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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to ______________________
Commission File Number: 0-27488
INCYTE PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3136539
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3174 Porter Drive, (650) 855-0555
Palo Alto, California 94304
(Address of principal executive offices) (Registrant's telephone number,
including area code)
Securities registered to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. [X]Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
The aggregate market value of Common Stock held by nonaffiliates (based upon the
closing sale price on the Nasdaq National Market) on January 31, 1998 was
approximately $1,149,702,104.
As of January 31, 1998, there were 26,506,101 shares of Common Stock, $.001 par
value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10 (as to directors), 11, 12 and 13 of Part III incorporate by reference
information from the registrant's proxy statement to be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the registrant's 1998 Annual Meeting of Stockholders to be held on
June 15, 1998.
PART I
ITEM 1. BUSINESS
When used in this Report, the word "expects," "anticipates," "estimates,"
and similar expressions are intended to identify forward-looking statements.
Such statements, which include statements as to the timing of availability of
products under development, the ability to commercialize products developed
under collaborations and alliances, the performance and utility of the Company's
products and services, earnings and profitability trends 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 database products and their use by potential collaborators of the Company;
the impact of technological advances and competition; the ability of the Company
to obtain and retain customers; competition from other entities; early
termination of a database collaborator 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 risks set forth below under "Factors That
May Affect Results." These forward-looking statements speak only as of the date
hereof. The Company expressly disclaims any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statements contained
herein to reflect any change in the Company's expectations with regard thereto
or any change in events, conditions or circumstances on which any such statement
is based.
Overview
Incyte Pharmaceuticals, Inc. ("Incyte" or the "Company") is a leading
provider of genomic information and services to the biotechnology,
pharmaceutical and agricultural industries. Incyte designs, develops and markets
genomic database products, genomic data management software tools and related
reagents and services. The Company completed the acquisition of Synteni, Inc.
("Synteni"), in January 1998. Synteni, located in Fremont, California, offers
microarray-based gene expression services.
Incyte currently provides access to its genomic databases through
collaborations with pharmaceutical, biotechnology, and agricultural companies
worldwide. As of December 31, 1997, nineteen companies had entered into
multi-year database collaboration agreements to obtain access to the Company's
databases on a non-exclusive basis. In January 1998, Incyte announced the
addition of Rhone-Poulenc S.A. as a database collaborator. Revenues from these
collaborators generally include database access fees and, in some cases,
additional fees for custom sequencing services, referred to as "satellite"
database services. The Company's database agreements also provide for milestone
payments and royalties to be received from database collaborators from the sale
of products derived from proprietary information contained within one or more
database modules.
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. By searching the
genomic databases, collaborators can integrate and analyze genetic information
from multiple sources in order to discover genes that may represent the basis
for new biological targets, therapeutic proteins, or gene therapy, antisense or
diagnostic products. The Company's genomic products and services are designed to
meet the need of the pharmaceutical and biotechnology industries to utilize
genomic information for the acceleration of the discovery and development of new
diagnostic and therapeutic products. These products and services can assist not
only with gene and target discovery, but also with functional genomic studies,
preclinical pharmacology and toxicology studies as well as understanding
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and analyzing the results of clinical development studies.
Incyte's portfolio of database modules includes the LifeSeq(R) human gene
sequence and expression database, the LifeSeq FL(R) database of full-length
human genes, the LifeSeq Atlas(TM) mapping database, the PathoSeq(TM) microbial
genomic database, the ZooSeq(TM) animal genomic database, the LifeTools(TM)
suite of bioinformatics software programs, and LifeSeq(R) 3D data mining and
visualization software, and a variety of custom database and sequencing
services. Each database module consists of a relational database that runs on
UNIX-based client/server networks and incorporates HyperText Markup Language
("HTML") and JAVA graphical user interfaces enabling collaborators to use
multiple search tools and browse various database modules. The databases are
available using either Oracle or Sybase database architectures and operate on
Sun Microsystems, Digital Equipment Corporation and Silicon Graphics
workstations.
Background
Genes, found in all living cells, are comprised of DNA, which in turn is
comprised of nucleotide base pairs, or bases. Genes provide the necessary
information to code for the synthesis of proteins, the molecules which conduct
all functions within a cell. Many human diseases are associated with the
inadequate or inappropriate presence, production or performance of proteins. As
such, pharmaceutical and biotechnology companies often seek to develop drugs
that will bind to a targeted protein involved in disease in order to regulate,
inhibit or stimulate its biological activity. The serotonin receptor and the
estrogen receptor are examples of targeted proteins. Other proteins, known as
therapeutic proteins, have direct biological activity and may be capable of
treating disease. Insulin and human growth hormone are examples of therapeutic
proteins. Understanding the role genes play in disease, and the protein targets
or therapeutic proteins which they encode, has thus become a significant area of
interest and research within the pharmaceutical and biotechnology industries.
One frequently employed method for determining gene function involves the
grouping of genes into "related" families based on similarities in DNA sequence.
DNA sequencing is a process that identifies the order in which the bases in DNA
are arranged in a particular section of DNA, or DNA fragment. Once a gene's
sequence is known, its function may be inferred by comparing its sequence with
the sequences of other human genes of known function, as genes with similar, or
homologous, sequences may have related functions. For example, if an unknown
gene shares sequence homology with a known tumor suppressor gene, the unknown
gene could similarly play a role in cancer. Comparing gene sequences across
species has also become a useful tool for understanding gene function, as
frequently it is easier to assess gene function in lower organisms than it is in
humans.
Another method used to determine gene function focuses on the analysis of
gene activity within a cell. When a gene is active, its DNA is copied into
messenger RNA or "mRNA." The population of mRNA within a cell can be isolated
and converted into copy DNA or "cDNA," thereby creating a cDNA library that
represents the population of mRNAs present in a cell type at a particular time.
In a process called "gene expression profiling," high-throughput cDNA
sequencing, computer analysis and microarray technologies can be used to
identify which genes are active or inactive and, if active, at what levels.
Expression profiles provide a more detailed picture of cellular genetics than
conventional laboratory techniques by indicating which genes, both known and
novel, are specifically correlated to discrete biological events in normal and
disease-state cells.
Due to improvements in sequencing technology, genomic information from both
public and private sources is increasing at a dramatic rate. As a result,
bioinformatics, or the use of computers and sophisticated algorithms to store,
analyze and interpret large volumes of biological data, is essential in order to
capture value from this growing pool of data. To date, the main focus of
bioinformatic and genomic tools has been drug discovery. The Company believes
these tools, as well as tools under development, will also assist researchers
with the preclinical and clinical development process. For example, with the
help of new technology and bioinformatic analyses, scientists may be able to
correlate genetic and physiologic response in preclinical animal models, examine
gene expression profiles in drug-treated animals to assess the pharmacological
activity and toxicity of new drugs, and stratify clinical trial patients
according to their genetic profiles.
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Products
Incyte's products include an integrated platform of genomic databases, data
management software tools, and related reagents and services.
Genomic Databases. The Company provides its database collaborators with
non-exclusive database access. Database collaborators receive periodic data
updates, typically monthly, as well as software upgrades and additional search
and analysis tools when they become available. The fees and the period of access
are negotiated with each database collaborator, with the initial term typically
lasting for a period of three years. Fees generally consist of database access
fees, non-exclusive or exclusive license fees and option fees corresponding to
patent rights on proprietary sequences. Incyte may also receive milestone and
royalty payments from database collaborators from the sale of products derived
from the Company's technology and database information. Collaborators can browse
not only Incyte-generated data, but also public domain information provided
through HTML links to the World Wide Web. Incyte currently offers the following
database modules:
o LifeSeq Database. The LifeSeq human gene sequence and expression
database consists of a proprietary sequence database module linked to
a proprietary gene expression database module. Researchers can easily
move from one module to another through HTML-based graphical
interfaces. The sequence database contains Incyte's computer-edited
gene sequence files and is used by collaborators to identify related
or homologous genes. For example, a collaborator may wish to identify
new genes homologous to a gene identified through the collaborator's
own research and believed to be linked to a disease. The expression
database contains biological information about each sequence in the
Company's sequence database, including tissue source, homologies, and
annotations regarding characteristics of the gene sequence. Most
importantly, the expression database contains a gene expression
profile for every tissue in the database combined with proprietary
bioinformatics software to allow collaborators to browse data and
compare differences in gene expression across cells, tissues, and
different disease states. Thus, the expression database can be used to
assist researchers in correlating the presence of specific genes to
discrete biological events in normal and disease-state cells. Incyte
continually adds additional sequences and expression data from normal
and diseased tissues to the LifeSeq database.
o LifeSeq FL Database. This database contains the full-length gene
sequences for DNA fragments of medically interesting genes found in
the LifeSeq human gene sequence and expression database. Incyte
scientists and the Company's collaborators select genes for inclusion
in this database based on a number of factors, including their
sequence homologies to known therapeutically important gene families,
unusual tissue or disease-related expression patterns and chromosomal
location. A variety of methods, including a proprietary,
high-throughput cloning technology, Hidden Markov Models (HMM) and
algorithms to identify secreted proteins, are used to identify
medically interesting genes and obtain the full-length sequence.
o LifeSeq Atlas Database. This database contains the chromosomal
locations for certain genes and gene fragments identified in the
Company's LifeSeq human gene sequence and expression database that the
Company believes may be of utility to its database collaborators. In
particular, this database may be useful for companies engaged in
positional cloning, a technique used to identify genes believed to be
responsible for genetic disorders, which relies heavily on comparative
analysis of the chromosomes of members of families afflicted by a
disease.
o PathoSeq Database. The PathoSeq database currently contains
proprietary and public domain genomic data for over two dozen
medically relevant bacterial and fungal microorganisms. With
drug-resistant strains of bacteria and other microorganisms posing an
increasing threat to world health, pharmaceutical and biotechnology
companies are searching for genes unique to these pathogens that will
aid in the development of new drugs to treat infectious disease.
