<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
TRANSITION REPORT UNDER SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-22873
Hyseq, Inc.
-----------
(Exact name of Registrant as specified in its charter)
Nevada 36-3855489
------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
670 Almanor Avenue, Sunnyvale, CA 94086
---------------------------------------
(Address of principal executive offices, including zip code)
(408) 524-8100
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Sections 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
----- -----
COMMON STOCK OUTSTANDING ON AUGUST 7, 1998: 12,925,222
Page 1 of 18
Exhibit Index on Page 17
<PAGE> 2
HYSEQ, INC.
INDEX
<TABLE>
<CAPTION>
Page
<S> <C> <C>
PART I Financial Information
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at
June 30, 1998, and December 31, 1997..........................................3
Condensed Consolidated Statements of Operations
for the Three Months and Six Months Ended
June 30, 1998 and 1997........................................................4
Condensed Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 1998 and
1997..........................................................................5
Notes to Condensed Consolidated Financial Statements..........................6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations.................................................................8
Item 3. Quantitative and Qualitative Disclosures about Market Risk...................12
PART II Other Information
Item 1. Legal Proceedings............................................................13
Item 2. Change in Securities and Use of Proceeds.....................................13
Item 3. Defaults Upon Senior Securities..............................................14
Item 4. Submission of Matters to a Vote of Security Holders..........................14
Item 5. Other Information............................................................15
Item 6. Exhibits and Reports on Form 8-K.............................................15
SIGNATURES .............................................................................16
EXHIBIT INDEX .............................................................................17
</TABLE>
2
<PAGE> 3
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HYSEQ, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997*
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 11,500 $ 23,204
Short-term investments 37,287 33,930
Accounts receivable 3,299 2,186
Other current assets 736 904
------------ ------------
Total current assets 52,822 60,224
Cash on deposit 2,106 2,106
Equipment and leasehold improvements, net 5,929 3,947
Patents, licenses and other assets, net 663 673
------------ ------------
$ 61,520 $ 66,950
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,466 $ 1,571
Accrued professional fees 1,302 584
Other current liabilities 768 907
Current portion of lease and loan obligations 309 338
------------ ------------
Total current liabilities 3,845 3,400
Noncurrent portion of capital lease and loan obligations 498 613
Commitments and contingencies
Stockholders' equity:
Preferred stock -- --
Common stock
Issued and outstanding shares - 12,925,222 and
12,733,965 at June 30, 1998 and December 31, 1997,
respectively 82,339 81,795
Notes receivable from stockholders (3,503) (3,658)
Deferred compensation (286) (445)
Net unrealized gain (loss) on securities
available-for-sale (17) (6)
Accumulated deficit (21,356) (14,749)
------------ ------------
Total stockholders' equity 57,177 62,937
------------ ------------
$ 61,520 $ 66,950
============ ============
</TABLE>
* The condensed consolidated balance sheet at December 31, 1997 has been derived
from the audited financial statements at that date.
See accompanying notes.
3
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HYSEQ, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Contract and other revenues $ 2,680 $ 1,134 $ 5,363 $ 1,406
Operating expenses:
Research and development 4,921 1,842 9,015 3,148
General and administrative 2,414 795 4,490 1,726
-------- -------- -------- --------
Total operating expenses 7,335 2,637 13,505 4,874
-------- -------- -------- --------
Loss from operations (4,655) (1,503) (8,142) (3,468)
Interest income (expense), net 737 85 1,536 134
-------- -------- -------- --------
Net loss $ (3,918) $ (1,418) $ (6,606) $ (3,334)
======== ======== ======== ========
Basic and diluted net loss per share (1) $ (0.31) $ (0.33) $ (0.52) $ (0.76)
======== ======== ======== ========
Shares used in computing basic and
diluted net loss per share (1) 12,769 4,251 12,751 4,362
======== ======== ======== ========
Pro forma basic and diluted net
loss per share (1) $ (0.17) $ (0.39)
======== ========
Shares used in computing pro forma basic and
diluted net loss per share (1) 8,529 8,585
======== ========
</TABLE>
(1) Basic and diluted net loss per share for the period ending June 30, 1997
has been retroactively restated to apply the requirements of Staff
Accounting Bulletin No. 98, issued by the Securities and Exchange
Commission in February 1998 ("SAB 98"). Under SAB 98, certain shares of
common stock and options and warrants to purchase shares of common stock
issued at prices substantially below the per share price of shares sold
in the Company's initial public offering previously included in the
computation of shares outstanding pursuant to Staff Accounting Bulletins
Nos. 55, 64 and 83 are now excluded from the computation.
