UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2002

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 0-31035

VARIAGENICS, INC.

(Exact name of registrant as specified in its charter)

Delaware		04-3182077
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

60 Hampshire St., Cambridge, MA		02139-1548
(Address of principal executive offices)		(Zip code)

Registrant’s telephone number, including area code: (617) 588-5300

Former name, former address, and former year, if changed since last report: Not applicable

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

24,117,061 shares of Common Stock, par value $.01 per share, were outstanding on November 12, 2002.

VARIAGENICS, INC.
INDEX TO FINANCIAL STATEMENTS

PART I. FINANCIAL INFORMATION

Item 1.	Unaudited Consolidated Financial Statements

Consolidated Balance Sheets as of December 31, 2001 and September 30, 2002
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2001 and 2002
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2002
Notes to Consolidated Financial Statements

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.	Quantitative and Qualitative Disclosures About Market Risk

Item 4.	Controls and Procedures

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings

Item 2.	Changes in Securities and Use of Proceeds

Item 3.	Defaults Upon Senior Securities

Item 4.	Submission of Matters to a Vote of Security Holders

Item 5.	Other Information

Item 6.	Exhibits and Reports on Form 8-K

Signature

Certifications

PART I. FINANCIAL INFORMATION

ITEM 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Variagenics, Inc. and Subsidiary

Consolidated Balance Sheets

(in thousands, except per share amounts)

(Unaudited)

	December 31, 2001			September 30, 2002
Assets
Current assets:
Cash and cash equivalents	$	25,142		$	32,594
Short-term marketable securities	47,776			23,104
Assets held for sale	—			1,380
Prepaid expenses and other current assets	2,225			1,077
Total current assets	75,143			58,155
Restricted cash	750			750
Property and equipment, net	7,785			5,531
Long-term marketable securities	7,111			5,085
Other assets	143			109

Total assets	$	90,932		$	69,630

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	1,566		$	1,213
Accrued expenses and other liabilities	2,081			1,948
Accrued restructure and related charges	—			116
Deferred revenue	229			286
Current portion of capital lease obligations	1,558			2,136
Total current liabilities	5,434			5,699
Capital lease obligations	2,515			1,348

Total liabilities	7,949			7,047

Commitments and contingencies

Stockholders’ Equity:
Preferred stock, $.01 par value; 5,000 shares authorized, 0 shares issued and outstanding	—			—
Common stock, $.01 par value; 70,000 shares authorized, 23,371 and 24,105 shares issued and outstanding	234			241
Additional paid-in capital	171,035			169,847
Accumulated deficit	(77,998		)	(104,198		)
Promissory note from scientific advisor	(110		)	(118		)
Deferred compensation	(10,178		)	(3,183		)
Less treasury stock, at cost, 0 and 2 shares, respectively	—			(6		)

Total stockholders’ equity	82,983			62,583

Total liabilities and stockholders’ equity	$	90,932		$	69,630

The accompanying notes are an integral part of these unaudited consolidated financial statements.

Variagenics, Inc. and Subsidiary

Consolidated Statements of Operations

(in thousands, except per share amounts)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2001			2002			2001			2002
Revenue:
Research and development collaborations and other	$	574		$	178		$	2,381		$	592
Product sales	—			—			210			450

Total revenue	574			178			2,591			1,042

Costs and expenses:
Cost of product sales	—			—			186			236
Research and development:
Non-cash equity compensation	563			501			1,417			2,180
All other research and development expenses	4,519			4,450			11,477			14,612
General and administrative:
Non-cash equity compensation	840			181			2,426			3,123
All other general and administrative expenses	2,312			1,818			6,626			6,064
Restructure and related charges	—			—			—			1,974

Loss from operations	(7,660		)	(6,772		)	(19,541		)	(27,147		)

Other income (expense):
Interest income	1,114			326			3,803			1,206
Interest expense	(78		)	(87		)	(156		)	(259		)

Net loss	$	(6,624	)	$	(6,533	)	$	(15,894	)	$	(26,200	)

Net loss per share (basic and diluted)	$	(0.28	)	$	(0.27	)	$	(0.68	)	$	(1.11	)
Weighted average common shares outstanding (basic and diluted)	23,346			24,076			23,272			23,688

The accompanying notes are an integral part of these unaudited consolidated financial statements.

