndedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income (loss), as reported
    
    $
    1,565,348
    
    
    $
    2,490,119
    
    
    $
    (4,404,257
    )
    
    $
    4,093,885Add: Stock-based non-employee
compensation expense
included in reported net
income (loss), net of
taxes
    
    
    
    
    
    
    20,290
    
    
    
    (54,459
    )
    
    
    318,725Deduct: Stock-based employee
compensation expense if
SFAS No. 123 had been
applied
to all grants
    
    
    (11,290,370
    )
    
    
    (4,049,070
    )
    
    
    (17,678,180
    )
    
    
    (12,485,559
    )Pro forma net loss
    
    $
    (9,725,022
    )
    
    $
    (1,538,661
    )
    
    $
    (22,136,896
    )
    
    $
    (8,072,949
    )Net income (loss) per share:Basic  as reported
    
    $
    0.08
    
    
    $
    0.13
    
    
    $
    (0.22
    )
    
    $
    0.22Basic  pro forma
    
    $
    (0.49
    )
    
    $
    (0.08
    )
    
    $
    (1.11
    )
    
    $
    (0.43
    )Diluted  as reported
    
    $
    0.08
    
    
    $
    0.12
    
    
    $
    (0.22
    )
    
    $
    0.20Diluted  pro forma
    
    $
    (0.49
    )
    
    $
    (0.08
    )
    
    $
    (1.11
    )
    
    $
    (0.43
    )
 On March 7, 2005, the Compensation Committee (the Committee) of the Companys Board of
Directors approved the acceleration of vesting of underwater unvested stock options held by
certain current employees, including executive officers. The Committee and the independent members
of the Companys Board of Directors imposed restrictions on the stock option awards granted to
executive officers of the Company, which restrict the ability of each such executive officer to
sell any shares underlying any such stock option award until the earlier of (1) the original
vesting date applicable to such shares (or any portion thereof) underlying such stock option award
or (2) the executive officers termination of employment with the Company, death or disability.
Stock options held by non-employee directors were not included in such acceleration. A stock
option was considered underwater if the option exercise price was greater than or equal to $32.35
per share. As such, the Company fully vested options to purchase 622,202 shares of the Companys
common stock. The Company took this action primarily to avoid recognizing compensation cost in
future financial statements when SFAS 123R becomes effective, which will be the first quarter of
the Companys 2006 fiscal year. For pro forma disclosure requirements under SFAS 123, during the three- and nine-month periods
ended March 31, 2005, the Company recognized $8.5 million of additional stock-based compensation
for all options for which vesting was accelerated. The pro forma amounts stated above are not likely to be representative of the effect on reported
results for future years due to, among other things, the number of stock options granted, the
vesting period of the stock options and the fair value of options to be granted in future years.
Due to the uncertainty of realization of certain tax benefits, the Company did not reverse the
portion of the valuation allowance established for the net operating loss carryforwards that are
related to the exercise of stock options and, therefore, the stock-based employee compensation
expense deducted above is not shown net of tax. 9




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##### 



Comprehensive Income (Loss) Comprehensive income (loss) for the quarter- and year-to-date ended March 31, 2005 and 2004 was as
follows: Three Months Ended
    
    
    Nine Months EndedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income (loss), as reported
    
    $
    1,565,348
    
    
    $
    2,490,119
    
    
    $
    (4,404,257
    )
    
    $
    4,093,885Other comprehensive income:Unrealized gain (loss) on
available-for-sale
securities, net of income
tax benefit (expense) of
$4,661 and $(1,749),
respectively
    
    
    (7,302
    )
    
    
    
    
    
    
    (805
    )
    
    
    Foreign currency
translation gain (loss)
    
    
    (587,860
    )
    
    
    (253,100
    )
    
    
    793,994
    
    
    
    501,576Comprehensive income (loss)
    
    $
    970,186
    
    
    $
    2,237,019
    
    
    $
    (3,611,068
    )
    
