UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 27,746,906 as of September 30, 1998.
<PAGE>
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INCYTE PHARMACEUTICALS, INC.
INDEX
PART I: FINANCIAL INFORMATION PAGE
- ----------------------------------------------------------------------------------- ----
<S> <C>
ITEM 1 Financial Statements - Unaudited
Condensed Consolidated Balance Sheets - September 30, 1998 and
December 31, 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Operations - three and nine month
periods ended September 30, 1998 and 1997. . . . . . . . . . . . . . . 4
Condensed Consolidated Statements of Cash Flows - nine month
periods ended September 30, 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. . . . . . . . . . . . . . . . . . . . . . . 14
PART II: OTHER INFORMATION
- -----------------------------------------------------------------------------------
ITEM 1 Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
ITEM 2 Changes in Securities.. . . . . . . . . . . . . . . . . . . . . . . . . . . 35
ITEM 3 Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . 36
ITEM 4 Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . 36
ITEM 5 Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
ITEM 6 Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . 37
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Exhibit Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
</TABLE>
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
<S> <C> <C>
SEPTEMBER 30, DECEMBER 31,
1998 1997*
--------------- --------------
ASSETS
Current assets:
Cash and cash equivalents. . . . . . . . . . . . $ 45,350 $ 55,598
Restricted cash. . . . . . . . . . . . . . . . . - 6,000
Marketable securities - available-for-sale . . . 80,861 57,497
Accounts receivable, net . . . . . . . . . . . . 4,079 19,983
Prepaid expenses and other current assets. . . . 7,263 3,836
--------------- --------------
Total current assets . . . . . . . . . . . 137,553 142,914
Property and equipment, net. . . . . . . . . . . . . . 50,326 38,070
Long-term investments. . . . . . . . . . . . . . . . . 21,305 14,800
Goodwill and other intangible assets . . . . . . . . . 17,553 -
Deposits and other assets. . . . . . . . . . . . . . . 6,222 3,305
--------------- --------------
Total assets . . . . . . . . . . . . . . . $ 232,959 $ 199,089
=============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . $ 5,650 $ 5,791
Accrued and other current liabilities. . . . . . 15,633 14,608
Deferred revenue . . . . . . . . . . . . . . . . 34,437 31,815
--------------- --------------
Total current liabilities. . . . . . . . . 55,720 52,214
Non-current portion of accrued rent and other
non-current liabilities. . . . . . . . . . . . . 1,510 1,173
--------------- --------------
Total liabilities. . . . . . . . . . . . . 57,230 53,387
--------------- --------------
Stockholders' equity:
Capital stock. . . . . . . . . . . . . . . . . . 28 26
Additional paid-in capital . . . . . . . . . . . 206,196 175,749
Deferred compensation. . . . . . . . . . . . . . (1,310) -
Receivable from stockholders . . . . . . . . . . (49) -
Accumulated other comprehensive income . . . . . 750 56
Accumulated deficit. . . . . . . . . . . . . . . (29,886) (30,129)
Total stockholders' equity . . . . . . . . 175,729 145,702
--------------- --------------
Total liabilities and stockholders' equity $ 232,959 $ 199,089
=============== ==============
<FN>
See accompanying notes
</TABLE>
<PAGE>
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
THREE MONTHS ENDED NINE MONTHS ENDED
September 30, September 30,
1998 1997 1998 1997
-------- ------- -------- -------
Revenues. . . . . . . . . . . . . . . . . $34,692 $23,226 $98,164 $62,649
Costs and expenses:
Research and development . . . . . . 24,762 18,524 69,581 51,027
Selling, general and administrative. 6,874 3,779 17,196 9,882
Charge for purchase of in-process. . 10,978 - 10,978 -
research and development
Acquisition-related charges. . . . . - - 1,171 -
-------- ------- -------- -------
Total costs and expenses. . . . . . . . . 42,614 22,303 98,926 60,909
Income (loss) from operations . . . . . . (7,922) 923 (762) 1,740
Interest and other income, net. . . . . . 1,819 1,336 5,500 2,405
Losses from joint venture . . . . . . . . - - (640) -
-------- ------- -------- -------
Income (loss) before income taxes . . . . (6,103) 2,259 4,098 4,145
Provision for income taxes. . . . . . . . 683 155 2,111 313
-------- ------- -------- -------
Net income (loss) . . . . . . . . . . . . $(6,786) $ 2,104 $ 1,987 $ 3,832
======== ======= ======== =======
Basic net income (loss) per share . . . . $ (0.25) $ 0.08 $ 0.07 $ 0.16
======== ======= ======== =======
Shares used in computing
basic net income (loss) per share. . . 26,821 24,966 26,634 23,694
======== ======= ======== =======
Diluted net income (loss) per share . . . $ (0.25) $ 0.08 $ 0.07 $ 0.15
======== ======= ======== =======
Shares used in computing
diluted net income (loss) per share. . 26,821 27,137 28,753 25,864
======== ======= ======== =======
<FN>
See accompanying notes
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
INCYTE PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------
<S> <C> <C>
1998 1997
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,987 $3,832
Adjustments to reconcile net income to net cash provided by
Operating activities:
Depreciation and amortization. . . . . . . . . . . . . . . . 11,666 7,128
Charge for purchase of in-process research and development . 10,978 -
Losses from joint venture. . . . . . . . . . . . . . . . . . 640 -
Amortization of deferred compensation. . . . . . . . . . . . 348 -
Adjustment to conform pooled entity. . . . . . . . . . . . . 278 -
Changes in certain assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . 16,124 (6,787)
Prepaid expenses, deposits and other assets . . . . . . (6,063) (1,916)
Accounts payable. . . . . . . . . . . . . . . . . . . . (821) (202)
Accrued and other liabilities . . . . . . . . . . . . . 3,458 4,975
Deferred revenue. . . . . . . . . . . . . . . . . . . . 3,383 9,825
------- -------
Net cash provided by operating activities . . . . . . . . . . . . . . 41,978 16,855
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . (21,493) (16,864)
Long-term investments. . . . . . . . . . . . . . . . . . . . . . (7,145) (8,537)
Purchase of Hexagen Limited. . . . . . . . . . . . . . . . . . . (3,977) -
Transfer to restricted cash. . . . . . . . . . . . . . . . . . . - (6,000)
Proceeds from sale of assets leased back under
operating leases . . . . . . . . . . . . . . . . . . . . . . - 1,694
Purchases of marketable securities . . . . . . . . . . . . . . . (71,566) (49,489)
Sales and maturities of marketable securities. . . . . . . . . . 48,897 15,240
Net cash used in investing activities . . . . . . . . . . . . . . . . (55,284) (63,956)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock . . . . . . . . . . . . . 3,278 93,405
Principal payments on capital lease obligations and notes payable (220) (43)
--------- --------
Net cash provided by financing activities . . . . . . . . . . . . . . 3,058 93,362
--------- --------
Net increase (decrease) in cash and cash equivalents. . . . . . . . . (10,248) 46,261
Cash and cash equivalents at beginning of period. . . . . . . . . . . 55,598 9,616
--------- --------
Cash and cash equivalents at end of period. . . . . . . . . . . . . . $ 45,350 $55,877
========= ========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Interest paid. . . . . . . . . . . . . . . . . . . . . . . . . . $ 61 $ 14
========= ========
Income taxes paid. . . . . . . . . . . . . . . . . . . . . . . . $ 725 $ 125
========= ========
CASH FLOW FOR ACQUISITION
Tangible assets acquired (excluding $1,023 cash received). . . . $ 3,025 -
Intangible assets acquired . . . . . . . . . . . . . . . . . . . 28,531 -
Liabilities assumed. . . . . . . . . . . . . . . . . . . . . . . (4,141) -
Common stock issued. . . . . . . . . . . . . . . . . . . . . . . (23,438) -
--------- -------
Cash paid for acquisition (net of $1,023 cash received). . . . . $ 3,977 -
========= =======
See accompanying notes
</TABLE>
<PAGE>
INCYTE PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 sheets as of
September 30, 1998 and December 31, 1997, statements of operations for the
three and nine month periods ended September 30, 1998 and 1997 and the
statements of cash flows for the nine month periods ended September 30, 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 for the year ended December 31, 1997
included in the Company's Current Report on Form 8-K, dated June 12, 1998.
2. PROPERTY AND EQUIPMENT
Property and equipment consisted of:
<TABLE>
<CAPTION>
<S> <C> <C>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- ----------
Office equipment . . . . . . . . . . . . . . . $ 3,362 $ 2,588
Laboratory equipment . . . . . . . . . . . . . 22,986 18,939
Computer equipment . . . . . . . . . . . . . . 34,146 22,168
Leasehold improvements . . . . . . . . . . . . 21,085 14,495
-------------- ---------
81,579 58,190
Less accumulated depreciation and amortization 31,253 20,120
-------------- ----------
$ 50,326 $38,070
============== ==========
</TABLE>
<PAGE>
3. 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.
4. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net (loss) 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 net income (loss) per share gives
effect to all dilutive potential common shares outstanding during a period. In
computing diluted net income (loss) per share, the average stock price for the
period is used in determining the number of shares assumed to be purchased
from exercise of stock options.
Following is a reconciliation of the numerators and denominators of the basic
and diluted net income (loss) per share computations for the periods presented
below.
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<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- --------------
<S> <C> <C> <C> <C>
1998 1997 1998 1997
-------- ------- ------- -------
Numerator:
Net income (loss) . . . . . . . . . . . . . . . $(6,786) $ 2,104 $ 1,987 $ 3,832
======== ======= ======= =======
Denominator:
Denominator for basic net income (loss)
per share - weighted-average shares. . . . . 26,821 24,966 26,634 23,694
Dilutive potential common shares-
stock options. . . . . . . . . . . . . . . . - 2,171 2,119 2,170
-------- ------- ------- -------
Denominator for diluted net income (loss)
per share . . . . . . . . . . . . . . 26,821 27,137 28,753 25,864
======== ======= ======= =======
Basic net income (loss) per share. . . . . . . . $ (0.25) $ 0.08 $ 0.07 $ 0.16
======== ======= ======= =======
Diluted net income (loss) per share. . . . . . . $ (0.25) $ 0.08 $ 0.07 $ 0.15
======== ======= ======= =======
</TABLE>
Options to purchase 3,885,987 shares of common stock were outstanding at
September 30, 1998, but were not included in the computation of diluted loss
per share for the three month period ended September 30, 1998, as their effect
was antidilutive. Options to purchase 994,128 shares of common stock were
outstanding at September 30, 1998, but were not included in the computation of
diluted loss per share for the nine month period ended September 30, 1998, as
their effect was antidilutive
<PAGE>
5. BUSINESS COMBINATIONS
In September 1998, the Company completed the acquisition of Hexagen Limited
("Hexagen"), a privately held genomics company based in Cambridge, England.