See accompanying notes.
4
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HYSEQ, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(in thousands, except share amounts)
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-------------------------
1998 1997
-------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,606) $ (3,334)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 819 344
Amortization of deferred compensation 159 91
Shares of common stock issued for services and equipment -- 116
Unrealized loss on short-term investments (11) --
Changes in assets and liabilities:
Accounts receivable (1,113) 13
Other current assets 167 (7)
Other assets (39) (507)
Accounts payable (105) 722
Accrued processional fees 718 598
Other current liabilities (139) 68
Deferred revenue -- 75
-------- --------
Net cash used in operating activities (6,150) (1,821)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property and equipment (2,751) (1,055)
Purchases of short-term investments (34,381) --
Maturities of short-term investments 31,025 --
-------- --------
Net cash used in investing activities (6,107) (1,055)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of stockholders' notes receivable 155 38
Cash proceeds from issuance of Series B preferred stock -- 10,000
Cash proceeds from the issuance of common stock 543 22
Cash used to repurchase common stock -- (2)
Principal payments on capital lease and loan obligations (166) (132)
Borrowings under capital lease/financing loan 21 181
-------- --------
Net cash provided by financing activities 553 10,107
-------- --------
Net increase (decrease) in cash and cash equivalents (11,704) 7,231
Cash and cash equivalents at beginning of period 23,204 6,707
-------- --------
Cash and cash equivalents at end of period $ 11,500 $ 13,938
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Interest paid $ 31 $ 83
======== ========
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES
Issuance of 15,728 shares of common stock in exchange for
legal services $---- $ 102
======== ========
Issuance of 1,142 shares of common stock in exchange for
equipment $---- $ 14
======== ========
</TABLE>
See accompanying notes.
5
<PAGE> 6
HYSEQ, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The condensed consolidated balance sheet as of June 30,
1998, the statements of operations for the three and six months ended June 30,
1998 and 1997 and the statements of cash flows for the six months ended June 30,
1998 and 1997 are unaudited, but include all adjustments (consisting of normal
recurring adjustments) which the Company considers necessary for a fair
presentation of the financial position, operating results and cash flows for the
periods presented. The condensed consolidated financial statements include the
accounts of the Company's wholly-owned subsidiary, Hyseq Diagnostics, Inc. The
results of operations for the interim periods shown herein are not necessarily
indicative of operating results expected for the entire year.
2. Cash, Cash Equivalents and Short-Term Investments
As of June 30, 1998, short-term investments are classified as available-for-sale
securities and are carried at fair market value with unrealized gains and losses
reported in stockholders' equity. The following is a summary of
available-for-sale securities as of June 30, 1998:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
(in thousands) Cost Gains Losses FairValue
<S> <C> <C> <C> <C>
Cash $ 816 $- $- $ 816
Certificates of deposit 22,996 - (10) 22,986
Commercial paper 19,295 - (7) 19,288
Money market funds 5,697 - -- 5,697
------------------------------------------------
$ 48,804 $- $ (17) $ 48,787
================================================
Above amounts are included in the
balance sheet as follows:
Cash and cash equivalents $ 11,501 $- $ (1) $ 11,500
Short-term investments 37,303 - (16) 37,287
------------------------------------------------
Total: $ 48,804 $- $ (17) $ 48,787
================================================
</TABLE>
The estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation methodologies.
