Incyte Annual Report 2007

Plain-text annual report

THE DRIVE TO DISCOVER. THE EXPERIENCE TO DELIVER. Front Cover Rendering of a small molecule bound to the JAK2 ATP binding site I N C Y T E A n n u a l R e p o r t 2 0 0 7 Incyte Corporation Experimental Station Route 141 & Henry Clay Road, Building E336 Wilmington, DE 19880 www.incyte.com INCYTE Ann ua l Report 2007 I I I e s a h P I I e s a h P I e s a h P e t a t S e s a e s D i t c u d o r P E T Y C N I t e g r a T e n i l e p P i l a c n i i l ’ C s e t y c n I l a m o e y m e p i t l u M l * T E / V P i s i t i r h t r a d o t a m u e h R r e c n a c e t a t s o r P i s s a i r o s P i s s a i r o s P ) l i a c p o t ( 4 2 4 8 1 B C N I n o - w o l l o f d a e L ) l a c n i i l c e r p ( 0 5 0 8 2 B C N I s e t e b a d 2 i e p y T s e t e b a d 2 i e p y T 9 3 7 3 1 B C N I 7 1 8 0 2 B C N I 1 D S H s e t e b a d 2 i e p y T 2 0 6 9 1 B C N I a 4 7 M H r e c n a c t s a e r B s r e c n a c d i l l o s e p i t l u M 9 3 8 7 B C N I e s a d d e h S i s s o r b i f o e y M l ) l a r o ( 4 2 4 8 1 B C N I K A J l i s s o r e c s e p i t l u M l 6 9 6 8 B C N I 2 R C C i n a p s i t i r h t r a o e t s O ) r e z i f P ( 9 0 3 6 3 1 4 - F P I V H I V H 0 5 0 5 1 B C N I 1 7 4 9 B C N I 5 R C C i a m e h t y c o b m o r h t l a i t n e s s E / i a r e v a m e h t y c y o P * l BOARD OF DIRECTORS EXECUTIVE MANAGEMENT Richard U. De Schutter Chairman of the Board Formerly Chairman and Chief Executive Ofﬁ cer DuPont Pharmaceuticals Company Paul A. Friedman, M.D. President and Chief Executive Ofﬁ cer Incyte Corporation Barry M. Ariko President, Chief Executive Ofﬁ cer and Chairman Mirapoint, Inc. Paul A. Friedman, M.D. President and Chief Executive Ofﬁ cer David C. Hastings Executive Vice President and Chief Financial Ofﬁ cer John A. Keller, Ph.D. Executive Vice President and Chief Business Ofﬁ cer Brian W. Metcalf, Ph.D. Executive Vice President and Chief Drug Discovery Scientist Julian C. Baker Managing Member Baker Bros. Advisors, LLC Patricia A. Schreck Executive Vice President and General Counsel Paul A. Brooke Chairman, Alsius Corporation Managing Member, PMSV Holdings, LLC Human Resources Senior Advisor, Morgan Stanley Paula J. Swain Executive Vice President, Matthew W. Emmens Chief Executive Ofﬁ cer Shire plc John F. Niblack, Ph.D. Formerly Vice Chairman and President of Global Research and Development Pﬁ zer Inc. Roy A. Whitﬁ eld Formerly Chairman of the Board and Chief Executive Ofﬁ cer Incyte Corporation Transfer Agent and Registrar BNY Mellon Shareowner Services PO Box 358015 Pittsburgh, PA 15252-8015 or 480 Washington Boulevard Jersey City, NJ 07310-1900 Phone: 800/851-9677 TDD for Hearing Impaired: 800/231-5469 Foreign Shareholders: 201/680-6610 TDD Foreign Shareholders: 201/680-6578 www.bnymellon.com/shareowner/isd Annual Meeting The Annual Meeting of Stockholders will be held on May 22, 2008, at 10:00 a.m., Eastern Daylight Time, at the Hotel du Pont, 11th and Market Streets, Wilmington, Delaware. Outside Counsel Pillsbury Winthrop Shaw Pittman LLP Independent Registered Public Accounting Firm Ernst & Young LLP Market Information Incyte’s Common Stock trades on The NASDAQ Global Market under the symbol INCY. Investor Relations You can obtain recent press releases and other publicly available information on Incyte by visiting our web site at www.incyte.com. Contact Pamela Murphy Vice President, Investor Relations and Corporate Communications Email: pmurphy@incyte.com Corporate Headquarters Incyte Corporation Experimental Station Route 141 & Henry Clay Road Building E336 Wilmington, Delaware 19880 302/498-6700 Forward-looking Statements Except for the historical statements contained herein, the statements contained in this annual report, including without limitation, statements as to our productivity and transition from a pure drug discovery company, the anticipated advancement and composition of our pipeline, the expected timing, progress, number of and other information regarding our preclinical and clinical trials, the likelihood of initiating registration trials of and receiving expedited review for our JAK inhibitor for myeloﬁ brosis, our expectations with respect to our development plans and program objectives for 2008, plans to present and disclose data from our clinical trials, the potential beneﬁ ts and effectiveness of our compounds in treating disease, and our plans to seek strategic partnerships or out-licensing opportunities and to commercialize certain programs on our own, are forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements are based on our current intent, belief and expectations, using information currently available to us, and are therefore subject to certain risks, uncertainties, and assumptions that may cause actual results to differ materially, including the high degree of risk associated with drug development and clinical trials, the uncertainty of the FDA approval process, results of further research and development, the impact of technological advances and competition, our ability to enroll a sufﬁ cient number of patients for our clinical trials, unanticipated delays in programs or uses of capital, and other risks discussed in our Annual Report on Form 10-K for the year ended December 31, 2007, which is contained herein, and in our ﬁ lings with the Securities and Exchange Commission. These forward-looking statements speak only as of the date hereof. Incyte disclaims any intent or obligation to update these forward- looking statements. To Our Shareholders: Incyte’s rapid transition from a pure discovery company to one that can develop new medicines comes from experience, intellectual discipline and a shared focus on fulﬁ lling unmet medical needs. The rigorous and systematic approach to drug discovery and development we have employed over the last six years has allowed us to create a diverse product pipeline that includes programs in oncology, inﬂ ammation, metabolic disease and HIV. The programs that have the greatest near-term potential to create substantial and sustained shareholder value are those that are focused on indications that we can develop and commercialize independently. Therefore, our janus- associated kinase inhibitor (JAK) program, which has shown compelling early efﬁ cacy results in myeloﬁ brosis, psoriasis, and rheumatoid arthritis, is now our highest priority program. In contrast, for programs that are focused on primary care markets, such as our metabolic disease programs, or are outside our core areas of oncology and inﬂ ammation, such as our CCR5 antagonist program, our objective is to form strategic partnerships at appropriate points in their development, and to use the proceeds from these alliances to fund the programs we elect to retain. With as many as a dozen Phase II trials expected in 2008, as well as the potential initiation of registration trials for myelofibrosis, I believe we are making demonstrable progress in building a successful biopharmaceutical company. 2007 Program Achievements In 2007, the potential value of the pipeline was substantially enhanced through multiple positive Phase IIa proof-of-concept results. ›› Our lead JAK inhibitor, INCB18424, has demonstrated: › Unprecedented efficacy in patients with myelofibrosis, a serious neoplastic condition characterized by bone marrow failure, life-threatening splenic enlargement and marked constitutional symptoms that adversely affect patients’ quality of life; › Compelling early efficacy results in a 28-day trial, comparable to results seen with injectable anti-TNF therapies in patients with rheumatoid arthritis; and › Striking improvement in psoriatic skin lesions in a 28-day trial in patients with mild to moderate psoriasis, comparable to a potent topical steroid without the skin atrophy associated with steroid treatment. ›› Our lead HSD1 inhibitor, INCB13739, completed a 28-day Phase IIa trial in patients with type 2 diabetes. Improvements were achieved in six parameters of glucose control and cardiovascular risk: fasting plasma glucose, clamp-measured glucose production, clamp-measured glucose utilization, LDL cholesterol, total cholesterol, and triglycerides. ›› Our lead HM74a agonist, INCB19602, also for type 2 diabetes, reduced circulating free fatty acids which are associated with insulin desensitization, with no rebound or cutaneous flushing. These results in a Phase I trial with healthy volunteers suggest that INCB19602 could achieve similar results in type 2 diabetics. ›› Our sheddase inhibitor, INCB7839, demonstrated improvement in several clinically relevant pharmacodynamic markers and produced stable disease in five of six Her2-positive breast cancer patients. These encouraging clinical results are evidence that Incyte is rapidly transitioning from a pure drug- discovery company into a highly productive drug discovery and development company. As such, it is now both realistic and essential that we prioritize our programs. JAK Inhibitor Program Is Now Our Highest Priority Program The success we achieved in 2007 in the JAK inhibitor program for myeloﬁ brosis, a rare life-threatening myeloproliferative disease for which there are no approved drug therapies, is gratifying. Importantly, based on recent discussions with representatives from the U.S. Food and Drug Administration (FDA) in which we reached agreement on the type of endpoints that will support approval in myeloﬁ brosis, I believe we are well-positioned to begin registration trials in the fourth quarter of this year. As this indication is likely to receive expedited FDA review, the JAK program offers tremendous potential for creating near-term value. It is a program we can develop and commercialize on our own, and it is now our highest priority. There also is a growing body of preclinical and clinical evidence suggesting JAK inhibitors may represent a new class of drugs to treat other hematological conditions, solid tumors and multiple inﬂ ammatory conditions. Given this broad potential, and the fact that we have one of the most advanced compounds in clinical development, we are aggressively moving INCB18424 forward in multiple indications. Currently, we are evaluating the oral form of INCB18424 in four Phase II trials: myeloﬁ brosis, multiple myeloma, hormone refractory prostate cancer, and rheumatoid arthritis. Phase II trials are also scheduled to begin this year for polycythemia vera, essential thrombocythemia and psoriasis. In addition to the oral formulation, we have developed a topical formulation of INCB18424 for mild-to- moderate psoriasis. Clinical results from a 28-day study indicate an exceptionally clean safety proﬁ le and impressive efﬁ cacy. This indication is also one we could commercialize on our own and could prove quite valuable as we believe we are the only company developing a topical JAK inhibitor. INCB28050, our lead follow-on JAK inhibitor, is expected to begin Phase I trials in the ﬁ rst half of this year. If this compound achieves comparable pharmacodynamics and safety characteristics as our lead compound, we intend to move INCB28050 forward as an oral agent in rheumatoid arthritis and psoriasis, and possibly other chronic inﬂ ammatory conditions such as Crohn’s disease. Decision to Out-License CCR5 Antagonist Program Conﬁ rms Focus on Near-term Value We have made good progress advancing our CCR5 antagonist, INCB9471, as a treatment for HIV. We believe it has potential to become the best-in-class CCR5 antagonist. However, as we prioritize the programs in our growing pipeline, it is essential that we focus our resources on those with the greatest near-term value. Considering that this program is one of our more expensive, time- and labor-intensive efforts, and is now our only HIV product, we have decided not to initiate Phase IIb trials and intend to pursue out-licensing options. 2008 Program Objectives In the coming year, we expect to make signiﬁ cant and visible progress toward the following program objectives: JAK Inhibitor Program INCB18424 for oncology: ›› Begin registration trials in myelofibrosis in the fourth quarter of the year. ›› Present results from the ongoing myelofibrosis Phase I/II trial at the American Society of Clinical Oncology and European Hematology Association meetings in June, and the American Society of Hematology meeting in December. ›› Conduct Phase II trials in: › Polycythemia vera and essential thrombocythemia; › Multiple myeloma; and, › Hormone refractory prostate cancer. INCB18424 for inﬂ ammation: ›› Complete a 28-day Phase IIa dose-ranging study in patients with rheumatoid arthritis, and present results from this study at the European League Against Rheumatism meeting in June. ›› Present Phase IIa results using the topical formulation at the European Academy of Dermatology and Venereology meeting in September. ›› Begin a Phase IIa study in psoriatic patients with the oral-dosing form of INCB18424. ›› Begin a three-month Phase IIb study with topical dosing in patients with mild-to-moderate psoriasis. INCB28050 (follow-on JAK inhibitor): ›› Conduct Phase I trials in healthy volunteers. ›› Begin Phase II trials in rheumatoid arthritis patients. HSD1 Inhibitor Program INCB13739: ›› Conduct a dose-ranging three-month Phase IIb trial in type 2 diabetics. ›› Present the 28-day Phase IIa trial results at the American Diabetes Association meeting in June. INCB20817 (follow-on HSD1 inhibitor): ›› Conduct Phase I trials in healthy volunteers. HM74a Agonist Program INCB19602: ›› Complete Phase I trials in healthy volunteers. ›› Conduct 28-day fasting plasma glucose Phase IIa trial in type 2 diabetics. Sheddase Inhibitor Program INCB7839: ›› Conduct a Phase IIa trial in combination with Herceptin® in patients with breast cancer. CCR2 Antagonist Program INCB8696: ›› Complete Phase I trials in healthy volunteers. Discovery ›› Advance at least one new oncology program through preclinical development and initiate Phase I trials. Remarkable Productivity The level of productivity of the entire Incyte team, and the success achieved in so many of our programs during 2007, are nothing short of remarkable. With as many as a dozen Phase II trials underway and planned in 2008, as well as the potential initiation of registration trials for our lead program in myeloﬁ brosis, this year promises to be at least as dynamic. I remain optimistic about our future and fully expect the year ahead to validate our near-term focus on oncology and inﬂ ammation – areas where there is clear unmet medical need and tremendous potential for value creation. Sincerely, Paul A. Friedman, M.D. President and Chief Executive Ofﬁ cer April 2008 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (cid:1) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (cid:2) For the fiscal year ended December 31, 2007 or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 0-27488 INCYTE CORPORATION (Exact name of registrant as specified in its charter) Delaware (State of other jurisdiction of incorporation or organization) Experimental Station, Route 141 & Henry Clay Road, Building E336, Wilmington, DE 19880 (Address of principal executives offices) 94-3136539 (IRS Employer Identification No.) (302) 498-6700 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock, par value $.001 per share Series A Participating Preferred Stock Purchase Rights Name of exchange on which registered The NASDAQ Stock Market LLC The NASDAQ Stock Market LLC Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:1) No (cid:2) Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Exchange Act. Yes (cid:2) No (cid:1) 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 (cid:1) No (cid:2) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (cid:1) Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of ‘‘large accelerated filer’’, ‘‘accelerated filer’’ and ‘‘smaller reporting company’’ in Rule 12b-2 of the Exchange Act. Large accelerated filer (cid:2) Accelerated filer (cid:1) Non-accelerated filer (cid:2) Smaller reporting company (cid:2) (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:2) No (cid:1) The aggregate market value of Common Stock held by non-affiliates (based on the closing sale price on The Nasdaq Global Market on June 30, 2007) was approximately $443.3 million. As of February 28, 2008 there were 84,618,917 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, 13 and 14 of Part III incorporate by reference information from the registrant’s proxy statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the registrant’s 2008 Annual Meeting of Stockholders to be held on May 22, 2008. PART I Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. PART II Item 5. Item 6. Item 7. Item 7A. Item 8. Item 9. Item 9A. Item 9B. PART III Item 10. Item 11. Item 12. Item 13. Item 14. Table of Contents Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . Changes in and Disagreements With Accountants on Accounting and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Directors, Executive Officers and Corporate Governance . . . . . . . . . . . . . . . . . . Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Certain Relationships and Related Transactions, and Director Independence . . . Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PART IV Item 15. Exhibits, Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 18 30 30 31 31 32 33 35 46 47 78 78 80 80 80 81 81 81 82 86 2 Item 1. Business This report contains forward-looking statements that involve risks and uncertainties. These statements relate to future periods, future events or our future operating or financial plans or performance. These statements can often be identified by the use of forward-looking terminology such as ‘‘expects,’’ ‘‘believes,’’ ‘‘intends,’’ ‘‘anticipates,’’ ‘‘estimates,’’ ‘‘plans,’’ ‘‘may,’’ or ‘‘will,’’ or the negative of these terms, and other similar expressions. These forward-looking statements include statements as to: (cid:127) the discovery, development, formulation, manufacturing and commercialization of our compounds and our product candidates; (cid:127) focus on our drug discovery and development efforts; (cid:127) conducting clinical trials internally, with collaborators, or with clinical research organizations; (cid:127) our collaboration and strategic alliance strategy; anticipated benefits and disadvantages of entering into collaboration agreements; (cid:127) our licensing, investment and commercialization strategies; (cid:127) the regulatory approval process, including determinations to seek U.S. Food and Drug Administration, or FDA, approval for, and plans to commercialize, our products in the United States and abroad; (cid:127) the safety, effectiveness and potential benefits and indications of our product candidates and other compounds under development; potential uses for our product candidates and our other compounds; (cid:127) the timing and size of our clinical trials; the compounds expected to enter clinical trials; timing of clinical trial results; (cid:127) our ability to manage expansion of our drug discovery and development operations; (cid:127) future required expertise relating to clinical trials, manufacturing, sales and marketing; (cid:127) obtaining and terminating licenses to products, compounds or technology, or other intellectual property rights; (cid:127) the receipt from or payments pursuant to collaboration or license agreements resulting from milestones or royalties; the decrease in revenues from our information product-related activities; (cid:127) plans to develop and commercialize products on our own; (cid:127) plans to use third party manufacturers; (cid:127) expected expenses and expenditure levels; expected uses of cash; expected revenues and sources of revenues; (cid:127) expected losses; fluctuation of losses; (cid:127) our profitability; the adequacy of our capital resources to continue operations; (cid:127) the need to raise additional capital; (cid:127) the costs associated with resolving matters in litigation; (cid:127) our expectations regarding competition; (cid:127) our investments, including anticipated expenditures, losses and expenses; (cid:127) our gene and genomics-related patent prosecution and maintenance efforts; and (cid:127) our indebtedness, and debt service obligations. 3 These forward-looking statements reflect our current views with respect to future events, are based on assumptions and are subject to risks and uncertainties. These risks and uncertainties could cause actual results to differ materially from those projected and include, but are not limited to: (cid:127) our ability to discover, develop, formulate, manufacture and commercialize a drug candidate or product; (cid:127) the risk of unanticipated delays in research and development efforts; (cid:127) the risk that previous preclinical testing or clinical trial results are not necessarily indicative of future clinical trial results; (cid:127) risks relating to the conduct of our clinical trials; (cid:127) changing regulatory requirements; (cid:127) the risk of adverse safety findings; (cid:127) the risk that results of our clinical trials do not support submission of a marketing approval application for our product candidates; (cid:127) the risk of significant delays or costs in obtaining regulatory approvals; (cid:127) risks relating to our reliance on third party manufacturers, collaborators, and clinical research organizations; (cid:127) risks relating to the development of new products and their use by us and our current and potential collaborators; (cid:127) risks relating to our inability to control the development of out-licensed drug compounds or drug candidates; (cid:127) our ability to in-license a potential drug compound or drug candidate; (cid:127) the cost of accessing, licensing or acquiring potential drug compounds or drug candidates developed by other companies; (cid:127) the costs of terminating any licensing or access arrangement for third party drug compounds or drug candidates; (cid:127) costs associated with prosecuting, maintaining, defending and enforcing patent claims and other intellectual property rights; (cid:127) our ability to maintain or obtain adequate product liability and other insurance coverage; (cid:127) the risk that our product candidates may not obtain regulatory approval; (cid:127) the impact of technological advances and competition; (cid:127) the ability to compete against third parties with greater resources than ours; (cid:127) competition to develop and commercialize similar drug products; (cid:127) our ability to obtain patent protection and freedom to operate for our discoveries and to continue to be effective in expanding our patent coverage; (cid:127) the impact of changing laws on our patent portfolio; (cid:127) developments in and expenses relating to litigation; (cid:127) the impact of past or future acquisitions on our business; (cid:127) the results of businesses in which we have made investments; (cid:127) our ability to obtain additional capital when needed; 4 (cid:127) fluctuations in net cash used by investing activities; (cid:127) our history of operating losses; and (cid:127) the risks set forth under ‘‘Risk Factors.’’ Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by federal securities laws, we undertake no obligation to update any forward- looking statements for any reason, even if new information becomes available or other events occur in the future. In this report all references to ‘‘Incyte,’’ ‘‘we,’’ ‘‘us’’ or ‘‘our’’ mean Incyte Corporation and our subsidiaries, except where it is made clear that the term means only the parent company. Incyte is our registered trademark. We also refer to trademarks of other corporations and organizations in this Annual Report on Form 10-K. Overview Incyte is a drug discovery and development company focused on developing proprietary small molecule drugs to treat serious unmet medical needs. We have a pipeline with programs in oncology, inflammation, diabetes and human immunodeficiency virus (HIV). Thus far in our drug discovery and development activities, which began in early 2002, we have filed twelve Investigational New Drug Applications (INDs) and have progressed eight internally developed proprietary compounds into clinical development. Currently, four of these compounds have advanced into Phase II clinical trials. Our wholly-owned pipeline includes the following compounds: Drug Target JAK HSD1 HM74a CCR5 Sheddase CCR2 Drug Compound Indication Development Status INCB18424 (Oral) Phase IIa Myelofibrosis Rheumatoid Arthritis Phase IIa Refractory Prostate Cancer Phase IIa Phase IIa Multiple Myeloma Phase I Psoriasis INCB18424 (Topical) Psoriasis INCB28050 Rheumatoid Arthritis INCB13739 INCB20817 Type 2 Diabetes Type 2 Diabetes Phase IIa Preclinical Phase IIa Phase I INCB19602 Type 2 Diabetes Phase I INCB9471 INCB15050 INCB7839 HIV HIV Solid Tumors Breast Cancer Phase II Phase I Phase IIa Phase II INCB8696 Multiple Sclerosis Phase I Other Lead clinical candidate Lead clinical candidate Oncology Oncology Pre-clinical Pre-clinical 5 Our productivity in drug discovery is primarily a result of our core competency in medicinal chemistry which is tightly integrated with and supported by an experienced team of biologists with expertise in multiple therapeutic areas. As a number of our compounds have progressed into clinical development, we have also built a clinical development and regulatory team. This team utilizes clinical research organizations (CROs), expert scientific advisory boards, and leading consultants and suppliers in relevant drug development areas in an effort to conduct our clinical trials as efficiently and effectively as possible while maintaining strategic control of the design and management of our programs. Incyte’s Approach to Drug Discovery and Development To succeed in our objective to create a pipeline of novel, orally available drugs that address serious unmet medical needs, we have established a broad range of discovery capabilities in-house, including target validation, high-throughput screening, medicinal chemistry, computational chemistry, and pharmacological and ADME (absorption, distribution, metabolism and excretion) assessment. We augment these capabilities through collaborations with academic and contract laboratory resources with relevant expertise. We select drug targets with strong preclinical or clinical validation in areas where we have the potential to generate either first-in-class molecules or compounds that are highly differentiated from existing treatments. Our chemistry and biology efforts are highly integrated and are characterized by the rapid generation of relevant data on a broad and diverse range of compounds for each therapeutic target we pursue. This process allows our scientists to better understand, in real time, the potency and selectivity of the compounds, how they are likely to be absorbed and eliminated in the body, and to assess the potential safety of the compounds. We believe that this approach, along with stringent criteria for the selection of clinical candidates, will help us to select appropriate candidates for clinical development and rapidly assess key characteristics required for success. Given our chemistry-driven discovery process, our pipeline has grown to encompass multiple therapeutic areas: oncology, inflammation, diabetes and HIV. While our productivity has created a diverse pipeline, we conduct a limited number of discovery programs in parallel at any one time. This focus allows us to allocate resources to our selected programs at a level that we believe is competitive with much larger pharmaceutical companies. We believe this level of resource allocation, applied to the discovery process outlined above, has been critical to our success in our current programs, and that it remains a meaningful competitive advantage. Additionally, in all of our programs we strive to generate a diverse and broad range of proprietary compounds which we believe enhances the overall probability of success for our programs and creates the potential for multiple products. Once our compounds reach clinical development, our objective, whenever possible, is to rapidly progress the lead candidate into a proof-of-concept clinical trial prior to initiating larger definitive Phase IIb clinical trials to quickly assess the therapeutic potential of the clinical candidate itself and its underlying mechanism. This information is then used to evaluate the commercial potential of the compound and the most appropriate indication or indications to pursue. Incyte’s Development Teams Our development teams are responsible for ensuring that our clinical candidates are expeditiously progressed from preclinical development and IND-enabling studies into Phase I and Phase II development. To efficiently and effectively keep pace with the growth in our clinical pipeline, we have added new members to the development teams by internal transfers and by recruiting new employees with expertise in drug development including clinical trial design, statistics, regulatory affairs, and project 6 management. We have also built core internal process chemistry and formulation teams using this same strategy. Our internal multi-disciplinary project teams also work with experienced external CROs with expertise in managing clinical trials, process chemistry, product formulation, and the manufacture of clinical trial supplies to support our drug development efforts. Clinical Pipeline Our pipeline includes compounds in various stages of development in the areas of oncology, inflammation, diabetes and HIV. The following summarizes the status of and rationale for our most advanced compounds. JAK 2 Program for Inflammation, Hematologic Malignancies, and Solid Tumors The JAK family is composed of four tyrosine kinases—JAK1, JAK2, JAK3 and Tyk2—that are involved in signaling triggered by a number of cytokines and growth factors. JAKs are central to a number of biologic processes, including the formation and development of blood cells and the regulation of immune functions. Excessive signaling through the JAK pathways is believed to play a critical role in a number of disease states, including myeloproliferative disorders (MPDs), specifically myelofibrosis (MF), polycythemia vera and essential thrombocythemia, inflammatory conditions such as rheumatoid arthritis (RA) and psoriasis, and certain other solid and liquid tumors. Additionally, many MPD patients have a mutation that is associated with JAK2, V617F, as well as other JAK2 mutations, which result in increased JAK signaling and we believe further supports the hypothesis that hyperactivation of the JAK pathways is central to these disorders. We believe inhibition of aberrant JAK signaling may have therapeutic value in treating these various diseases. We have discovered multiple potent, selective and orally bioavailable JAK inhibitors that are selective for JAK1 and JAK2 from multiple distinct chemical scaffolds. Our lead JAK inhibitor, INCB18424, is currently being developed as a treatment for several of these conditions, including MF, RA and psoriasis. A lead follow-on JAK inhibitor compound, INCB28050, is expected to enter clinical trials in 2008. Thus far, our clinical trial results with INCB18424 include positive interim results from several Phase IIa clinical trials in MF, RA and psoriasis patients and the compound has been well tolerated. Myelofibrosis In December 2007, we reported positive interim results involving 11 MF patients from a dose-escalation Phase Ib/IIa trial with orally administered INCB18424. We also announced that we reached a maximum tolerated dose in this first Phase Ib/IIa trial and have expanded the study to include an additional 21 patients at this dose. If the compound continues to be well tolerated and demonstrates comparable efficacy in additional patients, we intend to begin discussions with the Food and Drug Administration (FDA) to define the potential registration pathway for INCB18424 as a treatment for MF. Provided the FDA agrees with our development plan, our objective is to initiate these trials in the second half of 2008. Rheumatoid Arthritis In January 2008, we announced positive interim results from a 28-day Phase IIa dose-ranging trial using the oral formulation of INCB18424 in six RA patients whose conditions were not well-controlled with their existing therapy. This trial is expected to involve a total of 48 patients with final results expected in the first half of 2008. Provided these results are positive, we plan to begin a six-month Phase IIb trial in RA patients in the second half of 2008. 