The Company issued 976,130 shares of its common stock and $5.0 million in cash
in exchange for all of Hexagen's outstanding capital stock. In addition, the
Company assumed Hexagen's stock options, which if fully vested and exercised,
would amount to 125,909 shares of the Company's common stock. The transaction
was accounted for as a purchase, with a purchase price of approximately $29.9
million, including transaction fees, and approximately $11.0 million was
expensed as a charge for the purchase of in-process research and development.
The Company allocated the purchase price based on the relative fair value of
the net tangible and intangible assets acquired, based on an independent
appraisal. In performing this allocation, the Company considered, among other
factors, the technology research and development projects in-process at the
date of acquisition. With regard to the in-process research and development
projects, the Company considered factors such as the stage of development of
the technology at the time of acquisition, the importance of each project to
the overall development plan, alternative future use of the technology and the
projected incremental cash flows from the projects when completed and any
associated risks. Associated risks include the inherent difficulties and
uncertainties in completing each project and thereby achieving technological
feasibility and risks related to the impact of potential changes in future
target markets. The Securities and Exchange Commission's (SEC) staff has
recently been reviewing accounting related to charges for the purchase of
in-process research and development. If the staff chooses to review the
Company's calculation of its charge for the purchase of in-process research
and development and the staff disagrees with the methodologies and/or
assumptions used in the computation of such amounts, the Company may be
required to adjust the portion of the purchase price allocated to in-
process research and development. The results of operations of Hexagen will
be included in the consolidated results of the Company from the date of
acquisition in September 1998.
The table below presents the proforma results of operations and earning per
shares for Hexagen and the Company. The transaction is assumed to be
completed on January 1, 1998 for the periods ended September 30, 1998 and
January 1, 1997 for the periods ended September 30, 1997.
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
------- ------- -------- -------
<S> <C> <C> <C> <C>
Revenues. . . . . . . . . . . . . . . . . . $ 34,692 $23,226 $98,164 $62,649
========= ======= ======= ========
Net income (loss) . . . . . . . . . . . . . $ 1,590 $ 322 $ 6,437 $ 1,053
Proforma basic net income (loss) per share. $ 0.06 $ 0.01 $ 0.23 $ (0.04)
========= ======= ======= ========
Proforma diluted net income (loss) per share $ 0.05 $ 0.01 $ 0.22 $ (0.04)
========= ======= ======= ========
Proforma shares for basic net income (loss) 27,710 25,942 27,523 24,670
per share
Proforma shares for basic net income (loss) 29,564 28,113 29,642 24,670
per share
</TABLE>
In January 1998, the Company issued 2,340,237 shares of common stock in
exchange for all of the capital stock of Synteni, a privately held
microarray-based gene expression 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.
The table below presents the separate results of operations for Synteni and
the Company for the periods prior to the merger with Synteni. The Company's
results of operations include Synteni since the transactions (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Merger
Related
Incyte Synteni Expenses Total
-------- --------- ---------- --------
Three months ended September 30, 1998
Revenue . . . . . . . . . . . . . $34,692 $ - $ - $34,692
Net income (loss) . . . . . . . . (6,786) - - (6,786)
Three months ended September 30, 1997
Revenue. . . . . . . . . . . . . . $22,662 $ 564 $ - $23,226
Net income (loss). . . . . . . . . 3,044 (940) - 2,104
Nine months ended September 30, 1998
Revenue. . . . . . . . . . . . . . $98,164 $ - $ - $98,164
Net income (loss). . . . . . . . . 3,047 - (1,060) 1,987
Nine months ended September 30, 1997
Revenue. . . . . . . . . . . . . . $61,714 $ 935 $ - $62,649
Net income (loss). . . . . . . . . 5,967 (2,135) - 3,832
</TABLE>
6. 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.
7. STOCKHOLDERS' EQUITY
In September 1998, the Board of Directors of the Company recommended
stockholder approval of a proposal (the "Incyte Genetics Stock Proposal") that
would create two series of common stock which are intended to reflect
separately the performance of the Company's Incyte General and Incyte Genetics
divisions. Under the Incyte Genetics Stock Proposal, the Company's Certificate
of Incorporation would be amended to designate a new series of common stock
entitled Incyte Genetics Stock and to redesignate each share of the Company's
existing common stock as one share of a new series of common stock entitled
Incyte General Stock. In addition, in conjunction with the Incyte Genetics
Stock Proposal, the Board has recommended for stockholder approval, amendments
to the Company's 1991 Stock Plan ("Stock Plan"), 1993 Directors' Stock Option
Plan ("Directors' Plan"), and 1997 Employee Stock Purchase Plan ("ESPP"),
which would allow for the issuance of both Incyte Genetics and Incyte General
Stock through these plans.
If the Incyte Genetics Stock Proposal and the related proposal to amend the
Stock Plan are approved by the Company's stockholders and implemented by the
Board of Directors, the Stock Plan will be amended to provide that up to
6,300,000 shares of Incyte General Stock and 2,400,000 shares of Incyte
Genetics Stock will be reserved for issuance under the plan, and each
outstanding option under the Stock Plan will be converted into an option to
purchase shares of Incyte General Stock. Upon any distribution of shares of
Incyte Genetics Stock to the holders of outstanding Incyte General Stock,
outstanding options under the Stock Plan will be adjusted so that a holder of
an outstanding option to purchase one share of Incyte General Stock under the
Stock Plan will be entitled to acquire one share of Incyte General Stock and
such number or fraction of shares of Incyte Genetics Stock as were distributed
with respect to each share of Incyte General Stock, for an aggregate exercise
price equal to the original exercise price of the outstanding option.
If the Incyte Genetics Stock Proposal and the related proposal to amend the
Directors' Plan are approved by the Company's stockholders and implemented by
the Board of Directors, the Directors' Plan will be amended to provide that up
to 400,000 shares of Incyte General Stock and 200,000 shares of Incyte
Genetics Stock will be reserved for issuance under the plan. Each annual
option grant will be amended to provide for the issuance of options to
purchase shares of Incyte General Stock and Incyte Genetics Stock in
proportion to the relative market capitalizations of the Incyte General and
Incyte Genetics Stock.
If the Incyte Genetics Stock Proposal and the related proposal to amend the
ESPP are approved by the Company's stockholders and implemented by the Board
of Directors, the ESPP will be amended to provide that up to 400,000 shares of
Incyte General Stock and 400,000 shares of Incyte Genetics Stock will be
reserved for issuance under the ESPP and that participants may purchase either
Incyte General Stock or Incyte Genetics Stock or both, in such proportions as
the participants may determine.
On September 25, 1998, the Board of Directors adopted a Stockholder Rights
Plan (the "Original Rights Plan"), pursuant to which one preferred stock
purchase right (an "Original Right") will be distributed for each outstanding
share of Common Stock held of record on October 13, 1998. One Original Right
will also attach to each share of Common Stock issued by the Company
subsequent to such date and prior to the distribution date defined below. Each
Original Right represents a right to purchase, under certain circumstances, a
fractional share of a newly created series of the Company's preferred stock at
an exercise price of $200.00, subject to adjustment. In general, the Original
Rights will become exercisable and trade independently from the Common Stock
on a distribution date that will occur on the earlier of (i) the public
announcement of the acquisition by a person or group of 15% or more of the
Common Stock or (ii) ten days after commencement of a tender or exchange offer
for the Common Stock that would result in the acquisition of 15% or more of
the Common Stock. Upon the occurrence of certain other events related to
changes in ownership of the Common Stock, each holder of an Original Right
would be entitled to purchase shares of Common Stock, or an acquiring
corporation's common stock, having a market value of twice the exercise price.
Under certain conditions, the Original Rights may be redeemed at $0.01 per
Original Right by the Board of Directors. The Original Rights expire on
September 25, 2008. If the Incyte Genetics Stock Proposal is approved by the
Company's stockholders and implemented by the Board of Directors, the Original
Rights Plan will be amended and restated to, among other things, (i) reflect
the new equity structure of the Company, (ii) redesignate each Original Right
as an Incyte General Stock Right, (iii) issue an Incyte Genetics Stock Right
with respect to each share of Incyte Genetics Stock, which will entitle the
holders thereof to purchase shares of a newly designated series of preferred
stock under the conditions similar to those specified for the Incyte General
Stock Rights and the Original Rights (the Incyte General Stock Rights and
Incyte Genetics Stock Rights being collectively referred to as the "Rights"),
and (iv) change the triggers for exercisability of the Rights to 15% of the
voting power of all outstanding voting securities of the Company from 15% of
the outstanding Common Stock. The Rights will otherwise have attributes
similar to those of the Original Rights.
