##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One)  [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934For the quarterly period ended March 31, 2004 OR  [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934For the transition period fromto 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 [X]  No [    ] Indicate by check mark whether Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X]  No [    ] Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. Shares outstanding as ofClass
    
    May 3, 2004Common Stock, par value $.01 per share
    
    19,755,774
    1




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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, 2004 and June 30, 2003
    
    
    3Consolidated
Statements of Operations-

Three and nine months ended March 31, 2004 and 2003
    
    
    4Consolidated
Statements of Cash Flows-

Nine months ended March 31, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    10Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    16Item 4. Controls and Procedures
    
    
    16Part II. Other Information:Item 1. Legal Proceedings
    
    
    17Item 5. Other Information
    
    
    17Item 6. Exhibits and Reports on Form 8-K
    
    
    18Signatures
    
    
    19Exhibit Index
    
    
    20
 2




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##### 



PART I. Consolidated Financial Information Item 1. Consolidated Financial Statements DIGENE CORPORATION
CONSOLIDATED BALANCE SHEETS March 31, 2004
    
    June 30, 2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    23,091,401
    
    
    $
    7,883,129Short-term investments
    
    
    23,832,291
    
    
    
    26,408,994Accounts receivable, less allowance of approximately $551,000 and
$432,000 at March 31, 2004 and June 30, 2003, respectively
    
    
    14,234,609
    
    
    
    10,344,597Inventories
    
    
    7,779,629
    
    
    
    7,073,920Prepaid expenses and other current assets
    
    
    2,302,896
    
    
    
    2,189,225Total current assets
    
    
    71,240,826
    
    
    
    53,899,865Property and equipment, net
    
    
    9,577,852
    
    
    
    7,515,104Intangible assets, net
    
    
    900,515
    
    
    
    900,515Deposits and other assets
    
    
    1,239,643
    
    
    
    1,059,666Total assets
    
    $
    82,958,836
    
    
    $
    63,375,150LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    6,140,313
    
    
    $
    7,489,700Accrued expenses
    
    
    3,003,500
    
    
    
    3,467,629Accrued payroll
    
    
    3,675,302
    
    
    
    4,182,327Current portion of long-term debt
    
    
    1,450,302
    
    
    
    2,640,363Total current liabilities
    
    
    14,269,417
    
    
    
    17,780,019Deferred rent
    
    
    472,801
    
    
    
    434,908Long-term debt, less current portion
    
    
    1,060,330
    
    
    
    2,154,244Stockholders 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, 19,738,550
and 18,325,208 shares issued and outstanding at March 31, 2004
and June 30, 2003, respectively
    
    
    197,385
    
    
    
    183,252Additional paid-in capital
    
    
    137,926,366
    
    
    
    118,535,272Deferred stock compensation
    
    
    (231,012
    )
    
    
    (380,633
    )Accumulated other comprehensive income
    
    
    857,991
    
    
    
    356,415Accumulated deficit
    
    
    (71,594,442
    )
    
    
    (75,688,327
    )Total stockholders equity
    
    
    67,156,288
    
    
    
    43,005,979Total liabilities and stockholders equity
    
    $
    82,958,836
    
    
    $
    63,375,150
 See accompanying notes. 3




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DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003(Unaudited)
    
    (Unaudited)Revenues:Product sales
    
    $
    23,158,679
    
    
    $
    16,900,922
    
    
    $
    63,402,586
    
    
    $
    43,505,215Other
    
    
    406,805
    
    
    
    80,958
    
    
    
    894,942
    
    
    
    542,720Total revenues
    
    
    23,565,484
    
    
    
    16,981,880
    
    
    
    64,297,528
    
    
    
    44,047,935Costs and expenses:Cost of product sales
    
    
    4,339,132
    
    
    
    3,812,189
    
    
    
    11,447,236
    
    
    
    9,999,579Research and development
    
    
    2,418,685
    
    
    
    2,481,681
    
    
    
    8,046,982
    
    
    
    6,647,962Selling and marketing
    
    
    9,221,061
    
    
    
    7,427,101
    
    
    
    26,854,372
    
    
    
    20,146,755General and administrative
    
    
    5,014,995
    
    
    
    4,076,798
    
    
    
    13,783,855
    
    
    
    12,342,245Income (loss) from operations
    
    
    2,571,611
    
    
    
    (815,889
    )
    
    
    4,165,083
    
    
    
    (5,088,606
    )Other income (expense):Interest income
    
    
    119,296
    
    
    
