Table of Contents

  **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 SECURITIESEXCHANGE ACT OF 1934****For the quarterly period ended March 31, 2006****OR**   o **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934******For the transition period from                      to**                    ****Commission file number 0-28194****DIGENE CORPORATION**(Exact name of registrant as specified in its charter)     **Delaware**   **52-1536128**     (State or other jurisdiction of   (I.R.S. Employer Identification No.)incorporation or organization)         **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 filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes þ No o     Indicate by check mark whether the registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer and large acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer o                     Accelerated filer þ                     Non-accelerated filer o     Indicate by check mark whether Registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934). Yes o No þIndicate the number of shares outstanding of each of the issuer’s classes of common stock, as ofthe latest practicable date.     Shares outstanding as ofClass May 5, 2006   **(Common Stock, par value $.01 per share)** **23,194,086**  
 

 
**DIGENE CORPORATION****INDEX TO FORM 10-Q**       **Page** **Part I. Consolidated Financial Information:**         Item 1. Consolidated Financial Statements         Consolidated Balance Sheets-March 31, 2006 and June 30, 2005  3      Consolidated Statements of Operations-Three and nine months ended March 31, 2006 and 2005  4      Consolidated Statements of Cash Flows-Nine months ended March 31, 2006 and 2005  5      Notes to Consolidated Financial Statements  6      Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations  16      Item 3. Quantitative and Qualitative Disclosures about Market Risk  25      Item 4. Controls and Procedures  25      **Part II. Other Information:**         Item 1. Legal Proceedings  26      Item 6. Exhibits  27      **Signatures**         **Exhibit Index**     EX-10.1 EX-10.2 EX-10.2(a) EX-10.3 EX-10.4 EX-10.4(a) EX-31.1 EX-31.2 EX-32
 

Table of Contents
**PART I. Consolidated Financial Information****Item 1. Consolidated Financial Statements****DIGENE CORPORATION****CONSOLIDATED BALANCE SHEETS**(in thousands, except share data)           **March 31,**  **June 30,**   **2006**  **2005**   **(Unaudited)**     **ASSETS**        Current assets:        Cash and cash equivalents $5,132  $15,789 Short-term investments  127,246   30,292 Accounts receivable, less allowance of approximately $327 and $288at March 31, 2006 and June 30, 2005, respectively  23,224   20,297 Inventories, net  6,380   7,197 Prepaid expenses and other current assets  3,622   3,130 Deferred tax asset, current  691   2,038                 Total current assets  166,295   78,743  Property and equipment, net  29,825   10,104 Deposits and other assets  2,388   2,237 Deferred tax asset, net  10,839   15,761                 Total assets $209,347  $106,845                 **LIABILITIES AND STOCKHOLDERS’ EQUITY**                 Current liabilities:        Accounts payable $8,901  $7,807 Accrued expenses  7,526   11,996 Accrued payroll  7,988   5,835 Current portion of long-term debt and lease obligation  1,150   116                 Total current liabilities  25,565   25,754          Deferred rent  229   763 Long-term debt, less current portion  479   572 Lease obligation, less current portion  18,338   —          Minority interest  410   353          Stockholders’ equity:        Preferred stock, $0.10 par value, 1,000,000 shares authorized, no sharesissued and outstanding  —   — Common stock, $0.01 par value, 50,000,000 shares authorized, 23,123,719and 20,037,253 shares issued and outstanding at March 31, 2006and June 30, 2005, respectively  231   200 Additional paid-in capital  220,622   140,914 Accumulated other comprehensive income  357   602 Accumulated deficit  (56,884)  (62,313)                Total stockholders’ equity  164,326   79,403                 Total liabilities and stockholders’ equity $209,347  $106,845        *See accompanying notes.*
3

Table of Contents
**DIGENE CORPORATION****CONSOLIDATED STATEMENTS OF OPERATIONS**(in thousands, except per share data)                   **Three Months Ended**  **Nine Months Ended**   **March 31,**  **March 31,**   **2006**  **2005**  **2006**  **2005**   **(Unaudited)**  **(Unaudited)** Revenues:                Product sales $38,533  $29,153  $107,915  $81,406 Other  597   513   1,661   1,424                               Total revenues  39,130   29,666   109,576   82,830                  Costs and expenses:                Cost of product sales  5,585   5,130   15,569   14,921 Royalty and technology  1,562   1,291   5,515   3,954 Research and development  5,641   3,265   13,258   9,128 Selling and marketing  16,343   11,697   44,770   31,014 General and administrative  7,472   5,614   19,335   14,537 Patent litigation settlement  —   —   —   14,000                               Income (loss) from operations  2,527   2,669   11,129   (4,724)                 Other income (expense):                Interest income  1,277   200   2,248   539 Interest expense  (318)  (2)  (482)  (27)Other expense  35   (35)  (10)  (96)                              Income (loss) before minorityinterest and income taxes  3,521   2,832   12,885   (4,308)                 Minority interest  5   (71)  (111)  (287)                              Income (loss) before income taxes  3,526   2,761   12,774   (4,595)                 Provision for (benefit from)income taxes  2,421   1,196   7,345   (191)                              Net income (loss) $1,105  $1,565  $5,429  $(4,404)                              Basic net income (loss) per share $0.05  $0.08  $0.25  $(0.22)                              Diluted net income (loss) per share $0.05  $0.08  $0.25  $(0.22)                              Weighted average shares outstanding                Basic  22,737   20,000   21,297   19,943                               Diluted  23,380   20,641   21,742   19,943              *See accompanying notes.*
4

