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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

/x/	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001

/ /	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO .

Commission file number 000-30977

Rosetta Inpharmatics, Inc.
(Exact Name of Registrant as Specified in Its Charter)

Delaware		91-1770023
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

12040 115^th Ave. NE, Kirkland, Washington 98034
(Address of Principal Executive Offices)

(425) 820-8900
(Registrant's Telephone Number, Including Area Code)

Indicate by check whether the issuer (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 / /

State the number of shares outstanding of each of the issuer's classes of common equity as of the latest practicable date.

Class		Outstanding at April 30, 2001
Common Stock, $.001 par value		32,204,417

Page 1 of 31 Pages
Exhibit Index appears on Page 28

Rosetta Inpharmatics, Inc.
Index to Form 10-Q

			Page Number
Part I.	Financial Information
	Item 1.	Financial Statements
		Balance Sheets as of December 31, 2000 and March 31, 2001 (unaudited)	3
		Statements of Operations (unaudited) for the three months ended March 31, 2000 and 2001	4
		Statements of Cash Flows (unaudited) for the three months ended March 31, 2000 and 2001	5
		Notes to Financial Statements	6
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	10
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Part II.	Other Information
	Item 1.	Legal Proceedings	25
	Item 2.	Changes in Securities and Use of Proceeds	25
	Item 6.	Exhibits and Reports on Form 8-K	26
Signature			27

Part I. Financial Information

Item 1: Financial Statements

Rosetta Inpharmatics, Inc.

Balance Sheets

			December 31, 2000			March 31, 2001
						(unaudited)
Assets
Current assets
	Cash and cash equivalents		$	32,584,777		$	53,267,082
	Investments			120,905,029			102,390,857
	Accounts receivable			2,097,871			711,706
	Accounts receivable from related party			2,150,618			939,680
	Interest receivable			898,671			1,524,003
	Prepaid expenses and other current assets			1,472,121			1,535,463

		Total current assets		160,109,087			160,368,791
Property and equipment, net				7,897,491			8,059,190
Intangible assets, net				15,265,084			14,335,369
Deposits and other assets				587,630			638,800

		Total assets	$	183,859,292		$	183,402,150

Liabilities and Stockholders' Equity
Current liabilities
	Accounts payable		$	1,476,876		$	1,284,003
	Accrued liabilities			2,456,651			7,728,730
	Related party payable			2,253,808			479,421
	License fees payable			166,667			166,667
	Deferred revenue			3,985,357			3,690,070
	Current portion of capital lease obligations			145,754			89,505
	Current portion of notes payable			754,475			659,609

		Total current liabilities		11,239,588			14,098,005
Notes payable, net of current portion				488,364			374,165
Deferred revenue				3,705,284			3,984,391

		Total liabilities		15,433,236			18,456,561

Contingencies and commitments
Stockholders' equity
	Common stock, par value $0.001; 75,000,000 shares authorized; 32,083,028 and 32,202,309 shares issued and outstanding			32,083			32,202
	Additional paid-in capital			238,394,336			238,953,121
	Notes and interest receivable from stockholders			(1,711,155	)		(1,737,610	)
	Deferred stock compensation			(6,276,203	)		(5,013,864	)
	Accumulated deficit			(62,013,005	)		(68,030,432	)
	Accumulated other comprehensive income			—			742,172

		Total stockholders' equity		168,426,056			164,945,589

		Total liabilities and stockholders' equity	$	183,859,292		$	183,402,150

See accompanying notes.

Rosetta Inpharmatics, Inc.

Statements of Operations

(Unaudited)

			Three Months Ended March 31,
			2000			2001
Revenues
	Collaboration agreements		$	547,977		$	3,767,942
	Product revenue			—			919,573

		Total revenues		547,977			4,687,515

Operating expenses
	Cost of product revenue			—			332,385
	Research and development (excludes stock-based compensation expense of $806,205 and $473,963 respectively)			3,286,032			6,851,538
	Marketing, general and administrative (excludes stock-based compensation expense of $1,670,121 and $776,734 respectively)			2,950,032			4,649,526
	Stock-based compensation			2,476,326			1,250,697

		Total operating expenses		8,712,390			13,084,146

Loss from operations				(8,164,413	)		(8,396,631	)
Other income (expense)
	Interest income			365,596			2,376,876
	Interest expense			(70,915	)		(25,823	)
	Other, net			(25,870	)		28,151

Net loss				(7,895,602	)		(6,017,427	)
Deemed dividend upon issuance of Series E convertible preferred stock				(7,285,500	)		—

Net loss attributable to common stockholders			$	(15,181,102	)	$	(6,017,427	)

Basic and diluted net loss per share			$	(2.77	)	$	(.19	)

Weighted-average shares used in computing basic and diluted net loss per share				5,472,798			31,623,383

See accompanying notes.

Rosetta Inpharmatics, Inc.

Statements of Cash Flows

(Unaudited)

				Three Months Ended March 31,
				2000			2001
Cash flows from operating activities
Net loss				$	(7,895,602	)	$	(6,017,427	)
Adjustments to reconcile net loss to net cash used in operating activities
	Depreciation and amortization				346,204			695,204
	Stock-based compensation				2,476,326			1,250,697
	Loss on sale and write-off of property and equipment				35,004			2,040
	Amortization of intangible assets				814,778			1,067,259
	Realized gain on disposal of investments				—			(20,704	)
	Investment amortization				(53,513	)		(651,445	)
	Changes in operating assets and liabilities:
		Accounts receivable			130,729			2,597,103
		Interest receivable			(212,803	)		(651,787	)
		Prepaid expenses and other assets			(453,694	)		(120,397	)
		Accounts payable			374,501			(336,249	)
		Accrued liabilities			(354,752	)		3,641,068
		Deferred revenue			788,674			(16,180	)

			Net cash provided by (used in) operating activities		(4,004,148	)		1,439,182

Cash flows from investing activities
Purchases of property and equipment					(688,137	)		(858,943	)
Capitalized software development costs					—			(131,659	)
Purchase of license agreement					(1,000,000	)		—
Purchases of short-term investments					(5,697,631	)		(29,957,709	)
Proceeds from sale and maturity of short-term investments					8,019,000			49,886,202

			Net cash provided by investing activities		633,232			18,937,891

Cash flows from financing activities
Payments on capital lease obligations					(50,074	)		(56,249	)
Payments on notes payable					(197,919	)		(209,065	)
Proceeds from issuance of preferred stock					41,306,487			—
Proceeds from issuance of common stock					511,859			570,546

			Net cash provided by financing activities		41,570,353			305,232

Net increase in cash and cash equivalents					38,199,437			20,682,305
Cash and cash equivalents, beginning of period					8,311,852			32,584,777

Cash and cash equivalents, end of period				$	46,511,289		$	53,267,082

Supplemental disclosure of cash flow information
Cash paid for interest				$	70,915		$	41,687

Common stock issued for notes receivable				$	1,627,500		$	—

Common stock issued for sub-licensing agreement				$	7,556,208		$	—

See accompanying notes.

Rosetta Inpharmatics, Inc.

Notes to Financial Statements

(Unaudited)

1. Basis of Presentation

The accompanying unaudited financial statements of Rosetta Inpharmatics, Inc. ("Rosetta") have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and reflect all adjustments consisting of normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the results for the periods shown. They do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period.

The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These financial statements should be read in conjunction with the audited financial statements and footnotes thereto included in the Form 10-K for the year ended December 31, 2000 and filed with the Securities and Exchange Commission on March 30, 2001.