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PathoSeq's software and bioinformatic tools edit all sequence data to
remove artifacts and contamination, assemble all sequences, display
the relative position of the DNA coding regions, and identify genes
either common among multiple microorganisms or unique to one microbial
genome. The Company believes PathoSeq can help researchers understand
the biology of microorganisms, study the mechanisms of drug
resistance, identify genes that may make effective drug targets, and,
ultimately, develop new therapeutics to treat and prevent infectious
disease.
o ZooSeq Database. The ZooSeq database, introduced in June 1997, was
developed to aid pharmaceutical and biotechnology companies in
designing and evaluating preclinical drug studies in animals, a
crucial step in the drug development process. ZooSeq contains genomic
information from animals commonly used in preclinical drug
pharmacology and toxicology studies. The database currently contains
gene sequence and expression data for the Sprague-Dawley rat, the most
common animal used in drug toxicology studies. The Company expects to
expand this database in 1998 to include mice and other research
animals. ZooSeq is designed to allow scientists to compare gene
sequence, expression patterns and function across species. By
correlating a drug's effects on a rat with the animal's genetic
makeup, and then cross-referencing these data with Incyte's LifeSeq
database, a researcher may better predict the drug's efficacy, and
side effects before moving to human clinical trials.
Satellite Database Services. To construct satellite databases, Incyte
generates sequence data and gene expression profiles using genetic material from
tissues or cells selected by the database collaborators. Such databases are
provided exclusively for a negotiated time period in a format compatible with
the Company's non-exclusive database modules. These tissues and cells can be
provided by the database collaborators from their own tissue banks, internal
research programs or from other sources. In 1998 the Company expects to begin
offering high volume sequencing services to pharmaceutical, biotechnology,
agricultural and academic researchers.
Software. LifeSeq 3D provides sophisticated three-dimensional visualization
and analysis tools for the LifeSeq human gene sequence and expression database.
LifeTools, a suite of specialized bioinformatic software programs, consists of
high-throughput sequence analysis and data management tools for handling complex
genomic information from multiple sources. LifeTools Blocks reads and edits raw
sequence data, including data imported from public databases, and annotates and
clusters sequence fragments based on sequence similarity. LifeTools SeqServer is
a fast, scaleable database search engine with intranet-based graphical tools for
interactive queries and analyses. LifeTools Relational, a relational database
management system, stores and distributes sequence cluster, homology, tissue
expression information and biological data. Incyte's database management
architecture is based on open system standards, providing interconnectivity
between disparate systems and applications, and enterprise-wide access to data
and functions. Incyte intends to continue to develop new bioinformatic software
programs internally, as well as with third party software developers and
development groups.
The Company has developed an enterprise-wide genomic information management
system capable of updating, reprocessing and integrating genetic data from
multiple sources and from different organisms. This system integrates Incyte
proprietary, collaborator-specific and public domain data, and is capable of
comparing information from humans, animals, microbes, fungi and plants. The
system incorporates the architecture necessary to integrate Incyte's software
tools with three-dimensional visualization tools, data mining programs and
project management capabilities, and is capable of being integrated with
additional technologies developed to more efficiently manage and analyze genomic
data.
DNA Clone and Other Services. Incyte offers a variety of DNA clone and
other services designed to assist its collaborators in using information from
its databases in internal lab-based experiments. The DNA fragments from which
the information in Incyte's databases is derived represent valuable resources
for researchers, enabling them to perform bench-style experiments to supplement
the information obtained from searching Incyte's databases. Incyte retains a
copy of all isolated clones corresponding to the sequences in the database. The
Company's collaborators may request from the Company clones corresponding to a
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sequence of interest on a one-by-one basis or through LifeSeq GeneAlbum, a
subscription-based service that provides database collaborators with large
numbers of sequence verified DNA clones. In addition, the Company produces a
broad line of genomic research products, such as DNA clones and insert
libraries, and offers technical support services, including high-throughput DNA
screening, custom robotic services, contract DNA preparation, and fluorescent
in-situ hybridization, to assist researchers in the identification and
isolation of novel genes.
Database Production
The Company engages in the high-throughput automated sequencing of genes
derived from tissue samples followed by the computer-aided analysis of each gene
sequence to identify homologies to genes of known function in order to predict
the biological function of newly identified sequences. The derivation of
information in the Company's databases involves the following steps:
Tissue Access. Incyte obtains tissue samples representing most major
organs in the human body from various academic and commercial sources.
Where possible, the Company obtains information as to the medical history
and pathology of the tissue. The genetic material is isolated from the
tissue and prepared for analysis. The results of this analysis as well as
the corresponding pathology and medical history information are
incorporated into the databases.
High-Throughput cDNA Sequencing. The Company utilizes specialized
teams in an integrated approach to its high-throughput sequencing and
analysis effort. Gene sequencing is performed using multiple work shifts to
increase daily throughput. One team develops and prepares cDNA libraries
from biological sources of interest, a second team prepares the cDNAs using
robotic workstations to perform key steps that result in purified cDNAs for
sequencing, and a third team operates the automated DNA sequencers.
Bioinformatics. Sequence information generated from Incyte's
high-throughput sequencing operations is uploaded to a network of servers.
Incyte's proprietary bioinformatic software then assembles and edits the
sequence information. The sequence of each cDNA is compared via automated,
computerized algorithms to the sequences of known genes in the Company's
databases and public domain databases to identify whether the cDNA codes
for a known protein or is homologous to a known gene. Each sequence is
annotated as to its cell or tissue source, its relative abundance and
whether it is homologous to a known gene with known function or previously
unidentified. The bioinformatics staff monitors this computerized analysis
and may perform additional analyses on sequence information. The finished
data are then added to Incyte's proprietary sequence databases.
Customers
The Company has entered into database collaboration agreements with
nineteen companies as of December 31, 1997. In January 1998, the Company
announced the addition of Rhone-Poulenc S.A. as a database collaborator. Each
collaborator has agreed to pay, during an average term of three years, annual
fees to receive non-exclusive access to the Company's databases. For the year
ended December 31, 1997, the Company recognized revenue from eighteen of these
companies, none of which individually contributed 10% or more of total revenues.
In 1996, the Company recognized revenue from ten of these companies, three of
which each contributed in excess of 10% of total revenues. As of February 1998,
the Company's database collaborators were:
Abbott Laboratories Monsanto Company
ARIAD Pharmaceuticals,Inc. Novartis AG
BASF AG Novo Nordisk A/S
Bristol-Myers Squibb Company NV Organon
Eli Lilly and Company Pfizer Inc
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Genentech, Inc. Pharmacia & Upjohn, Inc
Glaxo Wellcome plc Rhone-Poulenc S.A.
Hoechst AG Schering AG
F. Hoffmann-La Roche Ltd SmithKline Beecham
Johnson & Johnson Zeneca Ltd.
Certain of the Company's database collaboration agreements contain minimum
annual update requirements which if not met could result in Incyte's breach of
the respective agreement. One database collaborator has the right on 30 days'
written notice to terminate its database collaboration agreement. There can be
no assurance that any of the Company's database collaboration agreements will be
renewed upon expiration or will not be terminated earlier in accordance with
their 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 ResultsLimited Operating
History; History of Operating Losses; Uncertainty of Continued Profitability or
Revenues," "--New and Uncertain Business," and "--Competition and Technological
Changes."
Development Programs
Since its inception, the Company has made substantial investments in
research and technology development. During the years ended December 31, 1997,
1996 and 1995, the Company spent approximately $68.9 million, $40.9 million, and
$19.2 million, respectively, on research and development activities. This
investment in research and development includes an active program to enter into
relationships with other technology-driven companies and, when appropriate,
acquire licenses to technologies for evaluation or use in the production and
analysis process. Not all of these technologies or relationships survive the
evaluation process. The Company has entered into a number of research and
development relationships with companies and research institutions. The
Company's commitments under any one of these agreements do not represent a
significant expenditure in relation to the Company's total research and
development expense.
The Company is currently evaluating new technologies relating to tissue
processing, DNA amplification, microarray production, advanced automated
sequencing and expression profiling to expand the productivity, efficiency and
quality of its database products, and a variety of new bioinformatic and
software tools to assist in data analysis, data mining and data visualization.
Technologies in which the Company has made investments to increase and enhance
the content of such products include mass spectrometry for high-throughput
expression profiling and microarray technology to monitor the activity of many
specific genes simultaneously in multiple tissue samples. The Company has
aggressively pursued both the internal and external development of new
technologies. Some of the research and development relationships established in
1997 in order to access externally developed technologies include: the
application of NetGenics, Inc.'s Common Object Broker Architecture (CORBA) and
project management tools; the development of a tissue databank with the
assistance of OncorMed, Inc.; and the investigation of TIBCO's "push" software
or multicasting technology. In January 1998, the Company announced a
relationship with Oxford GlycoSciences plc, to investigate the use of
proteomics, the large-scale, high-throughput analysis of protein expression, in
the development of new database modules. As part of the relationship the Company
made a $5 equity million investment in Oxford GlycoSciences plc.
In September 1997, the Company established a 50-50 joint venture company,
diaDexus LLC ("diaDexus"), with SmithKline Beecham Corporation ("SB'). diaDexus
intends to utilize genomic and bioinformatic technologies in the discovery and
commercialization of novel molecular diagnostic products. The Company and SB
have agreed to contribute up to an aggregate of $25 million to diaDexus.
Patents and Proprietary Technology
The Company's database business and competitive position is dependent upon
its ability to protect its proprietary database information and software
technology. The Company relies on patent, trade secret and copyright
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law, and nondisclosure and other contractual arrangements to protect its
proprietary information.
The Company's ability to license proprietary genes may be dependent upon
its ability to obtain patents, protect trade secrets and operate without
infringing upon the proprietary rights of others. Other pharmaceutical,
biotechnology and biopharmaceutical companies, as well as academic and other
institutions have filed applications for, may have been issued patents or may
obtain additional patents and proprietary rights relating to products or
processes competitive with those of the Company. Patent applications filed by
competitors may claim some of the same gene sequences or partial gene sequences
as those claimed in patent applications filed by the Company. The Company is
aware that Merck & Co., Inc. ("Merck") (in conjunction with Washington
University) and The Institute for Genomic Research ("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. There can be no assurance
that such publication of sequence information will not adversely affect the
Company's ability to obtain patent protection for sequences that have been made
publicly available.
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 has been issued a number of patents with respect to full-length gene
sequences. Currently, the Company has no registered copyrights for its
database-related software.
The patentability of partial gene sequences in general is highly uncertain,
involves complex legal and factual questions and has recently been the subject
of much controversy. No clear policy has emerged with respect to the breadth of
claims allowable for partial gene fragments. There is significant uncertainty as
to what claims, if any, will be allowed on partial gene sequences derived
through high-throughout gene sequencing. 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. In 1996, the United States Patent and Trademark Office ("USPTO")
issued guidelines limiting the number of gene sequences that can be examined in
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 it is possible that due to the resources needed to comply with the
guidelines, the Company may decide to abandon patent applications for some of
its partial gene sequences. To date, no patent has issued from any of the
Company's patent applications claiming partial gene sequences.
