# ** **

# **UNITED STATES**

# **SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC  20549**

 

# **FORM 10-Q/A**

 

**(AmendmentNo.  1)**

 

| **ý**                                                                                                                            | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                  |                                                                                          |
| **For The  Quarterly Period Ended June 30, 2003**                                                                                |
|                                                                                                                                  |                                                                                          |
| **o**                                                                                                                                 | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                  |                                                                                          |
| **For The Transition Period  From        To        ** |

 

**Commission File No. 000-30981**

 

**GENAISSANCEPHARMACEUTICALS, INC.**

(Exact Name ofRegistrant as Specified in its Charter)

 

| **Delaware**                                                     |   | **06-1338846**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **Five  Science Park, New Haven, Connecticut   06511**      |
| (Address of  principal executive office and zip code)            |
|                                                             |
| **(203)  773-1450**                                              |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by check markwhether the registrant:  (1) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days:

 

| Yes ý |   | No o |
|------------|--------|------|

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in rule 12b-2 of theExchange Act):

 

| Yes o |   | No ý |
|-------|--------|-----------|

 

The number of shares ofthe registrant’s outstanding common stock as of August 1, 2003 was  23,041,167 shares.

 

 

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**EXPLANATORYNOTE**

 

Thepurpose of this Form 10-Q/A is to amend and restate in its entirety Item 2 ofour Quarterly Report on Form 10-Q for the quarter ended June 30, 2003entitled “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in response to comments received by the Securities andExchange Commission (the “SEC”) to our Registration Statement on Form S-3 asfiled with the SEC on November 14, 2003, as amended.  This Amendment No. 1 to Form 10-Q does notreflect events occurring after the filing of the original Form 10-Q or modifyor update those disclosures affected by subsequent events.  No other modifications or changes have beenmade to the Form 10-Q as originally filed or the exhibits filed therewith,except for changes to the certifications required by (i) Rules 13a-14(a)/15d-14(a)promulgated under the Securities Exchange Act of 1934, as amended, and (ii) 18U.S.C. Section 1350.

 

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**Item2 – Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

*Thefollowing discussion and analysis of our financial condition and the results ofoperations should be read in conjunction with the financial statements andrelated notes appearing elsewhere in this Quarterly Report on Form 10-Q.  This Quarterly Report on Form 10-Q containsforward-looking statements within the meaning of Section 21E of the SecuritiesExchange Act of 1934, as amended, that involve risks and uncertainties,including, but not limited to, statements about management’s expectations as tocosts and our liquidity position.  Theseexpectations are based on certain assumptions regarding our research anddevelopment activities, projected expenditures, the ability of our technologiesto improve the drug development process, success of our commercializationefforts and growth in our revenues and other factors relating to our business.  These expectations may not materialize ifdevelopment efforts are delayed or suspended or if other assumptions proveincorrect.  These factors are more fullydiscussed below under the heading “Factors Affecting Future Operating Results”and in our other filings with the Securities and Exchange Commission.  Readers are cautioned not to place unduereliance on these or other forward-looking statements, which reflectmanagement’s analysis, judgment, belief or expectation only as of the date onwhich they are made.  While we may electto update forward-looking statements at some time in the future, wespecifically disclaim any obligation to do so, even if our estimates change.*

 

# **Common Terms**

# ** **

*HAP*TM Technology – the keycomponents of our *HAP*TMTechnology are: a database of highly-informative, proprietary measures ofgenomic variation, or haplotypes, which we call *HAP* TM Markers, for pharmaceutically relevantgenes; a proprietary informatics system, which we call DecoGen®, includingunique algorithms, for defining patient populations with different drugresponses; a cost-effective, efficient process for measuring genomic variationin clinical DNA samples, which we call *HAP*TM Typing; and clinical genetic development skills.

 

STRENGTH program (StatinResponse Examined by Genetic HAP TM Markers) – we applied our HAPTechnology and our clinical genetics development skills to the statin class ofdrugs, which doctors use to treat patients with high cholesterol and lipidlevels and who are, therefore, at risk for cardiovascular disease.

 

CARING program (ClozapineHAP Marker Discovery Study) – this program is designed to identify which of ourHAP Markers define the patients who are most likely to develop agranulocytosis,a potentially life-threatening depletion of white blood cells, if treated withclozpine.

 

**Overview**

 

Since our inception, wehave incurred significant operating losses, and, as of June 30, 2003, wehad an accumulated deficit of $202.1 million. The majority of our operating losses have resulted from costs we incurredin developing our *HAP*TM Technology, including our clinical trialsand administrative costs associated with operations.  As part of our *HAP*TMTechnology platform, we continue to populate our database with *HAP*TM Marker information forpharmaceutically relevant genes.  As ofJune 30, 2003 we had a total of 7,194 genes in our database with 478 and1,006 of these genes added during the three months and six months endedJune 30, 2003, respectively.  Thereis not necessarily any correlation between the costs incurred in any period andthe number

 

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of genes added to thedatabase in that period.  This is due tothe fact that the size of the gene and, therefore, the amount of work involvedvaries from gene to gene.  In addition,after a gene is sequenced it must be analyzed and go through an internalquality assurance check before it is added to the database.  This process may cause a gene sequenced inone period to be added to the database in a different period.  Furthermore, since additional informationabout genes continues to be discovered, we may resequence genes previouslyincluded in the database and do further quality assurance analysis.  We expect to dedicate a significant portionof our resources for the foreseeable future to service our *HAP*TMPartnership program partners, our pharmacogenetic support service customers,our CARING program and to maintain our HAPTM Technology.  To date, our revenue has been primarily fromlicensing and service fees from our agreements with AstraZeneca UK Limited(AstraZeneca), Biogen, Inc. (Biogen), Gene Logic, Inc. (GLI), Johnson &Johnson Pharmaceutical Research & Development, a division of JanssenPharmaceuticals, N.V., (J&J PRD), Millennium Pharmaceuticals, Inc. (Millennium)and Pfizer, Inc., as well as a sublicensing agreement with Visible Genetics,Inc. (a part of Bayer AG) and government grants.

 

On May 15, 2003,under order of the United States Bankruptcy Court, we acquired certain assetsand liabilities of DNA Sciences, Inc. for $1,778,000, inclusive of related feesand expenses.  Included in the fees andexpenses is $74,700 which represents the fair value of warrants exercisable forup to an aggregate of 75,000 shares of our common stock at an exercise price of$2 per share issued in connection with investment banking services performed aswell as $35,000 which represents the fair value of 25,000 shares we issued to alicensor in connection with a license modification.  The primary assets acquired consisted of a GLP compliant DNAbanking and a GLP compliant and CLIA licensed genotyping services business andlicenses and patent estates surrounding Long QT Syndrome and a TPMT diagnostictest as well as certain trade accounts receivable and fixed assets.  Subsequent to the closing, we entered intoan amendment (the TPMT Amendment) to an existing****license agreement with Prometheus under which we providePrometheus certain additional rights to the TPMT test for a $675,000 cashpayment, which is included in License and Service Revenue in the accompanyingstatement of operations for the three months ended June 30, 2003.  By combining DNA Sciences’ offerings of GLPcompliant DNA Banking and GLP compliant and CLIA licensed genotyping serviceswith our *HAP*TM Technology andhigh-throughput research genotyping capabilities, we seek to provide a completerange of offerings for the application of DNA tests to the clinical developmentand marketing of drugs. Additionally, we will seek to broaden our relationshipswith the pharmaceutical and biotechnology clients that had agreements with DNASciences by offering them access to our *HAP*TMTechnology platform as well as offering our existing customers access to ournewly acquired facility for their GLP compliant DNA banking and genotypingneeds.

