PARADIGM GENETICS INC, 10-Q, 2000-08-03

PARADIGM GENETICS INC
10-Q, 2000-08-03
COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH

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<PAGE>

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

(Mark One)

[X] Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of
1934 For the quarterly period ended: June 30, 2000.

[_] Transition report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from to

Commission File Number:
0-30365

Paradigm Genetics, Inc.
(Exact name of registrant as specified in its charter)

Delaware 56-2047837
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
104 Alexander Drive, Research Triangle Park, North Carolina 27709
(Address of principal executive offices and zip code)

Registrant's telephone number, including area code: (919) 425-3000

Former name, former address, and former year, if changed since last report:
Not applicable

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes [X] No [_]

Indicate the number of shares outstanding of each of the Issuer's classes of
Common Stock, as of the latest practicable date.

Title of each class
Common stock $.01 par value
Shares outstanding on August 3,
2000......................................................25,712,830
<PAGE>

INDEX

<TABLE>
<CAPTION>
Page
<S> <C>
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Balance Sheets - June 30, 2000 (unaudited) and December 31, 1999...... 3

Condensed Statements of Operations - Three and Six months ended
June 30, 2000 and 1999 (unaudited)............................................ 5

Condensed Statements of Cash Flows - Six months ended
June 30, 2000 and 1999 (unaudited)............................................ 6

Notes to Condensed Financial Statements......................................... 7

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................... 12

Item 3 Quantitative and Qualitative Disclosures About Market Risk...................... 16

PART II. OTHER INFORMATION

Item 1. Legal Proceedings............................................................... 17

Item 2. Changes in Securities and Use of Proceeds....................................... 17

Item 3. Defaults Upon Senior Securities................................................. 17

Item 4. Submission of Matters to a Vote of Security Holders............................. 17

Item 5 Other Information - Risk Factors................................................ 18

Item 6. Exhibits and Reports on Form 8-K................................................ 24

Signature................................................................................ 26

Exhibit Index............................................................................ 27
</TABLE>

2
<PAGE>

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

PARADIGM GENETICS, INC.
CONDENSED BALANCE SHEETS

<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------------------------------
(unaudited)
<S> <C> <C>
ASSETS

Current Assets:
Cash and cash equivalents $23,263,888 $ 468,342
Short-term investments 31,341,452 3,488,108
Accounts receivable 469,423 256,844
Prepaid expenses 919,150 1,157,851
------------------------------------
Total current assets 55,993,913 5,371,145

Property and equipment, net 14,567,646 8,816,665

Other assets, net 446,991 37,494
Long term investments 2,002,189 --
------------------------------------

Total assets $73,010,739 $14,225,304
====================================

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
Accounts payable $ 689,815 $ 1,327,423
Accrued liabilities 807,577 571,184
Deferred revenue 16,344,046 5,825,237
Long-term debt -- current portion 1,697,405 1,182,456
Capital lease obligation - current portion 105,315 100,075
------------------------------------

Total current liabilities 19,644,158 9,006,375

Long-term debt, net of current portion 6,817,431 7,823,780
Capital lease obligation, net of current portion 168,849 222,850
------------------------------------
Total liabilities 26,630,438 17,053,005
------------------------------------
</TABLE>

3
<PAGE>

<TABLE>
<S> <C> <C>
Stockholder's equity (deficit):

Convertible preferred stock, $0.01 par value; 5,000,000 and 15,000,000 shares
authorized as of June 30, 2000 and December 31, 1999, respectively:
Series A Convertible Preferred Stock, 8,000,000 shares designated; -0- and
7,562,500 shares issued and outstanding as of June 30, 2000 and December
31, 1999, respectively -- 5,950,899

Series B Convertible Preferred Stock; 2,790,698 shares designated; -0- and
2,790,698 shares issued and outstanding as of June 30, 2000 and December
31, 1999, respectively -- 5,967,819

Common Stock, $.01 par value; 50,000,000 shares authorized; 25,712,830 and 5,224,257
shares issued and outstanding as of June 30, 2000 and December 31, 1999, respectively 257,128 52,242
Additional paid-in capital 75,092,372 3,529,452
Deferred compensation (4,256,170) (3,165,430)
Accumulated deficit (24,713,029) (15,162,683)
-----------------------------

Total stockholder's equity (deficit) 46,380,301 (2,827,701)
-----------------------------

Total liabilities and stockholders' equity (deficit) $ 73,010,739 $ 14,225,304
=============================
</TABLE>

The accompanying notes are an integral part of these condensed financial
statements.

4
<PAGE>

PARADIGM GENETICS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)

<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
--------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Collaborative research agreements $ 1,570,870 $ 320,069 $ 2,039,090 $ 640,137
Grant revenues 125,001 12,294 250,002 24,588
--------------------------------------------------------
Total revenues 1,695,871 332,363 2,289,092 664,725
--------------------------------------------------------

Operating expenses:

Research and development (excludes $115,783 and $3,553
of stock based compensation expense for the three
months ended June 30, 2000 and June 30, 1999,
respectively, and excludes $218,135 and $5,258 of stock
based compensation expense for the six months ended
June 30, 2000 and June 30, 1999, respectively;) 4,166,011 1,766,837 7,166,378 3,339,948

Selling, general and administrative (excludes $200,776
and $1,100 of stock based compensation expense for the
three months ended June 30, 2000 and June 30, 1999,
respectively, and excludes $448,406 and $1,465 of stock
based compensation expense for the six months ended
June 30, 2000 and June 30, 1999, respectively;)
2,349,154 941,511 4,385,417 1,690,152

Stock based compensation expense 316,559 4,653 666,541 6,723
--------------------------------------------------------

Total operating expenses 6,831,724 2,713,001 12,218,336 5,036,823
--------------------------------------------------------

Loss from operations (5,135,853) (2,380,638) (9,929,244) (4,372,098)
--------------------------------------------------------

Interest income (expense):
Interest income 655,392 71,500 952,385 111,795
Interest expense 293,612 130,340 573,487 219,732
--------------------------------------------------------
Interest income (expense), net 361,780 (58,840) 378,898 (107,937)
--------------------------------------------------------

Net loss (4,774,073) (2,439,478) (9,550,346) (4,480,035)

Beneficial conversion feature of Series C Preferred Stock -- -- (12,000,000) --

Net loss attributable to common stockholders $(4,774,073) $(2,439,478) $(21,550,346) $(4,480,035)
========================================================

Net loss per share attributable to common stockholders - $ (0.29) $ (0.63) $ (1.95) $ (1.18)
basic and diluted

Weighted average common shares outstanding - basic and diluted 16,695,667 3,861,506 11,045,178 3,806,338
</TABLE>

The accompanying notes are an integral part of these condensed financial
statements

5
<PAGE>

PARADIGM GENETICS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

<TABLE>
<CAPTION>
Six Months Ended June 30,
2000 1999
-----------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (9,550,346) $ (4,480,035)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Deferred revenue 10,518,809 969,862
Depreciation and amortization 1,296,028 646,427
Stock based compensation 666,541 6,723

Changes in operating assets and liabilities:
Accounts receivable (212,579) (231,086)
Prepaid expenses and other assets 190,342 (458,036)
Accounts payable (637,608) 256,587
Accrued liabilities 236,393 181,809
-----------------------------

Net cash provided by (used in) operating activities 2,507,580 (3,107,749)
-----------------------------

Cash flows from investing activities:
Purchase of property and equipment (7,047,009) (2,055,853)
Purchase of investments (65,345,172) (13,713,695)
Maturities of investments 35,489,639 11,413,733
-----------------------------

Net cash used in investing activities (36,902,542) (4,355,815)
-----------------------------

Cash flows from financing activities:
Repayments of notes payable (491,400) (5,252)
Borrowings under notes payable -- 1,013,253
Repayments of capital lease obligations (48,761) (44,030)
Proceeds from issuance of convertible preferred stock, net 14,965,192 5,967,819
Proceeds from issuance of Common Stock, net 42,603,899 --
Proceeds from exercise of stock options 161,578 20,928
-----------------------------

Net cash provided by financing activities 57,190,508 6,952,718
-----------------------------

Net increase in cash and cash equivalents 22,795,546 (510,846)
Cash and cash equivalents, beginning of period 468,342 970,688
-----------------------------
Cash and cash equivalents, end of period $ 23,263,888 $ 459,842
=============================
</TABLE>

The accompanying notes are an integral part of these condensed financial
statements.