There can be no assurance that patent applications relating to the
Company's products or processes will result in patents being issued, or that any
issued patents will be enforceable against competitors. Even if patents are
issued on the basis of gene sequences, there may be uncertainty as to the scope
of the coverage, enforceability or commercial protection provided by any such
patents. See "Factors That May Affect Results--Uncertainty of Protection of
Patents and Proprietary Rights."
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 other genomic-related businesses, the risk increases that
the Company's potential products, and the processes used to develop these
products, may be subject to claims that they infringe the patents of others.
Further, the Company is aware of several issued patents in the field of
microarray or gridding technology, which can be utilized in the generation of
gene expression information. Certain of these patents are the subject of
litigation. Therefore, the Company's operations may require it to obtain
licenses under any such patents or proprietary rights, and no assurance can be
given that such licenses would 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 believes that certain of its patent
applications cover genes which may also be claimed in patent applications filed
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by other parties. Interference proceedings may be necessary to establish which
party was the first to invent a particular sequence for the purpose of patent
protection. Such litigation or interference proceedings 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, operating results and
financial condition. In addition, there can be no assurance that such
proceedings or litigation would be resolved in the Company's favor.
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, "Array of oligonucleotides on solid substrate,"
by both Synteni and Incyte. The Company believes that it and Synteni have
meritorious defenses and intend to defend the suit vigorously. See "Factors That
May Affect Results--Litigation."
Competition
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. A number of
companies, institutions, and government-financed entities, are 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 and TIGR, have made the results of
their sequencing efforts publicly available. These patent positions, or the
public availability of gene sequences comprising substantial portions of the
human genome or on microbial or plant genes, could decrease the potential value
of the Company's databases to the Company's collaborators and adversely affect
the Company's ability to realize royalties or other revenue from
commercialization of products based upon such 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. Moreover,
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. Specifically,
the Company is aware that there are a number of companies pursuing alternative
methods for deriving gene expression information, including those developing
microarray technologies. At least one other company currently offers
microarray-based services that might be competitive with those offered by
Synteni. These advanced sequencing or gene expression technologies, if
developed, may not be commercially available for purchase or license by the
Company on reasonable terms, or 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 there can be no
assurance that these products would not achieve greater market acceptance than
the products offered by the Company.
The Company believes that the features and ease of use of its database
software, its experience in high- throughput gene sequencing, the cumulative
size of its database, the quality of the data, including the annotations in its
database, and its experience with bioinformatics and database software are
important aspects of the Company's competitive position.
The genomics industry is characterized by extensive research efforts and
9
rapid technological progress. New developments are expected to continue and
there can be no assurance that discoveries by others will not render the
Company's services and potential products noncompetitive. In addition,
significant levels of research in biotechnology and medicine occur in
universities and other non-profit research institutions. These entities have
become increasingly active in seeking patent protection and licensing revenues
for their research results. These entities also compete with the Company in
recruiting talented scientists. See "Factors That May Affect Results--
Competition and Technological Changes."
Government Regulation
Regulation by governmental authorities in the United States and other
countries will be a significant factor in the production and marketing of any
pharmaceutical products that may be developed by a licensee of the Company or by
the Company. At the present time the Company does not intend to develop any
pharmaceutical products itself. The Company's agreements with its database
collaborators provide for the payment to the Company of royalties on any
pharmaceutical products developed by such collaborators derived from proprietary
information obtained from Incyte's genomic databases. Thus, the receipt and
timing of regulatory approvals for the marketing of such products may have a
significant effect in the future on the Company's revenues. Pharmaceutical
products developed by licensees will require regulatory approval by governmental
agencies prior to commercialization. In particular, human pharmaceutical
therapeutic products are subject to rigorous preclinical and clinical testing
and other approval procedures by the United States Food and Drug Administration
in the United States and similar health authorities in foreign countries.
Various federal and, in some cases, state statutes and regulations also govern
or influence the manufacturing, safety, labeling, storage, recordkeeping and
marketing of such pharmaceutical products, including the use, manufacture,
storage, handling and disposal of hazardous materials and certain waste
products. The process of obtaining these approvals and the subsequent compliance
with appropriate federal and foreign statutes and regulations require the
expenditure of substantial resources over a significant period of time, and
there can be no assurance that any approvals will be granted on a timely basis,
if at all. Any such delay in obtaining or failure to obtain such approvals could
adversely affect the Company's ability to earn milestone payments, royalties or
other license-based fees. Additional governmental regulations that might arise
from future legislation or administrative action cannot be predicted, and such
regulations could delay or otherwise affect adversely regulatory approval of
potential pharmaceutical products. See "Factors That May Affect
Results--Reliance on Pharmaceutical Industry; Uncertainty of Health Care Reform
and Related Matters."
Human Resources
As of January 31, 1998, the Company had 676 full-time equivalent employees
(141 of whom were contract or part-time employees), including 211 in sequencing
and reagent production, 168 in bioinformatics, 132 in research and technology
development, 108 in marketing, sales and administrative positions and 57 at
Synteni. None of the Company's employees is covered by collective bargaining
agreements, and management considers relations with its employees to be good.
The Company's future success 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. There is 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
such 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 operating results. See "Factors That
May Affect Results--Management of Growth" and "--Dependence on Key Employees."
10
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. The issuance of the Company's Common Stock in connection with the
merger, together with Synteni's operating losses, will reduce the Company's net
income per share, which could affect adversely the market price of the Company's
Common Stock unless and until revenue growth, cost savings or other business
synergies sufficient to offset the effect of such issuance can be achieved. This
growth, savings and synergies may never be achieved. 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. ("Genome Systems") and Combion,
Inc. ("Combion"), 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, 1997, 1996 and 1995, the Company had
net income (losses) of $10.4 million, ($6.8 million) and ($9.9 million),
respectively, and as of December 31, 1997, the Company had an accumulated
deficit of $26.1 million. The Company has experienced substantial revenue growth
since 1995 and has reported quarterly profits since the fourth quarter of 1996.
However, the Company may not be able to maintain revenue growth or
profitability. The Company's continued investment in new product and technology
development, obligations under existing and future research and development
alliances, and increased investment in marketing, sales and customer service
will require a continued increase in expenditures in 1998 and beyond. In
addition, the Company's earnings per shares and rate of growth in
11
profitability will likely be decreased for at least the first half of 1998, if
not longer, as a result of the incorporation into its consolidated results of
operations the losses incurred by the Synteni operations. 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. To date Synteni's microarray service agreements consist of
small volume pilot or feasibility agreements. The Company's ability to achieve
and maintain significant revenues will be dependent upon its ability to obtain
additional database collaborators and retain existing collaborators. The
Company's ability to maintain profitability will be dependent upon its ability
to obtain such database collaborators, the level of expenditures necessary for
the Company to maintain and support its services to its collaborators, and the
extent to which it incurs research and development, investment,
acquisition-related or other expenses related to the development and provision
of its products and services to database collaborators. While, as of February
1998, the Company had twenty 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. In
addition one database collaborator has the right on 30 days' written notice to
terminate its database collaboration agreement. 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. 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. In
addition, the Company could incur substantial expenses in its defense of the
lawsuit filed in January 1998 by Affymetrix alleging patent infringement by
Synteni and Incyte. See "--Litigation." 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
12
factors, it is likely that in some future quarter or quarters the Company's
operating results may be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially and adversely affected.
Competition and Technological Changes. There are a finite number of genes
in the human genome, and competitors may seek to identify, sequence and
determine in the shortest time possible the biological function of a large
number of genes in order to obtain a proprietary position with respect to the
largest number of new genes discovered. There are a number of companies, other
institutions, and government-financed entities engaged in gene sequencing, gene
discovery, gene expression analysis, positional cloning and other genomic
service businesses. Many of these companies, institutions and entities have
greater financial and human resources than the Company. 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 Company's databases. Further, certain entities
engaged in gene sequencing, including Merck and TIGR, have made the results of
their sequencing efforts publicly available. These patent positions or the
public availability of gene sequences comprising substantial portions of the
human genome or on microbial or plant genes could decrease the potential value
of the Company's databases to the Company's collaborators and adversely affect
the Company's ability to realize royalties or other revenue from
commercialization of products based upon this genetic information.
The gene sequencing machines that are utilized in the Company's
high-throughput computer-aided gene sequencing operations are commercially
available and are currently being utilized by several competitors. Some of the
Company's competitors or potential competitors are in the process of developing,
and may successfully develop, proprietary sequencing technologies that may be
more advanced than the technology used by the Company. In addition, the Company
is aware that there are a number of companies, in addition to Synteni, pursuing
alternative methods for generating gene expression information, including those
that have developed, and are developing, microarray technologies. At least one
other company currently offers microarray-based services that might be
competitive with those offered by Synteni. These advanced sequencing or gene
expression technologies, if developed, may not be commercially available for
purchase or license by the Company on reasonable terms, if at all.
A number of companies have announced their intent to develop and market
software to assist pharmaceutical companies and academic researchers in the
management and analysis of their own genomic data, as well as the analysis of
sequence data available in the public domain. Some of these entities have access
to significantly greater resources than the Company and these products may
achieve greater market acceptance than the Company's products.
The Company's databases also require extensive software support and
incorporate features determined by database collaborators' needs. If the Company
experiences delays or difficulties in implementing its database software or
collaborator-requested features, its ability to service its collaborators may be
adversely affected, which might have an adverse effect on the Company's business
and operating results.
The genomics industry is characterized by extensive research efforts and
rapid technological progress. To remain competitive, the Company will be
required to continue to expand its databases and to enhance the functionality of
its bioinformatics and database software. New developments are expected to
continue and discoveries by others may render the Company's services and
potential products noncompetitive.