The preparation of financial statements in conformity with generally accepted accounting principles 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 that effect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

2. Net Loss per Share

Basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period, less the weighted-average number of unvested shares of common stock issued that are subject to repurchase. Rosetta has excluded all convertible preferred stock, warrants to purchase convertible preferred stock, outstanding options and warrants to purchase common stock and common stock subject to repurchase from the calculation of diluted net

loss per share, as such securities are antidilutive for all periods presented. The following table presents the calculation of basic and diluted (unaudited) net loss per share:

		Three Months Ended March 31,
		2000			2001
Net loss		$	(7,895,602	)	$	(6,017,427	)
Deemed dividend upon issuance of convertible preferred stock			(7,285,500	)		—

Net loss attributable to common stockholders		$	(15,181,102	)	$	(6,017,427	)

Basic and diluted
	Weighted-average shares of common stock used in computing basic and diluted net loss per share		5,472,798			31,623,383

	Basic and diluted net loss per share	$	(2.77	)	$	(0.19	)

Antidilutive securities not included in diluted net loss per share calculation
	Convertible preferred stock		14,597,342			—
	Options to purchase common stock		2,148,945			3,106,709
	Warrants to purchase common stock		891,636			128,391
	Warrants to purchase Series A preferred stock		255,408			—
	Warrants to purchase Series B preferred stock		134,596			—
	Warrants to purchase Series C preferred stock		54,949			—
	Warrants to purchase Series E preferred stock		26,709			—
	Unvested shares of common stock subject to repurchase		1,033,871			484,263

			19,143,456			3,719,363

3. Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, and for hedging activities. SFAS 133, as amended by SFAS 138, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS 133 on January 1, 2001 did not have any impact on Rosetta's financial statements.

4. Investments

Investments consisted of the following at:

	December 31, 2000		March 31, 2001
Certificate of deposit	$	—	$	1,001,480
Commercial paper		50,106,121		15,305,029
Market auction preferreds		13,350,000		16,875,000
Government securities		6,233,940		9,409,996
Corporate notes		51,214,968		59,799,352

	$	120,905,029	$	102,390,857

5. Prepaid Expenses and Other Assets

Prepaid expenses and other assets consisted of the following at:

	December 31, 2000		March 31, 2001
Prepaid expenses	$	1,034,761	$	932,280
Inventory		120,156		276,591
Capitalized software, net		115,600		109,715
Other current assets		201,604		216,877

	$	1,472,121	$	1,535,463

6. Property and Equipment

Property and equipment consisted of the following at:

	December 31, 2000			March 31, 2001
Computer equipment	$	4,613,918		$	5,200,931
Lab equipment and technology development equipment		3,302,233			3,375,263
Office equipment, furniture and fixtures		790,060			810,858
Leasehold improvements		2,591,569			2,767,119

		11,297,780			12,154,171
Less: accumulated depreciation and amortization		(3,400,289	)		(4,094,981	)

	$	7,897,491		$	8,059,190

7. Intangible Assets

Intangible assets consisted of the following at:

	December 31, 2000			March 31, 2001
Purchased technology	$	9,443,000		$	9,443,000
License agreement		8,802,155			8,802,155
Goodwill		1,970,515			1,970,515
Assembled workforce		1,298,571			1,298,571
Trademarks and trade names		40,000			40,000

		21,554,241			21,554,241
Less: accumulated amortization		(6,289,157	)		(7,218,872	)

	$	15,265,084		$	14,335,369

8. Accrued Liabilities

Accrued liabilities consisted of the following at:

	December 31, 2000		March 31, 2001
Accrued legal and accounting fees	$	315,571	$	735,263
Deferred compensation		1,437,421		896,410
Refundable deposit on collaboration agreement		—		5,000,000
Other accrued liabilities		703,659		1,097,057

	$	2,456,651	$	7,728,730

9. Comprehensive Loss

The following table sets forth a reconciliation of net loss to comprehensive net loss:

	Three Months Ended March 31, 2000			Three Months Ended March 31, 2001
Net loss	$	(7,895,602	)	$	(6,017,427	)
Net unrealized gain on investments		—			742,172

Net comprehensive loss	$	(7,895,602	)	$	(5,275,255	)

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1993 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict, potential or continue, the negative of terms like these or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. In evaluating these statements, you should specifically consider various factors, including the risks outlined under the caption "Risk Factors" set forth at the end of this Item 2, the Risk Factors set forth in our Form 10-K dated March 30, 2001 and filed with the Securities and Exchange Commission and those contained from time to time in our other filings with the SEC. We caution investors that our business and financial performance are subject to substantial risks and uncertainties.

Overview

We are a leader in the emerging field of informational genomics. Our technology platform consists of the Rosetta Resolver™ Expression Data Analysis System ("Rosetta Resolver System"), our FlexJet™ DNA microarrays and our coherent data sets of information generated from DNA microarrays. We generate revenue by providing our technologies as individual components sold either by ourselves or our partners or as an integrated platform as part of research collaborations with pharmaceutical, biotechnology and agricultural customers. From our inception in December 1996 through June 2000, our operating activities were primarily devoted to research and development of technologies for our informational genomics platform, including the development of the Rosetta Resolver System and the FlexJet DNA microarrays, acquiring assets, recruiting personnel, business development and raising capital.

In October 1999, we entered into a seven-year strategic collaboration with Agilent Technologies, Inc. ("Agilent"). We agreed to exclusively partner with Agilent to make and sell products and services in the gene expression field, including DNA microarrays, DNA microarray design services, gene expression data analysis systems and other products. Agilent also purchased 2,285,714 shares of our Series D preferred stock at a per-share price of $5.25. In August 2000, we sold Agilent 714,285 shares of common stock at $14.00 per share in a private placement that closed concurrently with our initial public offering. Under the collaboration agreement, we co-market the Rosetta Resolver System with Agilent on an exclusive basis and share revenues for Rosetta Resolver System sales and DNA microarray design services.

Agilent also has the exclusive right to market and sell DNA microarrays manufactured using our inkjet and related DNA microarray design technology in exchange for royalty payments to us. In connection with this agreement, we have received payments of $7.4 million for research and development and for certain licensing rights as of March 31, 2001, of which $2.1 million was recorded as revenue through March 31, 2001, and $5.3 million was recorded as deferred revenue as of March 31, 2001. Agilent has agreed to pay us additional amounts during the remainder of 2001 as well as during 2002 for research and development activities. All research, development and licensing amounts previously paid as well as fixed amounts to be paid in connection with this agreement are being recognized as revenue ratably over the term of the agreement.

In May 2000, we entered into a supply agreement with Agilent pursuant to which Agilent supplies us with DNA microarrays. Our current purchase forecast for DNA microarrays during 2001 is

approximately $14.7 million. Our purchase obligations under this agreement may be reduced or increased if we provide revised forecasts to Agilent or if the parties otherwise agree during semiannual performance review meetings. In connection with this agreement, Agilent has paid us $3.0 million for the transfer of certain know how and technology related to our inkjet technology.

In June 2000, we commercially released the Rosetta Resolver System, an enterprise-wide, bioinformatics solution for deciphering the increasing amount of gene-expression data being generated as a result of the recent advances in genomics. The Rosetta Resolver System represents a major component of Rosetta's flexible gene-expression analysis platform. During the three months ended March 31, 2001, we installed a commercial version of the Rosetta Resolver System at Renovis, Inc. Additionally, we have received purchase orders from Biogen, Inc. and the University of Washington for the Rosetta Resolver System, both of which have not been installed yet as of March 31, 2001.

In November 2000, we entered into a three-year collaboration agreement with the Monsanto Company. Under the terms of the agreement, Monsanto has committed to pay us $15 million over a three-year period for the delivery of a substantial body of gene expression information. In addition, we have the potential to receive future payments, including royalties associated with the development of commercial products that incorporate discoveries from the collaboration.

Since our inception, we have incurred significant losses and as of March 31, 2001, we had an accumulated deficit of $68.0 million. Our losses have resulted principally from research and development costs, marketing costs, general and administrative costs associated with our operations and non-cash stock-based compensation expenses associated with stock options granted to employees and consultants prior to the closing of our initial public offering in August 2000. Operating expenses increased to $13.1 million for the three months ended March 31, 2001 compared to $8.7 million for the same period in 2000. We expect to incur additional operating losses over at least the next several years as we continue to expand our research and product development efforts and infrastructure.

