<PAGE> 1
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 March 31, 1998
or
[ ] TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to ______________________
Commission File Number: 0-27488
INCYTE PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3136539
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3174 Porter Drive
Palo Alto, California 94304
(Address of principal executive offices)
(650) 855-0555
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. [X] Yes [ ] No
The number of outstanding shares of the registrant's Common Stock, $0.001 par
value, was 26,525,429 as of March 31, 1998.
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INCYTE PHARMACEUTICALS, INC.
INDEX
<TABLE>
<CAPTION>
PART I: FINANCIAL INFORMATION PAGE
- ----------------------------- ----
<S> <C> <C>
ITEM 1 Financial Statements - Unaudited
Condensed Consolidated Balance Sheets - March 31, 1998 and
December 31, 1997.........................................................3
Condensed Consolidated Statements of Operations - three month
periods ended March 31, 1998 and 1997.....................................4
Condensed Consolidated Statements of Cash Flows - three month
periods ended March 31, 1998 and 1997.....................................5
Notes to Condensed Consolidated Financial Statements......................6
ITEM 2 Management's discussion and analysis of financial condition
and results of operations................................................10
PART II: OTHER INFORMATION
ITEM 1 Legal Proceedings........................................................26
ITEM 2 Changes in Securities....................................................26
ITEM 3 Defaults Upon Senior Securities..........................................26
ITEM 4 Submission of Matters to a Vote of Security Holders......................26
ITEM 5 Other Information........................................................26
ITEM 6 Exhibits and Reports on Form 8-K.........................................27
Signatures...............................................................28
Exhibit Index............................................................29
</TABLE>
Page 2 of 31
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands),
(unaudited),
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997*
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 42,726 $ 55,876
Restricted cash 6,000 6,000
Marketable securities - available-for-sale 89,713 57,497
Accounts receivable, net 8,626 20,203
Prepaid expenses and other current assets 5,125 3,792
--------- ---------
Total current assets 152,190 143,368
Property and equipment, net 43,369 37,817
Long-term investments 19,240 14,800
Deposits and other assets 4,298 3,286
--------- ---------
Total assets $ 219,097 $ 199,271
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 6,663 $ 5,605
Accrued and other current liabilities 15,113 15,518
Deferred revenue 44,964 31,054
--------- ---------
Total current liabilities 66,740 52,177
Non-current portion of accrued rent and other
non-current liabilities 382 426
Long term debt, net of current portion 626 686
--------- ---------
Total liabilities 67,748 53,289
--------- ---------
Stockholders' equity:
Capital stock 27 26
Additional paid-in capital 181,214 179,481
Deferred compensation (1,482) (1,658)
Receivable from stockholder (49) (49)
Accumulated other comprehensive income (loss) (54) 55
Accumulated deficit (28,307) (31,873)
--------- ---------
Total stockholders' equity 151,349 145,982
--------- ---------
Total liabilities and stockholders' equity $ 219,097 $ 199,271
========= =========
</TABLE>
* The condensed consolidated balance sheet at December 31, 1997 has been derived
from the audited financial statements at that date
See accompanying notes
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<PAGE> 4
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts),
(unaudited),
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1997
-------- --------
<S> <C> <C>
Revenues $ 30,379 $ 17,998
Costs and expenses:
Research and development 21,699 15,133
Selling, general and administrative 4,600 2,853
Acquisition-related charges 1,171 --
-------- --------
Total costs and expenses 27,470 17,986
-------- --------
Income from operations 2,909 12
Interest and other income, net 1,877 497
Losses from joint venture (640) --
-------- --------
Income before taxes 4,146 509
Provision for income taxes 580 52
-------- --------
Net income $ 3,566 $ 457
======== ========
Basic net income per share $ 0.13 $ 0.02
======== ========
Shares used in computing basic net income per share 26,470 22,995
======== ========
Diluted net income per share $ 0.12 $ 0.02
======== ========
Shares used in computing diluted net income per share 28,916 25,247
======== ========
</TABLE>
See accompanying notes
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<PAGE> 5
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands),
(unaudited),
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,566 $ 457
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 3,515 2,265
Equity losses in joint venture 640 --
Amortization of deferred compensation 176 --
Changes in certain assets and liabilities:
Accounts receivable 11,577 (6,209)
Prepaid expenses, deposits and other assets (2,345) (1,000)
Accounts payable 1,058 (723)
Accrued and other liabilities (432) 1,466
Deferred revenue 13,910 12,079
-------- --------
Net cash provided by operating activities 31,665 8,335
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Long-term investments (5,080) (3,000)
Capital expenditures (9,067) (4,756)
Purchases of marketable securities (53,181) (4,511)
Sales and maturities of marketable securities 20,856 4,510
-------- --------
Net cash used in investing activities (46,472) (7,757)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 1,734 91
Principal payments on capital lease obligations and
notes payable (77) (33)
-------- --------
Net cash provided by financing activities 1,657 58
-------- --------
Net increase (decrease) in cash and cash equivalents (13,150) 636
Cash and cash equivalents at beginning of period 55,876 9,616
-------- --------
Cash and cash equivalents at end of period $ 42,726 $ 10,252
======== ========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid $ 24 $ 5
======== ========
Income taxes paid $ 165 $ --
======== ========
</TABLE>
See accompanying notes
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<PAGE> 6
INCYTE PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. The condensed consolidated balance sheet as of March 31, 1998
and December 31, 1997, statements of operations for the three months ended March
31, 1998 and 1997 and the statements of cash flows for the three months ended
March 31, 1998 and 1997 are unaudited, but include all adjustments (consisting
of normal recurring adjustments) which the Company considers necessary for a
fair presentation of the financial position, operating results and cash flows
for the periods presented.
The condensed consolidated financial statements include the accounts of its
wholly-owned subsidiaries. In January 1998, all of the outstanding shares of
Synteni, Inc. ("Synteni") were acquired by the Company in a business combination
accounted for as a pooling-of-interests. Accordingly, all prior financial data
have been restated to represent the combined financial results of the previously
separate entities (Note 4). Although the Company believes that the disclosures
in these financial statements are adequate to make the information presented not
misleading, certain information and footnote information normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission.
Certain reclassifications were made to prior periods' balances to conform with
the 1998 presentation. Results for any interim period are not necessarily
indicative of results for any future interim period or for the entire year. The
accompanying financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1997.
2. REVENUE RECOGNITION
The Company recognizes revenue for database collaboration agreements evenly over
the term of the agreement. Revenue is deferred for fees received before earned.
Revenues from custom orders, such as satellite databases, are recognized upon
shipment. Revenues from reagents and genomic screening products are recognized
when shipped, and revenues from genomic screening services are recognized upon
completion. Revenues from gene expression microarray services are recognized on
completion of key stages in the performance of the service, in proportion to
costs incurred. Revenues from software licenses are recognized upon completion
of installation and revenues from software maintenance are recognized ratably
over the life of the maintenance period.
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<PAGE> 7
3. NET INCOME PER SHARE
Basic EPS is computed by dividing net income available to common stockholders
(numerator) by the weighted average number of common shares outstanding
(denominator) during the period and excludes the dilutive effect of stock
options. Diluted EPS gives effect to all dilutive potential common shares
outstanding during a period. In computing diluted EPS, the average stock price
for the period is used in determining the number of shares assumed to be
purchased from exercise of stock options.
Following is a reconciliation of the numerators and denominators of the basic
and diluted EPS computations for the periods presented below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1997
------- -------
<S> <C> <C>
Numerator:
Net income $ 3,566 $ 457
======= =======
Denominator
Denominator for basic net income per share -
weighted-average shares outstanding 26,470 22,995
Dilutive potential common shares-stock options 2,446 2,252
------- -------
Denominator for diluted net income per share -
adjusted weighted-average 28,916 25,247
======= =======
Basic net income per share $ 0.13 $ 0.02
======= =======
Diluted net income per share $ 0.12 $ 0.02
======= =======
</TABLE>
4. BUSINESS COMBINATIONS
In January 1998, the Company issued 2,340,237 shares of common stock in exchange
for all of the capital stock of Synteni, Inc., a privately held gene expression
microarray company located in Fremont, California. Synteni provides microarray
services to the pharmaceutical, biotechnology, and agricultural industries. The
merger has been accounted for as a pooling-of-interests and, accordingly, the
Company's financial statements and financial data have been restated to include
the accounts and operations of Synteni for all periods presented.