6
<PAGE> 7
3. Changes in Accounting Standards
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of this statement has no impact
on the Company's net loss or stockholders' equity. SFAS 130 requires, among
other things, unrealized gains or losses on the Company's short-term investments
to be included in comprehensive income or loss. During the six months ended June
30, 1998 and 1997, the Company's comprehensive loss amounted to $6,617,000 and
$3,334,000, respectively.
4. Net Loss Per Share
In accordance with SFAS No. 128, basic net loss per share has been computed
using the weighted-average number of shares of common stock outstanding during
the period.
Basic pro forma net loss per share as presented in the Statements of
Operations gives effect to the conversion of convertible preferred stock that
automatically converted at the completion of the Company's initial public
offering at August 1997 (using the if-converted method) from the original date
of issuance.
A reconciliation of shares used in the calculation of basic net loss per
share and pro forma net loss per share follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
(in thousands except per share amounts) JUNE30, JUNE30,
------------------------ -------------------------
1998 1997 1998 1997
-------- -------- ---------- --------
<S> <C> <C> <C> <C>
Net loss ............................................ $ (3,918) $ (1,418) $ (6,606) $ (3,334)
======== ======== ========== ========
Basic and Diluted
Weighted average shares of common
stock outstanding ................................... 12,769 4,251 12,751 4,362
======== ======== ========== ========
Basic and diluted net loss per share ................ $ (0.31) $ (0.33) $ (0.52) $ (0.76)
======== ======== ========== ========
Pro Forma Basic and Diluted
Shares used in computing basic and diluted net
loss per share ...................................... 4,251 4,362
Adjusted to reflect the effect of the assumed
conversion of preferred stock ....................... 4,278 4,223
-------- --------
Shares used in computing pro forma basic and
diluted net loss per share .......................... 8,529 8,585
======== ========
Pro forma basic and diluted net loss per share ...... $ (0.17) $ (0.39)
======== ========
</TABLE>
7
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements as that term is defined in the
Private Securities Litigation Reform Act of 1995 concerning existing and
potential collaboration arrangements, royalties and other payments under
existing and potential collaboration arrangements, and product development and
sales and other statements. Such statements are based on Management's current
expectations and involve risks and uncertainties. Actual results and performance
could differ materially from those projected in the forward-looking statements
as a result of many factors discussed herein and from time to time in the
Company's filings with the Securities and Exchange Commission ("SEC"), including
but not limited to, the following: the scientific progress of the Company's
programs; the ability of the Company to establish additional collaborative and
licensing arrangements; the extent to which the Company engages in development
of products without collaboration partners; the time and cost involved in
obtaining regulatory approvals for its diagnostics products; the costs involved
in preparing, filing, prosecuting, maintaining and enforcing patent claims;
competing technological and market developments; whether conditions to milestone
payments are met for any future collaborative agreements and the timing of such
payment or payments; and other factors and risks detailed under the caption
"Factors That May Impact Results" in the Company's 1997 Annual Report on Form
10-K.
Overview
The Company applies the proprietary DNA array technology of its HyX Platform to
develop gene-based therapeutic product candidates and diagnostic products and
tests. The Company believes that its proprietary HyGenomics Database of partial
human gene sequences is the largest such database in the world. The Company
presently is collaborating with Chiron Corporation ("Chiron") to develop
therapeutics, diagnostic molecules and vaccines relating to solid tumors and
with The Perkin-Elmer Corporation ("Perkin-Elmer") to commercialize HyChip
products. Hyseq recently announced its first therapeutic product candidate, a
new interleukin-1 gene, IL-1Hy273. In addition, the Company has filed for patent
protection on over 95,000 new gene discoveries, and over 2,200 new gene
discoveries related to solid tumor cancer as a result of the collaboration
between Hyseq and Chiron. Perkin-Elmer and Hyseq also recently announced an
"early access" program for the HyChip system. The Company intends to establish
additional collaborations in targeted disease categories. The Company is making
available its HyGnostics Module for DNA testing of genetic and infectious
disease and cancer to clinical reference laboratories.
