UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 66,328,478 as of June 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.. 13
Item 3 Quantitative and Qualitative Disclosures about Market Risk............................. 30
PART II: OTHER INFORMATION
- --------------------------
Item 1 Legal Proceedings...................................................................... 31
Item 2 Changes in Securities.................................................................. 33
Item 3 Defaults Upon Senior Securities........................................................ 33
Item 4 Submission of Matters to a Vote of Security Holders.................................... 33
Item 5 Other Information...................................................................... 33
Item 6 Exhibits and Reports on Form 8-K....................................................... 34
Signatures............................................................................. 35
Exhibit Index.......................................................................... 36
2
PART I: FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
Incyte Genomics, Inc.
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)
June 30, December 31,
2001 2000*
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents $ 64,395 $ 110,155
Marketable securities - available-for-sale 475,006 472,025
Accounts receivable, net 31,581 35,022
Prepaid expenses and other current assets 21,488 30,693
---------------- ---------------
Total current assets 592,470 647,895
Property and equipment, net 92,163 98,948
Long-term investments 66,425 40,003
Goodwill and other intangible assets, net 76,961 82,944
Deposits and other assets 24,049 17,030
---------------- ---------------
Total assets $ 852,068 $ 886,820
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,428 $ 17,497
Accrued compensation 16,544 13,023
Accrued and other current liabilities 23,598 23,036
Deferred revenue 19,737 22,756
---------------- ---------------
Total current liabilities 68,307 76,312
Convertible subordinated notes 179,469 187,814
---------------- ---------------
Total liabilities 247,776 264,126
---------------- ---------------
Stockholders' equity:
Common stock 66 66
Additional paid-in capital 695,918 689,392
Deferred compensation (2,026) (2,773)
Accumulated other comprehensive income 15,441 20,913
Accumulated deficit (105,107) (84,904)
---------------- ---------------
Total stockholders' equity 604,292 622,694
---------------- ---------------
Total liabilities and stockholders' equity $ 852,068 $ 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 Six Months Ended
June 30, June 30,
---------------------------------- -----------------------------------
2001 2000 2001 2000
-------------- -------------- --------------- --------------
Revenues $ 56,051 $ 46,015 $ 107,172 $ 86,769
Costs and expenses:
Research and development 55,155 45,407 111,114 86,741
Selling, general and administrative 18,591 15,000 35,152 29,821
-------------- -------------- --------------- --------------
Total costs and expenses 73,746 60,407 146,266 116,562
-------------- -------------- --------------- --------------
Loss from operations (17,695) (14,392) (39,094) (29,793)
Interest and other income, net 8,723 10,813 18,637 21,217
Interest expense (2,535) (3,011) (5,145) (4,908)
Gain on derivative financial instruments 1,841 - 1,214 -
Loss From joint venture - - - (1,283)
-------------- -------------- --------------- --------------
Loss before income taxes, extraordinary item
and accounting change (9,666) (6,590) (24,388) (14,767)
Provision for income taxes 225 - 480 -
-------------- -------------- --------------- --------------
Loss before extraordinary item and accounting change (9,891) (6,590) (24,868) (14,767)
Extraordinary gain, net of taxes - - 2,386 -
Cumulative effect of accounting change - - 2,279 -
-------------- -------------- --------------- --------------
Net loss $ (9,891) $ (6,590) $ (20,203) $ (14,767)
============== ============== =============== ==============
Per share data:
Loss before extraordinary item and accounting
change $ (0.15) $ (0.10) $ (0.38) $ (0.24)
Extraordinary gain, net of taxes - - $ 0.04 -
Cumulative effect of accounting change - - $ 0.03 -
-------------- -------------- --------------- --------------
Basic and diluted net loss per share $ (0.15) $ (0.10) $ (0.31) $ (0.24)
============== ============== =============== ==============
Shares used in computing
basic and diluted net loss per share 66,076 63,798 65,911 62,206
============== ============== =============== ==============
See accompanying notes
4
INCYTE GENOMICS, INC.
