-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ky4FovO/YI1iUlFhTW6Sd9alz86IuDErAyKDMOUrXsnk7U8qk2x1Jum2hqQ8YuYn 3XiyTcQE3jIPYHun2t7eQA== 0000950135-97-002990.txt : 19970716 0000950135-97-002990.hdr.sgml : 19970716 ACCESSION NUMBER: 0000950135-97-002990 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970531 FILED AS OF DATE: 19970715 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENOME THERAPEUTICS CORP CENTRAL INDEX KEY: 0000356830 STANDARD INDUSTRIAL CLASSIFICATION: IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES [2835] IRS NUMBER: 042297484 STATE OF INCORPORATION: MA FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-10824 FILM NUMBER: 97640415 BUSINESS ADDRESS: STREET 1: 1OO BEAVER ST CITY: WALTHAM STATE: MA ZIP: 02154 BUSINESS PHONE: 6178935007 MAIL ADDRESS: STREET 1: 100 BEAVER STREET CITY: WALTHAM STATE: MA ZIP: 02154 FORMER COMPANY: FORMER CONFORMED NAME: COLLABORATIVE RESEARCH INC DATE OF NAME CHANGE: 19920703 10-Q 1 GENOME THERAPEUTICS CORP. 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------ FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For Quarter Ended: May 31, 1997 ------------ Commission File No: 0-10824 ------- GENOME THERAPEUTICS CORP. ------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MASSACHUSETTS 04-2297484 ------------- ---------- (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER IDENTIFICATION OF INCORPORATION OR ORGANIZATION) NO.) 100 BEAVER STREET; WALTHAM, MASSACHUSETTS 02154 --- ------ ------ ------- ------------- ----- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER: (617) 398-2300 -------------- 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 X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. COMMON STOCK 17,704,977 ------------ ---------- $.10 PAR VALUE Outstanding July 9, 1997 -------------- 2 Genome Therapeutics Corp. and Subsidiaries Index to Financial Information (Unaudited) and Other Information Page ---- Part I Financial Information (Unaudited) : Consolidated Condensed Balance Sheets as of 3 August 31, 1996 and May 31, 1997 Consolidated Condensed Statements of Operations 4 for the 39 week period ended May 25, 1996 and May 31,1997 Consolidated Statements of Cash Flows for the 5 39 week period ended May 25, 1996 and May 31,1997 Notes to Consolidated Condensed Financial 6-11 Statements for the 39 week period ended May 25, 1996 and May 31,1997 Management's Discussion and Analysis of Financial Conditions and Results of Operations 12-18 Part II Other Information: Other Information 19-20 Signature 21 2 3 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS
- ------------------------------------------------------------------------------------ August 31, May 31, 1996 1997 (Unaudited) - ------------------------------------------------------------------------------------ ASSETS: Current Assets: Cash and cash equivalents $10,679,287 $ 7,125,677 Marketable securities 17,429,488 39,027,019 Interest receivable 1,296,657 1,293,732 Accounts receivable 1,338,418 1,899,856 Unbilled costs and fees 345,773 252,063 Prepaid expenses and other current assets 552,903 583,973 ----------- ----------- Total current assets 31,642,526 50,182,320 Equipment and leasehold improvements, at cost: Laboratory and scientific equipment 6,403,221 11,012,048 Leasehold improvements 1,939,545 1,964,981 Office equipment and furniture 581,533 807,217 Construction-in-progress 77,027 414,014 ----------- ----------- 9,001,326 14,198,260 Less-Accumulated depreciation and amortization 3,266,068 4,733,255 ----------- ----------- 5,735,258 9,465,005 Restricted cash 195,500 395,500 Long-term marketable securities 25,464,287 2,929,560 Other assets 241,446 318,532 ----------- ----------- Total assets $63,279,017 $63,290,917 ----------- ----------- LIABILITIES AND SHAREHOLDERS' EQUITY: Current Liabilities: Accounts payable $ 864,279 $ 692,794 Accrued expenses 1,731,220 2,186,688 Deferred revenue 1,035,504 2,932,403 Current maturities of capital lease obligations 2,106,882 3,292,412 ----------- ----------- Total current liabilities 5,737,885 9,104,297 ----------- ----------- Capital lease obligations, net of current maturities 3,228,374 4,549,151 Shareholders' equity 54,312,758 49,637,469 ----------- ----------- Total liabilities and shareholders' equity $63,279,017 $63,290,917 ----------- -----------
See Notes to Consolidated Condensed Financial Statements. 3 4 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------------------------------------------- Thirteen Weeks Ended Thirty-nine Weeks Ended May 25, May 31, May 25, May 31, 1996 1997 1996 1997 (Unaudited) (Unaudited) - --------------------------------------------------------------------------------------------------------------------- REVENUES: Collaborative research, license fees and royalties $ 3,024,264 $ 2,987,210 $10,040,447 $ 9,816,045 Government research 1,815,077 918,999 4,833,051 4,229,562 Interest income 701,499 741,152 1,010,206 2,270,910 ----------- ----------- ----------- ----------- Total revenues 5,540,840 4,647,361 15,883,704 16,316,517 ----------- ----------- ----------- ----------- COSTS AND EXPENSES: Research and development 2,076,438 5,787,821 4,685,563 13,975,650 Cost of government research 1,563,861 918,999 4,483,965 4,229,562 General, selling and administrative 596,163 1,166,428 1,839,453 3,037,313 Interest expense 92,491 159,066 175,793 430,545 Noncash charge for stock option grants 370,400 20,633 1,949,816 57,683 ----------- ----------- ----------- ----------- Total costs and expenses 4,699,353 8,052,947 13,134,590 21,730,753 ----------- ----------- ----------- ----------- NET INCOME (LOSS) $ 841,487 $(3,405,586) $ 2,749,114 $(5,414,236) ----------- ----------- ----------- ----------- Net income (loss) per common share $ 0.04 $ (0.19) $ 0.16 $ (0.31) ----------- ----------- ----------- ----------- Weighted average number of common and equivalent shares outstanding 20,022,584 17,666,731 17,565,343 17,569,640 ----------- ----------- ----------- -----------
See Notes to Consolidated Condensed Financial Statements. 4 5 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
- ---------------------------------------------------------------------------------------------------------- Thirty-nine Weeks Ended May 25, May 31, 1996 1997 (Unaudited) - ---------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net Income (loss) $ 2,749,114 $ (5,414,236) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 587,023 1,554,338 Deferred compensation 1,949,816 57,683 Changes in assets and liabilities: Interest receivable (724,290) 2,925 Accounts receivable (59,189) (561,438) Unbilled costs and fees (124,974) 93,710 Prepaid expenses and other current assets (68,438) (31,070) Accounts payable 274,249 (171,485) Accrued expenses (123,641) 455,468 Deferred revenue 458,752 1,896,899 ------------ ------------ Total adjustments 2,169,308 3,297,030 ------------ ------------ Net cash provided by (used in) operating activities 4,918,422 (2,117,206) ------------ ------------ Cash Flows from Investing Activities: Purchases of marketable securities (38,820,098) (18,236,804) Proceeds from sale of marketable securities 7,883,708 19,174,000 Increase in restricted cash 0 (200,000) Purchases of equipment and leasehold improvements, net (424,232) (643,716) Increase in other assets (42,944) (88,189) ------------ ------------ Net cash provided by (used in) investing activities (31,403,566) 5,291 ------------ ------------ Cash Flows from Financing Activities: Proceeds from sale of common stock and warrants 41,522,123 0 Proceeds from exercise of stock options and warrants 1,008,396 681,265 Payments on capital lease obligations (500,216) (2,122,960) ------------ ------------ Net cash provided by (used in) financing activities 42,030,303 (1,441,695) ------------ ------------ Net Increase in Cash and Cash Equivalents 15,545,159 (3,553,610) Cash and Cash Equivalents, at beginning of period 5,886,184 10,679,287 ------------ ------------ Cash and Cash Equivalents, at end of period $ 21,431,343 $ 7,125,677 ------------ ------------ Supplemental Disclosure of Cash Flow Information: Taxes paid during period $ 117,000 $ 29,142 ------------ ------------ Interest paid during period $ 175,793 $ 430,545 ------------ ------------ Supplemental Disclosure of Non-cash Investing Activities: Property and equipment acquired under capital leases $ 1,990,283 $ 4,629,267 ------------ ------------
See Notes to Consolidated Condensed Financial Statements. 5 6 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - ---------------------------------------------------------------- 1. BASIS OF PRESENTATION --------------------- The consolidated condensed financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the unaudited consolidated condensed financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of interim period results. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The Company believes, however, that its disclosures are adequate to make the information presented not misleading. The results of operations for the 39 week period ended May 31, 1997 are not necessarily indicative of the results to be expected for the full fiscal year. The accompanying consolidated condensed financial statements should be read in conjunction with the Company's Form 10-K which was filed with the Securities and Exchange Commission on November 27, 1996 and as amended on Form 10-K/A on December 4, 1996. 2. REVENUE RECOGNITION ------------------- Research and contract revenues are derived from government grant and contract arrangements as well as under collaborative agreements with pharmaceutical companies. Research revenues are recognized as earned under grants, which consist of cost-plus-fixed-fee contracts and fixed price contracts. Revenues are recognized under collaborative agreements as earned. Milestone payments from collaborative research and development arrangements are recognized when they are achieved. License fees are recognized as earned. Subscription revenues are recognized ratably over the term of the subscription agreement. Unbilled costs and fees represent revenue recognized prior to billing. Deferred revenue represents amounts received prior to revenue recognition. 3. NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE -------------------------------------------------------- Net income per common and common equivalent share is computed by dividing net income by the weighted average number of common and common equivalent shares outstanding during the period using the treasury method. Net loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during the period. 6 7 4. NEW ACCOUNTING STANDARD ----------------------- In March 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, Earnings Per Share. SFAS No. 128 establishes standards for computing and presenting earnings per share and applies to entities with publicly held common stock or potential common stock. This statement is effective for fiscal years ending after December 15, 1997 and early adoption is not permitted. When adopted, the statement will require restatement of prior years' earnings per share. The Company will adopt this statement for its fiscal year ended August 31, 1998 and does not believe that the effect of the adoption of this standard would be materially different from the amounts presented in the accompanying statements of operations. In October 1995, FASB issued SFAS No. 123, Accounting for Stock-Based Compensation. The Company has determined that it will continue to account for stock-based compensation for employees under Accounting Principles Board (APB) Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123. The Company will be required to disclose the pro forma net income or loss and per share amounts in the notes to the financial statements using the fair-value-based method for year ending August 31, 1997, with comparable disclosures for the year ended August 31, 1996. The Company has not determined the impact of these pro forma adjustments. 5. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES ------------------------------------------------ The Company applies SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company's cash equivalents and marketable securities are classified as held-to-maturity, as the Company has the positive intent and ability to hold these securities to maturity. Cash equivalents are short-term, highly liquid investments with original maturities of less than three months. Marketable securities are investment securities with original maturities of greater than three months. Cash equivalents are carried at cost, which approximates market value, and consist of money market funds, repurchase agreements and debt securities. Marketable securities are recorded at amortized cost which approximates market value. The Company has not recorded any realized holding gains or losses on its marketable securities. Marketable securities consist of commercial paper and U.S. Government debt securities. The Company has restricted cash of $195,500 and $395,500 at August 31, 1996 and May 31, 1997, respectively, in connection with certain capital lease obligations. 7 8 6. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS ----------------------------------------------------------- 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 disclosure 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 from those estimates. 7. CAPITAL LEASE OBLIGATIONS ------------------------- On February 28, 1997, the Company entered into a leasing arrangement under which it can finance up to $6.0. million of laboratory, computer and office equipment. The lease is payable in 48 monthly installments at a variable interest rate of prime (8.5% as of May 31, 1997) plus one-quarter of one percent. At any time during the term of this agreement, the Company may elect to convert to a fixed rate loan at the prevailing interest rate. The Company is required to maintain certain restricted cash balances, as defined (see Note 5). In addition, the Company is required to maintain certain financial ratios pertaining to minimum cash balances, tangible net worth and debt service coverage. The Company has approximately $4.2 million available under this capital lease agreement at May 31, 1997. The Company has other capital lease line arrangements under which it financed certain laboratory, computer and office equipment. These leases are payable in 36 monthly installments. The interest rates range from 7.52% to 11.42%. The Company is required to maintain certain restricted cash balances, as defined (see Note 5). In addition, the Company is required to maintain certain financial ratios pertaining to minimum cash balances, tangible net worth, debt to tangible net worth and maximum loss. The Company has no funds available under these capital lease agreements at May 31, 1997. 8. COLLABORATIVE AGREEMENTS ------------------------ 8 9 SCHERING-PLOUGH --------------- In December 1995, the Company entered into a collaboration and license agreement with Schering Corporation and Schering-Plough Ltd. (collectively, "Schering-Plough") providing for the use by Schering-Plough of the Company's Staph. aureus genomic database to identify new gene targets for development of antibiotics effective against drug resistant infectious organisms. As part of this agreement, the Company granted Schering-Plough exclusive access to certain of the Company's genomic sequence databases. The Company also granted Schering-Plough a non-exclusive license to use the Company's bioinformatics systems for Schering-Plough's internal use in connection with the genomic databases licensed to Schering-Plough under the agreement and other genomic databases Schering- Plough develops or acquires. The Company also agreed to undertake certain research efforts to identify bacteria-specific genes essential to microbial survival and to develop biological assays to be used by Schering-Plough in screening natural product and compound libraries to identify antibiotics with new mechanisms of action. Under the agreement, Schering-Plough made an up-front payment to the Company of $3 million. In addition, upon completion of certain development milestones, Schering-Plough has agreed to pay the Company a minimum of an additional $10.3 million in expense allowances, research funding and milestone payments. Subject to the achievement of additional product development milestones and Schering- Plough's election to extend the research collaboration, Schering-Plough has agreed to pay the Company up to an additional approximately $40.5 million (inclusive of the $10.3 million referred to in the previous sentence) in expense allowances, research funding and milestone payments. The agreement grants Schering-Plough exclusive world wide rights to make, use and sell pharmaceutical and vaccine products based on the Company's Staph. aureus genomic database and on the technology developed in the course of the research program. The Company has also granted Schering-Plough a right of first negotiation if during the term of the research plan the Company desires to enter into a collaboration with a third party with respect to the development or sale of any compounds which are targeted against Staph. aureus. The Company will be entitled to receive royalties on Schering-Plough's sale of therapeutic products and vaccines developed using the technology licensed from the Company. Subject to certain limitations, the Company retained the rights to make, use and sell diagnostic products developed based on the Company's database licensed to Schering-Plough or the technology developed in the course of the research program. 