<PAGE>
8. DIVISIONAL RESULTS OF OPERATIONS
The results of operations of Incyte General, Incyte Genetics and Incyte
Consolidated for the three and nine months ended September 30 are as follows
(in thousands):
<TABLE>
<CAPTION>
Three Months Ended September 30, 1998
<S> <C> <C> <C>
Incyte Incyte Incyte
General Genetics Consolidated
--------- ---------- --------------
Revenues $ 33,925 $ 767 $ 34,692
Research and development 23,078 1,684 24,762
Selling, general and administrative 5,761 1,113 6,874
Charge for in-process R&D - 10,978 10,978
--------- ---------- --------------
Total operating expenses 28,839 13,775 42,614
Income (loss) from operations 5,086 (13,008) (7,922)
Interest and other income, net 1,819 - 1,819
Benefit (provision) for income taxes (1,154) 471 (683)
--------- ---------- --------------
Net income (loss) $ 5,751 $ (12,537) $ (6,786)
========= ========== ==============
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended September 30, 1997
<S> <C> <C> <C>
Incyte Incyte Incyte
General Genetics Consolidated
--------- ---------- --------------
Revenues $ 22,902 $ 324 $ 23,226
Research and development 17,920 604 18,524
Selling, general and administrative 3,706 73 3,779
--------- ---------- --------------
Total operating expenses 21,626 677 22,303
Income (loss) from operations 1,276 (353) 923
Interest and other income, net 1,336 - 1,336
Benefit (provision) for income taxes (162) 7 (155)
Net income (loss) $ 2,450 $ (346) $ 2,104
========= ========== ==============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1998
<S> <C> <C> <C>
Incyte Incyte Incyte
General Genetics Consolidated
--------- ---------- --------------
Revenues $ 96,262 $ 1,902 $ 98,164
Research and development 66,299 3,282 69,581
Selling, general and administrative 15,894 1,302 17,196
Charge for in-process R&D - 10,978 10,978
Acquisition-related charges 1,171 - 1,171
--------- ---------- --------------
Total operating expenses 83,364 15,562 98,926
Income (loss) from operations 12,898 (13,660) (762)
Interest and other income, net 5,500 - 5,500
Losses from joint venture - (640) (640)
Benefit (provision) for income taxes (3,074) 963 (2,111)
--------- ---------- --------------
Net income (loss) $ 15,324 $ (13,337) $ 1,987
========= ========== ==============
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1997
<S> <C> <C> <C>
Incyte Incyte Incyte
General Genetics Consolidated
--------- ---------- --------------
Revenues $ 61,941 $ 708 $ 62,649
Research and development 49,473 1,554 51,027
Selling, general and administrative 9,750 132 9,882
--------- ---------- --------------
Total operating expenses 59,223 1,686 60,909
Income (loss) from operations 2,718 (978) 1,740
Interest and other income, net 2,405 - 2,405
Benefit (provision) for income taxes (334) 21 (313)
--------- ---------- --------------
Net income (loss) $ 4,789 $ (957) $ 3,832
========= ========== ==============
</TABLE>
9. 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 (loss) was $(6,249,000)
million and $2,476,000 for the three and nine months ended September 30, 1998,
respectively, and $2,162,000 and $3,933,000 for the respective periods in
1997.
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.
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. ("SFAS 133"). This statement is effective
for fiscal years beginning after June 15, 1999. SFAS 133 established standards
for reporting derivative instruments and hedging activities. Application of
SFAS 133 will have no impact on the consolidated financial position or results
of operations as currently reported.
10. LITIGATION
In January 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 United
States high density arrays by Synteni and Incyte and that such infringement
was willful. Affymetrix seeks a permanent injunction enjoining Synteni and
Incyte from further infringement of the '934 Patent and, in addition, seeks
damages, costs and attorney's fees and interest. Affymetrix further requests
that any such damages be trebled based on its allegation of willful
infringement by Incyte and Synteni.
In September 1998, Affymetrix filed an additional lawsuit in the United States
District Court for the District of Delaware alleging infringement of the U.S.
patent number 5,800,992 (the "'992 Patent") and U.S. patent number 5,744,305
(the "'305 Patent") by both Synteni and Incyte. The complaint alleges that the
'305 Patent has been infringed by the making, using, selling, importing,
distributing or offering to sell in the United States high density arrays by
Synteni and Incyte, that the '992 Patent has been infringed by the use of
Synteni's and Incyte's GEMTM microarray technology to conduct gene expression
monitoring using two-color labeling, and that such infringement was willful.
Affymetrix seeks a preliminary injunction enjoining Incyte and Synteni from
using Synteni's and Incyte's GEM microarray technology to conduct gene
expression monitoring using two-color labeling as described in the '992 patent
and a permanent injunction enjoining Synteni and Incyte from further
infringement of the '305 and '992 Patents.
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 these suits. Regardless of the
outcome, this litigation has resulted and is expected to continue to result in
substantial expenses and diversion of the efforts of management and technical
personnel. Further, there can be no assurance that any license that may be
required as a result of these suits or the outcome thereof would be made
available on commercially acceptable terms, if at all.
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations as of September 30, 1998 and for the three and nine
month periods ended September 30, 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 Current Report on Form 8-K, dated June 12, 1998.
When used in this discussion, the words "expects," "anticipates,"
"estimates," and similar expressions are intended to identify forward-looking
statements. Such statements, which include statements as to expected net
losses or profitability, expected expenditure levels, expected cash flows, the
adequacy of capital resources, growth in operations, and Year 2000 related
actions, are subject to risks and uncertainties that could cause actual
results to differ materially from those projected. These risks and
uncertainties include, but are not limited to, those risks discussed below, as
well as the extent of utilization of genomic information by the biotechnology,
pharmaceutical, and agricultural industries; risks relating to the development
of new 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; developments in and expenses relating
to litigation; the results and viability of joint ventures and businesses in
which the Company has purchased equity; uncertainties associated with the
Company's ability to raise capital through the sale of private or public
equity; the ability of the Company to implement in a timely manner the
programs and actions related to the Year 2000 issue; and the matters discussed
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. ("Incyte" and, together with its wholly
owned subsidiaries, the "Company") designs, develops and markets genomic
information-based tools including database products, genomic data management
software tools, genomic reagents and related services. The Company consists of
two divisions, the Incyte General division ("Incyte General") and the Incyte
Genetics division ("Incyte Genetics"). Incyte General focuses on information
that can assist pharmaceutical and biotechnology companies in the discovery
and development of new drugs including the identification of new disease
targets and novel disease pathways, and the evaluation of the safety and
efficacy of new drugs. Incyte Genetics focuses on products and services that
can assist pharmaceutical companies in the identification and analysis of a
type of genetic variation, called single nucleotide polymorphisms ("SNPs"),
believed to correlate to a patients' disease prognosis and drug response.
In September 1998, the Board of Directors of the Company recommended
stockholder approval of a proposal (the "Incyte Genetics Stock Proposal") that
would create two series of common stock which are intended to reflect
separately the performance of the Company's Incyte General and Incyte Genetics
divisions. Under the Incyte Genetics Stock Proposal, the Company's Certificate
of Incorporation would be amended to designate a new series of common stock to
track the performance of Incyte Genetics and to redesignate each share of the
Company's existing common stock to track the performance of Incyte General.
Incyte General's business is established, generating significant
revenues with profits reported since the first quarter of 1997. Incyte
Genetics' business is in an early stage and will require a substantial
investment over the next few years, estimated to be between $100 million to
$150 million. Incyte Genetics currently generates minimal revenues and is
expected to operate at a significant loss for the next few years. Due to
the investment required for Incyte Genetics and the resulting net loss
attributable to Incyte Genetics, on a consolidated basis the Company expects
to report a net loss for at least 1999 and possibly 2000.
Revenues recognized by the Company consist primarily of non-exclusive
Database access fees related to database agreements. Revenues also include the
sales of genomic screening products and services, gene expression microarray
services, fees for custom or "satellite" database services, and genomic data
management software tools and maintenance. The Company's database agreements
provide for future milestone payments and royalties from the sale of products
derived from proprietary information obtained through the databases. There
can be no assurance that any database collaborators will ever generate
products from information contained within the databases and thus that the
Company will ever receive milestone payments or royalties.
In September 1998, the Company completed the acquisition of Hexagen
Limited ("Hexagen"), a privately held SNP discovery company based in
Cambridge, England. The Company issued 976,130 shares of its common stock and
$5.0 million in cash in exchange for all of Hexagen's outstanding capital
stock. In addition, the Company assumed Hexagen's stock options, which if
fully vested and exercised, would amount to 125,909 shares of the Company's
common stock. The transaction was accounted for as a purchase, with a purchase
price of approximately $29.9 million, including transaction fees, with
approximately $11.0 million expensed as a charge for the purchase of
in-process research and development. The Company allocated the purchase price
based on the relative fair value of the net tangible and intangible assets
acquired, based on an independent appraisal. In performing this allocation,
the Company considered, among other factors, the technology research and
development projects in-process at the date of acquisition. With regard to the
in-process research and development projects, the Company considered factors
such as the stage of development of the technology at the time of acquisition,
the importance of each project to the overall development plan, alternative
future uses of the technology and the projected incremental cash flows from
the projects when completed and any associated risks. Associated risks include
the inherent difficulties and uncertainties in completing each project and
thereby achieving technological feasibility and risks related to the impact of
potential changes in future target markets. If the projects associated with
the development of in-process technology are not successfully completed the
Company may not realize the value assigned to the in-process research and
development projects. In addition, the value of the other acquired intangible
assets may also become impaired.
In January 1998, the Company completed the acquisition of Synteni, Inc.
("Synteni"), a privately-held microarray-based gene expression company. The
transaction has been accounted for as a pooling-of-interests, and the
consolidated financial statements discussed herein and all historical
financial information have been restated to reflect the combined operations of
both companies. The Company's ability to generate revenues and operating
profits from microarray-based gene expression services will be dependent on
the ability of the Company to obtain high volume customers for 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 records its share of diaDexus' earnings and losses on its
statement of operations.
The Company has made and intends to continue to make strategic equity
investments in, and strategic acquisitions of, technologies and businesses
that are complementary to the businesses of the Company. As a result, the
Company may record losses or expenses related to the Company's proportionate
ownership interest in such long-term equity investments, record charges for
the acquisition of in-process technologies, or record charges for the
recognition of the impairment in the value of the securities underlying such
investments.
On September 28, 1998, one company in which the Company holds an
equity investment, OncorMed, Inc. ("OncorMed"), was acquired in a stock
- -for-stock merger by Gene Logic, Inc. ("Gene Logic"). The investment in Gene
Logic is accounted for under the cost method of accounting. In January 1998,
the Company announced a relationship relating to the joint development of a
proteomics database with Oxford GlycoSciences plc ("OGS"). As part of this
relationship, the Company made a $5.0 million equity investment in OGS. In
April 1998, the Company made a follow-on investment in April 1998 of
approximately $0.8 million as part of the OGS initial public offering of its
ordinary shares. As part of the collaborative agreement, the Company has
agreed to reimburse OGS for up to $5.0 million in 1999 if revenues are not
sufficient to offset OGS' expenses for services rendered.
