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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[MARK ONE]
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
[ ] 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: 0-22873
HYSEQ, INC.
(Exact Name of Registrant as Specified in Its Charter)
NEVADA 36-3855489
(State or Other Jurisdiction
of Incorporation or Organization) (I.R.S. Employer Identification No.)
670 ALMANOR AVENUE, SUNNYVALE, CA 94086
(ADDRESS OF PRINCIPAL EXECUTIVE (ZIP CODE)
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 524-8100
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $.001
(Title of Class)
Indicate by check mark whether the registrant (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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant (without admitting that any person whose shares
are not included in such calculation is an affiliate) on March 23, 1998 was
$123,805,654, based on the last sale price as reported by The Nasdaq Stock
Market.
As of March 23, 1998, the Registrant had 12,733,963 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents (or parts thereof) are incorporated by reference into
the following parts of this Form 10-K: Items 10, 11, 12 and 13 of Part III
incorporate by reference information from the Registrant's Proxy Statement to be
filed with the Securities and Exchange Commission in connection with the
solicitation of proxies for the Registrant's 1998 Annual Meeting of Stockholders
to be held on May 18, 1998.
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PART I
ITEM 1. BUSINESS
Hyseq, Inc. ("Hyseq" or the "Company") was incorporated in August 1992 as an
Illinois corporation and was merged into a newly formed Nevada corporation in
November 1993, with the Nevada corporation being the survivor. References in
this Form 10-K to "Hyseq" and the "Company" include the Nevada corporation, its
predecessors and its subsidiary, Hyseq Diagnostics, Inc., a Nevada corporation,
unless otherwise stated or indicated by the context. The Company maintains its
principal executive offices at 670 Almanor Avenue, Sunnyvale, California 94086.
Its telephone number is (408) 524-8100. Hyseq(R) is a registered trademark
and service mark of the Company. HyChip(TM), HyGenomics(TM), HyGnostics(TM) and
HyProfile(TM) are trademarks and HyX(SM) is a service mark of the Company.
OVERVIEW
Hyseq applies the proprietary DNA array technology of its integrated HyX genomic
platform (the "HyX Platform") to develop gene-based therapeutic product
candidates and diagnostic products and tests. The Company believes that its HyX
Platform, which utilizes the Company's proprietary sequencing by hybridization
("SBH") technology as its foundation, generates higher gene sequence throughput
with greater analytical flexibility and accuracy and lower cost than prevailing
technologies, such as gel sequencing. In the fourth quarter of 1997, the HyX
Platform Gene Discovery Module achieved, on a single production line, a rate of
more than 1,000,000 human DNA samples analyzed per month. Based in part on this
rate of analysis and on published industry information, the Company believes
that its proprietary HyGenomics Database of over 5,000,000 partial human gene
sequences is the largest such database in the world. The Company expects to
complete installation of a second production line in the second quarter of 1998.
The gene sequence throughput capacity of Hyseq's Gene Discovery Module presently
permits analysis of batches of approximately 50,000 DNA samples that can be
1,000 bases in length each (up to approximately 50,000,000 total bases per
batch). By comparison, the gene sequence throughput capacity of gel sequencers
presently permits analysis of batches of approximately 75 DNA samples that can
be up to 500 bases in length (up to approximately 37,500 total bases per batch).
The Company believes the HyX Platform has greater analytical flexibility because
of its ability to sequence genes at multiple levels of completeness from
intermittent sequencing for gene identification and gene expression studies to
partial sequencing for motif searches to complete sequencing for diagnostics.
The Company believes that its sequencing capacity, coupled with the HyX
Platform's flexibility to sequence genes at multiple levels of completeness,
make it appropriate for a large number of therapeutic and diagnostic
applications. See "--Advantages of the HyX Platform." The HyX Platform employs
SBH to generate gene sequence information from DNA samples. The sequence
information from a DNA sample enables the Company to track a gene's role and
activity in disease conditions and, hence, to evaluate the gene as a potential
therapeutic or diagnostic candidate. See "--Technology" for a description of the
Company's gene sequencing process.
The Company believes that the ability of its HyX Platform to process millions of
samples per month and sequence billions of bases per year represents a
fundamental advance in performing genomic experimentation, gene discovery, gene
function analyses and diagnostic testing in commercial-scale volumes, providing,
for the first time, all active genes in a cell. The HyX Platform includes (i) a
comprehensive set of labeled DNA probes; (ii) DNA arrays of samples and probes;
(iii) three software-driven modules (the Gene Discovery, HyGnostics and HyChip
Modules) comprising software and a specific configuration of platform hardware,
which provide flexible DNA probe selection to customize the level and type of
analysis; (iv) industrial robots for screening DNA probes against DNA samples;
and (v) bioinformatic software to manage and analyze genetic information. These
combined technologies enable the Company to conduct a range of genomic
applications, including gene identification, expression level determination,
gene interaction studies, polymorphism screening, diagnostic testing and genetic
mapping, on one integrated platform.
Hyseq's strategy is to engage in large-scale gene discovery and to utilize
collaborations to facilitate development and commercialization activities. Hyseq
believes that this research- and partner-driven approach creates significant
operational and financial advantages for the Company and may accelerate
commercial development of new therapeutic and diagnostic products. The Company
has an exclusive collaboration with Chiron
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Corporation ("Chiron") to develop therapeutics, diagnostic molecules and
vaccines relating to solid tumors. The Company also is collaborating with the
University of California San Francisco ("UCSF") to conduct population genetic
and pharmacogenomic research on genes that may have important roles in the
development of cardiovascular and related diseases.
Hyseq intends to patent commercially relevant genes and gene-based products
obtained through application of its HyX Platform. The Company believes that
information about the biological function of genes is critical to obtaining such
patents. Further, the Company believes that the HyX Platform's ability to
perform complete sequencing rapidly and cost effectively may accelerate the
characterization of gene function and enhance the discovery and development of
new therapeutic product candidates and diagnostic products and tests. The
Company has five issued U.S. patents and several pending patent applications
covering apparatus, processes and over 63,500 gene discoveries identified in
Hyseq's gene discovery program.
The Company intends to license out its technology to expand its ability to
meet the needs of the market. The Company is collaborating on a 50-50 profit
sharing basis with The Perkin-Elmer Corporation ("Perkin-Elmer") to
commercialize a gene sequencing system that utilizes HyChip products. Pending
patent applications cover apparatus and other methods for genomic research.
BACKGROUND
Genes are the hereditary units that control the structure, health and
function of all organisms. The study of genes and their functions has led to the
development of products and services for diverse markets ranging from health
care to agriculture. In 1997, industry sales of human gene-based products,
including erythropoietin ("EPO"), human insulin, granulocyte colony stimulating
factor and tissue plasminogen activator, totaled over $13.3 billion. Genomics,
the study of all genetic information of organisms, is a growing field that is
expected to lead to the development of additional gene-based therapeutics like
EPO, small molecules and other drugs and diagnostic tests for detection of
genetic conditions.
The Genetic Code
The entire genetic content of each organism, known as its genome, is
encoded in deoxyribonucleic acid ("DNA"). DNA, which is found in cells, is a
molecule comprising two single strands entwined in the form of a double helix.
Various combinations of four chemical building blocks or "bases" of DNA, adenine
("A"), thymine ("T"), cytosine ("C") and guanine ("G"), are linked together in
series to form each DNA strand. The bases of one DNA strand bind to the bases of
the other strand in a specific fashion to form "base pairs": A pairs with T and
G pairs with C. In humans, there are approximately six billion base pairs
organized into 23 pairs of DNA structures called "chromosomes."
A gene comprises a series of groupings of three bases on a DNA strand that
encodes specific amino acids which, in turn, combine to form proteins. Gene
"sequencing" is the process of determining the order in which these bases are
linked together to form a gene. Scientists believe that approximately 10% of
human DNA comprises genes, with most of the remaining 90% being of unknown
function. The human genome has been estimated to contain approximately 150,000
genes which encode proteins. Proteins are essential to cellular structure,
growth and function and, thus, are the principal determinants of an organism's
characteristics.
Scientists believe that each gene has two basic regions, a structural
region and a regulatory region. The structural region of a gene encodes a
specific protein. The process by which the structural region of a gene directs
the production of a protein is known as gene expression. In that process, the
sequence of bases in a gene is copied into a related molecule called messenger
ribonucleic acid ("mRNA"). The mRNA instructs the cell to combine amino acids
together in a particular order to form a protein. The regulatory region of a
gene is responsible for the rate of gene expression and the resultant amount of
a given protein produced in specific cells of the body.
The Relationship Between Genes and Disease
Because genes encode proteins, which govern substantially all functions of
the human body, the sequences of genes and their levels of expression determine
when, where and how well essential functions are performed. The addition,
deletion or substitution of one or more bases in a gene, known as a "mutation,"
can alter a protein or a
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gene's level of expression and result in a disease condition. For example,
whether a cell is cancerous or normal may depend upon the presence or absence of
a mutation in the "p53" human cancer suppressor gene. Similarly, scientists
believe that whether an individual develops acquired immune deficiency syndrome
("AIDS") upon infection with the human immunodeficiency virus ("HIV") is, in
part, a function of at least one human gene sequence. Moreover, the
susceptibility of a particular strain of HIV to drug treatment may depend upon
the sequence of the viral strain's genome. Most diseases are believed to be
polygenic, in that multiple genes interact to cause or affect a disease
condition. In developing a drug for a polygenic disease like diabetes, the most
effective target may be best selected when all genes which interact to cause or
affect the disease are known.
Applications of Genomics to Understanding Disease
Detailed knowledge of gene sequences that encode missing, defective or
abnormally expressed proteins and an understanding of gene interactions in
disease conditions offer the potential to develop novel therapeutic products and
diagnostic tests. Genomics provides the basis for developing drugs designed to
replace missing or defective proteins or to deactivate or limit the effect of
proteins that are present at excessive levels. Drugs also may be designed to
supplement proteins produced by normal genes. For example, anemia can be treated
by injecting a patient with EPO, a protein that stimulates the production of red
blood cells. Drugs also may be designed to remedy the effects of defective genes
by affecting their expression. In addition, diagnostic tests for diseases can be
developed by determining gene sequences that predispose individuals to
gene-related diseases.
Several genomic applications, including (i) polymorphism screening, (ii)
gene expression level studies, (iii) motif searches, and (iv) gene
identification, can provide critical insight into understanding disease and
developing for therapeutic products and diagnostic tests. Polymorphism screening
involves sequencing the same gene in each member of a population of healthy and
diseased individuals to find naturally occurring variations or "polymorphisms"
in the gene sequence and correlating those polymorphisms with the disease
condition. Expression level studies compare the levels at which genes are
expressed in healthy and diseased individuals to correlate differences with the
disease condition. Motif searches, the screening of DNA samples for short DNA
segments that are associated with a specific function, can be used to identify
families of genes having similar functions as potential therapeutic product
candidates. Gene identification can be used to find genes expressed at low
levels. Such genes are said to be "rarely" expressed because their corresponding
mRNA is rarely found in tissue samples. Because proteins expressed by rarely
expressed genes, such as EPO, are more effective in small quantities than
proteins expressed by highly expressed genes, they represent attractive
candidates for potential therapeutic products.
Limitations of Prevailing Technologies
Many biotechnology companies historically have been involved in the search
for genes that encode proteins with functions known to have commercial value.
Information from traditional genetics and molecular biology provides clues about
where to look for these genes, but the rate at which these genes can be
identified from this information is limited. The large market potential for gene
products led to the initiation of the Human Genome Project by the United States
government and to the formation of genomics companies. Given the volume of
sequence information in the human genome, genomics companies have focused on
partially sequencing human DNA that contains genes that encode proteins
(approximately 10% of all human DNA).
To date, genomics companies have relied primarily on gel-sequencing
technology to identify genes and obtain sequence information. Gel sequencing
involves the production of multiple DNA copies, each of which is successively
shorter by one base. The last base of each copy is labeled with a fluorescent
tag to identify it as an A, T, C or G. The copies are then introduced into a gel
sequencer that uses an electrical field to move the labeled copies through a
gel. The copies move through the gel at different rates, with shorter copies
moving faster than longer copies. The gel must be run for several hours to
separate the copies sufficiently to be read by a detector which identifies the
end base as an A, T, C or G as the copies move through the detector. The
sequence of the successive readouts represents the sequence of the DNA sample.
Because the readouts generated by this process may yield ambiguous information,
the gel may be run several times to ensure complete accuracy. If a technician
cannot resolve an ambiguity, the process is repeated and may require additional
treatment of the DNA sample.
Genomics companies use gel sequencing primarily to generate short
sequences, known as expressed sequence tags ("ESTs"), which assist in gene
identification. In producing ESTs, portions of mRNA sequences from tissue
samples are first copied into a form of DNA called complementary DNA ("cDNA").
An EST is then obtained by sequencing an end of the cDNA, thereby "tagging" the
cDNA. As a result, the EST is only a partial sequence of one
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end of a partial copy of an mRNA. To identify new genes, genomics companies
produce large numbers of ESTs and collect them into databases. The ESTs are then
compared to sequences of known genes to determine whether a new gene may have
been identified. While gel sequencing and ESTs have generated higher volumes of
gene sequence information than other prevailing technologies, these technologies
are relatively labor intensive and time consuming, creating limitations in
throughput, flexibility of applications, accuracy and cost.
THE HYSEQ DNA ARRAY SOLUTION
The Company believes that the ability of its HyX Platform to process
millions of samples per month and sequence billions of bases per year represents
a fundamental advance in performing genomic experimentation, gene discovery,
gene function analyses and diagnostic testing in commercial-scale volumes. The
Company believes that its HyX Platform, which utilizes the Company's proprietary
SBH technology as its foundation, generates higher gene sequence throughput with
greater analytical flexibility and accuracy and lower cost than prevailing
technologies. The HyX Platform includes (i) a comprehensive set of labeled DNA
probes; (ii) DNA arrays of samples and probes; (iii) three software-driven
modules comprising software and a specific configuration of platform hardware,
which enable user-driven DNA probe selection to customize the level and type of
analysis; (iv) industrial robots for screening DNA probes against DNA samples;
and (v) bioinformatic software to manage and analyze genetic information. The
HyX Platform's software-driven modules include:
Gene Discovery Module: The Company's Gene Discovery Module is designed
to screen or sequence large numbers of human DNA samples (typically 50,000
samples per batch) for correlation and comparison of such sequences in gene
discovery and genomic experimentation. The information generated by the
Gene Discovery Module is stored in the Company's proprietary HyGenomics
Database, which the Company believes is the largest partial human gene
sequence database in the world. This module is being used internally to
identify proprietary gene-based therapeutic candidates in the central
nervous system, cardiovascular and infectious disease areas and therapeutic
product candidates that impact cell receptors. The Company is collaborating
with UCSF to identify genes that may have important roles in the
development of cardiovascular and related disease. Under the agreement,
UCSF researchers are collecting DNA samples from 20,000 genetically diverse
individuals. Many of these samples include results from angiogram,
ultrasound and biochemical tests, allowing a direct comparison of genetic
information with clinical histories. The Company believes this will be the
largest population genetic and pharmacogenomic project in terms of amount
of sequence data generated to thoroughly understand the roles of genes,
gene mutations and polymorphisms that may lead to diseases of the
cardiovascular system. Hyseq has the exclusive rights from UCSF to
commercialize the proprietary databases derived from this collaboration.
The Company also has an exclusive collaboration with Chiron to develop
therapeutics, diagnostic molecules and vaccines relating to solid tumors.
The Company has analyzed more than 1,500,000 DNA samples for Chiron under
the agreement. The collaboration has resulted in the filing of patent
applications on more than 2,200 gene discoveries to date
HyGnostics Module: The Company's HyGnostics Module is designed to
screen or sequence small to medium numbers of DNA samples (typically, 10 to
1,000 samples per batch) for applications, including polymorphism and
population genetics studies and DNA testing of genetic and infectious
disease and cancer. In a blind test conducted by SmithKline Beecham
Clinical Laboratories, Inc., and reported on by the Company and the
Department of Molecular Diagnostics of SmithKline Beecham Pharmaceutical
Co. in the January 1998 issue of Nature Biotechnology, the HyGnostics
Module was 100% accurate and met or exceeded all requirements for
sensitivity, cost, speed, correct heterozygote sequencing, reproducibility
and temperature range.
HyChip Module: The Company's HyChip Module is designed to screen or
sequence DNA samples in a single reaction with a capacity ranging from the
detection of single base mutations through the sequencing of entire viral
genomes. The Company is presently using the HyChip Module internally for
research applications. The Company has an exclusive collaboration with
Perkin-Elmer to co-develop and commercialize gene-sequencing systems
targeted at specific DNA research and diagnostic applications utilizing
HyChip products and Perkin-Elmer's life science system capabilities. The
Company has conducted tests on its HyChip Module in which a set of probes
capable of complete sequencing of all mutations was applied to samples of
the HIV genome, which the Company believes is the first time such capacity
has been demonstrated. The HyChip Module also has the capacity to sequence
64,000 bases in one reaction, which the Company believes is the greatest
amount of DNA sequencing capacity demonstrated to date.
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The Company believes that its HyX Platform represents a significant advance
in analyses such as gene identification, expression level determination, gene
interaction studies, polymorphism screening, diagnostic testing and genetic
mapping. As indicated in the chart below, the analyses performed on the modules
of the HyX Platform generate information for the HyGenomics Database, which the
Company intends to utilize independently and with collaboration partners to
develop potential therapeutic product candidates and diagnostics tests.
ADVANTAGES OF THE HYX PLATFORM
Higher Throughput
Ability to Obtain More Gene Targets for Monogenic and Polygenic Diseases.
Researchers have focused primarily on identifying single genes that may be
involved in a disease due to throughput limitations of prevailing technologies.
While this may be an effective approach to understanding monogenic disorders in
which one gene is the predominant cause of a disease, most diseases are believed
to be polygenic. The Company believes that the Hyseq gene sequencing approach
provides researchers with the first industrial-scale tool for comprehensively
analyzing gene identities and expression levels in a cell or tissue. Similarly,
effective gene interaction studies that identify genes involved in polygenic
diseases under various conditions require the ability to process millions of
cDNAs. The HyX Platform's Gene Discovery Module has achieved, on a single
production line, a DNA analysis rate of more than 1,000,000 DNA samples per
month. The Company believes that this high capacity gives it an advantage in
performing effective gene identification and gene interaction studies, which are
required to obtain gene targets on an industrial scale. The Company believes
that these capabilities enhance the ability of researchers to focus on multiple
genes involved in a disease.