6
<PAGE>

Paradigm Genetics, Inc.
Notes to Condensed Financial Statements
(unaudited)

Note 1. Organization and Summary of Significant Accounting Policies

Organization

Paradigm Genetics, Inc. (the "Company" or "Paradigm") was organized on September
9, 1997 to discover the function of genes in plant and fungal organisms. The
Company is industrializing the process of determining gene function by creating
an assembly-line process to generate information that, it believes, will enable
it to develop novel products in four major sectors of the global economy: crop
production, nutrition, human health and industrial products. The Company has
developed its GeneFunction Factory to simultaneously study the functions of many
genes in plants and fungi. The GeneFunction Factory is designed to be an
integrated, rapid, industrial-scale laboratory through which it can discover and
alter genes, understand the consequences of the modifications and reliably
determine the function of those genes. The Company stores and annotates gene
function information in its FunctionFinder bioinformatics system. Paradigm
generates revenues by licensing information mined from the data in
FunctionFinder for the development of products in crop production, nutrition,
human health and industrial applications. If the Company's strategic partners
commercialize products resulting from this information, the Company is entitled
to receive royalty payments based upon product revenues.

Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared by
the Company in accordance with generally accepted accounting principles for
interim financial information and pursuant to the instructions to Form 10-Q and
Article 10 of Regulation S-X of the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the six-month period ended June 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000, or for any future period. These financial statements and
notes should be read in conjunction with the financial statements and notes
thereto for the year ended December 31, 1999 included in the Company's
Registration Statement on Form S-1, as amended (No. 333-30758), which was
declared effective by the Securities and Exchange Commission on May 5, 2000.

Use of Estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents.

Investments

The Company considers all investments in debt and equity securities purchased
with a maturity of between three months and one year from the balance sheet date
to be short-term investments. All investments are considered as available for
sale and are carried at fair value. Unrealized gains and losses on investments
are recognized as a component of other comprehensive income (loss). At June 30,
2000 and December 31, 1999, the amortized costs of the Company's investments
approximated their fair value. Realized gains and losses on sales of investments
are determined using the specific identification method. Realized gains and
losses on sales of investments were not significant during the period ended June
30, 2000 or the year ended December 31, 1999.

7
<PAGE>

Paradigm Genetics, Inc.
Notes to Condensed Financial Statements (Continued)
(unaudited)

Property and Equipment

Property and equipment is primarily comprised of laboratory equipment, computer
equipment, furniture, and leasehold improvements which are recorded at cost and
depreciated using the straight-line method over their estimated useful lives,
which range from one to seven years. Expenditures for maintenance and repairs
are charged to operations as incurred; major expenditures for renewals and
betterments are capitalized and depreciated. Property and equipment acquired
under capital leases are being depreciated over their estimated useful lives or
the respective lease term, if shorter.

Other Assets

Other assets primarily consist of a deferred charge related to the warrants
issued in connection with the expansion of the operating lease agreement for a
new facility. This deferred charge will be amortized to rent expense over the
term of the lease. Also included in other assets are deposits for building
leases which will be returned to the Company upon the expiration of related
leases.

Capitalized Software Costs

The Company accounts for the costs of development of software applications to be
sold to or used by third parties in accordance with Statement of Financial
Accounting Standards No. 86 "Accounting for the Costs of Computer Software to Be
Sold, Leased or Otherwise Marketed." Software development costs are required to
be capitalized beginning when a product's technological feasibility has been
established and ending when a product is available for general release.

Fair Value of Financial Instruments

The carrying value of the Company's financial instruments, including cash and
cash equivalents, accounts receivable, investments, accounts payable, capital
lease obligations and long-term debt, at June 30, 2000 and December 31, 1999
approximated their fair value due to the short term nature of these items.

Impairment of Long-Lived Assets

The Company evaluates the recoverability of its property and equipment and other
long-lived assets when circumstances indicate that an event of impairment may
have occurred in accordance with the provisions of SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of"
("SFAS No. 121"). SFAS No. 121 requires recognition of impairment of long-lived
assets in the event the net book value of such assets exceeds the future
undiscounted cash flows attributable to such assets or the business to which
such assets relate. Impairment is measured based on the difference between the
carrying value of the related assets or businesses and the discounted future
cash flows of such assets or businesses. No impairment was required to be
recognized during the six months ended June 30, 2000 or the year ended December
31, 1999.

Income Taxes

The Company accounts for income taxes using the liability method, which requires
the recognition of deferred tax assets or liabilities for the temporary
differences between financial reporting and tax bases of the Company's assets
and liabilities and for tax carryforwards at enacted statutory rates in effect
for the years in which the differences are expected to reverse. The effect on
deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date. In addition, valuation allowances are
established where necessary to reduce deferred tax assets to the amounts
expected to be realized.

8
<PAGE>

Paradigm Genetics, Inc.
Notes to Condensed Financial Statements (Continued)
(unaudited)

Revenue Recognition

Revenues are derived from collaborative research agreements with strategic
partners and from government grants. Revenues related to fixed nonrefundable
payments are recognized under collaborative research agreements based on
progress to completion in accordance with the applicable performance
requirements of each collaboration agreement. The Company earns these revenues
as it meets the deliverable requirements in its collaborative research
agreements. Refundable fees received under collaborative research agreements are
initially deferred and recognized as revenues based on progress to completion
over the term of the collaborative research agreement beginning at the date that
the refund right expires, which is the date on which the related performance
requirements have been met. Nonrefundable fees received at the initiation of a
collaborative research agreement are deferred and recognized as revenues on a
progress to completion basis over the term of the collaboration agreement with
all other fixed nonrefundable payments received under the collaborative research
agreements. This is required as the Company has a future performance obligation
under these agreements which is met as the Company delivers the results of its
gene analysis to its collaborative partners. Progress to completion under
collaborative research agreements is measured based on a comparison of the
number of genes analyzed and delivered to the total number of genes to be
analyzed, on a contract by contract basis. The Company does not segment its
collaborative research agreements for purposes of the calculation of revenues to
be recognized as the Company does not meet the criteria to allow segmentation
specified in the relevant authoritative accounting guidance. Milestone payments
under collaborative agreements will be recognized as revenue when the applicable
milestone has been achieved and such achievement has been acknowledged by the
other party to the collaboration agreement. Revenues from government grants are
recognized as expenses are incurred over the period of each grant. Cash received
in excess of revenues recognized under collaborative agreements and government
grants is recorded as deferred revenue. Payments received under the Company's
collaborative research agreements and government grants are generally non-
refundable regardless of the outcome of the future research and development
activities to be performed by the Company under these arrangements.

