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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 December 31, 2003OR[ ]
    
    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

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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
    
    February 6, 2004Common Stock, par value $.01 per share
    
    19,456,152




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DIGENE CORPORATION

INDEX TO FORM 10-Q

PagePart I.    Consolidated Financial Information:Item 1.    Consolidated Financial StatementsConsolidated Balance Sheets-
      December 31, 2003 and June 30, 2003
    
    
    3Consolidated Statements of Operations-
      Three and six months ended December 31, 2003 and 2002
    
    
    4Consolidated Statements of Cash Flows-
      Six months ended December 31, 2003 and 2002
    
    
    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
    
    
    15Item 4.    Controls and Procedures
    
    
    15Part II.    Other Information:Item 1.    Legal Proceedings
    
    
    16Item 5.    Other Information
    
    
    16Item 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

December 31, 2003
    
    June 30, 2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    14,857,447
    
    
    $
    7,883,129Short-term investments
    
    
    24,676,293
    
    
    
    26,408,994Accounts receivable, less allowance of approximately $494,000 and

$432,000 at December 31, 2003 and June 30, 2003, respectively
    
    
    13,144,706
    
    
    
    10,344,597Inventories
    
    
    7,132,104
    
    
    
    7,073,920Prepaid expenses and other current assets
    
    
    2,099,934
    
    
    
    2,189,225Total current assets
    
    
    61,910,484
    
    
    
    53,899,865Property and equipment, net
    
    
    8,699,706
    
    
    
    7,515,104Intangible assets, net
    
    
    900,515
    
    
    
    900,515Deposits and other assets
    
    
    1,234,101
    
    
    
    1,059,666Total assets
    
    $
    72,744,806
    
    
    $
    63,375,150LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    4,664,106
    
    
    $
    7,489,700Accrued expenses
    
    
    3,541,941
    
    
    
    3,467,629Accrued payroll
    
    
    3,197,639
    
    
    
    4,182,327Current portion of long-term debt
    
    
    2,675,965
    
    
    
    2,640,363Total current liabilities
    
    
    14,079,651
    
    
    
    17,780,019Deferred rent
    
    
    466,524
    
    
    
    434,908Long-term debt, less current portion
    
    
    1,421,688
    
    
    
    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, 19,155,822
and 18,325,208 shares issued and outstanding at December 31, 2003
and June 30, 2003, respectively
    
    
    191,558
    
    
    
    183,252Additional paid-in capital
    
    
    129,955,584
    
    
    
    118,535,272Deferred stock compensation
    
    
    (396,729
    )
    
    
    (380,633
    )Accumulated other comprehensive income
    
    
    1,111,091
    
    
    
    356,415Accumulated deficit
    
    
    (74,084,561
    )
    
    
    (75,688,327
    )Total stockholders equity
    
    
    56,776,943
    
    
    
    43,005,979Total liabilities and stockholders equity
    
    $
    72,744,806
    
    
    $
    63,375,150


See accompanying notes.

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DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended
    
    Six Months EndedDecember 31,
    
    December 31,2003
    
    2002
    
    2003
    
    2002(Unaudited)
    
    (Unaudited)Revenues:Product sales
    
    $
    20,751,865
    
    
    $
    14,207,489
    
    
    $
    40,243,907
    
    
    $
    26,604,293Other
    
    
    362,348
    
    
    
    242,079
    
    
    
    488,137
    
    
    
    461,762Total revenues
    
    
    21,114,213
    
    
    
    14,449,568
    
    
    
    40,732,044
    
    
    
    27,066,055Costs and expenses:Cost of product sales
    
    
    3,722,174
    
    
    
    3,012,051
    
    
    
    7,108,104
    
    
    
    6,187,390Research and development
    
    
    2,773,711
    
    
    
    2,125,890
    
    
    
    5,628,297
    
    
    
    4,166,281Selling and marketing
    
    
    9,220,803
    
    
    
    6,683,861
    
    
    
    17,633,311
    
    
    
    12,719,654General and administrative
    
    
    4,600,148
    
    
    
    4,180,461
    
    
    
    8,768,860
    
    
    
    8,265,447Income (loss) from operations
    
    
    797,377
    
    
    
    (1,552,695
    )
    
    
    1,593,472
    
    
    