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<PAGE> 8
The table below presents the separate results of operations for Synteni for the
periods prior to the merger. The Company's results of operations include Synteni
since the transactions (in thousands):
<TABLE>
<CAPTION>
Merger
Related
Incyte Synteni Expenses Total
------- ------- -------- -----
<S> <C> <C> <C> <C>
Three months ended March 31, 1998
Revenue $30,379 -- -- $30,379
Net income (loss) 4,626 -- (1,060) 3,566
Three months ended March 31, 1997
Revenue $17,859 $ 139 -- $17,998
Net income (loss) 981 (524) -- 457
</TABLE>
5. JOINT VENTURE
In September 1997, the Company formed a joint venture, diaDexus, LLC,
("diaDexus") which will utilize genomic and bioinformatic technologies in the
discovery and commercialization of molecular diagnostics. The Company holds a 50
percent equity interest in diaDexus and accounts for the investment under the
equity method. A portion of the investment is reflected as restricted cash and
in accrued liabilities on the balance sheet since that balance is held in an
escrow account and will be distributed to diaDexus as needed.
6. STOCKHOLDERS' EQUITY
In October 1997, the Company's Board of Directors authorized a two-for-one stock
split to be effected in the form of a stock dividend payable November 7, 1997 to
holders of record on October 17, 1997. All share and per share data have been
adjusted retroactively to reflect the split.
7. NEW PRONOUNCEMENTS
In the first quarter of fiscal 1998 the Company adopted FASB Statement No. 130,
Reporting Comprehensive Income ("SFAS 130"). SFAS 130 requires companies to
disclose, both individually and in the aggregate, the change in equity from
non-owner sources. The Company's adjustment to net income to arrive at
comprehensive income is comprised of unrealized gains and losses on marketable
securities available-for-sale. Comprehensive income was $3,457,000 and $396,000
for the three months ended March 31, 1998 and 1997, respectively.
In June 1997, the FASB issued Statement No. 131, Disclosures about Segments of
an Enterprise and Related Information ("SFAS 131"). SFAS 131 establishes
standards for reporting financial and descriptive information about an
enterprise's operating segments in its annual financial statements and selected
segment information in interim financial reports. Reclassification or
restatement of comparative financial statements or financial information for
earlier periods is required upon adoption of SFAS 131. Application of the
Statements' disclosure requirements will have no impact on the Company's
consolidated financial position, results of operations or earnings per share
data as currently reported.
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<PAGE> 9
8. LITIGATION
On January 6, 1998, Affymetrix, Inc. ("Affymetrix") filed a lawsuit in the
United States District Court for the District of Delaware alleging infringement
of U.S. patent number 5,445,934 (the "'934 Patent") by both Synteni and Incyte.
The complaint alleges that the '934 Patent has been infringed by the making,
using, selling, importing, distributing or offering to sell in the U.S. high
density arrays by Synteni and Incyte and that such infringement was willful.
Affymetrix seeks a permanent injunction enjoining Synteni and Incyte from
further infringement of the '934 Patent and, in addition, seeks damages, costs
and attorney's fees and interest. Affymetrix further requests that any such
damages be trebled based on its allegation of willful infringement by Incyte and
Synteni. Incyte and Synteni believe they have meritorious defenses and intend to
defend the suit vigorously. However, there can be no assurance that Incyte and
Synteni will be successful in the defense of this suit, and litigation could
result in substantial expenses and diversion of the efforts of management and
technical personnel. Further, there can be no assurance that any license that
may be required as a result of this suit or the outcome thereof would be made
available on commercially acceptable terms, if at all.
Page 9 of 31
<PAGE> 10
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 March 31, 1998 and for the three month periods ended
March 31, 1998 and 1997 should be read in conjunction with the unaudited
condensed consolidated financial statements and notes thereto set forth in Item
1 of this report and the section entitled "Management's Discussion and Analysis
of Financial Condition and Results of Operations" in the Company's Annual Report
on Form 10-K for the year ended December 31, 1997.
When used in this discussion, the words "expects," "anticipates,"
"estimates," and similar expressions are intended to identify forward-looking
statements. Such statements, which include statements as to expected expenditure
levels, the adequacy of capital resources, and growth in operations, are subject
to risks and uncertainties that could cause actual results to differ materially
from those projected. These risks and uncertainties include, but are not limited
to, those risks discussed below, as well as the extent of utilization of genomic
information by the pharmaceutical industry in both research and development;
risks relating to the development of new database products and their use by
potential collaborators of the Company; the impact of technological advances and
competition; the ability of the Company to obtain and retain customers;
competition from other entities; early termination of a database collaboration
agreement or failure to renew an agreement upon expiration; the ability to
successfully integrate the operations of recent business combinations; the cost
of accessing technologies developed by other companies; uncertainty as to the
scope of coverage, enforceability or commercial protection from patents that
issue on gene sequences and other genetic information; the viability of joint
ventures and businesses in which the Company has purchased equity; and the
matters discussed below under the caption " -- Factors That May Affect Results."
These forward looking statements speak only as of the date hereof. The Company
expressly disclaims any obligation or undertaking to release publicly any
updates or revisions to any forward-looking statements contained herein to
reflect any change in the Company's expectations with regard thereto or any
change in events, conditions or circumstances on which any such statement is
based.
OVERVIEW
Incyte Pharmaceuticals, Inc. (the "Company") designs, develops and
markets genomic database products, genomic data management software tools, gene
expression mircroarray services and related reagents. The Company's genomic
databases integrate bioinformatics software with proprietary and, when
appropriate, publicly available genetic information to create information-based
tools used by pharmaceutical and biotechnology companies in drug discovery and
development. In building the databases, the Company utilizes high-throughput,
computer-aided gene sequencing and analysis technologies to identify and
characterize the expressed genes of the human genome, as well as certain animal,
plant and microbial genomes.
Page 10 of 31
<PAGE> 11
Revenues recognized by the Company consist primarily of non-exclusive
database access fees related to database collaboration agreements. Revenues also
include the sales of genomic screening products and services, gene expression
microarray services, and fees for custom or "satellite" database services. The
Company's database collaboration agreements provide for future milestone
payments and royalties from the sale of products derived from proprietary
information obtained through the databases. There can be no assurance that any
database collaborators will ever generate products from information contained
within the databases and thus that the Company will ever receive milestone
payments or royalties.
In January 1998, the Company completed the acquisition of Synteni,
Inc. ("Synteni"), a microarray-based gene expression company. The transaction
has been accounted for as a pooling-of-interests, and the consolidated financial
statements discussed herein and all historical financial information have been
restated to reflect the combined operations of both companies. Synteni's ability
to contribute to revenues and operating profits will be dependent on the ability
of the Company to obtain high volume customers for Synteni's microarray
services. Prior to the merger, Synteni's microarray service agreements consisted
of small volume pilot or feasibility agreements. In September 1997, the Company
formed a joint venture, diaDexus, LLC ("diaDexus"), with SmithKline Beecham
Corporation ("SB") which will utilize genomic and bioinformatic technologies in
the discovery and commercialization of molecular diagnostics. The Company and SB
each hold a 50 percent equity interest in diaDexus. The investment is accounted
for under the equity method and the Company will record its share of diaDexus'
earnings and losses on its statement of operations.
