SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended April 3, 2004
or

For the transition period from       to

Commission file number: 0-27892

SIPEX Corporation

(408) 934-7500
Registrant’s telephone number, including area code

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 o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No o

There were 33,071,737 shares of the Registrant’s Common Stock issued and outstanding as of May 7, 2004.

FORM 10-Q
THREE MONTHS ENDED APRIL 3, 2004

INDEX

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Part I: FINANCIAL INFORMATION

Item 1: Financial Statements

SIPEX CORPORATION

See accompanying notes to consolidated financial statements

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SIPEX CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements

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SIPEX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated financial statements

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SIPEX CORPORATION

Note 1 — Description of Business and Basis of Presentation

     Description of Business

     Sipex Corporation (“Sipex” or the “Company”) is a semiconductor company that designs, manufactures and markets high performance, value-added analog integrated circuits (“ICs”) that are used primarily by original equipment manufacturers (“OEMs”) operating in the historically high growth markets of computing, communications and networking infrastructure.

     While advances in digital technology have fueled the demand for digital integrated circuits, they have also created a rapidly growing demand for more precise, faster and more power efficient analog ICs. Sipex possesses a broad portfolio of analog ICs, organized into three product families: power management, serial interface and optical storage. Sipex uses its wafer fabrication facility in Milpitas, California and a number of third party vendors to fabricate, package and test its ICs. Sipex’s products are sold either directly to customers or through a global network of manufacturers’ representatives and distributors.

     Basis of Presentation

     The accompanying consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been omitted pursuant to such rules and regulations. In the opinion of management, the consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the Company’s financial position and the operating results and cash flows for the period presented. Actual results could differ materially from those estimates. Interim information is unaudited; however, in the opinion of the Company’s management, all adjustments of a normal recurring nature necessary for a fair statement of interim periods presented have been included. The results for interim periods are not necessarily indicative of results to be expected for the entire year.

     The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Sipex GmbH and Sipex Nippon. All significant intercompany accounts and transactions have been eliminated in consolidation.

     These consolidated financial statements and accompanying notes should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in its Annual Report on Form 10-K for fiscal year ended December 31, 2003, filed with the SEC. Certain prior period amounts have been reclassified to conform to the current period presentation.

     The balance sheet at December 31, 2003 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

     Effective January 1, 2004, the Company’s fiscal year has changed from calendar year end to 52 or 53 weeks which ends on the Saturday closest to December 31. As a result of the change in the fiscal reporting period, the first quarter of fiscal year 2004 covered 94 days from January 1, 2004 to April 3, 2004.

     Stock-Based Compensation

     The Company measures compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company applies the disclosure provisions of Statement of Financial Accounting

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Standards (SFAS) No. 123, “Accounting for Stock-based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-based Compensation — Transition and Disclosure” as if the fair value-based method had been applied in measuring compensation expense. Under APB Opinion No. 25, when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized. In certain situations, under these plans, options to purchase shares of common stock may be granted at less than fair market value, which results in compensation expense equal to the difference between the market value on the date of grant and the purchase price. This expense is recognized over the vesting period of the options and included in operations.

     As required under SFAS No. 123, the pro forma effects of stock-based compensation on net income and earnings per common share for employee stock options granted and employee stock purchase plan share purchases have been estimated at the date of grant and beginning of the period, respectively, using a Black-Scholes option pricing model. For purposes of pro forma disclosures, the estimated fair value of the options and shares is amortized to pro forma net income over the vesting period.

     The Company’s pro forma information for the three months ended April 3, 2004 and March 29, 2003 is as follows (in thousands, except per share data):

     For pro forma net loss computation, the fair value for each option grant was estimated at the date of grant using the Black-Scholes option-pricing model. The assumptions used to value the option grants are as follows:

     The weighted-average fair value of options granted for the three months ended April 3, 2004 and March 29, 2003 was $4.37 and $2.25, respectively.

     There were no purchases of common stock made under the Employee Stock Purchase Plan (ESPP) in the first quarter of 2004.