Table of Contents
**DIGENE CORPORATION****CONSOLIDATED STATEMENTS OF CASH FLOWS****(in thousands)**           **Nine Months Ended**   **March 31,**   **2006**  **2005**   **(Unaudited)** **Operating activities**        Net income (loss) $5,429  $(4,404)Adjustments to reconcile net income (loss) to net cashprovided by (used in) operating activities:        Depreciation and amortization of property and equipment  3,367   3,403 Loss on disposal of fixed assets  127   238 Compensation expense related to stock options  4,193   (89)Deferred tax benefit  3,474   (631)Minority interest  57   287 Changes in operating assets and liabilities:        Accounts receivable  (2,912)  (1,181)Inventories  817   923 Prepaid expenses and other current assets  (521)  (1,307)Deposits and other assets  (150)  (114)Accounts payable  1,136   87 Accrued expenses  3,029   342 Accrued patent litigation settlement  (7,500)  — Accrued payroll  2,160   (1,161)Deferred rent  (535)  326                 Net cash provided by (used in) operating activities  12,171   (3,281)         **Investing activities**        Purchases of short-term investments  (189,487)  (11,388)Sales and maturities of short-term investments  92,427   25,302 Capital expenditures  (3,566)  (4,271)                Net cash (used in) provided by investing activities  (100,626)  9,643          **Financing activities**        Net proceeds from issuance of Common Stock  60,079   — Exercise of common stock options  15,466   1,375 Excess tax benefits from stock-based compensation  2,837   — Principal payments of long-term debt  (376)  (1,431)                Net cash provided by (used in) financing activities  78,006   (56)         Effect of currency translations  (208)  370        Net (decrease) increase in cash and cash equivalents  (10,657)  6,676 Cash and cash equivalents at beginning of period  15,789   4,079                 Cash and cash equivalents at end of period $5,132  $10,755        *See accompanying notes.*
5

Table of Contents
**DIGENE CORPORATION****NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****1. Basis of Presentation**The consolidated financial statements of Digene Corporation (the “Company” or “Digene”) for thethree- and nine-month periods ended March 31, 2006 and 2005 are unaudited and include alladjustments which, in the opinion of management, are necessary to present fairly the financialposition and results of operations for the periods then ended. All such adjustments are of anormal recurring nature, except for the capitalization of the Gaithersburg facility (see Note 4)and patent litigation settlement accrual (see Note 7). These consolidated financial statementsshould be read in conjunction with the consolidated financial statements and notes thereto includedin our Annual Report on Form 10-K for the year ended June 30, 2005 filed with the Securities andExchange Commission.The results of operations for any interim period are not necessarily indicative of the results ofoperations for any other interim period or for a full fiscal year.**2. Recent Accounting Pronouncements**In December 2004 the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 151, “Inventory Costs” (“Statement 151”). Statement 151 requiresabnormal amounts of inventory costs related to idle facility, freight handling and wasted materialexpenses to be recognized as current period charges. Additionally, Statement 151 requires that theallocation of fixed production overheads to the costs of conversion be based on the normal capacityof the production facilities. The standard is effective for fiscal years beginning after June 15,2005 and Digene adopted the standard effective July 1, 2005. The adoption of Statement 151 has nothad a material impact on the Company’s consolidated financial statements.**3. Public Offering of Common Stock**On November 15, 2005, the Company and Armonk Partners (the “Selling Stockholder”), the Company’sprincipal stockholder, entered into an Underwriting Agreement, with J.P. Morgan Securities Inc. asrepresentative of several underwriters, (the “Underwriting Agreement”) to offer for sale up to2,000,000 shares of Common Stock by the Company and up to 1,000,000 shares of Common Stock byArmonk Partners. The Underwriting Agreement contained an option granted to the underwriters tooffer for sale up to an additional 450,000 shares of Common Stock (300,000 shares by the Companyand 150,000 shares by Armonk Partners) to cover over-allotments, if any. The public offering,pursuant to the Company’s effective shelf registration statement, closed on November 18, 2005 withthe sale of all initially offered shares of Common Stock. On December 14, 2005, the sale of theshares subject to the over-allotment option was closed following the exercise in full by theunderwriters of the over-allotment option. The Company’s net proceeds from the public offering,after deal expenses of approximately $457,000 and underwriters’ commissions, were approximately$60,079,000.
6