7 Psoriasis (Topical) In September 2007, we announced positive interim results from a 28-day Phase IIa dose-escalation trial with topical INCB18424, involving 24 patients with mild-to-moderate psoriasis. In this trial the compound was well tolerated with no adverse events reported at any dose administered and with rapid and sustained improvement observed in all subjects. These results suggest that topical intervention in the JAK pathway could be an effective way to treat psoriasis. If the compound continues to be well tolerated in the ongoing safety studies, we expect to begin a three-month Phase IIb trial in psoriasis using this topical formulation in the second half of 2008. Refractory Prostate Cancer and Multiple Myeloma We recently initiated Phase IIa clinical trials in refractory prostate cancer patients, as well as patients with multiple myeloma. Results from these trials are expected in the second half of 2008. We intend to complete our IND-enabling studies and initiate Phase I clinical trials with our follow-on JAK inhibitor compound INCB28050 in mid-2008. 11ßHSD1 Program for Type 2 Diabetes and Related Disorders We have developed a broad chemically diverse series of novel proprietary oral inhibitors of 11ßHSD1, an enzyme that converts the biologically-inactive steroid cortisone into the potent biologically-active hormone cortisol. Cortisol acts as a functional antagonist of insulin action in multiple tissue types, including the liver, adipose, skeletal muscle, and pancreas. Inhibition of 11ßHSD1 offers the potential to reduce insulin resistance and restore glycemic control in type 2 diabetes, and may also offer potential benefits in allied conditions such as dyslipidemia, atherosclerosis, and coronary heart disease. In September 2007, we reported positive interim results from the ongoing 28-day Phase IIa placebo- controlled clinical trial in type 2 diabetes. In the patients included in this interim analysis, we observed positive effects on multiple clinically relevant endpoints such as fasting plasma glucose and on dyslipidemia, including reduction of LDL, total cholesterol and triglycerides. A three-month Phase IIb trial in type 2 diabetes is scheduled to begin in the first half of 2008. For INCB20817, our follow on 11ßHSD1 compound, the Investigational New Drug Application (IND) has been accepted and Phase I trials are expected to begin in the first half of 2008. HM74a for Type 2 Diabetes HM74a is a G-protein-coupled receptor (GPCR) that is expressed in adipocytes (fat cells). GPCRs are a large protein family of transmembrane receptors that sense molecules outside the cell, activate signal transduction pathways and, ultimately, cellular responses. GPCRs are involved in many diseases, and are the target of many existing drugs. Agonism of HM74a by niacin causes a reduction in circulating free fatty acids (FFA). It is known that elevated levels of FFAs are associated with an increase in glucose production and a decrease in glucose uptake which leads to insulin resistance. While oral administration of niacin leads to a decrease in glucose production and an increase in glucose uptake, niacin treatments cannot be used to treat insulin resistance in type 2 diabetics because these compounds have very short half-lives that lead to intolerance and discomfort such as cutaneous flushing. Additionally, the short half-life of niacin treatments can cause FFA levels to rebound and actually lead to increased glucose level. In contrast to niacin containing treatments, our lead HM74a agonist, INCB19602, which is in Phase I clinical trials in healthy volunteers, does not appear to cause flushing and has resulted in profound and sustained reductions in FFA levels without causing rebound. We therefore believe an HM74a agonist could prove to be an effective treatment for insulin resistance in type 2 diabetics without the adverse effect and limitations of niacin containing 8 treatments. If the results from the Phase I trials continue to support development of INCB19602, we intend to begin a 28-day Phase IIa clinical trial in type 2 diabetics in the first half of 2008. CCR5 Antagonist Program for HIV CCR5 is a major chemokine receptor that the HIV virus uses to enter CD4 cells, which are critical to the human immune system. CCR5 antagonists belong to a new class of antiretrovirals known as HIV entry inhibitors. This new class includes various experimental compounds designed to block cell surface receptors, such as CCR5 or CXCR4, as well as other novel compounds that block HIV fusion with the cell surface. Entry inhibitors work by blocking HIV before the virus enters the cell and begins its replication process. In contrast, existing HIV drugs such as nucleoside or nucleotide reverse transcriptase inhibitors (NRTIs), non-nucleoside reverse transcriptase inhibitors (NNRTIs) and protease inhibitors work inside the cell and target the proteins, reverse transcriptases and proteases that are involved in the replication of the virus. Our CCR5 antagonist program has yielded potent, selective, proprietary compounds with pharmacokinetic properties that have the potential to allow once-daily dosing without use of ritonavir boosting, a key distinction from other CCR5 antagonists. Ritonavir is a protease inhibitor that is often used in combination with other drugs to improve or ‘boost’ the bioavailability and cellular penetration of other drugs but which is associated with increased cardiovascular risk. This dosing profile is particularly attractive in patients who are in the earlier stages of disease, where CCR5 is most prevalent, where the majority of regimens are once-daily (which improves patient compliance), and where ritonavir, which increases the risk of cardiovascular disease, is less frequently used. Once-a-day dosing also offers the potential for the development of once-daily fixed dose combination formulations with other anti-HIV medications. We have two CCR5 antagonists in development, INCB9471 and INCB15050. INCB9471 is the most advanced compound in this program. Thus far, from a 14-day Phase IIa clinical trial, we have seen positive results demonstrating that once-daily dosing with INCB9471 offers sustained inhibition of viral replication. This suggests that INCB9471 may provide an advantage over other CCR5 antagonists in development and other antiretroviral drugs that have shorter half-lives, less than 24 hours, especially in patients who are intermittently non-compliant with their medications. Lack of adherence with drugs that have short half lives can lead to insufficient drug levels, which reduces the effectiveness of the drug regimen and allows the virus to replicate. We are conducting several required drug interaction studies and completing longer-term safety studies with INCB9471 to support initiation of two Phase IIb trials in treatment-experienced HIV patients. Our follow-on CCR5 antagonist, INCB15050, has completed Phase I development. While the results from the Phase I clinical trials suggest that INCB15050 also has the potential to be a potent once-a-day treatment, based on the positive Phase IIa clinical trial data that we have seen with the lead compound, INCB9471, we do not plan to advance INCB15050 beyond Phase I clinical trials at this time. Sheddase Inhibitor Program for Solid Tumors As the fundamental biology of cancer has been explored at the molecular level, new therapeutics are emerging that distinguish themselves from the classic, relatively non-selective, cytotoxic agents. These new therapeutics are targeted specifically to pathways or proteins that are more critical for the growth of tumor cells than for the growth of normal cells, thereby having the potential to provide a greater therapeutic benefit, both when used alone and in combination with cytotoxic agents. Currently available therapeutics of this type have been shown to be effective in the treatment of certain important tumor types. The signaling pathways that utilize the receptors and ligands of the epidermal growth factor receptor (EGFR) family play a key role in the growth and survival of multiple tumor types, including breast, colorectal, and non-small cell lung cancers. The EGFR, or HER, signaling pathways consist of four known 9 cellular receptors: HER1 (also known as EGFR), HER2, HER3, and HER4. Under normal conditions, these pathways are tightly regulated. However, in cancer, the pathways can become dysregulated and changes in the amount or the activity of HER family members, primarily HER1, HER2 and HER3, have been shown to impact the growth, proliferation, migration, and survival of cancer cells. Sheddase is an enzyme that is believed to activate all four EGFR pathways. Currently approved therapies target one or more of the EGFR pathways. However, these currently available therapeutics may not block all EGFR family-mediated signaling, even in the tumor types in which they are approved. In contrast, we believe our sheddase inhibitor targets all four EGFR signaling pathways and may provide meaningful advantages over therapies that target one or two. We have identified novel, potent, and orally available small-molecule inhibitors of sheddase that, in preclinical models, show efficacy as single agents and show synergy with other targeted therapeutic agents and with cytotoxics. INCB7839, the lead compound from this program, is currently in Phase II development. The first of two Phase II trials has been initiated and is designed to determine the effectiveness of INCB7839 when used in combination with Herceptin. A second Phase II trial in breast cancer patients is planned that will evaluate INCB7839 as a monotherapy. CCR2 Receptor Antagonist Program for Inflammatory Diseases CCR2 is a key chemokine receptor found on monocytes that controls their migration into sites of inflammation. Once inside the monocytes differentiate into tissue scavenger cells known as macrophages. In their normal role, macrophages scavenge foreign organisms or injured tissues; however, excessive or inappropriately triggered macrophage activity results in the production of pro-inflammatory mediators that can cause damage to tissues and can lead to a chronic inflammatory response. There is substantial preclinical data from multiple academic centers suggesting that CCR2 antagonism could be of therapeutic benefit in multiple sclerosis (MS). Activated macrophages accumulate in MS lesions, where they are associated with and presumed to be required for the destruction of the myelin sheath, the protective coating around the nerves which disrupts nerve signaling and leads to loss of muscle control, vision, balance and sensation. Blocking macrophage accumulation at these sites could thus lead to significant amelioration of this chronic and debilitating disease. We established a collaborative research and license agreement with Pfizer Inc. (‘‘Pfizer) in January 2006 in which Pfizer gained worldwide development and commercialization rights to our portfolio of CCR2 antagonist compounds. We retained rights to certain CCR2 antagonists for MS and lupus nephritis and other autoimmune nephritides. We are pursuing MS first given the preclinical evidence suggesting that selective CCR2 antagonism has therapeutic potential in this disease. We have selected a lead clinical candidate, INCB8696, and initiated a Phase I clinical trial in healthy volunteers in 2007. Discovery We have a number of early discovery programs at various stages of preclinical testing, including two lead clinical candidates in oncology. We do not typically disclose these programs and/or targets until we have successfully completed preclinical toxicology tests with the lead clinical candidate. Commercial Strategy We intend to develop and commercialize some of our compounds on our own in selected markets where we believe a company of our size can compete effectively, such as oncology and certain inflammatory conditions. For programs that target large primary care indications such as diabetes, or require lengthy and expensive clinical development plans, we intend to form strategic alliances with 10 companies that have greater financial and commercial resources than we do, as we did with Pfizer for our CCR2 antagonist program. Collaborative Research and License Agreement with Pfizer Effective in January 2006, we entered a collaborative research and license agreement with Pfizer for the pursuit of our CCR2 antagonist program. We received an upfront nonrefundable payment of $40.0 million in January 2006. In addition, we received an aggregate of $20.0 million through the purchase of convertible subordinated notes, $10.0 million in February 2006 and $10.0 million in October 2007, and we are eligible to receive additional future development and milestone payments of up to $740.0 million for the successful development and commercialization of CCR2 antagonists in multiple indications, as well as royalties on worldwide sales. We received a $3.0 million milestone payment from Pfizer in 2007. Pfizer gained worldwide development and commercialization rights to our portfolio of CCR2 antagonist compounds, the most advanced of which was in Phase IIa clinical trials in rheumatoid arthritis and insulin- resistant obese patients at the time the agreement became effective in January 2006. Pfizer’s rights extend to the full scope of potential indications, with the exception of multiple sclerosis and lupus nephritis and other autoimmune nephritides, for which we retained worldwide rights, along with certain compounds. We do not have obligations to Pfizer on preclinical development candidates we select for pursuit in these indications. Patents and Other Intellectual Property We regard the protection of patents and other enforceable intellectual property rights that we own or license as critical to our business and competitive position. Accordingly, we rely on patent, trade secret and copyright law, as well as nondisclosure and other contractual arrangements, to protect our intellectual property. We have established a patent portfolio of owned or in-licensed patents and patent applications that cover aspects of all our drug candidates, as well as other patents and patent applications that relate to full-length genes and genomics-related technologies obtained as a result of our past high-throughput gene sequencing efforts. The patents and patent applications relating to our drug candidates generally include claims directed to the drug candidates, methods of using the drug candidates, formulations of the drug candidates, and methods of manufacturing the drug candidates. Our policy is to pursue patent applications on inventions and discoveries we believe that are commercially important to the development and growth of our business. Patents extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends on the type of patent, the scope of its coverage and the availability of legal remedies in the country. We have a number of established patent license agreements relating to our gene patent portfolio and our genomics-related technology patent portfolio. We are presently receiving royalties and other payments under certain of our gene and genomics-related patent license agreements. Under our gene patent license agreements, we may in the future receive royalties and other payments if our partners are successful in their efforts to discover drugs and diagnostics under these license agreements. We may seek to license rights relating to compounds or technologies in connection with our drug discovery and development programs. Under these licenses, we may be required to pay up-front fees, license fees, milestone payments and royalties on sales of future products. 11 Although we believe our rights under patents and patent applications provide a competitive advantage, the patent positions of pharmaceutical and biotechnology companies are highly uncertain and involve complex legal and factual questions. We may not be able to develop patentable products or processes, and may not be able to obtain patents in the United States or elsewhere from pending applications. Even if patent claims are allowed, the claims may not issue, or in the event of issuance, may not be valid or enforceable or may not be sufficient to protect the technology owned by or licensed to us or provide us with a competitive advantage. Any patent or other intellectual property rights that we own or obtain may be circumvented, challenged or invalidated by our competitors. Others may have patents that relate to our business or technology and that may prevent us from marketing our product candidates unless we are able to obtain a license to those patents. In addition, litigation or other proceedings may be necessary to defend against claims of infringement, to enforce patents, to protect our other intellectual property rights, to determine the scope and validity of the proprietary rights of third parties or to defend ourselves in patent or other intellectual property right suits brought by third parties. We could incur substantial costs in such litigation or other proceedings. An adverse outcome in any such litigation or proceeding could subject us to significant liability. With respect to proprietary information that is not patentable, and for inventions for which patents are difficult to enforce, we rely on trade secret protection and confidentiality agreements to protect our interests. While we require all employees, consultants and potential business partners to enter into confidentiality agreements, we may not be able to adequately protect our trade secrets or other proprietary information. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. Competition Our drug discovery and development activities face, and will continue to face, intense competition from organizations such as pharmaceutical and biotechnology companies, as well as academic and research institutions and government agencies. Our major competitors include fully integrated pharmaceutical companies that have extensive drug discovery efforts and are developing novel small molecule pharmaceuticals. We face significant competition from organizations that are pursuing pharmaceuticals that are competitive with our potential products. Many companies and institutions, either alone or together with their collaborative partners, have substantially greater financial resources and larger research and development staffs than we do. In addition, many competitors, either alone or together with their collaborative partners, have significantly greater experience than we do in: (cid:127) drug discovery; (cid:127) developing products; (cid:127) undertaking preclinical testing and clinical trials; (cid:127) obtaining FDA and other regulatory approvals of products; and (cid:127) manufacturing, marketing, distributing and selling products. Accordingly, our competitors may succeed in obtaining patent protection, receiving FDA approval or commercializing products before we do. If we commence commercial product sales, we will be competing against companies with greater manufacturing, marketing, distributing and selling capabilities, areas in which we have limited or no experience. 12 In addition, any drug candidate that we successfully develop may compete with existing therapies that have long histories of safe and effective use. Competition may also arise from: (cid:127) other drug development technologies and methods of preventing or reducing the incidence of disease; (cid:127) new small molecules; or (cid:127) other classes of therapeutic agents. Developments by others may render our drug candidates obsolete or noncompetitive. We face and will continue to face intense competition from other companies for collaborative arrangements with pharmaceutical and biotechnology companies, for establishing relationships with academic and research institutions and for licenses to proprietary technology. These competitors, either alone or with their collaborative partners, may succeed in developing products that are more effective than ours. Our ability to compete successfully will depend, in part, on our ability to: (cid:127) develop proprietary products; (cid:127) develop and maintain products that reach the market first, are technologically superior to and/or are of lower cost than other products in the market; (cid:127) attract and retain scientific and product development personnel; (cid:127) obtain patent or other proprietary protection for our products and technologies; (cid:127) obtain required regulatory approvals; and (cid:127) manufacture, market, distribute and sell any products that we develop. In a number of countries, including in particular, developing countries, government officials and other groups have suggested that pharmaceutical companies should make drugs available at a low cost. In some cases, governmental authorities have indicated that where pharmaceutical companies do not do so, their patents might not be enforceable to prevent generic competition. Some major pharmaceutical companies have greatly reduced prices for their drugs in certain developing countries. If certain countries do not permit enforcement of any of our patents, sales of our products in those countries, and in other countries by importation from low-price countries, could be reduced by generic competition or by parallel importation of our product. Alternatively, governments in those countries could require that we grant compulsory licenses to allow competitors to manufacture and sell their own versions of our products in those countries, thereby reducing our product sales, or we could respond to governmental concerns by reducing prices for our products. In all of these situations, our results of operations could be adversely affected. Government Regulation Our related ongoing research and development activities and any manufacturing and marketing of our potential small molecule products to treat major medical conditions are subject to extensive regulation by numerous governmental authorities in the United States and other countries. Before marketing in the United States, any drug developed by us must undergo rigorous preclinical testing and clinical trials and an extensive regulatory clearance process implemented by the FDA under the United States Food, Drug and Cosmetic Act. The FDA regulates, among other things, the development, testing, manufacture, safety, efficacy, record-keeping, labeling, storage, approval, advertising, promotion, sale and distribution of these products. None of our drug candidates has, to date, been submitted for approval for sale in the United States or any foreign market. The regulatory review and approval process, which includes preclinical testing and clinical trials of each drug candidate, is lengthy, expensive and uncertain. Securing FDA approval requires the submission of extensive preclinical and clinical data and supporting information to 13 the FDA for each indication to establish a drug candidate’s safety and efficacy. The approval process takes many years, requires the expenditure of substantial resources, involves post-marketing surveillance and may involve ongoing requirements for post-marketing studies. Before commencing clinical investigations in humans, we must submit to, and receive approval from, the FDA of an IND application. The steps required before a drug may be marketed in the United States include: (cid:127) preclinical laboratory tests, animal studies and formulation studies; (cid:127) submission to the FDA of an IND for human clinical testing, which must become effective before human clinical trials may commence; (cid:127) adequate and well-controlled clinical trials in three phases, as described below, to establish the safety and efficacy of the drug for each indication; (cid:127) submission to the FDA of a new drug application, or NDA, which must become effective before marketing can commence; (cid:127) satisfactory completion of an FDA inspection of the manufacturing facility or facilities at which the drug is produced to assess compliance with current good manufacturing practices; and (cid:127) FDA review and approval of the NDA. Similar requirements exist within many foreign agencies as well. The time required to satisfy FDA requirements or similar requirements of foreign regulatory agencies may vary substantially based on the type, complexity and novelty of the product or the targeted disease. Preclinical testing includes laboratory evaluation of product chemistry, toxicity and formulation, as well as animal studies. The results of the preclinical tests, together with manufacturing information and analytical data, are submitted to the FDA as part of an IND. An IND will automatically become effective 30 days after receipt by the FDA, unless before that time, the FDA raises concerns or questions about issues such as the conduct of the clinical trials as outlined in the IND. In the latter case, the IND sponsor and the FDA must resolve any outstanding FDA concerns or questions before clinical trials can proceed. We cannot be sure that submission of an IND will result in the FDA allowing clinical trials to commence. Clinical trials involve the administration of the investigational drug to human subjects under the supervision of qualified investigators. Clinical trials are conducted under protocols detailing the objectives of the study, the parameters to be used in monitoring safety and the effectiveness criteria to be evaluated. Each protocol must be submitted to the FDA as part of the IND and each trial must be reviewed and approved by an independent ethics committee or institutional review board (IRB) before it can begin. Clinical trials typically are conducted in three sequential phases, but the phases may overlap or be combined. Phase I usually involves the initial introduction of the investigational drug into healthy volunteers to evaluate its safety, dosage tolerance, absorption, metabolism, distribution and excretion, and, if possible, to gain an early indication of its effectiveness. Phase II usually involves clinical trials in a limited patient population to: (cid:127) evaluate dosage tolerance and optimal dosage; (cid:127) identify possible adverse effects and safety risks; and (cid:127) evaluate and gain preliminary evidence of the efficacy of the drug for specific indications. Phase III clinical trials usually further evaluate clinical efficacy and safety by testing the drug in its final form in an expanded patient population, providing statistical evidence of efficacy and safety and providing an adequate basis for physician labeling. We cannot guarantee that Phase I, Phase II or Phase III testing will be completed successfully within any specified period of time, if at all. Furthermore, we or the FDA may suspend clinical trials at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk. 14 Even after initial FDA approval has been obtained, further studies, including post-approval trials, may be required to provide additional data on safety and will be required to gain approval for the sale of a product as a treatment for clinical indications other than those for which the product was initially tested and approved. Also, the FDA will require post-approval reporting to monitor the side effects of the drug. Results of post-approval programs may limit or expand the indications for which the drug product may be marketed. Further, if there are any requests for modifications to the initial FDA approval for the drug, including changes labeling or manufacturing facilities, a supplemental NDA may be required to be submitted to the FDA. indication, manufacturing process, in Clinical trials must meet requirements for IRB oversight, informed consent and good clinical practices. Clinical trials must be conducted under FDA oversight. Before receiving FDA clearance to market a product, we must demonstrate that the product is safe and effective for the patient population that will be treated. If regulatory clearance of a product is granted, this clearance will be limited to those disease states and conditions for which the product is safe and effective, as demonstrated through clinical trials. Marketing or promoting a drug for an unapproved indication is prohibited. Furthermore, clearance may entail ongoing requirements for post-marketing studies. Even if this regulatory clearance is obtained, a marketed product, its manufacturer and its manufacturing facilities are subject to continual review and periodic inspections by the FDA. Discovery of previously unknown problems with a product, manufacturer or facility may result in restrictions on this product, manufacturer or facility, including costly recalls or withdrawal of the product from the market. The length of time and related costs necessary to complete clinical trials varies significantly and may be difficult to predict. Clinical results are frequently susceptible to varying interpretations that may delay, limit or prevent regulatory approvals. Additional factors that can cause delay or termination of our clinical trials, or cause the costs of these clinical trials to increase, include: (cid:127) slow patient enrollment due to the nature of the protocol, the proximity of patients to clinical sites, the eligibility criteria for the study, competition with clinical trials for other drug candidates or other factors; (cid:127) inadequately trained or insufficient personnel at the study site to assist in overseeing and monitoring clinical trials; (cid:127) delays in approvals from a study site’s IRB; (cid:127) longer than anticipated treatment time required to demonstrate effectiveness or determine the appropriate product dose; (cid:127) lack of sufficient supplies of the drug candidate for use in clinical trials; (cid:127) adverse medical events or side effects in treated patients; and (cid:127) lack of effectiveness of the drug candidate being tested. Any drug is likely to produce some toxicities or undesirable side effects in animals and in humans when administered at sufficiently high doses and/or for sufficiently long periods of time. Unacceptable toxicities or side effects may occur at any dose level, and at any time in the course of animal studies designed to identify unacceptable effects of a drug candidate, known as toxicological studies, or in clinical trials of our potential products. The appearance of any unacceptable toxicity or side effect could cause us or regulatory authorities to interrupt, limit, delay or abort the development of any of our drug candidates, and could ultimately prevent their marketing clearance by the FDA or foreign regulatory authorities for any or all targeted indications. The FDA’s fast track program is intended to facilitate the development and expedite the review of drug candidates intended for the treatment of serious or life-threatening diseases and that demonstrate the potential to address unmet medical needs for these conditions. Under this program, the FDA can, for 15 example, review portions of an NDA for a fast track product before the entire application is complete, thus potentially beginning the review process at an earlier time. We cannot guarantee that the FDA will grant any of our requests for fast track designation, that any fast track designation would affect the time of review or that the FDA will approve the NDA submitted for any of our drug candidates, whether or not fast track designation is granted. Additionally, FDA approval of a fast track product can include restrictions on the product’s use or distribution (such as permitting use only for specified medical procedures or limiting distribution to physicians or facilities with special training or experience). Approval of fast track products can be conditioned on additional clinical trials after approval. FDA procedures also provide for priority review of NDAs submitted for drugs that, compared to currently marketed products, offer a significant improvement in the treatment, diagnosis or prevention of a disease. The FDA seeks to review NDAs that are granted priority status more quickly than NDAs given standard status. The FDA’s stated policy is to act on 90% of priority NDAs within six months of receipt. Although the FDA historically has not met these goals, the agency has made significant improvements in the timeliness of the review process. We and any of our contract manufacturers are also required to comply with applicable FDA current good manufacturing practice regulations. Good manufacturing practices include requirements relating to quality control and quality assurance as well as to corresponding maintenance of records and documentation. Manufacturing facilities are subject to inspection by the applicable regulatory authorities. These facilities, whether our own or our contract manufacturers, must be approved before we can use them in commercial manufacturing of our related products. We or our contract manufacturers may not be able to comply with applicable good manufacturing practices and FDA or other regulatory requirements. If we or our contract manufacturers fail to comply, we or our contract manufacturers may be subject to legal or regulatory action, such as suspension of manufacturing, seizure of product, or voluntary recall of product. Furthermore, continued compliance with applicable good manufacturing practices will require continual expenditure of time, money and effort on the part of us or our contract manufacturers in the areas of production and quality control and record keeping and reporting, in order to ensure full compliance. Outside the United States, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authorities. The requirements governing the conduct of clinical trials, marketing authorization, pricing and reimbursement vary widely from country to country. At present, foreign marketing authorizations are applied for at a national level, although within the European Union, or EU, regional registration procedures are available to companies wishing to market a product in more than one EU member state. If the regulatory authority is satisfied that adequate evidence of safety, quality and efficacy has been presented, a marketing authorization may be granted. This foreign regulatory approval process involves all of the risks associated with FDA approval discussed above and may also include additional risks. Incyte’s Transition into Small-Molecule Drug Discovery and Development Before the completion of our transition into a drug discovery and development company, we marketed and sold access to our genomic information databases. However, in recent years, consolidation within the pharmaceutical and biotechnology sectors and a challenging economic environment led to reduced demand for research tools and services. This trend, together with the public availability of genomic information, significantly reduced the market for and revenues from, our information products. On February 2, 2004, we announced substantial changes in our information products operations, including the closure of our Palo Alto, California facility and the cessation of development of the information products developed at this facility. In January 2005, we sold certain assets and liabilities related to our Proteome facility based in Beverly, Massachusetts. We no longer have any activities in the 16 information products area. However, we retain certain existing licenses and licensing activities related to the intellectual property portfolio generated prior to the transition. Research and Development Since our inception, we have made substantial investments in research and technology development. During 2007, 2006 and 2005, we incurred research and development expenses of $104.9 million, $87.6 million and $95.6 million, respectively. Human Resources As of December 31, 2007, we had 196 employees, including 158 in research and development and 38 in operations support, finance and administrative positions. Of these employees, 74 employees have advanced technical degrees including 8 MD’s and 66 Ph.D’s. None of our employees are covered by collective bargaining agreements, and management considers relations with our employees to be good. Available Information We were incorporated in Delaware in 1991 and our website is located at www.