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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the Fiscal Year Ended December 31, 2002

For the transition period from           to
     Commission File Number 0-27892

SIPEX CORPORATION

Registrant’s telephone number, including area code: (408) 934-7500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

The aggregate market value of common stock held by non-affiliates of the registrant as of June 28, 2002 was approximately $136,600,000 based upon $4.89 per share, the last reported sale price of the common stock on The Nasdaq National Market on that date.

The number of shares of the registrant’s common stock outstanding on March 26, 2003 was 28,030,659.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates by reference certain portions of information from the Registrant’s Proxy Statement for the 2003 Annual Meeting of Shareholders.

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PART I

Item 1. Business:

     Some of the statements contained in this Annual Report on Form 10-K are forward-looking statements that involve risks and uncertainties. The statements contained in this Annual Report on Form 10-K that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this Annual Report on Form 10-K are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “intends,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot offer any assurance of future results, levels of activity, performance or achievements. Moreover, neither any other person nor we assume responsibility for the accuracy and completeness of such statements. Important factors that may cause actual results to differ from expectations include those discussed in “Factors Affecting Future Results” beginning on page 20 in this document. The terms “Sipex”, “the Company”, “we”, “us”, “its” and “our” as used in this Annual Report on Form 10-K refer to Sipex Corporation and its subsidiaries and its predecessors as a combined entity, except where the context requires otherwise.

Availability of Reports and Other Information

Our Internet website is www.sipex.com. On this web site, the public can access our annual, quarterly and current reports through a hyperlink to the Securities and Exchange Commission website.

Company Overview

     Sipex Corporation is a semiconductor company that designs, manufactures and markets, 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.

     While advances in digital technology have fueled the demand for digital integrated circuits, they have also created a 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 contractors to fabricate, package and test its ICs. Sipex’s products are sold either directly or through a global network of manufacturers’ representatives and distributors.

Semiconductor Industry Background

     Integrated circuits, the essential building blocks of today’s electronic products, are classified as either digital or analog ICs. Digital ICs (e.g. memory products, microprocessors and digital signal processors, or DSPs), process binary signals composed of strings of “0s” and “1s.” Often they are constrained by market-based standards and depend on a company’s ability to design and manufacture very large-scale circuits, using expensive, state-of-the-art process technologies that minimize device size.

     Analog ICs act as the bridge between the digital world and physical world. They transform signals derived from the physical environment, such as heat, pressure, sound and light, or monitor and condition analog signals derived from external electronic inputs. By contrast with digital ICs, analog ICs are most often designed and optimized for specialized applications in niche markets. Their development and successful market adoption require close customer contact and the deployment of small, tightly coordinated teams of experienced and highly skilled engineers who understand the complexities of the IC and understand the interrelationships with its layout, process technology, packaging and end application.

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     Analog and digital IC manufacturers often share the characteristics of the semiconductor industry including cyclical market demands, capacity limitations, occasional oversupply, manufacturing variation, accelerated product life cycles, price erosion, global competition, capital equipment expenditures and rapid technology changes. Product life cycles in the analog IC market tend to be longer and customer pricing less volatile because competition, particularly foreign competition, is more limited and customers avoid major changes in the analog portions of their products due to the design complexities involved and the volume of the product used in a typical application. The capital expenditures for analog IC manufacturers are typically lower because analog ICs usually consume less silicon area and their fabrication processes are focused on device matching and careful layout and do not require frequent and expensive equipment upgrades or replacements to remain competitive.

Sipex’s Business Strategy

     To remain competitive in the analog IC market, we supply customers in target markets with an array of standard product choices, which offer the features, performance and competitive pricing required to enable and enhance their end products. Sipex maintains close working relationships with strategic customers. We believe that our relationships enable us to create and follow future directed product and technology roadmaps, and shorten our customers’ product development cycles. In addition, Sipex has recently restructured its operations to reduce costs and improve quality.

Sipex Markets, Applications and Products

     Sipex sells its products into a variety of applications and markets including networking and communications, computer and peripherals, industrial controls and instrumentation and consumer products. The customer end-products in these markets are driven basically by the same requirements: higher operating efficiency, higher accuracy, more power at lower voltages, faster data transfer and higher bandwidth. These requirements provide opportunities for Sipex to develop power management, serial interface and optical storage ICs with features designed for applications, ranging from power modules in routers to pick-up heads in CD/DVD systems.