Table of Contents
**4. Other Balance Sheet Information****Inventories**Inventories are stated at the lower of cost or market. Inventories consist of the following(in thousands):           **March 31,**  **June 30,**   **2006**  **2005**   (unaudited)     Finished goods $3,859  $4,642 Work in process  3,592   3,343 Raw materials  1,238   1,187           8,689   9,172 Inventory reserve  (2,309)  (1,975)         $6,380  $7,197        **Lease Commitments**The Company leases a facility in Gaithersburg, Maryland, comprising a total of 111,000 squarefeet for its corporate headquarters and manufacturing operations pursuant to a Lease Agreementdated March 2, 1998 between Digene and ARE-Metropolitan Grove I, LLC, as landlord (the “Landlord”),as amended (the “Lease”). On November 15, 2005, the Company executed the Fourth Amendment to theLease (the “Amendment”). The Amendment provides for the Company to expand the rented premises to143,585 rentable square feet. The additional space will be used for manufacturing and research anddevelopment. Under the Amendment, both the Company and the Landlord are contributing financing tofund the expansion construction and outfitting. Construction is expected to be substantiallycomplete by September 2006. In addition, the initial term of the Lease has been extended ten yearsbeyond the earlier of substantial completion of the expansion work or September 2006.The Company has historically accounted for the Lease as an operating lease. Under the Amendment,the Company is responsible for a portion of the construction costs and is deemed to be the owner ofthe Gaithersburg facility for accounting purposes during the construction period under EmergingIssues Task Force (“EITF”) 97-10, “The Effect of Lessee Involvement in Asset Construction.” Duringthe quarter ended December 31, 2005, upon execution of the Amendment, the Company capitalized $21.4million to record the estimated fair value of the current building facility on its books with arelated lease obligation of approximately $19.7 million. In accordance with accounting guidance,the portion of the Lease related to ground rent will continue to be treated as an operating lease.Amounts paid by the Company for the construction have been recorded as construction in progress.Upon completion of construction, the Lease will not qualify for sale-leaseback treatment inaccordance with SFAS No. 98, “Accounting for Leases.” Accordingly, the Company will continue torecord the existing facility and expanded area as a capital asset. In addition, amounts paid forthe expansion by the Landlord will increase the lease obligation as the project is funded. Thischange in accounting treatment has no impact on the Company’s cash flow or total expense over theLease term; however, it results in the acceleration of expense from the latter years of the Leaseto the earlier years of the Lease. The impact of this acceleration on fiscal 2006 pre-tax earningsis approximately $700,000.
7

Table of Contents
**5. Income Taxes**The Company accounts for income taxes during interim periods in accordance with SFAS No. 109,“Accounting for Income Taxes,” Accounting Principles Board (“APB”) Opinion No. 28, “InterimFinancial Reporting,” and FASB Interpretation No. 18, “Accounting for Income Taxes in InterimPeriods,” an interpretation of APB Opinion No. 28. For interim reporting purposes, these rulesrequire that a company determine the best estimate of its annual effective tax rate and then applythat rate in providing for income taxes on a year-to-date basis. The Company’s provision forincome taxes recorded for the nine months ended March 31, 2006 and the benefit for income taxesrecorded for the nine months ended March 31, 2005 are based on an estimated annual effective taxrate. Items that caused recorded income to differ from taxes computed using the statutory federalincome tax rate include state income taxes, foreign losses not benefited, certain non-deductibleexpenses, and research and development tax credits.The Company expects to maintain a valuation allowance for the portion of deferred tax assets itbelieves is uncertain to be realized. This consists primarily of deferred tax assets relating toU.S. net operating losses generated from the exercise of stock options, research and developmentcredits expected to expire unused, and foreign deferred tax assets, including net operating losscarryforwards. The realization of these deferred tax assets is contingent upon the generation offuture taxable income.**6. Stockholders’ Equity****Common Stock and Per Share Calculation**For the three-month periods ended March 31, 2006 and 2005, in conjunction with stock optionexercises, the Company issued 642,396 and 60,299 shares of common stock, and 786,466 and 139,262shares of common stock for the nine-month periods ended March 31, 2006 and 2005, respectively. TheCompany received cash proceeds from the exercise of stock options of approximately $13,569,000 and$476,000 for the three-month periods ended March 31, 2006 and 2005, respectively and $15,466,000and $1,375,000 for the nine-month periods ended March 31, 2006 and 2005, respectively.The following table presents the calculation of basic and diluted net income (loss) per share:                   **Three Months Ended** **Nine Months Ended**  **March 31,** **March 31,**(in thousands, except per share data) **2006** **2005** **2006** **2005**   Numerator:                Net income (loss) $1,105  $1,565  $5,429  $(4,404)Denominator:                Weighted average shares outstanding — basic  22,737   20,000   21,297   19,943 Dilutive securities — stock options  643   641   445   —    Weighted average shares outstanding — diluted  23,380   20,641   21,742   19,943                  Basic net income (loss) per share $0.05  $0.08  $0.25  $(0.22)Diluted net income (loss) per share $0.05  $0.08  $0.25  $(0.22)
8

