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December 2000: What the Heck is Hyseq Up to?

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Feel like you have a fuzzy notion of what Hyseq is all about? Remember, the Silicon Valley genomics company that netted $38 million in the biggest biotech IPO of 1997? Its unique high-throughput sequencing technology and ultra rich database of cDNA sequences sounded so promising. But then things seemed to get hazy, didn't they?

Don't worry, it wasn't you. Turns out that the company itself was out of focus. Insiders and outside observers alike blame Hyseq's old scattershot business plan on inexperienced management. As far as the investment community is concerned, the company didn't have a clear mission, and its dealmaking was lethargic.

But that's all behind it now. Hyseq has hitched its wagon to a biotech business star, and investors and staff say good things are to come.

George Rathmann, 72, who became Hyseq's chairman early this year and then replaced the company's founding CEO in May, is a larger-than-life figure with the twinkle and charm of Santa Claus and the track record of Midas. His claim to fame is Amgen, the world's largest biotech company and a regular on 'best companies' lists, which he cofounded in 1980. In 1990, Rathmann founded another biotech, ICOS, and grew that too into a stock market success.

Chris Wolf, Hyseq's former CFO who is still a significant shareholder, says he was delighted to hear that Rathmann had taken command. Rathmann's reputation for creating 'very focused business strategies,' Wolf says, will get Hyseq 'back to its original focus to be a biopharmaceutical company.' What's more, Wolf claims, in terms of product candidates, Hyseq has far more to offer than Rathmann's previous companies did. Under Rathmann's guidance, Wolf predicts, Hyseq could grow into a $200-a-share company.

Fuzzy vision

Looking back, it's hard to pinpoint exactly when Hyseq started losing clarity.

The company was established in Sunnyvale, Calif., in 1994 on a proprietary technology called sequencing by hybridization. For several years Hyseq scientists employed that method, invented by Chief Scientific Officer Radoje Drmanac, to sequence tissue samples. They accumulated what is widely considered the world's largest collection of processed cDNAs—20 million to date. And, with patent attorney Lewis Gruber in the CEO spot, they filed patents for thousands of 'rarely expressed' genes—diamonds in the rough that they say competitors didn't have the technology or the wherewithal to find. Today Hyseq has 5,000 of them in the patent pipeline.

When the company went public in August 1997, its assets looked like gems to investors. Andrew Scott, an analyst at M.H. Meyerson, claims he made five millionaires out of Hyseq stock.

Scott is among several observers, however, who would also trace the point at which the company began losing focus to the year of its IPO. It was March 1997 when Hyseq filed a patent infringement suit against Affymetrix. Affy countersued, and in December Hyseq filed a second one. Says Scott, 'Gruber was more a lawyer than a business person. They were more focused on Affy.' Adds another investor, speaking not for attribution, 'Gruber was a patent attorney on the prosecutor side. That was his comfort zone.' Patent attorneys, he adds, don't make good team builders.

Overall, 1997 was a good year for Hyseq: aside from its IPO, it struck a deal with PE to commercialize a chip-based use of the sequencing-by -hybridization method, and it entered a partnership with Chiron to help it process tissue samples and discover cancer tumor genes.

But Hyseq also incurred legal fees that year of more than $1 million to its outside counsel, Gruber's wife. The company was embroiled. Rathmann says of patent wars in general, 'Even before the trial, there's a great deal of energy being expended between you and your lawyers and their lawyers and their scientists trying to nail down what is the right answer to this. You have an intensive focus on that area once you're in litigation, and it's tragically expensive in terms of time and effort.'

Indeed, for Gruber's gang, the intensive focus might have been at the cost of other goals. Asked why he ultimately left the company, Wolf, who led Hyseq's successful IPO but departed 20 months later for a nearby chip-maker, answers: 'Because I had the opportunity as president and CEO of Protogene to instill my vision in a very focused way.'

Focused is the operative word.