Variagenics, Inc. and Subsidiary

Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

	Nine Months Ended September 30,
	2001			2002
Cash flows from operating activities:
Net loss	$	(15,894	)	$	(26,200	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization	1,248			1,512
Non-cash compensation expense	3,843			5,303
Restructure and related charges	—			999
Amortization of premium and accretion of discount on marketable securities	(781		)	62
Changes in assets and liabilities:
Prepaid expenses and other current assets	(696		)	1,089
Accounts payable	208			(353		)
Accrued expenses	186			(133		)
Deferred revenue	(1,444		)	57

Net cash used for operating activities	(13,330		)	(17,664		)

Cash flows from investing activities:
Maturity of marketable securities	41,623			57,283
Purchase of marketable securities	(43,706		)	(30,647		)
Acquisition of property and equipment	(1,614		)	(1,444		)
Proceeds from sale/leaseback of equipment	746			702
Proceeds from sale of equipment	—			16

Net cash provided by (used for) investing activities	(2,951		)	25,910

Cash flows from financing activities:
Repayment of capital lease obligations	(811		)	(1,291		)
Proceeds from issuance of common stock	307			511
Promissory note secured by common stock	(107		)	—
Release of restricted cash for facility lease	250			—
Acquisition of treasury stock	—			(6		)
Interest on promissory note from scientific advisor	—			(8		)

Net cash used for financing activities	(361		)	(794		)

Net increase (decrease) in cash and cash equivalents	(16,642		)	7,452
Cash and cash equivalents at beginning of period	50,317			25,142

Cash and cash equivalents at end of period	$	33,675		$	32,594

The accompanying notes are an integral part of these unaudited consolidated financial statements.

Variagenics, Inc. and Subsidiary

Notes to Consolidated Financial Statements

(Unaudited)

1. Nature of the Business and Basis of Presentation

Variagenics, Inc. (the “Company”) was incorporated in Delaware on December 7, 1992. The Company was originally formed to develop a pharmacogenomic approach to cancer therapy. The Company has broadened that focus to discover genetic variations characterized by single nucleotide polymorphisms (“SNPs”) and other genetic differences. The Company will use this information to optimize drugs in development, develop new drug targets and bring diagnostic products to market. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Variagenics Securities Corporation. All intercompany balances and transactions have been eliminated.

The accompanying unaudited consolidated financial statements have been prepared on a basis which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company has incurred losses since its inception and, as of September 30, 2002, had an accumulated stockholders' deficit of $104.2 million. Management anticipates incurring additional operating losses through at least the end of 2003. The future viability of the Company is dependent upon its ability to: develop pharmacogenomic technologies, develop and commercialize proprietary molecular diagnostic products and commence generating cash from operations.

The Company is subject to risks common to companies in the industry including, but not limited to, uncertainty of product development and commercialization, lack of marketing and sales history, dependence on key personnel, market acceptance of products, competition, product liability, protection of proprietary technology, ability to raise additional financing, and compliance with FDA and other governmental regulations.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of these financial statements have been included. Interim results are not necessarily indicative of results that may be expected for a full year. These unaudited consolidated financial statements and notes should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, which was filed with the Securities and Exchange Commission on April 1, 2002.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

Certain reclassifications have been made to the unaudited consolidated financial statements for the nine months ended September 30, 2001 to conform to the current year presentation.

2. Summary of Significant Accounting Policies

Net Loss Per Share and Comprehensive Loss

Net loss per share is computed under SFAS No. 128 “Earnings Per Share.” Basic net loss per share is computed using the weighted average number of shares of common stock outstanding. Diluted net loss per share does not differ from basic net loss per share since potential common shares are antidilutive for all periods presented and, therefore, are excluded from the calculation of diluted net loss per share. Comprehensive loss is equal to net loss for all periods presented.

The following potentially dilutive common shares were excluded from the calculation of net loss per share because their effect was antidilutive (in thousands):

	September 30, 2001	September 30, 2002
Stock options	3,360	3,371
Warrants	1,277	1,270
Employee stock purchase plan	10	22

New Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("FAS 146"), which requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. FAS 146 is effective for exit or disposal activities initiated after December 31, 2002. The Company will adopt this statement effective January 1, 2003, and does not expect the adoption of this statement to have a material impact on its financial statements.

3. Supplemental Cash Flow Information (in thousands)

	Nine Months Ended September 30,
	2001		2002
Acquisition of property and equipment under capital lease agreements (excluding sale/leaseback transactions)	$	2,409	$	—

4. Capital Lease

In March 2002, the Company entered into a lease arrangement with a financing company for the sale and leaseback of $0.7 million of equipment.

5. Restructuring Charges and Asset Impairments

During the three months ended June 30, 2002, management formulated a restructuring plan in order to conserve cash and focus resources on the Company's oncology molecular diagnostic development programs. The Company has also discontinued its NuCleaveÒ product, which had been the source of revenue from product sales.

In connection with this restructure, a charge of $2.0 million was recorded, which consisted of $1.1 million related to employee separation costs and $0.9 million related to impairment of fixed assets which were taken out of service and held for sale as of June 30, 2002. None of these assets was sold as of September 30, 2002.

The restructuring reduced headcount by 44 positions, representing approximately 30% of the Company's workforce. Approximately half the reductions were in the high-throughput DNA sequencing group; the other half were spread throughout the organization, representing both research and development positions as well as general and administrative staff.

The employee separation costs were accounted for under EITF 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" and include amounts to be paid for severance and related benefits. As of September 30, 2002, all the employees to be terminated subject to the restructuring plan had ceased active employment with the Company; $1.0 million of severance and related benefits was paid out, with the remaining balance of $0.1 million included in accrued restructure and related charges and is expected to be substantially paid out prior to December 31, 2002.

