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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 | |
OR | |
[ ] | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM ________________ TO _________________ |
Commission File Number 000-22873
HYSEQ, INC.
(Exact Name of Registrant as Specified in Its Charter)
NEVADA (State or Other Jurisdiction of Incorporation or Organization) | 36-3855489 (I.R.S. Employer Identification Number) |
670 ALMANOR AVENUE, SUNNYVALE, CA 94085
(Address of Principal Executive Offices, including Zip Code)
408-524-8100
(Registrant’s Telephone Number, including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
COMMON STOCK OUTSTANDING ON NOVEMBER 1, 2001: 19,108,213
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HYSEQ PHARMACEUTICALS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2001
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PAGE | |||||
Part I Financial Information | |||||
Item 1. Financial Statements (unaudited) | |||||
Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000 | 3 | ||||
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2001 and 2000 | 4 | ||||
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2000 | 5 | ||||
Notes to Condensed Consolidated Financial Statements | 6 | ||||
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | 7 | ||||
Item 3. Quantitative and Qualitative Disclosures about Market Risk | 24 | ||||
Part II Other Information | |||||
Item 1. Legal Proceedings | 25 | ||||
Item 2. Change in Securities and Use of Proceeds | 25 | ||||
Item 3. Defaults Upon Senior Securities | 25 | ||||
Item 4. Submission of Matters to a Vote of Security Holders | 25 | ||||
Item 5. Other Information | 25 | ||||
Item 6. Exhibits and Reports on Form 8-K | 26 | ||||
Signature | 27 |
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ITEM 1. FINANCIAL STATEMENTS
HYSEQ PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
SEPTEMBER 30, | DECEMBER 31, | ||||||||||||
2001 | 2000 | ||||||||||||
(unaudited) | |||||||||||||
ASSETS | |||||||||||||
Current Assets: | |||||||||||||
Cash | $ | 16,534 | $ | 2,699 | |||||||||
Accounts receivable | 22 | 22 | |||||||||||
Other current assets | 3,770 | 2,906 | |||||||||||
Total Current Assets | 20,326 | 5,627 | |||||||||||
Cash on deposit | 1,606 | 2,106 | |||||||||||
Equipment, leasehold improvements and capitalized software, net | 16,517 | 12,465 | |||||||||||
Patents, licenses and other assets, net | 1,374 | 1,090 | |||||||||||
Total Assets | $ | 39,823 | $ | 21,288 | |||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||||
Current Liabilities: | |||||||||||||
Accounts payable | $ | 2,900 | $ | 1,979 | |||||||||
Accrued professional fees | 842 | 833 | |||||||||||
Other current liabilities | 5,176 | 1,215 | |||||||||||
Deferred revenue | 754 | 1,798 | |||||||||||
Current portion of capital lease and loan obligations | 2,560 | 2,379 | |||||||||||
Total Current Liabilities | 12,232 | 8,204 | |||||||||||
Noncurrent portion of capital lease and loan obligations | 2,911 | 4,722 | |||||||||||
Total Liabilities | 15,143 | 12,926 | |||||||||||
Commitments and contingencies | — | — | |||||||||||
Stockholders’ Equity: | |||||||||||||
Preferred stock, par value $0.001; 8,000,000 shares authorized; none issued and outstanding as of September 30, 2001 and December 31, 2000 | — | — | |||||||||||
Common stock, par value $0.001; 100,000,000 shares authorized; 19,103,574 and 13,722,388 issued and outstanding as of September 30, 2001 and December 31, 2000, respectively | 19 | 14 | |||||||||||
Additional paid-in capital | 121,698 | 80,278 | |||||||||||
Deferred stock compensation | — | (8 | ) | ||||||||||
Accumulated deficit | (97,037 | ) | (71,922 | ) | |||||||||
Total stockholders’ equity | 24,680 | 8,362 | |||||||||||
Total liabilities and stockholders’ equity | $ | 39,823 | $ | 21,288 | |||||||||
See accompanying notes to condensed consolidated financial statements.
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HYSEQ PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED | NINE MONTHS ENDED | |||||||||||||||||
SEPTEMBER 30 | SEPTEMBER 30, | |||||||||||||||||
2001 | 2000 | 2001 | 2000 | |||||||||||||||
Contract revenues | $ | 5,872 | $ | 5,936 | $ | 17,522 | $ | 11,315 | ||||||||||
Operating expenses: | ||||||||||||||||||
Research and development | 11,350 | 7,910 | 31,532 | 20,122 | ||||||||||||||
General and administrative | 3,602 | 2,225 | 9,805 | 7,296 | ||||||||||||||
Total operating expenses | 14,952 | 10,135 | 41,337 | 27,418 | ||||||||||||||
Loss from operations | (9,080 | ) | (4,199 | ) | (23,815 | ) | (16,103 | ) | ||||||||||
Interest income and other income | 38 | 312 | 217 | 1,181 | ||||||||||||||
Interest expense | (141 | ) | (229 | ) | (692 | ) | (636 | ) | ||||||||||
Restructuring charges | (825 | ) | — | (825 | ) | — | ||||||||||||
Net loss | $ | (10,008 | ) | $ | (4,116 | ) | $ | (25,115 | ) | $ | (15,558 | ) | ||||||
Basic and diluted net loss per share | $ | (0.59 | ) | $ | (0.30 | ) | $ | (1.64 | ) | $ | (1.16 | ) | ||||||
Shares used in computing basic and diluted net loss per share | 16,911 | 13,616 | 15,351 | 13,369 | ||||||||||||||
See accompanying notes to condensed consolidated financial statements.
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HYSEQ PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
NINE MONTHS ENDED | ||||||||||
SEPTEMBER 30, | ||||||||||
2001 | 2000 | |||||||||
NET CASH USED IN OPERATING ACTIVITIES | $ | (18,956 | ) | $ | (12,634 | ) | ||||
Cash flow from investing activities: | ||||||||||
Purchases of property and equipment | (7,504 | ) | (6,400 | ) | ||||||
Maturities of short-term investments | — | 15,514 | ||||||||
Proceeds from sale of fixed assets | — | 9 | ||||||||
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES | (7,504 | ) | 9,123 | |||||||
Cash flow from financing activities: | ||||||||||
Proceeds from financing loan | — | 2,073 | ||||||||
Release of restricted cash deposits | 500 | 0 | ||||||||
Payment on capital lease and loan obligations | (1,630 | ) | (1,597 | ) | ||||||
Proceeds from issuance of common stock, net of issuance costs | 40,744 | — | ||||||||
Proceeds from issuance of common stock upon exercise of options/ESPP | 681 | 1,203 | ||||||||
NET CASH PROVIDED BY FINANCING ACTIVITIES | 40,295 | 1,679 | ||||||||
Net increase in cash and cash equivalents | 13,835 | (1,832 | ) | |||||||
Cash and cash equivalents at beginning of period | 2,699 | 13,675 | ||||||||
Cash and cash equivalents at end of period | $ | 16,534 | $ | 11,843 | ||||||
See accompanying notes to condensed consolidated financial statements.
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HYSEQ PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared by Hyseq, Inc., d/b/a Hyseq Pharmaceuticals, Inc. (including our direct and indirect subsidiaries, unless the context otherwise indicates, “Hyseq,” the “Company,” “we,” “us,” or “our”) in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The condensed consolidated balance sheet as of September 30, 2001, the statements of operations for the three and nine months ended September 30, 2001 and 2000, and the statements of cash flows for the nine months ended September 30, 2001 and 2000 are unaudited, but include all adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial position, operating results and cash flows for the periods presented. The condensed consolidated balance sheet as of December 31, 2000 is derived from the Company’s audited financial statements. The condensed consolidated financial statements include the accounts of the Company’s wholly-owned subsidiaries. The results of operations for the interim period shown herein are not necessarily indicative of operating results expected for the entire year.
2. Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the Company’s consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.
3. Per Share Data
In the third quarter of 2001, the Company completed a private stock placement, of which 614,298 shares of common stock were issued and sold to its Chairman and senior management, which the Company’s stockholders will be asked to ratify at the Company’s 2002 annual meeting of stockholders. These shares are excluded from weighted-average shares outstanding in the earnings per share calculation.
4. Comprehensive Loss
During the three months ended September 30, 2001 and 2000 the Company’s comprehensive loss amounted to approximately $10.0 million or ($.59) per share and $4.1 million or ($.30) per share, respectively. During the nine months ended September 30, 2001 and 2000, the Company’s comprehensive loss amounted to approximately $25.1 million or ($1.64) per share and $15.6 or ($1.16) per share million, respectively. Total comprehensive loss is equal to net loss for the three and nine months ended September 30, 2001. Total comprehensive loss for the three and nine months ended September 30, 2000 includes unrealized gains and losses on marketable securities.
