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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended: March 31, 2004.

OR

For the transition period from              to             

Commission File Number:

0-30365

Paradigm Genetics, Inc.

(Exact name of registrant as specified in its charter)

108 T.W. Alexander Drive, Research Triangle Park, North Carolina 27709

(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (919) 425-3000

Former name, former address, and former year, if changed since last report: Not applicable

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12B-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the Issuer’s classes of Common Stock, as of the latest practicable date.

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PARADIGM GENETICS, INC.

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

PARADIGM GENETICS, INC.

CONDENSED BALANCE SHEETS

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

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PARADIGM GENETICS, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

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

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PARADIGM GENETICS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

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

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Note 1. Organization and Summary of Significant Accounting Policies

Paradigm Genetics, Inc. (the “Company” or “Paradigm”) was founded on September 9, 1997, and is a biotechnology company using proprietary systems biology to discover biomarkers to reduce cost, risk and time in the product development cycle as well as to discover inaccessible targets for small molecule discovery, both for its partners and for the Company. The Company is growing the business by partnering with life sciences companies in both healthcare and agriculture, while building its own portfolio of products. Additionally, the Company is leveraging their existing infrastructure to provide services that generate near-term revenue.

The accompanying financial statements have been prepared on a basis which assumes that the Company will continue as a going concern and which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company had an accumulated deficit of $88.2 million as of March 31, 2004, incurred a net loss of $3.7 million for the three months then ended and expects to incur substantial additional losses for the remainder of 2004.

The Company has historically financed its operations through the sale of common and preferred stock, debt and capital lease financing, payments received from commercial partnerships and government grants. As of March 31, 2004, the Company had total cash and investments of $15.2 million, which is comprised of cash and cash equivalents of $9.1 million and short-term investments of $6.1 million.

The Company expects to continue expanding its operations through internal growth and, possibly, through strategic acquisitions. The Company expects these activities will be funded from existing cash, cash flow from operations, issuances of stock and borrowings under credit facilities. Management believes that these sources of liquidity will be sufficient to fund its operations into 2005. From time to time, the Company evaluates potential acquisitions and other growth opportunities, which might require additional external financing, and the Company may seek funds from public or private issuances of equity or debt securities.

Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004 or for any future period. These financial statements and notes should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2003, included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 30, 2004.

Use of Estimates

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

Reclassifications

Certain amounts in the 2003 financial statements have been reclassified to conform to the 2004 presentations, with no effect on previously reported net loss, stockholders’ equity, or net loss per share.

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Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents.

Restricted Cash

Restricted cash comprises cash held in escrow for security deposits on the Company’s facilities.

Property and Equipment

Property and equipment is primarily comprised of buildings, laboratory equipment, computer equipment, furniture, and leasehold improvements, which are recorded at cost and depreciated using the straight-line method over their estimated useful lives. Expenditures for maintenance and repairs are charged to operations as incurred; major expenditures for renewals and betterments are capitalized and depreciated. Property and equipment acquired under capital leases are being depreciated over their estimated useful lives or the respective lease term, if shorter.

Other Assets

Other assets include intangible assets, resulting the Company’s acquisition of TissueInformatics.Inc (See Note 2), deposits for building leases and other deferred costs.

Capitalized Software Costs

The Company accounts for the costs of development of software applications to be sold to or used by third parties in accordance with Statement of Financial Accounting Standards No. 86 “Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed.” Software development costs are required to be capitalized beginning when a product’s technological feasibility has been established and ending when a product is available for general release. To date, the establishment of technological feasibility has substantially coincided with the release of any software products developed. Accordingly, no costs have been capitalized.

Impairment of Long-Lived Assets

The Company evaluates the recoverability of its property and equipment and intangible assets in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). SFAS No. 144 requires long-lived assets to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment is recognized in the event that the net book value of an asset exceeds the future undiscounted cash flows attributable to such asset or the business to which such asset relates and the net book value exceeds fair value. The impairment amount is measured as the amount by which the carrying amount of a long-lived asset (or asset group) exceeds its fair value. No impairment loss was required to be recognized during the three months ended March 31, 2004 or 2003.

Income Taxes

The Company accounts for income taxes using the liability method, which requires the recognition of deferred tax assets or liabilities for the temporary differences between financial reporting and tax bases of the Company’s assets and liabilities and for tax carryforwards at enacted statutory rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. In addition, valuation allowances are established where necessary to reduce deferred tax assets to the amounts expected to be realized.

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Revenue Recognition

Revenues are derived from commercial partnerships and services and government contracts and grants. Payments from our commercial contracts are generally related to refundable or nonrefundable fees, milestone achievements or assay deliveries. Payments for refundable and nonrefundable fees and milestone achievements are recognized as revenues on a progress to completion basis over the term of the respective commercial partnership, except with respect to refundable fees for which revenue recognition does not commence until the refund right expires. Payments related to assay deliveries are recognized as revenues when accepted by the other party. Payments received under the Company’s commercial partnerships and government contracts and grants are generally non-refundable regardless of the outcome of the future research and development activities to be performed by the Company. Payments from government contracts and grants are recognized as revenues as related expenses are incurred over the term of each contract or grant.

Progress to completion under commercial partnerships is measured based on a comparison of the number of genes analyzed to the total number of genes to be analyzed, on a contract by contract basis. To the extent payments received exceed revenue recognized for each contract or grant the excess portion of such payments are recorded as deferred revenues. To the extent revenues recognized exceed payments received for each contract or grant the excess of such revenues are recorded as accounts receivable. The Company recognizes revenue in accordance with Staff Accounting Bulletin No. 104 (“SAB 104”) issued by the Securities and Exchange Commission.

Research and Development

Research and development costs include personnel costs, costs of supplies, facility costs, license fees, consulting fees, the recording of deferred compensation and depreciation of laboratory equipment. These costs were incurred by the Company to develop its proprietary GeneFunction Factory^® platform and metabolic profiling platform, perform required services under commercial partnerships and government grants and perform research and development on internal projects. Research and development costs are expensed as incurred.