    (4,272,717
    )Other income (expense):Interest income
    
    
    100,118
    
    
    
    163,058
    
    
    
    189,941
    
    
    
    342,435Interest expense
    
    
    (58,160
    )
    
    
    (62,616
    )
    
    
    (118,681
    )
    
    
    (129,592
    )Other income
    
    
    228,332
    
    
    
    55,245
    
    
    
    210,520
    
    
    
    110,978Income (loss) before income taxes
    
    
    1,067,667
    
    
    
    (1,397,008
    )
    
    
    1,875,252
    
    
    
    (3,948,896
    )Provision for (benefit from) income taxes
    
    
    119,303
    
    
    
    (57,042
    )
    
    
    271,486
    
    
    
    15,112Net income (loss)
    
    $
    948,364
    
    
    $
    (1,339,966
    )
    
    $
    1,603,766
    
    
    $
    (3,964,008
    )Basic net income (loss) per share
    
    $
    0.05
    
    
    $
    (0.07
    )
    
    $
    0.09
    
    
    $
    (0.22
    )Diluted net income (loss) per share
    
    $
    0.05
    
    
    $
    (0.07
    )
    
    $
    0.08
    
    
    $
    (0.22
    )Weighted average shares outstandingBasic
    
    
    18,837,147
    
    
    
    18,115,585
    
    
    
    18,642,698
    
    
    
    18,115,585Diluted
    
    
    20,810,550
    
    
    
    18,115,585
    
    
    
    20,591,249
    
    
    
    18,115,585


See accompanying notes.

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DIGENE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months EndedDecember 31,2003
    
    2002(Unaudited)Operating activitiesNet income (loss)
    
    $
    1,603,766
    
    
    $
    (3,964,008
    )Adjustments to reconcile net income (loss) to net cash
used in operating activities:Depreciation and amortization of property and equipment
    
    
    1,829,518
    
    
    
    1,480,609Compensation expense related to stock options
    
    
    298,435
    
    
    
    16,069Changes in operating assets and liabilities:Accounts receivable
    
    
    (2,800,109
    )
    
    
    1,181,284Inventories
    
    
    (58,184
    )
    
    
    226,725Prepaid expenses and other current assets
    
    
    89,291
    
    
    
    (233,584
    )Deferred costs
    
    
    
    
    
    
    176,566Deposits and other assets
    
    
    (174,435
    )
    
    
    (1,547
    )Accounts payable
    
    
    (2,825,594
    )
    
    
    (1,500,359
    )Accrued expenses
    
    
    74,312
    
    
    
    (2,548,440
    )Accrued payroll
    
    
    (984,688
    )
    
    
    (174,757
    )Deferred revenues
    
    
    
    
    
    
    (287,545
    )Deferred rent
    
    
    31,616
    
    
    
    50,215Net cash used in operating activities
    
    
    (2,916,072
    )
    
    
    (5,578,772
    )Investing activitiesPurchases of short-term investments
    
    
    (14,165,607
    )
    
    
    (1,022,450
    )Sales of short-term investments
    
    
    15,898,308
    
    
    
    7,115,355Capital expenditures
    
    
    (3,014,120
    )
    
    
    (1,284,985
    )Net cash provided by (used in) investing activities
    
    
    (1,281,419
    )
    
    
    4,807,920Financing activitiesExercise of common stock options
    
    
    11,114,087
    
    
    
    Principal payments of long-term debt
    
    
    (696,954
    )
    
    
    (737,475
    )Net cash provided by (used in) financing activities
    
    
    10,417,133
    
    
    
    (737,475
    )Effect of currency translations
    
    
    754,676
    
    
    
    Net increase (decrease) in cash and cash equivalents
    
    
    6,974,318
    
    
    
    (1,508,327
    )Cash and cash equivalents at beginning of period
    
    
    7,883,129
    
    
    
    9,453,125Cash and cash equivalents at end of period
    
    $
    14,857,447
    
    
    $
    7,944,798


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 six-month periods ended December 31, 2003 and 2002
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:

December 31,
    
    June 30,2003
    
    2003(unaudited)Finished goods
    
    $
    4,152,032
    
    
    $
    5,132,328Work in process
    
    
    4,096,960
    
    
    
    2,897,539Raw materials
    
    
    1,387,396
    
    
    
    1,461,3479,636,388
    
    
    
    9,491,214Reserve
    
    
    (2,504,284
    )
    
    
    (2,417,294
    )$
    7,132,104
    
    
    $
    7,073,920


3.   Common Stock and Per Share Calculation

For the three- and six-month periods ended December 31, 2003, in conjunction
with stock option exercises, the Company issued 444,410 and 830,614 shares of
common stock, respectively. The Company received cash proceeds from the
exercise of these stock options of approximately $5,060,000 and $11,114,000 for
the three- and six-month periods ended December 31, 2003, respectively.

