SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended July 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 34,030,458 shares of the Registrant’s Common Stock issued and outstanding as of August 6, 2004.

SIPEX CORPORATION
FORM 10-Q
SIX MONTHS ENDED JULY 3, 2004

INDEX

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Part I: FINANCIAL INFORMATION

Item 1: Financial Statements

SIPEX CORPORATION

See accompanying notes to condensed consolidated financial statements

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SIPEX CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to condensed consolidated financial statements

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SIPEX CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to condensed 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 computing, communications and networking infrastructure markets.

     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 accounting principles generally accepted in the United States of America, 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 periods presented. Actual results could differ materially from those estimates. Interim information is unaudited; however, in the opinion of the Company’s management, all adjustments considered necessary for a fair presentation of interim periods 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 condensed consolidated 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 accounting principles generally accepted in the United States of America for complete financial statements.

     Effective January 1, 2004, the Company’s fiscal year has changed from calendar year end to a 52 or a 53 week fiscal year, 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 and the second quarter covered 91 days from April 4, 2004 to July 3, 2004.

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     Restricted Cash

     Restricted cash consists of $1.8 million held in a certificate of deposit as a guarantee of payment to fulfill the terms of a software license agreement. The agreement expires on November 2, 2007.

     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 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 on a straight-line basis and included in operations.

     As required under SFAS No. 123 and SFAS No. 148, the pro forma effects of stock-based compensation on net income (loss) 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, as if the Company had accounted for such awards under the fair value method of SFAS No. 123 using the 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 and six months ended July 3, 2004 and June 28, 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:

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     The weighted-average fair value of options granted for the three months ended July 3, 2004 and June 28, 2003 was $3.23 and $3.24, respectively.

     The fair value of Employee Stock Purchase Plan shares issued during the second quarter of 2004 and 2003, respectively, was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: volatility of 61% and 115%, risk free interest rate of 1.39% and 1.08% for the second quarter of 2004 and 2003, respectively; no dividend yield and option life of six months for both periods. The weighted-average fair value of Employee Stock Purchase Plan shares was $1.37 and $1.75 for the second quarter of 2004 and 2003, respectively.

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 and six months ended July 3, 2004 and June 28, 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, 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 three and six months ended July 3, 2004 by $0.02 and $0.03, respectively. The warrant, held by affiliates of Future, to purchase 900,000 shares of Sipex’s common stock for $2.9458 per share had not been exercised as of July 3, 2004 (see Note 12 for information regarding the subsequent exercise of the warrant).

     Antidilutive potential common shares excluded from the dilution calculation represented 2,757,721 and 8,949,000 potential common shares for three months ended July 3, 2004 and June 28, 2003, respectively, and 4,390,249 and 8,959,000 potential common shares for the six months ended July 3, 2004 and June 28, 2003, respectively.

Note 3 – Effect of Recent Accounting Pronouncements

     In January 2003, the Financial Accounting Standards Board (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, the adoption did not have a material impact on the Company’s financial position, results of operations or cash flows.

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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’s capital stock and became a related party. On September 27, 2002, Sipex sold a convertible secured note (“the First Note”) with an attached warrant to purchase 900,000 shares of Sipex common stock 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 attached warrant was exercisable for a two-year period beginning on the one-year anniversary of the date of issuance. The exercise price for the warrant was $2.9458. The First Note was secured by a Deed of Trust on the Company’s land and building at Milpitas, California.

     On June 20, 2003, Sipex sold a second convertible secured note (“the Second Note”) to an affiliate of Future for $10.6 million. 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 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 entered into a standstill agreement with affiliates of Future, pursuant to which these security holders agreed not to acquire more than 35% of the Company’s common stock on a fully diluted basis. 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 stockholders of Sipex.

     During the fourth quarter of 2003, Sipex entered into an agreement with the affiliates of Future to convert the First Note and Second Note into common stock subject to obtaining regulatory approval. In connection with the agreement, the Company accelerated the conversion rights of the Second Note and received $3.0 million and forgiveness of interest on both notes of $411,000. As a consequence, non-cash charges of $14.1 million had been recognized against sales in the second half of 2003 representing the fair value of the conversion rights earned by Future during this period 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 the Company’s common shares or approximately 30%. 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 the Company’s common stock for $2.9458 per share had not been exercised as of July 3, 2004 (see Note 12 for information regarding the subsequent exercise of the warrant).

     Future has historically accounted for a significant portion of the Company’s revenues and is the Company’s largest distributor worldwide. Revenue from Future accounted for 50% and 31% of total net sales for the three months ended July 3, 2004 and June 28, 2003, respectively, and 46% and 31% of total net sales for the six months ended July 3, 2004 and June 28, 2003, respectively. The Company anticipates that sales of its products to Future will continue to account for a significant portion of its sales.

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Note 5 — Restructuring Costs

     For the six months ended July 3, 2004, the Company utilized $223,000 of the restructuring reserve for payments of the Company’s Billerica, Massachusetts facility lease. The balance of the restructuring accrual as of July 3, 2004 consisted principally of facility related exit costs, and is expected to be paid in the next three and one-half years.

     Below is a summary of the activity related to restructuring costs for the three and six months ended July 3, 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 and six months ended July 3, 2004 and June 28, 2003.

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

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 revenue 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.

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     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 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.

     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: