ORKA

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2003, for Nuvelo, Inc. (formerly Hyseq, Inc.). The company is a biopharmaceutical firm focused on the discovery and development of therapeutics, with its lead candidate, alfimeprase, currently in Phase 2 clinical trials for peripheral arterial occlusion and catheter occlusion. The financial results include the operations of Variagenics, Inc., which Nuvelo acquired via merger on January 31, 2003. The company operates two reportable segments: Nuvelo (therapeutics) and Callida Genomics (sequencing technology).

Key Financial Metrics

Liquidity: As of September 30, 2003, the company held approximately $20.4 million in total liquid assets (cash, short-term investments, and restricted cash). However, current liabilities ($30.8 million) exceeded current assets ($24.1 million), indicating a working capital deficit.

Material Changes vs. Prior Period

• Revenue Decline: Contract revenues plummeted to $0.3 million for the quarter (from $11.0 million in Q3 2002) and $1.9 million for the nine-month period (from $22.9 million in 2002). This drastic decrease is attributed to the completion of the agricultural gene discovery collaboration with BASF Plant Science and the recognition of license fees from Affymetrix in early 2003.
• Increased Net Loss: The net loss for the quarter widened to $10.9 million from $1.4 million in the prior year quarter. The nine-month loss increased to $40.8 million from $28.5 million. This is primarily driven by the loss of collaboration revenue and increased operating costs associated with the Variagenics merger and Phase 2 clinical trials.
• Operating Expenses: Research and development expenses decreased slightly for the quarter ($8.4 million vs. $9.1 million) due to cost savings from the BASF collaboration completion and facility lease terminations, partially offset by increased clinical trial costs. General and administrative expenses remained flat for the quarter but increased significantly year-to-date ($14.4 million vs. $9.1 million) due to lease termination costs and merger integration expenses.
• Cash Flow: Net cash used in operating activities increased to $33.6 million for the nine months ended September 30, 2003, compared to $23.5 million in the prior year. However, investing activities provided $45.1 million in cash, primarily due to the cash infusion from the Variagenics acquisition ($25.7 million net) and maturities of short-term investments.

Guidance, Outlook, and Risks

• Clinical Progress: Nuvelo successfully completed an interim analysis of its Phase 2 trial for alfimeprase in peripheral arterial occlusion. The Data Safety and Monitoring Board recommended continuing the trial at all three dose levels. The company anticipates initiating Phase 3 trials in the first half of 2004.
• Capital Raise: Subsequent to the reporting period, on October 7, 2003, the company completed the sale of 11.5 million shares of common stock, raising approximately $26.2 million in net proceeds to fund clinical trials and operations.
• Debt Management: The company's line of credit with its Chairman, Dr. George Rathmann, totaling $11.0 million, was restructured in November 2003 to be repaid in 48 monthly installments. The remaining $9.0 million availability under the original $20.0 million line expired.
• Facility Rationalization: The company terminated its lease option for the Humboldt Court facility and assigned its Cambridge, Massachusetts lease to Idenix Pharmaceuticals to reduce costs and monetize non-core assets.
• Risks: The company faces significant risks including the need for additional capital to fund operations through 2004 and beyond, the uncertainty of clinical trial outcomes, potential dilution from future equity financings, and the volatility of the biotechnology sector. The company has an accumulated deficit of $194.2 million and expects to continue incurring losses.

Investor Verification Checklist

• Cash Runway: Verify the sufficiency of the $26.2 million raised in October 2003 combined with existing cash balances to fund operations through the anticipated Phase 3 trials in 2004.
• Debt Obligations: Confirm the repayment schedule and interest terms for the $11.0 million line of credit with Dr. Rathmann and the $6.6 million long-term note payable.
• Clinical Milestones: Monitor the full results of the Phase 2 alfimeprase trials and the timeline for Phase 3 initiation to assess the viability of the lead product.
• Revenue Pipeline: Assess the likelihood of generating new collaboration revenues to replace the lost BASF and Affymetrix income streams.
• Legal Contingencies: Review the status of the securities class action lawsuit inherited from Variagenics and the potential for settlement costs.