 

In December 2002, weannounced that we received a notice from General Electric Capital Corporation(GE) claiming that an event of default had occurred under the lease agreementas a result of an alleged material adverse change in our business.  Because of the alleged default, GE declaredthat all principal and future interest obligations were due and payableimmediately.  GE also filed a complaintin the Superior Court of the State of Connecticut, demanding payment of allamounts due under the lease agreements. In March 2003, we entered into an amendment (GE lease amendment) toour existing lease agreement with GE. In connection with this amendment, GE rescinded and withdrew its defaultclaim and both parties withdrew from any legal action.  The GE lease amendment requires compliancewith certain additional covenants as well as a $2.0 million letter of credit,which is collateralized by cash.  We alsoreceived a notice from Finova Capital Corporation (Finova), stating that as a resultof the alleged default claim by GE, there was a cross-default under ouragreement with Finova.  Because of theoutstanding claim of default by Finova, we recorded an additional charge tointerest expense during the fourth quarter of 2002.  This charge represents all future interest payments due under theterms of the agreement with

 

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Finova.  As a result of continuing material adversechange provisions within the GE agreement and as a result of the Finova defaultclaim, we have classified as current the GE and Finova lease obligations as ofDecember 31, 2002, and June 30, 2003.

 

In August 2002, weannounced a restructuring and cost reduction program to revise our businessfocus and to better align our operating cost structure with our current andprojected partner needs and projected revenues from our current and projectedpartners. The cost reduction program included a realignment of managementresponsibilities, a reduction in our workforce and a decision at that time toseek partners for all internal product development programs. The workforce wasreduced by 20 percent to 110 employees in the third fiscal quarter of 2002,with the majority of the workforce reductions occurring in our DNA sequencing facilityand related informatics support.  Weincurred a charge for severance and related costs of approximately $200,000,which was recorded in operating results in the third fiscal quarter of 2002.  All severance obligations associated withthis workforce reduction had been paid by December 31, 2002.

 

During the second quarterof 2002, we recorded a $6.0 million charge for the impairment of fixedassets.  This charge was related tosequencing equipment, computer hardware and software and leasehold improvementsin our DNA sequencing facility that we determined needed to be reviewed forpotential impairment.  As a result ofour review, we determined that the carrying value of the assets was in excessof expected discounted future cash flows to be generated by the asset group andwe recorded a write down of $6.0 million.

 

**CriticalAccounting Policies**

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make certain estimates and assumptions thataffect the reported amounts of assets and liabilities, the disclosure ofcontingent liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.

 

We believe the followingcritical accounting policies affect the more significant judgments andestimates used in the preparation of our financial statements:

•      revenuerecognition;

•      valuationof long-lived assets; and

•      researchand development expenses

 

Revenuerecognition.  We earnour revenues primarily through the licensing of our *HAP*TM Technology and by providing HAPTMTyping services, and GLP compliant DNA banking and genotyping services.  We have also entered into agreements, whichprovide for future milestones and royalty payments.  We recognize revenue in accordance with Staff Accounting BulletinNo. 101, *Revenue Recognition in FinancialStatements* (SAB 101), and in accordance with Statement of Position97-2, *Software Revenue Recognition*(SOP 97-2), as amended by Statement of Position 98-9 (SOP 98-9).  In accordance therewith, we recognize annuallicense and subscription fees over the term of the agreement and service feesas the services are performed.  Futuremilestones and royalty payments, if any, will be recognized when receivedprovided that the milestone is substantive and a culmination of the earningsprocess has occurred.  Revenues derivedfrom the achievement of milestones or recognition of related work performedunder the terms of a contract, as well as the access period of the licenseagreement, may cause our operating results to vary considerably from period toperiod.  Deferred revenue results fromcash received or amounts receivable in advance of revenue recognition.

 

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Valuationof long-lived assets. We assess the impairment of long-livedassets whenever events or changes in circumstances indicate that the carryingvalue may not be recoverable.  Factorswe consider important, which could trigger an impairment review, include, amongothers, the following:

 

•      asignificant adverse change in the extent or manner in which a long-lived assetis being used;

•      asignificant adverse change in the business climate that could affect the valueof a long-lived asset; and

•      asignificant decrease in the market value of assets.

 

If wedetermine 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,we compare the carrying value of the asset group to the undiscounted cash flowsexpected to be generated by the group. If the carrying value exceeds the undiscounted cash flows, an impairmentcharge may be needed.  To determine theamount of the impairment charge, we compare the carrying value of the applicablefixed asset group to its fair value.  Wedetermine the fair value of the fixed asset group by discounting expectedfuture cash flow using a discount rate determined by us to be commensurate withthe risk inherent in our current business. If the fair value is less than the carrying value, such amount isrecognized as an impairment charge.

 

Researchand development expenses. We record research and developmentexpenses when they are incurred or, in the case of clinical trial expenses,based upon information we receive from third party clinical researchorganizations.  Research and developmentexpenses include the following major types of costs: salaries and benefits,material and reagent costs, research license fees, clinical trial expenses,depreciation and amortization of laboratory equipment and leaseholdimprovements and building and utility costs related to research space.  We expense clinical trial costs as incurredbased on information we receive from third parties and estimates that wemake.  Our estimates may change asadditional information becomes available, which could cause results to varyfrom period to period.

 

**Results of Operations**

 

**Three Months Ended June 30, 2003 and 2002**

 

License and servicerevenue consists primarily of revenue recognized in connection with thelicensing of our *HAP*TM Technology and from HAPTM Tying and GLPcompliant DNA banking and genotyping services. Revenue increased toapproximately $3.1 million in the three months ended June 30, 2003 from$1.9 million in the three months ended June 30, 2002.  The increase in revenue is primarilyattributable to the $675,000 license fee received from Prometheus for theirexpanded rights to the TPMT test under the TPMT Amendment and approximately$390,000 in revenue recognized for services provided under contracts we assumedthrough the purchase of certain of the assets of DNA Sciences.  The cost of services provided under thecontracts we assumed totaled approximately $340,000 for the three months endedJune 30, 2003 and are included in research and development expensediscussed below.  The increase inrevenue is also due to the increased commercialization of our *HAP*TM Technology Partnershipprogram and our *HAP*TM Drug-SpecificPartnership program, including agreements entered into with Millennium in 2003and Pfizer (formerly Pharmacia & Upjohn) in 2002, which was partiallyoffset by the expiration of a contract with a customer in the fourth quarter of2002.

 

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Research and developmentexpenses consist primarily of payroll and benefits for research and developmentpersonnel, material and reagent costs, costs incurred in connection withclinical trials, depreciation and maintenance costs for equipment used for *HAP*TMMarker discovery and *HAP*TM Typing andfacility-related costs.  We expense ourresearch and development costs as incurred. Research and development expenses decreased to approximately $5.1million in the three months ended June 30, 2003 from approximately $6.6million in the three months ended June 30, 2002.  Except for clinical trial expenses and, in 2003, expensesassociated with the GLP and CLIA compliant laboratory services, substantiallyall of our research and development expenditures are incurred in processing andanalyzing gene information added to the *HAP*TMdatabase.  The following is a breakdownof research and development expense (in thousands):

 
|                           |   | **Three  months ended June 30,  2003** |   | **Three  months ended June 30, 2002** |   |
|--------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| Payroll  and related expenses  |   | $                                           | 2,130  |                                       | $      | 2,250 |   |
| Depreciation  and amortization |   | 1,600                                       |   | 2,100                                      |   |
| Consumables                    |   | 510                                         |   | 330                                        |   |
| Technology  license fees       |   | 60                                          |   | 810                                        |   |
| Other                          |   | 800                                         |   | 1,110                                      |   |
| Total                          |   | $                                           | 5,100  |                                       | $      | 6,600 |   |

 

The decrease in expensesis primarily attributable to a decrease of approximately $750,000 in technologylicense fees and a decrease of approximately $500,000 in depreciationexpense.  The decrease in technologylicense fees is primarily due to a license agreement that expired in the fourthquarter of 2002.  The decrease indepreciation expense is primarily due to the asset impairment charge recordedin the quarter ended June 30, 2002. We expect depreciation and amortization expense to decrease in thesecond half of 2004, as a significant portion of our assets will be fullydepreciated at June 30, 2004.  Wedo not necessarily expect a decrease in total research and development expensefor 2004.