Stock-Based Compensation

The Company accounts for stock-based compensation based on the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) which states that no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value of the Company’s common stock on the grant date. In the event that stock options are granted with an exercise price below the estimated fair value of the Company’s common stock at the grant date, the difference between the fair value of the Company’s common stock and the exercise price is recorded as deferred compensation. The Company reversed $0 and $1,665 of deferred compensation related to the cancellation of unvested options during the three months ended March 31, 2004 and 2003, respectively. Deferred compensation is amortized to compensation expense over the vesting period of the related stock option. The Company recognized $1,806 and $112,721 in non-cash compensation expense related to amortization of deferred compensation during the three months ended March 31, 2004 and 2003, respectively. During the three months ended March 31, 2003, the Company also accrued $172,375 in stock-based compensation related to stock grants that were made as part of the 2002 bonuses. The stock grants were paid in shares on June 27, 2003. The fair market value of the stock granted was $0.65 per share on March 31, 2003.

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Had compensation costs for the two plans been determined based on the fair value at the grant date for awards under the plans, consistent with the methods of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”), as amended, the Company’s net loss and net loss per share (basic and diluted) for the three months ended March 31, 2004 and 2003, would have been increased to the pro forma amounts indicated below:

The per share weighted average fair value of stock options granted during the three months ended March 31, 2004 and 2003 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for 2004 and 2003: expected dividend yield of 0%; risk free interest rates of 3.0% in 2004 and 3.82% in 2003; expected option lives of approximately four years in 2004 and 2003; and volatility factors of 105% in 2004 and 111% in 2003.

Concentration of Credit Risk

Financial instruments, which potentially subject the Company to a concentration of credit risk, consist principally of cash, investments, and accounts receivables. The Company primarily places its cash, short-term and long-term investments with high-credit quality financial institutions which invest primarily in U.S. Government securities, commercial paper of prime quality and certificates of deposit guaranteed by banks which are members of the FDIC. Cash deposits are all in financial institutions in the United States. The Company performs ongoing credit evaluations to reduce credit risk and requires no collateral from its customers. Management estimates the allowance for uncollectible accounts based on their historical experience and credit evaluation.

The Company has three commercial partnerships, a contract with the United States federal government, and a grant, which accounted for 56%, 9%, 4%, 17% and 11%, respectively, of the Company’s total revenue for the three months ended March 31, 2004. The Company had two commercial partnerships and a contract with the United States federal government, which accounted for 71%, 12% and 10%, respectively, of the Company’s total revenue for the three months ended March 31, 2003. Of the total accounts receivable balance at March 31, 2004 and 2003, 44% and 76%, respectively, is comprised of receivables from one of the commercial partnerships.

Comprehensive Income (Loss)

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income” established standards for reporting and display of comprehensive income and its components in the financial statements. Comprehensive income, as defined, includes all changes in equity during a period from non-owner sources. The Company’s total comprehensive loss for the three month periods ended March 31, 2004 and 2003 was $3,629,843 and $3,919,398, respectively. The Company’s other comprehensive loss consisted of unrealized gains on investments of $41,770 and $197,397 for the three months ended March 31, 2004 and 2003, respectively.

Net Loss Per Common Share

The Company computes net loss per common share in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share,” (“SFAS No. 128”). Under the provisions of SFAS No. 128, basic net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding. Diluted net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares and dilutive potential common share equivalents then outstanding. Potential common shares consist of shares issuable upon the exercise of stock options and warrants.

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The following table sets forth potential shares of common stock that are not included in the diluted net loss per share because to do so would be antidilutive for the periods indicated:

Segment Reporting

Statement of Financial Accounting Standards No. 131, “Disclosures About Segments of an Enterprise and Related Information,” (“SFAS No. 131”) requires companies to report information about operating segments in interim and annual financial statements. It also requires segment disclosures about products and services, geographic areas and major customers. The Company has determined that it operated in only one segment.

Internal Use Software

Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” (“SOP No. 98-1”) provides guidance regarding when software developed or obtained for internal use should be capitalized. The predominant portion of the software applications used by the Company were purchased from third parties. The Company expenses the cost of accumulating and preparing data for use in its database applications as such costs are incurred.

Discontinued Operations

In November 2002, the Company decided to close the operations of ParaGen, its plant genotyping business. At December 31, 2002, all of the goodwill and associated assets were written down to their fair value less cost to sell and reported in the loss from discontinued operations. In February 2003 the ParaGen business assets were sold to DNA Landmarks for $300,000 and potential future royalties between 10% and 15%, over the next three years, of revenues from certain identified customers.

The operating results from ParaGen are reported in discontinued operations. For the three months ended March 31, 2004 and 2003, these operations reported a gain of $22,725 and $24,669, respectively. ParaGen was purchased in 2001 from Celera Genomics for 422,459 shares of our common stock.

Note 2. Acquisition

On March 11, 2004, the Company purchased all of the outstanding common and preferred stock of TissueInformatics.Inc, in exchange for the issuance of 3,402,832 shares of the Company’s common stock with a total fair value of $4,614,250, based on the average closing price of the common stock of $1.36 for the two-day period immediately preceding and following the date of the announcement of the acquisition. In addition, subject to the achievement of performance milestones by December 31, 2004, the Company could be obligated to issue another 2.7 million shares.

The Company assumed approximately $0.6 million in net liabilities and incurred costs of approximately $0.5 million related to this acquisition. The Company also assumed TissueInformatics’s obligations under its qualified employee incentive stock option plan for TissueInformatics employees. At closing, approximately 200,000 shares were reserved to satisfy this obligation. Subject to the achievement of performance milestones by December 31, 2004, an additional 200,000 shares may need to be reserved for the incentive stock option plan. The acquisition has been accounted for using the purchase method of accounting and, accordingly, the initial purchase price of approximately $7.2 million was allocated to the assets acquired and liabilities assumed based on estimated fair values. This purchase price includes $2.6 million for the contingent purchase consideration that may be payable if certain performance milestones are achieved. The fair value assigned to intangible assets acquired was based on a preliminary valuation prepared by management of the Company. The Company is in the process of obtaining a valuation of these intangible assets and, as such, are subject to change.