Due to the recent stock market volatility, the market value of certain
investments held by the Company are below their book value. The decrease in
the market price of these investments is considered temporary and therefore no
change in the carrying value of the investments is currently considered
necessary. The Company will continue to evaluate 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, pharmacogenetics and proteomics. Given that many of these
address new markets, or involve untested technologies, it is not known if any
of them will generate revenues or if the revenues will be sufficient to
provide an adequate return on the investment. Depending on the investment
required and the timing of such investments, expenses or losses related to
these investments could adversely affect operating results.
The Company has incurred and is likely to continue to incur substantial
expenses in its defense of the lawsuits filed in January and September 1998 by
Affymetrix, Inc. ("Affymetrix") alleging patent infringement by Synteni and
Incyte. Affymetrix seeks a preliminary injunction enjoining Incyte and Synteni
from using certain microarray technology in a manner alleged to infringe an
Affymetrix patent and a permanent injunction enjoining Incyte and Synteni from
further infringement of certain Affymetrix patents. In addition, Affymetrix
seeks damages, costs, attorneys' fees and interest. Affymetrix further
requests that any such damages be trebled on its allegation of willful
infringement by Incyte and Synteni. Incyte and Synteni believe they have
meritorious defenses and intend to defend these suits vigorously. However,
there can be no assurance that Incyte and Synteni will be successful in the
defense of these suits. Regardless of the outcome, this litigation has
resulted and is expected to continue to result in substantial expenses and
diversion of the efforts of management and technical personnel. Further, there
can be no assurance that any license that may be required as a result of these
suits or the outcome thereof would be made available on commercially
acceptable terms, if at all.
RESULTS OF OPERATIONS
Net income and diluted net income per share, excluding the charge for the
purchase of in-process research and development and acquisition-related
charges, were $4.2 million and $14.0 million and $0.15 and $0.49 per share for
the three and nine months ended September 30, 1998, respectively. Including
such charges, net income (loss) and diluted net income (loss) per share were
$(6.8) million and $2.0 million and $(0.25) and $0.07 per share for the three
and nine months ended September 30, 1998, respectively, as compared to $2.1
million and $3.8 million and $0.08 and $0.15 in the same periods a year ago,
respectively. Net income (loss) per share was affected by a follow-on public
stock offering in August 1997 that resulted in an increase in the number of
shares outstanding of 2.7 million shares. The Company's results of operations
and earning per share for the three and nine months ended September 30, 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 and nine months ended September 30,
1997 were $3.0 million and $6.0 million, and $0.12 and $0.25, respectively.
Due to the expected expenditures of the Company's new Incyte Genetics
division, the Company expects to record net losses in fiscal 1999 and possibly
in fiscal 2000. See "Factors that May Affect Results - Factors Relating to
Both Incyte General and Incyte Genetics-History of Operating Losses;
Uncertainty of Continued Profitability or Revenues."
Revenues for the three and nine months ended September 30, 1998 increased
to $34.7 million and $98.2 million, respectively, compared to $23.2 million
and $62.6 million for the corresponding periods 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,
microarray-based gene expression services, and genomic data management
software tools. The increase in revenues was primarily due to new database
agreements, as well as expanded agreements with existing subscribers.
Total costs and expenses for the three and nine months ended September
30, 1998 increased to $42.6 million and $98.9 million, respectively, compared
to $22.3 million and $60.9 million for the corresponding periods in 1997.
Total costs and expenses for the nine month period ended September 30, 1998
included an acquisition-related charge of $1.2 million for the acquisition of
Synteni. The charge consisted primarily of accounting, legal and investment
banking fees. Total costs and expenses for the three and nine month periods
ended September 30, 1998 included a charge for the purchase of in-process
research and development of $11.0 million, related to the Hexagen acquisition.
Total costs and expenses are expected to increase in the foreseeable future
due to significant growth in expenses relating to the development of Incyte
Genetics database products and resources required to support these products,
significant growth in microarray production capacity, the continued investment
in new product development and bioinformatics, growth in marketing, sales and
customer support services, and defense of the Affymetrix lawsuits.
Research and development expenses for the three and nine months ended
September 30, 1998 increased to $24.8 million and $69.6 million, respectively,
compared to $18.5 million and $51.0 million for the corresponding periods in
1997. The increase in research and development expenses resulted primarily
from an increase in bioinformatics and software development efforts,
pharmacogenetic development efforts, microarray production and technology
development, and increased investment in the growth of the Company's
intellectual property portfolio. 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 and expansion of
existing databases, increases sequencing, microarray and SNP discovery
operations and invests in new technologies.
Selling, general and administrative expenses for the three and nine
months ended September 30, 1998 increased to $6.9 million and $17.2 million,
respectively, compared to $3.8 million and $9.9 million for the corresponding
periods in 1997. The increase in selling, general and administrative expenses
resulted primarily from the growth in marketing, sales and customer support,
additional expenses from the Company's United Kingdom subsidiary established
in the fourth quarter of 1997, expenses related to the defense of the
Affymetrix lawsuit and increased administrative personnel related to the
growth of Incyte General and the added complexity due to the formation of
Incyte Genetics. The Company expects that selling, general and administrative
expenses will increase over the next year due to the growth in marketing,
sales and customer service functions to support Incyte General's and Incyte
Genetics' products, legal expenses related to the Company's defense of the
Affymetrix lawsuits and increased administrative personnel required to support
the growing complexity of the Company's business.
Interest and other income, net for the three and nine months ended
September 30, 1998 increased to $1.8 million and $5.5 million, respectively,
from $1.3 million and $2.4 million for the corresponding periods 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 nine months ended
September 30, 1998 and zero for the three months ended September 30, 1998. The
loss represents the Company's equity share of diaDexus' net losses from
operations. Beginning in April 1998, the Company's share of diaDexus' net
losses was offset by the amortization of the excess of the Company's share of
diaDexus' net assets over its basis. The amortization of this amount is
expected to approximate the Company's equity share in diaDexus' net losses and
continue through the middle of the fourth quarter of 1998. As diaDexus was
formed in September 1997, no losses from joint venture were incurred in 1997.
The Company expects that losses from joint venture will continue at least
through 1999.
The estimated effective annual income tax rate for 1998 is 14.0% compared
to 8.4% in 1997 which represents the provision of federal and state
alternative minimum taxes after utilization of net operating loss
carryforwards and research and development credits. The increase in the
effective tax rate resulted primarily from the Company's expectation that in
1998 it would fully utilize all federal net operating loss carryforwards
available to benefit the income tax provision.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1998, the Company had $126.2 million in cash, cash
equivalents, restricted cash, and marketable securities, compared to $119.1
million as of December 31, 1997. For the nine months ended September 30, 1998,
cash provided by operating and financing activities was partially offset by
capital expenditures, investments in research and development alliances and
cash used in the purchase of Hexagen. 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.
Net cash provided by operating activities was $42.0 million for the nine
months ended September 30, 1998, as compared to $16.9 million for the nine
months ended September 30, 1997. The increase in net cash provided by
operating activities resulted primarily from an increase in net income net of
non-cash expenses, including depreciation and amortization and the charge for
the purchase of in-process research and development, and the decrease in
accounts receivables partially offset by the increase in prepaid expenses,
deposits and other assets and the decrease in accounts payable. Due to the
significant investment expected in the activities of Incyte Genetics in 1999,
the Company believes it may have a net cash use in operating activities in
1999. Net cash generated by or used in 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 mainly consisted of capital
expenditures and long-term investments. Capital expenditures for the nine
months ended September 30, 1998 increased to $21.5 million from $16.9 million
for the nine months ended September 30, 1997. Cash paid for the acquisition of
Hexagen was $4.0 million, net of $1.0 million cash held by Hexagen on the date
of the acquisition. 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 maturities/sales and purchases of
marketable securities.
Net cash provided by financing activities was $3.1 million for the nine
months ended September 30, 1998 as compared to $93.4 for the nine months ended
September 30, 1997. The decrease was primarily due to the follow-on stock
offering in August 1997. The Company expects its cash requirements to increase
significantly over the next year as it invests in the business of Incyte
Genetics, 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 being 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, of which approximately $1.7 million
have been expended through September 30, 1998. Given the current construction
schedule, the Company does not expect to begin to incur significant expenses
related to this facility until late 1998 or early 1999.
Based upon its current plans, the Company believes that its existing
resources and anticipated cash flow from operations will be adequate to
satisfy its capital needs at least through the next twelve months. However,
the Company may be unable to obtain additional collaborators or retain
existing collaborators for the Company's database products and services, 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 database 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, including capital equipment
necessary to ensure the Company's sequencing and microarray operations remain
competitive; capital expenditures required to expand the Company's facilities;
and costs associated with the integration of new operations assumed through
mergers and acquisitions. Changes in the Company's research and development
plans or other changes affecting the Company's operating expenses may result
in changes in the timing and amount of expenditures of the Company's capital
resources. In addition to funds provided prior to June 30, 1998 and related to
the purchase of Hexagen, the Company has committed to fund $20 million dollars
to support the ongoing operations of Incyte Genetics.
The Company expects to continue to fund future operations with revenues
from database products and services; with its current cash, cash equivalents,
and marketable securities; and with respect to Incyte Genetics, subject to the
approval of the Incyte Genetics Stock Proposal by stockholders and market and
other conditions, a private placement to a limited number of pharmaceutical
companies and depending on the capital needs of Incyte Genetics and market and
other conditions, from a public offering of Incyte Genetics Common Stock.
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:
fund Incyte Genetics operations with its own resources, which would result in
a significant increase in the use of cash; curtail operations significantly;
or to obtain funds by entering into collaborative arrangements that may
require the Company to relinquish rights to certain of its technologies,
product candidates, products or potential markets.
YEAR 2000
As a result of computer programs being written using two digits,
rather than four, to represent year dates, the performance of the Company's
computer systems and those of its suppliers and customers in the Year 2000 is
uncertain. Any computer programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in other normal business activities.
The Company is in the process of evaluating the Year 2000 readiness
of the software products sold by the Company ("Products"), the information
technology systems used in its operations ("IT Systems"), and its non-IT
Systems, such as building security, voice mail, and other systems. The Company
currently anticipates that this project will consist of the following phases:
(i) identification of all Products, IT Systems, and non-IT Systems; (ii)
assessment of repair or replacement requirements; (iii) repair or replacement;
(iv) testing; (v) implementation; and (vi) creation of contingency plans in
the event of Year 2000 failures.
