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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, 1998
OR
[ ] 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 5, 1999 was
$36,935,934, based on the last sale price as reported by The Nasdaq Stock
Market.
As of March 5, 1999, the Registrant had 12,981,352 shares of common stock
outstanding.
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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 1999 Annual Meeting of Stockholders
to be held on May 24, 1999.
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PART I
ITEM 1. BUSINESS
Many of the statements in this section, including those made in "Factors that
May Impact Results," below and "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations," as well as those discussed
elsewhere in this Annual Report on Form 10-K are forward looking. These may be
identified by words such as "believe," "expect," "anticipate," "should,"
"estimated" and "potential" among others. These forward looking statements are
based on our current expectations which could differ significantly from those
discussed in the forward-looking statements. The Private Securities Litigation
Reform Act of 1995 provides a "safe harbor" for such forward looking statements.
Forward-looking statements involve risks and uncertainty. Hyseq is a registered
trademark and service mark of the Company. HyChip, HyGenomics, HyProfile,
HyPace, HyGnostics and GET are trademarks and HyX and ProbeSure are service
marks of the Company.
GENERAL
Hyseq, Inc. (the "Company" or "Hyseq") is a biopharmaceutical company with a
growing pipeline of product candidates in its genomics-based HyProfile
portfolio. The primary product candidates are expressed proteins of novel rare
genes discovered through applications of the Company's proprietary HyX platform
in conjunction with work performed by its Functional Genomics, Protein
Purification and Bioinformatics Groups. The Company believes its high-throughput
HyX platform, which has an average DNA analysis rate of more than 1,000,000 DNA
samples per month per production line, gives it a statistical advantage in
finding novel rare genes. The Company believes such genes have greater potential
commercial value because they may regulate normal and disease physiology.
Hyseq's HyProfile portfolio includes many of these rare genes and their
expressed proteins.
The Company's core business is the development of biopharmaceutical product
candidates, using its novel rare genes as a foundation, with a primary emphasis
on cardiovascular ("CV"), hematopoietic ("HP") and immunological ("IM")
products. On a broader scale, the Company also has gene discovery efforts in CV,
central nervous system ("CNS") and infectious disease ("ID") product areas.
Management expects to select one to five product candidates which are
biologically active homologs of CV, HP or IM pharmaceutical products, with the
intent of identifying one of these for clinical trials initially and partnering
or licensing out the others. The Company has discovered a significant number of
novel rare genes, including a family of promising CV anti-clotting product
candidates announced in 1999 (CD39 Gene Family Members announced in February
1999) and promising HP and IM candidates announced in 1998 (IL-1Hy273 announced
in July 1998 and DFHy144 announced in December 1998).
The Company searches for rare genes in its proprietary HyGenomics database that
already contains more than 10,000,000 partial human gene sequences and is
believed to be the largest of its kind in the world. The Company believes that
the continued growth of its HyGenomics database and HyProfile portfolio has
generated a range of commercial opportunities for product development. The
Company has filed patent applications on over 175,000 partial and full length
gene sequences. In order to prioritize these novel rare genes as potential
product candidates, the Company ranks genes and their products for additional
assays and research in order of potential commercial importance. This ranking is
also utilized to determine which gene product candidates should be made
available for partnerships and licenses, while reserving important core business
candidates for the future.
The Company's overall goal is to have a growing revenue base from collaborations
incorporating gene products in various stages of development, while reserving
for itself candidates that offer the best opportunities for commercialization in
the CV, HP or IM areas. The Company has gene discovery collaborations with
Chiron Corporation ("Chiron") in solid tumor cancers and Kirin Brewery, Ltd.
("Kirin") in discovery of novel rare genes from certain Kirin cell lines. The
Company is developing its HyChip products for sale through a collaboration with
The PE Corporation (formerly known as The Perkin-Elmer Corporation, "PE").
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COMMERCIALIZATION STRATEGY
The Company's strategy for commercialization is to apply the expertise of its
Functional Genomics, Protein Purification and Bioinformatics Groups to
development of products from its large-scale gene discovery program and to
establish collaborations to facilitate development and commercialization
activities. Hyseq believes that this product 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's primary commercialization focus is on
generating revenues from gene discovery and gene-related product candidate
collaborations and sales of HyChip products.
Collaborations. The Company has a collaboration with Chiron in solid tumor
cancers. The collaboration requires Chiron to make payments of milestones,
research funding, royalties, up-front payments and license fees. The Company has
a collaboration with Kirin which requires the Company to apply its gene
discovery technology to Kirin cell lines in the discovery of novel genes from
those cell lines. The Company retained exclusive marketing rights in North
America and co-marketing rights in the rest of the world (excluding Asia and
Oceania) for discoveries from the Kirin collaboration. The Company is
collaborating with PE to sell its HyChip products.
Gene Products. As indicated in the overview, the Company's core business is the
development of biopharmaceuticals using its novel rare genes as a foundation,
with the primary emphasis on CV, HP and IM products. On a broader scale, the
Company also has a significant number of novel gene discoveries in CNS and ID
product areas. The Company isolates and patents genes coding for soluble factors
including those that are novel homologs of existing gene-based products in these
disease areas. The proteins expressed by its novel, soluble factor homologs in
these areas are put through functional genomics assays to determine whether they
are biologically active. The novel genes and their expressed proteins that are
shown to be biologically active are added to the Company's HyProfile database
for sale to third parties, for contribution to joint ventures or for further
development by the Company.
HyPace Cardiovascular and Polymorphism Databases. The Company is developing its
HyPace cardiovascular and polymorphism databases in conjunction with the
University of California San Francisco ("UCSF"). In constructing the HyPace
databases, the Company and UCSF are conducting population genetic and
pharmacogenomic research on genes that may have important roles in the
development of cardiovascular and related diseases. The Company believes the
HyPace database will be the largest polymorphism and pharmacogenomics project in
terms of amount of sequence data generated and will assist future users of the
databases in thoroughly understanding the roles of genes, gene mutations and
polymorphisms that may lead to diseases of the cardiovascular system.
HyChip Products. The Company is developing its HyChip products for sale through
a collaboration with PE. The HyChip system utilizes arrays of a complete set of
DNA probes in conjunction with a target-specific cocktail of labeled probes to
identify nucleotide differences between a reference and test sample. The Company
believes a major advantage of the HyChip system is that, because the chip
contains all possible probes, it can be used to sequence DNA from any source.
The HyChip system is therefore universal, meaning that one chip is applicable
for a wide variety of targets and there is no need to determine the sequence of
a target and then prepare a customized chip. The design employs a universal set
of probes which permit arrays to be developed at low density, combining the
benefits of low cost and ease of manufacturing with those of high accuracy and
reliability. Other existing technologies require previous knowledge of the
sequence and of the mutations to design the chip, and more than one chip may
have to be made for each targeted gene. In 1998, the collaboration announced its
Early Access Program through which a limited number of participants have access
to the preliminary version of the HyChip system for certain research and
diagnostic applications. Build-out of the Company's HyChip production facility
has been substantially completed. The Company is also using HyChip products for
internal purposes during the Early Access Program.
COMPANY TECHNOLOGY
The Company believes its technology 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 and flexibility to sequence
genes at multiple levels of completeness, make it appropriate for a large number
of therapeutic and diagnostic applications. The sequence information from DNA
samples enables the Company to track a gene's role and activity in disease
conditions and, hence, to evaluate the gene as a potential therapeutic
candidate.
The Company believes that its ability 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. These combined technologies enable the Company
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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.
The Company vigorously pursues patents to protect its intellectual property. As
of March 5, 1999, the Company had filed patent applications covering over
175,000 gene discoveries identified in Hyseq's gene discovery program. The
Company also has pending patent applications covering apparatus and other
methods for genomic research. The Company has six issued U.S. patents covering
apparatus, processes and methods.
GENOMICS AND DISEASE
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 1998, industry sales of human gene-based products,
including erythropoietin, a protein that stimulates the production of red blood
cells ("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.
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 process by which a gene directs the production of a protein is
known as gene expression. The human genome has been estimated to contain
approximately 150,000 genes which encode proteins.
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. 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, and (iii) 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. 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.
THE COMPANY'S RARE GENE AND GENE FAMILY DISCOVERY PROGRAM
Throughout 1997 and 1998, the Company focused the gene discovery applications of
its proprietary high-throughput technology on identifying rare genes and gene
pathways and monitoring gene expression associated with the normal processes of
development, differentiation and activation, as well as abnormal changes in gene
expression associated with diseases. With this focus, the Company has built its
HyGenomics database of partial human sequences which it believes to be the
world's largest with over 10,000,000 partial human DNA sequences. In the second
half of 1998, the Company's focus progressed to the creation of proprietary
product opportunities with the growth of its HyProfile database of genes and the
expressed proteins of those genes. Many of Company's rare gene products in the
HyProfile database are soluble factors and receptors, molecules that regulate
normal and disease state physiology. In addition to its announced IL-1, DDF and
CD39 Family Member proteins, Hyseq is identifying as potential therapeutic
targets molecules which include interleukins, chemokines, growth factors, stem
cell factors, interferons, integrins, hormones and their receptors. This process
involves the purification of proteins encoded by cDNAs of interest, the creation
of cell lines that express specific receptors of interest, and the testing of
the effects of purified proteins in cell and tissue-based in vitro assays.
During 1999, the Company expects to work with partners to study the effects of
the purified proteins in animals.
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CD39 Gene Family Members
In February 1999, the Company announced that potential anti-clotting products
may be produced by Hyseq proprietary genes in the family of human ectopyrases,
also known as the CD39 family. These potential anti-clotting products could help
prevent or treat blood vessel blockage that can cause cardiovascular disease
such as heart attacks and strokes. Hyseq consolidated its international position
in the CD39 family-derived products by acquiring certain exclusive rights from
Imperial Cancer Research Technology, Ltd., a wholly-owned subsidiary of
England's Imperial Cancer Research Fund. Hyseq identified naturally soluble
forms of ectoapyrases that in the past had only been genetically engineered. The
natural form may be superior to the engineered form because naturally soluble
forms of ectoapyrases are less likely to generate adverse reactions and may be
more effective.
