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 September 30, 2001
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 GENOMICS, INC.
(Formerly known as 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 66,402,217 as of September 30, 2001.
1
INCYTE GENOMICS, INC.
INDEX
PART I: FINANCIAL INFORMATION Page
- ----------------------------- ----
Item 1 Financial Statements - Unaudited
Condensed Consolidated Balance Sheets ................................................... 3
Condensed Consolidated Statements of Operations ......................................... 4
Condensed Consolidated Statements of Comprehensive Income (Loss) ........................ 5
Condensed Consolidated Statements of Cash Flows ......................................... 6
Notes to Condensed Consolidated Financial Statements .................................... 7
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ... 14
Item 3 Quantitative and Qualitative Disclosures about Market Risk .............................. 31
PART II: OTHER INFORMATION
- --------------------------
Item 1 Legal Proceedings ....................................................................... 32
Item 2 Changes in Securities. .................................................................. 34
Item 3 Defaults Upon Senior Securities ......................................................... 34
Item 4 Submission of Matters to a Vote of Security Holders ..................................... 34
Item 5 Other Information ....................................................................... 34
Item 6 Exhibits and Reports on Form 8-K ........................................................ 34
Signatures .............................................................................. 35
2
PART I: FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
Incyte Genomics, Inc.
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)
September 30, December 31,
2001 2000*
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 45,488 $ 110,155
Marketable securities - available-for-sale 472,058 472,025
Accounts receivable, net 44,117 35,022
Prepaid expenses and other current assets 31,252 30,693
--------- ---------
Total current assets 592,915 647,895
Property and equipment, net 80,194 98,948
Long-term investments 52,089 40,003
Goodwill and other intangible assets, net 73,970 82,944
Deposits and other assets 26,472 17,030
--------- ---------
Total assets $ 825,640 $ 886,820
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,212 $ 17,497
Accrued compensation 14,764 13,023
Accrued and other current liabilities 20,981 23,036
Deferred revenue 18,888 22,756
--------- ---------
Total current liabilities 62,845 76,312
Convertible subordinated notes 179,358 187,814
--------- ---------
Total liabilities 242,203 264,126
--------- ---------
Stockholders' equity:
Common stock 66 66
Additional paid-in capital 696,879 689,392
Deferred compensation (1,955) (2,773)
Accumulated other comprehensive income 11,382 20,913
Accumulated deficit (122,935) (84,904)
--------- ---------
Total stockholders' equity 583,437 622,694
--------- ---------
Total liabilities and stockholders' equity $ 825,640 $ 886,820
========= =========
* The condensed consolidated balance sheet at December 31, 2000 has been derived
from the audited financial statements at that date.
See accompanying notes
3
INCYTE GENOMICS, INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Revenues $ 57,319 $ 51,982 $ 164,491 $ 138,751
Costs and expenses:
Research and development 50,662 51,880 161,776 138,621
Selling, general and administrative 17,886 15,848 53,038 45,669
--------- --------- --------- ---------
Total costs and expenses 68,548 67,728 214,814 184,290
--------- --------- --------- ---------
Loss from operations (11,229) (15,746) (50,323) (45,539)
Interest income and other income/(expense), net 3,003 11,034 21,640 32,251
Interest expense (2,547) (2,886) (7,692) (7,794)
Loss on sale of assets (5,777) - (5,777) -
Gain/(loss) on derivative financial instruments (1,052) - 162 -
Loss from joint venture - - - (1,283)
--------- --------- --------- ---------
Loss before income taxes, extraordinary item
and accounting change (17,602) (7,598) (41,990) (22,365)
Provision for income taxes 225 - 705 -
--------- --------- --------- ---------
Loss before extraordinary item and accounting change (17,827) (7,598) (42,695) (22,365)
Extraordinary gain, net of taxes - - 2,386 -
Cumulative effect of accounting change, net of taxes - - 2,279 -
--------- --------- --------- ---------
Net loss $ (17,827) $ (7,598) $ (38,030) $ (22,365)
========= ========= ========= =========
Per share data:
Loss before extraordinary item and accounting
change $ (0.27) $ (0.12) $ (0.65) $ (0.36)
Extraordinary gain, net of taxes - - 0.04 -
Cumulative effect of accounting change, net of
taxes - - 0.03 -
--------- --------- --------- ---------
Basic and diluted net loss per share $ (0.27) $ (0.12) $ (0.58) $ (0.36)
========= ========= ========= =========
Shares used in computing
basic and diluted net loss per share 66,370 64,064 66,064 62,825
========= ========= ========= =========
See accompanying notes
4
INCYTE GENOMICS, INC.
Condensed Consolidated Statements Of Comprehensive Income (Loss)
(in thousands)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Net loss $(17,827) $ (7,598) $(38,030) $(22,365)
Other comprehensive income (loss), net of taxes:
Unrealized gains (losses) on
marketable securities (4,107) 6,669 (9,566) 30,321
Foreign currency translation
adjustments 48 933 35 816
-------- -------- -------- --------
Other comprehensive income (loss) (4,059) 7,602 (9,531) 31,137
-------- -------- -------- --------
Comprehensive income (loss) $(21,886) $ 4 $(47,561) $ 8,772
======== ======== ======== ========
See accompanying notes
5
Incyte Genomics, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine Months Ended
September 30,
-------------------------
2001 2000
--------- ---------
Cash flows from operating activities:
Net loss $ (38,030) $ (22,365)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 38,847 26,163
Extraordinary item, debt extinguishment (2,386) -
Cumulative effect of accounting change (2,279) -
Gain on derivative financial instruments, net (162) -
Gain on sale of long-term investments (2,505) (5,417)
Loss on sale of assets 5,777 -
Impairment of long-term investments 9,015 -
Debt instruments and equity received in exchange for goods or
services provided (8,100) (6,615)
Losses from joint venture - 1,283
Changes in certain assets and liabilities:
Accounts receivable (9,095) 5,593
Prepaid expenses and other assets (14,685) (6,467)
Accounts payable (9,285) 5,347
Accrued and other current liabilities (942) 6,956
Deferred revenue (3,868) (10,204)
--------- ---------
Net cash used in operating activities (37,698) (5,726)
--------- ---------
Cash flows from investing activities:
Purchase of long-term investments (28,019) (2,475)
Proceeds from the sale of long-term investments 4,337 7,917
Capital expenditures (11,494) (49,654)
Purchases of marketable securities (733,966) (449,778)
Sales and maturities of marketable securities 739,994 168,553
Other 300 -
--------- ---------
Net cash used in investing activities (28,848) (325,437)
--------- ---------
Cash flows from financing activities:
Proceeds from exercise of employee stock options 7,487 26,813
Proceeds from issuance of common stock - 403,351
Proceeds from the issuance of Convertible Subordinated Notes, net - 196,800
Repurchase of Convertible Subordinated Notes (5,643) -
Repayment of receivable from stockholder - 20
Principal payments on capital lease obligations and note payable - (480)
--------- ---------
Net cash provided by financing activities 1,844 626,504
--------- ---------
Effect of exchange rate on cash and cash equivalents 35 816
--------- ---------
Net increase (decrease) in cash and cash equivalents (64,667) 296,157
Cash and cash equivalents at beginning of period 110,155 32,220
--------- ---------
Cash and cash equivalents at end of period $ 45,488 $ 328,377
========= =========
See accompanying notes
6
INCYTE GENOMICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(Unaudited)
1. Organization and business
Incyte Genomics, Inc. (the "Company") was incorporated in Delaware in
April 1991 under the name Incyte Pharmaceuticals, Inc. In June 2000, the
Company's stockholders approved an amendment to the Company's Certificate of
Incorporation to change the Company's name to Incyte Genomics, Inc. The Company
designs, develops, and markets genomic information including database products,
microarray-based gene expression services, single nucleotide polymorphisms (SNP)
discovery services, 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 used
by pharmaceutical and biotechnology companies and academic researchers to
understand disease and to discover and develop drugs and diagnostic products.
The Company is also engaged in its own internal disease pathway and therapeutic
drug discovery programs.
On October 25, 2001, the Company announced a restructuring of its
operations in order to focus on its database and partnership operations and its
internal disease pathway and therapeutic drug discovery programs. As a part of
the restructuring, the Company plans to discontinue its microarray-based gene
expression products and services, genomic screening products and services,
public domain clone products and related services and contract sequencing
services. The Company discontinued its transgenics product line and sold certain
of its assets in the third quarter of 2001. As a part of these actions, the
Company will close its facilities in Fremont, California and St. Louis,
Missouri. The Company also proposes to discontinue, by the end of 2001, its
internal program on SNP discovery, which has been concentrated in Cambridge, UK.
In addition to the announced closures, the Company will make infrastructure
and other personnel reductions at its other locations. The restructuring will
result in a reduction of the Company's workforce by approximately 400 employees.
2. Basis of presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States 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 September 30, 2001, condensed consolidated statements of operations
for the three and nine months ended September 30, 2001 and 2000, condensed
consolidated statements of comprehensive income (loss) for the three and nine
months ended September 30, 2001 and 2000 and the condensed consolidated
statements of cash flows for the nine months ended September 30, 2001 and 2000
are unaudited, but include all adjustments (consisting of normal recurring
adjustments) which the Company considers necessary for a fair presentation of
the financial position, operating results and cash flows for the periods
presented. The balance sheet at December 31, 2000 has been derived from audited
financial statements.
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 accounting principles generally accepted
in the United States have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain amounts reported
in the previous year have been reclassified to conform to 2001 financial
statement presentation.
Results for any interim period are not necessarily indicative of
results for any future interim period or for the entire year. The accompanying
financial statements should be read in conjunction with the financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2000.