The Company will initiate an assessment of all current versions of
its Products and believes that this will be completed in the first half of
1999. Even so, whether a complete system or device in which a Product is
embedded will operate correctly for an end-user depends in large part on the
Year 2000 compliance of the system's other components, most of which are
supplied by parties other than the Company. The supplier of the Company's
current financial and accounting software has informed the Company that such
software is Year 2000 compliant. The Company relies, both domestically and
internationally, upon various vendors, government agencies, utility companies,
telecommunications service companies, delivery service companies, and other
service providers who are outside of the Company's control. There is no
assurance that such parties will not suffer a Year 2000 business disruption,
which could have a material adverse effect on the Company's financial
condition and results of operations.
To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues. Most of
its expenses have related to the opportunity cost of time spent by employees
of the Company evaluating its financial and accounting software, its Products,
and general Year 2000 compliance matters. Absent a significant Year 2000
compliance deficiency, management estimates that the cost to complete its Year
2000 compliance programs will be between $1.0 million and $1.5 million, which
will be expensed as incurred. The Company believes that available cash will be
sufficient to cover the projected costs associated with these activities.
The Company is focusing on identifying and addressing all aspects
of its operations that may be affected by the Year 2000 issue and is
addressing the most critical applications first. The Company intends to
develop and implement, if necessary, appropriate contingency plans to mitigate
to the extent possible the effects of any Year 2000 noncompliance. Although
the full consequences are unknown, the failure of either the Company's
critical systems or those of its material third parties to be Year 2000
compliant would result in the interruption of the Company's business, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
FACTORS THAT MAY AFFECT RESULTS
If the Incyte Genetics Stock Proposal is approved and implemented,
holders of Incyte General Stock and Incyte Genetics Stock will be stockholders
of the Company. The Company owns all of the assets and is responsible for all
of the liabilities of both Incyte General and Incyte Genetics. Losses and
liabilities of one division that affect the Company's resources or financial
condition could adversely affect the financial condition or results of
operations of the other division and the market price of the series of common
stock relating to that division.
FACTORS RELATING TO BOTH INCYTE GENERAL AND INCYTE GENETICS
Uncertain Effects of Recent Acquisitions. The combinations of Synteni and
Hexagen with the Company involve several potential operating and business
risks, including the integration of Synteni's, Hexagen'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 and
Hexagen's technology with the Company's 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. Also, any cost
savings that are realized may be offset by increases in other expenses or
operating losses, including losses due to problems in integrating the acquired
companies with the Company. See "--Factors Relating to Both Incyte General and
Incyte Genetics--Risks Associated With Acquisitions." Although the Company
believes that beneficial synergies will result from the Synteni merger and
Hexagen acquisition, the combination of the 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 "--Factors Relating to Both Incyte General and Incyte
Genetics--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 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,
acquired Synteni in January 1998, and acquired Hexagen in September 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 difficulties and
expenses in 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 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, resulting in
significant goodwill or other intangible assets; 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, 1996 and 1995, the Company had net
losses of $7.3 million and $9.9 million, respectively, and as of September 30,
1998, the Company had an accumulated deficit of $29.9 million. Driven by the
Incyte General division, the Company has experienced substantial revenue
growth since 1995 and has reported quarterly profits since the first quarter
of 1997, excluding the charge for the purchase of in-process research and
development. However, because the Company intends to make a significant
investment in building the business of Incyte Genetics over the next few
years, the Company expects to report a consolidated net loss at least for
1999 and possibly 2000.
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 other costs related to the expansion of
the Company's operations, including operating losses of acquired businesses
such as Synteni and Hexagen; the introduction of competitive databases or
services; and expenses related to, and results of, litigation (including the
lawsuits filed by Affymetrix, described below under "--Factors Relating to
Both Incyte General and Incyte Genetics-Litigation") and other proceedings
relating to intellectual property rights. In particular, the Company has a
limited ability to control the timing of database installations, a lengthy
sales cycle is 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 milestone payments, license fees or research
payments.
The Company's investments in joint ventures and businesses, particularly
diaDexus, the Company's joint venture with SmithKline Beecham Corporation, 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, the Company has not recognized any significant losses on its long-term
equity investments, all of which to date have been allocated to Incyte
General. Due to the recent stock market volatility, certain investments
allocated to Incyte General are below the investments' book value. The
decrease in the market price of these investments is considered temporary and
therefore no change in the carrying value of the investments is considered
necessary at this time. The Company will continue to evaluate its long term
equity investments for impairment on a quarterly basis. As part of the
collaborative agreement with OGS relating to the joint development of a
proteomics database, Incyte General has agreed to reimburse OGS up to
$5.0 million in 1999 if revenues are not sufficient to offset OGS'
expenses for services rendered. In an effort to broaden its business,
the Company is investing in a number of new areas, including
microarray services, molecular diagnostics, pharmacogenomics and
proteomics. Because 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 amount and timing of such investments,
expenses or losses related to these investments could adversely affect
operating results.
Litigation. In January 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 United
States 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 fees and interest. Affymetrix further requests
that any such damages be trebled based on its allegation of willful
infringement by Synteni and Incyte.
In September 1998, Affymetrix filed an additional lawsuit in the United
States District Court for the District of Delaware alleging infringement of
the U.S. patent number 5,800,992 (the "'992 Patent") and U.S. patent number
5,744,305 (the "'305 Patent") by both Synteni and Incyte. The complaint
alleges that the '305 Patent has been infringed by the making, using, selling,
importing, distributing or offering to sell in the United States high density
arrays by Synteni and Incyte, that the '992 Patent has been infringed by the
use of Synteni's and Incyte's GEMTM microarray technology to conduct gene
expression monitoring using two-color labeling, and that such infringement was
willful. Affymetrix seeks a preliminary injunction enjoining Synteni and
Incyte from using Synteni's and Incyte's GEM microarray technology to conduct
gene expression monitoring using two-color labeling, as described in the '992
patent, and a permanent injunction enjoining Synteni and Incyte from further
infringement of the '305 and '992 Patents.
Incyte and Synteni believe they have meritorious defenses and intend to
defend these suits vigorously. However, there can be no assurance that Incyte
and Synteni will be successful in the defense of these suits. Regardless of
the outcome, this litigation has resulted and is expected to continue to
result in substantial expenses and diversion of the efforts of management and
technical personnel. Further, there can be no assurance that any license that
may be required as a result of these suits or the outcome thereof would be
made available on commercially acceptable terms, if at all.
New and Uncertain Business. The Company's SNP discovery business and
microarray-based gene expression service business represents businesses for
which there is no precedent. The utility of the information generated by these
businesses is unproven. The nature and price of the products and services
offered in these businesses are such that there are a limited number of
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 pharmaceutical and biotechnology
companies may choose to generate the information in-house; the emergence of
competitors offering similar services at competitive prices; the extent to
which the information in the Company's databases 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 that are more advanced than the technology used by and available
to the Company.
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 be illiquid and may require
the Company to record losses and expenses related to its proportionate
ownership interest in such entities, to record charges related to the
acquisition of in-process technologies, or to record charges for
recognition of 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 microarray
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 microarray 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 collaboration will result.
Uncertainty of Protection of Patents and Proprietary Rights. Incyte
General's and Incyte Genetics' database businesses and competitive position
are dependent in part upon the Company's 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 filed for patents on
selected features of its related software, but has not been issued patents or
registered copyrights for that 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 Canada and Japan 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 a number of entities, such
as Merck & Co., Inc. (in conjunction with Washington University), 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"). The USPTO has declared an interference involving a
Company patent application covering one full-length gene, and the Company has
been informed that interferences may be declared with respect to applications
covering approximately a dozen additional genes.
In support of Incyte Genetics' plan to commercialize SNP data, the
Company plans to seek patent protection for patentable SNPs identified in the
LifeSeq database, through the Incyte Genetics human genome sequencing program,
and through the use of Hexagen's fSSCP SNP-discovery technology. These patents
will claim rights in patentable SNPs for diagnostic and genotyping purposes.
As information relating to particular SNPs is developed, the Company plans to
seek additional rights in those SNPs that are associated with specific
diseases, functions or drug responses. Incyte Genetics will have the exclusive
right to commercialize the SNP data, human genome data and human genome
mapping data, for use in pharmacogenetic applications.
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. 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 partial 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. Given that the Company's cost of filing large numbers of patent
applications and maintaining issued patents can be significant, the Company
may choose not to pursue every application. If the Company does not pursue
patent protection for all of its full-length and partial gene sequences, the
value of its intellectual property portfolio could be diminished.
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. Also, 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 and SNPs 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 owned by the Company, or to determine the
scope and validity of the proprietary rights of others. The Company could also
be involved in interferences with respect to patent applications. 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 Company's favor. 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 of patent rights. 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 above under "-Factors
Relating to Both Incyte General and Incyte Genetics-Litigation," no third
party has filed suit with respect to an alleged claim against the Company.
Action may, however, be taken against the Company in the future, either with
respect to previously asserted or new claims. The outcome of any such action
is uncertain.
Future Capital Needs; Uncertainty of Additional Funding. Based upon its
current plans, the Company believes that its existing resources and
anticipated cash flow from operations will be adequate to satisfy its capital
needs at least through the next twelve months. However, the Company may be
unable to raise sufficient funds to support the efforts of Incyte Genetics,
obtain additional collaborators or retain existing collaborators for the
Company's databases. In addition, the Company's 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 database 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, including capital equipment
necessary to ensure the Company's sequencing and microarray operations remain
competitive; capital expenditures required to expand the Company's facilities;
and costs associated with the integration of new operations assumed through
mergers and acquisitions. The Company expects to continue to fund future
operations with revenues from database products and services and with private
and/or public equity capital to support Incyte Genetics, 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. 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 by 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 for support 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 offices
in Fremont, California, St. Louis, Missouri and Cambridge, England, 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 management, operations and scientific 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. Although the Company is evaluating alternative
gene sequencing machines, these machines may not be available in sufficient
quantities, available at acceptable costs, or prove to be more cost-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 identify
genes and SNPs through gene sequencing and related methods would be adversely
affected. In addition, although the Company obtains, from a number of sources,
tissue samples from which mRNA or DNA 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 gene sequencing machines that are utilized in the Company's high
throughput computer-aided genomic sequencing operations are commercially
available and are currently being utilized by at least one competitor.