Research and Development

Research and development costs include expenses incurred by the Company to
develop its proprietary GeneFunction Factory, perform required services under
collaborative research agreements and government grants and perform research and
development on internal projects. Research and development costs are expensed as
incurred.

Concentration of Credit Risk

Financial instruments which potentially subject the Company to a concentration
of credit risk consist principally of temporary cash and short-term investments
and trade receivables. The Company primarily places its temporary cash and
short-term investments with high-credit quality financial institutions which
invest primarily in U.S. Government securities, commercial paper of prime
quality and certificates of deposit guaranteed by banks which are members of the
FDIC. Cash deposits are all in financial institutions in the United States. The
Company performs ongoing credit evaluations to reduce credit risk and requires
no collateral from its customers. Management estimates the allowance for
uncollectible accounts based on their historical experience and credit
evaluation.

Comprehensive Income (Loss)

Effective January 1, 1998, the Company adopted the provisions of SFAS No. 130,
"Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes
standards for reporting and displaying of comprehensive income and its
components in the financial statements. Comprehensive income, as defined,
includes all changes in equity during a period from non-owner sources. The
Company had no significant items of other comprehensive income during the
periods ended June 30, 2000 and 1999.

Net Loss per Share

The Company computes net loss per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share," ("SFAS 128") and
SEC Staff Accounting Bulletin No. 98 ("SAB No. 98"). Basic and diluted net loss
per share are computed by dividing the net loss for the period by the weighted
average number of shares of common stock outstanding during the period. The
calculation of diluted net loss per share excludes potential shares of common
stock if their effect is antidilutive. Potential common stock consists of
incremental common shares issuable upon the exercise of stock options and
warrants and shares issuable upon conversion of the preferred stock.

9
<PAGE>

Paradigm Genetics, Inc.
Notes to Condensed Financial Statements (Continued)
(unaudited)

The following table sets forth potential shares of common stock that are not
included in the diluted net loss per share because to do so would be
antidilutive for the periods indicated:

<TABLE>
<CAPTION>
Six Months Ended
June 30,
2000 1999
-------------------------
<S> <C> <C>
Preferred stock........................... - 10,353,198
Options to purchase common stock.......... 1,545,180 1,612,000
Warrants.................................. 763,779 437,500
</TABLE>

Segment Reporting

In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"). This statement requires companies to report information about
operating segments in interim and annual financial statements. It also requires
segment disclosures about products and services, geographic areas and major
customers. The Company adopted SFAS 131 effective for its year ended December
31, 1998. The Company has determined that it operates in only one segment as of
June 30, 2000 and 1999.

Internal Use Software

In March 1998, the Accounting Standards Executive Committee of the American
Institute of Public Accountants ("AICPA"), issued Statement of Position No. 98-
1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP No. 98-1"), which provides guidance regarding when software
developed or obtained for internal use should be capitalized. The Company
adopted SOP No. 98-1 effective January 1, 1999. The Company accounts for the
development of software for internal uses in accordance with SOP No. 98-1. The
adoption of SOP No. 98-1 did not have a material impact on the Company's
financial position or results of operations as the predominant portion of the
software applications used by the Company were purchased from third parties. The
Company expenses the cost of accumulating and preparing data for use in its
database applications as such costs are incurred.

Recent Accounting Pronouncements

In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as "derivatives"), and for hedging
activities. SFAS 133, as amended by SFAS 137, is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000, with earlier
application encouraged. The Company does not currently, nor does it intend in
the future, to use derivative instruments and therefore does not expect that the
adoption of SFAS 133 will have any impact on its financial position or the
results of operations.

Note 2. Initial Public Offering

On May 10, 2000, the Company completed an initial public offering in which it
sold 6,000,000 shares of common stock at $7.00 per share for net proceeds of
approximately $37.7 million, net of underwriting discounts, commissions and
other offering costs. Upon the closing of the offering, all the Company's
convertible preferred stock converted into 13,353,198 shares of common stock.
After the offering, the Company's authorized capital consisted of 50,000,000
shares of common stock, $0.01 par value, and 5,000,000 shares of preferred
stock, $0.01 par value. On May 31, 2000, the underwriters exercised an over-
allotment option to purchase an additional 750,000 shares resulting in net
proceeds of approximately $4.9 million.

10
<PAGE>

Paradigm Genetics, Inc.
Notes to Condensed Financial Statements (Continued)
(unaudited)

Note 3. Deferred Stock-Based Compensation

The Company accounts for stock-based compensation based on the provisions of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB No. 25") which states that no compensation expense is
recorded for stock options or other stock-based awards to employees that are
granted with an exercise price equal to or above the estimated fair value of the
Company's Common Stock on the grant date. In the event that stock options are
granted with an exercise price below the estimated fair value of the Company's
Common Stock at the grant date, the difference between the fair value of the
Company's Common Stock and the exercise price is recorded as deferred
compensation. The Company has recognized deferred compensation of $5,122,223 to
reflect the difference between the aggregate fair market value and exercise
price of all options granted with an exercise price below the fair market value
of the Company's Common Stock at the date of grant. Deferred compensation is
amortized to compensation expense over the vesting period of the related stock
option. The Company recognized non-cash stock based compensation expense related
to the amortization of deferred compensation of approximately $317,000 for the
three months ended June 30, 2000, approximately $5,000 for the three months
ended 1999, approximately $667,000 for the six months ended June 30, 2000, and
approximately $7,000 for the six months ended June 30, 1999.

Note 4. Series C Preferred Stock - Beneficial Conversion Feature

In January 2000, the Company sold 3,000,000 shares of Series C Preferred
Stock to a group of investors for gross proceeds of $15,000,000 or $5.00 per
share. The Series C Preferred Stock automatically converted into shares of the
Company's common stock at a one-to-one conversion ratio upon the consummation of
its initial public offering on May 10, 2000. The Company has recorded a
beneficial conversion feature charge of $12,000,000 to reflect the difference
between the estimated fair value of the Company's Series C Preferred Stock of
$9.00 per share and the $5.00 per share sales price of these shares.

11
<PAGE>

Item 2. Management's Discussion and Analysis of Financial Condition and Results
Of Operations

This discussion and analysis should be read in conjunction with our financial
statements and accompanying notes included in this report and the 1999 audited
financial statements and notes thereto included in our Registration Statement on
Form S-1, as amended (No. 333-30758), declared effective on May 5, 2000.
Operating results are not necessarily indicative of results that may occur in
future periods.

Overview

Paradigm Genetics was founded in September 1997. Since that time, we have been
industrializing the process of determining gene function by creating an
assembly-line process to generate information that we believe will enable us to
develop novel products in four major sectors of the global economy: crop
production, nutrition, human health and industrial products. We have developed
our GeneFunction Factory to simultaneously study the functions of many genes in
our selected plants and fungi. We designed our GeneFunction Factory to be an
integrated, rapid, industrial-scale laboratory through which we can discover and
modify genes, understand the consequences of the modifications and reliably
determine the function of those genes. We store and annotate gene function
information in our FunctionFinder bioinformatics system, which is a computer
system that helps us and our partners analyze the large volumes of complex data
generated from our study of genes. We currently have strategic alliances with
Bayer AG in the area of crop production and with Pharmacia Corporation (formerly
known as The Monsanto Company) in the areas of crop production and nutrition.