7
3. Property and equipment
Property and equipment consisted of:
September 30, December 31,
2001 2000
------------- ------------
Office equipment $ 5,535 $ 5,308
Laboratory equipment 33,404 32,286
Computer equipment 94,997 93,136
Leasehold improvements 45,175 48,924
--------- ---------
179,111 179,654
Less accumulated depreciation and amortization (98,917) (80,706)
--------- ---------
$ 80,194 $ 98,948
========= =========
4. Convertible subordinated notes
In February 2000, in a private placement, the Company issued $200.0
million of convertible subordinated notes, which resulted in net proceeds of
approximately $196.8 million. The notes bear interest at 5.5%, payable
semi-annually on February 1 and August 1, and are due February 1, 2007. The
notes are subordinated to all senior indebtedness, as defined. The notes can be
converted at the option of the holder at an initial conversion price of $67.42
per share, subject to adjustment. The Company may, at its option, redeem the
notes at any time before February 7, 2003, but only if the Company's stock price
exceeds 150% of the conversion price for 20 trading days in a period of 30
consecutive trading days. On or after February 7, 2003 the Company may, at its
option, redeem the notes at specific prices. Holders may require the Company to
repurchase the notes upon a change in control, as defined.
In November 2000, the Company repurchased on the open market, and
retired, $15.0 million in par value of the convertible subordinated notes. The
Company recognized a gain of $3.1 million on the transactions, which was
reported as an extraordinary gain in fiscal 2000.
In the first quarter of 2001, the Company repurchased on the open
market, and retired, $8.0 million in par value of the convertible subordinated
notes. The Company recognized a gain of $2.4 million, net of tax, on the
transactions, which was reported as an extraordinary gain in fiscal 2001.
5. Revenue recognition
Revenues are recognized when persuasive evidence of an arrangement
exists, delivery has occurred or services have been rendered, the price is fixed
and determinable and collectibility is reasonably assured. For database
collaboration agreements, revenues are recognized evenly over the term of each
agreement. Revenue is deferred for fees received before earned. Revenues from
licenses to the Company's intellectual property are recognized when earned under
the terms of the related agreements. Revenues from custom orders, such as
reagents, are recognized upon completion and delivery. Revenues from custom
services are recognized upon completion. Revenue from gene expression microarray
services includes: technology access fees, which are recognized ratably over the
access term, 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.
Revenues recognized from multiple elements contracts are allocated to
each element of the arrangement based on the relative fair values of the
elements. The determination of fair value of each element is based on objective
evidence such as historical sales of the individual element by us to other
customers. If adequate evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist or until all elements of the
arrangement are delivered. When contracts include non-monetary exchanges, the
non-monetary transaction is determined using the fair values of the assets or
services involved.
8
6. Loss per share
The following is a reconciliation of the numerators and denominators of
the basic and diluted net loss per share computations for the periods presented
below.
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2001 2000 2001 2000
--------- -------- --------- --------
Numerator:
Net loss $ (17,827) $ (7,598) $ (38,030) $(22,365)
========= ======== ========= ========
Denominator:
Denominator for basic net loss
Per share - weighted-average shares 66,370 64,064 66,064 62,825
========= ======== ========= ========
Basic and diluted net loss per share $ (0.27) $ (0.12) $ (0.58) $ (0.36)
========= ======== ========= ========
Options to purchase 7,885,393 and 7,696,420 shares of common stock were
outstanding at September 30, 2001 and 2000, respectively, and notes convertible
into 2,625,333 and 2,966,500 shares of common stock were outstanding at
September 30, 2001 and 2000, respectively, but were not included in the
computation of diluted net loss per share, as their effect was antidilutive.
7. Loss on Sale of Assets
In September 2001, the Company sold certain assets of its transgenics
product line. Loss on the sale of assets of $5.8 million for the three and nine
months ended September 30, 2001 resulted from the divestiture of the transgenics
product line and the sale of certain of those assets.
8. Business Combinations
In December 2000, the Company completed the acquisition of Proteome,
Inc., a privately held proteomics information company based in Beverly,
Massachusetts. The Company issued 1,248,522 shares of its common stock and $37.7
million in cash in exchange for all of Proteome's outstanding capital stock. In
addition, the Company assumed Proteome's stock options, which if fully vested
and exercised, would amount to 216,953 shares of its common stock. The
transaction was accounted for as a purchase. The amount of the purchase price in
excess of the net tangible assets acquired of $70.8 million, was allocated to
goodwill ($50.3 million); database ($16.6 million); tradename ($1.7 million);
Proteome's assembled work force ($1.6 million); and developed technology ($0.6
million), each of which is being amortized over 8, 8, 3, 3 and 5 years,
respectively.
The Company allocated Proteome'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. The
results of operations of Proteome have been included in the consolidated results
of the Company from the date of acquisition on December 28, 2000.
9
The table below presents the unaudited pro forma results of operations
and earnings per share for Proteome and the Company for the three and nine
months ended September 30, 2000 assuming that the transaction was completed on
January 1, 2000 (in thousands except per share data).
Three Months Nine Months
Ended Ended
Pro forma revenues $ 53,123 $ 141,358
========== ===========
Pro forma net loss $ (11,940) $ (34,018)
========== ===========
Pro forma basic and diluted net loss per share $ (0.18) $ (0.53)
========== ===========
Pro forma shares for basic and diluted net loss per share 65,313 64,074
========== ===========
9. Joint venture
In September 1997, the Company formed a joint venture, diaDexus, LLC
("diaDexus"), with SmithKline Beecham Corporation ("SB"), to utilize genomic and
bioinformatic technologies in the discovery and commercialization of molecular
diagnostics. The Company held a 50 percent equity interest in diaDexus and
accounted 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.
On April 4, 2000, diaDexus obtained additional financing through a
private equity offering. In connection with the offering, diaDexus converted
from an LLC to a corporation and repaid in full the $2.5 million principal
amount of, together with accrued interest on, the convertible note held by the
Company. Under diaDexus' new capital structure, the Company no longer has the
ability to exert significant influence over diaDexus. Accordingly, the Company
accounts for its investment in diaDexus under the cost method of accounting from
the date of this financing.
diaDexus purchased $0.1 million of contract sequencing, microarray and
software services from the Company in the nine months ended September 30, 2001,
and $0.7 million and $2.0 million in the three and nine months ended September
30, 2000, respectively. diaDexus did not make similar purchases in the three
months ended September 30, 2001.
10. Segment reporting
The Company's operations are treated as one operating segment, in
accordance with SFAS 131, the design, development, and marketing of genomic
information-based tools, as it only reports profit and loss information on an
aggregate basis to chief operating decision makers of the Company. For the three
and nine months ended September 30, 2001, the Company recorded revenue from
customers throughout the United States and in Asia, Austria, Belgium, Canada,
France, Germany, Israel, Netherlands, Switzerland, and the United Kingdom.
Export revenue for the three and nine months ended September 30, 2001 were $9.6
million and $31.6 million, respectively and $10.8 million and $32.9 million for
the three and nine months ended September 30, 2000, respectively.
11. New pronouncements
In June 1998, the FASB issued Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS 133"), as amended by SFAS
Nos. 137 and 138. The Company adopted SFAS 133 in the first quarter of 2001.
SFAS 133 established standards for accounting and reporting derivative
instruments and hedging activities. It requires companies to recognize all
derivatives as either assets or liabilities on the balance sheet and measure
these instruments at fair value. Derivatives that are not designated as hedges
must be adjusted to fair value through income. The Company adopted SFAS 133 on
January 1, 2001 and recorded a $2.3 million cumulative gain, net of income tax
expense, relating to the valuation of warrants held in other companies, which is
recorded in the consolidated statements of operations as a cumulative effect of
accounting change. The Company also recorded a loss of approximately $0.6
million and $1.1 million during the first and third quarters, respectively,
related to the decrease in value of the same instruments subject to SFAS 133,
and a gain of $1.8 million related to the
10
increase in value of the same instruments in the second quarter of 2001.
In July 2001, the FASB issued Statement No. 141, Business Combinations
("SFAS 141") and Statement No. 142, Goodwill and Other Intangible Assets ("SFAS
142"). SFAS 141 prohibits the use of the pooling-of-interest method for business
combinations initiated after June 30, 2001 and also applies to all business
combinations accounted for by the purchase method that are completed after June
30, 2001. There are also transition provisions that apply to business
combinations completed before July 1, 2001 that were accounted for by the
purchase method. SFAS 142 requires, among other things, the discontinuance of
goodwill amortization and includes provisions for the reclassification of
certain existing recognized intangibles as goodwill, reassessment of the useful
lives of existing recognized intangibles, and reclassification of certain
intangibles out of previously reported goodwill. The Company is currently
evaluating the provisions of SFAS 141 and SFAS 142 and will adopt these
statements during the first quarter of fiscal year 2002.
In October 2001, the FASB issued Statement No. 144, Accounting for the
Impairment of Long-Lived Assets ("SFAS 144"). The FASB's new rules on asset
impairment supersede FASB Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of, and portions of
APB Opinion 30, Reporting the Results of Operations. SFAS 144 provides a single
accounting model for long-lived assets to be disposed of and significantly
changes the criteria that would have to be met to classify an asset as
held-for-sale. SFAS 144 also requires expected future operating losses from
discontinued operations to be displayed in the period in which the losses are
incurred, rather than as of the measurement date as presently required. The
Company will adopt the provisions of SFAS 144 during the first quarter of fiscal
year 2002. The adoption of SFAS 144 is not expected to have a material impact on
the Company's consolidated financial statements.