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The following table presents the calculation of basic and diluted net income
(loss) per share:

Three Months Ended
    
    Six Months EndedDecember 31,
    
    December 31,2003
    
    2002
    
    2003
    
    2002Numerator:Net income (loss)
    
    $
    948,364
    
    
    $
    (1,339,966
    )
    
    $
    1,603,766
    
    
    $
    (3,964,008
    )Denominator:Weighted average shares outstanding  basic
    
    
    18,837,147
    
    
    
    18,115,585
    
    
    
    18,642,698
    
    
    
    18,115,585Dilutive securities  employee stock options
    
    
    1,973,403
    
    
    
    
    
    
    
    1,948,551
    
    
    
    Weighted average shares outstanding  diluted
    
    
    20,810,550
    
    
    
    18,115,585
    
    
    
    20,591,249
    
    
    
    18,115,585Basic net income (loss) per share
    
    $
    0.05
    
    
    $
    (0.07
    )
    
    $
    0.09
    
    
    $
    (0.22
    )Diluted net income (loss) per share
    
    $
    0.05
    
    
    $
    (0.07
    )
    
    $
    0.08
    
    
    $
    (0.22
    )


For the three- and six-month periods ended December 31, 2003, stock options to
purchase approximately 62,000 and 170,000 shares of common stock were
outstanding, but were not included in the computation of diluted net income per
share because the exercise price of the stock options was greater than the
average share price of the Companys stock for the applicable period since the
effect would have been antidilutive. None of the stock options outstanding in
the three- and six-month periods ended December 31, 2002 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:

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Three Months Ended December 31,
    
    Six Months Ended December 31,2003
    
    2002
    
    2003
    
    2002Net income (loss), as reported
    
    $
    948,364
    
    
    $
    (1,339,966
    )
    
    $
    1,603,766
    
    
    $
    (3,964,008
    )Add: Stock-based compensation
included in reported net income (loss)
    
    
    73,368
    
    
    
    8,035
    
    
    
    298,435
    
    
    
    16,069Deduct: Stock-based compensation
expense if SFAS No. 123 had been
applied to all grants
    
    
    (4,955,343
    )
    
    
    (4,050,800
    )
    
    
    (8,651,497
    )
    
    
    (7,490,688
    )Pro forma net loss
    
    $
    (3,933,611
    )
    
    $
    (5,382,731
    )
    
    $
    (6,749,296
    )
    
    $
    (11,438,627
    )Net income (loss) per share:Basic  as reported
    
    $
    0.05
    
    
    $
    (0.07
    )
    
    $
    0.09
    
    
    $
    (0.22
    )Basic  pro forma
    
    $
    (0.21
    )
    
    $
    (0.30
    )
    
    $
    (0.36
    )
    
    $
    (0.63
    )Diluted  as reported
    
    $
    0.05
    
    
    $
    (0.07
    )
    
    $
    0.08
    
    
    $
    (0.22
    )Diluted  pro forma
    
    $
    (0.21
    )
    
    $
    (0.30
    )
    
    $
    (0.36
    )
    
    $
    (0.63
    )


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

Items which caused recorded income taxes attributable to continuing operations
to differ from taxes computed using the statutory federal income tax rate
include state income taxes, foreign taxes, stock options, foreign income or
loss, valuation allowances and other miscellaneous items.