The Company has incurred operating losses since inception and expects to incur
operating losses at least through 1999 and possibly longer. The Company may
never achieve significant revenues or profitable operations. There can be no
assurance that the Company will be able to obtain licensees of its HyGnostics
Module, customers for HyChip products, additional collaboration partners on
acceptable terms or that its collaborative arrangements or products will produce
revenues adequate to fund the Company's operations. The Company's operating
results may fluctuate significantly in the future as a result of a variety of
factors, including, but not limited to, changes in the demand for the Company's
products; the nature, size and timing of collaborative arrangements and products
provided to or developed with the Company's current and future collaboration
partners; changes in the research and development budgets of the Company's
current and future collaboration partners; capital expenditures and other costs
related to the expansion of the Company's operations; litigation and other costs
associated with defending its proprietary rights; changes in government
regulations; and the introduction of competitive technologies.
Results of Operations
Three and Six Months Ended June 30, 1998 and 1997
Contract Revenues. Contract and other revenues were $2.7 million and $5.4
million for the three and six months ended June 30, 1998, compared to $1.1
million and $1.4 million for the comparable periods of 1997. All revenues
recorded during the three and six months ended June 30, 1998 were earned in
conjunction with the Company's research collaboration with Chiron. The Company
receives minimum research payments under its collaboration agreement with
Chiron, which are recognized as revenue based on the performance level for each
period. The recognition of revenues may vary from quarter to quarter and may
result in significant fluctuations in operating results from year to year. There
can be no assurance that the Company will be able to maintain its existing
collaborations or be able to obtain additional collaboration partners. The
failure to maintain its existing collaboration partners or the inability to
enter into additional
8
<PAGE> 9
collaborative arrangements could have a material adverse effect on the Company's
revenues and operating results.
Operating Expenses. Total operating expenses, consisting of research and
development expenses and general and administrative expenses, were $7.3 million
and $13.5 million for the three and six months ended June 30, 1998,
respectively, compared to $2.6 million and $4.9 million in the same periods of
1997. This increase in expenses during the three and six months ended June 30,
1998 compared to the corresponding period in 1997, is due primarily to the
addition of scientific personnel, software and database development, the costs
associated with the Company's collaborations with Chiron and UCSF, including the
associated scale-up of the Company's gene sequencing capacity, intellectual
property protection, as well as an increase in marketing and business
development expenses, the addition of management personnel and administrative
staff and expenses related to the new facility.
The research and development component of operating expenses increased to $4.9
million and $9.0 million during the three and six months ended June 30, 1998
from $1.8 million and $3.1 million during the comparable periods of 1997.
Increases in 1998 as compared to 1997 resulted primarily from the addition of
scientific personnel, software and database development, expanded internal
sequencing production and expanded sequencing production in connection with the
collaboration with Chiron, expenses associated with the UCSF collaboration,
further development of the HyChip system, and costs associated with protecting
and increasing the Company's intellectual property. The Company expects to
continue to expand research and development efforts in support of its gene
sequencing, functional genomics and database development programs. Under the
terms of the Company's collaboration agreement with Perkin-Elmer, the Company is
also obligated to spend an aggregate of $5.0 million through May 1999 for the
development of the chip component of the HyChip system. The Company spent
approximately $3.8 million for the development of the chip component of the
HyChip system from June 1997 through June 30, 1998. Of this amount, $504,000 was
reimbursed to the Company under its NIST grant during 1997.
The general and administrative component of operating expenses increased to $2.4
million and $4.5 million during the three and six months ended June 30, 1998
compared to $0.8 million and $1.7 million during the same periods of 1997. The
increase between the periods was due in part to increased marketing and business
development expenses, as well as the addition of management personnel and
administrative staff to support the expansion of the Company's sequencing
production, expanded functional genomics department and data analysis
capabilities, and increase expenses related to the new expanded facility. In
addition, for the six month period ended June 30, 1998, the Company's total
legal expenses increased by approximately $1.3 million (expenses related to new
patent prosecution have been allocated to research and development) as compared
to the same period in 1997, due primarily to its suits filed against Affymetrix,
Inc. in March and December 1997 and costs associated with being a public
company. Legal expenses relating to the Company's litigation with Affymetrix,
Inc. are expected to increase over the next year.