12. Litigation
In January 1998, Affymetrix Inc, ("Affymetrix") filed a lawsuit in the
United States District Court for the District of Delaware, which was
subsequently transferred to the United States District Court for the Northern
District of California in November 1998, alleging infringement of U.S. patent
number 5,444,934 by the Company. The complaint alleges that the Company
infringed the `934 patent by making, using, selling, importing, distributing or
offering to sell in the United States high density arrays and that this
infringement was willful. Affymetrix seeks a permanent injunction enjoining the
Company from further infringement of the `934 patent and, in addition, seeks
damages, costs, attorneys' fees and interest. Affymetrix also requests triple
damages based on its allegation of willful infringement by the Company.
In September 1998, Affymetrix filed an additional lawsuit in the United
States District Court for the District of Delaware, which was subsequently
transferred to the United States District Court for the Northern District of
California in November 1998, alleging the Company infringed U.S. patent number
5,800,992 and U.S. patent number 5,744,305. The complaint alleges that the
Company infringed the `305 patent by making, using, selling, importing,
distributing or offering to sell in the United States high density arrays. It
also alleges that the Company infringed the `992 patent by using its GEM
microarray technology to conduct gene expression monitoring and other
applications using two-color labeling, and that this infringement was willful.
Affymetrix seeks a permanent injunction enjoining the Company from further
infringement of the `305 and `992 patents, and in addition, seeks damages,
costs, attorneys' fees and interest. Affymetrix also requests triple damages
based on the allegation of willful infringement. In January, May and June 2001,
the court issued a ruling describing how the claims in the `934, `305 and `992
patents should be interpreted.
Following issuance of the Court's January 2001 claim construction
ruling, Incyte filed a motion for partial summary judgment that the Company's
cDNA arrays do not infringe any claim of the `934 patent or claims 1 and 3
through 13 of the `305 patent. On May 2, 2001, the court granted summary
judgement ruling that the Company's accused cDNA arrays do not infringe any
claim of the `934 patent claims or claims 1 and 3 through 13 of the `305 patent.
On September 20 and October 3, 2001, the Court issued orders in
Incyte's favor granting summary judgment of invalidity with respect to Incyte's
motions for invalidity of claims 1-3 of the `992 patent for indefiniteness and
invalidity of claims 4 and 5 of the `992 patent for lack of written description.
As a result,
11
every claim of the `992 patent has now been held invalid.
In April 1999, the Board of Patent Appeals and Interferences of the
United States Patent and Trademark Office declared interferences between pending
patent applications licensed exclusively to the Company and the Affymetrix `305
and `992 patents. The Board of Patent Appeals and Interferences invokes an
interference proceeding when more than one patent applicant claims the same
invention. During the proceeding, 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. In
September 1999, the Board of Patent Appeals and Interferences determined that
the Company had not met its prima facie case, and ruled that the patents
licensed by the Company from Stanford University were not entitled to priority
over corresponding claims in the two Affymetrix patents. The Company is seeking
de novo review of the Board's decisions in the United States District Court for
the Northern District of California.
In August 2000, the Company filed a lawsuit against Affymetrix in
federal court alleging infringement of U.S. patent numbers 5,716,785 and
5,891,636. The patents relate to technologies used in the amplification of RNA
and the generation of gene expression information. Affymetrix has filed
counterclaims in this lawsuit that allege, among other things, that the Company
infringes U.S. patent number 6,040,193 and U.S. patent number 5,871,928. These
counterclaims allege that the Company infringes these patents by making, using,
offering to sell and/or selling within the United States the inventions claimed
in the patents, including, in the case of the `193 patent, methods for forming
microarrays and, in the case of the `928 patent, methods for analyzing nucleic
acids. The counterclaims also allege that the Company engaged in acts of unfair
competition under California statutory and common law. Affymetrix seeks a
permanent injunction enjoining the Company from further infringement of the `193
patent and `928 patent and, in addition, seeks damages, costs and attorneys'
fees and interest. Affymetrix further requests triple damages from the
infringement claims based on its allegation of willful infringement by the
Company.
The Company believes it has meritorious defenses and intends to
vigorously defend the suits and counterclaims brought by Affymetrix. However,
the Company's defenses may be unsuccessful. At this time, the Company cannot
reasonably estimate the possible range of any loss resulting from these suits
and counterclaims due to uncertainty regarding the ultimate outcome. Regardless
of the outcome, the Affymetrix litigation has resulted and is expected to
continue to result in substantial expenses and diversion of the efforts of the
Company's management and technical personnel. Further, there can be no assurance
that any license that may be required as a result of this litigation or the
outcome thereof would be made available on commercially acceptable terms, if at
all. This litigation may also affect the Company's ability to make and use
microarrays.
On October 17, 2001, Invitrogen Corporation filed an action against the
Company in the United States District Court for the District of Delaware,
alleging infringement of three patents (U.S. patent number 5,244,797, U.S.
patent number 5,668,005, and U.S. patent number 6,063,608) that relate to the
use of reverse transcriptase with no RNase H activity in preparing complimentary
DNA from RNA. The complaint seeks unspecified money damages and injunctive
relief. The Company's response to the complaint is due on November 22, 2001. The
Company believes that it has meritorious defenses to the complaint and intends
to defend the suit brought by Invitrogen vigorously.
13. Related party transactions
The following are related party transactions as defined by FASB
Statement No. 57, Related Party Disclosures:
In March 2001, the Company entered into a LifeSeq Collaboration
Agreement, Patent License Agreement, Collaboration and Technology Transfer
Agreement and Proteome BioKnowledge Library License Agreement with Genomic
Health, Inc. ("Genomic Health"). Randal W. Scott, Chairman of the Board of the
Company, is Chairman of the Board, President and Chief Executive Officer of
Genomic Health and owns more than 10% of the outstanding capital stock of
Genomic Health. Under the agreements, Genomic Health obtained access to the
Company's LifeSeq Gold database and BioKnowledge Library and received licenses
to certain of the Company's intellectual property. Amounts Genomic Health will
pay the Company under these agreements are similar to those paid to the Company
under agreements between the Company and unrelated third party customers. The
Company received rights to certain intellectual property that Genomic Health
may, in the future, develop. At the same time, the Company
12
entered into an agreement to purchase shares of Series C Preferred Stock of
Genomic Health for an aggregate purchase price of $5.0 million which, together
with shares of Series A Preferred Stock purchased in November 2000 for an
aggregate purchase price of $1.0 million, results in the Company owning
approximately 10.9% of the outstanding capital stock of Genomic Health. Under
certain circumstances and if Genomic Health so elects, the Company has agreed to
purchase in a future offering of Genomic Health's capital stock an aggregate of
$5.0 million of the shares being sold in that offering.
In May 2001, the Company entered into a Development and License
Agreement with Iconix Pharmaceuticals, Inc. ("Iconix"). Jon S. Saxe, a director
of the Company, is Chairman of the Board of Iconix. Under the agreement, Iconix
obtained an exclusive license to the Company's LifeExpress Lead database, access
to LifeSeq and ZooSeq databases, licenses to certain of the Company's
intellectual property and use of the Company's LifeArray expression array
technology. Amounts Iconix will pay the Company under these agreements are
similar to those paid to the Company under agreements between the Company and
unrelated third party customers. The Company will become the exclusive
distributor for the database product to be developed by Iconix. At the same
time, the Company entered into an agreement to purchase shares of Series E
Preferred Stock of Iconix for an aggregate purchase price of $10.0 million.
Under certain circumstances, the Company has agreed to purchase in a future
offering of Iconix's capital stock up to an aggregate of $5.0 million of the
shares being sold in that offering.
In September 2001, the Company entered into a Technology Access for
Licensed Reagent Manufacture Agreement with Epoch Biosciences, Inc. ("Epoch").
Frederick B. Craves, a director of the Company, is Chairman of the Board of
Epoch. Under the agreements, Epoch obtained access to the
Company's LifeSeq Gold and ZooSeq databases and received licenses to certain of
the Company's intellectual property. Amounts Epoch will pay the Company under
these agreements are similar to those paid to the Company under agreements
between the Company and unrelated third party customers. The Company has
identified Epoch as the preferred provider of certain probes to Incyte's users
of LifeSeq Gold. Additionally, Epoch will supply Incyte with certain probes for
internal development purposes.
In September 2001, the Company entered into a Collaboration Agreement,
Patent License Agreement and two Unilateral Development and Commercialization
Agreements with Medarex, Inc. ("Medarex"). Frederick B. Craves, a director of
the Company, is also a director of Medarex. Under the agreements, Medarex
obtained access to the Company's LifeSeq Gold database and received licenses to
certain of the Company's intellectual property. The agreements were negotiated
by the parties at arm's-length. Additionally, under the terms of the agreements,
Medarex and Incyte expect to share equally the cost and responsibility of
preclinical and clinical development of antibody products. In addition, the two
companies plan to jointly commercialize any antibody products resulting from
this collaboration.
13
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 September 30, 2001 and for the three and nine month
periods ended September 30, 2001 and 2000 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, 2000.
When used in this Report, the words "expects," "anticipates,"
"estimates," "plans," "believes," "intends," and similar expressions are
intended to identify forward-looking statements. These are statements that
relate to future periods and include statements as to our expected net losses,
our expected expenditure levels and rate of growth of expenditures, our expected
cash flows, the adequacy of our capital resources, our expected growth in
operations, our expected revenues and sources of revenues, the ability to
commercialize products developed under collaborations and alliances, our plans
to restructure our operations and the expected closures and reductions, the
number of job losses to be incurred through our restructuring, and guidance as
to the expected non-recurring charge for the fourth quarter of 2001, and the
components thereof, our investment in our therapeutic drug discovery and
development programs, our ability to complete the sequence of full-length genes
in areas of therapeutic interest and obtain patents on these potential drug
targets, our ability to integrate companies, operations and their products that
we have acquired or will acquire, the scheduling and timing of current and
future litigation, our investments in our intellectual property portfolio, our
strategic equity investments in other companies, our strategy with regard to
protecting our proprietary technology, our investments in, and the success of,
our drug target identification and validation efforts, our investment in new
products and services, our ability to compete and respond to rapid technological
change, our competitive advantage as to the annotation of the human proteome,
the effect of government regulation, our compliance with applicable
environmental laws and regulations, the adequacy of our current facilities and
our ability to locate additional facilities at reasonable rates, our exposure to
foreign currency rate fluctuations, products and services under development, and
the performance, content and utility of our products and services.