IL-1Hy273
In July 1998, the Company announced a new interluekin-1 gene, IL-1Hy273, and the
protein it produces. The Company believes that the protein may have therapeutic
applications in the treatment of inflammatory disease and is focusing research
on the protein's potential ability to disrupt the process of inflammation in
such diseases as rheumatoid arthritis and inflammatory bowel disease. Chronic
inflammatory diseases represent a serious worldwide health issue. According to
industry sources, rheumatoid arthritis and inflammatory bowel disease affect
approximately four million people in the United States alone and may account for
over four billion dollars in annual drug sales within the next four years.
DDFHy144
In December 1998, the Company announced that a protein product from its
proprietary DDFHy144 gene may be effective in increasing the efficiency of
vaccines and in the development of new vaccines for diseases for which vaccines
are currently not available. The dendritic differentiation factor protein
("DDF") is a protein product from our HyProfile Portfolio. The Company is
exploring the licensing of DDF for use in vaccine development processes as well
as marketing it as a reagent to pharmaceutical and biotechnology companies with
vaccine programs. If the protein product proves commercially viable, such uses
should permit sales without the need for extensive regulatory review.
Genetic engineering technology has accelerated the growth of the vaccine market
in the past decade. In 1997, the reported global vaccine market was worth an
estimated $3.7 billion, with annual sales in the U.S. of over $1.1 billion. Yet
the new vaccines, while promising in their potential to address serious
conditions which have not previously been amenable to conventional vaccine
development, sometimes are not sufficiently immunogenic. This means that they
are unable to produce the strength of immune system response needed to generate
full protection. Dendritic cells produced using the DDF protein could serve to
stimulate the immune system, helping these vaccines to achieve their clinical
and commercial potential.
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 solid tumor cancer
therapeutics, diagnostic molecules and vaccines. 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
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 5, 1999, Hyseq has processed in excess of 5,000,000 samples
for Chiron and the collaboration has resulted in the filing of patent
applications covering in excess of 6,500 gene discoveries. Chiron recently
announced that it has identified 31 gene targets that are consistently different
in highly melastatic versus non-melatastic cancer. The Company believes this
announcement demonstrates its ability to produce results for its partners. Hyseq
retains rights in such gene discoveries outside the field of solid tumors.
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Kirin Brewery, Company Ltd. In October 1998, Hyseq and the pharmaceutical
division of Kirin Brewery Co, Ltd. of Japan entered into a collaboration in
which Hyseq uses its proprietary Gene Discovery platform to target novel genes
from specific cell lines provided by Kirin. Hyseq retained rights to 100% of
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. Kirin and Hyseq will
share rights to all profits equally in Europe and in the rest of the world.
The PE Corporation. In May 1997, the Company entered into an agreement with PE
to combine the Company's super chip technology with PE's life science system
capabilities to commercialize HyChip products (collectively, the "HyChip
System"). Pursuant to the terms of the agreement, the Company was obligated to
commit $5.0 million to further development of the Company's "chip" component of
the HyChip System, which commitment was satisfied in 1998 and included $504,000
reimbursed to the Company under a prior NIST grant. PE is also obligated to
commit certain funds for development of the overall system. 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 PE. HyChip products are being distributed
in the Early Access Program through PE's Biosystems Division. In June 1997, PE
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. PE
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 up to 20,000 genetically diverse individuals. The Company believes
an important component of the project is that many of these samples are
accompanied by 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.
DEVELOPING AND PROCESSING PRODUCT OPPORTUNITIES
The Company's program begins with the preparation of cDNA libraries from normal
and abnormal human tissues. A library is comprised of cDNA derived from samples
of mRNA expressed in a particular tissue. The Company's libraries reflect the
relative abundance of the various mRNAs expressed in each tissue. The Company
isolates and purifies individual cDNA fragments from each library for sequence
analysis to identify the structure and possible function of genes. The Company
sequences a portion of each cDNA, which the Company believes is often sufficient
to identify the expressed gene and represents the best method for rapid gene
discovery. The Company uses such information to analyze changes in gene
expression associated with development, differentiation and disease processes
primarily in CV, HP and IM diseases. The novel rare genes that come out of this
process are then studied for possible product opportunities.
The Company's research and product development activities have been organized
groups, including the following:
Gene Discovery Group. The Gene Discovery Group is responsible for preparing
biological samples and cDNA libraries, extracting and amplifying DNA, performing
sequencing reactions using the Company's HyX Platform, managing production
information and monitoring sequencing quality. The Company maintains an average
DNA analysis rate of over 1,000,000 DNA samples per month. The group has
developed technologies that streamline the Company's efforts to fully sequence
genes of interest in a high-throughput fashion. Based on results, the Company
believes its proprietary HyGenomics database is rich in genes with no
similarities to previously characterized genes and, more importantly many of
them are rarely expressed. These novel rare genes may have potential commercial
value because they encode for homologs of known genes of commercial value as
well as yet undescribed biological activities.
Bioinformatics. The Bioinformatics Group is responsible for the processing,
storage, analysis, and retrieval of biological information at Hyseq. Members of
the Group include computer scientists, biologists, mathematicians, and
statisticians who use the latest computational tools and information
technologies. Bioinformatics refers to the use of computers to process, analyze,
store and
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retrieve biological information. The Company believes it has one of the largest
sets of human gene sequences, and also uses its computer system to access
publicly available gene sequences. The Company's high capacity computer system
has been designed for ease of use by research scientists, who readily access the
system through desktop computers. The Bioinformatics Group develops systems for
high-volume data capture and analysis to support the Company's research and
collaborative efforts. All transactions occur on a Hyseq's secure research
network featuring hundreds of processors and over one terabyte of online NFS
data. The Bioinformatics Group applies advanced sequence data analysis
techniques to identify candidate genes for biological screening and drug
development. Daily, the gene discovery analysis pipeline processes over 1 GB of
image data representing over 10,000,000 hybridization events. With the
calculation of over 2 x 10(13) pairwise comparisons to date, HyGenomics database
is the world's largest collection of gene clusters, comprising more than
10,000,000 partial sequences. The Bioinformatics Group develops detailed
information characterizations for ESTs generated from samples in the gene
cluster database for use by the Functional Genomics Group.
Other efforts include polymorphism analyses and disease association studies for
Hyseq's pharmacogenomic projects; and software development and support for the
Hyseq - PE HyChip Early Access program. The division supports collaborative
relationships with the delivery of software, databases, training and support.
The Company believes that its proprietary Bioinformatics system is an important
asset for the identification and creation of gene-based product opportunities.
Functional Genomics and Protein Purification. The Company's Functional Genomics
and Protein Purification Group seeks to identify and evaluate genes that may be
useful for the creation of therapeutic protein drugs, small molecule drugs, gene
therapy, antisense treatments and diagnostic products. The Group identifies and
evaluates genes, which encode proteins that in turn may be useful as
biopharmaceutical products and determines the activities of purified therapeutic
protein candidates on cells in tissue cultures. When comparative analysis
indicates that a gene encodes a potential therapeutic protein, this group
isolates the corresponding full-length cDNA, determines its pattern of tissue
expression and its entire coding sequence. Hyseq's goal is to develop
high-throughput methods to link these potentially valuable genes to important
disease states, thereby creating therapeutic and diagnostic tools for the
medical community. The Functional Genomics Group tests for in vitro and in vivo
activity of therapeutic protein candidates and is also responsible for safety
studies. The division is responsible for preclinical animal testing of the
Company's therapeutic protein product candidates and employs a number of
standard assays for determining biological function. The Company intends to
utilize contract research organizations to conduct toxicology, pathology and
clinical trials on the Company's lead therapeutic protein product candidates.
The Group also provides proteins in a form suitable for in vitro and in vivo
testing. The Protein Purification Group has available bacterial, insect and
mammalian expression systems that express proteins. The Company generally
expects to provide highly purified proteins to collaborators for further
analysis once activity is determined.
HYSEQ TECHNOLOGY
The Company believes that its technology represents a significant advance in
analyses such as gene identification, expression level determination, gene
interaction studies, polymorphism screening and diagnostic testing. These
analyses generate information for the HyGenomics database and the HyProfile
portfolio, which the Company intends to utilize independently and with
collaboration partners to develop therapeutic products and diagnostics tests.
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 Company 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.
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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 Company 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
Company's technology can identify a copy of mRNA that appears only once per cell
in such a tissue sample.
Greater Flexibility
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 its technology, which allows researchers to obtain the
appropriate level of functional information from motifs, gene expression
studies, polymorphism studies and complete sequences, is expected to accelerate
the characterization of function. Unlike prevailing technologies, the Company's
technology 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.
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. Additionally, the Company's HyGnostics module and
HyChip system can accurately sequence mutations in the form of insertions or
deletions of bases.
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
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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.
HyGenomics Database. The Company compiles the DNA sequence information it
generates 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 believes that its proprietary
HyGenomics database of more than 10,000,000 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 HyGnostics module is designed to sequence numerous 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 HyGnostics module 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.
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 system internally for research
applications and is developing HyChip products for commercial applications with
PE. It is estimated that 5.8 million individuals worldwide were infected with
HIV in 1997 bringing the worldwide total of people living with HIV to 30
million. Approximately 30,986 individuals in the United States were diagnosed
with AIDS in 1997. 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 system, 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.
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 technology 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 technology 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
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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. In addition, certain of the Company's collaboration
partners could, in the future, become competitors. Competition in this field is
expected to intensify.
In the area of chip products, the Company competes primarily with Affymetrix,
Inc. ("Affymetrix"). See "--Litigation," regarding the Company's litigation
against Affymetrix. Additionally, although the Company is collaborating with PE
to develop HyChip products for commercial applications, PE 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
the chip arena will depend primarily upon its ability to demonstrate that the
HyChip system can provide higher levels of accuracy and a lower cost than other
prevailing technologies. Additionally, although the Company believes that the
ability of the HyChip system 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.
PATENTS AND PROPRIETARY TECHNOLOGY
Patent Rights Relating to Technology
Hyseq holds six United States patents with claims covering the methods and
applications for SBH, apparatus and processes. 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 files for patent protection on commercially relevant genes and their
products and partial gene sequences. Through March 5, 1999, the Company has
filed for patent protection on more than 175,000 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. Despite the recent position of the United States Patent and Trademark
Office (the "Patent Office") that partial sequences are patentable, 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 Company believes that SBH technology enables complete sequencing of genes
more rapidly and cost effectively than other existing technologies. The Company
also believes that its technology facilitates correlation between gene sequences
and gene functions. 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 "Factors That May Impact
Results -- 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 applied the
proceeds of a three-year, $2.0 million NIST grant to development of the super
chip technology. The Company's HyChip system, which is being developed for
commercial applications with PE, 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 primarily through collaborations with third parties who would be
responsible for obtaining regulatory approval or clearance. 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
is not presently pursuing, but may 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 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
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Improvement Amendments ("CLIA") as high-complexity laboratories. The Company may
market some diagnostic products, including 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.