Adjusting contrast

Today, Hyseq doesn't have a whole lot to show for its post-IPO years. PE has yet to start selling HyChips. Diagnostic products and partnerships mentioned in the company's S-1 prospectus haven't materialized. A wall map of Madagascar is the only remnant of a 'bioprospecting' deal cut in 1997 with the nonprofit organization Conservation International. Things didn't seem to go as planned for the e-commerce subsidiary, GeneSolutions.com, that Hyseq established in 1999 to sell targets from its database: Company officials now dismiss that as 'a marketing tool.' And, not surprisingly, the battle with Affymetrix is ongoing.

In fact, since Chiron, Hyseq has initiated only two additional industry partnerships: A deal in 1998 to identify genes for the pharmaceutical division of Kirin Brewery, and a $60 million agriculture gene discovery collaboration with American Cyanamid.

As of September 30, the company reported $13.3 million in cash, cash equivalents, and short-term investments. For the nine months ended that date, it reported a net loss of $1.16 per share, compared to $1.04 per share for that period last year. Analysts say Hyseq is running out of money and breaking no news.

And yet, investors remain patient. In November, Hyseq's stock was trading at around $28 a share — twice its offering price, and seven times its 52-week low.

In the opinion of Meyerson's Scott, who rates the stock a 'hold,' $25 of each share is attributable to the fact that George Rathmann has replaced Gruber as chief.

Culture change

Hyseq staff are careful not to utter unkind words about their exiled CEO, and Rathmann says that in fact it was Gruber who recruited him to the helm. But it's easy to see that the shift in power has brought welcome change to the corporate culture.

The reception counters at Hyseq's two facing stone-façade buildings are now furnished with large suggestion boxes. In late October, a pumpkin-carving contest is under way and pumpkins are perched on benches throughout the labs. A revised stock option plan now allows every employee the chance to own shares in the company. And Gruber's large corner office has been refurbished as a conference room and library, while the unassuming Rathmann, who works the same long hours as his staff, occupies a modest office down the hall.

'Having somebody like him here just gives an incredible boost to morale,' says David Rosen, vice president of operations. 'It's hard to put your finger on it, but the feel is different, and I think that's a very, very positive thing.'

John Ford, Hyseq's vice president of functional genomics, says Rathmann's sign-on felt like an honor. 'Everyone took it as a real pat on the back for all the hard work that we'd been doing over the past two years. He's such a wonderful person and such a visionary that everyone just sort of follows George. He has catalyzed a number of really important changes in the company.'

Indeed, Rathmann's name has lent Hyseq a new level of credibility. Rosen attributes his success recruiting several top-notch new hires to Rathmann's presence. And investor relations manager Dawn Nakao says she gets more respect from the community these days: 'There've been people who would never let us get our foot into the door who now say, When do you want to come in?'

And, of course, Ford credits Rathmann with getting Hyseq focused again. Rathmann is steering the crew back onto its original course: to develop biopharmaceuticals. 'It's not an easy transition, because there are so many potentially valuable products that could come out of this company. How do you weight them? How do you say that this has a better chance than this or this has more value than this?' Ford asks. 'It's a good position to be in, actually.'

Dust settling

Specifically, Rathmann's agenda calls for getting two drugs into clinical trials by the end of 2001: meeting the objectives of its Kirin, Chiron, and American Cyanamid contracts; sorting out the PE HyChip commercialization deal; raising money in coming months; establishing a new partnership by year's end; resolving the Affymetrix patent battle; and, ramping up staff and space.

During Hyseq's third-quarter conference call in late October, senior managers took turns methodically outlining their top six goals and describing the steps they would take to achieve them. Rathmann told analysts he was confident that the group would 'achieve a high percentage of our goals for the year 2000.' He added, 'That will assure us that we have the human and financial resources to complete the transformation of Hyseq to a biopharmaceutical genomics enterprise during the coming year.'

Few would argue that Rathmann is not capable of turning Hyseq into a biotech blockbuster. When Amgen began in 1980, he was one of three staff. When he left in 1990 that number was 1,000 and annual revenues were approaching $1 billion.

Perhaps more importantly, Rathmann is convinced of Hyseq's potential. Asked what it was about the company that lured him this late after retirement age, Rathmann admits that he had long had his eye on Hyseq: Back when its stock price was still a bargain, he had advised ICOS to consider acquiring it. He says, 'I was fascinated. I thought that the technology was wonderful.'

