UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
or
[ ] TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to ______________________
Commission File Number: 0-27488
INCYTE PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3136539
-------- ----------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3174 Porter Drive
Palo Alto, California 94304
(Address of principal executive offices)
(650) 855-0555
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required 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.
[X] Yes [ ] No
The number of outstanding shares of the registrant's Common Stock, $0.001 par
value, was 26,663,544 as of June 30, 1998.
INCYTE PHARMACEUTICALS, INC.
INDEX
PART I: FINANCIAL INFORMATION PAGE
- ------------------------------------------------------------------------------ ----
ITEM 1 Financial Statements - Unaudited
Condensed Consolidated Balance Sheets - June 30, 1998 and
December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Income - three and six month
periods ended June 30, 1998 and 1997. . . . . . . . . . . . . . . 4
Condensed Consolidated Statements of Cash Flows - six month
periods ended June 30, 1998 and 1997. . . . . . . . . . . . . . . 5
Notes to Condensed Consolidated Financial Statements. . . . . . . 6
ITEM 2 Management's discussion and analysis of financial condition
and results of operations . . . . . . . . . . . . . . . . . . . . 10
PART II: OTHER INFORMATION
- ------------------------------------------------------------------------------
ITEM 1 Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . 24
ITEM 2 Changes in Securities. . . . . . . . . . . . . . . . . . . . . . . . . 24
ITEM 3 Defaults Upon Senior Securities. . . . . . . . . . . . . . . . . . . . 24
ITEM 4 Submission of Matters to a Vote of Security Holders. . . . . . . . . . 24
ITEM 5 Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . 25
ITEM 6 Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . 25
Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . 27
PART I: FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands),
(unaudited),
JUNE 30, DECEMBER 31,
1998 1997*
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents. . . . . . . . . . . . $ 32,944 $ 55,598
Restricted cash. . . . . . . . . . . . . . . . . 4,000 6,000
Marketable securities - available-for-sale . . . 93,766 57,497
Accounts receivable, net . . . . . . . . . . . . 10,970 19,983
Prepaid expenses and other current assets. . . . 5,516 3,836
---------- -----------
Total current assets . . . . . . . . . . . 147,196 142,914
Property and equipment, net. . . . . . . . . . . . . . 45,653 38,070
Long-term investments. . . . . . . . . . . . . . . . . 21,054 14,800
Deposits and other assets. . . . . . . . . . . . . . . 5,285 3,305
---------- -----------
Total assets . . . . . . . . . . . . . . . $ 219,188 $ 199,089
========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . $ 3,527 5,791
Accrued and other current liabilities. . . . . . 13,664 14,608
Deferred revenue . . . . . . . . . . . . . . . . 43,213 31,815
---------- -----------
Total current liabilities. . . . . . . . . 60,404 52,214
Non-current portion of accrued rent and other
Non-current liabilities. . . . . . . . . . . . . 908 1,173
---------- -----------
Total liabilities. . . . . . . . . . . . . 61,312 53,387
---------- -----------
Stockholders' equity:
Capital stock. . . . . . . . . . . . . . . . . . 27 26
Additional paid-in capital . . . . . . . . . . . 182,403 175,749
Deferred compensation. . . . . . . . . . . . . . (1,412) -
Receivable from stockholder. . . . . . . . . . . (49) -
Accumulated other comprehensive income . . . . . 7 56
Accumulated deficit. . . . . . . . . . . . . . . (23,100) (30,129)
Total stockholders' equity . . . . . . . . 157,876 145,702
---------- -----------
Total liabilities and stockholders' equity $ 219,188 $ 199,089
========== ===========
<FN>
See accompanying notes
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts),
(unaudited),
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------- ---------
1998 1997 1998 1997
------- ------- -------- -------
Revenues . . . . . . . . . . . . . . $33,093 $21,425 $63,472 $39,423
Costs and expenses:
Research and development. . . . . . 23,120 17,370 44,819 32,503
Selling, general and administrative 5,722 3,250 10,322 6,103
Acquisition-related charges . . . . - - 1,171 -
------- ------- -------- -------
Total costs and expenses . . . . . . 28,842 20,620 56,312 38,606
Income from operations . . . . . . . 4,251 805 7,160 817
Interest and other income, net . . . 1,804 572 3,681 1,069
Losses from joint venture. . . . . . - - (640) -
------- ------- -------- -------
Income before income taxes . . . . . 6,055 1,377 10,201 1,886
Provision for income taxes . . . . . 848 106 1,428 158
------- ------- -------- -------
Net income . . . . . . . . . . . . . $ 5,207 $ 1,271 $ 8,773 $ 1,728
======= ======= ======== =======
Basic net income per share . . . . . $ 0.20 $ 0.05 $ 0.33 $ 0.07
======= ======= ======== =======
Shares used in computing
basic net income per share. . . . 26,610 23,122 26,504 23,059
======= ======= ======== =======
Diluted net income per share . . . . $ 0.18 $ 0.05 $ 0.30 $ 0.07
======= ======= ======== =======
Shares used in computing
diluted net income per share. . . 28,667 25,209 28,792 25,228
======= ======= ======== =======
<FN>
See accompanying notes
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands),
(unaudited),
SIX MONTHS ENDED
JUNE 30,
---------
1998 1997
--------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income. . . . . . . . . . . . . . . . . . . . . . . . . $ 8,773 $ 1,728
Adjustments to reconcile net income to net cash provided by
Operating activities:
Depreciation and amortization . . . . . . . . . . . . . 7,489 4,592
Losses in joint venture . . . . . . . . . . . . . . . . 640 -
Amortization of deferred compensation . . . . . . . . . 246 -
Adjustment to conform pooled entity . . . . . . . . . . 278 -
Changes in certain assets and liabilities:
Accounts receivable. . . . . . . . . . . . . . . . 9,233 (1,497)
Prepaid expenses, deposits and other assets. . . . (3,723) (1,077)
Accounts payable . . . . . . . . . . . . . . . . . (2,078) (963)
Accrued and other liabilities. . . . . . . . . . . 77 3,074
Deferred revenue . . . . . . . . . . . . . . . . . 12,159 6,178
--------- --------
Net cash provided by operating activities. . . . . . . . . . . . 33,094 12,035
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Long-term investments . . . . . . . . . . . . . . . . . . . (6,894) (5,000)
Capital expenditures. . . . . . . . . . . . . . . . . . . . (15,325) (9,136)
Proceeds from sale of assets leased back under
Operating leases. . . . . . . . . . . . . . . . . . . . - 1,528
Purchases of marketable securities. . . . . . . . . . . . . (60,171) (4,511)
Sales and maturities of marketable securities . . . . . . . 23,854 8,539
Net cash used in investing activities. . . . . . . . . . . . . . (58,536) (8,580)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock. . . . . . . . . . . 2,923 4,322
Principal payments on capital lease obligations and
Notes payable. . . . . . . . . . . . . . . . . . . . . (135) (53)
--------- --------
Net cash provided by financing activities. . . . . . . . . . . . 2,788 4,269
--------- --------
Net increase (decrease) in cash and cash equivalents . . . . . . (22,654) 7,724
Cash and cash equivalents at beginning of period . . . . . . . . 55,598 9,616
--------- --------
Cash and cash equivalents at end of period . . . . . . . . . . . $ 32,944 $17,340
========= ========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid. . . . . . . . . . . . . . . . . . . . . . . . . . $ 43 $ 14
========= ========
Income taxes paid. . . . . . . . . . . . . . . . . . . . . . . . $ 340 $ 70
========= ========
See accompanying notes
======
INCYTE PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. The condensed consolidated balance sheet as of
June 30, 1998 and December 31, 1997, statements of operations for the three
and six months ended June 30, 1998 and 1997 and the statements of cash flows
for the six months ended June 30, 1998 and 1997 are unaudited, but include all
adjustments (consisting of normal recurring adjustments) which the Company
considers necessary for a fair presentation of the financial position,
operating results and cash flows for the periods presented.
The condensed consolidated financial statements include the accounts of its
wholly-owned subsidiaries. In January 1998, all of the outstanding shares of
Synteni, Inc. ("Synteni") were acquired by the Company in a business
combination accounted for as a pooling-of-interests. Accordingly, all prior
financial data have been restated to represent the combined financial results
of the previously separate entities (Note 4). Although the Company believes
that the disclosures in these financial statements are adequate to make the
information presented not misleading, certain information and footnote
information normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to the rules and regulations of the Securities and Exchange
Commission.
