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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


                               -----------------
                                   
FORM 10-K

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(Mark
(Mark One)
    [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934

        
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001

                                      2002
OR

    [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934

        
¨
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 GENOMICS, INC.
            (ExactCORPORATION
(Formerly known as Incyte Genomics, Inc.)
(Exact name of registrant as specified in its charter)

                      Delaware                 94-3136539
                   (State of other            (IRS Employer
                   jurisdiction of         Identification No.)
                    incorporation
                  or organization)

               3160 Porter Drive, Palo       (650) 855-0555
               Alto, California 94304
                (Address of principal    (Registrant's telephone
                 executives offices)     number, including area
                                                  code)

            
Delaware
94-3136539
(State of other jurisdiction of incorporation
or organization)
(IRS Employer Identification No.)
3160 Porter Drive, Palo Alto, California 94304
(650) 855-0555
(Address of principal executives 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 per share
Series A Participating Preferred Stock Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]x    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'sregistrant’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
Indicate by check mark whether the registrant is an accelerated filer. Yesx    No¨
The aggregate market value of Common Stock held by non-affiliates (based uponon the closing sale price on the Nasdaq National Market on FebruaryJune 28, 2002) was approximately $735.0$511.8 million.
As of February 28, 2002,March 14, 2003, there were 66,897,66770,796,152 shares of Common Stock, $.001 per share par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10 (as to directors and Section 16(a) Beneficial Ownership Reporting Compliance), 11, 12 and 13 of Part III incorporate by reference information from the registrant'sregistrant’s proxy statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the registrant's 2002registrant’s 2003 Annual Meeting of Stockholders to be held on June 4, 2002.

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23, 2003.
Item 1.    Business
When used in this Report, the words "expects," "anticipates," "intends,"
"estimates," "plans," "believes,"“expects,” “anticipates,” “intends,” “estimates,” “plans,” “believes,” and similar expressions are intended to identify forward-looking statements. These are statements, that relate to future
periods andwhich include statements as to the Company's expected net profitsexpenses and losses, expected expenditure levels and rate of growth of expenditures,
expected cash flows, the adequacy of capital resources, growth in operations,levels; expected revenues and sources of revenues,revenues; expected uses of net cash; expected losses and net losses; expected expenditures including expenditures on intellectual property and research and development; the abilityoffset of profits from certain products by other expenditures; the adequacy of capital resources; the expected effect of our contractual obligations on our future liquidity and cash flow; our plans to commercialize
products developed under collaborationsreduce expenditures in 2003 and alliances,the expected spending reductions, workforce reductions and office consolidations; our abilitystrategic investments, including anticipated losses and expenses; the application of U.S. Patent and Trademark Office utility guidelines to complete
the sequence of full-length genes in areas of therapeutic interestour gene patent applications; costs associated with prosecuting, defending and obtain
patents on these potential drug targets, our ability to integrate companies,
operationsenforcing patent claims and their products that we have acquired or will acquire, the
scheduling and timing of current and future litigation,other intellectual property rights; the size of our intellectual property portfolio and its competitive position,position; our investments
inapproach to discovery research; the usefulness of certain antagonists; our intellectual property portfolio,ability to successfully facilitate the identification and development of novel drug therapies through our drug discovery efforts; expectation that our information product line assets will help drive co-development and collaborative opportunities for our drug discovery efforts; our strategy with regard to protecting our proprietary technology,intellectual property; the successeffect of pharmaceutical and biotechnology company consolidations, including reduced research and development spending and pricing constraints by pharmaceutical and biotechnology customers and the softening of the market for genomic information and the market for our information products; the effect of our pharmaceutical and biotechnology customers’ focus on late stage research and clinical products on the pricing of, and the length of contractual commitment for, our information products; the expected growth of, and our ability to manage expansion of, our therapeutic discovery and development efforts, our ability to compete and respond to rapid technological
change, our intention to develop pharmaceutical products and ability to compete
successfully,operations, including operations in multiple locations; our competitive advantage as to the annotation of the human
proteome, whether we receiveadvantage; future royalty payments from database
collaborators, our ability to leverage our intellectual property and genomic
information to take a lead position in therapeutic small molecule, secreted
protein and antibody discoveries, the effect ofrequired government regulation, the
receipt and timing of regulatory approvals obtained on pharmaceutical products
developed by our customers utilizing our database information, our compliance
with applicable environmental laws and regulations, the adequacy of our current
facilities and our ability to locate additional facilities at reasonable rates
including a permanent facility for our East Coast operations, our exposure to
foreign currency rate fluctuations, products and services under development,
and the performance, content and utility of, and the potential cost savings
associated with the use of our products prior to commercialization; future required expertise relating to clinical trials, manufacturing, sales and services. Forward-looking
statementsmarketing and for licenses to technology rights; the commercial availability of drugs resulting from our research; our reliance on our key personnel; 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 to whichof utilization of genomic information by the biotechnology and pharmaceutical industries; actual and future consolidations of pharmaceutical and biotechnology industries use
genomiccompanies; continuing trends with respect to reduced pharmaceutical and biotechnology research spending; our ability to manage our information in research and development,products on a cash flow positive basis; risks relating to the development of new products and services and their use by our potential customerscollaborators; the impact of technological advances and collaborators,competition; unanticipated delays in research and development efforts; the result of further research; the number of employees entitled to receive severance benefits or other costs to be recognized in connection with the expense reduction program; our ability to developconsolidate our facilities and commercialize drugs and other
products to improve human health,close, assign or sublease facilities upon anticipated timelines; our ability to workdeliver products and services to our customers effectively with our collaborators to
meet the goals of our collaborationsreduced headcount and alliances, the ability of all of our
information products whether developed alone or in collaboration with others to
aid the research endeavors of third party researchersmanagement and to conduct such
research in an early cost-effective manner,key employee diversion; our ability to enter into new
collaborations in supportobtain and retain customers; competition from other entities; early termination of our own drug discovery and development efforts,
our abilitya database collaboration agreement or failure to retain and obtain customers,renew an agreement upon expiration; the cost of accessing or acquiring technologies developed by other companies; significant delays or intellectual property,costs in obtaining regulatory approvals; failure to obtain regulatory approval; uncertainty as to the effectivenessscope of coverage, enforceability or commercial protection from patents that issue on gene and other discoveries; our researchability to integrate Maxia’s operations and development efforts,programs successfully; our ability to obtain patent protection for our discoveries and to continue to be effective in expanding our patent coverage; the impact of alternative technological advances and
competition,changing laws on our ability to compete with pharmaceutical, biotechnology or other
researchers with greater financial, personnel or other resources, uncertainties
associated with changes in patent laws andportfolio; developments in and expenses relatedrelating to litigation and interference proceedings;litigation; the results of businesses in which we have purchased equity; and the risks set forth below under
Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Factorsmatters discussed in “Factors That May Affect Results."” These forward-looking statements speak only as of the date hereof. The CompanyWe expressly disclaimsdisclaim 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'sour expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
In the sections of this report entitled "Business"“Business” and "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations--FactorsOperations—Factors That May Affect Results,"” all references to "Incyte," "we,"
"us," "our"“Incyte,” “we,” “us” or the "Company"“our” mean Incyte Genomics, Inc.Corporation and its subsidiaries,
except where it is made clear that the term means only the parent company.

   subsidiaries.
2
Incyte, LifeSeq, BioKnowledge and LifeSeqZooSeq are our registered trademarks. ZooSeq, GeneAlbum, and
BioKnowledge Library are our trademarks. We also refer to trademarks of other corporations and organizations in this document.

                                      1

Overview
Incyte believes it hasis a drug discovery company that develops proprietary genomic information and applies its expertise in medicinal chemistry and molecular, cellular and in vivo biology to the discovery of novel small molecule and protein therapeutics. We believe we have created the largest commercial portfolio of issued United States patents covering human, full-length genes and the proteins they encode, and the antibodies directed against them. We intend to leverage our leadinglicense this intellectual property, as well as market our genomic and genomicproteomic information, position to be a leader in
therapeutic small molecule, secreted protein and antibody discoveries. In
addition, Incyte has also developed a leading integrated platform of genomic
technologies designed to aid in the understandingmany of the molecular basis of
disease. These technologies primarily consist of genomic databases and
pharmaceutically relevant intellectual property licenses, which helpworld’s leading pharmaceutical and biotechnology researchers in their therapeuticcompanies and academic research centers. We have assembled an experienced and talented drug discovery team that is identifying potential new drug therapies for cancer, inflammatory diseases and development efforts. These efforts include gene discovery, understanding
disease pathways, identifying new disease targets and the discovery and
correlation of gene sequence variation to disease.

   other medical conditions.
During 2001, Incyte increased itswe turned our focus on itsto our therapeutic discovery and development programs and itsour information products, which include licensing
certain of its intellectual property. As a result, we exited the following
activities: microarray-related products and services, genomic screening
products and services, public domain clone products and related services,
contract sequencing services, transgenics products and services and single
nucleotide polymorphism ("SNP") discovery services.products. Our current products include information databases, intellectual property licensing, and certain other products, such as full-length clones.
Our databases integrate bioinformatics software with proprietary and, when appropriate, publicly available genomic information. In developing our databases, we utilize high-throughput, computer-aided gene sequencing and analysis technologies to identify and characterize the expressed genes of the human genome, as well as certain plant and animal genomes. By searching our proprietary genomic databases, customers can integrate and analyze genomic information from multiple sources to discover genes that may represent the basis for new drug targets, therapeutic proteins, antisense or diagnostic products. Our products can be applied to gene and target discovery, functional genomics studies, preclinical pharmacology and toxicology studies, and can aid in understanding and analyzing the results of clinical development studies.
We provide access to our databases to pharmaceutical and biotechnology companies and academic institutions worldwide. In addition, customers may access select databases online via our website. As of December 31, 2001,2002, we had agreements with more than fifty companies had entered into agreements100 customers for one or more of the products shown below to obtain access to our databases on a non-exclusive basis. Revenues from these companies have primarily consisted of database access fees. OurSome of our agreements also provide for future milestone payments and royalties from the development and sale of products derived from proprietary information contained in one or more database modules.
Our portfolio of database products and services includes:

  .   LifeSeq(R) Gold;

  .   LifeSeq(R) Foundation;

  .   ZooSeq(TM);

  .   Bioknowledge(TM) Library; and

  .   DrugMatrix(TM).

   
•
LifeSeq® Foundation;
•
ZooSeq®;
•
Bioknowledge® Library; and
•
DrugMatrix™.
The databases are available using the Oracle database architectureXML data files or flat files, which can be integrated into local customer databases and operate on various workstations.tools, or used in conjunction with third-party software tools. Online delivery of certain database products is available from the Company'sour website at www.incyte.com.
We are also generating revenue from licenses to a range of intellectual property, owned by or exclusively licensed by Incyte, covering genomic technologies and our gene portfolio.portfolio of patents claiming genes, proteins and antibodies. Revenues derived from genomic technology licenses are primarily related to microarray fabrication and gene expression,
automation, software and sequencing technology.

                                      2

expression.
3
Revenues are also generated from the licensing of our extensive gene intellectual propertypatent portfolio for use by genomic "tool"“tool” and service providers, such as microarray product manufacturers. As part of this licensing strategy, we anticipateour license agreements with some of our licensees provide that we will receive milestones and/or royalties on sales of commercial products developed by certain of ourthose licensees.
Background
All living cells contain DNA comprised of two strands of complementary molecules. These molecules, called poly-nucleotides, are strung together in specific patterns to create genes. Genes provide the necessary information to create proteins, the molecules that carry out 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. 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 that they encode, has thus become a significant area of interest and research within the pharmaceutical and biotechnology industries.
Sequencing
DNA sequencing is a process that identifies the order in which nucleotides are strung together in a segment of DNA. Once the sequence of a gene is known, the function of the gene may be inferred by comparing its sequence with the sequences of other human genes of known function, or it may be determined through use of other technologies. Genes with similar, or homologous, sequences are likely to have related functions. Comparing gene sequences across species is also a useful tool for understanding gene function, as frequently it is easier to first assess gene function in other organisms.
Single Nucleotide Polymorphism
The most common form of gene sequence variation is known as a single nucleotide polymorphism, or SNP. A SNP is defined as a single nucleotide difference within the same DNA region between two individuals. Genetic variation may cause individuals to respond differently to disease or treatment with the same drug. Few, if any, FDA-approved drugs can successfully treat every individual diagnosed with a targeted disease. The differences in patients'patients’ responses to a drug are believed to result in part from differences in the sequence of nucleotides within genes.
Proteomics
Proteomics is a relatively new field of study that involves the separation, identification, and characterization of proteins present in a biological sample. By comparing disease and control samples, it is possible to identify disease-specific proteins. These may have potential as targets for drug development or as molecular markers of disease.
Chemogenomics
Chemogenomics is a field of study bridging genomics into chemistry for drug discovery and development to understand and predict broad compound interaction and influence biological pathways and physiology.
Gene Expression Technology
Microarray technology can be used to analyze the expression patterns in a large number of genes simultaneously. A microarray consists of fragments of DNA attached to a surface in a grid-like formation. When
4
fragments of DNA from normal and diseased cells are applied to the microarray, complementary strands attach to each other. Microarray technology allows the fabrication of very small grids containing probes for thousands of

                                      3

 different genes. Microarrays can be used in drug discovery and development, to evaluate the behavior of a large number of related genes in a diseased tissue or in response to treatment with a new drug or in diagnostic testing to quickly detect the presence of a large number of disease markers.
Products and Services
Therapeutic Discovery and Development
In addition to offices and laboratories located at our headquarters in Palo Alto, California, we maintain research facilities in Newark, Delaware and San Diego, California dedicated to the discovery and development of new medicines to treat cancer, inflammatory, metabolic and other diseases. Our scientific staff are applying their expertise in medicinal, combinatorial and high speed chemistry, pharmacology, drug metabolism, molecular and cell biology and other disciplines to identify novel small molecule and protein therapeutics. We believe our highly-focused approach to discovery research and our integration of chemistry and biology with the latest research tools and techniques, such as gene cloning, gene knockouts in vitro and in vivo, high-throughput screening, molecular modeling and protein x-ray crystallography, will facilitate the identification and development of novel drug therapies.
Drug Discovery Programs.    By January 2003, we had launched three full-scale small molecule drug discovery programs: one in inflammation and two in cancer. Small molecule therapeutics offer some advantages over large molecules such as proteins, peptides and monoclonal antibodies as they are often administered orally on an outpatient basis and can be produced by conventional pharmaceutical manufacturing methods with the potential for greater efficiencies than large molecule drugs. The most advanced of these programs is focused on a class of proteins, known as chemokines, which has potential utility in treating inflammatory diseases. We are pursuing chemokine receptor antagonists that are orally active and may prevent tissue damage from the action of inflammatory cells known as macrophages. We believe these antagonists may be clinically useful in treating inflammatory conditions characterized by excessive macrophage activity such as rheumatoid arthritis, atherosclerosis, asthma and multiple sclerosis. We are currently testing novel chemokine antagonists in animal disease models and have applied for patents on these compounds.
Our research programs in cancer are targeting proteases and phosphatases that may prevent the proliferation of cancer cells in diseases such as breast, lung and colon cancer. Our scientists are applying their understanding of how these enzymes control the activities of other proteins that drive uncontrolled cell proliferation and how over-expression of phosphatase genes can be linked to cancer. Our scientists are targeting phosphatases to develop proprietary small molecule therapeutics.
Preclinical Drug Development.    We acquired several compounds already in development through our acquisition of Maxia Pharmaceuticals, Inc., including a program focused on new approaches to treat Type 2 diabetes. The first of these compounds, which are novel insulin sensitizers, is in late preclinical testing. We completed our acquisition of Maxia Pharmaceuticals, a privately held company based in San Diego, California, in February 2003.
Information and Licensing Products

   Sequence 
Databases.    We provide our database collaborators with non-exclusive database access. Database collaborators generally receive periodic data updates as well as upgrades and additional search and analysis tools when they becomeas available. Search and analysis tools are also available to our collaborators from a third-party vendor. The fees and the period of access to our database information are negotiated independently with each company. Fees payable by pharmaceutical and biotechnology collaborators generally consist of access fees, option fees, and
non-exclusive or exclusive license fees corresponding to patent rights on proprietary sequences.genes and proteins. We also provide access to our database to third parties who use the database to develop genomic tools, such as microarrays that require genetic content, which
5
they in turn sell to pharmaceutical and biotechnology researchers. We may also receive future milestone and royalty payments from database collaborators from the development and sale of their products derived from our technology and database information. Using our databases and the available tools, researchers can browse not only Incyte-generated data, but also public domain information. Customers may also access select Incyte-hosted databases online via our website. We currently offer the following database modules:

  .   LifeSeq Gold Database.  Incyte's flagship database, LifeSeq Gold,
      currently contains more than 7.5 million sequences--5.5 million of which
      are proprietary to Incyte--representing more than 90% of the human genes.
      These sequences come from more than 1,500 different libraries from both
      normal and diseased tissue, including many libraries biased toward rare
      genes and alternate splice variants, which are variations of known genes
      that can be similar to, but longer, shorter, or of the same length but of
      a different sequence from the known gene. More than 1,100 of the
      libraries in LifeSeq Gold are proprietary to Incyte. The database also
      contains public domain genomic data that has been curated and aligned
      with Incyte's gene transcript data using our proprietary informatics
      processes and sequences corresponding to rare genes. LifeSeq Gold
      partners also have access to more than 250,000 sequence-verified clone
      reagents. LifeSeq Gold data can be accessed via a browser-based
      customized analysis tool to identify genes based on function, disease
      association, or sequence. LifeSeq Gold is accessible to customers in
      several different configurations including installation behind the
      customer's firewall or through the Internet to an Incyte-hosted secure
      site.

  .   LifeSeq Foundation Database.  Incyte's new flagship database, LifeSeq
      Foundation, was built to serve the evolving needs of the
      biopharmaceutical industry in the post-genomic era. It moves in silico
      research down the drug discovery pipeline from target discovery toward
      target validation, the current bottleneck in drug discovery. It provides
      access to high quality, hand-edited, full-length genes from gene families
      that historically have been the most likely drug targets. In addition,
      LifeSeq Foundation allows the researcher to understand quickly the
      function and biology of a gene using proprietary SNPs, RNA expression,
      and a hand-curated summary of the published literature from our
      acquisition of Proteome, Inc. in December 2000. In addition, proprietary
      bioinformatics has allowed Incyte to identify thousands of putative
      secreted genes that have the potential to be novel protein therapeutics,
      which information is also included in LifeSeq Foundation. All of this
      data is anchored to the human genome to give a comprehensive, stable
      reference to the transcribed human genome. LifeSeq Foundation enables a
      rapid transition from the database to lab experiments with access to
      thousands of full-length clones. Moreover, integration with proprietary
      rat and mouse homologs from the ZooSeq database allows detailed
      functional experiments in disease models.

  .   ZooSeq Database.  The ZooSeq multi-species gene sequence database
      provides genetic data for animal model organisms used in drug discovery,
      drug development and testing, and gene discovery. With rat, mouse,
      monkey, and dog animal models currently available, ZooSeq enables
      individual and cross-species comparison of genes. This information can
      help uncover previously unknown homologs of human disease-relevant genes,
      improve understanding of disease pathways, and provide a basis for

                                      4



      optimizing drug selection before moving on to expensive human clinical
      trials. ZooSeq data is accessed from a browser-based interface that
      provides point-and-click control of analysis tools included with the
      database.

  .   DrugMatrix Database.  DrugMatrix is the result of a collaboration between
      Incyte and Iconix, together with development partner MDS Pharma Services,
      Inc. DrugMatrix is a comprehensive research tool in the emerging field of
      chemogenomics that is designed to enable researchers to select quality
      leads and drug candidates at an early stage of drug discovery and
      development, which can lead to cost savings. DrugMatrix brings together
      the previously isolated fields of chemistry, genomics, toxicology and
      pharmacology in a single environment, providing a research tool that
      enables pharmaceutical researchers to ask questions in new ways to help
      predict the potential success, failure or positioning of therapeutic
      programs. DrugMatrix integrates approved pharmaceuticals and failed drug
      molecules by profiling them in tens of thousands of standardized gene
      expression microarray and molecular pharmacology experiments. In
      addition, it is supported with scientific literature annotation on known
      drug pharmacology, toxicology, and pathway interactions. The chemogenomic
      content of DrugMatrix utilizes a 3-tier database architecture, with a
      web-based user interface and bio-and chemoinformatics tools, to
      facilitate access and data mining, to aid medicinal chemists,
      pharmacologists and toxicologists in accelerating drug discovery through
      drug lead optimization and reduction of drug candidate failure in
      clinical trials.

  .   BioKnowledge Library.  The BioKnowledge Library is a collection of
      databases focused on the compilation of available protein information.
      Using proprietary processes, Incyte sifts relevant biological literature
      for curation into our products. The data are then presented in a simple
      format that offers flexibility and time savings over traditional library
      research. Access to thousands of independent research results offers the
      advantage of reduced library research time and potentially faster
      progression through discovery pathways.

   We intend to use the anticipated cash generated from our information product
line to help fund the cost of our therapeutic discovery and development
efforts. Additionally, we anticipate that our information product line assets,
in particular our intellectual property, will be used to help drive
co-development and collaborative opportunities within our therapeutic discovery
and development efforts.

   As of March 1, 2002, we have hired 23 personnel in connection with our
therapeutic discovery and development operations in our East Coast facility,
and we anticipate that such number will grow throughout the remainder of 2002
as we continue to build these operations.

Therapeutic Discovery and Development

   Since our inception, we have made substantial investments in research and
technology development. 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. We have entered
into a number of research and development relationships with companies and
research institutions.

   We have increased our investments in identifying and validating drug
targets. We employ sophisticated data mining and functional biology tools along
with our sequence, gene expression and SNP data included in our databases to
identify therapeutic targets. Our target validation efforts are supported by
our use of technologies that include biological assays and readout, gene
manipulation by antisense, retroviral transfection, and in vivo gene knockouts.
Our in-house and collaborative efforts are focused on high-priority therapeutic
areas such as cancer, cardiovascular disease and related metabolic disorders,
inflammatory disease, neurodegenerative disease, and osteoporosis.

                                      5

products:
•
LifeSeq Foundation Database.    Our new flagship database, LifeSeq Foundation, was built to serve the evolving needs of the biopharmaceutical industry. It moves in silico research down the drug discovery pipeline from target discovery toward target validation, the current bottleneck in drug discovery. It provides access to high quality, hand-edited, full-length genes from gene families that historically have provided the most promising drug targets. In addition, LifeSeq Foundation allows the researcher to understand quickly the function and biology of a gene using proprietary SNPs, ribonucleic acid (RNA) expression, and a hand-curated summary of published literature. In addition, proprietary bioinformatics has allowed us to identify thousands of putative secreted genes and gene splice variants that have the potential to be novel protein therapeutics, which information is also included in LifeSeq Foundation. All of this data is anchored to the human genome to give a comprehensive, stable reference to the transcribed human genome. LifeSeq Foundation enables a rapid transition from the database to lab experiments with access to thousands of full-length clones. Moreover, integration with proprietary rat and mouse homologs from the ZooSeq database allows detailed functional experiments in disease models.
•
ZooSeq Database.    The ZooSeq multi-species gene sequence database provides genetic data for animal model organisms used in drug discovery, drug development and testing, and gene discovery. With rat, mouse, monkey, and dog animal models currently available, ZooSeq enables individual and cross-species comparison of genes. This information can help uncover previously unknown homologs of human disease-relevant genes, improve understanding of disease pathways, and provide a basis for optimizing drug selection before moving on to expensive human clinical trials. ZooSeq data is accessed from a browser-based interface that provides point-and-click control of analysis tools included with the database.
•
BioKnowledge Library.    The BioKnowledge Library is composed of six database volumes containing fundamental biological information about proteins, with each volume focused on different organisms important to pharmaceutically relevant biological research. Using proprietary processes, we sift relevant biological literature for curation into our products with manual, expert based literature annotation of the human, mouse, rat, worm and fungal proteomes. The data are then presented in a simple format that offers flexibility and time savings over traditional library research. Weekly updates are provided as new information is published. An extensive and comprehensive hierarchical classification system is utilized to describe protein activity, biological role and cellular location. We provide a search and data export application for performing genome scale biological based analysis within the BioKnowledge Library. Access to thousands of independent research results offers the advantage of reduced library research time and potentially faster progression through discovery pathways.
•
DrugMatrix Database.    DrugMatrix is the result of a collaboration between Incyte and Iconix Pharmaceuticals, Inc., together with development partner MDS Pharma Services, Inc. DrugMatrix is a comprehensive research tool in the emerging field of chemogenomics that is designed to enable researchers to select quality leads and drug candidates at an early stage of drug discovery and development, which can lead to cost savings. DrugMatrix brings together the previously isolated fields of chemistry, genomics, toxicology and pharmacology in a single environment, providing a research tool that enables pharmaceutical researchers to ask questions in new ways to help predict the potential success, failure or positioning of therapeutic programs. DrugMatrix integrates approved pharmaceuticals and failed drug molecules by profiling them in tens of thousands of standardized gene expression microarray and molecular pharmacology experiments. In addition, it is supported with scientific literature annotation on known drug pharmacology, toxicology, and pathway interactions. The chemogenomic content of DrugMatrix utilizes a three-tier database architecture, with a web-based user
6
interface and bio- and chemoinformatics tools, to facilitate access and data mining, and is designed to aid medicinal chemists, pharmacologists and toxicologists in accelerating drug discovery through drug lead optimization and reduction of drug candidate failure in clinical trials.
Discontinued Custom Genomics Products and Services
We recognized revenue in 20012002 from the following products and servicesproduct that we no longer offer:

  Expression

  .   LifeExpress Database.  The LifeExpress database provided RNA
•
LifeSeq Gold Database.    The LifeSeq Gold database contained more than 7.5 million sequences—5.5 million of which are proprietary to Incyte—representing more than 90% of the human genes. These sequences came from more than 1,500 different libraries from both normal and diseased tissue, including many libraries biased toward rare genes and alternate splice variants, which are variations of known genes that can be similar to, but longer, shorter, or of the same length but of a different sequence from the known gene. More than 1,100 of the libraries in LifeSeq Gold were proprietary to Incyte. The database also contained public domain genomic data that had been curated and aligned with our gene transcript data using our proprietary informatics processes and sequences corresponding to rare genes. Current LifeSeq Gold subscribers were converted to LifeSeq Foundation.
In addition, in 2001, we exited the following activities: genomic screening products, public domain clone products and protein
      expression data. LifeExpress Target provided comprehensive
      disease-focused expression data for a number of key therapeutic areas,
      including cancer, cardiovascular, central nervous system, immunologyrelated services, transgenic products and inflammation,services and metabolic diseases (obesity, osteoporosis, and type 2
      diabetes). Researchers used LifeExpress Target to prioritize targets
      earlier in the discovery cycle; discover genes and regulatory pathways
      involved in disease; and more quickly identify disease-associated genes
      by tissue type, cell line, or animal model. The protein expression module
      was developed in cooperation with our collaborator, Oxford GlycoSciences
      Plc. The data was accessed via our Java-based software interface that
      provided a variety of analysis tools.

  .   GEM microarrays.  Our GEM microarrays (also known as LifeArrays) provided
      researchers with a cost-effective way to perform detailed analysis of
      differential gene expression in normal and diseased or treated cells. We
      offered a variety of GEM microarrays that contained DNA fragments, or
      clones, from both human and animal genomes.

  Genetics

  .   Custom SNP discovery service.  We provided customers with high-throughput SNP discovery services. Incyte used its proprietary fSSCP screening
      method onRevenue from these product offerings was recognized in 2000, 2001 and 2002 associated with the customer's geneswind down of interest to detect 95 percent of the
      polymorphisms that had a frequency greater than or equal to 3.1 percent.

  .   IsSNPs.  Our In silico SNP data was mined from the LifeSeq Gold database.
      Researchers used data derived from Incyte's genetics programs to identify
      and characterize optimal therapeutic targets, gain a better understanding
      of the relationship between disease phenotypes and genetic variation,
      enable faster clinical proof of principle, and identify genetic markers
      of disease progression.

  .   Custom Sequencing.  Our custom sequencing services leveraged several of
      our core strengths, including library screening, library construction,
      high-throughput cDNA sequencing and bioinformatics.

  .   Bioreagents and Other Services.  We offered a variety of DNA reagents and
      other services, including clones from our extensive libraries, GEM
      microarray services, gene screening, clone resources, and robotics.

these activities.
Database Production
We engage 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 our databases that include gene sequences involves the following steps:

  .   Tissue Access.  We obtain tissue samples representing most major organs
      in the human body from various academic and commercial sources. Where
      possible, we obtain 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.  We utilize specialized teams in an
      integrated approach to our 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.

                                      6



  .   Bioinformatics.  Sequence information generated from our high-throughput
      sequencing operations is uploaded to a network of servers. Our
      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 our 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. The
      bioinformatics staff monitors this computerized analysis and may perform
      additional analyses on sequence information. The finished data are then
      added to our proprietary sequence databases.

•
Tissue Access.    We obtain tissue samples representing most major organs in the human body from various academic and commercial sources. Where possible, we obtain 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.    We utilize specialized teams in an integrated approach to our high-throughput sequencing and analysis effort. 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 our high-throughput sequencing operations is uploaded to a network of servers. Our 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 our 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. The bioinformatics staff monitors this computerized analysis and may perform additional analyses on sequence information. The finished data are then added to our proprietary sequence databases.
Patents and Proprietary Technology
Our ability to license proprietary genes may be dependent upon our ability to obtain patents, protect trade secrets and operate without infringing upon the proprietary rights of others. We rely on patent, trade secret and
7
copyright law, as well as nondisclosure and other contractual arrangements, to protect our intellectual property. Other pharmaceutical, biotechnology and biopharmaceutical companies, as well as academic and other institutions, have filed applications, may have been issued patents or may obtain additional patents and proprietary rights, relating to products or processes competitive to our products or processes. Patent applications filed by competitors may claim some of the same gene sequences or partial gene sequences as those claimed in patent applications that we file. We are aware that some entities have made, or have announced their intention to make, gene sequences publicly available. Publication of sequence information may adversely affect our ability to obtain patent protection for sequences that have been made publicly available.
Our current policy is to file patent applications on what we believe to be novel full-length gene sequencesgenes obtained through our high-throughput computer-aided gene sequencing and characterization efforts. We have filed U.S. patent applications in which we have claimed certain partial gene sequences and have filed patent applications in the U.S. and applications under the Patent Cooperation Treaty ("PCT"(“PCT”), designating countries in Europe as well as Canada and Japan, claiming full-length gene sequencesgenes associated with cells and tissues that are the subject of our high-throughput gene sequencing program. To date, we hold over 500 U.S. patents with respect to human full-length gene
sequencesgenes and one issued U.S. patent claiming multiple partial gene sequences.genes expiring between April 2008 and November 2021. Currently, we have no registered copyrights for our database-related software.
In 1996, the United States Patent and Trademark Office issued guidelines limiting the number of gene sequencesgenes that can be examined in a single patent application. Many of our patent applications containing multiple sequencesgenes or partial sequencesgenes contain more sequences than the maximum number allowed under the new guidelines. We are reviewing our options, and due to the resources needed to comply with the guidelines, we may decide to abandon patent applications for some or all of our partial gene sequences,genes, or may not pursue all sequencesgenes in every patent application.
In 2000, the U.S. Patent and Trademark Office issued new guidelines under which its examiners are to determine whether gene patent applications comply with the U.S. Patent Law'sLaw’s utility requirements. We believe that our gene patent applications comply with these legal requirements, but uncertainty remains regarding the application of these requirements to our gene patent applications.
We have filed patent applications for patentable SNPs identified with our LifeSeq GoldFoundation database, through our human genome sequencing program, and through the use of our SNP discovery efforts. These patents will claim rights to SNPs for diagnostic and genotyping purposes. As information relating to particular
SNPs is developed, we plan to seek additional rights in those SNPs that are
associated with specific diseases, functions or drug responses. The scope of patent protection for gene sequences,genes, including SNPs, 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 SNPs. There is significant uncertainty as to what, if any, claims will be allowed on SNPs discovered through high throughput discovery
programs.

                                      7

SNPs.
As the biotechnology industry expands, more patents are issued and other companies engage in the business of discovering genes and other genomic-related businesses, the risk increases that our potential products, and the processes used to develop these products, may be subject to claims that they infringe the patents of others. Therefore, our operations may require us to obtain licenses under any of these patents or proprietary rights, and these licenses may not be made available on terms acceptable to us. Litigation may be necessary to defend against or assert claims of infringement, to enforce patents issued to us, to protect trade secrets or know-how owned by us, or to determine the scope and validity of the proprietary rights of others. We believe that some of our patent applications cover genes that may also be claimed in patent applications filed 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. Several interferences involving our patent applications covering full length genes have been declared. Litigation or interference proceedings, regardless of the outcome, could result in substantial costs to us, and divert our efforts, and may have a material adverse effect on our business, operating results and financial condition. In addition, there can be no assurance that such proceedings or litigation would be resolved in our favor.
8
In January and September 1998, Affymetrix, Inc. filed lawsuits in the United States District Court for the District of Delaware alleging infringement by Incyte of three U.S. patents by the Company.patents. In December 2001, Affymetrix and the Company
agreed to settleIncyte settled the infringement claims. This settlement does not include
Incyte'sIn December 2002, we settled our appeal before the United States District Court for the Northern District of California seeking de novo review of the Board of Patent Appeals and Interferences'Interferences’ decision relating to patent applications licensed by Incyteus from Stanford University.
In October 2001, Invitrogen Corporation filed an action against the Companyus in the United States District Court for the District of Delaware, alleging infringement of three patents. The complaint seeks unspecified money damages and injunctive relief. The Company believesWe believe that it haswe have meritorious defenses and intendsintend to defend this suit vigorously. See "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations--FactorsOperations—Factors That May Affect Results."

”
Collaborators
As of December 31, 2001, Incyte2002, we had entered into agreements for information products, some of which include licensing a portion of itsour intellectual property, with over fifty100 pharmaceutical, biotechnology and agricultural companies and academic institutions. Over 96%, 79% and 75% of revenues in 2002, 2001 and 2000, respectively, were derived from such agreements. In general, collaborators agree to pay, during the term of the agreement, fees to receive non-exclusive access to selected modules of our databases and/or licenses of certain of our intellectual property. In addition, if a collaborator develops certain products utilizing our technology and proprietary database information, royalty paymentswe could potentially be received by Incyte.

   receive royalty payments.
One collaborator contributed 11% of our total revenues in 2000, but no collaborator accounted for 10% or more of total revenues in 20012002 or 1999.

   2001.
For the year ended December 31, 2001,2002, we recorded revenue from collaborators throughout the United States and in Austria, Belgium, Canada, France, Denmark, Germany, India, Israel, Japan, Scandinavia,the Netherlands, Switzerland and the United Kingdom. Export revenue for the years ended December 31, 2002, 2001 and 2000 and 1999 was $34.8 million, $49.7 million and $48.2 million, respectively.
Competition
Our therapeutic discovery and $43.7 million, respectively.

Competition

   development efforts compete with those of many companies in both the biotechnology and pharmaceutical sectors that are trying to develop new drugs. These competitors include many that have greater resources than we do. These competitors may also have programs addressing the same diseases as our programs but that are at more advanced stages. It is also possible that our therapeutic discovery and development efforts will require access to intellectual property or technologies that are not available to us, or are only available to us on terms that we consider unreasonable.
We believe the following are important aspects of the competitive position of our therapeutic discovery and development efforts:
our leading intellectual property portfolio;
the experience of our senior management in the discovery and development of drugs; and
our relationships with pharmaceutical and biotechnology collaborators.
There is a finite number of genes and gene transcripts 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 8

expression analysis, positional cloning and other genomic service businesses. Many of these companies, institutions and entities have greater financial and human resources than we do. In addition, we are aware that
9
other companies have developed databases containing gene sequence, gene expression, genetic variation or other genomic information and are marketing, or have announced their intention to market, their data to pharmaceutical companies. We expect
that additional competitors may attempt to establish databases containing this
information in the future.

   
In addition, competitors may discover and establish patent positions with respect to the gene sequences and polymorphisms in our databases. Further, some
entities engaged in or with stated intentions to engage in gene sequencing have
made or have stated their intention to make 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
Decrease the potential value of our databases to our subscribers; and

  .   
adversely affect our ability to realize royalties or other revenue from commercialization of products based upon such genetic information.

   We are aware that a number of companies are pursuing alternative methods for
generating gene expression information, including some that have developed and
are developing microarray technologies. These advanced gene expression
technologies, if developed, may not be commercially available for our purchase
or license on reasonable terms, if at all.

   
We believe that the following are important aspects of the competitive position of our database products:

  .   
the features and ease-of-use of our database software;

  .   ease-of-use;
our experience in high-throughput gene sequencing;

  .   
the cumulative size of our databases;

  .   
the quality of the data, including the annotations in our databases;

  .   
the consolidation of publicly available and proprietary information in a single product;
our computing infrastructure; and

  .   
our employees and their experience with bioinformatics and database
      software.

   Our therapeutic discovery and development efforts compete with those of many
companies in both the biotechnology and pharmaceutical sectors that are trying
to develop new drugs. These competitors include many that have greater
financial resources than us. It is also possible that our therapeutic discovery
and development efforts will require access to intellectual property or
technologies that are not available to us, or are only available on terms that
we consider unreasonable.

   We believe the following are important aspects of the competitive position
of our therapeutic discovery and development efforts:

  .   our leading intellectual property portfolio;

  .   the experience of our senior management in managing the discovery and
      development of drugs; and

  .   our relationships with pharmaceuticalsbioinformatics.
The genomics and biotechnology collaborators.

   The genomics industry isindustries are characterized by extensive research efforts and rapid technological progress. New developments are expected to continue and there can be no assurance that discoveries by others will not render our 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 9

also compete with us in recruiting talented scientists. See "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations--FactorsOperations—Factors That May Affect Results--OurResults—Our industry is intensely competitive, and if we do not compete effectively, our revenues may decline and our losses may increase."

”
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 us, our collaborators or our licensees. Our agreements with our LifeSeq GoldFoundation database subscribers provide for the payment to us of royalties on any pharmaceutical products developed by those subscribers derived from proprietary information obtained from our genomic databases. Thus, the receipt and timing of regulatory approvals for the marketing of such products may have a significant effect on our future revenues.
Any products that we or our collaborators develop will require regulatory
clearances prior to clinical trials and additional regulatory clearances prior to commercialization. We believe that the potential products developed by us or our collaborators will be regulated either as biological products or as new drugs. New drugs and biologics are subject to rigorous preclinical and clinical testing and other approval procedures by the United States Food and Drug Administration under the Federal Food, Drug, and Cosmetic Act in the United
States. In addition to beingmay be subject to certain provisions of that Act,
biologics are also regulated under the Public Health Service Act. Bothsimilar requirements by regulatory authorities in other countries. Various statutes and their corresponding regulations govern, among other things, the testing, manufacturing, distribution, safety, efficacy, labeling, storage, record keeping, advertising and other promotional practices involving biologics or new drugs. Obtaining FDA approval has historically been a costly and time-consuming process. We and our collaborators, may encounter significant
10
delays or excessive costs in our efforts to secure necessary approvals. If approvals are obtained, the subsequent compliance with applicable statutes and regulations can also require the expenditure of substantial resources. Any failure by us to obtain or maintain, or any delay in obtaining or maintaining, regulatory approvals could harm our business.
FDA approval or other clearances must be obtained before clinical testing, and before manufacturing and marketing, of biologics and drugs. FDA approval is required prior to marketing a pharmaceutical or biologic product in the United States. To obtain this approval the FDA requires clinical trials to demonstrate the safety, efficacy, and potency of the product candidates. Clinical trials are the means by which experimental drugs or treatments are tested in humans. New therapies typically advance from laboratory, research, testing through animal, preclinical testing and finally through several phases of human, clinical human testing. Upon successful completion of clinical trials, approval to market the therapy for a particular patient population may be requested from the FDA in the United States and/or its counterparts in other countries.

   Obtaining FDA approval has historically been a costly and time-consuming
process. We may not obtain FDA approvals in a timely manner, or at all. We and
our collaborators may encounter significant delays or excessive costs in our
efforts to secure necessary approvals or licenses. States.
Generally, in order to gain FDA pre-market approval, a developer first must conduct laboratory studies and animal-model studies to gain preliminary information on an agent'sa product’s efficacy and to identify any safety problems. The results of these studies are submitted as a part of an investigational new drug application, which the FDA must review before human clinical trials of an investigational druga product can start. The investigational new drug application includes a detailed description of the initial animal studies and human investigation to be undertaken. Laboratory studies can take several years to complete, and there is no assurance that an investigational new drug application based on such studies will ever become effective so as to permit human testing to begin. A 30-day
waiting period after the receipt of each investigational new drug application
is required by the FDA prior to the commencement of human testing. If the FDA
has not commented on or questioned the investigational new drug application
within this 30-day period, human studies may begin. If the FDA has comments or
questions, it places the studies on clinical hold and the questions must be
answered to the satisfaction of the FDA before human testing may begin.

   In order to commercialize pharmaceutical products, we or one of our
collaborators must sponsor and file an investigational new drug application and
be responsible for initiating and overseeing the human studies to demonstrate
the safety and efficacy and, for a biologic product, the potency, which are
necessary to obtain FDA approval of any such products. For our or our
collaborator-sponsored investigational new drug applications,

                                      10



we or our collaborator will be required to select qualified investigators
(usually physicians within medical institutions) to supervise the
administration of the products, and ensure that the investigations are
conducted and monitored in accordance with FDA regulations and the general
investigational plan and protocols contained in the investigational new drug
application. 
Human clinical trials are normally conducted in three phases, although the phases may overlap. Phase I trials are concerned primarily with the safety and preliminary activity of the drug, involve fewer than 100
subjectsproduct and may take from six months to overare typically conducted with a year to complete.relatively small number of subjects. Phase II trials normally involve a few hundred patients, but in some cases may involve
fewer. Phase II trialslarger group of subjects and are designed primarily to demonstrate effectiveness in
treating or diagnosing the disease or condition for which the drug is intended,
although short-term side effectson a preliminary basis efficacy, optimal dosages and risks in people whose health is impaired
may also be examined.expanded evidence of safety. Phase III trials are expanded trials with larger numbers of patients whichin a number of sites that are intended to gather enough information to statistically evaluate the additional information for proper
dosagesafety and labelingefficacy of the drug and demonstrate its overall safety and
effectiveness. All three phases generally take three to five years, but may
take longer, to complete. Regulations promulgated by the FDA may shorten the
time periods and reduce the number of patients required to be tested in the
case of certain life-threatening diseases which lack available alternative
treatments.

   product.
The FDA receives reports on the progress of each phase of testing, and it may require the modification, suspension, or termination of trials if an unwarranted risk is presented to patients. If the FDA imposes a clinical hold, trials may not recommence without FDA authorization and then only under terms authorized by the FDA. The investigational new drug application process can thus result in substantial delay and expense. Inadvertent regulatory noncompliance by thean investigator, or intentional investigator misconduct, can jeopardize the usefulness of study results and, in some circumstances, require thea company to repeat a study.

   After completion
In some cases, reviews of trialspotential drugs may proceed under the accelerated approval regulations, “fast track” statutory provisions, or the expedited review regulations. The accelerated approval provisions apply to products used in the treatment of serious or life-threatening illnesses that appear to provide meaningful therapeutic benefits over existing treatments. The expedited review regulations apply to products for life-threatening and severely debilitating illnesses, especially where no satisfactory alternative therapy exists. These regulations permit approval of such products at the end of Phase II, or before clinical research is completed based on the product’s effect on a clinical endpoint or surrogate endpoint. The FDA retains considerable discretion to determine eligibility for expedited and accelerated review and approval mechanisms.
The results of the preclinical and clinical testing, together with detailed information on the manufacture and composition of the product, are then submitted to the FDA in the form of a new drugBiologics License Application, or biologic product, FDA marketingBLA, for biologics or New Drug Application, or NDA, for other drugs for approval must be obtained. If the product is regulated as a biologic, the
Center for Biological Evaluation and Research will require the submission and
approval, depending on the type of biologic, of either a biologic license
application or, in some cases, a product license application and an
establishment license application beforeto commence commercial marketing of the biologic.
If the product is classified as a new drug, we must file a new drug application
with the Center for Drug Evaluation and Research and receive approval before
commercial marketing of the drug. The new drug application or biologic license
applications must include results of product development, laboratory, animal
and human studies, and manufacturing information.sales. The testing and approval processes require substantial time and effort and there can be no assurance that the FDA will accept the new drug applicationan NDA or biologic license
applicationsBLA for filing and, even if filed, that any approval will be granted on a timely basis, if at all. In the past, new drug applications and biologic
license applications submitted to the FDA have taken, on average, one to two
years to receive approval after submission of all test data. If questions arise
during the FDA review process, approval can take more than two years.
Notwithstanding the submission of relevant data, the FDA may ultimately decide that the new drug applicationan NDA or biologic license applicationBLA does not satisfy its regulatory criteria for approval and require additional studies. In addition, the FDA may
11
condition marketing approval on the conduct or specific post-marketing studies to further evaluate safety and effectiveness. Among the conditions for an NDA or BLA approval is the requirement that the prospective manufacturer’s quality control and manufacturing procedures conform on an ongoing basis with current Good Manufacturing Practices, or GMP. The FDA must inspect and approve all facilities used to manufacture, fill, test and distribute biologic products. Rigorous and extensive FDA regulation of pharmaceutical products continues after approval, particularly with respect to compliance with current good
manufacturing practices, or cGMPs,GMP, reporting of adverse effects, advertising, promotion and marketing. Discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions.
The requirements that we must satisfy to obtain regulatory approval by governmental agencies in other countries prior to commercialization of our products in such countries can be as rigorous, costly and uncertain.
We are also subject to various federal, state and local laws and regulations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals, and the use and disposal of hazardous or potentially hazardous substances, including radioactive compounds and infectious disease agents, that may be used in connection with our research. If our operations result in contamination of the environment or expose individuals to hazardous substances, we could be liable for damages and governmental fines. We believe that we are in material compliance with applicable environmental laws and that our continued compliance therewith will not have a material adverse effect on our business. We cannot predict, however, how changes in these laws and regulations may affect our future operations.

                                      11

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 our 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 those regulations could delay or otherwise affect adversely regulatory approval of potential pharmaceutical products.
Corporate History

   Incyte was
We were incorporated in Delaware in April 1991 under the name Incyte Pharmaceuticals, Inc. In June 2000,On March 15 2003, we changed our stockholders approved an amendment to
the Company's Certificate of Incorporation to change the Company's name tofrom Incyte Genomics, Inc. to Incyte Corporation.
Human Resources
As of DecemberJanuary 31, 2001,2003, we had 585491 employees, including 137 in sequencing
and reagent production, 71 in bioinformatics, 114235 in research and development (including patent legal)legal personnel), 61 in sequencing and 263reagent production, 33 in bioinformatics, and 162 in marketing, sales, business development, finance, operations support and administrative positions. None of our employees are covered by collective bargaining agreements, and management considers relations with our employees to be good. Our future success will depend in part on the continued service of our key scientific, bioinformatics and management personnel and our ability to identify, hire and retain qualified personnel, including personnel in the marketing, sales andfor our therapeutic discovery and development areas.programs. There is intense competition for qualified personnel in the areas of our activities, especially with respect to experienced scientific and
bioinformatics personnel, and there can be no assurance that we will be able to continue to attract and retain such personnel necessary for the development of our business. Failure to attract and retain key personnel could have a material adverse effect on our business, financial condition and operating results. See "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations--FactorsOperations—Factors that May Affect Results--If we are unable to manage
effectively our growth, our operations, and ability to support our customers
could be affected, which could harm our revenues" and "--WeResults—We depend on key employees in a competitive market for skilled personnel, and the loss of the services of any of our key employees would affect our ability to achieve our objectives"objectives” and "Competition for scientific“—We are at the early stage of our therapeutic discovery and managerial personneldevelopment efforts and we may be unsuccessful in our industry is intense; we will not be able to sustain our operations if we are
not able to attract and retain key personnel."

efforts.”
12
Research and Development
Since our inception, we have made substantial investments in research and technology development. During 2002, 2001 2000 and 1999,2000, we incurred research and development expenditures of $152.4 million, $213.3 million and $192.6 million, respectively.
Available Information
Our website is located atwww.incyte.com. We make available free of charge on our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and $146.8 million,
respectively.

amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the Securities and Exchange Commission. We began making available our current reports on Form 8-K on our website in January 2003. Our website and the information contained therein or connected thereto is not intended to be incorporated into this Annual Report on Form 10-K.
Item 2.    Properties

   Incyte's
Our corporate headquarters are in Palo Alto, California, where its main research
laboratories, sequencing facility, bioinformaticsCalifornia. Our therapeutic drug and administrative facilitiesdiscovery operations are located. Incyteprimarily located in our offices in Newark, Delaware. We also hashave offices in Beverly, Massachusetts; San Diego, California; and Cambridge, England; and Tokyo, Japan.England. We also had lease and sublease agreements at December 31, 20012002 that include facilities that were closed as a part of the restructuringrestructurings in Fremont, California; St. Louis, Missouri; Palo Alto, California; Beverly, Massachusetts; and Cambridge, England. As of December 31, 2001, Incyte2002, we had multiple sublease and lease agreements covering approximately 409,000460,000 square feet that expire on various dates ranging from November 2002May 2003 to March 2011. In March 2002, we entered into
a lease agreement forOf the approximately 460,000 square feet leased, approximately 243,000 square feet are currently occupied and 217,000 square feet relate to buildings included in the restructurings. We believe that our first East Coast therapeutic discovery and
development operation in Newark, Delaware. Incyte believes that its current facilities along with the East Coast lease signed in 2002, are adequate to support itsour current and anticipated near-term operations and believesbelieve that itwe can obtain additional space itwe may need in the future on commercially reasonable terms.