    $
    4,595,461
 6. Royalty and Technology Expenses The Company has in-licensed patents to a number of cancer-causing human papillomavirus types,
biological materials and other intellectual property on which it pays royalties, patent maintenance
and other technology access costs. On October 13, 2004, the Company executed a Settlement and License Agreement with Enzo Biochem,
Inc. and its subsidiary Enzo Life Sciences, Inc. (formerly known as Enzo Diagnostics, Inc.)
(collectively, Enzo), to settle patent litigation claims then pending in the United States
District Court for the District of Delaware. Under the Settlement and License Agreement (the Agreement), Digene received an irrevocable,
non-exclusive, royalty-bearing worldwide license under identified Enzo patents. Digene made an
initial payment to Enzo of $16.0 million, of which $2.0 million can be used to offset future
royalty payments under the terms of the Agreement, resulting in $14.0 million in patent litigation
settlement expense. Digene will also pay Enzo royalties on future net sales of products covered by
the license grant, which royalties will be at least $2.5 million for the first annual period,
beginning October 1, 2004 and ending September 30, 2005, and at least $3.5 million for each of the
next four annual periods under the Agreement. Digene is obligated to make such guaranteed minimum
payments in such first five annual periods. Digenes obligation to make royalty payments will end
on April 24, 2018, unless earlier terminated in accordance with the terms of the Agreement. On January 4, 2005, the Company made a payment for additional royalty and technology expense of
$750,000, which was accrued at December 31, 2004, relating to terms agreed to on October 14, 2004
with Institut Pasteur with respect to a non-exclusive license to Institut Pasteurs intellectual
property concerning the Hepatitis B virus genome (see Note 8). 10




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7.
    WarrantiesThe Company reserves 2% of product sales for future standard warranty costs. The reserve is
amortized ratably over the one-year standard warranty. The Company also offers its customers
extended warranties on its equipment. The revenue from these extended warranties is deferred and
is recognized evenly over the period of the extended warranty. Changes in the Companys standard
and deferred extended warranty revenue during the period are as follows: Nine Months EndedMarch 31,2005
    
    
    2004Balance, beginning of period
    
    $
    1,076,652
    
    
    $
    691,450Standard warranty revenue deferred during the period
    
    
    1,634,478
    
    
    
    1,266,078Standard warranty revenue recognized during the
period, including expirations
    
    
    (1,478,289
    )
    
    
    (1,085,827
    )Extended warranties sold during the period
    
    
    474,815
    
    
    
    60,786Extended warranty revenue recognized during the
period, including expirations
    
    
    (160,572
    )
    
    
    (29,948
    )Balance, end of period
    
    $
    1,547,084
    
    
    $
    902,539
 8. 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 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 intellectual property concerning the Hepatitis B virus genome. On October 14, 2004, the
Company and Institut Pasteur agreed to the principal terms of a non-exclusive license under such
intellectual property, which include a payment of $750,000 and a royalty on future sales of
licensed products. The $750,000 was included in royalty and technology expense in the statement of
operations in the quarter ended September 30, 2004. In December 2004, the Company and Institut
Pasteur finalized a license agreement to reflect such principal terms and the $750,000 was paid to
Institut Pasteur in January 2005. 11




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##### 



Through a license agreement with Georgetown University, the Company obtained exclusive, worldwide
rights to United States Patent No. 5,643,715 and corresponding foreign patents and patent
applications relating to human papillomavirus (HPV) type 52, and to United States Patent No.
5,057,411 and corresponding foreign patents relating to the use of the L1 gene sequence to detect
specific human papillomavirus types. Unless terminated earlier, the license agreement 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 of products (as
defined in the license agreement). The Company continues to accrue and pay royalties to Georgetown
University under the license agreement. The Company had been involved in discussions with
Georgetown University related to the interpretation over the calculation of such royalties. The
parties have not been able to resolve the differences in their interpretations of the royalty
calculation. On October 26, 2004, the Company received a copy of a complaint filed by Georgetown University in
the United States District Court for the District of Columbia, that was later served on November
22, 2004, containing allegations related to the royalties dispute and the Companys use of the
licensed patent rights under the license agreement. In its complaint, Georgetown University
alleges that it is entitled to royalties of 8% on net sales of products covered by the license
agreement, that the total amount of unpaid and past-due royalties owed by the Company to Georgetown
University exceeds $2.0 million, that the Companys license rights under the L1 Patent are
terminated under the provisions of the license agreement and that the Company is in breach of the
license agreement for not using its best efforts to develop products covered by the L1 Patent. The
Company asserts that it has complied fully with the terms of its license agreement with Georgetown
University. The Company believes that Georgetown Universitys interpretation of the license
agreement provisions related to the calculation of royalties is not correct, and that the
royalties, when calculated under the provisions of the license agreement, are consistent with the
Companys historical and previously agreed upon calculation of royalties. Moreover, the Company
disputes Georgetown Universitys claim that the rights as they relate to the L1 Patent are
terminated as the Company has complied with all obligations under the license agreement. On January 18, 2005, the Company filed an answer to the complaint, along with counterclaims against
Georgetown University stemming from Georgetown Universitys failure to meet certain legal and
fiduciary duties under the license agreement. The Company believes it has strong defenses and
counterclaims against each of the allegations made in the complaint and intends to vigorously
defend against such action, and to aggressively pursue its counterclaims against Georgetown
University if a resolution of this matter cannot be reached. An adverse outcome to such
proceeding, however, could subject the Company to significant liabilities or require the Company to
renegotiate the license agreement, or revise the applications or products that use the licensed
patents. The Company cannot provide assurances that it would be successful in negotiating
commercially reasonable license terms, if at all, or that any such application or product revisions
could be made without significant delay or cost. 12