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Note 2 — Net Loss Per Share

     Basic net loss per share is based upon the weighted-average number of common shares outstanding. Diluted net loss per share is based upon the weighted average number of common and common equivalent shares outstanding assuming dilution. Common equivalent shares, consisting of outstanding stock options, convertible debt and warrants, are included in the per share calculations where the effect of their inclusion would be dilutive. As the Company had net losses for the three months ended April 3, 2004 and March 29, 2003, respectively, the weighted average number of common shares outstanding equals the weighted average number of common and common equivalent shares assuming dilution. In February 2004, the affiliates of Future Electronics, Inc. (“Future”) exercised their conversion rights to exchange both the First Note (see Note 4) and the Second Note (see Note 4) for an aggregate of 4.6 million of common shares of Sipex, bringing their ownership to approximately 40% of the Company’s outstanding common stock. The increase in the weighted average number of common shares outstanding from the conversion of the notes reduced the net loss per share for the current quarter by $0.01. The warrant to purchase 900,000 shares of Sipex’s common stock for $2.9458 per share held by an affiliate of Future has not been exercised as of April 3, 2004.

     Antidilutive potential common shares excluded from the dilution calculation represent 6,002,000 and 7,368,000 potential common shares for April 3, 2004 and March 29, 2003, respectively.

Note 3 — Effect of Recent Accounting Pronouncements

     In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This interpretation provides guidance on the identification of entities controlled through means other than voting rights. FIN 46 specifies how a business enterprise should evaluate its interests in a variable interest entity to determine whether to consolidate that entity. A variable interest entity must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among the parties involved. In December 2003, the FASB issued FIN 46R which defers the implementation date for the Company to the year ending December 31, 2004. As the Company does not have an interest in any variable interest entity, it does not expect the adoption to have a material impact on the Company’s financial position, results of operations or cash flows.

Note 4 — Related Party Transactions

     The Company has a distributor agreement with Future that provides for Future to act as the Company’s exclusive distributor within North America and Europe. During 2003, Future increased its ownership of the Company and became a related party. On September 27, 2002, Sipex sold a convertible secured note (the “First Note”) with an attached warrant to an affiliate of Future for an aggregate cash amount of $12.0 million. The Company recorded the First Note at $10.4 million and the warrant at $1.6 million (recorded to additional paid-in capital) based upon their estimated fair values at the date of issuance using the Black-Scholes option pricing model. The First Note paid a 5.75% coupon and was convertible after one year into Sipex common stock at a conversion price of $7.50 per share. Following the one year anniversary of the issuance of the First Note, the Company could require the conversion of the First Note in installments if for a period of time Sipex common stock traded at a price in excess of 150% of the conversion price of $7.50. The private placement also included a warrant to purchase 900,000 shares of Sipex common stock exercisable for a two-year period beginning on the one-year anniversary of the date of issuance. The exercise price for the warrant is $2.9458. The First Note was secured by a Deed of Trust on the Company’s land and building located at Milpitas, California.

     On June 20, 2003, Sipex sold a second convertible secured note (the “Second Note”) to an affiliate of Future for $10.3 million (net of issuance costs of $216,000). The Second Note paid a 1.5% coupon rate per annum. The principal amount of the Second Note was contingently convertible into a maximum of 3.0 million shares of Sipex common stock at a conversion price of $3.52 per share, subject to Future attaining predetermined annual and/or cumulative sales levels over a three-year period. In accordance with Emerging Issues Task Force (EITF) Issue No. 01-1, “Accounting for a Convertible Instrument Granted or Issued to a Nonemployee for Goods or Services or a Combination of Goods or Services and Cash,” the Company was required to recognize non-cash charges against net sales for the fair value of these conversion rights earned by Future each period relative to the sales target. The fair value of the conversion rights has been measured pursuant to FASB No. 123, “Accounting for Stock-Based Compensation” and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” The Second Note was secured by a Deed of Trust on the Company’s land and building located at Milpitas, California as well as all other assets of the Company, except for the Company’s intellectual property. In connection with the issuance of the Second Note, the Company

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entered into a standstill agreement with affiliates of Future, pursuant to which these security holders agreed not to acquire more than 35% of our stock on a fully diluted basis measured as defined in our agreement with the affiliates of Future. Also, Sipex entered into a voting agreement with an affiliate of Future, pursuant to which this security holder agreed that the additional shares of the Company’s common stock issuable upon conversion of the Second Note (i) will not be voted or (ii) will be voted in the same proportion as the votes cast by all other stockholders of Sipex.