In refocusing the business, management identified certain laboratory equipment with a net book value of $2.3 million that will no longer be required by the Company. This equipment has been decommissioned and is expected to be sold by June 2003. Certain of this equipment was purchased under capital leases, and costs associated with the early termination of the related obligations have been accrued. The debt associated with these assets has been reclassified to the current portion of capital lease obligations. Finally, an impairment charge of $0.9 million related to this equipment has been recorded to write the asset down to its estimated net realizable

value in accordance with FAS 144 "Accounting for Impairment or Disposal of Long-Lived Assets".

6. Related Party Transaction

In July 2002, the Company entered into an exclusive license agreement with Renegade Therapeutics, Inc. (“Renegade”). Under this agreement, the Company will license to Renegade certain of the Company’s intellectual property in exchange for: an upfront license fee in the amount of $75,000 payable in Renegade fully-vested founders’ stock and a $20,000 reimbursement for the Company’s patent prosecution expenses and valuation report expenses. No cash or stock has been received to date in connection with this agreement. The agreement contains provisions for royalty and milestone payments based on the commercialization of related technology and the issuance of the first U.S. patent with respect to the technology, among others. One of the officers and stockholders of Renegade is a Director and stockholder of the Company. In addition the scientific advisor to whom the Company has extended a promissory note is also an officer and stockholder of Renegade.

7. Subsequent Event

On November 9, 2002, the Company and Hyseq, Inc. (“Hyseq”) signed a definitive agreement whereby the Company will merge with and into Hyseq in a stock-for-stock transaction. Under the terms of the agreement, which have been approved by the Boards of Directors of both the Company and Hyseq, each share of the Company will be exchanged for shares of Hyseq common stock at an exchange ratio of 1.6451 shares of Hyseq common stock for each share of the Company’s common stock. This exchange ratio implies a purchase price for the Company’s shareholders of $2.22 per common share of the Company, or approximately $55.9 million (including in-the-money options and warrants), based on the closing price of Hyseq shares on November 8, 2002. The transaction will be completed through a reverse triangular, stock-for-stock merger in which Hyseq will form a new wholly-owned subsidiary that will merge into the Company. The surviving entity will then be merged upstream into Hyseq. Subsequently, Hyseq will change its legal name to a yet-to-be determined name. The transaction, which is structured as a tax-free reorganization for federal income tax purposes, is subject to approval by the shareholders of both the Company and Hyseq and other closing conditions, and is expected to close by the end of February of 2003.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2001 filed with the Securities and Exchange Commission on April 1, 2002 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The following discussion contains forward–looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed here. See “Special Note Regarding Forward-Looking Statements.”

Overview

We are a leader in applying pharmacogenomics technologies to the discovery, development and commercialization of personalized drugs and molecular diagnostic products. Our primary therapeutic focus is cancer. As a pharmacogenomics company, we identify therapeutically important genetic markers, including the most common form of genetic variability, single nucleotide polymorphisms, or SNPs, groups of SNPs called haplotypes, and other genetic markers. We combine our technology, expertise and proprietary data to offer pharmaceutical and biotechnology companies a full range of solutions to support key steps of their drug discovery and development process. We also intend to develop our own proprietary molecular diagnostic products. From inception in December 1992 through 1996, the main focus of our research activities was directed toward developing a pharmacogenomic approach to cancer therapy. In 1996 that focus was broadened to include SNP discovery and development of pharmacogenomic technologies. Since our inception in 1992, our operating activities have been primarily devoted to research and development, recruiting personnel, raising capital, acquiring assets and business development. In 1999, we recognized revenue from our first commercial collaboration and in March 2001, we recognized our first product sale.

We have incurred losses since our inception and, as of September 30, 2002, we had an accumulated stockholders’ deficit of $104.2 million. We anticipate incurring additional operating losses through at least the end of 2003, as we continue to develop our pharmacogenomic technologies and develop and commercialize proprietary molecular diagnostic products. Payments under contracts, collaborations and licensing arrangements will be subject to significant fluctuation in both timing and amount and, therefore, our results of operations for any period may not be comparable to the results of operations for any other period. In April 2002, we announced the resignation of our President and Chief Executive Officer and the related promotions of two senior officers of the Company.

During the three months ended June 30, 2002, we formulated a restructuring plan in order to conserve cash and focus resources on our oncology molecular diagnostic development programs. We have also discontinued our NuCleaveÒ product, which had been the source of our revenue from product sales.

In connection with this restructure, we recorded a charge of $2.0 million, which consisted of $1.1 million related to employee separation costs and $0.9 million related to impairment of fixed assets which were taken out of service and held for sale as of June 30, 2002. None of these assets was sold as of September 30, 2002.

The restructuring reduced headcount by 44 positions, representing approximately 30% of our workforce. Approximately half the reductions were in the high-throughput DNA sequencing group; the other half were spread throughout the organization, representing both research and development positions as well as general and administrative staff.