Forward-looking statements 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 to which the pharmaceutical and biotechnology industries use
genomic information in research and development, risks relating to development
of new products and services and their use by our potential customers and
collaborators, our ability to develop and commercialize products to improve
human health, our ability to work with our collaborators to meet the goals of
our collaborations and alliances, our ability to retain and obtain customers,
the cost of accessing or acquiring technologies or intellectual property, the
effectiveness of our sequencing efforts, the effectiveness of our target
validation and drug discovery efforts, impairment of the value of the securities
underlying equity investments that we hold, the impact of alternative
technological advances and competition, the impact of further changes in our
business plan, changes in customer demand for our products, our success in
negotiating future licensing transactions, the development of new partnering and
collaborative relationships, the impact of competition and technological
advances, the number of employees entitled to receive retention benefits, and
other costs to be recognized in connection with the restructuring, our ability
to implement within the stated timeframe the restructuring and facility
closures, uncertainties associated with changes in patent laws and developments
in and expenses related to litigation and interference proceedings; 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.
In the section of this report entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Factors That May
Affect Results," all references to "Incyte," "we," "us," "our" or the "Company"
mean Incyte Genomics, Inc. and its subsidiaries.
Incyte, LifeSeq and BioKnowledge are our registered trademarks.
LifeExpress and GEM are our trademarks. We also refer to trademarks of other
corporations and organizations in this document.
14
Overview
Incyte Genomics, Inc. ("Incyte" or the "Company") designs, develops and
markets genomic information-based products and services. Through the third
quarter of 2001, these products and services include database products,
microarray-based gene expression services and single nucleotide polymorphism, or
SNP, discovery services, 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
products and services used by pharmaceutical and biotechnology companies and
academic researchers to understand disease and to discover and develop drugs and
diagnostic products. The Company is also engaged in its own internal disease
pathway and therapeutic drug discovery programs.
In July 2000, the Company's board of directors approved a two-for-one
stock split in the form of a stock dividend. Incyte stockholders of record on
August 7, 2000 received one additional share for each share of common stock held
at the time. The additional shares were distributed to eligible stockholders on
August 31, 2000. All share and per share data have been adjusted retroactively
to reflect the split.
On October 25, 2001, the Company announced a restructuring of its
operations in order to focus on its database and partnership operations and its
internal disease pathway and therapeutic drug discovery programs. As a part of
the restructuring, the Company plans to discontinue its microarray-based gene
expression products and services, genomic screening products and services,
public domain clone products and related services and contract sequencing
services. The Company discontinued its transgenics product line and sold certain
of its assets in the third quarter of 2001. As a part of these actions, the
Company will close its facilities in Fremont, California and St. Louis,
Missouri. The Company also proposes to discontinue, by the end of 2001, its
internal program on SNP discovery, which has been concentrated in Cambridge, UK.
In addition to the announced closures, the Company will make
infrastructure and other personnel reductions at its other locations. The
restructuring will result in a reduction of the Company's workforce by
approximately 400 employees.
In the third quarter of 2001, the Company recorded a charge of $5.8
million associated with the divestiture of its transgenics product line. In
connection with its restructuring, the Company also expects that, in the fourth
quarter of 2001, it will recognize an additional non-recurring charge that could
exceed $80 million. Approximately 25% of the fourth quarter charges are
anticipated to be cash related and the remainder of such fourth quarter charges
are anticipated primarily to be associated with the write-off of assets.
Revenues recognized by the Company consist primarily of non-exclusive
database access fees related to database agreements, gene product and database
related license fees, the sales of genomic screening products and services, fees
for contract sequencing services, fees for research programs, and fees for
microarray-based gene expression services. 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 additional milestone payments or royalties. The Company's ability to
maintain and increase revenues depends on its ability to obtain additional
database subscribers, to retain existing subscribers, to maintain adequate price
levels, to expand its product and service offerings and to expand its customer
base. 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.
In 2001, the Company has made and intends to continue to make
significant investments focused on the further development of its intellectual
property portfolio and its internal disease pathway and therapeutic drug
discovery programs. Depending on the investment required and the timing of such
15
investments, expenses or losses related to these investments could adversely
affect operating results. In addition to its investments in these areas, the
Company is continuing to invest in its identification and characterization of
full length genes, proteomics and protein annotation, increasing content in
the database products, and bioinformatics in 2001. As a result, the Company
expects to report a net loss at least through 2001. If the costs of these new
and existing programs are greater than anticipated, or if these programs take
longer to complete, or if losses are incurred from strategic investments, the
Company may incur losses in future periods as well.
In December 2000, the Company completed the acquisition of Proteome,
Inc., a privately held proteomics database company. The Company issued 1,248,522
shares of its common stock and $37.7 million in cash in exchange for all of
Proteome's outstanding capital stock. In addition, the Company assumed
Proteome's stock options, which if fully vested and exercised, would amount to
216,953 shares of its common stock. The fair value of the stock options assumed
were allocated between additional purchase price and deferred compensation in
accordance with guidance provided by the Financial Accounting Standards Board's
Interpretation No. 44. The transaction was accounted for as a purchase. The
amount of the purchase price in excess of net tangible assets acquired of
approximately $70.8 million was allocated to goodwill ($50.3 million), database
($16.6 million), developed technology ($0.6 million), tradename ($1.7 million),
and assembled workforce ($1.6 million), which are being amortized over 8, 8, 5,
3 and 3 years, respectively. The Company evaluates its intangible assets for
impairment on a quarterly basis.
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 Company has incurred and may 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 the Company and
in the lawsuits filed by the Company against Affymetrix in August 2000.
In its lawsuits against the Company, Affymetrix seeks a permanent
injunction enjoining the Company from further infringement of certain Affymetrix
patents. In addition, Affymetrix seeks damages, costs, attorneys' fees and
interest. Affymetrix further requests that any such damages be tripled on its
allegation of willful infringement by the Company.
In August 2000, the Company filed a patent infringement suit against
Affymetrix in the United States Court for the Northern District of California.
The suit alleges infringement of U.S. Patent Numbers 5,716,785 and 5,891,636.
These patents cover key technologies used in the amplification of RNA and the
creation of gene expression data.
With respect to the lawsuits filed by the Company, Affymetrix has filed
counterclaims against the Company. See Note 11 of Notes to Consolidated
Financial Statements.
The Company believes it has meritorious defenses and intends to defend
these suits and counterclaims vigorously. However, there can be no assurance
that the Company 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 and counterclaims 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 and
counterclaims or the outcome thereof would be made available on commercially
acceptable terms, if at all.
16
Results of Operations
Net loss and diluted net loss per share were $17.8 million and $38.0
million and $0.27 and $0.58 per share for the three and nine months ended
September 30, 2001, respectively, as compared to $7.6 million and $22.4 million
and $0.12 and $0.36 per share in the corresponding periods in 2000. Loss before
extraordinary item and cumulative effect of accounting change for the three and
nine months ended September 30, 2001 was $17.8 million and $42.7 million, or
$0.27 and $0.65 per diluted share, respectively. Basic and diluted net loss per
share for the three and nine months ended September 30, 2001 was impacted by the
issuance of 1,248,522 shares of common stock in the Proteome acquisition.
Diluted net loss per share for the three and nine months ended September 30,
2001 and 2000 was impacted by a private equity offering of 4,000,000 shares of
common stock in February 2000.
Revenues for the three and nine months ended September 30, 2001
increased to $57.3 million and $164.5 million, respectively, compared to $52.0
million and $138.8 million for the corresponding periods in 2000. Revenues
resulted primarily from database access fees, license and royalty fees,
microarray-based gene expression services, genomic screening products and
services, and fees for contract sequencing. The increase in revenues was
primarily attributable to the focus of our sales, marketing and business
development efforts to expand our customer base and leverage our intellectual
property portfolio.
Total costs and expenses for the three and nine months ended September
30, 2001 increased to $68.5 million and $214.8 million, respectively, compared
to $67.7 million and $184.3 million for the corresponding periods in 2000. The
Company anticipates continuing to invest in its intellectual property portfolio
and its internal disease pathway and therapeutic drug discovery programs.
Research and development expenses for the three months ended September
30, 2001 decreased to $50.7 million from $51.9 million for the corresponding
period in 2000, and for the nine months ended September 30, 2001 increased to
$161.8 million from $138.6 million for the corresponding period in 2000. The
decrease for the three months ended September 30, 2001 as compared to the
corresponding period in 2000 was primarily due to decreased expenses related to
internet marketing, software development efforts, and patent legal expenses,
partially offset by increased licensing royalties and goodwill amortization
related to the Proteome acquisition. The increase in research and development
expenses for the nine months ended September 30, 2001 resulted primarily from an
increase in bioinformatics efforts, software development efforts, licensing
royalties, goodwill amortization related to the Proteome acquisition, and an
increase in internal disease pathway and therapeutic drug discovery programs.
The Company is committed to continuing pursuit of the development of its
intellectual property portfolio and its internal disease pathway and therapeutic
drug discovery programs.