 

General and administrative expenses consist primarilyof payroll and benefits for executive, business development, finance and otheradministrative personnel as well as facility-related costs and outside professionalfees incurred in connection with corporate development and general legal andfinancial matters.  General andadministrative expenses decreased to approximately $2.1 million in the threemonths ended June 30, 2003 from approximately $2.6 million in the threemonths ended June 30, 2002.  Thedecrease is primarily attributable to a $288,000 sales and use tax refund,which was recognized during the quarter ended June 30, 2003 as well as ageneral reduction in expenses as part of our cost reduction program initiatedduring the quarter ended September 30, 2002.

 

The impairment of fixed assets charge relates tosequencing equipment, computer hardware and software and leasehold improvementsused in our DNA sequencing facility. During the quarter ended June 30, 2002, our management determinedthat certain conditions had arisen during the quarter that triggered the needfor a review of our long-lived assets for potential impairment.  These conditions include, but were notlimited to, the overall business climate in which we operate and a significantchange in the manner in which we were utilizing our DNA sequencing facility andrelated assets.  In particular, duringthe quarter ended June 30, 2002, we determined that our productioncapacity significantly exceeded our forecasted demand for the foreseeable

 

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future, which resulted in our decision to remove fromproduction the majority of our ABI Prism® 3700 DNA Analyzers, theprimary asset of the group.  Accordingly,we performed an impairment review on our sequencing long-lived assets.  As a result of our review, we determinedthat the carrying value of the assets was in excess of the projectedundiscounted cash flows to be generated by the asset group.  To determine the impairment charge wecompared the carrying value of the applicable fixed assets to their fairvalue.  We determined the fair value ofthe fixed assets by discounting expected future cash flows using a discountrate determined by our management to be commensurate with the risk inherent inour current business.  As a result ofour analysis, we determined that the carrying value of the assets was in excessof discounted future cash flow to be generated by the asset group and werecorded a write-down of $6.0 million. The impairment charge was allocated to the individual assets on apro-rata basis.  The revised carryingvalue of the assets is being depreciated over the average remaining life of theprimary asset of the group.

 

Interest income decreasedto approximately $90,000 in the three months ended June 30, 2003 fromapproximately $285,000 for the same period in 2002.  The decrease is the result of higher cash, cash equivalent andshort-term investment balances in 2002 and lower interest rates on investmentsduring 2003.

 

Interest expensedecreased to an expense of approximately $191,000 in the three months endedJune 30, 2003 from an expense of approximately $495,000 in the threemonths ended June 30, 2002.  Thedecrease is primarily the result of the recording of all future interestassociated with the Finova capital leases in the quarter endedDecember 31, 2002.  If, in thefuture, we enter into a settlement or amend our agreement with Finova, it mayresult in the reversal, in the period of amendment or settlement, of some ofthe interest expense recognized in the fourth quarter of 2002.

 

Income tax benefit was$320,000 for the three months ended June 30, 2003.  This increase is the result of recentlegislation passed by the State of Connecticut that reinstated the research anddevelopment tax credit exchange program. The legislation allows companies to exchange research and developmenttax credits earned in 2002.  The programallows companies to receive cash refunds from the State at a rate of 65% of theresearch tax credit, as defined, in exchange for foregoing the carryforward ofthe research and development tax credit.

 

**Six Months Ended June 30, 2003 and 2002**

 

Revenue increased toapproximately $5.3 million in the six months ended June 30, 2003 from $3.8million in the six months ended June 30, 2002.  The increase in revenue is primarily attributable to the $675,000license fee received from Prometheus for their expanded rights to the TPMT testunder the TPMT Amendment and approximately $390,000 of revenue recognized forservices, which were provided under contracts we assumed through the purchaseof certain of the assets of DNA Sciences. The cost of services provided under the contracts assumed totaled approximately$340,000 for the six months ended June 30, 2003 and are included inresearch and development expense discussed below.  The increase is also due to the increased commercialization ofour *HAP*TMTechnology Partnership program and our *HAP*TM Drug-Specific Partnershipprogram, including agreements entered into with Millennium in 2003 and Pfizerin 2002, which was partially offset by the expiration of a contract with acustomer in the fourth quarter of 2002.

 

Research and developmentexpenses decreased to approximately $9.8 million in the six months endedJune 30, 2003 from approximately $14.9 million in the six months endedJune 30, 2002.  Except for theclinical trial expenses and, in 2003, expenses associated with the GLP and CLIA

 

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compliant laboratoryservices, substantially all of our research and development expenditures areincurred in processing and analyzing gene information added to the *HAP*TM database.  The following is a breakdown of research anddevelopment expense (in thousands):

 
|                           |   | **Six months  ended June 30, 2003** |   | **Six months  ended June 30, 2002** |   |
|--------------------------------|--------|------------------------------------------|--------|------------------------------------------|--------|
| Payroll  and related expenses  |   | $                                        | 3,930  |                                     | $      | 4,530 |   |
| Depreciation  and amortization |   | 3,200                                    |   | 4,200                                    |   |
| Consumables                    |   | 1,040                                    |   | 1,370                                    |   |
| Technology  license fees       |   | 160                                      |   | 1,700                                    |   |
| Repair  and maintenance        |   | 270                                      |   | 890                                      |   |
| Other                          |   | 1,200                                    |   | 2,210                                    |   |
| Total                          |   | $                                        | 9,800  |                                     | $      | 14,900 |   |

 

The decrease in expensesis primarily attributable to a decrease of approximately $1.5 million intechnology license fees, a decrease of approximately $1.6 million indepreciation and repair and maintenance expenses and a decrease ofapproximately $600,000 in payroll and related costs. The decrease in technologylicense fees is primarily due to a license agreement that expired in the fourthquarter of 2002.  The decreases in depreciation and repair and maintenanceexpenses are primarily due to a reduction in DNA sequencing, consistent withthe removal of the majority of our ABI Prism® 3700 DNA analyzersfrom production and the asset impairment charge recorded in the quarter endedJune 30, 2002. The decrease in payroll and related costs is primarily dueto our work force reduction in connection with our restructuring program thatwas initiated in the third quarter of 2002. We expect depreciation and amortization expense to decrease in the secondhalf of 2004, as a significant portion of our assets will be fully depreciatedat June 30, 2004.  We do notnecessarily expect a decrease in total research and development expense for2004.

 

General andadministrative expenses decreased to approximately $4.1 million in the sixmonths ended June 30, 2003 from approximately $5.0 million in the sixmonths ended June 30, 2002.  Thedecrease is primarily attributable to a $288,000 sales and use tax refund recordedin the second quarter of 2003 and a general reduction in expenses as part ofour cost reduction program initiated during the quarter endedSeptember 30, 2002.

 

The impairment of fixedassets charge relates to sequencing equipment, computer hardware and softwareand leasehold improvements used in our DNA sequencing facility.  During the quarter ended June 30, 2002,our management determined that certain conditions had arisen during the quarterthat triggered the need for a review of our long-lived assets for potentialimpairment.  Our review determined thata $6.0 million write-down in the carrying value of the long-lived assets wasneeded.  Please see “Results ofOperations - Three Months ended June 30, 2003 and 2002” for furtherexplanation of this charge.

 

Interest income decreasedto approximately $224,000 in the six months ended June 30, 2003 from$639,000 in the six months ended June 30, 2002.  The decrease is the result of higher cash, cash equivalent andshort-term investment balances in 2002 and lower interest rates on investmentsduring 2003.

 

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Interest expensedecreased to of approximately $392,000 in the six months ended June 30,2003 from of approximately $1.0 million in the six months ended June 30,2002.  The decrease is primarily the resultof the recording of all future interest associated with the Finova capitalleases in the quarter ended December 31, 2002.  If, in the future, we enter into a settlement or amend ouragreement with Finova, it may result in the reversal, in the period ofamendment or settlement, of some of the remaining interest expense recognizedin the fourth quarter of 2002.

 

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**Liquidity and Capital Resources**

 

We have financed ouroperations primarily through the sale of common and preferred stock, paymentsreceived under licensing agreements, loans and capital leases.  From inception through June 30, 2003,we have received aggregate gross proceeds of approximately $163.2 million fromissuance of common and preferred stock. In addition, through June 30, 2003, we have received $22.7 millionfrom license and service fees, royalties and research

 

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contracts.  We have also received $26.2 million****fromcapital lease financing arrangements and $8.2 million from other loans.  We have acquired, through June 30,2003, $42.6 million of property and equipment. The majority of these assets were financed through capital leasefinancing arrangements and other loans.

