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, 1999
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)
3160 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 28,020,849 as of June 30, 1999.
INCYTE PHARMACEUTICALS, INC.
INDEX
PART I: FINANCIAL INFORMATION PAGE
- ---------------------------------------------------------------------------------------- ----
ITEM 1 Financial Statements - Unaudited
Condensed Consolidated Balance Sheets - June 30, 1999 and December 31, 1998 3
Condensed Consolidated Statements of Operations - three and six months
ended June 30, 1999 and 1998 4
Statements of Comprehensive Income (Loss) - three and six months
ended June 30, 1999 and 1998 5
Condensed Consolidated Statements of Cash Flows - six months
ended June 30, 1999 and 1998 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
PART II: OTHER INFORMATION
- ----------------------------------------------------------------------------------------
ITEM 1 Legal Proceedings 32
ITEM 2 Changes in Securities. 32
ITEM 3 Defaults Upon Senior Securities 33
ITEM 4 Submission of Matters to a Vote of Security Holders 33
ITEM 5 Other Information 33
ITEM 6 Exhibits and Reports on Form 8-K 33
Signatures 34
Exhibit Index 35
PART I: FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
JUNE 30, DECEMBER 31,
1999 1998*
---------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 53,284 $ 50,048
Marketable securities - available-for-sale 52,797 61,185
Accounts receivable, net 4,594 14,318
Prepaid expenses and other current assets 6,688 5,813
---------- --------------
Total current assets 117,363 131,364
Property and equipment, net 63,966 54,429
Long-term investments 16,917 20,653
Goodwill and other intangible assets, net 15,760 16,955
Deposits and other assets 10,164 6,889
---------- --------------
Total assets $ 224,170 $ 230,290
========== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,597 $ 8,244
Accrued and other current liabilities 8,131 7,843
Accrued compensation 5,084 4,786
Deferred revenue 35,042 29,054
---------- --------------
Total current liabilities 52,854 49,927
Non-current portion of capital lease obligations and note payable 382 796
---------- --------------
Total liabilities 53,236 50,723
---------- --------------
Stockholders' equity:
Common stock 28 28
Additional paid-in capital 210,943 209,192
Deferred compensation (1,008) (1,209)
Receivable from stockholders (29) (33)
Accumulated other comprehensive income (loss) (1,302) (10)
Accumulated deficit (37,698) (28,401)
---------- --------------
Total stockholders' equity 170,934 179,567
---------- --------------
Total liabilities and stockholders' equity $ 224,170 $ 230,290
========== ==============
* The condensed consolidated balance sheet at December 31, 1998 has been derived
from the audited financial statements at that date
.
See accompanying notes
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------- ---------
1999 1998 1999 1998
-------- ------- -------- --------
Revenues $37,893 $33,093 $75,523 $63,472
Costs and expenses:
Research and development 36,122 23,120 67,366 44,819
Selling, general and administrative 9,497 5,722 17,876 10,322
Acquisition-related charges - - - 1,171
-------- ------- -------- --------
Total costs and expenses 45,619 28,842 85,242 56,312
Income (loss) from operations (7,726) 4,251 (9,719) 7,160
Interest and other income, net 1,556 1,804 3,015 3,681
Losses from joint venture (1,217) - (2,593) (640)
-------- ------- -------- --------
Income (loss) before income taxes (7,387) 6,055 (9,297) 10,201
Provision for income taxes - 848 - 1,428
-------- ------- -------- --------
Net income (loss) $(7,387) $ 5,207 $(9,297) $ 8,773
======== ======= ======== ========
Basic net income (loss) per share $ (0.26) $ 0.20 $ (0.33) $ 0.33
======== ======= ======== ========
Shares used in computing
basic net income (loss) per share 27,961 26,610 27,920 26,504
======== ======= ======== ========
Diluted net income (loss) per share $ (0.26) $ 0.18 $ (0.33) $ 0.30
======== ======= ======== ========
Shares used in computing
diluted net income (loss) per share 27,961 28,667 27,920 28,792
======== ======= ======== ========
See accompanying notes
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------- ---------
1999 1998 1999 1998
-------- ------ --------- -------
Net income (loss) $(7,387) $5,207 $ (9,297) $8,773
Other comprehensive income (loss),
net of taxes:
Unrealized gains (losses) on
Marketable securities (693) 61 (1,095) (47)
Foreign currency translation
Adjustments (47) - (197) (2)
-------- ------ --------- -------
Other comprehensive income (loss) (740) 61 (1,292) (49)
-------- ------ --------- -------
Comprehensive income (loss) $(8,127) $5,268 $(10,589) $8,724
======== ====== ========= =======
See accompanying notes
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
SIX MONTHS ENDED
JUNE 30,
---------
1999 1998
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (9,297) $ 8,773
Adjustments to reconcile net income (loss) to net cash provided by
Operating activities:
Depreciation and amortization 11,626 7,489
Losses in joint venture 2,593 640
Gain on sale of long-term investment (104) -
Amortization of deferred compensation 201 246
Adjustment to conform pooled entity - 278
Changes in certain assets and liabilities:
Accounts receivable 9,724 9,233
Prepaid expenses, deposits and other assets (4,150) (3,723)
Accounts payable (3,647) (2,078)
Accrued and other liabilities 778 77
Deferred revenue 5,988 12,159
--------- ---------
Net cash provided by operating activities 13,712 33,094
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Long-term investments - (6,894)
Proceeds from sale of long-term investments 565 -
Capital expenditures (19,968) (15,325)
Purchases of marketable securities (23,013) (60,171)
Sales and maturities of marketable securities 30,988 23,854
--------- ---------
Net cash used in investing activities (11,428) (58,536)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 1,751 2,923
Proceeds from repayment of receivable from stockholder 4 -
Principal payments on capital lease obligations and
note payable (606) (135)
--------- ---------
Net cash provided by financing activities 1,149 2,788
--------- ---------
Effect of exchange rate on cash and cash equivalents (197) -
--------- ---------
Net increase (decrease) in cash and cash equivalents 3,236 (22,654)
Cash and cash equivalents at beginning of period 50,048 55,598
--------- ---------
Cash and cash equivalents at end of period $ 53,284 $ 32,944
========= =========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 154 $ 43
========= =========
Income taxes paid $ 136 $ 340
========= =========
See accompanying notes
======
INCYTE PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(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,
1999, the statements of operations for the three and six months ended June 30,
1999 and 1998, the statements of comprehensive income (loss) for the three and
six months ended June 30, 1999 and 1998 and the statements of cash flows for the
six months ended June 30, 1999 and 1998 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, comprehensive income and cash flows for the periods presented.
The condensed consolidated financial statements include the accounts of the
Company's wholly-owned subsidiaries. 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.
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 included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998. The condensed consolidated balance sheet at December 31, 1998
has been derived from the audited financial statements at that date.
2. PROPERTY AND EQUIPMENT
Property and equipment consisted of:
JUNE 30, DECEMBER 31,
1999 1998
---------- --------------
Office equipment $ 4,251 $ 3,577
Laboratory equipment 28,117 25,665
Computer equipment 41,847 35,209
Leasehold improvements 36,228 26,026
---------- --------------
110,443 90,477
Less accumulated depreciation and amortization (46,477) (36,048)
---------- --------------
$ 63,966 $ 54,429
========== ==============
3. REVENUE RECOGNITION
The Company recognizes revenue for database collaboration agreements evenly
over the term of each agreement. Revenue is deferred for fees received before
earned. Revenues from genomic screening services and reagents are recognized
upon completion and shipment. Revenues from contract sequencing are recognized
upon completion of milestones. Revenue from gene expression microarray services
includes: technology access fees, which are generally recognized ratably over
the access term; capacity ramp up charges, which are recognized ratably as
capacity is increased; and usage fees which are recognized at the completion of
key stages in the performance of the service, in proportion to costs incurred.
Generally, software revenue is allocated between license fees and maintenance
fees, in accordance with SOP 97-2, with the license revenue being recognized
upon installation, and maintenance fees recognized evenly over the maintenance
term.
4. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income (loss)
(numerator) by the weighted average number of common shares outstanding
(denominator) during the period and excludes the dilutive effect of stock
options. Diluted net income (loss) per share gives effect to all dilutive
potential common shares outstanding during a period. In computing diluted net
income (loss) per share, 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 net income (loss) computations for the periods presented below.
THREE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
----------------- ----------------
1999 1998 1999 1998
-------- ------- -------- -------
Numerator:
Net income (loss) $(7,387) $ 5,207 $(9,297) $ 8,773
======== ======= ======== =======
Denominator:
Denominator for basic net income (loss)
per share - weighted-average shares 27,961 26,610 27,920 26,504
Dilutive potential common shares-
stock options - 2,057 - 2,288
-------- ------- -------- -------
Denominator for diluted net income (loss)
per share 27,961 28,667 27,920 28,792
======== ======= ======== =======
Basic net income (loss) per share $ (0.26) $ 0.20 $ (0.33) $ 0.33
======== ======= ======== =======
Diluted net income (loss) per share $ (0.26) $ 0.18 $ (0.33) $ 0.30
======== ======= ======== =======
Options to purchase 5,053,779 shares of common stock were outstanding
at June 30, 1999, but were not included in the computation of diluted net income
(loss) per share for the three or six months ended June 30, 1999, as their
effect was antidilutive.