                                      12

Item 3.    Legal Proceedings
Affymetrix
In January and September 1998, Affymetrix, Inc. filed lawsuits in the United States District Court for the District of Delaware alleging infringement by Incyte of three U.S. patents. On December 21, 2001, Incyte agreed to settlewe settled the following existing patent infringement litigation with Affymetrix, Inc.: Affymetrix, Inc. v. Synteni, Inc. and Incyte Pharmaceuticals, Inc., Case Nos. C 99-21164 JF and C 99-21165 JF (N.D. Cal.); Incyte Genomics, Inc. v. Affymetrix, Inc., Case No. C 01-20065 JF (N.D. Cal.); and the Incyte Opposition to Affymetrix'sAffymetrix’s European Patent No. EP 0 619 321. The first lawsuit involved several of Affymetrix'sAffymetrix’s microarray-related patents (U.S. Patent Nos. 5,445,934, 5,744,305 and 5,800,992). The second lawsuit involved Incyte'sour RNA amplification patents (U.S. Patent Nos. 5,716,785 and 5,891,636) and two additional microarray-related patents held by Affymetrix (U.S. Patent Nos. 5,871,928 and 6,040,193). As a part of the settlement, the companies have agreed to certain non-exclusive, royalty-bearing licenses and an internal use license under their respective intellectual property portfolios. ThisPursuant to the settlement, does not include
Incyte'swe received a net cash settlement that was recorded as revenue in 2001. On December 2, 2002, we agreed to settle our appeal before the United States District Court for the Northern District of California seeking de novo review of the Board of Patent Appeals and Interferences'Interferences’ decision relating to patent applications licensed by Incyteus from Stanford University. There can be no assurances as to the outcome of that
appeal.

  University (Case No. C99-21111JF).
Invitrogen
On October 17, 2001, Invitrogen Corporation filed an actiona complaint for patent infringement against the
Company in the United States District Court for the District of Delaware,
alleging infringement of three patents (U.S. patent number 5,244,797, U.S.
patent number 5,668,005, and U.S. patent number 6,063,608) that relate to the
use of reverse transcriptase with no RNase H activity in preparing
complimentary DNA from RNA. The complaint seeks unspecified money damages and
injunctive relief.

   On November 21, 2001, the Company filed its answer to the complaint filed by
InvitrogenIncyte in the United States District Court for the District of Delaware. On November 21, 2001, we filed our answer to Invitrogen’s complaint. In addition, to its answers to Invitrogen's patent infringement claims, the Companywe asserted seven counterclaims against Invitrogen seeking declaratory relief with respect to the patents at issue, implied license, estoppel, laches, and patent misuse. The CompanyWe are also seeks itsseeking our fees, costs, and expenses. Invitrogen filed its answer to the Company'sour counterclaims on January 9, 2002. Simultaneously withThe parties are
13
presently engaged in discovery. We believe we have meritorious defenses and intend to defend vigorously the filing of its answer, the Company filed a motion to
transfer the action from the United States District Court for the District of
Delaware to the United States District Court for the District of Maryland,
where Invitrogen Corporation is currently a party to three infringement actions
alleging infringement of the same patents-in-suit. The issue of transfer has
been fully briefed and submitted to the court for decision.

   In addition, onsuit brought by Invitrogen.
On November 21, 2001, the Companywe filed a complaint against Invitrogen as amended on December 21, 2001 and March 7, 2002, in the United States District Court for the Southern District of California alleging infringement of fourteenthirteen of the Company'sour patents. NineEight of the asserted patents (U.S. patent numbers 5,633,149, 5,637,462, 5,817,497, 5,840,535, 5,919,686, 5,925,542, 5,962,263, 5,789,198 and 6,001,598)5,789,198) are gene patents. Three of the patents (U.S. patent numbers 5,716,785, 5,891,636, and 6,291,170) relate to RNA amplification and gene expression. Two of the patents (U.S. patent numbers 5,807,522 and 6,110,426) relate to methods of fabricating microarrays of biological samples. The complaint seeks a permanent injunction enjoining Invitrogen from further infringement of the patents at issue, damages for Invitrogen'sInvitrogen’s conduct, as well as the Company'sour fees, costs, and interest. The
CompanyWe further seeksseek triple damages from the infringement claim based on Invitrogen'sInvitrogen’s willful infringement of the Company'sour patents. Invitrogen's
response
Invitrogen has represented to the Company's Second Amended Complaint is due in April 2002.

   The Company believesCourt that its past sales of the eight GeneStorm cDNA clones charged with infringement of U.S. Patent Nos. 5,633,149, 5,637,462, 5,789,198, 5,817,497, 5,840,535, 5,919,686, 5,925,542 and 5,962,263 were not substantial and that it hasno longer sells these products. The parties are presently engaged in discovery concerning the RNA amplification and gene expression and the microarray fabrication patents.
We believe we have meritorious defenses and intendsintend to defend vigorously the suit and potential counterclaims brought by Invitrogen vigorously.Invitrogen. However, the Company'sour defenses may be unsuccessful. At this time, the Companywe cannot reasonably estimate the possible range of any loss resulting from this suit due to uncertainty regarding the ultimate outcome. Regardless of the outcome, the
Invitrogen litigation is expected to result in substantial costs to the
Company. Further, there can be no assurance that any license that may be 13

required as a result of this litigation onor the outcome thereof would be made available on commercially acceptable terms, if at all. Regardless of the outcome, the Invitrogen litigation is expected to result in future costs to us, which could be substantial.
Item 4.Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our security holders during the fourth quarter of 2002.
Executive Officers of the Registrant
Our executive officers are as follows:
Paul A. Friedman,M.D., age 60, joined Incyte as the Chief Executive Officer and a Director in November 2001. From 1998 until October 2001, Dr. Friedman served as President of DuPont Pharmaceuticals Research Laboratories, a wholly owned subsidiary of DuPont Pharmaceuticals Company (formerly The DuPont Merck Pharmaceutical Company), from 1994 to 1998 he served as President of Research and Development of The DuPont Merck Pharmaceutical Company, and from 1991 to 1994 he served as Senior Vice President at Merck Research Laboratories. Prior to his work at Merck and DuPont, Dr. Friedman was an Associate Professor of Medicine and Pharmacology at Harvard Medical School. Dr. Friedman is a Diplomat of the American Board of Internal Medicine, Member of the American Society of Pharmacology and Experimental Therapeutics, Member of the American Society of Clinical Investigation and a Member of the American Society of Biological Chemist. He received his A.B. in Biology from Princeton University and his M.D. from Harvard Medical School.
Robert B. Stein,Ph.D., M.D., age 52, joined Incyte in November 2001 as President and Chief Scientific Officer and as a Director. From September 1996 to November 2001, Dr. Stein was the Executive Vice President of Research and Preclinical Development of DuPont Pharmaceuticals Company (formerly The DuPont Merck Pharmaceutical Company). From May 1990 to September 1996, Dr. Stein was employed by Ligand Pharmaceuticals, Inc., serving as Senior Vice President and Chief Scientific Officer from 1993 to 1996, as Vice President, Research and Preclinical Development from 1992 to 1993 and Vice President, Research from 1990 to 1992. From 1982 to 1990, Dr. Stein held various positions with Merck, Sharp & Dohme Research Laboratories, including Senior Director and Head of the Department of Pharmacology from 1989 to 1990. Dr. Stein received his B.S. in biology and chemistry from Indiana University, his doctorate in Physiology and Pharmacology, and
14
his M.D. from Duke University. He also serves on the Board of Directors of Geron Corporation and diaDexus, Inc.
John M. Vuko, age 52, joined Incyte as Chief Financial Officer in December 1999 and became an Executive Vice President of Incyte in June 2000. Prior to joining Incyte, Mr. Vuko was the primary financial consultant of an affiliate of Achievement Radio Holdings, Inc. from October 1998 to December 1999. From April 1997 to September 1998, Mr. Vuko served as the Senior Vice President and Chief Financial Officer of Achievement Radio Holdings, Inc. From October 1989 to March 1997, Mr. Vuko served in various positions with Ross Stores, Inc., most recently as Senior Vice President and Chief Financial Officer. Prior to his work at Ross Stores, Mr. Vuko held the positions of Corporate Development Executive, Vice President, Treasurer, and Controller with the Cooper family of companies, including CooperVision, Inc., Cooper LaserSonics, Inc. and The Cooper Companies, Inc. Mr. Vuko received his B.A. in Business from San Francisco State University.
Lee Bendekgey,age 45, has been General Counsel of Incyte since January 1998 and served as Interim Chief Financial Officer from June 1999 until December 1999. Mr. Bendekgey became the Secretary of Incyte in June 1998 and an Executive Vice President of Incyte in June 2000. Prior to joining Incyte, Mr. Bendekgey was the Director of Strategic Relations at Silicon Graphics, Inc. from July 1997 through December 1997. He held various positions with SGI from March 1993 through June 1997, including Director of Legal Services, Products and Technology; Senior Counsel, Product Divisions; Group Counsel, Computer Systems Group; and Division Counsel, MIPS Technologies, Inc. From 1982 to 1993, Mr. Bendekgey held associate and partner positions with Graham & James, a law firm in San Francisco, where he specialized in intellectual property protection and licensing. Mr. Bendekgey received his B.A. magna cum laude in Political Science and French from Kalamazoo College and his J.D. from Stanford University.
Kenneth P. Jacobsen, Ph.D., age 51, has served as Executive Vice President, Information Sciences, of Incyte since February 2003. Mr. Jacobsen joined the company in June 2001 as Senior Vice President of Information Sciences. Prior to joining the company, Dr. Jacobsen served as a Vice President at Silicon Graphics Inc. from December 1993 through June 2001. Previously, Dr. Jacobsen held positions with Maspar Computer Corporation, Cydrome Computer Corporation, and Earl and Wright Consultants, a division of SEDCO Corporation. Dr. Jacobsen received his B.Sc. degree in Astrophysics from the California Institute of Technology, and his Ph.D. in Ocean Engineering from the University of California at Berkeley.
James P. Merryweather,Ph.D., age 52, has been an Executive Vice President of Incyte since November 2000 and currently serves as Executive Vice President, Business Development and Commercial Operations. He has led Incyte’s Target Validation Research organization since December 2002 and, prior to that, led Incyte’s Business Development organization from November 2000 until December 2001. He served as Senior Vice President of Client Business Management from July 1999 until November 2000 and served as Vice President of Partnership Programs from March 1999 until July 1999. Prior to joining Incyte, Dr. Merryweather was the Vice President of Program Management at Millennium Pharmaceuticals, Inc. from September 1996 until November 1998. Prior to joining Millennium Pharmaceuticals, Dr. Merryweather was Director of Project Management at Chiron Corporation. Dr. Merryweather held various positions at Chiron from November 1981, including Senior Scientist, Research Leader and Director of Regulatory Affairs. Dr. Merryweather received his Ph.D. in Biochemistry from Washington State University.
Brian W. Metcalf,Ph.D., age 57, has served as Executive Vice President and Chief Drug Discovery Scientist since February 2002. From March 2000 to February 2002, Dr. Metcalf served as Senior Vice President and Chief Scientific Officer of Kosan Biosciences Incorporated. From December 1983 to March 2000, Dr. Metcalf held a number of executive management positions with SmithKline Beecham, most recently as Senior Vice President, Discovery Chemistry and Platform Technologies. Prior to joining SmithKline Beecham, Dr. Metcalf held positions with Merrell Research Center from 1973 to 1983. Dr. Metcalf received his B.S. and Ph.D. in organic chemistry from the University of Western Australia. Dr. Metcalf is also a director of Argonaut Technologies, Inc.
15
Jason Rubin, age 45, has served as an Executive Vice President, Corporate Affairs, of Incyte since September 2002. Prior to joining Incyte, Mr. Rubin founded and was President of The Redstone Group, LLC, an independent communications consulting firm, from December 1999 to September 2002. From October 1998 to December 1999, he was Vice President of Corporate Communications at Centocor, Inc., which was acquired by Johnson & Johnson in October 1999. From July 1993 to October 1998, he was Vice President of Corporate Communications at Cephalon, Inc. Mr. Rubin received a B.A. in geology from Middlebury College and an M.S. in management from the Massachusetts Institute of Technology.
Paula Swain, age 45, has served as an Executive Vice President, Human Resources, of Incyte since August 2002 and joined the company as Senior Vice President of Human Resources in January 2002. From July 1998 to November 2001, Ms. Swain was Senior Vice President of Human Resources at Bristol-Myers Squibb after it acquired DuPont Pharmaceuticals Company, where she served as Senior Vice President of Human Resources. From October 1992 to July 1998, Ms. Swain held a variety of human resources positions of increasing responsibility at DuPont Pharmaceuticals. Ms. Swain received her B.A. in Psychology and industrial relations from Rockhurst College.
PART II
Item 5.Market for Registrant'sRegistrant’s Common Equity and Related Stockholder Matters

   The Company's
Our common stock, par value $.001 ("(“Common Stock"Stock”), is traded on the Nasdaq National Market ("Nasdaq"(“Nasdaq”) under the symbol "INCY."“INCY.” The following table sets forth, for the periods indicated, the range of high and low sales prices for the Common Stock on Nasdaq as reported in its consolidated transaction reporting system.

                                                      High    Low
                                                     ------- ------
             
             2000
                First Quarter....................... $144.53 $32.63
                Second Quarter......................   60.25  21.69
                Third Quarter.......................   55.56  34.00
                Fourth Quarter......................   43.00  22.06

             2001
                First Quarter.......................   30.63  11.44
                Second Quarter......................   25.07  12.61
                Third Quarter.......................   22.56  10.76
                Fourth Quarter......................   21.22  12.68
 
  
High
  
Low
2001
  
 
 
  
 
 
First Quarter
  
$
30.63
  
$
11.44
Second Quarter
  
 
25.07
  
 
12.61
Third Quarter
  
 
22.56
  
 
10.76
Fourth Quarter
  
 
21.22
  
 
12.68
2002
  
 
 
  
 
 
First Quarter
  
 
20.45
  
 
10.45
Second Quarter
  
 
11.98
  
 
5.80
Third Quarter
  
 
7.47
  
 
3.80
Fourth Quarter
  
 
6.03
  
 
2.88
As of December 31, 2001, the2002, our Common Stock was held by 415369 stockholders of record. The Company hasWe have never declared or paid dividends on itsour capital stock and doesdo not anticipate paying any dividends in the foreseeable future. The
above high and low sales prices
Securities Authorized for Issuance Under Equity Compensation Plans
Information regarding the Common Stock have been adjusted to
reflectSecurities Authorized for Issuance under our Equity Compensation Plans is incorporated herein from the two-for-one stock split effectedinformation under the caption “Equity Compensation Plan Information” contained in the form of a stock dividend in
August 2000.

                                      14

Proxy Statement.
16
Item 6.Selected Consolidated Financial Data
Selected Annual Consolidated Financial Data
                     (in
(in thousands, except per share data)
The data set forth below should be read in conjunction with "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations"Operations” and the Consolidated Financial Statements and related Notes included in Item 8 of this Report.
 
  
Year Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
  
1999
 
  
1998
 
Consolidated Statement of Operations Data:
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Revenues
  
$
101,612
 
  
$
219,263
 
  
$
194,167
 
  
$
156,962
 
  
$
134,811
 
Costs and expenses:
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Research and development
  
 
152,373
 
  
 
213,336
 
  
 
192,556
 
  
 
146,833
 
  
 
97,192
 
Selling, general and administrative
  
 
47,147
 
  
 
70,626
 
  
 
64,201
 
  
 
37,235
 
  
 
25,438
 
Loss on sale of assets
  
 
313
 
  
 
5,777
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
Charge for purchase of in-process research and development
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
10,978
 
Acquisition-related charges
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
1,171
 
Other expenses(1)
  
 
37,331
 
  
 
130,372
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
 
  
  
  
  
  
Total costs and expenses
  
 
237,164
 
  
 
420,111
 
  
 
256,757
 
  
 
184,068
 
  
 
134,779
 
Income (loss) from operations
  
 
(135,552
)
  
 
(200,848
)
  
 
(62,590
)
  
 
(27,106
)
  
 
32
 
Interest and other income/(expense), net
  
 
9,434
 
  
 
23,453
 
  
 
41,735
 
  
 
5,485
 
  
 
7,416
 
Interest expense
  
 
(9,802
)
  
 
(10,128
)
  
 
(10,529
)
  
 
(316
)
  
 
(150
)
Gain (loss) on certain derivative financial instruments
  
 
(1,782
)
  
 
553
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
Gain on repurchase of convertible subordinated notes
  
 
1,937
 
  
 
2,386
 
  
 
3,137
 
  
 
—  
 
  
 
—  
 
Losses from joint venture
  
 
—  
 
  
 
—  
 
  
 
(1,283
)
  
 
(5,631
)
  
 
(1,474
)
 
  
  
  
  
  
Income (loss) before income taxes and accounting change
  
 
(135,765
)
  
 
(184,584
)
  
 
(29,530
)
  
 
(27,568
)
  
 
5,824
 
Provision (benefit) for income taxes
  
 
1,120
 
  
 
930
 
  
 
205
 
  
 
(800
)
  
 
2,352
 
 
  
  
  
  
  
Income (loss) before accounting change
  
 
(136,885
)
  
 
(185,514
)
  
 
(29,735
)
  
 
(26,768
)
  
 
3,472
 
Cumulative effect of accounting change(2)
  
 
—  
 
  
 
2,279
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
 
  
  
  
  
  
Net income (loss)
  
$
(136,885
)
  
$
(183,235
)
  
$
(29,735
)
  
$
(26,768
)
  
$
3,472
 
 
  
  
  
  
  
Basic net income (loss) per share
  
$
(2.03
)
  
$
(2.77
)
  
$
(0.47
)
  
$
(0.48
)
  
$
0.06
 
 
  
  
  
  
  
Number of shares used in computation of basic net income (loss) per share
  
 
67,403
 
  
 
66,193
 
  
 
63,211
 
  
 
56,276
 
  
 
53,842
 
 
  
  
  
  
  
Diluted net income (loss) per share
  
$
(2.03
)
  
$
(2.77
)
  
$
(0.47
)
  
$
(0.48
)
  
$
0.06
 
 
  
  
  
  
  
Number of shares used in computation of diluted net income (loss) per share
  
 
67,403
 
  
 
66,193
 
  
 
63,211
 
  
 
56,276
 
  
 
57,798
 
 
  
  
  
  
  
17
 
  
December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
  
1999
 
  
1998
 
Consolidated Balance Sheet Data:
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Cash, cash equivalents, and marketable securities available-for-sale
  
$
429,018
 
  
$
507,903
 
  
$
582,180
 
  
$
66,937
 
  
$
111,233
 
Working capital
  
 
381,078
 
  
 
505,113
 
  
 
571,583
 
  
 
58,043
 
  
 
81,437
 
Total assets
  
 
552,139
 
  
 
705,559
 
  
 
886,820
 
  
 
221,934
 
  
 
230,290
 
Non-current portion of capital lease obligations and notes payable
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
194
 
 ��
 
796
 
Convertible subordinated notes
  
 
172,036
 
  
 
179,248
 
  
 
187,814
 
  
 
—  
 
  
 
—  
 
Accumulated deficit
  
 
(405,024
)
  
 
(268,139
)
  
 
(84,904
)
  
 
(55,169
)
  
 
(28,401
)
Stockholders’ equity
  
 
302,410
 
  
 
440,203
 
  
 
622,694
 
  
 
170,282
 
  
 
179,567
 

                                                                                   Year Ended December 31,
                                                                      -------------------------------------------------
(1)
2002 charges relate to restructuring charges. 2001 2000      1999      1998      1997
                                                                      ---------  --------  --------  --------  --------
charges include the following: $68.7 million—goodwill and intangibles impairment; $55.6 million—restructuring charges and $6.1 million—impairment of a long-lived asset. See Note 15 of Notes to Consolidated StatementFinancial Statements.
(2)
Reflects the adoption of Operations Data:
Revenues............................................................. $ 219,263  $194,167  $156,962  $134,811  $ 89,996
Costs and expenses:
    Research and development.........................................   213,336   192,556   146,833    97,192    72,452
    Selling, general and administrative..............................    70,626    64,201    37,235    25,438    13,928
    Charge for purchaseSFAS 133 related to the recording of in-process research and development.......        --        --        --    10,978        --
    Acquisition-related charges......................................        --        --        --     1,171        --
    Other expenses /(1)/.............................................   130,372        --        --        --        --
                                                                      ---------  --------  --------  --------  --------
       Total costs and expenses......................................   414,334   256,757   184,068   134,779    86,380
Income (loss) from operations........................................  (195,071)  (62,590)  (27,106)       32     3,616
Interest andwarrants held in other income/(expense), net.............................    23,453    41,735     5,485     7,416     4,326
Interest expense.....................................................   (10,128)  (10,529)     (316)     (150)     (186)
Loss on salecompanies at fair value at the date of assets...............................................    (5,777)       --        --        --        --
Gain on certain derivative financial instruments.....................       553        --        --        --        --
Losses from joint venture............................................        --    (1,283)   (5,631)   (1,474)     (300)
                                                                      ---------  --------  --------  --------  --------
Income (loss) before income taxes, extraordinary item and accounting
 change..............................................................  (186,970)  (32,667)  (27,568)    5,824     7,456
Provision (benefit) for income taxes.................................       930       205      (800)    2,352       548
                                                                      ---------  --------  --------  --------  --------
Income (loss) before extraordinary item and accounting change........  (187,900)  (32,872)  (26,768)    3,472     6,908
Extraordinary item, net of taxes.....................................     2,386     3,137        --        --        --
Cumulative effect of accounting change, net of taxes /(2)/...........     2,279        --        --        --        --
                                                                      ---------  --------  --------  --------  --------
Net income (loss).................................................... $(183,235) $(29,735) $(26,768) $  3,472  $  6,908
                                                                      =========  ========  ========  ========  ========
Basic net income (loss) per share.................................... $   (2.77) $  (0.47) $  (0.48) $   0.06  $   0.14
                                                                      =========  ========  ========  ========  ========
Number of shares used in computation of basic net income (loss) per
 share...............................................................    66,193    63,211    56,276    53,842    48,600
                                                                      =========  ========  ========  ========  ========
Diluted net income (loss) per share.................................. $   (2.77) $  (0.47) $  (0.48) $   0.06  $   0.13
                                                                      =========  ========  ========  ========  ========
Number of shares used in computation of diluted net income (loss) per
 share...............................................................    66,193    63,211    56,276    57,798    52,996
                                                                      =========  ========  ========  ========  ========

                                                                                         December 31,
                                                                      -------------------------------------------------
                                                                        2001       2000      1999      1998      1997
                                                                      ---------  --------  --------  --------  --------
Consolidated Balance Sheet Data:
Cash, cash equivalents, and marketable securities available-for-sale. $ 507,903  $582,180  $ 66,937  $111,233  $113,095
Working capital......................................................   505,113   571,583    58,043    81,437    90,700
Total assets.........................................................   705,559   886,820   221,934   230,290   199,089
Non-current portion of capital lease obligations and notes payable...        --        --       194       796       801
Convertible subordinated notes.......................................   179,248   187,814        --        --        --
Accumulated deficit..................................................  (268,139)  (84,904)  (55,169)  (28,401)  (30,129)
Stockholders' equity.................................................   440,203   622,694   170,282   179,567   145,702
adoption.

- --------
(1) Includes the following charges recorded in 2001: $68,666--goodwill and
    intangibles impairment; $55,602--non-recurring restructuring charges; and
    $6,104--impairment of a long-lived asset. See Note 14 of Notes to
    Consolidated Financial Statements.
(2) Reflects the adoption of SFAS 133 related to the recording of warrants held
    in other companies at fair value at the date of adoption.

                                      15

18
Item 7.  Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the Company'sour financial condition and results of operations should be read in conjunction with "Selected“Selected Annual Consolidated Financial Data"Data” and the Consolidated Financial Statements and related Notes included elsewhere in this Report.
When used in this discussion, the words "expects," "believes,"
"anticipates," "estimates,"“expects,” “believes,” “anticipates,” “estimates,” “could,” “intends,” and similar expressions are intended to identify forward-looking statements. These statements, which include statements as to the Company's expected net losses,impact of certain critical accounting policies on our financial results; expected expenses and expenditure levels,levels; expected revenues and sources of revenues,revenues; expected uses of cash,net cash; expected cash
flows,losses, net losses and net loss levels; expected expenditures including expenditures on intellectual property and research and development, and expected investments, expected marketable
securities balances,development; the offset of profits from certain products by other expenditures; the adequacy of capital resources,resources; the expected effect of SFAS 142our contractual obligations on our future liquidity and SFAS 144,cash flow; our plans to reduce expenditures in 2003 and growth in operations,the expected spending reductions, workforce reductions and office consolidations; our strategic investments, including anticipated expenditures, losses and expenses; the application of U.S. Patent and Trademark Office utility guidelines to our gene patent applications; costs associated with prosecuting, defending and enforcing patent claims and other intellectual property rights; the size of our intellectual property portfolio and its competitive position,position; expectation that our abilityinformation product line assets will help drive co-development and collaborative opportunities for our drug discovery efforts; our strategy with regard to leverageprotecting our intellectual propertyproperty; the effect of pharmaceutical and biotechnology company consolidations, including reduced research and development spending and pricing constraints by pharmaceutical and biotechnology customers and the softening of the market for genomic information to take a lead position inand the market for our market,information products; the effect of pharmaceuticals company consolidations,our pharmaceutical and biotechnology customers’ focus on late stage research and clinical products on the pricing of, and the length of contractual commitment for, our information products; the expected growth of, and our ability to manage growthexpansion of, our therapeutic discovery and development operations, including operations in multiple locations; our competitive advantage and position; the expected duration of increased competition; future required expertise relating to clinical trials, manufacturing, sales and marketing and for licenses to technology rights; the commercial availability of drugs resulting from our research; our ability to obtain and maintain product liability insurance,insurance; and our strategy with regardplan not to protecting our intellectual propertyobtain earthquake insurance; are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those risks discussed below, as well as the extent of utilization of genomic information by the biotechnology and pharmaceutical industries; actual and future consolidations of pharmaceutical and biotechnology companies; continuing trends with respect to reduced pharmaceutical and biotechnology research spending; our ability to manage our information products on a cash flow positive basis; risks relating to the development of new products and their use by our potential collaborators of the Company;collaborators; the impact of technological advances and competition; unanticipated delays in research and development efforts; the result of further research; the number of employees entitled to receive severance benefits or other costs to be recognized in connection with the expense reduction program; our ability of the Companyto consolidate our facilities and to exit and close facilities upon anticipated timelines; our ability to deliver products and services to our customers effectively with reduced headcount and management and key employee diversion; our ability to obtain and retain customers; competition from other entities; early termination of a database collaboration agreement or failure to renew an agreement upon expiration; decreasing database revenues; the cost of accessing, licensing or acquiring technologies developed by other companies; significant delays or costs in obtaining regulatory approvals; failure to obtain regulatory approval; uncertainty as to the scope of coverage, enforceability or commercial protection from patents that issue on gene and other discoveries; our ability to integrate Maxia’s operations and programs successfully; our ability to obtain patent protection for our discoveries and to continue to be effective in expanding our patent coverage; the impact of changing laws on our patent portfolio; developments in and expenses relating to litigation; the results of businesses in which the Company haswe have purchased equity; and the matters discussed in "Factors“Factors That May Affect Results."” These forward-looking statements speak only as of the date hereof. The CompanyWe expressly disclaimsdisclaim 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'sour expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Overview
19
All references to “Incyte,” “we,” “us” or “our” mean Incyte believes it hasCorporation and its subsidiaries.
Incyte, LifeSeq, BioKnowledge and ZooSeq are our registered trademarks. We also refer to trademarks of other corporations and organizations in this document.
Overview
Incyte is a drug discovery company that develops proprietary genomic information and applies its expertise in medicinal chemistry and molecular, cellular and in vivo biology to the discovery of novel small molecule and protein therapeutics. We believe we have created the largest commercial portfolio of issued United States patents covering human, full-length genes and the proteins they encode, and the antibodies directed against them. We intend to leverage our leadinglicense this intellectual property, as well as market our genomic and genomicproteomic information, position to be a leadermany of the world’s leading pharmaceutical and biotechnology companies and academic research centers. We have assembled an experienced and talented drug discovery team that is identifying potential new drug therapies for cancer, inflammatory diseases and other medical conditions.
We were incorporated in therapeutic small molecule, secreted proteinDelaware in April 1991 and, antibody discoveries. In
addition, Incyte has also developed a leading integrated platformuntil 2001, devoted substantially all of genomicour resources to the development, marketing and sales of genomics technologies designedand products to the biotechnology and pharmaceutical industries and research and academic institutions to aid in the understanding of the molecular basisbetter and faster prevention, diagnosis and treatment of disease. These technologies primarily consist of genomicOur products and services included databases, bioreagents, custom sequencing, gene expression, single nucleotide polymorphism, or SNP, discovery, and pharmaceutically relevantother services. Over time, we also increased our investments in growing our intellectual property licenses, which help
pharmaceuticalestate to protect our proprietary information as well as our internal and biotechnology researchers in their therapeutic discoverycollaborative efforts to identify and development efforts. These efforts include gene discovery, understanding
disease pathways, identifying new disease targets and the discovery and
correlation of gene sequence variation to disease.

   In December 2001, Incyte agreed to settle existing patent infringement
litigation with Affymetrix, Inc. involving several of Affymetrix's
microarray-related patents and Incyte's RNA amplification patents and two
additional microarray-related patents held by Affymetrix. As a part of the
settlement, the companies have agreed to certain non-exclusive, royalty-bearing
licenses and an internal use license under their respective intellectual
property portfolios. This settlement does not include Incyte's appeal before
the United States District Court for the Northern District of California
seeking de novo review of the Board of Patent Appeals and Interferences'
decision relating to patent applications licensed by Incyte from Stanford
University. There can be no assurances as to the outcome of such an appeal.

                                      16

validate drug targets.
During 2001, Incytewe increased itsour focus on itsour therapeutic discovery and development program, and its information products, which include licensing a
portion of its intellectual property. As a result, we exited the following activities: microarray products and related services, genomic screening products and services, public domain clone products and related services, contract sequencing services, transgenicstransgenic products and services and SNP discovery services. As a part
Our business is now focused on our therapeutic discovery and development programs and our information products. Our current products include information databases, intellectual property licensing, and certain other products, such as full-length clones. The fees and the period of access to our database information are negotiated independently with each company. In addition to providing access to pharmaceutical and biotechnology customers, we also provide access to our database to third parties who use the database to develop genomic tools, such as microarrays that require genomic content, which they in turn sell to pharmaceutical and biotechnology researchers. Fees payable by pharmaceutical and biotechnology collaborators for our information products also generally consist of non-exclusive or exclusive fees corresponding to patent rights on proprietary genes and proteins. We may also receive future milestone and royalty payments from collaborators from the development and sale of their products derived from our technology and database information.
We expect that the overall market for our information products will continue to be competitive based on softening of the exitmarket for genomic information, shrinking research budgets of our current and potential customers and industry consolidation. Revenue trends indicate that subscribers are being more cautious with their spending to focus more of their resources on late stage research and clinical products than in the past, and this has adversely impacted the pricing of and, in some cases, the length of the contractual commitment for, our information products. We expect this trend to continue into 2003 and that revenues in 2003 will be lower than those recognized in the prior year.
We intend to manage our information products on a cash flow positive basis. Our ability to earn revenues and successfully manage our information products on a cash flow positive basis depends, in large part, on our ability to attract new customers and retain new and existing customers for our information products in an increasingly competitive market environment. Further, we have only received limited royalty revenues to date,
20
and do not expect to receive significant royalty or other revenues from development and commercialization by our customers using our information products for several years, if at all. Revenues from our customers may be subject to significant fluctuation in both timing and amount and, therefore, our results of operations for any period may not be comparable to the results of operations for any other period.
In conjunction with the 2002 restructuring program, we expect to reduce certain annual expenses by over $80.0 million beginning in 2003, compared with 2002, through a combination of decreased spending, job reductions and office consolidations. The restructuring programs will have little impact on our therapeutic discovery and development programs as we intend to continue to invest in research and development for our therapeutic discovery and development efforts. We expect these expenses to continue to increase in 2003 and that these increases will partially offset our expected expense reductions from the 2002 restructuring program.
We anticipate incurring additional losses for several years as we expand our therapeutic drug discovery and development programs. We also expect that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. We do not expect to generate revenues from our therapeutic discovery and development efforts for several years, if at all. If we are unable to successfully develop and market pharmaceutical products over the next several years, our business, financial condition and results of operations would be adversely impacted.
Our investment portfolio includes equity and debt investments in publicly-traded and privately-held companies. May of these companies are still in the start-up or development stage. Our investments in these companies are inherently risky because they technologies or products they have under development are typically in the early stages and may never become successful. The market values of many of these investments can fluctuate significantly. Current market conditions may cause us to write-down the value of our investments which could result in future charges to our earnings. The determination of investment impairment involves significant management judgement, and actual amounts realized for any specific investment may differ from recorded values. Because the market value of strategic investments that we hold can fluctuate significantly, and such fluctuations are highly variable and not within our control, any future gains or losses related to strategic investments have not been included in earnings estimates for 2003.
During 2002 and 2001, we reported charges of $37.3 million and $130.4 million, respectively, relating to restructuring programs and long-lived asset write-downs announced in the fourth quarter of each year. A discussion of each of these restructuring programs follows:
During 2001, we exited certain product lines and, as a result of exiting these activities, we have closed certain of our facilities in Fremont, California;California, Palo Alto, California, St. Louis, Missouri and Cambridge, England.United Kingdom. In addition to the product lines exited, we made infrastructure and other personnel reductions at our other locations resulting in an aggregate workforce reduction of approximately 400 employees. A non-recurring charge for restructure chargesthe 2001 restructuring program and impairment of long-lived assets of $130.4 million was recorded in the fourth quarter of 2001 as a result of the change in focus. This charge was comprised of the following items: $68.7 million--goodwillmillion—goodwill and intangibles impairment; $55.6 million--nonrecurring
million—restructuring charges (including $32.6 million in equipment and other assets impaired) and $6.1 million--impairmentmillion—impairment of a long-lived asset. Revenues from exited product lines for the years ended 2002 and 2001 were $3.6 million and $45.3 million, respectively. Additional charges for restructuring expenses of $3.4 million were recorded in 2002, primarily for contract-related settlements, impairment of long-lived assets and facilities lease expenses in excess of estimated amounts, offset by the release of other restructuring accruals in excess of actual expenses.
On November 12, 2002, we announced plans to reduce our expenditures, primarily in research and development, through a combination of spending reductions, workforce reductions and office consolidations. The expense reduction plan included elimination of approximately 37% of our workforce in Palo Alto, California, Beverly, Massachusetts, and Cambridge, England and consolidation of our office and research facilities in Palo Alto, California. As a result of these actions, we incurred a charge of $33.9 million during the fourth quarter of 2002.
21
In November 2002, we entered into an agreement to acquire Maxia Pharmaceuticals, Inc., a privately-held company based in San Diego, California. Maxia is a drug discovery and development company that specializes in small molecule drugs targeting diabetes and other metabolic disorders, cancer, inflammatory diseases and heart disease. On February 18, 2003, one of our wholly owned subsidiaries was merged with and into Maxia. As a result of the Company's changemerger:
Maxia became a wholly owned subsidiary of Incyte;
Each share of Maxia common stock outstanding immediately prior to the merger was converted into the right to receive 0.05496 of a share of our common stock;
Each share of Maxia Series A Preferred Stock outstanding immediately prior to the merger was converted into the right to receive 0.20035 of a share of our common stock; and
Each share of Maxia Series B Preferred Stock and Maxia Series C Preferred Stock outstanding immediately prior to the merger was converted into the right to receive 0.46237 of a share of our common stock and $0.14895 in strategic direction and restructuring
in 2001, pursuant to SFAS 121, Incyte performed an assessmentcash.
The former stockholders of the carrying
value of its long lived assets recorded in connection with its Hexagen and
Proteome acquisitions and usedMaxia received, in the operations being exited.

   Equipment and other assets that were disposed of or removed from operations
were written down to their estimated fair value of $0.7 million and that
resulted in a charge of $32.6 million. The write-down of equipment and other
assets primarily relates to leasehold improvements, computer equipment and
related software, lab equipment and office equipment associated with the
activities being exited and related infrastructure reduction. Additionally, the
write-off of equipment and other assets also includes certain software costs
related to products no longer being offered. We estimated the fair value of
equipment and other assets based on the current market conditions.

   In December 2000, we completed the acquisition of Proteome, Inc., a
privately held proteomics database company. We issued 1,248,522aggregate, approximately 2,625,820 shares of our common stock and $37.7approximately $580,000 in cash upon the consummation of the merger. We also assumed outstanding third party indebtedness of approximately $920,000. $2.5 million in cash in exchange for all of Proteome's
outstanding capital stock. In addition, we assumed Proteome's stock options,
which if fully vested and exercised, would amount to 216,953975,000 shares of itsour common stock.stock was paid to certain debt holders of Maxia. The fair value of the stock options assumed were allocated
between additional purchase price and deferred compensation in accordance with
guidance provided by the Financial Accounting Standards Board's Interpretation
No. 44. The transaction was accounted for as a purchase. The amountcash portion of the purchase price was provided from our existing cash balances.
In addition, upon the consummation of the merger, all outstanding shares of Maxia Series A-Additional Payments, Maxia Series B-Additional Payments, Maxia Series C-Additional Payments and Maxia Common-Additional Payments were converted, in excessthe aggregate, into the right to receive:
up to 437,636 shares of net tangible assets acquiredour common stock and $500,000 in cash on the second anniversary of approximately $70.8the consummation of the merger; and
up to 437,636 shares of our common stock and $500,000 in cash on the third anniversary of the consummation of the merger.
Further, all outstanding shares of Maxia Series A-Earn Out, Maxia Series B-Earn Out, Maxia Series C-Earn Out and Maxia Common-Earn Out were converted, in the aggregate, into the right to receive certain Earn Out Amounts of up to a potential aggregate amount of $14.0 million upon the occurrence of certain milestones set forth in the merger agreement. Twenty percent of each earn out payment, if earned, will be paid in cash and the remaining eighty percent will be paid in shares of our common stock such that an aggregate of $2.8 million in cash and $11.2 million in our common stock could potentially be paid pursuant to the earn out milestones. The milestones occur as Maxia products enter various stages of human clinical trials and may be earned at any time prior to the tenth anniversary of the consummation of the merger.
Prior to entering into the merger agreement, in August 2002, we loaned Maxia $1.5 million in exchange for the right to negotiate with Maxia exclusively regarding an acquisition or other strategic transaction. In exchange for the loan, Maxia issued a $1.5 million senior convertible note to us. Interest on the note would have accrued at the rate of 8% per year in the event the negotiations with Maxia had terminated. The note was allocated to goodwill ($50.3 million), database ($16.6 million),
developed technology ($0.6 million), tradename ($1.7 million), and assembled
workforce ($1.6 million), which are being amortized over 8, 8, 5, 3 and 3
years, respectively. Atconvertible into shares of any class or series of Maxia capital stock at a set conversion price. This note was applied as a portion of the time of acquisition, we believedconsideration in the acquisition
would strengthen our database offering with a larger collection of protein
annotation information. In the fourth quarter of 2001, we found that
collaborators were unwilling to pay fees to access the Proteome databases that
were sufficient to support the continued investment required to build and
sustain the Proteome products. transaction.
In addition, we eliminatedloaned Maxia an aggregate of $1.4 million to cover their operating expenses during the positions of
approximately 45% of Proteome employees. We consider these events to be
indicators of potential impairment and performed a forecast of future cash
flows evaluationperiod between the signing of the affected long-lived assets,merger agreement and the consummation of the merger. In exchange for the loan, Maxia issued to us a second senior convertible note. Through December 31, 2002, we had funded $0.9 million under this note, which indicated the
long-lived assets were impaired. Aswas charged to research and development expense. Although our analysis of purchase price allocation remains incomplete, we expect to record a result, we recorded an impairment charge
on the goodwill and intangible assets associated with the Proteome acquisition in the amountfirst quarter of $58.5 million. The net remaining balance of intangible assets
at December 31, 2001 related2003 to this acquisition is $2.9 million.

   The activities acquired through the Hexagen acquisition related primarily
22
extent our final analysis concludes that total purchase price should be allocated to a method of SNP discovery. Although SNP discovery will continue, the Hexagen
method isin-process research and development or other expenses.
Frederick B. Craves, one of the activities that will not be continued after the change in
strategic directionour directors, is a partner of Bay City Capital, which held shares of Maxia stock. The transaction with Maxia was negotiated at arms’ length and, restructuring. Asbecause Dr. Craves is a result, the company determined that
the goodwill and intangible assets related to this acquisition have no future
cash flows to support their carrying value anddirector of both companies, a $10.2 million charge was
recorded to write these assets down to their estimated fair value.

   In reviewing its existing long-lived assets, we determined, based on certain
impairment indicators, that an asset related to capitalized software should be
analyzed for impairment. As a result of this analysis, it was

                                      17



determined that the net book valuespecial committee of the assetBoard of Directors, which did not include Dr. Craves, was in excess of future
revenues expected from sale offormed to consider and approve this software reduced by costs to sell.
Therefore, it was determined that this capitalized software was impaired and we
recognized a $6.1 million impairment charge.

related party transaction.
Critical Accounting Policies and Significant Estimates

   Incyte believes
We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements:

  .   
Revenue recognition

  .   
Valuation of long-lived assets

  .   
Accounting for long-term investments
Restructuring charges
Revenue Recognition.    Revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. The
Company entersWe enter into various types of agreements for access to our information databases, use of our intellectual property and sales of our custom genomics
products and services. Revenue isRevenues are deferred for fees received before earned.

   Revenueearned or until no further obligations exist.
Revenues from ongoing database agreements are recognized evenly over the access period. RevenueRevenues from licenses to the Company'sour intellectual property are recognized when earned under the terms of the related agreements. Royalty revenues are recognized upon the sale of the products or services to third parties by the licensee or other agreed upon terms.
Revenues from custom products, such as clones and datasets, are recognized upon completion and delivery. Revenues from custom services are recognized upon completion of contract deliverables. RevenueRevenues from gene expression microarray services includes:include: technology access fees, which are recognized ratably over the access term, and progress payments, which are recognized at the completion of key stages in the performance of the service in proportion to the costs incurred.
Revenues recognized from multiple element contracts are allocated to each element of the arrangement based on the relative fair values of the elements. The determination of fair value of each element is based on objective evidence from historical sales of the individual element by us to other customers. If such evidence of fair value for each element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered. In accordance with Staff Accounting Bulletin No. 101, (“SAB 101,101”), when elements are specifically tied to a separate earnings process, revenue is recognized when the specific performance obligation associated with the element is completed. When revenues for an element are not specifically tied to a separate earnings process, they are recognized ratably over the term of the agreement.
When contracts include non-monetary exchanges,payments, the value of the non-monetary transaction is determined using the fair value of the products and services involved, as applicable. For non-monetary payments involving the receipt of equity in a public entity, the fair value is based on the traded stock price on the date revenue is earned. For non-monetary payments involving the receipt of equity in a privately-held company, fair value is determined either based on a current or recent arm’s length financing by the issuer or upon an independent valuation of the issuer.
23
Valuation of Long-Lived Assets.    We assess the impairment of long-lived assets, which includes property and equipment acquisition-related intangiblesas well as intangible and goodwillother assets, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could triggerindicate the need for an impairment review include the following:

  .   
Significant changes in the strategy of our overall business;

  .   
Significant underperformance relative to expected historical or projected future operating results;

  .   
Significant changes in the manner of use of the acquired assets;

  .   
Significant negative industry or economic trends;

                                      18



  .   
Significant decline in our stock price for a sustained period; and

  .   
Our market capitalization relative to net book value.
When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, in accordance with SFAS 121,144, we perform an undiscounted cash flow analysis to determine if impairment exists. If impairment exists, we measure the impairment based on a projected discounted cash flow method using a
discount rate determined by our management to be commensurate with the risk
inherent in our current business model. Net intangible assetsdifference between the asset’s carrying amount and long-lived
assets amounted to $50.8 million as of December 31, 2001. Included in that
amount are assets with a net book value of $0.7 million that are being marketed
for sale.

   its fair value.
Accounting for Long-Term Investments.    We holdmonitor our investment portfolio for impairment on a periodic basis. Our investment portfolio includes equity and debt securitiesinvestments in publicly-traded and warrantsprivately-held companies. Many of these companies are still in the start-up or development stage. Our investments in these companies having operationsare inherently risky because the technologies or technologyproducts they have under developement are typically in areas primarily
within our strategic focus, some of which are publicly tradedthe early stages and can have
volatile share prices.may never become successful. Investments in publicly tradedpublicly-traded companies are classified as available-for-sale and are adjusted to their fair value each monthperiod based on
the their traded market price with any adjustments being recorded in other comprehensive income. Investments in privately heldprivately-held companies are carried at cost, and we monitor the company's financial results and prospects on a regular
basis to determine whether an impairment exists.cost. We record an investment impairment charge when we believe that the investment has experienced a decline in value that is other than temporary. The determination of whether an impairment is other than temporary consists of a review of qualitative and quantitative factors by members of senior management. Generally, declines that persist for six months or more are considered other than temporary. We use the best information available in these assessments, however, the information available may be limited. These determinations involve significant management judgment, and actual amounts realized for any specific investment may differ from the recorded values. Future adverse changes in market conditions or poor operating results of underlying investments could result in additional impairment charges.
Restructuring Charges.    The restructuring charges resulting from the 2002 and 2001 restructuring programs have been recorded in accordance with EITF Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (“EITF 94-3”) and Staff Accounting Bulletin No. 100,Restructuring and Impairment Charges (“SAB 100”). The restructuring charges are comprised primarily of costs to exit facilities, reduce our workforce, write-off fixed assets, and costs of outside services incurred in the restructuring. The workforce reduction charge was determined based on the estimated severance and fringe benefit charge for identified employees. In calculating the cost to exit the facilities, we estimated for each location the amount to be paid in lease termination payments, the future lease and operating costs to be paid until the lease is terminated, the amount, if any, of sublease receipts and real estate broker fees. This required us to estimate the timing and costs of each lease to be terminated, the amount of operating costs, and the timing and rate at which we might be able to sublease the site. To form our estimates for these costs, we performed an assessment of the affected facilities and considered the current market conditions for each site. Estimates were also used in our calculation of the estimated realizable value on equipment that is being held for sale. These estimates were formed based on recent history of sales of similar equipment and market conditions. Our assumptions on either the lease termination payments, operating costs until terminated, the offsetting sublease receipts and estimated realizable value of fixed assets held for sale may turn out to be incorrect and our actual cost may be materially different from our estimates.
24
Results of Operations

   The Company
We recorded net losses for the years ended December 31, 2002, 2001 and 2000 and 1999 of $136.9 million, $183.2 million $29.7 million and $26.8$29.7 million, respectively. On a basic and diluted per share basis, net loss was $2.03, $2.77 $0.47 and $0.48$0.47 for the years ended December 31, 2002, 2001 and 2000, and 1999, respectively. The net loss per
share in 2000 and thereafter reflects the dilutive effect of four million
shares issued in a February 2000 private equity offering.

   
Revenues.    Revenues for the years ended December 31, 2001, 2000 and 1999
were $219.3 million, $194.2 million and $157.0 million, respectively.

   For the year ended December 31, 2001, revenues from companies considered to
be related parties, as defined by SFAS 57 were $24.6 million. With respect to
Incyte, related parties consist of companies in which members of Incyte's Board
of Directors have invested, either directly or indirectly, or in which a member
of Incyte's Board of Directors is an officer or holds a seat on the board of
directors.

   Revenues received from agreements in which collaborators paid with equity or
debt instruments in their company were $7.8 million and $6.6 million in2002, 2001 and 2000 respectively. Additionally, revenues received from agreements in
which the Company concurrently invested funds in the collaborator's stock were $14.1$101.6 million, $219.3 million and $6.4$194.2 million, in 2001 and 2000, respectively. We did not have
similar transactions in 1999.

   We also entered into transactions in which we have recognized revenues of
$24.7 million and $6.7 million in 2001 and 2000, respectively, with certain
customers from whom we concurrently committed to purchase goods or services of
$47.4 million and $12.4 million in 2001 and 2000, respectively. Of such
amounts, we expensed $18.3 million and $1.3 million in 2001 and 2000,
respectively. We did not have similar transactions in 1999.