Ability to Effectively Conduct Polymorphism Screening. Genes correlated
with disease may be sequenced to identify polymorphisms in an attempt to
understand what significance, if any, mutations may have. Polymorphism screening
for such polygenic diseases typically involves sequencing many genes, some or
all of which may be thousands of bases in length, from thousands of healthy and
diseased individuals. An understanding of polygenic disease also requires
analysis of gene interactions that cause or affect the disease. The Company
believes that effective polymorphism screening, which is an element of genomic
experimentation and diagnostic testing, requires the ability to sequence
billions of bases per year. The Hyseq Gene Discovery Module presently can
analyze batches of approximately 50,000 DNA samples that can be 1,000
bases in length each (up to approximately 50,000,000 total bases per batch).
Identification of Rarely Expressed Genes. Scientists believe that rarely
expressed genes encode regulatory proteins of all kinds, including receptors and
hormones. Because rarely expressed genes are represented by far fewer copies of
mRNA in a given tissue sample than highly expressed genes, large numbers of
cDNAs may have to be analyzed before the cDNA of a rarely expressed gene is
found. The Company believes that its high throughput significantly enhances its
ability to analyze the large number of cDNAs necessary to find rarely expressed
genes. Out of the hundreds of thousands of mRNAs present in a typical tissue
sample, only a few copies of mRNA for rarely expressed genes are present. The
Hyseq Gene Discovery Module is capable of identifying a copy of mRNA that
appears only once per cell in such a tissue sample.
Diagnostics. A gene involved in a disease like cystic fibrosis may be
thousands of bases long and can contain disease-causing mutations at any one or
more of hundreds of locations. Accurately diagnosing such a disease can often
depend upon complete sequencing of the gene. Moreover, accurately diagnosing
polygenic diseases such as diabetes may require sequencing of several genes. The
Company's HyGnostics Module can completely sequence genes such that all
mutations are identified. The high throughput of the HyGnostics Module also
allows many genes from the same sample to be sequenced in a single batch,
thereby facilitating diagnosis of polygenic disorders. The Company believes that
these features make the HyGnostics Module particularly useful in
commercial-scale diagnostic applications.
Greater Flexibility
Functional Analyses. The Company believes that determining a gene's
function is a critical step in patenting and commercializing a gene or gene
product. The Company believes that the flexibility of the Hyseq Gene Discovery
Module, which allows researchers to obtain the appropriate level of functional
information from motifs,
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gene expression studies and complete sequences, is expected to accelerate the
characterization of function. Unlike prevailing technologies, the HyX Platform's
ability to sequence genes at multiple levels of completeness makes it
appropriate for a large number of therapeutic and diagnostic applications. Using
software commands, the level of completeness can be adjusted from intermittent
sequencing for gene identification and expression level determination to partial
sequencing for motif searches to complete sequencing for diagnostics. For
example, in scanning sequences associated with a growth factor function, the
Company can screen millions of DNA samples for the presence of a growth factor
motif without completely sequencing the samples.
Expansion of Diagnostics Applications. The flexibility of the HyGnostics
Module is derived from simple software commands that allow the user to rapidly
add new DNA tests or new mutations to existing tests on one platform with one
set of supplies, rather than using systems supplied by multiple vendors. This
one-platform approach enables the user to screen for mutations and sequence the
identified mutation on a single platform and enables the user to introduce new
tests in response to market demand. Unlike biochip approaches which are
test-specific and require development of a new biochip for each modification or
for each new test, the HyGnostics Module's software allows the user to perform
multiple tests for multiple targets (e.g., both the CF gene and HIV) in one
batch without any hardware or biochip modifications.
High Degree of Accuracy
The Company believes that SBH is highly accurate because SBH technology
compiles multiple overlapping sequences of bases for each DNA sample, thereby
providing multiple verifications of each base in a sequence in one run as
opposed to the three to eight runs typically required for comparable accuracy in
gel sequencing. Accuracy is critical in patenting genes because a patent claim
containing inaccurate sequence information can nullify the protection intended
by the patent. In diagnostics, accuracy is critical to avoiding misdiagnoses and
possible injury to patients. Based in part upon a blind test conducted by
SmithKline Beecham, the Company believes that its Gene Discovery and HyGnostics
Modules produce complete sequences with significantly better accuracy per run
than gel sequencing. Additionally, the Company's HyGnostics and HyChip Modules
can accurately sequence mutations in the form of insertions or deletions of
bases. See "--Technology."
Greater Cost Effectiveness
Based on the Company's cost and cost information for gel sequencing
reported in commercial and scientific publications, the Company believes that it
can identify genes and produce complete DNA sequences at a lower cost than gel
sequencing. Overall, the Hyseq modules require less labor than gel sequencing,
in part because of the elimination of multiple steps involved in sample
preparation and interpretation. Hyseq can analyze approximately twice the amount
of DNA bases per sample in batches containing, on average, over 1,000 times the
total number of bases per batch as gel sequencing. Moreover, the Company's
modules can sequence DNA samples significantly faster per batch than current gel
sequencers.
STRATEGY
Hyseq's strategy is to engage in large-scale gene discovery and to utilize
collaborations to facilitate development and commercialization activities. Hyseq
believes that this research- and partner-driven approach may create significant
operational and financial advantages for the Company and accelerate commercial
development of new therapeutic and diagnostic products. The following are key
elements of the Company's strategy.
Therapeutics
Discover Gene-Based Pharmaceutical Candidates and Commercialize Them
Through Collaboration Partners. Hyseq presently is concentrating on generating
proprietary product candidates in areas where a gene sequence can be directly
used in manufacturing pharmaceuticals. Products may include therapeutic proteins
and gene therapy and diagnostic product candidates that the Company intends to
transfer to collaboration partners for bioassays, protein expression, regulatory
review, manufacturing and marketing. The Company is focusing initially on
candidates that affect cell receptors and certain central nervous system,
cardiovascular and infectious diseases.
Establish Collaborations for Disease-Specific Programs. The Company is
pursuing selected collaborations with pharmaceutical and biotechnology companies
to discover, develop and commercialize new product candidates
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in narrowly defined disease categories. The Company seeks collaboration partners
with expertise in expression, bioassays, preclinical and clinical regulatory
review and marketing. To enhance profitability in the near term, the Company
intends to seek revenues in the form of up-front and milestone payments and
database access fees. To enhance revenues in the long term, the Company intends
to seek royalties on sales of products resulting from the collaborations. The
Company has an exclusive collaboration with Chiron to develop therapeutics,
diagnostic molecules and vaccines relating to solid tumors. The Company also is
collaborating with UCSF to conduct research on genes that may have important
roles in the development of cardiovascular and related diseases. Hyseq has the
exclusive rights from UCSF to commercialize the proprietary databases derived
from this collaboration. See "--Collaborative and Other Arrangements--Chiron
Corporation," regarding the Company's collaboration with Chiron and UCSF.
Implement Commercial-Scale Genomic Experimentation. The Company believes
that the ability of its HyX Platform to process millions of samples per year and
sequence billions of bases per year represents a fundamental advance in DNA
sequencing analysis that enables genomic experimentation in commercial-scale
volumes. Hyseq's strategy is to leverage this genomic experimentation capacity
by screening large numbers of samples for expression levels from cells under
various conditions in order to correlate disease conditions with genetic changes
and by large-scale partial sequencing of samples to find disease-related
polymorphisms. The Company believes that the resultant rapid expansion of its
HyGenomics Database will provide the Company and its collaboration partners a
competitive advantage in patenting and commercializing gene-based pharmaceutical
products.
Diagnostics
Commercialize HyChip Products Through Collaborations. Hyseq presently is
using the HyChip Module internally for a variety of research applications. The
Company has identified numerous diagnostic and research applications that
require sequencing large amounts of DNA per sample, including sequencing of
entire viral genomes. The Company is collaborating with Perkin-Elmer to
co-develop and commercialize gene sequencing systems utilizing HyChip products
targeted at specific DNA research and diagnostic applications. The Company
believes Perkin-Elmer's expertise in designing, manufacturing and marketing
scientific instruments for research and diagnostics will allow the Company to
significantly accelerate HyChip product development and commercialization. The
Company and Perkin-Elmer intend to market HyChip systems so as to receive
revenues from sales of HyChip systems and from royalties on products discovered
using HyChip products. See "--Collaborative and Other Arrangements."
TECHNOLOGY
The HyX Platform
The HyX Platform combines the Company's DNA array technology with
software-driven flexibility for therapeutic candidate discovery and diagnostic
testing. The HyX Platform, which utilizes the Company's proprietary SBH
technology as its foundation, provides a range of genomic applications on one
integrated platform, including gene identification, expression level
determination, gene interaction studies, polymorphism screening, diagnostic
testing and genetic mapping. The HyX Platform includes (i) a comprehensive set
of labeled DNA probes; (ii) DNA arrays of samples and probes; (iii) three
software-driven modules comprising software and a specific configuration of
platform hardware, which enable user-driven probe selection to customize the
level and type of analysis; (iv) industrial robots for screening DNA probes
against DNA samples; and (v) bioinformatic software to manage and analyze
genetic information. The Company's Gene Discovery Module is designed for
discovery and functional analysis of potential therapeutic product candidates.
The Company's HyGnostics Module and HyChip Module are being used internally for
research applications and are being developed for commercial applications
targeted at specific DNA research and diagnostics. The Company purchases the
probe, computer and robot components of the HyX Platform from outside vendors.
All components are available from multiple vendors. See also "--Licensed
Technology."
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SBH Technology
In the versions of SBH technology presently used by the Company, DNA
sequences are determined by "hybridizing" or binding labeled DNA probes (short
fragments of chemically tagged DNA which have known sequences) to DNA samples.
Using Hyseq's proprietary software, labeled DNA probes are selected from the
Company's comprehensive set of DNA probes and screened against DNA samples. The
labeled probes used on a given DNA array are selected and applied in a highly
automated and proprietary software-controlled process, giving users flexibility
in directing the type and level of analysis to be performed. Each labeled probe
binds to segments of a DNA sample that have matching or "complementary"
sequences. Upon completion of the hybridization process, the sequences of the
labeled probes that bind to the sample are overlapped to form columns of
identical bases. Reading the base in each column, Hyseq's proprietary
bioinformatics then assembles a DNA sample's sequence. The redundancy created by
overlapping multiple DNA probes generates highly accurate DNA sequence
information. The DNA sequence information from the sample enables the Company to
track a gene's role and activity in disease conditions and, hence, to evaluate
the gene as a potential therapeutic or diagnostic product candidate.
DNA Arrays
The HyX Platform uses industrial robots to print DNA arrays onto substrates
such as glass, plastic or paper. The HyX Platform presently uses two types of
DNA arrays: (i) DNA sample arrays with unknown sequences in its Gene Discovery
and HyGnostics Modules; and (ii) DNA probe arrays with known sequences in its
HyChip Module, to which a sample and one or more labeled probes are applied.
Tissue samples, such as blood or biopsy tissues, are prepared by using standard
biochemical methods for use with any of the Company's DNA arrays.
Gene Discovery Arrays. The Gene Discovery array is designed to identify,
map and sequence large numbers of DNA samples within genomes and to correlate
and compare such sequences in gene discovery. The Gene Discovery Module
robotically prints an array of 50,000 DNA samples and then applies a labeled
probe or a set of probes of known sequence to each array. After washing the
array to remove unbound probes and determining which known probes have
hybridized to the DNA sample, an SBH process assembles the sequence of that
sample. The Company is using this type of array in generating proprietary
product candidates that affect cell receptors or that are candidates in disease
categories including certain cancer, central nervous system, cardiovascular and
infectious diseases.
HyGnostics Arrays. The HyGnostics array is designed to perform complete
sequencing of small to medium numbers of DNA samples. The HyGnostics Module
robotically prints duplicate arrays of 10 to 1,000 DNA samples, with each array
being printed inside a square of a grid that prevents fluid leakage from one
square to another, and then applies a labeled probe or set of probes to each
array. After washing the arrays, the known sequence of any labeled probe that
binds to a sample in the array is used in an SBH process to assemble the
sequence of that sample. The HyGnostics Module is being used internally for
polymorphism, genetic and pharmacogenomic applications. The HyGnostics Module
also has applications in DNA testing of genetic and infectious disease and
cancer.
HyChip Arrays. The HyChip array is designed for gene discovery and
diagnostic applications that require analysis of DNA samples in a range of
lengths, from detecting single base mutation to the sequencing of entire viral
genomes. The HyChip Module robotically prints duplicate arrays of different
unlabeled DNA probes on a substrate (the "chip" component of the HyChip Module).
The sequence of each unlabeled probe is known for each point in the array. A DNA
sample, a labeled probe or set of probes and a chemical linking agent are
applied to each array. The sample then hybridizes to a substrate-bound unlabeled
probe and a free-floating labeled probe. The two probes hybridize to the sample
end-to-end and are bound together by the chemical agent. After washing the
arrays, the combined known sequences of the labeled probe and the unlabeled
probe to which it is linked are used in an SBH process to assemble the sequence
of the sample. The HyChip Module currently is being used internally for research
applications, while being developed for commercial applications, including
applications for testing of genetic and infectious disease and cancer.
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Probe Selection
Hyseq's proprietary probe selection software gives users the flexibility to
select any combination of probes tailored for a given sample or genomic
application. For example, a technician can select the Gene Discovery Module
motif-searching application or the HyGnostics Module for complete sequencing.
The technician's selection is transmitted to an industrial robot that locates
appropriate probes from Hyseq's comprehensive collection of labeled probes and
then pipettes selected probes into multi-well plastic plates. By comparison,
other biochip approaches require hardware changes, in some cases including
design and retooling to manufacture new hardware, in order to switch among
applications.
Instrumentation
The multi-well plastic plate with the selected probes and one of the
Company's sample-containing DNA arrays are introduced into a proprietary robotic
hybridization station. The hybridization station applies the labeled probes to
the DNA array, incubates them for a programmed period of time and then washes
the unbound probes away. The DNA array with bound labeled probes is transferred
to a reader that detects the labeled probes' locations in the array and
transmits the data through a local area workstation network for sequence
assembly. The Company uses robots and readers with proprietary modifications for
integration into the Company's HyX Platform.
Bioinformatics
The HyX Platform's sophisticated proprietary image analysis software can
extract as much as 50,000 sequence information bits in less than three minutes.
Data is stored in the Company's proprietary HyGenomics Database, which the
Company believes is the largest human DNA sample database in the world. The
Company believes that the HyGenomics Database's design facilitates
commercial-scale genomic experimentation by providing capabilities for rapidly
processing, storing, retrieving and analyzing biological information and for
manipulating that information. The Company's proprietary software also performs
similarity analyses for identifying identical or related gene samples, sequence
motif identification, differential gene expression analysis and sequence
assembly. The Company's bioinformatics software allows it to analyze and compare
SBH and other data in the proprietary HyGenomics Database.
APPLICATIONS OF THE HYX PLATFORM
Therapeutics
Gene Discovery. To identify the best potential therapeutic and diagnostic
product candidates, the Company is analyzing selected human tissues to discover
disease-related human genes and their functions. In addition to screening for
highly expressed genes, the Company is focusing on screening for rarely
expressed genes in these tissues. By obtaining information about the degree to
which a small number of probes hybridize to a cDNA, the HyX Platform generates a
unique intermittent partial sequence called a "signature" for that cDNA. The
Company uses signatures for identifying genes and for characterizing their
functions. Because the signatures are spread throughout the cDNA, and not just
at its end as is the case with ESTs, the Company believes that the signature
process is more accurate than the EST process in determining the identity of a
cDNA and, as a result, whether it represents a known or new gene. By comparing
such signatures, the number of identical, similar and different cDNAs can be
determined and inventoried. The Company has achieved, on a single production
line, a DNA analysis rate of more than 1,000,000 DNA samples per month.
Expression Monitoring. The relative gene expression levels corresponding to
cDNAs can be determined by comparing the number of copies of each signature
found in collections of cDNA samples such as those obtained from diseased and
normal tissues or before and after drug administration. Hyseq's signature
analysis differs from other technologies in that it can provide both sequence
identity and expression level information in one analysis on a single platform.
Furthermore, unlike other approaches, expression levels of all expressed genes
can be determined. The Company believes that its high-throughput screening of
large DNA sample libraries may enable it to determine a gene's function by
examining the gene's pattern of expression. For example, a gene expressed in the
human prostate during the early stages of cancer, but not expressed in other
tissues or at other times, may be a marker for the cancer and may provide
insights into the biological mechanism of the cancer. The Company currently is
analyzing hundreds of thousands of DNA samples from a number of tissue types to
determine relative gene expression levels.
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HyGenomics Database. The Company compiles DNA sequence information
generated by its modules in its HyGenomics Database where the information is
compared against other sequences in the database and sequences of known genes
and proteins in public databases. The Company believes that information
generated by these comparative analyses may facilitate the development of
potential therapeutic products and diagnostic tests. The Company intends to
collaborate with collaboration partners to develop products based on genetic
information in its HyGenomics Database. The Company believes that its
proprietary HyGenomics Database of partial human gene sequences is the largest
such database in the world.
Polymorphism Screening and Pharmacogenomics. By correlating a polymorphism
with a specific condition, polymorphism screening can be used to determine the
significance of gene regions to the function of the gene as a whole. This
correlation assists in targeting pharmaceuticals to appropriate regions of gene
products (e.g., to a binding site of a receptor). In a polymorphism study, the
more types of sequences that are screened, the more information regarding
variability is obtained. Pharmacogenomic analysis identifies individual patients
who benefit from specific drugs in a safe and efficient way. Hyseq's
high-throughput Gene Discovery Module is designed to sequence tens of thousands
of samples simultaneously. The Company believes that conducting a successful
polymorphism or pharmacogenomic sequencing study requires the ability to
sequence billions of bases per year, which the HyX Platform can provide more
cost-effectively than other technologies. The Company's collaboration with UCSF
in cardiovascular and related diseases has been designed to capitalize on this
high throughput capacity of the HyX Platform.
Genetic Mapping. Genetic mapping is a method for linking diseases to
particular genes by correlating the presence or absence on chromosomes of
predetermined DNA sequences, known as markers, with a genetic trait. Researchers
attempt to locate genes by using markers in conditions such as diabetes, asthma
and cardiovascular disease. Tissue samples and histories from families with
members who have the disease are analyzed by comparing the patterns of markers
between healthy and diseased family members. A correlation of a marker with a
disease indicates that a gene or genes involved in the disease is located near
the marker. The more markers that are available, the more likely it will be that
a disease will be correlated with at least one of these markers. The usual
marker linkage process is labor intensive and requires significant computational
capabilities. The Company believes that its ability to sequence and analyze
billions of bases per year will generate substantial numbers of markers,
including markers consisting of entire gene sequences, thus facilitating linkage
of genes with disease.