As the Company expands its production and commercialization efforts, operating
expenses are expected to increase as a result of several factors including but
not limited to: (i) additional software development and enhancements and
increased work on gene discovery and functional genomics in connection with
development of potential therapeutic product candidates and diagnostic tests;
(ii) the continued expansion of its HyGenomics Database; (iii) expanded research
into new applications of its technologies; (iv) the expansion of marketing
capabilities with respect to its HyGnostics Module and collaborations; and (v)
new technology development expenses relating to the HyChip Module and other
products.
The magnitude of the increases in the Company's operating expenses will be
significantly affected by the Company's ability to secure new collaboration
partners. However, if the Company does not obtain additional collaboration
partners in a timely manner, it may not be able to adjust significantly its
level of expenditures in any such period, which could have an adverse effect on
the Company's operating results.
Interest Income, Net. Net interest income increased to $737,000 and $1.5 million
during the three months and six months ended June 30, 1998 from $85,000 and
$134,000 for the same periods in 1997. The increase in interest income during
the six months ended June 30, 1998 as compared to the comparable period of 1997
resulted from larger cash and investment balances held by the Company primarily
due to the realization of net proceeds from the Company's $17.5 million private
placements in May and August 1997, and the net proceeds of the Company's initial
public offering completed in August 1997.
9
<PAGE> 10
Net Loss. Since inception, the Company has incurred operating losses, and as of
June 30, 1998, had an accumulated deficit of $21.4 million. The Company incurred
a net loss for the three months and six months ended June 30, 1998 of $3.9
million and $6.6 million, respectively, compared to a net loss of $1.4 million
and $3.3 million in the comparable periods of 1997.
Liquidity and Capital Resources
As of June 30, 1998, the Company had $48.8 million in cash, cash equivalents and
short-term investments and $2.1 million in a restricted cash account, compared
to a total of $59.2 million at December 31, 1997 and $14.0 million at June 30,
1997. This increase in cash and investments from the corresponding quarter in
1997 was a result of the Company's initial public offering of 3.45 million
shares of common stock completed in the third quarter of 1997 and private
placements with Chiron and Perkin-Elmer in May and August 1997.
The Company has classified all of its investments as short-term as of June 30,
1998, as the Company's investments all mature in less than one year. Cash and
investments are held currently in investment-grade commercial paper, bank
certificates of deposit and other interest-bearing securities and are invested
in accordance with the Company's investment policy with primary objectives of
liquidity, safety of principal and diversity of investments. In addition, the
Company has $2.1 million on deposit with the Company's primary bank as security
for a letter of credit in conjunction with a facility lease. The letter of
credit and the cash collateralizing it will be reduced by $500,000 commencing in
2001 and will be further reduced by $500,000 each year thereafter provided the
Company is not in default under the lease. The cash on deposit at any time in
conjunction with this letter of credit is restricted and cannot be withdrawn.
The Company controls the investment of the cash and receives the interest earned
thereon.
Net cash used in operating activities increased from $1.8 million during the six
months ended June 30, 1997 to $6.2 million in the comparable period of 1998. The
increase in net cash used in operating activities for the six months of 1998 was
due primarily to increases in personnel to support gene sequencing, database
development programs, functional genomics and corporate development and
marketing, general corporate matters, litigation and legal expenses associated
with defending and expanding its proprietary rights.
The Company's investing activities, other than the purchase and sales of
short-term investments, have consisted of capital expenditures, which totaled
$2.8 million for the six months ended June 30, 1998 as compared to $1.1 million
for the comparable period of 1997. The capital expenditures increase in the
first half of 1998 is primarily due to the addition of capital equipment
necessary for the Company's expanded sequencing production and software
development activities, as well as expenditures related to the installation of
production facilities for the HyChip and expansion of bioinformatics and lab
space at the Company's new facility.