     Sipex currently supports approximately one thousand ICs in three product categories. These products, whether custom or proprietary, are designed for specific end applications that require unique feature sets, specific electrical performance criteria (speed, precision, power, etc.), and/or additional system-level integration. Sipex focuses on developing these products as standard analog ICs in order to serve larger markets and reduce the risk of dependency on single customer requirements.

     Power Management Products - These ICs regulate, control, monitor or provide the reference voltage for a system or portion of a system. DC/DC regulators and pulse-width modulation/pulse-frequency modulation controllers convert voltage up or down within a system and provide a controlled level of power to the system, independent of normal operating load, line and temperature fluctuations. Supervisory ICs monitor power levels and notify controller ICs of out-of-range power conditions. Voltage references establish benchmark voltages within a system and provide constant outputs independent of temperature and other operating variations. Within this product category, Sipex develops white light-emitting diode (LED) drivers needed in virtually every consumer portable device. This product family is replacing the electroluminescent lamp driver family, which developed high voltage alternating current (AC) signals from low voltage battery sources that provides backlighting for liquid crystal displays, or LCDs.

     The power management product portfolio continued to expand in 2002 with proprietary ICs including white LED drivers, DC/DC regulators and controllers. These new products deliver better power efficiency, increased miniaturization and more power at lower voltage levels to portable power and distributed power applications.

     Interface Products - Interface products facilitate the transfer of digital signals between or within electronic systems and ensure reliable connectivity between networks, computers and the rapidly expanding mix of digital peripherals and consumer portable devices that connect to them. The single protocol RS-232 and RS-485 transceivers comply with international standards in delivering multi-channel digital signals between two systems. The multi-protocol transceivers enable network equipment to communicate with a large population of peripherals that use a diverse set of serial protocol standards without the added burden of multiple add-on boards and cables.

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     The focus on lower voltage to conserve energy has made our low voltage, serial interface ICs popular in a variety of digital peripherals including data cables for PDAs, cellular phones and digital still cameras. Multi-protocol ICs continue to be used in networking and telecommunications equipment, but the overall slowdown in these markets has limited their growth.

     Optical Storage Products – The optical storage product family, a recent addition to the Sipex product portfolio, started shipping in volume in the second quarter of 2002. This family provides complete electronic solutions for pick-up heads used in optical storage systems, such as CD and DVD devices.

     The family currently consists of photo-detector ICs, advanced power control ICs and laser diode drivers. The photo-detector ICs capture a portion of the light reflected from the optical storage medium, convert it to a set of electronic digital signals and forward them to the chipset for processing. The reflected light contains both data and tracking information. The advanced power control ICs capture a portion of the optical power coming from the laser and feed it back into a control system that regulates laser intensity. This control function is used to prevent damage to the laser diode and extend the life of the system. For both of these functions, Sipex has developed technology that permits the photo-detection functions to be incorporated with their signal conditioning circuitry. This functional integration enables faster read speeds and smaller footprints in DVD-R/W, DVD-RAM and CD-R/W systems.

     Sipex is also developing a family of laser diode drivers that we anticipate will excite the laser diode in the pick-up head. The Sipex devices are designed to drive two lasers at high speed. This will allow the customer to build a 780nm and 650nm system on one pick-up head for combo CD/DVD devices. These products are scheduled for introduction in 2003.

Sales, Distribution and Marketing

     Sipex sells its products to OEM customers primarily through our exclusive distributor network, as well as through a direct sales force and a network of independent sales representatives. The direct sales force consists of regional sales managers and field applications engineers who support our sales representatives, distributors and customers with technical support services. Our sales staff and field application engineers also manage, train and support our network of distributors and representatives. The sales and field applications staff are located in our Billerica and Milpitas facilities and in field offices in China, France, Germany, Japan, Korea, Taiwan and the United Kingdom.

     Most of Sipex’s sales are generated through the worldwide distributor network. Most of our design win activity is generated through our wide network of distributors and independent representatives.