The Company's investments in joint ventures and businesses,
particularly diaDexus, a joint venture with SB, may require the Company to
record losses or expenses related to its proportionate ownership interest in
such entities, to record charges for the acquisition of in-process technologies,
or to record charges for the recognition of the impairment in the value of the
securities underlying such investments. To date, exclusive of losses from joint
ventures, the Company has not incurred significant losses on its long-term
equity investments. One equity investment, OncorMed, Inc. ("OncorMed"), received
a report from its independent auditors for the year ended December 31, 1997
which expressed substantial doubt as to OncorMed's ability to continue as a
going concern. OncorMed is pursuing various financing options and the Company
will continue to evaluate its investment in OncorMed and all of its long-term
equity investments for impairment on a quarterly basis.
The need for continued investment in development of the Company's
databases and related products and services and for extensive ongoing
collaborator support capabilities results in significant fixed expenses. If
revenue in a particular period does not meet expectations, the Company may not
be able to adjust significantly its level of expenditures in such period, which
would have an adverse effect on the Company's operating results. The Company may
also experience difficulty in forecasting levels of operating expenditures for,
and integration-related expenses with respect to, subsidiaries acquired through
acquisitions, at least until a substantial period of time has passed since the
acquisition date. This is particularly true when attempting to forecast
expenditure levels for acquired businesses that focus on technologies for which
there is not yet an established market. The Company believes that quarterly
comparisons of its financial results will not necessarily be meaningful and
should not be relied upon as an indication of future performance. Due to the
foregoing and other unforeseen factors, it is likely that in some future quarter
or quarters the Company's operating results may be below the expectations of
public market analysts and investors.
Page 11 of 31
<PAGE> 12
In an effort to broaden its business, the Company is investing in a
number of new areas, including microarray services, molecular diagnostics,
pharmacogenomics and proteomics. Given that many of these address new markets,
or involve untested technologies, it is not known if any of them will generate
revenues or if the revenues will be sufficient to provide an adequate return on
the investment. Depending on the investment required and the timing of such
investments, expenses or losses related to these investments could adversely
affect operating results.
The Company could incur substantial expenses in its defense of the
lawsuit filed in January 1998 by Affymetrix, Inc. ("Affymetrix") alleging patent
infringement by Synteni and Incyte. Affymetrix seeks a permanent injunction
enjoining Synteni and Incyte from further infringement and, in addition, seeks
damages, costs, attorneys' fees and interest. Affymetrix further requests that
any such damages be trebled on its allegation of willful infringement by Incyte
and Synteni. Incyte and Synteni believe they have meritorious defenses and
intend to defend the suit vigorously. However, there can be no assurance that
Incyte and Synteni will be successful in the defense of this suit, and
litigation, regardless of the outcome, could result in substantial expenses and
diversion of the efforts of management and technical personnel. Further, there
can be no assurance that any license that may be required as a result of this
suit or the outcome thereof would be made available on commercially acceptable
terms, if at all.
RESULTS OF OPERATIONS
Revenues for the three months ended March 31, 1998 increased to $30.4
million compared to $18.0 million for the corresponding period in 1997. Revenues
resulted primarily from database access fees and, to a much lesser extent, from
genomic screening products and services, custom satellite database services and
gene expression services. The increase in revenues was primarily attributed to
new, as well as expanded, collaborative database agreements.
Total costs and expenses for the three months ended March 31, 1998
increased to $27.5 million compared to $18.0 million for the corresponding
period in 1997. Total costs and expenses for the three month period ended March
31, 1998 included an acquisition-related charge of $1.2 million for the
acquisition of Synteni, Inc. The charge consisted primarily of accounting, legal
and investment banking fees. Total costs and expenses are expected to increase
in the foreseeable future due to the continued investment in new product
development, bioinformatics, microarray production capacity, and growth in
marketing, sales and customer services. However, if the Company does not obtain
additional collaborators in a timely manner or if the Company's database
collaborators do not renew their collaboration agreement at the end of their
applicable terms, the Company may not be able to adjust significantly its level
of expenditures in any period, which would have an adverse effect on the
Company's operating results.
Research and development expenses for the three months ended March
31, 1998 increased to $21.7 million compared to $15.1 million for the
corresponding period in 1997. The increase in research and development expenses
resulted primarily from an increase in bioinformatics and software development
efforts, microarray production and technology development, investment in the
growth of the Company's intellectual property portfolio, and the continued and
expanded operations relating to the acquisition of Synteni. The Company expects
research and development spending to increase over the next few years as the
Company continues to pursue the development of new database products and
services, invest in new technologies, broaden its gene sequence and microarray
production operations and invest in the continued protection of its intellectual
property.
Page 12 of 31
<PAGE> 13
Selling, general and administrative expenses for the three months
ended March 31, 1998 increased to $4.6 million compared to $2.9 million for the
corresponding period in 1997. The increase in selling, general and
administrative expenses resulted primarily from the growth in marketing, sales
and customer support. The Company expects that selling, general and
administrative expenses will increase throughout 1998 due to continued growth in
marketing, sales and customer support functions, the expansion of the Company's
United Kingdom operations, and legal expenses related to the Company's defense
of the patent infringement lawsuit filed by Affymetrix in January 1998.
Interest and other income, net for the three months ended March 31,
1998 increased to $1.9 million from $0.5 million for the corresponding period in
1997. This was primarily a result of increased interest income from higher
average combined cash, cash equivalent and marketable securities balances due
primarily to the completion of a follow-on public offering in August 1997
Losses from joint venture were $0.6 million for the three months
ended March 31, 1998. The loss represents the Company's share of diaDexus'
losses from operations. Since diaDexus was formed in September 1997, no losses
from joint venture were recognized for the three months ended March 31, 1997.
The Company expects that losses from joint venture will continue at least
through 1998.
The estimated effective annual income tax rate for the first quarter
of 1998 is 14%, which represents the provision of federal and state alternative
minimum taxes after utilization of net operating loss carryforwards and research
and development credits.
Net income and diluted earning per share were $3.6 million and $0.12
for the three months ended March 31, 1998, respectively, as compared to $0.5
million and $0.02 in the same period a year ago, respectively. Earnings per
share was impacted by a follow-on public stock offering in August 1997 that
resulted in an increase in the number of shares outstanding of 2.8 million
shares, including 0.4 million shares issued upon the exercise of the
underwriters' over-allotment option. The Company's results of operations and
earning per share for the three months ended March 31, 1997 have been restated
to account for the acquisition of Synteni, which was accounted for as a
pooling-of-interests. Previously reported net income and diluted earnings per
share for the three months ended March 31, 1997 were $1.0 million and $0.09,
respectively. While the Company has reported net income for the past five
quarters, there can be no assurance that the Company can maintain profitability.
See "Factors That May Affect Results -- History of Operating Losses; Uncertainty
of Continued Profitability or Revenues."
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1998, the Company had $132.4 million in cash, cash
equivalents and marketable securities, compared to $113.4 million as of December
31, 1997. For the three month period ended March 31, 1998, cash provided by
operating and financing activities was partially offset by capital expenditures,
consisting primarily of purchases of data processing-related computer hardware,
laboratory equipment and facilities improvements, as well as investments in
research and development alliances. The Company has classified all of its
marketable securities as short-term, as the Company may decide not to hold its
marketable securities until maturity in order to take advantage of favorable
market conditions. Available cash is invested in accordance with the Company's
investment policy's primary objectives of liquidity, safety of principal and
diversity of investments.
Page 13 of 31
<PAGE> 14
Net cash provided by operating activities was $31.7 million for the
three months ended March 31, 1998, as compared to $8.3 million for the three
months ended March 31, 1997. The increase in net cash provided by operating
activities resulted primarily from the increase in net income, decrease in
accounts receivable and increase in deferred revenues partially offset by the
increase in prepaid expenses, deposits and other assets as well as accrued and
other liabilities. Net cash generated by operating activities may in the future
fluctuate significantly from quarter to quarter due to the timing of large
prepayments by database collaborators.