Moreover, the majority owner of Celera Genomics Corporation ("Celera") has
announced that a new gel-based sequencing machine is expected to be ready for
commercial production in early 1999, and that a large number of these
sequencing machines will be provided to Celera. Although the Company has been
told that it will have access to these machines, there is no guarantee that
access will be provided under conditions that are acceptable to the Company or
at all.
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
contain no errors or omissions, or that the sources of these data have
acquired the data in compliance with applicable legal requirements, 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, to represent year dates, the performance of the
Company's computer systems and those of its suppliers and customers in the
Year 2000 is uncertain. Any computer programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in other normal
business activities.
The Company is in the process of evaluating the Year 2000 readiness of
the software products sold by the Company ("Products"), the information
technology systems used in its operations ("IT Systems"), and its non-IT
Systems, such as building security, voice mail, and other systems. The Company
currently anticipates that this project will consist of the following phases:
(i) identification of all Products, IT Systems, and non-IT Systems; (ii)
assessment of repair or replacement requirements; (iii) repair or replacement;
(iv) testing; (v) implementation; and (vi) creation of contingency plans in
the event of Year 2000 failures.
The Company will initiate an assessment of all current versions of its
Products and believes that this will be completed in the first half of 1999.
Even so, whether a complete system or device in which a Product is embedded
will operate correctly for an end-user depends in large part on the Year 2000
compliance of the system's other components, most of which are supplied by
parties other than the Company. The supplier of the Company's current
financial and accounting software has informed the Company that such software
is Year 2000 compliant. The Company relies, both domestically and
internationally, upon various vendors, government agencies, utility companies,
telecommunications service companies, delivery service companies, and other
service providers who are outside of the Company's control. There is no
assurance that such parties will not suffer a Year 2000 business disruption,
which could have a material adverse effect on the Company's financial
condition and results of operations.
To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues. Most of
its expenses have related to the opportunity cost of time spent by employees
of the Company evaluating its financial and accounting software, its Products,
and general Year 2000 compliance matters. Absent a significant Year 2000
compliance deficiency, management currently estimates that the cost to
complete its Year 2000 compliance programs will be between $1.0 million and
$1.5 million, which will be expensed as incurred.
The Company is focusing on identifying and addressing all aspects of its
operations that may be affected by the Year 2000 issue and is addressing the
most critical applications first. The Company intends to develop and
implement, if necessary, appropriate contingency plans to mitigate to the
extent possible the effects of any Year 2000 noncompliance. Although the full
consequences are unknown, the failure of either the Company's critical systems
or those of its material third parties to be Year 2000 compliant would result
in the interruption of the Company's business, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Hazardous Materials; Environmental Matters. The Company's research and
development involves the controlled use of hazardous and radioactive materials
and biological waste. The 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 and 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 a significant portion of its other activities at its facilities in Palo
Alto, California, and conducts all its of microarray-related 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.
FACTORS RELATING TO INCYTE GENERAL
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 Incyte General's businesses and management in
a timely, efficient and effective manner, the timely integration of Synteni's
microarray technology and services with Incyte General's database products and
services, integration of the respective sales and marketing and research and
development efforts, and any result in loss of efficiency or loss of
employees. The combined companies may not realize any revenue enhancements or
cost savings. 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 "--Factors Relating to
Both Incyte General and Incyte Genetics--Risks Associated With Acquisitions."
Although Incyte General 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 "--Factors Relating to Incyte General--History of Operating
Losses; Uncertainty of Continued Profitability or Revenues."
History of Operating Losses; Uncertainty of Continued Profitability or
Revenues. For the years ended December 31, 1996 and 1995, Incyte General had
net losses of $7.5 million and $9.9 million, respectively, and as of September
30, 1998, Incyte General had an accumulated deficit of $15.1 million. Incyte
General has experienced substantial revenue growth since 1995 and has reported
quarterly profits since the first quarter of 1997. However, Incyte General may
not be able to maintain revenue growth or profitability. Incyte General'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 Incyte General will be dependent on the ability of
Incyte General to obtain high volume customers for microarray services and the
costs associated with increasing microarray production capacity. Prior to the
merger, Synteni's microarray service agreements consist of small volume pilot
or feasibility agreements. Incyte General's ability to achieve and maintain
significant revenues will be dependent upon its ability to obtain additional
database collaborators, retain existing collaborators, and expand its customer
base for microarray services. Incyte General's ability to maintain
profitability will be dependent upon its ability to obtain database
collaborators, expand its customer base for microarray services, the level of
expenditures necessary for Incyte General 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 August 1998, Incyte General had twenty-one
database agreements, Incyte General may be unable to enter into any additional
collaborations. Further, Incyte General's database agreements typically have a
term of three years. Some of these agreements require Incyte General to meet
certain performance obligations. These agreements may not be renewed upon
expiration, and a database agreement may be terminated earlier by a
collaborator if Incyte General 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 Incyte General's
business, financial condition and results of operations.
Part of Incyte General's commercialization strategy is to license to
database collaborators Incyte General's patent rights to individual partial
genes or full-length cDNA sequences from Incyte General'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, Incyte General 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. Incyte General's operating results may
fluctuate significantly from quarter to quarter as a result of a variety of
factors, including: changes in the demand for Incyte General's products and
services; the pricing of database access to database collaborators; the
nature, pricing and timing of other products and services provided to Incyte
General's collaborators; changes in the research and development budgets of
Incyte General's collaborators and potential collaborators; capital
expenditures; acquisition and licensing costs and other costs related to the
expansion of Incyte General'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 and other
proceedings relating to intellectual property rights. In particular, Incyte
General has a limited ability to control the timing of database installations,
there is a lengthy sales cycle required for Incyte General's database
products, Incyte General's revenue levels are difficult to forecast, the time
required to complete custom orders can vary significantly and Incyte General's
increasing investments in external alliances could result in significant
quarterly fluctuations in expenses due to the payment of milestone payments,
license fees or research payments.
Incyte General's equity investments may require Incyte General to record
charges for the acquisition of in-process technologies or for recognition of
the impairment in the value of the securities underlying such investments. See
"-Factors Relating to Both Incyte General and Incyte Genetics--Fluctuations in
Operating Results."
To date, Incyte General has not recognized any significant losses on its
long-term equity investments. Due to the recent stock market volatility,
certain investments allocated to Incyte General are below the investments'
book value. The decrease in the market price of these investments is
considered temporary and therefore no change in the carrying value of the
investments is considered necessary at this time. Incyte General will continue
to evaluate its long-term equity investments for impairment on a quarterly
basis.
The need for continued investment in development of Incyte General'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, Incyte General may
not be able to adjust significantly its level of expenditures in such period,
which would have an adverse effect on Incyte General's operating results.
Incyte General 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.
Incyte General 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, Incyte
General's operating results will be below the expectations of public market
analysts and investors.
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 Incyte General. In addition, Incyte
General is aware that other companies have developed genomic databases and are
marketing, or have announced their intention to market their data to
pharmaceutical companies. Incyte General 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 Incyte General's databases. Further, certain
entities engaged in gene sequencing have made the results of their sequencing
efforts publicly available. Celera has announced plans to sequence the entire
human genome within three years and to make the sequencing data publicly
available. The public availability of gene sequences or resulting patent
positions comprising substantial portions of the human genome or microbial or
plant genomes could decrease the potential value of Incyte General's databases
to Incyte General's collaborators and adversely affect Incyte General's
ability to realize royalties or other revenue from commercialization of
products based upon this genetic information.
Some of Incyte General'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 Incyte
General. In addition, Incyte General is aware that a number of companies are
pursuing alternative methods for generating gene expression information,
including some 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 Incyte General. These
advanced sequencing or gene expression technologies, if developed, may not be
commercially available for purchase or license by Incyte General 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 Incyte General, and their
products may achieve greater market acceptance than Incyte General's products.
Incyte General's databases also require extensive software support and
incorporate features determined by database collaborators' needs. If Incyte
General 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
Incyte General's business and operating results.
The genomics industry is characterized by extensive research efforts and
rapid technological progress. To remain competitive, Incyte General 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 Incyte General's services and
potential products noncompetitive.
Future Capital Needs; Uncertainty of Additional Funding. Based upon its
current plans, Incyte General believes that its existing resources and
anticipated cash flow from operations will be adequate to satisfy its capital
needs at least through the next twelve months. However, Incyte General may be
unable to obtain additional collaborators or retain existing collaborators for
its databases, and its database products and services may not produce revenues
which, together with the Incyte General's cash, cash equivalents, and
marketable securities, would be adequate to fund its cash requirements. Incyte
General's cash requirements depend on numerous factors, including: the ability
of Incyte General to attract and retain collaborators for its databases and
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,
including capital equipment necessary to ensure Incyte General's sequencing
and microarray operations remain competitive; capital expenditures required to
expand Incyte General's facilities; costs associated with the integration of
new operations assumed through mergers and acquisitions; and funding
requirements of Incyte Genetics. Incyte General has committed to Incyte
Genetics to provide $20 million in cash and will provide additional funding,
as appropriate, in the form of loans or investments. Incyte General expects to
continue to fund future operations with revenues from database products and
services in addition to using its current cash, cash equivalents, and
marketable securities. Changes in Incyte General's research and development
plans or other changes affecting Incyte General's operating expenses may
result in changes in the timing and amount of expenditures of Incyte General'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 Incyte General's existing stockholders. Additional funding, if
necessary, may not be available on favorable terms, if at all. If adequate
funds are not available, Incyte General may be required to curtail operations
significantly or to obtain funds through entering into collaborative
arrangements that may require Incyte General to relinquish rights to certain
of its technologies, product candidates, products or potential markets.
FACTORS RELATING TO INCYTE GENETICS
New and Uncertain Business; Product Development Risk. Incyte Genetics'
business is based on developing database and other products and services to
assist pharmaceutical companies in the identification and correlation of
genetic variation to disease and drug response. This business is new and
unproven.
Incyte Genetics' products will focus on SNPs, one type of genetic variation.
The role of SNPs in disease and drug response is not fully understood, and
relatively few therapeutic or diagnostic products based on SNPs have been
developed and commercialized. Incyte Genetics believes that pharmaceutical
companies will be interested in its products and services due to their belief
that certain SNPs correlate with a patient's disease prognosis, disease
susceptibility and ability to respond to a particular drug or class of drugs,
and in particular with a patient's susceptibility to adverse drug reactions.
