<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
TRANSITION REPORT UNDER SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-22873
Hyseq, Inc.
------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Nevada 36-3855489
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
670 Almanor Avenue, Sunnyvale, CA 94086
------------------------------------------------------------
(Address of principal executive offices, including zip code)
(408) 524-8100
------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
COMMON STOCK OUTSTANDING ON November 9, 1998: 12,926,722
Page 1 of 18
Exhibit Index on Page 17
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HYSEQ, INC.
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I Financial Information
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at September 30, 1998, and
December 31, 1997.......................................................... 3
Condensed Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 1998 and 1997.......................... 4
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997.......................................... 5
Notes to Condensed Consolidated Financial Statements....................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.............................................................. 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................. 12
PART II Other Information
Item 1. Legal Proceedings........................................................... 13
Item 2. Change in Securities and Use of Proceeds.................................... 13
Item 3. Defaults Upon Senior Securities............................................. 14
Item 4. Submission of Matters to a Vote of Security Holders......................... 14
Item 5. Other Information........................................................... 14
Item 6. Exhibits and Reports on Form 8-K............................................ 15
SIGNATURES ............................................................................ 16
EXHIBIT INDEX ............................................................................ 17
</TABLE>
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HYSEQ, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997*
------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,558 $ 23,204
Short-term investments 31,963 33,930
Accounts receivable 2,526 2,186
Other current assets 1,210 904
-------- --------
Total current assets 46,257 60,224
Cash on deposit 2,106 2,106
Equipment and leasehold improvements, net 6,932 3,947
Patents, licenses and other assets, net 676 673
-------- --------
$ 55,971 $ 66,950
======== ========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Current liabilities:
Accounts payable $ 1,290 $ 1,571
Accrued professional fees 1,021 584
Other current liabilities 874 907
Current portion of lease and loan obligations 318 338
-------- --------
Total current liabilities 3,503 3,400
Noncurrent portion of capital lease and loan obligations 653 613
Commitments and contingencies
Stockholders' equity:
Preferred stock -- --
Common stock
Issued and outstanding shares -- 12,926,722 and 12,733,965
at September 30, 1998 and December 31, 1997, respectively 82,341 81,795
Notes receivable from stockholders (3,503) (3,658)
Deferred compensation (206) (445)
Net unrealized gain (loss) on securities available-for-sale 7 (6)
Accumulated deficit (26,824) (14,749)
-------- --------
Total stockholders' equity 51,815 62,937
-------- --------
$ 55,971 $ 66,950
======== ========
</TABLE>
* The condensed consolidated balance sheet at December 31, 1997 has been
derived from the audited financial statements at that date.
See accompanying notes.
3
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HYSEQ, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Contract revenues $ 1,352 $ 2,360 $ 6,715 $ 3,766
Operating expenses:
Research and development 4,969 3,285 13,984 6,433
General and administrative 2,601 1,234 7,091 2,960
-------- -------- -------- --------
Total operating expenses 7,570 4,519 21,075 9,393
-------- -------- -------- --------
Loss from operations (6,218) (2,159) (14,360) (5,627)
Interest income (expense), net 750 537 2,286 671
-------- -------- -------- --------
Net loss $ (5,468) $ (1,622) $(12,074) $ (4,956)
======== ======== ======== ========
Basic and diluted net loss per share (1) $ (0.42) $ (0.18) $ (0.94) $ (0.84)
======== ======== ======== ========
Shares used in computing basic and
diluted net loss per share (1) 12,926 8,902 12,809 5,875
======== ======== ======== ========
Pro forma basic and diluted net loss per share (1) $ (0.13) $ (0.50)
======== ========
Shares used in computing pro forma basic and
diluted net loss per share (1) 12,417 9,862
======== ========
</TABLE>
(1) Basic and diluted net loss per share for the three and nine months ending
September 30, 1997 has been retroactively restated to apply the
requirements of Staff Accounting Bulletin No. 98, issued by the Securities
and Exchange Commission in February 1998 ("SAB 98"). Under SAB 98, certain
shares of common stock and options and warrants to purchase shares of
common stock issued at prices substantially below the per share price of
shares sold in the Company's initial public offering previously included in
the computation of shares outstanding pursuant to Staff Accounting
Bulletins Nos. 55, 64 and 83 are now excluded from the computation.