Table of Contents
For the three-month periods ended March 31, 2006 and 2005, respectively, outstanding stockoptions to purchase approximately 137,000 and 2,436,000 shares of common stock were not included inthe computation of diluted net income per share because their effect would have been antidilutivesince the exercise prices of such stock options were greater than the average share price of theCompany’s stock for the applicable period. For the nine-month period ended March 31, 2006,outstanding stock options to purchase approximately 2,009,000 shares of common stock were notincluded in the computation of diluted net income per share because their effect would have beenantidilutive. None of the stock options outstanding in the nine-month period ended March 31, 2005were included in the computation of diluted net loss per share because the effect on net loss wouldhave been antidilutive.**Stock-Based Compensation**Prior to July 1, 2005, the Company accounted for its stock-based compensation plans under therecognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“Opinion 25”), and related Interpretations, as permitted by FASBStatement No. 123, “Accounting for Stock-Based Compensation” (“Statement 123”). Effective July 1,2005, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R),“Share-Based Payment” (“Statement 123(R)”), using the modified-prospective-transition method.Under the modified-prospective-transition method, compensation cost recognized in fiscal 2006includes: (a) compensation cost for all share-based payments granted prior to but not yet vested asof July 1, 2005, based on the grant date fair value estimated in accordance with the originalprovisions of Statement 123, and (b) compensation cost for all share-based payments grantedsubsequent to July 1, 2005, based on the grant-date fair value estimated in accordance with theprovisions of Statement 123(R). Results for prior periods have not been restated. As a result ofadopting Statement 123(R) on July 1, 2005, the Company’s income before income taxes and net incomefor the three- and nine-month periods ended March 31, 2006, is approximately $1,411,000 and$4,193,000 lower, respectively, than if it had continued to account for share-based compensationunder Opinion 25. Both basic and diluted earnings per share for the three-month period ended March31, 2006 would have been $0.07, if the Company had not adopted Statement 123(R), compared toreported basic and diluted earnings per share of $0.05. Basic and diluted earnings per share forthe nine-month period ended March 31, 2006 would have been $0.34 and $0.33, respectively, if theCompany had not adopted Statement 123(R), compared to reported basic and diluted earnings per shareof $0.25 and $0.25, respectively.The total intrinsic value of the stock options exercised during the three- and nine-month periodsended March 31, 2006 was approximately $11,817,000 and $14,131,000, respectively. Theweighted-average grant-date fair value of equity awards granted during the three- and nine-monthperiods ended March 31, 2006 was $14.90 and $13.23, respectively. The total fair value of equityawards which vested during the three- and nine-month periods ended March 31, 2006 was approximately$853,000 and $5,412,000, respectively. There were 2,931,657 equity awards outstanding at March 31,2006. These equity awards had a weighted-average exercise price of $25.80, an intrinsic value ofapproximately $39,179,000 and a weighted-average life of 6.7 years. There were 2,249,717 fullyvested equity awards exercisable at March 31, 2006. These equity awards had a weighted-averageexercise price of $27.19, an intrinsic value of approximately $26,800,000 and a weighted-averagelife of 6.3 years.
9

Table of Contents
The following table illustrates the effect on net income (loss) and net income (loss) per share ifthe Company had applied the fair value recognition provisions of Statement 123 to stock-basedemployee compensation for the three- and nine-month period ended March 31, 2005. The reported andpro forma net income and net income per share for the three- and nine-month periods ended March 31,2006 are the same because stock-based compensation expense is calculated under the provisions ofStatement 123(R). The amounts for the three- and nine-month periods ended March 31, 2006 areincluded in the table below only to provide net loss and net loss per share for a comparativepresentation to the similar periods of the previous fiscal year.                   **Three Months Ended** **Nine Months Ended**  **March 31,** **March 31,**(in thousands, except per share data) **2006** **2005** **2006** **2005**   Net income (loss), as reported $1,105  $1,565  $5,429  $(4,404)Add: Stock-based non-employeecompensation (income) expenseincluded in reportednet income (loss), net of taxes  —   —   —   (55)Deduct: Stock-based employeecompensation expense as if SFAS No.123