Certain reclassifications were made to prior periods' balances to conform with
the 1998 presentation. Results for any interim period are not necessarily
indicative of results for any future interim period or for the entire year.
The accompanying financial statements should be read in conjunction with the
financial statements and notes thereto for the year ended December 31, 1997
included in the Company's Current Report on Form 8-K.
2. REVENUE RECOGNITION
The Company recognizes revenue for database collaboration agreements evenly
over the term of the agreement. Revenue is deferred for fees received before
earned. Revenues from custom orders, such as satellite databases, are
recognized upon shipment. Revenues from reagents and genomic screening
products are recognized when shipped, and revenues from genomic screening
services are recognized upon completion. Revenues from gene expression
microarray services are recognized on completion of key stages in the
performance of the service, in proportion to costs incurred. Revenues from
software licenses are recognized upon completion of installation and revenues
from software maintenance are recognized ratably over the life of the
maintenance period.
3. NET INCOME PER SHARE
Basic EPS is computed by dividing net income available to common stockholders
(numerator) by the weighted average number of common shares outstanding
(denominator) during the period and excludes the dilutive effect of stock
options. Diluted EPS gives effect to all dilutive potential common shares
outstanding during a period. In computing diluted EPS, the average stock
price for the period is used in determining the number of shares assumed to be
purchased from exercise of stock options.
Following is a reconciliation of the numerators and denominators of the basic
and diluted EPS computations for the periods presented below.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------- ---------
1998 1997 1998 1997
------- ------- ------- -------
Numerator:
Net income . . . . . . . . . . . . . . . . $ 5,207 $ 1,271 $ 8,773 $ 1,728
======= ======= ======= =======
Denominator:
Denominator for basic earnings
Per share - weighted-average shares . . 26,610 23,122 26,504 23,059
Dilutive potential common shares-
Stock options . . . . . . . . . . . . . 2,057 2,087 2,288 2,169
------- ------- ------- -------
Denominator for diluted earnings per
Share. . . . . . . . . . . . . . 28,667 25,209 28,792 25,228
======= ======= ======= =======
Basic net income per share. . . . . . . . . $ 0.20 $ 0.05 $ 0.33 $ 0.07
======= ======= ======= =======
Diluted net income per share. . . . . . . . $ 0.18 $ 0.05 $ 0.30 $ 0.07
======= ======= ======= =======
4. BUSINESS COMBINATIONS
In January 1998, the Company issued 2,340,237 shares of common stock in
exchange for all of the capital stock of Synteni, Inc., a privately held
microarray-based gene expression company located in Fremont, California.
Synteni provides microarray services to the pharmaceutical, biotechnology, and
agricultural industries. The merger has been accounted for as a
pooling-of-interests and, accordingly, the Company's financial statements and
financial data have been restated to include the accounts and operations of
Synteni for all periods presented.
The table below presents the separate results of operations for Synteni for
the periods prior to the merger. The Company's results of operations include
Synteni since the transaction (in thousands):
Merger
Related
Incyte Synteni Expenses Total
------- --------- --------- -------
Three months ended June 30, 1998
Revenue. . . . . . . . . . . $33,093 - - $33,093
Net income (loss). . . . . . 5,207 - - 5,207
Three months ended June 30, 1997
Revenue . . . . . . . . . . . $21,192 $ 233 - $21,425
Net income (loss) . . . . . . 1,942 (671) - 1,271
Six months ended June 30, 1998
Revenue . . . . . . . . . . . $63,472 - - $63,472
Net income (loss) . . . . . . 9,833 - (1,060) 8,773
Six months ended June 30, 1997
Revenue . . . . . . . . . . . $39,051 $ 372 - $39,423
Net income (loss) . . . . . . 2,923 (1,195) - 1,728
5. JOINT VENTURE
In September 1997, the Company formed a joint venture, diaDexus, LLC,
("diaDexus") which will utilize genomic and bioinformatic technologies in the
discovery and commercialization of molecular diagnostics. The Company holds a
50 percent equity interest in diaDexus and accounts for the investment under
the equity method. A portion of the investment is reflected as restricted cash
and in accrued liabilities on the balance sheet since that balance is held in
an escrow account and will be distributed to diaDexus as needed.
6. STOCKHOLDERS' EQUITY
In October 1997, the Company's Board of Directors authorized a two-for-one
stock split to be effected in the form of a stock dividend payable November 7,
1997 to holders of record on October 17, 1997. All share and per share data
have been adjusted retroactively to reflect the split.
7. NEW PRONOUNCEMENTS
In the first quarter of fiscal 1998 the Company adopted FASB Statement No.
130, Reporting Comprehensive Income ("SFAS 130"). SFAS 130 requires companies
to disclose, both individually and in the aggregate, the change in equity from
non-owner sources. The Company's adjustment to net income to arrive at
comprehensive income is comprised of unrealized gains and losses on marketable
securities available-for-sale. Comprehensive income was $5,268,000 and
$8,725,000 for the three and six months ended June 30, 1998, respectively, and
$1,375,000 and $1,771,000 for the respective periods in 1997.
In June 1997, the FASB issued Statement No. 131, Disclosures about Segments of
an Enterprise and Related Information ("SFAS 131"). SFAS 131 establishes
standards for reporting financial and descriptive information about an
enterprise's operating segments in its annual financial statements and
selected segment information in interim financial reports. Reclassification
or restatement of comparative financial statements or financial information
for earlier periods is required upon adoption of SFAS 131. Application of the
Statements' disclosure requirements will have no impact on the Company's
consolidated financial position, results of operations or earnings per share
data as currently reported.
8. LITIGATION
On January 6, 1998, Affymetrix, Inc. ("Affymetrix") filed a lawsuit in the
United States District Court for the District of Delaware alleging
infringement of U.S. patent number 5,445,934 (the "'934 Patent") by both
Synteni and Incyte. The complaint alleges that the '934 Patent has been
infringed by the making, using, selling, importing, distributing or offering
to sell in the U.S. high density arrays by Synteni and Incyte and that such
infringement was willful. Affymetrix seeks a permanent injunction enjoining
Synteni and Incyte from further infringement of the '934 Patent and, in
addition, seeks damages, costs and attorney's fees and interest. Affymetrix
further requests that any such damages be trebled based on its allegation of
willful infringement by Incyte and Synteni. Incyte and Synteni believe they
have meritorious defenses and intend to defend the suit vigorously. However,
there can be no assurance that Incyte and Synteni will be successful in the
defense of this suit, and litigation has resulted and, if a settlement is not
reached is expected to continue to result in substantial expenses and
diversion of the efforts of management and technical personnel. Further, there
can be no assurance that any license that may be required as a result of this
suit or the outcome thereof would be made available on commercially acceptable
terms, if at all.
PART I: FINANCIAL INFORMATION
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations as of June 30, 1998 and for the three and six month
periods ended June 30, 1998 and 1997 should be read in conjunction with the
unaudited condensed consolidated financial statements and notes thereto set
forth in Item 1 of this report and the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
the Company's Current Report on Form 8-K. dated June 12, 1998.
When used in this discussion, the words "expects," "anticipates,"
"estimates," and similar expressions are intended to identify forward-looking
statements. Such statements, which include statements as to expected
expenditure levels, the adequacy of capital resources, and growth in
operations, are subject to risks and uncertainties that could cause actual
results to differ materially from those projected. These risks and
uncertainties include, but are not limited to, those risks discussed below, as
well as the extent of utilization of genomic information by the pharmaceutical
industry in both research and development; risks relating to the development
of new database products and their use by potential collaborators of the
Company; the impact of technological advances and competition; the ability of
the Company to obtain and retain customers; competition from other entities;
early termination of a database collaboration agreement or failure to renew an
agreement upon expiration; the ability to successfully integrate the
operations of recent business combinations; the cost of accessing technologies
developed by other companies; uncertainty as to the scope of coverage,
enforceability or commercial protection from patents that issue on gene
sequences and other genetic information; developments in and expenses relating
to litigation; the results and viability of joint ventures and businesses in
which the Company has purchased equity; and the matters discussed below under
the caption "-Factors That May Affect Results." These forward-looking
statements speak only as of the date hereof. The Company expressly disclaims
any obligation or undertaking to release publicly any updates or revisions to
any forward-looking statements contained herein to reflect any change in the
Company's expectations with regard thereto or any change in events, conditions
or circumstances on which any such statement is based.