To date, our revenue has been derived principally from the sale of Rosetta Resolver Systems and from collaborations. We have generated a substantial portion of our revenue to date from a limited number of sources. Our potential sources of revenue for the next several years are likely to be from the sale of our products and services by Agilent, research payments under existing and possible future collaborative arrangements, government research grants and royalties from collaborators based on revenues received from products commercialized under those agreements.

In view of our limited operating history and the rapidly evolving nature of our business, we believe that period-to-period comparisons of our operating results may not be meaningful and should not be relied upon as an indication of future performance.

Stock-Based Compensation

Stock-based compensation expense results from stock options granted to employees at exercise prices less than the fair market value of the common stock on the date of grant, options granted to outside consultants for services and for the sale of restricted stock to founders deemed to be nonemployees. Through March 31, 2001, we have recorded total deferred stock-based compensation of $19.8 million, of which $5.0 million remains unamortized as of March 31, 2001. Deferred stock-based compensation expense is being amortized to expense over the vesting periods of the underlying options, generally four years. Based on deferred stock-based compensation recorded as of March 31, 2001, we expect to record amortization for deferred stock-based compensation expense approximately as follows: $2.6 million for the remainder of 2001, $1.8 million in fiscal year 2002, $589,000 in fiscal year 2003 and $12,000 in fiscal year 2004. The amount of deferred compensation expected to be recorded in future periods may decrease if unvested options for which deferred stock-based compensation has been recorded are subsequently canceled or forfeited. The amount of deferred compensation expected to be

recorded in future years may increase if additional awards of options or shares are made for consideration that is less than fair value.

Results of Operations

Three Months Ended March 31, 2001 and 2000

Revenues. Revenues increased to $4.7 million for the three months ended March 31, 2001 from $548,000 for the three months ended March 31, 2000. The increase in revenues is primarily attributable to revenue recognized under our collaboration agreement with Monsanto ($2.5 million) and revenue recognized for licensing the Rosetta Resolver System ($920,000).

Cost of product sales. Cost of product sales increased to $332,000 for the three months ended March 31, 2001 from $0 for the three months ended March 31, 2000. The increase was primarily related to the third-party hardware and software costs associated with the revenue recognized for Rosetta Resolver System sales.

Research and development expenses. Research and development expenses increased to $6.9 million for the three months ended March 31, 2001 from $3.3 million for the six months ended March 31, 2000. The increase was primarily due to increased payroll and personnel expenses, increased usage of laboratory materials and supplies (including the purchase of DNA microarrays from Agilent) related to conducting research under collaboration agreements as well as internal efforts, facility costs and depreciation of leasehold improvements and laboratory equipment. The number of research and development personnel increased to 134 at March 31, 2001 compared to 83 at March 31, 2000. Research and development expenses consisted of costs to fulfill objectives of ongoing collaboration agreements, develop and use proprietary technologies to analyze DNA microarrays, build coherent data sets of expression profiles and to update and support the Rosetta Resolver System. We expect research and development expenses to increase significantly in the future to support the expansion of our research and development activities, accommodate existing and possible future collaborations, expand the production of our high-throughput gene expression profiling process and fund our obligations under the supply agreement we entered into with Agilent in May 2000, under which our current purchase forecast for DNA microarrays during 2001 is $14.7 million. Our purchase obligations under this agreement may be reduced or increased if we provide revised forecasts to Agilent or if the parties otherwise agree during semiannual performance review meetings.

Marketing, general and administrative expenses. Marketing, general and administrative expenses increased to $4.6 million for the three months ended March 31, 2001 from $3.0 million for the three months ended March 31, 2000. The increase was primarily due to increased payroll and personnel expenses, legal fees associated with intellectual property issues, business development activities and costs related to marketing the Rosetta Resolver System. We expect marketing, general and administrative expenses to continue to increase in the future to support the marketing of our products and efforts to engage in collaborations, the expansion of our business activities, and the protection of our intellectual property. In addition, we entered into a license agreement with Oxford Gene Technology in March 2000 for which we recorded an asset of $8.8 million. The amortization of this asset resulted in an increase in amortization expense of $262,000 for the three months ended March 31, 2001 compared to the comparable period in 2000. This agreement will result in $995,000 of amortization expense for the remainder of 2001 and will result in future amortization amounts of $1.3 million per year thereafter for the estimated useful life of this license, seven years.

Stock-based compensation. Stock-based compensation expense in 2001 and 2000 resulted from stock options granted to employees from 1998 through 2000 at exercise prices subsequently deemed to be less than the fair market value of the common stock on the date of grant to employees, options granted to outside consultants for services and for the sale of restricted stock to founders deemed to be

nonemployees. Deferred stock-based compensation is being amortized to expense over the vesting periods of the underlying options, generally four years. Stock-based compensation expense totaled $1.3 million for the three months ended March 31, 2001 compared to $2.5 million for the comparable period in 2000. The decrease in stock-based compensation expense for the periods is primarily attributable to the effects of the accelerated amortization method permitted by Financial Accounting Standards Board Interpretation No. 28.

Interest income. Interest income increased to $2.4 million for the three months ended March 31, 2001 from $366,000 for the comparable period in 2000. The increase was primarily due to higher average balances of cash and cash equivalents and investments for the period ended March 31, 2001 compared to the three month period ended March 31, 2000. The increase in average balances was primarily the result of the proceeds from the sale of Series E preferred stock in March 2000, and the initial public offering of our common stock and private placement with Agilent in August of 2000.

Deemed dividend upon issuance of convertible preferred stock. We recorded a deemed dividend of $7.3 million in March 2000 upon the issuance of Series E convertible preferred stock. At the date of issuance, we believed the per-share price of $9.36 represented the fair market value of the preferred stock and that it was in excess of the fair market value of our common stock. Subsequent to the commencement of our initial public offering process, we reevaluated the fair market value of our common stock as of March 2000 and determined it to be $11.00 per share. Accordingly, the incremental fair market value is deemed to be the equivalent of a preferred stock dividend. We recorded the deemed dividend at the date of issuance by offsetting charges and credits to additional paid-in capital, without any effect on total stockholders' equity. The amount increased the loss allocable to common stockholders in the calculation of basic and diluted net loss per share for 2000.

Liquidity and Capital Resources

From inception through March 31, 2001, we have funded our operations with the net proceeds of $106.3 million from our initial public offering, $89.2 million from private equity financings, $16.9 million from collaboration agreements and $3.3 million from equipment financing arrangements. At March 31, 2001, cash and cash equivalents and investments totaled $155.7 million. Our cash reserves are held in a variety of short-term interest-bearing instruments, including high-grade corporate bonds, commercial paper and money market accounts.

Cash provided by operations for the three months ended March 31, 2001 was $1.5 million compared to cash used in operations of $4.0 million for the comparable period in 2000. The improvement in operating cash flows was primarily the result of favorable changes in working capital as our operating losses were offset by decreases in accounts receivable and increases in accrued liabilities. We do not expect this favorable working capital trend to continue in the future. In addition, our net losses of $6.0 million and $7.9 million for the three month periods ended March 31, 2001 and 2000, respectively, were partially offset by non-cash charges of $3.0 million and $3.6 million, respectively, related to stock-based compensation, amortization, depreciation expense and amortization of intangible assets.

Investing activities for the three months ended March 31, 2001, other than changes in our investments, consumed $991,000 due to expenditures on leasehold improvements, capital expenditures and expenditures pursuant to license agreements. Investing activities for the comparable period in 2000, other than the changes in our investments, used $1.7 million primarily due to leasehold improvements and capital expenditures. We expect capital expenditures to increase in the future as we build additional infrastructure for our informational genomics systems and expand our facilities.

Cash provided by financing activities for the three months ended March 31, 2001 was $305,000 compared to $41.6 million for the comparable period in 2000. Financing activities for the period in

2000 included the sale of 4,442,378 shares of Series E preferred stock to investors for net proceeds of $41.3 million.

