Pursuant to Rule 424(b)(4)
Registration No. 333-29091
PROSPECTUS
3,000,000 SHARES
[LOGO OF HYSEQ INC.]
COMMON STOCK
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All of the 3,000,000 shares of Common Stock offered hereby are being sold by
Hyseq, Inc. ("Hyseq" or the "Company"). Prior to this offering, there has been
no public market for the Common Stock of the Company. See "Underwriting" for a
discussion of the factors to be considered in determining the initial public
offering price. The Common Stock has been approved for quotation on the Nasdaq
National Market upon issuance under the symbol "HYSQ."
Concurrent with this offering, Chiron Corporation ("Chiron") and The Perkin-
Elmer Corporation ("Perkin-Elmer") have agreed to purchase shares of Common
Stock directly from the Company at a price per share equal to the price to
public less one-half of the underwriting discounts and commissions applicable
to the shares of Common Stock being offered to the public hereby, for an
aggregate purchase price of approximately $2.5 million and $5.0 million,
respectively, pursuant to an existing agreement with the Company (the "Private
Placement"). See "Business--Collaborative and Other Arrangements."
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THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 6.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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Underwriting
Price to Discounts and Proceeds to
Public Commissions(1) Company(2)
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Per Share............................... $14.00 $.98 $13.02
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Total(3)................................ $42,000,000 $2,940,000 $39,060,000
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(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting estimated expenses of $1,100,000 payable by the Company.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
450,000 additional shares of Common Stock on the same terms and conditions
set forth herein, solely to cover over-allotments, if any. If such option
is exercised in full, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Company will be $48,300,000, $3,381,000 and
$44,919,000, respectively. See "Underwriting."
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The shares of Common Stock offered by this Prospectus are being offered by
the Underwriters subject to prior sale, to withdrawal, cancellation or
modification of the offer without notice, to delivery to and acceptance by the
Underwriters and to certain further conditions. It is expected that delivery of
certificates representing the shares of Common Stock will be made at the
offices of Lehman Brothers Inc., New York, New York, on or about August 13,
1997.
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LEHMAN BROTHERS
SMITH BARNEY INC.
FAHNESTOCK & CO. INC.
August 7, 1997
[GRAPHICS]
A color schematic flowchart entitled "Hyseq HyX Platform Technology
Opportunities". The flowchart has three columns of information with the
following headings, left to right: "Strategy", "Implementation" and "Revenue
Sources". Arrows from left to right connect each heading box. The subheadings
under the "Strategy" column are "Therapeutics" and each heading box. The
subheadings under the "Strategy" column are "Therapeutics" and "Diagnostics".
The subheadings under the "Implementation" are "Gene Discovery Module",
"HyGenomics Database", HyGnostics Module" and "HyChip Products". Under each of
these subheadings are listed the names of the Company's collaborators. In the
"Revenue Sources" column there are no subheadings but various revenue sources
are listed, such as "Licensing Fees", "Research Funding" and "Royalties".
Certain revenue sources are marked with an astericks referencing the footnote
below.
* The Company has not received revenues from this source.
The Company's actual results and performance could differ materially from
the results expressed in or implied by the forward-looking statements in this
Prospectus. Factors that could cause or contribute to such differences include
those discussed in "Risk Factors."
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF
THE COMPANY. SUCH TRANSACTIONS MAY INCLUDE THE PURCHASE OF SHARES OF COMMON
STOCK FOLLOWING THE OFFERING TO COVER A SYNDICATE SHORT POSITION IN THE COMMON
STOCK OR MAINTAIN THE PRICE OF THE COMMON STOCK, AND THE IMPOSITION OF PENALTY
BIDS. FOR A DISCUSSION OF THESE ACTIVITIES, SEE "UNDERWRITING."
[GRAPHICS]
A color schematic diagram entitled "Hyseq Hyx Platform Technology". Five
photographs are arranged in a circle, connected by arrows in a counterclockwise
direction, beginning from the photograph in the top left corner. Moving
counterclockwise, the photograph in the top left corner is of a Hyseq pipetting
robot and the caption reads "Pipetting Robot - Sample Preparation". The next
photograph is of a Hyseq spotting robot and the caption reads "Spotting Robot -
DNA Array Manufacture". The next photograph is of Hyseq hybridization robot and
the caption reads "Hybridization robot - Hybridization Probing." The next
photograph is of a sample Hyseq HyGnostics Array and the caption reads "Computer
Image of HyGnostics Array - Imaging of Results". The nest photograph is of
sample Hyseq sequence image and the caption reads "Computer Image of Sequence -
Analysis of Results".
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to, and
should be read in conjunction with, the more detailed information and the
Consolidated Financial Statements and related Notes thereto appearing elsewhere
in this Prospectus. Unless indicated otherwise, the information contained in
this Prospectus: (i) assumes that the Underwriters' over-allotment option is
not exercised; (ii) gives retroactive effect to the conversion of the Company's
Series A Preferred Stock and Series B Preferred Stock to Common Stock, par
value $.001 per share (the "Common Stock"), immediately prior to the completion
of this offering; and (iii) gives retroactive effect to a subsequent 1.92-for-1
split of the Company's shares of Common Stock, to be effected immediately prior
to the completion of this offering. Unless otherwise indicated, all references
to the "Company" or "Hyseq" include Hyseq, Inc. and its subsidiary.
THE COMPANY
Hyseq, Inc. ("Hyseq" or the "Company") applies the proprietary DNA array
technology of its integrated HyX genomics platform (the "HyX Platform") to
develop gene-based therapeutic product candidates and diagnostic products and
tests. The Company believes that its HyX Platform, which utilizes the Company's
proprietary sequencing by hybridization ("SBH") technology as its foundation,
generates higher gene sequence throughput with greater analytical flexibility
and accuracy and lower cost than prevailing technologies. The HyX Platform's
Gene Discovery Module presently is analyzing human DNA samples at a rate of
approximately 400,000 partial sequences per month, representing approximately
50% of a module's current capacity. Based in part on this rate of analysis and
on published industry information, the Company believes that its proprietary
HyGenomics Database of partial gene sequences is one of the largest human gene
databases in the world. The Company has collaborative agreements with Chiron
Corporation ("Chiron") in gene discovery and The Perkin-Elmer Corporation
("Perkin-Elmer") regarding commercialization of its HyChip products, and
initial agreements with SmithKline Beecham Clinical Laboratories, Inc.
("SmithKline Beecham") and Quest Diagnostics Incorporated ("Quest") regarding
evaluation of its HyGnostics Module for commercial-scale diagnostic testing.
In 1996, industry sales of human gene-based products (e.g., therapeutic
proteins), including erythropoietin, human insulin, granulocyte colony
stimulating factor and tissue plasminogen activator, totaled over $6 billion.
The large market potential for gene-based products has led to a worldwide
effort to discover and sequence the estimated 150,000 genes in the human
genome. Industry experts believe that after genes are discovered and sequenced,
many additional years of research will be required to determine their functions
and roles in disease. To date, genomics companies have relied primarily on gel-
sequencing technology and expressed sequence tags ("ESTs") to identify genes
and obtain sequence information.
The Company believes that the ability of its HyX Platform to process millions
of samples per year and sequence billions of bases per year represents a
fundamental advance in performing genomic experimentation, gene discovery, gene
function analyses and diagnostic testing in commercial-scale volumes. The HyX
Platform includes (i) a comprehensive set of labeled DNA probes; (ii) DNA
arrays of samples and probes; (iii) three software-driven modules (Gene
Discovery, HyGnostics and HyChip Modules), which enable user-driven DNA probe
selection to customize the level and type of analysis; (iv) industrial robots
for screening DNA probes against DNA samples; and (v) bioinformatic software to
manage and analyze genetic information. These combined technologies enable
Hyseq to conduct a range of genomic applications, including gene
identification, expression level determination, gene interaction studies,
polymorphism screening, diagnostic testing and genetic mapping, on one
integrated platform.
3
The HyX Platform's software-driven modules include:
. Gene Discovery Module. Designed to screen or sequence large numbers of
human DNA samples (typically, 30,000 to 50,000 samples per batch) for
gene discovery, gene function analysis and genomic experimentation. Hyseq
uses the Gene Discovery Module internally to identify proprietary gene-
based therapeutic candidates in the central nervous system,
cardiovascular and infectious disease areas and therapeutic product
candidates that impact cell receptors. The Company has an exclusive
collaboration with Chiron to develop therapeutics, diagnostic molecules
and vaccines relating to a specified disease area.
. HyGnostics Module. Designed to screen or sequence small to medium numbers
of DNA samples (typically, 10 to 1,000 samples per batch) for diagnostic
applications, including DNA testing of genetic and infectious disease and
cancer. The Company is currently marketing its HyGnostics Module to major
clinical reference laboratories. The Company has entered into initial
agreements with SmithKline Beecham and Quest, two of the three largest
clinical reference laboratories in the United States, relating to
evaluation of the HyGnostics Module for commercial-scale diagnostic
testing.
. HyChip Module. Designed to screen or sequence DNA samples in a single
reaction with a capacity ranging in size from the detection of single
base mutations to the sequencing of entire viral genomes. Hyseq is
presently using the HyChip Module internally for research applications.
The Company has an exclusive collaboration with Perkin-Elmer to co-
develop and commercialize gene-sequencing systems targeted at specific
DNA research and diagnostic applications utilizing HyChip products and
Perkin-Elmer's life science system capabilities.
Hyseq's strategy is to engage in large-scale gene discovery and to establish
collaborations to facilitate development and commercialization activities.
Hyseq believes that this research- and partner-driven approach may create
significant operational and financial advantages for the Company and accelerate
commercial development of new therapeutic and diagnostic products. In
therapeutics, Hyseq's strategy is to (i) discover candidates and then
collaborate to develop gene-based pharmaceuticals, including therapeutic
proteins, small molecules, gene therapy, antisense and other products, which
can be used to impact cell receptor targets and treat central nervous system,
cardiovascular and infectious diseases; (ii) develop disease-related programs,
such as the Company's program with Chiron, in conjunction with collaboration
partners; and (iii) perform genomic experimentation in commercial-scale volumes
by screening large numbers of DNA samples for expression levels under various
conditions and by large-scale partial sequencing of samples to find disease-
related polymorphisms. In diagnostics, Hyseq's strategy is to (i) expand its
HyGnostics Module licensing program to leading clinical reference laboratories
for multiple DNA analyses, including sequencing diagnostics, point mutation,
detection, population screening and confirmatory assays; (ii) market the
HyGnostics Module to pharmaceutical and biotechnology companies and clinical
research organizations as a resource for potentially accelerating clinical
trials; and (iii) commercialize HyChip products through its collaboration with
Perkin-Elmer.
Hyseq intends to patent commercially relevant genes and gene-based products
obtained through application of its HyX Platform. The Company believes that
information about the biological function of genes is critical to obtaining
such patents. Further, the Company believes that the HyX Platform's ability to
perform complete sequencing rapidly and cost effectively may accelerate the
characterization of gene function and enhance the discovery and development of
new therapeutic product candidates and diagnostic products and tests. The
Company has three issued U.S. patents and several pending patent applications
covering SBH technology and the use of its proprietary DNA array technology.
Several other pending patent applications cover apparatus and applications of
its technology and a number of partial gene sequences identified in its gene
discovery program.
Hyseq(R) is a registered trade and service mark of the Company; HyChip(TM),
HyGenomics(TM), HyGnostics(TM) and HyXSM are trade and service marks of the
Company. All other trademarks, service marks and trade names referred to in
this Prospectus are the property of their respective owners.
4
THE OFFERING
Common Stock offered by the
Company........................ 3,000,000 shares
Common Stock to be outstanding
after the offering............. 12,276,159 shares(1)
Use of Proceeds................. Development of potential therapeutic product
candidates and diagnostic tests, expansion of
the HyGenomics Database, further development
of the HyChip Module, investments in capital
equipment and leasing of additional space to
increase capacity and general corporate
purposes, including working capital. See "Use
of Proceeds."
Nasdaq National Market symbol... HYSQ
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(1) Includes an aggregate of 555,144 shares of Common Stock (based on the
initial public offering price of $14.00 per share) to be issued to Chiron
and Perkin-Elmer in the Private Placement. Excludes: (i) 708,883 shares of
Common Stock issuable upon exercise of vested options outstanding at a
weighted average exercise price of $2.16 per share; (ii) 692,847 shares of
Common Stock issuable upon exercise of warrants outstanding at a weighted
average exercise price of $3.81; (iii) 627,825 shares of Common Stock
issuable upon exercise of options outstanding but not vested; and (iv)
556,988 shares reserved for issuance upon exercise of options that may be
granted in the future under the Company's Stock Option Plan and Non-
Employee Director Stock Option Plan. See "Management and Scientific
Advisory Board--Stock Option Plans and Agreements," "Description of Capital
Stock" and Note 7 of Notes to Consolidated Financial Statements.
SUMMARY CONSOLIDATED FINANCIAL DATA
PERIOD FROM THREE MONTHS
AUGUST 14, 1992 ENDED
(INCEPTION) TO YEAR ENDED DECEMBER 31, MARCH 31,
DECEMBER 31, ------------------------------------ ------------------------
1993 1994 1995 1996 1996 1997
--------------- ----------- ---------- ----------- ----------- -----------
STATEMENT OF OPERATIONS
DATA:
Contract revenues....... $ -- $ 50,000 $2,127,000 $ 426,099 $ 78,327 $ 272,373
Operating expenses:
Research and develop-
ment.................. -- 850,707 1,811,212 3,735,925 946,324 1,306,233
General and administra-
tive.................. 511,755 1,477,664 937,656 1,749,086 400,670 931,298
--------- ----------- ---------- ----------- ----------- -----------
Total operating ex-
penses............... 511,755 2,328,371 2,748,868 5,485,011 1,346,994 2,237,531
--------- ----------- ---------- ----------- ----------- -----------
Loss from operations.... (511,755) (2,278,371) (621,868) (5,058,912) (1,268,667) (1,965,158)
Interest income (ex-
pense), net............ 2,473 15,926 20,604 219,977 (5,840) 49,093
--------- ----------- ---------- ----------- ----------- -----------
Net loss................ $(509,282) $(2,262,445) $(601,264) $(4,838,935) $(1,274,507) $(1,916,065)
========= =========== ========== =========== =========== ===========
Pro forma net loss per
share(1)............... $(0.52) $(0.21)
=========== ===========
Shares used in computing
pro forma net
loss per share(1)...... 9,403,000 9,067,000
=========== ===========
MARCH 31, 1997
------------------------------------------
PRO FORMA
ACTUAL PRO FORMA(2) AS ADJUSTED(3)
----------- ------------ ---------------
BALANCE SHEET DATA:
Cash and cash equivalents........... $ 4,743,260 $14,752,960 $60,212,960
Total assets........................ 7,549,233 17,558,933 63,018,933
Noncurrent portion of capital lease
and loan obligations............... 718,973 718,973 718,973
Deficit accumulated during the
development stage.................. (10,127,991) (10,142,266) (10,142,266)
Total stockholders' equity.......... 5,574,824 15,584,524 61,044,524
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(1) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the computation of pro forma net loss per share.
(2) Pro forma to give effect to: (i) the exercise of warrants and options to
purchase shares, and the issuance of shares for services completed in
January 1997, for an aggregate of 246,392 shares of Common Stock in June
1997 and (ii) the issuance of an aggregate of $10.0 million of Series B
Preferred Stock to Chiron and Perkin-Elmer in May and June, 1997. See "Use
of Proceeds," "Capitalization" and "Certain Transactions."
(3) Adjusted to give effect to (2) above and: (i) the sale of 3,000,000 shares
of Common Stock by the Company offered hereby at the initial public
offering price of $14.00 per share and the receipt of the estimated net
proceeds therefrom and (ii) the sale of 555,144 shares of Common Stock
(based on the initial public offering price of $14.00 per share) to be
issued to Chiron and Perkin-Elmer in the Private Placement and the receipt
of the net proceeds therefrom.
5
RISK FACTORS
An investment in the Common Stock involves a high degree of risk. In
evaluating the Company and its business, prospective investors should
carefully consider the following risk factors in addition to the other
information contained herein.
Unproven Ability to Commercialize Gene-Based Products. The Company's
strategy of using its Gene Discovery Module to rapidly identify and
characterize the function of a substantial number of genes and then selecting
from those genes promising candidates to be used to develop therapeutic
products and diagnostic products and tests is unproven. While other companies
have adopted a similar strategy, the application of this strategy is in too
early a stage to determine whether it can be successfully implemented. The
Company's development efforts with respect to therapeutic product candidates
and diagnostic tests are still in an early stage. Collaborations with the
Company's current and future collaboration partners will require significant
further research, development, testing and regulatory approvals by the Company
and any such collaboration partners prior to market release of any therapeutic
products or diagnostic tests developed. Even if the Company completely
sequences a substantial number of genes, its success in marketing potential
gene-based therapeutic product candidates and diagnostic tests will depend
upon its ability to determine which of those genes have potential value and to
select an appropriate commercialization strategy for each potential product it
chooses to pursue. To select those genes that are suitable for further
research and development, the Company will need to expend significant time and
resources isolating and sequencing the genes and analyzing them to determine
their function. There can be no assurance that the Company will be able to
successfully develop therapeutic product candidates that will be of commercial
interest to current or future collaboration partners, nor can there be any
assurance that therapeutic product candidates or diagnostic tests identified
for any such collaboration partners would result in the development of
commercially viable products.
To date, only a limited number of gene-based products have been developed
and commercialized, and none have been developed or commercialized by the
Company. Even if the Company identifies a gene and determines its function,
the Company or a collaboration partner may not be able to develop a
commercially feasible product based on the gene. The development of
therapeutic product candidates and diagnostic tests will be subject to risks
of failure inherent in the development of products based on new technologies,
including the possibilities that therapeutic product candidates will be found
toxic, defective, unreliable or otherwise fail to receive necessary regulatory
clearance; such products will be difficult to manufacture on a large scale or
uneconomical to market; proprietary rights of others will preclude marketing
of the Company's products; or products of third parties will be superior.
Certain areas of gene-based discovery that may be pursued by the Company under
current and future collaborative arrangements, including gene therapy, involve
new technologies, and existing data on the safety and efficacy of these
technologies is very limited. At present, no commercial products have been
developed from these technologies. Several significant scientific challenges
must be addressed before the therapeutic potential of these technologies can
be realized. Even if the Company and its collaboration partners are successful
in developing a therapeutic product, it would be a number of years before such
products could reach the market. The failure to successfully commercialize
products based on Company-discovered genes would have a material adverse
effect on the Company's business, financial condition and operating results.
See "Business--Competition."
Dependence upon Collaborative Arrangements. The Company presently plans to
develop therapeutic product candidates and diagnostic products and tests only
through collaborative arrangements with collaboration partners who would be
responsible for obtaining regulatory approval or clearance. As a result, the
Company's strategy for commercialization of such products relies substantially
upon arrangements with current and future collaboration partners and
licensees. There can be no assurance that the Company will be able to maintain
existing collaborations or obtain additional collaboration partners, or that
they will be on terms favorable to the Company. The Company will have only a
limited internal sales and marketing organization, and, with the exception of
the HyGnostics Module, which the Company markets directly, Hyseq will rely
primarily on collaboration partners or licensees or on arrangements with
others to market its products domestically and internationally. To the extent
the Company can establish additional collaborations, the Company will be
partially
6
dependent upon the subsequent success of these collaboration partners in
performing their responsibilities. There can be no assurance that any current
or future collaborations will ultimately succeed in obtaining commercially
viable products. There can be no assurance that these efforts or any products,
if approved, will gain market acceptance. Significant time may be required to
secure additional collaboration partners because of the need to effectively
sell the benefits of the Company's technology to a variety of constituencies
within future collaboration partners, including research and development
personnel and top management. In addition, each collaborative arrangement will
involve the negotiation of terms that may be unique to each collaboration
partner. The Company may expend substantial funds and management effort with
no assurance that a collaboration will result. Finally, there can be no
assurance that the Company's collaboration partners will not adopt alternative
technologies or develop alternative products either on their own or in
collaboration with others including the Company's competitors. The failure to
enter into and successfully maintain collaborative arrangements would have a
material adverse effect on the Company's business, financial condition and
operating results. See "Business--Collaborative and Other Arrangements."
Uncertainties Related to Certain Technological Approaches. The Company's
HyGnostics Module, which is used for DNA testing of genetic and infectious
diseases and cancer, has only been marketed as a module since 1996. There can
be no assurance that additional improvements or modifications will not be
necessary before the HyGnostics Module gains market acceptance, if at all. In
addition, the Company's HyChip Module, which is being used internally for
research applications in genomics and DNA testing, is under development for
commercial applications. As the HyChip Module undergoes further development,
there can be no assurance that previously unknown problems will not emerge or
that, if they do emerge, they can be solved. There also can be no assurance
that improvements in the HyChip Module or related products necessary for
successful commercialization will be achieved by the Company or by its
collaboration partner, Perkin-Elmer, which is developing the overall system
with the Company. Further, the HyChip Module and related products and the
Company's Gene Discovery and HyGnostics Modules will need to compete against
well-established technologies and enhancements to such technologies for
analyzing genes and performing diagnostics. The impact of these uncertainties
is difficult to predict and could have a material adverse effect on the
Company's business, financial condition and operating results.
Limited History of Operations, History of Losses and Uncertainty of Future
Profitability. The Company commenced operations in the fourth quarter of 1994.
As a development-stage company, there is limited historical information
available upon which an investor can base an evaluation of an investment in
the Company. For the three months ended March 31, 1997 and for the years ended
December 31, 1996, 1995 and 1994, the Company had net losses of $1.9 million,
$4.8 million, $601,000 and $2.3 million, respectively, and as of March 31,
1997, the Company had an accumulated deficit of $10.1 million. Expansion of
the Company's HyGenomics Database and marketing activities with respect to its
HyGnostics Module, together with the development of therapeutic product
candidates and diagnostic products and tests and development of the HyChip
Module and related products, will require substantial increases in
expenditures over the next several years. As a result, the Company currently
expects to incur operating losses at least through 1999, and the Company may
never achieve significant revenues or profitable operations. The likelihood of
success of the Company must be considered in light of the problems, expenses,
difficulties, complications and delays, many of which are beyond the Company's
control, frequently encountered in connection with the formation of a new
business, development and commercialization of new products, and the
utilization of new technology.
Competition. There is a finite number of genes (estimated by the Company to
be approximately 150,000 genes) in the human genome. A significant number of
such genes have been identified by the Company and others conducting genomic
research, and the Company believes that virtually all genes will be identified
within the next several years. To date, relatively few gene-based products
with significant commercial potential have been announced. While the Company's
goal has been to identify, establish the utility of and ultimately patent as
many genes as it can as rapidly as possible, the Company continues to face
substantial competition in these efforts from entities using gel sequencers
and other methods to discover genes. The Company believes that its primary
competitors in genomics are Human Genome Sciences, Inc. and Incyte
Pharmaceuticals, Inc., which are
7
using gel sequencers as part of their gene sequencing efforts. Research to
identify genes is also being conducted by various institutes and by United
States and foreign government-financed programs, which in some cases may be
competitive with the Company. A number of other companies also have announced
plans to engage in gene discovery using gel sequencers and may develop other
procedures for automated sequencing of genes. In addition, certain of the
Company's collaboration partners could, in the future, become competitors. As
a result, any one or more of these companies or other entities may discover
and establish, before the Company, a patent position in one or more genes that
the Company has identified. Any potential therapeutic products or diagnostic
products or tests based on genes identified by the Company may face
competition both from companies developing gene-based products and from
companies developing other forms of treatment for diseases that may be caused
by, or related to, genes identified by the Company. There can be no assurance
that the Company will compete successfully with its existing competitors or
with any new competitors.
The market for diagnostic products such as the HyGnostics Module and
diagnostic tests derived from the Company's gene discovery efforts is
currently limited and is expected to be highly competitive. In the area of
diagnostics, the Company competes primarily with Affymetrix, Inc.
("Affymetrix"). Additionally, the Applied Biosystems division of Perkin-Elmer
presently markets gel sequencers that are used by third parties to compete
with the Company in gene discovery and diagnostics. Many companies are
developing and marketing DNA probe tests for genetic and other diseases. Other
companies are conducting research on new technologies for diagnostic tests
based on advances in genetic information. Established diagnostic companies
have advantages over Hyseq, including greater financial and other resources to
invest in new technologies, substantial intellectual property portfolios,
substantial experience in new product development, regulatory expertise,
manufacturing capabilities and the distribution channels to deliver products
to customers. Potential customers for the HyGnostics Module, including
clinical reference laboratories, may have an existing base of instruments in
several markets and therefore be unwilling to adopt the HyGnostics Module in
lieu of existing instruments. Similarly, potential customers for HyChip
products, when introduced commercially, may already have existing instruments
and therefore be unwilling to adopt HyChip products. In addition, some of
these companies have formed alliances with genomics companies which provide
them access to genetic information that may be incorporated into their
diagnostic tests.
Several of the Company's existing and potential competitors have
substantially greater research and product development capabilities and
financial, scientific, marketing and human resources than the Company. These
competitors may succeed in identifying genes or developing products earlier
than the Company or its collaboration partners, obtaining approvals from the
United States Food and Drug Administration (the "FDA") or other regulatory
agencies for such products more rapidly than the Company or its collaboration
partners, or developing products that are more effective than those proposed
to be developed by the Company or its collaboration partners. Certain of these
competitors may be further advanced than the Company in developing potential
products that may compete with potential products of the Company. There can be
no assurance that research and development by others will not render obsolete
or non-competitive the products that the Company or its collaboration partners
may seek to develop. In addition, loss of the Company's patent rights to SBH
technology as a result of successful legal challenges could remove a legal
obstacle to competitors in designing platforms with similar competitive
advantages. The Company expects that competition in this field will intensify.
A failure of the Company to adequately compete in its markets would have a
material adverse effect on the Company's business, financial condition and
operating results. See "Business--Competition" and "--Litigation."
Fluctuations in Operating Results. The Company's operating results may
fluctuate significantly in the future as a result of a variety of factors,
including, but not limited to, changes in the demand for the Company's
products; the nature, size and timing of collaborative arrangements and
products provided to or developed with the Company's current and future
collaboration partners; changes in the research and development budgets of the
Company's current and future collaboration partners; capital expenditures and
other costs related to the expansion of the Company's operations; litigation
and other costs associated with defending its proprietary rights; changes in
government regulations; and the introduction of competitive technologies.
Changes in the number of collaboration partners could have a significant
effect on the Company's revenues and results of
8
operations. If revenues in a particular period do not meet expectations, the
Company may not be able to adjust significantly its level of expenditures in
such period, which would have an adverse effect on the Company's operating
results. The timing of revenues is difficult to forecast because the Company's
revenue generation cycle could be relatively long and may depend on factors
such as the size and scope of assignments and general economic conditions. The
need for continued investment in development of the Company's products and for
extensive ongoing support capabilities results in a high percentage of the
Company's expenses being fixed. Accordingly, fluctuations in revenues and
expenses due to a variation in the nature, number and timing of collaborative
arrangements, particularly at or near the end of a quarter, can cause
significant variations in operating results from quarter to quarter and could
result in continued losses to the Company. Although the Company can adjust
overhead expenditures to correspond to the number of active projects, it must
maintain a certain level of overhead expenditures to continue operations.
Quarterly comparisons of the Company's financial results may not necessarily
be meaningful and should not be relied upon as an indication of future
performance. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
Dependence upon Proprietary Rights; Risks of Infringement. The Company owns
certain proprietary information and expects to acquire additional proprietary
information in the course of its research and development activities. There
can be no assurance as to the breadth or the degree of protection that such
proprietary information or patents or pending patent applications, if issued,
will afford the Company. There also can be no assurance that issued patents
and any future issued patents will ultimately be found valid and enforceable.
There can be no assurance that any issued patents will provide protection
against any competitors or will provide the Company with competitive
advantages, nor can there be assurance that such patents will not be
challenged by others. Furthermore, there can be no assurance that others will
not independently develop similar products or, if patents are issued to the
Company, will not design around such patents.
Although the Company has sought or intends to timely seek international
coverage for all patent applications filed since its inception in August 1992,
the Company's rights in and to its three currently issued patents covering SBH
technology extend only to the United States. Therefore, the Company is not
currently able to prevent others from practicing the SBH process disclosed in
the currently issued SBH patents outside of the United States. Although the
Company intends to defend its patent rights to SBH technology, there can be no
assurance that it will be successful in such endeavor. Two of the patents
covering the Company's SBH technology are currently the subject of a
counterclaim by Affymetrix seeking declaratory relief that such patents are
invalid or that Affymetrix does not infringe them. See "--Certain Litigation"
and "Business--Litigation." Loss of its patent rights to SBH technology could
remove a legal obstacle to competitors in designing platforms with similar
competitive advantages. There can be no assurance that others will not develop
substantially equivalent know-how or otherwise obtain access to Company know-
how, or that others will not infringe the Company's patents, causing the
Company to incur substantial costs and expend substantial personnel time in
asserting the Company's patent rights.
The Company's long-term commercial success may depend in part on the ability
of the Company or its collaboration partners to obtain patent protection on
genes that the Company discovers. The Company intends to seek patent
protection for genes that it completely sequences as well as patent protection
for selected partial gene sequences. The patent positions of biotechnology
companies generally are highly uncertain and involve complex legal and factual
questions. There is a substantial backlog of biotechnology patent applications
at the United States Patent and Trademark Office (the "Patent Office"). No
consistent legislative or other policy has yet emerged regarding the breadth
of claims covered in biotechnology patents, and there also have been proposals
for review of the appropriateness of patents on genes and partial gene
sequences.
The Company's ability to obtain patent protection based on genes or partial
gene sequences will depend, in part, upon identification of a function for the
gene or gene sequences sufficient to meet the statutory requirement that an
invention have utility, which is a question of fact. Clinical data may be
required for issuance of patents for human therapeutics, which, if required,
could delay, add substantial costs to or affect the ability to obtain patent
protection. There can be no assurance that the Company's disclosures in its
current or future patent applications will be sufficient to meet these
requirements. Even if patents are issued, there may be current or
9
future uncertainty as to the scope of the coverage or protection provided by
any such patents. The Company cannot predict what issues may arise in
connection with the Company's patent applications or the timing of the grant,
if any, of patents with respect to genes or partial gene sequences covered by
such patent applications.
The Company also relies on trade secret protection for its confidential and
proprietary information. Although the Company's policy is to enforce security
measures to protect its assets, trade secrets are difficult to protect. While
the Company requires all employees to enter into confidentiality agreements,
there can be no assurance that others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to the Company's trade secrets or disclose such technology, or
that the Company can meaningfully protect its trade secrets.
The Company may be required to obtain licenses to patents or other
proprietary rights of others. There can be no assurance that any licenses
required under any such patents or proprietary rights would be made available
on terms acceptable to the Company or at all. If the Company does not obtain
such licenses, it could encounter delays in product market introductions and
incur substantial costs while it attempts to design around such patents, or
could find that the development, manufacture or sale of products requiring
such licenses could be foreclosed. Moreover, the Company could incur
substantial costs and expend substantial personnel time in defending itself in
any suits brought against the Company claiming infringement of the patent
rights of others or in asserting the Company's patent rights in a suit against
another party. Any of these factors could have a material adverse effect on
the Company's business, financial condition and operating results. See
"Business--Patents and Proprietary Technology" and "--Litigation."
Unproven Market for Genetic Testing. The Company's success in diagnostics
will depend in large part upon its ability to obtain customers and the ability
of these customers to properly market genetic tests performed with the
Company's technology. Genetic tests, including those performed using the
HyGnostics Module, may be difficult to interpret and may lead to
misinformation or misdiagnosis. Even when a genetic test identifies the
existence of a mutation in an individual, the interpretation of the result is
often limited to the identification of a statistical probability that the
tested individual will develop the disease or condition for which the test is
performed. The prospect of broadly available genetic predisposition testing
has raised societal and governmental concerns regarding the appropriate
utilization and the confidentiality of information provided by such testing.
Government authorities could, for social or other purposes, limit the use of
genetic testing or prohibit testing for genetic predisposition to certain
conditions that could adversely effect the use of the Company's products.