To date, we have generated revenues from a collaborative herbicide discovery and
commercialization agreement with Bayer, a joint development and
commercialization agreement with Pharmacia and a grant from the U.S. Department
of Energy. The agreement with Bayer was signed in September 1998 and generated
substantially all of our revenues for fiscal year 1999 and for the six months
ended June 30, 2000. In November 1999, we signed a joint development and
commercialization agreement with Pharmacia. This agreement began contributing to
our revenues in the second quarter of fiscal year 2000.

We have incurred significant losses since our inception. As of June 30, 2000,
our accumulated deficit was approximately $24.7 million and total stockholders'
equity was approximately $46.4 million. Our net loss increased from
approximately $4.5 million during the six months ended June 30, 1999, to
approximately $9.6 million during the six months ended June 30, 2000. Operating
expenses increased from approximately $5.0 million during the six months ended
June 30, 1999, to approximately $12.2 million during the six months ended June
30, 2000. We expect to incur additional operating losses over at least the next
two years as we continue to expand our research and development efforts on our
core technologies and establish the infrastructure necessary to support our
business.

Source of Revenue and Revenue Recognition Policy

12
<PAGE>
activities to be performed by the Company under these arrangements. As of June
30, 2000 we had deferred revenues of approximately $16.3 million. We are
currently recognizing revenue under Staff Accounting Bulletin 101 ("SAB 101")
as issued by the Securities and Exchange Commission. The effect of any change
in the Securities and Exchange Commission interpretation of SAB 101 is unknown
at this point in time.

Results of Operations

Three Months Ended June 30, 2000 and 1999

Total Revenues

Revenues are comprised of amounts recognized under two collaborative research
agreements and a grant from the U.S. Department of Energy. Total revenues were
approximately $1.7 million for the three months ended June 30, 2000, compared to
approximately $332,000 for the three months ended June 30, 1999. The increase
was primarily due to an increase in throughput through our GeneFunction Factory
and the successful delivery and acceptance of our second assay pursuant to our
collaboration research agreement with Bayer AG, the commencement of revenue
recognition under the joint development and commercialization agreement with
Pharmacia and additional grant revenues. We expect revenues to increase in
future quarters as we continue to increase the throughput through our
GeneFunction Factory.

Research and Development Expenses

Research and development expenses consist primarily of personnel costs, facility
costs, cost of supplies and depreciation of laboratory equipment. Research and
development expenses were approximately $4.2 million for the three months ended
June 30, 2000, compared to approximately $1.8 million for the three months ended
June 30, 1999. This increase was due primarily to increased staffing, other
personnel-related costs, depreciation, facilities and cost of supplies. We
expect to continue to devote substantial resources to research and development.
We also expect that research and development expenses will continue to increase
for the forseeable future and that net losses will continue as a result.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of personnel
costs, facilities costs, business development costs and professional expenses,
such as legal and accounting fees. Selling, general and administrative expenses
were approximately $2.3 million for the three months ended June 30, 2000,
compared to approximately $942,000 for the three months ended June 30, 1999.
This increase was due primarily to increased personnel expenses, depreciation,
business development, facilities and professional expenses. We expect that our
selling, general and administrative expenses will continue to increase for the
forseeable future as we expand our legal, accounting and business development
staff, add infrastructure to support our growing research and development
efforts and incur additional costs related to being a public company, including
directors' and officers' insurance premiums, investor relations programs and
continue to make commission payments related to our collaborative research
agreements.

Stock Based Compensation Expense

Stock based compensation expense represents the amortization of deferred
compensation related to stock options granted to employees with an exercise
price below the estimated fair value of our common stock at the date of grant,
as determined by our board of directors. Deferred compensation is amortized over
the vesting period of the related stock options, which is generally four years.
We recognized approximately $317,000 in non-cash compensation expense related to
amortization of deferred compensation for the three months ended June 30, 2000,
compared to approximately $4,700 for the three months ended June 30, 1999.

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Net Interest Income (Expense)

Net interest income (expense) represents interest earned on our cash and cash
equivalents and short-term investments offset by interest expense on long-term
debt and capital leases. Net interest income was approximately $362,000 for the
three months ended June 30, 2000, compared to net interest expense of
approximately $59,000 for the three months ended June 30, 1999. This increase
was attributable to the investment of the proceeds from our initial public
offering in May 2000 and our sale of preferred stock in January 2000.

Six Months Ended June 30, 2000 and 1999.

Total Revenues

Revenues are comprised of amounts recognized under two collaborative research
agreements and a grant from the U.S. Department of Energy. Total revenues were
approximately $2.3 million for the six months ended June 30, 2000, compared to
approximately $665,000 for the six months ended June 30, 1999. The increase was
primarily due to an increase in throughput through our GeneFunction Factory and
the successful delivery and acceptance of our first and second assays pursuant
to our collaboration research agreement with Bayer AG, the commencement of
revenue recognition under the joint development and commercialization agreement
with Pharmacia in the second quarter of 2000 and additional grant revenues. We
expect revenues to increase in future quarters as we continue to increase the
throughput through our GeneFunction Factory.

Research and Development Expenses

Research and development expenses consist primarily of personnel costs, facility
costs, cost of supplies and depreciation of laboratory equipment. Research and
development expenses were approximately $7.2 million for the six months ended
June 30, 2000, compared to approximately $3.3 million for the six months ended
June 30, 1999. This increase was due primarily to increased staffing, other
personnel-related costs, depreciation, facilities and cost of supplies. We
expect to continue to devote substantial resources to research and development.
We also expect that research and development expenses will continue to increase
for the forseeable future and that net losses will continue as a result.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of personnel
costs, facilities costs, business development costs and professional expenses,
such as legal and accounting fees. Selling, general and administrative expenses
were approximately $4.4 million for the six months ended June 30, 2000, compared
to approximately $1.7 million for the six months ended June 30, 1999. This
increase was due primarily to increased personnel expenses, depreciation,
business development, facilities and professional expenses. We expect that our
selling, general and administrative expenses will continue to increase for the
forseeable future as we expand our legal, accounting and business development
staff, add infrastructure to support our growing research and development
efforts and incur additional costs related to being a public company, including
directors' and officers' insurance premiums, investor relations programs and
continue to make commission payments related to our collaborative research
agreements.

Stock Based Compensation Expense

Stock based compensation expense represents the amortization of deferred
compensation related to stock options granted to employees with an exercise
price below the estimated fair value of our common stock at the date of grant,
as determined by our board of directors. Deferred compensation is amortized over
the vesting period of the related stock options, which is generally four years.
We recognized approximately $667,000 in non-cash compensation expense related to
amortization of deferred compensation for the six months ended June 30, 2000,
compared to approximately $6,700 for the six months ended June 30, 1999.

Deferred compensation for options granted to employees has been determined as
the difference between the estimated fair value for financial reporting purposes
of our common stock on the date the options were granted and the exercise price.
Deferred compensation for options granted to consultants has been determined in
accordance with Statement of Financial Accounting Standards No. 123 as the fair
value of equity instruments issued. In connection with the grant of stock
options to employees, we recorded deferred stock compensation of approximately
$1.8 million for the six months ended June 30, 2000. These amounts were recorded
as a component of stockholders' deficit and are being amortized as charges to
operations over the vesting periods of the options.

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Net Interest Income (Expense)

Net interest income (expense) represents interest earned on our cash and cash
equivalents and short-term investments offset by interest expense on long-term
debt and capital leases. Net interest income was approximately $379,000 for the
six months ended June 30, 2000, compared to net interest expense of
approximately $108,000 for the six months ended June 30, 1999. This increase was
attributable to the investment of the proceeds from our initial public offering
in May 2000 and our sale of preferred stock in January 2000.