With the exception of a few anecdotal examples, these correlations between
SNPs and disease and drug response are unproven. Furthermore, the process to
identify statistically significant correlations is time-consuming and could
involve the collection and screening of a large number of patient samples.
Incyte Genetics has not yet discovered the SNPs that would be the subject of
these correlation studies, and does not currently have access to the patient
samples needed, or access to a technology proven to be able to rapidly detect
pre-determined SNPs reproducibly and at a low cost in large numbers of patient
samples. Most SNPs may occur at a frequency in the population that is too low
to warrant their use in analyzing genetic variation in patients. It may be
difficult to identify SNPs that both correlate with patient disease and drug
response as well as occur at a high enough frequency to justify their use by
pharmaceutical companies in drug development or in disease management. Incyte
Genetics' strategy of using high-throughput mutation detection processes and
sequencing to identify SNPs and genes rapidly and obtain proprietary rights in
as many SNPs and genes as possible is also unproven. In addition, ethical and
social concerns about the confidentiality of patient specific genetic
information and about the use of genetic testing for diagnostic purposes could
adversely affect the market acceptance of Incyte Genetics' products or those
developed by its collaborators.
Incyte Genetics' success will also depend upon its ability to develop,
use and enhance new and relatively unproven technologies. Among other things,
Incyte Genetics will need to improve the throughput of Hexagen's fSSCP
SNP-discovery technology. Incyte Genetics may not be able to achieve these
necessary improvements and other factors may impair its ability to develop the
LifeSNPTM database. The failure to rapidly develop this database would
adversely affect Incyte Genetics' business and results of operations.
Early Stage of Development; Anticipated Operating Losses. Incyte Genetics
is at an early stage of development. To date, it has generated only limited
revenues from database agreements. All of these revenues relate to the LifeSeq
AtlasTM database previously developed by the Company. Hexagen, which will be
an important part of Incyte Genetics' business, was founded in 1996 and has
generated no revenues to date. Incyte Genetics' expansion of its research and
development efforts will require substantial increases in expenditures,
including the hiring of a substantial number of new employees, over the next
several years. As a result, Incyte Genetics currently expects to incur
operating losses for at least the next few years. Incyte Genetics may never
achieve significant revenues or profitable operations.
Incyte Genetics believes that, for at least the next two years, it will
derive the majority of its revenues from fees paid by pharmaceutical companies
in return for access to Incyte Genetics' databases and from fees paid by
pharmaceutical companies in return for pharmacogenetic and directed SNP
program services. The latter services are not yet offered. Incyte Genetics'
LifeSNP and LifeSeq GenomeTM databases are being developed and currently
generate no fees. Incyte Genetics' ability to generate significant revenues
will depend upon its ability to attract and retain pharmaceutical partners as
database subscribers. Only a limited number of pharmaceutical companies are
potential subscribers for Incyte Genetics' proposed products and services due
to their nature and price. These companies may choose to conduct SNP discovery
and analysis in-house, to form an industry consortium, or to work with Incyte
Genetics' competitors. Incyte Genetics has not entered into any database or
service agreements other than agreements relating to the existing LifeSeq
Atlas mapping database, and it may be unable to attract any additional
subscribers. Incyte Genetics expects that the database agreements will provide
for the payment of milestone and royalty payments from the sale of drugs,
diagnostic products and genotyping products derived from the information
within the databases. Subscribers may not develop such products or may
encounter delays and difficulties in developing and commercializing products
based on Incyte Genetics' products and services. Any product developed by a
database subscriber will require several years of development, clinical
testing and regulatory approval prior to commercialization. Accordingly,
Incyte Genetics does not expect to receive any milestone or royalty payments
under any collaborative arrangement for a substantial period of time, if at
all.
The level of demand for Incyte Genetics' products and services will be
unpredictable due to a number of other factors, including: the possible
emergence of competitors offering similar or superior products and services at
competitive prices; the extent to which the information in Incyte Genetics'
and the Company's databases is made public or is the subject of patents issued
to others; Incyte Genetics' ability to establish and enforce proprietary
rights to its products; regulatory developments or changes in public
perceptions relating to the use of genetic information and the diagnosis and
treatment of disease based on genetic information; and technological
innovations in gene sequencing, mapping and SNP discovery and detection.
Incyte Genetics' ability to achieve profitability will also depend upon the
level of expenditures necessary to support its services to subscribers, and
the extent to which it incurs research and development, investment,
acquisition-related or other expenses.
Incyte Genetics' operating results will be affected by losses and
expenses relating to its equity interest in diaDexus and any other strategic
investments Incyte Genetics might make in the future. Although it has no
specific plans at this time, Incyte Genetics will consider making strategic
equity investments in businesses perceived to be complementary. These
investments may be illiquid and may require Incyte Genetics to record losses
or expenses related to its proportionate ownership interest, to record charges
for acquisition of in-process technologies, or to record charges relating to
the impairment in the value of its investments. In addition, any investments
in external alliances could result in significant quarterly fluctuations in
expenses due to the payment of milestones, license fees or research payments.
Uncertain Effects of the Hexagen Acquisition. The acquisition of Hexagen
involves several potential risks, including the uncertainties associated with
attempting to integrate Hexagen's and Incyte Genetics' businesses, management,
technologies and research and development efforts. This integration has begun
only very recently, and it may result in a loss of efficiency or employees, or
may otherwise be unsuccessful. The timely development of the LifeSNP database
will depend upon the successful integration of Hexagen's fSSCP technology into
Incyte Genetics' technologies and processes, and also upon Incyte Genetics'
ability to improve the throughput of Hexagen's fSSCP technology. Incyte
Genetics may not be able to achieve these necessary improvements. The
discovery of SNPs is a competitive area and other companies may develop or
obtain access to SNP discovery and detection platforms, which Incyte Genetics
may not be provided access to, that may make Hexagen's fSSCP technology
obsolete.
Need for Additional Funding. Incyte Genetics will require substantial
additional funding to develop its databases and other products and services,
and to market any products and services that may be developed. Incyte Genetics
currently anticipates requiring total funds of approximately $100 million to
$150 million over the next few years. Initially, Incyte General has committed
to provide Incyte Genetics with $20 million in cash. Incyte Genetics intends
to fund the remainder of its anticipated cash requirements from third-party
sources, including database subscription revenues, strategic equity
investments from pharmaceutical companies and/or the public equity markets.
Other than the LifeSeq Atlas database revenues, Incyte Genetics currently has
no other database revenues and has no commitments for equity investments.
Incyte Genetics' ability to fund its anticipated cash requirements is
difficult to predict and dependent on a number of factors, some of which are
under the control of Incyte Genetics, and many of which are not. These factors
include the receptivity of pharmaceutical companies to Incyte Genetics'
products, the utility of SNPs, the ability to raise capital from the equity
markets, the effect of competitive efforts, and the progress of Incyte
Genetics' research and development efforts. Additional funding may not be
available on favorable terms or at all. If adequate funds are unavailable,
Incyte Genetics may be required to curtail its research and development and
other operations significantly. If operations are curtailed significantly,
Incyte Genetics' products and services may not develop in a sufficiently
timely manner and its long-term prospects may be materially and adversely
affected.
Competition and Technological Changes. A number of companies,
institutions, and government-financed entities are engaged in the study of
genetic variation, including gene sequencing, mapping and polymorphism
discovery or detection. Many of these companies, institutions and entities
have greater financial and human resources than Incyte Genetics. At least
three other companies, Celera, Affymetrix and Genset, S.A., have announced
their intent to market mapping, sequence and/ or polymorphism data to the
pharmaceutical industry. Incyte Genetics expects that additional competitors
may attempt to establish databases containing such information in the future
and that competition in the industry will continue to intensify.
In addition, competitors may discover and establish patent positions with
respect to gene sequences and polymorphisms in Incyte Genetics' databases.
Celera has announced its intention to make the results of its genomic
sequencing efforts publicly available. Competitors' patent positions or the
public availability of gene sequences and polymorphisms could decrease the
potential value of Incyte Genetics' databases and services to the Incyte
Genetics' collaborators and adversely affect the Incyte Genetics' ability to
realize royalties or other revenue from commercialization of products based
upon
such information.
The gene sequencing machines that are utilized in Incyte Genetics' high
throughput computer-aided genomic sequencing operations are commercially
available and are currently being utilized by at least one competitor.
Moreover, the majority owner of Celera has announced the development of a new
gel-based sequencing machine that it expects to have ready for commercial
production in early 1999, and that a large number of such sequencing machines
will be provided to Celera. See "--Factors Relating to Both Incyte General and
Incyte Genetics--Dependence on Others."
The SNP discovery platform used by Incyte Genetics represents a
modification of a process that is in the public domain. Although the patent
protection is being sought for these improvements, no patents have yet been
issued. Other companies could make similar or superior improvements in this
process without providing access to the Company to these improvements.
Incyte Genetics expects that its databases will require extensive software
support and will need to incorporate features determined by database
collaborators. If Incyte Genetics is delayed or has problems implementing its
database software or collaborator-requested features, its ability to service
its collaborators may be adversely affected. This could adversely affect
Incyte Genetics' business and operating results.
The genomics and pharmacogenetics industries are characterized by
extensive research efforts and rapid technological progress. To remain
competitive, Incyte Genetics will have to expand its databases rapidly,
enhance the functionality of its bioinformatics and database software and
invest in new technologies. In particular, the development of the LifeSNP
database will require improvements in the throughput of Hexagen's SNP
discovery technology. New developments in the industry are expected to
continue, and discoveries by others may render Incyte Genetics' potential
products and services noncompetitive.
Dependence on Incyte General. Incyte Genetics has made no investment in
marketing or product sales resources, and currently intends to rely upon
Incyte General's marketing and sales staff to market all of the potential
products and services to be developed by Incyte Genetics. Sufficient marketing
resources may not be available to Incyte Genetics when needed, and the Company
may determine that Incyte Genetics needs to have its own marketing and sales
staff, which could be difficult and expensive to create. In addition, Incyte
Genetics will depend on the sequencing operations of Incyte General. This
operation needs to be expanded significantly in order to meet the needs of
Incyte Genetics' genomic sequencing program. If sufficient sequencing
resources are not available to Incyte Genetics, it may be required to build
its own operations or seek third parties capable of meeting Incyte Genetics'
sequencing needs. If third party sequencing is needed, there is no assurance
that such sequencing capacity would be available, or if unavailable, that
Incyte Genetics would have the resources to build its own operations. Even if
Incyte Genetics had sufficient resources, this might significantly delay its
efforts to generate sequence and SNP data or meet potential future obligations
under database agreements.