     Future Electronics is our exclusive distributor for North America and Europe. It is also our largest distributor worldwide, and accounted for 24%, 21% and 23% of total net sales, respectively, for the years ended December 31, 2002, 2001 and 2000. Distributor sales to North America and Europe were approximately $13.3 million in 2002 and 2001 and $24.6 million in 2000, representing 20.1%, 18.5% and 21.5% of total net sales, respectively. Sipex has entered into a distributor agreement that provides for Future Electronics to act as our sole distributor for certain products within these territories. Sales to this distributor are made under an agreement that provides protection against price reduction for its inventory of Sipex products. Sipex maintains a separate price list for products sold to Future Electronics, which reflects discounts from the prices charged to customers in direct sales transactions. On a quarterly basis, this distributor is permitted to return for credit a total of 10% of its total purchases during the most recent three-month period. We recognize revenue on sales to Future Electronics under the distribution agreement when it sells the products through to the end customer. For sales to all other distributors and end customers we recognize revenue upon shipment.

     In Japan and the Far East, Sipex sells its products through a number of distributors. Distributor sales to these regions in 2002, 2001 and 2000 were approximately $30.4 million, $18.3 million and $34.8 million, respectively, representing 45.8%, 25.4% and 30.3% of total net sales, respectively. Substantially all sales to these international locations are denominated in U.S. dollars. Sipex maintains separate price lists for products sold to distributors, which typically reflect discounts from the prices charged to customers in direct sales transactions. Sipex generally does not provide price protection to these distributors on items that are included in their inventory. On a semi-annual basis, these distributors are permitted to return for credit against product purchases of an equivalent dollar value, up to 5% of their total purchases during the most recent six-month period.

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     Sipex is subject to the normal risks of conducting business internationally, including exchange rate fluctuations. To date, Sipex has not hedged the risks associated with fluctuations in exchange rates but may undertake such transactions in the future.

     Our marketing team develops long term product and technology roadmaps based on first hand market knowledge, close customer relationships, industry experience, and a variety of public and private market data. Detailed technical information in the form of data sheets, application notes and tutorials is posted on our website and a variety of technical and sales materials are published and distributed to customers, sales representative and distributors. Sipex engages in print advertising to raise market awareness of our products and services.

Customers

     Our customer base is comprised of merchant electronics distributors, manufacturers, subcontract-assembly companies, and customers with captive manufacturing operations. The captive manufacturers use our products as components in their equipment and systems. In certain cases, we sell our products to subcontract-assembly companies specified by the captive manufacturer. The merchant manufacturers typically function as OEMs as well as suppliers of sub-systems to other OEMs.

     The end users of our products, include ADC Telecommunications, Alcatel, Cisco Systems, Dell, IBM, L3, Lexmark, Nortel and Ricoh in the networking/data communications markets; ATI, BenQ, Casio, Matrox, NEC, Palm, Seiko, Sharp, Sony and Toshiba in the consumer markets; Cidco, Garmin, L.G. Information Systems, Motorola, NEC and Samsung in the telecommunications markets and Snecma in military applications markets.

Backlog

     Our product backlog was approximately $12.8 million at December 31, 2002 compared to $22.3 million at December 31, 2001. The decrease in Sipex’s backlog as of December 31, 2002 reflected the dramatic change experienced in our industry during 2002, where product demand visibility by our end customers was significantly shortened. This was a result of the general slowdown in the economy and the continued spending reductions by major customers.

     We generally include in backlog all orders scheduled for delivery within one year. However, our business, and to a large extent the entire semiconductor industry, is characterized by short-term orders and shipment schedules. Sipex generally permits orders to be canceled or rescheduled without significant penalty to customers. As a result, the quantities of our products to be delivered and their delivery schedules may be revised by customers to reflect changes in their needs. Since backlog can be canceled or rescheduled, our backlog at any time is not necessarily indicative of future revenues. In addition, due to the high percentage of our sales going through the distributors’ channel, our backlog may be affected by inventory levels at our distributors.

Manufacturing

     Sipex has a wafer fabrication facility in Milpitas, California which supplies most of our product needs except for the optical storage products and certain power products requiring more advanced process technologies. This wafer fabrication facility commenced manufacturing operations in the second half of 1999, and was used to produce both four-inch and six-inch diameter wafers. Sipex’s facilities have been certified as ISO-9001 compliant. The lease for the four-inch wafer facility, located in San Jose, California, was assumed by an unrelated third party in early 2003 as a part of Sipex’s restructuring initiative. At the end of December of 2002, all assembly and test operations in Billerica, Massachusetts were ceased and we transferred these operations to two subcontractors in Malaysia.