New and Uncertain Business. The Company's genomic database business and the
use of its databases, software tools and related services to assist its
collaborators and potentially improve the efficiency of the traditional drug
discovery process represent a business for which there is no precedent. In
addition, Synteni's microarray services business represents a business for which
there is no precedent. The Company's database collaborators or potential
collaborators, or Synteni's current or potential customers, may determine that
the databases, software tools and microarray and related services provided by
the Company and Synteni are not useful or cost-effective. The
13
Company's strategy of using high-throughput sequencing to identify genes rapidly
and obtain proprietary rights in as many genes as possible and Synteni's
strategy of using microarrays to identify differentially expressed genes is
unproven. In addition, the Company has limited experience in providing
bioinformatics software and database products and services. The Company's
ability to sustain profitability depends on attracting additional collaborators
and retaining existing collaborators for its database, sequencing and software
products and services and Synteni's 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 the 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 and therefore
subject to trading restrictions, either of which increases the Company's risk of
investment and reduces the liquidity of the Company's investment. In addition,
the Company could be required to invest greater amounts than initially
anticipated or to devote substantial management time to the management of
research and development relationships and joint ventures. The occurrence of any
of the foregoing could result in a material adverse effect on the Company's
business, financial condition and results of operations.
Lengthy Sales Cycle. The ability of the Company to obtain new collaborators
for its databases, software tools and microarray and other services depends in
significant part upon prospective collaborators' perceptions that the Company's
databases, software tools, and services can help accelerate drug discovery
efforts. The sales cycle is typically lengthy due to the education effort that
is required, as well as the need to effectively sell the benefits of the
Company's databases, software tools, and services to a variety of constituencies
within potential collaborator companies. In addition, each database
collaboration and microarray services agreement involves the negotiation of
agreements containing terms that may be unique to each partner, such as the
scope of any licenses granted and whether satellite database services or access
to multiple database modules is desired. The Company may expend substantial
funds and management effort with no assurance that a database collaboration will
result.
Uncertainty of Protection of Patents and Proprietary Rights. The Company's
database business and competitive position are dependent in part upon its
ability to protect its proprietary database information and software technology.
Despite the Company's efforts to protect its proprietary database information
and software technology, unauthorized parties may attempt to obtain and use
information that the Company regards as proprietary. Although the Company's
database collaboration agreements require its collaborators to provide adequate
security for, and to control access to the Company's databases, policing
unauthorized use of the Company's databases and software by the Company or its
collaborators is difficult. The Company relies on patent, trade secret, and
copyright law, and nondisclosure and other contractual arrangements to protect
its proprietary information.
To date, the Company has been issued a number of patents with respect to
the gene sequences in the Company's databases and has not been issued patents or
registered copyrights for its related software. Patents cannot
14
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 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 USPTO. Given the large number
of applications filed by the Company, a large number of interferences could be
expensive and time consuming. In addition, it is impossible to predict how many,
if any, of the interferences would be resolved in the Company's favor.
The patentability of partial gene sequences in general is uncertain,
involves complex legal and factual questions, and has recently been the subject
of much controversy. As a result, patent applications filed by the Company on
such partial gene sequences may not result in issued patents. Even if patents
are issued for partial gene sequences, there may be uncertainty as to the scope
of the coverage, enforceability or commercial protection provided by any such
patents. Certain court decisions suggest that disclosure of a partial sequence
may not be sufficient to support the patentability of a full-length sequence and
that patent claims to a partial sequence may not cover a full-length sequence
inclusive of that partial sequence.
The USPTO has had a substantial backlog of biotechnology patent
applications and, in particular, applications that claim gene sequences. In
1996, the USPTO issued guidelines limiting the number of gene sequences that can
be examined within a single patent application. Many of the Company's patent
applications containing multiple partial sequences contain more sequences than
the maximum number allowed under the new guidelines. The Company is reviewing
its options and, due to the resources needed to comply with the guidelines, may
decide to abandon patent applications for some of its partial gene sequences.
In view of the possible delay in obtaining allowance of some of the
Company's patent applications, and the secrecy of patent applications, the
Company does not know if other applications that would have priority over the
Company's applications have been filed. Furthermore, changes in U.S. patent laws
resulting from the General Agreement on Tariffs and Trade ("GATT") became
effective in June 1995. Most notably, GATT resulted in U.S. law being amended to
change the term of patent protection from seventeen years from patent issuance
to twenty years from the earliest effective filing date of the application.
15
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, 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. Further, the Company is aware of several issued patents in the field
of microarray or gridding technology, which can be utilized in the generation of
gene expression information. 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. Interference proceedings may be necessary to establish which party was
the first to invent or the first to obtain a particular gene sequence for the
purpose of patent protection. Litigation or interference proceedings 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 notices from third parties alleging infringement claims.
The Company believes that it is not infringing the patent rights of any such
third party, and in circumstances in which the Company has determined a response
to an alleged infringement claim to be appropriate, the Company has notified the
claimant to that effect. To date, except as set forth below under
"--Litigation," no third party has taken any action with respect to an alleged
claim against the Company. There can be no assurance that action will not be
taken against the Company in the future, either with respect to previously
asserted or new claims or that if any action is taken, what the outcome of such
action will be.
Litigation. On January 6, 1998, Affymetrix filed a lawsuit in the United
States District Court for the District of Delaware alleging infringement of U.S.
patent number 5,445,934 (the "934 Patent") by both Synteni and Incyte. The
complaint alleges that the '934 Patent has been infringed by the making, using,
selling, importing, distributing or offering to sell in the U.S. high density
arrays by Synteni and Incyte and that such infringement was willful. Affymetrix
seeks a permanent injunction enjoining Synteni and Incyte from further
infringement of the '934 Patent and, in addition, seeks damages, costs and
attorney's fees and interest. Affymetrix further requests that any such damages
be trebled based on its allegation of willful infringement by Incyte and
Synteni. Incyte and Synteni believe they have meritorious defenses and intend to
defend the suit vigorously. However, there can be no assurance that Incyte and
Synteni will be successful in the defense of this suit, and litigation 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,
16
capital expenditure and other cash requirements at least through 1998. However,
the Company may be unable to obtain additional database collaborators or retain
existing collaborators for the Company's databases, and its database products
and services may not produce revenues, which together with the Company's cash,
cash equivalents, and marketable securities, will be adequate to fund the
Company's cash requirements. The Company's cash requirements depend on numerous
factors, including the ability of the Company to attract and retain
collaborators for its databases and genomic products and services; expenditures
in connection with alliances, license agreements and acquisitions of and
investments in complementary technologies and businesses; competing
technological and market developments; the cost of filing, prosecuting,
defending, and enforcing patent claims and other intellectual property rights;
the purchase of additional capital equipment or other capital expenditures,
including capital equipment necessary to ensure that the Company's sequencing
and microarray operations remain competitive; capital expenditures required to
expand the Company's and Synteni's facilities; and costs associated with the
integration of new operations assumed through mergers and acquisitions. In
particular, the Company expects its cash requirements to increase in 1998 as it
increases its investment in data processing-related computer hardware in order
to support its existing and new database products; continues to seek access to
technologies through investments, alliances, license agreements, and/or
acquisitions; makes investments associated with integration of acquired
companies; and addresses its needs for larger facilities and/or improvements in
existing facilities. Changes in the Company's research and development plans, or
other changes affecting the Company's operating expenses, may result in changes
in the timing and amount of expenditures of the Company's capital resources. If
additional capital is raised through the sale of equity or convertible debt
securities, the issuance of these securities could result in dilution to the
Company's existing stockholders. Additional funding, if necessary, may not be
available on favorable terms, if at all. If adequate funds are not available,
the Company may be required to curtail operations significantly or to obtain
funds through entering into collaborative arrangements that may require the
Company to relinquish rights to certain of its technologies, product candidates,
products or potential markets.
Management of Growth. The Company has recently experienced, and expects to
continue to experience, significant growth in the number of its employees and
the scope of its operations. This growth has placed, and may continue to place,
a significant strain on the Company's management and operations. The Company's
ability to manage effectively this growth will depend upon its ability to
broaden its management team and its ability to attract, hire and retain skilled
employees. The Company's success will also depend on the ability of its officers
and key employees to continue to implement and improve its operational,
management information and financial control systems and to expand, train and
manage its employee base. In addition, the Company must continue to take steps
to provide customer support resources as the number of overall database
collaborators and the number of requests from collaborators increases. Further,
the Company's database collaborators typically have worldwide operations and may
require support at multiple U.S. and foreign sites. Providing this support may
require the Company to open offices in addition to its Palo Alto, California
headquarters and its office in the United Kingdom, which could result in
additional burdens on the Company's systems and resources. The Company's
inability to manage growth effectively, including its growth through
acquisitions, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Key Employees. The Company is highly dependent on the
principal members of its scientific and management staff, including Roy A.
Whitfield, its Chief Executive Officer, and Randal W. Scott, its President and
Chief Scientific Officer, the loss of whose services would have a material
adverse effect on the Company's business. The Company has not entered into any
employment agreements with any of these persons and does not maintain any key
person life insurance policy on the life of any employee. The Company's future
success also will depend in part on the continued service of its key scientific,
software, bioinformatics and management personnel and its ability to identify,
hire and retain additional personnel, including personnel in the customer
service, marketing and sales areas. The Company experiences intense competition
for qualified personnel in the areas of the Company's activities, especially
with respect to experienced bioinformatics and software personnel, and there can
be no assurance that the Company will be able to continue to attract and retain
personnel necessary for the development of the Company's business. Failure to
attract and retain key personnel could have a material adverse effect on the
Company's business, financial condition and results of operations.
17
Dependence on Others. The Company relies on a limited number of suppliers
of gene sequencing machines and certain reagents required in connection with the
gene sequencing process. While other gene sequencing machines are available, the
Company does not believe that they are as efficient as the machines currently
used by the Company. In addition, while the Company is evaluating certain future
generation gene sequencing machines, these future generation sequencing machines
may never become commercially available, available at acceptable costs, or prove
to be more effective than current machines. Patent right issues concerning
certain current and future generation sequencing machines may also arise which
could prevent the Company from using them or make their use more expensive. If
the Company is unable to obtain additional machines or an adequate supply of
reagents or other materials at commercially reasonable rates, its ability to
continue to identify genes through gene sequencing would be adversely affected.
In addition, although the Company obtains, from a number of sources, tissue
samples from which mRNA may be isolated, the loss of access to some of these
sources, increased fees for access to these sources or increased restrictions on
use of the information generated could adversely affect the Company's business.
The Company's strategy for the development of its database and sequencing
business and the commercialization of its portfolio of partial and full-length
gene sequences may require the Company to enter into various research and
development relationships with corporate and academic collaborators and others.