Diagnostics
The Company believes that the ability of its DNA array technology to
sequence DNA with a high level of accuracy broadens the scope of diagnostic
applications of its HyGnostics Module and can provide diagnostic tests on a
commercial scale more quickly and at a lower cost than other technologies. Hyseq
currently is making available its HyGnostics Module for diagnostics testing of
genetic and infectious disease and cancer primarily to clinical reference
laboratories. In 1996, the Company's wholly owned subsidiary, Hyseq Diagnostics,
Inc., and the Department of Molecular Diagnostics of SmithKline Beecham
Pharmaceutical Co. completed a project relating to the accuracy of SBH for DNA
and individual genomics in a blind test on the p53 gene. As reported in the
January 1998 issue of Nature Biotechnology, the HyGnostics Module consistently
sequenced base substitutions, mutations, insertions and deletions with 100%
accuracy. Although the Company is making available the HyGnostics Module for
commercial-scale diagnostic testing, it is expanding use of the HyGnostics
Module for polymorphism and population genetic research while evaluating the
optimal economics for diagnostics with respect to the roles of its the
HyGnostics Module and HyChip Module. See "--Collaborative and Other
Arrangements."
Cancer. An estimated 1.35 million new cases of cancer will be diagnosed in
1997 in the United States and approximately 530,000 people will die from cancer
in 1997. Colorectal, breast, prostate and lung cancer account for about half of
all cancer diagnoses. The normal protein product of the p53 gene controls cell
replication, but a mutation in the gene may contribute to the aggressive growth
of some cancers, including colorectal, breast and bladder cancers. Mutations
have been observed at more than 400 distinct sites in the p53 gene. Currently
available antibody-based diagnostic tests detect accumulation of p53 gene
products, but not gene mutations, and gel-sequencing methods are impractical
because mutations occur over a large area requiring many gels to be processed.
Other biochip approaches are reported to be under development for research
purposes, but these approaches reportedly are unable to sequence certain types
of mutations and therefore may be less reliable than gel sequencing. As a
result, these methods have thus far been unable to provide a practical
prediction of susceptibility to cancer or the rate of cancer progression, which
would be valuable for determining an appropriate cancer therapy.
The HyGnostics Module can apply any combination of its DNA sequence probes
to determine the gene sequences of patient samples. In a blind test administered
by SmithKline Beecham and designed to sequence p53 samples, the HyGnostics
Module was 100% accurate and met or exceeded all requirements of the test for
sensitivity, cost, speed, correct heterozygote sequencing, reproducibility and
temperature range. The results were reproducible within and between runs. All
types of mutations (substitutions, insertions and deletions) were correctly
sequenced, generating no false positives or false negatives.
Infectious Diseases. The Company believes that its proprietary DNA array
technology has the potential to significantly improve the understanding of
infectious diseases and thereby advance their diagnosis and treatment. Hyseq
currently is using a version of the HyChip Module internally for research
applications and is developing HyChip products for commercial applications with
Perkin-Elmer. Over 3.1 million individuals worldwide were estimated to be
infected with HIV in 1996. Approximately 75,000 individuals in the United States
were diagnosed with AIDS in 1996. Mutations in the HIV genome have been
correlated with the success of various therapies, and rapid mutation in the HIV
genome is an indicator of progression of the disease. Using the HyChip Module,
the Company has conducted tests in which it has scored all one million possible
probes 10 bases in length on HIV sequence samples. The Company believes this is
the first time that a set of probes capable of complete sequencing of all
mutations has been reported to be applied to HIV sequence samples. In addition,
complete SBH sequencing of HIV sequence samples has been performed on the
HyGnostics Module using probes seven bases in length.
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COLLABORATIVE AND OTHER ARRANGEMENTS
Chiron Corporation. In May 1997, the Company entered into an exclusive
collaboration with Chiron. Pursuant to the terms of the collaboration agreement,
the Company and Chiron are collaborating to develop therapeutics, diagnostic
molecules and vaccines relating to solid tumors. The collaboration has an
initial term of three years and can be extended at Chiron's option for two
additional two-year periods. Chiron paid a nonrefundable $1 million up-front
licensing fee upon signing the agreement and guaranteed payment of a minimum of
$8.5 million in the first year and $5.5 million in each of the two years
thereafter in connection with the Company's research on Chiron tissue sample
libraries. The agreement requires the Company to generate data at a specified
level per year which, if not met, could result in the Company's breach of the
agreement. Chiron has the exclusive right to commercialize any solid
tumor-related products resulting from the collaboration. The Company will
receive royalties on any such products. Pursuant to the terms of a stock
purchase agreement, Chiron concurrently made an equity investment of $5.0
million in shares of the Company's Series B Preferred Stock which converted
automatically to shares of Common Stock immediately prior to the completion of
Hyseq's initial public offering (the "IPO"). Chiron also purchased shares of
Common Stock directly from the Company concurrently with the IPO for an
aggregate purchase price of $2.5 million. As of March 27, 1998, the
collaboration has resulted in the filing of patent applications covering in
excess of 2,200 gene discoveries. Hyseq retains rights in such gene discoveries
outside the field of solid tumors.
The Perkin-Elmer Corporation. In May 1997, the Company entered into an
agreement with Perkin-Elmer to combine the Company's super chip technology and
Perkin-Elmer's life science system capabilities to commercialize HyChip products
(collectively, the "HyChip System"). Pursuant to the terms of the agreement, the
Company is obligated to commit $5.0 million to further development of the
Company's "chip" component of the HyChip System over the next two years, and
Perkin-Elmer must commit certain funds to develop the overall system. As of
December 31, 1997, Hyseq had spent approximately $2.0 million pursuant to the
collaboration, of which amount $504,000 was reimbursed to the Company under its
NIST grant. The collaboration has an initial term of five years and will be
extended automatically thereafter unless the parties mutually agree to
termination. The agreement contemplates that the design, development and
manufacture of the HyChip "chip" will be under the direction of the Company,
while design, development and manufacture of the system will be under the
direction of Perkin-Elmer. HyChip products will be distributed through
Perkin-Elmer's Applied Biosystems Division. In June 1997, Perkin-Elmer made an
equity investment of $5.0 million in shares of the Company's Series B Preferred
Stock which converted automatically to shares of Common Stock immediately prior
to the completion of the Company's initial public offering. Perkin-Elmer also
purchased shares of Common Stock directly from the Company concurrently with the
IPO for an aggregate purchase price of $5.0 million.
University of California San Francisco. In February 1998, the Company
entered into an agreement with UCSF to conduct research on genes that may have
important roles in the development of cardiovascular and related diseases. The
Company believes this will be the largest polymorphism and pharmacogenomic
project in terms of amount of sequence data generated to thoroughly understand
the roles of genes, gene mutations and polymorphisms that may lead to diseases
of the cardiovascular system. Under the agreement, UCSF researchers are
collecting DNA samples from 20,000 genetically diverse individuals. The Company
believes an important component of the project is that many of these samples
include results from angiogram, ultrasound and biochemical tests, allowing a
direct comparison of genetic information with clinical histories. DNA samples
will be sequenced and annotated and proprietary sequence databases owned by the
Company will be created. The Company believes that the resulting information
will create the largest cardiovascular polymorphism database with the potential
to identify genetic traits in heart disease, hypertension and diabetes. Hyseq
has the exclusive rights from UCSF to commercialize the proprietary sequence
databases derived from this collaboration.
The National Institute of Standards and Technology. In November 1994, the
Company was awarded a three-year, $2.0 million grant from The National Institute
of Standards and Technology ("NIST"). Funds received from NIST have been applied
to develop the Company's super chip technology, which is being used in the
HyChip Module. As of December 31, 1997, the Company had received a total of $2.0
million from NIST. Work under the NIST grant was completed at December 31, 1997
and there is no assurance that the Company will receive additional funding from
NIST in the future.
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See "--Licensed Technology."
Conservation International, Inc. In February 1997, the Company entered into
an agreement with Conservation International, Inc. ("CII"), an environmental
conservation organization, to search for genetic products with commercial
potential. Pursuant to the terms of the agreement, the Company will focus on
initial areas of interest for further development with potential corporate
partners, with the initial focus being on rain forest species. CII will provide
research and other assistance in identifying potential products for
consideration and has received an initial $30,000 payment from the Company for
research relating to a specified product. The Company and potential corporate
partners will be responsible for all costs of development. The Company believes
that rain forest genetic information may be an important source of genetic
variety for developing new drugs and agricultural products.
COMPETITION
The Company believes that virtually all genes in the human genome will be
identified within several years. However, the Company believes that
determination of function, rather than identification, will be the primary
driver of competition in genomics since function is a critical element in
obtaining patent protection with respect to gene discovery and
commercialization. The Company believes that its primary competitors in genomics
are Human Genome Sciences, Inc. and Incyte Pharmaceuticals, Inc., which are
using gel sequencers as part of their gene sequencing efforts. A number of other
companies engage in, or have announced plans to engage in, gene discovery and
have acquired, or could acquire, gel sequencers or other technologies, or may
develop alternative procedures for gene sequencing. Such competitors may include
major pharmaceutical and biotechnology firms and other companies, not-for-profit
entities and United States and foreign government-financed programs, many of
which have substantially greater research and product development capabilities
and financial, scientific, marketing and human resources than the Company. These
competitors may succeed in identifying genes and determining their functions or
developing products earlier than the Company or its current or future
collaboration partners, obtaining patents and regulatory approvals for such
products more rapidly than the Company or its current or future collaboration
partners, or developing products that are more effective than those proposed to
be developed by the Company or its collaboration partners.
The Company believes that its ability to compete in genomics is dependent,
in part, upon its ability to continue to improve the HyX Platform to permit more
rapid identification of genes while improving its bioinformatics capacity for
analyzing gene sequences and identifying the possible function of the genes
sequenced. While the Company believes that its HyX Platform provides a
significant competitive advantage, any one of the Company's competitors may
discover and establish a patent position in one or more genes which the Company
has identified and designated as a product candidate. Loss of its SBH patent
rights also could remove a legal obstacle to competitors in designing platforms
with similar competitive advantages. Further, any potential products based on
genes identified by the Company ultimately will face competition both from
companies developing gene-based products and from companies developing other
forms of treatment for diseases which may be caused by, or related to, genes
identified by the Company. There can be no assurance that research and
development by others will not render the products which the Company or its
collaboration partners may develop, obsolete or uneconomical or result in
treatments, cures or diagnostics superior to any therapy or diagnostic developed
by the Company or its collaboration partners, or that any therapy developed by
the Company or its collaboration partners will be preferred to any existing or
newly developed technologies. Competition in this field is expected to
intensify.
In the area of diagnostics, the Company competes primarily with Affymetrix,
Inc. ("Affymetrix"). See "--Litigation," regarding the Company's litigation
against Affymetrix. Additionally, although the Company is collaborating with
Perkin-Elmer to develop HyChip products for commercial applications, the Applied
Biosystems division of Perkin-Elmer presently markets gel sequencers that are
used by third parties to compete with the Company in gene discovery and
diagnostics. The Company believes that its ability to compete in diagnostics
will depend primarily upon its ability to demonstrate that the HyChip Module can
provide higher levels of accuracy and a lower cost per test for clinical
reference laboratories than other prevailing technologies. Additionally,
although the Company believes that the ability of the HyChip Module to
accommodate new tests through software modifications will be attractive to
clinical reference laboratories, biochips such as those being marketed by
Affymetrix may be competitive for certain applications. In addition, other
commercial diagnostic products from competitors or other companies could
adversely impact the Company's ability to market the HyChip products. See
"Factors That May Impact Results--Competition."
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PATENTS AND PROPRIETARY TECHNOLOGY
Patent Rights Relating to Technology
Hyseq holds five United States patents with claims covering the method of
SBH. Hyseq also has pending several patent applications covering SBH technology
and its applications in diagnostics, as well as applications covering apparatus
and processes. If granted, these pending applications would provide
supplementary protection in related areas of potential interest.
Patent Rights Relating to Genes
Hyseq intends to patent commercially relevant genes and ESTs obtained by
SBH technology and, to date has filed for patent protection on more than 63,500
gene discoveries. The patenting of genes is a well recognized commercial
practice in the United States. For example, hundreds of gene targets (not
including many times that number of constructions containing genes) have been
patented by others, including valuable human genes such as those encoding EPO
(patent owned by Amgen, Inc.), granulocyte colony stimulating factor (patent
owned by Amgen, Inc.), tissue plasminogen activator (patent owned by Genentech,
Inc.), immune interferon (patent owned by Genentech, Inc.), interleukin-2
muteins (patent owned by Chiron) and leukocyte interferon (patent owned by
Biogen, Inc.). Many more are claimed in patent applications, including patent
applications filed by competitors such as Human Genome Sciences, Inc.
There are certain court decisions indicating that disclosure of a partial
sequence may not be sufficient to support the patentability of a full-length
sequence. In view of these court decisions, as well as the position of the
United States Patent and Trademark Office (the "Patent Office") referred to
below, the Company believes that there is significant risk that patents will not
issue based on patent disclosures limited to partial gene sequences. Even if
patents issue on the basis of partial gene sequences, there is uncertainty as to
the scope of the coverage, enforceability or commercial protection provided by
any such patents. The Patent Office rejected patent claims contained in a patent
application filed by the National Institutes of Health ("NIH") relating to
partial gene sequence ESTs produced by conventional gel sequencing. The NIH
elected not to appeal the decision. The application generated substantial
controversy in the scientific community regarding the patentability of gene
fragments and the full-length gene based on only partial sequencing of genes,
particularly in cases where the biological function of the full-length gene is
not identified. In practice, the way in which ESTs are generated by gel
sequencing does not identify complete gene sequences nor are the ESTs readily
correlated with the function of the product of the gene. The Company believes
that SBH technology enables complete sequencing of genes more rapidly and cost
effectively than other existing technologies. The Company also believes that SBH
technology will facilitate correlation between gene sequences and gene
functions. The Company therefore believes that it will take entities using gel
sequencing significantly longer to obtain information about gene function for
patenting gene sequences. Information about the function of the gene products
provides the critical information for obtaining patents that Hyseq's competitors
may lack. Hyseq believes that this information would be useful for satisfying
the current requirements for obtaining patents on genes in the manner followed
by the biotechnology companies over the past 10 years. See "Risk
Factors--Dependence upon Proprietary Rights; Risks of Infringement."
LICENSED TECHNOLOGY
In 1994, the Company acquired an exclusive license from Arch Development
Corporation, a not-for-profit corporation affiliated with the University of
Chicago that manages The Argonne National Laboratories ("Argonne"), to further
develop and use certain SBH super chip improvements developed by one of the
Company's chief scientists while he was at Argonne. The Company was required to
spend a total of $2.5 million, directly or indirectly, through grants and other
sources of funding, to the development of super chip improvements by June 30,
1998, which condition was satisfied during 1997. In addition, the Company began
paying limited royalties commencing in July 1997. The Company has applied the
proceeds of a three-year, $2.0 million NIST grant to development of the super
chip technology. The Company's HyChip Module, which is being developed for
commercial applications with Perkin-Elmer, utilizes the Company's super chip
technology.
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GOVERNMENT REGULATION
The FDA regulates drugs, biologics and medical devices under the Federal
Food, Drug and Cosmetic Act and other laws, including, in the case of biologics,
the Public Health Service Act. These laws and implementing regulations govern,
among other things, the development, testing, manufacturing, record keeping,
storage, labeling, advertising, promotion and premarket clearance or approval of
products subject to regulation. The Company presently plans to develop drugs or
biologicals only through collaborations with third parties who would be
responsible for obtaining regulatory approval or clearance. Although the Company
believes that its HyGnostics Module, as presently marketed, is not subject to
regulation as a medical device, the FDA recently proposed regulations that may
subject it to such regulation. The Company believes that HyChip products sold as
diagnostic products will be subject to regulation as medical devices when
commercial sales for clinical use commence. The Company may ultimately determine
to pursue directly the development of therapeutic and other diagnostic products
requiring regulatory approval or clearance.
The Company believes that any pharmaceutical products that may be developed
by or with a collaboration partner will be regulated by the FDA as drugs or
biologicals. Additionally, any diagnostic products developed are likely to be
regulated as medical devices or biologicals. The following is a discussion of
the government regulation to which the Company or collaboration partners may
become subject.
FDA Regulation
Approval of Therapeutic Products. Generally, in order to gain FDA pre-market
approval, a company first must conduct pre-clinical studies in the laboratory
and in animal model systems to identify safety problems and to gain preliminary
information on an agent's efficacy. The results of these studies are submitted
as a part of an Investigational New Drug Application ("IND"), which the FDA must
review before human clinical trials of an investigational drug can start. In
order to commercialize any products, the collaboration partner or the Company
will be required to sponsor and file an IND and will be responsible for
initiating and overseeing the clinical studies to demonstrate the safety,
efficacy and potency that are necessary to obtain FDA approval of any such
products. Clinical trials are normally done in three phases, which may overlap,
and generally take two to five years, but may take longer to complete as a
result of many factors, including slower than anticipated patient enrollment,
difficulty in finding a sufficient number of patients fitting the appropriate
trial profile or in the acquisition of sufficient supplies of clinical trial
materials or adverse events occurring during the clinical trials. After
completion of clinical trials of a new product, FDA marketing approval must be
obtained. If the product is classified as a new drug, the collaboration partner
or the Company will be required to file a New Drug Application ("NDA") and
receive approval before commercial marketing of the drug. The testing and
approval processes require substantial time and effort and there can be no
assurance that any approval will be granted on a timely basis, if at all. NDAs
submitted to the FDA take, on average, two to five years to receive approval. If
questions arise during the FDA review process, approval can take more than five
years. The Company or its collaboration partners also must demonstrate the
approvability of a Biological License Application or a Product License
Application as well as an Establishment License Application for biological
products. Even if FDA regulatory clearances are obtained, a marketed product is
subject to continual review, and later discovery of previously unknown problems
or failure to comply with the applicable regulatory requirements may result in
restrictions on the marketing of a product or withdrawal of the product from the
market as well as possible civil or criminal sanctions. For marketing outside
the United States, the collaboration partner or the Company will be subject to
foreign regulatory requirements governing human clinical trials and marketing
approval for pharmaceutical products. The requirements governing the conduct of
clinical trials, product licensing, pricing and reimbursement vary widely from
country to country and are becoming more restrictive throughout the European
Union.