5. BUSINESS COMBINATIONS
In September 1998, the Company completed the acquisition of Hexagen Limited
("Hexagen"), a privately held single nucleotide polymorphism (SNP) discovery
company based in Cambridge, England. The Company issued 976,130 shares of the
Company's common stock and $5.0 million in cash in exchange for all of Hexagen's
outstanding capital stock. In addition, the Company assumed Hexagen's stock
options, which if fully vested and exercised, would amount to 125,909 shares of
its common stock. The transaction was accounted for as a purchase with a portion
of the purchase price, $11.0 million, expensed in the third quarter of 1998 as a
charge for the purchase of in-process research and development. The remaining
portion of the purchase price, approximately $17.6 million, was allocated to
goodwill ($16.3 million), developed technology ($0.7 million), and Hexagen's
assembled work force ($0.6 million), which are being amortized over 8, 5 and 3
years, respectively.
The Company allocated Hexagen's purchase price based on the relative fair
value of the net tangible and intangible assets acquired. In performing this
allocation, the Company considered, among other factors, the technology research
and development projects in process at the date of acquisition. Hexagen's
in-process research and development program consisted of the development of its
fSSCP technology for SNP discovery. At the date of the acquisition, Hexagen's
research and development program was approximately 80% completed and total
continuing research and development commitments to complete the projects were
expected to be approximately $1.4 million, and were expected to be successfully
completed by mid-2000. The value assigned to purchased in-process R&D was
determined by estimating the costs to develop Hexagen's purchased in-process
research and development into commercially viable products, estimating the
resulting net cash flows from the projects and discounting the net cash flows to
their present value. The rates utilized to discount the net cash flows to their
present value were based on Hexagen's weighted average cost of capital. A
discount rate of 24.0% was used for valuing the in-process research and
development and is intended to be commensurate with Hexagen's corporate maturity
and the uncertainties in the economic estimates described above. Additionally,
these projects will require maintenance expenditures when and if they reach a
state of technological and commercial feasibility. Management believes the
Company has positioned itself to complete the research and development program.
However, there is risk associated with the completion of the project, which
include the inherent difficulties and uncertainties in completing each project
and thereby achieving technological feasibility and risks related to the impact
of potential changes in future target markets and there is no assurance that the
project will meet either technological or commercial success. Failure to
complete the development of the fSSCP technology in its entirety, or in a timely
manner, could have a material adverse impact on the Company's financial
condition and results of operations.
The estimates used by the Company in valuing in-process research and
development were based upon assumptions the Company believes to be reasonable
but which are inherently uncertain and unpredictable. Accordingly, actual
results may vary from the projected results. The Company's assumptions may be
incomplete or inaccurate, and no assurance can be given that unanticipated
events and circumstances will not occur. To date, there have been no significant
changes to the Company's assumptions. Any such variance may result in a material
adverse effect on the financial condition and results of operations of the
Company. Associated risks include the inherent difficulties and uncertainties in
completing each project and thereby achieving technological feasibility and
risks related to the impact of potential changes in future target markets. The
results of operations of Hexagen have been included in the consolidated results
of the Company from the date of acquisition in September 1998.
The table below presents the pro forma results of operations and earnings
per share for the combined results of Hexagen and the Company for the three and
six months ended June 30, 1998 assuming that the transactions was completed on
January 1, 1998.
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1998 JUNE 30, 1998
--------------- ---------------
(In thousands, except per share amounts)
Revenues $33,093 $63,472
======= =======
Net income $ 3,085 $ 4,847
======= =======
Pro forma basic net income per share $ 0.11 $ 0.18
======= =======
Pro forma diluted net income per share $ 0.10 $ 0.16
======= =======
Pro forma shares for basic net income per share 27,586 27,480
======= =======
Pro forma shares for diluted net income per share 29,643 29,768
======= =======
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 gene
expression microarray 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.
6. JOINT VENTURE
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 holds a 50 percent equity interest in
diaDexus and accounts for the investment under the equity method. In July 1999,
the Company and SB each invested an additional $2.5 million in diaDexus through
convertible notes that mature in April 2000. The notes bear interest at 5.6%,
and are subordinate to all other claims. The notes, principal plus accrued
interest, will automatically convert into diaDexus Series C Preferred Stock upon
the closing of the sale of Series C Preferred Stock of diaDexus that results in
aggregate proceeds to diaDexus of at least $10 million, including the $5 million
that would result from the conversion of the loans from SB and the Company.
7. SEGMENT REPORTING
The Company operates primarily in one reportable segment: the design,
development, and marketing of genomic information based tools, and follows the
requirements of SFAS 131, Disclosures about Segments of an Enterprise and
Related Information. For the three and six months ended June 30, 1999, the
Company recorded revenue from customers throughout the United States and in
Canada, Austria, Belgium, France, Germany, Israel, Netherlands, Switzerland, and
the United Kingdom. Export revenues were $9,797,000 and $20,580,000 for the
three and six months ended June 30, 1999, respectively, and $7,546,000 and
$16,639,000 for the three and six months ended June 30, 1998, respectively.
8. NEW PRONOUNCEMENTS
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. ("SFAS 133"). As modified by Statement No.
137, Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of FASB Statement NO. 133, this statement is effective for
fiscal years beginning after June 15, 2000. SFAS 133 established standards for
reporting derivative instruments and hedging activities. Application of SFAS 133
is expected to have no impact on the consolidated financial position or results
of operations as currently reported.
9. LITIGATION
On January 6, 1998, Affymetrix, Inc. ("Affymetrix") filed a lawsuit in the
United States District Court for the District of Delaware, subsequently
transferred to the United States District Court for the Northern District of
California in November 1998, 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.
In September 1998, Affymetrix filed an additional lawsuit in the United
States District Court for the District of Delaware, subsequently transferred to
the United States District Court for the Northern District of California in
November 1998, alleging infringement of the U.S. patent number 5,800,992 (the
"'992 Patent") and U.S. patent number 5,744,305 (the "'305 Patent") by both
Synteni and Incyte. The complaint alleges that the '305 Patent has been
infringed by the making, using, selling, importing, distributing or offering to
sell in the United States high density arrays by Synteni and Incyte, that the
'992 Patent has been infringed by the use of Synteni's and Incyte's GEMTM
microarray technology to conduct gene expression monitoring using two-color
labeling, and that such infringement was willful. Affymetrix seeks a permanent
injunction enjoining Synteni and Incyte from further infringement of the '305
and '992 Patents and, in addition, Affymetrix had sought a preliminary
injunction enjoining Incyte and Synteni from using Synteni's and Incyte's GEM
microarray technology to conduct gene expression monitoring using two-color
labeling as described in the '992 Patent. Affymetrix's request for a preliminary
injunction was denied in April 1999 and the lawsuit is tentatively scheduled to
go to trial in July 2000.
In April 1999, the Board of Patent Appeals and Interferences of United
States Patent and Trademark Office (PTO) declared interferences between pending
patent applications licensed exclusively to Incyte and the Affymetrix '305 and
'992 Patents. An interference proceeding is invoked by the PTO when more than
one patent applicant claims the same invention. The Board of Patent Appeals and
Interferences evaluates all relevant facts, including those bearing on first to
invent, validity, enablement and scope of claims, and then makes a determination
as to who, if anyone, is entitled to the patent on the disputed invention.
Incyte and Synteni believe they have meritorious defenses and intend to
defend the suits vigorously. However, there can be no assurance that Incyte and
Synteni will be successful in the defense of these suits. At this time, the
Company cannot reasonably estimate the possible range of any loss resulting from
these suits due to uncertainty regarding the ultimate outcome. Regardless of the
outcome, this litigation has resulted and 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, 1999 and for the three and six month
periods ended June 30, 1999 and 1998 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
Annual Report on Form 10-K for the year ended December 31, 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 net loss,
expected expenditure levels, expected cash flows, the adequacy of capital
resources, growth in operations and Year 2000 related actions, 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 biotechnology, pharmaceutical, and agricultural industries;
risks relating to the development of new 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 and interference proceedings; the results and
viability of joint ventures and businesses in which the Company has purchased
equity; the ability of the Company to implement in a timely manner the programs
and actions related to the Year 2000 issue; and the matters discussed in
"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. ("Incyte" and, together with its wholly owned
subsidiaries, the "Company") designs, develops and markets genomic
information-based tools including database products, genomic data management
software tools, microarray-based gene expression services and genomic reagents
and related services. 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.
Revenues recognized by the Company consist primarily of non-exclusive
database access fees related to database agreements. Revenues also include the
sales of genomic screening products and services, fees for microarray-based gene
expression services, fees for contract sequencing services, and sales of genomic
data management software tools. The Company's database 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 subscriber will ever generate products from
information contained within the databases and thus that the Company will ever
receive milestone payments or royalties. The Company's ability to maintain and
increase revenues will be dependent upon its ability to obtain additional
database subscribers, retain and expand its relationships with existing
subscribers, and to expand its customer base and production capacity for
microarray services. The loss of revenues from any individual database
agreement, if terminated or not renewed, could have an adverse impact on the
Company's results of operations, although it is not anticipated to have a
material adverse impact on the Company's business or financial condition.