The success of these relationships is dependent upon the performance of outside
parties of their responsibilities. The Company may not be able to establish
collaborative arrangements or license agreements that the Company deems
necessary or acceptable to develop its database and sequencing business or, in
the future, to commercialize its portfolio of partial and full-length gene
sequences. In addition, these collaborative arrangements or license agreements
may not be successful. The Company's collaborators may also be pursuing
alternative technologies or developing alternative products either on their own
or in collaboration with others, including the Company's competitors.
The Company has relied on scientific, technical, pathology, commercial and
other data supplied and disclosed by others, including its academic
collaborators and sources of tissue samples, and may rely on these data in the
construction of its database. There can be no assurance that these data contains
no errors or omissions, the knowledge of which would adversely change the
prospects for the Company's business.
Year 2000 Issue. As a result of computer programs being written using two
digits, rather than four, the performance of the Company's computer systems and
those of its suppliers and customers in the Year 2000 is uncertain. Any computer
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities. The Company plans to initiate a Year 2000
project, using internal and external resources, to evaluate the impact of the
Year 2000 on its products and operating systems. This will include the
initiation of formal communications with its significant suppliers and customers
to determine the extent to which the Company's interface systems are vulnerable
to third party failures to remediate their own Year 2000 issues. There can be no
guarantee that the systems of other companies on which the Company's systems
rely will be timely converted and would not have an adverse effect on the
Company's systems. The Company will perform a comprehensive review of all
internally used financial and administrative systems as well as internally
developed products sold to customers. At this time, given that the Company's
internal financial and administrative systems have been installed within the
last few years, and all internally developed software-based products sold to
customers have been developed over the last few years, the Company does not
expect the cost of addressing the Year 2000 issue to have a material impact on
the Company's business, results of operations or financial condition. However,
there can be no guarantee that if modifications or replacement of portions of
the software are necessary, it will be completed in a timely manner.
Hazardous Materials; Environmental Matters. The Company's research and
development involves the controlled use of hazardous and radioactive materials
and biological waste. The 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
18
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.
19
ITEM 2. PROPERTIES
Incyte's headquarters are in Palo Alto, California, where its main research
laboratories, sequencing facility, bioinformatics and administrative facilities
are located. Incyte also operates facilities in St. Louis, Missouri. As of
February 28, 1998, Incyte had multiple sublease and lease agreements covering
approximately 112,000 square feet that expire on various dates ranging from
March 1998 to January 2006. In addition, Synteni, leases a 28,000 square foot
facility in Fremont, California. 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 Company is currently
pursuing options to obtain temporary space suitable to meet current growth
requirements until the Company can occupy the new Palo Alto building. There can
be no assurance that suitable additional space will be available to the Company,
when needed, on commercially reasonable terms. The Company's inability to obtain
sufficient additional space, when needed, could have a material adverse effect
on the Company's business, financial condition and results of operations.
ITEM 3. LEGAL PROCEEDINGS
On January 6, 1998, Affymetrix filed a lawsuit in the United States
District Court for the District of Delaware alleging infringement of 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock, par value $.001 ("Common Stock"), was traded on
the American Stock Exchange ("ASE") under the symbol "IPI" from the Company's
initial public offering on November 4, 1993 until January 15, 1996. Since
January 16, 1996, the Company's Common Stock has been traded on the Nasdaq
National Market ("Nasdaq") under the symbol "INCY." The following table sets
forth, for the periods indicated, the range of high and low sales prices for the
Common Stock on the ASE or Nasdaq, as applicable, as reported in their
respective consolidated transaction reporting systems.
1996 High Low
---- ---- ---
First Quarter 19 11/16 12 5/16
Second Quarter 19 15/16 11 9/16
Third Quarter 24 7/8 16 1/4
Fourth Quarter 26 7/16 17 3/4
1997
----
First Quarter 37 1/4 24 1/16
Second Quarter 35 7/8 20 3/4
Third Quarter 42 1/4 29 13/16
Fourth Quarter 45 1/4 31 1/2
The above high and low sales prices for the Common Stock have been adjusted
to reflect the November 1997 two-for-one stock split effected in the form of a
stock dividend.
As of December 31, 1998, the Common Stock was held by 157 stockholders of
record. The Company has never declared or paid dividends on its capital stock
and does not anticipate paying any dividends in the foreseeable future.
21
ITEM 6. 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 Items 7 and
8 in this Report.
Year Ended December 31,
-----------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(in thousands, except per share amounts)
Statement of Operations Data:1
Revenues $ 88,351 $ 41,785 $ 12,212 $ 1,512 $ 672
Costs and expenses:
Research and development 68,927 40,864 19,212 11,169 4,764
Selling, general and administrative 12,134 6,792 3,927 2,328 737
Charge for purchase of in-process
research and development -- 3,165 -- -- --
---------- ----------- ----------- ----------- --------
Total costs and expenses 81,061 50,821 23,139 13,497 5,501
---------- ----------- ----------- ----------- --------
Income (loss) from operations 7,290 (9,036) (10,927) (11,985) (4,829)
Interest and other income, net
and losses from joint venture 3,666 2,275 990 510 60
---------- ----------- ----------- ----------- --------
Income (loss) before income taxes 10,956 (6,761) (9,937) (11,475) (4,769)
Provision for income taxes 548 -- -- -- --
---------- ----------- ----------- ----------- --------
Net income (loss) $ 10,408 $ (6,761) $ (9,937) $ (11,475) $(4,769)
========== =========== =========== =========== ========
Basic net income (loss) per share2,3 $ 0.47 $ (0.33) $ (0.59) $(0.82) $(1.46)
========== =========== =========== ====== ======
Number of shares used in computation
of basic net income (loss) per share 22,215 20,313 16,734 14,060 3,264
========== =========== =========== =========== ========
Diluted net income (loss) per share2,3 $ 0.43 $ (0.33) $ (0.59) $ (0.82) $ (1.46)
========== =========== =========== =========== ========
Number of shares used in computation
of diluted net income (loss) per share 24,158 20,313 16,734 14,060 3,264
========== =========== =========== =========== ========
December 31,
------------
1997 1996 1995 1994 1993
--------- --------- --------- ----------- ----
Balance Sheet Data:1 (in thousands)
Cash, cash equivalents and
securities'available-for-sale $ 114,666 $ 38,250 $ 41,181 $ 25,257 $15,540
Working capital 91,523 22,047 38,983 20,866 14,865
Total assets 193,090 66,876 58,782 29,350 17,807
Noncurrent portion of capital lease
obligations and notes payable 53 37 147 148 517
Accumulated deficit (26,114) (36,522) (29,761) (19,824) (8,349)
Stockholders' equity 146,019 45,247 47,503 24,344 16,451
1 1993, 1994, 1995, 1996 restated to reflect combined results and financial
position of Incyte and Genome Systems.
2 Basic and diluted net loss per share for all periods have been restated
in accordance with FASB 128, which the Company adopted in December 31, 1997.
3 Basic and diluted net loss per share for 1993 has been restated to
retroactively reflect the requirements of Staff Accounting Bulletin No. 98,
issued by the staff of the Securities and Exchange Commission in February 1998.
22
ITEM 7. 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 in Items 6 and 8 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 database products and their use by
potential collaborators of the Company; the impact of technological advances and
competition; the ability of the Company to obtain and retain customers;
competition from other entities; early termination of a database collaboration
agreement or failure to renew an agreement upon expiration; the ability to
successfully integrate the operations of recent business combinations; the cost
of accessing technologies developed by other companies; uncertainty as to the
scope of coverage, enforceability or commercial protection from patents that
issue on gene sequences and other genetic information; the viability of joint
ventures and businesses in which the Company has purchased equity; and the
matters discussed in Item 1 under the caption "Business--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 and related
reagents and services. 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. In
January 1998, the Company completed the acquisition of Synteni, Inc.
("Synteni"), a microarray-based gene expression company.
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.
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
23
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. In addition, one database collaborator has the right on 30 days'
written notice to terminate its database collaboration 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.
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 Company's investments in joint ventures
and businesses, particularly diaDexus, LLC ("diaDexus"), a joint venture with
SmithKline Beecham Corporation ("SB"), may require the Company to record losses
or expenses related to its proportionate ownership interest in such entities, to
record charges for the acquisition of in-process technologies, or to record
charges for the recognition of the impairment in the value of the securities
underlying such investments. In addition, 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. The need for continued
investment in development of the Company's databases and related products and
services and for extensive ongoing collaborator support capabilities results in
significant fixed expenses. If revenue in a particular period does not meet
expectations, the Company may not be able to adjust significantly its level of
expenditures in such period, which would have an adverse effect on the Company's
operating results. The Company may also experience difficulty in forecasting
levels of operating expenditures for, and integration-related expenses with
respect to, subsidiaries acquired through acquisitions, at least until a
substantial period of time has passed since the acquisition date. This is
particularly true when attempting to forecast expenditure levels for acquired
businesses that focus on technologies for which there is not yet an established
market. The Company believes that quarterly comparisons of its financial results
will not necessarily be meaningful and should not be relied upon as an
indication of future performance. Due to the foregoing and other unforeseen
factors, it is likely that in some future quarter or quarters the Company's
operating results may be below the expectations of public market analysts and
investors. 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.
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
24
initiation of formalcommunications 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 the internally
developed products sold to customers. At this time, given that the Company's
internal financial and administrative systems have been installed within the
last few years, and all internally developed software-based products sold to
customers have been developed over the last few years, the Company does not
expect the cost of addressing the Year 2000 issue to have a material impact on
the Company's business, results of operations or financial condition. However,
there can be no guarantee that if modifications or replacement of portions of
the software are necessary, it will be completed in a timely manner.
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 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, 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. 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. In January 1998, the Company
issued Common Stock in exchange for all of the outstanding capital stock of
Synteni, a microarray-based genomics company located in Fremont, California. The
transaction will be accounted for as a pooling of interests in 1998. Pro forma
unaudited historical data summarizing the combined results of the Company and
Synteni is set forth in Note 10 of Notes to Consolidated Financial Statements
set forth in Item 8 of this report.