5. Restructuring Charges
During the quarter ended September 30, 2001, we recorded a restructuring charge of $0.8 million for personnel and severance costs. The strategic restructuring included a reduction of approximately 50 employees from operation and administration. We expect savings in operating expenses attributable to this restructuring to be approximately $3.8 million on an annualized basis.
6. Private Investment in Public Equity
On August 30, 2001, the Company announced the completion of a private placement of approximately 3.04 million newly issued shares of common stock at $7.00 per share, together with warrants to purchase approximately 1.52 million shares of common stock, for aggregate gross proceeds of approximately $21.3 million in the offering. The warrants are exercisable at any time through and including August 28, 2006 at $10.50 per share, a 50 percent premium to the per unit purchase price on the closing date, which may be
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adjusted to $7.95 per share based on certain future issuances. After August 28, 2003, the warrants may only be exercised on a cashless exercise basis.
The securities were sold to accredited investors in a private placement pursuant to Section 4(2) under the Securities Act of 1933, as amended. Officers and directors of the Company who participated in the offering agreed, pursuant to discussions held with the NASD, not to vote or transfer their shares of common stock acquired as a result of the offering until such time as the offer and sale of such shares to them has been ratified by the Company’s stockholders.
7. Line of Credit
In July 2001, the Company received a commitment from its Chairman to provide a line of credit of up to $20.0 million in aggregate principal amount, evidenced by a promissory note and available for draw down through August 5, 2003. Amounts outstanding under the line of credit shall bear interest at prime plus 1% and are payable in 48 equal monthly installments beginning August 5, 2003. Amounts outstanding may be converted into shares of common stock of the Company upon mutual agreement at any time at a price per share based upon a 20-day trailing average ending on the second trading day prior to conversion or, if in connection with an equity financing, at the offering price. There are no amounts currently outstanding under the line of credit.
8. Subsequent Events
In October 2001, the Company announced the comprehensive settlement of all existing litigation with Affymetrix, Inc. The Company also announced its plan to reorganize into two distinct companies, the Company continuing its biopharmaceutical business as “Hyseq Pharmaceuticals, Inc.” and a new majority-owned subsidiary, Callida Genomics, Inc. (“Callida”), focusing on the development and commercialization of its sequencing-by-hybridization (“SBH”) technology. Incident to the settlement, Callida entered into a collaboration arrangement with Affymetrix, through Callida’s wholly-owned subsidiary, N-Mer, Inc. (“N-Mer”), for the development and commercialization of a high speed DNA sequencing chip. The Company, Callida, N-Mer and Affymetrix also entered into various cross-licensing arrangements, and Affymetrix agreed to become the exclusive array and system supplier to N-Mer and the exclusive sales agent, subject to customary performance obligations, for the distribution of any products developed by N-Mer. Affymetrix agreed to pay the Company a one-time license fee for a non-exclusive license of array-related patents in the field of non-universal probe arrays and to loan the Company $4 million, all for use to fund Callida and N-Mer. The loan, which will bear interest at the rate of 7.5% and mature five years after closing, will be prepayable by the Company at any time, exchangeable at the option of the Company for common stock of the Company and secured by the Company’s equity interest in Callida. Affymetrix will have an initial 10% equity ownership interest in Callida. Affymetrix and the Company agreed to each make additional investments in N-Mer, conditioned on N-Mer’s attainment of a specified technical milestone and the procurement of third-party financing. Callida agreed to grant Affymetrix an option to purchase a majority interest in N-Mer, which will be exercisable at any time within five years.
In October 2001, the Company also amended its existing collaboration agreement with The Applera Corporation through its Applied Biosystems Stock Group to facilitate the settlement with Affymetrix. Significant components of this amendment include the conversion of the prior exclusive marketing arrangement with Applied Biosystems into a non-exclusive arrangement and the conclusion of all further collaboration obligations.
In October 2001, the Company announced a major collaboration with Deltagen, Inc. to undertake research and development activities on approximately 200 novel secreted proteins. The Company will provide gene sequences encoding for the secreted proteins, and Deltagen will utilize its in vivo mammalian gene knockout technology to identify and validate potential commercially relevant biopharmaceutical drug targets. Deltagen and the Company will each have certain joint development and commercialization rights around potential biopharmaceutical drug targets discovered through the collaboration. Deltagen and the Company will share the collaboration’s costs.
ITEM 2. 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. Forward-looking statements may be identified by words including “anticipate,” “believe,” “intends,” “estimates,” “expect,” “should,” “may,” “potential” and similar expressions. Such statements are based on our 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 elsewhere including, without limitation, uncertainties relating to unanticipated difficulties and delays relating to gene identification, drug discovery and clinical development processes; changes in relationships with strategic partners and dependence
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upon strategic partners for the performance of critical activities under collaborative agreements; the impact of competitive products and technological changes; uncertainties relating to patent protection and regulatory approval; and uncertainties relating to the ability of Hyseq to obtain substantial additional funds required for progress in drug discovery and development. These and other factors are identified and described in more detail under “Additional Factors that May Affect Future Results” set forth below, and in our other periodic reports filed from time to time with the SEC.
COMPANY OVERVIEW
We are engaged in research and development of novel biopharmaceutical products from our collection of proprietary genes discovered using our high-throughput screening-by-hybridization platform. We believe our screening-by-hybridization platform, which is related to our proprietary sequencing-by-hybridization (SBH) technology, gives us a significant advantage in discovering novel, rarely-expressed genes. We believe we possess one of the most important proprietary databases of full-length human gene sequences. To date, our activities have focused primarily on full-length gene sequencing, patenting, bioinformatics and early stage research activities to prioritize potential therapeutic protein candidates. As of September 30, 2001, we had filed patent applications on approximately 10,000 full-length gene sequences. We are currently investigating the potential therapeutic applications of several proteins and/or antibodies to these proteins, including EGFL6, IL-1Hy1 and CD39L4. Meanwhile, we are expanding and accelerating our research activities to elucidate the role of other novel genes in our proprietary database. Our database includes genes, which encode chemokines, growth factors, stem cell factors, interferons, integrins, hormones, receptors and other potential protein therapeutics or drug targets.
During the third quarter, Hyseq announced new research and development collaboration with Kirin Brewery Co., Ltd. As part of the collaboration, Kirin will fund three years of collaborative research work at Hyseq and both companies will conduct research directed toward discovering proteins and antibodies for a variety of diseases, including hematopoietic and inflammatory diseases. Discoveries in the collaboration will be jointly owned by Kirin and Hyseq, and will be jointly developed and marketed with costs and efforts shared equally.
RESULTS OF OPERATIONS
Contract Revenues
Comparison of the Three and Nine Months Ended September 30, 2001 and 2000.
Contract revenues were $5.9 million and $17.5 million for the three and nine months ended September 30, 2001, respectively, compared to $5.9 million and $11.3 million for the same periods in 2000. The increase for the nine months period was primarily due to higher revenues earned from our collaboration with BASF Plant Sciences GmbH (BASF), under which we provide gene screening services to target potential agricultural products. BASF contract revenues were $5.6 million and $16.4 million for the three and nine months ended September 30, 2001, respectively, during which period we were performing at full contractual capacity, compared to $5.2 million and $7.8 million during the three and nine months ended September 30, 2000, respectively, when we were ramping up at the beginning of our collaboration. We expect to receive a $5.0 million payment from BASF each calendar quarter for the next 6 quarters, provided that we meet our obligations under the agreement. There are one and a half years remaining on the term of our collaboration with BASF.
Contract revenues under our agreement with Chiron Corporation (Chiron) were $0.3 million and $0.9 million for the three and nine months ended September 30, 2001, compared to $0.5 million and $3.0 million for the same periods in 2000. The decrease in revenue under our agreement with Chiron was primarily due to the substantial completion of our gene screening services for Chiron in the first half of 2000 and the end of the initial term of our three year collaboration in May 2000. In May 2000, Chiron elected to extend our agreement for an additional two years, pursuant to which Chiron pays us $1.0 million minimum annual research funding payments for each extension year, plus approximately $0.1 million cost of storing Chiron clones. Chiron has the right to extend the agreement for one additional period of two years beginning June 2002, pursuant to which Chiron will pay us $1.0 million minimum annual research funding payments for each extension year.
Our revenues typically vary from quarter to quarter and may result in significant fluctuations in our operating results from year to year. In the future, we may not be able to maintain existing collaborations, obtain additional collaboration partners or obtain revenue from other sources. The failure to maintain existing collaborations or the inability to enter into additional collaborative arrangements or obtain revenues from other sources could have a material adverse effect on our revenues and operating results.