The employee separation costs were accounted for under EITF 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" and include amounts to be paid for severance and related benefits. As of September 30, 2002, all the employees to be terminated subject to the restructuring plan had ceased active employment with us; $1.0 million of severance and related benefits was paid out, with the remaining balance of $0.1 million included in accrued restructure and related charges, which we expect to be substantially paid out prior to December 31, 2002.

In refocusing the business, we identified certain laboratory equipment with a net book value of $2.3 million that will no longer be required by the Company. We have decommissioned this equipment and expect to sell it by June 2003. Certain of this equipment was purchased under capital leases, and we have accrued for costs

associated with the early termination of the related obligations. We have also classified the debt associated with these assets to the current portion of capital lease obligations. Finally, we recorded an impairment charge of $0.9 million related to this equipment to write the asset down to its estimated net realizable value in accordance with FAS 144 "Accounting for Impairment or Disposal of Long-Lived Assets".

We expect to substantially complete our restructuring program by the end of 2002. If our restructuring program is implemented in the manner and on the timeline we intend, we expect to realize the full benefits of our restructuring program by the first quarter of 2003, and anticipate reducing our quarterly cash burn from approximately $6 million to approximately $4 million. However, we cannot assure you that our restructuring program will achieve all of the cost and expense reductions and other benefits we anticipate or that the plan will be completed in the timetable contemplated.

Critical Accounting Policies

Valuation of Long-Lived and Intangible Assets.

We review our long-lived assets for impairment annually or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable.

During the three months ended June 30, 2002, and concurrent with our restructuring plan, we decommissioned some of our laboratory equipment and committed to a plan to sell it by June 2003. As a result of this decision, we measured our assets held for sale at the lower of its carrying amount or fair value less costs to sell and recognized an impairment charge of $0.9 million. Our estimate of the net realizable value of these assets depends on market conditions and the actual results may differ from our estimates. In the event actual net proceeds from these assets are below our expectations, or if we receive no proceeds at all, we will record an additional impairment loss up to an amount equal to the remaining carrying value of $1.4 million at September 30, 2002 (plus any related costs of disposal). In the event actual net sales proceeds from these assets exceed our expectations, we will recognize a gain. In addition, there could be new events and circumstances that would indicate impairment of additional long-lived assets; we will assess the value of such assets and provide for estimated losses when such impairments are identified.

Sources of Revenue and Revenue Recognition

Our revenue to date has been generated from research funding and milestones from collaborations, research grants from a governmental agency and license fees. In the first quarter of both 2001 and 2002, we recognized revenue from the sale of our NuCleaveÒ product; this product has been discontinued as a result of our restructuring program. As a result of our restructuring, we expect that future revenues will be derived from collaborations and our oncology molecular diagnostic development programs.

We recognize revenue from grants in the period in which related costs are incurred. We recognize revenue from collaborations under the percentage of completion method in accordance with SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.” Under percentage of completion accounting, revenue is based on the cost of effort from the contract’s commencement up to the reporting date, divided by the total expected research and development costs from the contract’s commencement to the end of the research and development period, multiplied by the total expected contractual payments under the arrangement. Revenue from product sales is generally recognized upon the Company’s receipt of the customer’s signed acceptance of the installed product, provided that there is evidence of arrangement, the fee is fixed or determinable and collection of resulting receivables is probable. Payments received in advance of being earned are recorded as deferred revenue. As of September 30, 2002, we had approximately $0.3 million of deferred revenue.

Results of Operations

Three Months Ended September 30, 2002 and 2001

Revenues. Revenues decreased to $0.2 million for the three months ended September 30, 2002 from $0.6 million for the comparable period ended September 30, 2001 due to the completion of a major collaboration in the fourth quarter of 2001. Revenues in both periods consisted principally of collaboration revenues.

Research and Development Expenses. Research and development expenses excluding non-cash equity compensation totaled $4.5 million in the three month periods of both 2002 and 2001. In 2002, increased costs in connection with clinical research projects ($0.6 million) and increased facility costs ($0.2 million) were substantially offset by decreased consumption of lab materials and consumables ($0.7 million) and decreased salary and related personnel costs ($0.2 million). We anticipate reductions in research and development expenses (principally, salary and related personnel costs, depreciation, equipment maintenance and lab materials and consumables) for the remainder of 2002 as the full impact of our restructuring program is realized.

General and Administrative Expenses. General and administrative expenses excluding non-cash equity compensation decreased to $1.8 million for the period ended September 30, 2002 from $2.3 million for the comparable period of 2001. The decrease in general and administrative expense was primarily due to decreased salary and related personnel costs ($0.3 million) and decreased facility costs ($0.2 million). We anticipate reductions in general and administrative expenses (principally, salary and related personnel costs) for the remainder of 2002 as the full impact of our restructuring program is realized.