See accompanying notes.
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HYSEQ, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(in thousands, except share amounts)
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(12,074) $ (4,956)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 1,293 602
Amortization of deferred compensation 239 170
Shares of common stock issued for services and equipment -- 116
Unrealized gain/(loss) on short-term investments 13 (8)
Changes in assets and liabilities:
Accounts receivable (340) (2,213)
Other current assets (306) (187)
Other assets (60) (76)
Accounts payable (281) 1,242
Accrued processional fees 437 701
Other current liabilities (33) 732
Deferred revenue -- 75
-------- --------
Net cash used in operating activities (11,112) (3,803)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property and equipment (4,221) (2,122)
Purchases of short-term investments (37,094) (22,956)
Maturities of short-term investments 39,062 --
-------- --------
Net cash used in investing activities (2,253) (25,078)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of stockholders' notes receivable 155 112
Cash proceeds from issuance of Series B preferred stock -- 17,500
Cash proceeds from the issuance of common stock 545 43,948
Cash used to repurchase common stock -- (2)
Principal payments on capital lease and loan obligations (262) (208)
Borrowings under capital lease/financing loan 281 181
-------- --------
Net cash provided by financing activities 719 61,531
-------- --------
Net increase (decrease) in cash and cash equivalents (12,646) 32,650
Cash and cash equivalents at beginning of period 23,204 6,707
-------- --------
Cash and cash equivalents at end of period $ 10,558 $ 39,357
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Interest paid $ 98 $ 122
======== ========
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES
Issuance of 15,728 shares of common stock in exchange
for legal services $ -- $ 102
======== ========
Issuance of 1,142 shares of common stock in exchange
for equipment $ -- $ 14
======== ========
</TABLE>
See accompanying notes.
5
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HYSEQ, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The condensed consolidated balance sheet as of September
30, 1998, the statements of operations for the three and nine months ended
September 30, 1998 and 1997 and the statements of cash flows for the nine months
ended September 30, 1998 and 1997 are unaudited, but include all adjustments
(consisting of normal recurring adjustments) which the Company considers
necessary for a fair presentation of the financial position, operating results
and cash flows for the periods presented. The condensed consolidated financial
statements include the accounts of the Company's wholly-owned subsidiary, Hyseq
Diagnostics, Inc. The results of operations for the interim periods shown herein
are not necessarily indicative of operating results expected for the entire
year.
2. Cash, Cash Equivalents and Short-Term Investments
As of September 30, 1998, short-term investments are classified as
available-for-sale securities and are carried at fair market value with
unrealized gains and losses reported in stockholders' equity. The following is a
summary of available-for-sale securities as of September 30, 1998:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
-------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Cash $ 2,740 $ -- $ -- $ 2,740
Certificates of deposit 21,518 10 -- 21,528
Commercial paper 14,828 -- (3) 14,825
Money market funds 3,428 -- -- 3,428
-------- ---- -------- --------
$ 42,514 $ 10 $ (3) $ 42,521
======== ==== ======== ========
Above amounts are included in the
balance sheet as follows:
Cash and cash equivalents $ 10,561 $ -- $ (3) $ 10,558
Short-term investments 31,953 10 -- 31,963
-------- ---- -------- --------
Total: $ 42,514 $ 10 $ (3) $ 42,521
======== ==== ======== ========
</TABLE>
The estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation methodologies.
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3. Changes in Accounting Standards
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of this statement has no impact
on the Company's net loss or stockholders' equity. SFAS 130 requires, among
other things, unrealized gains or losses on the Company's short-term investments
to be included in comprehensive income or loss. During the nine months ended
September 30, 1998 and 1997, the Company's comprehensive loss amounted to
$12,061,000 and $4,964,000, respectively.