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Operating Expenses
Comparison of the Three and Nine Months Ended September 30, 2001 and 2000.
Our total operating expenses, consisting of research and development expenses and general and administrative expenses, were $15.0 million and $41.3 million for the three and nine months ended September 30, 2001, respectively, compared to $10.1 million and $27.4 million for the same periods in 2000.
Our research and development expenses increased to $11.4 million and $31.5 million during the three and nine months ended September 30, 2001, respectively, from $7.9 million and $20.1 million during the same periods in 2000. Our increased research and development expenses reflect increased staffing and materials costs related to our biopharmaceutical research, and increased contractual gene screening efforts under our collaboration with BASF compared with last year. Due to the addition of newly leased laboratory and office space, rent expense increased by $2.1 million and by $4.0 million during the three and nine months ended September 30, 2001, respectively, compared to the same period last year. In addition, we made payments to contract manufacturers for protein production and cell assays of $.6 million and $1.5 million during the three and nine months ended September 30, 2001, respectively, compared to a negligible amount during the same periods in 2000.
Our general and administrative expenses increased to $3.6 million and $9.8 million during the three and nine months ended September 30, 2001, respectively, from $2.2 million and $7.3 million during the same periods in 2000. The increase in general and administrative expenses primarily reflected the addition of senior executives, with general and administrative salaries increasing by — $0.8 million and by $2.6 million for the three and nine months ended September 30, 2001, respectively, compared to — the same periods last year.
We expect operating expenses during the remainder of 2001 to increase as we continue to expand research and development of our biopharmaceutical product candidates. The magnitude of the increases in our operating expenses will be significantly affected by our ability to secure adequate sources of external financing or additional sources of revenue. If we do not obtain adequate financing or revenue in a timely manner, we may be required to delay or eliminate one or more of our research or development programs. Any such action could significantly harm our business and financial condition.
Interest Income and Expense
Comparison of the Three and Nine Months Ended September 30, 2001 and 2000.
Our net interest expense was $0.1 million and $0.5 million during the three and nine months ended September 30, 2001, respectively, compared with net interest income of $0.1 million and $0.5 million during the same periods in 2000. This decrease in interest income resulted from lower average cash and investment balances and lower interest rates.
Restructuring Costs
During the quarter ended September 30, 2001, we recorded a restructuring charge of $0.8 million for personnel and severance costs. The strategic restructuring included a reduction of approximately 50 employees from operation and administration. We expect savings in operating expenses attributable to this restructuring to be approximately $3.8 million on an annualized basis.
Net Loss
Since our inception, we have incurred operating losses, and as of September 30, 2001 we had an accumulated deficit of $97.0 million. The Company incurred a net loss for the three and nine months ended September 30, 2001 of $10.0 million and $25.1 million, respectively, compared to a net loss of $4.1 million and $15.6 million in the same periods of 2000. This increase in net loss resulted primarily from our expanded research and development of our potential biopharmaceutical product candidates. We expect to continue to incur significant operating losses, which may increase substantially as we further expand research and development of our potential biopharmaceutical product candidates and other operations.
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LIQUIDITY AND CAPITAL RESOURCES
Cash and Cash on Deposit
As of September 30, 2001, we had $16.5 million in cash. These amounts reflect a net increase of $13.8 million from the $2.7 million in cash and cash equivalents we had as of December 31, 2000.
In addition, we have $1.6 million in restricted cash on deposit as security for a $1.5 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 continue to be reduced by $0.5 million per year commencing in July 2002. The cash on deposit at any time in conjunction with this letter of credit is restricted and cannot be withdrawn. We control the investment of the cash and receive the interest earned thereon.
In July 2001, we received a commitment from our Chairman to provide a line of credit of up to $20.0 million. A line of credit agreement was executed on August 6, 2001, and makes the principal amount of $20.0 million, available for draw down through August 5, 2003. Amounts outstanding under the line of credit are evidenced by a promissory note which bears interest at a rate equal to one percent (1%) above the prime rate, and will be payable in 48 equal monthly installments beginning August 5, 2003. Amounts outstanding may be converted into shares of common stock of the Company upon mutual agreement at any time at a price per share based upon a 20-day trailing average ending on the second trading day prior to the conversion, or in connection with an equity offering of the Company’s stock at the offering price. There are no amounts currently outstanding under the line of credit.
On April 30, 2001, we leased an additional 138,698 square feet of space at 985 Almanor Avenue in Sunnyvale, California, adjacent to our current operating facilities. Lease payments over the ten-year term of the lease total approximately $54.1 million. Pursuant to the terms of the lease, we are required to provide a letter of credit in the amount of $4.0 million as additional security for the lease, which requirement terminates after 5 years if we have not been in monetary default under the lease.
We anticipate that existing capital resources, anticipated cash from existing collaborative partners and commitments will be sufficient to support our current biopharmaceutical research and development and other operations through the third quarter of 2002. However, we plan to seek additional funding prior to that time in order to finance the expansion of our biopharmaceutical research and the build out of our new leased facilities to support such research. If we do not obtain adequate financing or revenue in a timely manner, this could significantly harm our business, financial condition and results of operations, and may require us to delay, scale back or eliminate one or more of our research or development programs, discontinue the build out of our new leased facilities, or relinquish greater or all rights to products at an earlier stage of development or on less favorable terms than we would otherwise seek to obtain, which could materially adversely affect our business, financial condition and operating results.
Cash Used in Operating Activities
The amount of net cash used in operating activities was $19.0 million during the nine months ended September 30, 2001, increasing from $12.6 million used during the same period of 2000. The increase in cash used in operating activities was due primarily to higher research and development costs resulting from our biopharmaceutical development efforts. In addition, we experienced increased general and administrative costs due to the addition of senior executives, and decreased interest income resulting from lower average cash balances and lower interest rates.
Cash Provided by (Used in) Investing Activities
Our investing activities, other than purchases and sales of short-term investments, have consisted primarily of capital expenditures.
Net cash used in investing activities was $7.5 million during the nine months ended September 30, 2001, compared to $9.1 million net cash provided by investing activities during the same period of 2000, a net change of $16.6 million. The decrease was primarily due to no new net redemptions of short-term investments during the first nine months of 2001, compared to $15.5 million in net redemptions of short-term investments during the same period last year. Our leasehold improvement and equipment spending was $7.5 million for the nine months ended September 30, 2001, compared with $6.4 million for the same period of 2000. We expect net cash used in investing activities to continue to increase as we expand laboratory space and infrastructure for our biopharmaceutical development efforts.
Cash Provided/Used by Financing Activities
Net cash provided by financing activities for the nine months ended September 30, 2001 was $40.3 million compared to $1.7 million for the same period of 2000. The increase was primarily due to the draw down of the $20.0 million line of credit from the Chairman of our Board of Directors, and to the completion of a private placement from which the company received gross proceeds of approximately $21.3 million and paid related issuance cost of $0.5 million.
In the nine months ended September 30, 2001, principal payments of capital leases and loan obligations were $1.6 million, compared with $1.6 million for the same period last year. Proceeds from the issuance of common stock upon the exercise of stock options were $0.7 million, compared with $1.2 million for the same period of 2000.
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NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations”, which requires that all business combinations be accounted for under the purchase method of accounting. This statement is effective for all business combinations initiated after June 30, 2001. Implementation of SFAS No. 141 will not have a material effect on the Company’s results of operations or financial position.
In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” This statement applies to intangibles and goodwill acquired after June 30, 2001, as well as goodwill and intangibles previously acquired. Under this statement, goodwill, as well as other intangibles determined to have an infinite life, will no longer be amortized; however, these assets will be reviewed for impairment on a periodic basis. This statement becomes effective January 1, 2002. Implementation of SFAS No. 142 will not have a material effect on the Company’s results of operations or financial position.
In June 2001, the FASB issued SFAS No. 143, “ Accounting for Asset Retirement Obligations.” SFAS No. 143 requires liability recognition for obligations associated with the retirement of tangible long-lived asset and the associated asset retirement costs. The Company is required to adopt the provisions of SFAS No. 143 effective January 1, 2003, with earlier application encouraged. Implementation of SFAS 143 will not have a material effect on the Company’s results of operations or financial position.