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 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 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.
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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 5, 1999, the Company had 195 full-time equivalent employees,
including 175 scientists. Forty-three 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
- - Unproved Ability To Commercialize Gene-Based Products.
The Company and its collaboration partners have not developed any
commercial products using the genes it has discovered to date. Before any
therapeutic products are available to the public, further research, development
and testing will need to be done. Moreover, the Company or its collaboration
partners will need to obtain regulatory approval before any products may be
released. The Company has spent and expects to continue to spend significant
amounts of time and money in determining the function of genes; the first step
in developing commercial products. There are no guarantees that the Company with
or without its collaboration partners will ever develop a commercially viable
product from its gene discoveries.
Product development is risky because of many factors including (1)
the possibility that a product is toxic, defective or unreliable; (2) the
product candidate may fail to gain regulatory clearance; (3) the product
candidate may be hard to manufacture on a large scale or uneconomical to market;
(4) competitors may develop a superior product; or (5) other people's or
companies' copyrights and/or patents may preclude the Company from marketing a
product.
If the Company does not develop a commercially viable product based
on the genes it has discovered, then the Company would suffer a material adverse
effect on its business, financial condition and operating results.
- - Dependence Upon Collaborative Arrangements.
The Company plans to develop products based on its discovered genes
primarily through collaborative arrangements with collaboration partners. The
Company teams up with the other companies to take advantage of their expertise.
The collaboration partners are responsible for obtaining regulatory approvals
from applicable government agencies and for the eventual marketing of the
product both domestically and internationally. There is no guaranty that the
Company will keep its current collaboration partners or that the Company can
forge new relationships with new partners on terms favorable to the Company. The
Company depends upon the partners performing their responsibilities
successfully. In addition, there is no guaranty that the efforts of the Company
and its collaboration partners will produce commercially viable products even if
the Company and its collaboration partners spend considerable time and money. In
addition, there is no guaranty that collaboration partners will remain
collaboration partners or will not become partners with the Company's
competitors. The Company currently must spend a considerable amount of time and
money to establish new collaborations. Thus, if the Company loses one of its
partners, it would cause a materially adverse effect on the Company's business,
financial condition and operating results.
- - Uncertainties Related to Certain Technological Approaches.
The Company currently is developing the HyChip system with its
collaboration partner, PE. The HyChip system presently is available only through
the Early Access Program. As the HyChip system undergoes further development,
the Company may find problems. The Company may not improve the products enough
so that they can successfully market the HyChip products. Further, the HyChip
products compete against other chip products and well-established technologies.
The Company cannot predict the outcome of these uncertainties.
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- - Limited History of Operations.
The Company began operations in the fourth quarter of 1994. Investors
do not have much historical financial information to base a decision on whether
or not to buy the Company's stock. For the years ended December 31, 1998, 1997
and 1996, the Company had net losses of $16.4 million, $6.5 million and $4.8
million respectively. As of December 31, 1998, the Company had an accumulated
deficit of $31.1 million. In addition, the Company expects losses at least
through 1999 because it needs to continue to invest substantial sums into
research and development. The Company's projects include (1) continued expansion
of its HyGenomics database and the addition of gene product candidates for the
HyProfile portfolio; and (2) increased marketing and development efforts for
product candidates, the HyChip system and diagnostic products. The Company may
never achieve significant revenues or show a profit.
- - Fluctuations in Operating Results.
The Company's operating results may rise or fall significantly as a
result of many factors, including:
- demand swings for the Company's technology;
- the nature, size and timing of the Company's collaborative
arrangements;
- changes in the research and development budgets of the Company's
collaboration partners;
- increased costs related to the Company's expansion;
- litigation costs;
- changes in government regulation;
- if competitors release successful products into the market; and
- a change in collaboration partners.
The Company has a long revenue cycle because the timing of
collaboration agreements cannot be controlled. The Company also has fixed costs
such as research and development and may not always be able to adjust
expenditures timely if revenues decrease. Thus, the Company may experience
fluctuations in its operating results near the end of the quarter and continue
to generate losses. 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 on Patents and Other Proprietary Information and the Risks of
Infringement.
The Company currently has patents and will continue to apply for
patents for its patentable discoveries. There is no guaranty that the government
will issue the Company additional patents or that a court will find that the
Company's current and future patents are valid and enforceable. Moreover, just
because the Company owns patents does not ensure that (1) patents will not be
challenged; (2) protection against competitors will be provided; or (3)
competitors cannot independently develop similar products or design around the
Company's patents.
The Company owns patents covering its SBH technology in the United
States but not internationally. Therefore, the Company currently is not able to
prevent others from practicing the SBH process disclosed in the patents outside
of the United States. Although the Company intends to defend its patents, there
can be no assurance that the Company will win a court case. The Company
currently has brought a suit against and is defending a countersuit and suit
against its competitor Affymetrix. The Company claims that Affymetrix has
infringed the Company's SBH patents and Affymetrix claims that the Company's
patents are invalid. If the Company loses this suit and loses its rights to SBH
technology, then competitors could design products with similar competitive
advantages. The Company could incur substantial costs and expend substantial
personnel time in defending its patents rights in court.
The patent positions of biotechnology companies 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 seeks patents on (1) completely sequenced genes, (2)
partially-sequenced genes, (3) proteins expressed by those genes and
modifications thereof and (4) processes, devices and other technology that
enhance its ability to develop gene products. To obtain a patent, the Company
must identify a function of the gene or the protein. To identify a gene function
requires
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significant research and development costs and time. Patents applications the
Company may apply for human therapeutics could require clinical data which adds
substantial costs. Finally, the Company cannot predict the timing of the grant
of a patent.
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 is no guaranty that (1) competitors will not independently
develop substantially equivalent proprietary information and techniques, (2)
competitors will not otherwise gain access to the Company's trade secrets or
disclose such technology, or (3) 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 guaranty that these required
licenses would be made available on terms acceptable to the Company or at all.
If the Company does not obtain these 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. Any of these
factors could have a material adverse effect on the Company's business,
financial condition and operating results.
- - Certain Litigation.
The Company brought suit against its competitor, Affymetrix, alleging
infringement of certain of the Company's patents. Affymetrix has filed a
countersuit and a suit of its own alleging that the Company infringed certain of
Affymetrix's patents. The Company has and will continue to incur substantial
costs and expend substantial personnel time in asserting the Company's patent
rights against Affymetrix and in its defense in the suit brought by Affymetrix.
There can be no assurance that the Company will be successful in asserting its
patent rights or in its defense against Affymetrix. 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 (1) acquire additional equipment and supplies,
(2) upgrade software and (3) 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. There is no guaranty that the Company will be able to attract and
retain such qualified personnel. 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 future as well as over time.
There can be no assurance that the Company will be able to attract and retain
such qualified personnel.
- - Need for Future Capital; Uncertainty of Additional Funding.
The Company believes that existing capital resources will be
sufficient to support the Company's operations through 2000. Additional funds
may be necessary sooner depending upon the ability of the Company (1) to develop
additional collaborative arrangements, (2) to meet its budgeted expenditures for
expansion of operations and (3) to market its HyChip products. 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 some of its proposed products, or
obtain funds through arrangements with collaboration partners that require the
16
<PAGE> 17
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 traded 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. The market price of the Common Stock may fluctuate
substantially because of a variety of factors, including (1) quarterly
fluctuations in results of operations, (2) adverse circumstances affecting the
introduction or market acceptance of new products offered by the Company, (3)
announcements by competitors, (4) developments in the Company's litigation
proceedings, (5) changes in earnings estimates by analysts, (6) changes in
accounting principles, (7) sales of Common Stock by existing holders, and (8)
loss of key personnel. 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.
- - No Assurance of FDA Regulatory Approval; Government Regulation.
The Company plans to collaborate on, manufacture and sell products
with its collaborative partners who will be responsible for obtaining regulatory
approval or clearance. The Company may 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. In addition, the Company must show that the manufacturing
facilities are in compliance with current Good Manufacturing Practice ("cGMP")
requirements. If sold for clinical diagnostics, the Company or the collaborator
will need to comply with cGMP with respect to its HyChip system once HyChip
products are available for commercial sale. The Company or its collaboration
partners also must demonstrate an application for a Biological License
Application, a Product License Application, or an Establishment License
Application for any biological products would be approved by the applicable
government agency. In order to market its HyChip products as diagnostic products
that 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
(1) slower than anticipated patient enrollment; (2) difficulty in finding a
sufficient number of patients fitting the appropriate trial profile; (3)
difficulty in the acquisition of sufficient supply of clinical trial materials;
or (4) 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.
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 guaranty 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,
- warning letters;
- fines;
- injunctions;
- civil penalties;
- recall or seizure of products;
- total or partial suspension of production;
17
<PAGE> 18
- refusal of the government to grant approvals, premarket
clearance or premarket approval; or
- withdrawal of approvals and criminal prosecution.
If marketed outside the United States, then 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.
- - Unproven Market for Genetic Testing.
Diagnostic testing may be one of the Company's future development
areas. 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 HyChip products, may be difficult to interpret
and may lead to misinformation or misdiagnosis. Even when a genetic test
identifies the existence of a mutation in a person, 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. 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.
- - Uncertainty of Third-Party Reimbursement.
The Company's ability to receive significant royalties from its
products may depend on its ability, and 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 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, all third-party payors.
Third-party payors may deny their insured reimbursement if they determine that a
prescribed device or diagnostic test (1) has not received appropriate clearances
from the FDA or other government regulators, (2) is not used in accordance with
cost-effective treatment methods as determined by the payor, (3) or is
experimental, unnecessary or inappropriate. If reimbursement is routinely denied
by these third-party payors, then the Company may not be able to market its
products efficiently. Third-party payors are increasingly challenging the prices
charged for medical products and services. There is also a risk that the Company
would have to offer its diagnostic products at low prices because of trends
towards managed health care in the United States through health maintenance
organizations ("HMOs"). Prices could be driven down by HMOs who 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. 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.
- - 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.