4. Net Loss Per Share
In accordance with SFAS No. 128, basic net loss per share has been
computed using the weighted-average number of shares of common stock outstanding
during the period.
Basic pro forma net loss per share as presented in the condensed
consolidated statements of operations gives effect to the conversion of
convertible preferred stock that automatically converted at the completion of
the Company's initial public offering at August 1997 (using the if-converted
method) from the original date of issuance.
A reconciliation of shares used in the calculation of basic net loss
per share and pro forma net loss per share follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1998 1997 1998 1997
-------- -------- -------- --------
(in thousands except per share amounts)
<S> <C> <C> <C> <C>
Net loss $ (5,468) $ (1,622) $(12,074) $ (4,956)
======== ======== ======== ========
Basic and Diluted
Weighted average shares of common stock
outstanding 12,926 8,902 12,809 5,875
======== ======== ======== ========
Basic and diluted net loss per share $ (0.42) $ (0.18) $ (0.94) $ (0.84)
======== ======== ======== ========
Pro Forma Basic and Diluted
Shares used in computing basic and diluted net
loss per share 8,902 5,875
Adjusted to reflect the effect of the assumed
conversion of preferred stock 3,515 3,987
-------- --------
Shares used in computing pro forma basic
and diluted net loss per share 12,417 9,862
======== ========
Pro forma basic and diluted net loss per share $ (0.13) $ (0.50)
======== ========
</TABLE>
7
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements as that term is defined in the
Private Securities Litigation Reform Act of 1995 concerning existing and
potential collaboration arrangements, royalties and other payments under
existing and potential collaboration arrangements, and product development and
sales and other statements. Such statements are based on Management's current
expectations and involve risks and uncertainties. Actual results and performance
could differ materially from those projected in the forward-looking statements
as a result of many factors discussed herein and from time to time in the
Company's filings with the Securities and Exchange Commission ("SEC"), including
but not limited to, the following: the scientific progress of the Company's
programs; the ability of the Company to establish additional collaborative and
licensing arrangements; the extent to which the Company engages in development
of products without collaboration partners; the time and cost involved in
obtaining regulatory approvals for its pharmaceutical or other products; the
costs involved in preparing, filing, prosecuting, maintaining and enforcing
patent claims including the costs associated with its ongoing litigation with
Affymetrix; competing technological and market developments; whether conditions
to milestone payments are met for any future collaborative agreements and the
timing of such payment or payments; and other factors and risks detailed under
the caption "Factors That May Impact Results" in the Company's 1997 Annual
Report on Form 10-K.
Overview
The Company applies the proprietary DNA array technology of its HyX platform
primarily to develop gene-based therapeutic product candidates. The Company
believes that its proprietary HyGenomics Database of partial human gene
sequences is the largest such database in the world. The Company presently is
collaborating with Chiron Corporation ("Chiron") to develop therapeutics,
diagnostic molecules and vaccines relating to solid tumors, with The
Perkin-Elmer Corporation ("Perkin-Elmer") to commercialize HyChip products, and
with the pharmaceutical division of the Kirin Brewery Co. Ltd. ("Kirin") to
target, develop and commercialize novel genes involved in cell growth regulation
from specific cell lines supplied by Kirin. In July 1998, Hyseq announced its
first therapeutic product candidate, a rare gene that is a member of the
interleukin-1 family, IL-1Hy273. In addition, the Company has filed for patent
protection on over 150,000 new gene discoveries, including rarely expressed
genes and over 2,200 new gene discoveries related to solid tumor cancer as a
result of the collaboration between Hyseq and Chiron. Perkin-Elmer and Hyseq
also recently announced an "early access" program for the HyChip system. The
Company intends to establish additional collaborations, including collaborations
involving its gene discoveries.