 

We expect to continue tofinance our operations in the short-term from cash we received in 2000 from thesale of our common stock and revenue from our *HAP*TM Technology Partnershipprogram and our pharmacogenetic support service customers.  In addition, we may seek to raise additionalfunds through the issuance of debt and/or equity securities.  Our business strategy depends on, amongother things, entering into partnership agreements with pharmaceutical andbiotechnology companies and growing the revenue from our pharmacogeneticsupport services business.  If we areunsuccessful in entering into new partnership programs, growing the revenuefrom our pharmacogenetic support services business, or obtaining additionalfinancing funds, we may not generate sufficient funds to sustain our operationsat planned levels.

 

Cash used in operationsfor the six months ended June 30, 2003 was $5.1 million compared with$13.7 million for the same period in 2002. The cash used in operations for the six months ended June 30, 2003 resultedprimarily from a net loss of $8.5 million, partially offset by $3.7 million ofnon-cash charges for depreciation and amortization expense and stock-basedcompensation.  Cash used in operationsfor the six months ended June 30, 2002 resulted primarily from a net lossof $22.5 million and a $2.9 million decrease in accounts payable and accruedliabilities, partially offset by $4.8 million of non-cash charges fordepreciation and amortization expense and stock-based compensation and a $6.0million non-cash asset impairment charge.

 

Cash used in investingactivities for the six months ended June 30, 2003 was $161,000 comparedwith net cash provided by investing activities of $17.8 million for the sameperiod in 2002.  Net proceeds from thesale of marketable securities totaled $2.0 million for the six months endedJune 30, 2003 compared to $17.9 million for the same period in 2002.  During the six months ended June 30,2003 we used $1.7 million of cash for the purchase of certain assets andliabilities of DNA Sciences.  Inaddition, during the six months ended June 30, 2003, we used $530,000 ofcash for the purchase of property and equipment compared to $70,000 for thesame period in 2002.

 

Cash used for financingactivities for the six months ended June 30, 2003 was $3.5 millioncompared with $3.7 million for the same period in 2002.  The primary use of cash from financingactivities for the six months ended June 30, 2003 and 2002 was therepayment of long-term debt and capital lease obligations.

 

Ourcontractual cash obligations as of June 30, 2003, are as follows:

 
|                                                |   | **Payments Due by Period**          |   |
|-----------------------------------------------------|--------|-------------------------------------|--------|
|                                                |   | **(in thousands)**                  |   |
| **Contractual********Obligations**                  |   | **Total  Amounts********Committed** |   | **Total for  remainder of********Fiscal 2003** |   | **Total for  Fiscal Years  2004 and 2005** |   | **Total for  Fiscal Years  2006 and 2007** |   | **Total for  Fiscal Year  2008 and later** |   |
| Long-Term Debt, including interest                  |   | $                                   | 6,120  |   | $ | 352 |   | $ | 1,408 |   | $ | 1,408 |   | $ | 2,952 |   |
| Capital Lease  Obligations, including  interest (1) |   | 7,910                               |   | 7,910 |   | — |   | — |   | — |   |
| Operating Leases                                    |   | 8,615                               |   | 563 |   | 2,235 |   | 2,025 |   | 3,792 |   |
| Minimum License Obligations                         |   | 500                                 |   | 88 |   | 206 |   | 206 |   | — |   |
| Total Contractual Cash Obligations                  |   | $                                   | 23,145 |   | $ | 8,913 |   | $ | 3,849 |   | $ | 3,639 |   | $ | 6,744 |   |

 

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(1)                      Reflects all lease obligations as beingcurrent.  We are permitted however, as aresult of the GE Amendment that we entered into in March 2003 to pay theoutstanding GE lease obligations under the original maturity schedule throughFebruary 2005.  Obligations dueunder the original maturity schedules total $3,739,000 for fiscal 2003 and$4,171,000 in aggregate for fiscal 2004 and 2005.  See Management’s Discussion and Analysis – Overview and Note 7 ofNotes to Financial Statements for additional information regarding theclassification of certain amounts as current obligations.

 

Long-termdebt consists of three financing agreements with Connecticut Innovations Inc.(CII), a stockholder, used to finance certain leasehold improvements and othercosts associated with our facility expansion. Each agreement provided for interest only with principal payments, basedon a 120-month amortization beginning April 2001 throughOctober 2002, with final balloon payments due in March 2009 throughJune 2011.  Borrowings under theagreements

 

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bearinterest at 6.5% and are collateralized by the related leaseholdimprovements.  We are in compliance withall debt covenants as of June 30, 2003 and no cross default provisionsexist under these agreements.

 

Capitallease obligations related to equipment consist principally of arrangements withfour equipment leasing companies.  Theleases have terms ranging from two to four years with installments originallyscheduled to end between August 2003 and February 2005 and which bearinterest at rates ranging from 8.15% to 12.46%.  Borrowings under these agreements are secured by the underlyingleased equipment.  The majority of thecapital lease arrangements allow for the purchase of the related equipment atthe completion of the lease term, as defined in the agreements, and certain ofthe agreements require the purchase of the equipment at the completion of thelease term.

 

We lease our operatingfacilities located in New Haven, Connecticut and Morrisville, NorthCarolina.  We are currently atenant-at-will in the North Carolina facility and are in the process ofnegotiating a new lease agreement.  TheConnecticut lease agreements currently require annual lease payments ofapproximately $1.1 million per year over the original term, which expires in2006.  We have two five-year renewaloptions to extend the lease agreements beyond the initial term.  We are recording the expense associated withthe leases on a straight-line basis over the expected term of the leasesthrough September 2011.  Inaddition to the operating lease agreements for our current facility, we alsohave operating leases for certain of our office equipment.

 

Weperiodically enter into agreements with third parties to obtain exclusive ornon-exclusive licenses for certain technologies.  The terms of certain of these agreements require us to makefuture royalty payments and certain milestone payments based on product salesor sublicense income generated from the applicable technologies, if any, andinclude provisions requiring future minimum lease payments, whether or not thetechnology is commercialized.  Theamount of such payments will depend upon successful commercialization ofapplicable technologies, if any.  Thefuture minimum payments (assuming non-termination of these agreements) areincluded in the minimum license obligations above.

 

Basedon our current business plans, capital expenditures are not expected to exceed$1.5 million for each of fiscal 2003 and 2004.

 

Our cash requirementswill vary depending upon a number of factors, many of which are beyond ourcontrol, including:

 

•                  the demand for our *HAP*TM Technology;

 

•                  the efforts and success of our *HAP*TM partnership program;

 

•                  the commercialization of intellectualproperty derived from our associations;

 

•                  the growth of our pharmacogeneticssupport services business;

 

•                  the level of competition we face;

 

•                  our ability to maintain our *HAP* TM Technology; and

 

•                  our ability to effectively manage ouroperating expenses.

 

On June 30, 2003,cash, cash equivalents and short-term investments totaled $23.3 millioncompared to approximately $34.2 million at December 31, 2002.  Our cash reserves are held ininterest-bearing high-grade corporate bonds and money market accounts.  We believe that our existing cash reserveswill be sufficient to support our expected net losses, debt obligations andcapital expenditures for at least 15 months. To execute our long-term business plan, we will need to grow ourrevenues significantly each year and we may need to seek additional fundingthrough public or private equity offerings or debt financings or throughcommercial partners.  We cannot assureyou that we will obtain additional partners or capital funding on acceptableterms, if at all.

 

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**Factors Affecting Future Operating Results**

 

*This Quarterly Report on Form 10-Q contains “forward-lookingstatements” within the meaning of Section 21E of the Securities Exchange Act of1934, as amended.  These statements aresubject to risks and uncertainties and are based on the beliefs and assumptionsof our management based on information currently available to ourmanagement.  Use of words, such as “believes,”“expects,” “anticipates,” “intends,” “plans,” “estimates,” “should,” “likely”or similar expressions, indicate a forward-looking statement.  Forward-looking statements involve risks,uncertainties and assumptions.  Certainof the information contained in this Quarterly Report on Form 10-Q consists offorward-looking statements.  Importantfactors that could cause actual results to differ materially from theforward-looking statements include the following:*

 

**Weare an early stage company with a history of losses and we expect to incur netlosses for the foreseeable future such that we may never be profitable**.