6.   Comprehensive Income

Comprehensive income for the quarter- and year-to-date ended December 31, 2003
and 2002 was as follows:

Three Months Ended December 31,
    
    Six Months Ended December 31,2003
    
    2002
    
    2003
    
    2002Net income (loss), as reported
    
    $
    948,364
    
    
    $
    (1,339,966
    )
    
    $
    1,603,766
    
    
    $
    (3,964,008
    )Other comprehensive income:Foreign currency translation
    
    
    688,665
    
    
    
    
    
    
    
    754,676
    
    
    
    Comprehensive income (loss)
    
    $
    1,637,029
    
    
    $
    (1,339,966
    )
    
    $
    2,358,442
    
    
    $
    (3,964,008
    )


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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
    
    
    42,837Settlements made during the period
    
    
    Changes in liability for pre-existing warranties during the
period, including expirations
    
    
    (16,404
    )Balance, December 31, 2003
    
    $
    84,453


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 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 March
22, 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 us to significant
liabilities or require us to obtain royalty-bearing licenses, cease
sales of related products or revise the applications or products
which employ the technology.  We cannot provide assurances that any
such licenses would be made available to us on commercially reasonable
terms, if at all.

See Legal Proceedings in Part II of this Form 10-Q for additional discussion of
this matter.

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 ability to scale up our
manufacturing to the extent product sales increase; dependence on third-party
reimbursement from 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 propriety rights in
connection with our products and products in development; uncertainty as to
ongoing litigation; our limited sales and marketing experience; the extent of
future expenditures for sales and marketing programs; uncertainty of clinical
trial results for our products in development; delay in or failure to obtain
regulatory approvals 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 six months ended
December 31, 2003, accounted for 83% 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 and testing
services 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 expect to invest heavily in our European distribution operation during
fiscal 2004 and beyond while also expanding our direct sales organization in
the United States. We expect to moderately

10



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##### 



increase our expenditures in the
development of our next-generation Hybrid Capture platforms and clinical trial
activities for human papillomavirus screening in fiscal 2004 and beyond as
compared to fiscal 2003.

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 increase to provide
adequate infrastructure to support greater sales and marketing activities and
more focused research and development activities, to pay the anticipated
expenses 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 or improve 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 46% to approximately $20,752,000 for the three-month
period ended December 31, 2003 from approximately $14,207,000 for the
corresponding period in 2002. The increase was due primarily to a 47% growth
in sales of our HPV Tests and testing services 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 as compared to sales of such
products in the corresponding period in fiscal 2003, increasing by
approximately $3,523,000 (37%) and $1,767,000 (132%), respectively. 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 expired in accordance with its terms.

Product sales increased 51% to approximately $40,244,000 for the six-month
period ended December 31, 2003 from approximately $26,604,000 for the
corresponding period in fiscal 2003. The increase was due primarily to a 56%
growth in sales of our HPV Tests and testing services 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, increasing by approximately
$8,518,000 (48%) and $3,201,000 (136%), respectively, as compared to sales of
such products in the corresponding period in fiscal 2003.

Other revenues include research and development contract revenues, equipment
rental revenues and licensing revenues. Other revenues increased 50% to
approximately $362,000 for the three-month period ended December 31, 2003 from
approximately $242,000 for the corresponding period in fiscal 2003 primarily
due to increases in research and development contract revenue. Other revenues
increased 6% to approximately $488,000 for the six-month period ended December
31, 2003 from approximately $462,000 for the corresponding period in fiscal
2003.

Cost of product sales increased by 24% to approximately $3,722,000 for the
three-month period ended December 31, 2003 from approximately $3,012,000 for
the corresponding period in 2002 and increased 15% to approximately $7,108,000
for the six-month period ended December 31, 2003 from approximately $6,187,000
for the corresponding period in fiscal 2003. Gross margin on product sales
increased to 82% for the three-month period ended December 31, 2003 from 79%
for the corresponding period in fiscal 2003 and

11



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##### 



increased to 82% for the
six-month period ended December 31, 2003 from 77% for the corresponding period
in fiscal 2003. The increase in gross margin percentage was due primarily to
increased sales of our test kits, particularly HPV Tests, principally in the
United States and Europe.