   The above transactions were recorded at fair value in accordance with the
Company's revenue recognition policy.

   
Revenues are derived primarily from information products, which include licensing of our intellectual property, and custom genomics.genomics products. Information products include database subscriptions, licensing, and partner 19

programs and represented 79%96%, 75%79% and 80%75% of total net revenues in 2002, 2001 2000
and 1999,2000, respectively. Custom genomics includes microarray-based gene expression products and services, genomic screening products and services, public domain clone products and related services, contract sequencing and SNP discovery services and represented 21%4%, 25%21% and 20%25% of total net revenues in 2002, 2001 and 2000, respectively. The decrease in revenues in 2002 over 2001 reflects a softening in the market for genomic information, a reduction in research spending by pharmaceutical and 1999, respectively.biotechnology companies due in part to consolidations within these industries, their efforts to reduce spending and the concomitant impact on the price of our information products, and the elimination of several lower margin product lines. Our database subscription and licensing revenues have been adversely impacted as subscribers are being more cautious with their spending than in the past. Revenues for the years ended 2002 and 2001 included $3.6 million and $45.3 million, respectively, of revenue associated with the exited custom genomics product lines that was announced in the fourth quarter of 2001. The increase in information product revenues in 2001 from 2000 is primarily due to an increase in licensing of our intellectual property. The increase in
For the years ended December 31, 2002, 2001 and 2000, revenues from 1999companies considered to be related parties, as defined by SFAS 57 were $1.7 million, $27.0 million, and $0 million. Our related parties consist of companies in which members of our Board of Directors have invested, either directly or indirectly, or in which a member of our Board of Directors is an officer or holds a seat on the board of directors.
Revenues received from agreements in which collaborators paid with equity or debt instruments in their company were $2.4 million, $8.1 million and $6.6 million in 2002, 2001 and 2000, resulted
primarilyrespectively. Additionally, revenues received from database agreements with new customers, revenuesin which we concurrently invested funds in the collaborator’s equity securities were $0.7 million, $14.1 million and $6.4 million in 2002, 2001 and 2000, respectively.
Revenues recognized from agreements executed prior to 2002 in which a concurrent commitment was entered into to purchase goods or services from the Pfizer
partner program, revenues from new products, as well as increased revenues from
custom genomics productsother party for the years ended December 31, 2002, 2001 and services. Revenues2000 were $4.0 million, $24.7 million and $6.7 million, respectively. No transactions in which we had a concurrent commitment to purchase goods or services were entered into during the year ended December 31, 2002. Of commitments made in prior periods, we expensed $22.0 million, $18.7 million and $1.3 million for the years ended December 31, 2002, are expected to be2001 and 2000, respectively.
The above transactions were recorded at fair value in the range of $130.0 million to $150.0 million. This anticipated decrease
primarily reflects the impact expected from the exit of custom genomics
products and services and from utilizingaccordance with our information products differently
to facilitate our therapeutic discovery and development collaboration and
co-development efforts.

   revenue recognition policy.
Operating Expenses.    Total costs and expenses for the years ended December 31, 2002, 2001 and 2000 and 1999 were $414.3$237.2 million, $420.1 million and $256.8 million, and $184.1 million,
respectively. Total costs and expenses for 2002 are currently expected to be in
the range of $210 million to $220 million. This anticipated decrease reflects
the reduction in expenses derived from the activities and related
infrastructure that were exited in the restructuring and the non-recurring
restructuring charges and long-lived asset write-downs in 2001, offset by
expanded spending in connectionIn conjunction with the 2002 restructuring program, we expect to reduce certain annual expenses by over $80.0 million beginning in 2003, compared with 2002, through a combination of decreased spending, job reductions and office consolidations. The restructuring programs will have little impact on our therapeutic discovery and development programs as we intend to continue to invest in research and development for our therapeutic discovery and development efforts. We expect these expenses to continue to increase in 2003, and that such increases will partially offset our expected expense reductions from the 2002 restructuring program.
Research and development expenses.    Research and development expenses for the years ended December 31, 2002, 2001 and 2000 and 1999 were $152.4 million, $213.3 million $192.6 million and $146.8$192.6 million, respectively. The increasedecrease in
25
2002 from 2001 overwas primarily the result of expenses eliminated in the exit of the custom genomics product lines, partially offset by increased therapeutic discovery and development expenses and certain write-offs related to impaired research and development assets. Higher research and development expenses in 2001, when compared with 2000, resultedwere primarily due to 2001the result of having a full year of activity in 2001 related to the Proteome acquisition, which was completed in December 2000, and an increase in the costs related to the Company'sour therapeutic discovery and development efforts. The increase from 2000 over 1999 resulted primarily from an increase
in bioinformatics and software development efforts, SNP discovery efforts,
microarray production, partner program expenses, expression database
development, an increase in internal disease pathway and therapeutic discoveryResearch and development programs,expenses may fluctuate from period to period depending upon the stage of certain projects and the developmentlevel of internetpre-clinical and e-commerce
products.

       clinical trial-related activities.
Selling, general and administrative expenses.    Selling, general and administrative expenses for the years ended December 31, 2002, 2001 and 2000 and 1999
were $47.1 million, $70.6 million and $64.2 million, respectively. The decrease in 2002 over 2001 resulted primarily from the exit of the custom genomics product lines, infrastructure reductions and $37.2 million, respectively.decreased legal expenses, partially offset by general and administrative expenses incurred to support our therapeutic discovery and development efforts. The increase in 2001 over 2000 resulted primarily from having a full year of activity related to the Proteome acquisition, which was completed in December 2000, and increased legal expenses related to the Company'sour patent infringement cases. The increase inOur selling, general and administrative expenses in 2000 over 1999
resulted primarily from the growth in the Company's sales and marketing
function, including its branding efforts, and increased personnel to support
the growing complexity of the Company's operations. The Company's selling,
general and administrative expenses were also impacted byinclude legal expenses related to the Company's patent lawsuits with Affymetrix, GeneLogicof $4.6 million and
Invitrogen of approximately $14.6 million in 2002 and 2001, and the Company'srespectively, related to our patent infringement lawsuits with Affymetrix and GeneLogic ofInvitrogen, and $8.9 million and
$6.5 million in 2000 related to our patent infringement lawsuits with Affymetrix and 1999, respectively.

       Other expenses.  Other expensesGeneLogic. Regardless of $130.4 millionthe outcome, the Invitrogen litigation is expected to result in future costs to us, which could be substantial.
Loss on Sale of Assets.    Loss on sales of assets for the yearyears ended December 31, 2002 and 2001 were $0.3 million and $5.8 million, respectively. The 2002 loss is due to routine disposition of assets in the normal course of business. The loss in 2001 resulted from the divestiture of the transgenics product line and the sale of certain of those assets. There were no significant sales of assets in 2000.
Other expenses.    Other expenses for the years ended December 31, 2002 and 2001 were $37.3 million and $130.4 million, respectively, represent the charges recorded in connection with the fourth
quarter restructuring and long-lived asset impairments. TheseIn 2002, these expenses consisted of $7.3 million in workforce reduction, $8.6 million in equipment and other asset write-offs, $18.0 million in lease commitments and other accruals related to the restructuring announced in the fourth quarter of 2002, and $3.4 million related to the increase in the 2001 restructuring charges. In 2001, these expenses, of which $109.4 million were non-cash charges, were comprised of the following items:items related to the restructuring in the fourth quarter of 2001: $68.7 million--goodwillmillion—goodwill and intangibles impairment and $55.6 million--non-recurringmillion—nonrecurring restructuring charges and $6.1 million--impairmentmillion—impairment of long-lived asset.

   Other Income/Expense.  Other income/expense includes "Interest
Interest and Other Income/Expense", "Interest Expense" and "Income Tax Expense". Total other
income/expense for the years ended December 31, 2001, 2000 and 1999 were income
of $12.4 million, $31.0 million and $6.0 million, respectively. Total other
income/expense for 2002 is expected to be approximately $3 million to $7
million of income.

       Interest and other income/expense, net.Expense, Net.    Interest and other income/expense, net, for the years ended December 31, 2002, 2001 2000 and 1999,2000, was income of $9.4 million, $23.4 million and $41.7 million, respectively. The decrease in 2002 from 2001 was primarily due to a decrease in cash invested and $5.5lower interest rates in 2002, and long-term investment impairment charges deemed to be other than temporary, totaling $9.8 million respectively.

                                      20

in 2002, which were lower than 2001 impairment charges. The decrease in 2001 from 2000 was primarily due to the impact of impairment charges recorded in 2001 totaling $14.7 million on long-term investments due to declines in values deemed to be other than temporary. To a lesser degree, the decrease in the cash and marketable securities average balances for 2001 and lower interest rates also contributed to the lower interest income. The increaseactivity on discrete investments within our portfolio, in 2000 from 1999 was primarily due to higher interest income, and a
gain of $5.4 million from the sale of one of the Company's long-term strategic
investments. The higher interest income was primarily due to the convertible
debt offering and private equity offeringany given period, may result in February 2000 resulting in higher
cash, cash equivalent and marketable securities balances.

       gains or losses on sales or impairment charges.
Interest expense.Expense.    Interest expense for the years ended December 31, 2002, 2001 and 2000 and 1999 was $9.8 million, $10.1 million and $10.5 million, respectively. The decrease in 2002 from 2001 resulted primarily from the timing impact of the early retirement of $6.7 million and $0.3$8.0 million face value of our convertible subordinated notes in 2002 and 2001, respectively. The small decrease in 2001 from 2000 is due to a lower average outstanding balance of our convertible subordinated notes as a result of the timing of issuance in 2000 and subsequent repurchases of $23.0 million face value in par
value,2000 and 2001, causing the interest thereon to decrease. The increase in 2000 from 1999
was primarily due to the interest on the convertible subordinated notes issued
by the Company in February 2000.

       Income taxes.  Due to the Company's net loss in 2001 and 2000, the
Company had a minimal effective annual income tax rate. The income taxes for
2001 and 2000 are attributable to foreign operations. In 1999, the Company had
an effective income tax benefit rate of 3.0%, primarily due to the carryback of
the 1999 net operating loss.

   Loss on Sale of Assets.  Loss on the sale of assets of $5.8 million in 2001
resulted from the divestiture of the transgenics product line and the sale of
certain of those assets. There were no significant sales of assets in 2000 or
1999.

   Gain
26
Gain/(Loss) on Certain Derivative Financial Instruments.  GainInstruments, Net.    Loss on derivatives incertain derivative financial instruments for the year ended December 31, 2002 of $1.8 million and gain on certain derivative financial instruments for the year ended December 31, 2001 of $0.6 million represents the change in fair value of certain long-term investments, specifically warrants held in other companies, in accordance with SFAS 133. Losses from Joint Venture.  Losses from joint venture were $0, $1.3Gain or loss on derivative financial instruments may fluctuate in any given period based upon current market conditions and is recognized during the period of change.
Gain on Repurchase of Convertible Subordinated Notes.    In 2002, 2001 and 2000, we repurchased $6.7 million, $8.0 million and $5.6$15.0 million face value of our 5.5% convertible subordinated notes on the open market, respectively. The repurchase resulted in a gain of $1.9 million, $2.4 million and $3.1 million for the years ended December 31, 2002, 2001 and 2000, respectively.
Losses from Joint Venture.    We incurred no losses from joint venture for the years ended December 31, 2002 and 1999,
respectively.2001. Loss from joint venture was $1.3 million for the year ended December 31, 2000. In September 1997, the Companywe formed a joint venture, diaDexus, LLC ("diaDexus"(“diaDexus”) with SmithKline Beecham Corporation. The loss represents the
Company'sour share of diaDexus'diaDexus’ losses from operations. On April 4, 2000, diaDexus converted from an LLC to a corporation and completed a private equity financing at which time the Companywe no longer had significant influence over diaDexus. Accordingly, the Companywe began accounting for itsour investment in diaDexus under the cost method of accounting as of the date of the financing, and therefore did not include diaDexus'diaDexus’ results of operations in the Company'sour statement of operations subsequent to that date.

   Extraordinary Item, Net.  In
Provision for Income Taxes.    Due to our net loss in 2002, 2001 and 2000, the Company repurchased $8.0
million and $15.0 million face value of its 5.5% convertible subordinated notes
on the open market, respectively.we had a minimal effective annual income tax rate. The repurchase resulted in a gain of $2.4
million and $3.1 million,provisions for the years ended December 31,income taxes for 2002, 2001 and 2000 respectively.

   Cumulative Effect of Accounting Change, Net.  The Company adopted FASB
Statement No. 133 ("SFAS 133") on January 1, 2001. SFAS 133 requires companiesare primarily attributable to recognize all derivatives as either assets or liabilities on the balance
sheet and measure these instruments at fair value. The $2.3 million cumulative
effect reported in 2001 relates to the recording of warrants held in other
companies at fair value upon the adoption of SFAS 133.

foreign withholding taxes.
Recent Accounting Pronouncements
In July 2001,August 2002, the FASB issued Statement No. 142, Goodwill146,Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”). SFAS 146 supersedes EITF Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Intangible Assets ("SFAS 142"Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (“EITF 94-3”). SFAS 142146 requires among other things,that a liability for a cost associated with an exit or disposal activity be recognized when the discontinuance of goodwill amortization and includes provisionsliability is incurred. Additionally, SFAS 146 establishes that fair value is the objective for the
reclassification of certain existing recognized intangibles as goodwill,
reassessmentinitial measurement of the useful livesliability. The provisions of 21



existing recognized intangibles, and reclassification of certain intangibles
out of previously reported goodwill.SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of thisthe statement on January 1, 2002 is2003 will not expected to have a material impact on the Company'sour consolidated financial statements.
In October 2001,November 2002, the FASB issued Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of Others, (“FIN 45”). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including residual value guarantees issued in conjunction with operating lease agreements. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value of the obligation it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have a material impact on our results of operations or financial position.
In November 2002, the Emerging Issues Task Force (“EITF”) issued a consensus on Issue No. 00-21,Revenue Arrangements with Multiple Deliverables (“EITF Issue No. 00-21”). EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We are currently evaluating the effect that the adoption of EITF Issue No. 00-21 will have on our results of operations and financial position.
27
In December 2002, the FASB issued Statement No. 144, 148,Accounting for the
Impairment of Long-Lived Assets ("Stock-Based Compensation—Transition and Disclosure (“SFAS 144"148”). The FASB's new rules on asset
impairment supersede SFAS 148 amends FASB Statement No. 121, 123,Accounting for Stock-Based Compensation (“SFAS 123”) to provide alternative methods of transition for an entity that voluntarily changes to the Impairmentfair value based method of Long-Lived Assets andaccounting for Long-Lived Assetsstock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 to be Disposedrequire more prominent disclosure about the effects on reported net income of and portions ofan entity’s accounting policy decisions with respect to stock-based employee compensation. SFAS 148 also amends APB Opinion No. 30,28,Interim Financial Reporting (“APB 28”) to require disclosure about the Resultsnet income effects in interim financial information. The provisions of Operations. SFAS 144 provides a
single accounting modelthis statement are effective for long-lived assetsfinancial statements for fiscal years ending after December 15, 2002. The disclosure provisions of this statement have been included in our 2002 notes to consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46,Consolidation of Variable Interest Entities (“FIN 46”). The objective of FIN 46 is to improve financial reporting by companies involved with variable interest entities by requiring the variable interest entity to be disposedconsolidated by a company if that company is subject to a majority of and
significantly changes the criteria that would haverisk of loss from the variable interest entity’s activities or entitled to be metreceive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to classify an
asset as held-for-sale. SFAS 144 also requires expected future operating losses
from discontinued operationsvariable interest entities created after January 31, 2003. The consolidation requirements apply to be displayedolder entities in the first fiscal year or interim period in which the losses
are incurred, rather thanbeginning after June 15, 2003. We believe that none of our investments qualify as of the measurement date as presently required. The
Companyentities that require consolidation under FIN 46 and will adopt this Interpretation in the provisions of SFAS 144 during the firstthird quarter of fiscal year 2002. The adoption of this statement on January 1, 2002 is not
expected to have a material impact on the Company's consolidated financial
statements.

2003.
Liquidity and Capital Resources
As of December 31, 2001, the Company2002, we had $507.9$429.0 million in cash, cash equivalents and marketable securities, compared to $582.2$507.9 million as of December 31, 2000. The Company has2001. We have classified all of itsour marketable securities as short-term, as the Companywe may choose not to hold itsour marketable securities until maturity in order to take advantage of favorable market conditions. Available cash is invested in accordance with the Company'sour investment policy'spolicy’s primary objectives of liquidity, safety of principal and diversity of investments.
Net cash used in operating activities was $58.3 million, $47.0 million $13.9 million and $21.4$13.9 million for the years ended December 31, 2002, 2001 and 2000, respectively. The change in net cash used in 2002 as compared to 2001 was primarily due to the increase in net loss in 2002, adjusted for non-cash items such as restructuring charges and 1999,
respectively.impairment of long-lived assets, as well as the decrease in accrued and other liabilities and deferred revenue, offset by higher cash provided by the decrease in accounts receivable in 2002 as compared to 2001. The change in net cash used in 2001 as compared to 2000 was primarily due to the increase in net loss in 2001, less non-cash restructuring charges and impairment of long-lived assets, as well as increases in cash usage for accounts receivable and accounts payable. The change in net cash used in
2000 as compared to 1999 was primarily due to the increases in accounts payable
and accrued and other current liabilities and the slower increase of accounts
receivables in 2000 as compared to 1999. These were partially offset by the
increase in prepaid assets and the decrease in deferred revenue.

   The Company's
Our investing activities, other than purchases, sales and maturities of marketable securities, have consisted predominantly of capital expenditures and net purchases of long-term investments. Capital expenditures for the years ended December 31, 2002, 2001 and 2000, and 1999, were $11.9 million, $12.9 million $59.5
million and $34.8$59.5 million, respectively. Capital expenditures decreased in 2002 due to reduced operational needs given our exit of custom genomics product lines, partially offset by increased spending on our therapeutic discovery and development efforts. Capital expenditures decreased in 2001 from 2000 due to lower spending on computer equipment, laboratory equipment and minimal spending on leasehold improvements in 2001 and increased in 2000 and 1999
primarily due to investments in computer equipment and software, laboratory
equipment, and leasehold improvements related to the expansion of the Company's
facilities. Long-term2001. Cash used for long-term investments in companies having operations or technology in areas within our strategic focus werewas $5.0 million, $28.0 million $3.5 million and $4.2$3.5 million for the years ended December 31, 2002, 2001 2000 and 1999,2000, respectively. In 2000 the Companywe sold stock in ana strategic equity investment, resulting in proceeds of $7.9 million and a gain of $5.4 million, and diaDexus repaid its $2.5 million note to Incyte. In 1999 the Company liquidated its investment in two such companies,
resulting in proceeds of $4.3 million and a net realized gain of $0.2 million.us. In 2000, the Companywe paid $36.9 million, net of cash received, in connection with the acquisition of Proteome. In the future, net cash used by investing activities may fluctuate significantly from period to period due to the timing of strategic equity investments, acquisitions, including possible earn-out payments to former Maxia stockholders, capital expenditures and maturities/sales and purchases of marketable securities.
28
Net cash used by financing activities was $3.2 million for the year ended December 31, 2002 and net cash provided by financing activities was $5.8 million $619.1 million
and $12.5$619.1 million for the years ended December 31, 2001 and 2000, respectively. Net cash used by financing activities in 2002 was primarily due to amounts paid to repurchase shares of our common stock and 1999,
respectively.to repurchase convertible subordinated notes, offset by proceeds received from the issuance of common stock under our stock option and employee stock purchase plans. In October 2002, we announced that our board of directors authorized the expenditure of up to $30.0 million to repurchase shares of our common stock in open market and privately negotiated transactions. Through December 31, 2002, we had purchased, and retired, 1,135,000 shares of common stock for an aggregate purchase price of $5.7 million. Net cash provided by financing activities in 2001 was primarily due to proceeds received from the issuance of common stock under the Company'sour stock option and employee stock purchase plans, offset by amounts paid to repurchase convertible subordinated notes. Net cash 22

provided by financing activities in 2000 was primarily due to the Companyour raising of additional funds in two financing transactions. In February 2000, the
Companywe issued $200.0 million aggregate principal amount of 5.5% convertible subordinated notes due 2007 in a private placement, resulting in net proceeds of $196.8 million. Also in February 2000, the Companywe issued 4,000,000 shares of itsour common stock in a private placement, for an aggregate purchase price of $422.0 million. Net proceeds from the sale of those shares were $403.3 million.
Net cash provided by financing activities in 1999 was due to the issuance of
common stock under the Company's stock option and employee stock purchase plans.

   
The following summarizes the Company'sour contractual obligations at December 31, 20012002 and the effect those obligations are expected to have on itsour liquidity and cash flow in future periods (in millions):

                                                         Less Than Years Years  Over
Contractual Obligations:                          Total   1 Year    1-3   4-5  5 Years
- ------------------------                          ------ --------- ----- ----- -------

Convertible subordinated debt.................... $179.2   $  --   $  -- $  -- $179.2
Non-cancelable operating lease obligations.......   89.9    15.8    23.7  17.4   33.0
                                                  ------   -----   ----- ----- ------
Total contractual obligations.................... $269.1   $15.8   $23.7 $17.4 $212.2
                                                  ======   =====   ===== ===== ======


   The Company
Contractual Obligations:
  
Total
  
Less Than 1 Year
  
Years 1–3
  
Years 4–5
  
Over
5 Years
Convertible subordinated debt
  
$
170.3
  
$
—
  
$
—  
  
$
170.3
  
$
—
Interest on convertible subordinated debt
  
 
42.1
  
 
9.4
  
 
18.7
  
 
14.0
  
 
—  
Non-cancelable operating lease obligations
  
 
75.3
  
 
15.2
  
 
19.3
  
 
15.9
  
 
24.9
 
  
  
  
  
  
Total contractual obligations
  
$
287.7
  
$
24.6
  
$
38.0
  
$
200.2
  
$
24.9
 
  
  
  
  
  
We also hashave purchase commitments of $25.0$11.3 million at December 31, 2001,2002, the timing of which is dependent upon provision by the vendor of products or services. Additionally, the Company haswe have committed to purchase equity in certain companies when certain events occur. The total amount committed at December 31, 20012002 was $15.0$5.0 million. These commitments are considered contingent commitments as a future event must occur in order to cause the commitment to be enforceable.

   The Company expects
We expect to use net cash in 20022003 as it: investswe invest in itsour therapeutic discovery and development programs, including continued expansion of our laboratory facilities; continue to invest in our intellectual property portfolio, sequencing and bioinformatics; continuesportfolio; make payments related to our restructuring programs; continue to seek access to technologies through investments, research and development and new alliances, license agreements and/or acquisitions; makesmake strategic investments; and continuescontinue to make improvements in existing facilities. The Company expects,
based on its current operating plans,
We believe that the cash and marketable securities
balance at December 31, 2002 will be in the range of $400 million to $420
million, excluding any strategic investments.

   The Company believes that itsour existing resources will be adequate to satisfy itsour capital needs for at least the next twelve months. The Company'sOur cash requirements depend on numerous factors, including theour ability of the Company to attract and retain collaborators for itsour databases and other products and services; expenditures in connection with alliances, license agreements and acquisitions of and investments in complementary technologies and businesses; expenditures in connection with its recentour expansion of therapeutic discovery and development programs; competing technological and market developments; the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights; capital expenditures required to expand and
modify the Company'sour facilities, including facilities for the Company'sour expanding therapeutic discovery and development programs; and costs associated with the integration of new operations assumed through mergers and acquisitions. Changes in the Company'sour research and development plans or other changes affecting the Company'sour operating expenses may result in changes in the timing and amount of expenditures of the Company'sour capital resources.

                                      23

In February 2003, we completed our acquisition of Maxia. The former stockholders of Maxia received, in the aggregate, approximately 2,625,820 shares of our common stock and approximately $580,000 in cash upon
29
the consummation of the merger. We also assumed outstanding third party indebtedness of approximately $920,000. $2.5 million in cash and 975,000 shares of our common stock was paid to certain debt holders of Maxia. The cash portion of the purchase price was provided from our existing cash balances.
In addition, upon the consummation of the merger, all outstanding shares of Maxia Series A-Additional Payments, Maxia Series B-Additional Payments, Maxia Series C-Additional Payments and Maxia Common-Additional Payments were converted, in the aggregate, into the right to receive:
up to 437,636 shares of our common stock and $500,000 in cash on the second anniversary of the consummation of the merger; and
up to 437,636 shares of our common stock and $500,000 in cash on the third anniversary of the consummation of the merger.
Further, all outstanding shares of Maxia Series A-Earn Out, Maxia Series B-Earn Out, Maxia Series C-Earn Out and Maxia Common-Earn Out were converted, in the aggregate, into the right to receive certain Earn Out Amounts of up to a potential aggregate amount of $14.0 million upon the occurrence of certain milestones set forth in the merger agreement. Twenty percent of each earn out payment, if earned, will be paid in cash and the remaining eighty percent will be paid in shares of our common stock such that an aggregate of $2.8 million in cash and $11.2 million in our common stock could potentially be paid pursuant to the earn out milestones. The milestones occur as Maxia products enter various stages of human clinical trials and may be earned at any time prior to the tenth anniversary of the consummation of the merger.
Prior to entering into the merger agreement, in August 2002, we loaned Maxia $1.5 million in exchange for the right to negotiate with Maxia exclusively regarding an acquisition or other strategic transaction. In exchange for the loan, Maxia issued a $1.5 million senior convertible note to us. Interest on the note would have accrued at the rate of 8% per year in the event the negotiations with Maxia had terminated. The note was convertible into shares of any class or series of Maxia capital stock at a set conversion price. This note was applied as a portion of the consideration in the transaction.
In addition, we loaned Maxia an aggregate of $1.4 million to cover their operating expenses during the period between the signing of the merger agreement and the consummation of the merger. In exchange for the loan, Maxia issued to us a second senior convertible note. Through December 31, 2002, we had funded $0.9 million under this note, which was charged to research and development expense.
30
FACTORS THAT MAY AFFECT RESULTS
RISKS RELATING TO OUR FINANCIAL RESULTS
We have had only limited periods of profitability, we expect to incur losses in the future and we may not return to profitability

   profitability.
We had net losses from inception in 1991 through 1996 and in 1999 through 2001.2002. Because of those losses, we had an accumulated deficit of $268.1$405.0 million as of December 31, 2001.2002. We intend to continue to spend significant amounts on new product and technology development, including the expansion of our internal research and development efforts for therapeutic discovery and development, the determination of the sequence of genes and the filing of patent applications regarding those gene sequences, the determination of gene functions, and the
expansion of our research and development alliances. As a result, we expect to incur losses in 2002.2003. We expect to report net losses in future periods as well.
We expect that any profitscash flows from our information products, including our database products and our intellectual property licensing, will be more than offset by expenditures for our therapeutic discovery and development efforts. We anticipate that these efforts will increase as we focus on the studies that are required before we can sell, or license to a third party, a drug product. The development of therapeutic products will require significant expenses for research, development, testing and regulatory approvals. Unless we generate significant revenues to pay these costs, we will not return to profitability. We cannot be certain whether or when we will again become profitable because of the significant uncertainties relating to our ability to generate commercially successful drug products that will generate significant revenues.
Our operating results are difficult to predict, which may cause our stock price to decline and result in losses to investors

   investors.
Our operating results are difficult to predict and may fluctuate significantly from period to period, which may cause our stock price to decline and result in losses to investors. Some of the factors that could cause our operating results to fluctuate include:

  .   
changes in the demand for our products;

  .   
the timing of intellectual property licenses that we may grant;

  .   
the introduction of competitive databases or services, including databases of publicly available, or public domain, genetic information;

  .   
the nature, pricing and timing of products and services provided to our collaborators;

  .   
our ability to compete effectively in our therapeutic discovery and development efforts against competitors that have greater financial or other resources or drug candidates that are in further stages of development;

  .   
acquisition, licensing and other costs related to the expansion of our operations, including operating losses of acquired businesses;

  .   
losses and expenses related to our investments;

  .   
our ability to attract and retain key personnel;

  .   
regulatory developments or changes in public perceptions relating to the use of genetic information and the diagnosis and treatment of disease based on genetic information;

  .   
regulatory actions and changes related to the development of drugs;

  .   
changes in intellectual property laws that affect our rights in genetic information that we sell;

  .   license;
31
payments of milestones, license fees or research payments under the terms of our external alliances and collaborations and our ability to monitor and enforce such payments; and

  .   
expenses related to, and the results of, litigation and other proceedings relating to intellectual property rights, including the lawsuits filed by Invitrogen and counterclaims filed by us.

                                      24

We anticipate significant fixed expenses, due in part to our expansion of our therapeutic discovery and development programs, and our continuing investment in product development and extensive support for our database collaborators. We may be unable to adjust our expenditures if revenues in a particular period fail to meet our expectations, which would harm our operating results for that period. Forecasting operating and integration expenses for acquired businesses may be particularly difficult, especially where the acquired business focuses on technologies that do not have an established market. We believe that period-to-period comparisons of our financial results will not necessarily be meaningful. You should not rely on these comparisons as an indication of our future performance. If our operating results in any future period fall below the expectations of securities analysts and investors, our stock price will likely fall, possibly by a significant amount. In addition, if market or other economic conditions impact the stock market generally, or impact other companies in our industry, our stock price may also decline, possibly significantly.
If our strategic investments incur losses or charges, our earnings may decline or our losses may increase

   increase.
We make strategic investments in entities that complement our business. These investments may:

  .   
often be made in securities lacking a public trading market or subject to trading restrictions, either of which increases our risk and reduces the liquidity of our investment;

  .   
require us to record losses and expenses related to our ownership interest;

  .   
require us to record charges related to the impairment in the value of the securities underlying our investment;

  .   
require us to record acquisition-related charges, such as in-process research and development;

  .   
require us to record charges related to post-acquisition impairment in the value of the acquired assets, such as goodwill or intangibles; and

  .   
require us to invest greater amounts than anticipated or to devote substantial management time to the management of research and development or other relationships.
The market values of many of these investments can fluctuate significantly. We evaluate our long-term equity investments for impairment of their values on a quarterly basis. The volatility of the equity markets and the uncertainty of the biotechnology industry may result in fluctuations in the value of our investments in public companies. The value of our investments in private companies can also fluctuate significantly. Current market conditions may cause us to write-down the value of our private company investments. Many private companies are encountering difficulties in raising capital in the current market, and even if they are successful, subsequent rounds of financing are often at lower valuations than previous rounds. Impairment could result in future charges to our earnings. TheseOur strategic investments may cause our earnings to decline or our losses and expenses may exceed the amounts that we anticipated.

to increase.
Our debt investments are impacted by the financial viability of the underlying companies

   companies.
We have a diversified portfolio of investments. Our fixed rate debt
investments comply with our policy of investing in only investment-grade debt
instruments. The ability for theour debt investments to be repaid upon maturity or to have a viable resale market is dependent, in part, on the financial success of the underlying company. Should the underlying company suffer significant financial difficulty, the debt instrument could either be downgraded or, in the worst case, our investment could be worthless. This would result in our losing the cash value of the investment and incurring a charge to our statement of operations.
32
Because our sales cycle is lengthy, we may spend a lot of time and money trying to obtain new or renewed subscriptions to our products but may be unsuccessful, which could hurt our profitability

   profitability.
Our ability to obtain new customers for information products, to enter into license agreements for our intellectual property or to obtain renewals or additions to existing database product subscriptions, depends upon prospective subscribers'subscribers’ perceptions that our products and services can help accelerate their drug discovery efforts. Our database and licensing sales cycle is typically lengthy because we need to educate our potential subscribers and sell the benefits of our products to a variety of constituencies within potential subscriber companies. In addition, each agreement involves the negotiation of unique terms, and we may expend substantial funds and management effort with no assurance that a new, renewed or expanded agreement will result. These 25

expenditures, without increased revenues, will negatively impact our profitability. Consolidations of pharmaceutical companies involved in drug discovery and development as well as expenditure reductions and an increased focus by our current or potential subscribers on later stage development programs and clinical compounds have affected the timing, progress and relative success of our sales efforts. We expect that any future consolidations and reductions in research budgets will have similar effects. In addition, current or prospective subscribers may perceive us to be in competition with them given our therapeutic discovery and development efforts, which may adversely impact new sales or renewals.
We have a large amount of debt and our debt service obligations may prevent us from taking actions that we would otherwise consider to be in our best interests

   interests.
As of December 31, 2001,2002, we had

  .   had:
total consolidated debt of approximately $179.2$172.0 million,

  .   stockholders'
stockholders’ equity of approximately $440.2$302.4 million, and

  .   
a deficiency of earnings available to cover fixed charges of $182.3$135.8 million for the year ended December 31, 2001.

   2002.
A variety of uncertainties and contingencies will affect our future performance, many of which are beyond our control. We may not generate sufficient cash flow in the future to enable us to meet our anticipated fixed charges, including our debt service requirements with respect to our convertible subordinated notes due 2007 that we sold in February 2000. At December 31, 2001, $1772002, $170.3 million face value of those notes were outstanding. The following table shows, as of December 31, 2001,2002, the aggregate amount of our interest payments due in each of the next five calendar years listed:

                                     Aggregate
                                Year Interest
                                ---- ----------
                                
                                2002 $9,735,000
                                2003  9,735,000
                                2004  9,735,000
                                2005  9,735,000
                                2006  9,735,000
Year
  
Aggregate Interest
2003
  
$9,366,500
2004
  
9,366,500
2005
  
9,366,500
2006
  
9,366,500
2007
  
4,683,250
Our substantial leverage could have significant negative consequences for our future operations, including:

  .   
increasing our vulnerability to general adverse economic and industry conditions;

  .   
limiting our ability to obtain additional financing;

  .   
requiring the dedication of a substantial portion of our expected cash flow to service our indebtedness, thereby reducing the amount of our expected cash flow available for other purposes, including working capital and capital expenditures;

  .   
33
limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; or

  .   
placing us at a possible competitive disadvantage compared to less leveraged competitors and competitors that have better access to capital resources.
The capital markets may not permit us to raise additional capital at the time that we require it

   it.
We believe that we have sufficient capital to satisfy our capital needs for at least the next twelve months. However, our future funding requirements will depend on many factors and we anticipate that, at some future point, we will need to raise additional capital to fund our business plan and research and development efforts on a going-forward basis. If we require additional capital at a time when investment in biotechnology companies such as ours, or in the marketplace generally, is limited due to the then prevailing market or other conditions, we may not be able to raise such funds at the time that we desire or any time thereafter.

                                      26

Additional factors which may affect our future funding requirements include:
any changes in the breadth of our research and development programs;
the results of research and development, preclinical studies and clinical trials conducted by us or our future collaborative partners or licensees, if any;
the acquisition or licensing of businesses, technologies or compounds, if any;
our ability to maintain and establish new corporate relationships and research collaborations;
competing technological and market developments;
the amount of revenues generated from our business activities;
the time and costs involved in filing, prosecuting, defending and enforcing patent and intellectual property claims;
the receipt of contingent licensing or milestone fees from our current or future collaborative and license arrangements, if established; and
the timing of regulatory approvals.
RISKS RELATING TO OUR OPERATIONSBUSINESS AND INDUSTRY
Our workforce reduction announced in November 2002 may have an adverse impact on our ability to deliver our information products on time, and we may fail to meet the expectations of our customers, which could in turn negatively impact our operating results.
In November 2002, we announced a reduction of approximately 37% of our workforce, including significant personnel reductions in our information product operations, in order to reduce expenses. Many factors, such as the reallocation of responsibilities among remaining personnel, the planned consolidation of our facilities and employee morale issues, may adversely impact our ability to deliver our products in accordance with our current plans or customer expectations, cause delays in the delivery of our products, or lead us to change our information product plans, which in turn may have a negative impact on our revenues and customer relationships. In addition, the implementation of the expense reduction program may itself result in customer concerns regarding our future performance and our ability to meet their expectations for our products, the diversion of efforts of our executive management team and other key employees, and higher than anticipated costs, any of which may negatively impact our operating results. Further, our management has announced that if our information products activities are not cash flow positive in 2003, further expense reductions may be necessary which, in turn, may also have a negative impact on our operating results.
34
Difficulties we may encounter managing the growth of our therapeutic discovery and development efforts may divert resources and limit our ability to successfully expand our operations

   business.
Our anticipated growth in the future of our therapeutic discovery and development programs, and our establishment of significantthose operations on the
East Coast of the United States, placeplaces a strain on our administrative and
operational infrastructure. As ourthose operations expand, we expect that we will need to manage multiple locations and additional relationships with various collaborative partners, suppliers and other third parties. Our ability toTo manage our operations and growth effectively, requires us towe must continue to improve our operational financial and management controls, reporting systems and procedures. We may not be able to successfully implement improvements to our management informationsystems and control systemsprocedures in an efficient or timely mannermanner. In addition, we are currently exploring permanent locations on the East Coast of the United States for our therapeutic discovery and development operations. If we are unable to locate facilities on a timely basis, if at all, the growth of our therapeutic discovery and development operations may discover deficiencies in existing systems and controls.

be adversely impacted.
Our industry is intensely competitive, and if we do not compete effectively, our revenues may decline and our losses may increase

   increase.
We compete in markets that are new, intensely competitive, rapidly changing, and fragmented. Many of our current and potential competitors have greater financial, human and other resources than we do. If we cannot respond quickly to changing customer requirements, secure intellectual property positions, or adapt quickly and obtain access to new and emerging technologies, our revenues may decline and commercial opportunities for any of our drug products may be reduced or eliminated. Our competitors include:

  .   Celera Genomics Group of 
Applera Corporation,

  .   CuraGen Corporation,

  .   
Gene Logic Inc.,

  .   Human Genome Sciences, Inc.,

  .   
pharmaceutical and biotechnology companies, and

  .   
universities and other research institutions.
The human genome contains a finite number of genes. Our competitors may seek to identify, sequence and determine the biological function of numerous genes in order to obtain a proprietary position with respect to new genes.
In addition, we face competition from companies who are developing and may seek to develop new technologies for discovering the functions of genes, gene expression information, including microarray technologies, discovery of variations among genes and related technologies. Also, if we are unable to obtain the technology we currently use or new advanced technology on acceptable terms, but other companies are, we will be unable to compete.
We also face competition from providers of software. A number of companies have announced their intent to develop and market software to assist pharmaceutical companies and academic researchers in managing and analyzing their own genomic data and publicly available data. If pharmaceutical companies and researchers are able to manage their own genomic data, or find software solutions for managing genomic data that they find preferable to those provided by us and our collaborators, they may not subscribe to our databases.
Extensive research efforts resulting in rapid technological progress characterize the genomics industry. To remain competitive, we must continue to expand our databases, improve our software, and invest in new technologies. New developments will probably continue, and discoveries by others, or the availability of such new discoveries in the public domain, may render our services and potential products noncompetitive.

                                      27

We face significant competition for our therapeutic discovery and development efforts, and if we do not compete effectively, our commercial opportunity will be reduced or eliminated

   eliminated.
The biotechnology and pharmaceutical industries are intensely competitive and subject to rapid and significant technological change. Our therapeutic discovery and development efforts may target diseases and
35
conditions that are already subject to existing therapies or that are subject to the drug discovery efforts of other entities. These competitors may develop products more rapidly or successfully than we or our collaborators are able to do. Our competitors might develop drugs that are more effective or less costly than any that are being developed by us or that would render our products obsolete and noncompetitive. In addition, our competitors may succeed in obtaining regulatory approvals for drug candidates more rapidly. Also, our competitors may obtain patent protection or other intellectual property rights that would limit our rights. Any drugs resulting from our research and development efforts, or from our joint efforts with any future collaborators, might not be able to compete successfully with competitors'competitors’ existing and future products or obtain regulatory approval in the United States or elsewhere.

If we are unable to manage our growth effectively, our operations and ability
to support our customers could be affected, which could harm our revenues

   We may continue to experience growth in the number of our employees and the
scope of our operations. This growth has placed, and may continue to place, a
significant strain on our management and operations.

   In addition, we must continue to invest in customer support resources as the
number of database collaborators and their requests for support increase. Our
database collaborators typically have worldwide operations and may require
support at multiple U.S. and foreign sites. To provide this support, we may
need to open offices in additional locations, which could result in additional
burdens on our systems and resources.

We depend on key employees in a competitive market for skilled personnel, and the loss of the services of any of our key employees would affect our ability to achieve our objectives

   objectives.
We are highly dependent on the principal members of our management, operations and scientific staff. Our product development, operations and marketing efforts could be delayed or curtailed if we lose the services of any of these people.
Our future success also will depend in part on the continued service of our executive management team, key scientific, bioinformatics and management personnel and our ability to identify, hire, train and retain additional personnel including customer service, marketingfor our therapeutic drug discovery and sales staff.development programs. We experience intense competition for qualified personnel. If we are unable to continue to attract, train and retain these personnel, we may be unable to expand our business.
We rely on a small number of suppliers of certain products we need for our business and strategic collaborations with software providers for our information products, and if we are unable to obtain sufficient supplies, or maintain such strategic relationships, we will be unable to compete effectively

   effectively.
Currently, we use gene sequencing machines supplied by Molecular Dynamics, a subsidiary of Amersham Pharmacia Biotech, Ltd., and chemicals used in the sequencing process, called reagents, supplied by Roche Bioscience and Amersham Pharmacia Biotech, Ltd. in our gene sequencing operations. If we are not able to obtain an adequate supply of reagents or other materials at commercially reasonable rates, our ability to identify genes or genetic variations would be slower and more expensive.
In addition, we rely primarily on a strategic collaboration with one software provider to provide important functionality for our products. If this collaborator suffers business difficulties, or provides functionality that does not satisfy our customers’ needs, or that our customers can find less expensively elsewhere, we may spend time and money to replace the functionality, we may not be able to deliver on customer commitments, and we may be otherwise adversely affected or our customer relationships and revenues may suffer.
If the information we obtain from third-party data sources is corrupt or violates the law, our revenues and operating results could decline

   decline.
We rely on and include in our databases scientific and other data supplied by others, including publicly available information from sources such as the Human Genome Project. This data could contain errors or other

                                      28

 defects, which could corrupt our databases. In addition, we cannot guarantee that our data sources acquired this information in compliance with legal requirements. If this data caused database corruption or violated legal requirements, we would be unable to sell subscriptions to our databases. These lost sales would harm our revenue and operating results.
Security risks in electronic commerce, unfavorable Internet regulations, or unfavorable internet regulationsbusiness difficulties suffered by our collaborators may deter future use of our products, which could result in a loss of revenues

   revenues.
We offer several products through our website on the Internet and may offer additional products in the future. Our ability to provide secure transmissions of confidential information over the Internet may limit online
36
use of our products and services by our database collaborators as we may be limited by our inability to provide secure transmissions of confidential information over the Internet. Advances in computer capabilities and new discoveries in the field of cryptography may comprisecompromise the security measures we use to protect our website, access to our databases, and transmissions to and from our website. If our security measures are breached, our proprietary information or confidential information about our collaborators could be misappropriated. Also, a security breach could result in interruptions in our operations. The security measures we adopt may not be sufficient to prevent breaches, and we may be required to incur significant costs to protect against security breaches or to alleviate problems caused by breaches. Further, if the security of our website, or the website of another company, is breached, our collaborators may no longer use the Internet when the transmission of confidential information is involved. For example, recent attacks by computer hackers on major e-commerce websites and other Internet service providers have heightened concerns regarding the security and reliability of the Internet.
Because of the growth in electronic commerce, the United States Congress has held hearings on whether to further regulate providers of services and transactions in the electronic commerce market. The federal government could enact laws, rules and regulations that would affect our business and operations. Individual states could also enact laws regulating the use of the Internet. If enacted, these federal and state laws, rules and regulations could require us to change our online business and operations, which could limit our growth and our development of our online products.

   We also rely on strategic collaborations with software providers to provide
important functionality for our products. If any of these collaborators suffer
business difficulties, we may have to spend time and money to replace the
functionality, and we may also be adversely affected or our customer
relationships and revenues may suffer.

Because our revenues are derived primarily from the pharmaceutical and biotechnology industries, our revenues may fluctuate substantially due to reductions and delays in research and development expenditures

   expenditures.
We expect that our revenues in the foreseeable future will be derived primarily from products and services provided to the pharmaceutical and biotechnology industries as well as to the academic community. Accordingly, our success will depend in large part upon the success of the companies within these industries and their demand for our products and services. Our operating results may fluctuate substantially due to reductions and delays in research and development expenditures by companies in these industries or by the academic community. These reductions and delays may result from factors such as:

  .   
changes in economic conditions;

  .   
consolidation in the pharmaceutical industry;

  .   and biotechnology industries;
changes in the regulatory environment, including governmental pricing controls, affecting health care and health care providers;

  .   
pricing pressures;

                                      29



  .   
market-driven pressures on companies to consolidate and reduce costs; and

  .   
other factors affecting research and development spending.
These factors are not within our control.
We are at the early stage of our therapeutic discovery and development efforts and because we have limited experience in developing and commercializing
products, we may be unsuccessful in our efforts to do so

   efforts.
We are in the early stage of building our therapeutic discovery and development operations. Our ability to develop and commercialize pharmaceutical products based on proteins, antibodies and other compounds will depend on our ability to:

  .   
hire and retain key scientific employees;
identify high quality therapeutic targets;

  .   
37
identify potential therapeutic candidates;

  .   
develop products internally;

  .   
complete laboratory testing and human studies;

  .   
obtain and maintain necessary intellectual property rights to our products;

  .   
obtain and maintain necessary regulatory approvals related to the efficiency and safety of our products;

  .   
enter into arrangements with third parties to provide services or manufacture our products on our behalf or develop efficient production facilities meeting all regulatory requirements;

  .   
deploy sales and marketing resources effectively or enter into arrangements with third parties to provide these functions;
lease facilities at reasonable rates to support our growth; and

  .   
enter into arrangements with third parties to license and commercialize our products.
We have limited corporate experience with these activities and may not be successful in developing or commercializing drug products. If we choose to outsource some of these activities, we may be unable to enter into outsourcing or licensing agreements on commercially reasonable terms, or at all. In addition, if we, in the future, elect to manufacture our products in our own manufacturing facilities, those facilities will require substantial additional capital resources, and we will need to attract and retain qualified personnel to build or lease or operate any such facilities.
The success of our therapeutic discovery and development efforts may depend on our ability to usefind collaborators or other service providers to leverage our capabilities, and if we are unable to establish future collaborations or if these future collaborations are unsuccessful, our research and development efforts could be delayed

   negatively affected.
Our strategy may depend in part upon the formation and sustainability of multiple collaborative arrangements and license agreements with third parties in the future. We may rely on these arrangements for not only financial resources, but also for expertise or economies of scale that we expect to need in the future relating to clinical trials, manufacturing, sales and marketing, and for licenses to technology rights. In order for any future collaboration efforts to be successful, we must first identify potential collaborators whose capabilities complement and integrate well with ours. Our collaborators may prove difficult to work with or less skilled than we originally expected.
It is likely that we will not be able to control the amount and timing of resources that our future corporate collaborators devote to our programs or potential products. We do not know whether our future collaborators, if any, might pursue alternative technologies or develop alternative products either on their own or in collaboration with others, including our competitors, as a means for developing treatments for the diseases targeted by 30

collaborative arrangements with us. Conflicts also might arise with future collaborative partners concerning proprietary rights to particular compounds.
We might not be able to commercialize our therapeutic product candidates successfully, and we may spend significant time and money attempting to do so

   so.
At the present time, we are in the early stages of organizing our
therapeutic discovery and development operations. We have yetonly begun to identify potential therapeutic compounds and thenhave yet to put them into clinical testing. Of the compounds we identify as potential therapeutic candidates, at most, only a few are statistically likely to lead to successful therapeutic development efforts. We expect that any drugs that result from our research will not be commercially available for a number of years, if at all. Commercialization of any product candidates that we identify and develop depends on successful completion of preclinical studies and clinical trials. Preclinical testing and clinical development are long, expensive and uncertain processes, and we do not know
38
whether we, or any of our future collaborators, will be permitted to undertake clinical trials of any potential products. It may take us or any of our future collaborators several years to complete any such testing, and failure can occur at any stage of testing. Interim results of trial do not necessarily predict final results, and acceptable results in early trials may not be repeated in later trials. Data obtained from tests are susceptible to varying interpretation, which may delay, limit or prevent regulatory approval. Regulatory authorities may refuse or delay approval as a result of many other factors, including changes in regulatory policy during the period of product development. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after achieving promising results in earlier trials. Moreover, if and when our products reach clinical trials, we, or our future collaborators, may decide to discontinue development of any or all of these products at any time for commercial, scientific or other reasons. There is also a risk that competitors and third parties may develop similar or superior products or have proprietary rights that preclude us from ultimately marketing our products, as well as the potential risk that our products may not be accepted by the marketplace.
Completion of clinical trials may take many years. The length of time required varies substantially according to the type, complexity, novelty and intended use of the product candidate. Our rate of commencement and completion of clinical trials may be delayed by many factors, including:

  .   
our inability to manufacture sufficient quantities of materials for use in clinical trials;

  .   
variability in the number and types of patients available for each study;

  .   
difficulty in maintaining contact with patients after treatment, resulting in incomplete data;

  .   
unforeseen safety issues or side effects;

  .   
poor or unanticipated effectiveness of products during the clinical trials; or

  .   
government or regulatory delays.
An important element of our business strategy is entering into collaborative arrangements with third parties under which we license our therapeutic product candidates to those third parties for development and commercialization. We face significant competition in seeking appropriate collaborators. Also, these arrangements are complex to negotiate and time-consuming to document. We may not be successful in our attempts to establish these arrangements. The terms of any such arrangements that we establish may not be favorable to us. Further, any such arrangements may be unsuccessful.