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”, in that it removes goodwill from its impairment scope and allows for different approaches in cash flow estimation. However, SFAS No. 144 retains the fundamental provisions of SFAS No. 121 for (a) recognition and measurement of long-live assets to be held and used and (b) measurement of ling-lived assets to be disposed of. SFAS No. 144 also supersedes the business segment concept in APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” in that it permits presentation of a component of an entity, whether classified as held for sale or disposed of, as a discontinued operation. However, SFAS No.144 retains the requirement of APB Opinion No. 30 to report discontinued operations separately from continuing operations. The Company is required to adopt the provision of SFAS No. 144 effective January 1, 2002, with earlier application encouraged. Implementation of SFAS 144 will not have a material effect on the Company’s results of operations or financial position.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
We Must Be Able to Continue to Secure Additional Financing
Our business does not currently generate the cash needed to finance our operations. We will require substantial additional financial resources to conduct the time-consuming and costly research, preclinical development, clinical trials and regulatory approval and marketing activities necessary to commercialize our potential biopharmaceutical products. Also, in pursuing our goal of building a fully integrated biopharmaceutical company, we intend to expand our facilities and hire and train significant numbers of employees to staff these facilities, which will require substantial additional funds. We will need to secure additional financing within the next fiscal year in order to conduct our research and expand our facilities as we have planned. Unanticipated expenses, or unanticipated opportunities that require financial commitments, could give rise to requirements for additional financing sooner than we expect. However, financing may be unavailable when we need it or may not be available on acceptable terms. If we are unable to raise additional funds when we need them, we may be required to delay, scale back or eliminate expenditures for some of our development programs or our facilities expansion plans, or grant rights to third parties to develop and market product candidates that we would prefer to develop and market ourselves. If we were required to grant such rights, the ultimate value of these product candidates to us would be reduced.
We intend to seek additional funding through collaborations and public or private equity or debt financings. We have financed our operations since inception primarily through the sale of equity securities, and revenue from corporate collaborations. We have not generated royalty revenues from product sales, and do not expect to receive significant revenues from royalties in the foreseeable future, if ever. To execute our current operating plan, we will need to secure additional financing by at least the third quarter of 2002, however, we plan to seek additional funding prior to that time.
Additional financing, however, may not be available on acceptable terms, if at all. For approximately the past nine months, the capital markets have been volatile and uncertain. Given the current state of the markets for public and private offerings of securities, we may have difficulty raising the amount of funds, on reasonable terms, necessary to finance our current operating plan. If we cannot
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raise the financing that our current operating plan requires, we may have to scale back some of our operations, including our facilities expansion, which may have a negative effect on our business. In addition, the perception in the capital markets that we may not be able to raise the amount of financing we desire, or on terms favorable to us, may have a negative effect on the trading price of our stock. Additional equity financings could result in significant dilution of current stockholders’ equity interests. If sufficient capital is not available, we may be required to delay, reduce the scope of, eliminate or divest one or more of our subsidiaries, discovery, research or development programs or our facilities expansion. Any such action could significantly harm our business, financial condition and results of operations.
Our future capital requirements and the adequacy of our currently available funds will depend on many factors, including, among others, the following:
• | continued scientific progress in our research and development programs, including progress in our research and preclinical studies on our potential therapeutic protein candidates; | ||
• | the cost involved in our facilities expansion to support research and development of our potential therapeutic protein candidates; | ||
• | our ability to attract additional financing on favorable terms; | ||
• | the magnitude and scope of our research and development programs, including development of potential therapeutic protein candidates and Callida technology and applications; | ||
• | our ability to maintain, and the financial commitments involved in, our existing collaborative and licensing arrangements; | ||
• | our ability to establish new corporate relationships with other biotechnology and pharmaceutical companies to share costs and expertise of identifying and developing product candidates; | ||
• | the cost of prosecuting and enforcing our intellectual property rights; | ||
• | the cost of manufacturing material for preclinical, clinical and commercial purposes; | ||
• | the time and cost involved in obtaining regulatory approvals; | ||
• | our need to develop, acquire or license new technologies or products; | ||
• | competing technological and market developments; and | ||
• | other factors not within our control. |
Development of Our Products Will Take Years; Our Products Will Require Approval Before They Can Be Sold
Because substantially all of our potential products currently are in research or preclinical development, revenues from sales of any products will not occur for at least the next several years, if at all. We cannot be certain that any of our products will be safe and effective or that we will obtain regulatory approvals. In addition, any products that we develop may not be economical to manufacture on a commercial scale. Even if we develop a product that becomes available for commercial sale, we cannot be certain that consumers will accept the product. We cannot predict whether we will be able to successfully develop and commercialize any of our protein candidates. If we are unable to do so, our business, results of operations and financial condition will be materially adversely affected.
We do not yet have products in the commercial markets. All of our potential products are in research or preclinical development. We cannot apply for regulatory approval of our potential products until we have performed additional research and development and testing. We cannot be certain that we, or our strategic partners, will be permitted to undertake clinical testing of our potential products and, if we are successful in initiating clinical trials, we may experience delays in conducting them. Our clinical trials may not demonstrate the safety and efficacy of our potential products, and we may encounter unacceptable side effects or other problems in the clinical trials. Should this occur, we may have to delay or discontinue development of the potential product that causes the problem. After a successful clinical trial, we cannot market products in the United States until we receive regulatory approval. Even if we are
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able to gain regulatory approval of our products after successful clinical trials and then commercialize and sell those products, we may be unable to manufacture enough products to maintain our business, which could have a negative impact on our financial condition.
The Success of Our Potential Products in Preclinical Studies Does Not Guarantee that these Results Will Be Replicated in Humans
Even though some of our therapeutic protein candidates have shown results in preclinical studies, these results may not be replicated in our clinical trials with humans. Human clinical results could be different from our expectations following our preclinical studies. Consequently, there is no assurance that the results in our preclinical studies are predictive of the results that we will see in our clinical trials with humans. Also, while we have demonstrated some evidence that our therapeutic protein candidates have utility in preclinical studies, these results do not mean that the resulting products will be safe and effective in humans. Our therapeutic protein candidates may have undesirable and unintended side effects or other characteristics that may prevent or limit their use.
We Have a History of Operating Losses and May Never Be Profitable
For the years ended December 31, 2000, 1999 and 1998, we had net losses of $22.3 million, $18.5 million and $16.4 million, respectively. As of September 30, 2001, we had an accumulated deficit of $97.0 million. The process of developing our therapeutic protein candidates will require significant additional research and development, preclinical testing, clinical trials and regulatory approvals. These activities, together with general administrative expenses, are expected to result in operating losses for the foreseeable future. We may never generate profits, and if we do become profitable, we may be unable to sustain or increase profitability on a quarterly or annual basis. As a result, the trading price of our stock could decline.
Our Ability To Commercialize Gene-Based Products is Unproven
We have not developed any therapeutic or diagnostic products using proteins produced by the genes we have discovered. Before we make any products available to the public, we or our collaboration partners will need to conduct further research and development and complete laboratory testing and animal and human studies. Moreover, with respect to biopharmaceutical products, we or our collaboration partners will need to obtain regulatory approval before releasing any such products. With respect to agricultural products, our collaboration partner may need to obtain regulatory approval before releasing any such products. We have spent, and expect to continue to spend, significant amounts of time and money in determining the function of genes and the proteins they produce, using our own capabilities and those of our collaboration partners. Such determination process constitutes the first step in developing commercial products. We also have spent significant amounts of time and money in developing processes for manufacturing IL-1Hy1 and CD39L4, and expect to continue to spend significant resources on development and manufacturing of our proteins and other potential products. However, a commercially viable product may never be developed from our gene discoveries.
Our development of gene-based products is subject to several risks, including but not limited to:
• | the possibility that a product is toxic, ineffective or unreliable; | ||
• | failure to obtain regulatory approval for the product; | ||
• | the product may be hard to manufacture on a large scale or may not be economically feasible to market; | ||
• | competitors may develop a superior product; or | ||
• | other persons’ or companies’ patents may preclude our marketing of a product. |
Our biopharmaceutical development programs are currently in the research stage or in preclinical development. None of our potential therapeutic protein candidates have advanced to Phase I clinical trials. Our programs may not move beyond their current stages of development. Even if our research does advance, we will need to engage in certain additional preclinical development efforts to determine whether a product is sufficiently safe and efficacious to enter clinical trials. We have little experience with these activities and may not be successful in developing or commercializing products.
Under our collaboration arrangement with Chiron in the solid tumor cancer field, Chiron maintains responsibility for the development of a product. Under our collaboration arrangement with Kirin Brewery Company, Ltd. (Kirin), Kirin has primary responsibility for clinical development in its territory and we have primary responsibility in our territory. Under our collaboration arrangement with Deltagen, we share responsibility for development of a product. With respect to these arrangements, we run the risk
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that Chiron or Kirin may not pursue clinical development in a timely or effective manner, if at all, and that Deltagen may not cooperate with us in pursuing clinical development in a timely or effective manner.