Regulatory approval or clearance could include significant limitations on
the indicated uses for which a product could be marketed. The approval process
is affected by a number of factors, including the availability of alternative
treatments and the risks and benefits demonstrated in clinical trials. After FDA
approval for the initial indications, further clinical trials may be necessary
to gain approval for the use of the product for additional indications. The FDA
may also require post-marketing testing to monitor for adverse effects, which
can involve significant expense or result in restrictions on the product,
including withdrawal of the product from the market. In addition, the policies
of the FDA may change, and additional regulations may be promulgated which could
prevent or delay regulatory approval. There can be no assurance that any
approval or clearance will be granted on a timely basis, if at all. In the event
that a collaboration partner fails to receive FDA clearance for a therapeutic
product, the Company may not receive revenues from the collaboration until some
type of FDA approval is received, if at all.
Approval of Diagnostic Products. In the United States, the FDA regulates,
as medical devices, most diagnostic tests and in vitro reagents that are
marketed as finished test kits or equipment. Some clinical laboratories,
however, purchase individual reagents intended for specific analyses, and, using
those reagents, develop and prepare their own finished diagnostic tests.
Although the FDA has not generally exercised regulatory authority over these
individual reagents or the finished tests prepared from them by the clinical
laboratories, the FDA has recently proposed a rule that, if adopted, would
regulate reagents sold to clinical laboratories as medical devices. The proposed
rule would also restrict sales of these reagents to clinical laboratories
certified under the Clinical Laboratory Improvement Amendments ("CLIA") as
high-complexity laboratories. The Company intends to market its HyGnostics
Module and tests which may be run on the module as well as diagnostic products
primarily to clinical laboratories. The Company may market some diagnostic
products such as its HyChip products, as finished tests or equipment and others
as individual reagents; consequently, some or all of these products may be
regulated as medical devices.
The Food, Drug and Cosmetic Act requires that medical devices introduced to
the United States market, unless exempted by regulation, be the subject of
either a premarket notification clearance (known as a "510(k)") or premarket
approval ("PMA"). Some of the Company's diagnostic products may be deemed to be
medical devices and require a PMA or a 510(k). With respect to devices reviewed
through the 510(k) process, a Company may not market a device until an order is
issued by the FDA finding the product to be substantially equivalent to a
legally marketed device known as a "predicate device." A 510(k) submission may
involve the presentation of a substantial volume of data, including clinical
data, and may require a substantial review. The FDA may agree that the product
is substantially equivalent to a predicate device and allow the product to be
marketed in the United States. The FDA, however, may (i) determine that the
device is not substantially equivalent and require a PMA; or (ii) require
further information, such as additional test data, including data from clinical
studies, before it is able to make a determination regarding substantial
equivalence. By requesting additional information, the FDA can further delay
market introduction of a company's products. If the FDA indicates that a PMA is
required for any of the Company's diagnostic products, the application will
require extensive clinical studies, manufacturing information and likely review
by a panel of experts outside the FDA. Clinical studies to support either a
510(k) submission or a PMA application would need to be conducted in accordance
with FDA requirements. FDA review of PMA applications routinely takes
significantly longer than that of 510(k) applications.
If the Company's diagnostics products are subject to FDA regulation, there
can be no assurance that the Company will be able to meet the FDA's requirements
or that any necessary approval will be received. Once granted, a 510(k)
clearance or PMA may place substantial restrictions on how the device is
marketed or to whom it may be sold. Even where a device is exempted from 510(k)
clearance or PMA, the FDA may impose restrictions on its marketing. In addition
to requiring clearance or approval for new products, the FDA may require
clearance or approval prior to marketing products that are significant
modifications of existing products. There can be no assurance that any necessary
510(k) clearance or PMA will be granted on a timely basis or at all. FDA imposed
restrictions could limit the number of customers to whom particular products
could be marketed or what may be communicated about particular products. Delays
in receipt of or failure to receive any necessary 510(k) clearance or PMA could
have a material adverse effect on the Company.
Customers using the Company's diagnostic devices for clinical use in the
United States may be regulated under the CLIA. CLIA is intended to ensure
quality and reliability of clinical laboratories in the United States by
mandating specific standards in the areas of personnel, qualifications,
administration, participation in proficiency testing, patient test management,
quality control, quality assurance and inspections. The regulations promulgated
under CLIA establish three levels of diagnostic tests ("waived," "moderately
complex" and "highly complex"), and the standards applicable to a clinical
laboratory depend on the level of the tests it performs. CLIA requirements may
prevent some clinical laboratories from using certain of the Company's
diagnostic products. Therefore, there can be no assurances that the CLIA
regulations and future administrative interpretations of CLIA will not have a
material adverse impact on the Company by limiting the potential market for
diagnostic products.
Post-Approval Requirements. Even if regulatory approvals for the Company's
product candidates are obtained, the products and the facilities manufacturing
the products are subject to continued review and periodic inspection. Each drug
and device manufacturing establishment in the United States must be registered
with the FDA. Domestic manufacturing establishments are subject to biannual
inspections by the FDA and must comply with the FDA's current Good Manufacturing
Practice ("cGMP") regulations. The Company also may be required to comply with
standards prescribed by various other federal, state and local regulatory
agencies in the United States as well regulatory agencies in other countries. In
complying with cGMP regulations, manufacturers must expend funds, time and
effort to ensure full technical compliance. The FDA stringently applies
regulatory standards for manufacturing. The Company and its collaboration
partners will need to comply with cGMP regulations to manufacture HyChip
diagnostic products for sale to third parties.
The FDA's cGMP regulations require that drugs and medical devices be
manufactured and records be maintained in a prescribed manner with respect to
manufacturing, testing and control activities. Further, the Company would be
required to comply with the FDA requirements for labeling and promotion of its
medical devices. For example, the FDA prohibits cleared or approved drugs and
devices from being marketed for uncleared or unapproved uses. In addition, drugs
and medical device reporting regulations would require that the Company provide
information to the FDA whenever there is evidence to reasonably suggest that one
of its drugs or devices may have caused or contributed to a death or serious
injury, or a medical device malfunction that has occurred would be likely to
cause or contribute to a death or serious injury if the malfunction were to
recur.
Failure to comply with applicable regulatory requirements can result in,
among other things, warning letters, fines, injunctions, civil penalties, recall
or seizure of products, total or partial suspension of production, refusal of
the government to grant approvals, premarket clearance or premarket approval,
withdrawal of approvals and criminal prosecution of the Company and employees.
Environmental Regulation
The Company is subject to federal, state and local laws and regulations
governing the use, storage, handling and disposal of hazardous materials such as
p33, a low energy radioactive isotope used in labeling its probes and certain
waste products. Although the Company believes that its safety procedures for
handling and disposing of such materials comply with the standards prescribed by
state and federal laws and regulations, the risk of accidental contamination or
injury from these materials cannot be completely eliminated. In the event of
such an accident, the Company could be held liable for any damages that result
and any liability could exceed the resources of the Company.
HUMAN RESOURCES
As of March 23, 1998, the Company had 169 full-time equivalent employees,
including 149 scientists. Forty employees hold Ph.D.s or are M.D.s. No employees
are represented by unions. The Company believes that relations with its
employees are good.
FACTORS THAT MAY IMPACT RESULTS
Unproven Ability to Commercialize Gene-Based Products. The Company's
strategy of using its Gene Discovery Module to rapidly identify and characterize
the function of a substantial number of genes and then selecting from those
genes promising candidates to be used to develop therapeutic products and
diagnostic products
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and tests is unproven. While other companies have adopted a similar strategy,
the application of this strategy is in too early a stage to determine whether it
can be successfully implemented. The Company's development efforts with respect
to therapeutic product candidates and diagnostic tests are still in an early
stage. Collaborations with the Company's current and future collaboration
partners will require significant further research, development, testing and
regulatory approvals by the Company and any such collaboration partners prior to
market release of any therapeutic products or diagnostic tests developed. Even
if the Company completely sequences a substantial number of genes, its success
in marketing potential gene-based therapeutic product candidates and diagnostic
tests will depend upon its ability to determine which of those genes have
potential value and to select an appropriate commercialization strategy for each
potential product it chooses to pursue. To select those genes that are suitable
for further research and development, the Company will need to expend
significant time and resources isolating and sequencing the genes and analyzing
them to determine their function. There can be no assurance that the Company
will be able to successfully develop therapeutic product candidates that will be
of commercial interest to current or future collaboration partners, nor can
there be any assurance that therapeutic product candidates or diagnostic tests
identified for any such collaboration partners would result in the development
of commercially viable products.
To date, only a limited number of gene-based products have been developed
and commercialized, and none have been developed or commercialized by the
Company. Even if the Company identifies a gene and determines its function, the
Company or a collaboration partner may not be able to develop a commercially
feasible product based on the gene. The development of therapeutic product
candidates and diagnostic tests will be subject to risks of failure inherent in
the development of products based on new technologies, including the
possibilities that therapeutic product candidates will be found toxic,
defective, unreliable or otherwise fail to receive necessary regulatory
clearance; such products will be difficult to manufacture on a large scale or
uneconomical to market; proprietary rights of others will preclude marketing of
the Company's products; or products of third parties will be superior. Certain
areas of gene-based discovery that may be pursued by the Company under current
and future collaborative arrangements, including gene therapy, involve new
technologies, and existing data on the safety and efficacy of these technologies
is very limited. At present, no commercial products have been developed from
these technologies. Several significant scientific challenges must be addressed
before the therapeutic potential of these technologies can be realized. Even if
the Company and its collaboration partners are successful in developing a
therapeutic product, it would be a number of years before such products could
reach the market. The failure to successfully commercialize products based on
Company-discovered genes would have a material adverse effect on the Company's
business, financial condition and operating results.
Dependence upon Collaborative Arrangements. The Company presently plans to
develop therapeutic product candidates and diagnostic products and tests only
through collaborative arrangements with collaboration partners who would be
responsible for obtaining regulatory approval or clearance. As a result, the
Company's strategy for commercialization of such products relies substantially
upon arrangements with current and future collaboration partners and licensees.
There can be no assurance that the Company will be able to maintain existing
collaborations or obtain additional collaboration partners, or that they will be
on terms favorable to the Company. The Company has only a limited internal sales
and marketing organization, and, with the exception of the HyGnostics(TM)
Module, which the Company makes available directly, Hyseq will rely primarily on
collaboration partners or licensees or on arrangements with others to market its
products domestically and internationally. To the extent the Company can
establish additional collaborations, the Company will be partially dependent
upon the subsequent success of these collaboration partners in performing their
responsibilities. There can be no assurance that any current or future
collaborations will ultimately succeed in obtaining commercially viable
products. There can be no assurance that these efforts or any products, if
approved, will gain market acceptance. Significant time may be required to
secure additional collaboration partners because of the need to effectively sell
the benefits of the Company's technology to a variety of constituencies within
future collaboration partners, including research and development personnel and
top management. In addition, each collaborative arrangement will involve the
negotiation of terms that may be unique to each collaboration partner. The
Company may expend substantial funds and management effort with no assurance
that a collaboration will result. Finally, there can be no assurance that the
Company's collaboration partners will not adopt alternative technologies or
develop alternative products either on their own or in collaboration with others
including the Company's competitors. The failure to enter into and successfully
maintain collaborative arrangements would have a material adverse effect on the
Company's business, financial condition and operating results.
Uncertainties Related to Certain Technological Approaches. The Company's
HyGnostics(TM) Module, which is used for DNA testing of genetic and infectious
diseases and cancer, has only been made available as a module since 1996. There
can be no assurance that additional improvements or modifications will not be
necessary before the
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HyGnostics(TM) Module gains market acceptance, if at all. In addition, the
Company's HyChip(TM) Module, which is being used internally for research
applications in genomics and DNA testing, is under development for commercial
applications. As the HyChip(TM) Module undergoes further development, there can
be no assurance that previously unknown problems will not emerge or that, if
they do emerge, they can be solved. There also can be no assurance that
improvements in the HyChip(TM) Module or related products necessary for
successful commercialization will be achieved by the Company or by its
collaboration partner, The Perkin-Elmer Corporation ("Perkin-Elmer"), which is
developing the overall system with the Company. Further, the HyChip(TM) Module
and related products and the Company's Gene Discovery and HyGnostics(TM) Modules
will need to compete against well-established technologies and enhancements to
such technologies for analyzing genes and performing diagnostics. The impact of
these uncertainties is difficult to predict and could have a material adverse
effect on the Company's business, financial condition and operating results.
Limited History of Operations, History of Losses and Uncertainty of Future
Profitability. The Company commenced operations in the fourth quarter of 1994.
There is limited historical information available upon which an investor can
base an evaluation of an investment in the Company. For the years ended December
31, 1997, 1996 and 1995, the Company had net losses of $6.5 million, $4.8
million, and $601,000, respectively, and as of December 31, 1997, the Company
had an accumulated deficit of $14.8 million. Expansion of the Company's
HyGenomics(TM) Database and marketing activities with respect to its
HyGnostics(TM) Module, together with the development of therapeutic product
candidates and diagnostic products and tests and development of the HyChip(TM)
Module and related products, will require substantial increases in expenditures
over the next several years. As a result, the Company currently expects to incur
operating losses at least through 1999, and the Company may never achieve
significant revenues or profitable operations. The likelihood of success of the
Company must be considered in light of the problems, expenses, difficulties,
complications and delays, many of which are beyond the Company's control,
frequently encountered in connection with the formation of a new business,
development and commercialization of new products, and the utilization of new
technology.
Competition. There is a finite number of genes (estimated by the Company to
be approximately 150,000 genes) in the human genome. A significant number of
such genes have been identified by the Company and others conducting genomic
research, and the Company believes that virtually all genes will be identified
within the next several years. To date, relatively few gene-based products with
significant commercial potential have been announced. While the Company's goal
has been to identify, establish the utility of and ultimately patent as many
genes as it can as rapidly as possible, the Company continues to face
substantial competition in these efforts from entities using gel sequencers and
other methods to discover genes. The Company believes that its primary
competitors in genomics are Human Genome Sciences, Inc. and Incyte
Pharmaceuticals, Inc., which are using gel sequencers as part of their gene
sequencing efforts. Research to identify genes is also being conducted by
various institutes and by United States and foreign government-financed
programs, which in some cases may be competitive with the Company. A number of
other companies also have announced plans to engage in gene discovery using gel
sequencers and may develop other procedures for automated sequencing of genes.
In addition, certain of the Company's collaboration partners could, in the
future, become competitors. As a result, any one or more of these companies or
other entities may discover and establish, before the Company, a patent position
in one or more genes that the Company has identified. Any potential therapeutic
products or diagnostic products or tests based on genes identified by the
Company may face competition both from companies developing gene-based products
and from companies developing other forms of treatment for diseases that may be
caused by, or related to, genes identified by the Company. There can be no
assurance that the Company will compete successfully with its existing
competitors or with any new competitors.
The market for diagnostic products such as the HyGnostics(TM) Module and
diagnostic tests derived from the Company's gene discovery efforts is currently
limited and is expected to be highly competitive, low margin market. In the area
of diagnostics, the Company competes primarily with Affymetrix, Inc.
("Affymetrix"). Additionally, the Applied Biosystems division of Perkin-Elmer
presently markets gel sequencers that are used by third parties to compete with
the Company in gene discovery and diagnostics. Many companies are developing and
marketing DNA probe tests for genetic and other diseases. Other companies are
conducting research on new technologies for diagnostic tests based on advances
in genetic information. Established diagnostic companies have advantages over
Hyseq, including greater financial and other resources to invest in new
technologies, substantial intellectual property portfolios, substantial
experience in new product development, regulatory expertise, manufacturing
capabilities and the distribution channels to deliver products to customers.
Potential customers for the HyGnostics(TM) Module, including clinical reference
laboratories, may have an existing base of instruments in several markets and
therefore be unwilling to adopt the HyGnostics(TM) Module in lieu of existing
instruments. Similarly, potential customers for
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HyChip(TM) products, when introduced commercially, may already have existing
instruments and therefore be unwilling to adopt HyChip(TM) products. In
addition, some of these companies have formed alliances with genomics companies
which provide them access to genetic information that may be incorporated into
their diagnostic tests.
Several of the Company's existing and potential competitors have
substantially greater research and product development capabilities and
financial, scientific, marketing and human resources than the Company. These
competitors may succeed in identifying genes or developing products earlier than
the Company or its collaboration partners, obtaining approvals from the United
States Food and Drug Administration (the "FDA") or other regulatory agencies for
such products more rapidly than the Company or its collaboration partners, or
developing products that are more effective than those proposed to be developed
by the Company or its collaboration partners. Certain of these competitors may
be further advanced than the Company in developing potential products that may
compete with potential products of the Company. There can be no assurance that
research and development by others will not render obsolete or non-competitive
the products that the Company or its collaboration partners may seek to develop.
In addition, loss of the Company's patent rights to SBH technology as a result
of successful legal challenges could remove a legal obstacle to competitors in
designing platforms with similar competitive advantages. The Company expects
that competition in this field will intensify. A failure of the Company to
adequately compete in its markets would have a material adverse effect on the
Company's business, financial condition and operating results.
Fluctuations in Operating Results. 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. Changes in the number of
collaboration partners could have a significant effect on the Company's revenues
and results of operations. If revenues in a particular period do not meet
expectations, the Company may not be able to adjust significantly its level of
expenditures in such period, which would have an adverse effect on the Company's
operating results. The timing of revenues is difficult to forecast because the
Company's revenue generation cycle could be relatively long and may depend on
factors such as the size and scope of assignments and general economic
conditions. The need for continued investment in development of the Company's
products and for extensive ongoing support capabilities results in a high
percentage of the Company's expenses being fixed. Accordingly, fluctuations in
revenues and expenses due to a variation in the nature, number and timing of
collaborative arrangements, particularly at or near the end of a quarter, can
cause significant variations in operating results from quarter to quarter and
could result in continued losses to the Company. Although the Company can adjust
overhead expenditures to correspond to the number of active projects, it must
maintain a certain level of overhead expenditures to continue operations.
Quarterly comparisons of the Company's financial results may not necessarily be
meaningful and should not be relied upon as an indication of future performance.
Dependence upon Proprietary Rights; Risks of Infringement. The Company owns
certain proprietary information and expects to acquire additional proprietary
information in the course of its research and development activities. There can
be no assurance as to the breadth or the degree of protection that such
proprietary information or patents or pending patent applications, if issued,
will afford the Company. There also can be no assurance that issued patents and
any future issued patents will ultimately be found valid and enforceable. There
can be no assurance that any issued patents will provide protection against any
competitors or will provide the Company with competitive advantages, nor can
there be assurance that such patents will not be challenged by others.
Furthermore, there can be no assurance that others will not independently
develop similar products or, if patents are issued to the Company, will not
design around such patents.