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Of the total purchase price, $3.5 million was allocated to the tangible assets, which were comprised of cash, property and equipment and prepaid and other assets, $4.2 million has been allocated to intangible assets and $0.6 million has been allocated to liabilities. The intangible assets are being amortized over a period of five years.

The Company’s consolidated results of operations for the three-month period ended March 31, 2004 include the results of TissueInformatics operations from the day after the closing date of the acquisition, March 12, 2004, to March 31, 2004.

The following unaudited pro forma consolidated financial information reflects the results of operations of the Company for the three-month periods ended March 31, 2004 and 2003 as if the acquisition of TissueInformatics had occurred on January 1, 2004 and 2003, respectively. These pro forma results are not necessarily indicative of what the Company’s operating results would have been had the acquisition actually taken place on January 1, 2004 or 2003, and may not be indicative of future operating results.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results Of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that are based upon current expectations. Our actual results and the timing of events could differ materially from those anticipated in our forward-looking statements as a result of many factors, including those set forth under “Risk Factors,” “Forward-Looking Statements” and elsewhere in this report.

You should read the following discussion and analysis in conjunction with “Selected Financial Data” and the financial statements and related notes included elsewhere in this report.

Overview

Paradigm Genetics is a biotechnology company using proprietary systems biology to discover biomarkers to reduce cost, risk and time in the product development cycle as well as to discover otherwise inaccessible targets for small molecule discovery, both for our partners and for ourselves. We are growing our business by partnering with life sciences companies, while building our own portfolio of products. Additionally, we are leveraging our existing infrastructure to provide services that generate near-term revenue.

In March 2004, we acquired TissueInformatics.Inc, a privately held company, which develops and applies automated pathology software for the quantitative analysis of tissue changes in drug discovery, disease assessment, toxicology, and tissue engineering. We believe this acquisition provides us with a unique competitive advantage as the first company to combine gene expression profiling, biochemical profiling and quantitative tissue analysis in a systems biology approach to life sciences discovery. It is through this unique combination and analysis of different biological data that we can identify novel biomarkers and targets that were previously inaccessible due to biological “noise.”

Our business model targets near term and mid term revenues and cash flow from our current commercial partnerships, government contracts and grants, new commercial partnerships and our service businesses — Paradigm Array Labs^™ and TissueInformatics^® automated pathology software. In the long term, we are targeting revenues and cash flow through the development of our proprietary product portfolio. Our current proprietary product development efforts are focused on diagnostics for liver disease and injury, biomarkers and drugs for diabetes and obesity and novel agricultural compounds as well as the development and application of automated pathology software.

Commercial Partnership Revenue

Currently, we have several revenue generating partnerships and contracts. The table below presents these revenue sources:

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We currently have commercial partnerships with Bayer Crop Sciences (“Bayer”) in the area of crop protection, The Monsanto Company (“Monsanto”) in the areas of crop protection and nutrition and Pioneer Hi-Bred International, Inc. (“Pioneer”), a subsidiary of DuPont, in the area of crop trait discovery. Our partnership with Bayer was signed in September 1998 and was extended in November 2003. Under the terms of the agreement, the companies will collaborate on herbicide discovery through September 2006. The partnership with Monsanto was signed in November 1999 and began contributing revenues in the second quarter of fiscal year 2000. During September 2001, we announced that Monsanto had amended the partnership agreement by eliminating its option to terminate the agreement without cause in exchange for broader commercialization rights. This amendment commits Monsanto to a total partnership term of six years with committed funding through January 2006. During November 2002, we announced that the research plan under the commercial partnership with Monsanto had been revised. The revision only affected the fourth quarter of 2002 by slowing the timing of our revenue recognition. This revision will not alter the total amount of revenue we will recognize over the term of this commercial partnership. The partnership with Pioneer was signed in December 2003 and began contributing to our revenues in the first quarter of fiscal year 2004.

We also have a $23.8 million five-year contract with the National Institute of Environmental Health Sciences (“NIEHS”) that was signed in September 2002 and began contributing to our revenue in the fourth quarter of 2002. In April 2003, the Company announced that NIEHS exercised an $8.4 million option under this contract bringing the total contact value to $32.2 million. Under the terms of the contract we will use our technologies to determine how toxicants work and cause damage at the cellular level.

Our acquisition of TissueInformatics.Inc brings revenue-generating contracts, of which the most significant is the contract with L’Oréal for the development and license of TissueInformatics^® software for the automated pathology slide screening of tissue-engineered skin. This contract was signed in November 2003 and will begin contributing to revenue in late 2004.

In addition, we currently have one government grant. Our Advanced Technology Program (“ATP”) grant from National Institute of Standards and Technology (“NIST”) was awarded in June 2002 for $11.7 million over five years to develop innovative tools for target discovery through the analysis of complex coherent data sets. This grant, the largest bioinformatics grant ever awarded in NIST’s Advanced Technologies Program history, supports the development of methods and tools for the creation, evaluation and analysis of coherent data sets. The grant will be shared between the joint venture partners, currently Paradigm and LION bioscience Inc., based on the research work plan. We are expecting LION bioscience to be replaced as a joint venture partner. Another grant with the National Science Foundation (“NSF”) for the development of a high throughput gene discovery system in Arabidopsis using geminivirus ended in June 2003.

Liquidity and Capital Resources

We have historically financed our operations through the sale of common and preferred stock, debt and capital lease financing, payments received from commercial partnerships and government grants. From our inception through March 31, 2004, we have raised an aggregate of approximately $95.5 million through the sale of equity and approximately $25.6 million in proceeds from secured debt financing.

At March 31, 2004, we had cash, cash equivalents and short-term investments totaling approximately $15.2 million. We currently see several factors which could negatively impact our cash position:

During April 2004, we modified the financial covenants in our debt agreement with Silicon Valley Bank. We are now obligated to maintain a unrestricted cash to Silicon Valley Bank debt ratio of 1.75. This ratio is defined as the ratio of

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unrestricted cash to the amount of outstanding debt to Silicon Valley Bank (including all amounts outstanding under the line of credit). Prior to this modification, the Company was obligated to maintain a quick ratio of at least 1.5. The Company’s management believes that with this modification, it will have greater flexibility to continue targeted research and development.