Liquidity and Capital Resources

We have historically financed our operations through the sale of preferred
stock, debt and capital lease financing, payments received from collaborative
research agreements and a government grant. From our inception through June 30,
2000, we have raised approximately $26.9 million in net cash proceeds from the
sale of preferred stock. On May 10, 2000 the Company completed an initial public
offering in which it sold 6,000,000 shares of common stock at $7.00 per share
for net proceeds of approximately $37.7 million, net of underwriting discounts,
commissions and other offering costs. On May 31, 2000, the underwriters
exercised an over-allotment option to purchase an additional 750,000 shares
resulting in net proceeds of approximately $4.9 million.

We had cash, cash equivalents and short-term investments of approximately $54.6
million at June 30, 2000, compared to approximately $4.0 million at December 31,
1999. We had working capital of approximately $36.3 million at June 30, 2000,
compared to a working capital deficit of approximately $3.6 million at December
31, 1999. The increase in working capital was primarily due to the completion of
our initial public offering in May, 2000, the issuance of convertible preferred
stock and deferred revenue from our strategic partners.

Our operating activities provided cash of approximately $2.5 million for the six
months ended June 30, 2000, compared to a use of cash of approximately $3.1
million for the six months ended June 30, 1999. The increase was due primarily
to an increase in deferred revenue from strategic partners offset by an increase
in the net loss for the period.

Our investing activities used cash of approximately $36.9 million for the six
months ended June 30, 2000, compared to approximately $4.4 million for the six
months ended June 30, 1999. Investing activities consist primarily of additions
to property and equipment and net purchases of short-term investments. We expect
to continue to make significant investments in the purchase of property,
equipment and facilities to support our expanding operations. A portion of our
cash may be used to acquire or invest in complementary businesses, products or
technologies, or to obtain the right to use such complementary technologies.

Our financing activities provided cash of approximately $57.2 million for the
six months ended June 30, 2000, compared to approximately $7.0 million for the
six months ended June 30, 1999. The increase in cash provided by financing
activities primarily relates to our initial public offering in May 2000.

Our forecast of the period of time through which our financial resources will be
adequate to support our operations is a forward-looking statement that involves
risks and uncertainties, and actual results could vary as a result of a number
of factors. We believe that our existing cash and investment securities and
anticipated cash flow from existing collaborations together with the net
proceeds from our initial public offering will be sufficient to support our
current operating plan for at least the two years following our initial public
offering in May 2000. We have based this estimate on assumptions that may prove
to be wrong. It is possible that we may seek additional funding within this time
frame. We may raise additional funds through public or private financing,
collaborative relationships or other arrangements. We cannot assure you that
additional funding, if sought, will be available or, even if available, will be
available on terms favorable to us. Further, any additional equity financing may
be dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. Our failure to raise capital when needed may harm our
business and operating results. Our future capital requirements will depend on
many factors, including:

. the number, breadth and progress of our research programs;

. the achievement of the milestones under certain of our existing
strategic alliances;

. our ability to establish additional and maintain current and
additional strategic alliances;

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. our strategic partners' success in commercializing products
developed under our strategic alliances;

. our success in commercializing products to which we have retained
the rights under our strategic alliances;

. the costs incurred in enforcing and defending our patent claims and
other intellectual property rights; and

. the costs and timing of obtaining regulatory approvals for any of
our products.

FORWARD-LOOKING STATEMENTS

This report may contain forward-looking statements, including statements
regarding:

. our ability to successfully develop our GeneFunction Factory and
other technologies;
. our ability to industrialize the process of gene function discovery
and generate information enabling the development of novel products
for four major sectors of the global economy: nutrition, crop
production, industrial products and human health;
. product development;
. our strategy;
. sufficiency of our cash resources;
. anticipated increases in our revenues and timing of revenues from
strategic alliances;
. our intended use of the proceeds from our initial public offering
and other financial resources;
. our research and development and other expenses; and
. our operational and legal risks.

Such statements are based on management's current expectations and are subject
to a number of risks, factors and uncertainties that may cause actual results,
events and performance to differ materially from those referred to in the
forward-looking statements. These risks include, but are not limited to, our
early stage of development, history of net losses, technological and product
development uncertainties, reliance on research collaborations, uncertainty of
additional funding and ability to protect our patents and proprietary rights.
These and other risks are discussed in Part II, Item 5 of this report, titled
"Other Information - Risk Factors," as well as in our registration statement on
Form S-1 (Registration No. 333-30758) filed with the Securities and Exchange
Commission.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Paradigm was not exposed to material market risks associated with
activities in derivative financial instruments, other financial instruments or
commodity instruments as of the end of its most recent fiscal quarter.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Not applicable.

Item 2. Changes in Securities and Use of Proceeds

(a) Not applicable.

(b) Not applicable.

(c) During the quarter ended June 30, 2000, we sold the following
securities that were not registered under the Securities Act of 1933, as
amended:

During the quarter ended June 30, 2000, we granted options to purchase
61,996 shares of our common stock to directors, officers, employees and
consultants under our 2000 Stock Option plan. During the quarter ended June 30,
2000, directors, officers, employees and consultants exercised options for
50,608 shares of common.

The issuance and sale of the above securities that were not registered
under the Securities Act were deemed to be exempt from registration under the
Securities Act in reliance upon Section 4(2), Regulation D or Rule 701
promulgated thereunder.

(d) On May 5, 2000, in connection with our initial public offering, the
Securities and Exchange Commission declared a Registration Statement on Form S-1
(No. 333-30758) effective that registered 6,900,000 shares of our common stock.
The managing underwriters were Chase Securities Inc., J.P. Morgan Securities
Inc., Pacific Growth Equities, Inc. and Stephens Inc. On May 10, 2000, we sold
6,000,000 of such shares of our common stock at an initial public offering price
of $7.00 per share, generating gross offering proceeds of $42.0 million. After
deducting $2.45 million in underwriting discounts and approximately $1.8 million
in other related expenses, the net proceeds to the Company were approximately
$37.7 million. On May 31, 2000, we sold an additional 750,000 shares of common
stock at the initial public offering price of $7.00 per share pursuant to the
exercise by the underwriters of their over-allotment option with respect to such
shares, generating additional gross offering proceeds of $5.25 million. After
deducting $367,500 in underwriting discounts, the additional net proceeds to the
Company from the over-allotment were approximately $4.9 million.

The proceeds from our initial public offering have been invested in
corporate paper, bonds and money market funds. We intend to use the net proceeds
for research and development, acquisitions of plant and equipment, development
of our physical infrastructure and general corporate purposes, including the
possible acquisition of or investment in complementary businesses, products or
technologies. We are currently considering the specific uses and allocations of
these funds.

Item 3. Defaults Upon Senior Securities

Not applicable.

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

Not applicable

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Item 5. Other Information - Risk Factors

We have a history of net losses. We will continue to incur net losses that may
depress our stock price.

We have incurred net losses in each year since our inception and expect
these losses to continue. We experienced a net loss of approximately $9.6
million for the six months ended June 30, 2000. As of June 30, 2000, we had an
accumulated deficit of approximately $24.7 million. To date, we have derived all
of our revenues from two strategic alliances and a government grant. We expect
to derive revenue in the foreseeable future principally from strategic
alliances. We expect to spend a significant amount of capital to fund research
and development and enhance our core technologies, including our GeneFunction
Factory. As a result, we expect that our operating expenses will increase
significantly in the near term and, consequently, we will need to generate
significant additional revenues to become profitable. We cannot predict when, if
ever, we will become profitable.