The Company's investing activities, other than purchases, sales and
maturities of marketable securities, have consisted of capital expenditures and
long-term investments. Capital expenditures for the three months ended March 31,
1998 increased to $9.1 million from $4.8 million for the three months ended
March 31, 1997. Additional long-term investments in companies with which the
Company has research and development alliances increased to $5.1 million for the
three months ended March 31, 1998 from $3.0 million for the three months ended
March 31, 1997. Long-term investments for the period ended March 31, 1998
consisted primarily of a $5.0 million equity investment in Oxford GlycoSciences
plc, while long-term investments for the period ended March 31, 1997 consisted
of an equity investment in OncorMed. Net cash used by investing activities may
in the future fluctuate significantly from quarter to quarter due to the timing
of strategic equity investments, capital purchases and maturity/sales and
purchases of marketable securities.
Net cash provided by financing activities was $1.7 million for the
three months ended March 31, 1998 as compared to $58,000 for the three months
ended March 31, 1997. The increase was primarily due to proceeds from stock
option exercises. The Company expects its cash requirements to increase through
1998 as it increases its investment in data-processing-related computer hardware
in order to support its existing and new database products, continues to seek
access to technologies through investments, research and development alliances,
license agreements and/or acquisitions, and addresses its needs for larger
facilities and/or improvements in existing facilities. The Company has entered
into a multi-year lease with respect to a 95,000 square foot building to be
constructed adjacent to the Company's Palo Alto headquarters. The Company's
share of tenant improvements is estimated to be between $10.0 million and $15.0
million. Given the current construction schedule, the Company does not expect to
begin to incur expenses related to this facility until late 1998 or early
1999.The Company expects to continue to fund future operations with revenues
from genomic database products and services in addition to using its current
cash, cash equivalents and marketable securities.
Based upon its current plans, the Company believes that its existing
resources and anticipated cash flow from operations will be adequate to satisfy
its capital needs at least through 1998. However, the Company may be unable to
obtain additional collaborators or retain existing collaborators for the
Company's databases, and its database products and services may not produce
revenues which, together with the Company's cash, cash equivalents and
marketable securities, would be adequate to fund the Company's cash
requirements. The Company's cash requirements depend on numerous factors,
including the ability of the Company to attract and retain collaborators for its
databases and genomic products and services; competing technological and market
developments; the cost of filing, prosecuting, defending and enforcing patent
claims and other intellectual property rights; the purchase of additional
capital equipment, including capital equipment necessary to ensure the Company's
sequencing, data processing and microarray operations remain competitive and
costs associated with the integration of new operations assumed through mergers
and acquisitions. In particular, the Company expects its cash requirements to
increase in 1998 as it increases its investment in data processing-related
computer hardware in
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order to support its existing and new database products; continues to seek
access to technologies through investments, alliances, license agreements,
and/or acquisitions; makes investments associated with integration of acquired
companies; and addresses its needs for larger facilities and/or improvements in
existing facilities. The Company expects to continue to fund future operations
with revenues from genomic database products and services in addition to using
its current cash, cash equivalents and marketable securities. Changes in the
Company's research and development plans or other changes affecting the
Company's operating expenses may result in changes in the timing and amount of
expenditures of the Company's capital resources. If additional capital is raised
through the sale of equity or convertible debt securities, the issuance of these
securities could result in dilution to the Company's existing stockholders.
Additional funding, if necessary, may not be available on favorable terms, if at
all. If adequate funds are not available, the Company may be required to curtail
operations significantly or to obtain funds through entering into collaborative
arrangements that may require the Company to relinquish rights to certain of its
technologies, product candidates, products or potential markets.
FACTORS THAT MAY AFFECT RESULTS
Uncertain Effects of the Synteni Merger. The combination of Synteni
and the Company involves several potential operating and business risks,
including the integration of Synteni's and the Company's businesses and
management in a timely, efficient and effective manner, the timely integration
of Synteni's microarray technology and services with the Company's database
products and services, integration of the respective sales and marketing and
research and development efforts, and any resulting loss of efficiency or loss
of employees. The combined companies may not realize any revenue enhancements or
cost savings or maintain Synteni's business relationships with its customers
after the merger. Also, any cost savings that are realized due to the merger may
be offset by increases in other expenses or operating losses, including losses
due to problems in integrating the two companies. See " -- Risks Associated With
Acquisitions." Although the Company believes that beneficial synergies will
result from the Synteni merger, the combination of the two companies'
businesses, even if achieved in an efficient, effective and timely manner, may
not result in combined results of operations and financial condition superior to
what would have been achieved by each company independently, and may take longer
than expected. See " -- History of Operating Losses; Uncertainty of Continued
Profitability or Revenues."
Risks Associated with Acquisitions. As part of its business strategy,
the Company may from time to time acquire assets and businesses principally
relating to, or complementary to, its operations. These acquisitions may include
acquisitions for the purpose of acquiring specific technology. The Company
acquired two companies, Genome Systems, Inc. and Combion, Inc., in 1996 and
acquired Synteni in January 1998. If the Company acquires additional businesses
that are not located near the Company's Palo Alto, California headquarters, the
Company may experience more difficulty integrating and managing the acquired
businesses' operations. These and any other acquisitions by the Company involve
risks commonly encountered in acquisitions of companies. These risks include,
among other things, the following: the Company may be exposed to unknown
liabilities of acquired companies; the Company may incur acquisition costs and
expenses higher than it anticipated; fluctuations in the Company's quarterly and
annual operating results may occur due to the costs and expenses of acquiring
and integrating new businesses or technologies; the Company may experience
difficulty and expense of assimilating the operations and personnel of the
acquired businesses; the Company's ongoing business may be disrupted and its
management's time and attention may be diverted; the Company may be unable to
integrate successfully or to complete the development and application of
acquired technology and may fail to achieve the anticipated financial, operating
and strategic benefits from these acquisitions; the Company may experience
difficulties in establishing and maintaining uniform standards, controls,
procedures and policies; the
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Company's relationships with key employees and customers of acquired businesses
may be impaired, or these key employees and customers may be lost, as a result
of changes in management and ownership of the acquired businesses; the Company
may incur amortization expenses if an acquisition is accounted for as a
purchase; and the Company's stockholders may be diluted if the consideration for
the acquisition consists of equity securities. The Company may not overcome
these risks or any other problems encountered in connection with acquisitions.
If the Company is unsuccessful in doing so, its business, financial condition
and results of operations could be materially and adversely affected.
History of Operating Losses; Uncertainty of Continued Profitability
or Revenues. For the years ended December 31, 1997, 1996 and 1995, the Company
had net income (losses) of $6.9 million, ($7.3 million) and ($9.9 million),
respectively, and as of March 31, 1998, the Company had an accumulated deficit
of $28.3 million. The Company has experienced substantial revenue growth since
1995 and has reported quarterly profits since the first quarter of 1997.
However, the Company may not be able to maintain revenue growth or
profitability. The Company's continued investment in new product and technology
development, obligations under existing and future research and development
alliances, and increased investment in marketing, sales and customer service
will require a continued increase in expenditures in 1998 and beyond. Synteni's
ability to contribute to the profitability of the Company will be dependent on
the ability of the Company and Synteni to obtain high volume customers for
Synteni's microarray services and the costs associated with increasing
microarray production capacity. To date Synteni's microarray service agreements
consist of small volume pilot or feasibility agreements. The Company's ability
to achieve and maintain significant revenues will be dependent upon its ability
to obtain additional database collaborators and retain existing collaborators.
The Company's ability to maintain profitability will be dependent upon its
ability to obtain such database collaborators, the level of expenditures
necessary for the Company to maintain and support its services to its
collaborators, and the extent to which it incurs research and development,
investment, acquisition-related or other expenses related to the development and
provision of its products and services to database collaborators. While, as of
April 1998, the Company had twenty-one database collaborations, the Company may
be unable to enter into any additional collaborations. Further, the Company's
database collaboration agreements typically have a term of three years. Some of
these agreements require the Company to meet certain performance obligations.