The Company is making a significant investment in its genomic sequencing,
bioinformatics, mapping and SNP discovery programs in 1999, and as a result the
Company has reported a net loss for the first half of 1999 and expects to
continue to incur losses through 1999. The Company is anticipating a return to
profitability in the second half of 2000. If the costs of these programs are
greater than anticipated, or if these programs take longer to complete, or if
the Company's business is affected by factors discussed under "Factors That May
Affect Results" the Company may not return to profitability in 2000.
In September 1998, the Company completed the acquisition of Hexagen Limited
("Hexagen"), a privately held SNP discovery company based in Cambridge, England.
The Company issued 976,130 shares of its common stock and $5.0 million in cash
in exchange for all of Hexagen's outstanding capital stock. In addition, the
Company assumed Hexagen's stock options, which if fully vested and exercised,
would amount to 125,909 shares of the Company's common stock. The intrinsic
value of the stock options was included in the purchase price of Hexagen. The
transaction was accounted for as a purchase with a portion of the purchase
price, estimated to be approximately $11.0 million, expensed in the third
quarter of 1998 as a charge for the purchase of in-process research and
development. The remainder of the purchase price, approximately $17.6 million,
was allocated to goodwill ($16.3 million), developed technology ($0.7 million),
and Hexagen's assembled work force ($0.6 million), which are being amortized
over 8, 5 and 3 years, respectively. The Company will continue to evaluate its
intangible assets for impairment on a quarterly basis.
The Company allocated Hexagen's purchase price based on the relative fair value
of the net tangible and intangible assets acquired. In performing this
allocation, the Company considered, among other factors, the technology research
and development projects in process at the date of acquisition. Hexagen's
in-process research and development program consisted of the development of its
fSSCP technology for SNP discovery. At the date of the acquisition, Hexagen's
research and development program was approximately 80% completed and total
continuing research and development commitments to complete the projects were
expected to be approximately $1.4 million. The projects were expected to be
successfully completed by mid-2000. The value assigned to purchased in-process
R&D was determined by estimating the costs to develop Hexagen's purchased
in-process research and development into commercially viable products,
estimating the resulting net cash flows from the projects and discounting the
net cash flows to their present value. The rates utilized to discount the net
cash flows to their present value were based on Hexagen's weighted average cost
of capital. A discount rate of 24.0% was used for valuing the in-process
research and development and is intended to be commensurate with Hexagen's
corporate maturity and the uncertainties in the economic estimates described
above. Additionally, this project will require maintenance expenditures when and
if it reaches a state of technological and commercial feasibility. Management
believes the Company has positioned itself to complete the research and
development program. However, there is risk associated with the completion of
the project, which includes the inherent difficulties and uncertainties in
completing the project and thereby achieving technological feasibility and risks
related to the impact of potential changes in future target markets. There is no
assurance that the project will meet either technological or commercial success.
Failure to complete the development of the fSSCP technology in its entirety, or
in a timely manner, could have a material adverse impact on the Company's
financial condition and results of operations.
The estimates used by the Company in valuing in-process research and
development were based upon assumptions the Company believes to be reasonable
but which are inherently uncertain and unpredictable. To date, there have been
no significant changes to the Company's assumptions. The Company's assumptions
may be incomplete or inaccurate, and no assurance can be given that
unanticipated events and circumstances will not occur. Accordingly, actual
results may vary from the projected results. Any such variance may result in a
material adverse effect on the financial condition and results of operations of
the Company.
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. The Company's ability to generate revenues and operating profits from
microarray-based gene expression services will be dependent on the ability of
the Company to obtain additional high volume customers for microarray services
and to expand capacity in a cost-effective manner. 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 bioinformatics 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 records its share of diaDexus' earnings and losses in its
statement of operations.
In July 1999, the Company and SB each invested an additional $2.5 million
in diaDexus through convertible subordinated notes that mature in April, 2000.
The notes bear interest at 5.6% and are subordinate to all other claims. The
notes, principal plus accrued interest, will automatically convert into diaDexus
stock upon diaDexus obtaining at least $10 million of funding, including the $5
million from that would result from the conversion of the loans from SB and the
Company, in the form of Series C Preferred Stock.
The Company has made and intends to continue to make strategic equity
investments in, and acquisitions of, technologies and businesses that are
complementary to the businesses of the Company. As a result, the Company may
record losses or expenses related to the Company's proportionate ownership
interest in such long-term equity investments, record charges for the
acquisition of in-process technologies, or record charges for the recognition of
the impairment in the value of the securities underlying such investments. The
market prices of the securities of the companies in which the Company invests
are highly volatile and therefore subject to declines in market value. The
Company will continue to evaluate its long-term equity investments for
impairment on a quarterly basis.
In January 1998, the Company announced a relationship relating to the joint
development of proteomics data and related software with Oxford GlycoSciences
plc ("OGS"). As part of this relationship, the Company made a $5.0 million
initial equity investment and a follow-on investment in April 1998 of
approximately $0.8 million as part of the OGS initial public offering of its
ordinary shares. As part of the collaborative agreement, the Company has agreed
to reimburse OGS for up to $5.0 million in 1999 if revenues are not sufficient
to offset OGS' expenses for services rendered.
In an effort to broaden its business, the Company is investing in a number
of new areas, including molecular diagnostics, genome sequencing, SNP discovery
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 is likely to continue to incur substantial
expenses in its defense of the lawsuits filed in January and September 1998 by
Affymetrix, Inc. ("Affymetrix") alleging patent infringement by Synteni and
Incyte. Affymetrix seeks a permanent injunction enjoining Incyte and Synteni
from further infringement of certain Affymetrix microarray patents. In addition,
Affymetrix 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 these suits vigorously. However, there
can be no assurance that Incyte and Synteni will be successful in the defense of
these suits. At this time, the Company cannot reasonably estimate the possible
range of any loss related to these suits due to uncertainty regarding the
ultimate outcome. Regardless of the outcome, this litigation has resulted and is
expected to continue to result in substantial expenses and diversion of the
efforts of management and technical personnel. Any future litigation could
result in similar expenses and diversion of efforts. Further, there can be no
assurance that any license that may be required as a result of these suits or
the outcome thereof would be made available on commercially acceptable terms, if
at all.
RESULTS OF OPERATIONS
Net loss and diluted net loss per share were $7.4 million and $9.3 million
and $0.26 and $0.33 per share for the three and six months ended June 30, 1999,
respectively, as compared to net income and diluted net income per share of $5.2
million and $8.8 million and $0.18 and $0.30 per share in the same periods a
year ago, respectively.
Revenues for the three and six months ended June 30, 1999 increased to
$37.9 million and $75.5 million, respectively, compared to $33.1 million and
$63.5 million for the corresponding periods in 1998. Revenues resulted primarily
from database access fees and, to a much lesser extent, from genomic screening
products and services, microarray-based gene expression services, contract
sequencing, and genomic data management software tools and maintenance. The
increase in revenues was primarily attributed to expanded collaborative database
agreements, and to a lesser extent, to increased revenues from microarray-based
gene expression services.
Total costs and expenses for the three and six months ended June 30, 1999
increased to $45.6 million and $85.2 million, respectively, compared to $28.8
million and $56.3 million for the corresponding periods in 1998. 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 expansion of microarray production capacity, the continued
investment in new product development and bioinformatics, and the growth in
marketing, sales and customer services.
Research and development expenses for the three and six months ended June
30, 1999 increased to $36.1 million and $67.4 million, respectively, compared to
$23.1 million and $44.8 million for the corresponding periods in 1998. The
increase in research and development expenses resulted primarily from the ramp
up in expenses related to the Company's investment in its genomic sequencing,
bioinformatics, gene mapping and SNP discovery programs, increase in its
microarray production, and continued investment in the growth of the Company's
intellectual property portfolio. The Company expects research and development
spending to continue to increase 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, 1999 increased to $9.5 million and $17.9 million, respectively,
compared to $5.7 million and $10.3 million for the corresponding periods in
1998. The increase in selling, general and administrative expenses resulted
primarily from the expansion of the Company's United Kingdom operations, the
growth in sales and marketing activities and increased personnel to support the
growing complexity of the Company's operations. The Company's operations for the
three and six months ended June 30, 1999 were also impacted by legal expenses
from the patent infringement lawsuits filed by Affymetrix of approximately $2.0
million and $4.1 million, respectively. The Company expects that selling,
general and administrative expenses will increase throughout 1999 due to
continued growth in marketing, sales and customer support functions and
increases in personnel to support the Company's growing complexity. Selling,
general and administrative expenses could fluctuate from quarter to quarter due
to the timing of legal expenses related to the Affymetrix lawsuits.
Interest and other income, net for the three and six months ended June 30,
1999 decreased to $1.6 million and $3.0 million, respectively, from $1.8 million
and $3.7 million for the corresponding periods in 1998. The decrease is
primarily due to the lower cash, cash equivalent, and marketable security
balances in 1999 as compared to 1998.