We may never become profitable if we and our strategic partners are unable to
develop or commercialize our technologies into products.

We have no experience in manufacturing and marketing products, and we
currently do not have the resources or capability to manufacture products on a
commercial scale. In order for us to commercialize our products on our own, we
would need to develop, or obtain through outsourcing arrangements or through
acquisitions, the capability to manufacture, market and sell products. Since we
do not currently possess the resources necessary to develop and commercialize
potential products ourselves, we must enter into strategic alliances to develop
and commercialize products.

We have entered into only two strategic alliances, with Bayer and
Pharmacia, to fund the development of certain new products, including herbicides
and plants with improved nutritional and growth characteristics. To date, we
have derived substantially all of our revenues from the Bayer collaborative
research and development agreement. If we are unable to successfully achieve
milestones or our strategic partners fail to develop successful products, we
will not earn the revenues contemplated under such collaborative agreements. In
addition, we may not be able to enter into additional strategic alliances. We do
not control the resources that our strategic partners devote to our projects and
our strategic partners may not perform their obligations. Also, we may pursue
opportunities in fields that conflict with our strategic partners or in which
our strategic partners could become active competitors. In either case, we may
not be able to commercialize our products.

We may need additional financing, which may not be available, and any financings
may dilute the percentage ownership of our existing stockholders, cause us to
relinquish rights to our technologies or cause us to grant licenses on
unfavorable terms.

Our existing capital resources may not be sufficient to fund our future
operating plans and we may therefore need to raise significant additional
capital. We have expended significant resources in developing our GeneFunction
Factory and expect our capital expenditures and operating expenses to increase
over the next several years as we continue developing the GeneFunction Factory
and increase our research and development activities. The amount of additional
capital which we expect we will need to raise will depend on many factors,
including:

. the number, breadth and progress of our research programs;
. the achievement of the milestones under certain of our existing
strategic alliances;
. our ability to establish additional and maintain current and
additional strategic alliances;
. our strategic partners' success in commercializing products
developed under our strategic alliances;
. our success in commercializing products to which we have retained
the rights under our strategic alliances;
. the costs incurred in enforcing and defending our patent claims and
other intellectual property rights; and
. the costs and timing of obtaining regulatory approvals for any of
our products.

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We may need to raise additional capital through public or private equity
offerings, debt financings or additional strategic alliances and licensing
arrangements. We may not be able to find additional financing when we need it or
on terms favorable to our stockholders or us. If we raise additional capital by
issuing equity securities, such an issuance will reduce the percentage ownership
of existing stockholders. Furthermore, we may need to issue securities that have
rights, preferences and privileges senior to our common stock. If we raise
additional funds through strategic alliances and licensing arrangements, we may
be required to relinquish rights to certain of our technologies or product
candidates, or to grant licenses on unfavorable terms.

If we lose our key personnel or are unable to attract and retain additional
personnel, our operations could be disrupted and our revenues could decrease.

Our success depends on the continued services and on the performance of our
senior management and scientific staff, in particular John Ryals, Ph.D., our
Chief Executive Officer and President. The loss of the services of Dr. Ryals or
any of our other senior management or scientific staff could seriously impair
our ability to operate and achieve our objectives, which could reduce our
revenues. We have $2 million of key man life insurance on Dr. Ryals. This amount
may not be sufficient to compensate us for the loss of his services. In
addition, recruiting and retaining qualified scientific personnel to perform
future research and development work will be critical to our success.

In order to achieve our business objectives, we must identify, attract,
train and motivate additional personnel with expertise in specific industries
and areas applicable to the products developed through our technologies. We
compete intensely for these personnel and we may be unable to achieve our
personnel goals. Our failure to achieve any of these goals could seriously limit
our ability to improve our operations and financial results.

If we were successfully sued for product liability, we could face substantial
liabilities that exceed our resources.

We may be held liable if any product we develop, or any product which is
made using our technologies, causes injury or is found unsuitable during product
testing, manufacturing, marketing, sale or use. For example, a genetically
modified food could, after it is sold, be found to cause illness in individuals
who eat the food. Also, like other pharmaceutical products, those produced
through genetically modified plants could be found to cause illness. These risks
are inherent in the development of chemical, agricultural and pharmaceutical
products. We currently do not have product liability insurance. If we choose to
obtain product liability insurance but cannot obtain sufficient insurance
coverage at an acceptable cost or otherwise protect against potential product
liability claims, the commercialization of products that we or our strategic
partners develop may be prevented or inhibited. If we are sued for any injury
caused by our products, our liability could exceed our total assets.

If we do not compete effectively, our losses could increase.

Our technology platform for the industrialization of gene function
determination faces competition from functional genomics technologies, which are
computer hardware and software technologies that researchers use to help them
identify the role that specific genes play within organisms, created by others,
including Exelixis, Inc., CuraGen Corporation, Rosetta Inpharmatics, Inc. and
Large Scale Biology Corporation (formerly known as Biosource Technologies,
Inc.). We expect competition to intensify in genomics research as scientists
achieve technology advances that become widely known. Genomic technologies have
undergone and are expected to continue to undergo rapid and significant change.
Our future success will depend in large part on maintaining a competitive
position in the genomics field, and particularly in the functional genomics
field. We or others may make rapid technological developments which may result
in products or technologies becoming obsolete before we recover the expenses we
incur in connection with our development. We or our strategic partners may offer
products which could be made obsolete by less expensive or more effective crop
enhancement, nutrition enhancement, drug discovery and industrial product
development technologies, including technologies that may be unrelated to
genomics. We may not be able to enhance our technology in ways necessary to
compete successfully with newly emerging technologies.

Any products that we may develop alone or in collaboration with others will
compete in highly competitive markets. In the specific markets in which we apply
or intend to apply our technology platform, we face competition from plant
genomics, pharmaceutical, agrochemical and biotechnology companies. Many of our
existing and potential competitors have substantially greater financial
resources, research and development staffs, facilities, manufacturing and
marketing experience, distribution channels and human resources than we do. Many
of these competitors have achieved substantial market penetration in the crop
production, nutrition, human health and industrial products markets.

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Our exclusive use of plant and fungal model organisms may limit our ability
to compete in the human health market and the industrial products markets. We
believe that our ability to compete in the human health market may depend on the
degree to which information we develop on plant and fungal gene and pathway
functions may relate to human physiology. Competing companies who use model
organisms with greater similarities to human genes, such as mice, as well as
companies that do direct studies of human populations, may have a substantial
advantage in developing products for humans.

If we are not able to adequately acquire and protect patents and licenses, we
may not be able to operate our business and remain competitive.

Our business and competitive position will depend in part on our ability to
obtain patents and maintain adequate protection of our other intellectual
property for our technologies and products in the United States and other
countries. As of August 3, 2000, we had 37 U.S. patent applications and 2
international patent application pending covering our technology. We hold no
issued patents and we may never receive patents on our applications in the
United States or other countries. The laws of some foreign countries do not
protect proprietary rights to the same extent as the laws of the United States,
and many companies have encountered significant problems in protecting their
proprietary rights in these foreign countries.

Third parties have filed, and in the future are likely to file, patent
applications covering genes and gene function that we have developed or may
develop or technology upon which our technology platform depends. If patent
offices issue patents on these patent applications and we wish to use the
claimed genes, gene functions or technology, we would need to obtain a license
from the third party. However, we might not be able to obtain any such license
on commercially favorable terms, if at all, and if we do not obtain these
licenses, we might be prevented from using certain technologies or taking
certain products to market.