These agreements may not be renewed upon expiration, and a database
collaboration agreement may be terminated earlier by a collaborator if the
Company breaches the agreement and fails to cure such breach within a specified
period. The loss of revenues from any database collaborator could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Part of the Company's commercialization strategy is to license to
database collaborators the Company's patent rights to individual partial genes
or full-length cDNA sequences from the Company's proprietary sequence database,
for development as potential pharmaceutical, diagnostic or other products. Any
potential product that is the subject of such a license will require several
years of further development, clinical testing and regulatory approval prior to
commercialization. Accordingly, the Company does not expect to receive any
milestone or royalty payments from any such licenses for a substantial period of
time, if at all.
Fluctuations in Operating Results. The Company's operating results
may fluctuate significantly from quarter to quarter as a result of a variety of
factors, including; changes in the demand for the Company's products and
services; the pricing of database access to database collaborators; the nature,
pricing and timing of other products and services provided to the Company's
collaborators; changes in the research and development budgets of the Company's
collaborators and potential collaborators; capital expenditures; acquisition and
licensing costs and
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other costs related to the expansion of the Company's operations, including
operating losses of acquired businesses such as Synteni; the introduction of
competitive databases or services; and expenses related to, and results of,
litigation (including the lawsuit filed by Affymetrix described below under
"-Litigation") and other proceedings relating to intellectual property rights.
In particular, the Company has a limited ability to control the timing of
database installations, there is a lengthy sales cycle required for the
Company's database products, the Company's revenue levels are difficult to
forecast, the time required to complete custom orders can vary significantly and
the Company's increasing investments in external alliances could result in
significant quarterly fluctuations in expenses due to the payment of milestones,
license fees or research payments.
The Company's investments in joint ventures and businesses,
particularly diaDexus, a joint venture with SB, may require the Company to
record losses or expenses related to its proportionate ownership interest in
such entities, to record charges for the acquisition of in-process technologies,
or to record charges for recognition of the impairment in the value of the
securities underlying such investments. To date, exclusive of losses from joint
ventures, the Company has not incurred significant losses on its long-term
equity investments. One entity in which the Company has made an equity
investment, OncorMed, received a report from its independent auditors for the
year ended December 31, 1997 which expressed substantial doubt as to OncorMed's
ability to continue as a going concern. OncorMed is pursuing various financing
options and the Company will continue to evaluate its investment in OncorMed and
all of its long-term equity investments for impairment on a quarterly basis. In
an effort to broaden its business, the Company is investing in a number of new
areas, including microarray services, molecular diagnostics, pharmacogenomics
and proteomics. Given that many of these address new markets, or involve
untested technologies, it is not known if any of them will generate revenues or
if the revenues will be sufficient to provide an adequate return on the
investment. Depending on the investment required and the timing of such
investments, expenses or losses related to these investments could adversely
affect operating results.
The need for continued investment in development of the Company's
databases and related products and services and for extensive ongoing
collaborator support capabilities results in significant fixed expenses. If
revenue in a particular period does not meet expectations, the Company may not
be able to adjust significantly its level of expenditures in such period, which
would have an adverse effect on the Company's operating results. The Company may
also experience difficulty in forecasting levels of operating expenditures for,
and integration-related expenses with respect to, subsidiaries acquired through
acquisitions, at least until a substantial period of time has passed since the
acquisition date. This is particularly true when attempting to forecast
expenditure levels for acquired businesses that focus on technologies for which
there is not yet an established market. The Company believes that quarterly
comparisons of its financial results will not necessarily be meaningful and
should not be relied upon as an indication of future performance. Due to the
foregoing and other unforeseen factors, it is likely that in some future quarter
or quarters the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially and adversely affected.
Competition and Technological Changes. There are a finite number of
genes in the human genome, and competitors may seek to identify, sequence and
determine in the shortest time possible the biological function of a large
number of genes in order to obtain a proprietary position with respect to the
largest number of new genes discovered. There are a number of companies, other
institutions, and government-financed entities engaged in gene sequencing, gene
discovery, gene expression analysis, positional cloning and other genomic
service businesses. Many of these companies, institutions and entities have
greater financial and human resources than the Company.
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In addition, the Company is aware that other companies have developed genomic
databases and are marketing, or have announced their intention to market their
data to pharmaceutical companies. The Company expects that additional
competitors may attempt to establish gene sequence, gene expression or other
genomic databases in the future.
In addition, competitors may discover and establish patent positions
with respect to gene sequences in the Company's databases. Further, certain
entities engaged in gene sequencing, including Merck & Co., Inc. ("Merck") and
The Institute for Genomic Research ("TIGR"), have made the results of their
sequencing efforts publicly available. The Perkin-Elmer Corporation, Dr. J.
Craig Venter, and TIGR announced in May 1998 the signing of a letter of intent
to form a new company that has the goal of sequencing the entire human genome
within three years and to make the sequence information publicly available.
These patent positions or the public availability of gene sequences comprising
substantial portions of the human genome or on microbial or plant genes could
decrease the potential value of the Company's databases to the Company's
collaborators and adversely affect the Company's ability to realize royalties or
other revenue from commercialization of products based upon this genetic
information.
The gene sequencing machines that are utilized in the Company's
high-throughput computer-aided gene sequencing operations are commercially
available and are currently being utilized by several competitors. Some of the
Company's competitors or potential competitors are in the process of developing,
and may successfully develop, proprietary sequencing technologies that may be
more advanced than the technology used by the Company. In addition, the Company
is aware that there are a number of companies, in addition to Synteni, pursuing
alternative methods for generating gene expression information, including those
that have developed, and are developing, microarray technologies. At least one
other company currently offers microarray-based services that might be
competitive with those offered by Synteni. These advanced sequencing or gene
expression technologies, if developed, may not be commercially available for
purchase or license by the Company on reasonable terms, if at all.
A number of companies have announced their intent to develop and
market software to assist pharmaceutical companies and academic researchers in
the management and analysis of their own genomic data, as well as the analysis
of sequence data available in the public domain. Some of these entities have
access to significantly greater resources than the Company and these products
may achieve greater market acceptance than the Company's products.
The Company's databases also require extensive software support and
incorporate features determined by database collaborators' needs. If the Company
experiences delays or difficulties in implementing its database software or
collaborator-requested features, its ability to service its collaborators may be
adversely affected, which might have an adverse effect on the Company's business
and operating results.
The genomics industry is characterized by extensive research efforts
and rapid technological progress. To remain competitive, the Company will be
required to continue to expand its databases and to enhance the functionality of
its bioinformatics and database software. New developments are expected to
continue and discoveries by others may render the Company's services and
potential products noncompetitive.
New and Uncertain Business. The Company's genomic database business
and the use of its databases, software tools and related services to assist its
collaborators and potentially improve the efficiency of the traditional drug
discovery process represent a business for which there is no precedent. In
addition, Synteni's microarray services business represents a business for which
there
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is no precedent. The Company's database collaborators or potential
collaborators, or Synteni's current or potential customers, may determine that
the databases, software tools and microarray and related services provided by
the Company are not useful or cost-effective. The Company's strategy of using
high-throughput sequencing to identify genes rapidly and obtain proprietary
rights in as many genes as possible and Synteni's strategy of using microarrays
to identify differentially expressed genes is unproven. In addition, the Company
has limited experience in providing bioinformatics software and database
products and services. The Company's ability to sustain profitability depends on
attracting additional collaborators and retaining existing collaborators for its
database, sequencing and software products and services and microarray services.
The nature and price of these database, sequencing and software products and
services and microarray services are such that there is a limited number of
pharmaceutical and biotechnology companies that are potential collaborators for
such products and services. Additional factors that may affect demand for the
Company's products and services include the extent to which potential
collaborators choose to conduct in-house gene sequencing and bioinformatics
analysis, the emergence of competitors offering similar services at competitive
prices, the ability of the Company to service satisfactorily its existing
collaborators, the extent to which the gene and related information in the
Company's database is made public by, or is the subject of, patents issued to
others, the Company's ability to establish and enforce proprietary rights to its
products, and the emergence of technological innovations in gene sequencing,
gene expression profiling or bioinformatics and relational database software
that are more advanced than the technology used by and available to the Company.