ITEM 2. PROPERTIES
The Company leases a 12,000 square foot facility at 670 Almanor Avenue,
Sunnyvale, California, which serves primarily as the Company's production
facility. The lease on this facility expires in November 1999 and requires base
payments on average of approximately $12,300 per month, subject to standard
pass-throughs and escalations. The Company has not determined whether it will
enter into a new lease for this facility.
18
<PAGE> 19
The Company also leases approximately 59,000 square feet of space at 675 Almanor
Avenue, Sunnyvale, California (across the street from 670 Almanor). The 675
Almanor facility houses the Company's Engineering, Bioinformatics, Finance,
Administrative, and Research and Development departments. In 1998, the Company
completed construction of its state-of-the-art HyChip product manufacturing
facility within the 675 Almanor space. Approximately 20,000 square feet remains
available 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 leased the
remaining space (approximately 30,000 square feet) in July 1998. This facility
lease requires base payments of approximately $89,000 per month, subject to
standard pass-throughs and escalations. 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.
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) ("Hyseq I"). On May 5, 1997, the Company filed an Amended
Complaint. 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"). On April 22, 1998 the two cases were consolidated.
The suit alleges that Affymetrix willfully infringed, and continues
to infringe, upon the Company's 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 to Hyseq I and also filed a
counterclaim against the Company. The counterclaim seeks a declaratory judgment
of invalidity and non-infringement with respect to the two patents in Hyseq I.
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 (Hyseq I), and on
March 28, 1998 (Hyseq II), an initial case management conference for each case
was held by the Court and a pre-trial schedule was entered by the Court. A
claims construction hearing occurred on November 17 and 18, 1998, but the court
has yet to render its decision on those issues. The Company and Affymetrix are
currently engaged in pretrial discovery during which documents are being
exchanged and depositions are being taken.
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 No. 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. Procedurally, Affymetrix has moved to disqualify counsel
for the Company, and a Magistrate Judge has recommended that present counsel be
prevented from future participation in this litigation. The Company objected to
the Magistrate's Judge recommendation. The matter is presently before the
District Court Judge.
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.
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, 1998.
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<PAGE> 20
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:
Fourth Quarter $ 5.88 $ 4.00
Third Quarter $11.88 $ 4.25
Second Quarter $15.25 $ 9.50
First Quarter $15.25 $ 7.88
FISCAL 1997:
Fourth Quarter $20.13 $ 7.88
Third Quarter
(from August 8, 1997) $21.63 $13.00
</TABLE>
As of March 5, 1999, there were approximately 220 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 year ended December 31, 1998, the Company issued options to purchase
a total of 9,500 shares of common stock to three members of the Board of
Directors and a member of the Scientific Advisory Board of the Company at prices
between $4.75 and $10.06 per share. No person acted as an underwriter with
respect to those transactions. In each of the foregoing instances, the Company
relied on Section 4(2) of the Securities Act of 1933, as amended (the
"Securities Act").
(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
that 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, $15.1 million, (ii) develop its HyChip system and related
products, $3.8 million, (iii) invest in capital equipment and lease additional
space to increase sequencing capacity, $2.6 million, (iv) working capital and
other general corporate purposes, $12.6 million, and (v) temporary investments,
$9.9 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 an
affiliate of any such persons.
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<PAGE> 21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
(In Thousands, Except Per Share
Amounts)
Contract revenues ...................... $ 9,590 $ 6,199 $ 426 $ 2,127 $ 50
Operating expenses:
Research and development ............. 19,207 9,430 3,736 1,811 851
General and administrative ........... 9,495 4,854 1,749 938 1,477
-------- -------- -------- -------- --------
Total operating expenses ........... 28,702 14,284 5,485 2,749 2,328
-------- -------- -------- -------- --------
Loss from operations ................... (19,112) (8,085) (5,059) (622) (2,278)
Interest income, net and other ......... 2,743 1,548 220 21 15
-------- -------- -------- -------- --------
Net loss ............................... $(16,369) $ (6,537) $ (4,839) $ (601) $ (2,263)
======== ======== ======== ======== ========
Basic and diluted net loss per share (1) $ (1.27) $ (0.86) $ (0.91) $ (0.08) $ (0.28)
======== ======== ======== ======== ========
Shares used in computing basic
and diluted net loss per share (1) ..... 12,839 7,589 5,344 7,343 8,023
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
(In Thousands)
Cash, cash equivalents, short-
term investments and
cash on deposit (2) ........ $ 48,541 $ 59,240 $ 6,707 $ 750 $ 1,196
Working capital .............. $ 42,345 $ 56,824 $ 5,955 $ 331 $ 430
Total assets ................. $ 57,914 $ 66,950 $ 9,366 $ 2,740 $ 2,455
Noncurrent portion of
capital lease and loan
obligations .................. $ 4,479 $ 613 $ 791 $ 32 --
Accumulated deficit .......... $(31,122) $(14,749) $ (8,212) $ (3,373) $ (2,772)
Total stockholders' equity ... $ 47,576 $ 62,937 $ 7,364 $ 1,977 $ 1,625
</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 since their
impact is anti-dilutive.
(2) The 1998 and 1997 balance includes $2.1 million of cash on deposit, which
is restricted and cannot be withdrawn. The cash on deposit has been made
in connection with a letter of credit. See Note 5 of Notes to the
Consolidated Financial Statements.
21
<PAGE> 22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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 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.
RESULTS OF OPERATIONS
Contract Revenues. Contract and other revenues increased to $9.6 million in 1998
from $6.2 million and $0.4 million for the years ended December 31, 1997 and
1996, respectively. Contract and other revenues earned during 1998 included $8.1
million received from Chiron and $1.5 million received from Kirin and recognized
as revenue in 1998. The Company receives research payments under its
collaboration agreement with Chiron, which are recognized as revenue based on
performance level for each period. The $1.5 million fee received from Kirin
covered costs related to work performed by the Company and for certain set-up
costs incurred by the Company prior to commencement of the research program.
Contract and other revenues earned during 1997 included $5.3 million received
from Chiron and $0.9 million received in conjunction with the Company's NIST
grant. The Company recognized revenues under its NIST grant as research was
performed. Funding under the NIST grant was completed at December 31, 1997. The
Company did not apply for any NIST grants or other government sponsored programs
in 1998. Although the Company may apply for grants in the future there can be no
assurance that any such grants will be received or that they will provide
significant funds. Contract revenues in 1996 were received in conjunction with
the Company's NIST grant. 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 $28.7
million, $14.3 million and $5.5 million for the years ended December 31, 1998,
1997 and 1996, respectively. The increase in expenses in 1998 compared to the
corresponding years in 1997 and 1996 is due primarily to the addition of
scientific personnel, software and database development, costs associated with
the Company's collaborations including the associated scale-up of the Company's
gene discovery capacity, increased depreciation and rental expenses associated
with expansion of the Company's facilities and legal expenses associated with
the Company's litigation with Affymetrix.
The research and development component of operating expenses increased to $19.2
million in 1998 from $9.4 million in 1997 and $3.7 million in 1996. Increases in
1998 as compared to 1997 resulted primarily from the addition of scientific and
bioinformatic personnel, which increased by approximately $5.2 million. The
remaining portion of the increase is due to increased sequencing production in
connection with gene discovery, expression of gene based product candidates and
the collaboration with Chiron, expenses associated with the UCSF collaboration,
and further development of the HyChip system, including related costs associated
with expansion of the Company's facilities. Increases in 1997 as compared to
1996 resulted primarily from expanded sequencing production, which 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 on-going costs related to intellectual property protection. The Company
expects to continue to expand research and development efforts in support of its
gene discovery and database development programs. Under the terms of the
Company's collaboration agreement with PE, the Company was 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, $0.5 million was reimbursed to the
Company under its NIST grant. As of December 31, 1998, the Company had satisfied
the $5.0 million obligation under its agreement with PE.
The general and administrative component of operating expenses increased to $9.5
million in 1998 from $4.9 million in 1997 and $1.7 million in 1996. Increases in
each period were due, in significant part, to the addition of management
personnel and
22
<PAGE> 23
administrative staff, which increased by approximately $1.1 million in 1998 and
$0.4 million in 1997, to support the continued expansion of the Company's
sequencing production and data analysis capabilities. In addition, in 1998, the
Company's total legal expenses increased by approximately $2.3 million due
primarily to costs associated with 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. Expenses related
to new patent prosecution have been allocated to research and development. 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: (i)
additional software development and enhancements and increased work on gene
discovery and functional genomics in connection with development of potential
therapeutic product candidates; (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 possible new
collaborations; and (v) new technology development expenses relating to the
HyChip system 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. 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 $2.7 million in 1998 from
$1.5 million in 1997 and $0.2 million in 1996. The increase in interest income
in 1998 as compared to 1997 resulted from larger cash and investment balances
held by the Company primarily due to the 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 in August 1997. This was partially offset by
interest expense of $176,000, $158,000 and $43,000, respectively, in 1998, 1997
and 1996 related to various capital financing of the Company. An $82,000
write-off of fixed assets pending disposal is also included in 1998.
Net Loss. Since inception, the Company has incurred operating losses, and as of
December 31, 1998 had an accumulated deficit of $31.1 million. The Company
incurred a net loss for the year ended December 31, 1998 of $16.4 million
compared to losses of $6.5 million and $4.8 million in 1997 and 1996,
respectively. As of December 31, 1998, the Company had a net operating loss
carryover for federal income tax purposes of approximately $28.6 million, which
will expire at various dates from 2008 through 2018, if not utilized.
Utilization of the net operating loss carryover may be subject to an annual
limitation due to "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, 1998, the Company had $48.5 million in cash and investments
which includes $46.4 million in cash, cash equivalents and short-term
investments and $2.1 million in a restricted cash account, compared to $59.2
million as of December 31, 1997 and $6.7 million as of December 31, 1996. The
decrease between 1998 and 1997 primarily resulted from an increase in the
Company's gene discovery capacity, completion of its HyChip production facility,
costs related to further HyChip development and commencement of production of
its HyChip universal sequencing chip product, costs associated with expanding
patent protection related to new gene discoveries and their expressed proteins,
as well as legal costs associated with the litigation with Affymetrix.
The Company has classified all of its investments as short-term as of December
31, 1998, as the Company's investments all mature in less than one year. Cash
and investments are currently held 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 $2.0 million letter of credit in conjunction with a facility lease.
