The following discussion of our financial condition and results of operations as of and for the three and nine months ended September 30, 2008 should be read in conjunction with the financial statements and notes to those statements included elsewhere in this Quarterly Report on Form 10-Q and our audited financial statements as of and for the year ended December 31, 2007 included in our Annual Report on Form 10-K previously filed with the SEC.

This report contains forward-looking statements that involve risks and uncertainties. These statements relate to future periods, future events or our future operating or financial plans or performance. These statements can often be identified by the use of forward-looking terminology such as "expects," "believes," "intends," "anticipates," "estimates," "plans," "may," or "will," or the negative of these terms, and other similar expressions. These forward-looking statements include statements as to:

† the discovery, development, formulation, manufacturing and commercialization of our compounds and our product candidates;

† focus on our drug discovery and development efforts;

† conducting clinical trials internally, with collaborators, or with clinical research organizations;

† our collaboration and strategic alliance strategy; anticipated benefits and disadvantages of entering into collaboration agreements;

† our licensing, investment and commercialization strategies;

† the regulatory approval process, including determinations to seek U.S. Food and Drug Administration (FDA) and other international health authorities approval for, and plans to commercialize, our products in the United States and abroad;

† the safety, effectiveness and potential benefits and indications of our product candidates and other compounds under development; potential uses for our product candidates and our other compounds;

† the timing and size of our clinical trials; the compounds expected to enter clinical trials; timing of clinical trial results;

† our ability to manage expansion of our drug discovery and development operations;

† future required expertise relating to clinical trials, manufacturing, sales and marketing;

† obtaining and terminating licenses to products, compounds or technology, or other intellectual property rights;

† the receipt from or payments pursuant to collaboration or license agreements resulting from milestones or royalties; the decrease in revenues from our information product-related activities;

† plans to develop and commercialize products on our own;

† plans to use third party manufacturers;

† expected expenses and expenditure levels; expected uses of cash; expected revenues and sources of revenues;

† expected losses; fluctuation of losses;

† our profitability; the adequacy of our capital resources to continue operations;

† the need to raise additional capital;

† the costs associated with resolving matters in litigation;

† our expectations regarding competition;

† our investments, including anticipated expenditures, losses and expenses;

† our gene and genomics-related patent prosecution and maintenance efforts; and

† our indebtedness, and debt service obligations.

These forward-looking statements reflect our current views with respect to future events, are based on assumptions and are subject to risks and uncertainties. These risks and uncertainties could cause actual results to differ materially from those projected and include, but are not limited to:

† our ability to discover, develop, formulate, manufacture and commercialize a drug candidate or product;

† the risk of unanticipated delays in research and development efforts;

† the risk that previous preclinical testing or clinical trial results are not necessarily indicative of future clinical trial results;

† risks relating to the conduct of our clinical trials;

† changing regulatory requirements;

† the risk of adverse safety findings;

† the risk that results of our clinical trials do not support submission of a marketing approval application for our product candidates;

† the risk of significant delays or costs in obtaining regulatory approvals;

† risks relating to our reliance on third party manufacturers, collaborators, and clinical research organizations;

† risks relating to the development of new products and their use by us and our current and potential collaborators;

† risks relating to our inability to control the development of out-licensed drug compounds or drug candidates;

† our ability to in-license a potential drug compound or drug candidate;

† the cost of accessing, licensing or acquiring potential drug compounds or drug candidates developed by other companies;

† the costs of terminating any licensing or access arrangement for third party drug compounds or drug candidates;

† costs associated with prosecuting, maintaining, defending and enforcing patent claims and other intellectual property rights;

† our ability to maintain or obtain adequate product liability and other insurance coverage;

† the risk that our product candidates may not obtain regulatory approval;

† the impact of technological advances and competition;

† the ability to compete against third parties with greater resources than ours;

† competition to develop and commercialize similar drug products;

† our ability to obtain patent protection and freedom to operate for our discoveries and to continue to be effective in expanding our patent coverage;

† the impact of changing laws on our patent portfolio;

† developments in and expenses relating to litigation;

† the impact of past or future acquisitions on our business;

† the results of businesses in which we have made investments;

† our ability to obtain additional capital when needed;

† fluctuations in net cash used by investing activities;

† our history of operating losses; and

† the risks set forth under "Risk Factors."

Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by federal securities laws, we undertake no obligation to update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

In this report all references to "Incyte," "we," "us" or "our" mean Incyte Corporation and our subsidiaries, except where it is made clear that the term means only the parent company.

Incyte is our registered trademark. We also refer to trademarks of other corporations and organizations in this Quarterly Report on Form 10-Q.

Overview

Incyte is a drug discovery and development company focused on developing proprietary small molecule drugs to treat serious unmet medical needs. We have a pipeline with programs in oncology, inflammation, diabetes and human immunodeficiency virus (HIV).

Our wholly-owned pipeline includes the following compounds:

Drug Target           Drug Compound               Indication            Development Status

JAK
                   INCB18424 (Oral)      Myelofibrosis                  Phase II
                                         Polycythemia vera/Essential    Phase II
                                         thrombocythemia
                                         Rheumatoid Arthritis           Phase IIa
                                         Refractory Prostate Cancer     Phase IIa
                                         Multiple Myeloma               Phase IIa

                   INCB18424 (Topical)   Psoriasis                      Phase IIb

                   INCB28050             Rheumatoid Arthritis           Phase I

HSD1
                   INCB13739             Type 2 Diabetes                Phase IIb

                   INCB20817             Type 2 Diabetes                Phase I

HM74a
                   INCB19602             Type 2 Diabetes                Phase IIa

Sheddase

                   INCB7839              Solid Tumors                   Phase IIa
                                         Breast Cancer                  Phase II

CCR2
                   INCB8696              Multiple Sclerosis             Phase I

CCR5
                   INCB9471              HIV                            Phase II

                   INCB15050             HIV                            Phase I

Other
Lead clinical                            Oncology                       Pre-clinical
candidate
Lead clinical                            Oncology                       Pre-clinical
candidate

In March 2008, we announced that we would not advance our lead CCR5 antagonist into Phase IIb trials and that we are seeking to out-license this program. This decision reflects our objective to focus our resources on programs that we believe have the greatest near-term value.

We anticipate incurring additional losses for several years as we expand our drug discovery and development programs. We also expect that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. Conducting clinical trials for our drug candidates in development is a lengthy, time-consuming and expensive process. We do not expect to generate product sales from our drug discovery and development efforts for several years, if at all. If we are unable to successfully develop and market pharmaceutical products over the next several years, our business, financial condition and results of operations would be adversely impacted.

Critical Accounting Policies and Significant Estimates

The preparation of financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions.

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

† Revenue recognition;

† Research and development costs;

† Valuation of long-lived assets;

† Restructuring charges; and

† Stock compensation.

Revenue Recognition. Revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. We have entered into various types of agreements for access to our information databases and use of our intellectual property. Revenues are deferred for fees received before earned or until no further obligations exist. We exercise judgment in determining that collectibility is reasonably assured or that services have been delivered in accordance with the arrangement. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectibility based primarily on the customer's payment history and on the creditworthiness of the customer.

Revenues from ongoing database agreements are recognized evenly over the access period. Revenues from licenses to our intellectual property are recognized when earned under the terms of the related agreements. Royalty revenues are recognized upon the sale of products or services to third parties by the licensee or other agreed upon terms. We estimate royalty revenues based on previous period royalties received and information provided by the third party licensee. We exercise judgment in determining whether the information provided by licensees is sufficiently reliable for us to base our royalty revenue recognition thereon.

Under agreements involving multiple products, services and/or rights to use assets, the multiple elements are divided into separate units of accounting when certain criteria are met, including whether the delivered items have stand alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. When separate units of accounting exist, consideration is allocated among the separate elements based on their respective fair values. The determination of fair value of each element is based on objective evidence from historical sales of the individual elements by us to other customers. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value for each undelivered element does exist or until all elements of the arrangement are delivered. When elements are specifically tied to a separate earnings process, revenue is recognized when the specific performance obligation tied to the element is completed. When revenues for an element are not specifically tied to a separate earnings process, they are recognized ratably over the term of the agreement.