Condensed Consolidated Statements Of Comprehensive Income (Loss)
(in thousands)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------- -----------------------------------
2001 2000 2001 2000
-------------- -------------- --------------- --------------
Net loss $ (9,891) $ (6,590) $ (20,203) $ (14,767)
Other comprehensive income (loss),
net of taxes:
Unrealized gains (losses) on (1,940) 822 (5,459) 23,652
marketable securities
Foreign currency translation (25) (119) (13) (117)
adjustments
--------------- -------------- -------------- --------------
Other comprehensive income (loss) (1,965) 703 (5,472) 23,535
--------------- -------------- -------------- --------------
Comprehensive income (loss) $ (11,856) $ (5,887) $ (25,675) $ 8,768
=============== ============== ============== ==============
See accompanying notes
5
Incyte Genomics, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Ended
June 30,
------------------ --------------------
2001 2000
------------------ --------------------
Cash flows from operating activities:
Net loss $ (20,203) $ (14,767)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 25,195 16,529
Extraordinary item, debt extinguishment (2,386) -
Cumulative effect of accounting change (2,279) -
Gain on derivative financial instruments, net (1,214) -
Gain on sale of long-term investments (2,184) (5,417)
Impairment of long-term investments 3,765 -
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 3,441 11,876
Prepaid expenses and other assets (950) (2,138)
Accounts payable (9,069) 7,046
Accrued and other current liabilities 4,222 8,190
Deferred revenue (3,019) 4,925
------------------ --------------------
Net cash provided by (used in) operating activities (12,781) 20,912
------------------ --------------------
Cash flows from investing activities:
Purchase of long-term investments (28,019) (250)
Proceeds from the sale of long-term investments 3,482 7,917
Capital expenditures (8,999) (33,488)
Purchases of marketable securities (581,159) (299,747)
Sales and maturities of marketable securities 580,846 91,561
------------------ --------------------
Net cash used in investing activities (33,849) (234,007)
------------------ --------------------
Cash flows from financing activities:
Proceeds from exercise of employee stock options 6,526 24,407
Proceeds from issuance of common stock - 398,290
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 - (411)
------------------ --------------------
Net cash provided by financing activities 883 619,106
------------------ --------------------
Effect of exchange rate on cash and cash equivalents (13) (118)
------------------ --------------------
Net increase (decrease) in cash and cash equivalents (45,760) 405,893
Cash and cash equivalents at beginning of period 110,155 32,220
------------------ --------------------
Cash and cash equivalents at end of period $ 64,395 $ 438,113
================== ====================
See accompanying notes
6
INCYTE GENOMICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 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, 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.
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 June 30, 2001, condensed consolidated statements of operations for
the three and six months ended June 30, 2001 and 2000, condensed consolidated
statements of comprehensive income (loss) for the three and six months ended
June 30, 2001 and 2000 and the condensed consolidated statements of cash flows
for the six months ended June 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.
3. Property and equipment
Property and equipment consisted of:
June 30, December 31,
2001 2000
---------- ------------
Office equipment $ 5,470 $ 5,308
Laboratory equipment 33,267 32,286
Computer equipment 99,101 93,136
Leasehold improvements 50,598 48,924
---------- ------------
188,436 179,654
Less accumulated depreciation and amortization (96,273) (80,706)
---------- ------------
$ 92,163 $ 98,948
========== ============
7
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
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. Revenues from licenses to the Company's intellectual property
are recognized when earned under the terms of the related agreements. 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 from historical sales of the individual element by us to other
customers. If such 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.