Losses from joint venture were $1.2 million and $2.6 million for the three
and six months ended June 30, 1999, respectively, and zero and $0.6 million for
the three and six months ended June 30, 1998, respectively. 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. diaDexus is expected to incur operating losses through at
least 2000.
Due to the Company's expected net loss in 1999, the Company expects a
minimal effective annual income tax rate. The effective annual income tax rate
for 1998 was 14%, which represented the provision of federal and state
alternative minimum taxes after utilization of net operating loss carryforwards
and research and development credits.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1999, the Company had $106.1 million in cash, cash
equivalents and marketable securities, compared to $111.2 million as of December
31, 1998. The Company has classified all of its marketable securities as
short-term, as the Company may choose 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 $13.7 million for the six
months ended June 30, 1999, as compared to $33.1 million for the six months
ended June 30, 1998. The decrease in net cash provided by operating activities
resulted primarily from the change to a net loss for the six months ended June
30, 1999 from net income in the corresponding period in 1998 as well as the
lower increase in deferred revenues in 1999 as compared to 1998, which were
partially offset by higher non cash charges from depreciation and amortization
and losses in joint venture. 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. Although the Company is expected to
be cash flow positive from operations in 1999, due to the significant investment
in the Company's genomic sequencing, bioinformatics, mapping and SNP discovery
programs, the Company expects a continued significant decrease in cash flows
from operations in the remainder of 1999 as compared to 1998.
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, 1999 increased to $20.0 million from $15.3 million for the six
months ended June 30, 1998. In 1999, the Company has made no long-term
investments in companies with which the Company has research and development
alliances as compared to $6.9 million for the six months ended June 30, 1998.
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 $1.1 million for the six
months ended June 30, 1999 as compared to $2.8 million for the six months ended
June 30, 1998. The decrease was primarily due to lower proceeds from stock
option exercises in 1999.
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 the next twelve months. However, the Company
may be unable to obtain additional collaborators or retain existing
collaborators for its databases, and its 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 other products and services; the cost required to complete the
genomic sequencing and human genome mapping programs; 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, including capital equipment necessary to ensure the Company's
sequencing and microarray operations remain competitive; capital expenditures
required to expand the Company's facilities; and costs associated with the
integration of new operations assumed through mergers and acquisitions. 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.
The Company expects to continue to fund future operations with revenues
from database products and services and with its current cash, cash equivalents,
and marketable securities. Additional funding, if necessary, may not be
available on favorable terms, if at all. If adequate funds are not available
through the public markets and/or other sources, the Company may be required to
curtail operations significantly or to obtain funds by entering into
collaborative arrangements that may require the Company to relinquish rights to
certain of its technologies, product candidates, products or potential markets.
EURO CONVERSION
A single currency called the euro was introduced in Europe on January 1,
1999. Eleven of the fifteen member countries of the European Union agreed to
adopt the euro as their common legal currency on that date. Fixed conversion
rates between these participating countries' existing currencies (the "legacy
currencies") and the euro were established as of that date. The legacy
currencies are scheduled to remain legal tender as denominations of the euro
until at least January 1, 2002, but not later than July 1, 2002. During this
transition period, parties may settle transactions using either the euro or a
participating country's legal currency. The Company does not expect this
conversion to have a material impact on its results of operations, financial
position or cash flows.
YEAR 2000
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 other normal business activities.
The Company is in the process of evaluating the Year 2000 readiness of the
software products sold by the Company ("Products"), the information technology
systems used in its operations ("IT Systems"), and its non-IT Systems, such as
building security, voice mail, and other systems. The project consists of the
following phases: (i) identification of all Products, IT Systems, and non-IT
Systems; (ii) assessment of repair or replacement requirements; (iii) repair or
replacement; (iv) testing; (v) implementation; and (vi) creation of contingency
plans in the event of Year 2000 failures.
The supplier of the Company's current financial and accounting software has
informed the Company that such software is Year 2000 compliant. The Company
relies, both domestically and internationally, upon various vendors, government
agencies, utility companies, telecommunications service companies, delivery
service companies, and other service providers who are outside of the Company's
control. There is no assurance that such parties will not suffer a Year 2000
business disruption, which could have a material adverse effect on the Company's
financial condition and results of operations.
The Company relies for its successful operation upon goods and services
purchased from certain vendors. If these vendors fail to adequately address the
Year 2000 such that their delivery of goods and services to the Company is
materially impaired, it could have a material adverse impact on the Company's
operations and financial results. The Company is in the process of surveying its
principal vendors to assess the effect the Year 2000 issue will have on their
ability to supply their goods and services without material interruption, and at
this time the Company cannot determine or predict the outcome of this effort.
Contingency plans will be developed and executed with respect to vendors who
will not be Year 2000 ready in a timely manner where such lack of readiness is
expected to have a material adverse impact on the Company's operations. However,
because the Company cannot be certain that its vendors will be able to supply
material goods and services without material interruption, and because the
Company cannot be certain that execution of its contingency plans will be
capable of implementation or result in a continuous and adequate supply of such
goods and services, the Company can give no assurance that these matters will
not have a material adverse effect on the Company's future consolidated
financial position, results of operations, or cash flows.
If the Company's customers fail to achieve an adequate state of Year 2000
readiness in their own operations, or if their Year 2000 readiness efforts
consume significant resources, their ability to purchase the Company's products
may be impaired. This could adversely affect demand for the Company's products
and, therefore, the Company's future revenues. The Company plans to develop a
contingency plan for Year 2000 noncompliant customers and at this time cannot
determine the impact it will have, if any.
In the second quarter of 1999, the Company completed its testing of all
current versions of its software products, which disclosed nothing that results
in Year 2000 non compliance. Even so, whether a complete system or device in
which a Product is embedded will operate correctly for an end-user depends in
large part on the Year 2000 compliance of the system's other components, most of
which are supplied by parties other than the Company. The Company is currently
evaluating systems and software used internally at all locations of the Company
(including those from third-party vendors) for Year 2000 compliance. The initial
assessment as been completed, and all testing and remediation for
mission-critical systems is expected to be completed by the end of the third
quarter of 1999.
To date, the Company has had expenditures of approximately $0.4 million for
external vendors for assistance with its Year 2000 assessment of IT internal
systems and for certification of its database and software products. In addition
the Company has incurred minimal opportunity cost of time spent by employees of
the Company evaluating its financial and accounting software, its products, and
general Year 2000 compliance matters. Absent a significant Year 2000 compliance
deficiency, management currently estimates that total costs for its Year 2000
compliance programs will be between $1.0 million and $1.5 million, which will
total approximately 10% of the total 1999 IT budget and is being expensed as
incurred. The Company has not deferred any IT projects due to its efforts to
ensure Year 2000 compliance. The Company believes that available cash will be
sufficient to cover the projected costs associated with these activities.
The Company intends to develop and implement, if necessary, appropriate
contingency plans to mitigate to the extent possible the effects of any Year
2000 noncompliance, and expects to have such plans completed in the second half
of 1999. As part of the development of a contingency plan, the Company will
evaluate its worst case scenario in the event of Year 2000 noncompliance.
Although the full consequences are unknown, the failure of either the Company's
critical systems or those of its material third party suppliers to be Year 2000
compliant would result in the interruption of the Company's business, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
FACTORS THAT MAY AFFECT RESULTS
The risks and uncertainties described below are not the only ones facing
our company. Additional risks and uncertainties not presently known to us or
that we currently deem immaterial may also impair our business operations.
If any of the following risks actually occur, our business, financial
condition and results of operations could be materially and adversely affected.
WE HAVE HAD ONLY LIMITED PERIODS OF PROFITABILITY, AND WE EXPECT TO INCUR LOSSES
IN THE FUTURE AND MAY NOT RETURN TO PROFITABILITY
We had net losses from inception in 1991 through 1996, reported net income
in 1997 and 1998, and as anticipated we were unprofitable in the first half of
1999. Because of those losses, we had an accumulated deficit of $37.7 million as
of June 30, 1999. Because we intend to make a significant investment in genomic
sequencing, mapping and SNP discovery over the next 12 to 18 months, we expect
to report a net loss for 1999 and possibly 2000. We may report net losses in
future periods as well. We expect that our expenditures will continue to
increase, due in part to our continued investment in new product and technology
development, including the ramp-up of our genomic sequencing, bioinformatics,
mapping and SNP-discovery programs, obligations under existing and future
research and development alliances, and our increasing investment in marketing,
sales and customer service. Our profitability depends on our ability to increase
our revenues:
TO GENERATE SIGNIFICANT REVENUES, WE MUST OBTAIN ADDITIONAL DATABASE
COLLABORATORS AND RETAIN EXISTING COLLABORATORS. While we had 22 database
agreements as of June 30, 1999, we may be unable to enter into any additional
agreements. Although all agreements that have expired to date have been renewed,
we cannot assure you that any other agreements will be renewed upon expiration.
Our database revenues are also affected by the extent to which existing
collaborators expand their agreements with us to include our new database
products and to the extent that existing collaborators reduce the number of
products or services for which they subscribe. Some of our database agreements
require us to meet performance obligations. A database collaborator can
terminate its agreement before the end of its scheduled term if we breach the
agreement and fail to cure the breach within a specified period.