    136,404
    
    
    
    309,237
    
    
    
    478,839Interest expense
    
    
    (33,378
    )
    
    
    (72,307
    )
    
    
    (152,059
    )
    
    
    (201,899
    )Other income (expense)
    
    
    (5,327
    )
    
    
    196,026
    
    
    
    205,193
    
    
    
    307,004Income (loss) before income taxes
    
    
    2,652,202
    
    
    
    (555,766
    )
    
    
    4,527,454
    
    
    
    (4,504,662
    )Provision for income taxes
    
    
    162,083
    
    
    
    63,615
    
    
    
    433,569
    
    
    
    78,727Net income (loss)
    
    $
    2,490,119
    
    
    $
    (619,381
    )
    
    $
    4,093,885
    
    
    $
    (4,583,389
    )Basic net income (loss) per share
    
    $
    0.13
    
    
    $
    (0.03
    )
    
    $
    0.22
    
    
    $
    (0.25
    )Diluted net income (loss) per share
    
    $
    0.12
    
    
    $
    (0.03
    )
    
    $
    0.20
    
    
    $
    (0.25
    )Weighted average shares outstandingBasic
    
    
    19,493,223
    
    
    
    18,118,253
    
    
    
    18,924,145
    
    
    
    18,116,461Diluted
    
    
    21,026,892
    
    
    
    18,118,253
    
    
    
    20,734,205
    
    
    
    18,116,461
 See accompanying notes. 4




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DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months EndedMarch 31,2004
    
    2003(Unaudited)Operating activitiesNet income (loss)
    
    $
    4,093,885
    
    
    $
    (4,583,389
    )Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:Depreciation and amortization of property and equipment
    
    
    2,856,988
    
    
    
    2,448,423Compensation expense related to stock options
    
    
    318,725
    
    
    
    24,102Changes in operating assets and liabilities:Accounts receivable
    
    
    (3,890,012
    )
    
    
    (99,165
    )Inventories
    
    
    (705,709
    )
    
    
    122,067Prepaid expenses and other current assets
    
    
    (113,671
    )
    
    
    300,778Deposits and other assets
    
    
    (179,977
    )
    
    
    (130,587
    )Accounts payable
    
    
    (1,349,387
    )
    
    
    (694,268
    )Accrued expenses
    
    
    (464,129
    )
    
    
    (2,421,429
    )Accrued payroll
    
    
    (507,025
    )
    
    
    325,141Deferred rent
    
    
    37,893
    
    
    
    66,023Net cash provided by (used in) operating activities
    
    
    97,581
    
    
    
    (4,642,304
    )Investing activitiesPurchases of short-term investments
    
    
    (20,419,247
    )
    
    
    (15,201,254
    )Sales and maturities of short-term investments
    
    
    22,995,950
    
    
    
    22,776,891Capital expenditures
    
    
    (4,919,736
    )
    
    
    (2,946,260
    )Net cash provided by (used in) investing activities
    
    
    (2,343,033
    )
    
    
    4,629,377Financing activitiesExercise of common stock options
    
    
    19,236,123
    
    
    
    55,096Principal payments of long-term debt
    
    
    (2,283,975
    )
    
    
    (1,080,884
    )Net cash provided by (used in) financing activities
    
    
    16,952,148
    
    
    
    (1,025,788
    )Effect of currency translations
    
    
    501,576
    
    
    
    Net increase (decrease) in cash and cash equivalents
    
    
    15,208,272
    
    
    
    (1,038,715
    )Cash and cash equivalents at beginning of period
    
    
    7,883,129
    
    
    
    9,453,125Cash and cash equivalents at end of period
    
    $
    23,091,401
    
    
    $
    8,414,410
 See accompanying notes. 5




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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, 2004 and 2003
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. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in our Annual Report on Form 10-K for the year ended June 30, 2003
filed with the Securities and Exchange Commission. The results of operations for any interim period are not necessarily indicative
of the results of operations for any other interim period or for a full fiscal
year. 2. Inventories Inventories are stated at the lower of cost or market. Inventories consist of the following: March 31,
    
    June 30,2004
    
    2003(unaudited)Finished goods
    
    $
    4,876,308
    
    
    $
    5,132,328Work in process
    
    
    3,496,498
    
    
    
    2,897,539Raw materials
    
    
    1,560,380
    
    
    
    1,461,3479,933,186
    
    
    
    9,491,214Reserve
    
    
    (2,153,557
    )
    