The Company has incurred operating losses since inception and expects to incur
operating losses at least through 1999 and possibly longer. The Company may
never achieve significant revenues or profitable operations. There can be no
assurance that the Company will be able to obtain licensees of its HyGnostics
Module, customers for HyChip products, additional collaboration partners on
acceptable terms or that its collaborative arrangements or products will produce
revenues adequate to fund the Company's operations. The Company's operating
results may fluctuate significantly in the future as a result of a variety of
factors, including, but not limited to, changes in the demand for the Company's
products; the nature, size and timing of collaborative arrangements and products
provided to or developed with the Company's current and future collaboration
partners; changes in the research and development budgets of the Company's
current and future collaboration partners; capital expenditures and other costs
related to the expansion of the Company's operations; litigation and other costs
associated with defending its proprietary rights; changes in government
regulations; and the introduction of competitive technologies.
Results of Operations
Three and Nine Months Ended September 30, 1998 and 1997
Contract Revenues. Contract revenues were $1.4 million and $6.7 million for the
three and nine months ended September 30, 1998, compared to $2.4 million and
$3.8 million for the comparable periods of 1997. All revenues recorded during
the three and nine months ended September 30, 1998 were earned in conjunction
with the Company's research collaboration with Chiron. Approximately $235,000
and $641,000 of the revenue for the
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three and nine month periods ended September 30, 1997 were received as part of
the Company's NIST grant, with the balance primarily resulting from the Chiron
collaboration. The Company receives minimum research payments under its
collaboration agreement with Chiron, which are recognized as revenue based on
the performance level for each period. The recognition of revenues may vary from
quarter to quarter and may result in significant fluctuations in operating
results from year to year. There can be no assurance that the Company will be
able to maintain its existing collaborations or be able to obtain additional
collaboration partners. The failure to maintain its existing collaboration
partners or the inability to enter into additional collaborative arrangements
could have a material adverse effect on the Company's revenues and operating
results.
Operating Expenses. Total operating expenses, consisting of research and
development expenses and general and administrative expenses, were $7.6 million
and $21.1 million for the three and nine months ended September 30, 1998,
respectively, compared to $4.5 million and $9.4 million in the same periods of
1997. This increase in expenses during the three and nine months ended September
30, 1998 compared to the corresponding period in 1997, is due primarily to the
addition of scientific personnel, software and database development, the costs
associated with the Company's collaborations with Chiron and UCSF, including the
associated scale-up of the Company's gene sequencing capacity, intellectual
property protection, including expenses associated with the Company's ongoing
litigation with Affymetrix, as well as an increase in marketing and business
development expenses, the addition of management personnel and administrative
staff and expenses related to the new facility.
The research and development component of operating expenses increased to $5.0
million and $14.0 million during the three and nine months ended September 30,
1998 from $3.3 million and $6.4 million during the comparable periods of 1997.
Increases in 1998 as compared to 1997 resulted primarily from the addition of
scientific personnel, software and database development, expanded internal
sequencing production and expanded sequencing production in connection with the
collaboration with Chiron, expenses associated with the UCSF collaboration,
further development of the HyChip system, and costs associated with protecting
and increasing the Company's intellectual property. The Company expects to
continue to expand research and development efforts in support of its gene
sequencing, functional genomics and database development programs. Under the
terms of the Company's collaboration agreement with Perkin-Elmer, the Company is
also obligated to spend an aggregate of $5.0 million through May 1999 for the
development of the chip component of the HyChip system. The Company has incurred
direct and indirect costs of approximately $5.0 million for the development of
the chip component of the HyChip system from June 1997 through September 30,
1998. Of this amount, $504,000 was reimbursed to the Company under its NIST
grant during 1997.
The general and administrative component of operating expenses increased to $2.6
million and $7.1 million during the three and nine months ended September 30,
1998 compared to $1.2 million and $3.0 million during the same periods of 1997.