The patent positions of biopharmaceutical and biotechnology companies,
including our patent position, are generally uncertain and involve complex legal
and factual questions. Patent law relating to the scope of claiming the
technology field in which we operate is still evolving. We will be able to
protect our proprietary rights from unauthorized use by third parties only to
the extent that our proprietary technologies are covered by valid and
enforceable patents or are effectively maintained as trade secrets. We will
apply for patents covering both our technologies and products, as we deem
appropriate. However, other companies may challenge these applications and
governments may not issue patents we request. Any future patents we obtain may
not be sufficiently broad to prevent others from practicing our technologies or
from developing competing products. Furthermore, others may independently
develop similar or alternative technologies or design around our patented
technologies. In addition, our patents may be challenged, invalidated or fail to
provide us with any competitive advantages.

We rely upon trade secret protection for our confidential and proprietary
information. We have taken security measures to protect our proprietary
information. These measures may not provide adequate protection for our trade
secrets or other proprietary information. Even though we seek to protect our
proprietary information by entering into confidentiality agreements with
employees, strategic partners and consultants, people may still disclose our
proprietary information, and we might not be able to meaningfully protect our
trade secrets.

If third parties make or file claims of intellectual property infringement
against us or otherwise seek to establish their intellectual property rights, we
may have to spend time and money in response and shut down some of our
operations.

Third parties may claim that we are employing their proprietary technology
without authorization or that we are infringing their patents. We could incur
substantial costs and diversion of management and technical personnel in
defending ourselves against any of these claims. Furthermore, parties making
claims against us may be able to obtain injunctive or other equitable relief
which could effectively block our ability to further develop, commercialize and
sell products. In the event of a successful claim of infringement, courts may
order us to pay damages and obtain one or more licenses from third parties. We
may not be able to obtain these licenses at a reasonable cost, if at all.
Defense of any lawsuit or failure to obtain any of these licenses could prevent
us from commercializing available products.

We are an early stage company using unproven technologies and, as a result, we
may never achieve, or be able to maintain, profitability.

You should evaluate us in light of the uncertainties affecting an early
stage biotechnology company. Our GeneFunction Factory is still in the early
stages of development. We have not yet proven that determining the function of a
gene in commercially significant target organisms will enable us to develop
commercial products.

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If adverse public reaction limits the acceptance of genetically modified
products, demand for any products that we or our collaborators may develop may
decrease.

The commercial success of our product candidates will depend in part on
public acceptance of the use of genetically modified products, including drugs,
plants and plant products. Claims that genetically modified products are unsafe
for consumption or pose a danger to the environment may influence public
attitudes. Any genetically modified products that our collaborators or we may
develop may not gain public acceptance. Due to public reaction in both the
United States and Europe, some food manufacturers and restaurants have already
decided not to sell food that has been genetically altered. If this continues or
increases, this could cause a decrease in demand for products that we or our
collaborators may develop.

Any products that we or our strategic partners develop using the gene function
information we provide may be subject to a lengthy and uncertain government
regulatory process that may not result in the necessary approvals, may delay the
commercialization of these products or may be costly, any of which could reduce
our revenues.

Any new product that we or our strategic partners develop will likely
undergo extensive regulatory review process in the United States by the FDA and
the USDA and by regulators in other countries before it can be marketed or sold.
For example, in the United States, the FDA must approve any drug or biologic
product before it can be marketed in the U.S. This regulatory review process can
take many years and require substantial expense. Adverse publicity could lead to
greater regulation and trade restrictions on imports and exports of genetically
modified products. Changes in the policies of U.S. and foreign regulatory bodies
could increase the time required to obtain regulatory approval for each new
product.

Our efforts to date have been primarily limited to identifying targets. If
regulators approve any products that we or our strategic partners develop, the
approval may impose limitations on the uses for which a product may be marketed.
Regulators may continue to review a product after approving it for marketing to
the public. Regulators may impose restrictions and sanctions, including banning
the continued sale of the product, if they discover problems with the product or
its manufacturer.

We may face a financial liability arising out of a possible violation of the
Securities Act of 1933 in connection with e-mails sent to all of our employees
regarding participation in our directed share program.

As part of our initial public offering, we sold 480,000 shares of our
common stock at the initial public offering price to certain directors,
employees, business associates and related persons associated with us. On
February 28 and March 13, 2000, we sent e-mail messages with respect to the
proposed directed share program to all of our employees setting forth procedural
aspects for participating in the directed share program and informing them about
the administration of the program and that their friends and families might have
an opportunity to participate in the proposed program. No person who received
either e-mail should rely on it in any manner in making a decision whether to
purchase shares of our common stock. We did not deliver a preliminary prospectus
prior to distribution of the e-mails, and each e-mail may constitute a non-
conforming prospectus under the Securities Act of 1933. As a result, we may have
a contingent liability under the Securities Act of 1933. Any liability would
depend upon the number of shares of our common stock purchased by the recipients
of the e-mails. The recipients of the e-mails who purchased shares of our common
stock in our initial public offering may have a right for a period of one year
from the date of the purchase to obtain recovery of the consideration paid in
connection with their purchase of shares of our common stock or, if they had
already sold the stock, sue us for damages resulting from their purchase of
shares of our common stock. If any liability is asserted with respect to either
e-mail, we will vigorously contest the matter. However, if a violation of the
Securities Act were deemed to apply to the entire allocation of 480,000 shares
in the directed share program, our damages could total up to approximately $3.4
million (or less if only the recipients of the e-mails were awarded damages)
plus interest based on the initial public offering price of $7.00 per share. If
this occurs, our financial condition would be adversely affected.

Our management will have broad discretion as to the use of proceeds from our
initial public offering and may spend the proceeds in ways with which you may
not agree.

Our management will have broad discretion over the use of proceeds from our
initial public offering. We currently intend to use the proceeds for research
and development and general corporate purposes. Our management may allocate the
net proceeds among these purposes as it determines is necessary. In addition,
market factors may require our management to allocate all or portions of the net
proceeds for other purposes. Management may not use the proceeds in a manner in
which you approve.

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Our stock price may be extremely volatile.

The stock market has experienced significant price and volume fluctuations,
and the market prices of technology companies, particularly life science
companies, have been highly volatile. Our common stock began public trading in
May 2000. We believe the trading price of our common stock will remain highly
volatile and may fluctuate substantially.

If our results of operations fluctuate and quarterly results are lower than the
expectations of securities analysts, then the price of our common stock could
fall.

Our operating results historically have fluctuated on a quarterly basis and
are likely to continue to do so in the future. These fluctuations could cause
our stock price to fluctuate significantly or decline. Some of the factors,
which could cause our operating results to fluctuate, include:

. expiration of research contracts with strategic partners, which may
not be renewed or replaced;
. the success rate of our discovery efforts leading to milestones and
royalties;
. the timing and willingness of strategic partners to commercialize
our products which would result in royalties; and
. general and industry specific economic conditions, which may affect
our strategic partners' research and development expenditures.

A large portion of our expenses, including expenses for facilities,
equipment and personnel are relatively fixed. Accordingly, if revenues decline
or do not grow as anticipated due to expiration of research contracts or
government research grants, failure to obtain new contracts or other factors, we
may not be able to correspondingly reduce our operating expenses. In addition,
we plan to significantly increase operating expenses in 2000. Failure to achieve
anticipated levels of revenues could therefore significantly harm our operating
results for a particular fiscal period.

Our operating results in some quarters may not meet the expectations of
stock market analysts and investors. In that case, our stock price would likely
decline.