OVERVIEW
Incyte Pharmaceuticals, Inc. (the "Company") designs, develops and
markets genomic database products, genomic data management software tools,
microarray-based gene expression services and related reagents. The Company's
genomic databases integrate bioinformatics software with proprietary and, when
appropriate, publicly available genetic information to create
information-based tools used by pharmaceutical and biotechnology companies in
drug discovery and development. In building the databases, the Company
utilizes high-throughput, computer-aided gene sequencing and analysis
technologies to identify and characterize the expressed genes of the human
genome, as well as certain animal, plant and microbial genomes.
Revenues recognized by the Company consist primarily of non-exclusive database
access fees related to database collaboration agreements. Revenues also
include the sales of genomic screening products and services, gene expression
microarray services, fees for custom or "satellite" database services, and
genomic data management software tools and maintenance. The Company's database
collaboration agreements provide for future milestone payments and royalties
from the sale of products derived from proprietary information obtained
through the databases. There can be no assurance that any database
collaborators will ever generate products from information contained within
the databases and thus that the Company will ever receive milestone payments
or royalties.
In January 1998, the Company completed the acquisition of Synteni, Inc.
("Synteni"), a privately-held microarray-based gene expression company. The
transaction has been accounted for as a pooling-of-interests, and the
consolidated financial statements discussed herein and all historical
financial information have been restated to reflect the combined operations of
both companies. Synteni's ability to contribute to revenues and operating
profits will be dependent on the ability of the Company to obtain high volume
customers for Synteni's microarray services. Prior to the merger, Synteni's
microarray service agreements consisted of small volume pilot or feasibility
agreements. In September 1997, the Company formed a joint venture, diaDexus,
LLC ("diaDexus"), with SmithKline Beecham Corporation ("SB") which will
utilize genomic and bioinformatic technologies in the discovery and
commercialization of molecular diagnostics. The Company and SB each hold a 50
percent equity interest in diaDexus. The investment is accounted for under
the equity method and the Company will record its share of diaDexus' earnings
and losses on its statement of operations.
The Company's investments in joint ventures and businesses, particularly
diaDexus, may require the Company to record losses or expenses related to its
proportionate ownership interest in such entities, to record charges for the
acquisition of in-process technologies, or to record charges for the
recognition of the impairment in the value of the securities underlying such
investments. To date, exclusive of losses from joint ventures, the Company
has not incurred significant losses on its long-term equity investments. One
company in which the company holds an equity investment, OncorMed, Inc.
("OncorMed"), received a report from its independent auditors for the year
ended December 31, 1997 which expressed substantial doubt as to OncorMed's
ability to continue as a going concern. On July 7, 1998 Gene Logic Inc.
("Gene Logic") announced its that it entered into an agreement to acquire
OncorMed in exchange for shares of Gene Logic common stock with a value not to
exceed approximately $38 million. Consummation of the acquisition is subject
to approval by the stockholders of both companies. The investment in OncorMed
is accounted for under the cost method of accounting, and the acquisition
supports the Company's carrying value of the investment. The Company will
continue to evaluate its investment in OncorMed and all of its long-term
equity investments for impairment on a quarterly basis.
The need for continued investment in development of the Company's
databases and related products and services and for support of ongoing
collaborations results in significant fixed expenses. If revenue in a
particular period does not meet expectations, the Company may not be able to
adjust significantly its level of expenditures in such period, which would
have an adverse effect on the Company's operating results. The Company may
also experience difficulty in forecasting levels of operating expenditures
for, and integration-related expenses with respect to, subsidiaries acquired
through acquisitions, at least until a substantial period of time has passed
since the acquisition date. This is particularly true when attempting to
forecast expenditure levels for acquired businesses that focus on technologies
for which there is not yet an established market. The Company believes that
quarterly comparisons of its financial results will not necessarily be
meaningful and should not be relied upon as an indication of future
performance. Due to the foregoing and other unforeseen factors, it is likely
that in some future quarter or quarters the Company's operating results may be
below the expectations of public market analysts and investors.
In an effort to broaden its business, the Company is investing in a number of
new areas, including microarray services, molecular diagnostics,
pharmacogenomics and proteomics. Given that many of these address new
markets, or involve untested technologies, it is not known if any of them will
generate revenues or if the revenues will be sufficient to provide an adequate
return on the investment. Depending on the investment required and the timing
of such investments, expenses or losses related to these investments could
adversely affect operating results.
The Company has incurred, and unless a settlement is reached, and is
likely to continue to incur, substantial expenses in its defense of the
lawsuit filed in January 1998 by Affymetrix, Inc. ("Affymetrix") alleging
patent infringement by Synteni and Incyte. Affymetrix seeks a permanent
injunction enjoining Synteni and Incyte from further infringement and, in
addition, seeks damages, costs, attorneys' fees and interest. Affymetrix
further requests that any such damages be trebled on its allegation of willful
infringement by Incyte and Synteni. Incyte and Synteni believe they have
meritorious defenses and intend to defend the suit vigorously. However, there
can be no assurance that Incyte and Synteni will be successful in the defense
of this suit, and litigation, regardless of the outcome, could result in
substantial expenses and diversion of the efforts of management and technical
personnel. Further, there can be no assurance that any license that may be
required as a result of this suit or the outcome thereof would be made
available on commercially acceptable terms, if at all.
RESULTS OF OPERATIONS
Revenues for the three and six months ended June 30, 1998 increased to
$33.1 million and $63.5 million, respectively, compared to $21.4 million and
$39.4 million for the corresponding periods in 1997. Revenues resulted
primarily from database access fees and, to a much lesser extent, from genomic
screening products and services, custom satellite database services,
microarray-based gene expression services, and genomic data management
software tools and maintenance. The increase in revenues was primarily
attributed to new, as well as expanded, collaborative database agreements.
Total costs and expenses for the three and six months ended June 30, 1998
increased to $28.8 million and $56.3 million, respectively, compared to $20.6
million and $38.6 million for the corresponding periods in 1997. Total costs
and expenses for the six month period ended June 30, 1998 included an
acquisition-related charge of $1.2 million for the acquisition of Synteni,
Inc. The charge consisted primarily of accounting, legal and investment
banking fees. Total costs and expenses are expected to increase in the
foreseeable future due to significant growth in microarray production
capacity, the continued investment in new product development and
bioinformatics, growth in marketing, sales and customer services, and defense
of the Affymetrix lawsuit.
Research and development expenses for the three and six months ended June
30, 1998 increased to $23.1 million and $44.8 million, respectively, compared
to $17.4 million and $32.5 million for the corresponding periods in 1997. The
increase in research and development expenses resulted primarily from an
increase in bioinformatics and software development efforts, microarray
production and technology development, and continued investment in the growth
of the Company's intellectual property portfolio. The Company expects
research and development spending to increase over the next few years as the
Company continues to pursue the development of new database products and
services, invests in new technologies, broadens its microarray production
operations and invests in the protection of its intellectual property.
Selling, general and administrative expenses for the three and six months
ended June 30, 1998 increased to $5.7 million and $10.3 million, respectively,
compared to $3.3 million and $6.1 million for the corresponding periods in
1997. The increase in selling, general and administrative expenses resulted
primarily from the growth in marketing, sales and customer support, expenses
related to the defense of the Affymetrix lawsuit and increased administrative
personnel related to the growing complexity of the Company's business. The
Company expects that selling, general and administrative expenses will
increase throughout 1998 due particularly to continued growth in marketing,
sales and customer support functions, the expansion of the Company's United
Kingdom operations, and legal expenses related to the Company's defense of the
Affymetrix lawsuit.
Interest and other income, net for the three and six months ended June
30, 1998 increased to $1.8 million and $3.7 million, respectively, from $0.6
million and $1.1 million for the corresponding periods in 1997. This was
primarily a result of increased interest income from higher average combined
cash, cash equivalent and marketable securities balances due primarily to the
completion of a follow-on public offering in August 1997.
Losses from joint venture were $0.6 million for six months ended June 30,
1998 and zero for the three months ended June 30, 1998. The loss represents
the Company's equity share of diaDexus' net losses from operations. In the
three months ended June 30, 1998, the Company's share in diaDexus' net losses
was offset by the amortization of the excess of the Company's share of
diaDexus net assets over its basis. The amortization of this amount is
expected to approximate the Company's equity share in diaDexus losses through
the third quarter of 1998. As diaDexus was formed in September 1997, no
losses from joint venture were incurred in the three and six months ended June
30, 1997. The Company expects that losses from joint venture will continue at
least through 1999.
The estimated effective annual income tax rate for 1998 is 14%, which
represents the provision of federal and state alternative minimum taxes after
utilization of net operating loss carryforwards and research and development
credits.
