<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT: JUNE 12, 1998
(Date of earliest event reported)
INCYTE PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 0-27488 94-3136539
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
3174 PORTER DRIVE
PALO ALTO, CALIFORNIA, 94304
(Address of principal executive offices)
(650) 855-0555
(Registrant's telephone number, including area code)
<PAGE> 2
Item 5. Other Events
On January 22, 1998, Synteni Inc. ("Synteni"), a Delaware corporation,
became a wholly-owned subsidiary of the registrant, Incyte
Pharmaceuticals, Inc. ("Incyte"), as a result of the merger (the
"Merger") of Bond Acquisition Corporation ("Merger Subsidiary"), a
Delaware corporation and a wholly-owned subsidiary of Incyte, with and
into Synteni pursuant to the Agreement and Plan of Merger, dated as of
December 23, 1997, among Incyte, Merger Subsidiary, and Synteni (the
"Agreement"). The merger was accounted for as a pooling of interests.
The agreement and required pro forma information reflecting the Merger
have previously been filed by Incyte on Form 8-K, as amended by Form
8-K/A, dated January 22, 1998. Incyte is filing this Current Report on
Form 8-K in order to file, as Exhibit 99.1 hereto, its selected
consolidated financial data, management's discussion and analysis of
financial condition and results of operations, and audited
consolidated financial statements as of and for the periods listed
therein, which have been restated to reflect the combined results of
Incyte and Synteni.
(a) Financial Data and Financial Statements of Business Acquired.
None required
(b) Pro Forma Financial Information.
None required
(c) Exhibits.
Exhibit 27.01 Restated Financial Data Schedule
Exhibit 27.02 Restated Financial Data Schedule
Exhibit 27.03 Restated Financial Data Schedule
Exhibit 27.04 Restated Financial Data Schedule
Exhibit 27.05 Restated Financial Data Schedule
Exhibit 27.06 Restated Financial Data Schedule
Exhibit 27.07 Restated Financial Data Schedule
Exhibit 27.08 Restated Financial Data Schedule
Exhibit 27.09 Restated Financial Data Schedule
Exhibit 99.1 Selected consolidated financial data
Management's discussion and analysis of financial
condition and results of operations
Report of Ernst & Young LLP, Independent Auditors
Consolidated Balance Sheets at December 31, 1997 and
1996
Consolidated Statements of Operations for the Years
Ended December 31, 1997, 1996 and 1995
Consolidated Statement of Stockholders' Equity for
the three year period ended December 31, 1997.
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1997, 1996, and 1995
Notes to the Consolidated Financial Statements
2
<PAGE> 3
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description
-------- -----------
<S> <C>
27.01 Restated Financial Data Schedule
27.02 Restated Financial Data Schedule
27.03 Restated Financial Data Schedule
27.04 Restated Financial Data Schedule
27.05 Restated Financial Data Schedule
27.06 Restated Financial Data Schedule
27.07 Restated Financial Data Schedule
27.08 Restated Financial Data Schedule
27.09 Restated Financial Data Schedule
99.1 Selected consolidated financial data
Management's discussion and analysis of financial
condition and results of operations
Report of Ernst & Young LLP, Independent Auditors
Consolidated Balance Sheets at December 31, 1997 and
1996
Consolidated Statements of Operations for the Years
Ended December 31, 1997, 1996 and 1995
Consolidated Statement of Stockholders' Equity for
the three year period ended December 31, 1997.
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1997, 1996, and 1995
Notes to the Consolidated Financial Statements
</TABLE>
<PAGE> 4
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: June 12, 1998 By: /s/ Denise M. Gilbert
----------------------------
Denise M. Gilbert
Executive Vice President and
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Exhibit 99.1
of the Company's Current Report on Form 8-K dated June 12, 1998 for the period
ended December 31, 1995 restated to reflect the combined results of Incyte
Pharmaceuticals, Inc. and Synteni, Inc. and is qualified in its entirety by
reference to such Form 8-K.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<CASH> 10,584
<SECURITIES> 30,634
<RECEIVABLES> 7,643
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 49,619
<PP&E> 12,440
<DEPRECIATION> 3,297
<TOTAL-ASSETS> 58,892
<CURRENT-LIABILITIES> 10,604
<BONDS> 0
0
0
<COMMON> 21
<OTHER-SE> 47,585
<TOTAL-LIABILITY-AND-EQUITY> 58,892
<SALES> 0
<TOTAL-REVENUES> 12,299
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 19,272
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (9,937)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,937)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,937)
<EPS-PRIMARY> (0.53)
<EPS-DILUTED> (0.53)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information for the period ended March
31, 1996, restated to reflect the combined results of Incyte Pharmaceuticals,
Inc. and Synteni, Inc.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 12,638
<SECURITIES> 36,558
<RECEIVABLES> 473
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 50,881
<PP&E> 16,329
<DEPRECIATION> 4,339
<TOTAL-ASSETS> 63,311
<CURRENT-LIABILITIES> 17,099
<BONDS> 0
0
0
<COMMON> 22
<OTHER-SE> 45,333
<TOTAL-LIABILITY-AND-EQUITY> 63,311
<SALES> 0
<TOTAL-REVENUES> 6,274
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 7,839
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,086)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,086)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,086)
<EPS-PRIMARY> (0.09)
<EPS-DILUTED> (0.09)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information for the period ended June
30, 1996, restated to reflect the combined results of Incyte Pharmaceuticals,
Inc. and Synteni, Inc..
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 7,183
<SECURITIES> 30,399
<RECEIVABLES> 9,928
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 48,478
<PP&E> 24,017
<DEPRECIATION> 5,665
<TOTAL-ASSETS> 67,271
<CURRENT-LIABILITIES> 22,581
<BONDS> 0
0
0
<COMMON> 22
<OTHER-SE> 43,675
<TOTAL-LIABILITY-AND-EQUITY> 67,271
<SALES> 0
<TOTAL-REVENUES> 14,687
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 17,152
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (3,763)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,763)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,763)
<EPS-PRIMARY> (0.17)
<EPS-DILUTED> (0.17)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information for the period ended
September 30, 1996, restated to reflect the combined results of Incyte
Pharmaceuticals, Inc. and Synteni, Inc.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 20,392
<SECURITIES> 29,946
<RECEIVABLES> 3,847
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 55,381
<PP&E> 27,466
<DEPRECIATION> 7,314
<TOTAL-ASSETS> 76,003
<CURRENT-LIABILITIES> 31,129
<BONDS> 0
0
0
<COMMON> 22
<OTHER-SE> 32,232
<TOTAL-LIABILITY-AND-EQUITY> 76,003
<SALES> 0
<TOTAL-REVENUES> 27,604
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 32,352
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (7,260)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,260)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,260)
<EPS-PRIMARY> (0.33)
<EPS-DILUTED> (0.33)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Exhibit
99.1 to the Company's Current Report on Form 8-K dated June 12, 1998 for the
period ended December 31, 1996, restated to reflect the combined results of
Incyte Pharmaceuticals, Inc. and Synteni, Inc. and is qualified in its entirety
by reference to such Form 8-K.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 9,616
<SECURITIES> 30,622
<RECEIVABLES> 2,126
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 45,189
<PP&E> 32,892
<DEPRECIATION> 9,696
<TOTAL-ASSETS> 69,173
<CURRENT-LIABILITIES> 23,838
<BONDS> 0
0
0
<COMMON> 22
<OTHER-SE> 44,812
<TOTAL-LIABILITY-AND-EQUITY> 69,173
<SALES> 0
<TOTAL-REVENUES> 41,895
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 44,502
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (7,276)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,276)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,276)
<EPS-PRIMARY> (0.32)
<EPS-DILUTED> (0.32)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information for the period ended March
31, 1997, restated to reflect the combined results of Incyte Pharmaceuticals,
Inc. and Synteni, Inc.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 10,252
<SECURITIES> 30,539
<RECEIVABLES> 8,678
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 52,266
<PP&E> 37,648
<DEPRECIATION> 11,939
<TOTAL-ASSETS> 82,449
<CURRENT-LIABILITIES> 36,649
<BONDS> 0
0
0
<COMMON> 23
<OTHER-SE> 45,297
<TOTAL-LIABILITY-AND-EQUITY> 82,449
<SALES> 0
<TOTAL-REVENUES> 17,998
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 15,133
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 509
<INCOME-TAX> 52
<INCOME-CONTINUING> 457
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 457
<EPS-PRIMARY> 0.02
<EPS-DILUTED> 0.02
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information, for the period ended
June 30, 1997, restated to reflect the combined results of Incyte
Pharmaceuticals, Inc. and Synteni, Inc.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 17,340
<SECURITIES> 26,597
<RECEIVABLES> 3,966
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 50,068
<PP&E> 40,610
<DEPRECIATION> 14,359
<TOTAL-ASSETS> 83,502
<CURRENT-LIABILITIES> 32,123
<BONDS> 0
0
0
<COMMON> 23
<OTHER-SE> 50,903
<TOTAL-LIABILITY-AND-EQUITY> 83,502
<SALES> 0
<TOTAL-REVENUES> 39,423
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 32,503
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,886
<INCOME-TAX> 158
<INCOME-CONTINUING> 1,728
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,728
<EPS-PRIMARY> 0.07
<EPS-DILUTED> 0.07
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information for the period ended
September 30, 1997, restated to reflect the combined results of Incyte
Pharmaceuticals, Inc. and Synteni, Inc.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 55,877
<SECURITIES> 65,006
<RECEIVABLES> 9,256
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 138,385
<PP&E> 48,003
<DEPRECIATION> 16,800
<TOTAL-ASSETS> 187,066
<CURRENT-LIABILITIES> 44,471
<BONDS> 0
0
0
<COMMON> 25
<OTHER-SE> 142,146
<TOTAL-LIABILITY-AND-EQUITY> 187,066
<SALES> 0
<TOTAL-REVENUES> 62,649
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 51,027
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,145
<INCOME-TAX> 313
<INCOME-CONTINUING> 3,832
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,832
<EPS-PRIMARY> 0.16
<EPS-DILUTED> 0.15
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Exhibit
99.1 to the Company's Current Report on Form 8-K dated June 12, 1998 for the
period ended December 31, 1997 restated to reflect the combined results of
Incyte Pharmaceuticals, Inc. and Synteni, Inc. and is qualified in its
entirety by reference to such Form 8-K.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 55,598
<SECURITIES> 57,497
<RECEIVABLES> 20,208
<ALLOWANCES> 225
<INVENTORY> 0
<CURRENT-ASSETS> 142,914
<PP&E> 58,190
<DEPRECIATION> 20,120
<TOTAL-ASSETS> 199,089
<CURRENT-LIABILITIES> 52,214
<BONDS> 0
0
0
<COMMON> 26
<OTHER-SE> 145,676
<TOTAL-LIABILITY-AND-EQUITY> 199,089
<SALES> 0
<TOTAL-REVENUES> 89,996
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 72,452
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 7,456
<INCOME-TAX> 548
<INCOME-CONTINUING> 6,908
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,908
<EPS-PRIMARY> 0.28
<EPS-DILUTED> 0.26
</TABLE>
<PAGE> 1
EXHIBIT 99.1
SELECTED CONSOLIDATED FINANCIAL DATA
The data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and related Notes included
in this Report.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:(1)
Revenues $ 89,996 $ 41,895 $ 12,299 $ 1,512 $ 672
Costs and expenses:
Research and development 72,452 41,337 19,272 11,169 4,764
Selling, general and administrative 13,928 6,957 3,952 2,328 737
Charge for purchase of in-process
research and development -- 3,165 -- -- --
-------- -------- -------- -------- --------
Total costs and expenses 86,380 51,459 23,224 13,497 5,501
-------- -------- -------- -------- --------
Income (loss) from operations 3,616 (9,564) (10,925) (11,985) (4,829)
Interest and other income, net
and losses from joint venture 3,840 2,288 988 510 60
-------- -------- -------- -------- --------
Income (loss) before income taxes 7,456 (7,276) (9,937) (11,475) (4,769)
Provision for income taxes 548 -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) $ 6,908 $ (7,276) $ (9,937) $(11,475) $ (4,769)
======== ======== ======== ======== ========
Basic net income (loss) per share(2),(3) $ 0.28 $ (0.32) $ (0.53) $ (0.82) $ (1.46)
======== ======== ======== ======== ========
Number of shares used in computation
of basic net income (loss) per share 24,300 22,398 18,819 14,060 3,264
======== ======== ======== ======== ========
Diluted net income (loss) per share(2),(3) $ 0.26 $ (0.32) $ (0.53) $ (0.82) $ (1.46)
======== ======== ======== ======== ========
Number of shares used in computation
of diluted net income (loss) per share 26,498 22,398 18,819 14,060 3,264
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:(1)
Cash, cash equivalents and
securities available-for-sale $ 119,095 $ 40,238 $ 41,218 $ 25,257 $ 15,540
Working capital 90,700 21,351 39,015 20,866 14,865
Total assets 199,089 69,173 58,892 29,350 17,807
Noncurrent portion of capital lease
obligations and notes payable 801 37 147 148 517
Accumulated deficit (30,129) (37,037) (29,761) (19,824) (8,349)
Stockholders' equity 145,702 44,834 47,606 24,344 16,451
</TABLE>
(1) Financial data for the years ended December 31, 1993, 1994, 1995, and 1996,
restated to reflect combined results and financial position of Incyte, and
Genome Systems, Inc. All periods restated to reflect combined results and
financial position of Incyte, and Synteni, Inc.