If our stockholders sell substantial amounts of our common stock, the market
price of our common stock may fall.

The market price of our common stock could decline as a result of sales of
substantial amounts of our common stock in the public market, or the perception
that these sales could occur. In addition, these factors could make it more
difficult for us to raise funds through future offerings of common stock. As of
August 3, 2000, there were 25,712,830 shares of common stock outstanding. All of
the 6,750,000 shares sold in our initial public offering are freely transferable
without restriction or further registration under the Securities Act, except for
shares purchased by our "affiliates," as defined in Rule 144 of the Securities
Act, and except for shares that are subject to 180- day lock-up agreements
providing that the stockholders will not offer, sell, pledge or otherwise
dispose of their shares prior to November 1, 2000 without the prior written
consent of Chase Securities Inc. The remaining shares of common stock
outstanding will be "restricted securities" as defined in Rule 144. Holders of
these shares may sell them in the future without registration under the
Securities Act to the extent permitted by Rule 144 or other exemptions under the
Securities Act.

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Anti-takeover provisions of Delaware law and our charter could make a third-
party acquisition of us difficult.

The anti-takeover provisions of Delaware law could make it more difficult
for a third party to acquire control of us, even if the change in control would
be beneficial to stockholders. We will be subject to the provisions of Section
203 of the General Corporation Law of Delaware. Section 203 will prohibit us
from engaging in certain business combinations, unless the business combination
is approved in a prescribed manner. Accordingly, Section 203 may discourage,
delay or prevent someone from acquiring or merging with us. In addition, our
restated certificate of incorporation and amended and restated by-laws contain
certain provisions that may make a third party acquisition of us difficult,
including:

. a classified board of directors, with three classes of directors
each serving a staggered three-year term;
. the ability of the board of directors to issue preferred stock; and
. the inability of our stockholders to call a special meeting or act
by written consent.

Some of our existing stockholders can exert control over us, and may not make
decisions that are in the best interests of all stockholders.

Due to their combined stock holdings, our officers, directors and
stockholders who beneficially own more than five percent of our common stock, if
they act together, will be able to exert a significant degree of influence over
our management and affairs and over matters requiring stockholder approval,
including the election of directors and approval of significant corporate
transactions. In addition, this concentration of ownership may delay or prevent
a change in control of us and might affect the market price of our common stock,
even when a change may be in the best interests of all stockholders. In
addition, the interests of this concentration of ownership may not always
coincide with our interests or the interests of other stockholders and
accordingly, they could cause us to enter into transactions or agreements, which
we would not otherwise consider.

Future issuances of preferred stock may dilute the rights of our common
stockholders.

Our board of directors will have the authority to issue up to 5,000,000
shares of preferred stock and to determine the price, rights, privileges and
other terms of these shares. The board of directors may exercise this authority
without the approval of the stockholders. The rights of the holders of any
preferred stock that we may issue in the future may adversely affect the rights
of holders of our common stock.

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Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit 3.1 Restated Certificate of Incorporation (Filed as Exhibit 3.2 to
Registration Statement on Form S-1, Registration No. 333-30758,
and incorporated herein by reference).

Exhibit 3.2 Amended and Restated Bylaws (Filed as Exhibit 3.4 to Registration
Statement on Form S-1, Registration No. 333-30758, and
incorporated herein by reference).

Exhibit 4.1 Form of Common Stock Certificate (Filed as Exhibit 4.1 to
Registration Statement on Form S-1, Registration No. 333-30758,
and incorporated herein by reference).

Exhibit 10.1 First Amendment to the Amended and Restated Registration Rights
Agreement, between the Registrant and certain Founders and
Investors (Filed as Exhibit 10.6.1 to Registration Statement on
Form S-1, Registration No. 333-30758, and incorporated herein by
reference).

Exhibit 10.2 Amendment to the Founder Stock Repurchase and Vesting Agreement
between the Registrant and John Ryals (Filed as Exhibit 10.13.1
to Registration Statement on Form S-1, Registration No.
333-30758, and incorporated herein by reference).

Exhibit 10.3 Amendment to the Founder Stock Repurchase and Vesting Agreement
between the Registrant and Jorn Gorlach (Filed as Exhibit
10.14.1 to Registration Statement on Form S-1, Registration No.
333-30758, and incorporated herein by reference).

Exhibit 10.4 Amendment to the Founder Stock Repurchase and Vesting Agreement
between the Registrant and Sandy J. Stewart (Filed as Exhibit
10.15.1 to Registration Statement on Form S-1, Registration No.
333-30758, and incorporated herein by reference).

Exhibit 10.5 Amendment to the Founder Stock Repurchase and Vesting Agreement
between the Registrant and Scott Uknes (Filed as Exhibit 10.16.1
to Registration Statement on Form S-1, Registration No.
333-30758, and incorporated herein by reference).

Exhibit 10.6 Amended and Restated Lease Agreement, dated April 2000, between
the Registrant and ARE-104 Alexander Road LLC (Filed as Exhibit
10.25.1 to Registration Statement on Form S-1, Registration No.
333-30758, and incorporated herein by reference).

Exhibit 10.7 Lease Agreement, dated April 2000, between the Registrant and
ARE-104 Alexander Road LLC (Filed as Exhibit 10.25.2 to
Registration Statement on Form S-1, Registration No. 333-30758,
and incorporated herein by reference).

Exhibit 10.8 First Amendment to Warrant to ARE-104 Alexander Road LLC (Filed
as Exhibit 10.43.1 to Registration Statement on Form S-1,
Registration No. 333-30758, and incorporated herein by
reference).

Exhibit 10.9 First Amendment to Warrant to ARE-104 Alexander Road LLC (Filed
as Exhibit 10.45.1 to Registration Statement on Form S-1,
Registration No. 333-30758, and incorporated herein by
reference).

Exhibit 10.10 First Amendments to Warrant to Intersouth III, L.P. and
Intersouth Partners IV, L.P. (Filed as Exhibit 10.46.1 to
Registration Statement on Form S-1, Registration No. 333-30758,
and incorporated herein by reference).

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Exhibit 10.11 First Amendment to Warrant to Innotech Investments Limited (Filed
as Exhibit 10.47.1 to Registration Statement on Form S-1,
Registration No. 333-30758, and incorporated herein by
reference).

Exhibit 27.1 Financial Data Schedule

Exhibit 27.2 Financial Data Schedule

(b) Reports on Form 8-K

Paradigm filed no reports on Form 8-K during the quarter ended June 30, 2000.

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PARADIGM GENETICS, INC.

SIGNATURES

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.

PARADIGM GENETICS, INC.

DATE: August 3, 2000 SIGNATURE: /s/ Ian A.W. Howes

Ian A.W. Howes
Chief Financial Officer and
Vice President of Finance
and Operations (chief
accounting officer)

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EXHIBIT INDEX

Exhibit 3.1 Restated Certificate of Incorporation (Filed as Exhibit 3.2 to
Registration Statement on Form S-1, Registration No. 333-30758,
and incorporated herein by reference).

Exhibit 3.2 Amended and Restated Bylaws (Filed as Exhibit 3.4 to Registration
Statement on Form S-1, Registration No. 333-30758, and
incorporated herein by reference).

Exhibit 4.1 Form of Common Stock Certificate (Filed as Exhibit 4.1 to
Registration Statement on Form S-1, Registration No. 333-30758,
and incorporated herein by reference).

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Exhibit 27.1 Financial Data Schedule

Exhibit 27.2 Financial Data Schedule