If we were required to pay off the loan with Silicon Valley Bank and restrict cash under the loan covenants with General Electric Corporation, we believe our remaining cash would be sufficient to support our operations into 2005.

In order to best understand the Company’s cash flow, management believes that the cash flow measure presented below, which includes Short- and Long-Term Investments, is an appropriate measure for evaluating the Company’s liquidity, because this reflects all liquid resources available for strategic opportunities including, among others, investment in the business and continuing operating activities. However, this measure should be considered in addition to, and not as a substitute for, or superior to, cash flows prepared in accordance with generally accepted accounting principles in the U.S.

Cash used in operating activities:

We expect our cash from operating activities will improve slightly in 2004 when compared to 2003, as we are expecting new revenues in 2004 to contribute to our cash flow from operations offset, in part, by higher research and development costs from our expanding research programs. No assurance can be given that we will earn the new revenues anticipated in 2004.

Cash provided by (used in) investing activities:

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We expect our cash used in investing activities will increase in 2004 compared to 2003 as we continue to make investments in the purchase of equipment to support our operations.

Cash used in financing activities:

For the remainder of 2004, our obligation for financing activities amounts to $3.6 million.

Based on the above discussion, we believe that we have sufficient cash to fund our operations into 2005. We expect to raise additional funds to support our expanding research and development programs through the public or private offering of our equity securities, additional debt financing or both. No assurance can be given that such additional financings will be available or, if available, can be obtained on terms acceptable to us.

Under GAAP, cash flows from investing activities above would improve by net maturities of investment securities and unrealized gains and losses on investments; also under GAAP, cash and cash equivalents at the beginning and end of the period would be less, as they would exclude short and long-term investments. The following table presents these differences:

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Results of Operations

Three Months Ended March 31, 2004 and 2003.

Revenues

The table below presents our revenue sources for the three months ended March 31, 2004 compared to the three months ended March 31, 2003.

Notes:

1. We recognize revenues relating to our partnership with Bayer in two components, gene discovery and assay development. For the gene discovery component, from which the majority of the revenue is generated, we recognize revenue by comparing the number of genes analyzed during the period to the total number of genes to be analyzed over the term of the contract. As this contract has entered its later phases, there is a corresponding decrease in the number of genes to be analyzed. Therefore, the revenue associated with the gene discovery component has declined. For the assay component, we recognize revenue when Bayer accepts assays. There was no significant difference in revenues related to assays in the first quarter of 2004 compared to the same period in 2003. Overall, we expect to recognize less revenue in 2004 when compared to 2003 for this commercial partnership.

2. We recognize revenues relating to our partnership with Monsanto by comparing the number of genes analyzed during the period to the total number of genes to be analyzed over the term of the contract. We expect that revenues related to this commercial partnership will decline in 2004 when compared to 2003 as the project enters later phases in which there is a decrease in the number of genes to be analyzed.

3. We recognize revenues relating to our partnership with Pioneer by comparing the number of plant lines analyzed during the period to the total number of plant lines to be analyzed over the term of the contract. This commercial partnership was signed in December 2003.

4. We recognize revenues relating to our partnership with NIEHS as samples are processed. In the first quarter of 2004, revenues increased as a result of the continued increase in the number of samples processed under this contract. We expect this increase to continue in 2004 and, as a result, we expect revenues will increase in 2004 when compared to 2003.

5. We recognize revenues relating to our service business, Paradigm Array Labs^™, as we complete work for our various customers. We expect that revenues related to this service will increase in 2004 when compared to 2003 as we are expecting an increase in the volume of business.

6. We recognize revenues under our grants as the related expenses are incurred. Grant revenues for the three months ended March 31, 2004 were generated from our ATP grant. Grant revenues for the three months ended March 31, 2003 were generated from our ATP grant and one grant with NSF, which ended in June 2003. We are expecting that our grant revenues will remain flat in 2004 when compared to 2003, due to revenues from our ATP grant increasing in 2004 offset, in part, by decreases in our grant revenue from NSF, which ended in June 2003.

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Research and Development and Selling, General and Administrative Expenses

The table below presents our operating expenses for the first quarter of 2004 compared to the same period in 2003.

Notes:

1. Our costs increased during the first quarter of 2004 when compared to the same period in 2003. The increase was primarily related to payroll costs, which increased approximately $378 thousand, primarily as a result of increased headcount and laboratory supply costs which increased approximately $392 thousand as we ramped up the work on our contract with NIEHS. Other expenses, which consist primarily of facilities costs, corporate support costs and licenses fees, remained flat when compared to the same period in 2003. We are expecting our payroll, lab supply and other expenses to increase in 2004 when compared to 2003 as we continue to expand our services under our contract with NIEHS, expand our healthcare business and deliver on our new contract with Pioneer Hi-Bred.

2. Total depreciation and amortization expense remained flat during the first quarter of 2004 when compared to the same period in 2003. We are expecting depreciation and amortization expense to increase in 2004 compared to 2003 as we increase our capital expenditures and amortize intangible assets associated with the TissueInformatics acquisition.

3. At March 31, 2004 we amortized the remaining balance of our deferred compensation expense and as such deferred compensation expense will be lower in 2004 when compared to 2003.

4. Our costs declined during the first quarter of 2004 when compared to the same period in 2003. Payroll costs decreased approximately $224 thousand, primarily due to lower headcount. Other expenses, which consist primarily of professional expenses, such as legal and accounting fees, facilities costs, business development costs, taxes and insurance costs, remained flat. We are expecting our payroll and other expenses to increase in 2004 when compared to 2003 as we expand our operations, deliver on new revenue generating contracts and increase our business development activities.