If a product receives approval from the FDA to enter clinical trials, Phases I, II, and III of those trials include multi-phase, multi-center clinical studies to determine the product’s safety and efficacy prior to marketing. We cannot predict the number or extent of clinical trials that will be required or the length of the period of mandatory patient follow-up that will be imposed. Assuming clinical trials of any product are successful and other data appear satisfactory to us, we or our applicable collaboration partner will submit an application to the FDA and appropriate regulatory bodies in other countries to seek permission to market the product. Typically, the review process at the FDA is not predictable and can take up to several years. Upon completion of such review, the FDA may not approve our or our collaboration partner’s application or may require us to conduct additional clinical trials or provide other data prior to approval. Furthermore, even if our products or our collaboration partner’s products receive regulatory approval, delays in the approval process could significantly harm our business, financial condition and results of operations.
In addition, we may not be able to produce any products in commercial quantities at a reasonable cost or may not be able to successfully market such products. If we do not develop a commercially viable product, then we would suffer significant harm to our business, financial condition and operating results.
The Success of Our Business Depends on Patents and Other Proprietary Information
We currently have patents that cover some of our technological discoveries and patent applications that we expect to cover some of our gene, protein and technological discoveries. We have one issued patent relating to our gene and protein discoveries, U.S. Patent No. 6,294,655 issued September 25, 2001. We will continue to apply for patents for our discoveries. We cannot assure you that any of our currently pending or future applications will issue as patents, or that any patent issued to us will not be challenged, invalidated, circumvented or held unenforceable by way of an interference proceeding or litigation. The patent positions of biotechnology companies involve complex legal and factual questions. Even though we own patents, we cannot be certain that:
• | our patents will not be challenged; | ||
• | protection against competitors will be provided by such patents; or | ||
• | competitors will not independently develop similar products or design around our patents. |
We seek patents on:
• | full-length gene sequences; | ||
• | partially-sequenced gene sequences; | ||
• | proteins produced by those genes; | ||
• | antibodies to those proteins; and | ||
• | processes, devices and other technology that enhance our ability to develop and/or manufacture gene-based products. |
To obtain a patent, we must identify a utility for the gene or the protein we seek to patent. Identifying a utility may require significant research and development with respect to which we may incur a substantial expense and invest a significant amount of time.
Patent applications we may apply for with respect to human therapeutics could require us to generate data, which may involve substantial costs. Finally, we cannot predict the timing of the grant of a patent.
We also rely on trade secret protection for our confidential and proprietary information. Although our policy is to enforce security measures to protect our assets, trade secrets are difficult to protect. We require all employees to enter into confidentiality agreements with us. However:
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• | competitors may independently develop substantially equivalent proprietary information and techniques; | ||
• | competitors may otherwise gain access to our trade secrets; | ||
• | persons with whom we have confidentiality agreements may disclose our trade secrets; or | ||
• | we may be unable to protect our trade secrets meaningfully. |
Certain of our patents protecting our SBH technology are filed only in the United States. Therefore, we currently are not able to prevent others from practicing SBH technology outside of the United States. Furthermore, although we intend to defend our patents, we may not prevail in a court case against others who use our SBH technology.
We may be required to obtain licenses to patents or other proprietary rights of others. These required licenses may not, however, be made available on terms acceptable to us, or at all. If we do not obtain these licenses, we may not be able to develop, manufacture or sell products, or encounter delays in product market introductions, or incur substantial costs while we attempt to design around existing patents. Any of these obstacles could significantly harm our business, financial condition and operating results.
Our Business is Difficult to Evaluate Because We Have Been Focused on Our Current Business Strategy for Only Approximately Three Years.
Our company commenced operations in the fourth quarter of 1994. Our initial business focused on gene discovery using our screening by hybridization platform, and applications of our SBH technology including the HyChip system. Not only is our operating history relatively short, but we began to transition our business strategy from gene discovery to research and development of potential therapeutic protein candidates in 1998. Accordingly, we have a limited operating history from which you can evaluate our present business and future prospects. As a relatively new entrant to the business of biopharmaceutical research and development, we face risks and uncertainties relating to our ability to implement our business plan successfully. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early state of development, particularly companies in new and rapidly evolving markets such as research and development of gene-based products. If we are unsuccessful in addressing these risks and uncertainties, our business, results of operations, financial condition and prospects will be materially adversely affected.
We Have Experienced Fluctuation in the Number of Our Employees, and Any Inability to Manage this Fluctuation Could Harm Our Business.
The number of our employees has fluctuated over the last two fiscal years in response to changing market conditions and the evolution of our business. The number of our employees grew from 161 as of December 31, 1999, to 257 as of December 31, 2000. At September 30, 2001 Hyseq had 225 employees. On July 26, 2001 Hyseq announced a reduction in force of approximately 20%, to be implemented immediately and be completed over the next three months. This fluctuation has placed a significant strain on our management, systems, and resources. We expect that we will need to continue to maintain close coordination among our research and development and administrative groups in order to successfully manage such fluctuations in personnel.
We Lack Manufacturing Experience and We Intend to Rely Initially on Contract Manufacturers
We do not currently have significant manufacturing facilities. We are dependent on contract research and manufacturing organizations, and will be subject to the risks of finalizing contractual arrangements, transferring technology and maintaining relationships with such organizations in order to file an IND with the FDA and proceed with clinical trials for any of our potential therapeutic protein candidates. We are dependent on third-party contract research organizations to conduct certain research, including good laboratory practices (GLP) toxicology studies in order to gather the data necessary to file an IND with the FDA for any of our potential therapeutic protein candidates. Our potential therapeutic protein candidates have never been manufactured on a commercial scale. Third-party manufacturers may not be able to manufacture such proteins at a cost or in quantities necessary to make them commercially viable. In addition, if any of our potential therapeutic protein candidates enter the clinical trial phase, initially we will be dependent on third-party contract manufacturers to produce the volume of current good manufacturing practices (cGMP) materials needed to complete such trials. We will need to enter into contractual relationships with these or other organizations in order to (i) complete the GLP toxicology and other studies necessary to file an IND with the FDA, and (ii) produce a sufficient volume of cGMP material in order to conduct clinical trials of our potential therapeutic protein candidates. We cannot assure you that we will be able to do so on a timely basis or that we will be able to obtain sufficient quantities of material on commercially reasonable terms. In addition,
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the failure of any of these relationships with third-party contract organizations may result in a delay of our filing for an IND, or our progress through the clinical trial phase. Any significant delay or interruption would have a material adverse effect on our ability to file an IND with the FDA and/or proceed with the clinical trial phase for any of our potential therapeutic protein candidates.
Moreover, contract manufacturers that we may use must continually adhere to current cGMP regulations enforced by the FDA through a facilities inspection program. If the facilities of such manufacturers cannot pass a pre-approval plant inspection, the FDA premarket approval of our products will not be granted.
We Are Dependent Upon Collaborative Arrangements
As we have transitioned our business from gene discovery to research and development of biopharmaceutical candidates, we have shifted our focus for new collaborative arrangements. We are now focusing on new collaborative arrangements where we would share costs of identifying, developing and marketing product candidates. There can be no assurance that we will be able to negotiate new collaboration arrangements of this type on acceptable terms, or at all.
We also recently entered into a collaborative arrangement, through our indirectly owned subsidiary, N-Mer, to develop a high-speed DNA sequencing chip as part of our litigation settlement with Affymetrix. See Item 1, “Subsequent Events” above for further information. Our subsidiaries engaged in the development of SBH technology may also need to negotiate new collaborative arrangements in the future.
The success of our business is dependent, in significant part, upon our ability to enter into multiple collaboration arrangements and to effectively manage the numerous issues that arise from such collaborations. Management of our relationships with our collaboration partners will require:
• | our management team to devote a significant amount of time and effort to the management of these relationships; | ||
• | effective allocation of our resources to multiple projects; and | ||
• | an ability to obtain and retain management, scientific and other personnel. |
Our need, including the need of our direct and indirect subsidiaries, to manage simultaneously a number of collaboration arrangements may not be successful, and the failure to effectively manage such collaborations would significantly harm our business, financial condition and results of operations.
The research we perform in our gene discovery collaborative arrangements is at an early stage of product development. The successful development of products under these collaborations is highly dependent on the performance of our collaboration partners. Under our gene discovery collaborative arrangements, our collaboration partners are generally required to (i) undertake and fund certain research and development activities with us, (ii) make payments to us upon achievement of certain scientific milestones and (iii) pay royalties to us when and if they commercially market a product developed from the collaborative arrangement. We do not directly control the amount or timing of resources devoted to development activities by our collaboration partners. We, therefore, face a risk that our collaboration partners may not commit sufficient resources to our research and development programs or the commercialization of our products or may not perform their obligations as expected. If any collaboration partner fails to conduct its activities to be performed under our collaboration arrangement in a timely manner, or at all, our expectations of royalties and milestone payments related to such collaboration arrangement could be delayed or eliminated. Also, our current or future collaboration partners, if any, may independently pursue existing or other development-stage products or alternative technologies in preference to those they are developing in collaboration with us. Further, disputes may arise with respect to ownership of products developed under any such collaboration arrangement. Finally, any of our current collaboration arrangements may be terminated or not renewed by our collaboration partners, and we may not be able to negotiate additional collaboration arrangements in the future on acceptable terms, or at all.