Research and development expenses increased 30% to approximately $2,774,000 for
the three-month period ended December 31, 2003 from approximately $2,126,000
for the corresponding period in fiscal 2003 and increased 35% to approximately
$5,628,000 for the six-month period ended December 31, 2003 from approximately
$4,166,000 for the corresponding period in fiscal 2003. For the three-month
period ended December 31, 2003, the majority of the increase was due to a 184%
increase in professional services expenses to $661,000, primarily related to
costs incurred in preparation for compliance with the European Union In Vitro
Diagnostic Directive (or IVDD) regulations, which was successfully
accomplished for our HPV, chlamydia and gonorrhea test kits in the second
quarter of fiscal 2004, and a 62% increase in lab supplies to approximately
$300,000. For the six-month period ended December 31, 2003, the majority of
the increase was due to a 238% increase in professional services expenses to
$1,415,000, primarily related to the IVDD preparation, a 6% increase in
personnel costs to approximately $2,304,000, and a 25% increase in lab supplies
to approximately $547,000. 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.

Our research and development activities focus on our platform technology,
including adaptations of such technology, and improvements to our diagnostic
test and equipment products. During the six-month period ended December 31,
2003, we focused our research and development activities in four areas: (1)
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; (2) support and improvement of existing product lines;
(3) new product development activities; and (4) core research efforts for
next-generation technologies.

With respect to regulatory submissions and existing product line activities we:



| |  | completed the clinical validation of a procedural modification to
our Hybrid Capture 2 assay, designed to improve test robustness, and
submitted a Pre-Market Approval Supplement to the U.S. Food and Drug Administration
(FDA) in September 2003, which was approved on November 7, 2003;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | concluded the clinical validation of our Rapid
CaptureTM System
(RCS) for automated processing of Hybrid Capture HPV Tests and
submitted a Pre-Market Approval Supplement to the FDA on November 5, 2003; if
approved by the FDA, the RCS system will complement our HPV Test and
facilitate high-throughput HPV testing; and
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | completed the clinical validation of the performance of chlamydia
(CT)/gonorrhea (GC) testing using our Hybrid Capture products from
Cytyc Corporations ThinPrep® specimens. A 510(k) application related
to chlamydia testing using ThinPrep specimens was submitted to the FDA
on November 26, 2003 and the 510(k) applications relating to gonorrhea
and chlamydia/gonorrhea combination testing using ThinPrep specimens
were submitted to the FDA in January 2004.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

12



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material from a single patient sample, and the SurePathTM (TriPath Imaging)
medium, for which the clinical validation is ongoing.

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.

Selling and marketing expenses increased 38% to approximately $9,221,000 for
the three-month period ended December 31, 2003 from approximately $6,684,000
for the corresponding period in fiscal 2003 and increased 39% to approximately
$17,633,000 for the six-month period ended December 31, 2003 from approximately
$12,720,000 for the corresponding period in fiscal 2003. For the three-month
period ended December 31, 2003, the increase was due to personnel costs, which
increased 36% to approximately $3,025,000; agency fees, which increased 111% to
approximately $1,521,000; and various marketing programs, which increased 26%
to approximately $1,757,000. The increase in agency fees relates to our
agreement with PDI, Inc. (PDI). PDI recruited and administers a
Digene-specific physician detailing sales organization dedicated to educating
physicians about the benefits of the DNAwithPap Test in the U.S. The increase
for the six-month period ended December 31, 2003 was due primarily to personnel
costs, which increased 38% to approximately $5,769,000; agency fees, which
increased 102% to approximately $2,596,000; various marketing programs, which
increased 16% to approximately $3,357,000; and professional fees, which
increased 71% to approximately $1,384,000, and includes approximately $298,000
of stock option compensation expense.

General and administrative expenses increased 10% to approximately $4,600,000
for the three-month period ended December 31, 2003 from approximately
$4,180,000 for the corresponding period in fiscal 2003 and increased 6% to
approximately $8,769,000 for the six-month period ended December 31, 2003 from
approximately $8,265,000 for the corresponding period in fiscal 2003. The
increase for the three-month period ended December 31, 2003 was primarily
attributed to an increase in insurance costs, which increased 53% to
approximately $325,000, and professional fees, which increased 5% to $1,789,000
as compared to $1,697,000 for the same period in fiscal 2003. The increase for
the six-month period ended December 31, 2003 was primarily attributed to an
increase in personnel costs, which increased 16% to approximately $3,514,000,
and insurance, which increased 50% to approximately $657,000. The increase was
partially offset by a 15% decrease in professional services to approximately
$3,349,000, largely related to a decrease in legal fees associated with our
litigation with Ventana Medical Systems, Inc. and with Enzo Biochem, Inc. and
its subsidiary, Enzo Diagnostics, Inc. Professional fees associated with
litigation are expected to increase during the second half of fiscal 2004.