Non-cash Equity Compensation. We recognize equity-related charges resulting from grants of options to employees and non-employees; a total of $0.7 million in the third quarter of 2002 versus $1.4 million in the same period of 2001. These charges are included in research and development expenses ($0.5 million and $0.6 million in the three month periods of 2002 and 2001, respectively) or general and administrative expenses ($0.2 million and $0.8 million in the three month periods of 2002 and 2001, respectively), depending upon the nature of the work performed by the individuals receiving the grants. We incurred expenses of $0.7 million in the third quarter of 2002 versus $1.4 million in the same period of 2001 related to stock options previously issued to employees. Employee options generally vest over four years, which is expected to result in additional compensation expense of $3.2 million for periods ending subsequent to September 30, 2002. We recorded a decrease in expense of less than $0.1 million for each of the quarters ended September 30, 2002 and September 30, 2001 related to options granted to non-employees. Non-employee equity grants are subject to remeasurement over the vesting period and we cannot estimate the expense we will recognize in future periods because the expense will depend on a number of variables, including our stock price.

Interest Income. Interest income, which is earned on cash equivalents and short- and long-term marketable securities, decreased to $0.3 million for the third quarter of 2002 from $1.1 million for the comparable period in 2001. The lower interest income was due to the effect of falling interest rates and the continued use of invested cash to fund operations.

Interest Expense. Interest expense increased to $87,000 for the third quarter of 2002 from $78,000 for the comparable period in 2001 due to an increase in capital lease obligations.

Net Loss. The net loss decreased to $6.5 million for the third quarter of 2002 from $6.6 million for the comparable period in 2001 primarily due to the reasons listed above.

Nine Months Ended September 30, 2002 and 2001

Revenues. Revenues decreased to $1.0 million for the nine months ended September 30, 2002 from $2.6 million for the comparable period ended September 30, 2001 due to the completion of a major collaboration in the fourth quarter of 2001. Revenues for the period ended September 30, 2002 consisted of $0.5 million in collaboration revenues, $0.5 million in product sales, and just under $0.1 million in license fees, while revenues for the period ended September 30, 2001 consisted of $2.4 million in collaboration revenues and $0.2 million in product sales.

Cost of Product Sales. Cost of product sales was $0.2 million for each of the nine month periods ended September 30, 2002 and September 30, 2001.

Research and Development Expenses. Research and development expenses excluding non-cash equity

compensation increased to $14.6 million for the nine months ended September 30, 2002 from $11.5 million for the comparable period ended September 30, 2001. The increase was due primarily to increased costs in connection with clinical research projects ($2.3 million), increased salary and related personnel costs ($1.4 million), increased facility costs ($0.7 million), and increased depreciation and amortization due to property and equipment additions ($0.4 million). These increases were partially offset by decreased consumption of lab materials and consumables ($1.6 million). We anticipate reductions in research and development expenses (principally, salary and related personnel costs, depreciation, equipment maintenance and lab materials and consumables) for the remainder of 2002 as the full impact of our restructuring program is realized.

General and Administrative Expenses. General and administrative expenses excluding non-cash equity compensation decreased to $6.1 million for the period ended September 30, 2002 from $6.6 million for the comparable period of 2001. The decrease in general and administrative expense was primarily due to decreased facility costs ($0.6 million) and decreased salary and related personnel costs ($0.3 million) offset by increased fees relating to outsourced functions ($0.3 million). We anticipate reductions in general and administrative expenses (principally, salary and related personnel costs) for the remainder of 2002 as the full impact of our restructuring program is realized.

Non-cash Equity Compensation. We recognize equity-related charges resulting from grants of options to employees and non-employees; a total of $5.3 million in the nine month period of 2002 versus $3.8 million in the same period of 2001. These charges are included in research and development expenses ($2.2 million and $1.4 million in the nine month periods of 2002 and 2001, respectively) or general and administrative expenses ($3.1 million and $2.4 million in the nine month periods of 2002 and 2001, respectively), depending upon the nature of the work performed by the individuals receiving the grants. We incurred expenses of $5.4 million in the nine month period of 2002 and $4.4 million for the comparable period in 2001 related to stock options previously issued to employees. (The 2002 total includes $3.0 million for the acceleration of option vesting for two executive officers who terminated their employment with the Company. Of this amount, $2.4 million is included in general and administrative expenses while $0.6 million is related to research and development.) Employee options generally vest over four years, which is expected to result in additional compensation expense of $3.2 million for periods ending subsequent to September 30, 2002. Employee terminations as a result of the Company's restructuring resulted in a reversal of $1.5 million of deferred compensation in the equity section of the Company's balance sheet. This reversal will cause a reduction in the amount of non-cash equity compensation expensed in future periods. We recorded a decrease in expense of $0.1 million for the nine month period of September 30, 2002 and $0.6 million for the nine month period of September 30, 2001 related to options granted to non-employees. Non-employee equity grants are subject to remeasurement over the vesting period and we cannot estimate the expense we will recognize in future periods because the expense will depend on a number of variables, including our stock price.