Net income and diluted earning per share were $5.2 million and $8.8
million and $0.18 and $0.30 per share for the three and six months ended June
30, 1998, respectively, as compared to $1.3 million and $1.7 million and $0.05
and $0.07 in the same periods a year ago, respectively. Earnings per share
were affected by a follow-on public stock offering in August 1997 that
resulted in an increase in the number of shares outstanding of 2.8 million
shares, including 0.4 million shares issued upon the exercise of the
underwriters' over-allotment option. The Company's results of operations and
earning per share for the three and six months ended June 30, 1997 have been
restated to account for the acquisition of Synteni, which was accounted for as
a pooling-of-interests. Previously reported net income and diluted earnings
per share for the three and six months ended June 30, 1997 were $1.9 million
and $2.9 million, and $0.17 and $0.26, respectively. While the Company has
reported net income for the past six quarters, there can be no assurance that
the Company can maintain profitability. See "Factors that May Affect
Results-History of Operating Losses; Uncertainty of Continued Profitability or
Revenues."
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1998, the Company had $130.7 million in cash, cash
equivalents, restricted cash, and marketable securities, compared to $119.1
million as of December 31, 1997. For the six month period ended June 30, 1998,
cash provided by operating and financing activities was partially offset by
capital expenditures, consisting primarily of purchases of data
processing-related computer hardware, laboratory equipment and facilities
improvements, as well as investments in research and development alliances.
The Company has classified all of its marketable securities as short-term, as
the Company may decide not to hold its marketable securities until maturity in
order to take advantage of favorable market conditions. Available cash is
invested in accordance with the Company's investment policy's primary
objectives of liquidity, safety of principal and diversity of investments.
Net cash provided by operating activities was $33.1 million for the six
months ended June 30, 1998, as compared to $12.0 million for the six months
ended June 30, 1997. The increase in net cash provided by operating activities
resulted primarily from the increase in net income and deferred revenues, and
the decrease in accounts receivable partially offset by the increase in
prepaid expenses, deposits and other assets and the decrease in accounts
payable. Net cash generated by operating activities may in the future
fluctuate significantly from quarter to quarter due to the timing of large
prepayments by database collaborators.
The Company's investing activities, other than purchases, sales and
maturities of marketable securities, have mainly consisted of capital
expenditures and long-term investments. Capital expenditures for the six
months ended June 30, 1998 increased to $15.3 million from $9.1 million for
the six months ended June 30, 1997. Long-term investments in companies with
which the Company has research and development alliances increased to $6.9
million for the six months ended June 30, 1998 from $5.0 million for the six
months ended June 30, 1997. Long-term investments for the period ended June
30, 1998 consisted primarily of a $5.8 million equity investment in Oxford
GlycoSciences plc and $0.8 million equity investment in Layton Biosciences,
Inc, while long-term investments for the period ended June 30, 1997 consisted
of an equity investment in OncorMed. Net cash used by investing activities may
in the future fluctuate significantly from quarter to quarter due to the
timing of strategic equity investments, capital purchases and maturity/sales
and purchases of marketable securities.
Net cash provided by financing activities was $2.8 million for the six months
ended June 30, 1998 as compared to $4.3 for the six months ended June 30,
1997. The Company expects its cash requirements to increase through 1998 as
it increases its investment in data-processing-related computer hardware in
order to support its existing and new database products, continues to seek
access to technologies through investments, research and development
alliances, license agreements and/or acquisitions, and addresses its needs for
larger facilities and/or improvements in existing facilities. The Company has
entered into a multi-year lease with respect to a 95,000 square foot building
being constructed adjacent to the Company's Palo Alto headquarters. The
Company's share of tenant improvements is estimated to be between $10.0
million and $15.0 million, of which approximately $0.9 million have been
expended through June 30, 1998. Given the current construction schedule, the
Company does not expect to begin to incur significant expenses related to this
facility until late 1998 or early 1999. The Company expects to continue to
fund future operations with revenues from genomic database products and
services in addition to using its current cash, cash equivalents and
marketable securities.
Based upon its current plans, the Company believes that its existing
resources and anticipated cash flow from operations will be adequate to
satisfy its capital needs at least through 1999. However, the Company may be
unable to obtain additional collaborators or retain existing collaborators for
the Company's databases, genomic products and services, and these database
products and services may not produce revenues which, together with the
Company's cash, cash equivalents and marketable securities, would be adequate
to fund the Company's cash requirements. The Company's cash requirements
depend on numerous factors, including the ability of the Company to attract
and retain collaborators for its databases and genomic products and services;
competing technological and market developments; the cost of filing,
prosecuting, defending and enforcing patent claims and other intellectual
property rights; the purchase of additional capital equipment, including
capital equipment necessary to ensure the Company's sequencing, data
processing and microarray operations remain competitive and costs associated
with the integration of new operations assumed through mergers and
acquisitions. In particular, the Company expects its cash requirements to
increase in 1998 as it increases its investment in data processing-related
computer hardware in order to support its existing and new database products;
continues to seek access to technologies through investments, alliances,
license agreements, and/or acquisitions; makes investments associated with
integration of acquired companies; and addresses its needs for larger
facilities and/or improvements in existing facilities. The Company expects to
continue to fund future operations with revenues from genomic database
products and services in addition to using its current cash, cash equivalents
and marketable securities. Changes in the Company's research and development
plans or other changes affecting the Company's operating expenses may result
in changes in the timing and amount of expenditures of the Company's capital
resources. If additional capital is raised through the sale of equity or
convertible debt securities, the issuance of these securities could result in
dilution to the Company's existing stockholders. Additional funding, if
necessary, may not be available on favorable terms, if at all. If adequate
funds are not available, the Company may be required to curtail operations
significantly or to obtain funds through entering into collaborative
arrangements that may require the Company to relinquish rights to certain of
its technologies, product candidates, products or potential markets.
FACTORS THAT MAY AFFECT RESULTS
Uncertain Effects of the Synteni Merger. The combination of Synteni and
the Company involves several potential operating and business risks, including
the integration of Synteni's and the Company's businesses and management in a
timely, efficient and effective manner, the timely integration of Synteni's
microarray technology and services with the Company's database products and
services, integration of the respective sales and marketing and research and
development efforts, and any resulting loss of efficiency or loss of
employees. The combined companies may not realize any revenue enhancements or
cost savings or maintain Synteni's business relationships with its customers
after the merger. Also, any cost savings that are realized due to the merger
may be offset by increases in other expenses or operating losses, including
losses due to problems in integrating the two companies. See "-Risks
Associated With Acquisitions." Although the Company believes that beneficial
synergies will result from the Synteni merger, the combination of the two
companies' businesses, even if achieved in an efficient, effective and timely
manner, may not result in combined results of operations and financial
condition superior to what would have been achieved by each company
independently, and may take longer than expected. See "-History of Operating
Losses; Uncertainty of Continued Profitability or Revenues."
Risks Associated with Acquisitions. As part of its business strategy,
the Company may from time to time acquire assets and businesses principally
relating or complementary to its operations. These acquisitions may include
acquisitions for the purpose of acquiring specific technology. The Company
acquired two companies, Genome Systems, Inc. and Combion, Inc., in 1996 and
acquired Synteni in January 1998. If the Company acquires additional
businesses that are not located near the Company's Palo Alto, California
headquarters, the Company may experience more difficulty integrating and
managing the acquired businesses' operations. These and any other
acquisitions by the Company involve risks commonly encountered in acquisitions
of companies. These risks include, among other things, the following: the
Company may be exposed to unknown liabilities of acquired companies; the
Company may incur acquisition costs and expenses higher than it anticipated;
fluctuations in the Company's quarterly and annual operating results may occur
due to the costs and expenses of acquiring and integrating new businesses or
technologies; the Company may experience difficulty and expense of
assimilating the operations and personnel of the acquired businesses; the
Company's ongoing business may be disrupted and its management's time and
attention may be diverted; the Company may be unable to integrate successfully
or to complete the development and application of acquired technology and may
fail to achieve the anticipated financial, operating and strategic benefits
from these acquisitions; the Company may experience difficulties in
establishing and maintaining uniform standards, controls, procedures and
policies; the Company's relationships with key employees and customers of
acquired businesses may be impaired, or these key employees and customers may
be lost, as a result of changes in management and ownership of the acquired
businesses; the Company may incur amortization expenses if an acquisition is
accounted for as a purchase; and the Company's stockholders may be diluted if
the consideration for the acquisition consists of equity securities. The
Company may not overcome these risks or any other problems encountered in
connection with acquisitions. If the Company is unsuccessful in doing so, its
business, financial condition and results of operations could be materially
and adversely affected.