Interest income decreased 39% to approximately $100,000 for the three-month
period ended December 31, 2003 from approximately $163,000 for the
corresponding period in fiscal 2003 and decreased 45% to approximately $190,000
for the six-month period ended December 31, 2003 from $342,000 for the
corresponding period in fiscal 2003. The decrease was primarily due to lower
interest rates in fiscal 2004 compared to the corresponding period in fiscal
2003, partially offset by an increase in average cash balances in the fiscal
2004 period.

Other income (expense) consists primarily of foreign exchange gains and losses.
For the three- and six-month periods ended December 31, 2003, Other income was
approximately $228,000 and $211,000, respectively, compared to Other income of
approximately $55,000 and $111,000, respectively, for the corresponding periods
in fiscal 2003.

13



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Liquidity and Capital Resources

Since inception, our expenses have significantly exceeded our revenues,
resulting in an accumulated deficit of approximately $74,085,000 at December
31, 2003. We have funded our operations primarily through the sale of equity
securities and revenues from product sales and research and development
contracts. At December 31, 2003, we had cash, cash equivalents and short-term
investments aggregating approximately $39,534,000. We had negative cash flows
from operations of approximately $2,916,000 for the six-months ended December
31, 2003 compared to negative cash flows from operations of approximately
$5,579,000 for the comparable period in fiscal 2003. The decrease in cash used
in operations was due primarily to net income in the current fiscal year of
approximately $1,604,000 compared to a net loss of approximately $3,964,000 for
the corresponding period in fiscal 2003, partially offset by an increase of
approximately $3,981,000 in the cash used for net accounts receivable due to
increased sales in fiscal 2004, compared to a decrease in net accounts
receivable in fiscal 2003 as a result of strong collection efforts in the
corresponding period in fiscal 2003.

We anticipate that working capital requirements will increase moderately for
the foreseeable future due to the investment necessary to support our European
direct distribution operations, as well as increasing accounts receivable as a
result of expected revenue growth. 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, product candidates, products or potential markets. Under such
conditions, our business, financial condition and results of operations will be
materially adversely affected.

14



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We have summarized below our material contractual obligations as of December
31, 2003 (in thousands):

Contractual Obligations
    
    
    
    
    
    Less Than
    
    One to
    
    Four to
    
    After FiveTotal
    
    One Year
    
    Three Years
    
    Five Years
    
    YearsLong-term debt (1)
    
    $
    4,097,653
    
    
    $
    2,675,965
    
    
    $
    981,461
    
    
    $
    440,227
    
    
    $
    Physician detailing
agreement
    
    
    2,866,859
    
    
    
    2,866,859
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    
    18,745,955
    
    
    
    3,140,280
    
    
    
    9,253,070
    
    
    
    6,140,016
    
    
    
    212,589Total contractual cash
obligations
    
    $
    25,710,467
    
    
    $
    8,683,104
    
    
    $
    10,234,531
    
    
    $
    6,580,243
    
    
    $
    212,589




|(1) |  | Includes debt payable to Roche Molecular Systems and Abbott Laboratories
related to the repurchase of equipment in prior periods.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------

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 December 31,
2003, 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 six-month periods ended December 31, 2003 and 2002,
respectively. Interest rate exposure is primarily limited to the approximately
$39,534,000 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 December 31, 2003, 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.

15



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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
on March 22, 2004.

Item 5.   Other Information

On December 9, 2003, Kenneth R. Weisshaar was elected by the directors to serve
on our Board of Directors. Mr. Weisshaar joins the Board in the class of
directors whose terms will expire at the 2006 annual meeting of stockholders.
This election increases the size of our Board from six to seven.

Mr. Weisshaar was Chief Operating Officer and Strategy Advisor of Sensatex/Life
Link, Inc. from 2000 to 2003. Prior to joining Sensatex, Mr. Weisshaar held a
number of senior positions at Becton, Dickinson & Company, including Chief
Financial Officer; President, Worldwide Consumer Health Care; Sector President,
Bioscience Cell Analysis; President BD Division; and Vice President Corporate
Planning and

16



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Development. Mr. Weisshaar received his M.B.A. from the Harvard
Business School in 1974, and he graduated from the Massachusetts Institute of
Technology in 1972.