Net cash provided by financing activities decreased to $0.6 million for the six
months ended June 30, 1998 as compared to net cash of $10.1 million for the
comparable period of 1997. Net cash provided by financing activities for the six
months ended June 30, 1998 reflects primarily payments received on notes held by
shareholders and on issuance of common stock related to the exercise of options
and warrants. Net cash provided by financing activities of $10.1 million during
the first half of 1997 reflects primarily the $10.0 million in net proceeds from
the private placement of Series B Preferred Stock with Chiron and Perkin-Elmer.
The Company expects that existing capital resources will be sufficient to
support the Company's operations through 1999. The Company's estimate of the
time period for which cash funds will be adequate to fund its operations is a
forward-looking estimate subject to risks and uncertainty, and actual results
may differ materially. The Company's future capital requirements and the
adequacy of its available funds will depend on many factors, including, but not
limited to, scientific progress in its research and development programs and the
magnitude of financial commitments involved in such arrangements. There can be
no assurance that the Company will be able to establish additional
collaborations or that such collaborations will produce revenues, which together
with the Company's cash, cash equivalents and short-term investments, will be
adequate to fund the Company's operations. The Company's cash requirements
depend on numerous factors, including the ability of the Company to attract
collaboration partners; the Company's research and development activities;
competing technological and market developments; the cost of filing,
prosecuting, defending and enforcing patent claims and other intellectual
property rights. There can be no assurance that additional funding, if
necessary, will be available on favorable terms, if at all.
10
<PAGE> 11
Year 2000 Compliance
The Company's internal operations use a significant number of computer software
programs and operating systems. To the extent that these software applications
contain source code that is unable to appropriately interpret the upcoming
calendar year 2000, some level of modification or possibly even replacement of
such source code or applications will be necessary. The Company is in the
process of identifying the software applications that are not "Year 2000"
compliant. Given the information known at this time about the Company's systems,
coupled with the Company's ongoing efforts to upgrade and maintain critical
business systems as necessary, it is currently not anticipated that the "Year
2000" issue or related costs will have a material adverse effect on the
Company's business, financial condition and results of operations. However, the
Company is still analyzing its software applications and those utilized by key
suppliers and, to the extent they are not fully "Year 2000" compliant, there can
be no assurance that the costs necessary to update software or potential systems
interruptions would not have a material adverse effect on the Company's
business, financial condition and results of operations.
11
<PAGE> 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company currently does not invest excess funds in derivative financial
instruments or other market rate sensitive instruments for any purpose.
12
<PAGE> 13
PART II
HYSEQ, INC.
(A NEVADA CORPORATION)
ITEM 1. LEGAL PROCEEDINGS.
On March 3, 1997, the Company brought suit against Affymetrix in the U.S.
District Court for the Northern District of California, San Jose Division,
alleging infringement by Affymetrix of the Company's U.S. Patents Nos. 5,202,231
and 5,525,464 (Hyseq, Inc. v. Affymetrix, Inc., Case No. C 97-20188 RMW ENE,
U.S. District Court) ("Hyseq I"). On May 5, 1997, the Company filed an Amended
Complaint. The suit alleges that Affymetrix willfully infringed, and continues
to infringe, upon these patents covering SBH technology. Through the lawsuit,
the Company seeks both to enjoin Affymetrix from infringing upon the patents
covering SBH technology and an award of monetary damages for Affymetrix's past
infringement. On May 19, 1997, Affymetrix filed an Answer and Affirmative
Defenses to the First Amended Complaint and also filed a counterclaim against
the Company. The counterclaim seeks a declaratory judgment of invalidity and
non-infringement with respect to these patents covering SBH technology. On June
9, 1997, the Company filed a reply to the counterclaim in which it denied the
allegation of invalidity and non-infringement. While the Company believes it has
made valid claims and has a meritorious defense to the counterclaim, this
litigation is at an early stage and there can be no assurance that the Company
will prevail in the claim. On August 1, 1997, an initial case management
conference was held by the Court and a pre-trial schedule was entered by the
Court. The Company and Affymetrix are currently engaged in pretrial discovery
during which documents are being exchanged and depositions are being taken.