                                      31

We may encounter difficulties in integrating companies we acquire, and our operations and financial results could be harmed

   In December 2000, we acquired Proteome, Inc. harmed.
As part of our business strategy we may acquire other assets, technologies, compounds and businesses. Our past acquisitions, including our recent acquisition of Maxia Pharmaceuticals, Inc., have involved, and our future acquisitions may involve risks such as the following:

  .   
we may be exposed to unknown liabilities of acquired companies;

  .   
our acquisition and integration costs may be higher than we anticipated and may cause our quarterly and annual operating results to fluctuate;

  .   
we may experience difficulty and expense in assimilating the operations and personnel of the acquired businesses, disrupting our business and diverting management'smanagement’s time and attention;

  .   
we may be unable to integrate or complete the development and application of acquired technology;

  .   technology, or compounds;
we may experience difficulties in establishing and maintaining uniform standards, controls, procedures and policies;

  .   
our relationships with key customers of acquired businesses may be impaired, due to changes in management and ownership of the acquired businesses;

  .   
39
we may be unable to retain key employees of the acquired businesses;

  .   
we may incur amortization or impairment expenses if an acquisition results in significant goodwill or other intangible assets; and

  .   or
our stockholders may be diluted if we pay for the acquisition with equity securities.
In addition, if we acquire additional businesses that are not located near our Palo Alto, California headquarters,existing sites, we may experience more difficulty integrating and managing the acquired businesses'businesses’ operations.
If product liability lawsuits are successfully brought against us, we could face substantial liabilities and may be required to limit commercialization of our products.
The testing and marketing of medical products entails an inherent risk of product liability. If we cannot successfully defend ourselves against product liability claims, we may incur substantial liabilities or be required to limit commercialization of our products. Although we intend to obtain product liability insurance, this insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Our inability to obtain sufficient product liability insurance at an acceptable cost to protect against potential product liability claims could prevent or inhibit the commercialization of pharmaceutical products we develop, alone or with our future collaborators. We, or our future collaborators, might not be able to obtain insurance at a reasonable cost, if at all.
If a natural disaster occurs, we may have to cease or limit our business operations

   operations.
We conduct our database and a significant portion of our other activities at our facilities in Palo Alto, California and San Diego, California, which isare in a seismically active area.areas. Although we maintain business interruption insurance, we do not have orand do not plan to obtain earthquake insurance. A major catastrophe, such as an earthquake or other natural disaster, could result in a prolonged interruption of our business.

                                      32

RISKS RELATING TO CUSTOMERS AND COLLABORATORS
To generate significant revenues, we must obtain additional database collaboratorscustomers and retain existing collaborators

   As of December 31, 2001, we had over 50 database agreements. customers.
If we are unable to enter into additional agreements, or if our current database collaboratorscustomers choose not to renew their agreements upon expiration or choose to renew their agreements at lower prices or for shorter durations, we may not generate additional revenues or maintain our current revenues. Our database revenues are also affected by the extent to which existing collaboratorscustomers expand their agreements with us to include our new database products and the extent to which existing collaboratorscustomers reduce the number of products for which they subscribe, the impact of which will vary based upon our pricing of those products.products, as well as the pricing of new information product offerings. If the market for genomic information continues to soften, we may be required to lower prices further or restructure our product offerings to continue to meet customer demands which, in turn, may adversely impact our revenues. Some of our database agreements require us to meet performance obligations, some or all of which we may not be successful in attaining. A database collaboratorcustomer can terminate its agreement before the end of its scheduled term if we breach the agreement and fail to cure the breach within a specified period. In addition, it is likely that database revenues will decrease if we are successful in entering into co-development arrangements with some of our current database subscribers to develop new therapeutic products.
Licensing our gene-related intellectual property may not contribute to revenues for several years, and may never result in revenues

   revenues.
Part of our strategy is to license to database collaboratorscustomers and to some of our other customers our know-how and patent rights associated with the genetic information in our proprietary databases, for use in the discovery and development of 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
40
approval before commercialization. Therefore, milestone or royalty payments from these collaborations may not contribute to revenues for several years, if at all.
If conflicts arise between our future collaborators or advisors and us, they may act in their self-interest, which may be adverse to our interests or to the interests of our shareholders

   stockholders.
If conflicts arise between us and our future corporate collaborators or future scientific advisors, if any, the other party may act in its self-interest and not in the interest of our stockholders. It is likely that many of our future collaborators will be conducting multiple product development efforts within each disease area that is the subject of the collaboration with us. Our future corporate collaborators may develop, either alone or with others, products in related fields that are competitive with the products or potential products that are the subject of these collaborations. Competing products, either developed by our future collaborators or to which our future collaborators have rights, may result in their withdrawal of support for our product candidates.
If we fail to enter into future collaborative arrangements or if these arrangements are unsuccessful, our business and operations would be negatively impacted

   impacted.
We do not know if we will be able to establish collaborative arrangements, or whether any such future collaborative arrangements will ultimately be successful. For example, there have been, and may continue to be, a significant number of recent business combinations among large pharmaceutical companies that have resulted, and may continue to result, in a reduced number of potential future corporate collaborators. This consolidation may limit our ability to find partners who will work with us in developing and commercializing drugs. If business combinations involving our existing corporate collaborators were to occur, the effect could be to diminish, terminate or cause delays in one or more of our corporate collaborations or agreements. We believe that our existing capital resources, together with the proceeds
from future and current collaborations and agreements, will be sufficientIf we are unable to support our current operations. Nonetheless, our future funding requirements
will depend on many factors, including, but not limited to:

  .   any changes in the breadth ofenter into collaborative arrangements or if those arrangements are unsuccessful, our research and development programs;

                                      33



  .   the results of researchefforts could be negatively impacted and development, preclinical studies and clinical
      trials conducted by uswe may need to seek additional capital resources during times when those resources may not be available or our future collaborative partners or licensees,
      if any;

  .   the acquisition or licensing of technologies or compounds, if any;

  .   our ability to maintain and establish new corporate relationships and
      research collaborations;

  .   our ability to manage growth;

  .   competing technological and market developments;

  .   the time and costs involved in filing, prosecuting, defending and
      enforcing patent and intellectual property claims;

  .   the receipt of contingent licensing or milestone fees from our current or
      future collaborative and license arrangements, if established; and

  .   the timing of regulatory approvals.

                    are available on less favorable terms.
RISKS RELATING TO INTELLECTUAL PROPERTY
Our database revenues could decline due to sequences becoming publicly available

   available.
Our competitors may discover and establish patent positions with respect to the genes in our databases. Our competitors and other entities who engage in discoveringgene discovery may make the results of their sequencing efforts publicly available. Currently, academic institutions and other laboratories participating in the Human Genome Project make their gene sequence information available through a number of publicly available databases, including the GenBank database. The public availability of these discoveries or resulting patent positions covering substantial portions of the human genome could reduce the potential value of our databases to our collaborators. Public availability of sequences could also impair our ability to realize royalties or other revenue from any commercialized products based on genetic information made public prior to our patent filings.
We are involved in patent litigation, which if not resolved favorably, could require us to pay damages

   damages.
We are currently involved in patent litigation.
In October 2001, Invitrogen Corporation filed an action against us in federal court, alleging infringement of three patents that relate to the use of reverse transcriptase with no RNase H activity in preparing complimentary DNA from RNA. The complaint seeks unspecified money damages and injunctive relief. In November 2001, we filed our answers to Invitrogen'sInvitrogen’s patent infringement claims, and asserted seven counterclaims against Invitrogen seeking declaratory relief with respect to the patents at issue, implied license, estoppel, laches, and patent misuse. We are also seeking our fees, costs and expenses.
41
In November 2001, we filed a complaint against Invitrogen in federal court alleging infringement of 1413 of our patents relating to genes, RNA amplification and gene expression, and methods of fabricating microarrays of biological samples. The complaint seeks a permanent injunction enjoining Invitrogen from further infringement of the patents at issue, damages for Invitrogen'sInvitrogen’s conduct, as well as our fees, costs, and interest. We are further seeking triple damages from the infringement claim based on Invitrogen'sInvitrogen’s willful infringement of our patents. In April 2002, Invitrogen filed answers to our patent infringement claims.
We believe we have meritorious defenses and intend to defend the suit and
potential counterclaims brought by Invitrogen vigorously. However, our defenses may be unsuccessful. At this time, we cannot reasonably estimate the possible range of any loss or damages resulting from these suits and counterclaims due to uncertainty regarding the ultimate outcome. In addition, regardless of the outcome, we expect that the Invitrogen litigation will result in substantialfuture costs to us.us, which could be substantial. Further, there can be no assurance that any license that may be 34

required as a result of this litigation or the outcome thereof may notwill be made available on commercially acceptable terms, if at all.
If we are subject to additional litigation and infringement claims, they could be costly and disrupt our business

   business.
The technology that we use to develop our products, and the technology that we incorporate in our products, may be subject to claims that they infringe the patents or proprietary rights of others. The risk of this occurring will tend to increase as the genomics, biotechnology and software industries expand, more patents are issued and other companies attempt to discover genes and SNPs and engage in other genomic-related businesses. The success of our therapeutic discovery and development efforts will also depend, in part, on our ability to operate without infringing or misappropriating the proprietary rights of others.
As is typical in the genomics, biotechnology and software industries, we have received, and we will probably receive in the future, notices from third parties alleging patent infringement. Except for Invitrogen, no third party has a current filed patent lawsuit against us.
We may, however, be involved in future lawsuits alleging patent infringement or other intellectual property rights violations. In addition, litigation may be necessary to:

  .   
assert claims of infringement;

  .   
enforce our patents;

  .   
protect our trade secrets or know-how; or

  .   
determine the enforceability, scope and validity of the proprietary rights of others.
We may be unsuccessful in defending or pursuing these lawsuits. Regardless of the outcome, litigation can be very costly and can divert management'smanagement’s efforts. An adverse determination may subject us to significant liabilities or require us or our future collaborators to seek licenses to other parties'parties’ patents or proprietary rights. We or our future collaborators may also be restricted or prevented from manufacturing or selling our products and services. Further, we, or our future collaborators may not be able to obtain any necessary licenses on acceptable terms, if at all.
We may be unable to protect our proprietary information, which may result in its unauthorized use and a loss of revenue

   revenue.
Our business and competitive position depend upon our ability to protect our proprietary database information and software technology. Despite our efforts to protect this information and technology, unauthorized parties may attempt to obtain and use information that we regard as proprietary. Although our database subscription agreements require our subscribers to control access to our databases, policing unauthorized use of our databases and software may be difficult.

   difficult, both domestically and internationally.
We pursue a policy of having our employees, consultants and advisors execute proprietary information and invention agreements when they begin working for us. However, these agreements may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure.
42
Our means of protecting our proprietary rights may not be adequate, and our competitors may:

  .   
independently develop substantially equivalent proprietary information and techniques;

  .   
otherwise gain access to our proprietary information; or

  .   
design around patents issued to us or our other intellectual property.

                                      35

If the inventions described in our patent applications on full-length or partial genes, proteins and antibodies are found to be unpatentable, our issued patents are not enforced or our patent applications conflict with patent applications filed by others, our revenues may decline

   decline.
One of our strategies is to file patent applications on what we believe to be novel full-length and partial genes, proteins, antibodies and SNPs obtained through our efforts to discover the order, or sequence, of the molecules, or bases, of genes. We have filed U.S. patent applications in which we claimed partial sequences of some
genes. We have also applied for patents in the U.S. and other countries claiming full-length gene sequencesgenes associated with cells and tissues involved in our gene sequencing program. We hold a number of issued U.S. patents on full-length genes, the proteins they encode and antibodies directed against them and one issued U.S. patent claiming multiple partial gene
sequences.genes. While the United States Patent and Trademark Office has issued patents covering full-length genes, partial gene sequencesgenes and SNPs, the Patent and Trademark Office may choose to interpret new guidelines for the issuance of patents in a more restrictive manner in the future, which could affect the issuance of our pending patent applications. We also do not know whether or how courts may enforce our issued patents, if that becomes necessary. If a court finds these types of inventoriesinventions to be unpatentable, or interprets them narrowly, the value of our patent portfolio and possibly our revenues could be diminished.
We believe that some of our patent applications claim genes and partial
sequences of genes that may also be claimed in patent applications filed by others. In some or all of these applications, a determination of priority of inventorship may need to be decided in an interference before the United States Patent and Trademark Office, before a patent is issued. If a full-length or partial length sequencegenes for which we seek a patent is issued to one of our competitors, we may be unable to include that full-length or partial length sequence orgene in a library of bioreagents. This could result in a loss of revenues.
If the effective term of our patents is decreased due to changes in the U.S.United States patent laws or if we need to refile some of our patent applications, the value of our patent portfolio and the revenues we derive from it may be decreased

   decreased.
The value of our patents depends in part on their duration. A shorter period of patent protection could lessen the value of our rights under any patents that we obtain and may decrease the revenues we derive from our patents. The U.S. patent laws were amended in 1995 to change the term of patent protection from 17 years from patent issuance to 20 years from the earliest effective filing date of the application. Because the average time from filing to issuance of biotechnology applications is at least one year and may be more than three years depending on the subject matter, a 20-year patent term from the filing date may result in substantially shorter patent protection. Also, we may need to refile some of our applications claiming large numbers of gene
sequencesgenes and, in these situations, the patent term will be measured from the date of the earliest priority application. This would shorten our period of patent exclusivity and may decrease the revenues that we might obtain from the patents.
If patent application filing fees are significantly increased, our expenses related to intellectual property or our intellectual property strategy may be adversely affected.
Our ability to license proprietary genes may be dependent on our ability to obtain patents. We believe we have the largest commercial portfolio of issued United States patents covering human full-length genes, the proteins they encode and the antibodies directed against them. If legislation currently proposed by the United States Patent and Trademark Office is adopted, fees associated with filing and prosecuting patent applications
43
would increase significantly. If such fees are significantly increased, we would incur higher expenses and our intellectual property strategy could be adversely affected.
International patent protection is particularly uncertain, and if we are involved in opposition proceedings in foreign countries, we may have to expend substantial sums and management resources

   resources.
Biotechnology patent law outside the United States is even more uncertain than in the United States and is currently undergoing review and revision in many countries. Further, the laws of some foreign countries may not protect our intellectual property rights to the same extent as U.S. laws. We may participate in opposition proceedings to determine the validity of our foreign patents or our competitorscompetitors’ foreign patents, which could result in substantial costs and diversion of our efforts.

                                      36

REGULATORY RISKS
If we are unable to obtain regulatory approval to develop and market products in the United States and foreign jurisdictions, we or our future collaborators might not be permitted to commercialize products from our research

   research.
Before commencing clinical trials in humans, we, or our future collaborators, will need to submit and receive approval from the FDA of an Investigational New Drug application, or IND. The regulatory process also requires preclinical testing. Data obtained from preclinical and clinical activities are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. In addition, delays or rejections may be encountered based upon changes in regulatory policy for product approval during the period of product development and regulatory agency review. Any failure to obtain regulatory approval could delay or prevent us from commercializing products.
Due, in part, to the early stage of our drug candidate research and development process, we cannot predict whether regulatory approval will be obtained for any product we, or our future collaborators, hope to develop. Significant research and development efforts will be necessary before any products can be commercialized. Satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources.
If regulatory approval of a product is granted, this approval will be limited to those disease states and conditions for which the product is demonstrated through clinical trials to be safe and efficacious. We cannot ensure that any compound developed by us, alone or with others, will prove to be safe and efficacious in clinical trials and will meet all of the applicable regulatory requirements needed to receive marketing approval.
Outside the United States, our ability, or that of our future collaborative partners, to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authorities. This foreign regulatory approval process typically includes all of the risks associated with FDA approval described above and may also include additional risks.
Because our activities involve the use of hazardous materials, we may be subject to claims relating to improper handling, storage or disposal of these materials that could be time consuming and costly

   costly.
Our research and development processes involve the controlled use of hazardous and radioactive materials and biological waste. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and waste products. We may be sued for any injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our insurance coverage and our total assets.
44
Compliance with environmental laws and regulations may be expensive, and current or future environmental regulations may impair our research, development and production efforts.
Future changes to environmental, health and safety laws could cause us to incur additional expense or restrict our operations. In addition, our future collaborators may use hazardous materials in connection with our collaborative efforts. To our knowledge, their work is performed in accordance with applicable biosafety regulations. In the event of a lawsuit or investigation, however, we could be held responsible for any injury caused to persons or property by exposure to, or release of, these hazardous materials useused by these parties. Further, we may be required to indemnify our collaborators against all damages and other liabilities arising out of our development activities or products produced in connection with these collaborations.
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to interest rate risk primarily through its investments in short-term marketable debt securities. The Company'sCompany’s investment policy calls for investment in short term, low risk, investment-grade 37

instruments. As of December 31, 2001,2002, investments in marketable debt securities were $500.0$428.3 million. Due to the nature of these investments, if market interest rates were to increase immediately and uniformly by 10% from levels as of December 31, 2001,2002, the decline in the fair value of the portfolio would not be material.
The Company is exposed to equity price risks on the marketable portion of equity securities included in its portfolio of investments and long-term investments, entered into to further its business and strategic objectives. These investments are in small capitalization stocks in the pharmaceutical/biotechnology industry sector, in companies with which the
Company has research and development or licensing agreements.sector. The Company typically does not attempt to reduce or eliminate its market exposure on these securities. As of December 31, 2001,2002, long-term investments were $45.3$35.5 million.
The Company is exposed to foreign exchange rate fluctuations as the financial results of its foreign operations are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact the Company'sCompany’s financial position or results of operations. All of the Company'sCompany’s revenues are denominated in U.S. dollars. The Company does not enter into forward exchange contracts as a hedge against foreign currency exchange risk on transactions denominated in foreign currencies or for speculative or trading purposes. If currency exchange rates were to fluctuate immediately and uniformly by 10% from levels as of December 31, 2001,2002, the impact to the Company'sCompany’s financial position or results of operations would not be material.

                                      38

45
Item 8.     Financial Statements and Supplementary Data
INDEX
Page
                                                                                                       ----
Consolidated Financial Statements of Incyte Genomics, Inc.
   Corporation
Report of Ernst & Young LLP, Independent Auditors..................................................  40
   Auditors
47
Consolidated Balance Sheets at December 31, 20012002 and 2000..........................................  41
   2001
48
Consolidated Statements of Operations for the years ended December 31, 2002, 2001 2000 and 1999.........  42
   2000
49
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2002, 2001 2000 and 1999....................................................................................  43
   2000
50
Consolidated Statement of Stockholders'Stockholders’ Equity for the years ended December 31, 2002, 2001 2000 and 1999.............................................................................................  44
   2000
51
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 2000 and 1999.........  45
   2000
52
Notes to the Consolidated Financial Statements.....................................................  46
   Statements
53
Interim Consolidated Financial Information (unaudited).............................................  66

Financial Statements of diaDexus, Inc., a Development Stage Company
   Report of PricewaterhouseCoopers LLP, Independent Accountants......................................  68
   Balance Sheets at December 31, 2001 and 2000.......................................................  69
   Statements of Operations for the years ended December 31, 2001, 2000, 1999 and for the period from
     August 29, 1997 (inception) through December 31, 2001............................................  70
   Statements of Members' and Stockholders' Equity for the period from August 29, 1997 (inception)
     through December 31, 2001........................................................................  71
   Statements of Cash Flows for the years ended December 31, 2001, 2000, 1999 and for the period
     from August 29, 1997 (inception) through December 31, 2001.......................................  72
   Notes to Financial Statements......................................................................  73
   Schedule II--Valuation and Qualifying Accounts.....................................................  67
79


                                      39

46
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Incyte Genomics, Inc.

   Corporation
We have audited the accompanying consolidated balance sheets of Incyte Corporation, formerly known as Incyte Genomics, Inc., as of December 31, 20012002 and 2000,2001, and the related consolidated statements of operations, comprehensive income (loss), stockholders'stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2001.2002. Our audits also included the financial statement schedule listed in the Index at Item 14(a)item 15 (a). These financial statements and schedule are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We did not audit
the financial statements of diaDexus, Inc., a development stage company, which
statements reflect a net loss of $11,286,000 for the year ended December 31,
1999. Those statements were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the 1999 losses from
joint venture recorded under the equity method and other data included for
diaDexus, Inc. is based solely on the report of the other auditors.

   
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 and the report of
other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Incyte Corporation, formerly known as Incyte Genomics, Inc., at December 31, 20012002 and 2000,2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001,2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

                                          /s/  ERNST & YOUNG
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets in 2002 upon adoption of Statement of Financial Accounting Standards No. 142, “Accounting for Goodwill and Other Intangible Assets”.
/s/    ERNST & YOUNG LLP         
Palo Alto, California
January 25, 2002

                                      40

31, 2003, except for Note 16 and for the second
    sentence of the first paragraph of Note 1 as to which the dates
    are February 18, 2003 and March 15, 2003, respectively
47
INCYTE GENOMICS, INC.

                          CORPORATION
CONSOLIDATED BALANCE SHEETS
             (in
(in thousands, except number of shares and par value)
 
  
December 31,
 
 
  
2002
 
  
2001
 
ASSETS
  
 
 
 
  
 
 
 
Current assets:
  
 
 
 
  
 
 
 
Cash and cash equivalents
  
$
22,928
 
  
$
43,368
 
Marketable securities—available-for-sale
  
 
406,090
 
  
 
464,535
 
Accounts receivable, net(1)
  
 
8,485
 
  
 
54,038
 
Prepaid expenses and other current assets(2)
  
 
21,268
 
  
 
29,280
 
 
  
  
Total current assets
  
 
458,771
 
  
 
591,221
 
Property and equipment, net
  
 
31,787
 
  
 
47,927
 
Long-term investments(3)
  
 
35,515
 
  
 
45,272
 
Intangible and other assets, net(4)
  
 
26,066
 
  
 
21,139
 
 
  
  
Total assets
  
$
552,139
 
  
$
705,559
 
 
  
  
LIABILITIES AND STOCKHOLDERS’ EQUITY
  
 
 
 
  
 
 
 
Current liabilities:
  
 
 
 
  
 
 
 
Accounts payable
  
$
9,073
 
  
$
7,347
 
Accrued compensation
  
 
14,319
 
  
 
18,812
 
Interest payable
  
 
3,903
 
  
 
4,060
 
Royalties payable
  
 
926
 
  
 
5,001
 
Accrued and other current liabilities(5)
  
 
6,214
 
  
 
11,873
 
Deferred revenue
  
 
11,662
 
  
 
24,045
 
Accrued restructuring charges
  
 
31,596
 
  
 
14,970
 
 
  
  
Total current liabilities
  
 
77,693
 
  
 
86,108
 
Convertible subordinated notes
  
 
172,036
 
  
 
179,248
 
 
  
  
Total liabilities
  
 
249,729
 
  
 
265,356
 
 
  
  
Commitments and contingencies
  
 
 
 
  
 
 
 
Stockholders’ equity:
  
 
 
 
  
 
 
 
Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued and outstanding at December 31, 2002 and 2001
  
 
—  
 
  
 
—  
 
Common stock, $0.001 par value; 200,000,000 shares authorized; 67,177,591 and 66,745,577 shares issued and outstanding at December 31, 2002 and 2001, respectively
  
 
67
 
  
 
67
 
Additional paid-in capital
  
 
708,163
 
  
 
707,412
 
Deferred stock-based compensation
  
 
(3,250
)
  
 
(8,127
)
Accumulated other comprehensive income
  
 
2,454
 
  
 
8,990
 
Accumulated deficit
  
 
(405,024
)
  
 
(268,139
)
 
  
  
Total stockholders’ equity
  
 
302,410
 
  
 
440,203
 
 
  
  
Total liabilities and stockholders’ equity
  
$
552,139
 
  
$
705,559
 
 
  
  

                                                                                        December 31,
                                                                                    -------------------
                                                                                      2001       2000
                                                                                    ---------  --------


                                      ASSETS
Current assets:
   Cash
(1)
Includes receivables from companies considered related parties under SFAS 57 of $0.6 million and cash equivalents....................................................... $  43,368  $110,155
   Marketable securities--available-for-sale.......................................   464,535   472,025
   Accounts receivable, net/(1)/...................................................    54,038    35,022
   Prepaid expenses and other current assets.......................................    29,280    30,693
                                                                                    ---------  --------
       Total current assets........................................................   591,221   647,895
Property and equipment, net........................................................    47,927    98,948
Long-term investments..............................................................    45,272    40,003
Goodwill and other intangible assets, net..........................................     2,914    82,944
Deposits and other assets..........................................................    18,225    17,030
                                                                                    ---------  --------
   Total assets.................................................................... $ 705,559  $886,820
                                                                                    =========  ========

                       LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable................................................................ $   7,347  $ 17,497
   Accrued compensation............................................................    18,812    13,023
   Interest payable................................................................     4,060     4,310
   Royalties payable...............................................................     5,001       465
   Accrued and other current liabilities...........................................    11,873    18,261
   Deferred revenue................................................................    24,045    22,756
   Accrued restructuring charges...................................................    14,970        --
                                                                                    ---------  --------
       Total current liabilities...................................................    86,108    76,312
Convertible subordinated notes.....................................................   179,248   187,814
                                                                                    ---------  --------
       Total liabilities...........................................................   265,356   264,126
                                                                                    ---------  --------
Commitments and contingencies

Stockholders' equity:..............................................................
   Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued and
     outstanding$10.9 million at December 31, 2002 and 2001, respectively.
(2)
Includes loan receivable from a company considered a related party under SFAS 57 of $1.5 million and 2000.....................................        --        --
   Common stock, $0.001 par value; 200,000,000 shares authorized; 66,745,577 and
     65,691,623 shares issued and outstanding$0 million at December 31, 2002 and 2001, respectively, and 2000,
     respectively..................................................................        67        66
   Additional paid-in capital......................................................   707,412   689,392
   Deferred compensation...........................................................    (8,127)   (2,773)
   Accumulated other comprehensive income..........................................     8,990    20,913
   Accumulated deficit.............................................................  (268,139)  (84,904)
                                                                                    ---------  --------
       Total stockholders' equity..................................................   440,203   622,694
                                                                                    ---------  --------
       Total liabilitiesprepaid expenses to companies considered related parties under SFAS 57 of $2.1 million and stockholders' equity.................................. $ 705,559  $886,820
                                                                                    =========  ========
$1.4 million at December 31, 2002 and 2001, respectively.

- --------
(1) Includes receivables from related parties of $10,936
(3)
Includes investments in companies considered related parties under SFAS 57 of $26.1 million and $17.3 million at December 31, 2002 and 2001, respectively.
(4)
Includes loans to executive officers of $0.8 million and $0 million at December 31, 2002 and $0 in 2001, and
    2000, respectively. See Note 4.
(5)
Includes accruals of payments to companies considered related parties under SFAS 57 of $1.5 million and $0 million at December 31, 2002 and 2001, respectively.
See accompanying notes

                                      41

48
INCYTE GENOMICS, INC.

                     CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
                   (in
(in thousands, except per share amounts)
 
  
Year Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
Revenues(1)
  
$
101,612
 
  
$
219,263
 
  
$
194,167
 
Costs and expenses:
  
 
 
 
  
 
 
 
  
 
 
 
Research and development(2)
  
 
152,373
 
  
 
213,336
 
  
 
192,556
 
Selling, general and administrative(3)
  
 
47,147
 
  
 
70,626
 
  
 
64,201
 
Loss on sale of assets
  
 
313
 
  
 
5,777
 
  
 
  —  
 
Other expenses(4)
  
 
37,331
 
  
 
130,372
 
  
 
—  
 
 
  
  
  
Total costs and expenses
  
 
237,164
 
  
 
420,111
 
  
 
256,757
 
 
  
  
  
Loss from operations
  
 
(135,552
)
  
 
(200,848
)
  
 
(62,590
)
Interest and other income (expense), net(5)
  
 
9,434
 
  
 
23,453
 
  
 
41,735
 
Interest expense
  
 
(9,802
)
  
 
(10,128
)
  
 
(10,529
)
Gain (loss) on certain derivative financial instruments
  
 
(1,782
)
  
 
553
 
  
 
—  
 
Gain on repurchase of convertible subordinated notes
  
 
1,937
 
  
 
2,386
 
  
 
3,137
 
Losses from joint venture
  
 
—  
 
  
 
—  
 
  
 
(1,283
)
 
  
  
  
Loss before income taxes and accounting change
  
 
(135,765
)
  
 
(184,584
)
  
 
(29,530
)
Provision for income taxes
  
 
1,120
 
  
 
930
 
  
 
205
 
 
  
  
  
Loss before accounting change
  
 
(136,885
)
  
 
(185,514
)
  
 
(29,735
)
Cumulative effect of accounting change
  
 
—  
 
  
 
2,279
 
  
 
—  
 
 
  
  
  
Net loss
  
$
(136,885
)
  
$
(183,235
)
  
$
(29,735
)
 
  
  
  
Per share data:
  
 
 
 
  
 
 
 
  
 
 
 
Loss before accounting change
  
$
(2.03
)
  
$
(2.80
)
  
$
(0.47
)
Cumulative effect of accounting change
  
 
—  
 
  
 
0.03
 
  
 
—  
 
 
  
  
  
Basic and diluted net loss per share
  
$
(2.03
)
  
$
(2.77
)
  
$
(0.47
)
 
  
  
  
Shares used in computing basic and diluted net loss per share
  
 
67,403
 
  
 
66,193
 
  
 
63,211
 
 
  
  
  

                                                                      Year Ended
(1)
Includes revenues from transactions with companies considered related parties under SFAS 57 of $1.7 million, $27.0 million and $0 for the years ended December 31, -----------------------------2002, 2001 and 2000, 1999
                                                                   ---------  --------  --------

Revenues/(1)/..................................................... $ 219,263  $194,167  $156,962
Costsrespectively.
(2)
Includes expenses from transactions with companies considered related parties under SFAS 57 of $11.7 million, $0.6 million and expenses:
   Research$0 million for the years ended December 31, 2002, 2001 and development/(2)/..................................   213,336   192,556   146,833
   Selling, general2000, respectively, and administrative/(3)/.......................    70,626    64,201    37,235
   Other expenses/(4)/............................................   130,372        --        --
                                                                   ---------  --------  --------
       Total costsstock based compensation charges of $0 million, $0.1 million and expenses...................................   414,334   256,757   184,068
                                                                   ---------  --------  --------
Loss from operations..............................................  (195,071)  (62,590)  (27,106)
Interest$0 million in 2002, 2001 and other income (expense), net..........................    23,453    41,735     5,485
Interest expense..................................................   (10,128)  (10,529)     (316)
Loss2000, respectively.
(3)
Includes stock-based compensation charges of $4.2 million, $1.3 million and $0.3 million in 2002, 2001 and 2000, respectively, and compensation expense related to loans to executive officers of $0.4 million, $0 million and $0 million in 2002, 2001 and 2000, respectively.
(4)
2002 charges relate to restructuring charges. 2001 charges include the following: $68.7 million—goodwill and intangibles impairment; $55.6 million—restructuring charges and $6.1 million—impairment of a long-lived asset.
(5)
Includes gains on saleinvestments in companies considered related parties under SFAS 57 of assets............................................    (5,777)       --        --
Gain on certain derivative financial instruments..................       553        --        --
Losses from joint venture.........................................        --    (1,283)   (5,631)
                                                                   ---------  --------  --------
Loss before income taxes, extraordinary item$1.5 million, $0 million and accounting change  (186,970)  (32,667)  (27,568)
Provision (benefit)$0 million for income taxes..............................       930       205      (800)
                                                                   ---------  --------  --------
Loss before extraordinary itemthe years ended December 31, 2002, 2001 and accounting change..............  (187,900)  (32,872)  (26,768)
Extraordinary gain................................................     2,386     3,137        --
Cumulative effect of accounting change............................     2,279        --        --
                                                                   ---------  --------  --------
       Net loss................................................... $(183,235) $(29,735) $(26,768)
                                                                   =========  ========  ========
Per share data:
   Loss before extraordinary item................................. $   (2.84) $  (0.52) $  (0.48)
   Extraordinary gain.............................................      0.04      0.05        --
   Cumulative effect of accounting change.........................      0.03        --        --
                                                                   ---------  --------  --------
   Basic and diluted net loss per share........................... $   (2.77) $  (0.47) $  (0.48)
                                                                   =========  ========  ========
Shares used in computing basic and diluted net loss per share.....    66,193    63,211    56,276
                                                                   =========  ========  ========
2000, respectively.

- --------
(1) Includes revenues from transactions with related parties of $24,615, $0 and
    $0 for the years ended December 31, 2001, 2000 and 1999, respectively.
(2) Includes stock based compensation charges of $1,268, $336 and $416 in 2001,
    2000 and 1999, respectively.
(3) Includes stock-based compensation charges of $137, $0 and $0 in 2001, 2000
    and 1999, respectively.
(4) Includes the following charges recorded in 2001: $68,666--goodwill and
    intangibles impairment; $55,602--non-recurring restructuring charges and
    $6,104--impairment of a long-lived asset.

                            
See accompanying notes

                                      42

49
INCYTE GENOMICS, INC.

            CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
                                (in
(in thousands)

                                                                               Year Ended December 31,
                                                                            -----------------------------
                                                                              2001       2000      1999
                                                                            ---------  --------  --------

Net loss................................................................... $(183,235) $(29,735) $(26,768)
Other comprehensive income (loss):
   Unrealized gains (losses) on marketable securities......................   (13,919)   17,446     3,346
   Reclassification adjustment for realized gains on marketable securities.     1,993       172       272
   Foreign currency translation adjustment.................................         3      (148)     (165)
                                                                            ---------  --------  --------
Other comprehensive income (loss)..........................................   (11,923)   17,470     3,453
                                                                            ---------  --------  --------
Comprehensive loss......................................................... $(195,158) $(12,265) $(23,315)
                                                                            =========  ========  ========
 
  
Year Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
Net loss
  
$
(136,885
)
  
$
(183,235
)
  
$
(29,735
)
Other comprehensive income (loss):
  
 
 
 
  
 
 
 
  
 
 
 
Unrealized gains (losses) on marketable securities
  
 
(7,666
)
  
 
(13,919
)
  
 
17,446
 
Reclassification adjustment for realized gains on marketable securities
  
 
1,373
 
  
 
1,993
 
  
 
172
 
Foreign currency translation adjustment
  
 
(243
)
  
 
3
 
  
 
(148
)
 
  
  
  
Other comprehensive income (loss)
  
 
(6,536
)
  
 
(11,923
)
  
 
17,470
 
 
  
  
  
Comprehensive loss
  
$
(143,421
)
  
$
(195,158
)
  
$
(12,265
)
 
  
  
  
See accompanying notes

                                      43

50
INCYTE GENOMICS, INC.

                CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS'STOCKHOLDERS’ EQUITY
                    (in
(in thousands, except number of shares)

                                                                                 Accumulated
                                            Additional              Receivable      Other                     Total
                                     Common  Paid-in     Deferred      From     Comprehensive Accumulated Stockholders'
                                     Stock   Capital   Compensation Stockholder    Income       Deficit      Equity
                                     ------ ---------- ------------ ----------- ------------- ----------- -------------

Balances at January 1, 1999.........  $56    $209,164    $(1,209)      $(33)      $    (10)    $ (28,401)   $ 179,567
Issuance of 1,961,696 shares of
 Common Stock upon exercise of
 stock options and 158,754 shares of
 Common Stock under the ESPP........    2      13,612         --         --             --            --       13,614
Amortization of deferred
 compensation.......................   --          --        403         --             --            --          403
Repayment of receivable from
 stockholder........................   --          --         --         13             --            --           13
Other comprehensive income (loss)...                                                 3,453                      3,453
Net loss............................   --          --         --         --             --       (26,768)     (26,768)
                                      ---    --------    -------       ----       --------     ---------    ---------
Balances at December 31, 1999.......   58     222,776       (806)       (20)         3,443       (55,169)     170,282
Issuance of 2,448,612 shares of
 Common Stock upon exercise of
 stock options and 214,617 shares of
 Common Stock under the ESPP........    3      28,625         --         --             --            --       28,628
Issuance of 4,000,000 shares of
 Common Stock in private equity
 offering...........................    4     403,351         --         --             --            --      403,355
Issuance of 1,248,522 shares of
 Common Stock and deferred
 compensation from stock options
 assumed in the acquisition of
 Proteome Inc.......................    1      34,640     (2,479)        --             --            --       32,162
Amortization of deferred
 compensation.......................   --          --        512         --             --            --          512
Repayment of receivable from
 stockholder........................   --          --         --         20             --            --           20
Other comprehensive income (loss)...                                                17,470                     17,470
Net loss............................   --          --         --         --             --       (29,735)     (29,735)
                                      ---    --------    -------       ----       --------     ---------    ---------
Balances at December 31, 2000.......   66     689,392     (2,773)        --         20,913       (84,904)     622,694
Issuance of 752,151 shares of
 Common Stock upon exercise of
 stock options and 301,763 shares of
 Common Stock under the ESPP........    1      11,645         --         --             --            --       11,646
Other...............................   --        (234)        --         --             --            --         (234)
Deferred compensation on issuance of
 restricted stock units.............   --       7,933     (7,933)        --             --            --           --
Adjustment of deferred compensation
 for terminated employees...........   --      (1,324)     1,324         --             --            --           --
Amortization of deferred
 compensation.......................   --          --      1,255         --             --            --        1,255
Other comprehensive income (loss)...                                               (11,923)                   (11,923)
Net loss............................   --          --         --         --             --      (183,235)    (183,235)
                                      ---    --------    -------       ----       --------     ---------    ---------
Balances at December 31, 2001.......  $67    $707,412    $(8,127)      $ --       $  8,990     $(268,139)   $ 440,203
                                      ===    ========    =======       ====       ========     =========    =========
 
  
Common Stock
 
 
Additional Paid-in Capital
 
  
Deferred Compensation
 
    
Receivable From Stockholder
 
  
Accumulated Other Comprehensive Income (Loss)
 
  
Accumulated Deficit
 
  
Total Stockholders’ Equity
 
Balances at January 1, 2000
  
$
58
 
 
$
222,776
 
  
$
(806
)
    
$
(20
)
  
$
3,443
 
  
$
(55,169
)
  
$
170,282
 
Issuance of 2,448,612 shares of Common Stock upon exercise of stock options and 214,617 shares of Common Stock under the ESPP
  
 
3
 
 
 
28,625
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
28,628
 
Issuance of 4,000,000 shares of Common Stock in private equity offering
  
 
4
 
 
 
403,351
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
403,355
 
Issuance of 1,248,522 shares of Common Stock and deferred compensation from stock options assumed in the acquisition of Proteome, Inc.
  
 
1
 
 
 
34,640
 
  
 
(2,479
)
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
32,162
 
Amortization of deferred compensation
  
 
—  
 
 
 
—  
 
  
 
512
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
512
 
Repayment of receivable from stockholder
  
 
—  
 
 
 
—  
 
  
 
—  
 
    
 
20
 
  
 
—  
 
  
 
—  
 
  
 
20
 
Other comprehensive income
  
 
—  
 
 
 
—  
 
  
 
—  
 
    
 
—  
 
  
 
17,470
 
  
 
—  
 
  
 
17,470
 
Net loss
  
 
—  
 
 
 
—  
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
(29,735
)
  
 
(29,735
)
 
  
 
  
    
  
  
  
Balances at December 31, 2000
  
 
66
 
 
 
689,392
 
  
 
(2,773
)
    
 
—  
 
  
 
20,913
 
  
 
(84,904
)
  
 
622,694
 
Issuance of 752,191 shares of Common Stock upon exercise of stock options and 301,763 shares of Common Stock under the ESPP
  
 
1
 
 
 
11,645
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
11,646
 
Other
  
 
—  
 
 
 
(234
)
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
(234
)
Deferred compensation on issuance of restricted stock units
  
 
—  
 
 
 
7,933
 
  
 
(7,933
)
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
Adjustment of deferred compensation for terminated employees
  
 
—  
 
 
 
(1,324
)
  
 
1,324
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
Amortization of deferred compensation
  
 
—  
 
 
 
—  
 
  
 
1,255
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
1,255
 
Other comprehensive loss
  
 
—  
 
 
 
—  
 
  
 
—  
 
    
 
—  
 
  
 
(11,923
)
  
 
—  
 
  
 
(11,923
)
Net loss
  
 
—  
 
 
 
—  
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
(183,235
)
  
 
(183,235
)
 
  
 
  
    
  
  
  
Balances at December 31, 2001
  
 
67
 
 
 
707,412
 
  
 
(8,127
)
    
 
—  
 
  
 
8,990
 
  
 
(268,139
)
  
 
440,203
 
Issuance of 1,133,045 shares of Common Stock upon exercise of stock options and 433,969 shares of Common Stock under the ESPP
  
 
1
 
 
 
7,181
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
7,182
 
Other
  
 
—  
 
 
 
72
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
72
 
Adjustment of deferred compensation for terminated employees
  
 
—  
 
 
 
(1,180
)
  
 
1,180
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
Amortization of deferred compensation
  
 
—  
 
 
 
—  
 
  
 
3,697
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
3,697
 
Stock compensation expense
  
 
—  
 
 
 
400
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
400
 
Repurchase of 1,135,000 shares of Common Stock
  
 
(1
)
 
 
(5,722
)
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
(5,723
)
Other comprehensive loss
  
 
—  
 
 
 
—  
 
  
 
—  
 
    
 
—  
 
  
 
(6,536
)
  
 
—  
 
  
 
(6,536
)
Net loss
  
 
—  
 
 
 
—  
 
  
 
—  
 
    
 
—  
 
  
 
—  
 
  
 
(136,885
)
  
 
(136,885
)
 
  
 
  
    
  
  
  
Balances at December 31, 2002
  
$
67
 
 
$
708,163
 
  
$
(3,250
)
    
$
—  
 
  
$
2,454
 
  
$
(405,024
)
  
$
302,410
 
 
  
 
  
    
  
  
  
See accompanying notes

                                      44

51
INCYTE GENOMICS, INC.

                     CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (in
(in thousands)

                                                                                         Year Ended December 31,
                                                                                     ------------------------------
                                                                                       2001       2000       1999
                                                                                     ---------  ---------  --------

Cash flows from operating activities:
Net loss............................................................................ $(183,235) $ (29,735) $(26,768)
Adjustments to reconcile net loss to net cash used in operating activities:
   Non-cash restructuring charges and impairment of long-lived assets...............   109,423         --        --
   Depreciation and amortization....................................................    46,410     34,842    28,106
   Amortization of deferred compensation............................................     1,255
   Gain on repurchase of convertible subordinated notes.............................    (2,386)    (3,137)       --
   Cumulative effect of accounting change...........................................    (2,279)        --        --
   Gain on derivative financial instruments, net....................................      (553)        --        --
   Impairment of long-term investments..............................................    14,665
   Gain on sale of long-term investments, net.......................................    (2,505)    (4,384)     (241)
   Loss on sale of assets...........................................................     5,777         --        --
   Debt instruments and equity received in exchange for goods or services provided..    (8,100)    (6,600)       --
   Losses from joint venture........................................................        --      1,283     5,631
   Changes in operating assets and liabilities:
      Accounts receivable...........................................................   (21,406)    (8,414)  (12,290)
      Prepaid expenses and other assets.............................................   (14,916)   (19,824)  (17,973)
      Accounts payable..............................................................   (10,150)    10,816    (1,743)
      Accrued and other current liabilities.........................................    19,557     14,912     6,427
      Deferred revenue..............................................................     1,439     (3,703)   (2,595)
                                                                                     ---------  ---------  --------
         Net cash used in operating activities......................................   (47,004)   (13,944)  (21,446)
                                                                                     ---------  ---------  --------
Cash flows from investing activities:
Capital expenditures................................................................   (12,919)   (59,510)  (34,758)
Purchase of long-term investments...................................................   (28,019)    (3,494)   (4,181)
Proceeds from the sale of long-term investments.....................................     4,337      7,917     4,321
Purchase of subsidiary (net of cash received).......................................        --    (36,866)       --
Purchases of marketable securities..................................................  (888,366)  (822,357)  (22,998)
Sales of marketable securities......................................................   601,884    274,267    38,932
Maturities of marketable securities.................................................   297,226    112,950    10,000
Other...............................................................................       300         --        --
                                                                                     ---------  ---------  --------
         Net cash used in investing activities......................................   (25,557)  (527,093)   (8,684)
                                                                                     ---------  ---------  --------
Cash flows from financing activities:
Proceeds from issuance of common stock under stock plans............................    11,268     31,297    13,614
Proceeds from private equity offering...............................................        --    403,355        --
Proceeds from the issuance of Convertible Subordinated Notes........................        --    196,800        --
Repurchase of Convertible Subordinated Notes........................................    (5,643)   (11,872)       --
Principal payments on capital lease obligations and note payable....................        --       (480)   (1,160)
Other...............................................................................       145         20        13
                                                                                     ---------  ---------  --------
         Net cash provided by financing activities..................................     5,770    619,120    12,467
                                                                                     ---------  ---------  --------
Effect of exchange rate on cash and cash equivalents................................         4       (148)     (165)
Net increase (decrease) in cash and cash equivalents................................   (66,787)    77,935   (17,828)
Cash and cash equivalents at beginning of period....................................   110,155     32,220    50,048
                                                                                     ---------  ---------  --------
Cash and cash equivalents at end of period.......................................... $  43,368  $ 110,155  $ 32,220
                                                                                     =========  =========  ========
Supplemental Schedule of Cash Flow Information
Interest paid....................................................................... $   9,526  $   6,219  $    316
                                                                                     =========  =========  ========
Taxes paid.......................................................................... $     780  $     226  $    224
                                                                                     =========  =========  ========
Cash Flow for Acquisition of Subsidiaries
Tangible assets acquired (excluding $808 cash received in 2000).....................        --  $   1,597        --
Purchased in-process research and development.......................................        --         --        --
Goodwill and other intangible assets acquired.......................................        --     70,771        --
Acquisition costs incurred..........................................................        --     (2,300)       --
Liabilities assumed.................................................................        --     (1,039)       --
Deferred compensation assumed.......................................................        --      2,479        --
Common stock issued.................................................................        --    (34,642)       --
                                                                                                ---------
Cash paid for acquisition (net of $808 cash received in 2000).......................        --  $  36,866        --
                                                                                                =========
Supplemental Disclosure of Non-Cash Activity
Deferred compensation on restricted stock units..................................... $   7,933         --        --
                                                                                     =========
Reversal of deferred compensation on Proteome....................................... $  (1,324)        --        --
                                                                                     =========
 
  
Year Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
Cash flows from operating activities:
  
 
 
 
  
 
 
 
  
 
 
 
Net loss
  
$
(136,885
)
  
$
(183,235
)
  
$
(29,735
)
Adjustments to reconcile net loss to net cash used in operating activities:
  
 
 
 
  
 
 
 
  
 
 
 
Non-cash restructuring charges and impairment of long-lived assets
  
 
16,720
 
  
 
109,423
 
  
 
—  
 
Depreciation and amortization
  
 
23,206
 
  
 
46,410
 
  
 
34,330
 
Stock-based compensation
  
 
4,097
 
  
 
1,255
 
  
 
512
 
Gain on repurchase of convertible subordinated notes
  
 
(1,937
)
  
 
(2,386
)
  
 
(3,137
)
Compensation expense on executive loans
  
 
350
 
  
 
—  
 
  
 
—  
 
Cumulative effect of accounting change
  
 
—
 
  
 
(2,279
)
  
 
—  
 
(Gain) loss on derivative financial instruments, net
  
 
1,782
 
  
 
(553
)
  
 
—  
 
Impairment of long-term investments
  
 
9,734
 
  
 
14,665
 
  
 
1,033
 
Realized gain on long-term investments, net
  
 
(1,187
)
  
 
(2,505
)
  
 
(5,417
)
Loss on sale of assets
  
 
313
 
  
 
5,777
 
  
 
—  
 
Debt instruments and equity received in exchange for goods or services provided
  
 
(2,688
)
  
 
(8,100
)
  
 
(6,600
)
Losses from joint venture
  
 
—
 
  
 
—  
 
  
 
1,283
 
Changes in operating assets and liabilities:
  
 
 
 
  
 
 
 
  
 
 
 
Accounts receivable
  
 
45,553
 
  
 
(21,406
)
  
 
(8,414
)
Prepaid expenses and other assets
  
 
(10,061
)
  
 
(14,916
)
  
 
(19,824
)
Accounts payable
  
 
1,726
 
  
 
(10,150
)
  
 
10,816
 
Accrued and other current liabilities
  
 
3,394
 
  
 
19,557
 
  
 
14,912
 
Deferred revenue
  
 
(12,383
)
  
 
1,439
 
  
 
(3,703
)
 
  
  
  
Net cash used in operating activities
  
 
(58,266
)
  
 
(47,004
)
  
 
(13,944
)
 
  
  
  
Cash flows from investing activities:
  
 
 
 
  
 
 
 
  
 
 
 
Capital expenditures
  
 
(11,890
)
  
 
(12,919
)
  
 
(59,510
)
Purchase of long-term investments
  
 
(5,000
)
  
 
(28,019
)
  
 
(3,494
)
Proceeds from the sale of long-term investments
  
 
2,637
 
  
 
4,337
 
  
 
7,917
 
Purchase of subsidiary (net of cash received)
  
 
—
 
  
 
—  
 
  
 
(36,866
)
Purchases of marketable securities
  
 
(749,352
)
  
 
(888,366
)
  
 
(822,357
)
Sales of marketable securities
  
 
534,009
 
  
 
601,884
 
  
 
274,267
 
Maturities of marketable securities
  
 
271,974
 
  
 
297,226
 
  
 
112,950
 
Loans to executive officers
  
 
(1,150
)
  
 
—  
 
  
 
—  
 
Other
  
 
—  
 
  
 
300
 
  
 
—  
 
 
  
  
  
Net cash provided by (used in) investing activities
  
 
41,228
 
  
 
(25,557
)
  
 
(527,093
)
 
  
  
  
Cash flows from financing activities:
  
 
 
 
  
 
 
 
  
 
 
 
Proceeds from issuance of common stock under stock plans
  
 
7,182
 
  
 
11,268
 
  
 
31,297
 
Proceeds from private equity offering
  
 
—  
 
  
 
—  
 
  
 
403,355
 
Repurchase of common stock
  
 
(5,723
)
  
 
—  
 
  
 
—  
 
Proceeds from the issuance of Convertible Subordinated Notes
  
 
—  
 
  
 
—  
 
  
 
196,800
 
Repurchase of Convertible Subordinated Notes
  
 
(4,690
)
  
 
(5,643
)
  
 
(11,872
)
Principal payments on capital lease obligations and note payable
  
 
—  
 
  
 
—  
 
  
 
(480
)
Other
  
 
72
 
  
 
145
 
  
 
20
 
 
  
  
  
Net cash provided by (used in) financing activities
  
 
(3,159
)
  
 
5,770
 
  
 
619,120
 
 
  
  
  
Effect of exchange rate on cash and cash equivalents
  
 
(243
)
  
 
4
 
  
 
(148
)
Net increase (decrease) in cash and cash equivalents
  
 
(20,440
)
  
 
(66,787
)
  
 
77,935
 
Cash and cash equivalents at beginning of period
  
 
43,368
 
  
 
110,155
 
  
 
32,220
 
 
  
  
  
Cash and cash equivalents at end of period
  
$
22,928
 
  
$
43,368
 
  
$
110,155
 
 
  
  
  
Supplemental Schedule of Cash Flow Information
  
 
 
 
  
 
 
 
  
 
 
 
Interest paid
  
$
9,564
 
  
$
9,526
 
  
$
6,219
 
 
  
  
  
Taxes paid
  
$
1,000
 
  
$
780
 
  
$
226
 
 
  
  
  
Cash Flow for Acquisition of Subsidiaries
  
 
 
 
  
 
 
 
  
 
 
 
Tangible assets acquired (excluding $808 cash received in 2000)
  
$
—   
 
  
$
—   
 
  
$
1,597
 
Goodwill and other intangible assets acquired
  
 
—  
 
  
 
—  
 
  
 
70,771
 
Acquisition costs incurred
  
 
—  
 
  
 
—  
 
  
 
(2,300
)
Liabilities assumed
  
 
—  
 
  
 
—  
 
  
 
(1,039
)
Deferred compensation assumed
  
 
—  
 
  
 
—  
 
  
 
2,479
 
Common stock issued
  
 
—  
 
  
 
—  
 
  
 
(34,642
)
 
  
  
  
Cash paid for acquisition (net of $808 cash received in 2000)
  
$
—   
 
  
$
—   
 
  
$
36,866
 
 
  
  
  
Supplemental Disclosure of Non-Cash Activity
  
 
 
 
  
 
 
 
  
 
 
 
Deferred compensation on restricted stock units
  
$
—   
 
  
$
7,933
 
  
$
—   
 
 
  
  
  
Reversal of deferred compensation
  
$
(1,180
)
  
$
(1,324
)
  
$
—   
 
 
  
  
  
See accompanying notes

                                      45

52
INCYTE GENOMICS, INC.

                  CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1.     Organization and Summary of Significant Accounting Policies
Organization and Business.    Incyte Corporation (the “Company”), formerly Incyte Genomics, Inc. (the "Company"), was incorporated in Delaware in April 1991 under1991. In March 2003, the name Incyte Pharmaceuticals,
Inc. In June 2000, the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation to change the Company'sCompany changed its name to Incyte Genomics, Inc.Corporation. The Company is a drug discovery company that develops proprietary genomic information and applies its expertise in medicinal chemistry and molecular, cellular and in vivo biology to the discovery of novel small molecule and protein therapeutics. The Company believes it has created the largest commercial portfolio of issued United States patents covering human, full-length genes and the proteins they encode, and antibodies they encode. The Company intends to leverage its leadinglicenses this intellectual property, as well as markets this genomic and genomicproteomic information, position to be a leader in
therapeutic small molecule, secreted protein and antibody discoveries. In
addition, the Company has also developed a leading integrated platform of
genomic technologies designed to aid in the understandingmany of the molecular
basis of disease. These technologies primarily consist of genomic databases and
pharmaceutically relevant intellectual property licenses, which helpworld’s leading pharmaceutical and biotechnology researchers in their therapeuticcompanies and academic research centers. The Company has assembled an experienced and talented drug discovery and
development efforts. These efforts include gene discovery, understanding
disease pathways,team that is identifying potential new disease targets and the discovery and
correlation of gene sequence variation to disease.