(2) Basic and diluted net income (loss) per share for all periods have been
restated in accordance with FASB 128, which the Company adopted on December 31,
1997 (see Footnote 1 to consolidated financial statements).
(3) Basic and diluted net income (loss) per share for 1993 has been restated to
retroactively eliminate cheap stock in accordance with the requirements of Staff
Accounting Bulletin No. 98, issued by the staff of the Securities and Exchange
Commission in February 1998.
3
<PAGE> 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of the Company's financial
condition and results of operations should be read in conjunction with "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and
related Notes included elsewhere in this Report.
When used in this discussion, the words "expects," "anticipates,"
"estimates," and similar expressions are intended to identify forward-looking
statements. Such statements, which include statements as to expected expenditure
levels and the adequacy of capital resources, are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. These risks and uncertainties include, but are not limited to, those
risks discussed below, as well as the extent of utilization of genomic
information by the pharmaceutical industry in both research and development;
risks relating to the development of new products and their use by potential
collaborators of the Company; the impact of technological advances and
competition; the ability of the Company to obtain and retain customers;
competition from other entities; early termination of a database collaboration
agreement or failure to renew an agreement upon expiration; the ability to
successfully integrate the operations of recent business combinations; the cost
of accessing technologies developed by other companies; uncertainty as to the
scope of coverage, enforceability or commercial protection from patents that
issue on gene sequences and other genetic information; the viability of joint
ventures and businesses in which the Company has purchased equity; and the
matters discussed below under the caption "Factors That May Affect Results."
These forward-looking statements speak only as of the date hereof. The Company
expressly disclaims any obligation or undertaking to release publicly any
updates or revisions to any forward-looking statements contained herein to
reflect any change in the Company's expectations with regard thereto or any
change in events, conditions or circumstances on which any such statement is
based.
OVERVIEW
Incyte Pharmaceuticals, Inc. (the "Company") designs, develops and
markets genomic database products, genomic data management software tools, gene
expression microarray services and genomic reagents. The Company's genomic
databases integrate bioinformatics software with proprietary and, when
appropriate, publicly available genetic information to create information-based
tools used by pharmaceutical and biotechnology companies in drug discovery and
development. In building the databases, the Company utilizes high-throughput,
computer-aided gene sequencing and analysis technologies to identify and
characterize the expressed genes of the human genome, as well as certain animal,
plant and microbial genomes. Revenues recognized by the Company are
predominantly related to database collaboration agreements and consist primarily
of non-exclusive database access fees. Revenues also include sales of genomic
screening products and services and fees for custom or "satellite" database
services. The Company's database collaboration agreements provide for future
milestone payments and royalties from the sale of products derived from
proprietary information obtained through the databases. There can be no
assurance that any database collaborators will ever generate products from
information contained within the databases and thus that the Company will ever
receive milestone payments or royalties.
In January 1998, the Company completed the merger with Synteni, Inc.
("Synteni"), a microarray-based gene expression company, located in Fremont,
California. The transaction has been accounted for as a pooling-of-interests,
and the consolidated financial statements discussed herein and all historical
financial information have been restated to reflect the combined operations of
both companies. Synteni's ability to contribute to revenues and income from
operations will be dependent on the ability of the Company of obtain high volume
customers for Synteni's microarray services. Prior to the merger, Synteni's
microarray service agreements consisted of small volume pilot or feasibility
agreements.
In July 1996, the Company issued Common Stock in exchange for all of the
outstanding shares of Genome Systems, Inc. ("Genome Systems"), a genomics
service company located in St. Louis, Missouri. The transaction has been
accounted for as a pooling of interests, and the consolidated financial
statements discussed herein and all historical
4
<PAGE> 3
financial information have been restated to reflect the combined operations of
both companies. In August 1996, the Company acquired for Common Stock Combion,
Inc. ("Combion"), a microarray technology company located in Pasadena,
California. The acquisition of Combion has been accounted for as a purchase, and
the consolidated financial statements discussed herein include the results of
Combion from the date of acquisition, August 15, 1996, forward. In September
1997, the Company formed a joint venture, diaDexus, LLC ("diaDexus"), with
SmithKline Beecham Corporation ("SB"), which will utilize genomic and
bioinformatic technologies in the discovery and commercialization of molecular
diagnostics. The Company and SB each hold a 50 percent equity interest in
diaDexus. The investment is accounted for under the equity method and the
Company will record its share of diaDexus' earnings and losses on its statement
of operations.
The Company's investments in joint ventures and businesses, particularly
diaDexus 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.
One equity investment, OncorMed, Inc.("OncorMed"), received a report from its
independent auditors for the year ended December 31, 1997 which expressed
substantial doubt as to OncorMed's ability to continue as a going concern.
OncorMed is pusuing various financing options and the Company will continue to
evaluate its investments in OncorMed and all of its long-term equity investments
for impairment on a quarterly basis.
While the Company reported net income for 1997, there can be no
assurance that the Company can maintain profitability. The Company's ability to
maintain significant revenues will be dependent upon its ability to obtain
additional database collaborators and retain existing collaborators. The
Company's ability to maintain profitability will also be dependent upon the
level of expenditures necessary for the Company to maintain and support its
services to its collaborators and the extent to which it incurs research and
development, investment, acquisition-related or other expenses related to the
development and provision of its products and services to database
collaborators. Further, the Company's database collaboration agreements
typically have a term of three years. Some of these agreements require the
Company to meet certain performance obligations. These agreements may not be
renewed upon expiration and a database collaboration agreement may be terminated
earlier by a collaborator if the Company breaches the agreement There can be no
assurance that any of the Company's database collaboration agreements will be
renewed upon expiration or not terminated earlier in accordance with its terms.
The loss of revenues from any database collaborator could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Factors That May Affect Results -- History of Operating Losses;
Uncertainty of Continued Profitability or Revenues."
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; the introduction of competitive databases
or services; and expenses related to, and results of, litigation. In particular,
the Company has a limited ability to control the timing of database
installations; there is a lengthy sales cycle required for the Company's
database products; the Company's revenue levels are difficult to forecast; the
time required to complete custom orders can vary significantly; and the
Company's increasing investments in external alliances could result in
significant quarterly fluctuations in expenses due to the payment of milestones,
license fees or research payments.
The need for continued investment in development of the Company's
databases and related products and services and for extensive ongoing
collaborator support capabilities results in significant fixed expenses. If
revenue in a particular period does not meet expectations, the Company may not
be able to adjust significantly its level of expenditures in such period, which
would have an adverse effect on the Company's operating results. The Company may
also experience difficulty in forecasting levels of operating expenditures for,
and integration-related expenses with respect to, subsidiaries acquired through
acquisitions, at least until a substantial period of time has passed since the
acquisition date. This is particularly true when attempting to forecast
expenditure levels for acquired businesses that focus on technologies for which
there is not yet an established market. The Company believes that quarterly
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comparisons of its financial results will not necessarily be meaningful and
should not be relied upon as an indication of future performance. Due to the
foregoing and other unforeseen factors, it is likely that in some future quarter
or quarters the Company's operating results will be below the expectations of
public market analysts and investors. See "Factors that May Affect Results -
Fluctuations in Operating Results."
In an effort to broaden its business, the Company is investing in a
number of new areas, including microarray services, molecular diagnostics,
pharmacogenomics and proteomics. Given that many of these areas address new
markets, or involve untested technologies, it is not known if any of them will
generate revenues or if any revenues that are generated will be sufficient to
provide an adequate return on the investment. Depending on the investment
required and the timing of such investments, expenses or losses related to these
investments could adversely affect operating results.
The Company could incur substantial expenses in its defense of the
lawsuit filed in January 1998 by Affymetrix, Inc. ("Affymetrix") alleging patent
infringement by Synteni and Incyte. Affymetrix seeks a permanent injunction
enjoining Synteni and Incyte from further infringement and, in addition, seeks
damages, costs, attorneys' fees and interest. Affymetrix further requests that
any such damages be trebled on its allegation of willful infringement by Incyte
and Synteni. Incyte and Synteni believe they have meritorious defenses and
intend to defend the suit vigorously. However, there can be no assurance that
Incyte and Synteni will be successful in the defense of this suit, and
litigation, regardless of the outcome, could result in substantial expenses and
diversion of the efforts of management and technical personnel. Further, there
can be no assurance that any license that may be required as a result of this
suit or the outcome thereof would be made available on commercially acceptable
terms, if at all. See "Factors That May Affect Results -- Litigation."
As part of its business strategy, the Company may from time to time
acquire assets and businesses principally relating to, or complementary to, its
operations. These acquisitions, such as the acquisitions mentioned above, are
accompanied by risks commonly encountered in acquisitions of companies. These
risks include, among other things, potential fluctuations in the Company's
quarterly and annual operating results (as discussed above), the difficulty and
expense of assimilating the operations and personnel of the acquired businesses,
the potential disruption of the Company's ongoing business and diversion of
management time and attention, the inability to successfully integrate or to
complete the development and application of acquired technology and the
potential failure to achieve anticipated financial, operating and strategic
benefits from such acquisitions, and difficulties in establishing and
maintaining uniform standards, controls, procedures and policies.
See "Factors That May Affect Results" for a discussion of additional
factors that could affect the Company's results of operations.
RESULTS OF OPERATIONS
The Company recorded net income for the year ended December 31, 1997 of
$6.9 million, compared to net losses of $7.3 million and $9.9 million for the
years ended December 31, 1996 and 1995, respectively. On a per share basis,
basic net income per share was $0.28 for the year ended December 31, 1997 and
basic net loss per share was $0.32 and $0.53 for the years ended December 31,
1996 and 1995, respectively. Diluted net income per share was $0.26 for the year
ended December 31, 1997 and diluted net loss per share was $0.32 and $0.53 for
the years ended December 31, 1996 and 1995, respectively. The net income per
share in 1997 reflects the issuance of approximately 2.7 million shares in an
August 1997 follow-on public offering. The net loss per share in 1996 and 1995
reflects the issuance of approximately 0.6 million shares in 1996 in connection
with the Company's business combinations with Genome Systems and Combion and the
issuance of approximately 3.7 million shares in a November 1995 follow-on
public offering. The net loss per share for all periods presented reflects the
issuance of approximately 2.3 million shares in January 1998 in connection with
the Company's business combination with Synteni. All share and per share data
have been adjusted retroactively for a two-for-one stock split effected in the
form of a stock dividend paid on November 7, 1997 to holders of record on
October 17, 1997.
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Revenues. Revenues for the years ended December 31, 1997, 1996 and 1995
were $90.0 million, $41.9 million and $12.3 million, respectively. Revenues
resulted primarily from database access fees and, to a much lesser extent, from
custom satellite database services, genomic screening products and services, and
gene expression services. The increase in revenues from year to year was
predominantly driven by an increase in the number of database collaboration
agreements.
Expenses. Total costs and expenses for the years ended December 31,
1997, 1996 and 1995 were $86.4 million, $51.5 million and $23.2 million,
respectively. Total costs and expenses for the year ended December 31, 1996
included a one-time charge of $3.2 million for the purchase of in-process
research and development relating to the acquisition of Combion. Total costs and
expenses are expected to increase in the foreseeable future due to the continued
investment in new product development, bioinformatics, microarray production
capacity, and growth in marketing, sales and customer services. However, if the
Company does not obtain additional collaborators in a timely manner, if the
Company's database collaborators do not renew their collaboration agreement at
the end of their applicable terms, or if the delivery of custom orders is
delayed, the Company may not be able to adjust significantly its level of
expenditures in any period, which would have an adverse effect on the Company's
operating results.