Although the Company has sought or intends to timely seek international
coverage for all patent applications filed since its inception in August 1992,
the Company's rights in and to its three currently issued patents covering SBH
technology extend only to the United States. Therefore, the Company is not
currently able to prevent others from practicing the SBH process disclosed in
the currently issued SBH patents outside of the United States. Although the
Company intends to defend its patent rights to SBH technology, there can be no
assurance that it will be successful in such endeavor. Three of the patents
covering the Company's SBH technology are currently the subject of counterclaims
by Affymetrix seeking declaratory relief that such patents are
invalid or that Affymetrix does not infringe them. See "--Certain Litigation."
Loss of its patent rights to SBH technology could remove a
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legal obstacle to competitors in designing platforms with similar competitive
advantages. There can be no assurance that others will not develop substantially
equivalent know-how or otherwise obtain access to Company know-how, or that
others will not infringe the Company's patents, causing the Company to incur
substantial costs and expend substantial personnel time in asserting the
Company's patent rights.
The Company's long-term commercial success may depend in part on the
ability of the Company or its collaboration partners to obtain patent protection
on genes that the Company discovers. The Company intends to seek patent
protection for genes that it completely sequences as well as patent protection
for selected partial gene sequences. The patent positions of biotechnology
companies generally are highly uncertain and involve complex legal and factual
questions. There is a substantial backlog of biotechnology patent applications
at the United States Patent and Trademark Office (the "Patent Office"). No
consistent legislative or other policy has yet emerged regarding the breadth of
claims covered in biotechnology patents, and there also have been proposals for
review of the appropriateness of patents on genes and partial gene sequences.
The Company's ability to obtain patent protection based on genes or partial
gene sequences will depend, in part, upon identification of a function for the
gene or gene sequences sufficient to meet the statutory requirement that an
invention have utility, which is a question of fact. Clinical data may be
required for issuance of patents for human therapeutics, which, if required,
could delay, add substantial costs to or affect the ability to obtain patent
protection. There can be no assurance that the Company's disclosures in its
current or future patent applications will be sufficient to meet these
requirements. Even if patents are issued, there may be current or future
uncertainty as to the scope of the coverage or protection provided by any such
patents. The Company cannot predict what issues may arise in connection with the
Company's patent applications or the timing of the grant, if any, of patents
with respect to genes or partial gene sequences covered by such patent
applications.
The Company also relies on trade secret protection for its confidential and
proprietary information. Although the Company's policy is to enforce security
measures to protect its assets, trade secrets are difficult to protect. While
the Company requires all employees to enter into confidentiality agreements,
there can be no assurance that others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to the Company's trade secrets or disclose such technology, or that
the Company can meaningfully protect its trade secrets.
The Company may be required to obtain licenses to patents or other
proprietary rights of others. There can be no assurance that any licenses
required under any such patents or proprietary rights would be made available on
terms acceptable to the Company or at all. If the Company does not obtain such
licenses, it could encounter delays in product market introductions and incur
substantial costs while it attempts to design around such patents, or could find
that the development, manufacture or sale of products requiring such licenses
could be foreclosed. Moreover, the Company could incur substantial costs and
expend substantial personnel time in defending itself in any suits brought
against the Company claiming infringement of the patent rights of others or in
asserting the Company's patent rights in a suit against another party. Any of
these factors could have a material adverse effect on the Company's business,
financial condition and operating results.
Unproven Market for Genetic Testing. The Company's success in diagnostics
will depend in large part upon its ability to obtain customers and the ability
of these customers to properly market genetic tests performed with the Company's
technology. Genetic tests, including those performed using the HyGnostics(TM)
Module, may be difficult to interpret and may lead to misinformation or
misdiagnosis. Even when a genetic test identifies the existence of a mutation in
an individual, the interpretation of the result is often limited to the
identification of a statistical probability that the tested individual will
develop the disease or condition for which the test is performed. The prospect
of broadly available genetic predisposition testing has raised societal and
governmental concerns regarding the appropriate utilization and the
confidentiality of information provided by such testing. Government authorities
could, for social or other purposes, limit the use of genetic testing or
prohibit testing for genetic predisposition to certain conditions that could
adversely effect the use of the Company's products. There can be no assurance
that ethical concerns about genetic testing will not materially adversely effect
market acceptance of the Company's technology for diagnostic applications, which
could materially and adversely effect the Company's business, financial
condition and operating results.
Certain Litigation. 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.
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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 that
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 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. Although Affymetrix's
answer to this complaint was due to be filed by December 30, 1997, it did not
file its Answer, Affirmative Defenses and Counterclaim until January 6, 1998 in
violation of the Federal Rules of Civil Procedure. The Company has reserved all
of its rights against Affymetrix for its failure to respond to the Company's
complaint within the time allowed by rules of court. The counterclaim seeks a
declaratory judgment of non-infringement, invalidity and/or unenforceability
with respect to the patent covering SBH technology. On January 29, 1998 the
Company filed a reply to the counterclaim in which it denied the allegations of
non-infringement, invalidity and/or unenforceability. 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 claims. By order of Court, an initial case management
conference will be held by the Court on March 27, 1998 at which time the Company
expects that Hyseq I and Hyseq II will be consolidated for pre-trial discovery
and possibly for trial. 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, which could have a material adverse effect on the
Company's business, financial condition and operating results. See ---Item 3
"Legal Proceedings."
Management of Growth. The Company has recently experienced, and expects to
continue to experience, significant growth in the number of its employees and
the scope of its operations. Continued growth may place a significant strain on
the Company's management and operations. In order to significantly increase
capacity to remain competitive or satisfy the needs of current and future
collaboration partners, the Company will be required to acquire additional
equipment and supplies, upgrade software and adapt robotics and bioinformatics
resources to meet increased sequencing rates. The Company's ability to manage
such growth effectively will depend upon its ability to broaden its management
team and to attract, hire and retain skilled employees. The Company's success
also will depend on the ability of its officers and key employees to continue to
implement and improve its operational, management information and financial
control systems and to expand, train and manage its employee base. Inability to
manage growth effectively could have a material adverse effect on the Company's
business, financial condition and operating results.
Dependence on Key Personnel. Recruiting and retaining qualified scientific
and other management personnel to perform research and development work is
critical to Hyseq's success, and there can be no assurance that the Company will
be able to attract and retain such qualified personnel. The Company employs and
expects to rely heavily, for the foreseeable future, upon Dr. Radoje T. Drmanac
and Dr. Radomir B. Crkvenjakov for their SBH technology expertise. Loss of the
services of either Dr. Drmanac or Dr. Crkvenjakov would impede the achievement
of its business and scientific objectives and could have a material adverse
effect on the Company's business, financial condition and operating results. The
Company's projected growth and expansion into activities requiring additional
expertise, production and marketing also are expected to place increased demands
upon the Company's resources and organization. These demands are expected to
require the addition of new management and scientific personnel in the near term
as well as over time. There can be no assurance that the Company will be able to
attract and retain such qualified personnel.
Uncertainty of Third-Party Reimbursement. The Company's ability to receive
significant royalties from its products may depend on the ability of its
collaboration partners or customers to obtain adequate levels of third-party
reimbursement. Currently, availability of third-party reimbursement is limited
and uncertain for genetic
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predisposition tests. In the United States, the cost of medical care is funded
by government insurance programs, such as Medicare and Medicaid, and private and
corporate health insurance plans. Third-party payors may deny reimbursement if
they determine that a prescribed device or diagnostic test has not received
appropriate clearances from the FDA or other government regulators, is not used
in accordance with cost-effective treatment methods as determined by the payor,
or is experimental, unnecessary or inappropriate. The Company's ability to
commercialize certain of its products successfully may depend on the extent to
which appropriate reimbursement levels are obtained from authorities, private
health insurers and other organizations, such as health maintenance
organizations ("HMOs"). Third-party payors are increasingly challenging the
prices charged for medical products and services. The trend towards managed
health care in the United States and the concurrent growth of organizations such
as HMOs, which could control or significantly influence purchases of health care
services and products, as well as legislative proposals to reform health care or
reduce government insurance programs, may all result in lower prices for certain
of the Company's diagnostics products. The cost containment measures that health
care providers are instituting and the results of any health care reform may
have a material adverse effect on the Company's business, financial condition
and operating results.
No Assurance of FDA Regulatory Approval; Government Regulation. The
Company initially plans to collaborate on, manufacture and sell products through
collaborative arrangements with third parties who will be responsible for
obtaining regulatory approval or clearance. However, the Company may ultimately
determine to pursue directly the development of certain therapeutic or
diagnostic products requiring regulatory approval or clearance. Products such as
those proposed to be developed by the Company or with collaboration partners
typically will be subject to an extensive regulatory process by the FDA and
comparable agencies in other countries. In order to obtain regulatory approval
of a drug product, the Company or its collaboration partners must demonstrate to
the satisfaction of the applicable regulatory agency, among other things, that
such product is safe and effective for its intended uses and that the
manufacturing facilities are in compliance with current Good Manufacturing
Practice ("cGMP") requirements. Although the Company believes it does not need
to comply with cGMP with respect to the HyGnostics(TM) Module under current law,
it may need to comply with cGMP if currently proposed legislative changes are
adopted, and it will need to comply with cGMP with respect to its HyChip(TM)
Module once HyChip(TM) products are available for commercial sale, if sold for
clinical diagnostics. The Company or its collaboration partners also must
demonstrate the approvability of a Biological License Application or a Product
License Application and an Establishment License Application for any biological
products. In order to market its HyGnostics(TM) Module and other diagnostic
products, which may be considered to be medical devices, the Company or its
collaboration partners will be required to receive 510(k) marketing clearance or
Premarket Approval ("PMA") from the FDA for such products among other regulatory
requirements. To obtain 510(k) marketing clearance, the Company must show that
the diagnostic product is substantially equivalent to a legally marketed product
not requiring FDA approval. In addition, the Company must demonstrate that it is
capable of manufacturing the product to the relevant standards. To obtain a PMA,
the Company or its collaboration partners must submit extensive data, including
pre-clinical and clinical trial data to prove the safety and efficacy of the
device. Clinical trials are normally done in three phases over two to five
years, but may take longer to complete as a result of many factors, including
slower than anticipated patient enrollment, difficulty in finding a sufficient
number of patients fitting the appropriate trial profile, difficulty in the
acquisition of sufficient supply of clinical trial materials or adverse events
occurring during the trials. In the event the Company or its collaborators
develop products classified as drugs, the Company and its collaborators will be
required to obtain additional approvals.
Moreover, several areas in which the Company or its collaboration partners
may develop therapeutic products involve relatively new technology and have not
been subject to extensive product testing in patients. Accordingly, the
regulatory requirements governing such products and related clinical procedures
are uncertain and such products may be subject to substantial additional review
by various governmental regulatory authorities, which could prevent or delay
regulatory approval. Regulatory requirements ultimately imposed in these areas
could adversely affect the Company's ability to clinically test, manufacture or
market products. No assurance can be given that any applicable regulations will
not be amended, or that the Company will be able to comply with any new or
modified regulations.
The process of obtaining FDA and other required regulatory approvals and
clearances is lengthy and will require the expenditure of substantial capital
and resources. There can be no assurance that the Company will be able to obtain
the necessary approvals and clearances. Moreover, if and when such approval or
clearances are obtained, the marketing, distribution and manufacture of such
products would remain subject to extensive regulatory requirements administered
by the FDA and other regulatory bodies. Failure to comply with applicable
regulatory requirements can result in, among other things, warning letters,
fines, injunctions, civil penalties, recall or seizure of products, total or
partial suspension of production, refusal of the government to grant approvals,
23
<PAGE> 22
premarket clearance or premarket approval, withdrawal of approvals and criminal
prosecution. If marketed outside the United States, the Company's therapeutic
and diagnostic products will be subject to foreign regulatory requirements
governing the conduct of clinical trials, product licensing, pricing and
reimbursement, which vary from country to country and are becoming more
restrictive throughout the European Union. The process of obtaining foreign
regulatory approvals can be lengthy and require the expenditure of substantial
capital and resources, and there can be no assurance that the Company or its
collaboration partners will be successful in obtaining the necessary approvals.
Any delay or failure by the Company or its collaboration partners to obtain
regulatory approvals for its products would adversely affect the Company's
ability to generate product and royalty revenues, which could have a material
adverse effect on the Company's business, financial condition and operating
results.
Need for Future Capital; Uncertainty of Additional Funding. While the
Company believes that existing capital resources will be sufficient to support
the Company's operations through 1999, depending upon the ability of the Company
to develop additional collaborative arrangements, meet its budgeted expenditures
for expansion of operations and market its HyGnostics(TM) Module, additional
funds may be necessary sooner. There can be no assurance that additional funds
will be available when needed or on terms acceptable to the Company. If adequate
additional funds are not available, the Company may have to reduce substantially
or eliminate expenditures for the development, production and marketing of
certain of its proposed products, or obtain funds through arrangements with
collaboration partners that require the Company to relinquish rights to certain
of its technologies or products, which could have a material adverse effect on
the Company's business, financial condition and operating results.
Possible Volatility of Stock Price. The Common Stock has been included for
quotation on the Nasdaq National Market only since August 1997, and, as a
result, the trading market for the Common Stock has been limited. There can be
no assurance that an active trading market will develop and be sustained
subsequent to this offering. The market price of the Common Stock may fluctuate
substantially because of a variety of factors, including quarterly fluctuations
in results of operations, adverse circumstances affecting the introduction or
market acceptance of new products offered by the Company, announcements by
competitors, developments in the Company's litigation proceedings, changes in
earnings estimates by analysts, changes in accounting principles, sales of
Common Stock by existing holders, loss of key personnel and other factors. In
addition, the stock market in general, and the market for biotechnology and
other life science stocks in particular, has historically been subject to
extreme price and volume fluctuations. This volatility has had a significant
effect on the market prices of securities issued by many companies for reasons
unrelated to the operating performance of these companies. In the past,
following periods of volatility in the market price of a company's securities,
class action securities litigation has often been instituted against such a
company. Any such litigation instigated against the Company could result in
substantial costs and a diversion of management's attention and resources, which
could have a material adverse effect on the Company's business, financial
condition and operating results.
Use and Disposal of Hazardous Materials. The Company's operations require
the controlled use of hazardous and radioactive materials. Although the Company
believes that its safety procedures for handling such materials comply with the
standards prescribed by federal, state and local regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damages that result, which could have a material adverse effect on the
Company's business, financial condition and operating results.
Risk of Natural Disaster. The Company's facilities are located in
Sunnyvale, California. In the event that a fire or other natural disaster (such
as an earthquake) prevents the Company from operating its production line, the
Company's business, financial condition and operating results would be
materially, adversely affected. The Company maintains earthquake coverage for
its facility, but does not maintain such coverage for personal property or
resulting business interruption.
24
<PAGE> 23
ITEM 2. PROPERTIES
The Company leases a 12,000 square foot facility at 670 Almanor Avenue,
Sunnyvale, California, which serves as a production facility. The facility lease
expires in November 1999 and requires base payments on average of approximately
$12,300 per month, subject to standard pass-throughs and escalations. In 1997,
the Company leased an additional 15,000 square feet of space at 575 Maude Court,
Sunnyvale, California, which served as its administrative offices and as a
research facility. The 575 Maude Court facility lease expires in September 1998
and requires base payments of $15,000 per month, subject to standard
pass-throughs of approximately $1,700 per month. Effective March 24, 1998, the
Company subleased this facility through the end of the lease period in
September 1998. The Company will not renew the lease when it expires. The
Company also has leased an additional 59,000 square feet of space at 675 Almanor
to accommodate expected increases in operations and additional full-time
employees. The Company began leasing approximately one-half of the space
(approximately 29,000 square feet) in December 1997 and will lease the remaining
space (approximately 30,000 square feet) once the existing tenant vacates the
space which is expected to be in the late spring or summer of 1998. This lease
expires on June 30, 2005 and has a five-year renewal option which, if exercised,
would extend the lease to June 30, 2010. This facility lease requires payments
of approximately $89,000 per month, once the entire 59,000 square feet is
leased, subject to standard pass-throughs and escalations. In 1998, the Company
expects to spend approximately $2.0 million to lease and expand laboratory and
office facilities, approximately $2.0 million to acquire additional capital
equipment and increase sequencing capacity, and approximately $2.0 million to
construct a state-of-the-art HyChip product manufacturing capacity at the
Company's new facility.
ITEM 3. 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). 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 will be 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). 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 and under the Federal Rules of Civil Procedure had until December 30, 1997,
to respond to the Company's complaint. Although Affymetrix's answer to this
complaint was due to be filed by December 30, 1997, it did not file its Answer,
Affirmative Defenses and Counterclaim until January 6, 1998 in violation of the
Federal Rules of Civil Procedure. The Company has reserved all of its rights
against Affymetrix for its failure to respond to the Company's complaint within
the time allowed by rules of court. The counterclaim seeks a declaratory
judgment of non-infringement, invalidity and/or unenforceability with respect to
the patent covering SBH technology. On January 29, 1998 the Company filed a
reply to the counterclaim in which it denied the allegations of
non-infringement, invalidity and/or unenforceability. 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 claims. By order of Court, an initial case management
conference will be held by the Court on March 27, 1998 at which time the Company
expects that Hyseq I and Hyseq II will be consolidated for pre-trial discovery
and possibly for trial. 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
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<PAGE> 24
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.
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<PAGE> 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to the vote of stockholders through the
solicitation of proxies or otherwise during the fourth quarter of the year ended
December 31, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) The Company's Common Stock began trading on the Nasdaq National Market on
August 8, 1997 under the symbol "HYSQ". Prior to that date, there was no
established trading market for the Common Stock. The following table sets forth,
for the periods indicated, the high and low sales prices for the Common Stock,
as reported by the Nasdaq National Market, since the Common Stock commenced
public trading:
<TABLE>
<CAPTION>
HIGH LOW
------------------ -----------------
<S> <C> <C>
FISCAL 1998:
First Quarter (through March 23, 1998) ........... $15.25 $7.875
FISCAL 1997:
Fourth Quarter ................................... $20.125 $7.875
Third Quarter (from August 8, 1997) .............. $21.625 $13.00
</TABLE>
As of March 23, 1998, there were approximately 268 stockholders of record of the
Common Stock. The Company has not paid dividends to its stockholders since its
inception and does not plan to pay cash dividends in the foreseeable future. The
Company currently intends to retain earnings, if any, to finance the growth of
the Company.