9 10 For the 13 and 39 week periods ended May 31, 1997, the Company recorded revenue of $1.0 million and $2.8 million, respectively, under this agreement, which consisted of sponsored research funding. For the 13 week period ended May 25, 1996, the Company recorded revenue of $2.2 million under this agreement, which consisted of sponsored research and a milestone payment. For the 39 week period ended May 25, 1996, the Company recorded revenue of $6.2 million under this agreement, which consisted of a license fee, sponsored research and milestone payments. The Company entered into its second research collaboration agreement with Schering-Plough in December 1996. This agreement calls for the use of genomics to discover new therapeutics for treating asthma. As part of the agreement, the Company will employ its high-throughput positional cloning, bioinformatics, and genomics sequencing capabilities to identify genes and associated proteins that can be utilized by Schering-Plough to develop new pharmaceuticals. Under this agreement, the Company has granted Schering-Plough exclusive access to (i) certain gene sequence databases made available under this research program, (ii) information made available to the Company under certain third party research agreements, (iii) an exclusive worldwide right and license to make, use and sell pharmaceutical and vaccine products based on the technology developed in the course of the research program. The Company will retain all rights to develop and commercialize diagnostic products that may result from this collaboration. In December 1996, Schering-Plough made an initial payment for a license fee and an expense allowance to the Company. Schering-Plough is also required to fund a research program for a minimum number of years with an option to extend. In addition, upon completion of certain scientific developments, Schering-Plough will make milestone payments to the Company, as well as pay royalties to the Company based upon sales of therapeutics products developed from this collaboration. If all milestones are met and the research program continues for its full term, total payments to the Company will approximate $67 million, excluding royalties. Of the total potential payments, approximately $22.5 million represents license fees and research payments, and $44.5 million represents milestone payments based on achievement of research and product development objectives. For the 13 week period ended May 31, 1997, the Company recorded revenue of $0.7 million under this agreement, which consisted primarily of sponsored research and subcontract activity. For the 39 week period ended May 31, 1997, the Company recorded revenue of $3.5 million under this agreement, which consisted primarily of a license fee, expense allowance, sponsored research and subcontract activity. ASTRA AB -------- In August 1995, the Company entered into a collaboration agreement with Astra Hassle AB ("Astra") to develop pharmaceutical, vaccine and diagnostic products 10 11 effective against gastrointestinal infection or any other disease caused by H. pylori. Under the terms of the agreement, the Company granted Astra exclusive access to its H. pylori genomic sequence database and agreed to undertake certain research efforts in exchange for a minimum of approximately $11 million and up to $22 million in license fees, expense allowances, research funding and milestone payments. The agreement granted Astra exclusive worldwide rights to make, use and sell products based on the Company's H. pylori technology and requires Astra to provide research funding to the Company over a minimum period of two and one-half years to further develop and annotate the Company's H. pylori genomic sequence database, identify therapeutic and vaccine targets and develop appropriate biological assays. The Company will also be entitled to receive royalties on Astra's sale of any products (i) protected by claims of patents licensed exclusively to Astra by the Company pursuant to the agreement, or (ii) the discovery of which were enabled in a significant manner by the genomic database licensed to Astra by the Company. For the 13 week period ended May 31, 1997, the Company recorded revenue of $0.8 million under this agreement, which consisted of sponsored research funding and a milestone payment. For the 13 week period ended May 25, 1996, the Company recorded revenue of $0.8 million under this agreement, which consisted of sponsored research funding. For the 39 week periods ended May 31, 1997 and May 25, 1996, the Company recorded revenue of $2.4 million and $3.7 million, respectively, under this agreement, which consisted of sponsored research funding and milestone payments. 9. DATABASE SUBSCRIPTIONS ---------------------- BAYER AG -------- In May 1997, the Company entered into a license agreement with Bayer AG, ("Bayer") to provide Bayer with a non-exclusive license to the Company's proprietary genome sequence database, PathoGenome(TM) and associated information relating to microbial organisms. The subscription agreement calls for the Company to provide Bayer with periodic data updates, analysis tools and software support. Under the agreement, Bayer has agreed to pay a license fee, annual subscription fees and royalties on any molecules developed as a result of access to the information provided by PathoGenome(TM). The Company retains all rights associated with protein therapeutic, diagnostic and vaccine use of bacterial genes or gene products. The Company records an upfront license fee and revenue derived from subscription fees ratably over the term of the subscription agreement. 11 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW - -------- The Company is engaged in the field of genomics -- the discovery and characterization of genes. Currently, the Company's primary activity is genomic research and development. For the past several years, the Company's primary source of revenues have been government research grants and contracts and collaborative agreements with pharmaceutical company partners. The Company entered into corporate collaborations with Astra Hassle AB ("Astra") relating to H. Pylori in August 1995 and with Schering Corporation and Schering-Plough, Ltd. (collectively, "Schering-Plough") in December 1995 providing for the use by Schering-Plough of the Company's Staph. aureus genomic database to identify new gene targets for the development of novel antibiotics. In December 1996, the Company entered into its second research collaboration with Schering-Plough to identify genes and associated proteins that can be utilized by Schering-Plough to develop new pharmaceuticals for treating asthma. In May 1997, the Company entered into an agreement with Bayer AG ("Bayer") to provide Bayer with non-exclusive license to the Company's proprietary genome sequence database, PathoGenome(TM). As of May 31, 1997, the Company had outstanding approximately $3,000,000 of government grants and research contracts under which services were yet to be performed. These grants and contracts call for services to be performed over the next 33 months. The Company's government grants and contracts are typically funded annually and are subject to appropriation by the United States Congress each year. Funding may be discontinued or reduced at any time by the Congress. For the 39 week periods ended May 25, 1996 and May 31, 1997, revenue recognized pursuant to United States government grants and research accounted for approximately 30% and 26%, respectively, of the Company's total revenues. The Company expects government revenue, in absolute dollars and as a percentage of total revenues, to decline in the future periods as the Company focuses its resources towards Company sponsored research and development in order of obtaining additional corporate partnerships. The Company plans to continue to seek government grants and contracts which are synergistic to the Company's overall strategic focus and to enter into additional corporate partnering arrangements with the goal of advancing the Company's genomic technologies and gene discovery programs and of obtaining revenues sufficient to cover a portion of the Company's cash requirements. There can be no assurance that the Company will be able to pursue this strategy successfully. The Company will not receive significant product revenues on a sustained basis until such time, if any, at which products based on the Company's research efforts are commercialized. The Company's product development strategy is to enter into collaborations with pharmaceutical and biotechnology companies whereby these corporate partners will provide most of or all of the financial and other resources required to complete the development and to commercialize products based on the Company's genomics research in exchange for a variety of license and milestone payments, research 12 13 support and royalties. In order for a product to be commercialized based on the Company's research, it will be necessary for the collaborators to conduct preclinical tests and clinical trials, obtain regulatory clearances and make manufacturing, distribution and marketing arrangements. Accordingly, the Company does not expect to receive royalties based on product revenues for many years. The Company has incurred significant losses, since inception, with an accumulated deficit of approximately $38,668,000 as of May 31, 1997. The Company's results of operations have fluctuated from period to period and may continue to fluctuate in the future based upon the timing and composition of funding under existing and new government grants and contracts and collaborative agreements. The Company is subject to risks common to companies in its industry including unproven technology and business strategy, availability of, and competition for, family resources, reliance upon collaborative partners and others, reliance on United States government funding, history of operating losses, need for future capital, competition, patent and proprietary rights, dependence on key personnel, uncertainty of regulatory approval, uncertainty of pharmaceutical pricing, health care reform and related matters, product liability exposure, and volatility of the Company's stock price. RESULTS OF OPERATIONS - --------------------- THIRTEEN WEEK PERIOD ENDED MAY 25, 1996 AND MAY 31, 1997 - -------------------------------------------------------- REVENUE - ------- Total revenues decreased 16% from $5,541,000 for the 13 week period ended May 25, 1996 to $4,647,000 for the 13 week period ended May 31, 1997. Collaborative research, license fees and royalties remained relatively constant for the 13 week period ended May 31, 1997 when compared to the same period last year. Government research revenue decreased 49% from $1,815,000 for the 13 week period ended May 25, 1996 to $919,000 for the 13 week period ended May 31, 1997. The decrease in government research revenue was primarily attributable to a higher concentration of research effort on Company sponsored research and development programs, particularly the microbial genetic database program. The Company expects government research revenue to continue to decrease, in absolute dollars and as a percentage of total revenues, in the future periods as the Company focuses its resources toward Company sponsored research and development programs. Revenue derived from government research grants and contracts is generally based upon direct cost such as labor, laboratory supplies, as well as an allocation for reimbursement of a portion of overhead. Interest income increased 6% from $701,000 for the 13 week period ended May 25, 1996 to $741,000 for the 13 week period ended May 31, 1997 reflecting an increase in the return on invested cash. 13 14 COST AND EXPENSES - ----------------- Total cost and expenses increased 71% from $4,699,000 for the 13 week period ended May 25, 1996 to $8,053,000 for the 13 week period ended May 31, 1997. Research and development expense, which includes company-sponsored research and development and research funded pursuant to arrangements with the Company's corporate collaborators increased 179% from $2,076,000 for the 13 week period ended May 25, 1996 to $5,788,000 for the 13 week period ended May 31, 1997. The increase in research and development expenses was directly related to the Company's expansion of its pathogen, microbial genetic database and gene discovery programs which consisted primarily of increases in payroll and related expenses, laboratory supplies and overhead expenses. The Company expects to continue to increase research and development expenditures in the future periods, particularly with respect to its human gene discovery and microbial genetic database programs. The cost of government research decreased 41% from $1,564,000 for the 13 week period ended May 25, 1996 to $919,000 for the 13 week period ended May 31, 1997. The decrease in cost of government research was primarily attributable to the decrease in government research revenues. Cost of government research, as a percentage of government research revenue, was 86% for the 13 week period ended May 25, 1996 and 100% for the 13 week period ended May 31, 1997. The increase was primarily due to an increase in overhead expenses associated with the expansion of the Company's laboratory space as well as purchases of research and development equipment. General, selling, and administrative expenses increased 96% from $596,000 for the 13 week period ended May 25, 1996 to $1,166,000 for the 13 week period ended May 31, 1997. The increase in general, selling, and administrative expenses was primarily due to increases in payroll and related expenses, legal fees and facility expenses. Interest expense increased from $92,000 for the 13 week period ended May 25, 1996 to $159,000 for the 13 week period ended May 31, 1997 which was attributable to the increase in the Company's outstanding balance under its capital lease arrangements. In November and December 1995, the Company's Board of Directors granted certain employees, officers, and directors options to purchase an aggregate of 440,000 shares of common stock which were subject to shareholder approval. The options were granted at exercise prices ranging from $7.25 to $9.56 per share, in each case, the fair market value of the common stock on the date the Company's Board of Directors granted the option. The Company recorded deferred compensation of $2,565,000 which represents an amount equal to the difference between the fair market value of the common stock on February 16, 1996, the date of shareholder approval, and the per share exercise price of the options. Additionally, in March 1997, the Company granted options valued at $51,000 to certain consultants in lieu of cash for services. The Company recorded $370,000 and $21,000 as compensation expense in the 13 week periods ended May 25, 1996 and May 31, 1997, respectively. 