Research and development expenses for the years ended December
31, 1997, 1996 and 1995 were $72.5 million, $41.3 million and $19.3 million,
respectively. The increase in research and development expenses resulted
primarily from an increase in bioinformatics and software development efforts,
increased data and reagent production capacity, increased microarray production
and technology development initiatives, license and milestone payments under
research and development alliances, and increased costs related to intellectual
property protection. The Company expects research and development spending to
increase over the next few years as the Company continues to pursue the
development of new database products and services, invest in new technologies,
broaden its gene sequence and microarray production operations and invest in the
continued protection of its intellectual property.
Selling, general and administrative expenses for the years ended
December 31, 1997, 1996 and 1995 were $13.9 million, $7.0 million and $4.0
million, respectively. The increase in selling, general and administrative
expenses resulted primarily from the growth in marketing, sales, customer
support, and corporate administration. The Company expects that selling, general
and administrative expenses will continue to increase due to continued growth in
marketing, sales and customer support; the expansion of the Company's United
Kingdom operations; and legal expenses related to the Company's defense of the
patent infringement lawsuit filed by Affymetrix in January 1998.
Interest and Other Income, Net. Interest and other income, net for the
years ended December 31, 1997, 1996 and 1995 were $4.1 million, $2.3 million and
$1.0 million, respectively. Interest and other income, net increased as a result
of increased interest income from higher average combined cash, cash equivalent
and marketable securities balances.
Losses from Joint Venture. Losses from joint ventures were $0.3 million
for the year ended December 31, 1997. The loss represents the Company's share of
diaDexus' losses from operations. Since diaDexus was formed in September 1997,
no losses from joint ventures were recognized prior to 1997. The Company expects
that losses from joint ventures will increase in 1998, accounting for a full
year of expanding operations.
Income Taxes. The estimated effective annual income tax rate for 1997 is
7.3%, which represents the provision of federal and state alternative minimum
taxes after utilization of net operating loss carryforwards. No provisions have
been recorded prior to the 1997 fiscal year as the Company incurred annual net
operating losses.
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LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, the Company had $119.1 million in cash, cash
equivalents, restricted cash and marketable securities, compared to $40.2
million as of December 31, 1996. This increase was primarily due to net proceeds
of $87.2 million from the issuance of common stock in a July 1997 follow-on
public offering. The Company has classified all of its marketable securities as
short-term, as the Company may not 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 $17.7 million for the year
ended December 31, 1997, compared to $18.5 million for the year ended December
31, 1996 and net cash used by operating activities of $8.8 million for the year
ended December 31, 1995. The decrease in net cash provided by operating
activities in 1997 compared to 1996 resulted primarily from increases in
accounts receivable partially offset by the change from net loss to net income,
increases in accrued and other liabilities, increases in deferred revenue due to
the prepayment of database collaboration fees, and increased depreciation and
amortization expenses. Net cash provided by operating activities in 1996 as
compared to a use of cash in 1995 resulted from increases in deferred revenue
and accounts payable, and decreases in net loss and accounts receivable. In the
future, net cash generated by operating activities may fluctuate significantly
from period to period due to the timing of large prepayments by database
collaborators.
The Company's investing activities, other than purchases, sales and
maturities of marketable securities, have consisted predominantly of capital
expenditures and long-term investments. Capital expenditures for the years ended
December 31, 1997, 1996 and 1995 were $27.2 million, $20.5 million and $8.1
million, respectively. Capital expenditures increased in 1997 and 1996 primarily
due to investments in computer and laboratory equipment as well as leasehold
improvements related to the expansion of the Company's facilities. The Company
has entered into a multi-year lease with respect to a 95,000 square foot
building to be constructed adjacent to the Company's Palo Alto headquarters. The
Company does not expect to incur expenses related to this facility until late
1998 or early 1999. Long-term investments in companies with which the Company
has research and development alliances increased to $8.2 million for the year
ended December 31, 1997 from $0.3 million for the year ended December 31, 1996.
New investments in 1997 included equity investments in NetGenics, Inc. and
OncorMed, Inc. In addition, $6.0 million was categorized as restricted cash due
to future obligations to diaDexus pursuant to a joint venture agreement with SB
entered into in 1997. In the future, net cash used by investing activities may
fluctuate significantly from period to period due to the timing of strategic
equity investments, capital expenditures and maturity/sales and purchases of
marketable securities.
Net cash provided by financing activities was $94.8 million, $1.5
million and $32.9 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Net cash provided by financing activities in 1997 and 1995 was
primarily due to proceeds from follow-on public stock offerings in August 1997
and November 1995, respectively, while net cash provided by financing activities
in 1996 was due to issuances of common stock upon exercise of stock options.
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 June 1999. However, the Company may be unable
to obtain additional collaborators or retain existing collaborators for the
Company's databases, and its database products and services may not produce
revenues which, together with the Company's cash, cash equivalents and
marketable securities, would be adequate to fund the Company's cash
requirements. The Company's cash requirements depend on numerous factors,
including the ability of the Company to attract and retain collaborators for its
databases and genomic products and services; 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. In
particular, the Company expects its cash requirements to increase in 1998 as it
increases its investment in data processing-related computer hardware in order
to support its existing and new database products; continues to seek access to
technologies through investments, alliances, license agreements, and/or
acquisitions; makes investments associated with integration of acquired
companies;
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and addresses its needs for larger facilities and/or improvements in existing
facilities. The Company expects to continue to fund future operations with
revenues from genomic database products and services in addition to using its
current cash, cash equivalents and marketable securities. Changes in the
Company's research and development plans or other changes affecting the
Company's operating expenses may result in changes in the timing and amount of
expenditures of the Company's capital resources. If additional capital is raised
through the sale of equity or convertible debt securities, the issuance of these
securities could result in dilution to the Company's existing stockholders.
Additional funding, if necessary, may not be available on favorable terms, if at
all. If adequate funds are not available, the Company may be required to curtail
operations significantly or to obtain funds through entering into collaborative
arrangements that may require the Company to relinquish rights to certain of its
technologies, product candidates, products or potential markets.
FACTORS THAT MAY AFFECT RESULTS
Uncertain Effects of the Synteni Merger. The combination of Synteni and
the Company involves several potential operating and business risks, including
the integration of Synteni's and the Company's businesses and management in a
timely, efficient and effective manner, the timely integration of Synteni's
microarray technology and services with the Company's database products and
services, integration of the respective sales and marketing and research and
development efforts, and any resulting loss of efficiency or loss of employees.
The combined companies may not realize any revenue enhancements or cost savings
or maintain Synteni's business relationships with its customers after the
merger. Also, any cost savings that are realized due to the merger may be offset
by increases in other expenses or operating losses, including losses due to
problems in integrating the two companies. See " -- Risks Associated With
Acquisitions." Although the Company believes that beneficial synergies will
result from the Synteni merger, the combination of the two companies'
businesses, even if achieved in an efficient, effective and timely manner, may
not result in combined results of operations and financial condition superior to
what would have been achieved by each company independently, and may take longer
than expected. See " -- History of Operating Losses; Uncertainty of Continued
Profitability or Revenues."
Risks Associated with Acquisitions. As part of its business strategy,
the Company may from time to time acquire assets and businesses principally
relating to, or complementary to, its operations. These acquisitions may include
acquisitions for the purpose of acquiring specific technology. The Company
acquired two companies, Genome Systems, Inc. and Combion, Inc., in 1996 and
acquired Synteni in January 1998. If the Company acquires additional businesses
that are not located near the Company's Palo Alto, California headquarters, the
Company may experience more difficulty integrating and managing the acquired
businesses' operations. These and any other acquisitions by the Company involve
risks commonly encountered in acquisitions of companies. These risks include,
among other things, the following: the Company may be exposed to unknown
liabilities of acquired companies; the Company may incur acquisition costs and
expenses higher than it anticipated; fluctuations in the Company's quarterly and
annual operating results may occur due to the costs and expenses of acquiring
and integrating new businesses or technologies; the Company may experience
difficulty and expense of assimilating the operations and personnel of the
acquired businesses; the Company's ongoing business may be disrupted and its
management's time and attention may be diverted; the Company may be unable to
integrate successfully or to complete the development and application of
acquired technology and may fail to achieve the anticipated financial, operating
and strategic benefits from these acquisitions; the Company may experience
difficulties in establishing and maintaining uniform standards, controls,
procedures and policies; the Company's relationships with key employees and
customers of acquired businesses may be impaired, or these key employees and
customers may be lost, as a result of changes in management and ownership of the
acquired businesses; the Company may incur amortization expenses if an
acquisition is accounted for as a purchase; and the Company's stockholders may
be diluted if the consideration for the acquisition consists of equity
securities. The Company may not overcome these risks or any other problems
encountered in connection with acquisitions. If the Company is unsuccessful in
doing so, its business, financial condition and results of operations could be
materially and adversely affected.
History of Operating Losses; Uncertainty of Continued Profitability or
Revenues. For the years ended December 31, 1996 and 1995, the Company had net
losses of $7.3 million and $9.9 million, respectively, and as of December 31,
1997, the Company had an accumulated deficit of $30.1 million. The Company has
experienced substantial revenue growth since 1995 and has reported quarterly
profits only since the first quarter of 1997. However, the Company may not be
able to maintain revenue growth or profitability. The Company's continued
investment in new
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product and technology development, obligations under existing and future
research and development alliances, and increased investment in marketing, sales
and customer service will require a continued increase in expenditures in 1998
and beyond. Synteni's ability to contribute to the profitability of the Company
will be dependent on the ability of the Company and Synteni to obtain high
volume customers for Synteni's microarray services and the costs associated with
increasing microarray production capacity. Prior to the Merger, Synteni's
microarray service agreements consist of small volume pilot or feasibility
agreements. The Company's ability to achieve and maintain significant revenues
will be dependent upon its ability to obtain additional database collaborators
and retain existing collaborators. The Company's ability to maintain
profitability will be dependent upon its ability to obtain such database
collaborators, the level of expenditures necessary for the Company to maintain
and support its services to its collaborators, and the extent to which it incurs
research and development, investment, acquisition-related or other expenses
related to the development and provision of its products and services to
database collaborators. While, as of April 1998, the Company had twenty-one
database collaborations, the Company may be unable to enter into any additional
collaborations. Further, the Company's database collaboration agreements
typically have a term of three years. Some of these agreements require the
Company to meet certain performance obligations. These agreements may not be
renewed upon expiration, and a database collaboration agreement may be
terminated earlier by a collaborator if the Company breaches the agreement and
fails to cure such breach within a specified period. The loss of revenues from
any database collaborator could have a material adverse effect on the Company's
business, financial condition and results of operations.
Part of the Company's commercialization strategy is to license to
database collaborators the Company's patent rights to individual partial genes
or full-length cDNA sequences from the Company's proprietary sequence database,
for development as potential pharmaceutical, diagnostic or other products. Any
potential product that is the subject of such a license will require several
years of further development, clinical testing and regulatory approval prior to
commercialization. Accordingly, the Company does not expect to receive any
milestone or royalty payments from any such licenses for a substantial period of
time, if at all.
Fluctuations in Operating Results. The Company's operating results may
fluctuate significantly from quarter to quarter as a result of a variety of
factors, including; changes in the demand for the Company's products and
services; the pricing of database access to database collaborators; the nature,
pricing and timing of other products and services provided to the Company's
collaborators; changes in the research and development budgets of the Company's
collaborators and potential collaborators; capital expenditures; acquisition and
licensing costs and other costs related to the expansion of the Company's
operations, including operating losses of acquired businesses such as Synteni;
the introduction of competitive databases or services; and expenses related to,
and results of, litigation (including the lawsuit filed by Affymetrix described
below under "-Litigation") and other proceedings relating to intellectual
property rights. In particular, the Company has a limited ability to control the
timing of database installations, there is a lengthy sales cycle required for
the Company's database products, the Company's revenue levels are difficult to
forecast, the time required to complete custom orders can vary significantly and
the Company's increasing investments in external alliances could result in
significant quarterly fluctuations in expenses due to the payment of milestones,
license fees or research payments.