   During 2001, the Company increased its focus on its therapeutic discovery
and development programs and its information products and services, which
includes licensing a portion of its intellectual property. As a result, the
Company exited the following activities: microarray-related products and
services, genomic screening products and services, public domain clone products
and related services, contract sequencing services, transgenics products and
services and SNP discovery services. As a part of the exit of these activities,
the Company closed certain of its facilities in Fremont, California; St. Louis,
Missouri and Cambridge, England. In addition to the product lines exited, it
made infrastructuredrug therapies for cancer, inflammatory diseases and other personnel reductions at its other locations,
resulting in an aggregate workforce reduction of approximately 400 employees.

   medical conditions.
Principles of Consolidation.    The consolidated financial statements include the accounts of Incyte Genomics, Inc.,Corporation and its wholly owned subsidiaries. All material intercompany accounts, transactions, and profits have been eliminated in consolidation.
Reclassifications.    Certain amounts reported in previous years have been reclassified to conform to 20012002 financial statement 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.date, as appropriate. The resultant translation adjustments are included in the accumulated other comprehensive income (loss), a separate component of stockholders'stockholders’ equity. Income and expense items are translated at average monthly rates of exchange.
Concentrations of Credit Risk.    Cash, cash equivalents, short-term investments, trade receivables, and long-term strategic investments 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'sCompany’s customers are primarily pharmaceutical and biotechnology companies which are typically located in the United States and Europe. The Company has not experienced any 46



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

significant credit losses on cash, cash equivalents, short-term investments or trade receivables to date and does not require collateral on receivables. The Company'sCompany’s long-term investments represent equity and debt investments in a number of companies whose businesses may be complementary to the Company'sCompany’s business. The Company routinely evaluates the long-term investments quarterly for impairment.impairment and such evaluations require significant management judgment. The Company records an investment impairment charge when it believes that the investment has experienced a decline in value that is other than temporary. The determination of whether an impairment is other than temporary consists of a review of qualitative and quantitative factors by members of senior management. Generally, declines that persist for six months or more are considered other than temporary. The Company uses the best information available in these assessments, however, the information available may be limited. These determinations involve significant management judgment, and actual amounts realized for any specific investment may differ from the recorded values. Future adverse changes in market conditions, poor
53
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
operating results of underlying investments, or company valuations being lowered due to future financing or other specific activity within such company, could result in additional impairment charges. The activity on discrete investments within the Company’s portfolio, in any given quarter, may result in gains or losses on sales or impairment charges. For the years ended December 31, 2002, 2001 and 2000, the Company recognized impairment charges related to long-term investments of $9.8 million, $14.7 million and $1.0 million, respectively. (SeeLong-Term Investments)

   Investments)
Cash and Cash Equivalents.    Cash and cash equivalents are held in U.SU.S. banks or in custodial accounts with U.S., U.K. and U.K.Japan 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.
Marketable Securities--Available-for-Sale.Securities—Available-for-Sale.    All marketable securities are classified as available-for-sale. Available-for-sale securities are carried at fair value, based on quoted market prices, with unrealized gains and losses reported as a separate component of stockholders'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 income/expense. The cost of securities sold is based on the specific identification method.
The following is a summary of the Company'sCompany’s marketable security portfolio including cash equivalents of $35,415,000$22.2 million and $69,330,000$35.4 million as of December 31, 2002 and 2001, and 2000, respectively.

                                                         Net
                                          Amortized   Unrealized   Estimated
                                            Cost    Gains (Losses) Fair Value
                                          --------- -------------- ----------
                                                    (in thousands)
  
  December 31, 2001
  U.S. Treasury notes and other U.S.
    government and agency securities..... $131,086     $   533      $131,619
  Corporate debt securities..............  363,764       4,567       368,331
  Long term equity investments...........    4,947       4,602         9,549
                                          --------     -------      --------
                                          $499,797     $ 9,702      $509,499
                                          ========     =======      ========

  December 31, 2000
  U.S. Treasury notes and other U.S.
    government and agency securities..... $173,614     $   226      $173,840
  Corporate debt securities..............  365,896       1,619       367,515
  Long term equity investments...........    5,761      19,783        25,544
                                          --------     -------      --------
                                          $545,271     $21,628      $566,899
                                          ========     =======      ========
 
  
Amortized Cost
    
Net Unrealized Gains (Losses)
  
Estimated Fair Value
 
  
(in thousands)
December 31, 2002
  
 
 
    
 
 
  
 
 
U.S. Treasury notes and other U.S. government and agency securities
  
$
146,314
    
$
1,589
  
$
147,903
Corporate debt securities
  
 
278,684
    
 
1,696
  
 
280,380
Long term equity investments
  
 
1,381
    
 
124
  
 
1,505
 
  
    
  
 
  
$
426,379
    
$
3,409
  
$
429,788
 
  
    
  
December 31, 2001
  
 
 
    
 
 
  
 
 
U.S. Treasury notes and other U.S. government and agency securities
  
$
131,086
    
$
533
  
$
131,619
Corporate debt securities
  
 
363,764
    
 
4,567
  
 
368,331
Long term equity investments
  
 
4,947
    
 
4,602
  
 
9,549
 
  
    
  
 
  
$
499,797
    
$
9,702
  
$
509,499
 
  
    
  
54
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
At December 31, 20012002 and 2000,2001, all of the Company'sCompany’s debt 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. Unrealized losses were not material and have therefore been netted against unrealized gains. At December 31, 2001,2002, the Company'sCompany’s debt marketable securities had the following maturities:

                                                          Amortized Estimated
                                                            Cost    Fair Value
                                                          --------- ----------
                                                             (in thousands)
  
  Less than one year..................................... $296,872   $299,009
  Between one and two years..............................  178,164    181,020
  Between two and three years............................   19,814     19,921
                                                          --------   --------
                                                          $494,850   $499,950
                                                          ========   ========


                                      47



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   
 
  
Amortized
Cost
  
Estimated Fair Value
 
  
(in thousands)
Less than one year
  
$
260,243
  
$
261,954
Between one and two years
  
 
146,800
  
 
148,239
Between two and three years
  
 
17,955
  
 
18,090
 
  
  
 
  
$
424,998
  
$
428,283
 
  
  
Net realized gains of $1,993,000, $172,000$1.4 million, $2.0 million and $272,000$0.2 million from sales of marketable securities were included in "interest“interest and other income/expense, net"net” in 2002, 2001 and 2000, and 1999, respectively.
Accounts Receivable.    Accounts receivable at December 31, 20012002 and 20002001 included an allowance for doubtful accounts of $2,101,000$0.5 million and $356,000,$2.1 million, respectively, with a portion of the allowance reflecting reserves for activities exited in the restructure.

   2001 restructuring.
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 three 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,
                                                        ------------------
                                                          2001      2000
                                                        --------  --------
                                                          (in thousands)
    
    Office equipment................................... $  4,944  $  5,308
    Laboratory equipment...............................   21,149    32,286
    Computer equipment.................................   75,906    93,136
    Leasehold improvements.............................   33,433    48,924
                                                        --------  --------
                                                         135,432   179,654
    Less accumulated depreciation and amortization.....  (87,505)  (80,706)
                                                        --------  --------
                                                        $ 47,927  $ 98,948
                                                        ========  ========
 
  
December 31,
 
 
  
2002
 
  
2001
 
 
  
(in thousands)
 
Office equipment
  
$
4,968
 
  
$
4,944
 
Laboratory equipment
  
 
24,489
 
  
 
21,149
 
Computer equipment
  
 
70,817
 
  
 
75,906
 
Leasehold improvements
  
 
31,010
 
  
 
33,433
 
 
  
  
 
  
 
131,284
 
  
 
135,432
 
Less accumulated depreciation and amortization
  
 
(99,497
)
  
 
(87,505
)
 
  
  
 
  
$
31,787
 
  
$
47,927
 
 
  
  
Depreciation expense, including amortization expense of assets under capital leases and leasehold improvements, was $31,240,000, $28,922,000$19.1 million, $31.2 million and $21,849,000$28.9 million for 2002, 2001 and 2000, and 1999, 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.
55
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Valuation of Long-Lived Assets.    Long-lived assets, including certain identifiable intangible assets and goodwill, to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable such as a significant industry downturn or a significant decline in the market value of the Company. Determination of recoverability is based on an estimate of undiscounted cash flows resulting from the use of the asset and its eventual disposition. Measurement of impairment charges for long-lived assets and certain identifiable intangible assets including goodwill relating to those assets that management expects to hold and use are based on the fair value of such assets. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
Long-Term Investments.    The Company has made equity and debt investments in a number of companies whose businesses may be complementary to the Company'sCompany’s business. The Company accounts for its investments for which the shares are freely tradable or become freely tradable within one year of the balance sheet date in 48



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

accordance with Financial Accounting Standard Board ("FASB"(“FASB”) Statement No. 115,Accounting for CertainInvestments in Debt and Equity Securities ("(“SFAS 115"115”), with unrealized gains and losses being reported in accumulated other comprehensive income (loss) as a separate component of stockholders'stockholders’ equity. In all other cases, the cost method of accounting is used. The Company owns less than 20% of the outstanding voting stock of each long-term investment, and does not have the ability to exert significant influence over these investments.
Derivative Financial Instruments.  In June 1998,    The Company holds warrants to purchase equity securities of other companies. Warrants that can be exercised and settled by delivery of net shares such that the Company pays no cash upon exercise or that are held in public companies are deemed derivative financial instruments. Gains and losses resulting from changes in fair value are recognized on the consolidated statement of operations, “Gain (loss) on certain derivative financial instruments” in the period of change. The Company determines the fair value of its warrants through option pricing models using current market price and volatility assumptions. The Company adopted FASB issued Statement No. 133,Accounting for Derivative Financial Instruments and Hedging Activities ("(“SFAS 133"133”), as amended by SFAS Nos. 137 and 138. SFAS 133 established standards for
accounting and reporting derivative instruments and hedging activities. It
requires companies to recognize all derivatives as either assets or liabilities
on the balance sheet and measure these instruments at fair value. Derivatives
that are not designated as hedges must be adjusted to fair value through the
Statement of Operations. The Company adopted SFAS 133 on January 1, 2001 and recorded a $2.3 million cumulative gain, or $0.03 per share, relating to the valuation of warrants held in other companies, which is recorded in the consolidated statements of operations as a cumulative effect of accounting change. The Company also recorded a gain of $0.6 million during the year ended
December 31, 2001 related to the increase in value of the same instruments
subject to SFAS 133. The asset balances are included in long-term investments.
Joint Venture.    In September 1997, the Company formed a joint venture, diaDexus, LLC, with SmithKline Beecham Corporation ("SB"(“SB”), to utilize genomic and bioinformatic technologies in the discovery and commercialization of molecular diagnostics. The Company and SB each held a 50 percent equity interest in diaDexus and the Company accounted for the investment under the equity method. On April 4, 2000, diaDexus converted from an LLC to a corporation and completed a private equity financing, at which time the Company no longer had significant influence over diaDexus. Accordingly, the Company began accounting for its investment in diaDexus under the cost method of accounting as of the date of the financing. (SeeNote 11)12).
Other Intangible Assets.    In July 2001, the FASB issued Statement No. 142,Goodwill and Other Intangible Assets.Assets (“SFAS 142”). SFAS 142 requires, among other things, the discontinuance of goodwill amortization and includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, and reclassification of certain intangibles out of previously reported goodwill. The adoption of this statement on January 1, 2002 did not have a material impact on the Company’s consolidated financial statements; however, it requires disclosure of the effect of the application of SFAS 142 on all periods presented as if the adoption of the statement occurred as of January 1, 2000. The
56
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
reconciliation of reported net income (loss) for the adoption of SFAS 142 is as follows (in thousands, except per share amounts):
 
  
For the Year Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
Reported loss before accounting change
  
$
(136,855
)
  
$
(185,514
)
  
$
(29,735
)
Add back: Goodwill amortization
  
 
—
 
  
 
6,938
 
  
 
2,030
 
Add back: Assembled workforce amortization
  
 
—
 
  
 
540
 
  
 
115
 
 
  
  
  
Adjusted loss before accounting change
  
$
(136,855
)
  
$
(178,036
)
  
$
(27,590
)
 
  
  
  
Reported net loss
  
$
(136,855
)
  
$
(183,235
)
  
$
(29,735
)
Add back: Goodwill amortization
  
 
—
 
  
 
6,938
 
  
 
2,030
 
Add back: Assembled workforce amortization
  
 
—
 
  
 
540
 
  
 
115
 
 
  
  
  
Adjusted net loss
  
$
(136,855
)
  
$
(175,757
)
  
$
(27,590
)
 
  
  
  
Basic and diluted net loss per share:
  
 
 
 
  
 
 
 
  
 
 
 
Reported loss before accounting change
  
$
(2.03
)
  
$
(2.80
)
  
$
(0.47
)
Goodwill amortization
  
 
—
 
  
 
0.10
 
  
 
0.03
 
Assembled workforce amortization
  
 
—
 
  
 
0.01
 
  
 
—
 
 
  
  
  
Adjusted loss before accounting change
  
$
(2.03
)
  
$
(2.69
)
  
$
(0.44
)
 
  
  
  
Reported net loss
  
$
(2.03
)
  
$
(2.77
)
  
$
(0.47
)
Goodwill amortization
  
 
—
 
  
 
0.10
 
  
 
0.03
 
Assembled workforce amortization
  
 
—
 
  
 
0.01
 
  
 
—
 
 
  
  
  
Adjusted net loss
  
$
(2.03
)
  
$
(2.66
)
  
$
(0.44
)
 
  
  
  
The Intangible and other assets, represent purchasednet totaling $26.1 million and $21.1 million at December 31, 2002 and 2001, respectively, consist of $20.1 million and $15.8 million of other intangibles, net at December 31, 2002 and 2001, respectively and $6.0 million and $5.3 million of other assets at December 31, 2002 and 2001, respectively. Other intangible assets consist of the following (in thousands):
 
  
December 31, 2002
  
December 31, 2001
 
  
Gross Carrying Amount
  
Accumulated Amortization
 
  
Other Intangibles, Net
  
Gross Carrying Amount
  
Accumulated Amortization
 
  
Other Intangibles, Net
Capitalized patents
  
$
14,465
  
$
(1,582
)
  
$
12,883
  
$
7,404
  
$
(478
)
  
$
6,926
Capitalized software
  
 
7,638
  
 
(2,797
)
  
 
4,841
  
 
6,736
  
 
(748
)
  
 
5,988
Acquired database technology
  
 
2,638
  
 
(429
)
  
 
2,209
  
 
2,638
  
 
(61
)
  
 
2,577
Other intangibles
  
 
362
  
 
(171
)
  
 
191
  
 
362
  
 
(25
)
  
 
337
 
  
  
  
  
  
  
Total
  
$
25,103
  
$
(4,979
)
  
$
20,124
  
$
17,140
  
$
(1,312
)
  
$
15,828
 
  
  
  
  
  
  
Costs of patents and the excess acquisition costpatent applications are capitalized and amortized on a straight-line basis over the fair valuetheir estimated usefully lives of tangible and identified intangible assets of businesses acquired (goodwill).
Purchased intangible assets include developed technology, database, tradename
and assembled workforce. Intangible assets are being amortized using the
straight-line method over estimated useful lives ranging from 3 to 8 years. At
December 31, 2001 and 2000, accumulated amortization was $8,064,000 and
$5,380,000, respectively. See Note 14 for a discussion of impairment charges
recognizedapproximately 10 years in 2001.

   Software Costs.  In accordance with the provisions of Accounting Principles Board Opinion No. 17,Intangible Assets (“APB 17”). Capitalized software costs, which consist of software development costs incurred in developing certain products once the technological feasibility of the products has been determined, are recorded in accordance with FASB Statement No. 86,Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed ("(“SFAS 86"86”), and are amortized on a straight-line basis over the Company has capitalized software
development costs incurredestimated useful life of 3 years. Acquired database technology and other intangible assets recorded in developing certain products once technological
feasibilityconjunction with the acquisition of Proteome, Inc. are being amortized using the products has been determined. At December 31, 2001 and 2000,
capitalized software was $5,988,000 and $8,166,000, respectively, net of
accumulated amortization of $748,000 and $9,785,000, respectively.straight-line method over
57
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
estimated useful lives ranging from 3 to 8 years. Amortization expense was $4,327,000; $4,799,000; and $3,418,000 for the years ended December 31, 2002, 2001 and 2000 related to other intangibles, including goodwill, was $3.7 million, $14.8 million and 1999,$7.3 million, respectively.
The expected future annual amortization expense of other intangible assets is as follows (in thousands):
Year ended December 31,
  
Amortization Expense
 
  
(in thousands)
2003
  
$
3,942
2004
  
 
3,917
2005
  
 
2,731
2006
  
 
1,974
2007
  
 
1,876
Thereafter
  
 
5,684
 
  
Total future amortization expense
  
$
20,124
 
  
See Note 1415 for a discussion of impairment charges recognized in 2001.

   Patent Costs.  In accordance with the provisions of the Accounting
Principles Board Opinion No. 17, Intangible Assets ("APB 17"), the Company has
capitalized direct costs incurred in preparing, filing and maintaining patent
applications. At December 31, 2001 and 2000, capitalized patents were
$6,926,000 and $1,340,000, respectively, net of accumulated amortization of
$478,000 and $78,000, respectively. Amortization expense was $400,000; $78,000;
and $0 for the years ended December 31, 2001, 2000 and 1999, respectively.

   
Internal Use Software.    The Company accounts for software developed or obtained for internal use in accordance with Statement of Position 98-1Accounting for the Costs of Computer Software Developed or 49



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Obtained for Internal Use ("(“SOP 98-1"98-1”). The statement requires capitalization of certain costs incurred in the development of internal-use software, including external direct material and service costs, employee payroll and payroll related costs. Capitalized software costs, which are included in property and equipment, are depreciated over three to five years.
Royalties Payable.    Royalties payable arise from the sublicense of third party patents. These costs are accrued and matched with revenue recognition in the period of the recording of revenue. The amount accrued at December 31, 2001
reflects increased2002 arises from the sale of information products and services sales in 2001.

   for which we owe royalties to third parties.
Accumulated Other Comprehensive Income.Income.    Accumulated Other Comprehensive Income consists of the following:

                                                           December 31,
                                                         ---------------
                                                          2001    2000
                                                         ------  -------
                                                          (in thousands)
       
       Unrealized gains on marketable securities........ $9,702  $21,628
       Cumulative translation adjustment................   (712)    (715)
                                                         ------  -------
                                                         $8,990  $20,913
                                                         ======  =======
 
  
December 31,
 
 
  
2002
 
  
2001
 
 
  
(in thousands)
 
Unrealized gains on marketable securities
  
$
3,409
 
  
$
9,702
 
Cumulative translation adjustment
  
 
(955
)
  
 
(712
)
 
  
  
 
  
$
2,454
 
  
$
8,990
 
 
  
  
Revenue Recognition.    Revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. The Company enters into various types of agreements for access to its databases of information, use of its intellectual property and sales of its custom genomics products and services. Revenue isRevenues are deferred for fees received before earned or until no further obligations exist.

   Revenue
Revenues from ongoing database agreements are recognized evenly over the access period. RevenueRevenues from licenses to the Company'sCompany’s intellectual property are recognized when earned under the terms of the related agreements. Royalty revenues are recognized upon the sale of the products or services to third parties by the licensee or other agreed upon terms.
58
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Revenues from custom products, such as clones and datasets, are recognized upon completion and delivery. Revenues from custom services are recognized upon completion of contract deliverables. RevenueRevenues from gene expression microarray services includes: technology access fees, which are recognized ratably over the access term, and progress payments, which are recognized at the completion of key stages in the performance of the service in proportion to the costs incurred.
Revenues recognized from multiple element contracts are allocated to each element of the arrangement based on the relative fair values of the elements. The determination of fair value of each element is based on objective evidence from historical sales of the individual element by usthe Company to other customers. If such evidence of fair value for each element of the arrangement does not exist, all revenuerevenues from the arrangement isare deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered. In accordance with Staff Accounting Bulletin No. 101 (“SAB 101,101”), when elements are specifically tied to a separate earnings process, revenue isrevenues are recognized when the specific performance obligation associated with the element is completed. When revenues for an element are not specifically tied to a separate earnings process they are recognized ratably over the term of the agreement.
When contracts include non-monetary exchanges,payments, the value of the non-monetary transaction is determined using the fair value of the products and services involved, as applicable. For non-monetary payments involving the receipt of equity in a public entity, the fair value is based on the traded stock price on the date revenue is earned. For non-monetary payments involving the receipt of equity in a privately-held company, fair value is determined either based on a current or recent arm’s length financing by the issuer or upon an independent valuation of the issuer.
Revenues received from agreements in which collaboratorscustomers paid with equity or debt instruments in their company were $7.8$2.4 million, $8.1 million and $6.6 million infor the years ended December 31, 2002, 2001 and 2000, respectively. Additionally, revenues received

                                      50



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) from agreements in which the Company concurrently invested funds in the collaborator'scustomer’s stock were $0.7 million, $14.1 million and $6.4 million infor the years ended December 31, 2002, 2001 and 2000, respectively. We did not have similar transactions
Revenues recognized from agreements executed prior to 2002 in 1999.

   We alsowhich a concurrent commitment was entered into transactions in which we recognized revenues ofby the Company to purchase goods or services from the other party for the years ended December 31, 2002, 2001 and 2000 were $4.0 million, $24.7 million and $6.7 million, respectively. No transactions in 2001 and 2000, respectively, with certain
customers from whom we concurrently committedwhich there was a concurrent commitment by the Company to purchase goods or services of
$47.4were entered into during the year ended December 31, 2002. Of commitments made in prior periods, the Company expensed $22.0 million, $18.7 million and $12.4$1.3 million infor the years ended December 31, 2002, 2001 and 2000, respectively. Of such
amounts, we expensed $18.3 million and $1.3 million in 2001 and 2000,
respectively. We did not have similar transactions in 1999.

   
The above transactions were recorded at fair value in accordance with the Company'sCompany’s revenue recognition policy.
Research and Development.    Research and development costs are charged to operations as incurred.
Stock-Based Compensation.    In accordance with the provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation (“SFAS 123”), the Company has elected to continue applying the provisions APB Opinion No. 25,Accounting for Stock Issued to Employees ("(“APB 25"25”),as amended by FASB Interpretation No. 44,Accounting for Certain Transactions Involving Stock Compensation ("(“FIN 44"44”), in accounting for its stock-based compensation plans. Accordingly, the Company does not recognize compensation expense for stock options granted to employees and directors when the stock option price at the grant date is equal to or greater than the fair market value of the stock at that date.
59
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The fair value of each option and employee purchase right was estimated at the date of grant using a Black-Scholes option-pricing model, assuming no expected dividends and the following weighted average assumptions:
 
  
Employee Stock Options
 
  
Employee Stock Purchase Plan
 
 
  
For the Years Ended December 31,
 
  
For the Years Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
  
2002
 
  
2001
 
  
2000
 
Average risk-free interest rates
  
2.77
%
  
4.25
%
  
6.26
%
  
1.80
%
  
4.41
%
  
5.89
%
Average expected life (in years)
  
3.31
 
  
3.46
 
  
3.04
 
  
0.50
 
  
0.50
 
  
0.50
 
Volatility
  
89
%
  
86
%
  
92
%
  
84
%
  
98
%
  
76
%
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The following illustrates the pro forma effect on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS 123:
 
  
For the Years Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
 
  
(in thousands, except per share amounts)
 
Net loss, as reported
  
$
(136,885
)
  
$
(183,235
)
  
$
(29,735
)
Add: Stock-based compensation, as reported
  
 
4,169
 
  
 
1,405
 
  
 
336
 
Deduct: Total stock-based compensation determined under the fair value based method for all awards
  
 
(21,284
)
  
 
(20,160
)
  
 
(21,101
)
 
  
  
  
Pro forma net loss, SFAS 123 adjusted
  
$
(154,000
)
  
$
(201,990
)
  
$
(50,500
)
 
  
  
  
Basic and diluted net loss per share—as reported
  
$
(2.03
)
  
$
(2.77
)
  
$
(0.47
)
Basic and diluted net loss per share—SFAS 123 adjusted
  
$
(2.28
)
  
$
(3.05
)
  
$
(0.80
)
The weighted average fair value of stock awards (including restricted stock units) granted during 2002, 2001 and 2000 was $4.40, $10.56 and $28.30 per share, respectively. The average fair value of the employees’ purchase rights under the Employee Stock Purchase Plan during 2002, 2001 and 2000 is estimated at $4.08, $8.34 and $6.67, respectively, on the date of grant using the Black-Scholes multiple-options pricing model.
The Company also records, and amortizes over the related vesting periods, deferred compensation representing the difference between the price per share of stock issued or the exercise price of stock options granted and the fair value of the Company'sCompany’s common stock at the time of issuance or grant.
Advertising Costs.    All costs associated with advertising products are expensed in the year incurred. Advertising expense for the years ended December 31, 2002, 2001 and 2000, was $0.3 million, $1.4 million and 1999, was $1,423,000, $2,482,000 and $1,051,000,$2.5 million, respectively.

   New Pronouncements.
Pronouncements Adopted in 2002.    In July 2001,April 2002, the FASB issued Statement No. 142,
Goodwill145,Rescission of FASB Statements No. 4, 44, and Other Intangible Assets ("64, Amendment of FASB Statement No. 13, and Technical Corrections (“SFAS
60
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
145”). By rescinding FASB Statement No. 4,Reporting Gains and Losses from Extinguishment of Debt (“SFAS 142"4”)., the FASB eliminated the requirement to classify gains and losses from extinguishment of debt as extraordinary items. SFAS 142 requires, among
other things,145 indicates that these gains and losses should only be classified as extraordinary if they meet the discontinuance of goodwill amortization and includes
provisions for the reclassification of certain existing recognized intangibles
as goodwill, reassessment of the useful lives of existing recognized
intangibles, and reclassification of certain intangibles out of previously
reported goodwill.criteria in APB Opinion No. 30. The adoption of thisthe statement on JanuaryApril 1, 2002 will not
have a material impactcaused the Company to change its classification of all gains and losses from the repurchase of its convertible subordinated notes from “Extraordinary Gain” to “Gain on the Company's consolidated financial statements.

   repurchase of convertible subordinated notes,” which is an element of “Other Income”.
In October 2001, the FASB issued Statement No. 144,Accounting for the Impairment of Long-Lived Assets (" (“SFAS 144"144”). The FASB'sFASB’s new rules on asset impairment supersede FASB Statement No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, and portions of APB Opinion No. 30, Reporting the Results of Operations. SFAS 144 provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. SFAS 144 also requires expected future operating losses from discontinued operations to be displayed in the period in which the losses are incurred, rather than as of the measurement date as presently required. The adoption of this statement on January 1, 2002 caused the Company to change its classification of all gains and losses on fixed asset disposition from a component of “Interest and other income, net” to a component of operating expenses.
New Pronouncements.    In August 2002, the FASB issued Statement No. 146,Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”). SFAS 146 supersedes EITF Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (“EITF 94-3”). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Additionally, SFAS 146 establishes that fair value is the objective for initial measurement of the liability. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of the statement on January 1, 2003 will not impact the Company’s consolidated financial statements through December 31, 2002.
In December 2002, the FASB issued Statement No. 148,Accounting for Stock-Based Compensation—Transition and Disclosure (“SFAS 148”). SFAS 148 amends FASB Statement No. 123,Accounting for Stock-Based Compensation (“SFAS 123”) to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 to require more prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. SFAS 148 also amends APB Opinion No. 28,Interim Financial Reporting (“APB 28”) to require disclosure about the net income effects in interim financial information. The provisions of this statement are effective for financial statements for fiscal years ending after December 15, 2002. The disclosure provisions of this statement have been included in the Company’s 2002 notes to consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of Others, (“FIN 45”). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including residual value guarantees issued in conjunction with operating lease agreements. It also clarifies that at the time a materialcompany issues a guarantee, the company must recognize an initial liability for the fair value of the obligation it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have an impact on the Company'sCompany’s results of operations or financial position.
61
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
In November 2002, the Emerging Issues Task Force (“EITF”) issued a consensus on Issue No. 00-21,Revenue Arrangements with Multiple Deliverables (“EITF Issue No. 00-21”). EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We are currently evaluating the effect that the adoption of EITF Issue No. 00-21 will have on our results of operations and financial position.
In January 2003, the FASB issued Interpretation No. 46,Consolidation of Variable Interest Entities (“FIN 46”). The objective of FIN 46 is to improve financial reporting by companies involved with variable interest entities by requiring the variable interest entity to be consolidated financial statements.

by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. The Company believes that none of its investments qualify as entities that require consolidation under FIN 46 and will adopt this Interpretation in the third quarter of fiscal year 2003.
Note 2.    Information Product and Service Agreements

   Concentrations of Credit Risk
As of December 31, 2001,2002, the Company had entered into agreements for information products and services, which includes licensing a portion of the Company'sCompany’s intellectual property, with over fifty100 pharmaceutical, biotechnology and agricultural companies and academic institutions. Over 96%, 79% and 75% of revenues in 2002, 2001 and 2000, respectively, were derived from such agreements. In general, collaborators agree to pay, during the term of the agreement, fees to receive non-exclusive access to selected modules of the Company'sCompany’s databases and/or

                                      51



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) licenses of certain of its intellectual property. In addition, if a collaborator develops certain products utilizing the Company'sCompany’s technology andor proprietary database information, royalty payments could potentially be received by the Company.
One collaboratorcustomer contributed 11% of total revenues infor the year ended December 31, 2000. No customer contributed 10% or more of revenues for the years ended December 31, 2002 or 2001.
Three customers comprised 45% of the accounts receivable balance at December 31, 2002. Three customers comprised 48% of the accounts receivable balance at December 31, 2001.
One long-term strategic investment comprised 42% of the total revenuesstrategic investments balance at December 31, 2002. Three investments comprised 51% of the total strategic investments balance at December 31, 2001. The activity on discrete investments within the Company’s portfolio, in 2001any given quarter, may result in gains or 1999.

losses on sales or impairment charges.
Note 3.    Commitments
At December 31, 2001,2002, the Company had noncancelable operating leases on multiple facilities and equipment, including facilities in Palo Alto, and
Fremont, California; Newark, Delaware; St. Louis, Missouri; Beverly, Massachusetts; and Cambridge, England. Effective January 30, 2002, the Company assigned its lease
obligation for the Fremont facility to another party. The leases expire on various dates ranging from November 2002May 2003 to March 2011. Certain leases have renewal options for periods ranging up to 5 years. Rent expense, excluding rent expense recognized in the restructuring charges, for the years ended December 31, 2002, 2001 2000 and 1999,2000, was approximately $13,081,000,
$12,696,000$11.6 million, $13.1 million and $8,674,000.

   $12.7 million.
62
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
At December 31, 2001,2002, future noncancelable minimum payments under the
operating leases, including leases for sites included in the restructuring programs, were as follows:

                                                       Operating
                                                         Leases
                                                     --------------
            Year ended December 31,
            -----------------------                  (in thousands)
            
               2002.................................    $15,799
               2003.................................     13,884
               2004.................................      9,827
               2005.................................      9,118
               2006.................................      8,310
               Thereafter...........................     32,953
                                                        -------
                   Total minimum lease payments.....    $89,891
                                                        =======
Year ended December 31,
    
Operating Leases
 
    
(in thousands)
2003
    
$
15,196
2004
    
 
10,151
2005
    
 
9,169
2006
    
 
8,318
2007
    
 
7,573
Thereafter
    
 
24,902
 
    
Total minimum lease payments
    
$
75,309
 
    
The Company also has purchase commitments of $25.0$11.3 million at December 31, 2001,2002, the timing of which is dependent upon provision by the vendor of products or services. Additionally, the Company has committed to purchase equity in certain companies when certain events occur. The total amount committed is $15.0$5.0 million. These commitments are considered contingent commitments as a future event must occur in order to cause the commitment to be enforceable.
Note 4.    Other assets
In January 2002, in connection with his employment by the Company as President and Chief Scientific Officer, Robert B. Stein received an interest-free loan from the Company in the amount of $750,000 to be used toward the purchase of a residence in California. The loan is evidenced by a promissory note and secured by the residence. On November 26, 2004, 50% of the outstanding principal balance will be forgiven, and the remaining outstanding principal balance of the loan will be forgiven on November 26, 2005, if Dr. Stein is still employed by the Company on those dates. Any acceleration of the loan or termination of Dr. Stein’s employment relationship with the Company prior to the then-applicable forgiveness date will terminate and void any remaining right of Dr. Stein to receive any forgiveness of the then-outstanding principal balance of the loan.
In March 2002, in connection with his employment by the Company as Executive Vice President and Chief Drug Discovery Scientist, Brian W. Metcalf received an interest-free loan from the Company in the amount of $400,000 to be used for financing his residence in California. The loan is evidenced by a promissory note and secured by the residence. On February 6, 2003, 25% of the outstanding principal balance will be forgiven, and 1/48 of the principal amount will be forgiven on the last day of each month thereafter, with the remaining outstanding principal balance of the loan forgiven on February 6, 2006, if Dr. Metcalf is still employed by the Company on those dates. Any acceleration of the loan or termination of Dr. Metcalf’s employment relationship with the Company prior to the then-applicable forgiveness date will terminate and void any remaining right of Dr. Metcalf to receive any forgiveness of the then-outstanding principal balance of the loan.
The Company amortizes these loans on a straight-line basis over the forgiveness periods. Compensation expense related to this amortization was $0.4 million for the year ended December 31, 2002.
Note 5.    Convertible Subordinated Notes
In February 2000, in a private placement, the Company issued $200.0 million of convertible subordinated notes, which resulted in net proceeds of approximately $196.8 million. The notes bear interest at 5.5%, payable semi-annually on February 1 and August 1, and are due February 1, 2007. The notes are subordinated to all senior indebtedness, as
63
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
defined. The notes can be converted at the option of the holder at an initial conversion price of $67.42 per share, subject to adjustment. The Company may, at its option, redeem the notes at any time before February 7, 2003, but only if the Company'sCompany’s stock price exceeds 150% of the conversion price for 20 trading days in a period of 30 consecutive trading days. On or after February 7, 2003 the Company may, at its option, redeem the notes at specific prices. Holders may require the Company to repurchase the notes upon a change in control, as defined. As of December 31, 2001, the fair
value of the notes was approximately $135.0 million based upon trading prices
on the over-the-counter market.

                                      52



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   In November 2000, the
The Company repurchased on the open market, and retired, $6.7 million, $8.0 million and $15.0 million in parface value of convertible subordinated notes during the years ended December 31, 2002, 2001 and 2000, respectively. Gains of $1.9 million, $2.4 million and $3.1 million on these transactions were recognized for the years ended December 31, 2002, 2001 and 2000, respectively. As of December 31, 2002, the Company had repurchased $29.7 million face value of the convertible subordinated notes. The Company
recognized a gain of $3.1 million on the transactions, which was reported as an
extraordinary item. In 2001, the Company repurchasednotes on the open market, and
retired, $8.0 million in par valuemarket. All gains on repurchase of the convertible subordinated notes. The
Company recognized a gainnotes are presented as “Gain on repurchase of $2.4 million on the transactions, which was
reported as an extraordinary item in fiscal 2001.

convertible subordinated notes.”
Note 5.  Stockholders'6.    Stockholders’ Equity
Common Stock.    At December 31, 2001,2002, the Company had reserved a total of 17,058,92118,608,165 shares of its common stock for issuance upon exercise of outstanding and available for issuance stock options and purchases under the Employee Stock Purchase Plan described below and the conversion of the convertible subordinated notes described in Note 7.5. In July 2000, the Company'sCompany’s Board of Directors authorized a two-for-one stock split effected in the form of a stock dividend paid on August 31, 2000 to holders of record on August 7, 2000. All share and per share data have been adjusted retroactively to reflect the split.
On June 6, 2000, the Company'sCompany’s stockholders approved an increase in the number of shares authorized for issuance from 75,000,000 to 200,000,000.
In October 2002, the Company announced that its board of directors authorized the expenditure of up to $30 million to repurchase shares of the Company’s common stock in open market and privately negotiated transactions. Through December 31, 2002, the Company repurchased, and retired, 1,135,000 shares for an aggregate purchase price of $5.7 million.
Preferred Stock.    The Company is authorized to issue 5,000,000 shares of preferred stock, none of which was outstanding at December 31, 20012002 or 2000.2001. The Board of Directors may determine the rights, preferences and privileges of any preferred stock issued in the future. The Company has reserved 500,000 shares of preferred stock designated as Series A Participating Preferred Stock for issuance in connection with the Stockholders Rights plan described below.
Sales of Stock.    In February 2000, in a private offering, the Company issued 4,000,000 shares of common stock at $105.50 per share. Net proceeds from this offering were approximately $403.4 million, net of 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, excluding options issued by Synteni prior to
the 1997 merger, has been recognized for its fixed stock option plans. Had
compensation cost for the Company's three stock-based compensation plans been
determined consistent with SFAS 123, the Company's pro forma net loss in 2001,
2000 and 1999 would have been approximately $202.0 million, $50.5 million and
$40.0 million, respectively. The Company's pro forma basic and diluted net loss
per share in 2001, 2000 and 1999 would have been $3.05, $0.80 and $0.71 per
share, respectively. The weighted average fair value of the options granted
during 2001, 2000 and 1999 are estimated at $10.56, $28.30 and $6.71 per share,
respectively, on the date of grant, using the Black-Scholes multiple-option
pricing model with the following assumptions: dividend yield 0%, 0% and 0%,
volatility of 86%, 92% and 66%, risk-free interest rate of 4.25%, 6.26% and
5.43%, and an average expected life of 3.46, 3.04 and 3.32 years, for 2001,
2000 and 1999, respectively. The average fair value of the employees' purchase
rights under the Employee Stock Purchase Plan during 2001, 2000 and 1999 is
estimated at $8.34, $6.67 and $4.07, respectively, on the date of grant, using
the Black-Scholes multiple-option pricing model with the following assumptions:
dividend yield 0%, 0% and 0%, volatility of 98%, 76% and 66%, risk free
interest rate of 4.41%, 5.89% and 5.14%, and an expected life of 6 months,
respectively.

   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,

                                      53



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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'sCompany’s stock option plans as of December 31, 2002, 2001 2000 and 1999,2000, 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 (the "Stock Plan"“Stock Plan”), which was amended and restated in 1992, 1995,
1996, 1997, 1999, 2000 and 2001 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.options or restricted stock units. The exercise prices of incentive and non-statutory stock options granted under the plan are not less than the fair market value
64
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
on the date of the grant, as determined by the Board of Directors. Options generally vest over four years, pursuant to a formula determined by the Company'sCompany’s Board of Directors, and expire after ten years. Certain options granted in 2002 vest over three years and expire after ten years. In June 2001,2002, the Company'sCompany’s stockholders approved an increase in the number of shares of common stock reserved for issuance under the plan from 17,400,00019,900,000 to 19,900,000.

   22,350,000.
During 2001, the Company granted 490,000 restricted stock units under the Stock Plan to certain management personnel. In connection with the grant of these restricted stock units, the Company recorded deferred compensation of $7,933,000$7.9 million in 2001. These restricted stock units have cliff vesting terms over one to four years and are being amortized to stock compensation expense over those vesting terms. During 2002, two executives who were granted restricted stock units terminated their employment with the Company. Accordingly, the Company reduced deferred compensation by $1.1 million to reflect the restricted stock units forfeited.
1998 Proteome Stock Plan.    In October 1998, Proteome'sProteome’s Board of Directors approved and adopted the Proteome, Inc. 1998 Employee, Director and Consultant Stock Option Plan, as amended through August 6, 1999 (the "Proteome Plan"“Proteome Plan”). Under the Proteome Plan, Proteome could grant incentive stock options and non-qualified options to purchase the equivalent of 216,953 shares of Incyte common stock. Incentive stock options could be granted to employees at exercise prices of no less than 100% of the fair value of the common stock on the grant date, as determined by the board of directors or a committee of the board of directors. Non-qualified options could be granted to employees, outside directors and consultants who provided services to Proteome at exercise prices no less than par value of the common stock, as determined by the board of directors or a committee of the board of directors. Options could be granted with different vesting terms from time to time and options issued under the Proteome Plan expire no more than 10 years after the date of grant. All outstanding options at the time of the merger with Incyte were converted to options to purchase Incyte common stock, and the Proteome Plan was assumed by the Company. No further options will be granted under the Proteome Plan.
Non-Employee Directors'Directors’ Stock Option Plan.    In August 1993, the Board of Directors approved the 1993 Directors'Directors’ Stock Option Plan (the "Directors'
Plan"“Directors’ Plan”), which was amended in 1995.amended. The Directors'Directors’ Plan provides for the automatic grant of options to purchase shares of common stock to non-employee directors of the Company. The maximumIn June 2002, the Company’s stockholders approved an increase in the number of shares issuableof common stock reserved for issuance under the Directors' Plan is 800,000.