During the three months ended December 31, 1997, the Company issued a total of
7,832 shares of Common Stock to a member of the Company's Scientific Advisory
Board and an employee of the Company pursuant to the exercise of stock options
at a weighted average exercise price of $1.51 per share. No person acted as an
underwriter with respect to the transactions set forth above. In each of the
foregoing instances, the Company relied on Section 4(2) of the Securities Act of
1933, as amended (the "Securities Act") or Rule 701 promulgated under the
Securities Act, as applicable.
(b) 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, issuance and sale of the shares in the 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:
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<PAGE> 26
<TABLE>
<S> <C>
Purchase and installation of capital equipment: $ 2,054,000
Lease and improvement of real estate: $ 200,000
Working Capital: $11,413,000
Temporary Investment: $30,303,000
</TABLE>
The temporary investments specified above have consisted primarily of
investment-grade commercial paper, bank certificates of deposit 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 6. SELECTED CONSOLIDATED FINANCIAL DATA.
<TABLE>
<CAPTION>
PERIOD FROM
AUGUST 14, 1992
YEAR ENDED DECEMBER 31, (INCEPTION) TO
----------------------- DECEMBER 31,
1997 1996 1995 1994 1993
-------- ---------- --------- --------- ----------------
STATEMENTS OF OPERATIONS DATA:
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C> <C> <C> <C>
Contract revenues ................ $ 6,199 $ 426 $ 2,127 $ 50 $ --
Operating expenses:
Research and development ....... 9,430 3,736 1,811 851 --
General and administrative ..... 4,854 1,749 938 1,477 511
-------- -------- -------- -------- --------
Total operating expenses ..... 14,284 5,485 2,749 2,328 511
-------- -------- -------- -------- --------
Loss from operations ............. (8,085) (5,059) (622) (2,278) (511)
Interest income (expense), net ... $ 1,548 220 21 15 2
-------- -------- -------- -------- --------
Net loss ......................... $ (6,537) $ (4,839) $ (601) $ (2,263) $ (509)
======== ======== ======== ======== ========
Basic and diluted net loss per
share (1) ........................ $ (0.86) $ (0.91) $ (0.08) $ (0.28) $ (0.37)
======== ======== ======== ======== ========
Shares used in computing basic
and diluted net loss per share (1) 7,589 5,344 7,343 8,023 1,384
======== ======== ======== ======== ========
Pro forma basic and diluted net
loss per share(1) ................ $ (0.62) $ (0.56) $ (0.07)
======== ======== ========
Shares used in computing pro
forma basic and diluted net loss
per share(1) ..................... 10,579 8,629 8,773
======== ======== ========
</TABLE>
28
<PAGE> 27
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------
1997 1996 1995 1994 1993
----- ----- ---- ---- ----
BALANCE SHEET DATA:
<S> <C> <C> <C> <C> <C>
Cash and investments ........ $ 59,240 $ 6,707 $ 750 $ 1,196 $ 1,010
Working capital ............. 56,824 5,955 331 430 886
Total assets ................ 66,950 9,366 2,740 2,455 1,539
Noncurrent portion of capital
lease and loan obligations 613 791 32 -- --
Accumulated deficit ......... (14,755) (8,212) (3,373) (2,772) (509)
Total stockholders' equity .. $ 62,937 $ 7,364 $ 1,977 $ 1,625 $ 1,416
</TABLE>
(1) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the computation of net loss per share. Basic and diluted net loss
per share for all periods presented have been retroactively restated to
apply the requirements of Staff Accounting Bulletin No. 98, issued by the
SEC 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.
29
<PAGE> 28
ITEM 7. 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; and whether
conditions to milestone payments are met and the timing of such payment or
payments.
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 to develop
therapeutics, diagnostic molecules and vaccines relating to solid tumors and
with Perkin-Elmer to commercialize HyChip products. See "Business--Collaborative
and Other Arrangements." 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.
In August 1997, the Company completed an initial public offering (the
"IPO") of 3,000,000 shares of its common stock, for net proceeds of
approximately $38.0 million. In September 1997, the Company's underwriters
exercised their option to purchase 450,000 additional shares at $14.00 per share
to cover over-allotments, for additional net proceeds of approximately $5.9
million. Concurrently with completion of the IPO, the Company privately placed
shares of its common stock for net proceeds of $5.0 million from Perkin-Elmer
and $2.5 million from Chiron (the "Private Placement"). 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
Contract Revenues. Contract and other revenues increased significantly to
$6.2 million in 1997 from $426,000 and $2.1 million for the years ended December
31, 1996 and 1995, respectively. Contract and other revenues earned during 1997
included $5.3 million received from Chiron (including the $1.0 million licensing
fee received from Chiron in June 1997) and $874,000 received in conjunction with
the Company's NIST grant. The Company receives minimum research payments under
its collaboration agreement with Chiron which are recognized as revenue ratably
over the contract term based on the specified funding level for each period. The
Company recognized revenues under its NIST grant as research was performed. Work
under the NIST grant was completed at December 31, 1997 and there is no
assurance that the Company will receive additional funding from NIST in the
future. Contract revenues in 1996 were received in conjunction with the
Company's NIST grant. Contract revenues in 1995 were received in conjunction
with the NIST grant and agreements with two pharmaceutical
30
<PAGE> 29
companies. The Company recognized revenues under those agreements as milestones
were achieved. The recognition of revenues will 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 existing
collaborations and obtain additional collaboration partners. The failure to
maintain existing collaboration partners or the inability to enter into
additional 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 $14.3
million, $5.5 million and $2.7 million for the years ended December 31, 1997,
1996 and 1995, respectively. This increase in expenses in 1997 is due primarily
to costs associated with the Company's collaboration with Chiron, and the
associated scale-up of the Company's gene sequencing capacity from less than
100,000 partial human gene sequences per month at the beginning of 1997 to more
than one million partial human gene sequences per month at the end of 1997.
The research and development component of operating expenses increased to
$9.4 million in 1997 from $3.7 million in 1996 and $1.8 million in 1995.
Increases in 1997 as compared to 1996 resulted primarily from expanded internal
sequencing production and expanded sequencing production in connection with the
collaboration with Chiron, which together increased by approximately $2.9
million, as well as the addition of scientific personnel and software and
database development, which increased by approximately $2.1 million, and costs
associated with protecting and increasing the Company's intellectual property.
Increases in 1996 as compared to 1995 resulted primarily from expanded
sequencing production, which increased by approximately $620,000, as well as the
addition of scientific personnel and software and database development, which
increased by approximately $640,000, and intellectual property protection. The
Company expects to continue to expand research and development efforts in
support of its gene sequencing 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 $2.0 million for the development of the chip component of the
HyChip system from June 1997 through December 1997. Of this amount, $504,000 was
reimbursed to the Company under its NIST grant.
The general and administrative component of operating expenses increased to
$4.9 million in 1997 from $1.7 million in 1996 and $938,000 in 1995. Increases
in each period were due in part to increased marketing and business development
expenses, which increased by approximately $365,000 in 1997 and $150,000 in
1996, as well as the addition of management personnel and administrative staff,
which increased by approximately $375,000 in 1997 and $80,000 in 1996, to
support the continued expansion of the Company's sequencing production and data
analysis capabilities. In addition, in 1997, the Company's total legal expenses
increased by approximately $1.9 million (expenses related to new patent
prosecution have been allocated to research and development), due primarily to
costs associated with being a public company and signing two new collaborations,
and its suits filed against Affymetrix, Inc. in March and December 1997. Legal
expenses relating to the Company's litigation with Affymetrix, Inc. are expected
to remain at approximately the same level 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: (i) the planned expansion of sequencing operations, software
development and enhancements and increased work on gene discovery 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. At times, however, the Company may choose to increase sequencing
production and analysis capabilities in order to expand its internal sequencing
effort and to support its efforts to recruit 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 $1.5 million in 1997
from $220,000 in 1996 and $21,000 in 1995. The increase in interest income in
1997 as compared to 1996 resulted from larger cash and investment balances held
by the Company primarily due to the realization of net proceeds from the
Company's $10.0 million private placement of Series B preferred stock and the
net proceeds of the Company's initial public offering and concurrent private
placement of common stock completed in 1997. The increase in interest income for
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<PAGE> 30
1996 resulted from larger cash and investment balances held by the Company
primarily due to the realization of approximately $9.9 million in net proceeds
from its private placement of Series A Preferred Stock in 1996.
Net Loss. Since inception, the Company has incurred operating losses, and
as of December 31, 1997 had an accumulated deficit of $14.8 million. The Company
incurred a net loss for the year ended December 31, 1997 of $6.5 million
compared to losses of $4.8 million and $601,000 in 1996 and 1995, respectively.
As of December 31, 1997, the Company had a net operating loss carryover for
federal income tax purposes of approximately $13,200,000 million, which will
expire at various dates beginning in the year 2008 through 2012 if not utilized.
Utilization of the net operating loss carryover is expected to be subject to a
substantial annual limitation because of the "change in ownership" provisions of
the Internal Revenue Code of 1986, as amended. The annual limitation may result
in the expiration of net operating losses before utilization. See Note 8 of
Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, the Company had $57.1 million in cash, cash
equivalents and short-term investments and $2.1 million in a restricted cash
account, compared to $6.7 million as of December 31, 1996. This increase
reflects the net proceeds of the Company's initial public offering and its
private placements with Chiron and Perkin-Elmer, payments received under the
Company's NIST grant and fees received from Chiron, partially offset by net cash
used in operations of $8.1 million and capital expenditures of $3.1 million
during 1997.
The Company has classified all of its investments as short-term as of
December 31, 1997, 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.
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 will receive the interest earned thereon.
Net cash used in operating activities increased to $8.1 million in 1997
from $4.3 million in 1996 and $510,000 in 1995. The increases in cash usage for
each period were associated with the costs of expanding the Company's sequencing
production and data analysis capabilities and increased legal costs associated
with prosecuting patent applications and maintaining existing intellectual
property. In addition, the costs associated with the Company's IPO and ongoing
litigation with Affymetrix contributed to cash usage during 1997.
The Company's investing activities, other than the purchase and sales of
short-term investments, have consisted of capital expenditures, which
totaled $3.1 million for the year ended December 31, 1997 as compared to
$943,000 for 1996 and $679,000 for 1995. Capital expenditures increased in 1997
primarily due to the addition of capital equipment necessary for the Company's
expanded sequencing production and software development activities. Capital
expenditures increased in 1996 primarily due to leasehold improvements in the
Company's facilities and the purchase of new equipment and workstations required
in conjunction with the Company's expanded sequencing production and software
development activities.
Net cash provided by financing activities increased to $61.6 million for
the year ended December 31, 1997 from $11.2 million for 1996. Net cash provided
by financing activities in 1997 reflects primarily the $44.0 million in net
proceeds from the IPO and $17.5 million from its private placements with Chiron
and Perkin-Elmer. Net cash provided by financing activities increased to $11.2
million for the year ended December 31, 1996 from $953,000 in 1995. Net cash
provided by financing activities in 1996 reflects primarily the $9.9 million in
net proceeds from its private placement of Series A preferred stock in the first
half of 1996 as well as a $750,000 equipment loan.
The Company expects its cash requirements to increase significantly in
future periods because of the planned expansion of sequencing operations and
software development and enhancements and increased work on gene discovery and
new technology development expenses relating to the HyChip Module and related
products. In addition, the Company expects to expend additional cash in 1998 and
beyond for the leasing and upgrade of the Company's new larger facility and the
associated lease expenses related thereto. In 1998, the Company expects to spend
32
<PAGE> 31
approximately $2.0 million to lease and expand laboratory and office
facilities, approximately $2.0 million to acquire additional capital
equipment to increase sequencing capacity, and approximately $2.0 million
to construct a state-of-the-art HyChip product manufacturing capacity at
the new facility. The Company expects to continue to fund future operations
with revenues from existing collaborations in addition to using its current
cash, cash equivalents and investments when necessary. The Company intends
to continue funding development of HyChip products with the proceeds of its
$5.0 million private placement of Series B preferred stock with
Perkin-Elmer. As of December 31, 1997, the Company had a remaining
commitment to spend approximately $3.0 million under its collaboration
agreement with 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 those programs, the ability
of the Company to establish collaborative and licensing arrangements and
the 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; and the purchase of
additional capital equipment, including capital equipment necessary to
insure that the Company's sequencing operation remains competitive. There
can be no assurance that additional funding, if necessary, will be
available on favorable terms, if at all.
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.
ITEM 7A. QUANTITATIVE AND QUANTITATIVE 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.
33
<PAGE> 32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF ERNST &YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Hyseq, Inc.
We have audited the accompanying consolidated balance sheets of Hyseq, Inc. as
of December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Hyseq, Inc. at
December 31, 1997 and 1996, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
---------------------
Palo Alto, California
January 30, 1998
<PAGE> 33
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share information)
<TABLE>
<CAPTION>
December 31,
1997 1996
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 23,204 $ 6,707
Short-term investments 33,930 --
Accounts receivable 2,186 147
Other current assets 904 312
- ------------------------------------------------------------------------------------------------------------
Total current assets 60,224 7,166
Cash on deposit 2,106 --
Equipment and leasehold improvements, net 3,947 1,639
Patents, licenses and other assets, net 673 561
$ 66,950 $ 9,366
- ------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,571 $ 572
Accrued professional fees 584 89
Other current liabilities 907 285
Current portion of lease and loan obligations 338 265
- ------------------------------------------------------------------------------------------------------------
Total current liabilities 3,400 1,211
Noncurrent portion of lease and loan obligations 613 791
Commitments and contingencies Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized shares -- 8,000,000 at December 31,
1997 and 1996, respectively
Issued and outstanding -- none and 2,170,460 at
December 31, 1997 and 1996, respectively -- 14,780
Common stock, $0.001 par value:
Authorized shares -- 50,000,000
Issued and outstanding shares -- 12,733,965 and 4,472,716
at December 31, 1997 and 1996, respectively 81,795 2,033
Notes receivable from stockholders (3,658) (1,237)
Deferred compensation (445) --
Accumulated deficit (14,755) (8,212)
Total stockholders' equity 62,937 7,364
$ 66,950 $ 9,366
- ------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 34
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995
<S> <C> <C> <C>
Contract revenues $ 6,199 $ 426 $ 2,127
Operating expenses:
Research and development 9,430 3,736 1,811
General and administrative 4,854 1,749 938
Total operating expenses 14,284 5,485 2,749
- -------------------------------------------------------------------------------------------------------------------
Loss from operations (8,085) (5,059) (622)
Interest expense (158) (43) (2)
Interest income 1,706 263 23
Net loss $ (6,537) $ (4,839) $ (601)
Basic and diluted net loss per share $ (0.86) $ (0.91) $ (0.08)
Shares used in computing basic and diluted net loss per share 7,589 5,344 7,343
Pro forma basic and diluted net loss per share $ (0.62) $ (0.56) $ (0.07)
Shares used in computing pro forma basic and diluted net loss per share 10,579 8,629 8,773
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 35
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Convertible Notes
Preferred Stock Common Stock Receivable
------------------ -------------------- From
Shares Amount Shares Amount Stockholders
------ --------- ------ ------ ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 670 $ 3,971 7,353 $ 506 $ (80)
Issuance of Series A
preferred stock, net 119 949 -- -- --
Issuance of common stock -- -- 2 2 --
Cash payment of note
receivable from
stockholders -- -- -- -- 2
Repurchase of common stock
from Hyseq One Trust -- -- (230) -- --
Net loss -- -- -- -- --
- -------------------------------------------------------------------------------------------------
Balances at December 31, 1995 789 4,920 7,125 508 (78)
Issuance of Series A
preferred stock, net 1,381 9,860 -- -- --
Issuance of common stock -- -- 242 1,008 (672)
Issuance of common
stock upon exercise
of stock option grants -- -- 67 105 (75)
Issuance of common stock
upon exercise of warrants -- -- 144 417 (417)
Repurchase of common
stock from Hyseq One Trust -- -- (3,105) (5) --
Cash payment of note
receivable from stockholders -- -- -- -- 5
Net loss -- -- -- -- --
- -------------------------------------------------------------------------------------------------
Balances at December 31, 1996
(carried forward) 2,170 $14,780 4,473 $ 2,033 $(1,237)
</TABLE>
<TABLE>
<CAPTION>
Total
Deferred Accumulated Stockholders'
Compensation Deficit Equity
------------ ----------- ------------
<S> <C> <C> <C>
Balance at December 31, 1994 $-- $(2,772) $ 1,625
Issuance of Series A
preferred stock, net -- -- 949
Issuance of common stock -- -- 2
Cash payment of note
receivable from
stockholders -- -- 2
Repurchase of common stock
from Hyseq One Trust -- -- --
Net loss -- (601) (601)
--- ------- -------
Balances at December 31, 1995 -- (3,373) 1,977
Issuance of Series A
preferred stock, net -- -- 9,860
Issuance of common stock -- -- 336
Issuance of common
stock upon exercise
of stock option grants -- -- 30
Issuance of common stock
upon exercise of warrants -- -- --
Repurchase of common
stock from Hyseq One Trust -- -- (5)
Cash payment of note
receivable from stockholders -- -- 5
Net loss -- (4,839) (4,839)
--- ------- -------
Balances at December 31, 1996
(carried forward) $-- $(8,212) $ 7,364
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 36
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Convertible Notes
Preferred Stock Common Stock Receivable
--------------------- ---------------------- From
Shares Amount Shares Amount Stockholders
------- ------ ------ ------ ------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1996
(brought forward) 2,170 $ 14,780 4,473 $ 2,033 $ (1,237)
Issuance of common stock for
services and equipment -- -- 79 514 (398)
Forfeiture of note receivable
from stockholders -- -- (86) (68) 68
Purchase of common stock
by Hyseq One Trust -- -- 86 -- --
Issuance of common stock to
certain officers of the
Company -- -- 359 2,340 (2,340)
Deferred compensation -- -- -- 695 --
Amortization of deferred
compensation -- -- -- -- --
Issuance of common stock upon
exercise of stock option grants -- -- 21 33 --
Issuance of common stock upon
cashless exercise of warrants -- -- 241 -- --
Issuance of Series B
preferred stock 350 10,000 -- -- --
Issuance of common stock in
connection with the initial
public offering, net -- -- 3,450 43,970 --
Issuance of common stock in
a private placement -- -- 555 7,500 --
Conversion of preferred stock
to common stock upon closing
of initial public offering (2,520) (24,780) 4,961 24,780 --
Repurchase of common stock
from the Hyseq One Trust -- -- (1,405) (2) --
Cash payments of note
receivable from stockholders -- -- -- -- 249
Net unrealized gain(loss) on
short-term investments -- -- -- -- --
Net loss -- -- -- -- --
Balances at December 31, 1997 -- $ -- 12,734 $ 81,795 $ (3,658)
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Total
Deferred Accumulated Stockholders'
Compensation Deficit Equity
------------ ----------- -----------
<S> <C> <C> <C>
Balances at December 31, 1996
(brought forward) $ -- $ (8,212) $ 7,364
Issuance of common stock for
services and equipment -- -- 116
Forfeiture of note receivable
from stockholders -- -- --
Purchase of common stock
by Hyseq One Trust -- -- --
Issuance of common stock to
certain officers of the
Company -- --
Deferred compensation (695) -- --
Amortization of deferred
compensation 250 -- 250
Issuance of common stock upon
exercise of stock option grants -- -- 33
Issuance of common stock upon
cashless exercise of warrants -- -- --
Issuance of Series B
preferred stock -- -- 10,000
Issuance of common stock in
connection with the initial
public offering, net -- -- 43,970
Issuance of common stock in
a private placement -- -- 7,500
Conversion of preferred stock
to common stock upon closing
of initial public offering -- --
Repurchase of common stock
from the Hyseq One Trust -- -- (2)
Cash payments of note
receivable from stockholders -- -- 249
Net unrealized gain(loss) on
short-term investments -- (6) (6)
Net loss -- (6,537) (6,537)
Balances at December 31, 1997 $ (445) $(14,755) $ 62,937
- -----------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 37
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (6,537) $ (4,839) $ (601)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 926 444 287
Amortization of deferred compensation 250 -- --
Shares of common stock issued for services 116 -- --
Unrealized loss on short-term investments (6) -- --
Changes in assets and liabilities:
Accounts receivable (2,039) (10) (136)
Other current assets (592) (136) (111)
Cash on deposit and other assets (2,320) (24) (27)
Accounts payable 999 352 (9)
Accrued professional fees 495 (315) 12
Other current liabilities 622 209 75
Net cash used in operating activities (8,086) (4,319) (510)
- -----------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Expenditures for property and equipment (3,131) (943) (679)
Purchases of short-term investments (38,930) -- --
Maturities of short-term investments 5,000 -- --
Patents and other intangibles -- -- (210)
Net cash used in investing activities (37,061) (943) (889)
- -----------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Payments of stockholders' notes receivable 249 -- 2
Net cash proceeds from issuance of:
Preferred stock 10,000 9,860 949
Common stock 51,502 371 2
Cash used to repurchase common stock (2) (5) --
Cash proceeds from sale leaseback and financing loan 181 1,119 --
Principal payments on capital lease and loan obligations (286) (126) --
Net cash provided by (used in) financing activities 61,644 11,219 953
- -----------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents 16,497 5,957 (446)
Cash and cash equivalents at beginning of period 6,707 750 1,196
Cash and cash equivalents at end of period $ 23,204 $ 6,707 $ 750
- -----------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flows information
Cash paid for interest $ 158 $ 43 $ 3
- -----------------------------------------------------------------------------------------------------
Supplemental schedule of non-cash financing activities
Cashless exercise of warrant $ 1,133 $ -- $ --
- -----------------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
[ 1 ] Organization and Summary of Significant Accounting Policies
Organization and Basis of Presentation
Hyseq, Inc. (the "Company") was established in August 1992 as an Illinois
corporation and subsequently reincorporated as a Nevada corporation on November
12, 1993. The Company's wholly owned subsidiary, Hyseq Diagnostics, Inc.
