By Lisa Seachrist

Washington Editor

Affymetrix Inc.'s stock closed up 20 percent following news that the U.S. Patent and Trademark Office (PTO) ruled in favor of the Santa Clara, Calif.-based company's intellectual property in its suit against Incyte Pharmaceuticals Inc., which saw its shares fall 34 percent.

Separately, Affymetrix said it is acquiring Genetic MicroSystems Inc., a Woburn, Mass.-based instrumentation company specializing in DNA array technology in a stock deal that could be worth more than $100 million. GMS manufactures and markets exportable instruments for both fabricating and analyzing DNA arrays for use in life science research.

Affymetrix is suing Incyte for patent infringement over its use of a chip microarray system. Palo Alto, Calif.-based Incyte requested two of Affymetrix's patents be found in interference with two pending Incyte patents. The PTO ruled Incyte didn't establish a sufficient case for the interference to proceed and effectively reaffirmed the validity of the two Affymetrix patents.

"[Incyte was] basically trying to sidetrack this lawsuit," said Vernon Norviel, senior vice president and general counsel for Affymetrix. "The interferences were a creative and reasonable way to stall the proceedings. Instead of slowing down the lawsuit, they sped up the validation of our patents."

Affymetrix's suit involves patents covering microarray DNA analysis - the technology that is the basis for Affymetrix's GeneChip technology. GeneChip is a technology for acquiring, analyzing and managing complex genetic information. The system uses microchips embedded with DNA and software systems to analyze gene expression.

Affymetrix sued Incyte in January 1998 over one patent related to the technology and amended the suit in September of that year to include a second patent. The U.S. District Court for the Northern District of California denied Affymetrix's request to enjoin Incyte from expanding its microarray business. In April 1999, the PTO issued a "show cause" order to initiate the interference proceedings and the two companies presented oral arguments in August. On Sept. 10, the PTO issued its decision against Incyte.

Incyte will appeal the decision and continue to fight the patent infringement suit filed by Affymetrix.

"This was simply a way for us to shortcut everything and get a favorable ruling early," said Roy Whitfield, CEO for Incyte. "This suit didn't include anything that we have obtained during the discovery phase of the lawsuit. It was disappointing, but it's not over."

Norviel, however, noted Incyte had admitted to the district court the basis for its defense was encompassed in the interferences. Analysts view the decision as less than favorable to Incyte.

Kevin Tang, an analyst with Deutsche Bank Alex. Brown in New York, wrote in a research note that "the recent USPTO decision darkens the cloud that has been overhanging Incyte's microarray business." Mike King, vice president and senior biotechnology analyst at BancBoston Robertson Stephens in New York, viewed the decision with greater import.

"This decision virtually eliminates the patent risk in the Affymetrix story," King said. "They can proceed with no [intellectual property] encumbrances."

Affymetrix's stock (NASDAQ:AFFX) closed Monday at $121.062, up $19.937 a share. Incyte's stock (NASDAQ:INCY) closed at $27.25, down $14.125.

Affymetrix's purchase of Genetic MicroSystems is being done as a straight stock deal. Affymetrix said it would issue approximately 1 million shares, or 4 percent of the company, but did not give specifics about the terms or if they would change if the stock price rose significantly. One million shares would be worth about $121 million at Monday's closing price, but would have been worth about $101 million when the market opened Monday. The deal is expected to close in January and is intended to qualify as a tax-free reorganization.

In return, Affymetrix is gaining swift entry into the lower-end microarray market. There are two basic uses for these smaller microarrays, or "spotted arrays." The first is to do more focused study on genes that have been identified through large microarrays such as GeneChip, or other means. The second is to study genes when their sequences are unknown.

Currently, researchers produce their own microarrays as well as their own software to analyze the results using systems like Genetic MicroSystems'. With the merger, researchers will have the option to purchase chips and software integrating the larger and smaller microarray systems.

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