Selling, general and administrative expenses for the three and nine
months ended September 30, 2001 increased to $17.9 million and $53.0 million,
respectively, compared to $15.8 million and $45.7 million for the corresponding
periods in 2000. The increase in selling, general and administrative expenses
resulted primarily from higher litigation expenses, and the growth in the
Company's sales and marketing function. The Company's selling, general and
administrative expenses were also impacted by legal expenses related to the
Company's patent infringement lawsuits with Affymetrix and GeneLogic of
approximately $4.1 million and $10.7 million in the three and nine months ended
September 30, 2001, respectively, and $2.2 million and $5.6 million in the
corresponding periods in 2000. The litigation-related expenses, in any given
quarter, may result in significant fluctuations impacting the overall selling,
general and administrative expenses.
Interest and other income, net for the three and nine months ended
September 30, 2001 decreased to $3.0 million and $21.6 million, respectively,
from $11.0 million and $32.3 million for the corresponding periods in 2000. The
decrease for the three months ended September 30, 2001 resulted from a lower
average level of interest bearing investments combined with a $5.3 million
impairment charge. For the nine months ended September 30, 2001, the decrease
resulted from a $9.0 million impairment charge on strategic investments taken in
2001 and a $5.4 million gain in 2000 compared to a $2.5 million gain in 2001
from investment activity, partially offset by a higher average level of interest
bearing investments. The activity on discrete
17
investments within the portfolio, in any given quarter, may result in gains or
losses on sales or impairment charges.
Interest expense for the three and nine months ended September 30, 2001
decreased to $2.5 million and $7.7 million, respectively, from $2.9 million and
$7.8 million for the corresponding periods in 2000. The decrease was due to a
reduction of the interest expense associated with the Company's convertible
subordinated notes issued in February 2000, due to repurchases on the open
market in the fourth quarter of 2000 and first quarter of 2001 leaving the face
value of the notes outstanding at September 30, 2001 at $177.0 million compared
to $200.0 million at September 30, 2000.
Loss on the sale of assets of $5.8 million for the three and nine
months ended September 30, 2001 resulted from the divestiture of the transgenics
product line and the sale of certain of those assets. There were no sales of
assets in the three or nine month periods ended September 30, 2000.
Loss on derivative financial instruments for the three months ended
September 30, 2001 of $1.1 million and gain on derivative financial instruments
for the nine months ended September 30, 2001 of $0.2 million represents the
change in fair value of certain long-term investments, specifically warrants
held in other companies, in accordance with SFAS 133.
Loss from joint venture represents the Company's share of diaDexus'
losses from operations. The Company incurred no losses from joint venture for
the three and nine months ended September 30, 2001 and the three months ended
September 30, 2000. The Company incurred $1.3 million in losses from joint
venture for the nine months ended September 30, 2000. Beginning on April 4,
2000, the Company accounted for its investment in diaDexus under the cost method
of accounting as it no longer had significant influence over diaDexus and
therefore did not reflect any portion of diaDexus' results of operations in the
Company's statement of operations in the three and nine months ended September
30, 2001.
Provision for income taxes for the three and nine months ended
September 30, 2001 of $0.2 million and $0.7 million, respectively, primarily
relate to foreign withholding taxes. The Company had no such taxes in the
corresponding periods in 2000.
Extraordinary gain, net of taxes, for the nine months ended September
30, 2001 resulted from the Company's repurchase of $8.0 million face value of
its 5.5% convertible subordinated notes on the open market in the first quarter
of 2001. The repurchases resulted in a gain of $2.4 million, net of taxes.
The cumulative effect of an accounting change for the nine months ended
September 30, 2001 resulted from the adoption of SFAS 133 in the first quarter
of 2001. The Company recorded the fair value of its warrants in certain
long-term strategic investments at January 1, 2001, resulting in a gain of $2.3
million.
Liquidity and Capital Resources
As of September 30, 2001, the Company had $517.5 million in cash, cash
equivalents and marketable securities, compared to $582.2 million as of December
31, 2000. 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 used in operating activities was $37.7 million and $5.7
million for the nine months ended September 30, 2001 and 2000, respectively. The
increase was primarily due to the increase in net loss, accounts receivable and
prepaid expenses and other assets and decrease in accounts payable as compared
to 2000. These changes were partially offset by the increase in depreciation and
amortization as compared to 2000. Net cash generated by operating activities may
fluctuate significantly from quarter to quarter due to the timing of large
prepayments by database collaborators.
In February 2000, in a private placement, the Company issued $200.0
million of convertible
18
subordinated notes, which resulted in net proceeds of approximately $196.8
million. The notes bear interest at 5.5%, payable semi-annually on February 1
and August 1, and are due February 1, 2007. The notes are subordinated to senior
indebtedness, as defined. The notes can be converted at the option of the holder
at an initial conversion price of $67.42 per share, subject to adjustment. The
Company may redeem the notes at any time before February 7, 2003, only if the
Company's stock exceeds 150% of the conversion price for 20 trading days in a
period of 30 consecutive trading days. On or after February 7, 2003 the Company
may redeem the notes at specific prices. Holders may require the Company to
repurchase the notes upon a change in control, as defined. As of September 30,
2001, the Company had repurchased $23.0 million face value of the notes on the
open market.
In February 2000, in a private placement, the Company issued 4,000,000
shares of its common stock at a price of $105.50 per share, resulting in net
proceeds of $403.4 million.
The Company's investing activities, other than purchases, sales and
maturities of marketable securities, have consisted predominantly of capital
expenditures and net purchases of long-term investments. Capital expenditures
for the nine months ended September 30, 2001 were $11.5 million as compared to
$49.7 million in the same period in 2000, primarily due to the timing of capital
purchases. Purchases of long-term investments in companies with which the
Company has research and development agreements were $28.0 million for the nine
months ended September 30, 2001. In the future, net cash used by investing
activities may fluctuate significantly from period to period due to the timing
of strategic equity investments, capital expenditures and maturity/sales and
purchases of marketable securities.
Net cash provided by financing activities was $1.8 million for the nine
months ended September 30, 2001 as compared to $626.5 million for the nine
months ended September 31, 2000. The Company repurchased $8.0 million face value
of its 5.5% convertible subordinated notes on the open market for $5.6 million
in 2001 offset by proceeds from the exercise of employee stock options of $7.5
million. The 2000 activity included the issuance of common stock in a private
equity offering resulting in net proceeds of $403.4 million, the net proceeds
from the issuance of 5.5% Convertible Subordinated Notes of $196.8 million, and
the proceeds from the exercise of employee stock options of $26.8 million.
On October 25, 2001, the Company announced a restructuring of its
operations in order to focus on its database and partnership operations and its
internal disease pathway and therapeutic drug discovery programs. As a part of
the restructuring, the Company plans to discontinue its microarray-based gene
expression products and services, genomic screening products and services,
public domain clone products and related services and contract sequencing
services. The Company discontinued its transgenics product line and sold certain
of its assets in the third quarter of 2001. As a part of these actions, the
Company will close its facilities in Fremont, California and St. Louis,
Missouri. The Company also proposes to discontinue, by the end of 2001, its
internal program on SNP discovery, which has been concentrated in Cambridge, UK.
In addition to the announced closures, the Company will make
infrastructure and other personnel reductions at its other locations. The
restructuring will result in a reduction of the Company's workforce by
approximately 400 employees.
In the third quarter of 2001, the Company recorded a charge of $5.8
million associated with the divestiture of its transgenics product line. In
connection with its restructuring, the Company also expects that in the fourth
quarter of 2001 it will recognize an additional non-recurring charge that could
exceed $80 million. Approximately 25% of the fourth quarter charges are
anticipated to be cash related and the remainder is anticipated primarily to be
associated with the write-off of assets.
The Company expects to use net cash in 2001 as it: invests in its
internal disease pathway and therapeutic drug discovery programs, intellectual
property portfolio, sequencing, and bioinformatics; invests in data
processing-related computer hardware to support its existing and new database
products and to enable the on-line delivery of those products; continues to
seek access to technologies through investments, research and development
alliances, license agreements and/or acquisitions; and makes strategic
investments.
Based upon its current plans, the Company believes that its existing
resources will be adequate to satisfy its capital needs for at least the next
twelve months. 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; expenditures in connection with
alliances, license agreements and acquisitions of and investments in
complementary technologies and businesses; expenditures in connection with its
internal disease pathway and therapeutic drug discovery programs; competing
technological and market developments; and the cost of filing, prosecuting,
defending and enforcing patent claims and other intellectual property rights.
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.
19
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 will evaluate the impact of
the euro conversion on its computer and financial systems, business processes,
market risk, and price competition. The Company does not expect this conversion
to have a material impact on its results of operations, financial position or
cash flows.
FACTORS THAT MAY AFFECT RESULTS
We recently announced a restructuring of our operations that includes
discontinuing certain of our product lines and a reduction in force, which could
negatively impact our operating results
In October 2001, we announced plans to restructure our operations in
order to focus on our database and partnership operations and our internal
disease pathway and therapeutic drug discovery programs. As a part of the
restructuring, we plan to discontinue our microarray-based gene expression
products and services, genomic screening products and services, public domain
clone products and related services and contract sequencing services. As a
result, we plan to close our facilities in Fremont, California and St. Louis,
Missouri. By the end of 2001, we also propose to discontinue our internal
program on single nucleotide polymorphism discovery, which is concentrated in
Cambridge, UK. In the third quarter of 2001, we discontinued our transgenics
product line. We believe the restructuring of our operations to focus on our
database and partnership operations and our internal disease pathway and
therapeutic discovery programs will result in the reduction of our workforce by
approximately 400 employees. In connection with the implementation of these
actions, we currently expect that we will record an additional non-recurring
charge that could exceed $80 million in the fourth quarter of 2001. We
anticipate that approximately 25% of the fourth quarter costs will be cash
related and that the remainder will primarily be associated with the write-off
of assets. Some of our customers that purchase continuing and discontinued
products could become dissatisfied as a result of our restructuring, and our
future revenues could suffer as a result. In addition, our restructuring plans
may result in diversion of the efforts of our sales force, higher than
anticipated costs associated with our restructuring plans, and diversion of the
efforts of our executive management team and other key employees, any of which
may negatively impact our operating results.