     During the fourth quarter of 2003, Sipex entered into an agreement with the affiliates of Future to convert the First and Second Notes into common stock subject to obtaining regulatory approval. In connection with the agreement, we accelerated the conversion rights of the Second Note and received $3.0 million cash and forgiveness of aggregate interest of $411,000 on both notes. As a consequence, non-cash charges of $14.1 million had been recognized against sales in 2003 representing the fair value of the conversion rights earned by Future as well as the net cost from terminating the sales incentive feature of the Second Note (thereby vesting the conversion rights). As of December 31, 2003, affiliates of Future held approximately 8.5 million shares of Sipex’s common shares or approximately 30% of our outstanding capital stock. Upon the receipt of regulatory approval in February 2004, the affiliates of Future exercised their conversion rights to exchange both the First Note and the Second Note for 4.6 million common shares of Sipex, bringing their ownership to approximately 40% of our outstanding capital stock. As a result of the conversion, all the related collateral and sales incentives have been waived. The warrant to purchase 900,000 shares of Sipex’s common stock for $2.9458 per share has not been exercised as of April 3, 2004.

     Future has historically accounted for a significant portion of the Company’s revenues. It is the Company’s largest distributor worldwide, and accounted for 42% and 30% of total net sales for the three months ended April 3, 2004, and March 29, 2003, respectively. The Company anticipates that sales of its products to Future will continue to account for a significant portion of its net sales.

Note 5 — Restructuring Costs

     During the first quarter of 2004, the Company utilized $111,000 of the restructuring reserve for payments of the Company’s Billerica, Massachusetts facility lease. The balance of the restructuring accrual as of April 3, 2004 consisted principally of facility exit costs, and is expected to be paid in the next four years.

     Below is a summary of the activity related to restructuring costs for the first quarter of 2004 (in thousands):

Note 6 — Comprehensive Loss

     Comprehensive income (loss) is the total of net income (loss) and all other revenue, expenses, gains and losses recorded directly in equity. Sipex’s “other comprehensive loss” consists of foreign currency translation adjustments. There was no significant tax effect on the components of other comprehensive loss for the three months ended April 3, 2004 and March 29, 2003.

     The following table provides the comprehensive loss information (in thousands):

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Note 7 — Segment Information and Major Customers

     The Company’s Chief Executive Officer (CEO) is considered to be the Company’s chief operating decision maker. The Company has organized its operations based on a single operating segment: the development and delivery of high performance analog integrated circuits that are used primarily by original equipment manufacturers operating in the computing, communications and networking infrastructure markets. The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by product family and geographic region for purposes of making operating decisions and assessing financial performance. The Company has aligned its organization with the primary management objective of increasing overall sales unit volume, regardless of whether a distributor or the Company is the seller. The disaggregated sales information reviewed on a product family basis by the CEO includes the interface, power management and optical storage families along with other legacy product families.

     The disaggregated sales information reviewed on a product line basis by the CEO is as follows (in thousands):

     The Company markets its products primarily from its operations in the United States. International sales are made primarily to customers in Canada, Europe and Asia. Information regarding the Company’s net sales derived from products shipped to different geographic regions is as follows (in thousands):

     Substantially all the Company’s operations and long-lived assets reside in the United States although Sipex has operations in Malaysia, China, Taiwan, Japan, Germany and Belgium.

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     Information on major customers which accounted for 10% or more of the Company’s total net sales and total gross accounts receivable is as follows:

Note 8 — Inventories

     Inventories were as follows (in thousands):

Note 9 — Accrued Warranty

     Products are generally sold with a one-year warranty. Reserve requirements are recorded in the period of sale and are based on an assessment of the products sold with warranty and historical warranty costs incurred. The Company also assesses its pre-existing warranty obligations and may adjust the amounts based on actual experience or changes in future expectations:

     The following table summarizes the activity in the warranty reserve for the three months ended April 3, 2004 and March 29, 2003, respectively (in thousands):

Note 10 — Commitments

     On August 21, 2003, Sipex announced an exclusive sourcing agreement with PolarFab, a U.S. based semiconductor foundry. This arrangement provides Sipex with favorable delivery terms and engineering support from PolarFab in return for exclusive manufacturing rights for certain products. The Company is under obligation to make minimum purchase commitments based on quarterly rolling forecasts extending out one year. The initial term of the agreement is five years with renewals on a negotiated basis. As of April 3, 2004, the minimum purchase commitment with PolarFab was approximately $2.7 million for the following twelve months.