These days, VPs Ford and Rosen don't mind that the company isn't pumping out press releases. They're optimistically patient. Says Ford, 'It's a transition period. Whenever there's a transition period there's …'

'A lot of dust,' says Rosen.

'And a little bit of silence,' adds Ford. 'There's a little bit of time to get some real work done before you want to start making any noise. So that's what we're doing. Hunkering down and getting things done.'

'And when the dust settles,' Rosen chimes in, 'it'll be, Oh boy, this is quite an organization.

SIDEBAR: Sequencing by Hybridization: From Serbia to Silicon Valley

A newspaper cartoon of two octopi is taped to the door of Radoje Drmanac's office. The drawing shows a how-to guide for knife throwers in the foreground, and one octopus comforting his companion, an amputee eight times over: 'Hey, look on the bright side. At least no one can call you a quitter.'

Drmanac's subtle self-deprecation is heart-rending. For 13 years now, the gentle inventor, Hyseq's founder and chief scientific officer, has relentlessly promoted a method he developed for high-throughput DNA sequencing. Through journal rejections, patent suits, and a paralyzed commercial-ization deal with PE, Drmanac has persevered.

Today — even after the human and other genomes have been sequenced by alternative methods — he will tell you that his 'will be the technology of the future.' He says, 'I have all kinds of deep analysis [that show] why this technology should be better than others.'

Drmanac was just 29 when, as a doctoral candidate at the Institute of Molecular Genetics and Genetic Engineering in Belgrade, Yugoslavia, he invented sequencing by hybridization — a technique that rapidly assesses gene sequences by probing their binding sites with oligonucleotide arrays. Ever since, Drmanac confesses, he has averaged 12 hours a day, seven days a week consumed in thought about how to improve the technology.

To be sure, Drmanac's journey from researcher in a communist country laboratory to principal stockholder in a 260-person Silicon Valley biotech company is the stuff of American dreams. It's just a good thing he is tenacious.

It was at an international scientific meeting in Slovenia in 1987 when Drmanac described his DNA sequencing method to an American scientist who, in turn, encouraged him to submit a grant proposal to the US Department of Energy. Lo and behold, the DOE, which was seeking technologies to support its fledgling Human Genome Project, awarded Drmanac's lab $150,000.

Three years later, instead of extending the grant, the DOE invited Drmanac, his wife, and their team of nine scientists to continue their research at Argonne National Laboratory. The timing was serendipitous. Within three months of the Drmanacs's arrival in the US with their twin children, war broke out in Slovenia. 'If it had been three months later, we would probably still be in Yugoslavia,' he says.

In Chicago, Drmanac hooked up with patent attorney Lewis Gruber who helped him and his coinventor Radomir Crkvenjakov file a patent application for sequencing by hybridization. The procedure was new territory for the Yugoslavians. Recalls Drmanac: 'In Belgrade, when I mentioned to people that I want to file a patent, they said, Patent in molecular biology? What do you need patent for?' His is still the only patent held by the institute, which today is a major shareholder in Hyseq.

Drmanac wasn't dissuaded. 'I had a feeling that it must be useful because we have to sequence genomes,' he says. Gruber must have seen promise in Drmanac's invention too: He persuaded him to go into business. They incorporated Hyseq in 1992.

There's no doubt Drmanac's technology has been fruitful for Hyseq. The company has used the method to process more than 20 million cDNA libraries and discover some 5,000 rarely expressed genes. Sequencing by hybridization is so central to the business that email domains there are @sbh.com rather than @hyseq.

But Drmanac's dream — that the rest of the genomics universe sees the beauty of his invention — has yet to be realized. Since 1997, Hyseq has been hung up in patent battles with Affymetrix. And a deal struck the same year with PE aimed at large scale commercialization of sequencing by hybridization chips has yet to go anywhere. Drmanac is eternally optimistic. He predicts that someday SBH will be used to sequence the genome of every newborn baby. No one can call him a quitter.

— AB