Divestiture

We are reporting a small gain from discontinued operations in 2004. In November 2002, we decided to discontinue the operations of our plant genotyping business, ParaGen, and in February 2003 we sold ParaGen to DNA Landmarks. We are expecting a minimal income contribution from discontinued operations as we recognize royalties from the sale during 2004.

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Interest Income (Expense), Net

Interest income (expense), net represents interest earned on our cash, cash equivalents and short-term and long-term investments, offset by interest expense on long-term debt and capital leases. Interest income (expense) net, decreased to an expense of approximately $62,000 for the quarter ended March 31, 2004 compared to an expense of $125,000 for the quarter ended March 31, 2003. This decrease was primarily attributable to a decrease in our interest expense. Interest expense declined as a result of the Silicon Valley Bank financing that we closed in July of 2003. The financing replaced some of our existing debt, which carried higher interest rates. We expect that net interest expense will increase as we use our cash balances to fund our operations and service our debt.

Net Loss

Net loss decreased 11% to approximately $3.7 million for the quarter ended March 31, 2004, compared to approximately $4.1 million for the quarter ended March 31, 2003. The decrease in the net loss was primarily due to increased revenues between the two periods and lower selling, general and administrative costs offset in part by higher research and development costs.

Critical Accounting Policies and 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 reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The most significant estimates that management makes with respect to our financial statements is the progress to completion under our long-term commercial contracts. We currently recognize revenue based on a comparison of the number of genes analyzed to the total number of genes to be analyzed, on a contract-by-contract basis. We track the number of genes analyzed through our computer systems. If these computer systems were to incorrectly count the number of genes analyzed our revenues may be impacted. Alternatively, if we were to incorrectly estimate the number of genes to be analyzed in order to complete our commercial contracts, our future revenues may be impacted.

Potential Volatility of Quarterly Operating Results and Stock Price

Our quarterly and annual operating results have fluctuated, and we expect that they will continue to fluctuate in the future. Factors that could cause these fluctuations include:

Fluctuations in quarterly results or other factors beyond our control could affect the market price of our common stock. Such factors include changes in earnings estimates by analysts, market conditions in our industry, changes in pharmaceutical, agri-chemical, and biotechnology industries, and general economic conditions. Any effect on our common stock could be unrelated to our longer-term operating performance.

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FORWARD-LOOKING STATEMENTS

Our forecast of the period of time through which our financial resources will be adequate to support our operations and other statements contained in this report are forward-looking and involve risks and uncertainties. Actual results could vary as a result of a number of factors. We believe that our existing cash and investment securities and anticipated cash flow from existing revenue sources will be sufficient to support our current operating plan into 2005. We have based this estimate on assumptions that may prove to be wrong. It is possible that we may seek additional funding within this time frame. We may raise additional funds through public or private financing, collaborative relationships or other arrangements. We cannot assure you that additional funding, if sought, will be available or, even if available, will be available on terms favorable to us. Further, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. Our failure to raise capital when needed may harm our business and operating results. Our future capital requirements will depend on many factors, including:

This report contains other forward-looking statements, including statements regarding: our ability to successfully develop and improve our GeneFunction Factory^® platform, FunctionFinder^® system, our Gene to Cell System^™ approach, our metabolic profiling platform, databases and other technologies; the future prospects of our metabolomic platform, including the potential of the platform to improve the efficiency and lower the cost of drug discovery, decrease the time to market for new drugs, reduce toxic side effects of drugs, complement other genomic tools, and attract commercial partners to be a more efficient and proximal indicator of cellular physiology than genomics and proteomics platforms; our ability to industrialize the process of gene function discovery and metabolomics and generate information enabling the development of novel products; our ability to establish intellectual property protection for our gene function information, databases, processes and other technologies; product development and commercialization efforts; our strategy and market opportunities, anticipated increases in our revenues, and timing of revenues from commercial partnerships; our ability to meet or exceed our milestone targets and earn royalties under our commercial partnerships; our ability to enter into new partnerships and alliances; our intended use of our financial resources; our research and development and other expenses; our operational and legal risks; our ability to remain listed on the Nasdaq National Market or become listed on the Nasdaq SmallCap Market; and building shareholder value.

Such statements are based on management’s current expectations and are subject to a number of risks, factors and uncertainties that may cause actual results, events and performance to differ materially from those referred to in the forward-looking statements. These risks include, but are not limited to, our early stage of development, history of net losses, technological and product development uncertainties, reliance on research collaborations, uncertainty of additional funding and ability to protect our patents and proprietary rights. These and other risks are discussed below in Item 5, of this report, titled “Other Information – Risk Factors.”

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes since December 31, 2003.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our principal executive officer and principal financial officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and effective to ensure that material information relating to us, was made known to them by others within the Company, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

Changes in Internal Controls

There were no changes in our internal control over financial reporting, identified in connection with the evaluation of such internal control that occurred during the last fiscal quarter, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Not applicable.

Item 2. Changes in Securities and Use of Proceeds

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

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Item 5. Other Information - Risk Factors

(a) Risk Factors

We are an early stage company using novel technologies and, as a result, we may never achieve, or be able to maintain, profitability.

You should evaluate us in light of the uncertainties affecting an early stage biotechnology company. Our GeneFunction Factory^® platform, our FunctionFinder^® system, our biochemical profiling platform, our bioinformatics efforts and our TissueInformatics^® software are still evolving. We have not yet proven that determining the function of a gene in commercially significant target organisms or elucidating the biochemical profiles of cells, tissues, or fluids will enable us or our partners to develop commercial products. Furthermore, while we are continuing with our work in the agriculture sector, we are increasing our efforts to address the human health market with our biochemical profiling platform.