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##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements The following discussion of our financial condition and results of operations should be read in
conjunction with our Consolidated Financial Statements and the related Notes thereto included
elsewhere in this report and in our Annual Report on Form 10-K for the year ended June 30, 2004.
Some of the information that follows are not statements of historical fact, but merely reflect our
intent, belief or expectations regarding the anticipated effect of events, circumstances and
trends. Such statements should be considered as forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. We believe that our expectations are based
on reasonable assumptions within the bounds of our knowledge of our business and operations.
Factors that might cause or contribute to differences between our expectations and actual results
include: uncertainty of market acceptance of our products by the worldwide medical community; our
need to obtain third-party reimbursement approval from additional government entities, managed care
organizations, and private insurance plans, particularly outside the United States; risk that other
companies may develop and market human papillomavirus (HPV) tests competitive with our own; uncertainty regarding patents
and proprietary rights in connection with our products and products in development; uncertainty to
the outcome of patent litigation in which we are currently engaged; 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 fiscal 2006; 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 in our Annual Report on Form 10-K for the year ended June 30, 2004. Overview Since our incorporation in 1987, we have devoted substantially all of our resources to developing,
manufacturing and marketing our proprietary gene-based testing systems using our patented Hybrid
Capture® technology for the screening, monitoring and diagnosis of human diseases. Since our
inception, we have incurred substantial operating losses, resulting principally from expenses
associated with our research and development programs, including preclinical studies, clinical
trials and regulatory submissions for our products, the expansion of our manufacturing facilities
and our global sales and marketing activities. Our revenues, to a significant extent, have been derived from the sales of our diagnostic tests for
the presence of HPV, which, for fiscal 2004, accounted for 83% of total
revenues and, for the nine months ended March 31, 2005, accounted for 84% 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 2005, we believe that we will be able to sustain a gross margin consistent with fiscal
2004, which was 81% for the full 2004 fiscal year. We calculate gross margin as the difference
between product sales and the cost of product sales, which exclude royalty and technology expense,
as a percentage of product sales for the period. 13




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##### 



We have in-licensed patents to a number of cancer-causing human papillomavirus types, biological
materials and other intellectual property on which we pay royalties, patent maintenance and other
technology access costs. Our total royalty and technology expenses are expected to be
approximately 5% to 6% of product sales in fiscal 2005. 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. We believe that we need to continue to increase investment in our sales and marketing activities,
which are essential to allow us to capitalize more fully on the potential of our HPV test products.
During fiscal 2004 one significant area of investment was in our European infrastructure and
distribution operations, and we expect to maintain such investment for the remainder of fiscal 2005
and beyond. We are also significantly expanding our sales organization in the United States and
increasing our investment in physician detailing and direct-to-consumer promotion activities. We expect to increase the size of our investment in research and development for the next several
quarters and focus our research and development expenditures in the development of our
next-generation Hybrid Capture platforms and other research and development programs related to HPV
testing. We expect our general and administrative expenses will increase to support the overall growth of
our business. On October 13, 2004, we executed a Settlement and License Agreement to settle the then-pending
patent litigation with Enzo Biochem, Inc. and its subsidiary Enzo Life Sciences, Inc. (formerly
known as Enzo Diagnostics, Inc.) (collectively, Enzo). As a result, we recorded a pre-tax charge
of $14 million in patent litigation settlement expense in the quarter ended September 30, 2004.
Additionally, we will pay Enzo royalties on future net sales of products covered by the license
grant. Please see Liquidity and Capital Resources below for a description of the Enzo
settlement. Although we anticipate increasing our expenditures as described above, we expect to generate
operating profit for the remainder of fiscal 2005; however, there can be no assurance that we will
meet this goal. We do not expect that this profit will exceed the operating loss for the nine
months ended March 31, 2005. 14




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Results of Operations Three Months Ended March 31,
    
    
    Nine Months Ended March 31,%
    
    
    
    
    
    
    
    
    
    
    %2005
    
    
    2004
    
    
    change
    
    
    2005
    
    
    2004
    
    
    change($ in thousands)Total revenue
    
    $
    29,667
    
    
    $
    23,565
    
    
    
    26
    %
    
    $
    82,830
    
    
    $
    64,298
    
    
    
    29
    %Product sales
    
    
    29,153
    
    
    
    23,136
    
    
    
    26
    %
    
    
    81,407
    
    
    
    63,326
    
    
    
    29
    %HPV test product revenue
    
    
    25,042
    
    
    
    18,790
    
    
    
    33
    %
    
    
    69,832
    
    
    