The Company's investments in joint ventures and businesses, particularly
diaDexus, a joint venture with SB, may require the Company to record losses or
expenses related to its proportionate ownership interest in such entities, to
record charges for the acquisition of in-process technologies, or to record
charges for recognition of the impairment in the value of the securities
underlying such investments. To date, exclusive of losses from joint ventures,
the Company has not incurred significant losses on its long-term equity
investments. One entity in which the Company has made an equity investment,
OncorMed, received a report from its independent auditors for the year ended
December 31, 1997 which expressed substantial doubt as to OncorMed's ability to
continue as a going concern. OncorMed has indicated to the Company that it is
pursuing various financing options and the Company will continue to evaluate its
investment in OncorMed and all of its long-term equity investments for
impairment on a quarterly basis. In an effort to broaden its business, the
Company is investing in a number of new areas, including microarray services,
molecular diagnostics, pharmacogenomics and proteomics. Given that many of these
address new markets, or involve untested technologies, it is not known if any of
them will generate revenues or if the revenues will be sufficient to provide an
adequate return on the investment. Depending on the investment required and the
timing of such investments, expenses or losses related to these investments
could adversely affect operating results.
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The need for continued investment in development of the Company's
databases and related products and services and for extensive ongoing
collaborator support capabilities results in significant fixed expenses. If
revenue in a particular period does not meet expectations, the Company may not
be able to adjust significantly its level of expenditures in such period, which
would have an adverse effect on the Company's operating results. The Company may
also experience difficulty in forecasting levels of operating expenditures for,
and integration-related expenses with respect to, subsidiaries acquired through
acquisitions, at least until a substantial period of time has passed since the
acquisition date. This is particularly true when attempting to forecast
expenditure levels for acquired businesses that focus on technologies for which
there is not yet an established market. The Company believes that quarterly
comparisons of its financial results will not necessarily be meaningful and
should not be relied upon as an indication of future performance. Due to the
foregoing and other unforeseen factors, it is likely that in some future quarter
or quarters the Company's operating results will be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially and adversely affected.
Competition and Technological Changes. There are a finite number of
genes in the human genome, and competitors may seek to identify, sequence and
determine in the shortest time possible the biological function of a large
number of genes in order to obtain a proprietary position with respect to the
largest number of new genes discovered. There are a number of companies, other
institutions, and government-financed entities engaged in gene sequencing, gene
discovery, gene expression analysis, positional cloning and other genomic
service businesses. Many of these companies, institutions and entities have
greater financial and human resources than the Company. In addition, the Company
is aware that other companies have developed genomic databases and are
marketing, or have announced their intention to market their data to
pharmaceutical companies. The Company expects that additional competitors may
attempt to establish gene sequence, gene expression or other genomic databases
in the future.
In addition, competitors may discover and establish patent positions
with respect to gene sequences in the Company's databases. Further, certain
entities engaged in gene sequencing, including Merck & Co., Inc. ("Merck") and
The Institute for Genomic Research ("TIGR"), have made the results of their
sequencing efforts publicly available. The Perkin-Elmer Corporation, Dr. J.
Craig Venter, and TIGR announced in May 1998 the signing of a letter of intent
to form a new company that has the goal of sequencing the entire human genome
within three years and to make the sequence information publicly available. 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 the Company's databases to the Company's
collaborators and adversely affect the Company's ability to realize royalties or
other revenue from commercialization of products based upon this genetic
information.
The gene sequencing machines that are utilized in the Company's
high-throughput computer-aided gene sequencing operations are commercially
available and are currently being utilized by several competitors. Some of the
Company's competitors or potential competitors are in the process of developing,
and may successfully develop, proprietary sequencing technologies that may be
more advanced than the technology used by the Company. In addition, the Company
is aware that there are a number of companies pursuing alternative methods for
generating gene expression information, including those that have developed, and
are developing, microarray technologies. At least one other company currently
offers microarray-based services that might be competitive with those offered by
the Company. These advanced sequencing or gene expression technologies, if
developed, may not be commercially available for purchase or license by the
Company on reasonable terms, if at all.
A number of companies have announced their intent to develop and market
software to assist pharmaceutical companies and academic researchers in the
management and analysis of their own genomic data, as well as the analysis of
sequence data available in the public domain. Some of these entities have access
to significantly greater resources than the Company and these products may
achieve greater market acceptance than the Company's products.
The Company's databases also require extensive software support and
incorporate features determined by database collaborators' needs. If the Company
experiences delays or difficulties in implementing its database software or
collaborator-requested features, its ability to service its collaborators may be
adversely affected, which might have an adverse effect on the Company's business
and operating results.
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The genomics industry is characterized by extensive research efforts and
rapid technological progress. To remain competitive, the Company will be
required to continue to expand its databases and to enhance the functionality of
its bioinformatics and database software. New developments are expected to
continue and discoveries by others may render the Company's services and
potential products noncompetitive.
New and Uncertain Business. The Company's genomic database business and
the use of its databases, software tools and related services to assist its
collaborators and potentially improve the efficiency of the traditional drug
discovery process represent a business for which there is no precedent. In
addition, the Company's microarray services business represents a business for
which there is no precedent. The Company's collaborators or potential
collaborators may determine that the databases, software tools and microarray
and related services provided by the Company are not useful or cost-effective.
The Company's strategy of using high-throughput sequencing to identify genes
rapidly and obtain proprietary rights in as many genes as possible and its
strategy of using microarrays to identify differentially expressed genes is
unproven. In addition, the Company has limited experience in providing
bioinformatics software and database products and services. The Company's
ability to sustain profitability depends on attracting additional collaborators
and retaining existing collaborators for its database, sequencing and software
products and services and microarray services. The nature and price of these
database, sequencing and software products and services and microarray services
are such that there is a limited number of pharmaceutical and biotechnology
companies that are potential collaborators for such products and services.
Additional factors that may affect demand for the Company's products and
services include the extent to which potential collaborators choose to conduct
in-house gene sequencing and bioinformatics analysis, the emergence of
competitors offering similar services at competitive prices, the ability of the
Company to service satisfactorily its existing collaborators, the extent to
which the gene and related information in the Company's database is made public
by, or is the subject of, patents issued to others, the Company's ability to
establish and enforce proprietary rights to its products, and the emergence of
technological innovations in gene sequencing, gene expression profiling or
bioinformatics and relational database software that are more advanced than the
technology used by and available to the Company. The Company may be unable to
attract additional collaborators on acceptable terms for its products and
services or develop a sustainable profitable business.
Risks Associated with Strategic Investments. The Company has funded and
intends in the future to fund strategic equity investments in joint ventures or
businesses that complement the business of the Company. These investments, such
as the Company's investment in diaDexus, may require the Company to record
losses and expenses related to its proportionate ownership interest in such
entities, the acquisition of in-process technologies, or the impairment in the
value of the securities underlying such investments. These losses may exceed
amounts anticipated, which could result in the Company's operating results being
below the expectations of public market analysts and investors. These
investments may often be made in securities for which there is no public trading
market or in securities not registered under the Securities Act of 1933 and
therefore subject to trading restrictions, either of which increases the
Company's risk of investment and reduces the liquidity of the Company's
investment. In addition, the Company could be required to invest greater amounts
than initially anticipated or to devote substantial management time to the
management of research and development relationships and joint ventures. The
occurrence of any of the foregoing could result in a material adverse effect on
the Company's business, financial condition and results of operations.
Lengthy Sales Cycle. The ability of the Company to obtain new
collaborators for its databases, software tools and microarray and other
services depends in significant part upon prospective collaborators' perceptions
that the Company's databases, software tools, and 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
database collaboration will result.
Uncertainty of Protection of Patents and Proprietary Rights. The
Company's database business and competitive position are dependent in part upon
its ability to protect its proprietary database information and software
technology. Despite the Company's efforts to protect its proprietary database
information and software technology, unauthorized parties may attempt to obtain
and use information that the Company regards as proprietary. Although the
12
<PAGE> 11
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 sofware, but 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 Asia, Canada, Japan, Mexico and New Zealand claiming
full-length gene sequences associated with cells and tissues that are the
subject of the Company's high-throughput gene sequencing program. To date, the
Company holds a number of issued U.S. patents on full-length genes, but no
patent has issued from any of the Company's patent applications that claim
partial gene sequences. The Company is aware that Merck (in conjunction with
Washington University) and TIGR have made certain gene sequences publicly
available, which may adversely affect the ability of the Company and others to
obtain patents on such genes. The Company's ability to obtain patent protection
for certain sequences that have been made publicly available may be adversely
affected.
The Company believes that certain of its patent applications claim genes
which may also be claimed in patent applications filed by other parties. In some
or all of these applications, a determination of priority of inventorship may
need to be decided in an interference before the United States Patent and
Trademark Office ("USPTO"). The USPTO has declared an interference involving a
Company patent application covering one full-length gene, and has informed the
Company that interferences may be declared with respect to applications covering
an additional ten genes.
The patentability of partial gene sequences in general is uncertain,
involves complex legal and factual questions, and has recently been the subject
of much controversy. As a result, patent applications filed by the Company on
such partial gene sequences may not result in issued patents. Even if patents
are issued for partial gene sequences, there may be uncertainty as to the scope
of the coverage, enforceability or commercial protection provided by any such
patents. Certain court decisions suggest that disclosure of a partial sequence
may not be sufficient to support the patentability of a full-length sequence and
that patent claims to a partial sequence may not cover a full-length sequence
inclusive of that partial sequence.
13
<PAGE> 12
The USPTO has had a substantial backlog of biotechnology patent
applications and, in particular, applications that claim gene sequences. In
1996, the USPTO issued guidelines limiting the number of gene sequences that can
be examined within a single patent application. Many of the Company's patent
applications containing multiple partial sequences contain more sequences than
the maximum number allowed under the new guidelines. The Company is reviewing
its options and, due to the resources needed to comply with the guidelines, may
decide to abandon patent applications for some of its partial gene sequences.
In view of the possible delay in obtaining allowance of some of the
Company's patent applications, and the secrecy of patent applications, the
Company does not know if other applications that would have priority over the
Company's applications have been filed. Furthermore, changes in U.S. patent laws
resulting from the General Agreement on Tariffs and Trade ("GATT") became
effective in June 1995. Most notably, GATT resulted in U.S. law being amended to
change the term of patent protection from seventeen years from patent issuance
to twenty years from the earliest effective filing date of the application.
Because the average time from filing to issuance of biotechnology applications
is at least one year and may be more than three years depending on the subject
matter, a twenty-year patent term from the date of filing may result in a
substantially shortened term of patent protection, which may adversely affect
the Company's period of exclusivity under any patents that may issue to the
Company. Pending applications claiming large numbers of gene sequences may, in
some situations, need to be refiled while claiming priority to the earliest
filing date and, in such situations, the patent term will be measured from the
date of the earliest priority application. This would reduce the patent term and
have a potentially adverse effect on the Company's period of exclusivity.
Biotechnology patent law outside the United States is even more
uncertain and is currently undergoing review and revision in many countries.
Further, the laws of certain foreign countries may not protect the Company's
intellectual property rights to the same extent as do the laws of the United
States. The Company may participate in opposition proceedings to determine the
validity of its or its competitors' non-U.S. patents, which could result in
substantial costs to and diversion of effort by the Company.
As the biotechnology industry expands, more patents are issued and other
companies engage in the business of discovering genes through the use of high
speed sequencers and in other genomic-related businesses, such as microarray and
gene expression profiling, the risk increases that the Company's potential
products or the processes used by the Company to develop these products, may be
subject to claims that they infringe the patents of others. Certain of these
patents are the subject of litigation. Therefore, the Company's operations may
require it to obtain licenses under any of these patents or proprietary rights,
and these licenses may not be made available on terms acceptable to the Company.
Litigation may be necessary to defend against or assert claims of infringement,
to enforce patents issued to the Company, to protect trade secrets or know-how
owned by the Company, or to determine the scope and validity of the proprietary
rights of others. The Company could also be involved in interference 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 claims. The Company
believes that it is not infringing the patent rights of any such third party,
and in circumstances in which the Company has determined a response to an
alleged infringement claim to be appropriate, the Company has notified the
claimant to that effect. To date, except as set forth below under "-Litigation,"
no third party has taken any action with respect to an alleged claim against the
Company. There can be no assurance that action will not be taken against the
Company in the future, either with respect to previously asserted or new claims
or that if any action is taken, what the outcome of such action will be.