OUR REVENUES AND PROFITABILITY WILL ALSO DEPEND ON OUR ABILITY TO EXPAND
OUR CUSTOMER BASE FOR MICROARRAY SERVICES. We acquired Synteni, Inc. in January
1998 primarily for this purpose. Synteni's contribution to our operating results
will depend on whether we can obtain high-volume customers for microarray
services, whether we can increase our microarray production capacity in a timely
manner and with consistent volumes and quality, and the costs associated with
increasing our microarray production capacity. Before we acquired Synteni, its
microarray service agreements consisted of small volume pilot or feasibility
agreements.
WE DO NOT EXPECT MILESTONE OR ROYALTY PAYMENTS TO CONTRIBUTE TO REVENUES
FOR A SUBSTANTIAL PERIOD OF TIME. Part of our strategy is to license to
database collaborators our know how and patent rights associated with the gene
sequences and related information in our proprietary databases, for use in the
discovery and development of 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 before commercialization. Accordingly, we do not expect to receive any
milestone or royalty payments from any of these licenses for a substantial
period of time, if at all.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY
Our operating results are unpredictable and may fluctuate significantly
from period to period due to a variety of factors, including:
- - changes in the demand for our products and services;
- - the introduction of competitive databases or services;
- - the pricing of access to our databases;
- - the nature, pricing and timing of other products and services provided to
our collaborators;
- - changes in the research and development budgets of our collaborators and
potential collaborators;
- - depreciation expense from capital expenditures;
- - acquisition, licensing and other costs related to the expansion of our
operations, including operating losses of acquired businesses such as Synteni
and Hexagen;
- - losses and expenses related to our investments in joint ventures and
businesses, including our proportionate share of operating losses of our
diaDexus, LLC, joint venture with SmithKline Beecham Corporation;
- - payments of milestones, license fees or research payments under the terms
of our increasing number of external alliances; and
- - expenses related to, and the results of, litigation and other proceedings
relating to intellectual property rights (including the lawsuits filed by
Affymetrix, Inc. described below).
In particular, revenues from our database business are unpredictable
because:
- - the timing of our database installations is determined by our
collaborators,
- - the sales cycle for our database products is lengthy, and
- - the time required to complete custom orders can vary significantly.
We expect our microarray services to represent an increasing amount of our
revenues. Revenues from these sources depend on volume of usage by our
collaborators, and can therefore fluctuate significantly. Also, revenues can be
affected by developments in the Affymetrix litigation, which may cause potential
customers to postpone or change their decision to use our microarray services.
We are investing in a number of new areas to try to broaden our business.
These areas include genomic sequencing and mapping, SNP discovery, molecular
diagnostics, and proteomics, or the large scale, high-throughput analysis of
protein expression. Because many of these address new markets or involve
untested technologies, they may not generate any revenues or provide an adequate
return on our investment. In these cases, we may have to recognize expenses or
losses.
We have significant fixed expenses, due in part to our need to continue to
invest in product development and extensive support for our database
collaborators. We may be unable to adjust our expenditures if revenues in a
particular period fail to meet our expectations, which would adversely affect
our operating results for that period. Forecasting operating and integration
expenses for acquired businesses may be particularly difficult, especially where
the acquired business focuses on technologies that do not have an established
market.
We believe that period-to-period comparisons of our financial results will
not necessarily be meaningful. You should not rely on these comparisons as an
indication of our future performance. If our operating results in any future
period fall below the expectations of securities analysts and investors, our
stock price will likely fall, possibly by a significant amount.
WE EXPERIENCE INTENSE COMPETITION AND RAPID TECHNOLOGICAL CHANGE
GENOMIC BUSINESSES ARE INTENSELY COMPETITIVE The human genome contains a
finite number of genes. Our competitors may seek to identify, sequence and
determine the biological function of numerous genes in order to obtain a
proprietary position with respect to new genes. A number of companies, other
institutions and government-financed entities are engaged in gene sequencing,
gene discovery, gene expression analysis, positional cloning, the study of
genetic variation, and other genomic service businesses. Many of these
companies, institutions and entities have greater financial and human resources
than we do.
Some of our competitors have developed databases containing gene sequence,
gene expression, genetic variation or other genomic information and are
marketing or plan to market their data to pharmaceutical companies. Additional
competitors may attempt to establish databases containing this information in
the future. We expect that competition in our industry will continue to
intensify. Several large pharmaceutical companies have announced their intent to
form a consortium to create a SNPs database and to make all of the information
publicly available. The formation of this sort of consortium could delay or
reduce the potential revenues related to our SNP-related business.
PATENT POSITIONS OR PUBLIC DISCLOSURES MAY REDUCE THE VALUE OF OUR
DATABASES. Competitors may discover and establish patent positions with respect
to gene sequences in our databases. Further, certain entities engaged in gene
sequencing have made the results of their sequencing efforts publicly available.
The Celera Genomics Group of PE Corporation has announced plans to sequence the
entire human genome by the end of 2001 and to make the basic human sequence data
publicly available. The Human Genome Project, which is coordinated by the U.S.
Department of Energy and the National Institutes of Health, has announced that a
consortium of laboratories associated with the Project predicts that they will
produce at least 90 percent of the human genome sequence in a "working draft
form" by the spring of 2000 and that they intend to make the information
publicly available. The public availability of gene sequences or resulting
patent positions covering substantial portions of the human genome or microbial
or plant genomes could reduce the potential value of our databases to our
collaborators. It could also impair our ability to realize royalties or other
revenue from any commercialized products based on this genetic information.
COMPETITORS MAY DEVELOP SUPERIOR TECHNOLOGY. The gene sequencing machines
used in our computer-aided sequencing operations are commercially available and
are being used by at least one competitor. In addition, some of our competitors
and potential competitors are developing proprietary sequencing technologies
that may be more advanced than ours. PE Corporation has announced that it has
begun commercial shipments of a new gel-based sequencing machine, and that a
large number of these machines will be provided to Celera Genomics Group. We may
be unable to obtain access to these machines on acceptable terms.
In addition, a number of companies are pursuing alternative methods for
generating gene expression information, including microarray technologies. These
advanced sequencing or gene expression technologies may not be commercially
available for us to purchase or license on reasonable terms, if at all. At least
one other company currently offers microarray-based services that might be
competitive with ours.
Our SNP discovery platform represents a modification of a process that is
in the public domain. We are seeking patent protection for these improvements,
but have not yet received any patents. Other companies could make similar or
superior improvements to this process without infringing our rights, and we may
not have access to those improvements. The discovery of SNPs is a competitive
area. Other companies may develop or obtain access to different SNP discovery
platforms, to which we may not have access, that may make our technology
obsolete.
We also face competition from providers of software. A number of companies
have announced their intent to develop and market software to assist
pharmaceutical companies and academic researchers in managing and analyzing
their own genomic data and publicly available data. Some of these entities have
access to significantly greater resources than we do, and their products may
achieve greater market acceptance than ours.
WE MUST CONTINUE TO INVEST IN NEW TECHNOLOGIES. The genomics industry is
characterized by extensive research efforts, resulting in rapid technological
progress. To remain competitive, we must continue to expand our databases,
improve our software, and invest in new technologies. New developments are
expected to continue, and discoveries by others may render our services and
potential products noncompetitive.
WE ARE INVOLVED IN PATENT LITIGATION
In January 1998, Affymetrix filed a lawsuit in federal court alleging
infringement of U.S. patent number 5,445,934 by both Synteni and Incyte. The
complaint alleges that the '934 patent has been infringed by Synteni's and
Incyte's making, using, selling, importing, distributing or offering to sell
high density arrays in the United States and that this infringement was willful.
Affymetrix seeks a permanent injunction enjoining Synteni and Incyte from
further infringement of the '934 patent and seeks damages, costs, attorneys'
fees and interest. Affymetrix also requests triple damages based on allegedly
willful infringement.
In September 1998, Affymetrix filed an additional lawsuit alleging
infringement of U.S. patent numbers 5,744,305 and 5,800,992 by Synteni and
Incyte. The complaint alleges that the '305 patent has been infringed by
Synteni's and Incyte's making, using, selling, importing, distributing or
offering to sell high density arrays in the United States. It also alleges that
the '992 patent has been infringed by the use of Synteni's and Incyte's GEM
microarray technology to conduct gene expression monitoring using two-color
labeling and that this infringement was willful. Affymetrix had sought a
preliminary injunction enjoining Synteni and Incyte from using GEM microarray
technology to conduct this kind of gene expression monitoring, and a permanent
injunction enjoining Synteni and Incyte from further infringing the '305 and
'992 patents.
The lawsuits were initially filed in the United States District Court for
the District of Delaware. In November 1998, the court granted Incyte's motion to
transfer the suits to the United States District Court for the Northern District
of California. Affymetrix's request for a preliminary injunction was denied in
April 1999 and the lawsuit is tentatively scheduled to go to trial in July 2000.