In connection with our collaborative research and license agreement with Pfizer Inc. ("Pfizer"), we received an upfront non-refundable payment of $40.0 million in January 2006. The $40.0 million upfront fee was recorded as deferred revenue and was recognized on a straight-line basis over two years, our estimated performance period under the agreement. In February 2006 and October 2007, Pfizer purchased, for a total of $20.0 million, a convertible subordinated note due 2013 and a convertible subordinated note due 2014 (collectively, the "Pfizer Notes"). As the Pfizer Notes are non-interest bearing, they have been discounted to their net present value. The difference between the cash received and the present value of the Pfizer Notes, plus the related beneficial conversion feature, totals $3.2 million for each note, which represented additional consideration from Pfizer under the agreement. We have accounted for this additional consideration as deferred revenue and have recognized it over our estimated performance period under the agreement. We recognized contract revenues for research services provided by our full time equivalents to Pfizer in the periods in which the services were performed. We received a $3.0 million milestone payment from Pfizer in the second quarter of 2007. All milestone payments will be recognized as revenue upon the achievement of the associated milestone.

Research and Development Costs. In accordance with Statement of Financial Accounting Standards No. 2 ("SFAS 2"), Accounting for Research and Development Costs, it is our policy to expense research and development costs as incurred. We often contract with clinical research organizations ("CROs") to facilitate, coordinate and perform agreed upon research and development of a new drug. To ensure that research and development costs are expensed as incurred, we record monthly accruals for clinical trials and preclinical testing costs based on the work performed under the contract.

These CRO contracts typically call for the payment of fees for services at the initiation of the contract and/or upon the achievement of

certain clinical trial milestones. In the event that we prepay CRO fees, we record the prepayment as a prepaid asset and amortize the asset into research and development expense over the period of time the contracted research and development services are performed in accordance with EITF 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities. Most professional fees, including project and clinical management, data management, monitoring, and medical writing fees are incurred throughout the contract period. These professional fees are expensed based on their percentage of completion at a particular date.

Our CRO contracts generally include pass through fees. Pass through fees include, but are not limited to, regulatory expenses, investigator fees, travel costs, and other miscellaneous costs, including shipping and printing fees. We expense the costs of pass through fees under our CRO contracts as they are incurred, based on the best information available to us at the time. The estimates of the pass through fees incurred are based on the amount of work completed for the clinical trial and are monitored through correspondence with the CROs, internal reviews and a review of contractual terms. The factors utilized to derive the estimates include the number of patients enrolled, duration of the clinical trial, estimated patient attrition, screening rate and length of the dosing regimen. CRO fees incurred to set up the clinical trial are expensed during the setup period.

Valuation of Long-Lived Assets. We assess the impairment of long-lived assets, which includes property and equipment as well as intangible and other assets, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could indicate the need for an impairment review include the following:

† Significant changes in the strategy of our overall business;

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

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

† Significant negative industry or economic trends;

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

† Our market capitalization relative to net book value.

When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, in accordance with Financial Accounting Standards Board ("FASB") Statement No. 144, Accounting for the Impairment or Disposal of Long Lived Assets ("SFAS 144"), we perform an undiscounted cash flow analysis to determine if impairment exists. If impairment exists, we measure the impairment based on the difference between the asset's carrying amount and its fair value.

Restructuring Charges. Costs associated with restructuring activities initiated after December 31, 2002, are accounted for in accordance with FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities("SFAS 146"). Costs associated with restructuring activities initiated prior to December 31, 2002 have been recorded in accordance with Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) ("EITF 94-3") and Staff Accounting Bulletin No. 100, Restructuring and Impairment Charges ("SAB 100"). Restructuring costs resulting from the acquisition of Maxia Pharmaceuticals, Inc. ("Maxia") have been recorded in accordance with EITF Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination ("EITF 95-3"). The restructuring charges are comprised primarily of costs to exit facilities, reduce our workforce, write-off fixed assets, and pay for outside services incurred in the restructuring. The workforce reduction charge is determined based on the estimated severance and fringe benefit charge for identified employees. In calculating the cost to exit the facilities, we estimate for each location the amount to be paid in lease termination payments, the future lease and operating costs to be paid until the lease is terminated, the amount, if any, of sublease receipts and real estate broker fees. This requires us to estimate the timing and costs of each lease to be terminated, the amount of operating costs, and the timing and rate at which we might be able to sublease the site. To form our estimates for these costs, we perform an assessment of the affected facilities and consider the current market conditions for each site. We also estimate our credit adjusted risk free interest rate in order to discount our projected lease payments in accordance with SFAS 146. Estimates are also used in our calculation of the estimated realizable value on equipment that is being held for sale. These estimates are formed based on recent history of sales of similar equipment and market conditions. Our assumptions on either the lease termination payments, operating costs until terminated, the offsetting sublease receipts and estimated realizable value of fixed assets held for sale may turn out to be incorrect and our actual cost may be materially different from our estimates. Our estimates of future liabilities may change, requiring us to record additional restructuring charges or reduce the amount of liabilities recorded.