History of Operating Losses; Uncertainty of Continued Profitability or
Revenues. For the years ended December 31, 1996 and 1995, the Company had
net losses of $7.3 million and $9.9 million, respectively, and as of June 30,
1998, the Company had an accumulated deficit of $23.1 million. The Company has
experienced substantial revenue growth since 1995 and has reported quarterly
profits only since the first quarter of 1997. However, the Company may not be
able to maintain revenue growth or profitability. The Company's continued
investment in new product and technology development, obligations under
existing and future research and development alliances, and increased
investment in marketing, sales and customer service will require a continued
increase in expenditures in 1998 and beyond. Synteni's ability to contribute
to the profitability of the Company will be dependent on the ability of the
Company and Synteni to obtain high volume customers for Synteni's microarray
services and the costs associated with increasing microarray production
capacity. Prior to the merger, Synteni's microarray service agreements consist
of small volume pilot or feasibility agreements. The Company's ability to
achieve and maintain significant revenues will be dependent upon its ability
to obtain additional database collaborators, retain existing collaborators,
and expand its customer base for microarray services. The Company's ability to
maintain profitability will be dependent upon its ability to obtain database
collaborators, expand its customer base for microarray services, the level of
expenditures necessary for the Company to maintain and support its services to
its collaborators, and the extent to which it incurs research and development,
investment, acquisition-related or other expenses related to the development
and provision of its products and services to database collaborators. While,
as of June 1998, the Company had twenty-one database collaborations, the
Company may be unable to enter into any additional collaborations. Further,
the Company's database collaboration agreements typically have a term of three
years. Some of these agreements require the Company to meet certain
performance obligations. These agreements may not be renewed upon expiration,
and a database collaboration agreement may be terminated earlier by a
collaborator if the Company breaches the agreement and fails to cure such
breach within a specified period. The loss of revenues from any database
collaborator could have a material adverse effect on the Company's business,
financial condition and results of operations.
Part of the Company's commercialization strategy is to license to
database collaborators the Company's patent rights to individual partial genes
or full-length cDNA sequences from the Company's proprietary sequence
database, for development as potential pharmaceutical, diagnostic or other
products. Any potential product that is the subject of such a license will
require several years of further development, clinical testing and regulatory
approval prior to commercialization. Accordingly, the Company does not expect
to receive any milestone or royalty payments from any such licenses for a
substantial period of time, if at all.
Fluctuations in Operating Results. The Company's operating results may
fluctuate significantly from quarter to quarter as a result of a variety of
factors, including; changes in the demand for the Company's products and
services; the pricing of database access to database collaborators; the
nature, pricing and timing of other products and services provided to the
Company's collaborators; changes in the research and development budgets of
the Company's collaborators and potential collaborators; capital expenditures;
acquisition and licensing costs and other costs related to the expansion of
the Company's operations, including operating losses of acquired businesses
such as Synteni; the introduction of competitive databases or services; and
expenses related to, and results of, litigation (including the lawsuit filed
by Affymetrix described below under "Litigation") and other proceedings
relating to intellectual property rights. In particular, the Company has a
limited ability to control the timing of database installations, there is a
lengthy sales cycle required for the Company's database products, the
Company's revenue levels are difficult to forecast, the time required to
complete custom orders can vary significantly and the Company's increasing
investments in external alliances could result in significant quarterly
fluctuations in expenses due to the payment of milestones, license fees or
research payments.
The Company's investments in joint ventures and businesses, particularly
diaDexus, a joint venture with SB, may require the Company to record losses or
expenses related to its proportionate ownership interest in such entities, to
record charges for the acquisition of in-process technologies, or to record
charges for recognition of the impairment in the value of the securities
underlying such investments. To date, exclusive of losses from joint ventures,
the Company has not incurred significant losses on its long-term equity
investments. One entity in which the Company has made an equity investment,
OncorMed, received a report from its independent auditors for the year ended
December 31, 1997 which expressed substantial doubt as to OncorMed's ability
to continue as a going concern. On July 7, 1998 Gene Logic announced its that
it entered into an agreement to acquire OncorMed in exchange for shares of
Gene Logic common stock with a value not to exceed approximately $38 million.
Consummation of the acquisition is subject to approval by the stockholders of
both companies. The investment in OncorMed is accounted for under the cost
method of accounting, and the acquisition supports the Company's carrying
value of the investment. The Company will continue to evaluate its investment
in OncorMed and all of its long-term equity investments for impairment on a
quarterly basis. In an effort to broaden its business, the Company is
investing in a number of new areas, including microarray services, molecular
diagnostics, pharmacogenomics and proteomics. Given that many of these
address new markets, or involve untested technologies, it is not known if any
of them will generate revenues or if the revenues will be sufficient to
provide an adequate return on the investment. Depending on the investment
required and the timing of such investments, expenses or losses related to
these investments could adversely affect operating results.
The need for continued investment in development of the Company's
databases and related products and services and for extensive ongoing
collaborator support capabilities results in significant fixed expenses. If
revenue in a particular period does not meet expectations, the Company may not
be able to adjust significantly its level of expenditures in such period,
which would have an adverse effect on the Company's operating results. The
Company may also experience difficulty in forecasting levels of operating
expenditures for, and integration-related expenses with respect to,
subsidiaries acquired through acquisitions, at least until a substantial
period of time has passed since the acquisition date. This is particularly
true when attempting to forecast expenditure levels for acquired businesses
that focus on technologies for which there is not yet an established market.
The Company believes that quarterly comparisons of its financial results will
not necessarily be meaningful and should not be relied upon as an indication
of future performance. Due to the foregoing and other unforeseen factors, it
is likely that in some future quarter or quarters the Company's operating
results will be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially and adversely affected.
Competition and Technological Changes. There are a finite number of
genes in the human genome, and competitors may seek to identify, sequence and
determine in the shortest time possible the biological function of a large
number of genes in order to obtain a proprietary position with respect to the
largest number of new genes discovered. There are a number of companies, other
institutions, and government-financed entities engaged in gene sequencing,
gene discovery, gene expression analysis, positional cloning and other genomic
service businesses. Many of these companies, institutions and entities have
greater financial and human resources than the Company. In addition, the
Company is aware that other companies have developed genomic databases and are
marketing, or have announced their intention to market their data to
pharmaceutical companies. The Company expects that additional competitors may
attempt to establish gene sequence, gene expression or other genomic databases
in the future.
In addition, competitors may discover and establish patent positions with
respect to gene sequences in the Company's databases. Further, certain
entities engaged in gene sequencing, including Merck & Co., Inc. ("Merck") and
The Institute for Genomic Research ("TIGR"), have made the results of their
sequencing efforts publicly available. The Perkin-Elmer Corporation, Dr. J.
Craig Venter, and TIGR announced in May 1998 the signing of a letter of intent
to form a new company that has the goal of sequencing the entire human genome
within three years and to make the sequence information publicly available.
The public availability of gene sequences or resulting patent positions
comprising substantial portions of the human genome or microbial or plant
genomes could decrease the potential value of the Company's databases to the
Company's collaborators and adversely affect the Company's ability to realize
royalties or other revenue from commercialization of products based upon this
genetic information.
The gene sequencing machines that are utilized in the Company's
high-throughput computer-aided gene sequencing operations are commercially
available and are currently being utilized by several competitors. Some of the
Company's competitors or potential competitors are in the process of
developing, and may successfully develop, proprietary sequencing technologies
that may be more advanced than the technology used by the Company. In
addition, the Company is aware that there are a number of companies pursuing
alternative methods for generating gene expression information, including
those that have developed, and are developing, microarray technologies. At
least one other company currently offers microarray-based services that might
be competitive with those offered by the Company. These advanced sequencing or
gene expression technologies, if developed, may not be commercially available
for purchase or license by the Company on reasonable terms, if at all.
A number of companies have announced their intent to develop and market
software to assist pharmaceutical companies and academic researchers in the
management and analysis of their own genomic data, as well as the analysis of
sequence data available in the public domain. Some of these entities have
access to significantly greater resources than the Company and these products
may achieve greater market acceptance than the Company's products.
The Company's databases also require extensive software support and
incorporate features determined by database collaborators' needs. If the
Company experiences delays or difficulties in implementing its database
software or collaborator-requested features, its ability to service its
collaborators may be adversely affected, which might have an adverse effect on
the Company's business and operating results.