Restructuring and Related Charges. During the three months ended June 30, 2002, we formulated a restructuring plan in order to conserve cash and focus resources on our oncology molecular diagnostic development programs. We have also discontinued our NuCleaveÒ product, which had been the source of our revenue from product sales. In connection with this restructure, we recorded a charge of $2.0 million, which consisted of $1.1 million related to employee separation costs and $0.9 million related to impairment of fixed assets which were taken out of service and held for sale as of June 30, 2002. None of these assets was sold as of September 30, 2002.

Interest Income. Interest income, which is earned on cash equivalents and short- and long-term marketable securities, decreased to $1.2 million for the nine month period of 2002 from $3.8 million for the comparable period in 2001. The lower interest income was due to the effect of falling interest rates and the continued use of invested cash to fund operations.

Interest Expense. Interest expense increased to $259,000 for the nine month period of 2002 from $156,000 for the comparable period in 2001 due to an increase in capital lease obligations.

Net Loss. The net loss increased to $26.2 million for the nine month period of 2002 from $15.9 million for the comparable period in 2001 primarily due to the reasons listed above.

Liquidity and Capital Resources

Cash and cash equivalents totaled $32.6 million at September 30, 2002, an increase of $7.5 million from the December 31, 2001 balance of $25.1 million. The increase in cash is principally due to the maturity of marketable securities. For the nine-month period, cash, cash equivalents, and short and long-term marketable securities combined decreased by $19.2 million. For the first nine months of 2002, we used $17.7 million for operations, which consisted of the net loss of $26.2 million offset by non–cash compensation expense of $5.3 million, depreciation and amortization of $1.5 million and restructuring and related charges of $1.0 million.

We used $30.6 million to purchase marketable securities and $1.4 million to purchase property and equipment, and received $57.3 million from the maturity of marketable securities and $0.7 million from the sale and leaseback of equipment. We used $0.8 million for our financing activities, which included net proceeds of $0.5 million from the exercise of common stock options offset by the repayment of $1.3 million of capital lease obligations.

Our cash, cash equivalents, and short and long-term marketable securities totaled $60.8 million at September 30, 2002 versus $80.0 million at December 31, 2001. We believe that our cash reserves and our expected short–term revenue will be sufficient to fund our operations at least through the year 2003. During or after this period, or in the event of acquisitions or extraordinary events, if cash generated by operations is insufficient to satisfy our liquidity requirements, we may need to issue additional equity or debt securities or obtain additional credit arrangements. Additional financing may not be available on terms acceptable to us or at all. The sale of additional equity or convertible debt securities may result in additional dilution to our stockholders.

The Company has incurred losses since its inception and, as of September 30, 2002, had an accumulated stockholders' deficit of $104.2 million. Management anticipates incurring additional operating losses through at least the end of 2003. The future viability of the Company is dependent upon its ability to: develop pharmacogenomic technologies, develop and commercialize proprietary molecular diagnostic products and commence generating cash from operations.

Restructuring

Our cash requirements under the restructuring program are expected to total approximately $1.2 million (excluding lease repayments of approximately $1.4 million at September 30, 2002). We paid $1.0 million through September 30, 2002 under the restructuring program; $0.1 million of severance and related benefits was accrued, which we expect to be substantially paid out prior to December 31, 2002. We expect to substantially complete our restructuring program by the end of 2002. If our restructuring program is implemented in the manner and on the timeline we intend, we expect to realize the full benefits of our restructuring program by the first quarter of 2003, and anticipate reducing our quarterly cash burn from approximately $6 million to approximately $4 million. However, we cannot assure you that our restructuring program will achieve all of the cost and expense reductions and other benefits we anticipate or that the plan will be completed in the timetable contemplated.

Additionally, our restructuring program included the elimination of our NuCleaveÒ product. NuCleaveÒ was the Company's only source of product revenues; as such, we anticipate no further revenues or cash inflows from product sales at the current time. To the extent that the Company is able to outlicense patents held relative to NuCleaveÒ, we may be able to recognize future license fee revenue and receive cash payments from licensing and royalties; however, we cannot assure you that we will be able to obtain any future benefits from our NuCleaveÒ technology.

Our business or operations may change in a manner that would consume available resources more rapidly than anticipated. As a result, we may require substantial additional funding before we can achieve profitable operations. Our capital requirements depend on numerous factors, including the following:

• the extent of our restructuring activities and our ability to sell long-lived assets held for sale;

Ÿ our ability to enter into additional collaborative agreements;

Ÿ competing technological and market developments;

Ÿ changes in our existing collaborative relationships;

Ÿ the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;

Ÿ the purchase of additional capital equipment;

Ÿ the expansion of our facilities;

Ÿ the progress of our existing and future milestone and royalty producing activities; and

Ÿ the availability of additional funding, if necessary, and if at all, on favorable terms.