Provided that no event of default under the lease has occurred, the letter of
credit and the cash collateralizing it will be reduced by $0.5 million
commencing in 2001 and will be further reduced by $0.5 million 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 receives the interest earned thereon.
Net cash used in operating activities increased to $11.7 million in 1998 from
$8.1 million in 1997 and $4.3 million in 1996. The increases in cash usage in
1998 was due primarily to increases in personnel to support gene discovery,
database development programs, functional genomics, corporate development and
marketing, general corporate matters, litigation expenses and costs related
23
<PAGE> 24
to the new facility. The increased cash usage in 1997 compared to 1996 was due
to expanding the Company's sequencing production, data analysis and database
development, legal costs associated with intellectual property protection and
the litigation with Affymetrix.
The Company's investing activities, other than purchases and sales of short-term
investments, have consisted primarily of capital expenditures, which totaled
$4.6 million for the year ended December 31, 1998 as compared to $3.1 million
for 1997 and $0.9 million for 1996. Capital expenditures increased in both 1998
and 1997 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 facilities.
Net cash provided by financing activities was $5.6 million for the year ended
December 31, 1998 compared to $61.6 million and $11.2 million for 1997 and 1996,
respectively. Net cash provided by financing activities in 1998 reflects funding
under a $5.0 million loan secured by certain equipment, as well as payments
received on notes held by shareholders and the issuance of common stock related
to the exercise of options and warrants. 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 PE. Net cash
provided by financing 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 $0.8 million loan secured by certain equipment.
The Company expects that existing capital resources and anticipated revenue from
existing collaborative partners will be sufficient to support the Company's
operations through 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 those programs,
the ability of the Company to establish new 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 revenues from existing collaboration partners, 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 Year 2000 compliance 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 recent assessment, the Company believes that substantially all of its
critical bioinformatics software and internal IT systems are Y2K compliant. The
Company has developed most of it bioinformatics software in-house during the
last three years, and has been aware of the Y2K issue. As a result, the Company
believes that its proprietary software is Y2K compliant. The Company is
currently assessing the status of its third party software and hardware,
including embedded chips, used in its production line. Affected systems may
include certain older robotic technologies.
Due to the recent upgrade of the Company's accounting and human resource systems
and software, and based on representations of the manufacturers, the Company
believes that its accounting and human resource systems are Y2K compliant.
The Company has sent letters to its vendors, collaborators and other third
parties regarding their Y2K compliance. To date, the Company has identified
areas that are supplied by third party vendors that may not be Y2K compliant
based on the representations of such vendors. The Company is independently
testing these systems and is also evaluating the cost to upgrade or replace
these systems if necessary. 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. The Company
expects to complete its assessment during the third quarter of 1999.
24
<PAGE> 25
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 "Y2K" issue or related costs
will have a material adverse effect on the Company's business, financial
condition and results of operations. The cost of any required modifications
likely to be found in this process is expected not to exceed $50,000. However,
disruptions in the economy generally resulting from Y2K issues could materially
adversely affect the Company. The amount of potential liability and loss of
revenue cannot be reasonably estimated at this time.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
Market Rate Risk
The Company's exposure to market rate risk for changes in interest rates relates
primarily to the Company's investment portfolio. The Company does not use
derivative financial instruments in its investment portfolio. The Company places
its investments with high quality issuers and, by policy, limits the amount of
credit exposure to any one issuee. The Company is averse to principal loss and
ensures the safety and preservation of its invested funds by limiting default,
market and reinvestment risk. The Company classifies its cash equivalents and
marketable securities as "fixed-rate" if the rate of return on such instruments
remains fixed over their term. These "fixed-rate" investments include U.S.
government securities, commercial paper, corporate bonds, certificates of
deposit, and all such investments held in the Company's portfolio as of December
31, 1998 mature in 1999. The Company classifies its cash equivalents and
marketable securities as "variable-rate" if the rate of return on such
investments varies based on the change in a predetermined index or set of
indices during their term. These "variable-rate" investments primarily include
money market accounts. The table below presents the amounts and related weighted
interest rates of the Company's investment portfolio as of December 31, 1998:
<TABLE>
<CAPTION>
AVERAGE INTEREST
(In thousands, except interest rates) RATE COST FAIR VALUE
---------------- --------- -----------
<S> <C> <C> <C>
Cash equivalents
Variable rate 4.82% 13,104 13,104
Fixed rate 5.34% 8,412 8,451
Marketable securities
Fixed rate 5.50% 24,805 24,880
</TABLE>
25
<PAGE> 26
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, 1998 and 1997, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1998. 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, 1998 and 1997, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Palo Alto, California
January 29, 1999
26
<PAGE> 27
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share information)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................... $ 21,555 $ 23,204
Short-term investments ....................................... 24,880 33,930
Accounts receivable .......................................... 651 2,186
Other current assets ......................................... 1,118 904
-------- --------
Total current assets ........................................... 48,204 60,224
Cash on deposit ................................................ 2,106 2,106
Equipment and leasehold improvements, net ...................... 6,902 3,947
Patents, licenses and other assets, net ........................ 702 673
-------- --------
Total assets ................................................... $ 57,914 $ 66,950
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................. $ 1,905 $ 1,571
Accrued professional fees .................................... 1,575 584
Other current liabilities .................................... 1,025 907
Current portion of lease and loan obligations ................ 1,354 338
-------- --------
Total current liabilities ...................................... 5,859 3,400
Noncurrent portion of lease and loan obligations ............... 4,479 613
-------- --------
Commitments and contingencies
Total liabilities .............................................. 10,338 4,013
Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized shares -- 8,000,000
Issued and outstanding -- none at December 31,
1998 and 1997 .......................................... -- --
Common stock, $0.001 par value:
Authorized shares -- 50,000,000
Issued and outstanding shares -- 12,930,589 and 12,733,965
at December 31, 1998 and 1997, respectively ............ 82,341 81,795
Notes receivable from stockholders ......................... (3,503) (3,658)
Deferred compensation ...................................... (126) (445)
Accumulated other comprehensive loss ....................... (14) (6)
Accumulated deficit ........................................ (31,122) (14,749)
-------- --------
Total stockholders' equity ..................................... 47,576 62,937
-------- --------
Total liabilities and stockholders' equity ..................... $ 57,914 $ 66,950
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
27
<PAGE> 28
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Contract revenues ........................................... $ 9,590 $ 6,199 $ 426
Operating expenses:
Research and development .................................. 19,207 9,430 3,736
General and administrative ................................ 9,495 4,854 1,749
-------- -------- --------
Total operating expenses .................................... 28,702 14,284 5,485
-------- -------- --------
Loss from operations ........................................ (19,112) (8,085) (5,059)
Interest income, net and other .............................. 2,743 1,548 220
-------- -------- --------
Net loss .................................................... $(16,369) $ (6,537) $ (4,839)
======== ======== ========
Basic and diluted net loss per share ........................ $ (1.27) $ (0.86) $ (0.91)
======== ======== ========
Shares used in computing basic and diluted net loss per share 12,839 7,589 5,344
======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
28
<PAGE> 29
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the
Years Ended December 31, 1996, 1997 and 1998
(In thousands)
<TABLE>
<CAPTION>
CONVERTIBLE NOTES
PREFERRED STOCK COMMON STOCK RECEIVABLE
---------------------- ---------------------- FROM DEFERRED
SHARES AMOUNT SHARES AMOUNT STOCKHOLDERS COMPENSATION
-------- -------- -------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
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 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 -- (695)
Amortization of deferred
compensation -- -- -- -- -- 250
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) $ (445)
======== ======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
LOSS DEFICIT EQUITY
------------- ----------- ------------
<S> <C> <C> <C>
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 -- (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 -- -- --
Amortization of deferred
compensation -- -- 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 $ (6) $(14,749) $ 62,937
======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
29
<PAGE> 30
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the
Years Ended December 31, 1996, 1997 and 1998
(In thousands)
(Continued)
<TABLE>
<CAPTION>
CONVERTIBLE NOTES ACCUMULATED
PREFERRED STOCK COMMON STOCK RECEIVABLE OTHER
---------------- ------------------- FROM DEFERRED COMPREHENSIVE ACCUMULATED
SHARES AMOUNT SHARES AMOUNT STOCKHOLDERS COMPENSATION LOSS DEFICIT
------ ------ -------- -------- ------------ ------------ ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1997 -- $ -- 12,734 $ 81,795 $ (3,658) $ (445) $ (6) $(14,749)
Cash payment of note
receivable from stockholders -- -- -- 155 -- -- --
Issuance of common
stock upon exercise
of stock option grants -- -- 24 46 -- -- -- --
Issuance of common stock
upon exercise of warrants -- -- 173 500 -- -- -- --
Amortization of deferred
compensation -- -- -- -- -- 319 -- --
Net unrealized loss on
short-term investments -- -- -- -- -- -- (8) --
Cost to re-purchase
common stock for ESPP -- -- -- -- -- -- -- (4)
Net loss -- -- -- -- -- -- -- (16,369)
--- ----- -------- -------- -------- -------- -------- --------
Balances at December 31, 1998 -- $ -- 12,931 $ 82,341 $ (3,503) $ (126) $ (14) $(31,122)
=== ===== ======== ======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
-----------
<S> <C>
Balances at December 31, 1997 $ 62,937
Cash payment of note
receivable from stockholders 155
Issuance of common
stock upon exercise
of stock option grants 46
Issuance of common stock
upon exercise of warrants 500
Amortization of deferred
compensation 319
Net unrealized loss on
short-term investments (8)
Cost to re-purchase
common stock for ESPP (4)
Net loss (16,369)
--------
Balances at December 31, 1998 $ 47,576
========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
30
<PAGE> 31
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(16,369) $ (6,537) $ (4,839)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 1,626 823 341
Amortization of patents and licenses 65 103 103
Amortization of deferred compensation 319 250 --
Shares of common stock issued for services and equipment -- 116 --
Unrealized loss on short-term investments (8) (6) --
Changes in assets and liabilities:
Accounts receivable 1,535 (2,039) (10)
Other current assets (214) (592) (136)
Cash on deposit and other assets (94) (2,320) (24)
Accounts payable 334 999 352
Accrued professional fees 991 495 (315)
Other current liabilities 118 622 209
-------- -------- --------
Net cash used in operating activities (11,697) (8,086) (4,319)
-------- -------- --------
Cash flows from investing activities:
Expenditures for property and equipment (4,581) (3,131) (943)
Purchases of short-term investments (44,511) (38,930) --
Maturities of short-term investments 53,561 5,000 --
-------- -------- --------
Net cash provided by (used in) investing activities 4,469 (37,061) (943)
-------- -------- --------
Cash flows from financing activities:
Payments of stockholders' notes receivable 155 249 --
Net cash proceeds from issuance of:
Preferred stock -- 10,000 9,860
Common stock 546 51,502 371
Cash used to repurchase common stock (4) (2) (5)
Cash proceeds from sale leaseback and financing loan 5,324 181 1,119
Principal payments on capital lease and loan obligations (442) (286) (126)
-------- -------- --------
Net cash provided by financing activities 5,579 61,644 11,219
-------- -------- --------
Net (decrease) increase in cash and cash equivalents (1,649) 16,497 5,957
Cash and cash equivalents at beginning of period 23,204 6,707 750
-------- -------- --------
Cash and cash equivalents at end of period $ 21,555 $ 23,204 $ 6,707
======== ======== ========
Supplemental disclosure of cash flows information
Cash paid for interest $ 176 $ 158 $ 43
======== ======== ========
Supplemental schedule of non-cash financing activities
Cashless exercise of stock options $ 74 $ -- $ --
======== ======== ========
Cashless exercise of warrant $ -- $ 1,133 $ --
======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
31
<PAGE> 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
[1] Organization and Summary of Significant Accounting Policies
Organization and Basis of Presentation
Hyseq, Inc. (the "Company" or "Hyseq") 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.