There can be no assurance that ethical concerns about genetic testing will not
materially adversely effect market acceptance of the Company's technology for
diagnostic applications, which could materially and adversely effect the
Company's business, financial condition and operating results. See "Business--
Government Regulation."
Certain Litigation. On March 3, 1997, the Company brought suit against
Affymetrix in the U.S. District Court for the Northern District of California,
San Jose Division, alleging infringement by Affymetrix of the Company's U.S.
Patents Nos. 5,202,231 and 5,525,464 (Hyseq, Inc. v. Affymetrix, Inc., Case
No. C 97-20188 RMW ENE, U.S. District Court). On May 5, 1997, the Company
filed an Amended Complaint. The suit alleges that Affymetrix willfully
infringed, and continues to infringe, upon these patents covering SBH
technology. Through the lawsuit, the Company seeks both to enjoin Affymetrix
from infringing upon the patents covering SBH technology and an award of
monetary damages for Affymetrix's past infringement. On May 19, 1997,
Affymetrix filed an Answer and Affirmative Defenses to the First Amended
Complaint and also filed a counterclaim against the Company. The counterclaim
seeks a declaratory judgment of invalidity and non-infringement with respect
to these patents covering SBH technology. On June 9, 1997, the Company filed a
reply to the counterclaim in which it denied the allegation of invalidity and
non-infringement. An initial case management conference was held on August 1,
1997. While the Company believes that it has made valid claims and has a
meritorious defense to the counterclaim, this litigation is at an early stage
and there can be no assurance that the Company will prevail in the claim. The
Company may incur substantial costs and expend substantial personnel time in
asserting the Company's patent rights against Affymetrix or others and there
can be no assurance that the Company will be successful in asserting its
patent rights. Failure to successfully enforce its patent rights or the loss
of these patent rights covering SBH technology also could remove a legal
obstacle to competitors in designing platforms with similar competitive
advantages, which could have a material adverse effect on the Company's
business, financial condition and operating results.
10
Management of Growth. The Company has recently experienced, and expects to
continue to experience, significant growth in the number of its employees and
the scope of its operations. Continued growth may place a significant strain
on the Company's management and operations. In order to significantly increase
capacity to remain competitive or satisfy the needs of current and future
collaboration partners, the Company will be required to acquire additional
equipment and supplies, upgrade software and adapt robotics and bioinformatics
resources to meet increased sequencing rates. The Company's ability to manage
such growth effectively will depend upon its ability to broaden its management
team and to attract, hire and retain skilled employees. The Company's success
also will depend on the ability of its officers and key employees to continue
to implement and improve its operational, management information and financial
control systems and to expand, train and manage its employee base. Inability
to manage growth effectively could have a material adverse effect on the
Company's business, financial condition and operating results.
Dependence on Key Personnel. Recruiting and retaining qualified scientific
and other management personnel to perform research and development work is
critical to Hyseq's success, and there can be no assurance that the Company
will be able to attract and retain such qualified personnel. The Company
employs and expects to rely heavily, for the foreseeable future, upon Dr.
Radoje T. Drmanac and Dr. Radomir B. Crkvenjakov for their SBH technology
expertise. Loss of the services of either Dr. Drmanac or Dr. Crkvenjakov would
impede the achievement of its business and scientific objectives and could
have a material adverse effect on the Company's business, financial condition
and operating results. The Company's projected growth and expansion into
activities requiring additional expertise, production and marketing also are
expected to place increased demands upon the Company's resources and
organization. These demands are expected to require the addition of new
management and scientific personnel in the near term as well as over time.
There can be no assurance that the Company will be able to attract and retain
such qualified personnel. See "Management and Scientific Advisory Board."
Uncertainty of Third-Party Reimbursement. The Company's ability to receive
significant royalties from its products may depend on the ability of its
collaboration partners or customers to obtain adequate levels of third-party
reimbursement. Currently, availability of third-party reimbursement is limited
and uncertain for genetic predisposition tests. In the United States, the cost
of medical care is funded by government insurance programs, such as Medicare
and Medicaid, and private and corporate health insurance plans. Third-party
payors may deny reimbursement if they determine that a prescribed device or
diagnostic test has not received appropriate clearances from the FDA or other
government regulators, is not used in accordance with cost-effective treatment
methods as determined by the payor, or is experimental, unnecessary or
inappropriate. The Company's ability to commercialize certain of its products
successfully may depend on the extent to which appropriate reimbursement
levels are obtained from authorities, private health insurers and other
organizations, such as health maintenance organizations ("HMOs"). Third-party
payors are increasingly challenging the prices charged for medical products
and services. The trend towards managed health care in the United States and
the concurrent growth of organizations such as HMOs, which could control or
significantly influence purchases of health care services and products, as
well as legislative proposals to reform health care or reduce government
insurance programs, may all result in lower prices for certain of the
Company's diagnostics products. The cost containment measures that health care
providers are instituting and the results of any health care reform may have a
material adverse effect on the Company's business, financial condition and
operating results.
No Assurance of FDA Regulatory Approval; Government Regulation. The Company
initially plans to collaborate on, manufacture and sell products through
collaborative arrangements with third parties who will be responsible for
obtaining regulatory approval or clearance. However, the Company may
ultimately determine to pursue directly the development of certain therapeutic
or diagnostic products requiring regulatory approval or clearance. Products
such as those proposed to be developed by the Company or with collaboration
partners typically will be subject to an extensive regulatory process by the
FDA and comparable agencies in other countries. In order to obtain regulatory
approval of a drug product, the Company or its collaboration partners must
demonstrate to the satisfaction of the applicable regulatory agency, among
other things, that such product is safe and effective for its intended uses
and that the manufacturing facilities are in compliance with current Good
Manufacturing Practice ("cGMP") requirements. Although the Company does not
need to comply with
11
cGMP with respect to the HyGnostics Module under current law, it may need to
comply with cGMP if currently proposed legislative changes are adopted, and it
will need to comply with cGMP with respect to its HyChip Module once HyChip
products are available for commercial sale, if sold for clinical diagnostics.
The Company or its collaboration partners also must demonstrate the
approvability of a Biological License Application or a Product License
Application and an Establishment License Application for any biological
products. In order to market its HyGnostics Module and other diagnostic
products, which may be considered to be medical devices, the Company or its
collaboration partners will be required to receive 510(k) marketing clearance
or Premarket Approval ("PMA") from the FDA for such products among other
regulatory requirements. To obtain 510(k) marketing clearance, the Company
must show that the diagnostic product is substantially equivalent to a legally
marketed product not requiring FDA approval. In addition, the Company must
demonstrate that it is capable of manufacturing the product to the relevant
standards. To obtain a PMA, the Company or its collaboration partners must
submit extensive data, including pre-clinical and clinical trial data to prove
the safety and efficacy of the device. Clinical trials are normally done in
three phases over two to five years, but may take longer to complete as a
result of many factors, including slower than anticipated patient enrollment,
difficulty in finding a sufficient number of patients fitting the appropriate
trial profile, difficulty in the acquisition of sufficient supply of clinical
trial materials or adverse events occurring during the trials. In the event
the Company or its collaborators develop products classified as drugs, the
Company and its collaborators will be required to obtain additional approvals.
Moreover, several areas in which the Company or its collaboration partners
may develop therapeutic products involve relatively new technology and have
not been subject to extensive product testing in patients. Accordingly, the
regulatory requirements governing such products and related clinical
procedures are uncertain and such products may be subject to substantial
additional review by various governmental regulatory authorities, which could
prevent or delay regulatory approval. Regulatory requirements ultimately
imposed in these areas could adversely affect the Company's ability to
clinically test, manufacture or market products. No assurance can be given
that any applicable regulations will not be amended, or that the Company will
be able to comply with any new or modified regulations.
The process of obtaining FDA and other required regulatory approvals and
clearances is lengthy and will require the expenditure of substantial capital
and resources. There can be no assurance that the Company will be able to
obtain the necessary approvals and clearances. Moreover, if and when such
approval or clearances are obtained, the marketing, distribution and
manufacture of such products would remain subject to extensive regulatory
requirements administered by the FDA and other regulatory bodies. Failure to
comply with applicable regulatory requirements can result in, among other
things, warning letters, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, refusal of the
government to grant approvals, premarket clearance or premarket approval,
withdrawal of approvals and criminal prosecution. If marketed outside the
United States, the Company's therapeutic and diagnostic products will be
subject to foreign regulatory requirements governing the conduct of clinical
trials, product licensing, pricing and reimbursement, which vary from country
to country and are becoming more restrictive throughout the European Union.
The process of obtaining foreign regulatory approvals can be lengthy and
require the expenditure of substantial capital and resources, and there can be
no assurance that the Company or its collaboration partners will be successful
in obtaining the necessary approvals. Any delay or failure by the Company or
its collaboration partners to obtain regulatory approvals for its products
would adversely affect the Company's ability to generate product and royalty
revenues, which could have a material adverse effect on the Company's
business, financial condition and operating results. See "Business--Government
Regulation."
Need for Future Capital; Uncertainty of Additional Funding. While the
Company believes that estimated net proceeds from this offering and the
Private Placement, together with existing capital resources, will be
sufficient to support the Company's operations through 1999, depending upon
the ability of the Company to develop additional collaborative arrangements,
meet its budgeted expenditures for expansion of operations and market its
HyGnostics Module, additional funds may be necessary sooner. There can be no
assurance that additional funds will be available when needed or on terms
acceptable to the Company. If adequate additional funds are not available, the
Company may have to reduce substantially or eliminate expenditures for the
12
development, production and marketing of certain of its proposed products, or
obtain funds through arrangements with collaboration partners that require the
Company to relinquish rights to certain of its technologies or products, which
could have a material adverse effect on the Company's business, financial
condition and operating results. See "Use of Proceeds" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Liquidity and Capital Resources."
No Prior Public Market; Possible Volatility of Stock Price. Prior to this
offering, there has been no public market for the Common Stock. The initial
public offering price per share of the Common Stock will be determined by
negotiations between management of the Company and the representatives of the
Underwriters (the "Representatives"). See "Underwriting" for factors to be
considered in determining the initial public offering price per share. The
Common Stock has been approved for quotation on the Nasdaq National Market
upon issuance; however, there can be no assurance that an active trading
market will develop and be sustained subsequent to this offering. The market
price of the Common Stock may fluctuate substantially because of a variety of
factors, including quarterly fluctuations in results of operations, adverse
circumstances affecting the introduction or market acceptance of new products
offered by the Company, announcements by competitors, developments in the
Company's litigation proceedings, changes in earnings estimates by analysts,
changes in accounting principles, sales of Common Stock by existing holders,
loss of key personnel and other factors. In addition, the stock market in
general, and the market for biotechnology and other life science stocks in
particular, has historically been subject to extreme price and volume
fluctuations. This volatility has had a significant effect on the market
prices of securities issued by many companies for reasons unrelated to the
operating performance of these companies. In the past, following periods of
volatility in the market price of a company's securities, class action
securities litigation has often been instituted against such a company. Any
such litigation instigated against the Company could result in substantial
costs and a diversion of management's attention and resources, which could
have a material adverse effect on the Company's business, financial condition
and operating results.
Use and Disposal of Hazardous Materials. The Company's operations require
the controlled use of hazardous and radioactive materials. Although the
Company believes that its safety procedures for handling such materials comply
with the standards prescribed by federal, state and local regulations, the
risk of accidental contamination or injury from these materials cannot be
completely eliminated. In the event of such an accident, the Company could be
held liable for any damages that result, which could have a material adverse
effect on the Company's business, financial condition and operating results.
Risk of Natural Disaster. The Company's sole facility is located in
Sunnyvale, California. In the event that a fire or other natural disaster
(such as an earthquake) prevents the Company from operating its production
line, the Company's business, financial condition and operating results would
be materially, adversely affected. The Company maintains earthquake coverage
for its facility, but does not maintain such coverage for personal property or
resulting business interruption.
Immediate and Substantial Dilution. The initial public offering price per
share of Common Stock is substantially higher than the net tangible book value
per share of the Common Stock. At the initial public offering price at $14.00
per share, purchasers of shares of Common Stock in this offering will
experience immediate and substantial dilution of $9.07 in the pro forma net
tangible book value per share of Common Stock. To the extent outstanding
options and warrants to purchase Common Stock are exercised, there will be
further dilution. See "Dilution."
Shares Eligible for Future Sale. Immediately after completion of this
offering and the Private Placement, the Company will have 12,276,159 shares of
Common Stock outstanding (assuming no exercise of outstanding options or
warrants). Of these shares, the 3,000,000 shares sold pursuant to this
offering will be freely tradable without restriction or further registration
under the Securities Act of 1933, as amended (the "Securities Act"), except
those shares acquired by affiliates of the Company. The remaining 9,276,159
shares (including the 555,144 shares of Common Stock, based on the initial
public offering price of $14.00 per share in this offering, sold in the
Private Placement) will be restricted securities within the meaning of Rule
144 under the Securities Act. The Company intends to register the shares sold
in the Private Placement following the expiration of the 180 day lock-up
agreements covering these shares, as described below. Chiron and Perkin-Elmer
have no present intentions to dispose of any shares of Common Stock which will
be owned by them at the completion of
13
this offering. However, there can be no assurance that such intentions will
not change in the future. The Company, executive officers and directors and
certain stockholders (including Chiron and Perkin-Elmer) have agreed not to
(1) offer, pledge, sell, contract to sell, engage in any short sale, sell any
option or contract to purchase, purchase any option or contract to sell, grant
any option, right or warrant to purchase, or otherwise transfer or dispose of,
directly or indirectly, any shares of Common Stock or any securities
convertible into or exercisable or exchangeable for Common Stock, or (2) enter
into any swap or similar agreement that transfers, in whole or in part, the
economic risk of ownership of the Common Stock, until 180 days after the
effective date of this Prospectus (the "Lock-Up Period"), without the prior
consent of Lehman Brothers Inc. However, Lehman Brothers Inc. may, in its sole
discretion and at any time without notice, release all or any portion of the
securities subject to lock-up agreements.
Of the 9,276,159 Restricted Shares, 1,612,339 shares will be freely
transferable pursuant to Rule 144 at the end of the Lock-Up Period and
2,262,778 shares will be held by affiliates and transferable pursuant to Rules
144 and 701, subject to the volume limitations of Rule 144, at the end of the
Lock-Up Period. Additional Restricted Shares, which will be transferable at
the end of the Lock-Up Period subject to the volume limitations of Rule 144,
will become freely transferable pursuant to Rule 144(k) as follows: 66,960
shares at various times during February and March 1998; 2,585,280 at various
times during April and May 1998; and 81,600 at various times during December
1998 and January 1999. An additional 1,403,578 Restricted Shares will not be
transferable pursuant to Rule 144 until the expiration of their one-year
holding periods, beginning at various times following the end of the Lock-Up
Period. An additional 708,480 shares are held in a blocked account and
therefore may not be voted or transferred pursuant to restrictions imposed by
the U.S. Department of Treasury. The 555,144 shares of Common Stock (based on
the initial public offering price of $14.00 per share) sold in the Private
Placement will be freely transferable following the effectiveness of a
registration statement which the Company intends to file at the end of the
Lock-Up Period. There can be no assurance as to how long such restrictions
will remain in effect. The Company has granted to certain securities holders
demand and piggyback registration rights covering an aggregate of 3,892,140
shares of Common Stock upon conversion of Series A and Series B Preferred
Stock and 216,422 shares of Common Stock issuable upon the exercise of
warrants (registration rights covering 227,760 of such shares will expire
prior to the end of the Lock-Up Period and registration rights covering an
additional 2,729,040 of such shares will expire at various times between the
end of the Lock-Up Period and January 1999). Sales of substantial amounts of
such shares in the public market or the availability of such shares for future
sale could adversely affect the market price of these shares of Common Stock
and the Company's ability to raise additional capital at a price favorable to
the Company. Within approximately 180 days after the date of this Prospectus,
the Company expects to file a Registration Statement on Form S-8 registering
1,893,696 shares of Common Stock reserved for issuance under the Company's
stock option agreements, Stock Option Plan and Non-Employee Director Stock
Option Plan. See "Shares Eligible for Future Sale" and "Underwriting."
Anti-Takeover Provisions. Certain provisions of the Company's Amended and
Restated Articles of Incorporation, as amended ("Articles"), and By-Laws ("By-
Laws") and the Nevada General Corporation Law (the "NGCL") will effectively
make it more difficult for a third party to acquire control of the Company by
means of a tender offer through a proxy contest for the election of directors
or otherwise. The Articles contain provisions which: (i) classify the Board of
Directors into three classes, with one class being elected each year; (ii)
require that stockholder action be taken only at a duly called meeting and not
by written consent; (iii) permit the Company's stockholders to call a special
meeting of the stockholders only upon request of stockholders owning at least
50% of the Company's capital stock; and (iv) do not provide for cumulative
voting. The Company may issue shares of Preferred Stock without stockholder
approval and upon such terms as the Board of Directors may determine. The
rights of the holders of the Common Stock will be subject to, and may be
adversely affected by, the rights of the holders of any Preferred Stock that
may be issued in the future. These provisions may have the effect of
lengthening the time required for a person to acquire control of the Company
through a proxy contest for the election of a majority of the Board of
Directors, may discourage bids for the Common Stock at a premium over market
price and may deter efforts to obtain control of the Company. See "Description
of Capital Stock--Preferred Stock" and "--Anti-Takeover Effects of Provisions
of the Articles and By-Laws and Nevada Law."
14
THE COMPANY
Hyseq, Inc. was incorporated in August 1992 as an Illinois corporation and
was merged into a newly formed Nevada corporation in November 1993, with the
Nevada corporation being the survivor. References in this Prospectus to
"Hyseq" and the "Company" include the Nevada corporation, its predecessor and
its subsidiary, Hyseq Diagnostics, Inc., a Nevada corporation, unless
otherwise stated or indicated by the context. The Company maintains its
principal executive offices at 670 Almanor Avenue, Sunnyvale, California
94086. Its telephone number is (408) 524-8100.
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 3,000,000 shares of
Common Stock offered by the Company hereby, at the initial public offering
price of $14.00 per share, and after deducting underwriting discounts and
commissions and other estimated offering expenses, are estimated to be
approximately $37,960,000 ($43,819,000 if the Underwriters' over-allotment
option is exercised in full). Concurrent with this offering, Chiron and
Perkin-Elmer have agreed to purchase shares of Common Stock directly from the
Company at a price per share equal to the price to public less one-half of the
underwriting discounts and commissions applicable to the shares of Common
Stock being offered to the public hereby, for an aggregate purchase price of
approximately $2.5 million and $5.0 million, respectively. Total net proceeds
from this offering and the Private Placement are estimated to be approximately
$45,460,000 ($51,319,000 if the Underwriters' over-allotment option is
exercised in full).
The Company intends to use approximately $27.0 million of the net proceeds
from this offering and the Private Placement primarily to develop potential
therapeutic product candidates and diagnostic tests and products while
continuing to expand its HyGenomics Database. The Company also expects to use
approximately $4.0 million of the proceeds to further develop its HyChip
Module and related products, approximately $1.0 million to fund expanded
research into new applications of its technologies, to expand marketing
capabilities with respect to its HyGnostics Module and collaborations, and
approximately $2.0 million to invest in capital equipment and lease additional
space to increase sequencing capacity through 1998. The Company intends to use
the balance of the net proceeds for working capital and other general capital
purposes. Pending such uses, the Company intends to invest the net proceeds of
this offering in short-term, investment-grade, interest-bearing securities.
These amounts are estimates only and the amounts actually expended for each
purpose and the timing of such expenditures may vary significantly depending
on numerous factors, including, but not limited to payments received under
current and possible future collaborative arrangements; the progress of the
Company's collaborative and independent research and development projects; the
prosecution, defense and enforcement of patent claims and other intellectual
property rights; and the expansion of marketing capabilities.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock. The Company currently anticipates that any future earnings will be
retained for development of the Company's business, and does not anticipate
paying any cash dividends in the foreseeable future. Future cash dividends, if
any, will be at the discretion of the Company's Board of Directors and will
depend upon, among other things, the Company's future operations and earnings,
capital requirements and surplus, general financial condition, contractual
restrictions, if any, and such other factors as the Board of Directors may
deem relevant.
15
CAPITALIZATION
The following table sets forth the capitalization of the Company (i) as of
March 31, 1997; (ii) on a pro forma basis to reflect the exercise of a warrant
and options to purchase shares, and the issuance of shares for services
completed in January 1997, for an aggregate of 246,392 shares of Common Stock
in June 1997, the automatic conversion of all outstanding Series A Preferred
Stock into Common Stock on a 1-for-1 basis concurrently with the closing of
this offering and the issuance of an aggregate of 793,651 shares of Common
Stock (based on the initial public offering price of $14.00 per share) upon
conversion of shares of Series B Preferred Stock sold to Chiron and Perkin-
Elmer in May and June, 1997; and (iii) pro forma as adjusted to reflect (ii)
above and the sale of 3,000,000 shares of Common Stock offered by the Company
hereby at the initial public offering price of $14.00 per share and the
receipt of estimated net proceeds therefrom and the Private Placement and the
receipt of the net proceeds therefrom. The following table should be read in
conjunction with "Business," and the Consolidated Financial Statements and
Notes thereto included elsewhere in this Prospectus.
AS OF MARCH 31, 1997
------------------------------------------
PRO FORMA
ACTUAL PRO FORMA(2) AS ADJUSTED(3)
------------ ------------ --------------
Cash and cash equivalents........... $ 4,743,260 $ 14,752,960 $ 60,212,960
============ ============ ============
Current maturities of capital lease
and loan obligations............... $ 274,893 $ 274,893 $ 274,893
============ ============ ============
Non-current portion of capital lease
and loan obligations (1)........... $ 718,973 $ 718,973 $ 718,973
Stockholders' equity:
Preferred stock, $.001 par value;
8,000,000 shares authorized,
2,170,460 shares issued and
outstanding, actual; no shares
issued and outstanding, pro
forma; no shares issued and
outstanding, pro forma as
adjusted......................... 14,780,013 -- --
Common stock, $.001 par value;
20,000,000 shares authorized;
2,329,540 shares issued and
outstanding, actual; 50,000,000
shares authorized, 8,721,015
shares issued and outstanding,
pro forma; 12,276,159 shares
issued and outstanding, pro forma
as adjusted (4).................. 5,396,571 30,200,559 75,660,559
Notes receivable (5).............. (3,905,705) (3,905,705) (3,905,705)
Deferred compensation............. (568,064) (568,064) (568,064)
Deficit accumulated during the
development stage................ (10,127,991) (10,142,266) (10,142,266)
------------ ------------ ------------
Total stockholders' equity...... 5,574,824 15,584,524 61,044,524
------------ ------------ ------------
Total capitalization.......... $ 6,293,797 $ 16,303,497 $ 61,763,497
============ ============ ============
- --------
(1) See Notes 4 and 5 of Notes to Consolidated Financial Statements for a
description of the Company's obligations.
(2) Gives effect to: (i) the exercise of a warrant and options to purchase an
aggregate of 246,392 shares of Common Stock in June 1997; (ii) the
automatic conversion of all outstanding Series A Preferred Stock into
Common Stock on a 1-for-1 basis concurrently with the closing of this
offering; and (iii) the issuance of an aggregate of 793,651 shares of
Common Stock (based on the initial public offering price of $14.00 per
share) upon conversion of shares of Series B Preferred Stock sold to
Chiron and Perkin-Elmer in May and June, 1997.
(3) Adjusted to give effect to: (2) above and (i) the sale of 3,000,000 shares
of Common Stock offered by the Company hereby at the initial public
offering price of $14.00 per share and the receipt of estimated net
proceeds therefrom and; (ii) the sale of 555,144 shares of Common Stock
(based on the initial public offering price of $14.00 per share) sold in
the Private Placement and the receipt of the net proceeds therefrom.
(4) Excludes: (i) 708,883 shares of Common Stock issuable upon exercise of
vested options outstanding at a weighted average exercise price of $2.16
per share; (ii) 692,847 shares of Common Stock issuable upon exercise of
warrants outstanding at a weighted average exercise price of $3.81; (iii)
627,825 shares of Common Stock issuable upon exercise of options
outstanding but not vested; and (iv) 556,988 shares reserved for issuance
upon exercise of options that may be granted in the future under the
Company's Stock Option Plan and Non-Employee Director Stock Option Plan.
See "Management and Scientific Advisory Board--Stock Option Plans and
Agreements," "Description of Capital Stock" and Note 7 of Notes to
Consolidated Financial Statements.
(5) Notes receivable includes loans with outstanding principal balances at
March 31, 1997 of $1,662,000, $1,842,000 and $4,120 to three officers in
connection with their purchases of Common Stock. Also includes a loan with
an outstanding principal balance at March 31, 1997 of $397,585 to Sachnoff
& Weaver, Ltd. in connection with its purchase of Common Stock. See
"Certain Transactions."
16
DILUTION
As of March 31, 1997, the pro forma net tangible book value of the Company
was $15,110,820 or $1.73 per share. "Pro forma net tangible book value per
share" represents the amount of tangible net assets of the Company, less total
liabilities, divided by the pro forma number of shares of Common Stock
outstanding as of March 31, 1997. After giving effect to the sale by the
Company of 3,000,000 shares of its Common Stock offered hereby at the initial
public offering price of $14.00 per share and the receipt of the net proceeds
therefrom and the sale of 555,144 shares of Common Stock (based on the initial
public offering price of $14.00 per share) by the Company in the Private
Placement and the receipt of the net proceeds therefrom, the pro forma net
tangible adjusted book value of the Company at March 31, 1997 would have been
$60,570,820 or $4.93 per share. This amount represents an immediate increase
in pro forma net tangible book value of $3.20 per share to existing owners of
the Company and an immediate dilution in net tangible book value per share of
$9.07 per share to purchasers of Common Stock in this offering. The following
table illustrates this per share dilution, without giving effect to any
exercise of the Underwriters' over-allotment options:
Initial public offering price per share.......................... $14.00
Pro forma net tangible book value per share at March 31, 1997.. $ 1.73
Increase attributable to new investors (1)..................... 3.20
------
Pro forma net tangible book value per share after this offering
and the Private Placement....................................... 4.93
------
Dilution per share to new investors.............................. $ 9.07
======
- --------
(1) Includes increase attributable to the Private Placement and the sale of
shares in this offering.
The following table summarizes, on a pro forma basis as of March 31, 1997,
the differences in the number of shares of capital stock purchased from the
Company, the total cash consideration paid and the average price paid per
share by existing stockholders and by new investors before deducting the
underwriting discounts and commissions and estimated offering expenses payable
by the Company at the initial public offering price of $14.00 per share.
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE PRICE
------------------ ------------------- -------------
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
Existing stockholders (1). 8,721,015 71.0% $30,788,289 38.3% $ 3.53
New investors (1)(2)...... 3,555,144 29.0 49,500,000 61.7 13.92
---------- ----- ----------- -----
Total................... 12,276,159 100.0% $80,288,289 100.0%
========== ===== =========== =====
- --------
(1) If exercised, the Underwriters' over-allotment option to purchase 450,000
additional shares will further reduce the percentage held by existing
stockholders to 68.7% and increase the percentage held by new investors to
31.3%.
(2) Includes shares sold in the Private Placement and this offering.
The foregoing tables (i) include the issuance of an aggregate of 793,651
shares of Common Stock (based on the initial public offering price of $14.00
per share) upon the conversion of shares of Series B Preferred Stock issued in
May and June, 1997; (ii) the exercise of warrants and options to purchase
shares, and the issuance of shares for services completed in January 1997, for
an aggregate of 246,392 shares of Common Stock in June 1997; and (iii) assume
no exercise of outstanding options or warrants. As of June 30, 1997, there
were options and warrants outstanding to purchase a total of 2,029,555 shares
of Common Stock at a weighted average exercise price of $3.70 per share.
Assuming that all of these options and warrants were exercised and proceeds
were received therefrom, net tangible book value dilution per share to new
investors would be $9.24. See "Management and Scientific Advisory Board--Stock
Option Plans and Agreements" and Note 7 of Notes to Consolidated Financial
Statements.
17
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below as of December 31,
1995 and 1996 and for the years ended December 31, 1994, 1995 and 1996 have
been derived from the Company's consolidated financial statements, which have
been audited by Ernst & Young LLP, independent auditors, and are included
elsewhere herein. The selected consolidated financial data as set forth below
as of December 31, 1993 and 1994 and for the period from August 14, 1992
(inception) to December 31, 1993 have been derived from the Company's audited
consolidated financial statements not included herein. The selected
consolidated financial data as set forth below as of March 31, 1997--actual,
and for the three months ended March 31, 1996 and 1997 and the period from
August 14, 1992 (inception) to March 31, 1997, have been derived from the
Company's unaudited financial statements which are included elsewhere herein.
The unaudited financial statements have been prepared by the Company on a
basis consistent with the Company's audited financial statements and, in the
opinion of management, include all adjustments, consisting of only normal
recurring adjustments, necessary for a fair presentation of the Company's
results of operations and financial condition for such periods. Operating
results for the three months ended March 31, 1997 are not necessarily
indicative of results that may be expected for the entire year ending December
31, 1997. The selected consolidated financial data set forth below should be
read in conjunction with the Consolidated Financial Statements and related
Notes thereto and with "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
PERIOD FROM THREE MONTHS PERIOD FROM
AUGUST 14, 1992 ENDED AUGUST 14, 1992
(INCEPTION) TO YEAR ENDED DECEMBER 31, MARCH 31, (INCEPTION) TO
DECEMBER 31, ----------------------------------- ------------------------ MARCH 31,
1993 1994 1995 1996 1996 1997 1997
--------------- ----------- --------- ----------- ----------- ----------- ---------------
STATEMENT OF OPERATIONS
DATA:
Contract revenues....... $ -- $ 50,000 $2,127,00 $ 426,099 $ 78,327 $ 272,373 $ 2,875,472
Operating expenses:
Research and
development........... -- 850,707 1,811,212 3,735,925 946,324 1,306,233 7,704,077
General and
administrative........ 511,755 1,477,664 937,656 1,749,086 400,670 931,298 5,607,459
---------- ----------- --------- ----------- ----------- ----------- ------------
Total operating
expenses.............. 511,755 2,328,371 2,748,868 5,485,011 1,346,994 2,237,531 13,311,536
---------- ----------- --------- ----------- ----------- ----------- ------------
Loss from operations.... (511,755) (2,278,371) (621,868) (5,058,912) (1,268,667) (1,965,158) (10,436,064)
Interest income
(expense), net......... 2,473 15,926 20,604 219,977 (5,840) 49,093 308,073
---------- ----------- --------- ----------- ----------- ----------- ------------
Net loss................ $(509,282) $(2,262,445) $(601,264) $(4,838,935) $(1,274,507) $(1,916,065) $(10,127,991)
========== =========== ========= =========== =========== =========== ============
Pro forma net loss per
share(1)............... $(0.52) $(0.21)
=========== ===========
Shares used in computing
pro forma net loss per
share(1)............... 9,403,000 9,067,000
=========== ===========
DECEMBER 31, MARCH 31, 1997
----------------------------------------------- --------------------------------------
PRO FORMA
AS
1993 1994 1995 1996 ACTUAL PRO FORMA(2) ADJUSTED(3)
---------- ----------- ---------- ---------- ----------- ------------ -----------
BALANCE SHEET DATA:
Cash and cash equiva-
lents.................. $1,009,563 $ 1,196,044 $ 750,291 $6,707,288 $ 4,743,260 $ 14,752,960 $60,212,960
Working capital......... 886,272 429,995 331,251 5,954,671 4,051,350 14,061,050 59,521,050
Total assets............ 1,539,393 2,455,508 2,739,679 9,365,814 7,549,233 17,558,933 63,018,933
Noncurrent portion of
capital lease and loan
obligations............ -- -- 32,360 791,405 718,973 718,973 718,973
Deficit accumulated
during the development
stage.................. (509,282) (2,771,727) (3,372,991) (8,211,926) (10,127,991) (10,142,266) (10,142,266)
Total stockholders'
equity................. $1,416,102 $ 1,625,203 $1,976,557 $7,363,537 $ 5,574,824 $ 15,584,524 $61,044,524
- -------
(1) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the computation of pro forma net loss per share.