The genomics industry is characterized by extensive research efforts and
rapid technological progress. To remain competitive, the Company will be
required to continue to expand its databases and to enhance the functionality
of its bioinformatics and database software. New developments are expected to
continue and discoveries by others may render the Company's services and
potential products noncompetitive.
New and Uncertain Business. The Company's genomic database business and
the use of its databases, software tools and related services to assist its
collaborators and potentially improve the efficiency of the traditional drug
discovery process represent a business for which there is no precedent. In
addition, the Company's microarray services business represents a business for
which there is no precedent. The Company's collaborators or potential
collaborators may determine that the databases, software tools and microarray
and related services provided by the Company are not useful or cost-effective.
The Company's strategy of using high-throughput sequencing to identify genes
rapidly and obtain proprietary rights in as many genes as possible and its
strategy of using microarrays to identify differentially expressed genes is
unproven. In addition, the Company has limited experience in providing
bioinformatics software and database products and services. The Company's
ability to sustain profitability depends on attracting additional
collaborators and retaining existing collaborators for its database,
sequencing and software products and services and microarray services. The
nature and price of these database, sequencing and software products and
services and microarray services are such that there is a limited number of
pharmaceutical and biotechnology companies that are potential collaborators
for such products and services. Additional factors that may affect demand for
the Company's products and services include the extent to which potential
collaborators choose to conduct in-house gene sequencing, bioinformatics
analysis, and microarray-based gene expression analysis, the emergence of
competitors offering similar services at competitive prices, the ability of
the Company to service satisfactorily its existing collaborators, the extent
to which the gene and related information in the Company's database is made
public by, or is the subject of, patents issued to others, the Company's
ability to establish and enforce proprietary rights to its products, and the
emergence of technological innovations in gene sequencing, gene expression
profiling or bioinformatics and relational database software that are more
advanced than the technology used by and available to the Company. The Company
may be unable to attract additional collaborators on acceptable terms for its
products and services or develop a sustainable profitable business.
Risks Associated with Strategic Investments. The Company has funded and
intends in the future to fund strategic equity investments in joint ventures
or businesses that complement the business of the Company. These investments,
such as the Company's investment in diaDexus, may require the Company to
record losses and expenses related to its proportionate ownership interest in
such entities, the acquisition of in-process technologies, or the impairment
in the value of the securities underlying such investments. These losses may
exceed amounts anticipated, which could result in the Company's operating
results being below the expectations of public market analysts and investors.
These investments may often be made in securities for which there is no public
trading market or in securities not registered under the Securities Act of
1933 and therefore subject to trading restrictions, either of which increases
the Company's risk of investment and reduces the liquidity of the Company's
investment. In addition, the Company could be required to invest greater
amounts than initially anticipated or to devote substantial management time to
the management of research and development relationships and joint ventures.
The occurrence of any of the foregoing could result in a material adverse
effect on the Company's business, financial condition and results of
operations.
Lengthy Sales Cycle. The ability of the Company to obtain new
collaborators for its databases, software tools and microarray and other
services depends in significant part upon prospective collaborators'
perceptions that the Company's databases, software tools, and microarray
services can help accelerate drug discovery efforts. The sales cycle is
typically lengthy due to the education effort that is required, as well as the
need to effectively sell the benefits of the Company's databases, software
tools, and microarray services to a variety of constituencies within potential
collaborator companies. In addition, each database collaboration and
microarray services agreement involves the negotiation of agreements
containing terms that may be unique to each partner, such as the scope of any
licenses granted and whether satellite database services or access to multiple
database modules is desired. The Company may expend substantial funds and
management effort with no assurance that a collaboration will result.
Uncertainty of Protection of Patents and Proprietary Rights. The
Company's database business and competitive position are dependent in part
upon its ability to protect its proprietary database information and software
technology. Despite the Company's efforts to protect its proprietary database
information and software technology, unauthorized parties may attempt to
obtain and use information that the Company regards as proprietary. Although
the Company's database collaboration agreements require its collaborators to
provide adequate security for, and to control access to the Company's
databases, policing unauthorized use of the Company's databases and software
by the Company or its collaborators is difficult. The Company relies on
patent, trade secret, and copyright law, and nondisclosure and other
contractual arrangements to protect its proprietary information.
To date, the Company has been issued a number of patents with respect to
the gene sequences in the Company's databases and has filed for patents on
selected features of its related software, but has not been issued patents or
registered copyrights for that software. Patents cannot prevent others from
developing, selling or licensing databases that include sequences which might
be covered by the Company's patents and copyrights. The Company cannot prevent
others from independently developing software that might be covered by any
copyrights issued to the Company and trade secret laws do not prevent
independent development. Thus, there can be no assurance that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's proprietary information,
that this information will not be disclosed or that the Company can
effectively protect its rights to unpatented trade secrets.
The Company pursues a policy of having its employees, consultants and
advisors execute proprietary information and invention agreements upon
commencement of employment or consulting relationships with the Company. These
agreements provide that all confidential information developed or made known
to the individual during the course of the relationship shall be kept
confidential except in specified circumstances. These agreements may not,
however, provide meaningful protection for the Company's trade secrets or
other proprietary information in the event of unauthorized use or disclosure
of this information.
The Company's current policy is to file patent applications on what it
believes to be novel full-length cDNA sequences and partial sequences obtained
through the Company's high-throughput computer-aided gene sequencing efforts.
The Company has filed U.S. patent applications in which the Company has
claimed certain partial gene sequences and has filed patent applications in
the U.S. and applications under the Patent Cooperation Treaty ("PCT")
designating countries in Europe as well as Canada, Japan, Mexico and New
Zealand claiming full-length gene sequences associated with cells and tissues
that are the subject of the Company's high-throughput gene sequencing program.
To date, the Company holds a number of issued U.S. patents on full-length
genes, but no patent has issued from any of the Company's patent applications
that claim partial gene sequences. The Company is aware that Merck (in
conjunction with Washington University) and TIGR have made certain gene
sequences publicly available, which may adversely affect the ability of the
Company and others to obtain patents on such genes. The Company's ability to
obtain patent protection for certain sequences that have been made publicly
available may be adversely affected.
The Company believes that certain of its patent applications claim genes
which may also be claimed in patent applications filed by other parties. In
some or all of these applications, a determination of priority of inventorship
may need to be decided in an interference before the United States Patent and
Trademark Office ("USPTO"). The USPTO has declared an interference involving a
Company patent application covering one full-length gene, and the Company has
been informed that interferences may be declared with respect to applications
covering approximately a dozen additional genes.
The patentability of partial gene sequences in general is uncertain,
involves complex legal and factual questions, and has recently been the
subject of much controversy. As a result, patent applications filed by the
Company on such partial gene sequences may not result in issued patents. Even
if patents are issued for partial gene sequences, there may be uncertainty as
to the scope of the coverage, enforceability or commercial protection provided
by any such patents. Certain court decisions suggest that disclosure of a
partial sequence may not be sufficient to support the patentability of a
full-length sequence and that patent claims to a partial sequence may not
cover a full-length sequence inclusive of that partial sequence.
The USPTO has had a substantial backlog of biotechnology patent
applications and, in particular, applications that claim gene sequences. In
1996, the USPTO issued guidelines limiting the number of partial gene
sequences that can be examined within a single patent application. Many of the
Company's patent applications containing multiple partial sequences contain
more sequences than the maximum number allowed under the new guidelines. The
Company is reviewing its options and, due to the resources needed to comply
with the guidelines, may decide to abandon patent applications for some of its
partial gene sequences. Given that the Company's cost of filing large numbers
of patent applications and maintaining issued patents can be significant, and
the Company may choose not to pursue every applications. If the Company does
not pursue patent protection for all of its full-length and partial gene
sequences, the value of its intellectual property portfolio could be
diminished.
In view of the possible delay in obtaining allowance of some of the
Company's patent applications, and the secrecy of patent applications, the
Company does not know if other applications that would have priority over the
Company's applications have been filed. Furthermore, changes in U.S. patent
laws resulting from the General Agreement on Tariffs and Trade ("GATT") became
effective in June 1995. Most notably, GATT resulted in U.S. law being amended
to change the term of patent protection from seventeen years from patent
issuance to twenty years from the earliest effective filing date of the
application. Because the average time from filing to issuance of biotechnology
applications is at least one year and may be more than three years depending
on the subject matter, a twenty-year patent term from the date of filing may
result in a substantially shortened term of patent protection, which may
adversely affect the Company's period of exclusivity under any patents that
may issue to the Company. Pending applications claiming large numbers of gene
sequences may, in some situations, need to be refiled while claiming priority
to the earliest filing date and, in such situations, the patent term will be
measured from the date of the earliest priority application. This would reduce
the patent term and have a potentially adverse effect on the Company's period
of exclusivity.