On December 10, 2003, we executed an Amended and Restated Reseller Agreement
with the Applied Biosystems Group of Applera Corporation. This agreement
governs our purchase of Applied Biosystems CDP-Star® chemiluminescent
substrate from Applied Biosystems for use in connection with our marketed
Hybrid Capture products, including our HPV Tests. The amendment extends the
term of the agreement until at least June 30, 2015, subject to certain earlier
termination rights. Applied Biosystems has the right, effective after June 30,
2011, to terminate the agreement; subject to the grant of certain product
manufacturing rights to Digene.

At the request of Georgetown University, we are currently evaluating the
royalty payments made to Georgetown University under our license agreement
because of a disagreement over the calculation of such royalties. Our
discussions with Georgetown University are ongoing. Management currently believes we can resolve this matter
without a material adverse effect on our results of operation or financial condition, but we cannot provide
assurance 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)).10.1
    
    Amended and Restated
Reseller Agreement
dated December 10,
2003, between Digene
Corporation and
Applera Corporation,
acting through its
Applied Biosystems
Group.31.1
    
    Certification by Chief
Executive Officer
pursuant to Rule
13a-14(a) or Rule
15d-14(a) promulgated
under the Securities
Exchange Act of 1934,
as adopted pursuant to
Section 302 of the
Sarbanes-Oxley Act of
2002.31.2
    
    Certification by Chief
Financial Officer
pursuant to Rule
13a-14(a) or Rule
15d-14(a) promulgated
under the Securities
Exchange Act of 1934,
as adopted pursuant to
Section 302 of the
Sarbanes-Oxley Act of
2002.32.1
    
    Certification by Chief
Executive Officer
pursuant to Rule
13a-14(b) or Rule
15d-14(b) promulgated
under the Securities
Exchange Act of 1934
and Section 906 of the
Sarbanes-Oxley Act of
2002, 18 U.S.C.
Section 1350.32.2
    
    Certification by Chief
Financial Officer
pursuant to Rule
13a-14(b) or Rule
15d-14(b) promulgated
under the Securities
Exchange Act of 1934
and Section 906 of the
Sarbanes-Oxley Act of
2002, 18 U.S.C.
Section 1350.


(b)    Reports on Form 8-K:

Digene did not file any Current Reports on Form 8-K with the Commission during
the quarter ended December 31, 2003.

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:
    
    February 13, 2004
    
    By:
    
    /s/ Charles M. FleischmanCharles M. Fleischman
President, Chief Operating Officer and
Chief Financial Officer
(Principal Financial Officer)Date:
    
    February 13, 2004
    
    By:
    
    /s/ Joseph P. SlatteryJoseph P. Slattery
Senior Vice President, Finance and
Information 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)).10.1
    
    Amended and Restated
Reseller Agreement,
dated December 10,
2003, between Digene
Corporation and
Applera Corporation,
acting through its
Applied Biosystems
Group.31.1
    
    Certification by Chief
Executive Officer
pursuant to Rule
13a-14(a) or Rule
15d-14(a) promulgated
under the Securities
Exchange Act of 1934,
as adopted pursuant to
Section 302 of the
Sarbanes-Oxley Act of
2002.31.2
    
    Certification by Chief
Financial Officer
pursuant to Rule
13a-14(a) or Rule
15d-14(a) promulgated
under the Securities
Exchange Act of 1934,
as adopted pursuant to
Section 302 of the
Sarbanes-Oxley Act of
2002.32.1
    
    Certification by Chief
Executive Officer
pursuant to Rule
13a-14(b) or Rule
15d-14(b) promulgated
under the Securities
Exchange Act of 1934
and Section 906 of the
Sarbanes-Oxley Act of
2002, 18 U.S.C.
Section 1350.32.2
    
    Certification by Chief
Financial Officer
pursuant to Rule
13a-14(b) or Rule
15d-14(b) promulgated
under the Securities
Exchange Act of 1934
and Section 906 of the
Sarbanes-Oxley Act of
2002, 18 U.S.C.
Section 1350.