In the agriculture sector we have entered into only three commercial partnerships, with Bayer CropScience, Monsanto and Pioneer Hi-Bred International, Inc., a subsidiary of DuPont, to assist in development of certain new products that they are targeting, including herbicides and plants with improved nutritional and growth characteristics. In the human health sector we have only one contract, which is with L’Oréal for the development of software for automated pathology slide screening of tissue-engineered skin. We acquired this contract through our acquisition of TissueInformatics.Inc. We have entered into a government contract and have received a government grant, which are helping us to develop our human health technologies. If we are unable to successfully achieve milestones or our commercial partners fail to develop commercially successful products, we will not earn certain revenues contemplated under such partnerships. In addition, we may not be able to enter into additional commercial partnerships. We do not control the resources that our commercial partners devote to our projects and our commercial partners may not perform their obligations. Our commercial partnerships are subject to termination rights by the commercial partners. If any of our commercial partners were to terminate its relationship with us, or fail to meet its contractual obligations, it could have a material adverse effect on our revenues and our ability to undertake research, to fund related and other programs and to develop, manufacture and market any products that may have resulted from the commercial partnership. Also, we may pursue opportunities in fields that conflict with our commercial partners or in which our commercial partners could become active competitors.

We have a history of net losses. We will continue to incur net losses that may depress our stock price.

We have incurred net losses in each year since our inception and expect these losses to continue. We experienced a net loss of approximately $3.7 million for the three months ended March 31, 2004. As of March 31, 2004, we had an accumulated deficit of approximately $88.2 million. To date, we have derived substantially all of our revenues from three commercial partnerships, a government contract and government grants. We expect to derive revenue in the near future principally from government contracts and commercial contracts and partnerships. However, we expect our revenues from our commercial partnership with Bayer CropScience and Monsanto will decrease in 2004 offset by expected revenue increases from the NIEHS contract and our new commercial partnership with Pioneer Hi-Bred. We expect to spend a significant amount of capital to fund research and development and enhance our core technologies. As a result, we expect that our operating expenses will continue to increase in the near term and, consequently, we will need to generate significant additional revenues from existing commercial contracts and partnerships, grants and new revenue sources to become profitable. We cannot accurately predict when, if ever, we will become profitable.

Our business will require substantial additional capital, which we may not be able to obtain on commercially reasonable terms, if at all.

Our future capital requirements and level of expenses will depend upon numerous factors, including the costs associated with:

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We currently anticipate that our cash, cash equivalents and short-term investments will be sufficient to support our operations into 2005. To the extent that our existing resources are insufficient to fund our activities, we may need to raise funds through public or private financings involving the issuance of debt or equity securities. No assurance can be given that additional financings will be available or, if available, can be obtained on terms acceptable to us. If adequate funds are not available, we may have to reduce expenditures for research and development, administration, business development or marketing, which could have a material adverse effect on our business. To the extent that additional capital is raised through the sale of equity or convertible securities, the issuance of such securities could result in dilution to our shareholders.

Our debt covenants could impact our cash position.

In April 2004, we modified the financial covenant in our debt agreement with Silicon Valley Bank (“SVB”). We are now obligated to maintain a cash to SVB debt ratio of 1.75. This ratio is defined in our amended agreement with SVB as the ratio of unrestricted cash to the amount of outstanding debt to SVB (including all amounts outstanding under the line of credit.) If we were to default on this financial covenant, we may be required to pay off the loan with SVB. As of March 31, 2004, our cash to SVB debt ratio was 2.63 and the aggregate amount outstanding under the SVB line of credit and term loan was $5.8 million. Prior to this modification, the Company was obligated to maintain a quick ratio of at least 1.5. The Company’s management believes that with this modification, it will have greater flexibility to continue targeted research and development.

As a result of the equipment financing with General Electric Capital Corporation, we have a negative covenant pledge agreement which will require us to restrict a portion of our cash if at the end of any quarter our unrestricted cash balance falls below the greater of $15.0 million or nine months’ cash needs. If this covenant were triggered at March 31, 2004, we would have been required to restrict approximately $542,000 or fifty percent of the amount outstanding under this equipment financing arrangement. The term loan with General Electric Capital Corporation amortizes monthly.

Pursuant to our current operating plan, it is likely we will fail to meet the financial covenant with General Electric Capital Corporation in 2004. We expect to raise funds through public or private financings of our equity securities, which would, subject to the amount raised, allow us to avoid a default. No assurance can be given that such additional financings will be available or, if available, can be obtained on terms acceptable to us.

If we lose our key personnel or are unable to attract and retain additional personnel, our operations could be disrupted and our revenues could decrease.

Our success depends on the continued services and on the performance of our senior management and scientific staff. The loss of the services of any of our senior management or scientific staff could seriously impair our ability to operate and achieve our objectives, which could reduce our revenues. Recruiting and retaining qualified scientific personnel to perform future research and development work will be critical to our success.

In order to achieve our business objectives, we must identify, attract, train and motivate additional personnel with expertise in specific industries and areas applicable to the products developed through our technologies. We compete intensely for these personnel and we may be unable to achieve our personnel goals. Our failure to achieve any of these goals could seriously limit our ability to improve our operations and financial results.

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If we do not compete effectively, our losses could increase.

Our technology platform for the industrialization of gene function determination faces competition from functional genomics technologies, which are computer hardware and software technologies that researchers use to help them identify the role that specific genes play within organisms, created by others, including Exelixis, Inc., Ceres, Inc., Mendel Biotechnology Inc., and Large Scale Biology Corporation. Our biochemical profiling platform also faces competition from other companies attempting to analyze biochemicals in human beings. We expect competition to intensify in functional genomics and metabolomics research. Genomic technologies have undergone and are expected to continue to undergo rapid and significant change. Our future success will depend in large part on maintaining a competitive position in these fields. Metabolomics is a rapidly growing new technology. We or others may make rapid technological developments, which may result in products or technologies becoming obsolete before we recover the expenses we incur in connection with our development. We or our commercial partners may offer products which could be made obsolete by less expensive or more effective technologies. We may not be able to enhance our technology in ways necessary to compete successfully with newly emerging technologies.

Any products that we may develop alone or in collaboration with others will compete in highly competitive markets. In the specific markets in which we apply or intend to apply our technology platform, we face competition from pharmaceutical, plant genomics, and agri-chemical companies. Many of our existing and potential competitors have substantially greater financial resources, research and development staffs, facilities, manufacturing and marketing experience, distribution channels and human resources than we do. Many of these competitors have achieved substantial market penetration in the human health, agriculture and nutrition markets.