The increase between the periods was due in part to increased marketing and
business development expenses, as well as the addition of management personnel
and administrative staff to support the expansion of the Company's sequencing
production, expanded functional genomics department and data analysis
capabilities, and an increase in expenses related to the new expanded facility.
In addition, for the nine month period ended September 30, 1998, the Company's
total legal expenses increased by approximately $2.4 million (expenses related
to new patent prosecution have been allocated to research and development) as
compared to the same period in 1997, due primarily to its suits filed against
Affymetrix, Inc. in March and December 1997,and the Affymetrix suit filed
against the Company in August 1998, and costs associated with being a public
company. Legal expenses relating to the Company's litigation with Affymetrix,
Inc. may increase over the next several months as the case is expected to go to
trial in the second half of 1999.
As the Company expands its production and commercialization efforts, operating
expenses are expected to increase as a result of several factors including but
not limited to: (i) additional software development and enhancements and
increased work on gene discovery and functional genomics in connection with
development of potential therapeutic product candidates and diagnostic tests;
(ii) the continued expansion of its HyGenomics Database; (iii) expanded research
into new applications of its technologies; (iv) the expansion of marketing
capabilities with respect to its collaborations; and (v) new technology
development expenses relating to the HyChip Module and other products.
The magnitude of the increases in the Company's operating expenses will be
significantly affected by the Company's ability to secure new collaboration
partners. However, if the Company does not obtain additional
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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 $750,000 and $2.3 million
during the three months and nine months ended September 30, 1998 from $537,000
and $671,000 for the same periods in 1997. The increase in interest income
during the nine months ended September 30, 1998 as compared to the comparable
period of 1997 resulted from larger cash and investment balances held by the
Company primarily due to the realization of net proceeds from the Company's
$17.5 million private placements in May and August 1997, and the net proceeds of
the Company's initial public offering completed in August 1997.
Net Loss. Since inception, the Company has incurred operating losses, and as of
September 30, 1998, had an accumulated deficit of $26.8 million. The Company
incurred a net loss for the three months and nine months ended September 30,
1998 of $5.5 million and $12.1 million, respectively, compared to a net loss of
$1.6 million and $5.0 million in the comparable periods of 1997.
Liquidity and Capital Resources
As of September 30, 1998, the Company had $42.5 million in cash, cash
equivalents and short-term investments and $2.1 million in a restricted cash
account, compared to a total of $59.2 million at December 31, 1997 and $62.3
million at September 30, 1997. This decrease in cash and investments from the
corresponding quarter in 1997 resulted from expenses related to expanding
operations, ongoing costs associated with the patent litigation, increased
personnel, expansion of functional genomics capability and the substantial
completion of its HyChip(TM) production facility.
The Company has classified all of its investments as short-term as of September
30, 1998, as the Company's investments all mature in less than one year. Cash
and investments are held currently in investment-grade commercial paper, bank
certificates of deposit and other interest-bearing securities and are invested
in accordance with the Company's investment policy with primary objectives of
liquidity, safety of principal and diversity of investments. In addition, the
Company has $2.1 million on deposit with the Company's primary bank as security
for a letter of credit in conjunction with a facility lease. The letter of
credit and the cash collateralizing it will be reduced by $500,000 commencing in
2001 and will be further reduced by $500,000 each year thereafter provided the
Company is not in default under the lease. The cash on deposit at any time in
conjunction with this letter of credit is restricted and cannot be withdrawn.
The Company controls the investment of the cash and receives the interest earned
thereon.
Net cash used in operating activities increased from $3.8 million during the
nine months ended September 30, 1997 to $11.1 million in the comparable period
of 1998. The increase in net cash used in operating activities for the nine
months of 1998 was due primarily to increases in personnel to support gene
sequencing, database development programs, functional genomics and corporate
development and marketing, general corporate matters, litigation and legal
expenses associated with defending and expanding its proprietary rights.