Litigation. On January 6, 1998, Affymetrix filed a lawsuit in the United
States District Court for the District of Delaware alleging infringement of U.S.
patent number 5,445,934 (the "'934 Patent") by both Synteni and Incyte. The
14
<PAGE> 13
complaint alleges that the '934 Patent has been infringed by the making, using,
selling, importing, distributing or offering to sell in the U.S. high density
arrays by Synteni and Incyte and that such infringement was willful. Affymetrix
seeks a permanent injunction enjoining Synteni and Incyte from further
infringement of the '934 Patent and, in addition, seeks damages, costs and
attorney's fees and interest. Affymetrix further requests that any such damages
be trebled based on its allegation of willful infringement by Incyte and
Synteni. Incyte and Synteni believe they have meritorious defenses and intend to
defend the suit vigorously. However, there can be no assurance that Incyte and
Synteni will be successful in the defense of this suit, and litigation,
regardless of the outcome, could result in substantial expenses and diversion of
the efforts of management and technical personnel. Further, there can be no
assurance that any license that may be required as a result of this suit or the
outcome thereof would be made available on commercially acceptable terms, if at
all.
Future Capital Needs; Uncertainty of Additional Funding. The Company
believes that its existing cash, cash equivalents and marketable securities
should be adequate to satisfy the Company's projected working capital, capital
expenditure and other cash requirements at least through June 1999. However, the
Company may be unable to obtain additional database collaborators or retain
existing collaborators for the Company's databases, and its database products
and services may not produce revenues, which together with the Company's cash,
cash equivalents, and marketable securities, will be adequate to fund the
Company's cash requirements. The Company's cash requirements depend on numerous
factors, including the ability of the Company to attract and retain
collaborators for its databases and genomic products and services; expenditures
in connection with alliances, license agreements and acquisitions of and
investments in complementary technologies and businesses; competing
technological and market developments; the cost of filing, prosecuting,
defending, and enforcing patent claims and other intellectual property rights;
the purchase of additional capital equipment or other capital expenditures,
including capital equipment necessary to ensure that the Company's sequencing
and microarray operations remain competitive; capital expenditures required to
expand the Company's and Synteni's facilities; and costs associated with the
integration of new operations assumed through mergers and acquisitions. In
particular, the Company expects its cash requirements to increase in 1998 as it
increases its investment in data processing-related computer hardware in order
to support its existing and new database products; continues to seek access to
technologies through investments, alliances, license agreements, and/or
acquisitions; makes investments associated with integration of acquired
companies; and addresses its needs for larger facilities and/or improvements in
existing facilities. Changes in the Company's research and development plans, or
other changes affecting the Company's operating expenses, may result in changes
in the timing and amount of expenditures of the Company's capital resources. If
additional capital is raised through the sale of equity or convertible debt
securities, the issuance of these securities could result in dilution to the
Company's existing stockholders. Additional funding, if necessary, may not be
available on favorable terms, if at all. If adequate funds are not available,
the Company may be required to curtail operations significantly or to obtain
funds through entering into collaborative arrangements that may require the
Company to relinquish rights to certain of its technologies, product candidates,
products or potential markets.
Management of Growth. The Company has recently experienced, and expects
to continue to experience, significant growth in the number of its employees and
the scope of its operations. This growth has placed, and may continue to place,
a significant strain on the Company's management and operations. The Company's
ability to manage effectively this growth will depend upon its ability to
broaden its management team and its ability to attract, hire and retain skilled
employees. The Company's success will also depend on the ability of its officers
and key employees to continue to implement and improve its operational,
management information and financial control systems and to expand, train and
manage its employee base. In addition, the Company must continue to take steps
to provide customer support resources as the number of overall database
collaborators and the number of requests from collaborators increases. Further,
the Company's database collaborators typically have worldwide operations and may
require support at multiple U.S. and foreign sites. Providing this support may
require the Company to open offices in addition to its Palo Alto, California
headquarters and its offices in St Louis, Missouri and the United Kingdom, which
could result in additional burdens on the Company's systems and resources. The
Company's inability to manage growth effectively, including its growth through
acquisitions, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Key Employees. The Company is highly dependent on the
principal members of its scientific and management staff, including Roy A.
Whitfield, its Chief Executive Officer, and Randal W. Scott, its President and
Chief Scientific Officer, the loss of whose services would have a material
adverse effect on the Company's business. The
15
<PAGE> 14
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 continue to identify
genes through gene sequencing would be adversely affected. In addition, although
the Company obtains, from a number of sources, tissue samples from which mRNA
may be isolated, the loss of access to some of these sources, increased fees for
access to these sources or increased restrictions on use of the information
generated could adversely affect the Company's business.
The Company's strategy for the development of its database and
sequencing business and the commercialization of its portfolio of partial and
full-length gene sequences may require the Company to enter into various
research and development relationships with corporate and academic collaborators
and others. The success of these relationships is dependent upon the performance
of outside parties of their responsibilities. The Company may not be able to
establish collaborative arrangements or license agreements that the Company
deems necessary or acceptable to develop its database and sequencing business
or, in the future, to commercialize its portfolio of partial and full-length
gene sequences. In addition, these collaborative arrangements or license
agreements may not be successful. The Company's collaborators may also be
pursuing alternative technologies or developing alternative products either on
their own or in collaboration with others, including the Company's competitors.
The Company has relied on scientific, technical, pathology, commercial
and other data supplied and disclosed by others, including its academic
collaborators and sources of tissue samples, and may rely on these data in the
construction of its database. There can be no assurance that these data 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, the performance of the Company's computer systems
and those of its suppliers and customers in the Year 2000 is uncertain. Any
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities. The Company plans to initiate a
Year 2000 project, using internal and external resources, to evaluate the impact
of the Year 2000 on its products and operating systems. This will include the
initiation of formal communications with its significant suppliers and customers
to determine the extent to which the Company's interface systems are vulnerable
to third party failures to remediate their own Year 2000 issues. There can be no
guarantee that the systems of other companies on which the Company's systems
rely will be timely converted and would not have an adverse effect on the
Company's systems. The Company will perform a comprehensive review of all
internally used financial and administrative systems as well as internally
developed products sold to customers. At this time, given that the Company's
internal financial and administrative systems have been installed within the
last few years, and all internally developed software-based products sold to
customers have been developed over the last few years, the Company does not
expect the cost of addressing the Year 2000 issue to have a material impact on
the Company's business, results of operations or
16
<PAGE> 15
financial condition. However, there can be no guarantee that if modifications or
replacement of portions of the software are necessary, it will be completed in a
timely manner.
Hazardous Materials; Environmental Matters. The Company's research and
development involves the controlled use of hazardous and radioactive materials
and biological waste. The Company is subject to federal, state and local laws
and regulations governing the use, manufacture, storage, handling and disposal
of these materials and certain waste products. Although the Company believes
that its safety procedures for handling and disposing of these materials comply
with the standards prescribed by such laws and regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damages that result and any such liability could exceed the resources of
the Company. Although the Company believes that it is in compliance in all
material respects with applicable environmental laws and regulations and
currently does not expect to make material additional capital expenditures for
environmental control facilities in the near-term, the Company may in the future
be required to incur significant costs to comply with environmental laws and
regulations, and there can be no assurance that the operations, business or
assets of the Company will not be materially or adversely affected by current or
future environmental laws or regulations.
Reliance on Pharmaceutical Industry; Uncertainty of Health Care Reform
and Related Matters. The Company expects that all of its revenues in the
foreseeable future will be derived from products and services provided to the
pharmaceutical and biotechnology industries. Accordingly, the Company's success
in the foreseeable future is directly dependent upon the success of the
companies within those industries and their continued demand for the Company's
products and services. The Company's operations may in the future be subject to
substantial period-to-period fluctuations as a consequence of reductions and
delays in research and development expenditures by companies in these industries
resulting from factors such as changes in economic conditions, changes in the
regulatory environment affecting health care and health care providers, pricing
pressures, market-driven pressures on companies to consolidate and reduce costs,
and other factors affecting research and development spending. The occurrence of
any of the foregoing factors could have a material adverse effect on the
Company's business, financial condition and results of operations.
Risk of Business Interruption. The Company conducts all of its
sequencing and other activities at its facilities in Palo Alto, California, and
Synteni conducts all of its operations at its facilities in Fremont, California.
Both locations are in a seismically active area. Although the Company maintains
business interruption insurance, the Company does not currently have, nor does
it plan to obtain, earthquake insurance. A major catastrophe (such as an
earthquake or other natural disaster) could result in a prolonged interruption
of the Company's business.
17
<PAGE> 16
FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.......................... 19
Consolidated Balance Sheets at December 31, 1997 and 1996.................. 20
Consolidated Statements of Operations for the years ended December 31,
1997, 1996 and 1995........................................................ 21
Consolidated Statement of Stockholders' Equity for the three year
period ended December 31, 1997............................................. 22
Consolidated Statements of Cash Flow for the years ended December 31,
1997, 1996 and 1995........................................................ 23
Notes to the Consolidated Financial Statements............................. 25
</TABLE>
18
<PAGE> 17
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Incyte Pharmaceuticals, Inc.