The Company may be unable to attract additional collaborators on acceptable
terms for its products and services or develop a sustainable profitable
business.
Risks Associated with Strategic Investments. The Company has funded
and intends in the future to fund strategic equity investments in joint ventures
or businesses that complement the business of the Company. These investments,
such as the Company's investment in diaDexus, may require the Company to record
losses and expenses related to its proportionate ownership interest in such
entities, the acquisition of in-process technologies, or the impairment in the
value of the securities underlying such investments. These losses may exceed
amounts anticipated, which could result in the Company's operating results being
below the expectations of public market analysts and investors. These
investments may often be made in securities for which there is no public trading
market or in securities not registered under the Securities Act of 1933 and
therefore subject to trading restrictions, either of which increases the
Company's risk of investment and reduces the liquidity of the Company's
investment. In addition, the Company could be required to invest greater amounts
than initially anticipated or to devote substantial management time to the
management of research and development relationships and joint ventures. The
occurrence of any of the foregoing could result in a material adverse effect on
the Company's business, financial condition and results of operations.
Lengthy Sales Cycle. The ability of the Company to obtain new
collaborators for its databases, software tools and microarray and other
services depends in significant part upon prospective collaborators' perceptions
that the Company's databases, software tools, and services can help accelerate
drug discovery efforts. The sales cycle is typically lengthy due to the
education effort that is required, as well as the need to effectively sell the
benefits of the Company's databases, software tools, and services to a variety
of constituencies within potential collaborator companies. In addition, each
database collaboration and microarray services agreement involves the
negotiation of agreements containing terms that may be unique to each partner,
such as the scope of any licenses granted and whether satellite database
services or access to multiple database modules is desired. The Company may
expend substantial funds and management effort with no assurance that a database
collaboration will result.
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Uncertainty of Protection of Patents and Proprietary Rights. The
Company's database business and competitive position are dependent in part upon
its ability to protect its proprietary database information and software
technology. Despite the Company's efforts to protect its proprietary database
information and software technology, unauthorized parties may attempt to obtain
and use information that the Company regards as proprietary. Although the
Company's database collaboration agreements require its collaborators to provide
adequate security for, and to control access to the Company's databases,
policing unauthorized use of the Company's databases and software by the Company
or its collaborators is difficult. The Company relies on patent, trade secret,
and copyright law, and nondisclosure and other contractual arrangements to
protect its proprietary information.
To date, the Company has been issued a number of patents with respect
to the gene sequences in the Company's databases and has not been issued patents
or registered copyrights for its related software. Patents cannot prevent others
from developing, selling or licensing databases that include sequences which
might be covered by the Company's patents and copyrights. The Company cannot
prevent others from independently developing software that might be covered by
any copyrights issued to the Company and trade secret laws do not prevent
independent development. Thus, there can be no assurance that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's proprietary information,
that this information will not be disclosed or that the Company can effectively
protect its rights to unpatented trade secrets.
The Company pursues a policy of having its employees, consultants and
advisors execute proprietary information and invention agreements upon
commencement of employment or consulting relationships with the Company. These
agreements provide that all confidential information developed or made known to
the individual during the course of the relationship shall be kept confidential
except in specified circumstances. These agreements may not, however, provide
meaningful protection for the Company's trade secrets or other proprietary
information in the event of unauthorized use or disclosure of this information.
The Company's current policy is to file patent applications on what
it believes to be novel full-length cDNA sequences and partial sequences
obtained through the Company's high-throughput computer-aided gene sequencing
efforts. The Company has filed U.S. patent applications in which the Company has
claimed certain partial gene sequences and has filed patent applications in the
U.S. and applications under the Patent Cooperation Treaty ("PCT") designating
countries in Europe as well as Asia, Canada, Japan, Mexico and New Zealand
claiming full-length gene sequences associated with cells and tissues that are
the subject of the Company's high-throughput gene sequencing program. To date,
the Company holds a number of issued U.S. patents on full-length genes, but no
patent has issued from any of the Company's patent applications that claim
partial gene sequences. The Company is aware that Merck (in conjunction with
Washington University) and TIGR have made certain gene sequences publicly
available, which may adversely affect the ability of the Company and others to
obtain patents on such genes. The Company's ability to obtain patent protection
for certain sequences that have been made publicly available may be adversely
affected.
The Company believes that certain of its patent applications claim
genes which may also be claimed in patent applications filed by other parties.
In some or all of these applications, a determination of priority of
inventorship may need to be decided in an interference before the United States
Patent and Trademark Office ("USPTO"). Given the large number of applications
filed by the Company, a large number of interferences could be expensive and
time consuming. In addition, it is impossible to predict how many, if any, of
the interferences would be resolved in the
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Company's favor.
The patentability of partial gene sequences in general is uncertain,
involves complex legal and factual questions, and has recently been the subject
of much controversy. As a result, patent applications filed by the Company on
such partial gene sequences may not result in issued patents. Even if patents
are issued for partial gene sequences, there may be uncertainty as to the scope
of the coverage, enforceability or commercial protection provided by any such
patents. Certain court decisions suggest that disclosure of a partial sequence
may not be sufficient to support the patentability of a full-length sequence and
that patent claims to a partial sequence may not cover a full-length sequence
inclusive of that partial sequence.
The USPTO has had a substantial backlog of biotechnology patent
applications and, in particular, applications that claim gene sequences. In
1996, the USPTO issued guidelines limiting the number of gene sequences that can
be examined within a single patent application. Many of the Company's patent
applications containing multiple partial sequences contain more sequences than
the maximum number allowed under the new guidelines. The Company is reviewing
its options and, due to the resources needed to comply with the guidelines, may
decide to abandon patent applications for some of its partial gene sequences.
In view of the possible delay in obtaining allowance of some of the
Company's patent applications, and the secrecy of patent applications, the
Company does not know if other applications that would have priority over the
Company's applications have been filed. Furthermore, changes in U.S. patent laws
resulting from the General Agreement on Tariffs and Trade ("GATT") became
effective in June 1995. Most notably, GATT resulted in U.S. law being amended to
change the term of patent protection from seventeen years from patent issuance
to twenty years from the earliest effective filing date of the application.
Because the average time from filing to issuance of biotechnology applications
is at least one year and may be more than three years depending on the subject
matter, a twenty-year patent term from the date of filing may result in a
substantially shortened term of patent protection, which may adversely affect
the Company's period of exclusivity under any patents that may issue to the
Company. Pending applications claiming large numbers of gene sequences may, in
some situations, need to be refiled while claiming priority to the earliest
filing date and, in such situations, the patent term will be measured from the
date of the earliest priority application. This would reduce the patent term and
have a potentially adverse effect on the Company's period of exclusivity.
Biotechnology patent law outside the United States is even more
uncertain and is currently undergoing review and revision in many countries.
Further, the laws of certain foreign countries may not protect the Company's
intellectual property rights to the same extent as do the laws of the United
States. The Company may participate in opposition proceedings to determine the
validity of its or its competitors' non-U.S. patents, which could result in
substantial costs to and diversion of effort by the Company.
As the biotechnology industry expands, more patents are issued and
other companies engage in the business of discovering genes through the use of
high speed sequencers and in other genomic-related businesses, such as
microarray and gene expression profiling, the risk increases that the Company's
potential products or the processes used by the Company to develop these
products, may be subject to claims that they infringe the patents of others.
Certain of these patents are the subject of litigation. Therefore, the Company's
operations may require it to obtain licenses under any of these patents or
proprietary rights, and these licenses may not be made available on terms
acceptable to the Company. Litigation may be necessary to defend against or
assert claims of infringement, to enforce patents issued to the Company, to
protect trade secrets or know-how
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owned by the Company, or to determine the scope and validity of the proprietary
rights of others. Interference proceedings may be necessary to establish which
party was the first to invent or the first to obtain a particular gene sequence
for the purpose of patent protection. The Company is currently involved in
litigation and interference proceedings with respect to patents and intellectual
property rights. Litigation or interference proceedings, regardless of the
outcome, could result in substantial costs to, and diversion of effort by the
Company, and may have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, these efforts by the
Company may not be successful.
