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Time, for once, is not on Applied Biosystems’ side. Its most valuable patents, which cover a revolutionary process that speeds up DNA analysis, are speeding to their own expiration. In March, the first of Applied’s PCR patents expires. Others in the portfolio will follow over the next several years. For the Foster City company, a leading manufacturer of biotechnology research and analysis tools, the expiration of the patents is a business challenge. For other companies trying to bulk up their licensing revenue, it should be a reality check that licensing revenue comes and goes and is never a sure thing. PCR — or polymerase chain reaction, a process for rapidly multiplying fragments of DNA — isn’t just one of the most groundbreaking techniques in all of chemistry; it has been the most successful of Applied’s three major licensing initiatives, taking in an estimated $51 million a year, according to Pacific Growth Equities, a San Francisco investment bank. That’s in addition to the couple of hundred million dollars Applied expects to see this year from sales of its own PCR-related products. Pacific Growth estimates that Applied stands to lose as much as $25 million when the patents expire, which represents about 12 percent of current earnings. Pacific Growth gives Applied its lowest of three ratings as an investment over the next 18 months. “PCR is a technology area where Applied has really dominated, and their licensing royalties have been direct contributors to the bottom line, as there are very little expenditures related to it,” says Adam Chazan, senior equity analyst at Pacific Growth Equities. “But their patents are expiring, and the company is in tough straits.” The history of how Applied obtained its PCR rights, and what those rights cover, rivals the human genome in complexity. Kary Mullis invented PCR when he was a researcher at Cetus Corp. in the 1980s. In 1991, Hoffman-La Roche Inc. bought the rights from Cetus and divided them between a new company it formed, Roche Molecular Systems, and the Perkin Elmer Corp., which had owned 51 percent of a joint venture with Cetus to commercialize PCR. In 1993, Perkin Elmer and Applied Biosystems merged to form Applera Corp. Applera has two operating groups: Applied and Celera Genomics. Applied obtained exclusive PCR rights in two key markets: crime scene and human identification analysis [the stuff of CSI] and research — it licenses the makers of instruments used by scientists. Meanwhile, Roche retains the rights in two other key markets: paternity test kits and human diagnostics. Applied has deals with more than 100 licensees for PCR, according to Paul Grossman, Applied’s vice president of intellectual property. Typically Applied receives an up-front fee as well as an ongoing royalty, which, Grossman says, can range from 5 percent to 20 percent. Grossman acknowledges that Applied derives “substantial revenue from licensing” from PCR, but he downplays the significance of the expirations. He says that there are 30-40 patents in the PCR portfolio, the last of which won’t expire until 2017. In its most recent quarterly report, Applied was less nonchalant, warning that the expiring patents may result in reduced royalty revenue. The company has hired a consulting firm, which Grossman would not name, to help it identify new growth opportunities. There’s another problem: Spending in the biotech and pharmaceutical industry has shifted away from early stage drug discovery, where “Applied is a big player,” Chazan says, to clinical trials, an area Applied isn’t involved in. “They’ve found themselves with a dramatically lower growth rate,” he says. PCR is not Applied’s only licensing plank. The company also licenses out two other groups of patents, for DNA synthesis and DNA sequencing, but neither of these programs has been nearly as successful. The DNA synthesis patents have already started to expire, and the DNA sequencing program hasn’t brought in nearly as much money as PCR. “There’s a fewer number of licenses,” says Grossman. “The technology is not as ubiquitous as PCR.” Applied is working hard to develop new licensing revenue streams. “Either the [licensing] programs get shelved or new patents have to become active,” says Grossman. Applied already has roughly 700 U.S. patents and has 1,200 applications pending, roughly half, according to Grossman, in the United States. All of these cover technologies relating to analyzing biological material — everything from instrumentation to software. Applied doesn’t license all of its patents. Some don’t have a big payoff, and others enable Applied to retain market share for its own products. There isn’t a large appetite for Applied’s patents on protein sequencing and peptide synthesis, for example, Grossman says. But these patents let Applied keep prices high on many of its research products. Grossman makes no apologies for the markup: “We’re selling products to researchers who need the latest and greatest, so we have to be on the leading edge of technology. That means we need to spend money on R&D, which means we need margins, products that are profitable.” Applied’s dependence on patents means that the company — which had 2003 revenues of $1.7 billion — must be strict about IP enforcement. “They’re not shrinking violets,” says a lawyer who has worked with them. In April, Applied Biosystems won a $19.8 million PCR patent infringement victory over MJ Research Inc. In 2003 it won $25.8 million in a patent infringement case against Waters Technologies Corp. That same year, the company filed suit against Roche — its partner in the MJ Research suit — in San Mateo County Superior Court, alleging breach of contract and several tort claims, including unfair competition. The company is defending itself in infringement suits with Promega Corp., Beckman Coulter Inc., Genetic Technologies Limited and On-Line Technologies Inc. These suits — particularly the MJ Research case, which dragged on for six years — have run up huge legal bills. In the first nine months of its fiscal 2004, Applied’s litigation-related fees amounted to $17.6 million. A headache for Applied, the litigation has been a windfall for Weil, Gotshal & Manges, which handles the bulk of the work (Kenyon & Kenyon works on some as well). It also hasn’t hurt lawyers aspiring to in-house jobs at Applied, which has nearly doubled the size of its legal staff (to 17) over the past two years. Historically, Grossman says, the company was “scattershot” about the firms it hired to prosecute its patents, but in the past two to three years, Applied has settled on a few key firms — including Finnegan, Henderson, Farabow, Garrett & Dunner; Harness, Dickey & Pierce; and Dorsey & Whitney. “You want to find partner-level people who are strong in a certain area and have the ability to farm work out within the firm,” Grossman says. “For example, one firm may be strong in chemistry dye technology, another in molecular biology, another in software.” Applied has a tendency to play hardball with its attorneys, too. When Grossman, 43, was named to his current position in 2002, he replaced the company’s lead counsel on the MJ Research case, Orrick, Herrington & Sutcliffe, with Weil, Gotshal. Grossman won’t say why he replaced Orrick. Robert Cote, a partner at Orrick’s New York office, who remained involved in the MJ Research suit, says, “Paul [Grossman] looks to Weil, Gotshal because that’s the firm he had a relationship with when he was running cases.” Grossman began working with Weil, Gotshal in 1997, right after his graduation from law school. He was put in charge of an infringement case that had been brought against Applied by Amershan Biosciences (now part of General Electric Co.). Grossman promptly replaced the company’s long-standing attorneys, from a small New York patent boutique he wouldn’t name, with Weil, Gotshal. Grossman explains: “We weren’t a startup anymore, and the stakes were high. I wanted more experience in the courtroom. The lawyers we historically worked with — I didn’t think they were the kind of lawyers we needed.” The Amershan case settled in 2001, and Weil, Gotshal and the company have been tied as tight as a double helix. The future, however, may turn out to be a different story. If there’s nothing left to license, there may not be much to litigate. Alan Cohen is a freelance writer based in New York. This article was originally published in The American Lawyer magazine, a Recorder affiliate.

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