Hyseq is a biopharmaceutical company with a pipeline of product candidates in
its genomics-based HyProfile portfolio.
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 shares of common stock, options, warrants and price per share
amounts have been retroactively restated to reflect a 1.92-for-1 stock split
which was effective 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 short-term instruments.
These investments typically bear minimal risk. This minimization of risk is
consistent with the Company's policy to maintain high liquidity and ensure
safety of principal. As of December 31, 1998, 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. All available-for-sale securities held as of
December 31, 1998 mature in 1999. The following is a summary of
available-for-sale securities as of December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
-------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Money market funds $ 4,082 $ -- $ -- $ 4,082
Commercial paper 12,735 -- (1) 12,734
Certificates of deposit 11,506 2 -- 11,508
Corporate bonds 9,104 -- (15) 9,089
Cash 9,022 -- -- 9,022
-------- -------- -------- --------
$ 46,449 $ 2 $ (16) $ 46,435
======== ======== ======== ========
Above amounts are included in
the balance sheet as follows:
Cash and cash equivalents $ 21,556 $ -- $ (1) $ 21,555
Short-term investments 24,893 2 (15) 24,880
-------- -------- -------- --------
Total: $ 46,449 $ 2 $ (16) $ 46,435
======== ======== ======== ========
</TABLE>
The estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation methodologies.
32
<PAGE> 33
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 generally recognized over the related funding periods for each
contract as the reimbursable services are performed. The Company received
research payments under its collaboration with Chiron, which are recognized as
revenue based on performance level for each period. Nonrefundable signing fees,
under which no future obligation to perform exists, 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,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Source:
NIST Grant -- 14% 100%
Collaboration Partner A 84% 85% --
Collaboration Partner B 16% -- --
</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 and 1996. In 1997
and 1998, research and development costs also included costs related to the
Company's collaborations. Contract and grant related costs of $10,696,000,
$4,747,000 and $588,000 were recorded in the years ending December 31, 1998,
1997 and 1996, respectively.
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 since their impact is anti-dilutive.
Pro forma basic and diluted net loss per share for the year-ended
December 31, 1997 and 1996 of $0.62 and $0.56, respectively, 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. Assumed conversion of preferred
stock in 1997 and 1996 results in inclusion of an additional 2,990,000 and
3,225,000 shares, respectively, in computing the pro forma basic and diluted net
loss per share. During 1997, all issued and outstanding preferred stock
converted to common stock.
Had the Company been in a net income position, shares used in
calculating diluted earnings per share for 1998, 1997, and 1996 would have
included the effect of an additional 728,000, 963,000, and 243,000 shares,
respectively, related to outstanding options and warrants (as determined using
the treasury method).
33
<PAGE> 34
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 unrealized gains
or losses on the Company's available-for-sale securities, which prior to
adoption were included in accumulated deficit, to be included in other
comprehensive income or loss. Prior year statements have been reclassified to
conform to the requirements of SFAS 130.
Effective January 1, 1998, the Company adopted SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 131 superseded FASB Statement No. 14, "Financial Reporting for
Segments of a Business Enterprise". SFAS 131 establishes standards for the way
that public business enterprises disclose certain information about reportable
operating segments in the Company's financial reports. SFAS 131 also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. The Company operates as one reportable segment and has
determined that the specific additional information and disclosure requirements
under SFAS 131 are not material to the Company for the periods ended December
31, 1998.
In March 1998, the AICPA issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed For or Obtained For
Internal Use" (the "SOP"). The Company plans to adopt the SOP on January 1,
1999. The SOP will require the capitalization of certain costs incurred after
the date of adoption in connection with developing or obtaining software for
internal use. The Company currently expenses such costs as incurred. The
adoption of the new SOP is not expected to have a material impact on the
Company's consolidated results of operations, financial position or cash flows.
In June 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"), which is required
to be adopted in fiscal years beginning after June 15, 1999. Because the Company
does not use derivatives, management does not anticipate that the adoption of
SFAS 133 will have a significant effect on the Company's consolidated results of
operations or financial position.
[2] Equipment and Leasehold Improvements
Equipment and leasehold improvements consist of the following (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997
------- -------
<S> <C> <C>
Machinery, equipment, and furniture $ 7,839 $ 5,117
Leasehold improvements 2,015 156
------- -------
Subtotal 9,854 5,273
Less accumulated depreciation (2,952) (1,326)
------- -------
Equipment and leasehold improvements, net $ 6,902 $ 3,947
======= =======
</TABLE>
Depreciation expense amounted to $1,626,000, $823,000 and $341,000
for the years ended December 31, 1998, 1997 and 1996, respectively. Equipment
and leasehold improvements at December 31, 1998 and 1997 include items under
capitalized leases in the amount of $722,000 and $482,000, respectively.
Accumulated amortization related to these leased assets is included in
depreciation expense in the amounts of $331,000 and $243,000 for the years ended
December 31, 1998 and 1997, respectively.
[3] Patents, Licenses and Other Assets
Patents
Patents consist primarily of costs and expenses incurred in
connection with obtaining certain patents and filing of related patent
applications. Amortization, which amounted to $27,633 for the years ended
December 31, 1998 and 1997 and $42,735 in the year ended December 31, 1996, is
recorded on a straight-line basis over the patents' estimated useful lives,
which approximate 17 years.
34
<PAGE> 35
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 $37,500 for the year ended December 31, 1998 and $75,000 for each of the two
years in the period ended December 31, 1997. As of December 31, 1998, the
license has been fully amortized. In 1998, the Company elected not to purchase
the remaining 10 robots specified in the agreement and the Company forfeited its
exclusive right to the robotic equipment through the remaining term of the
license which expired in June 1998. The Company believes the early forfeiture of
this exclusive right had no material effect on its business.
Patent License Agreement
In 1994, the Company entered into a patent agreement with an
affiliate of the University of Chicago for an exclusive license to use certain
SBH proprietary technology developed by the Company's Chief Scientific Officer
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
(which converted to common stock in connection with the Company's initial public
offering) and must pay minimum royalties of $25,000 per annum beginning in 1997
and increasing to $100,000 per annum over the term of the license. The
obligation to pay royalties terminates at expiration of the related patent. 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 Obligations
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 and a 48 month term.
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. The
outstanding principal balance at December 31, 1998 was $587,000.
In December 1998, the Company entered into a $5,000,000 loan
agreement with a capital financing corporation with an imputed interest rate of
11.32% per annum and a 48 month term. The loan is secured by certain equipment
owned by the Company. The outstanding balance at December 31, 1998 was
$4,918,000.
Future minimum loan payments under the loan agreements are as follows
(in thousands):
<TABLE>
<S> <C>
Years ending December 31:
1999 $ 1,854
2000 1,929
2001 1,597
2002 1,430
-------
Total loan payments 6,810
Less amount representing interest (1,305)
-------
Present value of future loan payments 5,505
Less current portion (1,278)
-------
Noncurrent portion $ 4,227
=======
</TABLE>
[5] Lease Commitments and Contingencies
Capital Lease Obligations
Future minimum lease payments under capital leases for certain
equipment purchases are as follows (in thousands):
<TABLE>
<S> <C>
Years ending December 31:
1999 $ 103
2000 76
2001 76
2002 76
2003 75
-----
Total minimum lease payments 406
Less amount representing interest (78)
-----
Present value of future lease payments 328
Less current portion (76)
-----
Noncurrent portion $ 252
=====
</TABLE>
35
<PAGE> 36
Operating Lease Commitments
The Company leases two facilities under operating lease agreements
that expire in 1999 and 2005. The Company may extend the lease that expires in
November 1999. The lease that expires in 2005 has a five-year renewal option,
which if exercised, would extend the lease to 2010. Rental expense was
approximately $1,098,000 in 1998, $241,000 in 1997, and $183,000 in 1996. The
leases provide for scheduled rent increases annually over the terms of the
leases. The rent is being recognized as expense on a straight-line basis and the
actual cash flow is included in the minimum lease payment schedule below.
Minimum non-cancelable future rental commitments under operating leases at
December 31, 1998 are as follows (in thousands):
<TABLE>
<S> <C>
1999 $ 1,261
2000 $ 1,141
2001 $ 1,177
2002 $ 1,212
2003 $ 1,248
Thereafter $ 1,921
--------
$ 7,960
========
</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. Provided that no event of
default under the lease has occurred, 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 receives 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 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. 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"). On April 22, 1998, the two cases were consolidated.
The suit alleges that Affymetrix willfully infringed, and continues
to infringe, upon the Company's 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 to Hyseq I and also filed a
counterclaim against the Company. The counterclaim seeks a declaratory judgment
of invalidity and non-infringement with respect to the two patents in Hyseq I.
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 (Hyseq I), and on
March 28, 1998 (Hyseq II), an initial case management conference for each case
was held by the Court and a pre-trial schedule was entered by the Court. A
claims construction hearing occurred on November 17 and 18, 1998, but the court
has yet to render its decision on those issues. The Company and Affymetrix are
currently engaged in pretrial discovery during which documents are being
exchanged and depositions are being taken.