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 amendments to those reports, as soon as reasonably practicable after we electronically file or furnish such materials to the Securities and Exchange Commission. Our website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. 17 Item 1A. Risk Factors RISKS RELATING TO OUR BUSINESS We are at the early stage of our drug discovery and development efforts and we may be unsuccessful in our efforts. We are in the early stage of building our drug discovery and development operations. Our ability to discover, develop, and commercialize pharmaceutical products will depend on our ability to: (cid:127) hire and retain key scientific employees; (cid:127) identify high quality therapeutic targets; (cid:127) identify potential drug candidates; (cid:127) develop products internally or license drug candidates from others; (cid:127) identify and enroll suitable human subjects, either in the United States or abroad, for our clinical trials; (cid:127) complete laboratory testing and clinical trials on humans; (cid:127) obtain and maintain necessary intellectual property rights to our products; (cid:127) obtain and maintain necessary regulatory approvals for our products, both in the United States and abroad; (cid:127) enter into arrangements with third parties to provide services or to manufacture our products on our behalf; (cid:127) deploy sales and marketing resources effectively or enter into arrangements with third parties to provide these functions; (cid:127) lease facilities at reasonable rates to support our growth; and (cid:127) enter into arrangements with third parties to license and commercialize our products. We have limited experience with the activities listed above and may not be successful in discovering, developing, or commercializing drug products. Our efforts to discover and develop potential drug candidates may not lead to the discovery, development, commercialization or marketing of drug products. Our drug candidates in clinical trials are in early stage Phase I and Phase II trials. Our other drug candidates are still undergoing preclinical testing. We have also licensed to Pfizer our portfolio of CCR2 antagonist compounds. We have no control over the further clinical development of any compounds we licensed to Pfizer. Discovery and development of potential drug candidates are expensive and time-consuming, and we do not know if our efforts will lead to discovery of any drug candidates that can be successfully developed and marketed. If our efforts do not lead to the discovery of a suitable drug candidate, we may be unable to grow our clinical pipeline or we may be unable to enter into agreements with collaborators who are willing to develop our drug candidates. Of the compounds that we identify as potential drug products or that we in-license from other companies, only a few, if any, are likely to lead to successful drug development programs. For example, in 2006, we discontinued the development of DFC, which was at the time our most advanced drug candidate and was in Phase IIb clinical trials. Prior to discontinuation of the DFC program, we expended a significant amount of effort and money on that program. 18 The success of our drug discovery and development efforts may depend on our ability to find suitable collaborators to fully exploit our capabilities. If we are unable to establish collaborations or if these future collaborations are unsuccessful, our research and development efforts may be unsuccessful, which could adversely affect our results of operations and financial condition. An important element of our business strategy will be to enter into collaborative or license arrangements with other parties, such as our collaboration with Pfizer, under which we license our drug candidates to those parties for development and commercialization. We expect that while we plan to conduct initial clinical trials on our drug candidates, we may need to seek collaborators for our drug candidates such as our chemokine receptor antagonists because of the expense, effort and expertise required to continue additional clinical trials and further develop those drug candidates. We may also seek collaborators for our drug candidates that target large primary care indications such as diabetes because of the expense involved in further clinical development of these indications and in establishing a sales and marketing organization to address these indications. Because collaboration arrangements are complex to negotiate, we may not be successful in our attempts to establish these arrangements. Also, we may not have drug compounds that are desirable to other parties, or we may be unwilling to license a drug compound because the party interested in it is a competitor. The terms of any such arrangements that we establish may not be favorable to us. Alternatively, potential collaborators may decide against entering into an agreement with us because of our financial, regulatory or intellectual property position or for scientific, commercial or other reasons. If we are not able to establish collaborative agreements, we may not be able to develop and commercialize a drug product, which would adversely affect our business and our revenues. In order for any of these collaboration or license arrangements to be successful, we must first identify potential collaborators or licensees whose capabilities complement and integrate well with ours. 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. However, it is likely that we will not be able to control the amount and timing of resources that our collaborators or licensees devote to our programs or potential products. If our collaborators or licensees prove difficult to work with, are less skilled than we originally expected or do not devote adequate resources to the program, the relationship will not be successful. If a business combination involving a collaborator or licensees and a third party were to occur, the effect could be to diminish, terminate or cause delays in development of a potential product. We face significant competition for our drug discovery and development efforts, and if we do not compete effectively, our commercial opportunities will be reduced or eliminated. The biotechnology and pharmaceutical industries are intensely competitive and subject to rapid and significant technological change. Our drug discovery and development efforts may target diseases and conditions that are already subject to existing therapies or that are being developed by our competitors, many of which have substantially greater resources, larger research and development staffs and facilities, more experience in completing preclinical testing and clinical trials, and formulation, marketing and manufacturing capabilities. As a result of these resources, our competitors may develop drug products that render our products obsolete or noncompetitive by developing more effective drugs or by developing their products more efficiently. Our ability to develop competitive products would be limited if our competitors succeeded in obtaining regulatory approvals for drug candidates more rapidly than we were able to or in obtaining patent protection or other intellectual property rights that limited our drug development efforts. Any drugs resulting from our research and development efforts, or from our joint efforts with collaborators or licensees, might not be able to compete successfully with our competitors’ existing and future products, or obtain regulatory approval in the United States or elsewhere. 19 We depend on our collaboration with Pfizer for the development and commercialization of CCR2 antagonist compounds. Under our collaborative research and license agreement with Pfizer, Pfizer gained worldwide development and commercialization rights to our portfolio of CCR2 antagonist compounds. Pfizer’s rights extend to the full scope of potential indications, with the exception of multiple sclerosis and autoimmune nephritides. Although Pfizer is required to use commercially reasonable efforts to develop and commercialize CCR2 antagonists for the indications for which they are responsible, we cannot control the amount and timing of resources Pfizer may devote to the development of CCR2 antagonists. Any failure of Pfizer to perform its obligations under our agreement could negatively impact the development of CCR2 antagonists, lead to our loss of potential revenues from product sales and milestones and delay our achievement, if any, of profitability. Pfizer has certain rights to terminate the license agreement, including the right to terminate upon 90 days’ notice for any reason. Pfizer also has the right to terminate its rights and obligations with respect to certain indications. If Pfizer terminates the license agreement or its rights with respect to certain indications, we may not be able to find a new collaborator to replace Pfizer, and our business could be adversely affected. If conflicts arise between our collaborators, including Pfizer, licensees, or advisors and us, our collaborators, licensees, or advisors may act in their self-interest, which may adversely affect our business. If conflicts arise between us and our collaborators or licensees, including Pfizer, or our scientific advisors, the other party may act in its self-interest and not in the interest of our stockholders. Conflicts may arise with our collaborators or licensees if they pursue alternative technologies or develop alternative products either on their own or in collaboration with others as a means for developing treatments for the diseases that we have targeted. Competing products, either developed by these future collaborators or licensees or to which these future collaborators or licensees have rights, may result in their withdrawal of support for our product candidates. Additionally, conflicts may arise if there is a dispute about the achievement and payment of a milestone amount or the ownership of intellectual property that is developed during the course of the relationship. Similarly, the parties to a collaboration or license agreement may disagree as to which party owns newly developed products. Should an agreement be terminated as a result of a dispute and before we have realized the benefits of the collaboration or license, our reputation could be harmed and we may not obtain revenues that we anticipated receiving. We have limited expertise with and capacity to conduct preclinical testing and clinical trials, and our resulting dependence on other parties could result in delays in and additional costs for our drug development efforts. trials, We have only limited experience with clinical formulation, manufacturing and commercialization of drug products. We also have limited internal resources and capacity to perform preclinical testing and clinical trials. As a result, we intend to hire Clinical Research Organizations, or CROs, to perform preclinical testing and clinical trials for drug candidates. If the CROs that we hire to perform our preclinical testing and clinical trials or our collaborators or licensees do not meet deadlines, do not follow proper procedures, or a conflict arises between us and our CROs, our preclinical testing and clinical trials may take longer than expected, may be delayed or may be terminated. If we were forced to find a replacement entity to perform any of our preclinical testing or clinical trials, we may not be able to find a suitable entity on favorable terms, or at all. Even if we were able to find another company to perform a preclinical test or clinical trial, the delay in the test or trial may result in significant expenditures. Events such as these may result in delays in our obtaining regulatory approval for our drug candidates or 20 our ability to commercialize our products and could result in increased expenditures that would adversely affect our operating results. In addition, for some of our drug candidates, we plan to contract with collaborators or licensees to advance those candidates through later-stage, more expensive clinical trials, rather than invest our own resources to perform these clinical trials. Depending on the terms of our agreements with these collaborators or licensees, we may not have any control over the conduct of these clinical trials, and in any event we would be subject to the risks associated with depending on collaborators or licensees to develop these drug candidates. If we fail to enter into additional licensing agreements or if these arrangements are unsuccessful, our business and operations might be adversely affected. In addition to establishing collaborative or license arrangements under which other parties license our drug candidates for development and commercialization, we intend to continue to explore opportunities to develop our clinical pipeline by in-licensing drug compounds that fit within our expertise and research and development capabilities. We may be unable to enter into any additional in-licensing agreements because suitable product candidates that are within our expertise may not be available to us on terms that are acceptable to us or because competitors with greater resources seek to in-license the same product candidates. Product candidates that we would like to develop may not be available to us because they are controlled by competitors who are unwilling to license the rights to the drug compound or candidate to us. In addition, we may enter into license agreements that are unsuccessful and our business and operations might be adversely affected by the termination of a drug candidate and termination and winding down of the related license agreement. For example, in April 2006, we announced the discontinuation of development of DFC and we gave notice of termination of our collaborative license agreement with Pharmasset, Inc., which licensed DFC to us. DFC was at the time our most advanced drug candidate. We may also need to license drug delivery or other technology in order to continue to develop our drug candidate pipeline. If we are unable to enter into additional agreements to license drug candidates, drug delivery technology or other technology or if these arrangements are unsuccessful, our research and development efforts could be adversely affected. If we are unable to obtain regulatory approval to develop and market products in the United States and foreign jurisdictions, we will not be permitted to manufacture or commercialize products resulting from our research. In order to manufacture and commercialize drug products in the United States, our drug candidates will have to obtain regulatory approval from the Food and Drug Administration, or the FDA. Satisfaction of regulatory requirements typically takes many years. To obtain regulatory approval, we must first show that our drug products are safe and effective for target indications through preclinical testing (animal testing) and clinical trials (human testing). Preclinical testing and clinical development are long, expensive and uncertain processes, and we do not know whether the FDA will allow us to undertake clinical trials of any potential drug products in addition to our compounds currently in clinical trials. Completion of clinical trials may take several years and failure may occur at any stage of testing. The length of time required varies substantially according to the type, complexity, novelty and intended use of the product candidate. Interim results of a preclinical test or clinical trial do not necessarily predict final results, and acceptable results in early clinical trials may not be repeated in later clinical trials. For example, a drug candidate that is successful at the preclinical level may cause harmful or dangerous side effects when tested at the clinical level. Our rate of commencement and completion of clinical trials may be delayed by many factors, including: (cid:127) the high degree of risk associated with drug development; (cid:127) our inability to formulate or manufacture sufficient quantities of materials for use in clinical trials; 21 (cid:127) variability in the number and types of patients available for each study; (cid:127) difficulty in maintaining contact with patients after treatment, resulting in incomplete data; (cid:127) unforeseen safety issues or side effects; (cid:127) poor or unanticipated effectiveness of drug candidates during the clinical trials; or (cid:127) government or regulatory delays. Data obtained from clinical trials are susceptible to varying interpretation, which may delay, limit or prevent regulatory approval. 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 clinical trials. In addition, regulatory authorities may refuse or delay approval as a result of other factors, such as changes in regulatory policy during the period of product development and regulatory agency review. For example, the FDA has in the past required and could in the future require that we conduct additional trials of any of our product candidates, which would result in delays. 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 develop. Our drug candidates in clinical trials are in early stage Phase I and Phase II trials. Our other drug candidates are still undergoing preclinical testing. We have also licensed to Pfizer our portfolio of CCR2 antagonist compounds. We have no control over the further clinical development of any compounds we licensed to Pfizer. Compounds developed by us, alone or with other parties, may not prove to be safe and effective in clinical trials and may not meet all of the applicable regulatory requirements needed to receive marketing approval. 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 effective. Failure to obtain regulatory approval would delay or prevent us from commercializing products. Outside the United States, our ability 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 the FDA approval process described above and may also include additional risks. Our reliance on other parties to manufacture our drug candidates could result in a short supply of the drugs, delays in clinical trials or drug development, increased costs and withdrawal or denial of the regulatory authority’s approval. We do not currently operate manufacturing facilities for clinical or commercial production of our drug candidates. We expect to continue to rely on third parties for the manufacture of our drug candidates and any drug products that we may develop. The FDA requires that drug products be manufactured according to its current Good Manufacturing Practices, or cGMP, regulations and a limited number of manufacturers comply with these requirements. If the other parties that we choose to manufacture our drug products are not compliant with cGMP, the FDA may not approve our application to manufacture our drug products. We may not be able to arrange for our drug candidates or any drug products that we may develop to be manufactured by one of these parties on reasonable terms, if at all. Failure to comply with cGMP in the manufacture of our products could result in the FDA withdrawing or denying regulatory approval of our drug product or other enforcement actions. We may not be able to obtain sufficient quantities of our drug candidates or any drug products we may develop if our designated manufacturers do not have the capacity or capability to manufacture our products according to our schedule and specifications. Also, raw materials that may be required to manufacture any products we develop may only be available from a limited number of suppliers. If we have promised delivery of a new product and are unable to meet the delivery requirement due to manufacturing difficulties, our development programs would be delayed, and we may have to expend additional sums in 22 order to ensure that manufacturing capacity is available when we need it even if we do not use all of the manufacturing capacity. This expense would adversely affect our operating results. Manufacturers of pharmaceutical products often encounter difficulties in production, especially in scaling up initial production. These problems include difficulties with production costs and yields, quality control and assurance and shortages of qualified personnel, as well as compliance with strictly enforced federal, state and foreign regulations. We may not be able to adequately manage and oversee the manufacturers we choose, they may not perform as agreed or they may terminate their agreements with us. Foreign manufacturing approval processes typically include all of the risks associated with the FDA approval process for manufacturing and may also include additional risks. We may incur additional expense in order to market our drug products. We do not have experience marketing drug products. If the FDA grants regulatory approval to one or more of our drug candidates, we would have to employ additional personnel or engage another party to market our drug products, which would be an additional expense to us. We might not be able to commercialize our drug candidates successfully, and we may spend significant time and money attempting to do so. We have a limited number of drug candidates in early stage Phase I and Phase II clinical trials. We have also licensed to Pfizer our portfolio of CCR2 antagonist compounds. We, or our collaborators or licensees, may decide to discontinue development of any or all of our drug candidates at any time for commercial, scientific or other reasons. We discontinued development of DFC in April 2006 for safety reasons. If a product is developed, but is not marketed, we may have spent significant amounts of time and money on it, which would adversely affect our operating results and financial condition. Even if a drug candidate that we develop receives regulatory approval, we may decide not to commercialize it if we determine that commercialization of that product would require more money and time than we are willing to invest. For example, drugs that receive approval are subject to post-regulatory surveillance and may have to be withdrawn from the market if previously unknown side effects occur. At this point, the regulatory agencies may require additional clinical trials or testing. Once a drug is marketed, if it causes side effects, the drug product may be recalled or may be subject to reformulation, additional studies, changes in labeling, warnings to the public and negative publicity. As a result, we may not continue to commercialize a product even though it has obtained regulatory approval. Further, we may decide not to continue to commercialize a product if the market does not accept the product because it is too expensive and third parties such as insurance companies or Medicare have not approved it for substantial reimbursement. In addition, we may decide not to continue to commercialize a product if another product comes on the market that is as effective but has fewer side effects. There is also a risk that competitors may develop similar or superior products or have proprietary rights that preclude us from ultimately marketing our products. Our ability to generate revenues will be diminished if we are unable to obtain acceptable prices or an adequate level of reimbursement from payors of healthcare costs. The continuing efforts of government and insurance companies, health maintenance organizations, or HMOs, and other payors of healthcare costs to contain or reduce costs of health care may affect our future revenues and profitability, and the future revenues and profitability of our potential customers, suppliers and collaborative or license partners and the availability of capital. For example, in certain foreign markets, pricing or profitability of prescription pharmaceuticals is subject to government control. In the United States, given recent federal and state government initiatives directed at lowering the total cost of health care, the U.S. Congress and state legislatures will likely continue to focus on health care reform, the cost of prescription pharmaceuticals and on the reform of the Medicare and Medicaid systems. While we cannot predict whether any such legislative or regulatory proposals will be adopted, the announcement or 23 adoption of these proposals could reduce the price that we or any of our collaborators or licensees receive for any products in the future. Our ability to commercialize our products successfully will depend in part on the extent to which appropriate reimbursement levels for the cost of our products and related treatment are obtained by governmental authorities, private health insurers and other organizations, such as HMOs. Third-party payors are increasingly challenging the prices charged for medical products and services. Also, the trend toward managed health care in the United States and the concurrent growth of organizations such as HMOs, which could control or significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care or reduce government insurance programs, may all result in lower prices for or rejection of our products. The cost containment measures that health care payors and providers are instituting and the effect of any health care reform could materially and adversely affect our ability to generate revenues. As our drug discovery and development operations are conducted at our headquarters in Wilmington, Delaware, the loss of access to this facility would negatively impact our business. Our facility in Wilmington, Delaware is our headquarters and is also where we conduct all of our drug discovery operations and research and development activities. Our lease contains provisions that provide for its early termination upon the occurrence of certain events of default or upon a change of control. Further, our headquarters facility is located in a large research and development complex that may be temporarily or permanently shutdown if certain environmental or other hazardous conditions were to occur within the complex. In addition, actions of activists opposed to aspects of pharmaceutical research may disrupt our experiments or our ability to access or use our facilities. The loss of access to or use of our Wilmington, Delaware, facility, either on a temporary or permanent basis, or early termination of our lease would result in an interruption of our business and, consequently, would adversely affect the advancement of our drug discovery and development programs and our overall business. We depend on key employees in a competitive market for skilled personnel, and the loss of the services of any of our key employees or our inability to attract and retain additional personnel would affect our ability to expand our drug discovery and development programs and achieve our objectives. We are highly dependent on the principal members of our management, operations and scientific staff. We experience intense competition for qualified personnel. Our future success also depends in part on the continued service of our executive management team, key scientific and management personnel and our ability to recruit, train and retain essential scientific personnel for our drug discovery and development programs, including those who will be responsible for overseeing our preclinical testing and clinical trials as well as for the establishment of collaborations with other companies. If we lose the services of any of these people or if we are unable to recruit sufficient qualified personnel, our research and product development goals, including the identification and establishment of key collaborations, operations and marketing efforts could be delayed or curtailed. We do not maintain ‘‘key person’’ insurance on any of our employees. 24 If we fail to manage our growth effectively, our ability to develop and commercialize products could suffer. We expect that if our clinical drug candidates continue to progress in development, we continue to build our development organization and our drug discovery efforts continue to generate drug candidates, we will require significant additional investment in personnel, management and resources. Our ability to commercialize our drug candidates and to achieve our research and development objectives depends on our ability to respond effectively to these demands and expand our internal organization, systems and controls to accommodate additional anticipated growth. If we are unable to manage our growth effectively, our business could be harmed and our ability to execute our business strategy could suffer. We may encounter difficulties in integrating companies we acquire, which may harm our operations and financial results. As part of our business strategy, we have in the past and may in the future acquire assets, technologies, compounds and businesses. Our past acquisitions, such as the acquisition of Maxia have involved, and our future acquisitions may involve, risks such as the following: (cid:127) we may be exposed to unknown liabilities of acquired companies; (cid:127) our acquisition and integration costs may be higher than we anticipated and may cause our quarterly and annual operating results to fluctuate; (cid:127) we may experience difficulty and expense in assimilating the operations and personnel of the acquired businesses, disrupting our business and diverting our management’s time and attention; (cid:127) we may be unable to integrate or complete the development and application of acquired technology, compounds or drug candidates; (cid:127) we may experience difficulties in establishing and maintaining uniform standards, controls, procedures and policies; (cid:127) our relationships with key customers, suppliers, or collaborative or license partners of acquired businesses may be impaired, due to changes in management and ownership of the acquired businesses; (cid:127) we may be unable to retain key employees of the acquired businesses; (cid:127) we may incur amortization or impairment expenses if an acquisition results in significant goodwill or other intangible assets; or (cid:127) our stockholders may be diluted if we pay for the acquisition with equity securities. If product liability lawsuits are brought against us, we could face substantial liabilities and may be required to limit commercialization of our products and our results of operations could be harmed. The clinical trials and marketing of medical products that are intended for human use entails an inherent risk of product liability. If any product that we or any of our collaborators or licensees develops causes or is alleged to cause injury or is found to be unsuitable during clinical trials, manufacturing or sale, we may be held liable. If we cannot successfully defend ourselves against product liability claims, we may incur substantial liabilities, including substantial damages to be paid to the plaintiffs and legal costs, or we may be required to limit commercialization of our products. Our product liability insurance policy that provides coverage for liabilities arising from our clinical trials may not fully cover our potential liabilities. In addition, we may determine that we should increase our coverage upon the undertaking of new clinical trials, and this insurance may be prohibitively expensive to us or our collaborators or licensees and 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 collaborators. Additionally, 25 any product liability lawsuit could cause injury to our reputation, recall of products, participants to withdraw from clinical trials, and potential collaborators or licensees to seek other partners, any of which could impact our results of operations. 