 

We have incurredsubstantial operating losses since our inception.  As of June 30, 2003, we have generated only minimal revenuefrom our *HAP*TMPartnership program and our pharmacogenetic support services, and we do notexpect to generate significant revenues for several years, if ever.  From inception through June 30, 2003,we had an accumulated deficit of approximately $202.1 million.  Our losses to date have resulted principallyfrom costs we incurred in the development of our *HAP*TM Technology, in our clinical trials and fromgeneral and administrative costs associated with operations.  We expect to devote substantially all of ourresources to service our *HAP*TMPartnership program and STRENGTH program partners, our pharmacogenetic supportservices customers and our CARING program and to maintain our *HAP*TM Technology.

 

We expect to incuradditional losses this year and in future years, and we may never achieveprofitability.  In addition,pharmaceutical and biotechnology companies are only now beginning to useproducts such as ours in their drug and diagnostic development or marketingefforts and, accordingly, they may not choose to use our *HAP*TM Technology.  We do not expect our losses to besubstantially mitigated by revenues from our *HAP*TMPartnership and STRENGTH programs and our CARING program, if any, and our LongQT program, if any, or from our pharmacogenomics support services for a numberof years.

 

**Wecurrently rely on a limited number of customers for substantially all of ourrevenues.  As a result, the loss of onemajor customer or our inability to secure additional significant customersduring a given period would have an adverse affect on our business andoperating results.**

 

We are dependent upon alimited number of customers that represent substantially all of ourrevenues.  In the quarter endedJune 30, 2003, two of our customers accounted for 47% of our totalrevenues.  The agreement with the one ofthe two customers expires in the fourth quarter of 2003.  If we are unable to replace, uponsubstantially similar terms, the agreement that expires in the fourth quarterof 2003, or the agreement which expired in 2002, which accounted for 26% of ourrevenue for the six months ended June 30, 2002 or if we lose any of ourother remaining significant customers, it would have a material adverse affecton our revenues and on our business in general and could cause volatility or adecline in our stock price.

 

**Togenerate significant revenues, we must obtain additional customers for our *HAP*TM Partnership program andour STRENGTH, CARING and Long QT programs and for our pharmacogenetic supportservices.**

 

Our strategy depends onentering into agreements with pharmaceutical and biotechnology companies forour *HAP*TM Partnershipprogram and our STRENGTH, CARING and Long QT programs and obtaining additionalcustomers for our pharmacogenetic support services.  We currently have a *HAP*TM Partnership program with fivepharmaceutical and biotechnology companies as well as an agreement witha major diagnostic company to commercialize exclusively the diagnostic rightsand non-exclusively the product development rights from our STRENGTHprogram.  Our contracts for ourpharmacogenetic support services are specific limited term projects.  Wemay not be successful in obtaining additional partners for our *HAP*TM Partnership program andour STRENGTH program or obtaining any partners for our CARING or Long QTprograms or obtain sufficient new customers for our pharmacogenetic supportservices to replace our current projects. If we are unsuccessful in finding additional partners for our *HAP*TM Partnership program andour STRENGTH program or in finding any partners for our CARING or Long QTprograms or new customers for our pharmacogenetic support services, we maynever generate sufficient revenues to sustain our operations.  In addition, we expect that some of ourfuture *HAP*TMPartnership

 

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program collaborations, like some of our current *HAP*TM Partnership programcollaborations, will be limited to specific, limited-term projects or that someof these collaborations may not be renewed. Accordingly, we must continually obtain new customers to besuccessful.  To date, the integration ofpharmacogenomics into drug development and marketing has not achievedwidespread market acceptance.

 

**Ifthe estimates we make, and the assumptions on which we rely, in preparing ourfinancial statements prove inaccurate, our actual results may vary from thosereflected in our projections.**

 

Our financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States of America.  Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of our assets, liabilities, revenuesand expenses, the amounts of charges accrued by us and related disclosure ofcontingent assets and liabilities.  Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable at that time under the circumstances.  There can be no assurance, however, that ourestimates or the assumptions underlying our estimates will be correct.

 

**Wemay require additional funding to fund operations and repay debt and we may notbe able to obtain any.**

 

We have used substantialamounts of cash to fund our research and development activities.  We will continue to spend funds to serviceour *HAP*TM Partnershipprogram and STRENGTH program partners, our pharmacogenetic support servicescustomers and our CARING and Long QT programs and to maintain our *HAP*TM Technology.  We plan to pay for these activities withfunds from:

 

•                  ourexisting cash and investment securities, and

 

•                  income that we may receive from our *HAP*TM Partnership program andSTRENGTH program partners and pharmacogenetic support services customers.

 

We intend to rely on ourcurrent *HAP*TMPartnership program and STRENGTH program partners and future partners, if any,and our current pharmacogenetic support services customers and futurecustomers, if any, for significant funding in the future to support ourdevelopment efforts.  To execute ourbusiness plans, we will need to grow our revenues significantly each year.  We cannot be certain when we will begin toreceive additional income, if at all, from our *HAP*TMPartnership and STRENGTH programs and our pharmacogenetic support services andincome, if any, from our CARING and Long QT programs.  If we do not receive this income or do not receive it as rapidlyas we expect, we would spend our existing cash and investment securities morerapidly than we currently plan.

 

We believe that ourexisting cash reserves will be sufficient to support our expected net losses,debt obligations and capital expenditures for at least 15 months.  We cannot assure you that we will be able toobtain new partners or to generate the increased revenues required to meet ourbusiness plan objectives.  In addition,to execute our business plans, we may need to seek additional funding throughpublic or private equity offerings, debt financings or through commercial partners.  We cannot assure you that we will obtainadditional partners or capital funding on acceptable terms, if at all.  If we are unable to generate sufficientrevenues or access capital on acceptable terms, we may be required to (a)obtain funds on unfavorable terms that may require us to relinquish rights tocertain of our technologies or that would significantly dilute our stockholdersand/or (b) significantly scale back current operations.  Either of these two possibilities would havea material adverse effect on our business.

 

**Our*HAP*TM Technology maynot allow our partners to develop commercial products or to increase sales oftheir marketed products.**

 

We developed our *HAP*TM Technology on theassumption that information about gene variation and gene variation associatedwith drug response may help drug development professionals better understandthe drug response of particular populations and complex disease processes.  Although the pharmaceutical and biotechnologyindustries are increasing their use of genomics in analyzing drug response anddiseases, we are unaware of any successful drug development program applyingpopulation genomics.

 

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We discover *HAP*TM Markers forpharmaceutically relevant genes.  If weare unable to find *HAP*TMMarkers for pharmaceutically relevant genes in a timely manner, our potentialpartners may lose confidence in our *HAP*TMTechnology and our company, which could decrease our ability to generaterevenues.  Even if we are able todiscover *HAP*TM Markersfor pharmaceutically relevant genes, this information may not prove to besuperior to genomic variation information discovered by our competitors.  Furthermore, pharmaceutical andbiotechnology companies may not choose our *HAP*TMTechnology over competing technologies.

 

Our *DecoGen*® Informatics System mayalso be less effective than we expect or may not allow our partners or us todetermine a correlation between drug response and genomic variation.  Furthermore, even if our partners or we aresuccessful in identifying such a correlation, our partners may not be able todevelop or sell commercially viable products nor may our partners be able toincrease the sales of their marketed products using this correlation.  Accordingly, our *HAP*TM Markers and *HAP*TM Technology may not improve the development,marketing and prescribing of drugs or the development and marketing ofdiagnostics developed by our *HAP*TMPartnership program and STRENGTH program partners.