We have had only limited periods of profitability, we expect to incur losses in
the future and we may not return to profitability
We had net losses from inception in 1991 through 1996 and again incurred
net losses in 1999 through the nine months ended September 30, 2001. Because of
those losses, we had an accumulated deficit of $122.9 million as of September
30, 2001. We intend to continue to spend significant amounts on new products
including therapeutic drug discovery and development programs. The amounts we
intend to spend on new product and technology development include spending for
our efforts to determine the sequence of genes, or genomic sequencing, determine
gene functions, develop database and software products and expand research and
development alliances. As a result, we expect to incur losses in 2001. We may
report net losses in future periods as well. We will not return to profitability
unless we increase our revenues, reduce our expenses or a combination thereof.
To generate significant revenues, we must obtain additional database
collaborators and retain existing collaborators
As of September 30, 2001, we had over 30 database agreements. If we are
unable to enter into additional agreements, or if our current database
collaborators choose not to renew their agreements upon expiration, we may not
generate additional revenues or maintain our current revenues. Our database
20
revenues are also affected by the extent to which existing collaborators expand
their agreements with us to include additional database products and the extent
to which existing collaborators reduce the number of products or services for
which they subscribe, the impact of which will vary based upon our pricing of
those products and services. Some of our database agreements require us to meet
performance obligations, some or all of which we may not be successful in
attaining. 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 longer-term strategy for profitability includes milestone payments and
royalties from the sale of products developed under licenses to our gene-related
intellectual property, but these licenses may not contribute to revenues for
several years, and may never result in revenues
Part of our strategy is to license to database collaborators and to some
of our other customers our know-how and patent rights associated with the
genetic information in our proprietary database, 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. Therefore, milestone or royalty payments from these
collaborations may not contribute to revenues for several years, if at all.
Our operating results are difficult to predict, which may cause our stock price
to decline and result in losses to investors
Our operating results are difficult to predict and may fluctuate
significantly from period to period, which may cause our stock price to decline
and result in losses to investors. Some of the factors that could cause our
operating results to fluctuate include:
. changes in the demand for our products and services, including our
database business;
. the introduction of competitive databases or services, including
databases of publicly available, or public domain, genetic information;
. the nature, pricing and timing of products provided to our
collaborators;
. acquisition, licensing and other costs related to the expansion of our
operations, including operating losses of acquired businesses;
. losses and expenses related to our investments in joint ventures and
businesses;
. 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;
. changes in intellectual property laws that affect our rights in genetic
information that we sell;
. 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 and counterclaims filed by Affymetrix.
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 harm 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
21
and investors, our stock price will likely fall, possibly by a significant
amount.
Our industry is intensely competitive, and if we do not compete effectively, our
revenues may decline
We compete in markets that are new, intensely competitive, rapidly
changing, and fragmented. Many of our current and potential competitors have
greater financial, human and other resources than we do. If we cannot respond
quickly to changing customer requirements, secure intellectual property
positions, or adapt quickly and obtain access to new and emerging technologies,
our revenues may decline. Our competitors include:
. Celera Genomics Group of Applera Corporation,
. CuraGen Corporation,
. Gene Logic Inc.,
. Human Genome Sciences, Inc.,
. Invitrogen Corporation,
. Millennium Pharmaceuticals, Inc.,
. major pharmaceutical companies, and
. universities and other research institutions, including those receiving
funding from the federally funded Human Genome Project.
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.
In addition, we face competition from companies who are developing and
may seek to develop new technologies for discovering the functions of genes,
gene expression information, discovery of variations among genes and related
technologies. Also, if we are unable to obtain the technology we currently use
or new advanced technology on acceptable terms, but other companies are, we will
be unable to compete.
Extensive research efforts resulting in rapid technological progress
characterize the genomics industry. To remain competitive, we must continue to
enhance our databases, improve our software, and invest in new technologies. New
developments will probably continue, and discoveries by others may render our
services and potential products noncompetitive.
Our new investments in validating drug targets will lead to increased expenses
and may not result in commercial products or services
We have recently decided to further invest in validating drug targets
associated with diseases that may be linked to several or many genes working in
combination. The process of discovering drugs based upon genomics is new and
evolving rapidly, and we have limited experience in discovering or developing
drugs. These efforts will result in increased expenses and may not result in
commercial products or services. There is limited scientific understanding
generally relating to the role of genes in diseases, and few, if any, products
based on gene discoveries have been developed and commercialized. Accordingly,
even if we are successful in identifying genes, biological pathways or drug
candidates associated with specific diseases, we or our collaborators may not be
able to develop or commercialize products to improve human health. Rapid
technological development by us or others may result in compounds, products or
processes becoming obsolete before we recover our development expenses.
22
Our revenues could decline due to patent positions becoming publicly available,
or due to our competitors publicly disclosing their discoveries
Our competitors may discover and establish patent positions with
respect to the genes in our databases. Our competitors and other entities who
engage in discovering the location of genes within a DNA strand may make the
results of their sequencing efforts publicly available. Currently, academic
institutions and other laboratories participating in the Human Genome Project
make their gene sequence information available through a number of publicly
available databases, including the GenBank database. Also, in 2001, Celera
Genomics Group made available to the public basic human sequence data. The
public availability of these discoveries or resulting patent positions covering
substantial portions of the human genome 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.
We are involved in patent litigation, which if not resolved favorably could
require us to pay damages and to stop making and using microarray products
We are currently involved in patent litigation. If we lose this
litigation we could be prevented from producing and using our microarray
products, including uses of those products for purposes of providing gene
expression database products. We could also be required to pay damages. In
January 1998, Affymetrix filed a lawsuit in federal court alleging that we
infringe U.S. patent number 5,445,934. The complaint alleges that we infringed
the `934 patent by making, using, selling, importing, distributing or offering
to sell in the United States high density arrays and that this infringement was
willful. Affymetrix seeks a permanent injunction enjoining us from further
infringement of the `934 patent and, in addition, seeks damages, costs,
attorneys' fees and interest. Affymetrix also requests triple damages based on
its allegation of willful infringement by us.
In September 1998, Affymetrix filed an additional lawsuit in federal
court, alleging we infringed U.S. patent number 5,800,992 and U.S. patent number
5,744,305. The complaint alleges that we infringed the `305 patent by making,
using, selling, importing, distributing or offering to sell in the United States
high density arrays. It also alleges that we infringed the `992 patent by using
GEM(TM) microarray technology to conduct gene expression monitoring and other
applications using two-color labeling, and that this infringement was willful.
Affymetrix seeks a permanent injunction enjoining us from further infringement
of the `305 and `992 patents, and in addition, seeks damages, costs, attorneys'
fees and interest. Affymetrix also requests triple damages based on the
allegation of willful infringement. In January, May and June 2001, the Court
issued claims construction rulings describing how the claims in the `934, `305
and `992 patents should be interpreted.
Following issuance of the Court's claims construction ruling, we filed
a motion for partial summary judgement that our cDNA arrays do not infringe any
claim of the `934 patent or claims 1 and 3 through 13 of the `305 patent. On May
2, 2001, the Court granted summary judgement ruling that our accused cDNA arrays
do not infringe any claim of the `934 patent claims or claims 1 and 3 through 13
of the `305 patent. On September 20 and October 3, 2001, the Court issued two
orders in our favor for partial summary judgment of invalidity, the combined
effect of which was to hold every claim of the `992 patent invalid.
In April 1999, the Board of Patent Appeals and Interferences of the
United States Patent and Trademark Office declared interferences between pending
patent applications licensed exclusively to us and the Affymetrix `305 and `992
patents. The Board of Patent Appeals and Interferences invokes an interference
proceeding when more than one patent applicant claims the same invention. During
the proceeding, 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. In September 1999, the Board
of Patent Appeals and Interferences determined that we had not met our prima
facie case, and ruled that the patents licensed by us from Stanford University
were not entitled to priority over corresponding claims in the two Affymetrix
patents. We are seeking de novo review of the Board's decisions in the United
States District Court for the Northern District of California.
23
In August 2000, we filed a lawsuit against Affymetrix in federal court
alleging infringement of U.S. patent numbers 5,716,785 and 5,891,636. The
patents relate to technologies used in the amplification of RNA and the
generation of gene expression information. Affymetrix has filed counterclaims in
this lawsuit that allege, among other things, that we infringe U.S. patent
number 6,040,193 and U.S. patent number 5,871,928. These counterclaims allege
that we infringe these patents by making, using, offering to sell and/or selling
within the United States the inventions claimed in the patents, including, in
the case of the `193 patent, methods for forming microarrays and, in the case of
the `928 patent, methods for analyzing nucleic acids. The counterclaims also
allege that we engaged in acts of unfair competition under California statutory
and common law. Affymetrix seeks a permanent injunction enjoining us from
further infringement of the `193 patent and `928 patent and, in addition, seeks
damages, costs and attorneys' fees and interest. Affymetrix further requests
triple damages from the infringement claims based on its allegation of willful
infringement by us.
We believe we have meritorious defenses and intend to defend the suits
and counterclaims brought by Affymetrix vigorously. However, our defenses may be
unsuccessful. At this time, we cannot reasonably estimate the possible range of
any loss resulting from these suits and counterclaims due to uncertainty
regarding the ultimate outcome. Regardless of the outcome, the Affymetrix
litigation has resulted and is expected to continue to result in substantial
expenses and diversion of the efforts of our management and technical personnel.
Further, there can be no assurance that any license that may be required as a
result of this litigation or the outcome thereof would be made available on
commercially acceptable terms, if at all. This litigation may also affect our
ability to make and use microarrays.