As is typical in the genomics and software industries, the Company
has from time to time received, and believes that it likely will receive in the
future, notices from third parties alleging infringement claims. The Company
believes that it is not infringing the patent rights of any such third party,
and in circumstances in which the Company has determined a response to an
alleged infringement claim to be appropriate, the Company has notified the
claimant to that effect. To date, except as set forth below under "-Litigation,"
no third party has taken any action with respect to an alleged claim against the
Company. There can be no assurance that action will not be taken against the
Company in the future, either with respect to previously asserted or new claims
or that if any action is taken, what the outcome of such action will be.
Litigation. On January 6, 1998, Affymetrix filed a lawsuit in the
United States District Court for the District of Delaware alleging infringement
of U.S. patent number 5,445,934 (the "'934 Patent") by both Synteni and Incyte.
The complaint alleges that the '934 Patent has been infringed by the making,
using, selling, importing, distributing or offering to sell in the U.S. high
density arrays by Synteni and Incyte and that such infringement was willful.
Affymetrix seeks a permanent injunction enjoining Synteni and Incyte from
further infringement of the '934 Patent and, in addition, seeks damages, costs
and attorney's fees and interest. Affymetrix further requests that any such
damages be trebled based on its allegation of willful infringement by Incyte and
Synteni. Incyte and Synteni believe they have meritorious defenses and intend to
defend the suit vigorously. However, there can be no assurance that Incyte and
Synteni will be successful in the defense of this suit, and litigation,
regardless of the outcome, could result in substantial expenses and diversion of
the efforts of management and technical personnel. Further, there can be no
assurance that any license that may be required as a result of this suit or the
outcome thereof would be made available on commercially acceptable terms, if at
all.
Future Capital Needs; Uncertainty of Additional Funding. The Company
believes that its existing cash, cash equivalents and marketable securities
should be adequate to satisfy the Company's projected working capital, capital
expenditure and other cash requirements at least through 1998. However, the
Company may be unable to obtain additional database collaborators or retain
existing collaborators for the Company's databases, and its database products
and services may not produce revenues, which together with the Company's cash,
cash equivalents, and marketable securities, will be adequate to fund the
Company's cash requirements. The Company's cash requirements depend on numerous
factors, including the ability of the Company to attract and retain
collaborators for its databases and genomic products and services; expenditures
in connection with alliances, license agreements and acquisitions of and
investments in complementary technologies and businesses; competing
technological and market developments; the cost of filing, prosecuting,
defending, and enforcing patent claims and other intellectual property rights;
the purchase of additional capital equipment or other capital expenditures,
including capital equipment necessary to ensure that the Company's sequencing
and microarray operations remain competitive; capital expenditures required to
expand the Company's and Synteni's facilities; and costs associated with the
integration of new operations assumed through mergers and acquisitions. In
particular, the Company expects its cash requirements to increase in 1998 as it
increases its investment in data
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processing-related computer hardware in order to support its existing and new
database products; continues to seek access to technologies through investments,
alliances, license agreements, and/or acquisitions; makes investments associated
with integration of acquired companies; and addresses its needs for larger
facilities and/or improvements in existing facilities. Changes in the Company's
research and development plans, or other changes affecting the Company's
operating expenses, may result in changes in the timing and amount of
expenditures of the Company's capital resources. If additional capital is raised
through the sale of equity or convertible debt securities, the issuance of these
securities could result in dilution to the Company's existing stockholders.
Additional funding, if necessary, may not be available on favorable terms, if at
all. If adequate funds are not available, the Company may be required to curtail
operations significantly or to obtain funds through entering into collaborative
arrangements that may require the Company to relinquish rights to certain of its
technologies, product candidates, products or potential markets.
Management of Growth. The Company has recently experienced, and
expects to continue to experience, significant growth in the number of its
employees and the scope of its operations. This growth has placed, and may
continue to place, a significant strain on the Company's management and
operations. The Company's ability to manage effectively this growth will depend
upon its ability to broaden its management team and its ability to attract, hire
and retain skilled employees. The Company's success will also depend on the
ability of its officers and key employees to continue to implement and improve
its operational, management information and financial control systems and to
expand, train and manage its employee base. In addition, the Company must
continue to take steps to provide customer support resources as the number of
overall database collaborators and the number of requests from collaborators
increases. Further, the Company's database collaborators typically have
worldwide operations and may require support at multiple U.S. and foreign sites.
Providing this support may require the Company to open offices in addition to
its Palo Alto, California headquarters and its office in the United Kingdom,
which could result in additional burdens on the Company's systems and resources.
The Company's inability to manage growth effectively, including its growth
through acquisitions, could have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Key Employees. The Company is highly dependent on the
principal members of its scientific and management staff, including Roy A.
Whitfield, its Chief Executive Officer, and Randal W. Scott, its President and
Chief Scientific Officer, the loss of whose services would have a material
adverse effect on the Company's business. The Company has not entered into any
employment agreements with any of these persons and does not maintain any key
person life insurance policy on the life of any employee. The Company's future
success also will depend in part on the continued service of its key scientific,
software, bioinformatics and management personnel and its ability to identify,
hire and retain additional personnel, including personnel in the customer
service, marketing and sales areas. The Company experiences intense competition
for qualified personnel in the areas of the Company's activities, especially
with respect to experienced bioinformatics and software personnel, and there can
be no assurance that the Company will be able to continue to attract and retain
personnel necessary for the development of the Company's business. Failure to
attract and retain key personnel could have a material adverse effect on the
Company's business, financial condition and results of operations.
Dependence on Others. The Company relies on a limited number of
suppliers of gene sequencing machines and certain reagents required in
connection with the gene sequencing process. While other gene sequencing
machines are available, the Company does not believe that they are as efficient
as the machines currently used by the Company. In addition, while the Company is
evaluating certain future generation gene sequencing machines, these future
generation sequencing machines may never become commercially available,
available at acceptable costs, or prove to be
Page 23 of 31
<PAGE> 24
more effective than current machines. Patent right issues concerning certain
current and future generation sequencing machines may also arise which could
prevent the Company from using them or make their use more expensive. If the
Company is unable to obtain additional machines or an adequate supply of
reagents or other materials at commercially reasonable rates, its ability to
continue to identify genes through gene sequencing would be adversely affected.
In addition, although the Company obtains, from a number of sources, tissue
samples from which mRNA may be isolated, the loss of access to some of these
sources, increased fees for access to these sources or increased restrictions on
use of the information generated could adversely affect the Company's business.
The Company's strategy for the development of its database and
sequencing business and the commercialization of its portfolio of partial and
full-length gene sequences may require the Company to enter into various
research and development relationships with corporate and academic collaborators
and others. The success of these relationships is dependent upon the performance
of outside parties of their responsibilities. The Company may not be able to
establish collaborative arrangements or license agreements that the Company
deems necessary or acceptable to develop its database and sequencing business
or, in the future, to commercialize its portfolio of partial and full-length
gene sequences. In addition, these collaborative arrangements or license
agreements may not be successful. The Company's collaborators may also be
pursuing alternative technologies or developing alternative products either on
their own or in collaboration with others, including the Company's competitors.
The Company has relied on scientific, technical, pathology,
commercial and other data supplied and disclosed by others, including its
academic collaborators and sources of tissue samples, and may rely on these data
in the construction of its database. There can be no assurance that these data
contains no errors or omissions, the knowledge of which would adversely change
the prospects for the Company's business.