 

**Ifwe are unable to obtain intellectual property protection for our *HAP*TM Technology, trade secretsor know how, we may not be able to operate our business profitably.**

 

Our success depends, inpart, on our ability to protect our *HAP*TMTechnology, any associations that we find between clinical outcomes and geneticvariation and any other proprietary software, methods and technologies that wedevelop, either as a trade secret or under the patent and other intellectualproperty laws of the United States and other countries, so that we can preventunauthorized entities from using our inventions and proprietaryinformation.  Because patentapplications that were filed prior to November 29, 2000 in the UnitedStates are confidential until patents issue, third parties may have filedpatent applications for technology covered by our pending patent applicationswithout our being aware of those applications, and our patent applications maynot have priority over any patent applications of others.  We are aware that there are other firms orindividuals who have discovered, or are currently discovering, informationsimilar to the information we are discovering, who may have filed, and in thefuture are likely to file, patent applications that are similar or identical toour *HAP*TM Technologypatent applications.

 

Our pending patentapplications may not result in issued patents. The patent positions of pharmaceutical and biotechnology companies,including ours, are generally uncertain as a result of the uncertain state ofthe patent law in the biotechnology field. There is no uniform, worldwide policy regarding the subject matter andscope of claims granted or allowable in biotechnology patents, particularlythose involving genomics.  In addition,some interest groups are lobbying for restrictions on patenting of genetictests.

 

**Wemay be unable to develop or commercialize our *HAP*TMTechnology if we cannot establish additional collaborative relationships and wewill depend on our partners to develop or to co-develop products.**

 

Wecurrently have a *HAP*TM Partnership program with five pharmaceutical and biotechnologycompanies as well as an agreement with a major diagnostic company tocommercialize exclusively the diagnostic rights and non-exclusively the productdevelopment rights from our STRENGTH program.  We do not currently have any partners for our CARING or Long QTprograms.  Under our current strategy,and for the foreseeable future, we do not expect to develop or market pharmaceuticalor diagnostic products on our own.  As aresult, part of our current and future revenues will depend on payments fromour current *HAP*TMPartnership program and STRENGTH program partners and our future *HAP*TM Partnership, STRENGTH,CARING and Long QT program partners, if any, for either the new products theymay develop, or for increased sales of their existing products, made possiblethrough the use of our *HAP*TMTechnology.  If we are unable to attractnew *HAP*TM Partnershipprogram and STRENGTH program partners or any partners for our CARING and LongQT programs, we may never generate sufficient revenues to sustain ouroperations.

 

Our partners for our *HAP*TM Partnership program andSTRENGTH program and our partners, if any, for our CARING and Long QT programs,will be responsible for pre-clinical study and clinical development oftherapeutic and diagnostic products and for regulatory approval, manufacturingand marketing of any products or enhanced marketing claims that result from theapplication of our *HAP*TMTechnology.  Our current agreements withthese partners, and we anticipate that any future agreements with partners,will allow them significant discretion in

 

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pursuing these activities.  Wecannot control the amount and timing of resources that any such current or potentialpartners will devote to our programs or potential products.  Our *HAP*TMPartnership program and STRENGTH program arrangements and our CARING and LongQT program arrangements, if any, may also have the effect of limiting the areasof research that we may pursue either alone or with others.  Because part of our revenues will bedependent on the successful commercialization or development of our partners’products, if, for any reason, a *HAP*TMPartnership program partner or our STRENGTH program partner delays or abandonsits development or commercialization of a product developed using our *HAP*TM Technology, we mayreceive reduced royalty or other payments or no royalty or other payments atall.  In addition, because part of ourfuture revenues will be dependent on the successful commercialization ofadditional aspects of our *HAP*TMPartnership and STRENGTH programs with partners and the successfulcommercialization of our CARING and Long QT programs with partners, if, for anyreason, a partner delays or abandons its development or commercialization ofthese additional aspects of our *HAP*TMPartnership program or STRENGTH program or its development or commercializationof our CARING and Long QT programs, we may receive reduced royalty or otherpayments or no royalty or other payments at all.

 

Although we intend toretain the rights to all *HAP*TMMarkers, which we discover as well as to *HAP*TMMarkers discovered jointly with our *HAP*TMPartnership and STRENGTH program partners and with our CARING and Long QTprogram partners, if any, we may not always be able to negotiate the retentionof these rights.  Furthermore, disputesmay arise in the future over the ownership of rights to *HAP*TM Markers as well as anyother technology we develop with our *HAP*TMPartnership and STRENGTH program partners or with our CARING and Long QTprogram partners, if any.  These andother possible disagreements between our *HAP*TMPartnership and STRENGTH program partners and us or between our CARING and LongQT program partners, if any, and us could lead to delays in the research,development or commercialization of their products.  These disagreements could also result in litigation or requirearbitration to resolve.  Any of theseevents could prevent us from effectively marketing our *HAP*TM Technology.

 

**Weinvest considerable amounts of time, effort, and money to license our *HAP***TM**Technology; and if we are unable to license ourtechnology, we may not generate sufficient revenue to sustain our operations**.

 

Our ability to obtainpartners for our *HAP*TMPartnership program and our STRENGTH, CARING and Long QT programs will dependin significant part upon the pharmaceutical and biotechnology industries’acceptance that our *HAP*TMTechnology can help accelerate or improve their drug and diagnostic developmentand marketing efforts.  To achievemarket acceptance, we must continue to educate the pharmaceutical andbiotechnology industries and the public in general as to the potential benefitsof our *HAP*TMPartnership, STRENGTH, CARING and Long QT programs.  Most importantly, we must convince the research and development,clinical and marketing departments of pharmaceutical and biotechnologycompanies that our *HAP*TMTechnology can accelerate and improve the processes for developing, marketingand prescribing drugs and for developing and marketing diagnostics and that our*HAP*TM Partnership,STRENGTH, CARING and Long QT programs will be commercially viable.  If we fail to gain this acceptance, we maynever generate sufficient revenues to sustain our operations.  We may expend substantial funds andmanagement effort to market our *HAP*TMPartnership, STRENGTH, CARING Long QT programs, without any resulting revenues.

 

**Ourability to make any acquisitions is dependent on the availability of adequatecash and the attractiveness of our stock price.**

 

We anticipate that any future acquisitions ofbusinesses or technologies will be financed through available cash, theissuance of shares of our common stock and/or seller financing.  We cannot assure you that we will have sufficientexisting capital resources or that we will be able to raise sufficientadditional capital resources on terms satisfactory to us, if at all, in orderto meet the capital requirements for such acquisitions.

 

We also believe that a significant factor in ourability to close acquisitions using stock as consideration will be theattractiveness of our common stock for potential acquisition candidates.  This attractiveness may, in large part, bedependent upon the relative market price and capital appreciation prospects ofour common stock compared to the equity securities of our competitors.  The trading price of our common stock on theNasdaq National Market could in the future materially adversely affect our acquisitionprogram.

 

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**Integrationof acquisitions or strategic investments could interrupt our business and ourfinancial condition could be harmed.**

 

From time to time, we mayacquire or make strategic investments in other businesses or technologies.  For example, on May 15, 2003, theUnited States Bankruptcy Court approved our bid to purchase substantially allof the assets and to assume certain liabilities of DNA Sciences, Inc.  In addition, we signed a modification to alicense agreement for certain intellectual property that we acquired from DNASciences.  The DNA Sciences acquisition,as well as any other acquisitions or strategic investments we may make in thefuture, entail numerous risks that include the following:

 

•                  difficultiesintegrating any acquired operations, personnel, technologies or products;

•                  diversionof management’s focus from our core business concerns;

•                  enteringmarkets in which we have no or limited prior experience or knowledge;

•                  exposureto litigation from stockholders or creditors of, or other parties affiliatedwith, the target company or companies;

•                  dilutionto existing stockholders and earnings per share; and

•                  incurrenceof substantial debt.

 

Any such difficulties encountered as a result of amerger, acquisition or strategic investment could adversely affect ourbusiness, operating results and financial condition.