In connection with financing arrangements for the purchase of property and equipment entered into from 1997 through 1999, we had $1.1 million in capitalized lease obligations and notes payable at March 31, 2001. These obligations bear interest at a weighted-average fixed rate of approximately 12.3%.

Our capital requirements depend on numerous factors, including market acceptance of our products, the resources we devote to developing and supporting our products and other factors. We expect to devote substantial capital resources to expand our research and development efforts, to expand marketing and sales efforts to support our products and services and for other general corporate activities. In connection with our research and development efforts, in May 2000 we entered into a supply agreement with Agilent under which our current purchase forecast for DNA microarrays during 2001 is $14.7 million. Our purchase obligations under this agreement may be reduced or increased if we provide revised forecasts to Agilent or if the parties otherwise agree during semiannual performance review meetings. We believe that our current cash balances, together with the net proceeds from the initial public offering of our common stock, the proceeds of the concurrent private placement to Agilent and revenue to be derived from our collaboration with Agilent, including revenue from the sales of the Rosetta Resolver System, will be sufficient to fund our operations at least through December 31, 2002. After this period, we may need to sell additional equity or debt securities or obtain additional credit arrangements. Additional financing may not be available on terms acceptable to us, or at all.

Recent Accounting Pronouncements

Risk Factors

We are at an early stage of development and may not succeed or become profitable.

We commenced operations in December 1996, are at an early stage of development, and have a limited operating history. We have just begun to incorporate our technologies into commercialized products and our commercialization of them may not be successful. We have recently begun commercial sales of the Rosetta Resolver System. All commercial sales are subject to negotiation and execution of definitive agreements, and the execution of definitive agreements may not occur in a timely manner or at all. Agilent, our strategic partner, has recently begun commercial distribution of DNA microarrays employing Rosetta's technology. The Rosetta Resolver System is currently being used by us internally and by a limited number of customers. As a result, our business is subject to all of the risks inherent in the development of a new business enterprise, such as the need to:

•: develop a market for our products and services;
•: successfully transition from a company with a research focus to a company capable of supporting commercial activities; and
•: attract and retain qualified management, sales, technical and scientific staff.

We expect to incur substantial operating losses in the future and, as a result, the value of our stock could decrease.

Our expenses have significantly exceeded revenue in each of the years since our inception. We are uncertain when, if ever, we will become profitable. We have incurred operating losses since our inception and we had no revenue in 1997 and 1998 and only limited revenue from collaborations, the sale of Rosetta Resolver Systems and government grants in 1999, 2000 and the first part of 2001. Our Rosetta Resolver System was introduced in 2000 and to date we have recorded $4.8 in revenue from sales of the system. As of March 31, 2001, we had an accumulated deficit of $68.0 million. We expect to continue to experience significant operating losses in the future as we continue our research and development efforts, further develop our products and services and expand our marketing and sales force in an effort to commercialize our products. The expansion of our operations will require substantial expenditures on our part for at least the next several years to support growth of the organization. In addition, we anticipate continued spending in research and development to remain a leader in our industry, as well as to meet our obligations under the supply agreement with Agilent. As a result, we expect to incur operating losses in the future, we may require additional funding, and the value of our stock could decrease.

If our existing collaboration with Agilent fails, is terminated, or if their ability to supply microarrays ceases or is limited, our potential revenues and development funds would be significantly reduced.

In our collaboration agreement with Agilent, we agreed to partner with them to make and sell products in the gene expression field including the Rosetta Resolver System, microarrays, array design services and other products. As part of our agreement, Agilent has the co-exclusive right to sell the Rosetta Resolver System and to use our inkjet synthesizer and related chip design technology in exchange for royalty payments. We also rely on Agilent for significant financial and technical contributions in connection with the development of products covered by the agreement. Our ability to develop, manufacture, and market these products successfully depends significantly on Agilent's performance under this agreement. In addition, in May 2000, we entered into a supply agreement with Agilent to supply us with DNA microarrays. If Agilent experiences manufacturing or distribution difficulties under these agreements, has difficulty obtaining or maintaining intellectual property rights, does not actively market the Rosetta Resolver System or does not otherwise perform its obligations under these agreements, our revenue derived from third party collaborations, revenues from the Rosetta Resolver System or other products and services, and our royalty revenue derived from Agilent's sales of DNA microarrays manufactured using Rosetta's inkjet technology could harm our business and financial condition.

Our collaboration agreement with Agilent may be terminated early by Agilent under certain circumstances, including the breach of exclusivity and confidentiality by us. If Agilent were to terminate its agreement with us, we could lose significant revenue and have limited means to commercialize our products. In addition, we would need to obtain development funding from other sources, and we may be required to find one or more other collaborators for the development and commercialization of our products. Agilent's early termination of our collaboration could harm our business and financial condition.

If we do not retain our customers and partners or obtain new customers and partners, our operating results will be materially and adversely affected.

Our strategy depends on selling our informational genomics products and services to pharmaceutical, biotechnology and agriculture companies. Historically, we have had very few customers and partners from which two, Agilent and Monsanto, we have derived the majority of our revenue. If we were to lose any one of these customers or partners, our revenue would decrease substantially. Agilent and Monsanto accounted for 15% and 53%, respectively, of the total revenues for the first

three months of 2001 and 49% and 9%, respectively, of the total revenue for the year ended December 31, 2000. We expect that we will continue to rely on a narrow base of customers and partners for the majority of our revenue for the foreseeable future. Although we are seeking to expand our customer and partner base, these efforts may not be successful. Our sales and revenues would be adversely affected if any significant customer or partner were to discontinue or significantly reduce the use of products or services or if we fail to obtain additional customers or partners.

If our technologies and initial commercial products to not achieve market acceptance or do not become commercially viable or successful, our results of operations would be adversely affected.

Our application of innovative informational genomics tools to drug discovery is a new and unproven approach. Market acceptance of our products and services will depend upon many factors which are not within our control, such as:

•: continued growth in the bioinformatics industry;
•: the availability and price of competing products, services and technologies; and
•: the success of our marketing and sales efforts.

If we are unable to compete successfully against existing technologies, our results of operations would be materially and adversely affected.

Our business depends upon successfully competing in the development and commercialization of products and services that improve the efficiency of the drug discovery process. Our drug discovery technology may not result in any commercially successful product or results. We may fail to compete successfully if:

•: our products or services are found to be ineffective or unreliable;
•: our products are difficult to manufacture or uneconomical to market;
•: unforeseen complications in the development or delivery of our products and services increase the costs of development of our products and services;
•: the proprietary rights of third parties preclude us or our collaborative partners from marketing our products; or
•: potential customers fail to use our technology and instead rely on existing internal processes or technologies or alternative technologies.

If we are unable to maintain or to enter into new collaborations or licensing arrangements, we will be limited in our ability to further commercialize our products.

We intend to enter into collaborative arrangements with pharmaceutical, biotechnology, and agricultural companies to apply our technology, to fund development and to commercialize our potential future products. We may not be able to negotiate collaborative agreements on acceptable terms, if at all, and such collaborative agreements may not be successful and may not provide us with expected benefits. To the extent we choose not to or are unable to enter into such collaborative agreements, we will require substantially greater capital to undertake the research, development, marketing, sales and distribution of systems and technologies at our own expense, which would increase our operating expenses and harm our revenues.

Additionally, our present or future collaborative partners may not perform their obligations under our agreements with them or may not devote sufficient resources to the development, testing or marketing of our potential products developed under collaborations. If one of our collaboration partners were to develop technologies or components competitive with our technologies or components

in parallel with us, or if we are precluded from entering into competitive arrangements under the terms of our collaboration agreements, our potential products could be rendered uncompetitive or obsolete, which would adversely affect our ability to generate sales and revenues. In addition, any premature termination of a collaboration agreement could have a material adverse effect on our revenue growth and potential profitability.