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 "Business--Factors That May Affect Results" in Item 1 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
$10.4 million, compared to a net loss of ($6.8 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 $0.47 for the year ended December 31, 1997 and
basic net loss per share was ($0.33) and ($0.59) for the years ended
December_31, 1996 and 1995, respectively. Diluted net income per share was $0.43
for the year ended December 31, 1997 and diluted net loss per share was ($0.33)
and ($0.59) for the years ended December 31, 1996 and 1995, respectively. The
net income per share in 1997 reflects the issuance of 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 0.6 million shares in 1996 in connection with the
Company's business combinations with Genome Systems and Combion and the issuance
of 3.7 million shares in a November 1995 follow-on public
25
offering. 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.
Revenues. Revenues for the years ended December 31, 1997, 1996 and 1995
were $88.4 million, $41.8 million and $12.2 million, respectively. Revenues
resulted primarily from database access fees and, to a much lesser extent, from
custom satellite database services and genomic screening products and 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 $81.1 million, $50.8 million and $23.1 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 continued investment in
new product and technology development, obligations under existing and future
research and development alliances, and increased investment in marketing, sales
and customer 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 $68.9 million, $40.9 million and $19.2 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, 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,
expands it microarray operations, invests in new technologies, and invests in
the continued protection of its intellectual property.
Selling, general and administrative expenses for the years ended December
31, 1997, 1996 and 1995 were $12.1 million, $6.8 million and $3.9 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 Company's defense, and
potential damages and fees, in the patent infringement lawsuit file 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 $4.0 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
5%, 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.
26
Liquidity and Capital Resources
As of December 31, 1997, the Company had $114.7 million in cash, cash
equivalents and marketable securities, compared to $38.3 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 $18.7 million for the year
ended December 31, 1997, compared to $16.3 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 increase in net cash provided by operating
activities in 1997 compared to 1996 resulted primarily from increases in
deferred revenue due to the prepayment of database collaboration fees, the
change from net loss to net income, and increased depreciation and amortization
expenses partially offset by the increase in accounts receivable. 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 $26.1 million, $20.2 million and $8.0
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 $90.2 million, $1.5 million
and $32.8 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 1998. However, the Company may be unable to
obtain additional collaborators or retain existing collaborators for the
Company's databases, and its database products and services may not produce
revenues which, together with the Company's cash, cash equivalents and
marketable securities, would be adequate to fund the Company's cash
requirements. The Company's cash requirements depend on numerous factors,
including the ability of the Company to attract and retain collaborators for its
databases and genomic products and services; 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 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
27
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. 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.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Ernst & Young LLP, Independent Auditors........................................................... 30
Consolidated Balance Sheets at December 31, 1997 and 1996................................................... 31
Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995.................. 32
Consolidated Statement of Stockholders' Equity for the three year period ended December 31, 1997............ 33
Consolidated Statements of Cash Flow for the years ended December 31, 1997, 1996 and 1995................... 34
Notes to the Consolidated Financial Statements.............................................................. 36
29
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
30
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except number of shares and par value)
December 31,
-----------------------------
1997 1996
-------------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 51,169 $ 7,628
Restricted cash 6,000 --
Marketable securities - available-for-sale 57,497 30,622
Accounts receivable 19,851 2,126
Prepaid expenses and other current assets 3,651 2,799
---------- ----------
Total current assets 138,168 43,175
Property and equipment, net 36,943 22,936
Long-term investments 14,800 313
Deposits and other assets 3,179 452
---------- ----------
Total assets $ 193,090 $ 66,876
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,503 $ 4,670
Accrued liabilities 4,860 727
Accrued compensation expense 3,192 853
Due to* joint venture 6,000 ---
Deferred revenue 27,090 14,878
---------- ----------
Total current liabilities 46,645 21,128
Non-current portion of accrued rent and other non-current liabilities 426 501
---------- ----------
Total liabilities 47,071 21,629
---------- ----------
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;
24,051,509 shares issued and outstanding at December 31, 1997;
20,894,602 shares at December 31, 1996 24 21
Additional paid-in capital 172,053 81,821
Unrealized gains (losses) on marketable securities and other 56 (73)
Accumulated deficit (26,114) (36,522)
----------
Total stockholders' equity 146,019 45,247
---------- ----------
Total liabilities and stockholders' equity $ 193,090 $ 66,876
========== ==========
See accompanying notes
31
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Year Ended December 31,
----------------------------------------
1997 1996 1995
----------------------------------------
Revenues (Notes 1 and 2) $ 88,351 $ 41,785 $ 12,212
Costs and expenses:
Research and development 68,927 40,864 19,212
Selling, general and administrative 12,134 6,792 3,927
Purchase of in-process research and development ' 3,165 --
---------- ---------- ----------
Total costs and expenses 81,061 50,821 23,139
Income (loss) from operations 7,290 (9,036) (10,927)
Interest income 4,118 2,495 1,186
Interest and other expense (152) (220) (196)
Losses from joint venture (300) -- --
---------- ---------- ----------
Income (loss) before income taxes 10,956 (6,671) (9,937)
Provision for income taxes 548 -- --
---------- ---------- ----------
Net income (loss) $ 10,408 $ (6,761) $ (9,937)
========== ========= ==========
Basic net income (loss) per share $ 0.47 $ (0.33) $ (0.59)
========== ========= ==========
Shares used in computing basic net income (loss) per share 22,215 20,313 16,734
========== ========== ==========
Diluted net income (loss) per share $ 0.43 $ (0.33) $ (0.59)
========== ========== ==========
Shares used in computing diluted net income (loss) per share 24,158 20,313 16,734
========== ========== ==========
See accompanying notes
32
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands, except number of shares)
Unrealized
Additional Gains(Losses) on Total
Common Paid-in Marketable Deferred Accumulated Stockholders'
Stock Capital Securities and Compensation Deficit Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1994 16 44,485 22 (355) (19,824) 24,344
Issuance of 57,630 shares of
Common Stock upon exercise of
stock options -- 88 -- -- -- 88
Issuance of 3,674,000 shares of
Common Stock, net of expenses and
underwriters' fees of $2,232 4 32,667 -- -- -- 32,671
Amortization of deferred compensation -- -- -- 326 -- 326
Net change in unrealized gains (losses)
on marketable securities -- -- 11 -- -- 11
Net (loss) -- -- -- -- (9,937) (9,937)
---------- --------- --------- ---------- --------- ---------
Balances at December 31, 1995 20 77,240 33 (29) (29,761) 47,503
Issuance of 457,296 shares of
Common Stock upon exercise of
stock options and 299,398 shares
upon exercise of warrant 1 1,581 -- -- -- 1,582
Issuance of 146,342 shares of
Common Stock in exchange for
shares of Combion, Inc. -- 3,000 -- -- -- 3,000
Amortization of deferred
compensation -- -- -- 29 -- 29
Net change in unrealized gains
(losses) on marketable securities -- -- (106) -- -- (106)
Net (loss) -- -- -- -- (6,761) (6,761)
---------- --------- ----------- ---------- --------- --------
Balances at December 31, 1996 21 81,821 (73) -- (36,522) 42,247
Issuance of 2,755,426 shares of
Common Stock, net of expenses and
underwriters' fees of $5,065 3 87,239 -- -- -- 87,242
Issuance of 386,547 shares of
Common Stock upon exercise of
stock options and 14,934 shares
upon exercise of warrant -- 2,993 -- -- -- 2,993
Net change in unrealized gains
(losses) on marketable securities -- -- 127 -- -- 127
Net change in cumulative
translation adjustment -- -- 2 -- -- 2
Net income -- -- -- -- 10,408 10,408
---------- -------- --------- ---------- --------- -------
Balances at December 31, 1997 $ 24 $172,053 $ 56 $ -- $(26,114) $146,019
========== ========= ========= ========== ========== ========
See accompanying notes
33
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)
(Increase (decrease) in cash and cash equivalents)
Year Ended December 31,
1997 1996 1995
----------------- ------------------ ------------
Cash flows from Operating
Activities
Net income (loss) $ 10,408 $ (6,761) $ (9,937)
Adjustments to reconcile
net loss to net cash
provided by (used in)
operating activities:
Depreciation and amortization 10,412 6,461 2,750
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 (3,102) (2,034) (571)
Accounts payable 851 2,326 760
Deferred revenue 12,212 7,610 4,498
Accrued and other liabilities 6,388 535 1,014
-------------- ------------ ------------
Total adjustments 8,310 23,072 1,136
-------------- ------------- ------------
Net cash provided by (used in)
operating activities 18,718 16,311 (8,801)
--------------- ------------- ------------
Cash Flows from Investing Activities
Long-term investments (8,237) (313) --
Transfer to restricted cash (6,000) -- --
Capital expenditures (26,136) (20,188) (8,042)
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 (65,401) (20,691) (20,357)
--------------- ------------- ----------
Cash Flows from Financing Activities
Net proceeds from issuances of common stock 90,235 1,582 32,759
Proceeds from capital leases and notes payable -- -- 69
Principal payments on capital lease obligations (8) (121) (72)
-------------- ------------- ------------
Net cash provided by financing activities 90,227 1,461 32,756
--------------- -------------- ------------
Effect of exchange rate on cash (3) -- --
Net increase (decrease) in cash and cash
equivalents 43,541 (2,919) 3,598
Cash and cash equivalents at beginning of
the period 7,628 10,547 6,949
-------------- --------------- ------------
Cash and cash equivalents at end of
the period $ 51,169 $ 7,628 $ 10,547
============== ============== ===========
(Continued)
See accompanying notes
34
INCYTE PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(in thousands)
Year Ended December 31,
---------------------------------------------------------------------------
1997 1996 1995
------------ ----------- -----------
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 $ -- $ --
============ ============ ===========
See accompanying notes
35
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, and
related reagents and services. 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.
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 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 $25,289,000, $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 short-term investments.
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.
36
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.
Net
Unrealized Estimated
Amortized Gains Fair
Cost (Losses) Value
------------- -------------- ----------
(in thousands)
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
============ =========== =========
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.
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:
December 31,
------------------------
1997 1996
---------- --------
(in thousands)
Office equipment $ 2,138 $ 950
Laboratory equipment 18,601 12,982
Computer equipment 21,797 9,935
Leasehold improvements 14,220 8,679
--------- --------
Less accumulated depreciation and amortization (19,813) (9,610)
-------- -------
$ 36,943 $ 22,936
========= ========
Depreciation expense, including depreciation expense of assets under capital
leases, was $8,537,000, $5,230,000, and $2,154,000 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.
37
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.
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.
Business Combinations. 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 of Notes to Consolidated Financial Statements.
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.