Potential Nasdaq Delisting

On October 29, 2002, we received a notice from the Nasdaq National Market that our common stock had failed to maintain the required minimum closing bid price of $1.00 for a period of 30 consecutive trading days. As a result, Nasdaq has provided us 90 calendar days, or until January 27, 2003, to regain compliance with this requirement or be delisted from trading. In order to regain compliance, the closing bid price of our common stock must stay above $1.00 for 10 consecutive trading days. If we are unable to regain compliance with this requirement during this time period, and any appeal to Nasdaq for relief from this requirement is unsuccessful, our common stock will be delisted from trading by the Nasdaq National Market. If this were to happen, trading in our common stock would decrease substantially, or cease altogether, the market price of our common stock may decline further, potentially to zero, and stockholders may lose some or all of their investment. Security analysts’ and news media’s coverage, if any, of us will be reduced. Furthermore, delisting of our common stock from the Nasdaq National Market would inhibit, if not preclude, our ability to raise additional working capital on acceptable terms, if at all.

New Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“FAS 146”), which requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. FAS 146 is effective for exit or disposal activities initiated after December 31, 2002. The Company will adopt this statement effective January 1, 2003, and does not expect the adoption of this statement to have a material impact on its financial statements.

Impact of Inflation

We do not believe inflation has had a material impact on our business or operating results during the periods presented.

Recent Developments

On July 25, 2002, we announced that we completed a license agreement with St. Jude Children’s Research Hospital in Memphis under which we obtained exclusive rights in the field of oncology to develop diagnostic test products predictive of drug response. The license agreement covers a patent application claiming CYP3A5 genotyping methods and diagnostic test kits predictive of variable expression of CYP3A5. We also announced the completion of the patient enrollment phase of a related pharmacogenomic research study.

On July 30, 2002, we announced that we entered into a research collaboration with Brigham & Women’s Hospital and Paul M. Ridker, M.D., M.P.H., Director of Brigham & Women’s Center for Cardiovascular Disease Prevention. Under the collaboration, we will apply our genotyping and haplotyping platforms and statistical analysis methodology to the PRINCE (Pravastatin Inflammation CRP Evaluation) study to explore the contribution of genetic variability to variations in patients’ therapeutic responses to pravastatin, a major cholesterol-lowering agent. We will receive an exclusive option to license intellectual property resulting from the research, which may lead to the future development of cardiovascular diagnostic tests.

On July 30, 2002, we announced that we granted a worldwide license for our RNA targeting patent (PCT/US00/05271) to Renegade Therapeutics, a novel drug discovery company. Under the terms of the agreement, we granted Renegade Therapeutics worldwide exclusive rights to all non-allele specific applications for the research, development, and commercialization of small molecule drugs that target RNA. The terms of the agreement include up-front fees, milestone payments, reimbursement for patent related expenses, and royalties on sales of any compounds developed using the licensed technology.

On September 26, 2002, we announced the launch of our program to develop molecular diagnostic tests predictive of the response of solid tumors to chemotherapy. The first clinical study will involve genetic analysis of over 100 patients who have experienced severe side effects following 5-fluorouracil (5-FU) chemotherapy for colorectal cancer. A retrospective study has been started with Dr. Andre van Kuilenburg from the Laboratory of Genetic Metabolic Diseases at the Academic Medical Center in Amsterdam.

On October 10, 2002, we announced licensing agreements under our MTHFR (methylenetetrahydrofolate reductase) patent rights with ARUP Laboratories, a leading full-service clinical reference laboratory. Under the terms of these agreements, we granted ARUP non-exclusive rights to commercialize home brew tests for MTHFR allele testing associated with increased thrombo-embolic disease risk and other disorders.

On October 16, 2002, we announced that we granted an option to a worldwide license to Strida Pharma, Inc., a new privately-held cancer therapeutics company, relating to certain or our MTHFR patent rights. Under the terms of the agreement, we granted Strida an option to a license granting worldwide exclusive rights to commercialize therapeutic inhibitors of the MTHFR gene. The terms of the agreement include an up-front fee, and may lead to milestone payments and royalties on sales of any compounds that are developed using the technology. We gain the right to use Strida’s data in support of its own patent applications.

On October 29, 2002, we announced that we signed a licensing agreement under our MTHFR patent rights with Quest Diagnostics, Inc. Under the terms of the agreement, we granted Quest Diagnostics non-exclusive rights to commercialize laboratory developed tests for MTHFR allele testing associated with increased thrombo-embolic disease risk and other disorders.

Subsequent Event

On November 9, 2002, we signed a definitive agreement whereby we will merge with and into Hyseq, Inc. (“Hyseq”) in a stock-for-stock transaction. Under the terms of the agreement, which have been approved by the Boards of Directors of both companies, each share of our common stock will be exchanged for shares of Hyseq common stock at an exchange ratio of 1.6451 shares of Hyseq common stock for each share of our common stock. This exchange ratio implies a purchase price for our shareholders of $2.22 per common share, or approximately $55.9 million (including in-the-money options and warrants), based on the closing price of Hyseq shares on November 8, 2002. The transaction will be completed through a reverse triangular, stock-for-stock merger in which Hyseq will form a new wholly-owned subsidiary that will merge into us. The surviving entity will then be merged upstream into Hyseq. Subsequently, Hyseq will change its legal name to a yet-to-be determined name. The transaction, which is structured as a tax-free reorganization for federal income tax purposes, is subject to approval by the shareholders of both companies and other closing conditions, and is expected to close by the end of February of 2003.