Generally, the terms of our collaboration agreements provide for a division of responsibility between us and our collaborators. Disputes concerning our obligations and rights under these agreements could result in litigation or arbitration, which would be time-consuming and expensive.

Fluctuations in our quarterly results of operations could cause our stock price to decline.

Our quarterly operating results have fluctuated in the past and are likely to do so in the future. Some of the factors that could cause our operating results to fluctuate include:

•: the timing and amount of revenue resulting from collaborations, product sales and royalties is not wholly predictable nor consistent from quarter to quarter;
•: changes in our percentage share of revenue generated from our collaboration with Agilent;
•: the success rate of our discovery efforts leading to milestone payments or royalties;
•: the timing and willingness of collaborators to commercialize products discovered through the use of our products or services which would result in milestone payments or royalties;
•: the expiration of research contracts with collaborators, which may not be renewed or replaced; and
•: general and industry-specific economic conditions, which may affect our collaborators' research and development expenditures.

Large portions of our expenses are relatively fixed, including expenses for facilities, equipment, and personnel. Accordingly, if revenues decline or do not grow as anticipated due to expiration of research contracts, failure to obtain new contracts or other factors, we may not be able to correspondingly reduce our operating expenses. In addition, we plan to significantly increase operating expenses in order to accelerate our product development and sales and marketing efforts. Due to the possibility of fluctuations in our revenues and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price could decline.

If we are unable to protect our proprietary rights adequately or operate without violating the intellectual property of others, our competitive position will suffer and our business and financial condition would be adversely affected.

Our success will depend, in large part, on our ability to obtain patent protection for our products and technologies, both in the United States and in other countries, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. Our patent portfolio may not protect our technologies or products for any one or more of the following reasons:

•: some or all of our pending patent applications may not result in issued patents and our competitors may be able to commercialize our discoveries;
•: we may develop additional proprietary technologies that are not patentable;
•: any patents issued to us may not cover commercially viable products;

•: any patents issued to us may not provide us with reasonable scope so as to block others from using our or similar technology;
•: any patents issued to us or to our licensors may be challenged, circumvented or invalidated by third parties; and
•: third parties may have patents of their own which could, if asserted, prevent us from practicing our patented technologies.

Even if we are able to obtain new patents, these patents may not provide us with substantial or meaningful protection or be commercially beneficial to us.

The laws of some foreign countries may not protect our intellectual property to the same extent that United States law does. Patent law is unsettled or undergoing review and revision in many countries. In addition, we could be forced to participate in opposition proceedings to determine the validity of our or our competitors' foreign patents, which could be costly and divert management's attention from other business concerns.

Should third parties file patent applications, or be issued patents, claiming technology also claimed by us in pending applications, we may be required to participate in interference proceedings in the United States Patent and Trademark Office to determine priority of invention. We also could be required to participate in interference proceedings involving our issued patents and pending applications of another entity. An adverse outcome in an interference proceeding could require us to cease using the technology or to license rights from prevailing third parties. There is no guarantee that any prevailing party would offer us a license or that such a license, if made available to us, could be acquired on commercially acceptable terms.

In order to protect or enforce our patent rights, we may become involved in patent litigation. These lawsuits would put our patents at risk of being invalidated or interpreted narrowly. We may also provoke third parties to assert claims against us. We may also participate in patent litigation to invalidate the patents of another. The outcome of any such potential suit is uncertain. Any lawsuits regarding intellectual property could be expensive, take significant time, and divert management's attention from other business concerns.

Third parties may claim we are infringing, including inducing others to infringe, their patents and other intellectual property, and we could suffer significant litigation or licensing expenses. We are aware that one of our commercial partners, Oxford Gene Technology, was involved in patent litigation with a second commercial partner, Affymetrix. In connection with that litigation, in May 2000 we received a third-party subpoena from Affymetrix requesting, among other things, documents relating to our DNA microarray development activities and our relationship with each of Oxford Gene Technology and Agilent, and we timely filed our initial response to the subpoena. The litigation between Oxford Gene Technology and Affymetrix was subsequently settled. While we are not currently a party to any litigation against us, third parties, including Affymetrix, may assert claims against us relating to our activities or to agreements with our commercial partners, including Oxford Gene Technology or Agilent, or other matters relating to such third party's intellectual property rights.

While we do not believe that any of our products or activities infringe any valid patent or other intellectual property of third parties, we may be unaware of patents or other intellectual property of others that may cover some of our technology, products or services. If we do not prevail in any proceeding or litigation, in addition to any damages we might have to pay, we could be required to stop the infringing activity or we may need to obtain a license to the intellectual property in question. We may not be able to obtain the necessary license to the intellectual property in order to avoid infringement, or negotiate such a license on reasonable terms, if at all. Even if we were able to obtain a license to such technology, some licenses may be non-exclusive, thereby giving our competitors access to the same technologies licensed to us. Ultimately we may be unable to sell some of our products or

may have to cease certain business operations, which would have a material adverse effect on our revenues. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks.

If our measures to protect our confidential and proprietary information fail, this information may be compromised and our competitive position will suffer.

We have taken security measures to protect our proprietary technologies, processes, information systems and data, and continue to explore ways to enhance such security. These measures may not provide adequate protection for our trade secrets or other proprietary information. While we require employees, academic collaborators and consultants to enter into confidentiality agreements where appropriate, any of the following could occur:

•: our proprietary information could be disclosed;
•: our trade secrets could be disclosed; or
•: others may independently develop substantially equivalent proprietary information and techniques, otherwise gain access to our trade secrets or disclose such technology.

If any of these events occur, our proprietary and confidential information would be compromised and our competitive position would suffer.

Intense competition in the market could prevent us from increasing our revenues and achieving profitability or result in the obsolescence of our technology.

The genomics industry is highly competitive. We compete with companies in the United States and abroad that are engaged in the development and production of products that analyze, collect, and manage genetic information and genomic data. Our competition in the United States and abroad can be broken down into the following categories:

•: bioinformatics solution providers, which are custom integrators, providers of desktop analysis tools and providers of database software;
•: array providers, which are commercial manufacturers of oligonucleotide microarrays and cDNA microarrays or providers of systems enabling customers to make their own microarrays; and
•: expression profile program providers, which are dedicated genomics companies building gene expression databases as well as pharmaceutical and biotechnology companies who have their own in-house gene expression profiling efforts.

Many of the organizations that compete with us have greater capital resources, more experienced research, development, sales, marketing, distribution and service staffs, superior facilities and manufacturing capabilities and a more established customer base. Our competitors are pursuing methods for using software and computers to assist in making the drug discovery process more efficient and less expensive which would compete with our products or render our products obsolete. Although we believe that there are few companies that currently have an integrated technology platform that includes all of the components for an informational genomics solution, we expect to encounter intense competition from companies that currently offer only certain components, but which may offer all of the components in an integrated system in the future. We are also likely to encounter increased competition as we enter new markets.

The relative speed with which we can develop products or technologies is expected to have an impact on our competitive position. We believe that customers in our markets display significant loyalty to specific technologies or products that they have used successfully in their research and development. Therefore, we may experience difficulties in generating sales from customers that initially purchased

products or services from competitors. We expect competition to intensify in the fields in which we are involved as technical advances in such fields are made and become more widely known. To the extent that other companies succeed in developing similar products that are introduced earlier, are more effective, are produced and marketed more effectively or priced more competitively than our products and services, the commercial success of our products or technologies to be developed may be harmed.

Our dependence on third-party products and services to develop and manufacture some components of our products could impair our ability to develop, manufacture and deliver our products on a timely basis.