If we are not able to adequately acquire and protect patents and licenses, we may not be able to operate our business and remain competitive.

Our business and competitive position will depend in part on our ability to obtain patents and maintain adequate protection of our other intellectual property for our technologies and products in the United States and other countries. As of May 01, 2004, we had 92 U.S. patent applications pending and 35 international patent applications pending, some of which are subject to rights that we have granted to various collaborators and development partners. We have 14 trademark applications pending in the United States, one trademark application pending in the U.K., and one pending European Community trademark application. We have 19 registered trademarks in the United States. We own 22 issued U.S. patents and no issued patents in any other country. If each of the 22 issued U.S. patents is maintained for the longest term available under law, the earliest a patent will expire is 2019.

The patent positions of life science companies are generally uncertain and involve complex legal and factual questions. Our business could be hurt by any of the following:

Third parties have filed, and in the future are likely to file, patent applications covering genes and gene function that we have developed or may develop or technology upon which our technology platform depends. If patent offices issue patents on these patent applications and we wish to use the claimed genes, gene functions or technology, we would need to obtain licenses from third parties. However, we might not be able to obtain any such license on commercially favorable terms, if at all, and if we do not obtain these licenses, we might be prevented from using certain technologies or taking certain products to market.

The patent positions of biopharmaceutical and biotechnology companies, including our patent position, are generally uncertain and involve complex legal and factual questions. Patent law relating to the scope of claims in the field in which we operate is still evolving. We will be able to protect our proprietary rights from unauthorized use by third

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parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. We will apply for patents covering both our technologies and products, as we deem appropriate. However, other companies may challenge these applications and governments may not issue patents we request. Any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products. Furthermore, others may independently develop similar or alternative technologies or design around our patented technologies. In addition, our patents may be challenged, invalidated or fail to provide us with any competitive advantages.

We rely upon trade secret protection for our confidential and proprietary information. We have taken security measures to protect our proprietary information. These measures may not provide adequate protection for our trade secrets or other proprietary information. Even though we seek to protect our proprietary information by entering into confidentiality agreements with employees, commercial partners and consultants, people may still disclose our proprietary information, and we might not be able to meaningfully protect our trade secrets.

If third parties make or file claims of intellectual property infringement against us or otherwise seek to establish their intellectual property rights, we may have to spend time and money in response and cease some of our operations.

In the future third parties could claim that we are employing their proprietary technology without authorization or that we are infringing their patents. We could incur substantial costs and diversion of management and technical personnel in defending ourselves against any of these claims. Furthermore, parties making claims against us may be able to obtain injunctive or other equitable relief which could effectively block our ability to further develop, commercialize and sell products. In the event of a successful claim of infringement, courts may order us to pay damages and obtain one or more licenses from third parties. We may not be able to obtain these licenses at a reasonable cost, if at all. An unsuccessful defense of any lawsuit or failure to obtain any of these licenses could prevent us from commercializing available products.

If adverse public reaction limits the acceptance of genetically modified products, demand for any products that we or our collaborators may develop in agriculture and nutrition may decrease.

The commercial success of our product candidates in agriculture and nutrition will depend in part on public acceptance of the use of genetically modified products, including drugs, food, plants and plant products. Claims that genetically modified products are unsafe for consumption or pose a danger to the environment may influence public attitudes. Any genetically modified product that our collaborators or we may develop may not gain public acceptance. Due to public reaction in both the United States and Europe, some food processors and restaurants have already decided not to sell food that has been genetically altered or that contains genetically altered ingredients. If this policy continues or becomes more common, there could be a decrease in demand for products that we or our commercial partners may develop.

If we were successfully sued for product liability, we could face substantial liabilities that exceed our resources.

We may be held liable if any product we develop, or any product which is made using our technologies, causes injury or is found unsuitable during product testing, manufacturing, marketing, sale or use. For example, a genetically modified food could, after it is sold, be found to cause illness in individuals who eat the food. Also, like other pharmaceutical products, those produced through genetically modified plants could be found to cause illness. These risks are inherent in the development of chemical, agricultural and pharmaceutical products. We currently do not have product liability insurance. If we choose to obtain product liability insurance but cannot obtain sufficient insurance coverage at an acceptable cost or otherwise protect against potential product liability claims, the commercialization of products that we or our commercial partners develop may be prevented or inhibited. If we are sued for any injury caused by our products, our liability could exceed our total assets.

Any product that we or our commercial partners develop using the gene function information we provide may be subject to a lengthy and uncertain government regulatory process that may not result in the necessary approvals, may delay the commercialization of these products or may be costly, any of which could reduce our revenues.

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Any new product that we or our commercial partners develop will likely undergo an extensive regulatory review process in the United States by the FDA and the USDA and by regulators in other countries before it can be marketed or sold. For example, the FDA must approve any drug or biologic product before it can be marketed in the U.S. This review process can take many years and require substantial expense. In the future, we and our commercial partners may also be required to submit pre-market information to the FDA about food developed through biotechnology. Adverse publicity could lead to greater regulation and trade restrictions on imports and exports of genetically modified products. Changes in the policies of U.S. and foreign regulatory bodies could increase the time required to obtain regulatory approval for each new product.

Our efforts to date have been primarily limited to identifying targets. If regulators approve any products that we or our commercial partners develop, the approval may impose limitations on the uses for which a product may be marketed. Regulators may require the submission of post-market launch information about a product after approving it, and may impose restrictions, including banning the continued sale of the product, if they discover problems with the product or its manufacturer.

Our stock price is extremely volatile.

The stock market has experienced significant price and volume fluctuations, and the market prices of technology companies, particularly life science companies, have been highly volatile. Our common stock began public trading in May 2000. The trading price of our common stock has been extremely volatile, and we believe it will remain highly volatile and may fluctuate substantially.

Our operating results continue to fluctuate, which could cause the price of our common stock to fall.