Management of Incyte Genetics. Incyte Genetics has only recently been
formed and its management team is still being completed. Randal W. Scott,
President and Chief Scientific Officer of the Company, is also acting as Chief
Executive Officer of Incyte Genetics. Mark Bodmer, formerly Chief Executive
Officer of Hexagen, has been appointed President of Incyte Genetics. See
"--Factors Relating to Both Incyte General and Incyte Genetics-Dependence on
Key Employees" and "--Factors Relating to Incyte Genetics-Uncertain Effects of
the Hexagen Acquisition."
<PAGE>
PART II: OTHER INFORMATION
ITEM 1 Legal Proceedings
In January 1998, Affymetrix, Inc. ("Affymetrix") filed a lawsuit in the United
States District Court for the District of Delaware 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 United
States high density arrays by Synteni and Incyte and that such infringement
was willful. Affymetrix seeks a permanent injunction enjoining Synteni and
Incyte from further infringement of the '934 Patent and, in addition, seeks
damages, costs and attorney's fees and interest. Affymetrix further requests
that any such damages be trebled based on its allegation of willful
infringement by Incyte and Synteni.
In September 1998, Affymetrix filed an additional lawsuit in the United States
District Court for the District of Delaware alleging infringement of the U.S.
patent number 5,800,992 (the "'992 Patent") and U.S. patent number 5,744,305
(the "'305 Patent") by both Synteni and Incyte. The complaint alleges that the
'305 Patent has been infringed by the making, using, selling, importing,
distributing or offering to sell in the United States high density arrays by
Synteni and Incyte, that the '992 Patent has been infringed by the use of
Synteni's and Incyte's GEMTM microarray technology to conduct gene expression
monitoring using two-color labeling, and that such infringement was willful.
Affymetrix seeks a permanent injunction enjoining Synteni and Incyte from
further infringement of the '305 and '992 Patents and, in addition, Affymetrix
seeks a preliminary injunction enjoining Incyte and Synteni from using
Synteni's and Incyte's GEM microarray technology to conduct gene expression
monitoring using two-color labeling as described in the '992 patent.
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 these suits. Regardless of the
outcome, this litigation has resulted and is expected to continue to result in
substantial expenses and diversion of the efforts of management and technical
personnel. Further, there can be no assurance that any license that may be
required as a result of these suits or the outcome thereof would be made
available on commercially acceptable terms, if at all.
ITEM 2 Changes in Securities
(a) On September 25, 1998, the Company's Board of Directors adopted a
stockholder rights plan, pursuant to which one preferred stock purchase right
(a "Right") was distributed for each share of Common Stock held as of October
13, 1998. Each Right, when exercis-able, will entitle the holder to purchase
from the Company one one-thousandth of a share of the Company's Series A
Partici-pating Preferred Stock at a price of $200.00 (the "Purchase Price"),
subject to antidilution adjustments.
In general, if a person or group (an "Acquiring Person") acquires beneficial
ownership of 15% or more of the outstanding shares of Common Stock, then each
Right (other than those held by an Acquiring Person) will entitle the holder
to receive, upon exer-cise, shares of Common Stock (or, under certain
circumstances, a combination of securities or other assets) having a value of
twice the Purchase Price. In addition, if following the announcement of the
existence of an Acquiring Person the Company is involved in a business
combina-tion or sale of 50% or more of its assets or earn-ing power, each
Right (other than those held by an Acquiring Person) will entitle the holder
to receive, upon exercise, shares of common stock of the acquiring entity
having a value of twice the Purchase Price. When the foregoing rights arise,
any Rights owned by an Acquiring Person will immediately become void. The
Board of Directors will also have the right, after there is an Acquiring
Person, to cause each Right (except those that have become void) to be
exchanged for Common Stock or substitute consideration.
The Company may redeem the Rights at a price of $0.01 per Right before the
existence of an Acquiring Person is announced. The Rights expire on September
25, 2008.
This summary description of the Rights does not purport to be complete and is
qualified in its entirety by reference to the Rights Agreement, was filed as
an exhibit to the Company's Registration Statement on Form 8-A filed on
September 30, 1998
(b) Not applicable
(c) On September 21, 1998, the Company issued 976,130 shares of its common
stock to the shareholders of Hexagen Limited, a company organized under the
laws of England and Wales ("Hexagen"), in exchange for all of the issued and
outstanding share capital of Hexagen. The Company relied upon the exemption
provided by Section 4(2) of the Securities Act of 1933, as amended (the
"Act"). These sales were made without general solicitation or advertising.
The recipients of the above-described securities represented their intention
to acquire the securities for investment only and not with a view to
distribution thereof. Appropriate legends were affixed to the stock
certificates issued in the transaction. Each recipient was an accredited
investor as such term is defined under Rule 501 of Regulation D under the Act
or was represented by a Purchaser Representative as that term is defined under
Rule 501 of Regulation D under the Act. All recipients were provided with or
had access to adequate information about the Company.
(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
To be considered for inclusion in the Company's proxy statement and form of
proxy for its 1999 Annual Meeting of Stockholders, a stockholder proposal must
be received at the principal executive offices of the Company not later than
January 1, 1999.
A stockholder proposal not included in the Company's proxy statement for the
1999 Annual Meeting will be ineligible for presentation at the meeting unless
the stockholder gives timely notice of the proposal in writing to the
Secretary of the Company at the principal executive offices of the Company and
otherwise complies with the provisions of the Company's Bylaws. To be timely,
the Company's Bylaws provide that the Company must have received the
stockholder's notice not less than 60 days nor more than 90 days prior to the
scheduled date of such meeting. However, if notice or prior public disclosure
of the date of the annual meeting is given or made to stockholders less than
70 days prior to the meeting date, the Company must receive the stockholder's
notice by the earlier of (i) the close of business on the 10th day after the
earlier of the day the Company mailed notice of the annual meeting date or
provided such public disclosure of the meeting date and (ii) two days prior to
the scheduled date of the annual meeting. For the Company's 1999 Annual
Meeting of Stockholders, which is scheduled to be held on June 8, 1999,
stockholders must submit written notice to the Secretary in accordance with
the foregoing Bylaw provisions no later than April 9, 1999 but not prior to
March 10, 1999.
<PAGE>
ITEM 6 Exhibits and Reports on Form 8-K.
a) Exhibits
See Exhibit Index on Page 27
b) Reports on Form 8-K
The Company filed the following reports on Form 8-K during the fiscal quarter
covered by this report:
i) Current Report on Form 8-K, filed on October 6, 1998, reporting under
Item 2 the completion of the acquisition of Hexagen Limited by the Company (to
be amended by Form 8-K/A to file under Item 7 of Form 8-K certain financial
statements and information required thereunder).
ii) Current Report on Form 8-K, filed on September 3, 1998, reporting
under Item 5 the adoption of a stockholder rights plan by the Company's Board
of Directors.
iii) Current Report on Form 8-K, filed on August 21, 1998, reporting under
Item 5 additional litigation brought against the Company by Affymetrix, Inc.
iv) Current Report on Form 8-K, filed on September 30, 1998, reporting
under Item 5 that the Company entered into an agreement to purchase Hexagen
Limited.
<PAGE>
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: November 13, 1998 By: /s/ Roy A. Whitfield
---------------------
Roy A. Whitfield
Chief Executive Officer
Date: November 13, 1998 By: /s/ Denise M. Gilbert
---------------------
Denise M. Gilbert
Executive Vice President and
Chief Financial Officer
<PAGE>
INCYTE PHARMACEUTICALS, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
NO. EXHIBIT PAGE
--- -------------------------------------------------- ----
<S> <C> <C> <C>
xxx 27 Financial Data Schedule, September 30, 1998 40
99 Amendment to the 1997 Employee Stock Purchase Plan 41
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 45,350
<SECURITIES> 80,861
<RECEIVABLES> 4,340
<ALLOWANCES> 261
<INVENTORY> 0
<CURRENT-ASSETS> 137,553
<PP&E> 81,579
<DEPRECIATION> 31,253
<TOTAL-ASSETS> 232,959
<CURRENT-LIABILITIES> 55,720
<BONDS> 0
0
0
<COMMON> 28
<OTHER-SE> 175,701
<TOTAL-LIABILITY-AND-EQUITY> 232,959
<SALES> 0
<TOTAL-REVENUES> 98,164
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 81,730
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,098
<INCOME-TAX> 2,111
<INCOME-CONTINUING> 1,987
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,987
<EPS-PRIMARY> 0.07
<EPS-DILUTED> 0.07
</TABLE>
Exhibit 99
1998 AMENDMENT TO THE
------------------------
1997 EMPLOYEE STOCK PURCHASE PLAN
-------------------------------------
OF INCYTE PHARMACEUTICALS, INC.
----------------------------------
THIS AMENDMENT amends the 1997 Employee Stock Purchase Plan of Incyte
Pharmaceuticals, Inc. (the "Company"), originally adopted by the Board of
Directors of the Company on February 27, 1997 (the "Plan"). Unless
specifically otherwise defined, each term used herein shall have the meaning
assigned to such term in the Plan.
WHEREAS, the Board of Directors has determined that it is in the best
interests of the Company to amend the Plan to provide for a six-month
employment eligibility period, commencing with the Offering Period beginning
May 1, 1998:
NOW THEREFORE, the Plan is hereby amended as follows:
Effective as of May 1, 1998 and concurrent with the Offering Period
commencing on such date, Section 3(a) of the Plan shall be amended and
restated to read in its entirety as follows:
"Any Employee who has been employed by the Company for six months or
more on a given Enrollment Date shall be eligible to participate in the Plan."
To record the adoption of this Amendment to the Plan by the Board of
Directors, as of April 28, 1998, the Company has caused its authorized officer
to execute the same.
INCYTE PHARMACEUTICALS, INC.
By /s/ ROY A. WHITFIELD
---------------------------------
Roy A. Whitfield
As its Chief Executive Officer
-----------------------------