   Throughplan from 800,000 to 1,100,000.
From the inception of the plan through March 1998, the Directors'Directors’ Plan provided that each new non-employee director joining the Board would receive an option to purchase 80,000 shares of common stock. In March 1998, the Directors Plan was amended to eliminate this initial grant. In May 2001, the Directors'Directors’ Plan was amended to provide that each new non-employee director joining the Board would receive an option to purchase 20,000 shares of common stock. In December 2001, the Directors'Directors’ Plan was amended to provide that this initial option shall cover the purchase of 30,000 shares of common stock. Additionally, members who continue to serve on the Board will receive annual option grants for 5,000 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. At December 31, 2001,2002, the Company had options outstanding under the Directors'Directors’ Plan to purchase 668,000592,919 shares 54



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)of common stock at a weighted average exercise price of $10.426 (668,000 and 535,000 shares of common stock at a weighted average exercise price of $10.756 (535,000 and 615,000 shares of common stock at a weighted average exercise price of $8.819
and $5.625 at December 31, 20002001 and 1999,2000, respectively); 536,000473,542 shares are vested and exercisable at December 31, 2001 (495,0002002 (536,000 and 575,000495,000 shares were vested and exercisable at December 31, 20002001 and 1999,2000, respectively). In 2002 and 2000, 55,000 and 120,000 shares of common stock, respectively, were purchased under the Directors'Directors’ Plan at a weighted average exercise price of $1.36.$2.474 and $1.36, respectively. No options were exercised prior to 2000.
65
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Activity under the combined plans was as follows:

                                                               Shares Subject to
                                                              Outstanding Options
                                                              --------------------
                                                                          Weighted
                                                   Shares                 Average
                                                  Available               Exercise
                                                  for Grant     Shares     Price
                                                  ----------  ----------  --------

Balance at January 1, 1999.......................  3,103,292   8,381,407   $ 9.57
   Additional authorization......................  2,200,000          --       --
   Options granted............................... (5,256,830)  5,256,880    13.77
   Options exercised.............................         --  (1,959,628)    6.38
   Options canceled..............................  1,258,705  (1,258,705)   14.30
                                                  ----------  ----------
Balance at December 31, 1999.....................  1,305,167  10,419,904    11.71
   Additional authorization......................  2,600,000          --       --
   Options granted............................... (1,043,922)  1,043,922    39.59
   Options exercised.............................         --  (2,446,632)   10.85
   Options canceled..............................    754,593    (754,593)   17.50
                                                  ----------  ----------
Balance at December 31, 2000.....................  3,615,838   8,262,601    14.96
   Additional authorization......................  2,500,000          --       --
   Options granted............................... (4,543,832)  4,543,832    17.66
   Options exercised.............................         --    (752,191)   11.01
   Options canceled..............................  1,633,830  (1,673,468)   22.75
                                                  ----------  ----------
Balance at December 31, 2001.....................  3,205,836  10,380,774   $15.18
                                                  ==========  ==========
 
  
 
 
  
Shares Subject to
Outstanding Options
 
  
Shares Available for Grant
 
  
Shares
 
    
Weighted Average Exercise Price
Balance at January 1, 2000
  
1,305,167
 
  
10,419,904
 
    
$
11.71
Additional authorization
  
2,600,000
 
  
—  
 
    
 
—  
Options granted
  
(1,043,922
)
  
1,043,922
 
    
 
39.59
Options exercised
  
—  
 
  
(2,446,632
)
    
 
10.85
Options canceled
  
754,593
 
  
(754,593
)
    
 
17.50
 
  
  
    
 
 
Balance at December 31, 2000
  
3,615,838
 
  
8,262,601
 
    
 
14.96
Additional authorization
  
2,500,000
 
  
—  
 
    
 
—  
Options granted
  
(4,543,832
)
  
4,543,832
 
    
 
17.66
Options exercised
  
—  
 
  
(752,191
)
    
 
11.01
Options canceled
  
1,633,830
 
  
(1,673,468
)
    
 
22.75
 
  
  
    
 
 
Balance at December 31, 2001
  
3,205,836
 
  
10,380,774
 
    
 
15.18
Additional authorization
  
2,750,000
 
  
—  
 
    
 
—  
Options granted
  
(3,876,975
)
  
3,876,975
 
    
 
7.44
Options exercised
  
—  
 
  
(1,133,045
)
    
 
4.29
Options canceled
  
1,933,565
 
  
(1,967,931
)
    
 
19.06
 
  
  
    
 
 
Balance at December 31, 2002
  
4,012,426
 
  
11,156,773
 
    
$
12.20
 
  
  
    
 
 
Options to purchase a total of 4,139,069;4,779,088, 4,139,069 and 3,469,661 and 3,725,352 shares at December 31, 2002, 2001 2000 and 1999,2000, respectively, were exercisable. Of the options exercisable, 4,127,069;4,779,088, 4,127,069 and 3,469,661 and 3,427,292 shares were vested at December 31, 2002, 2001 and 2000, and 1999, respectively.
Options Assumed in Proteome Acquisition.    As part of the Proteome acquisition, Proteome stock option holders received options to purchase 216,953 shares of Incyte common stock with a weighted average exercise price of $7.60. The Company recognized $2,479,000 of deferred compensation related to these options, which is being amortized over the vesting period of the options. In connection with the workforce reduction related to the restructuringrestructurings in 2002 and 2001, the Company terminated certain Proteome stock option holders included in the original calculation and reduced the deferred compensation by $1,324,000$0.1 million and $1.3 million at December 31, 2002 and 2001. Options to purchase a total of 29,372, 41,181 and 40,651 shares were vested and exercisable at December 31, 2002, 2001 and 2000, respectively.

                                      55

66
INCYTE GENOMICS, INC.

            CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--STATEMENTS—(Continued)
The following table summarizes information about stock options outstanding at December 31, 2001,2002, for the 1991 Stock Plan, the 1996 Synteni Stock Plan, the 1998 Proteome Stock Plan, and the 1993 Non-employee Directors'Directors’ Stock Option Plan:

                                  Options Outstanding          Options Exercisable
                         ------------------------------------- --------------------
                                         Weighted     Weighted             Weighted
                                         Average      Average              Average
                           Number       Remaining     Exercise   Number    Exercise
Range of Exercise Prices Outstanding Contractual Life  Price   Exercisable  Price
- ------------------------ ----------- ---------------- -------- ----------- --------

     $  0.01-  4.44.....  1,378,871        3.23       $  2.79   1,371,425  $  2.79
        4.66- 11.19.....  1,193,293        6.50          9.71     869,742     9.67
       11.31- 14.00.....  1,211,836        7.95         13.55     589,355    13.53
       14.07- 14.48.....  1,077,643        9.60         14.44      64,035    14.20
       14.49- 15.22.....  1,667,960        7.80         15.08     892,863    15.11
       15.32- 16.19.....  1,286,558        9.63         16.14      87,720    15.90
       16.38- 21.81.....  1,349,147        7.86         19.24     600,403    18.05
       21.94- 41.38.....  1,085,458        8.59         27.08     264,373    31.24
       42.88- 70.00.....     92,995        8.36         47.36      46,278    48.02
      119.88-119.88.....     37,013        8.18        119.88      18,804   119.88
                         ----------                             ---------
                         10,380,774        7.57         15.18   4,804,998    12.40
                         ==========                             =========
 
  
Options Outstanding
  
Options Exercisable
Range of Exercise Prices
  
Number Outstanding
    
Weighted Average Remaining Contractual Life
  
Weighted Average Exercise Price
  
Number Exercisable
  
Weighted Average Exercise Price
$  0.01–    3.48
  
971,819
    
3.45
  
$
1.23
  
367,735
  
$
1.33
    3.62–    5.24
  
1,287,732
    
9.11
  
 
5.10
  
163,705
  
 
4.27
    5.47–    7.89
  
1,394,250
    
9.76
  
 
6.12
  
36,846
  
 
5.94
    8.06–  10.72
  
837,719
    
5.36
  
 
9.64
  
770,021
  
 
9.64
  11.06–  13.80
  
1,482,109
    
8.86
  
 
12.30
  
202,558
  
 
12.93
  13.81–  14.75
  
1,784,882
    
7.66
  
 
14.32
  
1,044,122
  
 
14.23
  15.06–  16.19
  
1,674,603
    
7.48
  
 
15.60
  
1,039,108
  
 
15.39
  16.38–  21.94
  
909,919
    
6.87
  
 
19.42
  
653,067
  
 
18.99
  22.13–  39.75
  
686,490
    
7.61
  
 
25.35
  
417,446
  
 
25.74
  41.06–119.88
  
127,250
    
7.37
  
 
53.27
  
84,480
  
 
54.13
 
  
    
 
  
 
 
  
  
 
 
 
  
11,156,773
    
7.61
  
 
12.20
  
4,779,088
  
 
14.94
 
  
    
 
  
 
 
  
  
 
 
Employee Stock Purchase Plan.    On May 21, 1997, the Company'sCompany’s stockholders adopted the 1997 Employee Stock Purchase Plan ("ESPP"(“ESPP”). The Company has
authorized 1,200,000 shares of common stock for issuance under the ESPP. In June 2001,2002, the Company'sCompany’s stockholders approved an increase in the number of shares of common stock reserved for issuance under the plan from 1,600,000 to 1,600,000.2,100,000. Each regular full-time and part-time employee working 20 hours or more per week is eligible to participate after one month of employment. The Company issued 433,969, 301,763 214,617 and 158,754214,617 shares under the ESPP in 2002, 2001 2000 and 1999,2000, respectively. As of December 31, 2001, 846,9782002, 913,009 shares remain available for issuance under the ESPP.
Stockholders Rights Plan.    On September 25, 1998, the Board of Directors adopted a Stockholder Rights Plan (the "Rights Plan"“Rights Plan”), pursuant to which one preferred stock purchase right (a "Right"“Right”) was distributed for each outstanding share of common stock held of record on October 13, 1998. One Right will also attach to each share of common stock issued by the Company subsequent to such date and prior to the distribution date defined below. Each Right represents a right to purchase, under certain circumstances, a fractional share of the Company'sCompany’s Series A Participating Preferred Stock at an exercise price of $100.00, subject to adjustment. In general, the Rights will become exercisable and trade independently from the common stock on a distribution date that will occur on the earlier of (i) the public announcement of the acquisition by a person or group of 15% or more of the common stock or (ii) ten days after commencement of a tender or exchange offer for the common stock that would result in the acquisition of 15% or more of the common stock. Upon the occurrence of certain other events related to changes in ownership of the common stock, each holder of a Right would be entitled to purchase shares of common stock, or an acquiring corporation'scorporation’s common stock, having a market value of twice the exercise price. Under certain conditions, the Rights may be redeemed at $0.01 per Right by the Board of Directors. The Rights expire on September 25, 2008.

                                      56

67
INCYTE GENOMICS, INC.

            CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--STATEMENTS—(Continued)
Note 6.7.    Income Taxes
The provision (benefit) for income taxes consists of the following (in thousands):

                                                                Year Ended December 31,
                                                                ----------------------
                                                                 2001     2000   1999
                                                                ----     ----    -----

Current........................................................
   Federal..................................................... $ --     $ --   $(832)
   Foreign.....................................................  830      125     (92)
   State.......................................................  100       80     124
                                                                 ----     ----   -----
       Total provision (benefit) for income taxes.............. $930     $205   $(800)
                                                                 ====     ====   =====
 
  
Year Ended December 31,
 
  
2002
  
2001
  
2000
Current
  
 
 
  
 
 
  
 
 
Foreign
  
$
985
  
$
830
  
$
125
State
  
 
135
  
 
100
  
 
80
 
  
  
  
Total provision for income taxes
  
$
1,120
  
$
930
  
$
205
 
  
  
  
Income (loss) before provision for income taxes extraordinary items and cumulative effect of accounting change consisted of the following (in thousands):

                                                           Year Ended December 31,
                                                        -----------------------------
                                                          2001       2000      1999
                                                        ---------  --------  --------

U.S. taxable entities.................................. $(186,970) $(32,667) $(27,869)
Other..................................................        --        --       301
                                                        ---------  --------  --------
                                                        $(186,970) $(32,667) $(27,568)
                                                        =========  ========  ========
 
  
Year Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
U.S. taxable entities
  
$
(136,122
)
  
$
(184,584
)
  
$
(29,530
)
Other
  
 
357
 
  
 
—  
 
  
 
—  
 
 
  
  
  
 
  
$
(135,765
)
  
$
(184,584
)
  
$
(29,530
)
 
  
  
  
The provision (benefit) for income taxes before extraordinary items and cumulative effect of accounting change differs from the federal statutory rate as follows (in thousands):

                                                              Year Ended December 31,
                                                            ---------------------------
                                                              2001      2000     1999
                                                            --------  --------  -------

Provision (benefit) at U.S. federal statutory rate......... $(65,440) $(11,433) $(9,649)
Unbenefitted net operating losses..........................   47,408    11,144    8,604
Restructuring charges and long-lived asset impairments.....   15,791        --       --
Other......................................................    3,171       494      245
                                                            --------  --------  -------
Provision (benefit) for income taxes....................... $    930  $    205  $  (800)
                                                            ========  ========  =======


                                      57



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   
 
  
Year Ended December 31,
 
 
  
2002
 
  
2001
 
  
2000
 
Provision (benefit) at U.S. federal statutory rate
  
$
(47,518
)
  
$
(64,604
)
  
$
(10,336
)
Unbenefitted net operating losses
  
 
46,159
 
  
 
46,572
 
  
 
10,047
 
Restructuring charges and long-lived asset impairments
  
 
—  
 
  
 
15,791
 
  
 
—  
 
Other
  
 
2,479
 
  
 
3,171
 
  
 
494
 
 
  
  
  
Provision for income taxes
  
$
1,120
 
  
$
930
 
  
$
205
 
 
  
  
  
Significant components of the Company'sCompany’s deferred tax assets are as follows (in thousands):

                                                            December 31
                                                        -------------------
                                                          2001       2000
                                                        ---------  --------
    
    Deferred tax assets:
       Net operating loss carryforwards................ $ 105,000  $ 69,800
       Research credits................................    16,000    12,900
       Capitalized research and development............    16,800    13,000
       Accruals and reserves...........................    11,800     4,400
       Other, net......................................     1,000       400
                                                        ---------  --------
           Total gross deferred tax assets.............   150,600   100,500
    Less valuation allowance for deferred tax assets...  (149,400)  (91,900)
                                                        ---------  --------
    Net deferred tax assets............................     1,200     8,600
    Deferred tax liabilities:
       Purchased intangibles...........................     1,200     8,600
                                                        ---------  --------
           Net deferred tax assets and liabilities..... $      --  $     --
                                                        =========  ========
 
  
December 31
 
 
  
2002
 
  
2001
 
Deferred tax assets:
  
 
 
 
  
 
 
 
Net operating loss carryforwards
  
$
146,200
 
  
$
105,000
 
Research credits
  
 
17,500
 
  
 
16,000
 
Capitalized research and development
  
 
22,200
 
  
 
16,800
 
Accruals and reserves
  
 
10,000
 
  
 
11,800
 
Other, net
  
 
11,400
 
  
 
1,000
 
 
  
  
Total gross deferred tax assets
  
 
207,300
 
  
 
150,600
 
Less valuation allowance for deferred tax assets
  
 
(206,300
)
  
 
(149,400
)
 
  
  
Net deferred tax assets
  
 
1,000
 
  
 
1,200
 
Deferred tax liabilities:
  
 
 
 
  
 
 
 
Purchased intangibles
  
 
1,000
 
  
 
1,200
 
 
  
  
Net deferred tax assets and liabilities
  
$
—  
 
  
$
—  
 
 
  
  
68
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The valuation allowance for deferred tax assets increased by approximately $57,500,000, $48,500,000$56.9 million, $57.5 million and $20,400,000$48.5 million during the years ended December 31, 2002, 2001 2000 and 1999,2000, respectively. Approximately $57,500,000$59.0 million of the valuation allowance for deferred tax assets relates to benefits from stock option deductions which, when recognized, will be allocated directly to contributed capital.
The Company'sCompany’s management believes the uncertainty regarding the timing of the realization of net deferred tax assets requires a valuation allowance.
As of December 31, 2001,2002, the Company had federal net operating loss carryforwards of approximately $299,500,000.$417.2 million. The Company also had federal research and development tax credit carryforwards of approximately $10,500,000.$11.8 million. The net operating loss carryforwards will expire at various dates, beginning in 2009 through 2021,2022, if not utilized.
Utilization of the net operating losses and credits may be subject to an annual limitation, due to the "change“change in ownership"ownership” provisions of the Internal Revenue Code of 1986 and similar state provisions.

                                      58



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 7.8.    Net Income (Loss)Loss Per Share

   The following table sets forth the computation of basic and diluted net
income (loss) per share (in thousands, except per share amounts):


                                                           Year Ended December 31,
                                                        -----------------------------
                                                          2001       2000      1999
                                                        ---------  --------  --------

Numerator:
   Net income (loss)................................... $(183,235) $(29,735) $(26,768)
                                                        =========  ========  ========
Denominator:
   Denominator for basic net income (loss) per share--
     weighted-average shares outstanding...............    66,193    63,211    56,276
   Dilutive potential common shares--stock options.....        --        --        --
                                                        ---------  --------  --------
   Denominator for diluted net income (loss) per
     share.............................................    66,193    63,211    56,276
                                                        =========  ========  ========
Basic net income (loss) per share...................... $   (2.77) $  (0.47) $  (0.48)
                                                        =========  ========  ========
Diluted net income (loss) per share.................... $   (2.77) $  (0.47) $  (0.48)
                                                        =========  ========  ========
Options to purchase 11,156,773, 10,380,774 8,307,396 and 10,364,1568,262,601 shares of common stock were outstanding at December 31, 2002, 2001 2000 and 1999,2000, respectively, which were not included in the computation of diluted net income (loss)loss per share, as their effect was anti-dilutive. The Company'sCompany’s Convertible Subordinated Notes, convertible into 2,625,3832,525,957, 2,625,334 and 2,743,993 shares of common stock at December 31, 2002, 2001 and 2000, respectively, were not included in the computation of diluted net income (loss)loss per share, as the effect of their assumed conversion would be anti-dilutive.
Note 8.9.    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 $1,951,000, $1,735,000$1.5 million, $2.0 million and $1,259,000$1.7 million in 2002, 2001 and 2000, and
1999, respectively.
Note 9.10.    Segment Reporting
The Company'sCompany’s operations are treated as one operating segment, in accordance with FASB Statement No. 131 (“SFAS 131: drug discovery and development products and services.131”). For the yeartwelve months ended December 31, 2001,2002, the Company recorded revenue from customers throughout the United States and in Austria, Belgium, Canada, France, Denmark, Germany, India, Israel, Japan, Scandinavia,the Netherlands, Switzerland, and the United Kingdom. Export revenuerevenues for the years ended December 31, 2002, 2001 and 2000 and 1999, was $49,656,000,
$48,174,000 and $43,679,000,were $34.8 million, $50.8 million, $48.2 million, respectively.
Note 10.11.    Business Combinations    
Acquisitions accounted for under the purchase method of accounting
In December 2000, the Company completed the acquisition of Proteome, Inc., a privately held proteomics information company based in Beverly, Massachusetts. The Company issued 1,248,522 shares of its common stock and $37.7 million in cash in exchange for all of Proteome'sProteome’s outstanding capital stock. In addition, the Company assumed Proteome'sProteome’s stock options, which if fully vested and exercised, would amount to

                                      59



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 216,953 shares of its common stock. The transaction was accounted for as a purchase. The amount of the purchase price in excess of the net tangible assets acquired of $70.8 million, was allocated to goodwill ($50.3 million); acquired database technology ($16.6 million); tradename ($1.7 million); Proteome'sProteome’s assembled work force ($1.6 million); and developed technology ($0.6 million), each of which is being amortized over 8, 8, 3, 3 and 5 years, respectively.
69
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company allocated Proteome'sProteome’s purchase price based on the relative fair value of the net tangible and intangible assets acquired. In performing this allocation, the Company considered, among other factors, the technology research and development projects in process at the date of acquisition. The results of operations of Proteome have been included in the consolidated results of the Company from the date of acquisition on December 28, 2000.
The table below presents the pro forma results of operations and earnings per share for Proteome and the Company. The transaction is assumed to be completed on January 1, 2000 and 1999 for the periodsperiod ended December 31, 2000
and 1999, respectively (in thousands except per share data).

                                                              2000     1999
                                                            -------- --------
  
  Revenues................................................. $197,881 $158,773
                                                            ======== ========
  Loss before extraordinary item........................... $ 50,443 $ 38,122
                                                            ======== ========
  Net loss................................................. $ 47,306 $ 38,122
                                                            ======== ========
  Pro forma basic and diluted net loss per share........... $   0.73 $   0.66
                                                            ======== ========
  Pro forma shares for basic and diluted net loss per share   64,460   57,525
                                                            ======== ========
 
  
2000
Revenues
  
$
197,881
 
  
Net loss
  
$
47,306
 
  
Pro forma basic and diluted net loss per share
  
$
0.73
 
  
Pro forma shares for basic and diluted net loss per share
  
 
64,460
 
  
Note 11.12.    Joint Venture
In September 1997, the Company formed a joint venture, diaDexus, LLC ("diaDexus"(“diaDexus”), with SmithKline Beecham Corporation ("SB"(“SB”), to utilize genomic and bioinformatic technologies in the discovery and commercialization of molecular diagnostics. The Company held a 50 percent equity interest in diaDexus and accounted for the investment under the equity method. In July 1999, the Company and SB each invested an additional $2.5 million in diaDexus through convertible notes.
On April 4, 2000, diaDexus obtained additional financing through a private equity offering. In connection with the offering, diaDexus converted from an LLC to a corporation and repaid in full the $2.5 million principal amount of, together with accrued interest on, the convertible note held by the company. Under diaDexus'diaDexus’ new capital structure, the Company no longer has the ability to exert significant influence over diaDexus. Accordingly, the Company accounts for its investment in diaDexus under the cost method of accounting as of the date of the financing.
diaDexus purchased $0 million, $0.1 million $2.6 million and $1.9$2.6 million of contract sequencing, microarray and software services from the Company in the year ended December 31, 2002, 2001 2000 and 1999,2000, respectively. At December 31, 2001,2002, the Company had no receivables outstanding from diaDexus related to these services.

                                      60



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   The following is a summary of diaDexus' financial information as of December
31, 2001, 2000, and 1999, and for the years then ended (in thousands):


                                                      2001    2000    1999
                                                     ------- ------- -------
   
   Current assets................................... $68,919 $49,579 $ 8,786
   Total assets.....................................  83,538  96,072  11,297
   Current liabilities..............................   3,720   2,384   5,957
   Total liabilities................................   3,720   2,431   6,044
      Net loss......................................  24,517  23,346  11,286
Note 12.13.    Litigation
Affymetrix
On December 21, 2001, Incyte agreed to settlethe Company settled the following existing patent infringement litigation with Affymetrix, Inc.: Affymetrix, Inc. v. Synteni, Inc. and Incyte Pharmaceuticals, Inc., Case Nos. C 99-21164 JF and C 99-21165 JF (N.D. Cal.); Incyte Genomics, Inc. v. Affymetrix, Inc., Case No. C 01-20065 JF (N.D. Cal.); and the Incyte Opposition to Affymetrix'sAffymetrix’s European Patent No. EP 0 619 321. The first lawsuit involved several of Affymetrix'sAffymetrix’s microarray-related patents (U.S. Patent Nos. 5,445,934, 5,744,305 and
5,800,992).patents. The second lawsuit involved Incyte'sour RNA amplification patents
(U.S. Patent Nos. 5,716,785 and 5,891,636) and two additional microarray-related patents held by Affymetrix (U.S. Patent Nos. 5,871,928 and
6,040,193).Affymetrix. As a part of the settlement, the companies have agreed to certain non-exclusive, royalty-bearing licenses and an internal use license under their respective intellectual property portfolios. Pursuant to the settlement, the Company received a net cash settlement that was recorded as
70
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
revenue in 2001. This settlement does not include Incyte'sOn December 2, 2002, the Company agreed to settle its appeal before the United States District Court for the Northern District of California seeking de novo review of the Board of Patent Appeals and Interferences'Interferences’ decision relating to patent applications licensed by Incyteus from Stanford University. There can be no
assurances as to the outcome of that appeal.

  University (Case No. C99-21111JF).
Invitrogen
On October 17, 2001, Invitrogen Corporation filed an actiona complaint for patent infringement against the
Company in the United States District Court for the District of Delaware,
alleging infringement of three patents (U.S. patent number 5,244,797, U.S.
patent number 5,668,005, and U.S. patent number 6,063,608) that relate to the
use of reverse transcriptase with no RNase H activity in preparing
complimentary DNA from RNA. The complaint seeks unspecified money damages and
injunctive relief.

   On November 21, 2001, the Company filed its answer to the complaint filed by
InvitrogenIncyte in the United States District Court for the District of Delaware. On November 21, 2001, the Company filed its answer to Invitrogen’s complaint. In addition, to its answers to Invitrogen's patent infringement claims, the Company asserted seven counterclaims against Invitrogen seeking declaratory relief with respect to the patents at issue, implied license, estoppel, laches, and patent misuse. The Company is also seeksseeking its fees, costs, and expenses. Invitrogen filed its answer to the Company'sCompany’s counterclaims on January 9, 2002. Simultaneously withThe parties are presently engaged in discovery. The Company believes it has meritorious defenses and intends to defend vigorously the filing of its answer, the Company filed a motion to
transfer the action from the United States District Court for the District of
Delaware to the United States District Court for the District of Maryland,
where Invitrogen Corporation is currently a party to three infringement actions
alleging infringement of the same patents-in-suit. The issue of transfer has
been fully briefed and submitted to the court for decision.

   In addition, onsuit brought by Invitrogen.
On November 21, 2001, the Company filed a complaint against Invitrogen as amended on December 21, 2001 and March 7, 2002, in the United States District Court for the Southern District of California 61



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

alleging infringement of fourteenthirteen of the Company'sits patents. NineEight of the asserted patents (U.S. patent numbers 5,633,149, 5,637,462, 5,817,497,
5,840,535, 5,919,686, 5,925,542, 5,962,263, 5,789,198 and 6,001,598) are gene patents. Three of the patents (U.S. patent numbers 5,716,785, 5,891,636, and
6,291,170) relate to RNA amplification and gene expression. Two of the patents
(U.S. patent numbers 5,807,522 and 6,110,426) relate to methods of fabricating microarrays of biological samples. The complaint seeks a permanent injunction enjoining Invitrogen from further infringement of the patents at issue, damages for Invitrogen'sInvitrogen’s conduct, as well as the Company'sCompany’s fees, costs, and interest. The Company further seeks triple damages from the infringement claim based on Invitrogen'sInvitrogen’s willful infringement of the Company'sits patents. Invitrogen's
response
Invitrogen has represented to the Company's complaint is dueCourt that its past sales of the eight GeneStorm cDNA clones charged with infringement of eight of the Company’s patents were not substantial and that it no longer sells these products. The parties are presently engaged in April 2002.

   discovery concerning the RNA amplification and gene expression and the microarray fabrication patents.
The Company believes it has meritorious defenses and intends to defend vigorously the suit and potential counterclaims brought by Invitrogen. However, the Company'sits defenses may be unsuccessful. At this time, the Company cannot reasonably estimate the possible range of any loss resulting from this suit due to uncertainty regarding the ultimate outcome. Regardless of the outcome, the
Invitrogen litigation is expected to result in substantial costs to the
Company. Further, there can be no assurance that any license that may be required as a result of this litigation or the outcome thereof would be made available on commercially acceptable terms, if at all. Regardless of the outcome, the Invitrogen litigation is expected to result in future costs to the Company, which could be substantial.
Note 13.14.    Related Party Transactions
The following aresummarizes the Company’s related party transactions as defined by FASB Statement No. 57,Related Party Disclosures ("(“SFAS 57"57”). In each of the transactions noted in which a director of the Company iswas at the time of the transaction in some way affiliated with the other party to the transaction, such director has recused himself from voting on the related party transaction. For the years ended December 31, 2002, 2001 2000
and 1999,2000, revenues from transactions with companies considered to be related parties as defined by SFAS 57 were $24,615,000, $0,$1.7 million, $27.0 million and $0, respectively. At December 31, 2002 and 2001, and
2000, receivablesaccounts receivable from related parties were $10,936,000$0.6 million and $10.9 million, respectively, and loans receivable from related parties were $2.3 million and $0 million, respectively. At December 31, 2002 and 2001, prepaid expenses to related parties were $2.1 million and $1.4 million, respectively.
71
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
In March 2001, the Company entered into a LifeSeq Collaboration Agreement, Patent License Agreement, Collaboration and Technology Transfer Agreement and Proteome BioKnowledge Library License Agreement with Genomic Health, Inc. ("(“Genomic Health"Health”). Randal W. Scott, who served as Chairman of the Board of the Company until November 2001 and as a director of the Company through December 2001, is Chairman of the Board, President and Chief Executive Officer of Genomic Health and owns more than 10% of the outstanding capital stock of Genomic Health. Julian C. Baker, who joined the Company’s Board in November 2001, is also a director of Genomic Health and holds shares, directly or beneficially, of both companies. Under the agreements, Genomic Health obtained access to the Company'sCompany’s LifeSeq Gold database and BioKnowledge Library and received licenses to certain of the Company'sCompany’s intellectual property. Amounts Genomic Health will
payis paying the Company under these agreements are similar to those paid to the Company under agreements between the Company and unrelated third parties. The Company received rights to certain intellectual property that Genomic Health may, in the future, develop. At the same time, the Company entered into an agreement to
purchasepurchased shares of Series C Preferred Stock of Genomic Health for an aggregate purchase price of $5.0 million which, together withmillion. In addition, in November 2000, the Company purchased shares of Series A Preferred Stock purchased in November 2000of Genomic Health for an aggregate purchase price of $1.0 million, resulted in the Company owning approximately 10.9% of the
outstanding capital stock of Genomic Health as of December 31, 2001.million. Under certain circumstances and if Genomic Health so elects, the Company has agreed to purchase in a future offering of Genomic Health'sHealth’s capital stock an aggregate of $5.0 million of the shares being sold in that offering.
In May 2001, the Company entered into a Development and License Agreement with Iconix Pharmaceuticals, Inc. ("Iconix"(“Iconix”). Jon S. Saxe, a director of the Company, is Chairman of the Board of Iconix. Roy A. Whitfield, who is Chairman of the Board of the Company, is also a director of Iconix and is serving as the Company’s representative on the board. Under the agreement, Iconix obtained an exclusive license to the Company'sCompany’s LifeExpress Lead database, access to LifeSeq and ZooSeq databases, licenses to certain of the Company'sCompany’s intellectual property and use of the Company'sCompany’s LifeArray expression array technology. Amounts Iconix will payis paying the Company under these

                                      62



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) agreements are similar to those paid to the Company under agreements between the Company and unrelated third parties. The Company is the exclusive distributor for the database product to be developed by Iconix. At the same time, the Company entered into an agreement to purchasepurchased shares of Series E Preferred Stock of Iconix for an aggregate purchase price of $10.0 million. Under certain circumstances,In the first quarter of 2002, the Company has agreed to purchase in a future
offering of Iconix's capital stock up to an aggregate ofpurchased $5.0 million of shares of Series F Preferred Stock of Iconix, fulfilling a commitment set forth in the shares being sold in that offering.

   agreements described above. The Company owned more than 10% of the outstanding capital stock of Iconix at December 31, 2002 and 2001.
In September 2001, the Company entered into a Technology Access for Licensed Reagent Manufacture Agreement with Epoch Biosciences, Inc. ("Epoch"(“Epoch”). Frederick B. Craves, a director of the Company, is Chairman of the Board of Epoch and Bay City Capital, of which Dr. Craves is a partner, holds shares of Epoch stock. Dr. Craves also holds shares of Epoch stock directly. Under the agreements, Epoch obtained access to the Company'sCompany’s LifeSeq Gold and ZooSeq databases and received licenses to certain of the Company'sCompany’s intellectual property. Amounts Epoch will payhas paid the Company under these agreements are similar to those paid to the Company under agreements between the Company and unrelated third party customers. The Company has identified Epoch as the preferred provider of certain probes to Incyte'sIncyte’s users of LifeSeq Gold. Additionally, Epoch will supply the Company with certain probes for internal development purposes.
In September 2001, the Company entered into a Collaboration Agreement, Patent License Agreement and two Unilateral Development and Commercialization Agreements with Medarex, Inc. ("Medarex"(“Medarex”). Frederick B. Craves, a director of the Company, is also a director of Medarex and Bay City Capital, of which Dr. Craves is a partner, holds shares of Medarex stock. Under the agreements, Medarex obtained access to the Company'sCompany’s LifeSeq Gold database and received licenses to certain of the Company'sCompany’s intellectual property. Amounts Medarex will payhas paid the Company under these agreements are similar to those paid to the Company under agreements between the Company and unrelated third party customers. Additionally, under the terms of the
72
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
agreements, Medarex and the Company expect to share equally the cost and responsibility of preclinical and clinical development of antibody products. In addition, the two companies plan to jointly commercialize any antibody products resulting from this collaboration.
In January 2002, the Company assigned its lease agreement for its Fremont, California facility to Genospectra, Inc. (“Genospectra”). Frederick B. Craves, a director of the Company, is also a director of Genospectra. The Company does not expect to have any further obligations pursuant to this lease.
In March 2002, the Company converted $3.0 million of convertible notes from Odyssey Pharmaceuticals, Inc. (“Odyssey”) into 1,705,919 shares of Odyssey’s preferred stock, resulting in the Company owning more than 10% of the outstanding capital stock of Odyssey at December 31, 2002. The number of shares received upon conversion reflects the number pursuant to the related agreement. The Company has recorded a gain on this conversion of $0.8 million.
During the third quarter of 2002, the Company loaned $1.5 million to Maxia Pharmaceuticals, Inc. (“Maxia”) in connection with its exclusive negotiations with Maxia regarding an acquisition or other strategic transaction. Frederick B. Craves, a director of the Company, is a partner of Bay City Capital, which holds shares of Maxia stock. In exchange for the loan, Maxia issued to the Company a $1.5 million senior convertible note that bears interest at 8% per annum and can be converted into Maxia common stock a set conversion price. On November 12, 2002, the Company announced that it entered into a definitive agreement to acquire Maxia for up to $28.3 million in cash and stock and up to $14 million in future clinical performance milestone payments. See also Note 14.16.
In addition, the Company loaned Maxia an aggregate of $1.4 million to cover their operating expenses during the period between the signing of the merger agreement and the consummation of the merger. In exchange for the loan, Maxia issued to the Company a second senior convertible note. Through December 31, 2002, the Company had funded $0.9 million under this note, which was charged to research and development expense. Although the Company’s analysis of purchase price allocation remains incomplete, the Company expects to record a charge in the first quarter of 2003 to the extent the final analysis concludes that total purchase price should be allocated to in-process research and development or other expenses.
Frederick B. Craves, one of the Company’s directors, is a partner of Bay City Capital, which held shares of Maxia stock. The transaction with Maxia was negotiated at arms’ length and, because Dr. Craves is a director of both companies, a special committee of the Board of Directors, which did not include Dr. Craves, was formed to consider and approve this related party transaction.
Note 15.    Other Expenses

                                                            For the Year                       Provision
                                                               Ended                         Balance as of
                                                            December 31,   Cash   Non-Cash   December 31,
                                                                2001     Payments Charges        2001
                                                            ------------ -------- ---------  -------------
                                                                            (in thousands)

Restructuring expenses:
   Workforce reduction.....................................   $  8,114   $(5,226) $      --     $ 2,888
   Equipment
During 2002 and other assets..............................     32,629        --    (32,629)         --
   Lease commitments and other restructuring charges.......     14,859      (753)    (2,024)     12,082
                                                              --------   -------  ---------     -------
                                                                55,602    (5,979)   (34,653)     14,970
Impairment of goodwill and other intangible assets.........     68,666        --    (68,666)         --
Impairment of other long-lived assets......................      6,104        --     (6,104)         --
                                                              --------   -------  ---------     -------
Other expenses.............................................   $130,372   $(5,979) $(109,423)    $14,970
                                                              ========   =======  =========     =======


   On October 25, 2001, the Company announced areported other expenses of $37.3 million and $130.4 million, respectively, relating to restructuring of its operations
in order to focus on its database and partnership programs and its therapeutic
drug discoverylong-lived asset write-downs announced in the fourth quarter of each year. The other expenses recognized in 2002 are comprised of charges of $33.9 million and development programs. As a part of$3.4 million relating to the restructuring programs from 2002 and 2001, respectively, as discussed in the Company is discontinuing its microarray-based gene expression products and
services, genomic screening products and services, public domain clone products
and related services, contract sequencing services

                                      63

following information relating to these restructuring programs.
73
INCYTE GENOMICS, INC.

            CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--STATEMENTS—(Continued)
2002 Restructuring
 
  
Original Charge Recorded in 2002
  
2002 Cash Payments
 
  
2002 Non-Cash Charges
 
  
Accrual Balance as of December 31, 2002
 
  
(in thousands)
Restructuring expenses:
  
 
 
  
 
 
 
  
 
 
 
  
 
 
Workforce reduction
  
$
7,325
  
$
(2,458
)
  
$
—  
 
  
$
4,867
Equipment and other assets
  
 
8,662
  
 
—  
 
  
 
(8,662
)
  
 
—  
Lease commitments and other restructuring charges
  
 
17,924
  
 
(440
)
  
 
1,020
 
  
 
18,504
 
  
  
  
  
Other expenses
  
$
33,911
  
$
(2,898
)
  
$
(7,642
)
  
$
23,371
 
  
  
  
  
On November 12, 2002, the Company announced plans to reduce its expenditures, primarily in research and internal program on SNP discovery. These custom genomics activities
contributeddevelopment, through a combination of spending reductions, workforce reductions, and office consolidations. The plan included elimination of approximately $45,267,00037% of revenuethe Company’s approximately 700-person workforce from its offices in 2001.Palo Alto, California, Beverly, Massachusetts, and Cambridge, England and the consolidation of its office and research facilities in Palo Alto, California. Consequently, this resulted in the Company recording an expense of $55,602,000$33.9 million related to restructuring activities in the restructuring activities. In addition, the Company recorded a reduction in
goodwill and other intangible assets and impairmentfourth quarter of other long-lived assets
totaling $74,770,000.

   2002.
The workforce reduction charge of approximately $8,718,000$7.3 million was determined based on the severance and fringe benefit chargesbenefits for approximately 400250 employees. These employees primarily worked inat the activities being exited as
described above and related infrastructure support positions.Company’s Palo Alto, California location. As of December
31, 2001, approximately 370January 11, 2003, all of these employees had been terminated.
Equipment and other assets that were disposed of or removed from operations were written down to their estimated fair value of $740,000 and that resulted$0.2 million, resulting in a charge of $32,629,000.$8.7 million in the fourth quarter of 2002. Assets held for sale are expected to be sold within one year. The write-down of equipment and other assets relates primarily relates to leasehold improvements, computer equipment and related software, lab equipment and office equipment associated with the activities being exited and related infrastructure reduction. Additionally, the write-off
of equipment and other assets also includes certain software costs related to
products no longer being offered.reductions. The Company estimated the fair value of equipment and other assets based on the then current market conditions.
Lease commitments and other restructuring related charges have been accrued of $14.9$17.9 million for facilities and equipment leases related to the activitiessites being exited and contract-related provisions and settlement and professional fees. Specifically, the Company is exiting two buildings located in St. Louis,
Missouri; Fremont, California; Palo Alto, California; and Cambridge, United
Kingdom.California. The Company estimated the costs based on the contractual terms of agreements and then current real estate market conditions. It is estimated that it will take the Company six to twelve months to sublease the various properties that will behave been vacated. The two leases related to activitiessites being exited expire on various dates ranging from Mayin July 2003 to March 2007.

   and December 2010.
The estimates above have been made based upon management'smanagement’s best estimate of the amounts and timing of certain events included in the restructurerestructuring plan that will occur in the future. It is possible that the actual outcome of certain events may differ from the estimates. Changes will be made to the restructuring accrual at the point that the differences become known.

   determinable.
74
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
2001 Restructuring and Other Impairments
 
  
Original Charge Recorded in 2001
  
Accrual Balance as of December 31, 2001
  
2002
Cash Payments
 
  
2002
Non-Cash Charges
 
  
Accrual Balance as of December 31, 2002
 
  
(in thousands)
Restructuring expenses:
  
 
 
  
 
 
  
 
 
 
  
 
 
 
  
 
 
Workforce reduction
  
$
8,114
  
$
2,888
  
$
(2,857
)
  
$
(31
)
  
$
—  
Equipment and other assets
  
 
32,629
  
 
—  
  
 
—  
 
  
 
—  
 
  
 
—  
Lease commitments and other restructuring charges
  
 
14,859
  
 
12,082
  
 
(7,163
)
  
 
3,306
 
  
 
8,225
 
  
  
  
  
  
Subtotal
  
 
55,602
  
 
14,970
  
 
(10,020
)
  
 
3,275
 
  
 
8,225
Impairment of goodwill and other intangible assets
  
 
68,666
  
 
—  
  
 
—  
 
  
 
—  
 
  
 
—  
Impairment of other long-lived assets
  
 
6,104
  
 
—  
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
  
  
  
  
Other expenses
  
$
130,372
  
$
14,970
  
$
(10,020
)
  
$
3,275
 
  
$
8,225
 
  
  
  
  
  
On October 25, 2001, the Company announced a restructuring of its operations in order to focus on its database licensing and partnership programs and its therapeutic drug discovery and development programs. As a part of the restructuring, the Company discontinued its microarray-based gene expression products and services, genomic screening products and services, public domain clone products and related services, contract sequencing services and internal program on single nucleotide polymorphism (SNP) discovery. Consequently, this resulted in the Company recording an expense of $55.6 million related to restructuring activities in the fourth quarter of 2001. In addition, in the fourth quarter of 2001 the Company recorded a reduction in goodwill and other intangible assets and impairment of other long-lived assets totaling $74.8 million. During 2002, the Company also recorded an additional charge of $3.4 million, which is comprised of a $0.7 million charge related to assets disposed of at prices less than originally estimated, a $3.3 million charge related to non-cash increases to the accrual as described below and a $0.6 million benefit related to reserves in excess of amounts originally estimated. Revenues from exited product lines for the year ended December 31, 2002 and 2001 were $3.6 million and $45.3 million, respectively.
The workforce reduction charge of approximately $8.1 million was determined based on the estimated severance and fringe benefit charges for approximately 400 employees. These employees primarily worked in the activities being exited as described above and related infrastructure support positions. As of December 31, 2002, all such employees have been terminated as a result of the workforce reduction.
Equipment and other assets that were disposed of or removed from operations were written down to their estimated fair value of $0.7 million, resulting in an original charge of $32.6 million in the fourth quarter of 2001. The write-down of equipment and other assets primarily relates to leasehold improvements, computer equipment and related software, lab equipment and office equipment associated with the activities being exited and related infrastructure reductions. Additionally, the write-off of equipment and other assets also includes certain software costs related to products no longer being offered. The Company estimated the fair value of equipment and other assets based on the then current market conditions. During 2002, the Company recorded a non-cash charge of $0.7 million related primarily to assets disposed of at prices less than originally estimated.
Lease commitments and other restructuring related charges of $14.9 million have been accrued for facilities and equipment leases related to the activities being exited and contract-related provisions and settlement and professional fees. Specifically, the Company is exiting or has exited buildings located in St. Louis, Missouri;
75
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Fremont, California; Palo Alto, California; and Cambridge, United Kingdom. The Company estimated the original charge based on the contractual terms of agreements and real estate market conditions in the fourth quarter of 2001. It was originally estimated that it would take the Company six to twelve months to sublease the various properties that are being vacated. The leases related to facilities being exited expire on various dates ranging from May 2003 to March 2007. The $3.3 million increase in this accrual recorded in the year ended December 31, 2002 is due primarily to contract-related settlements and facilities lease expenses in excess of amounts originally estimated, offset by the release of other restructuring accruals in excess of actual expenses. Additionally, in 2002, the Company also recognized a benefit of $0.6 million related to reserves in excess of the amounts originally estimated.
As a result of the Company'sCompany’s change in strategic direction and restructuring and, pursuant to SFAS 121, the Company performed an assessment of the carrying value of its goodwill and other intangible assets recorded in connection with its Hexagen Limited (“Hexagen”) and Proteome, assets.

   Inc. (“Proteome”) acquisitions.
The activities acquired through the Hexagen acquisition related primarily to a method of SNP discovery. AlthoughThe Hexagen method of SNP discovery will continue, the Hexagen
method is one of the activities that willwas not be continued after the change in strategic direction and restructuring. As a result, it was determined that the unamortized goodwill and intangible assets related to this acquisition have no future cash flows to support their carrying value and a $10,201,000$10.2 million charge was recorded to write these assets down to their estimated fair value.
The Company acquired Proteome Inc. in December 2000 and recorded goodwill and other intangible assets of $70,800,000.$70.8 million. At that time, the Company believed the acquisition would strengthen its database offering with a larger collection of protein annotation information. In the fourth quarter of 2001, the Company found that collaborators were unwilling to pay fees to access the Proteome databases that were sufficient to support the continued investment required to build and sustain the Proteome'sProteome’s products. In addition, the Company eliminated the positions of approximately 45% of Proteome employees. The Company considered these events to be indicators of potential impairment and performed an evaluation of the affected long-lived assets in accordance 64



                             INCYTE GENOMICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

with the Company'sCompany’s policy. The forecast of future cash flows indicated that the long-lived assets were impaired. The Company estimated the fair value of long-lived assets by discounting the cash flow forecast using a discount rate, which represented the Company'sCompany’s weighted average cost of capital. As a result of the evaluation, the Company concluded that unamortized goodwill and other intangible assets were impaired and accordingly, $58,465,000$58.5 million was charged to operations in the fourth quarter of 2001 to write these assets down to their estimated fair value. The carrying value of these intangible assets is
$2,900,000was $2.4 million and $2.9 million at December 31, 2001.

   2002 and 2001, respectively.
In reviewing its existing long-lived assets, the Company determined, based on certain impairment indicators, that an asset relating to capitalized software should be analyzed for impairment. As a result of this analysis, it was determined that the net book value of the asset was in excess of future revenues expected from sale of this software reduced by costs to sell. Therefore, it was determined that this capitalized software was impaired and the Company recognized a $6,104,000$6.1 million impairment charge.

                                      65



            Interim Consolidated Financial Information (Unaudited)
                     (in thousands, except per share data)


                                                                       Fiscal 2001 Quarter Ended
                                                             --------------------------------------------
                                                             March 31, June 30, September 30, December 31,
                                                             --------- -------- ------------- ------------

Revenues.................................................... $ 51,121  $56,051    $ 57,319     $  54,772
Loss before extraordinary item and cumulative effect
The estimates above have been made, and such estimates were updated during 2002, based upon management’s best estimate of
  accounting change/(1)/....................................  (14,977)  (9,891)    (17,827)     (145,205)
   Net loss/(1)/............................................  (10,312)  (9,891)    (17,827)     (145,205)
Basic and diluted loss before extraordinary item and
  cumulative effect of accounting change.................... $  (0.23) $ (0.15)   $  (0.27)    $   (2.18)
                                                             ========  =======    ========     =========
Basic and diluted net loss per share........................ $  (0.16) $ (0.15)   $  (0.27)    $   (2.18)
                                                             ========  =======    ========     =========
Shares used in computation of basic and diluted net loss per
  share.....................................................   65,745   66,076      66,370        66,565
                                                             ========  =======    ========     =========

                                                                       Fiscal 2000 Quarter Ended
                                                             --------------------------------------------
                                                             March 31, June 30, September 30, December 31,
                                                             --------- -------- ------------- ------------
Revenues.................................................... $ 40,754  $46,015    $ 51,982     $  55,416
Loss before extraordinary item..............................   (8,177)  (6,590)     (7,598)      (10,507)
   Net loss.................................................   (8,177)  (6,590)     (7,598)       (7,370)
Basic and diluted loss before extraordinary item............ $  (0.13) $ (0.10)   $  (0.12)    $   (0.16)
                                                             ========  =======    ========     =========
Basic and diluted net loss per share........................ $  (0.13) $ (0.10)   $  (0.12)    $   (0.11)
                                                             ========  =======    ========     =========
Shares used in computation of basic and diluted net loss per
  share.....................................................   60,612   63,798      64,064        64,369
                                                             ========  =======    ========     =========

- --------
(1) The December 31, 2001 quarter includes $130,372 of other expenses relating
    primarily to restructuring charges and long-lived asset write-downs.

                                      66



                SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS


                                                            Balance at Charged to            Balance at
                                                            Beginning  Costs and               End of
           Description--Year Ended December 31,             of Period   Expenses  Deductions   Period
           ------------------------------------             ---------- ---------- ---------- ----------
                                                                          (in thousands)

Allowance for doubtful accounts--1999......................    $434      $   --     $(200)     $  234
Allowance for doubtful accounts--2000......................     234         122        --         356
Allowance for doubtful accounts--2001......................     356       1,745        --       2,101


                                      67



                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of diaDexus, Inc.