     Manufacturing capabilities are broadened by using third-party foundries to produce complementary metal-oxide semiconductor (CMOS) processed wafers and BiCMOS processed wafers. The use of third-party foundries enables us to minimize fixed costs and capital expenditures while providing access to diverse manufacturing technologies without bearing the full risk of obsolescence. All of these foundries have been certified as ISO-9001 compliant. Products produced by third party foundries represented 29.6%, 26.4% and 30.2% of Sipex shipments in 2002, 2001 and 2000, respectively.

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     Sipex tests integrated circuits or “die” on the wafers produced internally and by its foundries for compliance with performance specifications before assembly. Our commercial products are assembled and tested by a variety of subcontractors in Malaysia, Indonesia and other locations in Asia which have been certified as ISO-9002, QS 9000, or ISO-14000 compliant. Following testing, the packaged units are shipped directly from our subcontractors to our customers worldwide.

Product Quality Assurance and Reliability

     Sipex is committed to customer satisfaction and continuous improvement in all aspects of its business. This is accomplished through a comprehensive quality and reliability system founded on documented procedures. Quality tools such as statistical process control, cross-functional teaming and advanced statistical analysis are used in qualification, production processes and quality improvement activities. We maintain close relationships with our subcontractors and routinely qualify suppliers to established standards. Sipex is ISO-9001 certified and has continuously maintained its ISO certification since 1996.

Patents, Licenses and Trademarks

     Sipex seeks to protect its proprietary technology through patents and trade secret protection. Currently, we hold a number of patents expiring between now and 2021 and have additional United States patent applications pending, although there can be no assurance that any patents will result from these applications. While Sipex intends to continue to seek patent coverage for our products and manufacturing technology where appropriate, we believe that our success depends more heavily on the technical expertise and innovative abilities of our personnel than on our patent position. Accordingly, Sipex also relies on trade secrets and confidential technological know-how in the conduct of its business. There can be no assurance that Sipex’s patents or applicable trade secret laws will provide adequate protection for our technology against competitors who may develop or patent similar technology or reverse engineer our products. In addition, the laws of certain territories in which Sipex’s products are or may be developed, manufactured or sold, including Asia, Europe and Latin America, may not protect Sipex’s products and intellectual property rights to the same extent as the laws of the United States.

     Pursuant to license agreements, Sipex pays a royalty to Timex Corporation for certain electroluminescent product sales, to Maxim Integrated Products and Analog Devices for certain interface product sales and the Lemelson Medical, Education and Research Foundation and Syndia Corporation for certain CMOS and BiCMOS processes.

Research and Development

     Sipex believes that continued introduction of new products in target markets is essential to growth. As performance demands have increased the complexity of analog circuits, the design and development process has become a multi-disciplinary effort, requiring diverse competencies to achieve customers’ desired performance. In addition to our staff of design engineers, we have an infrastructure of product and test engineers who perform various support functions.

     In 2002 and 2001, Sipex spent approximately $12.9 million and in 2000 spent $13.2 million on research and development, representing 19.5%, 17.9% and 11.5%, respectively, of net sales for these periods. Sipex expects to focus more on the productivity of its research and development investment through better product definition, consistent strategy and excellent execution. Overall expenditures in support of research and development activity is likely to increase slightly in absolute terms in the near future.

     Sipex’s ability to compete depends in part upon its continued introduction of technologically innovative products on a timely basis. Our research and development efforts are directed primarily at designing and introducing new products and technologies. Sipex seeks to continually upgrade its internal technology while also working with foundries to develop new technologies for new generations of products. In addition, Sipex seeks to continually refine its manufacturing practices and technology to improve product yields.

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Competition

     Sipex competes in multiple segments of the analog integrated circuit market. This market is intensely competitive and many major semiconductor companies presently compete or could compete with Sipex in the same applications or products. Sipex’s current primary competitors include Analog Devices, Intersil, Linear Technology, Maxim Integrated Products, Micrel Semiconductor, National Semiconductor, On Semiconductor, Pioneer, Semtech, Sharp, Sony and Texas Instruments among others. Our primary competitors have substantially greater financial, technical, manufacturing, marketing, distribution, other resources and broader product lines than we do. Although foreign companies, active in the semiconductor market, have not traditionally focused on the high performance analog market, with the exception of the optical marketplace, many foreign companies have the financial and other resources to participate successfully in these markets and may become formidable competitors in the future.