At the end of each reporting period, we evaluate the remaining accrued balances to ensure their adequacy, that no excess accruals are retained and the utilization of the provisions are for their intended purposes in accordance with developed exit plans. We periodically evaluate current available information and adjust our restructuring reserve as necessary. We also make adjustments related to accrued professional fees to adjust estimated amounts to actual.

Stock Compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) ("SFAS 123R"), Share-Based Payment, which revised Statement of Financial Accounting Standards 123 ("SFAS 123"), Accounting for Stock-Based Compensation. SFAS 123R requires all share-based payment transactions with employees,

including grants of employee stock options, to be recognized as compensation expense over the requisite service period based on their relative fair values. SFAS 123R requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility and expected option lives, as well as expected option forfeiture rates, to value equity-based compensation. SFAS 123R requires the recognition of the fair value of stock compensation in the statement of operations. Prior to the adoption of SFAS 123R, stock-based compensation expense related to employee stock options was not recognized in the statement of operations. Prior to January 1, 2006, we had adopted the disclosure-only provisions under SFAS 123. Under the provisions of SFAS 123R, we recorded $3.9 million and $11.1 million of stock compensation expense for the three and nine months ended September 30, 2008, respectively, and $2.6 million and $7.4 million for the three and nine months ended September 30, 2007, respectively.

Results of Operations

We recorded net losses of $44.8 million and $130.5 million and basic and diluted net losses per share of $0.48 and $1.50 per share for the three and nine months ended September 30, 2008, respectively, as compared to net losses of $24.5 million and $65.1 million and basic and diluted net losses per share of $0.29 and $0.77 per share in the corresponding periods in 2007.

Revenues.



                                      For the three months ended,         For the nine months ended,
                                             September 30,                      September 30,
                                        2008              2007             2008              2007
                                             (in millions)                      (in millions)
Contract revenues                   $           -     $         5.9    $        0.7     $          20.9
License and royalty revenues                  1.1               0.8             2.3                 3.8
Total revenues                      $         1.1     $         6.7    $        3.0     $          24.7

Our contract revenues for the nine months ended September 30, 2008 decreased to $0.7 million from $20.9 million for the nine months ended September 30, 2007 as we have fully recognized at September 30, 2008 contract revenues associated with the Pfizer $40.0 million upfront fee, the debt discount and beneficial conversion feature related to the Pfizer Notes and the reimbursement of certain expenses by Pfizer for research and development expenses pursuant to the collaborative research and license agreement.

Our license and royalty revenues for the nine months ended September 30, 2008 decreased to $2.3 million from $3.8 million for the nine months ended September 30, 2007. License and royalty revenues were derived from the licensing of our gene- and genomic-related intellectual property. We expect that revenues generated from information products, including licensing of gene- and genomic-related intellectual property, will decline as we focus on our drug discovery and development programs.

Operating Expenses.



Research and development expenses.



                                       For the three months ended,          For the nine months ended,
                                              September 30,                        September 30,
                                         2008               2007              2008               2007
                                              (in millions)                        (in millions)
Salary and benefits related         $          8.7     $          7.5    $          26.6     $        23.0
Stock compensation                             2.8                1.8                8.1               5.1
Clinical research and outside
services                                      20.9               11.3               60.8              30.8
Occupancy and all other costs                  4.5                4.4               12.5              13.4

Total research and development
expenses                            $         36.9     $         25.0    $         108.0     $        72.3

We currently track research and development costs by natural expense line and not costs by project. For salary and benefit related costs, the increase from the three and nine months ended September 30, 2007 to the three and nine months ended September 30, 2008 was primarily the result of increased headcount to sustain our development pipeline. Stock compensation increased for the three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007 due primarily to an increase in our average stock price. Stock compensation expense may fluctuate from period to period based on the number of options granted, stock price volatility and expected option lives, as well as expected option forfeiture rates which are used to value equity-based compensation. For clinical research and outside services, the increase from the three and nine months ended September 30, 2007 to the . . .