 

**Ifwe are unable to prevent others from unauthorized use of, or are unable todefend our use of, our *HAP*TMTechnology, trade secrets or know how, we may not be able to operate ourbusiness profitably.**

 

Despite ourefforts to protect our proprietary rights, unauthorized parties may be able toobtain and use information that we regard as proprietary.  The issuance of a patent does not guaranteethat it is valid or enforceable; thus, even if we obtain patents, they may notbe valid or enforceable against third parties.

 

We also rely uponunpatented trade secrets and improvements, unpatented know-how and continuingtechnological innovation to develop and maintain our competitive position.  We generally protect this information withreasonable security measures, including confidentiality agreements signed byour employees, academic collaborators and consultants that provide that allconfidential information developed or made known to others during the course ofthe employment, consulting or business relationship will be kept confidentialexcept in specified circumstances. Agreements with employees, consultants and collaborators generallyprovide that all inventions conceived by the individual while employed by usare our exclusive property.  Ifemployees, consultants or collaborators do not honor these agreements, we maynot have adequate remedies for breach. Furthermore, our trade secrets may otherwise become known or beindependently discovered by competitors.

 

Further, a patent doesnot provide the patent holder with freedom to operate in a way that infringesthe patent rights of others.  A thirdparty may sue us for infringing on its patent rights.  Likewise, we may need to resort to litigation to enforce a patentissued to us or to determine the scope and validity of third party proprietaryrights.  The cost to us of anylitigation or other proceeding relating to intellectual property rights, evenif resolved in our favor, could be substantial, and the litigation would divertour management’s focus from our core business concerns.  Some of our competitors may be able tosustain the costs of complex patent litigation more effectively than we canbecause they have substantially greater resources.  Uncertainties resulting from the initiation and continuation ofany litigation could limit our ability to continue our operations.

 

If any party shouldsuccessfully claim that the creation or use of our *HAP*TM Technology or *HAP*TM Marker association data infringe upon theirintellectual property rights, in addition to any damages we might have to pay,a court could require us to stop the infringing activity or obtain a license onunfavorable terms.  Moreover, any legalaction against us or any of our program partners claiming damages or seeking toenjoin commercial activities relating to the affected products and processescould, in addition to subjecting us to potential liability for damages, requireus or our *HAP*TMPartnership and STRENGTH program partners or any CARING program partners toobtain a license in order to continue to manufacture or market the affectedproducts and processes.  Any licenserequired under any patent may not be made available on commercially acceptableterms, if at all.  In addition, somelicenses may be non-exclusive and, therefore, our competitors may have accessto the same technology licensed to us. If we

 

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fail to obtain a required license or are unable to design around apatent, we may be unable to market effectively some of our *HAP*TM Technology, which couldlimit our profitability and possibly prevent us from generating revenuesufficient to sustain our operations.

 

**Regulatoryoversight of our *HAP*TMTechnology and public opinion regarding ethical issues surrounding the use ofgenetic information may adversely affect our ability to market our *HAP*TM Technology.**

 

Currently, there islimited Food and Drug Administration (FDA) regulation of genetic tests.  The Secretary’s Advisory Committee onGenetic Testing, an advisory panel to the Secretary of the U.S. Department ofHealth and Human Services, has recommended that the FDA expand its regulationof genetic testing to require FDA approval for all new genetic tests andlabeling of genetic tests.  If the FDAadopts this recommendation, it may require that we, or our partners, apply forFDA approval as a prerequisite to marketing genetic tests that incorporate our *HAP*TM Technology.  If the FDA were to deny any application ofthis kind, it could adversely affect our business and we may be unable togenerate sufficient revenues to sustain our operations.

 

The FDA has only oncerequired that a physician must have genomic variation information determinedabout a patient before the doctor prescribes a drug.  In this one instance, the FDA has stipulated that thisrequirement can be fulfilled with either gene expression information or genomicvariation information.  OnJanuary 31, 2003, the FDA announced an initiative to help make innovativemedical technology available sooner, including the use of pharmacogenomicsduring drug development.  The FDAindicated that the agency would issue guidance on when and how to submit pharmacogenomicinformation to the FDA during the drug development process.  The FDA said that this guidance wouldfacilitate the exploratory use of pharmacogenomic screening during drugdevelopment and would clarify when such information would be considered part ofthe evaluation of drug safety.  Inaddition, the FDA stated that the agency would hold a workshop in 2003 onissues that are involved in the co-development of a pharmacogenomic test and adrug and that within 18 months the agency would issue guidance on theregulatory pathway for such combinations through the agency’s Center for DrugEvaluation and Research and the Center for Devices and RadiologicalHealth.  Our success will depend in parton what guidance the FDA issues with regard to the use of genomic variationanalysis as part of the drug approval process and, accordingly, the validity ofour *HAP*TM Technologyas a basis for identifying genomic variation and for correlating drug responsewith genomic variation.  Without thisacceptance by the FDA and the pharmaceutical and biotechnology industry, we maybe unable to market effectively our *HAP*TMTechnology and we may not generate sufficient revenues to sustain ouroperations.

 

Within the field ofpersonalized health and medicine, governmental and other entities may enactpatient privacy and healthcare laws and regulations that may limit the use ofgenomic variation data.  To the extentthat these laws and regulations limit the use of our *HAP*TM Technology or impose additional costs onour partners, we may be unable to market effectively our *HAP*TM Partnership, STRENGTH,CARING and Long QT programs and we may not generate sufficient revenues tosustain our operations.

 

Additionally, publicopinion on ethical issues related to the confidentiality and appropriate use ofgenetic testing results may influence governmental authorities to call forlimits on, or regulation of the use of, genetic testing.  In addition, governmental authorities orother entities may call for limits on, or regulation of the use of, genetictesting or prohibit testing for genetic predisposition to certain conditions,particularly for those that have no known cure.  The occurrence of any of these events could reduce the potentialmarkets for our *HAP*TMTechnology, which could prevent us from generating sufficient revenues tosustain our operations.

 

Furthermore, we may bedirectly subject to regulations as a provider of diagnostic information.  To the extent that these regulationsrestrict the sale of our *HAP*TMTechnology or impose other costs, we may be unable to provide our *HAP*TM Technology to ourcustomers on terms sufficient to recover our expenses.

 

**Ifour partners do not seek, or do not receive, marketing approval for productsdeveloped, if any, using our *HAP*TMTechnology, we may receive delayed royalty or other payments or no royalty orother payments at all.**

 

Any new drug, biologic ornew drug or biologic indication our partners develop using our *HAP*TM Technology must undergoan extensive regulatory review process in the United States and other countriesbefore a new product or indication of this kind could be marketed.  This regulatory process can take many yearsand require

 

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substantial expense.  Changes inFDA policies and the policies of similar foreign regulatory bodies can prolongthe regulatory review of each new drug or biologic license application orprevent approval of the application.  Weexpect similar delays and risks in the regulatory review process for anydiagnostic product developed by our partners, whenever this regulatory reviewis required.  Even if a product obtainsmarketing clearance, a marketed product and its manufacturer are subject tocontinuing review.  A manufacturer maybe forced to withdraw a product from the market if a previously unknown problemwith a product becomes apparent. Because our future revenues will be dependent on the successfulcommercialization or development of products using our *HAP*TM Technology, any delay ofour partners in obtaining, failing to obtain, or failing to maintain regulatoryapproval for a product developed using our *HAP*TMTechnology may delay our receipt of royalty or other payments or prevent usfrom receiving royalty or other payments sufficient to recover our expenses.

 

**Ifour partners are unable to obtain FDA approval for therapeutic or diagnosticproducts developed using our *HAP*TMTechnology, the lack of regulatory approval will diminish the value of our *HAP*TM Technology.**

 

To date, no one hasdeveloped or commercialized any therapeutic product or commercialized anydiagnostic product using our *HAP*TMTechnology.  We expect to rely on ourprogram partners to file applications for regulatory approval and generallydirect the regulatory review process and obtain FDA acceptance of our *HAP*TM Partnership and STRENGTHprograms and our CARING and Long QT programs, if any.  Our program partners may not submit an application for regulatoryreview.  Even if they do submitapplications, they may not be able to obtain marketing clearance for anyproducts on a timely basis, if at all. If our partners fail to obtain required governmental clearances fortherapeutic or diagnostic products, they will not be able to market theseproducts unless and until they obtain these clearances.  As a result, we may not receive royalty orother payments from our customers.  Theoccurrence of any of these events may prevent us from generating revenuessufficient to sustain our operations.