Our operating results historically have fluctuated on a quarterly basis and are likely to continue to do so in the future. These fluctuations could cause our stock price to fluctuate significantly or decline. Some of the factors, which could cause our operating results to fluctuate, include:

A large portion of our expenses, including expenses for facilities, equipment and personnel are relatively fixed. Accordingly, if revenues decline or do not grow as anticipated due to expiration of commercial partnerships or government contract or research grants, failure to obtain new contracts or other factors, we may not be able to correspondingly reduce our operating expenses. Failure to achieve anticipated levels of revenues could therefore significantly harm our operating results for a particular fiscal period.

Our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price would likely decline.

If our stockholders sell substantial amounts of our common stock, the market price of our common stock may fall.

The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of common stock. As of May 1, 2004, there were 36,214,497 shares of common stock outstanding. All of the (i) 11,847,727 shares sold in our initial public offering and our October 2001 direct offering, (ii) 422,459 shares issued to Celera and subsequently registered on Form S-3, (iii)

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outstanding shares issued pursuant to stock option exercises or purchases under our Employee Stock Purchase Plan that were registered on one of our registration statements on Form S-8, and (iv) shares that have been sold pursuant to Rule 144 or Rule 701 are freely transferable without restriction or further registration under the Securities Act, except for shares purchased by our “affiliates,” as defined in Rule 144 of the Securities Act. The remaining shares of common stock outstanding are “restricted securities” as defined in Rule 144. Holders of these shares may sell them in the future without registration under the Securities Act to the extent permitted by Rule 144 or other exemptions under the Securities Act.

We may face challenges in integrating TissueInformatics.Inc, which could have negative financial consequences to our shareholders and us.

Our acquisition of TissueInformatics.Inc will involve the integration of operations and personnel of TissueInformatics, including, among other things, the integration of TissueInformatics technologies in quantitative tissue analysis with our biomarker and target discovery programs. In addition, we expect to maintain operations in Pennsylvania for some period of time. As a result, we will face challenges in managing an increased number of employees over a geographic distance. The process of this integration could cause an interruption of the activities of our businesses. The inability to successfully integrate the operations and personnel of TissueInformatics could have an adverse effect on us, and, as a result, the market price of our common stock could decline.

Anti-takeover provisions of Delaware law and our charter could make a third-party acquisition of us difficult.

The anti-takeover provisions of Delaware law could make it more difficult for a third party to acquire control of us, even if the change in control would be beneficial to stockholders. We will be subject to the provisions of Section 203 of the General Corporation Law of Delaware. Section 203 will prohibit us from engaging in certain business combinations, unless the business combination is approved in a prescribed manner. Accordingly, Section 203 may discourage, delay or prevent someone from acquiring or merging with us. In addition, our restated certificate of incorporation and amended and restated by-laws contain certain provisions that may make a third party acquisition of us difficult, including:

Some of our existing stockholders can exert control over us and may not make decisions that are in the best interests of all stockholders.

Due to their combined stock holdings, certain institutional stockholders who beneficially own more than five percent of our common stock, if they act together, will be able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of us and might affect the market price of our common stock, even when a change may be in the best interests of all stockholders. In addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders and accordingly, they could cause us to enter into transactions or agreements, which we would not otherwise consider.

Future issuances of preferred stock may dilute the rights of our common stockholders.

Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, privileges and other terms of these shares. The board of directors may exercise this authority without the approval of the stockholders. The rights of the holders of any preferred stock that we may issue in the future may adversely affect the rights of holders of our common stock.

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If performance milestones, as detailed under our merger agreement with TissueInformatics.Inc, are achieved we will be required to issue additional shares which will dilute the rights of our common stockholders.

In March 2004, we issued a total of approximately 3,400,000 shares of our common stock in connection with our acquisition of TissueInformatics.Inc. We may become obligated to issue up to an additional 2,700,000 shares of our common stock on an “earn-out” basis upon the successful achievement of performance milestones on or before December 31, 2004. In connection with the acquisition, we also assumed outstanding options and warrants to purchase up to 385,000 additional shares of our common stock. If we are required to issue additional shares of common stock as a result of the “earn out” or upon the exercise or conversion of assumed options and warrants, our stockholders’ percentage ownership will be diluted.

Although we currently meet all NASDAQ National Market System listing requirements, we could in the future fail to meet such requirements and be delisted from the Nasdaq System.

If we are unable to maintain a $1.00 bid price for our common stock, or maintain $10,000,000 in stockholders’ equity, our common stock would be subject to delisting from the Nasdaq National Market, in which case we plan to apply for continued listing on the Nasdaq SmallCap Market. While we currently meet the criteria that would enable us to transfer to the Nasdaq SmallCap Market, there is no assurance we will be accepted or that we will continue to meet the criteria at the time we apply for SmallCap inclusion. If we could not transfer to the Nasdaq SmallCap Market and were forced to be listed on the NASD’s OTC Bulletin Board, trading in our common stock would likely decrease substantially, or cease altogether, the market price of our common stock may decline further, and stockholders may lose some or all of their investment. Securities analysts’ and news media’s coverage, if any, of us would also be reduced or eliminated altogether. Furthermore, delisting of our common stock from the Nasdaq National Market and subsequent delisting from the Nasdaq SmallCap Market or failure to meet the requirements for transferring to the SmallCap Market could inhibit, if not preclude, our ability to raise additional working capital on acceptable terms, if at all, or to utilize our stock as full or partial consideration for the acquisition of any lines of business from third parties. Additionally, if we continue with our history of net losses and are not successful in raising additional funds, through the sale of our equity securities, our stockholders’ equity could fall below $10 million.

Item 6. Exhibits and Reports on Form 8-K

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On January 30, 2004, the Company filed a report on Form 8-K in conjunction with a press release announcing that the Company had entered into a definitive agreement with TissueInformatics.Inc whereby the Company will acquire TissueInformatics, a privately held company.

On February 20, 2004, the Company furnished a report on Form 8-K in conjunction with a press release announcing the financial results for the quarter and year ended December 31, 2003.

On March 24, 2004, the Company filed a report on Form 8-K in conjunction with a press release announcing the completion of its acquisition of TissueInformatics.Inc.

PARADIGM GENETICS, INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX

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