In April 1999, the Board of Patent Appeals and Interferences of United
States Patent and Trademark Office declared interferences between pending patent
applications licensed exclusively to us and the Affymetrix '305 and '992
patents. An interference proceeding is invoked by the Patent and Trademark
Office when more than one patent applicant claims the same invention. The Board
of Patent Appeals and Interferences evaluates all relevant facts, including
those bearing on first to invent, validity, enablement and scope of claims, and
then makes a determination as to who, if anyone, is entitled to the patent on
the disputed invention. At this time, we can not predict the outcome of the
interference proceeding.
We believe we have meritorious defenses and intend to defend these suits
vigorously. However, our defense may be unsuccessful. At this time, we cannot
reasonably estimate the possible range of any loss resulting from these suits
due to uncertainty about the ultimate outcome. We have spent and expect to
continue to spend a significant amount of money and management time on this
litigation. Also, if we are required to license any technology as a result of
these suits, we do not know whether we will be able to do so on commercially
acceptable terms, if at all.
WE ARE SPENDING A LOT OF MONEY ON NEW AND UNCERTAIN BUSINESSES AND DEMAND FOR
OUR PRODUCTS AND SERVICES MAY BE INSUFFICIENT TO COVER OUR COSTS
There is no precedent for our microarray-based gene expression service
business or the use of SNP-based genetic variation information. The usefulness
of the information generated by these businesses is unproven. Our collaborators
and potential collaborators may determine that our databases, software tools and
microarray-related services are not useful or cost-effective. Due to the nature
and price of the products and services we offer, only a limited number of
companies are potential collaborators for our products and services. If we do
not develop these new products and services in time to meet market demand or if
there is insufficient demand for these products and services, we may not be able
to cover our costs of developing these products and services or earn a
sufficient return on our investment.
Additional factors that may affect demand for our products and services
include:
- - the extent to which pharmaceutical and biotechnology companies conduct
these activities in-house or through industry consortia;
- - the emergence of competitors offering similar services at competitive
prices;
- - the extent to which the information in our databases is made public or is
covered by others' patents;
- - our ability to establish and enforce proprietary rights to our products;
- - regulatory developments or changes in public perceptions relating to the
use of genetic information and the diagnosis and treatment of disease based on
genetic information; and
- - technological innovations that are more advanced than the technologies
that we have developed or that are available to us.
Many of these factors are beyond our control.
OUR NEW PROGRAMS RELATING TO THE ROLE OF GENETIC VARIATION IN DISEASE AND DRUG
RESPONSE ARE RISKY
We recently began to focus part of our business on developing databases and
other products and services to assist pharmaceutical companies in a new and
unproven area: the identification and correlation of genetic variation to
disease and drug response. Hexagen, which will be an important part of this
business, was founded in 1996 and has generated no revenues to date. We will
incur significant costs over the next several years in expanding our research
and development in this area. These activities may never generate significant
revenues or profitable operations.
This new aspect of our business will focus on SNPs, one type of genetic
variation. The role of SNPs in disease and drug response is not fully
understood, and relatively few, if any, therapeutic or diagnostic products based
on SNPs have been developed and commercialized. Among other things, demand in
this area may be adversely affected by ethical and social concerns about the
confidentiality of patient-specific genetic information and about the use of
genetic testing for diagnostic purposes.
Except for a few anecdotal examples, there is no proof that SNPs have any
correlation to diseases or a patient's response to a particular drug or class of
drug. Identifying statistically significant correlations is time-consuming and
could involve the collection and screening of a large number of patient samples.
We do not know if the SNPs we have discovered to date are suitable for these
correlation studies. Nor do we currently have access to the patient samples
needed or technology allowing us to rapidly and cost-effectively identify
pre-determined SNPs in large numbers of patients.
Most SNPs may occur too infrequently to warrant their use in analyzing
patients' genetic variation. We may have trouble identifying SNPs that both
correlate with diseases or drug responses and occur frequently enough to justify
their use by pharmaceutical companies.
Our success will also depend upon our ability to develop, use and enhance
new and relatively unproven technologies. Our strategy of using high-throughput
mutation detection processes and sequencing to identify SNPs and genes rapidly
is unproven. Among other things, we will need to improve the throughput of our
SNP-discovery technology. We may not be able to achieve these necessary
improvements, and other factors may impair our ability to develop our
SNP-related products and services in time to be competitively available.
OUR STRATEGIC INVESTMENTS MAY RESULT IN LOSSES AND OTHER ADVERSE EFFECTS
We make strategic investments in joint ventures or businesses that
complement our business. These investments, such as our investment in diaDexus,
may:
- - often be made in securities lacking a public trading market or subject to
trading restrictions, either of which increases our risk and reduces the
liquidity of our investment,
- - require us to record losses and expenses related to our ownership
interest,
- - require us to record charges related to the acquisition of in-process
technologies or for the impairment in the value of the securities underlying our
investment, and
- - require us to invest greater amounts than anticipated or to devote
substantial management time to the management of research and development
relationships and joint ventures.
The market values of many of these investments fluctuate significantly. We
evaluate our long-term equity investments for impairment of their values on a
quarterly basis. Impairment could result in future charges to our earnings.
These losses and expenses may exceed the amounts that we anticipated.
OUR SALES CYCLE IS LENGTHY
Our ability to obtain new subscribers for our databases, software tools and
microarray and other services depends upon prospective subscribers' perceptions
that our products and services can help accelerate drug discovery efforts. Our
sales cycle is typically lengthy because we need to educate our potential
subscribers and sell the benefits of our tools and services to a variety of
constituencies within potential subscriber companies. In addition, each database
subscription and microarray services agreement involves the negotiation of
unique terms. We may expend substantial funds and management effort with no
assurance that a subscription or services agreement will result. Actual and
proposed consolidations of pharmaceutical companies have affected the timing and
progress of our sales efforts. We expect that future proposed consolidations
will have similar effects.
PATENTS AND OTHER PROPRIETARY RIGHTS PROVIDE UNCERTAIN PROTECTION
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY INFORMATION. Our business and
competitive position depend upon our ability to protect our proprietary database
information and software technology, but our strategy of obtaining proprietary
rights in as many genes and SNPs as possible is unproven. Despite our efforts to
protect this information and technology, unauthorized parties may attempt to
obtain and use information that we regard as proprietary. Although our database
subscription agreements require our subscribers to control access to our
databases, policing unauthorized use of our databases and software may be
difficult.
We have been issued a number of patents with respect to the gene sequences
in our databases and have filed for patents on selected features of our
software. However, as of the date of this report, we have no issued patents or
registered copyrights for that software. We cannot prevent others from
independently developing software that might be covered by copyrights issued to
us, and trade secret laws do not prevent independent development.
We pursue a policy of having our employees, consultants and advisors
execute proprietary information and invention agreements when they begin working
for us. However, these agreements may not provide meaningful protection for our
trade secrets or other proprietary information in the event of unauthorized use
or disclosure.
Our means of protecting our proprietary rights may not be adequate and our
competitors may:
- - independently develop substantially equivalent proprietary information and
techniques,
- - otherwise gain access to our proprietary information, or
- - design around patents issued to us or our other intellectual property.
OUR PATENT APPLICATIONS MAY CONFLICT WITH OTHERS. Our current policy is to
file patent applications on what we believe to be novel full-length and partial
gene sequences obtained through our gene sequencing efforts. We have filed U.S.
patent applications in which we have claimed certain partial gene sequences. We
have also applied for patents in the U.S. and other countries claiming
full-length gene sequences associated with cells and tissues involved in our
gene sequencing program. We hold a number of issued U.S. patents on full-length
genes and one issued U.S. patent claiming multiple partial gene sequences. A
number of entities make certain gene sequences publicly available, which may
adversely affect our ability to obtain patents on those genes.
We believe that some of our patent applications claim genes that may also
be claimed in patent applications filed by others. 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 Board of Patent Appeals and Interferences has declared interferences
with respect to two patent applications directed to technology licensed
exclusively to us and two Affymetrix patents that are the subject of our
litigation with Affymetrix. The Board of Patent Appeals has also declared two
interferences involving applications covering Incyte full-length genes, and has
advised us of approximately a dozen additional interferences that might be
declared. We cannot predict whether any of the interferences would be resolved
in our favor. Regardless of the outcome, interferences could be expensive and
time-consuming.
ENFORCEMENT OF GENE PATENTS IS UNCERTAIN. One of our strategies is to
obtain proprietary rights in as many genes (including partial gene sequences)
and SNPs as possible. While the USPTO has issued patents covering full-length
genes, partial gene sequences and SNPs, we do not know whether or how courts may
enforce those patents, if that becomes necessary. If a court finds these types
of inventions to be unpatentable, or interprets them narrowly, the benefits of
our strategy may not materialize.
WE MAY DECIDE TO ABANDON PATENT APPLICATIONS. The USPTO has had a
substantial backlog of biotechnology patent applications, particularly those
claiming 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 our patent applications contain more partial sequences than
the maximum number allowed under these guidelines. Due to the resources needed
to comply with the guidelines, we may decide to abandon patent applications for
some of our partial gene sequences.
Because filing large numbers of patent applications and maintaining issued
patents can be very costly, we may choose not to pursue every application. If we
do not pursue patent protection for all of our full-length and partial gene
sequences, the value of our intellectual property portfolio could be diminished.