The Company's investing activities, other than the purchase and sales of
short-term investments, have consisted of capital expenditures, which totaled
$4.2 million for the nine months ended September 30, 1998 as compared to $2.1
million for the comparable period of 1997. The capital expenditures increase in
the first nine months of 1998 is primarily due to the addition of capital
equipment necessary for the Company's expanded sequencing production and
software development activities, as well as expenditures related to the build
out of the HyChip production facility and expansion of bioinformatics and lab
space at the Company's new facility.
Net cash provided by financing activities decreased to $0.7 million for the nine
months ended September 30, 1998 as compared to net cash of $61.5 million for the
comparable period of 1997. Net cash provided by financing activities for the
nine months ended September 30, 1998 reflects primarily payments received on
notes held by shareholders and on issuance of common stock related to the
exercise of options and warrants. Net cash provided by financing activities of
$61.5 million during the first half of 1997 reflects primarily the $17.5 million
in net proceeds from the private placement of Series B Preferred Stock and
Common Stock with Chiron and Perkin-Elmer, and the net proceeds of the Company's
initial public offering completed in August 1997.
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The Company believes that existing capital resources and anticipated revenue
from existing collaborative partners will be sufficient to support the Company's
operations into the second half of the year 2000. The Company's estimate of the
time period for which cash funds will be adequate to fund its operations is a
forward-looking estimate subject to risks and uncertainty, and actual results
may differ materially. The Company's future capital requirements and the
adequacy of its available funds will depend on many factors, including, but not
limited to, scientific progress in its research and development programs and the
magnitude of financial commitments involved in such arrangements. There can be
no assurance that the Company will be able to establish additional
collaborations or that such collaborations will produce revenues, which together
with the Company's cash, cash equivalents and short-term investments, will be
adequate to fund the Company's operations. The Company's cash requirements
depend on numerous factors, including the ability of the Company to attract
collaboration partners; the Company's research and development activities;
competing technological and market developments; the costs of filing,
prosecuting, defending and enforcing patent claims and other intellectual
property rights including the costs associated with the ongoing patent
litigation with Affymetrix. There can be no assurance that additional funding,
if necessary, will be available on favorable terms, if at all.
Year 2000 Compliance
The Year 2000 problem or "Y2K" issue is the result of computer programs being
written using two digits rather than four to define the applicable year. Any of
the Company's or its vendors' or collaborators' computer programs or hardware
that have date-sensitive software or embedded chips may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in system
failures or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process data or engage in certain
business activities.
Based on a recent assessment, the Company believes that its bioinformatics
software and internal IT systems are Year 2000 compliant. The Company has
developed most of its bioinformatics in-house during the last three years, and
has been aware of the Y2K issue. As a result, the Company's proprietary software
is Year 2000 compliant. The Company is currently assessing the status of its
software and hardware, including embedded chips, used in its production line.
Affected systems may include certain older robotic technologies. The Company
expects to have this analysis completed by the end of 1998 and to complete
remediation of any affected systems by the end of the third quarter of 1999.
Hyseq is currently assessing its non-IT systems with respect to Year 2000
compliance.
Due to the recent upgrade of the Company's accounting systems and software, and
based on representations of the manufacturer, the Company believes that its
accounting systems are Year 2000 compliant.
The Company is in the process of sending letters to its vendors, collaborators
and other third parties regarding their Year 2000 compliance. To date, the
Company has identified areas that are supplied by third party vendors that are
not in compliance with respect to the Year 2000 issue. The Company is evaluating
the costs to upgrade and/or replace these systems and expects to have these
systems Year 2000 complaint by the third quarter of 1999. However, the Company
does not believe the failure to upgrade or replace these systems would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Given the information known at this time about the Company's systems, coupled
with the Company's ongoing efforts to upgrade and maintain 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
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condition and results of operations. However, disruptions in the economy
generally resulting form Year 2000 issues could materially adversely affect the
Company. The amount of potential liability and lost revenue cannot be reasonably
estimated at this time.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company currently does not invest excess funds in derivative financial
instruments or other market rate sensitive instruments for any purpose.
12
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PART II
HYSEQ, INC.