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 Six Months Ended
June 30, June 30,
------------------ --------------------
2001 2000 2001 2000
-------- -------- --------- ---------
Numerator:
Net loss $(9,891) $(6,590) $(20,203) $(14,767)
======== ======== ========= =========
Denominator:
Denominator for basic net loss
Per share - weighted-average shares 66,076 63,798 65,911 62,206
======== ======== ========= =========
8
Basic and diluted net loss per share $ (0.15) $ (0.10) $ (0.31) $ (0.24)
======== ======== ========= =========
Options to purchase 8,115,142 and 8,395,320 shares of common stock
were outstanding at June 30, 2001 and 2000, respectively, and notes convertible
into 2,625,353 shares of common stock were outstanding at June 30, 2001, but
were not included in the computation of diluted net loss per share, as their
effect was antidilutive.
7. 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.
The table below presents the pro forma results of operations and
earnings per share for Proteome and the Company for the three and six months
ended June 30, 2000 assuming that the transaction was completed on January 1,
2000 (in thousands except per share data).
Three Months Six Months
Ended Ended
Pro forma revenues $ 46,815 $ 88,235
========== ==========
Pro forma net loss $(10,633) $(22,078)
========== ==========
Pro forma basic and diluted net loss per share $ ( 0.16) $ ( 0.35)
========== ==========
Pro forma shares for basic and diluted net loss per share 65,047 63,455
========== ==========
8. 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.
9
diaDexus purchased $0.1 million of contract sequencing, microarray and
software services from the Company in the three and six months ended June 30,
2001, and $0.7 million and $1.3 million in the corresponding periods in 2000.
9. 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 six months ended June 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 six months ended June 30, 2001 were $13,516,000 and
$22,045,000, respectively and $11,594,000 and $23,438,000 for the three and six
months ended June 30, 2000, respectively.
10. 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 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 related
to the decrease during the first quarter in value of the same instruments
subject to SFAS 133, and a gain of $1.8 million related to the 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 is effective for fiscal years beginning after
December 15, 2001 to all goodwill and other intangible assets recognized in an
entity's statement of financial position at that date, regardless of when those
assets were initially recognized. The Company is currently evaluating the
provisions of SFAS 141 and SFAS 142 and will adopt these statements during the
first quarter of fiscal 2002.
11. 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
10
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 May 8, 2001
the Court concluded that the term "substantially complementary" as used in the
`992 patent was indefinite and that claims in the `992 patent that use the term
are therefore invalid.
On July 23, 2001, the Company filed the following five partial summary
judgment motions: (i) for invalidity of Claims 4 and 5 of the `992 patent for
lack of written description and for indefiniteness; (ii) for invalidity of the
`305 patent for lack of written description; (iii) for invalidity of claims 1-3
of the `992 patent for indefiniteness; (iv) for non-infringement of the `305
patent; and (v) for non-infringement of the `934 patent. Affymetrix also filed
motions for summary judgment as follows: for literal infringement by the Company
of claim 15 of the `305 patent; for judgment that claims 4 and 5 of the `992
patent are not invalid for lack of written description; for literal infringement
by the Company of claims 4 and 5 of the `992 patent; and for dismissal of the
Company's counterclaims against Affymetrix. All of these motions are scheduled
for hearing on August 27, 2001.
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 infringe U.S.
patent number 6,040,193 and U.S. patent number 5,871,928. These counterclaims
allege that the Company 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 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
11
commercially acceptable terms, if at all. This litigation may also affect
potential customers' willingness to use the Company's microarray services and
gene expression databases, which could adversely affect the Company's revenue.
12. Related party transactions
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 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, member of the Board
of Directors 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.
12
PART I: FINANCIAL INFORMATION
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations as of June 30, 2001 and for the three and six month
periods ended June 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, expected expenditure
levels and rate of growth of expenditures, expected cash flows, the adequacy of
capital resources, growth in operations, expected revenues and sources of
revenues, the ability to commercialize products developed under collaborations
and alliances, 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, the success of our custom genomic 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 collaborators 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, changes to 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, 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 sections of this report entitled "Business" and "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.
13
Overview
Incyte Genomics, Inc. ("Incyte" or the "Company") designs, develops and
markets genomic information-based products and services. These products and
services include database products, microarray-based gene expression services
and 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.