On December 9, 1997, the Company filed a second lawsuit against Affymetrix
which alleges infringement by Affymetrix of the Company's patent No. 5,695,940
(Hyseq, Inc. v. Affymetrix, Inc., Case No. C-97-4469 THE) ("Hyseq II"). Like the
Company's first action against Affymetrix, this action was filed in the U.S.
District Court for the Northern District of California, San Jose Division.
Affymetrix was served with a summons and complaint in the Company's new case on
December 9, 1997. After the March 28, 1997 case management conference, the Court
issued a case management order under which, like the June 9, 1997 case
management order entered in Hyseq I, the parties will engage in pretrial
discovery. The Company may incur substantial costs and expend substantial
personnel time in asserting the Company's patent rights against Affymetrix or
others and there can be no assurance that the Company will be successful in
asserting its patent rights. Failure to successfully enforce its patent rights
or the loss of these patent rights covering SBH technology also could remove a
legal obstacle to competitors in designing platforms with similar competitive
advantages.
The Company is not a party to any other litigation that is expected to
have a material effect on the Company or its business.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
(d) On August 7, 1997, the Company's Registration
Statement on Form S-1 (File No. 333-209091) was declared effective by the
Securities and Exchange Commission (the "Commission") and the Company's
Registration Statement on Form S-1 (File No. 333-13417) filed pursuant to Rule
462(b) of the Securities Act of 1933, as amended, was automatically effective
upon filing (collectively, the "IPO Registration Statements"). The IPO
Registration Statements registered a total of 3,450,000 shares of Common Stock,
including the underwriters' over-allotment which was exercised in full, all of
which were issued and sold by the Company (the "Offering"). All of the shares
covered by the Registration Statements were sold upon termination of the
Offering in September 1997 to an underwriting syndicate managed by Lehman
Brothers Inc. The shares sold by the Company were sold at an aggregate price to
public of $48,300,000, netting $44,919,000 to the Company after underwriters'
discount of $3,381,000. Since the effective date of the IPO Registration
Statements, the Company has incurred approximately $949,000 in expenses in
addition to the underwriters' discount described above in connection with the
registration, offering, issuance and sale of the shares in the
13
<PAGE> 14
Offering, netting estimated proceeds from the Offering to the Company of
approximately $43,970,000 (the "Net Proceeds"). None of such expenses were paid
to any officer, director or 10% or greater stockholder of the Company or an
affiliate of any such persons. Since the effective date of the IPO Registration
Statements, the Net Proceeds have been applied to the following uses in the
following estimated amounts:
<TABLE>
<S> <C>
Purchase and installation of capital equipment: $ 2,963,000*
Lease and improvement of real estate: $ 1,272,000*
Working Capital: $20,080,000
Temporary Investment: $19,655,000
</TABLE>
*These amounts include expenses related to the further development of
the HyChip Module and the "early access" program for the HyChip in addition to
expenses related to the expansion of the Company's functional genomics program
to develop potential therapeutic products.
The temporary investments specified above have consisted primarily of
investment-grade commercial paper, bank CDs and other interest-bearing
securities. None of the payments of proceeds mentioned above have been paid to
any officer, director or 10% or greater stockholder of the Company or and
affiliate of any such persons.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company held its Annual Meeting of Stockholders on May 18,
1998. At that meeting, in addition to the election of the
Class II members of the Board of Directors, five proposals
were voted upon. The proposals and the results of the voting
are as follows:
1. The following persons were nominees for election as Class
II Directors, each to hold office for a term as outlined
in the proxy statement and until his or her successor is
duly elected and qualified. Each such Director received
the number of votes set opposite his or her respective
name:
<TABLE>
<CAPTION>
Nominee For Percent Withheld Percent
------- --- ------- -------- -------
<S> <C> <C> <C> <C>
Raymond F. Baddour 9,282,671 72.90 28,810 0.20
Greta E. Marshall 9,282,871 72.90 26,610 0.20
</TABLE>
THE AFORESAID NOMINEES HAVE BEEN ELECTED AS CLASS II
DIRECTORS FOR THE TERM SET FORTH IN THE PROXY STATEMENT.
