The following discussion of our financial condition and results of operations as of and for the three and nine months ended September 30, 2009 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, 2008 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 relationship 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 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;

† 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 or maintain regulatory approval;

†          the impact of technological advances and competition;



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

† risks relating to changes in pricing and reimbursements in the markets in which we may compete;

†          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 substantial leverage and limitations on our ability to incur additional indebtedness and incur liens on our assets

imposed by our debt obligations;

† 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," "our" or the "Company" 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 broad pipeline with programs focused primarily in the areas of oncology, inflammation, and diabetes.

Our wholly-owned pipeline includes the following compounds:

Drug Target           Drug Compound                Indication             Development Status

Active Programs

JAK
                   INCB18424 (Oral)      Myelofibrosis                    Phase III
                                         Polycythemia Vera/Essential      Phase II
                                         Thrombocythemia
                   INCB18424 (Topical)   Psoriasis                        Phase IIb
                   INCB28050             Rheumatoid Arthritis             Phase II

HSD1
                   INCB13739             Type 2 Diabetes                  Phase IIb

Sheddase
                   INCB7839              Breast Cancer                    Phase II

Programs pending additional funding or seeking collaborative partner

c-MET
                   INCB28060             Solid Cancers                    IND Cleared

IDO
                   INCB24360             Oncology                         IND Cleared

HM74a
                   INCB19602             Type 2 Diabetes                  Phase IIa

CCR5
                   INCB9471              Human Immunodeficiency Virus     Phase II
                                         (HIV)
                   INCB15050             HIV                              Phase I

Since the beginning of 2009, we have focused our efforts on clinical programs that we believe have the greatest likelihood of creating near-term value and on compounds that we believe a company of our size can effectively develop and commercialize on its own, or that we can further develop and commercialize through strategic relationships. Currently, our highest priority program involves our JAK inhibitors. Our JAK inhibitor program includes an oral formulation of INCB18424 as a treatment for myeloproliferative disorders (myelofibrosis, polycythemia vera and essential thrombocythemia) and certain other oncology indications, a topical formulation of INCB18424 for psoriasis, and an oral formulation of INCB28050 for rheumatoid arthritis and other chronic inflammatory conditions.

We intend to retain rights in the United States for INCB18424 for myeloproliferative disorders and other oncology indications, as we believe this is a market where a company of our size can effectively compete. For markets outside of the United States, we are currently evaluating strategic relationships. We may progress topical INCB18424 for psoriasis on our own, or we may seek to partner INCB18424 for this indication. For INCB28050 for rheumatoid arthritis and other chronic inflammatory conditions, we are evaluating a number of broad global alliances which may allow us to participate in the commercialization of INCB28050 and retain rights in certain indications. We are evaluating strategic relationships with respect to several of our programs and may enter into an agreement with respect to one or more of these programs in the near future. However, these arrangements and negotiations are complex and time consuming and there can be no assurance that we will reach agreement with a strategic partner with respect to any of these programs in the near future or at all.

We have several other oncology programs, including our sheddase inhibitor, INCB7839, that is under development as a treatment for breast cancer. We have two earlier stage oncology programs involving an oral c-MET inhibitor, INCB28060, and an indoleamine dioxygenase, or IDO, inhibitor, INCB24360. We do not intend to initiate clinical trials for either of these programs until we have either secured additional capital or found a strategic partner for these programs.

We have several other clinical programs that target either large primary care indications or require lengthy and expensive clinical development programs. These include: our 11ßHSD1 inhibitors, INCB13739 and INCB20817, for which we have shown positive results for the lead compound in a three-month Phase IIb trial in patients with type 2 diabetes; our HM74a agonist, INCB19602, also for type 2 diabetes; and our CCR5 receptor antagonists, INCB9471 and INCB15050, for HIV. Because these therapeutic areas require greater financial and commercial resources than we currently possess, we are seeking strategic relationships or collaborative partners for these programs.