(2) Pro forma to give effect to: (i) the exercise of warrants and options to
purchase shares, and the issuance of shares for services completed in
January 1997, for an aggregate of 246,392 shares of Common Stock in June
1997 and (ii) the issuance of an aggregate of $10.0 million of Series B
Preferred Stock to Chiron and Perkin-Elmer in May and June, 1997.
(3) Adjusted to give effect to (2) above and: (i) the sale of 3,000,000 shares
of Common Stock by the Company offered hereby and (ii) the receipt of the
net proceeds therefrom and the sale of 555,144 shares of Common Stock
(based on the initial public offering price of $14.00 per share) to Chiron
and Perkin-Elmer in the Private Placement and the receipt of the net
proceeds therefrom.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in this Prospectus, including statements
concerning potential collaboration arrangements, royalties and other payments
under potential collaboration arrangements, and product development and sales
and other statements, are forward-looking statements, which statements 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, including but not limited to, the following: the scientific
progress of the Company's programs; the ability of the Company to establish
additional collaborative and licensing arrangements; the extent to which the
Company engages in development of products without collaboration partners; the
time and cost involved in obtaining regulatory approvals for its diagnostics
products; the costs involved in preparing, filing, prosecuting, maintaining
and enforcing patent claims; competing technological and market developments;
and whether conditions to milestone payments are met and the timing of such
payment or payments. Prospective investors are also directed to the other
risks discussed under "Risk Factors."
OVERVIEW
The Company applies the proprietary DNA array technology of its HyX Platform
to develop gene-based therapeutic product candidates and diagnostic products
and tests. The Company believes that its HyGenomics Database of partial gene
sequences is one of the largest proprietary human gene databases in the world.
The Company presently is collaborating with Chiron to develop therapeutics,
diagnostic molecules and vaccines relating to a specified disease area and
with Perkin-Elmer to commercialize HyChip products for commercial
applications. See "Business--Collaborative and Other Arrangements." The
Company intends to form additional collaborations in targeted disease
categories. The Company is marketing its HyGnostics Module for DNA testing of
genetic and infectious disease and cancer to clinical reference laboratories.
The Company has initial agreements with SmithKline Beecham and Quest relating
to evaluation of the HyGnostics Module for commercial-scale diagnostic
testing.
Subsequent to March 31, 1997, Chiron and Perkin-Elmer invested $5.0 million
each in connection with collaboration agreements with the Company. The
majority of revenues received by the Company through March 31, 1997 related to
agreements with pharmaceutical companies and a clinical reference laboratory
entered into in 1995 and to a three-year, $2 million grant awarded in November
1994 from the National Institute of Standards and Technology ("NIST"), the
proceeds of which are being applied to development of the Company's super chip
technology. The Company expects to receive the remainder of the NIST grant and
to begin earning revenues under its collaboration with Chiron in 1997. The
Company has incurred operating losses since inception and expects to incur
operating losses at least through 1999 and possibly longer. The Company may
never achieve significant revenues or profitable operations. There can be no
assurance that the Company will be able to obtain licensees of its HyGnostics
Module, customers for HyChip products, additional collaboration partners on
acceptable terms or that its collaborative arrangements or products will
produce revenues adequate to fund the Company's operations.
The Company's operating results may fluctuate significantly in the future as
a result of a variety of factors, including, but not limited to, changes in
the demand for the Company's products; the nature, size and timing of
collaborative arrangements and products provided to or developed with the
Company's current and future collaboration partners; changes in the research
and development budgets of the Company's current and future collaboration
partners; capital expenditures and other costs related to the expansion of the
Company's operations; litigation and other costs associated with defending its
proprietary rights; changes in government regulations; and the introduction of
competitive technologies.
19
RESULTS OF OPERATIONS
Three Months Ended March 31, 1997 and 1996
Contract Revenues. Contract revenues were $272,000 and $78,000 for the
quarters ended March 31, 1997 and 1996, respectively. Contract revenues earned
in both periods related to the Company's NIST grant. The Company recognizes
revenues under the grant as research is performed. The Company expects to
receive the remaining balance of the NIST grant in 1997. The recognition of
revenues will vary from quarter to quarter and may result in significant
fluctuations in operating results from year to year. There can be no assurance
that the Company will be able to maintain existing collaborations and obtain
additional collaboration partners. The failure to maintain existing
collaboration partners or the inability to enter into additional collaborative
arrangements could have a material effect on the Company's revenues and
operating results.
Operating Expenses. Total operating expenses, consisting of research and
development expenses and general and administrative expenses, were $2.2
million in the quarter ended March 31, 1997 compared to $1.3 million in the
same period of 1996. As the Company expands its commercialization efforts,
operating expenses are expected to increase as a result of several factors
including: (i) the planned expansion of sequencing operations, software
development and enhancements and increased work on gene discovery in
connection with development of potential therapeutic product candidates and
diagnostic tests; (ii) the continued expansion of its HyGenomics Database;
(iii) expanded research into new applications of its technologies; (iv) the
expansion of marketing capabilities with respect to its HyGnostics Module and
collaborations; and (v) new technology development expenses relating to the
HyChip Module and related products.
The magnitude of the increases in the Company's operating expenses will be
significantly affected by the Company's ability to secure new collaboration
partners. At times, the Company may choose to increase sequencing production
and analysis capabilities in order to support its efforts to recruit new
collaboration partners. However, if the Company does not obtain additional
collaboration partners in a timely manner, it may not be able to adjust
significantly its level of expenditures in any such period, which could have
an adverse effect on the Company's operating results.
Research and development expenses increased to $1.3 million in the quarter
ended March 31, 1997 from $946,000 in the same period of 1996. This increase
resulted primarily from expanded sequencing production, software and database
development, the addition of scientific personnel and costs associated with
prosecuting the Company's intellectual property. The Company expects research
and development spending to increase in the future as the Company further
expands research and product development efforts in support of its gene
sequencing and database development programs. The Company is also obligated to
commit an aggregate of $5.0 million over the next two years for the
development of the chip component of the HyChip system.
General and administrative expenses were $931,000 in the quarter ended March
31, 1997 compared to $401,000 in the same period of 1996. This increase
resulted from increased marketing and business development expenses, which
increased by approximately $95,000, as well as the addition of management
personnel and administrative staff to support the continued expansion of the
Company's sequencing production and data analysis capabilities which increased
by approximately $50,000. In addition, during the period ended March 31, 1997,
the Company's legal expenses increased by approximately $280,000, due to
general corporate legal matters and its suit filed against Affymetrix in March
1997. As the Company expands operations, general and administrative expenses
in support of such expansion are expected to increase.
Interest Income (Expense), Net. Net interest income increased to $49,000 in
the quarter ended March 31, 1997 from an expense of $6,000 in the same period
of 1996. The increase in interest income for the first quarter of 1997 as
compared to the first quarter of 1996 results from larger cash and investment
balances held by the Company primarily due to the realization of $9.9 million
in net proceeds from its private placement of Series A Preferred Stock in the
second quarter of 1996.
Net Loss. The Company incurred a net loss for the three months ended March
31, 1997 of $1.9 million compared to $1.3 million in the same period of 1996.
Since inception, the Company has incurred operating losses, and as of March
31, 1997, had an accumulated deficit of $10.1 million. As of December 31,
1996, the
20
Company had a net operating loss carryover for federal income tax purposes of
approximately $7.4 million, the majority of which expires, if unused, in the
year 2011. Utilization of the net operating loss carryover is expected to be
subject to a substantial annual limitation because of the "change in
ownership" provisions of the Internal Revenue Code of 1986, as amended. The
annual limitation may result in the expiration of net operating losses before
utilization. See Note 8 of Notes to Consolidated Financial Statements.
Years Ended December 31, 1996, 1995 and 1994
Contract Revenues. Contract revenues were $426,000 and $2.1 million in 1996
and 1995, respectively. The Company did not lease and begin build-out of a
facility until May 1994, and did not commence operations until the fourth
quarter of 1994. As a result, the Company did not recognize any significant
revenues in 1994. Contract revenues recognized in 1996 related to the
Company's NIST grant, and in 1995 related to the NIST grant and agreements
with a pharmaceutical company and with SmithKline Beecham. The Company
recognized revenues under those agreements as milestones were achieved.
Operating Expenses. Total operating expenses, consisting of research and
development expenses and general and administrative expenses, were $5.5
million in 1996 compared to $2.7 million in 1995 and $2.3 million in 1994.
Research and development expenses increased to $3.7 million in 1996 from
$1.8 million in 1995 and $851,000 in 1994. Increases in expenses from 1995 to
1996 resulted primarily from expanded sequencing production, which increased
by approximately $620,000, as well as the addition of scientific personnel and
software and database development, which increased by approximately $640,000,
and intellectual property protection. Increases from 1994 to 1995 were
primarily the result of the addition of scientific personnel, which expenses
increased by approximately $510,000, as well as growth of research activities
and increased legal costs associated with prosecuting the Company's patent
portfolio, all primarily related to the expansion and improvements in
sequencing production.
General and administrative expense were $1.7 million in 1996 compared to
$938,000 in 1995 and $1.5 million in 1994. The increase from 1995 to 1996 was
due primarily to increased marketing and business development expenses, which
increased by approximately $150,000, as well as the addition of management
personnel and administrative staff, which increased by approximately $80,000,
to support the continued expansion of the Company's sequencing production and
data analysis capabilities. The decrease from 1994 to 1995 was primarily the
result of the reduction in non-recurring start-up expenses.
Interest Income (Expense), Net. Net interest income increased to $220,000 in
1996 from $21,000 in 1995 and $16,000 in 1994. The increase in interest income
for 1996 resulted from larger cash and investment balances held by the Company
primarily due to the realization of approximately $9.9 million in net proceeds
from its private placement of Series A Preferred Stock in 1996. The increase
from 1994 to 1995 is primarily due to the interest income on higher average
investment balances resulting from approximately $1.0 million of net proceeds
received in 1995 from its private placement of Series A Preferred Stock.
Net Loss. Since inception the Company has incurred operating losses, and as
of December 31, 1996 had an accumulated deficit of $8.2 million. The Company
incurred a net loss for the year ended December 31, 1996 of $4.8 million
compared to a loss of $601,000 and $2.3 million in 1995 and 1994,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1997, the Company had $4.7 million in cash, cash equivalents
and marketable securities, compared to $6.7 million as of December 31, 1996.
This decrease reflects net cash used in operations of $1.7 million and for
capital expenditures of $208,000 during the three months ended March 31, 1997,
partially offset by payments received under the Company's NIST grant.
Subsequent to March 31, 1997, Chiron and Perkin-Elmer invested $5.0 million
each in connection with collaboration agreements with the Company. The Company
has classified all of its investments as short-term at March 31, 1997, as the
Company may hold its investments until maturity in order to take advantage of
favorable
21
market conditions. Cash and investments are held currently in U.S. Treasury
and government agency obligations, investment-grade commercial paper and
interest-bearing securities and are invested in accordance with the Company's
investment policy with primary objectives of liquidity, safety of principal
and diversity of investments.
Cash used in operating activities increased from $510,000 in 1995 to $4.3
million in 1996 due to costs associated with the expansion of the Company's
sequencing production and data analysis capabilities. The increases in cash
used in operating activities for the year ended December 31, 1996 as compared
to 1995 were offset in part by payments received in those periods pursuant to
collaborative arrangements and receipt of revenues from the Company's NIST
grant.
The Company's investing activities, other than purchase and sales of cash
equivalent investments, have consisted of capital expenditures, which totaled
$943,000, $679,000 and $415,000 for the years ended December 31, 1996, 1995
and 1994, respectively. Capital expenditures increased in 1996 and 1995
primarily due to leasehold improvements in the Company's facilities and the
purchase of new equipment and workstations required in conjunction with the
Company's expanded sequencing production and software development activities.
Capital expenditures increased in 1994 related primarily to leasehold
improvements and as a result of purchases of new equipment to commence
operations.
Net cash provided by financing activities increased to $11.2 million for the
year ended December 31, 1996 from $1.0 million in 1995. Net cash provided by
financing activities in 1996 reflects primarily the $9.9 million in net
proceeds from its private placement of Series A Preferred Stock in the first
half of 1996 as well as a $750,000 equipment loan. Net cash provided by
financing activities of $1.0 million in 1995 reflects primarily the $949,000
in net proceeds from the sale of Series A Preferred Stock, partially offset by
principal payments on capital lease obligations.
The Company expects its cash requirements to increase significantly in
future periods because of the planned expansion of sequencing operations and
software development and improvement efforts and increased work on gene
discovery and new technology development expenses relating to the HyChip
Module and related products. In addition, the Company expects to expend
additional cash in 1998 and beyond for capital improvements to acquire a
larger facility and the associated lease expenses related thereto. The Company
expects to spend approximately $2.0 million for its anticipated facility
expansion and capital equipment to increase sequencing capacity through 1998.
The Company expects to continue to fund future operations with revenues from
existing collaborations in addition to using its current cash, cash
equivalents and investments when necessary. The Company intends to fund
development of HyChip products with funds received under its NIST grant and
the proceeds of its $5.0 million private placement of Series B Preferred Stock
with Perkin-Elmer.
The Company expects that the estimated net proceeds from this offering and
the Private Placement, together with existing capital resources, will be
sufficient to support the Company's operations through 1999. The Company's
estimate of the time period for which cash funds will be adequate to fund its
operations is a forward-looking estimate subject to risks and uncertainty, and
actual results may differ materially. The Company's future capital
requirements and the adequacy of its available funds will depend on many
factors, including, but not limited to, scientific progress in its research
and development programs and the magnitude of those programs, the ability of
the Company to establish collaborative and licensing arrangements and the
financial commitments involved in such arrangements.
There can be no assurance that the Company will be able to establish
additional collaborations or that such collaborations will produce revenues,
which together with the Company's cash, cash equivalents and marketable
securities, will be adequate to fund the Company's operations. The Company's
cash requirements depend on numerous factors, including the ability of the
Company to attract collaboration partners; the Company's research and
development activities; competing technological and market developments; the
cost of filing, prosecuting, defending and enforcing patent claims and other
intellectual property rights; and the purchase of additional capital
equipment, including capital equipment necessary to insure that the Company's
sequencing operation remains competitive. There can be no assurance that
additional funding, if necessary, will be available on favorable terms, if at
all. See "Risk Factors--Need for Future Capital; Uncertainty of Additional
Funding."
22
BUSINESS
OVERVIEW
Hyseq, Inc. ("Hyseq" or the "Company") applies the proprietary DNA array
technology of its integrated HyX genomic platform (the "HyX Platform") to
develop gene-based therapeutic product candidates and diagnostic products and
tests. The Company believes that its HyX Platform, which utilizes the
Company's proprietary sequencing by hybridization ("SBH") technology as its
foundation, generates higher gene sequence throughput with greater analytical
flexibility and accuracy and lower cost than prevailing technologies, such as
gel sequencing. The HyX Platform's Gene Discovery Module presently is
analyzing human DNA samples at a rate of approximately 400,000 partial
sequences per month, representing approximately 50% of a module's current
capacity. Based in part on this rate of analysis and on published industry
information, the Company believes that its proprietary HyGenomics Database of
partial gene sequences is one of the largest human gene databases in the
world.
The gene sequence throughput capacity of Hyseq's Gene Discovery Module
presently permits analysis of batches of approximately 30,000 to 50,000 DNA
samples that can be 1,000 bases in length each (up to approximately 50,000,000
total bases per batch). By comparison, the gene sequence throughput capacity
of gel sequencers presently permits analysis of batches of approximately 75
DNA samples that can be up to 500 bases in length (up to approximately 37,500
total bases per batch). The Company believes the HyX Platform has greater
analytical flexibility because of its ability to sequence genes at multiple
levels of completeness from intermittent sequencing for gene identification
and gene expression studies to partial sequencing for motif searches to
complete sequencing for diagnostics. The Company believes that its sequencing
capacity, coupled with the HyX Platform's flexibility to sequence genes at
multiple levels of completeness, make it appropriate for a large number of
therapeutic and diagnostic applications. See "--Advantages of the HyX
Platform." The HyX Platform employs SBH to generate gene sequence information
from DNA samples. The sequence information from a DNA sample enables the
Company to track a gene's role and activity in disease conditions and, hence,
to evaluate the gene as a potential therapeutic or diagnostic candidate. See
"--Technology" for a description of the Company's gene sequencing process.
The Company believes that the ability of its HyX Platform to process
millions of samples per year and sequence billions of bases per year
represents a fundamental advance in performing genomic experimentation, gene
discovery, gene function analyses and diagnostic testing in commercial-scale
volumes. The HyX Platform includes (i) a comprehensive set of labeled DNA
probes; (ii) DNA arrays of samples and probes; (iii) three software-driven
modules (Gene Discovery, HyGnostics and HyChip Modules) comprising software
and a specific configuration of platform hardware, which provide flexible DNA
probe selection to customize the level and type of analysis; (iv) industrial
robots for screening DNA probes against DNA samples; and (v) bioinformatic
software to manage and analyze genetic information. These combined
technologies enable the Company to conduct a range of genomic applications,
including gene identification, expression level determination, gene
interaction studies, polymorphism screening, diagnostic testing and genetic
mapping, on one integrated platform.
Hyseq's strategy is to engage in large-scale gene discovery and to establish
collaborations to facilitate development and commercialization activities.
Hyseq believes that this research- and partner-driven approach creates
significant operational and financial advantages for the Company and may
accelerate commercial development of new therapeutic and diagnostic products.
The Company has an exclusive collaboration with Chiron Corporation ("Chiron")
to develop therapeutics, diagnostic molecules and vaccines relating to a
specified disease area. The Company has entered into initial agreements with
SmithKline Beecham Clinical Laboratories, Inc. ("SmithKline Beecham") and
Quest Diagnostics Incorporated ("Quest"), two of the three largest clinical
reference laboratories in the United States, relating to evaluation of the
HyGnostics Module for commercial-scale diagnostic testing. The Company is
collaborating with The Perkin-Elmer Corporation ("Perkin-Elmer") to
commercialize HyChip products.
23
Hyseq intends to patent commercially relevant genes and gene-based products
obtained through application of its HyX Platform. The Company believes that
information about the biological function of genes is critical to obtaining
such patents. Further, the Company believes that the HyX Platform's ability to
perform complete sequencing rapidly and cost effectively may accelerate the
characterization of gene function and enhance the discovery and development of
new therapeutic product candidates and diagnostic products and tests. The
Company has three issued U.S. patents and several pending patent applications
covering SBH technology and the use of its proprietary DNA array technology.
Several other pending patent applications cover apparatus and applications of
its technology and a number of partial gene sequences identified in its gene
discovery program.
BACKGROUND
Genes are the hereditary units that control the structure, health and
function of all organisms. The study of genes and their functions has led to
the development of products and services for diverse markets ranging from
health care to agriculture. In 1996, industry sales of human gene-based
products, including erythropoietin ("EPO"), human insulin, granulocyte colony
stimulating factor and tissue plasminogen activator, totaled over $6 billion.
Genomics, the study of all genetic information of organisms, is a growing
field that is expected to lead to the development of additional gene-based
therapeutics like EPO, small molecules and other drugs and diagnostic tests
for detection of genetic conditions.
The Genetic Code
The entire genetic content of each organism, known as its genome, is encoded
in deoxyribonucleic acid ("DNA"). DNA, which is found in cells, is a molecule
comprising two single strands entwined in the form of a double helix. Various
combinations of four chemical building blocks or "bases" of DNA, adenine
("A"), thymine ("T"), cytosine ("C") and guanine ("G"), are linked together in
series to form each DNA strand. The bases of one DNA strand bind to the bases
of the other strand in a specific fashion to form "base pairs": A pairs with T
and G pairs with C. In humans, there are approximately six billion base pairs
organized into 23 pairs of DNA structures called "chromosomes."
A gene comprises a series of groupings of three bases on a DNA strand that
encodes specific amino acids which, in turn, combine to form proteins. Gene
"sequencing" is the process of determining the order in which these bases are
linked together to form a gene. Scientists believe that approximately 10% of
human DNA comprises genes, with most of the remaining 90% being of unknown
function. The human genome has been estimated to contain approximately 150,000
genes which encode proteins. Proteins are essential to cellular structure,
growth and function and, thus, are the principal determinants of an organism's
characteristics.
Scientists believe that each gene has two basic regions, a structural region
and a regulatory region. The structural region of a gene encodes a specific
protein. The process by which the structural region of a gene directs the
production of a protein is known as gene expression. In that process, the
sequence of bases in a gene is copied into a related molecule called messenger
ribonucleic acid ("mRNA"). The mRNA instructs the cell to combine amino acids
together in a particular order to form a protein. The regulatory region of a
gene is responsible for the rate of gene expression and the resultant amount
of a given protein produced in specific cells of the body.
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THE HUMAN GENOME
[GRAPHIC APPEARS HERE]
Figure 1 is a black and white schematic diagram entitled "The Human Genome"
which illustrates protein formation. At the top left corner of the diagram are
pictures of five human cells. An arrow points from the cells to a karyotype of
chromosomes. An arrow points from this picture to an enlarged figure of double
stranded DNA. An arrow points from the DNA picture to a figure representing
messenger RNA ("mRNA"). Lastly, an arrow points from the mRNA to a molecule
representing protein.
The Relationship Between Genes and Disease
Because genes encode proteins, which govern substantially all functions of
the human body, the sequences of genes and their levels of expression
determine when, where and how well essential functions are performed. The
addition, deletion or substitution of one or more bases in a gene, known as a
"mutation," can alter a protein or a gene's level of expression and result in
a disease condition. For example, whether a cell is cancerous or normal may
depend upon the presence or absence of a mutation in the "p53" human cancer
suppressor gene. Similarly, scientists believe that whether an individual
develops acquired immune deficiency syndrome ("AIDS") upon infection with the
human immunodeficiency virus ("HIV") is, in part, a function of at least one
human gene sequence. Moreover, the susceptibility of a particular strain of
HIV to drug treatment may depend upon the sequence of the viral strain's
genome. Most diseases are believed to be polygenic, in that multiple genes
interact to cause or affect a disease condition. In developing a drug for a
polygenic disease like diabetes, the most effective target may be best
selected when all genes which interact to cause or affect the disease are
known.
Applications of Genomics to Understanding Disease
Detailed knowledge of gene sequences that encode missing, defective or
abnormally expressed proteins and an understanding of gene interactions in
disease conditions offer the potential to develop novel therapeutic products
and diagnostic tests. Genomics provides the basis for developing drugs
designed to replace missing or defective proteins or to deactivate or limit
the effect of proteins that are present at excessive levels. Drugs also may be
designed to supplement proteins produced by normal genes. For example, anemia
can be treated by injecting a patient with EPO, a protein that stimulates the
production of red blood cells. Drugs also may be designed to remedy the
effects of defective genes by affecting their expression. In addition,
diagnostic tests for diseases can be developed by determining gene sequences
that predispose individuals to gene-related diseases.
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Several genomic applications, including (i) polymorphism screening, (ii)
gene expression level studies, (iii) motif searches, and (iv) gene
identification, can provide critical insight into understanding disease and
developing for rapeutic products and diagnostic tests. Polymorphism screening
involves sequencing the same gene in each member of a population of healthy
and diseased individuals to find naturally occurring variations or
"polymorphisms" in the gene sequence and correlating those polymorphisms with
the disease condition. Expression level studies compare the levels at which
genes are expressed in healthy and diseased individuals to correlate
differences with the disease condition. Motif searches, the screening of DNA
samples for short DNA segments that are associated with a specific function,
can be used to identify families of genes having similar functions as
potential therapeutic product candidates. Gene identification can be used to
find genes expressed at low levels. Such genes are said to be "rarely"
expressed because their corresponding mRNA is rarely found in tissue samples.
Because proteins expressed by rarely expressed genes, such as EPO, are more
effective in small quantities than proteins expressed by highly expressed
genes, they represent attractive candidates for potential therapeutic
products.
Limitations of Prevailing Technologies
Many biotechnology companies historically have been involved in the search
for genes that encode proteins with functions known to have commercial value.
Information from traditional genetics and molecular biology provides clues
about where to look for these genes, but the rate at which these genes can be
identified from this information is limited. The large market potential for
gene products led to the initiation of the Human Genome Project by the United
States government and to the formation of genomics companies. Given the volume
of sequence information in the human genome, genomics companies have focused
on partially sequencing human DNA that contains genes that encode proteins
(approximately 10% of all human DNA).
To date, genomics companies have relied primarily on gel-sequencing
technology to identify genes and obtain sequence information. Gel sequencing
involves the production of multiple DNA copies, each of which is successively
shorter by one base. The last base of each copy is labeled with a fluorescent
tag to identify it as an A, T, C or G. The copies are then introduced into a
gel sequencer that uses an electrical field to move the labeled copies through
a gel. The copies move through the gel at different rates, with shorter copies
moving faster than longer copies. The gel must be run for several hours to
separate the copies sufficiently to be read by a detector which identifies the
end base as an A, T, C or G as the copies move through the detector. The
sequence of the successive readouts represents the sequence of the DNA sample.
Because the readouts generated by this process may yield ambiguous
information, the gel may be run several times to ensure complete accuracy. If
a technician cannot resolve an ambiguity, the process is repeated and may
require additional treatment of the DNA sample.
Genomics companies use gel sequencing primarily to generate short sequences,
known as expressed sequence tags ("ESTs"), which assist in gene
identification. In producing ESTs, portions of mRNA sequences from tissue
samples are first copied into a form of DNA called complementary DNA ("cDNA").
An EST is then obtained by sequencing an end of the cDNA, thereby "tagging"
the cDNA. As a result, the EST is only a partial sequence of one end of a
partial copy of an mRNA. To identify new genes, genomics companies produce
large numbers of ESTs and collect them into databases. The ESTs are then
compared to sequences of known genes to determine whether a new gene may have
been identified. While gel sequencing and ESTs have generated higher volumes
of gene sequence information than other prevailing technologies, these
technologies are relatively labor intensive and time consuming, creating
limitations in throughput, flexibility of applications, accuracy and cost.
THE HYSEQ DNA ARRAY SOLUTION
The Company believes that the ability of its HyX Platform to process
millions of samples per year and sequence billions of bases per year
represents a fundamental advance in performing genomic experimentation, gene
discovery, gene function analyses and diagnostic testing in commercial-scale
volumes. The Company believes that its HyX Platform, which utilizes the
Company's proprietary SBH technology as its foundation, generates higher gene
sequence throughput with greater analytical flexibility and accuracy and lower
cost than
26
prevailing technologies. The HyX Platform includes (i) a comprehensive set of
labeled DNA probes; (ii) DNA arrays of samples and probes; (iii) three
software-driven modules comprising software and a specific configuration of
platform hardware, which enable user-driven DNA probe selection to customize
the level and type of analysis; (iv) industrial robots for screening DNA
probes against DNA samples; and (v) bioinformatic software to manage and
analyze genetic information. The HyX Platform's software-driven modules
include:
Gene Discovery Module: The Company's Gene Discovery Module is designed to
screen or sequence large numbers of human DNA samples (typically, 30,000 to
50,000 samples per batch) for correlation and comparison of such sequences
in gene discovery and genomic experimentation. The information generated by
the Gene Discovery Module is stored in the Company's proprietary HyGenomics
Database, which the Company believes is one of the largest human gene
databases in the world. This module is being used internally to identify
proprietary gene-based therapeutic candidates in the central nervous
system, cardiovascular and infectious disease areas and therapeutic product
candidates that impact cell receptors. The Company has an exclusive
collaboration with Chiron to develop therapeutics, diagnostic molecules and
vaccines relating to a specified disease area.
HyGnostics Module: The Company's HyGnostics Module is designed to screen
or sequence small to medium numbers of DNA samples (typically, 10 to 1,000
samples per batch) for diagnostic applications, including DNA testing of
genetic and infectious disease and cancer. The Company is currently
marketing its HyGnostics Module to major clinical reference laboratories,
and has entered into initial agreements with SmithKline Beecham and Quest
relating to evaluation of the HyGnostics Module for commercial-scale
diagnostic testing. In a recent blind test conducted by SmithKline Beecham,
the HyGnostics Module was 100% accurate and met or exceeded all
requirements for sensitivity, cost, speed, correct heterozygote sequencing,
reproducibility and temperature range.
HyChip Module: The Company's HyChip Module is designed to screen or
sequence DNA samples in a single reaction with a capacity ranging from the
detection of single base mutations to the sequencing of entire viral
genomes. The Company is presently using the HyChip Module internally for
research applications. The Company has an exclusive collaboration with
Perkin-Elmer to co-develop and commercialize gene-sequencing systems
targeted at specific DNA research and diagnostic applications utilizing
HyChip products and Perkin-Elmer's life science system capabilities. The
Company has conducted tests on its HyChip Module in which a set of probes
capable of complete sequencing of all mutations was applied to samples of
the HIV genome, which the Company believes is the first time such capacity
has been demonstrated. The HyChip Module also has the capacity to sequence
64,000 bases in one reaction, which the Company believes is the greatest
amount of DNA sequencing capacity demonstrated to date.
The Company believes that its HyX Platform represents a significant advance
in analyses such as gene identification, expression level determination, gene
interaction studies, polymorphism screening, diagnostic testing and genetic
mapping. As indicated in the chart below, the analyses performed on the
modules of the HyX Platform generate information for the HyGenomics Database,
which the Company intends to utilize independently and with collaboration
partners to develop potential therapeutic product candidates and diagnostics
tests.
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HyX PLATFORM APPLICATIONS IN GENOMICS
[GRAPHIC APPEARS HERE]
Figure 2 is a black and white schematic diagram entitled "HyX Platform
Applications in Genomics". From top to bottom, the diagram reads across five
tiers of boxes. At the top of the diagram is a small box labeled "Tissue
Samples". An arrow extends from this box and points to a large box labeled
"Hyseq's Fully Integrated, Industrial Scale Genomics Platform" with three
subheadings listed as follows: "Gene Discovery Module, "HyGnostics Module" and
HyChip Module". Six arrows extend from this box and each point to one of six
boxes, all located on the same tier. The six boxes are labeled as follows:
"Motif Searching", Gene Identification", "Expression Level Determination",
"Gene Interaction Studies", "Polymorphism Analysis' Diagnostics" and "Genetic
Mapping". Each of these six boxes has a doubled headed arrow which points to
one box situated at the next tier below the six boxes and this box is labeled
"HyGenomics Database". Two arrows point down from the "HyGenomics Database"
box to one of two boxes situated on the last tier; one box is labeled
"Therapeutic Target and Product Opportunities" and the other box is labeled
"Diagnostic Test Opportunities".
ADVANTAGES OF THE HyX PLATFORM
Higher Throughput
Ability to Obtain More Gene Targets for Monogenic and Polygenic
Diseases. Researchers have focused primarily on identifying single genes that
may be involved in a disease due to throughput limitations of prevailing
technologies. While this may be an effective approach to understanding
monogenic disorders in which one gene is the predominant cause of a disease,
most diseases are believed to be polygenic. The Company believes that the
Hyseq gene sequencing approach provides researchers with the first industrial-
scale tool for comprehensively analyzing gene identities and expression levels
in a cell or tissue. Similarly, effective gene interaction studies that
identify genes involved in polygenic diseases under various conditions require
the ability to process millions of cDNAs. The HyX Platform's Gene Discovery
Module presently is analyzing human tissue samples at a rate of approximately
400,000 partial gene sequences per month, representing approximately 50% of a
module's current capacity. The Company believes that this high capacity gives
it an advantage in performing effective gene identification and gene
interaction studies, which are required to obtain gene targets on an
industrial scale. The Company believes that these capabilities enhance the
ability of researchers to focus on multiple genes involved in a disease.
Ability to Effectively Conduct Polymorphism Screening. Genes correlated with
disease may be sequenced to identify polymorphisms in an attempt to understand
what significance, if any, mutations may have. Polymorphism screening for such
polygenic diseases typically involves sequencing many genes, some or all of
which may be thousands of bases in length, from thousands of healthy and
diseased individuals. An
28
understanding of polygenic disease also requires analysis of gene interactions
that cause or affect the disease. The Company believes that effective
polymorphism screening, which is an element of genomic experimentation and
diagnostic testing, requires the ability to sequence billions of bases per
year. The Hyseq Gene Discovery Module presently can analyze batches of
approximately 30,000 to 50,000 DNA samples that can be 1,000 bases
in length each (up to approximately 50,000,000 total bases per batch). By
comparison, gel sequencers presently can analyze batches of approximately 75
DNA samples that each can be up to 500 bases in length (up to approximately
37,500 total bases per batch).