    
    (2,417,294
    )$
    7,779,629
    
    
    $
    7,073,920
 3. Common Stock and Per Share Calculation For the three- and nine-month periods ended March 31, 2004, in conjunction with
stock option exercises, the Company issued 582,728 and 1,413,342 shares of
common stock, respectively. The Company received cash proceeds from the
exercise of these stock options of approximately $8,122,000 and $19,236,000 for
the three- and nine-month periods ended March 31, 2004, respectively. 6




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The following table presents the calculation of basic and diluted net income
(loss) per share: Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Numerator:Net income (loss)
    
    $
    2,490,119
    
    
    $
    (619,381
    )
    
    $
    4,093,885
    
    
    $
    (4,583,389
    )Denominator:Weighted average shares outstanding  basic
    
    
    19,493,223
    
    
    
    18,118,253
    
    
    
    18,924,145
    
    
    
    18,116,461Dilutive securities  stock options
    
    
    1,533,669
    
    
    
    
    
    
    
    1,810,060
    
    
    
    Weighted average shares outstanding  diluted
    
    
    21,026,892
    
    
    
    18,118,253
    
    
    
    20,734,205
    
    
    
    18,116,461Basic net income (loss) per share
    
    $
    0.13
    
    
    $
    (0.03
    )
    
    $
    0.22
    
    
    $
    (0.25
    )Diluted net income (loss) per share
    
    $
    0.12
    
    
    $
    (0.03
    )
    
    $
    0.20
    
    
    $
    (0.25
    )
 For the three- and nine-month periods ended March 31, 2004, outstanding stock
options to purchase approximately 68,000 and 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 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 in the three- and
nine-month periods ended March 31, 2003 were included in the computation of
diluted net loss per share because the effect on net loss would have been
antidilutive. 4. 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. In accordance with Statement of Financial Accounting Standards No.
148, Accounting for Stock-Based CompensationTransition and Disclosure, the
effect on net income (loss) and net income (loss) per share if the Company had
applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation, to
stock-based employee compensation is as follows: 7




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Three Months Ended March 31,
    
    Nine Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Net income (loss), as reported
    
    $
    2,490,119
    
    
    $
    (619,381
    )
    
    $
    4,093,885
    
    
    $
    (4,583,389
    )Add: Stock-based compensation
included in reported net income (loss)
    
    
    20,290
    
    
    
    
    
    
    
    318,725
    
    
    
    Deduct: Stock-based compensation
expense if SFAS No. 123 had been
applied
to all grants
    
    
    (4,049,070
    )
    
    
    (2,681,405
    )
    
    
    (12,485,559
    )
    
    
    (10,550,781
    )Pro forma net loss
    
    $
    (1,538,661
    )
    
    $
    (3,300,786
    )
    
    $
    (8,072,949
    )
    
    $
    (15,134,170
    )Net income (loss) per share:Basic  as reported
    
    $
    0.13
    
    
    $
    (0.03
    )
    
    $
    0.22
    
    
    $
    (0.25
    )Basic  pro forma
    
    $
    (0.08
    )
    
    $
    (0.18
    )
    
    $
    (0.43
    )
    
    $
    (0.84
    )Diluted  as reported
    
    $
    0.12
    
    
    $
    (0.03
    )
    
    $
    0.20
    
    
    $
    (0.25
    )Diluted  pro forma
    
    $
    (0.08
    )
    
    $
    (0.18
    )
    
    $
    (0.43
    )
    
    $
    (0.84
    )
 These pro forma amounts are not necessarily indicative of future effects of
applying the fair value-based method due to, among other things, the vesting
period of the stock options and the fair value of the additional stock options
issued in future years. 5. Income Taxes The Companys provision for income taxes has been reduced by the net operating
loss carryforward. At March 31, 2004 the Company has a net operating loss
carryforward of approximately $100 million. Items which caused recorded income
taxes attributable to continuing operations to differ from taxes computed using
the statutory federal income tax rate include state minimum income taxes,
foreign taxes, foreign income or loss, valuation allowances, alternative
minimum tax and other miscellaneous taxes. 6. Comprehensive Income Comprehensive income for the quarter- and year-to-date ended March 31, 2004 and
2003 was as follows: Three Months Ended March 31,
    
    Nine Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Net income (loss), as reported
    
    $
    2,490,119
    
    
    $
    (619,381
    )
    