We rely to a substantial extent on outside vendors to supply many of the hardware and software components of the Rosetta Resolver System. We also rely on outside vendors to supply us with chemicals and other items necessary to fabricate microarrays and conduct expression profiling experiments. Some of these items and components are obtained from a single supplier or a limited group of suppliers. In particular, in May 2000 we entered into a supply agreement with Agilent to supply us with DNA microarrays. In addition, we obtain computer hardware used in our Rosetta Resolver System from Sun Microsystems and the Rosetta Resolver System incorporates software programs developed by third parties, including database software from Oracle. If we are unable to acquire required third party products and services, the quality of our products could deteriorate and we would face higher development costs. Our reliance on outside vendors generally, and a sole or a limited group of suppliers in particular, involves several risks, including:

•: the inability to obtain an adequate supply of required materials due to manufacturing capacity constraints, discontinuance of a product by a third-party manufacturer or other supply constraints;
•: reduced control over quality and pricing of components;
•: delays and long lead times in receiving materials from vendors; and
•: delay and expense caused by the need to redesign our product to accommodate the replacement of a vendor.

We rely on scientific and other data obtained from public genomic databases. This data could contain errors or other defects, which if used in our internal or external research collaborations may result in inaccurate conclusions made by us or our third party collaborators that could materially affect the results of such research efforts. This reliance on inaccurate or defective data could materially affect our relationships with our collaborators and harm our revenues.

If we fail to maintain or obtain rights to third party technology, it could harm our developmental and commercial efforts.

Our success is dependent on our ability to enter into licensing arrangements with commercial or academic entities for technology that is advantageous or necessary to the development and commercialization of our technologies. We may not be able to negotiate additional license agreements in the future on acceptable terms, if at all.

In our existing and potential future collaborations, disputes may arise as to the inventorship and corresponding rights in inventions and know-how resulting from research by us and our licensors or scientific collaborators. Additionally, our present and future in-licensing agreements may contain provisions requiring us to meet performance obligations, or milestones, within specified time periods. If we fail to meet any significant milestones, our licensors or collaborators may be permitted to terminate such agreements.

Any of our current license agreements may be terminated under certain circumstances by the other party, and we may not be able to maintain the exclusivity of our exclusive licenses. In the event we are

unable to obtain or maintain licenses to technology necessary and advantageous to our business, we may be required to expend significant time and resources to develop or in-license alternative technology. We may not be successful in this regard. If we cannot acquire or develop necessary technology, we may be prevented from commercializing some of our products or may need to limit our operations.

The sales cycles for our products are lengthy, and we may spend considerable resources on unsuccessful sales efforts or may not be able to complete deals.

Our ability to obtain new customers for our technologies depends in significant part upon the perception that our products and services can help accelerate their discovery efforts. Our sales cycle and Agilent's sales cycle are likely to be lengthy because of the need to educate our potential customers and convince a variety of constituencies within such companies of the benefits of our technologies. In addition, each agreement involves the negotiation of unique terms. We and Agilent may be required to expend substantial funds and management effort with no assurance that an agreement will result.

If we lost principal members of our management and scientific staff or are unable to hire additional qualified personnel, our future growth and ability to compete would suffer.

We are highly dependent on the principal members of our management and scientific staff. The loss of the services of any of these persons could delay or reduce our product development and commercialization efforts. We do not have "key person" insurance on the lives of our executives. We are also highly dependent upon our ability to attract and retain additional qualified scientific and technical personnel. Our business is located in the Seattle, Washington, metropolitan area, where demand for these types of personnel is extremely high and is likely to remain high. As a result, competition for and retention of personnel, particularly for employees with technical expertise, is intense, and the turnover rate for these people is high. If we are not able to attract, hire, train and retain a sufficient number of qualified personnel, our ability to compete could be seriously harmed and our future financial success would be jeopardized.

We have limited capacity and experience in sales, marketing, installation and industrialized processes.

We have only a small internal sales force to market and sell our products and have only limited experience in sales and marketing. In order to successfully market our products and services to pharmaceutical, biotechnology and agricultural companies, we are substantially dependent on Agilent to commercialize our products. We may not be able to establish a direct sales force or to establish collaborative or distribution arrangements to market our products and technologies. If Agilent fails to market our products successfully or if we fail to establish a significant sales force of our own, our sales and our revenues would be harmed.

The Rosetta Resolver System was commercially launched in June 2000. To achieve successful commercialization of our products, we will need to increase our installation and customer support capabilities. If we cannot achieve the required level and quality of system installation and support, we may need to outsource such services or rely on licensing and other arrangements with third parties who possess sufficient service capabilities. This could reduce our gross margins and expose us to the risks inherent in relying on others. We may not be able to successfully outsource our installation or customer service functions or enter into licensing or other arrangements with these third parties, which could harm our sales and our revenues.

In 2000, we opened a high-throughput gene expression profiling facility in which we generate data from gene expression profiling experiments. Data generation from these experiments is typically a key element in our performance obligations under collaboration agreements. Since we have only recently

opened our high-throughput gene expression profiling facility, we have limited experience industrializing data generation processes. Our limited experience in predicting demand in this area increases the risk that we may be unable to satisfy supply commitments or unable to enter into additional agreements if we cannot increase capacity quickly enough or if we encounter unanticipated problems in increasing capacity. As a result, we could lose existing customers, fail to attract additional customers, or fail to obtain further orders from existing customers, any of which would adversely affect revenues and our financial position.

If we are not able to successfully manage our expansion, our results of operations would be harmed.

We have expanded rapidly over the past year and expect to experience significant growth in the number of our employees and customers and the scope of our operations. This expansion may continue to place a significant strain on our management and operations. Our ability to manage this expansion will depend upon our ability to broaden our management team. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to train and manage our employees.

If we are unable to successfully adapt our products for commercial applications, our revenues and results of operations will suffer.

We have completed the initial development of the Rosetta Resolver System technology and FlexJet™ DNA microarray technology for applications in gene expression profile analysis. We may not be able to successfully adapt our products to the commercial requirements of drug discovery or healthcare research. A number of potential applications of our technology in these fields will require significant enhancements in our core technology, including adaptation of our software. Market acceptance will depend on many factors, including demonstrating to customers that our technology is superior to other technologies and products which are available now or which may become available in the future. We believe that our revenue growth and profitability will substantially depend on our ability to overcome significant technological challenges and successfully introduce our products into the marketplace. If we are unable, for technological or other reasons, to complete the development, introduction or scale-up of the manufacturing of any product, or if any product does not achieve a significant level of market acceptance, our revenues and results of operations will be seriously harmed.

We face risks associated with acquisitions.

As part of our business strategy, we may from time to time acquire assets and businesses principally relating to, or complementary to, our operations. For example, in 1999 we acquired Acacia Biosciences, Inc. in order to acquire specific technology. Risks of acquisitions include, among other things, the following:

•: exposure to unknown liabilities of acquired companies;
•: acquisition costs and expenses; and
•: difficulty and expense of assimilating the technology and operations and retaining personnel and customers of the acquired businesses.

Our financial condition could be materially and adversely affected if we do not overcome these potential problems in the event that we decide to pursue additional acquisitions.

RISKS RELATED TO THE GENOMICS INDUSTRY

There may be ethical and other concerns surrounding the use of genetic information which could limit our ability to develop and sell our existing products and new products.

The genetic screening of humans has raised ethical issues regarding the confidentiality and appropriate uses of the resulting information. Government authorities may regulate or prohibit the use of genetic testing to determine genetic predispositions to certain conditions. Additionally, the public may disfavor and reject the use of genetic testing. It is possible that the government authorities and the public may fail to distinguish between the genetic screening of humans and genomic and proteomic research. If this occurs, our products and the processes for which our products are used may be subject to government regulations intended to affect genetic screening. Further, if the public fails to distinguish between the two fields, it may pressure our customers to discontinue the research and development initiatives for which our products are used. If this occurs, the potential market for our products could be reduced, which could seriously harm our financial condition and results of operations.

Consolidation within the pharmaceutical and biotechnology industries may harm our efforts to market and commercialize our products.

Consolidation within the pharmaceutical and biotechnology industries has heightened the competition for services of the type provided by us. If this consolidation trend continues, it may result in fewer customers for our services, price erosion and greater competition among us and our competitors. Our potential partners may consolidate, which could decrease the value of our technologies and shrink the research market we target for our products.