14 15 THIRTY-NINE WEEK PERIOD ENDED MAY 25, 1996 AND MAY 31, 1997 - ----------------------------------------------------------- REVENUE - ------- Total revenues increased 3% from $15,884,000 for the 39 week period ended May 25, 1996 to $16,317,000 for the 39 week period ended May 31, 1997. Collaborative research, license fees and royalties decreased 12% from $10,040,000 for the 39 week period ended March 25, 1996 to $9,816,000 for the 39 week period ended May 31, 1997. The decrease reflects a reduction in milestone payments and license fees received from the Company's corporate partners, partially offset by an increase in collaborative research revenues. Government research revenue decreased 12% from $4,833,000 for the 39 week period ended May 25, 1996 to $4,230,000 for the 39 week period ended May 31, 1997. The decrease in government research revenue was primarily attributable to a higher concentration of research effort on Company sponsored research and development programs, particularly the microbial genetic database program. The Company expects government research revenue to continue to decrease, in absolute dollars and as a percentage of total revenues, in the future periods as the Company focuses its resources toward Company sponsored research and development programs. Revenue derived from government research grants and contracts is generally based upon direct cost such as labor, laboratory supplies, as well as an allocation for reimbursement of a portion of overhead expenses. Interest income increased from $1,010,000 for the 39 week period ended May 25, 1996 to $2,271,000 for the 39 week period ended May 31, 1997 reflecting the increase in funds available for investment as a result of proceeds received from the sale of common stock through a public offering in February 1996. COST AND EXPENSES - ----------------- Total cost and expenses increased 65% from $13,135,000 for the 39 week period ended May 25, 1996 to $21,731,000 for the 39 week period ended May 31, 1997. Research and development expense, which includes company-sponsored research and development and research funded pursuant to arrangements with the Company's corporate collaborators increased 198% from $4,686,000 for the 39 week period ended May 25, 1996 to $13,976,000 for the 39 week period ended May 31, 1997. The increase in research and development expenses was directly associated with the Company's expansion of its pathogen, microbial genetic database and gene discovery programs which consisted of increases in payroll and related expenses, laboratory supplies, and overhead expenses. The Company expects to continue to increase research and development expenditures in the future periods, particularly with respect to its human gene discovery and microbial genetic database programs. The cost of government research decreased 6% from $4,484,000 for the 39 week period ended May 25, 1996 to $4,230,000 for the 39 week period ended May 31, 1997. The 15 16 decrease in cost of government research revenue was primarily attributable to a decrease in government research revenue. Cost of government research, as a percentage of government research revenue, was 93% for the 39 week period ended May 25, 1996 and 100% for the 39 week period ended May 31, 1997. The increase was primarily due to an increase in overhead expenses associated with the expansion of the Company's laboratory space as well as purchases of research and development equipment. General, selling, and administrative expenses increased 65% from $1,839,000 for the 39 week period ended May 25, 1996 to $3,037,000 for the 39 week period ended May 31, 1997. The increase in general, selling, and administrative expenses was primarily due to increases in payroll and related expenses, legal fees, and facility expenses. Interest expense increased from $176,000 for the 39 week period ended May 25, 1996 to $431,000 for the 39 week period ended May 31, 1997 which was attributable to the increase in the Company's outstanding balance under its capital lease arrangements. In November and December 1995, the Company's Board of Directors granted certain employees, officers, and directors options to purchase an aggregate of 440,000 shares of common stock which were subject to shareholder approval. The options were granted at exercise prices ranging from $7.25 to $9.56 per share, in each case, the fair market value of the common stock on the date the Company's Board of Directors granted the option. The Company recorded deferred compensation of $2,565,000 which represents an amount equal to the difference between the fair market value of the common stock on February 16, 1996, the date of shareholder approval, and the per share exercise price of the options. Additionally, in March 1997, the Company granted options valued at $51,000 to certain consultants in lieu of cash for services. The Company recorded $1,950,000 and $58,000 as compensation expense in the 39 week periods ended May 25, 1996 and May 31, 1997, respectively. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- The Company's primary sources of cash have been revenue from government grants and contract, revenue from collaborative research agreements, borrowings under capital leases and proceeds from sale of equity securities. In fiscal 1996, the Company received $11,671,000 in payments from its corporate partners consisting of an up-front license fee, milestone payments and sponsored research funding. In fiscal 1996, the Company closed a public offering of 3,000,000 shares of its common stock at $13.00 per share, resulting in proceeds of approximately $36,007,000, net of issuance costs. The Company also sold an additional 450,000 shares of its common stock in the underwriter's over-allotment, resulting in proceeds of 16 17 $5,515,000, net of issuance costs. Additionally, the Company received proceeds of $1,311,000 from the issuance of 534,831 shares of common stock resulting from the exercise of stock options and warrants during fiscal 1996. For the 39 week period ending May 31, 1997, the Company received payments of $9,304,000 from its corporate partners consisting of an up-front license fee, expense allowance, milestone payments and sponsored research funding. As of May 31, 1997, the Company had cash, cash equivalents, restricted cash and long and short-term marketable securities of approximately $49,478,000. The Company has various arrangements under which it can finance certain office and laboratory equipment and leasehold improvements. Under these arrangements, the Company is required to maintain certain financial ratios, including minimum levels of tangible net worth, total indebtedness to tangible net worth, maximum loss, and minimum restricted cash balances. At May 31, 1997, the Company had approximately $4,168,000 available under these arrangements and had an outstanding balance of approximately $7,842,000 which is repayable over the four year period ending May 2001. The Company's operating activities used cash of approximately $2,117,000 for the 39 week period ended May 31, 1997 primarily to fund the Company's operations. The Company's operating activities provided cash of approximately $4,918,000 for the 39 week period ended May 25, 1996 primarily from an up-front license fee from Schering-Plough, as well as milestone payments under its collaborative agreements. These payments were partially offset by cash used to fund the Company's operations. The Company's investing activities provided cash of approximately $5,000 for the 39 week period ended May 31, 1997 from the sale of marketable securities, partially offset by purchases of marketable securities, and property and equipment. The Company investing activities for the 39 week period ended May 25, 1996 used cash of approximately $31,404,000 for purchases of marketable securities. Financing activities used cash of approximately $1,442,000 for the 39 week period ended May 31, 1997 primarily for payments of capital lease obligations, partially offset by the exercise of stock options. Financing activities provided cash of approximately $42,030,000 for the 39 week period ended May 25, 1996 primarily from the sale of equity securities and the exercise of stock options, net of payments of capital lease obligations. Capital expenditures totaled $5,273,000 during the 39 week period ended May 31, 1997. The Company currently estimates that it will acquire an additional $2,000,000 in capital equipment in fiscal 1997, consisting primarily of laboratory, computer and office equipment. The Company also plans to consolidate its operations at its Beaver Street facility at an estimated cost of $6,000,000 which consists of laboratory and office renovations. The Company plans to utilize capital lease arrangements to finance 17 18 substantially all of these capital expenditures which will be incurred through October 1997. At August 31, 1996, the Company had net operating loss and tax credit carryforwards of approximately $33,968,000 and $1,128,000 respectfully. These losses and tax credits are available to reduce federal taxable income and federal income taxes, respectively, in future years, if any. These losses and tax credits are subject to review and possible adjustment by the Internal Revenue Service and may be limited in the event of certain cumulative changes in ownership interests of significant shareholders over a three-year period in excess of 50%. The Company does not believe it has experienced a cumulative ownership change in excess of 50%. However, there can be no assurance that ownership changes will not occur in future periods which will limit the Company's ability to utilize the losses and tax credits. The Company believes that its existing capital resources are adequate to meet its cash requirements for the foreseeable future. There is no assurance, however, that changes in the Company's plans or events affecting the Company's operations will not result in accelerated or unexpected expenditures. The Company may seek additional funding through public or private financing and expects additional funding through collaborative or other arrangements with corporate partners. There can be no assurance, however, that additional financing will be available from any of these sources or will be available on terms acceptable to the Company. Statements in this Form 10Q that are not strictly historical are "forward looking" statements as defined in the Private Securities Litigation Reform Act of 1995. The actual results may differ from those projected in the forward looking statement due to risks and uncertainties that exist in the Company's operations and business environment, described more fully in the Company's Annual Report on Forms 10-K and 10-K/A for the year ended August 31, 1996, filed with the Securities and Exchange Commission. 18 19 Part II ------- Item 1. Legal Proceedings ----------------- None Item 2. Changes In Securities --------------------- None Item 3. Defaults Upon Senior Securities ------------------------------- None Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- None Item 5. Other Information ----------------- None. Item 6. Exhibits and Reports on Form 8-K -------------------------------- a) Exhibits: -------- Exhibit 10.39 filed herewith. b) Reports on Form 8-K ------------------- None. 19 20 EXHIBIT INDEX 10.39 Credit agreement between the Company and Fleet National Bank dated February 28, 1997. (22) FOOTNOTES (22) Filed herewith. 20 21 Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized who also serves in the capacity of principal financial officer. Genome Therapeutics Corp. /s/ Fenel M. Eloi ----------------- Fenel M. Eloi (Principal Financial Officer) Date: July 14, 1997 21 EX-10.39 2 CREDIT AGREEMENT WITH FLEET NATIONAL BANK 2/28/97 1 EXHIBIT 10.39 GENOME THERAPEUTICS CORP. 100 Beaver Street Waltham, MA 02154 February 28, 1997 Fleet National Bank 75 State Street Boston, MA 02109 Gentlemen: This letter agreement will set forth certain understandings between Genome Therapeutics Corp., a Massachusetts corporation (the "Borrower") and Fleet National Bank (the "Bank") with respect to Term Loans (hereinafter defined) to be made by the Bank to the Borrower. In consideration of the mutual promises contained herein and in the other documents referred to below, and for other good and valuable consideration, receipt and sufficiency of which are hereby acknowledged, the Borrower and the Bank agree as follows: I. AMOUNTS AND TERMS ----------------- 1.1. REFERENCES TO DOCUMENTS. Reference is made to (i) that certain $6,000,000 face principal amount promissory note (the "Term Note") of even date herewith made by the Borrower and payable to the order of the Bank, and (ii) that certain Security Agreement (Equipment) of even date herewith from the Borrower to the Bank (the "Security Agreement"). 1.2. THE BORROWING; TERM NOTE. Subject to the terms and conditions hereinafter set forth, the Bank will make one or more loans (the "Term Loans") to the Borrower, as the Borrower may request, on any Business Day prior to the first to occur of (i) December 31, 1997 or (ii) the earlier termination of the within-described term loan facility pursuant to [Section]5.2 or [Section]6.5. A Term Loan shall be made, not more than once per calendar month (except that more than one Term Loan may be made in any calendar month provided that each additional Term Loan in any one calendar month is in an amount of at least $500,000), in order to finance costs of Qualifying Equipment acquired by the Borrower within the 90 days preceding the request for such Term Loan, each such Term Loan to be in such amount as may be requested by the Borrower; provided that (i) no Term Loan will be made after December 31, 1997; (ii) the aggregate original principal amounts of all Term Loans will not exceed $6,000,000; and (iii) no Term Loan will be in an amount more than 100% of the invoiced actual costs of the tangible property constituting the items of Qualifying Equipment with respect to which such Term Loan is made (excluding taxes, shipping, software, installation charges, training fees and other "soft costs"). Prior to the making of each Term Loan, and as a precondition thereto, the Borrower will provide the Bank with: (i) invoices supporting the costs of the relevant Qualifying Equipment; (ii) such evidence as the Bank may reasonably require showing that the Qualifying Equipment has been delivered to and installed at the Borrower's Waltham, MA premises, has become fully operational, has been paid for by the Borrower and is owned by the Borrower free of all liens and interests of any other 2 Person (other than the security interest of the Bank pursuant to the Security Agreement); (iii) Uniform Commercial Code financing statements covering the relevant Qualifying Equipment with respect to which such Term Loan is being made and an appropriate supplement to the Security Agreement adding the relevant Qualifying Equipment to the description of Collateral; and (iv) evidence satisfactory to the Bank that the Qualifying Equipment is fully insured against casualty loss, with insurance naming the Bank as secured party and first loss payee. The Term Loans will be evidenced by the Term Note. The Borrower hereby irrevocably authorizes the Bank to make or cause to be made, on a schedule attached to the Term Note or on the books of the Bank, at or following the time of making each Term Loan and of receiving any payment of principal, an appropriate notation reflecting such transaction and the then aggregate unpaid principal balance of the Term Loans. The amount so noted shall constitute presumptive evidence as to the amount owed by the Borrower with respect to principal of the Term Loans. Failure of the Bank to make any such notation shall not, however, affect any obligation of the Borrower or any right of the Bank hereunder or under the Term Note. 1.3. PRINCIPAL REPAYMENT OF TERM LOANS. The Borrower shall repay principal of each Term Loan in 48 equal consecutive monthly installments, commencing on the first day of the month next following the end of the calendar month in which such Term Loan is made and continuing on the first day of each month thereafter. Each such monthly installment of principal shall be in an amount equal to 1/48th of the original principal amount of such Term Loan. In any event, the then outstanding principal balance of each Term Loan and all interest then accrued but unpaid thereon shall be due and payable in full on the first day of the 48th month next following the end of the calendar month in which such Term Loan is made. The Borrower may prepay, at any time or from time to time, without premium or penalty, the whole or any portion of any Term Loan; provided that each such principal prepayment shall be accompanied by payment of all interest under the Term Note accrued but unpaid to the date of payment. Any partial prepayment of principal of the Term Loans will be applied to installments of principal of the Term Loans thereafter coming due in inverse order of normal maturity. Amounts repaid or prepaid with respect to the Term Loans are not available for reborrowing. 