   In our opinion, the accompanying balance sheets and the related statements
of operations, of members' and stockholders' equity and of cash flows present
fairly, in all material respects, the financial position of diaDexus, Inc. (a
development stage company) at December 31, 2001 and 2000, and the results of
its operations and its cash flows for each of the three years in the period
ended December 31, 2001 and for the cumulative period from August 29, 1997
(date of inception) to December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America. 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 of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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 disclosurestiming of certain events included in the financial statements, assessingrestructuring plan that will occur in the accounting principles
used and significant estimatesfuture. It is possible that the actual outcome of certain events may differ from the estimates. Changes will be made by management, and evaluatingto the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

/s/  PRICEWATERHOUSECOOPERS LLP

San Jose, California
January 14, 2002, except as
to Paragraph 2 of
Note 8 which is as of
January 31, 2002

                                      68



                                DIADEXUS, INC.
                         (a development stage company)

                                BALANCE SHEETS
                (in thousands, except share and per share data)


                                                                                               December 31,
                                                                                            ------------------
                                                                                              2000      2001
                                                                                            --------  --------
                                          ASSETS
                                          ------

Current Assets:
   Cash and cash equivalents............................................................... $ 13,043  $ 24,557
   Short-term investments..................................................................   33,874    41,194
   Interest receivable.....................................................................    1,556       816
   Prepaid expenses and other current assets...............................................    1,106     2,352
                                                                                            --------  --------
       Total current assets................................................................   49,579    68,919
Long-term investments......................................................................   44,271     8,872
Restricted cash............................................................................       --       161
Property and equipment, net................................................................    2,152     5,110
Notes receivable from employees............................................................       --       409
Other assets...............................................................................       70        67
                                                                                            --------  --------
       Total assets........................................................................ $ 96,072  $ 83,538
                                                                                            ========  ========
                           LIABILITIES AND STOCKHOLDERS' EQUITY
                           ------------------------------------
Current Liabilities:
   Accounts payable........................................................................ $    790  $    908
   Deferred revenue........................................................................       --       475
   Accrued liabilities.....................................................................    1,108     2,270
   Due to related parties..................................................................      486        67
                                                                                            --------  --------
       Total current liabilities...........................................................    2,384     3,720
Deferred rent..............................................................................       47        --
                                                                                            --------  --------
       Total liabilities...................................................................    2,431     3,720
                                                                                            --------  --------
Commitments and contingencies (Notes 4 and 7)

Stockholders' Equity:
   Series A preferred stock, $0.01 par value; 4,400,000 shares authorized, issued and
     outstanding at December 31, 2000 and December 31, 2001 (liquidation value: $15,000)...       44        44
   Series B preferred stock, $0.01 par value; 4,400,000 shares authorized, issued and
     outstanding at December 31, 2000 and December 31, 2001 (liquidation value: $10,000)...       44        44
   Series C preferred stock, $0.01 par value; 13,500,000 shares authorized at December 31,
     2000 and December 31, 2001, 13,225,807 shares issued and outstanding at
     December 31, 2000 and December 31, 2001 (liquidation value: $102,500).................      132       132
   Series D preferred stock, $0.01 par value; none authorized, issued and outstanding at
     December 31, 2000, 21,000 shares authorized at December 31, 2001, 20,833 shares
     issued and outstanding at December 31, 2001 (liquidation value: $250).................       --        --
   Common stock, $0.01 par value; 50,000,000 shares authorized at December 31, 2000 and
     December 31, 2001, 2,076,698 shares issued and outstanding at December 31, 2000 and
     2,099,968 shares issued and outstanding at December 31, 2001..........................       21        21
   Additional paid-in capital..............................................................  128,060   140,207
   Deferred stock compensation.............................................................  (12,773)  (14,322)
   Notes receivable from stockholders......................................................   (1,591)   (1,697)
   Accumulated other comprehensive income..................................................      482       684
   Deficit accumulated during the development stage........................................  (20,778)  (45,295)
                                                                                            --------  --------
       Total stockholders' equity..........................................................   93,641    79,818
                                                                                            --------  --------
       Total liabilities and stockholders' equity.......................................... $ 96,072  $ 83,538
                                                                                            ========  ========


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

                                      69



                                DIADEXUS, INC.
                         (a development stage company)

                           STATEMENTS OF OPERATIONS
                     (in thousands, except per share data)


                                                                                             Cumulative
                                                                                             Period from
                                                                                           August 29, 1997
                                                                                             (inception)
                                                                Year Ended December 31,        through
                                                             ----------------------------   December 31,
                                                               1999      2000      2001         2001
                                                             --------  --------  --------  ---------------

Revenues:
   License revenue.......................................... $     --  $     --  $     17     $     17
   Collaborative research revenue...........................       --        --       258          258
   Product sales............................................       --        --         2            2
   License revenue from related party.......................      100        --        --          100
                                                             --------  --------  --------     --------
       Total revenues.......................................      100        --       277          377
                                                             --------  --------  --------     --------
Operating expenses:
   Research and development (including stock compensation
     expense of $0, $2,811, $5,882 and $8,693 for the years
     ended December 31, 1999, 2000, 2001, and the
     cumulative period from inception through
     December 31, 2001, respectively).......................    9,461    12,297    20,911       49,831
   General and administrative (including stock
     compensation expense of $0, $12,345, $4,439 and
     $16,784 for the years ended December 31, 1999, 2000,
     2001 and the cumulative period from inception through
     December 31, 2001, respectively).......................    2,345    16,010     9,455       29,971

                                                             --------  --------  --------     --------
   Total operating expenses.................................   11,806    28,307    30,366       79,802
                                                             --------  --------  --------     --------
Loss from operations........................................  (11,706)  (28,307)  (30,089)     (79,425)
Interest and other income...................................      540     5,034     5,572       11,993
Interest expense............................................     (120)      (73)       --         (193)

                                                             --------  --------  --------     --------
Net loss.................................................... $(11,286) $(23,346) $(24,517)    $(67,625)

                                                             ========  ========  ========     ========



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

                                      70



                                DIADEXUS, INC.
                         (a development stage company)

                STATEMENTS OF MEMBERS' AND STOCKHOLDERS' EQUITY
                       (in thousands, except share data)



                                                         Series A             Series B                         Series A
                                                    Preferred Capital    Preferred Capital      Member      Preferred Stock
                                                   -------------------  -------------------  Contributions -----------------
                                                     Units     Dollars    Units     Dollars   Receivable    Shares   Dollars
                                                   ----------  -------  ----------  -------  ------------- --------- -------

Issuance, at inception, of Series A units at
 $3.41 per unit...................................  4,400,000  $15,000          --  $    --    $(11,000)          --  $ --
Issuance, at inception, of Series B units at
 $2.27 per unit...................................         --       --   4,400,000   10,000      (6,000)          --    --
Net loss..........................................         --     (274)         --     (274)         --           --    --
                                                   ----------  -------  ----------  -------    --------    ---------  ----
Balances at December 31, 1997.....................  4,400,000   14,726   4,400,000    9,726     (17,000)          --    --
Proceeds received from Members....................         --       --          --       --      17,000           --    --
Stock-based compensation..........................         --       --          --       --          --           --    --
Net loss..........................................         --   (3,964)         --   (3,964)         --           --    --
                                                   ----------  -------  ----------  -------    --------    ---------  ----
Balances at December 31, 1998.....................  4,400,000   10,762   4,400,000    5,762          --           --    --
Stock-based compensation..........................         --       --          --       --          --           --    --
Net loss..........................................         --   (5,643)         --   (5,643)         --           --    --
                                                   ----------  -------  ----------  -------    --------    ---------  ----
Balances at December 31, 1999.....................  4,400,000    5,119   4,400,000      119          --           --    --
Net loss to April 4...............................         --   (1,284)         --   (1,284)         --           --    --
Conversion to C corporation....................... (4,400,000)  (3,835) (4,400,000)   1,165          --    4,400,000    44
Issuance of Series C preferred stock upon
 conversion of note payable to related party......         --       --          --       --          --           --    --
Issuance of Series C preferred stock, net of
 issuance costs of $7,322.........................         --       --          --       --          --           --    --
Issuance of common stock..........................         --       --          --       --          --           --    --
Deferred stock compensation.......................         --       --          --       --          --           --    --
Amortization of deferred stock compensation.......         --       --          --       --          --           --    --
Remeasurement of stock options....................         --       --          --       --          --           --    --
Notes receivable from stockholders, net of
 discount.........................................         --       --          --       --          --           --    --
Comprehensive loss:
 Net loss from April 5............................         --       --          --       --          --           --    --
 Change in unrealized gain on available-for-sale
  securities......................................         --       --          --       --          --           --    --

Comprehensive loss................................
                                                   ----------  -------  ----------  -------    --------    ---------  ----
Balances at December 31, 2000.....................         --       --          --       --          --    4,400,000    44
                                                   ----------  -------  ----------  -------    --------    ---------  ----
Issuance of Series D preferred stock..............         --       --          --       --          --           --    --
Issuance of common stock..........................         --       --          --       --          --           --    --
Deferred stock compensation.......................         --       --          --       --          --           --    --
Remeasurement of stock options....................         --       --          --       --          --           --    --
Amortization of deferred stock compensation.......         --       --          --       --          --           --    --
Reversal of deferred compensation upon termination         --       --          --       --          --           --    --
Notes receivable from stockholders, net of
 discount.........................................         --       --          --       --          --           --    --
Comprehensive loss:                                        --       --          --       --          --           --    --
 Net loss.........................................         --       --          --       --          --           --    --
 Change in unrealized gain on available-for-sale
  securities......................................         --       --          --       --          --           --    --

Comprehensive loss................................
                                                   ----------  -------  ----------  -------    --------    ---------  ----
Balances at December 31, 2001.....................         --  $    --          --  $    --    $     --    4,400,000  $ 44
                                                   ==========  =======  ==========  =======    ========    =========  ====


                                                       Series B           Series C         Series D
                                                    Preferred Stock   Preferred Stock   Preferred Stock   Common Stock
                                                   ----------------- ------------------ --------------- -----------------
                                                    Shares   Dollars   Shares   Dollars Shares  Dollars  Shares   Dollars
                                                   --------- ------- ---------- ------- ------  ------- --------- -------

Issuance, at inception, of Series A units at
 $3.41 per unit...................................        --  $ --           --  $ --       --   $ --          --   $--
Issuance, at inception, of Series B units at
 $2.27 per unit...................................        --    --           --    --       --     --          --    --
Net loss..........................................        --    --           --    --       --     --          --    --
                                                   ---------  ----   ----------  ----   ------   ----   ---------   ---
Balances at December 31, 1997.....................        --    --           --    --       --     --          --    --
Proceeds received from Members....................        --    --           --    --       --     --          --    --
Stock-based compensation..........................        --    --           --    --       --     --          --    --
Net loss..........................................        --    --           --    --       --     --          --    --
                                                   ---------  ----   ----------  ----   ------   ----   ---------   ---
Balances at December 31, 1998.....................        --    --           --    --       --     --          --    --
Stock-based compensation..........................        --    --           --    --       --     --          --    --
Net loss..........................................        --    --           --    --       --     --          --    --
                                                   ---------  ----   ----------  ----   ------   ----   ---------   ---
Balances at December 31, 1999.....................        --    --           --    --       --     --          --    --
Net loss to April 4...............................        --    --           --    --       --     --          --    --
Conversion to C corporation....................... 4,400,000    44           --    --       --     --          --    --
Issuance of Series C preferred stock upon
 conversion of note payable to related party......        --    --      322,580     3       --     --          --    --
Issuance of Series C preferred stock, net of
 issuance costs of $7,322.........................        --    --   12,903,227   129       --     --          --    --
Issuance of common stock..........................        --    --           --    --       --     --   2,076,698    21
Deferred stock compensation.......................        --    --           --    --       --     --          --    --
Amortization of deferred stock compensation.......        --    --           --    --       --     --          --    --
Remeasurement of stock options....................        --    --           --    --       --     --          --    --
Notes receivable from stockholders, net of
 discount.........................................        --    --           --    --       --     --          --    --
Comprehensive loss:                                                          --    --       --     --
 Net loss from April 5............................        --    --           --    --       --     --          --    --
 Change in unrealized gain on available-for-sale
  securities......................................        --    --           --    --       --     --          --    --

Comprehensive loss................................
                                                   ---------  ----   ----------  ----   ------   ----   ---------   ---
Balances at December 31, 2000..................... 4,400,000    44   13,225,807   132       --     --   2,076,698    21
                                                   ---------  ----   ----------  ----   ------   ----   ---------   ---
Issuance of Series D preferred stock..............        --    --           --    --   20,833     --          --    --
Issuance of common stock..........................        --    --           --    --       --     --      23,270    --
Deferred stock compensation.......................        --    --           --    --       --     --          --    --
Remeasurement of stock options....................        --    --           --    --
Amortization of deferred stock compensation.......        --    --           --    --       --     --          --    --
Reversal of deferred compensation upon termination        --    --           --    --       --     --          --    --
Notes receivable from stockholders, net of
 discount.........................................        --    --           --    --       --     --          --    --
Comprehensive loss:                                       --    --           --    --
 Net loss.........................................        --    --           --    --       --     --          --    --
 Change in unrealized gain on available-for-sale
  securities......................................        --    --           --    --       --     --          --    --

Comprehensive loss................................
                                                   ---------  ----   ----------  ----   ------   ----   ---------   ---
Balances at December 31, 2001..................... 4,400,000  $ 44   13,225,807  $132   20,833   $ --   2,099,968   $21
                                                   =========  ====   ==========  ====   ======   ====   =========   ===

                                                                                                        Deficit
                                                                              Notes      Accumulated  Accumulated
                                                   Additional   Deferred    Receivable      Other     During the
                                                    Paid-In      Stock         from     Comprehensive Development
                                                    Capital   Compensation Stockholders Income (Loss)    Stage     Total
                                                   ---------- ------------ ------------ ------------- ----------- --------

Issuance, at inception, of Series A units at
 $3.41 per unit...................................  $     --    $     --     $    --        $ --       $     --   $  4,000
Issuance, at inception, of Series B units at
 $2.27 per unit...................................        --          --          --          --             --      4,000
Net loss..........................................        --          --          --          --             --       (548)
                                                    --------    --------     -------        ----       --------   --------
Balances at December 31, 1997.....................        --          --          --          --             --      7,452
Proceeds received from Members....................        --          --          --          --             --     17,000
Stock-based compensation..........................        10          --          --          --             --         10
Net loss..........................................        --          --          --          --             --     (7,928)
                                                    --------    --------     -------        ----       --------   --------
Balances at December 31, 1998.....................        10          --          --          --             --     16,534
Stock-based compensation..........................         5          --          --          --             --          5
Net loss..........................................        --          --          --          --             --    (11,286)
                                                    --------    --------     -------        ----       --------   --------
Balances at December 31, 1999.....................        15          --          --          --             --      5,253
Net loss to April 4...............................        --          --          --          --             --     (2,568)
Conversion to C corporation.......................     2,582          --          --          --             --         --
Issuance of Series C preferred stock upon
 conversion of note payable to related party......     2,497          --          --          --             --      2,500
Issuance of Series C preferred stock, net of
 issuance costs of $7,322.........................    92,549          --          --          --             --     92,678
Issuance of common stock..........................     2,487          --          --          --             --      2,508
Deferred stock compensation.......................    18,331     (18,331)         --          --             --         --
Amortization of deferred stock compensation.......        --       5,558          --          --             --      5,558
Remeasurement of stock options....................     9,599          --          --          --             --      9,599
Notes receivable from stockholders, net of
 discount.........................................        --          --      (1,591)         --             --     (1,591)
Comprehensive loss:
 Net loss from April 5............................        --          --          --          --        (20,778)   (20,778)
 Change in unrealized gain on available-for-sale
  securities......................................        --          --          --         482             --        482
                                                                                                                  --------
Comprehensive loss................................                                                                 (20,296)
                                                    --------    --------     -------        ----       --------   --------
Balances at December 31, 2000.....................   128,060     (12,773)     (1,591)        482        (20,778)    93,641
                                                    --------    --------     -------        ----       --------   --------
Issuance of Series D preferred stock..............       250          --          --          --             --        250
Issuance of common stock..........................        27          --          --          --             --         27
Deferred stock compensation.......................    12,257     (12,257)         --          --             --         --
Remeasurement of stock options....................       102                                                           102
Amortization of deferred stock compensation.......        --      10,219          --          --             --     10,219
Reversal of deferred compensation upon termination      (489)        489          --          --             --         --
Notes receivable from stockholders, net of
 discount.........................................        --          --        (106)         --             --       (106)
Comprehensive loss:
 Net loss.........................................        --          --          --          --        (24,517)   (24,517)
 Change in unrealized gain on available-for-sale
  securities......................................        --          --          --         202             --        202
                                                                                                                  --------
Comprehensive loss................................                                                                 (24,315)
                                                    --------    --------     -------        ----       --------   --------
Balances at December 31, 2001.....................  $140,207    $(14,322)    $(1,697)       $684       $(45,295)  $ 79,818
                                                    ========    ========     =======        ====       ========   ========


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

                                      71



                                DIADEXUS, INC.
                         (a development stage company)

                           STATEMENTS OF CASH FLOWS
                                (in thousands)

                                                                                                               Cumulative
                                                                                                               Period from
                                                                                                             August 29, 1997
                                                                                                               (Inception)
                                                                                  Year Ended December 31,        through
                                                                               ----------------------------   December 31,
                                                                                 1999      2000      2001         2001
                                                                               --------  --------  --------  ---------------

Cash flows from operating activities:
  Net loss.................................................................... $(11,286) $(23,346) $(24,517)    $ (67,625)
  Adjustments to reconcile net loss to net cash used in operating activities:
    Depreciation and amortization.............................................    1,072     1,167     2,254         6,152
    Stock compensation expense................................................        5    15,157    10,321        25,493
    Discount on notes receivable from stockholders............................       --     1,281        --         1,281
    Imputed interest on notes receivable from stockholders....................       --       (12)     (106)         (119)
    Loss on disposal of property and equipment................................        3        --        --            26
    Changes in operating assets and liabilities:
     Interest receivable......................................................       --    (1,556)      740          (816)
     Prepaid expenses and other assets........................................      (24)     (678)   (1,244)       (2,351)
     Restricted cash..........................................................       --        --      (161)         (161)
     Accounts payable.........................................................     (197)      748       118           908
     Accrued liabilities......................................................     (177)      649     1,162         2,085
     Issuance of notes receivable to stockholders.............................       --      (465)       --          (465)
     Due to related parties...................................................   (2,234)      153      (419)       (2,183)
     Deferred revenue.........................................................       --        --       475           475
     Deferred rent............................................................      (29)      (41)      (43)            3

                                                                               --------  --------  --------     ---------
       Net cash used in operating activities..................................  (12,867)   (6,943)  (11,420)      (37,297)

                                                                               --------  --------  --------     ---------
Cash provided by (used in) investing activities:
  Purchases of property and equipment.........................................     (238)     (877)   (5,212)       (7,759)
  Proceeds from sale of equipment.............................................        9        --        --             9
  Purchases of other assets...................................................       --        (1)       --            (1)
  Maturities of investments...................................................       --        --    57,327        57,327
  Purchases of investments....................................................       --   (77,664)  (29,049)     (106,713)

                                                                               --------  --------  --------     ---------
       Net cash provided by (used in) investing activities....................     (229)  (78,542)   23,066        57,137

                                                                               --------  --------  --------     ---------
Cash provided by (used in) financing activities:
  Discount on notes receivable from employees.................................       --        --       102           102
  Imputed interest on notes receivable from employees.........................       --        --       (11)          (11)
  Issuance of notes receivable to employees...................................       --        --      (500)         (500)
  Proceeds from issuance of convertible notes payable to related parties......    5,000        --        --         5,000
  Repayment of convertible note payable to related party......................       --    (2,621)       --        (2,621)
  Proceeds from related party contributions receivable........................       --        --        --        17,000
  Proceeds from issuance of Series A preferred units..........................       --        --        --         2,953
  Proceeds from issuance of Series B preferred units..........................       --        --        --         4,000
  Proceeds from issuance of Series C preferred stock, net of issuance costs...       --    92,678        --        92,678
  Proceeds from issuance of Series D preferred stock, net of issuance costs...       --        --       250           250
  Proceeds from issuance of common stock......................................       --       113        27           140

                                                                               --------  --------  --------     ---------
       Net cash provided by (used in) financing activities....................    5,000    90,170      (132)      118,991

                                                                               --------  --------  --------     ---------
Net increase (decrease) in cash and cash equivalents..........................   (8,096)    4,685    11,514        24,557
Cash and cash equivalents at beginning of period..............................   16,454     8,358    13,043            --

                                                                               --------  --------  --------     ---------
Cash and cash equivalents at end of period.................................... $  8,358  $ 13,043  $ 24,557     $  24,557

                                                                               ========  ========  ========     =========
Supplemental disclosures of cash flow information:
  Interest paid............................................................... $     --  $    193  $     --     $     193
Noncash investing and financing activities:
  Conversion of notes payable into Series C preferred stock...................       --     2,500        --         2,500
  Issuance of common stock in exchange for notes receivable from stockholders.       --     2,395        --         2,395


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

                                      72



                                DIADEXUS, INC.
                         (a development stage company)

                         NOTES TO FINANCIAL STATEMENTS

Note 1.  The Company:

   diaDexus, Inc. (the "Company"), was founded as a Delaware limited liability
company in August 1997 by SmithKline Beecham Corporation ("SmithKline Beecham")
and Incyte Genomics, Inc. ("Incyte") (together, the "Members"). On April 4,
2000, the Company was converted to a Delaware corporation (see Note 2).

   The Company focuses on the discovery, development and commercialization of
novel, patent-protected diagnostic and therapeutic products with high clinical
value. Since its formation in 1997, the Company has focused on discovering
molecular targets and developing novel diagnostic products for the improved
detection, classification and prognosis of diseases. Where possible, the
Company seeks to develop diagnostic and therapeutic products that are directedrestructuring accrual at the same molecular target, enabling a diagnostic/therapeutic tandem approach
to detect and treat disease.

Note 2.  Summary of Significant Accounting Policies:

  Use of estimates

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

  Concentration of credit risk and other risks and uncertainties

   The Company's financial instruments that are subject to concentration of
credit risk consist primarily of cash and cash equivalents and marketable
securities. The Company's policy is to place its cash and cash equivalents and
marketable securities with high credit quality financial institutions in order
to limit the amount of credit exposure. The Company has not experienced any
losses to date.

   The Company's future products may require approval from the U.S. Food and
Drug Administration ("FDA") and may require approval from certain international
regulatory agencies prior to commencing commercial sales. There can be no
assurancepoint that the Company's products will receive any of these required
approvals. If the Company was denied such approvals or such approvals were
delayed, it would have a material adverse impact on the Company's results of
operations.

   The Company is subject to risks common to companies in the biotechnology
industry including, but not limited to, new technological innovations,
dependence on key personnel, protection of proprietary technology, compliance
with government regulations, uncertainty of market acceptance of products,
product liability and the need to obtain additional financing.

   SmithKline Beecham accounted for 100% of revenues during the year ended
December 31, 1999.

  Cash and cash equivalents

   The Company considers all highly liquid investments with original maturities
of less than 90 days to be cash equivalents. Investments with maturities of
less than one year from the balance sheet date and with original maturities
greater than 90 days are considered short-term investments. Investments consist
primarily of money market accounts, commercial paper, certificates of deposit
and other short-term instruments. These investments

                                      73



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

typically bear minimal risk. This minimization of risk is consistent with the
Company's policy to maintain high liquidity and ensure safety of principal.

  Restricted cash

   Restricted cash represents term deposits held at a financial institution as
collateral under the Company's operating lease arrangement for research and
development facilities in South San Francisco for the remainder of the lease,
which expires in September 2003.

  Investments

   The Company's short-term and long-term investments are classified as
available-for-sale. Available-for-sale securities are carried at fair value
based on quoted market prices, with the unrealized gains and losses included in
accumulated other comprehensive income within stockholders' equity. The
amortized cost of debt securities in this category is adjusted for amortization
of premiums and accretion of discounts to maturity. Such amortization is
included in interest and other income. Realized gains and losses and declines
in value judged to be other-than-temporary on available-for-sale securities are
also included in interest and other income. Interest and dividends on
securities classified as available-for-sale are also included in interest and
other income. The cost of securities sold is based on the specific
identification method.

   The amortized cost and fair value of securities, with gross unrealized gains
and losses, were as follows (in thousands):


                                                   Gross      Gross
                                       Amortized Unrealized Unrealized  Fair
                                         Cost      Gains      Losses    Value
                                       --------- ---------- ---------- -------
  
  Debt securities at December 31, 2000
     Corporate bonds..................  $77,663     $493       $(11)   $78,145
                                        =======     ====       ====    =======
  Debt securities at December 31, 2001
     Corporate bonds..................  $49,382     $684       $ --    $50,066
                                        =======     ====       ====    =======


   The fair value of available-for-sale debt securities by contractual maturity
at December 31, 2000 and December 31, 2001 was as follows (in thousands):


                                                               December 31,
                                                              ---------------
                                                               2000    2001
                                                              ------- -------
  
  Within 1 year.............................................. $33,874 $41,194
  Greater than 1 year, less than 5 years.....................  44,271   8,872
                                                              ------- -------
                                                              $78,145 $50,066
                                                              ======= =======


  Property and equipment

   Property and equipment are recorded at cost and depreciated over their
estimated useful lives using the straight-line method. Assets contributed by
the Members during 1997 were recorded at amounts equal to the Members' net
carrying value. Laboratory equipment, computers, software, and office furniture
are depreciated over three years. Leasehold improvements are recorded at cost
and amortized over the term of the non-cancelable lease or their useful life,
whichever is shorter. Maintenance and repairs are expensed as incurred.

                                      74



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


  Impairment of long-lived assets

   The Company reviews long-lived assets for impairment whenever events or
circumstances suggest that the carrying amount of those assets may not be fully
recoverable or that the estimated useful life of those assets has changed
significantly. When expected future undiscounted cash flows that are expected
to be generated by an asset are less than its carrying amount, then an
impairment loss is recognized and the asset is written down to its estimated
fair value.

  Revenue recognition

   The amount received from SmithKline Beecham under a non-refundable license
arrangement was recognized during 1999 as the earnings process was completed
pursuant to the terms of the agreement and no remaining performance obligations
existed. Any amounts received in advance of completing the earnings process are
recorded as deferred revenue. As of July 11, 2001, the Company entered into a
research and license agreement with Fujirebio, Inc. Pursuant to the agreement,
the Company will receive an aggregate amount of $1,750,000 in the form of an
upfront license fee, an anniversary fee and research support payments. The
upfront license fee will be recognized as revenue over the three-year term of
the agreement and the anniversary payment will be recognized over the remaining
two-year term of the agreement. The research support payments will be
recognized as revenue as the research work is performed and the related
research costs are incurred. As of December 31, 2001, $375,000 was received as
upfront license fee and research support payments prior to completion of the
earnings process. This amount was recorded as deferred revenue as of December
31, 2001. During the last quarter of 2001, the Company entered into several
agreements for the sale of clinical diagnostic test kits to clinical reference
laboratories. Pursuant to these agreements, the Company received prior to
December 31, 2001 an aggregate amount of $100,000 prior to completion of the
earnings process. The amount of $100,000 was recorded as deferred revenue as of
December 31, 2001, and will be recognized as revenue upon completion of the
earnings process. Product sales are recognized as revenue upon completion of
the earnings process. The earning process is complete upon delivery, provided
that persuasive evidence of an arrangement exists, the price is fixed or
determinable and collection of the resulting receivable is reasonably assured.
The Company's revenue recognition practices are in accordance with SEC Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements."

  Research and development

   The Company recognizes research and development expense as incurred.

  Income taxes

   From the Company's inception through April 4, 2000, no provision or benefit
for federal or state income taxes was recorded in the financial statements as
the Company was a limited liability company and, therefore, was taxed as a
partnership. Rather, the federal and state income tax effects of the Company's
results of operations were recorded by the Members in their respective income
tax returns. On April 4, 2000, in connection with completing the Series C
preferred stock financing, the Company became subject to the C corporation
provisions of the Internal Revenue Code. Accordingly, any earnings after this
date are taxed at federal and state corporate income tax rates.

   Current income tax expense (benefit) is the amount of income taxes expected
to be payable (refundable) for the current year. A deferred income tax asset or
liability is computed for the expected future impact of the differences between
the financial reporting and tax bases of assets and liabilities as well as the
expected future

                                      75



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

tax benefit to be derived from tax loss and tax credit carryforwards. Deferred
income tax expense (benefit) is generally the net change during the year in the
deferred income tax assets or liability. A valuation allowance is established
when necessary to reduce deferred tax assets to the amount more likely than not
to be realized in future tax returns.

  Stock-based compensation

   The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25"), Financial Accounting
Standards Board Interpretation No. 28, "Accounting for Stock Appreciation
Rights and Other Variable Stock Option or Award Plans" ("FIN No. 28"),
Financial Accounting Standards Board Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation--an Interpretation of APB No.
25" ("FIN No. 44"), and Emerging Issues Task Force No. 00-23, "Issues Related
to the Accounting for Stock Compensation Under APB No. 25 and FIN No. 44"
("EITF No. 00-23") and complies with the pro forma disclosure provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123").

   Under APB No. 25, compensation expense is based on the difference, if any,
on the date of the grant between the estimated fair value of the Company's
common stock and the exercise price. SFAS No. 123 defines a "fair value" based
method of accounting for employee stock options. Pro forma disclosures of the
difference between compensation expense included in net loss and the related
cost measured by the fair value method are presented in Note 5.

   The Company accounts for stock issued to non-employees in accordance with
the provisions of SFAS No. 123 and Emerging Issues Task Force No. 96-18,
"Accounting for Equity Instruments that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services" ("EITF No.
96-18").

  Comprehensive income (loss)

   The Company accounts for comprehensive income in accordance with Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and
displaying comprehensive income (loss) and its components. Comprehensive income
(loss) refers to revenues, expenses, gains and losses that under generally
accepted accounting principles are included in comprehensive income (loss) but
excluded from net income (loss).

  Recent accounting pronouncements

   become determinable.
16.    Subsequent Events
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141 "Business Combinations" which establishes financial accounting and
reporting for business combinations and supercedes APB Opinion No. 16,
"Business Combinations," and SFAS No. 38, "Accounting for Preacquisition
Contingencies of Purchased Enterprises." SFAS No. 141 requires that all
business combinations be accounted for using one method, the purchase method.
The provisions of this statement apply to all business combinations initiated
after June 30, 2001. The Company will adopt SFAS No. 141 during the first
quarter of fiscalNovember 2002, and this adoption is expected to have no impact on the
Company's financial reporting and related disclosures.

   In July 2001, the FASB issued SFAS No. 142 "Goodwill and Other Intangible
Assets," which establishes financial accounting and reporting for acquired
goodwill and other intangible assets and supercedes APB Opinion No. 17,
Intangible Assets. SFAS No. 142 addresses how intangible assets that are
acquired individually

                                      76



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

or with a group of other assets (but not those acquired in a business
combination) should be accounted for in financial statements upon their
acquisition, and after they have been initially recognized in the financial
statements. The provisions, of this statement are effective for fiscal years
beginning after December 15, 2001. The Company will adopt SFAS No. 142 during
the first quarter of fiscal 2002, and this adoption is expected to have no
material impact on the Company's financial reporting and related disclosures.

   In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of," in that it removes goodwill from its impairment scope and
allows for different approaches in cash flow estimation. However, SFAS No. 144
retains the fundamental provisions of SFAS No. 121 for (a) recognition and
measurement of the impairment of long-lived assets to be held and used and (b)
measurement of long-lived assets to be disposed of. SFAS No. 144 also
supercedes the business segment concept in APB Opinion No. 30, "Reporting the
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," in that it permits presentation of a component of an entity,
whether classified as held for sale or disposed of, as a discontinued
operation. However, SFAS No. 144 retains the requirement of APB Opinion No. 30
to report discontinued operations separately from continuing operations. The
Company is required to adopt the provisions of SFAS No. 144 effective January
1, 2002, with earlier application encouraged. The Company believes that the
implementation of this standard will not have a material effect on the
Company's results of operations and financial position.

Note 3.  Balance Sheet Components

   Property and equipment consist of the following (in thousands):


                                                          December 31,
                                                        ----------------
                                                         2000     2001
                                                        -------  -------
      
      Laboratory, computer and office equipment........ $ 3,382  $ 5,686
      Leasehold improvements...........................   2,649    2,611
                                                        -------  -------
      Total............................................   6,031    8,297
      Less: Accumulated depreciation and amortization..  (3,879)  (3,187)
                                                        -------  -------
                                                        $ 2,152  $ 5,110
                                                        =======  =======


   Accrued liabilities consist of the following (in thousands):


                                                          December 31,
                                                          -------------
                                                           2000   2001
                                                          ------ ------
        
        Payroll and related.............................. $  424 $  658
        Outside services.................................    347     60
        Deposits.........................................     72     64
        Accrued loss on the Santa Clara facility lease...     --    426
        Accrued moving and relocation expenses...........     --    605
        Accrued legal expenses...........................     --    160
        Other............................................    265    297
                                                          ------ ------
                                                          $1,108 $2,270
                                                          ====== ======


                                      77



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


Note 4.  Commitments and Contingencies

   The Company has an operating lease for laboratory and office facilities in
Santa Clara, California through September 30, 2002. The Company declined the
option to renew the lease. During 2001, the Company vacated the facility and
accrued for the loss on the facility lease.

   In July 2001, the Company entered a facility lease agreement expiring in
September 2003. Minimum future lease payments as of December 31, 2001 are as
follows (in thousands):


            Year Ending December 31,
            ------------------------
            
            2002............................................. $1,580
            2003.............................................    744
                                                              ------
                                                              $2,324
                                                              ======


   Rent expense was $838,000, $804,000 and $1,413,438 for the years ended
December 31, 1999, 2000 and 2001, respectively. A security deposit of $67,000
relating to our facility lease was paid by SmithKline Beecham and is included
in due to related parties in the accompanying balance sheets.

   The Company has subleased a portion of its leased office facilities in Santa
Clara under a non-cancelable lease agreement since 1998. Rental income for the
years ended December 31, 1999, 2000 and 2001 was $202,000, $299,000 and
$272,000, respectively. The aggregate minimum future lease payments to be
received by the Company under the sublease are $155,000.

   The Company entered into a collaboration agreement with the University of
Pittsburgh Medical Center effective October 1, 2000 to analyze RNA expression
in human cancer tissues. Under this agreement, the University of Pittsburgh
Medical Center will perform RNA expression analysis on human cancer and
corresponding non-malignant tissues to establish genotypic classifications. The
Company will pay the University of Pittsburgh Medical Center approximately
$1,218,000 over the three year term of this agreement. The Company paid $0 and
$405,000 in relation to work done by the University of Pittsburgh Medical
Center for the years ended December 31, 2000 and 2001, respectively.

   The Companywe entered into an agreement to acquire Maxia Pharmaceuticals, Inc., a privately-held company based in San Diego, California. Maxia is a drug discovery and development company that specializes in
76
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
small molecule drugs targeting diabetes and other metabolic disorders, cancer, inflammatory diseases and heart disease. On February 18, 2003, one of our wholly owned subsidiaries was merged with Agilent Technologies, Inc. in
August 2000 for early access to Agilent's DNA microarray technology. Under the
termsand into Maxia. As a result of the agreement, the Company can purchasemerger:
Maxia became a numberwholly owned subsidiary of custom in-situ
microarrays at a costIncyte;
Each share of approximately $405,000. The agreement expires in
August 2002 or when the products become available, whichever is sooner, and may
not be terminated by either party except under specified circumstances. The
Company paid $0 and $242,000 for the purchase of microarrays for the years
ended December 31, 2000 and 2001, respectively.

   The Company has entered into employment agreements with certain key
executive officers. Such agreements provide for severance payments and, in one
case, provide for accelerated vesting ofMaxia common stock options following a change in
control of the Company.

   On October 1, 2001, in connection with the relocation of its office and
laboratory premises, the Company offered a relocation assistance program to
employees who met specific criteria, for a period of one year from the date of
relocation. This relocation assistance program provides for qualified
relocating expense claims. Relocation expenses are expensed as incurred.
Employee relocation expense for the year ended December 31, 2001 was $708,000.

                                      78



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


   On December 18, 2001, the Company entered into a Services Agreement with
Compugen Ltd. ("Compugen"). Pursuantoutstanding immediately prior to the agreement, the Company is committed
to pay up to $1.1 million for services received from Compugen. In conjunction
with enteringmerger was converted into the agreement, the Company also issuedright to receive 0.05496 of a warrant to Compugen
to purchase up to 393,571 sharesshare of the company'sour common stock at a pricestock;
Each share of $12.00 per share. The warrant will vest as certain future performance criteria
are met by Compugen. The warrant expires in December 2006 (see Note 5).

Note 5.  Members' and Stockholders' Equity:

  Preferred units and stock

   In September 1997, the Company issued 4,400,000 Series A Preferred units, no
par value, to SmithKline Beecham, at $3.41 per unit. At the time these units
were issued, the Company received an initial capital contribution of $4,000,000
in cash and assets and a contractual commitment for additional cash
contributions of $7,000,000 and $4,000,000 which were received on April 15,
1998 and July 15, 1998, respectively. Upon conversion of the Company from a
limited liability company into a C corporation, the Series A Preferred units
were exchanged for shares ofMaxia Series A Preferred Stock on a one-to-one basis.
The Series A Preferred Stock converts automatically to Common Stock upon
completion of an initial public offering by the Company that results in net
proceeds of at least $20,000,000 and an offering price of at least $10.00 per
share.

   In September 1997, the Company also issued 4,400,000 Series B Preferred
units, no par value, to Incyte at $2.27 per unit. At the time these units were
issued, the Company received an initial capital contribution of $4,000,000 in
cash and a contractual commitment for additional cash contributions of
$2,000,000 and $4,000,000 which were received on April 15, 1998 and July 15,
1998, respectively. Upon conversion of the Company from a limited liability
company into a C corporation, the Series B Preferred units were exchanged for
shares of Series B Preferred Stock on a one-to-one basis. The Series B
Preferred Stock converts automatically to Common Stock upon completion of an
initial public offering by the Company that results in net proceeds of at least
$20,000,000 and an offering price of at least $10.00 per share.

   In April 2000, the Company issued 13,225,807 shares of Series C Preferred
Stock, $0.01 par value, at $7.75 per share. Net proceeds were approximately
$92,678,000 after cash offering expenses of $7,322,000. The Series C Preferred
Stock converts automatically to Common Stock upon completion of an initial
public offering by the Company that results in net proceeds of at least
$20,000,000 and an offering price of at least $10.00 per share.

   In connection with the sale of Series C Preferred Stock, the Company issued
a warrant in June 2000 to purchase 129,032 shares of Series C Preferred Stock
at $7.75 per shareoutstanding immediately prior to the placement agent. The Series C Preferred Stock warrant
converts automaticallymerger was converted into the right to a Common Stock warrant upon completionreceive 0.20035 of an initial
public offering by the Company that results in net proceeds of at least
$20,000,000 and an offering price of at least $10.00 per share. The warrant
becomes exercisable in 2005. The Company valued this warrant using the
Black-Scholes option pricing model with the following assumptions: expected
life of five years; risk free interest rate of 6.23%; expected dividend yield
of zero, and volatility of 85%. The fair value of the warrant of $846,367 is
included in the carrying value of the Series C Preferred Stock.

   In connection with signing of the Fujirebio research and license agreement
in July 2001 (see Note 2), the Company issued 20,833 shares of Series D
Preferred Stock, $0.01 par value, at $12.00 per share. The Series D Preferred
Stock converts automatically to Common Stock upon completion of an initial
public offering by the Company that results in net proceeds of at least
$20,000,000 and an offering price of at least $10.00 per share.

                                      79



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


   At December 31, 2000 and 2001, the Company has reserved 22,154,839 and
22,175,672 shares respectively, of Common Stock for future issuance upon the
conversion of the Preferred Stock. Included in the December 31, 2000 and 2001
shares reserved for future issuance upon the conversion of Preferred Stock, is
a warrant to purchase 129,032 shares of Series C Preferred Stock.

  Dividends

   In the event dividends are paid on any share of Common Stock, an additional
dividend must be paid with respect to all outstanding shares of Preferred Stock
in an amount per share (on an as-if-converted basis) equal to the amount paid
or set aside for eachour common stock; and
Each share of Common Stock, whenever funds are legally
available. Such dividends are payable when, as and if declared by the Board of
Directors. No dividends accrue unless declared by the Board of Directors. As of
December 31, 2001, no dividends had been declared.

  Liquidation preference

   In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, holders of the Series A, Series B, Series C
and Series D Preferred Stock shall be entitled to receive, prior and in
preference to any distribution of any of the assets to the holders of the
Common Stock, an amount per share equal to $3.41 for each outstanding share of
Series A Preferred Stock, $2.27 for each outstanding share ofMaxia Series B Preferred Stock and $7.75 for each outstanding share ofMaxia Series C Preferred Stock and $12.00 for each outstanding immediately prior to the merger was converted into the right to receive 0.46237 of a share of Series D Preferred Stock, plus
any declared but unpaid dividends on suchour common stock and $0.14895 in cash.
The former stockholders of Maxia received, in the aggregate, approximately 2,625,820 shares of our common stock and approximately $580,000 in cash upon the consummation of the merger. We also assumed outstanding third party indebtedness of approximately $920,000. $2.5 million in cash and 975,000 shares of our common stock was paid to certain debt holders of Maxia. The cash portion of the purchase price was provided from our existing cash balances.
In addition, upon the consummation of the merger, all outstanding shares of Maxia Series A,A-Additional Payments, Maxia Series B,B-Additional Payments, Maxia Series C orC-Additional Payments and Maxia Common-Additional Payments were converted, in the aggregate, into the right to receive:
up to 437,636 shares of our common stock and $500,000 in cash on the second anniversary of the consummation of the merger; and
up to 437,636 shares of our common stock and $500,000 in cash on the third anniversary of the consummation of the merger.
Further, all outstanding shares of Maxia Series D Preferred Stock. IfA-Earn Out, Maxia Series B-Earn Out, Maxia Series C-Earn Out and Maxia Common-Earn Out were converted, in the aggregate, into the right to receive certain Earn Out Amounts of up to a potential aggregate amount of $14.0 million upon the occurrence of certain milestones set forth in the merger agreement. Twenty percent of each earn out payment, if earned, will be paid in cash and the remaining eighty percent will be paid in shares of our common stock such that an aggregate of $2.8 million in cash and $11.2 million in our common stock could potentially be paid pursuant to the earn out milestones. The milestones occur as Maxia products enter various stages of human clinical trials and may be earned at any time prior to the tenth anniversary of the consummation of the merger.
Prior to entering into the merger agreement, in August 2002, we loaned Maxia $1.5 million in exchange for the right to negotiate with Maxia exclusively regarding an acquisition or other strategic transaction. In exchange for the loan, Maxia issued a $1.5 million senior convertible note to us. Interest on the note would have accrued at the rate of 8% per year in the event the assets and funds thus distributed among the holders of the Preferred Stock
shall be insufficient to permit the payment to such holders of the full
aforesaid preferential amounts, then the entire assets and funds of the Company
legally available for distribution shall be distributed ratably among the
holders of the Series A, Series B, Series C and Series D Preferred Stock in
proportion to the aggregate liquidation preference of such stock owned by each
such holder.

   Upon completion of the distributions described above, all of the remaining
assets of the Company available for distribution to stockholders shall be
distributed among the holders of Common Stock pro rata based on the number of
shares of Common Stock held by each.

  Voting rights

   Holders of Series A, Series B, Series C and Series D Preferred Stock are
entitled to one vote for each share of Common Stock into which such shares can
be converted.negotiations with Maxia had terminated. The holders of the outstanding shares of Series A and Series B
Preferred Stock, voting as separate classes, are each entitled to elect one
member to the Company's Board of Directors and the holders of the outstanding
shares of Series C Preferred Stock, voting as a separate class, are entitled to
elect two members to the Company's Board of Directors. Any remaining board
members will be elected by the holders of Common Stock and the holders of
Preferred Stock voting together as a single class.

  Conversion rights

   Shares of Series A, Series B, Series C and Series D Preferred Stock arenote was convertible into shares of Common Stockany class or series of Maxia capital stock at a set conversion price. We forgave the optionprincipal of the holder, or
automatically upon completing a public offering of at least $20,000,000 of
Common Stock at an offering price of at least $10.00 per share,note upon the written consentconsummation of the holders of at least 80%merger as a portion of the then outstanding sharesconsideration in the transaction.
In addition, we loaned Maxia an aggregate of Series A, Series B, Series C$1.4 million to cover their operating expenses during the period between the signing of the merger agreement and Series D Preferred Stock voting together

                                      80



                                DIADEXUS, INC.
                         (a development stage company)

                  the consummation of the merger. In exchange for the loan, Maxia issued to us a second senior convertible note. Through December 31, 2002, we had funded
77
INCYTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--STATEMENTS—(Continued)

as a single class on an as-if-converted basis. The conversion rate is one share
$0.9 million of Common Stock for one shareMaxia’s operating expenses. Although our analysis of Preferred Stock (subjectpurchase price allocation remains incomplete, we expect to certain
adjustments).

  Common stock

   As of December 31, 2001, the Company had issued 2,099,968 shares of Common
Stock, $0.01 par value, primarily in connection with the exercise of stock
options. No dividends have been declared. In the event of any liquidation,
dissolution or winding up of the Company, either voluntary or involuntary,
holders of Common Stock shall be entitled to receive the remaining assets of
the Company after distribution to holders of Preferred Stock, pro rata based on
the number of shares of Common Stock held by each holder.

   In March 2000 the Company committed to grantrecord a warrant to purchase 50,000
shares of Common Stock at $1.20 per share for services to be received. This
warrant has not been granted as of December 31, 2001.

  Stock option plans

   In January 1998, the Company's Board of Directors adopted the 1997 Incentive
Plan ("1997 Plan") under which 1,200,000 shares of the Company's Common Units
("Units") were reserved for issuance to employees and consultants of the
Company. During 1999, the Company increased the number of Units reserved for
future issuance by 1,000,000. Options granted under the 1997 Plan are for terms
not to exceed ten years. If the option is granted to an individual who, at the
time of grant, owns a membership interest in the Company representing more than
10% of the voting power of all classes of membership interest of the Company or
any parent or subsidiary, the exercise price of the option must be at least
110% of the estimated fair value of the Units at the date of grant. Exercise
prices of options granted to all other persons must be at least 85% of the
estimated fair value of the Units at the date of grant. Options under the 1997
Plan generally vest over four years. The 1997 Plan expires in 2008.

   In April 2000, all of the Units originally granted under the 1997 Plan were
converted into options to acquire shares of Common Stock under the 2000 Equity
Incentive Plan (the "2000 Plan"), which provides for the issuance of options to
purchase up to 2,200,000 shares of the Company's Common Stock. The Board of
Directors has the authority to determine to whom options will be granted, the
number of shares, the term and exercise price (which cannot be less than the
estimated fair value at date of grant for incentive stock options or 85% of the
estimated fair value for nonstatutory stock options). Historically, estimated
fair value has been determined by the Board of Directors. If an employee owns
stock representing more than 10% of the outstanding shares, the price of each
share shall be at least 110% of estimated fair value. Options generally vest
ratably over four years and expire within ten years of the date of the grant.
In June 2000 and December 2001, the Company reserved an additional 2,500,000
and 2,500,000 shares of Common Stock, respectively, under the 2000 Plan.

   In February 2001, the Company's Board of Directors adopted the 2000 Employee
Stock Purchase Plan (the "2000 ESPP") under which a total of 350,000 shares of
Common Stock were approved for issuance.

   In February 2001, the Company's Board of Directors adopted the 2001 Equity
Incentive Plan (the "2001 Plan") which will become effective upon completion of
the Company's initial public offering. Under the 2001 Plan, a maximum of
2,500,000 shares of Common stock will be reserved for issuance in addition to
any shares of Common Stock that remain reserved for issuance under the 2000
Plan at the time of completion of the Company's initial public offering.
However, in no event shall the total number of shares reserved for issuance
under the 2001 Plan, together with the total number of shares originally
reserved under the 2000 Plan, exceed 7,200,000 shares.

                                      81



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


   Stock option activity under the Company's plans is as follows:


                                                       Outstanding Options
                                                       --------------------
                                                                   Weighted
                                            Options                Average
                                           Available   Number of   Exercise
                                           for Grant    Options     Price
                                           ----------  ----------  --------
    
    Options reserved at the plan inception  1,200,000          --   $  --
    Options granted.......................   (760,500)    760,500    0.36
    Options canceled......................     44,250     (44,250)   0.35
                                           ----------  ----------
    Balances, December 31, 1998...........    483,750     716,250    0.36
    Additional shares reserved............  1,000,000          --      --
    Options granted....................... (1,055,083)  1,055,083    0.75
    Options canceled......................    433,738    (433,738)   0.47
                                           ----------  ----------
    Balances, December 31, 1999...........    862,405   1,337,595    0.63
    Additional shares reserved............  2,500,000          --      --
    Options granted....................... (2,438,213)  2,438,213    1.85
    Options exercised.....................         --  (2,076,498)   1.21
    Options canceled......................    204,303    (204,303)   0.68
                                           ----------  ----------
    Balances, December 31, 2000...........  1,128,495   1,495,007    1.81
    Additional shares reserved............  2,500,000          --      --
    Options granted....................... (1,759,590)  1,759,590    5.03
    Options exercised.....................         --     (23,270)   1.14
    Options canceled......................    189,089    (189,089)   2.07
                                           ----------  ----------
    Balances, December 31, 2001...........  2,057,994   3,042,238    3.68
                                           ==========  ==========


   The following summarizes information about stock options outstanding at
December 31, 2001:


                             Options Outstanding       Options Exercisable
                       ------------------------------- -------------------
                                   Weighted
                                   Average                        Weighted
                                  Remaining                       Average
      Exercise                   Contractual  Exercise            Exercise
       Prices           Number   Life (Years)  Price    Number     Price
      --------         --------- ------------ --------  -------   --------
      
      $0.35               76,000     6.07      $0.35    67,672     $0.35
       0.75              229,356     7.30       0.75    95,860      0.75
       1.20               58,812     8.16       1.20    25,603      1.20
       1.30              551,167     8.50       1.30   258,873      1.30
       1.80              134,813     8.88       1.80    30,610      1.80
       5.00            1,992,090     9.65       5.00    29,091      5.00
                       ---------                        -------
                       3,042,238     9.11              507,709      1.31
                       =========                        =======


   The weighted average grant date fair value of options granted during the
years ended December 31, 1999, 2000 and 2001, was $0.14, $7.41 and $7.73 per
share, respectively.

                                      82



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)


   Had compensation cost for the Company's stock options been calculated based
upon the fair value at the date of grant, the Company's net loss would have
increased to the pro forma amounts shown in the table that follows:


                                                  Year Ended December 31,
                                           ------------------------------------
                                              1999          2000        2001
                                            --------      --------    --------
                                           (in thousands, except per share data
   
   Net loss:
      As reported......................... $ 11,286      $ 23,346    $(24,517)
      Pro forma...........................  (11,313)      (24,002)    (25,305)


   The fair value of each option grant is estimated at the grant date using the
minimum value method, assuming an expected option term of four years, no
dividend yield, and risk-free interest rates of 5.11% to 5.86%, 5.10% to 6.20%
and 3.58% to 4.88% for the years ended December 31, 1999, 2000 and 2001
respectively.