     Sipex believes that product innovation, quality, reliability, performance and the ability to introduce products rapidly are important competitive factors in our target markets, because we compete primarily during the customer’s design-in stage of product development. We further believe that cost competitiveness is paramount in every segment of the semiconductor industry.

Employees

     At December 31, 2002, we had 334 full-time employees, as compared with 442 employees in the prior year. During the later part of 2002, we implemented a restructuring program that included discontinuing the Billerica manufacturing activities, discontinuing the four-inch wafer fabrication in San Jose, California, the reorganization of the company into functional groups and the full conversion to six-inch wafer fabrication facility in Milpitas, California. These actions have resulted in a significant reduction of the Company’s headcount. Additional restructuring actions may be required. However, if demand for our product increases, we may be required to increase our headcount in certain areas.

     We believe that our future success will depend, in part, on our ability to attract and retain qualified technical and manufacturing personnel. This is particularly important in the areas of product design and development, where competition for skilled personnel is intense. None of our employees are subject to a collective bargaining agreement and we have never experienced a work stoppage.

Item 2. Properties:

     Sipex’s corporate office is located in Milpitas, California. Information regarding our principal plants and properties appears below:

     We believe that our existing facilities will be adequate after our restructuring efforts are completed. The Company is seeking to terminate its lease on the facility located in Billerica, Massachusetts. The lease for the manufacturing facility located in San Jose, California was assumed by a third party in the first quarter of 2003, as part of the Company’s restructuring effort.

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Item 3. Legal Proceedings:

     Sipex may become involved in various legal actions arising in the ordinary course of business, including securities class actions and other actions.

     In February 1999, Sipex filed a lawsuit against Maxim Integrated Products, Inc. (“Maxim”) with the U.S. District Court for the District of Massachusetts seeking a declaratory judgment that three of Sipex’s products did not infringe Maxim patents. Maxim filed counterclaims alleging certain products sold by Sipex infringe a Maxim patent. The counterclaims seek injunctive relief and unspecified damages. Sipex has denied infringement and alleges that the patent is invalid. The results of any litigation or arbitration are inherently uncertain, and Sipex can offer no assurance that in any future legal actions Sipex will prevail. If Sipex does not prevail, we would be required to pay cash damages, injunctive relief could be issued which would prohibit Sipex from selling the infringing product and liquidity could be adversely affected. The Company has accrued $450,000 toward a potential settlement.

Item 4. Submission of Matters to a Vote of Security Holders:

     No matters were submitted to a vote of Sipex’s security holders during the quarter ended December 31, 2002.

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Executive Officers of Sipex

     Information relating to the executive officers of Sipex is set forth below. All officers held office as of December 31, 2002 except for Mr. Kagel who was employed by Sipex beginning February 10, 2003.

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PART II

Item 5. Market for the Company’s Common Equity and Related Shareholder Matters:

     Since April 2, 1996, the date of our initial public offering, our common stock has been available for quotation on The Nasdaq National Market under the symbol “SIPX.” The following table sets forth, for the period indicated, the high and low sale prices per share as reported on The Nasdaq National Market:

Quarterly Stock Market Data

     On December 31, 2002, there were approximately 67 shareholders of record. We believe that the number of beneficial holders of common stock exceeds 3,000. The last reported sale price of the common stock on March 26, 2003 was $3.50 per share. We have never declared or paid a cash dividend on our capital stock. We currently intend to retain all of our earnings to finance future growth and, therefore, do not anticipate paying any cash dividends on our common stock in the foreseeable future.

     The disclosure required by Item 201(d) of Regulation S-K is included in Item 12 of this Annual Report on Form 10-K.

Item 6. Selected Consolidated Financial Data:

     Selected financial data for the last five years appear below (in thousands, except per share data):

*     The financial data has been adjusted to reflect the combined operations of Sipex Corporation and Calogic as a result of the November, 1999 merger which was recorded as a pooling of interests.

**     In June 2001, Sipex purchased the land, building and equipment of its Milpitas manufacturing facility for $35.0 million which was formerly under lease. Proceeds for the buyout were provided through the liquidation of $36.8 million of restricted cash that had previously secured the lease of the facility and equipment.

*** The 2002 decrease in total assets was mainly due to the establishment of a 100% valuation allowance of $31.9 million for deferred tax assets, the disposition of machinery and equipment with a net book value of $6.7 million and $3.0 million writeoff of goodwill.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations:

     The following discussion should be read together with our financial statements and the related notes contained elsewhere in this Annual Report on Form 10-K.