    52,417
    
    
    
    33
    %Cost of product sales
    
    
    5,130
    
    
    
    4,339
    
    
    
    18
    %
    
    
    14,921
    
    
    
    11,447
    
    
    
    30
    %Gross margin (1)
    
    
    82
    %
    
    
    81
    %
    
    
    
    
    
    
    82
    %
    
    
    82
    %Royalty and technology expense
    
    $
    1,291
    
    
    $
    29
    
    
    
    4,316
    %
    
    $
    3,955
    
    
    $
    1,049
    
    
    
    277
    %
   (1)
    
    We calculate gross margin as the difference between product
sales and the cost of product sales, which exclude royalty and technology
expense, as a percentage of product sales for the period. Product sales increased 26% to approximately $29,153,000 for the three-month period ended
March 31, 2005 from approximately $23,136,000 for the corresponding period in fiscal 2004. The
increase was due primarily to a 33% growth in sales of our HPV test products over such sales in the
corresponding period in fiscal 2004. The majority of the growth in our HPV test product revenue
was in the United States, which increased 39% to approximately $19,870,000. Product sales increased 29% to approximately $81,407,000 for the nine-month period ended March 31,
2005 from approximately $63,326,000 for the corresponding period in fiscal 2004. The increase was
due primarily to a 33% growth in sales of our HPV test products over such sales in the
corresponding period in fiscal 2004. The majority of the growth in our HPV test product revenue
was in the United States, which increased 36% to approximately $55,247,000. The increases in
United States HPV test product revenue for both the three- and nine-month periods ended March 31,
2005, versus the comparable periods in fiscal 2004, were due largely
to the continued market acceptance of our HPV test in cervical cancer
screening programs. The net impact of foreign exchange rate
fluctuations on product sales was immaterial for the three- and
nine-month periods ended March 31, 2005 and 2004, respectively. Other revenues primarily include research and development contract revenues and equipment rental
revenues. Other revenues increased 20% to approximately $513,000 for the three-month period ended
March 31, 2005 from approximately $429,000 for the corresponding period in fiscal 2004. Other
revenues increased 47% to approximately $1,424,000 for the nine-month period ended March 31, 2005
from approximately $972,000 for the corresponding period in fiscal 2004. The increase for the
nine-month period ended March 31, 2005 was due primarily to an increase of approximately $164,000
in research and development contract revenue in the current period versus the corresponding period
in fiscal 2004. 15




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##### 



Cost of product sales increased by 18% to approximately $5,130,000 for the three-month period ended
March 31, 2005 from approximately $4,339,000 for the corresponding period in 2004 and increased 30%
to approximately $14,921,000 for the nine-month period ended March 31, 2005 from approximately
$11,447,000 for the corresponding period in fiscal 2004. The increase
for both periods was primarily due to increased product sales volume. Gross margin percentage on product sales
increased to 82% for the three-month period ended March 31, 2005 from 81% for the corresponding
period in fiscal 2004 and remained constant at 82% for the nine-month period ended March 31, 2005
compared to the corresponding period in fiscal 2004. The increase in gross margin percentage for
the three-month period ended March 31, 2005 was the result of a shift in product mix from
lower-margin test products to higher-margin HPV test products as well as a decrease in lower-margin
equipment sales, which decreased 20% to approximately $1,893,000. These increases in gross margin
percentage due to product mix changes were partially offset by increased manufacturing overhead
costs. For the nine-months ended March 31, 2005, an increase in gross margin percentage due to
decreasing equipment sales as a percentage of product sales was offset by increased manufacturing
overhead costs. Royalty and technology expense increased to approximately $1,291,000 for the three-month period
ended March 31, 2005 from approximately $29,000 for the corresponding period in 2004 and increased
277% to approximately $3,955,000 for the nine-month period ended March 31, 2005 from approximately
$1,049,000 for the corresponding period in fiscal 2004. The increase for the three-month period
ended March 31, 2005 was primarily due to increased royalty expenses on net sales of our products
based on a Settlement and License Agreement with Enzo Biochem, Inc. and its subsidiary Enzo Life
Sciences, Inc. (collectively Enzo), under which we will pay Enzo royalties on future net sales of
products covered by the license grant, and the reversal of approximately $535,000 of accrual during
the three-month period ended March 31, 2004 based on the expectation that a specific royalty
accrual would not materialize. The increase for the nine-month period
ended March 31, 2005 was due
to royalty expenses beginning October 1, 2004 based on the aforementioned Enzo settlement, a charge
of $750,000 accrued during the quarter ended September 30, 2004 relating to a non-exclusive license
to Institut Pasteurs intellectual property concerning the Hepatitis B virus genome, and the
aforementioned reversal of approximately $535,000 of accrual during the three-month period ended
March 31, 2004. Please see Liquidity and Capital Resources below for a description of the Enzo
settlement. Research and development expenses increased 35% to approximately $3,265,000 for the three-month
period ended March 31, 2005 from approximately $2,419,000 for the corresponding period in fiscal
2004 and increased 13% to approximately $9,128,000 for the nine-month period ended March 31, 2005
from approximately $8,047,000 for the corresponding period in fiscal 2004. The increase for the
three-month period ended March 31, 2005 was primarily attributed to a 267% increase in professional
services to approximately $832,000 and a 17% increase in personnel costs to approximately
$1,466,000 from the corresponding period in fiscal 2004. The increase in professional services for
the three-month period ended March 31, 2005 was largely due to costs relating to automating
preparation of clinical specimens for Hybrid Capture testing, and costs incurred for the
preparation of compliance with the European Union In Vitro Diagnostic Directive (or IVDD)
regulations for our Rapid Capture® System and related accessories, for which compliance is expected
to be obtained in the last quarter of fiscal 2005. The increase for the nine-month period ended
March 31, 2005 compared to the corresponding period in fiscal 2004 was largely due to a 25%
increase in personnel cost to approximately $4,462,000. Because our research and development
expenditures tend to benefit multiple product offerings, we do not account for research and
development expenses on a per-product or per-disease target basis. 16