 

**Ifwe do not successfully distinguish and commercialize our *HAP*TM Technology, we may beunable to compete successfully with our competitors or to generate revenuesignificant to sustain our operations**.

 

Numerous entities areattempting to identify genomic variation predictive of specific diseases anddrug response and to develop products and services based on thesediscoveries.  We face competition inthese areas from pharmaceutical, biotechnology and diagnostic companies,academic and research institutions and government and other publicly-fundedagencies, both in the United States and abroad, most of which havesubstantially greater capital resources, research and development staffs,facilities, manufacturing and marketing experience, distribution channels andhuman resources than we do.

 

These competitors maydiscover, characterize or develop important technologies applying populationgenomics before us or our partners for our *HAP*TMPartnership and STRENGTH programs that are more effective than thosetechnologies which, we develop or which our partners for our *HAP*TM Partnership and STRENGTHprograms develop, or these competitors may obtain regulatory approvals of theirdrugs and diagnostics more rapidly than our partners for our *HAP*TM Partnership and STRENGTHprograms do, any of which could limit our ability to market effectively our *HAP*TM Technology.

 

**Somecompanies and governments are marketing or developing a number of databases andinformatics tools to assist participants in the healthcare industry andacademic researchers in the management and analysis of genomic data.  Entities such as Perlegen Sciences, CeleraGenomics Group and the International HapMap Project have developed or plan todevelop databases containing gene sequence, genomic variation or other genomicinformation and are marketing or plan to market their data to pharmaceuticaland biotechnology companies or plan to make freely available theirdatabases.  In addition, numerouspharmaceutical and biotechnology companies, such as GlaxoSmithKline plc, eitheralone or in partnership with our competitors, are developing genomic researchprograms that involve the use of information that can be found in thesedatabases.  Furthermore, companies, suchas deCODE genetics, Inc., have technologies for using genetic variation indiagnostics and in the drug development process and have partnerships with companiesemploying these technologies.**

** **

Genomic technologies haveundergone, and are expected to continue to undergo, rapid and significantchange.  Our future success will dependin large part on maintaining a competitive position in the genomics field.  Others may rapidly develop new technologiesthat may result in our products or technologies becoming obsolete

 

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before we recover the expenses that we incur in connection with thedevelopment of these products.  Our *HAP*TM Technology could becomeobsolete if our competitors offer less expensive or more effective drugdiscovery and development technologies, including technologies that may beunrelated to genomics.

 

**We depend on third-party products andservices and limited sources of supply for our sequencing and genotypinglaboratories.**

 

We rely onoutside vendors to supply certain software, products and materials used in ourlaboratories. Some of these products and materials are obtained from a singlesupplier or a limited group of suppliers. Our reliance on outside vendors generally, and a sole or a limited groupof suppliers in particular, involves several risks, including:

 

•                  the inability to obtain anadequate supply of required software, products and materials due to capacityconstraints, product defects, a discontinuance of a product by a supplier orother supply constraints;

•                  reduced control over qualityand pricing of software, products and materials; and

•                  delays and long lead timesin receiving software, products, or materials from vendors.

 

**Ifwe fail to maintain our computer hardware, software and related infrastructure,we could experience loss of, or delay in, revenues and market acceptance.**

 

Because our businessrequires manipulating and analyzing large amounts of data, we depend on thecontinuous, effective, reliable and secure operation of our computer hardware,software and related infrastructure.  Tothe extent that our hardware or software malfunctions, we will experiencereduced productivity.  We protect ourcomputer hardware through physical and software safeguards.  However, our computer hardware is stillvulnerable to fire, weather, earthquake, or other natural disaster and powerloss, telecommunications failures, physical or software break-ins and similarevents.  In addition, the software andalgorithmic components of our *DecoGen*®Informatics System are complex and sophisticated, and as such, could containdata, design or software errors that could be difficult to detect andcorrect.  Users of our system may findsoftware defects in current or future products.  If we fail to maintain the necessary computer capacity and datato support our computational needs and our customers’ drug and diagnostic discoveryand development efforts, we could experience a loss in revenues, or a delay inreceiving revenues and a delay in obtaining market acceptance for ourtechnology.

 

**Ouroperating results may fluctuate significantly and any failure to meet financialexpectations may disappoint securities analysts or investors and result in adecline in our common stock price.**

 

Our operating resultshave fluctuated in the past and we expect they will fluctuate in the future.These fluctuations could cause our common stock price to decline.  Some of the factors that could cause ouroperating results to fluctuate include:

 

•                  recognitionof non-recurring revenues due to receipt of license fees, achievement ofmilestones, completion of contracts or other revenues;

 

•                  demand for and market acceptance ofour *HAP*TM Partnership,STRENGTH, CARING and Long QT programs;

 

•                  timing of the execution of agreementson our *HAP*TMPartnership, STRENGTH, CARING and Long QT programs and other materialcontracts;

 

•                  our competitors’ announcements orintroduction of new products, services or technological innovations;

 

•                  disputes regarding patents or otherintellectual property rights;

 

•                  securities class actions or otherlitigation;

 

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•                  adverse changes in the level ofeconomic activity in the United States and other major regions in which we dobusiness; and

 

•                  general and industry-specificeconomic conditions, which may affect our partners’ use of our *HAP*TM Technology.

 

Due to volatile andunpredictable revenues and operating expenses, we believe that period-to-periodcomparisons of our results of operations may not be a good indication of ourfuture performance.  It is possible thatour operating results may be below the expectations of securities analysts orinvestors.  In this event, the marketprice of our common stock could fluctuate significantly or decline.

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**Item6 – Exhibits and Reports on Form 8-K.**

 

(a) Exhibits

 

See Index toExhibits attached hereto.

 

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(b) Reports onForm 8-K

 

We filed thefollowing reports on Form 8-K during the fiscal quarter ended June 30,2003:

 

Current Report onForm 8-K dated May 13, 2003, furnishing under Item 12 our financialresults for our first quarter ended March 31, 2003.

 

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** **

**GENAISSANCE PHARMACEUTICALS, INC.**

 

**SIGNATURE**

 

Pursuant to the requirements of the Securities ExchangeAct of 1934, as amended, the Registrant has duly caused this Amendment No.  1 to its Quarterly Report on Form 10-Q to besigned on its behalf by the undersigned thereunto duly authorized.

 
|                          | GENAISSANCE  PHARMACEUTICALS, INC.                 |
|-------------------------------|----------------------------------------------------|
|                          |                                               |   |
|                          |                                               |   |
| Date: February 11,  2004 | By:                                                |    /s/  Ben Kaplan |   |
|                          | Ben Kaplan                                         |
|                          | Senior Vice President  and Chief Financial Officer |
|                          | (Principal Financial  and Accounting Officer)      |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** |   | **Description of Document**                                                                                                              |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1*(1)        |   | Employment  Agreement with Ben Kaplan dated May 6, 2003.                                                                                 |
|            |   |                                                                                                                                     |
| 31.1            |   | Certification  pursuant to Rules 13a-14(a)/15d-14(a) promulgated under the Securities  Exchange Act of 1934, as amended. Filed herewith. |
|            |   |                                                                                                                                     |
| 31.2            |   | Certification  pursuant to Rules 13a-14(a)/15d-14(a) promulgated under the Securities  Exchange Act of 1934, as amended. Filed herewith. |
|            |   |                                                                                                                                     |
| 32.1            |   | Certification  pursuant to 18 U.S.C. Section 1350. Filed herewith.                                                                       |
|            |   |                                                                                                                                     |
| 32.2            |   | Certification  pursuant to 18 U.S.C. Section 1350. Filed herewith.                                                                       |

 

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*                 Indicates amanagement contract or compensatory plan.

 

(1)   Filed as an Exhibit to the Registrant’sQuarterly Report on Form 10-Q (File No. 000 - 30981) for the quarter ended June30, 2003 and incorporated herein by reference.

 

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