The application of government regulations may adversely affect our business.

Any new drug or agricultural product developed by the efforts of our customers as a result of their use of our technologies must undergo an extensive regulatory review process in the United States and other countries before it can be marketed. This regulatory process can take many years and requires substantial expense. Changes in policies at the U.S. Food and Drug Administration and the policies of similar foreign regulatory bodies can increase the delay for each new drug, product license and biological license application. We expect similar delays in the regulatory review process for any diagnostic or agricultural product, where similar review or other approval is required. Even if marketing clearance is obtained, a marketed product and its manufacturer are subject to continuing review. Discovery of previously unknown problems with a product may result in withdrawal of the product from the market.

No product resulting from the use of our data has been released for commercialization in the United States or elsewhere. In addition, no investigational new drug application has been submitted for any such product candidate. We expect to rely on our customers to file such applications and generally direct the regulatory review process. Our customers may not submit applications for regulatory review, or may not obtain marketing clearance for any products on a timely basis, if at all. If our customers fail to obtain required governmental clearances, it will prevent them from marketing drugs or diagnostic products until such clearance can be obtained, if at all. The occurrence of any of these events may cause our business and results of operations to suffer.

In addition, our access to and use of human or other tissue samples or biological or hazardous material in the expansion of our array and informatics and genomic platforms technologies may become subject to government regulation, both in the United States and abroad. United States and foreign government agencies may also impose restrictions on the use of data derived from human or other tissue samples or biological or hazardous material. If our access to or use of human tissue samples or biological or hazardous material, or our customers' use of data derived from such samples or other materials, is restricted, our business will suffer.

Item 3: Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risk is limited to interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term debt securities issued by U.S. corporations. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive without significantly increasing risk. To minimize risk, we maintain our portfolio of cash, cash equivalents and short term investments in a variety of high-grade securities and with a variety of issuers, including corporate notes, commercial paper and money market funds. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any foreign currency or other derivative financial instruments.

Part II. Other Information

Item 1: Legal Proceedings

While we require our employees to disclose their prior inventions to us and not use or disclose to us proprietary information obtained from former employers, disputes concerning these prior inventions or proprietary information may arise. On January 6, 2000 we received, through our legal counsel, a request for information from the FBI pertaining to one of our then recently hired employees related to his involvement in certain software development activities prior to his employment with us. On April 11, 2000, we received, through our legal counsel, a grand jury subpoena requiring the production of an expanded set of information and documents pertaining to the subject of the original request from the FBI. We are cooperating fully with the FBI and the grand jury. While we believe that we, as a company, are not currently the target of the investigation, we are unable at this time to predict the outcome of this investigation. The FBI investigation may result in publicity that could adversely affect our business and revenues.

Item 2: Changes in Securities and Use of Proceeds

(c) Recent Sales of Unregistered Securities

In the three months ended March 31, 2001, we issued 1,831 shares of unregistered common stock in connection with cash exercises of warrants to purchase common stock which resulted in net proceeds to the Company of $9,219. We additionally issued 5,233 shares of common stock in exchange for 7,307 outstanding warrants to purchase common stock in connection with cashless warrant exercises. The value of the warrants surrendered to Rosetta to purchase the shares was $23,829. The exercise prices of the above warrants ranged from $4.54 to $6.21. We additionally issued to an outside consultant a warrant to purchase 20,000 shares of common stock at an exercise price of $10.13 in January 2001. The warrant has a term of two years from the date of grant. The issuance of these securities was deemed to be exempt from registration under the Securities Act of 1933 in reliance on Section 4(2) of the Securities Act of 1933.

(d) Use of Proceeds from Sale of Registered Securities

The Company's Registration Statement under the Securities Act of 1933 (File No. 333-32780) was declared effective by the SEC on August 2, 2000. All 7,200,000 shares of common stock offered in the final prospectus, as well as an additional 1,080,000 shares of common stock subject to the underwriters' over-allotment option that was exercised on August 28, 2000, were sold at a price per share of $14.00. The managing underwriters of our offering were Lehman Brothers, Lazard Freres, Prudential Vector Healthcare and Fidelity Capital Markets. The aggregate gross proceeds of the shares offered and sold was $115.9 million which resulted in net proceeds to Rosetta of approximately $106.3 million after deducting underwriting discounts and commissions and other offering expenses of $9.6 million. From the effective date of the offering through March 31, 2001, Rosetta has used approximately $14.2 million of the proceeds which were applied as follows:

•: Approximately $10.0 million was applied towards working capital expenditures related to payroll and personnel expenses, including recruitment and relocation expenses, usage of laboratory materials and supplies (including the purchase of DNA microarrays from Agilent) related to conducting research, legal fees associated with intellectual property issues, business development activities, and costs associated with operating as a public company.
•: Approximately $2.7 million was used to purchase computer and lab equipment.
•: Approximately $1.5 million was used for leasehold improvement related items.

Rosetta has invested the remainder of the net proceeds from the offering in investments such as high-quality corporate issues and government obligations.

Item 6: Exhibits and Reports on Form 8-K

(a): Exhibits

The exhibits filed as part of this report on Form 10-Q are listed in the Index to Exhibits immediately preceding such exhibits, which Index to Exhibits is incorporated herein by reference.

(b): Reports on Form 8-K

No reports on Form 8-K were filed by Rosetta during the three months ended March 31, 2001.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 7^th day of May, 2001.

		Rosetta Inpharmatics, Inc.
Date: May 7, 2001		By:		/s/ GREGORY SESSLER Gregory Sessler Chief Financial Officer

Index to Exhibits

Exhibit Number			Description
	3.1		Amended and Restated Certificate of Incorporation. (filed as Exhibit 3.1 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	3.2		Amended and Restated Bylaws (filed as Exhibit 3.2 to Rosetta's Annual Report on Form 10-K for the year ended December 31, 2000 and incorporated herein by reference).
	4.1		Reference is made to Exhibits 3.1 and 3.2.
	4.2		Specimen stock certificate (filed as Exhibit 4.1 to Rosetta's S-1/A dated June 21, 2000 and incorporated herein by reference).
	4.3		Amended and Restated Investors' Rights Agreement dated March 15, 2000 between Rosetta and holders of Rosetta's Series A, Series B, Series C, Series D and Series E preferred stock (filed as Exhibit 4.2 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.1		1997 Stock Plan (filed as Exhibit 10.2 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.2		2000 Stock Incentive Plan (filed as Exhibit 10.3 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.3		2000 Employee Stock Purchase Plan (filed as Exhibit 10.4 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
	10.4		2000 Directors' Stock Option Plan (filed as Exhibit 10.5 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.5		Amended and Restated Contribution Agreement dated November 1997 by and among Stephen Friend, Leroy Hood and the Fred Hutchinson Cancer Research Center and Rosetta (filed as Exhibit 10.6 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.6		Series C Preferred Stock Purchase Agreement between Rosetta and certain stockholders, dated April 1, 1999 (filed as Exhibit 10.7 to Rosetta's S-1 dated March 17, 2000 and incorporated herein by reference).
	10.7		Series D Preferred Stock Purchase Agreement between Rosetta and Hewlett-Packard Company, dated October 1, 1999 (filed as Exhibit 10.8 to Rosetta's S-1 dated March 17, 2000 and incorporated herein by reference).
	10.8		Series E Preferred Stock Purchase Agreement between Rosetta and certain stockholders, dated March 15, 2000 (filed as Exhibit 10.9 to Rosetta's S-1 dated March 17, 2000 and incorporated herein by reference).
	10.9		Common Stock Purchase Agreement between Rosetta and Stephen Friend, dated January 31, 1997 (filed as Exhibit 10.10 to Rosetta's S-1 dated March 17, 2000 and incorporated herein by reference).
	10.10		Common Stock Purchase Agreement between Rosetta and Stephen Friend dated May 15, 1997 (filed as Exhibit 10.11 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.11		Common Stock Purchase Agreement between Rosetta and John King, dated May 15, 1997 (filed as Exhibit 10.12 to Rosetta's S-1 dated March 17, 2000 and incorporated herein by reference).