    $
    4,093,885
    
    
    $
    (4,583,389
    )Other comprehensive income:Foreign currency translation
    
    
    (253,100
    )
    
    
    
    
    
    
    501,576
    
    
    
    Comprehensive income (loss)
    
    $
    2,237,019
    
    
    $
    (619,381
    )
    
    $
    4,595,461
    
    
    $
    (4,583,389
    )
 8




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##### 



7. Warranties The Company offers its customers extended warranties on its equipment. The
revenues from these extended warranties are deferred and are recognized evenly
over the life of the extended warranty. Changes in the Companys deferred
extended warranty revenue during the period are as follows: Balance, June 30, 2003
    
    $
    58,020Warranties issued during the period
    
    
    60,787Settlements made during the period
    
    
    Changes in liability for pre-existing warranties during the
period, including expirations
    
    
    (29,948
    )Balance, March 31, 2004
    
    $
    88,858
 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. A specific
royalty liability of approximately $535,000, which was previously accrued, was
reversed in the quarter ended March 31, 2004 based on the reduced probability
that a liability would materialize. 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 has established June 14, 2004 as a trial date in
this matter. The Company does not believe it infringes such patent and
continues to vigorously defend against Enzos claim of patent infringement. 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. 9




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##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations Forward-Looking Statements The following discussion of our financial condition and results of operations
should be read in conjunction with our Consolidated Financial Statements and
the related Notes thereto included elsewhere in this report and in our Annual
Report on Form 10-K for the year ended June 30, 2003. Some of the information
that follows are not statements of historical fact, but merely reflect our
intent, belief or expectations regarding the anticipated effect of events,
circumstances and trends. Such statements should be considered as
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. We believe that our expectations are based on
reasonable assumptions within the bounds of our knowledge of our business and
operations. Factors that might cause or contribute to differences between our
expectations and actual results include: uncertainty of market acceptance of
our products by the worldwide medical community; our need to obtain third-party
reimbursement approval from more government entities, managed care
organizations, and private insurance plans; risk that other companies may
develop and market HPV tests competitive with our own; uncertainty regarding
patents and proprietary rights in connection with our products and products in
development; uncertainty as to ongoing litigation; 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 2004; risks inherent in
international transactions, including those relating to our expansion in Europe
and elsewhere; and other factors as set forth under the caption Additional
Considerations in our Annual Report on Form 10-K for the year ended June 30,
2003. Overview Since our incorporation in 1987, we have devoted substantially all of our
resources to developing, manufacturing and marketing our proprietary gene-based
testing systems using our patented Hybrid Capture® technology for the
screening, monitoring and diagnosis of human diseases. Since our inception, we
have incurred substantial operating losses, resulting principally from expenses
associated with our research and development programs, including preclinical
studies, clinical trials and regulatory submissions for our products, the
expansion of our manufacturing facilities and our global sales and marketing
activities. Our revenues to a significant extent have been derived from the sales of our
diagnostic tests for the presence of human papillomavirus (HPV), which, for
fiscal 2003, accounted for 81% of total revenues and, for the nine months ended
March 31, 2004, accounted for 82% of total revenues. We expect that the
growing acceptance of our HPV Tests in both the United States and abroad will
continue to drive the growth in revenues from our HPV Tests in the future. In fiscal 2003, our gross margins (79% for the full fiscal year) improved
substantially over fiscal 2002 (gross margins of 72%). In fiscal 2004, we
believe that we will be able to sustain gross margins consistent with, or
better than, fiscal 2003 as we continue to scale up our manufacturing
operations and realize expanded margins as a result of our direct distribution
efforts in Europe. We believe that increasing our investment in sales and marketing and focusing
our investment in research and development is essential to allow us to
capitalize more fully on the potential of our HPV Test and our core technology.
We have invested heavily in our European infrastructure and distribution
operations during fiscal 2004 to date and expect this to continue beyond fiscal
2004. We are also expanding our sales organization in the United States. We
have moderately increased our expenditures related to the 10