We have audited the accompanying consolidated balance sheets of Incyte
Pharmaceuticals, Inc., as of December 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Incyte
Pharmaceuticals, Inc., at December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/S/ERNST & YOUNG LLP
Palo Alto, California
January 12,1998
except for "Principles of Consolidation" in Note 1 and paragraph 3 of Note 7
as to which the date is
January 22, 1998
19
<PAGE> 18
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except number of shares and par value)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1997 1996
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 55,598 $ 9,616
Restricted cash 6,000 --
Marketable securities - available-for-sale 57,497 30,622
Accounts receivable 19,983 2,126
Prepaid expenses and other current assets 3,836 2,825
--------- ---------
Total current assets 142,914 45,189
Property and equipment, net 38,070 23,196
Long-term investments 14,800 452
Deposits and other assets 3,305 336
--------- ---------
Total assets $ 199,089 $ 69,173
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,791 $ 4,780
Accrued liabilities 5,416 794
Accrued compensation expense 3,192 853
Due to joint venture 6,000 --
Deferred revenue 31,815 17,411
--------- ---------
Total current liabilities 52,214 23,838
Non-current portion of accrued rent and other
non-current liabilities 1,173 501
--------- ---------
Total liabilities 53,387 24,339
--------- ---------
Commitments
Stockholders' equity:
Preferred stock, $0.001 par value; 5,000,000
shares authorized; none issued and outstanding
at December 31, 1997 and 1996 -- --
Common stock, $0.001 par value; 75,000,000 shares
authorized; 26,054,475 shares issued and
outstanding at December 31, 1997; 22,389,802
shares at December 31, 1996 26 22
Additional paid-in capital 175,749 81,922
Unrealized gains (losses) on marketable
securities and other 56 (73)
Accumulated deficit (30,129) (37,037)
--------- ---------
Total stockholders' equity 145,702 44,834
--------- ---------
Total liabilities and stockholders' equity $ 199,089 $ 69,173
========= =========
</TABLE>
See accompanying notes
20
<PAGE> 19
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Revenues (Notes 1 and 2) $ 89,996 $ 41,895 $ 12,299
Costs and expenses:
Research and development 72,452 41,337 19,272
Selling, general and administrative 13,928 6,957 3,952
Purchase of in-process research and development -- 3,165 --
-------- -------- --------
Total costs and expenses 86,380 51,459 23,224
Income (loss) from operations 3,616 (9,564) (10,925)
Interest income 4,326 2,538 1,186
Interest and other expense (186) (250) (198)
Losses from joint venture (300) -- --
-------- -------- --------
Income (loss) before income taxes 7,456 (7,276) (9,937)
Provision for income taxes 548 -- --
-------- -------- --------
Net income (loss) $ 6,908 $ (7,276) $ (9,937)
======== ======== ========
Basic net income (loss) per share $ 0.28 $ (0.32) $ (0.53)
======== ======== ========
Shares used in computing basic net income (loss) per share 24,300 22,398 18,819
======== ======== ========
Diluted net income (loss) per share $ 0.26 $ (0.32) $ (0.53)
======== ======== ========
Shares used in computing diluted net income (loss) per share 26,498 22,398 18,819
======== ======== ========
</TABLE>
See accompanying notes
21
<PAGE> 20
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands, except number of shares)
<TABLE>
<CAPTION>
UNREALIZED
GAINS (LOSSES)
ADDITIONAL ON MARKETABLE
COMMON PAID-IN SECURITIES COMMON STOCK DEFERRED
STOCK CAPITAL AND OTHER TO BE ISSUED COMPENSATION
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCES AT JANUARY 1, 1995 $ 16 $ 44,485 $ 22 $ -- $ (355)
Issuance of 57,630 shares of Common Stock
upon exercise of stock options -- 88 -- -- --
Issuance of 1,246,000 shares of Common Stock 1 1 -- -- --
Issuance of 3,674,000 shares of Common Stock,
net of expenses and underwriters' fees
of $ 2,232 4 32,667 -- -- --
Cash received for common stock subscription -- -- -- 100 --
Amortization of deferred compensation -- -- -- -- 326
Net change in unrealized gains (losses) on
marketable securities -- -- 11 -- --
Net loss -- -- -- -- --
--------- --------- --------- --------- ---------
BALANCES AT DECEMBER 31, 1995 21 77,241 33 100 (29)
Issuance of 457,296 shares of Common Stock
upon exercise of stock options and 299,398
shares upon exercise of warrant 1 1,581 -- -- --
Issuance of 249,200 common stock previously
subscribed -- 100 -- (100) --
Issuance of 146,342 shares of Common Stock in
exchange for shares of Combion, Inc. -- 3,000 -- -- --
Amortization of deferred compensation -- -- -- -- 29
Net change in unrealized gains (losses) on
marketable securities -- -- (106) -- --
Net loss -- -- -- -- --
--------- --------- --------- --------- ---------
BALANCES AT DECEMBER 31, 1996 22 81,922 (73) -- --
Issuance of 2,755,426 shares of Common Stock,
net of expenses and underwriters'
fees of $5,065 3 87,239 -- -- --
Issuance of 462,434 shares of Common Stock,
net of expenses of $41 1 3,559 -- -- --
Issuance of 431,879 shares of Common Stock
upon exercise of stock options and 14,934
shares upon exercise of warrant -- 3,029 -- -- --
Net change in unrealized gains (losses) on
marketable securities -- -- 127 -- --
Net change in cumulative translation adjustment -- -- 2 -- --
Net income -- -- -- -- --
--------- --------- --------- --------- ---------
BALANCES AT DECEMBER 31, 1997 $ 26 $ 175,749 $ 56 $ -- $ --
========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT EQUITY
- -----------------------------------------------------------------------------------
<S> <C> <C>
BALANCES AT JANUARY 1, 1995 $ (19,824) $ 24,344
Issuance of 57,630 shares of Common Stock
upon exercise of stock options -- 88
Issuance of 1,246,000 shares of Common Stock -- 2
Issuance of 3,674,000 shares of Common Stock,
net of expenses and underwriters' fees
of $ 2,232 -- 32,671
Cash received for common stock subscription -- 100
Amortization of deferred compensation -- 326
Net change in unrealized gains (losses) on
marketable securities -- 11
Net loss (9,937) (9,937)
--------- ---------
BALANCES AT DECEMBER 31, 1995 (29,761) 47,605
Issuance of 457,296 shares of Common Stock
upon exercise of stock options and 299,398
shares upon exercise of warrant -- 1,582
Issuance of 249,200 common stock previously
subscribed -- --
Issuance of 146,342 shares of Common Stock in
exchange for shares of Combion, Inc. -- 3,000
Amortization of deferred compensation -- 29
Net change in unrealized gains (losses) on
marketable securities -- (106)
Net loss (7,276) (7,276)
--------- ---------
BALANCES AT DECEMBER 31, 1996 (37,037) 44,834
Issuance of 2,755,426 shares of Common Stock,
net of expenses and underwriters'
fees of $5,065 -- 87,242
Issuance of 462,434 shares of Common Stock,
net of expenses of $41 -- 3,560
Issuance of 431,879 shares of Common Stock
upon exercise of stock options and 14,934
shares upon exercise of warrant -- 3,029
Net change in unrealized gains (losses) on
marketable securities -- 127
Net change in cumulative translation adjustment -- 2
Net income 6,908 6,908
--------- ---------
BALANCES AT DECEMBER 31, 1997 $ (30,129) $ 145,702
========= =========
</TABLE>
See accompanying notes
22
<PAGE> 21
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Increase (decrease) in cash and cash equivalents)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 6,908 $ (7,276) $ (9,937)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 10,633 6,529 2,771
Expense for abandoned equipment -- -- 124
Noncash portion of purchase of
in-process research and development -- 3,000 --
Changes in certain assets and liabilities:
Accounts receivable (18,451) 5,174 (7,439)
Prepaid expenses, deposits and other assets (3,495) (2,074) (585)
Accounts payable 1,028 2,430 766
Deferred revenue 14,404 10,143 4,498
Accrued and other liabilities 6,660 601 1,015
-------- -------- --------
Net cash provided by (used in) operating activities 17,687 18,527 (8,787)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Long-term investments (8,237) (313) --
Transfer to restricted cash (6,000) -- --
Capital expenditures (27,225) (20,453) (8,122)
Proceeds from sale of assets leased back under operating leases 1,696 -- --
Purchases of securities - available-for-sale (53,464) (16,526) (74,037)
Sales of securities- available-for-sale 8,515 -- --
Maturities of securities- available-for-sale 18,225 16,336 61,722
-------- -------- --------
Net cash (used in) investing activities (66,490) (20,956) (20,437)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuances of stock 93,831 1,582 32,862
Proceeds from capital leases and notes payable 1,000 -- 69
Principal payments on capital lease obligations (46) (121) (72)
-------- -------- --------
Net cash provided by financing activities 94,785 1,461 32,859
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 45,982 (968) 3,635
Cash and cash equivalents at beginning of the period 9,616 10,584 6,949
-------- -------- --------
Cash and cash equivalents at end of the period $ 55,598 $ 9,616 $ 10,584
======== ======== ========
</TABLE>
(Continued)
See accompanying notes
23
<PAGE> 22
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
----------- ----------- ---------
<S> <C> <C> <C>
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Interest paid $ 16 $ 17 $ 45
=========== =========== =========
Taxes paid $ 252 $ -- $ --
=========== =========== =========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Property and equipment acquired pursuant to capital lease obligations $ -- $ -- $ 69
=========== =========== =========
Unrealized gain (loss) on marketable securities-available-for-sale$ 127 $ (106) $ 11
=========== =========== =========
Long-term investments acquired pursuant to obligation to distribute
restricted cash $ 6,000 $ -- $ --
=========== =========== =========
</TABLE>
See accompanying notes
24
<PAGE> 23
INCYTE PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Business. Incyte Pharmaceuticals, Inc. (the "Company") was
incorporated in Delaware in April 1991. The Company designs, develops, and
markets genomic database products, genomic data management software tools, gene
expression microarray services and genomic reagents. The Company's genomic
databases integrate bioinformatics software with proprietary and, when
appropriate, publicly available genetic information to create information-based
tools used by pharmaceutical and biotechnology companies in drug discovery and
development.
Principles of Consolidation. The consolidated financial statements include the
accounts of Incyte Pharmaceuticals, Inc., and its wholly owned subsidiaries. All
material intercompany accounts, transactions, and profits have been eliminated
in consolidation.
In January 1998, the Company issued 2,340,237 shares of Common Stock in exchange
for all of the capital stock of Synteni, Inc., a privately held microarray-based
genomics company in Fremont, California. Synteni is developing and
commercializing technology for generating microarrays and related software and
services. The merger has been accounted for as a pooling of interests and,
accordingly, the Company's financial statements and financial data for all
periods have been retroactively restated to include the accounts and operations
of Synteni since inception. Synteni's fiscal year ends on September 30.
Synteni's results of operations for the period from October 1, 1997 to December
31, 1997 will be recorded directly in retained earnings in the first quarter of
fiscal 1998.
In July 1996, the Company issued shares of its Common Stock in exchange for all
of the outstanding shares of Genome Systems, Inc. ("Genome Systems"). 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.
In August 1996, the Company acquired Combion, Inc. ("Combion") for shares of the
Company's Common Stock. The acquisition of Combion has been accounted for as a
purchase, and the consolidated financial statements discussed herein reflect the
inclusion of the results of Combion from the date of acquisition, August 15,
1996.
See Note 7 to the Consolidated Financial Statements
Reclassifications. Certain reclassifications were made to prior periods'
balances to conform with the 1997 presentation.
Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Foreign Currency Translation. The financial statements of subsidiaries outside
the United States are measured using the local currency as the functional
currency. Assets and liabilities of these subsidiaries are translated at the
rates of exchange at the balance sheet date. The resultant translation
adjustments are included in the cumulative translation adjustment, a separate
component of stockholders' equity. Income and expense items are translated at
average monthly rates of exchange.
Concentrations of Credit Risk. Cash, cash equivalents, and short-term
investments and trade receivables are financial instruments which potentially
subject the Company to concentrations of credit risk. The estimated fair value
of financial instruments approximates the carrying value based on available
market information. The Company primarily invests its excess available funds in
notes and bills issued by the U.S. government and its agencies and corporate
debt securities and, by policy, limits the amount of credit exposure to any one
issuer and to any one type of investment, other than
25
<PAGE> 24
securities issued or guaranteed by the U.S. Government. The Company's customers
are pharmaceutical, biotechnology companies and agricultural companies which are
typically located in the United States and Europe. The Company has not
experienced any credit losses to date and does not require collateral on
receivables.
Segment Information. Export revenue for the years ended December 31, 1997, 1996
and 1995 were $25,694,000, $9,743,000 and $1,525,000, respectively.
Cash and Cash Equivalents. Cash and cash equivalents are held in U.S. banks or
in custodial accounts with U.S. banks. Cash equivalents are defined as all
liquid investments with maturity from date of purchase of 90 days or less that
are readily convertible into cash and have insignificant interest rate risk. All
other investments are reported as marketable securities - available-for-sale.
Restricted Cash. Restricted cash consists of cash held in an escrow account
which will be disbursed to the Company's joint venture, diaDexus, LLC
("diaDexus"), as needed in accordance with the joint venture agreement (see
Joint Venture and Note 8).
Marketable Securities Available-for-Sale. All marketable securities are
classified as available-for-sale. Available-for-sale securities are carried at
fair value, with unrealized gains and losses reported as a separate component of
stockholders' equity. The amortized cost of debt securities in this category is
adjusted for amortization of premiums and accretions of discounts to maturity.
Such amortization is included in interest income. Realized gains and losses and
declines in value judged to be other than temporary for available-for-sale
securities are included in interest and other expense.
The following is a summary of the Company's investment portfolio, including cash
equivalents of $40,064,000 and $398,000 as of December 31, 1997 and 1996,
respectively.
<TABLE>
<CAPTION>
NET
UNREALIZED ESTIMATED
AMORTIZED GAINS FAIR
COST (LOSSES) VALUE
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
DECEMBER 31, 1997
U.S. Treasury notes and other U.S. government
and agency securities $ 53,951 $ 47 $ 53,998
Corporate debt securities 30,543 -- 30,543
Floating rate notes 13,013 7 13,020
-------- -------- --------
$ 97,507 $ 54 $ 97,561
======== ======== ========
DECEMBER 31, 1996
U.S. Treasury notes and other U.S. government
and agency securities $ 30,695 $ (73) $ 30,622
Corporate debt securities 398 -- 398
-------- -------- --------
$ 31,093 $ (73) $ 31,020
======== ======== ========
</TABLE>
At December 31, 1997 and 1996, all of the Company's investments are classified
as short-term, as the Company has classified its investments as available for
sale and may not hold its investments until maturity in order to take advantage
of market conditions. Of the marketable securities held at December 31, 1997,
$78,530,000 had maturities under a year and $19,031,000 had maturities over a
year, but less than two years. Unrealized gains were not material and have
therefore been netted against unrealized losses. Realized gains and losses from
sales and maturities of marketable securities have not been material to date.
Accounts Receivable. Accounts receivable at December 31, 1997 and 1996 included
an allowance for doubtful accounts of $225,000 and $0, respectively.