Biotechnology patent law outside the United States is even more uncertain
and is currently undergoing review and revision in many countries. Further,
the laws of certain foreign countries may not protect the Company's
intellectual property rights to the same extent as do the laws of the United
States. The Company may participate in opposition proceedings to determine the
validity of its or its competitors' non-U.S. patents, which could result in
substantial costs to and diversion of effort by the Company.
As the biotechnology industry expands, more patents are issued and other
companies engage in the business of discovering genes through the use of high
speed sequencers and in other genomic-related businesses, such as microarray
and gene expression profiling, the risk increases that the Company's potential
products or the processes used by the Company to develop these products may be
subject to claims that they infringe the patents of others. Certain of these
patents are the subject of litigation. Therefore, the Company's operations may
require it to obtain licenses under any of these patents or proprietary
rights, and these licenses may not be made available on terms acceptable to
the Company. Litigation may be necessary to defend against or assert claims of
infringement, to enforce patents issued to the Company, to protect trade
secrets or know-how owned by the Company, or to determine the scope and
validity of the proprietary rights of others. The Company could also be
involved in interferences with respect to patent applications. Given the large
number of applications filed by the Company, a large number of interferences
could be expensive and time consuming. In addition, it is impossible to
predict how many, if any, of the interferences would be resolved in the
Company's favor. The Company is currently involved in litigation and
interference proceedings with respect to patents and intellectual property
rights. Litigation or interference proceedings, regardless of the outcome,
could result in substantial costs to, and diversion of effort by the Company,
and may have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, these efforts by the
Company may not be successful.
As is typical in the genomics and software industries, the Company has
from time to time received, and believes that it likely will receive in the
future, notices from third parties alleging infringement claims. The Company
believes that it is not infringing the patent rights of any such third party,
and in circumstances in which the Company has determined a response to an
alleged infringement claim to be appropriate, the Company has notified the
claimant to that effect. To date, except as set forth below under
"Litigation," no third party has filed suit with respect to an alleged claim
against the Company. There can be no assurance that action will not be taken
against the Company in the future, either with respect to previously asserted
or new claims or that if any action is taken, what the outcome of such action
will be.
Litigation. On January 6, 1998, Affymetrix filed a lawsuit in the United
States District Court for the District of Delaware alleging infringement of
U.S. patent number 5,445,934 (the "'934 Patent") by both Synteni and Incyte.
The complaint alleges that the '934 Patent has been infringed by the making,
using, selling, importing, distributing or offering to sell in the U.S. high
density arrays by Synteni and Incyte and that such infringement was willful.
Affymetrix seeks a permanent injunction enjoining Synteni and Incyte from
further infringement of the '934 Patent and, in addition, seeks damages, costs
and attorney's fees and interest. Affymetrix further requests that any such
damages be trebled based on its allegation of willful infringement by Incyte
and Synteni. Discovery has commenced, and the court has tentatively scheduled
trial for May 1999. Incyte and Synteni believe they have meritorious defenses
and intend to defend the suit vigorously. However, there can be no assurance
that Incyte and Synteni will be successful in the defense of this suit, and
litigation, regardless of the outcome, has resulted and unless a settlement
is reached, is expected to continue to result in substantial expenses and
diversion of the efforts of management and technical personnel. Further, there
can be no assurance that any license that may be required as a result of this
suit or the outcome thereof would be made available on commercially acceptable
terms, if at all.
Future Capital Needs; Uncertainty of Additional Funding. The Company
believes that its existing cash, cash equivalents and marketable securities
should be adequate to satisfy the Company's projected working capital, capital
expenditure and other cash requirements at least through June 1999. However,
the Company may be unable to obtain additional database collaborators or
retain existing collaborators for the Company's databases, and its database
products and services may not produce revenues, which together with the
Company's cash, cash equivalents, and marketable securities, will be adequate
to fund the Company's cash requirements. The Company's cash requirements
depend on numerous factors, including the ability of the Company to attract
and retain collaborators for its databases and genomic products and services;
expenditures in connection with alliances, license agreements and acquisitions
of and investments in complementary technologies and businesses; competing
technological and market developments; the cost of filing, prosecuting,
defending, and enforcing patent claims and other intellectual property rights;
the purchase of additional capital equipment or other capital expenditures,
including capital equipment necessary to ensure that the Company's sequencing
and microarray operations remain competitive; capital expenditures required to
expand the Company's and Synteni's facilities; and costs associated with the
integration of new operations assumed through mergers and acquisitions. In
particular, the Company expects its cash requirements to increase in 1998 as
it increases its investment in data processing-related computer hardware in
order to support its existing and new database products; continues to seek
access to technologies through investments, alliances, license agreements,
and/or acquisitions; makes investments associated with integration of acquired
companies; and addresses its needs for larger facilities and/or improvements
in existing facilities. Changes in the Company's research and development
plans, or other changes affecting the Company's operating expenses, may result
in changes in the timing and amount of expenditures of the Company's capital
resources. If additional capital is raised through the sale of equity or
convertible debt securities, the issuance of these securities could result in
dilution to the Company's existing stockholders. Additional funding, if
necessary, may not be available on favorable terms, if at all. If adequate
funds are not available, the Company may be required to curtail operations
significantly or to obtain funds through entering into collaborative
arrangements that may require the Company to relinquish rights to certain of
its technologies, product candidates, products or potential markets.
Management of Growth. The Company has recently experienced, and expects
to continue to experience, significant growth in the number of its employees
and the scope of its operations. This growth has placed, and may continue to
place, a significant strain on the Company's management and operations. The
Company's ability to manage effectively this growth will depend upon its
ability to broaden its management team and its ability to attract, hire and
retain skilled employees. The Company's success will also depend on the
ability of its officers and key employees to continue to implement and improve
its operational, management information and financial control systems and to
expand, train and manage its employee base. In addition, the Company must
continue to take steps to provide customer support resources as the number of
overall database collaborators and the number of requests from collaborators
increases. Further, the Company's database collaborators typically have
worldwide operations and may require support at multiple U.S. and foreign
sites. Providing this support may require the Company to open offices in
addition to its Palo Alto, California headquarters and its offices in St.
Louis, Missouri and the United Kingdom, which could result in additional
burdens on the Company's systems and resources. The Company's inability to
manage growth effectively, including its growth through acquisitions, could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Dependence on Key Employees. The Company is highly dependent on the
principal members of its scientific and management staff, including Roy A.
Whitfield, its Chief Executive Officer, and Randal W. Scott, its President and
Chief Scientific Officer, the loss of whose services would have a material
adverse effect on the Company's business. The Company has not entered into any
employment agreements with any of these persons and does not maintain any key
person life insurance policy on the life of any employee. The Company's
future success also will depend in part on the continued service of its key
scientific, software, bioinformatics and management personnel and its ability
to identify, hire and retain additional personnel, including personnel in the
customer service, marketing and sales areas. The Company experiences intense
competition for qualified personnel in the areas of the Company's activities,
especially with respect to experienced bioinformatics and software personnel,
and there can be no assurance that the Company will be able to continue to
attract and retain personnel necessary for the development of the Company's
business. Failure to attract and retain key personnel could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Others. The Company relies on a limited number of
suppliers of gene sequencing machines and certain reagents required in
connection with the gene sequencing process. Although the Company is
evaluating alternative gene sequencing machines, these machines may not be
available in sufficient quantities, available at acceptable costs, or prove to
be more cost-effective than current machines. Patent right issues concerning
certain current and future generation sequencing machines may also arise which
could prevent the Company from using them or make their use more expensive. If
the Company is unable to obtain additional machines or an adequate supply of
reagents or other materials at commercially reasonable rates, its ability to
continue to identify genes through gene sequencing would be adversely
affected. In addition, although the Company obtains, from a number of
sources, tissue samples from which mRNA may be isolated, the loss of access to
some of these sources, increased fees for access to these sources or increased
restrictions on use of the information generated could adversely affect the
Company's business.