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##### 



development of our next-generation Hybrid Capture platforms and clinical trial
activities for human papillomavirus screening in fiscal 2004 to date as
compared to fiscal 2003 and expect to continue such funding in fiscal 2004. Our sales and marketing expenditures have been and will continue to be focused
on accelerating the adoption of human papillomavirus testing worldwide. We
intend to capitalize on the growing acceptance of our HPV Tests in the United
States and internationally by physicians, laboratories and health insurance
providers by materially increasing sales and marketing expenditures over the
next several quarters. The increase in expenditures will be primarily directed
at expanded direct sales and marketing efforts in Europe and the United States. We expect our general and administrative expenses will continue to 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. We anticipate that the impact of our ability to sustain our gross margins will
offset the impact of these increased expenditures on operating profits. Certain
revenues and expenses resulting from our operations outside of the United
States are impacted by foreign currency exchange rate changes. We expect the
operating profits which we experienced for the first time at the end of fiscal
2003 will continue through fiscal 2004. There can be no assurance that we will
meet this goal. Results of Operations Product sales increased 37% to approximately $23,159,000 for the three-month
period ended March 31, 2004 from approximately $16,901,000 for the
corresponding period in 2003. The increase was due primarily to a 38% growth
in sales of our HPV Tests over such sales in the corresponding period in fiscal
2003. The majority of the growth in HPV products sales was in the United
States and Europe where such sales increased by approximately $3,931,000 (38%)
and $1,026,000 (41%), respectively over the corresponding period in fiscal
2003. Product sales increased 46% to approximately $63,403,000 for the nine-month
period ended March 31, 2004 from approximately $43,505,000 for the
corresponding period in fiscal 2003. The increase was due primarily to a 49%
growth in sales of our HPV Tests over such sales in the corresponding period in
fiscal 2003. The majority of the growth in HPV products sales was in the
United States and Europe, where such sales increased by approximately
$12,449,000 (44%) and $4,227,000 (87%), respectively, as compared to sales of
such products in the corresponding period in fiscal 2003. In December 2003, we
terminated all marketing of our hepatitis B virus and cytomegalovirus products
in Europe, and our marketing and distribution agreement with Abbott
Laboratories for these products expired in accordance with its terms. Other revenues include research and development contract revenues, equipment
rental revenues and licensing revenues. Other revenues increased 402% to
approximately $407,000 for the three-month period ended March 31, 2004 from
approximately $81,000 for the corresponding period in fiscal 2003 primarily due
to a 176% increase in equipment rental revenues to approximately $193,000 and
revenues of approximately $183,000 under new research and development
contracts. Other revenues increased 65% to approximately $895,000 for the
nine-month period ended March 31, 2004 from approximately $543,000 for the
corresponding period in fiscal 2003 due primarily to a 514% increase in
research and development contract revenue to approximately $385,000. Cost of product sales increased by 14% to approximately $4,339,000 for the
three-month period ended March 31, 2004 from approximately $3,812,000 for the
corresponding period in 2003 and increased 14% to 11




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approximately $11,447,000 for the nine-month period ended March 31, 2004 from
approximately $10,000,000 for the corresponding period in fiscal 2003. Gross
margin percentage on product sales increased to 81% for the three-month period
ended March 31, 2004 from 77% for the corresponding period in fiscal 2003 and
increased to 82% for the nine-month period ended March 31, 2004 from 77% for
the corresponding period in fiscal 2003. The increase in gross margin
percentage for the nine-month period ended March 31, 2004 was due primarily to an increase in the sale of our higher margin
HPV kits, which increased to 83% of product sales in fiscal 2004 from 81% of
product sales in the comparable period in fiscal 2003, partially offset by the
lower gross margin from equipment sales, which increased 135% to approximately
$4,270,000 in the nine months ended March 31, 2004. Research and development expenses decreased 3% to approximately $2,419,000 for
the three-month period ended March 31, 2004 from approximately $2,482,000 for
the corresponding period in fiscal 2003 and increased 21% to approximately
$8,047,000 for the nine-month period ended March 31, 2004 from approximately
$6,648,000 for the corresponding period in fiscal 2003. For the three-month
period ended March 31, 2004, there was a 69% decrease in professional services
expenses to $227,000, primarily related to reduced expenditures in this quarter
for the preparation for compliance with the European Union In Vitro Diagnostic
Directive (or IVDD) regulations, for which we spent heavily in the
corresponding period in fiscal 2003 and the first half of fiscal 2004.
Personnel related costs increased by 22% to approximately $1,247,000 and lab
supply costs increased 52% to approximately $284,000 for the three months ended
March 31, 2004, compared to the corresponding period in fiscal 2003 which
partially offset the decrease. For the nine-month period ended March 31, 2004,
the majority of the increase was due to a 42% increase in professional services
expenses to $1,642,000, primarily related to the IVDD compliance activities
preparation, an 11% increase in personnel costs to approximately $3,550,000, and
a 33% increase in lab supply costs to approximately $831,000 compared to the
first nine months of fiscal 2003. 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. Our research and development activities focus on our platform technology,
including adaptations of such technology, and improvements to our diagnostic
test and equipment products. We focus 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. 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 for 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 third quarter
of fiscal 2004 we completed the establishment of a research team to pursue this
program. Our new product development activities currently focus on the discovery of
innovative methods to improve specimen processing procedures and throughput,
and include procedures for the improved processing of PreservCytTM (Cytyc Corporation) specimens and equipment upgrades for high throughput HPV, CT, and
GC testing. We are also working to expand HPV testing capabilities to allow
testing from additional liquid cytology media, including our proprietary
Universal Collection Medium (UCMTM), which is expected to allow simultaneous
testing for cytology, HPV DNA, CT/GC DNA, and of other genetic and cellular
material from a single patient sample, and the SurePathTM (TriPath Imaging)
medium, 12