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. We are subject to various environmental, health and safety laws and regulations governing, among other things, the use, handling, storage and disposal of regulated substances and the health and safety of our employees. Our research and development processes involve the controlled use of hazardous and radioactive materials and biological waste resulting in the production of hazardous waste products. We cannot completely eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. If any injury or contamination results from our use or the use by our collaborators or licensees of these materials, we may be sued and our liability may exceed our insurance coverage and our total assets. Further, we may be required to indemnify our collaborators or licensees against all damages and other liabilities arising out of our development activities or products produced in connection with these collaborations or licenses. Compliance with the applicable environmental and workplace laws and regulations is expensive. Future changes to environmental, health, workplace and safety laws could cause us to incur additional expense or may restrict our operations or impair our research, development and production efforts. RISKS RELATING TO OUR FINANCIAL RESULTS We expect to incur losses in the future and we may not achieve or maintain profitability in the future. We had net losses from inception in 1991 through 1996 and in 1999 through 2007. Because of those losses, we had an accumulated deficit of $1.0 billion as of December 31, 2007. We will continue to spend significant amounts on our efforts to discover and develop drugs. As a result, we expect to continue to incur losses in 2008 and in future periods as well. We anticipate that our drug discovery and development efforts will increase as we focus on the studies, including preclinical tests and clinical trials prior to seeking regulatory approval, that are required before we can sell a drug product. The development of drug products will require us to spend significant funds on research, development, testing, obtaining regulatory approvals, manufacturing and marketing. To date, we do not have any drug products that have generated revenues and we cannot assure you that we will generate revenues from the drug candidates that we license or develop for several years, if ever. We cannot be certain whether or when we will achieve profitability because of the significant uncertainties relating to our ability to generate commercially successful drug products. Even if we were successful in obtaining regulatory approvals for manufacturing and commercializing a drug candidate, we expect that we will continue to incur losses if our drug products do not generate significant revenues. If we achieve profitability, we may not be able to sustain or increase profitability. We will need additional capital in the future. The capital markets may not permit us to raise additional capital at the time that we require it, which could result in limitations on our research and development or commercialization efforts or the loss of certain of our rights in our technologies or drug candidates. Our future funding requirements will depend on many factors and we anticipate that we will need to raise additional capital to fund our business plan and research and development efforts going-forward. Additional factors that may affect our future funding requirements include: (cid:127) any changes in the breadth of our research and development programs; (cid:127) the results of research and development, preclinical testing and clinical trials conducted by us or our future collaborative partners or licensees, if any; 26 (cid:127) the acquisition or licensing of businesses, technologies or compounds, if any; (cid:127) our ability to maintain and establish new corporate relationships and research collaborations; (cid:127) competing technological and market developments; (cid:127) the amount of revenues generated from our business activities, if any; (cid:127) the time and costs involved in filing, prosecuting, defending and enforcing patent and intellectual property claims; (cid:127) the receipt of contingent licensing or milestone fees or royalties on product sales from our current or future collaborative and license arrangements, if established; and (cid:127) the timing of regulatory approvals, if any. If we require additional capital at a time when investment in companies such as ours, or in the marketplace generally, is limited due to the then prevailing market or other conditions, we may have to scale back our operations, eliminate one or more of our research or development programs, or attempt to obtain funds by entering into an agreement with a collaborative partner that would result in terms that are not favorable to us or relinquishing our rights in certain of our proprietary technologies or drug candidates. If we are unable to raise funds at the time that we desire or at any time thereafter on acceptable terms, we may not be able to continue to develop our potential drug products. The sale of equity or additional convertible debt securities in the future would be dilutive to our stockholders, and debt financing arrangements may require us to pledge certain assets or enter into covenants that could restrict our operations or our ability to incur further indebtedness. Our current revenues are derived from collaborations and from licensing our intellectual property. If we are unable to achieve milestones, develop products or renew or enter into new collaborations, our revenues may decrease, and future milestone and royalty payments from our gene and genomics-related intellectual property may not contribute significantly to revenues for several years, and may never result in revenues. We derived substantially all of our revenues for the year ended December 31, 2007 from our collaborative research and license agreement with Pfizer and from licensing our intellectual property to others. We may be unable to enter into additional collaborative agreements. Revenues from research and development collaborations depend upon continuation of the collaborations, the achievement of milestones and royalties we earn from any future products developed from our research. If we are unable to successfully achieve milestones or our collaborators fail to develop successful products, we will not earn the revenues contemplated under our collaborative agreements. Part of our prior strategy was to license to our database customers and to other pharmaceutical and biotechnology companies our know-how and patent rights associated with the information we have generated in the creation of 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 trials and regulatory approval before commercialization, all of which is beyond our control, and possibly beyond the control of our licensee. These licensees may not develop the potential product if they do not devote the necessary resources or decide that they do not want to expend the resources to do the clinical trials necessary to obtain the necessary regulatory approvals. Therefore, milestone or royalty payments from these licenses may not contribute to our revenues for several years, if at all. We have decided to discontinue some of our gene and genomics-related patent prosecution and maintenance, and may in the future decide to discontinue additional gene and genomics-related patent prosecution and maintenance, which could limit our ability to receive license-based revenues from our gene and genomics-related patent portfolio. 27 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. As of December 31, 2007, the aggregate principal amount of total consolidated debt was $421.8 million and our stockholders’ deficit was $159.5 million. The documents pursuant to which our outstanding convertible senior and subordinated notes were issued do not limit the issuance of additional indebtedness. Our substantial leverage could have significant negative consequences for our future operations, including: (cid:127) increasing our vulnerability to general adverse economic and industry conditions; (cid:127) limiting our ability to obtain additional financing for working capital, capital and research and development expenditures, and general corporate purposes; (cid:127) requiring the dedication of a substantial portion of our expected cash flow or our existing cash to service our indebtedness, thereby reducing the amount of our cash available for other purposes, including working capital, capital expenditures and research and development expenditures; (cid:127) limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; or (cid:127) placing us at a possible competitive disadvantage compared to less leveraged competitors and competitors that have better access to capital resources. In the past five years, we have had negative cash flow from operations. We likely will not generate sufficient cash flow from our operations in the future to enable us to meet our anticipated fixed charges, including our debt service requirements with respect to our outstanding convertible senior notes and convertible subordinated notes. As of December 31, 2007, $151.8 million aggregate principal amount of our 31⁄2% convertible senior notes due 2011 was outstanding. Our annual interest payments, beginning in 2007, for the 31⁄2% convertible senior notes through 2010, assuming none of these notes are converted, redeemed, repurchased or exchanged, are $5.3 million, and an additional $2.6 million in interest is payable in 2011. As of December 31, 2007, $250.0 million aggregate principal amount of our 31⁄2% convertible subordinated notes due 2011 was outstanding. Our annual interest payments for the 31⁄2% convertible subordinated notes through 2010, assuming none of these notes are converted, redeemed, repurchased or exchanged, are $8.8 million, and an additional $4.4 million in interest is payable in 2011. As of December 31, 2007, $20.0 million aggregate principal amount of the non-interest bearing convertible subordinated notes held by Pfizer was outstanding, of which $10.0 million is due in 2013 and $10.0 million is due in 2014. If we are unable to generate cash from our operations or raise additional cash through financings sufficient to meet these obligations, we will need to use existing cash or liquidate marketable securities in order to fund these obligations, which may delay or curtail our research, development and commercialization programs. RISKS RELATING TO INTELLECTUAL PROPERTY AND LEGAL MATTERS If we are subject to arbitration, litigation and infringement claims, they could be costly and disrupt our drug discovery and development efforts. The technology that we use to make and develop our drug products, the technology that we incorporate in our products, and the products we are developing may be subject to claims that they infringe the patents or proprietary rights of others. The success of our drug discovery and development efforts will also depend on our ability to develop new compounds, drugs and technologies without infringing or misappropriating the proprietary rights of others. We are aware of patents and patent applications filed in certain countries claiming certain intellectual property relating to certain of our drug discovery targets such as CCR5. While the validity of issued patents, patentability of pending patent applications and applicability of any of them to our programs are uncertain, if any of these patents are asserted against us or if we choose 28 to license any of these patents, our ability to commercialize our products could be harmed or the potential return to us from any product that may be successfully commercialized could be diminished. From time to time we may receive notices from third parties offering licenses to technology or alleging patent, trademark, or copyright infringement, claims regarding trade secrets or other contract claims. Receipt of these notices could result in significant costs as a result of the diversion of the attention of management from our drug discovery and development efforts. Parties sending these notices may have brought and in the future may bring litigation against us or seek arbitration relating to contract claims. We may be involved in future lawsuits or other legal proceedings alleging patent infringement or other intellectual property rights or contract violations. In addition, litigation or other legal proceedings may be necessary to: (cid:127) assert claims of infringement; (cid:127) enforce our patents or trademarks; (cid:127) protect our trade secrets or know-how; or (cid:127) determine the enforceability, scope and validity of the proprietary rights of others. We may be unsuccessful in defending or pursuing these lawsuits, claims or other legal proceedings. Regardless of the outcome, litigation or other legal proceedings can be very costly and can divert management’s efforts. For example, we recently settled patent litigation with Invitrogen Corporation. We incurred significant expenses related to this litigation and, as part of the settlement, paid Invitrogen $3.4 million. An adverse determination may subject us to significant liabilities or require us or our collaborators or licensees to seek licenses to other parties’ patents or proprietary rights. We or our collaborators or licensees may also be restricted or prevented from manufacturing or selling a drug or other product that we or they develop. Further, we or our future collaborators or licensees may not be able to obtain any necessary licenses on acceptable terms, if at all. If we are unable to develop non-infringing technology or license technology on a timely basis or on reasonable terms, our business could be harmed. We may be unable to adequately protect or enforce our proprietary information, which may result in its unauthorized use, a loss of revenue under a collaboration agreement or loss of sales to generic versions of our products or otherwise reduce our ability to compete in developing and commercializing products. Our business and competitive position depends in significant part upon our ability to protect our proprietary technology, including any drug products that we create. Despite our efforts to protect this information, unauthorized parties may attempt to obtain and use information that we regard as proprietary. For example, one of our collaborators may disclose proprietary information pertaining to our drug discovery efforts. Our patent applications may fail to result in issued patents. In addition, because patent applications can take several years to issue as patents, there may be pending patent applications of others that may later issue as patents that cover some aspect of our drug candidates. Our existing patents and any future patents we may obtain may not be broad enough to protect our products or all of the potential uses of our products, or otherwise prevent others from developing competing products or technologies. In addition, our patents may be challenged and invalidated or may fail to provide us with any competitive advantages if, for example, others were first to invent or first to file a patent application for the technologies and products covered by our patents. Additionally, when we do not control the prosecution, maintenance and enforcement of certain important intellectual property, such as a drug compound in-licensed to us or subject to a collaboration with a third party, the protection of the intellectual property rights may not be in our hands. If we do not control the intellectual property rights in-licensed to us with respect to a compound and the entity that controls the intellectual property rights does not adequately protect those rights, our rights may be impaired, which may impact our ability to develop, market and commercialize the in-licensed compound. 29 Our means of protecting our proprietary rights may not be adequate, and our competitors may: (cid:127) independently develop substantially equivalent proprietary information, products and techniques; (cid:127) otherwise gain access to our proprietary information; or (cid:127) design around patents issued to us or our other intellectual property. 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. If we fail to maintain trade secret and patent protection, our potential, future revenues may be decreased. If the effective term of our patents is decreased due to changes in the 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. 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 United States 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 time from filing to issuance of biotechnology applications 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 filed before 1995 that claim large numbers of genes or other additional subject matter 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 derive from the patents. International patent protection is particularly uncertain and costly, and if we are involved in opposition proceedings in foreign countries, we may have to expend substantial sums and management resources. Biotechnology and pharmaceutical patent law outside the United States is even more uncertain and costly 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 United States laws. For example, certain countries do not grant patent claims that are directed to the treatment of humans. We may participate in opposition proceedings to determine the validity of our foreign patents or our competitors’ foreign patents, which could result in substantial costs and diversion of our efforts. Item 1B. Unresolved Staff Comments. None. Item 2. Properties Our corporate headquarters is in Wilmington, Delaware, which is where our drug discovery and development operations are also located. These facilities are leased to us until June 2010. We believe that these facilities are adequate to meet our business requirements for the near-term and that additional space will be available on commercially reasonable terms, if required. In addition to this lease, we had lease agreements as of December 31, 2007 for facilities that were closed as a part of the restructurings of our genomic information business in Palo Alto and San Diego, California. As of December 31, 2007, we had multiple sublease and lease agreements covering approximately 273,000 square feet that expire on various dates ranging from June 2008 to March 2011. Of the approximately 273,000 square feet leased, approximately 174,000 square feet of this space is currently subleased to others. 30 Item 3. Legal Proceedings We are not currently a party to any material legal proceedings. We may from time to time become involved in various legal proceedings arising in the ordinary course of business. 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 2007. Executive Officers of the Registrant Our executive officers are as follows: Paul A. Friedman, M.D., age 65, joined Incyte as the Chief Executive Officer and a Director in November 2001. Dr. Friedman also serves as our President. 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 Diplomate of the American Board of Internal Medicine and a Member of the American Society of Clinical Investigation. He received his A.B. in Biology from Princeton University and his M.D. from Harvard Medical School. David C. Hastings, age 46, has served as Executive Vice President and Chief Financial Officer since October 2003. From February 2000 to September 2003, Mr. Hastings served as Vice President, Chief Financial Officer, and Treasurer of ArQule, Inc. Prior to his employment with ArQule, Mr. Hastings was Vice President and Corporate Controller at Genzyme, Inc., where he was responsible for the management of the finance department. Prior to his employment with Genzyme, Mr. Hastings was the Director of Finance at Sepracor, Inc., where he was primarily responsible for Sepracor’s internal and external reporting. Mr. Hastings is a Certified Public Accountant and received his B.A. in Economics at the University of Vermont. John A. Keller, Ph.D., age 43, has served as Executive Vice President and Chief Business Officer since September 2003. From January 2001 to September 2003, Dr. Keller served as Vice President, Business Development at GlaxoSmithKline. From February 1987 to January 2001, Dr. Keller held a range of positions at SmithKline Beckman and SmithKline Beecham, in areas encompassing discovery research, project management, R&D strategy, alliance management and business development. Dr. Keller received his B.A. from Johns Hopkins University and his Ph.D. in Microbiology from Rutgers University. 31 Brian W. Metcalf, Ph.D., age 62, 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. Patricia A. Schreck, age 54, joined Incyte as Executive Vice President and General Counsel in December 2003. Prior to joining Incyte, Ms. Schreck was Chief Patent Counsel at Elan Drug Delivery, Inc. Previously, she served as General Counsel for Genomics Collaborative, Inc. and diaDexus, Inc. (a SmithKline Beecham and Incyte joint venture). From 1992 through 1998, Ms. Schreck held a variety of senior patent and corporate legal positions at SmithKline Beecham. Ms. Schreck holds a B.A. in Chemistry and Biology from the University of Colorado and a J.D. from Villanova University School of Law. Ms. Schreck is admitted to practice before the United States Patent bar. Paula Swain, age 50, has served as Executive Vice President, Human Resources, of Incyte since August 2002 and joined the company as Senior Vice President of Human Resources in January 2002. Ms. Swain served as Senior Vice President of Human Resources at Bristol Meyers Squibb from October 2001 to January 2002, after they acquired DuPont Pharmaceuticals Company. From July 1998 to October 2001, Ms. Swain was Senior Vice President of Human Resources at DuPont Pharmaceuticals. 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 University. PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Our common stock, par value $.001, is traded on The Nasdaq Global Market (‘‘Nasdaq’’) under the symbol ‘‘INCY.’’ The following table sets forth, for the periods indicated, the range of high and low sales prices for our common stock on Nasdaq as reported in its consolidated transaction reporting system. 2006 First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2007 First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . High Low $ 6.25 4.62 5.20 6.10 $5.01 3.51 3.85 4.12 7.70 8.30 7.76 10.93 5.84 5.79 4.75 7.02 As of December 31, 2007, our common stock was held by 323 stockholders of record. We have never declared or paid dividends on our capital stock and do not anticipate paying any dividends in the foreseeable future. 32 Item 6. Selected Financial Data Selected Consolidated Financial Data (in thousands, except per share data) The data set forth below should be read in conjunction with ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ included in Item 7 and the Consolidated Financial Statements and related Notes included in Item 8 of this Report. Year Ended December 31, 2007 2006 2005 2004 2003 Consolidated Statement of Operations Data(1): Revenues: Contract revenues(2) . . . . . . . . . . . . . . . . License and royalty revenues . . . . . . . . . . $ 29,852 4,588 $ 24,226 3,417 Total revenues . . . . . . . . . . . . . . . . . . . 34,440 27,643 Costs and expenses: Research and development . . . . . . . . . . . Selling, general and administrative . . . . . . Purchased in-process research and development . . . . . . . . . . . . . . . . . . . . Other expenses(3) . . . . . . . . . . . . . . . . . . 104,889 15,238 87,596 14,027 — (407) — 2,884 $ — $ — $ 7,846 7,846 95,618 11,656 — 1,356 14,146 14,146 88,271 20,551 — 54,177 — 41,197 41,197 111,404 29,370 33,952 15,823 Total costs and expenses . . . . . . . . . . . . 119,720 104,507 108,630 162,999 190,549 Loss from operations . . . . . . . . . . . . . . . . . Interest and other income (expense), net . . . Interest expense . . . . . . . . . . . . . . . . . . . . . Gain (loss) on certain derivative financial instruments . . . . . . . . . . . . . . . . . . . . . . . Gain (loss) on redemption/repurchase of convertible subordinated notes . . . . . . . . . Loss from continuing operations before (85,280) 22,431 (24,032) (76,864) 20,679 (17,911) (100,784) 12,527 (16,052) (148,853) 3,563 (17,241) (149,352) (7,988) (9,561) — — — (70) (106) (454) 506 (226) 151 706 income taxes . . . . . . . . . . . . . . . . . . . . . . Provision (benefit) for income taxes . . . . . . . (86,881) — (74,166) — (103,909) (552) (163,211) 453 (166,044) 342 Loss from continuing operations . . . . . . . . . Gain (loss) from discontinued operation, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . (86,881) (74,166) (103,357) (163,664) (166,386) — — 314 (1,153) (77) Net loss . . . . . . . . . . . . . . . . . . . . . . . $ (86,881) $ (74,166) $(103,043) $(164,817) $(166,463) Basic and diluted per share data Continuing operations . . . . . . . . . . . . . . . Discontinued operation . . . . . . . . . . . . . . $ $ (1.03) $ — (0.89) $ — (1.24) $ — (2.19) $ (0.02) (2.33) — (1.03) $ (0.89) $ (1.24) $ (2.21) $ (2.33) Number of shares used in computation of basic and diluted per share data . . . . . . . . 84,185 83,799 83,321 74,555 71,369 (1) In December 2004, we entered into an agreement to sell certain assets and liabilities related to our Proteome facility based in Beverly, Massachusetts, which subsequently closed in January 2005. Fiscal 33 years 2003 through 2004 have been restated to present the operations of our Proteome facility as a discontinued operation. (2) 2007 and 2006 contract revenues relate to our collaborative research and license agreement with Pfizer Inc. (3) 2007 and 2005 charges relates to restructuring activity. 2006 charges relate to restructuring charges and $3.4 million paid to Invitrogen as a settlement fee. 2004 and 2003 charges relate to restructuring charges and impairment of a long-lived asset. 2007 2006 2005 2004 2003 December 31, Consolidated Balance Sheet Data: Cash, cash equivalents, and short-term and long-term marketable securities . . . . . . . . . Working capital . . . . . . . . . . . . . . . . . . . . . . Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . Convertible senior notes . . . . . . . . . . . . . . . . Convertible subordinated notes . . . . . . . . . . . Stockholders’ equity (deficit) . . . . . . . . . . . . . $ 257,327 227,817 275,695 122,180 264,376 (159,517) $329,810 278,421 353,603 113,981 257,122 (84,908) $344,971 326,119 374,108 — 341,862 (19,397) $469,764 449,832 516,919 — 378,766 78,517 $293,807 268,937 379,545 — 167,786 154,333 34 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with ‘‘Selected Consolidated Financial Data’’ and the Consolidated Financial Statements and related Notes included elsewhere in this Report. Overview Incyte is a drug discovery and development company focused on developing proprietary small molecule drugs to treat serious unmet medical needs. We have a pipeline with programs in oncology, inflammation, diabetes and human immunodeficiency virus (HIV). Thus far in our drug discovery and development activities, which began in early 2002, we have filed twelve Investigational New Drug Applications (INDs) and have progressed eight internally developed proprietary compounds into clinical development. Currently, four of these compounds have advanced into Phase II clinical trials. Our wholly-owned pipeline includes the following compounds: Drug Target JAK HSD1 HM74a CCR5 Sheddase CCR2 Drug Compound Indication Development Status INCB18424 (Oral) Phase IIa Myelofibrosis Rheumatoid Arthritis Phase IIa Refractory Prostate Cancer Phase IIa Phase IIa Multiple Myeloma Phase I Psoriasis INCB18424 (Topical) Psoriasis INCB28050 Rheumatoid Arthritis INCB13739 INCB20817 Type 2 Diabetes Type 2 Diabetes Phase IIa Preclinical Phase IIa Phase I INCB19602 Type 2 Diabetes Phase I INCB9471 INCB15050 INCB7839 HIV HIV Solid Tumors Breast Cancer Phase II Phase I Phase IIa Phase II INCB8696 Multiple Sclerosis Phase I Other Lead clinical candidate Lead clinical candidate Oncology Oncology Pre-clinical Pre-clinical We anticipate incurring additional losses for several years as we expand our drug discovery and development programs. We also expect that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. Conducting clinical trials for our drug candidates in development is a lengthy, time-consuming and expensive process. We do not expect to generate product sales from our drug 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. 35 Collaborative Research and License Agreement with Pfizer Effective in January 2006, we entered a collaborative research and license agreement with Pfizer Inc. (‘‘Pfizer’’) for the pursuit of our CCR2 antagonist program. We received an upfront nonrefundable payment of $40.0 million in January 2006. In addition, we received an aggregate of $20.0 million through the purchase of convertible subordinated notes, $10.0 million in February 2006 and $10.0 million in October 2007 (the ‘‘Pfizer Notes’’), and we are eligible to receive additional future development and milestone payments of up to $740.0 million for the successful development and commercialization of CCR2 antagonists in multiple indications, as well as royalties on worldwide sales. We received a $3.0 million milestone payment from Pfizer in 2007. Pfizer gained worldwide development and commercialization rights to our portfolio of CCR2 antagonist compounds, the most advanced of which was in Phase IIa clinical trials in rheumatoid arthritis and insulin-resistant obese patients at the time the agreement became effective in January 2006. Pfizer’s rights extend to the full scope of potential indications, with the exception of multiple sclerosis and lupus nephritis and other autoimmune nephritides, for which we retained worldwide rights, along with certain compounds. We do not have obligations to Pfizer on preclinical development candidates we select for pursuit in these indications. Restructuring Programs In February 2004, we made the decision to discontinue further development of our information products line, close our Palo Alto headquarters and focus solely on the discovery and development of novel drugs. We recorded $42.1 million in restructuring charges in 2004, including charges related to the closure of our facilities, prior tenant improvements and equipment, a workforce reduction and other items. The restructuring charge originally included the present value of future lease obligations for two facilities. In the fourth quarter of 2004, we made a lease termination payment to satisfy our remaining lease obligation with respect to one of the facilities. The lease obligation for the second facility extends through March 2011. As a result of the long term nature of the remaining lease obligation, we will be recording a charge each period through the March 2011 termination date of the lease related to increases in the fair value of the lease obligations in accordance with the provisions of Financial Accounting Standards Board (‘‘FASB’’) Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which total approximately $0.9 million at December 31, 2007. The cash impact in 2007 from restructuring related charges was $5.6 million. Critical Accounting Policies and Significant Estimates The preparation of financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions. We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements: (cid:127) Revenue recognition; (cid:127) Research and development costs; (cid:127) Valuation of long-lived assets; (cid:127) Restructuring charges; and (cid:127) Stock compensation. 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. 36 We have entered into various types of agreements for access to our information databases and use of our intellectual property. Revenues are deferred for fees received before earned or until no further obligations exist. We exercise judgment in determining that collectibility is reasonably assured or that services have been delivered in accordance with the arrangement. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectibility based primarily on the customer’s payment history and on the creditworthiness of the customer. Revenues from ongoing database agreements are recognized evenly over the access period. Revenues from licenses to our intellectual property are recognized when earned under the terms of the related agreements. Royalty revenues are recognized upon the sale of products or services to third parties by the licensee or other agreed upon terms. We estimate royalty revenues based on previous period royalties received and information provided by the third party licensee. We exercise judgment in determining whether the information provided by licensees is sufficiently reliable for us to base our royalty revenue recognition thereon. Under agreements involving multiple products, services and/or rights to use assets, the multiple elements are divided into separate units of accounting when certain criteria are met, including whether the delivered items have stand alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. When separate units of accounting exist, consideration is allocated among the separate elements based on their respective fair values. The determination of fair value of each element is based on objective evidence from historical sales of the individual elements by us to other customers. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value for each undelivered element does exist or until all elements of the arrangement are delivered. When elements are specifically tied to a separate earnings process, revenue is recognized when the specific performance obligation tied to 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. In connection with our collaborative research and license agreement with Pfizer, we received an upfront non-refundable payment of $40.0 million in January 2006. The $40.0 million upfront fee was recorded as deferred revenue and is being recognized on a straight-line basis over two years, our estimated performance period under the agreement. In February 2006 and October 2007, Pfizer purchased the Pfizer Notes. As the Pfizer Notes are non-interest bearing, they have been discounted to their net present value. The difference between the cash received and the present value of the Pfizer Notes, plus the related beneficial conversion feature, totals $3.2 million for each note, which represents additional consideration from Pfizer under the agreement. We have accounted for this additional consideration as deferred revenue and will recognize it over our estimated performance period under the agreement. We recognize contract revenues in connection with research services provided to Pfizer as earned. We received a $3.0 million milestone payment from Pfizer in 2007 that is included in contract revenues. All milestone payments will be recognized as revenue upon the achievement of the associated milestone. Research and Development Costs. In accordance with Statement of Financial Accounting Standards No. 2 (‘‘SFAS 2’’), Accounting for Research and Development Costs, it is our policy to expense research and development costs as incurred. We often contract with clinical research organizations (‘‘CROs’’) to facilitate, coordinate and perform agreed upon research and development of a new drug. To ensure that research and development costs are expensed as incurred, we record monthly accruals for clinical trials and preclinical testing costs based on the work performed under the contract. These CRO contracts typically call for the payment of fees for services at the initiation of the contract and/or upon the achievement of certain clinical trial milestones. In the event that we prepay CRO fees, we record the prepayment as a prepaid asset and amortize the asset into research and development expense over the period of time the contracted research and development services are performed in accordance 37 with EITF 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities. Most professional fees, including project and clinical management, data management, monitoring, and medical writing fees are incurred throughout the contract period. These professional fees are expensed based on their percentage of completion at a particular date. Our CRO contracts generally include pass through fees. Pass through fees include, but are not limited to, regulatory expenses, investigator fees, travel costs, and other miscellaneous costs including shipping and printing fees. Because these fees are incurred at various times during the contract term and they are used throughout the contract term, we record a monthly expense allocation to recognize the fees during the contract period. Fees incurred to set up the clinical trial are expensed during the setup period. Valuation of Long-Lived Assets. We assess the impairment of long-lived assets, which includes property and equipment as well as intangible and other assets, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could indicate the need for an impairment review include the following: (cid:127) Significant changes in the strategy of our overall business; (cid:127) Significant underperformance relative to expected historical or projected future operating results; (cid:127) Significant changes in the manner of use of the acquired assets; (cid:127) Significant negative industry or economic trends; (cid:127) Significant decline in our stock price for a sustained period; and (cid:127) 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 Financial Accounting Standards Board (‘‘FASB’’) Statement No. 144, Accounting for the Impairment or Disposal of Long Lived Assets (‘‘SFAS 144’’), we perform an undiscounted cash flow analysis to determine if impairment exists. If impairment exists, we measure the impairment based on the difference between the asset’s carrying amount and its fair value. Restructuring Charges. Costs associated with restructuring activities initiated after December 31, 2002, are accounted for in accordance with FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities (‘‘SFAS 146’’). Costs associated with restructuring activities initiated prior to December 31, 2002 have been recorded in accordance with Emerging Issues Task Force (‘‘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’’). Restructuring costs resulting from the acquisition of Maxia Pharmaceuticals, Inc. (‘‘Maxia’’) have been recorded in accordance with EITF Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination (‘‘EITF 95-3’’). The restructuring charges are comprised primarily of costs to exit facilities, reduce our workforce, write-off fixed assets, and pay for outside services incurred in the restructuring. The workforce reduction charge is determined based on the estimated severance and fringe benefit charge for identified employees. In calculating the cost to exit the facilities, we estimate 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 requires 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 perform an assessment of the affected facilities and consider the current market conditions for each site. We also estimate our credit adjusted risk free interest rate in order to discount our projected lease payments in accordance with SFAS 146. Estimates are also used in our calculation of the estimated realizable value on equipment that is being held for sale. These estimates are formed based on recent history of sales of similar equipment and 38 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. Our estimates of future liabilities may change, requiring us to record additional restructuring charges or reduce the amount of liabilities recorded. At the end of each reporting period, we evaluate the remaining accrued balances to ensure their adequacy, that no excess accruals are retained and the utilization of the provisions are for their intended purposes in accordance with developed exit plans. We periodically evaluate current available information and adjust our restructuring reserve as necessary. We also make adjustments related to accrued professional fees to adjust estimated amounts to actual. For the year ended December 31, 2007, such adjustments were made for the 2002 restructuring program, 2004 restructuring program, and the acquisition of Maxia. Stock Compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (‘‘SFAS 123R’’), Share-Based Payment, which revised Statement of Financial Accounting Standards 123 (‘‘SFAS 123’’), Accounting for Stock-Based Compensation. SFAS 123R requires all share-based payment transactions with employees, including grants of employee stock options, to be recognized as compensation expense over the requisite service period based on their relative fair values. SFAS 123R requires significant judgment and the use of estimates, particularly surrounding Black- Scholes assumptions such as stock price volatility and expected option lives, as well as expected option forfeiture rates, to value equity-based compensation. SFAS 123R requires the recognition of the fair value of stock compensation in the statement of operations. Prior to the adoption of SFAS 123R, stock-based compensation expense related to employee stock options was not recognized in the statement of operations. Prior to January 1, 2006, we had adopted the disclosure-only provisions under SFAS 123. Under the provisions of SFAS 123R, we recorded $10.1 million and $8.9 million of stock compensation expense for the years ended December 31, 2007 and 2006, respectively. Results of Operations Years Ended December 31, 2007 and 2006 We recorded net losses from operations for the years ended December 31, 2007 and 2006 of $86.9 million and $74.2 million, respectively. On a basic and diluted per share basis, net loss from operations was $1.03 and $0.89 for the years ended December 31, 2007 and 2006, respectively. Revenues Contract revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . License and royalty revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . For the Years Ended, December 31, 2007 2006 (in millions) $29.8 4.6 $34.4 $24.2 3.4 $27.6 Our contract revenues were $29.8 million and $24.2 million in 2007 and 2006, respectively. Contract revenues were derived from recognition of revenue associated with the Pfizer $40.0 million upfront fee, recognition of revenue associated with the debt discount and beneficial conversion feature related to the Pfizer Notes, and research services provided to Pfizer. In addition, we received a $3.0 million milestone payment from Pfizer during 2007. Our license and royalty revenues were $4.6 million and $3.4 million in 2007 and 2006, respectively. License and royalty revenues were derived from database subscriptions and licensing of our gene- and 39 genomic-related intellectual property. We expect that revenues generated from information products, including licensing of gene- and genomic-related intellectual property, will decline as we focus on our drug discovery and development programs. For the year ended December 31, 2006, revenues from companies considered to be related parties, as defined by FASB Statement No. 57, Related Party Disclosures (‘‘SFAS 57’’) was $0.3 million. There was no such revenue recorded for the year ended December 31, 2007. 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 (other than an Incyte-held Board seat). Operating Expenses Research and development expenses Salary and benefits related . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collaboration and outside services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Occupancy and all other costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total research and development expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . For the Years Ended, December 31, 2007 2006 (in millions) $ 32.8 6.9 47.9 17.3 $104.9 $27.1 5.7 38.9 15.9 $87.6 We currently track research and development costs by natural expense line and not costs by project. Salary and benefits related expense increased from 2006 to 2007 due to increased development headcount and incentive compensation expense. Stock compensation expense may fluctuate from period to period based on the number of options granted, stock price volatility and expected option lives, as well as expected option forfeiture rates which are used to value equity-based compensation. The increase in collaboration and outside services from 2006 to 2007 is due primarily from the growth and steady advancement of our clinical pipeline. The increase in occupancy and other costs from 2006 to 2007 was primarily the result of costs associated with intellectual property protection. Research and development expenses may fluctuate from period to period depending upon the stage of certain projects and the level of preclinical and clinical trial-related activities. Many factors can affect the cost and timing of our clinical trials, including inconclusive results requiring additional clinical trials, slow patient enrollment, the need to enroll additional patient cohorts, adverse side effects among patients, the availability of supplies for our clinical trials and real or perceived lack of effectiveness or safety of our investigational drugs in our clinical trials. In addition, the development of all of our product candidates will be subject to extensive governmental regulation. These factors make it difficult for us to predict the timing and costs of the further development and approval of our products. Selling, general and administrative expenses Salary and benefits related . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other contract services and outside costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total selling, general and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . For the Years Ended, December 31, 2007 2006 ($ in millions) $ 6.4 3.2 5.6 $15.2 $ 5.4 3.2 5.4 $14.0 40 Salary and benefits related expense increased from 2006 to 2007 due to increased incentive compensation expense. Stock compensation expense may fluctuate from period to period based on the number of options granted, stock price volatility and expected option lives, as well as expected option forfeiture rates which are used to value equity-based compensation. Other expenses. Other expenses for the years ended December 31, 2007 and 2006 were $(0.4) million and $2.9 million, respectively. The decrease from 2006 to 2007 is due primarily to the settlement agreement with Invitrogen related to our discontinued genomic information business which resulted in a $3.4 million charge recorded in other expenses in 2006. This settlement resolved all outstanding claims included in the litigation. In 2007, we recorded $0.7 million of expense in connection with our 2004 restructuring program and $0.9 million of benefit in connection with our 2002 restructuring program and a facility closed in connection with our acquisition of Maxia. In 2006, we recorded $1.0 million of expense in connection with our 2004 restructuring program and $1.5 million of benefit in connection with our 2002 restructuring program and a facility closed in connection with our acquisition of Maxia. Other income (expense) Interest and other income (expense), net. Interest and other income (expense), net, for the years ended December 31, 2007 and 2006 was $22.4 million and $20.7 million, respectively. The increase in 2007 from 2006 was primarily attributable to the $8.5 million realized gain recorded from the sale of our investment in a privately-held company in December 2007 offset by a lower average cash balance during 2007. In 2006, we recorded a $6.2 million realized gain from the sale of our investment in a publicly-held company offset by an impairment charge of $1.3 million recorded to reduce the carrying value of our investment in a privately-held investee. Interest expense. Interest expense for the years ended December 31, 2007 and 2006 was $24.0 million and $17.9 million, respectively. The increase in 2007 from 2006 is primarily attributable to the increase in accretion of the discount related to the 31⁄2% convertible senior notes due 2011 (the ‘‘31⁄2% Senior Notes’’) issued in September 2006 of $8.2 million in 2007 compared to $2.1 million in the corresponding period of 2006. Gain (loss) on redemption/repurchase of convertible subordinated notes. In 2006 we redeemed $91.6 million principal amount of our 5.5% convertible subordinated notes due 2007 (the ‘‘5.5% Notes’’). The redemption resulted in a loss of $0.1 million for the year ended December 31, 2006. Provision (benefit) for income taxes. Due to our net losses in 2007 and 2006, we did not have an annual income tax provision. 41 Years Ended December 31, 2006 and 2005 We recorded net losses from continuing operations for the years ended December 31, 2006 and 2005 of $74.2 million and $103.4 million, respectively. On a basic and diluted per share basis, net loss from continuing operations was $0.89 and $1.24 for the years ended December 31, 2006 and 2005, respectively. Revenues Contract revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . License and royalty revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . For the Years Ended, December 31, 2006 2005 (in millions) $24.2 3.4 27.6 $ — 7.8 7.8 Our contract revenues were $24.2 million and $0.0 million in 2006 and 2005, respectively. Contract revenues were derived from recognition of revenue associated with the Pfizer $40.0 million upfront fee, recognition of revenue associated with the debt discount and beneficial conversion feature related to the Pfizer Note due 2013, and research services provided to Pfizer. Our license and royalty revenues were $3.4 million and $7.8 million in 2006 and 2005, respectively. License and royalty revenues were derived from database subscriptions and licensing of our gene- and genomic-related intellectual property. The decrease in license and royalty revenues from 2005 to 2006 is attributable to our decision to discontinue offering information products. The increase in revenues from 2005 to 2006 was due to our collaborative research and license agreement with Pfizer. For the year ended December 31, 2006 revenues from companies considered to be related parties, as defined by SFAS 57 were $0.3 million. There were no such revenues recorded for the year ended December 31, 2005. Operating Expenses Research and development expenses Salary and benefits related . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collaboration and outside services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Occupancy and all other costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total research and development expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . For the Years Ended, December 31, 2006 2005 ($ in millions) $27.1 5.7 38.9 15.9 $87.6 $27.3 — 49.9 18.4 $95.6 We currently track research and development costs by natural expense line and not costs by project. Stock compensation costs for the year ended December 31, 2006 was the result of our adoption of SFAS 123R which required the recognition of stock compensation expense in our consolidated statement of operations. Stock compensation expense may fluctuate from period to period based on the number of options granted, stock price volatility and expected option lives, as well as expected option forfeiture rates which are used to value equity-based compensation. The decrease in collaboration and outside services from 2005 to 2006 is due primarily the result of decreased drug discovery and development costs due to our collaborative research and license agreement with Pfizer and the decision in April 2006 to discontinue the 42 development of our DFC program. The decrease in occupancy and other costs from 2005 to 2006 was primarily the result of increased efficiency in our use of laboratory and reagent supplies. Selling, general and administrative expenses Salary and benefits related . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other contract services and outside costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total selling, general and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . For the Years Ended, December 31, 2006 2005 ($ in millions) $ 5.4 3.2 5.4 $14.0 $ 5.6 0.2 5.9 $11.7 Stock compensation costs for the year ended December 31, 2006 was the result of our adoption of SFAS 123R which required the recognition of stock compensation expense in our consolidated statement of operations. Stock compensation expense may fluctuate from period to period based on the number of options granted, stock price volatility and expected option lives, as well as expected option forfeiture rates which are used to value equity-based compensation. Other expenses. Other expenses for the years ended December 31, 2006 and 2005 were $2.9 million and $1.4 million, respectively, and represent charges recorded in connection with restructuring and long-lived asset impairments. The increase from 2005 to 2006 is due primarily to the settlement agreement with Invitrogen related to our discontinued genomic information business which resulted in a $3.4 million charge recorded in other expenses. This settlement resolved all outstanding claims included in the litigation. In 2006, we recorded $1.0 million of expense in connection with our 2004 restructuring program and $1.5 million of benefit in connection with our 2002 restructuring program and a facility closed in connection with our acquisition of Maxia. In 2005, in conjunction with our 2004 restructuring program, we recorded $1.0 million in expense, including charges related to the closure of our Palo Alto facility, previously capitalized tenant improvements and equipment, a workforce reduction and other items. During 2005, we also recorded charges of $0.4 million of expense in connection with our 2002 restructuring program and a facility closed in connection with our acquisition of Maxia. Other income (expense) Interest and other income (expense), net. Interest and other income (expense), net, for the years ended December 31, 2006 and 2005 was $20.7 million and $12.5 million, respectively. The increase in 2006 from 2005 was primarily attributable to the $6.2 million realized gain recorded from the sale of our investment in a publicly-held company in March 2006 and due to higher interest rates in 2006 offset by an impairment charge of $1.3 million recorded in June 2006 to reduce the carrying value of our investment in a privately-held investee. In 2005 we realized a $2.8 million gain from the sale of securities of a strategic investee. Interest expense. Interest expense for the years ended December 31, 2006 and 2005 was $17.9 million and $16.1 million, respectively. The increase in 2006 from 2005 is primarily attributable to the accretion of $2.1 million of the discount related to the 31⁄2% Senior Notes issued in September 2006. Losses on certain derivative financial instruments. Losses on certain derivative financial instruments for the year ended December 31, 2005 of $0.1 million represents the change in fair value of certain long-term investments, specifically warrants held in other companies, in accordance with FASB Statement 43 No. 133, Accounting for Derivative Financial Instruments and Hedging Activities (‘‘SFAS 133’’). Gain 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 (loss) on repurchase of convertible subordinated notes. In 2006 we redeemed $91.6 million principal amount and in 2005 we repurchased, on the open market, $36.5 million face value of our 5.5% Notes. The redemption and repurchase resulted in a gain (loss) of $(0.1) million and $0.5 million, respectively, for the years ended December 31, 2006 and 2005. Provision (benefit) for income taxes. Due to our net losses in 2006 and 2005, we had a minimal effective annual income tax rate. The benefit for income taxes for 2005 is primarily attributable to foreign withholding taxes. Gain (loss) from discontinued operation. The gain from discontinued operation of $0.3 million in 2005 represent the results of our Proteome facility based in Beverly, Massachusetts. In December 2004, we entered into an agreement to sell certain assets and liabilities related to our Proteome facility, which subsequently closed in January 2005. The consolidated financial statements have been restated to present the operations of our Proteome facility as a discontinued operation for all periods presented. Recent Accounting Pronouncements In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (‘‘FIN 48’’). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material impact on our condensed consolidated financial statements. Liquidity and Capital Resources December 31: Cash, cash equivalents, and short-term and long-term marketable securities . . . Working capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year ended December 31: Cash provided by (used in): 2007 2006 2005 (in millions) $257.3 $227.8 $329.8 $278.4 $ 345.0 $ 326.1 Operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital expenditures (included in investing activities above) . . . . . . . . . . . . $ (92.7) $ (50.4) $(101.9) $ 15.5 $ 26.0 $170.4 $ (34.3) $ 31.7 $ 12.3 1.6 $ 1.6 $ 1.2 $ Sources and Uses of Cash. Due to our significant research and development expenditures, we have not been profitable and have generated operating losses since we were incorporated in 1991 through 1996 and in 1999 through 2007. As such, we have funded our research and development operations through sales of equity securities, the issuance of convertible subordinated notes, cash received from customers, and collaborative arrangements. As of December 31, 2007, approximately $0.9 million of marketable securities were classified as long-term assets on the condensed consolidated balance sheet as they had been in an unrealized loss position for longer than six months and we had the ability to hold them until the carrying value recovers, which may be longer than one year. At December 31, 2007, we had available cash, cash equivalents, and short-term and long-term marketable securities of $257.3 million. Our cash and marketable securities balances are held in a variety of interest-bearing instruments including obligations of U.S. government agencies, high-grade corporate bonds, asset backed and mortgage backed securities and 44 money market accounts. Available cash is invested in accordance with our investment policy’s primary objectives of liquidity, safety of principal and diversity of investments. Cash used in Operating Activities. The $42.3 million increase in cash used in operating activities from 2006 to 2007 was due primarily to the $40.0 million nonrefundable upfront fee received from Pfizer in January 2006. The $51.5 million decrease in cash used in operating activities from 2005 to 2006 was also due primarily to the $40.0 million upfront fee received from Pfizer in January 2006. Cash provided by Investing Activities. Our investing activities, other than purchases, sales and maturities of marketable securities, have consisted predominantly of capital expenditures and sales and purchases of long-term investments. 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. Cash provided by (used in) Financing Activities. In connection with the collaborative research and license agreement, Pfizer purchased a $10.0 million Pfizer Note in October 2007. In addition, we received $2.3 million of proceeds from issuance of common stock under our stock plans and employee stock purchase plan. During 2006, we issued a total of $151.8 million of 31⁄2% Senior Notes, which resulted in cash proceeds of approximately $111.9 million. In addition, we redeemed $91.6 million of the 5.5% Notes during 2006. In connection with the collaborative research and license agreement, Pfizer purchased a $10.0 million Pfizer Note in February 2006. During 2005, we paid $35.8 million in connection with repurchases of $36.5 million in face value of the 5.5% Notes, offset partially by $1.5 million of proceeds from issuance of common stock under our stock plans and employee stock purchase plan. The following summarizes our significant contractual obligations as of December 31, 2007 and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in millions): Total Less Than 1 Year Years 1 - 3 Years 4 - 5 Over 5 Years Contractual Obligations: Principal on convertible subordinated debt . . . . . . . . . . . . Principal on convertible senior debt . . . . . . . . . . . . . . . . . Interest on convertible subordinated debt . . . . . . . . . . . . Interest on convertible senior debt . . . . . . . . . . . . . . . . . Non-cancelable operating lease obligations: Related to current operations . . . . . . . . . . . . . . . . . . . . . Related to vacated space . . . . . . . . . . . . . . . . . . . . . . . . $270.0 151.8 30.6 18.6 11.9 25.6 $ — $ — $250.0 — 151.8 4.4 2.7 — 8.7 5.3 17.5 10.6 $20.0 — — — 4.8 8.4 7.1 16.1 — 1.1 — — Total contractual obligations . . . . . . . . . . . . . . . . . . . . . . $508.5 $27.2 $51.3 $410.0 $20.0 The amounts and timing of payments related to vacated facilities may vary based on negotiated timing of lease terminations. We have entered into sublease agreements for our vacated space with scheduled payments to us of $3.1 million (less than 1 year), $4.2 million (years 1 - 3), and $0.3 million (years 4 - 5); these scheduled payments are not reflected in the above table. The table above excludes certain commitments that are contingent upon future events. The most significant of these contractual commitments that we consider to be contingent obligations are summarized below. Commitments related to our acquisition of Maxia are considered contingent commitments as future events must occur to cause these commitments to be enforceable. We completed our acquisition of Maxia in February 2003. Under the merger agreement, former Maxia stockholders have the right to receive certain earn out amounts of up to a potential aggregate amount of $14.0 million upon the occurrence of 45 certain research and development 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 (based upon the then fair value) could potentially be paid pursuant to the earn out milestones. The milestones are set to 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. In any event, no more than 13,531,138 shares of our common stock may be issued to former Maxia stockholders in the aggregate pursuant to the merger agreement. None of these milestones has been achieved as of December 31, 2007. We have entered into and may in the future seek to license additional rights relating to compounds or technologies in connection with our drug discovery and development programs. Under these licenses, we may be required to pay up-front fees, milestone payments, and royalties on sales of future products. We believe that our cash, cash equivalents and marketable securities will be adequate to satisfy our capital needs for at least the next twelve months. Our cash requirements depend on numerous factors, including our expenditures in connection with alliances, license agreements and acquisitions of and investments in complementary products, technologies and businesses; expenditures in connection with potential repayments of our 31⁄2% Senior Notes, 31⁄2% Subordinated Notes, the Pfizer Notes; expenditures in connection with our drug discovery and development programs; expenditures in connection with litigation or other legal proceedings; competing technological and market developments; the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights; our receipt of any milestone or other payments under any collaborative agreements we may enter into, including the agreement with Pfizer; and costs associated with the integration of new operations assumed through any mergers and acquisitions. Changes in our research and development plans or other changes affecting our operating expenses may result in changes in the timing and amount of expenditures of our capital resources. We expect that future revenues generated from information products, including licensing of intellectual property, will continue to decline as we focus on drug discovery and development programs, and in 2008, will not represent a significant source of cash inflow for us. Off Balance Sheet Arrangements We have no material off-balance sheet arrangements other than those that are discussed under Contractual Obligations. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Our investments in marketable securities, which are composed primarily of investment-grade corporate bonds, U.S. government agency debt securities, mortgage and asset-backed securities and money market funds, are subject to default, changes in credit rating and changes in market value. These investments are also subject to interest rate risk and will decrease in value if market rate interest rates increase. As of December 31, 2007, cash, cash equivalents and short-term and long-term marketable securities were $257.3 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, 2007 the decline in fair value would not be material. 46 Item 8. Financial Statements and Supplementary Data INDEX Consolidated Financial Statements of Incyte Corporation Report of Ernst & Young LLP, Independent Registered Public Accounting Firm . . . . . . . . . . . . . Consolidated Balance Sheets as of December 31, 2007 and 2006 . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005 . . Consolidated Statements of Comprehensive Loss for the years ended December 31, 2007, 2006 and 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statement of Stockholders’ Equity (Deficit) for the years ended December 31, 2007, 2006 and 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005 . Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interim Consolidated Financial Information (unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 48 49 50 51 52 53 54 77 47 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders of Incyte Corporation We have audited the accompanying consolidated balance sheets of Incyte Corporation as of December 31, 2007 and 2006, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index at item 15 (a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Incyte Corporation, at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. 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. As discussed in Note 1 to the consolidated financial statements, Incyte Corporation changed its method of accounting for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004) on January 1, 2006. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Incyte Corporation’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2008 expressed an unqualified opinion thereon. /s/ ERNST & YOUNG LLP Philadelphia, Pennsylvania February 26, 2008 48 INCYTE CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except number of shares and par value) Current assets: ASSETS Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marketable securities—available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . $ Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marketable securities—available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Intangible and other assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2007 2006 108,854 147,576 1,551 6,431 264,412 897 3,943 6,443 $ 18,861 299,712 2,073 7,115 327,761 11,237 5,890 8,715 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 275,695 $ 353,603 LIABILITIES AND STOCKHOLDERS’ DEFICIT Current liabilities: Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued and other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued restructuring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Convertible senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Convertible subordinated notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stockholders’ deficit: Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued and outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common stock, $0.001 par value; 200,000,000 shares authorized; 84,533,069 and 83,972,726 shares issued and outstanding as of December 31, 2007 and 2006, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,806 10,693 5,273 7,226 649 4,948 36,595 122,180 264,376 — 12,061 435,212 $ 5,916 6,879 4,668 4,024 22,883 4,970 49,340 113,981 257,122 348 17,720 438,511 — — 85 841,320 (528) (1,000,394) 84 828,936 (415) (913,513) Total stockholders’ deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (159,517) (84,908) Total liabilities and stockholders’ deficit . . . . . . . . . . . . . . . . . . . . . . . . . $ 275,695 $ 353,603 See accompanying notes. 49 INCYTE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) Revenues: Contract revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . License and royalty revenues(1) . . . . . . . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 29,852 4,588 34,440 $ 24,226 3,417 27,643 $ — 7,846 7,846 Year Ended December 31, 2007 2006 2005 Costs and expenses: Research and development(2) . . . . . . . . . . . . . . . . . . . . . . . . . . Selling, general and administrative(3) . . . . . . . . . . . . . . . . . . . . . Other expenses(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total costs and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest and other income, net(5) . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss on certain derivative financial instruments . . . . . . . . . . . . . . . Gain (loss) on redemption/repurchase of convertible subordinated notes(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss from continuing operations before income taxes . . . . . . . . . . . Benefit for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss from continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . Gain from discontinued operation, net of tax . . . . . . . . . . . . . . . . . Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic and diluted per share data: Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Discontinued operation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104,889 15,238 (407) 119,720 (85,280) 22,431 (24,032) — 87,596 14,027 2,884 104,507 (76,864) 20,679 (17,911) — 95,618 11,656 1,356 108,630 (100,784) 12,527 (16,052) (106) — (86,881) — (86,881) — 506 (103,909) (552) (103,357) 314 $ (86,881) $ (74,166) $(103,043) (70) (74,166) — (74,166) — $ $ (1.03) $ — (1.03) $ (0.89) $ — (0.89) $ (1.24) — (1.24) Shares used in computing basic and diluted net loss per share . . . . . 84,185 83,799 83,321 (1) Includes revenues from transactions with companies considered related parties under SFAS 57 of $0.3 million for the year ended December 31, 2006. (2) Includes expenses from transactions with companies considered related parties under SFAS 57 of $0.1 million for the year ended December 31, 2005. Also includes stock-based compensation charges of $6.9 million and $5.7 million in 2007 and 2006, respectively. (3) Includes stock-based compensation charges of $3.2 million, $3.2 million and $0.2 million in 2007, 2006 and 2005, respectively. (4) 2006 charges relate to $3.4 million settlement fee paid to Invitrogen and restructuring charges. Amounts for 2007 and 2005 are related to restructuring activity. (5) Includes a gain on the sale of securities of $6.2 million and $2.8 million for the years ended December 31, 2006 and 2005, respectively, and losses on long-term investments in companies considered related parties under SFAS 57 of $1.3 million for the year ended December 31, 2006. (6) Includes a gain from a transaction with an individual considered a related party under SFAS 57 of $0.1 million for the year ended December 31, 2005. See accompanying notes. 50 INCYTE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (in thousands) Year Ended December 31, 2007 2006 2005 $(86,881) $(74,166) $(103,043) (113) 1,428 3,776 — — (3,071) — (1,643) (1,281) 959 3,454 Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other comprehensive gain (loss): Unrealized gains (losses) on marketable securities . . . . . . . . . . . . . Reclassification adjustment for realized losses on marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign currency translation adjustment . . . . . . . . . . . . . . . . . . . . Other comprehensive gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . (113) Comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(86,994) $(75,809) $ (99,589) See accompanying notes. 51 INCYTE CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT) (in thousands, except number of shares) Balances at December 31, 2004 . . . . Issuance of 184,865 shares of Common Stock upon exercise of stock options and 389,801 shares of Common Stock under the ESPP . . . . . . . . . . . . . . . . . . . . Amortization of deferred compensation . . . . . . . . . . . . . . Other comprehensive gain . . . . . . . Net loss . . . . . . . . . . . . . . . . . . . . Balances at December 31, 2005 . . . . Issuance of 61,931 shares of Common Stock upon exercise of stock options and 313,715 shares of Common Stock under the ESPP . . . . . . . . . . . . . . . . . . . . Stock compensation expense . . . . . . Other comprehensive loss . . . . . . . . Net loss . . . . . . . . . . . . . . . . . . . . Balances at December 31, 2006 . . . . Issuance of 222,654 shares of Common Stock upon exercise of stock options and 337,689 shares of Common Stock under the ESPP . . . . . . . . . . . . . . . . . . . . Stock compensation expense . . . . . . Other comprehensive loss . . . . . . . . Net loss . . . . . . . . . . . . . . . . . . . . Common Stock Additional Paid-in Capital Deferred Compensation Accumulated Other Comprehensive Income (Loss) Accumulated Deficit Total Stockholders’ Equity (Deficit) $83 $817,150 $(186) $(2,226) $ (736,304) $ 78,517 1 — — — 1,488 — — — — 186 — — — — 3,454 — — 1,489 — — (103,043) 186 3,454 (103,043) $84 $818,638 $ — $ 1,228 $ (839,347) $ (19,397) — — — — 1,408 8,890 — — — — — — — — (1,643) — — — — (74,166) 1,408 8,890 (1,643) (74,166) $84 $828,936 $ — $ (415) $ (913,513) $ (84,908) 1 — — — 2,325 10,059 — — — — — — — — (113) — — — (86,881) 2,326 10,059 (113) (86,881) Balances at December 31, 2007 . . . . $85 $841,320 $ — $ (528) $(1,000,394) (159,517) See accompanying notes. 52 INCYTE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Cash flows from operating activities: Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net loss to net cash used in operating activities: Gain from discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-cash restructuring charges and impairment of long-lived assets . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain on repurchase of convertible subordinated notes . . . . . . . . . . . . . . . . Compensation expense on executive loans . . . . . . . . . . . . . . . . . . . . . . . . Loss on derivative financial instruments, net . . . . . . . . . . . . . . . . . . . . . . Impairment of long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . Realized gain on long-term investments, net . . . . . . . . . . . . . . . . . . . . . . Changes in operating assets and liabilities: Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2007 2006 2005 $ (86,881) $ (74,166) $(103,043) — (407) 12,963 10,059 — — — — (8,479) 522 1,121 1,890 2,349 (25,831) — (552) 7,411 8,890 (70) 18 — 1,312 (6,230) (650) 586 2,343 (8,653) 19,394 (314) 2,324 8,192 186 (506) 75 106 — (2,791) 721 2 1,252 (6,849) (1,203) Net cash used in continuing operating activities . . . . . . . . . . . . . . . . . (92,694) (50,367) (101,848) Net cash used in discontinued activities . . . . . . . . . . . . . . . . . . . . . . — — (24) Net cash used in operating activities . . . . . . . . . . . . . . . . . . . . . . . . . (92,694) (50,367) (101,872) Cash flows from investing activities: Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from the sale of equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchases of marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales of marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maturities of marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,153) — (45,024) 135,150 81,389 (1,568) — (511,408) 109,971 429,040 (1,633) 59 (348,540) 134,327 231,315 Net cash provided by investing activities . . . . . . . . . . . . . . . . . . . . . . 170,362 26,035 15,528 Cash flows from financing activities: Proceeds from issuance of common stock under stock plans . . . . . . . . . . . . . Redemption/repurchase of convertible subordinated notes . . . . . . . . . . . . . . . Net proceeds from issuance of convertible senior and subordinated notes . . . . Net cash provided by (used in) financing activities . . . . . . . . . . . . . . . Effect of exchange rate on cash and cash equivalents . . . . . . . . . . . . . . . . . . Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . . . . . . . . . 2,325 — 10,000 12,325 — 89,993 18,861 1,408 (91,614) 121,905 1,489 (35,837) — 31,699 (34,348) — 7,367 11,494 6 (120,686) 132,180 Cash and cash equivalents at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . $108,854 $ 18,861 $ 11,494 Supplemental Schedule of Cash Flow Information Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,464 $ 14,839 $ 15,467 Taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ — $ 24 See accompanying notes. 53 INCYTE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Organization and Summary of Significant Accounting Policies Organization and Business. Incyte Corporation (‘‘Incyte,’’ ‘‘we,’’ ‘‘us,’’ or ‘‘our’’) is a drug discovery and development company focused on developing proprietary small molecule drugs to treat serious unmet medical needs. We have a pipeline with programs in oncology, inflammation, diabetes, and human immunodeficiency virus (HIV). We were founded and incorporated in Delaware in 1991. Until 2001, we devoted substantially all of our resources to the development, marketing and sales of information and genomic products. We began our drug discovery and development activities in early 2002. Principles of Consolidation. The consolidated financial statements include the accounts of Incyte Corporation and our wholly owned subsidiaries. All material inter-company accounts, transactions, and profits have been eliminated in consolidation. Reclassifications. Certain amounts reported in previous years have been reclassified to conform to the 2007 financial statement presentation. Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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, as appropriate. The resulting translation adjustments are included in accumulated other comprehensive income (loss), a separate component of stockholders’equity (deficit). Income and expense items are translated at average monthly rates of exchange. Concentrations of Credit Risk. Cash, cash equivalents, marketable securities, trade receivables, and long-term strategic investments are financial instruments which potentially subject us to concentrations of credit risk. The estimated fair value of financial instruments approximates the carrying value based on available market information. We primarily invest our excess available funds in notes and bills issued by the U.S. government and its agencies and corporate debt securities and, by policy, limit 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. Our customers for our information products are primarily pharmaceutical and biotechnology companies which are typically located in the United States and Europe. We have not experienced any significant credit losses on cash, cash equivalents, marketable securities or trade receivables to date and do not require collateral on receivables. Cash and Cash Equivalents. Cash and cash equivalents are held in U.S. banks or in custodial accounts with U.S., and U.K. banks. Cash equivalents are defined as all liquid investments and money market funds 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. All marketable as available-for-sale. Available-for-sale securities are carried at fair value, based on quoted market prices, with unrealized gains and losses, net of tax, reported as a separate component of stockholders’ equity (deficit). We classify marketable securities available to fund current operations as current assets on the consolidated balance sheets. Marketable securities are classified as long-term assets on the consolidated securities classified are 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 1. Organization and Summary of Significant Accounting Policies (Continued) balance sheets if (i) they have been in an unrealized loss position for longer than six months and (ii) we have the ability to hold them until the carrying value is recovered and such holding period may be longer than one year. 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), net.’’ The cost of securities sold is based on the specific identification method. Accounts Receivable. As of December 31, 2007 and 2006 we had no allowance for doubtful accounts. We provide an allowance for doubtful accounts based on experience and specifically identified risks. Accounts receivable are carried at fair value and charged off against the allowance for doubtful accounts when we determine that recovery is unlikely and we cease collection efforts. 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. Certain laboratory and computer equipment used by us 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 our assets. In the event that a currently unknown significantly advanced technology became commercially available, we would re-evaluate the value and estimated useful lives of our existing equipment, possibly having a material impact on the financial statements. Valuation of Long-Lived Assets. Long-lived assets, including certain identifiable intangible assets, 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 our market value. 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 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. There have been no impairments of long-lived assets during the years ended December 31, 2007, 2006 or 2005. Long-Term Investments. We have made equity and debt investments in a number of companies whose businesses may be complementary to our business. Most of these investments were made in connection with the establishment of a collaborative arrangement between us and the investee company. Our long-term investments have historically consisted of investments in both privately and publicly-held companies in which we have owned less than 20% of the outstanding voting stock and have not had the ability to exert significant influence over the investees. Accordingly, our long-term investments in privately-held companies have been accounted for under the cost method and our investments in publicly-held companies have been accounted for in accordance with Financial Accounting Standards Board (‘‘FASB’’) Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. Our investments in publicly-held companies are classified as available-for-sale and are adjusted to their fair 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 1. Organization and Summary of Significant Accounting Policies (Continued) value each period based on their quoted market price with any adjustments being recorded in accumulated other comprehensive income (loss) as a separate component of stockholders’ equity (deficit). We periodically evaluate the carrying value of our ownership interests in privately-held cost method investees by reviewing conditions that might indicate an other-than temporary decline in fair value, including the following: (cid:127) Financial performance of the investee; (cid:127) Achievement of business plan objectives and milestones including the hiring of key employees, obtaining key business partnerships, and progress related to research and development activities; (cid:127) Available cash; and (cid:127) Completion of debt and equity financings. If our review of these factors indicates that an other-than-temporary decline in the fair value of the investee has occurred, we estimate the fair value of the investee. When the carrying value of our investments is materially greater than our pro-rata share of the estimated fair value of the investee, we record an impairment charge to reduce our carrying value. Impairment charges are recorded in the period when the related triggering condition becomes known to management. We use the best information available in performing our periodic evaluations; however, the information available may be limited. These evaluations involve significant management judgment, and the actual amounts realized for a specific investment may differ from the carrying value. For our available-for-sale investments in publicly-held investees, we monitor all unrealized losses to determine whether a decline in fair value below carrying value is other-than-temporary. Generally, when fair value is materially less than carrying value for six consecutive months, we consider the decline to be other-than-temporary. When we conclude that a decline is other-than-temporary, we adjust the carrying value of our long-term investments in publicly-held investees so that our carrying value per share is equal to the quoted market price per share. Future adverse changes in market conditions or poor operating results of underlying investments could result in additional impairment charges. Derivative Financial Instruments. We hold warrants to purchase equity securities of a publicly-held company. Warrants that can be exercised and settled by delivery of net shares such that we pay 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 statements of operations in ‘‘Gain (loss) on certain derivative financial instruments’’ in the period of change. We determine the fair value of our warrants through option pricing models using current market price and volatility assumptions. Intangible and Other Assets. Patent application costs relating to ongoing drug discovery and development are charged to expense as incurred. In prior years, costs of patents, patent applications and patent defense for gene and genomic patents were capitalized and amortized on a straight-line basis over their estimated useful lives of approximately five years in accordance with the provisions of Accounting Principles Board Opinion No. 17, Intangible Assets (‘‘APB 17’’). Income Taxes. Income taxes are accounted for using SFAS No. 109, Accounting for Income Taxes. Deferred income taxes are provided at the currently enacted income tax rates for the difference between the financial statement and income tax basis of assets and liabilities and carry-forward items. The effective tax rate and the tax basis of assets and liabilities reflect management’s estimates of the ultimate outcome of various tax audits and issues. In addition, valuation allowances are established for deferred tax assets 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 1. Organization and Summary of Significant Accounting Policies (Continued) where the amount of expected future taxable income from operations does not support the realization of the asset. We believe that the current assumptions and other considerations used to estimate the current year effective and deferred tax positions are appropriate. However, if the actual outcome of future tax consequences differs from our estimates and assumptions, the resulting change to the provision for income taxes could have a material impact on our consolidated financial statements. In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (‘‘FIN 48’’). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material impact on our condensed consolidated financial statements. Financing Costs Related to Long-term Debt. Costs associated with obtaining long-term debt are deferred and amortized over the term of the related debt using the effective interest method. Net Income (Loss) Per Share. We follow the provisions of SFAS No. 128, Earnings Per Share, which requires us to present basic and diluted earnings per share. Our basic and diluted losses per share are calculated by dividing the net loss by the weighted average number of shares of common stock outstanding during all periods presented. Options to purchase stock and convertible debt are included in diluted earnings per share calculations, unless the effects are anti-dilutive. Accumulated Other Comprehensive Income (Loss). Accumulated other comprehensive income (loss) consists of the following: Unrealized losses on marketable securities . . . . . . . . . . . . . . . . . . . . Cumulative translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2007 2006 (in thousands) $(521) $(408) (7) (7) $(528) $(415) 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. We have entered into various types of agreements for access to our information databases and use of our intellectual property. Revenues are deferred for fees received before earned or until no further obligations exist. We exercise judgment in determining that collectibility is reasonably assured or that services have been delivered in accordance with the arrangement. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectibility based primarily on the customer’s payment history and on the creditworthiness of the customer. Revenues from ongoing database agreements are recognized evenly over the access period. Revenues from licenses to our intellectual property are recognized when earned under the terms of the related agreements. Royalty revenues are recognized upon the sale of products or services to third parties by the licensee or other agreed upon terms. We estimate royalty revenues based on previous period royalties received and information provided by the third party licensee. We exercise judgment in determining whether the information provided by licensees is sufficiently reliable for us to base our royalty revenue recognition thereon. 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 1. Organization and Summary of Significant Accounting Policies (Continued) Under agreements involving multiple products, services and/or rights to use assets, the multiple elements are divided into separate units of accounting when certain criteria are met, including whether the delivered items have stand alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. When separate units of accounting exist, consideration is allocated among the separate elements based on their respective fair values. The determination of fair value of each element is based on objective evidence from historical sales of the individual elements by us to other customers. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value for each undelivered element does exist or until all elements of the arrangement are delivered. When elements are specifically tied to a separate earnings process, revenue is recognized when the specific performance obligation tied to 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. In connection with our collaborative research and license agreement with Pfizer Inc. (‘‘Pfizer’’), we received an upfront non-refundable payment of $40.0 million in January 2006. The $40.0 million upfront fee was recorded as deferred revenue and is being recognized on a straight-line basis over two years, our estimated performance period under the agreement. Pfizer purchased a $10.0 million principal amount convertible subordinated note in February 2006 and an additional $10.0 million principal amount convertible subordinated note (the ‘‘Pfizer Notes’’) in October 2007. As the Pfizer Notes are non-interest bearing, they have been discounted to their net present value. The difference between the cash received and the present value of the Pfizer Notes, plus the related beneficial conversion feature, totals $3.2 million for each note, which represents additional consideration from Pfizer under the agreement. We have accounted for this additional consideration as deferred revenue and will recognize it over our estimated performance period under the agreement. We recognize contract revenues in connection with research services provided to Pfizer as earned. We received a $3.0 million milestone payment from Pfizer in 2007 that is included in contract revenues. All milestone payments will be recognized as revenue upon the achievement of the associated milestone. Research and Development. Research and development expenses are comprised of the following types of costs incurred in performing research and development activities: salaries and related benefits, collaboration and outside services, and occupancy and all other costs. In accordance with Statement of Financial Accounting Standards No. 2 (‘‘FAS 2’’), Accounting for Research and Development Costs, it is our policy to expense research and development costs as incurred. We often contract with Clinical Research Organizations (‘‘CROs’’) to facilitate, coordinate and perform agreed upon research and development of a new drug. To ensure that research and development costs are expensed as incurred, we record monthly accruals for clinical trial and preclinical testing costs based on the work performed under the contract. These CRO contracts typically call for payment of fees for services at the initiation of the contract and/or upon the achievement of certain clinical trial milestones. In the event that we prepay CRO fees for future milestones, we record the prepayment as a prepaid asset and amortize the asset into research and development expense over the period of time the contracted research and development services are performed in accordance with EITF 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities. Most professional fees, including project and clinical management, data management, monitoring, and medical writing fees are incurred throughout the contract period. These professional fees are expensed based on their percentage of completion at a particular date. 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 1. Organization and Summary of Significant Accounting Policies (Continued) Our CRO contracts generally include pass through fees. Pass through fees include, but are not limited to, regulatory expenses, investigator fees, travel costs, and other miscellaneous costs including shipping and printing fees. Because these fees are incurred at various times during the contract term and they are used throughout the contract term, we record a monthly expense allocation to recognize the fees during the contract period. Fees incurred to set up the clinical trial are expensed during the setup period. Other Expenses. We recognize other expenses in connection with our plans to exit certain activities. In connection with our exit activities, we record other expenses for employee termination benefit costs, long-lived asset impairments, costs related to leased facilities to be abandoned or subleased, and other exit-related costs. These charges were incurred pursuant to formal plans developed by management and accounted for in accordance with FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (‘‘SFAS 146’’), 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 EITF Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination (‘‘EITF 95-3’’). Fixed assets that are written off or impaired as a result of restructuring plans are typically held for sale or scrapped. The remaining carrying value of such assets was not material as of December 31, 2007 and 2006. The recognition of other expenses requires our management to make judgments and estimates regarding the nature, timing, and amount of costs associated with the planned exit activity, including estimating sublease income and the fair value, less sales costs, of equipment to be disposed of. Management’s estimates of future liabilities may change, requiring us to record additional restructuring charges or reduce the amount of liabilities already recorded. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that they are adequate, that no excess accruals are retained, and that the utilization of the provisions are for their intended purposes in accordance with developed exit plans. Stock-Based Compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (‘‘SFAS 123R’’), Share-Based Payment, which revised Statement of Financial Accounting Standards 123 (‘‘SFAS 123’’), Accounting for Stock-Based Compensation. SFAS 123R requires all share-based payment transactions with employees, including grants of employee stock options, to be recognized as compensation expense over the requisite service period based on their relative fair values. The application of SFAS 123R requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility and expected option lives, as well as expected option forfeiture rates, to value equity-based compensation. Prior to the adoption of SFAS 123R, stock-based compensation expense related to employee stock options was not recognized in the statement of operations. Prior to January 1, 2006, we had adopted the disclosure-only provisions under SFAS 123. Under the provisions of SFAS 123R, we recorded $10.1 million and $8.9 million, respectively, of stock compensation expense on our consolidated statements of operations for the years ended December 31, 2007 and 2006. For the year ended December 31, 2005 we recorded stock compensation expense of $0.2 million in the consolidated statements of operations related to restricted shares issued to our Chief Executive Officer. 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 2. Marketable Securities The following is a summary of our marketable security portfolio as of December 31, 2007 and 2006, respectively. December 31, 2007 U.S. Treasury notes . . . . . . . . . . . . . . . . . . . Mortgage backed securities . . . . . . . . . . . . . . Asset backed securities . . . . . . . . . . . . . . . . . Corporate debt securities . . . . . . . . . . . . . . . December 31, 2006 Debt securities fund . . . . . . . . . . . . . . . . . . . U.S. Treasury notes . . . . . . . . . . . . . . . . . . . U.S. government and agency securities . . . . . . Mortgage backed securities . . . . . . . . . . . . . . Asset backed securities . . . . . . . . . . . . . . . . . Corporate debt securities . . . . . . . . . . . . . . . Amortized Cost Net Unrealized Gains Net Unrealized Losses Estimated Fair Value (in thousands) $ 10,133 25,184 49,562 64,115 $148,994 $ 30,662 34,743 5,750 46,120 121,442 72,640 $311,357 $116 95 111 6 $328 $ — 4 — 15 151 30 $200 $ — (239) (38) (572) $(849) $ — (174) — (212) (178) (44) $(608) $ 10,249 25,040 49,635 63,549 $148,473 $ 30,662 34,573 5,750 45,923 121,415 72,626 $310,949 As of December 31, 2007, our marketable securities, excluding equity securities, had the following maturities: Amortized Cost Estimated Fair Value (in thousands) Less than one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Between one and two years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Between two and five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 72,126 2,122 — $ 71,619 2,179 — Mortgage and asset-backed securities . . . . . . . . . . . . . . . . . . . . . . . . . . 