---



##### 



During the nine-month period ended March 31, 2005, our research and development activities focused
on our platform technology, including adaptations of such technology, and improvements to our
diagnostic test and equipment products. We focused our research and development activities in four
areas: (1) core research efforts for next-generation technologies; (2) new product development activities; (3)
support and improvement of existing product lines and equipment offerings; and (4) support of
regulatory submissions to seek approvals to market our existing products for additional uses and
indications in the U.S. and abroad. Our core research efforts for next-generation technologies include research programs for improved
molecular diagnostic assay systems for 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. We completed initial technical feasibility of our proprietary next generation DNA test
platform for ultra-sensitive detection of DNA targets in a multiplexed format and we are conducting
further evaluations to confirm the applicability of the new method. We are working on products
that will enable HPV genotyping, and have two products in the development pipeline. We continue
our collaborative product development and commercialization agreement with PATH (Program for
Appropriate Technology in Health) to develop a rapid, batch HPV test for resource constrained
countries and have entered the second year of that program. Digene and PATH jointly fund the
efforts subject to certain maximum funding obligations and Digene performs the product development
and commercialization activities. Product development activities are currently focused on improving and simplifying cervical specimen
processing procedures and increasing Hybrid Capture 2 assay throughput, including a new batch
preparation method for processing liquid-based cytology (LBC) specimens for Hybrid Capture
testing. In support of this new method, we are conducting a multi-center clinical evaluation
specifically for the processing of cervical specimens collected in ThinPrep®
PreservCytTM Solution (Cytyc Corporation). The results of this study will support a
Pre-Market Approval Supplement for the Hybrid Capture 2 testing of PreservCyt Solution specimens
processed in this manner and is expected to lead to a FDA submission in fiscal 2006. This
processing method is expected to become part of a more comprehensive clinical sample preparation
workstation also in development, which is being designed to automate the front-end processing of
all clinical specimen types for HPV, Chlamydia trachomatis(CT), and Neisseria gonorrhoeae(GC)
testing, including specimens collected in our Specimen Transport Media (STM). This sample
preparation workstation is intended to provide a streamlined means to prepare samples for transfer
to the Rapid Capture System. We have also begun validation of the next version of Digene
Microplate Luminometer (DML) software, which is expected to provide new features and improvements
in the data acquisition and result reporting capabilities from our luminometer. We are continuing efforts to expand HPV testing capabilities for additional LBC media, including
the SurePathTM collection and preservative medium (TriPath Imaging). The regulatory
work required to obtain FDA approval for use of SurePath for HPV testing following TriPath
Imagings voluntary withdrawal of their Pre-Market Approval in February 2005 is ongoing as part of
the continued collaboration between Digene and TriPath Imaging. Regulatory work was also completed
that will enable the Rapid Capture System and associated products to be sold in the European Union. 17




