ORKA

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2002, for Hyseq Pharmaceuticals, Inc. (also referred to as Hyseq, Inc.). The company is a biopharmaceutical firm focused on developing therapeutic protein-based products from its proprietary gene database. In October 2001, the company formed a majority-owned subsidiary, Callida Genomics, Inc., to develop sequencing-by-hybridization (SBH) technology. As of the reporting date, Hyseq is primarily focused on the clinical development of alfimeprase, a thrombolytic agent for peripheral arterial occlusion, in collaboration with Amgen, Inc.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Contract revenues decreased by approximately $0.4 million (7%) compared to Q1 2001. This was primarily due to lower revenues from the collaboration with BASF Plant Sciences ($4.2 million in Q1 2002 vs. $5.2 million in Q1 2001), as the company processed clones slightly ahead of contractual levels in the prior year.
• Expense Surge: Total operating expenses increased by $12.0 million (99%). R&D expenses jumped $12.0 million, driven largely by a $10.0 million non-cash charge representing the fair value of warrants granted to Amgen, Inc. under a new collaboration agreement. Additional R&D increases included $1.7 million in higher rent costs.
• Liquidity Position: Cash and cash equivalents decreased by $5.8 million from the prior year-end balance of $12.3 million. The company drew down $4.0 million on a line of credit provided by its Chairman in February 2002.
• Segment Reporting: The company began reporting Callida Genomics as a separate segment in Q1 2002. Callida reported a loss from operations of $1.6 million, while the Hyseq segment reported a loss of $17.3 million.

Guidance, Outlook, and Risks

• Alfimeprase Development: The company plans to begin Phase I human studies for alfimeprase in Q2 2002. If safety is acceptable, Phase II studies are expected in 2003. The company estimates R&D costs for alfimeprase to be approximately $3.0 million in 2002, with costs expected to increase substantially in 2003 and beyond.
• Cost Reduction Measures: Management expects operating expenses to decrease moderately for the remainder of 2002. Measures include a partial hiring freeze, reduction in capital expenditures, and a workforce reduction of 79 employees (primarily in agricultural gene discovery) to reach approximately 125 employees by year-end.
• Financing Needs: The company explicitly states it requires substantial additional financing to fund operations and facility expansion. It does not currently generate sufficient cash from operations. Failure to secure funding could force the company to delay or eliminate research programs.
• Subsequent Events:
  • April 5, 2002: Completed a private placement raising approximately $15.0 million gross ($14.2 million net) by selling 3.58 million shares at $4.20 per share.
  • May 14, 2002: Amended the BASF collaboration agreement to accelerate completion to January 2003, resulting in cost savings but reduced royalties.
• Risks: Key risks include the inability to secure additional financing, the uncertainty of clinical trial results for alfimeprase, dependence on collaboration partners (Amgen, BASF, Affymetrix), and the potential for significant dilution from future equity offerings.

Investor Verification Checklist

• Non-Cash Charges: Verify the impact of the $10.0 million non-cash warrant expense on the reported net loss and its effect on future dilution.
• Cash Burn Rate: Assess the sustainability of operations given the $8.4 million cash burn in Q1 2002 and the reliance on the Chairman's line of credit and recent private placement.
• Collaboration Terms: Review the specific milestones and funding responsibilities in the Amgen (alfimeprase) and BASF agreements to understand future revenue and cost obligations.
• Workforce Reduction: Monitor the execution of the planned 79-employee reduction and its impact on R&D timelines.
• Subsequent Financing: Confirm the closing details and use of proceeds from the $15.0 million private placement completed in April 2002.