26
<PAGE> 25
Property and Equipment. Property and equipment is stated at cost, less
accumulated depreciation and amortization. Depreciation is recorded using the
straight-line method over the estimated useful lives of the respective assets
(generally two to five years). Leasehold improvements are amortized over the
shorter of the estimated useful life of the assets or lease term. Property and
equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
-------- --------
(in thousands)
<S> <C> <C>
Office equipment $ 2,588 $ 1,018
Laboratory equipment 18,939 13,182
Computer equipment 22,168 9,990
Leasehold improvements 14,495 8,702
-------- --------
58,190 32,892
Less accumulated depreciation and amortization (20,120) (9,696)
-------- --------
$ 38,070 $ 23,196
======== ========
</TABLE>
Depreciation expense, including depreciation expense of assets under capital
leases, was $8,758,000, $5,298,000, and $2,175,000 for 1997, 1996, and 1995,
respectively. Amortization of leasehold improvements was $2,260,000, $1,061,000,
and $266,000 for 1997, 1996, and 1995, respectively.
Certain laboratory and computer equipment used by the Company could be subject
to technological obsolescence in the event that significant advancement is made
in competing or developing equipment technologies. Management continually
reviews the estimated useful lives of technologically sensitive equipment and
believes that those estimates appropriately reflect the current useful life of
its assets. In the event that a currently unknown significantly advanced
technology became commercially available, the Company would re-evaluate the
value and estimated useful lives of its existing equipment, possibly having a
material impact on the financial statements.
Long-Term Investments. The Company has made equity investments in a number of
companies whose businesses may be complementary to the Company's business. All
investments, except diaDexus which is accounted for under the equity method (see
Joint Venture), are carried at cost which approximates the fair market value.
Software Costs. In accordance with the provisions of the Financial Accounting
Standards Board Statement No. 86, "Accounting for the Costs of Computer Software
to be Sold, Leased or Otherwise Marketed," the Company has capitalized software
development costs incurred in developing certain products once technological
feasibility of the products has been determined. Capitalized software costs are
amortized over three years and have been immaterial to date.
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. Revenue from gene expression
microarray services is recognized at the completion of key stages in the
performance of the service, in proportion to costs incurred.
Stock-Based Compensation. The Company accounts for stock option grants in
accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees.
The Company currently grants stock options for a fixed number of shares to
employees and directors with an exercise price equal to the fair value of the
shares at the date of grant, and therefore records no compensation expense.
Advertising Costs. All costs associated with advertising products are expensed
in the year incurred. Advertising expense for the years ended December 31, 1997,
1996 and 1995 were $772,000, $573,000 and $324,000, respectively.
27
<PAGE> 26
Joint Venture. In September 1997, the Company formed a joint venture, diaDexus,
LLC, with SmithKline Beecham Corporation ("SB"). The Company and SB each hold a
50 percent equity interest in diaDexus and the Company accounts for the
investment under the equity method.
See Note 8 of Notes to Consolidated Financial Statements.
Net Income (Loss) Per Share. On December 31, 1997, the Company adopted the
Financial Accounting Standards Board (FASB) Statement No. 128, Earnings per
Share, which requires the Company to change the method currently used to compute
earnings per share and to restate all prior periods. The following table sets
forth the computation of basic and diluted net income (loss) per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
-------- ---------- --------
(in thousands)
<S> <C> <C> <C>
Numerator:
Net income (loss) $ 6,908 $ (7,276) $ (9,937)
======== ========== ========
Denominator:
Denominator for basic net income (loss) per
share - weighted-average shares outstanding 24,300 22,398 18,819
Dilutive potential common shares-stock options 2,198 -- --
-------- ---------- --------
Denominator for diluted net income (loss) per
share - adjusted weighted-average 26,498 22,398 18,819
======== ========== ========
Basic net income (loss) per share $ 0.28 $ (0.32) $ (0.53)
======== ========== ========
Diluted net income (loss) per share $ 0.26 $ (0.32) $ (0.53)
======== ========== ========
</TABLE>
Options and warrants to purchase 3,194,000 and 3,100,000 shares of Common Stock
were outstanding at December 31, 1996 and 1995, respectively, but were not
included in the computation of diluted loss per share, as their effect was
antidilutive.
NOTE 2. COLLABORATIVE AGREEMENTS
As of December 31, 1997, the Company had entered into database collaboration
agreements with nineteen pharmaceutical, biotechnology and agricultural
companies. Each collaborator has agreed to pay, during the term of the
agreement, annual fees to receive non-exclusive access to selected modules of
the Company's databases. In addition, if a collaborator develops certain
products utilizing the Company's technology and proprietary database
information, potential milestone and royalty payments could be received by the
Company. If these agreements are not renewed and if the Company cannot sign a
sufficient number of new database agreements, the loss of revenue could have a
material adverse effect on the Company's business and operating results. Certain
companies also have satellite database agreements, whereby the Company provides
custom sequencing services, which are billed for separately. Satellite database
services are provided to the customer on an exclusive basis for a negotiated
period of time. None of the collaborators individually contributed more than 10%
of the Company's total revenues in 1997. Over 90% of the revenues in 1996 are
derived from ten collaborators, three of which individually contributed more
than 10% of the total, or approximately 37% in the aggregate. In 1995, the
majority of the revenues were derived from five collaborators, including three
of which contributed more than 10% individually, or approximately 71% in the
aggregate.
In addition to the database collaboration agreements, the Company has entered
into a number of research and development alliances with companies and research
institutions. These agreements provide for the funding of research activities by
the Company and the possible payment of milestones, license fees, and, in some
cases, royalties.
28
<PAGE> 27
NOTE 3. COMMITMENTS
At December 31, 1997, the Company had signed noncancelable operating leases on
multiple facilities, including facilities in Palo Alto and Fremont, California
and St. Louis, Missouri. The leases expire on various dates ranging from March
1998 to January 2006. Rent expense for the years ended December 31, 1997, 1996,
and 1995 was approximately $3,490,000, $1,675,000, and $1,251,000, respectively.
The Company had laboratory and office equipment with a cost of approximately
$189,000 and $370,000 at December 31, 1997 and 1996, respectively, and related
accumulated amortization of approximately $136,000 and $268,000 at December 31,
1997 and 1996, respectively, under capital leases. These leases are secured by
the equipment leased thereunder.
At December 31, 1997, future noncancelable minimum payments under the operating
and capital leases and notes payable were as follows:
<TABLE>
<CAPTION>
CAPITAL LEASES
OPERATING AND
LEASES NOTES PAYABLE
--------- --------------
(In thousands)
<S> <C> <C>
Year ended December 31,
1998 $ 5,517 $ 48
1999 4,381 38
2000 3,902 19
2001 3,426 --
2002 and thereafter 4,592 --
-------- ------
Total minimum lease payments $ 21,818 105
========
Less amount representing interest 6
------
Present value of minimum lease payments 99
Less current portion 46
------
Noncurrent portion $ 53
======
</TABLE>
In July 1997, Synteni obtained $1,000,000 in debt financing secured by the
Company's property and equipment. The loan is repayable in 48 equal monthly
installments commencing on September 1, 1997 and carries an annual interest rate
of 9%. In connection with the financing, the Company issued a warrant to
purchase 2,569 shares of common stock, exercisable for a period of seven years
from the date of issue at an exercise price of $7.79 per share. Using the
Black-Scholes model to determine the fair market value of the warrant,
management has determined that such fair value is nominal.
In July 1997, the Company entered into a multi-year lease with respect to a
95,000 square foot building to be constructed adjacent to the Company's Palo
Alto headquarters. The term of the lease is twelve years at an approximate
annual rent of $3.4 million. The lease is expected to commence in early 1999.
The Company has entered into a number of research and development alliances with
companies and research institutions. Under one agreement, the Company has
committed to fund, subject to the terms and conditions of the agreement, at
least $3.0 million over three years.. The Company's commitments under any other
of these agreements do not represent a significant expenditure in relation to
the Company's total research and development expense. See Note 2 of Notes to
Consolidated Financial Statements.
29
<PAGE> 28
NOTE 4. STOCKHOLDERS' EQUITY
Common Stock. At December 31, 1997, the Company had reserved a total of
4,630,645 shares of its Common Stock for issuance upon exercise of outstanding
stock options described below. In October 1997, the Company's Board of Directors
authorized a two-for-one stock split effected in the form of a stock dividend
paid on November 7, 1997 to holders of record on October 17, 1997. All share and
per share data have been adjusted retroactively to reflect the split.
On May 21, 1997, the Company's stockholders approved an increase in the number
of shares authorized for issuance from 20,000,000 to 75,000,000.
Sales of Stock. In November 1995, the Company completed a follow-on public stock
offering and issued 3,674,000 shares of Common Stock, including 274,000 shares
issued on December 13, 1995 upon partial exercise of the underwriters'
over-allotment option, at $9.50 per share before deducting the underwriting
discount and offering expenses. In August 1997, the Company completed another
follow-on public stock offering and issued 2,755,426 shares of Common Stock,
including 355,426 shares covered by the exercise of the underwriters'
over-allotment option, at $33.50 per share. Net proceeds from this offering were
approximately $87.2 million after deducting the underwriting discount and
offering expenses.
Stock Compensation Plans. The Company applies APB Opinion No. 25 and related
Interpretations in accounting for its stock compensation plans. Accordingly, no
compensation cost has been recognized for its fixed stock option plans. Had
compensation cost for the Company's two stock-based compensation plans been
determined consistent with FASB Statement No. 123, the Company's pro forma net
loss in 1997 and 1996 would have been approximately $(0.5 million) and $(11.0
million), respectively. Both the Company's pro forma basic and diluted net
(loss) per share in 1997 and 1996 would have been $(0.02) per share and $(0.49)
per share. The weighted average fair value of the options granted during 1997
and 1996 are estimated at $14.66 and $9.44 per share, respectively, on the date
of grant, using the Black-Scholes multiple-option pricing model with the
following assumptions: dividend yield 0% and 0%, volatility of 56% and 55%,
risk-free interest rate with an average of 6.05% and 6.10%, and an average
expected life of 3.37 and 3.25 years, for 1997 and 1996, respectively. The fair
value of the employees' purchase rights under the Employee Stock Purchase Plan
during 1997 is estimated at $11.86, on the date of grant, using the
Black-Scholes multiple-option pricing model with the following assumptions:
dividend yield 0%, volatility of 56%, risk free interest rate of 5.64%, and an
expected life of 9 months.
The effects on pro forma disclosures of applying FASB 123 are not likely to be
representative of the effects on pro forma disclosures of future years. As FASB
123 is only applicable to options granted after December 31, 1994, the pro forma
effect will not be fully reflected until 1998. The Black-Scholes option
valuation model was developed for use in estimating the fair value of traded
options which have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions, including the expected stock price volatility and option life.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, because changes in the subjective input
assumptions can materially affect the fair value estimate, and because the
Company has a relatively limited history with option behavior, in management's
opinion the existing models do not necessarily provide a reliable single measure
of the fair value of its employee stock options.
Summaries of stock option activity for the Company's three fixed stock option
plans as of December 31, 1997, 1996 and 1995, and related information for the
years ended December 31 are included in the plan descriptions below.
1991 Stock Plan. In November 1991, the Board of Directors adopted the 1991 Stock
Plan, which was amended and restated in 1992, 1995, 1996 and 1997 for issuance
of Common Stock to employees, consultants, and scientific advisors. Options
issued under the plan shall, at the discretion of the compensation committee of
the Board of Directors, be either incentive stock options or nonstatutory stock
options. The exercise prices of incentive stock options granted under the plan
are not less than the fair market value on the date of the grant, as determined
by the Board of Directors. The exercise prices of nonstatutory stock options
granted under the plan are not less than 85% of the fair market value on the
date of the grant, as determined by the Board of Directors. Options generally
vest over approximately four years, pursuant to a formula determined by the
Company's Board of Directors, and expire after ten years. On May 21, 1997, the
Company's stockholders approved an increase in the number of shares of Common
Stock reserved for issuance
30
<PAGE> 29
under the plan from 4,000,000 to 4,800,000.