The Company's strategy for the development of its database and sequencing
business and the commercialization of its portfolio of partial and full-length
gene sequences may require the Company to enter into various research and
development relationships with corporate and academic collaborators and
others. The success of these relationships is dependent upon the performance
of outside parties of their responsibilities. The Company may not be able to
establish collaborative arrangements or license agreements that the Company
deems necessary or acceptable to develop its database and sequencing business
or, in the future, to commercialize its portfolio of partial and full-length
gene sequences. In addition, these collaborative arrangements or license
agreements may not be successful. The Company's collaborators may also be
pursuing alternative technologies or developing alternative products either on
their own or in collaboration with others, including the Company's
competitors.
The Company has relied on scientific, technical, pathology, commercial
and other data supplied and disclosed by others, including its academic
collaborators and sources of tissue samples, and may rely on these data in the
construction of its database. There can be no assurance that these data
contain no errors or omissions, or that the sources of these data have
acquired the data in compliance with applicable legal requirements, the
knowledge of which would adversely change the prospects for the Company's
business.
Year 2000 Issue. As a result of computer programs being written using
two digits, rather than four, to represent year dates, the performance of the
Company's computer systems and those of its suppliers and customers in the
Year 2000 is uncertain. Any computer programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities. The Company plans to initiate a Year 2000 project, using
internal and external resources, to evaluate the impact of the Year 2000 on
its products and operating systems. This will include the initiation of formal
communications with its significant suppliers and customers to determine the
extent to which the Company's interface systems are vulnerable to third party
failures to remediate their own Year 2000 issues. There can be no guarantee
that the systems of other companies on which the Company's systems rely will
be timely converted and would not have an adverse effect on the Company's
systems. The Company will perform a comprehensive review of all internally
used financial and administrative systems as well as internally developed
products sold to customers. At this time, given that the Company's internal
financial and administrative systems have been installed within the last few
years, and all internally developed software-based products sold to customers
have been developed over the last few years, the Company does not expect the
cost of addressing the Year 2000 issue to have a material impact on the
Company's business, results of operations or financial condition. However,
there can be no guarantee that if modifications or replacement of portions of
the software are necessary, it will be completed in a timely manner.
Hazardous Materials; Environmental Matters. The Company's research and
development involves the controlled use of hazardous and radioactive materials
and biological waste. The Company is subject to federal, state and local laws
and regulations governing the use, manufacture, storage, handling and disposal
of these materials and certain waste products. Although the Company believes
that its safety procedures for handling and disposing of these materials
comply with the standards prescribed by such laws and regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held
liable for any damages that result and any such liability could exceed the
resources of the Company. Although the Company believes that it is in
compliance in all material respects with applicable environmental laws and
regulations and currently does not expect to make material additional capital
expenditures for environmental control facilities in the near-term, the
Company may in the future be required to incur significant costs to comply
with environmental laws and regulations, and there can be no assurance that
the operations, business or assets of the Company will not be materially or
adversely affected by current or future environmental laws or regulations.
Reliance on Pharmaceutical Industry; Uncertainty of Health Care Reform
and Related Matters. The Company expects that all of its revenues in the
foreseeable future will be derived from products and services provided to the
pharmaceutical and biotechnology industries. Accordingly, the Company's
success in the foreseeable future is directly dependent upon the success of
the companies within those industries and their continued demand for the
Company's products and services. The Company's operations may in the future be
subject to substantial period-to-period fluctuations as a consequence of
reductions and delays in research and development expenditures by companies in
these industries resulting from factors such as changes in economic
conditions, changes in the regulatory environment affecting health care and
health care providers, pricing pressures, market-driven pressures on companies
to consolidate and reduce costs, and other factors affecting research and
development spending. The occurrence of any of the foregoing factors could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Risk of Business Interruption. The Company conducts all of its
sequencing and other activities at its facilities in Palo Alto, California,
and Synteni conducts all of its operations at its facilities in Fremont,
California. Both locations are in a seismically active area. Although the
Company maintains business interruption insurance, the Company does not
currently have, nor does it plan to obtain, earthquake insurance. A major
catastrophe (such as an earthquake or other natural disaster) could result in
a prolonged interruption of the Company's business.
PART II: OTHER INFORMATION
ITEM 1 Legal Proceedings
On January 6, 1998, Affymetrix, Inc. ("Affymetrix") filed a lawsuit in the
United States District Court for the District of Delaware alleging
infringement of U.S. patent number 5,445,934 (the "'934 Patent") by both
Synteni and Incyte. The complaint alleges that the '934 Patent has been
infringed by the making, using, selling, importing, distributing or offering
to sell in the U.S. high density arrays by Synteni and Incyte and that such
infringement was willful. Affymetrix seeks a permanent injunction enjoining
Synteni and Incyte from further infringement of the '934 Patent and, in
addition, seeks damages, costs and attorney's fees and interest. Affymetrix
further requests that any such damages be trebled based on its allegation of
willful infringement by Incyte and Synteni. Incyte and Synteni believe they
have meritorious defenses and intend to defend the suit vigorously. However,
there can be no assurance that Incyte and Synteni will be successful in the
defense of this suit, and litigation has resulted and, if a settlement is not
reached is expected to continue to result in substantial expenses and
diversion of the efforts of management and technical personnel. Further, there
can be no assurance that any license that may be required as a result of this
suit or the outcome thereof would be made available on commercially acceptable
terms, if at all.
ITEM 2 Changes in Securities
(a) Not applicable
(b) Not applicable
(c) Not applicable
(d) Not applicable
ITEM 3 Defaults upon Senior Securities
None
ITEM 4 Submission of Matters to a Vote of Security Holders
On June 15, 1998, the Company held its Annual
Meeting of Stockholders. The following actions were
taken at the annual meeting:
FOR WITHHELD
---------- --------
a. Roy A. Whitfield . . 23,027,296 110,784
b. Barry M. Bloom . . . 23,021,466 116,614
c. Frederick B. Craves. 23,019,043 119,037
d. Randal W. Scott. . . 23,025,315 112,765
e. Jeffrey J. Collinson 23,026,615 111,465
f. Jon S. Saxe . . . . 23,026,896 111,184
1. The following Directors were elected
For. . . . Against Abstain Broker Non-Vote
---------- --------- ------- ---------------
12,820,634 7,666,888 68,375 5,948,843
2. A proposal to amend the Company's 1991 Stock Plan
For Against Abstain Broker Non-Vote
---------- ------- ------- ---------------
23,113,143 12,426 12,511 3,366,660
3. The selection of the Company's independent auditors was ratified
ITEM 5 Other Information
To be considered for inclusion in the Company's proxy statement and form of
proxy for its 1999 Annual Meeting of Stockholders, a stockholder proposal must
be received at the principal executive offices of the Company not later than
January 1, 1999.
A stockholder proposal not included in the Company's proxy statement for the
1999 Annual Meeting will be ineligible for presentation at the meeting unless
the stockholder gives timely notice of the proposal in writing to the
Secretary of the Company at the principal executive offices of the Company and
otherwise complies with the provisions of the Company's Bylaws. To be timely,
the Company's Bylaws provide that the Company must have received the
stockholder's notice not less than 60 days nor more than 90 days prior to the
scheduled date of such meeting. However, if notice or prior public disclosure
of the date of the annual meeting is given or made to stockholders less than
70 days prior to the meeting date, the Company must receive the stockholder's
notice by the earlier of (i) the close of business on the 10th day after the
earlier of the day the Company mailed notice of the annual meeting date or
provided such public disclosure of the meeting date and (ii) two days prior to
the scheduled date of the annual meeting.
ITEM 6 Exhibits and Reports on Form 8-K.
a) Exhibits
See Exhibit Index on Page 27
b) Reports on Form 8-K
The Company filed one report on Form 8-K during the fiscal quarter covered by
this report, as follows:
i) Current Report on Form 8-K, filed on June 12, 1998, reporting under Item 5
the Company's selected consolidated financial data, management's discussion
and analysis of financial condition and results of operations, and audited
consolidated financial statements as of and for the periods listed therein,
which have been restated to reflect the combined results of Incyte, Inc. and
Synteni, Inc.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INCYTE PHARMACEUTICALS, INC.
Date: August 14, 1998 By: /s/ Roy A. Whitfield
-----------------------
Roy A. Whitfield
Chief Executive Officer
Date: August 14, 1998 By: /s/ Denise M. Gilbert
-----------------------
Denise M. Gilbert
Executive Vice President and
Chief Financial Officer
INCYTE PHARMACEUTICALS, INC.
EXHIBIT INDEX
NO. EXHIBIT PAGE
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27 Financial Data Schedule, June 30, 1998 28