---



##### 



Selling and marketing expenses increased 27% to approximately $11,697,000 for the three-month
period ended March 31, 2005 from approximately $9,192,000 for the corresponding period in fiscal
2004 and increased 20% to approximately $31,014,000 for the nine-month period ended March 31, 2005
from approximately $25,805,000 for the corresponding period in fiscal 2004. The increase for the
three-month period ended March 31, 2005 was due to personnel costs, which increased 56% to
approximately $4,109,000 and marketing programs, which increased 46% to approximately $2,723,000.
The increase in personnel costs is due largely to increasing the size of our physician detailing
sales force for which we began hiring extensively in the quarter ended March 31, 2005. We expect
to continue to grow the sales organization through fiscal 2006. The increase in marketing programs
is the result of a direct-to-consumer marketing campaign implemented during the quarter ended March
31, 2005. The increase for the nine-month period ended March 31, 2005 was primarily due to
personnel costs, which increased 41% to approximately $10,516,000; marketing programs, which
increased 22% to approximately $6,380,000; and facility and overhead costs, including travel, which
increased 29% to approximately $7,125,000. These increases were partially offset by a decrease in
professional fees, which decreased 8% to approximately $5,730,000 due largely to a reduction in
non-cash stock compensation expense related to a European consultant. Professional fees include
costs based on our agreement with PDI, Inc. (PDI) since July 2003. PDI has recruited and
administered a Digene-specific physician detailing sales organization dedicated to educating
physicians about the benefits of the DNAwithPapTM Test in the U.S. General and administrative expenses increased 12% to approximately $5,614,000 for the three-month
period ended March 31, 2005 from approximately $5,015,000 for the corresponding period in fiscal
2004 and increased 5% to approximately $14,537,000 for the nine-month period ended March 31, 2005
from approximately $13,784,000 for the corresponding period in fiscal 2004. The increase for the
three-month period ended March 31, 2005 was primarily the result of a 29% increase in personnel
costs to approximately $2,483,000. The increase for the nine-month period ended March 31, 2005 was
primarily attributed to a 20% increase in personnel costs to approximately $6,371,000 and a 20%
increase in facility and overhead costs to approximately $2,367,000. This increase was partially
offset by a 15% decrease in professional services to approximately $4,509,000, largely related to a
decrease in legal fees, which decreased 31% to approximately $2,934,000. The patent litigation settlement charge relates to the October 2004 settlement with Enzo, which was
$14,000,000 for the nine-months ended March 31, 2005. Please see Liquidity and Capital Resources
below for a description of the Enzo settlement. Interest income increased to approximately $201,000 for the three-month period ending March 31,
2005 from approximately $119,000 for the corresponding period in 2004 and increased 74% to
approximately $539,000 for the nine-month period ended March 31, 2005 from approximately $309,000
for the corresponding period in fiscal 2004. The increases are primarily due to increases in the
market yield on the balance of cash, cash equivalents and short-term investments for the three- and
nine-months ended March 31, 2005 compared to the corresponding period in fiscal 2004. Minority interest of approximately $71,000 and approximately $287,000 for the three- and nine-month
periods ended March 31, 2005, respectively, represents third party interest in the earnings of
Digene do Brasil LTDA (DDB), a majority-owned subsidiary of the Company. Historically DDB has
had cumulative losses and accordingly minority interest had not been recorded. Significant
intercompany accounts and transactions have been eliminated. 18




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##### 



During the fourth quarter of fiscal 2004 we reduced our estimate of the valuation allowance
previously established against our deferred tax assets. The realization of total deferred tax
assets is contingent upon the generation of future taxable income. Due to the uncertainty of
realization of certain tax benefits, we did not reverse the portion of the valuation allowance
established for the net operating loss carryforwards 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. The provision for and benefit from income taxes recorded in the three- and nine-month periods ended
March 31, 2005, respectively, are based on our estimated annual effective tax rate. Items which
caused recorded income taxes to differ from taxes computed using the statutory federal income tax
rate include state income taxes, foreign losses not benefited, certain non-deductible expenses and
research and development tax credits. The change in the estimated annual effective tax rate from
the quarter ended December 31, 2004, was due to changes in projected operating results for the full
fiscal year. Although our projected operating results for the full fiscal year result in a net
loss due to the $14,000,000 patent litigation settlement, we project income tax expense because a
substantial portion of this net loss is expected to be derived from Europe and we cannot use Europe
losses to offset income generated in the United States. 19