Special Note Regarding Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act that involve risks and uncertainties. Discussions containing forward-looking statements may be found in the material set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as in this report generally. We generally use words such as “believe,” “may,” “could,” “will,” “intend,” “expect,” “anticipate,” “plan,” and similar expressions to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described above and elsewhere in this report. We discuss these risks in detail in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2002.

Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made, and we cannot assure you that our future results, levels of activity, performance or achievements will meet these expectations. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We do not intend to update any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations, except as required by law.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk is principally confined to our cash equivalents and marketable securities, all of which have maturities of less than eighteen months. We maintain a non-trading investment portfolio of investment grade, liquid debt securities that limits the amount of credit exposure to any one issue, issuer or type of instrument.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) on November 4, 2002, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and effective to ensure that material information relating to us, including our consolidated subsidiary, was made known to them by others within that entity, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

(b) Changes in Internal Controls. Our principal executive officer and principal financial officer have indicated that there have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, nor were there any significant deficiencies or material weaknesses in our internal controls. Accordingly, no corrective actions were required or undertaken.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

On or about December 6, 2001, the Company was sued in a complaint filed in the United States District Court for the Southern District of New York naming as defendants the Company and certain of its officers and its underwriters. The complaint purportedly is filed on behalf of persons purchasing the Company’s stock between July 21, 2000 and December 6, 2000, and alleges violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, as amended, and Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder.

The complaint alleges that, in connection with the Company’s July 21, 2000 initial public offering, the defendants failed to disclose additional and excessive commissions purportedly solicited by and paid to the underwriter defendants in exchange for allocating shares of the Company’s stock to preferred customers and alleged agreements among the underwriter defendants and preferred customers tying the allocation of IPO shares to agreements to make additional aftermarket purchases at pre-determined prices. Plaintiffs claim that the failure to disclose these alleged arrangements made the Company’s registration statement on Form S-1 filed with the SEC in July 2000 and the prospectus, a part of the registration statement, materially false and misleading. Plaintiffs seek unspecified damages. On or about April 19, 2002, an amended complaint was filed which makes essentially the same allegations. On or about July 15, 2002, the Company and the individuals filed a motion to dismiss.

The Company believes that the allegations are without merit and intends to vigorously defend against the plaintiffs’ claims.

Other than the litigation disclosed above, we are not involved in any legal proceedings that are material to our business or financial condition.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

(a) Not applicable.

(b) Not applicable.

(d) Use of Proceeds from Sale of Registered Securities. On July 20, 2000, in connection with our initial public offering, the Securities and Exchange Commission declared a Registration Statement on Form S-1 (No.333-33558) effective that registered 5,750,000 shares of our common stock. On July 26, 2000, we sold 5,000,000 of such shares of our common stock at an initial public offering price of $14.00 per share, generating gross offering proceeds of $70,000,000. After deducting $4,900,000 in underwriting discounts and approximately $1,806,000 in other related expenses, the net proceeds to the Company were approximately $63,294,000. On July 26, 2000, we sold an additional 750,000 shares of Common Stock at the initial public offering price of $14.00 per share pursuant to the exercise by the underwriters of their over-allotment option with respect to such shares, generating additional gross offering proceeds of $10,500,000. After deducting $735,000 in underwriting discounts, the additional net proceeds to the Company were $9,765,000.

The proceeds from our initial public offering have been invested in money market funds and corporate obligations. We intend to use the net proceeds for general corporate purposes, including research and development and potential acquisitions.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders of the Company, through solicitation of proxies or otherwise, during the three months ended September 30, 2002.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Exhibit No.		Description

3.1		Restated Certificate of Incorporation of the Company (filed as Exhibit 3.2 to the Company’s Registration Statement on Form S-1, No. 333-33558, and incorporated herein by reference)
3.2		Restated Bylaws of the Company (filed as Exhibit 3.4 to the Company’s Registration Statement on Form S-1, No. 333-33558, and incorporated herein by reference)
4.1		Specimen certificate for shares of common stock (filed as Exhibit 4.1 to the Company’s Registration Statement on Form S-1, No. 333-33558, and incorporated herein by reference)

(b) Reports on Form 8-K

No reports on Form 8-K were filed in the three month period ended September 30, 2002.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Variagenics, Inc.

	By:	/s/ RICHARD P. SHEA

		Richard P. Shea Chief Operating Officer, Chief Financial Officer and Treasurer (Duly authorized officer and principal accounting and finance officer)
Date: November 14, 2002

CERTIFICATIONS

I, Joseph S. Mohr, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Variagenics, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within that entity, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 14, 2002

	/s/ JOSEPH S. MOHR
	Joseph S. Mohr
	President and Chief Business Officer

I, Richard P. Shea, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Variagenics, Inc.;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date: November 14, 2002

	/s/ RICHARD P. SHEA
	Richard P. Shea
	Chief Operating Officer, Chief Financial Officer and Treasurer

VARIAGENICS INC 10-Q