Identification of Rarely Expressed Genes. Scientists believe that rarely
expressed genes encode regulatory proteins of all kinds, including receptors
and hormones. Because rarely expressed genes are represented by far fewer
copies of mRNA in a given tissue sample than highly expressed genes, large
numbers of cDNAs may have to be analyzed before the cDNA of a rarely expressed
gene is found. The Company believes that its high throughput significantly
enhances its ability to analyze the large number of cDNAs necessary to find
rarely expressed genes. Out of the hundreds of thousands of mRNAs present in a
typical tissue sample, only a few copies of mRNA for rarely expressed genes
are present. The Hyseq Gene Discovery Module is capable of identifying a copy
of mRNA that appears only once per cell in such a tissue sample.
Diagnostics. A gene involved in a disease like cystic fibrosis may be
thousands of bases long and can contain disease-causing mutations at any one
or more of hundreds of locations. Accurately diagnosing such a disease can
often depend upon complete sequencing of the gene. Moreover, accurately
diagnosing polygenic diseases such as diabetes may require sequencing of
several genes. The Company's HyGnostics Module can completely sequence genes
such that all mutations are identified. The high throughput of the HyGnostics
Module also allows many genes from the same sample to be sequenced in a single
batch, thereby facilitating diagnosis of polygenic disorders. The Company
believes that these features make the HyGnostics Module particularly useful in
commercial-scale diagnostic applications.
Greater Flexibility
Functional Analyses. The Company believes that determining a gene's function
is a critical step in patenting and commercializing a gene or gene product.
The Company believes that the flexibility of the Hyseq Gene Discovery Module,
which allows researchers to obtain the appropriate level of functional
information from motifs, gene expression studies and complete sequences, is
expected to accelerate the characterization of function. Unlike prevailing
technologies, the HyX Platform's ability to sequence genes at multiple levels
of completeness makes it appropriate for a large number of therapeutic and
diagnostic applications. Using software commands, the level of completeness
can be adjusted from intermittent sequencing for gene identification and
expression level determination to partial sequencing for motif searches to
complete sequencing for diagnostics. For example, in scanning sequences
associated with a growth factor function, the Company can screen millions of
DNA samples for the presence of a growth factor motif without completely
sequencing the samples.
Expansion of Diagnostics Applications. The flexibility of the HyGnostics
Module is derived from simple software commands that allow the user to rapidly
add new DNA tests or new mutations to existing tests on one platform with one
set of supplies, rather than using systems supplied by multiple vendors. This
one-platform approach enables the user to screen for mutations and sequence
the identified mutation on a single platform and enables the user to introduce
new tests in response to market demand. Unlike biochip approaches which are
test-specific and require development of a new biochip for each modification
or for each new test, the HyGnostics Module's software allows the user to
perform multiple tests for multiple targets (e.g., both the CF gene and HIV)
in one batch without any hardware or biochip modifications.
High Degree of Accuracy
The Company believes that SBH is highly accurate because SBH technology
compiles multiple overlapping sequences of bases for each DNA sample, thereby
providing multiple verifications of each base in a sequence in
29
one run as opposed to the three to eight runs typically required for
comparable accuracy in gel sequencing. Accuracy is critical in patenting genes
because a patent claim containing inaccurate sequence information can nullify
the protection intended by the patent. In diagnostics, accuracy is critical to
avoiding misdiagnoses and
possible injury to patients. Based in part upon a blind test conducted by
SmithKline Beecham, the Company believes that its Gene Discovery and
HyGnostics Modules produce complete sequences with significantly better
accuracy per run than gel sequencing. Additionally, the Company's HyGnostics
and HyChip Modules can accurately sequence mutations in the form of insertions
or deletions of bases. See "--Technology."
Greater Cost Effectiveness
Based on the Company's cost and cost information for gel sequencing reported
in commercial and scientific publications, the Company believes that it can
identify genes and produce complete DNA sequences at a lower cost than gel
sequencing. Overall, the Hyseq modules require less labor than gel sequencing,
in part because of the elimination of multiple steps involved in sample
preparation and interpretation. Hyseq can analyze approximately twice the
amount of DNA bases per sample in batches containing, on average, over 1,000
times the total number of bases per batch as gel sequencing. Moreover, the
Company's modules can sequence DNA samples significantly faster per batch than
current gel sequencers.
STRATEGY
Hyseq's strategy is to engage in large-scale gene discovery and to establish
collaborations to facilitate development and commercialization activities.
Hyseq believes that this research- and partner-driven approach may create
significant operational and financial advantages for the Company and
accelerate commercial development of new therapeutic and diagnostic products.
The following are key elements of the Company's strategy.
Therapeutics
Discover Gene-Based Pharmaceutical Candidates and Commercialize Them Through
Collaboration Partners. Hyseq presently is concentrating on generating
proprietary product candidates in areas where a gene sequence can be directly
used in manufacturing pharmaceuticals. Products may include therapeutic
proteins and gene therapy and diagnostic product candidates that the Company
intends to transfer to collaboration partners for bioassays, protein
expression, regulatory review, manufacturing and marketing. The Company is
focusing initially on candidates that affect cell receptors and certain
central nervous system, cardiovascular and infectious diseases.
Establish Collaborations for Disease-Specific Programs. The Company is
pursuing selected collaborations with pharmaceutical and biotechnology
companies to discover, develop and commercialize new product candidates in
narrowly defined disease categories. The Company seeks collaboration partners
with expertise in expression, bioassays, preclinical and clinical regulatory
review and marketing. To enhance profitability in the near term, the Company
intends to seek revenues in the form of up-front and milestone payments and
database access fees. To enhance revenues in the long term, the Company
intends to seek royalties on sales of products resulting from the
collaborations. The Company has an exclusive collaboration with Chiron to
develop therapeutics, diagnostic molecules and vaccines relating to a
specified disease area. See "--Collaborative and Other Arrangements--Chiron
Corporation," regarding the Company's collaboration with Chiron.
Implement Commercial-Scale Genomic Experimentation. The Company believes
that the ability of its HyX Platform to process millions of samples per year
and sequence billions of bases per year represents a fundamental advance in
DNA sequencing analysis that enables genomic experimentation in commercial-
scale volumes. Hyseq's strategy is to leverage this genomic experimentation
capacity by screening large numbers of samples for expression levels from
cells under various conditions in order to correlate disease conditions with
genetic changes and by large-scale partial sequencing of samples to find
disease-related polymorphisms. The Company believes that the resultant rapid
expansion of its HyGenomics Database will provide the Company and its
collaboration partners a competitive advantage in patenting and
commercializing gene-based pharmaceutical products.
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Diagnostics
Expand Marketing of the HyGnostics Module for Diagnostic Testing. The
Company seeks to become a leader in the field of DNA sequence diagnostics by
expanding its HyGnostics Module licensing program for clinical reference
laboratories. The HyGnostics Module permits multiple DNA analyses, including
sequencing
diagnostics, point mutation detection, population screening, gene sequencing
and confirmatory assays on an integrated platform, which the Company believes
can replace proprietary technologies from multiple vendors. The Company
believes that licensing of the HyGnostics Module and diagnostic tests may
offer near-term and intermediate sources of product revenues. The independent
clinical reference laboratory market is highly concentrated in three
companies, LabCorps, Quest and SmithKline Beecham, which account for
approximately 42% of that market. The Company believes that in the near and
intermediate term such genetic tests will be predominately performed by large
clinical reference laboratories which have the resources to introduce, market
and support such tests. The Company presently has initial agreements with
SmithKline Beecham and Quest relating to evaluation of its HyGnostics Module
for commercial-scale diagnostic testing.
Market HyGnostics Module for Accelerating Clinical Trials. As part of its
HyGnostics licensing program, the Company intends to design and market
diagnostic tests for use by companies in qualifying participants for clinical
trials. In the pharmaceutical industry, the availability of diagnostic tests
which allow patients to be genetically profiled for response to a therapeutic
product and to proactively profile patients at risk for major diseases offers
the potential to dramatically reduce the cost and time of the pharmaceutical
development cycle. Such diagnostic tests also can be effective in diagnosing
and monitoring patients once the drugs are approved. The Company believes that
tests for accelerating clinical trials may provide near-term and intermediate-
term sources of revenue.
Commercialize HyChip Products Through Collaborations. Hyseq presently is
using the HyChip Module internally for a variety of research applications. The
Company has identified numerous diagnostic and research applications that
require sequencing large amounts of DNA per sample, including sequencing of
entire viral genomes. The Company is collaborating with Perkin-Elmer to
commercialize HyChip products targeted at specific DNA research and diagnostic
applications. The Company believes Perkin-Elmer's expertise in the design,
manufacture and marketing of scientific instruments for research and
diagnostics will allow the Company to significantly accelerate HyChip product
development. The Company and Perkin-Elmer intend to market HyChip products so
as to receive revenues from sales of HyChip systems and from royalties on
products discovered using HyChip products. See "--Collaborative and Other
Arrangements."
TECHNOLOGY
The HyX Platform
The HyX Platform combines the Company's DNA array technology with software-
driven flexibility for therapeutic candidate discovery and diagnostic testing.
The HyX Platform, which utilizes the Company's proprietary SBH technology as
its foundation, provides a range of genomic applications on one integrated
platform, including gene identification, expression level determination, gene
interaction studies, polymorphism screening, diagnostic testing and genetic
mapping. The HyX Platform includes (i) a comprehensive set of labeled DNA
probes; (ii) DNA arrays of samples and probes; (iii) three software-driven
modules comprising software and a specific configuration of platform hardware,
which enable user-driven probe selection to customize the level and type of
analysis; (iv) industrial robots for screening DNA probes against DNA samples;
and (v) bioinformatic software to manage and analyze genetic information. The
Company's Gene Discovery Module is designed for discovery and functional
analysis of potential therapeutic product candidates. The Company's HyGnostics
Module is designed for use by clinical reference laboratories for diagnostic
testing of genetic and infectious diseases and cancer. The Company's HyChip
Module is being used internally for research applications and is being
developed for commercial applications targeted at specific DNA research and
diagnostic applications. The Company purchases the probe, computer and robot
components of the HyX Platform from outside vendors. All components are
available from multiple vendors. See also "--Licensed Technology."
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SBH Technology
In the versions of SBH technology presently used by the Company, DNA
sequences are determined by "hybridizing" or binding labeled DNA probes (short
fragments of chemically tagged DNA which have known sequences) to DNA samples.
Using Hyseq's proprietary software, labeled DNA probes are selected from the
Company's comprehensive set of DNA probes and screened against DNA samples.
The labeled probes used on a given DNA array are selected and applied in a
highly automated and proprietary software-controlled process, giving users
flexibility in directing the type and level of analysis to be performed. Each
labeled probe binds to segments of a DNA sample that have matching or
"complementary" sequences. Upon completion of the hybridization process, the
sequences of the labeled probes that bind to the sample are overlapped to form
columns of identical bases. Reading the base in each column, Hyseq's
proprietary bioinformatics then assembles a DNA sample's sequence. The
redundancy created by overlapping multiple DNA probes generates highly
accurate DNA sequence information. The DNA sequence information from the
sample enables the Company to track a gene's role and activity in disease
conditions and, hence, to evaluate the gene as a potential therapeutic or
diagnostic product candidate.
THE HYBRIDIZATION AND SEQUENCE ASSEMBLY PROCESS
[GRAPHIC APPEARS HERE]
Figure 3 is a black and white schematic diagram entitled "The Hybridization
and Sequence Assembly Process". From left to right, the diagram reads across
four stations. The first station, on the leftmost side of the diagram, has
three vertical, parallel lines, two of which represent a sample of DNA as two
single strands, and a third line, which is placed between the two strands of
DNA, which represents a probe hybridized to one of the DNA strands. A sunburst
figure is placed at the base of the third line to represent a label attached
to the probe. An arrow from this station points to a second station which is a
box with a list of probe DNA sequences which hybridize to the DNA sample. An
arrow from the second station points to the next station which is a box with a
list of the probes' DNA sequences maximally overlapped. An arrow from this
station points down to the fourth station which is a box with a unique
assembled DNA sequence obtained by reading down each column in the third
station.
DNA Arrays
The HyX Platform uses industrial robots to print DNA arrays onto substrates
such as glass, plastic or paper. The HyX Platform presently uses two types of
DNA arrays: (i) DNA sample arrays with unknown sequences in its Gene Discovery
and HyGnostics Modules; and (ii) DNA probe arrays with known sequences in its
HyChip Module, to which a sample and one or more labeled probes are applied.
Tissue samples, such as blood or biopsy tissues, are prepared by using
standard biochemical methods for use with any of the Company's DNA arrays.
Gene Discovery Arrays. The Gene Discovery array is designed to identify, map
and sequence large numbers of DNA samples within genomes and to correlate and
compare such sequences in gene discovery. The Gene Discovery Module
robotically prints an array of 30,000 to 50,000 DNA samples and then applies a
labeled probe or a set of probes of known sequence to each array. After
washing the array to remove unbound probes
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and determining which known probes have hybridized to the DNA sample, an SBH
process assembles the sequence of that sample. The Company is using this type
of array in generating proprietary product candidates that affect cell
receptors or that are candidates in disease categories including certain
cancer, central nervous system, cardiovascular and infectious diseases.
HyGnostics Arrays. The HyGnostics array is designed to perform complete
sequencing of small to medium numbers of DNA samples. The HyGnostics Module
robotically prints duplicate arrays of 10 to 1,000 DNA samples, with each
array being printed inside a square of a grid that prevents fluid leakage from
one square to another, and then applies a labeled probe or set of probes to
each array. After washing the arrays, the known
sequence of any labeled probe that binds to a sample in the array is used in
an SBH process to assemble the sequence of that sample. The Company is
marketing the HyGnostics Module to clinical reference laboratories for the
testing of genetic and infectious disease and cancer.
HyChip Arrays. The HyChip array is designed for gene discovery and
diagnostic applications that require analysis of DNA samples in a range of
lengths, from detecting single base mutation to the sequencing of entire viral
genomes. The HyChip Module robotically prints duplicate arrays of different
unlabeled DNA probes on a substrate (the "chip" component of the HyChip
Module). The sequence of each unlabeled probe is known for each point in the
array. A DNA sample, a labeled probe or set of probes and a chemical linking
agent are applied to each array. The sample then hybridizes to a substrate-
bound unlabeled probe and a free-floating labeled probe. The two probes
hybridize to the sample end-to-end and are bound together by the chemical
agent. After washing the arrays, the combined known sequences of the labeled
probe and the unlabeled probe to which it is linked are used in an SBH process
to assemble the sequence of the sample. The HyChip Module currently is being
used internally for research applications, while being developed for
commercial applications.
HyX PLATFORM
[GRAPHIC APPEARS HERE]
Figure 4 is a black and white schematic diagram entitled "The HyX Platform".
The diagram is arranged as three boxes, two of which are juxtaposed to each
other and a third box is placed below and centered between the two upper
boxes. A line with a sunburst image placed at one end of the line is situated
between the two upper boxes and is labeled "Labeled Probe Set". Three arrows
point from the Labeled Probe Set to one of the three boxes. The upper left box
is an image of laboratory results and is labeled "Gene Discovery Module". The
upper right box is an image of laboratory results and is labeled "HyGnostics
Module". The lower center box is an image of laboratory results and is labeled
"HyChip Module".
THE HYX PLATFORM--The comprehensive set of labeled probes is a common
element among the types of DNA arrays currently being used by Hyseq.
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Probe Selection
Hyseq's proprietary probe selection software gives users the flexibility to
select any combination of probes tailored for a given sample or genomic
application. For example, a technician can select the Gene Discovery Module
motif-searching application or the HyGnostics Module for complete sequencing.
The technician's selection is transmitted to an industrial robot that locates
appropriate probes from Hyseq's comprehensive collection of labeled probes and
then pipettes selected probes into multi-well plastic plates. By comparison,
other biochip approaches require hardware changes, in some cases including
design and retooling to manufacture new hardware, in order to switch among
applications.
Instrumentation
The multi-well plastic plate with the selected probes and one of the
Company's sample-containing DNA arrays are introduced into a proprietary
robotic hybridization station. The hybridization station applies the labeled
probes to the DNA array, incubates them for a programmed period of time and
then washes the unbound probes away. The DNA array with bound labeled probes
is transferred to a reader that detects the labeled probes' locations in the
array and transmits the data through a local area workstation network for
sequence assembly. The Company uses robots and readers with proprietary
modifications for integration into the Company's HyX Platform.
Bioinformatics
The HyX Platform's sophisticated proprietary image analysis software can
extract as much as 50,000 sequence information bits in less than three
minutes. Data is stored in the Company's proprietary HyGenomics Database,
which the Company believes is one of the largest human gene databases in the
world. The Company believes that the HyGenomics Database's design facilitates
commercial-scale genomic experimentation by providing capabilities for rapidly
processing, storing, retrieving and analyzing biological information and for
manipulating that information. The Company's proprietary software also
performs similarity analyses for identifying identical or related gene
samples, sequence motif identification, differential gene expression analysis
and sequence assembly. The Company's bioinformatics software allows it to
analyze and compare SBH and other data in the proprietary HyGenomics Database.
The Company presently licenses the commercially available BioMerge software
from Molecular Informatics Inc. for searching publicly available gene sequence
and EST data.
APPLICATIONS OF THE HyX PLATFORM
Therapeutics
Gene Discovery. To identify the best potential therapeutic and diagnostic
product candidates, the Company is analyzing selected human tissues to
discover disease-related human genes and their functions. In addition to
screening for highly expressed genes, the Company is focusing on screening for
rarely expressed genes in these tissues. By obtaining information about the
degree to which a small number of probes hybridize to a cDNA, the HyX Platform
generates a unique intermittent partial sequence called a "signature" for that
cDNA. The Company uses signatures for identifying genes and for characterizing
their functions. Because the signatures are spread throughout the cDNA, and
not just at its end as is the case with ESTs, the Company believes that the
signature process is more accurate than the EST process in determining the
identity of a cDNA and, as a result, whether it represents a known or new
gene. By comparing such signatures, the number of identical, similar and
different cDNAs can be determined and inventoried. The Company presently is
analyzing human DNA samples at a rate of approximately 400,000 partial gene
sequences per month, representing 50% of the Gene Discovery Module's present
capacity.
Expression Monitoring. The relative gene expression levels corresponding to
cDNAs can be determined by comparing the number of copies of each signature
found in collections of cDNA samples such as those obtained from diseased and
normal tissues or before and after drug administration. Hyseq's signature
analysis
34
differs from other technologies in that it can provide both identity and
expression level information in one analysis on a single platform.
Furthermore, unlike other approaches, expression levels of all expressed genes
can be determined. The Company believes that its high-throughput screening of
large DNA sample libraries may enable it to determine a gene's function by
examining the gene's pattern of expression. For example, a gene expressed in
the human prostate during the early stages of cancer, but not expressed in
other tissues or at other times, may be a marker for the cancer and may
provide insights into the biological mechanism of the cancer. The Company
currently is analyzing hundreds of thousands of DNA samples from a number of
tissue types to determine relative gene expression levels.
HyGenomics Database. The Company compiles DNA sequence information generated
by its modules in its HyGenomics Database where the information is compared
against other sequences in the database and sequences of known genes and
proteins in public databases. The Company believes that information generated
by these comparative analyses may facilitate the development of potential
therapeutic products and diagnostic tests. The Company intends to collaborate
with collaboration partners to develop products based on genetic information
in its HyGenomics Database. The Company believes that its HyGenomics Database
of partial gene sequences is one of the largest proprietary human gene
databases in the world.
Polymorphism Screening. By correlating a polymorphism with a specific
condition, polymorphism screening can be used to determine the significance of
gene regions to the function of the gene as a whole. This correlation assists
in targeting pharmaceuticals to appropriate regions of gene products (e.g., to
a binding site of a receptor). In a polymorphism study, the more types of
sequences that are screened, the more information regarding variability is
obtained. Hyseq's high-throughput Gene Discovery Module is designed to
sequence tens of thousands of samples simultaneously. The Company believes
that conducting a successful polymorphism study requires the ability to
sequence billions of bases per year, which the HyX Platform can provide more
cost-effectively than other technologies.
Genetic Mapping. Genetic mapping is a method for linking diseases to
particular genes by correlating the presence or absence on chromosomes of
predetermined DNA sequences, known as markers, with a genetic trait.
Researchers attempt to locate genes by using markers in conditions such as
diabetes, asthma and cardiovascular disease. Tissue samples and histories from
families with members who have the disease are analyzed by comparing the
patterns of markers between healthy and diseased family members. A correlation
of a marker with a disease indicates that a gene or genes involved in the
disease is located near the marker. The more markers that are available, the
more likely it will be that a disease will be correlated with at least one of
these markers. The usual marker linkage process is labor intensive and
requires significant computational capabilities. The Company believes that its
ability to sequence and analyze billions of bases per year will generate
substantial numbers of markers, including markers consisting of entire gene
sequences, thus facilitating linkage of genes with disease.
Diagnostics
The Company believes that the ability of its DNA array technology to detect
gene mutations with a high level of accuracy broadens the scope of diagnostic
applications of its HyGnostics Module and can provide diagnostic tests on a
commercial scale more quickly and at a lower cost than other technologies.
Hyseq currently is marketing its HyGnostics Module for diagnostics testing of
genetic and infectious disease and cancer primarily to clinical reference
laboratories. In October 1995, the Company's wholly owned subsidiary, Hyseq
Diagnostics, Inc., entered into an initial agreement with SmithKline Beecham,
one of the nation's leading clinical reference laboratories. The agreement,
among other things, provides for the granting of a non-exclusive license to
use the HyGnostics Module in the United States for testing human genetic
disease and cancer. In May 1997, the Company entered into an initial agreement
with Quest relating to evaluation of the HyGnostics Module for commercial-
scale diagnostic testing. See "--Collaborative and Other Arrangements."
Cancer. An estimated 1.35 million new cases of cancer will be diagnosed in
1997 in the United States and approximately 530,000 people will die from
cancer in 1997. Colorectal, breast, prostate and lung cancer
35
account for about half of all cancer diagnoses. The normal protein product of
the p53 gene controls cell replication, but a mutation in the gene may
contribute to the aggressive growth of some cancers, including colorectal,
breast and bladder cancers. Mutations have been observed at more than 400
distinct sites in the p53 gene. Currently available antibody-based diagnostic
tests detect accumulation of p53 gene products, but not gene mutations, and
gel-sequencing methods are impractical because mutations occur over a large
area requiring many gels to be processed. Other biochip approaches are
reported to be under development for research purposes, but these approaches
reportedly are unable to sequence certain types of mutations and therefore may
be less reliable than gel sequencing. As a result, these methods have thus far
been unable to provide a practical prediction of susceptibility to cancer or
the rate of cancer progression, which would be valuable for determining an
appropriate cancer therapy.
The Company is currently developing cancer DNA sequencing tests for future
commercialization. The HyGnostics Module can apply any combination of its DNA
sequence probes to determine the gene sequences of patient samples. In a
recent blind test administered by SmithKline Beecham and designed to sequence
p53 samples, the HyGnostics Module was 100% accurate and met or exceeded all
requirements of the test for sensitivity, cost, speed, correct heterozygote
sequencing, reproducibility and temperature range. The results were
reproducible within and between runs. All types of mutations (substitutions,
insertions and deletions) were correctly sequenced, generating no false
positives or false negatives.
Infectious Diseases. The Company believes that its proprietary DNA array
technology has the potential to significantly improve the understanding of
infectious diseases and thereby advance their diagnosis and treatment. Hyseq
currently is using a version of the HyChip Module internally for research
applications and is developing HyChip products for commercial applications
with Perkin-Elmer. The Company is currently developing an HIV test for
commercial use. Over 3.1 million individuals worldwide were estimated to be
infected with HIV in 1996. Approximately 75,000 individuals in the United
States were diagnosed with AIDS in 1996. Mutations in the HIV genome have been
correlated with the success of various therapies, and rapid mutation in the
HIV genome is an indicator of progression of the disease. Using the HyChip
Module, the Company has conducted tests in which it has scored all one million
possible probes 10 bases in length on HIV sequence samples. The Company
believes this is the first time that a set of probes capable of complete
sequencing of all mutations has been reported to be applied to HIV sequence
samples.
COLLABORATIVE AND OTHER ARRANGEMENTS
Chiron Corporation. In May 1997, the Company entered into an exclusive
collaboration with Chiron. Pursuant to the terms of the collaboration
agreement, the Company and Chiron are collaborating to develop therapeutics,
diagnostic molecules and vaccines relating to a specified disease area (the
"Disease Area"). The collaboration has an initial term of three years and can
be extended at Chiron's option for two additional two-year periods. Chiron
paid a nonrefundable $1 million up-front licensing fee upon signing the
agreement and guaranteed payment of a minimum of $8.5 million in the first
year and $5.5 million in each of the two years thereafter in connection with
the Company's research on Chiron tissue sample libraries. The agreement
requires the Company to generate data at a specified level per year which, if
not met, could result in the Company's breach of the agreement. Chiron has the
exclusive right to commercialize any Disease Area products resulting from the
collaboration. The Company will receive royalties on any such products.
Pursuant to the terms of a stock purchase agreement, Chiron concurrently
acquired 396,825 shares of Common Stock issuable upon the conversion of shares
of Series B Preferred Stock at $12.60 per share (based on the initial public
offering price of $14.00 per share in this offering) for a total investment of
$5.0 million. The Series B Preferred Stock will convert automatically into
Common Stock on a 1.18-for-1 basis immediately prior to the completion of this
offering, which Common Stock will split on a 1.92-for-1 basis. Concurrent with
this offering, Chiron has agreed to purchase 185,048 shares of Common Stock
(based on the initial public offering price of $14.00 per share in this
offering) directly from the Company in the Private Placement at a price per
share equal to the price to public, less one-half of the underwriting
discounts and commissions applicable to the shares of Common Stock being
offered to the public hereby, for an aggregate purchase price of $2.5 million.
36
The Perkin-Elmer Corporation. In May 1997, the Company entered into an
agreement with Perkin-Elmer to combine the Company's super chip technology and
Perkin-Elmer's life science system capabilities to commercialize HyChip
products (collectively, the "HyChip System"). Pursuant to the terms of the
agreement, the Company is obligated to commit $5.0 million to further
development of the Company's "chip" component of the HyChip System over the
next two years, and Perkin-Elmer must commit certain funds to develop the
overall system. The collaboration has an initial term of five years and will
be extended automatically thereafter unless the parties mutually agree to
termination. The agreement contemplates that the design, development and
manufacture of the HyChip "chip" will be under the direction of the Company,
while design, development and manufacture of the system will be under the
direction of Perkin-Elmer. HyChip products will be distributed through Perkin-
Elmer's Applied Biosystems Division. In June 1997, Perkin-Elmer acquired
396,825 shares of Common Stock issuable upon the conversion of shares of
Series B Preferred Stock at $12.60 per share (based on the initial public
offering price of $14.00 per share in this offering) for a total investment of
$5.0 million. The Series B Preferred Stock will convert automatically into
Common Stock on a 1.18-for-1 basis immediately prior to the completion of this
offering, which Common Stock will split on a 1.92-for-1 basis. Concurrent with
this offering, Perkin-Elmer has agreed to purchase 370,096 shares of Common
Stock (based on the initial public offering price of $14.00 per share in this
offering) directly from the Company in the Private Placement at a price per
share equal to the price to public, less one-half of the underwriting
discounts and commissions applicable to the shares of Common Stock being
offered to the public hereby, for an aggregate purchase price of $5.0 million.
See "--Government Regulation."
SmithKline Beecham Clinical Laboratories, Inc. In September 1995, the
Company entered into an initial agreement with SmithKline Beecham. The
agreement, among other things, required an up-front payment to the Company and
grants SmithKline Beecham a non-exclusive license to use the HyGnostics Module
in the United States for testing human genetic disease and cancer upon
satisfaction of certain conditions by the Company and payment of a license fee
by SmithKline Beecham. Under the conditions, which were satisfied in February
1997, SmithKline Beecham administered a blind test designed to sequence p53
samples. The HyGnostics Module was 100% accurate and met or exceeded all
requirements of the test for sensitivity, cost, speed, correct heterozygote
sequencing, reproducibility and temperature range. All types of mutations
(substitutions, insertions and deletions) were correctly sequenced, generating
no false positives or false negatives. The agreement expires in October 1997
unless SmithKline Beecham pays the license fee. The Company and SmithKline
Beecham are discussing possible modifications to, and expansion of, their
relationship under the agreement. As of June 30, 1997, the Company had
received a total of $200,000 from SmithKline Beecham.
Quest Diagnostics Incorporated. In May 1997, the Company entered into an
initial agreement with Quest pursuant to which the Company is performing an
evaluation project for Quest. The Company received a total of $75,000 from
Quest under the initial agreement. Depending upon the results of the
evaluation, Quest will continue negotiation of a non-exclusive license from
the Company.
The National Institute of Standards and Technology. In November 1994, the
Company was awarded a three-year, $2.0 million grant from The National
Institute of Standards and Technology ("NIST"). Funds received from NIST are
being applied to develop the Company's super chip technology, which is being
used in the HyChip Module. As of May 31, 1997, the Company had received a
total of approximately $1.4 million from NIST. The Company expects to receive
and apply the balance of the NIST grant in 1997. See "--Licensed Technology."
Conservation International, Inc. In February 1997, the Company entered into
an agreement with Conservation International, Inc. ("CII"), an environmental
conservation organization, to search for genetic products with commercial
potential. Pursuant to the terms of the agreement, the Company will focus on
initial areas of interest for further development with potential corporate
partners, with the initial focus being on rain forest species. CII will
provide research and other assistance in identifying potential products for
consideration and has received an initial $30,000 payment from the Company for
research relating to a specified product. The Company and potential corporate
partners will be responsible for all costs of development. The Company
37
believes that rain forest genetic information may be an important source of
genetic variety for developing new drugs and agricultural products.
COMPETITION
The Company believes that virtually all genes in the human genome will be
identified within several years. However, the Company believes that
determination of function, rather than identification, will be the primary
driver of competition in genomics since function is a critical element in
obtaining patent protection with respect to gene discovery and
commercialization. The Company believes that its primary competitors in
genomics are Human Genome Sciences, Inc. and Incyte Pharmaceuticals, Inc.,
which are using gel sequencers as part of their gene sequencing efforts. A
number of other companies engage in, or have announced plans to engage in,
gene discovery and have acquired, or could acquire, gel sequencers or other
technologies, or may develop alternative procedures for gene sequencing. Such
competitors may include major pharmaceutical and biotechnology firms and other
companies, not-for-profit entities and United States and foreign government-
financed programs, many of which have substantially greater research and
product development capabilities and financial, scientific, marketing and
human resources than the Company. These competitors may succeed in identifying
genes and determining their functions or developing products earlier than the
Company or its current or future collaboration partners, obtaining patents and
regulatory approvals for such products more rapidly than the Company or its
current or future collaboration partners, or developing products that are more
effective than those proposed to be developed by the Company or its
collaboration partners.
The Company believes that its ability to compete in genomics is dependent,
in part, upon its ability to continue to improve the HyX Platform to permit
more rapid identification of genes while improving its bioinformatics capacity
for analyzing gene sequences and identifying the possible function of the
genes sequenced. While the Company believes that its HyX Platform provides a
significant competitive advantage, any one of the Company's competitors may
discover and establish a patent position in one or more genes which the
Company has identified and designated as a product candidate. Loss of its SBH
patent rights also could remove a legal obstacle to competitors in designing
platforms with similar competitive advantages. Further, any potential products
based on genes identified by the Company ultimately will face competition both
from companies developing gene-based products and from companies developing
other forms of treatment for diseases which may be caused by, or related to,
genes identified by the Company. There can be no assurance that research and
development by others will not render the products which the Company or its
collaboration partners may develop, obsolete or uneconomical or result in
treatments, cures or diagnostics superior to any therapy or diagnostic
developed by the Company or its collaboration partners, or that any therapy
developed by the Company or its collaboration partners will be preferred to
any existing or newly developed technologies. Competition in this field is
expected to intensify.