38
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:
Year Ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
(in thousands)
Numerator:
Net income (loss) $ 10,408 $ (6,671) $ (9,937)
========== =========== ===========
Denominator:
Denominator for basic net income (loss) per
share - weighted-average shares outstanding 22,215 20,313 16,734
Dilutive potential common shares-stock options 1,943 -- --
---------- ----------- -----------
Denominator for diluted net income (loss) per
share - adjusted weighted-average 24,158 20,313 16,734
========== =========== ===========
Basic net income (loss) per share $ 0.47 $ (0.33) $ (0.59)
========== =========== =========
Diluted net income (loss) per share $ 0.43 $ (0.33) $ (0.59)
========== =========== =========
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 73% 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.
Note 3. Commitments
At December 31, 1997, the Company had signed noncancelable operating leases on
multiple facilities, including facilities in Palo Alto, 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 $3,211,000, $1,645,000, and $1,251,000, respectively.
39
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:
Capital Leases
Operating and
Leases Notes Payable
------ -------------
(In thousands)
Year ended December 31,
1998 $ 4,924 $ 48
1999 3,771 38
2000 3,275 19
2001 2,782 --
2002 and thereafter 2,866 --
---------- -----------
Total minimum lease payments $ 17,618 105
==========
Less amount representing interest 6
-----------
Present value of minimum lease payments 99
Less current portion 46
-----------
Noncurrent portion $ 53
===========
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 late 1998.
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.
Note 4. Stockholders' Equity
Common Stock. At December 31, 1997, the Company had reserved a total of
4,239,877 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 income (loss) in 1997 and 1996 would have been
40
reduced (increased) to approximately $3.0 million and $(10.5 million),
respectively. The Company's pro forma basic and diluted net income (loss) per
share in 1997 and 1996 would have been reduced (increased) to $0.13 per share
and $(0.52) per share and $0.12 per share and $(0.52) per share, respectively.
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 two 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 under the plan from 4,000,000 to 4,800,000.
41
Activity under the plan was as follows:
Shares Subject To
Outstanding Options
-------------------
Shares Weighted Average
Available Exercise
For Grant Shares Price
--------- ------ -----
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
========== =========== =========
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).
42
The following table summarizes information about stock options outstanding at
December 31, 1997, for both the 1991 Stock Plan and the 1993 Directors' Stock
Option Plan.
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
- --------------- -------------------------------------------------------------------------------------
$0.15--1.00 175,654 4.92 $ 0.74 175,654 $ 0.74
$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 3,588,896 8.14 $ 17.01 2,316,903 $ 10.28
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.
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 November 1, 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 $23,900,000. 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 2011 if not utilized.
Significant components of the Company's deferred tax assets are as follows:
December 31,
------------
1997 1996
---- ----
(in thousands)
Deferred tax assets:
Net operating loss carryforwards $ 8,400 $10,100
Research credits 4,000 1,500
Capitalized research and development 1,400 1,600
Other, net 2,800 1,500
--------- -------
Deferred tax assets 16,600 14,700
Valuation allowance for deferred tax assets (16,600) (14,700)
Net deferred tax asset $ -- $ --
========= =======
The valuation allowance for deferred tax assets increased by approximately
$1,900,000 million, $2,600,000 million and $4,100,000 million 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.
43
The provision for income taxes consists primarily of federal Alternative Minimum
Tax and differs from the federal statutory rate as follows:
Year ended December 31,
1997
(in thousands)
--------------
Tax at U.S federal statutory rate 3,835
Use of net operating loss carryforwards (4,814)
Non-deductible in-process research and development charges 1,108
Other 419
---------
Provision for income tax $ 548
=========
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 $516,000, $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.
The table below presents the separate results of operations for Incyte and
Genome Systems for the periods prior to the merger. Incyte's results of
operations include Genome Systems since the transaction:
Year Ended December 31,
-----------------------
1996 1995
---- ----
(in thousands)
Revenues:
Incyte $ 40,051 $ 9,908
Genome 1,734 2,304
--------- -------
$ 41,785 $12,212
========= =======
Net income (loss):
Incyte $ (6,724) $(10,142)
Genome 106 205
Merger related expenses (143) --
-------- --------
$ (6,761) $(9,937)
======== ========
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.
Note 8. Joint Venture
44
In September 1997, the Company formed a joint venture, diaDexus, in conjunction
with SB, on 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
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 will be accounted for as a pooling of interests and,
accordingly, the Company's financial statements and financial data will be
restated in 1998 to include the accounts and operations of Synteni since
inception.
The following unaudited pro forma data summarizes the combined results of
operations of the Company and Synteni as though the merger had occurred at the
beginning of fiscal 1995.
Year Ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
(unaudited pro forma)
(in thousands, except per share amounts)
Revenues $ 89,996 $ 41,895 $ 12,299
Net income (loss) 6,908 (7,276) (9,937)
Net income (loss) per share:
Basic 0.28 (0.32) (0.53)
Diluted 0.26 (0.32) (0.53)
Synteni's fiscal year ends September 30. Synteni's results of operation for the
period from October 1, 1997 to December 31, 1997 will be recorded directly in
retained earnings.
In addition, each option to purchase Synteni common stock granted under
Synteni's 1996 Equity Incentive Plan ("Synteni Plan") outstanding immediately
prior to the merger was converted into an option to purchase Incyte Common Stock
and Incyte assumed each such outstanding Synteni stock option in accordance with
the terms of the Synteni Plan and the stock option agreement by which it is
evidenced. The former Synteni stock option holders received options to purchase
318,655 shares of Incyte Common Stock.
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
45
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, plan 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.
46
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item (with respect to Directors) is
incorporated by reference from the information under the caption "Election of
Directors" contained in the Company's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the Company's 1998 Annual Meeting of Stockholders to be held on June
15, 1998 (the "Proxy Statement").
The executive officers of the Company are as follows:
Roy A. Whitfield, age 45, has been Chief Executive Officer of the Company
since June 1993 and a director since June 1991. Mr. Whitfield served as
President of the Company from June 1991 until January 1997 and as Treasurer of
the Company from April 1991 until October 1995. Previously, Mr. Whitfield served
as the President of Ideon Corporation, which was a majority owned subsidiary of
Invitron Corporation ("Invitron"), a biotechnology company, from October 1989
until April 1991. From 1984 to 1989, Mr. Whitfield held senior operating and
business development positions with Technicon Instruments Corporation
("Technicon"), a medical instrumentation company, and its predecessor company,
CooperBiomedical, Inc., a biotechnology and medical diagnostics company. Prior
to his work at Technicon, Mr. Whitfield spent seven years with the Boston
Consulting Group's international consulting practice. Mr. Whitfield received a
B.S. with First Class Honors in mathematics from Oxford University, and an
M.B.A. with Distinction from Stanford University.
Randal W. Scott, Ph.D., age 40, has been President of the Company since
January 1997. He has served as Chief Scientific Officer of the Company since
March 1995, Secretary of the Company since April 1991, and a director since June
1991. Dr. Scott served as Executive Vice President of the Company from March
1995 until January 1997 and Vice President, Research and Development of the
Company from April 1991 until February 1995. Dr. Scott was one of Invitron's
founding scientists and was employed by Invitron from March 1985 to June 1991.
In 1987, Dr. Scott started the Protein Biochemistry Department at Invitron's
California Research Division and became Senior Director of Research in November
1988. Dr. Scott was responsible for developing Invitron's proprietary products
and discovery programs and is an inventor of several of the Company's patents.
Prior to joining Invitron, he was a Senior Scientist at Unigene Laboratories, a
biotechnology company. Dr. Scott received his Ph.D. in Biochemistry from the
University of Kansas.
Denise M. Gilbert, Ph.D., age 40, has been Executive Vice President, Chief
Financial Officer and Treasurer of the Company since October 1995. From July
1993 to October 1995 Dr. Gilbert was Vice President and Chief Financial Officer
of Affymax N.V., a biopharmaceutical company. Prior to joining Affymax, Dr.
Gilbert spent seven years as a Wall Street biotechnology analyst, serving as a
Managing Director of Smith Barney from July 1991 to July 1993, Vice President at
NatWest Securities from July 1990 to July 1991, and senior analyst at Montgomery
Securities from July 1986 to July 1990. Dr. Gilbert received her B.A. in
Biological Sciences from Cornell University and Ph.D. in Cell and Developmental
Biology from Harvard University.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
information under the captions "Election of Directors--Compensation of
Directors," "Executive Compensation," and "Report of the Compensation Committee
of the Board of Directors on Executive Compensation--Compensation Committee
Interlocks and Insider Participation" contained in the Proxy Statement.
47
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
information under the captions "Election of Directors - Compensation of
Directors," "Executive Compensation," and "Report of the Compensation Committee
of the Board of Directors on Executive Compensation--Compensation Committee
Interlocks and Insider Participation" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
information contained under the caption "Certain Transactions" contained in the
Proxy Statement.
48
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
(1) Financial Statements
Reference is made to the Index to Consolidated Financial Statements
under Item 8 of Part II hereof.
(2) Financial Statement Schedules
All financial statement schedules have been omitted because they are
not applicable or not required or because the information is included elsewhere
in the Consolidated Financial Statements or the Notes thereto.
(3) Exhibits
See Item 14(c) below. Each management contract or compensatory plan or
arrangement required to be filed has been identified.
(b) Reports on Form 8-K.
There were no reports on Form 8-K filed by the Company during the
quarter ended December 31, 1997.
(c) Exhibits
Exhibit
Number Description of Document
------- -----------------------
2.1 Agreement and Plan of Merger dated as of December 23, 1997
among Incyte Pharmaceuticals, Inc., Bond Acquisition Corp.
and Synteni, Inc. (incorporated by reference to Exhibit 2.1 to
the Company's Current Report on Form 8-K dated January 22,
1998 (File No. 0-27488)).
3(i) Restated Certificate of Incorporation, as amended
(incorporated by reference to Exhibit 4.1 to the
Company's Registration Statement on Form S-3 (File
No. 333-31307)).
3(ii) Bylaws of the Company, as amended (incorporated by reference
to Exhibit 4.2 to the Company's Registration Statement on
Form S-3 (File No. 333-31307)).
Form of Common Stock Certificate (incorporated by
reference to the exhibit of the same number to the
Company's Registration Statement on Form S-1 (File
No. 33-68138)).