On October 17, 2001, Invitrogen Corporation filed an action against us
in the United States District Court for the District of Delaware, alleging
infringement of three patents that relate to the use of reverse transcriptase
with no RNase H activity in preparing complimentary DNA from RNA. The complaint
seeks unspecified money damages and injunctive relief. Our response to the
complaint is due on November 22, 2001. We believe that we have meritorious
defenses to the complaint and intend to defend the suit brought by Invitrogen
vigorously. However, our defenses may be unsuccessful, and we may incur
significant costs in defending this litigation, as well as face diversion of our
management and technical personnel. At this time we cannot reasonably estimate
the possible costs associated with, or ultimate outcome of, this suit.
If we are subject to additional litigation and infringement claims, they could
be costly and disrupt our business
The technology that we use to develop our products, and the technology
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 third parties. Except for Affymetrix and Invitrogen, 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
24
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 and services. Further, we may not be able
to obtain any necessary licenses on acceptable terms, if at all.
We may be unable to protect our proprietary information, which may result in its
unauthorized use and a loss of revenue
Our business and competitive position depend upon our ability to protect
our proprietary database information and software technology. 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 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.
If the inventions described in our patent applications on full-length or partial
genes are found to be unpatentable, our issued patents are not enforced or our
patent applications conflict with patent applications filed by others, our
revenues may decline
One of our strategies is to file patent applications on what we believe
to be novel full-length and partial genes and SNPs obtained through our efforts
to discover the order, or sequence, and functions, of genes. We have filed U.S.
patent applications in which we claimed partial sequences of some genes. We have
also applied for patents in the U.S. and other countries claiming full-length
gene sequences. We hold a number of issued U.S. patents on full-length genes and
one issued U.S. patent claiming multiple partial gene sequences. While the
United States Patent and Trademark Office has issued patents covering
full-length genes, partial gene sequences and SNPs, the Patent and Trademark
Office may choose to interpret new guidelines for the issuance of patents in a
more restrictive manner in the future, which could impact the issuance of our
pending patent applications. We also do not know whether or how courts may
enforce our issued patents, if that becomes necessary. If a court finds these
types of inventions to be unpatentable, or interprets them narrowly, the value
of our patent portfolio and possibly our revenues could be diminished.
We believe that some of our patent applications claim genes and partial
sequences of 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, before a patent is issued. If a full-length or
partial length sequence for which we seek a patent is issued to one of our
competitors, we may be unable to include that full-length or partial length
sequence on a microarray or in a library of bioreagents. This could result in a
loss of revenues.
If the effective term of our patents is decreased due to changes in the U.S.
patent laws or if we need to refile some of our patent applications, the value
of our patent portfolio and the revenues we derive from it may be decreased
The value of our patents depends in part on their duration. A shorter
period of patent protection could lessen the value of our rights under any
patents that we obtain and may decrease the revenues we derive from our patents.
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.
25
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. Also, we may need to refile some of our 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 and may decrease the revenues
that we might obtain from the patents.
International patent protection is particularly uncertain, and if we are
involved in opposition proceedings in foreign countries, we may have to expend
substantial sums and management resources
Biotechnology patent law outside the United States is even more
uncertain than in the United States 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 foreign
patents or our competitors foreign patents, which could result in substantial
costs and diversion of our efforts.
If our strategic investments result in losses, our earnings may decline
We make strategic investments in joint ventures or businesses that
complement our business. These investments 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, such as the losses we reported in 1997, 1998, 1999
and the first quarter of 2000 related to our investment in diaDexus,
LLC;
. 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.
Because our sales cycle is lengthy, we may spend a lot of time and money trying
to obtain new or renewed subscriptions to our products and services but may be
unsuccessful, which could hurt our profitability
Our ability to obtain new subscribers for our databases, software tools
and other services or to obtain renewals or additions to existing subscriptions
depends upon prospective subscribers' perceptions that our products and services
can help accelerate drug discovery efforts. Our database 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 involves
the negotiation of unique terms. We may expend substantial funds and management
effort with no assurance that a new, renewed or expanded subscription or
services agreement will result. These expenditures, without increased revenues,
will negatively impact our profitability. 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.
If we encounter problems in meeting customers' software needs, our revenues
could decline and we could lose our customers' goodwill
Our databases require software support and will need to incorporate
features determined by
26
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, which could result in a loss of revenues and customer
goodwill.
We have encountered difficulties integrating companies we acquired, and if in
the future we cannot smoothly integrate businesses we acquire, our operations
and financial results could be harmed
In December 2000, we acquired Proteome, Inc. As part of our business
strategy, we may acquire other assets, technologies and businesses. Our past
acquisitions have involved and our future acquisitions may 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 impairment 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 depend on key employees in a competitive market for skilled personnel, and
the loss of the services of any of our key employees would affect our ability to
achieve our objectives
We are highly dependent on the principal members of our management,
operations and scientific staff. Our product development, operations and
marketing efforts would be delayed or curtailed if we lose the services of any
of these people.
Our future success also will depend in part on the continued service of
our executive management team, key scientific, software, bioinformatics and
management personnel and our ability to identify, hire, train and retain
additional personnel, including customer service, marketing and sales staff. We
experience intense competition for qualified personnel. If we are unable to
continue to attract, train and retain these personnel, we may be unable to
expand our business.
We rely on a small number of suppliers of products we need for our business, and
if we are unable to obtain sufficient supplies, we will be unable to compete
effectively
Currently, we use gene sequencing machines supplied by Molecular
Dynamics, a subsidiary of Amersham Pharmacia Biotech, Ltd., and chemicals used
in the sequencing process, called reagents,
27
supplied by Sigma-Aldrich, Inc. in our gene sequencing operations. If we are not
able to obtain additional machines or an adequate supply of reagents or other
materials at commercially reasonable rates, our ability to identify genes or
genetic variations would be slower and more expensive.
If the information we obtain from third-party data sources is corrupt or
violates the law, our revenues and operating results could decline
We rely on and include in our databases scientific and other data
supplied by others, including publicly available information from sources such
as the Human Genome Project. This 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
this data caused database corruption or violated legal requirements, we would be
unable to sell subscriptions to our databases. These lost sales would harm our
revenue and operating results.
Security risks in electronic commerce or unfavorable Internet regulations may
deter future use of our products and services, which could result in a loss of
revenues
We offer several products through our website on the Internet and may
offer additional products in the future. Our ability to provide secure
transmissions of confidential information over the Internet may limit online use
of our products and services by our database collaborators as we may be limited
by our inability to provide secure transmissions of confidential information
over the Internet. Advances in computer capabilities and new discoveries in the
field of cryptography may compromise the security measures we use to protect our
website, access to our databases, and transmissions to and from our website. If
our security measures are breached, our proprietary information or confidential
information about our collaborators could be misappropriated. Also, a security
breach could result in interruptions in our operations. The security measures we
adopt may not be sufficient to prevent breaches, and we may be required to incur
significant costs to protect against security breaches or to alleviate problems
caused by breaches. Further, if the security of our website, or the website of
another company, is breached, our collaborators may no longer use the Internet
when the transmission of confidential information is involved. For example,
attacks by computer hackers on major e-commerce websites and other Internet
service providers have heightened concerns regarding the security and
reliability of the Internet.
Because of the growth in electronic commerce, the United States
Congress has held hearings on whether to further regulate providers of services
and transactions in the electronic commerce market. The federal government could
enact laws, rules and regulations that would affect our business and operations.
Individual states could also enact laws regulating the use of the Internet. If
enacted, these federal and state laws, rules and regulations could require us to
change our online business and operations, which could limit our growth and our
development of our online products.
Our customers may not consider the Internet as an acceptable method for
accessing our products and services
We have expended a significant amount of time and money to make our
products available through the Internet. In 2000, we introduced our on-line
product LifeSeq Gene-by-Gene and made LifeSeq Gold and LifeExpress available
on-line. If only a few of our customers choose to use the Internet as a method
for accessing our products and services, we may have to incur a charge against
earnings to write-off Internet related assets.
Because our activities involve the use of hazardous materials, we may be subject
to costly environmental liability that could exceed our resources
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 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
28
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.
Because our revenues are derived primarily from the pharmaceutical and
biotechnology industries, our revenues may fluctuate substantially due to
reductions and delays in research and development expenditures
We expect that our revenues in the foreseeable future will be derived
primarily from products and services provided to the pharmaceutical and
biotechnology industries as well as to the academic community. Accordingly, our
success will depend in large part 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 or by the academic
community. These reductions and delays may result from factors such as:
. changes in economic conditions;
. consolidation in the pharmaceutical and biotechnology industries;
. changes in the regulatory environment, including governmental
pricing controls, affecting health care and health care providers;
. pricing pressures;
. market-driven pressures on companies to consolidate and reduce costs;
. development of internal genomics programs by current and potential
pharmaceutical, biotechnology and academic customers; and
. other factors affecting research and development spending.
In addition, increasing mergers and consolidation in the pharmaceutical and
biotechnology industries will reduce the number of current and potential
customers for us, which may also adversely affect our future revenues.
These factors are not within our control.
If a natural disaster occurs, we may have to cease or limit our business
operations
We conduct our database, sequencing and a significant portion of our
other activities at our facilities in Palo Alto, California, which is 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.
We may experience power blackouts and higher electricity prices as a result of
California's current energy crisis, which could disrupt our operations and
increase our expenses
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. We rely on the major Northern California
public utility, Pacific Gas & Electric Company, or PG&E, to supply electric
power to our facilities in Northern California. Due to problems associated with
the de-regulation of the power industry in California and shortages in wholesale
electricity supplies, customers of PG&E have been faced with increased
electricity prices, power shortages and, in some cases, rolling blackouts. If
blackouts interrupt our power supply, we may be temporarily unable to continue
operations at our facilities. Any such interruption in our ability to continue
operations at our facilities could delay our
29
ability to develop or provide our products and services, which could damage our
reputation and result in lost revenue, either of which could substantially harm
our business and results of operations.