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
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, SNP discovery, 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
14
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 the U.S. Patent Numbers 5,716,785 and
5,891,636. These patents cover key technologies used in 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.
Results of Operations
Net loss and diluted net loss per share were $9.9 million and $20.2 million
and $0.15 and $0.31 per share for the three and six months ended June 30, 2001,
respectively, as compared to $6.6 million and $14.8 million and $0.10 and $0.24
per share in the corresponding periods in 2000. Loss before extraordinary item
and cumulative effect of accounting change for the three and six months ended
June 30, 2001 was $9.9 million and $24.9 million, or $0.15 and $0.38 per diluted
share, respectively. Basic and diluted net loss per share for the three and six
months ended June 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 six months ended June 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 six months ended June 30, 2001 increased to
$56.1 million and $107.2 million, respectively, compared to $46.0 million and
$86.8 million for the corresponding periods in 2000. Revenues resulted primarily
from database access fees, royalty and license fees, microarray-based gene
expression services, genomic screening products and services, fees for contract
sequencing, and fees from partnering programs. 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, revenues from partner programs, as well as increased
revenues from custom genomics products and services.
Total costs and expenses for the three and six months ended June 30, 2001
increased to $73.7 million and $146.3 million, respectively, compared to $60.4
million and $116.6 million for the corresponding periods in 2000. Total costs
and expenses are expected to increase in the foreseeable future due to our
continuing investment in new products and services, including internal disease
pathway and
15
therapeutic drug discovery programs, and additional costs associated with
Proteome operations.
Research and development expenses for the three and six months ended June
30, 2001 increased to $55.2 million and $111.1 million, respectively, compared
to $45.4 million and $86.7 million for the corresponding periods in 2000. The
increase in research and development expenses resulted primarily from an
increase in bioinformatics and software development efforts, SNP discovery
efforts, licensing royalties, goodwill amortization related to the Proteome
acquisition, and an increase in internal disease pathway and therapeutic drug
discovery programs. The Company expects research and development spending to
increase as the Company continues to pursue the development of new database
products and services, including Proteome's proteomic database, and as the
Company expands its internal disease pathway and therapeutic drug discovery
programs.
Selling, general and administrative expenses for the three and six months
ended June 30, 2001 increased to $18.6 million and $35.2 million, respectively,
compared to $15.0 million and $29.8 million for the corresponding periods in
2000. The increase in selling, general and administrative expenses resulted
primarily from the growth in the Company's sales and marketing function and
increased personnel to support the growing complexity of the Company's
operations. 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 $4.8 million and $6.7 million in
the three and six months ended June 30, 2001, respectively, and $1.5 million and
$2.9 million in the corresponding periods in 2000. The Company expects that
total selling, general and administrative expenses will continue to increase due
to the expenses to support the growing complexity of the Company's operations
and legal expenses associated with our defense of the Affymetrix patent
infringement lawsuits.
Interest and other income, net for the three and six months ended June 30,
2001 decreased to $8.7 million and $18.6 million, respectively, from $10.8
million and $21.2 million for the corresponding periods in 2000. The decrease
for the three months ended June 30, 2001 resulted from a lower average level of
interest bearing investments, combined with a $3.8 million impairment charge
partially offset by a $1.9 million gain from investment activity. For the six
months ended June 30, 2001, the decrease resulted from the $3.8 million
impairment charge taken in 2001 and a $5.4 million gain in 2000 compared to $2.2
million in 2001 from investment activity, partially offset by a higher average
level of interest bearing investments. The activity on discrete investments
within the portfolio, in any given quarter, may result in gains or losses on
sales or impairment charges.