---



##### 



Liquidity and Capital Resources Since inception, our expenses have significantly exceeded our revenues, resulting in an accumulated
deficit of approximately $58,551,000 at March 31, 2005. We have funded our operations primarily
through the sale of equity securities and revenues from product sales and research and development
contracts. At March 31, 2005, we had cash, cash equivalents and short-term investments aggregating
approximately $41,496,000. We had negative cash flows from operations of approximately $3,281,000
for the nine-months ended March 31, 2005, due largely to the $14,000,000 settlement of patent
litigation with Enzo discussed below, compared to positive cash flows from operations of
approximately $98,000 for the comparable period in fiscal 2004. Net cash provided by investing activities for the nine-months ended March 31, 2005 of approximately
$9,643,000 included approximately $14,000,000 of net sales and maturities of short-term investments
to pay patent litigation settlement expenses, as more fully described below, partially offset by
approximately $4,271,000 of capital expenditures. On October 13, 2004 we entered into a Settlement and License Agreement (the Agreement) to settle
our patent litigation with Enzo Biochem, Inc. and its subsidiary Enzo Life Sciences, Inc. (formerly
known as Enzo Diagnostics, Inc.) (collectively, Enzo). Under the Agreement, we received an
irrevocable, non-exclusive, royalty-bearing worldwide license under identified Enzo patents. We
made an initial payment to Enzo of $16,000,000, of which $2,000,000 can be used to offset future
royalty payments under the terms of the Agreement, resulting in a one-time pre-tax charge of
$14,000,000 in patent settlement expense. We will also pay Enzo royalties on future net sales of
products covered by the license grant, which royalties will be at least $2,500,000 for the first
annual period (October 1, 2004 to September 30, 2005) and at least $3,500,000 for each of the next
four annual periods. We are obligated to make such guaranteed minimum payments in such first five
annual periods under the Agreement. Our obligation to make royalty payments will end on April 24,
2018, unless earlier terminated in accordance with the terms of the Agreement. In August 2004, we established a leasing facility with ePlus Group, Inc. with a total commitment of
$1,000,000. We intend to use such facility to fund the lease of computer hardware and associated
software. As of March 31, 2005, we have used approximately $350,000 of such commitment. 20




---



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We anticipate that working capital requirements will increase moderately for the foreseeable future
due to the investment necessary to expand our Gaithersburg facility, as well as increasing accounts
receivable as a result of expected revenue growth. 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 fiscal 2006. 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; the effectiveness of our
sales and marketing activities; 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 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. Other than our equipment leasing facility with
ePlus Group, Inc., 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 would be materially adversely affected. We have summarized below our material contractual obligations as of March 31, 2005 (in thousands): Less Than
    
    
    One to
    
    
    Four to
    
    
    After FiveContractual Obligations
    
    Total
    
    
    One Year
    
    
    Three Years
    
    
    Five Years
    
    
    YearsLong-term debt
    
    $
    714,889
    
    
    $
    116,138
    
    
    $
    355,546
    
    
    $
    243,205
    
    
    $
    Physician detailing
agreement
    
    
    1,720,750
    
    
    
    1,720,750
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    
    16,095,392
    
    
    
    3,576,853
    
    
    
    9,915,322
    
    
    
    2,501,138
    
    
    
    102,079Minimum royalty
payments
(1)
    
    
    16,003,107
    
    
    
    2,003,107
    
    
    
    10,500,000
    
    
    
    3,500,000
    
    
    
    Total contractual cash
obligations
    
    $
    34,534,138
    
    
    $
    7,416,848
    
    
    $
    20,770,868
    
    
    $
    6,244,343
    
    
    $
    102,079
   (1)
    
    On October 14, 2004, we paid Enzo $16 million under the terms of the Agreement.
Of the $16 million payment, $2 million will be used to offset future minimum royalty payments. 21




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Item 3. Quantitative and Qualitative Disclosures about Market Risk We are subject to market risk associated with changes in foreign currency exchange rates and
interest rates. Our exchange rate risk comes from our operations in Europe and South America. In
the quarter ended March 31, 2005, foreign currency exchange rate fluctuations had an impact on
revenues from our operations outside the United States and impacted the amount of expenditures
recorded for international operations. The net impact of foreign
exchange rate fluctuations on earnings
was immaterial for the three- and nine-month periods ended March 31, 2005 and 2004, respectively.
Interest rate exposure is primarily limited to the approximately $41,496,000 of cash, cash
equivalents and short-term investments owned by us at March 31, 2005. Such investments are money
market debt securities that generate interest income for us on cash balances. We do not actively
manage the risk of interest rate fluctuations; however, such risk is mitigated by the relatively
short-term nature of our investments. We do not consider the present rate of inflation to have a
significant impact on our business. Item 4. Controls and Procedures Our management, under the supervision and with the participation of the principal executive officer
and principal financial officer, have evaluated the effectiveness of our controls and procedures
related to our reporting and disclosure obligations as of March 31, 2005, which is the end of the
period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the principal
executive officer and principal financial officer have concluded that these disclosure controls and
procedures are sufficient to provide that (a) material information relating to us, including our
consolidated subsidiaries, is made known to these officers by other employees of us and our
consolidated subsidiaries, particularly material information related to the period for which this
periodic report is being prepared; and (b) this information is recorded, processed, summarized,
evaluated and reported, as applicable, within the time periods specified in the rules and forms
promulgated and adopted by the Securities and Exchange Commission. There were no changes that occurred during the fiscal quarter covered by this Quarterly Report on
Form 10-Q that have materially affected, or are reasonable likely to materially affect, our
internal controls over financial reporting. 22