74,248 74,746 73,798 74,675 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $148,994 $148,473 Actual maturities may differ from those scheduled as a result of prepayments by the issuers. Because of the potential for prepayment on mortgage and asset-backed securities, they are not categorized by contractual maturity. 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 2. Marketable Securities (Continued) Our net unrealized losses and fair value of investments with net unrealized losses were as follows: Loss Position For Less Than Twelve Months December 31, 2007 Loss Position For Greater Than Twelve Months Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (in thousands) Mortgage backed securities . . . . . . . . $ 7,140 36,324 Corporate debt securities . . . . . . . . . . 3,468 Asset-backed securities . . . . . . . . . . . $(139) $ 6,099 1,991 5,310 (564) (32) $(100) $13,239 38,315 8,778 (9) (1) $(239) (573) (33) Total—Marketable securities . . . . . . $46,932 $(735) $13,400 $(110) $60,332 $(845) As of December 31, 2007, approximately $0.9 million of marketable securities were classified as long-term assets on the consolidated balance sheets as they have been in an unrealized loss position for longer than six months and we have the ability to hold them until the carrying value recovers, which may be longer than one year. Net realized gains (loss) of ($0.4) million, $6.1 million and $1.3 million from sales of marketable securities were included in ‘‘Interest and other income/(expense), net’’ in 2007, 2006 and 2005, respectively. Note 3. Concentrations of Credit Risk As of December 31, 2007, we previously had entered into agreements for information products and services, which include licensing a portion of our intellectual property, with pharmaceutical, biotechnology and agricultural companies and academic institutions. Such agreements represented 100% of license and royalty revenues in 2007, 2006 and 2005. In general, customers 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 customer develops certain products utilizing our technology or proprietary information, we could potentially receive royalty and milestone payments. In November 2005, we entered into a collaborative research and license agreement with Pfizer, which became effective in January 2006. A single customer contributed 87%, 88% and 21% of total revenues for the years ended December 31, 2007, 2006 and 2005, respectively. Three customers comprised 68% and 78% of the accounts receivable balance as of December 31, 2007 and 2006, respectively. Note 4. Collaborative License Agreement Effective in January 2006, we entered a collaborative research and license agreement with Pfizer for the pursuit of our CCR2 antagonist program. Pfizer gained worldwide development and commercialization rights to our portfolio of CCR2 antagonist compounds. Pfizer’s rights extend to the full scope of potential indications, with the exception of multiple sclerosis and autoimmune nephritides, where we retained worldwide rights, along with certain compounds. We do not have obligations to Pfizer on pre-clinical development candidates we select for pursuit in these indications. 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 4. Collaborative License Agreement (Continued) We received an upfront nonrefundable payment of $40.0 million in January 2006 and are eligible to receive additional future development and milestone payments of up to $740.0 million for the successful development and commercialization of CCR2 antagonists in multiple indications, as well as royalties on worldwide sales. We received a $3.0 million milestone payment from Pfizer in 2007. The $40.0 million upfront fee was recorded as deferred revenue and is being recognized on a straight-line basis over two years, our estimated performance period under the agreement. Contract revenues related thereto of approximately $20.7 million and $20.3 million, respectively, were recognized for the years ended December 31, 2007 and 2006. All milestone payments will be recognized as revenue upon the achievement of the associated milestone. We also recognized contract revenues of approximately $1.5 million and $2.4 million, respectively, for the years ended December 31, 2007 and 2006 in connection with research services provided to Pfizer. We recognize contract revenues in connection with research services provided to Pfizer as earned. At December 31, 2007 approximately $0.4 million was receivable from Pfizer for reimbursement of expenses incurred by us pursuant to the agreement. Note 5. Property and Equipment Property and equipment consists of the following: December 31, 2007 2006 Office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Laboratory equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Computer equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ (in thousands) 598 13,809 9,186 2,093 571 13,108 9,153 2,016 Less accumulated depreciation and amortization . . . . . . . . . . . 25,686 (21,743) 24,848 (18,958) $ 3,943 $ 5,890 Depreciation expense, including amortization expense of leasehold improvements, was $3.1 million, $3.3 million and $3.9 million for 2007, 2006 and 2005, respectively. Note 6. Long-Term Investments In December 2007, we recorded a gain of approximately $8.5 million in interest and other income, net as a result of the sale of Velocity11, a privately-held life sciences technology company in which we held an ownership position. We may receive additional consideration of approximately $0.9 million after a one year escrow period. In June 2006, we recorded an impairment charge of $1.3 million in interest and other income, net to reduce the carrying value of our investment in a privately-held investee because the investee had less than six months of cash and we believed that the likelihood of obtaining future debt or equity financing that would not result in an impairment was remote. 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 6. Long-Term Investments (Continued) In March 2006, we sold a portion of our investment in a publicly-held company accounted for under FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, for $11.5 million, and in October 2006, we sold the remaining portion of this investment for $5.8 million, which resulted in a aggregate realized gain of $6.2 million in interest and other income, net for the year ended December 31, 2006. In May 2005, we sold our investment in a publicly-held company accounted for under FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, for $5.7 million, resulting in a realized gain of $2.8 million in interest and other income, net. The activity in our long-term investments, in any given period, may result in gains or losses on sales or impairment charges. Amounts realized upon disposition of these investments may be different from their carrying value. Note 7. Intangible and Other Assets Intangible and other assets consist of the following (in thousands): December 31, 2007 December 31, 2006 Gross Carrying Amount Accumulated Amortization Intangible Assets, Net Gross Carrying Amount Accumulated Amortization Intangible Assets, Net Gene and genomics- related patent costs . . . Debt issuance cost . . . . . Other assets . . . . . . . . . . Total intangible and other assets . . . . . . . . . . . . . $ 1,381 8,578 3,574 $ (975) (4,638) (1,477) $ 406 3,940 2,097 $ 1,381 8,529 4,000 $ (651) (3,377) (1,167) $ 730 5,152 2,833 $13,533 $(7,090) $6,443 $13,910 $(5,195) $8,715 Amortization expense for the years ended December 31, 2007, 2006 and 2005 related to intangible assets was $1.9 million, $2.3 million and $2.7 million, respectively. In March 2002, in connection with his employment by Incyte as Executive Vice President and Chief Drug Discovery Scientist, Brian W. Metcalf received an interest-free loan from us in the amount of $400,000 to be used for financing his residence in California. The loan was evidenced by a promissory note and secured by the residence. On February 6, 2003, 25% of the outstanding principal balance was forgiven, and 1⁄48 of the principal amount was forgiven on the last day of each month thereafter, with the remaining outstanding principal balance of the loan forgiven on February 6, 2006. We amortized this loan to compensation expense on a straight-line basis over the forgiveness period. In 2004, we sublet one of our existing facilities to a third party. Under the terms of the consent agreement with the facility’s landlord, we were required to obtain a letter of credit in favor of the landlord in the amount of $2.6 million. The deposit and the related amount required under the letter of credit declines monthly on a pro-rata basis through March 2011, the remaining term of the lease agreement assigned. The deposit is included in other assets at December 31, 2007. 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 8. Convertible Notes The components of the Convertible Notes are as follows (in thousands): December 31, December 31, Carrying Amount Debt 2007 Interest Rates Maturities 2007 2006 31⁄2% Convertible Senior Notes due 2011 . . . . . . . 31⁄2% Convertible Subordinated Notes due 2011 . . . . Pfizer Convertible Subordinated Note due 2013 . . . . Pfizer Convertible Subordinated Note due 2014 . . . . 3.5% 3.5% 0.0% 0.0% 2011 2011 2013 2014 122,180 113,981 250,000 250,000 7,122 — 7,531 6,845 Less current portion . . . . . . . . . . . . . . . . . . . . — — $386,556 $371,103 Annual maturities of all Convertible Notes are as follows: 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — — — 401,800 — 20,000 $421,800 The carrying amount and fair value of our Convertible Notes are as follows (in thousands): 31⁄2% Convertible Senior Notes due 2011 . . . . . . . 31⁄2% Convertible Subordinated Notes due 2011 . . Pfizer Convertible Subordinated Note due 2013 . . Pfizer Convertible Subordinated Note due 2014 . . December 31, 2007 2006 Carrying Amount $122,180 250,000 7,531 6,845 Fair Value $122,339 253,045 7,531 6,845 Carrying Amount $113,981 250,000 7,122 — Fair Value $126,563 200,625 7,122 — $386,556 $389,760 $371,103 $334,310 In September 2006, we received proceeds of $111.9 million from the sale of $151.8 million aggregate principal amount of the 31⁄2% convertible senior notes due 2011 (the ‘‘31⁄2% Senior Notes’’). The 31⁄2% Senior Notes bear interest at the rate of 3.5% per year, payable semi-annually on February 15 and August 15, and are due February 15, 2011. The 31⁄2% Senior Notes are convertible into shares of our common stock at an initial conversion rate of 89.1385 shares per $1,000 principal amount of the 31⁄2% Senior Notes, equivalent to an initial conversion price of approximately $11.22 per share. The 31⁄2% Senior Notes are senior in right of payment to our outstanding 31⁄2% convertible subordinated notes due 2011 (the ‘‘31⁄2% Subordinated Notes’’) and the Pfizer Notes due 2013 and 2014. We may redeem the 31⁄2% Senior Notes beginning on February 20, 2007. The 31⁄2% Senior Notes were issued at a discount to par of 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 8. Convertible Notes (Continued) approximately $39.9 million. The carrying value of the 31⁄2% Senior Notes is $122.2 million at December 31, 2007. The 31⁄2% Senior Notes will accrete up to their face value over the 53 month term of the notes by recording interest expense under the effective interest method. In connection with the collaborative research and license agreement, Pfizer purchased a $10.0 million principal amount Pfizer Note in February 2006 and an additional $10.0 million principal amount Pfizer Note in October 2007. The Pfizer Notes bear no interest, are due seven years from the date of issuance and are convertible into our common stock at initial conversion prices of $6.8423 and $9.75 per share, respectively, subject to adjustments. The Pfizer Notes are subordinated to all senior indebtedness, including the 31⁄2% Senior Notes, and pari passu in right of payment with our 31⁄2% Subordinated Notes. We may, at our option, repay the Pfizer Notes beginning February 3, 2009 and October 10, 2010, respectively. Pfizer may require us to repay the Pfizer Notes upon a change of control, as defined. As the Pfizer Notes are non interest bearing, they have been discounted to their net present value of $6.8 million each by imputing interest at a rate of 4.5% and 3.9%, respectively, which represented market conditions in place at the time the notes were issued. The carrying value of the Pfizer Notes were $7.5 million and $6.8 million, respectively, at December 31, 2007. We will accrete the Pfizer Notes up to their face value over their term of seven years by recording interest expense under the effective interest method. The difference between the cash received and the present value of the Pfizer Notes plus the related beneficial conversion feature totals $3.2 million for each note, which represents additional consideration from Pfizer under the agreement. We have accounted for this additional consideration as deferred revenue and will recognize it over our estimated performance period under the agreement. Contract revenues related thereto of approximately $4.7 million and $1.5 million, respectively, were recognized for the years ended December 31, 2007 and 2006. In February and March 2004, in a private placement, we issued a total of $250.0 million of the 31⁄2% Subordinated Notes, which resulted in net proceeds of approximately $242.5 million. The notes bear interest at the rate of 3.5% per year, payable semi-annually on February 15 and August 15. The notes are subordinated to all senior indebtedness, including the 31⁄2% Senior Notes, and pari passu in right of payment with the Pfizer Notes. The notes are convertible into shares of our common stock at an initial conversion price of approximately $11.22 per share, subject to adjustments. Holders may require us to repurchase the notes upon a change in control, as defined. We may redeem the notes beginning February 20, 2007. Note 9. Other Expenses The estimates below have been made based upon management’s best estimate of the amounts and timing of certain events included in the restructuring 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 determinable. The accrual balances for the restructuring plans are included in accrued restructuring and other liabilities (long-term) in the consolidated balance sheets. 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 9. Other Expenses (Continued) 2004 Restructuring and Other Impairments (in thousands) Accrual Balance as of 2005 2005 Accrual Balance as of 2006 2006 Accrual Balance as of 2007 2007 Accrual Balance as of December 31, Charges to Charges December 31, Charges to Charges December 31, Charges to Charges December 31, Operations Utilized Operations Utilized Operations Utilized 2007 2005 2006 2004 Workforce reduction . . Lease commitments and related costs . . . Other costs . . . . . . . . $ 2 $ (2) $ — $ — $ — $ — $ — $ — $ — $ — 15,497 — 733 255 (2,685) (255) 13,545 — 893 92 (2,966) (92) 11,472 — 571 125 (2,864) (125) 9,179 — Total . . . . . . . . . . . . $15,499 $986 $(2,940) $13,545 $985 $(3,058) $11,472 $696 $(2,989) $9,179 In February 2004, we announced a restructuring plan to close our information products research facility and headquarters in Palo Alto, California and move our headquarters to our Wilmington, Delaware pharmaceutical research and development facility. The closure of the Palo Alto facility corresponded with terminating further development activities around our Palo Alto-based information products line. The restructuring plan included the elimination of 183 employees and charges related to the closure of our Palo Alto facilities, previously capitalized tenant improvements and equipment and other items. The lease commitment and related costs originally included the present value of future lease obligations for two facilities. In the fourth quarter of 2004, we made a lease termination payment to satisfy our remaining lease obligation with respect to one of the facilities. The lease obligation for the second facility extends through March 2011. As a result of the long term nature of the remaining lease obligation, we will be recording a charge each period through the March 2011 termination date of the lease related to increases in the fair value of the lease obligations in accordance with the provisions of FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which total approximately $0.9 million at December 31, 2007. 2002 Restructuring (in thousands) Accrual Balance as of 2005 2005 Accrual Balance as of 2006 2006 Accrual Balance as of 2007 2007 Accrual Balance as of December 31, Charges to Charges December 31, Charges to Charges December 31, Charges to Charges December 31, Operations Utilized Operations Utilized Operations Utilized 2006 2004 2005 2007 Lease commitments and other restructuring charges . . . . . $16,155 $ 57 $(2,512) $13,700 $(1,450) $(2,250) $10,000 $(282) $(2,184) $7,534 In November 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 plan included elimination of approximately 37% of our approximately 700-person workforce from our offices in Palo Alto, California; Beverly, Massachusetts; and Cambridge, England and the consolidation of our office and research facilities in Palo Alto, California. As a result, we recorded an expense of $33.9 million related to restructuring activities in the fourth quarter of 2002. 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 9. Other Expenses (Continued) We currently have one remaining lease related to an exited site that is due to expire in December 2010. During the years ended December 31, 2007, 2006 and 2005, we recognized additional charges of $(0.3) million, $(1.5) million and $0.1 million, respectively, primarily relating to this facility for lease expenses in excess or less than of amounts originally estimated. We estimated the costs based on the contractual terms of agreements and current real estate market conditions. We may incur additional costs associated with these subleasing and lease termination activities. Maxia Acquisition (in thousands) Accrual Balance as of 2005 2005 Accrual Balance as of 2006 2006 Accrual Balance as of 2007 2007 Accrual Balance as of December 31, Charges to Accrual December 31, Charges to Accrual December 31, Charges to Accrual December 31, Operations Utilized Operations Utilized Operations Utilized 2005 2004 2007 2006 Lease commitments and other costs . . . . . . . $2,373 $312 $(616) $2,069 $(79) $(772) $1,218 $(568) $(376) $274 In accordance with EITF 95-3, we recorded a $2.9 million charge in 2003 related to restructuring costs for Maxia Pharmaceuticals, Inc. (‘‘Maxia’’), which consisted of workforce reductions and consolidation of facilities. We recorded employee termination costs of approximately $0.8 million for 28 employee positions. The job eliminations were completed in July 2003. We also recorded restructuring costs related to lease payments for property that has been vacated and other costs of $2.0 million. In 2007, 2006 and 2005 we recorded additional charges of $(0.6) million, $(0.1) million and $0.3 million, respectively, relating to facilities lease expenses in excess of amounts originally estimated. The operating lease related to the vacated facility expires in November 2008. Note 10. Stockholders’ Deficit Preferred Stock. We are authorized to issue 5,000,000 shares of preferred stock, none of which was outstanding as of December 31, 2007 or 2006. The Board of Directors may determine the rights, preferences and privileges of any preferred stock issued in the future. We have reserved 250,000 shares of preferred stock designated as Series A Participating Preferred Stock for issuance in connection with the Stockholders Rights plan described below. Common Stock. As of December 31, 2007, we had reserved a total of 17,300,458 shares of our common stock for future issuance related to our stock plans as described below. On November 5, 2004, we completed a public offering of 9 million shares of our authorized but unissued common stock at $9.75 per share pursuant to an effective shelf registration statement, resulting in net proceeds of $83.3 million after deducting the underwriting discounts, commissions and offering expenses. Stock Compensation Plans. Summaries of stock option activity for our stock option plans as of December 31, 2007, 2006 and 2005, 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’’), which was amended and restated 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 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 10. Stockholders’ Deficit (Continued) the Board of Directors, be either incentive stock options, nonstatutory stock 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 on the date of the grant, as determined by the Board of Directors. Options granted after February 2007 generally vest over three years, pursuant to a formula determined by our Board of Directors, and expire after seven years. Options granted prior to February 2007 generally vest over four years, pursuant to a formula determined by our Board of Directors, and expire after ten years. Certain options granted in 2002 vest pro rata monthly over three years and expire after ten years. In May 2007, our stockholders approved an increase in the number of shares of common stock reserved for issuance under the Stock Plan from 22,350,000 to 25,350,000. During 2001, we granted 490,000 restricted stock units under the Stock Plan to certain management personnel. Stock compensation expense of $0.2 million was recorded in 2005. As of December 31, 2005, all of the restricted stock units had vested or had been previously forfeited. Non-Employee Directors’ Stock Option Plan. In August 1993, the Board of Directors approved the 1993 Directors’ Stock Option Plan (the ‘‘Directors’ Plan’’), which was later amended. The Directors’ Plan provides for the automatic grant of options to purchase shares of common stock to our non-employee directors. In June 2005, our stockholders approved an increase in the number of shares of common stock reserved for issuance under the plan from 1,100,000 to 1,500,000. Under the Directors’ Plan, each new non-employee director joining the Board will receive an option to purchase 35,000 shares of common stock. Additionally, members who continue to serve on the Board will receive annual option grants for 20,000 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. 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 10. Stockholders’ Deficit (Continued) Activity under the combined plans was as follows: Shares Subject to Outstanding Options Shares Available for Grant Shares Weighted Average Exercise Price Balance at December 31, 2004 . . . . . . . . . . . . . . . . . . . . 7,247,237 6,518,745 Additional authorization . . . . . . . . . . . . . . . . . . . . . . . . . Options granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 (2,794,200) — 20,000 1,275,121 — 2,794,200 (203,602) (20,000) (1,290,942) Balance at December 31, 2005 . . . . . . . . . . . . . . . . . . . . 6,148,158 7,798,401 Additional authorization . . . . . . . . . . . . . . . . . . . . . . . . . Options granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (2,834,227) — 33,736 442,814 — 2,834,227 (61,931) (33,736) (442,814) Balance at December 31, 2006 . . . . . . . . . . . . . . . . . . . . 3,790,481 10,094,147 Additional authorization . . . . . . . . . . . . . . . . . . . . . . . . . Options granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000,000 (2,892,975) — 18,000 311,963 — 2,892,975 (222,654) (18,000) (311,963) Balance at December 31, 2007 . . . . . . . . . . . . . . . . . . . . 4,227,469 12,434,505 $ 9.61 — $ 8.53 $ 1.33 $ 3.78 $11.97 $ 8.99 — $ 5.25 $ 4.72 $ 9.39 $ 9.55 $ 7.94 — $ 7.07 $ 4.90 $18.31 $ 6.57 $ 7.81 Options to purchase a total of 7,593,670, 5,577,911 and 4,181,999 shares as of December 31, 2007, 2006 and 2005, respectively, were exercisable and vested. The aggregrate intrinsic value of options exercised for the years ended December 31, 2007, 2006 and 2005 were $0.7 million, $0.0 million and $1.2 million, respectively. At December 31, 2007 the aggregate intrinsic value of options outstanding and vested options are $34.6 million and $18.8 million, respectively. 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 10. Stockholders’ Deficit (Continued) The following table summarizes information about stock options outstanding as of December 31, 2007 for the 1991 Stock Plan and the 1993 Directors’ Stock Option Plan: Range of Exercise Prices $3.10 - $5.24 . . . . . . . . . . . . . . . . . . . . . . $5.29 - $5.43 . . . . . . . . . . . . . . . . . . . . . . $5.46 - $5.46 . . . . . . . . . . . . . . . . . . . . . . $5.67 - $7.04 . . . . . . . . . . . . . . . . . . . . . . $7.09 - $7.09 . . . . . . . . . . . . . . . . . . . . . . $7.10 - $8.19 . . . . . . . . . . . . . . . . . . . . . . $8.49 - $8.93 . . . . . . . . . . . . . . . . . . . . . . $8.99 - $8.99 . . . . . . . . . . . . . . . . . . . . . . $9.12 - $16.19 . . . . . . . . . . . . . . . . . . . . . $17.81 - $35.00 . . . . . . . . . . . . . . . . . . . . Options Outstanding Options Exercisable Number Outstanding Weighted Average Remaining Contractual Life 1,535,814 53,000 1,992,486 1,171,542 2,322,700 1,424,316 345,000 1,870,378 1,499,451 219,818 12,434,505 6.31 7.64 8.03 5.75 6.12 6.72 6.31 7.05 4.14 2.84 6.34 Weighted Average Exercise Price $ 4.70 $ 5.37 $ 5.46 $ 6.18 $ 7.09 $ 7.85 $ 8.68 $ 8.99 $13.10 $20.17 Number Exercisable 1,278,727 18,104 936,605 925,966 0 1,050,639 322,747 1,352,942 1,488,122 219,818 Weighted Average Exercise Price $ 4.76 $ 5.38 $ 5.46 $ 6.16 $ 0.00 $ 7.99 $ 8.69 $ 8.99 $13.12 $20.17 $ 7.81 7,593,670 $ 8.47 Employee Stock Purchase Plan. On May 21, 1997, our stockholders adopted the ESPP. In May 2006, our stockholders approved an increase in the number of shares available for grant from 3,100,000 shares to 3,850,000 shares. Each regular full-time and part-time employee working 20 hours or more per week is eligible to participate after one month of employment. We issued 337,689, 313,715 and 389,801 shares under the ESPP in 2007, 2006 and 2005, respectively. For the year ended December 31, 2007 and 2006 we recorded stock compensation expense of $0.4 million and $0.4 million, respectively, under SFAS 123R as the ESPP is considered compensatory under SFAS 123R. As of December 31, 2007, 638,484 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’’), pursuant to which one preferred stock purchase right (a ‘‘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 our 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’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. 70 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 11. Stock Compensation We adopted SFAS 123R on January 1, 2006. SFAS 123R requires the recognition of the fair value of stock compensation in the statement of operations. We recognize the stock compensation expense over the requisite service period of the individual grants, which generally equals the vesting period. Prior to January 1, 2006, we followed APB Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for our stock compensation. We elected the modified prospective method in adopting SFAS 123R. Under this method, the provisions of SFAS 123R apply to all awards granted or modified after the date of adoption. In addition, the unrecognized expense of awards not yet vested at the date of adoption is recognized in net income in the periods after the date of adoption using the same valuation method (Black-Scholes) and assumptions determined under the original provisions of SFAS 123, Accounting for Stock-Based Compensation, as disclosed in our previous filings. Under the provisions of SFAS 123R, we recorded $10.1 and $8.9 million, respectively, of stock compensation expense on our audited condensed consolidated statement of operations for the year ended December 31, 2007 and 2006. We utilized the Black-Scholes valuation model for estimating the fair value of the stock compensation granted, with the following weighted-average assumptions: Employee Stock Options For the Year Ended Employee Stock Purchase Plan For the Year Ended December 31, December 31, 2007 2006 2005 2007 2006 2005 Average risk-free interest rates . . . . . . . . . . . . . . . . . . . Average expected life (in years) . . . . . . . . . . . . . . . . . . Volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted-average fair value (in dollars) . . . . . . . . . . . . 4.81% 4.43% 3.95% 4.09% 4.80% 3.64% 2.91 0.50 3.29 3.13 0.50 0.50 65% 76% 86% 51% 63% 90% 3.22 2.75 4.94 1.24 1.26 2.81 The risk-free interest rate is derived from the U.S. Federal Reserve rate in effect at the time of grant. The expected life calculation is based on the observed and expected time to the exercise of options by our employees based on historical exercise patterns for similar type options. Expected volatility is based on the historical volatility of our common stock over the period commensurate with the expected life of the options. A dividend yield of zero is assumed based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends. Based on our historical experience, we have assumed an annualized forfeiture rate of 5% for our options. Under the true-up provisions of SFAS 123R, we will record additional expense if the actual forfeiture rate is lower than we estimated, and will record a recovery of prior expense if the actual forfeiture is higher than we estimated. SFAS 123R requires us to present pro forma information for the comparative period prior to the adoption as if we had accounted for all our stock options under the fair value method of the original SFAS 123. The following table illustrates the effect on net loss and loss per share if we had applied the fair 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 11. Stock Compensation (Continued) value recognition provisions of SFAS 123 to stock-based employee compensation in the prior-year period (dollars in thousands, except per-share data). Net loss, as reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add: Stock-based employee compensation . . . . . . . . . . . . . . . . . . . . . . Deduct: Total stock-based employee compensation determined under For the Year Ended December 31, 2005 $(103,043) 186 the fair value-based method for all awards . . . . . . . . . . . . . . . . . . . . (9,777) Pro forma net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(112,634) Net loss per share: Basic and diluted net loss per share—as reported . . . . . . . . . . . . . . . . . Basic and diluted net loss per share—as SFAS 123 adjusted . . . . . . . . . $ $ (1.24) (1.35) The amortization of stock compensation under SFAS 123R for the period after its adoption, and under APB Opinion 25 or SFAS 123 (pro forma disclosure) for the period prior to its adoption was calculated in accordance with FASB Interpretation (‘‘FIN’’) No. 28. Total compensation cost of options granted but not yet vested, as of December 31, 2007, was $6.0 million, which is expected to be recognized over the weighted average period of 3.17 years. Note 12. Income Taxes The benefit for income taxes consists of the following (in thousands): Current Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ — $(228) — (324) — Total benefit for income taxes . . . . . . . . . . . . . . . . . . . . . . $ — $ — $(552) Year Ended December 31, 2007 2006 2005 Loss from continuing operations before benefit for income taxes consists of the following (in thousands): Year Ended December 31, 2007 2006 2005 U.S. taxable entities . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(86,881) $(74,161) $(103,030) (879) (5) — $(86,881) $(74,166) $(103,909) 72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 12. Income Taxes (Continued) The benefit for income taxes differs from the federal statutory rate as follows (in thousands): Year Ended December 31, 2007 2006 2005 Benefit at U.S. federal statutory rate . . . . . . . . . . . . Unbenefitted net operating losses and tax credits . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(30,408) $(26,000) $(36,300) 36,200 25,800 (452) 200 30,238 170 Benefit for income taxes . . . . . . . . . . . . . . . . . . . . $ — $ — $ (552) Significant components of our deferred tax assets are as follows (in thousands): December 31, 2007 2006 Deferred tax assets: Federal and state net operating loss carryforwards . . . . . . . . Federal and state research credits . . . . . . . . . . . . . . . . . . . . Capitalized research and development . . . . . . . . . . . . . . . . . Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal and state capital loss carryforwards . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 327,000 37,000 76,000 6,000 8,000 12,000 $ 303,000 35,000 52,000 6,000 11,000 23,000 Total gross deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . Less valuation allowance for deferred tax assets . . . . . . . . . . 466,000 (466,000) 430,000 (430,000) Net deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ — The valuation allowance for deferred tax assets increased by approximately $36.0 million, $38.2 million and $48.8 million during the years ended December 31, 2007, 2006 and 2005, respectively. Approximately $61.7 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. Management believes the uncertainty regarding the realization of net deferred tax assets requires a full valuation allowance. As of December 31, 2007, we had federal and state net operating loss carryforwards of approximately $804.0 million. We also had federal and state research and development tax credit carryforwards of approximately $37.0 million. The net operating loss carryforwards and tax credits will expire at various dates, beginning in 2008 through 2027, if not utilized. Utilization of the net operating losses and credits may be subject to an annual limitation, due to the ‘‘change in ownership’’ provisions of the Internal Revenue Code of 1986 and similar state provisions. We also had federal and state capital loss carryforwards of approximately $19.4 million that will expire beginning in 2009. Note 13. Net Loss Per Share For all periods presented, both basic and diluted net loss per common share are computed by dividing the net loss by the number of weighted average common shares outstanding during the period. Stock 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 13. Net Loss Per Share (Continued) options and potential common shares issuable upon conversion of our 31⁄2% Senior Notes, 31⁄2% Subordinated Notes and 5.5% convertible subordinated notes due 2007 (the ‘‘5.5% Notes’’) were excluded from the computation of diluted net loss per share, as their share effect was anti-dilutive for all periods presented. The potential common shares that were excluded from the diluted net loss per share computation are as follows: Outstanding stock options . . . . . . . . . . . . . . . . . . . . . . Common shares issuable upon conversion of 31⁄2% December 31, 2007 2006 2005 12,434,505 10,094,147 7,798,401 Senior Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,531,224 13,531,224 — Common shares issuable upon conversion of 31⁄2% Subordinated Notes . . . . . . . . . . . . . . . . . . . . . . . . . 22,284,625 22,284,625 22,284,625 Common shares issuable upon conversion of Pfizer Note due 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,461,496 1,461,496 Common shares issuable upon conversion of Pfizer Note due 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,025,641 — — — Common shares issuable upon conversion of 5.5% Notes(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 1,358,865 Total potential common shares excluded from diluted net loss per share computation . . . . . . . . . . . . . . . . 50,737,491 47,371,492 31,441,891 (1) All of the outstanding 5.5% Notes were redeemed on October 16, 2006. Note 14. Segment Reporting Our operations are treated as one operating segment, biotechnology drug discovery and development, in accordance with FASB Statement No. 131 (‘‘SFAS 131’’). For the year ended December 31, 2007, we recorded revenue from customers throughout the United States and in Canada, Germany, Sweden, and the United Kingdom. Export revenues for the years ended December 31, 2007, 2006 and 2005 were $0.7 million, $0.6 million and $2.8 million, respectively. Note 15. Defined Contribution Plan We have a defined contribution plan qualified under Section 401(k) of the Internal Revenue Code covering all domestic employees. Employees may contribute a portion of their compensation, which is then matched by us, subject to certain limitations. Defined contribution expense was $0.5 million, $0.0 million and $0.5 million in 2007, 2006 and 2005, respectively. Note 16. Litigation Invitrogen In October 2001, Invitrogen Corporation (‘‘Invitrogen’’) filed an action against us in the federal court for the District of Delaware, alleging infringement of three patents. On June 15, 2006 we entered into a settlement agreement with Invitrogen pursuant to which we agreed to pay Invitrogen $3.4 million as a 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 16. Litigation (Continued) settlement fee. This amount is included in other expenses in the accompanying condensed consolidated statements of operations for the year ended December 31, 2006. In addition to the matter described above, from time to time we have been involved in certain legal actions arising in the ordinary course of business. In management’s opinion, the outcome of such actions will not have a material adverse effect on our financial position, results of operations, or liquidity. Note 17. Related Party Transactions The following summarizes our related party transactions as defined by FASB Statement No. 57, Related Party Disclosures (‘‘SFAS 57’’). In each of the transactions noted in which a director of Incyte was at the time of the transaction in some way affiliated with the other party to the transaction, such director recused himself from voting on the related party transaction, other than the Senomyx, Inc. transaction. During 1997, we purchased diaDexus Series B Preferred Stock at a cost of $1.3 million. We do not have the ability to exert significant influence over diaDexus. We have an executive officer who sits on diaDexus’ Board of Directors. In June 2006, we recorded an impairment charge of $1.3 million to reduce the carrying value of this investment because the investee had less than six months of cash and the likelihood of future debt or equity financing that would not result in an impairment was remote. During 2000 and 2001 we purchased shares of Series A Preferred Stock and Series C Preferred Stock of Genomic Health, Inc. (‘‘Genomic Health’’) for an aggregate purchase price of $6.0 million. In connection with the completion of its initial public offering on October 4, 2005, these shares were converted into common shares. Additionally as part of its initial public offering, Genomic Health exercised an election under which we were required to acquire an additional $5.0 million of Genomic Health common stock. In March 2006, we sold our initial investment for $11.5 million, and in October 2006, we sold the remaining portion of this investment for $5.8 million, which resulted in a aggregate realized gain of $6.2 million for the year ended December 31, 2006. Julian C. Baker, one of our directors, is also a director of Genomic Health and holds shares, directly or beneficially, of both companies. During 2000, we purchased shares of Series D Preferred Stock of Senomyx, Inc. (‘‘Senomyx’’) for an aggregate purchase price of $6.5 million. In connection with the completion of Senomyx’s initial public offering in 2004, our ownership interest was converted into common shares. These shares were sold in 2005 for $5.7 million, resulting in a realized gain of $2.8 million from their carrying value. Frederick B. Craves, one of our former directors, is a partner of Bay City Capital, which held shares of Senomyx stock. During 2005, we repurchased on the open market, and retired, $36.5 million in face value of 5.5% Notes. One such transaction in 2005 involved the repurchase, at a purchase price of 98.25% of face value, of $5.0 million in face value of such notes from a limited partnership of which Julian C. Baker, one of our directors, is a controlling member of the general partner of the general partner and may have a pecuniary interest. Mr. Baker did not participate in our decision to engage in such a repurchase transaction. The price paid by us in such repurchase transaction was equal to the price paid by us to an independent third party in a comparable transaction negotiated on an arms’-length basis a short time prior to such repurchase transaction. Note 18. Commitments As of December 31, 2007, we had noncancelable operating leases on multiple facilities and equipment, including facilities in Palo Alto, California; San Diego, California; and Wilmington, Delaware. 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 18. Commitments (Continued) The leases expire on various dates ranging from June 2008 to March 2011. Certain leases have renewal options for periods ranging up to 5 years. Rent expense for the years ended December 31, 2007, 2006 and 2005, was approximately $4.6 million, $4.4 million and $4.2 million, respectively. As of December 31, 2007, future noncancelable minimum payments under operating leases, including leases for sites included in the restructuring programs were as follows: Year ended December 31, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Operating Leases (in thousands) $13,142 12,699 10,506 1,134 — — Total minimum lease payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . $37,481 The amounts and timing of payments related to vacated facilities may vary based on negotiated timing of lease terminations. We have entered into sublease agreements for our vacated space with scheduled payments to us of $3.1 million (less than 1 year), $4.2 million (years 1-3), and $0.3 million (years 4-5). In addition to the non-cancelable commitments included in the table above, we have entered into contractual arrangements that obligate us to make payments to the contractual counterparties upon the occurrence of future events. We consider these potential obligations contingent, and have summarized all significant arrangements below. Commitments related to Maxia are considered contingent commitments as future events must occur to cause these commitments to be enforceable. In February 2003, we completed our acquisition of Maxia. Under the merger agreement, former Maxia stockholders have the right to receive certain earn out amounts of up to a potential aggregate amount of $14.0 million upon the occurrence of certain research and development 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 (based upon the then fair value) 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. In any event, no more than 13,531,138 shares of our common stock may be issued to former Maxia stockholders in the aggregate pursuant to the merger agreement. None of these milestones had been achieved as of December 31, 2007. We have entered into and intend to continue to seek to license additional rights relating to compounds or technologies in connection with our drug discovery and development programs. Under these licenses, we may be required to pay up-front fees, milestone payments and royalties on sales of future products. 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) INCYTE CORPORATION Note 19. Interim Consolidated Financial Information (Unaudited) (in thousands, except per share data) Fiscal 2007 Quarter Ended March 31 June 30 September 30 December 31 Revenues(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic and diluted net loss per share . . . . . . . . . . . . . . Shares used in computation of basic and diluted net $ 7,422 (22,147) $ (0.26) $ $ 10,576 (18,439) (0.22) $ 6,690 (24,494) (0.29) $ $ 9,752 (21,801) (0.26) $ loss per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83,985 84,136 84,213 84,405 Fiscal 2006 Quarter Ended March 31 June 30 September 30 December 31 Revenues(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net loss(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic and diluted net loss per share . . . . . . . . . . . . . . Shares used in computation of basic and diluted net $ 6,465 (17,306) $ (0.21) $ $ 6,855 (20,520) (0.24) $ 7,268 (15,838) (0.19) $ $ 7,056 (20,502) (0.24) $ loss per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83,627 83,786 83,852 83,931 (1) In November 2005, we entered into a collaborative research and license agreement with Pfizer, which became effective in January 2006. The March 31, 2007, June 30, 2007, September 30, 2007, and December 31, 2007 quarters include $6.1 million, $8.9 million, $5.9 million, and $8.9 million, respectively, of contract revenues relating to the agreement. The March 31, 2006, June 30, 2006, September 30, 2006, and December 31, 2006 quarters include $5.5 million, $6.3 million, $6.2 million, and $6.2 million, respectively, of contract revenues relating to the agreement. (2) The June 30, 2006 quarter includes a $3.4 million charge related to the settlement fee paid to Invitrogen. 77 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 Allowance for doubtful accounts—2005 . . . . . . . . . . . . . . Allowance for doubtful accounts—2006 . . . . . . . . . . . . . . Allowance for doubtful accounts—2007 . . . . . . . . . . . . . . $274 195 $ — (in thousands) 35 — — 114 195 — 195 $ — $ — Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Not applicable. Item 9A. Controls and Procedures Evaluation of disclosure controls and procedures. We maintain ‘‘disclosure controls and procedures,’’ as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level. Changes in internal control over financial reporting. There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Management’s annual report on internal control over financial reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting based on the issued by the Committee of Sponsoring framework Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2007. The effectiveness of our internal control over financial reporting as of December 31, 2007 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included herein. in Internal Control—Integrated Framework 78 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of Incyte Corporation We have audited Incyte Corporation’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Incyte Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Incyte Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Incyte Corporation as of December 31, 2007 and 2006, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2007 of Incyte Corporation and our report dated February 26, 2008 expressed an unqualified opinion thereon. Philadelphia, Pennsylvania February 26, 2008 /s/ Ernst & Young LLP 79 Item 9B. Other Information None. Item 10. Directors, Executive Officers and Corporate Governance PART III The information required by this item (with respect to Directors) is incorporated by reference from the information under the caption ‘‘Election of Directors’’ contained in our Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for our 2008 Annual Meeting of Stockholders to be held on May 22, 2008 (the ‘‘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’’ and is incorporated herein by reference. Item 405 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 16(a) Beneficial Ownership Reporting Compliance’’ in the Proxy Statement and is incorporated herein by reference. We have adopted a Code of Business Conduct and Ethics that applies to all of our officers and employees, including our Chief Executive Officer, Chief Financial Officer, Corporate Controller and other employees who perform financial or accounting functions. The Code of Business Conduct and Ethics sets forth the basic principles that guide the business conduct of our employees. We have also adopted a Senior Financial Officers’ Code of Ethics that specifically applies to our Chief Executive Officer, Chief Financial Officer, Corporate Controller, and others providing similar functions. Stockholders may request a free copy of our Code of Business Conduct and Ethics and our Senior Financial Officers’ Code of Ethics by contacting Incyte Corporation, Attention: Investor Relations, Experimental Station, Route 141 & Henry Clay Road, Building E336, Wilmington, DE 19880. To date, there have been no waivers under our Code of Business Conduct and Ethics or Senior Financial Officers’ Code of Ethics. We intend to disclose future amendments to certain provisions of our Code of Business Conduct and Ethics or Senior Financial Officers’ Code of Ethics or any waivers, if and when granted, of our Code of Business Conduct and Ethics or Senior Financial Officers’ Code of Ethics on our website at http://www.incyte.com within four business days following the date of such amendment or waiver. Our Board of Directors has appointed an Audit Committee, comprised of Mr. Barry M. Ariko, as Chairman, Mr. Roy A. Whitfield and Mr. Matthew W. Emmens. The Board of Directors has also determined that all three members of the Audit Committee are qualified as Audit Committee Financial Experts under the definition outlined by the Securities and Exchange Commission. In addition, each of the members of the Audit Committee qualifies as an ‘‘independent director’’ under the applicable standards of The Nasdaq Stock Market. Item 11. Executive Compensation The information required by this item is incorporated by reference from the information under the captions ‘‘Election of Directors—Compensation of Directors’’ and ‘‘Executive Compensation’’ contained in the Proxy Statement. 80 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this item is incorporated by reference from the information under the captions ‘‘Security Ownership of Certain Beneficial Owners and Management’’ and ‘‘Equity Compensation Plan Information’’ contained in the Proxy Statement. Item 13. Certain Relationships and Related Transactions, and Director Independence The information required by this item is incorporated by reference from the information under the captions ‘‘Certain Relationships and Related Transactions’’ and ‘‘Election of Directors—Director Independence’’ contained in the Proxy Statement. Item 14. Principal Accountant Fees and Services The information required by this item is incorporated by reference from the information under the caption ‘‘Principal Accountant Fees and Services’’ contained in the Proxy Statement. 81 PART IV Item 15. Exhibits, Financial Statement Schedules (a) Documents filed as part of this report: (1) Financial Statements Reference is made to the Index to Consolidated Financial Statements of Incyte Corporation under Item 8 of Part II hereof. (2) Financial Statement Schedules The following financial statement schedule of Incyte Corporation is filed as part of this Form 10-K included in Item 8 of Part II: Schedule II—Valuation and Qualifying Accounts for each of the three years in the period ended December 31, 2007. 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 See Item 15(b) below. Each management contract or compensatory plan or arrangement required to be filed has been identified. (b) Exhibits Exhibit Number 2.1 2.2 3(i) 3(ii) 4.1 4.2 Description of Document 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). 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). Integrated copy of the Restated Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3(i)(A) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002). Bylaws of the Company, as amended as of May 25, 2004 (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004). Form of Common Stock Certificate (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). 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’s Registration Statement on Form 8-A filed September 30, 1998). 82 Exhibit Number 4.3 Description of Document Indenture dated as of February 19, 2004 between the Company and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-3 (File No. 333-114863)). 4.4.1† Form of Convertible Subordinated Promissory Note (incorporated by reference to the Company’s Current Report on Form 8-K/A filed February 6, 2006). 4.4.2* Schedule of notes issued by the Company in the form of Exhibit 4.4.1 4.5 4.6 10.1# 10.2# 10.3# 10.4# 10.5# 10.6 10.7# 10.8# 10.9# Indenture dated as of September 26, 2006 between the Company and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on September 28, 2006). Registration Rights Agreement, dated as of September 26, 2006, by and between Incyte Corporation and Piper Jaffray & Co. (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on September 28, 2006). 1991 Stock Plan of Incyte Genomics, Inc., as amended and restated on March 13, 2007 (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007). Form of Incentive Stock Option Agreement under the 1991 Plan (incorporated by reference to the exhibit of the same number to the Company’s Registration Statement on Form S-1 (File No. 33-68138)). Form of Nonstatutory Stock Option Agreement under the 1991 Plan (incorporated by reference to the exhibit of the same number to the Company’s Registration Statement on Form S-1 (File No. 33-68138)). 1993 Directors’ Stock Option Plan of Incyte Genomics, Inc., as amended and restated on May 19, 2005 (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, 2005). Form of Indemnity Agreement between the Company and its directors and officers (incorporated by reference to Exhibit 10.5 to the Company’s Registration Statement on Form S-1 (File No. 33-68138)). Lease Agreement dated June 19, 1997 between the Company and The Board of Trustees of the Leland Stanford Junior University (incorporated by reference to Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999). 1997 Employee Stock Purchase Plan of Incyte Corporation, as amended and restated September 15, 2006 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on September 19, 2006). Form of Restricted Stock Unit Agreement under the 1991 Stock Plan of Incyte Genomics, Inc. (incorporated by reference to Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001). Offer of Employment Letter, dated November 21, 2001, from the Company to Paul A. Friedman (incorporated by reference to Exhibit 10.30 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001). 10.10# Employment Agreement, dated November 26, 2001, between Paul A. Friedman and Incyte Genomics, Inc. (incorporated by reference to Exhibit 10.32 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001). 83 Exhibit Number 10.11† 10.12 10.13# 10.14# 10.15# 10.16† 10.17 10.18 10.19* 12.1* 21.1* 23.1* 24.1* 31.1* 31.2* 32.1** 32.2** Description of Document Settlement Agreement dated December 21, 2001, between Affymetrix, Inc. and Incyte Genomics, Inc. (incorporated by reference to Exhibit 10.34 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001). Sublease Agreement, dated June 16, 2003, between E. I. DuPont de Nemours and Company and Incyte Corporation (incorporated by reference to Exhibit 10.45 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003). Offer of Employment Letter, dated September 2, 2003, from the Company to David C. Hastings (incorporated by reference to Exhibit 10.46 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003). Offer of Employment Letter, dated September 2, 2003, from the Company to John A. Keller (incorporated by reference to Exhibit 10.47 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003). Form of Employment Agreement, effective as of November 21, 2003 between Incyte Corporation and David C. Hastings, John A. Keller, Brian W. Metcalf, Patricia A. Schreck (effective date of December 8, 2003) and Paula J. Swain (incorporated by reference to Exhibit 10.48 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003). Collaborative Research and License Agreement, dated as of November 18, 2005, by and between the Company and Pfizer Inc. (incorporated by reference to Exhibit 10.49 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005). Note Purchase Agreement, dated as of November 18, 2005, by and between the Company and Pfizer Overseas Pharmaceuticals (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K/A filed February 6, 2006). Amendment No.1 to the Note Purchase Agreement, by and between the Company and Pfizer Overseas Pharmaceuticals, dated as of January 4, 2007 (incorporated by reference to Exhibit 10.18 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006). Amendment No.2 to the Note Purchase Agreement, by and among the Company, Pfizer Ireland Pharmaceuticals, and Pfizer Inc., dated as of October 10, 2007. Computation of Ratios of Earnings to Fixed Charges. Subsidiaries of the Company. Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm. Power of Attorney (see page 86 of this Form 10-K). Rule 13a-14(a) Certification of Chief Executive Officer. Rule 13a-14(a) Certification of the Chief Financial Officer. Statement of the Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C Section 1350). Statement of the Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C Section 1350). * Filed herewith. 84 ** In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management’s Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-K and will not be deemed ‘‘filed’’ for purpose of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference. † Confidential treatment has been requested with respect to certain portions of these agreements. # Indicates management contract or compensatory plan or arrangement. (c) Financial Statements and Schedules Reference is made to Item 15(a)(2) above. 85 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, we have duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SIGNATURES INCYTE CORPORATION By: /s/ PAUL A. FRIEDMAN Paul A. Friedman Chief Executive Officer Date: March 6, 2008 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Paul A. Friedman, David C. Hastings, and Patricia A. Schreck, 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 Paul A. Friedman /s/ DAVID C. HASTINGS David C. Hastings /s/ LAURENT CHARDONNET Laurent Chardonnet /s/ RICHARD U. DESCHUTTER Richard U. Deschutter /s/ BARRY M. ARIKO Barry M. Ariko /s/ JULIAN C. BAKER Julian C. Baker /s/ PAUL A. BROOKE Paul A. Brooke /s/ MATTHEW W. EMMENS Matthew W. Emmens /s/ JOHN F. NIBLACK John F. Niblack /s/ ROY A. WHITFIELD Roy A. Whitfield Chief Executive Officer (Principal Executive Officer) and Director Chief Executive Officer (Principal Financial Officer) and Director Vice President, Finance and Treasurer (Principal Accounting Officer) Chairman Director Director Director Director Director Director 86 March 6, 2008 March 6, 2008 March 6, 2008 March 6, 2008 March 6, 2008 March 6, 2008 March 6, 2008 March 6, 2008 March 6, 2008 March 6, 2008 STOCK PRICE PERFORMANCE GRAPH The following graph illustrates a comparison of the cumulative total stockholder return (change in stock price plus reinvested dividends) of the Company’s Common Stock, the Total Return Index for the NASDAQ U.S. Stocks (the ‘‘NASDAQ Composite Index’’), and the Total Return Index for the NASDAQ Biotechnology Stocks (the ‘‘NASDAQ Biotechnology Index’’) assuming an investment of $100 in each on December 31, 2002. In previous years, the Company used the Total Return Index for the NASDAQ Pharmaceutical Stocks (the ‘‘NASDAQ Pharmaceutical Index’’) as a comparative index, and that index is also presented below for comparison purposes. The Company elected to change the comparative index from the NASDAQ Pharmaceutical Index to the NASDAQ Biotechnology Index because the Company believes it better represents the Company’s peer group engaged in a similar line-of-business. The Company’s Common Stock is traded on the NASDAQ Global Market. The graph is required by the Securities and Exchange Commission and is not intended to forecast or be indicative of possible future performance of the Company’s Common Stock. $250 $200 $150 $100 $50 $0 12/02 12/03 12/04 12/05 12/06 12/07 Incyte Corporation NASDAQ Composite Index NASDAQ Pharmaceutical Index NASDAQ Biotechnology Index 21MAR200808464366 THIS PAGE INTENTIONALLY LEFT BLANK I I I e s a h P I I e s a h P I e s a h P e t a t S e s a e s D i t c u d o r P E T Y C N I t e g r a T e n i l e p P i l a c n i i l ’ C s e t y c n I l a m o e y m e p i t l u M l * T E / V P i s i t i r h t r a d o t a m u e h R r e c n a c e t a t s o r P i s s a i r o s P i s s a i r o s P ) l i a c p o t ( 4 2 4 8 1 B C N I n o - w o l l o f d a e L ) l a c n i i l c e r p ( 0 5 0 8 2 B C N I s e t e b a d 2 i e p y T s e t e b a d 2 i e p y T 9 3 7 3 1 B C N I 7 1 8 0 2 B C N I 1 D S H s e t e b a d 2 i e p y T 2 0 6 9 1 B C N I a 4 7 M H r e c n a c t s a e r B s r e c n a c d i l l o s e p i t l u M 9 3 8 7 B C N I e s a d d e h S i s s o r b i f o e y M l ) l a r o ( 4 2 4 8 1 B C N I K A J i l s s o r e c s e p i t l u M l 6 9 6 8 B C N I 2 R C C i n a p s i t i r h t r a o e t s O ) r e z i f P ( 9 0 3 6 3 1 4 - F P I V H I V H 0 5 0 5 1 B C N I 1 7 4 9 B C N I 5 R C C i a m e h t y c o b m o r h t l a i t n e s s E / i a r e v a m e h t y c y o P * l BOARD OF DIRECTORS EXECUTIVE MANAGEMENT Richard U. De Schutter Chairman of the Board Formerly Chairman and Chief Executive Ofﬁ cer DuPont Pharmaceuticals Company Paul A. Friedman, M.D. President and Chief Executive Ofﬁ cer Incyte Corporation Barry M. Ariko President, Chief Executive Ofﬁ cer and Chairman Mirapoint, Inc. Paul A. Friedman, M.D. President and Chief Executive Ofﬁ cer David C. Hastings Executive Vice President and Chief Financial Ofﬁ cer John A. Keller, Ph.D. Executive Vice President and Chief Business Ofﬁ cer Brian W. Metcalf, Ph.D. Executive Vice President and Chief Drug Discovery Scientist Julian C. Baker Managing Member Baker Bros. Advisors, LLC Patricia A. Schreck Executive Vice President and General Counsel Paul A. Brooke Chairman, Alsius Corporation Managing Member, PMSV Holdings, LLC Human Resources Senior Advisor, Morgan Stanley Paula J. Swain Executive Vice President, Matthew W. Emmens Chief Executive Ofﬁ cer Shire plc John F. Niblack, Ph.D. Formerly Vice Chairman and President of Global Research and Development Pﬁ zer Inc. Roy A. Whitﬁ eld Formerly Chairman of the Board and Chief Executive Ofﬁ cer Incyte Corporation Transfer Agent and Registrar BNY Mellon Shareowner Services PO Box 358015 Pittsburgh, PA 15252-8015 or 480 Washington Boulevard Jersey City, NJ 07310-1900 Phone: 800/851-9677 TDD for Hearing Impaired: 800/231-5469 Foreign Shareholders: 201/680-6610 TDD Foreign Shareholders: 201/680-6578 www.bnymellon.com/shareowner/isd Annual Meeting The Annual Meeting of Stockholders will be held on May 22, 2008, at 10:00 a.m., Eastern Daylight Time, at the Hotel du Pont, 11th and Market Streets, Wilmington, Delaware. Outside Counsel Pillsbury Winthrop Shaw Pittman LLP Independent Registered Public Accounting Firm Ernst & Young LLP Market Information Incyte’s Common Stock trades on The NASDAQ Global Market under the symbol INCY. Investor Relations You can obtain recent press releases and other publicly available information on Incyte by visiting our web site at www.incyte.com. Contact Pamela Murphy Vice President, Investor Relations and Corporate Communications Email: pmurphy@incyte.com Corporate Headquarters Incyte Corporation Experimental Station Route 141 & Henry Clay Road Building E336 Wilmington, Delaware 19880 302/498-6700 Forward-looking Statements Except for the historical statements contained herein, the statements contained in this annual report, including without limitation, statements as to our productivity and transition from a pure drug discovery company, the anticipated advancement and composition of our pipeline, the expected timing, progress, number of and other information regarding our preclinical and clinical trials, the likelihood of initiating registration trials of and receiving expedited review for our JAK inhibitor for myeloﬁ brosis, our expectations with respect to our development plans and program objectives for 2008, plans to present and disclose data from our clinical trials, the potential beneﬁ ts and effectiveness of our compounds in treating disease, and our plans to seek strategic partnerships or out-licensing opportunities and to commercialize certain programs on our own, are forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements are based on our current intent, belief and expectations, using information currently available to us, and are therefore subject to certain risks, uncertainties, and assumptions that may cause actual results to differ materially, including the high degree of risk associated with drug development and clinical trials, the uncertainty of the FDA approval process, results of further research and development, the impact of technological advances and competition, our ability to enroll a sufﬁ cient number of patients for our clinical trials, unanticipated delays in programs or uses of capital, and other risks discussed in our Annual Report on Form 10-K for the year ended December 31, 2007, which is contained herein, and in our ﬁ lings with the Securities and Exchange Commission. These forward-looking statements speak only as of the date hereof. Incyte disclaims any intent or obligation to update these forward- looking statements. THE DRIVE TO DISCOVER. THE EXPERIENCE TO DELIVER. Front Cover Rendering of a small molecule bound to the JAK2 ATP binding site I N C Y T E A n n u a l R e p o r t 2 0 0 7 Incyte Corporation Experimental Station Route 141 & Henry Clay Road, Building E336 Wilmington, DE 19880 www.incyte.com INCYTE Ann ua l Report 2007

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