Interest expense for the three months ended June 30, 2001 decreased to $2.5
million from $3.0 million for the corresponding period in 2000, and for the six
months ended June 30, 2001 increased slightly to $5.1 million from $4.9 million
for the corresponding period in 2000. The decrease for the three months ended
June 30, 2001 as compared to the corresponding period in 2000 is due to a
reduction of the interest expense associated with the Company's convertible
subordinated notes issued in February 2000, as the face value of the notes
outstanding at June 30, 2001 was $177 million compared to $200 million at June
30, 2000. The increase in interest expense for the six months ended June 30,
2001 results from a full six months of interest expense on the convertible
subordinated notes in 2001 as compared with interest expense for five months in
2000.
Gain on derivative financial instruments for the three and six months ended
June 30, 2001 of $1.8 million and $1.2 million, respectively, 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 six months ended June 30, 2001 and the three months ended June 30, 2000. The
Company incurred $1.3 million in losses from joint venture for the six months
ended June 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 six months ended June 30, 2001.
Provision for income taxes for the three and six months ended June 30, 2001
of $0.2 million and $0.5 million, respectively, primarily relate to foreign
withholding taxes. The Company had no such taxes in the corresponding period in
2000.
Extraordinary gain, net of taxes, for the six months ended June 30, 2001
resulted from the
16
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 six months ended June
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 June 30, 2001, the Company had $539.4 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 $12.8 million for the six months
ended June 30, 2001, as compared to net cash provided by operating activities of
$20.9 million for the six months ended June 30, 2000. The decrease was primarily
due to the decrease in accounts payable and deferred revenue in 2001 and lower
increase in accrued liabilities in 2001 as compared to 2000. These changes were
partially offset by the lower increase in prepaid expenses in 2001 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 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 June 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 six months ended June 30, 2001 were $9.0 million as compared to $33.5
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 six
months ended June 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 $0.9 million for the six
months ended June 30, 2001 as compared to $619.1 million for the six months
ended June 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. 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 $24.4 million.
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
17
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; makes strategic
investments; and continues to make improvements in existing facilities.
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
expansion of internal disease pathway and therapeutic drug discovery programs;
competing technological and market developments; the cost of filing,
prosecuting, defending and enforcing patent claims and other intellectual
property rights; the purchase of additional capital equipment, including capital
equipment necessary to ensure the Company's sequencing and microarray operations
remain competitive; capital expenditures required to expand the Company's
facilities; and costs associated with the integration of new operations assumed
through mergers and acquisitions. Changes in the Company's research and
development plans or other changes affecting the Company's operating expenses
may result in changes in the timing and amount of expenditures of the Company's
capital resources.
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 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 six months ended June 30, 2001. Because of those
losses, we had an accumulated deficit of $105.1 million as of June 30, 2001. We
intend to continue to spend significant amounts on new product and technology
development, including therapeutic drug discovery and development programs, and
to increase our investment in marketing, sales and customer service. 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 such as our
gene expression database, discover SNPs, expand research and development
alliances, and develop electronic commerce products. 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 or reduce our
expenses.
To generate significant revenues, we must obtain additional database
collaborators and retain existing collaborators
As of June 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 revenues are
also affected by the extent to which existing collaborators expand their
agreements with us to include our new 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
18
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 databases, for use in the discovery and
development of potential pharmaceutical, diagnostic or other products. Any
potential product that is the subject of such a license will require several
years of further development, clinical testing and regulatory approval before
commercialization. Therefore, milestone or royalty payments from these
collaborations may not contribute to revenues for several years, if at all.
We may not be able to maintain significant growth in revenue from our custom
genomic products and services
The market for custom genomic products and services, and notably custom
sequencing and microarray products and services, has become highly competitive.
Whether our custom genomic products and services will generate significant
revenues depends on our ability to increase our customer base, increase sales to
existing customers, and increase our production capacity in a timely manner and
with consistent volumes and quality to meet the increased demand, as well as our
ability to sell our custom genomic products and services profitably at
competitive prices.
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 and services 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
19
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
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:
. Affymetrix, Inc.,
. 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 The SNP Consortium,
which is funded by a number of pharmaceutical companies, and 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, including microarray technologies, 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
expand 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
20
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.