1.4. INTEREST RATE. Except as otherwise provided below in this [Section]1.4, interest on the Term Loans will be payable at a fluctuating rate per annum (the "Floating Rate") which shall at all times be equal to the sum of (i) one-quarter of one percent (0.25%) plus (ii) Prime Rate as in effect from time to time (but in no event in excess of the maximum rate permitted by then applicable law), with a change in such rate of interest to become effective on each day when a change in the Prime Rate becomes effective. Subject to the conditions set forth herein, the Borrower may elect that all or any portion of any Term Loan to be made under [Section]1.2 will be made as a LIBOR Loan, that all or any portion of any Floating Rate Loan (but not any COF Loan) will be converted to a LIBOR Loan and/or that any LIBOR Loan will be continued at the expiration of the Interest Period applicable thereto as a new LIBOR Loan. Such election shall be made by the Borrower giving to the Bank a written or telephonic notice received by the Bank within the time period and containing the information described in the next following sentence (a "Fixed Rate Borrowing Notice"). The Fixed Rate Borrowing Notice must be received by the Bank no later than 10:00 a.m. (Boston time) on that day which is two Business Days prior to the date of -2- 3 the proposed borrowing, conversion or continuation, as the case may be, and must specify the amount of the LIBOR Loan requested (which shall be $500,000 or an integral multiple thereof), must identify the particular Term Loan or Loans so to be made, converted or continued, as the case may be, and must specify the proposed commencement date of the relevant Interest Period. Notwithstanding anything provided elsewhere in this letter agreement, the Borrower may not elect to have any installment of a Term Loan included in a LIBOR Loan if the Interest Period applicable thereto would continue after the due date of such installment. Any Fixed Rate Borrowing Notice shall, upon receipt by the Bank, become irrevocable and binding on the Borrower, and the Borrower shall, upon demand and receipt of a Bank Certificate with respect thereto, forthwith indemnify the Bank against any loss or expense incurred by the Bank as a result of any failure by the Borrower to obtain or maintain any requested LIBOR Loan, including, without limitation, any loss or expense incurred by reason of the liquidation or redeployment of deposits or other funds acquired by the Bank to fund or maintain such LIBOR Loan. At the expiration of each Interest Period applicable to a LIBOR Loan, the principal amount of such LIBOR Loan may be continued as a new LIBOR Loan to the extent and on the terms and conditions contained in this letter agreement by delivery to the Bank of a new Fixed Rate Borrowing Notice conforming to the requirements set forth above in this [Section]1.4 (and any LIBOR Loan not repaid and not so continued as a new LIBOR Loan will be deemed (subject to the provisions of the next following paragraph) to have been converted into a Floating Rate Loan). Notwithstanding any other provision of this letter agreement, the Bank need not make any LIBOR Loan or allow any conversion of a Floating Rate Loan to a LIBOR Loan at any time when there exists any Default or Event of Default. On each of March 31, 1997, June 30, 1997, September 30, 1997 and December 31, 1997, the Borrower may convert to a COF Loan all (but not less than all) of the Terms Loans then outstanding and not already subject to a COF Interest Rate. If the Borrower desires such conversion to a COF Loan, it will notify the Bank of same not less than two Business Days prior to the proposed conversion and will request that the Bank offer with respect to such Term Loans a rate of interest which shall be fixed (subject to adjustment as provided in this letter agreement) for the period commencing on the date of such conversion and ending on the final maturity date applicable to such Term Loans (the "Fixed Rate Period"). Following such request for a fixed rate, the Bank will endeavor to offer a proposed COF Interest Rate at a rate determined as provided below and under conditions determined by the Bank in its sole discretion. The Borrower may elect to accept such offer in the manner and within the time period specified in such offer. Any such election shall be irrevocable on the part of the Borrower. Upon such election, the interest rate payable with respect to the outstanding Term Loans shall be fixed (subject to adjustment as provided in this letter agreement) for the Fixed Rate Period and at the rate communicated by the Bank as its proposed COF Interest Rate. Any proposed COF Interest Rate offered under this Section will be a rate per annum equal to the sum of (i) 2.0% per annum plus (ii) the COF Rate for the applicable Fixed Rate Period (expressed as a per annum rate); provided, however, that the COF Interest Rate shall in no event exceed the maximum rate permitted by applicable law. The COF Rate shall be determined by the Bank in its discretion for the purposes of any proposed COF Interest Rate offered under this Section. The Bank may base the COF Rate for the purpose of computing the proposed COF Interest Rate on any (or any -3- 4 combination of) recognized sources of available funding for transactions of this type, including, but not limited to, the interbank market, the domestic and European certificate of deposit market and sales of commercial paper. The COF Rate for purposes of this computation shall in any event include adjustments for the costs of maintaining reserves, insurance (including, without limitation, assessments by the FDIC), taxes, hedging and other costs which may be incurred by the Bank with respect to the applicable source or sources of funding, all as determined by the Bank in its discretion. The source or sources of funding utilized for the computation of the proposed rate shall be selected by the Bank at its sole discretion for offering to the Borrower, and the Borrower shall not have any claim against the Bank with respect to computation of any proposed COF Interest Rate. If the Borrower is dissatisfied with any proposed COF Interest Rate, the Borrower's sole remedy with respect thereto shall be not to accept such proposed COF Interest Rate within the applicable time period, and thus to cause interest on the Term Loans to be payable at the Floating Rate (subject to the Borrower's ability set forth elsewhere herein to obtain LIBOR Loans). Notwithstanding the foregoing provisions hereof, the Bank need not offer a proposed COF Interest Rate for any period of time with respect to which the Bank, in its sole discretion, determines that there are no recognized sources of funding available to it for such time period or principal amount or that the cost of funds with respect thereto would be unreasonably high or if there then exists any Default or Event of Default. Further, the Borrower may not convert into a COF Loan any LIBOR Loan prior to the end of the Interest Period applicable to such LIBOR Loan. Any request for a Fixed Rate Loan and any election to convert all or any portion of the Term Loans to a Fixed Rate Loan may be made on behalf of the Borrower only by a duly authorized officer; provided, however, that the Bank may conclusively rely upon any written or facsimile communication received from any individual whom the Bank believes in good faith to be such a duly authorized officer. 1.5. INTEREST PAYMENTS. The Borrower will pay interest on the principal amount of the Term Loans outstanding from time to time, from the date hereof until payment of the Term Loans and the Term Note in full and the termination of this letter agreement. Interest on Floating Rate Loans and COF Loans will be payable monthly in arrears on the first day of each month. Interest on each LIBOR Loan will be paid in arrears on the applicable Interest Payment Date. In any event, interest shall also be paid on the date of payment of the Term Loans in full. Interest on Floating Rate Loans shall be payable at the Floating Rate. The rate of interest payable on any LIBOR Loan will be the Eurodollar Interest Rate applicable thereto. Interest on any COF Loan will be payable at the applicable COF Interest Rate. In any event, overdue principal of any Term Loan and, to the extent permitted by law, overdue interest on any Term Loan shall bear interest at a rate per annum which at all times shall be equal to the sum of (i) two (2%) percent per annum plus (ii) the rate otherwise applicable to such overdue principal (or to the principal amount as to which such interest is overdue) under the Term Note, payable on demand. All interest payable hereunder and/or under the Term Note will be calculated on the basis of a 360-day year for the actual number of days elapsed. -4- 5 1.6. RATE DETERMINATION PROTECTION. In the event that: (i) the Bank shall determine that, by reason of circumstances affecting the London interbank market or otherwise, adequate and reasonable methods do not exist for ascertaining the Eurodollar Interest Rate which would otherwise be applicable during any Interest Period, or (ii) the Bank shall determine that: (A) the making or continuation of any LIBOR Loan has been made impracticable or unlawful by (1) the occurrence of any contingency that materially and adversely affects the London interbank market or (2) compliance by the Bank with any applicable law or governmental regulation, guideline or order or interpretation or change thereof by any governmental authority charged with the interpretation or administration thereof or with any request or directive of any such governmental authority (whether or not having the force of law); or (B) LIBOR will not, in the reasonable determination of the Bank, adequately and fairly reflect the cost to the Bank of funding the LIBOR Loans for such Interest Period then the Bank shall forthwith give notice of such determination (which shall be conclusive and binding on the Borrower) to the Borrower. In such event the obligations of the Bank to make LIBOR Loans shall be suspended until the Bank determines that the circumstances giving rise to such suspension no longer exist, whereupon the Bank shall notify the Borrower. 1.7. PREPAYMENT OF FIXED RATE LOANS. The following provisions of this [Section]1.7 shall be effective only with respect to Fixed Rate Loans: If, due to acceleration of the Term Note or due to voluntary prepayment or due to any other reason, the Bank receives payment of any principal of a LIBOR Loan on any date prior to the last day of the relevant Interest Period or receives payment of all or any portion of any installment of a COF Loan prior to the regularly scheduled due date for such installment, the Borrower shall, upon demand and receipt of a Bank Certificate from the Bank with respect thereto, pay forthwith to the Bank all amounts required to compensate the Bank for losses, costs or expenses which it may have incurred and may reasonably incur as a result of such payment, including, without limitation, any loss or expense incurred by reason of the liquidation or redeployment of funds acquired by the Bank to fund or maintain the relevant Fixed Rate Loan. 1.8. Increased Costs; Capital Adequacy. --------------------------------- (i) If the adoption, effectiveness or phase-in, after the date hereof, of any applicable law, rule or regulation, or any change therein, or any change in the -5- 6 interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by the Bank with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency: (A) shall subject the Bank to any Imposition or other charge with respect to any Fixed Rate Loan, the Term Note or the Bank's agreement to make Fixed Rate Loans, or shall change the basis of taxation of payments to the Bank of the principal of or interest on any Fixed Rate Loan or any other amounts due under this letter agreement in respect of the Fixed Rate Loans or the Bank's agreement to make Fixed Rate Loans (except for changes in the rate of tax on the over-all net income of the Bank); or (B) shall impose, modify or deem applicable any reserve, special deposit, deposit insurance or similar requirement (including, without limitation, any such requirement imposed by the Board of Governors of the Federal Reserve System, but excluding, with respect to any LIBOR Loan, any such requirement already included in the applicable Reserve Rate) against assets of, deposits with or for the account of, or credit extended by, the Bank or shall impose on the Bank or on the London interbank market any other condition affecting any Fixed Rate Loans, the Term Note or the Bank's agreement to make Fixed Rate Loans and the result of any of the foregoing is to increase the cost to the Bank of making or maintaining any Fixed Rate Loan or to reduce the amount of any sum received or receivable by the Bank under this letter agreement or under the Term Note with respect to any Fixed Rate Loan by an amount deemed by the Bank to be material, then, upon demand by the Bank and receipt of a Bank Certificate from the Bank with respect thereto, the Borrower shall pay to the Bank such additional amount or amounts as the Bank certifies to be necessary to compensate the Bank for such increased cost or reduction in amount received or receivable. (ii) If the Bank shall have determined that the adoption, effectiveness or phase-in after the date hereof of any applicable law, rule or regulation regarding capital requirements for banks or bank holding companies, or any change therein after the date hereof, or any change after the date hereof in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by the Bank with any request or directive of such entity regarding capital adequacy (whether or not having the force of law) has or would have the effect of reducing the return on the Bank's capital with respect to its agreement hereunder to make Term Loans or with respect to any Term Loan (whether or not then subject to any Eurodollar Interest Rate or COF Interest Rate) to a level below that which the Bank could have achieved (taking into consideration the Bank's policies with -6- 7 respect to capital adequacy immediately before such adoption, effectiveness, phase-in, change or compliance and assuming that the Bank's capital was then fully utilized) by any amount deemed by the Bank to be material: (A) the Bank shall promptly after its determination of such occurrence give notice thereof to the Borrower; and (B) the Borrower shall pay to the Bank as an additional fee from time to time on demand such amount as the Bank certifies to be the amount that will compensate it for such reduction. (iii) A Bank Certificate of the Bank claiming compensation under this [Section]1.8 shall be conclusive in the absence of manifest error. Such certificate shall set forth the nature of the occurrence giving rise to such compensation, the additional amount or amounts to be paid to the Bank hereunder and the method by which such amounts are determined. In determining any such amount, the Bank may use any reasonable averaging and attribution methods. (iv) No failure on the part of the Bank to demand compensation on any one occasion shall constitute a waiver of its right to demand such compensation on any other occasion and no failure on the part of the Bank to deliver any Bank Certificate in a timely manner shall in any way reduce any obligation of the Borrower to the Bank under this [Section]1.8. 1.9. ILLEGALITY OR IMPOSSIBILITY. Notwithstanding any other provision of this letter agreement, if the introduction of or any change in or in the interpretation or administration of any law or regulation applicable to the Bank or the Bank's activities in the London interbank market shall make it unlawful, or any central bank or other governmental authority having jurisdiction over the Bank or the Bank's activities in the London interbank market shall assert that it is unlawful, or otherwise make it impossible, for the Bank to perform its obligations hereunder to make LIBOR Loans or to continue to fund or maintain LIBOR Loans, then on notice thereof and demand therefor by the Bank to the Borrower, (i) the obligation of the Bank to fund LIBOR Loans shall terminate and (ii) the Borrower shall prepay in full all affected LIBOR Loans on or prior to the last day on which such LIBOR Loans may legally remain outstanding. 1.10. ADVANCES AND PAYMENTS. The proceeds of all Term Loans shall be credited by the Bank to a general deposit account maintained by the Borrower with the Bank. The proceeds of each Term Loan will be used by the Borrower solely for acquisition of Qualifying Equipment. The Bank may charge any general deposit account of the Borrower at the Bank with the amount of all payments of interest, principal and other sums due, from time to time, under this letter agreement and/or the Term Note; and will thereafter notify the Borrower of the amount so charged. The failure of the Bank so to charge any account or to give any such notice shall not affect the obligation of the Borrower to pay interest, principal or other sums as provided herein or in the Term Note. -7- 8 Whenever any payment to be made to the Bank hereunder or under the Term Note shall be stated to be due on a day which is not a Business Day, such payment may be made on the next succeeding Business Day, and interest payable on each such date shall include the amount thereof which shall accrue during the period of such extension of time. All payments by the Borrower hereunder and/or in respect of the Term Note shall be made net of any Impositions or taxes and without deduction, set-off or counterclaim, notwithstanding any claim which the Borrower may now or at any time hereafter have against the Bank. All payments of interest, principal and any other sum payable hereunder and/or under the Term Note shall be made to the Bank, in immediately available funds, at its office at 75 State Street, Boston, MA 02109 or to such other address as the Bank may from time to time direct. All payments received by the Bank after 2:00 p.m. on any day shall be deemed received as of the next succeeding Business Day. All monies received by the Bank shall be applied first to fees, charges, costs and expenses payable to the Bank under this letter agreement, the Term Note and/or any of the other Loan Documents, next to interest then accrued on account of any Term Loans and only thereafter to principal of the Term Loans. 