Year 2000 Issue. As a result of computer programs being written using
two digits, rather than four, the performance of the Company's computer systems
and those of its suppliers and customers in the Year 2000 is uncertain. Any
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities. The Company plans to initiate a
Year 2000 project, using internal and external resources, to evaluate the impact
of the Year 2000 on its products and operating systems. This will include the
initiation of formal communications with its significant suppliers and customers
to determine the extent to which the Company's interface systems are vulnerable
to third party failures to remediate their own Year 2000 issues. There can be no
guarantee that the systems of other companies on which the Company's systems
rely will be timely converted and would not have an adverse effect on the
Company's systems. The Company will perform a comprehensive review of all
internally used financial and administrative systems as well as internally
developed products sold to customers. At this time, given that the Company's
internal financial and administrative systems have been installed within the
last few years, and all internally developed software-based products sold to
customers have been developed over the last few years, the Company does not
expect the cost of addressing the Year 2000 issue to have a material impact on
the Company's business, results of operations or financial condition. However,
there can be no guarantee that if modifications or replacement of portions of
the software are necessary, it will be completed in a timely manner.
Hazardous Materials; Environmental Matters. The Company's research
and development involves the controlled use of hazardous and radioactive
materials and biological waste. The
Page 24 of 31
<PAGE> 25
Company is subject to federal, state and local laws and regulations governing
the use, manufacture, storage, handling and disposal of these materials and
certain waste products. Although the Company believes that its safety procedures
for handling and disposing of these materials comply with the standards
prescribed by such laws and regulations, the risk of accidental contamination or
injury from these materials cannot be completely eliminated. In the event of
such an accident, the Company could be held liable for any damages that result
and any such liability could exceed the resources of the Company. Although the
Company believes that it is in compliance in all material respects with
applicable environmental laws and regulations and currently does not expect to
make material additional capital expenditures for environmental control
facilities in the near-term, the Company may in the future be required to incur
significant costs to comply with environmental laws and regulations, and there
can be no assurance that the operations, business or assets of the Company will
not be materially or adversely affected by current or future environmental laws
or regulations.
Reliance on Pharmaceutical Industry; Uncertainty of Health Care
Reform and Related Matters. The Company expects that all of its revenues in the
foreseeable future will be derived from products and services provided to the
pharmaceutical and biotechnology industries. Accordingly, the Company's success
in the foreseeable future is directly dependent upon the success of the
companies within those industries and their continued demand for the Company's
products and services. The Company's operations may in the future be subject to
substantial period-to-period fluctuations as a consequence of reductions and
delays in research and development expenditures by companies in these industries
resulting from factors such as changes in economic conditions, changes in the
regulatory environment affecting health care and health care providers, pricing
pressures, market-driven pressures on companies to consolidate and reduce costs,
and other factors affecting research and development spending. The occurrence of
any of the foregoing factors could have a material adverse effect on the
Company's business, financial condition and results of operations.
Risk of Business Interruption. The Company conducts all of its
sequencing and other activities at its facilities in Palo Alto, California, and
Synteni conducts all of its operations at its facilities in Fremont, California.
Both locations are in a seismically active area. Although the Company maintains
business interruption insurance, the Company does not currently have, nor does
it plan to obtain, earthquake insurance. A major catastrophe (such as an
earthquake or other natural disaster) could result in a prolonged interruption
of the Company's business.
Page 25 of 31
<PAGE> 26
PART II: OTHER INFORMATION
ITEM 1 Legal Proceedings
On January 6, 1998, Affymetrix, Inc. ("Affymetrix") filed a
lawsuit in the United States District Court for the District
of Delaware alleging infringement of U.S. patent number
5,445,934 (the "'934 Patent") by both Synteni and Incyte.
The complaint alleges that the '934 Patent has been
infringed by the making, using, selling, importing,
distributing or offering to sell in the U.S. high density
arrays by Synteni and Incyte and that such infringement was
willful. Affymetrix seeks a permanent injunction enjoining
Synteni and Incyte from further infringement of the '934
Patent and, in addition, seeks damages, costs and attorney's
fees and interest. Affymetrix further requests that any such
damages be trebled based on its allegation of willful
infringement by Incyte and Synteni. Incyte and Synteni
believe they have meritorious defenses and intend to defend
the suit vigorously. However, there can be no assurance that
Incyte and Synteni will be successful in the defense of this
suit, and litigation, regardless of the outcome, could
result in substantial expenses and diversion of the efforts
of management and technical personnel. Further, there can be
no assurance that any license that may be required as a
result of this suit or the outcome thereof would be made
available on commercially acceptable terms, if at all.
ITEM 2 Changes in Securities
(a) Not applicable
(b) Not applicable
(c) Pursuant to an Agreement and Plan of Merger dated December
23, 1997 among the Company, Bond Acquisition Corporation, a
Delaware corporation and a wholly owned subsidiary of the
Company, and Synteni, on January 22, 1998, all outstanding
shares of capital stock of Synteni were converted into an
aggregate of 2,340,237 shares of the Company's common
stock. The Company relied on the exemption from
registration provided by Section 4(2) of the Securities Act
of 1933.
(d) Not applicable
ITEM 3 Defaults upon Senior Securities
None
ITEM 4 Submission of Matters to a Vote of Security Holders
None
ITEM 5 Other Information
None
Page 26 of 31
<PAGE> 27
ITEM 6 Exhibits and Reports on Form 8-K.
a) Exhibits
See Exhibit Index on Page 18
b) Reports on Form 8-K
The Company filed one report on Form 8-K during the
fiscal quarter covered by this report, as follows:
(i) Current Report on Form 8-K, filed on February 6, 1998,
reporting under Item 2 the completion of the merger with
Synteni, Inc. effective January 22, 1998, as amended by
Form 8-K/A filed on April 1, 1998 to file under Item 7
of Form 8-K certain financial statements and information
required thereunder.
Page 27 of 31
<PAGE> 28
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INCYTE PHARMACEUTICALS, INC.
Date: May 12, 1998 By: /s/ ROY A. WHITFIELD
---------------------------------
Roy A. Whitfield
Chief Executive Officer
Date: May 12, 1998 By: /s/ DENISE M. GILBERT
---------------------------------
Denise M. Gilbert
Executive Vice President and
Chief Financial Officer
Page 28 of 31
<PAGE> 29
INCYTE PHARMACEUTICALS, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
NO. EXHIBIT PAGE
--- ------- ----
<S> <C>
27 Financial Data Schedule, March 31, 1998
27.1 Financial Data Schedule, March 31, 1997
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Item 1 of
Form 10-Q for the period ended March 31, 1998 and is qualified in its entirety
by reference to such 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 42,726
<SECURITIES> 89,713
<RECEIVABLES> 8,903
<ALLOWANCES> 277
<INVENTORY> 0
<CURRENT-ASSETS> 152,190
<PP&E> 66,774
<DEPRECIATION> 23,405
<TOTAL-ASSETS> 219,097
<CURRENT-LIABILITIES> 66,740
<BONDS> 0
0
0
<COMMON> 27
<OTHER-SE> 151,404
<TOTAL-LIABILITY-AND-EQUITY> 219,097
<SALES> 0
<TOTAL-REVENUES> 30,379
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 27,470
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,146
<INCOME-TAX> 580
<INCOME-CONTINUING> 3,566
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,566
<EPS-PRIMARY> 0.13
<EPS-DILUTED> 0.12
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Item 1 of
Form 10-Q for the period ended March 31, 1997 and is qualified in its entirety
by reference to such 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 10,252
<SECURITIES> 30,539
<RECEIVABLES> 8,678
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 52,266
<PP&E> 37,648
<DEPRECIATION> 11,939
<TOTAL-ASSETS> 82,449
<CURRENT-LIABILITIES> 36,649
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 45,320
<TOTAL-LIABILITY-AND-EQUITY> 82,449
<SALES> 0
<TOTAL-REVENUES> 17,998
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 17,986
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 509
<INCOME-TAX> 52
<INCOME-CONTINUING> 457
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 457
<EPS-PRIMARY> 0.02
<EPS-DILUTED> 0.02
</TABLE>