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 and 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 stop selling 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 and gene expression services. 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 two claim construction rulings describing how the claims in the '934,
'305 and '992 patents should be interpreted.
Following issuance of the court's claim 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 May 8, 2001, the Court concluded that the
term "substantially complementary" as used in the '992 patent was indefinite and
that claims in the '992 patent that use the term are therefore 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
21
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.
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
potential customers' willingness to use our microarray services and gene
expression databases, which could affect our revenue.
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, 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
22
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.
23
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 programs relating to the role of genetic variation in disease and drug
response are not successful, they may not generate significant revenues or
result in profitable operations
Part of our business is focused on developing information-based and other
products and services to assist pharmaceutical companies in a new and unproven
area: the identification and correlation of variation in genetic composition to
disease and drug response. We will incur significant costs over the next several
years in expanding our research and development in this area. These activities
may never generate significant revenues or profitable operations.
This aspect of our business focuses on single nucleotide polymorphisms or
SNPs, one type of genetic variation. The role of SNPs in disease and drug
response is not fully understood, and relatively few, if any, therapeutic or
diagnostic products based on SNPs have been developed and commercialized. Among
other things, demand in this area may be adversely affected by ethical and
social concerns about the confidentiality of patient-specific genetic
information and about the use of genetic testing for diagnostic purposes.
Except for a few anecdotal examples, there is no proof that SNPs have any
correlation to diseases or a patient's response to a particular drug or class of
drug. Identifying statistically significant correlations is time-consuming and
could involve the collection and screening of a large number of patient samples.
We do not know if the SNPs we have discovered to date are suitable for these
correlation studies because the variations we discovered may not occur
frequently enough to justify use by a pharmaceutical company.
Our success in this area will also depend upon our ability to develop, use
and enhance new and relatively unproven technologies. Among other things, we
will need to continue to improve the throughput of our SNP-discovery technology.
We may not be able to achieve these necessary improvements, and other factors
may impair our ability to develop our SNP-related products and services in time
to be competitively available.
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
24
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
microarray 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 and microarray services agreement 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 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;
25
. we may incur amortization expenses if an acquisition results in significant
goodwill or other intangible assets; and
. our stockholders may be diluted if we pay for the acquisition with equity
securities.
In addition, if we acquire additional businesses that are not located near
our Palo Alto, California headquarters, we may experience more difficulty
integrating and managing the acquired businesses' operations.
If we are unable to manage effectively our growth, our operations and ability to
support our customers could be affected, which could harm our revenues
We may continue to experience growth in the number of our employees and the
scope of our operations. This growth has placed, and may continue to place, a
significant strain on our management and operations. Our ability to manage this
growth will depend upon our ability to attract, hire and retain skilled
employees. Our success will also depend on the ability of our officers and key
employees to continue to implement and improve our operational and other systems
and to hire, train and manage our employees.
In addition, we must continue to invest in customer support resources as
the number of database collaborators and their requests for support increase.
Our database collaborators typically have worldwide operations and may require
support at multiple U.S. and foreign sites. To provide this support, we may need
to open offices in additional locations, which could result in additional
burdens on our systems and resources.
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, 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.
26
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
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
27
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, and conduct our
microarray-related activities at our facilities in Fremont, California. Both
locations are in a seismically active area. Although we maintain business
interruption insurance, we do not have or plan to obtain earthquake insurance. A
major catastrophe, such as an earthquake or other natural disaster, could result
in a prolonged interruption of our business.
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 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 June 30, 2001, we had:
. total consolidated debt of approximately $179.5 million,
. stockholders' equity of approximately $604.3 million, and
. a deficiency of earnings available to cover fixed charges of $20.2 million
for the six months ended
28
June 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 June 30, 2001,
notes with a face value of $177 million were outstanding. The following table
shows, as of June 30, 2001, the aggregate amount of our interest payments due in
each of the next five years listed:
Aggregate
Year Interest
---- -----------
2001.......................................................................... $9,735,000
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;
. 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.