1.11. CONDITIONS TO ADVANCE. Prior to the making of the initial Term Loan, the Borrower shall deliver to the Bank duly executed copies of this letter agreement, the Security Agreement, the Term Note and the documents and other items listed on the Closing Agenda delivered herewith by the Bank to the Borrower, all of which, as well as all legal matters incident to the transactions contemplated hereby, shall be satisfactory in form and substance to the Bank and its counsel. Without limiting the foregoing, any Term Loan (including the initial Term Loan) is subject to the further conditions precedent that on the date on which such Term Loan is made (and after giving effect thereto): (a) All statements, representations and warranties of the Borrower made in this letter agreement and/or in the Security Agreement shall continue to be correct in all material respects as of the date of such Term Loan. (b) All covenants and agreements of the Borrower contained herein and/or in any of the other Loan Documents shall have been complied with in all material respects on and as of the date of such Term Loan. (c) No event which constitutes, or which with notice or lapse of time or both could constitute, an Event of Default shall have occurred and be continuing. (d) No material adverse change shall have occurred in the financial condition of the Borrower from that disclosed in the financial statements then most recently furnished to the Bank. Each request by the Borrower for any Term Loan, and each acceptance by the Borrower of the proceeds of any Term Loan, will be deemed a representation and warranty by the -8- 9 Borrower that at the date of such Term Loan and after giving effect thereto all of the conditions set forth in the foregoing clauses (a)-(d) of this [Section]1.11 will be satisfied. II. REPRESENTATIONS AND WARRANTIES ------------------------------ 2.1. REPRESENTATIONS AND WARRANTIES. In order to induce the Bank to enter into this letter agreement and to make Term Loans hereunder, the Borrower warrants and represents to the Bank as follows: (a) The Borrower is a corporation duly organized, validly existing and in good standing under the laws of The Commonwealth of Massachusetts. The Borrower has full corporate power to own its property and conduct its business as now conducted and as proposed to be conducted, to grant the security interests contemplated by the Security Agreement and to enter into and perform this letter agreement and the other Loan Documents. The Borrower is duly qualified to do business and in good standing in each jurisdiction in which the Borrower maintains any plant, office, warehouse or other facility and in each other jurisdiction where the failure so to qualify could (singly or in the aggregate with all other such failures) have a material adverse effect on the financial condition, business or prospects of the Borrower, all such jurisdictions being listed on item 2.1(a) of the attached Disclosure Schedule. At the date hereof, the Borrower has no Subsidiaries, except as shown on said item 2.1(a) of the attached Disclosure Schedule. The Borrower is not a member of any partnership or joint venture. (b) At the date of this letter agreement, no Person is known by the Borrower to own, of record and/or beneficially, more than 5% of the outstanding shares of any class of the Borrower's capital stock, except as set forth on item 2.1(b) of the attached Disclosure Schedule. (c) The execution, delivery and performance by the Borrower of this letter agreement and each of the other Loan Documents have been duly authorized by all necessary corporate and other action and do not and will not: (i) violate any provision of, or require as a prerequisite to effectiveness any filing (other than filings under the Uniform Commercial Code), registration, consent or approval under, any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to the Borrower; (ii) violate any provision of the charter or by-laws of the Borrower, or result in a breach of or constitute a default or require any waiver or consent under any indenture or loan or credit agreement or any other material agreement, lease or instrument to which the Borrower is a party or by which the Borrower or any of its properties may be bound or affected or require any other consent of any Person; or (iii) result in, or require, the creation or imposition of any lien, security interest or other encumbrance (other than in favor of the Bank), upon or with respect to any of the properties now owned or hereafter acquired by the Borrower. -9- 10 (d) This letter agreement and each of the other Loan Documents delivered herewith has been duly executed and delivered by the Borrower and each is a legal, valid and binding obligation of the Borrower, enforceable against the Borrower in accordance with its respective terms. (e) Except as described on item 2.1(e) of the attached Disclosure Schedule, there are no actions, suits, proceedings or investigations pending or, to the knowledge of the Borrower, threatened by or against the Borrower or any Subsidiary before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, which could hinder or prevent the consummation of the transactions contemplated hereby or call into question the validity of this letter agreement or any of the other Loan Documents or any action taken or to be taken in connection with the transactions contemplated hereby or thereby or which in any single case or in the aggregate may result in any material adverse change in the business, prospects, condition, affairs or operations of the Borrower or any Subsidiary. (f) The Borrower is not in violation of any term of its charter or by-laws as now in effect. Neither the Borrower nor any Subsidiary of the Borrower is in material violation of any term of any mortgage, indenture or judgment, decree or order, or any other material instrument, contract or agreement to which it is a party or by which any of its property is bound. (g) The Borrower has filed (and has caused each of its Subsidiaries to file) all federal, foreign, state and local tax returns, reports and estimates required to be filed by the Borrower and/or by any such Subsidiary. All such filed returns, reports and estimates are proper and accurate and the Borrower or the relevant Subsidiary has paid all taxes, assessments, impositions, fees and other governmental charges required to be paid in respect of the periods covered by such returns, reports or estimates. No deficiencies for any tax, assessment or governmental charge have been asserted or assessed, and the Borrower knows of no material tax liability or basis therefor. (h) The Borrower is in compliance (and each Subsidiary of the Borrower is in compliance) with all requirements of law, federal, foreign, state and local, and all requirements of all governmental bodies or agencies having jurisdiction over it, the conduct of its business, the use of its properties and assets, and all premises occupied by it, failure to comply with any of which could (singly or in the aggregate with all other such failures) have a material adverse effect upon the assets, business, financial condition or prospects of the Borrower or any such Subsidiary. Without limiting the foregoing, the Borrower has all the material franchises, licenses, leases, permits, certificates and authorizations needed for the conduct of its business and the use of its properties and all premises occupied by it, as now conducted, owned and used and as proposed to be conducted, owned and used. (i) The audited financial statements of the Borrower and Subsidiaries as at August 31, 1996 and the management-generated statements of the Borrower and Subsidiaries as at November 30, 1996, each heretofore delivered to the Bank, are complete and accurate and fairly -10- 11 present the financial condition of the Borrower and Subsidiaries as at the respective dates thereof and for the periods covered thereby, except that the management-generated statements do not have footnotes and thus do not present the information which would normally be contained in footnotes to financial statements and are subject to normal year-end adjustments, which shall not be material. Neither the Borrower nor any of the Borrower's Subsidiaries has any liability, contingent or otherwise, not disclosed in the aforesaid financial statements or in any notes thereto that could materially affect the financial condition of the Borrower. Since August 31, 1996, here has been no material adverse development in the business, condition or prospects of the Borrower, and the Borrower has not entered into any material transaction other than in the ordinary course. (j) The principal place of business and chief executive offices of the Borrower are located at 100 Beaver Street, Waltham, Massachusetts 02154 (the "Premises"). All of the books and records of the Borrower are located at the Premises. Except as described on item 2.1(j) of the attached Disclosure Schedule, no assets of the Borrower are located at any other address. Said item 2.1(j) of the attached Disclosure Schedule sets forth the names and addresses of all record owners of the Premises. (k) The Borrower owns or has a valid right to use all of the material patents, licenses, copyrights, trademarks and trade names now being used to conduct its business. The conduct of the Borrower's business as now operated does not conflict with valid patents, copyrights, trademarks or trade names of others in any manner that could materially adversely affect the business, prospects, assets or condition, financial or otherwise, of the Borrower. (l) None of the executive officers or key employees of the Borrower is subject to any agreement in favor of anyone other than the Borrower which materially limits or restricts that person's right to engage in the type of business activity conducted or proposed to be conducted by the Borrower or which grants to anyone other than the Borrower any rights in any inventions or other ideas susceptible to legal protection developed or conceived by any such officer or key employee. (m) The Borrower is not a party to any contract or agreement which now has or, as far as can be foreseen by the Borrower at the date hereof, may have a material adverse effect on the financial condition, business, prospects or properties of the Borrower. III. AFFIRMATIVE COVENANTS AND REPORTING REQUIREMENTS ------------------------------------------------ Without limitation of any other covenants and agreements contained herein or elsewhere, the Borrower agrees that so long as the financing arrangements contemplated hereby are in effect or all or any portion of any Term Loan or any of the other Obligations shall be outstanding: 3.1. LEGAL EXISTENCE; QUALIFICATION; COMPLIANCE. The Borrower will maintain (and will cause each Subsidiary of the Borrower to maintain) its corporate existence and good standing in the jurisdiction of its incorporation. The Borrower will qualify to do business and -11- 12 will remain qualified and in good standing (and the Borrower will cause each Subsidiary of the Borrower to qualify and remain qualified and in good standing) in each other jurisdiction where the Borrower or such Subsidiary, as the case may be, maintains any plant, office, warehouse or other facility and in each other jurisdiction where the failure so to qualify could (singly or in the aggregate with all other such failures) have a material adverse effect on the financial condition, business or prospects of the Borrower or any such Subsidiary. The Borrower will comply (and will cause each Subsidiary of the Borrower to comply) with its charter documents and by-laws. The Borrower will comply with (and will cause each Subsidiary of the Borrower to comply with) all applicable laws, rules and regulations (including, without limitation, ERISA and those relating to environmental protection) other than (i) laws, rules or regulations the validity or applicability of which the Borrower or such Subsidiary shall be contesting in good faith by proceedings which serve as a matter of law to stay the enforcement thereof and (ii) those laws, rules and regulations the failure to comply with any of which could not (singly or in the aggregate) have a material adverse effect on the financial condition, business or prospects of the Borrower or any such Subsidiary. 3.2. MAINTENANCE OF PROPERTY; INSURANCE. The Borrower will maintain and preserve (and will cause each Subsidiary of the Borrower to maintain and preserve) all of its fixed assets used in its business in good working order and condition, making all necessary repairs thereto and replacements thereof. The Borrower will maintain all such insurance as may be required under the Security Agreement and will also maintain, with financially sound and reputable insurers, insurance with respect to its property and business against such liabilities, casualties and contingencies and of such types and in such amounts as shall be reasonably satisfactory to the Bank from time to time and in any event all such insurance as may from time to time be customary for companies conducting a business similar to that of the Borrower in similar locales. 3.3. PAYMENT OF TAXES AND CHARGES. The Borrower will pay and discharge (and will cause each Subsidiary of the Borrower to pay and discharge) all taxes, assessments and governmental charges or levies imposed upon it or upon its income or property, including, without limitation, taxes, assessments, charges or levies relating to real and personal property, franchises, income, unemployment, old age benefits, withholding, or sales or use, prior to the date on which penalties would attach thereto, and all lawful claims (whether for any of the foregoing or otherwise) which, if unpaid, might give rise to a lien upon any property of the Borrower or any such Subsidiary, except any of the foregoing which is being contested in good faith and by appropriate proceedings which serve as a matter of law to stay the enforcement thereof and for which the Borrower has established and is maintaining adequate reserves. The Borrower will pay, and will cause each of its Subsidiaries to pay, in a timely manner, all material lease obligations, material trade debt, material purchase money obligations and material equipment lease obligations. The Borrower will perform and fulfill all material covenants and agreements under any material leases of real estate, material agreements relating to purchase money debt, material equipment leases and other material contracts. The Borrower will maintain in full force and effect, and comply with the terms and conditions of, all permits, permissions and licenses necessary or desirable for its business. -12- 13 3.4. ACCOUNTS. The Borrower will maintain its principal depository and operating accounts with the Bank. The average daily collected balance in such account (averaged over the period of each calendar quarter) shall be not less than $200,000. 3.5. CONDUCT OF BUSINESS. The Borrower will conduct, in the ordinary course, the business in which it is presently engaged. The Borrower will not, without the prior written consent of the Bank, directly or indirectly (itself or through any Subsidiary) enter into any other unrelated lines of business, businesses or ventures. 