In the area of diagnostics, the Company competes primarily with Affymetrix,
Inc. ("Affymetrix"). See "--Litigation," regarding the Company's litigation
against Affymetrix. Additionally, although the Company is collaborating with
Perkin-Elmer to develop HyChip products for commercial applications, the
Applied Biosystems division of Perkin-Elmer presently markets gel sequencers
that are used by third parties to compete with the Company in gene discovery
and diagnostics. The Company believes that its ability to compete in
diagnostics will depend primarily upon its continued ability to demonstrate
that the HyGnostics Module can provide higher levels of accuracy and a lower
cost per test for clinical reference laboratories than other prevailing
technologies. Additionally, although the Company believes that the ability of
the HyGnostics Module to accommodate new tests through software modifications
will be attractive to clinical reference laboratories, biochips such as those
being marketed by Affymetrix may be competitive for certain applications. In
addition, other commercial diagnostic products from competitors or other
companies could adversely impact the Company's ability to market the
HyGnostics Module or HyChip products. See "Risk Factors--Competition."
38
PATENTS AND PROPRIETARY TECHNOLOGY
Patent Rights Relating to Technology
Hyseq holds three United States patents with claims covering the method of
SBH. Hyseq also has pending several patent applications covering SBH
technology and its applications in diagnostics. If granted, these pending
applications would provide supplementary protection in related areas of
potential interest.
Patent Rights Relating to Genes
Hyseq intends to patent commercially relevant genes and ESTs obtained by SBH
technology and has filed for patent protection on a limited number of these
targets. The patenting of genes is a well recognized commercial practice in
the United States. For example, hundreds of gene targets (not including many
times that number of constructions containing genes) have been patented,
including valuable human genes such as those encoding EPO (patent owned by
Amgen, Inc.), granulocyte colony stimulating factor (patent owned by Amgen,
Inc.), tissue plasminogen activator (patent owned by Genentech, Inc.), immune
interferon (patent owned by Genentech, Inc.), interleukin-2 muteins (patent
owned by Chiron) and leukocyte interferon (patent owned by Biogen, Inc.). Many
more are claimed in patent applications, including patent applications filed
by competitors such as Human Genome Sciences, Inc.
There are certain court decisions indicating that disclosure of a partial
sequence may not be sufficient to support the patentability of a full-length
sequence. In view of these court decisions, as well as the position of the
United States Patent and Trademark Office (the "Patent Office") referred to
below, the Company believes that there is significant risk that patents will
not issue based on patent disclosures limited to partial gene sequences. Even
if patents issue on the basis of partial gene sequences, there is uncertainty
as to the scope of the coverage, enforceability or commercial protection
provided by any such patents. The Patent Office rejected patent claims
contained in a patent application filed by the National Institutes of Health
("NIH") relating to partial gene sequence ESTs produced by conventional gel
sequencing. The NIH elected not to appeal the decision. The application
generated substantial controversy in the scientific community regarding the
patentability of gene fragments and the full-length gene based on only partial
sequencing of genes, particularly in cases where the biological function of
the full-length gene is not identified. In practice, the way in which ESTs are
generated by gel sequencing does not identify complete gene sequences nor are
the ESTs readily correlated with the function of the product of the gene. The
Company believes that SBH technology enables complete sequencing of genes more
rapidly and cost effectively than other existing technologies. The Company
also believes that SBH technology will facilitate correlation between gene
sequences and gene functions. The Company therefore believes that it will take
entities using gel sequencing significantly longer to obtain information about
gene function for patenting gene sequences. Information about the function of
the gene products provides the critical information for obtaining patents that
Hyseq's competitors may lack. Hyseq believes that this information would be
useful for satisfying the current requirements for obtaining patents on genes
in the manner followed by the biotechnology companies over the past 10 years.
See "Risk Factors--Dependence upon Proprietary Rights; Risks of Infringement."
LICENSED TECHNOLOGY
In 1994, the Company acquired an exclusive license from Arch Development
Corporation, a not-for-profit corporation affiliated with the University of
Chicago that manages The Argonne National Laboratories ("Argonne"), to further
develop and use certain SBH super chip improvements developed by one of the
Company's chief scientists while he was at Argonne. The Company must commit a
total of $2.5 million, directly or indirectly, through grants and other
sources of funding, to the development of super chip improvements through June
30, 1998. In addition, the Company must pay royalties commencing in July 1997.
The Company is applying the proceeds of a three-year, $2.0 million NIST grant
to development of super chip technology. The Company's HyChip Module, which is
being developed for commercial applications with Perkin-Elmer, utilizes the
Company's super chip technology.
39
GOVERNMENT REGULATION
The FDA regulates drugs, biologics and medical devices under the Federal
Food, Drug and Cosmetic Act and other laws, including, in the case of
biologics, the Public Health Service Act. These laws and implementing
regulations govern, among other things, the development, testing,
manufacturing, record keeping, storage, labeling, advertising, promotion and
premarket clearance or approval of products subject to regulation. The Company
presently plans to develop drugs or biologicals only through collaborations
with third parties who would be responsible for obtaining regulatory approval
or clearance. Although the Company believes that its HyGnostics Module, as
presently marketed, is not subject to regulation as a medical device, the FDA
recently proposed regulations that may subject it to such regulation. The
Company believes that HyChip products sold as diagnostic products will be
subject to regulation as medical devices when commercial sales for clinical
use commence. The Company may ultimately determine to pursue directly the
development of therapeutic and other diagnostic products requiring regulatory
approval or clearance.
The Company believes that any pharmaceutical products that may be developed
by or with a collaboration partner will be regulated by the FDA as drugs or
biologicals. Additionally, any diagnostic products developed are likely to be
regulated as medical devices or biologicals. The following is a discussion of
the government regulation to which the Company or collaboration partners may
become subject.
FDA Regulation
Approval of Therapeutic Products. Generally, in order to gain FDA pre-market
approval, a company first must conduct pre-clinical studies in the laboratory
and in animal model systems to identify safety problems and to gain
preliminary information on an agent's efficacy. The results of these studies
are submitted as a part of an Investigational New Drug Application ("IND"),
which the FDA must review before human clinical trials of an investigational
drug can start. In order to commercialize any products, the collaboration
partner or the Company will be required to sponsor and file an IND and will be
responsible for initiating and overseeing the clinical studies to demonstrate
the safety, efficacy and potency that are necessary to obtain FDA approval of
any such products. Clinical trials are normally done in three phases, which
may overlap, and generally take two to five years, but may take longer to
complete as a result of many factors, including slower than anticipated
patient enrollment, difficulty in finding a sufficient number of patients
fitting the appropriate trial profile or in the acquisition of sufficient
supplies of clinical trial materials or adverse events occurring during the
clinical trials. After completion of clinical trials of a new product, FDA
marketing approval must be obtained. If the product is classified as a new
drug, the collaboration partner or the Company will be required to file a New
Drug Application ("NDA") and receive approval before commercial marketing of
the drug. The testing and approval processes require substantial time and
effort and there can be no assurance that any approval will be granted on a
timely basis, if at all. NDAs submitted to the FDA take, on average, two to
five years to receive approval. If questions arise during the FDA review
process, approval can take more than five years. The Company or its
collaboration partners also must demonstrate the approvability of a Biological
License Application or a Product License Application as well as an
Establishment License Application for biological products. Even if FDA
regulatory clearances are obtained, a marketed product is subject to continual
review, and later discovery of previously unknown problems or failure to
comply with the applicable regulatory requirements may result in restrictions
on the marketing of a product or withdrawal of the product from the market as
well as possible civil or criminal sanctions. For marketing outside the United
States, the collaboration partner or the Company will be
subject to foreign regulatory requirements governing human clinical trials and
marketing approval for pharmaceutical products. The requirements governing the
conduct of clinical trials, product licensing, pricing and reimbursement vary
widely from country to country and are becoming more restrictive throughout
the European Union.
Regulatory approval or clearance could include significant limitations on
the indicated uses for which a product could be marketed. The approval process
is affected by a number of factors, including the availability of alternative
treatments and the risks and benefits demonstrated in clinical trials. After
FDA approval for the initial indications, further clinical trials may be
necessary to gain approval for the use of the product for additional
40
indications. The FDA may also require post-marketing testing to monitor for
adverse effects, which can involve significant expense or result in
restrictions on the product, including withdrawal of the product from the
market. In addition, the policies of the FDA may change, and additional
regulations may be promulgated which could prevent or delay regulatory
approval. There can be no assurance that any approval or clearance will be
granted on a timely basis, if at all. In the event that a collaboration
partner fails to receive FDA clearance for a therapeutic product, the Company
may not receive revenues from the collaboration until some type of FDA
approval is received, if at all.
Approval of Diagnostic Products. In the United States, the FDA regulates, as
medical devices, most diagnostic tests and in vitro reagents that are marketed
as finished test kits or equipment. Some clinical laboratories, however,
purchase individual reagents intended for specific analyses, and, using those
reagents, develop and prepare their own finished diagnostic tests. Although
the FDA has not generally exercised regulatory authority over these individual
reagents or the finished tests prepared from them by the clinical
laboratories, the FDA has recently proposed a rule that, if adopted, would
regulate reagents sold to clinical laboratories as medical devices. The
proposed rule would also restrict sales of these reagents to clinical
laboratories certified under the Clinical Laboratory Improvement Amendments
("CLIA") as high-complexity laboratories. The Company intends to market its
HyGnostics Module and tests which may be run on the module as well as
diagnostic products primarily to clinical laboratories. The Company may market
some diagnostic products such as its HyChip products, as finished tests or
equipment and others as individual reagents; consequently, some or all of
these products may be regulated as medical devices.
The Food, Drug and Cosmetic Act requires that medical devices introduced to
the United States market, unless exempted by regulation, be the subject of
either a premarket notification clearance (known as a "510(k)") or premarket
approval ("PMA"). Some of the Company's diagnostic products may be deemed to
be medical devices and require a PMA or a 510(k). With respect to devices
reviewed through the 510(k) process, a Company may not market a device until
an order is issued by the FDA finding the product to be substantially
equivalent to a legally marketed device known as a "predicate device." A
510(k) submission may involve the presentation of
a substantial volume of data, including clinical data, and may require a
substantial review. The FDA may agree that the product is substantially
equivalent to a predicate device and allow the product to be marketed in the
United States. The FDA, however, may (i) determine that the device is not
substantially equivalent and require a PMA; or (ii) require further
information, such as additional test data, including data from clinical
studies, before it is able to make a determination regarding substantial
equivalence. By requesting additional information, the FDA can further delay
market introduction of a company's products. If the FDA indicates that a PMA
is required for any of the Company's diagnostic products, the application will
require extensive clinical studies, manufacturing information and likely
review by a panel of experts outside the FDA. Clinical studies to support
either a 510(k) submission or a PMA application would need to be conducted in
accordance with FDA requirements. FDA review of PMA applications routinely
takes significantly longer than that of 510(k) applications.
If the Company's diagnostics products are subject to FDA regulation, there
can be no assurance that the Company will be able to meet the FDA's
requirements or that any necessary approval will be received. Once granted, a
510(k) clearance or PMA may place substantial restrictions on how the device
is marketed or to whom it may be sold. Even where a device is exempted from
510(k) clearance or PMA, the FDA may impose restrictions on its marketing. In
addition to requiring clearance or approval for new products, the FDA may
require clearance or approval prior to marketing products that are significant
modifications of existing products. There can be no assurance that any
necessary 510(k) clearance or PMA will be granted on a timely basis or at all.
FDA imposed restrictions could limit the number of customers to whom
particular products could be marketed or what may be communicated about
particular products. Delays in receipt of or failure to receive any necessary
510(k) clearance or PMA could have a material adverse effect on the Company.
Customers using the Company's diagnostic devices for clinical use in the
United States may be regulated under the CLIA. CLIA is intended to ensure
quality and reliability of clinical laboratories in the United States by
mandating specific standards in the areas of personnel, qualifications,
administration, participation in proficiency
41
testing, patient test management, quality control, quality assurance and
inspections. The regulations promulgated under CLIA establish three levels of
diagnostic tests ("waived," "moderately complex" and "highly complex"), and
the standards applicable to a clinical laboratory depend on the level of the
tests it performs. CLIA requirements may prevent some clinical laboratories
from using certain of the Company's diagnostic products. Therefore, there can
be no assurances that the CLIA regulations and future administrative
interpretations of CLIA will not have a material adverse impact on the Company
by limiting the potential market for diagnostic products.
Post-Approval Requirements. Even if regulatory approvals for the Company's
product candidates are obtained, the products and the facilities manufacturing
the products are subject to continued review and periodic inspection. Each
drug and device manufacturing establishment in the United States must be
registered with the FDA. Domestic manufacturing establishments are subject to
biannual inspections by the FDA and must comply with the FDA's current Good
Manufacturing Practice ("cGMP") regulations. The Company also may be required
to comply with standards prescribed by various other federal, state and local
regulatory agencies in the United States as well regulatory agencies in other
countries. In complying with cGMP regulations, manufacturers must expend
funds, time and effort to ensure full technical compliance. The FDA
stringently applies regulatory standards for manufacturing. The Company and
its collaboration partners will need to comply with cGMP regulations to
manufacture HyChip diagnostic products for sale to third parties.
The FDA's cGMP regulations require that drugs and medical devices be
manufactured and records be maintained in a prescribed manner with respect to
manufacturing, testing and control activities. Further, the Company would be
required to comply with the FDA requirements for labeling and promotion of its
medical devices. For example, the FDA prohibits cleared or approved drugs and
devices from being marketed for uncleared or unapproved uses. In addition,
drugs and medical device reporting regulations would require that the Company
provide information to the FDA whenever there is evidence to reasonably
suggest that one of its drugs or devices may have caused or contributed to a
death or serious injury, or a medical device malfunction that has occurred
would be likely to cause or contribute to a death or serious injury if the
malfunction were to recur.
Failure to comply with applicable regulatory requirements can result in,
among other things, warning letters, fines, injunctions, civil penalties,
recall or seizure of products, total or partial suspension of production,
refusal of the government to grant approvals, premarket clearance or premarket
approval, withdrawal of approvals and criminal prosecution of the Company and
employees.
Environmental Regulation
The Company is subject to federal, state and local laws and regulations
governing the use, storage, handling and disposal of hazardous materials such
as p33, a low energy radioactive isotope used in labeling its probes and
certain waste products. Although the Company believes that its safety
procedures for handling and disposing of such materials comply with the
standards prescribed by state and federal laws and regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an
accident, the Company could be held liable for any damages that result and any
liability could exceed the resources of the Company.
FACILITIES AND EMPLOYEES
The Company leases a 12,000 square foot facility at 670 Almanor Avenue,
Sunnyvale, California, which serves as its executive offices and research and
production facility. The facility lease expires in November 1999 and requires
base payments on average of approximately $12,300 per month, subject to
standard pass-throughs and escalations. The Company expects to lease an
additional 10,000 to 15,000 square feet of space by the end of 1997 and an
additional 10,000 square feet of space by the end of 1998 to accommodate
expected increases in operations and additional full-time employees. The
Company expects to use approximately $2.0 million of the net proceeds from
this offering and the Private Placement for its anticipated facility expansion
and capital
42
equipment and lease additional space to increase sequencing capacity through
1998. As of the date of this Prospectus, the Company had approximately 75
full-time employees, including approximately 65 scientists. Fifteen employees
hold Ph.D.s or are M.D.s. No employees are represented by unions. The Company
believes that relations with its employees are good.
LITIGATION
On March 3, 1997, the Company brought suit against Affymetrix in the U.S.
District Court for the Northern District of California, San Jose Division,
alleging infringement by Affymetrix of the Company's U.S. Patents Nos.
5,202,231 and 5,525,464 (Hyseq, Inc. v. Affymetrix, Inc., Case No. C 97-20188
RMW ENE, U.S. District Court). On May 5, 1997, the Company filed an Amended
Complaint. The suit alleges that Affymetrix willfully infringed, and continues
to infringe, upon these patents covering SBH technology. Through the lawsuit,
the Company seeks both to enjoin Affymetrix from infringing upon the patents
covering SBH technology and an award of monetary damages for Affymetrix's past
infringement. On May 19, 1997, Affymetrix filed an Answer and Affirmative
Defenses to the First Amended Complaint and also filed a counterclaim against
the Company. The counterclaim seeks a declaratory judgment of invalidity and
non-infringement with respect to these patents covering SBH technology. On
June 9, 1997, the Company filed a reply to the counterclaim in which it denied
the allegation of invalidity and non-infringement. An initial case management
conference was held on August 1, 1997. While the Company believes it has made
valid claims and has a meritorious defense to the counterclaim, this
litigation is at an early stage and there can be no assurance that the Company
will prevail in the claim. The Company may incur substantial costs and expend
substantial personnel time in asserting the Company's patent rights against
Affymetrix or others and there can be no assurance that the Company will be
successful in asserting its patent rights. Failure to successfully enforce its
patent rights or the loss of these patent rights covering SBH technology also
could remove a legal obstacle to competitors in designing platforms with
similar competitive advantages.
On May 10, 1996, Sands Brothers & Co., Ltd. ("Sands") filed a suit against
the Company in the U.S. District Court for the Southern District of New York
alleging certain claims against the Company arising out of the Company's prior
engagement of Sands to act as a placement agent in a private placement. The
complaint seeks, among other things, damages in the aggregate amount of at
least $12 million. The Company filed a motion to dismiss the complaint with
the District Court on July 25, 1996. On June 30, 1997, Sands petitioned the
court for leave to file a motion for preliminary injunction. At the hearing,
also held on June 30, 1997, the court denied Sands' motion for preliminary
injunction. The court has not yet ruled on the Company's motion to dismiss.
The Company believes that the suit has no merit and that it has valid defenses
to the claims. There can be no assurance, however, that the Company will
prevail in its defense of the claims asserted by Sands. Any such failure to
prevail could have a material adverse effect on the Company's business,
financial condition and operating results.
The Company is not a party to any other litigation that is expected to have
a material effect on the Company or its business.
43
MANAGEMENT AND SCIENTIFIC ADVISORY BOARD
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth the names, ages and positions of the
executive officers and directors of the Company as of June 30, 1997:
NAME AGE POSITION
---- --- --------
Robert D. Weist (1)(2)........... 57 Chairman of the Board of Directors
Chief Executive Officer, President and
Lewis S. Gruber.................. 46 Director
Executive Vice President and Chief
Christopher R. Wolf.............. 43 Financial Officer
Co-Senior Vice President for Research
Radoje T. Drmanac, Ph.D.......... 39 and Director
Co-Senior Vice President for Research
Radomir B. Crkvenjakov, Ph.D..... 50 and Director
Vice President of Administration and
James N. Fletcher................ 44 Secretary
Raymond F. Baddour, Ph.D. (1)(3). 72 Director
Greta E. Marshall (2)............ 59 Director
Thomas N. McCarter III (3)....... 67 Director
Kenneth D. Noonan, Ph.D. (3)..... 49 Director
- --------
(1) Member of the Compensation Committee.
(2) Member of the Nominating Committee.
(3) Member of the Audit Committee.
Robert D. Weist has served as Chairman of the Board of Directors of the
Company since March 1994, and served as the President and a director of the
Company from May 1993 until March 1994. Mr. Weist has also been President of
Weist Associates, a management consulting firm, since April 1992. Mr. Weist
was a consultant to and Senior Vice President, Administration, General Counsel
and Secretary of Amgen Inc., a biotechnology company ("Amgen"), from January
1986 through April 1992, and served as its Vice President, General Counsel and
Secretary from May 1982 to January 1986. Mr. Weist also serves as a director
of BioSource International Inc., a biological products supplier. Mr. Weist
holds a B.S. in chemical engineering from Purdue University, a J.D. from New
York University and an M.B.A. from the University of Chicago.
Lewis S. Gruber, a founder of the Company, has been the Chief Executive
Officer, President and a director since joining the Company in June 1994. From
January 1989 until June 1994, Mr. Gruber was a partner with the law firm of
Marshall, O'Toole, Gerstein, Murray & Borun, which has represented the Company
as one of its patent counsel since May 1992. Mr. Gruber holds a B.S. in
sociology and M.S. in cell biology and genetics from the University of Arizona
and a J.D. from Arizona State University.
Christopher R. Wolf joined the Company as Executive Vice President and Chief
Financial Officer in December 1996. From May 1996 to December 1996, Mr. Wolf
was Senior Vice President, Investment Banking and Group Head of Healthcare for
Fahnestock & Co. Inc., an investment banking firm, and from February 1991
until May 1996, was a partner of the Georgica Group, Inc., a financial
consulting company. From 1989 until February 1991, Mr. Wolf was a partner of
Oppenheimer & Co., Inc., an investment banking firm, and from 1983 until 1988,
was with Kidder Peabody & Co. Incorporated, an investment banking firm. Mr.
Wolf holds a B.A. in political science from Ohio Wesleyan University and an
M.P.P.M. from Yale University School of Management.
Radoje T. Drmanac, Ph.D. joined the Company in August 1994 and serves as Co-
Senior Vice President for Research and a director. Dr. Drmanac co-invented SBH
technology while at the Institute of Molecular Genetics and Genetics
Engineering in Belgrade, Yugoslavia ("IMGGE"), where he conducted research
from May 1986 until February 1991. Dr. Drmanac served as a Molecular Biologist
and Group Leader at Argonne National Laboratory ("Argonne") from February 1991
until August 1994. Dr. Drmanac was a member of the Editorial Board of the
International Journal of Genome Research from 1992 to 1994, and has been a
member of the Human Genome Organization ("HUGO") since 1992. Dr. Drmanac
received his Ph.D. from Belgrade University and conducted post-doctoral
studies at the Imperial Cancer Fund Research Laboratories in London.
44
Radomir B. Crkvenjakov, Ph.D. joined the Company in August 1994 and serves
as Co-Senior Vice President for Research and a director. Dr. Crkvenjakov was
appointed to the Editorial Board of Mutation Research Genomics in January
1997. Dr. Crkvenjakov served as Senior Molecular Biologist and Group Leader at
Argonne from February 1991 until August 1994. Prior to joining Argonne, Dr.
Crkvenjakov was with IMGGE from May 1986 until February 1991, where he co-
invented SBH technology. Dr. Crkvenjakov has performed research projects for
the U.S. National Institutes of Health ("NIH") and has been a member of HUGO
since 1992. Dr. Crkvenjakov received his Ph.D. in biochemistry and molecular
biology from Harvard University and conducted post-doctoral studies at the
University of Heidelberg.
James N. Fletcher has served as the Company's Vice President of
Administration since September 1994 and as its Secretary since April 1996. Mr.
Fletcher was an independent consultant to the Company from April 1994 until
September 1994. Mr. Fletcher served as general counsel and a consultant to
National Business Funding, a development-stage financial services company,
from July 1993 until May 1994 and as assistant general counsel of ComputerLand
Corporation, a computer reseller, from November 1990 until December 1992 and
served as a consultant from December 1992 until May 1993. Mr. Fletcher holds a
B.S. in political science from Arizona State University and a J.D. from the
University of Arizona.
Raymond F. Baddour, Ph.D. has served as a director of the Company since
December 1993. Since July 1989, Dr. Baddour has served as the Lammot du Pont
Professor of Chemical Engineering, Emeritus, at the Massachusetts Institute of
Technology where he formerly served as the Lammot du Pont Professor of
Chemical Engineering from 1973 to 1989. Dr. Baddour also serves as a director
of Amgen, Ascent Pediatrics, Inc., a pharmaceutical company, and MatTet
Corporation, a bio-materials company. Dr. Baddour holds a B.S. in chemical
engineering from Notre Dame University and an M.S. and Sc.D. from the
Massachusetts Institute of Technology.
Greta E. Marshall has served as a director of the Company since July 1994.
Ms. Marshall is a principal of The Marshall Plan, an investment management
company, which she founded in 1989. From 1985 until 1989, Ms. Marshall was
Investment Manager of the California Public Employee's Retirement System, a
public pension organization. Ms. Marshall is also a director of EG&G Inc., a
technology and scientific instrument company. Ms. Marshall holds a B.A. in
English and an M.B.A. from the University of Louisville.
Thomas N. McCarter III has served as a director of the Company since October
1996. Mr. McCarter currently serves as Chairman of the Ramapo Land Company, a
real estate company, and is a general partner of Miles Timber Properties, a
land company which positions he has held for more than the past five years.
Mr. McCarter is a director and was past Chairman of Stillrock Management,
Inc., an investment company, serves as Chairman of Pendragon Technologies, a
diversified technology company, is a director of Parock Group, a diversified
investment company, and a director of other closely-held companies. Mr.
McCarter attended Princeton University from 1948 to 1951 and has been a
Certified Investment Counselor since 1972.
Kenneth D. Noonan, Ph.D. has served as a director of the Company since
October 1996. Dr. Noonan has been a Vice President at Booz-Allen & Hamilton,
Inc., a management consulting firm, since March 1996. From January 1992 until
February 1996, Dr. Noonan was the Managing Director of The Wilkerson Group,
Inc., a management consulting group specializing in medical products. Dr.
Noonan has also held senior positions in the diagnostics industry. Dr. Noonan
also serves as a director of Galenica Pharma. Dr. Noonan holds a Ph.D. in
biochemistry from Princeton University.
The Company's executive officers are appointed annually by, and serve at the
discretion of, the Board of Directors. All directors hold office until the
next annual meeting of stockholders or until their successors are duly elected
and qualified. The Board of Directors is divided into three classes, each of
whose members serve for a staggered three-year term. The Board comprises two
Class I Directors (Messrs. Weist and Gruber), two Class II Directors (Dr.
Baddour and Ms. Marshall) and four Class III Directors (Drs. Drmanac,
Crkvenjakov and Noonan and Mr. McCarter). At each annual meeting of
stockholders, the appropriate number of directors will be
45
elected for a three-year term to succeed the directors of the same class whose
terms are then expiring. The terms of the Class I Directors, Class II
Directors and Class III Directors expire upon the due election and
qualification of successor directors at the annual meetings of stockholders
held in calendar years 2000, 1998 and 1999, respectively. See "Description of
Capital Stock--Anti-Takeover Effects of Provisions of the Articles and By-Laws
and Nevada Law."
There are no family relationships among the directors and executive officers
of the Company. See "Certain Transactions."
SCIENTIFIC ADVISORY BOARD
Hyseq has established a Scientific Advisory Board ("SAB") of internationally
recognized scientists and may add additional members over time, as
appropriate. In addition to Drs. Drmanac and Crkvenjakov, who serve as Co-
Chairmen of the SAB, the following individuals serve on the SAB:
Paul Doty, Ph.D. is a member of the U.S. National Academy of Sciences
("NAS") and was a technical advisor to the Strategic Arms Limitation Treaty
negotiations. His career has included participation in the Manhattan Project
and membership in the President's Science Advisors Committee under Presidents
John F. Kennedy and Lyndon B. Johnson. Nucleic acid hybridization technology
was invented in the laboratory of Dr. Doty at Harvard University. Dr. Doty
presently serves as Director Emeritus of the Center for Science and
International Affairs at Harvard University.
Vladimir Glisin, Ph.D. is a Director of the IMGGE. Dr. Glisin is a recipient
of the U.S. National Science Foundation Senior Foreign Scientist Award. Dr.
Glisin serves as a consultant and science advisor to the United Nations and
has organized a United Nations Industrial Development Organization Genome
Sequencing Conference. Dr. Glisin conducted his post-graduate research with
Dr. Doty at Harvard University and has served as a visiting professor at
Harvard University and the University of New Hampshire. Dr. Glisin has also
served as invited professor of Biochemistry and Molecular Biology at the
Kuwait Medical School and is currently on the Faculty of Sciences of the
University of Belgrade.
Anthony Carrano, Ph.D. is the Associate Director, Biology and Biotechnology
Research Program of Lawrence Livermore National Laboratory, and a Professor of
Molecular Genetics and Human Genetics at the University of California at
Davis. Dr. Carrano is a fellow of the American Association for the Advancement
of Science ("AAAS"). Dr. Carrano is a recipient of the Environmental Mutagen
Society Recognition Award. Dr. Carrano has also served as special fellow to
the U.S. Atomic Energy Commission. Dr. Carrano is a member of the editorial
boards of numerous scientific journals, has been a member of HUGO since 1989,
the NIH/Department of Energy Joint Human Genome Advisory Committee since 1989
and the U.S. Department of Energy Human Genome Project Coordinating Committee
since 1988.
Michael Waterman, Ph.D. is a Professor of Mathematics and Biological
Sciences at the University of Southern California ("USC"). Dr. Waterman is a
co-developer of the Smith-Waterman algorithm used worldwide in gene sequence
analysis. Dr. Waterman serves on the editorial boards of numerous scientific
journals. Dr. Waterman is a fellow of the Institute of Mathematical Statistics
and the AAAS and a member of HUGO and numerous other professional societies.
Dr. Waterman received the USC Associates Award for Creativity in Research and
Scholarship and holds a USC Associates Endowed Professorship in Mathematics
and Biology.
Douglas Brutlag, Ph.D. is a Professor of Biochemistry at the Stanford
University School of Medicine. Dr. Brutlag was a co-founder of IntelliCorp,
Inc., a financial software development company, and IntelliGenetics Inc., a
biotech software supplier, and is the recipient of numerous professional
honors and memberships. Dr. Brutlag is a fellow of the AAAS and a member of
the American Association of Artificial Intelligence.
46
BOARD COMMITTEES
Compensation Committee; Compensation Committee Interlocks and Insider
Participation
In April 1994, the Board of Directors established a Compensation Committee.
The Compensation Committee recommends to the Board of Directors compensation
for certain of the Company's personnel and administers the Stock Option Plan.
The Compensation Committee comprises Dr. Baddour as the chairperson and Mr.
Weist. Mr. Weist served as Acting President of the Company from May 1993 until
March 1994. The Company entered into a consulting agreement with Mr. Weist in
May 1993 pursuant to which he received $125,000 in 1993 for services rendered
in connection with the original structuring of the Company and other matters.
Mr. Weist purchased 489,763 shares of Common Stock in May 1993 for $20,000 in
cash and delivery of a promissory note in the original principal amount of
$180,000. The promissory note accrued interest at 3.72% per annum and matured
in May 1994. Such promissory note had an outstanding balance of approximately
$55,000 (plus approximately $3,900 of accrued interest) at May 1, 1994 when it
was repaid in connection with the Company's exercise of an outstanding option
to repurchase 205,056 of Mr. Weist's shares at his original purchase price of
$0.41 per share.
Audit Committee
In March 1997, the Board of Directors established an Audit Committee. The
Audit Committee reviews the Company's annual audit and will meet with the
Company's independent accountants to review the Company's internal controls
and financial management practices. The Audit Committee comprises Mr. McCarter
as the chairperson, Dr. Baddour and Dr. Noonan.
Nominating Committee
In March 1997, the Board of Directors also established a Nominating
Committee. The Nominating Committee considers and recommends individuals for
Board membership and senior management positions. The Nominating Committee
comprises Ms. Marshall as the chairperson and Mr. Weist.
DIRECTOR COMPENSATION
From the Company's inception in August 1992 until October 1996, no fees were
paid to non-employee directors. Commencing in October 1996, the Company
instituted a policy to pay all non-employee directors a fee of $2,500 for each
Board meeting attended in person or by telephone, subject to an overall cap of
$10,000 per year. Each non-employee director earned $7,500 in 1996, of which
$2,500 was paid to each in 1996 and the balance was paid in the first quarter
of 1997. Employees of the Company who are also directors do not receive any
director fees. All directors are reimbursed for reasonable expenses incurred
in attending meetings. Directors do not receive fees for attendance at
Committee meetings. See "--Stock Option Plans and Agreements."
STOCK OPTION PLANS AND AGREEMENTS
Stock Option Agreements
The Company has reserved 603,456 shares of Common Stock for issuance upon
exercise of options granted in 1994, to certain executive officers, an
employee, directors and members of the Company's SAB. See "Certain
Transactions."