Because of the possible delay in obtaining allowance of some of our patent
applications, and the secrecy of patent applications, we do not know if other
applications having priority over ours have been filed.
WE MAY NEED TO REFILE SOME OF OUR PATENT APPLICATIONS, AND THE PERIOD OF
PATENT PROTECTION HAS BEEN SHORTENED. The value of our patents depends in part
on their duration. The U.S. patent laws were amended in 1995 to change the term
of patent protection from 17 years from patent issuance to 20 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 20-year patent term
from the filing date may result in substantially shorter patent protection,
which may adversely affect our rights under any patents that obtain. We may need
to refile applications claiming large numbers of gene sequences and, in these
situations, the patent term will be measured from the date of the earliest
priority application. This would shorten our period of patent exclusivity.
INTERNATIONAL PATENT PROTECTION IS PARTICULARLY UNCERTAIN. 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 some
foreign countries may not protect our intellectual property rights to the same
extent as U.S. laws. We may participate in opposition proceedings to determine
the validity of our or our competitors' foreign patents, which could result in
substantial costs and diversion of our efforts.
WE MAY BE SUBJECT TO ADDITIONAL LITIGATION AND INFRINGEMENT CLAIMS
The technology that we use to develop our products, and those that we
incorporate in our products, may be subject to claims that they infringe the
patents or proprietary rights of others. The risk of this occurring will tend to
increase as the genomics, biotechnology and software industries expand, more
patents are issued and other companies attempt to discover genes and SNPs and
engage in other genomic-related businesses.
As is typical in the genomics, biotechnology and software industries, we
have received, and we will probably receive in the future, notices from third
parties alleging patent infringement. We believe that we are not infringing the
patent rights of any such third party. Except for Affymetrix, no third party has
filed a patent lawsuit against us.
We may, however, be involved in future lawsuits alleging patent
infringement or other intellectual property rights violations. In addition,
litigation may be necessary to:
- - assert claims of infringement,
- - enforce our patents,
- - protect our trade secrets or know-how, or
- - determine the enforceability, scope and validity of the proprietary rights
of others.
We may be unsuccessful in defending or pursuing these lawsuits. Regardless
of the outcome, litigation can be very costly and can divert management's
efforts. An adverse determination may subject us to significant liabilities or
require us to seek licenses to other parties' patents or proprietary rights. We
may also be restricted or prevented from manufacturing or selling our products.
Further, we may not be able to obtain the necessary licenses on acceptable
terms, if at all.
WE MAY ENCOUNTER PROBLEMS IN MEETING CUSTOMERS' SOFTWARE NEEDS
Our databases also require software support and will need to incorporate
features determined by database collaborators. If we experience delays or
difficulties in implementing our database software or collaborator-requested
features, we may be unable to service our collaborators.
OUR RECENT ACQUISITIONS INVOLVE SEVERAL RISKS
Our acquisitions of Synteni and Hexagen involve several potential operating
and business risks, including potential problems and costs associated with
integrating Synteni's and Hexagen's businesses, technologies and management with
ours. Our integration efforts may also result in the loss of efficiency or
employees.
The combined companies may not realize any revenue enhancements or cost
savings. Increases in other expenses and operating losses, including losses due
to problems in integrating the acquired companies with ours, may offset any cost
savings. Our combined operating results and financial condition may not be
superior to what we could have achieved without these acquisitions, even if we
integrate the acquired business efficiently, effectively and quickly. The
combination of these businesses with ours may also take longer than expected.
In particular, we began our integration of Hexagen recently. We will need
to integrate Hexagen's technology with our existing technology and improve its
throughput, in order to develop SNP programs. We may be unable to achieve the
necessary improvements, which could slow our efforts to develop a SNP-related
business. Also, since Hexagen is located in England, we may experience
difficulties in integrating their operations with our U.S.-based operations. We
may also incur an expense if the goodwill and other intangible assets associated
with the Hexagen purchase are determined to be impaired in the future.
FUTURE ACQUISITIONS WILL CREATE RISKS AND UNCERTAINTIES
As part of our business strategy, we may acquire other assets, technologies
and businesses. We acquired two companies in 1996, Synteni in January 1998, and
Hexagen in September 1998.
These and any future acquisitions involve risks such as the following:
- - we may be exposed to unknown liabilities of acquired companies;
- - our acquisition and integration costs may be higher than we anticipated
and may cause our quarterly and annual operating results to fluctuate;
- - we may experience difficulty and expense in assimilating the operations
and personnel of the acquired businesses, disrupting our business and diverting
management's time and attention;
- - we may be unable to integrate or complete the development and application
of acquired technology;
- - we may experience difficulties in establishing and maintaining uniform
standards, controls, procedures and policies;
- - our relationships with key customers of acquired businesses may be
impaired, due to changes in management and ownership of the acquired businesses;
- - we may be unable to retain key employees of the acquired businesses;
- - we may incur amortization expenses if an acquisition results in
significant goodwill or other intangible assets; and
- - our stockholders may be diluted if we pay for the acquisition with equity
securities.
In addition, if we acquire additional businesses that are not located near
our Palo Alto, California headquarters, we may experience more difficulty
integrating and managing the acquired businesses' operations.
WE MAY HAVE DIFFICULTY MANAGING OUR GROWTH
We expect to continue to experience significant growth in the number of our
employees and the scope of our operations. This growth has placed, and may
continue to place, a significant strain on our management and operations. Our
ability to manage this growth will depend upon our ability to broaden our
management team and our ability to attract, hire and retain skilled employees.
Our success will also depend on the ability of our officers and key employees to
continue to implement and improve our operational and other systems and to hire,
train and manage our employees.
In addition, we must continue to invest in customer support resources as
the number of database collaborators and their requests for support increase.
Our database collaborators typically have worldwide operations and may require
support at multiple U.S. and foreign sites. To provide this support, we may need
to open offices in addition to our Palo Alto, California headquarters and our
offices in Fremont, California, St. Louis, Missouri and Cambridge, England,
which could result in additional burdens on our systems and resources.
WE DEPEND ON KEY EMPLOYEES IN A COMPETITIVE MARKET FOR SKILLED PERSONNEL
We are highly dependent on the principal members of our management,
operations and scientific staff, including Roy A. Whitfield, our Chief Executive
Officer, and Randal W. Scott, our President and Chief Scientific Officer. The
loss of either of these persons' services would have a material adverse effect
on our business. We have not entered into any employment agreement with either
of these persons and do not maintain a key person life insurance policy on the
life of any employee.
Our future success also will depend in part on the continued service of our
key scientific, software, bioinformatics and management personnel and our
ability to identify, hire and retain additional personnel, including customer
service, marketing and sales staff. We experience intense competition for
qualified personnel. We may not be able to continue to attract and retain
personnel necessary for the development of our business.
WE DEPEND ON THIRD PARTIES FOR NECESSARY EQUIPMENT, SUPPLIES AND DATA
WE RELY ON A SMALL NUMBER OF SUPPLIERS OF GENE SEQUENCING MACHINES AND
REAGENTS REQUIRED FOR GENE SEQUENCING. Although we are evaluating alternative
gene sequencing machines, they may not be available in sufficient quantities or
at acceptable costs. In addition, if a third party claims that our use of these
machines infringes their patent rights, our use of these machines could become
more costly or could be prevented. If we are unable to obtain additional
machines or an adequate supply of reagents or other materials at commercially
reasonable rates, our ability to identify genes and SNPs would be adversely
affected.
WE RELY ON OUTSIDE SOURCES FOR TISSUE SAMPLES FROM WHICH WE ISOLATE GENETIC
MATERIAL USED IN OUR OPERATIONS. Our business could be adversely affected if we
lose access to some of these sources, or if they charged us higher access fees
or imposed tighter restrictions on our use of the information generated from the
samples.
WE CANNOT CONTROL THE PERFORMANCE OF COLLABORATORS. We may enter into
research and development relationships with corporate and academic collaborators
and others. The success of these relationships depends upon third parties'
performance of their responsibilities. Our ability to develop these
relationships is uncertain, and any established relationships may prove
unsuccessful. Our collaborators may also be pursuing alternative technologies or
developing alternative products on their own or in collaboration with others,
including our competitors.
WE RELY ON THIRD-PARTY DATA SOURCES. We rely on scientific and other data
supplied by others, including our academic collaborators and sources of tissue
samples. These data could contain errors or other defects, which could corrupt
our databases. In addition, we cannot guarantee that our data sources acquired
this information in compliance with legal requirements. If either of these
happen and become known, our business prospects could be adversely affected.
OUR BUSINESS COULD BE AFFECTED BY THE YEAR 2000 ISSUE
As a result of computer programs being written using two digits, rather
than four, to represent year dates, the performance of our computer systems and
those of our 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 which disrupt our operations, such as a temporary inability
to process transactions, send invoices or engage in other normal business
activities.
We are evaluating the Year 2000 readiness of the software products that we
sell, the information technology systems used in our operations, and our other
systems such as building security and voicemail. This project consists of the
following phases:
- - identifying all of our software products, information technology systems
and other systems;
- - assessing repair or replacement requirements;
- - repair or replacement;
- - testing;
- - implementation; and
- - creating contingency plans in the event of Year 2000 failures.