3.6. REPORTING REQUIREMENTS. The Borrower will furnish to the Bank (or cause to be furnished to the Bank): (i) Within 90 days after the end of each fiscal year of the Borrower, a copy of the annual audit report for such fiscal year for the Borrower, including therein consolidated and consolidating balance sheets of the Borrower and Subsidiaries as at the end of such fiscal year and related consolidated and consolidating statements of income, stockholders' equity and cash flow for the fiscal year then ended. The annual consolidated financial statements shall be certified by independent public accountants selected by the Borrower and reasonably acceptable to the Bank, such certification to be in such form as is generally recognized as "unqualified". The Borrower will also deliver to the Bank, within 90 days after the commencement of each fiscal year, projections of sales, income and expenses of the Borrower for such fiscal year, prepared by the Borrower's management and approved by the Borrower's Board of Directors, such projections to be in such detail as is reasonably satisfactory to the Bank. (ii) Within 45 days after the end of each fiscal quarter of the Borrower, a copy of the Borrower's Quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission ("SEC"). If, for any reason, the Borrower is not required to file or does not file such Quarterly Report on Form 10-Q with the SEC within 45 days after the end of any fiscal quarter, then within such 45-day period after the end of such fiscal quarter the Borrower will deliver to the Bank consolidated and consolidating balance sheets of the Borrower and Subsidiaries and related consolidated and consolidating statements of income and cash flow, unaudited but complete and accurate and prepared in accordance with generally accepted accounting principles consistently applied fairly presenting the financial condition of the Borrower and Subsidiaries as at the dates thereof and for the periods covered thereby (except that such quarterly statements need not contain footnotes) and certified as accurate by the chief financial officer of the Borrower, such balance sheets to be as at the end of such fiscal quarter and such statements of income and cash flow to be for such fiscal quarter and for the year to date, in each case together with a comparison to budget and a comparison to the results for the corresponding fiscal period of the immediately prior fiscal year. (iii) At the time of delivery of each annual or quarterly report or financial statement of the Borrower, a certificate executed by the chief financial officer of the -13- 14 Borrower stating that he or she has reviewed this letter agreement and the other Loan Documents and has no knowledge of any default by the Borrower in the performance or observance of any of the provisions of this letter agreement or of any of the other Loan Documents or, if he or she has such knowledge, specifying each such default and the nature thereof. Each financial statement given as at the end of any fiscal quarter of the Borrower will also set forth the calculations necessary to evidence compliance with [Sections]3.7-3.9. (iv) Promptly after receipt, a copy of all audits or reports submitted to the Borrower by independent public accountants in connection with any annual, special or interim audits of the books of the Borrower and any letter of comments directed by such accountants to the management of the Borrower. (v) As soon as possible and in any event within five days after the occurrence of any Default or Event of Default, the statement of the Borrower setting forth details of each such Default or Event of Default and the action which the Borrower proposes to take with respect thereto. (vi) Promptly after the commencement thereof, notice of all actions, suits and proceedings before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, to which the Borrower or any Subsidiary of the Borrower is a party. (vii) Promptly upon filing any registration statement or listing application, a copy of same. (viii) As long as the Borrower has a class of securities which is publicly traded, a copy of each periodic or current report of the Borrower filed with the SEC or any successor agency and each annual report, proxy statement and other communication sent by the Borrower to shareholders or other securityholders generally, such copy to be provided to the Bank promptly upon such filing with the SEC or such communication with shareholders or securityholders, as the case may be. (ix) Promptly after the Borrower has knowledge thereof, written notice of any development or circumstance which may reasonably be expected to have a material adverse effect on the Borrower or its business, properties, assets, Subsidiaries or condition, financial or otherwise. (x) Promptly upon request, such other information respecting the financial condition, operations, receivables, inventory, machinery or equipment of the Borrower or any Subsidiary as the Bank may from time to time reasonably request. 3.7. CAPITAL BASE. The Borrower will maintain, as at the end of each fiscal quarter (commencing with February 28, 1997), a consolidated Capital Base of not less than $20,000,000. -14- 15 3.8. LIQUIDITY. The Borrower will maintain as at the end of each fiscal quarter of Borrower (commencing with February 28, 1997), a ratio of Net Quick Assets to Total Liabilities, which ratio shall be not less than 1.5 to 1. 3.9. DEBT SERVICE COVERAGE. As used herein, "Determination Date" means the last day of each fiscal quarter of the Borrower. The Borrower will maintain on a consolidated basis, as at each Determination Date (commencing with February 28, 1997), a Debt Service Coverage Ratio of not less than 2.0 to 1. As used herein, the "Debt Service Coverage Ratio", as determined as at any Determination Date, means the ratio of (x) EBITDA of the Borrower and Subsidiaries for the 12-month period ending on such Determination Date to (y) the total of (1) all interest on any Indebtedness (whether senior or subordinated, long-term or current), which interest was paid or payable or accrued by the Borrower or any Subsidiary of the Borrower during such 12-month period ending on such Determination Date, PLUS (2) the aggregate current maturities of long-term debt of the Borrower and Subsidiaries outstanding at such Determination Date. Notwithstanding the foregoing, the Borrower need not comply with the foregoing provisions of this [Section]3.9 as at any Determination Date if the Borrower's Unencumbered Cash Balance as at such Determination Date exceeds $18,000,000. 3.10. BOOKS AND RECORDS. The Borrower will maintain (and will cause each of its Subsidiaries to maintain) complete and accurate books, records and accounts which will at all times accurately and fairly reflect all of its transactions in accordance with generally accepted accounting principles consistently applied. The Borrower will, at any reasonable time and from time to time upon reasonable notice and during normal business hours (and at any time and without any necessity for notice following the occurrence of an Event of Default), permit the Bank, and any agents or representatives thereof, to examine and make copies of and take abstracts from the records and books of account of, and visit the properties of the Borrower and any of its Subsidiaries, and to discuss its affairs, finances and accounts with its officers, directors and/or independent accountants, all of whom are hereby authorized and directed to cooperate with the Bank in carrying out the intent of this [Section]3.10. Each financial statement of the Borrower hereafter delivered pursuant to this letter agreement will be complete and accurate and will fairly present the financial condition of the Borrower as at the date thereof and for the periods covered thereby. 3.11. SUBORDINATION AGREEMENTS. Prior to the making of the first Term Loan, the Borrower will obtain, and will thereafter maintain in effect at all times, subordination agreements in form and substance satisfactory to the Bank providing for full subordination of all of the obligations of the Borrower now or hereafter owed to any shareholder or other affiliates of the Borrower. -15- 16 IV. NEGATIVE COVENANTS ------------------ Without limitation of any other covenants and agreements contained herein or elsewhere, the Borrower agrees that so long as the financing arrangements contemplated hereby are in effect or all or any portion of any Term Loan or any of the other Obligations shall be outstanding: 4.1. INDEBTEDNESS. The Borrower will not create, incur, assume or suffer to exist any Indebtedness (nor allow any of its Subsidiaries to create, incur, assume or suffer to exist any Indebtedness), except for: (i) Indebtedness owed to the Bank, including, without limitation, the Indebtedness represented by the Term Note; (ii) Indebtedness of the Borrower or any Subsidiary for taxes, assessments and governmental charges or levies not yet due and payable; (iii) unsecured current liabilities of the Borrower or any Subsidiary (other than for money borrowed or for purchase money Indebtedness with respect to fixed assets) incurred upon customary terms in the ordinary course of business; (iv) other Indebtedness of the Borrower up to $15,000,000 in the aggregate outstanding at any time, provided such Indebtedness is unsecured and no Default exists at the time of the incurrence thereof or could reasonably be expected to result from the incurrence thereof; (v) purchase money Indebtedness (including, without limitation, Indebtedness in respect of capitalized equipment leases) owed to equipment vendors and/or lessors for equipment purchased or leased by the Borrower for use in the Borrower's business, provided that the total of Indebtedness permitted under this clause (iv) plus presently-existing equipment financing permitted under clause (v) of this [Section]4.1 will not exceed $1,000,000 in the aggregate outstanding at any one time; (vi) other Indebtedness (not described in any of clauses (i)-(iv) above) existing at the date hereof, but only to the extent set forth on item 4.1 of the attached Disclosure Schedule; and (vii) any guaranties or other contingent liabilities expressly permitted pursuant to [Section]4.3. 4.2. LIENS. The Borrower will not create, incur, assume or suffer to exist (nor allow any of its Subsidiaries to create, incur, assume or suffer to exist) any mortgage, deed of trust, pledge, lien, security interest, or other charge or encumbrance (including the lien or retained security title of a conditional vendor) of any nature (collectively, "Liens"), upon or with respect -16- 17 to any of its property or assets, now owned or hereafter acquired, except that the foregoing restrictions shall not apply to: (i) Liens for taxes, assessments or governmental charges or levies on property of the Borrower or any of its Subsidiaries if the same shall not at the time be delinquent or thereafter can be paid without interest or penalty or are being contested in good faith and by appropriate proceedings which serve as a matter of law to stay any enforcement thereof and as to which adequate reserves are maintained; (ii) Liens imposed by law, such as carriers', warehousemen's and mechanics' liens and other similar Liens arising in the ordinary course of business for sums not yet due or which are being contested in good faith and by appropriate proceedings which serve as a matter of law to stay the enforcement thereof and as to which adequate reserves are maintained; (iii) pledges or deposits under workmen's compensation laws, unemployment insurance, social security, retirement benefits or similar legislation; (iv) Liens in favor of the Bank; (v) Liens in favor of equipment vendors and/or lessors securing purchase money Indebtedness to the extent permitted by clause (iv) of [Section]4.1; provided that no such Lien will extend to any property of the Borrower other than the specific items of equipment financed; or (vi) other Liens existing at the date hereof, but only to the extent and with the relative priorities set forth on item 4.2 of the attached Disclosure Schedule. Without limitation of the foregoing, the Borrower covenants and agrees that it will not enter into (and represents and warrants that it is not now a party to or subject to) any agreement or understanding with any Person other than the Bank which could prohibit or restrict in any manner the right of the Borrower to grant Liens on its assets to the Bank. 4.3. GUARANTIES. The Borrower will not, without the prior written consent of the Bank, assume, guarantee, endorse or otherwise become directly or contingently liable (including, without limitation, liable by way of agreement, contingent or otherwise, to purchase, to provide funds for payment, to supply funds to or otherwise invest in any debtor or otherwise to assure any creditor against loss) (and will not permit any of its Subsidiaries so to assume, guaranty or become directly or contingently liable) in connection with any indebtedness of any other Person, except (i) guaranties by endorsement for deposit or collection in the ordinary course of business, and (ii) guaranties existing at the date hereof and described on item 4.3 of the attached Disclosure Schedule. -17- 18 4.4. DIVIDENDS. The Borrower will not, without the prior written consent of the Bank, make any distributions to its shareholders, pay any dividends (other than dividends payable solely in capital stock of the Borrower) or redeem, purchase or otherwise acquire, directly or indirectly any of its capital stock. 4.5. LOANS AND ADVANCES. The Borrower will not make (and will not permit any Subsidiary to make) any loans or advances to any Person, including, without limitation, the Borrower's directors, officers and employees, except advances to such directors, officers or employees with respect to expenses incurred by them in the ordinary course of their duties and advances against salary, all of which loans and advances will not exceed, in the aggregate, $200,000 outstanding at any one time. 4.6. INVESTMENTS. The Borrower will not, without the Bank's prior written consent, invest in, hold or purchase any stock or securities of any Person (nor will the Borrower permit any of its Subsidiaries to invest in, purchase or hold any such stock or securities) except: (i) readily marketable direct obligations of, or obligations guarantied by, the United States of America or any agency thereof; (ii) other investment grade debt securities; (iii) mutual funds, the assets of which are primarily invested in items of the kind described in the foregoing clauses (i) and (ii) of this [Section]4.6; (iv) deposits with or certificates of deposit issued by the Bank and any other obligations of the Bank or the Bank's parent; (v) deposits in any other bank organized in the United States having capital in excess of $100,000,000; (vi) investments in any Subsidiaries now existing or hereafter created by the Borrower pursuant to [Section]4.7 below and (vii) other investments consistent with the Borrower's existing investment policy as described in item 4.6 of the attached Disclosure Schedule; provided that in any event the Tangible Net Worth of the Borrower alone (exclusive of its investment in Subsidiaries and any debt owed by any Subsidiary to the Borrower) will not be less than 90% of the consolidated Tangible Net Worth of the Borrower and Subsidiaries. 4.7. SUBSIDIARIES; ACQUISITIONS. The Borrower will not, without the prior written consent of the Bank, form or acquire any Subsidiary or make any other acquisition of the stock of any other Person or of all or substantially all of the assets of any other Person. The Borrower will not become a partner in any partnership. 4.8. MERGER. The Borrower will not, without the prior written consent of the Bank, merge or consolidate with any Person, or sell, lease, transfer or otherwise dispose of any material portion of its assets (whether in one or more transactions), other than sale of inventory in the ordinary course. 4.9. AFFILIATE TRANSACTIONS. The Borrower will not, without prior written consent of the Bank, enter into any transaction, including, without limitation, the purchase, sale or exchange of any property or the rendering of any service, with any affiliate of the Borrower, except in the ordinary course of and pursuant to the reasonable requirements of the Borrower's business and upon fair and reasonable terms no less favorable to the Borrower than would be obtained in a comparable arms'-length transaction with any Person not an affiliate; provided that nothing in -18- 19 this [Section]4.9 shall be deemed to restrict the payment of salary or other similar payments to any officer or director of the Borrower at a level consistent with the salary and other payments being paid at the date of this letter agreement and heretofore disclosed in writing to the Bank, nor to prevent the hiring of additional officers at a salary level consistent with industry practice, nor to prevent reasonable periodic increases in salary. For the purposes of this letter agreement, "affiliate" means any Person which, directly or indirectly, controls or is controlled by or is under common control with the Borrower; any officer or director or former officer or director of the Borrower; any Person owning of record or beneficially, directly or indirectly, 5% or more of any class of capital stock of the Borrower or 5% or more of any class of capital stock or other equity interest having voting power (under ordinary circumstances) of any of the other Persons described above; and any member of the immediate family of any of the foregoing. "Control" means possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of any Person, whether through ownership of voting equity, by contract or otherwise. 