We Are Dependent on Key Personnel
The success of our business is highly dependent on the principal members of our scientific and management staff. The loss of the services of any such individual might significantly delay or prevent us from achieving our scientific or business objectives. Competition among biotechnology and biopharmaceutical companies for qualified employees is intense. The ability to retain and attract qualified individuals is critical to our success. We may not be able to attract and retain qualified employees currently or in the
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future on acceptable terms, or at all. The failure to do so would significantly harm our business, financial condition and results of operations.
Management of Growth
We expect to significantly increase the number of our employees and the scope of our operations. Such growth may place a significant strain on our management and operations. In order to execute our strategy to build a fully integrated biopharmaceutical company, develop therapeutic or diagnostic products, and obtain regulatory approvals, we will need to:
• | attract and train skilled employees; | ||
• | attract and retain employees with expertise to ensure that we meet FDA and foreign regulatory requirements for conducting clinical trials; | ||
• | expand our facilities for additional research and development laboratories and offices and acquire additional equipment and supplies; | ||
• | expand our protein production capacity; and | ||
• | enter into and manage contractual relationships with contract research and manufacturing organizations. |
Our ability to manage such growth effectively will depend upon our ability to broaden our management team and to attract, hire and retain skilled employees. Our success also will depend on the ability of our officers and key employees to continue to implement and improve our operational, management information and financial control systems and to expand, train and manage our employee base. Inability to manage growth effectively could significantly harm our business, financial condition and operating results.
We Must Attract and Retain Qualified Employees and Consultants
Our success will depend on our ability to retain our key executive officers and scientific staff to develop our potential products and formulate our research and development strategy. We have programs in place to retain personnel, including programs to create a positive work environment and competitive compensation packages. Because competition for employees in our field is intense, however, we may be unable to retain our existing personnel or attract additional qualified employees. Our success also depends on the continued availability of outside scientific collaborators to perform research and develop processes to advance and augment our internal research efforts. Competition for collaborators is intense. If we do not attract and retain qualified personnel and scientific collaborators, and if we experience significant turnover or difficulties recruiting new employees, our research and development programs could be delayed and we could experience difficulties in generating sufficient revenue to maintain our business.
Future Sales of Our Common Stock May Depress Our Stock Price
Sales in the public market of substantial amounts of our common stock could depress prevailing market prices of our common stock. As of November 1, 2001, we had 19,108,213 shares of our common stock outstanding. All of these shares are freely transferable without restriction or further registration under the Securities Act of 1933, as amended (Securities Act), except for shares held by our affiliates and unregistered shares held by non-affiliates. As of November 1, 2001, our affiliates held 4,713,232 shares of our common stock and non-affiliates held 543,027 unregistered shares of our common stock, which are transferable pursuant to Rule 144 as promulgated under the Securities Act, subject to the volume limitations of Rule 144. Although we do not believe that our affiliates have any present intentions to dispose of any shares of common stock owned by them, there can be no assurance that such intentions will not change in the future. An additional 708,480 shares owned by a Yugoslav entity have been held in a blocked account pursuant to restrictions imposed by the U.S. Department of Treasury arising from the political situation in former Yugoslavia and therefore have not been able to be voted or transferred. We believe that some of these restrictions may have recently been removed and the remaining restrictions may be removed in the future. There can be no assurance as to how long any such restrictions will remain in effect.
As of November 1, 2001, 3,040,734 shares of our common stock and 1,520,369 shares issuable upon exercise of warrants were registered for resale under a Registration Statement on Form S-3. For a discussion of the private placement in which these securities were issued, see Part II, Item 2 below. Sales of these securities could also depress prevailing market prices of our common stock.
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As of November 1, 2001, warrants to purchase 1,832,050 shares of our common stock were outstanding. In addition, under registration statements on Form S-8 under the Securities Act, we have registered approximately 5,605,572 shares of our common stock for sale upon the exercise of outstanding options under our 1995 Stock Option Plan, Non-Employee Director Stock Option Plan, Scientific Advisory Board/Consultants Stock Option Plan, and stock option agreements entered into outside of any of our stock option plans and under our Employee Stock Purchase Plan and our Non-Qualified Employee Stock Purchase Plan. Shares of our common stock acquired pursuant to these plans and agreements are available for sale in the open market. In addition, we have reserved approximately 1,268,160 shares of our common stock for issuance upon the exercise of outstanding options under stock option agreements entered into outside of any of our stock option plans. As of November 1, 2001, 150,000 of the 1,268,160 shares of these options were exercisable. Although these shares have not been registered under the Securities Act, and therefore are restricted securities within the meaning of Rule 144 under the Securities Act, we intend to register these shares on a registration statement on Form S-8 under the Securities Act. Certain options or warrants may have exercise prices that are substantially below the prevailing market price of our common stock. The exercise of those options or warrants, and the prompt resale of shares of our common stock received, may result in downward pressure on the price of our common stock. The existence of the currently outstanding warrants and options to purchase our common stock may negatively affect our ability to complete future equity financings at acceptable prices and on acceptable terms.
We May Face Fluctuations in Operating Results
Our operating results may rise or fall significantly as a result of many factors, including:
• | the amount of research and development we engage in; | ||
• | the progress we make with research and preclinical studies on our therapeutic protein candidates, and the number of candidates in research and preclinical studies; | ||
• | our ability to expand our facilities to support our operations; | ||
• | our ability to enter into new strategic relationships; | ||
• | the nature, effectiveness, size, timing or termination of our collaborative arrangements; | ||
• | the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims; | ||
• | the possibility that others may have or obtain patent rights that are superior to ours; | ||
• | changes in government regulation; and | ||
• | competitors’ release of successful products into the market. |
Because substantially all of our potential products currently are in research or preclinical development, revenues from sales of any products will not occur for at least the next several years, if at all. We also have a high percentage of fixed costs such as lease obligations. As a result, we may experience fluctuations in our operating results from quarter to quarter and continue to generate losses. Quarterly comparisons of our financial results may not necessarily be meaningful and investors should not rely upon such results as an indication of our future performance.
We Face Potential Volatility of Our Stock Price
Our common stock has been traded on the Nasdaq National Market since August 1997. The market price of our common stock may fluctuate substantially because of a variety of factors, including:
• | volatility and uncertain in the capital markets in general; | ||
• | quarterly fluctuations in our results of operations; | ||
• | sales of our common stock by existing holders; |
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• | loss of key personnel; | ||
• | economic and other external factors; | ||
• | announcements by governmental agencies which may have, or may be perceived to have, an impact on our potential products; | ||
• | changes in our earnings estimates; | ||
• | changes in accounting principles; | ||
• | announcements by competitors; and | ||
• | other factors not within our control. |
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 us could result in substantial costs and a diversion of management’s attention and resources, which could significantly harm our business, financial condition and operating results.
FDA Regulatory Approval of Our Products is Uncertain; We Face Heavy Government Regulation
Products such as those proposed to be developed by us or our collaboration partners, typically will be subject to an extensive regulatory process by federal, state and local governmental authorities, including the FDA, and comparable agencies in other countries before we may market and sell such products. In order to obtain regulatory approval of a drug product, we or our 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, we must show that the manufacturing facilities used to produce the products are in compliance with cGMP requirements. In the event we or our collaboration partners, develop products classified as drugs, we and our collaboration partners will be required to obtain appropriate approvals as well.
If we sell applications of our SBH technology for clinical diagnostics, we will need to comply with appropriate cGMP regulations pertaining to devices. The new Quality System Regulation imposes design controls and makes other significant changes in the requirements applicable to manufacturers. We must also demonstrate that a BLA or NDA for any biological products would be approved by the applicable government agency. In addition, if we market applications of our SBH technology as diagnostic products, they may be considered to be medical devices and we or our collaboration partners will be required to show that the diagnostic product is substantially equivalent to a legally marketed product not requiring FDA approval. In addition, we must demonstrate that we are capable of manufacturing the product in accordance with the relevant standards. To obtain FDA approval for such products, we must submit extensive data to the FDA, including pre-clinical and clinical trial data to prove the safety and efficacy of the device. Clinical trials are normally conducted over a two- to five-year period, 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 inclusion criteria; | ||
• | difficulty in acquiring a sufficient supply of clinical trial materials; or | ||
• | adverse events occurring during the trials. |
Furthermore, data obtained from preclinical and clinical activities are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval or clearance for a product.