We have a large amount of debt and our debt service obligations may prevent us
from taking actions that we would otherwise consider to be in our best interests
As of September 30, 2001, we had:
. total consolidated debt of approximately $179.4 million,
. stockholders' equity of approximately $583.4 million, and
. a deficiency of earnings available to cover fixed charges of
$37.3 million for the nine months ended September 30, 2001.
A variety of uncertainties and contingencies will affect our future
performance, many of which are beyond our control. We may not generate
sufficient cash flow in the future to enable us to meet our anticipated fixed
charges, including our debt service requirements with respect to our convertible
subordinated notes due 2007 that we sold in February 2000. At September 30,
2001, notes with a face value of $177 million were outstanding. The following
table shows, as of September 30, 2001, the aggregate amount of our interest
payments due in each of the five calendar years listed:
Aggregate
Year Interest
---- --------
2001................................. $9,808,300
2002................................. 9,735,000
2003................................. 9,735,000
2004................................. 9,735,000
2005................................. 9,735,000
Our substantial leverage could have significant negative consequences
for our future operations, including:
. increasing our vulnerability to general adverse economic and industry
conditions;
. limiting our ability to obtain additional financing;
. requiring the dedication of a substantial portion of our expected cash
flow from operations to service our indebtedness, thereby reducing the
amount of our expected cash flow available for other purposes,
including working capital and capital expenditures;
. limiting our flexibility in planning for, or reacting to, changes in
our business and the industry in which we compete; or
. placing us at a possible competitive disadvantage compared to less
leveraged competitors and competitors that have better access to
capital resources.
30
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. The Company's investment policy
calls for investment in short term, low risk instruments. As of September 30,
2001, investments in marketable securities were $509.8 million. Due to the
nature of these investments, if market interest rates were to increase
immediately and uniformly by 10% from levels as of September 30, 2001, the
decline in the fair value of the portfolio would not be material.
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 /
biotechnology industry sector, and are primarily in companies with which the
Company has research and development, licensing or other collaborative
agreements. The Company typically does not attempt to reduce or eliminate its
market exposure on these securities. As of September 30, 2001, long-term
investments were $52.1 million.
The Company is exposed to foreign exchange rate fluctuations as the
financial results of its foreign operations are translated into U.S. dollars in
consolidation. As exchange rates vary, these results, when translated, may vary
from expectations and adversely impact the Company's financial position or
results of operations. All of the Company's revenues are denominated in U.S.
dollars. The Company does not enter into forward exchange contracts as a hedge
against foreign currency exchange risk on transactions denominated in foreign
currencies or for speculative or trading purposes. If currency exchange rates
were to fluctuate immediately and uniformly by 10% from levels as of September
30, 2001, the impact to the Company's financial position or results of
operations would not be material.
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PART II: OTHER INFORMATION
Item 1 Legal Proceedings
In January 1998, Affymetrix, Inc. ("Affymetrix") filed a lawsuit in the
United States District Court for the District of Delaware, which was
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 by the Company. The complaint alleges that the Company
infringed the `934 patent by making, using, selling, importing, distributing or
offering to sell in the United States high density arrays and that this
infringement was willful. Affymetrix seeks a permanent injunction enjoining the
Company from further infringement of the `934 patent and, in addition, seeks
damages, costs, attorneys' fees and interest. Affymetrix also requests triple
damages based on its allegation of willful infringement by the Company.
In September 1998, Affymetrix filed an additional lawsuit in the United
States District Court for the District of Delaware, which was subsequently
transferred to the United States District Court for the Northern District of
California in November 1998, alleging the Company infringed U.S. patent number
5,800,992 and U.S. patent number 5,744,305. The complaint alleges that the
Company infringed the `305 patent by making, using, selling, importing,
distributing or offering to sell in the United States high density arrays. It
also alleges that the Company infringed the `992 patent by using their GEM
microarray technology to conduct gene expression monitoring and other
applications using two-color labeling, and that this infringement was willful.
Affymetrix seeks a permanent injunction enjoining the Company from further
infringement of the `305 and `992 patents, and, in addition, seeks damages,
costs, attorneys' fees and interest. Affymetrix also requests triple damages
based on the allegation of willful infringement. In January, May, and June 2001,
the Court issued three claims construction rulings describing how the claims in
the `934, `305 and `992 patents should be interpreted.
Following issuance of the Court's January 2001 claim construction
ruling, Incyte filed a motion for partial summary judgment that the Company's
cDNA arrays do not infringe any claim of the `934 patent or claims 1 and 3
through 13 of the `305 patent. On May 2, 2001, the court granted summary
judgment ruling that the Company's accused cDNA arrays do not infringe any
claim of the `934 patent claims or claims 1 and 3 through 13 of the `305 patent.
On September 20 and October 3, 2001, the Court issued two orders in
Incyte's favor: (i) granting summary judgment of invalidity with respect to
Incyte's motions for invalidity of claims 1-3 of the `992 patent; and (ii) for
indefiniteness and invalidity of claims 4 and 5 of the `992 patent for lack of
written description. As a result, every claim of the `992 patent has now been
held invalid.
In April 1999, the Board of Patent Appeals and Interferences of the
United States Patent and Trademark Office declared interferences between pending
patent applications licensed exclusively to the Company and the Affymetrix `305
and `992 patents. The Board of Patent Appeals and Interferences invokes an
interference proceeding when more than one patent applicant claims the same
invention. During the proceeding, 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. In
September 1999, the Board of Patent Appeals and Interferences determined that
the Company had not met its prima facie case, and ruled that the patents
licensed by the Company from Stanford University were not entitled to priority
over corresponding claims in the two Affymetrix patents. The Company is seeking
de novo review of the Board's decisions in the United States District Court for
the Northern District of California.
In August 2000, the Company filed a lawsuit against Affymetrix in
federal court alleging infringement of U.S. patent numbers 5,716,785 and
5,891,636. The patents relate to technologies used in the amplification of RNA
and the generation of gene expression information. Affymetrix has filed
counterclaims in this lawsuit that allege, among other things, that the Company
infringes U.S. patent number 6,040,193 and U.S. patent number 5,871,928. These
counterclaims allege that the Company infringes these patents by making, using,
offering to sell and/or selling within the United States the inventions claimed
in the patents, including, in the case of the `193 patent, methods for forming
microarrays and, in the case of the
32
`928 patent, methods for analyzing nucleic acids. The counterclaims also allege
that the Company engaged in acts of unfair competition under California
statutory and common law. Affymetrix seeks a permanent injunction enjoining the
Company from further infringement of the `193 patent and `928 patent and, in
addition, seeks damages, costs and attorneys' fees and interest. Affymetrix
further requests triple damages from the infringement claims based on its
allegation of willful infringement by the Company.
The Company believes it has meritorious defenses and intends to defend
vigorously the suits and counterclaims brought by Affymetrix. However, the
Company's defenses may be unsuccessful. At this time, the Company cannot
reasonably estimate the possible range of any loss resulting from these suits
and counterclaims due to uncertainty regarding the ultimate outcome. Regardless
of the outcome, the Affymetrix litigation has resulted and is expected to
continue to result in substantial expenses and diversion of the efforts of our
management and technical personnel. Further, there can be no assurance that any
license that may be required as a result of this litigation or the outcome
thereof would be made available on commercially acceptable terms, if at all.
This litigation may also affect the Company's ability to make and use
microarrays.
On October 17, 2001, Invitrogen Corporation filed an action against the
Company in the United States District Court for the District of Delaware,
alleging infringement of three patents (U.S. patent number 5,244,797, U.S.
patent number 5,668,005, and U.S. patent number 6,063,608) that relate to the
use of reverse transcriptase with no RNase H activity in preparing complimentary
DNA from RNA. The complaint seeks unspecified money damages and injunctive
relief. The Company's response to the complaint is due on November 22, 2001. The
Company believes that it has meritorious defenses to the complaint and intends
to defend the suit brought by Invitrogen vigorously.
33
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
None
Item 5 Other Information
The 2002 Annual Meeting of Stockholders will be held on June 4, 2002 at
such place and time as will be set forth in the Company's proxy statement
relating to that meeting. To be considered for inclusion in the Company's proxy
statement and form of proxy for its 2002 Annual Meeting of Stockholders, a
stockholder proposal must be received at the principal executive offices of the
Company not later than January 1, 2002.
A stockholder proposal not included in the Company's proxy statement
for the 2002 Annual Meeting will be ineligible for presentation at the meeting
unless the stockholder gives timely notice of the proposal in writing to the
Secretary of the Company at the principal executive offices of the Company and
otherwise complies with the provisions of the Company's Bylaws. To be timely,
the Company's Bylaws provide that the Company must have received the
stockholder's notice not less than 60 days nor more than 90 days prior to the
scheduled date of such meeting. However, if notice or prior public disclosure of
the date of the annual meeting is given or made to stockholders less than 70
days prior to the meeting date, the Company must receive the stockholder's
notice by the earlier of (i) the close of business on the 10th day after the
earlier of the day the Company mailed notice of the annual meeting date or
provided such public disclosure of the meeting date and (ii) two days prior to
the scheduled date of the annual meeting.
Item 6 Exhibits and Reports on Form 8-K.
a) Exhibits
None
b) Reports on Form 8-K
None
34
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 GENOMICS, INC.
Date: November 14, 2001 By: /s/ Roy A. Whitfield
_____________________________________
Roy A. Whitfield
Chief Executive Officer
(Duly Authorized Signatory)
Date: November 14, 2001 By: /s/ John M. Vuko
_____________________________________
John M. Vuko
Chief Financial Officer
(Principal Financial Officer)
35