4.10. CHANGE OF ADDRESS, ETC. The Borrower will not change its corporate name or legal structure, nor will the Borrower change its chief executive offices or principal place of business from the address described in [Section]2.1(j) above, nor will the Borrower keep any Collateral at any location other than the Premises without, in each instance, giving the Bank at least 30 days' prior written notice and providing all such financing statements, certificates and other documentation as the Bank may request in order to maintain the perfection and priority of the security interests granted or intended to be granted pursuant to the Security Agreement. The Borrower will not change its fiscal year or methods of financial reporting unless, in each instance, prior written notice of such change is given to the Bank and prior to such change the Borrower enters into amendments to this letter agreement in form and substance reasonably satisfactory to the Bank in order to preserve unimpaired the rights of the Bank and the obligations of the Borrower hereunder. 4.11. HAZARDOUS WASTE. Except as provided below, the Borrower will not dispose of or suffer or permit to exist any hazardous material or oil on any site or vessel owned, occupied or operated by the Borrower or any Subsidiary of the Borrower, nor shall the Borrower store (or permit any Subsidiary to store) on any site or vessel owned, occupied or operated by the Borrower or any such Subsidiary, or transport or arrange the transport of, any hazardous material or oil (the terms "hazardous material", "oil", "site" and "vessel", respectively, being used herein with the meanings given those terms in Mass. Gen. Laws, Ch. 21E or any comparable terms in any comparable statute in effect in any other relevant jurisdiction). The Borrower shall provide the Bank with written notice of (i) the intended storage or transport of any hazardous material or oil by the Borrower or any Subsidiary of the Borrower, (ii) any potential or known release or threat of release of any hazardous material or oil at or from any site or vessel owned, occupied or operated by the Borrower or any Subsidiary of the Borrower, and (iii) any incurrence of any expense or loss by any government or governmental authority in connection with the assessment, containment or removal of any hazardous material or oil for which expense or loss the Borrower or any Subsidiary of the Borrower may be liable. Notwithstanding the foregoing, the Borrower and its Subsidiaries may use, store and transport, and need not notify the Bank of the use, storage -19- 20 or transportation of, (x) oil in reasonable quantities, as fuel for heating of their respective facilities or for vehicles or machinery used in the ordinary course of their respective businesses and (y) hazardous materials that are solvents, cleaning agents or other materials used in the ordinary course of the respective business operations of the Borrower and its Subsidiaries, in reasonable quantities, as long as in any case the Borrower or the Subsidiary concerned (as the case may be) has obtained and maintains in effect any necessary governmental permits, licenses and approvals, complies with all requirements of applicable federal, state and local law relating to such use, storage or transportation, follows the protective and safety procedures that a prudent businessperson conducting a business the same as or similar to that of the Borrower or such Subsidiary (as the case may be) would follow, and disposes of such materials (not consumed in the ordinary course) only through licensed providers of hazardous waste removal services. 4.12. NO MARGIN STOCK. No proceeds of any Term Loan shall be used directly or indirectly to purchase or carry any margin security. 4.13. SUBORDINATED DEBT. The Borrower will not directly or indirectly make any optional or voluntary prepayment or purchase of Subordinated Debt or modify, alter or add any provisions with respect to payment of Subordinated Debt. In any event, the Borrower will not make any payment of any principal of or interest on any Subordinated Debt at any time when there exists, or if there would result therefrom, any Default or Event of Default hereunder. V. DEFAULT AND REMEDIES -------------------- 5.1. EVENTS OF DEFAULT. The occurrence of any one of the following events shall constitute an Event of Default hereunder: (a) The Borrower shall fail to make any payment of principal of or interest on the Term Note on or before the date when due; or (b) Any representation or warranty of the Borrower contained herein shall at any time prove to have been incorrect in any material respect when made or any representation or warranty made by the Borrower in connection with any Term Loan shall at any time prove to have been incorrect in any material respect when made; or (c) The Borrower shall default in the performance or observance of any agreement or obligation under any of [Sections]3.1, 3.3, 3.6, 3.7, 3.8 or 3.9 or any provision of Article IV; or (d) The Borrower shall default in the performance of any other term, covenant or agreement contained in this letter agreement and such default shall continue unremedied for 30 days after notice thereof shall have been given to the Borrower; or (e) Any default on the part of the Borrower or any Subsidiary of the Borrower shall exist, and shall remain unwaived or uncured beyond the expiration of any applicable notice -20- 21 and/or grace period, under any other contract, agreement or undertaking now existing or hereafter entered into with or for the benefit of the Bank (or any affiliate of the Bank); or (f) Any default shall exist and remain unwaived or uncured with respect to any Subordinated Debt of the Borrower or with respect to any instrument evidencing, guaranteeing or otherwise relating to any such Subordinated Debt, or any such Subordinated Debt shall not have been paid when due, whether by acceleration or otherwise, or shall have been declared to be due and payable prior to its stated maturity, or any event or circumstance shall occur which permits, or with the lapse of time or the giving of notice or both would permit, the acceleration of the maturity of any Subordinated Debt by the holder or holders thereof; or (g) Any default shall exist and remain unwaived or uncured with respect to any other Indebtedness of the Borrower or any Subsidiary of the Borrower in excess of $100,000 in aggregate principal amount or with respect to any instrument evidencing, guaranteeing, securing or otherwise relating to any such Indebtedness, or any such Indebtedness in excess of $100,000 in aggregate principal amount shall not have been paid when due, whether by acceleration or otherwise, or shall have been declared to be due and payable prior to its stated maturity, or any event or circumstance shall occur which permits, or with the lapse of time or the giving of notice or both would permit, the acceleration of the maturity of any such Indebtedness by the holder of holders thereof; or (h) The Borrower shall be dissolved, or the Borrower or any Subsidiary of the Borrower shall become insolvent or bankrupt or shall cease paying its debts as they mature or shall make an assignment for the benefit of creditors, or a trustee, receiver or liquidator shall be appointed for the Borrower or any Subsidiary of the Borrower or for a substantial part of the property of the Borrower or any such Subsidiary, or bankruptcy, reorganization, arrangement, insolvency or similar proceedings shall be instituted by or against the Borrower or any such Subsidiary under the laws of any jurisdiction (except for an involuntary proceeding filed against the Borrower or any Subsidiary of the Borrower which is dismissed within 60 days following the institution thereof); or (i) Any attachment, execution or similar process shall be issued or levied against any property of the Borrower or any Subsidiary and such attachment, execution or similar process shall not be paid, stayed, released, vacated or fully bonded within 10 days after its issue or levy; or (j) Any final uninsured judgment in excess of $100,000 shall be entered against the Borrower or any Subsidiary of the Borrower by any court of competent jurisdiction; or (k) The Borrower or any Subsidiary of the Borrower shall fail to meet its minimum funding requirements under ERISA with respect to any employee benefit plan (or other class of benefit which the PBGC has elected to insure) or any such plan shall be the subject of termination proceedings (whether voluntary or involuntary) and there shall result from such termination proceedings a liability of the Borrower or any Subsidiary of the Borrower to the -21- 22 PBGC which, in each case, in the reasonable opinion of the Bank may have a material adverse effect upon the financial condition of the Borrower or any such Subsidiary; or (l) The Security Agreement or any other Loan Document shall for any reason (other than due to payment in full of all amounts secured or evidenced thereby or due to discharge in writing by the Bank) not remain in full force and effect; or (m) The security interest and liens of the Bank in and on any of the Collateral covered or intended to be covered by the Security Agreement shall for any reason (other than written release by the Bank) not be fully perfected liens and security interests; or (n) If, at any time, more than 50% of any class of voting stock of the Borrower shall be held, of record and/or beneficially, by any Person or by any "group" (as defined in the Securities Exchange Act of 1934, as amended, and the regulations thereunder); or (o) There shall occur any other material adverse change in the conditions (financial or otherwise), operations, properties, assets, liabilities or earnings of the Borrower. 5.2. RIGHTS AND REMEDIES ON DEFAULT. Upon the occurrence of any Event of Default, in addition to any other rights and remedies available to the Bank hereunder or otherwise, the Bank may exercise any one or more of the following rights and remedies (all of which shall be cumulative): (a) Declare the entire unpaid principal amount of the Term Note then outstanding, all interest accrued and unpaid thereon and all other amounts payable under this letter agreement, and all other Indebtedness of the Borrower to the Bank, to be forthwith due and payable, whereupon the same shall become forthwith due and payable, without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived by the Borrower. (b) Terminate the arrangements for Term Loans provided for by this letter agreement. (c) Exercise all rights and remedies hereunder, under the Security Agreement, under the Term Note and under each and any other agreement with the Bank; and exercise all other rights and remedies which the Bank may have under applicable law. 5.3. SET-OFF. In addition to any rights now or hereafter granted under applicable law and not by way of limitation of any such rights, upon the occurrence of any Event of Default, the Bank is hereby authorized at any time or from time to time, without presentment, demand, protest or other notice of any kind to the Borrower or to any other Person, all of which are hereby expressly waived, to set off and to appropriate and apply any and all deposits and any other Indebtedness at any time held or owing by the Bank or any affiliate thereof to or for the credit or the account of the Borrower against and on account of the obligations and liabilities of the Borrower to the Bank under this letter agreement or otherwise, irrespective of whether or not the -22- 23 Bank shall have made any demand hereunder and although said obligations, liabilities or claims, or any of them, may then be contingent or unmatured and without regard for the availability or adequacy of other collateral. As security for the Obligations, the Borrower grants to the Bank a security interest with respect to all its deposits and all securities or other property in the possession of the Bank or any affiliate of the Bank from time to time, and, upon the occurrence of any Event of Default, the Bank may exercise all rights and remedies of a secured party under the Uniform Commercial Code. VI. MISCELLANEOUS ------------- 6.1. COSTS AND EXPENSES. The Borrower agrees to pay, on demand and delivery of a Bank Certificate therefor, all costs and expenses (including, without limitation, reasonable legal fees) of the Bank in connection with the preparation, execution and delivery of this letter agreement, the Security Agreement, the Term Note and all other instruments and documents to be delivered in connection with any Term Loan and any amendments or modifications of any of the foregoing, as well as the costs and expenses (including, without limitation, the reasonable fees and expenses of legal counsel) incurred by the Bank in connection with preserving, enforcing or exercising, upon default, any rights or remedies under this letter agreement, the Security Agreement, the Term Note and all other instruments and documents delivered or to be delivered hereunder or in connection herewith, all whether or not legal action is instituted. In addition, the Borrower shall be obligated to pay any and all stamp and other taxes payable or determined to be payable in connection with the execution and delivery of this letter agreement, the Security Agreement, the Term Note and all other instruments and documents to be delivered in connection with any Obligation. Any fees, expenses or other charges which the Bank is entitled to receive from the Borrower under this Section shall bear interest from the date of any demand therefor until the date when paid at a rate per annum equal to 2% per annum the highest per annum rate otherwise payable under the Term Note (but in no event in excess of the maximum rate permitted by then applicable law). 6.2. OTHER AGREEMENTS. The provisions of this letter agreement are not in derogation or limitation of any obligations, liabilities or duties of the Borrower under any of the other Loan Documents or any other agreement with or for the benefit of the Bank. No inconsistency in default provisions between this letter agreement and any of the other Loan Documents or any such other agreement will be deemed to create any additional grace period or otherwise derogate from the express terms of each such default provision. No covenant, agreement or obligation of the Borrower contained herein, nor any right or remedy of the Bank contained herein, shall in any respect be limited by or be deemed in limitation of any inconsistent or additional provisions contained in any of the other Loan Documents or any such other agreement. 6.3. GOVERNING LAW. This letter agreement and the Term Note shall be governed by, and construed and enforced in accordance with, the laws of The Commonwealth of Massachusetts. -23- 24 6.4. ADDRESSES FOR NOTICES, ETC. All notices, requests, demands and other communications provided for hereunder shall be in writing and shall be mailed or delivered to the applicable party at the address indicated below: If to the Borrower: Genome Therapeutics Corp. 100 Beaver Street Waltham, MA 02154 Attention: Fenel M. Eloi, Chief Financial Officer If to the Bank: Fleet National Bank High Technology Group 75 State Street Boston, MA 02109 Attention: Kimberly Martone, Vice President or, as to each of the foregoing, at such other address as shall be designated by such Person in a written notice to the other party complying as to delivery with the terms of this Section. All such notices, requests, demands and other communications shall be deemed delivered on the earlier of (i) the date received or (ii) the date of delivery, refusal or non-delivery indicated on the return receipt if deposited in the United States mails, sent postage prepaid, certified or registered mail, return receipt requested, addressed as aforesaid. 6.5. BINDING EFFECT; ASSIGNMENT; TERMINATION. This letter agreement shall be binding upon the Borrower, its successors and assigns and shall inure to the benefit of the Borrower and the Bank and their respective permitted successors and assigns. The Borrower may not assign this letter agreement or any rights hereunder without the express written consent of the Bank. The Bank may, in accordance with applicable law, from time to time assign or grant participations in this letter agreement, the Term Loans and/or the Term Note. The Borrower may terminate this letter agreement and the financing arrangements made herein by giving written notice of such termination to the Bank provided that no such termination will release or waive any of the Bank's rights or remedies or any of the Borrower's obligations under this letter agreement or any of the other Loan Documents unless and until the Borrower has paid in full the Term Loans and all interest thereon and all fees and charges payable in connection therewith. 