The process of obtaining FDA and other required regulatory approvals and clearances is lengthy and will require us to expend substantial capital and resources. We may not ultimately be able to obtain the necessary approvals and clearances. Moreover, if and when our products do obtain such approval or clearances, the marketing, distribution and manufacture of such products would remain subject to extensive ongoing regulatory requirements. Failure to comply with applicable regulatory requirements can result in:
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• | warning letters; | ||
• | fines; | ||
• | injunctions; | ||
• | civil penalties; | ||
• | recall or seizure of products; | ||
• | total or partial suspension of production; | ||
• | refusal of the government to grant approvals, premarket clearance or premarket approval; or | ||
• | withdrawal of approvals and criminal prosecution. |
We also are subject to numerous federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals, the environment and the use and disposal of hazardous substances used in connection with our discovery, research and development work, including radioactive compounds and infectious disease agents. In addition, we cannot predict the extent of government regulations or the impact of new governmental regulations which might significantly harm the discovery, development, production and marketing of our products. We may be required to incur significant costs to comply with current or future laws or regulations and we may be adversely affected by the cost of such compliance.
If we market therapeutic and diagnostic products outside the United States, such products will be subject to foreign regulatory requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement. Such requirements vary from country to country and are becoming more restrictive throughout the European Community. The process of obtaining foreign regulatory approvals can be lengthy and require the expenditure of substantial capital and resources. We or our collaboration partners may not be successful in obtaining the necessary approvals.
Any delay or failure by us or our collaboration partners to obtain regulatory approvals for our products:
• | would adversely affect our ability to generate product and royalty revenues; | ||
• | could impose significant additional costs on us or our collaboration partners; | ||
• | could diminish competitive advantages that we may attain; and | ||
• | would adversely affect the marketing of our products. |
We Face Intense Competition
The genomics and biopharmaceutical industries are intensely competitive. Our strategy as a biopharmaceutical company is to find the genes of the human genome that are most likely to be involved in a disease condition and to focus on identifying product candidates from the proteins produced by genes. There are a finite number of genes in the human genome, virtually all of which will soon be identified. Our competitors include major pharmaceutical and biotechnology firms, 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 we do. As a result, they may succeed in identifying genes and determining their functions or developing products earlier than we or our current or future collaboration partners do. They also may obtain patents and regulatory approvals for such products more rapidly than we or our current or future collaboration partners, or develop products that are more effective than those proposed to be developed by us or our collaboration partners. Further, any potential products based on genes we identify ultimately will face competition from other companies developing gene-based products as well as from companies developing other forms of treatment for diseases which may be caused by, or related to, the genes we identify.
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Many of the companies developing competing products have significantly greater financial resources than we have. Many such companies also have greater expertise than we or our collaboration partners have in discovery, research and development, manufacturing, preclinical and clinical testing, obtaining regulatory approvals and marketing. Other smaller companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. Academic institutions, government agencies and other public and private research organizations may also conduct research, seek patent protection and establish collaborative arrangements for discovery, research, clinical development and marketing of products similar to our products. These companies and institutions compete with us in recruiting and retaining qualified scientific and management personnel as well as in acquiring technologies complementary to our programs. We will face competition with respect to:
• | product efficacy and safety; | ||
• | the timing and scope of regulatory approvals; | ||
• | availability of resources; | ||
• | reimbursement coverage; and | ||
• | price and patent position, including potentially dominant patent positions of others. |
There can be no assurance that research and development by others will not render the products which we may develop obsolete or uneconomical, or result in treatments, cures or diagnostics superior to any therapy or diagnostic developed by us or that any therapy we develop will be preferred to any existing or newly developed technologies. While we believe that our technology provides a significant competitive advantage, any one of our competitors may discover and establish a patent position in one or more genes, which we designate as a product candidate before we do. Competition in this field is expected to intensify. Certain of our collaboration partners may now be, or could become, competitors.
Competition in the area of DNA analysis tools is intense and expected to increase. Technologies in this area are new and rapidly evolving. Other companies also are developing or have developed DNA analysis tools that may compete with applications of our SBH technology. Many of these companies have significantly greater research and development, marketing and financial resources than we do, and therefore represent significant competition.
We Lack Marketing Experience for Biopharmaceuticals
We currently have no sales, marketing or distribution capability. For the foreseeable future, we intend to rely primarily on our current and future collaboration partners or licensors, if any, to market our products. Such collaboration partners, however, may not have effective sales forces and distribution systems. If we are unable to maintain or establish such relationships and are required to market any of our products directly, we will have to develop our own marketing and sales force with the appropriate technical expertise and with supporting distribution capabilities. We may not be able to maintain or establish such relationships with third parties or develop in-house sales and distribution capabilities. To the extent that we depend on our collaboration partners or third parties for marketing and distribution, any revenues we receive will depend upon the efforts of such collaboration partners or third parties. Such efforts may not be successful.
Our Products May Not Be Accepted in the Marketplace
Even if they are approved for marketing, products we develop may never achieve market acceptance. Our products, if successfully developed, will compete with a number of traditional drugs and therapies manufactured and marketed by major pharmaceutical and other biotechnology companies. Our products will also compete with new products currently under development by such companies and others. The degree of market acceptance of any products developed by us, alone, or in conjunction with our collaboration partners, will depend on a number of factors, including:
• | the establishment and demonstration of the clinical efficacy and safety of the products; | ||
• | our products’ potential advantage over alternative treatment methods; and | ||
• | reimbursement policies of government and third-party payors. |
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Physicians, patients or the medical community in general may not accept and utilize any of the products that we alone, or in conjunction with our collaboration partners, develop. The lack of such market acceptance would significantly harm our business, financial condition and results of operations.
We may develop diagnostic testing products in the future. Our success in diagnostics will depend in large part upon our ability to obtain customers and upon the ability of these customers to properly market genetic tests performed with our technology. Genetic tests, including any performed using applications of our SBH technology, 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 test cannot determine with absolute certainty whether 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 use and the confidentiality of information provided by such testing. Government authorities could limit the use of genetic testing or prohibit testing for genetic predisposition to certain conditions. Ethical concerns about genetic testing may adversely effect market acceptance of our technology for diagnostic applications. Impaired market acceptance of our technology could significantly harm our business, financial condition and operating results.
We Face Uncertainties Related to SBH Technology Applications
We have developed applications of our SBH technology, including the chip component to be used with the HyChip system. As we continue development of SBH technology applications, we may discover problems in the functioning of these applications, including the HyChip system. We may be unable to improve applications of our SBH technology enough to be able to market them successfully. Further, SBH technology applications compete against other DNA analysis tools and well-established technologies. We cannot predict the outcome of these uncertainties.
We Face Uncertainty With Respect to Pricing, Third-Party Reimbursement and Health Care Reform
Our ability to collect significant royalties from our products may depend on our ability, and the ability of our collaboration partners or customers, to obtain adequate levels of reimbursement from third-party payors such as:
• | government health administration authorities; | ||
• | private health insurers; | ||
• | health maintenance organizations; | ||
• | pharmacy benefit management companies; and | ||
• | other health care related organizations. |
Currently, third-party payors are increasingly challenging the prices charged for medical products and services, and the overall availability of third-party reimbursement is limited and uncertain for genetic predisposition tests. Third-party payors may deny their insured reimbursement if they determine that a prescribed device or diagnostic test (i) has not received appropriate clearances from the FDA or other government regulators, (ii) is not used in accordance with cost-effective treatment methods as determined by the third-party payor, or (iii) is experimental, unnecessary or inappropriate. If third-party payors routinely deny reimbursement, we may not be able to market our products effectively. We also face the risk that we will have to offer our diagnostic products at low prices as a result of the current trend in the United States towards managed health care through health maintenance organizations. Prices could be driven down by health maintenance organizations which control or significantly influence purchases of health care services and products. Legislative proposals to reform health care or reduce government insurance programs could also adversely affect prices of our products. The cost containment measures that health care providers are instituting and the results of potential health care reforms may prevent us from maintaining prices for our products that are sufficient for us to realize profits and may otherwise significantly harm our business, financial condition and operating results.
We Face Product Liability Exposure and Potential Unavailability of Insurance
We risk financial exposure to product liability claims in the event that the use of products developed by us or our collaboration partners, if any, result in personal injury. We may experience losses due to product liability claims in the future. We have obtained limited product liability insurance coverage. Such coverage, however, may not be adequate or may not continue to be available to us
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in sufficient amounts or at an acceptable cost, or at all. We may not be able to obtain commercially reasonable product liability insurance for any product approved for marketing. A product liability claim or other claim, product recalls, as well as any claims for uninsured liabilities or in excess of insured liabilities, may significantly harm our business, financial condition and results of operations.