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for which the clinical validation is ongoing. We have also completed
development of a software improvement for our Rapid CaptureTM System to permit
the simultaneous testing of multiple DNA-probes, and to improve the related
laboratory processes and procedures. With respect to regulatory submissions and product modification activities we:  
    
    developed and completed the clinical validation of our Rapid
Capture System for semi-automated processing of Hybrid Capture HPV DNA
Tests, and initially submitted a 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 high-risk HPV Test to allow
high-volume semi-automated HPV DNA testing; and,  
    
    developed and completed the clinical validation of the use of
chlamydia (CT) and gonorrhea (GC) testing using our CT/GC Tests
from Cytyc Corporations ThinPrep® PreservCyt specimens. We submitted
510(k) pre-market notifications for each of our CT and GC Tests (each
test separately and the combined 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. Selling and marketing expenses increased 24% to approximately $9,221,000 for
the three-month period ended March 31, 2004 from approximately $7,427,000 for
the corresponding period in fiscal 2003 and increased 33% to approximately
$26,854,000 for the nine-month period ended March 31, 2004 from approximately
$20,147,000 for the corresponding period in fiscal 2003. For the three-month
period ended March 31, 2004, the increase was due to personnel costs, which
increased 33% to approximately $3,053,000; agency fees, which increased 177% to
approximately $1,406,000; professional fees, which increased 159% to
approximately $822,000, and conferences, which increased from approximately
$5,000 to approximately $235,000. The increase in agency fees relates to our
agreement with PDI, Inc. (PDI). PDI recruits and administers a
Digene-specific physician detailing sales organization dedicated to educating
physicians about the benefits of the DNAwithPap Test in the U.S. These
increases were partially offset by a decrease in royalties expense, which
decreased 96% to approximately $29,000 due to the reversal of an approximately
$535,000 accrual. This decrease was based on the reduced probability that a
specific royalty liability would materialize. The increase for the nine-month
period ended March 31, 2004 was due primarily to personnel costs, which
increased 37% to approximately $8,882,000; agency fees, which increased 123% to
approximately $4,002,000; and professional fees, which increased 96% to
approximately $2,206,000, and includes approximately $319,000 of stock option
compensation expense. These increases were partially offset by a 46% decrease
in royalty accruals to approximately $1,049,000 due to the aforementioned
accrual reversal. General and administrative expenses increased 23% to approximately $5,015,000
for the three-month period ended March 31, 2004 from approximately $4,077,000
for the corresponding period in fiscal 2003 and increased 12% to approximately
$13,784,000 for the nine-month period ended March 31, 2004 from approximately
$12,342,000 for the corresponding period in fiscal 2003. The increase for the
three-month period ended March 31, 2004 was primarily attributed to an increase
in personnel costs, which increased 24% to approximately $2,058,000;
professional fees, which increased 11% to $1,965,000; and insurance costs,
which increased 54% to approximately $362,000, as compared to the same period
in fiscal 2003, due to significant increases in Directors & Officers Liability
insurance and Product Liability insurance. The increase for the nine-month
period ended March 31, 2004 was primarily attributed to an increase in
personnel costs, which increased 21% to approximately $5,680,000; and
insurance, which increased 51% to approximately $1,019,000. The increase was
partially offset in the nine-month period by a 7% decrease in professional
services to approximately $5,314,000, largely related to a decrease in legal
fees associated with 13