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##### 



PART II. Other Information Item 1. Legal Proceedings Pending Legal Proceedings: Digene Corporation v. Ventana Medical Systems, Inc. and Beckman Coulter, Inc. 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 our claims against them. After a bench trial, the Court issued an order that
Beckman Coulter has a right to arbitrate our claims against it, but that Ventana does not. On
December 23, 2004, we submitted a demand for arbitration against Beckman with the American
Arbitration Association (AAA). No substantive actions have been taken by the AAA to date. The
Court, as a matter of judicial economy, has stayed the proceedings against Ventana pending the
outcome of the arbitration between us and Beckman Coulter. Georgetown University v. Digene Corporation Through a license agreement with Georgetown University, we obtained exclusive, worldwide rights to
United States Patent No. 5,643,715 and corresponding foreign patents and patent applications
relating to human papillomavirus (HPV) type 52, and to United States Patent No. 5,057,411 and
corresponding foreign patents relating to the use of the L1 gene sequence to detect specific human
papillomavirus types. Unless terminated earlier, the license agreement will terminate upon the
last to expire of the licensed patent rights. We are obligated to make royalty payments to
Georgetown University based on the percentage of net sales of products (as defined in the license
agreement). We continue to accrue and pay royalties to Georgetown University under the license
agreement. We had been involved in discussions with Georgetown University related to the
interpretation over the calculation of such royalties. The parties have not been able to resolve
the differences in their interpretations of the royalty calculation. 23




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##### 



On October 26, 2004, we received a copy of a complaint filed by Georgetown University in the United
States District Court for the District of Columbia, which was later served on November 22, 2004,
containing allegations related to the royalties dispute and our use of the licensed patent rights
under the license agreement. In its complaint, Georgetown University alleges that it is entitled
to royalties of 8% on net sales of products covered by the license agreement, that the total amount
of unpaid and past-due royalties owed by the Company to Georgetown University exceeds $2.0 million,
that the Companys license rights under the L1 Patent are terminated under the provisions of the
license agreement and that the Company is in breach of the license agreement for not using its best
efforts to develop products covered by the L1 Patent. We assert that we have complied fully with
the terms of our license agreement with Georgetown University. We believe that Georgetown
Universitys interpretation of the license agreement provisions related to the calculation of
royalties is not correct, and that the royalties, when calculated under the provisions of the
license agreement, are consistent with the Companys historical and previously agreed upon
calculation of royalties. Moreover, we dispute Georgetown Universitys claim that the rights as it
relates to the L1 Patent are terminated as we have complied with all obligations under the license
agreement. On January 18, 2005, we filed our answer to the complaint, along with counter claims against
Georgetown University stemming from Georgetown Universitys failure to meet certain legal and
fiduciary duties under the license agreement. We believe we have strong defenses and counterclaims
against each of the allegations made in the complaint and intend to vigorously defend against such
action, and to aggressively pursue our counterclaims against Georgetown University if a resolution
of this matter cannot be reached. 24




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##### 



Item 6. Exhibits Exhibit No.
    
    Description3.1
    
    Amended and Restated Certificate of Incorporation (Incorporated by
reference to Exhibit 3.1 to Digenes Registration Statement on Form
S-1 (File No. 333-02968)).3.2
    
    Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.2
to Digenes Annual Report on Form 10-K for the year ended June 30,
1999).4.1
    
    Form of Common Stock Certificate (Incorporated by reference to Exhibit
4.1 to Digenes Registration Statement on Form S-1 (File No.
333-02968)).10.1
    
    Amendment to the Amended and Restated 1999 Incentive Plan, Stock
Option Awards to Employees Working in France.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.
 25




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##### 



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. DIGENE CORPORATIONDate: May 9, 2005
    
    By:
    
    /s/ Charles M. FleischmanCharles M. FleischmanPresident, Chief Operating Officer andChief Financial Officer(Principal Financial Officer)Date: May 9, 2005
    
    By:
    
    /s/ Joseph P. SlatteryJoseph P. SlatterySenior Vice President, Finance andInformation Systems(Principal Accounting Officer)




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##### 



EXHIBIT INDEX Exhibit No.
    
    Description3.1
    
    Amended and Restated Certificate of Incorporation (Incorporated by
reference to Exhibit 3.1 to Digenes Registration Statement on Form
S-1 (File No. 333-02968)).3.2
    
    Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.2
to Digenes Annual Report on Form 10-K for the year ended June 30,
1999).4.1
    
    Form of Common Stock Certificate (Incorporated by reference to Exhibit
4.1 to Digenes Registration Statement on Form S-1 (File No.
333-02968)).10.1
    
    Amendment to the Amended and Restated 1999 Incentive Plan, Stock
Option Awards to Employees Working in France.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.