     In December 2002, Sipex entered into an agreement to use certain licensed tools for circuit design and development. The contract also provides maintenance support. Under the agreement Sipex is obligated to make $2.7 million in payments over three years. As of April 3, 2004, the total future payment commitment was $2.0 million.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can also be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled “Factors That May Affect Future Results and Financial Condition” below. The following discussion should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and the consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. All information is based on the Company’s fiscal calendar. Unless otherwise stated, references in this report to particular years or quarters refer to the Company’s fiscal years ended in December and the associated quarters of those fiscal years. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law.

Available Information

     The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available on its website at www.sipex.com/investor when such reports are available on the Securities and Exchange Commission (SEC) website. The public may read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The contents of these websites are not incorporated into this filing. Further, the Company’s references to the URLs for these websites are intended to be inactive textual references only.

Overview

     We design, manufacture and market, high performance, analog integrated circuits, or ICs, that are used primarily by original equipment manufacturers, or OEMs, operating in the computing, consumer, communications and networking infrastructure markets. End product applications that contain our ICs include cellular phones and base stations, computers, DVD players, and digital cameras.

     Although economic conditions in the analog semiconductor industry began to improve in 2003 following a prolonged downturn during 2001 and 2002, demand for our products in the first quarter of 2004 remained soft. Similar to other semiconductor manufacturers, we are affected by overall market demand trends. However, we believe our sales performance is more dependent on execution of our internal initiatives than on overall market conditions.

     Our products fall into three major product families: power management; interface; and optical storage. Change in product mix and the sale of new products within each of our product families can significantly impact overall gross margin. During the first quarter of 2004, we continued the transformation of our product mix, focusing on existing products and increasing the sale of new products introduced in our three core product families. New products introduced in power management enabled sales in this product family to grow $2.5 million, or 79% in the first quarter of 2004, compared to the corresponding period of 2003; and interface product sales grew $2.6 million, or 33% in the first quarter of 2004 compared to the corresponding period of 2003. Net sales of our three core product families increased to $18.1 million in the first quarter of 2004 from $13.2 million in the corresponding period of 2003.

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     We continually face both aggressive pricing practices as well as the emergence of new competitors in the market. In an effort to remain competitive, we intend to continue focusing on the key areas that drive operating and financial performance, including product mix, new product introductions, capacity utilization, cost reductions and productivity. All of these key areas are interrelated and important in affecting our gross margin. Cost reductions and productivity improvements are also required in order to remain competitive in our marketplace. Cost reductions are achieved in several ways, such as re-designing the products to “shrink” the size of the “die,” providing more individual products per wafer produced. This generates increased output without adding significant incremental cost. Other cost reductions and productivity improvements come through product back end yield improvement and test time reduction.

     Capacity utilization of our wafer fab in Milpitas, California is also an important factor impacting our gross margin. A large portion of our fab cost structure is fixed, such as depreciation and payroll expenses for process engineering and manufacturing support, which can be leveraged over an increasing volume of completed wafers. We build wafers for certain power management and all interface products in our fab. We outsource all of our optical storage products. Our wafer fab operation in Milpitas produced approximately 85% of our wafer requirements in the first quarter of 2004.

     With the sales product mix transformation and the manufacturing improvements, our gross profit (loss) improved from a $0.2 million loss in the first quarter of 2003 to a $4.5 million profit in the first quarter of 2004. Gross profit as a percentage of net revenue, or gross margin, was 25.1% in the first quarter of fiscal 2004 compared to (1.2%) in the corresponding quarter of 2003. The increase is attributable to the improvements in manufacturing yield and processes as a result of our continued efforts to standardize our manufacturing processes and improve our product design for manufacturability. Also, in the first quarter of 2003, gross loss was negatively impacted by lower capacity utilization within the manufacturing fab.