(A NEVADA CORPORATION)
ITEM 1. LEGAL PROCEEDINGS.
On March 3, 1997, the Company brought suit against Affymetrix in the U.S.
District Court for the Northern District of California, San Jose Division,
alleging infringement by Affymetrix of the Company's U.S. Patents Nos. 5,202,231
and 5,525,464 (Hyseq, Inc. v. Affymetrix, Inc., Case No. C 97-20188 RMW ENE,
U.S. District Court) ("Hyseq I"). On May 5, 1997, the Company filed an Amended
Complaint. The suit alleges that Affymetrix willfully infringed, and continues
to infringe, upon these patents covering SBH technology. Through the lawsuit,
the Company seeks both to enjoin Affymetrix from infringing upon the patents
covering SBH technology and an award of monetary damages for Affymetrix's past
infringement. On May 19, 1997, Affymetrix filed an Answer and Affirmative
Defenses to the First Amended Complaint and also filed a counterclaim against
the Company. The counterclaim seeks a declaratory judgment of invalidity and
non-infringement with respect to these patents covering SBH technology. On June
9, 1997, the Company filed a reply to the counterclaim in which it denied the
allegation of invalidity and non-infringement. While the Company believes it has
made valid claims and has a meritorious defense to the counterclaim, this
litigation is at an early stage and there can be no assurance that the Company
will prevail in the claim. On August 1, 1997, an initial case management
conference was held by the Court and a pre-trial schedule was entered by the
Court. The claims construction hearing is scheduled to be held on November 17th
and 18th, 1998 and a further case management conference is scheduled for January
15, 1999. The Company and Affymetrix are currently engaged in pretrial discovery
during which documents are being exchanged and depositions are being taken.
On December 9, 1997, the Company filed a second lawsuit against Affymetrix
which alleges infringement by Affymetrix of the Company's patent No. 5,695,940
(Hyseq, Inc. v. Affymetrix, Inc., Case No. C-97-4469 THE) ("Hyseq II"). Like the
Company's first action against Affymetrix, this action was filed in the U.S.
District Court for the Northern District of California, San Jose Division.
Affymetrix was served with a summons and complaint in the Company's new case on
December 9, 1997. After the March 28, 1997 case management conference, the Court
issued a case management order under which, like the June 9, 1997 case
management order entered in Hyseq I, the parties will engage in pretrial
discovery. The Company may incur substantial costs and expend substantial
personnel time in asserting the Company's patent rights against Affymetrix or
others and there can be no assurance that the Company will be successful in
asserting its patent rights. Failure to successfully enforce its patent rights
or the loss of these patent rights covering SBH technology also could remove a
legal obstacle to competitors in designing platforms with similar competitive
advantages.
On August 18, 1998, Affymetrix filed suit against the Company alleging
that the Company infringed two of Affymetrix's U.S. patents, No. 5,795,716 and
5,744,305 (Case C-98-013192 FMS). This action was filed in the U.S. District
Court for the Northern District of California, San Jose Division. Affymetrix
filed an amended complaint on September 1, 1998 alleging infringement of another
U.S. Patent, No. 5,800,992. The Company believes that the suit is without merit
and intends to vigorously defend the action. However, the litigation is at a
very early stage and it is impossible to predict the ultimate outcome of this
matter.