47
1995 Stock Option Plan
At the Company's 1995 annual meeting, the stockholders approved an incentive
and non-qualified stock option plan (the "Stock Option Plan") for the purposes
of incentivizing employees and attracting and retaining executive officers and
other key employees. The Stock Option Plan permits grants of incentive and
non-qualified stock options (within the meaning of the Internal Revenue Code
of 1986, as amended) that are exercisable at a price equal to the fair market
value of the Common Stock on the date of grant as established by the Board. A
total of 576,000 shares of Common Stock initially were reserved for issuance
under the Stock Option Plan. At the Company's 1997 annual meeting,
stockholders approved an amendment to the Stock Option Plan which reserved an
additional 576,000 shares for issuance under the Stock Option Plan. At June
30, 1997, options granted under the Stock Option Plan to purchase 684,292
shares were issued and outstanding, including options to purchase 63,360
shares issued to directors and options to purchase 13,440 shares issued to SAB
members. See "Principal Stockholders."
1996 Director Stock Option Plan
At the Company's 1996 annual meeting, the stockholders approved a Non-
Employee Director Stock Option Plan (the "Directors' Plan") providing for
periodic stock option grants to Company directors who are not employees of the
Company. Management believes that the inherent value created by the granting
of options under the Directors' Plan will prove to be a successful means of
attracting, retaining and motivating highly qualified individuals for the
Company's Board. Under the Directors' Plan, each new, non-employee director
receives a one-time grant of options to purchase 23,040 shares of Common
Stock, of which options to purchase 11,520 shares vest immediately, with the
balance vesting in two equal allotments on the first and second anniversaries
of joining the Board. All non-employee directors automatically receive options
to purchase up to 5,760 shares each year (such that the amount received under
the Directors' Plan when added to all prior options granted to a director
which vest in that year total 5,760) on the date of the annual meeting of the
stockholders, commencing in 1997. Mr. Weist, Dr. Baddour and Ms. Marshall each
received options to purchase 960 shares immediately following the annual
meeting in 1997 under the Directors' Plan. A total of 138,240 shares of Common
Stock have been reserved and are available for purchase upon the exercise of
options granted under the Directors' Plan, of which options to purchase 48,960
shares were issued and outstanding at June 30, 1997.
48
EXECUTIVE COMPENSATION
The following table sets forth certain information with respect to the
compensation earned for the fiscal year ended December 31, 1996 for the
Company's Chief Executive Officer and, based on actual or annualized salaries,
the four other most highly compensated executive officers (the "Named
Executive Officers"). No other executive officer's compensation exceeded
$100,000 for the fiscal year ended December 31, 1996.
SUMMARY COMPENSATION TABLE
1996
ANNUAL LONG-TERM
COMPENSATION COMPENSATION AWARDS
---------------- -------------------
RESTRICTED SECURITIES
NAME AND PRINCIPAL STOCK UNDERLYING ALL OTHER
POSITIONS SALARY BONUS AWARD OPTIONS COMPENSATION
- ------------------ -------- ------- ---------- ---------- ------------
Lewis S. Gruber............ $200,000 $ -- $-- 42,240 $ --
President and Chief Execu-
tive Officer
Christopher R. Wolf (1).... 10,416 -- 0(1) 144,000 30,000(1)
Executive Vice President
and Chief Financial Offi-
cer
Radoje T. Drmanac (2)...... 146,000 13,680 -- 35,476 46,200(2)
Co-Senior Vice President
for Research
Radomir B. Crkvenjakov (2). 146,000 13,680 -- 35,476 46,200(2)
Co-Senior Vice President
for Research
Douglas C. Lane (3)........ 55,000 -- -- 48,000 11,824(3)
Vice President of Corpo-
rate Development
- --------
(1) Mr. Wolf joined the Company in December 1996 and received compensation
based on an annual salary of $125,000. In addition, Mr. Wolf received a
one-time reimbursement for relocation expenses of $30,000. In December
1996, Mr. Wolf purchased 161,280 shares of Common Stock at $4.17 per
share. The shares vest over a period of two years, in equal allotments of
6,720 shares per month for so long as Mr. Wolf is employed by the Company.
As of December 31, 1996, the value of Mr. Wolf's aggregate restricted
stock holdings was $0.
(2) Pursuant to the terms of employment agreements dated as of August 1, 1994,
each of Drs. Drmanac and Crkvenjakov are entitled to annual bonuses of
$13,680 and were entitled to a one-time special bonus of $91,200 when the
Company reached $8.5 million of funding. Although the funding level was
reached in 1995, the special bonuses were not paid until January 1996. As
a condition of payment, Drs. Drmanac and Crkvenjakov forfeited options to
purchase 57,600 shares and 48,000 shares respectively, at an exercise
price of $1.56 per share and their two-year employment agreements were
automatically extended to terms of four years. The amounts paid were
offset against loans made in August 1994 by the Company to each of
Drs. Drmanac and Crkvenjakov in the amount of $45,000, such that each of
Drs. Drmanac and Crkvenjakov received a net payment of $46,200 in January
1996.
(3) Mr. Lane joined the Company in July 1996 and received compensation based
on an annual salary of $120,000. In addition, Mr. Lane received a one-time
reimbursement for relocation expenses of $11,824. Mr. Lane resigned from
the Company on June 23, 1997.
49
The following table sets forth certain information with respect to the grant
of options to purchase Common Stock by the Company during 1996 to the Named
Executive Officers.
OPTION GRANTS IN 1996
INDIVIDUAL GRANTS
-------------------------------------------------
NUMBER OF
SECURITIES % OF TOTAL
UNDERLYING OPTIONS GRANTED EXERCISE
OPTIONS TO EMPLOYEES IN PRICE EXPIRATION
NAME GRANTED(1) FISCAL YEAR (PER SHARE) DATE
---- ---------- --------------- ----------- ----------
Lewis S. Gruber............... 42,240 10.6% $4.17 5/31/06
Christopher R. Wolf........... 144,000 36.1 4.17 12/08/06
Radoje T. Drmanac............. 35,476 8.9 4.17 5/31/06
Radomir B. Crkvenjakov........ 35,476 8.9 4.17 5/31/06
Douglas C. Lane(2)............ 48,000 12.0 4.17 7/14/06
- --------
(1) All options were granted pursuant to the Stock Option Plan and, with the
exception of options granted to Mr. Wolf, vest in four equal annual
installments commencing one year after the date of grant. Mr. Wolf's
options were granted in connection with commencement of his employment in
December 1996 and vest in four equal annual installments commencing on the
date of grant.
(2) Mr. Lane resigned from the Company on June 23, 1997.
The following table sets forth for each of the Named Executive Officers
certain information with respect to the exercise of options to purchase Common
Stock during the year ended December 31, 1996 and the number of shares subject
to both exercisable and unexercisable stock options as of December 31, 1996.
AGGREGATE OPTION EXERCISES IN FISCAL 1996 AND FISCAL YEAR-END OPTION VALUES
NUMBER OF
SECURITIES UNDERLYING VALUE OF UNEXERCISED IN-
UNEXERCISED OPTIONS OF THE MONEY OPTIONS AT
SHARES DECEMBER 31, 1996 DECEMBER 31, 1996 (2)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME EXERCISE REALIZED (1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------ ----------- ------------- ----------- -------------
Lewis S. Gruber......... 67,200 $175,000 195,581 139,382 $2,423,681 $1,595,629
Christopher R. Wolf..... -- -- 36,000 108,000 353,880 1,061,640
Radoje T. Drmanac....... -- -- 76,800 73,876 955,392 826,425
Radomir B. Crkvenjakov.. -- -- 72,000 69,076 895,680 766,713
Douglas C. Lane(3)...... -- -- -- 48,000 -- 471,840
- --------
(1) Based on the fair market value at the date of exercise, as determined by
the Board of Directors, minus the exercise price.
(2) Based on the initial public offering price of $14.00 per share minus the
exercise price.
(3) Mr. Lane resigned from the Company on June 23, 1997.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with Dr. Drmanac and Dr. Crkvenjakov,
pursuant to which they became employees on August 1, 1994. These agreements
have terms of four years and expire on July 31, 1998. See "--Executive
Compensation" and "Principal Stockholders" regarding stock options granted in
connection with their employment. Pursuant to the terms of their employment
agreements, each of Drs. Drmanac and Crkvenjakov are entitled to annual
bonuses of $13,680 and were entitled to a one-time special bonus of $91,200
when the Company reached an aggregate of $8.5 million of funding. Although the
funding level was reached in 1995, the special bonuses were not paid until
January 1996. As a condition of payment, Drs. Drmanac and Crkvenjakov
surrendered options to purchase 57,600 shares and 48,000 shares respectively,
at an exercise price of $1.56 per share. The amounts paid were offset against
loans made in August 1994 by the Company to each of Drs. Drmanac and
Crkvenjakov in the amount of $45,000, such that each of Drs. Drmanac and
Crkvenjakov received a net payment in January 1996 of $46,200.
50
CERTAIN TRANSACTIONS
Robert D. Weist is a director and serves as chairperson of the Compensation
Committee. For a description of certain transactions relating to Mr. Weist,
see "Management and Scientific Advisory Board--Board Committees."
In December 1993, Lewis S. Gruber, a director and executive officer of the
Company, received a warrant to purchase 144,000 shares of Common Stock at
$2.90 per share in exchange for the assignment of all right, title and
interest in and to certain patent rights relating to diagnostic applications
owned by him. In connection with Mr. Gruber's employment by the Company in
June 1994, Mr. Gruber was granted a 10-year option to purchase 345,600 shares
of Common Stock at an exercise price of $1.56 per share. In September 1996,
Mr. Gruber exercised options to purchase 19,200 shares of Common Stock at an
exercise price of $1.56 per share. In December 1996, Mr. Gruber used the
proceeds of a loan from the Company to exercise the warrant to purchase
144,000 shares of Common Stock at $2.90 per share and to exercise options to
purchase 48,000 shares of Common Stock at an exercise price of $1.56 per
share. The loan, in the principal amount of $492,000, is evidenced by a
promissory note dated December 9, 1996, that bears interest at 3% per annum
and is due on December 8, 2001. The loan is secured by, and with recourse only
to, 118,080 shares of Mr. Gruber's Common Stock. In March and June 1997, Mr.
Gruber exercised options to purchase an additional 7,680 and 2,880 shares,
respectively, of Common Stock at an exercise price of $1.56 per share. Also in
March 1997, Mr. Gruber purchased 179,712 shares at $6.51 per share using the
proceeds of an additional $1,170,000 loan, as evidenced by a promissory note
dated March 12, 1997 on the same terms as his prior loan. As of June 30, 1997,
the amounts outstanding under such loans were $492,000 and $1,170,000,
respectively. The 179,712 shares are subject to a right of repurchase by the
Company over a period of two years. This repurchase option lapses in equal
allotments of 7,488 shares per month for so long as Mr. Gruber is employed by
the Company. As a condition of the purchase in March 1997, Mr. Gruber did not
and will not receive any options under the Stock Option Plan during 1997.
Until joining the Company, Mr. Gruber was a member of Marshall, O'Toole,
Gerstein, Murray & Borun, which firm has served as one of the Company's patent
counsel since its inception in 1992. He also is the spouse of Misty S. Gruber,
who was a director of the Company from inception to June 1994 and is a member
of Sachnoff & Weaver, Ltd., which law firm has served as general corporate
counsel to Hyseq since June 1996. Ms. Gruber formerly was a member of Shefsky
Froelich & Devine Ltd, which law firm served as general corporate counsel to
the Company from inception to June 1996. Sachnoff & Weaver, Ltd. and one
member in addition to Ms. Gruber and certain partners and related persons of
Marshall, O'Toole, Gerstein, Murray & Borun are stockholders of the Company.
Mr. and Ms. Gruber, individually and through a corporation that they control,
beneficially own a total of 559,941 shares of Common Stock, including 179,712
shares of Common Stock purchased in March 1997 at $6.51 per share, 144,000
shares of Common Stock issued upon the exercise of a warrant to purchase
shares in December 1996 at $2.90 per share, 158,469 shares of Common Stock
purchased in August 1992 and May 1993 at purchase prices of $0.35 and $0.41
respectively, and 77,760 shares of Common Stock at $1.56 per share issued upon
the exercise of options in September 1996, December 1996, March 1997 and June
1997 (which shares include the 297,792 shares pledged as security for the
loans referenced above). Mr. and Ms. Gruber also jointly purchased 6,716
shares of Series A Preferred Stock at $2.90 per share in November 1993 and
7,317 shares of Series A Preferred Stock at $3.46 per share in November 1994.
See also "Principal Stockholders."
In May 1996, the Company issued to Fahnestock & Co. Inc. a warrant to
purchase 206,822 shares of Common Stock at an exercise price of $4.58 per
share, a portion of which warrant was subsequently transferred to certain
officers of this firm, including a warrant to purchase 1,920 shares to
Christopher R. Wolf who was then an officer of the investment bank and is now
Executive Vice President and Chief Financial Officer of the Company.
Fahnestock & Co. Inc. is one of the Representatives. See "Underwriting." In
December 1996, Mr. Wolf borrowed $672,000 from the Company, as evidenced by a
promissory note dated December 9, 1996, which bears interest at 3% per annum
and is due on December 8, 2001. Mr. Wolf used the proceeds of the loan to
purchase 161,280 shares of Common Stock at $4.17 per share in December 1996.
The shares vest over a period of two years, in equal allotments of 6,720
shares per month for so long as Mr. Wolf is employed by the
51
Company. In March 1997, Mr. Wolf purchased 179,712 shares at $6.51 per share
using the proceeds of a $1,170,000 Company loan on the same terms as the loan
to Mr. Gruber in March 1997. As of June 30, 1997, the amounts outstanding
under such loans were $672,000 and $1,170,000, respectively. As a condition of
the purchase, Mr. Wolf did not and will not receive any options under the
Stock Option Plan during 1997. The loans are secured by, and with recourse
only to, all 340,992 shares purchased by Mr. Wolf using proceeds of Company
loans. Mr. Wolf also is a partner in Blue Hill Partners, a partnership
controlled by Thomas N. McCarter III, a director of the Company. Blue Hill
Partners purchased 76,800 shares of Common Stock at $4.17 per share in
September 1996.
In order to maintain certain agreed upon ratios of ownership in the Company,
the Company issued 5,446,502 shares of Common Stock at par ($0.001 per share)
to the Hyseq One Trust, an Illinois business trust (the "Trust"). The Trust
held 40,366 shares as of June 30, 1997. The Company has the right, among other
things, to repurchase shares from the Trust for $0.0016 per share (the
"Repurchase Price") as the Company issues Common Stock or Preferred Stock. The
Trust will terminate when all Trust shares have been repurchased. The Company
cancels all shares that are repurchased from the Trust. Pending repurchase,
all shares of Common Stock held by the Trust are voted by its trustee, who is
an independent third party with no relationship to the Company, or its
stockholders other than as trustee of the Trust. Concurrently with completion
of this offering, the Company will repurchase all remaining shares held by the
Trust for nominal consideration and the Trust will terminate. See "Principal
Stockholders."
In January 1997, Sachnoff & Weaver, Ltd. purchased 76,800 shares of Common
Stock at $6.51 per share. Sachnoff & Weaver, Ltd., a member of which is the
spouse of the Company's President and Chief Executive Officer, paid $102,415
and delivered a promissory note to the Company for the balance in the amount
of $397,585 secured by 61,069 shares of Common Stock. The note bears interest
at 8.25% per annum and is due on March 18, 2001. As of the date of this
Prospectus, the note had an outstanding balance of $345,535. Sachnoff &
Weaver, Ltd. will receive approximately $250,000 for legal services performed
in connection with this offering.
52
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of Common Stock as of June 30, 1997, and as adjusted to reflect the
sale of the shares offered hereby and the Private Placement, by: (i) each
person known by the Company to be the beneficial owner of more than five
percent of the outstanding shares of Common Stock; (ii) each of the Company's
directors; (iii) each of the Named Executive Officers; and (iv) all directors
and executive officers of the Company as a group.
SHARES BENEFICIALLY OWNED (1)
-----------------------------------
PERCENTAGE PERCENTAGE
NUMBER OF PRIOR TO AFTER
NAME AND ADDRESS (2) SHARES OFFERING (3) OFFERING (4)
-------------------- --------- ------------ ------------
Robert D. Weist (5)........................ 223,075 2.6% 1.8%
Lewis S. Gruber (6)........................ 859,536 9.5 6.8
Christopher R. Wolf (7).................... 378,912 4.3 3.1
Radoje T. Drmanac (8) ..................... 866,314 9.8 7.0
Radomir B. Crkvenjakov (9)................. 806,148 9.1 6.5
Raymond F. Baddour (10).................... 28,800 * *
Greta E. Marshall (11)..................... 32,640 * *
Thomas N. McCarter III (12)................ 88,320 1.0 *
Kenneth D. Noonan (13)..................... 11,520 * *
Institute of Molecular Genetics and Genetic
Engineering (14).......................... 708,480 8.1 5.9
Vojode Stepe 283
P.O. Box 794
11001 Belgrade Yugoslavia
Attn.: Dr. Zvezdana Popovic
Lindner Dividend Fund (15)................. 600,000 6.8 5.0
7711 Carondolet Avenue
Suite 700
Clayton, MO 63105
Lindner Growth Fund (15)................... 600,000 6.8 5.0
7711 Carondolet Avenue
Suite 700
Clayton, MO 63105
Chiron Corporation (16).................... 396,825 4.6 4.7
4560 Horton St.
Emeryville, CA 94608
The Perkin-Elmer Corporation (17).......... 396,825 4.6 6.3
761 Main Ave.
Norwalk, CT 06859
All directors and executive officers of the
Company, as a group (10 persons) (18)..... 3,304,920 33.4 25.0
- --------
* Represents beneficial ownership of less than 1% of the Common Stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission (the "Commission"), based on factors
including voting and investment power with respect to shares. Shares of
Common Stock issuable pursuant to stock options currently exercisable, or
exercisable within 60 days after June 30, 1997, are deemed outstanding
for purposes of computing the percentage owned by the person holding such
options, but are not deemed outstanding for computing the percentage of
any other person.
53
(2) Unless otherwise indicated, the persons named in the table above have the
sole voting and investment power with respect to all shares beneficially
owned by them, subject to applicable community property laws. Unless
otherwise indicated, the address of each beneficial owner is: c/o Hyseq,
Inc., 670 Almanor Avenue, Sunnyvale, California 94086.
(3) Applicable percentage ownership is based on 8,721,015 shares of Common
Stock outstanding as of June 30, 1997, which gives effect to the
conversion of Series A Preferred Stock to Common Stock on a 1-to-1 basis
and Series B Preferred Stock to Common Stock on a 1.18-to-1 basis and a
subsequent 1.92-for-1 split of the Common Stock.
(4) Applicable percentage ownership after this offering and the Private
Placement is based upon 12,276,159 shares of Common Stock outstanding,
which gives effect to the conversion of Series A Preferred Stock on a 1-
for-1 basis and Series B Preferred Stock to Common Stock on a 1.18-for-1
basis and a subsequent 1.92-for-1 split of the Common Stock.
(5) Includes 14,400 shares issuable upon exercise of options.
(6) Mr. Gruber holds shares individually, jointly with his wife and through a
corporation that they control. Includes 285,562 shares issuable upon
exercise of options.
(7) Includes 1,920 shares issuable upon exercise of a warrant and 36,000
shares issuable upon exercise of options. Does not include 76,800 shares
owned by a partnership controlled by Mr. McCarter and of which Mr. Wolf
is a partner.
(8) Includes 104,868 shares issuable upon exercise of options held
individually by Dr. Radoje Drmanac. Also includes 52,965 shares issuable
upon exercise of options held individually by Dr. Radoje Drmanac's
spouse, Dr. Snezana Drmanac. Dr. Radoje Drmanac disclaims beneficial
ownership of any shares owned by, or issuable upon the exercise of
options held by, Dr. Snezana Drmanac.
(9) Includes 97,668 shares issuable upon exercise of options.
(10) Includes 28,800 shares issuable upon exercise of options.
(11) Includes 28,800 shares issuable upon exercise of options.
(12) Mr. McCarter owns 76,800 shares through a partnership which he controls
and of which Mr. Wolf is a partner. Includes 11,520 shares issuable upon
exercise of options.
(13) Includes 11,520 shares issuable upon exercise of options.
(14) The 708,480 shares issued to the Institute of Molecular Genetics and
Genetic Engineering are being held by the First National Bank of Chicago
and cannot be voted or disposed of while held thereby until certain
restrictions imposed by the United States Department of the Treasury are
satisfied.
(15) An additional 120,000 shares of Series A Preferred Stock are held by the
Lindner Bulwark Fund.
(16) Applicable percentage ownership prior to the offering includes 396,825
shares of Common Stock (based on the initial public offering price of
$14.00 per share) issuable upon the conversion of shares of Series B
Preferred Stock sold by the Company to Chiron in May 1997. Applicable
percentage ownership after the offering includes an additional 185,048
shares of Common Stock to be purchased by Chiron in the Private Placement
concurrent with this offering.
(17) Applicable percentage ownership prior to the offering includes 396,825
shares of Common Stock (based on the initial public offering price of
$14.00 per share) issuable upon the conversion of shares of Series B
Preferred Stock sold to Perkin-Elmer in June 1997. Applicable percentage
ownership after the offering includes an additional 370,096 shares of
Common Stock to be purchased by Perkin-Elmer in the Private Placement
concurrent with this offering.
(18) Includes 1,123,233 shares issuable upon exercise of options.
54
DESCRIPTION OF CAPITAL STOCK
GENERAL
At the closing of this offering and the Private Placement, the authorized
capital stock of the Company will consist of 50,000,000 shares of Common
Stock, par value $.001 per share, 12,276,159 shares of which will be
outstanding and 8,000,000 shares of Preferred Stock, par value $.001 per
share, none of which will be issued or outstanding.
COMMON STOCK
Holders of Common Stock are entitled to one vote per share for the election
of directors and all other matters submitted for stockholder vote, except
matters submitted to the vote of another class or series of shares. Holders of
Common Stock are not entitled to cumulative voting rights. The holders of
Common Stock are entitled to dividends in such amounts and at such times, if
any, as may be declared by the Board of Directors out of funds legally
available therefor. The Company has not paid any dividends on its Common Stock
and does not anticipate paying any cash dividends on such stock in the
foreseeable future. See "Dividend Policy." Upon liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to share
ratably in all net assets available for distribution to stockholders after
payments to creditors and holders of senior securities. The Common Stock is
not redeemable and has no preemptive or conversion rights. The rights of the
holders of Common Stock are subject to the rights of the holders of any
Preferred Stock which may, in the future, be issued. All outstanding shares of
Common Stock are, and the shares of Common Stock to be sold by the Company in
this offering when issued will be, duly authorized, validly issued, fully paid
and non-assessable.
PREFERRED STOCK
The Board of Directors will have the authority to fix the price, rights,
preferences, privileges and restrictions thereof, including dividend rights,
dividend rates, conversion rights, voting rights, terms of redemption,
redemption prices, liquidation preferences and the number of shares
constituting any series or the designation of such series, without further
vote or action by the stockholders. The issuance of Preferred Stock may have
the effect of delaying, deferring or preventing a change in control of the
Company without further action by the stockholders and may adversely affect
the voting and other rights of the holders of Common Stock. The issuance of
Preferred Stock with voting and conversion rights may adversely affect the
voting power of the holders of Common Stock, including the loss of voting
control to others. The Company has no present plans to issue any series of
Preferred Stock.
WARRANTS
The warrants referenced in this paragraph were outstanding as of June 30,
1997. In connection with private placements of the Company's Series A
Preferred Stock, the Company issued a warrant to purchase 172,664 shares of
Common Stock issued in December 1993 at an exercise price of $2.90 per share,
which warrant is exercisable until December 1, 2000; a warrant to purchase
166,241 shares of Common Stock issued in November 1994 at an exercise price of
$3.42 per share, which warrant is exercisable until November 7, 2001; and a
warrant to purchase 137,520 shares of Common Stock issued in July 1995 at an
exercise price of $4.17 per share, which warrant is exercisable until July 15,
2002. The Company also issued a warrant to purchase 206,822 shares of Common
Stock at an exercise price of $4.58 per share to Fahnestock & Co. Inc., which
warrant is exercisable until May 16, 2001. A portion of the warrant was
subsequently transferred to certain officers of this firm, including a warrant
to purchase 1,920 shares to Christopher R. Wolf who was then an officer of
Fahnestock & Co. Inc. and is now Executive Vice President and Chief Financial
Officer of the Company. See "Certain Transactions." In December 1996, the
Company granted to a secured lender a warrant to purchase a total of 9,600
shares of Common Stock at an exercise price of $5.21 per share, which warrant
is exercisable until December 23, 2001. The average exercise price of all
warrants outstanding as of the date of this Prospectus was $3.81.
55
REGISTRATION RIGHTS
Pursuant to certain registration rights agreements ("Rights Agreements")
among the Company and certain of its securities holders, 3,892,140 shares of
Common Stock (including 308,160 shares held by affiliates of Fahnestock & Co.
Inc.) and 216,422 shares issuable upon the exercise of warrants (including
178,022 shares issuable to Fahnestock & Co. Inc. and certain affiliates) (the
"Registrable Securities") will be entitled to certain rights with respect to
the registration of the Registrable Securities under the Securities Act.
Registration rights covering 227,760 shares will expire prior to the end of
the Lock-Up Period; registration rights covering an additional 2,652,240
shares will expire between the end of the Lock-Up Period and May 1998; and
registration rights covering 76,800 shares will expire in January 1999. Under
all of the Rights Agreements, if after completion of this offering the Company
proposes to register any of its securities under the Securities Act, either
for its own account or the account of other stockholders, the holders of
Registrable Securities are entitled to notice of such registration and are
entitled to include their Registrable Securities therein. In addition, if at
any time beginning six months following the date of this Prospectus, the
Company receives a request from certain initiating holders of Registrable
Securities, the Company is obligated to cause such shares to be registered
under the Securities Act. Holders of Registrable Securities have the right to
cause two such demand registrations. In addition to these two demand
registrations, holders of Registrable Securities may also require the Company
to register all or a portion of their Registrable Securities on Form S-2 or
Form S-3 under the Securities Act, when such forms become available for use by
the Company, and subject to certain other conditions and limitations. The
holders' rights with respect to all such registrations are subject to certain
conditions, including the right of the underwriters to limit the number of
shares included in any such registration. The Company has agreed to pay all
expenses related thereto, except for underwriting discounts and commissions,
to effect the sale of the Registrable Securities.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE ARTICLES AND BY-LAWS AND NEVADA LAW
Articles of Incorporation and By-Laws
The Company's By-Laws provide that members of the Board of Directors serve
staggered three-year terms. The Articles provide that all stockholder action
must be effected at a duly called meeting and not by a consent in writing. The
By-Laws provide that the Company's stockholders may call a special meeting of
stockholders only upon a request of stockholders owning at least 50% of the
Company's capital stock. These provisions of the Articles and By-Laws could
discourage potential acquisition proposals and could delay or prevent a change
in control of the Company. These provisions are intended to enhance the
likelihood of continuity and stability in the composition of the Board of
Directors and in the policies formulated by the Board of Directors and to
discourage certain types of transactions that may involve an actual or
threatened change of control of the Company. These provisions are designed to
reduce the vulnerability of the Company to an unsolicited acquisition
proposal. The provisions also are intended to discourage certain tactics that
may be used in proxy fights. However, such provisions could have the effect of
discouraging others from making tender offers for the Company's shares. As a
consequence, they also may inhibit fluctuations in the market price of the
Company's shares that could result from actual or rumored takeover attempts.
Such provisions also may have the effect of preventing changes in the
management of the Company. See "Risk Factors--Anti-Takeover Provisions."
Nevada Statutory Provisions
Nevada "Combination with Interested Stockholders Statute." Nevada Revised
Statutes Sections 78.411 through 78.444 (the "Combination with Interested
Stockholders Statute") prohibit an "interested stockholder," under certain
circumstances, from entering into a "combination" with a Nevada corporation,
unless certain conditions are met. A "combination" includes (a) any merger
with an "interested stockholder," or any other corporation which is or after
the merger would be, an affiliate or associate of the interested stockholder,
(b) certain sales, leases, exchanges, mortgages, pledges, transfers or other
dispositions of assets, in one transaction or a series of transactions, to or
with an "interested stockholder," (c) any issuance or transfer of shares of
the corporation or its subsidiaries, to the "interested stockholder," having
an aggregate market value equal to 5% or
56
more of the aggregate market value of all the outstanding shares of the
corporation, (d) the adoption of any plan or proposal for the liquidation or
dissolution of the corporation proposed by the "interested stockholder," (e)
certain transactions which would result in increasing the proportionate share
of shares of the corporation owned by the "interested stockholder," or (f) the
receipt of benefits by an interested stockholder, except proportionately as a
stockholder, of any loans, advances or other financial benefits provided by
the corporation. 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 the corporation's voting stock. A
corporation to which the statute applies may not engage in a "combination"
within three years after the interested stockholder acquired its shares,
unless the combination or the interested stockholder's acquisition of shares
was approved by the board of directors before the interested stockholder
acquired the shares. Generally, the combination may be consummated after the
three-year period expires if either (i) the board of directors of the
corporation approved, prior to such person becoming an interested stockholder,
the combination or the purchase of shares by the interested stockholder or
(ii) the combination is approved by the affirmative vote of holders of a
majority of voting power not beneficially owned by the interested stockholder
at a meeting called no earlier than three years after the date the interested
stockholder became an interested director.
Nevada "Control Share Acquisition Statute." Nevada Revised Statutes Sections
78.378 through 78.3793 (the "Control Share Acquisition Statute") 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. The Control Share Acquisition Statute only applies to Nevada
corporations that do business directly or indirectly in Nevada. The Company
does not intend to "do business" in Nevada within the meaning of the Control
Share Acquisition Statute. Therefore, it is unlikely that the Control Share
Acquisition Statute will apply to the Company.
LIMITATION OF LIABILITY AND INDEMNIFICATION
Limitation of Liability
As permitted by the Nevada General Corporation Law, the Company's Articles
and By-Laws provide that officers and directors of the Company shall not be
personally liable for monetary damages to the Company for certain breaches of
their fiduciary duty as directors, unless they violated their duty of loyalty
to the Company or its stockholders, acted in bad faith, knowingly or
intentionally violated the law, authorized illegal dividends or redemptions,
or derived an improper personal benefit from their action as directors. This
provision would have no effect on the availability of equitable remedies or
nonmonetary relief, such as an injunction or rescission for breach of the duty
of care. Directors will, however, no longer be liable for monetary damages
arising from decisions involving violations of the duty of care which could be
deemed grossly negligent.
Indemnification
The By-Laws provide that directors of the Company shall be indemnified by
the Company to the fullest extent authorized by Nevada law, as it now exists
or may in the future be amended, against all expenses and liabilities
reasonably incurred in connection with service for or on behalf of the
Company. The By-Laws also authorizes the Company to enter into one or more
agreements with any person which provide for indemnification greater or
different from that provided in the Articles. The Company has entered into
indemnification agreements with all current officers and members of the Board
of Directors. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling persons
of the Company pursuant to the foregoing provisions, or otherwise, the Company
has been advised that in the opinion of the Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is U.S. Stock Transfer
Corporation, 1745 Gardena Ave., Glendale, California 91204, (818) 502-1404.
57
SHARES ELIGIBLE FOR FUTURE SALE
The number of shares of Common Stock available for sale in the public market
is limited by restrictions under the Securities Act and by the lock-up
agreements (the "Lock-Up Agreements"), both restrictions being described
below. Upon completion of this offering and the Private Placement, the Company
will have 12,276,159 shares of Common Stock outstanding (assuming no exercise
of outstanding warrants or options). Of these shares, the 3,000,000 shares
sold in this offering will be freely transferable without restriction or
further registration under the Securities Act, unless purchased by
"affiliates" of the Company, as that term is defined under the Securities Act
("Affiliates"). Such shares would generally only be sold in compliance with
the limitations of Rule 144 described below. The remaining 9,276,159
(including the 555,144 shares of Common Stock, based on the initial public
offering price of $14.00 per share, sold in the Private Placement) are deemed
"Restricted Shares" under Rule 144. The Company intends to register the shares
sold in the Private Placement following the expiration of the 180 day lock-up
agreements covering these shares as described below. Chiron and Perkin-Elmer
have no present intentions to dispose of any shares of Common Stock which will
be owned by them at the completion of this offering. However, there can be no
assurance that such intentions will not change in the future.