2. The proposal to ratify the selection of Ernst & Young
L.L.P. as independent auditors for the 1998 fiscal year
received the following votes.
<TABLE>
<CAPTION>
Percentage of
Outstanding Percentage of
Votes Shares Total Votes
----- ------ -----------
<S> <C> <C> <C>
For 9,075,241 71.27 97.49
Against 2,700 0.02 0.03
Abstain 230,540 1.81 2.48
</TABLE>
THE FOREGOING PROPOSAL WAS APPROVED.
3. The proposal to continue the Stock Option Plan (the
"1995") as required by Section 162(m) of the Internal
Revenue Code of 1986, as amended and to amend the 1995
Plan, including amendment to increase the number of shares
authorized thereunder received the following votes:
14
<PAGE> 15
<TABLE>
<CAPTION>
Percentage of
Outstanding Percentage of
Votes Shares Total Votes
----- ------ -----------
<S> <C> <C> <C>
For 7,023,315 55.16 87.75
Against 953,719 7.49 11.92
Abstain 26,900 0.21 0.33
</TABLE>
THE FOREGOING PROPOSAL WAS APPROVED.
4. The proposal to amend the Non-Employee Director Plan
received the following votes:
<TABLE>
<CAPTION>
Percentage of
Outstanding Percentage of
Votes Shares Total Votes
----- ------ -----------
<S> <C> <C> <C>
For 7,195,625 56.51 89.55
Against 794,254 6.24 9.88
Abstain 45,502 0.36 0.57
</TABLE>
THE FOREGOING PROPOSAL WAS APPROVED.
5. The proposal to approve and Employee Stock Purchase Plan
received the following votes:
<TABLE>
<CAPTION>
Percentage of
Outstanding Percentage of
Votes Shares Total Votes
----- ------ -----------
<S> <C> <C> <C>
For 7,805,922 61.31 97.14
Against 216,507 1.70 2.69
Abstain 12,952 0.10 0.17
</TABLE>
THE FOREGOING PROPOSAL WAS APPROVED.
6. The proposal to amend the 1995 Plan and the Directors Plan
to accelerate vesting of options upon a change of control
received the following votes:
<TABLE>
<CAPTION>
Percentage of
Outstanding Percentage of
Votes Shares Total Votes
----- ------ -----------
<S> <C> <C> <C>
For 7,912,984 62.14 98.48
Against 87,257 0.69 1.09
Abstain 35,140 0.28 0.43
</TABLE>
THE FOREGOING PROPOSAL WAS APPROVED.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 27.0 Financial Data Schedule
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter
ended June 30, 1998.
15
<PAGE> 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HYSEQ, INC.
(Registrant)
By:/s/ Christopher R. Wolf
----------------------------
Christopher R. Wolf
Executive Vice President and
Chief Financial Officer
Date: August 7, 1998
<PAGE> 17
HYSEQ, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
Page No.
<S> <C>
27.0 Financial Data Schedule 18
</TABLE>
17
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 11,500
<SECURITIES> 37,287
<RECEIVABLES> 3,299
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 52,822
<PP&E> 8,024
<DEPRECIATION> 2,095
<TOTAL-ASSETS> 61,520
<CURRENT-LIABILITIES> 3,845
<BONDS> 0
0
0
<COMMON> 82,339
<OTHER-SE> (25,162)
<TOTAL-LIABILITY-AND-EQUITY> 57,177
<SALES> 0
<TOTAL-REVENUES> 5,363
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 13,505
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (31)
<INCOME-PRETAX> (6,606)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,606)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,606)
<EPS-PRIMARY> (0.52)<F1>
<EPS-DILUTED> (0.52)
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, BOTH PRIMARY AND DILUTED MEAN BASIC AND DILUTED.
</FN>
</TABLE>