The Company is not a party to any other litigation that is expected to
have a material effect on the Company or its business.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
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(d) On August 7, 1997, the Company's Registration Statement on Form
S-1 (File No. 333-209091) was declared effective by the Securities and Exchange
Commission (the "Commission") and the Company's Registration Statement on Form
S-1 (File No. 333-13417) filed pursuant to Rule 462(b) of the Securities Act of
1933, as amended, was automatically effective upon filing (collectively, the
"IPO Registration Statements"). The IPO Registration Statements registered a
total of 3,450,000 shares of Common Stock, including the underwriters'
over-allotment which was exercised in full, all of which were issued and sold by
the Company (the "Offering"). All of the shares covered by the Registration
Statements were sold upon termination of the Offering in September 1997 to an
underwriting syndicate managed by Lehman Brothers Inc. The shares sold by the
Company were sold at an aggregate price to public of $48,300,000, netting
$44,919,000 to the Company after underwriters' discount of $3,381,000. Since the
effective date of the IPO Registration Statements, the Company has incurred
approximately $949,000 in expenses in addition to the underwriters' discount
described above in connection with the registration, offering, issuance and sale
of the shares in the 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 Company estimates that it has used a portion of the
net proceeds of the offerings as follows: (i) develop potential therapeutic
product candidates and diagnostic tests and products while continuing to expand
its HyGenomics Database, $12.5 million, (ii) develop its HyChip Module and
related products, $3.1 million, (iii) invest in capital equipment and lease
additional space to increase sequencing capacity, $2.2 million, (iv) working
capital and other general corporate purposes, $9.7 million, and (v) temporary
investments, $16.5 million.
The temporary investments specified above have consisted primarily of
investment-grade commercial paper, bank CDs and other interest-bearing
securities. None of the payments of proceeds mentioned above have been paid to
any officer, director or 10% or greater stockholder of the Company or and
affiliate of any such persons.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
In October 1998, the Company entered into a collaboration with Kirin
Brewery Co., Ltd. of Japan in which Hyseq will use its proprietary Gene
Discovery platform to target novel genes involved in cell growth regulation from
proprietary cell lines provided by Kirin. Kirin and Hyseq will co-develop and
co-market pharmaceutical products emanating from the collaboration.
Under the terms of the agreement, Kirin will pay Hyseq $3.0 million for the
initial phase of the collaboration. Kirin will pay additional amounts for
milestones related to the clinical development and commercialization of
pharmaceutical products from the collaboration in Kirin territories. The
two-year collaboration is exclusive to the discovery of genes from the
proprietary cell lines provided to Hyseq by Kirin. Hyseq will also receive
royalties from the sale of pharmaceutical products in Kirin territories. In
addition, Hyseq will retain rights to 100% of all North American profits from
sales of all pharmaceutical products resulting from the collaboration, subject
to milestone and royalty payments to Kirin. Kirin will have equivalent marketing
rights in Asia and Oceania to pharmaceutical products developed from the
collaboration. Kirin and Hyseq will share rights to all profits equally in
Europe and in the rest of the world.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 27.0 Financial Data Schedule
(b) Reports on Form 8-K
On July 31, 1998, the Company filed a Current Report on Form
8-K relating to the Company's Stockholders' Rights Plan. No
other Reports on Form 8-K were filed during the quarter ended
September 30, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HYSEQ, INC.
(Registrant)
By: /s/ Christopher R. Wolf
-------------------------------------
Christopher R. Wolf
Executive Vice President and
Chief Financial Officer
Date: November 9, 1998
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HYSEQ, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C> <C>
27.0 Financial Data Schedule 18
</TABLE>
17
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 10,558
<SECURITIES> 31,963
<RECEIVABLES> 2,526
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 46,257
<PP&E> 9,494
<DEPRECIATION> 2,562
<TOTAL-ASSETS> 55,971
<CURRENT-LIABILITIES> 3,503
<BONDS> 0
0
0
<COMMON> 82,341
<OTHER-SE> (30,526)
<TOTAL-LIABILITY-AND-EQUITY> 55,971
<SALES> 0
<TOTAL-REVENUES> 6,715
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 21,075
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 98
<INCOME-PRETAX> (12,074)
<INCOME-TAX> 0
<INCOME-CONTINUING> (12,074)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,074)
<EPS-PRIMARY> (0.94)<F1>
<EPS-DILUTED> (0.94)<F1>
<FN>
<F1>FOR THE PURPOSES OF THIS EXHIBIT, BOTH PRIMARY AND DILUTED MEAN BASIC AND
DILUTED.
</FN>
</TABLE>