Overview

     We are a semiconductor company that designs, manufactures and markets, high performance analog ICs that are used primarily by OEMs operating in the computing, communications and networking infrastructure markets.

Critical Accounting Policies

     The discussion and analysis of our financial condition and results of operations is based on our 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 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 reserves, 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 record revenue to our largest distributor at the time the product is sold through to the end user (sell-through). For all other product sales, assuming all other revenue recognition criteria have been met, revenue is recognized at the time of shipment because these distributors/customers have no price protection and have limited return rights. In addition, management believes that it is able to estimate and establish appropriate reserves for future returns from these distributors. For product sales recognized at the time of shipment, Sipex accrues for estimated sales returns upon shipment based upon our estimates of future returns.

     Beginning in the fourth quarter of 2000, we began deferring revenue on ordinary course shipments to our largest distributor until the product is resold by the distributor to the end user because the arrangement with this distributor includes price concessions and return rights, the potential impact of which we believed we could no longer reasonably estimate. In the fourth quarter of 2001, Sipex accepted distributor orders from our largest distributor for certain products on a discounted basis for which the distributor has no rights of return other than for product related issues, price protection or cancellation rights and which are not governed by the terms of the existing distributor contract. Revenue from these orders was recognized at the time of shipment, since these orders are non-cancelable, non returnable and for which such sales are not subject to the terms of the Company’s distribution agreement with the distributor, including without limitation the price protection, restocking and other returns rights the distributor is entitled to in the agreement. Revenue from engineering service contracts is recorded as performance is completed.

     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.

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     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, continued slowness 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 revenues in the period we determine that difference, and could have a material impact on our future results of operations.

     Inventory reserves. We establish inventory reserves for estimated excess quantities, obsolescence or unmarketability. In addition, the Company establishes estimates to write down inventory costs to the lower of cost or market. The excess and obsolescence reserve is calculated by comparing current inventory to both anticipated future demand and shipment history. Lower of cost or market adjustments are determined by reviewing shipments during the quarter 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 establishing the reserves and estimating anticipated market pricing, we also consider current market conditions, industry performance, distributor inventory levels and sales to end-users and all other relevant factors. If actual market conditions are less favorable than those projected by management, additional inventory reserves may be required. Reviews of the adequacy of inventory reserves are performed on a quarterly basis. In 2002, we recorded a $5.4 million provision for excess and slow moving inventory, which included a $1.5 million charge relating to product lines sold or discontinued as part of the Company’s third quarter restructuring plan and a $700,000 charge for physical inventory adjustments.

     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.

     Sipex reviews long-lived assets and certain identifiable intangibles, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. In estimating future net cash flows, management makes certain assumptions including future sales levels, gross profit margins and expense levels. The future net cash flows can vary from management estimates due to unforeseen circumstances which may result in an impairment or additional impairment charges required to be recognized in the income statement.

     We accounted for restructuring charges prior to January 1, 2003, in accordance with Emerging Issues Task Force Bulletin 94-3 (“EITF 94-3”), “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” and SEC Staff Accounting Bulletin No. 100 (“SAB 100”), “Restructuring and Impairment Charges.” Under EITF 94-3, costs associated with restructuring activities are recorded as restructuring costs in the consolidated statement of operations. In June 2002 the FASB issued 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. This Statement is effective for exit or disposal activities initiated after December 31, 2002. On January 1, 2003, the Company adopted SFAS No. 146 and at the time of adoption, there was no material impact on our financial position or results of operations; however, the Company has not yet determined the implications of adoption on future results of operations.

     Income taxes. In assessing the net realizable value of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become taxable. Management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes that it is not

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more likely than not that the deferred tax assets at December 31, 2002 will be realized in the future. We therefore established a full valuation allowance and incurred a tax charge for the full amount of deferred income tax asset of $48.8 million for the year 2002. Approximately $30,000 of the valuation allowance is attributable to stock compensation expense for tax purposes, the tax benefit of which, when realized, will be credited to shareholders’ equity.

Results of Operations

     For the periods indicated, the following table sets forth the percentage of net sales represented by the respective line items in our consolidated statements of operations.

Fiscal Year Ended December 31, 2002 compared to Fiscal Year Ended December 31,2001

     Net sales. Net sales decreased 8.1% to $66.3 million for the year ended December 3