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our litigation with Ventana Medical Systems, Inc., and litigation with Enzo
Biochem, Inc. and its subsidiary, Enzo Diagnostics, Inc. Professional fees
associated with these litigation matters are expected to increase during the
remainder of fiscal 2004. Other income (expense) consists primarily of 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 $71,594,000 at March 31,
2004. 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, 2004, we had cash, cash equivalents and short-term
investments aggregating approximately $46,924,000. We had positive cash flows
from operations of approximately $98,000 for the nine-months ended March 31,
2004 compared to cash used in operations of approximately $4,642,000 for the
comparable period in fiscal 2003. The increase in cash provided from
operations was due primarily to net income for the nine-months ended March 31,
2004 of approximately $4,094,000 compared to a net loss of approximately
$4,583,000 for the corresponding period in fiscal 2003, partially offset by an
increase of approximately $3,890,000 in the cash used for net accounts
receivable due to increased sales in fiscal 2004. Net cash used in investing
activities for the nine-months ended March 31, 2004 included approximately
$4,920,000 of capital expenditures. This included approximately $2,304,000 of
equipment placed at customer sites and approximately $1,401,000 of leasehold
improvements, primarily at our headquarters facility in Gaithersburg, Maryland.
The placed equipment allows our customers to run diagnostic tests using our
reagent test kit products. 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, and specifically Rapid Capture Systems, at our customers
sites, and as we further expand our warehouse capacity at our Gaithersburg
facility, for which we may obtain financing from our current landlord. We anticipate that working capital requirements will increase moderately for
the foreseeable future due to the investment necessary to support our European
infrastructure and direct distribution operations, as well as increasing
accounts receivable as a result of expected revenue growth. Until this fiscal
quarter we have incurred negative cash flows from operations since our
inception, and have expended, and expect to continue to expend in the future,
substantial funds to complete our planned product development efforts, expand
our sales and marketing activities and expand our manufacturing capabilities.
We expect that our existing capital resources will be adequate to fund our
operations through calendar year 2004. Our future capital requirements and the
adequacy of available funds may change, however, based on numerous factors,
including our degree of success in commercializing our products, progress in
our product development efforts and the magnitude and scope of such efforts,
progress with preclinical studies and clinical trials, progress in our
regulatory affairs activities, the cost and timing of expansion of our
manufacturing capabilities, the development and maintenance of effective sales
and marketing activities, the cost of filing, prosecuting, defending and
enforcing patent claims and other intellectual property rights, royalty
expenses, competing technological and market developments, and the development
and maturation of strategic alliances for the marketing of our products. To
the extent that our existing capital resources and funds generated from
operations are insufficient to meet current or planned operating requirements,
we will be required to obtain additional funds through equity or debt
financing, strategic alliances with corporate partners and others, or through
other sources. We do not have any committed sources of additional financing,
and there can be no assurance that additional funding, if necessary, will be
available on acceptable terms, if at all. If adequate funds are not available,
we may be required to delay, scale back or eliminate certain aspects of our
operations or attempt to obtain funds through arrangements with collaborative
partners or others that may require us to relinquish rights to certain of our
technologies, 14




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product candidates, products or potential markets. Under such conditions, our
business, financial condition and results of operations will be materially
adversely affected. We have summarized below our material contractual obligations as of March 31,
2004: Contractual Obligations
    
    
    
    
    
    Less Than
    
    One to
    
    Four to
    
    After FiveTotal
    
    One Year
    
    Three Years
    
    Five Years
    
    YearsLong-term debt (1)
    
    $
    2,510,632
    
    
    $
    1,450,302
    
    
    $
    645,302
    
    
    $
    415,028
    
    
    $
    Physician detailing
agreement
    
    
    1,383,885
    
    
    
    1,383,885
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    
    18,212,809
    
    
    
    3,241,505
    
    
    
    9,370,013
    
    
    
    5,413,018
    
    
    
    188,273Total contractual cash
Obligations
    
    $
    22,107,326
    
    
    $
    6,075,692
    
    
    $
    10,015,315
    
    
    $
    5,828,046
    
    
    $
    188,273
 (1) Includes debt payable to Abbott Laboratories related to the repurchase of
equipment in prior periods. 15




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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, 2004,
foreign currency exchange rate fluctuations had a positive impact on revenues
from our operations outside the United States and resulted in an increase in
the amount of expenditures recorded for international operations. The net
impact of foreign exchange activities on earnings was immaterial for the three-
and nine-month periods ended March 31, 2004 and 2003, respectively. Interest
rate exposure is primarily limited to the approximately $46,923,692 of cash,
cash equivalents and short-term investments owned by us. Such investments are
money market debt securities that generate interest income for us on cash
balances. We do not actively manage the risk of interest rate fluctuations;
however, such risk is mitigated by the relatively short-term nature of our
investments. We do not consider the present rate of inflation to have a
significant impact on our business. Item 4. Controls and Procedures Our management, under the supervision and with the participation of the
principal executive officer and principal financial officer, have evaluated the
effectiveness of our controls and procedures related to our reporting and
disclosure obligations as of March 31, 2004, 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. 16




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PART II. Other Information Item 1. Legal Proceedings On November 19, 2001, we filed an action for patent infringement against
Ventana Medical Systems, Inc. The action was filed in the United States
District Court for the District of Delaware. In the action, we allege that
Ventana Medical Systems, Inc. has made, used, sold and/or offered for sale
products embodying our patented inventions thereby infringing our United States
Patent No. 4,849,332 entitled Human Papilloma Virus 35 Nucleic Acid
Hybridization Probes and Methods for Employing the Same and our United States
Patent No. 4,849,331 entitled Human Papilloma Virus 44 Nucleic Acid
Hybridization Probes and Methods for Employing the Same. We are seeking a
permanent injunction and monetary damages for past infringement. On September
25, 2002, Ventana Medical Systems, Inc. publicly announced that it had acquired
Beckman Coulter, Inc.s human papillomavirus business and corresponding assets,
including the assignment of the human papillomavirus intellectual property
portfolio acquired by Beckman Coulter, Inc. from Institut Pasteur through a
1991 sublicense agreement. On October 18, 2002, we filed a motion to amend our
complaint to add Beckman Coulter, Inc. as a co-defendant, as well as additional
claims against Ventana. On 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. No trial
date has been set in this matter. On March 15, 2002, we filed an action for declaratory judgment against Enzo
Biochem, Inc. The action was filed in the United States District Court for the
District of Delaware. We filed this action after having received direct
threats from Enzo Biochem of infringement of U.S. Patent No. 6,221,581 entitled
Processes for Detecting Polynucleotides, Determining Genetic Mutations or
Defects in Genetic Material, Separating or Isolating Nucleic Acid of Interest
from Samples, and Useful Compositions of Matter and Multihybrid Complex
Compositions. We are seeking a judgment that the patent is invalid and has
not been infringed by us. On March 20, 2002, in response to our complaint,
Enzo Biochem filed a motion to dismiss our complaint for lack of subject matter
jurisdiction, based on assertions that Enzo Diagnostics, Inc. (a wholly owned
subsidiary of Enzo Biochem), not Enzo Biochem, was the holder of the patent in
question. On the same day, Enzo Diagnostics, Inc. also filed a complaint for
patent infringement against us in the Delaware District Court. Enzo
Diagnostics, Inc. asserts in its complaint that we have infringed U.S. Patent
No. 6,221,581 through the manufacture, sale and offer for sale of our Hybrid
Capture products. The two cases have now been consolidated. We have filed
counterclaims against Enzo Biochem for various business-related tortious
conduct. The Court has denied Enzo Biochems motion to dismiss our
counterclaims and has granted Digenes motion to amend our counterclaims to
include inequitable conduct claims. We do not believe we are infringing such
patent and will go forward with the action for declaratory judgment and
continue vigorously defending against Enzos claim of patent infringement. The
Court has indicated that a trial in this matter will be held commencing June
14, 2004. Item 5. Other Information During this quarter we engaged in discussions with Georgetown University
because of a disagreement over the calculation of royalties paid to Georgetown
University under an existing license agreement. To date, such discussions have
not resolved this matter. Management currently believes we can resolve this
matter without a material adverse effect on our results of operations or
financial condition, but we cannot provide assurances that such resolution will
occur. 17




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Item 6. Exhibits and Reports on Form 8-K (a) 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)).31.1
    
    Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer31.2
    
    Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer32
    
    Certification pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.
 (b) Reports on Form 8-K: Digene did not file any Current Reports on Form 8-K with the Commission during
the quarter ended March 31, 2004. 18




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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 7, 2004
    
    By: /s/ Charles M. FleischmanCharles M. FleischmanPresident, Chief Operating Officer andChief Financial Officer(Principal Financial Officer)Date: May 7, 2004
    
    By: /s/ Joseph P. SlatteryJoseph P. SlatterySenior Vice President, Finance andInformation Systems(Principal Accounting Officer)
 19




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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)).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.