Pursuant to the terms of the Lock-Up Agreements, all officers, directors and
substantially all stockholders (including Chiron and Perkin-Elmer),
optionholders and warrantholders of the Company have agreed not to (1) offer,
pledge, sell, contract to sell, engage in any short sale, sell any option or
contract to purchase, purchase any option or contract to sell, grant any
option, right or warrant to purchase, or otherwise transfer or dispose of,
directly or indirectly, any shares of Common Stock or any securities
convertible into or exercisable or exchangeable for Common Stock, or (2) enter
into any swap or similar agreement that transfers, in whole or in part, the
economic risk of ownership of the Common Stock of the Company, until 180 days
after the effective date of the registration statement filed in connection
with this offering (the "Lock-Up Period"), without the prior consent of Lehman
Brothers Inc. However, Lehman Brothers Inc. may, in its sole discretion and at
any time without notice, release all or any portion of the securities subject
to Lock-Up Agreements. As a result of these contractual restrictions,
Restricted Shares that would otherwise be eligible for sale after 90 days
under Rules 144 or 701, or eligible for sale pursuant to a subsequent
registration, as described below, will not be eligible for sale without prior
written consent of Lehman Brothers Inc. until the end of the Lock-Up Period.
Of the 9,276,159 Restricted Shares, 1,612,339 shares will be freely
transferable pursuant to Rule 144 at the end of the Lock-Up Period and
2,262,778 shares will be held by affiliates and transferable pursuant to Rules
144 and 701 subject to the volume limitations of Rule 144 at the end of the
Lock-Up Period. Additional Restricted Shares, which will be transferable at
the end of the Lock-Up Period subject to volume limitations of Rule 144, will
become freely transferable pursuant to Rule 144(k) as follows: 66,960 shares
at various time during February and March 1998; 2,585,280 at various times
during April and May 1998; and 81,600 at various times during December 1998
and January 1999. An additional 1,403,578 Restricted Shares will not be
transferable pursuant to Rule 144 until the expiration of their one-year
holding periods, beginning at various times following the end of the Lock-Up
Period. An additional 708,480 shares are expected to remain in a blocked
account and will therefore not be voted or transferable pursuant to
restrictions imposed by the U.S. Department of Treasury. The 555,144 shares of
Common Stock (based on the initial public offering price of $14.00 per share)
sold in the Private Placement will be freely transferable following the
effectiveness of a registration statement which the Company intends to file at
the end of the Lock-Up Period.
In addition, 1,453,811 shares will be issuable upon the exercise of options
and warrants which will have vested 180 days after the effective date of this
offering of which 1,243,023 shares will be subject to the one-year holding
period requirement of Rule 144 upon issuance and an additional 185,274 shares
will be subject to volume limitations of Rule 144 upon issuance. The Company
intends to file a registration statement on Form S-8 under the Securities Act
covering certain of these shares subject to issuance upon exercise of options,
as described below. The remaining 25,513 shares issuable upon exercise of
options and warrants which will have vested 180 days after the effective date
of the offering will be freely transferable upon exercise.
58
Pursuant to certain registration rights agreements among the Company and
certain of its securities holders, 3,892,140 shares of Common Stock and
216,422 shares issuable upon the exercise of warrants will be entitled to
certain rights with respect to the registration of such shares under the
Securities Act. Registration rights covering 227,760 of such shares will
expire prior to the end of the Lock-Up Period; registration rights covering an
additional 2,652,240 of such shares will expire between the end of the Lock-Up
Period and May 1998; and registration rights covering 76,800 of such shares
will expire in January 1999. See "Description of Capital Stock--
Registration Rights." Registration of such shares under the Securities Act
would result in such shares becoming freely tradable without restriction under
Securities Act immediately upon the effectiveness of such registration,
subject to the contractual obligations discussed above.
In general, under Rule 144 as currently in effect, beginning 90 days after
the offering, a person (or persons whose shares are aggregated), who owns
shares that were purchased from the Company (or any Affiliate) at least one
year previously, including persons who may be deemed Affiliates of the
Company, would be entitled to sell within any three-month period a number of
shares that does not exceed the greater of one percent of the then outstanding
shares of the Common Stock (approximately 123,000 shares immediately after the
offering) or the average weekly trading volume of Common Stock in the Nasdaq
National Market during the four calendar weeks preceding the date on which
notice of the sale is filed with the Commission. Sales under Rule 144 are also
subject to certain manner of sale provisions, notice requirements and the
availability of current public information about the Company. Any person (or
persons whose shares are aggregated) who is not deemed to have been an
Affiliate of the Company at any time during the 90 days preceding a sale, and
who owns shares within the definition of "restricted securities" under Rule
144 under the Securities Act that were purchased from the Company (or any
Affiliate) at least two years previously, would be entitled to sell such
shares under Rule 144(k) without regard to the volume limitations, manner of
sale provisions, public information requirements or notice requirements.
Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its
employees, directors, officers, consultants or advisers up to the date the
Company becomes subject to the reporting requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), pursuant to written
compensatory benefit plans or written contracts relating to the compensation
of such persons. In addition, the Commission has indicated that Rule 701 will
apply to typical stock options granted by an issuer before it becomes subject
to the reporting requirements of the Exchange Act, along with the shares
acquired upon exercise of such options (including exercises after the date of
this Prospectus). Securities issued in reliance on Rule 701 are restricted
securities and, subject to the contractual restrictions described above,
beginning 90 days after the effective date of this offering, such securities
may be sold (i) by persons other than Affiliates, subject only to the manner
of sale provisions of Rule 144 and (ii) by Affiliates under Rule 144 without
compliance with its one-year minimum holding period requirement.
The Company intends to file a registration statement on Form S-8 under the
Securities Act covering approximately 1,893,696 shares of Common Stock issued
or reserved for issuance under stock option agreements entered into in 1994,
the Stock Option Plan and the Directors' Plan. See "Management and Scientific
Advisory Board--Stock Option Plans and Agreements." Such registration
statement will be filed within approximately 180 days following the effective
date of this offering and will automatically become effective upon filing.
Accordingly, shares acquired pursuant to the Stock Option agreements, the
Stock Option Plan and the Directors' Plan will, subject to Rule 144 volume
limitations applicable to Affiliates, be available for sale in the open
market, except to the extent that such shares are subject to vesting
restrictions with the Company or the contractual restrictions described above.
At June 30, 1997, options to purchase 1,336,708 shares were issued and
outstanding under stock option agreements, the Stock Option Plan and the
Directors' Plan. See "Risk Factors--Shares Eligible for Future Sale."
59
UNDERWRITING
Under the terms and subject to the conditions contained in the Underwriting
Agreement, the form of which is filed as an exhibit to the Registration
Statement of which this Prospectus forms a part, the underwriters named below
(the "Underwriters"), for whom Lehman Brothers Inc., Smith Barney Inc. and
Fahnestock & Co. Inc. are acting as representatives (the "Representatives"),
have severally agreed to purchase from the Company, and the Company has agreed
to sell to each Underwriter, the number of shares set forth opposite of each
such Underwriter below:
NUMBER OF
UNDERWRITER SHARES
----------- ---------
Lehman Brothers Inc. .............................................. 728,000
Smith Barney Inc. ................................................. 727,500
Fahnestock & Co. Inc. ............................................. 727,500
Alex. Brown & Sons Incorporated.................................... 65,000
EVEREN Securities Inc.............................................. 65,000
Hambrecht & Quist LLC.............................................. 65,000
Lazard Freres & Co. LLC............................................ 65,000
Merrill Lynch & Co................................................. 65,000
Montgomery Securities.............................................. 65,000
Robertson, Stephens & Company LLC.................................. 65,000
UBS Securities LLC................................................. 65,000
William Blair & Co................................................. 33,000
Cowen & Co......................................................... 33,000
Furman Selz LLC.................................................... 33,000
Genesis Merchant Group Securities LLC.............................. 33,000
Needham & Co. Inc.................................................. 33,000
Pacific Growth Equities, Inc....................................... 33,000
Pennsylvania Merchant Group Ltd.................................... 33,000
Punk, Ziegel & Company............................................. 33,000
Vector Securities International, Inc............................... 33,000
---------
Total............................................................ 3,000,000
=========
The Company has been advised by the Representatives that the Underwriters
propose to offer the shares to the public initially at the public offering
price set forth on the cover page hereof, and to certain dealers at such
public offering price less a concession not in excess of $.55 per share. The
Underwriters may allow, and such dealers may re-allow, a concession not in
excess of $.10 per share to certain other Underwriters or to certain other
brokers or dealers. After the offering to the public, the offering price and
other selling terms may be changed by the Representatives.
The Underwriting Agreement provides that the obligation of the several
Underwriters to pay for and accept delivery of the shares offered hereby are
subject to approval of certain legal matters by counsel and to certain other
conditions, including the condition that no stop order suspending the
effectiveness of the Registration Statement is in effect and no proceedings
for such purpose are pending or threatened by the Commission and that there
has been no material adverse change or any development involving a prospective
material adverse change in the condition of the Company from that set forth in
the Registration Statement otherwise than as set forth or contemplated in this
Prospectus, and that certain certificates, opinions and letters have been
received from the Company and its counsel and independent auditors. The
Underwriters are obligated to take and pay for all of the above shares if any
such shares are taken.
The Company and the Underwriters have agreed in the Underwriting Agreement
to indemnify each other against certain liabilities, including liabilities
under the Securities Act.
The Company has granted to the Underwriters an option to purchase up to an
additional 412,500 shares, exercisable solely to cover over-allotments, at the
public offering price, less the underwriting discounts and
60
commissions shown on the cover page hereof. Such option may be exercised at
any time until 30 days after the date of the Underwriting Agreement. To the
extent that the option is exercised, each Underwriter will be committed,
subject to certain conditions, to purchase a number of the additional shares
that is proportionate to such Underwriter's initial commitment as indicated on
the preceding table.
The Company, the executive officers and directors of the Company and certain
employees of the Company have each agreed, pursuant to the terms of the Lock-
Up Agreement, that during the Lock-Up Period they will not, without the prior
written consent of Lehman Brothers Inc., (1) offer, pledge, sell, contract to
sell, engage in any short sale, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, or otherwise transfer or dispose of, directly or indirectly, any
shares of Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock, or (2) enter into any swap or similar agreement
that transfers, in whole or in part, the economic risk of ownership of the
Common Stock of the Company, except that the Company may issue shares upon the
exercise of stock options granted prior to the execution of the Underwriting
Agreement, and may grant additional options under its employee compensation
plans, provided that, without the prior written consent of the
Representatives, such options shall not be exercisable during such Lock-Up
Period.
The Representatives have informed the Company that the Underwriters do not
intend to confirm sales in excess of five percent of the total number of
shares offered hereby to accounts over which they exercise discretionary
authority. Until the distribution of the shares is completed, the rules of the
Commission may limit the ability of the Underwriters and certain selling group
members to bid for and purchase shares of Common Stock. As an exception to
these rules, the Representatives are permitted to engage in certain
transactions that stabilize the price of the Common Stock. Such transactions
may consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of the Common Stock. In addition, if the Representatives
over-allot (i.e., if they sell more shares of Common Stock than are set forth
on the cover page of this Prospectus), and thereby create a short position in
the Common Stock in connection with this offering, the Representatives may
reduce that short position by purchasing Common Stock in the open market. The
Representatives may also elect to reduce any short position by exercising all
or part of the over-allotment option described herein.
The Representatives may also impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representatives purchase
shares of the Common Stock in the open market to reduce the Underwriters'
short position or to stabilize the price of the Common Stock, they may reclaim
the amount of the selling concession from the Underwriters and selling group
members who sold those shares as part of this offering. In general, purchases
of a security for the purpose of stabilization or to reduce a syndicate short
position could cause the price of the security to be higher than it might
otherwise be in the absence of such purchases. The imposition of a penalty bid
might have an effect on the price of a security to the extent that it were to
discourage resales of the security by purchasers in the offering. Neither the
Company nor any of the Underwriters makes any representation or prediction as
to the direction or magnitude of any effect that the transactions described
above may have on the price of the Common Stock. In addition, neither the
Company nor any of the Underwriters makes any representation that the
Representatives will engage in such transactions or that such transactions,
once commenced, will not be discontinued without notice. Prior to this
offering, there has been no public market for the shares of Common Stock. The
initial public offering price will be negotiated among the Company and the
Representatives. Among the factors to be considered in determining the initial
public offering price of the Common Stock, in addition to prevailing market
conditions, will be the Company's historical performance, estimates of the
business potential and earnings prospects of the Company, an assessment of the
Company's management and the consideration of the above factors in relation to
market valuation of companies in related businesses.
An affiliate of Lehman Brothers Inc., one of the Representatives, is the
beneficial owner of 12,000 shares of Common Stock. Affiliates of Fahnestock &
Co. Inc., one of the Representatives, are the beneficial owner of 308,160
shares of Common Stock. Fahnestock & Co. Inc. and certain of its affiliates
are the beneficial owners of warrants to purchase 178,022 shares of Common
Stock at an exercise price of $4.58 per share which warrants expire in May
2001.
61
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Sachnoff & Weaver, Ltd., Chicago, Illinois. Sachnoff &
Weaver, Ltd. and certain of its members own shares of Common Stock. A member
of Sachnoff & Weaver, Ltd. is the spouse of Lewis S. Gruber, Chief Executive
Officer of the Company. See "Certain Transactions." Certain legal matters in
connection with the offering will be passed upon for the Underwriters by
Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California.
EXPERTS
The consolidated financial statements of Hyseq, Inc. at December 31, 1995
and 1996 and for each of the three years in the period ended December 31, 1996
and for the period from August 14, 1992 (inception) to December 31, 1996,
appearing in this Prospectus and Registration Statement, have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report
given upon the authority of such firm as experts in accounting and auditing.
Certain legal matters with respect to information contained in this
Prospectus under the captions "Risk Factors--Dependence upon Proprietary
Rights; Risks of Infringement," and "Business--Patents and Proprietary
Technology" will be passed upon for the Company by McCutchen, Doyle, Brown &
Enersen LLP, Palo Alto, California, patent counsel to the Company.
ADDITIONAL INFORMATION
The Company has filed with the Commission in Washington, D.C. a Registration
Statement, of which this Prospectus constitutes a part, on Form S-1 under the
Securities Act (herein, together with all amendments and exhibits referred to
herein as the "Registration Statement") with respect to the Common Stock
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement and the exhibits and schedules to the
Registration Statement, as certain parts have been omitted in accordance with
rules and regulations of the Commission. For further information with respect
to the Company and the Common Stock offered hereby, reference is made to the
Registration Statement and the exhibits and schedules filed as a part of the
Registration Statement. Statements contained in this Prospectus concerning the
contents of any contract, agreement or any other document referred to are not
necessarily complete; reference is made in each instance to the copy of such
contract or document filed as an exhibit to the Registration Statement. Each
such statement is qualified in all respects by such reference to such exhibit.
A copy of the Registration Statement, including exhibits and schedules
thereto, may be inspected without charge and obtained at the prescribed rates
at the Public Reference Section of the Commission at its principal offices,
located at 450 Fifth Street, N.W., Washington, D.C. 20549, and may be
inspected without charge at the regional offices of the Commission located at
Seven World Trade Center, 13th Floor, New York, New York 10048, and Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. The
Registration Statement, including the exhibits and schedules thereto, is also
available at the Commission's site on the World Wide Web at
http://www.sec.gov.
The Company intends to furnish its stockholders annual reports containing
consolidated financial statements audited by its independent auditors and
quarterly reports containing unaudited consolidated financial information.
62
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Consolidated Financial Statements
Consolidated Balance Sheets.............................................. F-3
Consolidated Statements of Operations.................................... F-4
Consolidated Statement of Stockholders' Equity........................... F-5
Consolidated Statements of Cash Flows.................................... F-8
Notes to Consolidated Financial Statements................................. F-9
F-1
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Hyseq, Inc.
We have audited the accompanying consolidated balance sheets of Hyseq, Inc.
(a development-stage company) as of December 31, 1995 and 1996, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1996 and
for the period from August 14, 1992 (inception) to December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Hyseq, Inc.
at December 31, 1995 and 1996, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December
31, 1996, and for the period from August 14, 1992 (inception) to December 31,
1996, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Palo Alto, California
February 20, 1997, except for
Note 10 as to which the date
is July 31, 1997
F-2
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
UNAUDITED
PRO FORMA
STOCKHOLDERS'
DECEMBER 31, EQUITY AT
------------------------ MARCH 31, MARCH 31,
1995 1996 1997 1997
----------- ----------- ------------ -------------
(UNAUDITED) (NOTE 10)
ASSETS
Current assets:
Cash and cash
equivalents........... $ 750,291 $ 6,707,288 $ 4,743,260
Accounts receivable.... 136,336 146,400 272,373
Notes receivable from
officers.............. 120,000 -- --
Prepaid expenses and
other current assets.. 55,386 311,855 291,153
----------- ----------- ------------
Total current assets..... 1,062,013 7,165,543 5,306,786
Equipment and leasehold
improvements, net....... 1,022,260 1,638,922 1,707,494
Patents, licenses and
other assets, net....... 655,406 561,349 534,953
----------- ----------- ------------
$ 2,739,679 $ 9,365,814 $ 7,549,233
=========== =========== ============
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....... $ 220,279 $ 572,049 $ 272,919
Accrued professional
fees.................. 403,278 88,620 396,193
Other current
liabilities........... 75,396 284,916 311,431
Current portion of
capital lease
obligations........... 31,809 132,173 136,730
Current portion of loan
obligation............ -- 133,114 138,163
----------- ----------- ------------
Total current
liabilities............. 730,762 1,210,872 1,255,436
Noncurrent portion of
capital lease
obligations............. 32,360 174,519 138,580
Noncurrent portion of
loan obligation......... -- 616,886 580,393
Commitments and
contingencies
Stockholders' equity:
Preferred stock, $0.001
par value:
Authorized shares--
8,000,000
Series A convertible
preferred stock:
Authorized shares--
3,000,000
Issued and
outstanding shares--
789,085 in 1995 and
2,170,460 in 1996
and 1997
Aggregate liquidation
value of $21,704,600
at March 31, 1997... 4,920,496 14,780,013 14,780,013 $ --
Common stock, $0.001
par value:
Authorized shares--
20,000,000
Issued and
outstanding shares--
7,124,956 in 1995
and 4,472,716 in
1996 and 1997....... 507,422 2,032,570 5,396,571 20,176,584
Notes receivable from
stockholders.......... (78,370) (1,237,120) (3,905,705) (3,905,705)
Deferred compensation.. -- -- (568,064) (568,064)
Deficit accumulated
during the development
stage................. (3,372,991) (8,211,926) (10,127,991) (10,127,991)
----------- ----------- ------------ -----------
Total stockholders'
equity.................. 1,976,557 7,363,537 5,574,824 $ 5,574,824
----------- ----------- ------------ ===========
$ 2,739,679 $ 9,365,814 $ 7,549,233
=========== =========== ============
See accompanying Notes to Consolidated Financial Statements.
F-3
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
PERIOD FROM PERIOD FROM
AUGUST 14, 1992 THREE MONTHS ENDED AUGUST 14, 1992
YEAR ENDED DECEMBER 31, (INCEPTION) TO MARCH 31, (INCEPTION) TO
------------------------------------ DECEMBER 31, ------------------------ MARCH 31,
1994 1995 1996 1996 1996 1997 1997
----------- ---------- ----------- --------------- ----------- ----------- ---------------
(UNAUDITED) (UNAUDITED)
Contract revenues....... $ 50,000 $2,127,000 $ 426,099 $ 2,603,099 $ 78,327 $ 272,373 $ 2,875,472
Operating expenses:
Research and
development............ 850,707 1,811,212 3,735,925 6,397,844 946,324 1,306,233 7,704,077
General and
administrative......... 1,477,664 937,656 1,749,086 4,676,161 400,670 931,298 5,607,459
----------- ---------- ----------- ----------- ----------- ----------- ------------
Total operating
expenses............... 2,328,371 2,748,868 5,485,011 11,074,005 1,346,994 2,237,531 13,311,536
----------- ---------- ----------- ----------- ----------- ----------- ------------
Loss from operations.... (2,278,371) (621,868) (5,058,912) (8,470,906) (1,268,667) (1,965,158) (10,436,064)
Interest expense........ (318) (2,655) (42,560) (45,533) (9,072) (42,776) (88,309)
Interest income......... 16,244 23,259 262,537 304,513 3,232 91,869 396,382
----------- ---------- ----------- ----------- ----------- ----------- ------------
Net loss................ $(2,262,445) $ (601,264) $(4,838,935) $(8,211,926) $(1,274,507) $(1,916,065) $(10,127,991)
=========== ========== =========== =========== =========== =========== ============
Pro forma net loss per
share.................. $ (0.52) $ (0.21)
=========== ===========
Shares used in computing
pro forma net loss per
share.................. 9,403,000 9,067,000
=========== ===========
See accompanying Notes to Consolidated Financial Statements.
F-4
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
DEFICIT
CONVERTIBLE NOTES ACCUMULATED
PREFERRED STOCK COMMON STOCK RECEIVABLE DURING THE TOTAL
------------------ ------------------- FROM DEFERRED DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT STOCKHOLDERS COMPENSATION STAGE EQUITY
------- ---------- --------- -------- ------------ ------------ ----------- -------------
Issuance of common stock
to founders for cash at
inception in August
1992................... -- $ -- 100,435 $ 35,000 $ -- $-- $ -- $ 35,000
Issuance of common stock
for cash and
stockholders' note
receivable in May 1993. -- -- 495,329 202,750 (180,000) -- -- 22,750
Issuance of common stock
for cash in September
1993................... -- -- 93,717 38,361 -- -- -- 38,361
Issuance of common stock
to acquire patent in
November 1993.......... -- -- 2,125,440 243,540 -- -- -- 243,540
Issuance of Series A
convertible preferred
stock for cash at $5.56
per share in November
1993................... 282,399 1,458,148 -- -- -- -- -- 1,458,148
Issuance of common stock
for cash at $0.001 per
share in November 1993
to Hyseq One Trust..... -- -- 5,446,502 2,837 -- -- -- 2,837
Issuance of common stock
for cash at $0.001 per
share in December 1993
to Hyseq One Trust..... -- -- 9,033 4 -- -- -- 4
Repurchase of common
stock for cash at
$0.002 per share from
Hyseq One Trust in
December 1993.......... -- -- (172,663) (256) -- -- -- (256)
Cash payment of note
receivable from
stockholder in December
1993................... -- -- -- -- 125,000 -- -- 125,000
Net loss................ -- -- -- -- -- -- (509,282) (509,282)
------- ---------- --------- -------- --------- ---- ----------- -----------
Balances at December 31,
1993................... 282,399 1,458,148 8,097,793 522,236 (55,000) -- (509,282) 1,416,102
Issuances of Series A
preferred stock for
cash and stockholders'
note receivable at
$6.56 per share in
January through
November 1994.......... 366,545 2,372,575 -- -- (13,120) -- -- 2,359,455
Issuance of Series A
preferred stock for
property and license in
lieu of cash at $6.56
per share in June and
November 1994.......... 21,516 141,145 -- -- -- -- -- 141,145
Issuance of common stock
for stockholders' note
receivable and cash at
$0.78 per share in
March 1994............. -- -- 88,320 69,000 (67,500) -- -- 1,500
Repurchase of common
stock at $0.41 per
share and repayment of
stockholders' note
receivable in March
1994................... -- -- (205,056) (84,372) 55,000 -- -- (29,372)
Issuance of common stock
at $0.001 per share in
March 1994 to Hyseq One
Trust.................. -- -- 191,873 100 -- -- -- 100
Repurchase of common
stock at $0.002 per
share from Hyseq One
Trust in January
through November 1994.. -- -- (820,214) (1,282) -- -- -- (1,282)
Net loss................ -- -- -- -- -- -- (2,262,445) (2,262,445)
------- ---------- --------- -------- --------- ---- ----------- -----------
Balances at December 31,
1994 (carried forward). 670,460 $3,971,868 7,352,716 $505,682 $ (80,620) $-- $(2,771,727) $ 1,625,203
See accompanying Notes to Consolidated Financial Statements.
F-5
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY--(CONTINUED)
DEFICIT
CONVERTIBLE NOTES ACCUMULATED
PREFERRED STOCK COMMON STOCK RECEIVABLE DURING THE TOTAL
--------------------- ---------------------- FROM DEFERRED DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT STOCKHOLDERS COMPENSATION STAGE EQUITY
--------- ----------- ---------- ---------- ------------ ------------ ----------- -------------
Balance at December
31, 1994 (brought
forward)............. 670,460 $ 3,971,868 7,352,716 $ 505,682 $ (80,620) $ -- $(2,771,727) $ 1,625,203
Issuance of Series A
preferred stock for
cash at $8.00 per
share in January
through December
1995, less issuance
costs of $372....... 118,625 948,628 -- -- -- -- -- 948,628
Issuance of common
stock for cash at
$0.78 per share in
December 1995....... -- -- 2,688 2,100 -- -- -- 2,100
Cash payment of note
receivable from
stockholders........ -- -- -- -- 2,250 -- -- 2,250
Repurchase of common
stock at $0.002 per
share from Hyseq One
Trust in January
through December
1995................ -- -- (230,448) (360) -- -- -- (360)
Net loss............. -- -- -- -- -- -- (601,264) (601,264)
--------- ----------- ---------- ---------- ----------- ------ ----------- -----------
Balances at December
31, 1995............. 789,085 4,920,496 7,124,956 507,422 (78,370) -- (3,372,991) 1,976,557
Issuance of Series A
preferred stock for
cash at $8.00 per
share in April and
May 1996, less
issuance costs of
$1,191,483.......... 1,381,375 9,859,517 -- -- -- -- -- 9,859,517
Issuance of common
stock for cash at
$4.17 per share in
September 1996...... -- -- 80,640 336,000 -- -- -- 336,000
Issuance of common
stock upon exercise
of stock option
grants for cash and
stockholders' note
receivable at $1.56
per share in
September and
December 1996....... -- -- 67,200 105,000 (75,000) -- -- 30,000
Issuance of common
stock upon exercise
of warrants for
stockholders' note
receivable at $2.90
per share in
December 1996....... -- -- 144,000 417,000 (417,000) -- -- --
Issuance of common
stock for
stockholders' note
receivable at $4.17
per share in
December 1996....... -- -- 161,280 672,000 (672,000) -- -- --
Repurchase of common
stock at $0.002 per
share from Hyseq One
Trust in January
through December
1996................ -- -- (3,105,360) (4,852) -- -- -- (4,852)
Cash payment of note
receivable from
stockholders........ -- -- -- -- 5,250 -- -- 5,250
Net loss............. -- -- -- -- -- -- (4,838,935) (4,838,935)
--------- ----------- ---------- ---------- ----------- ------ ----------- -----------
Balances at December
31, 1996 (carried
forward)............. 2,170,460 $14,780,013 4,472,716 $2,032,570 $(1,237,120) $ -- $(8,211,926) $ 7,363,537
See accompanying Notes to Consolidated Financial Statements.
F-6
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY--(CONTINUED)
DEFICIT
CONVERTIBLE NOTES ACCUMULATED
PREFERRED STOCK COMMON STOCK RECEIVABLE DURING THE TOTAL
--------------------- --------------------- FROM DEFERRED DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT STOCKHOLDERS COMPENSATION STAGE EQUITY
--------- ----------- --------- ---------- ------------ ------------ ------------ -------------
Balances at December
31, 1996 (brought
forward).............. 2,170,460 $14,780,013 4,472,716 $2,032,570 $(1,237,120) $ -- $ (8,211,926) $ 7,363,537
Issuance of common
stock for services and
stockholders' note
receivable at $6.51
per share in January
1997 (unaudited)...... -- -- 76,800 500,000 (397,585) -- -- 102,415
Forfeiture of note
receivable from
stockholders at $0.78
per share in February
1997 (unaudited)...... -- -- (86,400) (67,500) 67,500 -- -- --
Purchase of common
stock at $0.001 per
share by Hyseq One
Trust in February 1997
(unaudited)........... -- -- 86,400 45 -- -- -- 45
Issuance of common
stock for
stockholders' note
receivable at $6.51
per share in March
1997 (unaudited)...... -- -- 359,424 2,340,000 (2,340,000) -- -- --
Issuance of common
stock upon exercise of
stock option grants
for cash at $1.56 per
share in March 1997
(unaudited)........... -- -- 7,680 12,000 -- -- -- 12,000
Repurchase of common
stock at $0.002 per
share from Hyseq One
Trust in January
through March 1997
(unaudited)........... -- -- (443,904) (694) -- -- -- (694)
Deferred compensation
(unaudited)........... -- -- -- 580,150 -- (580,150) -- --
Amortization of
deferred compensation
(unaudited)........... -- -- -- -- -- 12,086 -- 12,086
Cash payment of note
receivable from
stockholders
(unaudited)........... -- -- -- -- 1,500 -- -- 1,500
Net loss (unaudited)... -- -- -- -- -- -- (1,916,065) (1,916,065)
--------- ----------- --------- ---------- ----------- --------- ------------ -----------
Balances at March 31,
1997 (unaudited)...... 2,170,460 $14,780,013 4,472,716 $5,396,571 $(3,905,705) $(568,064) $(10,127,991) $ 5,574,824
========= =========== ========= ========== =========== ========= ============ ===========
See accompanying Notes to Consolidated Financial Statements.