  Deferred stock compensation

   For the year ended December 31, 2000 and 2001, the Company recorded
$18,331,000 and $12,257,000 respectively of deferred stock compensation in
accordance with APB No. 25, SFAS No. 123 and EITF Issue No. 98-16 from the
grant of stock options to employees, directors and consultants. The difference
between exercise price of the option granted and the estimated fair value of
Common Stock on the grant date is recognized as deferred stock compensation.
Stock compensation expense is being recognized over the vesting period of the
related options in accordance with FIN No. 28. The Company amortized $5,558,000
and $10,219,000 of stock-based compensation expense during the years ended
December 31, 2000 and 2001, respectively.

   In November 2000, the Company modified certain outstanding stock options
which were then exercised in exchange for full recourse non-interest bearing
notes. In accordance with APB 25 and FIN No. 44, the associated remeasurement
of such options resulted in a one-time compensation charge in the statementsfirst quarter of operations for2003 to the year ended December 31, 2000 of $9,599,000.

   The notes mature over periods ranging from seven to ten years. The discount
associated with the use of non-interest bearing notes was calculated using an
interest rate of 6.5% and a weighted average term of 9.44 years, and resulted
in an immediate compensation charge of $1,281,000, of which $790,000 wasextent our final analysis concludes that total purchase price should be allocated to general and administrative expense and $491,000 was allocated toin-process research and development expense asor other expenses.
Frederick B. Craves, one of December 31, 2000. The discount will be
recognized as interest income over the lifeour directors, is a partner of the loans.

  Warrant for Common Stock

   In December 2001, the Company entered into a Service Agreement with Compugen
Ltd. ("Compugen"). In conjunction with entering into the agreement, the Company
issued a warrant to Compugen to purchase up to 393,571Bay City Capital, which held shares of the Company's
common stockMaxia stock. The transaction with Maxia was negotiated at arms’ length and, because Dr. Craves is a pricedirector of $12.00 per share. The warrant will vest upon the
outcome of certain future performance criteria expected to be met by Compugen
over the next six months, and will expire in December 2006. As the outcome of
these future events is not solely within Compugen's control, the Company valued
the warrant at its lowest aggregate fair value, which was zero, as of December
31, 2001.

  401(k) savings plan

   In January 1998, the Company has establishedboth companies, a qualified savings plan for
employees under Section 401(k) (the "401(k) Plan") of the Internal Revenue
Service Code, in which employees may defer as much as 15% of

                                      83



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

their pretax annual salary up to the statutory limits. The 401(k) Plan permits
discretionary matching and profit sharing contributions to be made by the
Company. Through December 31, 2001 the Company has not made any contributions
to the 401(k) Plan.

Note 6.  Income Taxes:

   On April 5, 2000, the Company became subject to the C corporation provisions
of the Internal Revenue Code. No provision or benefit for income taxes has been
recognized since April 5, 2000 as the Company has incurred net operating losses.

   The significant components of deferred tax assets and liabilities are as
follows (in thousands):


                                                          December 31,
                                                          -------------
                                                           2000   2001
                                                          ------ ------
        
        Net operating loss carryforwards................. $  212 $5,601
        Depreciation and amortization....................  2,635  2,560
        Research tax credit carryforwards................    530  1,165
        Other............................................     45    235
                                                          ------ ------
           Total deferred tax assets.....................  3,422  9,561
        Deferred interest income.........................    620     --
        Less: Valuation allowance........................  2,802  9,561
                                                          ------ ------
        Net deferred taxes............................... $   -- $   --
                                                          ====== ======


   The Company has provided a full valuation allowance for its deferred tax
assets at December 31, 2000 and 2001 due to the uncertainty surrounding the
future realization of such assets.

   At December 31, 2001, the Company had state and federal net operating loss
carryforwards of $5.1 million and $15.6 million, respectively, which expire in
2005 and 2020, respectively, and federal and state research tax credit
carryforwards of $1.2 million, which expire in 2020. Utilization of federal and
state net operating loss and tax credit carryforwards may be subject to an
annual limitation due to the "change in ownership" provisions of the Internal
Revenue Code.

Note 7.  Related Party Transactions:

   In connection with forming the Company, SmithKline Beecham, Incyte and the
Company entered into several agreements during September 1997, including an
Operating Agreement (the "Operating Agreement") and a Master Strategic
Relationship Agreement (the "Master Agreement"). The Operating Agreement served
as the Company's by-laws while the Master Agreement documents certain specific
matters regarding the operation of the Company. During September 1997, the
Company issued 4,400,000 shares of Series A Preferred units to SmithKline
Beecham in exchange for an initial capital contribution of $4,000,000 in cash
and assets and a contractual commitment for additional cash contributions of
$11,000,000, which was received in two installments on April 15 and July 15,
1998. Concurrently, the Company issued 4,400,000 shares of Series B Preferred
units to Incyte in exchange for an initial capital contribution of $4,000,000
in cash and a contractual commitment for additional cash contributions of
$6,000,000, which was received in two installments on April 15 and July 15,
1998.

   The Operating Agreement specified that the limited liability company would
merge into a C corporation at the earliest of (i) the eighteen month
anniversary of the Company's formation (March 1999); (ii) any time after

                                      84



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

January 1, 1999, if the Company's cash balance falls below $2,000,000, or (iii)
the mutual agreement of SmithKline Beecham and Incyte. Pursuant to the
Operating Agreement, the conversion of the Company into a C corporation was
deferred until completion of the Series C Preferred Stock financing in April
2000.

   In addition to the above contributions, SmithKline Beecham has granted the
Company various exclusive rights under a Collaboration and License Agreement
entered into by SmithKline Beecham, Incyte and the Company in September 1997.
Under this agreement, as amended, SmithKline Beecham has granted to the Company
an exclusive sublicenseable license under certain of its patents and know-how
with respect to genes and gene products for use as diagnostics through
September 2, 2001. In September 1997, the Company also entered into a
Collaborative LifeSeq Agreement and a Collaborative PathoSeq Database Agreement
with Incyte. Under these agreements, as amended and described below, Incyte has
provided the Company with non-exclusive access to certain of its gene sequence
and expression databases for research, diagnostic and therapeutic applications
until September 2003. These non-cash assets received as capital contributions
from SmithKline Beecham and Incyte were recorded at zero value, which was equal
to the carrying value of such assets by SmithKline Beecham and Incyte.

   Under the Collaboration and License Agreement as currently in effect, the
Company pays no milestones, royalties or other payments to SmithKline Beecham
but is obligated to pay pass-through royalties to Human Genome Sciences on
sales of products derived from the use of genes discovered by Human Genome
Sciences. In addition, although the Company has no plans to develop any
therapeutic products based on SmithKline Beecham's intellectual property, in
the event the Company does so, SmithKline Beecham has an exclusive license to
the Company's know-how or patents related to any such therapeutic products
until September 2005. In order to license the Company's products under this
arrangement, SmithKline Beecham must make milestone payments of up to an
aggregate of $4,000,000 for each patented product and up to an aggregate of
$1,600,000 for each product for which a patent is pending. As of December 31,
2001, no such milestone payments have been received or recognized by the
Company.

   Pursuant to the 1997 Collaboration and License Agreement and the 2000
Collaborative Agreement, the Company has committed to purchase $5,000,000 in
gene sequencing and microarray services from Incyte, including services
obtained under the GEM Services Agreement. As of December 31, 2000, the Company
had fulfilled all of its purchase commitments to Incyte under these agreements.

   Pursuant to an Intercompany Services Agreement, SmithKline Beecham and
Incyte provided the Company with certain legal, financial and research and
development services. Charges to the Company for these services were based upon
either actual costs or rates charged to other customers for similar services.
Such amounts, which were charged to research and development, were $0, $0 and
$0 in 1999, 2000 and 2001, respectively. Pursuant to the 1997 Collaboration and
License Agreement, and the Collaborative Agreement with Incyte, the Company
incurred costs which were charged to research and development of $449,000,
$2,600,000 and $0 during the years ended December 31, 1999, 2000 and 2001,
respectively.

   On September 28, 1998, the Company entered into a Service Agreement with
SmithKline Beecham. Under this agreement, SmithKline Beecham provided the
Company personnel support to identify diagnostic leads and research for a
period of one year. Pursuant to this agreement, the Company incurred costs
which were charged to research and development of $150,000 during the year
ended December 31, 1999. No such costs were incurred during the year ended
December 31, 2000 and 2001.

   On November 1, 1998, the Company entered into a GEM Services Agreement with
Incyte which was subsequently amended on September 1, 1999, pursuant to which
the Company obtains gene preparation and

                                      85



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

expression services from Incyte which the Company uses to generate gene
expression information and data. The Company paid Incyte for its services
pursuant to a pricing schedule for the production of standard and custom
microarrays, which pricing schedule was substantially similar to that contained
in GEM Services Agreements between Incyte and unrelated third parties. The GEM
Services Agreement expired on November 1, 2000. Pursuant to this agreement, the
Company incurred costs which were charged to research and development of
$1,479,000, $95,000 and $0 during the years ended December 31, 1999, 2000 and
2001, respectively.

   In February 1999, the Company entered into a License Agreement with
SmithKline Beecham Clinical Laboratories, Inc. Under the agreement, SmithKline
Beecham obtained licenses from the Company with respect to the Company's
technology for a potential molecular target for prostate cancer. Later during
1999, testing of this molecular target was discontinued and the parties agreed
that no additional work under the agreement was appropriate. Accordingly, the
non-refundable license fee of $100,000 was recognized as revenue in 1999.

   In July 1999, the Company issued two convertible notes payable in the amount
of $2,500,000 each to SmithKline Beecham and Incyte. The notes were due and
payable in April 2000, accruing interest at 5.6% per annum. Upon closing the
Series C financing, the note to SmithKline Beecham was converted to 322,580
shares of Series C Preferred Stock. Additionally, the Company paid interest of
$97,000 on the note to SmithKline Beecham and paid Incyte principal of
$2,500,000 and accrued interest of $97,000.

   In December 1999, the Company entered into a consulting agreement with Dr.
George Poste, Chairmanspecial committee of the Board of Directors, which did not include Dr. Craves, was formed to serve as the Company's
acting Chief Executive Officerconsider and as a consultant to the Company for a
quarterly fee of $20,000, plus travel expenses. For each of the years ended
December 31, 2000approve this related party transaction.
78
Interim Consolidated Financial Information (Unaudited)
(in thousands, except per share data)
 
  
Fiscal 2002 Quarter Ended
 
 
  
March 31,
 
  
June 30,
 
  
September 30,
 
  
December 31,
 
Revenues
  
$
29,014
 
  
$
29,059
 
  
$
22,390
 
  
$
21,149
 
Net loss(2)
  
 
(13,441
)
  
 
(17,541
)
  
 
(38,411
)
  
 
(67,492
)
Basic and diluted net loss per share
  
$
(0.20
)
  
$
(0.26
)
  
$
(0.57
)
  
$
(1.00
)
 
  
  
  
  
Shares used in computation of basic and diluted net loss per share
  
 
66,864
 
  
 
67,440
 
  
 
67,740
 
  
 
67,567
 
 
  
  
  
  
 
  
Fiscal 2001 Quarter Ended
 
 
  
March 31,
 
  
June 30,
 
  
September 30,
 
  
December 31,
 
Revenues
  
$
51,121
 
  
$
56,051
 
  
$
57,319
 
  
$
54,772
 
Loss before cumulative effect of accounting change(1)
  
 
(14,977
)
  
 
(9,891
)
  
 
(17,827
)
  
 
(145,205
)
Net loss(1)
  
 
(10,312
)
  
 
(9,891
)
  
 
(17,827
)
  
 
(145,205
)
Basic and diluted loss before extraordinary item
  
$
(0.23
)
  
$
(0.15
)
  
$
(0.27
)
  
$
(2.18
)
 
  
  
  
  
Basic and diluted net loss per share
  
$
(0.16
)
  
$
(0.15
)
  
$
(0.27
)
  
$
(2.18
)
 
  
  
  
  
Shares used in computation of basic and diluted net loss per share
  
 
65,745
 
  
 
66,076
 
  
 
66,370
 
  
 
66,565
 
 
  
  
  
  
(1)
The December 31, 2001 quarter includes $130.4 million of other expenses relating primarily to restructuring charges and long-lived asset write-downs.
(2)
The December 31, 2002 quarter includes $35.7 million of other expenses relating to restructuring charges.
79
SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS
Description—Year Ended December 31,
  
Balance at Beginning of Period
  
Charged to Costs and Expenses
  
Deductions
  
Balance at End of Period
 
  
(in thousands)
Allowance for doubtful accounts—2000
  
$
234
  
$
122
  
$
—  
  
$
356
Allowance for doubtful accounts—2001
  
 
356
  
 
1,745
  
 
—  
  
 
2,101
Allowance for doubtful accounts—2002
  
 
2,101
  
 
—  
  
 
1,568
  
 
533
Item 9.    Changes in and 2001, the Company paid an aggregate of $80,000 pursuant
to this agreement. In January 2000, the Company entered into a special
consulting agreementDisagreements with Dr. Poste to act as a consultant to the Company in
connection with the Series C preferred stock financing. Pursuant to this
agreement, the Company paid an aggregate of $15,000 to Dr. Poste in the year
ended December 31, 2000.

   In December 1999, the Company entered into a LifeArray Software License
Agreement with Incyte. Under this agreement, the Company has access to computer
software from Incyte for the processingAccountants on Accounting and analysis of microarray expression
data for a period of 12 months. The license fee paid for the use of the
software was $75,000 for the 12-month term.

   In February 2000, the Company entered into a Collaborative Agreement with
Incyte to replace and expand the rights that existed under the 1997
Collaborative LifeSeq and 1997 Collaborative PathSeq Database Agreements. Under
this new agreement the Company retained access to Incyte's human database,
LifeSeq Gold, and microbial database, PathoSeq, at no subscription cost until
September 2, 2003. Under the agreement, along with other database subscribers,
the Company has non-exclusive access to database products and database patents
for research, the diagnostic field of use and the pharmaceutical field of use.
Additionally, the Company has an option to exclusively license in the future
certain Incyte patents in the pharmaceutical field of use. The Company may pay
up to an aggregate of $4,622,500 in licensing fees and milestone payments for
each therapeutic product and up to an aggregate of $2,385,000 in licensing fees
and milestone payments for each antisense product, in addition to royalty
payments on the sale of these products. In October 2001, the Company amended
this agreement so that, under certain circumstances, it could sublicense to
third parties the rights to certain drug products, such as therapeutic
antibodies and small molecules. The Company also clarified in the amendment
that it had the right to use third party collaborators to conduct research and
development with respect to certain products. As of December 31, 2001, no
licensing fees or milestone payments have been paid or recognized by the
Company.


                                      86



                                DIADEXUS, INC.
                         (a development stage company)

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

   In June 2001, the Company made non-interest bearing secured loans totalling
$500,000 to two employees for the purchase of a home in connection with their
relocation to the Bay Area. These loans are repayable in a series of
installments, the first of which is due in November 2003 and the last in June
2006.

Note 8.  Subsequent Event:

   On January 4, 2002, the Company entered into an agreement with a third party
to purchase remnant anomyzed human biological material and corresponding
surgical pathology reports for an aggregate amount of $250,000 plus applicable
shipping costs not to exceed $6,000.

   On January 30, 2002, the Company entered into a collaboration and licensing
agreement with a third party to discover novel diagnostic markers and
therapeutic targets. Pursuant to the terms of the agreement, the Company has
purchased $1,000,000 of the third party's preferred stock and has committed to
pay up to $3,000,000 in research fees over the 18-month term of the agreement.

                                      87

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“Election of Directors"Directors” contained in the Company'sour Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Company's 2002our 2003 Annual Meeting of Stockholders to be held on June 4, 200123, 2003 (the "Proxy Statement"“Proxy Statement”). Certain information required by this item concerning executive officers is set forth in Part I of this Report under the caption “Executive Officers of the Registrant.”
Item 415405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16(a) of the Exchange Act. This disclosure is contained in the section entitled "Section“Section 16(a) Beneficial Ownership Reporting Compliance"Compliance” in the Proxy Statement and is incorporated herein by reference.

   The executive officers of the Company are as follows:

   Paul A. Friedman, Ph.D., age 59, joined the Company as the Chief Executive
Officer and a Director in November 2001. From 1994 until October 2001, Dr.
Friedman served as President of DuPont Pharmaceuticals Research Laboratories,
of DuPont Pharmaceuticals Company (formerly The DuPont Merck Pharmaceutical
Company), and from 1991 to 1994 he served as Senior Vice President at Merck
Research Laboratories. Prior to his work at Merck and DuPont, Dr. Friedman was
an Associate Professor of Medicine and Pharmacology at Harvard Medical School.
Dr. Friedman is a Diplomat of the American Board of Internal Medicine, Member
of the American Society of Pharmacology and Experimental Therapeutics, Member
of the American Society of Clinical Investigation and a Member of the American
Society of Biological Chemist. He received his A.B. in Biology from Princeton
University and his M.D. from Harvard Medical School.

   Roy A. Whitfield, age 48, co-founded the Company and has been a Director
since June 1991 and Chairman of the Board since November 2001. Mr. Whitfield
served as President of the Company from June 1991 until January 1997, as
Treasurer of the Company between April 1991 and October 1995 and as Chief
Executive Officer of the Company between June 1993 and November 2001.
Previously, Mr. Whitfield served as the President of Ideon Corporation, which
was a majority-owned subsidiary of Invitron Corporation, a biotechnology
company, from October 1989 until April 1991. From 1984 to 1989, he held senior
operating and business development positions with Technicon Instruments
Corporation, 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. Mr. Whitfield is also a
director of Inhale Therapeutics Systems, Inc.

   Robert B. Stein, Ph.D., age 51, joined the Company in November 2001 as
President and Chief Scientific Officer and as a Director. From September 1996
to November 2001, Dr. Stein was the Executive Vice President of Research and
Preclinical Development of DuPont Pharmaceuticals Company (formerly The DuPont
Merck Pharmaceutical Company). From May 1990 to September 1996, Dr. Stein was
employed by Ligand Pharmaceuticals, Inc., serving as Senior Vice President and
Chief Scientific Officer from 1993 to 1996, as Vice President, Research and
Preclinical Development from 1992 to 1993 and Vice President, Research from
1990 to 1992. From 1982 to 1990, Dr. Stein held various positions with Merck,
Sharp & Dohme Research Laboratories, including Senior Director and Head of the
Department of Pharmacology from 1989 to 1990. Dr. Stein received his B.S. in
biology and chemistry from Indiana University, his doctorate in Physiology and
Pharmacology, and his M.D. from Duke University. He also serves on the Board of
Directors of Geron Corporation.

   Michael D. Lack, age 50, has been the Chief Operating Officer of the Company
since July 1999 and became an Executive Vice President of the Company in June
2000. Prior to joining the Company, Mr. Lack was the President and Chief
Executive Officer of Silicon Valley Networks from July 1998 to July 1999.
Previously,

                                      88



Mr. Lack served as Chief Executive Officer with several software startup
companies, including Aqueduct Software from July 1997 to July 1998 and Presidio
Systems, Inc. from May 1994 to May 1997. He also held various senior positions
with Cadence Design Systems, Inc., including Senior Vice President of Product
Operations, Division President of Integrated Circuit Design, and Division
President of Systems. Mr. Lack received his B.S. in Physics from the University
of California, Los Angeles.

   John M. Vuko, age 51, joined the Company as Chief Financial Officer in
December 1999 and became an Executive Vice President of the Company in June
2000. Prior to joining the Company, Mr. Vuko was the primary financial
consultant of an affiliate of Achievement Radio Holdings, Inc. from October
1998 to December 1999. From April 1997 to September 1998, Mr. Vuko served as
the Senior Vice President and Chief Financial Officer of Achievement Radio
Holdings, Inc. From October 1989 to March 1997, Mr. Vuko served in various
positions with Ross Stores, Inc., most recently as Senior Vice President and
Chief Financial Officer. Prior to his work at Ross Stores, Mr. Vuko held the
positions of Corporate Development Executive, Vice President, Treasurer, and
Controller with the Cooper family of companies, including CooperVision, Inc.,
Cooper LaserSonics, Inc. and The Cooper Companies, Inc. Mr. Vuko received his
B.A. in Accounting from San Francisco State University.

   James R. Neal, age 46, has been the Executive Vice President of Sales and
Marketing since July 1999. From July 1997 to immediately prior to joining
Incyte, Mr. Neal served as General Manager of the Solaris Group, a division of
Monsanto Company. From 1982, he also held various positions with Monsanto,
including Vice President of Global Business Development, Director of Brand
Marketing and Residential Products, and Manager of New Product Introduction.
Mr. Neal received his B.S. in Biology and his M.S. in Genetics and Plant
Breeding from the University of Manitoba, Canada as well as an Executive M.B.A.
from Washington University, St. Louis.

   Lee Bendekgey, age 44, has been General Counsel of the Company since January
1998 and served as Interim Chief Financial Officer from June 1999 until
December 1999. Mr. Bendekgey became the Secretary of the Company in June 1998
and an Executive Vice President of the Company in June 2000. Prior to joining
the Company, Mr. Bendekgey was the Director of Strategic Relations at Silicon
Graphics, Inc. July 1997 through December 1997. He held various positions with
SGI from March 1993 through June 1997, including Director of Legal Services,
Products and Technology; Senior Counsel, Product Divisions; Group Counsel,
Computer Systems Group; and Division Counsel, MIPS Technologies, Inc. From 1982
to 1993, Mr. Bendekgey held associate and partner positions with Graham &
James, a law firm in San Francisco, where he specialized in intellectual
property protection and licensing. Mr. Bendekgey received his B.A. magna cum
laude in Political Science and French from Kalamazoo College and his J.D. from
Stanford University.

   James P. Merryweather, Ph.D., age 51, has been an Executive Vice President
of the Company since November 2000. He has led the Company's Target Validation
Research organization since December 2002 and, prior to that, led the Company's
Business Development organization from November 2000 until December 2001. He
served as Senior Vice President of Client Business Management from July 1999
until November 2000 and served as Vice President of Partnership Programs from
March 1999 until July 1999. Prior to joining the Company, Dr. Merryweather was
the Vice President of Program Management at Millennium Pharmaceuticals, Inc.
from September 1996 until November 1998. Prior to joining Millennium
Pharmaceuticals, Dr. Merryweather was Director of Project Management at Chiron
Corporation. Dr. Merryweather held various positions at Chiron from November
1981, including Senior Scientist, Research Leader and Director of Regulatory
Affairs. Dr. Merryweather received his Ph.D. in Biochemistry from Washington
State University.

   Brian W. Metcalf, Ph.D., age 56, has served as Executive Vice President and
Chief Drug Discovery Scientist since February 2002. From March 2000 to February
2002, Dr. Metcalf served as Senior Vice President and Chief Scientific Officer
of Kosan Biosciences Incorporated. From December 1983 to March 2000, Dr.
Metcalf held a number of executive management positions with SmithKline
Beecham, most recently as Senior Vice President, Discovery Chemistry and
Platform Technologies. Prior to joining SmithKline Beecham, Dr. Metcalf held
positions with Merrell Research Center from 1973 to 1983. Dr. Metcalf received
his B.S. and Ph.D. in organic chemistry from the University of Western
Australia. Dr. Metcalf is also a director of Argonaut Technologies, Inc.

                                      89

Item 11.Executive Compensation
The information required by this item is incorporated by reference from the information under the captions "Election“Election of Directors--CompensationDirectors—Compensation of Directors"Directors” and "Executive Compensation,"“Executive Compensation” contained in the Proxy Statement.
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 caption "Security“Security Ownership of Certain Beneficial Owners and Management"Management” contained in the Proxy Statement.
Information about securities authorized for issuance under our equity compensation plans appears under the caption “Equity Compensation Plan Information” in the Proxy Statement. That portion of the Proxy Statement is incorporated by reference into this report.
Item 13.Certain Relationships and Related Transactions

   In March 2001,
The information required by this Item 13 is incorporated by reference from the Company entered intoinformation under the caption “Certain Relationships and Related Transactions” contained in the Proxy Statement.
80
PART IV
Item 14.Controls and Procedures
(a)    Based on their evaluation as of a LifeSeq Collaboration Agreement,
Patent License Agreement, Collaboration and Technology Transfer Agreement and
Proteome BioKnowledge Library License Agreement with Genomic Health, Inc.
("Genomic Health"). Randal W. Scott, who served as Chairmandate within 90 days of the Boardfiling date of this Annual Report on Form 10-K, the Company until November 2001 and as a director of the Company through December
2001, is Chairman of the Board, President andCompany’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of Genomic Health1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act are recorded, processed, summarized and owns more than 10% ofreported within the outstanding capital stock of
Genomic Health. Undertime periods specified in Securities and Exchange Commission rules and forms.
(b)    There were no significant changes in the agreements, Genomic Health obtained accessCompany’s internal controls or, to our knowledge, in other factors that could significantly affect these controls subsequent to the Company's LifeSeq Gold databasedate of their evaluation, including any corrective actions with regard to significant deficiencies and BioKnowledge Library and received licenses
to certain of the Company's intellectual property. Amounts Genomic Health will
pay the Company under these agreements are similar to those paid to the Company
under agreements between the Company and unrelated third parties. The Company
received rights to certain intellectual property that Genomic Health may, in
the future, develop. At the same time, the Company entered into an agreement to
purchase shares of Series C Preferred Stock of Genomic Health for an aggregate
purchase price of $5.0 million which, together with shares of Series A
Preferred Stock purchased in November 2000 for an aggregate purchase price of
$1.0 million, resulted in the Company owning approximately 10.9% of the
outstanding capital stock of Genomic Health as of December 31, 2001. Under
certain circumstances and if Genomic Health so elects, the Company has agreed
to purchase in a future offering of Genomic Health's capital stock an aggregate
of $5.0 million of the shares being sold in that offering.

                                      90



                                    PART IV

material weaknesses.
Item 14.  15.Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)    Documents filed as part of this report:

   (1) Financial Statements

       
(1)
Financial Statements
Reference is made to the Index to Consolidated Financial Statements of Incyte Genomics, Inc. and the Index to Financial Statements of diaDexus,
       Inc.,Corporation under Item 8 of Part II hereof.

   (2) Financial Statement Schedules

       
(2)
Financial Statement Schedules
The following financial statement schedule of Incyte Genomics, Inc.Corporation is filed as part of this Form 10-K included in Item 8 of Part II:
Schedule II--ValuationII—Valuation and Qualifying Accounts for each of the three years in the period ended December 31, 2001.
   2002.
All other 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

       
(3)
Exhibits
See Item 14(c)15(c) below. Each management contract or compensatory plan or arrangement required to be filed has been identified.
(b)     Reports on Form 8-K.
The Company filed the following reports on Form 8-K during the fiscal quarter ended December 31, 2001:

    (i) Current Report on Form 8-K filed on November 13, 2001, reporting under
        Item 5 the Company's restructuring of its operations and related
        personnel reductions.

   (ii) Current Report on Form 8-K filed on November 30, 2001, reporting under
        Item 5 that it had filed a complaint against Invitrogen Corporation
        alleging infringement of sixteen patents. The Company also reported the
        appointment of Paul A. Friedman, M.D. as the Company's new Chief
        Executive Officer and the appointment of Robert Stein, M.D. as the
        Company's new President and Chief Scientific Officer.

  (iii) Current Report on Form 8-K filed on December 28, 2001, reporting under
        item 5 that Affymetrix, Inc. and the Company had agreed to settle
        patent infringement lawsuits.

2002:
(i)
Current Report on Form 8-K filed on December 10, 2002, reporting under Item 5 that Affymetrix, Inc., The Board of Trustees of the Leland Stanford Junior University and the Company had agreed to settle patent infringement lawsuits.
(ii)
Current Report on Form 8-K filed on December 19, 2002, reporting under Item 5 that the Company’s 2003 Annual Meeting of Stockholders will be held on June 23, 2003.
(c)     Exhibits
Exhibit
Number
Description of Document
- ------                                         -----------------------
2.1
Agreement and Plan of Merger, dated as of November 11, 2002, by and among the Company, Maxia Pharmaceuticals, Inc. and other parties signatory thereto (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed February 25, 2003).
2.2
Amendment to Agreement and Plan of Merger, dated as of December 19, 2002, by and among the Company, Monaco Acquisition Corporation, Maxia Pharmaceuticals, Inc. and Maxia Pharmaceuticals, LLC (incorporated by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K filed February 25, 2003).
3(i)(a)*
Integrated copy of the Restated Certificate of Incorporation, as amended (incorporated by reference to the Company's
          Annual Report on Form 10-K for the year ended December 31, 2000).amended.
81
Exhibit
Number
Description of Document
  3(i)(b) (c)*
Certificate of Designation of Series A Participating Preferred Stock (incorporated by reference to the
          Company's Annual Report on 10-K for the year ended December 31, 1998).Ownership and Merger merging Incyte Corporation into Incyte Genomics, Inc.
  3(ii)*  
Bylaws of the Company, as amended as of December 20, 2001.

4.1     Form of Common Stock CertificateJune 4, 2002 (incorporated by reference to the exhibit of the same number to the Company's Registration StatementCompany’s Quarterly Report on Form S-1 (File No. 33-68138))10-Q for the quarter ended September 30, 2002).
  4.1*
Form of Common Stock Certificate.
  4.2
Rights Agreement dated as of September 25, 1998 between the Company and Chase Mellon Shareholder Services, L.L.C., which includes as Exhibit B, the rights certificate (incorporated by reference to Exhibit 4.1 to the Company'sCompany’s Registration Statement on Form 8-A filed September 30, 1998).


                                      91


Exhibit
Number                                       Description of Document
- ------                                       -----------------------
  4.3
Indenture dated as of February 4, 2000 between the Company and State Street Bank and Trust Company of California, N.A., as trustee (incorporated by reference to the exhibit of the same number to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 1999).

10.1*#  
10.1#
1991 Stock Plan of Incyte Genomics, Inc., as amended and restated on February 15, 2001 (the "Plan"27, 2002 (incorporated by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8 (File No. 333-91542)).
10.2#
Form of Incentive Stock Option Agreement under the 1991 Plan (incorporated by reference to the exhibit of the same number to the Company'sCompany’s Registration Statement on Form S-1 (File No. 33-68138)).
10.3#
Form of Nonstatutory Stock Option Agreement under the 1991 Plan (incorporated by reference to the exhibit of the same number to the Company'sCompany’s Registration Statement on Form S-1 (File No. 33-68138)).

10.4*#  Amended and Restated 
10.4#
1993 Directors'Directors’ Stock Option Plan of Incyte Genomics, Inc., dated
          February 27, 2002.

as amended and restated (incorporated by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8 (File No. 333-91556)).
10.5#
Form of Indemnity Agreement between the Company and its directors and officers (incorporated by reference to Exhibit 10.5 to the Company'sCompany’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'sCompany’s Annual Report on Form 10-K for the year ended December 31, 1994).
10.9
Stock Purchase Agreement dated as of June 22, 1994 between the Company and Pfizer IncInc. (incorporated by reference to Exhibit B to the Company'sCompany’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 IncInc. (incorporated by reference to Exhibit C to the Company'sCompany’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'sCompany’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'sCompany’s Current Report on Form 8-K dated November 30, 1994).
10.13   Registration Rights Agreement dated as
Reserved.
82
Exhibit
Number
Description of February 4, 2000 among the Company and Deutsche
          Bank Securities Inc. and Warburg Dillon Read LLC (incorporated by reference to the exhibit of
          the same number to the Company's Annual Report on Form 10-K for the year ended
          December 31, 1999).

Document
10.14
Lease Agreement dated June 19, 1997 between the Company and The Board of Trustees of the Leland Stanford Junior University (incorporated by reference to the exhibit of the same number to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 1999).

10.15*# 
10.15#*
1997 Employee Stock Purchase Plan of Incyte Genomics, Inc. (asCorporation, as amended and restated June 26,
          2001).

March 15, 2003.
10.18#
1996 Synteni, Inc. Equity Incentive Stock Plan (incorporated by reference to Exhibit 10.19 to the Company'sCompany’s Registration Statement on Form S-8 (File No. 333-46639)).
10.19#
The Hexagen Limited Unapproved Company Share Option Plan 1996, as amended (incorporated by reference to Exhibit 10.1 to the Company'sCompany’s Registration Statement on Form S-8 (File No. 333-67691)).


                                      92


Exhibit
Number                                      Description of Document
- ------                                      -----------------------

10.20   Stock Purchase Agreement dated as February 24, 2000 between the Company and the investors
          named therein (incorporated by reference to the exhibit of the same number to the Company's
          Annual Report on Form 10-K for the year ended December 31, 1999).

10.21
Registration Rights Agreement, dated as of December 28, 2000, by and among the Company and the Stockholders of Proteome, Inc. (incorporated by reference to Exhibit 99.1 to the Company'sCompany’s Current Report on Form 8-K filed January 10, 2001).
10.22#
1998 Employee, Director and Consultant Stock Option Plan of Proteome, Inc., as amended (incorporated by reference to Exhibit 99.1 to the Company'sCompany’s Registration Statement on Form S-8 filed January 29, 2001 (File No. 333-54496)).

10.23*# 
10.23#
Form of Restricted Stock Unit Agreement under the 1991 Stock Plan of Incyte Genomics, Inc. 10.24*# (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.24#
Transition Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and Roy A. Whitfield.

10.25*# Whitfield (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.25#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and E. Lee Bendekgey.

10.26*# Bendekgey (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.26#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and Michael D. Lack.

10.27*# Lack (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.27#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and James P. Merryweather.

10.28*# Merryweather (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.28#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and James R. Neal.

10.29*# Neal (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.29#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and John M. Vuko.

10.30*# Vuko (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.30#
Offer of Employment Letter, dated November 21, 2001, from the Company to Paul A. Friedman.

10.31*# Friedman (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.31#
Offer of Employment Letter, dated November 16, 2001, from the Company to Robert B. Stein.

10.32*# Stein (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.32#
Employment Agreement, dated November 26, 2001, between Paul A. Friedman and Incyte Genomics, Inc. 10.33*# (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
83
Exhibit
Number
Description of Document
10.33#
Employment Agreement, dated November 26, 2001, between Robert B. Stein and Incyte Genomics, Inc. 10.34*+ (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.34†
Settlement Agreement dated December 21, 2001, between Affymetrix, Inc. and Incyte Genomics, Inc. 10.35*  (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.35
Lease Agreement, dated February 28, 2002, between Dupont Pharmaceuticals and Incyte Genomics, Inc. (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.36#
Promissory Note dated April 22, 2002 between Incyte Genomics, Inc. and Brian Metcalf and Heather Metcalf (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.37#
Promissory Note dated June 21, 2002 between Incyte Genomics, Inc. and Robert B. Stein and Faye E. Stein (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.38#
Amendment to Transition Agreement, effective as of April 1, 2002, between Incyte Genomics, Inc. and Roy A. Whitfield (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.39#
Amendment to Amended and Restated Employment Agreement, effective as of April 1, 2002, between Incyte Genomics, Inc. and James P. Merryweather (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.40#
Form of Amendment to Employment Agreement, effective as of July 24, 2002, between Incyte Genomics, Inc. and each of John M. Vuko, Lee Bendekgey, Michael D. Lack and James P. Merryweather (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.41#
Letter Agreement, dated July 25, 2002, between Incyte Genomics, Inc. and Michael D. Lack (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.42†
Letter Agreement, dated September 5, 2002, between the Company and Schering-Plough, Ltd. (incorporated by reference to Exhibit 10.44 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).
10.43*#
Letter Agreement, dated February 12, 2003, between Robert B. Stein and Incyte Genomics, Inc.
21.1*
Subsidiaries of the Company.
23.1*
Consent of Ernst & Young LLP, Independent Auditors.

23.2*   Consent of PricewaterhouseCoopers LLP, Independent Accountants.

24.1*
Power of Attorney (see page 9485 of this Form 10-K).

- --------
*  Filed herewith.
+  Confidential treatment has been requested with respect to certain portions
   of these agreements.
#  Indicates management contract or compensatory plan or arrangement.

*
Filed herewith.
†
Confidential treatment has been requested with respect to certain portions of these agreements.
#
Indicates management contract or compensatory plan or arrangement.
(d)    Financial Statements and Schedules
Reference is made to Item 14(a)15(a)(2) above.

                                      93

84
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 GENOMICS, INC.

                                               By:     /s/  PAUL A. FRIEDMAN
                                                   -----------------------------
                                                         Paul A. Friedman
                                                      Chief Executive Officer
INCYTE CORPORATION
By:
/S/    PAUL A. FRIEDMAN        
Paul A. Friedman
Chief Executive Officer
Date: April 1, 2002

                               March 28, 2003
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Paul A. Friedman, E. Lee Bendekgey, and John M. Vuko, and each of them, his 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.

          Signature                       Title                 Date
          ---------                       -----                 ----
    /s/  PAUL A. FRIEDMAN     
Signature
Title
Date
/s/    PAUL A. FRIEDMAN        
Paul A. Friedman
Chief Executive Officer       April 1, 2002
- ----------------------------- (Principal Executive Officer) and Director
March 28, 2003
/s/    ROBERT B. STEIN        
Robert B. Stein
President, Chief Scientific Officer and Director
March 28, 2003
/s/    JOHN M. VUKO        
John M. Vuko
Chief Financial Officer (Principal Financial Officer)
March 28, 2003
/s/    TIMOTHY G. HENN        
Timothy G. Henn
Senior Vice President, Finance and Corporate Controller (Principal Accounting Officer)
March 28, 2003
/s/    ROY A. WHITFIELD        
Roy A. Whitfield
Chairman
March 28, 2003
/s/    JEFFREY J. COLLINSON        
Jeffrey J. Collinson
Director
March 28, 2003
/s/    FREDERICK B. CRAVES        
Frederick B. Craves
Director
March 28, 2003
/s/    JON S. SAXE        
Jon S. Saxe
Director
March 28, 2003
85
Signature
Title
Date
/s/    BARRY M. ARIKO        
Barry M. Ariko
Director
March 28, 2003
Richard U. De Schutter
Director
/S/    PAUL A. BROOKE        
Paul A. Brooke
Director
March 28, 2003
Julian C. Baker
Director
86
CERTIFICATION
I, Paul A. Friedman, Officer) and Director

    /s/  ROBERT B. STEIN      President, Chief Scientific   April 1, 2002
- -----------------------------   Officer and Director
       Robert B. Stein

      /s/  JOHN M. VUKO       Chief Financial Officer       April 1, 2002
- -----------------------------   (Principal Financialcertify that:
1.
I have reviewed this annual report on Form 10-K of Incyte Corporation;
2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a.)
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b.)
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c.)
presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a.)
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b.)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/    PAUL A. FRIEDMAN        
Paul A. Friedman
Chief Executive Officer
87
CERTIFICATION
I, John M. Vuko, Officer)

    /s/  TIMOTHY G. HENN      Senior Vice President,        April 1,certify that:
1.
I have reviewed this annual report on Form 10-K of Incyte Corporation;
2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a.)
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b.)
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c.)
presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a.)
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b.)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/    JOHN M. VUKO        
John M. Vuko
Chief Financial Officer
88
COMPLIANCE WITH CERTIFICATION REQUIREMENTS
The certification by such officers of this report on Form 10-K, as required by Section 906 of the Sarbanes-Oxley Act of 2002, - -----------------------------   Finance and Corporate
       Timothy G. Henn          Controller (Principal
                                Accounting Officer)

    /s/  ROY A. WHITFIELD     Chairman                      April 1, 2002
- -----------------------------
      Roy A. Whitfield

  /s/  JEFFREY J. COLLINSON   Director                      April 1, 2002
- -----------------------------
    Jeffrey J. Collinson

     /s/  BARRY M. BLOOM      Director                      April 1, 2002
- -----------------------------
       Barry M. Bloom

  /s/  FREDERICK B. CRAVES    Director                      April 1, 2002
- -----------------------------
     Frederick B. Craves

                                      94



          Signature                       Title                 Date
          ---------                       -----                 ----

      /s/  JON S. SAXE        Director                      April 1, 2002
- -----------------------------
         Jon S. Saxe

     /s/  BARRY M. ARIKO      Director                      April 1, 2002
- -----------------------------
       Barry M. Ariko

 /s/  RICHARD U. DE SCHUTTER  Director                      April 1, 2002
- -----------------------------
   Richard U. De Schutter

     /s/  PAUL A. BROOKE      Director                      April 1, 2002
- -----------------------------
       Paul A. Brooke

    /s/  JULIAN C. BAKER      Director                      April 1, 2002
- -----------------------------
       Julian C. Baker

                                      95



                                 Exhibit Index

has been submitted to the SEC as additional correspondence accompanying this report.
89
EXHIBIT INDEX
Exhibit
Number
Description of Document
- ------                                            -----------------------
2.1
Agreement and Plan of Merger, dated as of November 11, 2002, by and among the Company, Maxia Pharmaceuticals, Inc. and other parties signatory thereto (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed February 25, 2003).
2.2
Amendment to Agreement and Plan of Merger, dated as of December 19, 2002, by and among the Company, Monaco Acquisition Corporation, Maxia Pharmaceuticals, Inc. and Maxia Pharmaceuticals, LLC (incorporated by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K filed February 25, 2003).
3(i)(a)*
Integrated copy of the Restated Certificate of Incorporation, as amended (incorporated by reference to the Company's
             Annual Report on Form 10-K for the year ended December 31, 2000).

   amended.
3(i)(b) (c)*
Certificate of Designation of Series A Participating Preferred Stock (incorporated by reference to the
             Company's Annual Report on 10-K for the year ended December 31, 1998).

   Ownership and Merger merging Incyte Corporation into Incyte Genomics, Inc.
3(ii)*  
Bylaws of the Company, as amended as of December 20, 2001.

   4.1     Form of Common Stock CertificateJune 4, 2002 (incorporated by reference to the exhibit of the same number to the Company's Registration StatementCompany’s Quarterly Report on Form S-1 (File No. 33-68138))10-Q for the quarter ended September 30, 2002).
4.1*
Form of Common Stock Certificate.
4.2
Rights Agreement dated as of September 25, 1998 between the Company and Chase Mellon Shareholder Services, L.L.C., which includes as Exhibit B, the rights certificate (incorporated by reference to Exhibit 4.1 to the Company'sCompany’s Registration Statement on Form 8-A filed September 30, 1998).
4.3
Indenture dated as of February 4, 2000 between the Company and State Street Bank and Trust Company of California, N.A., as trustee (incorporated by reference to the exhibit of the same number to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 1999).

  10.1*#   
10.1#
1991 Stock Plan of Incyte Genomics, Inc., as amended and restated on February 15, 2001 (the "Plan"27, 2002 (incorporated by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8 (File No. 333-91542)).
10.2#
Form of Incentive Stock Option Agreement under the 1991 Plan (incorporated by reference to the exhibit of the same number to the Company'sCompany’s Registration Statement on Form S-1 (File No. 33-68138)).
10.3#
Form of Nonstatutory Stock Option Agreement under the 1991 Plan (incorporated by reference to the exhibit of the same number to the Company'sCompany’s Registration Statement on Form S-1 (File No. 33-68138)).

  10.4*#   Amended and Restated 
10.4#
1993 Directors'Directors’ Stock Option Plan of Incyte Genomics, Inc., dated
             February 27, 2002.

  as amended and restated (incorporated by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8 (File No. 333-91556)).
10.5#
Form of Indemnity Agreement between the Company and its directors and officers (incorporated by reference to Exhibit 10.5 to the Company'sCompany’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'sCompany’s Annual Report on Form 10-K for the year ended December 31, 1994).
10.9
Stock Purchase Agreement dated as of June 22, 1994 between the Company and Pfizer IncInc. (incorporated by reference to Exhibit B to the Company'sCompany’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 IncInc. (incorporated by reference to Exhibit C to the Company'sCompany’s Current Report on Form 8-K dated June 23, 1994).
Exhibit
Number
Description of Document
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'sCompany’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'sCompany’s Current Report on Form 8-K dated November 30, 1994).
10.13    Registration Rights Agreement dated as of February 4, 2000 among the Company and Deutsche
             Bank Securities Inc. and Warburg Dillon Read LLC (incorporated by reference to the exhibit of
             the same number to the Company's Annual Report on Form 10-K for the year ended December 31,
             1999).

Exhibit
Number                                         Description of Document
- ------                                         -----------------------
Reserved.
10.14
Lease Agreement dated June 19, 1997 between the Company and The Board of Trustees of the Leland Stanford Junior University (incorporated by reference to the exhibit of the same number to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 1999).

10.15*#  
10.15#*
1997 Employee Stock Purchase Plan of Incyte Genomics, Inc. (asCorporation, as amended and restated June 26,
           2001).

March 15, 2003.
10.18#
1996 Synteni, Inc. Equity Incentive Stock Plan (incorporated by reference to Exhibit 10.19 to the Company'sCompany’s Registration Statement on Form S-8 (File No. 333-46639)).
10.19#
The Hexagen Limited Unapproved Company Share Option Plan 1996, as amended (incorporated by reference to Exhibit 10.1 to the Company'sCompany’s Registration Statement on Form S-8 (File No. 333-67691)).

 10.20   Stock Purchase Agreement dated as February 24, 2000 between the Company and the investors
           named therein (incorporated by reference to the exhibit of the same number to the Company's
           Annual Report on Form 10-K for the year ended December 31, 1999).

 
10.21
Registration Rights Agreement, dated as of December 28, 2000, by and among the Company and the Stockholders of Proteome, Inc. (incorporated by reference to Exhibit 99.1 to the Company'sCompany’s Current Report on Form 8-K filed January 10, 2001).
10.22#
1998 Employee, Director and Consultant Stock Option Plan of Proteome, Inc., as amended (incorporated by reference to Exhibit 99.1 to the Company'sCompany’s Registration Statement on Form S-8 filed January 29, 2001 (File No. 333-54496)).

10.23*#  
10.23#
Form of Restricted Stock Unit Agreement under the 1991 Stock Plan of Incyte Genomics, Inc. 10.24*#  (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.24#
Transition Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and Roy A. Whitfield.

10.25*#  Whitfield (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.25#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and E. Lee Bendekgey.

10.26*#  Bendekgey (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.26#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and Michael D. Lack.

10.27*#  Lack (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.27#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and James P. Merryweather.

10.28*#  Merryweather (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.28#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and James R. Neal.

10.29*#  Neal (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.29#
Amended and Restated Employment Agreement, dated as of November 26, 2001, between Incyte Genomics, Inc. and John M. Vuko.

10.30*#  Vuko (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.30#
Offer of Employment Letter, dated November 21, 2001, from the Company to Paul A. Friedman.

10.31*#  Friedman (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
Exhibit
Number
Description of Document
10.31#
Offer of Employment Letter, dated November 16, 2001, from the Company to Robert B. Stein.

10.32*#  Stein (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.32#
Employment Agreement, dated November 26, 2001, between Paul A. Friedman and Incyte Genomics, Inc. 10.33*#  (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.33#
Employment Agreement, dated November 26, 2001, between Robert B. Stein and Incyte Genomics, Inc. 10.34*+  (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.34†
Settlement Agreement dated December 21, 2001, between Affymetrix, Inc. and Incyte Genomics, Inc. 10.35*   (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.35
Lease Agreement, dated February 28, 2002, between Dupont Pharmaceuticals and Incyte Genomics, Inc. (incorporated by reference to the exhibit of the same number to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).
10.36#
Promissory Note dated April 22, 2002 between Incyte Genomics, Inc. and Brian Metcalf and Heather Metcalf (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.37#
Promissory Note dated June 21, 2002 between Incyte Genomics, Inc. and Robert B. Stein and Faye E. Stein (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.38#
Amendment to Transition Agreement, effective as of April 1, 2002, between Incyte Genomics, Inc. and Roy A. Whitfield (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.39#
Amendment to Amended and Restated Employment Agreement, effective as of April 1, 2002, between Incyte Genomics, Inc. and James P. Merryweather (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.40#
Form of Amendment to Employment Agreement, effective as of July 24, 2002, between Incyte Genomics, Inc. and each of John M. Vuko, Lee Bendekgey, Michael D. Lack and James P. Merryweather (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.41#
Letter Agreement, dated July 25, 2002, between Incyte Genomics, Inc. and Michael D. Lack (incorporated by reference to the exhibit of the same number to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.42†
Letter Agreement, dated September 5, 2002, between the Company and Schering-Plough, Ltd. (incorporated by reference to Exhibit 10.44 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).
10.43*#
Letter Agreement, dated February 12, 2003, between Robert B. Stein and Incyte Genomics, Inc.
21.1*
Subsidiaries of the Company.
23.1*
Consent of Ernst & Young LLP, Independent Auditors.

    Exhibit
    Number                      Description of Document
    ------                      -----------------------
    

     23.2*  Consent of PricewaterhouseCoopers LLP, Independent Accountants.

     
24.1*
Power of Attorney (see page 9485 of this Form 10-K).

- --------
*  Filed herewith.
+  Confidential treatment has been requested with respect to certain portions
   of these agreements.
#  Indicates management contract or compensatory plan or arrangement.

   
*
Filed herewith.
†
Confidential treatment has been requested with respect to certain portions of these agreements.
#
Indicates management contract or compensatory plan or arrangement.
Copies of above exhibits not contained herein are available to any stockholder upon written request to: Investor Relations, Incyte Genomics, Inc.,Corporation, 3160 Porter Drive, Palo Alto, CA 94034.