We Use Hazardous Materials
Our research and development activities involve the controlled use of hazardous materials. Although we believe that our safety procedures for handling and disposing of these materials comply with applicable laws and regulations, we cannot eliminate the risk of accidental contamination or injury from hazardous materials. If a hazardous material accident occurred, we would be liable for any resulting damages. This liability could exceed our financial resources. Additionally, hazardous materials are subject to regulatory oversight. If our access to hazardous materials necessary for our operations is limited by federal, state or local regulatory agencies, we could experience delays in our research and development programs. Paying damages or experiencing delays caused by restricted access to necessary materials could reduce our ability to generate revenues and make it more difficult to fund our operations.
We Have Implemented Anti-Takeover Provisions that May Reduce the Market Price of Our Common Stock
Our Amended and Restated By-Laws provide that members of our board of directors serve staggered three-year terms. Our Amended and Restated Articles of Incorporation provide that all stockholder action must be effected at a duly called meeting and not by a consent in writing. The Amended and Restated By-Laws provide, however, that our stockholders may call a special meeting of stockholders only upon a request of stockholders owning at least 50% of our capital stock. These provisions of our Amended and Restated Articles of Incorporation and our Amended and Restated By-Laws could discourage potential acquisition proposals and could delay or prevent a change in control. These provisions are intended to enhance the likelihood of continuity and stability in the composition of our board of directors and in the policies formulated by our board of directors. We also intended these provisions to discourage certain types of transactions that may involve an actual or threatened change of control. We designed these provisions to reduce our vulnerability to unsolicited acquisition proposals and to discourage certain tactics that may be used in proxy fights. These provisions, however, could also have the effect of discouraging others from making tender offers for our shares. As a consequence, they also may inhibit fluctuations in the market price of our shares that could result from actual or rumored takeover attempts. Such provisions also may have the effect of preventing changes in our management.
We are permitted to issue shares of our preferred stock without stockholder approval upon such terms as our board of directors determines. Therefore, the rights of the holders of our common stock are subject to, and may be adversely affected by, the rights of the holders of our preferred stock that may be issued in the future. In addition, the issuance of preferred stock could have a dilutive effect on the holdings of our current stockholders.
On June 5, 1998, our board of directors adopted a rights plan and declared a dividend with respect to each share of our common stock then outstanding. This dividend took the form of a right, which entitles the holders to purchase one-one thousandth of a share of our Series B Junior Participating Preferred Stock at a purchase price of $175, subject to adjustment from time to time. These rights have also been issued in connection with each share of our common stock issued after June 5, 1998. The rights are exercisable only if a person or entity or affiliated group of persons or entities acquires, or has announced its intention to acquire, 15% (27.5% in the case of certain approved stockholders) or more of our outstanding common stock. The adoption of the rights plan makes it more difficult for a third party to acquire control of us without the approval of our board of directors.
Nevada Revised Statutes Sections 78.411 through 78.444 prohibit an “interested stockholder,” under certain circumstances, from entering into specified combination transactions with a Nevada corporation, unless certain conditions are met. Under the statute, an “interested stockholder” is a person who, together with affiliates and associates, beneficially owns (or within the prior three years, did beneficially own) 10% or more of a corporation’s voting stock. According to the statute, we may not engage in a combination within three years after an interested stockholder acquires our shares, unless (i) our board of directors approves the combination prior to the interested stockholder becoming an interested stockholder or (ii) holders of a majority of voting power not beneficially owned by the interested stockholder approve the combination at a meeting called no earlier than three years after the date the interested stockholder became an interested stockholder.
Nevada Revised Statutes Sections 78.378 through 78.3793 further prohibit an acquirer, under certain circumstances, from voting shares of a target corporation’s stock after crossing certain threshold ownership percentages, unless the acquirer obtains the approval of the target corporation’s stockholders. This statute only applies to Nevada corporations that do business directly or indirectly in
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Nevada. We do not intend to do business in Nevada within the meaning of the statute. Therefore, it is unlikely that the statute will apply to us.
The provisions of our governing documents, our existing agreements and current Nevada law may, collectively:
• | lengthen the time required for a person or entity to acquire control of us through a proxy contest for the election of a majority of our board of directors; | ||
• | discourage bids for our common stock at a premium over market price; and | ||
• | generally deter efforts to obtain control of us. |
Risk of Natural Disasters and Power Blackouts
Our facilities are located in Sunnyvale, California. In the event that a fire or other natural disaster (such as an earthquake) prevents us from operating our production line, our business, financial condition and operating results would be materially, adversely affected. Some of our landlords maintain earthquake coverage for our facilities. Although we maintain personal property and business interruption coverage, we do not maintain earthquake coverage for personal property or resulting business interruption.
The State of California has experienced natural gas and electricity problems, which have resulted in rolling power blackouts, some of which have affected our facilities. In addition, we, like others, have experienced large fluctuation in our natural gas rates and may experience steep fluctuations in our electric rates. Although we have an auxiliary generator, it is intended for emergency backup in the event of a power outage and is not capable of powering our entire operations. Continued power blackouts and/or large increases in our utility costs could harm our business, financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RATE RISK
There were no significant changes in our market risk exposures through the third quarter 2001. For further discussion of our market risk exposures, refer to Part II, Item 7A., “Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2000.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 2001, the Company entered into a settlement agreement with Affymetrix providing for the comprehensive settlement of all existing litigation between the two companies that began in March 1997. The lawsuits involved are Hyseq, Inc., Plaintiff/Counterdefendant v. Affymetrix, Inc., Defendant/Counterclaimant, Case No. C 97-20188 RMW, United States District Court, Northern District of California, San Jose Division; Affymetrix, Inc., Plaintiff v. Hyseq, Inc., Defendant, Case No C 99-21163 JF, United States District Court, Northern District of California, San Jose Division; and Hyseq, Inc., Plaintiff/Counterdefendant v. Affymetrix, Inc., Defendant/Counterclaimant, Case No. C 00-20050 RMW, United States District Court, Northern District of California, San Jose Division. On October 26, 2001 Hyseq and Affymetrix jointly filed a “Stipulation and Proposed Order of Dismissal and Final Judgment” in each of these lawsuits which sought dismissal, with prejudice, in each case. Affymetrix and Hyseq have each acknowledged the validity and enforceability of the patents involved in these lawsuits, which are: Hyseq’s U.S. Patent Nos. 5,202,231, 5,525,464, 5,695,940, 6,018,041 and 5,972,619; and Affymetrix’ U.S. Patent Nos. 5,795,716, 5,744,305 and 5,800,992.
Hyseq and Affymetrix have also been involved in patent interference proceedings titled Chee v. Drmanac, Interference No. 104,552 before the U.S. Patent and Trademark Office. Hyseq and Affymetrix have entered into an interference settlement agreement in which Hyseq agreed to enter an abandonment of contest with respect to its pending patent application.
As part of the settlement arrangement, Hyseq and Affymetrix also entered into various licensing and collaborative arrangements. See Part I, Item I, "Subsequent Events" above for further information.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 30, 2001, the Company announced the completion of a private placement of approximately 3.04 million newly issued shares of common stock at $7.00 per share, together with warrants to purchase approximately 1.52 million shares of common stock, for aggregate gross proceeds of approximately $21.3 million in the offering. The warrants are exercisable at any time through and including August 28, 2006 at $10.50 per share, a 50 percent premium to the per unit purchase price on the closing date, which may be adjusted to $7.95 per share based on certain future issuances. The warrants may only be exercised on a cashless exercise basis after August 28, 2003.
The securities were sold to accredited investors in a private placement pursuant to Section 4(2) under the Securities Act of 1933, as amended. Officers and directors of the Company who participated in the offering agreed, pursuant to discussions held with the NASD, not to vote or transfer their shares of common stock acquired as a result of the offering until such time as the offer and sale of such shares to them has been ratified by the Company’s stockholders.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Not applicable.
(b) Reports on Form 8-K
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DATE OF FILING | SUBJECT | |||||
July 20, 2001 | Form 8-K, Item 5, Appointment of William F. Bennett as Senior Vice President, Research. | |||||
September 12, 2001 | Form 8-K, Item 5, Announcement of $21 Million Private Placement |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Hyseq, Inc. (Registrant) d/b/a Hyseq Pharmaceuticals, Inc. | ||
| ||
By: | /s/ Peter S. Garcia | |
Peter S. Garcia Senior Vice President and Chief Financial Officer |
Date: November 14, 2001
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