("HDI"), was formed as a Nevada corporation on July 18, 1995. The Company
applies the proprietary DNA array technology of its integrated HyX genomics
platform (the "HyX Platform") to develop gene-based therapeutic product
candidates and diagnostic products and tests. The Company believes that its HyX
Platform, which utilizes the Company's proprietary sequencing by hybridization
("SBH") technology as its foundation, generates higher gene sequence throughput
with greater analytical flexibility and accuracy and lower cost than prevailing
technologies. During 1997, the Company significantly expanded operations and
established new collaborations. Accordingly, the Company is no longer classified
as a development stage company.
In August and September 1997, the Company raised approximately $44 million
in net proceeds from the sale of 3,450,000 shares of common stock at $14.00 per
share in its initial public offering (the "IPO"). Concurrently with completion
of the IPO, the Company privately placed shares of its common stock for
additional net proceeds of $5.0 million from Perkin-Elmer and $2.5 million from
Chiron (the "Private Placement"). All of the Company's outstanding preferred
stock automatically converted into common stock in connection with the Company's
IPO.
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the
Company's wholly owned subsidiary. All significant intercompany transactions and
accounts have been eliminated.
All common stock and common per share amounts have been retroactively
restated to reflect a 1.92-for-1 stock split which was effected during the third
quarter of 1997. All references to the numbers of shares and share prices
retroactively reflect post-split activity.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Cash, Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with original
maturities of less than 90 days and insignificant interest rate risk to be cash
equivalents. Investments with maturities of less than one year from the balance
sheet date and with original maturities greater than 90 days are considered
short-term investments. Investments consist primarily of money market accounts,
commercial paper, certificates of deposit and other bank instruments. These
investments typically bear minimal risk. This diversification of risk is
consistent with the Company's policy to maintain high liquidity and ensure
safety of principal.
As of December 31, 1997, the Company had classified its entire investment
portfolio as available-for-sale. Available-for-sale securities are carried at
fair value, with the unrealized gains and losses, net of tax, included in
stockholders' equity. The amortized cost of debt securities in this category is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization is included in interest income. Realized gains and losses and
declines in value judged to be other-than-temporary on available-for-sale
securities are included in interest income or expense. Interest and dividends on
securities classified as available-for-sale are included in interest income. The
Company had no material investments as of December 31, 1996. The following is a
summary of available-for-sale securities as of December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
<S> <C> <C> <C> <C>
Money market funds $ 6,764 $ -- $ -- $ 6,764
Commercial paper 20,867 2 -- 20,869
Certificates of deposit 27,998 -- (8) 27,990
Cash 1,511 -- -- 1,511
$57,140 $ 2 $ (8) $57,134
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE> 39
<TABLE>
<S> <C> <C> <C> <C>
Above amounts are included in the
balance sheet as follows:
Cash and cash equivalents $23,200 $ 4 $ -- $23,204
Short-term investments 33,940 -- (10) 33,930
Total: $57,140 $ 4 $(10) $57,134
- ---------------------------------------------------------------------------------------------------------
</TABLE>
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies.
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are computed using the straight-line method over the estimated
useful lives ranging from three to five years, except that leasehold
improvements are amortized over the remaining life of the lease or the life of
the improvement, whichever is less.
Revenue Recognition
Revenue related to collaborative research agreements and government grants
are recognized over the related funding periods for each contract as the
reimbursable services are performed. Minimum payments received under the Chiron
collaborative agreement are recognized ratably over the contract term based on
the specified funding level for each period. Revenues related to license
agreements with noncancellable, nonrefundable terms and no significant future
obligations are recognized upon execution of the agreements.
Revenues from collaborative agreements representing 10% or more of total
revenue are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
<S> <C> <C> <C>
Source:
NIST Grant 14% 100% 33%
Collaboration Partner A -- -- 57%
Collaboration Partner B 85% -- --
</TABLE>
Stock-Based Compensation
In accordance with the provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
the Company has elected to account for stock-based compensation under the
provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB No. 25"), and to adopt the "disclosure only"
alternative described in SFAS No. 123.
Research and Development
Research and development costs are charged to operations as incurred and
include costs related to the Company's NIST grant in 1997, 1996, and 1995. In
1997, research and development costs also included costs related to the
Company's collaborations with Chiron and Perkin-Elmer. Contract and grant
related costs of $4,747,000, $588,000 and $898,000 were recorded in the years
ending December 31, 1997, 1996 and 1995, respectively.
<PAGE> 40
Net Loss Per Share
Effective December 31, 1997, the Company adopted statement of Financial
Accounting Standards No. 128 "Earnings Per Share" ("SFAS No. 128"). SFAS No. 128
requires the presentation of basic earnings (loss) per share and diluted
earnings (loss) per share, if more dilutive, for all periods presented.
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 net loss per share for all periods presented have been
retroactively restated to apply the requirements of Staff Accounting Bulletin
No. 98, issued by the SEC 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.
Basic and diluted pro forma net loss per share as presented in the
Statements of Operations has been computed as described above and also gives
effect to the conversion of convertible Preferred Stock that automatically
converted at the completion of the Company's initial public offering (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 (in thousands, except per share
data):
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
<S> <C> <C> <C>
Net loss $ (6,537) $ (4,839) $ (601)
- -----------------------------------------------------------------------------------------------------------------
Basic and Diluted
Weighted average shares of common stock outstanding 7,589 5,344 7,343
Basic and diluted net loss per share $ (0.86) $ (0.91) $ (0.08)
- -----------------------------------------------------------------------------------------------------------------
Pro Forma
Shares used in computing basic and diluted
net loss per share 7,589 5,344 7,343
Adjusted to reflect the effect of the assumed conversion
of preferred stock 2,990 3,285 1,430
Shares used in computing pro forma basic and diluted
net loss per share 10,579 8,629 8,773
Pro forma basic and diluted net loss per share $ (0.62) $ (0.56) $ (0.07)
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Had the Company been in a net income position, diluted earnings per share
for 1997, 1996, and 1995 would have been presented and would have included the
shares used in the computation of pro forma basic net loss per share as well as
an additional 963,000, 243,000 and 345,000 shares, respectively, related to
outstanding options and warrants not included above (as determined using the
treasury stock method).
Impact of Recently Issued Accounting Standards
In 1997, the Statement of Financial Accounting Standards No. 130 ("SFAS
130"), "Reporting Comprehensive Income," was issued and is effective for fiscal
years commencing after December 15, 1997.
<PAGE> 41
In 1997, the Statement of Financial Accounting Standards No. 131 ("SFAS
131"), "Disclosure About Segments of an Enterprise and Related Information," was
issued and is effected for fiscal years commencing after December 15, 1997.
The Company is required to adopt the provisions of SFAS' 130 and 131 in
fiscal year 1998 and expects the adoption will not materially impact results of
operations or financial position, but may require additional disclosure.
[ 2 ] Equipment and Leasehold Improvements
Equipment and leasehold improvements consist of the following (in
thousands):
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996
<S> <C> <C>
Machinery, equipment, and furniture $5,117 $2,017
Leasehold improvements 156 125
- ----------------------------------------------------------------------------
5,273 2,142
Less accumulated depreciation and amortization 1,326 503
$3,947 $1,639
- ---------------------------------------------------------------------------
</TABLE>
Depreciation and amortization expense amounted to $823,000, $326,000 and
$169,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Equipment and leasehold improvements at December 31, 1997 and 1996 include items
under capitalized leases in the amount of $482,000. Accumulated amortization
related to these leased assets is included in depreciation expense in the
amounts of $243,000 and $129,000 for the years ended December 31, 1997 and 1996,
respectively.
[ 3 ] Patents, Licenses and Other Assets
Patents
Patents consist primarily of costs and expenses incurred in connection
with obtaining patents and filing patent applications in the United States and
abroad. Amortization, which amounted to $27,633 for the year ended December 31,
1997 and $42,735 in each of the two years ended December 31, 1996, is recorded
over the patents' estimated useful lives, which approximate 17 years.
License and Franchise Agreement
In 1994, the Company entered into a license and franchise agreement with a
manufacturing company for the exclusive right to use and resell robotic
equipment in the field of manipulating, sorting, identifying or sequencing
nucleic acids in hybridization reactions of DNA or RNA. The agreement required
the Company to pay total license fees of $300,000. Amortization, which amounted
to $75,000 for each of the three years in the period ended December 31, 1997, is
being recorded over the four-year term of the agreement. As of December 31,
1997, the Company had a purchase commitment for 10 remaining additional robotic
units for a total remaining commitment of approximately $700,000 through 1998.
The Company is currently in the process of renegotiating this license agreement
and its commitment thereunder. Should the Company elect not to purchase the
remaining 10 robots, the Company will forfeit its exclusive right to the robotic
equipment through the remaining term of the license which expires in June 1998.
The Company believes the early forfeiture of this exclusive right would have no
material effect on its business.
<PAGE> 42
Patent Agreement
In 1994, the Company entered into a patent agreement with an affiliate of
the University of Chicago for the exclusive license to use certain SBH
proprietary technology (developed by one of the Company's two Co-Senior Vice
Presidents for Research) and to develop, use, and sell licensed products or
processes under the license patent rights. The Company issued 15,244 shares of
Series A preferred stock and must pay minimum royalties increasing from $25,000
to $100,000 per annum beginning in 1997 and expiring at expiration of the
related patents. The agreement required that the Company incur research and
development costs relating to the patent technology in the amount of $2,500,000
through June 1998. This cost requirement was satisfied during 1997.
[ 4 ] Loan Obligation
In December 1996, the Company entered into a $1,000,000 loan agreement
with a capital management partnership and issued a warrant to purchase 9,600
shares of common stock at $5.21 per share in connection with such loan. The loan
has an imputed interest rate of 15.62% per annum. As of December 31, 1997, the
Company had borrowed $931,000 under the loan agreement which amount is secured
by certain equipment owned by the Company. In January 1997, the Company obtained
a commitment for an additional $500,000 under this loan agreement. No funds were
drawn under this loan commitment which expired in December 1997.
Future minimum loan payments under the loan agreement are as follows (in
thousands):
<TABLE>
<CAPTION>
Years ending December 31:
<S> <C>
1998 $294
1999 294
2000 368
2001 37
------------------------------------------------------
Total loan payments 993
Less amount representing interest (216)
------------------------------------------------------
Present value of future loan payments 777
Less current portion (190)
Noncurrent portion $587
------------------------------------------------------
</TABLE>
[ 5 ] Lease Commitments and Contingencies
Capital Lease Obligations
During December 1995, the Company entered into capital lease agreements to
finance certain equipment purchases. In February and July 1996, the Company
entered into sale and leaseback transactions for certain equipment. The
Company's current capital lease obligations expire in 1999.
<PAGE> 43
Future minimum lease payments under capital leases are as follows (in
thousands):
<TABLE>
<CAPTION>
Capital
Leases
Years ending December 31:
<S> <C>
1998 $ 159
1999 26
---------------------------------------------------------------
Total minimum lease payments 185
Less amount representing interest (11)
---------------------------------------------------------------
Present value of future lease payments 174
Less current portion (148)
Noncurrent portion $ 26
---------------------------------------------------------------
</TABLE>
Operating Lease Commitments
The Company leases three facilities under operating lease agreements that
expire in 1998, 1999 and 2005. In March 1998, the Company vacated the facility
for which the lease expires in 1998, and has subleased the space for the balance
of the term. The lease that expires in 2005 has a five-year renewal option,
which if exercised, would extend the lease to 2010. The Company also leases
certain equipment under operating leases. Rental expense was approximately
$241,000 in 1997, $183,000 in 1996 and $182,000 in 1995. Minimum noncancellable
future rental commitments under operating leases at December 31, 1997 are as
follows (in thousands):
<TABLE>
<S> <C>
1998 $1,129
1999 1,265
2000 1,145
2001 1,180
2002 1,212
Thereafter 3,169
</TABLE>
Cash On Deposit
In accordance with the terms of a facility lease agreement signed in the
fourth quarter of 1997, the Company was required to obtain an irrevocable
standby letter of credit in the amount of $2,000,000 as partial security for the
Company's lease obligations. In connection with obtaining the letter of credit,
the Company was required to place $2,106,000 on deposit with the Company's
primary bank as security for the letter of credit. 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. 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 will receive
interest earned thereon.
Contingencies
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 No. 5,202,231
and 5,525,464 (Hyseq, Inc. v. Affymetrix, Inc., Case no. C 97-20188 RMW ENE,
U.S. District Court). 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 these 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. The Company and Affymetrix are currently engaged in pretrial
discovery during which documents are being exchanged and depositions will be
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). Like the
Company's first action against Affymetrix, this action was filed in the U.S.
<PAGE> 44
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. Although Affymetrix's answer to this complaint was due to be
filed by December 30, 1997, it did not file its Answer, Affirmative Defenses and
Counterclaim until January 6, 1998. The counterclaim seeks a declaratory
judgment of non-infringement, invalidity and/or unenforceabilty with respect to
the patent which Affymetrix is alleged to have infringed. On January 29, 1998,
the Company filed a reply to the counterclaim in which it denied the allegations
of non-infringement, invalidity and/or unenforceability. 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.
[ 6 ] Collaborative Agreements
In January 1995, the Company received a grant award from NIST to further
the development of the Company's SBH technology. Under this award, the Company
was entitled to receive approximately 80% of actual direct costs of this program
up to $2,000,000 over a three-year period. Total revenue recognized under the
NIST agreement for the three years ended December 31, 1997, 1996 and 1995 was
$873,901, $426,099 and $700,000, respectively. The term of the grant expired at
December 31, 1997.
The Company entered into collaborative agreements with two pharmaceutical
companies, which provided for contract fees of $1,400,000 recorded as revenue in
1995. No revenues were recorded under these agreements during 1996 or 1997, and
the terms of the agreements have been completed.
In May 1997, the Company entered into an exclusive collaboration with
Chiron. Pursuant to the terms of the collaboration agreement, the Company and
Chiron are collaborating to develop therapeutics, diagnostic molecules and
vaccines relating to solid tumors. The collaboration has an initial term of
three years and can be extended at Chiron's option for two additional two-year
periods. Chiron paid a nonrefundable $1 million up-front licensing fee upon
signing the agreement and guaranteed payment of a minimum of $8.5 million in the
first year and $5.5 million in each of the two years thereafter in connection
with the Company's research on Chiron tissue sample libraries. The agreement
requires the Company to generate data at a specified level per year which, if
not met, could result in the Company's breach of the collaboration. Chiron has
the exclusive right to commercialize any solid tumor-related products resulting
from the collaboration. The Company will receive royalties on any such products.
Concurrently, Chiron made an equity investment of $5.0 million in return for
shares of the Company's preferred stock which subsequently converted into common
stock. Chiron also purchased shares of Common Stock directly from the Company in
a private placement concurrent with the initial public offering for an aggregate
purchase price of $2.5 million. Total revenue recognized in 1997 under the
agreement with Chiron was $5,250,000.