Activity under the plan was as follows:
<TABLE>
<CAPTION>
SHARES SUBJECT TO
OUTSTANDING OPTIONS
-----------------------------
SHARES WEIGHTED AVERAGE
AVAILABLE EXERCISE
FOR GRANT SHARES PRICE
--------- ------ ----------------
<S> <C> <C> <C>
Balance at December 31, 1994 217,664 1,303,416 $ 3.86
Additional authorization 1,600,000 -- --
Options granted (1,246,800) 1,246,800 $ 9.14
Options exercised -- (57,630) $ 1.53
Options canceled 19,918 (19,918) $ 6.51
---------- ---------- ---------
Balance at December 31, 1995 590,782 2,472,668 $ 6.56
Additional authorization 800,000 -- --
Options granted (1,052,300) 1,052,300 $ 19.75
Options exercised -- (446,556) $ 3.54
Options canceled 140,326 (140,326) $ 8.38
---------- ---------- ---------
Balance at December 31, 1996 478,808 2,938,086 $ 11.63
Additional authorization 800,000 -- $ --
Options granted (876,604) 876,604 $ 33.55
Options exercised -- (387,759) $ 7.61
Options canceled 105,535 (105,535) $ 19.94
---------- ---------- ---------
Balance at December 31, 1997 507,739 3,321,396 $ 17.68
========== ========== =========
</TABLE>
Options to purchase a total of 2,145,403 and 2,914,596 shares at December 31,
1997 and 1996, respectively, were exercisable. Of the options exercisable,
1,197,542 and 803,004 shares were vested at December 31, 1997 and 1996,
respectively.
Non-Employee Directors' Stock Option Plan. In August 1993, the Board of
Directors approved the 1993 Directors' Stock Option Plan (the "Directors'
Plan"), which was amended in 1995. The Directors' Plan provides for the
automatic grant of options to purchase shares of Common Stock to non-employee
directors of the Company. The maximum number of shares issuable under the
Directors' Plan is 400,000.
The Directors' Plan provides immediate issuance of options to purchase an
initial 40,000 shares of Common Stock to each new non-employee director joining
the Board. The initial options are exercisable in five equal annual
installments. Additionally, members who continue to serve on the Board will
receive annual option grants for 10,000 shares exercisable in full on the first
anniversary of the date of the grant. All options are exercisable at the fair
market value of the stock on the date of grant. Through December 31, 1997, the
Company had granted options under the Directors' Plan to purchase 267,500 shares
of Common Stock at a weighted average exercise price of $8.71 (227,500 shares of
Common Stock at a weighted average exercise price of $5.37 at December 31,
1996); 171,500 shares are vested and exercisable at December 31, 1997 (141,500
shares were vested and exercisable at December 31, 1996).
31
<PAGE> 30
1996 Synteni Stock Plan. In December 1996, Synteni's board of directors approved
and adopted the 1996 Equity Incentive Plan ("Synteni Plan"). Under the Synteni
Plan, Synteni could grant an aggregate of 436,100 Incyte equivalent incentive
stock options, nonstatutory stock options, stock bonuses or rights to purchase
restricted stock. Incentive stock options could be granted to employees and
nonstatutory options and rights to purchase restricted stock may be granted to
employees, directors or consultants at exercise prices of no less than 100% and
85%, respectively, of the fair value of the common stock on the grant date, as
determined by the board of directors. Options could be granted with different
vesting terms from time to time and options expire no more than 10 years after
the date of grant. All outstanding options at the time of the merger with Incyte
were converted to options to purchase Incyte common stock, and the Synteni Plan
was terminated. Activity under the plan, adjusted to Incyte equivalent shares,
was as follows:
<TABLE>
<CAPTION>
SHARES SUBJECT TO
OUTSTANDING OPTIONS
--------------------------
SHARES WEIGHTED AVERAGE
AVAILABLE EXERCISE
FOR GRANT SHARES PRICE
--------- ------ -----
<S> <C> <C> <C>
Shares authorized 436,100 -- --
Options granted (282,904) 282,904 $0.80
Restricted stock issued (24,920) $0.80
Options exercised -- (20,412) $0.80
Options canceled 3,863 (3,863) $0.80
-------- -------- -----
Balance at September 30, 1997 132,139 258,629 $0.80
======== ======== =====
</TABLE>
Options to purchase a total of 36,411 shares at September 30, 1997 were vested
and exercisable.
Excluded from the table above were stock options issued by Synteni to purchase
89,587 Incyte equivalent common shares at a weighted average exercise price of
$1.49, in the period from October 1, 1997 to December 31, 1997. The Company
recorded $1,658,000 of deferred compensation related to these options, which
will be amortized over the vesting period of the options.
The following table summarizes information about stock options outstanding at
December 31, 1997, for the 1991 Stock Plan, the 1993 Directors' Stock Option
Plan and the Synteni 1996 Equity Incentive Plan
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- --------------- ---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.15 - 1.00 434,284 7.35 $ 0.78 212,065 $ 0.75
$2.00 - 4.75 236,382 5.98 $ 3.00 204,382 $ 3.04
$5.31 - 7.56 419,108 6.99 $ 7.19 419,108 $ 7.19
$8.44 - 9.56 729,279 7.79 $ 8.73 729,279 $ 8.73
$10.69 - 19.81 546,143 8.21 $ 15.67 522,143 $ 15.59
$20.19 - 28.19 858,330 8.99 $ 22.57 266,377 $ 20.81
$31.00 - 36.63 512,000 9.81 $ 35.57 -- $ 0.00
$40.25 - 43.88 112,000 9.80 $ 41.90 -- $ 0.00
--------- ---- ------- --------- -------
$0.15 - 43.88 3,847,526 8.20 $ 15.92 2,353,354 $ 10.13
</TABLE>
In July 1996, in connection with the Genome Systems transaction described in
Note 7 below, the Company issued, in exchange for an option to purchase capital
stock of Genome Systems, an option to purchase 21,482 shares of Common Stock at
an exercise price of $0.0235 per share. The option was not issued under the
provisions of either plan described above. The option has been exercised with
respect to 10,740 shares as of December 31, 1997. The remaining 10,742 shares
under the option were exercised in January 1998.
32
<PAGE> 31
Employee Stock Purchase Plan. On May 21, 1997, the Company's stockholders
adopted the 1997 Employee Stock Purchase Plan ("ESPP"). The Company has
authorized 400,000 shares of Common Stock for issuance under the ESPP. Each
regular full-time and part-time employee is eligible to participate after one
year of employment. The initial offering period commenced August 1, 1997 and
ends October 31, 1999. As of December 31, 1997, $238,000 has been deducted from
employees' payroll.
NOTE 5. INCOME TAXES
As of December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $27,800,000. The Company also had federal
research and development tax credit carryforwards of approximately $2,800,000.
The net operating loss carryforwards will expire at various dates, beginning on
2009, through 2012 if not utilized.
Significant components of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
-------- --------
(in thousands)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 10,000 $ 10,300
Research credits 4,000 1,500
Capitalized research and development 1,400 1,600
Other, net 2,800 1,500
-------- --------
Deferred tax assets 18,200 14,900
Valuation allowance for deferred tax assets (18,200) (14,900)
-------- --------
Net deferred tax asset $ -- $ --
======== ========
</TABLE>
The valuation allowance for deferred tax assets increased by approximately
$3,300,000, $2,800,000 and $4,100,000 during the years ended December 31, 1997,
1996 and 1995. Approximately $4,100,000 of the valuation allowance for deferred
tax assets relates to benefits of stock option deductions which, when
recognized, will be allocated directly to contributed capital.
Utilization of the net operating losses and credits may be subject to an annual
limitation, due to the "change in ownership" provisions of the Internal Revenue
Code of 1986 and similar state provisions.
The provision for income taxes consists primarily of federal Alternative Minimum
Tax and differs from the federal statutory rate as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997
-----------------------
(in thousands)
<S> <C>
Tax at U.S. federal statutory rate 2,610
Use of net operating loss carryforwards (4,814)
Unbenefitted net operating losses 1,225
Non-deductible in-process research and development charges 1,108
Other 419
--------
Provision for income tax $ 548
========
</TABLE>
33
<PAGE> 32
NOTE 6. DEFINED CONTRIBUTION PLAN
The Company has a defined contribution plan covering all domestic employees.
Employees may contribute a portion of their compensation, which is then matched
by the Company, subject to certain limitations. Defined contribution expense for
the Company was $520,000, $244,000 and $0 in 1997, 1996 and 1995, respectively.
NOTE 7. BUSINESS COMBINATIONS
In July 1996, the Company issued 408,146 shares of Common Stock in exchange for
all of the capital stock of Genome Systems, a privately held genomics company
located in St. Louis, Missouri. Genome Systems provides genomic research
products and technical support services to scientists to assist them in the
identification and isolation of novel genes. 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
Genome Systems since inception.
In August 1996, the Company acquired all the common stock of Combion, Inc., a
microarray technology company in Pasadena, California, in a stock-for-stock
exchange, issuing 146,342 shares of its Common Stock valued at $3 million. The
acquisition has been accounted for as a purchase transaction and, accordingly,
the purchase price was allocated to assets and liabilities based on the
estimated fair value as of the date of acquisition. The purchase price has been
allocated based on the fair value of the net assets and the technology acquired
(recorded as a charge to in-process research and development). Combion's results
of operations have been included in the consolidated results of operations since
the date of acquisition. Pro forma results of operations have not been presented
because the effect of this acquisition was not material to the Company's
consolidated results of operations or financial position.
In January 1998, the Company issued 2,340,237 shares of Common Stock in exchange
for all of the capital stock of Synteni, Inc., a privately held microarray-based
genomics company in Fremont, California. Synteni is developing and
commercializing technology for generating microarrays and related software and
services. The merger was 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 since inception.
The table below presents the separate results of operations for Incyte, Genome
Systems, and Synteni prior to the respective mergers. Incyte's results include
Genome Systems from August 1996.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Revenues:
Incyte $ 88,351 $ 40,051 $ 9,908
Genome -- 1,734 2,304
Synteni 1,645 110 87
-------- -------- --------
$ 89,996 $ 41,895 $ 12,299
======== ======== ========
Net income (loss):
Incyte $ 10,408 $ (6,724) $(10,142)
Genome -- 106 205
Synteni (3,500) (515) --
Merger related expenses -- (143) --
-------- -------- --------
$ 6,908 $ (7,276) $ (9,937)
======== ======== ========
</TABLE>
34
<PAGE> 33
NOTE 8. JOINT VENTURE
In September 1997, the Company formed a joint venture, diaDexus, in conjunction
with 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 and the Company accounts for
the investment under the equity method. A portion of the investment is reflected
as restricted cash and in accrued liabilities on the balance sheet since that
balance is held in an escrow account and will be disbursed to diaDexus as needed
in accordance with the joint venture agreement.
NOTE 9. NEW PRONOUNCEMENTS
In June 1997, the FASB issued Statement No. 130, Reporting Comprehensive Income
("SFAS 130"), and Statement No. 131, Disclosures about Segments of an Enterprise
and Related Information ("SFAS 131") (collectively, the "Statements"). The
Statements are effective for fiscal years beginning after December 15, 1997.
SFAS 130 establishes standard for reporting of comprehensive income and its
component in annual financial statements. 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 130 and SFAS 131, respectively. 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.
NOTE 10. SUBSEQUENT EVENTS
On January 6, 1998, Affymetrix, Inc. ("Affymetrix") filed a lawsuit in the
United States District Court for the District of Delaware alleging infringement
of U.S. patent number 5,445,934 (the "934 Patent") by both Synteni and Incyte.
The complaint alleges that the 934 Patent has been infringed by the making,
using, selling, importing, distributing or offering to sell in the U.S. high
density arrays by Synteni and Incyte and that such infringement was willful.
Affymetrix seeks a permanent injunction enjoining Synteni and Incyte from
further infringement of the 934 Patent and, in addition, seeks damages, costs
and attorney's fees and interest. Affymetrix further requests that any such
damages be trebled based on its allegation of willful infringement by Incyte and
Synteni. Incyte and Synteni believe they have meritorious defenses and intend to
defend the suit vigorously. However, there can be no assurance that Incyte and
Synteni will be successful in the defense of this suit, and litigation could
result in substantial expenses and diversion of the efforts of management and
technical personnel. Further, there can be no assurance that any license that
may be required as a result of this suit or the outcome thereof would be made
available on commercially acceptable terms, if at all.
In January 1998, the Company entered into a collaborative agreement with Oxford
GlycoSciences plc ("OGS") to develop and commercialize proteomics databases for
human, animal, plant and microbial organisms. In connection with the agreement,
the Company made a $5.0 million equity investment in OGS. The Company intends to
account for the investment under the cost method of accounting.
35