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. Procedurally, Affymetrix has moved to disqualify counsel
for the Company, and a Magistrate Judge has recommended that present counsel be
36
<PAGE> 37
prevented from future participation in this litigation. The Company objected to
the Magistrate's Judge recommendation. The matter is presently before the
District Court Judge.
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 received $2,000,000 over a three-year period. Total revenue recognized
under the NIST agreement for the year ended December 31, 1997 and 1996 was
$873,901 and $426,099, respectively. The term of the grant expired at December
31, 1997.
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 solid tumor therapeutics, diagnostic
molecules and vaccines. 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, which if not met, could result in
the Company's breach of the collaboration. If the Company fails to generate data
at a specified level, Chiron may terminate the collaboration effective 30 days
after written notice is given to the Company provided that the Company has not
cured such breach by the end of the 30 days period. Chiron has the exclusive
right to commercialize solid tumor products resulting from the collaboration.
The Company will receive royalties on any such products. Concurrently with
execution of the collaboration agreement, 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 1998 and 1997 under the agreement with Chiron was
$8,090,000 and $5,250,000, respectively. The Company has no future performance
obligations related to the revenue recognized in 1998 and 1997 and no portions
of such revenues are refundable.
In May 1997, the Company entered into an agreement with PE to combine
the Company's HyChip technology and PE'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 PE 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, 1998, the Company satisfied the $5.0 million obligation under its
agreement with PE. The collaboration has an initial term of five years and will
be extended automatically thereafter unless the parties mutually agree to
terminate the collaboration. Pursuant to the agreement, the design, development
and manufacture of the HyChip "chip" is under the direction of the Company,
while design, development and manufacture of the system is under the direction
of PE. HyChip products will be distributed through PE's Applied Biosystems
Division. In June 1997, PE made an equity investment of $5.0 million in return
for shares of the Company's preferred stock, which subsequently converted into
common stock. PE 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 PE collaboration in 1998 and 1997. In 1998, the Company and PE
announced their Early Access Program through which a limited number of
participants have access to the preliminary version of the HyChip system for
certain research and diagnostic applications.
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 makes quarterly payments of $136,000 in connection with
the agreement for direct and indirect expenses incurred in clinical sample
collection and for research conducted. The Company has the exclusive rights from
UCSF to commercialize the proprietary databases derived from this collaboration.
In October 1998, the Company entered into a collaboration with Kirin
in which the Company is using its proprietary Gene Discovery platform to target
novel genes from specific cell lines provided by Kirin. Kirin and the Company
will co-develop and co-
37
<PAGE> 38
market pharmaceutical products emanating from the collaboration. Under the terms
of the agreement, Kirin will pay the Company $3.0 million for the initial phase
of the collaboration. The Company retained rights to 100% of 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. Kirin and the Company will
share rights to profits equally in Europe and in the rest of the world. Kirin
will pay additional amounts for milestones relating to the clinical development
and commercialization of pharmaceutical products from the collaboration in Kirin
territories. As of December 1998, Kirin had paid, and the Company had recognized
as revenue, a $1.5 million nonrefundable up-front fee, which is intended by the
parties to cover costs related to work performed by the Company and for certain
set-up costs incurred by the Company prior to commencement of the research
program.
[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.
In May and June 1997, Chiron and PE 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.
As of December 31, 1997 and 1998, there were no issued or outstanding
preferred shares.
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 PE 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. 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 the exercises, 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, 1998, 44,928 shares of common
stock were 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 compensation is being
amortized to expense over the vesting period of the options and over the
two-year repurchase period for the stock awards. The deferred compensation
expense was $319,000 and $250,000 in 1998 and 1997, respectively.
38
<PAGE> 39
\
Warrants
As of December 31, 1998, the Company has outstanding and exercisable
warrants to purchase 520,184 shares of common stock at exercise prices ranging
from $3.42 to $5.21 ($4.11 weighted average exercise price) per share to certain
investors, executive officers and the private placement agent for a 1996
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 initially reserved a total of 1,152,000 common shares for
issuance under the Plan. At the 1998 annual meeting, the stockholders approved a
proposal to increase the number of shares authorized for issuance under the Plan
to 2,152,000. Under the Plan, the board of directors may grant stock options to
employees and consultants. Options granted may be either incentive stock options
or nonstatutory stock options. Incentive stock options may be granted to
employees with exercise prices of no less than fair value and nonstatutory
options may be granted to employees 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, 1998, 1,185,308 shares were
available for future grant under the Plan.
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. In 1998, the Company granted
options to purchase a total of 9,500 shares of common stock to three directors
and a scientific advisory board member at prices between $4.75 and $10.06 per
share. The options vest over periods up to four years. As of December 31, 1998,
592,866 options were outstanding.
In 1997, the Company adopted the 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 51,840 shares
were issued and outstanding at December 31, 1998.
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 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 beginning in 1997 and the minimum value method prior to 1997 with
the following weighted-average assumptions:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
------- ------- ------
<S> <C> <C> <C>
Volatility .77 .53 --
Risk-free interest rate 4.8% 6.2% 6.2%
Dividend yield -- -- --
Expected life of option 2.3 years 2.4 years 3.0 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,
-------------------------------------
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
As adjusted net loss $(16,896) $ (7,388) $ (4,891)
As adjusted basic and diluted net loss per share $ (1.31) $ (0.97) $ (0.92)
</TABLE>
39
<PAGE> 40
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,
--------------------------------------------------------------------------
1998 1997 1996
--------------------- ----------------------- -----------------------
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 1,356,941 $3.88 1,153,553 $2.77 860,131 $1.66
Options granted 424,780 $5.87 292,816 $8.34 569,397 $4.17
Options exercised (39,138) $3.17 (20,888) $1.60 (67,200) $1.56
Options canceled (159,025) $7.91 (68,540) $4.87 (208,775) $2.37
--------- --------- ---------
Options outstanding at
end of the period 1,583,558 $4.03 1,356,941 $3.88 1,153,553 $2.77
========= ========= =========
</TABLE>
The following table summarized information about stock options outstanding at
December 31, 1998:
<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 - $ 1.82 583,366 5.52 $ 1.56 579,526 $ 1.57
$ 4.17 - $ 6.51 790,896 8.47 $ 4.53 318,773 $ 4.27
$ 7.38 - $10.13 197,416 8.60 $ 8.69 38,132 $ 8.33
$13.00 - $14.25 11,880 8.94 $13.90 5,130 $13.52
--------- ---------
Total 1,583,558 7.41 $ 4.03 941,561 $ 2.82
========= =========
</TABLE>
The weighted-average grant-date fair value of options granted
during the years ended December 31, 1998, 1997 and 1996 was $3.71, $8.37 and
$0.69, respectively.
Employee Stock Purchase Plan
In 1998, the Company's stockholders approved an Employee Stock
Purchase Plan (the "ESPP"), covering an aggregate of 50,000 shares of the
Company's common stock. Each quarter, an eligible employee may elect to purchase
shares of the Company's stock through payroll deductions at a price equal to the
lower of 85% of the fair value of the stock as of the first business day of the
quarter or the last business day. In 1998, 4,446 shares of the Company's stock
were sold under the ESPP at $4.04 per share.
[8] Income Taxes
As of December 31, 1998, the Company had federal and state net
operating loss carryforwards of approximately $28,600,000 and $1,600,000,
respectively. The Company also had federal and California research and
development tax credit carryforwards of approximately $1,200,000 and $1,000,000,
respectively. The federal net operating loss and credit carryforwards will
expire at various dates beginning in the year 2008 through 2018, if not
utilized. The state of California net operating losses will expire at various
dates beginning in 1999 through 2003, 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:
40
<PAGE> 41
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Deferred tax assets
Net operating loss carryforwards $ 9,800,000 $ 4,700,000
Capitalized research and development 1,500,000 200,000
Other - net 2,500,000 400,000
------------ ------------
Total deferred tax assets 13,800,000 5,300,000
Valuation allowance (13,800,000) (5,300,000)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============
</TABLE>
The net valuation allowance increased by $8,500,000 and $2,400,000
for the fiscal years ended December 31, 1998 and 1997, respectively.
[9] Transactions with Related Parties
As of December 31, 1998, 1997 and 1996, the Company owed $100,237,
$152,113, and $44,026, 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 approximately $1,000,000 for each of the two
years ended December 31, 1998 and 1997. The Company incurred legal fees and
costs of $68,775 for the year ended December 31, 1996, to the other of these law
firms. The Company incurred no legal fees or costs with this second law firm in
1998 and 1997.
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 required payment of interest at 8.25% per
annum. As of December 31, 1998, the principal balance was paid in full.
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 1999 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 1999 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 1999 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 1999 Annual Meeting of Stockholders.
41
<PAGE> 42
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The Financial Statements and notes thereto included in Item 8 to
this Form 10-K Report are incorporated herein by reference.
(a)(2) The schedules have been omitted because they are not applicable or
are not required or the information required to be set forth therein is
included in the Financial Statements or notes thereto.
(a)(3) Exhibits.
The following documents are filed as part of this annual report on
Form 10-K. The Company will furnish a copy of any exhibit listed to requesting
stockholders upon payment of the Company's reasonable expenses in furnishing
those materials.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
3.1 Amended and Restated Articles of Incorporation of the Company,
as amended*
3.2(a) By-Laws of the Company*
3.2(b) First Amendment to the By-Laws
4.1 Specimen Common Stock certificate*
4.2 Form of Registration Rights Agreement*
4.3 Form of Warrant Agreement*
4.4 Rights Agreement between Hyseq, Inc. and U.S. Stock Transfer
dated June 5, 1998 **
10.1 Form of Indemnification Agreement between the Company and each
of its directors and officers*
10.2 Stock Option Plan, as amended+***
10.4 Non-Employee Director Stock Option Plan, as amended+****
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*
10.11 Employee Stock Purchase Plan+*****
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 an Exhibit to and incorporated
herein by reference from the Company's Registration Statement filed on
Form S-1, File No. 333-29091.
** Previously filed with the Commission as an Exhibit to and incorporated
herein by reference from the Company's Form 8-K, filed on July 31,
1998.
*** Previously filed with the Commission as an Exhibit to and incorporated
herein by reference from the Company's Registration Statement on Form
S-8, File No. 333-41663.