+	10.12	Amended and Restated Exclusive License by and between Rosetta and The Regents of The University of California for Gene Reporter Matrix with an original effective date of September 1, 1995 and amended and restated as of December 1, 1998 (filed as Exhibit 10.13 to Rosetta's S-1/A dated July 26, 2000 and incorporated herein by reference).
	10.13	Lease Agreement dated February 19, 1997 between Rosetta and Riggs Bank N.A., as trustee for Multi-Employer Property Trust for space at Building G at Suite 210, 12040 115^th Avenue NE, Kirkland, WA 98034, and amendments thereto (filed as Exhibit 10.16 to Rosetta's S-1 dated March 17, 2000 and incorporated herein by reference).
	10.14	Amended and Restated Loan Security Agreement dated November 10, 1998 between Rosetta and Silicon Valley Bank (filed as Exhibit 10.17 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
+	10.15	Patent License Agreement dated September 1, 1997 between Rosetta and the University of Washington (filed as Exhibit 10.19 to Rosetta's S-1/A dated July 26, 2000 and incorporated herein by reference).
	10.16	Equipment Financing Agreement dated September 10, 1997 between Rosetta and Lease Management Services, Inc. (filed as Exhibit 10.20 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.17	Letter Equipment Financing Proposal from Lease Management Services, Inc. to Rosetta dated June 18, 1997 and revised July 16, 1997 (filed as Exhibit 10.21 to Rosetta's S-1/A dated June 21, 2000 and incorporated herein by reference).
	10.18	Time and line letter extension from LMSI Venture Finance to Rosetta Inpharmatics, Inc. dated July 28, 1999 (filed as Exhibit 10.22 to Rosetta's S-1/A dated June 21, 2000 and incorporated herein by reference).
+	10.19	License Agreement between Rosetta and Fred Hutchinson Cancer Research Center dated December 23, 1997 (filed as Exhibit 10.23 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
+	10.20	Internal Use License Agreement between Rosetta and Affymetrix, Inc. dated November 30, 1998 (filed as Exhibit 10.25 to Rosetta's S-1/A dated July 26, 2000 and incorporated herein by reference).
+	10.21	License Agreement between Rosetta and Xenometrix, Inc. dated November 12, 1998 (filed as Exhibit 10.26 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
	10.22	Equipment Financing Agreement between Acacia Biosciences, Inc. and Lease Management Services, Inc. dated September 25, 1997 (filed as Exhibit 10.27 to Rosetta's S-1/A dated June 21, 2000 and incorporated herein by reference).
	10.23	Consulting Agreement between Rosetta and Dr. Jasper Rine, Ph.D dated February 23, 1999 (filed as Exhibit 10.28 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
+	10.24	Resolver Early Access Program Agreement between Rosetta and Dupont Pharmaceuticals Company dated September 30, 1999 (filed as Exhibit 10.29 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
+	10.25	Gene Expression Collaboration Agreement between Rosetta and Hewlett-Packard Company (Agilent) dated October 1, 1999 (filed as Exhibit 10.30 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).

+	10.26	License Agreement between Rosetta and Oxford Gene Technology IP Limited dated March 16, 2000 (filed as Exhibit 10.31 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
	10.27	Common Stock Issuance Agreement between Rosetta and Oxford Gene Technology IP Limited dated March 16, 2000 (filed as Exhibit 10.32 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
+	10.28	Collaboration Agreement between Rosetta and Corixa Corporation dated December 20, 1999 (filed as Exhibit 10.33 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
	10.29	Offer letter between Rosetta and Stephen Friend dated June 21, 1997 (filed as Exhibit 10.34 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.30	Offer letter between Rosetta and Roland Stoughton dated June 6, 1997 (filed as Exhibit 10.35 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.31	Offer letter between Rosetta and John King dated April 17, 1997 (filed as Exhibit 10.36 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.32	Offer letter between Rosetta and Mark Boguski dated March 13, 2000 (filed as Exhibit 10.37 to Rosetta's S-1/A dated May 9, 2000 and incorporated herein by reference).
+	10.33	Pilot Project Collaboration Agreement between Rosetta and Monsanto Company dated February 3, 2000 (filed as Exhibit 10.38 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
	10.34	Promissory Note between Mark Boguski and Rosetta dated March 14, 2000 (filed as Exhibit 10.39 to Rosetta's S-1/A dated April 5, 2000 and incorporated herein by reference).
	10.35	Offer letter between Rosetta and Gregory Sessler dated March 13, 2000 (filed as Exhibit 10.40 to Rosetta's S-1/A dated May 9, 2000 and incorporated herein by reference).
	10.36	Promissory note between Rosetta and Gregory Sessler dated March 13, 2000 (filed as Exhibit 10.41 to Rosetta's S-1/A dated May 9, 2000 and incorporated herein by reference).
+	10.37	Supply Agreement between Rosetta and Agilent Technologies, Inc. dated May 25, 2000 (filed as Exhibit 10.42 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
+	10.38	Sun Channel Agreement between Sun Microsystems Inc. and Rosetta dated February 1, 2000 (filed as Exhibit 10.43 to Rosetta's S-1/A dated August 2, 2000 and incorporated herein by reference).
	10.39	Letter lease proposal from Lease Management Services, Inc. to Acacia Biosciences, Inc. dated April 25, 1997 (filed as Exhibit 10.44 to Rosetta's S-1/A dated June 21, 2000 and incorporated herein by reference).
	10.40	Common Stock Purchase Agreement between Rosetta and Agilent Technologies, Inc. dated June 2000 (filed as Exhibit 10.45 to Rosetta's S-1/A dated July 26, 2000 and incorporated herein by reference).
	10.41	Amendment No. 1 (dated May 25, 2000) to the Gene Expression Agreement between Rosetta and Agilent Technologies, Inc. dated October 1, 1999 (filed as Exhibit 10.46 to Rosetta's S-1/A dated July 26, 2000 and incorporated herein by reference).
+	10.42	Monsanto/Rosetta Inpharmatics Collaboration Agreement between Rosetta and Monsanto Company dated November 21, 2000 (filed as Exhibit 10.42 to Rosetta's Annual Report on Form 10-K for the year ended December 31, 2000 and incorporated herein by reference).

	10.43	Lease Agreement dated September 30, 2000 between Rosetta and Richard and Jacquelyne Doane for property located at 12220 — 113th Avenue NE, Suite 210, Kirkland, WA 98034 (filed as Exhibit 10.43 to Rosetta's Annual Report on Form 10-K for the year ended December 31, 2000 and incorporated herein by reference).
+	10.44	Amendment No. 1 (dated March 28, 2001) to the Supply Agreement between Rosetta and Agilent Technologies, Inc. dated May 25, 2000 (filed as Exhibit 10.44 to Rosetta's Annual Report on Form 10-K for the year ended December 31, 2000 and incorporated herein by reference).
	10.45	Standstill Agreement dated October 1, 1999 between Rosetta and Hewlett-Packard Company, a Delaware Corporation (now Agilent Technologies, Inc.).

+ Confidential treatment requested or granted as to portions of this Exhibit.

QuickLinks

Rosetta Inpharmatics, Inc. Index to Form 10-Q

Part I. Financial Information

Rosetta Inpharmatics, Inc. Balance Sheets
Rosetta Inpharmatics, Inc. Statements of Operations (Unaudited)
Rosetta Inpharmatics, Inc. Statements of Cash Flows (Unaudited)
Rosetta Inpharmatics, Inc. Notes to Financial Statements (Unaudited)

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3: Quantitative and Qualitative Disclosures about Market Risk

Part II. Other Information

Item 1: Legal Proceedings

Item 2: Changes in Securities and Use of Proceeds

Item 6: Exhibits and Reports on Form 8-K

SIGNATURES
Index to Exhibits

ROSETTA INPHARMATICS INC 10-Q