In May 1997, the Company entered into an agreement with Perkin-Elmer to
combine the Company's super chip technology and Perkin-Elmer's life science
system capabilities to commercialize HyChip products (collectively, the "HyChip
System"). Pursuant to the terms of the agreement, the Company is obligated to
commit $5.0 million to further development of the Company's "chip" component of
the HyChip System over the next two years, and Perkin-Elmer must commit certain
funds to develop the overall system. The Company spent approximately $2.0
million for the development of the chip component of the HyChip system from June
1997 through December 1997. Of this amount, $504,000 was reimbursed to the
Company under its NIST grant. As of December 31, 1997, the Company had a
remaining commitment to spend approximately $3.0 million under its agreement
with Perkin-Elmer. The collaboration has an initial term of five years and will
be extended automatically thereafter unless the parties mutually agree to
terminate. The agreement contemplates that the design, development and
manufacture of the HyChip "chip" will be under the direction of the Company,
while design, development and manufacture of the system will be under the
direction of Perkin-Elmer. HyChip products will be distributed through
Perkin-Elmer's Applied Biosystems Division. In June 1997, Perkin-Elmer made an
equity investment of $5.0 million in return for shares of the Company's
preferred stock which subsequently converted into common stock. Perkin-Elmer
also purchased shares of Common Stock directly from the Company in a private
placement concurrent with the initial public offering for an aggregate purchase
price of $5.0 million. No revenue was recorded in conjunction with the
Perkin-Elmer collaboration in 1997.
[ 7 ] Stockholders' Equity
Preferred Stock
The Company is authorized to issue 8,000,000 shares of preferred stock.
The Company's Board of Directors may set the rights and privileges of any
preferred stock issued.
<PAGE> 45
In May and June 1997, Chiron and Perkin-Elmer acquired Series B preferred
stock in a private placement which generated net proceeds to the Company of
$10.0 million. All shares of the Company's outstanding preferred stock
automatically converted to common stock in connection with the Company's initial
public offering.
Common Stock
The Company's initial public offering of 3,000,000 shares of common stock,
which generated net proceeds of approximately $38.0 million, was effective
August 7, 1997. In September 1997, the Company's underwriters exercised their
option to purchase 450,000 additional shares at $14.00 per share to cover
over-allotments, for additional net proceeds to the Company of $5.9 million.
Concurrently with the initial public offering, the Company completed a private
placement of shares of its common stock to Chiron and Perkin-Elmer for net
proceeds of $2.5 million and $5.0 million, respectively.
In December 1996, an officer of the Company purchased 161,280 shares of
common stock at $4.17 per share for a total purchase price of $672,000.
Simultaneously with the purchase of such stock, the officer borrowed from the
Company $672,000 as evidenced by a promissory note that bears interest at 3% per
annum, matures in December 2001, and is secured by and with recourse only to the
161,280 shares. The Company has the right, but not the obligation to repurchase
certain of the shares if the officer's employment with the Company terminates
before December 1998. Also in December 1996, another officer exercised options
to purchase 48,000 shares of common stock at an exercise price of $1.56 per
share and exercised warrants to purchase 144,000 shares of common stock at $2.90
per share. Simultaneously with exercise, the officer borrowed from the Company
$492,000, as evidenced by a promissory note that bears interest at 3% per annum,
matures in December 2001, and is secured by and with recourse only to 118,080
shares.
In March 1997, the Company sold a total of 359,424 shares of common stock
for $6.51 per share to two officers of the Company in exchange for promissory
notes with terms similar to those described above. Such shares are subject to
repurchase by the Company if the officers do not remain employed by the Company
through March 1999; such repurchase rights of the Company expire ratably over
this two-year period. At December 31, 1997, 305,280 shares of common stock are
subject to repurchase by the Company. The weighted-average grant date fair value
of non-vested stock awards during 1997 and 1996 was $2.06 per share and $0.49
per share, respectively.
Deferred Compensation
The Company has recorded deferred compensation of $695,000 representing
the difference between the issuance and exercise prices related to stock awards
and options and the deemed fair value for financial reporting purposes of the
Company's common stock. The deferred stock compensation is being amortized to
expense over the vesting period of the options and over the two year repurchase
period for the stock awards.
Shares Held in Trust
In November 1993, the Company sold 5,446,502 shares of common stock to the
Hyseq One Trust (the "Trust") for $2,837 or $0.001 per share. The Trust was
formed to maintain certain agreed upon ownership ratios and avoid dilution to
existing stockholders. A trustee held the shares in accordance with terms of the
trust agreement. The trustee retained all voting rights attributable to those
shares held in the Trust.
The Company had the right to purchase from the Trust an equal number of
shares of its preferred or common stock that it issued in the same period
(excluding shares issued as a result of a stock split or stock dividend) to any
person other than the Trust for $0.002 per share.
<PAGE> 46
The Trust terminated upon completion of the Company's Initial Public
Offering, and as of December 31, 1997, no shares were owned by the Trust.
Warrants
As of December 31, 1997, the Company has outstanding warrants to purchase
692,847 shares of common stock at exercise prices ranging from $2.90 to $5.21
($3.81 average exercise price) per share to certain investors, an executive
officer and the private placement agent for the 1996 Series A Preferred Stock
financing. The value of these warrants was not material. In 1996, an executive
officer of the Company exercised a warrant to purchase 144,000 shares of common
stock at $2.90 per share.
Stock Option Plans
During 1995, the Company adopted the 1995 Stock Option Plan (the "Plan").
The Company has reserved a total of 1,152,000 common shares for issuance under
the Plan. Under the Plan, stock options may be granted by the board of directors
to employees and consultants. Options granted may be either incentive stock
options or nonstatutory stock options. Incentive stock options may be granted to
employees or consultants with exercise prices of no less than fair value and
nonstatutory options may be granted to employees or consultants at exercise
prices of no less than par value of the common stock on the date of grant as
determined by the board of directors. Options vest as determined by the board of
directors and expire 10 years from the date of grant. At December 31, 1997,
438,683 shares were available for future grant under the Plan. The Company
intends to submit a proposal to its stockholders to increase the number of
shares authorized for issuance under the Plan by 1,000,000 shares at the 1998
annual meeting.
The Company granted options to purchase common stock to several key
employees, directors, scientific advisory board members and scientists prior to
adoption of the Plan. Each option gives the holder the right to purchase common
stock at prices between $0.78 and $1.82 per share. The options vested over
periods up to four years. As of December 31, 1997, 596,152 options were
outstanding which were issued prior to adoption of the Stock Option Plan.
At the Company's 1996 annual meeting, the stockholders approved a
Non-Employee Director Stock Option Plan (the "Directors' Plan") providing for
periodic stock option grants to directors of the Company. Under the Directors'
Plan, each new, non-employee director receives a one-time grant of options to
purchase 23,040 shares of common stock, of which options to purchase 11,520
shares vest immediately, with the balance vesting in two equal allotments on the
first and second anniversaries of joining the Board. All non-employee directors
automatically receive options to purchase up to 5,760 shares each year (such
that the amount received under the Directors' Plan when added to all prior
options granted to a director which vest in that year total 5,760) on the date
of the annual meeting of the stockholders commencing in 1997. Options under the
Directors' Plan are granted at the fair market value of the Company's common
stock on the date of the grant. A total of 138,240 shares of common stock have
been reserved for issuance under the Directors' Plan, of which options to
purchase 48,960 shares were issued and outstanding at December 31, 1997.
As adjusted information regarding net loss and loss per share is required
by SFAS 123, which also requires that the information be determined as if the
Company has accounted for its employee stock options granted subsequent to
<PAGE> 47
December 31, 1994 under the fair value method. The fair value for these
options was estimated at the date of grant using the Black-Scholes option
pricing model in 1997 and the minimum value method prior to 1997 with the
following weighted-average assumptions:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
<S> <C> <C> <C>
Volatility .53 -- --
Risk-free interest rate 6.2% 6.2% 6.1%
Dividend yield -- -- --
Expected life of option 2.4 years 3.0 years 3.5 years
</TABLE>
The Black-Scholes option pricing model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of as adjusted disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
as adjusted information follows (in thousands, except for per share
information):
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
<S> <C> <C> <C>
As adjusted net loss $ (7,388) $ (4,891) $ (604)
As adjusted pro forma basic net loss per share $ (0.70) $ (0.62) $ (0.07)
</TABLE>
Because Statement 123 is applicable only to options granted subsequent to
December 31, 1994, its as adjusted effect will not be fully reflected until
fiscal 1999.
A summary of the Company's stock options activity, and related information
follows:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
Weighted - Weighted - Weighted -
Number Average Number Average Number Average
of Exercise of Exercise of Exercise
Shares Price Shares Price Shares Price
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of period 1,153,553 $2.77 860,131 $1.66 829,440 $1.55
Options granted 292,816 $8.34 569,397 $4.17 33,379 $4.17
Options exercised (20,888) $1.60 (67,200) $1.56 (2,688) $0.78
Options canceled (68,540) $4.87 (208,775) $2.37 -- $--
Options outstanding at
end of the period 1,356,941 $3.88 1,153,553 $2.77 860,131 $1.66
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE> 48
The following table summarized information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Weighted - Average
Weighted -
Number Remaining Average Number Weighted -
Range of of Contractual Exercise of Average
Exercise Price Shares Life Price Shares Exercise Price
(In years)
<S> <C> <C> <C> <C> <C>
$ 0.78 - $ 1.82 586,152 6.51 $ 1.55 542,872 $1.56
$ 4.17 - $ 6.51 556,527 8.64 $ 4.46 207,370 $4.17
$ 8.33 - $12.00 189,262 9.36 $ 8.72 2,880 $8.33
$13.75 - $14.25 15,000 9.78 $14.08 0 $0.00
Total 1,356,941 7.82 $ 3.88 753,122 $2.30
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
The weighted-average grant-date fair value of options granted during the
years ended December 31, 1997, 1996 and 1995 was $8.37, $0.69 and $0.74,
respectively.
[ 8 ] Income Taxes
As of December 31, 1997, the Company had federal and state net operating
loss carryforwards of approximately $13,200,000 and $4,500,000, respectively.
The Company also had federal and California research and development tax credit
carryforwards of approximately $200,000 and $200,000, respectively. The federal
net operating loss and credit carryforwards will expire at various dates
beginning in the year 2008 through 2012, if not utilized. The state of
California net operating losses will expire at various dates beginning in 1999
through 2002, if not utilized.
Utilization of the Company's net operating loss carryforwards and credits
may be subject to an annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986 and similar state provisions.
The annual limitation may result in the expiration of net operating losses and
credits before utilization.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets for financial reporting and the amount
used for income tax purposes. Significant components of the Company's deferred
tax assets for federal and state income taxes are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Deferred tax assets
Net Operating Loss Carryforwards 4,700 2,500
Capitalized Research and Development 200 200
Other -- Net 400 200
-----------------------------------------------------------------------------------
Total Deferred Tax Assets 5,300 2,900
Valuation Allowance (5,300) (2,900)
Net Deferred Tax Assets -- --
-----------------------------------------------------------------------------------
</TABLE>
The net valuation allowance increased by $2,400,000 and $1,700,000 for the
fiscal years ended December 31, 1997 and 1996, respectively.
[ 9 ] Transactions with Related Parties
As of December 31, 1997, 1996 and 1995, the Company owed $152,113, $44,026
and $238,602, respectively, for professional services rendered by two law firms
of which the spouse of the Company's President and Chief Executive Officer was a
member during these periods. The Company incurred legal fees and costs to one of
these law firms of $1.0 million and $83,112 for the years ended December 31,
1997 and 1996, respectively. The Company incurred legal fees and costs of
$68,775 and $34,834 for the years ended December 31, 1996 and 1995,
respectively, to the other of these law firms. The Company incurred no legal
fees or costs with this second law firm in 1997.
<PAGE> 49
In January 1997, Sachnoff & Weaver, Ltd., one of the firms identified
above, purchased 76,800 shares of the Company's common stock at $6.51 per
share. Sachnoff & Weaver, Ltd., a member of which is the spouse of the Company's
President and Chief Executive Officer, paid $102,415 and delivered a promissory
note to the Company for the balance in the amount of $397,585 secured by 61,069
shares of common stock. The note bears interest at 8.25% per annum. The
principal balance outstanding on the note at December 31, 1997 was $154,000.
[ 10 ] Subsequent Events (Unaudited)
In February 1998, the Company entered into a collaborative agreement with
the University of California San Francisco ("UCSF") to conduct a population
genetic and pharmacogenomic project on genes that may have important roles in
the development of cardiovascular disease. Under the terms of the five-year
agreement, the Company will reimburse UCSF for direct and indirect expenses
incurred in clinical sample collection and make additional quarterly payments
for research conducted. The Company has the exclusive rights from UCSF to
commercialize the proprietary databases derived from this collaboration.
<PAGE> 50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The response to this item is incorporated by reference from the discussion
responsive thereto under the captions "Management" and "Compliance with Section
16(a) of the Securities Exchange Act of 1934" in the Company's Proxy Statement
for its 1998 Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION.
The response to this item is incorporated by reference from the discussion
responsive thereto under the caption "Executive Compensation" in the Company's
Proxy Statement for its 1998 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The response to this item is incorporated by reference from the discussion
responsive thereto under the caption "Share Ownership" in the Company's Proxy
Statement for its 1998 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The response to this item is incorporated by reference from the discussion
responsive thereto under the caption "Certain Transactions" in the Company's
Proxy Statement for its 1998 Annual Meeting of Stockholders.
<PAGE> 51
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits
The following documents are filed as part of this annual report on Form
10-K.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
<S> <C>
3.1 Amended and Restated Articles of Incorporation of the Company, as amended*
3.2 By-Laws of the Company*
4.1 Specimen Common Stock certificate*
4.2 Form of Registration Rights Agreement*
4.3 Form of Warrant Agreement*
10.1 Form of Indemnification Agreement between the Company and each of its directors and
officers*
10.2 Stock Option Plan, as amended+*
10.3(a) Employment Agreement between the Company and Dr. Radoje T. Drmanac+*
10.3(b) Employment Agreement between the Company and Dr. Radomir B. Crkvenjakov+*
10.4 Non-Employee Director Stock Option Plan+*
10.5 Patent License Agreement between Arch Development Corporation and Hyseq, Inc. dated
June 7, 1994*
10.6 Stock Purchase Agreement for Series B Convertible Preferred Stock dated May 28, 1997*
10.7 Collaboration Agreement between Hyseq Inc. and Chiron Corporation dated May 28, 1997*
10.10 Collaboration Agreement between Hyseq Inc. and The Perkin-Elmer Corporation dated
May 28, 1997*
21.1 Subsidiaries of Hyseq, Inc.*
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedule
</TABLE>
- --------------------
* Previously filed with the Commission as Exhibits to and incorporated herein by
reference from the Company's Registration Statement filed on Form S-1, File No.
333-209091.
+ Denotes compensation plan in which an executive officer or director
participates.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the last quarter of the year ended
December 31, 1997.
<PAGE> 52
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of
Sunnyvale, State of California, on the 30th day of March, 1998.
HYSEQ, INC.
By: /s/ LEWIS S. GRUBER
----------------------------------
Lewis S. Gruber
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities indicated
on the 30th day of March, 1998.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
Chairman of the Board
- ------------------------------------
Robert D. Weist
/s/ LEWIS S. GRUBER President and Chief Executive Officer, Director
- ------------------------------------ (Principal Executive Officer)
Lewis S. Gruber
/s/ CHRISTOPHER R. WOLF Executive Vice President and Chief Financial
- ------------------------------------ Officer (Principal Financial and Accounting
Christopher R. Wolf Officer)
/s/ RADOJE T. DRMANAC Co-Senior Vice President for Research, Director
- ------------------------------------
Radoje T. Drmanac
/s/ RADOMIR B. CRKVENJAKOV Co-Senior Vice President for Research, Director
- ------------------------------------
Radomir B. Crkvenjakov
/s/ RAYMOND F. BADDOUR Director
- ------------------------------------
Raymond F. Baddour
/s/ GRETA E. MARSHALL Director
- ------------------------------------
Greta E. Marshall
Director
- ------------------------------------
Thomas N. McCarter III
/s/ KENNETH D. NOONAN Director
- ------------------------------------
Kenneth D. Noonan
</TABLE>
<PAGE> 53
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
<S> <C>
3.1 Amended and Restated Articles of Incorporation of the Company, as amended*
3.2 By-Laws of the Company*
4.1 Specimen Common Stock certificate*
4.2 Form of Registration Rights Agreement*
4.3 Form of Warrant Agreement*
10.1 Form of Indemnification Agreement between the Company and each of its directors and
officers*
10.2 Stock Option Plan, as amended+*
10.3(a) Employment Agreement between the Company and Dr. Radoje T. Drmanac+*
10.3(b) Employment Agreement between the Company and Dr. Radomir B. Crkvenjakov+*
10.4 Non-Employee Director Stock Option Plan+*
10.5 Patent License Agreement between Arch Development Corporation and Hyseq, Inc. dated
June 7, 1994*
10.6 Stock Purchase Agreement for Series B Convertible Preferred Stock dated May 28, 1997*
10.7 Collaboration Agreement between Hyseq Inc. and Chiron Corporation dated May 28, 1997*
10.10 Collaboration Agreement between Hyseq Inc. and The Perkin-Elmer Corporation dated
May 28, 1997*
21.1 Subsidiaries of Hyseq, Inc.*
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedule
</TABLE>
- --------------------
* Previously filed with the Commission as Exhibits to and incorporated herein by
reference from the Company's Registration Statement filed on Form S-1, File No.
333-209091.
+ Denotes compensation plan in which an executive officer or director
participates.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the last quarter of the year ended
December 31, 1997.
<PAGE> 1
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-41663) pertaining to the Hyseq, Inc. Stock Option Plan of our report
dated January 30, 1998, with respect to the consolidated financial statements of
Hyseq, Inc. included in this Annual Report on Form 10-K for the year ended
December 31, 1997, filed with the Securities and Exchange Commission.
ERNST & YOUNG LLP
Palo Alto, California
March 26, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) ITEM 8
OF FORM 10-K FOR THE PERIOD ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH (B) 10-K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 23,204
<SECURITIES> 33,930
<RECEIVABLES> 2,186
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 60,224
<PP&E> 5,273
<DEPRECIATION> 1,326
<TOTAL-ASSETS> 66,950
<CURRENT-LIABILITIES> 3,400
<BONDS> 0
0
0
<COMMON> 81,795
<OTHER-SE> (18,858)
<TOTAL-LIABILITY-AND-EQUITY> 66,950
<SALES> 0
<TOTAL-REVENUES> 6,199
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 14,284
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,548
<INCOME-PRETAX> (6,537)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,537)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,537)
<EPS-PRIMARY> (0.86)<F1>
<EPS-DILUTED> (0.62)<F2>
<FN>
<F1>For Purposes of This Exhibit, Primary means Basic and Diluted.
<F2>For Purposes of This Exhibit, Diluted means Pro Forma Basic and Diluted.
</FN>
</TABLE>