F-7
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIOD FROM
AUGUST 14,
1992 PERIOD FROM
(INCEPTION) THREE MONTHS ENDED AUGUST 14,
YEAR ENDED DECEMBER 31, TO MARCH 31, 1992
------------------------------------ DECEMBER 31, ------------------------ (INCEPTION) TO
1994 1995 1996 1996 1996 1997 MARCH 31, 1997
----------- ---------- ----------- ------------ ----------- ----------- --------------
(UNAUDITED) (UNAUDITED)
CASH FLOWS FROM
OPERATING ACTIVITIES:
Net loss................ $(2,262,445) $ (601,264) $(4,838,935) $(8,211,926) $(1,274,508) $(1,916,065) $(10,127,991)
Adjustments to reconcile
net loss to net cash
used in operating
activities:
Depreciation and
amortization.......... 91,164 286,844 444,036 822,044 93,660 165,542 987,586
Amortization of
deferred
compensation.......... -- -- -- -- -- 12,086 12,086
Shares of common stock
issued for services... -- -- -- -- -- 102,415 102,415
License fees acquired
through issuance of
preferred stock....... 100,000 -- -- 100,000 -- -- 100,000
Changes in assets and
liabilities:
Accounts receivable.. -- (136,336) (10,064) (146,400) 136,336 (125,973) (272,373)
Notes receivable from
officers............ -- (120,000) 120,000 -- 120,000 -- --
Prepaid expenses and
other current
assets.............. (64,256) 8,870 (256,469) (311,855) 16,812 20,702 (291,153)
Other assets......... -- (26,498) (23,678) (50,176) (91,598) 738 (49,438)
Accounts payable and
other current
liabilities......... 105,694 (8,706) 351,770 572,049 90,584 (299,130) 272,919
Accrued professional
fees................ 391,320 11,958 (314,658) 88,620 15,834 307,573 396,193
Other current
liabilities......... -- 75,396 209,520 284,916 67,143 26,515 311,431
----------- ---------- ----------- ----------- ----------- ----------- ------------
Net cash used in
operating activities... (1,638,523) (509,736) (4,318,478) (6,852,728) (825,737) (1,705,597) (8,558,325)
----------- ---------- ----------- ----------- ----------- ----------- ------------
CASH FLOWS FROM
INVESTING ACTIVITIES:
Expenditures for
property and equipment. (415,397) (678,635) (943,319) (2,037,351) (111,560) (208,456) (2,245,807)
Organization costs...... -- -- -- (14,763) -- -- (14,763)
Patents and other
intangibles............ (90,000) (210,000) -- (571,527) -- -- (571,527)
----------- ---------- ----------- ----------- ----------- ----------- ------------
Net cash used in
investing activities... (505,397) (888,635) (943,319) (2,623,641) (111,560) (208,456) (2,832,097)
----------- ---------- ----------- ----------- ----------- ----------- ------------
CASH FLOWS FROM
FINANCING ACTIVITIES:
Payments of
stockholders' notes
receivable............. 55,000 2,250 -- 57,250 -- 1,500 58,750
Cash proceeds from
issuance of:
Series A preferred
stock................. 2,359,455 948,628 9,859,517 14,625,748 279,000 -- 14,625,748
Common stock........... 1,600 2,100 371,250 598,646 1,000 12,000 610,646
Cash used to repurchase
common stock........... (85,654) (360) (4,852) (90,866) (105) (649) (91,515)
Cash proceeds from sale
leaseback.............. -- -- 369,350 369,350 369,350 -- 369,350
Principal payments on
capital lease.......... -- -- (126,471) (126,471) (29,331) (31,382) (157,853)
Financing loan.......... -- -- 750,000 750,000 -- -- 750,000
Principal payments on
financing loan......... -- -- -- -- -- (31,444) (31,444)
----------- ---------- ----------- ----------- ----------- ----------- ------------
Net cash provided by
(used in) financing
activities............. 2,330,401 952,618 11,218,794 16,183,657 619,914 (49,975) 16,133,682
----------- ---------- ----------- ----------- ----------- ----------- ------------
Net (decrease) increase
in cash and cash
equivalents............ 186,481 (445,753) 5,956,997 6,707,288 (317,383) (1,964,028) 4,743,260
Cash and cash
equivalents at
beginning of period.... 1,009,563 1,196,044 750,291 -- 750,291 6,707,288 --
----------- ---------- ----------- ----------- ----------- ----------- ------------
Cash and cash
equivalents at end of
period................. $ 1,196,044 $ 750,291 $ 6,707,288 $ 6,707,288 $ 432,908 $ 4,743,260 $ 4,743,260
=========== ========== =========== =========== =========== =========== ============
SUPPLEMENTAL DISCLOSURE
OF CASH FLOWS
INFORMATION
Cash paid for interest.. $ 318 $ 2,655 $ 42,560 $ 45,533 $ 9,072 $ 42,776 $ 88,309
=========== ========== =========== =========== =========== =========== ============
SUPPLEMENTAL SCHEDULE OF
NON-CASH FINANCING
ACTIVITIES
Equipment acquired under
capital leases......... $ -- $ 64,169 $ -- $ 64,169 $ -- $ -- $ 64,169
=========== ========== =========== =========== =========== =========== ============
Issuance of 708,480
shares of common stock
for patent............. $ -- $ -- $ -- $ 243,540 $ -- $ -- $ 243,540
=========== ========== =========== =========== =========== =========== ============
Issuance of 21,516
shares of Series A
preferred stock in
exchange for equipment
and license............ $ 141,145 $ -- $ -- $ 141,145 $ -- $ -- $ 141,145
=========== ========== =========== =========== =========== =========== ============
Issuance of 15,728
shares of common stock
in exchange for legal
services............... $ -- $ -- $ -- $ -- $ -- $ 102,415 $ 102,415
=========== ========== =========== =========== =========== =========== ============
See accompanying Notes to Consolidated Financial Statements.
F-8
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 1997 AND WITH RESPECT TO THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Hyseq, Inc. (the "Company") was established in August 1992 as an Illinois
corporation and subsequently reincorporated as a Nevada corporation on
November 12, 1993. The Company's wholly owned subsidiary, Hyseq Diagnostics,
Inc. ("HDI"), was formed as a Nevada corporation on July 18, 1995. The Company
applies the proprietary DNA array technology of its integrated HyX genomics
platform (the "HyX Platform") to develop gene-based therapeutic product
candidates and diagnostic products and tests. The Company believes that its
HyX Platform, which utilizes the Company's proprietary sequencing by
hybridization ("SBH") technology as its foundation, generates higher gene
sequence throughput with greater analytical flexibility and accuracy and lower
cost than prevailing technologies. To date, the Company's primary activities
have involved establishment of operations, recruiting of personnel and pursuit
of its research and development programs. Accordingly, it is classified as a
development-stage company.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company's
wholly owned subsidiary. All significant intercompany transactions and
accounts have been eliminated.
All common stock and common per share amounts have been retroactively
restated to reflect a 1.92-for-1 stock split of the Company's outstanding
common stock to be effected before the completion of the Company's initial
public offering -- See Note 10. All preferred share and preferred share
amounts are presented on a historical basis.
INTERIM FINANCIAL INFORMATION
The consolidated financial statements at March 31, 1997 and for the three-
month periods ended March 31, 1996 and 1997 are unaudited but include all
adjustments, consisting only of normal recurring adjustments, that management
of the Company believes are necessary for presentation of its financial
position and results of operations in accordance with generally accepted
accounting principles. The results of operations and cash flows for the three
months ended March 31, 1997 are not necessarily indicative of the results to
be expected for the full year 1997.
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid interest-bearing deposits with
original maturities of less than 90 days and insignificant interest rate risk
to be cash equivalents. The Company invests its excess cash in money market
accounts, certificates of deposit and other bank instruments.
F-9
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are computed using the straight-line method over the estimated
useful lives ranging from three to five years, except that leasehold
improvements are amortized over the remaining life of the lease or the life of
the improvement, whichever is less.
REVENUE RECOGNITION
Revenues from research, technology and license agreements are recognized
when the Company has satisfied milestones and payments received or to be
received are nonrefundable. Nonrefundable up-front payments are recognized
upon execution of the agreements and government grant revenue is recognized as
the reimbursable services are performed. See Notes 6 and 10.
Revenues from collaborative agreements representing 10% or more of total
revenue are as follows:
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
---------------- ------------
1994 1995 1996 1996 1997
---- ---- ---- ------ ------
Source:
NIST Grant........................... -- 33% 100% 100% 100%
Collaboration Partner A.............. -- 57% -- -- --
Collaboration Partner B.............. 100% -- -- -- --
ACCOUNTING FOR STOCK OPTIONS
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee and director stock options
rather than the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"), as
this alternative requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB 25, when the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant, no compensation expense is
recognized.
NET LOSS PER SHARE
Except as noted below, historical net loss per share is computed using the
weighted-average number of common shares outstanding. Common equivalent shares
are excluded from the computation as their effect is antidilutive, except
that, pursuant to the Securities and Exchange Commission ("SEC") Staff
Accounting Bulletins, common and common equivalent shares (stock options and
warrants) issued during the 12-month period prior to the initial filing of the
proposed offering at prices below the assumed public offering price have been
included in the calculation as if they were outstanding for all periods
presented (using the treasury stock method).
Historical net loss per share information is as follows:
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
Net loss per share...... $ (0.26) $ (0.07) $ (0.61) $ (0.16) $ (0.25)
Shares used in computing
net loss per share..... 8,820,000 8,140,000 7,888,000 7,910,000 7,552,000
F-10
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Pro forma net loss per share has been computed as described above and also
gives effect to the conversion of convertible preferred shares not included
above that will automatically convert upon completion of the Company's initial
public offering (using the if-converted method) from the original date of
issuance.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"),
which is required to be adopted on December 31, 1997. At that time, the
Company will be required to change the method currently used to compute
earnings per share and to restate all prior periods. Under the new
requirements for calculating primary earnings per share, the dilutive effect
of stock options will be excluded. The impact is not expected to result in a
change in primary earnings per share for the quarters ended March 31, 1996 and
1997 as the Company incurred net losses in those periods and, accordingly, the
calculation of earnings per share for those periods excluded stock options as
their effect was antidilutive.
2. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following:
DECEMBER 31,
--------------------- MARCH 31,
1995 1996 1997
---------- ---------- -----------
(UNAUDITED)
Machinery, equipment, and furniture....... $1,121,477 $2,016,656 $2,211,879
Leasehold improvements.................... 77,868 125,652 138,885
---------- ---------- ----------
1,199,345 2,142,308 2,350,764
Less accumulated depreciation and
amortization............................. 177,085 503,386 643,270
---------- ---------- ----------
$1,022,260 $1,638,922 $1,707,494
========== ========== ==========
Equipment and leasehold improvements at December 31, 1996 include items
under capitalized leases. Accumulated amortization related to leased assets is
included in depreciation expense.
3. PATENTS, LICENSES AND OTHER ASSETS
PATENTS
Patents consist primarily of costs and expenses incurred in connection with
obtaining patents and patent applications in the United States. Included in
patent costs is $243,540 related to the issuance of 708,480 shares of common
stock in November 1993 at an estimated fair value of $0.34 per share, as
determined by the management of the Company. The Company also issued 1,416,960
shares of common stock for technology related to the same patent to the
Company's two Co-Senior Vice Presidents for Research. Amortization, which
amounted to $42,735 in each of the three years ended December 31, 1996, is
being recorded over the patents' estimated useful lives, which approximate 17
years. For the three months ended March 31, 1996 and 1997, amortization
expense was $10,684 and $6,908, respectively.
LICENSE AND FRANCHISE AGREEMENT
In 1994, the Company entered into a license and franchise agreement for the
exclusive right to use and resell robotic equipment in the field of
manipulating, sorting, identifying or sequencing nucleic acids in
hybridization reactions of DNA or RNA. The agreement required the Company to
pay total license fees of $300,000. Amortization, which amounted to $75,000
for each of the years ended December 31, 1995 and 1996 and $37,500
F-11
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. PATENTS, LICENSES AND OTHER ASSETS--(CONTINUED)
for the year ended December 31, 1994, is being recorded over the four-year
term of the agreement. For each of the three months ended March 31, 1996 and
1997, amortization expense was $18,750. As of December 31, 1996, the Company
had a purchase commitment for 10 remaining additional robotic units for a
total remaining commitment of approximately $700,000 through 1998. These
purchase commitments may be met by reselling such units to third parties.
PATENT AGREEMENT
In 1994, the Company entered into a patent agreement for the exclusive
license to use certain SBH proprietary technology (developed by one of the
Company's two Co-Senior Vice Presidents for Research) and to develop, use, and
sell licensed products or processes under the license patent rights. The
Company issued 15,244 shares of Series A Preferred Stock and must pay minimum
royalties ranging from $25,000 to $100,000 per annum beginning in 1997 and
expiring at expiration of the related patents. The agreement requires that the
Company incur research and development costs relating to the patent technology
in the amount of $2,500,000 through June 1998. At March 31, 1997, the Company
estimates that its remaining obligation is less than $640,000.
4. LOAN OBLIGATION
In December 1996, the Company entered into a $1,000,000 loan agreement with
a capital management partnership and issued a warrant to purchase 9,600 shares
of common stock at $5.21 per share in connection with such loan. The loan has
an imputed interest rate of 14.9% per annum. As of December 31, 1996, the
Company had borrowed $750,000 under the loan agreement which amount is secured
by certain equipment owned by the Company.
Future minimum loan payments under the loan agreement are as follows:
Years ending December 31:
1997........................................................ $ 236,610
1998........................................................ 236,610
1999........................................................ 236,610
2000........................................................ 311,610
----------
Total loan payments........................................... 1,021,440
Loan amount representing interest............................. 271,440
----------
Present value of future loan payments......................... 750,000
Less current portion.......................................... 133,114
----------
Noncurrent portion............................................ $ 616,886
==========
F-12
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. LEASE COMMITMENTS AND CONTINGENCIES
CAPITAL LEASE OBLIGATIONS
During December 1995, the Company entered into capital lease agreements to
finance certain equipment purchases. In February and July 1996, the Company
entered into sale and leaseback transactions for certain equipment.
Future minimum lease payments under capital leases are as follows:
CAPITAL
LEASES
---------
Years ending December 31:
1997......................................................... $ 162,194
1998......................................................... 159,068
1999......................................................... 26,758
---------
Total minimum lease payments................................... 348,020
Less amount representing interest.............................. (41,328)
---------
Present value of future lease payments......................... 306,692
Less current portion........................................... (132,173)
---------
Noncurrent portion............................................. $ 174,519
=========
OPERATING LEASE COMMITMENTS
The Company leases its facilities under an operating lease agreement that
expires in 1999. The Company also leases certain equipment under operating
leases. Rental expense was approximately $86,000 in 1994, $182,000 in 1995,
$183,000 in 1996 and $453,000 for the period from August 14, 1992 (inception)
to December 31, 1996. Minimum future rental commitments under operating leases
at December 31, 1996 are approximately $181,000, $169,000 and $159,000 in
1997, 1998 and 1999, respectively. Rental expense was approximately $46,000
for each of the three months ended March 31, 1996 and 1997.
CONTINGENCIES
On May 10, 1996, Sands Brothers & Co., Ltd. ("Sands") filed a suit against
the Company arising out of the Company's prior engagement of Sands to act as a
placement agent in a private placement. The complaint seeks, among other
things, damages in the aggregate amount of at least $12 million. The Company
filed a motion to dismiss the complaint on July 25, 1996. The court has not
yet ruled on the Company's motion to dismiss. The Company believes that the
suit has no merit and that it has valid defenses to the claims. There can be
no assurance, however, that the Company will prevail in its defense of the
claims asserted by Sands. Any such failure to prevail could have a material
adverse effect on the Company's business, financial condition and operating
results.
On March 3, 1997, the Company brought suit against Affymetrix, Inc.
("Affymetrix"), alleging infringement by Affymetrix of two of the Company's
patents covering SBH technology. The Company may incur substantial costs and
expend substantial personnel time in asserting the Company's patent rights
against Affymetrix or others and there can be no assurance that the Company
will be successful in asserting its patent rights. See Note 10.
F-13
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. COLLABORATIVE AGREEMENTS
In January 1995, the Company received a grant award from the National
Institute of Standards and Technology ("NIST") to further the development of
the Company's SBH technology. Under this award, the Company is entitled to
receive approximately 80% of actual direct costs of this program up to
$2,000,000 over a three-year period. Total revenue recognized under the NIST
agreement for the years ended December 31, 1995 and 1996 and for the three
months ended March 31, 1996 and 1997 was $700,000, $426,098, $78,327 and
$272,373, respectively.
The Company entered into collaborative agreements with two pharmaceutical
companies, which provided for total contract fees of $1,250,000 and royalty
payments for any future sales of products generated from the agreements.
Contract fees are payable upon achievement of milestones and are
nonrefundable. During 1994, 1995 and 1996, the Company recorded revenues of
$50,000, $1,200,000 and zero, respectively, under these agreements. No
revenues were recorded under these agreements during each of the three months
ended March 31, 1996 and 1997.
Under the terms of another agreement with a clinical reference laboratory,
the Company has received an initial payment of $200,000 and will grant its
corporate partner a non-exclusive license to use, promote, commercialize,
market and sell certain technology for clinical diagnostic purposes upon
payment of the license fee. The corporate partner and the Company are in the
process of evaluating whether to enter into a broader license agreement. See
Note 10.
7. STOCKHOLDERS' EQUITY
SERIES A CONVERTIBLE PREFERRED STOCK
Each share of Series A Preferred Stock is convertible at any time into one
share of common stock, subject to adjustment for antidilution. Conversion is
automatic upon the closing of an underwritten public offering with aggregate
offering proceeds exceeding $15,000,000 and a preoffering valuation of the
Company exceeding $42,000,000.
The Series A preferred stockholders have one vote per share and are entitled
to receive, ratably with common stockholders, dividends when and if declared
by the board of directors. Through December 31, 1996, no such dividends have
been declared. The Series A preferred stockholders have liquidation
preferences equal to $10.00 per share, plus all dividends declared and unpaid.
COMMON STOCK
At December 31, 1996, an aggregate of 8,099,792 shares of common stock were
reserved for issuance upon the exercise of warrants (see "Warrants" below),
conversion of Series A Preferred Stock (5,760,000 shares) outstanding stock
options granted and stock options reserved for issuance.
In December 1996, an officer of the Company purchased 161,280 shares of
common stock at $4.17 per share for a total purchase price of $672,000.
Simultaneously with the purchase of such stock, the officer borrowed from the
Company $672,000 as evidenced by a promissory note that bears interest at 3%
per annum, matures in December 2001, and is secured by and with recourse only
to the 161,280 shares. The Company has the right, but not the obligation to
repurchase certain of the shares if the officer's employment with the Company
terminates
F-14
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY--(CONTINUED)
before December 1997. Also in December 1996, another officer exercised options
to purchase 48,000 shares of common stock at an exercise price of $1.56 per
share and exercised warrants to purchase 144,000 shares of common stock at
$2.90 per share. Simultaneously with exercise, the officer borrowed from the
Company $492,000, as evidenced by a promissory note that bears interest at 3%
per annum, matures in December 2001, and is secured by and with recourse only
to 118,080 shares.
In March 1997, the Company sold a total of 359,424 shares of common stock
for $6.51 per share to two officers of the Company in exchange for promissory
notes with terms similar to those described above. Such shares are subject to
repurchase by the Company if the officers do not remain employed by the
Company through March 1999; such repurchase rights of the Company expire
ratably over this two-year period. Additionally, the Company granted options
to purchase a total of 86,131 shares of common stock at an exercise price of
$6.51 per share to officers and employees.
DEFERRED COMPENSATION
The Company has recorded deferred compensation of $580,150 representing the
difference between the issuance and exercise prices related to stock awards
and options and the deemed fair value for financial reporting purposes of the
Company's common stock for 359,424 shares subject to stock awards and 86,131
shares subject to stock options granted during the three-months ended March
31, 1997. The deferred stock compensation will be amortized to expense over
the vesting period of the options and over the two year repurchase period for
the stock awards.
SHARES HELD IN TRUST
In November 1993, the Company sold 5,446,502 shares of common stock to the
Hyseq One Trust (the "Trust") for $2,837 or $0.001 per share. The Trust was
formed to maintain certain agreed upon ownership ratios and avoid dilution to
existing stockholders. A trustee holds the shares in accordance with terms of
the trust agreement. The trustee retained all voting rights attributable to
those shares held in the Trust.
The Company has the right to purchase from the Trust (i) the equal number of
shares of its preferred or common stock that it issues in the same period
(excluding shares issued as a result of a stock split or stock dividend) to
any person other than the Trust and (ii) the number of shares calculated as
the Company's revenues prior to May 1, 1994 divided by $2.90 or the Company's
revenues subsequent to May 1, 1994 divided by $5.21. The price that the
Company pays to purchase shares from the Trust is $0.002 per share. At such
time as the Company reacquires shares of common or preferred stock from anyone
other than the Trust, an equivalent number of common shares are to be issued
to the Trust at $0.001 per share.
As of March 31, 1997, the Trust owned 961,219 shares of the Company's common
stock; 4,686,190 shares of common stock had been purchased from the Trust and
retired by the Company. The Trust shall terminate at such time as there are no
shares held thereunder, at which time any remaining trust property shall be
distributed to the Company. The Trust will terminate upon completion of the
Company's proposed initial public offering. See Note 10.
F-15
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY--(CONTINUED)
WARRANTS
As of December 31, 1996, the Company has issued warrants to purchase up to
1,010,000 shares of common stock at exercise prices ranging from $2.90 to
$5.21 ($3.73 average exercise price) per share to certain investors, an
executive officer and the private placement agent for the 1996 Series A
Preferred Stock financing. The value of these warrants is not material. In
1996, an executive officer of the Company exercised a warrant to purchase
144,000 shares of common stock at $2.90 per share.
In January 1997, the Company obtained a commitment for an additional
$500,000 under its loan agreement with a capital management partnership
entered into in December 1996. The Company is committed to issuing an
additional warrant to purchase 4,800 shares of common stock at $5.21 per share
related to this loan commitment. This loan will be secured by certain
equipment owned by the Company to the extent it is used.
STOCK OPTION PLANS
During 1995, the Company adopted the 1995 Stock Option Plan (the "Stock
Option Plan"). The Company reserved a total of 576,000 common shares for
issuance under the Plan. Under the Plan, stock options may be granted by the
board of directors to employees and consultants. Options granted may be either
incentive stock options or nonstatutory stock options. Incentive stock options
may be granted to employees or consultants with exercise prices of no less
than fair value and nonstatutory options may be granted to employees or
consultants at exercise prices of no less than par value of the common stock
on the date of grant as determined by the board of directors. Options vest as
determined by the board of directors and expire 10 years from the date of
grant.
The Company had granted options to purchase common stock to several key
employees, directors, and scientists prior to adoption of the Plan. Each
option gives the holder the right to purchase common stock at prices between
$0.78 and $4.17 per share. The options vest over periods up to four years. As
of December 31, 1996, 615,552 options were outstanding which were issued
outside of the Stock Option Plan.
During 1996, the Company adopted the Non-Employee Directors Stock Option
Plan (the "Directors' Plan"), which provides for the issuance of nonqualified
stock options to nonemployee members of the board of directors. An aggregate
of 138,240 shares of the Company's authorized but unissued common stock has
been reserved for issuance upon the exercise of options granted under the
Directors' Plan.
As adjusted information regarding net loss and net loss per share is
required by FAS 123, which also requires that the information be determined as
if the Company has accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method. The fair value for these
options was estimated at the date of grant using the minimum value method with
the following weighted-average assumptions:
YEAR ENDED DECEMBER 31,
------------------------
1995 1996
----------- -----------
Risk-free interest rates........................ 6.1% 6.2%
Dividend yield.................................. -- --
Expected life of option......................... 3.5 years 3.0 years
F-16
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY--(CONTINUED)
The minimum value method estimates the fair value of options by calculating
the current price of the stock at the date of grant reduced by the present
value of the exercise price. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its
employee stock options.
For purposes of as adjusted disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's as adjusted information follows (in thousands, except for per share
information):
YEAR ENDED DECEMBER 31,
------------------------
1995 1996
----------- ------------
As adjusted net loss........................... $ (604,084) $ (4,891,322)
As adjusted net loss per share................. $ (0.07) $ (0.62)
Because Statement 123 is applicable only to options granted subsequent to
December 31, 1994, its as adjusted effect will not be fully reflected until
fiscal 1999.
A summary of the Company's stock options activity, and related information
follows:
YEAR ENDED DECEMBER 31, THREE MONTHS ENDED
--------------------------------------- MARCH 31,
1995 1996 1997
------------------ -------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- --------- --------- --------- --------- ---------
Options outstanding at
beginning of period.... 829,440 $1.55 860,131 $1.66 1,153,553 $2.77
Options granted......... 33,379 $4.17 569,397 $4.17 86,131 $6.51
Options exercised....... (2,688) $0.78 (67,200) $1.56 (7,680) $1.56
Options canceled........ -- -- (208,775) $2.37 (2,052) $4.17
------- --------- ---------
Options outstanding at
end of the period...... 860,131 $1.66 1,153,553 $2.77 1,229,952 $3.04
======= ========= =========
The following table summarized information about stock options outstanding
at December 31, 1996:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED-
AVERAGE
NUMBER REMAINING WEIGHTED- NUMBER WEIGHTED-
RANGE OF OF CONTRACTUAL AVERAGE OF AVERAGE
EXERCISE PRICE SHARES LIFE EXERCISE PRICE SHARES EXERCISE PRICE
-------------- --------- ----------- -------------- ------- --------------
(IN YEARS)
$0.78 - $0.78........... 24,192 7.20 $0.78 12,672 $0.78
$1.56 - $1.56........... 556,800 7.50 $1.56 379,200 $1.56
$1.82 - $1.82........... 34,560 7.86 $1.82 34,560 $1.82
$4.17 - $4.17........... 538,001 9.56 $4.17 87,114 $4.17
--------- -------
Total................. 1,153,553 8.46 $2.77 513,546 $2.00
========= =======
The weighted-average grant-date fair value of options granted during the
years ended December 31, 1995 and 1996 was $0.74 and $0.69, respectively.
F-17
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. INCOME TAXES
As of December 31, 1996, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $7,400,000. The net operating
loss carryforwards will expire at various dates beginning in 2008 through
2011, if not utilized.
Utilization of the net operating losses is expected to be subject to a
substantial annual limitation because of the "change in ownership" provisions
of the Internal Revenue Code of 1986, as amended. The annual limitation may
result in the expiration of net operating losses before utilization.
Significant components of the Company's deferred tax assets for federal and
state income taxes are as follows:
DECEMBER 31,
------------------------
1995 1996
----------- -----------
Net operating loss carryforwards.................. $ 1,000,000 $ 2,500,000
Capitalized research and development.............. -- 200,000
Other--net........................................ 200,000 200,000
----------- -----------
Net deferred tax assets........................... 1,200,000 2,900,000
Valuation allowance............................... (1,200,000) (2,900,000)
----------- -----------
$ -- $ --
=========== ===========
The net valuation allowance increased by $200,000 during 1995.
9. TRANSACTIONS WITH RELATED PARTIES
As of December 31, 1995 and 1996, the Company owed $238,602 and $44,026,
respectively, for professional services rendered by separate law firms of
which the spouse of the Company's President and Chief Executive Officer was a
member during each of the periods. The Company incurred legal fees and costs
to one of these law firms of $83,112 for the year ended December 31, 1996 and
$233,212 for the three months ended March 31, 1997. The Company incurred
legal fees and costs of $229,764, $34,834 and $68,775 for the years ended
December 31, 1994, 1995 and 1996, respectively, to one of these law firms.
In January 1997, the Sachnoff & Weaver, Ltd. purchased 76,800 shares of the
Company's common stock at $6.51 per share. Sachnoff & Weaver, Ltd., a member
of which is the spouse of the Company's President and Chief Executive Officer,
paid $102,415 and delivered a promissory note to the Company for the balance
in the amount of $397,585 secured by 61,069 shares of common stock. The note
bears interest at 8.25% per annum and is due on March 18, 2001.
10. SUBSEQUENT EVENTS
In April 1997, the Company's board of directors approved an increase of
576,000 in the number of shares authorized for issuance under the Stock Option
Plan.
F-18
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. SUBSEQUENT EVENTS--(CONTINUED)
On April 23, 1997, Affymetrix filed a motion to dismiss or, in the
alternative, for a more definitive statement. On May 5, 1997, the Company
filed an Amended Complaint. On May 19, 1997, Affymetrix filed an Answer and
Affirmative Defenses to the First Amended Complaint and also filed a
counterclaim against the Company. The counterclaim seeks a declaratory
judgment of invalidity and non-infringement with respect to these SBH patents
that are the basis for the infringement allegation. On June 9, 1997, the
Company filed a reply to the counterclaim in which it denied the allegation of
invalidity and non-infringement. By order of the court, an initial case
management conference is scheduled for August 1, 1997.
In May 1997, the Company entered into an exclusive collaboration with Chiron
Corporation ("Chiron"). Pursuant to the terms of the collaboration agreement,
the Company and Chiron are collaborating to develop therapeutics, diagnostic
molecules and vaccines relating to a specified disease area (the "Disease
Area"). The collaboration has an initial term of three years and can be
extended at Chiron's option for two additional two-year periods. Chiron paid a
nonrefundable $1 million up-front licensing fee upon signing the agreement and
guaranteed payment of a minimum of $8.5 million in the first year and $5.5
million in each of the two years thereafter in connection with the Company's
research on Chiron tissue sample libraries. The Company recognized the up-
front licensing fee as revenue when received, and will recognize the research
payments as related costs are incurred over the three year term of the
agreement. The agreement requires the Company to generate data at a specified
level per year, which if not met could result in the Company's breach of the
agreement. Chiron has the exclusive right to commercialize any Disease Area
products resulting from the collaboration. The Company will receive royalties
on any such products. Pursuant to the terms of a stock purchase agreement,
Chiron concurrently acquired 175,070 shares of the Series B Preferred Stock in
a private placement at $28.56 per share (before giving effect to the stock
split) for a total investment of $5.0 million and has committed to purchase an
additional $2.5 million under certain conditions.
In May 1997, the Company entered into an agreement with The Perkin-Elmer
Corporation ("Perkin-Elmer") to combine the Company's super chip technology
and Perkin-Elmer's life science system capabilities to commercialize HyChip
products (collectively, the "HyChip System"). Pursuant to the terms of the
agreement, the Company is obligated to commit $5.0 million to further
development of the Company's "chip" component of the HyChip System over the
next two years, and Perkin-Elmer must commit certain funds to develop the
overall system. The collaboration has an initial term of five years and will
be extended automatically thereafter unless the parties mutually agree to
termination. The agreement contemplates that the design, development and
manufacture of the HyChip "chip" will be under the direction of the Company,
while design, development and manufacture of the overall system will be under
the direction of Perkin-Elmer. HyChip products will be distributed through
Perkin-Elmer's Applied Biosystem Division. In June 1997, Perkin-Elmer acquired
175,070 shares of the Company's Series B Preferred Stock in a private
placement at $28.56 per share (before giving effect to the stock split) for a
total investment of $5.0 million and agreed to make an additional investment
of $5.0 million upon the earlier of the closing of this offering or December
2, 1997.
In May 1997, the Company executed a Certificate of Designations, Preferences
and Rights of Series B Preferred Stock providing for the issuance of up to
525,210 shares of Series B Preferred Stock. The Series B Preferred Stock has
certain anti-dilution rights in connection with automatic conversions
triggered by an initial public offering. If this offering is completed by
November 25, 1997 at a price to the public that is less than 1.1111 times the
conversion price of the Series B Preferred Stock then in effect (currently,
$28.56 per share before giving effect to the stock split), the conversion
price will decrease to an amount equal to ninety percent of the price to the
public.
F-19
HYSEQ, INC.
(A DEVELOPMENT-STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
10. SUBSEQUENT EVENTS--(CONTINUED)
Also in May 1997, the Company's board of directors authorized the filing of
a registration statement with the Securities and Exchange Commission for the
Company's initial public offering of its common stock. Under the terms
currently contemplated, all outstanding shares of Series A Convertible
Preferred Stock outstanding will automatically convert on a 1-for-1 basis into
2,170,460 shares of common stock upon completion of the offering. In addition,
all outstanding shares of Series B Preferred Stock outstanding will
automatically convert (based on the initial public offering price) into
793,650 shares of common stock upon completion of the offering. Such
conversion is reflected in the unaudited pro forma stockholders equity at
March 31, 1997 in the accompanying consolidated balance sheet.
In June 1997, the Company's board of directors approved a 1.92-for-1 stock
split of the Company's outstanding common stock to be effected before the
completion of the Company's initial public offering. In connection with this
split, the Company's board of directors approved an increase in the number of
authorized common shares to 50,000,000. All common share and common per share
amounts have been retroactively restated to reflect the stock split in the
accompanying consolidated financial statements.
On June 30, 1997, Sands petitioned the court for leave to file a motion for
preliminary injunction. At the hearing, also held on June 30, 1997, the court
denied Sands' motion for preliminary injunction.
F-20
[GRAPHICS]
A computer image in false colors of a Hyseq 55,000 DNA samples array entitled
"Hyseq Gene Discovery DNA Array". The computer image takes up most of the page.
The caption below the computer image reads "Image of 55,000 DNA Samples in a
Hyseq Gene Discovery Array. The entire human genome can fit into 60 of these
arrays."
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NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE
UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY THE SHARES BY ANYONE IN ANY JURISDICTION WHICH
SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING
THE OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR ANY PERSON TO WHOM IT
IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANYTIME SUBSEQUENT TO ITS DATE.
-------------------
TABLE OF CONTENTS
PAGE
----
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 6
The Company............................................................... 15
Use of Proceeds........................................................... 15
Dividend Policy........................................................... 15
Capitalization............................................................ 16
Dilution.................................................................. 17
Selected Consolidated Financial Data...................................... 18
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 19
Business.................................................................. 23
Management and Scientific Advisory Board.................................. 44
Certain Transactions...................................................... 51
Principal Stockholders.................................................... 53
Description of Capital Stock.............................................. 55
Shares Eligible for Future Sale........................................... 58
Underwriting.............................................................. 60
Legal Matters............................................................. 62
Experts................................................................... 62
Additional Information.................................................... 62
Index to Consolidated Financial Statements................................ F-1
UNTIL SEPTEMBER 1, 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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3,000,000 SHARES
[LOGO OF HYSEQ INC.]
COMMON STOCK
-------------------
PROSPECTUS
AUGUST 7, 1997
-------------------
LEHMAN BROTHERS
SMITH BARNEY INC.
FAHNESTOCK & CO. INC.
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