We have completed testing of all current versions of our software
products, which disclosed nothing that results in Year 2000 non compliance. Even
so, whether a complete system or device in which a software product is embedded
will operate correctly for an end-user depends largely on the Year 2000
compliance of other components, most of which are supplied by third parties.
We rely, both domestically and internationally, upon various vendors,
government agencies, utility companies, telecommunications service companies,
delivery service companies and other service providers. We have no control over
these third parties and they may suffer a Year 2000 business disruption.
We also rely upon goods and services purchased from certain vendors, and
our business could be disrupted if they fail to adequately address the Year 2000
issue. We are surveying our principal vendors to assess the potential effect of
the Year 2000 issue on their ability to supply us. We cannot currently predict
the outcome of this effort. We intend to develop contingency plans regarding
vendors whose failure to be Year 2000 ready is expected to have a material
adverse impact on our operations. However, our vendors may be unable to supply
important goods and services without material interruption and our contingency
plans may not keep us adequately supplied.
The demand for our products could also be affected by Year 2000 issues
affecting our customers. We plan to develop a contingency plan for customers
with Year 2000 problems, but we cannot presently determine what impact, if any,
it will have.
We intend to develop and implement, if necessary, appropriate contingency
plans to mitigate the effects of any Year 2000 noncompliance. We expect to have
these plans completed in the second half of 1999. As part of the development of
a contingency plan, we will evaluate our worst case scenario for Year 2000
noncompliance. Although the full consequences are unknown, the failure of our
critical systems or those of our material vendors and other business partners to
be Year 2000 complaint would interrupt our business.
OUR ACTIVITIES INVOLVE HAZARDOUS MATERIALS AND MAY SUBJECT US TO ENVIRONMENTAL
LIABILITY
Our research and development involves the controlled use of hazardous and
radioactive materials and biological waste. We are 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 we believe that
our safety procedures for handling and disposing of these materials comply with
legally prescribed standards, the risk of accidental contamination or injury
from these materials cannot be completely eliminated. In the event of an
accident, we could be held liable for damages, and this liability could exceed
our resources.
We believe that we are in compliance in all material respects with
applicable environmental laws and regulations and currently do not expect to
make material additional capital expenditures for environmental control
facilities in the near term. However, we may have to incur significant costs to
comply with current or future environmental laws and regulations.
OUR REVENUES ARE DERIVED PRIMARILY FROM THE PHARMACEUTICAL AND BIOTECHNOLOGY
INDUSTRIES
We expect that our revenues in the foreseeable future will be derived
primarily from products and services provided to the pharmaceutical and
biotechnology industries. Accordingly, our success will depend directly upon the
success of the companies within these industries and their demand for our
products and services. Our operating results may fluctuate substantially due to
reductions and delays in research and development expenditures by companies in
these industries. These reductions and delays may result 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.
These factors are not within our control.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL THAT MAY NOT BE AVAILABLE
Based upon our current plans, we believe that our existing resources and
anticipated cash flow from operations can satisfy our capital needs for at least
the next twelve months. However, our products and services may not produce
revenues which, together with our existing cash and other resources, are
adequate to meet our cash needs. Our cash requirements depend on numerous
factors, including:
- - our ability to attract and retain collaborators for our databases and
other products and services;
- - expenditures in connection with alliances, license agreements and
acquisitions of and investments in complementary technologies and businesses;
- - the need to increase research and development spending as a result of
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 equipment
necessary to process data for our databases and to ensure that our sequencing
and microarray operations remain competitive;
- - capital expenditures required to expand our facilities; and
- - costs associated with the integration of acquired operations.
Changes in our research and development plans or other changes affecting
our operating expenses may alter the timing and amount of expenditures of our
capital resources. If we need additional funding, we may be unable to obtain it
on favorable terms, or at all. If adequate funds are not available, we may have
to curtail operations significantly or obtain funds by entering into
arrangements requiring us to relinquish rights to certain technologies, products
or markets. In addition, if we raise funds by selling stock or convertible
securities, our existing stockholders could suffer dilution.
OUR BUSINESS COULD BE INTERRUPTED BY NATURAL DISASTERS
We conduct our sequencing and a significant portion of our other activities
at our facilities in Palo Alto, California, and conduct our microarray-related
activities at our facilities in Fremont, California. Both locations are in a
seismically active area. Although we maintain business interruption insurance,
we do not have or plan to obtain earthquake insurance. A major catastrophe (such
as an earthquake or other natural disaster) could result in a prolonged
interruption of our business.
PART I: FINANCIAL INFORMATION
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate risk primarily through its
investments in short-term marketable securities and its note payable. The
Company's investment policy calls for investment in short term, low risk
instruments. As of June 30, 1999, investments in marketable securities was $52.8
million. At June 30, 1999, the Company had a fixed rate note payable balance of
$0.6 million. Due to the nature of these investments and note, any decrease in
rates is not expected to have a material impact on the Company's financial
statements.
The Company is exposed to equity price risks on the marketable portion of equity
securities included in its portfolio of investments and long-term investments,
entered into to further its business and strategic objectives. These investments
are in small capitalization stocks in the pharmaceutical/biotech industry
sector, in companies which the Company has research and development or licensing
agreements. The Company typically does not attempt to reduce or eliminate its
market exposure on these securities. As of June 30, 1999, long-term investments,
excluding diaDexus, were $12.8 million.
The Company typically does not hedge its foreign currency exposure.
Management does not believe that the Company's exposure to foreign currency rate
fluctuations is material.
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, subsequently
transferred to the United States District Court for the Northern District of
California, 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.
In September 1998, Affymetrix filed an additional lawsuit in the United
States District Court for the District of Delaware, subsequently transferred to
the United States District Court for the Northern District of California in
November 1998, alleging infringement of the U.S. patent number 5,800,992 (the
"'992 Patent") and U.S. patent number 5,744,305 (the "'305 Patent") by both
Synteni and Incyte. The complaint alleges that the '305 Patent has been
infringed by the making, using, selling, importing, distributing or offering to
sell in the United States high density arrays by Synteni and Incyte, that the
'992 Patent has been infringed by the use of Synteni's and Incyte's GEMTM
microarray technology to conduct gene expression monitoring using two-color
labeling, and that such infringement was willful. Affymetrix seeks a permanent
injunction enjoining Synteni and Incyte from further infringement of the '305
and '992 Patents and, in addition, Affymetrix had sought a preliminary
injunction enjoining Incyte and Synteni from using Synteni's and Incyte's GEM
microarray technology to conduct gene expression monitoring using two-color
labeling as described in the '992 Patent. Affymetrix's request for a preliminary
injunction was denied in April 1999 and the lawsuit is tentatively scheduled to
go to trial in July 2000.
In April 1999, the Board of Patent Appeals and Interferences of United
States Patent and Trademark Office (PTO) declared interferences between pending
patent applications licensed exclusively to Incyte and the Affymetrix '305 and
'992 Patents. An interference proceeding is invoked by the PTO when more than
one patent applicant claims the same invention. The Board of Patent Appeals and
Interferences evaluates all relevant facts, including those bearing on first to
invent, validity, enablement and scope of claims, and then makes a determination
as to who, if anyone, is entitled to the patent on the disputed invention.
Incyte and Synteni believe they have meritorious defenses and intend to
defend the suits vigorously. However, there can be no assurance that Incyte and
Synteni will be successful in the defense of these suits. At this time, the
Company cannot reasonably estimate the possible range of any loss resulting from
these suits due to uncertainty regarding the ultimate outcome. Regardless of the
outcome, this litigation has resulted and 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 8, 1999, the Company held its Annual Meeting of Stockholders.
The following actions were taken at the annual meeting:
For Withheld
---------- --------
a. Roy A. Whitfield 23,384,886 90,937
b. Randal W. Scott 23,386,998 88,825
c. Barry M. Bloom 23,339,404 136,419
d. Jeffrey J. Collinson 23,352,919 122,904
e. Frederick B. Craves 23,352,482 123,341
f. Jon S. Saxe 23,346,984 128,839
1. The following Directors were elected
2. A proposal to amend the Company's 1991 Stock Plan
For Against Abstain
- ---------- --------- -------
16,544,042 6,757,571 53,352
3. The selection of the Company's independent auditors was ratified
For Against Abstain
- ---------- ------- -------
23,427,763 19,648 28,412
ITEM 5 Other Information
None
ITEM 6 Exhibits and Reports on Form 8-K.
a) Exhibits
See Exhibit Index on Page 35
b) Reports on Form 8-K
None
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 4, 1999 By: /s/ Roy A. Whitfield
-----------------------
Roy A. Whitfield
Chief Executive Officer
Date: August 4, 1999 By: /s/ Lee Bendekgey
------------------------
Lee Bendekgey
Chief Financial Officer
INCYTE PHARMACEUTICALS, INC.
EXHIBIT INDEX
NO. EXHIBIT PAGE
--- -------------------------------------- ----
27 Financial Data Schedule, June 30, 1999 36