4.2 Registration Rights Agreement dated as of December 23, 1997
among Incyte Pharmaceuticals, Inc. and the former
stockholders of Synteni , Inc. (incorporated by reference to
Exhibit 4.1 to the Company's Current Report on Form 8-K dated
January 22, 1998 (File No. 0-27488)).
10.1# 1991 Stock Plan of Incyte Pharmaceuticals, Inc., as amended
and restated (the "Plan") (incorporated by reference to
Exhibit 10.1 to the Company's Registration Statement on
Form S-8 (File No. 33-93666)).
10.2# Form of Incentive Stock Option Agreement under the
Plan (incorporated by reference to the exhibit of the
same number to the Company's Registration Statement
on Form S-1 (File No. 33-68138)).
49
10.3# Form of Nonstatutory Stock Option Agreement under the
Plan (incorporated by reference to the exhibit of the
same number to the Company's Registration Statement
on Form S-1 (File No. 33-68138)).
10.4# Amended and Restated 1993 Directors' Stock Option Plan of
Incyte Pharmaceuticals, Inc.
10.5# Form of Indemnity Agreement between the Company and
its directors and officers (incorporated by reference
to Exhibit 10.5 to the Company's Registration
Statement on Form S-1 (File No. 33-68138)).
10.6 Lease Agreement dated December 8, 1994 between the Company
and Matadero Creek (incorporated by reference to Exhibit
10.16 to the Company's Annual Report on Form
10-K for the year ended December 31, 1994).
10.7 Lease dated July 18, 1991 between the Company and Harry J.
Fair, Jr., as amended (incorporated by reference to
Exhibit 10.8 to the Company's Registration Statement on
Form S-1 (File No. 33-68138)).
10.8 Lease Amendment and Extension to Lease dated July 18, 1991
between the Company and Harry J. Fair, Jr., as amended
(incorporated by reference to Exhibit 10.11 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1993).
10.9 Stock Purchase Agreement dated as of June 22, 1994 between
the Company and Pfizer Inc. (incorporated by reference to
Exhibit B to the Company's Current Report on
Form 8-K dated June 23, 1994).
10.10 Registration Rights Agreement dated as of June 22, 1994
between the Company and Pfizer Inc. (incorporated by
reference to Exhibit C to the Company's Current Report
on Form 8-K dated June 23, 1994).
10.11+ Stock Purchase Agreement dated as of November 30, 1994
between the Company and The Upjohn Company (incorporated by
reference to Exhibit B to the Company's Current Report on
Form 8-K dated November 30, 1994, as amended by Form 8-K/A
filed with the Commission on March 27, 1995).
10.12 Registration Rights Agreement dated as of November 30, 1994
between the Company and The Upjohn Company (incorporated by
reference to Exhibit C to the Company's Current Report on
Form 8-K dated November 30, 1994).
10.13# 1996 Amendment to the Plan (incorporated by reference to
Exhibit 10.1 to the Company's Registration Statement on
Form S-8 (File No. 333-13449)).
10.14# 1997 Amendment to the Plan (incorporated by reference
to Exhibit 10.1 to the Company's Registration
Statement on Form S-8 (File No. 333-31413)).
10.15# 1997 Employee Stock Purchase Plan of Incyte Pharmaceuticals,
Inc. (incorporated by reference to Exhibit 10.1 to the
Company's Registration Statement on Form S-8 (File
No. 333-31409)).
10.16+ Master Strategic Relationship Agreement dated as of
September 2, 1997 between SmithKline Beecham Corporation,
Incyte Pharmaceuticals, Inc. and diaDexus, LLC
(incorporated by reference to Exhibit 10.18 to the Company's
Quarterly Report on Form 10-QA for the quarter ended
September 30, 1997).
10.17# 1996 Synteni, Inc. Equity Incentive Stock Plan
(incorporated by reference to Exhibit 10.19 to the Company's
Registration Statement on Form S-8 (File No. 333-46639)).
50
21.1 Subsidiaries of the Company.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (see Page 46 of this Form 10-K).
27 Financial Data Schedule
- ---------
+ Confidential treatment has been granted with respect to certain portions of
these agreements.
# Indicates management contract or compensatory plan or arrangement.
(d) Financial Statement Schedules
Not applicable
51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INCYTE PHARMACEUTICALS, INC.
Date: March 27, 1998 By /s/ROY A. WHITFIELD
-------------------------
Roy A. Whitfield
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Roy A. Whitfield, Randal W. Scott, and
Denise M. Gilbert, and each of them, his or her true and lawful
attorneys-in-fact, each with full power of substitution, for him or her in any
and all capacities, to sign any amendments to this report on Form 10-K and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact or their substitute or
substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ ROY A. WHITFIELD Chief Executive Officer March 27, 1998
- --------------------------- (Principal Executive Officer
Roy A. Whitfield and Director)
/s/ DENISE M. GILBERT Executive Vice President, March 27, 1998
- --------------------------- Finance and Chief Financial
Denise M. Gilbert Officer (Principal Financial
Officer)
/s/ WILLIAM DELANEY Corporate Controller March 27, 1998
- --------------------------- (Principal Accounting Officer)
William Delaney
/s/ JEFFREY J. COLLINSON Chairman of the Board March 27, 1998
- ---------------------------
Jeffrey J. Collinson
/s/ BARRY M. BLOOM Director March 27, 1998
- ---------------------------
Barry M. Bloom
/s/ FREDERICK B. CRAVES Director March 27, 1998
- ---------------------------
Frederick B. Craves
/s/ JON S. SAXE Director March 27, 1998
- ---------------------------
Jon S. Saxe
/s/ RANDAL W. SCOTT Director March 27, 1998
- ---------------------------
Randal W. Scott
52
EXHIBIT INDEX
Exhibit
Number Description of Document
- ------ -----------------------
2.1 Agreement and Plan of Merger dated as of December 23, 1997 among
Incyte Pharmaceuticals, Inc., Bond Acquisition Corp. and Synteni, Inc
(incorporated by reference to Exhibit 2.1 to the Company's Current
Report on Form 8-K dated January 22, 1998 (File No. 0-27488)).
3(i) Restated Certificate of Incorporation, as amended
(incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-3 (File No. 333-31307)).
3(ii) Bylaws of the Company, as amended (incorporated by reference to
Exhibit 4.2 to the Company's Registration Statement on Form S-3
(File No. 333-31307)).
Form of Common Stock Certificate (incorporated by reference to
the exhibit of the same number to the Company's Registration
Statement on Form S-1 (File No. 33-68138)).
4.2 Registration Rights Agreement dated as of December 23, 1997 among
Incyte Pharmaceuticals, Inc. and the former stockholders of Synteni,
Inc. (incorporated by reference to Exhibit 4.1 to the Company's
Current Report on Form 8-K dated January 22, 1998 (File No. 0-27488)).
10.1# 1991 Stock Plan of Incyte Pharmaceuticals, Inc., as amended
and restated (the "Plan") (incorporated by reference to
Exhibit 10.1 to the Company's Registration Statement on Form
S-8 (File No. 33-93666)).
10.2# Form of Incentive Stock Option Agreement under the Plan
(incorporated by reference to the exhibit of the same number
to the Company's Registration Statement on Form S-1 (File No.
33-68138)).
10.3# Form of Nonstatutory Stock Option Agreement under the Plan
(incorporated by reference to the exhibit of the same number
to the Company's Registration Statement on Form S-1 (File No.
33-68138)).
10.4# Amended and Restated 1993 Directors' Stock Option Plan of Incyte
Pharmaceuticals, Inc.
10.5# Form of Indemnity Agreement between the Company and its
directors and officers (incorporated by reference to Exhibit
10.5 to the Company's Registration Statement on Form S-1 (File
No. 33-68138)).
10.6 Lease Agreement dated December 8, 1994 between the Company and
Matadero Creek (incorporated by reference to Exhibit 10.16 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1994).
10.7 Lease dated July 18, 1991 between the Company and Harry J. Fair, Jr.,
as amended (incorporated by reference to Exhibit 10.8 to the
Company's Registration Statement on Form S-1 (File No. 33-68138)).
10.8 Lease Amendment and Extension to Lease dated July 18, 1991 between the
Company and Harry J. Fair, Jr., as amended (incorporated by reference
to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1993).
10.9 Stock Purchase Agreement dated as of June 22, 1994 between the Company
and Pfizer Inc. (incorporated by reference to Exhibit B to the
Company's Current Report on From 8-K dated June 23, 1994).
10.10 Registration Rights Agreement dated as of June 22, 1994 between the
Company and Pfizer Inc.
53
(incorporated by reference to Exhibit C to the Company's
Current Report on Form 8-K dated June 23, 1994).
10.11+ Stock Purchase Agreement dated as of November 30, 1994 between the
Company and The Upjohn Company (incorporated by reference to Exhibit B
to the Company's Current Report of Form 8-K dated November 30, 1994,
as amended by Form 8-K/A filed with the Commission on March 27, 1995).
10.12 Registration Rights Agreement dated as of November 30, 1994 between
the Company and The Upjohn Company (incorporated by reference to
Exhibit C to the Company's Current Report on Form 8-K dated
November 30, 1994).
10.13# 1996 Amendment to the Plan (incorporated by reference to Exhibit 10.1
to the Company's Registration Statement on Form S-8
(File No. 333-13449)).
10.14# 1997 Amendment to the Plan (incorporated by reference to Exhibit 10.1
to the Company's Registration Statement on Form S-8
(File No. 333-31413)).
10.15# 1997 Employee Stock Purchase Plan of Incyte Pharmaceuticals, Inc.
(incorporated by reference to Exhibit 10.1 to the Company's
Registration Statement on Form S-8 (File No. 333-31409)).
10.16+ Master Strategic Relationship Agreement dated as of September 2, 1997
between SmithKline Beecham Corporation, Incyte Pharmaceuticals, Inc.
and diaDexus, LLC (incorporated by reference to Exhibit 10.18 to the
Company's Quarterly Report on Form 10-QA for the quarter
ended September 30, 1997).
10.17# 1996 Synteni, Inc. Equity Incentive stock Plan (incorporated by
reference to Exhibit 10.19 to the Company's Registration Statement on
Form S-8 (File No. 333-46639)).
21.1 Subsidiaries of the Company.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (see Page 52 of this Form 10-K).
27 Financial Data Schedule.
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+ Confidential treatment has been granted with respect to certain
portions of these agreements.
# Indicates management contract or compensatory plan or arrangement.
54