6.6. CONSENT TO JURISDICTION. The Borrower irrevocably submits to the non-exclusive jurisdiction of any Massachusetts court or any federal court sitting within The Commonwealth of Massachusetts over any suit, action or proceeding arising out of or relating to this letter agreement and/or the Term Note. The Borrower irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of venue of any such suit, action or proceeding brought in such a court and any claim that any such suit, action or -24- 25 proceeding has been brought in an inconvenient forum. The Borrower agrees that final judgment in any such suit, action or proceeding brought in such a court shall be enforced in any court of proper jurisdiction by a suit upon such judgment, provided that service of process in such action, suit or proceeding shall have been effected upon the Borrower in one of the manners specified in the following paragraph of this [Section]6.6 or as otherwise permitted by law. The Borrower hereby consents to process being served in any suit, action or proceeding of the nature referred to in the preceding paragraph of this [Section]6.6 either (i) by mailing a copy thereof by registered or certified mail, postage prepaid, return receipt requested, to it at its address set forth in [Section]6.4 (as such address may be changed from time to time pursuant to said [Section]6.4) or (ii) by serving a copy thereof upon it at its address set forth in [Section]6.4 (as such address may be changed from time to time pursuant to said [Section]6.4). 6.7. SEVERABILITY. In the event that any provision of this letter agreement or the application thereof to any Person, property or circumstances shall be held to any extent to be invalid or unenforceable, the remainder of this letter agreement, and the application of such provision to Persons, properties or circumstances other than those as to which it has been held invalid and unenforceable, shall not be affected thereby, and each provision of this letter agreement shall be valid and enforced to the fullest extent permitted by law. VII. DEFINED TERMS ------------- 7.1. DEFINITIONS. In addition to terms defined elsewhere in this letter agreement, as used in this letter agreement, the following terms have the following respective meanings: "Bank Certificate" - A certificate signed by an officer of the Bank setting forth any additional amount required to be paid by the Borrower to the Bank pursuant to [Section]1.4, [Section]1.7, [Section]1.8 or [Section]6.1 of this letter agreement, which certificate shall be submitted by the Bank to the Borrower in connection with each demand made at any time by the Bank upon the Borrower with respect to any such additional amount, and each such certificate shall, save for manifest error, constitute presumptive evidence of the additional amount required to be paid by the Borrower to the Bank upon each demand. A claim by the Bank for all or any part of any additional amount required to be paid by the Borrower may be made before and/or after the end of the Interest Period to which such claim relates or during which such claim has arisen and before and/or after any payment hereunder to which such claim relates. Each Bank Certificate shall set forth in reasonable detail the basis for and the calculation of the claim to which it relates. "Business Day" - Any day which is not a Saturday, nor a Sunday nor a public holiday under the laws of the United States of America or The Commonwealth of Massachusetts applicable to a national bank; provided however that if the applicable provision relates to a LIBOR Loan, then the term "Business Day" shall not include any day on which dealings are not carried on in the London interbank market or on which banks are not open for business in London. -25- 26 "Capital Base" - At any time, the sum of (i) the consolidated Tangible Net Worth of the Borrower and Subsidiaries then existing, PLUS (ii) the principal amount of Subordinated Debt of the Borrower then outstanding (nothing contained herein being deemed to authorize the incurrence of any such Subordinated Debt). "Cash-Equivalents" - Each of the following: (i) readily marketable direct obligations of, or obligations guarantied by, the United States of America or any agency thereof and entitled to the full faith and credit of the United States of America, (ii) demand deposits with the Bank or with any other commercial bank chartered by the United States or by any state and having undivided capital and surplus of not less than $1,000,000,000, or (iii) interests in mutual funds, substantially all of the assets of which shall be governmental obligations of the type described in clause (i) of this sentence. "COF Interest Rate" - A rate of interest per annum which is offered to the Borrower with respect to its outstanding Term Loans pursuant to the second paragraph of [Section]1.4 and which is accepted by the Borrower as described therein. "COF Loan" - Any Term Loan which bears interest at a COF Interest Rate. "COF Rate" - A fixed rate of interest per annum determined by the Bank as described in the second paragraph of [Section]1.4. "Collateral" - All property now or hereafter owned by the Borrower or in which the Borrower now or hereafter has any interest which is now or hereafter described as "Collateral" in the Security Agreement. "Default" - Any event or circumstance which, with the passage of time or the giving of notice or both, could become an Event of Default. "EBITDA" - The consolidated Net Income (or consolidated Net Loss) of the Borrower and Subsidiaries for any period, PLUS, without duplication of any item, (i) all federal and state income taxes (but not taxes in the nature of an AD VALOREM property tax or a sales or excise tax) paid or accrued with respect to such period, (ii) all interest on any Indebtedness (whether senior debt or subordinated debt) paid or accrued by the Borrower and/or any of its Subsidiaries for such period and actually deducted on the consolidated books of the Borrower for the purposes of computation of consolidated Net Income (or consolidated Net Loss) for the period involved, and (iii) the amount of the provision for depreciation and/or amortization actually deducted on the consolidated books of the Borrower for the purposes of computation of consolidated Net Income (or consolidated Net Loss) for the period involved. "ERISA" - The Employee Retirement Income Security Act of 1974, as amended. -26- 27 "Eurocurrency Liabilities" - Has the meaning assigned to that term in Regulation D of the Board of Governors of the Federal Reserve System (or any successor), as in effect from time to time, or in any successor regulation relating to the liabilities described in said Regulation D. "Eurodollar Interest Rate" - For any Interest Period, an interest rate per annum, expressed as a percentage, determined by the Bank pursuant to the following formula: *EIR = LIBOR + 2.0 ------------- [1.00 - RR] Where EIR = Eurodollar Interest Rate LIBOR = See definition of LIBOR RR = Reserve Rate *EIR and each component thereof to be rounded upwards to the next higher 1/8th of 1% "FDIC" - The Federal Deposit Insurance Company or any successor thereto. "Fixed Interest Rate" - As to any LIBOR Loan, the applicable Eurodollar Interest Rate; and as to any COF Loan, the applicable COF Interest Rate. "Fixed Rate Loan" - All or any portion of any Term Loan which bears interest at a Fixed Interest Rate. "Floating Rate" - As defined in [Section]1.4. "Floating Rate Loan" - All or any portion of any Term Loan which bears interest at a rate calculated with reference to the Prime Rate. "Impositions" - All present and future taxes, levies, duties, impositions, deductions, charges and withholdings applicable to the Bank with respect to any Fixed Rate Loan, excluding, however, any taxes imposed directly on the Bank's income and any franchise taxes imposed on it by the jurisdiction under the laws of which the Bank is organized or any political subdivision thereof. "Indebtedness" - All obligations of a Person, whether current or long-term, senior or subordinated, which in accordance with generally accepted accounting principles would be included as liabilities upon such Person's balance sheet at the date as of which Indebtedness, is to be determined, and shall also include guaranties, endorsements (other than for collection in the ordinary course of business) or other arrangements whereby responsibility is assumed for the obligations of others, whether by agreement to purchase or otherwise acquire the obligations of others, including any agreement, contingent or otherwise, to furnish funds through the purchase of goods, supplies or services for the purpose of payment of the obligations of others. -27- 28 "Interest Payment Date" - As to each LIBOR Loan, the last day of Interest Period applicable to such LIBOR Loan. "Interest Period" - As to each LIBOR Loan, the period commencing with the date of the making of such LIBOR Loan and ending three months thereafter; provided that (A) any such Interest Period which would otherwise end on a day which is not a Business Day shall be extended to the next succeeding Business Day unless such Business Day occurs in a new calendar month, in which case such Interest Period shall end on the immediately preceding Business Day, (B) any such Interest Period which begins on a day for which there is no numerically corresponding day in the calendar month during which such Interest Period is to end shall end on the last Business Day of such calendar month, and (C) no Interest Period may be selected which would end after the Expiration Date. "LIBOR" - With respect to each Interest Period for a LIBOR Loan, that rate per annum (rounded upward, if necessary, to the nearest 1/8th of 1%) at which deposits in United States Dollars are offered to the Bank, for delivery on the first day of the applicable Interest Period, in the London interbank market at 10:00 a.m. London time two Business Days prior to the first day of the applicable Interest Period for a term equal to the term of the LIBOR Loan requested for such Interest Period and in an amount substantially equal to the principal amount of the relevant LIBOR Loan. The Bank shall give prompt notice to the Borrower of LIBOR as determined for each LIBOR Loan and such notice shall be conclusive and binding, absent manifest error. "LIBOR Loan" - All or any portion of a Term Loan which bears interest at a Eurodollar Interest Rate. "Loan Documents" - Each of this letter agreement, the Term Note, the Security Agreement and each other instrument, document or agreement evidencing, securing, guaranteeing or relating in any way to any of the Term Loans, all whether now existing or hereafter arising or entered into. "London" - The City of London in England. "Net Income" (or "Net Loss") - The book net income (or book net loss, as the case may be) of a Person for any period, after all taxes actually paid or accrued and all expenses and other charges determined in accordance with generally accepted accounting principles consistently applied. "Net Quick Assets" - Such current assets of the Borrower as consist of cash, Cash-Equivalents, readily-marketable securities and Receivables (less an allowance for bad debt consistent with the Borrower's prior experience). -28- 29 "Obligations" - All Indebtedness, covenants, agreements, liabilities and obligations, now existing or hereafter arising, made by the Borrower with or for the benefit of the Bank or owed by the Borrower to the Bank in any capacity. "PBGC" - The Pension Benefit Guaranty Corporation or any successor thereto. "Person" - An individual, corporation, partnership, limited liability company, joint venture, trust or unincorporated organization, or a government or any agency or political subdivision thereof. "Premises" - As defined in Subsection 2.1(j). "Prime Rate" - That rate of interest per annum announced by the Bank, from time to time, as being its prime rate, it being understood that such rate is merely a reference rate, not necessarily the lowest, which serves as the basis upon which effective rates of interest are calculated for obligations making reference thereto. "Qualifying Equipment" - Laboratory and computer-related equipment (including furniture and fixtures, but not including prepackaged software) purchased by the Borrower after October 1, 1996 for use in the Borrower's business which meets all of the following criteria: (i) such equipment consists of one of the items shown on the Equipment List heretofore delivered by the Borrower to the Bank or has otherwise been approved by the Bank for use in supporting a Term Loan, (ii) each item of such equipment has been delivered to and installed at the Premises and has become fully operational, and (iii) the Borrower has paid in full for each item of such equipment and holds title to same, free of all interests and claims of any other Person (other than the security interest of the Bank). "Receivables" - As to any Person, all of such Person's present and future accounts receivable for goods sold or for services rendered. "Reserve Rate" - The aggregate rate, expressed as a decimal, at which the Bank would be required to maintain reserves under Regulation D of the Board of Governors of the Federal Reserve System (or any successor or similar regulation relating to such reserve requirements) against Eurocurrency Liabilities, as well as any other reserve required of the Bank with respect to the LIBOR Loans. The Eurodollar Interest Rate shall be adjusted automatically on and as of the effective date of any change in the Reserve Rate. "Subordinated Debt" - Any Indebtedness of the Borrower which is expressly subordinated, pursuant to a subordination agreement in form and substance satisfactory to the Bank, to all Indebtedness now or hereafter owed by the Borrower to the Bank. "Subsidiary" - Any corporation or other entity of which the Borrower and/or any of its Subsidiaries, directly or indirectly, owns, or has the right to control or direct the voting of, fifty -29- 30 (50%) percent or more of the outstanding capital stock or other ownership interest having general voting power (under ordinary circumstances). "Tangible Net Worth" - An amount equal to the total assets of any Person (excluding (i) the total intangible assets of such Person, (ii) any minority interests in Subsidiaries and (iii) any assets representing amounts due from any officer or employee of such Person or from any Subsidiary of such Person) minus the total liabilities of such Person. Total intangible assets shall be deemed to include, but shall not be limited to, the excess of cost over book value of acquired businesses accounted for by the purchase method, formulae, trademarks, trade names, patents, patent rights and deferred expenses (including, but not limited to, unamortized debt discount and expense, organizational expense, capitalized software costs and experimental and development expenses). "Total Liabilities" - All Indebtedness of the Borrower and/or any Subsidiary of the Borrower (secured or unsecured, senior or subordinated) which would properly be included in liabilities shown on a balance sheet of the Borrower prepared in accordance with generally accepted accounting principles. "Unencumbered Cash Balance" - At any time, the total of all cash and Cash-Equivalents of the Borrower which are not subject to any pledge, lien, encumbrance or other restriction. Any defined term used in the plural preceded by the definite article shall be taken to encompass all members of the relevant class. Any defined term used in the singular preceded by "any" shall be taken to indicate any number of the members of the relevant class. -30- 31 This letter agreement is executed, as an instrument under seal, as of the day and year first above written. Very truly yours, GENOME THERAPEUTICS CORP. By ------------------------ Name: Title: Accepted and agreed: FLEET NATIONAL BANK By -------------------------- Its By -------------------------- Its -31- 32 DISCLOSURE SCHEDULE Item 2.1(a) Jurisdictions in which Borrower is qualified; Subsidiaries Item 2.1(b) 5% Stockholders Item 2.1(e) Litigation Item 2.1(j) Collateral locations; record owner of each location Item 4.1 Existing Indebtedness Item 4.2 Existing Liens Item 4.3 Existing Guaranties Item 4.6 Investment Policy EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS 9-MOS AUG-31-1997 SEP-01-1996 MAY-31-1997 1 7,126 41,957 1,900 0 0 50,182 14,198 4,733 63,291 9,104 0 0 0 1,770 47,867 63,291 0 16,317 0 21,300 0 0 431 0 0 0 0 0 0 (5,414) (0.31) 0
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