**** Previously filed with the Commission as an Exhibit to and incorporated
herein by reference from the Company's Registration Statement on Form
S-8, File No. 333-53089.
***** Previously filed with the Commission as an Exhibit to and incorporated
herein by reference from the Company's Registration Statement on Form
S-8, File No. 333-53087.
+ Denotes compensation plan in which an executive officer or director
participates.
42
<PAGE> 43
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the last quarter of the year ended
December 31, 1998.
43
<PAGE> 44
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 18th day of March, 1999.
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 18th day of March, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ Robert D. Weist
- -------------------------- Chairman of the Board
Robert D. Weist
/s/ Lewis S. Gruber
- -------------------------- President and Chief Executive Officer, Director
Lewis S. Gruber (Principal Executive Officer)
/s/ Mark E. Gitter
- -------------------------- Chief Financial Officer
Mark E. Gitter (Principal Financial and Accounting
Officer)
/s/ Radoje T. Drmanac
- -------------------------- Director
Radoje T. Drmanac
/s/ Raymond F. Baddour
- -------------------------- Director
Raymond F. Baddour
/s/ Greta E. Marshall
- -------------------------- Director
Greta E. Marshall
/s/ Thomas N. McCarter III
- -------------------------- Director
Thomas N. McCarter III
- -------------------------- Director
Ernst Schweizer
- -------------------------- Director
Janice M. LeCocq
</TABLE>
44
<PAGE> 45
EXHIBIT INDEX
-------------
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
3.1 Amended and Restated Articles of Incorporation of the Company,
as amended*
3.2(a) By-Laws of the Company*
3.2(b) First Amendment to the By-Laws
4.1 Specimen Common Stock certificate*
4.2 Form of Registration Rights Agreement*
4.3 Form of Warrant Agreement*
4.4 Rights Agreement between Hyseq, Inc. and U.S. Stock Transfer
dated June 5, 1998 **
10.1 Form of Indemnification Agreement between the Company and each
of its directors and officers*
10.2 Stock Option Plan, as amended+***
10.4 Non-Employee Director Stock Option Plan, as amended+****
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*
10.11 Employee Stock Purchase Plan+*****
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 an Exhibit to and incorporated
herein by reference from the Company's Registration Statement filed on
Form S-1, File No. 333-29091.
** Previously filed with the Commission as an Exhibit to and incorporated
herein by reference from the Company's Form 8-K, filed on July 31,
1998.
*** Previously filed with the Commission as an Exhibit to and incorporated
herein by reference from the Company's Registration Statement on Form
S-8, File No. 333-41663.
**** Previously filed with the Commission as an Exhibit to and incorporated
herein by reference from the Company's Registration Statement on Form
S-8, File No. 333-53089.
***** Previously filed with the Commission as an Exhibit to and incorporated
herein by reference from the Company's Registration Statement on Form
S-8, File No. 333-53087.
+ Denotes compensation plan in which an executive officer or director
participates.
<PAGE> 1
226044
HYSEQ, INC.
FIRST AMENDMENT TO THE BY-LAWS
The by-laws of the corporation are hereby amended as follows:
Section 5 of Article II of the by-laws of the corporation be and hereby is
deleted in its entirety and the following is substituted therefore:
SECTION 5. NOMINATIONS AND STOCKHOLDER BUSINESS.
(a) Annual Meeting of Stockholders.
(i) Nominations of persons for election to the board of directors and
the proposal of business to be considered by the stockholders may be made at an
annual meeting of stockholders (A) pursuant to the corporation's notice of
meeting, (B) by or at the direction of the board of directors, or (C) by any
stockholder of the corporation who was a stockholder of record at the time of
giving notice provided for in this Section 5(a)(ii), who is entitled to vote at
the meeting and who complied with the notice procedures set forth in this
Section 5(a)(ii).
(ii) For nominations or other business to be properly brought before
an annual meeting by a stockholder pursuant to clause (C) of Paragraph 5 (a)(i)
of this Section 5(a), the stockholder must have given timely notice thereof in
writing to the secretary of the corporation. To be timely, a stockholder's
notice shall be delivered to the secretary at the principal executive offices of
the corporation not less than 60 days nor more than 90 days prior to the first
anniversary of the preceding year's annual meeting; provided, however, that in
the event that the date of the annual meeting is advanced by more than 30 days
or delayed by more than 60 days from such anniversary date, notice by the
stockholder to be timely must be so delivered not earlier than the 90th day
prior to such annual meeting and not later than the close of business on the
later of the 60th day prior to such annual meeting or the 10th day following the
day on which public announcement of the date of such meeting is first made. Such
stockholder's notice shall set forth (A) as to each person whom the stockholder
proposes to nominate for election or reelection as a director, all information
relating to such person that is required to be disclosed in solicitations of
proxies for election of directors, or is otherwise required, in each case
pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as
amended (the "Exchange Act") (including such person's written consent to being
named in the proxy statement as a nominee and to serving as a director if
elected), (B) as to any other business that the stockholder proposes to bring
before the meeting, a brief description of the business desired to be brought
before the meeting, the reasons for conducting such business at the meeting and
any material interest in such business of such stockholder and of the beneficial
owner, if any, on whose behalf the proposal is made, and (C) as to the
stockholder giving the notice and the beneficial owner, if any, on whose behalf
the nomination or proposal is made, (i) the name and address of such
stockholder, as they appear on the corporation's books, and of such beneficial
owner and (ii) the
<PAGE> 2
class and number of shares of the corporation which are owned beneficially and
of record by such stockholders and such beneficial owner.
(iii) Notwithstanding anything in the second sentence of Paragraph
5(a)(ii) of this Section 5 to the contrary, in the event that the number of
directors to be elected to the board of directors is increased and there is no
public announcement naming all of the nominees for director or specifying the
size of the increased board of directors made by the corporation at least 70
days prior to the first anniversary of the preceding year's annual meeting, a
stockholder's notice required by this Section 5(a) shall also be considered
timely, but only with respect to nominees for any new positions created by such
increase, if it shall be delivered to the secretary at the principal executive
offices of the corporation not later than the close of business on the 10th day
following the day on which such public announcement is first made by the
corporation.
(b) Special Meeting of Stockholders. Only such business shall be conducted
at a special meeting of stockholders as shall have been brought before the
meeting pursuant to the corporation's notice of meeting. Nominations of persons
for election to the board of directors may be made at a special meeting of
stockholders at which directors are to be elected (a) pursuant to the
corporation's notice of meeting, (b) by or at the direction of the board of
directors, or (c) provided, that the board of directors has determined that
directors shall be elected at such special meeting, by any stockholder of the
corporation who is a stockholder of record at the time of giving of notice
provided for in this Section 5(b), who is entitled to vote at the meeting and
who complied with the notice procedures set forth in this Section 5(b). In the
event the corporation calls a special meeting of stockholders for the purpose of
electing one or more persons (as the case may be) for election to such position
as specified in the corporation's notice of meeting, if the stockholder's notice
required by Paragraph 5(a)(i) of this Section 5 shall be delivered to the
secretary at the principal executive offices of the corporation not earlier than
the 90th day prior to such special meeting and not later than the close of
business on the later of the 60th day prior to such special meeting or the 10th
day following the day on which public announcement is first made of the date of
the special meeting and of the nominees proposed by the board of directors to be
elected at such meeting.
(c) General.
(i) Except as set forth in Section 9 of Article III, only such
persons who are nominated in accordance with the procedures set forth in this
Section 5 shall be eligible to serve as directors and only such business shall
be conducted at a meeting of stockholders as shall have been brought before the
meeting in accordance with the procedures set forth in this Section 5. The
presiding officer of the meeting shall have the power and duty to determine
whether a nomination or any business proposed to be brought before the meeting
was made in accordance with the procedures set forth in this Section 5 and, if
any proposed nomination or business is not in compliance with this Section 5, to
declare that such defective nomination or proposal be disregarded.
(ii) For purposes of this Section 5, "public announcement" shall mean
disclosure in a press release reported by the Dow Jones News Service, Associated
Press or
<PAGE> 3
comparable news service or in a document publicly filed by the corporation with
the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of
the Exchange Act.
(iii) Notwithstanding the foregoing provisions of this Section 5, a
stockholder shall also comply with all applicable requirements of state law and
of the Exchange Act and the rules and regulations thereunder with respect to the
matters set forth in this Section 5. Nothing in this Section 5 shall be deemed
to affect any rights of stockholders to request inclusion of proposals in the
corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act.
A new Section 13 of Article III of the by-laws of the corporation be and hereby
is added to read as follows:
SECTION 13. WAIVER OF NOTICE. Anything herein to the contrary
notwithstanding, with respect to any meeting of the board of directors, any
director who shall have waived in writing notice of the meeting, either before
or after such meeting, or who shall attend the meeting in person, shall be
deemed to have waived notice of such meeting unless he attends for the express
purpose of objecting, at the beginning of the meeting, to the transaction of any
business because the meeting is not lawfully called or convened.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8 Nos. 333-41663, as amended, 333-53089, and 333-53087) pertaining to
the Hyseq, Inc. 1995 Stock Option Plan, the Hyseq, Inc. Non-Employee Director
Stock Option Plan, and the Hyseq, Inc. Employee Stock Purchase Plan of Hyseq,
Inc. of our report dated January 29, 1999, with respect to the consolidated
financial statements of Hyseq, Inc. included in its Annual Report (Form 10-K)
for the year ended December 31, 1998.
ERNST & YOUNG LLP
Palo Alto, California
March 19, 1999
<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, 1998 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-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 21,555
<SECURITIES> 24,880
<RECEIVABLES> 651
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 48,204
<PP&E> 9,854
<DEPRECIATION> 2,952
<TOTAL-ASSETS> 57,914
<CURRENT-LIABILITIES> 5,859
<BONDS> 0
0
0
<COMMON> 82,341
<OTHER-SE> (34,765)
<TOTAL-LIABILITY-AND-EQUITY> 57,914
<SALES> 0
<TOTAL-REVENUES> 9,590
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 28,702
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,743
<INCOME-PRETAX> (16,369)
<INCOME-TAX> 0
<INCOME-CONTINUING> (16,369)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (16,369)
<EPS-PRIMARY> (1.27)<F1>
<EPS-DILUTED> (1.27)<F1>
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC AND DILUTED.
</FN>
</TABLE>