29
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 June 30, 2001,
investments in marketable securities were $537.3 million. Due to the nature of
these investments, if market interest rates were to increase immediately and
uniformly by 10% from levels as of June 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 June 30, 2001, long-term investments
were $66.4 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 June 30,
2001, the impact to the Company's financial position or results of operations
would not be material.
30
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 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 May 8, 2001,
the Court concluded that the term "substantially complementary" as used in the
`992 patent was indefinite and that claims in the `992 patent that use the term
are therefore invalid.
On July 23, 2001, the Company filed the following five partial summary
judgment motions: (i) for invalidity of Claims 4 and 5 of the `992 patent for
lack of written description and for indefiniteness; (ii) for invalidity of the
`305 patent for lack of written description; (iii) for invalidity of claims 1-3
of the `992 patent for indefiniteness; (iv) for non-infringement of the `305;
patents and (v) for non-infringement of the `934 patent. Affymetrix also filed
motions for summary judgment as follows: for literal infringement by the Company
of claim 15 of the `305 patent; for judgment that claims 4 and 5 of the `992
patent are not invalid for lack of written description; for literal infringement
by the Company of claims 4 and 5 of the `992 patent; and for dismissal of the
Company's counterclaims against Affymetrix. All of these motions are scheduled
for hearing on August 27, 2001.
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
31
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 infringe U.S. patent number 6,040,193 and U.S. patent
number 5,871,928. These counterclaims allege that the Company 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 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 potential customers' willingness
to use its microarray services and gene expression databases, which could
adversely affect the Company's revenue.
32
Item 2 Changes in Securities
(a) Not applicable
(b) Not applicable
(c) Not applicable
(d) Not applicable
Item 3 Defaults Upon Senior Securities
None
Item 4 Submission of Matters to a Vote of Security Holders
On June 5, 2001, the Company held its Annual Meeting of Stockholders.
The following actions were taken at the annual meeting:
1. The following Directors were elected:
For Withheld
------------ ------------
Roy A. Whitfield 47,282,776 3,304,235
Randal W. Scott 50,245,430 341,581
Barry M. Bloom 50,242,283 344,728
Jeffrey J. Collinson 50,247,903 339,108
Frederick B. Craves 50,248,653 338,358
Jon S. Saxe 50,244,568 342,443
Barry M. Ariko 50,237,138 349,873
2. A proposal to amend the Company's 1991 Stock Plan.
For Against Abstain
------------ ------------- ------------
40,772,693 9,730,596 83,732
3. A proposal to amend the Company's 1997 Employee Stock Purchase Plan.
For Against Abstain
------------ ------------- ------------
49,937,124 573,601 76,286
4. The selection of the Company's independent auditors was ratified.
For Against Abstain
------------ ------------- ------------
50,466,471 101,870 18,670
Item 5 Other Information
None
33
Item 6 Exhibits and Reports on Form 8-K.
a) Exhibits
See Exhibit Index on Page 36.
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: August 13, 2001 By: /s/ Roy A. Whitfield
---------------------------------
Roy A. Whitfield
Chief Executive Officer
(Duly Authorized Signatory)
Date: August 13, 2001 By: /s/ John M. Vuko
---------------------------------
John M. Vuko
Chief Financial Officer
(Principal Financial Officer)
35
INCYTE GENOMICS, INC.
EXHIBIT INDEX
Exhibit
Number Description of Document
- ------ -----------------------
10.23 Employment Agreement, dated as of May 2, 2001, by and between Incyte
Genomics, Inc. and Roy A. Whitfield.
10.24 Form of Employment Agreement, dated as of May 2, 2001, by and between
Incyte Genomics, Inc. and each of E. Lee Bendekgey, Michael D. Lack,
James P. Merryweather, James R. Neal, and John M. Vuko.
36