     Our net cash used in operating activities improved to $1.6 million in the first quarter of 2004 from $4.3 million in the comparable period of 2003. This is primarily attributable to the $3.5 million reduction in net loss for the first quarter of 2004 compared with the corresponding period in 2003.

Critical Accounting Policies

     The discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those significant estimates that are particularly susceptible to change, which include revenue recognition, sales returns, inventory valuation, restructuring and impairment, and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. There can be no assurance that actual results will not differ from those estimates.

     We have identified the accounting policies below as the policies most critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results.

     Revenue recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collectibility is reasonable assured.

     Future, a related party, is our exclusive distributor for North America and Europe. Sales to this distributor are made under an agreement that provides protection against price reduction for Future’s inventory of our products. In addition, Future has stock rotation rights. Pursuant to these stock

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rotation rights, Future is permitted on a quarterly basis to return for credit up to 10% of its total purchases during the most recent three-month period. As the price of products sold to Future is not fixed or determinable until resold by Future to the end customer, we recognize net sales to Future when Future sells the products through to the end customer. Accounts receivable are recognized and inventory is relieved upon shipment as title to inventories generally transfers upon shipment at which point the Company has a legally enforceable right to collection under normal terms.

     For all other sales, net sales are recognized upon title transfer and shipment because these distributors/customers have no price protection and have limited return rights. Distributors are permitted to return products limited to a percentage of their purchases over a specified period of time. We are able to estimate and establish appropriate reserves for future returns from these distributors. For product sales recognized at the time of shipment, we accrue for estimated sales returns upon shipment based upon historical trends as well as any known pending sales returns.

     Sales returns. To estimate reserves for future sales returns, we regularly review our history of actual returns for each major product line. We also communicate monthly with our channel partners to gather information about sell-through activity, end user satisfaction and to determine the volume of inventory in the channel. We use the results of this analysis to estimate the reserves for sales returns. We adjust our reserves for future returns as necessary, based on returns experience, returns expectations and our communications with our channel partners.

     In estimating reserves, we also consider unusual events and market conditions. It is possible that future events such as the introduction of a competitive product, product obsolescence, price competition, weakness in the semiconductor industry and distributors’ desire to decrease levels of inventory in the distribution channel could result in significant changes in customer demand and cause future returns to increase beyond historical levels. Management believes that it is able to estimate returns and establish appropriate reserves for returns from customers for which Sipex recognizes revenue as of shipment, using the process described above. However, since reserves for estimated sales returns are recorded as a reduction in revenues, any significant difference between our estimated and actual returns experience, or changes in our estimate of reserves for future returns, would be reflected in our reported net sales in the period we determine that difference, and could have a material impact on our future results of operations.

     Inventory valuation. We write down inventory for estimated excess quantities, obsolescence or marketability. In addition, we write down inventory costs to the lower of cost or market. Excess and obsolete inventory is determined by comparing current inventory to current backlog, anticipated future demand and shipment history. Lower of cost or market adjustments are determined by reviewing shipments during the quarter as well as quarter beginning backlog and comparing standard cost to anticipated market pricing. Inventories are written down to the lower of cost or market which becomes the cost basis. In estimating anticipated market pricing, we also consider current market conditions, industry performance, distributor inventory levels and sales to end-users and other relevant factors. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Reviews of the valuation of inventory reserves are performed on a quarterly basis.

     Restructuring and impairment. The determination of the estimated restructuring accrual and impairment requires significant management judgment. To estimate the restructuring accrual, we prepare a plan that includes the number of employees to be terminated and the related severance cost, the amount of impairment for certain fixed assets and inventory, the termination costs of certain leases and the related actions required to execute the plan. It is possible that future events such as voluntary employee terminations, sublease agreements or a shift in the timing of the execution of the plan could result in significant changes to the original estimate.

     We accounted for restructuring charges beginning January 1, 2003 in accordance with Statement of Financial Accounting Standards (SFAS) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. Prior to January 1, 2003, we accounted for restructuring in accordance with Emerging Issues Task Force Issue No. 94-3 (“EITF 94-3”), “Liability Recognition