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:

† Investments;

† Revenue recognition;

† Research and development costs;

† Valuation of long-lived assets;

† Restructuring charges;

† Stock compensation; and

† Convertible debt and derivative accounting

Investments. We carry our investments at their respective fair values. We periodically evaluate the fair values of our investments to determine whether any declines in the fair value of investments represent an other-than-temporary impairment. This evaluation consists of a review of several factors, including the length of time and extent that a security has been in an unrealized loss position, the existence of an event that would impair the issuer's future repayment potential, the near term prospects for recovery of the market value of a security and if we intend to sell or if it is not more likely than not that the we will be required to sell the security before recovery of its amortized cost basis. If management determines that such an impairment exists, we would recognize an impairment charge. Because we may determine that market or business conditions may lead us to sell a short-term investment or marketable security prior to maturity, we classify our short-term investments and marketable securities as "available-for-sale." Investments in securities that are classified as available-for-sale and have readily determinable fair values are measured at fair market value in the balance sheets, and unrealized holding gains and losses for these investments are reported as a separate component of stockholders' equity until realized. We classify those marketable securities that may be used in operations within one year as short-term investments. Those marketable securities in which we have both the ability to hold until maturity and have a maturity date beyond one year from our most recent consolidated balance sheet date are classified as long-term marketable securities.

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.

Research and Development Costs. Our policy is 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.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, 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, including costs resulting from the acquisition of Maxia Pharmaceuticals, Inc. ("Maxia"), 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. 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. Financial Accounting Standards Board ("FASB") accounting guidance for stock compensation 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 fair values. The accounting guidance also 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 and requires the recognition of the fair value of stock compensation in the statement of operations. We recorded $2.2 million and $8.1 million of stock compensation expense for the three and nine months ended September 30, 2009, respectively, and $3.9 million and $11.1 million for the three and nine months ended September 30, 2008, respectively.

Convertible Debt and Derivative Accounting. We perform an assessment of all embedded features of a debt instrument to determine if (1) such features should be bifurcated and separately accounted for, and (2) if bifurcation requirements are met, whether such features should be classified and accounted for as equity or liability. If the embedded feature meets the requirements to be bifurcated and accounted for as a liability, the fair value of the embedded feature is measured initially, included as a liability on the consolidated balance sheet, and remeasured each reporting period. Any changes in fair value are recorded in the consolidated statement of operations. We monitor, on an ongoing basis, whether events or circumstances could give rise to a change in our classification of embedded features.

Due to the variable mix of common stock and series A preferred stock that would be issued to satisfy the conversion of our 4.75% convertible senior notes due 2015 (the "4.75% Senior Notes"), until we have reserved sufficient shares of our common stock for issuance upon conversion of all of the 4.75% Senior Notes, the embedded conversion feature is not considered indexed to our stock. As a result, the embedded conversion feature is not eligible for equity classification and is required to be bifurcated from the underlying debt instrument. Accordingly, the fair value of the embedded conversion feature on September 30, 2009 of $148.1 million was recorded as a derivative liability and the carrying value of the 4.75% Senior Notes was reduced to reflect a debt discount equal to the fair value of the embedded conversion feature. The derivative liability is classified as the embedded derivative liability on 4.75% convertible senior notes in our balance sheet. The derivative liability related to the conversion feature will be revalued on a quarterly basis with changes in fair market value recorded through earnings until we have reserved sufficient shares of our common stock. Once we have reserved sufficient shares of our common stock to satisfy the conversion provisions of the 4.75% Senior Notes, we expect the conversion feature to be considered indexed to our stock at which point the fair value of the conversion feature will be reclassified from a liability into stockholders' deficit. The debt discount related to the derivative liability will be amortized to interest expense over the six year term of the 4.75% Senior Notes using the effective interest method. We valued the embedded conversion feature using a single factor binomial lattice model, with the assistance of a valuation consultant. This model incorporates inputs . . .